**UNITEDSTATES****SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

**FORM 10-Q**

**(markone)**
| x                                                       | **Quarterly report pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934**  |
|---------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                                    | ** **                                                                                              |
| **For the  quarterly period ended March 31, 2006** |
|                                                    | ** **                                                                                              |
| o                                                       | **Transition Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |

**Commissionfile number 000-50856**

**NEUROMETRIX,INC.**(Exact name of registrant as specified in its charter)
| **Delaware**                                     | **04-3308180**                        |
|--------------------------------------------------|---------------------------------------|
| (State or other jurisdiction of incorporation or | (I.R.S. Employer  Identification No.) |
| organization)                                    |                                  |
|                                             |                                  |
| **62 Fourth Avenue, Waltham, Massachusetts**     | **02451**                             |
| (Address of principal executive offices)         | (Zip Code)                            |

 

**(781)890-9989**(Registrant’s telephone number, including area code)

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

Yes x    No o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler” and “large accelerated filer” in Rule 12b-2 of the ExchangeAct (check one):

Large acceleratedfiler o  Accelerated filer x  Non-accelerated filer o

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

Yes o No x

APPLICABLE ONLY TOCORPORATE ISSUERS

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock as of thelatest practicable date:

12,470,871 shares of common stock, par value $0.0001 per share, wereoutstanding as of May 5, 2006.

 

----

 

**NEUROMETRIX,INC.****FORM 10-Q****INDEX**
| **PART I - FINANCIAL INFORMATION** |
|-----------------------------------------|
|                                    |   |   |
| Item 1.                                 |   | Condensed Financial Statements |
|                                    |   |   |
|                                    |   | Balance Sheets (unaudited) as of March 31, 2006  and December 31, 2005 |
|                                    |   |   |
|                                    |   | Statements of Operations (unaudited) for the three  months ended March 31, 2006 and 2005 |
|                                    |   |   |
|                                    |   | Statements of Cash Flows (unaudited) for the three  months ended March 31, 2006 and 2005 |
|                                    |   |   |
|                                    |   | Notes to Financial Statements (unaudited) |
|                                    |   |   |
| Item 2.                                 |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                                    |   |   |
| Item 3.                                 |   | Quantitative  and Qualitative Disclosures About Market Risk |
|                                    |   |   |
| Item 4.                                 |   | Controls and  Procedures |
|                                    |   |   |
| **PART II - OTHER INFORMATION**    |
|                                    |   |   |
| Item  1.                                |   | Legal  Proceedings |
|                                    |   |   |
| Item  1A.                               |   | Risk  Factors |
|                                    |   |   |
| Item 2.                                 |   | Unregistered  Sales of Equity Securities and Use of Proceeds |
|                                    |   |   |
| Item 3.                                 |   | Defaults Upon  Senior Securities |
|                                    |   |   |
| Item 4.                                 |   | Submission of  Matters to a Vote of Security Holders |
|                                    |   |   |
| Item  5.                                |   | Other  Information |
|                                    |   |   |
| Item  6.                                |   | Exhibits |
|                                    |   |   |
| Signatures                              |

 

2

----

 

**NeuroMetrix, Inc.****Balance Sheets****(Unaudited)**
| ** **                                                                                                                                                                                | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                | ** ** | ** **               | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                           |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                |       | $                        | 5,395,753  |                        | $          | 8,170,037 |   |
| Short-term  held-to-maturity investments                                                                                                                                                  |       | 26,971,891               |       | 24,081,946                  |       |
| Accounts  receivable, net of allowance for doubtful accounts of $450,000 and $400,000  at March 31, 2006 and December 31, 2005, respectively                                    |       | 5,576,502                |       | 4,543,339                   |       |
| Inventories, net                                                                                                                                                                          |       | 3,036,472                |       | 2,683,409                   |       |
| Prepaid expenses  and other current assets                                                                                                                                                |       | 691,290                  |       | 614,169                     |       |
| Current portion  of deferred costs                                                                                                                                                        |       | 249,496                  |       | 223,009                     |       |
| Total current  assets                                                                                                                                                                     |       | 41,921,404               |       | 40,315,909                  |       |
|                                                                                                                                                                                      |       |                     |       |                        |       |
| Restricted cash                                                                                                                                                                           |       | 1,458,598                |       | 1,458,598                   |       |
| Fixed assets,  net                                                                                                                                                                        |       | 935,832                  |       | 875,551                     |       |
| Deferred costs                                                                                                                                                                            |       | 273,346                  |       | 247,013                     |       |
| Total assets                                                                                                                                                                              |       | $                        | 44,589,180 |                        | $          | 42,897,071 |   |
|                                                                                                                                                                                      |       |                     |       |                        |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                            |       |                     |       |                        |       |
| Current liabilities:                                                                                                                                                                      |       |                     |       |                        |       |
| Accounts payable                                                                                                                                                                          |       | $                        | 1,438,050  |                        | $          | 1,698,583 |   |
| Accrued  compensation                                                                                                                                                                     |       | 2,149,899                |       | 1,959,621                   |       |
| Other accrued  expenses                                                                                                                                                                   |       | 1,331,963                |       | 1,213,928                   |       |
| Current portion  of deferred revenue                                                                                                                                                      |       | 874,374                  |       | 760,613                     |       |
| Total current  liabilities                                                                                                                                                                |       | 5,794,286                |       | 5,632,745                   |       |
|                                                                                                                                                                                      |       |                     |       |                        |       |
| Deferred revenue                                                                                                                                                                          |       | 987,342                  |       | 885,354                     |       |
| Other long-term  liabilities                                                                                                                                                              |       | 116,364                  |       | 130,909                     |       |
| Total  liabilities                                                                                                                                                                        |       | 6,897,992                |       | 6,649,008                   |       |
|                                                                                                                                                                                      |       |                     |       |                        |       |
| Commitments and  contingencies                                                                                                                                                            |       |                     |       |                        |       |
|                                                                                                                                                                                      |       |                     |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                |       |                     |       |                        |       |
| Preferred stock,  $0.001 par value, 5,000,000 shares authorized, none outstanding                                                                                                         |       | —                   |       | —                      |       |
| Common stock,  $0.0001 par value; 50,000,000 shares authorized; 12,463,136 and 12,375,276  shares issued and outstanding at March 31, 2006 and December 31,  2005, respectively |       | 1,246                    |       | 1,238                       |       |
| Additional  paid-in capital                                                                                                                                                               |       | 94,426,347               |       | 93,212,368                  |       |
| Deferred  compensation                                                                                                                                                                    |       | (343,823                 | )          | (425,623                    | )          |
| Accumulated  deficit                                                                                                                                                                      |       | (56,392,582              | )          | (56,539,920                 | )          |
| Total  stockholders’ equity                                                                                                                                                          |       | 37,691,188               |       | 36,248,063                  |       |
| Total liabilities and  stockholders’ equity                                                                                                                                          |       | $                        | 44,589,180 |                        | $          | 42,897,071 |   |

 

The accompanyingnotes are an integral part of these financial statements.

3

----

 

**NeuroMetrix, Inc.****Statements of Operations****(Unaudited)**

 
| ** **                                                                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                   | ** ** | **March 31,  2006**         | ** ** | **March 31,  2005** | ** ** |
|                                                                         |       |                             |       |   |   |
| Revenues:                                                                    |       |                             |       |   |   |
| Diagnostic  device                                                           |       | $                                | 1,541,437  |   | $ | 812,400 |   |
| Biosensor                                                                    |       | 10,281,838                       |       | 5,977,364 |   |
| Total revenues                                                               |       | 11,823,275                       |       | 6,789,764 |   |
|                                                                         |       |                             |       |   |   |
| Cost of revenues                                                             |       | 2,879,913                        |       | 1,817,725 |   |
| Gross margin                                                                 |       | 8,943,362                        |       | 4,972,039 |   |
|                                                                         |       |                             |       |   |   |
| Operating expenses:                                                          |       |                             |       |   |   |
| Research and  development (1)                                                |       | 1,258,608                        |       | 904,204 |   |
| Sales and  marketing (1)                                                     |       | 5,268,253                        |       | 3,244,651 |   |
| General and  administrative (1)                                              |       | 2,555,249                        |       | 1,594,040 |   |
| Total operating  expenses                                                    |       | 9,082,110                        |       | 5,742,895 |   |
|                                                                         |       |                             |       |   |   |
| Loss from  operations                                                        |       | (138,748                         | )          | (770,856 | ) |
|                                                                         |       |                             |       |   |   |
| Interest income                                                              |       | 293,586                          |       | 176,380 |   |
| Interest expense                                                             |       | —                           |       | (1,838 | ) |
|                                                                         |       |                             |       |   |   |
| Income (loss)  before provision for income taxes                             |       | 154,838                          |       | (596,314 | ) |
| Provision for  income taxes                                                  |       | 7,500                            |       | — |   |
|                                                                         |       |                             |       |   |   |
| Net income  (loss)                                                           |       | $                                | 147,338    |   | $ | (596,314 | ) |
|                                                                         |       |                             |       |   |   |
| Net income (loss) per  common share:                                         |       |                             |       |   |   |
| Basic                                                                        |       | $                                | 0.01       |   | $ | (0.05 | ) |
| Diluted                                                                      |       | $                                | 0.01       |   | $ | (0.05 | ) |
|                                                                         |       |                             |       |   |   |
| Weighted average shares  used to compute net income (loss) per common share: |       |                             |       |   |   |
| Basic                                                                        |       | 12,414,479                       |       | 12,043,103 |   |
| Diluted                                                                      |       | 13,133,266                       |       | 12,043,103 |   |

