**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

**x**                                                         QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

** **

**For thequarterly period ended June 30, 2007**

 

**OR**

 

** ̈**                                                             TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

** **

**Forthe transition period from                to           **

 

**CommissionFile Number 000-50856**

** **

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**NEUROMETRIX, INC.**

(Exact name of registrantas specified in its charter)

** **

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

 

**(781)890-9989**

(Registrant’s telephonenumber, including area code)

 

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

 

Yes x    No o

 

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

 

Large acceleratedfiler o  Accelerated filer x  Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

 

Yeso Nox

 

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

12,624,813 shares of common stock, par value $0.0001 per share, wereoutstanding as of August 3, 2007.

 

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**NEUROMETRIX, INC.FORM 10-QINDEX**
| **PART I - FINANCIAL  INFORMATION** | ** ** |
|------------------------------------------|------------|
|                                     |       |   |   |
| Item 1.                                  |       | Condensed Financial  Statements |   |
|                                     |       |   |   |
|                                     |       | Balance Sheets (unaudited) as of June 30, 2007  and December 31, 2006 |   |
|                                     |       |   |   |
|                                     |       | Statements of Operations (unaudited)  for the three months and six months ended June 30, 2007 and 2006 |   |
|                                     |       |   |   |
|                                     |       | Statements of Cash Flows (unaudited) for  the six months ended June 30, 2007 and 2006 |   |
|                                     |       |   |   |
|                                     |       | 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**

**Item 1.  Condensed Financial Statements**

**NeuroMetrix, Inc.Balance Sheets(Unaudited)**
| ** **                                                                                                                                                                          | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                          | ** ** | ** **              | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                          | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                     |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                          |       | $                       | 4,777,996  |                        | $          | 7,909,778 |   |
| Short-term  held-to-maturity investments                                                                                                                                            |       | 32,315,685              |       | 32,410,685                  |       |
| Accounts  receivable, net of allowance for doubtful accounts of $1,200,000 and $900,000  at June 30, 2007 and December 31, 2006, respectively                                  |       | 6,247,135               |       | 7,698,550                   |       |
| Inventories, net                                                                                                                                                                    |       | 5,184,608               |       | 3,633,389                   |       |
| Prepaid expenses  and other current assets                                                                                                                                          |       | 872,614                 |       | 761,400                     |       |
| Current portion  of deferred costs                                                                                                                                                  |       | 422,691                 |       | 370,013                     |       |
| Total current  assets                                                                                                                                                               |       | 49,820,729              |       | 52,783,815                  |       |
|                                                                                                                                                                                |       |                    |       |                        |       |
| Restricted cash                                                                                                                                                                     |       | 1,458,598               |       | 1,458,598                   |       |
| Fixed assets,  net                                                                                                                                                                  |       | 1,095,259               |       | 1,115,436                   |       |
| Deferred costs                                                                                                                                                                      |       | 297,863                 |       | 348,430                     |       |
| Total assets                                                                                                                                                                        |       | $                       | 52,672,449 |                        | $          | 55,706,279 |   |
|                                                                                                                                                                                |       |                    |       |                        |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                      | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Current  liabilities:                                                                                                                                                               |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                                    |       | $                       | 2,907,916  |                        | $          | 2,766,650 |   |
| Accrued  compensation                                                                                                                                                               |       | 2,271,408               |       | 2,460,328                   |       |
| Other accrued  expenses                                                                                                                                                             |       | 2,380,257               |       | 4,275,983                   |       |
| Current portion  of deferred revenue                                                                                                                                                |       | 1,529,785               |       | 1,386,867                   |       |
| Current portion  of capital lease obligations                                                                                                                                       |       | 12,900                  |       | —                      |       |
| Total current  liabilities                                                                                                                                                          |       | 9,102,266               |       | 10,889,828                  |       |
|                                                                                                                                                                                |       |                    |       |                        |       |
| Deferred revenue                                                                                                                                                                    |       | 1,160,947               |       | 1,335,138                   |       |
| Capital lease  obligations                                                                                                                                                          |       | 25,800                  |       | —                      |       |
| Other long-term  liabilities                                                                                                                                                        |       | 43,636                  |       | 72,727                      |       |
| Total  liabilities                                                                                                                                                                  |       | 10,332,649              |       | 12,297,693                  |       |
|                                                                                                                                                                                |       |                    |       |                        |       |
| 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; 12,624,813 and 12,601,224  shares issued and outstanding at June 30, 2007 and December 31, 2006,  respectively |       | 1,262                   |       | 1,260                       |       |
| Additional  paid-in capital                                                                                                                                                         |       | 98,723,291              |       | 97,205,145                  |       |
| Deferred  compensation                                                                                                                                                              |       | (29,366                 | )          | (110,705                    | )          |
| Accumulated  deficit                                                                                                                                                                |       | (56,355,387             | )          | (53,687,114                 | )          |
| Total  stockholders’ equity                                                                                                                                                    |       | 42,339,800              |       | 43,408,586                  |       |
| Total liabilities and  stockholders’ equity                                                                                                                                    |       | $                       | 52,672,449 |                        | $          | 55,706,279 |   |

 

The accompanying notes are an integral part of thesefinancial statements.

3

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**NeuroMetrix, Inc.Statements of Operations(Unaudited)**
| ** **                                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                   | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006**    | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |
| ** **                                                                   | ** ** | ** **                       | ** ** | **(as restated)**         | ** ** | ** ** | ** ** | **(as restated)** | ** ** |
| Revenues:                                                                    |       |                             |       |                           |       |   |   |   |   |
| Diagnostic device                                                            |       | $                                | 1,223,173  |                           | $          | 1,933,594 |   | $ | 2,502,377 |   | $ | 3,475,031 |   |
| Biosensor                                                                    |       | 10,048,336                       |       | 12,036,456                     |       | 20,321,114 |   | 22,318,294 |   |
| Other                                                                        |       | 204,000                          |       | —                         |       | 409,804 |   | — |   |
| Total revenues                                                               |       | 11,475,509                       |       | 13,970,050                     |       | 23,233,295 |   | 25,793,325 |   |
|                                                                         |       |                             |       |                           |       |   |   |   |   |
| Cost of revenues                                                             |       | 3,067,635                        |       | 3,377,466                      |       | 6,162,253 |   | 6,257,379 |   |
| Gross margin                                                                 |       | 8,407,874                        |       | 10,592,584                     |       | 17,071,042 |   | 19,535,946 |   |
|                                                                         |       |                             |       |                           |       |   |   |   |   |
| Operating  expenses:                                                         |       |                             |       |                           |       |   |   |   |   |
| Research and development (1)                                                 |       | 1,266,691                        |       | 1,268,545                      |       | 2,481,763 |   | 2,527,153 |   |
| Sales and marketing (1)                                                      |       | 6,019,947                        |       | 5,408,315                      |       | 11,995,885 |   | 10,676,568 |   |
| General and administrative (1)                                               |       | 2,868,650                        |       | 2,987,772                      |       | 6,210,868 |   | 5,793,021 |   |
| Total operating  expenses                                                    |       | 10,155,288                       |       | 9,664,632                      |       | 20,688,516 |   | 18,996,742 |   |
|                                                                         |       |                             |       |                           |       |   |   |   |   |
| Income (loss)  from operations                                               |       | (1,747,414                       | )          | 927,952                        |       | (3,617,474 | ) | 539,204 |   |
|                                                                         |       |                             |       |                           |       |   |   |   |   |
| Interest income                                                              |       | 456,423                          |       | 372,348                        |       | 949,201 |   | 665,934 |   |
|                                                                         |       |                             |       |                           |       |   |   |   |   |
| Income (loss)  before provision for income taxes                             |       | (1,290,991                       | )          | 1,300,300                      |       | (2,668,273 | ) | 1,205,138 |   |
| Provision for  income taxes                                                  |       | —                           |       | 66,600                         |       | — |   | 74,100 |   |
|                                                                         |       |                             |       |                           |       |   |   |   |   |
| Net income  (loss)                                                           |       | $                                | (1,290,991 | )                              | $          | 1,233,700 |   | $ | (2,668,273 | ) | $ | 1,131,038 |   |
|                                                                         |       |                             |       |                           |       |   |   |   |   |
| Net income  (loss) per common share:                                         |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                        |       | $                                | (0.10      | )                              | $          | 0.10 |   | $ | (0.21 | ) | $ | 0.09 |   |
| Diluted                                                                      |       | $                                | (0.10      | )                              | $          | 0.09 |   | $ | (0.21 | ) | $ | 0.09 |   |
|                                                                         |       |                             |       |                           |       |   |   |   |   |
| Weighted average  shares used to compute net income (loss) per common share: |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                        |       | 12,611,880                       |       | 12,485,205                     |       | 12,608,673 |   | 12,450,037 |   |
| Diluted                                                                      |       | 12,611,880                       |       | 13,137,867                     |       | 12,608,673 |   | 13,136,868 |   |

 

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(1)            Non-cash stock-based compensation expense included in these amounts is asfollows:
| Research and  development   |   | $       | 152,483 |    | $      | 76,967  |   | $       | 194,114 |   | $ | 295,718 |   |
|-----------------------------|--------|---------|---------|---------|--------|---------|--------|---------|---------|--------|---|---------|--------|
| Sales and  marketing        |   | 286,649 |    | 200,147 |   | 500,789 |   | 391,055 |    |
| General and  administrative |   | 422,205 |    | 349,654 |   | 734,084 |   | 677,208 |    |

 

The accompanyingnotes are an integral part of these financial statements.

4

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**NeuroMetrix, Inc.Statements of Cash Flows(Unaudited)**
| ** **                                                                                           | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                           | ** ** | **June 30,  2007**        | ** ** | **June 30,  2006** | ** ** |
| ** **                                                                                           | ** ** | ** **                     | ** ** | **(as restated)** | ** ** |
| **Cash  flows from operating activities:**                                                           | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net income  (loss)                                                                                   |       | $                              | (2,668,273 | ) | $ | 1,131,038 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                           |       |   |   |
| Depreciation and  amortization                                                                       |       | 222,501                        |       | 174,314 |   |
| Compensation  expense associated with stock options                                                  |       | 1,428,987                      |       | 1,363,981 |   |
| Provision for  doubtful accounts                                                                     |       | 468,842                        |       | 343,265 |   |
| Amortization of  premium on investments                                                              |       | 10,683                         |       | 102,115 |   |
| Provision for  income taxes                                                                          |       | —                         |       | 74,100 |   |
| Changes in  operating assets and liabilities:                                                        |       |                           |       |   |   |
| Accounts receivable                                                                                  |       | 982,573                        |       | (2,120,289 | ) |
| Inventories                                                                                          |       | (1,551,219                     | )          | (261,454 | ) |
| Prepaid expenses and other current assets                                                            |       | (107,522                       | )          | (119,053 | ) |
| Accounts payable                                                                                     |       | 141,266                        |       | (99,401 | ) |
| Accrued compensation and other accrued expenses                                                      |       | (2,084,646                     | )          | 810,037 |   |
| Other long-term liabilities                                                                          |       | (29,091                        | )          | (29,091 | ) |
| Deferred revenue and deferred costs                                                                  |       | (33,384                        | )          | 371,883 |   |
| Net cash  provided by (used in) operating activities                                                 |       | (3,219,283                     | )          | 1,741,445 |   |
|                                                                                                 |       |                           |       |   |   |
| **Cash  flows from investing activities:**                                                           | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Purchases of  investments                                                                            |       | (17,811,395                    | )          | (23,752,079 | ) |
| Maturities of  investments                                                                           |       | 17,895,712                     |       | 18,229,724 |   |
| Purchases of  fixed assets                                                                           |       | (163,624                       | )          | (272,509 | ) |
| Net cash used in  investing activities                                                               |       | (79,307                        | )          | (5,794,864 | ) |
|                                                                                                 |       |                           |       |   |   |
| **Cash  flows from financing activities:**                                                           | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Proceeds from sale  of stock under employee stock purchase plan                                      |       | 146,751                        |       | 828,363 |   |
| Proceeds from  exercise of stock options                                                             |       | 20,057                         |       | 216,913 |   |
| Net cash  provided by financing activities                                                           |       | 166,808                        |       | 1,045,276 |   |
|                                                                                                 |       |                           |       |   |   |
| Net decrease in  cash and cash equivalents                                                           |       | (3,131,782                     | )          | (3,008,143 | ) |
| Cash and cash  equivalents, beginning of period                                                      |       | 7,909,778                      |       | 8,170,037 |   |
| Cash and cash  equivalents, end of period                                                            |       | $                              | 4,777,996  |   | $ | 5,161,894 |   |
|                                                                                                 |       |                           |       |   |   |
| **Supplemental  Disclosure of Non-Cash Investing Activities:**                                       | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Equipment acquired  under capital lease                                                              |       | $                              | 38,700     |   | $ | — |   |

 

The accompanying notes are an integral part of thesefinancial statements.

