Use these links to rapidly review the documentTable of Contents Item 8. Financial Statements and Supplementary Data

Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-K

ý

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2010ORo

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period
from                                to


KIPS BAY MEDICAL, INC.(Exact name of registrant as specified in its charter)

Delaware(State or other jurisdiction
of incorporation)

000-1460198(Commission
File Number)

20-8947689(IRS Employer
Identification No.)




3405 Annapolis Lane North, Suite 200Minneapolis, Minnesota

55447(Address of principal executive offices)

(Zip Code)


Registrant's
telephone number, including area code:(763) 235-3540

Securities
Registered Pursuant to Section 12(b) of the Act:Common Stock, $0.01 par value

Name
of Each Exchange on Which Registered:The NASDAQ Stock Market LLC

Securities
Registered Pursuant to Section 12(g) of the Act:None

Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o    No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o    No ý

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes o    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained
herein, and will not be contained, to the best or registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o (Do not check if
smaller reporting company)

Smaller reporting company ý


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

The registrant completed the initial public offering of its common stock on February 16, 2011. Accordingly, there was no public market for the registrant's
common stock as of June 30, 2010, the last day of the registrant's most recently completed second fiscal quarter.

As
of March 25, 2011, there were 15,734,291 shares of the registrant's common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the registrant's 2011 Annual Meeting of Stockholders are incorporated by reference into Items 10, 11, 12, 13 and 14 of
Part III of this report.



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Table of Contents



PART IItem 1. Business

1Item 1A. Risk Factors

28Item 1B. Unresolved Staff Comments

45Item 2. Properties

45Item 3. Legal Proceedings

46Item 4. [Removed and Reserved]

46PART IIItem 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities

48Item 6. Selected Financial Data

49Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

50Item 7A. Quantitative and Qualitative Disclosures About Market
Risk

66Item 8. Financial Statements and Supplementary
Data

67Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

68Item 9A. Controls and Procedures

68Item 9B. Other Information

68PART IIIItem 10. Directors, Executive Officers and Corporate
Governance

68Item 11. Executive Compensation

68Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters

69Item 13. Certain Relationships and Related Transactions, and Director
Independence

69Item 14. Principal Accounting Fees and Services

69PART IVItem 15. Exhibits, Financial Statement Schedules

69


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PART I

Item 1.    Business

Overview

We are a development stage medical device company focused on developing, manufacturing and commercializing our external saphenous vein
support technology, or eSVS MESH, for use in coronary artery bypass grafting, or CABG, surgery. Our eSVS MESH is a nitinol mesh sleeve that, when placed over a saphenous vein graft during CABG
surgery, is designed to improve the structural characteristics and long-term performance of the vein graft. CABG is one of the most commonly performed surgeries in the United States, with
the American Heart Association estimating that 448,000 CABG procedures were performed in the United States in 2006, the most recent year for which the American Heart Association has published such
estimates. In addition, the Millennium Research Group, an independent market research firm, estimates that there will be 165,000 CABG procedures per year in Europe by 2013. In CABG procedures,
surgeons harvest blood vessels, including the internal mammary artery from the chest and the saphenous vein from the leg, and attach the harvested vessels to bypass, or provide blood flow around,
blocked coronary arteries. The effectiveness of the procedure, however, is often limited by the failure rate of saphenous vein grafts, which has been shown in various studies to range from 6% to 30%
one year after surgery and 60% ten years after surgery. Failure of these grafts, typically evidenced by partial or complete blockage and reduced or stopped blood flow, can lead to the need for further
coronary interventions up to and including additional CABG procedures. We believe the use of our eSVS MESH with saphenous vein grafts in CABG surgery could improve the long-term outcome of
CABG procedures, including improved openness, or patency, and improved blood flow through the saphenous vein graft, resulting in a reduced need for costly and potentially complicated reoperations or
revascularization procedures.

According
to the American Heart Association, approximately 17.6 million people in the United States have coronary artery disease, and approximately 587,000 people in the United
States die each year as a result of the disease. In addition, according to a 2007 World Health Organization report, approximately 7.2 million people worldwide died of coronary heart disease in
2002. The direct and indirect cost of coronary artery disease to the U.S. economy is estimated to be over $177 billion in 2010. Physicians and patients may select among a variety of treatments
to address coronary artery disease, including pharmaceutical therapy, balloon angioplasty, stenting with bare metal or drug-eluting stents, and CABG procedures, with the selection often
depending upon the stage of the disease. The SYNTAX study, comparing CABG and implantation of drug-eluting stents, found that CABG is the more effective long-term treatment for
coronary artery disease, achieving the best long-term patient outcomes as measured by survival rate and need for re-intervention 12 months after surgery. Moreover,
patients with severe and multi-vessel coronary artery disease often cannot be effectively treated with methods other than CABG. The prevalence of coronary artery disease and the success rates for CABG
procedures versus other treatments for coronary artery disease has made CABG surgery one of the most commonly performed surgeries in the United States. Based on a report published by the Millennium
Research Group, moderate growth in coronary artery bypass procedures is expected in the United States through 2012 and in Europe through 2013, largely due to the increase in procedure volumes caused
by rising rates of coronary artery disease and the need for repeat revascularizations.

According
to results published in the European Journal of Cardio-Thoracic Surgery in 2006, each CABG procedure involves an average of 3.3 bypass grafts, typically consisting of the left
internal mammary artery, or LIMA, for one graft and the saphenous vein for the remaining 2.3 grafts per procedure. Saphenous vein grafts fail more frequently than LIMA grafts due to differences in
structure and size of saphenous vein grafts as compared to LIMA grafts. Unlike the LIMA, which is a thick-walled artery intended to handle the high pressure blood flow from the heart, saphenous veins
are thin-walled vessels that are intended for a low-pressure venous environment. Saphenous veins are also

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typically
larger than the coronary arteries to which they are attached and this difference in size disrupts blood flow, adding stress to the vessel wall and increasing the risk of thrombosis, or blood
clotting. When the vein grafts used to bypass a blocked artery are exposed to the high pressure of arterial flow, there is significant stress on the thin wall of the veins. The vein responds to this
injury by causing its inner walls to thicken, decreasing the inner diameter of the graft and often leading to failure of the bypass graft.

Our
eSVS MESH is a nitinol mesh sleeve that is placed over the saphenous vein graft during CABG surgery and is designed to constrict the vein and prevent expansion of the vein graft and
resulting injury due to increased pressure. The constriction of the vein graft also causes the diameter of the graft, or lumen, to more closely match the diameter of the target coronary artery to
which it is attached, thereby reducing blood flow disruption. Our eSVS MESH is designed to be applied quickly and is compatible with most current CABG surgery protocols. In addition, nitinol is
commonly used in many other implantable medical devices.

In
order to obtain authorization to apply the CE Mark to our product and begin sales in Europe, we conducted a 90 patient multi-center clinical trial outside the United States. The goals
of this trial were to demonstrate that CABG surgery using our eSVS MESH was not inferior as to either safety or effectiveness as compared to traditional CABG surgery. We received our CE Mark in May
2010 based on data from angiographic studies nine to 12 months following surgery of the first 38 patients in the trial to complete such follow-up studies. Analysis of this
data showed that the patency of vessels treated with our eSVS MESH was statistically equivalent and therefore non-inferior to the patency of untreated saphenous vein bypass vessels. The
final results of the trial, which included angiographic data for 73 patients, differed from the results for the first 38 patients and were inconclusive as to whether the patency of eSVS
MESH treated vessels was non-inferior to untreated vessels. Because our CE Mark submission was made pursuant to a protocol accepted by all participating clinical study sites and their
respective Competent Authorities (government or government-appointed agencies in charge of approving medical device clinical studies prior to enrollment in such a study), and device and procedure
safety have been demonstrated (no increase in adverse events as compared to published literature for CABG surgery), the final results do not impact the status or validity of our CE Mark. We began
marketing and commenced shipments of our eSVS MESH in select European Union markets in June 2010, in the United Arab Emirates in October 2010 and in Turkey in January 2011, but we have not generated
significant revenue from the sale of products to date.

In
the trial, we evaluated the safety of our eSVS MESH by comparing the rate of major adverse cardiac and cerebral events, or MACCE, 30 days following surgery for patients treated
with our eSVS MESH against the same rate reported in published literature for patients with traditional CABG surgery. We evaluated efficacy by comparing the patency of vessels treated with eSVS MESH
against the patency of untreated saphenous vein bypass vessels as measured by angiographic studies nine to 12 months following implant. The safety data from this trial has indicated that our
eSVS MESH and implant procedure do not result in an increase in patient complications during or after surgery. However, the effectiveness data from the trial is inconclusive primarily due to two
complicating factors. First, one of the centers participating in the trial used implant methods incompatible with our eSVS MESH. Second, the amount of reduction in the diameter of the saphenous vein
grafts, or downsizing, prescribed in our instructions for use and sizing tool was too aggressive, resulting in a higher than anticipated closure rate in saphenous vein grafts utilizing the eSVS MESH,
particularly when our smallest device, 3.0 millimeters, was used. In response to this data, we have modified our instructions for use to provide clear direction on the surgical method to be
used with our eSVS MESH, discontinued the use of our 3.0 millimeter eSVS MESH and reduced the amount of downsizing specified for other device sizes. We also exclude saphenous veins with walls
thicker than 0.7 millimeters. We believe these steps will resolve the patency issues identified in the trial.

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The
U.S Food and Drug Administration, or FDA, has reviewed and disapproved our most recent amendment to our application for an investigational device exemption, or IDE.
Follow-up conversations with the FDA have been held to further understand the FDA requirements in order to obtain our IDE approval. The FDA has recently indicated that they need to review
our IDE information with outside experts before they provide further guidance to the Company. The IDE approval, if obtained before the end of the third quarter of 2011, would allow us to begin the
clinical trials of our eSVS MESH in the United States in 2011. However, we could be delayed by adverse clinical results or regulatory complications, and we may never receive U.S. marketing approval.
We are pursuing additional applications for our eSVS MESH, including applications for use in peripheral artery bypass surgery, for use with coronary allografts, and for use in arteriovenous, or AV,
fistula dialysis applications. In peripheral artery bypass surgery, saphenous vein grafts are used to bypass obstructed arterial vessels in the legs. Coronary allografts are saphenous veins obtained
from cadavers that are used in CABG procedures for patients who do not have appropriate arterial or venous conduits. An AV fistula is a surgically created connection, or fistula, between an artery and
a vein used to provide access to the circulatory system of patients with kidney disease for chronic dialysis treatment. We believe that these applications could have significant commercial potential.

Our Strategy

Our objective is to achieve significant market adoption of our eSVS MESH technology in CABG and other vascular applications. Key
elements of our strategy to achieve this objective include the following:



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Treatment of Coronary Artery Disease

According to the American Heart Association, approximately 17.6 million people in the United States have coronary artery
disease, and approximately 587,000 people in the United States die each year as a result of the disease. In addition, according to a 2007 World Health Organization report, approximately
7.2 million people worldwide died of coronary heart disease in 2002. The direct and indirect cost of coronary artery disease to the U.S. economy is estimated to be over $177 billion in
2010. Primary treatment options for coronary artery disease are pharmaceutical therapy, balloon angioplasty, intravascular stents, and CABG surgery. A description of each of these options is provided
below:



In patients with less severe disease, pharmaceuticals remain the primary treatment approach and include drugs such as platelet adhesion
inhibitors or drugs that reduce the blood cholesterol or triglyceride levels. For more serious disease, however, pharmacological therapy alone is often inadequate.



Percutaneous transluminal coronary angioplasty, commonly referred to as balloon angioplasty, is a surgical procedure that involves the
dilation of the obstructed artery with a balloon catheter. Angioplasty is generally successful in increasing immediate blood flow and, relative to current surgical procedures, offers the benefits of
shorter periods of hospitalization, quicker recovery times, reduced patient discomfort and lower cost. However, according to a trial published in the journal Circulation in 2006, up to 40% of vessels
treated with balloon angioplasty return to their pre-treatment, narrowed size, a process known as restenosis, within six to 12 months following the procedure.



High rates of restenosis following treatment by balloon angioplasty led to the introduction of stents, mesh-like metallic
tubes that are placed within the narrowed portion of the coronary vessel to hold the vessel open after the angioplasty balloon has been removed. Although clinical outcomes for procedures using stents
reflect an improvement over balloon angioplasty alone, the effectiveness of stents is still limited by restenosis, which for bare metal stents occurs in about 20% of cases within six months of the
procedure.

Drug
eluting stents are coated with specially formulated, slow-release drugs designed to prevent restenosis. According to the FDA in 2008, drug eluting stents were shown in
clinical trials to reduce the rate of restenosis within one year after placement to 10%. Drug eluting stents are widely used, with a current market share relative to total stent usage in the range of
70%. However, some studies have been presented that associate drug eluting stents with late stage thrombosis, or clotting, which can be an adverse event.

Despite
the advancements and market success of drug-eluting stents and angioplasty therapies, these interventional procedures may be less effective than surgical procedures
in addressing diffuse

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progressive
coronary artery disease. In this advanced stage of coronary artery disease, intervention is required for multiple vessels, many of which are less than two millimeters in internal diameter,
a diameter currently unsuitable for angioplasty and stenting. In addition, stents have been shown to be difficult to place in patients with coronary lesions in sections with vessel branches and in
patients with narrowings in the left main coronary artery. In a study published in the New England Journal of Medicine in January 2008 that compared drug-eluting stents with CABG in
multivessel coronary disease, death rates and revascularization rates were higher in patients receiving drug-eluting stents than in patients receiving CABG, even though the cohort of
patients receiving CABG was older and had more severe coronary disease.



Coronary Artery Bypass Grafting involves the construction of an alternative path to bypass a narrowed or occluded coronary artery and
restore blood flow from the aorta to an area past the occlusion. This procedure is normally accomplished using saphenous veins from the leg and the LIMA from the chest as bypass grafts. Most commonly,
the LIMA is utilized for bypassing the left anterior descending artery of the heart, or LAD, while saphenous veins are utilized for bypassing other coronary arteries.

For
vein grafts, one end of the harvested vessel is then generally attached to the aorta for blood inflow, and the opposite end is attached to the target coronary vessel. If a mammary
artery is used as the bypass graft, it must be dissected from the chest wall, leaving one end in place on the aorta, while the opposite end is attached to the target vessel, providing uninterrupted
blood flow from the arterial circulation. Once in place, these grafts provide sufficient blood flow to bypass the narrowed or occluded portion of the coronary artery. The following diagram illustrates
the use of the internal mammary artery graft and saphenous vein graft in CABG surgery:

GRAPHIC

Current Disadvantages of Saphenous Vein Grafts

Since its first successful use in the 1960's, the saphenous vein graft has been one of the most commonly used conduits in CABG surgery.
Some of the main advantages of using the saphenous vein include its ease of accessibility, its ease of handling, and the number of grafts, typically three, that can be constructed from a single vein.
Despite these advantages and the widespread use of saphenous veins in CABG surgery, several issues have been identified, such as:



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The
higher pressure of arterial blood flow and the size mismatch that results when a saphenous vein is used as a graft in CABG surgery often cause the vein to expand, damaging the lining
of the vein. The vein responds to this damage by causing its walls to thicken in a manner that often leads to failure of the bypass graft. Smooth muscle cells proliferate in the middle layer of the
vein wall and migrate to the inner surface of the vein in a process known as neointimal hyperplasia. The resulting accumulation of activated smooth muscle cells secrete inflammatory and growth factors
leading to a stenotic build-up, or constriction and narrowing of the graft, and graft failure over time. The
failure rates of saphenous vein grafts in CABG procedures is well documented in the scientific literature. A sampling of data from some of the larger benchmark studies is provided below:

Saphenous Vein Graft Failure Rates1 Year

5 Year*

10 Year*Year

Author

Number of
Patients

Failure
Rate

Number of
Patients

Failure
Rate

Number of
Patients

Failure
Rate1984

Barner, et al.


248


7
%

112


26
%




1996

Fitzgibbon, et al.


3,993


19
%

1978


25
%




2004

Goldman, et al.


660


8
%

336


25
%

368


61
%2005

Alexander


2,000


30
%










2009

Serruys, et al.


870


6
%










2009

Puskas, et al.


183


18
%













*Five
and ten year data is not available for those studies for which data is not presented in these columns.


Failure
of these grafts, typically evidenced by partial or complete blockage and reduced or stopped blood flow, can lead to chest pain, congestive heart failure, irregular heartbeat,
myocardial infarction,
revascularization or death. A repeat of a CABG procedure to repair a failing or failed graft is a technically more difficult procedure with mortality rates three to five times higher than the original
CABG procedure.

eSVS MESHOur Solution

Our eSVS MESH is designed to improve the long-term outcome of CABG procedures by addressing limitations of unsupported
saphenous veins. Our eSVS MESH is a highly flexible, semi-compliant, kink-resistant extra-vascular tubular prosthesis made of knitted nickel/titanium, or nitinol, wire mesh.
Our eSVS MESH is designed to be fitted like a sleeve over vein grafts, thereby providing the vein graft with physiological attributes similar to those of an artery.

An
artery has a thick muscular wall to handle higher pressures, and a relatively small lumen that produces higher blood velocities, offering less chance for blood to pool and clot. In
contrast, a vein has a thinner, less muscular wall due to the lower pressures normally found in veins and a larger lumen designed to maintain these lower pressures. We believe that larger,
thinner-walled veins will have greater potential benefit from our eSVS MESH.

Our
eSVS MESH is designed to provide the vein graft with physiological attributes similar to those of an artery by reducing the lumen diameter and strengthening the vessel wall. We
believe the key benefits of our eSVS MESH technology include:



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Our
eSVS MESH technology consists of the following:



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Clinical Development of our eSVS MESH



The first human clinical trial of our eSVS MESH is a non-inferiority trial where each patient is randomized to receive a
saphenous vein graft with our eSVS MESH to bypass either the right coronary artery or the circumflex artery, two arteries commonly bypassed during CABG. The bypassed artery not chosen to receive our
eSVS MESH serves as the control and receives a standard saphenous vein graft. To ensure Good Clinical Practices compliance, outside resources are utilized for data collection and analysis, including a
contract research organization for data entry and verification, a physician clinical events committee for the review and evaluation of adverse events, and an angiographic core lab for assessment of
saphenous vein graft patency.

Seven
international centers enrolled 90 patients in this trial. Enrollment in this trial closed on July 21, 2009. As of December 31, 2010, 88 patients have
been implanted for 18 months or more and 36 patients have been implanted for 24 months or more.

The
international sites involved in this trial, and the number of patients enrolled at each site, is provided below:

Center Name

Number of Patients
EnrolledSchleswig-Holstein University Hospital, Kiel, Germany


25National University Hospital, Singapore


21University Of Cape Town, Cape Town, South Africa


20Hospital Regional De Sion, Sion, Switzerland


9Auckland City Hospital, Auckland, New Zealand


8Hospital Universitario 12 de Octubre, Madrid, Spain


5Prince Charles Hospital, Brisbane, Australia


2Total


90


In
this trial, our goal was to demonstrate that the use of our eSVS MESH results in no more major adverse cardiac and cerebral events, or MACCE, than standard CABG surgery. The primary
safety endpoint of this trial was statistical non-inferiority based on the total rate of MACCE at 30-days post-implant as compared to published literature. MACCE is
a composite of the following:



In
summary, there were four adverse events that met the protocol definition of MACCE, which compared favorably to the compilation of published literature that presented
30-day post-implant MACCE rates for CABG surgery patients, separating the MACCE category into the composite factors listed above.

A
table summarizing these results is shown below:

Trial Data

Objective
Performance CriteriaMI


2(2.2
)%

2.8
%Stroke


2(2.2
)%

1.8
%Revascularization


0


0
%Death*


0


4.8
%Total


4(4.4
)%

9.4
%


*One
patient death eight months after surgery due to non-cardiac causes


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The
primary effectiveness endpoint of this trial is statistical non-inferiority of angiographic stenosis, or patency, of eSVS MESH vessels as compared to control vessels at
nine to 12 months post-implant. A vessel is considered to be patent if there is less than 50% stenosis. This data has been inconclusive regarding the effectiveness of the eSVS MESH
primarily due to the following two factors:



Of
the 90 patients participating in the study, 73 patients returned for angiographic studies nine to 12 months following their implant. In this group, 49% (36 of 73)
of the eSVS MESH vessels were patent and 81% (59 of 73) of the untreated vessels were patent. If, however, we exclude eSVS MESH grafts implanted at the center with the incompatible treatment methods
and grafts treated with our 3.0 millimeter eSVS MESH, at nine to 12 months following the implant, 73% (24 of 33) of the eSVS MESH vessels were patent and 81% (59 of 73) of the untreated
vessels were patent, statistically equivalent results. The following table shows the patency of (i) vessels treated with eSVS MESH implanted at the center with incompatible treatment methods
("Site 3" in the table below), (ii) vessels treated with eSVS MESH implanted at all other centers and (iii) untreated saphenous veins used as controls, for each of the 3.0, 3.5
and 4.0/4.5 millimeter eSVS MESH sizes. We combined the 4.0 and 4.5 sizes since only one patient received the 4.5 millimeter eSVS MESH.

GRAPHIC

This
trial formed the basis for our CE Mark application, which we submitted in February 2010 and received in May 2010. We began marketing and commenced shipments of our eSVS MESH in
select European Union markets in June 2010,in the United Arab Emirates in October 2010 and in Turkey in January 2011.

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The U.S Food and Drug Administration, or FDA, has reviewed and disapproved our most recent amendment to our application for an
investigational device exemption, or IDE. Follow-up conversations with the FDA have been held to further understand the FDA requirements in order to obtain our IDE approval. The FDA has
recently indicated that they need to review our IDE information with outside experts before they provide further guidance to the Company. The IDE approval, if obtained before the end of the third
quarter of 2011, would allow us to begin the clinical trials of our eSVS MESH in the United States in 2011. However, we could be delayed by adverse clinical results or regulatory complications, and we
may never receive U.S. marketing approval. The FDA has not approved our IDE submission and the summary below of the trial design is based upon our current expectations of the IDE protocol. The
ultimate trial design, if and when approved by the FDA, may be materially different than our expectations set forth below.

We
expect that the FDA will require a feasibility phase as part of our IDE trial. We are proposing that up to the first 60 patients enrolled in the trial will have a
90-day post-implant assessment of device patency, in addition to normal follow-ups prescribed in the clinical trial protocol. We are also proposing that success
criteria for this feasibility analysis be non-inferiority. Once the 90-day follow-up is completed and the data is reported to the FDA, subject to FDA consent, we
expect to continue enrollment at all sites and these feasibility phase patients will be included in the IDE trial data set. The feasibility phase will delay completion of our IDE trial by at least
five to six months compared to a trial that does not incorporate a feasibility phase.

The
primary safety endpoint of the IDE trial is expected to be statistical non-inferiority based on the total rate of major adverse cardiac events, or MACE, at
30-days post-implant as compared to published literature. The primary effectiveness endpoint of this trial is expected to be statistical superiority of the patency of eSVS MESH
vessels as compared to control vessels at nine-months post-implant. This effectiveness endpoint is more rigorous than the effectiveness endpoint of our international trial,
which was a non-inferiority comparison. The IDE protocol reflects our prior observations from the international trial. For example, the IDE protocol will only include eSVS MESH sizes of
3.5 mm or greater in diameter and will include detailed instruction regarding preparation of anastomotic sites. We expect the IDE trial to require enrollment of at least 366 patients and
include up to 20 clinical trial sites. Of these patients, we expect that we will be required to perform nine-month post-implant angiograph procedures on at least
293 patients. We would be dependent upon our clinical sites and enrolled subjects for compliance in returning and agreeing to the nine-month angiograms and expect that a certain
percent of subjects will either not
return or will refuse the nine-month angiogram. We are in discussions with 13 clinical trial sites to participate in our IDE trial, six of which have been engaged as of December 31,
2010.

Enrollment
in the IDE trial is expected to take approximately 21 months, and follow-up is expected to take up to an additional year from the completion of enrollment.
Prior to commercializing our eSVS MESH in the United States, we will be required to submit a Pre-Market Approval, or PMA, application to the FDA. Approval of a PMA by the FDA generally
takes approximately one year after the application. We could be delayed by adverse clinical results or regulatory complications, and we may never receive marketing approval.



Preclinical trials of our eSVS MESH technology have been presented in peer-reviewed journals, including The Journal of
Thoracic and Cardiovascular Surgery in February 2008 and the Journal of Vascular Surgery in June 2009. Between 2002 and 2007, Medtronic, Inc. sponsored multiphase trials with the Cardiovascular
Research Unit of the Christiaan Barnard Department of Cardiothoracic Surgery at the University of Cape Town in South Africa, or UCT, to evaluate the effects of various

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designs
of external nitinol mesh sleeves on the vascular architecture of vein grafts used in CABG and peripheral bypass procedures. This multiphase research concluded that the use of our eSVS MESH
showed a statistically significant decrease in intimal hyperplasia after six months of implantation. In addition to these trials, Medtronic, Inc. and UCT collaborated on stress, fatigue, durability,
and finite element analysis of knitted eSVS MESH designs.

In
October 2007, we acquired ownership of the core intellectual property relating to our eSVS MESH from Medtronic, Inc. and initiated additional work on the technology. This work
included developing additional sizes of our eSVS MESH, completing required preclinical and biological testing of the product and accessories, developing packaging and labeling for our eSVS MESH, and
creating product documentation intended to comply with relevant FDA and international standards.

In
addition, we initiated and completed a series of animal trials utilizing sheep to confirm that our eSVS MESH, as manufactured by us, performed as expected, and produced the expected
results. These animal trials showed a statistically significant inhibition of the formation of intimal hyperplasia when our eSVS MESH was used with a saphenous vein graft in CABG procedures. However,
sheep arterial pressures and vasculature differ from humans, and human clinical studies may not be consistent with animal trial results.

