**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**(mark one)**

**x****           ****Quarterly report pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934**

**Forthe quarterly period ended September 30, 2006**

**o****              ****Transition Report Pursuantto Section 13 or 15(d) of the Securities Exchange Act of 1934**

**Commissionfile number 000-50856**

**NEUROMETRIX,INC.**

(Exact name ofregistrant as specified in its charter)

| **Delaware**                                      | **04-3308180**                        |
|---------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or | (I.R.S. Employer  Identification No.) |
| organization)                                     |                                  |
|                                              |                                  |
| **62  Fourth Avenue, Waltham, Massachusetts**     | **02451**                             |
| (Address of  principal executive offices)         | (Zip Code)                            |

 

**(781)890-9989**

(Registrant’stelephone number, including area code)

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding twelve (12) months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past ninety (90) days.

Yes x    No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer” and “largeaccelerated filer” in Rule 12b-2 of the Exchange Act (check one):

Large acceleratedfiler o  Accelerated filer x  Non-accelerated filer o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yes o     No x

APPLICABLE ONLY TOCORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock as of the latest practicable date:

12,581,786 shares of common stock, par value $0.0001 per share, wereoutstanding as of November 3, 2006.

 

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**NEUROMETRIX,INC.**

**FORM 10-Q**

**INDEX**
| **PART I — FINANCIAL  INFORMATION** |
|-----------------------------------------------|
|                                          |   |
| Item 1.                                       | Condensed Financial Statements |
|                                          |   |
|                                          | Balance Sheets (unaudited) as of September 30, 2006  and December 31, 2005 |
|                                          |   |
|                                          | Statements  of Operations (unaudited) for the three and nine months ended September 30,  2006 and 2005 |
|                                          |   |
|                                          | Statements of Cash Flows (unaudited) for the nine  months ended September 30, 2006 and 2005 |
|                                          |   |
|                                          | Notes  to Financial Statements (unaudited) |
|                                          |   |
| Item 2.                                       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |
|                                          |   |
| Item 3.                                       | Quantitative and Qualitative Disclosures About Market  Risk |
|                                          |   |
| Item 4.                                       | Controls and Procedures |
|                                          |   |
| **PART II  — OTHER INFORMATION**    |
|                                          |   |
| Item  1.                                      | Legal  Proceedings |
|                                          |   |
| Item  1A.                                     | Risk Factors |
|                                          |   |
| Item 2.                                       | Unregistered Sales of Equity Securities and Use of  Proceeds |
|                                          |   |
| Item 3.                                       | Defaults Upon Senior Securities |
|                                          |   |
| Item 4.                                       | Submission of Matters to a Vote of Security Holders |
|                                          |   |
| Item  5.                                      | Other  Information |
|                                          |   |
| Item 6.                                       | Exhibits |
|                                          |   |
| Signatures                                    |   |
|                                               |  |  |

 

2

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**Part I**

**FinancialInformation**

**Item1. Condensed Financial Statements**

**NeuroMetrix, Inc.**

**Balance Sheets**

**(Unaudited)**
| ** **                                                                                                                                                                               | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                                                                               | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                          |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                               |       | $                            | 6,567,007  |                        | $          | 8,170,037 |   |
| Short-term held-to-maturity  investments                                                                                                                                                 |       | 31,569,544                   |       | 24,081,946                  |       |
| Accounts receivable,  net of allowance for doubtful accounts of $575,000 and $400,000 at September 30, 2006 and  December 31, 2005, respectively                     |       | 7,785,011                    |       | 4,543,339                   |       |
| Inventories, net                                                                                                                                                                         |       | 2,818,133                    |       | 2,683,409                   |       |
| Prepaid expenses and  other current assets                                                                                                                                               |       | 741,839                      |       | 614,169                     |       |
| Current portion of  deferred costs                                                                                                                                                       |       | 316,746                      |       | 223,009                     |       |
| Total current assets                                                                                                                                                                     |       | 49,798,280                   |       | 40,315,909                  |       |
|                                                                                                                                                                                     |       |                         |       |                        |       |
| Restricted cash                                                                                                                                                                          |       | 1,458,598                    |       | 1,458,598                   |       |
| Fixed assets, net                                                                                                                                                                        |       | 999,256                      |       | 875,551                     |       |
| Deferred costs                                                                                                                                                                           |       | 335,708                      |       | 247,013                     |       |
| Total assets                                                                                                                                                                             |       | $                            | 52,591,842 |                        | $          | 42,897,071 |   |
|                                                                                                                                                                                     |       |                         |       |                        |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                           | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                                     |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                                         |       | $                            | 1,864,200  |                        | $          | 1,698,583 |   |
| Accrued compensation                                                                                                                                                                     |       | 2,703,798                    |       | 1,959,621                   |       |
| Other accrued expenses                                                                                                                                                                   |       | 1,669,071                    |       | 1,213,928                   |       |
| Current portion of  deferred revenue                                                                                                                                                     |       | 1,165,745                    |       | 760,613                     |       |
| Total current  liabilities                                                                                                                                                               |       | 7,402,814                    |       | 5,632,745                   |       |
|                                                                                                                                                                                     |       |                         |       |                        |       |
| Deferred revenue                                                                                                                                                                         |       | 1,267,788                    |       | 885,354                     |       |
| Other long-term  liabilities                                                                                                                                                             |       | 87,273                       |       | 130,909                     |       |
| Total liabilities                                                                                                                                                                        |       | 8,757,875                    |       | 6,649,008                   |       |
|                                                                                                                                                                                     |       |                         |       |                        |       |
| Commitments and  contingencies                                                                                                                                                           |       |                         |       |                        |       |
|                                                                                                                                                                                     |       |                         |       |                        |       |
| Stockholders’ equity:                                                                                                                                                               |       |                         |       |                        |       |
| Preferred stock, $0.001  par value, 5,000,000 shares authorized, none outstanding                                                                                                        |       | —                       |       | —                      |       |
| Common stock, $0.0001  par value; 50,000,000 shares authorized; 12,581,786 and 12,375,276 shares  issued and outstanding at September 30, 2006 and December 31, 2005,  respectively |       | 1,258                        |       | 1,238                       |       |
| Additional paid-in  capital                                                                                                                                                              |       | 96,467,661                   |       | 93,212,368                  |       |
| Deferred compensation                                                                                                                                                                    |       | (186,700                     | )          | (425,623                    | )          |
| Accumulated deficit                                                                                                                                                                      |       | (52,448,252                  | )          | (56,539,920                 | )          |
| Total stockholders’  equity                                                                                                                                                         |       | 43,833,967                   |       | 36,248,063                  |       |
| Total liabilities and stockholders’ equity                                                                                                                                          |       | $                            | 52,591,842 |                        | $          | 42,897,071 |   |

 

The accompanyingnotes are an integral part of these financial statements.

3

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**NeuroMetrix, Inc.**

**Statements of Operations**

**(Unaudited)**
| ** **                                                            | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                            | ** ** | **September 30,  2006**     | ** ** | **September 30,  2005**    | ** ** | **September 30,  2006** | ** ** | **September 30,  2005** | ** ** |
| Revenues:                                                             |       |                             |       |                            |       |   |   |   |   |
| Diagnostic  device                                                    |       | $                                | 2,203,706  |                            | $          | 1,133,378 |   | $ | 5,678,737 |   | $ | 2,906,291 |   |
| Biosensor                                                             |       | 13,057,545                       |       | 7,976,058                       |       | 35,375,839 |   | 21,060,415 |   |
| Total revenues                                                        |       | 15,261,251                       |       | 9,109,436                       |       | 41,054,576 |   | 23,966,706 |   |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Cost of revenues                                                      |       | 3,735,952                        |       | 2,317,841                       |       | 9,993,331 |   | 6,225,630 |   |
| Gross margin                                                          |       | 11,525,299                       |       | 6,791,595                       |       | 31,061,245 |   | 17,741,076 |   |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Operating  expenses:                                                  |       |                             |       |                            |       |   |   |   |   |
| Research and  development(1)                                          |       | 1,288,151                        |       | 929,905                         |       | 3,815,304 |   | 2,863,179 |   |
| Sales and  marketing(1)                                               |       | 5,666,314                        |       | 3,489,091                       |       | 16,342,882 |   | 10,228,241 |   |
| General and  administrative(1)                                        |       | 2,526,281                        |       | 1,821,878                       |       | 7,772,302 |   | 5,094,398 |   |
| Total operating  expenses                                             |       | 9,480,746                        |       | 6,240,874                       |       | 27,930,488 |   | 18,185,818 |   |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Income (loss)  from operations                                        |       | 2,044,553                        |       | 550,721                         |       | 3,130,757 |   | (444,742 | ) |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Interest income                                                       |       | 435,977                          |       | 218,544                         |       | 1,101,911 |   | 579,591 |   |
| Interest expense                                                      |       | —                           |       | —                          |       | — |   | (2,042 | ) |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Income before  provision for income taxes                             |       | 2,480,530                        |       | 769,265                         |       | 4,232,668 |   | 132,807 |   |
| Provision for  income taxes                                           |       | 66,900                           |       | —                          |       | 141,000 |   | — |   |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Net income                                                            |       | $                                | 2,413,630  |                            | $          | 769,265 |   | $ | 4,091,668 |   | $ | 132,807 |   |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Net income per  common share:                                         |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                 |       | $                                | 0.19       |                            | $          | 0.06 |   | $ | 0.33 |   | $ | 0.01 |   |
| Diluted                                                               |       | $                                | 0.18       |                            | $          | 0.06 |   | $ | 0.31 |   | $ | 0.01 |   |
|                                                                  |       |                             |       |                            |       |   |   |   |   |
| Weighted average  shares used to compute net income per common share: |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                 |       | 12,539,709                       |       | 12,187,835                      |       | 12,477,152 |   | 12,105,992 |   |
| Diluted                                                               |       | 13,095,430                       |       | 13,103,158                      |       | 13,126,593 |   | 12,880,666 |   |

 

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(1)               Non-cashstock-based compensation expense included in these amounts is as follows:
| Research and  development   |   | $       | 57,741 |   | $      | 19,162    |   | $       | 353,459 |   | $ | 58,204 |   |
|-----------------------------|--------|---------|--------|--------|--------|-----------|--------|---------|---------|--------|---|--------|--------|
| Sales and  marketing        |   | 224,092 |   | 67,824 |   | 615,147   |   | 137,594 |    |
| General and  administrative |   | 353,399 |   | 24,629 |   | 1,030,607 |   | 63,708  |    |

 

The accompanyingnotes are an integral part of these financial statements.