5

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

**1.****                 Business and Basis of Presentation**

**Business**

NeuroMetrix, Inc. (the “Company”), a Delawarecorporation, was formed in June 1996. The Company designs, develops andsells proprietary medical devices used to help physicians diagnose neuropathiesand neurovascular diseases. Neuropathies are diseases of the peripheral nervesand parts of the spine that frequently are caused by or associated withdiabetes, low back pain and carpal tunnel syndrome, as well as other clinicaldisorders. The Company markets and sells the NC-stat System, aninternally-developed product, to physician practice groups for the diagnosis ofneuropathies. Diabetic retinopathy is a neurovascular disease affecting thevision of patients with diabetes. The Company has an exclusive sales andmarketing license with EyeTel Imaging, Inc. (“EyeTel”) to market theDigiScope®, a product designed to detect diabetic retinopathy. The Companyoperates in one business segment.

In October 2006, the Company entered into anexclusive seven year licensing agreement with EyeTel. The agreement grants theCompany an exclusive license to market, brand, and sell EyeTel’s DigiScope throughoutthe primary care physician and endocrinologist market in the United States. TheDigiScope, developed by EyeTel in collaboration with the Wilmer Eye Instituteat Johns Hopkins, is a United States Food and Drug Administration (“FDA”)cleared diagnostic device that primary care physicians and endocrinologists canuse for the early detection of diabetic retinopathy.  Revenues from the DigiScope, for which weinitiated sales and marketing efforts during the first quarter of 2007, arederived through: (a) eye scan fees, (b) monthly rental fees and (c)installation and training fees.  Eye scanfees using the DigiScope are recognized at the time of the patientexamination.  Installation and trainingfees are deferred and recognized on a straight line basis over thenon-cancelable term of the customer contract, currently one year, and rentalfees are recognized on a monthly basis.

The accompanying unaudited balance sheet as of June30, 2007, unaudited statements of operations for the three and six month periodsended June 30, 2007 and 2006 and the unaudited statements of cash flows for thesix month periods ended June 30, 2007 and 2006 have been prepared in accordancewith accounting principles generally accepted in the United States of Americafor interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by accounting principles generallyaccepted in the United States of America for complete financial statements. Inthe opinion 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 six month period endedJune 30, 2007 are not necessarily indicative of the results that may beexpected for the year ending December 31, 2007 or any other period. Thesefinancial statements and notes should be read in conjunction with the financialstatements for the year ended December 31, 2006 included in the Company’sAnnual Report on Form 10-K (File No. 000-50856). The accompanyingbalance sheet as of December 31, 2006 has been derived from auditedfinancial statements prepared at that date, but does not include all disclosuresrequired by accounting principles generally accepted in the United States ofAmerica.

**Use of Estimates**

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and the disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could differfrom those estimates.

**Recent Accounting Pronouncements**

In February 2007, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 159, “*The Fair Value Option for Financial Assets and Financial Liabilities,including an amendment of FASB Statement No. 115*.” (“SFASNo. 159”)  SFAS No. 159 permits entities to choose to measuremany financial instruments and certain other items at fair value that are notcurrently required to be measured at fair value. Unrealized gains and losses onitems for which the fair value option has been elected are reported inearnings. SFAS No. 159 does not affect any existing accounting literaturethat requires certain assets and liabilities to be carried at fair value. SFASNo. 159 is effective for fiscal years beginning after November 15,2007. The Company does not believe that the adoption of SFAS No. 159 willhave a material impact on its financial position, results of operations or cashflows.

In September 2006, the FASB issued SFASNo. 157, *“Fair Value Measurements”*(“SFAS No. 157”). SFAS No. 157 defines fair value in numerousaccounting pronouncements, establishes a framework for measuring fair value ingenerally accepted accounting 

6

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principles (“GAAP”) and expands disclosures related to the use of fairvalue measures in financial statements. SFAS No. 157 does not expand theuse of fair value measures in financial statements, but standardizes itsdefinition and guidance in GAAP.  The standard emphasizes that fair valueis a market-based measurement and not an entity-specific measurement based onan exchange transaction in which the entity sells an asset or transfers aliability (exit price). SFAS No. 157 establishes a fair value hierarchyfrom observable market data as the highest level to fair value based on anentity’s own fair value assumptions as the lowest level. SFAS No. 157 iseffective for our financial statements issued in 2008; however, earlierapplication is encouraged. The Company has not yet determined the impact thatthe adoption of SFAS No. 157 will have on its financial position, resultsof operations or its cash flows.

In June 2006, the FASB issued FASB InterpretationNo. 48,*“Accounting for Uncertainty inIncome Taxes—an interpretation of FASB Statement No. 109”* (“FINNo. 48”), which clarifies the accounting and disclosure for uncertainty intax positions, as defined. FIN No. 48 requires that management recognizein the Company’s financial statements the impact of the tax position if thatposition is more likely than not of being sustained upon examination, based onthe technical merits of the position. The Company adopted the provisions of FINNo. 48 effective January 1, 2007 and such adoption did not have a materialeffect on the financial statements.   SeeNote 7 — Income Taxes - Adoption of FIN No. 48.

**2.****                 Restatement**

As previously disclosed in Note 2 - Restatement of theNotes to Financial Statements included in the Company’s Annual Report on Form10-K for the year ended December 31, 2006, the Company has restated itsfinancial statements for the three and six months ended June 30, 2006 tocorrect an error in accounting for sales tax liabilities. The error arose fromthe Company’s failure in certain states within the United States to chargesales tax to customers as required by state law and subsequently file and remitsuch collections to the state tax authorities. The Company has computed theerror as the total of the sales tax due, based on historical sales in thosestates where sales tax should have been collected, and the resulting interestand penalties in accordance with the applicable state laws.

The impact of correcting this error resulted in anincrease in general and administrative expenses of $297,000 and a reduction ofnet income of $297,000 for the quarter ended June 30, 2006 and an increase ingeneral and administrative expenses of $547,000 and a reduction of net incomeof $547,000 for the six months ended June 30, 2006.

The following table presents the impact of therestatement:

|                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                | ** ** | **June 30, 2006**      | ** ** | **June 30, 2006**    | ** ** |
| ** **                                | ** ** | **As  Previously  Reported**     | ** ** | **Restated**                   | ** ** | **As  Previously  Reported** | ** ** | **Restated** | ** ** |
| **Statement  of Operations:**             | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| General and  administrative               |       | $                                | 2,690,772  |                           | $          | 2,987,772 |   | $ | 5,246,021 |   | $ | 5,793,021 |   |
| Total operating  expenses                 |       | 9,367,632                        |       | 9,664,632                      |       | 18,449,742 |   | 18,996,742 |   |
| Income from  operations                   |       | 1,224,952                        |       | 927,952                        |       | 1,086,204 |   | 539,204 |   |
| Income before  provision for income taxes |       | 1,597,300                        |       | 1,300,300                      |       | 1,752,138 |   | 1,205,138 |   |
| Net income                                |       | 1,530,700                        |       | 1,233,700                      |       | 1,678,038 |   | 1,131,038 |   |
| Net income per  common share:             |       |                             |       |                           |       |   |   |   |   |
| Basic                                     |       | $                                | 0.12       |                           | $          | 0.10 |   | $ | 0.13 |   | $ | 0.09 |   |
| Diluted                                   |       | $                                | 0.12       |                           | $          | 0.09 |   | $ | 0.13 |   | $ | 0.09 |   |

 

|                                    | ** ** | **Six Months Ended** | ** ** |
|------------------------------------|------------|--------------------------------|------------|
| ** **                         | ** ** | **June 30, 2006**    | ** ** |
| ** **                         | ** ** | **As  Previously  Reported**   | ** ** | **Restated** | ** ** |
| **Cash  Flows:**                   | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net income                         |       | $                              | 1,678,038  |   | $ | 1,131,038 |   |
| Accrued expenses and  compensation |       | 263,037                        |       | 810,037 |   |
|                                    |            |                                |            |  |  |  |  |

 

As applicable, the footnotes contained elsewherewithin these financial statements have also been restated to correct thiserror.

7

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**3.****                 Net Income (Loss)Per Common Share**

The Company accounts for and discloses net income(loss) per common share in accordance with SFAS No. 128, “*Earnings Per Share*”.   Basic net income (loss) per common share iscomputed by dividing net income (loss) attributable to common stockholders bythe weighted average number of common shares outstanding. Diluted net income(loss) per common share is computed by dividing net income (loss) attributableto common stockholders by the weighted average number of common shares anddilutive potential common share equivalents then outstanding. Potential commonshares consist of shares issuable upon the exercise of stock options using thetreasury stock method.

|                                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                          | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006**    | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |
| ** **                                          | ** ** | ** **                       | ** ** | **(as restated)**         | ** ** | ** ** | ** ** | **(as restated)** | ** ** |
|                                                |       |                             |       |                           |       |   |   |   |   |
| Basic:                                              |       |                             |       |                           |       |   |   |   |   |
| Net income  (loss) available to common stockholders |       | $                                | (1,290,991 | )                              | $          | 1,233,700 |   | $ | (2,668,273 | ) | $ | 1,131,038 |   |
|                                                |       |                             |       |                           |       |   |   |   |   |
| Weighted average  shares                            |       | 12,611,880                       |       | 12,485,205                     |       | 12,608,673 |   | 12,450,037 |   |
|                                                |       |                             |       |                           |       |   |   |   |   |
| Basic income  (loss) per common share               |       | $                                | (0.10      | )                              | $          | 0.10 |   | $ | (0.21 | ) | $ | 0.09 |   |
|                                                |       |                             |       |                           |       |   |   |   |   |
| Diluted:                                            |       |                             |       |                           |       |   |   |   |   |
| Net income  (loss) available to common stockholders |       | $                                | (1,290,991 | )                              | $          | 1,233,700 |   | $ | (2,668,273 | ) | $ | 1,131,038 |   |
|                                                |       |                             |       |                           |       |   |   |   |   |
| Weighted average  shares                            |       | 12,611,880                       |       | 12,485,205                     |       | 12,608,673 |   | 12,450,037 |   |
| Effect of stock  options                            |       | —                           |       | 652,662                        |       | — |   | 686,831 |   |
| Weighted average  shares, as adjusted               |       | 12,611,880                       |       | 13,137,867                     |       | 12,608,673 |   | 13,136,868 |   |
|                                                |       |                             |       |                           |       |   |   |   |   |
| Diluted income (loss)  per common share             |       | $                                | (0.10      | )                              | $          | 0.09 |   | $ | (0.21 | ) | $ | 0.09 |   |

 

The following potentially dilutive common shares were excluded from thecalculation of diluted net income (loss) per common share because their effectwas antidilutive for each of the periods presented:

| ** **          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **          | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006**    | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |
|                |       |                             |       |                           |       |   |   |   |   |
| Options outstanding |       | 1,794,029                        |       | 375,200                        |       | 1,794,029 |   | 396,700 |   |

 

**4.****              Inventories**

Inventories consist of the following:

|                       | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-----------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **            | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Purchased  components |       | $                       | 433,941    |                        | $          | 345,852 |   |
| Finished goods        |       | 4,750,667               |       | 3,287,537                   |       |
|                  |       | $                       | 5,184,608  |                        | $          | 3,633,389 |   |

 

Finished goods included$2.0 million and $262,900 related to the Company’s third-generationneurodiagnostic system, the ADVANCE System, at June 30, 2007 and December 31,2006, respectively.  The Company iscurrently attempting to obtain510(k) regulatory clearance from the FDA in order to begin selling thisproduct.

