UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q





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




For the
quarterly period ended September 30, 2008




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




For the
transition period from 
to




Commission
File Number: 001-33382





SENORX,
INC.


(Exact
name of registrant as specified in its charter)





Delaware
            33-0787406(State
      or other jurisdiction of
              incorporation
      or organization)
            (I.R.S.
      Employer
              Identification
      No.)




3
Morgan


Irvine,
California 92618


(Address
of principal executive offices) (Zip Code)




(949)
362-4800


(Registrant’s
telephone number, including area code)




11
Columbia, Suite A


Aliso
Viejo, California 92656


(Former
name, former address and former fiscal year if changed since last
report)




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  x    No   ̈




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




Large
      accelerated Filer   ̈
            Accelerated
      filer   ̈
            Non-accelerated
      filer  x
            Smaller reporting company   ̈(Do not check if a smaller
      reporting company)




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




As of
October 31, 2008, 17,268,348 shares of the registrant’s common stock were
outstanding.













SENORX,
INC.


INDEX




PagePART I
            FINANCIAL
      INFORMATIONITEM 1.
            CONDENSED
      FINANCIAL STATEMENTS (unaudited)Condensed
      Balance Sheets as of September 30, 2008 and December 31,
    2007
            3Condensed
      Statements of Operations for the three and nine months ended September 30,
      2008 and September 30, 2007
            4Condensed
      Statements of Cash Flows for the nine months ended September 30, 2008 andSeptember
      30, 2007
            5Notes
      to Unaudited Condensed Financial Statements
            6ITEM 2.
            MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
            13ITEM 3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
            20ITEM 4.
            CONTROLS
      AND PROCEDURES
            20PART II
            OTHER
      INFORMATIONITEM 1.
            LEGAL
      PROCEEDINGS
            21ITEM 1A.
            RISK
      FACTORS
            21ITEM 2
            UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
            34ITEM 3
            DEFAULTS
      UPON SENIOR SECURITIES
            34ITEM 4
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
            34ITEM 5
            OTHER
      INFORMATION
            35ITEM 6.
            EXHIBITS
            35SIGNATURES
            37




2


PART I.  FINANCIAL
INFORMATION




ITEM
1: FINANCIAL STATEMENTS


SENORX,
INC.


CONDENSED
BALANCE SHEETS


(Unaudited)




September 30,
              2008
            
            
            December 31,
              2007ASSETSCurrent
      Assets:Cash
      and cash equivalents
            
            $
            14,609,523
            
            
            $
            17,185,259Short-term
      investments
            
            
            —
            
            
            
            10,764,490Accounts
      receivable, net of allowance for doubtful accounts of $232,115, and
      $107,728, respectively
            
            
            7,133,540
            
            
            
            5,421,184Inventory
            
            
            9,158,486
            
            
            
            6,650,955Prepaid
      expenses and deposits
            
            
            575,101
            
            
            
            544,276Total
      current assets
            
            
            31,476,650
            
            
            
            40,566,164Property
      and equipment, net
            
            
            1,523,417
            
            
            
            1,071,435Other
      assets, net of accumulated amortization of $702,926,and
      $436,380, respectively
            
            
            952,788
            
            
            
            424,649TOTAL
            
            $
            33,952,855
            
            
            $
            42,062,248LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      Liabilities:Accounts
      payable
            
            $
            2,427,229
            
            
            $
            2,580,249Accrued
      expenses, including accrued employee compensation of $2,015,156 and
      $1,137,889, respectively
            
            
            3,793,367
            
            
            
            2,904,603Deferred
      revenues
            
            
            143,059
            
            
            
            93,888Current
      portion of long-term debt
            
            
            30,332
            
            
            
            2,093,346Total
      current liabilities
            
            
            6,393,987
            
            
            
            7,672,086Long-term
      debt—less current portion
            
            
            9,904
            
            
            
            26,820Total
      liabilities
            
            
            6,403,891
            
            
            
            7,698,906Commitments
      and contingencies (Note 11)Stockholders’
      Equity:Common
      stock, $0.001 par value—100,000,000 shares authorized; 17,268,348
      (2008) and 17,202,395 (2007) issued and
    outstanding
            
            
            17,268
            
            
            
            17,202Additional
      paid-in capital
            
            
            111,804,318
            
            
            
            109,815,612Accumulated
      deficit
            
            
            (84,272,622
            )
            
            
            (75,469,472
            )Total
      stockholders’ equity
            
            
            27,548,964
            
            
            
            34,363,342TOTAL
            
            $
            33,952,855
            
            
            $
            42,062,248




3


SENORX,
INC.


CONDENSED
STATEMENTS OF OPERATIONS


(Unaudited)




Three Months
      Ended
              September 30,
            
            
            Nine
      Months Ended
              September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Net
      revenues
            
            $
            11,264,471
            
            
            $
            8,906,086
            
            
            $
            33,133,364
            
            
            $
            24,727,447Cost
      of goods sold
            
            
            3,942,922
            
            
            
            3,555,638
            
            
            
            12,322,674
            
            
            
            10,582,993Gross
      profit
            
            
            7,321,549
            
            
            
            5,350,448
            
            
            
            20,810,690
            
            
            
            14,144,454Operating
      expenses:Selling
      and marketing
            
            
            6,063,248
            
            
            
            4,354,056
            
            
            
            16,928,701
            
            
            
            13,085,547Research
      and development
            
            
            1,631,898
            
            
            
            1,580,130
            
            
            
            4,656,700
            
            
            
            4,694,999General
      and administrative
            
            
            1,380,333
            
            
            
            1,205,515
            
            
            
            8,474,316
            
            
            
            3,092,703Total
      operating expenses
            
            
            9,075,479
            
            
            
            7,139,701
            
            
            
            30,059,717
            
            
            
            20,873,249Loss
      from operations
            
            
            (1,753,930
            )
            
            
            (1,789,253
            )
            
            
            (9,249,027
            )
            
            
            (6,728,795
            )Interest
      expense
            
            
            22,334
            
            
            
            452,670
            
            
            
            59,160
            
            
            
            1,379,405Change
      in fair value of convertible promissory notes and warrant
      valuation
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            (990,875
            )Interest
      income
            
            
            (99,243
            )
            
            
            (551,288
            )
            
            
            (505,037
            )
            
            
            (1,182,327
            )Loss
      before provision for income taxes
            
            
            (1,677,021
            )
            
            
            (1,690,635
            )
            
            
            (8,803,150
            )
            
            
            (5,934,998
            )Provision
      for income taxes
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —Net
      loss
            
            $
            (1,677,021
            )
            
            $
            (1,690,635
            )
            
            $
            (8,803,150
            )
            
            $
            (5,934,998
            )Net
      loss per share-basic and diluted
            
            $
            (0.10
            )
            
            $
            (0.10
            )
            
            $
            (0.51
            )
            
            $
            (0.50
            )Weighted
      average shares outstanding-basic and diluted
            
            
            17,262,817
            
            
            
            17,076,002
            
            
            
            17,232,661
            
            
            
            11,973,240




4


SENORX,
INC.


CONDENSED
STATEMENTS OF CASH FLOWS


(Unaudited)




Nine Months
      Ended September 30,2008
            
            
            2007Cash
      Flows From Operating Activities:Net
      loss
            
            $
            (8,803,150
            )
            
            $
            (5,934,998
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
            
            
            1,191,487
            
            
            
            1,056,766Stock-based
      compensation
            
            
            1,735,295
            
            
            
            1,522,648Loss
      on fixed asset abandonment
            
            
            16,191
            
            
            
            28,871Amortization
      of debt discounts
            
            
            —
            
            
            
            306,189Provision
      for bad debt
            
            
            124,387
            
            
            
            —Change
      in fair value of convertible promissory notes and warrant debt
      discount
            
            
            —
            
            
            
            (990,875
            )Changes
      in operating assets and liabilities:Accounts
      receivable
            
            
            (1,836,743
            )
            
            
            (1,097,247
            )Inventory
            
            
            (3,511,828
            )
            
            
            (1,830,400
            )Prepaid
      expenses and deposits
            
            
            (40,803
            )
            
            
            (471,138
            )Other
      assets
            
            
            (269,204
            )
            
            
            469,384Accounts
      payable
            
            
            (165,283
            )
            
            
            (2,518,879
            )Accrued
      expenses
            
            
            888,764
            
            
            
            694,745Deferred
      revenues
            
            
            49,171
            
            
            
            30,800Net
      cash used in operating activities
            
            
            (10,621,716
            )
            
            
            (8,734,134
            )Cash
      Flows From Investing Activities:Maturities
      of short-term investments
            
            
            10,764,490
            
            
            
            (13,068,123
            )Acquisition
      of property and equipment
            
            
            (862,057
            )
            
            
            (389,422
            )Net
      cash provided by (used in) investing activities
            
            
            9,902,433
            
            
            
            (13,457,545
            )Cash
      Flows From Financing Activities:Proceeds
      from issuance of common stock from stock option exercises
            
            
            45,626
            
            
            
            52,638Proceeds
      from issuance of common stock under the ESPP plan
            
            
            207,851
            
            
            
            —Proceeds
      from initial public offering
            
            
            —
            
            
            
            47,058,000Payment
      of deferred offering costs
            
            
            —
            
            
            
            (941,027
            )Proceeds
      from other borrowings
            
            
            —
            
            
            
            2,750,000Payment
      of debt issuance costs
            
            
            (30,000
            )
            
            
            (49,496
            )Repayment
      of other borrowings
            
            
            (2,073,072
            )
            
            
            (4,949,984
            )Repayment
      of capital leases
            
            
            (6,858
            )
            
            
            (5,100
            )Net
      cash (used in) provided by financing activities
            
            
            (1,856,453
            )
            
            
            43,915,031Net
      decrease in cash and cash equivalents
            
            
            (2,575,736
            )
            
            
            21,723,352Cash
      and cash equivalents—beginning of period
            
            
            17,185,259
            
            
            
            7,412,986Cash
      and cash equivalents—end of period
            
            $
            14,609,523
            
            
            $
            29,136,338Supplemental
      Disclosure of Cash Flow Information:Cash
      paid for income taxes
            
            $
            —
            
            
            $
            —Cash
      paid for interest
            
            $
            31,244
            
            
            $
            807,450Inventory
      transferred to fixed assets and other assets
            
            $
            1,004,297
            
            
            $
            898,235Deferred
      offering costs offset against proceeds of initial public
      offering
            
            $
            —
            
            
            $
            1,325,131Warrant
      liability transferred to equity
            
            $
            —
            
            
            $
            698,374Promissory
      note converted to common stock
            
            $
            —
            
            
            $
            10,000,000Preferred
      stock converted to common stock
            
            $
            —
            
            
            $
            46,816,923Transfers
      between fixed assets and other assets
            
            $
            31,626
            
            
            $
            26,512Property
      and equipment acquired included in accounts payable
            
            $
            12,263
            
            
            $
            18,804Equipment
      acquired under capital leases
            
            $
            —
            
            
            $
            14,477




5


SENORX,
INC.


NOTES
TO UNAUDITED CONDENSED FINANCIAL STATEMENTS




1. BASIS
OF PRESENTATION




The
accompanying unaudited condensed financial statements have been prepared by
SenoRx, Inc. (the “Company”), pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations, although the Company believes that the disclosures
included in these notes and the accompanying condensed consolidated financial
statements are adequate to make the information presented not misleading. The
unaudited condensed financial statements reflect all adjustments, consisting
only of normal recurring adjustments, that are, in the opinion of management,
necessary to fairly state the financial position as of September 30, 2008 and
the results of operations and cash flows for the related interim periods ended
September 30, 2008 and 2007. The results of operations for the three and nine
months ended September 30, 2008 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2008 or for any other
period.




The
accounting policies followed by the Company and other information are contained
in the notes to the Company’s audited financial statements filed on
March 21, 2008 as part of the Company’s Annual Report on Form 10-K. This
quarterly report should be read in conjunction with such report.




2. SIGNIFICANT
ACCOUNTING POLICIES




The
Company’s significant accounting policies are disclosed in our Annual Report on
Form 10-K for the year ended December 31, 2007 which was filed with the
Securities and Exchange Commission. The Company’s significant accounting
policies have not changed as of September 30, 2008.




3.
RECENT ACCOUNTING PRONOUNCEMENTS




In
September 2006, the FASB issued SFAS No. 157,Fair Value Measurements
(“SFAS 157”), which defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements.
SFAS 157 applies to other accounting pronouncements that require or permit
fair value measurements. The new guidance is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and for interim
periods within those fiscal years. The Company adopted the provisions of
SFAS 157 as of January 1, 2008. The adoption of SFAS 157 did not have
a material impact on the Company’s financial position.




In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (“SFAS 159”), including an
amendment of SFAS No. 115. SFAS 159 permits entities to choose, at
specified election dates, to measure eligible items at fair value (the “fair
value option”). A business entity shall report unrealized gains and losses on
items for which the fair value option has been elected in earnings at each
subsequent reporting period. SFAS 159 is effective for years beginning
after November 15, 2007. The adoption of SFAS 159 did not have a material
impact on the Company’s financial position, as the Company did not make any fair
value elections under SFAS 159.




In
December 2007, the FASB issued SFAS No. 141—revised 2007, “Business Combinations”
(“SFAS 141R”). SFAS 141R establishes principles and requirements for
how an acquirer in a business combination recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
and any noncontrolling interest; recognizes and measures the goodwill acquired
in the business combination or a gain from a bargain purchase; and determines
what information to disclose to enable financial statement users to evaluate the
nature and financial effects of the business combination. SFAS 141R applies
to business combinations for which the acquisition date is on or after
December 15, 2008. Early adoption is prohibited. The Company is currently
evaluating the effect, if any, that the adoption of SFAS 141R will have on
its results of operations, financial position and cash flows.


