BUSINESS

Overview

      We design and manufacture proprietary automated anastomotic systems used by surgeons to perform coronary artery bypass surgery. In coronary artery bypass grafting procedures, or CABG, veins or arteries are used to construct alternative conduits to restore blood flow beyond narrowed or occluded portions of coronary arteries, “bypassing” the narrowed or occluded portion of the artery that is impairing blood flow to the heart muscle. Our first two products, the C-Port ^® Distal Anastomosis System, referred to as the C-Port system, and the PAS-Port ^® Proximal Anastomosis System, referred to as the PAS-Port system, provide cardiovascular surgeons with easy-to -use automated systems to perform consistent, rapid and reliable connections, or anastomoses, of the vessels, which surgeons generally view as the most critical aspect of the bypass procedure. We received 510(k) clearance from the FDA to market our C-Port system in the United States in November 2005. We currently sell both the C-Port system and the PAS-Port system in Europe, and we sell the PAS-Port system in Japan through our distributor, Century Medical, Inc., referred to as Century. Our strategy is to further enhance and leverage our technology to develop additional automated anastomotic systems that facilitate the performance of minimally invasive endoscopic coronary bypass surgery, as well as automated systems to be used in other surgical applications, such as vascular closure.

      The current method of performing an anastomosis in a CABG procedure utilizes a tedious and time-consuming hand-sewn suturing technique to connect a bypass graft to the aorta at one end, the proximal end, and to a small-diameter coronary artery at the other end, the distal end. We estimate that approximately 1.2 million of these blood vessel connections are performed annually in the United States. Proper vessel alignment and suture tension among the many individually placed fine stitches are critical for optimal bypass graft blood flow and function. By replacing the hand-sewn sutures with an easy-to -use, highly reliable and consistent automated system, the time required for completing the anastomoses can be reduced. We believe that our automated systems can also improve the quality and consistency of the anastomoses, which we believe will ultimately contribute to improved patient outcomes.

      Our C-Port system is used to perform a distal anastomosis, which is the connection of a bypass graft vessel to the coronary artery downstream of the narrowed or occluded coronary artery. The C-Port system received the CE Mark in April 2004, which is required for marketing in the European Union, and 510(k) clearance from the FDA in November 2005, which is required for marketing in the United States. The C-Port system is currently being sold on a limited basis to selected customers in Europe. We are currently training physicians in the United States to use our C-Port system, and we plan to commence sales in the United States later this year. As of September 30, 2005, we had sold over 250 C-Port systems internationally. In addition, we are currently designing the next iteration of our C-Port system intended for use in endoscopic coronary bypass surgery.

      Our PAS-Port system is used to perform a proximal anastomosis, which is the connection of a bypass graft vessel to the aorta, the source of blood for the bypass. The PAS-Port system received the CE Mark in March 2003 and regulatory approval from Japanese regulatory authorities in January 2004 for distribution in Japan. The PAS-Port system is being sold in Japan through Century. According to Century, the PAS-Port system has been used in Japan in over 130 hospitals and has an estimated 15% market share of all proximal anastomoses performed in beating heart surgery using a vein as the bypass graft. As of September 30, 2005, more than 2,400 PAS-Port systems had been sold in Europe and Japan. We have recently obtained conditional approval of an Investigational Device Exemption, referred to as an IDE, from the FDA to perform a randomized, prospective clinical trial in centers in the United States and in Europe to study the safety and efficacy of the PAS-Port system.

Industry Background

          Coronary Artery Disease

      According to the American Heart Association, approximately 13.2 million Americans have coronary artery disease, and approximately 653,000 people in the United States die each year as a result of the disease. Coronary artery disease, sometimes referred to as atherosclerosis, is a degenerative disease resulting from the

deposit of cholesterol and other fatty materials on the interior walls of blood vessels, forming a build-up known as plaque. The accumulation of plaque, usually over decades, causes the vessel to become inelastic and progressively narrows the interior of the artery, impairing its ability to supply blood and oxygen to the heart muscle. When there is insufficient blood flow to the heart muscle, an injury may occur, often resulting in chest pain, or angina, a heart attack or even death. Coronary artery disease is caused by aging and is exacerbated by dietary and environmental factors, as well as by genetic predisposition. As a patient ages, the disease will typically advance and become more diffuse, compromising the coronary artery system more globally and occluding more small-diameter vessels.

Current Treatment Alternatives for Coronary Artery Disease

      Physicians and patients may select among a variety of treatments to address coronary artery disease, with the selection often depending upon the stage and severity of the disease and the age of the patient. In addition to changes in patient lifestyle, such as smoking cessation, weight reduction, diet changes and exercise programs, the principal existing treatments for coronary artery disease include the following:

          Medical Treatment with Pharmaceuticals

      Before the advent of interventional cardiology or bypass surgery, medical treatment with pharmaceuticals was the only form of therapy available to patients with coronary heart disease. In patients with less severe disease, pharmaceuticals remain the primary treatment approach and include drugs such as platelet adhesion inhibitors or drugs that reduce the blood cholesterol or triglyceride levels. The objective for medical treatment with pharmaceutical agents is to reduce the incidence, progression or exacerbation of coronary artery disease and its associated symptoms. For more serious disease, however, pharmacological therapy alone is often inadequate.

          Interventional Cardiology Techniques

      Coronary Angioplasty. Percutaneous transluminal coronary angioplasty, commonly referred to as balloon angioplasty, is a surgical procedure that involves the dilation of the obstructed artery with a balloon catheter. To perform an angioplasty, the surgeon maneuvers a flexible balloon catheter to the site of the blockage in the coronary artery, inflates the balloon, compressing the plaque and stretching the artery wall to create a larger channel for blood flow. The balloon is then deflated and removed. Angioplasty is generally successful in increasing immediate blood flow and, relative to current surgical procedures, offers the benefits of shorter periods of hospitalization, quicker recovery times, reduced patient discomfort and lower cost. However, angioplasty does not always provide prolonged efficacy: independent studies indicate that 25% to 40% of vessels treated with balloon angioplasty return to their pre-treatment, narrowed size, a process known as restenosis, within six months following the procedure. Restenosis is primarily the result of cell proliferation in response to the “injury” caused by the angioplasty procedure.

      Stents. High rates of restenosis following treatment by balloon angioplasty led to the introduction of stents, mesh-like metallic tubes that are placed within the narrowed portion of the coronary vessel to hold the vessel open after the angioplasty balloon has been removed. Although clinical outcomes for procedures using stents reflect an improvement over balloon angioplasty alone, the effectiveness of stents is still limited by restenosis, which occurs in about 10% to 35% of cases within six months of the procedure.

      Recently, some manufacturers have introduced drug-eluting stents, which incorporate, on the surface of the stent, specially formulated, slow-release drugs designed to prevent restenosis. According to published studies, currently marketed drug-eluting stents have been shown in clinical trials to reduce the rate of restenosis, within the first nine months after placement, to less than 10%. Market adoption of drug-eluting stents has been rapid, and industry observers predict that drug-eluting stents will capture approximately 90% of the stent market within three years.

      Despite the advancements and market success of drug-eluting stents and angioplasty therapies, these interventional procedures may be less effective than CABG in addressing diffuse progressive coronary artery disease. In this advanced stage of coronary artery disease, intervention is required for multiple vessels, many of

which are less than two millimeters in internal diameter, a diameter unsuited for angioplasty and stenting. In addition, stents have been shown to be difficult to place in patients with coronary lesions in sections with vessel branches and in patients with narrowings in the left main coronary artery.

      Bypass Surgery. CABG involves the construction of an alternative path to bypass a narrowed or occluded coronary artery and restore blood flow from the aorta to an area past the occlusion. This procedure can be accomplished using either veins or arteries as bypass grafts. Veins are typically harvested from the patient’s leg, while arteries are taken from either the patient’s arm (radial artery) or chest wall (mammary artery). One end of the harvested vessel is then generally attached to the aorta for blood inflow, and the opposite end is attached to the target coronary vessel. If a mammary artery is used as the bypass graft, it must be dissected from the chest wall, leaving one end in place, while the opposite end is attached to the target vessel, providing uninterrupted blood flow from the arterial circulation. Once in place, these grafts provide sufficient blood flow to bypass the narrowed or occluded portion of the coronary artery. (See Figure Below).

      Over the last decade approximately 90% of patients undergoing first time CABG surgery received a mammary artery as a bypass graft vessel, a graft that does not require a proximal anastomosis, in addition to other bypass grafts such as veins and radial arteries. When the left anterior descending or LAD, artery is obstructed, CABG is most commonly performed by grafting the left internal mammary artery, or LIMA, to the LAD. When other coronary arteries are obstructed, saphenous vein grafts are typically used as the bypass vessel. A study shows that patients who undergo a CABG procedure typically receive at least three bypass grafts, of which we believe a majority are performed using one artery and two veins as the bypass graft vessels.

      Although CABG surgery is generally a highly invasive and even traumatic procedure, an independent study comparing CABG and implantation of conventional stents has shown that CABG is the more effective treatment for coronary artery disease, achieving the best long-term patient outcomes as measured by survival rate and need for intervention. Studies have shown that following CABG, grafts can remain patent, or open, and functional for as long as 10 years in approximately 50% of venous grafts and approximately 90% of arterial grafts. In addition, CABG procedures can be used to treat diffuse, end-stage coronary artery disease states that are not amenable to treatment by angioplasty or stents.