**5.****              Other Balance SheetItems**

Other accrued expenses consist of the following:

|                        | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                   |       |                    |       |                        |       |
| Professional  services |       | $                       | 686,542    |                        | $          | 401,186 |   |
| Sales taxes            |       | 900,010                 |       | 2,851,307                   |       |
| Other                  |       | 793,705                 |       | 1,023,490                   |       |
|                   |       | $                       | 2,380,257  |                        | $          | 4,275,983 |   |

 

8

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At June 30, 2007, the decrease in state sales tax liability reflects a reversal of $1.7 million in previously accrued expenses resulting fromthe receipt of amnesty and other forms of relief from a number of states in theform of a limited look back period and waiver of penalties.

Product Warranty Costs

The Company accrues estimated product warranty costsat the time of sale which are included in cost of revenues in the statements ofoperations. The amount of the accrued warranty liability is based on historicalinformation such as past experience, product failure rates, number of unitsrepaired and estimated cost of material and labor. The liability for productwarranty costs is included in accrued expenses in the balance sheet.

The following is a rollforward of the Company’saccrued warranty liability for the three and six month periods ended June 30,2007 and 2006:

|                                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                      | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006**    | ** ** | **June 30, 2007** | ** ** | **June 30, 2006** | ** ** |
| Balance at  beginning of period |       | $                                | 252,258    |                           | $          | 113,892 |   | $ | 231,725 |   | $ | 124,852 |   |
| Accrual for  warranties         |       | 211,688                          |       | 165,345                        |       | 396,976 |   | 258,873 |   |
| Settlements made                |       | (183,743                         | )          | (138,351                       | )          | (348,498 | ) | (242,839 | ) |
| Balance at end of  period       |       | $                                | 280,203    |                           | $          | 140,886 |   | $ | 280,203 |   | $ | 140,886 |   |

 

**6.****              Shareholder RightsPlan**

On March 7, 2007, the Company’s Board of Directorsadopted a Shareholder Rights Plan and declared a dividend distribution of onepreferred stock purchase right for each outstanding share of the Company’scommon stock to shareholders of record as of the close of business on March 8,2007.  Initially, these rights will notbe exercisable and will trade with the shares of the Company’s commonstock.  Under the Shareholder RightsPlan, the rights generally will become exercisable if a person becomes an “acquiringperson” by acquiring 15% or more of the common stock of the Company or if aperson commences a tender offer that could result in that person owning 15% ormore of the common stock of the Company. If a person becomes an acquiring person, each holder of a right (otherthan the acquiring person) would be entitled to purchase, at the then-currentexercise price, such number of shares of preferred stock which are equivalentto shares of the Company’s common stock having a value of twice the exerciseprice of the right.  If the Company isacquired in a merger or other business combination transaction after any suchevent, each holder of a right would then be entitled to purchase, at thethen-current exercise price, shares of the acquiring company’s common stockhaving a value of twice the exercise price of the right.

**7.****                 Income Taxes -Adoption of FIN No. 48**

On January 1, 2007, the Company adopted theprovisions of FIN No. 48.  FIN No. 48requires that the impact of tax positions be recognized in the financialstatements if they are more likely than not of being sustained based on thetechnical merits of the position.  Asdisclosed in the financial statements included in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2006, the Company has a valuationallowance against the full amount of its net deferred taxes.  The Company currently provides a valuationallowance against deferred taxes when it is more likely than not that someportion, or all, of its deferred tax assets will not be realized.

As a result of the implementation of FIN No. 48, theCompany reduced its deferred tax assets and the associated valuation allowancefor gross unrecognized tax affected benefits of approximately $120,000.  There was no adjustment to the Company’saccumulated deficit as a result of these unrecognized tax benefits since therewas a full valuation allowance against the related deferred tax assets.  If these unrecognized tax benefits areultimately recognized, they would have no impact on the effective tax rate tothe extent the Company continues to maintain a valuation allowance.

The Company files income tax returns in the U.S.federal jurisdiction and various state jurisdictions. The Company has not beenaudited by the Internal Revenue Service (“IRS”) or any states in connectionwith income taxes.  The periods from 1996— 2006 remain open to examination by the IRS and state jurisdictions.

The Company’s policy is to recognize interest andpenalties accrued on any unrecognized tax benefits as a component of income taxexpense. As of the date of adoption of FIN No. 48, the Company did not have anyaccrued interest or penalties associated with any unrecognized tax benefits,nor was any interest expense recognized during the quarter. The Company’seffective tax rate differs from the 

9

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federal statutory rate primarily due to non-deductible expenses and isoffset somewhat by state tax credits.

Under Internal Revenue Code Section 382, cumulativeownership changes by material shareholders exceeding 50% during a 3-year periodcan potentially limit a company’s future use of its net operating losses.  The Company has performed a Section 382 study and, under currenttax rules, the limitations are not expected to significantly impact therecorded value or timing of utilization of the Company’s net operatinglosses.  However, ownership changes sincethe completion of the study and in future periods may further limit theutilization of net operating losses and tax credit carryforwards.

**8.****                 Commitments andContingencies**

** **In the second quarter of2006, the Company received a subpoena from the Office of Inspector General (“OIG”),of the Department of Health and Human Services requesting documents inconnection with an investigation of potential violations of the federalanti-kickback statute and False Claims Act. In addition, on June 21, 2007, the Company received a subpoena from theU.S. Attorney’s Office for the District of Massachusetts requesting documentsin connection with an investigation by the U.S. Department of Justice (“DOJ”).  It is believed that the DOJ is investigatingvarious aspects of the Company’s sales and marketing practices respecting theNC-stat System.  The likelihood or magnitude of any potential liabilitiesarising out of these investigations cannot be reasonably estimated andtherefore no loss contingency has been accrued as of June 30, 2007.

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**Item 2.    Management’s Discussion and Analysis ofFinancial 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 the accompanyingnotes to those financial statements included elsewhere in this Quarterly Reporton Form 10-Q. This discussion contains forward-looking statements thatinvolve risks and uncertainties. For a description of factors that may causeour actual results to differ materially from those anticipated in these forwardlooking statements, please refer to the section of this Quarterly Report onForm 10-Q titled “Cautionary Note Regarding Forward-Looking Statements.”*

We have restatedour financial statements as of and for the quarter and six months ended June30, 2006 to correct an error in accounting for sales taxes, as discussed inNote 2 - Restatement of the Notes to Unaudited Financial Statements includedelsewhere in this Quarterly Report on Form 10-Q.   Additional information about thisrestatement may be found in Note - 2 Restatement of the Notes to FinancialStatements included in our Annual Report on Form 10-K for the year endedDecember 31, 2006.

**Overview**

NeuroMetrix wasfounded in June 1996. We design, develop and sell proprietary medicaldevices used to help physicians diagnose neuropathies and neurovasculardisease. Our proprietary technology provides physicians with an in-officediagnostic system, the NC-stat System, which enables physicians to make rapidand accurate diagnoses of neuropathies, including carpal tunnel syndrome, lowback and leg pain and diabetic peripheral neuropathy. The NC-stat System iscomprised of: (a) disposable single use NC-stat biosensors that are placedon the patient’s body; (b) the NC-stat monitor and related components; and(c) the NC-stat docking station, an optional device that enables thephysician’s office to transmit data to our onCall Information System. Eachcomponent of the NC-stat System is also sold separately. The sensitivity of thenervous system to metabolic and mechanical damage, compounded by its limitedregenerative ability, creates a market opportunity for a medical device thatcan assist in point-of-service diagnoses of neuropathies in a manner that is cost-effectivefor the patient and third-party payer. We believe the accuracy and convenienceprovided by the NC-stat System position it to become a standard of care for theassessment of neuropathies at the point-of-service.

Neurovasculardisease includes conditions such as retinopathy, an eye disease prevalent inpatients with diabetes. We hold an exclusive sales and marketing license to aproduct known as the DigiScope®, which allows primary care and specialistphysicians to diagnose diabetic retinopathy and refer patients to an eyespecialist for treatment if deemed necessary based on the results. It isrecommended by the American Diabetes Association, or ADA, that all patientswith diabetes receive an annual dilated eye examination to monitor vision. Thereare approximately 21 million people in the United States with diabetesaccording to the ADA and only approximately 50% comply with the recommendationto have an annual eye examination. We believe that a product such as theDigiScope in primary care physicians’ and endocrinologists’ offices couldpotentially lead to an increase in the level of testing and result in theearlier detection of eye diseases in patients with diabetes.

We derive themajority of our revenues from the sale of NC-stat biosensors, monitors anddocking stations directly to end users, which are generally physician practicegroups. Our NC-stat biosensors are disposable products that are used once andinactivated after use. The NC-stat monitor is an electronic instrument that isused with the NC-stat biosensors to perform nerve conduction studies for thepurpose of diagnosing neuropathies. The NC-stat monitor displays the pertinentresults of nerve conduction studies on a LCD screen immediately at theconclusion of each study. The NC-stat docking station is an optional devicethat is used to transmit to the onCall Information System data generated by thenerve conduction study performed with the NC-stat monitor. The onCallInformation System formulates the data it receives for each test into adetailed report that is provided to the customer through facsimile or e-mail.

InOctober 2006, we entered into an exclusive seven year licensing agreementwith EyeTel Imaging, Inc., or EyeTel. The agreement grants us an exclusivelicense to market, brand and sell EyeTel’s DigiScope throughout the primarycare physician and endocrinologist market in the United States.   Revenues associated with the DigiScope arederived through: (a) eye scan fees; (b) monthly rental fees and (c) installationand training fees.  Under the terms ofagreement, we are required to remit a percentage of the revenues related to theDigiScope to EyeTel.

