BUSINESS

Overview

We are a leading provider of medical devices for the minimally invasive treatment of venous reflux disease. Venous reflux disease, a progressive condition caused by incompetent vein valves, is characterized by the poor return of blood from the legs to the heart. The disease results in symptoms such as leg pain, swelling, fatigue, skin ulcers and painful varicose veins. Our primary product line, the Closure system, consists of a proprietary RF generator and proprietary disposable endovenous catheters to close diseased veins through the application of temperature-controlled RF energy. We estimate that in excess of 60,000 patients have been treated using our Closure system since 1999, with approximately 18,000 of these patients treated in the first half of 2004.

Published population studies indicate that approximately 25 million people in the United States and 40 million people in Western Europe suffer from symptomatic venous reflux disease and experience painful symptoms. Due to the pain and discomfort of the condition, venous reflux disease can be disabling and have a significant impact on quality of life by disrupting physical, social and professional activities. We believe that the large prevalence of venous reflux disease and the limitations of other available treatments have created a significant opportunity for our Closure system.

Treatment for symptomatic venous reflux disease often begins with conservative therapy such as compression stockings or leg elevation to temporarily relieve symptoms. Patients may also receive treatments for the cosmetic signs of venous reflux disease such as visible varicose veins. None of these treatments, however, address the underlying cause of the disease. They may alleviate, but do not eliminate, symptoms such as leg pain or swelling, and the cosmetic signs of the disease frequently recur. For patients with more advanced stages of the disease who seek long-term relief from symptoms, treatment often involves removing a patient’s diseased saphenous vein from the circulatory system. Historically, open surgery, such as vein stripping and ligation, has been the standard of care, but it is traumatic and can result in significant post-operative pain and extended recuperation. We believe that physicians and patients are seeking minimally invasive alternatives to surgery that effectively treat venous reflux and painful varicose veins.

We believe our Closure system represents a significant advance over vein stripping and also provides significant advantages over minimally invasive treatments that use laser energy to treat the vein in a procedure referred to as endovenous laser ablation, or EVL. Our Closure procedure effectively treats venous reflux disease and painful varicose veins, is minimally invasive, can be used in an outpatient or physician office setting and allows patients to quickly resume normal activities. Moreover, our Closure procedure is supported by a significant amount of clinical data. We sponsored a randomized trial that compared the Closure procedure to vein stripping, and found the Closure procedure to be as effective as vein stripping at two years following treatment, with fewer side effects and faster recovery. In an independent comparative study of the Closure system versus EVL, patients’ legs treated with the Closure procedure exhibited significantly better results, as demonstrated by higher rates of vein occlusion, less bruising and less post-operative pain.

The Closure procedure is accepted by the policies of approximately 95 health insurers, representing over 200 million covered lives in the United States. We sell the Closure system in the United States through our 44 person direct sales organization and market the closure system in selected international markets, primarily through distributors.

Venous Reflux Disease

Healthy leg veins contain valves that allow blood to move in one direction from the lower limbs towards the heart. These valves open when blood is flowing toward the heart, and close to prevent venous reflux, or the backward flow of blood. When veins weaken and become enlarged, their valves cannot close properly,

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The following is a depiction of the leg vein system and diseased and healthy vein valves.

Venous reflux is most common in the superficial veins. The largest superficial vein is the great saphenous vein, which runs from the top of the foot to the groin, where it attaches to a deep vein. A primary goal of treating symptomatic venous reflux is to eliminate the reflux at its source, usually the great saphenous vein. If a diseased vein is either closed or removed, blood automatically reroutes into other veins without any known negative consequences to the patient.

Venous reflux can be classified as either asymptomatic or symptomatic, depending on the degree of severity. Asymptomatic venous reflux generally involves spider veins or painless varicose veins for which treatment is not a medical necessity. However, these patients often still seek treatment to address the cosmetic conditions. Venous reflux disease in patients with cosmetic signs can progress to more advanced stages and become symptomatic.

Symptomatic venous reflux disease is a more advanced stage of the disease and can have a profound impact on the patient’s quality of life. Persons with symptomatic venous reflux disease are more likely to seek treatment due to a combination of symptoms and signs. The symptoms and signs of venous reflux disease may include:

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Based on the large prevalence of the disease and its potentially debilitating outcomes, the economic impact of venous reflux is significant. A study we commissioned estimated that approximately two million work days are lost annually in the United States as a result of symptomatic venous reflux.

Factors that contribute to venous reflux disease include female gender, heredity, obesity, lack of physical activity, multiple pregnancies, age, past history of blood clots in the legs and professions that involve long periods of standing. According to population studies, the prevalence rate of visible tortuous varicose veins, a common indicator of venous reflux disease, is up to 15% for adult men and up to 25% for adult women. Our clinical registry of over 1,000 patients shows that the average age of patients treated with the Closure procedure is 48 and that over 75% of the patients are women.

Market Opportunity

We believe that the market opportunity for the treatment of venous reflux disease is large and underserved. Based on published population studies, approximately 25 million people in the United States have symptomatic venous reflux disease. A separate study we commissioned found that of the symptomatic patients, approximately 1.2 million currently seek treatment each year in the United States, of which we estimate over 800,000 have reflux in the great saphenous vein. We estimate that, of these 800,000 patients, approximately:

As more people become aware of minimally invasive alternatives to vein stripping, we believe a larger percentage of the 25 million symptomatic patients in the United States will seek therapy.

In Western Europe, the prevalence rate of venous reflux disease is comparable to the United States, resulting in approximately 1.6 times the number of people in the United States, or 40 million people, suffering from symptomatic venous reflux disease. However, we estimate the incidence of vein stripping procedures is approximately five times the incidence in the United States, with approximately 700,000 patients treated annually.