4

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**NeuroMetrix, Inc.**

**Statements of Cash Flows**

**(Unaudited)**
| ** **                                                                         | ** ** | **Nine Months Ended**                | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                         | ** ** | ** September 30,    2006** | ** ** | ** September 30,    2005** | ** ** |
| **Cash  flows for operating activities:**                                          | ** ** | ** **                                     | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                              | 4,091,668  |   | $ | 132,807 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                           |       |   |   |
| Depreciation and  amortization                                                     |       | 271,357                                        |       | 204,033 |   |
| Compensation  expense associated with stock options                                |       | 1,999,213                                      |       | 259,506 |   |
| Provision for  doubtful accounts                                                   |       | 515,922                                        |       | 180,199 |   |
| Amortization of  premium on investments                                            |       | 152,119                                        |       | 357,997 |   |
| Provision for  income taxes                                                        |       | 141,000                                        |       | — |   |
| Changes in  operating assets and liabilities:                                      |       |                                           |       |   |   |
| Accounts receivable                                                                |       | (3,757,594                                     | )          | (1,214,302 | ) |
| Inventories                                                                        |       | (134,724                                       | )          | (838,782 | ) |
| Prepaid expenses and other current assets                                          |       | (127,670                                       | )          | 153,896 |   |
| Accounts payable                                                                   |       | 165,617                                        |       | 368,763 |   |
| Accrued compensation and other accrued expenses                                    |       | 1,199,320                                      |       | 783,145 |   |
| Other long-term liabilities                                                        |       | (43,636                                        | )          | (43,636 | ) |
| Deferred revenue and deferred costs                                                |       | 605,134                                        |       | 406,889 |   |
| Net cash  provided by operating activities                                         |       | 5,077,726                                      |       | 750,515 |   |
|                                                                               |       |                                           |       |   |   |
| **Cash  flows for investing activities:**                                          | ** ** | ** **                                     | ** ** | ** ** | ** ** |
| Purchases of  investments                                                          |       | (35,469,441                                    | )          | (13,310,598 | ) |
| Maturities of  investments                                                         |       | 27,829,724                                     |       | 13,504,592 |   |
| Purchases of  fixed assets                                                         |       | (395,062                                       | )          | (314,350 | ) |
| Release of  restricted cash                                                        |       | —                                         |       | 438,600 |   |
| Net cash  provided by (used in) investing activities                               |       | (8,034,779                                     | )          | 318,244 |   |
|                                                                               |       |                                           |       |   |   |
| **Cash  flows from financing activities:**                                         | ** ** | ** **                                     | ** ** | ** ** | ** ** |
| Proceeds from  exercise of stock options                                           |       | 1,137,110                                      |       | 171,356 |   |
| Proceeds from  issuance of common stock under employee stock purchase plan         |       | 216,913                                        |       | 127,263 |   |
| Net cash  provided by financing activities                                         |       | 1,354,023                                      |       | 298,619 |   |
|                                                                               |       |                                           |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | (1,603,030                                     | )          | 1,367,378 |   |
| Cash and cash  equivalents, beginning of period                                    |       | 8,170,037                                      |       | 1,936,241 |   |
| Cash and cash  equivalents, end of period                                          |       | $                                              | 6,567,007  |   | $ | 3,303,619 |   |

 

The accompanyingnotes are an integral part of these financial statements.

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**NeuroMetrix, Inc.Notes to Financial Statements**

**1.             Nature of the Business and Basis ofPresentation**

NeuroMetrix, Inc.(the “Company”), a Delaware corporation, was formed in June 1996. TheCompany designs, develops and sells proprietary medical devices used todiagnose neuropathies. Neuropathies are diseases of the peripheral nerves andparts of the spine that frequently are caused by or associated with diabetes,low back pain and carpal tunnel syndrome, as well as other clinical disorders.The Company operates in one business segment.

The accompanyingunaudited balance sheet as of September 30, 2006 and unaudited statements ofoperations for the three and nine month periods ended September 30, 2006 and2005 and the unaudited statements of cash flows for the nine month periodsended September 30, 2006 and 2005 have been prepared in accordance withaccounting principles generally accepted in the United States of America forinterim financial information and with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements. In theopinion of management, all adjustments (consisting only of normal recurringaccruals) considered necessary for a fair statement of the results ofoperations have been included. Operating results for the nine month periodended September 30, 2006 are not necessarily indicative of the results that maybe expected for the year ending December 31, 2006 or any other period.These financial statements and notes should be read in conjunction with thefinancial statements for the year ended December 31, 2005 included in theCompany’s Annual Report on Form 10-K (File No. 000-50856). Theaccompanying balance sheet as of December 31, 2005 has been derived fromaudited financial statements prepared at that date, but does not include alldisclosures required by accounting principles generally accepted in the UnitedStates of America.

**Use ofEstimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities andthe disclosure of contingent liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

**RecentAccounting Pronouncements**

In July 2006, theFinancial Accounting Standards Board (“FASB”) issued FASB Interpretation No.48,*“Accounting for Uncertainty in IncomeTaxes—an interpretation of FASB Statement No. 109”* (“FIN No. 48”),which clarifies the accounting and disclosure for uncertainty in tax positions,as defined. FIN No. 48 seeks to reduce the diversity in practice associatedwith certain aspects of the recognition and measurement related to accountingfor income taxes. This interpretation is effective for fiscal years beginningafter December 15, 2006. The Company has not yet determined the impact thisinterpretation will have on its results from operations or financial position.

In September 2006, theFASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, *“Fair Value Measurements”* (“SFAS No. 157”),which establishes a comprehensive framework for measuring fair value ingenerally accepted accounting principles and expands disclosures about fairvalue measurements. Specifically, SFAS No. 157 sets forth a definition of fairvalue, and establishes a hierarchy prioritizing the inputs to valuationtechniques, giving the highest priority to quoted prices in active markets foridentical assets and liabilities and the lowest priority to unobservableinputs. This statement is effective for financial statements issued for fiscalyears beginning after November 15, 2007, and interim periods within thosefiscal years. The provisions of SFAS No. 157 are generally required to beapplied on a prospective basis. The Company will adopt SFAS No. 157 in thefirst quarter of 2008. The Company does not expect this standard to have amaterial effect on its financial position, results of operations or cash flows.

In September 2006,the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108*“Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements”*. This standard addresses quantifying the financialstatement effect of misstatements, specifically, how the effects of prior yearuncorrected errors must be considered in quantifying misstatements in thecurrent year financial statements. This standard is effective for fiscal yearsending after November 15, 2006. The Company does not expect this standardto have a material effect on its financial position, results of operations orcash flows.

**2.             Accounting for Stock-BasedCompensation**

In December 2004, the FASB issued SFAS No. 123(R), *“Share Based Payment”* (“SFASNo. 123(R)”), which requires that the cost resulting from all share-basedpayment transactions be recognized in the financial statements. SFASNo. 123(R) revises SFAS No. 123 *“Accountingfor Stock-Based Compensation”* (“SFAS No. 123”) and supersedesAccounting Principles Board Opinion No. 25, *“Accounting for Stock Issued to Employees”* (“APB No. 25”)and SFAS No. 148, *“Accounting for StockBased Compensation—Transition and Disclosure—an amendment of FinancialAccounting Standards Board Statement No. 123*”. As a result,beginning January 1, 2006, the Company adopted SFASNo. 123(R) using the modified prospective method and has begunreflecting the

6

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stock-based compensationexpense determined under fair value based methods in statement of operationsrather than as pro forma disclosure in the notes to the financial statements.Under this transition method, the compensation cost recognized beginningJanuary 1, 2006 includes compensation cost for (i) all share-basedpayments granted prior to, but not yet vested as of January 1, 2006, basedon the grant-date fair value estimated in accordance with the provisions ofSFAS No. 123, and (ii) all share based payments granted subsequent toJanuary 1, 2006 based on the grant-date fair value estimated in accordancewith the provisions of SFAS No. 123(R). Compensation cost is generallyrecognized ratably over the requisite service period. Prior period amounts havenot been restated. The Company uses the Black-Scholes option pricing model fordetermining the fair value of its stock options and amortizes its stock-basedcompensation expense using the straight-line method.

During 1996, the Companyadopted the 1996 Stock Option/Restricted Stock Plan (the “1996 Stock Plan”).The 1996 Stock Plan provides for the granting of incentive and non-qualifiedstock options and stock bonus awards to officers, directors and employees ofthe Company. The maximum number of shares that may be issued pursuant to the1996 Stock Plan is 156,250. All of the outstanding options under the 1996 StockPlan are fully vested and terminate 10 years after the grant date, or earlierif the option holder is no longer an executive officer, employee, consultant,advisor or director, as applicable, of the Company. As of September 30, 2006,all shares had been issued under the 1996 Stock Plan.

During 1998, the Companyadopted the 1998 Equity Incentive Plan (the “1998 Stock Plan”). The 1998 StockPlan also provides for granting of incentive and nonqualified stock option andstock bonus awards to officers, consultants and employees of the Company. Outstandingoptions under the 1998 Stock Plan generally vest over three or four years andterminate 10 years after the grant date, or earlier if the option holder is nolonger an executive officer, employee, consultant, advisor or director, asapplicable, of the Company. As of September 30, 2006, 1,250,000 shares ofcommon stock were authorized for issuance under the 1998 Stock Plan, of which533,290 shares had been issued and 637,033 shares were subject to outstandingoptions at a weighted average exercise price of $7.01 per share. The 1998 StockPlan was closed to any future grants at the time of the Company’s initialpublic offering and therefore we will not make any additional grants under the1998 Stock Plan.

During 2004, the Companyadopted the 2004 Stock Option and Incentive Plan (the “2004 Stock Plan”). The2004 Stock Plan also provides for granting of incentive and nonqualified stockoption and stock bonus awards to officers, consultants and employees of theCompany. Outstanding options under the 2004 Stock Plan generally vest overthree or four years and terminate 10 years after the grant date, or earlier ifthe option holder is no longer an executive officer, employee, consultant,advisor or director, as applicable, of the Company. As of September 30, 2006,1,946,022 shares of common stock were authorized for issuance under the 2004Stock Plan, of which 88,785 shares had been issued, 601,996 shares were subjectto outstanding options at a weighted average exercise price of $23.06 per shareand 1,255,241 shares were available for future grant. In March 2006, theCompany’s Board of Directors voted to discontinue the provision of the 2004Stock Plan which automatically increased the number of options available forgrant under the 2004 Stock Plan based on the net increase in the total numberof outstanding shares of common stock during the year.

The exercise price ofeach stock option issued under the 1996 and 1998 Stock Plans was specified bythe Board of Directors at the time of grant. The exercise price of stockoptions awarded under the 2004 Stock Plan may not be less than the fair marketvalue of the common stock on the date of the option grant. For holders of morethan 10% of the Company’s total combined voting power of all classes of stock,incentive stock options may not be granted at less than 110% of the fair marketvalue of the Company’s common stock at the date of grant and for a term not toexceed five years.

Certain stockoptions granted prior to January 1, 2006 covering a total of 15,480 shareswere modified during the third quarter of 2006 to increase the exerciseprice to the fair market value as of the original date of grant. These stockoptions were originally issued at a discount to fair market value inthe first half of 2004 prior to the Company’s initial public offering. Thegrants have been revalued using the Black Scholes option pricing model and forunvested shares, the sum of the difference between fair value immediatelybefore and after the modifications and the remaining original intrinsicvalue is being amortized to expense over the remaining vesting period.

In June 2004, theCompany adopted the 2004 Employee Stock Purchase Plan (“ESPP”). All of ouremployees who have been employed by the Company for at least 60 days and whosecustomary employment is for more than 20 hours per week and for more than fivemonths in any calendar year are eligible to participate. Any employee who owns5% or more of the voting power or value of our stock is not eligible toparticipate and an employee may purchase no more than $25,000 worth of commonstock, valued at the start of the purchase period, in any calendar year. TheESPP authorizes the issuance of up to a total of 375,000 shares of our commonstock to participating employees.

Under the ESPP, participating employees can authorize the Company towithhold up to 10% of their earnings during consecutive six-month paymentperiods for the purchase of the shares. At the conclusion of each period,participating employees can purchase shares at 85% of the lower of their fairmarket value at the beginning or end of the period. The ESPP is regarded as acompensatory plan according to the provisions of SFAS No. 123(R). Underthis plan, the Company has issued 41,911 shares of its common stock throughSeptember 30, 2006.

