The following Management's Discussion and Analysis ("MD&A") is intended to help the reader understand the results of operations and financial condition of VNUS Medical Technologies, Inc. MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes to the consolidated financial statements ("Notes").

Business Overview

We develop, manufacture and sell our proprietary products used in the minimally invasive treatment of venous reflux disease. We also generate revenue from licensing our intellectual property to companies that sell minimally invasive products for the treatment of venous reflux disease in the United States. For the year ended December 31, 2008, we generated net revenues of $101.2 million and net income of $13.5 million. As of December 31, 2008, we have incurred cumulative losses of approximately $35.0 million. We incurred net losses in 2006 and through the third quarter of 2007. During the fourth quarter of 2007, we were profitable. We incurred a net loss for the fiscal year ended 2007.

We market our Closure system through a direct sales organization in the United States, France, Germany and the United Kingdom. We also market and sell our products through distributors throughout the world.

Most of our United States customers are reimbursed by governmental and third-party payors, and that reimbursement is subject to periodic review and adjustment. Currently, our Closure procedure is covered by the policies of approximately 120 health insurers, representing over 240 million covered lives in the United States.

Internationally, our Closure procedure is accepted by several national health systems and many third-party private health insurance policies.

We manufacture, package and label our disposable endovenous catheters and devices and outsource the manufacture of our RF generators and accessory packs.

We have a diverse customer base of hospitals, physicians and physician groups, with no single customer accounting for 10% or more of our net revenues or accounts receivable in the years ended December 31, 2008, 2007, and 2006.

We intend to sustain our long term growth through delivering new and improved products, through continued acceptance and reimbursement of our procedure by private and government sponsored health insurance plans, creating new opportunities, and improving our internal processes.

Financial Operations Overview

Net Revenues. We derive our net revenues from net product revenues and royalty revenues. Net product revenues are derived from the sale of disposable endovenous catheters and devices, RF generators and accessory products. Our large installed base of RF generators facilitates a recurring revenue stream from the sale of disposable catheters. Royalty revenues are derived from licensing our patents which describe methods of vein ablation.

Cost of Revenues. Our cost of revenues represents the cost of materials, overhead, direct labor and delivery charges associated with the manufacture of disposable catheters, the purchase and delivery of RF generators, the purchase and delivery of accessory products, warranty, inventory reserves and share-based compensation.

Sales and Marketing Expenses. Sales and marketing expenses consist primarily of sales and marketing personnel expenses, sales force incentive compensation, travel, promotional materials, advertising, patient education materials, other expenses incurred to provide reimbursement services, clinical training and share-based compensation.

Research and Development Expenses. Research and development expenses consist primarily of personnel expenses, supplies, materials and other expenses associated with product development, expenses associated with preclinical and clinical studies and share-based compensation.

General and Administrative Expenses. General and administrative expenses consist primarily of personnel expenses for accounting, human resources, information technology and corporate administration, professional fees and share-based compensation.

Critical Accounting Policies and Estimates

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we re-evaluate our judgments and estimates. We base our estimates and judgments on our historical experience, knowledge of current conditions and our belief of what could occur in the future considering available information, including assumptions that are believed to be reasonable under the circumstances. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results could differ materially from the amounts reported based on these policies.

We believe the following critical accounting policies reflect our most significant estimates, judgments and assumptions used in the preparation of our consolidated financial statements:

• Revenue recognition;

• Valuation of inventory;

• Allowance for doubtful accounts;

• Income taxes; and

• Share-based compensation expense.

Revenue Recognition. We sell our disposable catheters RF generators to end-users in the United States and in international markets. Catheters and RF generators are also sold through distributors in international markets. We also sell RF generators to third-party leasing companies in the United States. These third party leasing companies provide long-term lease financing to end-users. We do not provide such long-term lease financing to end-users. The Company also licenses its proprietary technology to third parties in exchange for royalties.

We recognize revenues in accordance with Staff Accounting Bulletin ("SAB") No. 104, Revenue Recognition, when persuasive evidence of an arrangement exists, title has transferred, our price is fixed or determinable and collectability is reasonably assured. For an arrangement with multiple deliverables, we recognize revenue in accordance with Emerging Issues Task Force ("EITF") No. 00-21, Revenue Arrangements with Multiple Deliverables with revenues allocated among the different elements, and in accordance with EITF No. 03-05, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software.

