**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM10-Q**

 

----

 

**(MarkOne)**

 
| **x**      | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|------------|-----------------------------------------------------------------------------------------------|
|       |
| ** ** | **For the quarterly period ended  September 30, 2007**                                        |
|       |
| **OR**     |
|       |
| **o**      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**CommissionFile Number 001-33770**

 

----

 

**PowerMedical Interventions, Inc.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **23-3011410**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer Identification No.) |

 

**2021Cabot Boulevard, Langhorne, Pennsylvania 19047**

(Address of principal executive offices)

 

**(267)775-8100**

(Registrant’stelephone number, including area code)

 

----

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 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 90 days. Yes  o    No  x.

 

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer (as defined in Rule 12b-2 of the Exchange Act). 

 

Large acceleratedfiler  o            Acceleratedfiler  o            Non-acceleratedfiler  **x**

 

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes  o.    No  x.

 

Indicate the number ofshares outstanding of each of the Registrant’s classes of Common Stock. 

 

As of November 30, 2007,17,106,895 shares of the Registrant’s Common Stock, $0.001 par value, wereoutstanding. 

 

 

----

 

**POWERMEDICAL INTERVENTIONS, INC.**

 
| PART I:  | FINANCIAL INFORMATION                                                                                                                |     |
|---------------|--------------------------------------------------------------------------------------------------------------------------------------|----------|
|          |                                                                                                                                 |     |
| Item 1.  | Financial Statements                                                                                                                 | **Page** |
|          |                                                                                                                                 |     |
|          | Condensed  Consolidated Balance Sheets as of September 30, 2007 (Unaudited) and December  31, 2006                                   | 1        |
|          |                                                                                                                                 |     |
|          | Condensed Consolidated  Statements of Operations for the Three Months and Nine Months Ended September  30, 2007 and 2006 (Unaudited) | 2        |
|          |                                                                                                                                 |     |
|          | Condensed Consolidated  Statements of Cash Flows for the Nine Months Ended September 30, 2007 and  2006 (Unaudited)                  | 3        |
|          |                                                                                                                                 |     |
|          | Notes to Unaudited Condensed Consolidated Financial  Statements                                                                      | 4        |
|          |                                                                                                                                 |     |
| Item 2.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                          | 13       |
|          |                                                                                                                                 |     |
| Item 3.  | Quantitative  and Qualitative Disclosures About Market Risk                                                                          | 19       |
|          |                                                                                                                                 |     |
| Item 4.  | Controls and  Procedures                                                                                                             | 20       |
|          |                                                                                                                                 |     |
| PART II: | OTHER INFORMATION                                                                                                                    | 20       |
|          |                                                                                                                                 |     |
| Item 1.  | Legal Proceedings                                                                                                                    | 20       |
|          |                                                                                                                                 |     |
| Item 1A. | Risk Factors                                                                                                                         | 22       |
|          |                                                                                                                                 |     |
| Item 2.  | Unregistered Sales of Equity  Securities and Use of Proceeds                                                                         | 45       |
|          |                                                                                                                                 |     |
| Item 3.  | Defaults Upon Senior Securities                                                                                                      | 46       |
|          |                                                                                                                                 |     |
| Item 4.  | Submission of Matters to a Vote of  Security Holders                                                                                 | 46       |
|          |                                                                                                                                 |     |
| Item 5.  | Other Information                                                                                                                    | 46       |
|          |                                                                                                                                 |     |
| Item 6.  | Exhibits                                                                                                                             | 47       |
|          |                                                                                                                                 |     |
|          | Signatures                                                                                                                           | 48       |

 

----

 
| PART I:     | FINANCIAL INFORMATION     |
|-------------|---------------------------|
|        |                      |
| **Item 1.** | **Financial Statements.** |

 

**Power Medical Interventions, Inc.**

**Condensed Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                                                                       | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                       | ** ** | **(unaudited)**              | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                                                       |       |                         |       |                        |       |
| Current assets:                                                                                                                                                                                                                  |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                       |       | $                            | 5,711,243  |                        | $          | 8,684,341 |   |
| Restricted cash                                                                                                                                                                                                                  |       | 1,750,000                    |       | —                      |       |
| Accounts  receivable less allowance of $200,686 and $173,000 in 2007 and 2006,  respectively                                                                                                                                     |       | 1,508,467                    |       | 1,654,815                   |       |
| Inventory                                                                                                                                                                                                                        |       | 6,158,351                    |       | 4,475,693                   |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                       |       | 1,309,465                    |       | 497,959                     |       |
| Deferred equity  offering costs                                                                                                                                                                                                  |       | 2,641,537                    |       | 51,807                      |       |
| Total current  assets                                                                                                                                                                                                            |       | 19,079,063                   |       | 15,364,615                  |       |
| Property and  equipment, net                                                                                                                                                                                                     |       | 4,680,584                    |       | 4,871,450                   |       |
| Intangible  assets, net                                                                                                                                                                                                          |       | 929,735                      |       | 757,894                     |       |
| Deferred  financing fees                                                                                                                                                                                                         |       | 1,422,946                    |       | —                      |       |
| Other assets                                                                                                                                                                                                                     |       | 271,618                      |       | 268,569                     |       |
| Restricted cash                                                                                                                                                                                                                  |       | 1,613,621                    |       | 879,310                     |       |
| Total assets                                                                                                                                                                                                                     |       | $                            | 27,997,567 |                        | $          | 22,141,838 |   |
| **Liabilities  and shareholders’ deficit**                                                                                                                                                                                  |       |                         |       |                        |       |
| Current  liabilities:                                                                                                                                                                                                            |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                                                                                 |       | $                            | 3,688,183  |                        | $          | 2,582,196 |   |
| Accrued expenses                                                                                                                                                                                                                 |       | 2,892,381                    |       | 2,172,459                   |       |
| Current portion  of long-term debt                                                                                                                                                                                               |       | 68,756                       |       | 75,610                      |       |
| Total current  liabilities                                                                                                                                                                                                       |       | 6,649,320                    |       | 4,830,265                   |       |
|                                                                                                                                                                                                                             |       |                         |       |                        |       |
| Long-term debt,  net of current portion                                                                                                                                                                                          |       | 24,698,110                   |       | 376,826                     |       |
| Deferred rent,  net of current portion                                                                                                                                                                                           |       | 747,372                      |       | 765,918                     |       |
| Total  liabilities                                                                                                                                                                                                               |       | 32,094,802                   |       | 5,973,009                   |       |
| ** **                                                                                                                                                                                                                       |       |                         |       |                        |       |
| **Redeemable  convertible preferred stock, $.001 par value:**                                                                                                                                                                    |       |                         |       |                        |       |
| Series  A—authorized, issued and outstanding shares—22,668,764                                                                                                                                                         |       | 19,030,489                   |       | 18,244,492                  |       |
| Series  B—authorized, issued and outstanding shares—47,489,822                                                                                                                                                         |       | 45,538,937                   |       | 42,893,061                  |       |
| Series  C—authorized shares—22,935,780; issued and outstanding shares—21,223,750                                                                                                                                  |       | 18,554,691                   |       | 17,789,085                  |       |
| Series  D—authorized shares—50,954,779; issued and outstanding shares—50,596,158                                                                                                                                  |       | 39,867,995                   |       | 37,271,570                  |       |
| Total redeemable  convertible preferred stock                                                                                                                                                                                    |       | 122,992,112                  |       | 116,198,208                 |       |
| ** **                                                                                                                                                                                                                       |       |                         |       |                        |       |
| **Shareholders’  deficit:**                                                                                                                                                                                                 |       |                         |       |                        |       |
| Common stock,  $.001 par value:                                                                                                                                                                                                  |       |                         |       |                        |       |
| Authorized  shares—316,000,000 and 260,000,000 at September 30, 2007 and December 31,  2006, respectively; issued and outstanding shares 3,805,983 and 3,757,775 at  September 30, 2007 and December 31, 2006, respectively |       | 3,806                        |       | 3,758                       |       |
| Additional  paid-in capital                                                                                                                                                                                                      |       | 32,175,413                   |       | 37,188,432                  |       |
| Accumulated  other comprehensive loss                                                                                                                                                                                            |       | (109,703                     | )          | (155,533                    | )          |
| Accumulated  deficit                                                                                                                                                                                                             |       | (159,158,863                 | )          | (137,066,036                | )          |
| Total shareholders’  deficit                                                                                                                                                                                                |       | (127,089,347                 | )          | (100,029,379                | )          |
| Total  liabilities, redeemable convertible preferred stock, and shareholders’  deficit                                                                                                                                      |       | $                            | 27,997,567 |                        | $          | 22,141,838 |   |

 

*Seeaccompanying notes.*

 

1

----

 

**Power Medical Interventions, Inc.**

**Condensed Consolidated Statements ofOperations (Unaudited)**

 
| ** **                                                 | ** ** | **Three Months Ended  September 30,** | ** **  | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------------------|-------------|-----------------------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                                             | ** **  | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Sales**                                                  |       | $                                                    | 1,701,127   |                                                | $          | 1,521,640 |   | $ | 5,893,744 |   | $ | 6,043,304 |   |
| **Cost of  sales**                                         |       | 1,281,410                                            |        | 2,195,200                                           |       | 4,581,337 |   | 6,934,793 |   |
|                                                       |       | 419,717                                              |        | (673,560                                            | )          | 1,312,407 |   | (891,489 | ) |
| **Costs  and expenses:**                                   |       |                                                 |        |                                                |       |   |   |   |   |
| Research and  development                                  |       | 1,820,676                                            |        | 978,183                                             |       | 4,373,862 |   | 3,378,454 |   |
| Sales and  marketing                                       |       | 3,977,684                                            |        | 3,049,882                                           |       | 11,087,967 |   | 9,309,601 |   |
| General and  administrative                                |       | 2,005,227                                            |        | 1,994,818                                           |       | 6,331,109 |   | 5,238,240 |   |
|                                                       |       | 7,803,587                                            |        | 6,022,883                                           |       | 21,792,938 |   | 17,926,295 |   |
|                                                       |       |                                                 |        |                                                |       |   |   |   |   |
| Operating loss                                             |       | (7,383,870                                           | )           | (6,696,443                                          | )          | (20,480,531 | ) | (18,817,784 | ) |
| **Other  income (expense):**                               |       |                                                 |        |                                                |       |   |   |   |   |
| Interest income                                            |       | 198,553                                              |        | 261,928                                             |       | 564,051 |   | 320,324 |   |
| Interest expense                                           |       | (1,084,034                                           | )           | (242,566                                            | )          | (2,176,348 | ) | (980,668 | ) |
| **Total  other income (expense)**                          |       | (885,481                                             | )           | 19,362                                              |       | (1,612,297 | ) | (660,344 | ) |
| Net loss                                                   |       | $                                                    | (8,269,351  | )                                                   | $          | (6,677,081 | ) | $ | (22,092,828 | ) | $ | (19,478,128 | ) |
|                                                       |       |                                                 |        |                                                |       |   |   |   |   |
| Accretion of  preferred stock                              |       | (2,259,411                                           | )           | (2,029,854                                          | )          | (6,786,913 | ) | (4,847,133 | ) |
| Net loss  applicable to common shares                      |       | $                                                    | (10,528,762 |                                                | $          | (8,706,935 | ) | $ | (28,879,741 | ) | $ | (24,325,261 | ) |
| **Net  loss per common share:**                            |       |                                                 |        |                                                |       |   |   |   |   |
| Basic and  diluted                                         |       | $                                                    | (2.78       | )                                                   | $          | (2.32 | ) | $ | (7.59 | ) | $ | (6.48 | ) |
| **Weighted  average number of common shares outstanding:** |       |                                                 |        |                                                |       |   |   |   |   |
| Basic and  diluted                                         |       | 3,782,405                                            |        | 3,757,543                                           |       | 3,805,800 |   | 3,755,023 |   |

 

*Seeaccompanying notes.*

 

2

----

 

**Power MedicalInterventions, Inc.**

**Condensed Consolidated Statements ofCash Flows (Unaudited)**

 
| ** **                                                                            | ** ** | **Nine Months Ended September 30,** | ** **  |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------------|-------------|
| ** **                                                                            | ** ** | **2007**                                                | ** **  | **2006** | ** ** |
| **Operating  activities**                                                             |       |                                                    |        |   |   |
| Net loss                                                                              |       | $                                                       | (22,092,828 | ) | $ | (19,478,128 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:          |       |                                                    |        |   |   |
| Depreciation and  amortization                                                        |       | 1,649,268                                               |        | 1,346,984 |   |
| Amortization of  debt discount                                                        |       | 124,536                                                 |        | 170,377 |   |
| Loss on the  disposal of property and equipment                                       |       | 3,492                                                   |        | 55,596 |   |
| Stock-based compensation                                                              |       | 395,978                                                 |        | 109,219 |   |
| Changes in  operating assets and liabilities:                                         |       |                                                    |        |   |   |
| Accounts  receivable                                                                  |       | 159,499                                                 |        | (46,053 | ) |
| Inventory                                                                             |       | (1,320,629                                              | )           | 1,137,039 |   |
| Prepaid expenses  and other assets                                                    |       | (1,092,011                                              | )           | (14,163 | ) |
| Accounts payable                                                                      |       | 1,039,006                                               |        | (1,912,580 | ) |
| Accrued expenses                                                                      |       | 327,728                                                 |        | 274,331 |   |
| Deferred rent                                                                         |       | (18,545                                                 | )           | (103,487 | ) |
| Net cash used in  operating activities                                                |       | (20,824,506                                             | )           | (18,460,865 | ) |
|                                                                                  |       |                                                    |        |   |   |
| **Investing  activities**                                                             |       |                                                    |        |   |   |
| Proceeds from  disposal of assets                                                     |       | —                                                  |        | 6,000 |   |
| Purchase of property  and equipment                                                   |       | (1,301,340                                              | )           | (706,714 | ) |
| Patent  application costs                                                             |       | (309,185                                                | )           | (95,699 | ) |
| Change in  restricted cash                                                            |       | (2,484,311                                              | )           | 140,690 |   |
| Net cash used in  investing activities                                                |       | (4,094,836                                              | )           | (655,723 | ) |
|                                                                                  |       |                                                    |        |   |   |
| **Financing  activities**                                                             |       |                                                    |        |   |   |
| Repayments on  long-term debt                                                         |       | (62,914                                                 | )           | (2,780,300 | ) |
| Proceeds of  long-term debt                                                           |       | 23,577,054                                              |        | — |   |
| Principal  payments on capital lease obligations                                      |       | —                                                  |        | (12,353 | ) |
| Net proceeds  from the issuance of preferred stock, warrants, and bridge loans        |       | —                                                  |        | 37,274,498 |   |
| Net proceeds  from the issuance of common stock and exercise of common stock warrants |       | 637,764                                                 |        | 14,184 |   |
| Payment of  deferred equity financing costs                                           |       | (1,897,019                                              | )           | — |   |
| Net cash  provided by financing activities                                            |       | 22,254,885                                              |        | 34,496,029 |   |
|                                                                                  |       |                                                    |        |   |   |
| Effect of exchange  rate changes on cash and cash equivalents                         |       | (308,641                                                | )           | (362,825 | ) |
| Net (decrease)  increase in cash and equivalents                                      |       | (2,973,098                                              | )           | 15,016,616 |   |
| Cash and cash  equivalents, beginning of period                                       |       | 8,684,341                                               |        | 7,932,601 |   |
| Cash and  equivalents, end of period                                                  |       | $                                                       | 5,711,243   |   | $ | 22,949,217 |   |
| ** **                                                                            |       |                                                    |        |   |   |
| **Supplemental  disclosure of cash flow information**                                 |       |                                                    |        |   |   |
| Cash paid for  interest                                                               |       | $                                                       | 898,759     |   | $ | 22,980 |   |

 

*Seeaccompanying notes.*

 

3

----

 

**PowerMedical Interventions, Inc.**

** **

**Notes to Unaudited CondensedConsolidated Financial Statements September 30, 2007**

 

**1.    Business**

 

Power MedicalInterventions, Inc. (the Company), a Delaware corporation, is a medicaldevice company that designs, manufactures and markets the SurgASSIST® system ofcomputer-assisted, power-actuated endomechanical surgical instruments, referredto as Intelligent Surgical InstrumentsTM. Surgeons use Intelligent SurgicalInstruments for cutting, stapling and tissue manipulation in a variety ofprocedures in open surgery, minimally invasive surgery MIS, and in the emergingfield of natural orifice translumenal endoscopic surgery, or NOTES. To date,the majority of the Company’s efforts have been devoted to research anddevelopment, raising capital, recruiting personnel, and the commercializationof products and the commencement of manufacturing activities. 

