Form 10-Q for period ended 9/30/2005

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

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

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

The registrant had 33,672,487 shares of Common Stock, $0.001 par value per share, outstanding as of October 31, 2005.

Conor Medsystems, Inc. (the “Company”) was incorporated on October 25, 1999 and is developing innovative controlled vascular drug delivery technologies. Historically, the Company’s activities have consisted primarily of recruiting personnel, raising capital and performing product development. The Company was in the development stage through 2004. In 2005, the Company began commercializing its CoStar^™ stent in certain countries in Asia and Latin America. Accordingly, the Company is no longer in the development stage as of September 30, 2005.

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

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

The unaudited condensed consolidated financial statements and the accompanying notes should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. Operating results for the three and nine months ended September 30, 2005 are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year ending December 31, 2005. Stockholders are encouraged to review the Company’s Annual Report on Form 10-K for a broader discussion of the Company’s business and the risks inherent therein.

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

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

The Company is aware of patents owned by third parties, to which it does not have licenses, which relate to, among other things, the use of paclitaxel to treat restenosis, stent structure, catheters used to deliver stents, stent manufacturing processes and composition of materials used on or with stents. For example, Boston Scientific Corporation owns a series of patents that claim the use of paclitaxel to treat restenosis generally and also to treat restenosis via a stent. In addition, Angiotech Pharmaceuticals, Inc. is the owner of a number of patents, and has licensed from the U.S. government a number of other patents, that also claim the use of paclitaxel coated stents to treat angiogenesis and restenosis. Boston Scientific, Johnson & Johnson, Guidant Corporation and other parties also own other patents that may have a material adverse affect on the Company. On February 1, 2005, Angiotech Pharmaceuticals, Inc. and Boston Scientific (as Angiotech’s licensee) initiated legal proceedings against the Company in the District Court in the Hague, Netherlands seeking a declaration that the Company’s CoStar stent infringes Angiotech’s patent rights. In the suit, Angiotech and Boston Scientific are also seeking orders, among other things, preventing the Company from commercializing its CoStar stent in many European countries and requiring the Company to pay damages. Also, on November 8, 2005, Boston Scientific and Boston Scientific Scimed, Inc. (Scimed) initiated legal proceedings against the Company in the District Court for the District of Delaware seeking a judgment that the Company’s CoStar stent infringes U.S. Patent No. 5,922,021, one of the Jang patents assigned to Boston Scientific. In the suit, Boston Scientific and Scimed are also seeking orders, among other things, preventing the Company from commercializing its CoStar stent in the United States and requiring the Company to pay damages. Based on the prolific litigation that has occurred in the stent industry and the fact that the Company may pose a competitive threat to other large and well-capitalized companies who own or control patents relating to stents and their use, manufacture and delivery, the Company believes that it is highly likely that additional third parties will assert patent infringement claims against the manufacture, use or sale of the Company’s CoStar stent. Any lawsuit could seek to enjoin, or prevent, the Company from commercializing its CoStar stent and may seek damages from the Company, and would likely be expensive for the Company to defend against. The Company has also received letters from third parties, some of whom have been actively involved in coronary stent litigation, asserting that they may have rights to patents that are relevant to the Company’s operations or its stent platform and requesting the initiation of discussions. In the event a court determines that the Company infringes any valid claim in a patent held by a third party, the Company expects that such a determination would have a material adverse effect on its results of operations, financial condition and liquidity, and that the Company may, among other things, be required to pay substantial damages, cease the development, manufacture, use and sale of products that infringe the patent rights of others, including its CoStar stent, expend significant resources to redesign the Company’s technology so that it does not infringe others’ patent rights, or to develop or acquire non-infringing intellectual property, which may not be possible, discontinue manufacturing or other processes incorporating infringing technology, and/or obtain licenses to the infringed intellectual property. The Company believes that it is unlikely that it would be able to obtain a license to any necessary patent rights controlled by companies, like Boston Scientific, against which it would compete directly. In addition, the Company’s competitors have significant resources to devote to litigation against the Company, and the Company may need to expend significant resources to defend against such litigation. The Company could require significant additional funds to bear the costs of this litigation, regardless of whether the Company prevails. The Company’s ability to continue to operate under its current operating plan could be impaired if such funds are not available. Since the Company’s costs in connection with any such litigation will vary greatly depending on the nature and timing of the litigation, it is not possible for the Company to estimate the effect of such costs on its financial condition and results of operations. Amounts, ultimately payable, if any, resulting from an adverse outcome of any of these matters cannot be reasonably estimated at this time.

The functional currency of the Company’s subsidiaries in Ireland is the euro. Foreign assets and liabilities are translated into U.S. dollars at the quarter-end exchange rates, while components of the statement of operations are translated using average exchange rates in effect throughout the year. Gains and losses from foreign currency transactions are included in the condensed consolidated statements of operations. Foreign currency translation adjustments are included as a component of stockholders’ equity.

The Company recognizes revenue from product sales when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable, and collectibility is reasonably assured. Product sales to date have been to the Company’s distributors and revenue from such product sales has been recognized in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition (“SAB 104”). The Company’s distributors have no price protection or rights of return.

The Company warrants products shipped against defects in design, material and workmanship. The Company estimates the costs that may be incurred under its warranties and records a liability in the amount of such estimated costs at the time the product is sold. Factors that affect the Company’s warranty liability include the number of units sold, anticipated rate of warranty returns and cost per return. The Company periodically assesses the adequacy of its recorded warranty liability and based upon the outcome of this assessment, records any changes in the estimated warranty liability. To date, the warranty expense that has been included in cost of goods sold, has not been material.

Inventories are stated at the lower of cost (first in, first out) or market. The Company provides for excess and obsolete inventories based on estimated forecasts of demand. Inventories are summarized as follows (in thousands):

The Company issues stock options to its employees and outside directors and provides employees the right to purchase the Company’s common stock pursuant to stockholder approved stock option and employee stock purchase plans. The Company accounts for employee stock options using the intrinsic-value method in accordance with Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB Opinion No. 25”), Financial Accounting Standards Board (“FASB”) Interpretation (“FIN”) No. 44, Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB No. 25, and related interpretations and has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”).

The Company estimates the fair value of its options and employee stock purchase plan shares using the Black-Scholes option pricing model, which is one of several methods that can be used to estimate option and share values. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. The Company’s options have characteristics significantly different from traded options, and changes in the subjective input assumptions can materially affect the fair value estimates.

The fair value of options granted was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

The fair value of employee stock purchase plan shares was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

During 2003 and 2004, stock options were granted at exercise prices that were below the reassessed fair value of the common stock on the date of grant. Accordingly, deferred stock compensation of $30.5 million was recorded during 2003 and 2004 in accordance with APB Opinion No. 25. The deferred stock compensation will be amortized on a straight-line basis over the vesting period of the related awards, which is generally four years. The related stock-based compensation expense was $2.4 million and $2.0 million during the three months ended September 30, 2005 and 2004, respectively. During the nine months ended September 30, 2005 and 2004, the related stock-based compensation expense was $7.1 million and $2.5 million, respectively.

The information regarding pro forma net loss as required by SFAS No. 123, as amended, has been determined as if the Company had accounted for its employee stock options and employee stock purchase plan shares under the fair-value method. The table below illustrates the effect on net loss attributable to common stockholders and net loss per share attributable to common stockholders had the Company applied the fair value provisions of SFAS No. 123 to employee stock compensation (in thousands, except per share amounts):

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

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

In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”) which is a revision of SFAS No. 123, and supersedes APB Opinion 25. SFAS No. 123R requires all share-based payments to employees and directors, including grants of stock options, to be recognized in the statement of operations based on their fair values, beginning with the first annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS No. 123 will no longer be an alternative to financial statement recognition. As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using APB Opinion 25’s intrinsic value method and, as such, recognizes no compensation cost for employee stock options.

