Dex Liquidating 10Q 2008 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q


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

For the quarterly period ended December 31, 2007


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

For the transition period from to

Commission File Number: 000-51772

Cardica, Inc.

(Exact name of registrant as specified in its charter)


Delaware		94-3287832
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

900 Saginaw Drive
Redwood City, California 94063
(Address of principal executive offices, including zip code)

(650) 364-9975
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

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

o Large accelerated filer o Accelerated filer þ Non-accelerated filer o Smaller reporting company

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yeso Noþ

On January 31, 2008, there were 15,667,194 shares of common stock, par value $.001 per share, of Cardica, Inc. outstanding.

CARDICA, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2007

INDEX

Item


		Page
	PART I.
	FINANCIAL INFORMATION

1.	Condensed Financial Statements (unaudited)

	a. Condensed Balance Sheets at December 31, 2007 and June 30, 2007		3
	b. Condensed Statements of Operations for the three and six months ended December 31, 2007 and 2006		4
	c. Condensed Statements of Cash Flows for the six months ended December 31, 2007 and 2006		5
	d. Notes to Condensed Financial Statements		6

2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		13

3.	Quantitative and Qualitative Disclosures About Market Risk		20

4T.	Controls and Procedures		20

	PART II.
	OTHER INFORMATION

1A.	Risk Factors		22

4.	Submission of Matters to a Vote of Security Holders		41

5.	Other Matters		41

6.	Exhibits		42

	SIGNATURES		43

EXHIBIT 3.2
EXHIBIT 10.23
EXHIBIT 10.24
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CARDICA, INC.

CONDENSED BALANCE SHEETS
(In thousands, except share and per share data)


	December 31,			June 30,
	2007			2007
	(unaudited)			(Note 1)
Assets
Current assets:
Cash and cash equivalents	$	16,010		$	14,539
Short-term investments		14,893			8,895
Accounts receivable		587			283
Inventories		1,089			1,229
Prepaid expenses and other current assets		368			418

Total current assets		32,947			25,364

Property and equipment, net		1,959			1,450
Restricted cash		510			510

Total assets	$	35,416		$	27,324


Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	601		$	758
Accrued compensation		580			516
Other accrued liabilities		587			926
Current portion of leasehold improvement obligation		72			122
Deferred development revenue		1,102			882
Deferred rent		66			111

Total current liabilities		3,008			3,315

Deferred rent		—			9
Note payable		2,000			2,000
Leasehold improvement obligation		—			11

Commitments and contingencies

Stockholders’ equity:
Preferred stock, $0.001 par value, 5,000,000 shares authorized, no shares issued and outstanding		—			—
Common stock, $0.001 par value, 45,000,000 shares authorized, 15,663,222 and 13,606,333 shares issued and outstanding at December 31, 2007 and June 30, 2007, respectively		16			14
Additional paid-in capital		113,258			97,171
Treasury stock at cost (66,227 shares at December 31 and June 30, 2007)		(596	)		(596	)
Deferred stock compensation		(433	)		(591	)
Accumulated other comprehensive loss		(4	)		(2	)
Accumulated deficit		(81,833	)		(74,007	)

Total stockholders’ equity		30,408			21,989

Total liabilities and stockholders’ equity	$	35,416		$	27,324

See accompanying notes to the condensed financial statements.

CARDICA, INC.

CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)


	Three months ended						Six months ended
	December 31,						December 31,
	2007			2006			2007			2006
Net revenue:
Product revenue, net	$	1,283		$	416		$	2,309		$	874
Development revenue		395			500			702			500
Royalty revenue from related party		16			12			32			25

Total net revenue		1,694			928			3,043			1,399

Operating costs and expenses:
Cost of product revenue		1,199			884			2,212			1,563
Research and development		1,746			1,661			3,434			3,149
Selling, general and administrative		3,176			2,203			5,729			4,273

Total operating costs and expenses		6,121			4,748			11,375			8,985


Loss from operations		(4,427	)		(3,820	)		(8,332	)		(7,586	)

Interest income		283			298			553			687
Interest expense (includes related party interest expense of $94 for the three months ended December 31, 2006 and $320 for the six months ended December 31, 2006)		(25	)		(132	)		(50	)		(396	)
Other income		2			—			3			—
Gain on early retirement of notes payable to related party		—			1,183			—			1,183

Net loss	$	(4,167	)	$	(2,471	)	$	(7,826	)	$	(6,112	)


Basic and diluted net loss per share	$	(0.29	)	$	(0.23	)	$	(0.56	)	$	(0.60	)

Shares used in computing basic and diluted net loss per share		14,471			10,642			14,037			10,210

See accompanying notes to the condensed financial statements.

CARDICA, INC.

CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)


	Six months ended
	December 31,
	2007			2006
Operating activities:
Net loss	$	(7,826	)	$	(6,112	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		435			370
Loss on disposal of property and equipment		12			—
Gain on early retirement of notes payable to related party		—			(1,433	)
Stock-based compensation expenses		788			444
Changes in assets and liabilities:
Accounts receivable		(304	)		(24	)
Prepaid expenses and other current assets		50			177
Inventories		140			(130	)
Accounts payable and other accrued liabilities		(490	)		(458	)
Accrued compensation		64			45
Deferred development revenue		220			—
Deferred rent		(54	)		(45	)
Leasehold improvement obligation		(61	)		(61	)
Interest payable to related party		—			(2,333	)

Net cash used in operating activities		(7,026	)		(9,560	)

Investing activities:
Purchases of property and equipment		(956	)		(230	)
Purchases of short-term investments		(20,853	)		(4,994	)
Proceeds from sales and maturities of short-term investments		14,853			21,244

Net cash (used in) provided by investing activities		(6,956	)		16,020

Financing activities:
Payment of notes payable to related party		—			(3,087	)
Proceeds from issuance of common stock pursuant to the exercise of stock options for cash		76			99
Net proceeds from issuance of common stock		15,377			—
Proceeds from payment of receivable from stock option exercises		—			79

Net cash provided by (used in) financing activities		15,453			(2,909	)


Net increase in cash and cash equivalents		1,471			3,551
Cash and cash equivalents at beginning of period		14,539			4,102

Cash and cash equivalents at end of period	$	16,010		$	7,653

See accompanying notes to the condensed financial statements.

CARDICA, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS
December 31, 2007
(unaudited)

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

Cardica, Inc. (“Cardica”, the “Company”, “we”, “our” or “us”) was incorporated in the state of Delaware on October 15, 1997, as Vascular Innovations, Inc. On November 26, 2001, the Company changed its name to Cardica, Inc. The Company designs, manufactures and markets proprietary automated anastomotic systems used in surgical procedures.

Basis of Presentation

The accompanying unaudited condensed financial statements of Cardica have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. The unaudited interim financial statements have been prepared on the same basis as the annual financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary for the fair statement of results for the periods presented, have been included. The results of operations of any interim period are not necessarily indicative of the results of operations for the full year or any other interim period.

The accompanying condensed financial statements should be read in conjunction with the audited financial statements and notes thereto for the fiscal year ended June 30, 2007 filed on Form 10-K with the Securities and Exchange Commission on September 19, 2007.

New Accounting Standards

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115”. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. This statement also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for the Company as of July 1, 2008. The Company is currently evaluating the impact this statement will have on its financial statements.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements”, which provides guidance for using fair value to measure assets and liabilities. The pronouncement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 will apply whenever another standard requires (or permits) assets or liabilities to be measured at fair value. SFAS No. 157 is effective for the Company as of July 1, 2008. The Company is currently evaluating the impact this statement will have on its financial statements.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles generally requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from these estimates.

Available-for-Sale Securities

The Company has classified its investments in marketable securities as available-for-sale. Investments are reported at market value. The cost of securities sold is based on the specific-identification method. Interest on securities classified as available-for-sale is included in interest income. The net realized gains and losses on sales of available-for-sale securities were not material in the periods presented.

Unrealized gains or losses on available-for-sale securities at December 31, 2007 and June 30, 2007 are classified as accumulated other comprehensive loss on the accompanying balance sheet.

Available-for-sale securities at December 31, 2007 consisted primarily of auction rate preferred securities, corporate debt securities and debt instruments of the U.S. Government and its agencies. We restrict our exposure to any single corporate issuer by imposing concentration limits. The underlying contractual maturities of the auction rate securities are greater than one year. Although maturities may extend beyond one year, it is management’s intent that these securities will be used for current operations, and, therefore, such investments are classified as short-term.

Inventories

Inventories are recorded at the lower of standard cost (which approximates actual cost on a first-in, first-out basis) or market. The Company periodically assesses the recoverability of all inventories, including raw materials, work-in-process and finished goods, to determine whether adjustments for impairment are required. Inventory that is obsolete or in excess of forecasted usage is written down to its estimated realizable net value based on assumptions about future demand and market conditions.

Revenue Recognition

Revenue is recognized in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 104,“Revenue Recognition”. SAB No. 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) title has transferred; (3) the fee is fixed or determinable; and (4) collectibility is reasonably assured. The Company uses contracts and customer purchase orders to determine the existence of an arrangement. The Company uses shipping documents and third-party proof of delivery to verify that title has transferred. The Company assesses whether the fee is fixed or determinable based upon the terms of the agreement associated with the transaction. To determine whether collection is probable, the Company assesses a number of factors, including past transaction history with the customer and the creditworthiness of the customer. If the Company determines that collection is not reasonably assured, then the recognition of revenue is deferred until collection becomes reasonably assured, which is generally upon receipt of payment.

The Company records product revenue net of estimated product returns and discounts from the list prices for its products. The amounts of product returns and the discount amounts have not been material to date. The Company includes shipping and handling costs in cost of product revenue.

Revenue generated from development contracts is recognized upon acceptance of milestone payments or upon incurrence of the related development expenses by the customer in accordance with contractual terms, only to the extent of actual costs incurred to date. Amounts paid but not yet expended on the project are refundable and are recorded as deferred revenue until such time as project milestones are achieved or the related development expenses are incurred.

NOTE 2 — STOCK-BASED COMPENSATION

During fiscal year 2006, the Company adopted SFAS No. 123R, “Share-Based Payments”, which revises SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123R establishes accounting for stock-based awards exchanged for employee and director services. Accordingly, stock-based compensation cost is measured on the grant date, based on the fair value of the award, and is recognized as an expense over the requisite service period. Upon adoption of SFAS No. 123R, the Company elected to recognize compensation expense using the accelerated method. Prior to the adoption of SFAS No. 123R in the second quarter of fiscal year 2006, the Company accounted for stock-based employee compensation

arrangements using the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”and FASB Interpretation No. (“FIN”) 44, “Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB No. 25”. The Company adopted SFAS No. 123R applying the “prospective method” under which it would continue to account for nonvested equity awards outstanding at the date of adoption of SFAS No. 123R in the same manner as they had been accounted for prior to adoption, that is, it would continue to apply APB No. 25 in future periods to equity awards outstanding at the date it adopted SFAS No. 123R.

SFAS No. 123R applies to new awards and to awards modified, repurchased or cancelled after the required effective date. The Company used the Black-Scholes model to value its new stock option grants under SFAS No. 123R, with the following assumptions:


	Three months ended						Six months ended
	December 31,						December 31,
	2007			2006			2007			2006
Risk-free interest rate		3.53	%		4.61	%		3.53	%		4.75	%
Dividend yield		—			—			—			—
Weighted-average expected life	4.6 years			6 years			4.6 years			6 years
Volatility		70	%		70	%		70	%		70	%

Since the Company has limited historical data on volatility of its stock, the expected volatility used in fiscal years 2008 and 2007 is based on volatility of similar entities (referred to as “guideline” companies). In evaluating similarity, the Company considered factors such as industry, stage of life cycle, size and financial leverage.

The expected term of options granted is determined using the “simplified” method allowed by Staff Accounting Bulletin (“SAB”) 110. Under this approach, the expected term is presumed to be the mid-point between the vesting date and the end of the contractual term. The risk-free rate for periods within the contractual life of the option is based on a risk-free zero-coupon spot interest rate at the time of grant. The Company recognizes the stock compensation expense for option awards using the accelerated method over the requisite service period of the award, which generally equals the vesting period of each grant. The Company has never declared or paid any cash dividends and does not presently plan to pay cash dividends in the foreseeable future. SFAS No. 123R also requires the Company to estimate forfeitures in calculating the expense related to stock-based compensation. The Company recorded fair-value stock-based compensation expenses of $397,000, or $0.03 per share and $206,000, or $0.02 per share, for the three months ended December 31, 2007 and 2006, respectively, and $633,000, or $0.05 per share and $260,000, or $0.03 per share, for the six months ended December 31, 2007 and 2006, respectively.