6




In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements—an amendment to ARB No. 51
(“SFAS 160”). SFAS 160 requires all entities to report noncontrolling
(minority) interests in subsidiaries as equity in the consolidated financial
statements, but separate from the equity of the parent company. The statement
further requires that consolidated net income be reported at amounts
attributable to the parent and the noncontrolling interest, rather than
expensing the income attributable to the minority interest holder. This
statement also requires that companies provide sufficient disclosures to clearly
identify and distinguish between the interests of the parent company and the
interests of the noncontrolling owners, including a disclosure on the face of
the consolidated statements for income attributable to the noncontrolling
interest holder. This statement is effective for fiscal years beginning on or
after December 15, 2008. Early adoption is prohibited. The Company is
currently evaluating the effect, if any, that the adoption of SFAS 160 will
have on its results of operations, financial position and cash
flows.




In
February 2008, the FASB issued FASB Staff Position No. 157-2, which
deferred the effective date for certain portions of SFAS 157 related to
nonrecurring measurements of nonfinancial assets and liabilities. That
provision of SFAS 157 will be effective for the Company’s fiscal year
2009. The Company is currently evaluating the effect, if any, that the
adoption of SFAS 157-2 will have on its results of operations, financial
position and


cash
flows.




In April
2008, the FASB issued FASB Staff Position 142-3, Determination of the Useful Lives of
Intangible Assets(“FSP 142-3”), which amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under FASB No. 142, Goodwill and Other Intangible
Assets. The intent of FSP 142-3 is to improve the consistency between the
useful life of a recognized intangible asset under SFAS No. 142 and the
period of expected cash flows used to measure the fair value of the asset under
SFAS No. 141(R) and other U.S. generally accepted accounting principles.
FSP 142-3 is effective for fiscal years beginning after December 15, 2008
and for interim periods within those fiscal years. The Company does not expect
the adoption of FSP 142-3 to have a material effect on its results of
operations, financial position and cash flows.




In June
2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities,
which addresses whether instruments granted in share-based payment transactions
are participating securities prior to vesting and, therefore, need to be
included in the earnings allocation in computing earnings per share under the
two-class method described in paragraphs 60 and 61 of FASB Statement
No. 128, Earnings per
Share. The Company does not expect the adoption of FSP EITF 03-6-1 to
have a material effect on its results of operations, financial position and cash
flows.




4. INVENTORY




Inventories
consist of the following:




September 30,
              2008
            
            
            December 31,
              2007Raw
      materials
            
            $
            4,241,660
            
            
            $
            3,051,800Work-in-process
            
            
            750,383
            
            
            
            391,431Finished
      goods
            
            
            4,166,444
            
            
            
            3,207,724$
            9,158,486
            
            
            $
            6,650,955




5. LONG-TERM
DEBT




On
September 30, 2008, the Company and Silicon Valley Bank (“SVB”) entered
into an amendment to the Amended and Restated Loan and Security Agreement dated
February 20, 2007 (as so amended, the “Domestic Loan Agreement”), a Loan
and Security Agreement (Ex-Im Loan Facility) (the “Export-Import Loan
Agreement”), and an Export-Import Bank of the United States Working Capital
Guarantee Program Borrower Agreement (the “Borrower Agreement,” and together
with the Domestic Loan Agreement and the Export-Import Loan Agreement, the “Loan
Agreement”). The total maximum amount available for borrowing under the Loan
Agreement is $12.0 million.


7




Revolving
Line




The Loan
Agreement provides for a domestic receivables-based revolving line of credit in
an aggregate amount of up to $10.0 million, or, if less, the sum of 80% of
eligible domestic accounts receivable plus 25% of eligible domestic inventory
(the “Domestic Revolving Line”), coupled with a foreign receivables-based
revolving line of credit in an aggregate amount of up to $2.5 million, or if
less, the sum of 90% of eligible foreign accounts receivable plus 50% of
eligible export-related inventory (the “Export-Import Revolving Line,” and
together with the Domestic Revolving Line, the “Revolving Line”). No more than
$10.0 million, in the aggregate, will be available for combined draw-downs under
the Domestic Revolving Line and the Export-Import Revolving Line. The Domestic
Revolving Line is subject to a $1.0 million sublimit available for cash
management services provided by SVB, including the issuance of short-term
letters of credit and foreign exchange contracts. The Export-Import Revolving
Line is guaranteed by the U.S. Export-Import Bank. The Revolving Line maturity
date is September 30, 2010.




The
Revolving Line bears interest at an annual rate equal to the prime rate plus
0.25%.  However, the annual rate applicable to the Revolving Line
increases to the prime rate plus 1.00% if a financial ratio relating to the
Company’s liquidity falls below a specified level. Interest on the Revolving
Line is due monthly, with the principal due at the maturity date.




Term
Loan




The Loan
Agreement provides for a term loan in an aggregate amount of up to $2.0 million
(the “Term Loan”), with a maturity date of March 30, 2013, unless the
Revolving Line is not renewed at its maturity date in which case, all amounts
outstanding under the Term Loan will become due at such time. The Term Loan
bears interest at an annual rate equal to the prime rate plus 0.75%. However,
the annual rate applicable to the Term Loan increases to the prime rate plus
1.50% if a financial ratio relating to the Company’s liquidity falls below a
specified level. The Loan Agreement allows for a single advance under the Term
Loan, to be requested by the Company no later than November 17, 2008.
Monthly payments of interest only on the amount outstanding on the Term Loan are
due through March 31, 2009, followed by monthly installments of amortized
principal and interest through the maturity date of the Term Loan.




Loan
Agreement Obligations




The
obligations under the Loan Agreement are secured by a security interest on
substantially all assets of the Company, excluding intellectual property. The
Loan Agreement contains certain restrictive loan covenants, including, among
others, financial covenants requiring a minimum tangible net worth and a minimum
liquidity ratio, and covenants limiting the Company’s ability to dispose of
assets, make acquisitions, be acquired, incur indebtedness, grant liens or enter
into negative pledge agreements, make investments, make distributions in respect
of the Company’s capital stock (including repurchases of such capital stock) or
enter into transactions with affiliates.




The Loan
Agreement contains events of default that include, among others, failure to make
payments when due, inaccuracy of representations and warranties, violation of
covenants, events constituting a material adverse change, bankruptcy and
insolvency events, material judgments, and cross defaults to certain other
agreements. The occurrence of an event of default could result in the
acceleration of the Company’s obligations under the Loan Agreement and an
increase to the applicable interest rate, and would permit SVB to exercise
remedies with respect to the collateral under the Loan
Agreement.




2003 Subordinated
Note—The 2003 subordinated note is uncollateralized and provides for a
five-year term (maturing in February 2008) requiring the payment of interest
only on a quarterly basis with an annual interest rate of 4%. At
December 31, 2007, the outstanding balance on the note was $1,000,000. In
February 2008 the Company made a payment in the amount of $1,006,633, in full
satisfaction of the outstanding principal balance and accrued unpaid
interest.


8




Note
Payable —In 2002, the Company entered into an arrangement with a
distributor whereby the distributor advanced a total of $1,000,000 cash to the
Company for the future purchase of product. The Company classified these
advances as deferred revenues in the 2005 balance sheet. As product was
purchased, the applicable sales value was recognized as revenues. Although the
Company was not obligated to refund any of these advances, effective
December 31, 2006, the Company agreed to terminate the distribution
agreement and repay the outstanding prepayment of $953,015 before
February 20, 2008. The obligation bore interest at 2% per annum
applied on a semi-monthly basis, not to exceed $19,060 per year. In February
2008, the Company made a payment in the amount of $954,634, in full satisfaction
of the outstanding principal balance and accrued unpaid interest.




6. STOCK
OPTION PLANS




The
Company’s 2006 Stock Option Plan (the “2006 Plan”), which was adopted by the
Company’s board of directors in May 2006 and approved by the Company’s
stockholders in June 2006 is designed to enable the Company to offer an
incentive-based compensation system to employees, officers and directors of the
Company and to consultants who do business with the Company. The 2006 Plan
provides for the grant of incentive stock options and nonqualified stock options
to purchase up to an aggregate of 2,434,312 shares of common stock. The 2006
plan will terminate in 2016 and also provides for annual increases in the number
of shares available for issuance thereunder on the first day of each fiscal
year, beginning with the 2007 fiscal year, equal to the lesser of:




•
            3.5%
      of the outstanding shares of the Company’s common stock on the first day
      of the fiscal year;




•
            630,000
      shares; or




•
            Such
      other amount as the board of directors may
  determine.




As of
September 30, 2008, options to purchase a total of 981,399 shares of common
stock were outstanding under the 2006 Plan and options to purchase a total of
1,476,329 shares were available for issuance under the 2006 Plan.




The
Company also has a 1998 Stock Option Plan (“1998 Plan”), which plan was approved
by the Company’s board of directors and stockholders in 1998. As of September
30, 2008, options to purchase a total of 629,709 shares of common stock were
outstanding under the 1998 Plan and no options to purchase shares were available
for issuance under the 1998 Plan.




The 2006
Plan and the 1998 Plan are administered by a committee appointed by the board of
directors that determines the recipients and the terms of the options granted.
Options may be granted to eligible employees, directors and consultants to
purchase shares of the Company’s common stock at a price that is at least equal
to the fair market value of the common stock on the date of grant for incentive
stock options (or 110% of the fair market value in the case of an optionee who
holds more than 10% of the voting power of the Company on the date of grant).
Subject to termination of employment, options may expire up to ten years from
the date of grant.




The
exercise price, term and other conditions applicable to each option granted
under the 2006 and 1998 Plans are generally determined by the Administrator at
the time of grant of each option and may vary with each option granted. The
stock options granted generally vest 25% per year over a four-year period
and expire after seven to 10 years. The options are exercisable according to the
vesting schedule. Options granted to certain officers of the Company vest
immediately in the event of a change in control.  Alternatively, the
options may be exercised in whole or in part at any time into restricted,
unvested common shares which are subject to the risk of forfeiture, and to the
Company’s repurchase rights.




As of
September 30, 2008, there was unrecognized compensation expense of $2.2 million
related to unvested stock options, which the Company expects to recognize over a
weighted average period of 1.5 years. The weighted average grant date fair value
of stock options granted during the nine months ended September 30, 2008 was
$3.23.




As of
September 30, 2008, the total number of options exercisable was 664,272 shares,
which had a weighted average exercise price of $5.43. The average remaining life
of these options was 6.3 years and the aggregate intrinsic value was $0 at
September 30, 2008.


9




As of
September 30, 2008, the total number of outstanding options vested or expected
to vest (considering anticipated forfeitures) was 1,590,403 shares, which had a
weighted average exercise price of $7.16. The average remaining life of these
options was 6.9 years and the aggregate intrinsic value was $0 at September 30,
2008.




Stock-based
compensation included in the Company’s statement of operations is as
follows:




Three
      Months Ended
              September 30,
            
            
            Nine
      Months Ended
              September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Cost
      of goods sold
            
            $
            23,267
            
            
            $
            32,483
            
            
            $
            65,232
            
            
            $
            73,884Selling
      and marketing expense
            
            
            259,589
            
            
            
            133,091
            
            
            
            565,995
            
            
            
            382,434Research
      and development expense
            
            
            99,529
            
            
            
            142,107
            
            
            
            334,768
            
            
            
            339,649General
      and administrative expense
            
            
            214,663
            
            
            
            297,764
            
            
            
            655,575
            
            
            
            628,137Total
            
            $
            597,048
            
            
            $
            605,445
            
            
            $
            1,621,570
            
            
            $
            1,424,104




7. EMPLOYEE
STOCK PURCHASE PLAN




Effective
April 3, 2007, the closing date of the IPO, the Employee Stock Purchase
Plan (“Purchase Plan”) was established. The Company’s Purchase Plan was adopted
by the Company’s board of directors effective as of May 2006 and approved by the
Company’s stockholders in June 2006. The Purchase Plan provides eligible
employees of the Company with an incentive by providing a method whereby they
may voluntarily purchase common stock of the Company upon terms described in the
Purchase Plan. The Purchase Plan is designed to be operated on the basis of six
consecutive month offering periods commencing May 15 and November 15 of each
remaining year during the term of the Purchase Plan.  The 2006
Purchase Plan terminates in 2016. The Purchase Plan provides that eligible
employees may authorize payroll deductions of up to 10% of their salary to
purchase shares of the Company’s common stock at 85% of the fair market value of
common stock on the first or last day of the applicable purchase period. During
the nine months ended September 30, 2008, the Company recorded $113,725 for
compensation related to the discounted purchase price and look back feature of
the Purchase Plan. The fair value of these discounts was estimated using a
Black-Scholes pricing method with the following assumptions: $6.16 and $7.60
strike price; $7.25 and 8.94 share price; 184 and 228 days until expiration; 45%
and 44% volatility and 1.89% and 4.08% interest rate on May 16, 2008 and
October 1, 2007, respectively. As of September 30, 2008, Purchase Plan
participant contributions of $202,873 were included in other current liabilities
in the accompanying 2008 balance sheet. A total of 550,000 shares of common
stock are authorized for issuance under the Purchase Plan, and as of September
30, 2008, 69,691 shares have been issued under the Purchase Plan.




8. INCOME
TAXES




Under
Accounting Principles Board Opinion No. 28, “Interim Financial Reporting,”
the Company is required to adjust its effective tax rate each quarter to be
consistent with the estimated annual effective tax rate. The Company is also
required to record the tax impact of certain discrete items, unusual or
infrequently occurring, including changes in judgment about valuation allowances
and effects of changes in tax laws or rates, in the interim period in which they
occur. In addition, jurisdictions with a projected loss for the year or a
year-to-date loss where no tax benefit can be recognized are excluded from the
estimated annual effective tax rate. The impact of such an exclusion could
result in a higher or lower effective tax rate during a particular quarter,
based upon the mix and timing of actual earnings versus annual
projections.