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A summary ofactivity under the Company’s 1996, 1998 and 2004 Stock Plans for the ninemonths ended September 30, 2006 is presented below:
|                                        | ** ** | **Number  of Shares** | ** ** | **Exercise          Price Range        ** | ** **     | **Weighted  Average  Exercise Price** | ** ** |
|----------------------------------------|------------|----------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------|----------------|--------------------------------------------|------------|
| Outstanding at  December 31, 2005 |       | 1,120,619                  |       | $                                                                                                                              | 0.200 - 37.230 |                                       | $          | 8.3316 |   |
| Granted at fair value                  |       | 370,800                    |       | 19.550 - 38.960                                                                                                                |           | 30.5098                                    |       |
| Exercised                              |       | (197,396                   | )          | 0.200 - 12.600                                                                                                                 |           | 5.7606                                     |       |
| Forfeited                              |       | (54,994                    | )          | 2.250 - 36.111                                                                                                                 |           | 21.7347                                    |       |
| Outstanding at September  30, 2006     |       | 1,239,029                  |       | $                                                                                                                              | 0.400 - 38.960 |                                       | $          | 14.8092 |   |

 

The aggregate intrinsicvalue of options exercised during the third quarter and first nine months of2006 was $1,564,700 and $5,250,400, respectively.

The followingtable summarizes information about stock options outstanding at September 30,2006:
| Exercise Price | ** ** | **Number of  Options  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|---------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| $0.40 — 4.48   |       | 116,204                                  |       | 6.5                                                                  |       | $                                          | 2.4675     |   |
| $8.00 — 8.00   |       | 514,375                                  |       | 7.7                                                                  |       | 8.0000                                     |       |
| $8.25 — 9.78   |       | 72,705                                   |       | 8.1                                                                  |       | 9.1550                                     |       |
| $9.90 — 14.76  |       | 147,045                                  |       | 8.4                                                                  |       | 10.3360                                    |       |
| $17.34 — 29.50 |       | 105,500                                  |       | 9.3                                                                  |       | 26.4348                                    |       |
| $30.10 — 38.96 |       | 283,200                                  |       | 9.3                                                                  |       | 31.6841                                    |       |
|                |       | 1,239,029                                |       | 8.2                                                                  |       | $                                          | 14.8092    |   |

 

The followingtable summarizes information about stock options exercisable at September 30,2006:
| Exercise Price | ** ** | **Number of  Options  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|---------------------|------------|------------------------------------------|------------|--------------------------------------------|------------|
| $0.40 — 4.48   |       | 57,254                                   |       | $                                          | 2.4278     |   |
| $8.00 — 8.00   |       | 286,842                                  |       | 8.0000                                     |       |
| $8.25 — 9.78   |       | 24,360                                   |       | 9.1633                                     |       |
| $9.90 — 14.76  |       | 15,905                                   |       | 10.5103                                    |       |
| $17.34 — 29.50 |       | 7,812                                    |       | 24.9936                                    |       |
| $30.10 — 38.96 |       | —                                   |       | N/A                                        |       |
|                |       | 392,173                                  |       | $                                          | 7.6991     |   |

 

The weighted average remaining contractual life for stock optionsexercisable at September 30, 2006 was 7.54 years. The aggregate intrinsic valuefor stock options outstanding and exercisable at September 30, 2006 was$9,580,900 and $4,483,600 respectively.

8

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Prior toJanuary 1, 2006, the Company accounted for stock-based compensation plansin accordance with the provisions of APB No. 25, as permitted by SFASNo. 123, and accordingly did not recognize compensation expense for theissuance of options with an exercise price equal to or greater than the fairvalue at the date of grant. Had the fair value based method as prescribed bySFAS No. 123 been applied by the Company, the effect on net income (loss)and net income (loss) per common share for the third quarter and first ninemonths of 2005 would have been as follows:
|                                                                                    | ** ** | **Three months  Ended September  30, 2005** | ** ** | **Nine months  ended  September 30, 2005** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Net income, as  reported                                                           |       | $                                                          | 769,265    |                                                      | $          | 132,807 |   |
| Add employee  stock-based compensation expense included in reported net income     |       | 111,615                                                    |       | 259,506                                                   |       |
| Less employee  stock-based compensation expense determined under fair value method |       | (364,551                                                   | )          | (1,044,214                                                | )          |
| Net income  (loss) — pro forma                                                |       | 516,329                                                    |       | (651,901                                                  | )          |
| Net income  (loss) per common share (basic and diluted)                            |       |                                                       |       |                                                      |       |
| As reported                                                                        |       | $                                                          | 0.06       |                                                      | $          | 0.01 |   |
| Pro forma                                                                          |       | $                                                          | 0.04       |                                                      | $          | (0.05 | ) |

 

The weightedaverage grant date fair value used in the calculation of stock-basedcompensation expense in the accompanying statement of operations for the thirdquarter and first nine months of 2006 and the pro forma net income (loss) andnet income (loss) per common share information presented above has been calculatedusing the Black-Scholes option pricing model with the following weightedaverage assumptions:
|                                                 | ** ** | **Three Months Ended**         | ** ** | **Nine months ended**          | ** ** |
|-------------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|
| ** **                                      | ** ** | ** September 30,   2006** | ** ** | ** September 30,   2005** | ** ** | ** September 30,   2006** | ** ** | ** September 30,   2005** | ** ** |
| Risk-free  interest rate                        |       | 4.5%-5.2                                 | %          | 3.7%-4.1                                 | %          | 4.3%-5.2 | % | 3.5%-4.3 | % |
| Expected  dividend yield                        |       | —                                   |       | —                                   |       | — |   | — |   |
| Expected option  term                           |       | 5 years                                  |       | 5 years                                  |       | 5 years |   | 5 years |   |
| Volatility                                      |       | 70.0                                     | %          | 53.6                                     | %          | 50.0%-70.0 | % | 58.6 | % |
| Weighted average  fair value of options granted |       | $                                        | 14.97      |                                     | $          | 13.03 |   | $ | 14.96 |   | $ | 6.40 |   |
|                                                 |            |                                          |            |                                          |            |  |  |  |  |  |  |  |  |

 

The risk-free interestrate assumption was based on the United States Treasury’s constant maturityrate for a five year term (corresponding to the expected option term) on thedate the option was granted. The assumed dividend yield was based on theCompany’s expectation of future dividend payouts. The expected option term offive years was estimated based on an analysis of actual option exercises and areview of comparable medical device companies. The volatility assumption wasbased on weekly historical volatility during the time period that correspondsto the expected option term, a review of comparable medical device companiesand expected future stock price volatility. The post-vesting forfeiture rate isbased on the historical and projected average turnover rate using fourclassifications of employees. These assumptions will be evaluated and revisedas necessary based on changes in market conditions and historical experience.

The Company uses theBlack-Scholes option pricing model for determining the fair value of shares ofcommon stock issued or to be issued under the ESPP. The following assumptionswere used in determining fair value: The risk-free interest rate assumption wasbased on the United States Treasury’s constant maturity rate for a period oftime corresponding to the expected term. The assumed dividend yield was basedon the Company’s expectation of future dividend payouts. An expected term ofsix months was used based on the duration of each plan offering period. Thevolatility assumption was based on stock price volatility over the most recentperiod of time corresponding to the expected term and was also based onexpected future stock price volatility. These assumptions will be evaluated andrevised as necessary based on changes in market conditions and historicalexperience.

The Company recorded stock-based compensation expense for the thirdquarter and first nine months of 2006 of approximately $635,200 and $1,999,200,respectively. Included in the stock-based compensation expense recorded by theCompany in the third quarter and first nine months of 2006 is (a) $600,900and $1,714,100, respectively, in compensation expense relating to stock optionsgranted to employees subsequent to the Company’s July 2004 initial publicoffering (“IPO”) that are accounted for according to the provisions of SFASNo. 123(R); (b) $76,400 and $27,400, respectively, in reductions ofcompensation expense related to stock options granted to non-employees that areaccounted for according to the provisions of Emerging Issues Task Force (“EITF”)Issue No. 96-18 *“Accounting for EquityInstruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services”* (“EITF No. 96-18”);(c) $49,000 and $124,900, respectively, in compensation expense related tothe ESPP and accounted for under the provisions of SFASNo. 123(R) and (d) $61,800 and $187,600, respectively, incompensation expense relating to stock options granted to employees prior tothe Company’s IPO that are being accounted for using the intrinsic value methodaccording to the provisions of SFAS No. 123(R).

9

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Stock options granted tonon-employees are recorded at fair value and adjusted to market over thevesting period according to the provisions of EITF No. 96-18. The Companydetermines fair value using the Black-Scholes option pricing model, an expectedterm equal to the remaining vesting period, a risk-free interest ratecorresponding to the expected term, an expected volatility of 70% and adividend yield of zero.

Deferred compensation wasrecorded in connection with stock option grants made prior to the Company’sIPO. The deferred compensation represents the difference between the estimatedmarket value of common stock on the date of grant and the exercise priceassociated with the stock options. The deferred compensation is amortized toexpense over the vesting period of the related stock options. The unamortizedbalance of deferred compensation as of September 30, 2006 is approximately$186,700.

Total unrecognizedstock-based compensation costs related to non-vested stock options wasapproximately $6,623,200 as of September 30, 2006 which related toapproximately 846,900 shares with a per share weighted fair value of $7.82. Thisunrecognized cost is expected to be recognized over a weighted average periodof approximately 2.2 years.

The Company has no taxwindfall or shortfall as of September 30, 2006 as a result of having a 100%valuation allowance established against deferred tax assets.

**3.             Net Income Per Common Share**

The Companyaccounts for and discloses net income per common share in accordance with SFASNo. 128, *“Earnings Per Share*”.Basic net income per common share is computed by dividing net income by theweighted average number of common shares outstanding. Diluted net income percommon share is computed by dividing net income by the weighted average numberof common shares and dilutive potential common shares then outstanding.Potential common shares consist of shares issuable upon the exercise of stockoptions (using the treasury stock method).
|                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **September  30, 2006**     | ** ** | **September  30, 2005**    | ** ** | **September  30, 2006** | ** ** | **September  30, 2005** | ** ** |
| Basic:                                       |       |                             |       |                            |       |   |   |   |   |
| Net income available  to common stockholders |       | $                                | 2,413,630  |                            | $          | 769,265 |   | $ | 4,091,668 |   | $ | 132,807 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Weighted average  shares                     |       | 12,539,709                       |       | 12,187,835                      |       | 12,477,152 |   | 12,105,992 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Basic income per  common share               |       | $                                | 0.19       |                            | $          | 0.06 |   | $ | 0.33 |   | $ | 0.01 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Diluted:                                     |       |                             |       |                            |       |   |   |   |   |
| Net income  available to common stockholders |       | $                                | 2,413,630  |                            | $          | 769,265 |   | $ | 4,091,668 |   | $ | 132,807 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Weighted average  shares                     |       | 12,539,709                       |       | 12,187,835                      |       | 12,477,152 |   | 12,105,992 |   |
| Effect of stock  options                     |       | 555,721                          |       | 915,323                         |       | 649,441 |   | 753,425 |   |
| Effect of  warrant                           |       | —                           |       | —                          |       | — |   | 21,249 |   |
| Weighted average  shares, as adjusted        |       | 13,095,430                       |       | 13,103,158                      |       | 13,126,593 |   | 12,880,666 |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Diluted income per  common share             |       | $                                | 0.18       |                            | $          | 0.06 |   | $ | 0.31 |   | $ | 0.01 |   |

 

The followingpotentially dilutive common shares were excluded from the calculation ofdiluted net income per common share because their effect was antidilutive foreach of the periods presented:
|                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **           | ** ** | **September  30, 2006**     | ** ** | **September  30, 2005**    | ** ** | **September  30, 2006** | ** ** | **September  30, 2005** | ** ** |
| Options  outstanding |       | 383,124                          |       | 18,000                          |       | 357,281 |   | 38,500 |   |

 

**4.             Inventories**

Inventoriesconsist of the following:
|                       | ** ** | **  September 30,    2006** | ** ** | **  December 31,    2005** | ** ** |
|-----------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Purchased  components |       | $                                                    | 259,017    |                                                | $          | 276,167 |   |
| Finished goods        |       | 2,559,116                                            |       | 2,407,242                                           |       |
|                  |       | $                                                    | 2,818,133  |                                                | $          | 2,683,409 |   |

 

10

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**5.             Other Balance Sheet Items**

Accrued expensesconsist of the following:
| ** **            | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------|------------|------------------------------|------------|-----------------------------|------------|
| Professional services |       | $                            | 388,298    |                        | $          | 438,519 |   |
| Other                 |       | 1,280,773                    |       | 775,409                     |       |
|                  |       | $                            | 1,669,071  |                        | $          | 1,213,928 |   |

 

Product Warranty Costs

The Company accruesestimated product warranty costs at the time of sale which are included in costof sales in the statements of operations. The amount of the accrued warrantyliability is based on historical information such as past experience, productfailure rates, number of units repaired and estimated cost of material andlabor. The liability for product warranty costs is included in accrued expensesin the balance sheet.