Under SFAS No. 123R, the Company must determine the appropriate fair value model and related assumptions to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition methods include modified prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS No. 123R, while the retroactive method would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. The Company is currently evaluating the requirements of SFAS No. 123R as well as option valuation methodologies related to its employee and director stock options and employee stock purchase plan. Although the Company has not yet determined the method of adoption or the effect of adopting SFAS

No. 123R, it is expected that the adoption of SFAS No. 123R will have a material impact on the Company’s consolidated results of operations. The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will depend on, among other things, the levels of share-based payments granted in the future, the method of adoption and the option valuation method used. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.

In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”), a replacement of APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 changes the requirements related to accounting for and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle and changes required by a new accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. Under SFAS No. 154, the Company must record the impact of a change in accounting principle retrospectively to financial statements of prior periods. Previously, the guidance allowed the recording of the impact of an accounting change in the current period’s net income as a cumulative effect adjustment. SFAS No. 154 is effective for the Company beginning January 1, 2006. The adoption of SFAS No. 154 is not expected to have a material impact on the Company’s consolidated earnings, financial position or cash flows.

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

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

The Company leases certain real and personal property under noncancelable operating leases. Future minimum payments under these leases as of September 30, 2005 were as follows (in thousands):

In addition to these minimum lease payments, the Company is required to pay its share of operating expenses related to property taxes, insurance and routine maintenance in connection with its facility leases. Rent expense under the operating leases was approximately $0.2 million and $0.1 million for the three months ended September 30, 2005 and 2004, respectively, and approximately $0.7 million and $0.4 million for the nine months ended September 30, 2005 and 2004, respectively.

In February 2005, the Company entered into a ten-year lease, which has an option for an additional ten year term, for an approximately 27,000 square foot permanent manufacturing facility in Athlone, Ireland. This facility includes an approximately 5,000 square foot clean room. Lease payments are fixed for a period of five years, with provisions for annual adjustments for market changes, for the duration of the lease.

In March 2005, the Company entered into an amendment of the lease agreement for the Company’s current headquarters in Menlo Park, California. The amendment provides for an additional approximately 26,000 square feet of space in a building adjacent to the Company’s current headquarters and extends the term of the Company’s lease for an additional year to August 2008.

On February 1, 2005, Angiotech Pharmaceuticals, Inc. and Boston Scientific Corporation (as Angiotech’s licensee) initiated legal proceedings against the Company in the District Court in the Hague, Netherlands, seeking: a declaration that the Company’s CoStar stent infringes European Patent No. (EP) 0 706 376 B1 in the Netherlands and other countries designated in EP 0 706 376 B1; an order that the Company and its affiliates cease any infringement of EP 0 706 376 B1 in the Netherlands and other designated European countries; an order that the Company not use its CE marketing approval, if obtained by the Company, for three years or for a period of time which the District Court deems appropriate and/or at the choice of Boston Scientific and Angiotech; an order requiring the Company to withdraw all information and documentation concerning the clinical trials the Company has conducted in the Netherlands from all relevant regulatory authorities worldwide; an order requiring the Company to pay 2,460 euros per sale of its CoStar stent in Europe or, at the choice of Boston Scientific and Angiotech, 2,460 euros per day that the Company does not comply; an order that the Company indemnify Boston Scientific and Angiotech or surrender its profit on sales of its CoStar stent in countries covered by EP 0 706 376 B1; and an order that the Company pay the costs of the proceedings. A scheduling hearing has been set for April 2006. A trial date for these proceedings has not yet been set. The Company is unable to predict the outcome of these proceedings.

On February 18, 2005, the Company initiated proceedings against Angiotech and the University of British Columbia in the High Court of Justice in the United Kingdom requesting that the court invalidate EP 0 706 376 B1 based on the grounds that all claims of the patent either lack novelty or are obvious in light of the state of scientific knowledge at the priority date of the patent. The trial began on October 4, 2005, and the High Court of Justice is expected to hear the parties’ closing arguments in mid December 2005. The Company anticipates that the High Court of Justice will deliver its decision in early 2006. The Company is unable to predict the outcome of these proceedings.

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

On October 14, 2005, the Company adopted a Change of Control Severance Benefit Plan for the benefit of all non-executive employees. Pursuant to the Change of Control Severance Benefit Plan, if one month prior to or within thirteen months after the effective date of a change of control of the Company, the employee is terminated without cause or the employee is constructively terminated, the employee is entitled to, subject to certain conditions, (1) receive a severance payment, (2) continuation of benefits for three months and (3) full acceleration of option vesting.

On November 8, 2005, Boston Scientific and Boston Scientific Scimed, Inc. (Scimed) initiated legal proceedings against the Company in the District Court for the District of Delaware seeking a judgment that the Company’s CoStar stent infringes U.S. Patent No. 5,922,021, one of the Jang patents assigned to Boston Scientific. In the suit, Boston Scientific and Scimed are also seeking orders, among other things, preventing the Company from commercializing its CoStar stent in the United States and requiring the Company to pay damages. The Company is unable to predict the outcome of these proceedings.

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

We develop innovative controlled vascular drug delivery technologies. We have initially focused on the development of drug eluting stents to treat coronary artery disease. Our clinical efforts are currently focused on the commercialization of our CoStar^™ stent, which is a cobalt chromium paclitaxel eluting stent, for the treatment of restenosis.

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

In early 2003, we initiated our PISCES study to evaluate the safety and performance of paclitaxel delivered with different release kinetics and doses using our stainless steel stent. We completed enrollment of 191 patients in late 2003 and announced twelve-month follow-up data in March 2005. The most favorable formulations from our PISCES study are the focus of our subsequent EuroSTAR and COSTAR I trials, as well as our U.S. pivotal clinical trial, which are designed to evaluate our CoStar stent. The COSTAR I trial began in late 2003. During 2004 and 2005, we presented four- and twelve-month follow-up data for all three formulation groups in our COSTAR I trial. The EuroSTAR trial began in early 2004. In March 2005, we announced six-month follow-up data from the first arm of our EuroSTAR trial, and

May 2005, we announced twelve-month follow-up data from the first arm of our EuroSTAR trial. In October 2005, we announced six-month follow-up data from the second arm of our EuroSTAR trial. The EuroSTAR trial served as our pivotal trial to support our submission in the first quarter of 2005 of an application to a designated Notified Body in the European Community, which is one of the steps we must undertake prior to marketing our CoStar stent in the European Community. In March 2005, we received conditional approval of our investigational device exemption, or IDE, application from the FDA to permit the commencement of our U.S. pivotal clinical trial, COSTAR II, which is designed to evaluate our CoStar stent against a conventional drug eluting stent. In May 2005, we announced that the first patient had been enrolled in our COSTAR II trial. We have not yet received any government regulatory approvals necessary to commercialize our CoStar stent. If our clinical trials proceed as scheduled and the outcomes of these clinical trials are favorable, we anticipate receiving regulatory approval for our CoStar stent in the European Community in late 2005 or early 2006 and in the United States in late 2007. We could be delayed by adverse results or regulatory complications, and we may never achieve regulatory approval.

If we obtain the necessary regulatory approval, we plan to pursue commercialization of our CoStar stent in the United States with our own sales force and internationally through distribution arrangements. We entered into an agreement with Biotronik AG in May 2004 to distribute our CoStar stent in countries outside of the United States, Japan, Australia, New Zealand and Korea and certain other countries. In July 2004, we entered into an agreement with Interventional Technologies, Pvt., Ltd., or IVT, to distribute our UniStar^™ cobalt chromium bare-metal stent and our CoStar stent in India, Pakistan, Bangladesh, Sri Lanka, Kenya and Tanzania. In November 2004, we entered into agreements with affiliates of St. Jude Medical, Inc. to distribute our UniStar stent and CoStar stent in Japan, Korea, New Zealand and Australia. A decision to seek regulatory approval of, or to sell, our CoStar stent has not yet been made in respect to all of these countries. In the first half of 2005, we began selling commercial units of our CoStar stent in certain countries in Asia and Latin America pursuant to our distribution agreements. We do not expect sales of our CoStar stent in these countries to be significant during 2005, and we do not expect to generate any revenues from sales of our UniStar stent. No regulatory approval is currently required to market our CoStar stent in the countries in which we are currently commercializing our CoStar stent. However, the Indian Ministry of Health has indicated that it will adopt a regulatory framework for medical devices in India. While Indian Ministry of Health officials continue to debate the framework to be adopted, our distributor’s ability to commercialize our CoStar stent in India has been limited. We believe that receiving CE Mark for the CoStar stent may reduce these limitations. However, if we are required to obtain some form of license or regulatory approval in addition to CE Mark from Indian regulatory agencies, our distributor’s ability to commercialize in India may be limited until such license or regulatory approval is obtained. We have established manufacturing capacity in Athlone, Ireland to manufacture commercial quantities of our CoStar stent, initially for sale outside of the United States, and we are currently in the process of preparing the facility for our planned commercial launch in the European Community.