      According to an independent analysis by Medtech Insight, a division of Windhover Information, entitled “Emerging U.S. Markets for Myocardial Revascularization, Repair, and Regeneration Products and Technologies,” dated November 2004, an estimated 260,000 CABG procedures will be performed in 2005 in the United States, as compared to approximately 280,000 procedures in 2004. We believe that the decrease in CABG procedures is primarily attributable to the increase in other interventional cardiology procedures, including the

increased use of drug-eluting stents. The average CABG surgery requires approximately three bypass grafts per patient, and a majority of grafts require an anastomotic connection at both ends of the graft. Assuming an average of approximately five anastomoses per CABG procedure, we estimate that approximately 1.2 million of these blood vessel connections are performed in connection with CABG procedures annually in the United States. We believe approximately two-thirds of the procedures are performed using veins as the bypass graft.

Types of CABG Procedures

      There are currently three types of CABG, two of which are commonly performed:

      Conventional On-Pump CABG Procedures. Conventional on-pump CABG procedures are particularly invasive and traumatic to the patient, typically requiring the surgeon to open the patient’s chest cavity by splitting the sternum and to place the patient on a pump to circulate the blood throughout the body. Redirecting the blood flow to a pump enables the surgeon to clamp the aorta and stop the heart, which results in a motionless and bloodless field in which the surgeon can perform the difficult and tedious task of manually suturing the small vessels to one another. The absence of blood flow and motion are important factors in ensuring precision and providing positive clinical outcomes; however, the use of a pump for circulation exposes the patient’s blood to foreign surfaces, which has been shown to increase the incidence of bleeding and short-term neurocognitive defects. Additionally, stopping the heart may result in impairment or damage to the heart muscle. Moreover, clamping of the aorta has been shown, in clinical studies, to cause the release of particles into the blood stream that may produce blockages in other parts of the body, such as the brain. Blockages in the brain can lead to neurological damage, including strokes. Clamping the aorta also carries the risk of injury to the vessel wall with later bleeding complications. Notwithstanding these potential problems the majority of CABG procedures performed today use this on-pump technique.

      Off-Pump CABG Procedures. In 1995, a new method of performing CABG was introduced that avoids the use of external pumps, requiring the surgeon to perform the anastomosis while the heart is beating. The clinical literature suggests that this procedure, termed off-pump coronary artery bypass, or OPCAB, offers several benefits, including reductions in bleeding, kidney dysfunction, short-term neurocognitive dysfunction and length of hospital stay. OPCAB is currently used in approximately 25% of all CABG procedures performed in the United States.

      Notwithstanding these advantages, the technical challenges inherent in OPCAB have impeded its widespread adoption. Because the patient’s heart is beating during the procedure, the surgeon is required to perform the delicate anastomosis on a target vessel, which could be as narrow as one millimeter in internal diameter, while the vessel is moving with each heart contraction. The technical demands of the procedure, together with the longer learning curve required to achieve surgical proficiency, may also initially adversely affect long-term graft patency and completion of revascularization. In addition, surgeons will still typically be required to place a partially occluding clamp on the ascending aorta to hand suture the proximal vein graft anastomosis. As a result, even in OPCAB procedures, patients still face the risk of the serious adverse effects associated with the application of aortic clamps.

      Minimally Invasive Endoscopic Procedures. Recently, a very small number of CABG procedures have been performed using minimally invasive endoscopic procedures to reduce patient trauma. In this approach, the sternum is left intact and the surgery is performed through small access ports. The anastomoses are performed on selected, readily reachable vessels using special surgical instruments, and this procedure requires special surgical skills. Although endoscopic procedures offer the promise of faster post-operative patient recovery times, rapid ambulation, long-term graft patency and a low incidence of adverse outcomes, there are a number of challenges to wide-scale realization of that potential, in particular, the absence of a method to enable surgeons to perform reproducible and effective anastomoses that can be rapidly deployed through small incisions. Currently, it is estimated that fewer than 3% of CABG patients are eligible for minimally invasive endoscopic techniques.

          Surgical Techniques for Anastomoses

      The current method of performing anastomoses, the most critical aspect of CABG procedures, typically employs tedious and time-consuming hand-sewn placement of individual stitches with a continuous suture to

connect the bypass graft to the aorta or coronary vessels. Conventional anastomosis can require ten to 25 minutes to suture, depending upon the size of the vessels. Proper vessel alignment and suture tension among the many individually placed fine stitches are critical for optimal bypass graft blood flow and function. Furthermore, long-term clinical outcomes may be improved if the anastomosis is “compliant,” that is, if its shape and size can adapt to changes in flow and blood pressure by placement of many single sutures rather than one continuous suture. However, most surgeons prefer the use of a continuous suture because placement of individual sutures may be more technically challenging and time-consuming. Whether the surgeon elects to operate on the patient on- or off-pump, a hand-sewn proximal anastomosis generally requires clamping of the aorta and therefore carries with it the risk of neurological damage and other serious adverse effects. Recently, new technology has been introduced that allows the surgeon to perform hand-sewn proximal anastomoses to the aorta without clamping of the aorta. These facilitating devices temporarily cover the opening in the aortic wall from the inside while the surgeon places the stitches to create the anastomosis and are removed after the anastomosis has been completed to allow blood flow into the bypass graft. We believe these systems, in their current implementations, are not suitable for endoscopic bypass surgery.

      The laborious and time-consuming nature of manually applied sutures and the limitations associated with their use, together with advances occurring in coronary surgical procedures, have fueled the need for easy-to -use, fast and highly reliable automated systems to expedite and standardize the performance of anastomoses in CABG procedures. Although a number of companies have attempted to develop automated systems to perform anastomoses, to date only one system, which is for use in performing a proximal anastomosis, is currently commercially available in the United States.

Our Solutions

      We design and manufacture proprietary automated anastomotic systems used by surgeons to perform anastomoses during on- or off-pump CABG procedures. We believe that by enabling consistent and reliable anastomoses of the vessels at this most critical step in CABG surgery through a fast, automated process, our products can improve the quality and consistency of these anastomoses, which we believe will ultimately contribute to improved patient outcomes. We have designed our products to meet the needs of surgeons, including:

Our Strategy

      Our goal is to become the leading provider of automated anastomotic systems for cardiac bypass surgeries. Although CABG may offer the most effective treatment for many patients with coronary artery disease, patients are often deterred by the invasiveness and trauma associated with the procedure. As a result, some patients may opt to accept less invasive procedures, such as balloon angioplasty and coronary stent implantation, even though the procedure may result in a less favorable outcome for that patient. For CABG to be a more attractive treatment alternative, surgeons must strive to decrease the invasiveness and trauma associated with current procedures by introducing endoscopic or keyhole surgery for CABG, similar to the success seen in laparoscopic or arthroscopic procedures over the past decade. However, for endoscopic CABG to be widely adopted, several challenges must be overcome, including, most significantly, the development and successful implementation of innovative technology that safely accomplishes the most critical step in this procedure, the anastomosis. We believe that our anastomotic technology will become a key enabling technology for endoscopic CABG.

      We believe we must follow a step-by-step process of technology development and market introduction to achieve our goals. In the first step, we must show strong clinical evidence that our products are safe and effective in an open chest setting, an environment in which the surgeon currently feels most comfortable. Anastomotic systems are disruptive technology and, to gain the trust and confidence of cardiac surgeons, we must carefully familiarize them with these systems. If we are successful in this first step of the process and the surgical community has started to adopt this technology in open chest surgery, the second step would involve introducing follow-on products that have been tested in a closed chest setting and have incorporated all the features necessary to safely and effectively perform this type of procedure.

      The principal elements of our strategy to achieve our vision and goals include:

Our Products

      We have developed three proprietary systems to perform anastomoses, the C-Port system, the C-Port xA Distal Anastomosis System, or C-Port xA system, and the PAS-Port system. The C-Port system automates a distal anastomosis between the graft vessel and target artery. This system has been studied using veins rather than arteries as the graft vessel and has received FDA 510(k) clearance for the creation of anastomoses between grafts and target vessels generally. The C-Port xA system, developed as an iteration of the C-Port system, has been studied in animals using veins and arteries as the bypass graft vessel, and we have submitted a 510(k) application for the C-Port xA system in December 2005. The PAS-Port system automates the performance of a proximal anastomosis between a graft vessel, typically a saphenous vein, and the aorta. A study shows that patients who undergo a CABG procedure typically receive at least three bypass grafts, of which we believe a majority are performed using one artery and two veins as the bypass graft vessels.

           C-Port ^® Distal Anastomosis System

      Our C-Port system, which may be used in either on- or off-pump CABG procedures, is designed to perform an end-to -side distal anastomosis by attaching the end of a bypass vein graft to a coronary artery downstream of an occlusion or narrowing. The system uses miniature stainless steel staples to securely attach the bypass graft to the coronary artery. As depicted in Figure 2, the individually placed staples inserted by the C-Port system mimic individual sutures, expeditiously and easily creating a compliant anastomosis. In contrast to a non-compliant hand-sewn anastomosis using a continuous suture, the compliant nature of the C-Port anastomosis potentially allows the anastomosis to adapt to changes in blood flow or pressure. Our C-Port system is effective in creating compliant anastomoses in vessels as small as one millimeter in internal diameter. In addition, the C-Port system has been designed to:

      In preparing to deploy the C-Port system, the surgeon cuts the end of the bypass graft as he would for a hand-sewn anastomosis and attaches the graft to four hooks situated on the base of the cartridge. The surgeon then creates a small incision in the target coronary artery and inserts the anvil, a small metal structure of one millimeter diameter. Pressing the button on the C-Port system handle, the surgeon lowers the cartridge with the graft attached onto the target coronary artery and then deploys the staples through the graft and coronary artery against the anvil. The staples are formed on the anvil surface, joining the coronary artery and graft. In addition, a small knife located inside the anvil is released to cut the coronary artery from the inside out to create an opening in the coronary wall through which the blood can flow. Following completion of the anastomosis, the surgeon removes the anvil from the coronary artery and manually stitches the small opening initially created to insert the anvil.