Our revenues declined to $11.5 million for the threemonths ended June 30, 2007, compared to $14.0 for the same period a year ago,and declined to $23.2 million for the six months ended June 30, 2007, comparedto $25.8 million for the same period a year ago.  Additionally, we incurred a net loss of $1.3million for the three months ended June 30, 2007, compared to net income of $1.2million for the same period a year ago, and incurred a net loss of $2.7 millionfor the six months ended June 30, 2007, compared to net income of $1.1 millionfor the same period a year ago.  Thesecond quarter of 2007 represents our second consecutive quarter of net lossesand declining revenues following our first profitable year in 2006 and a periodof significant growth in our revenues extending back through 2002.  We believe that the decline in our revenues hasbeen caused primarily by adverse developments over the last several quartersrelating to the reimbursement by third-party payers of nerve conduction studiesperformed using the NC-stat, and we expect that our revenues will continue tobe adversely affected by the uncertainty regarding reimbursement.  One important development that may resolvesome of the uncertainty, as described in more detail below, occurred when theAmerican Medical Association, or AMA, CPT 

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EditorialPanel recently formed a committee to examine reimbursement coding of nerveconduction studies.  We believe thiscommittee may issue a recommendation, which may or may not be beneficial to us,for consideration by the AMA CPT Editorial Panel in either late 2007 or early2008.  Other significant developmentsrelating to our financial condition and results of operations include:

·            the launch of our sales and marketing efforts relating to the DigiScopein the first quarter of 2007, which increased our revenues in the secondquarter of 2007 by $204,000 and is expected to continue to increase ourrevenues going forward;

·            our decision to terminate our relationships with all independent salesagencies following the end of the second quarter of 2007, which may adverselyimpact future revenues, but is likely to reduce future expenses;

·            the delay of our expected launch of our third-generation neurodiagnosticsystem, the ADVANCETM System, as we remain in theprocess of attempting to obtain regulatory clearance from the U.S. Food and Drug Administration, or FDA;

·            our receipt of amnesty and other forms of relief from a number of statesrelated to state sales tax liability that we had previously accrued, whichresulted in a reversal of $1.7 million of state sales tax liability in thesecond quarter of 2007; and

·            the governmental investigations by the Office of Inspector General, orOIG, of the Department of Health and Human Services and the U.S. Department ofJustice, or DOJ, that we are subject to, which resulted in increased expensesduring the second quarter of 2007.

In addition, we continued tomake progress with our research and development efforts, particularly with aminimally invasive neurotherapeutic product. These developments are discussed in greater detail below and elsewherein this Quarterly Report on Form 10-Q.

Reimbursement fromthird-party payers is an important element of success for medical productscompanies. As our presence in the market expands and the use of the NC-statSystem increases, we have experienced and are likely to continue toexperience an increased focus from third-party payers and governmental agenciesregarding the reimbursement of nerve conduction studies performed using theNC-stat System and an increased focus from these organizations regarding theprofessional requirements for performing nerve conduction studies in general. Anumber of third-party payers, including commercial payers, have taken and maycontinue to take the position of not reimbursing our customers for their use ofthe NC-stat System.

During the secondhalf of 2006 and early 2007, five local Medicare carriers covering a total oftwenty states issued draft local coverage decisions, or LCDs, final LCDs orcoding articles particularly addressing coverage and reimbursement policiesunder Medicare for nerve conduction studies performed using the NC-stat System.Several of these carriers indicated that they will not reimburse physiciansunder Medicare for nerve conduction studies performed using the NC-stat Systemunder the three existing Current Procedural Terminology, or CPT, codes forconventional nerve conduction studies (95900, 95903 and 95904), which providefor levels of reimbursement fixed by the Center for Medicaid and MedicareServices, or CMS, but rather that physicians must submit claims forreimbursement for these procedures under a miscellaneous CPT code (95999), inwhich case the local carriers may determine the level of reimbursement to bepaid, if any. One of these Medicare carriers recently indicated in their finalLCD that the NC-Stat should be reimbursed under the CPT codes for conventionalnerve conduction studies, reversing their initial position that themiscellaneous CPT code should be used. In certain regions impacted by these reimbursement decisions, ourcustomers have experienced lower levels of reimbursement and higher levels ofclaims denials. If physicians do not receive adequate reimbursement under themiscellaneous CPT code from those local carriers, our existing customers maycontinue to limit or curtail their use of the NC-stat System and we may beunable to obtain new customers, both of which could materially and adverselyimpact our revenues and profitability. The AMA CPT Editorial Panel has formed acommittee which is expected to examine the reimbursement coding of automatednerve conduction studies, including the NC-stat System and other traditionalequipment. The findings of this committee may affect which CPT codes Medicarecarriers and commercial payers require from physicians who perform procedureswith the NC-stat System.  Since the formation of this committee, noneof the local Medicare carriers have issued any new draft LCDs or codingarticles addressing coverage and reimbursement policies under Medicare fornerve conduction studies performed using the NC-stat System.

The LCDs andcoding articles issued by local Medicare carriers have also addressed a numberof other issues, including (a) the background and training of physicianssupervising or performing nerve conduction studies; (b) the level oftraining requirements for technicians performing a nerve conduction study;(c) whether nerve conduction tests should be required to be performedconcomitantly with a needle electromyography procedure; and (d) whetherthe NC-stat System is comparable to conventional nerve conduction testingequipment. We do not believe that these LCDs prohibit physicians from receivingreimbursement under Medicare for medically necessary nerve conduction studiesperformed using the NC-stat System. However, these LCDs do appear to betargeted at limiting access to perform and/or reimbursement for nerveconduction studies. In certain cases, these LCDs are being interpreted orimplemented in a manner that impacts the ability of physicians to receivereimbursement under Medicare, including lower levels of reimbursement and anincrease in the number of claims being denied, for nerve conduction studiesperformed using the NC-stat System, which are having an adverse impact on ourrevenues.

Additionally, a growing number of commercial payers, including asignificant number of regional Blue Cross Blue Shield carriers, 

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haveadopted policies indicating that they will not provide reimbursement for theuse of the NC-stat System.  Thesecommercial payers have cited various reasons for their reimbursement policies,including, among others, that the NC-stat System is experimental andinvestigational.  We are in the processof communicating with these payers, directly or through our network ofreimbursement consultants, to attempt to address their concerns. Third-partypayers may also impose requirements on physicians to submit additionalpaperwork supporting the medical necessity of nerve conduction studiesperformed using the NC-stat System. We believe these requirements arenegatively impacting the use of the NC-stat System by existing customers andour sales to new customers, both of which are having an adverse impact on ourrevenues.

Additional third-party payers, including local Medicare carriers andcommercial payers, could potentially take a position that could reduce or eliminatethe reimbursement for the NC-stat System and could have the impact of deterringusage by our customers.

We believe thateye scans performed using the DigiScope are being reimbursed by the majority ofthird party payers.  Many commercialpayers have policies in place providing for reimbursement for the use of theDigiScope and many of these payers have published favorable articles about theDigiScope in their newsletters.  However,several Medicare carriers have issued draft LCDs and coding articles thatrequire a diagnosis of pre-existing retinal disease and/or will only reimbursefor fundus photography, a highly specialized form of medical imaging, whenperformed in conjunction with an eye examination performed by an eyespecialist.  There are no assurances thatother Medicare carriers will not issue similar draft LCDs, final LCDs or codingarticles restricting the reimbursement for the use of the DigiScope.  We believe that eye examinations performed onpatients covered by Medicare represented less than 25% of our DigiScoperevenues in the second quarter of 2007. However, the restrictions on reimbursement by Medicare carriers couldhave an adverse impact on our ability to grow our DigiScope revenues in futureperiods.

One of the primarychallenges we face in our business is successfully expanding the market fornerve conduction studies. A successful market expansion will depend upon, inpart, our targeting of primary care and specialist physicians who traditionallyhave not been targeted by companies selling equipment used to perform nerveconduction studies and our ability to alter physicians’ practices relating tothe diagnosis of neuropathies. Our strategy to date had been to sell theNC-stat System through a combination of independent sales agencies and a directsales force of experienced sales representatives.  The independent sales agencies, includingsmall to medium sized regional firms and larger national firms, have primarilybeen responsible for generating sales leads and our direct sales force has beenresponsible for bringing these sales leads to closure.  These independent sales agencies typicallyhave not served in a traditional distribution role and therefore have not beenresponsible for maintaining inventories, for making shipments to customers orfor billing and collection functions.

Our strategy ofutilizing independent sales agencies has been effective historically, but wehave recently experienced a significant decline in the percentage of newcustomers being sourced through our independent sales agency network.  As a result, consistent with our long termbusiness objectives, we recently made a decision to terminate our relationshipswith all independent sales agencies and focus our selling efforts exclusivelythrough our direct sales force, which, as of June 30, 2007, was comprised of 46regional sales managers, 5 sales directors and 1 national sales director.

We expect that ourdirect sales force will expand their role in generating new customer salesleads, and we plan to increase efforts to generate sales leads through variousmarketing activities including mailings and tradeshows.  However, it is possible that our sales toexisting customers and our ability to add new customers may be adverselyimpacted by the decision to terminate our relationships with independent salesagencies.  This could potentiallyadversely impact our revenues in the future.

Our long-termfinancial objectives are to grow our business through the sale of the NC-statSystem and the DigiScope and additional products that may be commercialized forthe diagnosis and treatment of neuropathies and to achieve sustainableprofitability. However, during the remainder of 2007 our revenues may continueto decline and we expect to continue to incur losses as a result of thereimbursement and other issues we are currently facing. Our efforts during theremainder of 2007 will focus on (a) sales of the NC-stat System;(b) sales and marketing of the DigiScope for the detection of diabeticretinopathy; (c) attempting to obtain regulatory clearance from the FDAfor our third-generation neurodiagnostic system, the ADVANCE System, in orderto launch this product; (d) efforts to manage the reimbursement challengesposed by third-party payers for the NC-stat System; (e) cooperating with, andworking to resolve, the government investigations of which we are subject; and(f) our ongoing research and development programs.

Our launch of the ADVANCE System will depend upon ourreceipt of regulatory clearance from the FDA. We submitted our initial 510(k)filing for the ADVANCE System in the first quarter of 2007, subsequentlysubmitted a response to a request for additional information from the FDA andrecently received a request for further information from the FDA.  During the fourth quarter of 2006, wesubmitted a 510(k) filing for an updated version of the onCall InformationSystem, and we have submitted a response to a request for additionalinformation from the FDA related to this filing.

With respect toour research and development programs, during the remainder of 2007, we expectto continue efforts to develop new biosensors, on the development of productsto diagnose additional neuropathies, on the development of a product forthe minimally invasive treatment of neuropathies and on thefinal development efforts on the ADVANCE System. During 2007, we initiatedtesting 

13

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of our minimallyinvasive neurotherapeutic product for the treatment of neuropathies by bothspecialist and primary care physicians.

**Resultsof Operations**

The following tablepresents certain statement of operations information stated as a percentage oftotal revenues:
| ** **                                       | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | ** **                                          | ** ** | **(as restated)**                            | ** ** | ** ** | ** ** | **(as restated)** | ** ** |
| Revenues:                                        |       |                                                |       |                                              |       |   |   |   |   |
| Diagnostic  device                               |       | 10.7                                                | %          | 13.8                                              | %          | 10.8 | % | 13.5 | % |
| Biosensor                                        |       | 87.6                                                |       | 86.2                                              |       | 87.5 |   | 86.5 |   |
| Other                                            |       | 1.8                                                 |       | —                                            |       | 1.8 |   | — |   |
| Total revenues                                   |       | 100.0                                               |       | 100.0                                             |       | 100.0 |   | 100.0 |   |
|                                             |       |                                                |       |                                              |       |   |   |   |   |
| Cost of revenues                                 |       | 26.7                                                |       | 24.2                                              |       | 26.5 |   | 24.3 |   |
|                                             |       |                                                |       |                                              |       |   |   |   |   |
| Gross margins                                    |       | 73.3                                                |       | 75.8                                              |       | 73.5 |   | 75.7 |   |
|                                             |       |                                                |       |                                              |       |   |   |   |   |
| Operating  expenses:                             |       |                                                |       |                                              |       |   |   |   |   |
| Research and  development                        |       | 11.0                                                |       | 9.1                                               |       | 10.7 |   | 9.8 |   |
| Sales and  marketing                             |       | 52.5                                                |       | 38.7                                              |       | 51.6 |   | 41.4 |   |
| General and  administrative                      |       | 25.0                                                |       | 21.4                                              |       | 26.7 |   | 22.5 |   |
| Total operating  expenses                        |       | 88.5                                                |       | 69.2                                              |       | 89.0 |   | 73.6 |   |
| Income (loss)  from operations                   |       | (15.2                                               | )          | 6.6                                               |       | (15.6 | ) | 2.1 |   |
| Interest income,  net                            |       | 4.0                                                 |       | 2.7                                               |       | 4.1 |   | 2.6 |   |
| Income (loss)  before provision for income taxes |       | (11.2                                               | )          | 9.3                                               |       | (11.5 | ) | 4.7 |   |
| Provision for  income taxes                      |       | —                                              |       | 0.5                                               |       | — |   | 0.3 |   |
| Net income (loss)                                |       | (11.2                                               | )%         | 8.8                                               | %          | (11.5 | )% | 4.4 | % |