In
accordance with Statements of Financial Accounting Standards No. 109,
“Accounting for Income Taxes,” the Company evaluates whether a valuation
allowance should be established against its deferred tax assets based on the
consideration of all available evidence using a “more likely than not”
standard.




As of
September 30, 2008, the Company has provided a full valuation allowance and no
benefit has been recognized for net operating losses and other deferred tax
assets due to the uncertainty of future utilization.


10




On
January 1, 2007, the Company adopted Financial Accounting Standards Board
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN
48). As of September 30, 2008, the Company had unrecognized tax benefits of
$410,000.




The
Company estimates that the unrecognized tax benefit will not change
significantly within the next twelve months. Future changes in the unrecognized
tax benefit will have no impact on the effective tax rate due to the existence
of the valuation allowance. The Company will continue to classify income tax
penalties and interest as part of general and administrative expense in its
Statements of Operations. Accrued interest on uncertain tax positions is not
material as of September 30, 2008. There are no penalties accrued as of
September 30, 2008.




Jurisdiction
            
            Open Tax YearsFederal
            1998 - 2007California
            1998 - 2007




9. NET
LOSS PER SHARE




Basic
loss per share is based on the weighted-average number of shares of common stock
outstanding during the period. Diluted loss per share also includes the effect
of stock options, warrants and other common stock equivalents outstanding during
the period. In periods of a net loss position, basic and diluted weighted
average shares are the same.




The
following table sets forth the computation of denominator used in the
computation of net loss per share:




Three
      Months Ended
              September 30,
            
            
            Nine
      Months Ended
              September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Weighted-average
      common stock outstanding
            
            
            17,268,348
            
            
            
            17,096,433
            
            
            
            17,238,192
            
            
            
            11,993,671Less:
      Unvested common shares subjectto
      repurchase
            
            
            (5,531
            )
            
            
            (20,431
            )
            
            
            (5,531
            )
            
            
            (20,431
            )Total
      weighted-average number of shares used in computing net loss per
      share-basic and diluted
            
            
            17,262,817
            
            
            
            17,076,002
            
            
            
            17,232,661
            
            
            
            11,973,240




10. LITIGATION




The
Company may be subject to legal proceedings, claims and litigation arising in
the ordinary course of business. While the amounts claimed may be substantial,
the ultimate liability cannot presently be determined because of considerable
uncertainties that exist.




On
January 8, 2008, Hologic and its wholly-owned subsidiaries, including Cytyc
Corporation and Cytyc LP, filed a lawsuit against the Company in the United
States District Court, Northern District of California, San Jose Division. The
complaint generally alleges patent infringement of certain Hologic brachytherapy
patent claims, seeking unspecified monetary damages and an injunction against
the Company for infringement of those claims. On February 6, 2008, Hologic
filed a motion seeking a preliminary injunction in the case and requested that
the Court stop the sale of Contura MLB. On March 7, 2008, Hologic filed an
amended complaint restating its allegations regarding patent infringement, and
adding new claims related to unfair competition under the Lanham Act and
California state unfair competition and false advertising statutes. On
April 25, 2008, the court denied Hologic’s request for a preliminary
injunction and ordered the parties to schedule a trial within 60 to 90 days of
such date. On May 22, 2008, the Court issued an order scheduling the
Markman claims construction hearing on the patent counts for June 25, 2008,
and the trial in the case to start July 14, 2008. Pursuant to an agreement
of the parties, the order also dismissed Hologic’s unfair competition and false
advertising claims under the Lanham Act and California state law, without
prejudice. On June 24, 2008, the Court granted a joint request by Hologic
and the Company to stay all proceedings, including the previously scheduled
Markman claims construction hearing and the trial, until at least
August 22, 2008 in order to provide the parties time to discuss possible
resolution of the matter. On August 22, 2008, the Company and Hologic jointly
requested that the Court resume proceedings in the pending lawsuit. On October
15, 2008, a Markman claims construction hearing was held by the
Court.  No ruling has yet been issued.  The Company remains
confident in its proprietary intellectual property and actions, and intends to
continue to vigorously defend itself in this matter.


11









11. COMMITMENTS
AND CONTINGENCIES




In March
2008, the Company entered into an agreement to lease a new corporate and
manufacturing facility in Irvine, California consisting of 41,402 square feet of
space. The lease has an initial term of 63 months commencing November 1,
2008, with the Company’s right of earlier occupancy, and one five-year option to
extend. The initial monthly base rent is approximately $44,300 and increases at
a rate of 4% per annum.




12. SEGMENT
INFORMATION




Net
revenues by geographic area are presented based upon the country of destination.
No foreign country represented 10% or more of net revenues for any period
presented. Net revenues by geographic area were




as
follows:




Three
      Months Ended
              September 30,
            
            
            Nine
      Months Ended
              September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007United
      States
            
            $
            10,383,884
            
            
            $
            8,446,449
            
            
            $
            29,595,532
            
            
            $
            23,223,670Canada
            
            
            878
            
            
            
            -
            
            
            
            652,377
            
            
            
            541,135Rest
      of world
            
            
            879,709
            
            
            
            459,637
            
            
            
            2,885,455
            
            
            
            962,642Total
            
            $
            11,264,471
            
            
            $
            8,906,086
            
            
            $
            33,133,364
            
            
            $
            24,727,447




No
customer accounted for 10% or more of net revenues for any period
presented.




At
September 30, 2008, the Company has four product classes. Biopsy disposable
products include the Company’s EnCor and SenoCor products. Biopsy capital
equipment products include the consoles and other pieces (non-disposable) of the
EnCor and SenoCor products. Diagnostic adjunct products include the Marker
product, the Gamma Finder product and the Anchor Guide product. Therapeutic
disposables include the Company’s recently commercialized Contura Multi-Lumen
Balloon (MLB) Catheter, which received FDA 510(k) clearance in May
2007.




Net
revenues by product class are as follows:




Three
      Months Ended
              September 30,
            
            
            Nine
      Months Ended
              September 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Biopsy
      disposable products
            
            $
            5,068,871
            
            
            $
            3,945,941
            
            
            $
            15,130,043
            
            
            $
            11,487,122Biopsy
      capital equipment products
            
            
            979,922
            
            
            
            1,029,065
            
            
            
            3,330,531
            
            
            
            2,130,294Diagnostic
      adjunct products
            
            
            3,834,850
            
            
            
            3,744,039
            
            
            
            11,636,457
            
            
            
            10,897,893Therapeutic
      disposables
            
            
            1,380,828
            
            
            
            187,041
            
            
            
            3,036,333
            
            
            
            212,138Total
            
            $
            11,264,471
            
            
            $
            8,906,086
            
            
            $
            33,133,364
            
            
            $
            24,727,447




Substantially
all of the Company’s assets are in the United States.




12


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




This
Quarterly Report on Form 10-Q contains forward-looking statements within the
meaning of the federal securities laws. These statements are subject to risks
and uncertainties that could cause actual results and events to differ
materially from those expressed or implied by such forward-looking statements.
For a detailed discussion of these risks and uncertainties, see the “Risk
Factors” section in Item 1A of this Form 10-Q. We caution the reader not to
place undue reliance on these forward-looking statements, which reflect
management’s analysis only as of the date of this Form 10-Q. We undertake no
obligation to update forward-looking statements to reflect events or
circumstances occurring after the date of this Form 10-Q.




Overview




We
develop, manufacture and sell minimally-invasive medical devices that are used
in the diagnosis of breast cancer. We were incorporated in 1998. From our
inception until 2002, our principal activity was the development and regulatory
clearance of our initial products, primarily our biopsy tissue markers and our
first breast biopsy system, the EnCor 360 (previously referred to by us and
marketed as SenoCor 360). We launched our first biopsy tissue markers in
2002 and our EnCor 360 in 2003. The EnCor 360 hardware subsequently served as a
platform to facilitate the later launch of the EnCor probes, handpieces and
other probes, which are compatible with the major imaging
modalities




In 2004,
we received 510(k) clearance from the FDA to market our EnCor breast biopsy
system, our flagship product for use in breast biopsy procedures, conducting
market preference testing commencing in the fourth quarter of 2004. Over the
subsequent period ending in October 2005, we began selling the product on a
limited basis while we focused on enhancing certain components of the product to
optimize its performance, and we subsequently progressed with a full commercial
launch of our EnCor system in November 2005.




We have
and are continuing to develop minimally-invasive products for surgical excision
of lesions and for breast cancer treatment. We received 510(k) clearance for our
Contura Multi-Lumen Radiation Balloon Catheter, or Contura MLB, in May 2007 and
launched in January 2008. Contura MLB is one of a new class of devices designed
to reduce radiation treatment time to five days from six to eight weeks in
patients eligible for the treatment. We also believe that Contura MLB may
present radiation oncologists with opportunities to optimize dosing for certain
patients. We are also developing next generation tissue marker products,
additional EnCor line extensions, line extensions of Contura MLB, and certain
radio frequency based tissue cutting devices.




Before
2007, we had historically derived our revenues primarily from our tissue marker
products. However, our EnCor system accounted for a majority of our revenue
growth in 2007. Our ability to continue to grow revenues is based upon a number
of assumptions, which may not ultimately occur, including retention of our sales
force, growth in the market for minimally-invasive breast biopsy procedures and
rapid adoption of the product by physicians who specialize in breast care. We
expect our Contura MLB to increasingly contribute to our revenues and we are
marketing this device as a compelling alternative to competing
devices.




For the
nine months ended September 30, 2008, we generated net revenues of $33.1 million
and a net loss of $8.8 million. As of September 30, 2008, our accumulated
deficit was $84.3 million. We have not been profitable since inception. We
expect our operating expenses to increase as we expand our business to meet
anticipated increased demand for our EnCor system, expand sales of our Contura
MLB and devote resources to our sales and marketing and research and development
activities.




Net
Revenues




We derive
our revenues primarily from the sales of our breast biopsy systems, breast
biopsy capital equipment, our tissue markers, and other products for breast
care. Our largest market for these products is in the United States and Canada,
where we employ a direct sales force. Our breast biopsy systems, the EnCor and
EnCor 360, consist of two primary components: reusable handpieces and disposable
probes, and are used in conjunction with our SenoRx Breast Biopsy Console. The
disposable probes form the basis of a recurring revenue stream and also
contribute to the sales of tissue markers. Diagnostic adjunct revenue consists
primarily of tissue marker sales, both used with our breast biopsy systems and
with competitor’s biopsy products. Our breast biopsy capital equipment includes
a reusable handpiece, a control module and vacuum source used in conjunction
with our disposable biopsy probe. We expect that the sales of biopsy disposable,
biopsy capital equipment and marker products will continue to grow for the
remainder of 2008 and into 2009. We further expect that the sales of our adjunct
and excision products will also grow, though at a slower rate. In January 2008,
we began the full commercialization of our Contura MLB Catheter, which we
anticipate will provide meaningful revenue increases for the remainder of 2008
and future years.


13




Cost
of Goods Sold




Our cost
of goods sold consists of the cost to manufacture and assemble our products,
primarily including materials, components and labor. We assemble and package all
of our finished products with the exception of our Gamma Finder product. We
expect that our cost of goods sold as a percentage of revenues will decrease,
and, correspondingly, gross profits will increase, as a percentage of net
revenues with increased sales volume, product enhancements and outsourced
manufacturing efficiencies. At the end of 2005, we entered into an agreement
with a contract manufacturer in Thailand and began to transfer a portion of our
manufacturing for certain components of our products to this site, and we
anticipate that we will transfer additional manufacturing to this site in order
to increase gross margins. We anticipate that our gross margin will continue to
increase for the remainder of 2008 due to design and production process
improvements, changes in product mix, the manufacturing efficiencies that we
expect to see with increased production, and the continued successful transfer
of manufacturing of certain products and product components to our Thailand
contract manufacturer.




Operating
Expenses




Our
operating expenses consist of research and development, selling and marketing,
and general and administrative expenses. Stock-based compensation, a non-cash
item, is primarily included in these expenses.




Our
selling and marketing expenses consist of salaries and related expenses of our
direct sales team and sales management, travel, clinical education and training
expenses, marketing and promotional expenses, and costs associated with
tradeshows. We expect selling and marketing expenses to increase in absolute
terms as we expand our sales organization and promotional activities, although
at a rate less than our revenue growth rate.




Our
research and development expenses consist of salaries and related expenses of
our research and development personnel and consultants and costs of product
development, which include patent filing and maintenance costs, production
engineering, clinical and regulatory support and post-clearance clinical product
enhancements. We expense all our research and development costs as they are
incurred. We expect research and development expenses to increase in absolute
terms as we continue to develop, enhance, obtain clinical results and
commercialize existing and new products.




Our
general and administrative expenses consist of the cost of corporate operations,
litigation and professional services. We expect general and administrative
expenses to increase in absolute dollars as we increase our infrastructure to
comply with the regulatory requirements associated with publicly-traded
companies and anticipated litigation expenses relating to the current Hologic
patent infringement lawsuit. With regard to the complaint filed by Hologic in
January 2008, both parties jointly requested a stay of proceedings until at
least August 22, 2008 in order to provide the parties time to discuss
possible resolution of the matter. The stay was granted shortly before the
previously scheduled respective starts of the Markman claims construction
hearing (previously scheduled for June 25, 2008) and the trial (previously
scheduled to begin on July 14, 2008). On August 22, 2008, both parties
jointly requested that the Court resume proceedings in the pending
lawsuit.  On October 15, 2008, a Markman claims construction hearing
was held by the Court.  No ruling has yet been
issued.   Our current outlook for patent litigation costs beyond
the $4.4 million incurred to date, is an additional $750,000 to $1.5 million for
the remainder of 2008, depending upon the timing of a potential jury
trial.