Additional eSVS MESH Applications

Additional development projects based on our eSVS MESH technology that we are exploring and may advance include:



In this clinical application, saphenous vein grafts are used to bypass obstructed arterial vessels in the legs. We have begun initial
preclinical trials for this application, utilizing saphenous vein grafts with our eSVS MESH in place. We plan to complete research and development bench testing for our preclinical trials relating to
this application in 2011 and begin additional animal studies in 2011, in support of future potential regulatory submissions. We estimate that the animal study will take between one and two years to
complete.



In this clinical application, cadaver, or allograft, saphenous vein grafts are used in CABG procedures for patients who do not have
appropriate arterial or venous conduits. We have had discussions with suppliers of this allograft material to determine usage patterns. We plan to begin research and development bench testing for our
preclinical trials relating to this application in 2011 and begin an animal study in 2011. We estimate that the animal study will take between one and two years to complete.



In this clinical application, a fistula, or connection, is made between an artery and a vein, normally in the nondominant arm, for
circulatory system access in patients requiring chronic dialysis. We plan to begin research and development bench testing for our preclinical trials relating to this application in 2011 and 2012 and
begin an animal study in 2011 or 2012. We estimate that the animal study will take between one and two years to complete.

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Sales and Marketing



On May 13, 2010, we obtained the CE Mark for our eSVS MESH. The CE Mark allows us to sell our eSVS MESH for use in CABG
procedures in 32 countries within the European Union, the European Economic Area, and the European Free Trade Association. We began marketing and commenced shipments of our eSVS MESH in select
European Union markets in June 2010, but we have not generated significant revenue from the sale of products to date. Our plan is to utilize independent distributors to commercialize our technology in
Europe. We have entered into agreements with independent distributors for Switzerland, Italy, Spain, Belgium, the Netherlands, Luxembourg, the UK, Ireland, Greece, Denmark, Sweden, Norway, Turkey and
Germany to conduct sales in these markets and we intend to enter into additional distribution agreements to conduct sales in other select European nations. These distribution agreements generally have
terms of three years, restrict distributors from selling products competitive with our eSVS MESH and grant exclusivity within
a territory, which is generally limited to a single country. In addition, we may terminate the distributor's exclusivity or the entire agreement if the distributor fails to achieve agreed upon sales
targets. These distributors will be supported by our U.S.-based staff with regard to training and promotional materials. We intend to work with our distributors with respect to product reimbursement
and have also identified other third parties that may be contracted to assist in obtaining country-specific product reimbursement. We were recently denied government-sponsored reimbursement in Germany
for our eSVS MESH for calendar year 2011, and will need to reapply in order to be considered for this reimbursement in 2012.

As
the European cardiac surgery market is characterized by centralized, high-volume cardiac surgery centers, we believe this market can be effectively addressed through a
small, highly-focused independent distributor network.

We
will be an active participant in post-market clinical trials aimed at validating the long-term outcomes of patients who receive our eSVS MESH. These studies
will be designed to show that eSVS MESH patients require less revascularization procedures than standard CABG patients, thereby also reducing the costs associated with revascularization procedures for
eSVS MESH patients. We envision that the results of these studies will be presented at scientific sessions and presented in peer-reviewed journals, thereby increasing the visibility and
adoption of our eSVS MESH. These studies will also be used to support applications for public hospital reimbursement in those countries that require outcomes data for such reimbursement.

We
believe that the CE Mark will allow us to begin regulatory submissions to obtain marketing approval in other select markets, including South Africa, Canada, New Zealand and Argentina.
These markets require either the CE Mark or FDA approval to begin the submission process, per their current medical device regulatory requirements. Therefore, obtaining the CE Mark will allow us to
begin regulatory submissions in these countries. In addition, we have begun the regulatory submission process for Singapore, Hong Kong and Malaysia, and have entered into an agreement with an
independent distributor for Singapore, Hong Kong, Thailand, Malaysia, Indonesia, the Philippines, Cambodia, Laos, Vietnam and Brunei. We have also entered into an agreement and begun commercial sales
with an independent distributor for the United Arab Emirates.



We are required to conduct a PMA IDE trial in the United States. Enrollment in this trial, follow-up of trial patients, and
subsequent PMA approval are anticipated to take approximately 42 months. If the U.S. IDE trial commences enrollment in 2011, has the trial design we expect as described above, is successful and
our resulting PMA is approved, we expect to launch our eSVS MESH in the United States no sooner than 2015.

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Based
upon the 2009 Society of Thoracic Surgeons Adult Cardiac Surgery Database, we believe CABG surgeries were performed in approximately 1,150 U.S. hospitals in 2009.

According
to an article published in the journal Health Affairs in 2007, the volume of CABG surgeries performed per U.S. hospital in 2003, the most recent year for which such data was
published, was:

CABG Volume per Year

Percent of Hospitals
in this Category

Number of Hospitals
in this Category<130 cases


29
%

310130 - 199 cases


20
%

214200 - 314 cases


22
%

235315 - 484 cases


15
%

160>484 cases


14
%

150


Based
upon this information, approximately 545 hospitals in the United States perform at least 200 CABG surgeries each year. Of these, approximately 310 hospitals perform
more than 315 surgeries each year. Our initial marketing focus will be on these 300 to 500 hospitals.

Our
plan is to utilize independent distributors to commercialize our eSVS MESH in the U.S. We have identified and are in preliminary discussions with independent distributors that may be
contracted to conduct sales, but we have not yet entered into any distribution agreements. We expect that these contracts will be on terms similar to those described above for our agreements with
international distributors. These distributors will be supported by Kips Bay staff with regard to training and promotional materials. We have contracted outside reimbursement experts to assist in
obtaining Centers for Medicare & Medicaid Services, or CMS, product reimbursement.

Intellectual Property

As of March 31, 2011, we had six patent applications pending in the United States and eleven patent applications pending in
countries outside the United States (including one Canadian application, one Japanese application, and one European application for which we recently received notices of allowance) covering various
aspects of our eSVS MESH. Our pending patent applications include claims directed towards, among other things, the knitted, resilient structure of our eSVS MESH which is designed to provide structural
support to inhibit vessel expansion and provide the vein graft with physiological attributes similar to those of an artery, and the surgical procedures relating to implanting our eSVS MESH. We also
have one pending international patent application which will be filed in Europe and Japan by May 2011. We commenced shipments of our eSVS MESH in select European Union markets in June 2010, before any
of our pending European patent applications have issued as patents.

Some
of our patent applications have entered the examination phase of the patent application process and some currently stand rejected, while others have been allowed. During the
examination phase, the examiner assesses the patentability of the invention by comparing the pending claims to the relevant prior art. If the examiner determines that the claimed invention is
unpatentable, the examiner will issue an "office action" providing the grounds for rejecting the claims. Such grounds for rejection can include, for example, that the claimed invention lacks novelty
or is obvious in view of the relevant prior art. It is common for most U.S. patent applications to be rejected at least one time before issuing as a U.S. patent. To overcome the rejection, the
applicant must generally reply by amending the claims and/or providing arguments to distinguish the claimed invention from the cited prior art. If the examiner is not persuaded by the amendments
and/or arguments, the applicant can either continue to make amendments and/or arguments to the examiner, for example, by filing a Request for Continued Examination, or a RCE, or by appealing the
examiner's decision to the Board of Patent Appeals and Interferences, or the BPAI.

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Our
six pending U.S. patent applications relate to intellectual property that we believe is significant to our eSVS MESH. Four of our pending U.S. patent applications have entered the
examination phase and were rejected by the examiner. In our replies for each of the first two rejected applications, we identified what we believe are meaningful differences between the claimed
invention and the prior art relied upon by the examiner, which prior art was the same in both cases. In both cases, however, the examiner was not persuaded by our arguments. We elected to appeal the
examiner's decision on the first application to the BPAI, and we elected to continue the examination process with examiner by filing an RCE for the second application. In November 2010, we received a
favorable decision from the BPAI reversing the initial rejection of the first application. We have recently received a new rejection of our first application citing prior art not previously applied by
the U.S. patent examiner. Foreign patent offices have also used such prior art in rejecting our corresponding foreign patent applications. We
have, however, successfully overcome such foreign patent rejections through clarifying arguments and claim amendments, and we anticipate similar results in responding to the current U.S. patent
application rejection. Because the prior art cited in the rejections of our pending U.S. patent applications is distinguishable from our unique eSVS MESH, we continue to believe that these
applications will ultimately issue as U.S. patents having meaningful scope of protection relating to our eSVS MESH. However, the U.S. patent examiners have not issued, nor indicated they intend to
issue, allowances with respect to any of our pending U.S. patent applications.

Due
to the indeterminate time frames in which patent examiners engage in prosecution and the uncertainty of how the examiners will respond to our submissions, it is difficult to
accurately predict when prosecution of our patent applications will end. To the extent that these applications or other pending patent applications do not issue as patents, or, if issued, are not
issued in a form that is desirable or advantageous to us, we would be exposed to a greater risk of direct competition. Competitors could purchase our eSVS MESH and attempt to replicate some or all of
the competitive advantages we derive from our eSVS MESH or more readily be able to design around our technology, and they might be able to market products and use manufacturing processes that are
substantially similar to ours, each of which we believe would be highly likely if we are able to achieve significant market acceptance of our eSVS MESH. In addition, third parties may assert that our
eSVS MESH infringes the claims in their patents or seek to expand their patent claims to cover aspects of our eSVS MESH. An adverse determination in litigation or interference proceedings to which we
may become a party could subject us to significant liabilities or require us to seek licenses. Although patent and intellectual property disputes in the medical device area have often been settled
through licensing or similar arrangements, costs associated with these arrangements may be substantial and could include ongoing royalties. We may be unable to obtain necessary licenses on
satisfactory terms, if at all, and we may be required to redesign our eSVS MESH to avoid infringement.

The
core intellectual property relating to our eSVS MESH, including five patent applications pending in the United States and nine patent applications pending in countries outside the
United States, was sold to us by Medtronic, Inc. pursuant to an Assignment and License Agreement dated October 9, 2007. Pursuant to the Assignment and License Agreement, Medtronic also sold to
us intellectual property relating to a brushed ePTFE vascular graft, or the Brushed Graft Product. Currently, such intellectual property is embodied in two patents and four pending patent applications
in the United States and one patent and four pending patent applications in countries outside the United States.

As
consideration for the sale of intellectual property relating to the eSVS MESH and the Brushed Graft Product and other rights granted by the Assignment and License Agreement, we have
agreed to pay Medtronic an aggregate of $20.0 million upon the achievement of certain sales milestones relating to the eSVS MESH and the Brushed Graft Product and a royalty of 4% on sales of
our eSVS MESH and the Brushed Graft Product. The royalty will terminate upon the earlier of the expiration of all of the patents and patent applications, or when the aggregate royalties paid reach
$100.0 million.

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In
the recitals to the Assignment and License Agreement, we stated that we would use our reasonable best efforts to develop and commercialize both the Brushed Graft Product and the eSVS
MESH. While we have undertaken activities to develop and commercialize the Brushed Graft Product, we are currently primarily focused on the development of our eSVS MESH for use in CABG surgery and
additional applications of our eSVS MESH.

In
connection with its development of the Brushed Graft Product, Medtronic used certain technology to produce platelet-poor plasma for use in the Brushed Graft Product.
Pursuant to the Assignment and License Agreement, Medtronic licensed to us certain patent rights necessary to produce this platelet-poor plasma and provided for a continuing license of
such rights in the event Medtronic sold the technology used to produce such platelet-poor plasma. These licensed patent rights are different from the patents related to the Brushed Graft
Product itself that were sold to us, and we have not yet determined whether the platelet-poor plasma is necessary or useful in the commercialization of the Brushed Graft Product. We may
ultimately elect to commercialize the Brushed Graft Product without the platelet-poor plasma and believe that we have the intellectual property rights to do so without the license to
produce platelet-poor plasma.

The
original eSVS MESH technology was developed at the University of Cape Town, South Africa. On June 12, 2003, Medtronic, the University of Cape Town and a professor at the
University of Cape Town entered into a Research and Scientific Collaboration Agreement, pursuant to which the University of Cape Town assigned to the professor all its ownership rights in the eSVS
MESH technology and any patents that may arise therefrom, subject to the South African Exchange Control approval process. Prior to receipt of such approval, the professor and other researchers
assigned to Medtronic all their ownership rights in the eSVS MESH patents and technology, and Medtronic subsequently granted us an irrevocable, exclusive license of the eSVS MESH patents and
technology pursuant to the Assignment and License Agreement until the South African Exchange Control approval process could be completed. On or about November 8, 2007, the South African Federal
Reserve Bank approved the Research and Scientific Collaboration Agreement, and on August 26, 2008, Medtronic assigned the patents relating to the eSVS MESH to us in fulfillment of its
obligations under the Assignment and License Agreement.

Any
or all licenses granted to us pursuant to our agreement with Medtronic may be terminated and potentially all of the core intellectual property and patent rights related to our eSVS
MESH will revert to Medtronic, upon notice by Medtronic, if we become insolvent, make an assignment for the benefit of creditors, go into liquidation or receivership or otherwise lose legal control of
our business. In addition, Medtronic may terminate the license to the platelet-poor plasma if we determine to cease commercializing the Brushed Graft Product. Medtronic may also cause the
core intellectual property and patent rights related to our eSVS MESH to revert to Medtronic if we determine to cease commercializing our eSVS MESH. The agreement with Medtronic does not define what
constitutes "commercializing" for these purposes.

Competition

The development and commercialization of medical devices to treat cardiovascular disease is a highly competitive industry. Physicians
and patients may select among a variety of treatments to address coronary artery disease, including pharmaceutical therapy, balloon angioplasty, stenting with bare metal or drug-eluting
stents, and CABG procedures, with the selection often depending upon the stage of the disease. According to the American Heart Association, in 2006, approximately 661,000 balloon angioplasty
procedures were performed, with approximately 652,000 of these procedures involving the placement of one or more stents. The American Heart Association also reports that in 2006, approximately
253,000 patients received 448,000 bypass procedures. If physicians choose alternative treatments to CABG surgery due to the disadvantages of CABG surgery, such as the failure rate of CABG
surgery, or if additional alternative treatments for cardiovascular disease are developed, there

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may
be a decrease in the number of CABG surgery procedures. The American College of Cardiology/American Heart Association treatment guidelines state that CABG is the only recommended revascularization
procedure for those patients with left main or three-vessel coronary disease.

Our
eSVS MESH is designed to improve the structural characteristics and long-term performance of vein grafts in CABG surgery. If our eSVS MESH is proven to do so
successfully, we believe physicians may more frequently choose to perform CABG surgery over alternative treatments. We expect the primary competition for our eSVS MESH to be other products or
techniques to improve the effectiveness of vein grafts in CABG surgery.

We
are aware of two companies that have developed mesh devices to be used on the outside of blood vessels. Alpha Research, a Swiss company, has developed a product known as the
Biocompound Graft for use in coronary and peripheral bypass operations. The product is a stainless steel braided mesh, indicated for use in coronary or peripheral bypass with patients who have
irregularly shaped veins. B. Braun, a German company, has developed a product known as ProVena for use in peripheral bypass operations. The product is a woven polymer mesh, indicated for use in
peripheral artery bypass operations using vein grafts.

We
believe that these two products are not currently direct competitors to our eSVS MESH, and are not likely to become direct competitors in the near future, because the Biocompound
Graft is intended for use only with irregularly shaped veins and the ProVena is intended for use with non-coronary procedures. However, it is possible that one or both of these companies,
or other potential competitors, will seek approval to use these or similar devices for procedures with similar or identical indications for use as our eSVS MESH. In addition, we may seek approval of
the
use of our eSVS MESH in the procedures for which these other products are used, such as peripheral artery bypass operations.

The
key competitive factors affecting the success of our eSVS MESH are likely to be the effectiveness, safety profile and price of our eSVS MESH, as compared to existing methods for CABG
surgery. We believe a potential disadvantage associated with our eSVS MESH is the possibility of allergic reaction to the implant materials. According to a July 2009 article in the Journal of Invasive
Cardiology, nickel allergy after implantation of a nitinol-containing device is rare. This article described the rate of nickel allergy in cardiovascular implants to be between 0.002% and 0.02%. The
article also stated that the patients with nickel allergy symptoms responded to medical management at the time of the reaction, did not require device explant, and no longer require medications for
the reaction. In order to further safeguard against this rare occurrence, the eSVS MESH instructions for use state that it is contraindicated for patients with a known allergy to nitinol. We believe
another potential disadvantage associated with our eSVS MESH is the possibility of damage to the saphenous vein during placement of our eSVS MESH. If the physician does not select the proper size eSVS
MESH relative to the size of the vein, the saphenous vein may be damaged while placing our eSVS MESH over the vein. For example, if too small an eSVS MESH is chosen, there could be damage to the
saphenous vein caused by stretching the vein while trying to place it in our eSVS MESH. We have provided specific directions in the eSVS MESH instructions for use on how to properly size veins and
place our eSVS MESH. In addition, we provide a sizing tool with our eSVS MESH to ensure proper vein sizing. The commercial success of our eSVS MESH will depend upon the results of clinical trials of
the technology and experience with the technology in the commercial marketplace.

If
the commercialization of our eSVS MESH technology is successful, we expect that other medical device companies, many of whom are larger and have greater financial resources than us,
will seek to enter into this market by introducing competing technologies.

Manufacturing and Suppliers

We fabricate our eSVS MESH both at our facility and at a contract manufacturer. We conduct final assembly and packaging inside a
controlled environment area within our facility that satisfies the

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requirements
of a Class 10,000 level clean room. We have implemented systems to ensure that our manufacturing operations comply with relevant United States and International Good Manufacturing
Practices requirements.

We
have vendors for all of our key components and outsourced processes. We have identified alternate suppliers for each key component and outsourced process; however, in some cases,
components are provided by single source suppliers at this time due to quality considerations, costs, or regulatory requirements. We have established redundancy for custom equipment used in the
manufacture of our eSVS MESH. A third-party supplier performs sterilization services for our eSVS MESH. We currently use four knitting machines that knit the mesh sleeve of our eSVS MESH, with three
located at our facility and the other located off-site. We believe that these four machines will produce sufficient quantities of our eSVS MESH to meet our expected needs for the
foreseeable future. In the event that one or all of our knitting machines were to become unavailable, we believe that we can obtain one or more replacement knitting machines, although the custom work
required to enable the machines to produce our eSVS MESH would likely result in some delays in our production process.

Research and Development

During 2008, 2009 and 2010, we incurred $2.6 million, $3.0 million and $2.5 million, respectively, of research and
development expenses. Research and development costs include the costs to design, develop, test, seek approval for, and enhance our eSVS MESH and production process. Expenses related to research and
development consist primarily of personnel costs, including salaries, benefits and stock-based compensation, product development, pre-clinical and clinical trials, materials and supplies,
and facilities-related costs. While our research and development expenses to date have been focused on product development and evaluating the feasibility of our eSVS MESH, we expect that a large
percentage of our research and development expenses in the future will be incurred in support of our current and future clinical trials. As we develop further applications for our eSVS MESH, we intend
to utilize internal resources, outside contract resources and facilities, and our Scientific Advisory Board.

Employees

As of March 25, 2011, we had 13 employees. We plan to continue to expand our research and development and commercialization
activities. To support this growth, we will need to expand managerial, research and development, operations and other functions. None of our employees is represented by a labor union, and we consider
our relationship with our employees to be good.

Government Regulation



The Federal Food, Drug, and Cosmetic Act, or FDCA, and the FDA's implementing regulations, govern medical device design and
development, preclinical and clinical testing, premarket clearance or approval, registration and listing, manufacturing, labeling, storage, advertising and promotion, sales and distribution, and
post-market surveillance. Medical devices and their manufacturers are also subject to inspection by the FDA. The FDCA, supplemented by other federal and state laws, also provides civil and
criminal penalties for violations of its provisions. We intend to manufacture and market a medical device that is regulated by the FDA, comparable state agencies and regulatory bodies in other
countries.

Our
eSVS MESH will require marketing authorization from the FDA prior to commercial distribution in the United States. The two primary types of FDA marketing authorization are premarket
notification (also called 510(k) clearance) and premarket approval (also called PMA approval). The type of marketing authorization applicable to a device510(k) clearance or PMA

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approvalis
generally linked to classification of the device. The PMA approval process is generally more stringent, time-consuming and expensive than the 510(k) clearance
process.

The
FDA classifies medical devices into one of three classes (Class I, II or III) based on the degree of risk FDA determines to be associated with a device and the extent
of control deemed necessary to ensure the device's safety and effectiveness. Devices requiring fewer controls because they are deemed to pose lower risk are placed in Class I or II.
Class I devices are deemed to pose the least risk and are subject only to general controls applicable to all devices, such as requirements for device labeling, premarket notification, and
adherence to the FDA's current good manufacturing practice requirements, as reflected in its Quality System Regulation, or QSR. Class II devices are intermediate risk devices that are subject
to general controls and may also be subject to special controls such as performance standards, product-specific guidance documents, special labeling requirements, patient registries or postmarket
surveillance. Class III devices are those for which insufficient information exists to assure safety and effectiveness solely through general or special controls, and include
life-sustaining, life-supporting, or implantable devices, and devices not "substantially equivalent" to a device that is already legally marketed.

Most
Class I devices and some Class II devices are exempted by regulation from the 510(k) clearance requirement and can be marketed without prior authorization from FDA.
Class I and Class II devices that have not been so exempted are eligible for marketing through the 510(k) clearance pathway. By contrast, devices placed in Class III generally
require PMA approval prior to commercial marketing. To obtain 510(k) clearance for a medical device, an applicant must submit a premarket notification to the FDA demonstrating that the device is
"substantially equivalent" to a predicate device legally marketed in the United States. A device is substantially equivalent if, with respect to the predicate device, it has the same intended use and
(1) the same technological characteristics, or (2) has different technological characteristics and the information submitted demonstrates that the device is as safe and effective as a
legally marketed device and does not raise different questions of safety or effectiveness. A showing of substantial equivalence sometimes, but not always, requires clinical data. Generally, the 510(k)
clearance process can exceed 90 days and may extend to a year or more.

After
a device has received 510(k) clearance for a specific intended use, any modification that could significantly affect its safety or effectiveness, such as a significant change in
the design, materials, method of manufacture or intended use, will require a new 510(k) clearance or (if the device as modified is not substantially equivalent to a legally marketed predicate device)
PMA approval. While the determination as to whether new authorization is needed is initially left to the manufacturer, the FDA may review this determination and evaluate the regulatory status of the
modified product at any time and may require the manufacturer to cease marketing and recall the modified device until 510(k) clearance or PMA approval is obtained. The manufacturer may also be subject
to significant regulatory fines or penalties.

Our
coronary eSVS MESH has been designated a Class III product by the FDA and will be required to go through the PMA process. Other indications of our eSVS MESH, including
peripheral and arteriovenous fistula applications, have not been classified at this time.

The
FDA will require us to file a PMA application with respect to our eSVS MESH and there is no assurance that PMA approval will be granted. A PMA application requires the payment of
significant User Fees, and must be supported by valid scientific evidence, which typically requires extensive data, including technical, preclinical, clinical and manufacturing data, to demonstrate to
the FDA's satisfaction the safety and effectiveness of the device. A PMA application also must include a complete description of the device and its components, a detailed description of the methods,
facilities and controls used to manufacture the device, and proposed labeling. After a PMA application is submitted and found to be sufficiently complete, the FDA begins an in-depth review
of the submitted information. During this review period, the FDA may request additional information or clarification of information already provided. Also during the review period, an advisory panel
of experts from outside

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the
FDA may be convened to review and evaluate the application and provide recommendations to the FDA as to the approvability of the device. In addition, the FDA will conduct a
pre-approval inspection of the manufacturing facility to ensure compliance with the
QSR, which requires manufacturers to follow design, testing, control, documentation and other quality assurance procedures.

FDA
review of a PMA application is required by statute to take no longer than 180 days, although the process typically takes significantly longer, and may require several years to
complete. The FDA can delay, limit or deny approval of a PMA application for many reasons, including:



If
the FDA evaluations of both the PMA application and the manufacturing facilities are favorable, the FDA will either issue an approval letter, or an approvable letter, which usually
contains a number of conditions that must be met in order to secure final approval of the PMA. When and if those conditions have been fulfilled to the satisfaction of the FDA, the agency will issue a
PMA approval letter authorizing commercial marketing of the device for certain indications. If the FDA's evaluation of the PMA or manufacturing facilities is not favorable, the FDA will deny approval
of the PMA or issue a not approvable letter. The FDA may also determine that additional clinical trials are necessary, in which case the PMA approval may be delayed for several months or years while
the trials are conducted and then the data submitted in an amendment to the PMA. The PMA process can be expensive, uncertain and lengthy and a number of devices for which FDA approval has been sought
by other companies have never been approved for marketing. Even if a PMA application is approved, the FDA may approve the device with an indication that is narrower or more limited than originally
sought. The agency can also impose restrictions on the sale, distribution, or use of the device as a condition of approval, or impose post approval requirements such as continuing evaluation and
periodic reporting on the safety, effectiveness and reliability of the device for its intended use.

New
PMA applications or PMA supplements may be required for modifications to the manufacturing process, labeling, device specifications, materials or design of a device that is approved
through the PMA process. PMA approval supplements often require submission of the same type of information as an initial PMA application, except that the supplement is limited to information needed to
support any changes from the device covered by the original PMA application and may not require as extensive clinical data or the convening of an advisory panel.

Clinical
trials are almost always required to support a PMA application and are sometimes required for a 510(k) clearance. These trials generally require submission of an application for
an investigational device exemption, or IDE, to the FDA. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the
device in humans and that the testing protocol is scientifically sound. The IDE application must be approved in advance by the FDA for a specified number of patients, unless the product is deemed a
non-significant risk device and eligible for more abbreviated IDE requirements. Generally, clinical trials for a significant risk device may begin once the IDE application is approved by
the FDA and the trial protocol and informed consent are approved by appropriate institutional review boards at the clinical trial sites.