 

----

(1) Non-cashstock-based compensation expense included in these amounts is as follows:

 
| Research and  development                        |   | $       | 218,751 |   | $      | 19,880 |   |
|--------------------------------------------------|--------|---------|---------|--------|--------|--------|--------|
| Sales and marketing                              |   | 190,908 |    | 36,269 |   |
| General and  administrative                      |   | 327,554 |    | 19,826 |   |
| Total non-cash  stock-based compensation expense |   | $       | 737,213 |   | $      | 75,975 |   |

 

The accompanyingnotes are an integral part of these financial statements.

4

----

** **

**NeuroMetrix, Inc.****Statements of Cash Flows****(Unaudited)**
| ** **                                                                                           | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                           | ** ** | **March 31,  2006**         | ** ** | **March 31,   2005** | ** ** |
|                                                                                                 |       |                             |       |   |   |
| **Cash flows for operating  activities:**                                                            | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Net income  (loss)                                                                                   |       | $                                | 147,338    |   | $ | (596,314 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                             |       |   |   |
| Depreciation and  amortization                                                                       |       | 83,876                           |       | 63,288 |   |
| Compensation  expense associated with stock options                                                  |       | 737,213                          |       | 75,975 |   |
| Provision for  doubtful accounts                                                                     |       | 108,529                          |       | — |   |
| Amortization of  premium on investments                                                              |       | 55,484                           |       | 124,065 |   |
| Provision for  income taxes                                                                          |       | 7,500                            |       | — |   |
| Changes in operating  assets and liabilities:                                                        |       |                             |       |   |   |
| Accounts receivable                                                                                  |       | (1,141,692                       | )          | (400,996 | ) |
| Inventories                                                                                          |       | (353,063                         | )          | (214,964 | ) |
| Prepaid expenses and other current assets                                                            |       | (77,121                          | )          | (102,754 | ) |
| Accounts payable                                                                                     |       | (260,533                         | )          | 606,931 |   |
| Accrued compensation and other accrued expenses                                                      |       | 308,313                          |       | 351,712 |   |
| Other long-term liabilities                                                                          |       | (14,545                          | )          | (14,546 | ) |
| Deferred revenue and deferred costs                                                                  |       | 162,929                          |       | 107,739 |   |
| Net cash  provided by (used in) operating activities                                                 |       | (235,772                         | )          | 136 |   |
|                                                                                                 |       |                             |       |   |   |
| **Cash flows for investing  activities:**                                                            | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Purchases of  investments                                                                            |       | (13,786,153                      | )          | (2,845,675 | ) |
| Maturities of  investments                                                                           |       | 10,840,724                       |       | 3,376,068 |   |
| Purchases of  fixed assets                                                                           |       | (144,157                         | )          | (59,183 | ) |
| Net cash  provided by (used in) investing activities                                                 |       | (3,089,586                       | )          | 471,210 |   |
|                                                                                                 |       |                             |       |   |   |
| **Cash flow from financing  activities:**                                                            | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Proceeds from  exercise of stock options                                                             |       | 551,074                          |       | 30,207 |   |
| Net cash  provided by financing activities                                                           |       | 551,074                          |       | 30,207 |   |
|                                                                                                 |       |                             |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                                |       | (2,774,284                       | )          | 501,553 |   |
| Cash and cash  equivalents, beginning of period                                                      |       | 8,170,037                        |       | 1,936,241 |   |
| Cash and cash  equivalents, end of period                                                            |       | $                                | 5,395,753  |   | $ | 2,437,794 |   |

 

The accompanyingnotes are an integral part of these financial statements.

5

----

 

**NeuroMetrix, Inc.**

**Notesto Financial Statements**

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

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

The accompanyingunaudited balance sheet as of March 31, 2006 and unaudited statements ofoperations for the three month periods ended March 31, 2006 and 2005 andthe unaudited statements of cash flows for the three month periods ended March 31,2006 and 2005 have been prepared in accordance with accounting principlesgenerally accepted in the United States of America for interim financialinformation and with the instructions to Form 10-Q and Article 10of Regulation S-X. Accordingly, they do not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates of America for complete financial statements. In the opinion ofmanagement, all adjustments (consisting only of normal recurring accruals)considered necessary for a fair statement of the results of operations havebeen included. Operating results for the three month period ended March 31,2006 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2006 or any other period. These financialstatements and notes should be read in conjunction with the financialstatements for the year ended December 31, 2005 included in the Company’sAnnual Report on Form 10-K (File No. 000-50856). Theaccompanying balance sheet as of December 31, 2005 has been derived fromaudited financial statements prepared at that date, but does not include alldisclosures required by accounting principles generally accepted in the UnitedStates of America.

**Use ofEstimates**

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

**2.             Accounting for Stock-BasedCompensation**

In December 2004,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 123(R), “Share Based Payment” (“SFAS No. 123(R)”),which requires that the cost resulting from all share-based paymenttransactions be recognized in the financial statements. SFAS No. 123(R) revisesSFAS No. 123 “Accounting for Stock-Based Compensation” (“SFAS No. 123”)and supersedes Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees” (“APB No. 25”) and SFAS No. 148, “Accountingfor Stock Based Compensation—Transition and Disclosure—an amendment ofFinancial Accounting Standards Board Statement No. 123”. As a result,beginning January 1, 2006, the Company adopted SFAS No. 123(R) usingthe modified prospective method and has begun reflecting the stock-basedcompensation expense determined under fair value based methods in the incomestatement rather than as pro forma disclosure in the notes to the financialstatements. Under this transition method, the compensation cost recognizedbeginning January 1, 2006 includes compensation cost for (i) allshare-based payments granted prior to, but not yet vested as of January 1,2006, based on the grant-date fair value estimated in accordance with theprovisions of SFAS No. 123, and (ii) all share based payments grantedsubsequent to January 1, 2006 based on the grant-date fair value estimatedin accordance with the provisions of SFAS No. 123(R). Compensation cost isgenerally recognized ratably over the requisite service period. Prior periodamounts have not been restated. The Company uses the Black-Scholes optionpricing model for determining the fair value of its stock options and amortizesits stock-based compensation expense using the straight-line method.

During 1996, the Companyadopted the 1996 Stock Option/Restricted Stock Plan (the “1996 Stock Plan”).The 1996 Stock Plan provides for the granting of incentive and non-qualifiedstock options and stock bonus awards to officers, directors and employees ofthe Company. The maximum number of shares that may be issued pursuant to the1996 Stock Plan is 156,250. All of the outstanding options under the 1996 StockPlan are fully vested and terminate 10 years after the grant date, or earlier ifthe option holder is no longer an executive officer, employee, consultant,advisor or director, as applicable, of the Company. As of March 31, 2006,6,250 shares were subject to outstanding options at a weighted average exerciseprice of $0.20 per share, 127,962 shares had been issued under the 1996 StockPlan and no shares were available for future grant. If any options grantedunder the 1996 Stock Plan are forfeited, such shares are not available forfuture grant and revert back to the founder.

During 1998, the Companyadopted the 1998 Equity Incentive Plan (the “1998 Stock Plan”). The 1998 StockPlan also provides for granting of incentive and nonqualified stock option andstock bonus awards to officers, consultants and employees of the Company. As ofMarch 31, 2006, 1,250,000 shares of common stock were authorized forissuance under the 1998 Stock Plan, of which 475,478 shares had been issued and695,343 shares were subject to outstanding options at a weighted averageexercise price of $6.57 per share. Outstanding options under the 1998 StockPlan generally vest over three or four years and terminate 10 years after thegrant date, or earlier if the option holder is no longer an executive officer,employee, consultant, advisor or director, as applicable, of the Company. The1998 Stock Plan was closed to any future grants at the time of the Company’sinitial public offering and therefore we will not make any additional grantsunder the 1998 Stock Plan.