 

The Company has whollyowned subsidiaries in Germany, Power Medical Interventions Deutschland GmbH; inFrance, Power Medical Interventions France; and in Japan, Power Medical InterventionsJapan, which conduct sales and marketing operations. The Company also has adormant U.S. subsidiary, Power Medical Vascular, Inc. 

 

On October 31, 2007, theCompany completed its initial public offering generating net proceeds ofapproximately $41.9 million, after deducting underwriting commissions andestimated offering expenses.

 

**2.    Summaryof Significant Accounting Policies**

 

*Unauditedinterim financial data*

* *

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States and the requirements of Form 10-Q and Regulation S-X.

 

The accompanyingconsolidated balance sheet as of September 30, 2007, the consolidatedstatements of operations for the three months ended September 30, 2007 and 2006and for the nine months ended September 30, 2007 and 2006, and the consolidatedstatement of cash flows for the nine months ended September 30, 2007 and2006 are unaudited. The unaudited interim financial statements have beenprepared on the same basis as the annual financial statements and, in theopinion of management, reflect all adjustments, which include only normalrecurring adjustments, necessary to state fairly the Company’s financialposition as of September 30, 2007 and the results of its operations and cashflows for the three and  nine monthsended September 30, 2007 and 2006. The financial data and other informationdisclosed in these notes to the financial statements related to the three and ninemonth periods are unaudited. The results for the

 

4

----

 

three and the nine monthsended September 30, 2007 are not necessarily indicative of the results to beexpected for any future period. 

 

*Deferredequity offering costs*

 

Costs were incurred inconnection with the initial public offering of the Company’s common stock.  As of September 30, 2007 legal and accounting costs aggregatingapproximately $2,642,000 have been deferred and are reflected as a currentasset in the accompanying consolidated balance sheet. Upon the completion ofthe offering in October 2007, these costs were treated as a reduction of theproceeds from the offering and were included as a component of additionalpaid-in capital. 

 

*Revenuerecognition*

 

The Company’s SurgASSISTsurgical platform includes cutting and stapling devices in a variety of sizesand linear, right angle and circular configurations designed for differingsurgical needs. The Company’s Intelligent Surgical Instruments are available asdisposable, single-patient devices as well as in a reusable multiple-patientformat which can be autoclaved and used in multiple cases. The Company’sreusable Intelligent Surgical Instruments use disposable cutting and staplingcartridges in various sizes, which the Company refers to as reload cartridges. 

 

In the originalconfiguration of the SurgASSIST system, Intelligent Surgical Instruments areconnected through a flexible shaft, or FlexShaft, to a power console and, insome cases, a separate remote control unit. The Company’s next generationproducts, beginning with the i60 linear stapler that the Company introduced inthe fourth quarter of 2007, will be self-contained hand held instruments thatdo not require a FlexShaft or separate power console. 

 

Most of the Company’srevenue is derived from the sale of single-patient, disposable IntelligentSurgical Instruments and from the sale of reload cartridges for reusableIntelligent Surgical Instruments. Revenue related to the sale of suchindividual products is recognized when persuasive evidence of an arrangementexists, delivery has occurred, the sale price is fixed and determinable, andcollectibility is reasonably assured, which is generally at the time ofshipment upon delivery to a common carrier. 

 

Historically, the Companyalso has derived a limited amount of revenue from the sale of completeSurgASSIST systems, consisting of one or more Intelligent Surgical Instruments,together with the related power console, FlexShaft and remote control unit.Revenue related to the complete sale of a SurgASSIST system is recognized atthe time of shipment upon delivery to a common carrier. Sales of these completesystems have not been significant during any period presented. 

 

The Company has historicallyprovided power consoles, FlexShafts, remote control units and mobile carts tocustomers at no cost as loaner equipment. In addition, the Company has incertain cases agreed to transfer title to such systems to the customer upon thecustomer’s purchase of a specified number of disposable Intelligent SurgicalInstruments although the customer is under no obligation to purchase theIntelligent Surgical Instruments. In these instances, the Company

 

5

----

 

recognizes revenueattributable to the complete system as the Intelligent Surgical Instruments aredelivered, in accordance with EITF 00-21, *RevenueArrangements with Multiple Deliverables.*

 

In 2007, the Companyinstituted a program whereby it may provide reusable Intelligent SurgicalInstruments and FlexShafts to customers at no cost in exchange for higher unitpricing on the sale of reload cartridges over a specified period of time. Inthese cases, the Company recognizes the revenue on a units of delivery basisover the period of delivery of the reload cartridges in accordance with theguidance of EITF 00-21, as long as such revenue is not contingent on thedelivery of the undelivered products. 

 

The Company’s customersgenerally order product using standard purchase orders and payment terms are 30days. The Company provides discounted pricing to its customers based on volumeand commitment levels. Allowance for product returns are estimated based onhistorical experience and provisions are recorded at the time of shipment. TheCompany also provides limited warranties to its customers against materialdefects in materials and workmanship. Such warranties are generally for a oneyear period from the date of shipment. Historically, warranty costs have notbeen material. 

 

Amounts billed tocustomers for shipping and handling of products are included in sales. Costsincurred related to shipping and handling are included in cost of sales. 

 

*Stock-basedcompensation*

 

In December 2004,the Financial Accounting Standards Board (FASB) issued SFAS No. 123(revised 2004), *Share-Based Payment*(SFAS No. 123(R)), which replaces SFAS No. 123, *Accounting for Stock-Based Compensation*(SFAS 123), and supersedes Accounting Principles Board (APB) OpinionNo. 25, *Accounting for Stock Issued toEmployees* (APB 25). SFAS No. 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the financial statements based on their fair values beginningwith the first annual period after December 15, 2005. SFAS No. 123(R)requires that an entity measure the cost of equity-based service awards basedon the grant-date fair value of the award and recognize the cost of such awardover the period during which the employee is required to provide service inexchange for the award (vesting period). The pro forma disclosures previouslypermitted under SFAS No. 123 are no longer an alternative to financialstatement recognition. The Company adopted SFAS No. 123(R) onJanuary 1, 2006 using the prospective transition method, which requiredthat all new stock-based awards granted subsequent to adoption be recognized inthe financial statements at fair value. The Company accounts for equity issuedto nonemployees in accordance with EITF 96-18, *Accountingfor Equity Investments that are Issued to Other Than Employees for Acquiring,or in Conjunction with, Selling Goods or Services* (EITF 96-18). 

 

The following tablesummarizes the grants made by the Company since January 1, 2006: 

 

6

----

 
| **Date of Grant** | ** ** | **Number  of  Options  Granted** | ** ** | **Exercise  Price of  Options  Granted** | ** ** | **Weighted  Average  Fair Value  of Common  Stock** | ** ** | **Intrinsic  Value  (if any)** | ** ** |
|-----------------------------|------------|----------------------------------|------------|-----------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------------------------|------------|
| First Quarter  2006         |       | 77,437                           |       | $                                             | 6.40       |                                                          | $          | 4.64                                |       | — |   |
| Second Quarter  2006        |       | 168,687                          |       | $                                             | 10.24      |                                                          | $          | 7.20                                |       | — |   |
| Third Quarter  2006         |       | 1,063                            |       | $                                             | 10.24      |                                                          | $          | 7.68                                |       | — |   |
| Fourth Quarter  2006        |       | 192,907                          |       | $                                             | 10.24      |                                                          | $          | 7.36                                |       | — |   |
| First Quarter  2007         |       | —                           |       | —                                        |       | —                                                        |       | —                              |       |
| Second Quarter  2007        |       | 533,237                          |       | $                                             | 10.24      |                                                          | $          | 7.68                                |       | — |   |
| Third Quarter  2007         |       | 111,094                          |       | $                                             | 10.24      |                                                          | $          | 7.68                                |       | — |   |

 

The Company estimated thefair value of its common stock during 2006 by utilizing a retrospective thirdparty valuation.  The Company estimatedthe fair value of its common stock during 2007 by utilizing a contemporaneousthird party valuation. The valuation methodology utilized relied primarily onthe “income approach” to estimate enterprise value. The income approachinvolves projecting future cash flows and discounting them to present valueusing a discount rate based on a risk adjusted weighted average cost of capitalof comparable companies. The projection of future cash flows and thedetermination of an appropriate discount rate involve a significant level ofjudgment. In order to allocate the enterprise value to the various securitiesthat comprise the Company’s capital structure, the option-pricing method wasused. The retrospective valuation of the Company’s common stock yielded a rangeof fair values of $4.48 to $7.68 during 2006, and the contemporaneous valuationyielded a fair value of $7.68 during the second and third quarter of 2007. Theoptions granted during the second quarter of 2007 include 380,068 optionsgranted to an executive officer which are performance based and will vest onlyupon the achievement of certain corporate performance targets in 2007. 

 

The per-share weightedaverage fair value on the date of grant of the options granted was estimated at$4.48 during the second and third quarter of 2007 and $4.16 during 2006 andusing the Black-Scholes option-pricing model with the following weightedaverage assumptions, which are based upon Company history or industrycomparative information: 

 

7

----

 
| ** **                | ** ** | **Three months  Ended  September 30,  2007** | ** ** | **Three  months  Ended  September  30, 2006** | ** ** | **Nine  months  Ended  September  30, 2007** | ** ** | **Nine  months  Ended  September  30, 2006** | ** ** |
|---------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                | ** ** | ** **                                             | ** ** | ** **                                         | ** ** | ** **                                        | ** ** | ** **                                        | ** ** |
| Expected  dividend yield  |       | 0                                                      | %          | 0                                                  | %          | 0                                                 | %          | 0                                                 | %          |
| Expected  volatility      |       | 60                                                     | %          | 65                                                 | %          | 60                                                | %          | 65                                                | %          |
| Risk-free  interest rates |       | 4.58                                                   | %          | 4.75                                               | %          | 4.58                                              | %          | 4.6                                               | %          |
| Expected life             |       | 7 years                                                |       | 7 years                                            |       | 7 years                                           |       | 7 years                                           |       |

 

Since the Company’s stockwas not publicly traded during the period presented, the expected volatilitywas calculated for each date of grant based on an alternative method (definedas “calculated value”). The Company identified similar public entities forwhich share price information is available and considered the historicalvolatility of these entities’ share prices in estimating expected volatility.The Company used the average volatility of these guideline companies over aseven year period, consistent with the expected term calculated pursuant toStaff Accounting Bulletin No. 107. Compensation expense under SFAS No. 123(R) and EITF 96-18 for thenine months ended September 30, 2007 related to share-based service awardsgranted in 2006 and 2007 was $395,978, of which $2,316 is included in cost ofsales, $9,211 is included in research and development, $59,531 is included insales and marketing and $324,920 is included in general and administrativeexpense in the accompanying consolidated statements of operations.  Compensation expense under SFASNo. 123(R) and EITF 96-18 for the nine months ended September 30, 2006related to share-based service awards granted in 2006 was $109,219, of which$597 is included in cost of sales, $28,162 is included in sales and marketing,and $80,460 is included in general and administrative expense in theaccompanying consolidated statements of operations.  The Company recognizes the compensation expenseof such share-based service awards on a straight-line basis. Total compensationcost of options granted but not yet vested, exclusive of the performance grantto an executive during the second quarter as of September 30, 2007, was$1,953,757, net of estimated forfeitures, which is expected to be recognizedover the weighted average period of 2.8 years. The Company utilized anestimated forfeiture rate of 15% for the 2006 and 2007 grants, based on theCompany’s historical forfeiture rate as well as an analysis of current marketconditions.  The Company does not expectcertain of the 380,068 performance-based options granted to an executiveofficer to vest, as the performance targets are not expected to be achieved.

 

*Netloss attributable to common shares*

 

The Company computes netloss per share in accordance with SFAS No. 128, *Earnings Per Share* (SFAS No. 128). Under SFASNo. 128, basic net loss per share is computed by dividing net loss pershare available to common stockholders by the weighted average number of commonshares outstanding for the period and excludes the effects of any potentiallydilutive securities. Diluted earnings per share, if presented, would includethe dilution that would occur upon the exercise or conversion of allpotentially dilutive securities into common stock using the “treasury stock”and/or “if converted” methods as applicable. 

 

8

----

 

The following summarizesthe potential outstanding common stock of the Company as of the end of eachperiod as adjusted for a one-for-sixteen reverse stock split effected byCompany on October 5, 2007 (Note 7): 

 
| ** **                                | ** ** | **September  30, 2007** | ** ** | **September  30, 2006** | ** ** |
|-------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                | ** ** | ** **                   | ** ** | ** **                   | ** ** |
| Redeemable  convertible preferred stock   |       | 8,873,412                    |       | 8,873,412                    |       |
|                                      |       |                         |       |                         |       |
| Common stock  warrants                    |       | 1,105,290                    |       | 1,167,011                    |       |
|                                      |       |                         |       |                         |       |
| Common stock  options outstanding         |       | 1,797,043                    |       | 1,148,967                    |       |
|                                      |       |                         |       |                         |       |
| Common stock  options available for grant |       | 575,489                      |       | 174,402                      |       |
|                                      |       |                         |       |                         |       |
| Total                                     |       | 12,351,234                   |       | 11,363,792                   |       |

 

If the outstandingoptions, warrants, and preferred stock were exercised or converted into commonstock, the result would be anti-dilutive. Accordingly, basic and diluted netloss attributable to common stockholders per share are identical for allperiods presented in the accompanying consolidated statements of operations.The potential outstanding common stock as of September 30, 2007 reflected abovedoes not include any shares related to the conversion of the Company’sconvertible senior secured promissory notes issued in March 2007, as such notesare only convertible upon a qualified initial public offering or qualifiedsale, as defined. The Company completed a qualified initial public offering inOctober 2007 and therefore the senior secured promissory notes are nowconvertible. (Note 3)

 

In addition, thepotential outstanding common stock as of September 30, 2007, reflected above,does not reflect 4,427,500 shares of common stock issued in connection with theCompany’s initial public offering in October 2007.

 

**3.****              Long-TermDebt**

** **

During March 2007, theCompany sold $25.0 million of convertible senior secured promissory notesdue March 2010 (the “Convertible Notes”) which generated net proceeds to theCompany of $23,309,361 ($25,000,000 less financing fees of $1,690,639). Of thisamount, $3,500,000 was placed in escrow to fund the first four interestpayments on the Convertible Notes. These convertible notes

 

9

----

 

are secured bysubstantially all of the Company’s assets and accrue interest at the rate of 7%per annum, payable semiannually in arrears, and subject to an increase to 8.5%per annum in the event that a qualified initial public offering, as defined inthe Convertible Notes (a “Convertible Note Qualified IPO”), did not occur byDecember 31, 2007.  The Company’sinitial public offering in October 2007 qualified as a Convertible NoteQualified IPO, and therefore, the interest rate is no longer adjustable.   Interest accruing on or beforeMarch 31, 2009 is payable in cash, while interest accruing afterMarch 31, 2009 is payable, at the Company’s option, in cash orpaid-in-kind in the form of additional notes (“PIK Notes”). The principalamounts of such PIK Notes will have the same maturity as the Convertible Notes.Should the Company elect to pay interest on the Convertible Notes in PIK Notes,the interest rate on such PIK Notes shall be equal to the then applicableinterest rate plus 1.5%. 