We expect
to incur stock-based compensation expense for option grants, which will be
accounted for under SFAS No. 123R. We anticipate that non-cash expenses for
options accounted for under SFAS No. 123R will increase in 2008 based upon
the number of options granted. We also expect to incur stock-based compensation
expense related to the issuance of common stock under our employee stock
purchase plan.




Interest




Interest
income represents income generated from our cash and cash equivalents and
short-term investments that are invested generally in liquid money-market funds
and commercial paper. During 2007, debt obligations included a working capital
facility, an equipment facility and long-term notes payable resulted in interest
expense. Interest expense also includes the fair value for any equity interests,
such as warrants, granted in conjunction with the debt obligations. The fair
value of the equity interests were amortized to interest expense over the term
of the related debt obligations. Interest expense has decreased due to the
retirement of certain debt obligations in 2007 and early 2008.


14




Income
Tax Expense




Due to
uncertainty surrounding the realization of deferred tax assets through future
taxable income, we have provided a full valuation allowance and no benefit has
been recognized for our net operating loss and other deferred tax
assets.




Results
of Operations




The
following table sets forth our results of operations expressed as percentages of
revenues:




For the
              Three Months Ended
              September
      30,2008
            
            
            2007Net
      revenues
            
            
            100.0
            %
            
            
            100.0
            %Cost
      of goods sold
            
            
            35.0
            
            
            
            39.9Gross
      profit
            
            
            65.0
            
            
            
            60.1Operating
      expenses:Selling
      and marketing
            
            
            53.8
            
            
            
            48.9Research
      and development
            
            
            14.5
            
            
            
            17.7General
      and administrative
            
            
            12.3
            
            
            
            13.5Total
      operating expenses
            
            
            80.6
            
            
            
            80.2Loss
      from operations
            
            
            (15.6
            )
            
            
            (20.1
            )Interest
      expense
            
            
            0.2
            
            
            
            5.1Interest
      income
            
            
            (0.9
            )
            
            
            (6.2
            )Provision
      for income taxes
            
            
            —
            
            
            
            —Net
      loss
            
            
            (14.9
            )%
            
            
            (19.0
            )%




Three
months ended September 30, 2008 and 2007




Net
Revenues. Net revenues increased $2.4 million, or 26.5%, to $11.3 million
for the three months ended September 30, 2008 from $8.9 million for the three
months ended September 30, 2007. The increase primarily consisted of $1.1
million in biopsy disposable revenues, an increase of 28.5% from the three
months ended September 30, 2007 due to a larger installed base of EnCor systems.
Biopsy capital equipment revenues decreased $49,000, or 4.8% due to less
placements in the quarter. Diagnostic adjunct revenues increased $91,000, or
2.4%, primarily due to an increase in marker sales resulting from increased
EnCor disposable biopsy sales and sales of markers used with competitive biopsy
disposables and increased Gamma Finder sales. Therapeutic revenues increased
$1.2 million as we began sales of our Contura MLB to a limited number of
clinical sites in June 2007 following the May 2007 FDA 510(k) clearance, with
full commercialization in January 2008.


15




Cost of Goods
Sold and Gross Profit. Cost of good sold increased $387,000, or 10.9%, to
$3.9 million for the three months ended September 30, 2008 from $3.6 million for
the three months ended September 30, 2007. The increase in total cost of goods
sold primarily consisted of an increase in direct labor, manufacturing overhead
and material costs associated with our increase in unit sales. Gross profit
increased 36.8% for the three months ended September 30, 2008 to $7.3 million
from $5.4 million for the three months ended September 30, 2007. Gross profit as
a percentage of net revenues increased by 4.9% to 65.0% for the three months
ended September 30, 2008 from 60.1% for the three months ended September 30,
2007. The increase in gross profit as a percentage of net revenues was primarily
attributable to improved efficiencies in the production of our disposable biopsy
probe and gross margin contribution from the sales of our Contura MLB.
Additionally, gross margins continue to benefit from the allocation of
manufacturing overhead over greater product revenues and inventory unit
production.




Selling and
Marketing Expenses. Selling and marketing expenses increased $1.7
million, or 39.3%, to $6.1 million for the three months ended September 30, 2008
from $4.4 million for the three months ended September 30, 2007. The increase
primarily consisted of $1.1 million in salaries and related employee costs due
to the expansion of our sales organization, a $230,000 increase in departmental
expenses, a $212,000 increase in selling and promotional related expenses and an
increase in equity based compensation expense of $130,000.




Research and
Development Expenses. Research and development expenses increased
$52,000, or 3.3%, to $1.6 million for the three months ended September 30, 2008
from $1.6 million for the three months ended September 30, 2007. Departmental
related expenses increased $88,000 and professional fees increased $74,000,
which were partially offset by reductions in salaries and related personnel
expenses of $25,000, reduced equity based compensation expenses of $49,000 and
reduced project related expenses of $35,000.




General and
Administrative Expenses. General and administrative expenses increased
$175,000, or 14.5%, to $1.4 million for the three months ended September 30,
2008 from $1.2 million for the three months ended September 30, 2007. The
increase primarily consisted of $128,000 in attorney and related litigation
costs incurred in connection with responding to the allegations by Hologic of
patent infringement relating to our Contura MLB, $110,000 for public company
related costs, including legal and reporting expenses, $92,000 for increased
departmental costs, and $50,000 related to increased headcount and increased
compensation, which were partially offset by a reductions of $118,000 in
professional fees and a $83,000 decrease in equity based
compensation.




Interest Expense.Interest expense decreased $430,000 to $22,000 for the three months ended
September 30, 2008 from $453,000 for the three months ended September 30, 2007.
The decrease was primarily due to the repayment of the December 2006 notes
payable.




Interest Income.Interest income decreased $452,000 to $99,000 for the three months ended
September 30, 2008 from $551,000 for the three months ended September 30, 2007
primarily due to lower cash and short-term investment balances resulting from
the repayment of $10.3 million for the retirement of the December 2006
subordinated note, $2.0 million to repay the February 2003 convertible
subordinated note and the 2002 note obligations owing to Century Medical as well
as working capital needs.


16




Results
of Operations




The
following table sets forth our results of operations expressed as percentages of
revenues for the nine months ended September 30, 2008 and 2007:




For the
              Nine Months Ended
              September
      30,2008
            
            
            2007Net
      revenues
            
            
            100.0
            %
            
            
            100.0
            %Cost
      of goods sold
            
            
            37.2
            
            
            
            42.8Gross
      profit
            
            
            62.8
            
            
            
            57.2Operating
      expenses:Selling
      and marketing
            
            
            51.1
            
            
            
            52.9Research
      and development
            
            
            14.1
            
            
            
            19.0General
      and administrative
            
            
            25.6
            
            
            
            12.5Total
      operating expenses
            
            
            90.7
            
            
            
            84.4Loss
      from operations
            
            
            (27.9
            )
            
            
            (27.2
            )Interest
      expense
            
            
            0.2
            
            
            
            5.6Change
      in fair value of convertible promissory notes and warrant
      valuation
            
            
            —
            
            
            
            (4.0
            )Interest
      income
            
            
            (1.5
            )
            
            
            (4.8
            )Provision
      for income taxes
            
            
            —
            
            
            
            —Net
      loss
            
            
            (26.6
            )%
            
            
            (24.0
            )%




Nine
months ended September 30, 2008 and 2007




Net
Revenues. Net revenues increased $8.4 million, or 34.0%, to $33.1 million
for the nine months ended September 30, 2008 from $24.7 million for the nine
months ended September 30, 2007. The increase primarily consisted of $3.6
million in biopsy disposable revenues, an increase of 31.7% from the nine months
ended September 30, 2007 due to a larger installed base of EnCor systems. Biopsy
capital equipment revenues increased $1.2 million, or 56.3% due to a greater
number of customers purchasing our breast biopsy systems as compared to those
customers acquiring the capital through a “product supply agreement” in 2007.
Diagnostic adjunct revenues increased $739,000, or 6.8%, primarily due to an
increase in marker sales resulting from increased EnCor disposable biopsy sales
and sales of markers used with competitive biopsy disposables and increased
Gamma Finder sales. Therapeutic revenues increased $2.8 million as we began
sales of our Contura MLB to a limited number of clinical sites in June 2007
following the May 2007 FDA 510(k) clearance, with full commercialization in
January 2008.




Cost of Goods
Sold and Gross Profit. Cost of good sold increased $1.7 million, or
16.4%, to $12.3 million for the nine months ended September 30, 2008 from $10.6
million for the nine months ended September 30, 2007. The increase in total cost
of goods sold primarily consisted of an increase in direct labor, manufacturing
overhead and material costs associated with our increase in unit sales. Gross
profit increased $6.7 million or 47.1% for the nine months ended September 30,
2008 to $20.8 million from $14.1 million for the nine months ended September 30,
2007. Gross profit as a percentage of net revenues increased by 5.6% to 62.8%
for the nine months ended September 30, 2008 from 57.2% for the nine months
ended September 30, 2007. The increase in gross profit as a percentage of net
revenues was primarily attributable to improved efficiencies in the production
of our disposable biopsy probe and gross margin contribution from the sales of
our Contura MLB. Additionally, gross margins continue to benefit from the
allocation of manufacturing overhead over greater product revenues and inventory
unit production.




Selling and
Marketing Expenses. Selling and marketing expenses increased $3.8
million, or 29.4%, to $17.0 million for the nine months ended September 30, 2008
from $13.1 million for the nine months ended September 30, 2007. The increase
primarily consisted of $2.8 million in salaries and related employee costs due
to the expansion of our sales organization, a $508,000 increase in departmental
related expenses, a $308,000 increase in selling and promotional related
expenses and a $210,000 increase in equity based compensation.


17




Research and
Development Expenses. Research and development expenses decreased
$38,000, or 0.8%, to $4.7 million for the nine months ended September 30, 2008
from $4.7 million for the nine months ended September 30, 2007. The decrease in
these expenses consisted primarily of project costs, predominately for the
Contura MLB, which decreased $416,000 and a decrease of $17,000 in equity based
compensation. This decrease was partially offset by an increase of $101,000 for
salaries and the related employee costs, a 186,000 increase for patent related
expenses and an increase of $109,000 in departmental related
expenses.




General and
Administrative Expenses. General and administrative expenses increased
$5.4 million, or 174.0%, to $8.5 million for the nine months ended September 30,
2008 from $3.1 million for the nine months ended September 30, 2007. The
increase primarily consisted of $4.4 million in attorney and related litigation
costs incurred in connection with responding to the allegations by Hologic of
patent infringement relating to our Contura MLB, $481,000 for public company
related costs, including legal and reporting expenses, $348,000 related to
increased headcount and increased compensation, $163,000 for increased
professional fees and departmental costs and a $31,000 increase in equity based
compensation.




Interest Expense.Interest expense decreased $1.3 million to $59,000 for the nine months
ended September 30, 2008 from $1.4 million for the nine months ended September
30, 2007. The decrease was primarily due to the repayment of the December 2006
subordinated note.




Change in Fair
Value of Convertible Promissory Notes and Warrant Valuation . For the
nine months ended September 30, 2007, we recorded income of $160,000 for the
changes in fair value of our May 2006 Notes in accordance with FAS No.155 and
$831,000 of income for the reduction in the fair value of the warrant
liability.




Interest Income.Interest income decreased $677,000 to $505,000 for the nine months ended
September 30, 2008 from $1.2 million for the nine months ended September 30,
2007 primarily due to lower cash and short-term investment balances resulting
from the repayment of $10.3 million for the retirement of the December 2006
subordinated note, $2.0 million to repay the February 2003 convertible
subordinated note and the 2002 note obligations owing to Century Medical as well
as working capital needs.




Liquidity
and Capital Resources




General




We have
incurred losses since our inception in January 1998 and, as of September 30,
2008, we had an accumulated deficit of $84.3 million. From inception through
September 30, 2008, we generated cumulative gross profit from the sale of our
product offerings of $77.5 million. To date, our operations have been funded
primarily with proceeds from the issuance of our preferred stock and borrowings,
including our issuance of the May 2006 Notes and the December 2006 Subordinated
Note, and our IPO that closed in April 2007. Cumulative net proceeds from the
issuance of preferred stock totaled $46.8 million. Proceeds from the issuance of
the May 2006 Notes totaled $8.0 million. Proceeds from the issuance of the
December 2006 Subordinated Note was $10.0 million, of which $1.2 million was
used to repay the 2004 Subordinated Note payable. Net proceeds from our IPO,
including the sale of shares pursuant to the subsequent underwriters’
overallotment and after deducting total expenses, was $44.8 million. All of our
preferred stock converted into common stock upon the closing of the IPO. In
November 2007 we used $10.3 million to retire the December 2006 Subordinated
Note and in February 2008 we used $2.0 million to repay the February 2003
convertible subordinated note and 2002 note obligations owing to Century
Medical.




On
September 30, 2008, we amended the terms of our working capital facility with
Silicon Valley Bank extending the expiration date to September, 2010 and
increasing the aggregate amount available for borrowing under the facility from
$4.0 million to $12.0 million.




We
believe that our cash and cash equivalents, and our ability to draw down on our
working capital and equipment facilities, will be sufficient to meet our
projected operating requirements for at least the next 12 months. We anticipate
that we will continue to use cash in our operating activities and investing
activities for the foreseeable future as we grow our business.


18




Net
Cash Used in Operating Activities




Net cash used in operating activities
was $10.6 million, for the nine months ended September 30, 2008, which was
primarily a function of an increase in inventory of $3.5 million, an increase in
accounts receivable of $1.8 million, an increase in accounts payable and accrued
expenses of $723,000, an increase in other assets of $269,000 and an increase in
prepaid expenses of $41,000. The aggregate increased investment in inventory of
$3.5 million resulted primarily from two major factors, including (i) our
decision to build shelf stock of our higher volume products in order to better
service our customers as well as accommodate our move to the new manufacturing
facility in late August 2008, and (ii) the need to purchase longer-term
quantities of certain parts due to long lead times. We expect inventory will
continue to modestly increase for the remainder of 2008.The increase in accounts receivable
was primarily due to anincrease in net sales and an increase
in sales outside the United States, which include extended payment terms for
initial stocking orders.
While we expect that the amount of accounts receivable will fluctuate based on
the timing of sales and collections, we expect our ratio of overall investment
in accounts receivable as compared to revenues will continue to modestly
increase.