We were incorporated in Delaware in October 1999 and have a limited operating history. To date, we have not generated significant revenues, and we have incurred net losses in each year since our inception. We anticipate that we will continue to incur net losses for the next several years as we develop new products, expand our clinical development team and corporate infrastructure and prepare for the potential broader commercialization of our CoStar stent. We have financed our operations primarily through private placements of preferred stock and convertible promissory notes, as well as through our initial public offering of our common stock. In July and August 2004, we raised aggregate net cash proceeds of $38.9 million in a private placement of 6,711,431 shares of our Series E convertible preferred stock. In December 2004 and January 2005, we raised net cash proceeds of $78.1 million, after deducting underwriting discounts, commissions, and other offering expenses, in our initial public offering of our common stock.

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

In the first half of 2005, we began commercializing our CoStar stent in certain countries in Asia and Latin America. Prior to February 2005, we had not generated any revenues from the sale of our stents. We do not expect sales of our CoStar stent in these countries to be significant during 2005, and we do not expect to generate significant product sales until we successfully obtain marketing approval for and begin selling our CoStar stent in the European Community. We expect that revenues from the sales of our CoStar stent will fluctuate from quarter to quarter.

Cost of sales is composed of the material, labor, overhead and transportation costs of production and variances associated with inefficiencies in manufacturing. We expect that as our production processes mature and volumes increase, our cost of sales as a percent of product sales will decline.

Our research and development expenses primarily consist of clinical and regulatory expenses, including pre-clinical and clinical trial costs and the cost of manufacturing clinical supplies. Research and development costs also consist of employee compensation, supplies and materials, consultant services, facilities, and non-cash stock-based compensation. We expense research and development costs as they are incurred. We expect our research and development expenses to increase significantly as we complete the development of our CoStar stent, research new product opportunities, conduct additional clinical trials and hire additional employees. We anticipate that the cost of completing our EuroSTAR trial will be approximately $1.0 million. If our COSTAR II trial proceeds as currently planned, we anticipate that it will cost at least $15.0 million to complete. In addition, we plan to conduct additional clinical trials using our CoStar stent as well as other drug eluting stents that we are currently developing.

Our general and administrative expenses consist primarily of compensation for executive, finance and administrative personnel and non-cash stock-based compensation. Other significant costs include professional fees for accounting and legal services, including legal services associated with our efforts to obtain and maintain protection for the intellectual property related to our stent technology. We expect our general and administrative expenses to increase substantially due to the costs associated with operating as a

publicly-traded company, costs associated with defending patent infringement claims asserted against us and the costs associated with the infrastructure necessary to support the commercialization of our product candidates.

Revenues from product sales were $1.0 million and $0 for the three months ended September 30, 2005 and 2004, respectively. Revenues from product sales were $1.4 million and $0 for the nine months ended September 30, 2005 and 2004, respectively. Product sales in 2005 were the result of shipments of our CoStar stent to our distributors. We have not generated any revenues from the sale of our UniStar stent, and prior to February 2005, we had not generated any revenues from the sale of our CoStar stent.

Cost of sales was $2.3 million and $0 for the three months ended September 30, 2005 and 2004, respectively. Cost of sales was $3.1 million and $0 for the nine months ended September 30, 2005 and 2004, respectively. During the nine months ended September 30, 2005, we began production of our CoStar stent for commercial sale. The cost of sales for the three and nine months ended September 30, 2005 is representative of the production costs and variances associated with the early commercialization of our CoStar stent. The cost of sales for the three months or nine months ended September 30, 2005 is not necessarily indicative of production costs in future periods. Prior to February 2005, we had no product shipments and no associated cost of sales.

Research and development expenses were $7.7 million and $4.6 million for the three months ended September 30, 2005 and 2004, respectively. The $3.1 million increase was primarily due to $1.7 million of higher payroll and related expenses as we increased research and development personnel, an increase of $0.8 million in non-cash non-employee stock-based compensation expenses, and higher clinical trial expenses of $0.3 million for such items as supplies, tooling, consulting and outside services.

Research and development expenses were $21.8 million and $11.9 million for the nine months ended September 30, 2005 and 2004, respectively. The $9.9 million increase was primarily due to $5.0 million of higher payroll and related expenses as we increased research and development personnel, higher clinical trial expenses of $1.9 million for such items as supplies, tooling, consulting and outside services, an increase of $1.5 million in non-cash non-employee stock-based compensation expenses, and an increase of $1.4 million in non-cash employee stock-based compensation expenses.

General and administrative expenses were $6.4 million and $2.4 million for the three months ended September 30, 2005 and 2004, respectively. The $4.0 million increase was primarily due to $2.1 million of higher expenses related to professional services for legal, audit and other consulting services, an increase of $0.7 million in trade show, promotional, franchise tax and other expenses and $0.6 million of higher payroll and related expenses as we increased management and administrative personnel.

General and administrative expenses were $16.5 million and $4.1 million for the nine months ended September 30, 2005 and 2004, respectively. The $12.4 million increase was primarily due to $5.2 million of higher expenses related to professional services for legal, audit and other consulting services, an increase of $3.3 million in non-cash employee stock-based compensation expenses, $1.7 million of higher payroll and related expenses as we increased management and administrative personnel and an increase of $1.5 million in trade show, promotional, franchise tax and other expenses.

Interest income was $0.8 million and $0.1 million for the three months ended September 30, 2005 and 2004, respectively, and $2.3 million and $0.2 million for the nine months ended September 30, 2005 and 2004, respectively. The increases in both periods were primarily due to higher cash balances resulting from our initial public offering of common stock and higher yields on our investments.

Other expense was $49,000 and $0 for the three months ended September 30, 2005 and 2004, respectively, and $0.3 million and $0 for the nine months ended September 30, 2005 and 2004, respectively. The increases in both periods were due to the currency translation adjustments when translating intercompany balances from the euro to the U.S. dollar.

We have incurred losses since our inception in October 1999, and, as of September 30, 2005, we had an accumulated deficit of $82.6 million. We have funded our operations to date principally from proceeds from our initial public offering of common stock in December 2004 and private placements of equity securities and convertible promissory notes, raising aggregate net proceeds of $162.7 million through September 30, 2005.

As of September 30, 2005, we did not have any outstanding or available debt financing arrangements, we had working capital of $91.6 million and our primary source of liquidity was $97.1 million in cash and cash equivalents. Pending their ultimate use, we currently invest our available funds in liquid money market accounts.

Net cash used in operating activities was $26.4 million during the nine months ended September 30, 2005. The net cash used during the nine months ended September 30, 2005 primarily reflected the net loss of $38.1 million, partially reduced by stock-based compensation of $9.1 million, increased accrued liabilities for legal expenses of $1.8 million, increased inventories of $1.4 million, net changes in other operating assets and liabilities of $1.2 million, depreciation of $0.7 million and increased clinical development liabilities of $0.3 million.

Net cash used in operating activities was $13.0 million during the nine months ended September 30, 2004. The net cash used during the nine months ended September 30, 2004 primarily reflected the net loss of $15.8 million, partially reduced by stock-based compensation of $2.8 million, depreciation of $0.2 million and net changes in operating assets and liabilities of $0.2 million.