 

The Convertible Notesalso require the payment of a terminal value that (i) will be due uponredemption or conversion of the Convertible Notes, (ii) will be consideredpart of the conversion amount for purposes of determining the conversion rate(see below) or (iii) will be due upon maturity as part of the principalamount. In each case, the terminal value payment will be equal to 7% per annumof the applicable principal from the closing date of the Convertible Notes inMarch 2007 to the earlier of the declaration of the effectiveness of aregistration statement covering the resale of the underlying shares, ormaturity of the Convertible Notes, provided that if a registration statement isdeclared effective, the accretion of the terminal value payment will onlyaccrue to the first conversion event. There is no possible future scenario inwhich the accrued terminal value would not be required to be paid to theholders of the Convertible Notes or realized by such holders upon conversion ofthe Convertible Notes. 

 

The Convertible Noteswere not convertible until the occurrence of a conversion event, which isdefined as a Convertible Note Qualified IPO described above or a qualified saleof the Company. 

 

Upon the occurrence ofthe Convertible Note Qualified IPO in October 2007,  the notes plus accrued interest thereon aswell as the accreted terminal value became convertible into the Company’sCommon Stock at the option of the holder at any time from the date of theconversion event through the maturity date of the notes. The conversion priceof the notes was set at the time the conversion event occurred. The conversionprice was set based on a 9% discount from the Company’s initial public offeringprice of $11.00 per share or a conversion price of $10.01 per share, subject tocertain anti-dilution adjustments. The conversion price of $10.01 does notresult in a beneficial conversion feature on the convertible notes.  As of the date of the closing of the Company’sinitial public offering on October 31, 2007, the Convertible Notes, includingaccrued interest and accreted terminal value, were convertible intoapproximately 2,614,000 shares of common stock. 

 

Beginning on April 28,2008, the Company may, at its option, redeem the Convertible Notes in whole atany time or in part from time to time, upon 15 days prior written notice to theholder, at a redemption price payable in cash, equal to the principal amountplus any interest (including the terminal value) accrued and unpaid, subject tothe satisfaction of the following conditions precedent: 

 

10

----

 

(a)   thedeclaration of effectiveness of a registration statement filed with the SEC forthe resale of the underlying shares;

 

(b)   theaverage of the high and low sale price of the Common Stock, as reported on theprincipal securities exchange on which the Common Stock is listed, on each ofany 20 trading days during any period of 30 consecutive trading days endingwithin 45 days prior to the Redemption Date (so long as, during the entire 30trading day period, the aforementioned registration statement has beeneffective and there has been no suspension of trading of the Common Stock),having been equal to or greater than 140% of the initial public offering pricein the Convertible Notes Qualified IPO (in each case, with prices adjusted forstock splits, reverse splits, stock dividends, share combination and other antidilutionevents); and

 

(c)   nomore than $12,500,000 of outstanding Convertible Notes may be redeemed pursuantto this provision in any period of 30 consecutive trading days; and

 

(d)   anysuch redemption shall be effected on a pro rata basis with respect to all thenoutstanding Convertible Notes (including PIK Notes).

 

Concurrent with theissuance of the Convertible Notes, the Company entered into a RegistrationRights Agreement with the note holders pursuant to which the Company agreed tofile a registration statement covering the resale of the underlying sharesissuable upon conversion of the notes by January 29, 2008.  In accordance with the terms of theRegistration Rights Agreement, from and after, and during the continuation of,a Registration Default (as defined in the Registration Rights Agreement), theinterest rate borne by the notes shall be increased by (i) 0.5% per annumor (ii) if any Registration Default shall continue for more than 180consecutive days, 1.0% per annum after such 180th day. With respect to noteswhich have been converted to Common Stock prior to a Registration Default, theCompany will pay an amount equal to 4% per annum multiplied by the portion ofthe principal amount of each such note as was converted into Common Stock. 

 

**4.****              Inventory**

 

Inventoryis stated at the lower of cost or market value, with cost being determined on afirst-in, first-out (FIFO) basis and market value based on the lower ofreplacement cost, or the estimated net realizable value, reduced by anallowance for normal profit margin. Inventory consists of the following:

 
| ** **      | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|-----------------|------------|----------------------------------|------------|---------------------------------|------------|
| Raw Materials   |       | $                                | 3,161,815  |                            | $          | 2,575,848 |   |
| Work in process |       | 499,305                          |       | 589,630                         |       |
| Finished goods  |       | 2,497,231                        |       | 1,310,215                       |       |
|            |       | $                                | 6,158,351  |                            | $          | 4,475,693 |   |

 

Duringthe nine months ended September 30, 2007 and 2006, and for the year endedDecember 31, 2006, the Company recorded inventory obsolescence charges in theamount of approximately

 

11

----

 

$430,000,$115,000 and $585,000 respectively.  Suchcharges are reflected in cost of sales in the accompanying condensedconsolidated statements of operations.  

 

**5.****              Comprehensive Loss**

 

TheCompany’s comprehensive loss was as follows:

 
| ** **                                                           | ** ** | **Three Months ended  September 30,** | ** ** | **Nine Months ended  September 30,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                           | ** ** | **2007**                                             | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net loss as  reported                                                |       | $                                                    | (8,269,351 | )                                                   | $          | (6,677,081 | ) | $ | (22,092,828 | ) | $ | (19,478,128 | ) |
| Other  comprehensive loss 

Foreign currency  translation adjustment |       | 46,707                                               |       | (110,759                                            | )          | 45,830 |   | (3,159 | ) |
| Comprehensive  loss                                                  |       | $                                                    | (8,222,644 | )                                                   | $          | (6,787,840 | ) | $ | (22,046,998 | ) | $ | (19,481,287 | ) |

 

**6.****              Contingencies**

 

TheCompany has, on occasion, been named as a defendant in lawsuits allegingproduct failure, patent infringement, and breach of contract.  These cases are routinely handled by externalcounsel.  Management has providedreserves for the estimated potential losses, when such losses are deemedprobable and estimable.  The Companycurrently has a patent infringement case outstanding.  The Company received a favorable ruling fromthe German courts on two of the patent infringement claims and an unfavorableruling on one of the claims.  However,the Company is in the process of appealing the ruling.  The Company intends to defend this claimvigorously and has concluded it is too early to determine whether or not theCompany will incur any loss under this claim. As such, no amounts are accrued in the accompanying consolidated balancesheets related to this claim.

 

TheCompany also has a product liability case outstanding which is currentlysuspended and the company has continued to contest the claim.  The Company has accrued $100,000 related tothis matter which represents its best estimate of the potential liabilityrelated to this claim.  

 

**7.****              Subsequent Events**

** **

InOctober 2007, the Company completed its initial public offering, selling 4,427,500shares of common stock for net proceeds, after underwriting discounts andestimated offering expenses, of approximately $41.9 million.

 

Inconnection with the initial public offering, the Company on October 5, 2007effected a one-for-sixteen reverse stock split with respect to its outstandingcommon stock.  In addition, at theclosing of the offering on October 31, 2007, all outstanding shares of theCompany’s redeemable convertible preferred stock were converted into anaggregate of 8,873,412 shares of common stock.

 

12

----

 

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

 

**Overview**

 

We design, manufactureand market the SurgASSIST® system of computer-assisted, power-actuatedendomechanical surgical instruments, which we refer to as Intelligent SurgicalInstrumentsTM. Surgeons use our Intelligent Surgical Instruments for cutting,stapling and tissue manipulation in a variety of procedures in open surgery,minimally invasive surgery, or MIS, and in the emerging field of naturalorifice translumenal endoscopic surgery, or NOTES. Our SurgASSIST system hasbeen used in an estimated 30,000 surgical procedures in more than 350 hospitalsand medical institutions worldwide. 

 

Since our inception, wehave devoted substantially all our resources to the development andcommercialization of our SurgASSIST system and, more recently, to the expansionof our manufacturing and direct sales and marketing operations. We currentlyoutsource the manufacture of components such as machined and molded parts,mechanical sub-assemblies and circuit boards and perform the final assembly andtesting of our products in our Langhorne, Pennsylvania facility. We sell ourIntelligent Surgical Instruments through our direct sales force in the UnitedStates, parts of Europe and Japan and through distributors in other parts ofEurope. 

 

We have incurred netlosses in each year since our inception and have an accumulated deficit atSeptember 30, 2007 of $159.2 million. We expect our losses tocontinue through at least 2008 as we develop and introduce our next generationof Intelligent Surgical Instruments and build the infrastructure necessary tosupport our anticipated sales growth. To date, we have financed our operationsprimarily through the initial public offering of our common stock, privateplacements of our preferred stock and the issuance of debt. 

 

**FinancialOperations Overview**

 

The following is adescription of the principal components of our sales and expenses and ofsignificant trends and challenges that we believe are important to anunderstanding of our business and results of operations. 

 

*Sales.*    OurSurgASSIST surgical platform includes cutting and stapling devices in a varietyof sizes and linear, right angle and circular configurations designed fordiffering surgical needs.  OurIntelligent Surgical Instruments are available as disposable, single-patientdevices as well as in a reusable multiple-patient format which can beautoclaved and used in multiple cases. Our reusable Intelligent SurgicalInstruments use disposable cutting and stapling cartridges in various sizes,which we refer to as reload cartridges. 

 

In the originalconfiguration of our system, our Intelligent Surgical Instruments must beconnected through a flexible shaft, or FlexShaft, to a power console and, insome cases, a separate remote control unit. Our next generation products,beginning with the i60 linear stapler that we introduced in September 2007,will be self-contained hand held instruments that do not require a FlexShaft orseparate power console. 

 

13

----

 

Most of our revenue hasbeen derived from the sale of our single-patient, disposable IntelligentSurgical Instruments and, to a lesser extent, from the sale of reloadcartridges for our reusable Intelligent Surgical Instruments. We expect that,as our installed base of reusable, multiple-patient Intelligent SurgicalInstruments grows, sales of reload cartridges will become the largest componentof our total sales. We have not historically derived, and do not expect toderive, substantial sales from the sale of power consoles. Currently, we makepower consoles and related accessories such as remote control units availableto institutions at no charge. We also instituted a program in 2007 related toour reusable PLC 60 instrument or our FlexShafts, whereby we make theinstrument or FlexShaft available to the customer at no cost, in exchange for acommitment by the customer to purchase a minimum number of reload cartridges ata higher unit price. 

 

*Cost ofsales.*    Cost of sales includes the costof supplies, components and sub-assemblies that we purchase from third partiesand use in the assembly of our products. Cost of sales also includes personnelcosts and overhead related to our assembly and test operations, relatedoccupancy, equipment depreciation, shipping costs and charges for inventory obsolescence.

 

Since the introduction ofour SurgASSIST system in 2001, our gross margins have ranged from a negativegross margin of 56.9% in 2002 to a positive gross margin of 24.7% in the threemonths ended September 30, 2007. Our high cost of sales has been attributableto a number of factors, including product defects that have required rework byus and by our suppliers, a labor-intensive manual assembly process that hasresulted in high labor costs, and excess manufacturing capacity in relation toour sales, which has resulted in inefficient absorption of manufacturingoverhead. 

 

In order to achieve andsustain profitability, we will need to devote substantial resources toimproving our procurement and manufacturing processes, upgrading our managementinformation systems, and implementing new quality assurance, inventory and costcontrols in order to reduce the cost of the components we purchase from thirdparty vendors and improve the efficiency of our manufacturing operations. Wehave recently acquired the capital equipment necessary to enable us to assemblethe reload cartridges that are used in our reusable multiple-patient linearstaplers, which we currently purchase from a contract manufacturer.  Installation of the equipment is anticipatedin December 2007.  We believe this willenable us to significantly reduce the cost of these components, while alsoenabling us to better control their supply and quality. However, we cannotassure you that manufacturing yields or costs will not be adversely affected,at least initially, by the transition to in-house production or to newproduction processes. Because we have limited experience in manufacturing ourproducts in commercial quantities, increasing our manufacturing capacity tosupport our planned sales growth while significantly improving our grossmargins and maintaining product quality will involve significant challenges. 

 

*Researchand development expenses.*    Research anddevelopment expenses consist primarily of salaries and related expenses and overheadfor our research, development and engineering personnel, prototype materialsand research studies. We expense our research and development costs asincurred. 

 

14

----

 

Our research anddevelopment expenses have fluctuated significantly in dollar amount and as apercentage of sales in the last five years, due primarily to the timing ofresearch and development efforts associated with significant new productintroductions. We anticipate that our research and development expenses willincrease as we continue to invest in the development of new products andtechnologies. 

 

*Salesand marketing expenses.*    Sales andmarketing expenses consist primarily of salaries and related expenses, salescommissions and overhead for personnel performing sales and marketingfunctions. Other significant sales and marketing expenses include travel andentertainment expense, costs of attending medical conferences and trade shows,clinician training and other promotional costs and costs of demonstrationsystems and samples. 

 

Our sales and marketingexpenses have substantially exceeded our sales in each year since 2004, and weexpect that they will continue to increase significantly as we invest inbuilding the sales and marketing organization and administrative infrastructurenecessary to support our planned sales growth. 

 

*Generaland administrative expenses.*    Generaland administrative expenses consist primarily of salaries and related expensesand overhead for personnel performing executive, finance, informationtechnology and human resource functions. Other significant general andadministrative expenses include consulting fees and professional fees for legalservices (including services related to obtaining and maintaining protection ofour intellectual property) and accounting services. 

 

*Interestincome.*    Interest income consists ofinterest earned on our cash and cash equivalents. 

 

*Interestexpense.*    Interest expense consists ofinterest expense on our convertible promissory notes and equipment loans. 

 

**InternalControl over Financial Reporting**

 

Our management determinedthat as of September 30, 2007 and December 31, 2006, we had a material weaknessin our internal control over financial reporting related to our financialstatement close process that, until remediated, results in more than a remotelikelihood that a material misstatement to the annual or interim consolidatedfinancial statements could occur and not be prevented or detected by ourinternal controls in a timely manner. We concluded that there is a materialweakness in our internal control over financial reporting because we do nothave a sufficient number of personnel with the appropriate level of experienceand technical expertise to appropriately resolve non-routine and complexaccounting matters or to evaluate the impact of new and existing accountingpronouncements on our consolidated financial statements while completing thefinancial statement close process. In order to remediate this material weakness,we are taking the following actions: 

 

•                  weare actively seeking additional accounting and finance staff members, includinga senior accounting officer, to augment our current staff and to improve theeffectiveness of our financial statement close process; and 

 

15

----

 

•                  wewill also expand the training and education of our accounting and finance staffmembers in an effort to improve their effectiveness.  

 

Notwithstanding thematerial weakness that existed as of September 30, 2007 andDecember 31, 2006, our management has concluded that the consolidatedfinancial statements included elsewhere in this prospectus present fairly, inall material respects, our financial position, results of operation and cashflows in conformity with U.S. generally accepted accounting principles. 

 

**CriticalAccounting Policies and Estimates**

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expenses during thereporting period. These estimates and judgments are inherently subject touncertainty. On an ongoing basis, we re-evaluate our judgments and estimates,including those related to uncollectible accounts receivable, inventories,recoverability of long-lived assets, stock-based compensation, accrued expensesand other contingencies. We base our estimates and judgments on our historicalexperience and on other assumptions that we believe are reasonable under thecircumstances, the results of which form the basis for making the judgmentsabout the carrying values of assets and liabilities that are not readilyapparent from other sources. Actual results could differ from those estimates,and material effects on our operating results and financial position couldresult. 