Net
Cash Provided by Investing Activities




Net cash
provided by investing activities amounted to $9.9 million during the nine months
ended September 30, 2008, was primarily attributable to the maturities of
short-term investments which was partially offset by the $862,000 addition for
new manufacturing molds and equipment, business intelligence software, leasehold
improvements to our new Irvine facility and demonstration units.




Net
Cash Used in Financing Activities




Net cash
used in financing activities was $1.9 million during the nine months ended
September 30, 2008 was primarily attributable to the repayment of $2.0 million
for the Century Medical notes and $30,000 cash paid for the annual renewal of
the working capital facility. These uses of cash were offset by $253,000 related
to proceeds from the issuance of common stock from option exercises and ESPP
stock purchases.




Off-Balance
Sheet Arrangements




Since
inception, we have not engaged in material off-balance sheet activities,
including the use of structured finance, special purpose entities or variable
interest entities.




Recent
Accounting Pronouncements




In
September 2006, the FASB issued SFAS No. 157,Fair Value Measurements
(“SFAS 157”), which defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements.
SFAS 157 applies to other accounting pronouncements that require or permit
fair value measurements. The new guidance is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and for interim
periods within those fiscal years. We adopted the provisions of SFAS 157 as
of January 1, 2008. The adoption of SFAS 157 did not have a material
impact on our financial position.




In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities — Including an amendment of FASB
Statement No. 115.” SFAS 159 expands the use of fair value accounting
to many financial instruments and certain other items. The fair value option is
irrevocable and generally made on an instrument-by-instrument basis, even if a
company has similar instruments that it elects not to measure based on fair
value. SFAS 159 is effective for fiscal years beginning after
November 15, 2007. The adoption of SFAS 159 did not have a material impact
on our financial position, as we did not make any fair value elections under
SFAS 159.




In
December 2007, the FASB issued SFAS No. 141—revised 2007, “Business Combinations”
(“SFAS 141R”). SFAS 141R establishes principles and requirements for
how an acquirer in a business combination recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
and any noncontrolling interest; recognizes and measures the goodwill acquired
in the business combination or a gain from a bargain purchase; and determines
what information to disclose to enable financial statement users to evaluate the
nature and financial effects of the business combination. SFAS 141R applies
to business combinations for which the acquisition date is on or after
December 15, 2008. Early adoption is prohibited. We are currently
evaluating the effect, if any, that the adoption of SFAS 141R will have on
our results of operations, financial position and cash flows.


19




In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements—an amendment to ARB No. 51
(“SFAS 160”). SFAS 160 requires all entities to report noncontrolling
(minority) interests in subsidiaries as equity in the consolidated financial
statements, but separate from the equity of the parent company. The statement
further requires that consolidated net income be reported at amounts
attributable to the parent and the noncontrolling interest, rather than
expensing the income attributable to the minority interest holder. This
statement also requires that companies provide sufficient disclosures to clearly
identify and distinguish between the interests of the parent company and the
interests of the noncontrolling owners, including a disclosure on the face of
the consolidated statements for income attributable to the noncontrolling
interest holder. This statement is effective for fiscal years beginning on or
after December 15, 2008. Early adoption is prohibited. We are currently
evaluating the effect, if any, that the adoption of SFAS 160 will have on
our results of operations, financial position and cash flows.




In
February 2008, the FASB issued FASB Staff Position No. 157-2, which
deferred the effective date for certain portions of SFAS 157 related to
nonrecurring measurements of nonfinancial assets and liabilities. That
provision of SFAS 157 will be effective for fiscal year 2009. We are
currently evaluating the effect that the adoption of SFAS 157-2 will have
on our financial position and results of operations.




In April
2008, the FASB issued FASB Staff Position 142-3, Determination of the Useful Lives of
Intangible Assets(“FSP 142-3”), which amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under FASB No. 142, Goodwill and Other Intangible
Assets. The intent of FSP 142-3 is to improve the consistency between the
useful life of a recognized intangible asset under SFAS No. 142 and the
period of expected cash flows used to measure the fair value of the asset under
SFAS No. 141(R) and other U.S. generally accepted accounting principles.
FSP 142-3 is effective for fiscal years beginning after December 15, 2008
and for interim periods within those fiscal years. We do not expect the adoption
of FSP 142-3 to have a material effect on our results of operations, financial
position and cash flows.




In June
2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities,
which addresses whether instruments granted in share-based payment transactions
are participating securities prior to vesting and, therefore, need to be
included in the earnings allocation in computing earnings per share under the
two-class method described in paragraphs 60 and 61 of FASB Statement
No. 128, Earnings per
Share. We do not expect the adoption of FSP EITF 03-6-1 to have a
material effect on our results of operations, financial position and cash
flows.




ITEM 3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK




The
primary objective of our investment activities is to preserve our capital for
the purpose of funding operations while at the same time maximizing the income
we receive from our investments without significantly increasing risk. To
achieve these objectives, our investment policy allows us to maintain a
portfolio of cash equivalents and investments in a variety of marketable
securities, including commercial paper, money market funds and corporate debt
securities and U.S. government securities. Our cash and cash equivalents as of
September 30, 2008, included liquid money market accounts. Due to the short-term
nature of our investments, we believe we have no material exposure to interest
rate risk. Our revenues are denominated in U.S. dollars. Accordingly, we have
not had exposure to foreign currency rate fluctuations. We expect to continue to
realize our revenues in U.S. dollars.




ITEM 4.
            CONTROLS
      AND PROCEDURES




Evaluation of Disclosure Controls and
Procedures. Our management evaluated, with the participation of our Chief
Executive Officer and our Chief Financial Officer, the effectiveness of our
disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange
Act of 1934, as amended) as of the end of the period covered by this Quarterly
Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and
our Chief Financial Officer have concluded that our disclosure controls and
procedures are effective to ensure that information we are required to disclose
in reports that we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms, and that such information
is accumulated and communicated to management as appropriate to allow for timely
decisions regarding required disclosure.


20




Changes in Internal Control Over
Financial Reporting. There was no change in our internal control over
financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that
occurred during the period covered by this Quarterly Report on Form 10-Q that
has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.




PART
II – OTHER INFORMATION




ITEM 1.
            LEGAL
      PROCEEDINGS




On
January 8, 2008, Hologic and its wholly-owned subsidiaries, including Cytyc
Corporation and Cytyc LP, filed a lawsuit against us in the United States
District Court, Northern District of California, San Jose Division. The
complaint generally alleges patent infringement of certain Hologic brachytherapy
patent claims, seeking unspecified monetary damages and an injunction against us
for infringement of those claims. On February 6, 2008, Hologic filed a
motion seeking a preliminary injunction in the case and requested that the Court
stop the sale of Contura MLB. On March 7, 2008, Hologic filed an amended
complaint restating its allegations regarding patent infringement, and adding
new claims related to unfair competition under the Lanham Act and California
state unfair competition and false advertising statutes. On April 25, 2008,
the court denied Hologic’s request for a preliminary injunction and ordered the
parties to schedule a trial within 60 to 90 days of such date. On May 22,
2008, the Court issued an order scheduling the Markman claims construction
hearing on the patent counts for June 25, 2008, and the trial in the case
to start July 14, 2008. Pursuant to an agreement of the parties, the order
also dismissed Hologic’s unfair competition and false advertising claims under
the Lanham Act and California state law, without prejudice. On June 24,
2008, the Court granted our joint request with Hologic to stay all proceedings,
including the previously scheduled Markman claims construction hearing and the
trial until at least August 22, 2008 in order to provide the parties time
to discuss possible resolution of the matter. On August 22, 2008, both parties
jointly requested that the Court resume proceedings in the pending
lawsuit.  On October 15, 2008, a Markman claims construction hearing
was held by the Court.  No ruling has yet been
issued.   We remain confident in our proprietary intellectual
property and actions, and intends to continue to vigorously defend ourselves in
this matter. Because the outcome of this litigation is undetermined, we cannot
reasonably estimate the possible loss or range of loss that may arise from the
litigation, we have not recorded an accrual for possible damages. Our current
outlook for patent litigation costs beyond the $4.4 million incurred to date, is
an additional $750,000 to $1.5 million for the remainder of 2008, depending upon
the disposition of the Markman hearing and a trial.




ITEM 1A.
            RISK
      FACTORS




RISKS
RELATED TO OUR BUSINESS




We
have a limited history of operations and a history of net losses, and we may not
be able to achieve profitability even if we are able to generate significant
revenues.




We have a
limited history of operations upon which you can evaluate our business. We began
selling our first products in 2002, fully launched our flagship product for use
in breast biopsy procedures, the EnCor system, in November 2005, and launched
our flagship radiation therapy product, the Contura MLB, in January 2008. We
incurred net losses of $9.9 million in 2007, $15.4 million in 2006, and, as of
September 30, 2008, had an accumulated deficit of approximately $84.3 million.
In addition, we expect our operating expenses to increase as we expand our
business to meet anticipated increased demand for our EnCor system, continue
with the full commercialization of the Contura MLB, and devote resources to our
sales and marketing and research and development activities. In order for us to
become profitable, we believe that our EnCor system and Contura MLB must be
widely adopted. We cannot assure you that we will be able to achieve or sustain
profitability even if we are able to generate significant revenues. Our failure
to achieve and sustain profitability would negatively impact the market price of
our common stock and require us to obtain additional funding. If our future
funding requirements increase beyond currently expected levels, as a result of
our failure to achieve or sustain profitability relating to sales, litigation
expenses or otherwise, we cannot make any assurance that additional funding will
be available on a timely basis on terms acceptable to us, or at all,
particularly in the short-term due to the current credit and equity market
funding environments.


21




Our
success depends upon market adoption of our EnCor system and Contura MLB,
without which our results of operations will suffer.




We have
historically derived our revenues primarily from our tissue marker products.
However, our EnCor system, launched in November 2005, accounts for a majority of
our revenue growth, and we expect this to continue for the foreseeable future.
Our ability to meet this expectation is based upon a number of assumptions,
including:




•
            the
      adequacy of third-party reimbursement for the minimally-invasive
      procedures in which EnCor is used;




•
            the
      market for minimally-invasive breast biopsy procedures will continue to
      grow and we will maintain or grow our current share of this
      market;




•
            we
      will be able to demonstrate compelling clinical data supporting EnCor’s
      safety and effectiveness;




•
            key
      features of EnCor will represent compelling technological advancements to
      potential users;




•
            EnCor
      will be endorsed by key opinion leaders;
and




•
            physicians
      who specialize in breast care will rapidly adopt
  EnCor.




Even if
we are able to present potential customers with compelling clinical data,
technological advancements or influential user experiences, they may be
reluctant to switch from a competing device to which they have grown accustomed.
We may not be successful in our near-term strategy of marketing EnCor to our
existing customer base of tissue marker users, and users of our earlier
vacuum-assisted breast biopsy system, our EnCor 360. Our commercial success also
depends on the continued general market shift to less invasive biopsy
procedures.




We
commercially launched Contura MLB in January 2008 and have yet to achieve
significant sales. Failure of EnCor or Contura MLB to be widely adopted would
significantly harm our future financial performance.




Our
future success will depend in part upon our ability to successfully
commercialize our Contura MLB.




We expect
our Contura MLB, which we received FDA 510(k) clearance in May 2007, to rapidly
become a significant contributor to our revenues. The Contura MLB development
has been completed, but there remain significant challenges that must be
overcome before we can obtain significant revenues from this product,
including:




•
            we
      have limited experience selling to radiological oncologists, the primary
      market for this product;




•
            attracting
      and retaining qualified sales professionals to sell
  it;




•
            differentiating
      Contura MLB from competing products and obtaining a significant share of
      this market;




•
            protecting
      it with intellectual property
rights;




•
            obtaining
      adequate third-party reimbursement;




•
            producing
      compelling clinical data on safety and
  effectiveness;




•
            partnering,
      as necessary, with suppliers; and




•
            manufacturing
      it consistently within our specifications and in accordance with the FDA’s
      Quality System Regulations.




If we are
able to overcome these challenges, we may nevertheless be unable to convince
potential customers that the Contura MLB represents a compelling alternative to
competing products. It has been reported that new short-term brachytherapy
products from Cianna Medical, North American Scientific and Xoft will all begin
to be commercialized in 2008. Our commercial success will also depend on a
general market shift from whole to partial breast radiation. If we are unable to
obtain a significant share of the brachytherapy market for the reasons listed
above, or that competing products are more compelling and achieve better
acceptance by the market, our long-term commercialization experience with the
Contura MLB could be significantly below expectations or not achieved at all,
which would have a material adverse effect on our future financial performance.
Additionally, the adoption of conformal radiotherapy may grow at a faster rate
than the overall market for partial breast radiation therapies, and as a result,
could impact the speed of adoption of balloon brachytherapy devices, including
Contura MLB.


22




We
are currently and may in the future be subject to costly claims of infringement
or misappropriation of the intellectual property rights of others, which could
impact our business and harm our operations.