Current Treatment Alternatives

Patients suffering from venous reflux disease can receive various treatments for relief from the condition. Treatments of varicose veins and spider veins can reduce the cosmetic signs of the diseases, but only provide temporary relief. To provide long-term elimination of symptoms as well as the signs of venous reflux, including varicose veins, refluxing veins are surgically removed or closed.

Treating the Signs of Venous Reflux Disease

There are a number of therapies commonly employed to address the visible signs of venous reflux disease and provide short-term relief. These therapies do not, however, reduce high venous pressure caused by valve failure in the great saphenous vein, a common source of venous reflux disease. As a result, the visible signs of venous reflux commonly recur following treatment using only these therapies.

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Compression Stockings. Initial therapy may involve the use of compression stockings or leg elevation. Compression stockings squeeze the leg from the ankle to the upper calf or thigh, applying greater pressure to the lower leg than the upper leg, thereby reducing blood pooling, swelling and pain. Both leg elevation and compression stockings involve inconvenient lifestyle modifications and, as a result, independent studies have shown that patient compliance is poor.

Cosmetic Laser Treatment. In cosmetic laser treatment, laser energy is directed at small visible veins to heat and close them so they can no longer be seen.

Sclerotherapy. In sclerotherapy, a chemical solution is injected into small or medium-sized veins near the skin surface causing them to become inflamed and eventually close.

Phlebectomy. Phlebectomy involves surgically removing medium to larger varicose veins near the skin surface by inserting a surgical instrument with a hook into small incisions in the skin and pulling veins out in segments. The procedure is often repeated 10 to 20 times per leg until all visible varicose veins have been removed. Phlebectomy is performed either as a stand alone procedure or in conjunction with saphenous vein treatment.

Treating the Source of Venous Reflux Disease

The primary goal in treating symptomatic venous reflux is to eliminate the reflux at its source, most commonly the great saphenous vein. Three treatments use this approach: conventional vein stripping, endovenous laser ablation and our Closure procedure.

Conventional Vein Stripping and Ligation Surgery. Vein stripping and ligation surgery has historically been the standard treatment for addressing reflux in the great saphenous vein. This procedure typically involves general anesthesia in a hospital outpatient setting and begins with groin surgery to expose and ligate, or tie off, the diseased great saphenous vein and surrounding tributary veins. Next, a stripping tool is inserted at the groin, threaded through the great saphenous vein along the length of the thigh and out through the skin just below the knee. The top of the great saphenous vein is then tied to the stripping tool, which is pulled from below the knee to remove the vein from the body. Branch veins connected to the great saphenous vein are broken as it is removed from the thigh. In conjunction with vein stripping, patients often undergo phlebectomy to remove individual visible varicose veins on the leg.

A commonly cited study of vein stripping and ligation surgery published in 1999 in the Journal of Vascular Surgery reported elimination of reflux in 71% of 51 limbs studied five years after treatment. Two year results from this study published in 1996 in the European Journal of Vascular and Endovascular Surgery reported elimination of reflux in 87% of 53 limbs studied after vein stripping surgery. Although vein stripping effectively treats saphenous vein reflux, the surgery can be traumatic. Recuperation may require days to weeks before patients resume normal activities or return to work. Other primary drawbacks of vein stripping include that it:

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Despite these drawbacks, we estimate there are approximately one million vein stripping surgeries performed worldwide each year, with approximately 130,000 performed in the United States and 700,000 in Western Europe. As a result, we believe there is a large opportunity for a minimally invasive venous reflux treatment that avoids or minimizes the drawbacks of vein stripping.

Endovenous Laser Ablation. EVL is a minimally invasive procedure that utilizes an optical fiber to deliver laser energy and heat the blood inside the saphenous vein. The laser delivers energy that boils the blood, producing steam that damages the vein and creates a blood clot. The optical fiber is withdrawn while laser energy is delivered, inducing a blood clot to occlude the length of the treated vein.

A September 2003 article in the Journal of Vascular Surgery reported that 67% of EVL patients had pain for a median of one week (with a range of 0.2 to 8 weeks) and 51% used prescription pain medication. Another study of EVL published in an article in April 2002 in the Journal of Vascular Surgery describes laser-induced vein perforation, with bruising in patients lasting approximately two weeks. EVL efficacy is depicted in single center reports as achieving vein occlusion rates of 90% to 97% at one-year follow-up, and 93% at two-year follow up.

We believe the drawbacks of the current EVL procedure and technology are significant in that they do not provide feedback during treatment to guide laser energy delivery or optical fiber withdrawal speed to reflect variability in vein size and blood volume. Without guidance from feedback, EVL can result in undesirable treatment outcomes such as perforation of the vein wall or a large blood clot along the treated vein. This creates the potential for:

EVL is less invasive than vein stripping and according to published reports, can effectively treat venous reflux disease. However, due to the drawbacks of EVL, we believe significant opportunity exists for a minimally invasive procedure that has substantial clinical evidence establishing equivalence or superiority to vein stripping, provides physicians more control over the therapy and results in less pain and discomfort for patients.

The VNUS Closure Solution

The Closure procedure offers patients significant clinical benefits without many of the drawbacks associated with other available treatment alternatives such as vein stripping or EVL. We believe that the benefits of the Closure procedure, including its minimally invasive nature, short recovery time and minimal post-operative pain, appeal to patients considering vein stripping or EVL as well as to patients who have previously chosen to forego treatment because of the drawbacks associated with vein stripping.

Using our Closure system, physicians close diseased, large superficial veins such as the great saphenous vein. This is accomplished by inserting our proprietary catheter into a vein to directly heat the vein wall with temperature-controlled RF energy. Heating the vein wall causes collagen in the wall to shrink and the vein to close. The blood then naturally reroutes to healthy veins.

We believe the Closure procedure provides the following benefits for patients and physicians:

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We believe the primary disadvantages of the Closure procedure versus treatment using EVL are that the Closure catheter is more expensive than the EVL optical fiber and, according to suppliers of EVL products, the EVL procedure is approximately 10 minutes shorter than the Closure procedure.