FDA
approval of an IDE allows clinical testing to go forward, but does not bind the FDA to accept the results of the trial as sufficient to prove the product's safety and effectiveness,
even if the trial meets its intended success criteria. With certain exceptions, changes made to an investigational plan after an IDE is approved must be submitted in an IDE supplement and approved by
the FDA (and by governing institutional review boards when appropriate) prior to implementation.

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All
clinical trials must be conducted in accordance with regulations and requirements collectively known as Good Clinical Practice, or GCP. GCPs include the FDA's IDE regulations, which
describe the conduct of clinical trials with medical devices, including the recordkeeping, reporting and monitoring responsibilities of sponsors and investigators, and labeling of investigation
devices. They also prohibit promotion, test marketing, or commercialization of an investigational device, and any representation that such a device is safe or effective for the purposes being
investigated. GCPs also include FDA's regulations for institutional review board approval and for protection of human subjects (informed consent), as well as disclosure of financial interests by
clinical investigators.

Required
records and reports are subject to inspection by the FDA. The results of clinical testing may be unfavorable or, even if the intended safety and effectiveness success criteria
are achieved, may not be considered sufficient for the FDA to grant approval or clearance of a product. The commencement or completion of any of our clinical trials may be delayed or halted, or be
inadequate to support
approval of a PMA application or clearance of a premarket notification for numerous reasons, including, but not limited to, the following:



After
a device is approved and placed in commercial distribution, numerous regulatory requirements apply. These include:



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Also,
the FDA may require us to conduct postmarket surveillance studies or order us to establish and maintain a system for tracking our eSVS MESH through the chain of distribution to the
patient level. The FDA enforces regulatory requirements by conducting periodic, announced and unannounced inspections and market surveillance. Inspections may include the manufacturing facilities of
our subcontractors.

Failure
to comply with applicable regulatory requirements, including those applicable to the conduct of our clinical trials, can result in enforcement action by the FDA, which may lead
to any of the following sanctions:



We
and our contract manufacturers, specification developers and suppliers are also required to manufacture our eSVS MESH in compliance with current Good Manufacturing Practice
requirements set forth in the QSR. The QSR requires a quality system for the design, manufacture, packaging, labeling, storage, installation and servicing of marketed devices, and includes extensive
requirements with respect to quality management and organization, device design, buildings, equipment, purchase and handling of components, production and process controls, packaging and labeling
controls, device evaluation, distribution, installation, complaint handling, servicing and record keeping. The FDA enforces the QSR through periodic announced and unannounced inspections that may
include the manufacturing facilities of our subcontractors. If the FDA believes we or any of our contract manufacturers or regulated suppliers is not in compliance with these requirements, it can shut
down our manufacturing operations, require recall of our eSVS MESH, refuse to clear or approve new marketing applications, institute legal proceedings to detain or seize products, enjoin future
violations, or assess civil and criminal penalties against us or our officers or other employees. Any such action by the FDA would have a material adverse effect on our business.



Our operations will be directly, or indirectly through our customers, subject to various state and federal fraud and abuse laws,
including, without limitation, the FDCA, federal Anti-Kickback Statute and False Claims Act. These laws may impact, among other things, our proposed sales, marketing and education
programs. In addition, these laws require us to screen individuals and other companies, suppliers and vendors in order to ensure that they are not "debarred" by the federal government and therefore
prohibited from doing business in the healthcare industry. The association or conduct of business with a "debarred" entity could be detrimental to our operations and result in a negative impact on our
business.

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The
federal Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in
exchange for or to induce either the referral of an individual, or the furnishing or arranging for a good or service, for which payment may be made under a federal healthcare program such as the
Medicare and Medicaid programs. Several courts have interpreted the statute's intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of
federal healthcare covered business, the statute has been violated. The Anti-Kickback Statute is broad and prohibits many arrangements and practices that are lawful in businesses outside
of the healthcare industry. Many states have also adopted laws similar to the federal Anti-Kickback Statute, some of which apply to the referral of patients for healthcare items or
services reimbursed by any source, not only the Medicare and Medicaid programs.

The
federal False Claims Act prohibits persons from knowingly filing or causing to be filed a false claim to, or the knowing use of false statements to obtain payment from, the federal
government. Various states have also enacted laws modeled after the federal False Claims Act.

In
addition to the laws described above, the Health Insurance Portability and Accountability Act of 1996 created two new federal crimes: healthcare fraud and false statements relating to
healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private payors. The false statements statute
prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment
for healthcare benefits, items or services.

Voluntary
industry codes, federal guidance documents and a variety of state laws address the tracking and reporting of marketing practices relative to gifts given and other expenditures
made to doctors and other healthcare professionals. In addition to impacting our marketing and educational programs, internal business processes will be affected by the numerous legal requirements and
regulatory guidance at the state, federal and industry levels.

If
our operations are found to be in violation of any of the laws described above or other applicable state and federal fraud and abuse laws, we, as well as our employees, may be subject
to penalties, including civil and criminal penalties, damages, fines, exclusion from government healthcare programs, and the curtailment or restructuring of our operations. Individual employees may
need to defend such suits on behalf of us or themselves, which could lead to significant disruption in our present and future operations. We cannot assure you that we will be able to comply with the
above laws and regulations.



The European Union has adopted directives and numerous standards that govern and harmonize the national laws and standards regulating
the design, manufacture, clinical trials, labeling, adverse event reporting and post-market surveillance activities for medical devices that are marketed in member states.

Compliance
with voluntary harmonized standards including ISO 13485 issued by the International Organization for Standards establishes the presumption of conformity with the
essential requirements for a CE Mark. ISO certification is commonly a pre-requisite to use of the CE Mark and indicates that a quality system complies with standards applicable to
activities ranging from initial product design and development through production and distribution.

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Devices that comply with the requirements of a relevant directive will be entitled to bear the CE Mark and, accordingly, can be commercially distributed
throughout the member states of the European Union, and other countries that comply with or have adopted these directives. The method of assessing conformity varies depending on the type and class of
the product, but typically involves a combination of self-assessment by the manufacturer and a third-party assessment by a "Notified Body," an independent and neutral institution appointed
to conduct conformity assessment. This third-party assessment consists of an audit of the manufacturer's quality system and technical review of the manufacturer's product. For most classes of medical
devices, an assessment by a Notified Body residing within the European Union is required in order for a manufacturer to commercially distribute the product throughout the European Union. The
manufacturer's assessment will include a clinical evaluation of the conformity of the device with applicable regulatory requirements, which for our eSVS MESH will include clinical study
results. The clinical data presented by us must provide evidence that the products meet the performance specifications claimed by us, provide sufficient evidence of adequate assessment of unwanted
side effects and demonstrate that the benefits to the patient outweigh the risks associated with the device. We are subject to continued surveillance by the Notified Body and are required to report
any serious adverse incidents to the appropriate authorities of the European Union member states.

Products
intended for sale must bear the CE mark to show compliance with the Medical Devices Directive, or MDD. If a Notified Body is involved in the approval, the number of the Notified
Body must also appear adjacent to the CE Mark.

The
routes to compliance under the MDD depend on the classification of the product:

Class I devicesare low risk, such as stethoscopes, hospital beds and wheelchairs. The manufacturer must produce a technical file,
including product test results compared to relevant standards. In addition, manufacturers of sterile products and devices with a measuring function must apply to a Notified Body for certification of
the aspects of manufacture relating to sterility or measurement.

Class IIa devicesare low to medium risk, such as hearing aids, electrocardiographs and ultrasonic diagnostic equipment. As with
Class I devices, the manufacturer produces a technical file, but a conformity assessment must be carried out by a Notified Body, according to one of the following routes, at the manufacturer's
option:



Class IIb devicesare medium-high risk devices, such as surgical lasers, infusion pumps, ventilators, intensive care
monitoring equipment and many implantable devices. Routes to compliance are the same as for Class IIa devices, with the addition of required examination and testing of the product by the
Notified Body; however, the full quality assurance route does not require type examination and testing.

Class III devicesare high risk, such as balloon catheters and prosthetic heart valves. Our eSVS MESH is classified as a
Class III device. Routes to compliance are:



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We
have obtained CE Mark approval to market our eSVS MESH in the European Union and other countries that accept the CE Mark.



The availability of insurance coverage and reimbursement for newly approved medical devices is variable. The commercial success of our
eSVS MESH in both domestic and international markets will be substantially dependent on whether third-party coverage and reimbursement is available for patients receiving bypass grafts with our eSVS
MESH. Medicare, Medicaid, health maintenance organizations and other third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement
of new medical devices, and, as a result, they may not cover or provide additional payment for our eSVS MESH. In order to position our device for coverage by third-party payors, we may have to agree
to a lower net sales price than we might otherwise charge. The continuing efforts of governmental and commercial third-party payors to contain or reduce the costs of healthcare may limit our revenue.

In
many countries including the United States, third-party payors consist of both government funded insurance programs and private insurance programs who cover a significant portion of a
patient's medical expenses. The trends toward managed healthcare in the U.S. and legislation intended to reduce the cost of government insurance programs will significantly influence the purchase of
healthcare services and products, and could result in lower or no reimbursement for our eSVS MESH. Even before reimbursement may be obtained for our eSVS MESH in the United States, FDA approval will
be required.

Providers
have sought ways to manage costs, such as through the use of group purchasing organizations. It is our belief that the planned economic benefits provided by our eSVS MESH to
physicians and hospitals through lower revascularization costs (PCI and/or CABG) will be viewed by providers and third-party payors as cost-effective. However, there remains uncertainty
whether our eSVS MESH will be viewed positively in a cost-avoidance model so as to warrant adequate coverage and reimbursement levels.

Outside
of the United States, there are many reimbursement programs through private payors as well as government programs. In some countries, government reimbursement is the predominant
program available to patients and hospitals. While the majority of countries have existing reimbursement for CABG procedures and products, a number of countries may require us to gather additional
clinical data before recognizing coverage and reimbursement for our eSVS MESH. It is our intent to complete the requisite clinical trials and obtain coverage and reimbursement approval in countries
where it makes economic sense to do so.



Reimbursement systems for certain key European markets that we will initially pursue are outlined below:



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In the United States, governmental and private sector payors have instituted initiatives to limit the growth of healthcare costs,
using, for example, price regulation or controls and competitive pricing programs. Some third party payors require pre-approval of coverage for new or innovative devices or therapies
before they will reimburse healthcare providers who use such devices or therapies.

In
the United States, CMS is the government entity responsible for oversight of the Medicare program. Medicare establishes coverage and reimbursement policies at a federal and local
level for medical products and procedures, and such policies are periodically reviewed and updated. While private payors vary in their coverage and payment policies, the Medicare program is viewed as
a benchmark.

There
are established codes for CABG procedures and products that are payable for both Medicare and commercial payors. There are no assurances that our eSVS MESH technology would fall
under existing policies or reimbursement codes. There are also no assurances that existing payment rates for such reimbursement codes will continue to hold at the current levels, such as if regulatory
changes are implemented regarding the methodology for calculating hospital payments for current inpatient procedures. Medicare payment rates have decreased approximately 10% to 14% for those
procedures using drug eluting stents. The reductions are being transitioned over a three-year period that began in fiscal year 2007. In 2007, CMS also implemented a revised payment
methodology that more accurately reflects the severity of the patient's condition.

Medicare
reimburses hospital inpatient stays under the Medicare Severity Diagnosis-Related Group (MS-DRG) system. The MS-DRG system assigns individual cases to an
MS-DRG according to the patient's diagnoses, the procedures performed, and the severity of a patient's condition as identified by the presence or absence of complications and
comorbidities, or CCs, or major CCs, or MCCs. MS-DRGs provide a single bundled payment which serves as reimbursement for all items and services provided to the Medicare beneficiary during
a single hospitalization.

Additionally,
a relative weight is calculated for each individual MS-DRG, which represents the average resources required to care for cases within a particular
MS-DRG relative to the average resources required to treat cases in all MS-DRGs. Generally, MS-DRG relative weights are adjusted annually to reflect changes in
medical practice in a budget neutral manner.

CMS
has made no decisions with respect to MS-DRG assignment for patients who undergo CABG procedures in which our eSVS MESH would be used, and there can be no assurance that
the MS-DRG to which such patients will be assigned will result in Medicare payment levels that are considered by hospitals to be adequate to further support purchase of our eSVS MESH.
Under current CMS reimbursement policies, the agency offers a process to obtain add-on payment for a new medical technology when the existing MS-DRG prospective payment rate is
inadequate. To obtain add-on payment, a technology must be considered "new," demonstrate substantial improvement above the

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current
standard of care and exceed certain payment thresholds. Add-on payments are made for no less than two years and no more than three years. Following FDA approval in the United
States, we intend to pursue an application for a hospital inpatient new technology add-on payment with CMS. We must demonstrate the safety and effectiveness of our eSVS MESH to the FDA in
addition to the CMS requirements listed above before add-on payments will be approved. Should the clinical trial results or peer-reviewed publications prove that use of our
eSVS MESH results in a lowering of revascularization rates, we believe there is a reasonable chance that CMS will grant our request. If CMS grants our request, we expect it will approve an
add-on payment equal to 50% of the cost of labor and materials incurred. We do not expect that failure to receive approval for an add-on payment would have an adverse impact on
our business because existing MS-DRGs already reimburse CABG procedures at a high level, and we believe that physicians and hospitals would be willing to use our eSVS MESH even if an
add-on payment is not approved.

For
reporting of physician services, the American Medical Association, or AMA, has developed a coding system known as Current Procedural Terminology, or CPT. CPT codes are established by
the AMA and statutorily adopted by all government and commercial payors to describe and develop payment amounts for physician services. Physician services are reimbursed by Medicare based on a
physician fee schedule whereby payment is based generally on the number of "relative value units" assigned by the AMA to each CPT code. No decision has been made concerning whether existing CPT codes
would be appropriate for use in coding CABG procedures when our eSVS MESH is used or if separate, new CPT codes are required. We cannot assure you that codes used for submitting claims for CABG
procedures using our eSVS MESH will result in incremental payment to physicians. Failure by physicians to receive what they consider to be adequate reimbursement for CABG procedures in which our eSVS
MESH is used could harm our business, financial condition and results of operations.

Item 1A.    Risk Factors

You should carefully consider the following information about risks, together with the other information contained in this annual
report on Form 10-K,
before making an investment in our common stock. If any of the circumstances or events described below actually arises or occurs, our business, results of operations, cash flows and financial
condition could be harmed.

Risks Related to Our Business and Strategy

We have a limited operating history, expect future losses, and may be unable to achieve or maintain profitability.

We were founded on May 1, 2007 and to date we have engaged primarily in development of and initial clinical trials of our
external saphenous vein support system, or eSVS MESH. Accordingly, we have limited operating history on which to base an evaluation of our business and prospects. As of December 31, 2010, we
had an accumulated deficit of $20.1 million. We have incurred net losses in each year since our inception, and we expect to continue to incur operating losses for the foreseeable future. These
losses, among other things, have had and will continue to have an adverse effect on our stockholders' equity 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 any significant product revenues and
we have financed our operations and internal growth primarily through private placements of equity securities and convertible promissory notes. Our prospects must be considered in light of the
significant risks, expenses, and difficulties frequently encountered by medical device companies in their early stage of development. We may not be successful in addressing the risks we will
encounter, and our failure to do so would likely harm our business and our ability to continue to operate.

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The results of our initial human trial were inconclusive with respect to efficacy of our eSVS MESH and if we are unable to conclusively demonstrate the efficacy of our eSVS
MESH through additional human trials, we may be unable to commercialize our eSVS MESH in the United States or other major markets or may experience significant delays in doing so, and our ability to
generate revenue will be significantly delayed and our business will be harmed.

Our time and financial resources since our inception have largely been devoted to the development of our eSVS MESH. We have only
completed one human clinical trial of 90 patients for our eSVS MESH, which was conducted outside of the United States. The safety data from this trial has indicated that our eSVS MESH and implant
procedure do not result in an increase in patient complications during or in the 30 days after surgery. However, the effectiveness data from the trial is inconclusive primarily due to two
complicating factors. First, one of the centers participating in the trial used implant methods incompatible with our eSVS MESH. Second, the amount of reduction in the diameter of the saphenous vein
grafts, or downsizing, prescribed in our instructions for use and sizing tool was too aggressive, resulting in a higher than anticipated closure rate in saphenous vein grafts utilizing our eSVS MESH,
particularly when our smallest device, 3.0 millimeters, was used. As a result, based on angiographic studies nine to 12 months following surgery, 49% (36 of 73) of the eSVS MESH vessels
were patent or open and 81% (59 of 73) of the untreated vessels were patent. We are currently seeking FDA authorization to commence a trial in the U.S. involving a larger number of patients. In
support of our request for such authorization, we have submitted to the FDA the results of our human clinical trial outside the U.S. as well as the results of our animal studies. The efficacy data
from our trial outside the U.S. may cause the FDA to deny authorization for a larger human clinical trial in the U.S., in which case we would incur delays as we seek further efficacy data outside the
U.S.
If we are unable to demonstrate with human clinical data that our eSVS MESH is safe and improves the long term patency of saphenous vein grafts as compared to traditional CABG surgery, we will be
unable to obtain regulatory approval for, or successfully commercialize, our eSVS MESH. We have no other products ready for clinical testing or commercialization; therefore, our ability to remain in
business would be doubtful if our eSVS MESH is not proven to be safe and effective.

If
the data from our clinical trials is not adequate, we may not proceed with our planned filing of applications for regulatory approvals in the United States or other major markets, or
we may be forced to delay these 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. Delays in collecting or analyzing our clinical trial data could result in delays in filing regulatory applications with
the FDA or other regulatory authorities. The FDA or foreign regulatory authorities may also approve our eSVS MESH for very limited purposes with many restrictions on its use or in limited sizes, may
delay approvals, or ultimately may not grant marketing approval for our eSVS MESH. Although we have obtained CE Mark approval in Europe and even if we do receive FDA or other foreign regulatory
approval, we may be unable to successfully commercialize our eSVS MESH in Europe, the United States, or other major markets, and our ability to generate revenue will be significantly impaired.

Our success depends on the coronary bypass graft market and the superior outcomes of coronary bypass surgery over competitive procedures, and such superior outcomes may not
continue.

Physicians
treat coronary artery disease with methods other than CABG procedures, including interventional techniques such as balloon angioplasty with or
without the use of stents, pharmaceuticals, atherectomy catheters, and lasers. Several of these alternative treatments are widely accepted in the medical community and have a long history of use. In
addition, technological advances may result in improvements in these alternative treatments or new therapies that produce superior treatment outcomes as compared to CABG surgery. The medical device
industry is highly competitive and subject to rapid and profound technological change. Our success depends, in part, upon physicians continuing

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to
perform a significant number of CABG procedures and our ability to achieve and maintain a competitive position in the development of technologies and products in the coronary artery bypass field.
If physicians, patients, or hospitals opt to use our competitors' products, our commercial opportunity will be reduced and our potential revenues will suffer.

The market acceptance of new medical technologies is uncertain, and we may be unable to obtain market acceptance of our eSVS MESH.

Even if our clinical trials demonstrate that the use of our eSVS MESH provides equivalent or more effective results as compared to
coronary bypass operations using only the unsupported saphenous vein grafts and if all regulatory approvals are obtained, the success of our eSVS MESH will depend upon the acceptance by cardiovascular
and cardiothoracic surgeons of our eSVS MESH as equivalent or better than the current procedure using unsupported saphenous veins and other available treatments. We believe that physicians'
recommendations will be essential for the development and successful marketing of our eSVS MESH, and physicians will not begin to use our eSVS MESH unless they determine that it is a safe and
effective alternative to current treatment methods. The degree of physician and market acceptance of our eSVS MESH will depend on a number of factors, including:



If
our eSVS MESH does not achieve an adequate level of acceptance by physicians, healthcare payors, and patients, we may not generate meaningful revenue and we may not become profitable.
In addition, we have limited experience selling our eSVS MESH and our current pricing policies could adversely impact market acceptance of our eSVS MESH as compared to competing products and
treatments. Any of the foregoing factors, or other factors, could limit or detract from market acceptance of our eSVS MESH. If our eSVS MESH is not accepted by the market, our business would be
harmed.

We will be subject to intense competition and the risk of obsolescence if our competitors develop products superior to our eSVS MESH.

We face competition from established medical technology, pharmaceutical and biotechnology companies, as well as from academic
institutions, government agencies, and private and public research institutions in the United States and abroad. 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 medical

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device
or pharmaceutical products that are safer or more effective, have fewer side effects or are less expensive than coronary artery bypass surgery. For example, we are aware of companies that are
developing various other less invasive technologies for treating cardiovascular disease, which could make our technology obsolete. We also compete 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.

Furthermore,
companies with 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 have may be working on products similar to our eSVS MESH. Our eSVS MESH may not replace current surgical techniques and
other products or techniques may render our eSVS MESH obsolete. In addition, our distributors will also face competition from established companies with significantly greater financial and marketing
resources. Our competitors may produce more advanced products than ours or demonstrate superior safety of their products. Our ability to effectively compete depends on our ability to innovate
successfully. There are few barriers that would prevent new or existing competitors from developing products that compete directly with ours. Demand for our eSVS MESH could be diminished by equivalent
or superior products and technologies offered by competitors.

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
competitive position also depends on:



If
our eSVS MESH is not competitive based on these or other factors, our business would be harmed.

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We have limited manufacturing resources and experience, and if our manufacturing facilities are unable to provide an adequate supply of our eSVS MESH, our growth could be
limited and our business could be harmed.

We have limited experience in manufacturing our eSVS MESH and rely on outside vendors for several materials and processes. We currently
manufacture our eSVS MESH for our clinical trials, research and development purposes and commercialization at our manufacturing facility in Minnesota. If our existing manufacturing facility
experiences a disruption, we would have no other means of manufacturing our eSVS MESH until we are able to restore the manufacturing capability at our current facility or develop alternative
manufacturing facilities.

If
we are unable to produce sufficient quantities of our eSVS MESH for use in our current and planned clinical trials or for commercialization, or if our manufacturing process yields a
substandard product, our regulatory, development and commercialization efforts would be delayed.

In
order to produce our eSVS MESH in the quantities that will be required for commercialization, we will have to increase, or "scale up," the production process over the current level of
production. Manufacturers often encounter difficulties in scaling up production, including problems involving yields, controlling and anticipating costs, quality control and assurance, supply and
shortages of qualified personnel. If the scaled-up production process is not efficient or produces a product that does not meet quality and other standards, we may be unable to meet market
demand and our revenues, business and financial prospects would be adversely affected. The contract vendors with which we are and will be developing relationships may not have the ability to produce
the quantities of the materials needed for human clinical trials or commercial sales or may not do so at prices that allow our eSVS MESH to compete successfully in the market.

Additionally,
any damage to or destruction of our facilities or our equipment, prolonged power outage or contamination at our facilities would significantly impair our ability to produce
our eSVS MESH.

We depend upon third-party suppliers, making us vulnerable to supply problems and price fluctuations.

We rely on third-party suppliers to provide us certain components of our eSVS MESH. We depend on these suppliers to provide us with
materials in a timely manner that meet our quality, quantity and cost requirements. These suppliers may encounter problems during manufacturing for a variety of reasons, including unanticipated demand
from larger customers, failure to follow specific protocols and procedures, failure to comply with applicable regulations, equipment malfunction, quality or yield problems, and environmental factors,
any of which could delay or impede their ability to meet our demand. Our reliance on these outside suppliers also subjects us to other risks that could harm our business,
including:



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Other
than existing, unfulfilled purchase orders, our suppliers have no contractual obligations to supply us with, and we are not contractually obligated to purchase from them, any of
our supplies. Any supply interruption from our suppliers or failure to obtain additional suppliers for any of the components used in our eSVS MESH would limit our ability to manufacture our eSVS MESH
and could have a material adverse effect on our business, financial condition and results of operations. We have no reason to believe that any of our current suppliers could not be replaced if they
were unable to deliver components to us in a timely manner or at an acceptable price and level of quality. However, if we lost
one of these suppliers and were unable to obtain an alternate source on a timely basis or on terms acceptable to us, our production schedules could be delayed, our margins could be negatively
impacted, and we could fail to meet our customers' demand. Our customers will rely upon our ability to meet committed delivery dates and any disruption in the supply of key components would adversely
affect our ability to meet these dates and could result in legal action by our customers, cause us to lose customers or harm our ability to attract new customers, any of which could decrease our
revenue and negatively impact our growth. In addition, to the extent that our suppliers use technology or manufacturing processes that are proprietary, we may be unable to obtain comparable materials
or components from alternative sources.

Manufacturing
operations are often faced with a supplier's decision to discontinue manufacturing a component, which may force us to make last time purchases, qualify a substitute part,
or make a design change which may divert engineering time away from the development of new products.

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

Even if we are able to contract with manufacturers for key materials or supplies, we may experience future manufacturing difficulties.
Any difficulties in locating and hiring material manufacturers or in the ability of manufacturers to supply materials at the times and in the quantities we need, and at prices that allow us to
compete, could have a material adverse effect on our business.

The
production of our eSVS MESH 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. In addition, we must meet certain lot release
specifications before our eSVS MESH can be shipped to our clinical trial sites or to commercial markets. If a particular lot fails to meet lot release specifications, we will not be able to ship that
lot to our clinical trial sites or to commercial markets. If we are not able to maintain stringent quality controls, if contamination problems arise or if we are not able to meet our lot release
specifications, our clinical trials or sales efforts could be delayed, which would harm our business and our results of operations.

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Our business is subject to risks relating to operating internationally.

As part of our product development and regulatory strategy, we intend to market our eSVS MESH internationally. There are a number of
risks associated with conducting business internationally, including:



Any
of these risks could adversely affect our international operations or financial results, which would harm our business.

We could become subject to product liability claims, product recalls, other field actions and warranty claims that could be expensive, divert management's attention, and
harm our business.