 

For a description ofthose of our accounting policies that, in our opinion, involve the mostsignificant application of judgment or involve complex estimation and whichcould, if different judgments or estimates were made, materially affect ourreported results of operations, see “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations—Critical Accounting Policies andEstimates” in our Registration Statement on Form S-1, Commission No.333-142926. 

 

**Resultsof Operations**

 

**Three and nine month periods ended September 30, 2007and September 30, 2006**

** **

*Sales.*  Our sales in the three monthsended September 30, 2007 increased by 11.8%, to $1.7 million compared with $1.5million during the corresponding period in 2006, due to increased sales of ourPLC 75 and RALC products. Our sales in the nine months ended September 30, 2007decreased by 2.5%, to $5.9 million compared with $6.0 million during thecorresponding period in 2006. The decrease in 2007 sales was the result of thelimited availability of our reload cartridges for the PLC 60 product during2007 and the decision by management to stop selling PLC 60 product in the thirdquarter of 2007 in anticipation of the launch of the i60 which occurred inSeptember 2007.

 

16

----

 

*Cost of sales and gross profit.*  Ourcost of sales in the three months ended September 30, 2007 decreased by 41.6%,to $1.3 million compared with $2.2 million during the corresponding periodin 2006. Our cost of sales in the nine months ended September 30, 2007decreased by 33.9%, to $4.6 million compared with $6.9 million during thecorresponding period in 2006. Our gross profit increased to $0.40 million, or24.7% of sales, in the three months ended September 30, 2007 from $(0.7)million, or (44.3%) of sales, during the corresponding period in 2006.   The increase in our gross profit and ourgross margin percentage was attributable to increased efficiency of ourmanufacturing operations in Langhorne, Pennsylvania and, to a lesser extent, tolower charges for inventory obsolescence in 2007.  The increase in gross margin in 2007 is alsoin part attributable to higher sales of lower cost circular and right anglelinear products versus higher cost straight linear cutter products in 2006. Weexpect our gross margins to continue to improve over the balance of 2007 and2008.  Initiatives to improve theefficiency of our manufacturing operations through increased automation andenhanced systems and controls and increased sales should allow us to moreeffectively utilize our manufacturing capacity.

 

*Research and development expenses.*  Ourresearch and development expenses in the three months ended September 30, 2007increased by 86.1%, to $1.8 million compared with $ 1.0 million during thecorresponding period in 2006.  Researchand development costs increased as a percentage of sales to 107.0% in the threemonths ended September 30, 2007, compared with 64.3% of sales during thecorresponding period in 2006. Our research and development expenses in the ninemonths ended September 30, 2007 increased by 29.5%, to $4.4 million comparedwith $3.4 million during the corresponding period in 2006 and increased as apercentage of sales to 74.2% of sales in the nine months ended September 30, 2007compared with 55.9% of sales during the corresponding period in 2006.  The expense increases in both dollars andpercentage of sales was due to increases in prototype and component costs, andcompensation expenses associated with incremental headcount.  We expect our research and developmentexpenses to continue to increase as we invest in new products.

 

*Sales and marketing expenses.*  Oursales and marketing expenses in the three months ended September 30, 2007increased by 30.4%, to $4.0 million, compared with $3.0 million during thecorresponding period in 2006, and increased as a percentage of sales to233.8%  of sales in the three monthsended September 30, 2007.  This comparesto 200.4% of sales during the corresponding period in 2006. Our sales andmarketing expenses in the nine months ended September 30, 2007 increased by19.1%, to $11.1 million, compared with $9.3 million during the correspondingperiod in 2006 and increased as a percentage of sales to 188.1 %  of sales in the nine months ended September30, 2007.  This compares to 154.0% ofsales during the corresponding period in 2006. The increase in both dollaramount and percentage of sales was due to sales force expansion, training costsand planned increases in marketing expense associated with trade shows andconventions.

 

*General and administrative expenses.*  Ourgeneral and administrative expenses in the three months ended September 30,2007 were $2.0 million, consistent with the corresponding period in 2006, anddecreased as a percentage of sales to 117.9% of sales in the three months endedSeptember 30, 2007.  This compares to131.1% of sales during the corresponding period in 2006. Our general andadministrative expenses in the nine months ended September 30, 2007 increasedby 20.9%, to $6.3 million compared with $5.2 million during thecorresponding period in 2006 and

 

17

----

 

increasedas a percentage of sales to 107.4% of sales in the nine months ended September30, 2007.  This compares to 86.7% ofsales during the corresponding period in 2006. The increase in dollar amountand percentage of sales was due to higher salaries, stock-based compensationexpense and recruitment costs associated with the hiring of additionalexecutive personnel.

* *

*Interest income.*  Ourinterest income in the three months ended September 30, 2007 decreased by24.2%, to $0.2 million  comparedwith $0.3 million during the corresponding period in 2006, due to lower averagecash balances during the three months ended September 30, 2007. Our interestincome in the nine months ended September 30, 2007 increased by 76.1%, to $0.6million compared with $0.3 million during the corresponding period in 2006. Theincrease was the result of the investment of higher average cash balancesresulting from our issuance of $25.0 million convertible debt in March 2007.

 

*Interest expense.*  Ourinterest expense in the three months ended September 30, 2007 increased by346.9%, to $1.1 million compared with $0.2 million during the correspondingperiod in 2006. Our interest expense in the nine months ended September 30,2007 increased by 121.9 %, to $2.2 million compared with $1.0 million duringthe corresponding period in 2006. The increases were the result of interestexpense related to our convertible debt issued in March 2007. 

 

**Liquidityand Capital Resources**

 

Since our inception, wehave financed our operations primarily through private placements of ourpreferred stock, unsecured borrowings from our stockholders, a credit facilityand, more recently, the issuance in March 2007 of our convertible notes inthe aggregate principal amount of $25.0 million and our initial publicoffering in October 2007, in which we received net proceeds, after underwritingdiscounts and offering expenses, of approximately $41.9 million. Our principalsource of liquidity as of September 30, 2007 consisted of our cash and cashequivalents of $5.7 million and our accounts receivable balance of $1.5million. 

 

In the first nine monthsof 2007, our operating activities used $20.8 million in cash, dueprimarily to our net operating loss of $22.1 million. We used cash of $1.1million for prepaid expenses and other assets, and $1.3 million to increaseinventory, primarily raw materials and components required for assembly of ouri60 instrument and reload cartridges, which we manufacture ourselves ratherthan purchasing them from contract manufacturers. These uses were partiallyoffset by a $1.4 million increase in accounts payable and accrued expenses. Ofour other non-cash expenses of approximately $2.2 million, the largestcomponent was depreciation and amortization of $1.8 million. We used$4.1 million in our investing activities, primarily consisting ofpurchases of property and equipment of $1.3 million and an increase inrestricted cash of $2.5 million, attributable to interest payments of $3.5million required to be deposited in escrow pursuant to our convertible noteagreements, which was offset by approximately $875,000 of interest paid fromthe escrow account to the holders of the notes and by the release of $140,000of cash which previously served as collateral under a letter of credit whichrelates to our lease agreement for our facility in Langhorne, Pennsylvania. Our financingactivities provided $22.3 million of cash, including $23.6 million ofnet proceeds from the issuance of our convertible notes, and $638,000 from theissuance of common stock, offset by $1.9 million of financing costs paidrelated to our initial public offering.

 

We believe that our cashand cash equivalents, including the proceeds of our convertible notes and ourinitial public offering, will be sufficient to meet our anticipated cashrequirements

 

18

----

 

through at least 2008.Our future cash requirements will depend on many factors, including our rate ofsales growth, if any, the timing and extent of spending to support new productdevelopment efforts, the expansion of our sales and marketing activities, thetiming and introductions of new products and the amount and timing of capitalinvestments we make and cost we incur to expand our manufacturing capacity. 

 

**Item 3.            Quantitativeand Qualitative Disclosures About Market Risk.**

 

We do not utilize derivative financial instruments, derivativecommodity instruments or other market risk sensitive instruments, positions ortransactions.

 

We are exposed to marketrisk in the ordinary course of business, which consists primarily of interestrate risk associated with our cash and cash equivalents and debt and foreignexchange rate risk. 

 

*Interestrate risk.*  AtSeptember 30, 2007, we had $5.7 million of cash and cash equivalents. Theseamounts were invested primarily in money market funds.  The primary objective of our investment activityis to preserve principal, provide liquidity and maximize income withoutincreasing risk.  Our investments havelimited exposure to market risk. The interest rates are variable and fluctuatewith current market conditions. The risk associated with fluctuating interestrates is limited to our investments in money market funds, and we do notbelieve that a 10% change in interest rates would have a material impact on ourfinancial position or results of operations. 

 

The interest rate on our7% convertible senior secured promissory notes is fixed and therefore exposesus to limited market risk. 

 

*Foreigncurrency risk.*  Todate, our international customer agreements have been denominated primarily inthe local currency of the international customer.  The functional currency of our foreignoperations in Europe and Japan is the local currency and, as a result, anyfluctuation in the exchange rates of these net assets, denominated in localcurrency, would be reflected in the translation gains or losses, which are accountedfor in other comprehensive income in our statements of changes in equity. We donot believe that a change of 10% in the foreign currency exchange rates wouldhave a material impact on our financial position or results of operations.  

 

19

----

 

**Item 4.            Controlsand Procedures.**

 

Our chief executive officer and chief financial officer have performedan evaluation of the effectiveness of the design and operation of ourdisclosure controls and procedures as of September 30, 2007. Based on thatevaluation, our chief executive officer and chief financial officer concludedthat, as of September 30, 2007, our disclosure controls and procedureswere ineffective, due to the material weaknesses in our internal control overfinancial reporting previously described in our Registration Statement on FormS-1, Commission File No. 333-142926, which identified the following materialweaknesses that have not been fully remediated as of September 30, 2007: 

 

Our management has determined that we have a material weakness in ourinternal control over financial reporting related to not having a sufficientnumber of personnel with the appropriate level of experience and technicalexpertise to appropriately resolve non-routine and complex accounting mattersor to evaluate the impact of new and existing accounting pronouncements on ourconsolidated financial statements while completing the financial statementclose process. Until this design deficiency in our internal control overfinancial reporting is remediated, there is more than a remote likelihood thata material misstatement to our annual or interim consolidated financialstatements could occur and not be prevented or detected by our internalcontrols in a timely manner.  

 

Ourefforts to remediate this material weakness in our internal controls overfinancial reporting through the hiring and training of additional qualifiedfinancial and accounting personnel are currently in process, and consist of thefollowing:

 

•                  weare actively seeking additional accounting and finance staff members, includinga senior accounting officer, to augment our current staff and to improve theeffectiveness of our financial statement close process; and 

 

•                  wewill also expand the training and education of our accounting and finance staffmembers in an effort to improve their effectiveness.  

 

Exceptas set forth above, there was no change in our internal control over financialreporting during our most recent fiscal quarter that has materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

 
| **PART II:** | **OTHER  INFORMATION**  |
|--------------|-------------------------|
|         |                    |
| **Item 1:**  | **Legal  Proceedings.** |

 

*Product liability suit in Belgium.*    In earlyDecember 2004, we were made a party to a lawsuit filed in a Belgian courton September 30, 2004 by a patient and his co-habiting female partneragainst the insurer for a Belgian surgeon and hospital as well as against PMI’sformer Belgian distributor. The complaint alleged that the patient suffered injuriesas a result of a surgery performed using one of our surgical instruments. Thecomplaint alleged that our instrument was “deficient” and claimed estimateddamages in the amount of €100,000 with “reservation for modification during theproceedings.” We have notified our insurance carrier of the lawsuit, and

 

20

----

 

thecarrier has not disclaimed coverage. We intend to continue to contest the claimwith the assistance of U.S. and Belgian counsel.

 

*Patent litigation against Ethicon Endo-Surgery in Germany.*    In March 2005,Ethicon Endo-Surgery initiated three patent infringement lawsuits against usand our German subsidiary in district court in Düsseldorf, Germany. Thelawsuits allege that certain of our products infringe the German counterpartsof three European patents owned by Ethicon Endo-Surgery, which we refer to asthe Hoover, Clark and Rothfuss patents. We hired German counsel to defend thepatent infringement cases and to seek revocation of Ethicon Endo-Surgery’spatents in nullity proceedings before a separate court in Munich, Germany.

 

Weprevailed in the Hoover patent infringement action, and the products inquestion were found not to infringe this patent. Ethicon Endo-Surgery did notappeal the infringement decision, and the case is closed. A decision in thenullity action related to the Hoover patent is expected before the end of 2007.

 

Weprevailed in both the infringement and nullity actions related to the Clarkpatent; the products in question were found not to infringe this patent, andthe nullity court recently declared the asserted patent revoked. EthiconEndo-Surgery is appealing both the infringement and nullity decisions. Theinfringement appeal has been stayed by the appellate court until the finaloutcome of the nullity proceedings, which is not expected before 2010.

 

Welost the infringement action related to the Rothfuss patent, which concerns aparticular stapling cartridge that can be used in our surgical instruments. Weare appealing that infringement decision. We prevailed in the nullity actionrelated to the Rothfuss patent, and the nullity court recently declared theasserted patent revoked.

 

Wehave introduced a redesigned product that would not infringe the Rothfusspatent even if the patent and the infringement decision were upheld. In theRothfuss infringement action, Ethicon Endo Surgery asserts that it is entitledto collect damages of approximately €526,000, and has recently instituteddamages proceedings for part of its claim, asking the Düsseldorf court for apartial damages award of at least €142,000, or alternatively, €263,000.

 

EthiconEndo-Surgery has not yet appealed the Rothfuss patent nullity decision. IfEthicon Endo-Surgery does appeal, we expect the courts before which theRothfuss infringement appeal and the damages action are pending to stay thoseproceedings until final resolution of the Rothfuss nullity action, which is notexpected before 2010.

 

Inthe event Ethicon Endo-Surgery were to prevail in its appeal of the Clarkpatent decisions and in any appeal of the Rothfuss nullity action decision, wemay be precluded from selling certain of our products in Germany.

 

21

----

 

**Item 1A.            RiskFactors.**

 

**Risks Related to Our Business**

 

**We have incurred losses since inception and anticipate thatwe will incur continued losses for the foreseeable future.**

** **

Weare a company with a limited operating history and have sustained net lossessince our inception, including a net loss of $22.1 million for the nine monthsended September 30, 2007 and a net loss of $28.3 million for the yearended December 31, 2006.  We had anaccumulated deficit of $159.2 million at September 30, 2007. Weexpect to continue to incur significant operating losses at least through 2008,as we invest in the development of our business. Additionally, we expect thatour general and administrative expenses will increase due to additionaloperational and regulatory burdens associated with being a public company. Ourlosses have had and will continue to have an adverse effect on our stockholders’equity and working capital.

 

**We are dependent on the success of our SurgASSIST platformand cannot be certain that our technology and our products will achieve the broadmarket acceptance necessary to develop a sustainable, profitable business.**

** **

Oursales are primarily derived from the sale of our Intelligent SurgicalInstruments and our staple and cutter reloads. We expect that sales of ourcurrent suite of products will continue to account for most of our sales for atleast the next twelve months. It is difficult to predict the penetration,future growth rate or size of the market for our SurgASSIST platform.