The following is arollforward of the Company’s accrued warranty liability for the three and ninemonth periods ended September 30, 2006 and 2005:
| ** **                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **September 30,  2006**     | ** ** | **September 30,  2005**    | ** ** | **September 30,  2006** | ** ** | **September 30,  2005** | ** ** |
| Balance at beginning of  period |       | $                                | 45,127     |                            | $          | 71,353 |   | $ | 64,122 |   | $ | 59,876 |   |
| Accrual for warranties          |       | 220,783                          |       | 90,522                          |       | 444,627 |   | 229,838 |   |
| Settlements made                |       | (171,340                         | )          | (89,407                         | )          | (414,179 | ) | (217,246 | ) |
| Balance at end of period        |       | $                                | 94,570     |                            | $          | 72,468 |   | $ | 94,570 |   | $ | 72,468 |   |

 

There have been noadjustments to the amounts disclosed above for prior periods.

**6.             Subsequent Event**

In October 2006, the Company entered into an exclusive seven yearlicensing agreement with EyeTel Imaging, Inc. (“EyeTel”). The agreement grantsthe Company an exclusive license to market, brand, and sell EyeTel’s DigiScope®throughout the primary diabetes care physician market. The DigiScope, developedin collaboration with the Wilmer Eye Institute at Johns Hopkins, is anFDA-cleared diagnostic device that primary diabetes care physicians can use forthe early detection of diabetic retinopathy. In connection with the agreement,the Company received warrants to purchase up to 500,000 shares of EyeTel commonstock at an exercise price of $0.16 per share, subject to adjustment for stocksplits and with a term of ten years. The warrants are subject to vesting basedon the Company’s achievement of performance milestones relating to sales andcustomer usage of the DigiScope.

11

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**Item 2.     Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

*Youshould read the following discussion of our financial condition and results ofoperations in conjunction with our condensed financial statements and theaccompanying notes to those financial statements included elsewhere in thisQuarterly Report on Form 10-Q. This discussion contains forward-lookingstatements that involve risks and uncertainties. For a description of factorsthat may cause our actual results to differ materially from those anticipatedin these forward looking statements, please refer to the section of thisQuarterly Report on Form 10-Q titled “Cautionary Note RegardingForward-Looking Statements.”*

**Overview**

NeuroMetrix was foundedin June 1996. We design, develop and sell proprietary medical devices usedto diagnose neuropathies. Our proprietary technology provides physicians withan in-office diagnostic system, the NC-stat System, which enables physicians tomake rapid and accurate diagnoses of neuropathies, including carpal tunnelsyndrome, low back and leg pain and diabetic peripheral neuropathy. The NC-statSystem is comprised of: (1) disposable single use NC-stat biosensors thatare placed on the patient’s body; (2) the NC-stat monitor and relatedcomponents; and (3) the NC-stat docking station, an optional device thatenables the physician’s office to transmit data to our onCall InformationSystem. Each component of the NC-stat System is also sold separately. Thesensitivity of the nervous system to metabolic and mechanical damage,compounded by its limited regenerative ability, creates a market opportunityfor a medical device that can assist in point-of-service diagnoses ofneuropathies in a manner that is cost-effective for the patient and third-partypayer. We believe the ease of use, accuracy and convenience provided by theNC-stat System position it to become a standard of care for the assessment ofneuropathies at the point-of-service.

We derive our revenuesfrom the sale of NC-stat biosensors, monitors and docking stations directly toend users, which are generally physician practice groups. Our NC-statbiosensors are disposable products that are used once and inactivated afteruse. The NC-stat monitor is an electronic instrument that is used with theNC-stat biosensors to perform nerve conduction studies for the purpose ofdiagnosing neuropathies. The NC-stat monitor displays the pertinent results ofnerve conduction studies on an LCD screen immediately at the conclusion of eachstudy. The NC-stat docking station is an optional device that is used totransmit to the onCall Information System data generated by the nerveconduction study performed with the NC-stat monitor. The onCall InformationSystem formulates the data it receives for each test into a detailed reportthat is provided to the customer through facsimile or e-mail.

Reimbursement fromthird-party payers is an important element of success for medical productscompanies. Generally, we believe that the nerve conduction studies performed byour customers with the NC-stat System have been satisfactorily covered bythird-party payers. As our presence in the market expands and the use of theNC-stat System increases, we have experienced and are likely to continueto experience an increased focus from third-party payers and governmentalagencies regarding the reimbursement of nerve conduction studies performedusing the NC-stat System and an increased focus from these organizationsregarding the professional requirements for performing nerve conduction studiesin general. At any point in time, a number of third-party payers may take theposition of not reimbursing our customers for their use of the NC-stat System.Recently, two local Medicare carriers covering Florida, Texas and severaladditional states issued policies indicating that physicians using the NC-statSystem will not be reimbursed under the existing Current Procedural Terminology(“CPT”) codes for nerve conduction testing (95900, 95903 and 95904) but rathershould submit for reimbursement under a separate miscellaneous neurologicalprocedure code (95999). We do not know what success our customers will have inobtaining reimbursement under this code and what level of reimbursement theymay receive. This decision could potentially adversely impact our future revenues.In addition, several additional local Medicare carriers have issued draft localcoverage determinations, which if implemented as final policies, couldadversely impact the reimbursement received by our customers and thereforepotentially adversely impact our future revenues. Widespread adoption of theNC-stat System by the medical community is unlikely to occur if physicians donot receive satisfactory reimbursement from third-party payers for proceduresperformed with the NC-stat System. One of the primary challenges we face in ourbusiness is successfully expanding the market for nerve conduction studies. Asuccessful market expansion will depend upon, in part, our targeting of primarycare and specialty physicians who traditionally have not been targeted bycompanies selling equipment used to perform nerve conduction studies and ourability to alter physicians’ practices relating to the diagnosis ofneuropathies. In order to successfully implement this growth strategy, we haveestablished a sales force of 49 employees, including 45 regional salesmanagers, as of September 30, 2006. We have also expanded the network ofindependent sales agents we use to generate sales leads for our regional salesmanagers through the signing of an agreement with Physician Sales & Service(“PSS”). PSS has a direct sales force of nearly 700 representatives. As aresult we now have over 1,000 independent sales agents assisting us in ourefforts to penetrate the market of primary care and specialty care physicians.We also will participate in various industry conferences in order to acceleratethe market awareness and adoption of our products. These efforts, as well asthe overall expansion of our business, will provide challenges to ourorganization and may increase the burden on our management and operations. Weplan to monitor our business as it grows and appropriately acquire and allocateresources to address these issues, with a goal of sustaining profitable growth.

Our financial objective is to grow our business through the sale of theNC-stat System and additional products that may be commercialized for thediagnosis and treatment of neuropathies and to achieve sustainableprofitability. Our efforts in the remainder of 2006 will continue to focusprimarily on sales of the NC-stat System and continuing our ongoing program ofmaking enhancements and

12

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improvements to theNC-stat System, with the goal of increasing our market penetration. During thefirst nine months of 2006, we continued efforts on improvements to ourbiosensors, on the development of new biosensors, on the development ofproducts to diagnose additional neuropathies, and on the development of a thirdgeneration neurodiagnostic system. We are also in the early stages of designinga drug delivery system for the minimally invasive treatment of neuropathies byboth primary care and specialist physicians. We believe that the accomplishmentof these goals will have a positive impact on our progress toward the objectiveof growing the business and achieving sustainable profitability.

Effective January 1,2006, we adopted Statement of Financial Accounting Standards (“SFAS”)No. 123(R), *“Share Based Payment”*(“SFAS No. 123(R)”), which requires that the cost resulting from allshare-based payment transactions be recognized in the financial statements.SFAS No. 123(R) is a revision of SFAS No. 123, *“Accounting for Stock-Based Compensation”*(“SFAS No. 123”) and supersedes Accounting Principles Board OpinionNo. 25, *“Accounting for Stock Issued toEmployees”* (“APB No. 25”) and SFAS No. 148, *“Accounting for Stock Based Compensation—Transitionand Disclosure—an amendment of Financial Accounting Standards Board StatementNo. 123”* (“SFAS No. 148”). This statement establishes fairvalue as the measurement objective in accounting for share-based paymentarrangements and requires all entities to apply a fair value based measurementmethod in accounting for share-based payment transactions with employees exceptfor equity instruments held by employee share ownership plans. As a result,beginning January 1, 2006, we adopted SFAS No. 123(R) using themodified prospective method and have begun reflecting the stock-basedcompensation expense determined under fair value based methods in the incomestatement rather than as pro forma disclosure in the notes to the financialstatements. Prior period results have not been revised. We use theBlack-Scholes option pricing model for determining the fair value of its stockoptions and amortize our stock-based compensation expense using the straight-linemethod. During the first nine months of 2006, we recorded stock-basedcompensation of approximately $2.0 million. We expect stock-based compensationexpense recognized in accordance with the provisions of SFAS 123(R) in thefourth quarter of 2006 to be relatively consistent with the amount recognizedin the first three quarters of 2006, but this amount could increase if thereare additional stock options granted. The stock-based compensation expenserecognized in accordance with Emerging Issues Task Force Issue No. 96-18 *“Accounting for Equity Instruments That Are Issued toOther Than Employees for Acquiring, or in Conjunction with Selling, Goods orServices”* for option grants to non-employees may vary significantlybased on the performance of the Company’s stock price since these grants arevalued at the end of each reporting period.

In October 2006, weentered into an exclusive seven year licensing agreement with EyeTel Imaging,Inc. (“EyeTel”). The agreement grants us an exclusive license to market, brandand sell EyeTel’s DigiScope® throughout the primary diabetes care physicianmarket. The DigiScope, developed in collaboration with the Wilmer Eye Instituteat Johns Hopkins, is an FDA-cleared diagnostic device that primary diabetescare physicians can use for the early detection of diabetic retinopathy. Inconnection with the agreement, we received warrants to purchase up to 500,000shares of EyeTel common stock at an exercise price of $0.16 per share, subjectto adjustment for stock splits and with a term of ten years. The warrants aresubject to vesting based on our achievement of performance milestones relatingto sales and customer usage of the DigiScope.