 

**Comparisonof Three Months Ended June 30, 2007 and June 30, 2006**

*Revenues*

The following tablespresent a breakdown of our customers, biosensor units used and revenues:
| ** ** | ** ** | **12-Month Period  Ended June 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------|------------|----------------------------------------------------|------------|------------|------------|------------|------------|
| ** ** | ** ** | **2007**                                           | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
|       |       |                                               |       |       |       |       |       |   |   |
| Customers  |       | 5,401                                              |       | 4,068      |       | 1,333      |       | 32.8 | % |

 
| ** **            | ** ** | **Three Months Ended   June 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------|------------|-------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **            | ** ** | **2007**                                              | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
|                  |       |                                                  |       |       |       |       |       |   |   |
| Biosensor units  used |       | 275,900                                               |       | 287,200    |       | (11,300    | )          | (3.9 | )% |
| ** **            | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                  | ** ** | **($ in thousands)**                             | ** ** | ** ** | ** ** |
| Revenues:             |       |                                                  |       |       |       |       |       |   |   |
| Diagnostic  device    |       | $                                                     | 1,223.2    |       | $          | 1,933.6    |       | $ | (710.4 | ) | (36.7 | ) |
| Biosensor             |       | 10,048.3                                              |       | 12,036.5   |       | (1,988.1   | )          | (16.5 | ) |
| Other                 |       | 204.0                                                 |       | —     |       | 204.0      |       | N/A |   |
| Total revenues        |       | $                                                     | 11,475.5   |       | $          | 13,970.1   |       | $ | (2,494.5 | ) | (17.9 | )% |

 

14

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Diagnostic devicerevenues were $1.2 million and $1.9 million for the three months ended June 30,2007 and 2006, respectively, a decrease of $710,400, or 36.7%.  This decrease is attributable to a lowernumber of units sold, which we believe resulted primarily from uncertainty and adversedevelopments relating to the reimbursement for procedures performed with ourproduct.  Diagnostic device revenuesaccounted for 10.7% and 13.8% of our total revenues for the three months endedJune 30, 2007 and June 30, 2006, respectively.

Biosensor revenueswere $10.0 million and $12.0 million for the three months ended June 30, 2007and 2006, respectively, a decrease of $2.0 million, or 16.5%.  Biosensor revenues accounted for 87.6% and86.2% of our total revenues for the three months ended June 30, 2007 and 2006,respectively.  This decrease isattributable to lower sales of biosensors, which we believe resulted primarilyfrom uncertainty and adverse developments relating to the reimbursement forprocedures performed with our product.

Our customers used275,900 biosensors in the three months ended June 30, 2007, compared to 287,200biosensors for the same period in 2006, a decrease of 11,300 or 3.9%. Thisdecrease in biosensor usage is primarily the result of a decline in averageusage per customer offset by an increase in our customer base.  During the 12-month period ended June 30,2007, a total of 5,401 customers used the NC-stat System compared to 4,068customers for the same period ending June 30, 2006.  The average usage per account declined to 51biosensors per quarter for the quarter ended June 30, 2007 from 71 biosensorsper quarter for the quarter ended June 30, 2006.

Other revenues areattributable to the DigiScope, for which we obtained an exclusive sales andmarketing license from EyeTel in October 2006 and launched our sales andmarketing efforts during the first quarter of 2007.  The majority of revenues related to theDigiScope were derived from customer accounts that existed at the time of oursigning of the license agreement with EyeTel and were transferred to us.

Our total revenueswere $11.5 million and $14.0 million for the three months ended June 30, 2007and 2006, respectively.

We anticipate thatrevenues in the remainder of 2007 may continue to decline. In the secondquarter of 2007, we experienced a decline in revenues of 17.9% from the secondquarter of 2006, which we believe primarily resulted from the uncertaintycreated by the issuance of draft LCDs, final LCDs and coding articlesaddressing reimbursement for nerve conduction studies and policies issued by commercialpayers intended to deter usage or limit the reimbursement for the NC-statSystem. These developments and other future reimbursement decisions couldcontinue to adversely impact reimbursement for procedures performed using theNC-stat System. Our revenues in the remainder of 2007 are likely to be impactedby (a) the level of reimbursement, if any, established for procedures performedusing the NC-stat System by these carriers and other third-party payers; (b)whether final LCDs are applied in a manner that places additional restrictionsor qualifications on the performance of these procedures; (c) any otherreimbursement determinations relating to nerve conduction studies that may beissued by third-party payers; (d) any other events causing uncertainty as tothe existence or amount of reimbursement physicians are likely to receive forperforming procedures using the NC-stat System or (e) decisions potentiallyforthcoming from the AMA CPT Editorial Panel regarding reimbursement codes fornerve conduction studies.  Separately, weexpect revenues to continue to be positively impacted by the initiation of oursales and marketing efforts for the DigiScope. Overall, revenues could beimpacted by a variety of factors, including the level of demand for our products,potential for changes in third-party reimbursement for nerve conductionstudies, the decision to terminate our relationships with independent salesagencies, 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.”

15

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*Costsand expenses*

The following tablepresents our costs and expenses and net income (loss):
| ** **                                       | ** ** | **Three Months Ended  June 30,** | ** ** | ** **             | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|------------------------|------------|------------|------------|
| ** **                                       | ** ** | **2007**                                        | ** ** | **2006**               | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                                       | ** ** | ** **                                      | ** ** | **(as restated)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | **($ in thousands)**                  | ** ** | ** **             | ** ** |
| Cost of revenues:                                |       |                                            |       |                   |       |       |       |   |   |
| Diagnostic device                                |       | $                                               | 235.5      |                   | $          | 358.8      |       | $ | (123.3 | ) | (34.4 | )% |
| Biosensor                                        |       | 2,669.6                                         |       | 3,018.7                |       | (349.1     | )          | (11.6 | ) |
| Other                                            |       | 162.6                                           |       | —                 |       | 162.6      |       | N/A |   |
| Total costs of  revenues                         |       | 3,067.6                                         |       | 3,377.5                |       | (309.8     | )          | (9.2 | ) |
|                                             |       |                                            |       |                   |       |       |       |   |   |
| Gross Margin:                                    |       |                                            |       |                   |       |       |       |   |   |
| Diagnostic device                                |       | 987.7                                           |       | 1,574.8                |       | (587.1     | )          | (37.3 | ) |
| Biosensor                                        |       | 7,378.7                                         |       | 9,017.8                |       | (1,639.0   | )          | (18.2 | ) |
| Other                                            |       | 41.4                                            |       | —                 |       | 41.4       |       | N/A |   |
| Total gross  margin                              |       | 8,407.9                                         |       | 10,592.6               |       | (2,184.7   | )          | (20.6 | ) |
|                                             |       |                                            |       |                   |       |       |       |   |   |
| Gross Margin %:                                  |       |                                            |       |                   |       |       |       |   |   |
| Diagnostic device                                |       | 80.7                                            | %          | 81.4                   | %          |       |       |   |   |
| Biosensor                                        |       | 73.4                                            |       | 74.9                   |       |       |       |   |   |
| Other                                            |       | 20.3                                            |       | —                 |       |       |       |   |   |
| Total gross  margin %                            |       | 73.3                                            |       | 75.8                   |       |       |       |   |   |
|                                             |       |                                            |       |                   |       |       |       |   |   |
| Operating  Expenses:                             |       |                                            |       |                   |       |       |       |   |   |
| Research and  development (1)                    |       | 1,266.7                                         |       | 1,268.5                |       | (1.9       | )          | (0.1 | ) |
| Sales and  marketing (1)                         |       | 6,019.9                                         |       | 5,408.3                |       | 611.6      |       | 11.3 |   |
| General and  administrative (1)                  |       | 2,868.7                                         |       | 2,987.8                |       | (119.1     | )          | (4.0 | ) |
| Total operating  expenses                        |       | 10,155.3                                        |       | 9,664.6                |       | 490.7      |       | 5.1 |   |
|                                             |       |                                            |       |                   |       |       |       |   |   |
| Income (loss)  from operations                   |       | (1,747.4                                        | )          | 928.0                  |       | (2,675.4   | )          | (288.3 | ) |
|                                             |       |                                            |       |                   |       |       |       |   |   |
| Interest income                                  |       | 456.4                                           |       | 372.3                  |       | 84.1       |       | 22.6 |   |
|                                             |       |                                            |       |                   |       |       |       |   |   |
| Income (loss)  before provision for income taxes |       | (1,291.0                                        | )          | 1,300.3                |       | (2,591.3   | )          | (199.3 | ) |
| Provision for  income taxes                      |       | —                                          |       | 66.6                   |       | (66.6      | )          | (100.0 | ) |
|                                             |       |                                            |       |                   |       |       |       |   |   |
| Net Income (loss)                                |       | $                                               | (1,291.0   | )                      | $          | 1,233.7    |       | $ | (2,524.7 | ) | (204.6 | )% |

 

----

(1)   Non-cashstock-based compensation expense included in these amounts is as follows:
| Research and development   |   | $     | 152.5  |   | $      | 77.0   |   |   |   |   |   |
|----------------------------|--------|-------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Sales and  marketing       |   | 286.6 |   | 200.1  |   |   |   |   |   |
| General and administrative |   | 422.2 |   | 349.7  |   |   |   |   |   |

 

*GrossMargin*

Diagnostic devicegross margin percentage decreased to 80.7% for the three months ended June 30,2007 from 81.4% for the same period in 2006. The decrease in the gross marginpercentage is primarily attributable to a decrease in the number of devicessold partially offset by an increase in the list price of our NC-stat Systemfrom $5,000 to $6,000 effective January 1, 2007.

Biosensor grossmargin percentage decreased to 73.4% for the three months ended June 30, 2007from 74.9% for the same period in 2006. The decrease in the biosensor grossmargin percentage is primarily due to the change in the mix of biosensors soldand higher product warranty costs.

Other gross marginpercentage, which related entirely to the DigiScope, was 20.3% for the threemonths ended June 30, 2007.  DigiScoperevenues in the second quarter of 2007 represent monthly rental fees and eyescan fees associated with customer accounts that existed at the time of oursigning the license agreement with EyeTel. Under the terms of agreement, we arerequired to remit a percentage of the revenues related to the DigiScope toEyeTel. The agreement includes a provision for a higher percentage of the scanfees to be remitted to EyeTel for these existing customers for the first ninemonths of the agreement.

Our overall grossmargin percentage was 73.3% for the three months ended June 30, 2007 comparedto 75.8% for the same period in 2006.

Our gross marginsmay decline during the remainder of 2007 due to: (a) increased placements andscans performed with the DigiScope, which has lower gross margins as comparedwith our other products and (b) the potential introduction of the ADVANCESystem, subject to obtaining regulatory clearance from the FDA, which is expectedto have lower gross margins due to higher production costs compared with thecurrent diagnostic devices.  We do,however, expect that the DigiScope gross margins will improve as we obtain newcustomers and realize a higher percentage of the eye scan fees compared withthe existing customer base.

*Researchand Development*

Our research anddevelopment, or R&D, expenses include expenses associated with ourresearch, product development, clinical, 

16

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regulatory and qualityassurance departments.