Our
industry has been characterized by frequent demands for licenses and litigation.
On January 8, 2008, Hologic and its wholly-owned subsidiaries, including
Cytyc Corporation and Cytyc LP, filed a lawsuit against us in the United States
District Court, Northern District of California, San Jose Division. The
complaint generally alleges patent infringement of certain Hologic brachytherapy
patent claims, seeking unspecified monetary damages and an injunction against us
for infringement of those claims. On February 6, 2008, Hologic filed a
motion seeking a preliminary injunction in the case and requested that the Court
stop the sale of Contura MLB. On March 7, 2008, Hologic filed an amended
complaint restating its allegations regarding patent infringement, and adding
new claims related to unfair competition under the Lanham Act and California
state unfair competition and false advertising statutes. On April 25, 2008,
the court denied Hologic’s request for a preliminary injunction and ordered the
parties to schedule a trial within 60 to 90 days of such date. On May 22,
2008, the Court issued an order scheduling the Markman claims construction
hearing on the patent counts for June 25, 2008, and the trial in the case
to start July 14, 2008. Pursuant to an agreement of the parties, the order
also dismissed Hologic’s unfair competition and false advertising claims under
the Lanham Act and California state law, without prejudice. On June 24,
2008, the Court granted our joint request with Hologic to stay all proceedings,
including the previously scheduled Markman claims construction hearing and the
trial, until at least August 22, 2008 in order to provide the parties time
to discuss possible resolution of the matter. Because the outcome of this
litigation is undetermined, we cannot reasonably estimate the possible loss or
range of loss that may arise from the litigation or the likelihood of success.
If we lose the law suit, we may be completely prevented from selling Contura MLB
and as a result, our future prospects will be significantly harmed.




Our
competitors, potential competitors or other patent holders may, in the future,
assert that our products and the methods we employ are covered by their patents
or misappropriate their intellectual property. In addition, we do not know
whether our competitors will apply for and obtain patents that will prevent,
limit or interfere with our ability to make, use, sell or import our products.
Because patent applications may take years to issue, there may be applications
now pending of which we are unaware that may later result in issued patents that
our products infringe. There also could be existing patents that one or more
components of our systems may inadvertently infringe. Although we may seek to
settle any future claims, we may not be able to do so on reasonable terms, or at
all. If we lose a claim against us, we may be ordered to pay substantial
damages, including compensatory damages, which may be trebled in certain
circumstances, plus prejudgment interest. We also could be enjoined,
temporarily, preliminarily or permanently, from making, using, selling, offering
to sell or importing our products or technologies essential to our products,
which could significantly harm our business and operating
performance.




We may
become involved in litigation not only as a result of alleged infringement of a
third party’s intellectual property rights but also to protect our own
intellectual property. Enforcing our patent rights against infringers, even when
such litigation is resolved in our favor, could involve substantial costs and
divert management’s attention from our core business and harm our
reputation.




We
have limited clinical data regarding the safety and efficacy of our products. If
future data or clinical experience is negative, we may lose significant market
share.




Our
success depends on the acceptance of our products by the medical community as
safe and effective. Physicians that may be interested in using our products may
hesitate to do so without long-term data on safety and efficacy. The limited
clinical studies on some of our products that have been published or presented
as abstracts at major medical meetings typically have been based on the work of
a small number of physicians examining small patient populations over relatively
short periods. Accordingly, the results of these clinical studies do not
necessarily predict long-term clinical results, or even short-term clinical
results from the broader physician community. If future safety or efficacy data
or clinical experience is negative, we may lose significant market
share.


23




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




Many of
our products compete, and our future products may compete, against products that
are more established and accepted within our target markets. With fewer
resources and operating history than many of our competitors and potential
future competitors, and a less-established reputation, it may be difficult for
our products to gain significant market penetration. We may be unable to
convince physicians to switch their practice away from competing devices.
Competing effectively will require us to distinguish our company and our
products from our competitors and their products, and turns on factors such
as:




•
            ease
      of use and performance;




•
            price;




•
            quality
      and scale of our sales and marketing
efforts;




•
            our
      ability to offer a broad portfolio of products across the continuum of
      breast care;




•
            establishing
      a strong reputation through compelling clinical study publications and
      endorsements from influential physicians;
and




•
            brand
      and name recognition.




Competition
could result in price-cutting, reduced profit margins and loss of market share,
any of which could have a material adverse effect on our results of operations.
In addition, our competitors with greater financial resources could acquire
other companies that would enhance their name recognition and market share, and
allow them to compete more effectively by bundling together related products.
For example one competitor provides incentives for the purchase of its biopsy
capital equipment and disposables when purchased with its digital mammography
and stereotactic tables. Certain potential customers may view this value
proposition as attractive, which could result in their decision not to purchase
our products. We also anticipate that new products and improvements to existing
products could be introduced that would compete with our current and future
products. If we are unable to compete effectively, we will not be able to
generate expected sales and our future financial performance will
suffer.




Our
ability to compete depends upon our ability to innovate, develop and
commercialize new products and product enhancements.




The
markets in which we compete involve rapid and substantial technological
development and product innovations. There are few barriers to prevent new
entrants or existing competitors from developing or acquiring products or
technological improvements that compete effectively against our products or
technology. If we are unable to innovate successfully to anticipate or respond
to competitive threats, obtain regulatory approvals, or protect such innovation
with defensible intellectual property, our revenues could fail to grow or could
decline. Our business strategy is in part based upon our expectation that we
will continue to make frequent new product introductions and improvements to
existing products that will be demanded by our target customers. If we are
unable to continue to develop new products and technologies as anticipated, our
ability to grow and our future financial performance could be materially harmed.
For example, we recently received 510(k) clearance from the FDA for our new
SenoSonix System, an integration of EnCor with ultra sound technology from
Ultrasonix Medical Corporation of Canada. We have yet to commercially launch
this product and there can be no assurances that we will be successful in
obtaining meaningful revenues once it has been commercialized.


24




Our
business strategy is heavily focused on integrated breast centers and other
large institutions.




We are
focusing our sales efforts on becoming a preferred provider to integrated breast
centers and other large customer accounts. We cannot assure you that we will be
able to secure or maintain these accounts or that this strategy will maximize
our revenue growth. These targeted customers often have a rigorous and lengthy
qualification process for approving new vendors and products. Additionally,
breast centers are in many cases not located at one physical location, but
instead involve the coordinated efforts of various geographically dispersed
offices and physicians, which may complicate the qualification process and may
strain our sales and support organizations. Further, these customers have not
entered, and we do not expect them in the future to enter, long-term contracts
to purchase our products. Therefore, obtaining approval from these potential
customers to sell them our products may not result in significant or long-term
sales of our products to them. Our strategy of focusing on large institutions
may result in relatively few customers contributing a significant amount to our
revenues. For example, Kaiser Permanente is our largest customer, and in the
quarter ended September 30, 2008 and year ended December 31, 2007,
represented approximately 4.8% and 5.8%, respectively, of our total revenues. We
cannot assure you that Kaiser or other large customer accounts will continue to
purchase our products. The loss of any of these customers could have a material
adverse impact on our results of operations.




Our
strategy of providing a broad array of products to the breast care market may be
difficult to achieve, given our size and limited resources.




We aim to
be an attractive and convenient supplier for integrated breast centers by
offering a broad product line of minimally-invasive devices for breast care
specialists. Commercializing several product lines simultaneously may be
difficult because we are a relatively small company. Additionally, offering a
broad product line will require us to manufacture, sell and support some
products that are not as profitable or in as high demand as some of our other
products, which could have a material adverse effect on our overall results of
operations. To succeed in our approach, we will need to grow our organization
considerably and enhance our relationships with third-party manufacturers and
suppliers. If we fail to make product introductions successfully or in a timely
manner because we lack resources, or if we fail to adequately manufacture, sell
and support our existing products, our reputation may be negatively affected and
our results of operations could be materially harmed.




We
believe that demand for minimally-invasive products for the diagnosis and
treatment of breast cancer must grow in order for our business to grow as
anticipated.




While
there have been trends in recent years that favor increased screening, diagnosis
and treatment of breast cancer, these trends may not continue. For example, the
incidence of breast cancer in the United States appears to have fallen from its
highest level over the last few years. Additionally, while the number of breast
biopsies performed annually has increased significantly since 1997 when the
American Cancer Society updated its guidelines for breast cancer screening,
recommending that women should begin annual screening at age 40 rather than the
previously recommended age 50, new guidance could be published that could
support a reversal of this trend. Some studies conclude that annual breast
cancer screening by mammography for women under age 50 may be more harmful, due
to increased radiation exposure, than beneficial. These factors, in addition to
possible future innovations in screening technologies or in breast cancer
treatment options, could result in a decline in breast biopsy procedures and
radiation therapy, which could reduce our overall market.




We
have limited sales and marketing experience and failure to build and manage our
sales force or to market and distribute our products effectively could have a
material adverse effect on our results of operations.




We rely
on a direct sales force to sell our products. In order to meet our anticipated
sales objectives, we expect to grow our sales organization significantly over
the next several years. There are significant risks involved in building and
managing our sales organization, including our ability to:




•
            hire
      and successfully integrate qualified individuals as
  needed;




•
            provide
      adequate training for the effective sale of our
  products;




•
            retain
      and motivate our sales employees;
and




•
            integrate
      our new brachytherapy sales professionals and successfully sell into the
      radiationoncology
      market.






25




We expect
that our Contura MLB will be a principal driver of future growth. However, our
sales force historically has primarily sold diagnostic products and therefore
has limited experience selling a therapeutic device. Our Contura MLB competes
with products that are well-established. Accordingly, it is difficult for us to
predict how well our sales force will perform.




Our
failure to adequately address these risks could have a material adverse effect
on our ability to sell our products, causing our revenues to be lower than
expected and harming our results of operations.




If
we are unable to obtain and maintain intellectual property protection covering
our products, others may be able to make, use or sell our products, which could
have a material adverse effect on our business and results of
operations.




We rely
on patent, copyright, trade secret and trademark laws and confidentiality
agreements to protect our technology, products and our competitive position in
the market. Additionally, our patent applications, including those covering our
EnCor system, may not result in patents being issued to us or, if they are
issued, may not be in a form that is advantageous to us. Any patents we obtain
may be challenged or invalidated by third parties. Competitors also may design
around our protected technology or develop their own technologies that fall
outside our intellectual property rights. In addition, we may not be able to
prevent the unauthorized disclosure or use of our technical knowledge or other
trade secrets by consultants, vendors, former employees or current employees,
despite the existence of confidentiality agreements and other contractual
restrictions. Monitoring unauthorized uses and disclosures of our intellectual
property is difficult, and we cannot be certain that the steps we have taken to
protect our intellectual property will be effective or that any remedies we may
have in these circumstances would be adequate. Moreover, the laws of foreign
countries may not protect our intellectual property rights to the same extent as
the laws of the United States.




We may
not have adequate intellectual property protection for some of our products and
products under development and consequently may need to obtain licenses from
third parties. If any such licenses are required, we may be unable to negotiate
terms acceptable to us and such failure could have a material adverse effect on
our future results of operations.




We
may be unsuccessful in our long-term goal of expanding our product offerings
outside the United States and Canada.




For the
nine months ended September 30, 2008, we derived approximately 91.3% of our net
revenues from sales within the United States and Canada. We have entered into
distribution agreements with third parties outside the United States and Canada,
but do not anticipate sales of our products through these distributors becoming
a significant portion of our revenues in the foreseeable future. If we do begin
to offer our products more broadly outside the United States and Canada, we
expect that we will remain dependent on third-party distribution relationships
and will need to attract additional distributors to increase the number of
territories in which we sell our products. Distributors may not commit the
necessary resources to market and sell our products to the level of our
expectations. If current or future distributors do not perform adequately, or we
are unable to locate distributors in particular geographic areas, our ability to
realize long-term international revenue growth could be materially adversely
affected.




Although
some of our products have regulatory clearances and approvals from jurisdictions
outside the United States and Canada, many do not. These products may not be
sold in these jurisdictions until the required clearances and approvals are
obtained. We cannot assure you that we will be able to obtain these clearances
or approvals on a timely basis, or at all. In Japan, recent changes in the laws
and regulations governing the approval process for medical devices has made it
unlikely that we will be able to obtain approvals for our products within the
foreseeable future.




26


We
are dependent on sole-source and single-source suppliers for certain of our
products and components, thereby exposing us to supply interruptions that could
have a material adverse effect on our business.




We have
one product and several components of other products that we obtain from sole
suppliers. We rely on one vendor for our Gamma Finder product, one vendor for
our biopsy probe motors, one vendor for a biopsy probe coating, one vendor for
the ultrasound technology used in SenoSonix with EnCor and one vendor for
circuit boards in the Encore and the SenoSonix with Encore hardware. Other
products and components come from single suppliers, but alternate suppliers are
easier to identify. However, in many of these cases we have not yet qualified
alternate suppliers and rely upon purchase orders, rather than longer-term
supply agreements. We also do not carry a significant inventory of most
components used in our products and generally could not replace our suppliers
without significant effort and delay in production. In addition, switching
components may require product redesign and new regulatory clearances by the
FDA, either of which could significantly delay or prevent production and involve
substantial costs.




Reliance
on third-party vendors may lead to unanticipated interruptions in supply or
failure to meet demand on a timely basis. Any supply interruption from our
vendors or failure to obtain additional vendors for any of the components could
limit our ability to manufacture our products and fulfill customer orders on a
timely basis, which could harm our reputation and revenues.




We
have limited experience manufacturing certain components of our products in
significant quantities, which could adversely impact the rate at which we
grow.




We may
encounter difficulties in manufacturing relating to our products and products
under development for the following reasons:




•
            our
      limited experience in manufacturing such products in significant
      quantities and in compliance with the FDA’s Quality System
      Regulation;




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




•
            some
      of the components and materials that we use in our manufacturing
      operations are currently provided by sole and single sources of
      supply.




Our
limited manufacturing experience has in the past resulted in unexpected and
costly delays. For example, in 2006, as a part of our settlement of litigation
with Suros Surgical Systems, a wholly-owned subsidiary of Hologic, we
implemented a redesign to the EnCor system cutter. This effort resulted in a
short-term decrease in yields and a delay in implementing certain cost
improvements, which had an adverse effect on our costs of goods sold. In
addition, although we believe that our current manufacturing capabilities will
be adequate to support our commercial manufacturing activities for the
foreseeable future, we may be required to expand our manufacturing facilities if
we experience faster-than-expected growth. If we are unable to provide customers
with high-quality products in a timely manner, we may not be able to achieve
wide market adoption for our EnCor system or other products and products under
development. Our inability to successfully manufacture or commercialize our
devices could have a material adverse effect on our product sales.