      The C-Port system is currently approved for use in Europe, and in November 2005, we received 510(k) clearance to market the C-Port system in the United States.

      Figure 3: C-Port xA Anastomosis System

      The C-Port xA system is our next-iteration C-Port system. We have applied for 510(k) clearance of the C-Port xA system for the same intended use as the C-Port system. The C-Port xA system features several modifications designed to improve the safety and reliability of the system, including a change from a spring-driven to a gas release-driven stapling mechanism, optimizing the staple configuration to further stabilize the graft; incorporation of non-traumatic vessel clamps to better position the graft vessel for anastomosis; and incorporation of safety mechanisms to minimize the chance of unintentional staple deployment. The C-Port xA

system is also designed to deploy more staples around the periphery of the anastomosis than the original C-Port system to help ensure leak-proof sealing without the need for additional stitches at either end of the anastomosis, as may currently be required with the C-Port system.

           PAS-Port ^® Proximal Anastomosis System

      Our PAS-Port system is a fully automated device used to perform an end-to -side proximal anastomosis between a saphenous vein and the aorta. To complete a proximal anastomosis, the cardiac surgeon simply loads the bypass graft vessel into the PAS-Port system, places the end of the delivery device against the aorta and turns the knob on the opposite end of the delivery tool. The device first creates an opening in the aorta and subsequently securely attaches the bypass graft to the aortic wall, using a medical grade stainless steel implant that is formed into its final shape by the delivery tool. The innovative design of the PAS-Port system allows the surgeon to load the bypass graft and rapidly complete the anastomosis, typically in approximately three minutes, with little or no injury to the bypass graft vessel or the aorta.

      An important advantage of our PAS-Port system is that, in contrast to conventional hand-sewn proximal anastomoses, the vascular connections created can be performed without clamping the aorta, potentially avoiding the associated risks such as neurological complications. Surgeons use our PAS-Port system in conventional CABG procedures and in OPCAB. While we are not aware of any patients who required additional surgery to correct leakage from an anastomosis performed with our PAS-Port system, the design of the PAS-Port requires an additional stitch intra-operatively to obtain hemostasis (absence of bleeding in the anastomosis site) in approximately 5% to 10% of the deployments. Additional stitches may be required intra-operatively in an individual anastomosis depending on the quality of the target and graft vessels, adequacy of target site preparation and quality of the loading of the graft to the deployment cartridge. We will be working on adaptations to the PAS-Port system for use in endoscopic applications.

      The PAS-Port system is approved for sale and marketed in Europe and Japan. As of September 30, 2005, over 2,400 PAS-Port systems had been sold, primarily in Japan. In addition, we have recently obtained conditional approval from the FDA for an Investigational Device Exemption to conduct a prospective, randomized, multi-center and multi-national clinical trial to evaluate the safety and efficacy of the PAS-Port system.

Future Product Programs

      Our product research and development efforts are focused on building innovative devices that enhance our current products or leverage our core competency in mechanical clip formation for applications in endoscopic

CABG and other medical fields. We currently have active programs to design and develop the following products:

      Figure 6: C-Port Flex A Anastomosis System

      The C-Port Flex A Anastomosis System, or the C-Port Flex A system, includes modifications to the C-Port xA system that are designed to enable automated anastomoses to be performed as part of robot-facilitated CABG procedures. The C-Port Flex A system includes all the features and benefits of the C-Port xA system and has a flexible, rather than rigid, shaft. The flexible shaft is designed to allow the working end of the device that creates the anastomosis to be inserted through a 12-millimeter diameter port to access the chest cavity and heart. The device would then be loaded with the bypass graft vessel inside or outside the chest cavity and deployed to create the anastomosis to the coronary artery. This product is designed to enable technology for completion of robotically assisted, including endoscopic, CABG surgery through four or five relatively small incisions between the ribs. Avoiding both the incision through the sternum and the use of a pump should significantly reduce patient trauma and accelerate post-operative recovery. We are currently conducting preclinical animal-model studies with the C-Port Flex A, supported in part by a grant from the NIH.

      We believe that our proprietary technology used in our automated vascular anastomosis systems may provide an innovative, simple mechanical solution to close the vascular access sites used in interventional vascular procedures. We are currently designing the X-Port ^tm Vascular Access Closure Device, or X-Port, to address this clinical need.

      Similar to our other products, the X-Port consists of a deployment tool and a vascular clip. At the end of an interventional vascular procedure, the surgeon would insert the deployment tool into a standard introducer sheath and then simply press a button to deploy a micro-stainless steel clip over the opening in the vessel wall, sealing off the vascular access site.

      Currently, vascular closure is accomplished by one of two methods, manual compression or alternative vascular closure devices. Simple manual compression, the most frequently used method of closure, is a time-consuming process that requires the patient to lie flat while pressure is manually applied directly to the access site for an average of 25 minutes. Once this initial period of compression is completed, the patient must continue to remain immobile for up to another four to 24 hours, depending upon the amount of anticoagulant drug therapy used during and after the procedure. Manual compression causes patient discomfort, is resource intensive and can increase the duration of the patient’s hospitalization. As a result, a variety of devices have been developed and commercialized to replace manual compression. Most of these products substantially decrease the duration of hospitalization, time to ambulation and, in most instances, patient discomfort.

      It is estimated that approximately 8.5 million diagnostic and interventional catheterization procedures will be performed worldwide in 2005. In each of these procedures, the access site must be closed by one of these closure methods. It is estimated that in approximately 45% of these patients a device is employed. The

worldwide market for femoral artery closure devices is estimated to be approximately $500 million in 2005 and is estimated to increase to approximately $790 million by 2008.

      We have targeted this rapidly growing market because we believe that, by integrating many of the desired features into a single product, the X-Port, if it is successfully developed and receives regulatory clearance or approval, may be well-positioned to outperform existing vascular access closure devices. The X-Port is designed to have the following advantages:

      We are currently conducting preclinical animal-model studies of the X-Port to assess its safety and efficacy.

Agreement with Cook Incorporated

      On December 9, 2005, we entered into an agreement with Cook Incorporated, or Cook, to develop the X-Port. Under the agreement, we and Cook will jointly develop the X-Port, under the direction of a Development Committee that includes representatives from each party. Cook receives an exclusive, worldwide, royalty-bearing license, with the right to grant sublicences, to make, have made, use, sell, offer for sale and import the X-Port for medical procedures in any part of the body. The parties may also agree to perform research on the product in new formats, in which case Cook would reimburse us for work we perform in connection with such research.

      We will receive an initial payment of $500,000 after we complete, to Cook’s satisfaction, certain tasks under an agreed upon development plan. Cook will also pay us up to a total of an additional $1.5 million in the form of milestone payments that become due upon achievement of certain development milestones. Additionally, we will receive a royalty based on Cook’s annual worldwide sales of the X-Port. This royalty is reduced if Cook sells a designated number of product units per calendar year for a defined period of time, and may also be reduced if patents are not issued covering the product in certain countries within a defined period of time. Certain minimum royalty payments are required under the agreement, which may be reduced during time periods in which certain product improvements are being developed because product sales are unexpectedly low for reasons other than Cook’s failure to commercialize diligently the product.

      Cook must use commercially reasonable efforts to develop a production version of the product, and to apply for a CE mark and for FDA approval of the product, at its own expense. Additionally, Cook must use commercially reasonable efforts to commercialize the product following regulatory approval. We must supply a certain number of product units for Cook’s use in development of the product. Cook has the right to manufacture the product during later stages of development, and has the obligation to supply the product for commercial purposes. The term of the agreement will expire on December 9, 2025, subject to renewal by mutual agreement between Cook and us. Cook may terminate the agreement for convenience at any time, and either party may terminate the agreement for uncured material breach by the other party.

      If the agreement is terminated either by Cook for convenience, or by us for Cook’s material breach, then Cook must pay to us a pro-rated payment for work performed by us under the development plan prior to such termination, not to exceed an amount equal to the milestone payments made during the term of the agreement plus $300,000. Additionally, in such case, Cook must transfer to us certain technology and regulatory filings and assist us in other respects to enable us to develop, manufacture and commercialize the product, and Cook agrees not to sue us under certain intellectual property rights as necessary to allow us to continue, on our own or with or through third parties, to make, use, sell, offer for sale and import the product anywhere in the world for use in medical procedures in the body. In such case, for five years after such termination (unless a court does not determine that our termination for Cook’s breach was proper), Cook cannot grant to any competitor of ours a license under Cook’s intellectual property rights to facilitate the competitor in making, using, selling, offering for

sale or importing the X-Port or any improvement anywhere in the world for use in medical procedures in the body.

      If Cook terminates the agreement for our breach after it has paid to us all of the milestone payments, then Cook’s license survives such termination, subject to its continuing obligation to pay royalties to us. If Cook terminates the agreement for material breach by us in failing to meet any of the milestones defined in the agreement, then we must repay the initial fee and the milestone payments, less certain costs we incurred in developing the product.