For product revenues, we generally use contracts and customer purchase orders to determine the existence of an arrangement. We use shipping documents and third-party proof of delivery to verify delivery. We assess whether the fee is fixed or determinable based on the terms of the agreement associated with the transaction. In order to determine whether collection is reasonably assured, we assess a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. If we determine that collection is not reasonably assured, we defer the recognition of revenue until collection becomes reasonably assured, which is generally upon receipt of payment.

Our domestic and international return policy allows customers to return unused products for a period of 30 and 60 days, respectively, subject to restocking fees. We make provisions for estimated returns and allowances based on historical levels. To date, returns and allowances have been insignificant.

For royalty revenues, we use negotiated royalty licensing agreements to determine the existence of an arrangement and transfer of title. Royalty licensing agreements typically cover products shipped by the licensee after the date that the license agreement has been entered into and until the patent has expired or when the agreement expires, whichever is shorter. The Company's royalties are computed at a fixed price per unit shipped, are paid quarterly in arrears and recognized as revenue at the time the amount of the quarterly royalty payment becomes determinable and collection is reasonably assured.

Valuation of Inventory. We value our inventory at the lower of cost or market, cost being determined on a first in first out basis. We calculate an inventory reserve for estimated obsolescence or excess inventory based upon historical demand and assumptions about future demand for our products and market conditions. The allowance is measured as the difference between the current cost of the inventory and estimated market value and is charged to the provision for inventory obsolescence, which is a component of our cost of revenues. At the point of recognition of the loss, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.

Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We estimate the allowance based on the aging of account balances, collection history, credit quality of the customer and current economic conditions that may affect a customer's ability to pay.

Income Taxes. We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions, realization and carrying amounts of deferred tax assets and determining our provision for income taxes. Effective January 1, 2007, we adopted Financial Interpretation ("FIN") No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 ("FIN 48"). FIN 48 contains a two step approach to recognizing and measuring uncertain tax positions accounted for in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of

related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement.

Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest.

The Company maintained a full valuation allowance for deferred tax assets as of December 31, 2008. The determination to maintain an allowance is highly subjective. The factors we considered in making this determination include, but are not limited to (i) the Company's historical cumulative net losses, after adjustment for permanent tax differences, over the previous three years through 2008; (ii) the dependence on continued high growth rates in achieving forecasted profitability; (iii) operation in an industry subject to rapid technological changes; and (iv) the unknown impact of current negative macroeconomic factors on forecasted results of operations. Based on our consideration of these factors, we believe there is sufficient uncertainty regarding our ability to generate future taxable income. We will retain a full valuation allowance until such time that we determine it is more likely than not that we will recognize the benefit of the deferred tax assets. Throughout 2009, we will continually evaluate these, and other, factors, and the impact any changes in these factors has on our judgment regarding the realization of the deferred tax assets.

Share-Based Compensation Expense. We account for share-based compensation expense in accordance with SFAS No. 123R "Share-Based Payment," or SFAS 123R. Under the provisions of SFAS No. 123R, share-based compensation expense is estimated at the grant date based on the award's fair value. Fair value for restricted stock units is determined by the stock's closing price on the grant date. For options the fair value is calculated by using the Black-Scholes option-pricing model. The instruments fair value is recognized as expense over the requisite service period. The Black-Scholes model requires various highly judgmental assumptions including expected volatility, forfeiture rates and expected option life.

Recent Accounting Pronouncements

In 2008, the following new accounting pronouncements, discussed in"Item 8- "Financial Statements," Note 1. "Accounting Policies, Recent Accounting Pronouncements," have been considered and evaluated for required application and their impact:

• SFAS No. 157, Fair Value Measurements

• SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities

• SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities

• SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles

Results of Operations

The following table sets forth our results of operations expressed as percentages of net revenues, for the years ended December 31, 2008, 2007, and 2006:

                                                                       Years Ended December 31,
                                                                   2008          2007          2006

Net revenues                                                          100 %       100.0 %       100.0 %
Cost of revenues                                                       29            36            33

Gross profit                                                           71            64            67
Operating expenses:
Sales and marketing                                                    28            36            43
Research and development                                               10            13            14
General and administrative                                             20            27            30