We
are entering into a difficult economic period, and the uncertainty in the
economy may increase stock price volatility, reduce customer demand for our
products, and cause potential customers to delay their purchase
decisions.




Economic
conditions have recently deteriorated, and we may be entering, or already
are in, a global recession. This uncertainty may increase the volatility of our
stock price and may cause potential customers to delay their capital equipment
purchases, and may make it more difficult for potential customers to obtain
financing necessary to purchase our products, each of which can have a material
adverse effect on our revenue, profitability and business. Our capital equipment
revenues have historically ranged between 10% and 20% of annualized
revenues.  Credit constraints for both institutional as well as individual
physicians may slow the purchase of EnCor systems and Gamma Finders and may, as
a result, have a negative effect on the purchase of disposables related to
delays in capital equipment purchases or lead to a reduction in the overall
number of biopsy procedures.


27




We
rely on third-party manufacturers for certain components, and the loss of any of
these manufacturers, or their inability to provide us with an adequate supply of
high-quality components, could have a material adverse effect on our
business.




Although
we manufacture certain components and assemble some of our products at our
corporate headquarters in Irvine, California, we rely on third parties to
manufacture most of the components of our products and are in the process of
transferring additional manufacturing and assembly to our Thailand contract
manufacturer. Some of these relationships are new and we have not had experience
with their large commercial-scale manufacturing capabilities. For example, since
the end of 2005, we have been transferring a portion of our manufacturing
operations to a third party in Thailand. Because of the distance between
California and Thailand, we may have difficulty adequately supervising and
supporting its operations. There are several risks inherent in relying on
third-party manufacturers, including:




•
            failure
      to meet our requirements on a timely basis as demand grows for our
      products;




•
            errors
      in manufacturing components that could negatively affect the performance
      of our products, cause delays in shipment of our products, or lead to
      malfunctions or returns;




•
            inability
      to manufacture products to our quality specifications and strictly
      enforced regulatory requirements;




•
            inability
      to implement design modifications that we develop in the
      future;




•
            unwillingness
      to negotiate a long-term supply contract that meets our needs or to supply
      components on a short-term basis on commercially reasonable
      terms;




•
            prioritization
      of other customers orders over
ours;




•
            inability
      to fulfill our orders due to unforeseen events, including foreign
      political events, that result in a disruption of their operations;
      and




•
            continued
      fluctuations in the value of the U.S. dollar could impact our future
      third-party manufacturing costs.




If a
manufacturer fails to meet our needs with high-quality products on a timely
basis, we may be unable to meet customer demand, which could have a material
adverse effect on our reputation and customer relationships.




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




Breast
biopsy procedures and markers are typically reimbursed by third-party payors,
including Medicare, Medicaid and private healthcare insurance companies. These
payors may adversely change their coverage amounts and reimbursement policies.
Also, healthcare reform legislation or regulation may be proposed or enacted in
the future that adversely affects these policies and amounts. For example, the
Federal Deficit Reduction Act of 2006 may in the future affect future
reimbursement rates for our vacuum- assisted biopsy products and Contura MLB
products. We cannot assure you that the current scope of coverage or levels of
reimbursement will continue to be available or that coverage of, or
reimbursement for, our products will be available at all. If physicians,
hospitals and other providers are unable to obtain adequate reimbursement for
our current products or future products, or for the procedures in which such
products are used, they may be less likely to purchase the products, which could
have a material adverse impact on our market share. For example, Medicare
modestly reduced 2008 reimbursement rates for multiple-dwell radiation balloon
catheter procedures, which includes Contura MLB, performed by surgeons when
compared with other radiation balloons.


28




Any
acquisitions that we make could disrupt our business and have an adverse effect
on our financial condition.




We expect
that in the future we may identify and evaluate opportunities for strategic
acquisitions of complementary product lines, technologies or companies. We may
also consider joint ventures and other collaborative projects. However, we may
not be able to identify appropriate acquisition candidates or strategic
partners, or successfully negotiate, finance or integrate any businesses,
products or technologies that we acquire. Furthermore, the integration of any
acquisition and the management of any collaborative project may divert
management’s time and resources from our core business and disrupt our
operations. We do not have any experience with acquiring other product lines,
technologies or companies. We may spend time and money on projects that do not
increase our revenues. Any cash acquisition we pursue would diminish the funds
available to us for other uses, and any stock acquisition would be dilutive to
our stockholders.




Our
financial controls and procedures may not be sufficient to ensure timely and
reliable reporting of financial information, which, as a public company, could
materially harm our stock price and NASDAQ listing.




As a
public company, we will require greater financial resources than we have had as
a private company. We will need to hire additional employees for our finance
department. We cannot provide you with assurance that our finance department has
or will maintain adequate resources to ensure that we will not have any future
material weakness in our system of internal controls. The effectiveness of our
controls and procedures may in the future be limited by a variety of factors
including:




•
            faulty
      human judgment and simple errors, omissions or
  mistakes;




•
            fraudulent
      action of an individual or collusion of two or more
  people;




•
            inappropriate
      management override of procedures;
and




•
            the
      possibility that any enhancements to controls and procedures may still not
      be adequate to assure timely and accurate financial
      information.




If we
fail to have effective controls and procedures for financial reporting in place,
we could be unable to provide timely and accurate financial information and be
subject to NASDAQ delisting, SEC investigation, and civil or criminal
sanctions.




Product
liability claims may lead to expensive and time-consuming litigation,
substantial damages, increased insurance rates, and may have a material adverse
effect on our financial condition.




Our
business exposes us to potential product liability claims that are inherent in
the manufacturing, marketing and sale of medical devices. For example, in the
past we experienced, and in the future could experience, an issue related to the
tip of our Gel Mark Ultra Biopsy Site Marker shearing off in the patient’s
breast during the biopsy procedure, which could lead to a claim of damages,
though none has previously been made. We may be unable to avoid product
liability claims, including those based on manufacturing defects or claims that
the use, misuse or failure of our products resulted in a misdiagnosis or harm to
a patient. Although we believe that our liability coverage is adequate for our
current needs, and while we intend to expand our product liability insurance
coverage to any products we intend to commercialize, insurance may be
unavailable, prohibitively expensive or may not fully cover our potential
liabilities. If we are unable to maintain sufficient insurance coverage on
reasonable terms or to otherwise protect against potential product liability
claims, we may be unable to continue to market our products and to develop new
products. Defending a product liability lawsuit could be costly and have a
material adverse effect on our financial condition, as well as significantly
divert management’s attention from conducting our business. In addition, product
liability claims, even if they are unsubstantiated, may damage our reputation by
raising questions about our products’ safety and efficacy, which could
materially adversely affect our results of operations, interfere with our
efforts to market our products and make it more difficult to obtain commercial
relationships necessary to maintain our business.


29




We
may be adversely affected by the impact of environmental and safety
regulations.




We are
subject to federal, state, local and foreign laws and regulations governing the
protection of the environment and occupational health and safety, including laws
regulating the disposal of hazardous wastes and the health and safety of our
employees. We may be required to obtain permits from governmental authorities
for certain operations. If we violate or fail to comply with these laws and
regulations, we could incur fines, penalties or other sanctions, which could
adversely affect our business and our financial condition and cause our stock
price to decline. We also may incur material expenses in the future relating to
compliance with future environmental laws. In addition, we could be held
responsible for substantial costs and damages arising from any contamination at
our present facilities or third-party waste disposal sites. We cannot completely
eliminate the risk of contamination or injury resulting from hazardous
materials, and we may incur material liability as a result of any contamination
or injury.




Our
success will depend on our ability to attract and retain key personnel,
particularly members of management and scientific staff.




We
believe our future success will depend upon our ability to attract and retain
employees, including members of management, engineers and other highly skilled
personnel. Our employees may terminate their employment with us at any time.
Hiring qualified personnel may be difficult due to the limited number of
qualified professionals and the fact that competition for these types of
employees is intense. If we fail to attract and retain key personnel, we may not
be able to execute our business plan.




Our
ability to use net operating loss carryforwards may be limited.




Section 382
of the Internal Revenue Code generally imposes an annual limitation on the
amount of net operating loss carryforwards that may be used to offset taxable
income when a corporation has undergone significant changes in its stock
ownership. We have internally reviewed the applicability of the annual
limitations imposed by Section 382 caused by previous changes in our stock
ownership and believe such limitations should not be significant. Future
ownership changes, including changes resulting from or affected by our IPO, may
adversely affect our ability to use our remaining net operating loss
carryforwards. If our ability to use net operating loss carryforwards is
limited, we may be subject to tax on our income earlier than we would otherwise
be had we been able to fully utilize our net operating loss
carryforwards.


30




RISKS
RELATED TO REGULATORY MATTERS




The
FDA may find that we do not comply with regulatory requirements and take action
against us.




Our
products and facilities are subject to periodic unannounced inspections by the
FDA and other regulatory bodies. In particular, we are required to comply with
the FDA’s Quality System Regulations, or QSRs, and other regulations, which
cover the methods and documentation of the design, testing, production, control,
quality assurance, labeling, packaging, storage, shipping and post-market
surveillance of our products.




We
underwent an inspection of our facilities by the FDA in April 2005, which
resulted in the issuance in July 2005 of a Warning Letter from the FDA related
to, among other things, our failure to adequately validate manufacturing changes
we undertook to prevent the tip of the Gel Mark Ultra Biopsy Site Marker from
shearing off in the patient’s breast during the biopsy procedure, which we had
experienced. The letter required us to take prompt action to strengthen our
Quality System and product engineering area. We responded to the FDA with a
comprehensive corrective action plan in August 2005. We believe we are in
compliance with the QSRs. However, during a future inspection, the FDA may
determine that we have failed to adequately or completely implement the
corrective action plan or may find additional material violations. Such a
determination could lead the FDA to commence an enforcement action against us,
which may include the following sanctions:




•
            injunctions,
      fines, other civil penalties or additional Warning
  Letters;




•
            the
      refusal of, or delay by, the FDA in granting further 510(k) clearances or
      approving further premarket approval
  applications;




•
            suspension
      or withdrawal of our FDA clearances or
  approvals;




•
            operating
      restrictions, including total or partial suspension of production,
      distribution, sales and marketing of our products;
  or




•
            product
      recalls, product seizures or criminal prosecution of our company, our
      officers or our employees.




Any of
these could have a material adverse effect on our reputation, results of
operation and financial condition.




If
we fail to obtain or maintain necessary FDA clearances or approvals for
products, or if clearances or approvals are delayed, we will be unable to
commercially distribute and market our products in the United
States.




Our
products are medical devices, and as such are subject to extensive regulation in
the United States and in the foreign countries where we do business. Unless an
exemption applies, each medical device that we wish to market in the United
States must first receive 510(k) clearance or premarket approval from the FDA.
Either process can be lengthy and expensive. The FDA’s 510(k) clearance process
usually takes from three to twelve months from the date the application is
complete, but it may take longer. The premarket approval process is much more
costly, lengthy and uncertain. It generally takes from one to three years from
the date the application is completed or even longer. Achieving a completed
application is a process that may require numerous clinical trials and the
filing of amendments over time. We expect that our products in the foreseeable
future will be subject to 510(k) procedures and not premarket approval, or PMA,
applications. We may not be able to obtain additional FDA clearances or
approvals in a timely fashion, or at all. Delays in obtaining clearances or
approvals could adversely affect our revenues and profitability.




Modifications
to our devices may require new 510(k) clearances, which may not be
obtained.




The FDA
requires device manufacturers to initially make and document a determination of
whether or not a modification requires a new clearance; however, the FDA can
review a manufacturer’s decision. Any modifications to an FDA-cleared device
that could significantly affect its safety or effectiveness, or that would
constitute a major change in its intended use would require a 510(k) clearance
or possibly a premarket approval.


31




We have
modified aspects of some of our products since receiving FDA clearance, but we
believe that new 510(k) clearances are not required. We may make additional
modifications, and in appropriate circumstances, determine that new clearance or
approval is unnecessary. The FDA may not agree with our decisions not to seek
new clearances or approvals. If the FDA requires us to seek 510(k) clearances or
approval for any modifications to a previously cleared product, we may be
required to cease marketing or recall the modified device until we obtain
clearance or approval. Also, in these circumstances we may be subject to adverse
publicity, regulatory Warning Letters and significant fines and
penalties.




Government
regulation imposes significant restrictions and costs on the development and
commercialization of our products.




Any
products cleared or approved by the FDA are subject to on-going regulation. Any
discovery of previously unknown or unrecognized problems with the product or a
failure of the product to comply with any applicable regulatory requirements can
result in, among other things:




•
            Warning
      Letters, injunctions, fines or other civil
  penalties;




•
            the
      refusal of, or delay by, the FDA in granting further 510(k) clearances or
      approving further premarket approval
  applications;




•
            suspension
      or withdrawal of our FDA clearances or
  approvals;




•
            operating
      restrictions, including total or partial suspension of production,
      distribution, sales and marketing of our products;
  or




•
            product
      recalls, product seizures or criminal prosecution of our company, our
      officers or our employees.




Any of
these could have a material adverse effect on our reputation and results of
operations.




RISKS
RELATED TO THE SECURITIES MARKETS AND OWNERSHIP OF OUR COMMON STOCK




Our
common stock has been publicly traded for a short time and an active trading
market may not be sustained.




Prior to
March 2007, there had been no public market for our common stock. An active
trading market may not be sustained. The lack of an active market may impair the
value of your shares and your ability to sell your shares at the time you wish
to sell them. An inactive market may also impair our ability to raise capital by
selling shares and may impair our ability to acquire other companies, products
or technologies by using our shares as consideration.