We face an inherent risk of exposure to product liability claims in the event that the use of our eSVS MESH results or is alleged to
have resulted in adverse effects to a patient. In many jurisdictions, producers of medical products are strictly liable for personal injuries caused by medical devices. A product liability claim
against us, even if we are ultimately successful in defending it, could have a material adverse effect on our business, results of operations and reputation.

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We may be held liable if our eSVS MESH causes injury or death or is found otherwise unsuitable during usage. Because our eSVS MESH is designed to be used in
complex surgical procedures, defects could result in a number of complications, including serious injury or death. It is also possible that defects in the design, manufacture or labeling of our eSVS
MESH might necessitate a product recall or other field corrective action, which may result in warranty claims beyond our expectations and may harm our reputation. We believe potential disadvantages
associated with our eSVS MESH include the possibility of allergic reaction to the implant materials and the possibility of damage to the saphenous vein during placement of our eSVS MESH. A product
liability claim, regardless of its merit or eventual outcome, could result in significant legal defense costs. The coverage limits of our insurance policies may not be adequate to cover future claims.
We may be unable to maintain product liability insurance in the future at satisfactory rates or with adequate amounts. A product liability claim, any product recalls or other field actions or
excessive warranty claims, whether arising from defects in design or manufacture or otherwise, could divert management's attention from our core business, be expensive to defend and result in sizable
damage awards against us, any of which could harm our reputation and business.

If third-party payors do not provide sufficient coverage or reimbursement to healthcare providers for the use of our eSVS MESH, our acceptance in the marketplace would be
harmed.

The availability of insurance coverage and reimbursement for newly approved medical devices and procedures is uncertain. Our success
depends upon the use of our eSVS
MESH and whether third-party insurance coverage and reimbursement for the use of this product is available.

Our
success in international markets depends upon the eligibility of reimbursement for our eSVS MESH through government-sponsored healthcare payment systems and third-party payors.
Reimbursement and healthcare payment systems in international markets vary significantly by country and, within some countries, by region. In many international markets, payment systems may control
reimbursement for procedures performed using new products as well as procurement of these products. As an example, we were recently denied government-sponsored reimbursement in Germany for our eSVS
MESH for calendar year 2011. In addition, as economies of emerging markets develop, these countries may implement changes in their healthcare delivery and payment systems. Furthermore, healthcare cost
containment efforts similar to those underway in the United States are prevalent in many of the other countries in which we intend to sell our eSVS MESH and these efforts are expected to continue.
Market acceptance of our eSVS MESH in a particular country may depend on the availability and level of reimbursement in that country. In the event that our customers are unable to obtain adequate
reimbursement for our eSVS MESH in international markets in which we are seeking to sell our eSVS MESH, market acceptance of our eSVS MESH would be adversely affected.

In
the United States, our eSVS MESH would be purchased primarily by medical institutions, which would then bill various third-party payors, such as the Centers for Medicare &
Medicaid Services, or CMS, which administer the Medicare program, and other government programs and private insurance plans, for the healthcare services provided to their patients. The process
involved in applying for coverage and incremental reimbursement from CMS is lengthy and expensive. Even if our eSVS MESH receives FDA and other regulatory approval, it may not be granted coverage and
reimbursement in the foreseeable future, if at all. Moreover, many private payors look to CMS in setting their reimbursement policies and amounts. If CMS or other agencies limit coverage or decrease
or limit reimbursement payments for doctors and hospitals, this may affect coverage and reimbursement determinations by many private payors.

CMS
may not provide coverage and reimbursement for our eSVS MESH. If a medical device does not receive incremental reimbursement from CMS, then a medical institution would have to absorb
the cost of our eSVS MESH as part of the cost of the procedure in which the products are used. Acute care hospitals are now generally reimbursed by CMS for inpatient operating costs under a Medicare

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hospital
inpatient prospective payment system. Under the Medicare hospital inpatient prospective payment system, acute care hospitals receive a fixed payment amount for each covered hospitalized
patient based upon the Diagnosis-Related Group, or DRG, to which the inpatient stay is assigned, regardless of the actual cost of the services provided. At this time, we do not know the extent to
which medical institutions would consider insurers' payment levels adequate to cover the cost of our eSVS MESH. Failure by hospitals and physicians to receive an amount that they consider to be
adequate reimbursement for procedures in which our eSVS MESH is used could deter them from purchasing our eSVS MESH and limit our revenue growth. In addition, pre-determined DRG payments
may decline over time, which could deter medical institutions from purchasing our eSVS MESH. If
medical institutions are unable to justify the costs of our eSVS MESH, they may refuse to purchase it, which would significantly harm our business.

We may not be able to attract and retain the technical, regulatory, and sales personnel necessary for our success, which may divert management's attention and negatively
impact our operations.

We are highly dependent on our senior management, specifically Manny Villafaña, our Chairman and Chief Executive
Officer, and Michael Winegar, our Chief Operating Officer and Vice President of Regulatory Affairs. The loss of services of either of these individuals would impair our ability to commercialize our
eSVS MESH and develop new products and would harm our business. Our success will depend on our ability to retain our senior management and to attract and retain qualified personnel in the future.
Competition for senior management personnel, as well as clinical and regulatory specialists, engineers and sales personnel, is intense and we may not be able to retain our personnel. The loss of a
member of our senior management or our professional staff would require the remaining senior executive officers to divert immediate and substantial attention to seeking a replacement. Each of our
senior officers may terminate his employment at any time without notice and without cause or good reason. We do not carry key person life insurance on any of our employees. If we lose the services of
any key personnel, our business, financial condition and results of operations may suffer.

We will need to increase the size of our organization and we may experience difficulties managing growth. If we are unable to manage the anticipated growth of our business,
our future revenue and operating results may be adversely affected.

We expect to expand our manufacturing operations, sales support and marketing staff, and administrative and financial resources to meet
anticipated growth in demand for our eSVS MESH. We may face difficulties in recruiting, training, managing and retaining an adequate number of qualified personnel to support this growth. Rapid
expansion in personnel may mean that less experienced people could be manufacturing and providing clinical and sales and marketing support for our eSVS MESH, and managing our administrative and
financial functions, which could result in unanticipated costs and disruptions to our operations. If we cannot scale and manage our business appropriately, our anticipated growth may be impaired and
our financial results will suffer.

Becoming a public company will cause us to incur increased costs and demands on our management and divert management's attention from our core business.

The obligations of being a public company, including substantial public reporting and auditing obligations, requires significant
additional expenditures, places additional demands on our management and diverts management's time and attention away from our core business. These additional obligations may require us to hire
additional personnel in order to ensure compliance with the regulatory requirements of the Securities and Exchange Commission and the NASDAQ Global Market. We will be required to report on our
internal controls, as required by Section 404 of the Sarbanes-Oxley Act, beginning with our annual report for the year ending December 31, 2011. We cannot be certain as to

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the
timing of completion of our evaluation, testing and remediation actions relating to our internal controls or the impact of the same on our operations. Our management may not be able to effectively
and timely implement controls and procedures that adequately respond to the increased regulatory compliance and reporting requirements that are now applicable to us as a public company. If we fail to
staff our accounting and finance function adequately or maintain internal controls adequate to meet the demands that will be placed upon us as a public company, including the requirements of the
Sarbanes-Oxley Act, we may be unable to report our financial results accurately or in a timely manner and our business and stock price may suffer. The costs of being a public company, as well as
diversion of management's time and attention, may harm our business, financial condition and results of operations.

Risks Related to Our Intellectual Property

If we are unable to protect our intellectual property rights, our ability to compete will be harmed.

We currently rely upon trade secret laws and confidentiality agreements to protect our technology. We have six patent applications
currently pending in the United States and eleven patent applications pending in countries outside the United States (including one Canadian application, one Japanese application, and one European
application for which we recently received notices of allowance) on our eSVS MESH. We also have one pending international patent application which will be filed in Europe and Japan by May 2011. Some
of our pending patent applications have been examined and currently stand rejected, while others have been allowed. These currently rejected
patent applications relate to intellectual property that we believe is significant to the design of our eSVS MESH. We will continue to pursue obtaining patents from these rejected applications and
other pending patent applications. Although we have received a favorable decision from the BPAI reversing the initial rejection of the first of these applications, we have recently received a new
rejection of this application. Our pending patent applications may not mature into issued patents, or, if issued, may not issue in a form that is desirable or advantageous to us. In that case, we
would be exposed to a greater risk of direct competition. Competitors could purchase our eSVS MESH and attempt to replicate some or all of the competitive advantages we derive from our eSVS MESH or
competitors could more readily be able to design around our technology. We began marketing and commenced shipments of our eSVS MESH in select European Union markets in June 2010, before any of our
pending European patent applications have issued as patents. Any patents we obtain in the future might be invalidated or circumvented by third parties. If any challenges are successful or if we fail
to obtain patents from pending applications, competitors might be able to market products and use manufacturing processes that are substantially similar to ours. We may not be able to prevent the
unauthorized disclosure or use of our technical knowledge or other trade secrets by consultants, vendors or former or current employees, despite the existence generally of confidentiality agreements
and other contractual restrictions. Monitoring unauthorized use and disclosure of our intellectual property is difficult, and we do not know whether the steps we have taken to protect our intellectual
property will be adequate. In addition, the laws of many foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States. If our intellectual
property is not adequately protected against competitors' products and methods, our competitive position could be adversely affected, as could our business.

In
the event a competitor infringes upon our patent or other intellectual property rights, enforcing those rights may be difficult and time consuming. Even if successful, litigation to
enforce our intellectual property rights or to defend our patents against challenge could be expensive and time consuming and could divert our management's attention. We may not have sufficient
resources to enforce our intellectual property rights or to defend our patents against a challenge.

We
also rely upon trade secrets, technical know-how and continuing technological innovation to develop and maintain our competitive position. We require our employees to
execute appropriate confidentiality and assignment-of-inventions agreements with us. These agreements typically provide that all materials and confidential information
developed or made known to the individual during the

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course
of the individual's relationship with us be kept confidential and not disclosed to third parties except in specific circumstances and that all inventions arising out of the individual's
relationship with us will be our exclusive property. Additionally, we seek to have our consultants and advisors execute similar confidentiality and assignment-of-inventions
agreements with us, but in some instances these agreements have not included assignment-of-invention provisions. These agreements may be breached, and in some instances, we may
not have an appropriate remedy available for breach of the agreements. Furthermore, our competitors may independently develop substantially equivalent proprietary information and techniques, reverse
engineer our information and techniques, or otherwise gain access to our proprietary technology.

Claims of infringement or misappropriation of the intellectual property rights of others could prohibit us from commercializing our eSVS MESH and harm our business.

The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights,
and companies in the industry have used intellectual property litigation to gain a competitive advantage. We may become a party to patent infringement claims and litigation or interference proceedings
declared by the U.S. Patent and Trademark Office to determine the priority of inventions. The defense and prosecution of these matters are both costly and time consuming.

Additionally,
we may need to commence proceedings against others to enforce our patents, to protect our trade secrets or know-how or to determine the enforceability, scope
and validity of the proprietary rights of others. These proceedings would result in substantial expense to us and significant diversion of effort by our technical and management personnel.

We
are aware of patents issued to third parties that contain subject matter related to our technology. These or other third parties may assert that our eSVS MESH infringes the claims in
their patents or seek to expand their patent claims to cover aspects of our eSVS MESH. An adverse determination in litigation or interference proceedings to which we may become a party could subject
us to significant liabilities or require us to seek licenses. In addition, if we are found to willfully infringe third-party patents, we could be required to pay treble damages in addition to other
penalties. Although patent and intellectual property disputes in the medical device area have often been settled through licensing or similar arrangements, costs associated with these arrangements may
be substantial and could include ongoing royalties. We may be unable to obtain necessary licenses on satisfactory terms, if at all. If we do not obtain necessary licenses, we may be required to
redesign our eSVS MESH to avoid infringement, and it may not be possible to do so effectively. Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses
could cause us to incur significant costs, place significant strain on our resources, divert management's attention from our business and harm our reputation and prevent us from commercializing our
eSVS MESH or any other product we may develop, which would have a significant adverse impact on our business. Some of our competitors may be able to sustain the costs of complex patent litigation more
effectively than we can because they have substantially greater resources.

If the core intellectual property relating to our eSVS MESH reverts to Medtronic, Inc., our business will be adversely affected.

The core intellectual property relating to our eSVS MESH, including five patent applications pending in the United States and nine
patent applications pending in countries outside the United States, was sold to us by Medtronic, Inc. pursuant to an Assignment and License Agreement dated October 9, 2007. Any or all licenses
granted to us pursuant to our agreement with Medtronic may be terminated and potentially all of the core intellectual property and patent rights related to our eSVS MESH will revert to Medtronic, upon
notice by Medtronic, if we become insolvent, make an assignment for the benefit of creditors, go into liquidation or receivership or otherwise lose legal

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control
of our business. Medtronic may also cause the core intellectual property and patent rights related to our eSVS MESH to revert to Medtronic if we determine to cease commercializing our eSVS
MESH. The agreement with Medtronic does not define what constitutes "commercializing" for these purposes and we may disagree with Medtronic as to whether any delays, suspensions or deprioritizing of
our activities with respect to our eSVS MESH constitute a determination to cease commercializing. A dispute over the circumstances under which the core intellectual property rights revert to Medtronic
could be expensive and time consuming, and any reversion of these rights to Medtronic would adversely affect our business.

Risks Related to Regulatory Approval and Other Government Regulations

We will be subject to government regulation, and we may not receive approval for our eSVS MESH in the United States on a timely basis, if at all.

Our eSVS MESH, product development activities and manufacturing processes are, and will continue to be, subject to extensive and
rigorous scrutiny and regulation by the FDA and by comparable agencies in foreign countries. In the United States, the FDA regulates the introduction of medical devices, as well as manufacturing,
labeling and record keeping procedures for such products. The process of obtaining marketing clearance or approval for new medical products from the FDA is costly and time consuming, and there can be
no assurance that such approval will be granted for our eSVS MESH on a timely basis, if at all, or that the FDA review will not involve delays that would adversely affect our ability to commercialize
our eSVS MESH. Even if regulatory clearance
or approval to market a product is obtained from the FDA, this clearance or approval may entail limitations on the indicated uses of the product. Marketing clearance or approval can also be withdrawn
by the FDA due to failure to comply with regulatory standards or the occurrence of unforeseen problems following initial clearance.

The
FDA will require us to file a Pre-Market Approval, or PMA, application with regard to our eSVS MESH, and there is no assurance whatsoever that approval will be obtained.
Even if approval is obtained, the process of obtaining a PMA is expensive, uncertain and lengthy, frequently requiring several years from the date of submission. Changing FDA policies and requirements
for PMA products may add additional uncertainty. Significant delay or failure to obtain FDA approval to market our eSVS MESH would harm our business.

The FDA may not approve our investigational device exemption application for our eSVS MESH, which would prevent us from conducting our clinical trials in the United States,
and even if the FDA does grant such approval, our clinical trials may be more costly and burdensome than we currently anticipate, which would limit or delay our ability to complete clinical trials and
ultimately market our eSVS MESH in the United States.

The U.S Food and Drug Administration, or FDA, has reviewed and disapproved our most recent amendment to our application for an
investigational device exemption, of IDE. Follow-up conversations with the FDA have been held to further understand the FDA requirements in order to obtain our IDE approval. The FDA has
recently indicated that they need to review our IDE information with outside experts before they provide further guidance to the Company. The IDE approval, if obtained before the end of the third
quarter of 2011, would allow us to begin the clinical trials of our eSVS MESH in the United States in 2011. However, we could be delayed by adverse clinical results or regulatory complications, and we
may never receive U.S. marketing approval.

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If the FDA approves our IDE application, the clinical trials we conduct may have unanticipated complications and delays and may be more costly than we currently
anticipate. The FDA may approve our IDE application with conditions relating to the scope or design of our clinical trials for which we have not planned. These conditions may require us to collect
additional data, enroll more patients, spend more time and expend more resources than we currently anticipate, and these conditions may make a clinical trial in the United States more costly and time
consuming than we currently plan. Any unanticipated costs and length of U.S. clinical trials would delay our ability to market our eSVS MESH in the United States, which would harm our business.

If
the FDA does not approve our IDE application, we would be unable to conduct clinical trials of our eSVS MESH in the United States. If our IDE application is not approved and we are
unable to conduct U.S. clinical trials, we would not be able to submit a PMA application and we would be unable to market our eSVS MESH in the United States, which would have an adverse effect on our
business.

Even if our eSVS MESH is approved by regulatory authorities, if we fail to comply with ongoing regulatory requirements, or if we experience unanticipated problems with our
eSVS MESH, it 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 our eSVS MESH is granted in
the United States, 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 effectiveness of the product. Later discovery of previously unknown problems with our eSVS MESH, including unanticipated adverse events or adverse events of
unanticipated severity or frequency, manufacturer or manufacturing processes, 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.

We will be highly dependent on third-party institutions to conduct our clinical testing, and the results of such testing may delay or prevent regulatory approval of our eSVS
MESH.

We rely on clinical investigators and clinical trial sites to enroll patients in our clinical trials and other third parties to manage
our trials and to perform related data collection and analysis. However, we are not able to control the amount and timing of resources that clinical trial sites devote to our clinical trials. If these
clinical investigators and clinical trial sites fail to enroll a sufficient number of patients in our clinical trials or fail to ensure compliance by patients with clinical protocols, we will be
unable to complete our planned trials, which could prevent us from obtaining regulatory approvals for our eSVS MESH. Our agreements with clinical investigators and clinical trial sites for clinical
testing place substantial responsibilities on these parties and, if these parties fail to perform as expected, our planned trials could be delayed or terminated. If these clinical investigators,
clinical trial sites, or other third parties do not carry out their contractual duties or obligations or fail to meet expected deadlines, or if the quality or accuracy of the clinical data they obtain
is compromised due to their failure to adhere to our clinical protocols, the FDA's good clinical practice regulations or for other reasons, our clinical trials may be extended, delayed or terminated,
and we may be unable to obtain regulatory approval for, or successfully commercialize, our eSVS MESH.

In
addition, the data obtained from human clinical testing is subject to varying interpretations that could delay, limit or prevent regulatory approval, and delays or rejection may be
encountered based upon changes in FDA policy for device approval during the period of development.

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Our facilities will be subject to inspection by the FDA and international authorities, and we could face penalties if we are found to be non-compliant with the
regulations of the FDA or international authorities.

The FDA and various other authorities will inspect our facilities from time to time to determine whether we are in compliance with
regulations relating to medical device manufacturing, including regulations concerning design, manufacturing, testing, quality control, product labeling, distribution, promotion, and record keeping
practices. A determination that we are in material violation of such regulations could lead to the imposition of civil penalties, including fines, product recalls, product seizures or, in extreme
cases, criminal sanctions. Even if regulatory approvals to market a product are obtained from the FDA, such approvals may contain limitations on the indicated uses of our eSVS MESH. The FDA could also
limit or prevent the manufacture or distribution of our eSVS MESH and has the power to require the recall of products. FDA regulations depend heavily on administrative interpretation, and there can be
no assurance that the future interpretations made by the FDA or other regulatory bodies with possible retroactive effect will not adversely affect us.

Our promotional and marketing activities will be subject to regulation by the FDA and international authorities, and we could face severe penalties if we are found to be
promoting our eSVS MESH for an unapproved use.

If the FDA or international authorities determine that our promotional materials or activities constitute promotion of our eSVS MESH
for an unapproved use, it could demand that we cease the use of or modify our promotional materials or subject us to regulatory enforcement actions, including the issuance of a warning letter,
injunction, civil fine and criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider promotional or other materials to
constitute promotion of our eSVS MESH for an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for
reimbursement.

Our success will also be dependent on complying with foreign regulatory requirements, and our inability to do so could result in sales of our eSVS MESH being restricted
internationally.

Our revenues will initially be dependent upon sales of our eSVS MESH outside the United States. Foreign regulatory bodies have
established varying regulations governing product standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. We will rely heavily
upon independent foreign distributors to comply with such foreign regulatory requirements. Our inability or failure or the inability or failure of such foreign distributors to comply with varying
foreign regulation or the imposition of new regulations could restrict the sale of our eSVS MESH internationally and thereby harm our business.

Legislation may negatively affect coverage and reimbursement levels for our eSVS MESH.

Even if third-party payors provide adequate coverage and reimbursement for our eSVS MESH, adverse changes in third-party payors'
general policies toward reimbursement could preclude market acceptance for our eSVS MESH and harm our potential sales and revenue growth, which in turn would harm our business. Recently, healthcare
reform legislation was signed into law in the United States and we expect that there will continue to be legislative proposals for governmental controls over healthcare in the United States and other
countries. Some third-party payors also require pre-approval of coverage or companies to demonstrate the superiority of their product before they will reimburse healthcare providers who
use such devices or procedures.

The
trend toward managed healthcare in the United States and other countries and legislation intended to reduce the cost of government insurance programs will significantly influence the
purchase of healthcare services and products, and could result in lower or no reimbursement for our eSVS

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MESH.
It is uncertain whether our eSVS MESH will be viewed as sufficiently cost-effective to warrant adequate coverage and reimbursement levels.

Our operations involve hazardous materials, and we must comply with environmental laws and regulations.

We are subject to a variety of state and local regulations relating to the use, handling, storage, disposal and human exposure to
hazardous and toxic materials. We currently generate small quantities of waste alcohol and acids, classifying us as a Very Small Quantity Generator with the Minnesota Pollution Control Agency, which
requires us to comply with county and state registration requirements. We expect that compliance costs will be less than $5,000 for 2011. However, environmental laws could become more stringent over
time, and we may increase the use of hazardous materials in our operations in the future, which could impose greater compliance costs on us and increase the risks and penalties associated with
violations, any of which could harm our business. Compliance with future environmental and safety laws and regulations could restrict our ability to expand our facilities, impair our research,
development or production efforts, or require us to incur other significant expenses. We could incur costs, fines and civil and criminal sanctions, third-party property damage or personal injury
claims, or could be required to incur substantial investigation or remediation costs, if we were to violate or become liable under environmental laws. There can be no assurance that violations of
environmental laws or regulations will not occur in the future as a result of the inability to obtain permits, human error, accident, equipment failure or other causes.

Risks Related to Our Common Stock

Prior to our initial public offering, there had not been a public market for our common stock and our stock price may be volatile and decrease significantly in the future.

Prior to our initial public offering in February 2011, there had not been a public market for our common stock. We cannot predict the
extent to which investors' interests will lead to an active trading market for our common stock or whether the market price of our common stock will be volatile in the future. If an active trading
market does not develop or is not sustained, investors may have difficulty selling any of our common stock. In addition to the risk factors discussed elsewhere in this section, the following factors,
most of which are outside of our control, could cause the market price of our common stock to decrease significantly in the future:



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Each
of these factors could cause the market price of our stock to decline significantly in the future.

In
addition, the stock markets have been extremely volatile. Securities class action litigation is often initiated against a company following a period of volatility in the market price
of the company's securities. If class action litigation is initiated against us, we would incur substantial costs and our management's attention would be diverted from our operations.

If equity research analysts do not publish research or reports about our business or if they issue unfavorable research or downgrade our common stock, the price of our
common stock could decline.

The trading market for our common stock will rely in part on the research and reports that equity research analysts publish about us
and our business. We do not control these analysts. Equity research analysts may elect not to provide research coverage of our common stock, which may adversely affect the market price of our common
stock. If equity research analysts do provide research coverage of our common stock, the price of our common stock could decline if one or more of these analysts downgrade our common stock or if they
issue other unfavorable commentary about us or our business. If one or more of these analysts ceases coverage of our company, we could lose visibility in the market, which in turn could cause our
stock price to decline.

Future sales of our common stock by our existing stockholders could cause our stock price to decline and cause you to lose part or all of your investment.

If our stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could
decrease significantly. The perception in the public market that our stockholders might sell shares of our common stock could also depress the market price of our common stock. Substantially all of
our existing stockholders prior to our initial public offering in February 2011 are subject to lock-up agreements that restrict their ability to transfer their shares of our common stock
for at least 180 days after the effective date of our registration statement on Form S-1, which was February 10, 2011, subject to certain exceptions. Upon expiration
of the lock-up period, shares of our common stock will be eligible for sale in the public market. In addition, we intend to file registration statements with the SEC covering
(a) any shares of our common stock acquired upon option exercises prior to the closing of our initial public offering, (b) all of the shares subject to options outstanding, but not
exercised, as of the closing of our initial public offering and (c) all of the shares available for future issuance under our stock incentive plan upon the closing of our initial public
offering. The market price of shares of our common stock may decrease significantly when the restrictions on resale by our existing stockholders lapse and our stockholders, warrant holders and option
holders are able to sell shares of our common stock into the market. A decline in the price of shares of our common stock might impede our ability
to raise capital through the issuance of additional shares of our common stock or other equity securities, and our ability to grow our business in the future.

Our directors, executive officers and significant stockholders have substantial control over us and could limit stockholders' ability to influence the outcome of key
transactions, including changes of control.

As of March 25, 2011, our directors and executive officers and their affiliated entities beneficially own 37.3% of our
outstanding common stock. In addition, Kips Bay Investments, LLC beneficially owns 42.9% and Mr. Villafaña, our Chairman and Chief Executive Officer, beneficially owns
34.1% of our outstanding common stock, and together are able to control or influence significantly all matters requiring approval by our stockholders. Our directors, executive officers, significant
stockholders and affiliated entities, if acting together, are able to control or influence significantly all matters requiring

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approval
by our stockholders, including the election of directors and the approval of mergers or other significant corporate transactions. These stockholders may have interests that differ from other
stockholders, and they may vote in a way with which other stockholders disagree and that may be adverse to the interests of other stockholders. The concentration of ownership of our common stock may
have the effect of delaying, preventing or deterring a change of control of our company, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale
of our company, and may affect the market price of our common stock. This concentration of ownership of our common stock may also have the effect of influencing the completion of a change in control
that may not necessarily be in the best interests of all of our stockholders.

Our charter documents and Delaware law may inhibit a takeover that stockholders consider favorable and our certificate of incorporation allows us to authorize and issue
preferred stock with rights and preferences superior to our common stock without stockholder approval.