Products

Our Closure system consists of a proprietary RF generator and proprietary disposable catheters. We also sell accessory products such as sterile supply kits used to conduct our Closure procedure.

Disposable Endovenous Catheters

Our proprietary disposable endovenous catheters are used to deliver RF energy to heat the walls of saphenous veins. Each catheter has a set of collapsible electrodes located at the tip. The electrodes expand to contact the inner wall of the vein to be treated and produce uniform heating on all sides of the vein wall as well as a localized depth of heating to limit damage to surrounding tissue. The electrodes collapse as the vein shrinks in response to heating.

A temperature sensor located on one of the electrodes measures and transmits the temperature of the vein wall to the RF generator, which automatically adjusts the power level. This enables the generator to use the minimum amount of power necessary for the catheter to deliver a consistent temperature and close the vein. The catheters also have a hollow center, or lumen, which allows fluid delivery or standard guidewire usage. Our catheters are available in two sizes, which allows doctors to treat saphenous vein diameters that encompass over 95% of patients.

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RF Generator

Our RF generator delivers energy to the catheter and continuously monitors the temperature at the vein wall, automatically adjusting the power delivered to the catheter to achieve a target temperature. This feedback system is designed to allow the physician to perform the Closure procedure at a relatively constant temperature over the entire length of the treated vein. The RF generator is controlled by proprietary software which allows it to recognize each catheter model and to automatically select the appropriate algorithm. The RF generator is a table top unit and has a digital display panel that can be configured for multiple languages and provides readings of:

Accessories

Our accessory products include the Closure procedure pack and other ancillary products. The Closure procedure pack contains the sterile supplies needed to perform the Closure procedure, consisting of gowns, surgical drapes, scalpels, introducer sheaths and other incidental supplies. We typically purchase procedure packs from a single supplier, although we are aware of a number of alternative suppliers who can meet our specifications and delivery requirements. We sell the procedure packs separately from our catheters to our customers, which include physicians and hospitals. Our other ancillary products include reusable phlebectomy instruments for removal of varicose veins and vein access supplies such as introducer sheaths and needles.

The Closure Procedure

Our Closure procedure can be performed on an outpatient basis using local anesthesia in which the physician numbs the leg before treatment. Currently, it is predominantly performed in a hospital setting, though it may also be performed in a physician’s office. The procedure consists of four principal steps.

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Physicians generally instruct their patients to walk regularly for several days after the Closure procedure and return within 72 hours for an ultrasound examination. Many physicians, at their discretion, prescribe compression stockings to be worn for several days or weeks after the procedure. Compression stockings are prescribed as a routine item for vein procedures with the goal of enhancing patient comfort in the initial days after treatment.

Clinical Results

We have established a significant body of clinical data demonstrating the effectiveness and advantages of the Closure procedure.

A randomized comparative trial of the Closure procedure versus vein stripping demonstrated that the Closure procedure resulted in:

Based on our clinical registry data and independent single-center reports, the Closure procedure has been demonstrated to provide:

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A randomized comparative trial of the Closure procedure versus EVL found that the Closure procedure:

The two largest independent single-center studies of the Closure procedure reported 97% vein occlusion in 170 patients, as reported in a peer-reviewed article in 2002 in the Japanese Journal of Phlebology, and 99% vein occlusion in 217 limbs, as reported at the European Society of Vascular Surgery in September 2003, in each case at one year after treatment with the Closure system. In September 2004, an article published in the Journal of Vascular Surgery by a group of physicians at Maimonides Medical Center in Brooklyn, New York, reported a 16% incidence of blood clots extending into deep veins in the first 73 legs treated by the group with the Closure procedure. Complete clot resolution was achieved within two weeks in all but one patient and no patient developed serious subsequent issues. The incidence of blood clots reported by this group is inconsistent with several previously published independent peer-reviewed reports that found an incidence of blood clots from 0% to 1% in over 450 limbs treated. In addition, we are not aware of any other physicians to whom we have sold catheters that have reported an incidence of blood clots similar to that found by the Maimonides Medical Center physicians. Although we believe this is an isolated occurrence, prospective customers may deem this report relevant and require additional information or references prior to purchasing our products or refrain from purchasing our products.

Randomized Trials of the Closure Procedure versus Vein Stripping

In 2000 we sponsored an 80 patient multicenter randomized comparative trial of the Closure procedure versus vein stripping, referred to as the EVOLVeS trial. In the EVOLVeS trial every clinical outcome that resulted in a statistical difference between treatment groups was in favor of the Closure system over vein stripping.

Results from the EVOLVeS trial showed that the minimally invasive Closure procedure provided equivalent elimination of venous reflux at two years after treatment. In the EVOLVeS trial, venous reflux was absent at two years in 91.2% of the limbs treated with the Closure procedure and in 91.7% of limbs treated with vein stripping. There was no statistical difference between the two groups in rates of nerve injury, infection and psychological scores related to quality of life measurement.

In the EVOLVeS trial, patients treated with the Closure system recuperated faster, had less post-operative pain, fewer adverse events and better health-related quality of life than patients treated with vein stripping surgery. These data were published in August 2003 in a peer-reviewed article in the Journal of Vascular Surgery. Superior results of the Closure system were demonstrated by:

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The Closure procedure also resulted in significantly fewer complications and adverse findings than vein stripping at 72 hours, one week and three weeks after treatment as shown in the following table. Potential complications and adverse findings included events such as infection, blood clots, tenderness, bruising, skin redness, subcutaneous bleeding and nerve injury resulting in localized numbness or tingling.

Severity of patient leg pain was scored at pre-treatment, three days, one week, three weeks, four months, one year and two years after treatment. Patients treated with vein stripping reported worsening of leg pain three days and one week after surgery, while patients treated with the Closure procedure reported a reduction of leg pain as early as three days after treatment. Patients treated with the Closure procedure reported significantly better reduction of leg pain than patients treated with vein stripping at every follow up. Two years after treatment, patients from the Closure procedure treatment group reported an 86% reduction of leg pain compared to only 51% after vein stripping surgery.