Included in the statement of operations were the following non-cash stock-based compensation amounts for the periods reported, including non-employee stock based compensation expense and the amortization of deferred compensation recorded prior to the adoption of SFAS No. 123R (in thousands).


	Three months ended				Six months ended
	December 31,				December 31,
	2007		2006		2007		2006
Cost of product revenue	$	13	$	17	$	27	$	34
Research and development		146		71		255		3
Selling, general and administrative		316		208		506		407

Total	$	475	$	296	$	788	$	444

The Company recorded stock compensation expense associated with the amortization of deferred stock compensation of $78,000 and $90,000 for the three months ended December 31, 2007 and 2006, respectively, and $155,000 and $184,000 for the six months ended December 31, 2007 and 2006, respectively.

The expected future amortization expense for deferred stock compensation as of December 31, 2007 was as follows (in thousands):


Fiscal year ending June 30, 2008 (remaining)	$	150
2009		262
2010		21

	$	433

Options granted to non-employees, including lenders and consultants, are accounted for in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force (“EITF”) Consensus No. 96-18,“Accounting for Equity Instruments That Are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services”. The Company applies the Black-Scholes method to determine the estimated fair value of such awards, which are periodically remeasured as they vest. The resulting value is recognized as an expense over the period of services received or the term of the related financing.

Activity in our Stock-Based Compensation Plans:


				Outstanding Options
							Weighted-
							Average
	Shares						Exercise
	Available for			Number			Price Per
	Grant			of Shares			Share
Balance at June 30, 2007		117,967			1,316,006		$	4.67
Shares reserved		500,000			—			—
Options granted		(82,700	)		82,700			7.74
Restricted shares issued		(52,450	)		—			—
Options exercised		—			(23,269	)		3.32
Options forfeited		24,692			(24,692	)		6.63

Balance at December 31, 2007		507,509			1,350,745		$	4.85

The following table summarizes information about options outstanding and vested and exercisable at December 31, 2007:


			Weighted-
			Average
			Remaining		Number
	Number		Contractual		Vested and
Exercise Price	Outstanding		Life		Exercisable
$0.30 - $2.25		197,049		4.24		197,049
$2.85		389,701		7.01		288,156
$4.38 - $6.00		186,183		6.00		41,581
$6.03		274,675		6.49		22,939
$6.75 - $8.00		255,975		7.59		97,997
$9.00 - $9.75		47,162		7.91		24,456

Total outstanding		1,350,745		6.50		672,178

Options vested and expected to vest		1,077,240

NOTE 3 — NET LOSS PER SHARE

Basic net loss per share is calculated by dividing the net loss by the weighted-average number of common shares outstanding for the period less the weighted average unvested common shares subject to repurchase and without consideration for potential common shares. Diluted net loss per share is computed by dividing the net loss by the weighted-average number of common shares outstanding for the period less the weighted average unvested common shares subject to repurchase and plus dilutive potential common shares for the period determined using the treasury-stock method. For purposes of this calculation, options and warrants to purchase stock and unvested restricted stock awards are considered to be potential common shares and are only included in the calculation of diluted net loss per share when their effect is dilutive (in thousands, except per share data).


	Three months ended						Six months ended
	December 31,						December 31,
	2007			2006			2007			2006
Numerator:
Net loss	$	(4,167	)	$	(2,471	)	$	(7,826	)	$	(6,112	)

Denominator:
Weighted-average common shares outstanding		14,531			10,669			14,074			10,238
Less: Weighted-average unvested common shares subject to repurchase		(1	)		(7	)		(2	)		(8	)
Less: Weighted-average unvested restricted shares		(59	)		(20	)		(35	)		(20	)

Denominator for basic and diluted net loss per share		14,471			10,642			14,037			10,210

Basic and diluted net loss per share	$	(0.29	)	$	(0.23	)	$	(0.56	)	$	(0.60	)


Outstanding securities not included in historical diluted net loss per share calculation Options to purchase common stock		1,351			951			1,351			951
Unvested restricted shares		62			20			62			20
Warrants		732			157			732			157

Total		2,145			1,128			2,145			1,128

NOTE 4—COMPREHENSIVE LOSS

Comprehensive loss is comprised of net loss and unrealized gains/losses on available-for-sale securities, in accordance with SFAS No. 130, “Reporting Comprehensive Income”.

Comprehensive loss and its components for the three- and six-month periods ended December 31, 2007 and 2006 were as follows (in thousands):


	Three months ended						Six months ended
	December 31,						December 31,
	2007			2006			2007			2006
Net loss	$	(4,167	)	$	(2,471	)	$	(7,826	)	$	(6,112	)
Change in unrealized loss on investments		1			20			(2	)		38

Comprehensive loss	$	(4,166	)	$	(2,451	)	$	(7,828	)	$	(6,074	)

NOTE 5 —SHORT-TERM INVESTMENTS

The following is a summary of short-term investments (in thousands):


	December 31, 2007
			Gross		Gross
	Amortized		Unrealized		Unrealized
	Cost		Gains		Losses			Fair Value
Available-for-sale securities:
Auction rate preferred	$	4,400	$	—	$	—		$	4,400
Commercial paper		5,523		—		(5	)		5,518
Federal agency bonds		4,974		1		—			4,975

Total	$	14,897	$	1	$	(5	)	$	14,893


	June 30, 2007
			Gross		Gross
	Amortized		Unrealized		Unrealized
	Cost		Gains		Losses			Fair Value
Available-for-sale securities:
Auction rate preferred	$	5,850	$	—	$	—		$	5,850
Commercial paper		1,298		—		(1	)		1,297
Federal agency bonds		1,749		—		(1	)		1,748

Total	$	8,897	$	—	$	(2	)	$	8,895

NOTE 6—INVENTORIES

Inventories consisted of the following (in thousands):


	December 31,		June 30,
	2007		2007
Raw materials	$	462	$	405
Work in progress		259		296
Finished goods		368		528

	$	1,089	$	1,229

NOTE 7—LICENSE, DEVELOPMENT AND COMMERCIALIZATION AGREEMENTS

In December 2005, the Company entered into, and in September 2007 amended, a license, development and commercialization agreement with Cook Incorporated (“Cook”) relating to development of the Cook Vascular Closure Device, previously called the X-Port Vascular Access Closure Device, an innovative automated system designed to close access openings in femoral arteries after interventional vascular procedures. Under the agreement, the Company agreed to develop the Cook Vascular Closure Device with Cook, and Cook has exclusive commercialization rights to market any product that is developed in collaboration for medical procedures anywhere in the body. Through December 31, 2007, the Company had received payments totaling $3.2 million, including $572,000 during the six-month period ended December 31, 2007. The Company recorded as development revenue under the agreement $258,000 and $500,000 for the three-month periods ended December 31, 2007 and 2006, respectively, and $496,000 and $500,000 for the six-month periods ended December 31, 2007 and 2006, respectively. A total of $458,000 had been recorded as deferred development revenue on the balance sheet as of December 31, 2007 related to this agreement. The Company is also entitled to receive from Cook up to a total of an additional $800,000 in future payments if additional development milestones under the agreement are achieved. The Company may potentially receive a royalty based on Cook’s annual worldwide sales of the Cook Vascular Closure Device, if any.

In June 2007, the Company entered into, and in September 2007 amended, a license, development and commercialization agreement with Cook relating to development and commercialization of a specialized device (the “PFO device”) designed to close holes in the heart from generic heart defects known as patent foramen ovales. Under the agreement, the Company agreed to develop the PFO device with Cook, and Cook has exclusive worldwide commercialization rights to market any product that is developed in collaboration. Through December 31, 2007, the Company had received payments totaling $850,000, including $350,000 received during the six-month period ended December 31, 2007. The Company recorded as development revenue under the agreement a total of $137,000 and $206,000 for the three- and

six-month periods ended December 31, 2007, respectively, and none in 2006. A total of $644,000 had been recorded as deferred development revenue on the balance sheet as of December 31, 2007 related to this agreement. The Company is also entitled to receive from Cook up to a total of an additional $2.6 million in future payments if additional development milestones under the agreement are achieved. The Company may potentially receive a royalty based on Cook’s annual worldwide sales of the PFO Closure Device, if any.

NOTE 8—INCOME TAXES

The Company adopted the provisions of FIN 48, “Accounting for Uncertainty in Income Taxes,” an interpretation of SFAS 109 on July 1, 2007. As a result of the implementation of FIN 48, the Company recognized no liabilities for unrecognized income tax benefits. At the adoption date of July 1, 2007, the Company had approximately $574,000 of unrecognized tax benefits, all of which would not currently affect the Company’s effective tax rate if recognized due to the Company’s deferred tax assets being fully offset by a valuation allowance. The Company is uncertain about the timing and amount of future earnings. Unrecognized tax benefits are anticipated to increase related to certain tax credits. While the increase cannot be estimated at this time, such increase in unrecognized tax benefits would be entirely offset by a change in the valuation allowance and therefore would not have a material effect on the Company’s financial statements.

The Company would classify interest and penalties related to uncertain tax positions in income tax expense, if applicable. There was no interest expense or penalties related to unrecognized tax benefits recorded through December 31, 2007. The tax years 1998 through 2006 remain open to examination by one or more of the major taxing jurisdictions to which the Company is subject.

NOTE 9—PUBLIC OFFERING

On November 14, 2007, the Company sold 1,500,000 shares of its common stock, and Guidant Investment Corporation sold 2,575,795 shares of the Company’s common stock, in a public offering for aggregate gross proceeds to the Company of $12.8 million. After deducting the underwriters’ commissions and discounts and other issuance costs, the Company received net proceeds of approximately $11.6 million. On December 13, 2007, the Company sold an additional 481,170 shares of its common stock to the underwriters pursuant to the exercise of the over-allotment option. The Company received aggregate gross proceeds of $4.1 million from the exercise of the underwriters’ over-allotment option. After deducting the underwriters’ commission and related expenses, the Company received from the exercise of the underwriters’ over-allotment option net proceeds of approximately $3.8 million.

NOTE 10—OFFICE LEASE AMENDMENT

On December 3, 2007, the Company executed and delivered a second amendment to its Office Lease Agreement whereby the Company extended the operating lease for its headquarters through August 2011. The original non-cancelable operating lease expires in July 2008. As of December 31, 2007, the Company’s operating lease commitment is approximately $2.8 million.

NOTE 11—SUBSEQUENT EVENT

On January 7, 2008 the Company announced that it had received nearly $2.0 million in payments from Cook for the achievement of significant milestones pursuant to its development agreements with Cook. This amount was comprised of the fourth and final milestone payment of $500,000 for the delivery of the Cook Vascular Closure Device and $1.3 million for the Company’s successful completion of the first phase of design and development of the PFO device. The Company also received a payment of $185,000 from Cook for the initial purchase of parts to build a specific number of the Cook Vascular Closure Devices for commercial use.

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

This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended. All statements other than statements of historical facts are “forward-looking statements” for purposes of these provisions, including any projections of earnings, revenue or other financial items, any statement of the plans and objectives of management for future operations, any statements concerning proposed new products or licensing or collaborative arrangements, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as “may,” “will,” “expects,” “plans,” “anticipates,” “estimates,” “potential,” or “continue” or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the risk factors set forth in Item 1A below, and for the reasons described elsewhere in this report. All forward-looking statements and reasons why results may differ included in this report are made as of the date hereof, and we assume no obligation to update these forward-looking statements or reasons why actual results might differ.

Overview

We are a leading provider of proprietary automated systems used by surgeons to perform anastomoses during coronary artery bypass surgery. In coronary artery bypass grafting, or CABG, procedures, 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 systems, the C-Port® Distal Anastomosis System, or C-Port system, which currently includes our C-Port xA system, C-Port Flex A system and C-Port XCHANGE system and the PAS-Port® Proximal Anastomosis System, or 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. References related to forward-looking statements and risks to the C-BAxA system include the C-Port XCHANGE system. Our C-Port systems are each used to perform a distal anastomosis, which is the connection of a bypass graft vessel to the occluded coronary artery downstream of the occlusion. Our C-Port systems are the only FDA-cleared automated distal anastomosis systems currently marketed in the United States. 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 is the only fully automated proximal anastomosis system marketed today.