6

----

 

During 2004, the Companyadopted the 2004 Stock Option and Incentive Plan (the “2004 Stock Plan”). The2004 Stock Plan also provides for granting of incentive and nonqualified stockoption and stock bonus awards to officers, consultants and employees of theCompany. Outstanding options under the 2004 Stock Plan generally vest overthree or four years and terminate 10 years after the grant date, or earlier ifthe option holder is no longer an executive officer, employee, consultant,advisor or director, as applicable, of the Company. As of March 31, 2006,946,022 shares of common stock were authorized for issuance under the 2004Stock Plan, of which 43,311 shares had been issued, 622,514 shares were subjectto outstanding options at a weighted average exercise price of $21.87 per shareand 280,197 shares were available for future grant. In March 2006, theCompany’s Board of Directors voted to discontinue the provision of the 2004Stock Plan which automatically increased the number of options available forgrant under the 2004 Stock Plan based on the net increase in the total numberof outstanding shares of common stock during the year. In April 2006,subject to stockholder approval, the Company’s Board of Directors authorized anadditional 1,000,000 shares of common stock for future issuance under the 2004Stock Plan**.**

The exercise price ofeach stock option issued under the 1996 and 1998 Stock Plans was specified bythe Board of Directors at the time of grant. However, incentive stock optionsmay not be granted at less than the fair market value of the Company’s commonstock as determined by the Board of Directors at the date of grant or for aterm in excess of 10 years. The exercise price of stock options awarded underthe 2004 Stock Plan may not be less than the fair market value of the commonstock on the date of the option grant. For holders of more than 10% of theCompany’s total combined voting power of all classes of stock, incentive stockoptions may not be granted at less than 110% of the fair market value of theCompany’s common stock at the date of grant and for a term not to exceed fiveyears. All options granted under the 1996 and 1998 Stock Plans generally becomeexercisable over three or four years from the date of grant or such time as theBoard of Directors specifies and expire 10 years from the date of grant.

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

Under the ESPP,participating employees can authorize the Company to withhold up to 10% oftheir earnings during consecutive six-month payment periods for the purchase ofthe shares. At the conclusion of the period, participating employees canpurchase shares at 85% of the lower of their fair market value at the beginningor end of the period. The ESPP is regarded as a compensatory plan according tothe provisions of SFAS No. 123(R). Under this plan, the Company has issued32,797 shares of its common stock through March 31, 2006.

A summary of activityunder the Company’s 1996, 1998 and 2004 Stock Plans for the quarter ended March 31,2006 is presented below:

 
| ** **                             | ** ** | **Number of Shares** | ** ** | **Exercise  Price Range** | ** **          | **Weighted  Average Exercise  Price** | ** ** |
|----------------------------------------|------------|--------------------------------|------------|--------------------------------|---------------------|--------------------------------------------|------------|
|                                   |       |                           |       |                           |                |                                       |       |
| Outstanding at  December 31, 2005 |       | 1,120,619                      |       | $                              | 0.200 – 37.230 |                                       | $          | 8.3316 |   |
| Granted at fair value                  |       | 332,500                        |       | 27.280 – 38.600           |                | 30.6666                                    |       |
| Exercised                              |       | (87,860                        | )          | 0.400 – 11.470            |                | 6.2722                                     |       |
| Forfeited                              |       | (41,152                        | )          | 2.250 – 35.040            |                | 19.3486                                    |       |
| Outstanding at  March 31, 2006    |       | 1,324,107                      |       | $                              | 0.200 – 38.600 |                                       | $          | 13.7345 |   |

 

The following tablesummarizes information about stock options outstanding at March 31, 2006:

 
| **Exercise Price** | ** ** | ** ** | ** ** | **Number of  Options  Outstanding** | ** ** | **Weighted Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|-------------------------|------------|------------|------------|------------------------------------------|------------|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
|                    |       |       |       |                                     |       |                                                                 |       |
| $0.20 – 1.35       |       | 27,506     |       | 3.3                                      |       | $                                                                    | 0.6337     |                                       |
| $2.25 – 2.25       |       | 139,770    |       | 7.1                                      |       | $                                                                    | 2.2500     |                                       |
| $4.48 – 8.00       |       | 526,609    |       | 8.2                                      |       | $                                                                    | 7.9065     |                                       |
| $8.25 – 9.92       |       | 210,839    |       | 8.8                                      |       | $                                                                    | 9.5731     |                                       |
| $10.00 – 14.76     |       | 55,983     |       | 8.9                                      |       | $                                                                    | 11.3283    |                                       |
| $17.34 – 29.65     |       | 86,500     |       | 9.6                                      |       | $                                                                    | 26.6837    |                                       |
| $30.10 – 38.60     |       | 276,900    |       | 9.8                                      |       | $                                                                    | 31.5265    |                                       |
|                    |       | 1,324,107  |       | 8.5                                      |       | $                                                                    | 13.7345    |                                       |

 

7

----

 

The following tablesummarizes information about stock options exercisable at March 31, 2006:

 
| **Exercise Price** | ** ** | ** ** | ** ** | **Number of  Options  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|-------------------------|------------|------------|------------|------------------------------------------|------------|--------------------------------------------|------------|
|                    |       |       |       |                                     |       |
| $0.20 – 1.35       |       | 27,506     |       | $                                        | 0.6337     |                                       |
| $2.25 – 2.25       |       | 62,749     |       | $                                        | 2.2500     |                                       |
| $4.48 – 8.00       |       | 231,861    |       | $                                        | 7.8261     |                                       |
| $8.25 – 9.92       |       | 15,404     |       | $                                        | 9.5552     |                                       |
| $10.00 – 14.76     |       | 8,021      |       | $                                        | 10.1245    |                                       |
| $17.34 – 29.65     |       | —     |       | N/A                                      |       |
| $30.10 – 38.60     |       | —     |       | N/A                                      |       |
|                    |       | 345,541    |       | $                                        | 6.3714     |                                       |

 

The weighted averageremaining contractual life for stock options exercisable at March 31, 2006was 7.61 years. The aggregate intrinsic value for stock options outstanding andexercisable at March 31, 2006 was $33,374,800 and $11,253,800,respectively.

Prior to January 1,2006, the Company accounted for stock-based compensation plans in accordancewith the provisions of APB No. 25, as permitted by SFAS No. 123, andaccordingly did not recognize compensation expense for the issuance of optionswith an exercise price equal to or greater than the market price at the date ofgrant. Had the fair value based method as prescribed by SFAS No. 123 beenapplied by the Company, the effect on net loss and net loss per common sharefor the first quarter of 2005 would have been as follows:

 
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **March 31, 2005**     | ** ** |
|                                                                               |       |                             |       |
| Net loss, as  reported                                                             |       | $                                | (596,314   | ) |
| Add employee  stock-based compensation expense included in reported net loss       |       | 75,975                           |       |
| Less employee  stock-based compensation expense determined under fair value method |       | (329,033                         | )          |
| Net loss — pro  forma                                                         |       | $                                | (849,372   | ) |
| Net loss per common  share (basic and diluted)                                     |       |                             |       |
| As reported                                                                        |       | $                                | (0.05      | ) |
| Pro forma                                                                          |       | $                                | (0.07      | ) |

 

The weighted averagegrant date fair value used in the calculation of stock-based compensationexpense in the accompanying statement of operations for the three months ended March 31,2006 and the pro forma net income (loss) and earnings (loss) per common shareinformation presented above has been calculated using the Black-Scholes optionpricing model with the following weighted average assumptions:

 
| ** **                                      | ** ** | **Three months ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **March 31,  2006**         | ** ** | **March 31,  2005** | ** ** |
|                                            |       |                             |       |   |   |
| Risk-free  interest rate                        |       | 4.3 – 4.8                   | %          | 3.7 – 4.3 | % |
| Expected  dividend yield                        |       | —                           |       | — |   |
| Expected option  term                           |       | 5 years                          |       | 5 years |   |
| Volatility                                      |       | 50.0                             | %          | 57.2 | % |
| Weighted average fair  value of options granted |       | $                                | 14.87      |   | $ | 5.23 |   |
|                                                 |            |                                  |            |  |  |  |  |

 

The expected option termof five years was estimated based on an analysis of actual option exercises anda review of comparable medical device companies. The risk-free interest rateassumption was based on the United States Treasury’s constant maturity’s ratefor a five year term (corresponding to the expected option term) on the datethe option was granted. The volatility assumption was based on weeklyhistorical volatility during the time period that corresponds to the expectedoption term and a review of comparable medical device companies. The assumeddividend yield was based on the Company’s expectation of future dividendpayouts. The post-vesting forfeiture rate is based on the historical andprojected average turnover rate using four classifications of employees. Theseassumptions will be evaluated and revised as necessary based on changes inmarket conditions and historical experience.