      Cook has the first right to enforce the X-Port intellectual property against third parties, and Cook bears all expenses associated with such enforcement unless we choose to participate. We may undertake such enforcement if Cook permits us to do so. In the event that a third party takes legal action to assert intellectual property rights against us and/or Cook with regard to the X-Port product, then Cook may offset against the total royalty payment due to us a portion of any monies expended by Cook in defending against the action.

Clinical Trial Summary and Timeline

      The C-Port system received the CE Mark in April 2004 and the PAS-Port system received the CE Mark in March 2003. The PAS-Port system also received regulatory approval to be sold in Japan in January 2004. We plan to submit the C-Port xA for regulatory approval in Europe and Japan as well.

           United States

      We commenced our European pivotal clinical trial to study our PAS-Port system in 2002. In 2001 and 2002, the FDA approved two proximal anastomosis devices for sale in the United States, the Symmetry system developed by St. Jude Medical and the CorLink system developed by Bypass, Inc. and Johnson & Johnson. The design of the pivotal clinical trial for the PAS-Port was based on the trial designs of these two predicate devices. We submitted the results of our pivotal clinical trial for the PAS-Port system to the FDA in an application for 510(k) clearance in 2003. After receiving reports of apparently device-related adverse events with the Symmetry device, the FDA revisited the criteria for a 510(k) clearance of subsequent anastomosis products. The FDA sponsored a special panel meeting on March 19, 2004 to redefine objective performance criteria for safety and efficacy of anastomosis products, which are significantly more rigorous than when we submitted our data. Following redefinition of the objective performance criteria, we resubmitted pooled data from two trials evaluating safety and efficacy of the PAS-Port system to the FDA. In April of 2005, the FDA asked the Circulatory System Devices Panel to consider the data submitted on the PAS-Port system. The panel concurred that vascular anastomotic devices have great potential and the data regarding the PAS-Port system looked promising. The majority of panel members, however, believed that more robust data were required. Following this recommendation from the panel, we withdrew our 510(k) submission. To collect data to address the new criteria, we obtained a conditional approval of an Investigational Device Exemption, or IDE, for a new randomized prospective clinical trial to be conducted in the United States and Europe.

      We commenced our pivotal clinical trial to study our C-Port system in 2003 and submitted the data from this trial in an application for 510(k) clearance in 2004. We received 510(k) clearance from the FDA to market the C-Port system in the United States in November 2005. In December 2005, we submitted an application for 510(k) clearance of the C-Port xA system using the C-Port as a predicate device.

      The C-Port system pivotal trial was designed to prospectively assess the safety and effectiveness of the C-Port system in creating an anastomosis between a coronary artery and a vein graft harvested from the patient. The primary effectiveness endpoint was angiographic evidence of patency at six months and absence of major adverse cardiac events, or MACE, at one year.

      Patient enrollment for the C-Port system pivotal clinical trial began in July 2003. Ultimately, 133 patients met the criteria for enrollment in this multi-center, prospective, non-randomized clinical trial conducted in four hospitals in Germany and one hospital in Switzerland. In this study, surgeons successfully used the C-Port system for anastomosis for 113, or approximately 85%, of these patients. Of the remaining 20 patients, three died for reasons that were unrelated to the device, 16 were converted to hand-sewn anastomoses, and the coronary target vessel for one patient was deemed unsuitable after intra-operative site assessment. Intra-operative conversion to a hand-sewn anastomosis was necessary for 16 grafts due to a variety of factors. We believe inadequate target site preparation and excessive coronary wall thickness (> 0.75 mm) were responsible for the need to convert to hand-sewn anastomoses for seven patients, inadequate site preparation was responsible for the need to convert to hand-sewn anastomoses for five patients, inadequate inter-operative coronary run-off was responsible for the need to convert to hand-sewn anastomoses for three patients (including two exhibiting inadequate flow), and excessive graft thickness (> 1.4 mm) was responsible for the need to convert to hand-sewn anastomosis for one patient. We do not believe any of the conversions were directly or indirectly associated with C-Port device use or failures. In 45 of these patients (40%), the C-Port systems were used in small diameter coronary arteries with an internal diameter of 1.5 millimeters. At six and 12 months following the surgical procedure involving the C-Port system, 105 patients and 107 patients, respectively, were available for clinical follow-up. Graft patency was assessed angiographically prior to discharge and again at six months following the procedure. The six-month assessment indicated patent grafts in 92.1% of the patients assessed angiographically. By contrast, an analysis of published data studying hand-sewn anastomoses generally showed average patency of approximately 84% at six months following the procedure in more than 28,000 bypass grafts collectively studied. At 12 months, two of the implanted patients did not reenroll for evaluation and, of the remaining 111 patients implanted, nine had died and none of the others had suffered myocardial infarction or required revascularization of the target vessel.

      After submitting the results from the clinical trial and implementing corrections to resolve the minor mechanical reliability problems, the C-Port system received the CE Mark and was approved for sale in Europe and, in November 2005, received 510(k) clearance from the FDA for marketing in the United States.

          PAS-Port European Pivotal Trial

      The PAS-Port European pivotal trial was designed to prospectively assess the safety and effectiveness of the PAS-Port system in creating an anastomosis between an aorta and a vein graft harvested from the patient. We sought to demonstrate rates of patency at six months that were at least as favorable as those for hand-sewn anastomoses as well as absence of MACE at two years. Based on the FDA’s criteria as defined in March 2004, quantitative angiography was to be used to assess patency of grafts connected with an anastomotic device at a minimum of six months after surgery. Following March 2004, the FDA expects an average vein graft patency rate of at least 85% with a specified statistical confidence level. For the FDA’s purposes, graft patency is defined as less than 50% stenosis, or narrowing, at the site of the mechanical anastomosis, and patency must be determined by angiography and evaluated by an independent core laboratory.

      We enrolled 55 patients in this study, which commenced in June 2002. This multi-center, prospective, non-randomized clinical trial was conducted at three sites in Europe, two in Germany and one in Switzerland.

      Of the 55 patients enrolled in the study, 47 patients, or approximately 85%, were successfully implanted with an aggregate of 50 PAS-Port implants. In eight patients, the PAS-Port deployments were unsuccessful either due to technical errors with the PAS-Port or technique errors by the surgeons. Patients who were not successfully implanted with the PAS-Port device were successfully converted to hand-sewn anastomoses without compromise to long-term patient outcome.

      Graft patency was assessed angiographically prior to discharge and again at six months post-procedure. Angiograms were evaluated by a core laboratory at Stanford University Medical Center for independent analysis. The original study called for follow-up at three and six months. The study was later amended to obtain a two-year follow-up evaluation to meet FDA requirements for long-term follow-up. Clinical follow-up at three months was available on all 47 PAS-Port implanted patients, on 44 patients (93.6%) with PAS-Port implants at six months and on 42 PAS-Port implanted patients (89.4%) at two years. Angiograms were obtained at six months on 39 patients (42 PAS-Port grafts). Stress electrocardiograms, or ECG, tests were obtained at two years on 36 patients with 38 PAS-Port grafts.

      The angiographic observed rate of patency of the PAS-Port system at six months was 85.7% for the patients available for evaluation. Five patients with five PAS-Port grafts were evaluated by magnetic resonance imaging, or MRI, and these grafts were shown to be patent. Including this data, the overall patency was 87.2% at six months. At 24 months, three of the implanted patients did not reenroll for evaluation and, of the remaining 44 patients implanted, two had died, one had a myocardial infarction, and none required revascularization of the target vessel.

      This trial demonstrated favorable long-term (24-month) clinical outcomes for the patients implanted with the PAS-Port implant, including an overall patency rate after six months of 87.2%. Historical data compiled from many studies indicates a 84.1% patency rate for grafts anastomosed using hand-sewn suturing techniques and studied six months after surgery. This clinical trial also revealed minor mechanical reliability problems with the PAS-Port system that prevented successful implantation in several patients. After submitting the results from the clinical trial and implementing corrections to address the mechanical reliability problems, the product received the CE Mark and was approved for sale in Europe.

          PAS-Port II Trial

      To gain further clinical experience with the PAS-Port system, the PAS-Port device was also used in 54 of the 133 patients enrolled in the C-Port pivotal trial described above. In patients receiving more than one vein graft, the study protocol allowed usage of the PAS-Port system in additional vein grafts in which the C-Port system was not used.

      Of the patients in the C-Port pivotal trial, 50 patients were successfully implanted with an aggregate of 59 PAS-Port implants and discharged from the hospital. Clinical follow-up was available on 47 (94%) of these patients at three months and on 46 (92%) of these patients at six and 12 months. The original protocol called for follow-up at three and six months. The protocol was later amended to include a 12-month follow-up evaluation to meet FDA requirements for long-term follow-up. Angiograms were obtained at six month follow-up on

38 patients having an aggregate of 47 PAS-Port grafts. Stress ECG tests were obtained at 12 months on 42 patients (51 PAS-Port grafts).

      Angiograms were performed at six months and demonstrated average patency rates for the PAS-Port grafts of approximately 95.7%. At 12 months, two patients did not reenroll for evaluation, and of the remaining 46 patients implanted, two patients had died, three required revascularization of the target vessel and none had suffered myocardial infarction.