We currently sell C-Port systems in the United States and Europe and the PAS-Port system in Europe, and the PAS-Port system is sold in Japan through our distributor, Century Medical, Inc, or Century. In November 2006, we received 510(k) clearance of the C-Port xA system from the FDA. Our original C-Port system received the CE Mark in April 2004 for marketing in the European Union and 510(k) clearance from the FDA in November 2005. With the introduction of the C-Port xA system, the original C-Port system was discontinued. In March 2007, we received 510(k) clearance of the C-Port Flex A system.

We completed enrollment in March 2007 of 220 patients in 12 sites in the U.S. and Europe in a prospective, randomized, multi-center and multi-national clinical trial under an Investigational Device Exemption, or IDE, from the FDA to evaluate the safety and efficacy of the PAS-Port system. We expect to complete the 9 month follow up angiograms in early 2008 and, if the results of the clinical trial are favorable, to include the results as part of a 510(k) submission in the second quarter of calendar year 2008.

In December 2005 we entered into, and in September 2007 amended, a license, development and commercialization agreement with Cook Incorporated, or Cook, to develop the Cook Vascular Closure Device, formerly called the X-Port Vascular Closure Device. Under our agreement, Cook funds certain

development activities, and we and Cook are jointly developing the device. Cook has received an exclusive worldwide, royalty-bearing license, with the rights to grant sublicenses, to make, have made, use, sell, offer for sale and import the Cook Vascular Closure Device for medical procedures in any part of the body. Through December 31, 2007, we had received payments totaling $3.2 million for development work and production tooling, including $572,000 received during the six-month period ended December 31, 2007. We have recorded as development revenue under the agreement $258,000 and $500,000 for the three-month periods ended December 31, 2007 and 2006, respectively, and $496,000 and $500,000 for the six-month periods ended December 31, 2007 and 2006, respectively. A total of $458,000 had been recorded as deferred development revenue on the balance sheet as of December 31, 2007 related to this agreement. We are also entitled to receive from Cook up to a total of an additional $800,000 in future payments if additional development milestones under the agreement are achieved. We may potentially receive a royalty based on Cook’s annual worldwide sales of the Cook Vascular Closure Device, if any.

In June 2007, we entered into, and in September 2007 amended, a license, development and commercialization agreement with Cook to develop and commercialize a specialized device, referred to as the PFO device, designed to close holes in the heart from genetic heart defects known as patent foramen ovales. Under the agreement, we and Cook will jointly develop the device. Cook receives an exclusive, worldwide, royalty-bearing license, with the right to grant sublicenses, to make, have made, use, sell, offer for sale and import the PFO device. Through December 31, 2007, we had received payments totaling $850,000, including $350,000 received during the six-month period ended December 31, 2007. We recorded as development revenue under the agreement a total of $137,000 and $206,000 for the three- and six-month periods ended December 31, 2007, respectively, and none in 2006. A total of $644,000 has been recorded as deferred development revenue on the balance sheet as of December 31, 2007 related to this agreement. We are also entitled to receive from Cook up to a total of an additional $2.6 million in future payments if development milestones under the agreement are achieved. We may potentially receive a royalty based on Cook’s annual worldwide sales of the PFO device, if any.

In January 2008, we announced that we had received nearly $2.0 million in payments from Cook for the achievement of significant milestones pursuant to our development agreements with Cook. This amount was comprised of the fourth and final milestone payment of $500,000 for the delivery of the Cook Vascular Closure Device and $1.3 million for the successful completion of the first phase of design and development of the PFO device. We also received a payment of $185,000 from Cook for the initial purchase of parts to build a specific number of the Cook Vascular Closure Devices for commercial use.

We manufacture the C-Port and PAS-Port systems with parts and components supplied by vendors, which we then assemble, test and package. For the six month period ended December 31, 2007, we generated total net revenue of $3.0 million and incurred a net loss of $7.8 million. As of December 31, 2007, our accumulated deficit was $81.8 million. Since our inception, we have not been profitable. We expect to continue to incur net losses for the foreseeable future.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our financial statements which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of our financial statements requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Actual results could differ materially from those estimates.

There have been no significant changes in our critical accounting estimates during the three and six months ended December 31, 2007 as compared to the critical accounting estimates disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended June 30, 2007.

Results of Operations

Comparison of the three months ended December 31, 2007 and 2006

Net Revenue.Total net revenue increased by $766,000, or 83%, to $1.7 million for the three months ended December 31, 2007 compared to $928,000 for the same period in 2006. Product revenue increased by $867,000, or 208%, to $1.3 million for the three months ended December 31, 2007 compared to $416,000 for the same period in 2006. The increase in product revenue for the three months ended December 31, 2007 reflected higher C-Port xA and C-Port Flex A system sales in the United States and Europe. Product revenue for the three-month period ended December 31, 2006 included no C-Port Flex A system sales and only limited C-Port xA system sales as the C-Port Flex A was not cleared by the FDA until March 2007 and the C-Port xA was not cleared by the FDA until November 2006.

Product revenue for the three-month period ended December 31, 2006 was negatively impacted by the voluntary recall of 55 units of our C-Port xA system shipped to our customers due to a supplier manufacturing defect in a single component. Only a portion of the C-Port xA systems in specific manufacturing lots was affected. The voluntary recall was not based on any customer complaint.

Development revenue was $395,000 and $500,000 for the three-month periods ended December 31, 2007 and 2006, respectively. The development revenue for the three-month period ended December 31, 2007 was comprised of $258,000 for development activities for the Cook Vascular Closure Device under our development agreement with Cook, and $137,000 for development activities on the PFO project also under a development agreement with Cook.

Development revenue of $500,000 for the three-month period ended December 31, 2006 was comprised of the payment from Cook for the achievement of the third milestone in the development of the Cook Vascular Closure Device under our development agreement with Cook. The achievement of the milestone was based upon the completion to Cook’s satisfaction of certain deliverables under the development agreement.

Cost of Product Revenue.Cost of product revenue consists primarily of material, labor and overhead costs. Cost of product revenue increased $315,000, or 36%, to $1.2 million for the three months ended December 31, 2007 compared to $884,000 for the same period in 2006. The increase in costs in the three months ended December 31, 2007 was primarily attributable to increased product sales. The costs in the three-month period ended December 31, 2006 included $205,00 for write-offs of excess C-Port inventories, $93,000 for write-offs of C-Port xA inventories as a result of the announced product recall as well as increased scrap expenses on production of the C-Port systems.

Research and Development Expense.Research and development expenses consist primarily of personnel costs within our product development, regulatory and clinical groups and the costs of clinical trials. Research and development expenses increased by $85,000, or 5%, to $1.7 million for the three months ended December 31, 2007 compared to $1.7 million for the same period in 2006. The increase in costs for the three-month period ended December 31, 2007 was attributable to increases in personnel related costs of $242,000, increased non-cash stock compensation expenses of $75,000, offset in part by lower facility related expenses of $104,000 and lower tooling expenses of $58,000 due to timing of the activities to support the development projects for Cook.

Selling, General and Administrative Expense.Selling, general and administrative expenses consist primarily of stock-based compensation charges, administrative and sales and marketing personnel, intellectual property and marketing expenses. Selling, general and administrative expenses increased $973,000, or 44%, to $3.2 million for the three months ended December 31, 2007 compared to $2.2 million for the same period in 2006. The increase in expenses in the three-month period ended December 31, 2007 was attributable to higher sales and marketing activities as the result of building a field sales force in the United States to sell C-Port xA and C-Port Flex A systems, including increased personnel related expenses of $402,000, increased travel expenses of $176,000, in addition, higher public company expenses of $130,000, offset in part by lower legal expenses of $63,000.

Interest Income. Interest income decreased $15,000, or 5%, to $283,000 for the three months ended December 31, 2007 compared to $298,000 for the same period in 2006. The decrease in interest income for the three months ended December 31, 2007 was primarily due to lower average cash and short-term investment balances available for investing during the period.

Interest Expense.Interest expense decreased $107,000, or 81%, to $25,000 for the three months ended December 31, 2007 compared to $132,000 for the same period in 2006 The decrease in interest expense for the three months ended December 31, 2007 was due to lower average long-term debt balances during the period as a result of the elimination of the related party debt of $10.3 million in 2006.

Gain on early retirement of notes payable to related party.Gain on early retirement of notes payable to related party of $1.2 million for the three-month period ended December 31, 2006 resulted from the lower market value of the 1,432,550 shares of common stock issued to Guidant at a conversion price of $5.00 per share in connection with the conversion of outstanding notes in the aggregate principal amount of $7.2 million, offset in part by $250,000 of expense paid. The closing market price of the common stock on the delivery date was $4.00 per share.

Comparison of the six months ended December 31, 2007 and 2006

Net Revenue.Total net revenue increased by $1.6 million, or 118%, to $3.0 million for the six months ended December 31, 2007 compared to $1.4 million for the same period in 2006. Product revenue increased by $1.4 million, or 164%, to $2.3 million for the six months ended December 31, 2007 compared to $874,000 for the same period in 2006. The increase in product revenue for the six months ended December 31, 2007 reflected higher sales of the C-Port xA and C-Port Flex A systems in the United States and Europe and higher sales of the PAS-Port system in Japan. Product revenue for the six-month period ended December 31, 2006 did not include any C-Port Flex A system sales in the United States and only a limited number of C-Port xA system sales as the C-Port Flex A system was not cleared by the FDA until March 2007 and the C-Port xA system was not cleared by the FDA until November 2006.

Development revenue was $702,000 and $500,000 for the six-month periods ended December 31, 2007 and 2006, respectively. The development revenue for the six-month period ended December 31, 2007 was comprised of $496,000 for development activities for the Cook Vascular Closure Device under our development agreement with Cook, and $206,000 for development activities on the PFO project also under a development agreement with Cook.

Development revenue of $500,000 for the six-month period ended December 31, 2006 was comprised of the payment from Cook for the achievement of the third milestone in the development of the Cook Vascular Closure Device under our development agreement with Cook. The achievement of the milestone was based upon the completion to Cook’s satisfaction of certain deliverables under the development agreement.

Cost of Product Revenue.Cost of product revenue consists primarily of material, labor and overhead costs. Cost of product revenue increased $649,000, or 42%, to $2.2 million for the six months ended December 31, 2007 compared to $1.6 million for the same period in 2006. The increase in costs in the six months ended December 31, 2007 was primarily attributable to increased unit sales of our products during the period. Cost of product revenue in the six-month period ended December 31, 2006 included write-offs of excess C-Port inventories of $205,000, write-offs of C-Port xA inventories as a result of the announced product recall, higher scrap expenses on production of the C-Port and C-Port xA systems and a lower of cost or market reserve for Pas-Port systems of $112,000.

Research and Development Expense.Research and development expenses consist primarily of personnel costs within our product development, regulatory and clinical groups and the costs of clinical trials. Research and development expenses increased by $285,000, or 9%, to $3.4 million for the six months ended December 31, 2007 compared to $3.1 million for the same period in 2006. The increase in costs for the six-month period ended December 31, 2007 was attributable to increases in personnel related expenses of $357,000, higher non-cash compensation charges of $253,000 and higher clinical trial expenses of $129,000 primarily for the PAS-Port system, offset in part by lower facility related expenses of $182,000 and lower travel of $123,000 in support of the PAS-Port clinical trial.

We anticipate that research and development expenses will increase in absolute terms in future periods as we continue the clinical study for the PAS-Port system, continue to enhance our existing product lines and begin to develop new applications of our technology.

Selling, General and Administrative Expense.Selling, general and administrative expenses consist primarily of stock-based compensation charges, administrative and sales and marketing personnel, intellectual property and marketing expenses. Selling, general and administrative expenses increased $1.5 million, or 34%, to $5.7 million for the six months ended December 31, 2007 compared to $4.3 million for the same period in 2006. The increase in expenses in the six-month period ended December 31, 2007 was attributable to higher sales and marketing expenses to support a field sales activities in the United States to sell the C-Port xA and C-Port Flex A systems, including increased personnel related expenses of $734,000, higher travel of $251,000, in addition, higher public company expenses of $135,000, offset in part by a decrease in legal expenses of $134,000.

We expect selling, general and administrative expenses to increase as we expand our sales and marketing efforts and continue to address the requirements of being a public company, including costs associated with compliance with Section 404 of the Sarbanes-Oxley Act of 2002.

Interest Income. Interest income decreased $134,000, or 20%, to $553,000 for the six months ended December 31, 2007 compared to $687,000 for the same period in 2006. The decrease in interest income for the six months ended December 31, 2007 was primarily due to lower average cash and short-term investment balances available for investing.