The weighted averagegrant date fair values of stock options granted during the three months ended March 31,2006 and March 31, 2005 were estimated at $14.87 and $5.23, respectively.

The Company recordedstock-based compensation expense for the first quarter of 2006 of approximately$737,200. Included in the stock-based compensation expense recorded by theCompany is (a) $534,000 in compensation expense relating to stock-optionsgranted to employees subsequent to the Company’s July 2004 initial publicoffering (“IPO”) that are accounted for according to the provisions of SFAS No. 123(R);(b) $101,200 in compensation expense related to stock options granted tonon-employees that are accounted for

8

----

 

according to theprovisions of Emerging Issues Task Force (“EITF”) Issue No. 96-18 “Accountingfor Equity Instruments That Are Issued to Other Than Employees for Acquiring,or in Conjunction with Selling, Goods or Services” (“EITF No. 96-18”);(c) $37,900 in compensation expense related to the ESPP and accounted forunder the provisions of SFAS No. 123(R) and (d) $64,100 incompensation expense relating to stock options granted to employees prior tothe Company’s initial public offering that are being accounted for using theintrinsic value method according to the provisions of SFAS No. 123.

Stock options granted tonon-employees be recorded at fair value and adjusted to market over the vestingperiod according to the provisions of EITF No. 96-18. The Companydetermines fair value using the Black-Scholes option pricing model, an expectedterm equal to the remaining vesting period, a risk-free interest ratecorresponding to the expected term, an expected volatility of 50% and adividend yield of zero.

Deferred compensation wasrecorded in connection with stock option grants made prior to the Company’s IPO.The deferred compensation represents the difference between the estimatedmarket value of common stock on the date of grant and the exercise priceassociated with the stock options. The deferred compensation is amortized toexpense over the vesting period of the related stock options. The unamortizedbalance of deferred compensation as of March 31, 2006 is approximately$343,800.

Total unrecognizedstock-based compensation costs related to non-vested stock options wasapproximately $7,810,700 as of March 31, 2006 which related toapproximately 1,144,600 shares with a per share weighted fair value of $6.82.This unrecognized cost is expected to be recognized over a weighted averageperiod of approximately 2.8 years.

The Company has no taxwindfall or shortfall as of March 31, 2006 as a result of having a 100%valuation allowance established against deferred tax assets.

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

The Company accounts forand discloses net income (loss) per common share in accordance with SFAS No. 128,“Earnings Per Share”. Basic net income (loss) per common share is computed bydividing net income (loss) by the weighted average number of common sharesoutstanding. Diluted net income (loss) per common share is computed by dividingnet income (loss) by the weighted average number of common shares and dilutivepotential common share equivalents then outstanding. Potential common sharesconsist of shares issuable upon the exercise of stock options and warrants(using the treasury stock method) and unvested restricted stock awards.

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **March 31, 2006**     | ** ** | **March 31, 2005** | ** ** |
|                                        |       |                             |       |   |   |
| Basic:                                      |       |                             |       |   |   |
| Net income  (loss)                          |       | $                                | 147,338    |   | $ | (596,314 | ) |
|                                        |       |                             |       |   |   |
| Weighted average  shares                    |       | 12,414,479                       |       | 12,043,103 |   |
|                                        |       |                             |       |   |   |
| Basic net income  (loss) per common share   |       | $                                | 0.01       |   | $ | (0.05 | ) |
|                                        |       |                             |       |   |   |
| Diluted:                                    |       |                             |       |   |   |
| Net income  (loss)                          |       | $                                | 147,338    |   | $ | (596,314 | ) |
|                                        |       |                             |       |   |   |
| Weighted average  shares                    |       | 12,414,479                       |       | 12,043,103 |   |
| Dilutive effect  of stock options           |       | 718,787                          |       | — |   |
| Weighted average  shares, as adjusted       |       | 13,133,266                       |       | 12,043,103 |   |
|                                        |       |                             |       |   |   |
| Diluted net income  (loss) per common share |       | $                                | 0.01       |   | $ | (0.05 | ) |

 

The following potentiallydilutive common shares were excluded from the calculation of diluted net income(loss) per common share because their effect was antidilutive for each of theperiods presented:

 
| ** **           | ** ** | **Three Months Ended** | ** ** |
|----------------------|------------|----------------------------------|------------|
| ** **           | ** ** | **March 31, 2006**     | ** ** | **March 31, 2005** | ** ** |
|                 |       |                             |       |   |   |
| Options  outstanding |       | 328,739                          |       | 1,303,076 |   |
| Warrants outstanding |       | —                           |       | 100,000 |   |

 

9

----

 

**4.             Inventories**

Inventories consist ofthe following:

 
| ** **            | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **            | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Purchased  components |       | $                        | 259,111    |                        | $          | 276,167 |   |
| Finished goods        |       | 2,777,361                |       | 2,407,242                   |       |
|                  |       | $                        | 3,036,472  |                        | $          | 2,683,409 |   |

 

**5.             Other Balance Sheet Items**

Accrued expenses consistof the following:

 
| ** **             | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                   |       |                     |       |                        |       |
| Professional  services |       | $                        | 306,373    |                        | $          | 438,519 |   |
| Other                  |       | 1,025,590                |       | 775,409                     |       |
|                   |       | $                        | 1,331,963  |                        | $          | 1,213,928 |   |

 

Product Warranty Costs

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

The following is arollforward of the Company’s accrued warranty liability for the three monthperiods ended March 31, 2006 and 2005:

 
| ** **                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **March 31,  2006**         | ** ** | **March 31,  2005** | ** ** |
|                            |       |                             |       |   |   |
| Balance at  beginning of period |       | $                                | 64,122     |   | $ | 59,876 |   |
| Accrual for  warranties         |       | 93,528                           |       | 59,694 |   |
| Settlements made                |       | (104,488                         | )          | (55,388 | ) |
| Balance at end  of period       |       | $                                | 53,162     |   | $ | 64,182 |   |

 

10

----

 

**Item2.      Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

*Youshould read the following discussion of our financial condition and results ofoperations in conjunction with our condensed financial statements and theaccompanying notes to those financial statements included elsewhere in thisQuarterly Report on Form 10-Q. This discussion containsforward-looking statements that involve risks and uncertainties. For adescription of factors that may cause our actual results to differ materiallyfrom those anticipated in these forward looking statements, please refer to thesection of this Quarterly Report on Form 10-Q titled “CautionaryNote Regarding Forward-Looking Statements.”*

**Overview**

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

From our inception until May 1999,we had devoted substantially all of our efforts to designing and developing theNC-stat System and other potential products, raising capital and recruitingpersonnel. We believe that one of our strengths is our ability to develop andcommercialize innovative products for neurological applications. In May 1999,we shipped our first NC-stat System. At that time we sold one type of biosensorfor the testing of the median motor nerve. In 2000, we introduced an additionalbiosensor for the testing of the ulnar motor nerve. In 2002, we introduced oursecond-generation NC-stat System, as well as two additional biosensors. In2003, we added to our product line two biosensors with higher functionalitythat have the ability to test both motor and sensory nerves. In 2004, weintroduced two new NC-stat biosensors as well as components for the NC-statmonitor to utilize these new biosensors. The first new biosensor is used totest the ulnar nerve at the elbow and the second to test the sural nerve. Inthe first three months of 2006, our revenues grew 74.1% to $11.8 million from$6.8 million in the first three months of 2005, of which 87.0% was attributableto sales of NC-stat biosensors in the first three months of 2006. Our grossmargin percentage in the first three months of 2006 was 75.6%.

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

Diagnostic devicerevenues include revenues derived from the sale of our NC-stat monitors andNC-stat docking stations. Biosensor revenues include revenues derived from thesale of various types of disposable biosensors used to perform nerve conductionstudies with the NC-stat monitor. Our revenue recognition policy is torecognize revenue from our monitors and biosensors upon shipment if the fee isfixed and determinable, persuasive evidence of an arrangement exists,collection of the resulting receivable is reasonably assured and productreturns are reasonably estimable. Revenues from our docking station aredeferred and recognized over the shorter of the estimated customer relationshipperiod or the estimated useful life of the product, currently three years.