Net cash used in investing activities increased to $3.1 million for the nine months ended September 30, 2005, from $1.1 million for the nine months ended September 30, 2004, primarily as a result of increased purchases of property and equipment.

Net cash provided by financing activities for the nine months ended September 30, 2005 was $9.0 million, primarily due to the net proceeds we received from the sale and issuance of shares of our common stock upon the exercise of the over-allotment option by the underwriters of our initial public offering in January 2005. Net cash provided by financing activities for the nine months ended September 30, 2004 was $39.2 million, primarily due to the net proceeds we received from the sale and issuance of our Series E convertible preferred stock.

As of September 30, 2005, we had not recognized a significant amount of revenue from commercial product sales and we had not achieved profitability. We anticipate that we will continue to incur net losses for the next several years as we develop new products, expand our clinical development team and corporate infrastructure and prepare for the potential broader commercialization of our CoStar stent. We expect that our research and development and general and administrative expenses will continue to increase and, as a result, we will need to generate significant product revenues or raise additional capital to achieve profitability.

We do not expect to generate significant product sales until we successfully obtain marketing approval for and begin selling our CoStar stent in the European Community. We believe that our cash and cash equivalent balances as well as the interest we earn on these balances and revenues from future product sales will be sufficient to meet our anticipated cash requirements through at least the first half of 2007. If our available cash and cash equivalents are insufficient to satisfy our liquidity requirements, or if we develop additional products, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity and debt securities may result in additional dilution to our stockholders. If we raise additional funds through the issuance of debt securities, these securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on reasonable terms, if at all. If we are unable to obtain additional financing, we may be required to liquidate some or all of our assets or reduce the scope of, delay or eliminate some or all of our planned research, development and commercialization activities, which could harm our business.

We anticipate spending at least $16.0 million over the next two years for clinical trials to obtain regulatory approvals of our CoStar stent. We estimate that the development of any new product candidates will cost between $15.0 million and $25.0 million per product candidate and will take up to four years to complete. We expect to fund the development of potential product candidates with our existing cash and cash equivalent balances or with cash received from sales of our securities.

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

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

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

On February 1, 2005, Angiotech Pharmaceuticals, Inc. and Boston Scientific Corporation (as Angiotech’s licensee) initiated legal proceedings against us in the District Court in the Hague, Netherlands seeking a declaration that our CoStar stent infringes Angiotech’s patent rights. In the suit, Angiotech and Boston Scientific are also seeking orders, among other things, preventing us from commercializing our CoStar stent in many European countries and requiring us to pay damages. Also, on November 8, 2005, Boston Scientific and Boston Scientific Scimed, Inc. (Scimed) initiated legal proceedings against us in the District Court for the District of Delaware seeking a judgment that our CoStar stent infringes U.S. Patent No. 5,922,021, one of the Jang patents assigned to Boston Scientific. In the suit, Boston Scientific and Scimed are also seeking orders, among other things, preventing us from commercializing our CoStar stent in the United States and requiring us to pay damages. Based on the prolific litigation that has occurred in the stent industry and the fact that we may pose a competitive threat to some large and well-capitalized companies who own or control patents relating to stents and their use, manufacture and delivery, we believe that it is highly likely that additional third parties will assert patent infringement claims against the manufacture, use or sale of our CoStar stent. A number of these patents are owned by very large and well-capitalized companies that are active participants in the stent market, such as Johnson & Johnson, Boston Scientific and Guidant Corporation. Several of these third-party patents have been or are being asserted in litigation against purported infringers, including against us, demonstrating a willingness by the patent owners to litigate their claims. Any lawsuit could seek to enjoin, or prevent, us from commercializing our CoStar stent and may seek damages from us, and would likely be expensive for us to defend. We have also received letters from third parties, some of whom have been actively involved in coronary stent litigation, asserting that they may have rights to patents that are relevant to our operations or our stent platform and requesting the initiation of discussions. A court may determine that these patents are valid and infringed by us. A finding that we infringe any valid claim in a patent held by a third party would have a material adverse effect on our results of operations, financial condition and liquidity, and we may, among other things, be required to:

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

The following table summarizes our outstanding contractual obligations as of September 30, 2005 and the effect those obligations are expected to have on our liquidity and cash flows in future periods (in thousands):

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

In February 2005, we entered into a ten-year operating lease, which has an option for an additional ten years, for manufacturing facilities in Athlone, Ireland. Total future minimum lease payments are $3.3 million. The lease payments for our facilities in Ireland are denominated in euros and have been converted into U.S. dollars using the exchange rate in effect as of September 30, 2005.

In March 2005, we entered into an amendment of the lease agreement for our current headquarters in Menlo Park, California. The amendment provides for an additional 26,000 square feet of space in a building adjacent to our current headquarters and extends the term of our lease for an additional year to August 2008. Total future minimum lease payments are $2.0 million.

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

Under SFAS No. 123R, we must determine the appropriate fair value model and related assumptions to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition methods include modified prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS No. 123R, while the retroactive method would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. We are currently evaluating the requirements of SFAS No. 123R as well as option valuation methodologies related to its employee and director stock options and employee stock purchase plan. Although we have not yet determined the method of adoption or the effect of adopting SFAS No. 123R, it is expected that the adoption of SFAS No. 123R will have a material impact on our consolidated results of operations. The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will

depend on, among other things, the levels of share-based payments granted in the future, the method of adoption and the option valuation method used. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption.

In June 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”), a replacement of APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 changes the requirements related to accounting for and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle and changes required by a new accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. Under SFAS No. 154, we must record the impact of a change in accounting principle retrospectively to financial statements of prior periods. Previously, the guidance allowed the recording of the impact of an accounting change in the current period’s net income as a cumulative effect adjustment. SFAS No. 154 is effective for us beginning January 1, 2006. The adoption of SFAS No. 154 is not expected to have a material impact on our consolidated earnings, financial position or cash flows.

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

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

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

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

A number of these patents are owned by very large and well-capitalized companies that are active participants in the stent market, such as Boston Scientific Corporation, Johnson & Johnson and Guidant Corporation. Several of these third-party patents have been or are being asserted in litigation against purported infringers, including against us, demonstrating a willingness by the patent owners to litigate their claims. On February 1, 2005, Angiotech Pharmaceuticals, Inc. and Boston Scientific (as Angiotech’s licensee) initiated legal proceedings against us in the District Court in the Hague, Netherlands seeking a declaration that our CoStar stent infringes European Patent No. 0 706 376 B1, one of the Hunter patents owned by Angiotech and licensed to Boston Scientific. In the suit, Angiotech and Boston Scientific are also seeking orders, among other things, preventing us from commercializing our CoStar stent in many European countries and requiring us to pay damages. Also, on November 8, 2005, Boston Scientific and Boston Scientific Scimed, Inc. (Scimed) initiated legal proceedings against us in the District Court for the District of Delaware seeking a judgment that our CoStar stent infringes U.S. Patent No. 5,922,021, one of the Jang patents assigned to Boston Scientific. In the suit, Boston Scientific and Scimed are also seeking orders, among other things, preventing us from commercializing our CoStar stent in the United States and requiring us to pay damages. We are unable to predict the outcome of these legal proceedings. Based on the prolific litigation that has occurred in the stent industry and the fact that we may pose a competitive threat to other large and well-capitalized companies who own or control patents relating to stents and their use, manufacture and delivery, we believe that it is highly likely that additional third parties will assert patent infringement claims against the manufacture, use or sale of our CoStar stent based on one or more of these or other patents. We have also received letters from third parties who have intellectual property rights in, or who have been actively involved in litigation or oppositions relating to, coronary stents, asserting that they may have rights to patents that are relevant to our operations or our stent platform and requesting the initiation of discussions. Any lawsuit could seek to enjoin, or prevent, us from commercializing our CoStar stent and may seek damages from us, and would likely be expensive for us to defend. A court may determine that these patents are valid and infringed by us. For a description of patents that we consider to pose a material litigation risk to us, see the discussion under the caption “Business-Patents and Proprietary Rights-Third-Party Patent Rights” in our Annual Report on Form 10-K for the year ended December 31, 2004, filed with the SEC on March 31, 2005. There may be patents in addition to those described under that caption that relate to aspects of our technology and that may materially and adversely affect our business. Moreover, because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that pose a material risk to us.