**Resultsof Operations**

The followingtable presents certain statement of operations information stated as apercentage of total revenues:
| ** **                                | ** ** | **Three Months Ended September 30,**                                                                         | ** ** | **Nine Months Ended September 30,**                                                                          | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **          2006          ** | ** ** | **          2005          ** | ** ** | **          2006          ** | ** ** | **          2005          ** | ** ** |
| Revenues:                                 |       |                                                                                                                             |       |                                                                                                                             |       |   |   |   |   |
| Diagnostic  device                        |       | 14.4                                                                                                                             | %          | 12.4                                                                                                                             | %          | 13.8 | % | 12.1 | % |
| Biosensor                                 |       | 85.6                                                                                                                             |       | 87.6                                                                                                                             |       | 86.2 |   | 87.9 |   |
| Total revenues                            |       | 100.0                                                                                                                            |       | 100.0                                                                                                                            |       | 100.0 |   | 100.0 |   |
|                                      |       |                                                                                                                             |       |                                                                                                                             |       |   |   |   |   |
| Cost of revenues                          |       | 24.5                                                                                                                             |       | 25.4                                                                                                                             |       | 24.3 |   | 26.0 |   |
|                                      |       |                                                                                                                             |       |                                                                                                                             |       |   |   |   |   |
| Gross margins                             |       | 75.5                                                                                                                             |       | 74.6                                                                                                                             |       | 75.7 |   | 74.0 |   |
|                                      |       |                                                                                                                             |       |                                                                                                                             |       |   |   |   |   |
| Operating  expenses:                      |       |                                                                                                                             |       |                                                                                                                             |       |   |   |   |   |
| Research and  development                 |       | 8.4                                                                                                                              |       | 10.2                                                                                                                             |       | 9.3 |   | 11.9 |   |
| Sales and  marketing                      |       | 37.1                                                                                                                             |       | 38.3                                                                                                                             |       | 39.8 |   | 42.7 |   |
| General and  administrative               |       | 16.6                                                                                                                             |       | 20.0                                                                                                                             |       | 18.9 |   | 21.3 |   |
| Total operating  expenses                 |       | 62.1                                                                                                                             |       | 68.5                                                                                                                             |       | 68.0 |   | 75.9 |   |
| Income (loss)  from operations            |       | 13.4                                                                                                                             |       | 6.0                                                                                                                              |       | 7.6 |   | -1.9 |   |
| Interest income,  net                     |       | 2.9                                                                                                                              |       | 2.4                                                                                                                              |       | 2.7 |   | 2.4 |   |
| Income before  provision for income taxes |       | 16.3                                                                                                                             |       | 8.4                                                                                                                              |       | 10.3 |   | 0.6 |   |
| Provision for  income taxes               |       | 0.4                                                                                                                              |       | —                                                                                                                           |       | 0.3 |   | — |   |
| Net income                                |       | 15.8                                                                                                                             | %          | 8.4                                                                                                                              | %          | 10.0 | % | 0.6 | % |

 

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**Comparisonof Three Months Ended September 30, 2006 and September 30, 2005**

***Revenues***

The followingtables present a breakdown of our customers, biosensor units used and revenues:
| ** ** | ** ** | **12-Month Period  Ended September 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------|------------|---------------------------------------------------------|------------|------------|------------|------------|------------|
| ** ** | ** ** | **2006**                                                | ** ** | **2005**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
|       |       |                                                    |       |       |       |       |       |   |   |
| Customers  |       | 4,518                                                   |       | 2,969      |       | 1,549      |       | 52.2 | % |

 
| ** **            | ** ** | **Three Months Ended  September 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **            | ** ** | **2006**                                             | ** ** | **2005**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| Biosensor units  used |       | 302,200                                              |       | 187,900    |       | 114,300    |       | 60.8 | % |

 
| ** **         | ** ** | **($ in thousands)** | ** ** | ** ** | ** ** |
|--------------------|------------|--------------------------------|------------|------------|------------|
| Revenues:          |       |                           |       |       |       |   |   |   |   |
| Diagnostic  device |       | $                              | 2,203.7    |       | $          | 1,133.4 |   | $ | 1,070.3 |   | 94.4 |   |
| Biosensor          |       | 13,057.5                       |       | 7,976.1    |       | 5,081.5 |   | 63.7 |   |
| Total revenues     |       | $                              | 15,261.3   |       | $          | 9,109.4 |   | $ | 6,151.8 |   | 67.5 | % |

 

Diagnostic devicerevenues were $2.2 million and $1.1 million for the three months endedSeptember 30, 2006 and September 30, 2005, respectively, representing ayear-over-year increase for the comparative periods of $1.1 million, or 94.4%.Of this increase, approximately $836,700 is attributable to a greater number ofunits sold, primarily as a result of an increase in the number of regionalsales managers. In addition, approximately $233,600 of this increase isattributable to an increase in the list price of our NC-stat monitors anddocking stations from $4,000 to $5,000 effective January 1, 2006, whichresulted in a higher average selling price during the three months ended September30, 2006 as compared to the same period in 2005. Diagnostic device revenuesaccounted for 14.4% and 12.4% of our total revenues for the three months endedSeptember 30, 2006 and September 30, 2005, respectively.

Biosensor revenues were$13.1 million and $8.0 million for the three months ended September 30, 2006and September 30, 2005, respectively, representing a year-over-year increasefor the comparative periods of $5.1 million, or 63.7%. The increase wasprimarily due to an increased customer base for our biosensors and increasedfrequency of testing by our customers. Biosensor revenues accounted for 85.6%and 87.6% of our total revenues for the three months ended September 30, 2006and September 30, 2005, respectively.

Our customers used302,200 biosensor units in the three months ended September 30, 2006, comparedto 187,900 units for the same period in 2005, an increase for the comparativeperiods of 114,300 units, or 60.8%. This increase in biosensor usage isprimarily the result of the increase in the customer base and increased usageper customer.

Our total revenues were$15.3 million and $9.1 million for the three months ended September 30, 2006and September 30, 2005, respectively, representing a year-over-year increasefor the comparative periods of $6.2 million, or 67.5%. During the 12-monthperiod ending September 30, 2006, a total of 4,518 customers used our NC-statSystem compared to 2,969 customers for the same period ending September 30,2005. This represents a 52.2% year-over-year increase in the number ofcustomers that used our NC-stat System.

We expect revenues to continue to increase in 2006 as a result of therecent expansion of our sales force, which grew from 36 employees as ofDecember 31, 2005 to 49 employees at the end of the third quarter of 2006,and as a result of the expansion of our network of independent sales agents,with the addition of PSS and their nearly 700 sales representatives in thesecond quarter of 2006. However, our revenues could be negatively impacted by avariety of factors, including the level of demand for nerve conduction studies,potential for changes in third-party reimbursement for nerve conductionstudies, the overall economy, competitive factors and the factors described inthe section of this Quarterly Report on Form 10-Q titled “Cautionary NoteRegarding Forward-Looking Statements.”

14

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***Costs and expenses***

The followingtable presents our costs and expenses and net income:
| ** **                                | ** ** | **Three Months Ended  September 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                | ** ** | **2006**                                             | ** ** | **2005**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **($ in thousands)**                       | ** ** | ** ** | ** ** |
| Cost of  revenues:                        |       |                                                 |       |       |       |       |       |   |   |
| Diagnostic  device                        |       | $                                                    | 340.3      |       | $          | 281.6      |       | $ | 58.7 |   | 20.8 | % |
| Biosensor                                 |       | 3,395.6                                              |       | 2,036.3    |       | 1,359.4    |       | 66.8 |   |
| Total costs of  revenues                  |       | 3,736.0                                              |       | 2,317.8    |       | 1,418.1    |       | 61.2 |   |
|                                      |       |                                                 |       |       |       |       |       |   |   |
| Gross Margin:                             |       |                                                 |       |       |       |       |       |   |   |
| Diagnostic  device                        |       | 1,863.4                                              |       | 851.8      |       | 1,011.6    |       | 118.8 |   |
| Biosensor                                 |       | 9,661.9                                              |       | 5,939.8    |       | 3,722.1    |       | 62.7 |   |
| Total gross  margin                       |       | 11,525.3                                             |       | 6,791.6    |       | 4,733.7    |       | 69.7 |   |
|                                      |       |                                                 |       |       |       |       |       |   |   |
| Gross Margin %:                           |       |                                                 |       |       |       |       |       |   |   |
| Diagnostic  device                        |       | 84.6                                                 | %          | 75.2       | %          |       |       |   |   |
| Biosensor                                 |       | 74.0                                                 |       | 74.5       |       |       |       |   |   |
| Total gross  margin %                     |       | 75.5                                                 |       | 74.6       |       |       |       |   |   |
|                                      |       |                                                 |       |       |       |       |       |   |   |
| Operating  Expenses:                      |       |                                                 |       |       |       |       |       |   |   |
| Research and  development(1)              |       | 1,288.2                                              |       | 929.9      |       | 358.2      |       | 38.5 |   |
| Sales and  marketing(1)                   |       | 5,666.3                                              |       | 3,489.1    |       | 2,177.2    |       | 62.4 |   |
| General and  administrative(1)            |       | 2,526.3                                              |       | 1,821.9    |       | 704.4      |       | 38.7 |   |
| Total operating  expenses                 |       | 9,480.7                                              |       | 6,240.9    |       | 3,239.9    |       | 51.9 |   |
|                                      |       |                                                 |       |       |       |       |       |   |   |
| Income from  operations                   |       | 2,044.6                                              |       | 550.7      |       | 1,493.8    |       | 271.3 |   |
|                                      |       |                                                 |       |       |       |       |       |   |   |
| Interest income                           |       | 436.0                                                |       | 218.5      |       | 217.4      |       | 99.5 |   |
|                                      |       |                                                 |       |       |       |       |       |   |   |
| Income before  provision for income taxes |       | 2,480.5                                              |       | 769.3      |       | 1,711.3    |       | 222.5 |   |
| Provision for  income taxes               |       | 66.9                                                 |       | —     |       | 66.9       |       | N/A |   |
| Net income                                |       | $                                                    | 2,413.6    |       | $          | 769.3      |       | $ | 1,644.4 |   | 213.8 |   |

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(1)             Includesnon-cash stock-based compensation expense of:
| Research and  development  |   | $     | 57.7   |   | $      | 19.2   |   |   |   |   |   |
|----------------------------|--------|-------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Sales and marketing        |   | 224.1 |   | 67.8   |   |   |   |   |   |
| General and administrative |   | 353.4 |   | 24.6   |   |   |   |   |   |

 

Gross Margin

Diagnostic device grossmargin increased to $1.9 million, or 84.6% of revenues, for the three monthsended September 30, 2006 from $851,800, or 75.2% of revenues, for the sameperiod in 2005. The increase in the gross margin percentage is primarilyattributable to an increase in the list price of our NC-stat System from $4,000to $5,000 effective January 1, 2006 and manufacturing price reductionsrealized for our device beginning in the second quarter of 2006.

Biosensor gross marginincreased to $9.7 million, or 74.0% of revenues, for the three months endedSeptember 30, 2006 from $5.9 million, or 74.5% of revenues, for the same periodin 2005. The decrease in the biosensor gross margin percentage is primarily duea change in the mix of biosensors sold, offset in part by manufacturing pricereductions realized for several of our biosensors during the second half of2005 and the first quarter of 2006.

Our overall gross margin was $11.5 million, or 75.5% of revenues, forthe three months ended September 30, 2006 compared to $6.8 million, or 74.6% ofrevenues, for the same period in 2005.

15

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Research and Development

Our research anddevelopment, or R&D, expenses include expenses associated with ourresearch, product development, clinical, regulatory and quality assurancedepartments.

R&D expensesincreased $358,200, or 38.5%, to $1.3 million for the three months endedSeptember 30, 2006 from $929,900 for the same period in 2005. As a percentageof revenues, R&D expenses were 8.4% and 10.2% for the three months endedSeptember 30, 2006 and September 30, 2005, respectively. The increase inexpenses was primarily due to an increase of $214,400 in personnel costsresulting from the hiring of additional employees in our R&D department andincreases in employee compensation. In addition, product development andtemporary labor costs increased $44,300 and $41,800, respectively. Theseincreases are primarily related to the development of the third generationmonitor and docking station and of new biosensors. Also contributing to theincrease was an increase of $38,600 in stock-based compensation expense due tothe adoption of the provisions of SFAS No. 123(R).

