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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

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**(Mark One)**

 
| **x**  | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|--------|------------|----------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                     |
|   |       | **For the  quarterly period ended June 30, 2008**                                                   |
|   |       |                                                                                                     |
|   |       | **OR**                                                                                                   |
|   |       |                                                                                                     |
| **o**  | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

** **

**Commission File Number****001-33770**

 

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**PowerMedical Interventions, Inc.**

(Exact name of registrant asspecified in its charter)

 

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

 

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

(Addressof principal executive offices)

 

**(267) 775-8100**

(Registrant’s telephone number, including area code)

 

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Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes  x    No  o.

 

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

 

Large accelerated filer  o      Acceleratedfiler  o      Non-acceleratedfiler  x      Smallerreporting company  o

 

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 August 13,2008, 17,124,313 shares of the Registrant’s Common Stock, $0.001 par value,were outstanding.

 

 

 

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Tableof Contents

 

**POWER MEDICAL INTERVENTIONS, INC.**

 
|          |                                                                                                                                | **PAGE** |
|---------------|-------------------------------------------------------------------------------------------------------------------------------------|----------|
| PART I:  | FINANCIAL INFORMATION                                                                                                               | 1        |
|          |                                                                                                                                |     |
| Item 1.  | Financial Statements                                                                                                                | 1        |
|          |                                                                                                                                |     |
|          | Condensed  Consolidated Balance Sheets as of June 30, 2008 and December 31,  2007 (Unaudited)                             | 1        |
|          |                                                                                                                                |     |
|          | Condensed  Consolidated Statements of Operations for the Three Months and Six Months  Ended June 30, 2008 and 2007 (Unaudited) | 2        |
|          |                                                                                                                                |     |
|          | Condensed  Consolidated Statements of Cash Flows for the Six Months Ended June 30,  2008 and 2007 (Unaudited)                  | 3        |
|          |                                                                                                                                |     |
|          | Notes to Unaudited Condensed  Consolidated Financial Statements                                                                     | 4        |
|          |                                                                                                                                |     |
| Item 2.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                         | 10       |
|          |                                                                                                                                |     |
| Item 3.  | Quantitative  and Qualitative Disclosures About Market Risk                                                                         | 16       |
|          |                                                                                                                                |     |
| Item 4.  | Controls and  Procedures                                                                                                            | 17       |
|          |                                                                                                                                |     |
| PART II: | OTHER INFORMATION                                                                                                                   | 17       |
|          |                                                                                                                                |     |
| Item 1.  | Legal Proceedings                                                                                                                   | 17       |
|          |                                                                                                                                |     |
| Item 1A. | Risk Factors                                                                                                                        | 17       |
|          |                                                                                                                                |     |
| Item 2.  | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                        | 37       |
|          |                                                                                                                                |     |
| Item 3.  | Defaults Upon  Senior Securities                                                                                                    | 38       |
|          |                                                                                                                                |     |
| Item 4.  | Submission  of Matters to a Vote of Security Holders                                                                                | 38       |
|          |                                                                                                                                |     |
| Item 5.  | Other Information                                                                                                                   | 38       |
|          |                                                                                                                                |     |
| Item 6.  | Exhibits                                                                                                                            | 38       |
|          |                                                                                                                                |     |
|          | Signatures                                                                                                                          | 39       |

 

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Table ofContents

 

PART I:                             FINANCIAL INFORMATION

 

**Item 1.****                                  ****Financial Statements.**

 