In addition to the EVOLVeS trial, two single center randomized trials were independently performed by third parties comparing the Closure procedure to vein stripping. These trials involved treatment of 28 patients in one trial and 60 in the other and reached the same general conclusions as the published EVOLVeS trial results. The clinical outcomes from these trials showed that patients treated with our Closure procedure exhibited significantly less post-operative pain, faster return to normal activities, faster restoration of physical function and better quality of life than vein stripping patients. Other clinical outcomes in these trials showed no significant differences between the treatment groups.

Clinical Registry of the Closure Procedure

In 1998 we established an ongoing clinical registry to which more than 30 centers worldwide have contributed data. Our registry now contains long-term data for up to five years following treatment and shows the efficacy of the Closure procedure at eliminating venous reflux.

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Long term elimination of saphenous vein reflux by the Closure procedure was accompanied by significant relief of symptoms. Our clinical registry data show that, prior to treatment with the Closure procedure, 85% of patients reported leg pain, 79% reported leg heaviness and fatigue and 39% exhibited leg swelling. The following data from our clinical registry demonstrates that patients experience prompt and persistent relief of symptoms following the Closure procedure out to five years.

Incidence of Patients Symptoms at Follow-up

Closure Procedure Versus Endovenous Laser Treatment

An independent randomized comparative trial of the Closure procedure and EVL was reported at the American Venous Forum meeting in February 2003. This unpublished study involved 50 patients with saphenous vein reflux in both legs. For each patient, the Closure procedure was performed in one leg and EVL in the other leg. Patients treated with the Closure procedure experienced significantly better efficacy as determined by vein occlusion rates, and had less post-operative pain and thigh bruising than patients treated with EVL, as shown in the following table.

The investigator in this trial also used foam sclerotherapy injections at any patient follow up in which it was observed that the treated veins were not completely closed. With the assistance of foam sclerotherapy injections, the vein occlusion rates remained significantly better for the Closure treated legs, reporting 92% for Closure treated limbs and 84% for EVL treated limbs.

In the study, there was no statistical difference found between the Closure procedure and EVL for other potential clinical outcomes such as rates of nerve injury, skin burns or infection. We are not aware of any comparative trials of EVL versus vein stripping.

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Business Strategy

Our goal is to establish the Closure procedure as the leading treatment for venous reflux disease and to leverage our market position into providing other products for the treatment of vascular diseases. To achieve this goal, we have implemented a business strategy based on the following:

Sales and Marketing

We have focused our sales and marketing efforts on increasing awareness of our Closure system among physicians with an active vein treatment practice and among those looking to establish such a practice. These physicians include vascular and general surgeons, interventional radiologists and phlebologists.

We maintain a direct sales organization in the United States, which as of June 30, 2004, consisted of 44 employees. We market our products in selected international markets primarily through exclusive distributors. Our international network of distributors currently market and sell our products in nine countries in Europe, six countries in Asia and six countries in the rest of the world. We plan to enter into additional distribution agreements on a market-by-market basis. We also have a direct sales presence in France and Germany, and a clinical specialist based in Europe.

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Our marketing group supports our sales representatives primarily through four physician-targeted initiatives:

Our marketing group also engages in consumer-directed initiatives to encourage patients to contact their physicians regarding the Closure procedure. We seek to educate potential patients through public relations, advertisements and articles in prominent magazines, newspapers, websites and local and national television. We have also established a website where we provide information to patients and physicians interested in the Closure procedure. We believe this patient education is an important element of our strategy.

We had zero customers that accounted for 10% or more of our net revenues in the years ended December 31, 2001, 2002 and 2003 or in the first six months of 2004.

Reimbursement

Payment for patient care in the United States is generally made by third-party payors, which include private insurers and governmental insurance programs such as Medicare. We anticipate that sales volumes and prices of our products will continue to be dependent in large part on the availability of reimbursement from these third-party payors. To date, third-party reimbursement for our Closure procedure is well established in the United States. Over 95 individual third-party payors have established a policy of coverage encompassing over 200 million lives in the United States. Nine of the top ten health insurers and administrators in the United States cover the Closure procedure, including nearly all Blue Cross Blue Shield entities, United Healthcare, Aetna, Cigna, Humana and Kaiser.

The coding classification of physician services is established by the American Medical Association under the Current Procedural Terminology, or CPT, coding system. Third-party payors, including the Medicare program, have incorporated into their physician fee schedule CPT codes (and other codes) as part of the determination of allowable payment amounts for a physician’s services in performing various medical procedures.

To obtain reimbursement for the Closure procedure, physicians and medical facilities utilize established CPT codes that describe procedures that encompass the methods used in the Closure procedure. This typically results in a number of coding scenarios for the Closure procedure. Medical policy from insurers such as certain Blue Cross Blue Shield plans may require the use of a procedure code that is specific for endovenous radiofrequency ablation of refluxing saphenous veins. Other insurers such as Medicare may

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National Medicare reimbursement rates in 2004 for vein stripping and ligation surgery are $355 for physician professional fees, and $1,369 hospital fees associated with outpatient treatment. Based upon information from customers of the Closure system and from the published Medicare fee schedule for 2004, we estimate that professional fees for a doctor performing the Closure procedure have ranged from approximately $400 to approximately $1,100 in 2004. Based upon information from our hospital customers, we estimate hospital facility reimbursement for out-patient treatment with the Closure procedure has averaged approximately $2,000, plus additional fees for adjunctive procedures such as phlebectomy.