Reimbursement fromthird-party payers is an important element of success for medical productscompanies. Generally, we believe that the nerve conduction studies performed byour customers with the NC-stat System have been satisfactorily covered by third-partypayers. As our presence in the market expands and the use of the NC-stat Systemincreases, we have experienced and are likely to continue to experience anincreased focus from third-party payers and governmental agencies regarding thereimbursement of nerve conduction studies performed using the NC-stat Systemand an increased focus from these organizations regarding the professionalrequirements for performing nerve conduction studies in general. Widespreadadoption of the NC-stat System by the medical community is unlikely to occur ifphysicians do not receive satisfactory reimbursement from third-party payersfor procedures performed with the NC-stat System. One of the primary challengeswe face in our business is successfully expanding the market for nerveconduction studies. A successful market expansion will depend upon, in part,our targeting of primary care and specialty physicians who traditionally havenot been targeted by companies selling equipment used to perform nerveconduction studies and our ability to alter physicians’ practices relating tothe diagnosis of neuropathies. In order to successfully implement this growthstrategy, we have increased our sales force to 46 employees, including regionalsales managers and sales directors, as of March 31, 2006. We also willparticipate in various industry conferences in order to accelerate the marketawareness and adoption of our products. These efforts, as well as the overallexpansion of our business, will provide challenges to our organization and mayincrease the burden on our management and operations. We plan to monitor ourbusiness as it grows and appropriately acquire and allocate resources toaddress these issues, with a goal of sustaining profitable growth.

11

----

 

We incurred losses everyyear from the inception of the Company in 1996 through 2004 and recorded ourfirst year of profitability in 2005. We incurred net losses of approximately$8.7 million in 2001, $4.8 million in 2002, $3.7 million in 2003and $4.3 million in 2004 and recorded net income of $938,000 in 2005 and$147,300 in the first three months of 2006. We do not know whether we will beable to sustain the profitability achieved in 2005 and in the first threemonths of 2006. As of March 31, 2006, we had an accumulated deficit ofapproximately $56.4 million. Historically, we have primarily financed ouroperations through the public and private placement of equity securities andthrough debt facilities. As of March 31, 2006, we had received netproceeds of $43.5 million from the issuance of redeemable convertiblepreferred stock and $24.0 million in net proceeds from our July 2004initial public offering (“IPO”). Upon completion of the IPO, all thenoutstanding shares of preferred stock converted into shares of our commonstock.

Our financial objectiveis to grow our business through the sale of the NC-stat System and additionalproducts that may be commercialized for the diagnosis and treatment ofneuropathies and to achieve sustainable profitability. Our efforts in theremainder of 2006 will continue to focus primarily on sales of the NC-statSystem and continuing our ongoing program of making enhancements andimprovements to the NC-stat System, with the goal of increasing our marketpenetration. During 2005 and the first three months of 2006, we continuedefforts on improvements to our biosensors, on the development of newbiosensors, on the development of products to diagnose additional neuropathies,and on the development of a third generation neurodiagnostic system. We are alsoin the early stages of designing a drug delivery system for the minimallyinvasive treatment of neuropathies by both primary care and specialistphysicians. We believe that the accomplishment of these goals will have apositive impact on our progress toward the objective of growing the businessand achieving sustainable profitability.

Effective January 1,2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R),“Share Based Payment” (“SFAS No. 123(R)”), which requires that the costresulting from all share-based payment transactions be recognized in thefinancial statements. SFAS No. 123(R) is a revision of SFAS No. 123,“Accounting for Stock-Based Compensation” (“SFAS No. 123”) and supersedesAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” (“APB No. 25”) and SFAS No. 148, “Accounting for StockBased Compensation—Transition and Disclosure—an amendment of FinancialAccounting Standards Board Statement No. 123” (“SFAS No. 148”). Thisstatement establishes fair value as the measurement objective in accounting forshare-based payment arrangements and requires all entities to apply a fairvalue based measurement method in accounting for share-based paymenttransactions with employees except for equity instruments held by employeeshare ownership plans. As a result, beginning January 1, 2006, we adoptedSFAS No. 123(R) using the modified prospective method and have begunreflecting the stock-based compensation expense determined under fair valuebased methods in the income statement rather than as pro forma disclosure inthe notes to the financial statements. Prior period results have not beenrestated. We use the Black-Scholes option pricing model for determining thefair value of its stock options and amortize our stock-based compensationexpense using the straight-line method. During the first quarter of 2006, werecorded stock-based compensation of approximately $737,200. We expectstock-based compensation expense recognized in accordance with the provisionsof SFAS 123(R) in each of the remaining quarters of 2006 to be relatively consistentwith the amount recognized in the first quarter of 2006, but this amount couldincrease if there are additional stock options granted. The stock-basedcompensation expense recognized in accordance with Emerging Issues Task ForceIssue No. 96-18 “Accounting for Equity Instruments That Are Issuedto Other Than Employees for Acquiring, or in Conjunction with Selling, Goods orServices” for option grants to non-employees may vary significantly based onthe performance of the Company’s stock price since these grants are valued atthe end of each reporting period.

 **Results of Operations**

The following tablepresents certain statement of operations information stated as a percentage oftotal revenues:

 
| ** **                                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                       | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Revenues:                                        |       |                                             |       |   |   |
| Diagnostic  device                               |       | 13.0                                             | %          | 12.0 | % |
| Biosensor                                        |       | 87.0                                             |       | 88.0 |   |
| Total revenues                                   |       | 100.0                                            |       | 100.0 |   |
|                                             |       |                                             |       |   |   |
| Cost of revenues                                 |       | 24.4                                             |       | 26.8 |   |
|                                             |       |                                             |       |   |   |
| Gross margins                                    |       | 75.6                                             |       | 73.2 |   |
|                                             |       |                                             |       |   |   |
| Operating expenses:                              |       |                                             |       |   |   |
| Research and  development                        |       | 10.6                                             |       | 13.3 |   |
| Sales and  marketing                             |       | 44.6                                             |       | 47.8 |   |
| General and  administrative                      |       | 21.6                                             |       | 23.5 |   |
| Total operating  expenses                        |       | 76.8                                             |       | 84.6 |   |
| Loss from  operations                            |       | -1.2                                             |       | -11.4 |   |
| Interest income,  net                            |       | 2.5                                              |       | 2.6 |   |
| Income (loss)  before provision for income taxes |       | 1.3                                              |       | -8.8 |   |
| Provision for  income taxes                      |       | 0.1                                              |       | — |   |
| Net income (loss)                                |       | 1.2                                              | %          | -8.8 | % |

 

12

----

 

 **Comparison of Three Months Ended March 31, 2006and March 31, 2005**

***Revenues***

The following tablespresent a breakdown of our customers, biosensor units used and revenues:

 
| ** ** | ** ** | **12-Month Period  Ended March 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------|------------|-----------------------------------------------------|------------|------------|------------|------------|------------|
| ** ** | ** ** | **2006**                                            | ** ** | **2005**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
|       |       |                                                |       |       |       |       |       |   |   |
| Customers  |       | 3,639                                               |       | 2,424      |       | 1,215      |       | 50.1 | % |

 
| ** **            | ** ** | **Three Months Ended  March 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------|------------|--------------------------------------------------|------------|------------|------------|------------|------------|
| ** **            | ** ** | **2006**                                         | ** ** | **2005**   | ** ** | **Change** | ** ** | **%Change** | ** ** |
|                  |       |                                             |       |       |       |       |       |   |   |
| Biosensor units  used |       | 255,500                                          |       | 137,600    |       | 117,900    |       | 85.7 | % |
| ** **            |       |                                             |       |       |       |       |       |   |   |
|                  |       | **($ in thousands)**                        |       |       |       |
| Revenues:             |       |                                             |       |       |       |       |       |   |   |
| Diagnostic  device    |       | $                                                | 1,541.4    |       | $          | 812.4      |       | $ | 729.0 |   | 89.7 |   |
| Biosensor             |       | 10,281.8                                         |       | 5,977.4    |       | 4,304.5    |       | 72.0 |   |
| Total revenues        |       | $                                                | 11,823.3   |       | $          | 6,789.8    |       | $ | 5,033.5 |   | 74.1 | % |

 

Diagnostic devicerevenues were $1.5 million and $812,400 for the three months ended March 31,2006 and March 31, 2005, respectively, representing a year-over-yearincrease of $729,000, or 89.7%. Of this increase, approximately $604,400 isattributable to a greater number of units sold, primarily as a result of anincrease in the number of regional sales managers. In addition, approximately$124,600 of this increase is attributable to an increase in the list price ofour NC-stat monitors and docking stations from $4,000 to $5,000 effective January 1,2006, which resulted in a higher average sale price during the three monthsended March 31, 2006 as compared to the same period in 2005. Diagnosticdevice revenues accounted for 13.0% and 12.0% of our total revenues for thethree months ended March 31, 2006 and March 31, 2005, respectively.