The stent and related markets have experienced rapid technological change and obsolescence in the past, and our competitors have strong incentives to stop or delay the introduction of new products and technologies. Some of the companies in these markets, such as Boston Scientific, Johnson & Johnson and Guidant, have been able to capture significant market share by introducing new technologies. These companies have maintained their position in the market by, among other things, establishing intellectual property rights relating to their products and enforcing these rights aggressively against their competitors and potential new entrants into the market. All of the major companies in the stent and related markets, including Boston Scientific, Johnson & Johnson, Guidant and Medtronic Inc., have been repeatedly involved in patent litigation relating to stents since at least 1997. Ongoing patent litigation includes litigation between Boston Scientific and Johnson & Johnson relating to Boston Scientific’s drug eluting stent and Johnson & Johnson’s drug eluting stent. Each company is claiming that the other company infringes its intellectual property. We may pose a competitive threat to many of the companies in the stent and related markets. Accordingly, many of these companies, especially Boston Scientific and others against which we would compete directly, have a strong incentive to take steps, through patent litigation or otherwise, to prevent us from commercializing our CoStar stent and as indicated above, Angiotech and Boston Scientific have initiated legal proceedings in the Netherlands against us seeking to prevent us from commercializing our CoStar stent in certain European countries, and Boston Scientific and Boston Scientific Scimed have initiated legal proceedings in Delaware against us seeking to prevent us from commercializing our CoStar stent in the United States. Boston Scientific also owns a series of patents, known as the “Kunz” patents, which cover the use of paclitaxel to treat restenosis generally and also to treat restenosis via a stent. It is possible that Boston Scientific could assert a patent infringement claim against us based on these patents.

Angiotech is the owner of a number of patents, sometimes referred to as the “Hunter” patents, and has licensed from the U.S. government a number of other patents, sometimes referred to as the “Kinsella” patents, that also claim the use of paclitaxel coated stents to treat angiogenesis and restenosis. Angiotech granted an exclusive license to Boston Scientific under these patents in the coronary vascular field of use. The legal proceedings initiated by Angiotech and Boston Scientific against us in the Netherlands allege that the CoStar stent infringes one of the Hunter patents.

Boston Scientific owns other patents that may have a material adverse affect on us. These include the “Jang” stent structure patents, including patents with claims covering a stent with a plurality of cavities which are micro-holes or micro-slits which act as reservoirs for a substance and claims covering an expandable stent having expansion columns and connecting strut columns. The legal proceedings initiated by Boston Scientific and Boston Scientific Scimed against us in Delaware allege that our CoStar stent infringes one of the Jang patents.

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

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

Whether we would, upon commercialization, infringe any patent claim will not be known with certainty unless and until a court interprets the patent claim in the context of litigation. If an infringement allegation is made against us, we may seek to invalidate the asserted patent claim and/or to allege non-infringement of the asserted patent claim. In Europe, individual country laws control the standard for patent invalidation, and the burden of proof to invalidate a particular claim can vary among countries. In order for us to invalidate a U.S. patent claim, we would need to rebut the presumption of validity afforded to issued patents in the United States with clear and convincing evidence of invalidity, which is a high burden of proof. In February 2005, we initiated legal proceedings in the High Court of Justice in the United Kingdom requesting that the court invalidate EP 0 706 376 B1, which is one of the Hunter patents owned by Angiotech and licensed to Boston Scientific that is the subject of the legal proceedings asserted against us in the Netherlands. The trial began on October 4, 2005, and the High Court of Justice is expected to hear the parties’ closing arguments in mid December 2005. We anticipate that the High Court of Justice will deliver its decision in early 2006. We are unable to predict the outcome of these proceedings.

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

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

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

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

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

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

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

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

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

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

If third parties file patent applications or are issued patents claiming technology also claimed by us in pending applications, we may be required to participate in interference proceedings with the U.S. Patent Office or in other proceedings outside the United States, including oppositions, to determine priority of invention or patentability. For example, we have filed an application seeking to provoke an interference with a patent owned by MicroCHIPS, Inc. with claims directed to an implantable stent having reservoirs and a system for releasing drugs contained in the reservoirs, as the priority date of the MicroCHIPS patent is after the priority date of our patent. Even if we are successful in these proceedings, we may incur substantial costs, and the time and attention of our management and scientific personnel will be diverted in pursuit of these proceedings.

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

We have invested all of our product development time and resources in our drug eluting stent technology, which we have commercialized initially in the form of our CoStar stent in certain countries in Asia and Latin America. We do not anticipate that the commercialization of our CoStar stent in these countries will provide us with significant revenues. We anticipate that in the near term our ability to generate meaningful revenues will depend solely on the receipt of regulatory approval and successful

commercialization of our CoStar stent in major markets. If we are not successful in the completion of clinical trials for the approval and commercialization of our CoStar stent, we may never generate any meaningful revenues and may be forced to cease operations. Although we are investigating the potential applicability of our stent technology to the treatment of an acute myocardial infarction, or AMI, we do not expect to seek regulatory approval of this product candidate for many years, if at all.

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

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

We do not have the necessary regulatory approvals to market our CoStar stent or any other product in the United States or in any foreign market. The regulatory approval process for our CoStar stent involves, among other things, successfully completing clinical trials and obtaining FDA approval of a premarket approval application, or PMA, and obtaining equivalent foreign market approvals, including taking the steps necessary for our CoStar stent to bear CE marking in the European Community. We cannot assure you that we will obtain the necessary regulatory approvals to market our CoStar stent in the United States or abroad. No regulatory approval is currently required to market our CoStar stent in the countries in which we are currently commercializing our CoStar stent. However, the Indian Ministry of Health has indicated that it will adopt a regulatory framework for medical devices in India. While Indian Ministry of Health officials continue to debate the framework to be adopted, our distributor’s ability to commercialize the CoStar stent in India has been limited. We believe that receiving CE Mark for the CoStar stent may reduce these limitations. However, if we are required to obtain some form of license or regulatory approval in addition to CE Mark from Indian regulatory agencies, our distributor’s ability to commercialize in India may be limited until such license or regulatory approval is obtained.

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

If our pre-clinical tests or clinical trials for our CoStar stent or other product candidates do not meet safety or efficacy endpoints, our ability to commercialize our CoStar stent or other product candidates and our financial position will be substantially impaired.

Before marketing our CoStar stent or any other product candidate, we must successfully complete pre-clinical studies and clinical trials that demonstrate that the product is safe and effective. Product development, including pre-clinical studies and clinical testing, is a long, expensive and uncertain process and is subject to delays. It may take us several years to complete our testing, if at all, and a clinical trial may fail at any stage. If our pre-clinical studies and clinical trials fail to demonstrate that our product candidates are safe and effective, our ability to commercialize our product candidates will be substantially impaired.

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

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

The results of these prior trials may not be indicative of the behavior of, and therefore the clinical results we will obtain with, our CoStar stent in our U.S. pivotal clinical trial. If results at least as favorable as the results observed in our prior trials are not observed in our U.S. pivotal clinical trial, our commercialization efforts will be delayed or halted and our business may be harmed.