Total operating expenses                                               58            76            87

Income (loss) from operations                                          13           (12 )         (20 )
Interest income and other, net                                          1             5             7
Income (loss) before provision for income taxes                        14            (7 )         (13 )
Provision for income taxes                                              1             1             0

Net income (loss) before cumulative effect of change in
accounting principle                                                   13            (8 )         (13 )
Cumulative effect of change in accounting principle, net of tax         -             -             1

Net income (loss) after cumulative effect of change in
accounting principle                                                   13 %          (8 )%        (14 )%

Known Trends and Uncertainties Impacting Future Results of Operations: Global Market and Economic Conditions. Recent global market and economic conditions have been unprecedented and challenging with tighter credit conditions and recession in most major economies continuing into 2009. As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide credit to businesses and consumers. These factors have lead to a decrease in spending by businesses and consumers alike, and a corresponding decrease in global infrastructure spending. Continued turbulence in the United States and international markets and economies and prolonged declines in business and consumer spending may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers, including our ability to obtain external debt or equity financing to meet our liquidity needs.

Net Revenues by Period

The following table sets forth our net revenues for the fiscal years ending 2008, 2007 and 2006, and the percentage change between periods.

Years Ended December 31, 2008 2007 % Change 2007 2006 % Change

Net revenues increased in 2008 as compared to 2007 primarily due to the following:

• increased catheter sales in both units and dollars due to increased demand for the ClosureFAST catheter, offset by a lower average sales price;

• increased accessory product sales in both dollars and units directly related to products used in the performance of our Closure procedure; and

• royalty revenues of $12.9 million dollars of which $8.7 million relates to periods prior to 2008.

Net revenues increased in 2007 as compared to 2006 primarily due to the following:

• increased catheter sales in both units and dollars due to increased demand for the ClosureFAST catheter, offset by a lower average sales price;

• increased RF generator sales in both units and dollars, primarily due to international expansion and recognition of $1.9 million of generator sales due to the undelivered software upgrade promoted in 2006 and delivered in 2007; and

• increased accessory sales in both units and dollars.

We expect net revenues to continue to increase in 2009 as a result of continued domestic and international market demand for our Closure system.

Net Product Revenues by Product

The following table sets forth the percentage of net product revenues derived
from the sale of disposable endovenous catheters and devices, RF generators and
accessories for the years ended December 31, 2008, 2007 and 2006:


                                            Years Ended December 31,
                                          2008           2007       2006

                Catheters and devices         78 %           73 %      81 %
                RF generators                  8             14         8
                Accessories                   14             13        11

                                             100 %          100 %     100 %

We derive our net product revenues from the sale of disposable endovenous catheters and devices, RF generators and accessory products. Our large installed base of RF generators facilitates a recurring revenue stream from the sale of disposable catheters. We manufacture, package and label our disposable endovenous catheters and devices. We do not manufacture our RF generators and accessory products. We have several competitors selling a laser-based alternative to our Closure system.

Net Revenues by Geographic Region as a Percentage of Net Revenues

The following table sets forth the percentage of net revenues from domestic and
international sales for the years ended December 31, 2008, 2007, and 2006:


                                          Years Ended December 31,
                                        2008           2007       2006

                   United States            90 %           93 %      96 %
                   Europe and other         10              7         4

                                           100 %          100 %     100 %

We market our Closure system through a direct sales organization in the United States, France, Germany and the United Kingdom. We also market and sell our products through distributors throughout the world. We continue to see increases in our sales outside the United States, primarily due to the addition of a direct sales presence in the United Kingdom in 2007. Excluding the $8.7 million of royalty revenue received in 2008 but related to periods prior to 2008, Europe and other accounted for 11% of total net revenues. We expect our net revenues derived from sales outside the United States to increase in 2009 primarily related to international expansion.