 

Thecommercial success of our various Intelligent Surgical Instruments will requirebroad acceptance of the SurgASSIST platform by the surgeons who specialize inthe procedures we target, a limited number of whom may be able to influencedevice selection and purchasing decisions. If the concept of computer-assistedpower-actuated devices for tissue manipulation, cutting and stapling is notbroadly accepted and perceived as having significant advantages overmanually-actuated devices, then we will not meet our business objectives. Broadacceptance of our SurgASSIST platform will require a determination by hospitalsand surgeons that our products are safe, cost-effective and representacceptable methods of treatment. In addition, certain components of ourSurgASSIST platform in its current configuration may be considered to becapital purchases that require administrative procedures and approvals fromsenior hospital management, the result of which can be an extended sales cyclerequiring multiple individuals to believe in the advantages of our products. Wecannot assure that our existing relationships and arrangements with hospitalsand surgeons can be maintained or that new relationships will be established insupport of our products. In addition, our competitors may develop newtechnology for tissue manipulation, cutting and stapling that is moreattractive to surgeons and hospitals. If surgeons do not consider our productsto be suitable for application in the procedures we are targeting and animprovement over the use of competing products, our business goals will not berealized.

 

22

----

 

**The success of our business is dependent on our ability todevelop new and innovative products and to enhance our existing products. Wehave experienced significant delays in new product introduction in 2006 and2007, and if we do not achieve our current development goals in the time frameswe expect, the commercialization of our new products may be delayed and, as aresult, our operations may be adversely affected.**

** **

Thesuccess of our business is dependent on our ability to develop new products, tointroduce enhancements to our existing products and to develop these newtechnologies within targeted time frames. These target estimates are based on avariety of assumptions. The actual timing of these milestones can varydramatically compared to our estimates for reasons that may or may not bewithin our control. For example, the commercial release of our PLC 60linear stapler in 2006 was delayed almost nine months due to product designflaws and supply chain problems, and our ability to generate revenue from thePLC 60 staplers that we have placed in hospitals since December 2006 wasadversely affected due to the unavailability in 2007 of certain reloadcartridges for the device. Any further delays in product releases, includingany delays in the broad commercial availability of our i60 untetheredarticulating linear stapler which we introduced in September 2007, maynegatively affect our business. Customers may forego purchases of our existingproducts and purchase our competitors’ products as a result of delays in theintroduction of our new products and enhancements, failure by us to choosecorrectly among technical alternatives or failure by us to offer innovativeproducts or enhancements at competitive prices and in a timely manner. Inaddition, announcements of new products by us or by competitors may result in adelay in or cancellation of purchasing decisions in anticipation of such newproducts. Any such losses could impair the value of your investment.

 

**We have limited manufacturing experience, have experiencedsignificant manufacturing problems in the past, and may encounter difficultiesin increasing production to provide an adequate supply to customers.**

** **

Themanufacture of our products is a complex and costly operation involving anumber of separate processes and components. To date, our manufacturingactivities have consisted primarily of assembling limited quantities of ourproducts. We have considered, and will continue to consider as appropriate,manufacturing components that are currently provided by third parties, as wellas implementing new production processes. We do not have experience inmanufacturing our products in the commercial quantities that might be requiredto market our products in the United States, Europe and Japan. During 2006, weexperienced significant difficulties in our supply chain and manufacturingoperations, which impaired our ability to ship our products on a timely basisand had a material adverse impact on our results of operations for 2006.Similarly, during the first three quarters of 2007 we have experienced delaysin the availability from a third party vendor of a critical component necessaryto enable us to assemble one of the two sizes of reload cartridge that are usedin our PLC 60 linear stapler. Our inability to ship reload cartridges inthis size has adversely affected our ability to generate revenue from thePLC 60 devices we have placed in hospitals.  We currently expect to resume shipping thesereload cartridges in December 2007. Manufacturing of our products in commercial quantities will require usto expand our manufacturing capabilities and to hire and train additionalpersonnel. We expect that any expansion would be achieved through modifiedspace utilization in our current leased facilities, improved efficiencies,increased automation and acquisition of

 

23

----

 

additional tooling and equipment. We may encounter difficulties inincreasing our manufacturing capacity and in manufacturing commercialquantities, including:

 

• maintaining product yields;

 

• maintaining quality control and assurance;

 

• providing component and serviceavailability;

 

• maintaining adequate control policies andprocedures; and

 

• hiring and retaining qualified personnel.

 

Difficultiesencountered in increasing our manufacturing capacity could impact our abilityto adequately supply our customers.

 

**In order to achieve and sustain profitability, we mustsubstantially improve our gross margins.**

** **

Thehistorical unit costs for our products, based on limited manufacturing volumes,have been very high in relation to our sales, resulting in low or negativegross margins. It will be necessary for us to achieve substantial reductions inour cost of sales as a percentage of sales in order to become profitable. Thetransition to in-house production or to new production processes may initiallyhave a negative effect on our manufacturing yields or costs, which wouldmaterially and adversely affect our business, financial condition and resultsof operations. Certain of our manufacturing processes are labor intensive, andachieving significant cost reductions will depend in part upon reducing thetime required to perform these processes. We cannot assure you that we will beable to achieve the significant cost reductions in the manufacture of ourproducts necessary for our business to achieve profitability.

 

**If our products are not considered to be a safe and effectivealternative to existing technologies, we will not be commercially successful.**

** **

OurIntelligent Surgical Instruments rely on new technology, and our successdepends upon acceptance of this technology by the medical community as safe,clinically effective and cost effective and a preferred device as compared toproducts of our competitors. We have not collected, and are not aware thatothers have collected, long-term data regarding efficacy, safety and clinicaloutcomes associated with the use of our products. Any data that is generated inthe future may not be positive or consistent with our current, largelyanecdotal data, which would negatively affect market acceptance and the rate atwhich our Intelligent Surgical Instruments are adopted. Equally important willbe physicians’ perceptions of the safety of our products. Our technology isrelatively new in surgery, and the results of short-term clinical experiencewith our SurgASSIST system do not necessarily predict long-term clinicalbenefits as compared to the products of our competitors. If, over the longterm, our SurgASSIST system does not meet surgeons’ expectations as to safety,efficacy and ease of use, the SurgASSIST system may not become widely adopted.

 

Evenif the data collected from future clinical studies or clinical experienceindicates positive results, each surgeon’s actual experience with our deviceoutside the clinical study setting may vary. Consequently, both short- andlong-term results reported in any future clinical

 

24

----

 

studies may be significantly more favorable than typical results ofother practicing surgeons, which could negatively affect rates of adoption andnegatively affect our results.

 

**Because our markets are highly competitive, customers maychoose to purchase our competitors’ products, which would result in reducedsales and harm our financial results.**

** **

OurSurgASSIST system is a new technology and must compete with the moreestablished manual devices of our competitors, such as United States Surgical Corporation,a business unit of Tyco Healthcare and Covidien (formerly Ethicon Endo-Surgery,Inc.), a Johnson & Johnson company, or Ethicon Endo-Surgery.Conventional manual devices are widely accepted in the medical community, havea long history of use and do not require the purchase of additional, expensivecapital equipment. We cannot be certain that surgeons will use our products toreplace or supplement established treatments or that our products will becompetitive with current or future products and technologies.

 

Mostof our competitors enjoy competitive advantages over us, including:

 

•                  significantly greater name recognition;

 

•                  longer operating histories;

 

•                  established relationships with healthcareprofessionals, customers and third-party payors;

 

•                  established distribution networks;

 

•                  additional lines of products and the abilityto offer rebates or bundle products to offer higher discounts or incentives togain a competitive advantage;

 

•                  greater experience in conducting research anddevelopment, manufacturing, clinical trials, obtaining regulatory clearance forproducts and marketing approved products; and

 

•                  greater financial and human resources forproduct development, sales and marketing and patent litigation.

 

Inaddition, our SurgASSIST system in its original configuration has certainperceived disadvantages compared to conventional manual endomechanical devices.For example, except for our new i60 linear stapler, our Intelligent SurgicalInstruments currently must be tethered by a flexible shaft to a power consolewhich is located outside the sterile field. Some surgeons and operating roompersonnel may find this to be cumbersome and not well suited for allprocedures.

 

Ourfuture success depends upon maintaining a competitive position in thedevelopment of products and technologies in our areas of focus. Our competitorsmay:

 

•                  develop technologies and products that aremore effective than our products or that render our technologies or productsobsolete or noncompetitive;

 

•                  obtain patent protection or otherintellectual property rights that would prevent us from developing or enhancingour products; or

 

•                  obtain regulatory approval for thecommercialization of their products more rapidly or effectively than we do.

 

Additionalcompetitors also may enter our market. As a result, we cannot assure you thatwe will be able to compete successfully against existing or new competitors.Our sales would be

 

25

----

 

reduced or eliminated if our competitors develop and market productsthat are more effective and less expensive than our products. Volatility in thedemand for our products could, among other things, make it more difficult togauge the manufacturing capacity necessary to meet our demand, decrease ourmanufacturing efficiency and increase our working capital requirements. If anyof these occur, your investment in our common stock may decrease in value.

 

**We assemble our Intelligent Surgical Instruments using ourown customized equipment and plan to undertake a new manufacturing process,making us vulnerable to production and supply problems that could negativelyimpact our sales.**

** **

Wepresently use customized equipment for certain steps in the assembly of ourIntelligent Surgical Instruments. Because of the customized nature of ourequipment, we cannot rely on third parties to find new parts or replace theequipment. As a result, we are responsible for maintaining the equipment andfor locating spare parts. If the equipment malfunctions and we are unable tolocate spare parts or hire qualified personnel to repair the equipment, we mayencounter delays in the manufacture of our Intelligent Surgical Instruments andreloads and may not have sufficient inventory to meet our customers’ demands,which could adversely affect our business, financial condition and results ofoperations.

 

Wehave engaged a third party to develop and fabricate an automated system toenable us to assemble our PLC 60 reload cartridges, which we currently assemblemanually. While we believe the use of this new system should reduce our risk ofsupply problems, the automated system must be capable of manufacturing at ouranticipated volume. Manufacture of the automated system was completed in thethird quarter of 2007, and installation of the system is expected to becompleted in December 2007.* * However, there is no guarantee that theautomated system will be completed in a timely manner or that, uponinstallation, it will be able to function at the capacity we require. Uponcompletion, the automated system will be located at our facility in Langhorne,Pennsylvania, which requires us to be responsible for the day-to-day controland protection of the system. Delay in the availability of, or unanticipatedproblems in our utilization of, this automated system could jeopardize ourinitiatives to improve our gross margins.

 

**We are dependent upon a number of key suppliers, includingsole source suppliers, the loss of which would materially harm our business.**

** **

Werely upon sole source suppliers for a number of key components and servicesused in manufacturing our products and, in general, we do not have long-termcontracts with these suppliers. We cannot assure you that we will be able toobtain sufficient quantities of such components or services in the future.Because we do not have long-term contracts, our suppliers generally are notrequired to provide us with any guaranteed minimum production levels.

 

Inaddition, our reliance on third parties involves a number of risks, including,among other things:

 

•                  suppliers may fail to comply with regulatoryrequirements or make errors in manufacturing components that could negativelyaffect the efficacy or safety of our products or cause delays in shipments ofour products;

 

26

----

 

•                  we may not be able to respond tounanticipated changes and increases in customer orders;

 

•                  we may be subject to price fluctuations dueto a lack of long-term supply arrangements for key components;

 

•                  we may experience delays in delivery by oursuppliers due to changes in demand from us or their other customers;

 

•                  we may lose access to critical services andcomponents, resulting in an interruption in the manufacture, assembly andshipment of our systems;

 

•                  fluctuations in demand for products that oursuppliers manufacture for others may affect their ability or willingness todeliver components to us in a timely manner;

 

•                  our suppliers may wish to discontinuesupplying components or services to us for risk management reasons;

 

•                  we may not be able to find new or alternativecomponents or reconfigure our system and manufacturing processes in a timelymanner if the necessary components become unavailable; and

 

•                  our suppliers may encounter financialhardships unrelated to our demand for components, which could inhibit theirability to fulfill our orders and meet our requirements.

 

Ifany of these risks materialize, it could significantly increase our costs andimpact our ability to meet demand for our products.

 

Wecannot quickly replace suppliers or establish additional new suppliers for someof these components, due to both the complex nature of the manufacturingprocess used by our suppliers and the time and effort that may be required toobtain regulatory clearance or approval to use materials from alternativesuppliers. Any significant supply interruption or capacity constraintsaffecting our facilities or those of our suppliers would impair our ability tomanufacture our products.

 

**If we are unable to manage our expected growth, ourperformance may suffer.**

** **

Asof September 30, 2007, we had approximately 197 employees, compared with133 at December 31, 2006.  We will needto continue to expand our managerial, operational, financial and otherresources to manage and fund our operations, continue our research anddevelopment activities, increase the sales force and develop our products. Itis possible that our management, finance, technical and regulatory personnel,systems and facilities currently in place may not be adequate to support thisfuture growth. Our need to effectively manage our operations, growth andprograms requires that we continue to improve our systems and procedures ineach of these areas and to attract and retain sufficient numbers of talentedemployees. We may be unable to successfully implement these tasks on a largerscale and, accordingly, may not achieve our research, development and growthgoals.

 

**We must upgrade and correct deficiencies in our regulatorycompliance operations, and our failure to do so could impair our ability tomarket our products or lead to regulatory enforcement action against us.**

** **

Weare subject to extensive regulation in the United States and other countries,including by the United States Food and Drug Administration, or FDA. Wemaintain an organization of

 

27

----

 

managers, engineers and administrative personnel, consisting of 19persons at September 30, 2007, whose responsibility it is to ensure thatour products, facilities and operations comply with applicable regulatoryrequirements. However, we have during 2007 experienced shortages of qualifiedregulatory compliance staff due to turnover and illness, among other factors,and we need to upgrade and carefully manage our regulatory compliance operationsin order to accommodate our expected growth. The FDA recently inspected our facilities and in April 2007 issueda Notice of Inspectional Observations, or Form 483, which included 24inspectional observations, which are more fully described elsewhere in thisprospectus. We were also inspected by the FDA in 2002, 2003 and 2005, and someof the observations in the FDA’s April 2007 Form 483 are similar tothose we received in earlier inspections. As a result of these events, weconcluded that there are significant deficiencies in our regulatory complianceoperations, and are taking steps to rectify these deficiencies. Among otherthings, we hired a new Senior Vice President of Regulatory Affairs and QualityAssurance, and are seeking to hire a quality assurance manager and additionaltechnical personnel. We also have begun the process of making neededimprovements in our corrective and preventive action, complaint handling andmedical device reporting procedures, in our processes for compliance with otherrequirements of the FDA’s quality system regulations and in our relatedcontrols and internal audit functions. We recently engaged an independentconsultant to audit our compliance with certain aspects of the FDA’s qualitysystem regulations. The consultant noted improvements in our complaintmanagement, failure investigation, medical device report reporting, managementreview, internal audit and corrective and preventative action processes, butalso identified areas for improvement in our FDA quality system regulations ineach of these areas, some of which related to occurrences after the FDA’sApril 2007 Form 483.  If we arenot successful in identifying and recruiting qualified personnel to manage andstaff our regulatory compliance operations or in implementing necessary processimprovements on a timely basis, we could be subject to regulatory enforcementactions which could damage our reputation, impair our ability to obtainregulatory clearances for new products, prevent us from manufacturing and sellingour products and harm our business.

 

**We have a material weakness in our internal control overfinancial reporting, and if we are unable to achieve and maintain effectiveinternal control over financial reporting, investors could lose confidence inour financial statements and our company, which could have a material adverseeffect on our business and stock price.**

** **

Weproduce our consolidated financial statements in accordance with therequirements of United States generally accepted accounting principles, but ourinternal accounting controls may not currently meet all standards applicable tocompanies with publicly traded securities. Effective internal controls arenecessary for us to provide reliable financial reports to help mitigate therisk of fraud and to operate successfully as a publicly traded company.