We obtained a Medicare pass-through code in 2002 for our disposable catheter that allows a hospital to receive reimbursement for the catheter for Medicare patients treated in a hospital out-patient setting. The Medicare pass-through code expires at the end of 2004. We have applied for a new code that we believe will go into effect on January 1, 2005. We have received an indication that beginning in 2005, Medicare will pay physicians under the Medicare fee schedule a specific amount for the Closure catheter and supplies when the Closure procedure is performed in the physician’s office. The outcome of this decision, and the amount that may be paid for the supplies will not be known until November 2004. We estimate that approximately 10% of the U.S. patients who receive treatment with the Closure system are covered by or eligible for Medicare coverage.

As new procedures grow in acceptance and volume, the AMA may issue new CPT codes to reflect the procedure. Separate new CPT codes have been approved by the AMA for both radio-frequency and laser ablation of venous reflux and are scheduled to become effective at the beginning of 2005. These new codes for physician services have undergone a process to determine 2005 reimbursement levels but those levels are not expected to be published until November 2004. At the present time, the Medicare payment levels of these codes for hospital outpatient treatment and physician office treatment have not been set, and it is expected that these payment levels will be finalized in the fourth quarter of 2004. Professional fees paid to doctors for the Closure procedure came under pressure in 2003. This pressure has continued in the first half of 2004 and we cannot assure you that when finalized, the Medicare CPT code for the Closure procedure will not provide a lower reimbursement rate than rates being currently achieved.

Market acceptance of our products in international markets is dependent, in part, upon the availability and adequacy of reimbursement within prevailing healthcare payment systems. In international markets, reimbursement and healthcare payment systems vary significantly by country. International reimbursement and healthcare payment systems include both government sponsored healthcare and private insurance. Currently, the Closure procedure is covered and reimbursed by the five largest private healthcare insurers in the United Kingdom. We have launched several initiatives in Europe to achieve third party or national reimbursement, particularly in France and Germany where we sell the Closure system through a direct sales force. We have been informed that the Closure procedure has received provisional approval for listing in the nomenclature of surgical procedures in France, which is expected to be finalized by the end of 2004.

Research and Development

In response to physician feedback and our own assessments, we are continually working on enhancements to our product designs and procedures to improve patient outcomes, increase ease-of-use and shorten procedure time. In addition, we are exploring the development of new products and new indications in the treatment of various venous diseases. From time to time we have considered the acquisition of product lines and licensing of technology and complementary products.

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We sponsor and conduct clinical research activities with investigators and institutions to measure key clinical outcomes that can influence market adoption of our Closure procedure. We also conduct clinical studies in support of new products that we are developing. We perform preclinical studies for the development and evaluation of new products and procedural techniques. We also support the clinical studies of our Closure procedure for the treatment of large veins, venous ulcer patients and small saphenous veins.

In the years ended December 31, 2001, 2002 and 2003, we incurred $2.5 million, $2.2 million and $3.7 million, respectively, of research and development expense.

Manufacturing

We manufacture, package and label our disposable catheters within our 30,000 square foot facility in San Jose, California. We outsource the manufacture of our RF generators and accessory products. We believe that our existing manufacturing facilities are adequate to support our growth through 2006.

The manufacturing process for our disposable catheters includes the assembly, testing, packaging, sterilization and inspection of components that have been manufactured by us or to our specifications by suppliers. We purchase components used in our disposable products from various suppliers. When practicable, we have established second-source suppliers. However, we rely on sole-source suppliers to manufacture a limited number of the components used in our disposable catheters. We believe that alternative suppliers for these products would be available to us without significant delay if the need should arise. In addition, we attempt to mitigate supply shortages through maintaining inventory levels based on the risk associated with a particular supplier. Typically, we have not obtained contractual commitments from our suppliers to continue to supply products to us, nor are we contractually obligated to continue to purchase from a particular supplier.

Our quality assurance group provides an independent inspection at various steps in the manufacturing cycle that is designed to verify that each lot of components and finished products are compliant with our specifications and applicable regulatory requirements. We inspect incoming components, and inspect and test products both during and after the manufacturing process. We also inspect our packaged products and audit the sterilization process to ensure quality products. Sterilization testing is processed at a certified third-party laboratory to verify the effectiveness of the sterilization process. Our quality assurance systems are required to be in conformance with the Quality System Regulations as mandated by the Food and Drug Administration. For sale of products in European Community, our products and quality structure are required to be compliant to the current standard, ISO 13485 for medical devices. Prior to receiving certification to ISO 13485 in October 2003, we maintained certification to ISO 9001/ EN46001 for the same purpose.

We rely on Stellartech Research Corporation to manufacture our RF generators to our custom specifications. Our relationship with Stellartech has been conducted under a binding letter of intent since 1996 and we have entered into an agreement with this supplier for the warranty and service of the RF generators it manufactures. We are currently transitioning the manufacture of our RF generators to Byers Peak, Inc., and expect that Byers Peak, Inc. will be a sole-source supplier of the RF generators in the future. Under our non-exclusive agreement with Byers Peak, Inc. we will provide a rolling 90-day firm commitment order for generators and a six month rolling forecast. We are required to purchase all inventory of parts and work in progress if we revise our commitment or forecast, cancel orders or terminate the agreement. Byers Peak, Inc. also provides us a warranty on the generators for the shorter of 18 months from the date of shipment to us or 12 months from the date of first use. The agreement has an initial term of three years and continues indefinitely thereafter until terminated by us or Byers Peak, Inc. upon 180 days notice.

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Suppliers of components used in the manufacture of our disposable catheters and of our RF generators may encounter problems during manufacturing due to a variety of reasons, including failure to follow specific protocols and procedures, failure to comply with applicable regulations, including the Food and Drug Administration’s Quality System Regulations, equipment malfunction and environmental factors. Furthermore, establishing additional or replacement suppliers for our materials may take a substantial period of time, as a change in supplier may require us to submit a new 510(k) submission. This could create supply disruptions that would materially adversely affect our reputation, product sales and profitability.