Interest Expense.Interest expense decreased $346,000, or 87%, to $50,000 for the six months ended December 31, 2007 compared to $396,000 for the same period in 2006. The decrease in interest expense for the six months ended December 31, 2007 was due to lower average loan balances as a result of the elimination of the related party debt of $10.3 million in November 2006.

Gain on early retirement of notes payable to related party.Gain on early retirement of notes payable to related party of $1.2 million for the six-month period ended December 31, 2006 resulted from the lower market value of the 1,432,550 shares of common stock issued to Guidant at a conversion price of $5.00 per share in connection with the conversion of outstanding notes in the aggregate principal amount of $7.2 million offset in part by $250,000 of expense paid. The closing market price of the common stock on the delivery date was $4.00 per share.

Liquidity and Capital Resources

As of December 31, 2007, our accumulated deficit was $81.8 million. We currently invest our cash and cash equivalents in large money market funds and our short-term investments primarily in debt instruments of the U.S. government, its agencies and high-quality corporate issuers. Since inception, we have financed our operations primarily through private sales of convertible preferred stock, long-term notes payable and public and private sales of common stock.

On November 14, 2007, we sold 1,500,000 shares of our common stock, and Guidant Investment Corporation sold 2,575,795 shares of our common stock, in a public offering for aggregate gross proceeds of $12.8 million. After deducting the underwriters’ commissions and discounts and other issuance costs, we received net proceeds of approximately $11.6 million. On December 13, 2007, we sold an additional 481,170 shares of our common stock to the underwriters pursuant to the exercise of the over-allotment. We received aggregate gross proceeds of $4.1 million from the exercise of the underwriters’ over-allotment option. After deducting the underwriters’ commission and associated expenses, we received from the exercise of the underwriters’ over-allotment option net proceeds of approximately $3.8 million.

As of December 31, 2007, except for operating leases, we did not have any off-balance sheet liabilities. We had cash, cash equivalents and short-term investments of $30.9 million as of December 31, 2007.

We extended our current facility lease in December 2007. The following table discloses aggregate information, as of December 31, 2007, about our contractual obligations and the periods in which payments are due (in thousands):


			Less than 1				More than
Contractual Obligations	Total		Year		1-3 Years		3 Years
Operating lease — real estate	$	2,775	$	613	$	1,658	$	504
Note payable, including interest		2,303		108		2,195		—

Total	$	5,078	$	721	$	3,853	$	504

The commitments under operating leases shown above consist of payments related to our real estate leases for our headquarters in Redwood City, California expiring in 2011.

The note payable was originally issued in connection with our Japan Distribution Agreement with Century Medical, Inc. in June 2003. We extended the distribution agreement and restructured the $3.0 million note payable in March 2007 and paid $1.0 million in April 2007. The remaining $2.0 million is due in June 2010. The note bears interest at 5% per annum through June 2008 and then increases to 6% per annum until maturity in June 2010. All interest due is payable quarterly. The holder of the note has a continuing security interest in all of our personal property and assets, including intellectual property.

Summary cash flow data is as follows (in thousands):


	Six months ended
	December 31,
	2007			2006
Net cash used in operating activities	$	(7,026	)	$	(9,560	)
Net cash (used in) provided by investing activities		(6,956	)		16,020
Net cash provided by (used in) financing activities		15,453			(2,909	)

Net cash used in operating activities for the six-month periods ended December 31, 2007 and 2006 was $7.0 million and $9.6 million, respectively. The use of cash for the six months ended December 31, 2007 was attributable to our net loss adjusted for non-cash stock-based compensation charges and depreciation, an increase in accounts receivable reflecting increased product revenues and a decrease in accounts payable and other accrued liabilities resulting from payments made for professional services and $360,000 to Allen & Company (a related-party) for advisory services. The use of cash for the six months ended December 31, 2006 was attributable to our net loss and a $1.4 million gain on early retirement of notes payable to Guidant Investment Corporation (“Guidant”), a related party, adjusted for non-cash stock-based compensation charges and depreciation, a payment made to Guidant of interest payable of $2.3 million, a decrease in accounts payable and other accrued liabilities and an increase in inventories, offset in part by a decrease in prepaid expenses due to the amortization of insurances to operating expense.

Net cash used in investing activities for the six-month period ended December 31, 2007 was $7.0 million compared to net cash provided by investing activities for the six-month period ended December 31, 2006 of $16.0 million. Net cash used or provided by investing activities represents the net purchases, sales and maturities of investments and purchases of property and equipment. Net cash used by investing activities for the six months ended December 31, 2007 was primarily related to net purchases of investments as a result of increased cash available for investing received from the public offering in November 2007. The increase in net cash provided by investing activities for the six months ended December 31, 2006 was primarily related to the net maturities of investments used to fund our operating losses. Purchases of property and equipment were $956,000 and $230,000 in the six-month periods ended December 31, 2007 and 2006, respectively. The increase in purchases of property and equipment in the six-month period ended December 31, 2007 was primarily related to higher expenditures for molds and tooling used to make our products.

Net cash provided by financing activities for the six-month period ended December 31, 2007 was $15.5 million compared to net cash used in financing activities of $2.9 million for the six-month period ended December 31, 2006. Net cash provided by financing activities for the six-month period ended December 31, 2007 was primarily from proceeds received from the sale of common stock in the November 2007 public offering and from the underwriters’ exercise of the over-allotment during the period. Net cash

used by financing activities for the six months ended December 31, 2006 consisted primarily of $3.1 million paid in cash to Guidant to retire a portion of notes payable and $250,000 paid for advisement services in conjunction with the retirement of the notes payable.

Our future capital requirements depend upon numerous factors. These factors include but are not limited to the following:

	•		market acceptance and adoption of our products;

	•		our revenue growth;

	•		costs associated with our sales and marketing initiatives and manufacturing activities;

	•		costs of obtaining and maintaining FDA and other regulatory clearances and approvals for our products;

	•		securing, maintaining and enforcing intellectual property rights and the cost thereof;

	•		costs of developing marketing and distribution capabilities;

	•		the extent of our ongoing research and development programs;

	•		the progress and results of clinical trials; and

	•		the effects of competing technological and market developments.

We believe that our existing cash, cash equivalents and short-term investments, along with the cash that we expect to generate from operations, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures through June 30, 2009. If these sources of cash are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities, obtain a credit facility or enter into development or license agreements with third parties. The sale of additional equity or convertible debt securities could result in dilution to our stockholders. If additional funds are raised through the issuance of debt securities, these securities could have rights senior to those associated with our common stock and could contain covenants that would restrict our operations. Any corporate collaboration or licensing arrangements may require us to relinquish valuable rights. Additional financing may not be available at all, or in amounts or upon terms acceptable to us. If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate our commercialization efforts or one or more of our research and development programs.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The primary objective of our investment activities is to preserve our capital for the purpose of funding operations while at the same time maximizing the income we receive from our investments without significantly increasing risk. To achieve these objectives, our investment policy allows us to maintain a portfolio of cash equivalents and short-term investments in a variety of securities, including auction rate preferred securities, corporate debt securities and debt instruments of the U.S. Government and its agencies. Due to the short-term nature of these instruments, a 1% movement in market interest rates would not have a significant impact on the total value of our portfolio as of December 31, 2007.

We do not utilize derivative financial instruments, derivative commodity instruments or other market risk-sensitive instruments, positions or transactions to any material extent. Accordingly, we believe that, while the instruments we hold are subject to changes in the financial standing of the issuer of such securities, we are not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments.

Although substantially all of our sales and purchases are denominated in U.S. dollars, future fluctuations in the value of the U.S. dollar may affect the price competitiveness of our products outside the United States. We do not believe, however, that we currently have significant direct foreign currency exchange rate risk and have not hedged exposures denominated in foreign currencies.

ITEM 4T. CONTROLS AND PROCEDURES

Evaluation of Effectiveness of Disclosure Controls and Procedures

Based on their evaluation as of December 31, 2007, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a—15(e) and 15d—15(e) of the Securities Exchange Act of 1934, as amended) were effective.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended December 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls

Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II. OTHER INFORMATION

ITEM 1A. RISK FACTORS

Our business is subject to the risks set forth below.

Risks Related to Our Business

We are dependent upon the success of our current products, and we have U.S. regulatory clearance for our C-Port, C-Port xA and C-Port Flex A systems only. We cannot be certain that any of our other products will receive regulatory clearance or approval or that any of our products, including the C-Port xA or C-port Flex A systems, will be successfully commercialized in the United States. If we are unable to successfully commercialize our products in the United States, or experience significant delays in doing so, our ability to generate revenue will be significantly delayed or halted, and our business will be harmed.

We have expended significant time, money and effort in the development of our current products, the C-Port xA and C-Port Flex A systems, and the PAS-Port system. While we have received regulatory approval for the commercial sale of, and currently sell our C-Port xA and C-Port Flex A systems in the United States and in the European Union and of our PAS-Port system in the European Union and Japan, we do not have clearance or approval in the United States for the PAS-Port system, later generations of the C-Port xA or C-Port Flex A systems or any other product. While we believe most of our revenue in the near future will be derived from the sales and distribution of the C-Port xA and C-Port Flex A systems, we anticipate that our ability to increase our revenue in the longer term will depend on the regulatory clearance or approval and commercialization of the PAS-Port system and later generations of the C-Port xA or C-Port Flex A systems in the United States.

If we are not successful in commercializing our C-Port xA or C-Port Flex A systems or obtaining U.S. Food and Drug Administration, or FDA, clearance or approval of either our later generations of the C-Port xA or C-Port Flex A systems or the current generation of the PAS-Port system, or if FDA clearance or approval of any of our products is significantly delayed, we may never generate substantial revenue, our business, financial condition and results of operations would be materially and adversely affected, and we may be forced to cease operations. We commenced sales of our C-Port xA system in December 2006 (after introduction of our original C-Port system in January 2006), and our C-Port Flex A in April 2007 but sales may not meet our expectations. Although we have other products under development, we may never obtain regulatory clearance or approval of those devices. We may be required to spend significant amounts of capital or time to respond to requests for additional information by the FDA or foreign regulatory bodies or may otherwise be required to spend significant amounts of time and money to obtain FDA clearance or approval and foreign regulatory approval. Imposition of any of these requirements could substantially delay or preclude us from marketing our products in the United States or foreign countries.

A prior automated cardiac proximal anastomosis system was introduced by another manufacturer but was withdrawn from the market, and, as a result, we may experience difficulty in commercializing our C-Port xA, C-Port Flex A and PAS-Port systems.

A prior automated proximal anastomosis device was introduced by another manufacturer in the United States in 2002. The FDA received reports of apparently device-related adverse events, and in 2004, the device was voluntarily withdrawn from the market by the manufacturer. Because of the FDA’s experience with this prior device, the FDA has identified new criteria for the clinical data required to obtain clearance for a proximal anastomosis device like the PAS-Port. We may not be able to show that the PAS-Port satisfies these criteria, and we may therefore be unable to obtain FDA clearance or approval to market the device in the United States, which would substantially harm our business and prospects. Moreover, physicians who have experience with or knowledge of prior anastomosis devices may be predisposed against using our C-Port xA, C-Port Flex A or PAS-Port products, which could limit our ability to commercialize them if they are approved by the FDA. If we fail to achieve market adoption, our business, financial condition and results of operations would be materially harmed.

Lack of third-party coverage and reimbursement for our products could delay or limit their adoption.

We may experience limited sales growth resulting from limitations on reimbursements made to purchasers of our products by third-party payors, and we cannot assure you that our sales will not be impeded and our business harmed if third-party payors fail to provide reimbursement that hospitals view as adequate.

In the United States, our products will be purchased primarily by medical institutions, which then bill various third-party payors, such as the Centers for Medicare & Medicaid Services, or CMS, which administer the Medicare program, and other government programs and private insurance plans, for the health care services provided to their patients. The process involved in applying for coverage and incremental reimbursement from CMS is lengthy and expensive. Under current CMS reimbursement policies, CMS offers a process to obtain add-on payment for a new medical technology when the existing Diagnosis-Related Group, or 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. In November 2006, CMS denied our request for an add-on payment. According to CMS, we met the “new” criteria and exceeded the payment threshold but did not in their view demonstrate substantial improvement in care. Even if our products receive FDA and other regulatory clearance or approval, they may not be granted coverage and reimbursement in the foreseeable future, if at all. Moreover, many private payors look to CMS in setting their reimbursement policies and amounts. If CMS or other agencies limit coverage or decrease or limit reimbursement payments for doctors and hospitals, this may affect coverage and reimbursement determinations by many private payors.