      Based on the PAS-Port European pivotal trial and the additional data gathered during the PAS-Port II trial, we believe we have confirmed the safety and effectiveness of the PAS-Port system; however, our data did not achieve the level of statistical confidence required to obtain FDA clearance at that time. As discussed under “Clinical Trial Summary and Timeline — Regulatory Status, United States” above, the Circulatory System Devices Panel determined that additional data is required before a conclusion as to safety and effectiveness could be formed by the FDA. We cannot assure you that additional data we obtain will be as favorable as the data discussed above or will establish the safety or efficacy of our PAS-Port system.

          Post-Marketing Surveillance

      Post-marketing studies are conducted to provide data regarding disease treatment outcomes. These studies often collect acute, procedural, safety and long-term efficacy data. Acute data from post-marketing studies on CABG procedures often describe the amount of stenosis immediately pre- and post-procedure, and provide data as to procedure-related morbidity, such as heart attack or stroke. Long-term efficacy data collected weeks, months or years after a procedure can be measured in terms of patency or re-intervention rates. Reintervention, also referred to as revascularization, rates measure the number of grafts that have required treatment within a defined period of time because of narrowing or occlusion.

      Studies are subject to a number of factors that can influence results, making it difficult to draw general conclusions. The rate of graft occlusion and the need for re-intervention may be influenced by factors unrelated to the method of treatment, such as the type of artery in which the stenosis is located or a patient’s overall health. Because of the relatively small number of treated patients, these factors can influence the meaningfulness of clinical study results. Consequently, findings from one study should not be used to predict limitations or benefits of a particular means of treatment.

      The PAS-Port system has been marketed in Europe since March 2003 and in Japan since January 2004. Since commercial launch, we have sold more than 2,400 PAS-Port systems. We have obtained data on the performance of the PAS-Port system from three different sources:

      European PAS-Port Registry. A multi-center patient registry for the PAS-Port system was compiled from data reported by five centers in Europe, which reported data on 95 patients implanted with 123 PAS-Port devices between April 2003 and March 2004. The registry was designed to collect information on the performance of the delivery system during the formation of the anastomosis and to assess any device-related adverse events in the short-term following the procedure. There were no defined exclusion criteria; therefore, this registry was conducted in a patient population that we believe had a greater extent of underlying coronary artery disease, co-existing cardiac conditions, previous coronary interventions or surgery and other adverse health factors than the patient populations in our clinical studies. Acute procedural success was demonstrated by a successful PAS-Port system deployment rate of approximately 95%. There were no reports of re-operation for revision or bleeding associated with a PAS-Port anastomosis. Average clinical follow-up in these patients was at seven months following surgery. In these follow-up evaluations, there were no PAS-Port-related patient deaths and only approximately 6.1% of grafts demonstrated stenosis or occlusion.

      Investigator-Sponsored Single Center Randomized Trial. In June 2005, data was presented at the annual meeting of the International Society for Minimally Invasive Cardiac Surgery describing results from a single

center, prospective, randomized clinical trial comparing the PAS-Port system to hand-sewn anastomosis in patients requiring CABG. The primary outcome variable in this study was one-year graft patency assessed by computer tomography. An aggregate of 99 patients were enrolled in the study, of whom 51 were enrolled to receive anastomoses performed using the PAS-Port system and 48 were enrolled to receive anastomoses completed by hand-sewn sutures. Of the 48 patients originally enrolled for hand-sewing, five patients were converted to a PAS-Port anastomosis due to presence of severely calcified aortas, which makes hand-sewing more challenging, and one PAS-Port patient was converted to a hand-sewn anastomosis. At discharge, 55 PAS-Port-implanted patients and 39 hand-sutured patients had CT scans. These scans demonstrated graft patency of 100% in PAS-Port grafts and 97.4% in hand-sewn grafts. At 12 months, the patency rates of 32 patients with PAS-Port anastomoses and 15 patients with hand-sewn anastomoses were 96.8% and 86.7%, respectively.

      Worldwide Market Survey. We performed a post-market survey with five European centers and four Japanese centers using the PAS-Port system. The primary outcome variable evaluated in this survey was the incidence of myocardial ischemia and MACE in patients with PAS-Port devices. The surgeons using the PAS-Port system were asked to submit adverse outcomes of all patients that had received a PAS-Port implant. This study included 449 patients, and 496 PAS-Port implants were successfully implanted. During the follow-up period, which was approximately one year for most patients, 11 patients died. During this follow-up period, six, or approximately 1.3% of patients returned to the treating center for evaluation of recurrent chest pain. Stress-induced myocardial ischemia detected following CABG surgery may be unrelated to any of the bypass grafts installed, or the method used to perform the anastomoses on the grafts, during surgery but rather a function of progression of the native coronary artery disease.

      We intend to continue to gather additional clinical data for our products to further support our sales and marketing efforts. We believe these studies will primarily consist of registry trials and physician-initiated studies.

Sales and Marketing

      Our initial products focus on the needs of cardiovascular surgeons worldwide. We are beginning to build a direct sales force in the United States to sell our C-Port system, which received 510(k) clearance in November 2005. Our sales force will initially target selected influential surgeons in high volume cardiac surgery centers. Approximately half of all U.S. CABG procedures are performed at 225 cardiac surgery centers. We plan to selectively target institutions within this group of centers and to conduct intensive focused marketing and training for the C-Port system and for our products that receive FDA clearance or approval in the future. Through this effort, we hope to generate wider demand for our products by training well-respected clinical supporters of our products and leveraging their reputations in the clinical community. In addition, we intend to promote our systems at major medical conventions and through other marketing efforts such as seminars, workshops, brochures and internet-based training. We will also work with our investigators to present the results of our clinical trials at cardiovascular meetings.

      We currently distribute our PAS-Port system in Japan through our exclusive distributor, Century Medical, Inc., or Century. In the fiscal year ended June 30, 2005, sales to Century comprised approximately 33% of our net revenue. Century has a direct sales organization of approximately 16 representatives who are responsible for the development of the anastomotic device market and directly contact cardiac surgeons. Century provides clinical training and support for end-users in Japan. We provide Century with promotional support, ongoing clinical training, representation at trade shows and guidance in Century’s sales and marketing efforts. Our agreement with Century expires in July 2009. The agreement renews automatically for a second five-year term if Century meets certain sales milestones. Either party may terminate this agreement if the other party defaults in performance of material obligations and such default is not cured within a specified period or if the other party becomes insolvent or subject to bankruptcy proceedings. In addition, we may terminate the agreement within 90 days following a change of control by payment of a specified termination fee.

      Guidant distributed our products in Europe under a distribution agreement that terminated in September 2004. Guidant accounted for 75% of our total revenue in fiscal year 2004 and 65% of our total revenue in fiscal year 2005. The revenue generated from the distribution agreement in Europe was $0.4 million, or 48% of fiscal year 2004 revenue, and $1.0 million, or 50% of fiscal year 2005 revenue.

      We are currently building a distribution network in Europe for both our PAS-Port and C-Port systems. We have currently engaged SIC Systems as our exclusive distributor in Italy, and we may engage additional distributors in several other European countries; however, we do not anticipate significant product sales from Europe in part because their healthcare systems are difficult to penetrate for new higher cost medical products. We are continuing to sell to selected customers and will continue to evaluate further opportunities to expand our distribution network in Europe and in other parts of the world where the healthcare economics are conducive to the introduction and adoption of new medical device technologies.

Competition

      The market for medical devices used in the treatment of coronary artery disease is intensely competitive, subject to rapid change, and significantly affected by new product introductions and other market activities of industry participants. We believe the principal competitive factors in the market for medical devices used in the treatment of coronary artery disease include:

      There are numerous potential competitors in the medical device, biotechnology and pharmaceutical industries, such as Boston Scientific Corporation, Edwards Lifesciences Corporation, Guidant Corporation, Johnson & Johnson, Inc., Medtronic, Inc. and St. Jude Medical, that are targeting the treatment of coronary artery disease broadly. Each of these companies has significantly greater financial, clinical, manufacturing, marketing, distribution and technical resources and experience than we have. In addition, new companies have been, and are likely to continue to be, formed to pursue opportunities in our market.

      The landscape of active competitors in the market for anastomotic solutions is currently limited. Medtronic, with its recent acquisition of Coalescent Surgical, obtained the only marketed proximal anastomotic system in United States, the Spyder, which deploys a series of nitinol-based U-Clips to attach a graft to the aorta. Several companies market systems designed to facilitate or stabilize proximal anastomoses, such as Guidant’s Heartstring Aortic Occluder and Novare Surgical Systems’ Enclose anastomotic assist device. St. Jude Medical previously had a commercially available proximal anastomotic system that was marketed both in the United States and Europe; however, St. Jude Medical voluntarily withdrew this product from the market in 2004. Johnson & Johnson has obtained FDA clearance for a proximal system that has been developed by Bypass Inc.

      Our C-Port system is the only automated anastomosis device for distal anastomosis cleared for marketing in the United States as of November 10, 2005. The only currently marketed facilitating device for distal anastomosis is the U-Clip, which substitutes clips for sutures, but still requires manual application of typically 12 to 14 individually placed clips per anastomosis by the surgeon.

      Currently, the vast majority of anastomoses are performed with sutures and, for the foreseeable future, sutures will continue to be the principal competitor for alternative anastomotic solutions. The sutures used for anastomoses in CABG procedures are far less expensive than automated anastomotic systems, and surgeons, who have been using sutures for their entire careers, may be reluctant to consider alternative technologies, despite potential advantages.