For those components other than RF generators for which there are relatively few alternate sources of supply, we believe that we could establish additional or replacement sources of supply in a timely manner to meet the requirements of our business.

Patents and Proprietary Technology

We believe that in order to maintain our competitive advantage, we must develop and maintain the proprietary aspects of our technologies. To this end, we file patent applications to protect technology, inventions and improvements that we believe are significant to the growth of our business. In the United States, as of September 15, 2004, we had 29 issued patents and 15 pending patent applications, many of which relate to our Closure system and procedure, including, among other things, vein shrinkage and occlusion using various forms of energy, including RF; self expanding and collapsing electrodes; and use of single and double electrode array devices. Fourteen of the issued patents relate to devices or devices with methods and 15 relate to methods.

We also have other issued patents and pending patent applications that are not directly related to the Closure system or the Closure procedure. Our issued patents related to the Closure system and procedure will expire between 2016 and 2018. Internationally, as of September 15, 2004, we have 8 foreign patents providing protection in Australia, New Zealand, Singapore, Russia, China and Europe. In addition, we have 29 pending foreign patent applications, many of which relate to the Closure technology. There are applications pending in Europe, Japan, Australia, Canada, New Zealand, Singapore, Russia and other countries.

We require our employees, consultants and advisors to execute confidentiality agreements in connection with their employment, consulting or advisory relationships with us. We also require our employees, consultants and advisors who we expect to work on our products to agree to disclose and assign to us all inventions conceived during their term of employment or contract, using our property, or which relate to our business. Despite measures taken to protect our intellectual property, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Finally, our competitors may independently develop similar technologies.

The medical device industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. As the number of entrants into our market increases, the risk of an infringement claim against us grows. While we attempt to ensure that our products and methods do not infringe other parties’ patents and proprietary rights, our competitors may assert that our products, and the methods we employ, are covered by U.S. patents held by them. In addition, our competitors may assert that future products and methods we may market infringe their patents.

Competition

Within the market for the treatment of venous reflux disease, we principally compete against vein stripping procedures, as well as companies that have commercialized and sell EVL systems. Sclerotherapy and phlebectomy procedures that treat varicose veins at the surface of the skin are complementary to the Closure procedure because they do not treat saphenous vein reflux and may be used in conjunction with the Closure system.

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Vein stripping and ligation surgery has historically been the standard of care to address venous reflux disease. This procedure is well established among physicians who treat venous reflux disease, has extensive long-term data, is routinely taught to new surgeons and has remained relatively unchanged for the past 50 years.

Competitors that have developed and market EVL systems include AngioDynamics, Inc., biolitec AG, Diomed Holdings, Inc., Dornier MedTech GmbH, New Star Lasers, Inc., doing business as CoolTouch Inc., and Vascular Solutions, Inc. Most of these competitors’ EVL systems use laser energy to occlude diseased veins by clotting the blood in the vein. New Star Lasers claims that its EVL system occludes diseased veins by causing the collagen in the vein wall to shrink, rather than by clotting the blood. Some of these competitors may have substantially greater financial, technical and marketing resources than we do, and they may succeed in developing products that would render our instruments obsolete or noncompetitive.

Additionally, we are aware that physicians have used foam sclerotherapy to treat great saphenous reflux. Similar to sclerotherapy, in this procedure the physician combines air with a sclerosant solution to create a foam for injection into the refluxing saphenous vein. The FDA has not approved the marketing of sclerosant solutions for this purpose. Provensis, a division of BTG plc, is currently conducting clinical trials of a sclerosant foam, however, it does not expect approval by the Food and Drug Administration prior to 2009.

Because of the size of the potential market, we anticipate that new or existing competitors may develop competing products, procedures or clinical solutions. These products, procedures or solutions could prove to be more effective, safer or less costly than the Closure procedure. The introduction of new products, procedures or clinical solutions by competitors may result in price reductions, reduced margins or loss of market share and may render our products obsolete.

We believe that the principal competitive factors in the market for the treatment of venous reflux include:

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Government Regulation

United States

Our products are regulated in the United States as medical devices by the Food and Drug Administration and other regulatory bodies. Food and Drug Administration regulations govern, among other things, the following activities:

Unless an exemption applies, each medical device we wish to commercially distribute in the United States will require either prior 510(k) clearance or prior premarket approval from the Food and Drug Administration. The Food and Drug Administration classifies medical devices into one of three classes, depending on the degree of risk associated with each medical device and the extent of controls that are needed to ensure safety and effectiveness. Devices deemed to pose the least risk are placed in class I. Intermediate risk devices are placed in class II, which requires the manufacturer to submit to the Food and Drug Administration a premarket notification requesting authorization for commercial distribution, known as “510(k) clearance,” and subjects the device to special controls such as performance standards, guidance or post-market surveillance. Most class I and some low-risk class II devices are exempted from this 510(k) requirement. Devices deemed by the Food and Drug Administration to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or a device deemed to be not substantially equivalent to a previously cleared 510(k) device, are placed in class III. In general, a class III device cannot be marketed in the United States unless the Food and Drug Administration approves the device after submission of a premarket approval application. The Food and Drug Administration can also impose restrictions on the sale, distribution or use of devices at the time of their clearance or approval, or subsequent to marketing.

510(k) Clearance Pathway. When we are required to obtain a 510(k) clearance for a device which we wish to market, we must submit a premarket notification to the Food and Drug Administration demonstrating that the device is substantially equivalent to a previously cleared 510(k) device or a device that was in commercial distribution before May 28, 1976 (or to a pre-1976 class III device for which the Food and Drug Administration has not yet called for the submission of premarket approval applications). The Food and Drug Administration attempts to respond to a 510(k) premarket notification within 90 days of submission of the notification, but the response may be a request for additional information or data, sometimes including clinical data. As a practical matter, premarket clearance can take significantly longer, including up to one year or more. If Food and Drug Administration determines that the device, or its intended use, is not substantially equivalent to a previously-cleared device or use, the Food and Drug Administration will place the device, or the particular use of the device, into class III.