Provisions of our certificate of incorporation and amended and restated 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:



In
addition, Section 203 of the Delaware General Corporation Law generally limits our ability to engage 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 stockholders of the opportunity to sell their 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.

We do not intend to declare dividends on our common stock and stockholders should not expect to receive dividends on their common stock in the foreseeable future.

We currently intend to retain all future earnings for the operation and expansion of our business and, therefore, do not anticipate
declaring or paying cash dividends on our common stock in the foreseeable future. Any payment of cash dividends on our common stock will be at the discretion of our board of directors and will depend
upon our results of operations, earnings, capital requirements, financial condition, future prospects, contractual restrictions and other factors deemed relevant by our board of directors. Therefore,
our stockholders should not expect to receive dividend income from shares of our common stock.

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We anticipate future losses and may require additional financing, and our failure to obtain additional financing when needed could force us to delay, reduce or eliminate our
product development programs or commercialization efforts.

We expect to incur losses for the foreseeable future, and we may require future financing in order to satisfy our capital requirements.
In particular, we may require additional capital in order to continue to conduct the research and development and obtain regulatory clearances and approvals necessary to bring any future products to
market and to establish effective marketing and sales capabilities for existing and future products. Additional funds may not be available when we need them on terms that are acceptable to us, or at
all. If adequate funds are not available on a timely basis, we may terminate or delay the development of our eSVS MESH, or delay establishment of sales and marketing capabilities or other activities
necessary to commercialize our eSVS MESH.

Our
future capital requirements will depend on many factors, including:



Raising additional capital may cause dilution to our stockholders or restrict our operations.

To the extent that we raise additional capital through the sale of equity or convertible debt securities, stockholders' ownership
interest will be diluted, and the terms may include liquidation or other preferences that adversely affect their rights as stockholders. Debt financing, if available, may involve agreements that
include covenants limiting or restricting our ability to take specific actions such as incurring additional debt, making capital expenditures or declaring dividends. Any of these events could
adversely affect our ability to achieve our product development and commercialization goals and harm our business. We expect that the proceeds from our initial public offering in February 2011 will be
sufficient to fund our planned operations for at least the next 12 months, and we have no current intention to enter into any credit facility or loan agreement, but may do so in the future. We
do not anticipate any adverse effects stemming from the lack of available credit facilities at this time.

Item 1B.    Unresolved Staff Comments

None.

Item 2.    Properties

We lease approximately 5,000 square feet of office, laboratory, manufacturing and warehouse space at 3405 Annapolis Lane North,
Suite 200, Minneapolis, Minnesota. In June 2010, we executed an amendment to our lease that extends the lease term through September 30, 2011. The amendment also provides us a right of
first refusal to lease approximately 11,000 additional square feet of space adjoining our current facility. Our corporate offices, research and development facilities, prototype development,
manufacturing, warehousing, and shipping facilities are located at this facility.

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Item 3.    Legal Proceedings

We are not a party to any pending or threatened litigation.

Item 4.    [Removed and Reserved]

Executive Officers of the Registrant

The name, age and position of each of our executive officers as of the date of this annual report are as follows:

Name

Age

PositionManny Villafaña


70

Chairman of the Board and Chief Executive OfficerMichael P. Winegar


50

Chief Operating Officer and Vice President of Regulatory AffairsScott Kellen


45

Chief Financial Officer, Vice President of Finance, and Secretary


Manny Villafañais our founder, and has been our Chairman of the Board and Chief Executive Officer since our inception in
2007. Prior to founding us and since 1999, Mr. Villafaña founded and served as Chairman of the Board and Chief Executive Officer of CABG Medical, Inc., formed to develop
an artificial coronary graft for use in bypass surgery. From 1987 to 2004, Mr. Villafaña founded and served as Chairman of the Board and Chief Executive Officer of ATS
Medical, Inc., which developed open-pivot mechanical heart valves. ATS Medical was subsequently acquired by Medtronic, Inc. From 1976 to 1982,
Mr. Villafaña founded and served as President and Chairman of the Board of St. Jude Medical, Inc. From 1972 to 1976, Mr. Villafaña founded and
served as President and Chairman of the Board of Cardiac Pacemakers, Inc., or CPI, a cardiac rhythm management company. CPI was ultimately acquired by Eli Lilly and Company, which spun out CPI
as Guidant Corporation. Guidant was, in turn, purchased by Boston Scientific Corporation.

Mr. Villafaña
has received numerous awards and honors, including the "Living Legend of Medicine" award from the International Society of Cardio Thoracic Surgeons,
the Ellis Island Medal of Honor, the Grand Prize RecipientMediterranean Institute of Cardiology, the Ernst & Young LLP National Master Entrepreneur of the Year, the Top 100
Hispanics in the USA, the Boys and Girls Club of America Hall of Fame, and induction into the Minnesota Business Hall of Fame.

Michael P. Winegarjoined us as Chief Operating Officer and Vice President of Regulatory Affairs in September 2007, and as a director in
February 2011. From 2006 to September 2007, Mr. Winegar was the Vice President of Regulatory and Quality at Enpath Medical, Inc., up to and through the company's acquisition by
Greatbatch, Inc. While at Enpath, Mr. Winegar oversaw the regulatory and quality functions of various Class II and III devices and coordinated relevant functions for facility
consolidations. From 2001 to 2005, Mr. Winegar was an early employee of ev3 Inc., holding various management positions in the Regulatory Affairs, Clinical Research, and Quality Assurance
departments. From 2000 to 2001, Mr. Winegar was the Vice President of Regulatory Affairs, Clinical Research, and Quality Assurance for Myocor, Inc., where he oversaw the first chronic
implants of Myocor heart failure therapy technologies. Mr. Winegar began his career with positions at Medical Incorporated, Medtronic, Inc., SciMed Life Systems Inc., and Boston
Scientific Corporation. Mr. Winegar has also acted as a medical device industry consultant in the areas of regulatory affairs, quality assurance, and clinical research.

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Scott Kellenjoined us as Chief Financial Officer, Vice President of Finance, and Secretary in February 2010. From 2007 to 2009,
Mr. Kellen served as Director of Finance from 2007 to 2009 and Chief Financial Officer from February 1, 2009 to May 1, 2009 for Transoma Medical, Inc., including during the
preparation of its proposed initial public offering, which was withdrawn in February 2008 due to deteriorated market conditions. From 2005 to 2007, Mr. Kellen served as the Corporate Controller
for ev3 Inc. during the company's initial public offering and during additional follow-on offerings. From 2003 to 2005, Mr. Kellen served as Senior Audit Manager of
Deloitte & Touche, LLP (now Deloitte LLP), providing auditing and consulting services to mid-size public companies after the passage of the Sarbanes-Oxley Act.
Altogether, Mr. Kellen has spent more than 12 years in the medical device industry, serving early stage and growth companies that produced Class II and III devices.
Mr. Kellen began his career with Deloitte & Touche in 1987.

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Table of Contents

PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock began trading on the NASDAQ Global Market on February 11, 2011 under the symbol "KIPS" in connection with our
initial public offering. Our stock was not publicly traded during fiscal 2010.

As
of March 25, 2011, there were 68 registered holders of our common stock.

Dividends

We have never paid cash dividends on any of our securities. We currently intend to retain any earnings for use in operations and do not
anticipate paying cash dividends in the foreseeable future.

Recent Sales of Unregistered Equity Securities

None.

Purchase of Equity Securities by the Company

None.

Use of Proceeds

We completed our initial public offering of shares of common stock (the "Offering") during the first quarter of our 2011 fiscal year.
The effective date of our registration statement relating to the Offering, filed on Form S-1 under the Securities Act of 1933 (File No. 333-165940), was
February 10, 2011. A total of 2,062,500 shares of our common stock were registered and sold in the Offering. In addition, we granted Rodman & Renshaw, LLC ("Rodman"), the
underwriter of the Offering, and its designees a 45 day over-allotment option to purchase 309,375 shares at $8.00 per share, less an underwriting discount of $0.56 per share.
This option expired unexercised. We also granted to Rodman a warrant to purchase 103,125 shares of our common stock which becomes exercisable at a price of $10.00 per share on
February 10, 2012 and expires on February 10, 2016.

The
aggregate offering price of our securities sold was $16.5 million. The aggregate underwriting discount for shares sold in the offering was $1.1 million, none of which
was or will be paid to our affiliates. We incurred approximately $1.7 million of offering costs in connection with the Offering, including a non-accountable expense allowance to
Rodman of $165,000. We received net proceeds from this Offering of approximately $13.6 million. We have used and intend to use the proceeds from the Offering to fund the process of seeking
regulatory approval to market our eSVS MESH in the United States and abroad, including human clinical trials in the United States; fund the development and testing of additional applications of our
eSVS MESH; fund certain milestone payments payable to Medtronic, Inc. for the acquisition of certain intellectual property rights to our eSVS MESH; and for working capital and general corporate
purposes, including commercialization activities for our eSVS MESH in select European and other international markets and for the purchase of capital equipment and expansion of facilities.

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Item 6.    Selected Financial Data

Selected Financial Data

The following tables summarize our selected financial data for the periods and as of the dates indicated. The selected financial data
should be read in conjunction with, and are qualified by reference to, our financial statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this annual report. The following selected financial data as of December 31, 2010 and 2009 and for the years ended December 31, 2010, 2009 and 2008 are
derived from, and should be read together with, our audited financial statements included elsewhere in this annual report. We have derived the selected financial data as of December 31, 2008
and 2007 and for the year ended December 31,2008 and the period from May 1, 2007 (inception) through December 31, 2007 from our audited financial statements not included in this
annual report. The historical results are not necessarily indicative of results to be expected in any future period.

Period from
May 1, 2007 (Date
of Inception) to
December 31,
2007

Period from
May 1, 2007 (Date
of Inception) to
December 31,
2010Year Ended December 31,2010

2009

2008(In thousands, except share and per share amounts)Statements of Operations Data:Net sales

$
223

$


$


$


$
223Cost of sales


(77
)










(77
)Gross profit


146











146Operating expenses:Research and development


2,521


3,004


2,635


196


8,356Selling, general and administrative


1,326


779


754


381


3,240Milestone expense


5,000











5,000Operating loss


(8,701
)

(3,783
)

(3,389
)

(577
)

(16,450
)Interest income


12


17


52


65


146Interest expense


(1
)

(181
)

(390
)

(164
)

(736
)Realized gain on sale of short-term investments


46











46Impairment of available for sale securities








(85
)




(85
)Change in fair value of investor stock purchase option


(2,290
)

610








(1,680
)Net loss before income taxes


(10,934
)

(3,337
)

(3,812
)

(676
)

(18,759
)Provision for income tax benefit


42











42Net loss attributable to common stockholders

$
(10,892
)
$
(3,337
)
$
(3,812
)
$
(676
)
$
(18,717
)Basic and diluted net loss per share

$
(0.81
)
$
(0.30
)
$
(0.62
)
$
(0.16
)Weighted average common shares outstandingbasic and diluted


13,431,661


11,069,342


6,100,767


4,106,557


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As of December 31,2010

2009

2008

2007(in thousands)Balance Sheet Data:Cash, cash equivalents and short-term investments

$
3,784

$
3,417

$
1,124

$
2,370Working capital


(18
)

2,226


607


2,262Total assets


6,172


3,740


1,452


2,637Long-term debt, net








2,862


2,770Total stockholders' equity (deficit)

$
448

$
2,512

$
(2,016
)
$
(305
)


Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operation

You should read the following discussion and analysis of financial condition and results of operations together
with our financial statements and the related notes included elsewhere in this annual report. This discussion and analysis contains forward-looking statements about our business and operations, based
on current expectations and related to future events and our future financial performance, that involve risks and uncertainties. Our actual results may differ materially from those we currently
anticipate as a result of many important factors, including the factors we describe under "Risk Factors" and elsewhere in this annual report.

Overview

We are a medical device company focused on developing, manufacturing and commercializing our external saphenous vein support
technology, or eSVS MESH, for use in coronary artery bypass grafting, or CABG, surgery. Our eSVS MESH is a nitinol mesh sleeve that, when placed over a saphenous vein graft during CABG surgery, is
designed to improve the structural characteristics and long-term performance of the vein graft. CABG surgery is one of the most commonly performed surgeries in the United States, with the
American Heart Association estimating that 448,000 CABG procedures were performed in the United States in 2006. In addition, the Millennium Research Group estimates that there will be 165,000 CABG
procedures per year in Europe by 2013. In CABG procedures, surgeons harvest blood vessels, including the internal mammary artery from the chest and the saphenous vein from the leg, and attach the
harvested vessels to bypass, or provide blood flow around, blocked coronary arteries. We believe the use of our eSVS MESH with saphenous vein grafts in CABG surgery will improve the
long-term outcome of CABG procedures, including improved openness, or patency, and improved blood flow characteristics through the saphenous vein graft, resulting in a reduced need for
costly and potentially complicated reoperations or revascularization procedures.

In
order to obtain authorization to apply the CE Mark to our product and begin sales in Europe, we conducted a 90 patient multi-center clinical trial outside the United States. The goals
of this trial were to demonstrate that CABG surgery using our eSVS MESH was not inferior as to either safety or effectiveness as compared to traditional CABG surgery. Based on early results from this
trial we received our CE Mark in May 2010. In the trial, we evaluated the safety of our eSVS MESH by comparing the rate of major adverse cardiac and cerebral events, or MACCE, 30 days following
surgery for patients treated with our eSVS MESH against the same rate reported in published literature for patients with traditional CABG surgery. We evaluated efficacy by comparing the patency of
vessels treated with eSVS MESH against the patency of untreated saphenous vein bypass vessels as measured by angiographic studies nine to 12 months following implant. The safety data from this
trial has indicated that our eSVS MESH and implant procedure do not result in an increase in patient complications during or for 30 days after surgery. However, the effectiveness data from the
trial is inconclusive primarily due to two complicating factors. First, one of the centers participating in the trial used implant methods incompatible with our eSVS MESH. Second, the amount of
reduction in the diameter of the saphenous vein grafts, or downsizing, prescribed in our instructions for use and sizing tool was too aggressive, resulting in a higher than anticipated closure rate in
saphenous vein grafts

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utilizing
the eSVS MESH, particularly when our smallest device, 3.0 millimeters, was used. In response to this data, we have modified our instructions for use to provide clear direction on the
surgical method to be used with our eSVS MESH, discontinued the use of our 3.0 millimeter eSVS MESH and reduced the amount of downsizing specified for other device sizes. We also exclude
saphenous veins with walls thicker than 0.7 millimeters. We believe these steps will resolve the patency issues identified in the trial.

We
began marketing and commenced shipments of our eSVS MESH in select European Union markets in June 2010, in the United Arab Emirates in October 2010 and in Turkey in January 2011, but
we have not generated significant revenue from the sale of products to date. We believe that the safety data collected in the international trial, plus the known graft failure rates associated with
standard CABG surgery, will support commercial use of our eSVS MESH in Europe. The U.S Food and Drug Administration, or FDA, has reviewed and disapproved our most recent amendment to our application
for an investigational device exemption, or IDE. Follow-up conversations with the FDA have been held to further understand the FDA requirements in order to obtain our IDE approval. The FDA
has recently indicated that they need to review our IDE information with outside experts before they provide further guidance to the Company. The IDE approval, if obtained before the end of the third
quarter of 2011, would allow us to begin the clinical trials of our eSVS MESH in the United States in 2011. However, we could be delayed by adverse clinical results or regulatory complications, and we
may never receive U.S. marketing approval.

We
were incorporated and commenced operations in May 2007. Since our inception, we have generated losses. From inception to December 31, 2010, we had an accumulated deficit of
$20.1 million. We expect to incur losses for the foreseeable future as we pursue the development and commercialization of our eSVS MESH. Our activities since inception have consisted
principally of acquiring product and technology rights, raising capital, performing research and development and conducting preclinical and clinical trials. We have not generated significant revenue
from operations to date, as we only began selling our eSVS MESH in select European Union markets in June 2010. Accordingly, we are considered to be a development stage company as of
December 31, 2010.

Successful
completion of our development programs and, ultimately, our ability to generate revenues and attain profitable operations are dependent on future trends or events,
including:



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Key Components of Our Results of Operations



We received CE Mark approval in May 2010 and began marketing and commenced shipments of our eSVS MESH in select European markets in
June 2010. We sell our eSVS MESH to distributors who, in turn, sell to hospitals and clinics. The pricing in all distributor agreements is denominated in U.S. dollars and provides for the transfer of
title when we ship our eSVS MESH to the distributors. We invoice shipping charges to our distributors and include them in net sales. We expense shipping costs at the time we report the related revenue
and record them in cost of sales.



We fabricate our eSVS MESH both at our facility and at a contract manufacturer. We conduct final assembly and packaging at our
facility. Our cost of sales consists
primarily of purchased components, direct labor, allocated manufacturing overhead and royalties payable to Medtronic, Inc. ("Medtronic").



Since our inception, we have focused our activities on the development of our eSVS MESH. We expense both internal and external research
and development costs as incurred. Research and development costs include the costs to design, develop, test, seek approval for, and enhance our eSVS MESH and production processes. Expenses related to
research and development consist primarily of personnel costs, including salaries, benefits and stock-based compensation, product development, preclinical and clinical trials, professional service
fees, materials and supplies and facilities-related costs. We expense amounts paid to obtain patents or acquire licenses, as the ultimate recoverability of the amounts paid is uncertain.

While
our research and development expenses to date have been focused on product development and evaluating the feasibility of our eSVS MESH, we expect that a large percentage of our
research and development expenses in the future will be incurred in support of our current and future clinical trials. These expenditures are subject to numerous uncertainties in timing and costs to
complete. As we obtain results from clinical trials, we may elect to discontinue or delay clinical trials for certain product applications or programs in order to focus our resources on more promising
product applications. Completion of clinical trials may take several years or more, but the length of time generally varies

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according
to the type, complexity, novelty and intended use of a product. The cost of clinical trials may vary significantly over the life of the trial as a result of differences arising during the
clinical trial, including:



Our
expenses related to clinical trials are based on estimates of the services received and efforts expended pursuant to contracts with multiple clinical trial sites and contract
research organizations, or CROs, which administer clinical trials on our behalf. The financial terms of these agreements are subject to negotiation and vary from contract to contract and may result in
uneven payment flows. Generally, these agreements set forth the scope of work to be performed at a fixed fee or unit price. Payments under the contracts depend on factors such as the successful
enrollment of patients and the completion of clinical trial milestones. Expenses related to clinical trials generally are accrued based on contracted amounts and the achievement of milestones, such as
number of patients enrolled. If timelines or contracts are modified based upon changes to the clinical trial design or scope of work to be performed, we modify our estimates of accrued expenses
accordingly.

We
anticipate the direct costs of completing our U.S. clinical trial will be approximately $5.0-7.0 million, based upon our current expectation for the trial design.
Because of the numerous risks and uncertainties associated with developing medical devices, we are unable to determine the duration and completion costs of our development projects or when and to what
extent sales of our eSVS MESH will commence and become significant.

In
addition, we plan to begin non-human preclinical trials in 2011 designed to evaluate the use of our eSVS MESH for peripheral artery bypass surgery. We expect that the cost
of these preclinical trials will range from $250,000 to $500,000 in each of 2011, 2012 and 2013.



Our selling, general and administrative expenses consist primarily of salaries and benefits and other costs, including stock-based
compensation, for our executive and administrative personnel; legal and other professional fees; travel, business development; insurance and other corporate costs. We anticipate incurring a
significant increase in selling general and administrative expenses as we are now operating as a public company. These increases will likely include increased costs for insurance, costs related to the
hiring of additional personnel and payments to outside consultants, lawyers and accountants. We also expect to incur significant costs to comply with the corporate governance, internal controls and
similar requirements applicable to public companies. While our selling, general and administrative expenses to date have been primarily comprised of general and
administrative costs, we expect that we will incur significant additional sales and marketing expenses as we continue commercialization of our eSVS MESH.



As consideration for the purchase of the core intellectual property relating to our eSVS MESH, we have agreed to pay Medtronic an
aggregate of up to $15.0 million upon the achievement of certain sales milestones. The milestones and related payments consist of $5.0 million due on the one-year anniversary
of the first commercial sale of our eSVS MESH, $5.0 million due when our cumulative net sales reach $15.0 million and $5.0 million due when our cumulative net sales reach
$40.0 million. We recorded our first commercial sale in June 2010 and recorded an expense for the first milestone obligation at that time.

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Interest income consists of interest earned on investments in certificates of deposits and money market accounts.



Interest expense results primarily from interest associated with secured convertible notes in the aggregate principal amount of
$3.0 million issued to Kips Bay Investments, LLC ("KBI"), or the Notes. Our reported interest expense includes interest payable in cash based upon the stated rate in the Notes and the
amortization of discount recorded on the Notes created by the allocation of a portion of the Note proceeds to the fair value of the stock purchase options granted in conjunction with the issuance of
the Notes and due to the beneficial conversion feature specified in the Notes. Beneficial conversion feature accounting rules require the recognition of the intrinsic value of the conversion feature
at the time of the Notes' issuance, which is then amortized as additional interest expense over the life of the Notes.

Critical Accounting Policies and Estimates

Our management's discussion and analysis of financial condition and results of operations is based on our financial statements, which
have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of these financial statements requires us to make estimates and judgments
that affect the reported amounts of assets, liabilities and expenses. On an ongoing basis, we evaluate these estimates and judgments, including those described below. We base our estimates on our
historical experience and on various other assumptions that we believe to be reasonable under the circumstances. These estimates and assumptions form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other sources. Actual results and experiences may differ materially from these estimates.

While
our significant accounting policies are more fully described in Note 2 to our financial statements, we believe that the following accounting policies are the most critical
to aid you in fully understanding and evaluating our reported financial results and affect the more significant judgments and estimates that we use in the preparation of our financial statements.



We sell our eSVS MESH to international distributors, which subsequently resell it to hospitals and clinics. We recognize revenue in
accordance with generally accepted accounting principles as outlined in SEC Staff Accounting Bulletin No. 104,Revenue Recognition, and ASC
605-10-S99; specifically, when persuasive evidence of an arrangement exists, delivery of goods occurs through the transfer of title and risks and rewards of ownership, the
selling price is fixed or determinable and collectability is reasonably assured.

We
recognize revenue as products are shipped based on agreements with each of our distributors, which provide that title and risk of loss pass to the distributor upon shipment of the
products to the distributor and do not provide the distributors a right of return.



We expense research and development costs, including clinical trial costs, when incurred, consistent with the guidance of FASB ASC 730, Research and
Development. All of our clinical trials are performed at clinical trial sites and are administered by CROs. We accrue costs for clinical
trials performed by CROs based on estimates of work performed under the contracts. Costs of setting up clinical trial sites

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are
accrued immediately. Expenses related to clinical trials generally are accrued based on contracted amounts and the achievement of milestones, such as number of patients enrolled.

All
material clinical trial and CRO contracts are terminable by us upon written notice and we are generally only liable for actual effort expended by the CROs and certain
non-cancelable expenses incurred at any point of termination.



Stock-based incentive awards are accounted for under the provisions of FASB ASC 718, CompensationStock Compensation, which requires
companies to measure and recognize the cost of employee and non-employee
services received in exchange for awards of equity instruments based on the grant date fair value of those awards. Compensation cost is recognized ratably using the straight-line
attribution method over the expected vesting period, which is considered to be the requisite service period. In addition, we are required to estimate the amount of expected forfeitures when
calculating the compensation costs, instead of accounting for forfeitures as they occur. All of our previously awarded options were classified as equity instruments and continue to maintain their
equity classification.

The
fair value of options is estimated at the date of grant using the Black-Scholes option pricing model with the assumptions described in the following sentences. Risk free interest
rates are based upon U.S. Treasury rates appropriate for the expected term. Expected volatility and forfeiture rates are based on the volatility rates of a set of guideline companies, which consist of
public and recently public medical technology companies. The assumed dividend yield is zero, as we do not expect to declare any dividends in the foreseeable future. The expected term is determined
using the simplified method allowed by SEC Staff Accounting Bulletin No. 110. The fair market value of the common stock underlying the stock options has been determined by our board of
directors at each award grant date based upon a variety of factors, as discussed below. If we had made different assumptions and
estimates, the amount of our recognized and to be recognized stock-based compensation expense could have been materially different. We believe that we have used reasonable methodologies, approaches
and assumptions in determining the fair market value of our common stock.

We
grant options to employees and non-employees, including members of our Scientific Advisory Board. Option grants to employees have a maximum term of ten years and generally
vest over four years at the rate of 25% of the total shares underlying the option each year. Options granted to non-employees have a maximum term of ten years and generally vest over three
years with 25% of the total shares underlying the option vesting on the date of grant and 25% of the total shares vesting in each of the next three years.

Option
grants to non-employees have been made in conjunction with and as sole consideration for their service as advisors to us. Certain of these advisors have also purchased
shares of stock in our private placement offerings, but none beneficially own 5% or more of our outstanding common stock. The fair value of options granted to non-employees is measured at
each reporting date until the option, or respective portion of the option, vests and the expense recorded by us is updated accordingly. See Note 8 to our financial statements included
elsewhere in this annual report for additional information.