We cannot assure you that CMS will provide coverage and reimbursement for our products. If a medical device does not receive incremental reimbursement from CMS, then a medical institution would have to absorb the cost of our products as part of the cost of the procedure in which the products are used. Acute care hospitals are now generally reimbursed by CMS for inpatient operating costs under a Medicare hospital inpatient prospective payment system. Under the Medicare hospital inpatient prospective payment system, acute care hospitals receive a fixed payment amount for each covered hospitalized patient based upon the DRG to which the inpatient stay is assigned, regardless of the actual cost of the services provided. At this time, we do not know the extent to which medical institutions would consider insurers’ payment levels adequate to cover the cost of our products. Failure by hospitals and physicians to receive an amount that they consider to be adequate reimbursement for procedures in which our products are used could deter them from purchasing our products and limit our revenue growth. In addition, pre-determined DRG payments may decline over time, which could deter medical institutions from purchasing our products. If medical institutions are unable to justify the costs of our products, they may refuse to purchase them, which would significantly harm our business.

We have limited data regarding the safety and efficacy of the PAS-Port, C-Port xA and C-Port Flex A and have only recently begun training physicians in the United States to use the C-Port xA and C-Port Flex A systems. Any data that is generated in the future may not be positive or consistent with our existing data, which would affect market acceptance and the rate at which our devices are adopted.

The C-Port xA, C-Port Flex A and PAS-Port systems are innovative products, and our success depends upon their acceptance by the medical community as safe and effective. An important factor upon which the efficacy of the C-Port xA, C-Port Flex A and PAS-Port will be measured is long-term data regarding the duration of patency, or openness, of the artery or the graft vessel. Equally important will be physicians’ perceptions of the safety of our products. Our technology is relatively new in cardiac bypass surgery, and the results of short-term clinical experience of the C-Port, C-Port xA, C-Port Flex A and PAS-Port systems do not necessarily predict long-term clinical benefit. We believe that physicians will compare long-term

patency for the C-Port, C-Port xA, C-Port Flex A and PAS-Port devices against alternative procedures, such as hand-sewn anastomoses. If the long-term rates of patency do not meet physicians’ expectations, or if physicians find our devices unsafe, the C-Port xA, C-Port Flex A and PAS-Port systems may not become widely adopted and physicians may recommend alternative treatments for their patients. In addition, we have recently begun training physicians in the United States to use our C-Port, C-Port xA and C-Port Flex A systems. Any adverse experiences of physicians using the C-Port xA, or C-Port Flex A systems, or adverse outcomes to patients, may deter physicians from using our products and negatively impact product adoption.

Our C-Port, C-Port xA, C-Port Flex A and PAS-Port systems were designed for use with venous grafts. Additionally, while our indications for use of the C-Port system cleared by the FDA refer broadly to grafts, we have studied the use of the C-Port systems only with venous grafts and not with arterial grafts. Using the C-Port systems with arterial grafts may not yield patency rates or material adverse cardiac event rates comparable to those found in our clinical trials using venous grafts, which could negatively affect market acceptance of our C-Port systems. In addition, the clips and staples deployed by our products are made of 316L medical-grade stainless steel, to which some patients are allergic. These allergies may result in adverse reactions that negatively affect the patency of the anastomoses or the healing of the implants and may therefore adversely affect outcomes, particularly when compared to anastomoses performed with other materials, such as sutures. Additionally, in the event a surgeon, during the course of surgery, determines that it is necessary to convert to a hand-sewn anastomosis and to remove an anastomosis created by one of our products, the removal of the implants may result in more damage to the target vessel (such as the aorta or coronary artery) than would typically be encountered during removal of a hand-sewn anastomosis. Moreover, the removal may damage the target vessel to an extent that could further complicate construction of a replacement hand-sewn or automated anastomosis, which could be detrimental to patient outcome. These or other issues, if experienced, could limit physician adoption of our products.

Even if the data collected from future clinical studies or clinical experience indicates positive results, each physician’s actual experience with our devices outside the clinical study setting may vary. Clinical studies conducted with the C-Port, C-Port xA, C-Port Flex A and PAS-Port systems have involved procedures performed by physicians who are technically proficient, high-volume users of the C-Port, C-Port xA, C-Port Flex A and PAS-Port systems. Consequently, both short- and long-term results reported in these studies may be significantly more favorable than typical results of practicing physicians, which could negatively impact rates of adoption of the C-Port xA, C-Port Flex A and PAS-Port systems.

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

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

	•		the FDA or other regulatory authorities suspend or place on hold a clinical trial, or do not approve a clinical trial protocol or a clinical trial;

	•		the data and safety monitoring committee of a clinical trial recommends that a trial be placed on hold or suspended;

	•		patients do not enroll in clinical trials at the rate we expect;

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

	•		clinical trial sites decide not to participate or cease participation in a clinical trial;

	•		patients experience adverse side effects or events related to our products;

	•		patients die or suffer adverse medical effects during a clinical trial for a variety of reasons, which may not be related to our product candidates, including the advanced stage of their disease and medical problems,;

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

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

	•		third-party suppliers fail to provide us with critical components that conform to design and performance specifications;

	•		the failure of our manufacturing process to produce finished products that conform to design and performance specifications;

	•		changes in governmental regulations or administrative actions;

	•		the interim results of the clinical trial are inconclusive or negative;

	•		pre-clinical or clinical data is interpreted by third parties in different ways; or

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

Clinical trials sometimes experience delays related to outcomes experienced during the course of the trials. For example, in our PAS-Port pivotal trial, we recently had an administrative hold of the trial related to an adverse event, which lasted approximately 72 hours while the adverse event was investigated. The data safety monitoring board subsequently concluded that there was no clear evidence that our device had caused the adverse event and enrollment continued. While this event was resolved in a timely manner and did not result in any material delay in the trial, future similar or other types of events could lead to more significant delays or other effects on the trial.

Clinical trials may require the enrollment of large numbers of patients, and suitable patients may be difficult to identify and recruit. Patient enrollment in clinical trials and completion of patient follow-up in clinical trials depend on many factors, including the size of the patient population, the nature of the trial protocol, the proximity of patients to clinical sites and the eligibility criteria for the study and patient compliance. For example, patients may be discouraged from enrolling in our clinical trials if the trial protocol requires them to undergo extensive post-treatment procedures to assess the safety and effectiveness of our product candidates, or they may be persuaded to participate in contemporaneous trials of competitive products. Delays in patient enrollment or failure of patients to continue to participate in a study may cause an increase in costs and delays or result in the failure of the trial.

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

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

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

extended, delayed, suspended or terminated, and we may not be able to obtain regulatory approval for or successfully commercialize our product candidates on a timely basis, if at all.

Even though our C-Port xA and C-Port Flex A products have received U.S. regulatory clearance, our PAS-Port system, as well as our future products, may still face future development and regulatory difficulties.

Even though the current generation of the C-Port xA and C-Port Flex A systems have received U.S. regulatory clearance, the FDA may still impose significant restrictions on the indicated uses or marketing of this product or ongoing requirements for potentially costly post-clearance studies. Any of our other products, including the PAS-Port system and future generations of the C-Port xA and C-Port Flex A systems, may also face these types of restrictions or requirements. In addition, regulatory agencies subject a product, its manufacturer and the manufacturer’s facilities to continual review, regulation and periodic inspections. If a regulatory agency discovers previously unknown problems with a product, including adverse events of unanticipated severity or frequency, or problems with the facility where the product is manufactured, a regulatory agency may impose restrictions on that product, our collaborators or us, including requiring withdrawal of the product from the market. Our products will also be subject to ongoing FDA requirements for the labeling, packaging, storage, advertising, promotion, record-keeping and submission of safety and other post-market information on the product. If our products fail to comply with applicable regulatory requirements, a regulatory agency may impose any of the following sanctions:

	•		warning letters, fines, injunctions, consent decrees and civil penalties;

	•		customer notifications, repair, replacement, refunds, recall or seizure of our products;

	•		operating restrictions, partial suspension or total shutdown of production;

	•		delay in processing marketing applications for new products or modifications to existing products;

	•		withdrawing approvals that have already been granted; and

	•		criminal prosecution.

To market any products internationally, we must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods. The time required to obtain approval in other countries might differ from that required to obtain FDA clearance or approval. The regulatory approval process in other countries may include all of the risks detailed above regarding FDA clearance or approval in the United States. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may negatively impact the regulatory process in others. Failure to obtain regulatory approval in other countries or any delay or setback in obtaining such approval could have the same adverse effects detailed above regarding FDA clearance or approval in the United States, including the risk that our products may not be approved for use under all of the circumstances requested, which could limit the uses of our products and adversely impact potential product sales, and that such clearance or approval may require costly, post-marketing follow-up studies. If we fail to comply with applicable foreign regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecution.

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

From time to time, we may estimate and publicly announce the timing anticipated for the accomplishment of various clinical, regulatory and other product development goals, which we sometimes refer to as milestones. These milestones may include an Investigational Device Exemption application to commence our enrollment of patients in our clinical trials, the release of data from our clinical trials, receipt

of clearances or approvals from regulatory authorities or other clinical and regulatory events. These estimates are based on a variety of assumptions. The actual timing of these milestones can vary dramatically compared to our estimates, in some cases for reasons beyond our control. If we do not meet these milestones as publicly announced, the commercialization of our products may be delayed and, as a result, our stock price may decline.

Our products may never gain any significant degree of market acceptance, and a lack of market acceptance would have a material adverse effect on our business.

We cannot assure you that our products will gain any significant degree of market acceptance among physicians or patients, even if necessary regulatory and reimbursement approvals are obtained. We believe that recommendations by physicians will be essential for market acceptance of our products; however, we cannot assure you that any recommendations will be obtained. Physicians will not recommend the products unless they conclude, based on clinical data and other factors, that the products represent a safe and acceptable alternative to other available options. In particular, physicians may elect not to recommend using our products in surgical procedures until such time, if ever, as we successfully demonstrate with long-term data that our products result in patency rates comparable to or better than those achieved with hand-sewn anastomoses, and we resolve any technical limitations that may arise.

We believe graft patency will be a significant factor for physician recommendation of our products. Although we have not experienced low patency rates in our clinical trials, graft patency determined during the clinical trials conducted by us or other investigators may not be representative of the graft patency actually encountered during commercial use of our products. The surgical skill sets of investigators in our clinical trials may not be representative of the skills of future product users, which could negatively affect graft patency. In addition there may have been a selection bias in the patients, grafts and target vessels used during the clinical trials that positively affected graft patency. The patients included in the clinical trials may not be representative of the general patient population in the United States, which may have resulted in improved graft patency in patients enrolled in the clinical trials. Finally, patient compliance in terms of use of prescribed anticlotting medicines may have been higher in clinical trials than may occur during commercial use, thereby negatively affecting graft patency during commercial use.

Market acceptance of our products also depends on our ability to demonstrate consistent quality and safety of our products. For example, in the second quarter of fiscal year 2007 we initiated a voluntary recall of 55 units of our C-Port xA device from specific manufacturing lots. Internal testing had revealed a supplier manufacturing defect in a single component of the device in the most recently received incoming lots of this component. Only a portion of the C-Port xA devices in specific manufacturing lots were affected. A portion of the devices manufactured in the affected lots was utilized in patients prior to the recall. While we believe the altered product does not present a hazard to patients, we may incur liabilities to patients in connection with these devices. This recall may impact physicians’ perception of our products.

Widespread use of our products will require the training of numerous physicians, and the time required to complete training could result in a delay or dampening of market acceptance. Even if the safety and efficacy of our products is established, physicians may elect not to use our products for a number of reasons beyond our control, including inadequate or no reimbursement from health care payors, physicians’ reluctance to perform anastomoses with an automated device, the introduction of competing devices by our competitors and pricing for our products. Failure of our products to achieve any significant market acceptance would have a material adverse effect on our business, financial condition and results of operations.

Because one customer accounts for a substantial portion of our product revenue, the loss of this significant customer would cause a substantial decline in our revenue.

We derive a substantial portion of our revenue from sales to Century Medical,Inc., or Century, our distributor in Japan. The loss of Century as a customer would cause a decrease in revenue and, consequently, an increase in net loss. For the six-month periods ended December 31, 2007 and 2006, sales to Century accounted for approximately 22% and 53%, respectively, of our total product revenue. We

expect that Century will continue to account for a substantial portion of our revenue in the near term. As a result, if we lose Century as a customer, our revenue and net loss would be adversely affected. In addition, customers that have accounted for significant revenue in the past may not generate revenue in any future period. The failure to obtain new significant customers or additional orders from existing customers will materially affect our operating results.