 

Wehave concluded that there is a material weakness in our internal control overfinancial reporting because we do not have a sufficient number of personnelwith the appropriate level of experience and technical expertise toappropriately resolve non-routine and complex accounting matters or to evaluatethe impact of new and existing accounting pronouncements on our consolidatedfinancial statements while completing the financial statement close process. Amaterial weakness is a control deficiency, or a combination of controldeficiencies, that results in

 

28

----

 

morethan a remote likelihood that a material misstatement of annual or interimfinancial statements would not be prevented or detected. Until this designdeficiency in our internal control over financial reporting is remediated,there is more than a remote likelihood that a material misstatement to ourannual or interim consolidated financial statements could occur and not beprevented or detected by our internal controls in a timely manner.

 

Pursuantto Section 404 of the Sarbanes-Oxley Act of 2002, when we file our AnnualReport on Form 10-K for the fiscal year ending December 31, 2008, wemust assess the effectiveness of our internal control over financial reportingas of the end of our fiscal year. This assessment must include disclosure ofany material weaknesses in our internal control over financial reporting thatare identified by management. The report must also contain a statement that ourindependent registered public accounting firm has issued an attestation reporton management’s assessment of such internal controls.

 

Ifwe are unable to assert that our internal control over financial reporting iseffective because the material weakness identified above has not beenremediated, or for any other reason, or if our independent registered publicaccounting firm is unable to attest that our management’s report is fairlystated or it is unable to express an opinion on the effectiveness of ourinternal controls, investors could lose confidence in the accuracy andcompleteness of our financial reports, which could have an adverse effect onour stock price.

 

**Any failure in our training efforts could result in lowerthan expected product sales and potential liabilities.**

** **

Acritical component of our sales and marketing efforts is the training of asufficient number of surgeons, other clinicians and hospital staff to properlyuse our SurgASSIST system. We rely on clinicians and hospital staff to devoteadequate time to learn to use our products. If surgeons or hospital staff arenot properly trained in the use of our Intelligent Surgical Instruments, theymay misuse or ineffectively use our products. For example, we have receivedreports of incomplete firings of our reusable PLC 60 instrument that we believeare attributable to improper installation of reload cartridges by our customers’medical personnel. We have initiated improvements in our training procedures toalert customers to the need to properly seat the reload cartridges, and alsoare designing new versions of the reload cartridge to incorporate a positivelocking feature that will make this error less likely to occur.

 

However,if nurses or other members of the hospital staff are not adequately trained toassist in using our SurgASSIST system, surgeons may be unwilling to use ourproducts, and insufficient training may result in unsatisfactory patientoutcomes, patient injury and related liability or negative publicity, whichcould have an adverse effect on our product sales.

 

**The use of our products could result in product liabilityclaims that could be expensive, divert management’s attention and harm ourreputation and business.**

** **

Ourbusiness exposes us to significant risks of product liability claims that areinherent in the testing, manufacturing and marketing of medical devices. Themedical device industry has historically been subject to extensive productliability litigation. We have in the past been, and in

 

29

----

 

the future may be, subject to claims by consumers, healthcareproviders, third-party payors or others selling our products if the use of ourproducts were to cause, or merely appear to cause, injury or death. We arecurrently the subject of a product liability suit in Belgium. Any weakness intraining and service associated with our products may also result in productliability lawsuits. Additionally, we may be unable to maintain our existingproduct liability insurance in the future at satisfactory rates or adequateamounts. A product liability claim, regardless of its merit or eventual outcomeor the availability of insurance coverage, could result in:

 

•                  decreased demand for our products;

 

•                  injury to our reputation;

 

•                  diversion of management’s attention;

 

•                  significant costs of related litigation;

 

•                  substantial monetary awards to patients;

 

•                  product recalls or market withdrawals;

 

•                  loss of sales; and

 

•                  the inability to successfully commercializeour products that are under development.

 

**If we deliver products with defects, our credibility may beharmed and market acceptance of our products may decrease.**

** **

Themanufacturing and marketing of our products involve an inherent risk of productliability claims. In addition, our product development and production processesare complex and could expose our products to defects. Our SurgASSIST systemincorporates sophisticated computer software. Complex software frequentlycontains errors, especially when first introduced. We cannot assure you thatour software will not experience errors or performance problems in the future.If our products contain mechanical defects, or software errors, or haveperformance problems, we would likely experience:

 

•                  loss of sales;

 

•                  delay in market acceptance of our products;

 

•                  damage to our reputation;

 

•                  additional regulatory filings;

 

•                  product recalls;

 

•                  increased service or warranty costs; or

 

•                  product liability claims.

 

**We may need substantial additional funding and we may beunable to raise capital when needed, which would force us to delay, reduce oreliminate our product development programs or commercialization efforts.**

** **

Webelieve that the net proceeds from our recent initial public offering, togetherwith our future sales, existing cash and cash equivalent balances and interestwe earn on these balances, will be sufficient to meet our anticipated cashrequirements for at least the next twelve months. However, our actual capitalrequirements will depend on many factors, many of which are outside ourcontrol, including:

 

30

----

 

•                  future revenue generation;

 

•                  future operating expenses, including plannedincreases in our research and development and sales and marketing expenses;

 

•                  the cost of filing and prosecuting patentapplications and defending and enforcing our patent and other intellectualproperty rights;

 

•                  the cost of defending, in litigation orotherwise, any claims that we infringe third party patent or other intellectualproperty rights;

 

•                  the cost and timing of regulatory approvals;

 

•                  expenses of future clinical studies;

 

•                  the effect of competing technological andmarket developments;

 

•                  licensing technologies for futuredevelopment; and

 

•                  the extent to which we acquire or invest inbusinesses, products and technologies, although we currently have nocommitments or agreements relating to any of these types of transactions.

 

Historically,we have financed our operations and internal growth primarily through privateplacements of equity securities and debt and, more recently, our initial publicoffering. We cannot be certain that additional public or private financing willbe available in amounts acceptable to us, or at all. If we raise additionalfunds by issuing equity securities, you may experience dilution. Debtfinancing, if available, may involve restrictive covenants. Any debt financingor additional equity that we raise may contain terms that are not favorable tous or our stockholders. Substantially all our assets are subject to a securityinterest in favor of the holders of our convertible notes, which may limit ourability to obtain additional debt financing. Additionally, if we default in thepayment of our convertible notes, our noteholders will be entitled to exercisetheir rights as secured creditors, which include the right to foreclose on theassets we have provided as collateral, which could materially impair ourability to continue to operate our business.

 

Ifwe are unable to raise additional funds when needed, we may have to delay orreduce the scope of or eliminate some or all of our development programs or wemay be forced to seek protection under applicable bankruptcy laws. Anyrestructuring or bankruptcy could materially impair your investment.

 

**We sell our systems internationally and are subject tovarious risks relating to these international activities, which could adverselyaffect our business, financial condition and results of operations.**

** **

Inthe first nine months of 2007, 22% of our sales occurred in internationalmarkets.  In 2006, 21% of our salesoccurred in international markets.  Bydoing business in international markets, we are exposed to risks separate anddistinct from those we face in our domestic operations. Our internationalbusiness may be adversely affected by changing economic conditions in foreigncountries. Because most of our international sales are denominated in thefunctional currency of the country where the product is being shipped,increases or decreases in the value of the U.S. dollar relative to foreigncurrencies could affect our results of operations. Engaging in internationalbusiness inherently involves a number of other difficulties and risks,including:

 

31

----

 

•                  export restrictions and controls relating totechnology and government regulation;

 

•                  the availability and level of reimbursementwithin prevailing foreign healthcare payment systems;

 

•                  pricing pressure that we may experienceinternationally;

 

•                  required compliance with existing andchanging foreign regulatory requirements and laws;

 

•                  laws and business practices favoring localcompanies;

 

•                  longer payment cycles;

 

•                  difficulties in enforcing agreements andcollecting receivables through certain foreign legal systems;

 

•                  political and economic instability;

 

•                  potentially adverse tax consequences, tariffsand other trade barriers;

 

•                  international terrorism and anti-Americansentiment;

 

•                  difficulties and costs of staffing andmanaging foreign operations; and

 

•                  difficulties in enforcing intellectualproperty rights.

 

Ourexposure to each of these risks may increase our costs, impair our ability tomarket and sell our products and require significant management attention. Wecannot assure you that one or more of these factors will not harm our business.

 

**If we choose to acquire or invest in new and complementarybusinesses, products or technologies instead of developing them ourselves, suchacquisitions or investments could disrupt our business.**

** **

Wemay attempt to expand our business through acquisitions. To the extent we growour business through acquisitions, our future success may be partiallydependent upon our ability to effectively integrate acquired businesses withour own. There can be no assurance that our acquisitions will be successfullyintegrated or that any such acquisitions will otherwise be successful. If ouracquisitions are unsuccessful for any reason, our business may be harmed andthe value of your investment may decline.

 

**We are dependent upon key personnel, the loss of any of whichcould harm our business.**

** **

Ourfuture business and operating results depend significantly on the continuedcontributions of our key technical personnel and senior management,particularly those of our co-founder, Chief Executive Officer and President,Michael P. Whitman. These individuals and the services they provide would bedifficult or impossible to replace. While we are subject to certain severanceobligations to Mr. Whitman, either he or we may terminate his employmentat any time and for any lawful reason or for no reason. Our business and futureoperating results also depend significantly on our ability to attract andretain qualified management, manufacturing, technical, regulatory, marketing,sales and support personnel for our operations. Competition for such personnelis intense, and there can be no assurance that we will be successful in attractingor retaining such personnel.

 

Althoughwe have key-person life insurance in the amount of $2.0 million on thelife of Mr. Whitman, this amount would not fully compensate us for theloss of Mr. Whitman’s services.

 

32

----

 

The loss of key employees, the failure of any key employee to performor our inability to attract and retain skilled employees, as needed, could harmour business.

 

**Lack of third-party coverage and reimbursement for ourproducts could delay or limit their adoption.**

** **

Wemay experience limited sales growth resulting from limitations onreimbursements made to purchasers of our products by third-party payors, and wecannot assure you that our sales will not be impeded and our business harmed ifthird-party payors fail to provide reimbursement that hospitals view asadequate.

 

Inthe United States, our products are purchased primarily by medicalinstitutions, which then bill various third-party payors, such as the Centersfor Medicare and Medicaid Services, or CMS, which administers the Medicareprogram, and other government programs and private insurance plans, for thehealthcare services provided to their patients. The process involved inapplying for coverage and incremental reimbursement from CMS is lengthy andexpensive.

 

Moreover,many private payors look to CMS in setting their reimbursement policies andamounts. If CMS or other agencies limit coverage for procedures utilizing ourSurgASSIST system or decrease or limit reimbursement payments for doctors andhospitals, this may affect coverage and reimbursement determinations by manyprivate payors.

 

Ifa medical device does not receive incremental reimbursement from CMS, then amedical institution would have to absorb the cost of our products as part ofthe cost of the procedure in which the products are used. Acute care hospitalsare now generally reimbursed by CMS for inpatient operating costs under aMedicare hospital inpatient prospective payment system. Under the Medicarehospital inpatient prospective payment system, acute care hospitals receive afixed payment amount for each covered hospitalized patient based upon theDiagnosis-Related Group, or DRG, to which the inpatient stay is assigned,regardless of the actual cost of the services provided. At this time, we do notknow the extent to which medical institutions would consider insurers’ paymentlevels adequate to cover the cost of our products. Failure by hospitals andsurgeons to receive an amount that they consider to be adequate reimbursementfor procedures in which our products are used could deter them from purchasingour products and limit our sales growth. In addition, pre-determined DRGpayments may decline over time, which could deter medical institutions frompurchasing our products. If medical institutions are unable to justify thecosts of our products, they may refuse to purchase them, which wouldsignificantly harm our business.

 

**Our operations are currently conducted primarily at a singlelocation that may be at risk from fire, earthquakes, terror attacks or otherdisasters.**

** **

Wecurrently conduct all of our manufacturing and management activities andcertain research and development activities at a single location in Langhorne,Pennsylvania. We have taken precautions to safeguard our facilities, includinginsurance, health and safety protocols and off-site storage of computer data.However, a casualty due to fire or natural disaster, such as an earthquake,storm or terrorist attack, could cause substantial delays in our operations,damage or

 

33

----

 

destroy our equipment or inventory and cause us to incur additionalexpenses. A disaster could seriously harm our business and results ofoperations. Our insurance does not cover earthquakes and floods and may not beadequate to cover our losses in any particular case.

 

**Risks Related to Our Intellectual Property**

 

**If we fail to adequately enforce or defend our intellectualproperty rights, our business may be harmed.**

 

Muchof the technology used in the markets in which we compete is covered bypatents, and our commercial success will depend in large part on our ability toobtain and maintain patent and trade secret protection for our products andmethods. We currently hold 24 issued United States patents, three grantedEuropean patents, more than 100 pending United States and foreign patentapplications and two licensed patents that cover key aspects of our technology.Our issued patents expire at various dates beginning in 2019. The loss of ourpatents could reduce the value of the related products. In addition, the costto litigate infringements of our patents or the cost to defend ourselvesagainst patent infringement actions by others could be substantial.

 

Ourability to obtain additional patents is uncertain and the legal protectionafforded by these patents is limited and may not adequately protect our rightsor permit us to gain or keep any competitive advantage. In addition, thespecific content required of patents and patent applications that is necessaryto support and interpret patent claims is highly uncertain due to the complexnature of the relevant legal, scientific and factual issues. Changes in eitherpatent laws or in interpretations of patent laws in the United States orelsewhere may diminish the value of our intellectual property or narrow thescope of our patent protection. Even if patents are issued regarding ourproducts and methods, our competitors may challenge the validity of thosepatents. Patents also will not protect our products and methods if competitorsdevise ways of making competitive products without infringing our patents.

 

Proprietarytrade secrets and unpatented know-how are also very important to our business.We rely on trade secrets to protect certain aspects of our technology,especially where we do not believe that patent protection is appropriate orobtainable. However, trade secrets are difficult to protect. Our employees,consultants, contractors, outside clinical collaborators and other advisors mayunintentionally or willfully disclose our confidential information tocompetitors, and confidentiality agreements may not provide an adequate remedyin the event of unauthorized disclosure of confidential information. Enforcinga claim that a third party illegally obtained and is using our trade secrets isexpensive and time consuming, and the outcome is unpredictable. Moreover, ourcompetitors may independently develop equivalent knowledge, methods andknow-how. Failure to obtain or maintain trade secret protection could adverselyaffect our competitive business position.

 

**If we infringe intellectual property rights of third parties,it may increase our costs or prevent us from being able to sell our existingproducts or commercialize new products.**

 

Thereis a risk that we are infringing the proprietary rights of third parties underpatents and pending applications belonging to third parties that may exist inthe United States and

 

34

----

 

elsewhere in the world and that relate to the products we market anddevelop. Because the patent application process can take several years tocomplete, there may be currently pending applications, unknown to us, which mayresult in issued patents that cover the production, manufacture,commercialization or use of our products. In addition, the production,manufacture, commercialization or use of our product candidates may infringeexisting patents of which we are not aware.