If
our public guidance or our future operating performance does not meet investor
expectations, our stock price could decline.




As a
public company, we provide guidance to the investing community regarding our
anticipated future operating performance. Our business typically has a short
sales cycle, so that we do not have significant backlog of orders at the start
of a quarter, and our ability to sell our products successfully is subject to
many uncertainties. In light of these factors, it is difficult for us to
estimate with accuracy our future results. Our expectations regarding these
results will be subject to numerous risks and uncertainties that could make
actual results differ materially from those anticipated. If our actual results
do not meet our public guidance or our guidance or actual results do not meet
the expectations of third-party financial analysts, our stock price could
decline significantly.




We
expect that the price of our common stock will fluctuate
substantially.




The
market price of our common stock is likely to be highly volatile and may
fluctuate substantially due to many factors, including:




•
            volume
      and timing of sales of our
products;




•
            the
      introduction of new products or product enhancements by us or our
      competitors;




•
            disputes
      or other developments with respect to our intellectual property rights or
      the intellectual property rights of
others;


32




•
            our
      ability to develop, obtain regulatory clearance or approval for, and
      market, new and enhanced products on a timely
  basis;




•
            product
      liability claims or other
litigation;




•
            quarterly
      variations in our or our competitors’ results of
    operations;




•
            sales
      of large blocks of our common stock, including sales by our executive
      officers and directors;




•
            announcements
      of technological or medical innovations for the diagnosis and treatment of
      breast cancer;




•
            changes
      in governmental regulations or in the status of our regulatory approvals
      or applications;




•
            changes
      in the availability of third-party reimbursement in the United States or
      other countries;




•
            changes
      in earnings estimates or recommendations by securities analysts;
      and




•
            general
      market conditions and other factors, including factors unrelated to our
      operating performance or the operating performance of our
      competitors.




These and
other factors may make the price of our stock volatile and subject to unexpected
fluctuation.




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




Our
officers, directors and principal stockholders that currently hold more than 5%
of our common stock together control nearly a majority of our outstanding common
stock. As a result, these stockholders, if they act together, will be able to
exercise significant influence over the management and affairs of our company
and all matters requiring stockholder approval, including the election of
directors and approval of significant corporate transactions. This concentration
of ownership may have the effect of delaying or preventing a change in control,
might have a material adverse effect on the market price of our common stock and
may not be in the best interest of our other stockholders.




A
sale of a substantial number of shares of our common stock may cause the price
of our common stock to decline.




Following
the expiration of lock-up arrangements with our stockholders in September 2007
that were entered into in connection with our IPO, all shares of our common
stock that were outstanding before the IPO are now eligible for resale, subject
to compliance with Rule 144 under the Securities Act. If our stockholders sell
substantial amounts of our common stock, the market price of our common stock
could decline.




Our
Amended and Restated Certificate of Incorporation and Bylaws, and Delaware law,
contain provisions that could discourage a takeover.




Our
Amended and Restated Certificate of Incorporation and Bylaws, and Delaware law,
contain provisions that might enable our management to resist a takeover, and
might make it more difficult for an investor to acquire a substantial block of
our common stock. These provisions include:




•
            a
      classified board of directors;




•
            advance
      notice requirements to stockholders for matters to be brought at
      stockholder meetings;




•
            a
      supermajority stockholder vote requirement for amending certain provisions
      of our Amended and Restated Certificate of Incorporation and
      Bylaws;




•
            limitations
      on stockholder actions by written consent;
and




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




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


33




We
do not intend to pay cash dividends.




We have
never declared or paid cash dividends on our capital stock. We currently intend
to retain all available funds and any future earnings for use in the operation
and expansion of our business and do not anticipate paying any cash dividends in
the foreseeable future. In addition, the terms of any future debt or credit
facility may preclude us from paying any dividends. As a result, we anticipate
that capital appreciation of our common stock, if any, will be your sole source
of potential gain for the foreseeable future.




ITEM 2.
            UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS




We did
not sell any equity securities during the period covered by this
report.




ITEM 3.
            DEFAULTS
      UPON SENIOR SECURITIES




None.




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






None.


34


ITEM 5.
            OTHER
      INFORMATION




None.




ITEM 6.
            EXHIBITS




Exhibit
              Number
            
            Description3.2(1)
            
            Amended
      and Restated Certificate of Incorporation.3.4(1)
            
            Bylaws.4.1(1)
            
            Specimen
      Common Stock certificate of the Registrant.4.2(1)
            
            Fourth
      Amended and Restated Investors’ Rights Agreement, dated May 3, 2006,
      by and among the Registrant and certain stockholders.10.1(1)
            
            Form
      of Indemnification Agreement for directors and executive
      officers.10.2(1)
            
            1998
      Stock Plan.10.3(1)
            
            2006
      Equity Incentive Plan.10.4(1)
            
            Employee
      Stock Purchase Plan.10.5(1)
            
            Fourth
      Amended and Restated Investors’ Rights Agreement, dated May 3, 2006,
      by and among the Registrant and certain stockholders.10.6(1)
            
            Standard
      Industrial/Commercial Multi-Tenant Lease, dated September 15, 1999,
      as amended on March 28, 2003 and November 1, 2003, by and
      between the Registrant and Columbia Investors, LLC.10.7(1)
            
            Loan
      and Security Agreement, dated March 15, 2002, and various amendments
      thereto, by and between the Registrant and Silicon Valley
      Bank.10.7.1(1)
            
            Amended
      and Restated Loan and Security Agreement, dated February 20, 2007, by
      and between the Registrant and Silicon Valley Bank.10.8(1)
            
            Convertible
      Subordinated Note Agreement, dated May 9, 2002, by and between the
      Registrant and Century Medical, Inc.10.9(1)
            
            $2,500,000
      Loan and Security Agreement, dated December 27, 2004, by and between
      the Registrant and Venture Lending & Leasing IV,
  Inc.10.10(1)
            
            Note
      Purchase Agreement and Form of Subordinated Convertible Promissory Note,
      each dated May 4, 2006, by and between the Registrant and certain
      stockholders.10.11(1)†
            
            Agreement
      for Vacuum Assisted Breast Biopsy Needle, System, and Accessory Products,
      effective April 1, 2005 by and between the Registrant and KP
      Select.10.12(1)
            
            Executive
      Employment Agreement, dated May 1, 1999, by and between the
      Registrant and Lloyd Malchow.10.13(1)†
            
            Distribution
      Agreement, dated June 11, 2003, and various amendments thereto, by
      and among the Registrant, W.O.M. World of Medicine USA, Inc. and W.O.M.
      World of Medicine AG.10.14(1)
            
            Settlement
      Agreement, effective as of May 22, 2006, by and between the
      Registrant and Suros Surgical Systems, Inc.10.15(1)
            
            Loan
      and Security Agreement, dated December 8, 2006, by and between the
      Registrant and Escalate Capital I, L.P.10.16(2)
            
            Lease
      Agreement between The Irvine Company LLC and Registrant dated
      March 5, 2008.10.17(3)
            
            Change
      in Control Agreement between Registrant and Lloyd
  Malchow.10.18(3)
            
            Change
      in Control Agreement between Registrant and Paul
Lubock.10.19(3)
            
            Change
      in Control Agreement between Registrant and Kevin
  Cousins.10.20(3)
            
            Change
      in Control Agreement between Registrant and William
    Gearhart.10.21(3)
            
            Change
      in Control Agreement between Registrant and Eben
Gordon.10.22(4)
            
            Amendment
      dated September 30, 2008, to the Amended and Restated Loan and Security
      Agreement dated February 27, 2007, by and between the Registrant and
      Silicon Valley Bank.10.23(4)
            
            Loan
      and Security Agreement (Ex-Im Loan Facility) dated September 30, 2008, by
      and between the Registrant and Silicon Valley Bank.10.24(4)
            
            Export-Import
      Bank of the United States Working Capital Guarantee Program Borrower
      Agreement dated September 30, 2008, by and between the Registrant and
      Silicon Valley Bank.


35





31.1
            
            Certification
      of Chief Executive Officer under Securities Exchange Act Rule
      13a-14(a).31.2
            
            Certification
      of Chief Financial Officer under Securities Exchange Act Rule
      13a-14(a).32.1
            
            Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. Section 1350 and Securities Exchange Act Rule
      13a-14(b).





(1)
            Incorporated
      by reference from our Registration Statement on Form S-1 (Registration
      No. 333-134466), which was declared effective on March 28,
      2007.




(2)
            Incorporated
      by reference from our Current Report on Form 8-K filed on March 10,
      2008.




(3)
            Incorporated
      by reference from our Current Report on Form 8-K filed on August 29,
      2008.




(4)
            Incorporated
      by reference from our Current Report on Form 8-K filed on October 2,
      2008.




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



























36


SIGNATURES




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




Date:
      November 10, 2008
            
            /s/
      Lloyd H.
      MalchowLloyd
      H. Malchow
              President
      and Chief Executive Officer
              (Principal
      Executive Officer)




Date:
      November 10, 2008
            
            /s/
      Kevin J.
      CousinsKevin
      J. Cousins
              Chief
      Financial Officer
              (Principal
      Financial and Accounting Officer)



























37


INDEX
TO EXHIBITS




Exhibit
              Number
            
            Description3.2(1)
            
            Amended
      and Restated Certificate of Incorporation.3.4(1)
            
            Bylaws.4.1(1)
            
            Specimen
      Common Stock certificate of the Registrant.4.2(1)
            
            Fourth
      Amended and Restated Investors’ Rights Agreement, dated May 3, 2006,
      by and among the Registrant and certain stockholders.10.1(1)
            
            Form
      of Indemnification Agreement for directors and executive
      officers.10.2(1)
            
            1998
      Stock Plan.10.3(1)
            
            2006
      Equity Incentive Plan.10.4(1)
            
            Employee
      Stock Purchase Plan.10.5(1)
            
            Fourth
      Amended and Restated Investors’ Rights Agreement, dated May 3, 2006,
      by and among the Registrant and certain stockholders.10.6(1)
            
            Standard
      Industrial/Commercial Multi-Tenant Lease, dated September 15, 1999,
      as amended on March 28, 2003 and November 1, 2003, by and
      between the Registrant and Columbia Investors, LLC.10.7(1)
            
            Loan
      and Security Agreement, dated March 15, 2002, and various amendments
      thereto, by and between the Registrant and Silicon Valley
      Bank.10.7.1(1)
            
            Amended
      and Restated Loan and Security Agreement, dated February 20, 2007, by
      and between the Registrant and Silicon Valley Bank.10.8(1)
            
            Convertible
      Subordinated Note Agreement, dated May 9, 2002, by and between the
      Registrant and Century Medical, Inc.10.9(1)
            
            $2,500,000
      Loan and Security Agreement, dated December 27, 2004, by and between
      the Registrant and Venture Lending & Leasing IV,
  Inc.10.10(1)
            
            Note
      Purchase Agreement and Form of Subordinated Convertible Promissory Note,
      each dated May 4, 2006, by and between the Registrant and certain
      stockholders.10.11(1)†
            
            Agreement
      for Vacuum Assisted Breast Biopsy Needle, System, and Accessory Products,
      effective April 1, 2005 by and between the Registrant and KP
      Select.10.12(1)
            
            Executive
      Employment Agreement, dated May 1, 1999, by and between the
      Registrant and Lloyd Malchow.10.13(1)†
            
            Distribution
      Agreement, dated June 11, 2003, and various amendments thereto, by
      and among the Registrant, W.O.M. World of Medicine USA, Inc. and W.O.M.
      World of Medicine AG.10.14(1)
            
            Settlement
      Agreement, effective as of May 22, 2006, by and between the
      Registrant and Suros Surgical Systems, Inc.10.15(1)
            
            Loan
      and Security Agreement, dated December 8, 2006, by and between the
      Registrant and Escalate Capital I, L.P.10.16(2)
            
            Lease
      Agreement between The Irvine Company LLC and Registrant dated
      March 5, 2008.10.17(3)
            
            Change
      in Control Agreement between Registrant and Lloyd
  Malchow.10.18(3)
            
            Change
      in Control Agreement between Registrant and Paul
Lubock.10.19(3)
            
            Change
      in Control Agreement between Registrant and Kevin
  Cousins.10.20(3)
            
            Change
      in Control Agreement between Registrant and William
    Gearhart.10.21(3)
            
            Change
      in Control Agreement between Registrant and Eben
Gordon.10.22(4)
            
            Amendment
      dated September 30, 2008, to the Amended and Restated Loan and Security
      Agreement dated February 27, 2007, by and between the Registrant and
      Silicon Valley Bank.10.23(4)
            
            Loan
      and Security Agreement (Ex-Im Loan Facility) dated September 30, 2008, by
      and between the Registrant and Silicon Valley
  Bank.


38





10.24(4)
            
            Export-Import
      Bank of the United States Working Capital Guarantee Program Borrower
      Agreement dated September 30, 2008, by and between the Registrant and
      Silicon Valley Bank.31.1
            
            Certification
      of Chief Executive Officer under Securities Exchange Act Rule
      13a-14(a).31.2
            
            Certification
      of Chief Financial Officer under Securities Exchange Act Rule
      13a-14(a).32.1
            
            Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. Section 1350 and Securities Exchange Act Rule
      13a-14(b).





(1)
            Incorporated
      by reference from our Registration Statement on Form S-1 (Registration
      No. 333-134466), which was declared effective on March 28,
      2007.




(2)
            Incorporated
      by reference from our Current Report on Form 8-K filed on March 10,
      2008.




(3)
            Incorporated
      by reference from our Current Report on Form 8-K filed on August 29,
      2008.




(4)
            Incorporated
      by reference from our Current Report on Form 8-K filed on October 2,
      2008.




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














39