R&D expenseswere $1.3 million for the three months ended June 30, 2007 and June 30,2006.  As a percentage of revenues,R&D expenses were 11.0% and 9.1% for the three months ended June 30, 2007and 2006, respectively.  A decrease inexpenses of $71,200 related to developmental costs expended on the ADVANCESystem and on new prototype biosensors was offset by an increase of $75,500 instock-based compensation expense.

We expect ourspending on R&D will be relatively unchanged during the remainder of 2007.We anticipate that resources devoted to the development of the ADVANCE Systemwill be reallocated to other research and development efforts. This amount mayvary, however, depending on the opportunities and challenges that arise duringthe year.

*Salesand Marketing*

Our sales andmarketing expenses include expenses from the marketing, field sales, salesadministration and reimbursement departments.

Sales andmarketing expenses increased $611,600, or 11.3%, to $6.0 million for the threemonths ended June 30, 2007 from $5.4 million for the same period in 2006. As apercentage of revenues, sales and marketing expenses were 52.5% and 38.7% forthe three months ended June 30, 2007 and June 30, 2006, respectively. Theincrease in expenses was primarily due to (a) an increase of $312,800 inemployee compensation and benefit costs attributable to the expansion of oursales force; (b) an increase of $219,100 in consulting services, primarily toassist us with the reimbursement challenges we are facing; (c) an increase of$86,500 in stock-based compensation expense; and (d) an increase of $42,200 inadvertising and promotional expenses. These amounts were partially offset by a decrease in third party salescommissions of $257,300, primarily due to decreased revenues.  We expect to record the expenses incurred inconnection with the termination of our relationships with independent salesagencies in the third quarter and early fourth quarter of 2007, and weanticipate that our sales and marketing expenses may decline in the fourth quarterof 2007 as a result of reduced payments to independent sales agencies.

Our sales force is52 employees, including 46 regional sales managers, as of June 30, 2007compared to 50 employees, including 46 regional sales managers as of June 30,2006. We plan to continue selling the DigiScope through the same sales forceused to sell the NC-stat System and as a result we do not anticipate the needto expand the sales force to support the sales and marketing efforts for theDigiScope. However, we may incur additional expenses relating to salescommissions and marketing materials in connection with the sale of theDigiScope.

*Generaland Administrative*

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

General andadministrative expenses decreased $119,100, or 4.0%, to $2.9 million for thethree months ended June 30, 2007 from $3.0 million for the same period in 2006.As a percentage of revenues, general and administrative expenses were 25.0% and21.4% for the three months ended June 30, 2007 and June 30, 2006, respectively.The decrease in expenses is primarily due to a reversal of $1.7 million ofsales tax liability as a result of receiving amnesty from a number of statesand receiving relief from other states in the form of a limited look backperiod and waiver of penalties.  Alsocontributing to the decrease of general and administrative expenses was adecrease of $83,400 in bad debt expense. These amounts were offset by an increase of $1.5 million in professionalfees for legal and tax services and an increase of $140,400 in consultingservices both primarily related to the government investigations previouslydisclosed by us and to reimbursement matters.

We believe ourgeneral and administrative expenses, excluding the $1.7 million reversal of oursales tax liability recorded in the second quarter of 2007, will be relativelyunchanged for the remainder of 2007. However, our general and administrative expenses may be impacted bycertain factors including the governmental investigations previously disclosed.

*InterestIncome*

Interest incomewas $456,400 and $372,300 during the three months ended June 30, 2007 and June30, 2006, respectively. Interest income was earned from investments in cashequivalents and short-term investments. The increase in interest income for thequarter ended June 30, 2007, as compared to the quarter ended June 30, 2006 isprimarily due to higher average cash balances and an increase in the averageportfolio yield attributable to a shift in the portfolio mix to higher yieldingfixed maturities and the impact of higher market interest rates in 2007.

17

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*Provision for Income Taxes*

We recorded no taxprovision for the three months ended June 30, 2007.  We recorded a tax provision related to thealternative minimum tax of $66,600 for the three months ended June 30, 2006.

**Comparisonof Six Months Ended June 30, 2007 and June 30, 2006**

*Revenues*

The following tablespresent a breakdown of our customers, biosensor units used and revenues:
| ** ** | ** ** | **12-Month Period   Ended June 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------|------------|----------------------------------------------------------|------------|------------|------------|------------|------------|
| ** ** | ** ** | **2007**                                                 | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** ** | ** ** | ** **                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Customers  |       | 5,401                                                    |       | 4,068      |       | 1,333      |       | 32.8 | % |

 
| ** **            | ** ** | **Six Months Ended  June 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------|------------|-----------------------------------------------|------------|------------|------------|------------|------------|
| ** **            | ** ** | **2007**                                      | ** ** | **2006**   | ** ** | **Change** | ** ** | **%Change** | ** ** |
|                  |       |                                          |       |       |       |       |       |   |   |
| Biosensor units  used |       | 569,100                                       |       | 542,800    |       | 26,300     |       | 4.8 | % |
| ** **            |       |                                          |       |       |       |       |       |   |   |
|                  | ** ** | **($ in thousands)**                     |       |       |       |
| Revenues:             |       |                                          |       |       |       |       |       |   |   |
| Diagnostic  device    |       | $                                             | 2,502.4    |       | $          | 3,475.0    |       | $ | (972.7 | ) | (28.0 | ) |
| Biosensor             |       | 20,321.1                                      |       | 22,318.3   |       | (1,997.2   | )          | (8.9 | ) |
| Other                 |       | 409.8                                         |       | —     |       | 409.8      |       | N/A |   |
| Total revenues        |       | $                                             | 23,233.3   |       | $          | 25,793.3   |       | $ | (2,560.0 | ) | (9.9 | )% |

 

Diagnostic devicerevenues were $2.5 million and $3.5 million for the six months ended June 30,2007 and 2006, respectively, a decrease of $972,700, or 28.0%.  Of this decrease, approximately $1.1 millionis attributable to a lower number of units sold, which we believe resultedprimarily from uncertainty and adverse developments relating to thereimbursement for procedures performed with our product.   Conversely, this decrease is offset by anincrease of approximately $90,100 attributable to the increase in the listprice of our NC-stat monitors and docking stations from $5,000 to $6,000effective January 1, 2007, which resulted in a higher average sale priceduring the six months ended June 30, 2007 as compared to the same period in2006. Diagnostic device revenues accounted for 10.8% and 13.5% of our totalrevenues for the six months ended June 30, 2007 and June 30, 2006,respectively.

Biosensor revenueswere $20.3 million and $22.3 million for the six months ended June 30, 2007 and2006. Biosensor revenues accounted for 87.5% and 86.5% of our total revenuesfor the six months ended June 30, 2007 and 2006, respectively.  This decrease is attributable to lower salesof biosensors, which we believe resulted primarily from uncertainty and adversedevelopments relating to the reimbursement for procedures performed with ourproduct.

Our customers used569,100 biosensors in the six months ended June 30, 2007, compared to 542,800biosensors for the same period in 2006, an increase of 26,300 or 4.8%. Thisincrease in biosensor usage is primarily the result of the increase in thecustomer base, offset by a decline in average usage per customer.  During the 12-month period ending June 30,2007, a total of 5,401 customers used our NC-stat System compared to 4,068customers for the same period ending June 30, 2006.  The average usage per account declined to 105biosensors for the six months ended June 30, 2007 from 133 biosensors for the sixmonths ended June 30, 2006.

Other revenues areattributable to the DigiScope.

Our total revenueswere $23.2 million and $25.8 million for the six months ended June 30, 2007 and2006, respectively.

18

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*Costsand expenses*

The following tablepresents our costs and expenses and net income (loss):
| ** **                                       | ** ** | **Six Months Ended   June 30,** | ** ** | ** **             | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------|------------|------------------------|------------|------------|------------|
| ** **                                       | ** ** | **2007**                                            | ** ** | **2006**               | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                                       | ** ** | ** **                                          | ** ** | **(as restated)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | **($ in thousands)**                      | ** ** | ** **             | ** ** |
| Cost of  revenues:                               |       |                                                |       |                   |       |       |       |   |   |
| Diagnostic  device                               |       | $                                                   | 466.0      |                   | $          | 661.8      |       | $ | (195.9 | ) | (29.6 | )% |
| Biosensor                                        |       | 5,365.3                                             |       | 5,595.6                |       | (230.2     | )          | (4.1 | ) |
| Other                                            |       | 331.0                                               |       | —                 |       | 331.0      |       | N/A |   |
| Total costs of  revenues                         |       | 6,162.3                                             |       | 6,257.4                |       | (95.1      | )          | (1.5 | ) |
|                                             |       |                                                |       |                   |       |       |       |   |   |
| Gross Margin:                                    |       |                                                |       |                   |       |       |       |   |   |
| Diagnostic  device                               |       | 2,036.4                                             |       | 2,813.2                |       | (776.7     | )          | (27.6 | ) |
| Biosensor                                        |       | 14,955.8                                            |       | 16,722.7               |       | (1,767.0   | )          | (10.6 | ) |
| Other                                            |       | 78.8                                                |       | —                 |       | 78.8       |       | N/A |   |
| Total gross  margin                              |       | 17,071.0                                            |       | 19,535.9               |       | (2,464.9   | )          | (12.6 | ) |
|                                             |       |                                                |       |                   |       |       |       |   |   |
| Gross Margin %:                                  |       |                                                |       |                   |       |       |       |   |   |
| Diagnostic  device                               |       | 81.4                                                | %          | 81.0                   | %          |       |       |   |   |
| Biosensor                                        |       | 73.6                                                |       | 74.9                   |       |       |       |   |   |
| Other                                            |       | 19.2                                                |       | —                 |       |       |       |   |   |
| Total gross  margin %                            |       | 73.5                                                |       | 75.7                   |       |       |       |   |   |
|                                             |       |                                                |       |                   |       |       |       |   |   |
| Operating  Expenses:                             |       |                                                |       |                   |       |       |       |   |   |
| Research and  development (1)                    |       | 2,481.8                                             |       | 2,527.2                |       | (45.4      | )          | (1.8 | ) |
| Sales and  marketing (1)                         |       | 11,995.9                                            |       | 10,676.6               |       | 1,319.3    |       | 12.4 |   |
| General and  administrative (1)                  |       | 6,210.9                                             |       | 5,793.0                |       | 417.8      |       | 7.2 |   |
| Total operating  expenses                        |       | 20,688.5                                            |       | 18,996.7               |       | 1,691.8    |       | 8.9 |   |
|                                             |       |                                                |       |                   |       |       |       |   |   |
| Income (loss)  from operations                   |       | (3,617.5                                            | )          | 539.2                  |       | (4,156.7   | )          | (770.9 | ) |
|                                             |       |                                                |       |                   |       |       |       |   |   |
| Interest income                                  |       | 949.2                                               |       | 665.9                  |       | 283.3      |       | 42.5 |   |
|                                             |       |                                                |       |                   |       |       |       |   |   |
| Income (loss)  before provision for income taxes |       | (2,668.3                                            | )          | 1,205.1                |       | (3,873.4   | )          | (321.4 | ) |
| Provision for  income taxes                      |       | —                                              |       | 74.1                   |       | (74.1      | )          | (100.0 | ) |
|                                             |       |                                                |       |                   |       |       |       |   |   |
| Net income (loss)                                |       | $                                                   | (2,668.3   | )                      | $          | 1,131.0    |       | $ | (3,799.3 | ) | (335.9 | )% |

 

----

(1)   Non-cashstock-based compensation expense included in these amounts is as follows:
| Research and development    |   | $     | 194.1  |   | $      | 295.7  |   |   |   |   |   |
|-----------------------------|--------|-------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Sales and  marketing        |   | 500.8 |   | 391.1  |   |   |   |   |   |
| General and  administrative |   | 734.1 |   | 677.2  |   |   |   |   |   |

 

*GrossMargin*

Diagnostic devicegross margin percentage increased to 81.4% for the six months ended June 30,2007 from 81.0% for the same period in 2006. The increase in the gross marginpercentage is primarily attributable to an increase in the list price of ourNC-stat System from $5,000 to $6,000 effective January 1, 2007.