Biosensor revenues were$10.3 million and $6.0 million for the three months ended March 31, 2006and March 31, 2005, respectively, representing a year-over-year increaseof $4.3 million, or 72.0%. The increase was primarily due to an increasedcustomer base for our biosensors and increased frequency of testing by ourcustomers. Biosensor revenues accounted for 87.0% and 88.0% of our total revenuesfor the three months ended March 31, 2006 and March 31, 2005,respectively.

Our customers used255,500 biosensor units in the three months ended March 31, 2006, comparedto 137,600 units for the same period in 2005, an increase of 117,900 units, or85.7%. This increase in biosensor usage is primarily the result of the increasein the customer base and increased usage per customer.

Our total revenues were$11.8 million and $6.8 million for the three months ended March 31, 2006and March 31, 2005 respectively, representing a year-over-year increase of$5.0 million, or 74.1%. During the 12-month period ending March 31,2006, a total of 3,639 customers used our NC-stat System compared to 2,424customers for the same period ending March 31, 2005. This represents a50.1% year-over-year increase in the number of customers that used our NC-statSystem.

We expect revenues tocontinue to increase in 2006 as a result of the recent expansion of our salesforce, which grew from 36 employees as of December 31, 2005 to 46employees, including regional sales managers and sales directors, at the end ofthe first quarter of 2006. We expect to increase the sales force toapproximately 50 employees during the remainder of 2006, including 46 regionalsales managers. However, our revenues could be negatively impacted by a varietyof factors, including the level of demand for nerve conduction studies,potential for changes in third-party reimbursement for nerve conductionstudies, the overall economy, competitive factors and the factors described inthe section of this Quarterly Report on Form 10-Q titled “CautionaryNote Regarding Forward-Looking Statements.”

13

----

 

***Costs and expenses***

The following tablepresents our costs and expenses and net income (loss):

 
| ** **                                       | ** ** | **Three Months Ended  March 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                       | ** ** | **2006**                                         | ** ** | **2005**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                                       | ** ** | **($ in thousands)**                   | ** ** | ** ** | ** ** |
| Cost of  revenues:                               |       |                                             |       |       |       |       |       |   |   |
| Diagnostic  device                               |       | $                                                | 303.1      |       | $          | 219.1      |       | $ | 84.0 |   | 38.3 | % |
| Biosensor                                        |       | 2,576.9                                          |       | 1,598.6    |       | 978.2      |       | 61.2 |   |
| Total costs of  revenues                         |       | 2,879.9                                          |       | 1,817.7    |       | 1,062.2    |       | 58.4 |   |
|                                             |       |                                             |       |       |       |       |       |   |   |
| Gross Margin:                                    |       |                                             |       |       |       |       |       |   |   |
| Diagnostic  device                               |       | 1,238.4                                          |       | 593.3      |       | 645.1      |       | 108.7 |   |
| Biosensor                                        |       | 7,705.0                                          |       | 4,378.7    |       | 3,326.2    |       | 76.0 |   |
| Total gross  margin                              |       | 8,943.4                                          |       | 4,972.0    |       | 3,971.3    |       | 79.9 |   |
|                                             |       |                                             |       |       |       |       |       |   |   |
| Gross Margin %:                                  |       |                                             |       |       |       |       |       |   |   |
| Diagnostic  device                               |       | 80.3                                             | %          | 73.0       | %          |       |       |   |   |
| Biosensor                                        |       | 74.9                                             |       | 73.3       |       |       |       |   |   |
| Total gross  margin %                            |       | 75.6                                             |       | 73.2       |       |       |       |   |   |
|                                             |       |                                             |       |       |       |       |       |   |   |
| Operating  Expenses:                             |       |                                             |       |       |       |       |       |   |   |
| Research and  development (1)                    |       | 1,258.6                                          |       | 904.2      |       | 354.4      |       | 39.2 |   |
| Sales and  marketing (1)                         |       | 5,268.3                                          |       | 3,244.7    |       | 2,023.6    |       | 62.4 |   |
| General and  administrative (1)                  |       | 2,555.2                                          |       | 1,594.0    |       | 961.2      |       | 60.3 |   |
| Total operating  expenses                        |       | 9,082.1                                          |       | 5,742.9    |       | 3,339.2    |       | 58.1 |   |
|                                             |       |                                             |       |       |       |       |       |   |   |
| Loss from  operations                            |       | (138.7                                           | )          | (770.9     | )          | 632.1      |       | -82.0 |   |
|                                             |       |                                             |       |       |       |       |       |   |   |
| Interest income                                  |       | 293.6                                            |       | 176.4      |       | 117.2      |       | 66.5 |   |
| Interest expense                                 |       | —                                           |       | (1.8       | )          | 1.8        |       | -100.0 |   |
|                                             |       |                                             |       |       |       |       |       |   |   |
| Income (loss)  before provision for income taxes |       | 154.8                                            |       | (596.3     | )          | 751.2      |       | -126.0 |   |
| Provision for  income taxes                      |       | 7.5                                              |       | —     |       | 7.5        |       | N/A |   |
|                                             |       |                                             |       |       |       |       |       |   |   |
| Net income (loss)                                |       | $                                                | 147.3      |       | $          | (596.3     | )          | $ | 743.7 |   | -124.7 |   |

----

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

 
| Research and  development                        |   | $     | 218.8  |   | $      | 19.9   |   |   |   |   |   |
|--------------------------------------------------|--------|-------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Sales and marketing                              |   | 190.9 |   | 36.3   |   |   |   |   |   |
| General and  administrative                      |   | 327.6 |   | 19.8   |   |   |   |   |   |
| Total non-cash  stock-based compensation expense |   | $     | 737.2  |   | $      | 76.0   |   |   |   |   |   |

 

Gross Margin

Diagnostic device grossmargin percentage increased to 80.3% for the three months ended March 31,2006 from 73.0% for the same period in 2005. The increase in the gross marginpercentage is primarily attributable to an increase in the list price of ourNC-stat System from $4,000 to $5,000 effective January 1, 2006.

Biosensor gross marginpercentage increased to 74.9% for the three months ended March 31, 2006from 73.3% for the same period in 2005. The increase in the biosensor grossmargin percentage is primarily due to manufacturing price reductions realizedfor several of our biosensors during 2005 and the first quarter of 2006partially offset by a change in the mix of biosensors sold.

Our overall gross marginpercentage was 75.6% for the three months ended March 31, 2006 compared to73.2% for the same period in 2005.

 

14

----

Research and Development

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

R&D expensesincreased $354,400, or 39.2%, to $1.3 million for the three months ended March 31,2006 from $904,200 for the same period in 2005. As a percentage of revenues,R&D expenses were 10.6% and 13.3% for the three months ended March 31,2006 and March 31, 2005, respectively. The increase in expenses was primarilydue to an increase of $198,900 in stock-based compensation expense due to theadoption of the provisions of SFAS No. 123(R). Also contributing to theincrease was an increase of $102,800 in personnel costs resulting from thehiring of additional employees in our R&D department and increases inemployee compensation and an increase of $49,000 in clinical development andsupplies costs. These increases are primarily related to efforts expended onthe development of a third generation monitor and docking station and on newbiosensors.

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

Sales and Marketing

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

Sales and marketingexpenses increased $2.0 million, or 62.4%, to $5.3 million for the three monthsended March 31, 2006 from $3.2 million for the same period in 2005. As apercentage of revenues, sales and marketing expenses were 44.6% and 47.8% forthe three months ended March 31, 2006 and March 31, 2005,respectively. The change in expenses was primarily due to an increase of $1.3million in employee compensation and benefit costs, including sales commissionspaid to our regional sales managers. This increase is due to the expansion ofthe sales force and higher revenues in the first quarter of 2006 compared to thefirst quarter of 2005.  Also contributingto the change in expenses was an increase of $270,400 in sales commissions paidto our independent regional sales agencies, which were related to our higherrevenues in the first quarter of 2006, an increase in stock-based compensationexpense of $154,600 due to the adoption of the provisions of SFAS No. 123(R) andan increase of $66,000 in travel expenses due to the expansion of the salesforce. The change in expenses was also partially due to an increase of $62,100in costs for new promotional materials.