If our competitors have products that are approved in advance of ours, marketed more effectively or demonstrated to be more effective than ours, our commercial opportunity will be reduced or eliminated and our business will be harmed.

The market for anastomotic solutions and cardiac bypass products is competitive. Competitors include a variety of public and private companies that currently offer or are developing cardiac surgery products generally and automated anastomotic systems specifically that would compete directly with ours.

We believe that the primary competitive factors in the market for medical devices used in the treatment of coronary artery disease include:

	•		improved patient outcomes;

	•		access to and acceptance by leading physicians;

	•		product quality and reliability;

	•		ease of use;

	•		device cost-effectiveness;

	•		training and support;

	•		novelty;

	•		physician relationships; and

	•		sales and marketing capabilities.

We may be unable to compete successfully on the basis of any one or more of these factors, which could have a material adverse affect on our business, financial condition and results of operations.

A number of different technologies exist or are under development for performing anastomoses, including sutures, mechanical anastomotic devices, suture-based anastomotic devices and shunting devices. Currently, substantially all anastomoses are performed with sutures and, for the foreseeable future we believe that sutures will continue to be the principal alternative to our anastomotic products. Sutures are far less expensive than our automated anastomotic products, and other anastomotic devices may be less expensive than our own. Surgeons, who have been using sutures for their entire careers, may be reluctant to consider alternative technologies, despite potential advantages. Any resistance to change among practitioners could delay or hinder market acceptance of our products, which would have a material adverse effect on our business.

Cardiovascular diseases may also be treated by other methods that do not require anastomoses, including, interventional techniques such as balloon angioplasty with or without the use of stents, pharmaceuticals, atherectomy catheters and lasers. Several of these alternative treatments are widely accepted in the medical community and have a long history of use. In addition, technological advances with other therapies for cardiovascular disease, such as drugs, or future innovations in cardiac surgery techniques could make other methods of treating this disease more effective or lower cost than bypass procedures. For example, the number of bypass procedures in the United States and other major markets has declined in recent years and is expected to decline in the years ahead because competing treatments are, in many cases, far less invasive and provide acceptable clinical outcomes. Many companies working on

treatments that do not require anastomoses may have significantly greater financial, manufacturing, marketing, distribution and technical resources and experience than we have. Many of our competitors have significantly greater financial resources and expertise in research and development, manufacturing, pre-clinical testing, clinical trials, obtaining regulatory clearance or approval and marketing approved products than we do. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. Our competitors may succeed in developing technologies and therapies that are more effective, better tolerated or less costly than any that we are developing or that would render our product candidates obsolete and noncompetitive. Our competitors may succeed in obtaining clearance or approval from the FDA and foreign regulatory authorities for their products sooner than we do for ours. We will also face competition from these third parties in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient enrollment for clinical trials and in acquiring and in-licensing technologies and products complementary to our programs or advantageous to our business.

We have limited manufacturing experience and may encounter difficulties in increasing production to provide an adequate supply to customers.

To date, our manufacturing activities have consisted primarily of producing limited quantities of our products for use in clinical studies and for commercial sales in Japan, Europe and the United States. Production in commercial quantities will require us to expand our manufacturing capabilities and to hire and train additional personnel. We may encounter difficulties in increasing our manufacturing capacity and in manufacturing larger commercial quantities, including:

	•		maintaining product yields;

	•		maintaining quality control and assurance;

	•		providing component and service availability;

	•		maintaining adequate control policies and procedures; and

	•		hiring and retaining qualified personnel.

Difficulties encountered in increasing our manufacturing could have a material adverse effect on our business, financial condition and results of operations.

The manufacture of our products is a complex and costly operation involving a number of separate processes and components. In addition, the current unit costs for our products, based on limited manufacturing volumes, are very high, and it will be necessary to achieve economies of scale to become profitable. Certain of our manufacturing processes are labor intensive, and achieving significant cost reductions will depend in part upon reducing the time required to complete these processes. We cannot assure you that we will be able to achieve cost reductions in the manufacture of our products and, without these cost reductions, our business may never achieve profitability.

We have considered, and will continue to consider as appropriate, manufacturing in-house certain components currently provided by third parties, as well as implementing new production processes. Manufacturing yields or costs may be adversely affected by the transition to in-house production or to new production processes, when and if these efforts are undertaken, which would materially and adversely affect our business, financial condition and results of operations.

Our manufacturing facilities, and those of our suppliers, must comply with applicable regulatory requirements. Failure to obtain regulatory approval of our manufacturing facilities would harm our business and our results of operations.

Our manufacturing facilities and processes are subject to periodic inspections and audits by various U.S. federal, U.S. state and foreign regulatory agencies. For example, our facilities have been inspected by State of California regulatory authorities pursuant to granting a California Device Manufacturing License,

but not, to date, by the FDA. Additionally, to market products in Europe, we are required to maintain ISO 13485:2003 certification and are subject to periodic surveillance audits. We are currently ISO 13485:2003 certified; however, our failure to maintain necessary regulatory approvals for our manufacturing facilities could prevent us from manufacturing and selling our products.

Additionally, our manufacturing processes and, in some cases, those of our suppliers are required to comply with FDA’s Quality System Regulation, or QSR, which covers the procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, storage and shipping of our products, including the PAS-Port, C-Port xA and C-Port Flex A systems. We are also subject to similar state requirements and licenses. In addition, we must engage in extensive record keeping and reporting and must make available our manufacturing facilities and records for periodic inspections by governmental agencies, including FDA, state authorities and comparable agencies in other countries. If we fail a QSR inspection, our operations could be disrupted and our manufacturing interrupted. Failure to take adequate corrective action in response to an adverse QSR inspection could result in, among other things, a shut-down of our manufacturing operations, significant fines, suspension of product distribution or other operating restrictions, seizures or recalls of our device and criminal prosecutions, any of which would cause our business to suffer. Furthermore, our key component suppliers may not currently be or may not continue to be in compliance with applicable regulatory requirements, which may result in manufacturing delays for our products and cause our revenue to decline.

We may also be required to recall our products due to manufacturing supply defects. Our recall in fiscal 2007 had a negative impact on our revenue for the quarter ended December 31, 2006. If we issue additional recalls of our products in the future, our revenue and business could be further harmed.

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

We are in the beginning stages of building a sales and marketing organization, and we have limited experience as a company in the sales, marketing and distribution of our products. Century is responsible for marketing and commercialization of the PAS-Port system in Japan. To promote our current and future products in the United States and Europe, we must develop our sales, marketing and distribution capabilities or make arrangements with third parties to perform these services. Competition for qualified sales personnel is intense. Developing a sales force is expensive and time consuming and could delay any product launch. We may be unable to establish and manage an effective sales force in a timely or cost-effective manner, if at all, and any sales force we do establish may not be capable of generating sufficient demand for our products. To the extent that we enter into arrangements with third parties to perform sales and marketing services, our product revenue may be lower than if we directly marketed and sold our products. We expect to rely on third-party distributors for substantially all of our international sales. If we are unable to establish adequate sales and marketing capabilities, independently or with others, we may not be able to generate significant revenue and may not become profitable.

We will need to increase the size of our organization, and we may experience difficulties in managing this growth.

As of December 31, 2007, we had 73 employees. We will need to continue to expand our managerial, operational, financial and other resources to manage and fund our operations and clinical trials, continue our research and development activities and commercialize our products. It is possible that our management and scientific personnel, systems and facilities currently in place may not be adequate to support this future growth. Our need to effectively manage our operations, growth and programs requires that we continue to improve our operational, financial and management controls, reporting systems and procedures and to attract and retain sufficient numbers of talented employees. We may be unable to successfully implement these tasks on a larger scale and, accordingly, may not achieve our research, development and commercialization goals.

We are dependent upon a number of key suppliers, including single source suppliers, the loss of which would materially harm our business.

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 materials for use in implantable medical devices. We cannot assure you that materials required by us will not be restricted or that we will be able to obtain sufficient quantities of such materials or services in the future. Moreover, the continued use by us of materials manufactured by third parties could subject us to liability exposure. Because we do not have long-term contracts, none of our suppliers is required to provide us with any guaranteed minimum production levels.

We cannot quickly replace suppliers or establish additional new suppliers for some of these components, particularly due to both the complex nature of the manufacturing process used by our suppliers and the time and effort that may be required to obtain FDA clearance or approval 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 have a material adverse effect on our ability to manufacture our products and, therefore, a material adverse effect on our business, financial condition and results of operations.

We may in the future be a party to patent litigation and administrative proceedings that could be costly and could interfere with our ability to sell our products.

The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights, and companies in the industry have used intellectual property litigation to gain a competitive advantage. We may become a party to patent infringement claims and litigation or interference proceedings declared by the U.S. Patent and Trademark Office to determine the priority of inventions. The defense and prosecution of these matters are both costly and time consuming. Additionally, we may need to commence proceedings against others to enforce our patents, to protect our trade secrets or know-how or to determine the enforceability, scope and validity of the proprietary rights of others. These proceedings would result in substantial expense to us and significant diversion of effort by our technical and management personnel.

We are aware of patents issued to third parties that contain subject matter related to our technology. We cannot assure you that these or other third parties will not assert that our products and systems infringe the claims in their patents or seek to expand their patent claims to cover aspects of our products and systems. An adverse determination in litigation or interference proceedings to which we may become a party could subject us to significant liabilities or require us to seek licenses. In addition, if we are found to willfully infringe third-party patents, we could be required to pay treble damages in addition to other penalties. Although patent and intellectual property disputes in the medical device area have often been settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and could include ongoing royalties. We may be unable to obtain necessary licenses on satisfactory terms, if at all. If we do not obtain necessary licenses, we may be required to redesign our products to avoid infringement, and it may not be possible to do so effectively. Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling the C-Port xA, C-Port Flex A or PAS-Port systems or any other product we may develop, which would have a significant adverse impact on our business.

Intellectual property rights may not provide adequate protection, which may permit third parties to compete against us more effectively.

We rely upon patents, trade secret laws and confidentiality agreements to protect our technology and products. Our pending patent applications may not issue as patents or, if issued, may not issue in a form that will be advantageous to us. Any patents we have obtained or will obtain in the future might be invalidated or circumvented by third parties. If any challenges are successful, competitors might be able to market products and use manufacturing processes that are substantially similar to ours. We may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by consultants, vendors or former or current employees, despite the existence generally of confidentiality agreements and other contractual restrictions. Monitoring unauthorized use and disclosure of our intellectual property is difficult, and we do not know whether the steps we have taken to protect our

intellectual property will be adequate. In addition, the laws of many foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States. To the extent that our intellectual property protection is inadequate, we are exposed to a greater risk of direct competition. In addition, competitors could purchase any of our products and attempt to replicate some or all of the competitive advantages we derive from our development efforts or design around our protected technology. If our intellectual property is not adequately protected against competitors’ products and methods, our competitive position could be adversely affected, as could our business.

We also rely upon trade secrets, technical know-how and continuing technological innovation to develop and maintain our competitive position. We require our employees, consultants and advisors to execute appropriate confidentiality and assignment-of-inventions agreements with us. These agreements typically provide that all materials and confidential information developed or made known to the individual during the course of the individual’s relationship with us be kept confidential and not disclosed to third parties except in specific circumstances and that all inventions arising out of the individual’s relationship with us shall be our exclusive property. These agreements may be breached, and in some instances, we may not have an appropriate remedy available for breach of the agreements. Furthermore, our competitors may independently develop substantially equivalent proprietary information and techniques, reverse engineer our information and techniques, or otherwise gain access to our proprietary technology.

Our products face the risk of technological obsolescence, which, if realized, could have a material adverse effect on our business.

The medical device industry is characterized by rapid and significant technological change. There can be no assurance that third parties will not succeed in developing or marketing technologies and products that are more effective than ours or that would render our technology and products obsolete or noncompetitive. Additionally, new, less invasive surgical procedures and medications could be developed that replace or reduce the importance of current procedures that use our products. Accordingly, our success will depend in part upon our ability to respond quickly to medical and technological changes through the development and introduction of new products. The relative speed with which we can develop products, complete clinical testing and regulatory clearance or approval processes, train physicians in the use of our products, gain reimbursement acceptance, and supply commercial quantities of the products to the market are expected to be important competitive factors. Product development involves a high degree of risk, and we cannot assure you that our new product development efforts will result in any commercially successful products. We have experienced delays in completing the development and commercialization of our planned products, and there can be no assurance that these delays will not continue or recur in the future. Any delays could result in a loss of market acceptance and market share.