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

The clinical results that we have reported to date are limited to four- and twelve-month follow-up data from our PISCES study, six- and twelve-month follow-up data from the first arm of our EuroSTAR trial, six-month follow-up data from the second arm of our EuroSTAR trial and four- and twelve-month follow-up data from our COSTAR I trial. Our U.S. pivotal clinical trial, COSTAR II, will require at least eight-month follow-up data. While the stainless steel, paclitaxel eluting stent has shown favorable results after twelve months in our PISCES study and our CoStar stent has shown favorable results after twelve months in our COSTAR I trial and in the first arm of our EuroSTAR trial, it is possible that the long-term results we obtain with our CoStar stent in our U.S. pivotal clinical trial may not show similar effectiveness. In addition, any pre-clinical or clinical tests may fail to produce results satisfactory to the FDA or foreign regulatory authorities.

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

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

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

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

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

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

Our U.S. pivotal clinical trial of our CoStar stent could be significantly delayed or harmed if we experience problems with the stent to be used in the control group for this trial. We plan to use Boston Scientific’s TAXUS^™ Express²^™ stent as the control stent in our U.S. pivotal clinical trial. In July 2004, Boston Scientific announced the recall of approximately 85,000 TAXUS^™ Express²^™ stent systems and approximately 11,000 Express²^™ stent systems due to characteristics in the delivery catheters that have the potential to impede balloon deflation during a coronary angioplasty procedure. In August 2004, Boston Scientific announced that it would recall an additional 3,000 TAXUS^™ Express²^™ stents. If during the enrollment and treatment period for our U.S. pivotal clinical trial, there is a recall of the control stent or the control stent is removed from the market, our trial would likely be substantially delayed. In addition, if certain sites decide not to participate or to cease participation in the trial because of a determination not to use the control stent, our U.S. pivotal clinical trial may be delayed. The FDA could also require us to redesign the trial based on an alternative control stent. Any significant delay or redesign would significantly delay and potentially impair our ability to commercialize our CoStar stent in the U.S.

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

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

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

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

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

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

We rely on third parties to supply us with the critical components used in our CoStar stent. Phytogen International LLC, which had been our sole supplier of paclitaxel, is operating under Canadian bankruptcy protection. If we are unable to obtain paclitaxel from Phytogen as a result of the bankruptcy proceedings, or for any other reason, or if Phytogen’s supplies do not meet quality or other specifications, the commercialization of our CoStar stent could be prevented or delayed. We have obtained paclitaxel from another qualified supplier, but we have not yet used it for commercial production. If we obtain market approval for our CoStar stent, we anticipate that we will require substantially larger quantities of paclitaxel. Our suppliers my not provide us with sufficient quantities of paclitaxel that meet quality and other specifications, and we may not be able to locate alternative suppliers of paclitaxel in a timely manner or on commercially reasonable terms, if at all.

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

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

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

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

In order to produce our CoStar stent in the quantities that we anticipate will be required to meet our distributors’ forecasts, we have increased, or “scaled up,” the production process by a significant factor over the previous level of production. If the scaled-up production process is not efficient or produces stents that do not meet quality and other standards, our future gross margins may decline. In addition, if we obtain regulatory approval for our CoStar stent and are unable to manufacture sufficient quantities of our CoStar stent to meet market demand, our revenues, business and financial prospects would be adversely affected.

In addition, while we have validated our manufacturing process for consistency, we experience variability within and between manufacturing lots. Manufacturing lot variability may result in unfavorable clinical results.

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

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

Completion of our clinical trials and commercialization of our product candidates require access to, or the development of, manufacturing facilities that meet applicable regulatory standards to manufacture a sufficient supply of our products. While our manufacturing facility in Ireland has received the requisite foreign regulatory approval, the FDA must also approve the facilities that manufacture our products for U.S. commercial purposes, as well as the manufacturing processes and specifications for the product. Suppliers of components of, and products used to manufacture, our products must also comply with FDA and foreign regulatory requirements, which often require significant time, money and record-keeping and quality assurance efforts and subject us and our suppliers to potential regulatory inspections and stoppages. Our suppliers may not satisfy these requirements. If we or our suppliers do not achieve required regulatory approval for our manufacturing operations, our commercialization efforts could be delayed, which would harm our business and our results of operations. In addition, from time to time, suppliers are required to provide information to, and answer questions of, the regulatory authorities. If our suppliers are unable to satisfactorily respond to the regulatory authorities’ requests for information, we may experience delays in obtaining, or may not obtain, regulatory approvals for our product candidates.

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

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

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

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

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

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

The availability and levels of reimbursement by governmental and other third-party payors affect the market for our product candidates. The efficacy, safety, performance and cost-effectiveness of our product candidates and of any competing products will determine the availability and level of reimbursement. If we are not able to obtain an adequate level of reimbursement for our product candidates by U.S. government sponsored healthcare or private insurance, the U.S. market may be much smaller than we expect. In

addition, reimbursement and healthcare payment systems in international markets vary significantly by country, and include both government sponsored healthcare and private insurance. To obtain reimbursement or pricing approval in some countries, we may be required to produce clinical data, which may involve one or more clinical trials, that compares the cost-effectiveness of our products to other available therapies. We may not obtain international reimbursement or pricing approvals in a timely manner, if at all. Our failure to receive international reimbursement or pricing approvals would negatively impact market acceptance of our products in the international markets in which those approvals are sought. Although we recently launched our CoStar stent in certain countries in Asia and Latin America, these countries do not currently have a reimbursement infrastructure, and we do not anticipate that the commercialization of our CoStar stent in these markets will provide us with significant revenues.

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

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

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

If our CoStar stent is approved for commercial sale in the United States, we currently plan to establish our own sales force to market it in the United States. If we develop our own marketing and sales capabilities, our sales force will be competing with the experienced and well-funded marketing and sales operations of our competitors. Developing a sales force is expensive and time consuming and could delay or limit the success of any product launch. We may not be able to develop this capacity on a timely basis or at all. If we are unable to establish sales and marketing capabilities, we will need to contract with third parties to market and sell our CoStar stent in the United States. To the extent that we enter into arrangements with third parties to perform sales, marketing and distribution services in the United States, our product revenues could be lower than if we directly marketed and sold our CoStar stent, or any other drug delivery device that we may develop. Furthermore, to the extent that we enter into co-promotion or other marketing and sales arrangements with other companies, any revenues received will depend on the skills and efforts of others, and we do not know whether these efforts will be successful. Some of our existing or future distributors may have products or product candidates that compete with ours, and they may have an incentive not to devote sufficient efforts to marketing our products. For example, Biotronik AG, with whom we have an agreement that primarily covers European distribution, is developing an absorbable magnesium alloy stent. If we are unable to establish and maintain adequate sales, marketing and distribution capabilities, independently or with others, we may not be able to generate product revenue and may not become profitable.

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

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

We face competition from established pharmaceutical and biotechnology companies, as well as from academic institutions, government agencies and private and public research institutions in the United States and abroad. Our principal competitors have significantly greater financial resources and expertise in research and development, manufacturing, pre-clinical testing, conducting clinical trials, obtaining regulatory approvals and marketing approved products than we do. For example, Johnson & Johnson and Boston Scientific, two companies with far greater financial and marketing resources than we possess, have both developed, and are actively marketing, drug eluting stents which have been approved by the FDA. In addition, Medtronic Inc. recently announced that it received CE Mark approval for commercial sale of its Endeavor^™ drug eluting coronary stent in European Community member countries. We may be unable to demonstrate that our CoStar stent offers any advantages over Johnson & Johnson’s CYPHER^™ stent, Boston Scientific’s TAXUS^™ Express²^™ stent or Medtronic’s Endeavor^™ stent. In addition, in September 2005, Boston Scientific announced that it had received CE Mark approval for commercial sale of its Liberte^™ paclitaxel eluting coronary stent system. Boston Scientific has stated that the TAXUS^™ Liberte^™ stent system is designed to further enhance deliverability and conformability, particularly in challenging lesions. Many other large companies, including Guidant Corporation and Abbott Laboratories, among others, are developing drug eluting stents. Guidant has announced that it has completed enrollment in its SPIRIT II and has enrolled more than 400 patients in its SPIRIT III clinical trials evaluating the safety and efficacy of its drug eluting stent system. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with, or mergers with or acquisitions by, large and established companies or through the development of novel products and technologies. For example, Biosensors International Group, Ltd. announced that its Netherlands-based subsidiary, Occam International B.V., received CE Mark approval for the Group’s paclitaxel eluting stent, Axxion.