Gross Profit by Period

The following table sets forth our gross profit for the fiscal years ending
2008, 2007 and 2006, and the percentage change between periods:


                                                 Years Ended December 31,
                         2008         2007        % Change        2007         2006        % Change
                                             (In thousands except percentages)

 Gross profit          $ 71,823     $ 45,198             59 %   $ 45,198     $ 34,397             31 %
 Gross profit margin         71 %         64 %                        64 %         67 %

The overall increase in gross profit margin in 2008 compared to 2007 was primarily due to:

• the recognition of $12.9 million of royalty revenues with no associated cost of revenues increased gross profit margin by 4.3%; and

• higher margin of ClosureFAST catheters in 2008 as compared to 2007. This is the result of reductions in the initial manufacturing inefficiencies in 2007 associated with launching a new product.

The overall decrease in gross profit margin in 2007 compared to 2006 was primarily due to:

• lower margin of ClosureFAST catheters, which were introduced by the Company in the first quarter of 2007, as compared to ClosurePLUS catheters, due to initial manufacturing inefficiencies associated with launching a new product; and

• increases in inventory reserves primarily related to inventory balances on hand in excess of forecasted demand.

Assuming we do not experience reductions in average sales price or experience unexpected manufacturing inefficiencies, we expect gross margins for 2009 to range from 68% to 70%.

Operating Expenses by Period


                                                               Years Ended December 31,
                                    2008          2007         % Change         2007          2006         % Change
                                                          (In thousands except percentages)

Sales and marketing               $ 28,369      $ 25,311              12 %    $ 25,311      $ 22,343              13 %
Research and development            10,443         9,444              11 %       9,444         7,422              27 %
General and administrative          19,672        19,340               2 %      19,340        15,402              26 %

                                  $ 58,484      $ 54,095               8 %    $ 54,095      $ 45,167              20 %

Operating Expense Summary

Overall operating expenses increased $4.4 million in 2008 as compared to 2007, primarily due to:

• an increase of $4.5 million due to increased headcount;

• an increase of $3.0 million due to increased share-based compensation expense;

• an increase of $471,000 in trade show and travel related expenses;

• an increase of $308,000 in international expenditures related to our international expansion, and;

• an increase of $307,000 in general business expenses; partially offset by

• a decrease of $2.5 million in legal fees, primarily associated with resolution of certain on-going patent litigation;

• a decrease of $834,000 in clinical studies and consulting fees; and

• a decrease of $325,000 in advertising relating to our direct marketing and advertising expenses.

Overall operating expenses increased $8.9 million in 2007 as compared to 2006, primarily due to:

• an increase of $6.2 million due to increased headcount and related expense (including share-based compensation);

• an increase of $2.5 million in legal expense related to our on-going patent litigation;

• an increase of $476,000 in trade show and travel related expenses;

• an increase of $400,000 in direct marketing and advertising expenses, and;

• an increase of $225,000 in spending on clinical studies expenses; partially offset by

• a decrease of $861,000 in facility-related expenses due to the termination of the lease agreement for our previous facility in the second quarter of 2007; and

• a decrease of $300,000 in legal and other professional fees, primarily associated with filings, patent and trademark registration.

Sales and Marketing Expenses

Sales and marketing expenses increased $3.1 million in 2008 as compared to 2007, primarily due to:

• an increase of $3.0 million due to increased commissions from higher sales and increased headcount and related expense (including share-based compensation);

• an increase of $471,000 in trade show and travel related expenses; and

• an increase of $308,000 in international expenditures; partially offset by

• a decrease of $325,000 in advertising expenditures.

Sales and marketing expenses increased $3.0 million in 2007 as compared to 2006, primarily due to:

• an increase of $2.1 million due to increased commissions from higher sales and increased headcount and related expense (including share-based compensation);

• an increase of $476,000 in trade show and travel related expenses; and

• an increase of $400,000 in direct marketing and advertising expenses.

We expect sales and marketing expenses to increase in absolute dollars in 2009 but to decrease as a percentage of net revenues as compared to 2008.

Research and Development Expenses

Research and development expenses increased $1.0 million in 2008 as compared to 2007, primarily due to:

• an increase of $2.3 million due to increased headcount and related expense (including share-based compensation); partially offset by,

• a decrease of $575,000 in spending on consultants; and

• a decrease of $477,000 in spending on clinical studies.

Research and development expenses increased $2.0 million in 2007 as compared to 2006, primarily due to:

• an increase of $1.8 million due to increased headcount and related expense (including share-based compensation); and

• an increase of $225,000 in spending on clinical studies.

. . .