We may not be successful in our efforts to expand our product portfolio, and our failure to do so could cause our business and prospects to suffer.

We intend to use our knowledge and expertise in anastomotic technologies to discover, develop and commercialize new applications in endoscopic surgery, general vascular surgery or other markets. However, the process of researching and developing anastomotic devices is expensive, time-consuming and unpredictable. Our efforts to create products for these new markets are at a very early stage, and we may never be successful in developing viable products for these markets. Even if our development efforts are successful and we obtain the necessary regulatory and reimbursement approvals, we cannot assure you that these or our other products will gain any significant degree of market acceptance among physicians, patients or health care payors. Accordingly, we anticipate that, for the foreseeable future, we will be substantially dependent upon the successful development and commercialization of anastomotic systems and instruments for cardiac surgery, mainly the PAS-Port, C-Port xA and C-Port Flex A systems. Failure by us to successfully develop and commercialize these systems for any reason, including failure to overcome regulatory hurdles or inability to gain any significant degree of market acceptance, would have a material adverse effect on our business, financial condition and results of operations.

We may be subject, directly or indirectly, to federal and state healthcare fraud and abuse laws and regulations and, if we are unable to fully comply with such laws, could face substantial penalties.

Our operations may be directly or indirectly affected by various broad state and federal healthcare fraud and abuse laws, including the federal healthcare program Anti-Kickback Statute, which prohibit any person from knowingly and willfully offering, paying, soliciting or receiving remuneration, directly or indirectly, to induce or reward either the referral of an individual, or the furnishing or arranging for an item or service, for which payment may be made under federal healthcare programs, such as the Medicare and Medicaid programs. Foreign sales of our products are also subject to similar fraud and abuse laws, including application of the U.S. Foreign Corrupt Practices Act. If our operations, including any consulting arrangements we may enter into with physicians who use our products, are found to be in violation of these laws, we or our officers may be subject to civil or criminal penalties, including large monetary penalties, damages, fines, imprisonment and exclusion from Medicare and Medicaid program participation. If enforcement action were to occur, our business and financial condition would be harmed.

We could be exposed to significant product liability claims, which could be time consuming and costly to defend, divert management attention, and adversely impact our ability to obtain and maintain insurance coverage. The expense and potential unavailability of insurance coverage for our company or our customers could adversely affect our ability to sell our products, which would adversely affect our business.

The testing, manufacture, marketing, and sale of our products involve an inherent risk that product liability claims will be asserted against us. Additionally, we are currently training physicians in the United States on the use of our C-Port xA and C-Port Flex A systems. During training, patients may be harmed, which could also lead to product liability claims. Product liability claims or other claims related to our products, or their off-label use, regardless of their merits or outcomes, could harm our reputation in the industry, reduce our product sales, lead to significant legal fees, and result in the diversion of management’s attention from managing our business. As of February 4, 2008, we were not aware of any existing product liability claims.

Although we maintain product liability insurance in the amount of $5,000,000, we may not have sufficient insurance coverage to fully cover the costs of any claim or any ultimate damages we might be required to pay. We may not be able to obtain insurance in amounts or scope sufficient to provide us with adequate coverage against all potential liabilities. Any product liability claims brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing continuing coverage. Product liability claims in excess of our insurance coverage would be paid out of cash reserves, harming our financial condition and adversely affecting our financial condition and operating results.

Some of our customers and prospective customers may have difficulty in procuring or maintaining liability insurance to cover their operations and use of the C-Port xA, C-Port Flex A or PAS-Port systems. Medical malpractice carriers are withdrawing coverage in certain states or substantially increasing premiums. If this trend continues or worsens, our customers may discontinue using the C-Port xA, C-Port Flex A or PAS-Port systems and potential customers may opt against purchasing the C-Port xA, C-Port Flex A or PAS-Port systems due to the cost or inability to procure insurance coverage.

We sell our systems internationally and are subject to various risks relating to these international activities, which could adversely affect our revenue.

To date, a substantial portion of our product revenue has been attributable to sales in international markets. By doing business in international markets, we are exposed to risks separate and distinct from those we face in our domestic operations. Our international business may be adversely affected by changing economic conditions in foreign countries. Because most of our sales are currently denominated in U.S. dollars, if the value of the U.S. dollar increases relative to foreign currencies, our products could become more costly to the international customer and, therefore, less competitive in international markets, which could affect our results of operations. Engaging in international business inherently involves a number of other difficulties and risks, including:

	•		export restrictions and controls relating to technology;

	•		the availability and level of reimbursement within prevailing foreign healthcare payment systems;

	•		pricing pressure that we may experience internationally;

	•		required compliance with existing and changing foreign regulatory requirements and laws;

	•		laws and business practices favoring local companies;

	•		longer payment cycles;

	•		difficulties in enforcing agreements and collecting receivables through certain foreign legal systems;

	•		political and economic instability;

	•		potentially adverse tax consequences, tariffs and other trade barriers;

	•		international terrorism and anti-American sentiment;

	•		difficulties and costs of staffing and managing foreign operations; and

	•		difficulties in enforcing intellectual property rights.

Our exposure to each of these risks may increase our costs, impair our ability to market and sell our products and require significant management attention. We cannot assure you that one or more of these factors will not harm our business.

We are dependent upon key personnel, the loss of any of which could have a material adverse affect on our business.

Our business and future operating results depend significantly on the continued contributions of our key technical personnel and senior management, including those of our co-founder, CEO and President, Bernard Hausen, M.D., Ph.D. These services and individuals would be difficult or impossible to replace and none of these individuals is subject to a post-employment non-competition agreement. While we are subject to certain severance obligations to Dr. Hausen, either he or we may terminate his employment at any time and for any lawful reason or for no reason. Our business and future operating results also depend significantly on our ability to attract and retain qualified management, manufacturing, technical, marketing, sales and support personnel for our operations. Competition for such personnel is intense, and there can be no assurance that we will be successful in attracting or retaining such personnel. Additionally, although we have key-person life insurance in the amount of $3.0 million on the life of Dr. Hausen, we cannot assure you that this amount would fully compensate us for the loss of Dr. Hausen’s services. The loss of key employees, the failure of any key employee to perform or our inability to attract and retain skilled employees, as needed, could materially adversely affect our business, financial condition and results of operations.

Our operations are currently conducted at a single location that may be at risk from earthquakes, terror attacks or other disasters.

We currently conduct all of our manufacturing, development and management activities at a single location in Redwood City, California, near known earthquake fault zones. We have taken precautions to safeguard our facilities, including insurance, health and safety protocols, and off-site storage of computer data. However, any future natural disaster, such as an earthquake, or a terrorist attack, could cause substantial delays in our operations, damage or destroy our equipment or inventory and cause us to incur additional expenses. A disaster could seriously harm our business and results of operations. Our insurance does not cover earthquakes and floods and may not be adequate to cover our losses in any particular case.

If we use hazardous materials in a manner that causes injury, we may be liable for damages.

Our research and development and manufacturing activities involve the use of hazardous materials. Although we believe that our safety procedures for handling and disposing of these materials comply with federal, state and local laws and regulations, we cannot entirely eliminate the risk of accidental injury or contamination from the use, storage, handling or disposal of these materials. We do not carry specific hazardous waste insurance coverage, and our property and casualty and general liability insurance policies specifically exclude coverage for damages and fines arising from hazardous waste exposure or contamination. Accordingly, in the event of contamination or injury, we could be held liable for damages or penalized with fines in an amount exceeding our resources, and our clinical trials or regulatory clearances or approvals could be suspended or terminated.

We may be subject to fines, penalties or injunctions if we are determined to be promoting the use of our products for unapproved or “off-label” uses.

If our products receive FDA clearance or approval, our promotional materials and training methods regarding physicians will need to comply with FDA and other applicable laws and regulations. If the FDA determines that our promotional materials or training constitutes promotion of an unapproved use, it could request that we modify our training or promotional materials or subject us to regulatory enforcement actions, including the issuance of a warning letter, injunction, seizure, civil fine and/or criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our promotional or training materials to constitute promotion of an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement. In that event, our reputation could be damaged and adoption of our products would be impaired.

Risks Related to Our Finances and Capital Requirements

We have a history of net losses, which we expect to continue for the foreseeable future, and we are unable to predict the extent of future losses or when we will become profitable, if at all.

We have incurred net losses since our inception in October 1997. As of December 31, 2007, our accumulated deficit was approximately $81.8 million. We expect to incur substantial additional losses until we can achieve significant commercial sales of our products, which depend upon a number of factors, including increased commercial sales of our C-Port xA and C-Port Flex A systems in the United States and receipt of regulatory clearance or approval and market adoption of our additional products in the United States. We commenced commercial sales of the C-Port system in Europe in 2004 and in the United States in 2006 and the PAS-Port system in Japan in 2004, and our short commercialization experience makes it difficult for us to predict future performance. Our failure to accurately predict financial performance may lead to volatility in our stock price.

Our cost of product revenue was 96% and 179% of our net product revenue for the six-month periods ended December 31, 2007 and 2006, respectively. We expect to continue to have high costs of product revenue for the foreseeable future. In addition, we expect that our operating expenses will increase as we expand our commercialization efforts and devote resources to our sales and marketing, as well as conduct other research and development activities. If, over the long term, we are unable to reduce our cost of producing goods and expenses relative to our net revenue, we may not achieve profitability even if we are able to generate significant revenue from sales of the C-Port and PAS-Port systems. Our failure to achieve and sustain profitability would negatively impact the market price of our common stock.

We currently lack a significant source of product revenue, and we may not become or remain profitable.

Our ability to become and remain profitable depends upon our ability to generate product revenue. Our ability to generate significant continuing revenue depends upon a number of factors, including:

	•		achievement of U.S. regulatory clearance or approval for our additional products;

	•		successful completion of ongoing clinical trials for our products; and

•

successful sales, manufacturing, marketing and distribution of our products.

For the six-month periods ended December 31, 2007 and 2006, sales of our products and development activities generated only $3.0 million and $1.4 million, respectively. For fiscal year 2007, sales of our products and development activities generated only $3.5 million of revenue. For fiscal year 2006, sales of our products and development activities generated only $2.1 million of revenue. For fiscal year 2005, sales of our products and development activities generated only $2.1 million of revenue, 65% of which was from Guidant under agreements that are now terminated.

We do not anticipate that we will generate significant product revenue for the foreseeable future. If we are unable to generate significant product revenue, we will not become or remain profitable, and we may be unable to continue our operations.

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

Our development efforts have consumed substantial capital to date. We believe that our existing cash, cash equivalents and short-term investments, along with cash that we expect to generate from operations, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures through June 30, 2009. Because we do not anticipate that we will generate significant product revenue for the foreseeable future, if at all, we will need to raise substantial additional capital to finance our operations in the future. Our future liquidity and capital requirements will depend upon, and could increase significantly as a result of, numerous factors, including:

	•		market acceptance and adoption of our products;

	•		our revenue growth;

	•		costs associated with our sales and marketing initiatives and manufacturing activities;

	•		costs of obtaining and maintaining FDA and other regulatory clearances and approvals for our products;

	•		securing, maintaining and enforcing intellectual property rights and the costs thereof;

	•		the costs of developing marketing and distribution capabilities;

	•		the extent of our ongoing research and development programs;

	•		the progress and results of clinical trials; and

	•		effects of competing technological and market developments.

Until we can generate significant continuing revenue, if ever, we expect to satisfy our future cash needs through public or private equity offerings, debt financings or corporate collaboration and licensing arrangements, as well as through interest income earned on cash balances. We cannot be certain that additional funding will be available on acceptable terms, or at all. The sale of additional equity or convertible debt securities could result in dilution to our stockholders. If additional funds are raised through the issuance of debt securities, these securities could have rights senior to those associated with our common stock and could contain covenants that would restrict our operations. Any corporate collaboration or licensing arrangements may require us to relinquish valuable rights. If adequate funds are not available, we may be required to delay, reduce the scope of or eliminate our commercialization efforts or one or more of our research and development programs.

If we do not generate sufficient cash flow through increased revenue or raising additional capital, then we may not be able to meet our debt obligation that becomes due in 2010.

As of December 31, 2007, we had an aggregate principal amount of approximately $2.0 million in notes payable to Century that are due in June 2010. This substantial indebtedness has and may continue to impact us by:

	•		making it more difficult to obtain additional financing; and

	•		constraining our ability to react quickly in an unfavorable economic climate.