After a device receives 510(k) clearance for a specific intended use, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, design or manufacture, will require a new 510(k) clearance or could require premarket approval. The Food and Drug Administration requires each manufacturer to make this determination initially, but the Food and Drug Administration can review any such decision and can disagree with a manufacturer’s determination. If the Food and Drug Administration disagrees with a manufacturer’s determination that a new clearance or approval

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Premarket Approval Pathway. A premarket approval application must be submitted if the device cannot be cleared through the 510(k) process. The premarket approval process is much more demanding than the 510(k) premarket notification process. A premarket approval application must be supported by extensive data and information including, but not limited to, technical, preclinical, clinical trials, manufacturing and labeling to demonstrate to the Food and Drug Administration’s satisfaction the safety and effectiveness of the device.

After the Food and Drug Administration determines that a premarket approval application is complete, the Food and Drug Administration accepts the application and begins an in-depth review of the submitted information. The Food and Drug Administration, by statute and regulation, has 180 days to review an accepted premarket approval application, although the review generally occurs over a significantly longer period of time, and can take up to several years. During this review period, the Food and Drug Administration may request additional information or clarification of information already provided. Also during the review period, an advisory panel of experts from outside the Food and Drug Administration may be convened to review and evaluate the application and provide recommendations to the Food and Drug Administration as to the approvability of the device. In addition, the Food and Drug Administration will conduct a preapproval inspection of the manufacturing facility to ensure compliance with the Quality System Regulations. New premarket approval applications or supplemental premarket approval applications are required for significant modifications to the manufacturing process, labeling, use and design of a device that is approved through the premarket approval process. Premarket approval supplements often require submission of the same type of information as a premarket approval, except that the supplement is limited to information needed to support any changes from the device covered by the original premarket approval application, and may not require as extensive clinical data or the convening of an advisory panel.

Clinical Trials. A clinical trial is almost always required to support a premarket approval application and is sometimes required for a 510(k) premarket notification. Clinical trials for a “significant risk” device require submission of an application for an investigational device exemption, or IDE, to the Food and Drug Administration. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. Clinical trials for a significant risk device may begin once the IDE application is approved by the Food and Drug Administration and the Institutional Review Board overseeing the clinical trial. If the product is deemed a “non-significant risk” device under Food and Drug Administration regulations, only informed consent and approval from the IRB overseeing the clinical trial is required. Clinical trials are subject to extensive recordkeeping and reporting requirements. Our clinical trials must be conducted under the oversight of an IRB at the relevant clinical trials site and in accordance with applicable regulations and policies including, but not limited to, the Food and Drug Administration’s good clinical practice, or GCP, requirements. We, the Food and Drug Administration or the Institutional Review Board at each site at which a clinical trial is being performed may suspend a clinical trial at any time for various reasons, including a belief that the risks to study subjects outweigh the anticipated benefits. The results of clinical testing may not be sufficient to obtain approval of the product.

Continuing Food and Drug Administration Regulation. After a device is placed on the market, numerous regulatory requirements apply. These include:

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The MDR regulations require that we report to the Food and Drug Administration any incident in which our product may have caused or contributed to a death or serious injury, or in which our product malfunctioned and, if the malfunction were to recur, it would likely cause or contribute to a death or serious injury. As of September 15, 2004 we have submitted 41 MDRs. In 36 cases, a thrombus, or blood clot, was noticed after varying lengths of time after the Closure procedure. In four cases, the patient developed a pulmonary embolism. In each of these cases the patients were successfully treated with appropriate drug therapies and the symptoms were no longer evident. We believe that none of these incidents were caused by design faults in the product.

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

We have registered with the Food and Drug Administration as a medical device manufacturer and we have obtained a manufacturing license from the California Department of Health and Services. Compliance with regulatory requirements is assured through periodic, unannounced facility inspections by the Food and Drug Administration and the Food and Drug Branch of the California Department of Health Services, and these inspections may include the manufacturing facilities of our subcontractors. Failure to comply with applicable regulatory requirements can result in enforcement action by the Food and Drug Administration, which may include any of the following sanctions:

The Food and Drug Administration has twice inspected our facility and Quality System twice, and the Food and Drug Branch of the California Department of Health Services has inspected our facility and Quality System once. In each of these inspections no significant incidents of non-compliance were found.

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Current Clearances. We have received 510(k) clearances to market our VNUS Closure system, our VNUS Vessel and Tissue Coagulation System (proprietary name: TBD), and our VNUS RF Generator. Our VNUS VarEx Phlebectomy Instruments are class I devices under Food and Drug Administration regulations, and exempt from the premarket notification requirements. Closure procedure supplies include a combination of class I and class II devices. We do not presently have any 510(k) or premarket approval submissions pending at the Food and Drug Administration.

European Union

Our products are regulated in the European Union as medical devices per the European Union Directive (93/42/ EEC), also known as the Medical Device Directive. An authorized third party, notified body, must approve our products for CE marking. The Closure system was approved for CE marking in 1998. The remaining products are currently CE marked. We cannot assure you that we will be able to obtain the CE mark approval for new products in the future. The CE mark is contingent upon our continued compliance to the applicable regulations and the Quality System Requirements of ISO 13485 standard.

The European Community has regulations similar to that of the Food and Drug Administration for the advertising and promotion of the medical devices, clinical investigations, and adverse events. We believe that we are in compliance with such regulations at this time.