      In addition, cardiovascular diseases may also be treated by other methods that do not require anastomoses, including interventional techniques such as balloon angioplasty and use of drug-eluting stents, pharmaceuticals, atherectomy catheters and lasers. Further, technological advances with other therapies for cardiovascular disease such as drugs, local gene therapy or future innovations in cardiac surgery techniques could make other methods of treating this disease more effective or less expensive than CABG procedures.

      Our X-Port system, if developed and approved, would compete in the market for femoral artery closure devices. Two large competitors, St. Jude Medical and Abbott Vascular Devices, currently control over 80% of this market. St Jude Medical’s Angioseal vascular closure device, which is licensed from Kensey-Nash, is based on a collagen plug and has the leading market share. Other FDA-cleared products in this market include Abbott Vascular Devices’ suture-based Perclose and nitinol-based StarClose devices and Medtronic’s Angiolink Stapler. In addition to these large existing and potential competitors, there are a number of venture capital-backed private companies that are developing devices and technologies for this market.

Manufacturing

      Our headquarters provides space for our manufacturing operations, sterile products manufacturing, packaging, storage and shipping, as well as for our research and development laboratories and general administrative facilities. We believe that our current facilities will be sufficient to meet our manufacturing needs for at least the next two years.

      We believe our manufacturing operations are in compliance with regulations mandated by the FDA and the European Union. Our facility is ISO 13485:2003 certified. In connection with our CE mark approval and compliance with European quality standards, our facility was initially certified in June 2002 and has been inspected annually thereafter.

      There are a number of critical components and sub-assemblies required for manufacturing the C-Port and PAS-Port systems that we purchase from third-party suppliers. The vendors for these materials are qualified through stringent evaluation and monitoring of their performance over time. We audit our critical component manufacturers on a regular basis and at varied intervals based on the nature and complexity of the components they provide and the risk associated with the components’ failure.

      We use or rely upon sole source suppliers for certain components and services used in manufacturing our products, and we utilize materials and components supplied by third parties, with which we do not have any long-term contracts. In recent years, many suppliers have ceased supplying raw materials for use in implantable medical devices. We cannot quickly establish additional or replacement suppliers for certain components or materials, due to both the complex nature of the manufacturing processes employed by our suppliers and the time and effort that may be required to obtain FDA clearance or other regulatory approval to use materials from alternative suppliers. Any significant supply interruption or capacity constraints affecting our facilities or those of our suppliers would affect our ability to manufacture and distribute our products.

Third-Party Reimbursement

      Sales of medical products are increasingly dependent in part on the availability of reimbursement from third-party payors such as government and private insurance plans. Currently, payors provide coverage and reimbursement for CABG procedures only when they are medically necessary. Our technology will be used concomitantly in CABG procedures. We realize though that Cardica technologies will bring added costs to medical providers and may not be reimbursed separately by third-party payors at rates sufficient to allow us to sell our products on a competitive and profitable basis.

      We believe the majority of bypass graft patients in the United States will be Medicare beneficiaries. Further, private payors often consider Medicare’s coverage and payment decisions when developing their own policies. The Centers for Medicare & Medicaid Services, referred to as CMS, is the agency within the Department of Health and Human Services that administers Medicare and will be responsible for reimbursement decisions for the Cardica devices when used to treat Medicare beneficiaries during CABG surgery.

      Once a device has received approval or clearance for marketing by the FDA, there is no assurance that Medicare will cover the device and related services. In some cases, CMS may place certain restrictions on the circumstances in which coverage will be available. In making such coverage determinations, CMS considers, among other things, peer-reviewed publications concerning the effectiveness of the technology, the opinions of medical specialty societies, input from the FDA, the National Institutes of Health, and other government agencies. We cannot assure you that once our products are commercially available, they will be covered by Medicare and other third-party payors. Limited coverage of our products could have a material adverse effect on our business, financial condition and results of operations.

      In general, Medicare makes a predetermined, fixed payment amount for its beneficiaries receiving covered inpatient services in acute care hospitals. This payment methodology is part of the inpatient prospective payment system, or IPPS. For acute care hospitals, under IPPS, payment for an inpatient stay is based on diagnosis-related groups, or DRGs, which include reimbursement for all covered medical services and medical products that are provided during a hospital stay. Additionally, a relative weight is calculated for each individual DRG which represents the average resources required to care for cases in that particular DRG relative to the average resources required to treat cases in all DRGs. Generally, DRG relative weights are adjusted annually to reflect changes in medical practice in a budget neutral manner.

      CMS has made no decisions with respect to DRG assignment when patients undergo CABG procedures in which our products would be used, and there can be no assurance that the DRG to which such patients will be assigned will result in Medicare payment levels that are considered by hospitals to be adequate to support purchase of our products.

      Under current CMS reimbursement policies, CMS offers a process to obtain add-on payment for a new medical technology when the existing DRG prospective payment rate is inadequate. To obtain add-on payment, a technology must be considered “new,” demonstrate substantial improvement in care and exceed certain payment thresholds. Add-on payments are made for no less than two years and no more than three years. We must demonstrate the safety and effectiveness of our technology to the FDA in addition to CMS requirements before add-on payments can be made. Further, Medicare coverage is based on our ability to demonstrate the treatment is “reasonable and necessary” for Medicare beneficiaries. The process involved in applying for additional reimbursement for new medical technologies from CMS is lengthy and expensive. Our products may not be awarded additional or separate reimbursement in the foreseeable future, if at all. Moreover, many private payors look to CMS in setting their reimbursement policies and payment amounts. If CMS or other agencies limit coverage and decrease or limit reimbursement payments for hospitals and physicians, this may affect coverage and reimbursement determinations by many private payors.

      Medicare policies allow Medicare contractors discretion to cover items involving Category B investigational devices. However, even with items or services involving Category B devices, Medicare coverage may be denied if any other coverage requirements are not met, for example if the treatment is not medically necessary for the specific Medicare beneficiary. In our conditionally approved IDE, the PAS-Port system has been classified by the FDA as a Category B1 device. To that end, the five planned U.S. investigational sites for our upcoming trial may be able to seek specific CMS reimbursement for use of the PAS-Port.

      For classification of physician services, the American Medical Association, referred to as the AMA, has developed a coding system known as the Current Procedural Terminology, or CPT. CPT codes are established by the AMA and adopted by the Medicare program in the Healthcare Common Procedure Coding System, to describe and develop payment amounts for physician services. Physician services are reimbursed by Medicare based on a physician fee schedule whereby payment is based generally on the number of “relative value units” assigned by CMS to the service furnished by the physician. No decision has been made concerning whether existing CPT codes would be appropriate for use in coding anastomosis procedures when our products are used or if new CPT codes and payment are required. We cannot assure you that codes used for submitting claims for anastomosis procedures using our products will result in incremental payment to physicians. CPT codes are used by many other third-party payors in addition to Medicare. Failure by physicians to receive what they consider to be adequate reimbursement for anastomosis procedures in which our products are used could have a material adverse effect on our business, financial condition and results of operations.

Research and Development

      As of November 30, 2005, we had 16 employees in our research and development department. We currently have a preclinical program to develop smaller devices designed for endoscopic use and for use with automated surgical robotic systems. Future research and development efforts will involve continued enhancements to and cost reductions for our current C-Port and PAS-Port systems. We are also exploring the development of other products that can be derived from our core technology platform and intellectual property. Research and development expenses for fiscal years ended June 30, 2003, 2004 and 2005 were $6.7 million, $5.8 million and $6.3 million, respectively. In August, 1999, we entered into a Sponsored Research Agreement with Stanford University to study the efficacy of our products in-vivo in Stanford’s animal lab. The original expiration date of the Agreement was June 15, 2000, and the agreement has been amended to extend the study through December 31, 2006. The total cost of the agreement to us is projected to be approximately $1.2 million, of which we have already paid approximately $1.0 million as of September 30, 2005. We expect research and development efforts and expenses to increase in absolute dollar terms as we enhance the capabilities of our current products and explore new applications and indications for our automated anastomosis technology platform.

Patents and Intellectual Property

      We believe our competitive position will depend significantly upon our ability to protect our intellectual property. Our policy is to seek to protect our proprietary position by, among other methods, filing U.S. and foreign patent applications related to our technology, inventions and improvements that are important to the development of our business. As of September 30, 2005, we have 29 issued U.S. patents, 62 additional U.S. patent applications and another six patent applications filed in select international markets. Our issued patents expire between 2018 and 2023.

      We also rely upon trade secrets, technical know-how and continuing technological innovation to develop and maintain our competitive position. We typically require our employees, consultants and advisors to execute confidentiality and assignment of inventions agreements in connection with their employment, consulting or advisory relationships with us. There can be no assurance, however, that these agreements will not be breached or that we will have adequate remedies for any breach. Furthermore, no assurance can be given that competitors will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our proprietary technology, or that we can meaningfully protect our rights in unpatented proprietary technology.

      Patent applications in the United States and in foreign countries are maintained in secrecy for a period of time after filing, which results in a delay between the actual discoveries and the filing of related patent applications and the time when discoveries are published in scientific and patent literature. Patents issued and patent applications filed relating to medical devices are numerous, and there can be no assurance that current and potential competitors and other third parties have not filed or in the future will not file applications for, or have not received or in the future will not receive, patents or obtain additional proprietary rights relating to products, devices or processes used or proposed to be used by us. We are aware of patents issued to third parties that contain subject matter related to our technology. We believe that the technologies we employ in our products and systems do not infringe the valid claims of any such patents. There can be no assurance, however, that third parties will not seek to assert that our devices and systems infringe their patents or seek to expand their patent claims to cover aspects of our products and systems.