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Results of Operations



Year Ended
December 31Percent
Change2010

2009(In thousands)Net sales

$
223

$



Cost of sales


(77
)




Gross profit


146





Operating expenses:Research and development


2,521


3,004


(16.1
)%Selling, general and administrative


1,326


779


70.2Milestone expense


5,000





Total operating expenses


8,847


3,783


133.9Other income (expense):Interest income


12


17


Interest expense


(1
)

(181
)

Realized gain on sale of short-term investment


46





Change in fair value of investor stock purchase option


(2,290
)

610


Net loss before income tax

$
(10,934
)
$
(3,337
)

227.7
%


Cost
of sales, research and development expenses and selling, general and administrative expenses include non-cash stock-based compensation expense as a result of our
issuance of stock options. We expense the fair value of stock options over their vesting periods. The terms and vesting schedules for share-based awards vary by type of grant and the employment status
of the grantee. The awards granted through December 31, 2010 vest upon time-based conditions. We expect to record additional non-cash compensation expense in the future,
which may be significant. The following table summarizes the stock-based compensation expense in our statements of operations for the years ended December 31, 2010 and 2009:

Year Ended
December 312010

2009(In thousands)Cost of sales

$
12

$
Research and development


520


390Selling, general and administrative


93


47Total stock-based compensation

$
625

$
437




Our research and development ("R&D") expenses decreased 16.1% from $3.0 million in the year ended December 31, 2009 to
$2.5 million for the year ended December 31, 2010. This decrease was driven by a $420,000 decrease in expenses related to our international feasibility trial, which completed enrollment
in July 2009, and a $243,000 decrease in expense related to product development and testing related to our eSVS MESH. We began commercial sales of our eSVS MESH in June 2010 and in conjunction with
the start-up of commercial manufacturing certain costs associated with personnel and facilities previously includes in R&D were moved to manufacturing. This change resulted in a

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further
decrease in R&D expenses of $248,000. These decreases were partially offset by increases in preclinical testing and stock-based compensation expenses of $310,000 and $130,000, respectively.



Selling, general and administrative expenses increased 70.2% from $779,000 in the year ended December 31, 2009 to
$1.3 million in the year ended December 31, 2010. This increase was primarily due to a $301,000 increase in salaries and benefits and a $45,000 increase in stock-based compensation
costs, both related to the expansion of our management team, and an $89,000 increase in accounting and professional fees related to preparing the audited financial statements for our initial public
offering. Prior to this offering, our financial statements were not audited. Sales and marketing travel and related costs were also higher by $144,000 as a result commercialization activities we
commenced after our receipt of the CE Mark for our eSVS MESH in May 2010. These increases were partially offset by a decrease of $67,000 related to the termination in July 2009 of a temporary
consultant who performed marketing related work.



Our milestone expense for the year ended December 31, 2010 was $5.0 million. We recorded this milestone expense in
conjunction with the first commercial sale of our eSVS MESH and it represents the first sales milestone under our Assignment and License Agreement with Medtronic. Under the provisions of this
agreement, the payment of this milestone is not due until the first anniversary of our first commercial sale of the eSVS MESH, or June 2011.



Interest income decreased from $17,000 in the year ended December 31, 2009 to $12,000 in the year ended December 31,
2010. Our interest income decreased due to the decline in rates paid on money market accounts, in which our cash and cash equivalents are primarily invested, offsetting the increase in our available
cash and cash equivalents.



Interest expense declined from $181,000 in the year ended December 31, 2009 to $1,000 in the year ended December 31,
2010. The Notes were converted into shares of common stock in February 2009, which eliminated all debt from our balance sheet. The year ended December 31, 2009 included two months of interest
expense and the write-off of the $138,000 balance in unamortized discount on the Notes at the time of the conversion.



The change in fair value of investor stock purchase option was a loss of $2.3 million in the year ended December 31,
2010, as compared to a gain of $610,000 in the year ended December 31, 2009. The loss in the year ended December 31, 2010 resulted from a modification to the second KBI stock purchase
option, which resulted in an increase in the estimated fair value of the option of $2.3 million. KBI exercised this option in February 2010.

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Year Ended
December 31,Percent
Change2009

2008(In thousands)Operating expenses:Research and development

$
3,004

$
2,635


14.0
%Selling, general and administrative


779


754


3.3Total operating expenses


3,783


3,389


11.6Other income (expense):Interest income


17


52


(67.3
)Interest expense


(181
)

(390
)

(53.6
)Impairment of available for sale securities





(85
)

Change in fair value of investor stock purchase option


610





Net loss

$
(3,337
)
$
(3,812
)

(12.5
)%


Research
and development expense and selling, general and administrative expenses include non-cash stock-based compensation expense as a result of our issuance of stock
options. We expense the fair value of stock options over their vesting periods. The terms and vesting schedules for share-based awards vary by type of grant and the employment status of the grantee.
The awards granted through December 31, 2009 vest upon time-based conditions. We expect to record additional non-cash compensation expense in the future, which may be
significant. The following table summarizes the stock-based compensation expense in our statements of operations for 2009 and 2008:

December 31,2009

2008(In thousands)Research and development

$
390

$
298Selling, general and administrative


47


40Total stock-based compensation

$
437

$
338




Our research and development expenses increased 14.0% from $2.6 million in 2008 to $3.0 million in 2009. This increase
was caused primarily by an increase of approximately $350,000 from 2008 to 2009 in the expenses associated with our international feasibility trial for our eSVS MESH, which began enrolling patients in
August 2008. These expenses include per patient and per procedure fees payable to the clinical trial sites, clinical trial administration costs payable to a CRO, and costs related to the
set-up of clinical trial sites and training of medical staff.



Selling, general and administrative expenses increased 3.3% from $754,000 in 2008 to $779,000 in 2009. This increase was the result of
an increase in salary expense related to the temporary addition of an individual performing marketing related work, partially offset by reduced travel expenses and professional fees.



Interest income declined from $52,000 in 2008 to $17,000 in 2009. This decline resulted primarily from decline in
short-term interest rates from 2008 to 2009.

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Interest expense declined from $390,000 in 2008 to $181,000 in 2009. The Notes were converted into shares of common stock in February
2009, resulting in only two months of interest expense in 2009, as compared with a full year of interest in 2008. This decline was offset by the write-off of the $138,000 balance in
unamortized discount on the Notes at the time of the conversion.



The change in fair value of investor stock purchase option was a gain of $610,000 in 2009. This gain resulted from a decline in the
estimated fair value of the investor stock purchase option during 2009. The decline in the value of investor stock purchase option liability resulted primarily from a reduction in the expected term
for which the option would be outstanding. The investor stock purchase option liability was initially recorded January 1, 2009 in conjunction with our adoption of new accounting standards (ASC
815-40) which were effective as of January 1, 2009.



In conjunction with a simplified employee retirement plan that we maintain for the benefit of our employees, we invested $250,000 in a
mutual fund under an arrangement that resulted in reduced maintenance and transaction costs for our employees. Due primarily to the significant decline in the U.S. stock market and the accompanying
declines in the U.S. economy during 2008, we concluded as of December 31, 2008 that the value of this mutual fund investment was impaired and that this decline in value was other than
temporary. We recorded a charge of $85,000, which resulted in a new adjusted cost basis for this investment.

Income Taxes

Since inception, we have incurred operating losses and, accordingly, have not recorded a provision for income taxes for any of the
periods prior to the current year. The state of Minnesota enacted a change to their tax code which made the Minnesota Research and Tax Credit a refundable credit for fiscal years starting on or after
January 1, 2010. Based upon our research and development costs which qualify under the Minnesota tax code, we have recorded an income tax benefit of $42,000 for the year ended
December 31, 2010.

As
of December 31, 2010, we had net operating loss carryforwards for federal and state income tax purposes of approximately $9.4 million. We also had federal research and
development tax credit carryforwards of approximately $434,000. If not utilized, the federal net operating loss and tax credit carryforwards will expire beginning in 2027. Utilization of net operating
loss and credit carryforwards may be subject to a substantial annual limitation due to limitations provided by the Internal Revenue Code of 1986, as amended, that are applicable if we experience an
"ownership change" that may occur, for example, as a result of our initial public offering of common stock in February 2011 aggregated with certain other sales of our stock before or after this
offering. If not utilized, the state net operating loss carryforward will expire beginning in 2022. The annual limitation may result in the expiration of our net operating loss and tax credit
carryforwards before they can be used.

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Liquidity and Capital Resources

The following table summarizes our liquidity and capital resources as of December 31, 2010 and 2009 and for each of fiscal years
ended December 31, 2010, 2009 and 2008, and is intended to supplement the more detailed discussion that follows:

December 31,Liquidity and Capital Resources

2010

2009(In thousands)Cash and cash equivalents

$
3,548

$
2,469Short-term investments


236


948Working capital


(18
)

2,226




Period from
May 1, 2007(Date
of Inception)
to December 31,
2010Year Ended December 31,Cash Flow Data

2010

2009

2008(In thousands)Cash provided by (used in):Operating activities

$
(4,378
)
$
(3,382
)
$
(2,838
)
$
(11,103
)Investment activities


471


(840
)

196


(933
)Financing activities


4,986


5,748


1,750


15,584Net increase (decrease) in cash and cash equivalents

$
1,079

$
1,526

$
(892
)
$
3,548




Our total cash resources, excluding short-term investments, as of December 31, 2010 were $3.5 million
compared to $2.5 million as of December 31, 2009. As of December 31, 2010, we had $5.7 million in current liabilities and an $18,000 net working capital deficit. As of
December 31, 2009, we had $1.2 million in current liabilities and $2.2 million in net working capital. We incurred a net loss of $10.9 million and had negative cash flow
from operating activities of $4.4 million for the year ended December 31, 2010. Since May 1, 2007 (date of inception) through December 31, 2010, we had an accumulated
deficit of $20.1 million, while negative cash flow from operating activities has amounted to $11.1 million. The difference between our accumulated deficit and negative cash flow from
operations results primarily from the adoption of FASB ASC 815-40 on January 1, 2009 and the milestone payment to Medtronic recorded as a result of achieving our first commercial
sale of our eSVS MESH. Under the provisions of FASB ASC 815-40, certain instruments previously reported as equity are now accounted for as derivative instruments. These provisions were
initially applied by recording a non-cash, cumulative effect adjustment of $1.4 million to deficit accumulated during the development stage. The provisions of FASB ASC
815-40 also require the fair value of such derivative instruments to be measured at each reporting date. The subsequent remeasurements of the fair value of a stock purchase option granted
to KBI to purchase up to 600,000 shares of common stock at $5.83 per share through the exercise of the option term in February 2010, resulted in our recording additional non-cash charges,
net, over the period of January 2009 through February 2010 of $1.9 million. Under the provisions of the Assignment and License Agreement with Medtronic, our first milestone payment obligation
of $5.0 million is due and payable on the one year anniversary of the first commercial sale of our eSVS MESH. Accordingly, we will be required to remit this milestone payment in June 2011. Our
accumulated deficit also includes non-cash charges for stock based compensation and depreciation of $1.4 million and $192,000, respectively, and $467,000 of accrued interest expense
which was settled through conversion into our common stock.

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As
we continue to pursue regulatory approvals, continue the process of commercialization in international markets, develop our manufacturing capabilities and develop additional
applications for our eSVS MESH, we expect to continue to incur substantial and increasing losses, which will continue to generate negative net cash flows from operating activities.

To
date, we have funded our operations primarily through private sales of common stock and convertible debt. As of December 31, 2010, we had received net proceeds of approximately
$12.6 million from the sale of equity securities, and net proceeds of approximately $3.0 million from the issuance of the Notes, all of which have been converted into common stock. We
began marketing and commenced shipments of our eSVS MESH in select European Union markets in June 2010, but we have not generated significant revenue from the sale of products to date. We intend to
use the net proceeds of
our initial public offering, as further described below, to seek regulatory approval to market our technology in the United States and to expand regulatory approval abroad, including human clinical
trials in the United States; to develop and test additional applications of our eSVS MESH; to make certain milestone payments for our acquired intellectual property; and for working capital and
general corporate purposes.

In
February 2011 we completed an initial public offering of our common stock. In this offering we sold 2,062,500 shares of common stock receiving net proceeds of $13.6 million. In
the future we may seek to raise additional funds through various sources, such as equity and debt financings, or through strategic collaborations. and license agreements. We can give no assurances
that we will be able to secure such additional sources of funds to support our operations, or if such funds are available to us, that such additional financing will be sufficient to meet our needs. We
expect that the proceeds from the initial public offering will be sufficient to fund our planned operations for at least the next 12 months, and we have no current intention to enter into a
credit facility or loan agreement. We do not anticipate any adverse effects stemming from the lack of available credit facilities at this time



Net cash used in operating activities was $4.4 million in 2010, $3.4 million in 2009, and $2.8 million in 2008.
From May 1, 2007 (date of inception) to December 31, 2010, net cash used in operating activities was $11.1 million. The net cash used in each of these periods primarily reflects
the net loss for those periods, offset in part by depreciation, non-cash stock-based compensation, changes in the fair value of the KBI stock purchase option liability and the effects of
changes in operating assets and liabilities.



Net cash provided by (used in) investment activities was $471,000 in 2010, ($840,000) in 2009 and $196,000 in 2008. From May 1,
2007 (date of inception) to December 31, 2010, net cash used in investment activities was $933,000. Cash provided by or used in investment activities is related to purchases and sales of
short-term investments and purchases of property and equipment.



Net cash provided by financing activities was $5.0 million in 2010, $5.7 million in 2009 and $1.8 million in 2008.
From May 1, 2007 (date of inception) to December 31, 2010, net cash provided by financing activities was $15.6 million. Net cash provided by financing activities was primarily
attributable to proceeds from issuances of the Notes and from private sales of our common stock.

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We expect to incur substantial expenses and generate significant operating losses as we continue to execute our business strategy
including:



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



We
began marketing and commenced shipments of our eSVS MESH in select European Union markets in June 2010, in the United Arab Emirates in October 2010 and in Turkey in January 2011, but
we have not generated significant revenue from the sale of products to date. We did not generate meaningful sales in the fiscal year ended December 31, 2010 and we expect our operating losses
and negative cash flows from operations to continue for the foreseeable future. Our future capital requirements will depend upon a number of factors as indicated above.

We
expect that our existing resources as of the date of this annual report, which includes $13.6 million of net proceeds from our February 2011 initial public offering, to be
sufficient to fund our planned operations for at least the next 12 months. However, we may require significant additional funds earlier than we currently expect in order to conduct additional
clinical trials to obtain regulatory approvals of our eSVS MESH. To the extent that we raise additional capital through the sale of equity or convertible debt securities, stockholders' interest will
be diluted, and the terms may include

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liquidation
or other preferences that adversely affect the rights of our stockholders. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability
to take specific actions such as incurring additional debt, making capital expenditures or declaring dividends. Any of these events could adversely affect our ability to achieve our product
development and commercialization goals and harm our business.

If
adequate funds are not available, we may be required to terminate, significantly modify or delay our development programs, reduce our planned commercialization efforts, or obtain
funds through collaborators that may require us to relinquish rights to our technologies or product candidates that we might otherwise seek to develop or commercialize independently. We may elect to
raise additional funds even before we need them if the conditions for raising capital are favorable.

Contractual Obligations, Commitments and Contingencies

To date, we have not entered into long-term minimum purchase commitments with suppliers. Our principal commitments consist
of obligations relating to our international clinical trial and obligations under the lease for our facility in Minneapolis, Minnesota, and certain office equipment.

The
following table summarizes our outstanding contractual obligations as of December 31, 2010:

Payments Due by PeriodTotal

Less than
1 Year

1 - 3 Years

4 - 5 Years

After
5 Years(In thousands)International clinical trial obligations(1)

$
48

$
48

$


$


$
Operating lease obligations(2)


49


46


3





Key supplier purchase commitment(3)


14


14








Total

$
111

$
108

$
3

$


$



(1)The
outstanding obligations for our international clinical trial represents our remaining obligation for costs related to patient monitoring and
follow-up and trial data collection and analysis for our 90 patient multi-center clinical trial conducted outside the United States. Patient enrollment in this trial was completed in July
2009.(2)Operating
lease obligations represent future minimum lease payments under non-cancelable operating leases for our facility and certain office
equipment. The operating lease obligation for our corporate facility ends September 30, 2011.(3)The
amount presented reflects the undelivered portion of an outstanding purchase order with one of our key suppliers. To date we have not entered into any
long term supply agreements with any of our vendors. As of December 31, 2010, remaining outstanding purchase orders were not significant.


Royalty Payments

The core intellectual property relating to our eSVS MESH, including five patent applications pending in the United States and nine
patent applications pending in countries outside the United States, was sold to us by Medtronic pursuant to an Assignment and License Agreement dated October 9, 2007. Pursuant to the Assignment
and License Agreement, Medtronic also sold to us intellectual property relating to a brushed ePTFE vascular graft, or the Brushed Graft Product. Currently, such intellectual property is embodied in
two patents and four pending patent applications in the United States, and one patent and four pending patent applications in countries outside the United States.

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As
consideration for the sale of intellectual property relating to the eSVS MESH and the Brushed Graft Product and other rights granted by the Assignment and License Agreement, we have
agreed to pay Medtronic an aggregate of $20.0 million upon the achievement of certain sales milestones relating to our eSVS MESH and the Brushed Graft Product and a royalty of 4% on sales of
our eSVS MESH and the Brushed Graft Product. The royalty will terminate upon the earlier of the expiration of all of the patents and patent applications, or when the aggregate royalties paid reach
$100.0 million. As of December 31, 2010, we have accrued the first $5.0 million milestone payment and have recorded $9,000 of royalty expense.

In
the recitals to the Assignment and License Agreement, we stated that we would use our reasonable best efforts to develop and commercialize both the Brushed Graft Product and the eSVS
MESH. While we have undertaken activities to develop and commercialize the Brushed Graft Product, we are currently primarily focused on the development of our eSVS MESH for use in CABG surgery and
additional applications of our eSVS MESH. In connection with its development of the Brushed Graft Product, Medtronic used certain technology to produce platelet-poor plasma for use in the
Brushed Graft Product. Pursuant to the Assignment and License Agreement, Medtronic licensed to us certain patent rights necessary to produce this platelet-poor plasma and provided for a
continuing license of such rights in the event Medtronic sold the technology used to produce such platelet-poor plasma. These licensed patent rights are different from the patents related
to the Brushed Graft Product itself that were sold to us, and we have not yet determined whether the platelet-poor plasma is necessary or useful in the commercialization of the Brushed
Graft Product. We may ultimately elect to commercialize the Brushed Graft Product without the platelet-poor plasma and believe that we have the intellectual property rights to do so
without the license to produce platelet-poor plasma.

The
original eSVS MESH technology was developed at the University of Cape Town, South Africa. On June 12, 2003, Medtronic, the University of Cape Town and a professor at the
University of Cape Town entered into a Research and Scientific Collaboration Agreement, pursuant to which the University of Cape Town assigned to the professor all its ownership rights in the eSVS
MESH technology and any patents that may arise therefrom, subject to the South African Exchange Control approval process. Prior to receipt of such approval, the professor and other researchers
assigned to Medtronic all their ownership rights in the eSVS MESH patents and technology, and Medtronic subsequently granted us an irrevocable, exclusive license of the eSVS MESH patents and
technology pursuant to the Assignment and License Agreement until the South African Exchange Control approval process could be completed. On or about November 8, 2007, the South African Federal
Reserve Bank approved the Research and Scientific Collaboration Agreement, and on August 26, 2008, Medtronic assigned the patents relating to the eSVS MESH to us in fulfillment of its
obligations under the Assignment and License Agreement.

Any
or all licenses granted to us pursuant to our agreement with Medtronic may be terminated and potentially all of the core intellectual property and patent rights related to our eSVS
MESH will revert to Medtronic, upon notice by Medtronic, if we become insolvent, make an assignment for the benefit of creditors, go into liquidation or receivership or otherwise lose legal control of
our business. In addition, Medtronic may terminate the license to the platelet-poor plasma if we determine to cease commercializing the Brushed Graft Product. Medtronic may also cause the
core intellectual property and patent rights related to our eSVS MESH to revert to Medtronic if we determine to cease commercializing our eSVS MESH. The agreement with Medtronic does not define what
constitutes "commercializing" for these purposes.

Off-Balance Sheet Arrangements

Since inception, we have not engaged in any off-balance sheet activities as defined in Regulation S-K
Item 303(a)(4).

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Recent Accounting Pronouncements

In January 2010, the FASB issued ASU 2010-6,Fair Value Measurements and Disclosures
ASC Topic 820: Improving Disclosures about Fair Value Measurements, which requires reporting entities to make new disclosures about recurring or nonrecurring fair
value measurements including (i) significant transfers into and out of Level 1 and Level 2 fair value measurements and (ii) information on purchases, sales , issuances and
settlements on a gross basis in the reconciliation of Level 3 fair value measurements. ASU 2010-6 was effective for interim and annual reporting periods beginning after
December 15, 2009, except for Level 3 reconciliation disclosures which are effective for interim and annual periods beginning after December 15, 2010. We adopted the additional
disclosures required for Level 1 and Level 2 fair value measurements in the first quarter of 2010 (see Note 3). We adopted Level 3 disclosures beginning in the first
quarter of 2011.

Special Note Regarding Forward-Looking Statements

This annual report contains forward-looking statements that involve risks and uncertainties. In some cases, you can identify
forward-looking statements by the following words: "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," "ongoing," "plan," "potential," "predict," "project," "should,"
"will," "would," or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. The forward-looking statements in this annual report
include, but are not limited to, statements regarding uses for our technology, the timing of governmental approvals and product introductions, expansion of governmental regulations, use of research
and development expenditures, commencement and cost of preclinical trials, increased costs as a public company, future tax benefits, use of proceeds from our initial public offering, the adequacy of
our capital resources to fund future expenditures, and operating and capital requirement expectations. These statements involve known and unknown risks, uncertainties and other factors that may cause
our or our industry's results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Although we
believe that we have a reasonable basis for each forward-looking statement contained in this annual report, we caution you that these statements are based on a combination of facts and factors
currently known by us and our projections of the future, about which we cannot be certain. Many important factors affect our ability to achieve our objectives, including:



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You
should read these risk factors and the other cautionary statements made in this annual report as being applicable to all related forward-looking statements wherever they appear in
this annual report. We cannot assure you that the forward-looking statements in this annual report will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the
inaccuracy may be material. You should read this annual report completely. Other than as required by law, we undertake no obligation to update these forward-looking statements, even though our
situation may change in the future.

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

Not required.

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Item 8.    Financial Statements and Supplementary Data

Index To Financial Statements



PageReport of Independent Registered Public Accounting Firm

F-1Statements of Operations

F-2Balance Sheets

F-3Statements of Stockholders' Equity (Deficit)

F-4Statements of Cash Flows

F-5Notes to the Financial Statements

F-6


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Item 9.    Change in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A.    Controls and Procedures

Evaluation of Disclosure Controls and Procedures.We maintain controls and procedures designed to ensure that we are able to collect
the information
we are required to disclose in the reports we file with the SEC, and to process, summarize and disclose this information within the time periods specified in the rules of the SEC. Our management, with
the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities and Exchange Act of 1934, as amended). Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of
December 31, 2010, our controls and procedures were effective.

Management's annual report on internal control over financial reporting.This annual report does not include a report of management's
assessment
regarding internal control over financial reporting or an attestation report of the company's registered public accounting firm due to a transition period established by rules of the Securities and
Exchange Commission for newly public companies.

Changes in Internal Control over Financial Reporting.There were no changes in our internal control over financial reporting during the
quarter ended
December 31, 2010 that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

Item 9B.    Other Information

On March 29, 2011, the Company's Board of Directors approved an amendment to the Company's bylaws regarding the procedure for
determining the size of the Board of Directors. Article IV, Section 15 of the bylaws was amended to read, in relevant part, "[the] authorized number of directors
of the corporation shall be fixed from time to time by resolution of the Board of Directors." The section previously read, in relevant part, "[the] authorized number of
directors of the corporation shall be fixed in accordance with the Certificate of Incorporation." The Company's bylaws, as amended, are attached as exhibit 3.2 to this annual report.

PART III

Item 10.    Directors, Executive Officers And Corporate Governance

Other than the information included in Part I of this Form 10-K under the heading "Executive Officers of the
Registrant," the information required by Item 10 is incorporated by reference to the sections labeled "Election of Directors," "Corporate Governance" and "Section 16(a) Beneficial
Ownership Reporting Compliance," which appear in our definitive proxy statement for our 2011 Annual Meeting.

Item 11.    Executive Compensation

The information required by Item 11 is incorporated herein by reference to the sections entitled "Executive Compensation,"
"Director Compensation" and "Compensation Committee," which appear in our definitive proxy statement for our 2011 Annual Meeting.

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Item 12.    Security Ownership Of Certain Beneficial Owners And Management And Related Stockholder Matters

The information required by Item 12 is incorporated herein by reference to the sections entitled "Principal Stockholders" and
"Equity Compensation Plan Information," which appear in our definitive proxy statement for our 2011 Annual Meeting.

Item 13.    Certain Relationships And Related Transactions, And Director Independence

The information required by Item 13 is incorporated herein by reference to the sections entitled "Corporate
GovernanceIndependence" and "Certain Relationships and Related Party Transactions," which appear in our definitive proxy statement for our 2011 Annual Meeting.

Item 14.    Principal Accounting Fees And Services

The information required by Item 14 is incorporated herein by reference to the section entitled "Audit Fees" and "Audit
Committee Pre-Approval Policies and Procedures," which appear in our definitive proxy statement for our 2011 Annual Meeting.

PART IV

Item 15.    Exhibits and Financial Statements Schedules





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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date:
March 31, 2011

KIPS BAY MEDICAL, INC.By:

/s/ MANNY VILLAFAÑA Manny Villafaña Chairman of the Board and Chief Executive Officer


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POWER OF ATTORNEY

Each person whose signature appears below constitutesScott Kellenas his true and
lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any or all
amendments to this Annual Report on Form 10-K and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorney-in-fact and agent, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and
about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all said attorney-in-fact and agent, or his or her
substitute or substitutes, may lawfully do or cause to be done by virtue thereof.

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on
the dates indicated.

Signatures

Title

Date/s/ MANNY VILLAFAÑA Manny Villafaña

Chairman and Chief Executive Officer (principal executive officer)

March 31, 2011/s/ SCOTT KELLEN Scott Kellen

Chief Financial Officer and Vice President of Finance (principal financial and accounting officer)

March 31, 2011/s/ MICHAEL P. WINEGAR Michael P. Winegar

Chief Operating Officer, Vice President of Regulatory Affairs, and Director

March 31, 2011/s/ ROBERT E. MUNZENRIDER Robert E. Munzenrider

Director

March 31, 2011/s/ ARCH C. SMITH Arch C. Smith

Director

March 31, 2011/s/ ROBERT J. SHEEHY Robert J. Sheehy

Director

March 31, 2011


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Report of Independent Registered Public Accounting Firm

To
the Board of Directors and Stockholders
Kips Bay Medical, Inc.