We expect our spending onR&D will increase during the remainder of 2006 due to additional consultingservices and the hiring of several additional employees to support productdevelopment efforts as well as increased clinical study costs. We expectR&D expenses, as a percentage of total revenues, to continue to decreaseslightly due to an expected increase in revenue. This percentage may vary,however, depending primarily on our revenues for the remainder of 2006.

Sales and Marketing

Our sales and marketingexpenses include expenses from the marketing, field sales, sales administrationand reimbursement departments.

Sales and marketingexpenses increased $2.2 million, or 62.4%, to $5.7 million for the three monthsended September 30, 2006 from $3.5 million for the same period in 2005. As apercentage of revenues, sales and marketing expenses were 37.1% and 38.3% forthe three months ended September 30, 2006 and September 30, 2005, respectively.The change in expenses was primarily due to an increase of $943,400 in employeecompensation and benefit costs, including sales commissions paid to ourregional sales managers. This increase is due to the expansion of the salesforce and higher revenues in the third quarter of 2006 compared to the thirdquarter of 2005. Also contributing to the change in expenses was an increase of$612,400 in sales commissions paid to our independent regional sales agencies,which were related to our higher revenues in the third quarter of 2006 as wellas the addition of PSS as a distributor in May 2006, an increase in stock-basedcompensation expense of $156,300 due to the adoption of the provisions of SFASNo. 123(R), an increase of $89,700 in trade show expenses due to severallarge shows attended in 2006 that were not attended in 2005 and an increase of$81,000 in travel expenses due to the expansion of the sales force. The changein expenses was also partially due to an increase of $102,400 in costs for newpromotional materials.

We have increased oursales force to 49 employees, including 45 regional sales managers, as of theend of the third quarter of 2006. For the remainder of 2006, we expect salesand marketing expenses, as a percentage of total revenues, to decrease slightlyfrom the level experienced in 2005. This percentage may vary, however,depending primarily on our revenues for the remainder of 2006.

General andAdministrative

Our general andadministrative expenses include expenses from the executive, finance,administrative, customer service and information technology departments.

General andadministrative expenses increased $704,400, or 38.7%, to $2.5 million for thethree months ended September 30, 2006 from $1.8 million for the same period in2005. As a percentage of revenues, general and administrative expenses were16.6% and 20.0% for the three months ended September 30, 2006 and September 30,2005, respectively. The increase in expenses was primarily due to (a) anincrease in stock-based compensation expense of $328,800 due to the adoption ofthe provisions of SFAS No. 123(R); (b) an increase of $124,000 inprofessional fees for legal services and accounting and audit services; (c) anincrease in insurance costs of $119,100; (d) an increase in credit card andbank fees of $65,500 related to increased customer transactions; and(e) an increase of $42,300 in bad debt expense.

We expect our general andadministrative expenses to increase during the remainder of 2006 as a result ofour expected growth and the expected hiring of additional general andadministrative staff to support this growth. Total general and administrativeexpenses, as a percentage of total revenues, are expected to decrease in 2006,in spite of the anticipated need to hire additional staff. This percentage mayvary, however, depending primarily on our revenues for 2006. We expect to beable to leverage existing resources such that the growth in general andadministrative expenses is anticipated to be less than the growth in ourrevenues. Furthermore, while we experienced an increase in professional fees in2005 largely due to the effect of the first year of compliance with theprovisions of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley 404”), we do notexpect the costs associated with Sarbanes-Oxley 404 to increase in 2006.

16

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Interest Income andExpense

Interest income was$436,000 and $218,500 during the three months ended September 30, 2006 andSeptember 30, 2005, respectively. Interest income was earned from investmentsin cash equivalents, short-term investments and long-term investments. Interestincome increased during the three months ended September 30, 2006 compared tothe same period in 2005 because of increased yields on invested funds in 2006.

**Comparisonof Nine Months Ended September 30, 2006 and September 30, 2005**

***Revenues***

The followingtables present a breakdown of our customers, biosensor units used and revenues:
| ** ** | ** ** | **12-Month Period   Ended September 30,**        | ** ** | ** **                                                           | ** ** | ** ** | ** ** |
|------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------|------------|
| ** ** | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| Customers  |       | 4,518                                                                |       | 2,969                                                                |       | 1,549      |       | 52.2 | % |

 
| ** **           | ** ** | **Nine Months Ended  September 30,**                  | ** ** | ** **                                                           | ** ** | ** ** | ** ** |
|----------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|------------|------------|
| ** **           | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** | **Change** | ** ** | **% Change** | ** ** |
| Biosensor units used |       | 845,000                                                              |       | 498,600                                                              |       | 346,400    |       | 69.5 | % |

 
| ** **        | ** ** | **($ in thousands)** | ** ** | ** ** | ** ** |
|-------------------|------------|--------------------------------|------------|------------|------------|
| Revenues:         |       |                           |       |       |       |   |   |   |   |
| Diagnostic device |       | $                              | 5,678.7    |       | $          | 2,906.3 |   | $ | 2,772.4 |   | 95.4 |   |
| Biosensor         |       | 35,375.8                       |       | 21,060.4   |       | 14,315.4 |   | 68.0 |   |
| Total revenues    |       | $                              | 41,054.6   |       | $          | 23,966.7 |   | $ | 17,087.9 |   | 71.3 | % |

 

Diagnostic devicerevenues were $5.7 million and $2.9 million for the nine months ended September30, 2006 and September 30, 2005, respectively, representing a year-over-yearincrease for the comparative periods of $2.8 million or 95.4%. Of thisincrease, approximately $2.2 million is attributable to a greater number ofunits sold, primarily as a result of an increase in the number of regionalsales managers. In addition, approximately $553,300 of this increase isattributable to an increase in the list price of our NC-stat monitors anddocking stations from $4,000 to $5,000 effective January 1, 2006, whichresulted in a higher average selling price during the nine months endedSeptember 30, 2006 as compared to the same period in 2005. Diagnostic devicerevenues accounted for 13.8% and 12.1% of our total revenues for the ninemonths ended September 30, 2006 and September 30, 2005, respectively.

Biosensor revenues were $35.4million and $21.1 million for the nine months ended September 30, 2006 andSeptember 30, 2005, respectively, representing a year-over-year increase forthe comparative periods of $14.3 million, or 68.0%. The increase was primarilydue to an increased customer base for our biosensors and increased frequency oftesting by our customers. Biosensor revenues accounted for 86.2% and 87.9% ofour total revenues for the nine months ended September 30, 2006 and September30, 2005, respectively.

Our customers used845,000 biosensor units in the nine months ended September 30, 2006, comparedto 498,600 units for the same period in 2005, an increase for the comparativeperiods of 346,400 units, or 69.5%. This increase in biosensor usage isprimarily the result of the increase in the customer base and increased usageper customer.

Our total revenues were$41.1 million and $24.0 million for the nine months ended September 30, 2006and September 30, 2005 respectively, representing a year-over-year increase forthe comparative periods of $17.1 million, or 71.3%. During the 12-month periodending September 30, 2006, a total of 4,518 customers used our NC-stat Systemcompared to 2,969 customers for the same period ending September 30, 2005. Thisrepresents a 52.2% year-over-year increase in the number of customers that usedour NC-stat System.

17

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***Costs and expenses***

The following tablepresents our costs and expenses and net income:
| ** **                                | ** ** | **Nine Months Ended  September 30,**                                                                              | ** ** | ** **                                                                                                                       | ** ** | ** **                                                             | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **          2006          ** | ** ** | **          2005          ** | ** ** | **     Change     ** | ** ** | **% Change** | ** ** |
| ** **                                | ** ** | **($ in thousands)**                                                                                                   | ** ** | ** **                                                                                                                       | ** ** |
| Cost of  revenues:                        |       |                                                                                                                             |       |                                                                                                                             |       |                                                                   |       |   |   |
| Diagnostic  device                        |       | $                                                                                                                                | 1,002.1    |                                                                                                                             | $          | 760.6                                                                  |       | $ | 241.5 |   | 31.8 | % |
| Biosensor                                 |       | 8,991.2                                                                                                                          |       | 5,465.1                                                                                                                          |       | 3,526.2                                                                |       | 64.5 |   |
| Total costs of  revenues                  |       | 9,993.3                                                                                                                          |       | 6,225.6                                                                                                                          |       | 3,767.7                                                                |       | 60.5 |   |
|                                      |       |                                                                                                                             |       |                                                                                                                             |       |                                                                   |       |   |   |
| Gross Margin:                             |       |                                                                                                                             |       |                                                                                                                             |       |                                                                   |       |   |   |
| Diagnostic  device                        |       | 4,676.6                                                                                                                          |       | 2,145.7                                                                                                                          |       | 2,530.9                                                                |       | 118.0 |   |
| Biosensor                                 |       | 26,384.6                                                                                                                         |       | 15,595.3                                                                                                                         |       | 10,789.3                                                               |       | 69.2 |   |
| Total gross  margin                       |       | 31,061.2                                                                                                                         |       | 17,741.1                                                                                                                         |       | 13,320.2                                                               |       | 75.1 |   |
|                                      |       |                                                                                                                             |       |                                                                                                                             |       |                                                                   |       |   |   |
| Gross Margin %:                           |       |                                                                                                                             |       |                                                                                                                             |       |                                                                   |       |   |   |
| Diagnostic  device                        |       | 82.4                                                                                                                             | %          | 73.8                                                                                                                             | %          |                                                                   |       |   |   |
| Biosensor                                 |       | 74.6                                                                                                                             |       | 74.1                                                                                                                             |       |                                                                   |       |   |   |
| Total gross  margin %                     |       | 75.7                                                                                                                             |       | 74.0                                                                                                                             |       |                                                                   |       |   |   |
|                                      |       |                                                                                                                             |       |                                                                                                                             |       |                                                                   |       |   |   |
| Operating  Expenses:                      |       |                                                                                                                             |       |                                                                                                                             |       |                                                                   |       |   |   |
| Research and  development(1)              |       | 3,815.3                                                                                                                          |       | 2,863.2                                                                                                                          |       | 952.1                                                                  |       | 33.3 |   |
| Sales and  marketing(1)                   |       | 16,342.9                                                                                                                         |       | 10,228.2                                                                                                                         |       | 6,114.6                                                                |       | 59.8 |   |
| General and  administrative(1)            |       | 7,772.3                                                                                                                          |       | 5,094.4                                                                                                                          |       | 2,677.9                                                                |       | 52.6 |   |
| Total operating  expenses                 |       | 27,930.5                                                                                                                         |       | 18,185.8                                                                                                                         |       | 9,744.7                                                                |       | 53.6 |   |
|                                      |       |                                                                                                                             |       |                                                                                                                             |       |                                                                   |       |   |   |
| Income (loss)  from operations            |       | 3,130.8                                                                                                                          |       | (444.7                                                                                                                           | )          | 3,575.5                                                                |       | -803.9 |   |
|                                      |       |                                                                                                                             |       |                                                                                                                             |       |                                                                   |       |   |   |
| Interest income                           |       | 1,101.9                                                                                                                          |       | 579.6                                                                                                                            |       | 522.3                                                                  |       | 90.1 |   |
| Interest expense                          |       | —                                                                                                                           |       | (2.0                                                                                                                             | )          | 2.0                                                                    |       | -100.0 |   |
|                                      |       |                                                                                                                             |       |                                                                                                                             |       |                                                                   |       |   |   |
| Income before  provision for income taxes |       | 4,232.7                                                                                                                          |       | 132.8                                                                                                                            |       | 4,099.9                                                                |       | 3,087.1 |   |
| Provision for  income taxes               |       | 141.0                                                                                                                            |       | —                                                                                                                           |       | 141.0                                                                  |       | N/A |   |
|                                      |       |                                                                                                                             |       |                                                                                                                             |       |                                                                   |       |   |   |
| Net income                                |       | $                                                                                                                                | 4,091.7    |                                                                                                                             | $          | 132.8                                                                  |       | $ | 3,958.9 |   | 2,980.9 |   |

 

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| (1)     Includes  non-cash stock-based compensation expense of: |   |   |   |   |   |   |   |
|------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|

 
| Research and development   |   | $       | 353.5  |   | $      | 58.2   |   |   |   |   |   |
|----------------------------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Sales and marketing        |   | 615.1   |   | 137.6  |   |   |   |   |   |
| General and administrative |   | 1,030.6 |   | 63.7   |   |   |   |   |   |

 

Gross Margin

Diagnostic device grossmargin increased to $4.7 million, or 82.4% of revenues, for the nine monthsended September 30, 2006 from $2.1 million, or 73.8% of revenues, for the sameperiod in 2005. The increase in the gross margin percentage is primarilyattributable to an increase in the list price of our NC-stat System from $4,000to $5,000 effective January 1, 2006 and manufacturing price reductionsrealized for our device beginning in the second quarter of 2006.