      The medical device industry in general, and the industry segment that includes products for the treatment of cardiovascular disease in particular, has been characterized by substantial litigation regarding patents and other intellectual property rights. Any such claims, regardless of their merit, could be time-consuming and expensive to respond to and could divert our technical and management personnel. We may be involved in litigation to defend against claims of infringement by other patent holders, to enforce patents issued to us, or to protect our trade secrets. If any relevant claims of third-party patents are upheld as valid and enforceable in any litigation or administrative proceeding, we could be prevented from practicing the subject matter claimed in such patents, or would be required to obtain licenses from the patent owners of each such patent, or to redesign its products, devices or processes to avoid infringement. There can be no assurance that such licenses would be available or, if

available, would be available on terms acceptable to us or that we would be successful in any attempt to redesign our products or processes to avoid infringement. Accordingly, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling our products, which would have a material adverse effect on our business, financial condition and results of operations. We intend to vigorously protect and defend our intellectual property. Costly and time-consuming litigation brought by us may be necessary to enforce patents issued to us, to protect trade secrets or know-how owned by us or to determine the enforceability, scope and validity of the proprietary rights of others. See “Risk Factors.”

      On October 28, 2005, we received a letter from Integrated Vascular Interventional Technologies, Inc., referred to as IVIT, advising us for the first time of IVIT’s effort (thus far unsuccessful) to provoke an interference in the U.S. Patent and Trademark Office between one of IVIT’s patent applications (serial no. 10/243,543) and a patent currently held by us (U.S. patent no. 6,391,038) and relating to the C-Port system. We also learned on that date that IVIT is attempting to provoke an interference in the U.S. Patent and Trademark Office between another of its U.S. patent applications (serial no. 10/706,245) and another of our issued patents (U.S. Patent No. 6,478,804). IVIT makes no specific demands in the letter, but alleges that it has an indication of an allowed claim and that it expects to receive a declaration of interference regarding that claim, and states that it would be “strategically beneficial” for us to discuss this matter prior to receiving a declaration of interference.

      An interference is a proceeding within the U.S. Patent and Trademark Office to determine priority of invention of the subject matter of patent claims. The decision to declare an interference is solely within the power of the Board of Patent Appeals and Interferences of the U.S. Patent and Trademark Office, and can be made only after claims in a patent application are allowed by the examiner and a determination is made that interfering subject matter exists. As yet, no claims have been allowed in either of IVIT’s two patent applications referenced above.

      We believe, after conferring with intellectual property counsel, that IVIT’s attempts to provoke an interference are unlikely to succeed, and we will vigorously defend our patents against such claims of interference, although there can be no assurance that we will succeed in doing so. We further believe that if IVIT’s patent claims are allowed in their present form, our products would not infringe such claims. There can be no assurance that IVIT’s patent claims, if allowed, will be in their present form, or that our products would not be found to infringe such claims or any other claims that are issued.

Government Regulation

      The FDA and other regulatory bodies extensively regulate the research, development, manufacture, labeling, distribution and marketing of our products. Our current products are regulated by the FDA as medical devices, and we are required to obtain review and clearance or approval from the FDA prior to commercializing our devices in the United States. As discussed above under the heading “Clinical Trial Summary and Timeline,” we obtained 510(k) clearance for marketing our C-Port system in the United States in November 2005. In addition, we have obtained conditional approval of an IDE for the PAS-Port system from the FDA to study this product in the United States and abroad in a prospective, randomized trial. We cannot assure you that we will obtain clearance or approval from the FDA for the PAS-Port, future iterations of the C-Port system or any other products.

      FDA regulations govern nearly all of the activities that we perform, or that are performed on our behalf, to ensure that medical products distributed domestically or exported internationally are safe and effective for their intended uses. The activities that the FDA regulates include the following:

      FDA’s Premarket Clearance and Approval Requirements. Unless an exemption applies, each medical device distributed commercially in the United States will require either prior 510(k) clearance or premarket approval, referred to as a PMA, from the FDA. The FDA classifies medical devices into one of three classes. Class I devices are subject to only general controls, such as establishment registration and device listing, labeling, medical devices reporting, and prohibitions against adulteration and misbranding. Class II medical devices generally require prior 510(k) clearance before they may be commercially marketed in the United States. The FDA will clear marketing of a medical device through the 510(k) process if the FDA is satisfied that the new product has been demonstrated to be substantially equivalent to another legally marketed device, or predicate, device, and otherwise meets the FDA’s requirements. Class II devices are also subject to general controls and may be subject to performance standards and other special controls. Devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or devices deemed not substantially equivalent to a predicate device, are placed in Class III, generally requiring submission of a PMA supported by clinical trial data.

      510(k) Clearance Pathway. To obtain 510(k) clearance, we must submit a notification to the FDA demonstrating that our proposed device is substantially equivalent to a predicate device, i.e., a device that was in commercial distribution before May 28, 1976, a device that has been reclassified from Class III to Class I or Class II, or a 510(k)-cleared device. The FDA’s 510(k) clearance process generally takes from three to 12 months from the date the application is submitted, but can take significantly longer. If the FDA determines that the device, or its intended use, is not substantially equivalent to a previously-cleared device or use, the device is automatically placed into Class III, requiring the submission of a PMA. Any modification to a 510(k)-cleared device that would constitute a major change in its intended use, design or manufacture, requires a new 510(k) clearance and may even, in come circumstances, require a PMA, if the change raises complex or novel scientific issues. The FDA requires every manufacturer to make the determination regarding the need for a new 510(k) submission in the first instance, but the FDA may review any manufacturer’s decision. If the FDA disagrees with a manufacturer’s determination, the FDA can require the manufacturer to cease marketing and/or recall the device until 510(k) clearance or PMA is obtained. If the FDA requires us to seek 510(k) clearance or PMAs for any modifications, we may be required to cease marketing and/or recall the modified device, if already in distribution, until 510(k) clearance or PMA is obtained and we could be subject to significant regulatory fines or penalties. Furthermore, our products could be subject to voluntary recall if we or the FDA determines, for any reason, that our products pose a risk of injury or are otherwise defective. Moreover, the FDA can order a mandatory recall if there is a reasonable probability that our device would cause serious adverse health consequences or death. Delays in receipt or failure to receive clearances or approvals, the loss of previously received clearances or approvals, or the failure to comply with existing or future regulatory requirements could reduce our sales, profitability and future growth prospects.

      Premarket Approval Pathway. A PMA must be submitted to the FDA if the device cannot be cleared through the 510(k) process. The PMA process is much more demanding than the 510(k) notification process. A PMA must be supported by extensive data, including but not limited to data obtained from preclinical or clinical studies or relating to manufacturing and labeling to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device.

      After a PMA is complete, the FDA begins an in-depth review of the submitted information, which generally takes between one and three years, but may take significantly longer. During this review period, the FDA will typically request additional information or clarification of the information already provided. Also, an advisory panel of experts from outside the FDA may be convened to review and evaluate the application and provide recommendations to the FDA as to the approvability of the device. The FDA may or may not accept the panel’s

recommendation. In addition, the FDA will conduct a pre-approval inspection of the manufacturing facility to ensure compliance with Quality System Regulation, or QSR. New PMA applications or PMA supplements are required for significant modifications to the device, including, for example, certain types of modifications to the device’s indication for use, manufacturing process, labeling and design. PMA supplements often require submission of the same type of information as a PMA application, except that the supplement is limited to information needed to support any changes from the device covered by the original PMA application and may not require as extensive clinical data or the convening of an advisory panel.

      Clinical Trials. Clinical trials are generally required to support a PMA application and are sometimes required for 510(k) clearance. To perform a clinical trial in the United States for a significant risk device, prior submission of an application for an IDE to the FDA is required. An IDE amendment must also be submitted before initiating a new clinical study under an existing IDE, such as initiating a pivotal trial following the conclusion of a feasibility trial. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, and any available data on human clinical experience, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The animal and laboratory testing must meet the FDA’s good laboratory practice requirements.

      The IDE and any IDE supplement for a new trial must be approved in advance by the FDA for a specific number of patients. Clinical trials conducted in the United States for significant risk devices may not begin until the IDE application or IDE supplement is approved by the FDA and the appropriate institutional review boards, or IRBs, overseeing the welfare of the research subjects and responsible for that particular clinical trial. If the product is considered a non-significant risk device under FDA regulations, only the patients’ informed consent and IRB approval are required. Under its regulations, the agency responds to an IDE or an IDE amendment for a new trial within 30 days. The FDA may approve the IDE or amendment, grant an approval with certain conditions, or identify deficiencies and request additional information. It is common for the FDA to require additional information before approving an IDE or amendment for a new trial, and thus final FDA approval on a submission may require more than the initial 30 days. The FDA may also require that a small-scale feasibility study be conducted before a pivotal trial may commence. In a feasibility trial, the FDA limits the number of patients, sites and investigators that may participate. Feasibility trials are typically structured to obtain information on safety and to help determine how large a pivotal trial should be to obtain statistically significant results.

      Clinical trials are subject to extensive recordkeeping and reporting requirements. Our clinical trials must be conducted under the oversight of an IRB for the relevant clinical trial sites and must comply with FDA regulations, including but not limited to those relating to good clinical practices. We are also required to obtain the patients’ informed consent in form and substance that complies with both FDA requirements and state and federal privacy and human subject protection regulations. We, the FDA or the IRB may suspend a clinical trial at any time for various reasons, including a belief that the risks to study subjects outweigh the anticipated benefits. Even if a trial is completed, the results of clinical testing may not adequately demonstrate the safety and efficacy of the device or may otherwise not be sufficient to obtain FDA approval to market the product in the United States. Similarly, in Europe the clinical study must be approved by a local ethics committee and in some cases, including studies with high-risk devices, by the ministry of health in the applicable country.