We have increased oursales force to 46 employees, including regional sales managers, as of the endof the first quarter of 2006 and expect to add four additional regional salesmanagers during the second quarter of 2006. For the remainder of 2006, weexpect sales and marketing expenses, as a percentage of total revenues, todecrease slightly from the level experienced in 2005. This percentage may vary,however, depending primarily on our revenues for the remainder of 2006.

15

----

General andAdministrative

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

General andadministrative expenses increased $961,200, or 60.3%, to $2.6 million for thethree months ended March 31, 2006 from $1.6 million for the same period in2005. As a percentage of revenues, general and administrative expenses were21.6% and 23.5% for the three months ended March 31, 2006 and March 31,2005, respectively. The increase in expenses was primarily due to (a) anincrease in stock-based compensation expense of $307,700 due to the adoption ofthe provisions of SFAS No. 123(R); (b) an increase of $135,800 inprofessional fees for legal services and accounting and audit services; (c) anincrease of $118,200 in our insurance costs; (d) an increase of $105,000in bad debt expense; (e) an increase in personnel costs of $104,200due to the expansion of staff and increases in employee compensation; and (f) anincrease in consulting services of $60,900 primarily to assist the Company withits compliance with the provisions of the Sarbanes-Oxley Act of 2002, and the rules promulgatedthereunder, regarding internal control over financial reporting (“Sarbanes-Oxley404”) and the adoption of new accounting pronouncements.

We expect our general andadministrative expenses to increase during the remainder of 2006 as a result ofour expected growth and the expected hiring of additional general andadministrative staff to support this growth. Total general and administrativeexpenses, as a percentage of total revenues, are expected to decrease in 2006,in spite of the anticipated need to hire additional staff. This percentage mayvary, however, depending primarily on our revenues for 2006. We expect to beable to leverage existing resources such that the growth in general andadministrative expenses is anticipated to be less than the growth in ourrevenues. Furthermore, while we experienced an increase in professional fees in2005 largely due to the effect of the first year of compliance with theprovisions of Sarbanes-Oxley 404, we do not expect the costs associated withSarbanes-Oxley 404 to increase in 2006.

Interest Income

Interest income was$293,600 and $176,400 during the three months ended March 31, 2006 and March 31,2005, respectively. Interest income was earned from investments in cashequivalents, short-term investments and long-term investments. Interest incomeincreased during the three months ended March 31, 2006 compared to thesame period in 2005 because of increased yields on invested funds in 2006.

**Liquidityand Capital Resources**

Our principal source ofliquidity is our current cash and cash equivalents and short-termheld-to-maturity investments. As of March 31, 2006, the weighted averagematurity of our cash equivalents and short-term held-to-maturity investmentswas 155 days. Our ability to generate cash from operations is dependentupon our ability to generate revenue from sales of our diagnostic devices andconsumable biosensors, as well as our ability to manage our operating costs andnet assets. A decrease in demand for our products or unanticipated increases inour operating costs would likely have an adverse effect on our liquidity andcash generated from operations. The following sets forth information relatingto our liquidity:
| ** **                                                                | ** ** | **March 31,  2006**       | ** ** | **December 31,  2005** | ** ** | **Change** | ** ** | **% Change** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                | ** ** | **($ in thousands)** | ** ** |
|                                                                      |       |                           |       |                        |       |       |       |              |       |
| Cash and cash  equivalents                                                |       | $                              | 5,396      |                        | $          | 8,170      |       | $                 | (2,774     | ) | -34.0 |   |
| Short-term held-to-maturity  investments                                  |       | 26,972                         |       | 24,082                      |       | 2,890      |       | 12.0              |       |
| Total cash, cash  equivalents and short-term held-to-maturity investments |       | $                              | 32,368     |                        | $          | 32,252     |       | $                 | 116        |   | 0.4 | % |

 

During the first threemonths of 2006, our cash and cash equivalents and short-term held-to-maturityinvestments increased $116,000, primarily due to $551,100 of proceeds receivedfrom the exercise of stock options, offset in part by cash used by operationsof $235,800 and capital expenditures of $144,200.

In managing our workingcapital, two of the financial measurements we monitor are days’ salesoutstanding, or DSO, and inventory turnover rate, which are presented in thetable below for the year ended December 31, 2005 and the three monthsended March 31, 2006 and March 31, 2005:
| ** **                                | ** ** | **Three Months Ended  March 31,** | ** ** | **Year Ended  December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                | ** ** | **2006**                                         | ** ** | **2005**                               | ** ** | **2005** | ** ** |
|                                      |       |                                             |       |                                   |       |   |   |
| Days’ sales  outstanding (days)      |       | 39                                               |       | 44                                     |       | 40 |   |
| Inventory turnover rate  (times per year) |       | 4.0                                              |       | 5.2                                    |       | 4.5 |   |

 

Our payment termsextended to our customers generally require payment within 30 days from invoicedate. At March 31, 2006, our DSO was 39 days, a decrease of 1 day ascompared to December 31, 2005. This decrease in DSO resulted fromincreasing revenues and a decrease in the percentage of accounts receivablebalances more than 60 days past due. This decrease in the percentage ofaccounts receivable balances more than 60 days past due was primarily due tomore aggressive management of collections and the significant revenue growth inthe three months ended March 31, 2006 relative to the more modest increasein our accounts receivable balances during the three months ended March 31,2006. We continue to focus our efforts on reducing our accounts receivablebalances over 60 days past due. Accounts payable are normally paid within 30 to40 days from receipt of a vendor’s invoice.

Our inventory turnoverfor the quarter ended March 31, 2006 was 4.0 times compared to 4.5 timesduring the year of 2005. The decrease in the inventory turnover rate in thefirst three months of 2006 as compared to the year ended December 31, 2005was primarily due to increasing our inventory levels to approximately threemonths of inventory in our facility in Waltham, MA. We expect to maintain ourinventory levels at approximately three months of inventory for the remainderof 2006.

The following sets forthinformation relating to the sources and uses of our cash:
| ** **                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                          | ** ** |
| Net cash  provided by (used in) operating activities |       | $                                                | (235.8     | ) | $ | 0.1 |   |
| Net cash  provided by (used in) investing activities |       | (3,089.6                                         | )          | 471.2 |   |
| Net cash  provided by financing activities           |       | 551.1                                            |       | 30.2 |   |
|                                                      |            |                                                  |            |  |  |  |  |

 

16

----

Cash used in operatingactivities was approximately $235,800 in the first quarter of 2006, comparedwith cash provided by operating activities of approximately $100 in the firstquarter of 2005. A net use of cash of approximately $1.4 million for ourinvestment in working capital was partly offset by $147,300 in net income and$992,600 in non-cash items, mainly compensation expense associated with stockoptions. The primary drivers of our investment in working capital were asfollows:  Our accounts receivableincreased $1.1 million, excluding the change in the allowance for doubtfulaccounts, due to growth in revenues offset in part by the more rapid collectionof amounts due from our customers. Our inventories increased $353,100 due tothe growth in our business and a strategic decision to increase inventorylevels from two months to three months of purchases. The net loss in the firstquarter of 2005 was $596,300 and was offset by cash provided by operatingassets and liabilities in the first quarter of 2005 totaling $333,100,including increases in accounts receivable, inventory and accounts payable, andnon-cash items totaling $263,300.

Cash used for investingactivities was $3.1 million in the first quarter of 2006, compared with cashprovided by investing activities of $471,200 in the first quarter of 2005. Inthe first quarter of 2006 there were net purchases of investments in the amountof approximately $2.9 million, compared with net maturities of investments of$530,400 in the first quarter of 2005. In the first quarter of 2006 and 2005cash was used for the purchase of fixed assets, in the amount of $144,200 and$59,200, respectively, primarily representing computer equipment.

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

Cash provided byfinancing activities was $551,100 and $30,200 in the first quarter of 2006 and2005, respectively. Cash provided by financing activities in the first quarterof 2006 and 2005 represents the proceeds from the exercise of stock options.