Biosensor gross marginincreased to $26.4 million, or 74.6% of revenues, for the nine months endedSeptember 30, 2006 from $15.6 million, or 74.1% of revenues, for the sameperiod in 2005. The increase in the biosensor gross margin percentage isprimarily due to manufacturing price reductions realized for several of ourbiosensors during the second half of 2005 and the first quarter of 2006partially offset by a change in the mix of biosensors sold.

Our overall gross marginwas $31.1 million, or 75.7% of revenues, for the nine months ended September30, 2006 compared to $17.7 million, or 74.0% of revenues, for the same periodin 2005.

18

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Research and Development

R&D expensesincreased $952,100, or 33.3%, to $3.8 million for the nine months endedSeptember 30, 2006 from $2.9 million for the same period in 2005. As apercentage of revenues, R&D expenses were 9.3% and 11.9% for the ninemonths ended September 30, 2006 and September 30, 2005, respectively. Theincrease in expenses was primarily due to an increase of $515,600 in personnelcosts resulting from the hiring of additional employees in our R&Ddepartment and increases in employee compensation.  In addition, product development andtemporary labor costs increased $58,600 and $56,800, respectively. Theseincreases are primarily related to the development of the third generationmonitor and docking station and of new biosensors.  Also contributing to the increase was anincrease of $295,300 in stock-based compensation expense due to the adoption ofthe provisions of SFAS No. 123(R).

Sales and Marketing

Sales and marketingexpenses increased $6.1 million, or 59.8%, to $16.3 million for the nine monthsended September 30, 2006 from $10.2 million for the same period in 2005. As apercentage of revenues, sales and marketing expenses were 39.8% and 42.7% forthe nine months ended September 30, 2006 and September 30, 2005, respectively.The change in expenses was primarily due to an increase of $3.3 million inemployee compensation and benefit costs, including sales commissions paid toour regional sales managers. This increase is due to the expansion of the salesforce and higher revenues in the first nine months of 2006 compared to thefirst nine months of 2005. Also contributing to the change in expenses was anincrease of $1.3 million in sales commissions paid to our independent regionalsales agencies, which were related to our higher revenues in the first ninemonths of 2006 as well as the addition of PSS as a distributor in May 2006, anincrease in stock-based compensation expense of $477,600 due to the adoption ofthe provisions of SFAS No. 123(R) and an increase of $308,900 intravel expenses due to the expansion of the sales force. The change in expenseswas also partially due to an increase of $235,800 in costs for new promotionalmaterials.

General andAdministrative

General and administrativeexpenses increased $2.7 million, or 52.6%, to $7.8 million for the nine monthsended September 30, 2006 from $5.1 million for the same period in 2005. As apercentage of revenues, general and administrative expenses were 18.9% and21.3% for the nine months ended September 30, 2006 and September 30, 2005,respectively. The increase in expenses was primarily due to (a) anincrease in stock-based compensation expense of $966,900 due to the adoption ofthe provisions of SFAS No. 123(R); (b) an increase of $425,100 inprofessional fees for legal services and accounting and audit services;(c) an increase of $332,400 in bad debt expense; (d) an increase of$239,900 in our insurance costs; (e) an increase in personnel costsof $224,300 due to the expansion of staff and increases in employeecompensation; (f) an increase in credit card and bank fees of $177,700related to increased customer transactions; and (g) an increase in consultingservices of $88,100 primarily to assist the Company with its compliance withSarbanes-Oxley 404 and the adoption of new accounting pronouncements.

Interest Income andExpense

Interest income was $1.1million and $579,600 during the nine months ended September 30, 2006 andSeptember 30, 2005, respectively. Interest income was earned from investmentsin cash equivalents, short-term investments and long-term investments. Interestincome increased during the nine months ended September 30, 2006 compared tothe same period in 2005 because of increased yields on invested funds in 2006. Interestexpense was immaterial for all periods presented.

**Liquidityand Capital Resources**

Our principalsources of liquidity are our current cash and cash equivalents and short-termheld-to-maturity investments. As of September 30, 2006, the weighted averagematurity of our cash equivalents and short-term held-to-maturity investmentswas 180 days. Our ability to generate cash from operations is dependentupon our ability to generate revenue from sales of our diagnostic devices andconsumable biosensors, as well as our ability to manage our operating costs andnet assets. A decrease in demand for our products or unanticipated increases inour operating costs would likely have an adverse effect on our liquidity andcash generated from operations. The following sets forth information relatingto our liquidity:
| ** **                                                                | ** ** | **September 30,  2006**   | ** ** | **December 31,  2005** | ** ** | **Change** | ** ** | **% Change** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                | ** ** | **($ in thousands)** | ** ** | ** **                  | ** ** |
| Cash and cash  equivalents                                                |       | $                              | 6,567      |                        | $          | 8,170      |       | $                 | (1,603     | ) | -19.6 |   |
| Short-term  held-to-maturity investments                                  |       | 31,570                         |       | 24,082                      |       | 7,488      |       | 31.1              |       |
| Total cash, cash  equivalents and short-term held-to-maturity investments |       | $                              | 38,137     |                        | $          | 32,252     |       | $                 | 5,885      |   | 18.2 | % |

 

During the first ninemonths of 2006, our cash and cash equivalents and short-term held-to-maturityinvestments increased $5.9 million, primarily due to $5.1 million of cashprovided by operations and $1.4 million of proceeds received from the exerciseof stock options and the issuance of common stock under our employee stockpurchase plan, offset in part by cash used for capital expenditures of$395,100.

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In managing our working capital, two of the financialmeasurements we monitor are days’ sales outstanding, or DSO, and inventoryturnover rate, which are presented in the table below for the year endedDecember 31, 2005 and the three months ended September 30, 2006 andSeptember 30, 2005:
| ** **                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                | ** ** | **2006**                                             | ** ** | **2005**                               | ** ** | **2005** | ** ** |
| Days’ sales  outstanding (days)      |       | 42                                                   |       | 39                                     |       | 40 |   |
| Inventory turnover rate  (times per year) |       | 5.2                                                  |       | 4.5                                    |       | 4.5 |   |

 

Our payment termsextended to our customers generally require payment within 30 days from invoicedate. At September 30, 2006, our DSO was 42 days, an increase of 2 days ascompared to December 31, 2005, primarily due to the timing of revenuesduring the period. We continue to focus our efforts on reducing our accountsreceivable balances over 60 days past due. Accounts payable are normally paidwithin 30 to 40 days from receipt of a vendor’s invoice.

Our inventory turnoverwas 5.2 times for the quarter ended September 30, 2006 and 4.5 times for theyear ended December 31, 2005. During the next several quarters, we anticipateincreasing our inventory levels by approximately $1.5 million to $2.0 millionin preparation for the release of our third generation neurodiagnostic system. Weanticipate this will have the impact of reducing our inventory turnover as webuild inventory prior to the initial sale of this new product.

The following setsforth information relating to the sources and uses of our cash:
| ** **                                           | ** ** | **Nine Months Ended  September 30,**                                                                              | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **          2006          ** | ** ** | **          2005          ** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                                                                                                          | ** ** |
| Net cash  provided by operating activities           |       | $                                                                                                                                | 5,077.7    |   | $ | 750.5 |   |
| Net cash  provided by (used in) investing activities |       | (8,034.8                                                                                                                         | )          | 318.2 |   |
| Net cash  provided by financing activities           |       | 1,354.0                                                                                                                          |       | 298.6 |   |
|                                                      |            |                                                                                                                                  |            |  |  |  |  |

 

Cash provided byoperating activities was approximately $5.1 million and $750,500 in the firstnine months of 2006 and 2005, respectively. In the first nine months of 2006, anet use of cash of approximately $2.1 million for our investment in workingcapital was offset by $4.1 million in net income and $3.1 million in non-cashitems, mainly compensation expense associated with stock options. The primarydrivers of our investment in working capital were as follows: Our accountsreceivable increased $3.8 million, excluding the change in the allowance fordoubtful accounts, due to growth in revenues. Our inventories increased$134,700 primarily due to the growth in our business. These items were offsetby a $1.2 million increase in accrued expenses. In the first nine months of 2005, increases in accrued expenses,deferred revenue (net of deferred costs) and accounts payable of $783,100,$406,900 and $368,800, respectively; non-cash items of $1.0 million and netincome of $132,800 were offset in part by increases in accounts receivable andinventory of $1.2 million and $838,800, respectively.

Cash used for investingactivities was $8.0 million in the first nine months of 2006, compared withcash provided by investing activities of $318,200 in the first nine months of2005. In the first nine months of 2006, there were net purchases of investmentsin the amount of approximately $7.6 million, compared with net maturities ofinvestments of approximately $194,000 in the first nine months of 2005. In thefirst nine months of 2006 and 2005, cash was used for the purchase of fixedassets, in the amount of $395,100 and $314,400, respectively, primarilyrepresenting computer equipment in 2006 and leasehold improvements and toolingequipment for new products in 2005.

In connection with ourproperty lease entered into at the beginning of January, 2001, we are requiredto maintain, for the benefit of the lessor, an irrevocable standby letter ofcredit stating the lessor as the beneficiary. The original amount of the letterof credit was $1,860,000. During September 2005, in accordance with theterms of the lease agreement, the amount required under the letter of creditwas reduced to $1,430,000. The letter of credit is secured by a certificate ofdeposit in an amount equal to 102% of the letter of credit. The lease expiresin March 2009. The certificate of deposit is renewable in 30-dayincrements. This amount is classified as restricted cash in the balance sheet.

Cash provided byfinancing activities was $1.4 million and $289,600 in the first nine months of2006 and 2005, respectively. Cash provided by financing activities in the firstnine months of 2006 and 2005 represents the proceeds from the exercise of stockoptions and the issuance of shares under our employee stock purchase plan.

During the remainder of2006, we may expend funds to expand our sales and marketing for the NC-statSystem, although more modestly than the expansion in the last several quarters,and continue our ongoing program of making enhancements and improvements to theNC-stat System, including the development of new and/or improved biosensors,products for the diagnosis of additional neuropathies, and the development of athird generation neurodiagnostic system.

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In addition, we plan to expend funds on the design ofa drug delivery system, which is in its early stages of development, for theminimally invasive delivery of therapeutic agents to treat neuropathies by bothprimary care and specialist physicians. We also expect to incur capitalexpenditures for computer hardware and software to support the growth in ourbusiness and the additional requirements of our customer base. We believe thatthe combination of funds available from cash and cash equivalents and fundsavailable from our short-term investments will be adequate to finance ourongoing operations for at least 24 months, including the expenditures describedabove.