**PowerMedical Interventions, Inc.**

**Condensed Consolidated Balance Sheets**

 
| ** **                                                                                                                                                                                                                   | ** ** | **June 30, 2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                   | ** ** | **(unaudited)**             | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                                                   |       |                        |       |                        |       |
| Current  assets:                                                                                                                                                                                                             |       |                        |       |                        |       |
| Cash  and cash equivalents                                                                                                                                                                                                   |       | $                           | 11,610,108 |                        | $          | 36,592,220 |   |
| Restricted  cash                                                                                                                                                                                                             |       | 1,750,000                   |       | 1,750,000                   |       |
| Accounts  receivable less allowance of $104,000 and $120,000 in 2008 and 2007,  respectively                                                                                                                                 |       | 1,571,788                   |       | 1,514,776                   |       |
| Inventory                                                                                                                                                                                                                    |       | 9,155,298                   |       | 7,371,205                   |       |
| Prepaid  expenses and other current assets                                                                                                                                                                                   |       | 1,290,156                   |       | 1,178,493                   |       |
| Total  current assets                                                                                                                                                                                                        |       | 25,377,350                  |       | 48,406,694                  |       |
| Property  and equipment, net                                                                                                                                                                                                 |       | 4,986,071                   |       | 4,713,010                   |       |
| Intangible  assets, net                                                                                                                                                                                                      |       | 1,033,560                   |       | 965,303                     |       |
| Deferred  financing fees                                                                                                                                                                                                     |       | 992,452                     |       | 1,276,010                   |       |
| Other  assets                                                                                                                                                                                                                |       | 242,382                     |       | 261,862                     |       |
| Restricted  cash, long term                                                                                                                                                                                                  |       | 1,388,028                   |       | 2,350,071                   |       |
| Total  assets                                                                                                                                                                                                                |       | $                           | 34,019,843 |                        | $          | 57,972,950 |   |
| **Liabilities and shareholders’ equity**                                                                                                                                                                                |       |                        |       |                        |       |
| Current  liabilities:                                                                                                                                                                                                        |       |                        |       |                        |       |
| Accounts  payable                                                                                                                                                                                                            |       | 3,292,150                   |       | $                           | 4,422,198  |   |
| Accrued  expenses                                                                                                                                                                                                            |       | 4,006,594                   |       | 4,506,748                   |       |
| Current  portion of long-term debt                                                                                                                                                                                           |       | 69,230                      |       | 69,230                      |       |
| Total  current liabilities                                                                                                                                                                                                   |       | 7,367,974                   |       | 8,998,176                   |       |
|                                                                                                                                                                                                                         |       |                        |       |                        |       |
| Long-term  debt, net of current portion                                                                                                                                                                                      |       | 24,833,037                  |       | 24,742,891                  |       |
| Deferred  rent, net of current portion                                                                                                                                                                                       |       | 598,017                     |       | 691,873                     |       |
| Total liabilities                                                                                                                                                                                                            |       | 32,799,028                  |       | 34,432,940                  |       |
|                                                                                                                                                                                                                         |       |                        |       |                        |       |
| **Shareholders’ equity:**                                                                                                                                                                                               |       |                        |       |                        |       |
| Common  stock, $.001 par value:                                                                                                                                                                                              |       |                        |       |                        |       |
| Authorized  shares—200,000,000 at June 30, 2008 and December 31, 2007,  respectively; issued and outstanding shares 17,124,313 and 17,107,052 at  June 30, 2008 and December 31, 2007, respectively |       | 17,124                      |       | 17,107                      |       |
| Additional  paid-in capital                                                                                                                                                                                                  |       | 198,706,158                 |       | 197,733,981                 |       |
| Accumulated  other comprehensive income (loss)                                                                                                                                                                               |       | 99,611                      |       | (300,184                    | )          |
| Accumulated  deficit                                                                                                                                                                                                         |       | (197,602,078                | )          | (173,910,894                | )          |
| Total  shareholders’ equity                                                                                                                                                                                             |       | 1,220,815                   |       | 23,540,010                  |       |
| Total  liabilities and shareholders’ equity                                                                                                                                                                             |       | $                           | 34,019,843 |                        | $          | 57,972,950 |   |

 

*Seeaccompanying notes.*

 

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**PowerMedical Interventions, Inc.**

**Condensed Consolidated Statements ofOperations (Unaudited)**

 
| ** **                                                 | ** ** | **Three Months Ended June 30,** | ** **  | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------|-------------|---------------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                            | ** **  | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Sales**                                                  |       | $                                                   | 2,159,405   |                                              | $          | 2,377,319 |   | $ | 4,383,610 |   | $ | 4,192,616 |   |
| **Cost of sales**                                          |       | 3,018,245                                           |        | 1,948,662                                         |       | 5,575,414 |   | 3,299,926 |   |
|                                                       |       | (858,840                                            | )           | 428,657                                           |       | (1,191,804 | ) | 892,690 |   |
| **Costs and expenses:**                                    |       |                                                |        |                                              |       |   |   |   |   |
| Research  and development                                  |       | 1,508,120                                           |        | 1,554,005                                         |       | 3,090,531 |   | 2,553,187 |   |
| Sales  and marketing                                       |       | 5,961,115                                           |        | 3,846,893                                         |       | 12,757,500 |   | 7,110,283 |   |
| General  and administrative                                |       | 2,622,165                                           |        | 2,108,975                                         |       | 5,635,442 |   | 4,325,882 |   |
|                                                       |       | 10,091,400                                          |        | 7,509,873                                         |       | 21,483,473 |   | 13,989,352 |   |
| Operating  loss                                            |       | (10,950,240                                         | )           | (7,081,216                                        | )          | (22,675,277 | ) | (13,096,662 | ) |
|                                                       |       |                                                |        |                                              |       |   |   |   |   |
| **Other income (expense):**                                |       |                                                |        |                                              |       |   |   |   |   |
| Interest  income                                           |       | 89,680                                              |        | 294,166                                           |       | 284,510 |   | 365,499 |   |
| Interest  expense                                          |       | (650,827                                            | )           | (1,086,520                                        | )          | (1,300,417 | ) | (1,092,314 | ) |
| **Total other income (expense)**                           |       | (561,147                                            | )           | (792,354                                          | )          | (1,015,907 | ) | (726,815 | ) |
| Net  loss                                                  |       | $                                                   | (11,511,387 | )                                                 | $          | (7,873,570 | ) | $ | (23,691,184 | ) | $ | (13,823,477 | ) |
|                                                       |       |                                                |        |                                              |       |   |   |   |   |   |   |   |   |
| Accretion  of preferred stock                              |       | —                                              |        | (2,271,620                                        | )          | — |   | (4,534,493 | ) |
| Net  loss applicable to common shares                      |       | $                                                   | (11,511,387 | )                                                 | $          | (10,145,190 | ) | $ | (23,691,184 | ) | $ | (18,357,970 | ) |
| **Net loss per common share:**                             |       |                                                |        |                                              |       |   |   |   |   |
| Basic  and diluted                                         |       | $                                                   | (0.67       | )                                                 | $          | (2.69 | ) | $ | (1.38 | ) | $ | (4.87 | ) |
| **Weighted average number of common shares  outstanding:** |       |                                                |        |                                              |       |   |   |   |   |
| Basic  and diluted                                         |       | 17,108,716                                          |        | 3,770,518                                         |       | 17,108,282 |   | 3,770,518 |   |