Currently we are not generating positive cash flow. Adverse occurrences related to our product commercialization, development and regulatory efforts would adversely impact our ability to meet our obligations to repay the principal amounts on our notes when due in 2010. If we are unable to satisfy our debt service requirements, we may not be able to continue our operations. We may not generate sufficient cash from operations to repay our notes or satisfy any additional debt obligations when they become due and may have to raise additional financing from the sale of equity or debt securities, enter into commercial transactions or otherwise restructure our debt obligations. There can be no assurance that any such financing or restructuring will be available to us on commercially acceptable terms, if at all. If we are unable to restructure our obligations, we may be forced to seek protection under applicable bankruptcy laws. Any restructuring or bankruptcy could materially impair the value of our common stock.

Existing creditors have rights to our assets that are senior to our stockholders.

An existing arrangement with our current lender Century, as well as future arrangements with other creditors, allow or may allow these creditors to liquidate our assets, which may include our intellectual property rights, if we are in default or breach of our debt obligations for a continued period of time. The proceeds of any sale or liquidation of our assets under these circumstances would be applied first to any of our debt obligations and would have priority over any of our capital stock. After satisfaction of our debt obligations, we may have little or no proceeds left under these circumstances to distribute to the holders of our capital stock.

Our quarterly operating results and stock price may fluctuate significantly.

We expect our operating results to be subject to quarterly fluctuations. The revenue we generate, if any, and our operating results will be affected by numerous factors, many of which are beyond our control, including:

	•		the rate of physician adoption of our products;

	•		the results of clinical trials related to our products;

	•		the introduction by us or our competitors, and market acceptance of, new products;

	•		the results of regulatory and reimbursement actions;

	•		the timing of orders by distributors or customers;

	•		the expenditures incurred in the research and development of new products; and

	•		competitive pricing.

Quarterly fluctuations in our operating results may, in turn, cause the price of our stock to fluctuate substantially.

Risks Related to Our Common Stock

The price of our common stock may continue to be volatile, and the value of an investment in our common stock may decline.

We sold shares of common stock in our IPO in February 2006 at a price of $10.00 per share, and our stock has subsequently traded as low as $3.84 per share. An active and liquid trading market for our common stock may not develop or be sustained. Factors that could cause volatility in the market price of our common stock include, but are not limited to:

	•		market acceptance and adoption of our products;

	•		regulatory clearance or approvals of our products;

	•		volume and timing of orders for our products;

	•		changes in earnings estimates, investors’ perceptions, recommendations by securities analysts or our failure to achieve analysts’ earning estimates;

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

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

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

	•		announcements related to patents issued to us or our competitors and to litigation; and

	•		developments in our industry.

In addition, the stock prices of many companies in the medical device industry have experienced wide fluctuations that have often been unrelated to the operating performance of those companies. These factors may materially and adversely affect the market price of our common stock.

The ownership of our common stock is highly concentrated, and your interests may conflict with the interests of our existing stockholders.

Our executive officers and directors and their affiliates, together with our current significant stockholders, beneficially owned approximately 26% of our outstanding common stock as of December 31, 2007. Accordingly, these stockholders have significant influence over the outcome of corporate actions requiring stockholder approval and continue to have significant influence over our operations. The interests of these stockholders may be different than the interests of other stockholders on these matters. This concentration of ownership could also have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could reduce the price of our common stock.

Evolving regulation of corporate governance and public disclosure will result in additional expenses and continuing uncertainty.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and The Nasdaq Stock Market rules are creating uncertainty for public companies. We are presently evaluating and monitoring developments with respect to new and proposed rules and cannot predict or estimate the amount of the additional compliance costs we may incur or the timing of such costs. These new or changed laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by courts and regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher

costs necessitated by ongoing revisions to disclosure and governance practices. Maintaining appropriate standards of corporate governance and public disclosure will result in increased general and administrative expenses and a diversion of management time and attention from product-generating and revenue-generating activities to compliance activities for example, in fiscal year 2008, we will need to comply with the internal control requirements of Section 404 of the Sarbanes-Oxley Act. In addition, if we fail to comply with new or changed laws, regulations and standards, regulatory authorities may initiate legal proceedings against us and our business and reputation may be harmed.

If we sell shares of our common stock in future financings, common stockholders may experience immediate dilution and, as a result, our stock price may decline.

We may from time to time issue additional shares of common stock at a discount from the current trading price of our common stock. As a result, our common stockholders would experience immediate dilution upon the purchase of any shares of our common stock sold at such discount. In addition, as opportunities present themselves, we may enter into financing or similar arrangements in the future, including the issuance of debt securities, preferred stock or common stock. If we issue common stock or securities convertible into common stock, our common stockholders could experience dilution and our stock price may decline.

Our future operating results may be below securities analysts’ or investors’ expectations, which could cause our stock price to decline.

The revenue and income potential of our products and our business model are unproven, and we may be unable to generate significant revenue or grow at the rate expected by securities analysts or investors. In addition, our costs may be higher than we, securities analysts or investors expect. If we fail to generate sufficient revenue or our costs are higher than we expect, our results of operations will suffer, which in turn could cause our stock price to decline. Our results of operations will depend upon numerous factors, including:

	•		FDA or other regulatory clearance or approval of our PAS-Port system, future generations of our C-Port system or our other products;

	•		demand for our products;

	•		the performance of third-party contract manufacturers and component suppliers;

	•		our ability to develop sales and marketing capabilities;

	•		our ability to develop, introduce and market new or enhanced versions of our products on a timely basis; and

	•		our ability to obtain and protect proprietary rights.

Our operating results in any particular period may not be a reliable indication of our future performance. In some future quarters, our operating results may be below the expectations of securities analysts or investors. If this occurs, the price of our common stock will likely decline.

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

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

	•		limit who may call a special meeting of stockholders;

	•		establish advance notice requirements for nominations for election to our board of directors or for

			proposing matters that can be acted upon at stockholder meetings;

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

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

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

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

We may become involved in securities class action litigation that could divert management’s attention and harm our business.

The stock market in general, the Nasdaq Global Market and the market for medical device companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Further, the market prices of securities of medical device companies have been particularly volatile. These broad market and industry factors may materially harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Litigation often is expensive and diverts management’s attention and resources, which could materially harm our financial condition and results of operations.

We have never paid dividends on our capital stock, and we do not anticipate paying any cash dividends in the foreseeable future.

We have paid no cash dividends on any of our classes of capital stock to date, and we currently intend to retain our future earnings to fund the development and growth of our business. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.

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

On November 14, 2007, our Annual Meeting of Stockholders was held at our corporate offices located at 900 Saginaw Drive, Redwood City, California. During this meeting, our stockholders voted on the following three proposals:

(a) To elect directors to hold office until our Annual Meeting of Stockholders and until their successors are elected and have qualified, or until such director’s death, resignation or removal. The votes regarding the election of the director were as follows:


	Votes
Nominee	For		Withheld
Bernard Hausen		10,707,471		58,233
J. Michael Egan		10,720,471		45,233
Kevin Larkin		10,720,971		44,733
Richard Powers		10,720,471		45,233
Jeffrey Purvin		10,720,471		45,233
Robert Robbins		10,720,971		44,733
John Simon		10,678,071		87,633
Stephen Yencho		10,707,871		57,833
William Younger		10,707,971		57,733

(b) To approve an amendment to our 2005 Equity Incentive Plan, as amended, to increase the aggregate number of shares of common stock authorized for issuance under the 2005 Plan by 500,000 shares.


Votes For	Votes against	Abstain

7,953,252	146,090	13,000

(c) To ratify the selection by the Audit Committee of our Board of Directors of Ernst & Young LLP as our independent registered public accounting firm for our fiscal year ending June 30, 2008:


Votes For	Votes against	Abstain

10,733,779	7,227	24,698

ITEM 5. OTHER MATTERS.

Fiscal Year 2008 Executive Officer Cash Bonus Plan

On February 6, 2008, the Board of Directors approved the terms of the Company’s fiscal year 2008 Cash Bonus Plan (the “2008 Bonus Plan”). A summary of the 2008 Bonus Plan is set forth on Exhibit 10.23 to this Quarterly Report on Form 10-Q, which is incorporated by reference herein.

The Board of Directors has designated for each of the Company’s executive officers a target cash bonus amount under the 2008 Bonus Plan. The target cash bonus amounts under the 2008 Bonus Plan for each of the Company’s named executive officers are as set forth on Exhibit 10.24 to this Quarterly Report on Form 10-Q, which is incorporated by reference herein.

Amendment and Restatement of Bylaws

On February 6, 2008, the Company amended and restated its bylaws to (i) allow it to be eligible for a Direct Registration Program operated by a clearing agency registered under Section 17A of the Exchange Act, and (ii) enable electronic communication by the Company with its stockholder and directors. A copy of the bylaws as so amended and restated is filed herewith as Exhibit 3.2.

ITEM 6. EXHIBITS.


Exhibit No.		Description.
3.1		Amended and Restated Certificate of Incorporation of Cardica, Inc. †

3.2		Amended and Restated Bylaws of Cardica, Inc.

4.1		Warrant dated March 17, 2000 exercisable for 12,270 shares of common stock. †

4.2		Warrant dated July 5, 2001 exercisable for 10,417 shares of common stock. †

4.3		Warrant dated July 5, 2001 exercisable for 41,665 shares of common stock. †

4.4		Warrant dated June 13, 2002 exercisable for 32,146 shares of common stock. †

4.5		Warrant dated October 31, 2002 exercisable for 60,017 shares of common stock. †

10.21		Amendment of Registration Rights dated October 15, 2007. **

10.22		Second Amendment to Office Lease Agreement executed and delivered on December 3, 2007, and effective November 19, 2007***

10.23		Summary of 2008 Cash Bonus Plan. +

10.24		Fiscal 2008 Bonus Compensation Information for Named Executive Officers. +

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

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

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


†		Filed as an exhibit to the Company’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on November 4, 2005, as amended.

*		The certification attached as Exhibit 32.1 accompanying this Quarterly Report on Form 10-Q is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Cardica, Inc., under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10-Q and irrespective of any general incorporation language contained in any such filing.

#		Portions of this exhibit (indicated by asterisks) have been omitted pursuant to a request for confidential treatment filed separately with the Securities and Exchange Commission.

**		Filed as Exhibit 4.5 to the Company’s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on October 15, 2007.

***		Filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on December 5, 2007.

+		Management contract or compensatory plan.

SIGNATURES

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


		Cardica, Inc.

Date: February 7, 2008		/s/ Bernard A. Hausen
		Bernard A. Hausen, M.D., Ph.D President, Chief Executive Officer, Chief Medical Officer and Director (Principal Executive Officer)


Date: February 7, 2008		/s/ Robert Y. Newell
		Robert Y. Newell
		Vice President, Finance & Operations and Chief Financial Officer
		(Principal Financial and Accounting Officer)

Exhibit Index


Exhibit No.		Description.
3.1		Amended and Restated Certificate of Incorporation of Cardica, Inc. †

3.2		Amended and Restated Bylaws of Cardica, Inc.

4.1		Warrant dated March 17, 2000 exercisable for 12,270 shares of common stock. †

4.2		Warrant dated July 5, 2001 exercisable for 10,417 shares of common stock. †

4.3		Warrant dated July 5, 2001 exercisable for 41,665 shares of common stock. †

4.4		Warrant dated June 13, 2002 exercisable for 32,146 shares of common stock. †

4.5		Warrant dated October 31, 2002 exercisable for 60,017 shares of common stock. †

10.21		Amendment of Registration Rights dated October 15, 2007. **

10.22		Second Amendment to Office Lease Agreement executed and delivered on December 3, 2007, and effective November 19, 2007***

10.23		Summary of 2008 Cash Bonus Plan. +

10.24		Fiscal 2008 Bonus Compensation Information for Named Executive Officers. +

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

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

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


†		Filed as an exhibit to the Company’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on November 4, 2005, as amended.

*		The certification attached as Exhibit 32.1 accompanying this Quarterly Report on Form 10-Q is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Cardica, Inc., under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10-Q and irrespective of any general incorporation language contained in any such filing.

#		Portions of this exhibit (indicated by asterisks) have been omitted pursuant to a request for confidential treatment filed separately with the Securities and Exchange Commission.

**		Filed as Exhibit 4.5 to the Company’s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on October 15, 2007.

***		Filed as an exhibit to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on December 5, 2007.

+		Management contract or compensatory plan.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Good

Dex Liquidating (CRDC) Inactive 10-Q2008 Q2 Quarterly report

Content analysis