We
have audited the accompanying balance sheets of Kips Bay Medical, Inc. (a development stage company) as of December 31, 2010 and 2009, and the related statements of
operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 2010 and the period from May 1, 2007 (date of inception) to
December 31, 2010. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial
reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose
of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Kips Bay Medical, Inc. at December 31, 2010
and 2009, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2010 and the period from May 1, 2007 (date of inception) to
December 31, 2010, in conformity with U.S. generally accepted accounting principles.

/s/
Ernst & Young, LLP

Minneapolis,
Minnesota
March 31, 2011

F-1

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Kips Bay Medical, Inc.  (A Development Stage Company)        Statements of Operations

Period from
May 1, 2007
(Date of
Inception) to
December 31,
2010Year Ended December 31,2010

2009

2008(In thousands, except share and per share amounts)Net sales

$
223

$


$


$
223Cost of sales


(77
)







(77
)Gross profit


146








146Operating Expenses:Research and development


2,521


3,004


2,635


8,356Selling, general and administrative


1,326


779


754


3,240Milestone expense


5,000








5,000Operating loss


(8,701
)

(3,783
)

(3,389
)

(16,450
)Interest income


12


17


52


146Interest Expense


(1
)

(181
)

(390
)

(736
)Realized gain on sale of short-term investments


46








46Impairment of available for sale securities








(85
)

(85
)Change in fair value of investor stock purchase option


(2,290
)

610





(1,680
)Net loss before income tax

$
(10,934
)
$
(3,337
)
$
(3,812
)
$
(18,759
)Income tax benefit


42








42Net loss

$
(10,892
)
$
(3,337
)
$
(3,812
)
$
(18,717
)Basic and diluted net loss per share

$
(0.81
)
$
(0.30
)
$
(0.62
)Weighted average shares outstandingbasic and diluted


13,431,661


11,069,342


6,100,767


See
accompanying notes to financial statements.

F-2

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Table of Contents

Kips Bay Medical, Inc.  (A Development Stage Company)    Balance Sheets

December 31,2010

2009(In thousands except
share and per share
amounts)ASSETSCurrent assets:Cash and cash equivalents

$
3,548

$
2,469Short-term investments


236


948Accounts receivable


56


Inventories


606


Prepaid expenses and other current assets


1,260


37Total current assets


5,706


3,454Property and equipment, net


466


286Total assets

$
6,172

$
3,740LIABILITIES AND STOCKHOLDERS' EQUITYCurrent liabilities:Accounts payable

$
180

$
84Accrued liabilities


539


184Accrued milestone and royalties


5,005


Investor stock purchase option liability





960Total current liabilities


5,724


1,228Commitments and contingencies (Note 6)Stockholders' equity:Undesignated stock, $0.01 par value, 10,000,000 shares authorized, no shares issued and outstanding as of December 31, 2010 and 2009,
respectively





Common stock, $0.01 par value, 40,000,000 shares authorized, 13,581,791 and 12,398,919 issued and outstanding as of December 31, 2010 and 2009,
respectively


136


124Additional paid-in capital


20,405


11,556Accumulated other comprehensive income





33Deficit accumulated during development stage


(20,093
)

(9,201
)Total stockholders' equity


448


2,512Total liabilities and stockholders' equity

$
6,172

$
3,740


See
accompanying notes to financial statements.

F-3

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Table of Contents

Kips Bay Medical, Inc.  (A Development Stage Company)        Statements of Stockholders' Equity (Deficit)

Deficit
Accumulated
During the
Development
StageCommon Stock



Accumulated
Other
Comprehensive
IncomeAdditional
Paid-In
Capital

Total
Stockholders'
EquityShares

Amount(In thousands except share amounts)Balance at May 1, 2007 (date of inception)




$


$


$


$


$
Comprehensive lossNet loss











(676
)




(676
)Unrealized loss on investments, net














(13
)

(13
)Comprehensive loss

















(689
)Common stock issued to founders at incorporation, $0.167 per share


6,000,000


60


40








100Issued stock purchase options in conjunction with issuance of secured convertible notes








194








194Effect of beneficial conversion feature on secured convertible notes








74








74Stock-based compensation expense








16








16Balance at December 31, 2007


6,000,000

$
60

$
324

$
(676
)
$
(13
)
$
(305
)Comprehensive lossNet loss











(3,812
)




(3,812
)Unrealized gain on investments, net














13


13Comprehensive loss

















(3,799
)Common stock issued at $5.83 per share


300,000


3


1,747








1,750Stock-based compensation expense








338








338Balance at December 31, 2008


6,300,000


63


2,409


(4,488
)




(2,016
)Comprehensive lossNet loss











(3,337
)




(3,337
)Unrealized gain on investments, net














33


33Comprehensive loss

















(3,304
)Cumulative effect adjustment for adoption of FASB ASC 815-40








(194
)

(1,376
)




(1,570
)Common stock issued at $5.83 per share


300,000


3


1,747








1,750Common stock issued upon conversion of note payable, conversion price of $0.625


4,800,000


48


2,952








3,000Common stock issued upon conversion of accumulated interest on note payable, conversion price of $0.625


347,389


4


213








217Common stock issued, $1.00 per share, employee exercise of incentive stock option


1,000





1








1Common stock issued, $6.00 per share, under private placement offering (net of issuance costs of $29)


516,241


5


3,063








3,068Common stock issued, $7.00 per share, under private placement offering (net of issuance costs of $11)


134,289


1


928








929Stock-based compensation expense








437








437Balance at December 31, 2009


12,398,919

$
124

$
11,556

$
(9,201
)
$
33

$
2,512Comprehensive lossNet loss











(10,892
)




(10,892
)Unrealized gain on investments, net














13


13Reclassification of unrealized gain on short-term investments














(46
)

(46
)Comprehensive loss

















(10,925
)Common stock issued upon exercise of investor stock purchase option


1,000,000


10


6,990








7,000Common stock issued, $7.00 per share, under private placement offering (net of issuance costs of $44)


182,872


2


1,234








1,236Stock-based compensation expense








625








625Balance at December 31, 2010


13,581,791

$
136

$
20,405

$
(20,093
)
$


$
448


See accompanying notes to financial statements.

F-4

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Table of Contents

Kips Bay Medical, Inc.  (A Development Stage Company)        Statements of Cash Flows

Period from
May 1, 2007
(Date of
Inception) to
December 31,
2010Year Ended December 31,2010

2009

2008(In thousands)Cash flows from operating activities:Net loss

$
(10,892
)
$
(3,337
)
$
(3,812
)
$
(18,717
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation expense


74


60


49


192Stock-based compensation


625


437


338


1,416Amortization of discount on secured convertible notes





138


92


268Impairment of available for sale securities








85


85Realized gain on sale of short-term investments


(46
)







(46
)Change in fair value of investor stock purchase option


2,290


(610
)




1,680Changes in operating assets and liabilities:Accounts receivable


(56
)







(56
)Inventories


(606
)







(606
)Prepaid expenses and other current assets


(1,223
)

52


(24
)

(1,260
)Accounts payable


96


60


7


180Accrued liabilities


355


25


129


539Accrued milestone and royalties


5,005








5,005Accrued interest payable





(207
)

298


217Net cash used in operating activities


(4,378
)

(3,382
)

(2,838
)

(11,103
)Cash flows from investing activities:Proceeds from sales and maturities of short-term investments


966





291


1,257Purchases of short-term investments


(241
)

(734
)

(9
)

(1,532
)Purchase of property and equipment


(254
)

(106
)

(86
)

(658
)Net cash provided by (used in) investing activities


471


(840
)

196


(933
)Cash flows from financing activities:Proceeds from sale of common stock











100Proceeds from issuances of notes payable











3,000Proceeds from exercise of investor option to purchase common stock


3,750


1,750


1,750


7,250Proceeds from sale of common stock under private placement offerings, net of issuance costs


1,236


3,997





5,233Proceeds from exercise of employee stock options





1





1Net cash provided by financing activities


4,986


5,748


1,750


15,584Net increase (decrease) in cash and cash equivalents


1,079


1,526


(892
)

3,548Cash and cash equivalents at beginning of period


2,469


943


1,835


Cash and cash equivalents at end of period

$
3,548

$
2,469

$
943

$
3,548Supplemental disclosures:Interest paid in cash

$
1

$
250

$


$
251Supplemental non-cash disclosures:Reclassification of investor stock purchase option liability to equity

$
3,250

$


$


$
3,250Conversion of note payable into common stock

$


$
3,000

$


$
3,000Accrued interest paid by conversion into common stock

$


$
217

$


$
217


See accompanying notes to financial statements.

F-5

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Table of Contents

Kips Bay Medical, Inc.  (A Development Stage Company)        Notes To Financial Statements

1. Organization and Business

Kips Bay Medical, Inc. was incorporated in the state of Delaware on May 1, 2007. We are a medical device company focused on developing, manufacturing and commercializing
our external saphenous vein support technology, or eSVS MESH, for use in coronary artery bypass grafting, or CABG, surgery. Our eSVS MESH is a nitinol mesh sleeve that, when placed over a saphenous
vein graft during CABG surgery, is designed to improve the structural characteristics and long-term performance of the vein graft. In CABG procedures, surgeons harvest blood vessels,
including the internal mammary artery from the chest and the saphenous vein from the leg, and attach the harvested vessels to bypass, or provide blood flow around, blocked coronary arteries.

Our
activities since inception have consisted principally of acquiring product and technology rights, raising capital, performing research and development and conducting preclinical and
clinical trials. Accordingly, we are considered to be in the development stage as of December 31, 2010, as defined by the Financial Accounting Standard Board, or FASB, Accounting Standard
Codification, or ASC, 915. At December 31, 2010, we had an accumulated deficit of $20.1 million and we expect to incur losses for the foreseeable future. To date, we have been funded by
private equity and debt financings. Subsequent to the end of the fiscal year, we completed an initial public offering of our common stock generating net proceeds of approximately $13.6 million.
See note 12 for information on our initial public offering.

2. Summary of Significant Accounting Policies



The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported amounts and disclosures in the combined consolidated financial statements and accompanying notes. Actual results could
differ from those estimates.



Cash and cash equivalents consist of cash and money market funds with original maturities of three months or less. The carrying value
of these instruments approximates fair value. We have not experienced any losses on our cash and cash equivalents.



Short-term investments consist of certificates of deposits, money market accounts and mutual fund investments with a
maturity of greater than three months and less than one year. Short-term investments have been classified and accounted for as
available-for-sale securities and are reported on the balance sheet at fair value with unrealized gains or losses reported as a component of other comprehensive income. We
continually evaluate our investments in marketable securities for impairment due to declines in market value considered to be other-than-temporary. That evaluation includes
persistent declining stock prices and general economic and company-specific evaluations.

F-6

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)



Accounts receivable are recorded at the invoiced amount and do not bear interest. We make judgments as to our ability to collect
outstanding receivables and will provide an allowance for credit losses when collection becomes doubtful.



Inventories are stated at the lower of cost (first-in, first-out method) or market. Appropriate consideration
is given to deterioration, obsolescence and other factors in evaluating net realizable value. Inventories consist of the following:

December 31, 2010(In thousands)Raw materials

$
102Work in process


231Finished goods


273$
606




Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed based upon the estimated useful lives
of the respective assets, or the lesser of the estimated useful life or the remaining life of the underlying facility lease for leasehold improvements, ranging from three to seven years, and is
recorded using the straight-line method. Repairs and maintenance costs are expensed as incurred.



In accordance with FASB ASC 360,Property, Plant and Equipment, long-lived
assets, such as property and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of
an asset exceeds its estimated future cash flows, then an impairment charge is recognized as the amount by which the carrying amount of the asset exceeds the fair value of the asset. As of
December 31, 2010 and 2009, no modification of the remaining useful lives or write-down of long-lived assets is required.



We sell our eSVS MESH to international distributors, which subsequently resell it to hospitals and clinics. We recognize revenue in
accordance with generally accepted accounting principles as outlined in SEC Staff Accounting Bulletin No. 104,Revenue Recognition, and ASC
605-10-S99; specifically, when persuasive evidence of an arrangement exists, delivery of goods occurs through the transfer of title and risks and rewards of ownership, the
selling price is fixed or determinable and collectability is reasonably assured.

F-7

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)

We
recognize revenue as products are shipped based on agreements with each of our distributors, which provide that title and risk of loss pass to the distributor upon shipment of the
products to the distributor and do not provide the distributors a right of return. We invoice shipping charges to our distributors and include them in net sales. We expense royalties and shipping
costs at the time we report the related revenue and record them in cost of sales.



Research and development costs are expensed as incurred and include the costs to design, develop, test, deploy and enhance our eSVS
MESH. It also includes costs related to the execution of clinical trials and to obtain regulatory approval for our eSVS MESH. We expense amounts paid to obtain patents or acquire licenses as the
ultimate recoverability of the amounts paid is uncertain.

We
charge research and development costs, including clinical trial costs, to expense when incurred, consistent with the guidance of FASB ASC 730,Research and
Development. Clinical trial costs are a significant component of research and development expenses. All of our clinical trials are performed at clinical trial sites and are
administered by contract research organizations, or CROs. Costs of setting up clinical trial sites are accrued immediately. Expenses related to clinical trials generally are accrued based on
contracted amounts and the achievement of milestones, such as number of patients enrolled. We monitor levels of performance under each significant contract, including the extent of patient enrollment
and other activities through communications with the CROs, and adjust the estimates, if required, on a quarterly basis so that clinical expenses reflect the actual effort expended by each CRO.

All
material CRO contracts are terminable by us upon written notice and we are generally only liable for actual effort expended by the CROs and certain non-cancelable
expenses incurred at any point of termination.



Comprehensive income/loss is computed as net loss plus certain other items that are recorded directly to stockholders' equity as other
comprehensive income or loss. Other comprehensive income or losses include unrealized gains and losses on available-for-sale securities. Comprehensive loss for each period
presented is set forth in the statements of stockholders' equity (deficit).



Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit
carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In light of our cumulative
losses, we believe that it is more likely than not that our net deferred tax asset will not be realized. Accordingly, a full valuation allowance has been recorded against our net deferred tax assets.

F-8

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)



Stock-based incentive awards are accounted for under the provisions of FASB ASC 718, CompensationStock Compensation, which requires
companies to measure and recognize the cost of employee and non-employee
services received in exchange for awards of equity instruments based on the grant date fair value of those awards. Compensation cost is recognized ratably using the straight-line
attribution method over the expected vesting period, which is considered to be the requisite service period. In addition, we are required to estimate the amount of expected forfeitures when
calculating the compensation costs, instead of accounting for forfeitures as incurred. All of our options previously awarded were classified as equity instruments and continue to maintain their equity
classification.

The
fair value of options is estimated at the date of grant using the Black-Scholes option pricing model with the assumptions listed in Note 8. Risk free interest rates are based
upon U.S. Treasury rates appropriate for the expected term. Expected volatility and forfeiture rates are based on the volatility rates of a set of guideline companies, which consist of public and
recently public medical technology companies. The assumed dividend yield is zero, as we do not expect to declare any dividends in the foreseeable future. The expected term is determined using the
simplified method allowed by SEC Staff Accounting Bulletin No. 110. The fair value of the common stock underlying the stock options has been determined by our Board of Directors at each award
grant date based upon a variety of factors, primarily the most recent purchase prices of our common stock issued to third parties in arms-length transactions, but also the progress of our
product development, the progress of our preclinical and clinical testing, and the risks associated with our business plan.

Stock-based
compensation expense in our statements of operations is summarized as follows:

December 31,

Period from May 1,
2007 (Date of
Inception) to
December 31, 20102010

2009

2008(In thousands)Cost of Sales

$
12

$


$


$
12Research and development


520


390


298


1,222Sales, general and administrative


93


47


40


182Total stock-based compensation

$
625

$
437

$
338

$
1,416




We compute net loss per share in accordance with FASB ASC 260,Earnings Per Share,
under which basic net loss attributable to common stockholders, on a per share basis, is computed by dividing income available to common stockholders (the numerator) by the weighted-average number of
common shares outstanding (the denominator) during the period. Shares issued during the period and shares reacquired during the period are weighted for the portion of the period that they were
outstanding. The computation of diluted earnings per share, or EPS, is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common
shares that would have been outstanding if the dilutive potential common shares had been issued. In addition, in

F-9

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

2. Summary of Significant Accounting Policies (Continued)

computing
the dilutive effect of convertible securities, the numerator is adjusted to add back the after-tax amount of interest recognized in the period associated with any convertible
debt. Diluted EPS is the same as basic EPS due to common equivalent shares being excluded from the calculation, as their effect is anti-dilutive.

The
following table summarizes our calculation of net loss per common share:

December 31,2010

2009

2008(In thousands, except share and per share amounts)Net loss

$
(10,892
)
$
(3,337
)
$
(3,812
)Weighted average shares outstandingbasic and diluted


13,431,661


11,069,342


6,100,767Net loss per sharebasic and diluted

$
(0.81
)
$
(0.30
)
$
(0.62
)


Outstanding
potential common shares not included in diluted net loss per share attributable to common stockholders calculations, as their effects were not dilutive, included:

December 31,2010

2009

2008Employee and non-employee stock options


813,000


598,000


531,750Common shares issuable for conversion of debt (See note 7)








4,800,000Common shares issuable under investor option purchase agreements (See note 7)





600,000


900,000




We operate on a manufacturing calendar with our fiscal year always ending on December 31. Each quarter is 13 weeks,
consisting of two four-week and one five-week periods.



In January 2010, the FASB issued ASU 2010-6,Fair Value Measurements and Disclosures ASC Topic 820:
Improving Disclosures about Fair Value Measurements, which requires reporting entities to make new disclosures about recurring or nonrecurring fair value
measurements including (i) significant transfers into and out of Level 1 and Level 2 fair value measurements and (ii) information on purchases, sales , issuances and
settlements on a gross basis in the reconciliation of Level 3 fair value measurements. ASU 2010-6 was effective for interim and annual reporting periods beginning after
December 15, 2009, except for Level 3 reconciliation disclosures which are effective for interim and annual periods beginning after December 15, 2010. We adopted the additional
disclosures required for Level 1 and Level 2 fair value measurements in the first quarter of 2010 (see Note 3). We adopted Level 3 disclosures beginning in the first
quarter of 2011.

F-10

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

3. Fair Value of Financial Instruments

We apply the provisions of FASB ASC 820,Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for
measuring fair value under U.S. GAAP, and enhances disclosures about fair value measurements.

Fair
value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Valuation techniques used to measure fair value, as required by FASB ASC 820, must maximize the use of observable inputs and minimize the use of unobservable inputs.

The
standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure
fair value. Our assessment of the significance of a particular input to the fair value measurements requires judgment,
and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy. The three levels of input are:



Following
is a description of our valuation methodologies for assets and liabilities measured at fair value.

Where
quoted prices are available in an active market, fair value is based upon quoted market prices and is classified in level 1 of the fair value hierarchy. If quoted market
prices are not available, fair value is based upon observable inputs such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are
observable or can be corroborated by observable market data, and the assets or liabilities are classified in level 2 of the valuation hierarchy. When quoted prices and observable inputs are
unavailable, fair values are based on internally developed cash flow models and are classified in level 3 of the valuation hierarchy. The internally developed cash flow models primarily use, as
inputs, estimates for interest rates and discount rates, including yields of comparable traded instruments adjusted for illiquidity and other risk factors, amount of cash flows and expected holding
periods of the assets. These inputs reflect our own assumptions about the assumptions market participants would use in pricing the assets, including assumptions about risk developed based on the best
information available in the circumstances.

Our
cash and equivalents consist of bank deposits and money market funds. Our short-term investments consist of a money market account at December 31, 2010 and a
mutual fund investment and certificates of deposit at December 31, 2009. We determine the fair value of these investments using Level 1 inputs. The certificates of deposit, money market
funds and mutual funds are traded in active exchange markets and are highly liquid.

F-11

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

3. Fair Value of Financial Instruments (Continued)

With
the adoption of FASB ASC 815-40, an outstanding option to purchase shares of our common stock held by Kips Bay Investments, LLC was determined to be a derivative
instrument as of January 1, 2009. This liability is reported at fair value and measured at each reporting date. We estimated the fair value of this liability using Level 3 inputs as
there was no active market for the investor stock purchase option. Additional information on our valuation of this liability is included in Note 7. Changes in the liability are reported as a
separate line item on our statement of operations.

Other
financial instruments, including accounts payable and accrued liabilities, are carried at cost, which we believe approximates fair value because of the short-term
maturity of these instruments.

A
summary of financial assets and liabilities measured at fair value on a recurring basis at December 31, 2010 and 2009 is as follows:

December 31, 2010

December 31, 2009Total

Quoted Prices
In Active
Markets
(Level 1)

Significant
Unobservable
Inputs
(Level 3)

Total

Quoted Prices
In Active
Markets
(Level 1)

Significant
Unobservable
Inputs
(Level 3)(In thousands)Assets:Cash and cash equivalents

$
3,548

$
3,548

$


$
2,469

$
2,469

$
Short-term investments


236


236





948


948


Total

$
3,784

$
3,784

$


$
3,417

$
3,417

$
Liabilities:Investor stock purchase option liability

$


$


$


$
960

$


$
960Total

$


$


$


$
960

$


$
960


A
summary of the activity in our investor stock purchase option liability, which is valued using significant unobservable inputs (Level 3), for the periods presented is as
follows:

(In thousands)Balance at December 31, 2008

$
Cumulative effect adjustment for adoption of FASB ASC 815-40


1,570Change in fair value included in statement of operations


(610
)Balance at December 31, 2009


960Change in fair value included in statement of operations


2,290Reclassified to additional paid-in capital upon exercise of the option (Note 7)


(3,250
)Balance at December 31, 2010

$



F-12

---



Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

4. Short-Term Investments and Impairment

Short-term investments include mutual fund investments, money market accounts and certificates of deposit. We determine the fair value of these investments using
Level 1 inputs.

Due
to the short-term maturities of our investments in certificates of deposits and money market accounts, their amortized cost approximates fair value.

As
of December 31, 2008, we concluded that the value of our mutual fund investment was impaired and that this impairment was other than temporary. We recorded an other than
temporary impairment charge of $85,000, which resulted in a new adjusted cost basis for this investment. We had no other unrealized gains or losses as of December 31, 2008. For the year ended
December 31, 2009, an unrealized gain of $33,000 was reported in other comprehensive income as the market value exceeded the cost of our mutual fund investment as of December 31, 2009.
During 2010 we sold our mutual fund investment and reclassified unrealized gains of $46,000 to be reflected in the Statements of Operations.

5. Property and Equipment

At December 31, 2010 and 2009, property and equipment consist of the following:

December 31,2010

2009(In thousands)Furniture and fixtures

$
41

$
36Machinery, equipment and tooling


494


254Computers and software


74


66Leasehold improvements


49


48Accumulated depreciation


(192
)

(118
)Property and equipment, net

$
466

$
286


Depreciation
expense for the years ended December 31, 2010, 2009 and 2008 was $74,000, $60,000 and $49,000, respectively.

6. Commitments and Contingencies



We entered into an operating lease agreement for our facility. The term of this lease originally ran from October 1, 2007
through September 30, 2010. In June 2010, we executed an amendment to our lease that extends the lease term through September 30, 2011. The amendment also provides us a right of first
refusal to lease approximately 11,000 additional square feet of space adjoining our current facility. The monthly base rent amount is fixed over the entire term of the lease, including the extended
term provided for in the June 2010 amendment. Terms of this lease arrangement include market rate renewal options, payment of executory costs such as real estate taxes, insurance and common area
maintenance. We also lease certain other office equipment under non-cancelable operating lease arrangements which are not recognized on our balance sheets.

F-13

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

6. Commitments and Contingencies (Continued)

Annual
future minimum lease obligations under our operating lease agreements as of December 31, 2010 are as follows:

(In thousands)2011

$
462012


32013


0Total

$
49


Rent
expense was $57,000 for each of the years ended December 31, 2010, 2009 and 2008 and $185,000 for the period from May 1, 2007 (date of inception) to
December 31, 2010.



The core intellectual property relating to our eSVS MESH, including five patent applications pending in the United States and nine
patent applications pending in countries outside the United States, was acquired from Medtronic, Inc. pursuant to an Assignment and License Agreement dated October 9, 2007. As
consideration for the assignment of such intellectual property, we have agreed to pay Medtronic an aggregate of up to $15.0 million upon the achievement of certain sales milestones and a
royalty of 4% on sales of our eSVS MESH. The milestones and related payments consist of $5.0 million due on the one-year anniversary of the first commercial sale of our eSVS MESH,
$5.0 million due when our cumulative net sales reach $15.0 million and $5.0 million due when our cumulative net sales reach $40.0 million. We reached the first milestone in
June 2010 and accrued an expense for the first milestone obligation. Royalty obligations are payable 60 days after the end of each fiscal quarter, are recorded as a component of our cost of
sales and will terminate upon the earlier of the expiration of all of the patents and patent applications, or when the aggregate royalties paid reaches $100.0 million. We recorded royalty
expense of $9,000 for the year ended December 31, 2010.



We are not currently engaged in any litigation.



We entered into an employment agreement with Manny Villafaña, our founder, Chief Executive Officer and sole director, on
July 19, 2007, which provides for a base salary and discretionary bonuses as determined by our Board of Directors. Mr. Villafaña is also entitled to participate in any
employee benefit plans we sponsor. If we terminate Mr. Villafaña's employment without cause, he is entitled to his base salary for the entire term of the employment agreement,
which expires on July 1, 2012.