 

*Seeaccompanying notes.*

 

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**PowerMedical Interventions, Inc.**

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

 
| ** **                                                                                         | ** ** | **Six Months Ended June 30,** | ** **  |
|----------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|-------------|
| ** **                                                                                         | ** ** | **2008**                                          | ** **  | **2007** | ** ** |
| **Operating activities**                                                                           |       |                                              |        |   |   |
| Net  loss                                                                                          |       | $                                                 | (23,691,184 | ) | $ | (13,823,477 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities:                       |       |                                              |        |   |   |
| Depreciation  and amortization                                                                     |       | 875,846                                           |        | 1,011,865 |   |
| Amortization  of debt discount and deferred financing fees                                         |       | 408,094                                           |        | 185,196 |   |
| Loss  on the disposal of property and equipment                                                    |       | 22,518                                            |        | — |   |
| Stock-based  compensation                                                                          |       | 899,570                                           |        | 234,859 |   |
| Changes  in operating assets and liabilities:                                                      |       |                                              |        |   |   |
| Accounts  receivable                                                                               |       | (42,868                                           | )           | 48,552 |   |
| Inventory                                                                                          |       | (1,798,109                                        | )           | (775,142 | ) |
| Prepaid  expenses and other assets                                                                 |       | (175,571                                          | )           | (188,913 | ) |
| Accounts  payable                                                                                  |       | (828,021                                          | )           | (29,001 | ) |
| Accrued  expenses                                                                                  |       | (563,424                                          | )           | 511,324 |   |
| Deferred  rent                                                                                     |       | (93,856                                           | )           | 25,525 |   |
| Net  cash used in operating activities                                                             |       | (24,987,005                                       | )           | (12,799,212 | ) |
|                                                                                               |       |                                              |        |   |   |
| **Investing activities**                                                                           |       |                                              |        |   |   |
| Purchase  of property and equipment                                                                |       | (1,056,779                                        | )           | (924,918 | ) |
| Patent  application costs                                                                          |       | (160,337                                          | )           | (133,731 | ) |
| Change  in restricted cash                                                                         |       | 1,015,690                                         |        | (3,359,311 | ) |
| Net  cash used in investing activities                                                             |       | (201,426                                          | )           | (4,417,960 | ) |
|                                                                                               |       |                                              |        |   |   |
| **Financing activities**                                                                           |       |                                              |        |   |   |
| Repayments  on long-term debt                                                                      |       | (34,390                                           | )           | (46,020 | ) |
| Proceeds  of long-term debt, net                                                                   |       | —                                            |        | 23,309,361 |   |
| Net  proceeds from the issuance of common stock and exercise of common stock  warrants and options |       | 72,626                                            |        | 630,953 |   |
| Payment  of deferred equity financing costs                                                        |       | —                                            |        | (1,458,853 | ) |
| Net  cash provided by financing activities                                                         |       | 38,236                                            |        | 22,435,441 |   |
|                                                                                               |       |                                              |        |   |   |
| Effect  of exchange rate changes on cash and cash equivalents                                      |       | 168,083                                           |        | (137,971 | ) |
| Net  (decrease) increase in cash and equivalents                                                   |       | (24,982,112                                       | )           | 5,080,298 |   |
| Cash  and cash equivalents, beginning of period                                                    |       | 36,592,220                                        |        | 8,684,341 |   |
| Cash  and equivalents, end of period                                                               |       | $                                                 | 11,610,108  |   | $ | 13,764,639 |   |
|                                                                                               |       |                                              |        |   |   |
| **Supplemental disclosure of cash flow information**                                               |       |                                              |        |   |   |
| Cash  paid for interest                                                                            |       | $                                                 | 888,564     |   | $ | 12,692 |   |