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

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

We do not have the ability to independently conduct clinical trials for our product candidates, and we must rely on third parties, such as contract research organizations, medical institutions, clinical investigators and contract laboratories to conduct our clinical trials. In addition, we rely on third parties to

assist with our pre-clinical development of product candidates. If these third parties do not successfully carry out their contractual duties or regulatory obligations or meet expected deadlines, if these third parties need to be replaced or if the quality or accuracy of the data they obtain is compromised due to the failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our pre-clinical development activities or clinical trials may be extended, delayed, suspended or terminated, and we may not be able to obtain regulatory approval for or successfully commercialize our product candidates on a timely basis, if at all. Furthermore, our third-party clinical trial investigators may be delayed in conducting our clinical trials for reasons outside of their control. For instance, one of our competitors is a major supplier of the intravascular ultrasound, or IVUS, catheters used in our clinical trials to measure percent volume obstruction, or the volume of the lumen, or the inner channel of the artery through which blood flows, in the stent occupied by restenotic tissue. If the supply of IVUS catheters to our clinical trial sites is interrupted, our clinical trials may be delayed or terminated.

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

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

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

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

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

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

We intend to market our products in international markets and recently began commercializing our CoStar stent in certain countries in Asia and Latin America. Although no regulatory approval is currently required to market our CoStar stent in these countries, we must obtain regulatory approvals to market our products in the European Community and many other foreign jurisdictions. In addition, countries that do not currently require regulatory approval to market our products may in the future require regulatory approval. The approval procedure varies among countries and can involve additional testing, and the time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory approval process may include all of the risks associated with obtaining FDA approval in addition to other risks. We may not obtain foreign regulatory approvals on a timely basis, if at all. Approval by the FDA does not ensure approval by regulatory authorities in other countries, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or by the FDA. We may not be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products in any market.

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

We have a limited operating history. As of September 30, 2005, we had an accumulated deficit of $82.6 million. We have incurred net losses in each year since our inception in 1999. We expect to continue to incur operating losses, in the aggregate and on a per share basis, for the next several years. These losses, among other things, have had and will continue to have an adverse effect on our stockholders’ equity, net current assets and working capital.

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

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

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

We believe that our cash and cash equivalent balances, as well as the interest we earn on these balances and revenues from future product sales will be sufficient to meet our anticipated cash requirements through at least the first half of 2007. However, our future funding requirements will depend on many factors, including:

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

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

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

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

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

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

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

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

Our current distribution agreement with Biotronik AG provides for payments to us in euros. In addition, we have established a manufacturing facility in Ireland, for which we incur expenses, including construction expenses, rental payments and employee salaries, denominated in euros. Our contracts for conducting certain of our clinical trials in Europe are also denominated in euros. Accordingly, if the euro strengthens against the U.S. dollar, our expenses related to our foreign clinical trials and Ireland facilities will increase, and if the U.S. dollar strengthens against the euro, our payments from Biotronik, if any, will decrease.

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

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

In both the United States and certain foreign jurisdictions, there have been a number of legislative and regulatory proposals to change the regulatory and healthcare systems in ways that could impact our

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

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

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

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

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

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

Our research and development activities involve the controlled use of hazardous chemicals. Our operations also produce hazardous waste products. We are subject to a variety of federal, state and local regulations relating to the use, handling, storage and disposal of these materials. We generally contract with third parties for the disposal of such substances. We cannot eliminate the risk of accidental contamination or injury from these materials. We may be required to incur substantial costs to comply with current or future environmental and safety regulations. If an accident or contamination occurred, we would likely incur significant costs associated with civil penalties or criminal fines and in complying with environmental laws and regulations. We do not have any insurance for liabilities arising from hazardous materials. Compliance with environmental laws and regulations is expensive, and current or future environmental regulation may impair our research, development or production efforts.

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

We are evaluating our internal control over financial reporting in order to allow management to report on, and our independent registered public accounting firm to attest to, our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002 and the rules and regulations of the SEC, which we collectively refer to as Section 404. We are currently in the process of evaluating our current systems and processes and implementing new systems and processes and conducting the testing required in an effort to comply with the management assessment and auditor certification requirements of Section 404, which will initially apply to us as of December 31, 2005. In the course of our ongoing Section 404 evaluation, we have identified and continue to identify areas of internal controls that may need improvement, and we have instituted and continue to institute remediation efforts where necessary. However, we are still in the evaluation process, and we may identify conditions that may result in significant deficiencies or material weaknesses in the future. If we determine that we do not have adequate internal control over financial reporting, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404. If we cannot favorably assess, or our independent registered public accountants are unable to provide an unqualified attestation report on our assessment of, and on the effectiveness of our internal control over financial reporting, investor confidence in the reliability of our financial reports may be adversely affected, which could have a material adverse effect on our stock price.

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

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

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

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

Our executive officers, current directors and holders of five percent or more of our common stock, as of September 30, 2005, beneficially owned approximately 36.4% of our common stock. The interests of these stockholders may be different than the interests of other stockholders on these matters. This concentration of ownership could also have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could reduce the price of our common stock.

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

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

There are many events that may influence the market price for our common stock, including:

In addition, from time to time, we publicly announce (including in this Quarterly Report on Form 10-Q) the estimated timing of the accomplishment of various clinical, regulatory and other product development goals, which we sometimes refer to as milestones. These milestones include the enrollment of patients in our clinical trials, the release of data from our clinical trials and other clinical and regulatory events, including the submission to the FDA of a PMA for our CoStar stent and the receipt of CE Mark. If we do not achieve our projected development goals in the time frames we announce and expect, our stock price may decline. A decline in the market price of our common stock could cause you to lose some or all of your investment and may adversely impact our ability to attract and retain employees and raise capital. In addition, stockholders may initiate securities class action lawsuits if the market price of our stock drops significantly, which may cause us to incur substantial costs and could divert the time and attention of our management.

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

If our existing stockholders sell a large number of shares of our common stock or the public market perceives that existing stockholders might sell shares of our common stock, the market price of our common stock could decline significantly. As of October 31, 2005, we had 33,672,487 outstanding shares of common stock. Of these shares, all of the 6,900,000 shares sold in our initial public offering were freely tradeable without restriction or further registration unless purchased by our affiliates. Of the remaining 26,772,487 shares of common stock outstanding as of October 31, 2005, 26,224,840 shares were

immediately eligible for sale in the public market, subject in some cases to the volume, manner of sale and other limitations under Rule 144 or Rule 701 and vesting in the case of early exercised options; and 547,647 shares will become eligible for sale in the public market under Rule 144 from time to time upon expiration of their respective holding periods.

We have filed a registration statement covering the shares of common stock that are authorized for issuance under our stock option plans and employee stock purchase plan, which can be freely sold in the public market upon issuance, subject to restrictions on our affiliates. In addition, certain holders of our common stock that are parties to our investor rights agreement have rights with respect to the registration of their shares of common stock with the Securities and Exchange Commission. If we register their shares of common stock, these holders can immediately sell their shares in the public market without restriction.

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

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

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

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

The primary objective of our investment activities is to preserve our capital for the purpose of funding operations while at the same time maximizing the income we receive from our investments without significantly increasing risk. To achieve these objectives, our investment policy allows us to maintain a portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds and corporate debt securities. Our cash and cash equivalents as of September 30, 2005 included liquid money market accounts. Due to the short-term nature of these investments, we believe that there is no material exposure to interest rate risk.