Biosensor grossmargin percentage decreased to 73.6% for the six months ended June 30, 2007from 74.9% for the same period in 2006. The decrease in the biosensor grossmargin percentage is primarily due to the change in the mix of biosensors soldand higher product warranty costs.

Other gross marginpercentage, which related entirely to the DigiScope, was 19.2% for the sixmonths ended June 30, 2007.

Our overall grossmargin percentage was 73.5% for the six months ended June 30, 2007 compared to75.7% for the same period in 2006.

*Researchand Development*

R&D expensesdecreased slightly by $45,400, or 1.8%, and were $2.5 million for the sixmonths ended June 30, 2007 and 2006.  Asa percentage of revenues, R&D expenses were 10.7% and 9.8% for the sixmonths ended June 30, 2007 and 2006, respectively.  The 

19

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decrease in expenses wasprimarily due to decreases of $101,600 in stock-based compensation expenserelating to option grants to non-employees; and $82,100 related to effortsexpended on the development of the ADVANCE System and on new biosensors.  These decreases were offset in part by anincrease of $152,800 in personnel costs resulting from the hiring of additionalemployees in our R&D department related to the development of the ADVANCESystem and also due to increases in employee compensation.

*Salesand Marketing*

Sales and marketingexpenses increased $1.3 million, or 12.4%, to $12.0 million for the six monthsended June 30, 2007 from $10.7 million for the same period in 2006.  As a percentage of revenues, sales andmarketing expenses were 51.6% and 41.4% for the six months ended June 30, 2007and June 30, 2006, respectively. The increase in expenses was primarily due to(a) an increase of $595,300 in employee compensation and benefit costsattributable to the expansion of our sales force; (b) an increase of $211,000in advertising and promotional expenses; (c) an increase of $357,200 inconsulting services, primarily to assist us with the reimbursement challengeswe are facing; and (d) an increase of $109,700 in stock-based compensationexpense.  These amounts were partiallyoffset by a decrease in third party sales commissions of $297,100, primarilydue to decreased revenues.

*Generaland Administrative*

General andadministrative expenses increased $417,800, or 7.2%, to $6.2 million for thesix months ended June 30, 2007 from $5.8 million for the same period in 2006.As a percentage of revenues, general and administrative expenses were 26.7% and22.5% for the six months ended June 30, 2007 and June 30, 2006, respectively.The increase in expenses is primarily due to an increase of $1.9 million inprofessional fees for legal and tax services, an increase of $162,400 inconsulting services and an increase of $125,600 in bad debt expense resultingfrom an increase in past due accounts. The increases to both professional fees and consulting services are bothprimarily related to the government investigations previously disclosed by usand to reimbursement matters.  Offsettingthis was a reversal of $1.7 million of sales tax liability as a result of receivingamnesty from a number of states and receiving relief from other states in theform of a limited look back period and waiver of penalties.

*InterestIncome*

Interest incomewas $949,200 and $665,900 during the six months ended June 30, 2007 and June30, 2006, respectively. Interest income was earned from investments in cashequivalents and short-term investments. The increase in interest income for thesix months ended June 30, 2007, as compared to the six months ended June 30,2006 is primarily due to higher average cash balances and an increase in theaverage portfolio yield attributable to a shift in the portfolio mix to higheryielding fixed maturities and the impact of higher market interest rates in2007.

*Provision for Income Taxes*

We recorded no taxprovision for the six months ended June 30, 2007.  We recorded a tax provision related to thealternative minimum tax of $74,100 for the six months ended June 30, 2006.

**Liquidityand Capital Resources**

Our principalsource of liquidity is our current cash and cash equivalents and short-term held-to-maturityinvestments. As of June 30, 2007, the weighted average maturity of our cashequivalents and short-term held-to-maturity investments was 149 days. Ourability to generate cash from operations is dependent upon our ability togenerate revenue from sales of our products, as well as our ability to manageour operating costs and manage our investments in inventories and othercomponents of working capital. A decrease in demand for our products orunanticipated increases in our operating costs or investments in inventoriesand other components of working capital, would likely have an adverse effect onour liquidity and cash generated from operations. The following sets forthinformation relating to our liquidity:

 
| ** **                                                                | ** ** | **June 30,   2007** | ** ** | **December 31,   2006** | ** ** | **Change** | ** ** | **% Change** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                | ** ** | ** **                    | ** ** | **($ in thousands)**    | ** ** | ** ** | ** ** |
|                                                                      |       |                          |       |                              |       |       |       |              |       |
| Cash and cash  equivalents                                                |       | $                             | 4,778.0    |                              | $          | 7,909.8    |       | $                 | (3,131,8   | ) | (39.6 | )% |
| Short-term  held-to-maturity investments                                  |       | 32,315.7                      |       | 32,410.7                          |       | (95.0      | )          | (0.3              | )          |
| Total cash, cash equivalents and short-term held-to-maturity  investments |       | $                             | 37,093.7   |                              | $          | 40,320.5   |       | $                 | (3,226.8   | ) | (8.0 | )% |

 

During the firstsix months of 2007, our cash and cash equivalents and short-termheld-to-maturity investments decreased by $3.2 million, primarily due to $3.2million of cash used in operations and $163,600 of cash used for capitalexpenditures offset partially by 

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$166,800 of proceedsreceived from the issuance of common stock under our employee stock purchaseplan and the exercise of stock options.

In managing ourworking capital, two of the financial measurements we monitor are days’ salesoutstanding, or DSO, and inventory turnover rate, which are presented in thetable below for the three month periods ended June 30, 2007, June 30, 2006 andthe year ended December 31, 2006:
| ** **                                | ** ** | **Three Months Ended   June 30,** | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                | ** ** | **2007**                                              | ** ** | **2006**                               | ** ** | **2006** | ** ** |
|                                      |       |                                                  |       |                                   |       |   |   |
| Days’ sales  outstanding (days)      |       | 51                                                    |       | 38                                     |       | 40 |   |
| Inventory turnover rate  (times per year) |       | 2.5                                                   |       | 4.5                                    |       | 4.3 |   |

 

Our payment termsextended to our customers generally require payment within 30 days from invoicedate. At June 30, 2007, we experienced an increase in DSO to 51 days from 40days at December 31, 2006 and there was a significant increase in thepercentage of accounts receivable past due 60 days or more. We believe that theseincreases were primarily the result of challenges surrounding the reimbursementby Medicare and commercial payers in certain regions of the United States fornerve conduction studies performed using the NC-stat System. As long as wecontinue to face these reimbursement challenges our DSO and our working capitalmay continue to be adversely impacted. Accounts payable are normally paidwithin 30 to 40 days from receipt of a vendor’s invoice.

Our inventoryturnover for the quarter ended June 30, 2007 was 2.5 times, compared with 4.3times for the year ended December 31, 2006. The decrease in the inventoryturnover rate for the quarter ended June 30, 2007 as compared to the year endedDecember 31, 2006 was primarily due to the initial production of the ADVANCESystem and decreased demand for the NC-stat System.

The following setsforth information relating to the sources and uses of our cash:
| ** **                                           | ** ** | **Six Months Ended   June 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | ** **                                          | ** ** | **(as restated)** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                             | ** ** |
| Net cash  provided by (used in) operating activities |       | $                                                   | (3,219.3   | ) | $ | 1,741.4 |   |
| Net cash used in  investing activities               |       | (79.3                                               | )          | (5,794.9 | ) |
| Net cash  provided by financing activities           |       | 166.8                                               |       | 1,045.3 |   |
|                                                      |            |                                                     |            |  |  |  |  |

 

Our operatingactivities used $3.2 million in the six months ended June 30, 2007, compared withcash provided of $1.7 million in the first six months of 2006.  In thefirst half of 2007, a net loss of $2.7 million and a net use of cash ofapproximately $2.7 million for our investment in working capital was offset by$2.1 million in non-cash items, mainly compensation expense associated withstock options.  The primary drivers forthe uses of cash in our investment in working capital were a decrease inaccrued expenses of $2.1 million due primarily to the reversal of $1.7 millionof sales tax liability as a result of receiving amnesty from a number of statesand receiving relief from other states in the form of a limited look backperiod and waiver of penalties and an increase in our inventories of $1.6million primarily for the production of the ADVANCE System.  These items were partially offset by a$982,600 decrease in accounts receivable, excluding the provision for doubtfulaccounts, due to a decline in revenues.   In the first six months of 2006, a net use of cash of approximately $1.4million for our investment in working capital was offset by $1.1 million in netincome and by $2.1 million in non-cash items, mainly compensation expenseassociated with stock options. The primary drivers for the uses of cash in ourinvestment in working capital were an increase in accounts receivable of $2.1million, excluding the provision for doubtful accounts, due to growth inrevenues.  Additionally, our inventoriesincreased $261,500, due to the growth in our business and a strategic decisionto increase inventory levels from two months to three months of purchases.   These items were offset by an $810,000increase in accrued expenses, partially attributable to state sales taxes.

As a result of thedecline in revenues and increase in expenses, we incurred a net loss in thefirst six months of 2007 and we expect to incur net losses for the remainder of2007. This may have an adverse impact on our cash flows from operatingactivities for the remainder of 2007.

Our investingactivities used $79,300 and $5.8 million of cash in the six months ended June30, 2007 and June 30, 2006, respectively.  In the first six months of 2007, $17.9 million in investment maturitiesprovided cash which was offset by $17.8 million in investment purchases and$163,600 used to fund purchases of fixed assets, primarily related to computerequipment and tooling equipment for new products.  In the first six months of 2006, $23.8million in investment purchases and $272,500 used to fund purchases of fixedassets, primarily computer equipment, were partially offset by $18.2 million incash provided from investment maturities.

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During theremainder of 2007, we expect to continue to maintain our cash and investmentsin money market funds and short-term investment vehicles. We do not currentlyhave any significant commitments to purchase capital equipment and we expectthat our capital expenditures will be comparable to the level of suchexpenditures in 2006.

In connection withour property lease entered into at the beginning of January 2001, we arerequired to maintain, for the benefit of the lessor, an irrevocable standbyletter of credit stating the lessor as the beneficiary. The original amount ofthe letter of credit was $1,860,000. During September 2005, in accordancewith the terms of the lease agreement, the amount required under the letter ofcredit was reduced to $1,430,000. The letter of credit is secured by acertificate of deposit in an amount equal to 102% of the letter of credit, or$1,458,600. The lease expires in March 2009. The certificate of deposit isrenewable in 30-day increments. This amount is classified as restricted cash inthe balance sheet.

Our financingactivities provided $166,800 and $1.0 million in the six months ended June 30,2007 and 2006, respectively. Cash provided by financing activities in the firstsix months of 2007 and 2006 represents the proceeds from the issuance of sharesunder our employee stock purchase plan and the exercise of stock options.

During theremainder of 2007, we may fund sales and marketing efforts for the DigiScopeand continue our research and development programs, including the ADVANCESystem and our neurotherapeutic product, which entered the clinical stage ofdevelopment in 2007, for the minimally invasive delivery of therapeutic agentsto treat neuropathies by both specialist and primary care physicians. We alsoexpect to incur capital expenditures for computer hardware and software tosupport our business and the additional requirements of our customer base. Webelieve that the combination of funds available from cash and cash equivalentsand funds available from our short-term investments will be adequate to financeour ongoing operations for at least 24 months, including the expendituresdescribed above.