Rest of the World

Most major markets have different levels of regulatory requirements for medical devices. The Closure system is currently approved/cleared/licensed/registered in Canada, South Korea, Taiwan, China, Hong Kong, and South Africa. The regulatory process is currently underway in Singapore and Australia. Modifications to the approved products require a new regulatory submission in all major markets. The regulatory process for the current models of our disposable catheter is underway in South Korea, Taiwan and China. The regulatory requirements, and the review time vary significantly from country to country. We cannot assure you that we will be able to obtain or maintain the required regulatory approvals. The VNUS Closure system can also be marketed in the several other countries that do not regulate medical devices. We cannot assure you the timing or the successes of our efforts to obtain the approvals for the current and future products in the international markets.

Fraud and Abuse Laws

Anti-Kickback Statute

The federal healthcare program Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing, arranging for or recommending a good or service, for which payment may be made in whole or part under a federal healthcare program such as the Medicare and Medicaid programs. The definition of “remuneration” has been broadly interpreted to include anything of value, including for example gifts, discounts, the furnishing of supplies or equipment, credit arrangements, payments of cash and waivers of payments. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals or otherwise generate business involving goods or services reimbursed in whole or in part under federal healthcare programs, the statute has been violated. Penalties for violations include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcare programs. In addition, some kickback allegations have been claimed to violate the Federal False Claims Act, discussed in more detail below.

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The Anti-Kickback Statute is broad and prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. Recognizing that the Anti-Kickback Statute is broad and may technically prohibit many innocuous or beneficial arrangements, the Office of Inspector General of Health and Human Services, or OIG, has issued a series of regulations, known as the “safe harbors,” beginning in July of 1991. These safe harbors set forth provisions that, if all their applicable requirements are met, will assure healthcare providers and other parties that they will not be prosecuted under the Anti-Kickback Statute. The failure of a transaction or arrangement to fit precisely within one or more safe harbors does not necessarily mean that it is illegal or that prosecution will be pursued. However, conduct and business arrangements that do not fully satisfy each applicable safe harbor may result in increased scrutiny by government enforcement authorities such as the OIG. Many states have adopted laws similar to the Anti-Kickback Statute. Some of these state prohibitions apply to referral of patients for healthcare items or services reimbursed by any source, not only the Medicare and Medicaid programs.

Government officials have focused recent enforcement efforts on marketing of healthcare services, among other activities, and recently have brought cases against individuals or entities with sales personnel who allegedly offered unlawful inducements to potential or existing customers in an attempt to procure their business.

Stark Law

The Ethics in Patient Referral Act of 1989, commonly referred to as the federal physician self-referral law or Stark Law, prohibits physician referrals of Medicare patients to an entity for certain “designated health services” if the physician or an immediate family member has an indirect or direct financial relationship with the entity and no statutory or regulatory exception applies. Financial relationships include an ownership interest in, or compensation arrangement with, the entity. It also prohibits an entity receiving a prohibited referral from billing and collecting for services rendered pursuant to such referral. “Designated health services” under Stark include inpatient and outpatient hospital services.

A person who engages in a scheme to circumvent the Stark Law’s prohibitions may be fined up to $100,000 for each such arrangement or scheme. In addition, anyone who presents or causes to be presented a claim to the Medicare program in violation of the Stark Law is subject to monetary penalties of up to $15,000 per claim submitted, an assessment of several times the amount claimed, and possible exclusion from participation in federal healthcare programs. In addition, claims submitted in violation of the Stark Law may be alleged to be subject to liability under the federal False Claims Act and its whistleblower provisions (as discussed below).

Several states in which we operate have enacted legislation that prohibits physician self-referral arrangements and/or requires physicians to disclose any financial interest they may have with a healthcare provider to their patients when referring patients to that provider. Some of these statutes cover all patients and are not limited to Medicare beneficiaries. Possible sanctions for violating state physician self-referral laws vary, but may include loss of license and civil and criminal sanctions. State laws vary from jurisdiction to jurisdiction and, in a few states, are more restrictive than the federal Stark Law. Some states have indicated they will interpret their own self-referral statutes the same way that CMS interprets the Stark Law, but it is possible the states will interpret their own laws differently in the future.

False Claims Laws

Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government or knowingly making, or causing to be made, a false statement to get a false claim paid. Recently, several healthcare companies have been prosecuted under the false claims laws for allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product. The majority of states also have statutes or regulations similar to the federal false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payer. Sanctions under

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Fraud on a Health Benefit Plan and False Statements

The Health Insurance Portability and Accountability Act of 1996, or HIPAA, created two new federal crimes: healthcare fraud and false statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private payors. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from government sponsored programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. A violation of this statute is a felony and may result in fines or imprisonment.

Privacy and Security

HIPAA requires certain “covered entities” to comply with established standards regarding the privacy and security of protected health information, or PHI, and to use standardized code sets when conducting certain electronic transactions. HIPAA further requires that covered entities enter into agreements meeting certain regulatory requirements with their “business associates”, which effectively obligate the business associates to safeguard the covered entity’s PHI against improper use and disclosure. While not directly regulated by HIPAA, a business associate may face significant contractual liability pursuant to such an agreement if the business associate breaches the agreement or causes the covered entity to fail to comply with HIPAA. In the course of our business operations, we have become the business associate of one or more covered entities. Accordingly, we incur compliance related costs in meeting HIPAA-related obligations under business associates agreements to which we are a party. Moreover, if we fail to meet our contractual obligations under such agreements, we may incur significant liability.

Employees

As of June 30, 2004, we had 154 employees, consisting of 19 in research and development, clinical research and regulatory affairs, 47 in manufacturing and quality assurance, 75 in sales and marketing and 13 in general and administrative functions. From time to time we also employ independent contractors to support our engineering, marketing, sales and support, clinical and administrative organizations.

Facilities

We are headquartered in San Jose, California, where we lease approximately 30,000 square feet under a lease expiring June 30, 2007. We believe that our existing facilities are adequate for our current needs and that suitable additional or alternative space will be available at such time as it becomes needed on commercially reasonable terms.

Legal Proceedings

From time to time we may be a party to various legal proceedings arising in the ordinary course of our business. We are not currently subject to any material legal proceedings.

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