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

Evaluation of disclosure controls and procedures. Based on their evaluation as of September 30, 2005, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) were effective to ensure, at the reasonable assurance level, that the information required to be disclosed by us in the reports that we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Changes in Internal Control over Financial Reporting. We are currently in the process of evaluating our current internal controls systems and processes, implementing new internal controls systems and processes and conducting the testing required in an effort to comply with the management assessment and auditor certification requirements of Section 404, which will initially apply to us as of December 31, 2005. In the course of this ongoing Section 404 evaluation, during the quarter ended September 30, 2005, we identified areas of internal controls that may need improvement, and we instituted remediation efforts where necessary. Changes in our internal control over financial reporting in connection with the implementation of new systems and processes and the remediation efforts are reasonably likely to materially affect our internal control over financial reporting.

During the three months ended September 30, 2005, there were no material developments in the litigation previously disclosed under Part II, Item 1 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, filed with the SEC on May 16, 2005 and under Part I, Item 3 of our Annual Report on Form 10-K for the year ended December 31, 2004, filed with the SEC on March 31, 2005.

On November 8, 2005, Boston Scientific and Boston Scientific Scimed, Inc. (Scimed) initiated legal proceedings against us in the District Court for the District of Delaware seeking a judgment that our CoStar stent infringes U.S. Patent No. 5,922,021, one of the Jang patents assigned to Boston Scientific. In the suit, Boston Scientific and Scimed are also seeking orders, among other things, preventing us from commercializing our CoStar stent in the United States and requiring us to pay damages. We are unable to predict the outcome of these proceedings.

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

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

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


CONOR MEDSYSTEMS, INC.

By:		/s/ MICHAEL BOENNIGHAUSEN
		Michael Boennighausen
		Vice President, Finance and
		Administration and Chief Financial Officer
		(Duly Authorized and Principal Financial
		and Accounting Officer)


PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements	3

	Condensed Consolidated Balance Sheets	3

	Condensed Consolidated Statements of Operations	4

	Condensed Consolidated Statements of Cash Flows	5

	Notes to Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	42

Item 4.	Controls and Procedures	42

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	43

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43

Item 6.	Exhibits	43

SIGNATURE		45


	September 30, 2005			December 31, 2004
	(unaudited)			(Note 1)
Assets
Current assets:
Cash and cash equivalents	$	97,142		$	117,676
Accounts receivable		986			—
Inventories		1,541			53
Prepaid expenses and other current assets		1,125			1,039

Total current assets		100,794			118,768
Property and equipment, net		4,182			1,716
Restricted cash		172			170
Other assets		795			235

Total assets	$	105,943		$	120,889

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	3,301		$	1,961
Accrued compensation		1,825			892
Accrued clinical development liabilities		1,009			729
Accrued legal expenses		1,795			12
Other accrued liabilities		1,066			422
Deferred rent		65			124
Liability for early exercise of stock options - current portion		105			107

Total current liabilities		9,166			4,247
Liability for early exercise of stock options		172			251

Commitments and contingencies (Notes 1 and 3)

Stockholders’ equity:
Common stock; $0.001 par value; 150,000 shares authorized at September 30, 2005 and December 31, 2004; 33,285 and 31,961 shares issued and outstanding at September 30, 2005 and December 31, 2004, respectively		33			32
Additional paid-in-capital		196,901			186,269
Accumulated other comprehensive income/(loss)		122			(32	)
Deferred stock compensation		(17,805	)		(25,367	)
Accumulated deficit		(82,646	)		(44,511	)

Total stockholders’ equity		96,605			116,391

Total liabilities and stockholders’ equity	$	105,943		$	120,889


	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
Product sales	$	1,045		$	—		$	1,369		$	—
Cost of sales		2,303			—			3,144			—

Gross profit		(1,258	)		—			(1,775	)		—
Operating expenses:
Research and development (1)		7,722			4,620			21,828			11,877
General and administrative (1)		6,375			2,383			16,544			4,101

Total operating expenses		14,097			7,003			38,372			15,978

Loss from operations		(15,355	)		(7,003	)		(40,147	)		(15,978	)
Interest income		841			119			2,309			215
Other expense		(49	)		—			(297	)		—

Net loss		(14,563	)		(6,884	)		(38,135	)		(15,763	)
Accretion to redemption value of redeemable convertible preferred stock		—			(833	)		—			(2,434	)
Deemed dividend upon issuance of Series E convertible preferred stock		—			(23,435	)		—			(23,435	)

Net loss attributable to common stockholders	$	(14,563	)	$	(31,152	)	$	(38,135	)	$	(41,632	)

Basic and diluted net loss per share attributable to common stockholders	$	(0.44	)	$	(8.22	)	$	(1.16	)	$	(11.29	)

Shares used to compute basic and diluted net loss per share attributable to common stockholders		33,170			3,789			32,903			3,687


(1) Includes non-cash stock-based compensation expense as follows:
Research and development	$	1,536			578		$	3,820		$	931
General and administrative		1,756			1,501			5,317			1,868

Total	$	3,292		$	2,079		$	9,137		$	2,799


	Nine Months Ended September 30,
	2005			2004
Operating activities
Net loss	$	(38,135	)	$	(15,763	)

Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		683			155
Amortization of deferred stock compensation		7,147			2,489
Loss on disposal of property and equipment		66			16
Stock compensation expense for consulting services		1,990			310
Accrued interest income on notes receivable		—			(5	)
Forgiveness of officer loan receivable		—			111
Changes in operating assets and liabilities:
Prepaid expenses and other current assets		(87	)		(602	)
Accounts receivable		(1,028	)		—
Inventories		(1,447	)		—
Other assets		(560	)		(151	)
Accounts payable		1,374			588
Accrued compensation		944			89
Accrued clinical development liabilities		280			(74	)
Other accrued liabilities		2,440			(157	)
Deferred rent		(59	)		22

Net cash used in operating activities		(26,392	)		(12,972	)

Cash flows from investing activities:
Transfers to restricted cash		(2	)		(32	)
Capital expenditures		(3,109	)		(1,076	)

Net cash used in investing activities		(3,111	)		(1,108	)

Financing activities:
Proceeds from issuance of common stock, including early exercise of stock options		8,977			334
Proceeds from issuance of redeemable convertible preferred stock, net		—			38,910

Net cash provided by financing activities		8,977			39,244

Effect of exchange rate changes on cash and cash equivalents		(8	)		—

Net (decrease) increase in cash and cash equivalents		(20,534	)		25,164
Cash and cash equivalents at beginning of period		117,676			22,389

Cash and cash equivalents at end of period	$	97,142		$	47,553

Supplemental schedule of noncash transactions
Accretion to redemption value of redeemable convertible preferred stock	$	—		$	2,434

Deferred stock compensation, net of terminations	$	(723	)	$	26,561

Deemed dividend to redeemable convertible preferred stockholders	$	—		$	23,435


	September 30, 2005		December 31, 2004
Raw materials	$	472	$	53
Work in progress		1,066		—
Finished goods		3		—

Total Inventory	$	1,541	$	53


Years ending December 31,
2005 (remainder of year)	$	295
2006		1,077
2007		981
2008		808
2009		346
Thereafter		1,796

	$	5,303


	Total		Payments due by period
	Total		Less than 1 Year		1-3 Years		3-5 Years		More than 5 Years
Operating Leases	$	5,303	$	1,120	$	1,952	$	663	$	1,568


Exhibit Number		Description of Document

3.1(1)		Amended and Restated Certificate of Incorporation.

3.2(2)		Amended and Restated Bylaws.

4.1		Reference is made to Exhibits 3.1 and 3.2.

4.2(3)		Form of Common Stock Certificate.

10.38(4)		Form of Executive Change of Control Severance Agreement, dated September 27, 2005, by and between the Registrant and each of Azin Parhizgar, Ph.D. and Michael Boennighausen.

10.39(4)		Letter agreement, dated September 27, 2005, by and between the Registrant and Frank Litvack, M.D.

10.40(4)		Chief Executive Change of Control and Severance Agreement, dated September 27, 2005, by and between the Registrant and Frank Litvack, M.D.


31.1		CEO Certification required by Rule 13a-14(a) or Rule 15d-14(a).

31.2		CFO Certification required by Rule 13a-14(a) or Rule 15d-14(a).

32.1(5)		Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350).