To date, inflation hasnot had a material impact on our financial operations.

*Off-BalanceSheet Arrangements*

As of September 30, 2006,we did not have any off-balance sheet financing arrangements.

**RecentAccounting Pronouncements**

In July 2006, theFinancial Accounting Standards Board (“FASB”) issued FASB Interpretation No.48,*“Accounting for Uncertainty in IncomeTaxes—an interpretation of FASB Statement No. 109”* (“FIN No. 48”),which clarifies the accounting and disclosure for uncertainty in tax positions,as defined. FIN No. 48 seeks to reduce the diversity in practice associatedwith certain aspects of the recognition and measurement related to accountingfor income taxes. This interpretation is effective for fiscal years beginningafter December 15, 2006. We have not yet determined the impact thisinterpretation will have on our results from operations or financial position.

InSeptember 2006, the FASB issued SFAS No. 157, *“FairValue Measurements”* (“SFAS No. 157”), which establishes acomprehensive framework for measuring fair value in generally acceptedaccounting principles and expands disclosures about fair value measurements.Specifically, SFAS No. 157 sets forth a definition of fair value, andestablishes a hierarchy prioritizing the inputs to valuation techniques, givingthe highest priority to quoted prices in active markets for identical assetsand liabilities and the lowest priority to unobservable inputs. This statementis effective for financial statements issued for fiscal years beginning afterNovember 15, 2007, and interim periods within those fiscal years. Theprovisions of SFAS No. 157 are generally required to be applied on aprospective basis. We will adopt SFAS No. 157 in the first quarter of 2008. Wedo not expect this standard to have a material effect on our financialposition, results of operations or cash flows.

InSeptember 2006, the Securities and Exchange Commission issued StaffAccounting Bulletin No. 108, *“Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements”*. This standard addressesquantifying the financial statement effect of misstatements, specifically, howthe effects of prior year uncorrected errors must be considered in quantifyingmisstatements in the current year financial statements. This standard iseffective for fiscal years ending after November 15, 2006. We do notexpect this standard to have a material effect on our financial position,results of operations or cash flows.

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**CAUTIONARY NOTEREGARDING FORWARD-LOOKING STATEMENTS**

The statements containedin this quarterly report on Form 10-Q, including under thesection titled “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and other sections of this quarterlyreport, include forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended, including,without limitation, statements regarding our or our management’s expectations,hopes, beliefs, intentions or strategies regarding the future. The words “believe,”“may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “plan”and similar expressions may identify forward-looking statements, but theabsence of these words does not mean that a statement is not forward-looking.The forward-looking statements contained in this quarterly report are based onour current expectations and beliefs concerning future developments and theirpotential effects on us. There can be no assurance that future developmentsaffecting us will be those that we have anticipated. These forward-lookingstatements involve a number of risks, uncertainties (some of which are beyondour control) or other assumptions that may cause actual results or performanceto be materially different from those expressed or implied by theseforward-looking statements. These risks and uncertainties include, but are notlimited to, risks associated with: our dependence on the NC-stat System and itscomponents; our ability to increase our customer base and expand the market forour products; our ability to accurately predict the size of the market for theNC-stat System; our ability to manage our growth; obtaining necessaryregulatory approvals; our reliance on single source third party manufacturersand suppliers to produce our products; reimbursement by third party payers toour customers for procedures performed using the NC-stat System; compliancewith applicable quality control and manufacturing standards; compliance withfederal and state laws protecting the confidentiality of patient healthinformation and prohibiting “kickbacks” and false or fraudulent claims oradverse publicity or costs relating to any investigation into our practicesunder these laws; our ability to retain and recruit key management, scientificand sales personnel; delays in the development of new products or to plannedimprovements to our products; effectiveness of our products compared to othermedical device products; competition; protection of our intellectual propertyand other proprietary rights; conflicts with the intellectual property of thirdparties; product liability lawsuits or claims that may be brought against us;dependence upon computer and communication infrastructure utilized by ourproducts; publication of future clinical studies or other articles orannouncement of positions by physician associations or other organizations thatare unfavorable to our products; our capital and financing needs; oursuccessful integration of any acquired businesses; and the other factorsdescribed in the section of our Annual Report on Form 10-K titled “Item1A. Risk Factors,” as updated in Part II, Item1A of this Quarterly Reporton Form 10-Q, our Quarterly Report on Form 10-Q for the period ended March31, 2006 and our other filings. Should one or more of these risks oruncertainties materialize, or should any of our assumptions prove incorrect,actual results may vary in material respects from those projected in theseforward-looking statements. We undertake no obligation to update or revise anyforward-looking statements, whether as a result of new information, futureevents or otherwise, except as may be required under applicable securitieslaws.

**Item3.    Quantitative and Qualitative Disclosures About Market Risk**

We do not use derivativefinancial instruments in our investment portfolio and have no foreign exchangecontracts. Our financial instruments consist of cash, cash equivalents,short-term investments, accounts receivable, accounts payable, accrued expensesand long-term obligations. We consider investments that, when purchased, have aremaining maturity of 90 days or less to be cash equivalents. The primaryobjectives of our investment strategy are to preserve principal, maintainproper liquidity to meet operating needs, and maximize yields. To minimize ourexposure to an adverse shift in interest rates, we invest mainly in cashequivalents and short-term investments and long-term investments with amaturity of eighteen months or less and maintain an average maturity of twelvemonths or less. We do not believe that a 10% change in interest rates wouldhave a material impact on the fair value of our investment portfolio or ourinterest income.

**Item4.    Controls and Procedures**

**(a)             **Evaluation of disclosure controls and procedures.

Our management carriedout an evaluation, with the participation of our Chief Executive Officer andour Chief Financial Officer, of the effectiveness of our disclosure controlsand procedures (as defined in Rules 13a-15(e) or 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as ofSeptember 30, 2006. Our disclosure controls and procedures are designed toprovide reasonable assurance that information required to be disclosed by us inthe reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms, and our management necessarily was required to apply its judgmentin evaluating and implementing our disclosure controls and procedures. Basedupon the evaluation described above, our Chief Executive Officer and ChiefFinancial Officer have concluded that they believe that our disclosure controlsand procedures were effective, as of the end of the period covered by thisreport, in providing reasonable assurance that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms. Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by an issuer in its Exchange Act reports isaccumulated and communicated to the issuer’s management, including itsprincipal executive and financial officers, as appropriate to allow timelydecisions regarding required disclosures. We continue to review and documentour disclosure controls and procedures, including our internal controls overfinancial reporting, and may from time to time make changes aimed at enhancingtheir effectiveness and to ensure that our systems evolve with our business.

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**(b) **  Changesin internal control over financial reporting.

There was no change inour internal control over financial reporting that occurred during the periodcovered by this Quarterly Report on Form 10-Q that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

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**Part IIOther Information**

**Item1.   Legal Proceedings**

None.

**Item1A. Risk Factors**

There have been nomaterial changes in the risk factors described in “Item 1A—Risk Factors”of our Annual Report on Form 10-K for the year ended December 31,2005, except as previously noted in our Form 10-Q for the three months endedMarch 31, 2006 and as noted below.

Withrespect to the risk factor titled “*Ifphysicians or other healthcare providers are unable to obtain sufficientreimbursement from third-party healthcare payers for procedures performed usingthe NC-stat System, the adoption of the NC-stat System and our future productsales will be severely harmed*.”  We note that as our presence in themarket expands and the use of the NC-stat System increases, we haveexperienced and are likely to continue to experience an increased focus fromthird-party payers and governmental agencies regarding the reimbursement ofnerve conduction studies performed using the NC-stat System and an increased focusfrom these organizations regarding the professional requirements for performingnerve conduction studies in general. At any point in time, a number ofthird-party payers may take the position of not reimbursing our customers fortheir use of the NC-stat System. Recently, two local Medicare carriers covering Florida, Texas andseveral other states issued policies indicating that physicians using theNC-stat System will not be reimbursed under the existing Current ProceduralTerminology (“CPT”) codes for nerve conduction testing (95900, 95903 and 95904)but rather should submit for reimbursement under a separate miscellaneousneurological procedure code (95999).  Wedo not know what success our customers will have in obtaining reimbursementunder this code and what level of reimbursement they may receive if they aresuccessful.  This decision couldpotentially adversely impact our future revenues.  In addition, several additional localMedicare carriers have issued draft local coverage determinations, which ifimplemented as final policies, could adversely impact the reimbursementreceived by our customers and therefore potentially adversely impact our futurerevenues.  If an increasing number ofpayers adopt a policy of not allowing all physicians to submit forreimbursement under the existing CPT codes, not allowing all physicians tosubmit for reimbursement for nerve conduction studies performed using theNC-stat System or if a decision is made to assign different CPT codes to theNC-stat System, this could have a potentially adverse impact on reimbursementand on our future revenues. Widespread adoption of the NC-stat System by themedical community is unlikely to occur if physicians do not receivesatisfactory reimbursement from third-party payers for procedures performedwith the NC-stat System.

**Item2.   Unregistered Sales of Equity Securities and Use of Proceeds**

(a)          On July 21, 2004, the Securities and Exchange Commission declaredeffective our registration statement on Form S-1 (FileNo. 333-115440), relating to the initial public offering of our commonstock. The aggregate price of the offering amount registered on our behalf was$27.6 million. In connection with the offering, we paid approximately$1.9 million in underwriting discounts and commissions to the underwritersand incurred an estimated $1.7 million in other offering expenses. None ofthe underwriting discounts and commissions or offering expenses were incurredor paid to directors or officers of ours or their associates or to personsowning 10 percent or more of our common stock or to any affiliates ofours. After deducting the underwriting discounts and commissions and offeringexpenses, we received net proceeds from the offering of approximately$24.0 million. From July 21, 2004, the effective date of theregistration statement, to September 30, 2006 we have used (i) $3.1million of the net proceeds to repay in full the outstanding balance under oursecured line of credit with Lighthouse Capital Partners, (ii) an estimated$6.9 million of the net proceeds to fund cash spending of our research anddevelopment activities, (iii) an estimated $13.1 million of the netproceeds to fund the expansion of our sales and marketing efforts and(iv) an estimated $912,200 for the purchase of capital equipment. As ofSeptember 30, 2006, we had used all of the proceeds from our initial publicoffering. Our use of the proceeds from our initial public offering did not representa material change from the description provided in our prospectus.

**Item3.    Defaults Upon Senior Securities**

None.

**Item4.    Submission of Matters to a Vote of Security Holders.**

None.

**Item5.    Other Information**

None.

**Item 6.    Exhibits**

See theExhibit Index on the page immediately preceding the exhibits for alist of exhibits filed as part of this quarterly report, whichExhibit Index is incorporated herein by this reference.

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SIGNATURES

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                         | ** ** | **NEUROMETRIX, INC.**                 |
|-------------------------|------------|---------------------------------------|
|                    | ** ** |
| ** **              | ** ** |
| Date: November  9, 2006 | /s/        | Shai N. Gozani, M.D., Ph. D.          |   |
|                    |       | Shai N. Gozani, M.D., Ph. D.          |
|                    |       | Chief Executive Officer and President |
|                    |       |                                  |
| Date: November  9, 2006 | /s/        | W. Bradford Smith                     |   |
|                    |       | W. Bradford Smith                     |
|                    |       | Chief Financial Officer               |

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Exhibit Index
| *10.1 | Executive Officer Compensation Arrangements (2006  Bonus).                                                                                     |
|-------|------------------------------------------------------------------------------------------------------------------------------------------------|
| *31.1 | Certification of Principal Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                   |
| *31.2 | Certification of Principal Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                  |
| *32   | Certification of Principal Executive Officer and  Principal Financial Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

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*                    Filedherewith

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