 

Therehas been substantial litigation and other proceedings regarding patent andother intellectual property rights in the medical device industry. Defendingourselves against third-party claims, including litigation in particular, wouldbe costly and time consuming and would divert management’s attention from ourbusiness, which could lead to delays in our development or commercializationefforts. Currently, we are involved in two appeal proceedings in Germany inconnection with two of three patent-infringement lawsuits against us. Thelawsuits alleged that certain of our products infringe three European patentsheld by Ethicon Endo-Surgery. We prevailed in two of the three infringementactions and the products in question were found not to infringe the EthiconEndo-Surgery patents, and Ethicon Endo-Surgery is appealing one of thosedecisions. We lost the other infringement action and are appealing thatdecision. If third parties are successful in their claims, we might have to paysubstantial damages or take other actions that are adverse to our business. Asa result of intellectual property infringement claims, or to avoid potentialclaims, we might:

 

•                  be prohibited from selling or licensing anyof our current products or any product that we may develop unless the patentholder licenses the patent to us, which it is not required to do;

 

•                  be required to pay substantial royalties orgrant a cross license to our patents to another patent holder; or

 

•                  be required to redesign a product so it doesnot infringe, which may not be possible or could require substantial funds andtime.

 

**We may be subject to damages resulting from claims that ouremployees or we have wrongfully used or disclosed alleged trade secrets oftheir former employers.**

** **

Manyof our employees were previously employed at universities or other medicaldevice companies, including our competitors or potential competitors. We couldin the future be subject to claims that these employees, or we, haveinadvertently or otherwise used or disclosed trade secrets or other proprietaryinformation of their former employers. Litigation may be necessary to defendagainst these claims. If we fail in defending against such claims, a courtcould order us to pay substantial damages and prohibit us from usingtechnologies or features that are essential to our products, if suchtechnologies or features are found to incorporate or be derived from the tradesecrets or other proprietary information of the former employers. In addition,we may lose valuable intellectual property rights or personnel. A loss of keyresearch personnel or their work product could hamper or prevent our ability tocommercialize certain potential products, which could severely harm ourbusiness. Even if we are successful in defending against these claims, suchlitigation could result in substantial costs and be a distraction tomanagement.

 

35

----

 

**Risks Related to Regulatory Compliance**

** **

**Our failure to meet strict regulatory requirements couldrequire us to pay fines, incur other costs or even close our facilities.**

** **

Ourfacilities and manufacturing techniques generally must conform to standardsthat are established by the United States Food and Drug Administration, or FDA,and other government agencies, including those of European and other foreigngovernments. These regulatory agencies may conduct periodic audits orinspections of our facilities or our processes to monitor our compliance withapplicable regulatory standards. If a regulatory agency finds that we havefailed to comply with the appropriate regulatory standards, it may impose fineson us, delay or withdraw pre- market clearances or other regulatory approvalsor, if such a regulatory agency determines that our non-compliance is severe,it may close our facilities. Any adverse action by an applicable regulatoryagency could impair our ability to produce our products in a cost-effective andtimely manner in order to meet our customers’ demands. We may also be requiredto bear other costs or take other actions that may have a negative impact onour future sales and our ability to generate profits.

 

BetweenMay 2002 and June 2005, the FDA conducted three inspections of our facilities.Each of those inspections resulted in the issuance of a Notice of InspectionalObservations, or Form 483. Certain observations regarding our processes tohandle customer complaints, submit medical device reports, initiate correctiveand preventive actions and to conduct internal quality audits were identifiedby the FDA as areas of possible non-compliance with FDA regulations. For eachof those Form 483s issued by the FDA, we submitted a response whichidentified our proposed corrective action plans to address the FDA’sinspectional observations. In each case, the FDA issued an EstablishmentInspection Report, or EIR, which officially closed FDA’s inspection. FromFebruary 13 to April 26, 2007, the FDA conducted an additionalinspection of our facility in Langhorne, Pennsylvania. A Form 483 wasprovided to us at the conclusion of the inspection. In the FDA’s most recent Form 483,24 inspectional observations were identified, including the failure to properlyprocess customer complaints, failure to submit to the FDA medical devicereports or to submit them within regulatory timeframes, and the lack ofreporting a field action. Certain of the FDA’s inspectional observations aresimilar to observations identified in the prior Form 483s issued to us. Wehave prepared and submitted a response to the FDA, which included our proposedcorrective actions to address the FDA’s observations.  Whether the FDA will accept our response isuncertain, particularly in light of the similar nature of the currentinspectional observations to the previous observations.  If the FDA does not agree with our proposedcorrective actions, or accepts them but finds that we have not implemented themadequately, if the FDA is concerned about the repetitive nature of theinspectional observations, or if we otherwise fail to comply with applicableregulatory requirements, the FDA could initiate an enforcement action,including any of the following sanctions:

 

•                  untitled letters, warning letters, fines,injunctions, consent decrees and civil penalties;

 

•                  customer notifications or repair,replacement, refunds, recall, detention or seizure of our products;

 

•                  operating restrictions or partial suspensionor total shutdown of production;

 

36

----

 

•                  refusing or delaying our requests for 510(k)clearance or premarket approval, or PMA, of new products or modified products;

 

•                  withdrawing 510(k) clearances or PMAapprovals that have already been granted;

 

•                  refusal to grant export approval for ourproducts; or

 

•                  criminal prosecution.

 

**We may be subject, directly or indirectly, to federal andstate healthcare fraud and abuse laws and regulations and could facesubstantial penalties if we are unable to fully comply with such laws.**

** **

Thefederal anti-kickback laws and several similar state laws prohibit paymentsthat are intended to induce physicians or others either to refer patients toacquire or arrange for or recommend the acquisition of healthcare products orservices. These laws affect our sales, marketing and other promotionalactivities by limiting the kinds of financial arrangements and sales programswe may have with hospitals, physicians or other potential purchasers or usersof medical devices. In particular, these laws influence how we structure oursales, customer support, education and training programs and physicianconsulting and other service arrangements. Although we seek to structure sucharrangements in compliance with applicable requirements, these laws are broadlywritten and it is difficult to determine precisely how these laws will beapplied in specific circumstances. We could be subject to a claim under theseanti-kickback laws for our consulting arrangements with surgeons, grants fortraining and other education, grants for research and other interactions withdoctors which have come under scrutiny by federal and state regulators and lawenforcement entities. Anti-kickback laws prescribe civil, criminal andadministrative penalties for noncompliance, which can be substantial. Due tothe breadth of the statutory provisions and the lack of guidance in the form ofregulations or court decisions addressing some industry activities, it ispossible that our sales, marketing and promotional activities practices mightbe challenged under anti-kickback or related laws. Even an unsuccessfulchallenge to or investigation into our practices could cause adverse publicity andthus could harm our business and results of operations.

 

Foreignsales of our products also subject us to similar fraud and abuse laws,including application of the U.S. Foreign Corrupt Practices Act. If ouroperations, including any consulting arrangements we may enter into withphysicians who use our products, are found to be in violation of these laws, weor our officers may be subject to civil or criminal penalties, including largemonetary penalties, damages, fines, imprisonment and exclusion from Medicareand Medicaid program participation. If enforcement action were to occur, ourbusiness and financial condition would be harmed.

 

**Modifications to our products may require new regulatoryclearances or approvals or may require us to recall or cease marketing ourproducts until clearances or approvals are obtained.**

** **

Modificationsto our products may require new regulatory approvals or clearances, including510(k) clearances or premarket approvals, or require us to recall or ceasemarketing the modified devices until these clearances or approvals areobtained. The FDA requires device manufacturers to initially make and documenta determination of whether or not a modification

 

37

----

 

requires a new approval, supplement or clearance. A manufacturer maydetermine that a modification could not significantly affect safety or efficacyand does not represent a major change in its intended use, so that no new510(k) clearance is necessary. However, the FDA can review a manufacturer’sdecision and may disagree. The FDA may also on its own initiative determinethat a new clearance or approval is required. We have made modifications to ourproducts in the past and may make additional modifications in the future thatwe believe do not or will not require additional clearances or approvals. Ifthe FDA disagrees and requires new clearances or approvals for themodifications, we may be required to recall and to stop marketing our productsas modified, which could require us to redesign our products and harm ouroperating results. In these circumstances, we may be subject to significantenforcement actions.

 

Ifa manufacturer determines that a modification to an FDA-cleared device couldsignificantly affect its safety or efficacy, or would constitute a major changein its intended use, then the manufacturer must file for a new 510(k) clearanceor possibly a premarket approval application. Where we determine thatmodifications to our products require a new 510(k) clearance or premarketapproval application, we may not be able to obtain those additional clearancesor approvals for the modifications or additional indications in a timelymanner, or at all. For those products sold in the European Union, we mustnotify Orion Registrar, Inc., or Orion, our E.U. Notified Body, if significantchanges are made to the products or if there are substantial changes to ourquality assurance systems affecting those products. Obtaining clearances andapprovals can be a time consuming process, and failure to obtain or delays inobtaining required future clearances or approvals would adversely affect ourability to introduce new or enhanced products in a timely manner, which in turnwould harm our future growth.

 

**There is no guarantee that the FDA will grant 510(k)clearance or PMA approval of our emerging technologies and failure to obtainnecessary clearances or approvals for our future products would adverselyaffect our ability to grow our business.**

** **

Someof our new products will require FDA clearance of a 510(k), or may require FDAapproval of a PMA. We are in the process of developing our regulatorystrategies for obtaining clearance or approval of these new products. The FDAmay not approve or clear these products for the indications that are necessaryor desirable for successful commercialization. Indeed, the FDA may refuse ourrequests for 510(k) clearance or premarket approval of new products, newintended uses or modifications to existing products. Failure to receiveclearance or approval for our new products would have an adverse effect on ourability to expand our business.

 

**If we or our contract manufacturers fail to comply with theFDA’s Quality System Regulations, our manufacturing operations could beinterrupted and our product sales and operating results could suffer.**

** **

Ourfinished goods manufacturing processes, and those of some of our contractmanufacturers, are required to comply with the FDA’s Quality SystemRegulations, or QSRs, which cover the procedures and documentation of the design,testing, production, control, quality assurance, labeling, packaging,sterilization, storage and shipping of our devices. The FDA enforces its QSRsthrough periodic inspections of manufacturing facilities. We and our contractmanufacturers have been, and anticipate in the future being, subject to suchinspections. If our

 

38

----

 

manufacturing facilities or those of any of our contract manufacturersfail to take satisfactory corrective action in response to an adverse QSRinspection, the FDA could take enforcement action, including any of thefollowing sanctions, which could have a material impact on our operations:

 

•                  untitled letters, warning letters, fines,injunctions, consent decrees and civil penalties;

 

•                  customer notifications or repair,replacement, refunds, recall, detention or seizure of our products;

 

•                  operating restrictions or partial suspensionor total shutdown of production;

 

•                  refusing or delaying our requests for 510(k)clearance or premarket approval of new products or modified products;

 

•                  withdrawing 510(k) clearances on PMAapprovals that have already been granted;

 

•                  refusal to grant export approval for ourproducts; or

 

•                  criminal prosecution.

 

**Our products may in the future be subject to product recallsthat could harm our reputation, business and financial results.**

** **

TheFDA and similar foreign governmental authorities have the authority to requirethe recall of commercialized products in the event of material deficiencies ordefects in design or manufacture. In the case of the FDA, the authority torequire a recall must be based on an FDA finding that there is a reasonableprobability that the device would cause serious injury or death. In addition,foreign governmental bodies have the authority to require the recall of ourproducts in the event of material deficiencies or defects in design ormanufacture. Manufacturers may, under their own initiative, recall a product ifany material deficiency in a device is found. A government-mandated orvoluntary recall by us or one of our distributors could occur as a result ofcomponent failures, manufacturing errors, design or labeling defects or otherdeficiencies and issues. Recalls of any of our products would divert managerialand financial resources and have an adverse effect on our financial conditionand results of operations. The FDA requires that certain classifications ofrecalls be reported to FDA within 10 working days after the recall isinitiated. Companies are required to maintain certain records of recalls, evenif they are not reportable to the FDA. We have initiated certain voluntaryrecalls involving products that have been distributed to our customers and maytake additional such actions in the future. We believe that certain of thoserecalls do not require notification of the FDA. If the FDA disagrees with ourdeterminations, they could require us to report those actions as recalls. Afuture recall announcement could harm our reputation with customers andnegatively affect our sales. In addition, the FDA could take enforcementaction, including any of the following sanctions for failing to report therecalls when they were conducted:

 

•                  untitled letters, warning letters, fines,injunctions, consent decrees and civil penalties;

 

•                  customer notifications or repair,replacement, refunds, recall, detention of seizure of our products;

 

•                  operating restrictions or partial suspensionor total shutdown of production;

 

•                  refusing or delaying requests for 510(k)clearance or premarket approval of new products or modified products;

 

•                  withdrawing 510(k) clearances or PMAapprovals that have already been granted;

 

39

----

 

•                  refusal to grant export approval for ourproducts; or

 

•                  criminal prosecution.

 

**If our products, or malfunction of our products, cause orcontribute to a death or a serious injury, we will be subject to medical devicereporting regulations, which can result in voluntary corrective actions oragency enforcement actions.**

** **

Underthe FDA medical device reporting regulations, medical device manufacturers arerequired to report to the FDA information that a device has or may have causedor contributed to a death or serious injury or has malfunctioned in a way thatwould likely cause or contribute to a death or serious injury if themalfunction of the device or one of our similar devices were to recur. Allmanufacturers placing medical devices in the market in the European Union arelegally bound to report any serious or potentially serious incidents involvingdevices they produce or sell to the Competent Authority in whose jurisdictionthe incident occurred. Were this to happen to us, the relevant CompetentAuthority would file an initial report, and there would then be a furtherinspection or assessment if there are particular issues. This would be carriedout either by the Competent Authority or it could require that Orion, as theNotified Body, carry out the inspection or assessment.

 

Anysuch adverse event involving our products could result in future voluntarycorrective actions, such as recalls or customer notifications, or agencyaction, such as inspection or enforcement action. Adverse events involving ourproducts have been reported to us in the past, and we cannot guarantee that theywill not occur in the future. Any corrective action, whether voluntary orinvoluntary, as well as defending ourselves in a lawsuit, will require thededication of our time and capital, distract management from operating ourbusiness, and may harm our reputation and financial results. Failure to reportsuch adverse events to appropriate government authorities on a timely basis, orat all, could result in an enforcement action against us.

 

**Failure to obtain regulatory approval in additional foreignjurisdictions will prevent us from expanding the commercialization of ourproducts abroad.**

** **

Weintend to market our products in a number of international markets. Althoughcertain of our products have been approved for commercialization in Japan andin the European Union, in order to market our products in other foreignjurisdictions we must obtain separate regulatory approvals. The approvalprocedure varies among jurisdictions and can involve substantial additionaltesting. Approval or clearance by the FDA does not ensure approval byregulatory authorities in other jurisdictions, and approval by one foreignregulatory authority does not ensure approval by regulatory authorities inother foreign jurisdictions or by the FDA. The foreign regulatory approvalprocess may include all of the risks associated with obtaining FDA approval inaddition to other risks. In addition, the time required to obtain foreignapproval may differ from that required to obtain FDA approval, and we may notobtain foreign regulatory approvals on a timely basis, if at all. We may not beable to file for regulatory approvals and may not receive necessary approvalsto commercialize our products in any foreign market other than in the EuropeanUnion and Japan.

 

40

----

 

**We may be subject to fines, penalties or injunctions if weare determined to be promoting the use of our products for unapproved or “off-label”uses.**

** **

Ourpromotional materials and training methods for surgeons must comply with FDAand other applicable laws and regulations. Many of our products are cleared bythe FDA for use in various surgical applications. We believe that the specificsurgical procedures for which our products are marketed fall within the scopeof the surgical applications that have been cleared by the FDA. However, theFDA could disagree and require us to stop promoting our products for thosespecific procedures until we obtain FDA clearance or approval for them. Inaddition, if the FDA determines that our promotional materials or trainingconstitutes promotion of an unapproved use, it could request that we modify ourtraining or promotional materials or subject us to regulatory or enforcementactions, including the issuance of an untitled letter, a warning letter,injunction, seizure, civil fine and criminal penalties. It is also possiblethat other federal, state or foreign enforcement authorities might take actionif they consider our promotional or training materials to constitute promotionof an unapproved use, which could result in significant fines or penaltiesunder other statutory authorities, such as laws prohibiting false claims forreimbursement. In that event, our reputation could be damaged and adoption ofthe products would be impaired.