To date, inflationhas not had a material impact on our financial operations.

*Off-BalanceSheet Arrangements, Contractual Obligation and Contingent Liabilities andCommitments*

As of June 30,2007, we did not have any off-balance sheet financing arrangements.

* NewAccounting Pronouncements*

InFebruary 2007, the Financial Accounting Standards Board, or FASB issuedSFAS No. 159, “*The Fair Value Optionfor Financial Assets and Financial Liabilities, including an amendment of FASBStatement No. 115*.”, or SFAS No. 159.  SFASNo. 159 permits entities to choose to measure many financial instrumentsand certain other items at fair value that are not currently required to bemeasured at fair value. Unrealized gains and losses on items for which the fairvalue option has been elected are reported in earnings. SFAS No. 159 doesnot affect any existing accounting literature that requires certain assets andliabilities to be carried at fair value. SFAS No. 159 is effective forfiscal years beginning after November 15, 2007. We believe that ouradoption of SFAS No. 159 will not have a material impact on our financialposition, results of operations or cash flows.

InSeptember 2006, the FASB issued SFAS No. 157, *“Fair Value Measurements”,*or**SFAS No. 157. SFAS No. 157defines fair value in numerous accounting pronouncements, establishes aframework for measuring fair value in generally accepted accounting principles(“GAAP”) and expands disclosures related to the use of fair value measures infinancial statements. SFAS No. 157 does not expand the use of fair valuemeasures in financial statements, but standardizes its definition and guidancein GAAP.  The Standard emphasizes that fair value is a market-basedmeasurement and not an entity-specific measurement based on an exchangetransaction in which the entity sells an asset or transfers a liability (exitprice). SFAS No. 157 establishes a fair value hierarchy from observablemarket data as the highest level to fair value based on an entity’s own fairvalue assumptions as the lowest level. SFAS No. 157 is effective for ourfinancial statements issued in 2008; however, earlier application isencouraged. We have not yet determined the impact that the adoption of SFASNo. 157 will have on our financial position, results of operations or itscash flows.

In June 2006,the FASB issued FASB Interpretation No. 48,*“Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109”,*or FIN No. 48, which clarifies theaccounting and disclosure for uncertainty in tax positions, as defined. FINNo. 48 requires that management recognize in the Company’s financialstatements the impact of the tax position if that position is more likely thannot of being sustained upon examination, based on the technical merits of theposition. The Company adopted the provisions of FIN No. 48 effectiveJanuary 1, 2007 and such adoption did not have a material effect on thefinancial statements.   See Note 7 —Income Taxes - Adoption of FIN No. 48.

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**CAUTIONARY NOTEREGARDING FORWARD-LOOKING STATEMENTS**

The statementscontained in 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 Systemand its components; our ability to increase our customer base and expand themarket for our products; our ability to accurately predict the size of themarket for the NC-stat System; our ability to manage our growth; obtainingnecessary regulatory approvals, including regulatory approval for the ADVANCESystem and the onCall Information System; our reliance on single source thirdparty manufacturers and suppliers to produce our products; reimbursement bythird party payors to our customers for procedures performed using the NC-statSystem; limitations on the reimbursement for the NC-stat System if the AMA CPTpanel renders a decision that the codes for traditional nerve conduction arenot applicable to the NC-stat System; compliance with applicable qualitycontrol and manufacturing standards; compliance with federal and state lawsprotecting the confidentiality of patient health information and prohibiting “kickbacks”and false or fraudulent claims or adverse publicity or costs relating to anyinvestigation into our practices under these laws; our ability to retain andrecruit key management, scientific and sales personnel; delays in thedevelopment of new products or to planned improvements to our products;effectiveness of our products compared to other medical device products;protection of our intellectual property and other proprietary rights; conflictswith the intellectual property of third parties; product liability lawsuits orclaims that may be brought against us; dependence upon computer andcommunication infrastructure utilized by our products; publication of futureclinical studies or other articles or announcement of positions by physicianassociations or other organizations that are unfavorable to our products; ourcapital and financing needs; our successful integration of any acquiredbusinesses; and the other factors described in the section of our Annual Reporton Form 10-K titled “Item 1A. Risk Factors,” as updated in Part II,Item1A of this Quarterly Report on Form 10-Q and our other filings. Should oneor more of these risks or uncertainties materialize, or should any of ourassumptions prove incorrect, actual results may vary in material respects fromthose projected in these forward-looking statements. We undertake no obligationto update or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise, except as may be required underapplicable securities laws.

**Item 3.   Quantitative and Qualitative Disclosures About Market Risk**

We do notuse derivative financial instruments in our investment portfolio and have noforeign exchange contracts. Our financial instruments consist of cash, cashequivalents, short-term investments, accounts receivable, accounts payable,accrued expenses and long-term obligations. We consider investments that, whenpurchased, have a remaining maturity of 90 days or less to be cashequivalents. The primary objectives of our investment strategy are to preserveprincipal, maintain proper liquidity to meet operating needs, and maximizeyields. To minimize our exposure to an adverse shift in interest rates, weinvest mainly in cash equivalents and short-term investments and long-terminvestments with a maturity of eighteen months or less and maintain an averagematurity of twelve months or less. We do not believe that a 10% change ininterest rates would have a material impact on the fair value of our investmentportfolio or our interest income.

**Item 4.   Controls and Procedures**

**(a)**   Evaluation of disclosure controls andprocedures.

Our managementcarried out an evaluation, with the participation of our Chief ExecutiveOfficer and our Chief Financial Officer, of the effectiveness of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as ofJune 30, 2007. Our disclosure controls and procedures are designed to providereasonable assurance that information required to be disclosed by us in thereports 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 that such information is accumulated and communicatedto our management, including our Chief Executive Officer and our ChiefFinancial Officer, to allow timely decisions regarding required disclosures.

Based upon theevaluation described above, our Chief Executive Officer and Chief FinancialOfficer have concluded that they 

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believe that ourdisclosure controls and procedures were effective, as of the end of the periodcovered by this report, in providing reasonable assurance that informationrequired to be disclosed by us in the reports that we file or submit under theExchange Act is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controlsand procedures designed to ensure that information required to be disclosed bythe issuer in its Exchange Act reports is accumulated and communicated to theissuer’s management, including its principal executive and financial officers,as appropriate to allow timely decisions regarding required disclosures.  We continue to review and document ourdisclosure controls and procedures, including our internal controls overfinancial reporting, and may periodically make changes aimed at enhancing theireffectiveness and to ensure that our systems evolve with our business.

**(b)**         Changes in internal control over financial reporting.

As previously disclosedin our Annual Report on Form 10-K for the year ended December 31, 2006, we hada material weakness in internal controls over financial reporting relating tostate sales tax as described below. A material weakness is a controldeficiency, or combination of control deficiencies, that results in more than aremote likelihood that a material misstatement of the annual or interimfinancial statements will not be prevented or detected. As of December 31,2006, we did not maintain effective controls over our sales tax liability andrelated expense accounts. Specifically*,*wedid not have adequate controls designed and in place to assure that state salestaxes were properly collected and remitted in all states in which we operate.This control deficiency resulted in the restatement of our financial statementsfor the years ended December 31, 2005 and 2004, each of the quarters of 2005and the first three quarters of the year ended December 31, 2006. Our ChiefExecutive Officer and Chief Financial Officer have concluded that this materialweakness has been remediated as of June 30, 2007. Our management designed andimplemented certain additional internal controls over the process forestimating our state sales tax liability in the first half of 2007. Thesecontrols include:  (a) a worksheetprepared on a quarterly basis to account for the state sales tax liability; (b)a checklist used to update the status of each state and to ensure that thesales tax liability accrual is complete; (c) the revenues for each state whichare included in the sales tax liability worksheet are reconciled to our booksand records; (d) the relevant sales tax rates for each state are obtained fromthird party sources and the state sales tax liability worksheet is updated toreflect the most current rates; (e) the sales tax liability worksheet isupdated to reflect the status of any special programs or terms offered by eachstate and to reflect all payments made to the states; and (f) a checklist usedto ensure that all of the steps described above have been performed.  In addition to the above controls, ourmanagement has retained the services of a company recognized by the StreamlinedSales Tax Program member states as a certified service provider to assist uswith the processing of state sales tax on customer invoices and with the filingof state sales tax returns.  

Our managementbelieves that the financial statements included in this Quarterly Report onForm 10-Q  are fairly presented in allmaterial respects in accordance with accounting principles generally acceptedin the United States of America.  Managementhas designed and implemented the internal controls described above over theprocess for estimating our state sales tax liability and has concluded thatthese controls are operating effectively as of June 30, 2007.

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**Part IIOther Information**

**Item 1.  Legal Proceedings**

In the second quarter of2006, we received a subpoena from the Office of Inspector General, or OIG, ofthe Department of Health and Human Services requesting documents from us inconnection with an investigation of potential violations of the federalanti-kickback statute and False Claims Act. In addition, on June 21, 2007, we received a subpoena from the U.S.Attorney’s Office for the District of Massachusetts requesting documents fromus in connection with an investigation by the DOJ.  We understand that the DOJ is investigatingvarious aspects of the Company’s sales and marketing practices respecting theNC-stat System.  We are cooperating with both investigations.  Wecannot predict the ultimate outcome of these investigations.   We areunable to determine when these matters will be resolved, whether any additionalareas of inquiry will be opened, or any outcome of this matter.  Anynegative findings in this matter could result in fines, penalties, or programexclusions, which could have a material adverse effect on our financialcondition, results of operations, and cash flows.

**Item 1A. RiskFactors**

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 31,2006, except to the extent updated or to the extent additional factualinformation disclosed elsewhere in this Quarterly Report on Form 10-Q relatesto such risk factors.

**Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds**

None.

**Item 3.   Defaults Upon Senior Securities**

None.

**Item 4.   Submission of Matters to a Vote of Security Holders**

At the Annual Meeting ofStockholders held on May 23, 2007, our stockholders voted as follows:

(a)           To elect two members to the Board ofDirectors as Class II Directors, to serve until the Company’s 2010 annualmeeting of stockholders and until their successors are duly elected andqualified or until their earlier resignation or removal.
| **Nominee**             | ** ** | **Vote “For”** | ** ** | **Vote Withheld** | ** ** |
|-------------------------|------------|-------------------------------|------------|------------------------|------------|
|                    |       |                          |       |                   |       |
| David E.  Goodman, M.D. |       | 6,342,025                     |       | 5,678,788              |       |
| W. Mark Lortz           |       | 6,342,467                     |       | 5,678,346              |       |

 

There were no brokernon-votes or abstentions with respect to this matter.  The terms in office of Shai N. Gozani, M.D.,Ph.D., Charles R. LaMantia, Allen J. Hinkle, M.D., and Jonathan T. Lord, M.D.continued after the annual meeting.

(b)         To ratify the selection of PricewaterhouseCoopers LLP to serve as ourindependent auditors for the year ending December 31, 2007.

| Vote “For” | ** ** | **Vote “Against”** | ** ** | **Abstentions** | ** ** | **Broker Non-Votes** | ** ** |
|---------------------------|------------|-----------------------------------|------------|-----------------|------------|---------------------------|------------|
| 11,980,038                |       | 36,618                            |       | 4,157           |       | —                    |       |

 

**Item 5.   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: August 9, 2007 | /s/        | Shai N. Gozani, M.D., Ph. D.          |
|                 |       | Shai N. Gozani, M.D., Ph. D.          |
|                 |       | Chief Executive Officer and President |
|                 |       |
|                 |       |
| Date: August 9, 2007 | /s/        | W. Bradford Smith                     |
|                 |       | W. Bradford Smith                     |
|                 |       | Chief Financial Officer               |

 

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Exhibit Index
| *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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*     Filed herewith

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