Mr. Villafaña's
employment agreement contains usual and customary provisions relating to confidential information and assignment of inventions to us. In addition,
the agreement contains certain provisions concerning Mr. Villafaña's post-employment activities. Pursuant to the agreement, he has agreed not to compete with us for a
period of two years after the termination of his employment. Such two-year period will automatically be extended by one year increments, up to a total of five years, unless terminated by
us. As consideration for this non-competition provision, we will make a monthly

F-14

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

6. Commitments and Contingencies (Continued)

payment
to Mr. Villafaña equal to one twelfth of his base salary at the time of termination, adjusted to the Consumer Price Index, or CPI, beginning with the first month after
termination of employment and continuing until the non-competition provision expires. Mr. Villafaña will also be entitled to continue his participation in our medical
benefits plan for the term of the non-competition provision, provided he continues to pay the employee portion of the premium. Following the termination of his employment with us,
Mr. Villafaña has also agreed to consult on non-confidential matters at the request of our Board of Directors.

We
also entered into a change in control agreement with Mr. Villafaña on September 12, 2008. Under the terms of this agreement, if, within 24 months
of a change in control, Mr. Villafaña's employment is terminated by us other than for cause, or if he resigns for good reason, Mr. Villafaña will be
entitled to a prorated portion of any annual incentive bonus for the fiscal year in which the termination occurs and a severance benefit equal to three years of his base salary. The change in control
agreement will expire on September 12, 2011, but will be automatically extended by one-year increments
thereafter unless either party provides written notice to the other of the intent not to extend the agreement.

We
have entered into employment agreements with certain key employees providing for an annual salary and such benefits in the future as may be approved by the Board of Directors. We have
also entered into change of control agreements with employees which provide that if the employee is terminated for a reason other than cause, or resigns for good reason, upon a merger, acquisition,
sale of substantially all of our assets, or liquidation, the employee will receive severance payments equal to his or her monthly salary for 12 to 36 months.



The Company, as permitted under Delaware law and in accordance with its Bylaws, indemnifies its officers and directors for certain
events or occurrences, subject to certain limits, while the officer or director is or was serving at the Company's request in such capacity. The term of the indemnification period is for the officer's
or director's lifetime. The Company may terminate the indemnification agreements with its officers and directors upon 90 days written notice, but termination will not affect claims for
indemnification relating to events occurring prior to the effective date of termination. The maximum amount of potential future indemnification is unlimited; however, the Company has a director and
officer insurance policy that limits its exposure and may enable it to recover a portion of any future amounts paid. The Company believes the fair value of these indemnification agreements is minimal.
Accordingly, the Company has not recorded any liabilities for these agreements as of December 31, 2010.

7. Convertible Promissory Notes and Equity Financing



We are a party to an Investment Agreement dated July 19, 2007 with Manny Villafana and Kips Bay Investments, LLC, or KBI,
which had no relationship to us prior to entering into the Investment Agreement. Pursuant to the Investment Agreement, KBI sold us all of its right, title and interest to certain intellectual property
assets in exchange for a first secured promissory note dated July 19, 2007 with a principal amount of $100,000 and loaned to us $2.9 million in exchange for a second secured

F-15

---



Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

7. Convertible Promissory Notes and Equity Financing (Continued)

promissory
note dated July 19, 2007 with a principal amount of $2.9 million. The $100,000 note and the $2.9 million note, collectively the Notes, accrued interest at a rate of 9%
per annum. All principal and accrued interest under the Notes was convertible into shares of our common stock at a per share price of $0.625 per share. In connection with the issuance of the Notes, we
entered into a Loan and Security Agreement with KBI, pursuant to which we granted a security interest in all of our existing and to-be-acquired property and proceeds therefrom,
including all intellectual property assets transferred to us pursuant to the first secured promissory note.

The
Investment Agreement also granted KBI two stock purchase options. The first stock purchase option granted KBI the right to purchase 600,000 shares of our common stock for
$3.5 million following our determination that our eSVS MESH was suitable for human implantation. The second stock purchase option granted KBI the right to purchase an additional 600,000 shares
of our common stock for $3.5 million following the first implantation of our eSVS MESH. The Investment Agreement also provides certain registration rights to KBI. The relative fair value of the
stock purchase options and the beneficial conversion feature on the Notes were recorded as discounts on the Notes and were amortized over the term of the Notes using the effective interest method.

In
April 2008, we determined that our eSVS MESH was suitable for human implantation, and KBI subsequently exercised its first stock purchase option under the Investment Agreement,
purchasing an aggregate of 600,000 shares of our common stock for a purchase price of $3.5 million in nine installments from May 2008 to June 2009. In August 2008, the first implantation of our
eSVS MESH took place thereby satisfying the condition to the second stock purchase option. KBI exercised the second option in February 2010, purchasing an additional 600,000 shares for a purchase
price of $3.5 million.

We
account for derivative instruments in accordance with FASB ASC 815,Derivatives and Hedging, which provides accounting and reporting
standards for derivative instruments, including certain derivative instruments embedded in other contracts. We do not use derivative instruments for hedging of market risks or for trading or
speculative purposes. Effective January 1, 2009, we were required to adopt FASB ASC 815-40, (formerly EITF Issue No. 07-5,Determining
Whether an Instrument (or Embedded Feature) is Indexed to an Entity's Own Stock), which clarified the
determination of whether equity-linked instruments (or embedded features), such as the options to purchase our common stock granted to KBI, are considered indexed to our own stock, which would qualify
as a scope exception under FASB ASC 815. As a result of adopting FASB ASC 815-40, the second option to purchase our common stock granted to KBI is considered a derivative liability and
must be measured at fair value. As noted above, the first option was exercised in 2008 and was not outstanding at the effective date for FASB ASC 815-40.

Prior
to their exercise, the estimated fair value of our investor stock purchase option liability was recorded as a current liability on our balance sheets. Changes in the estimated fair
value of this liability were recorded in our statements of operations.

On
January 1, 2009, the date of adoption, we estimated the fair value of the second option to be $1.6 million and this amount was recorded as a cumulative effect adjustment
on January 1, 2009, which increased our deficit accumulated during development stage by $1.4 million. We estimated the fair value of this option as of January 1, 2009 using a
Black-Scholes valuation model using the following assumptions: fair value of our common stock: $6.00; dividend yield: 0%; volatility: 70%; risk free

F-16

---



Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

7. Convertible Promissory Notes and Equity Financing (Continued)

interest
rate: 0.88%; and expected term: 2.5 years. The fair value of our common stock was determined based upon the sale price in our private placement offering that commenced in March 2009.
The estimated dividend yield is zero as we have no intent to pay dividends in the foreseeable future. Volatility was estimated based upon a portfolio of guideline companies in the same or similar
lines of business. The risk free interest rate was determined based upon the yield of constant maturity U.S. Treasury bills with durations approximating the expected term. The expected term was based
upon the term of the Notes.

The
effect of adjusting this liability to its estimated fair value at December 31, 2009 resulted in a net decrease in the estimated fair value of this liability of $610,000,
resulting in an estimated fair value of this liability of $960,000. We estimated the fair value of this option as of December 31, 2009 using a Black-Scholes valuation model using the following
assumptions: fair value of our common stock: $7.00; dividend yield: 0%; volatility: 70%; risk free interest rate: 0.06%; and expected term: 0.25 years. These assumptions changed from
January 1, 2009 due primarily to the commencement of our second private placement offering, under which we sold our common stock at $7.00 per share. In December 2009, we began discussions with
an investment banker in order to prepare for a potential initial public offering of our common stock. As a result, we decreased the estimated expected term to coincide with the anticipated timing of
an initial public offering.

In
March 2009, KBI converted the entire principal amount of $3.0 million and partially converted $217,188 of $467,188 in accrued interest on the Notes into 5,147,389 shares of our
common stock at a price of $0.625 per share, and we paid KBI the balance of $250,000 of accrued interest in cash. In connection with KBI's exercise of the second stock purchase option in February
2010, we and KBI entered into an agreement whereby KBI repaid us the $250,000 in cash and we issued KBI 400,000 shares of our common stock at a price of $0.625 per share. We accounted for this
agreement and its
effect on the second stock purchase option as an exchange of the original option for a new option. As the second stock purchase option was exercised concurrent with the repayment and conversion of
interest, the fair value of the option was determined based upon the difference between the fair value of our common stock and the exercise price of the option. The fair value of our common stock at
the date of modification was determined to be $7.00 per share, based upon the sale price of our common stock to unrelated third-party investors under a private offering which was completed in February
2010. We recorded a charge of $2.3 million as the change in fair value of investor stock purchase option, increasing the recorded investor stock purchase option liability to
$3.25 million. This liability was then reclassified to additional paid in capital in conjunction with issuance of shares related to the exercise of the second stock purchase option.



In March 2009, we commenced a private offering of a minimum of 500,000 shares of our common stock and up to a maximum of 1,666,667
shares of our common stock to certain accredited investors at an offering price of $6.00 per share. We sold an aggregate of 516,241 shares of common stock in the private offering, which was completed
in August 2009. KBI purchased 41,667 shares of our common stock in this private offering.

F-17

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

7. Convertible Promissory Notes and Equity Financing (Continued)

In October 2009, we commenced a private offering of 714,286 shares of our common stock to certain accredited investors at an offering price of $7.00 per share. We sold an aggregate of
317,161 shares of common stock in the private offering, which was completed in February 2010.

8. Stock-Based Compensation



Our 2007 Long-Term Incentive Plan, or the Plan, was adopted by the Board of Directors in July 2007. The Plan permits the
granting of incentive and non-statutory stock options, restricted stock, stock appreciation rights, performance units, performance shares and other stock awards to eligible employee,
directors and consultants. We grant options to purchase shares of common stock under the Plan at no less than the fair market value of the underlying common stock as of the date of grant. Options
granted under the Plan have a maximum term of ten years and generally vest over four years for employees, at the rate of 25% of total shares underlying the option each year, and over three years for
non-employees, with 25% vesting upon grant and 25% vesting each year thereafter. Under the Plan, a total of 2,000,000 shares of common stock were initially reserved for issuance.

A
summary of option activity is as follows:

Shares Under
Option

Weighted
Average
Exercise Price

Available
For GrantOptions outstanding at December 31, 2008


531,750


1.72


1,468,250Granted


70,000


5.93


(70,000
)Exercised


(1,000
)

1.00


Cancelled


(2,750
)

1.00


2,750Options outstanding at December 31, 2009


598,000


3.08


1,401,000Granted


215,000


7.00


(215,000
)Exercised








Cancelled








Options outstanding at December 31, 2010


813,000

$
4.12


1,186,000


The
grant date total fair value of employee options vested during the years ended December 31, 2010, 2009 and 2008 was $118,000, $67,000 and $27,000, respectively. The total
intrinsic value of options exercised during the years ended December 31, 2010, 2009 and 2008 was $0, $5,000 and $0, respectively. Total proceeds received for options exercised during the year
ended December 31, 2009 were $1,000. No options were exercised in 2010.

F-18

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

8. Stock-Based Compensation (Continued)

Information
about stock options outstanding, vested and expected to vest as of December 31, 2010, is as follows:

Outstanding, Vested and Expected to Vest

Options VestedPer Share
Exercise Price

Shares

Weighted
Average
Remaining
Contractual
Life (Years)

Weighted
Average
Exercise Price

Options
Exercisable$1.00


334,000


6.80

$
1.00


237,0002.00


10,000


7.19


2.00


5,0005.83


214,000


7.81


5.83


100,7506.00


40,000


8.68


6.00


10,0007.00


215,000


9.12


7.00


12,500813,000


7.78


2.69


365,250




Total employee stock-based compensation expense recognized under FASB ASC 718 was as follows:

December 31,

Period from May 1,
2007 (Date of
Inception) to
December 31, 20102010

2009

2008(In thousands)Cost of Sales

$
12

$


$


$
12Research and development


148


83


37


273Selling, general and administrative


76


12


9


99Total stock-based compensation

$
236

$
95

$
46

$
384


As
of December 31, 2010, 2009 and 2008, total compensation expense related to unvested employee stock options not yet recognized was $608,000, $297,000 and $199,000, respectively,
which is expected to be allocated to expenses over a weighted-average period of 1.88, 2.22 and 2.88 years, respectively.

F-19

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

8. Stock-Based Compensation (Continued)

The
assumptions used in the Black-Scholes option-pricing model for the years ended December 31, 2010, 2009 and 2008, for the period from May 1, 2007 (Date of Inception) to
December 31, 2010 are as follows:

December 31,

Period from May 1
2007(Date of
Inception) to
December 31, 20102010

2009

2008Risk free interest rate

2.45 - 2.82%

1.75 - 2.80%

2.66 - 3.58%

1.75 - 4.32%Dividend yield

0%

0%

0%

0%Expected volatility

50%

48%

53%

48 - 53%Expected term

5.75 - 6.25 years

6.25 years

5.75 - 6.25 years

5.75 - 6.25 yearsWeighted average grant date fair value

$3.56

$2.91

$2.42

$2.09




We account for stock options granted to nonemployees as required by FASB ASC 718. In connection with stock options granted to
nonemployees we recorded $388,000, $342,000 and $292,000 for nonemployee stock-based compensation during the years ended December 31, 2010, 2009 and 2008, respectively, and $1,031,000 for
nonemployee stock-based compensation for the period from May 1, 2007 (Date of Inception) to December 31, 2010. These amounts were based upon the fair value of the vested portion of the
grants.

Amounts
expensed during the remaining vesting period will be determined based on the fair value at the time of vesting.

9. Employee Benefit Plan

We maintain a simplified employee retirement plan, or SEP, which commenced on January 1, 2008. The SEP is a defined contribution plan; employee contributions are voluntary and are
determined on an individual basis, limited by the maximum amounts allowable under federal tax regulations. We contribute up to 3% of each individual's base salary as required under the
safe-harbor provisions of Internal Revenue Service rules governing SEP plans. Our contributions vest immediately and are expensed when paid. We have recorded contributions of $46,000 and
$38,000 for the years ended December 31, 2010 and 2009, respectively, and $117,000 for the period from May 1, 2007 (Date of Inception) to December 31, 2010.

10. Income Taxes

We have incurred net operating losses since inception. We have not reflected any benefit of such net operating loss carryforwards in the accompanying financial statements and have
established a full valuation allowance against our deferred tax assets.

The
state of Minnesota enacted a change to their tax code which made the Minnesota Research and Tax Credit a refundable credit for fiscal years starting on or after January 1,
2010. Based upon our

F-20

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

10. Income Taxes (Continued)

research
and development costs which qualify under the Minnesota tax code, we have recorded an income tax benefit of $42,000 for the year ended December 31, 2010.

Deferred
income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes, and (b) operating losses and tax credit carryforwards.

The
significant components of our deferred tax assets for are as follows:

December 31,2010

2009(In thousands)Deferred tax assets:Net operating loss carryforwards

$
4,099

$
2,838Intangible assetslicense agreement


119


89Stock-based compensation


451


283Accrued milestone obligation


2,190


Short-term investment impairment





37Research credit carryforwards


434


408Other


79


51Total deferred tax assets


7,372


3,706Deferred tax liabilities:





Total deferred taxes


7,372


3,706Valuation allowance


(7,372
)

(3,706
)Net deferred tax asset

$


$



A
reconciliation of the statutory tax rates and the effective tax rates is as follows:

Period from
May 1, 2007
(Date of Inception)
to December 31,
2010Year Ended December 31,2010

2009

2008Statutory rate


34.0
%

34.0
%

34.0
%

34.0
%Permanent differences


(8.8
)

(1.4
)

(3.3
)

(6.2
)State and local income taxes


7.5


9.4


8.9


8.2Credits and other


1.2


5.5


5.0


2.8Valuation allowance


(33.5
)

(47.5
)

(44.6
)

(38.6
)Effective rate


0.4
%

0.0
%

0.0
%

0.2
%


Realization
of the future tax benefits is dependent on our ability to generate sufficient taxable income within the carry-forward period. Because of our history of operating losses,
management believes that the deferred tax assets arising from the above-mentioned future tax benefits are currently not likely to be realized and, accordingly, we have provided a full valuation
allowance. The net valuation allowance increased by $3.7 million and $1.8 million for the years ended December 31, 2010

F-21

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Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

10. Income Taxes (Continued)

and
2009, respectively, and $7.4 million for the period from May 1, 2007 (Date of Inception) to December 31, 2010.

Net
operating losses and tax credit carryforwards as of December 31, 2010, are as follows:

Amount

Expiration Years(In thousands)Net operating lossesfederal

$
9,274

Beginning 2027Tax creditsfederal

$
379

Beginning 2027


Utilization
of the net operating loss carryforwards and credits may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue
Code of 1986, as amended, or the IRC, and similar state provisions. We have not performed a detailed analysis to determine whether an ownership change under Section 382 of the IRC has occurred.
The effect of an ownership change would be the imposition of an annual limitation on the use of net operating loss carryforwards attributable to periods before the change.

Effective
January 1, 2009 we adopted the changes issued by the Financial Accounting Standards Board related to accounting for uncertain tax positions. This did not result in a
cumulative adjustment to our tax liability at December 31, 2009. At December 31, 2010 there are no liabilities for unrecognized tax benefits.

We
would classify interest and penalties related to uncertain tax positions in income tax expense, if applicable. There was no interest expense or penalties related to unrecognized tax
benefits recorded through December 31, 2010. The tax years 2007 through 2010 remain open to examination by federal and state tax authorities.

11. Selected quarterly financial data (unaudited)

The following summarized unaudited quarterly financial data has been prepared using the unaudited quarterly financial statements of the Company:

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter(In thousands, except per share amounts)Fiscal 2010Net sales

$


$
48

$
59

$
116Gross profit





29


37


80Operating loss

$
(1,199
)
$
(5,875
)
$
(736
)

(891
)Net loss

$
(3,485
)
$
(5,871
)
$
(733
)

(803
)Basic and diluted net loss per share

$
(0.27
)
$
(0.43
)
$
(0.05
)

(0.06
)Fiscal 2009Operating loss


(1,022
)

(892
)

(939
)

(930
)Net loss


(1,125
)

(816
)

(1,279
)

(117
)Basic and diluted net loss per share


(0.14
)

(0.07
)

(0.10
)

(0.01
)


F-22

---



Table of Contents

Kips Bay Medical, Inc.
(A Development Stage Company)

Notes To Financial Statements (Continued)

11. Selected quarterly financial data (unaudited) (Continued)

Quarterly
calculations of basic and diluted loss per share are made independently during the fiscal quarter.

12. Subsequent Events (unaudited)

On February 16, 2011, we completed an initial public offering ("IPO") of 2,062,500 shares of our common stock at a purchase price of $8.00 per share. All shares sold in the IPO
were newly issued by the Company. Gross proceeds from the IPO were $16.5 million. After deducting the underwriting commissions and other expenses, we realized net proceeds of approximately
$13.6 million. As additional consideration for this transaction, we issued warrants for the purchase of 103,125 shares of our common stock to the underwriter and their designees. The warrants
have a 5 year term, an exercise price of $10.00 per share or 125% of the purchase price of shares sold in the IPO, and become exercisable on February 10, 2012, one year after the
effective date of the IPO.

F-23

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Table of Contents

Kips Bay Medical, Inc.  Annual Report On Form 10-K    Exhibit Index

Exhibit
Number

Description of Exhibit3.1

Certificate of Incorporation of the Registrant.(a)3.2

Amended and Restated Bylaws of the Registrant.+4.1

Form of Common Stock Certificate.(c)10.1

Lease Agreement by and between the Registrant and St. Paul Properties, Inc., as assigned to St. Paul Fire and Marine Insurance Company, dated as of July 26, 2007.(a)10.2

Investment Agreement by and between the Registrant and Kips Bay Investments, LLC, dated as of July 19, 2007.(b)10.3

Loan and Security Agreement by and between the Registrant and Kips Bay Investments, LLC, dated as of June 19, 2007.(a)10.4

First Secured Convertible Promissory Note executed by the Registrant in favor of Kips Bay Investments, LLC, dated as of July 19, 2007.(a)10.5

Second Secured Convertible Promissory Note executed by the Registrant in favor of Kips Bay Investments, LLC, dated as of July 19, 2007.(a)10.6

Agreement by and between the Registrant and Kips Bay Investments, LLC, dated as of February 12, 2010.(a)10.7

Debt Conversion Agreement by and between the Registrant and Kips Bay Investments, LLC, dated as of February 12, 2010.(a)10.8

Assignment and License Agreement by and between the Registrant and Medtronic, Inc., dated as of October 9, 2007.(d)10.9

Assignment by Medtronic, Inc. to the Registrant, dated as of August 26, 2008.(a)10.10

Trademark Transfer Agreement by Medtronic, Inc. to the Registrant, dated as of October 10, 2007.(a)10.11
@
Employment Agreement by and between the Registrant and Manuel A. Villafaña, dated as of July 19, 2007.(a)10.12
@
Employment Agreement by and between the Registrant and Michael Winegar, dated as of September 1, 2007.(a)10.13
@
Employment Agreement by and between the Registrant and Scott Kellen, dated as of February 8, 2010.(a)10.14

Form of Indemnification Agreement between the Registrant and its Directors and Executive Officers.(c)10.15
@
Change in Control Agreement by and between the Registrant and Manuel A. Villafaña, dated as of September 12, 2008.(a)10.16
@
Change in Control Agreement by and between the Registrant and Michael Winegar, dated as of September 12, 2008.(a)10.17
@
Change in Control Agreement by and between the Registrant and Scott Kellen, dated as of February 8, 2010.(a)10.18
@
2007 Long-Term Incentive Plan.(a)


---



Table of Contents

Exhibit
Number

Description of Exhibit10.19
@
Form of Incentive Stock Option Agreement under the 2007 Long-Term Incentive Plan.(a)10.20
@
Form of Non-Qualified Stock Option Agreement under the 2007 Long-Term Incentive Plan.(a)10.21
@
Form of Restricted Stock Agreement under the 2007 Long-Term Incentive Plan.(a)10.22

Letter by and between the Registrant and Kips Bay Investments, LLC dated May 19, 2010.(b)10.23

Indemnification Agreement between the Registrant and Manny Villafaña.(c)10.24

Indemnification Agreement between the Registrant and Michael P. Winegar.(c)10.25

Indemnification Agreement between the Registrant and Scott Kellen.(c)10.26

Indemnification Agreement between the Registrant and Arch C. Smith.(f)10.27

Indemnification Agreement between the Registrant and Robert E. Munzenrider.(f)10.28

Indemnification Agreement between the Registrant and Robert J. Sheehy.(f)10.29

Assignment by Medtronic, Inc. to the Registrant, dated as of October 10, 2007.(c)10.30

Consulting Agreement by and between the Registrant and Symbios Clinical, Inc., dated as of July 21, 2008.(c)10.31

CRO Services Agreement by and between the Registrant and Symbios Clinical, Inc., dated as of March 25, 2010.(c)10.32

Amendment No. 1 to Lease by and between the Registrant and St. Paul Fire and Marine Insurance Company, dated as of June 14, 2010.(d)10.33

Distribution Agreement by and between the Registrant and LeviBiotech s.r.l., dated July 1, 2010.(e)10.34

Distribution Agreement by and between the Registrant and Master Surgery Systems AS, dated November 22, 2010.(e)10.35

Distribution Agreement by and between the Registrant and Pacific Medical Systems Ltd., dated October 12, 2010.(e)10.36

Distribution Agreement by and between the Registrant and Systemed A.E., dated November 22, 2010.(e)10.37

Distribution Agreement by and between the Registrant and Transmedic PTE Ltd., dated August 2, 2010.(e)10.38

Distribution Agreement by and between the Registrant and Advanced Biomedical Pty Ltd., dated July 22, 2010.(e)10.39

Distribution Agreement by and between the Registrant and Biomed, S.A., dated July 12, 2010.(e)10.40

Distribution Agreement by and between the Registrant and Calmedical Ltd., dated June 17, 2010.(e)10.41

Distribution Agreement by and between the Registrant and Cardiac Services Ltd., dated November 22, 2010.(e)10.42

Distribution Agreement by and between the Registrant and F.O.C.S. Gmbh, dated June 17, 2010.(e)10.43

Distribution Agreement by and between the Registrant and Fehling Instruments Middle East F.Z.C., dated September 1, 2010.(e)


---



Table of Contents

Exhibit
Number

Description of Exhibit10.44

Distribution Agreement by and between the Registrant and Krijnen Medical Innovations B.V., dated June 17, 2010.(e)10.45

Distribution Agreement by and between the Registrant and ERA Foreign Trade Ltd., dated October 27, 2010.(e)10.46

Distribution Agreement by and between the Registrant and Sygan Medical Gmbh, dated January 11, 2011.(f)21

Subsidiaries of the RegistrantNone.+24.1

Powers of Attorney (see signature page).+31.1

Chief Executive Officer Certification Pursuant to Rule 13a-14(a), of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.+31.2

Chief Financial Officer Certification Pursuant to Rule 13a-14(a), of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.+32.1

Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.+32.2

Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.+
  +Filed
herewith.@Denotes
management compensation plan or contract.(a)Incorporated
by reference to the Registrant's registration statement on Form S-1 (Reg. No. 333-165940) filed with the
SEC on April 8, 2010.(b)Incorporated
by reference to the Registrant's amendment no. 1 to registration statement on Form S-1 (Reg.
No. 333-165940) filed with the SEC on May 20, 2010.(c)Incorporated
by reference to the Registrant's amendment no. 2 to registration statement on Form S-1 (Reg.
No. 333-165940) filed with the SEC on June 11, 2010.(d)Incorporated
by reference to the Registrant's amendment no. 4 to registration statement on Form S-1 (Reg.
No. 333-165940) filed with the SEC on August 12, 2010.(e)Incorporated
by reference to the Registrant's amendment no. 8 to registration statement on Form S-1 (Reg.
No. 333-165940) filed with the SEC on January 7, 2011.(f)Incorporated
by reference to the Registrant's amendment no. 9 to registration statement on Form S-1 (Reg.
No. 333-165940) filed with the SEC on January 18, 2011.


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