 

**Federal regulatory reforms may adversely affect our abilityto sell our products profitably.**

** **

Fromtime to time, legislation is drafted and introduced in Congress that couldsignificantly change the statutory provisions governing the clearance orapproval, manufacture and marketing of a medical device. In addition, FDAregulations and guidance are often revised or reinterpreted by the agency inways that may significantly affect our business and our products. It isimpossible to predict whether legislative changes will be enacted or FDAregulations, guidance or interpretations changed, and what the impact of suchchanges, if any, may be.

 

Withoutlimiting the generality of the foregoing, Congress has recently enacted, andthe President has signed into law, the Food and Drug Administration AmendmentsAct of 2007. The amendments require, among other things, that FDA propose, andultimately implement, regulations that will require manufacturers to labelmedical devices with unique identifiers unless a waiver is received from FDA.Once implemented, compliance with those regulations may require us to takeadditional steps in the manufacture of our products and labeling. These stepsmay require additional resources and could be costly. In addition, the law, asamended, will require us to, among other things, pay annual establishmentregistration fees to the FDA for each of our FDA registered facilities.

 

**Risks Related to Ownership of Our Common Stock**

** **

**We expect that the price of our common stock will fluctuatesubstantially.**

 

Untilour recent initial public offering, there was no public market for shares ofour common stock. The market price for our common stock is likely to fluctuateas a result of a number of factors, including:

 

41

----

 

•                  actual or anticipated announcements oftechnological innovations;

 

•                  introduction by us or by others of newcommercial products;

 

•                  actual or anticipated changes in laws andgovernmental regulations;

 

•                  disputes relating to patents or proprietaryrights;

 

•                  changes in business practices;

 

•                  developments relating to our efforts toobtain additional financing to fund our operations or our issuance ofadditional debt or equity securities;

 

•                  announcements by us regarding transactionswith potential strategic partners;

 

•                  changes in industry trends or conditions;

 

•                  trading volume of our common stock;

 

•                  changes in earnings estimates orrecommendations by securities analysts, failure to obtain analyst coverage ofour common stock or our failure to achieve analysts’ earnings estimates;

 

•                  developments in our industry; and

 

•                  general market conditions and other factorsunrelated to our operating performance or the operating performance of ourcompetitors or potential competitors.

 

Stockprices of many companies in the medical device industry have experienced widefluctuations that have often been unrelated to the operating performance ofthese companies. In the past, securities class action litigation often has beeninitiated against a company following a period of volatility in the marketprice of the company’s securities. If securities class action litigation isinitiated against us, we will incur substantial costs and our management’sattention will be diverted from our operations. All of these factors maymaterially and adversely affect the market price of our common stock, and youmay lose some or all of your investment.

 

**Securities analysts may not initiate coverage for our commonstock or may issue negative reports, and this may have a negative impact on themarket price of our common stock.**

** **

Securitiesanalysts may elect not to provide research coverage of our common stock, and ifa sufficient number of securities analysts do not cover our common stock, thelack of research coverage may adversely affect the market price of our commonstock. The trading market for our common stock may be affected in part by theresearch and reports that industry or financial analysts publish about us orour business. If one or more of the analysts who elect to cover us downgradesour stock, our stock price could decline. If one or more of these analystsceases coverage of our company, we could lose visibility in the market, whichin turn could cause our stock price to decline. In addition, rules mandated bythe Sarbanes-Oxley Act and a global settlement reached in 2003 between theSecurities and Exchange Commission, or SEC, other regulatory agencies and anumber of investment banks have led to a number of fundamental changes in howanalysts are reviewed and compensated. In particular, many investment bankingfirms will be required to contract with independent financial analysts fortheir stock research. It may be difficult for companies such as ours, withsmaller market capitalizations, to attract independent financial analysts thatwill cover our common stock. This could have a negative effect on the marketprice of our stock.

 

42

----

 

**Our principal stockholders, directors and management own alarge percentage of our voting stock, which allows them to exercise significantinfluence over matters subject to stockholder approval.**

 

Ourexecutive officers, directors and stockholders holding 5% or more of ouroutstanding common stock beneficially own or control approximately 39.0% of theoutstanding shares of our common stock, assuming no exercise of outstandingoptions and warrants or conversion of our convertible notes. Accordingly, theseexecutive officers, directors and principal stockholders, acting as a group,will have substantial influence over the outcome of corporate actions requiringstockholder approval, including the election of directors, any merger,consolidation or sale of all or substantially all of our assets or any othersignificant corporate transaction. These stockholders may also delay or preventa change of control or otherwise discourage a potential acquirer fromattempting to obtain control of our company, even if such a change of controlwould benefit our other stockholders. This significant concentration of stockownership may adversely affect the trading price of our common stock due toinvestors’ perception that conflicts of interest may exist or arise.

 

**Anti-takeover provisions in our charter documents andDelaware law could prevent or delay a change in control of our company.**

 

Provisionsin our amended and restated certificate of incorporation and amended andrestated bylaws, as well as provisions of Delaware law, may discourage, delayor prevent a merger, acquisition or change of control. These provisions couldalso discourage proxy contests and make it more difficult for stockholders toelect directors and take other corporate actions. These provisions include:

 

•                  advance notice requirements for stockholderproposals and nominations;

 

•                  limitations on convening stockholder meetings;

 

•                  the elimination of stockholder action bywritten consent;

 

•                  the elimination of cumulative voting; and

 

•                  a classified board of directors.

 

Inaddition, we are subject to Section 203 of the Delaware GeneralCorporation Law, which imposes certain restrictions on mergers and otherbusiness combinations between us and any holder of 15% or more of our commonstock.

 

**Sales of a substantial number of shares of our common stockin the public market, or the perception that they may occur, may depress the marketprice of our common stock.**

** **

Ifour existing stockholders sell substantial amounts of our common stock in thepublic market, or the public market perceives that existing stockholders mightsell substantial shares of common stock, the market price of our common stockcould decline significantly.  These salesmight also make it more difficult for us to sell equity securities at a timeand price that we deem appropriate.

 

43

----

 

Weare obligated to file a registration statement with the Securities andExchange Commission by January 29, 2008 to cover the resale of approximately2.7 million shares of our common stock that are issuable upon conversion of ourconvertible notes and will incur financial penalties if this resaleregistration statement is not effective by April 22, 2008. In addition, theholders of 11.7 shares of our outstanding common stock have registration rightswhich will entitle them to include their shares in the foregoing resaleregistration statement.

 

Approximately17.1 million shares of our common stock are outstanding, assuming no exerciseof outstanding options or warrants or conversion of our convertible notes atNovember 30, 2007.  Of these,12.5 million shares are held by existing stockholders who are subject tolock-up agreements with the underwriters of our initial public offering whichprohibit the sale of such shares until at least April 22, 2008. If the holdersof these restricted shares sell them or are perceived by the market as intendingto sell them when these restrictions on resale end, the market price of ourcommon stock could drop significantly. Any substantial sale of common stockpursuant to any resale registration statements or Rule 144 may have anadverse effect on the market price of our common stock by creating an excessivesupply.

 

44

----

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

** **

(a)                                      *Sales of UnregisteredSecurities:*

* *

During the three months ending September 30, 2007,17,655 shares of common stock were issued to employees upon the exercise ofcommon stock options.  These transactionswere exempt from registration under Section 4(2) of the Securities Act and pursuantto Rule 701 under the Securities Act.

 

(b)                                     *Use of Proceeds from PublicOffering of Common Stock*

 

Ourinitial public offering of common stock was effected through a RegistrationStatement on Form S-1 (File No. 333-142926) that was declared effective by theSecurities and Exchange Commission on October 25, 2007. The initial publicoffering was underwritten and managed by Jefferies & Company, Inc., LazardCapital Markets LLC and William Blair & Company L.L.C. At the closing ofthe offering on October 31, 2007, 4,427,500 shares of common stock, including577,500 shares issued upon exercise by the underwriters of their over-allotmentoption, were sold on our behalf at an initial public offering price of $11.00per share for an aggregate initial public offering price of $48.7 million.Following the sale of the 4,427,500 shares, the public offering terminated. Theunderwriters received underwriting discounts totaling approximately $3.4million in connection with the offering. In addition, we incurred offeringexpenses of approximately $3.4 million in connection with the offering. As aresult, the net offering proceeds to us, after deducting underwriting discountsand offering expenses, were approximately $41.9 million. No offering expenseswere paid directly or indirectly to any of our directors or officers (or theirassociates) or persons owning ten percent or more of any class of our equitysecurities or to any other affiliates. We have invested the $41.9 million in net proceeds from the offering in moneymarket funds and in investment-grade, interest bearing instruments, pendingtheir use. Through November 30, 2007, we have used approximately $500,000 ofthe net proceeds for working capital purposes.**Weintend to use the balance of the proceeds for general corporate purposes, including working capital, the expansion ofour sales and marketing organizations, continuation of our research anddevelopment efforts, expansion of our manufacturing capabilities and purchasesof capital equipment. We may also use a portion of the proceeds foracquisitions of businesses, products and technologies that are complementary toour business.

 

(c)                                      *Purchases of EquitySecurities by the Issuer and Affiliated Purchasers:*None.

 

45

----

 
| **Item 3.** | **Default  Upon Senior Securities.** |
|-------------|--------------------------------------|

 

None.

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

 

On September 21, 2007, stockholders holding approximately74.4 million shares of preferred stock, or 52.4% of the outstanding shares ofour preferred stock, consented to the conversion of all of our outstandingpreferred stock into shares of our common stock, which conversion becameeffective  upon the closing of ourinitial public offering on October 31, 2007.

 
| **Item 5.** | **Other  Information.** |
|-------------|-------------------------|

 

On December 4,2007, our  board of directors changed thecomposition of  the audit, compensationand nominating committees of the board. After these changes, the current members of each of committee are  as follows:

•                  the members ofthe audit committee are John C. Moran, Kenneth S. Abramowitz and Lon E.Otremba;

•                  the members ofthe compensation committee are Lon E. Otremba, Gerald Dorros, M.D., and DavidR. Murray; and

•                  the members ofthe nominating committee are James R. Locher III, Gerald Dorros and John C.Moran.

The board of directors has determined thateach of Messrs. Abramowitz, Dorros, Locher, Moran, Murray and Otremba qualifiesas an independent director as defined by applicable rules of the Nasdaq StockMarket.  In addition, the board hasdetermined that each of Messrs. Abramowitz, Moran and Otremba qualifies as anindependent director for purposes of service on the audit committee, and thatMr. Moran qualifies as an “audit committee financial expert.”

 

46

----

 
| **Item 6.** | **Exhibits.** |
|-------------|---------------|

 
| ** **           | ** ** | ** **                                                                                          | ** ** | **Filed with**      | ** ** | **Incorporated by Reference** |
|----------------------|------------|-----------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------------------|
| **Exhibit No.** | ** ** | **Description**                                                                                     | ** ** | **this Form  10-Q** | ** ** | **Form**                                | ** ** | **Filing Date** | ** ** | **Exhibit  No.** |
|                 |       |                                                                                                |       |                     |       |                                    |   |   |   |   |
| 3.1                  |       | Fourth Amended and  Restated Certificate of Incorporation of the Company                            |       |                     |       | S-1/A                                   |   | October  9, 2007 |   | 3.2 |
|                 |       |                                                                                                |       |                     |       |                                    |   |   |   |   |
| 3.2                  |       | Amended and Restated  By-Laws of the Company                                                        |       |                     |       | S-1/A                                   |   | October  9, 2007 |   | 3.4 |
|                 |       |                                                                                                |       |                     |       |                                    |   |   |   |   |
| 4.1                  |       | Specimen certificate for  common stock of Power Medical Interventions, Inc.                         |       |                     |       | S-1/A                                   |   | October  9, 2007 |   | 4.1 |
|                 |       |                                                                                                |       |                     |       |                                    |   |   |   |   |
| 31.1                 |       | Certification of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ** ** | **X**                    | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** |
|                 |       |                                                                                                |       |                     |       |                                    |   |   |   |   |
| 31.2                 |       | Certification of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ** ** | **X**                    | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** |
|                 |       |                                                                                                |       |                     |       |                                    |   |   |   |   |
| 32.1                 |       | Certification of Chief  Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ** ** | **X**                    | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** |
|                 |       |                                                                                                |       |                     |       |                                    |   |   |   |   |
| 32.2                 |       | Certification of Chief  Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ** ** | **X**                    | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** |

 

47

----

 

**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.

 

 
|             |   | POWER MEDICAL  INTERVENTIONS, INC.     |   |
|------------------|--------|----------------------------------------|--------|
|             |   | (Registrant)                           |   |
|             |   |                                   |
| December 4, 2007 | By:    | /s/ Michael P. Whitman                 |   |
|             |   | Michael P. Whitman                     |
|             |   | President and Chief  Executive Officer |
|             |   |                                   |
|             |   | POWER MEDICAL  INTERVENTIONS, INC.     |   |
|             |   | (Registrant)                           |   |
|             |   |                                   |
| December 4, 2007 | By:    | /s/ John P. Gandolfo                   |   |
|             |   | John P. Gandolfo                       |
|             |   | Chief Financial Officer                |

 

48

----

 

**ExhibitIndex**

 
| ** **           | ** ** | ** **                                                                                              | ** ** | **Filed with**      | ** ** | **Incorporated by Reference** |
|----------------------|------------|---------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------------------|
| **Exhibit No.** | ** ** | **Description**                                                                                         | ** ** | **this Form  10-Q** | ** ** | **Form**                                | ** ** | **Filing Date** | ** ** | **Exhibit  No.** |
|                 |       |                                                                                                    |       |                     |       |                                    |   |   |   |   |
| 3.1                  |       | Fourth Amended and  Restated Certificate of Incorporation of the Company                                |       |                     |       | S-1/A                                   |   | October  9, 2007 |   | 3.2 |
|                 |       |                                                                                                    |       |                     |       |                                    |   |   |   |   |
| 3.2                  |       | Amended and Restated  By-Laws of the Company                                                            |       |                     |       | S-1/A                                   |   | October  9, 2007 |   | 3.4 |
|                 |       |                                                                                                    |       |                     |       |                                    |   |   |   |   |
| 4.1                  |       | Specimen certificate for  common stock of Power Medical Interventions, Inc.                             | ** ** | ** **               |       | S-1/A                                   |   | October  9, 2007 |   | 4.1 |
| ** **           | ** ** | ** **                                                                                              |       |                     |       |                                    |   |   |   |   |
| 31.1                 |       | Certification of Principal  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ** ** | **X**                    |       |                                    |   |   |   |   |
| ** **           | ** ** | ** **                                                                                              |       |                     |       |                                    |   |   |   |   |
| 31.2                 |       | Certification of Principal  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | ** ** | **X**                    |       |                                    |   |   |   |   |
| ** **           | ** ** | ** **                                                                                              |       |                     |       |                                    |   |   |   |   |
| 32.1                 |       | Certification of Principal  Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ** ** | **X**                    |       |                                    |   |   |   |   |
| ** **           | ** ** | ** **                                                                                              |       |                     |       |                                    |   |   |   |   |
| 32.2                 |       | Certification of Principal  Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | ** ** | **X**                    |       |                                    |   |   |   |   |

 

49

----