During the remainder of2006, we will be continuing to expend funds in connection with our efforts toexpand our sales and marketing for the NC-stat System, although more modestlythan the expansion in the last several quarters, and continue our ongoingprogram of making enhancements and improvements to the NC-stat System,including the development of new and/or improved biosensors, products for thediagnosis of additional neuropathies, and the development of a third generationneurodiagnostic system. In connection with the development efforts on a thirdgeneration neurodiagnostic system, we expect to continue to incur additionalcapital expenditures in the second quarter of 2006 for production toolingcosts. We also plan to expend funds on the design of a drug delivery system,which is in its early stages of development, for the minimally invasivedelivery of therapeutic agents to treat neuropathies by both primary care andspecialist physicians. We also expect to incur capital expenditures forcomputer hardware and software to support the growth in our business and theadditional requirements of our customer base. We believe that the combinationof funds available from cash and cash equivalents and funds available from ourshort-term investments will be adequate to finance our ongoing operations forat least 24 months, including the expenditures described above.

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

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

As of March 31,2006, we did not have any off-balance sheet financing arrangements.

 Thefollowing table summarizes our principal contractual obligations as of March 31,2006 and the effects such obligations are expected to have on our liquidity andcash flows in future periods.
| ** **                       | ** ** | **Payments due in** | ** ** |
|----------------------------------|------------|-------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                     | ** ** | **2006** | ** ** | **2007 and 2008** | ** ** | **2009 and 2010** | ** ** | **After 2010** | ** ** |
| Operating lease  obligations     |       | $                             | 2,790,000  |   | $ | 697,500 |   | $ | 1,860,000 |   | $ | 232,500 |   | $ | — |   |
| Purchase order  obligations      |       | 3,162,200                     |       | 2,398,400 |   | 763,800 |   | — |   | — |   |
| License  agreement obligations   |       | 10,000                        |       | 10,000 |   | — |   | — |   | — |   |
| Total  contractual obligations   |       | $                             | 5,962,200  |   | $ | 3,105,900 |   | $ | 2,623,800 |   | $ | 232,500 |   | $ | — |   |

 

In April, 2006, weentered into additional purchase order obligations totaling $4,924,900 for thepurchase of inventory. Payments for these obligations are due as follows:  $1,934,800 in 2006 and $2,990,100 in 2007.

17

----

**CAUTIONARYNOTE REGARDING FORWARD-LOOKING STATEMENTS**

The statements containedin this quarterly report on Form 10-Q, including under thesection titled “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and other sections of this quarterlyreport, include forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities 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 similarexpressions may identify forward-looking statements, but the absence of thesewords does not mean that a statement is not forward-looking. The forward-lookingstatements contained in this quarterly report are based on our currentexpectations and beliefs concerning future developments and their potentialeffects on us. There can be no assurance that future developments affecting uswill be those that we have anticipated. These forward-looking statementsinvolve a number of risks, uncertainties (some of which are beyond our control)or other assumptions that may cause actual results or performance to bematerially different from those expressed or implied by these forward-lookingstatements. These risks and uncertainties include, but are not limited to,risks associated with:  our dependence onthe NC-stat System and its components; our ability to increase our customerbase and expand the market for our products; our ability to accurately predictthe size of the market for the NC-stat System; our ability to manage ourgrowth; obtaining necessary regulatory approvals; our reliance on single sourcethird party manufacturers and suppliers to produce our products; reimbursementby third party payors to our customers for procedures performed using theNC-stat System; compliance with applicable quality control and manufacturingstandards; compliance with federal and state laws protecting theconfidentiality of patient health information and prohibiting “kickbacks” andfalse 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 inPart II, Item1A of this Quarterly Report on Form 10-Q and our otherfilings. Should one or more of these risks or uncertainties materialize, orshould any of our assumptions prove incorrect, actual results may vary inmaterial respects from those projected in these forward-looking statements. Weundertake no obligation to update or revise any forward-looking statements,whether as a result of new information, future events or otherwise, except asmay be required under applicable securities laws.

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

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

**Item4.    Controls and Procedures**

**(a)****             **Evaluation ofdisclosure controls and procedures.

Our management carriedout an evaluation, with the participation of our Chief Executive Officer andour Chief Financial Officer, of the effectiveness of our disclosure controlsand procedures (as defined in Rules 13a-15(e) or 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of March 31,2006. Based upon that evaluation, our Chief Executive Officer and our ChiefFinancial Officer concluded that they believe that our disclosure controls andprocedures are effective to ensure that information required to be disclosed byus in reports that we file or submit under the Exchange Act, is recorded,processed, summarized and reported, within the time periods specified in theSecurities and Exchange Commission’s rules and forms. In designing andevaluating our disclosure controls and procedures, we and our managementrecognize that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and our management necessarily was required to apply itsjudgment in evaluating and implementing possible controls and procedures. Wecontinue to review and document our disclosure controls and procedures,including our internal controls over financial reporting, and may from time totime make changes aimed at enhancing their effectiveness and to ensure that oursystems evolve with our business.

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

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

18

----

**Part IIOther Information**

**Item1.   Legal Proceedings**

None.

**Item1A. Risk Factors**

There have been nomaterial changes in the risk factors described in “Item 1A—Risk Factors”of our Annual Report on Form 10-K for the year ended December 31,2005, with the exception of the risk factor titled “*We are subject to federal and state laws prohibiting “kickbacks” andfalse or fraudulent claims, which, if violated, could subject us to substantialpenalties. Additionally, any challenge to or investigation into our practicesunder these laws could cause adverse publicity and be costly to respond to, andthus could harm our business*.”We note that the medical device industry has recently experienced heightenedfocus by regulators such as the Department of Health and Human Services. In thesecond quarter of 2006, we received a subpoena from the Office of the InspectorGeneral of the Department of Health and Human Services requesting documentsfrom us in connection with an investigation of potential violations of thefederal anti-kickback statute and False Claims Act. We are fully cooperatingand the government has not instituted proceedings against us relating in any wayto this investigation.

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

(a)          On July 21, 2004, the Securities and Exchange Commission declaredeffective our registration statement on Form S-1 (File No. 333-115440),relating to the initial public offering of our common stock. We expect tocontinue to use the net proceeds from the initial public offering for generalcorporate purposes, including to expand our selling and marketing and servicesorganizations, develop new distribution channels, expand our research anddevelopment efforts, improve our operational and financial systems and forother working capital purposes. We may also use a portion of the net proceedsto acquire or invest in complementary businesses, products or technologies. Wehave no specific understandings, commitments or agreements with respect to anysuch acquisition or investment. Except as set forth below, we have notallocated any portion of the net proceeds for any specific purpose. Theaggregate price of the offering amount registered on our behalf was$27.6 million. In connection with the offering, we paid approximately$1.9 million in underwriting discounts and commissions to the underwritersand incurred an estimated $1.7 million in other offering expenses. None ofthe underwriting discounts and commissions or offering expenses were incurredor paid to directors or officers of ours or their associates or to personsowning 10 percent or more of our common stock or to any affiliates of ours.After deducting the underwriting discounts and commissions and offeringexpenses, we received net proceeds from the offering of approximately$24.0 million. From July 21, 2004, the effective date of theregistration statement, to March 31, 2006 we have used (i) $3.1 millionof the net proceeds to repay in full the outstanding balance under our securedline of credit with Lighthouse Capital Partners, (ii) an estimated $5.1million of the net proceeds to fund cash spending of our research anddevelopment activities, (iii) an estimated $9.5 million of the netproceeds to fund the expansion of our sales and marketing efforts and (iv) anestimated $661,300 for the purchase of capital equipment. The remainder of thenet proceeds have been invested in marketable, investment grade,interest-bearing securities pending their use. Our use of the proceeds from ourinitial public offering does not represent a material change from thedescription provided in our prospectus.

**Item3.    Defaults Upon Senior Securities**

None.

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

None.

**Item5.    Other Information**

None.

**Item6.    Exhibits**

See the Exhibit Indexon the page immediately preceding the exhibits for a list of exhibitsfiled as part of this quarterly report, which Exhibit Index isincorporated herein by this reference.

19

----

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:  May 10, 2006 | /s/        | Shai N. Gozani, M.D., Ph. D.          |
|                     |       | Shai N. Gozani, M.D., Ph. D.          |
|                     |       | Chief Executive Officer and President |
|                     |       |
|                     |       |
| Date:  May 10, 2006 | /s/        | W. Bradford Smith                     |
|                     |       | W. Bradford Smith                     |
|                     |       | Chief Financial Officer               |

 

20

----

Exhibit Index
| *10.1            |   | Executive Officer Compensation Arrangements (2006  Salaries)                                                                                   |   |
|------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   10.2 |   | Amended and Restated 2004 Stock Option and Incentive  Plan (1)                                                                                 |   |
| *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. |   |

 

* Filed herewith

(1)  Incorporatedherein by reference to Appendix B to NeuroMetrix, Inc.’s Proxy Statement onSchedule 14A filed April 24, 2006 (File No. 000-50856)

21

----