      Educational Grants. The FDA permits a device manufacturer to provide financial support, including support by way of grants, to third parties for the purpose of conducting medical educational activities. If these funded activities are considered by the FDA to be independent of the manufacturer, then the activities fall outside the restrictions on off-label promotion to which the manufacturer is subject.

      The FDA considers several factors in determining whether an educational event or activity is independent from the substantive influence of the device manufacturer and therefore nonpromotional, including the following:

      Pervasive and Continuing Regulation. There are numerous regulatory requirements governing the approval and marketing of a product. These include:

Advertising and promotion of medical devices are also regulated by the Federal Trade Commission and by state regulatory and enforcement authorities. Recently, some promotional activities for FDA-regulated products have been the subject of enforcement action brought under healthcare reimbursement laws and consumer protection statutes. In addition, under the federal Lanham Act and similar state laws, competitors and others can initiate litigation relating to advertising claims.

We have registered with the FDA as a medical device manufacturer. The FDA has broad post-market and regulatory enforcement powers. We are subject to unannounced inspections by the FDA to determine our compliance with the QSR, and other regulations, and these inspections may include the manufacturing facilities of our suppliers.

Failure by us or by our suppliers to comply with applicable regulatory requirements can result in enforcement action by the FDA or state authorities, which may include any of the following sanctions:

      Fraud and Abuse and False Claims. We are directly and indirectly subject to various federal and state laws governing our relationship with healthcare providers and pertaining to healthcare fraud and abuse, including anti-kickback laws. In particular, the federal healthcare program Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing, arranging for or recommending a good or service, for which payment may be made in whole or part under federal healthcare programs, such as the Medicare and Medicaid programs. Penalties for violations include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcare programs. The Anti-Kickback Statute is broad and prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. In implementing the statute, the Office of Inspector General of the U.S. Department of Health and Services, or OIG, has issued a series of regulations, known as the “safe harbors.” These safe harbors set forth provisions that, if all their applicable requirements are met, will assure healthcare providers and other parties that they will not be prosecuted under the Anti-Kickback Statute. The failure of a transaction or arrangement to fit precisely within one or more safe harbors does not necessarily mean that it is illegal or that prosecution will be pursued. However, conduct and business arrangements that do not fully satisfy each applicable element of a safe harbor may result in increased scrutiny by government enforcement authorities, such as the OIG.

      The Federal False Claims Act imposes civil liability on any person or entity who submits, or causes the submission of a false or fraudulent claim to the United States Government. Damages under the Federal False Claims Act can be significant and consist of the imposition of fines and penalties. The Federal False Claims Act also allows a private individual or entity with knowledge of past or present fraud on the federal government to sue on behalf of the government to recover the civil penalties and treble damages. The U.S. Department of Justice on behalf of the government has successfully enforced the Federal False Claims Act against pharmaceutical manufacturers. Federal suits have alleged that pharmaceutical manufacturers whose marketing and promotional practices were found to have included the off-label promotion of drugs or the payment of prohibited kickbacks to doctors violated the Federal False Claims Act on the grounds that these prohibited activities resulted in the submission of claims to federal and state healthcare entitlement programs such as Medicaid, resulting in the payment of claims by Medicaid for the off-label use of the drug that was not a use of the drug otherwise covered by Medicaid. Such manufacturers have entered into settlements with the federal government under which they paid amounts and entered into corporate integrity agreements that require, among other things, substantial reporting and remedial actions.

      The Federal authorities, and state equivalents, may likewise seek to enforce the False Claims Act against medical device manufacturers. We believe that our marketing practices are not in violation of the Federal False Claims Act or state equivalents, but we cannot assure you that the federal authorities will not take action against us and, if such action were successful, we could be required to pay significant fines and penalties and change our marketing practices. Such enforcement could have a significant adverse effect on our ability to operate.

      We engage in a variety of activities that are subject to these laws and that have come under particular scrutiny in recent years by federal and state regulators and law enforcement entities. These activities have included, consulting arrangements with cardiothoracic surgeons, grants for training and other education, grants for research, and other interactions with doctors.

      International Regulation. International sales of medical devices are subject to foreign governmental regulations, which vary substantially from country to country. The time required to obtain certification or approval by a foreign country may be longer or shorter than that required for FDA clearance or approval, and the requirements may differ.

      The primary regulatory body in Europe is the European Union, which has adopted numerous directives and has promulgated voluntary standards regulating the design, manufacture and labeling of and clinical trials and adverse event reporting for medical devices. Devices that comply with the requirements of a relevant directive will be entitled to bear CE conformity marking, indicating that the device conforms with the essential requirements of the applicable directives and, accordingly, can be commercially distributed throughout the member states of the European Union and other countries that comply with or mirror these directives. The method for assessing conformity varies depending upon the type and class of the product, but normally involves a combination of self-assessment by the manufacturer and a third-party assessment by a notified body, which is an independent and neutral institution appointed by a country to conduct the conformity assessment. This third-party assessment may consist of an audit of the manufacturer’s quality system and specific testing of the manufacturer’s device. Such an assessment is required for a manufacturer to commercially distribute the product throughout these countries. International Standards Organization, or ISO, 9001 and ISO 13845 certifications are voluntary standards. Compliance establishes the presumption of conformity with the essential requirements for the CE Mark. We have the authorization to affix the CE Mark to the PAS-Port and C-Port devices and to commercialize the devices in the European Union for coronary artery bypass grafting.

      In Japan, medical devices must be approved prior to importation and commercial sale by the Ministry of Health, Labor and Welfare, or MHLW. Manufacturers of medical devices outside of Japan must utilize a contractually bound In-Country Caretaker, or ICC, to submit an application for device approval to the MHLW. The MHLW evaluates each device for safety and efficacy. As part of its approval process, the MHLW may require that the product be tested in Japanese laboratories. The approval process for products such as our existing anastomotic products is typically 13 to 14 months. Other medical devices may require a longer review period for approval. Once approved, the manufacturer may import the device into Japan for sale by the manufacturer’s contractually bound importer or distributor.

      After a device is approved for importation and commercial sale in Japan, the MHLW continues to monitor sales of approved products for compliance with labeling regulations, which prohibit promotion of devices for unapproved uses and reporting regulations, which require reporting of product malfunctions, including serious injury or death caused by any approved device. Failure to comply with applicable regulatory requirements can result in enforcement action by the MHLW, which may include fines, injunctions, and civil penalties, recall or seizure of our products, operating restrictions, partial suspension or total shutdown of sales in Japan, or criminal prosecution.

      We have received approval from the MHLW to distribute our PAS-Port system in Japan. We will be required to submit applications with respect to all new products and product enhancements for review and approval by the MHLW. Our contract with Century, our distributor in Japan, has a multi-year term and is renewable for additional multi-year terms upon mutual agreement of the parties.

      In addition to MHLW oversight, the regulation of medical devices in Japan is also governed by the Japanese Pharmaceutical Affairs Law, or PAL. PAL was substantially revised in July 2002, and the new provisions were implemented in stages through April 2005. Revised provisions of the approval and licensing system of medical devices in Japan, which constitutes the core of import regulations, came into effect on April 1, 2005. The revised law changes class categorizations of medical devices in relation to risk, introduces a third-party certification system, strengthens safety countermeasures for biologically derived products, and reinforces safety countermeasures at the time of resale or rental. The revised law also abolishes the ICC system and replaces it with the “primary distributor” system. Under the PAL in effect prior to April 1, 2005, manufacturers of medical devices outside of Japan were required to utilize an ICC to obtain on their behalf approval of each product by the MHLW prior to the sale or distribution of their products in Japan. Under the revised PAL, manufacturers outside of Japan must now appoint a “primary distributor” located in Japan that holds a primary distributor license for medical devices to provide primary distribution services, including conducting quality assurance and safety control tasks, for each product at the time an application for the approval of each such product is submitted to the MHLW. Century Medical serves as the “primary distributor” for Cardica. As an interim measure, an ICC licensed under the PAL in effect prior to April 1, 2005 will be deemed to be the primary distributor under the revised PAL if that ICC had a license to import and distribute the relevant medical devices that was applied for and obtained under the old PAL. We are unable at this time to determine the impact of such changes on our

approved products or future products. We do not anticipate that these changes will have a material impact on our existing level of third-party reimbursement for sales of our products in Japan.

Employees

      As of November 30, 2005, we had 42 employees, including 16 employees in manufacturing, one employee in sales and marketing, four employees in clinical, regulatory and quality assurance, five employees in general and administrative and 16 employees in research and development. We believe that our future success will depend upon our continued ability to attract, hire and retain qualified personnel. None of our employees is represented by a labor union or party to a collective bargaining agreement, and we believe our employee relations are good.

Facilities

      We currently lease approximately 29,000 square feet in Redwood City, California, containing approximately 9,000 square feet of manufacturing space, 7,000 square feet used for research and development and 3,000 square feet devoted to administrative offices. Our facility is leased through August 2008. We believe that our existing facility should meet our needs for at least the next 24 months. Our facility is subject to periodic inspections by state and federal regulatory authorities.

Litigation

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