 

*Seeaccompanying notes.*

 

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**Power Medical Interventions, Inc.**

 

**Notes to Unaudited CondensedConsolidated Financial Statements**

 

**June 30, 2008**

 

**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, or MIS, and in theemerging field of natural orifice translumenal endoscopic surgery, or NOTES. Todate, 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 MedicalInterventions Japan, which conduct sales and marketing operations. The Companyalso has a dormant U.S. subsidiary, Power Medical Vascular, Inc.

 

**2.  Summary of 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 accompanyingcondensed consolidated balance sheet as of June 30, 2008, the condensedconsolidated statements of operations for the three and six months ended June 30,2008 and 2007, and the condensed consolidated statement of cash flows for thesix months ended June 30, 2008 and 2007 are unaudited. The unauditedinterim financial statements have been prepared on the same basis as the annualfinancial statements and, in the opinion of management, reflect alladjustments, which include only normal recurring adjustments, necessary tostate fairly the Company’s financial position as of June 30, 2008 and theresults of its operations and cash flows for the three and six months ended June 30,2008 and 2007. The financial data and other information disclosed in thesenotes to the financial statements are unaudited. The results for the three andsix months ended June 30, 2008 are not necessarily indicative of theresults to be expected for any future period.

 

*Revenuerecognition*

 

The Company’s SurgASSISTsurgical platform includes cutting and stapling devices in a variety of sizes andlinear, right angle and circular configurations designed for differing surgicalneeds. 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 wereconnected 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, are self-contained hand held instruments that donot 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.

 

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The Company historicallyprovided power consoles, FlexShafts, remote control units and mobile cartsassociated with its first-generation SurgASSIST system to customers at no costas loaner equipment. In addition, the Company has in certain cases agreed totransfer title to such systems to the customer upon the customer’s purchase ofa specified number of disposable Intelligent Surgical Instruments although thecustomer is under no obligation to purchase the Intelligent SurgicalInstruments. In these instances, the Company recognizes revenue attributable tothe complete system as the Intelligent Surgical Instruments are delivered, inaccordance 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 certain cases, the Company offers suchIntelligent Surgical Instruments and FlexShafts at no cost in exchange forhigher unit pricing on the sale of reload cartridges over a specified period oftime. In these cases, the Company recognizes the revenue ratably over theperiod of delivery of the reload cartridges in accordance with the guidance ofEITF 00-21, as long as such revenue is not contingent on the delivery of theundelivered products. The Company currently makes its i60 and iDriveinstruments available to customers at no cost without condition. No revenue isassociated with the shipment to customers of these instruments.

 

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.

 

During the six monthsended June 30, 2008, the Company’s revenues were from customers located inNorth America (83%), Europe (12%) and Asia (5%). During the six months ended June 30,2007, the Company’s revenues were from customers located in North America (77%)and  Europe (21%) and Asia (2%).   Amounts billed to customers for shipping andhandling of products are included in sales. Costs incurred related to shippingand 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) Opinion No. 25,*Accounting for Stock Issued to Employees*(APB 25). SFAS No. 123(R) requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thefinancial statements based on their fair values beginning with the first annualperiod after December 15, 2005. SFAS No. 123(R) requires that anentity measure the cost of equity-based service awards based on the grant-datefair value of the award and recognize the cost of such award over the periodduring which the employee is required to provide service in exchange for theaward (vesting period). The pro forma disclosures previously permitted underSFAS No. 123 are no longer an alternative to financial statementrecognition. The Company adopted SFAS No. 123(R) on January 1,2006 using the prospective transition method, which required that all newstock-based awards granted subsequent to adoption be recognized in thefinancial statements at fair value. The Company accounts for equity issued tononemployees 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).

 

*Netloss attributable to common shares*

 

The Company computes netloss per share in accordance with SFAS No. 128, *Earnings Per Share* (SFAS No. 128). Under SFAS No. 128,basic net loss per share is computed by dividing net loss per share availableto common stockholders by the weighted average number of common sharesoutstanding for the period and excludes the effects of any potentially dilutivesecurities. Diluted earnings per share, if presented, would include thedilution that would occur upon the exercise or conversion of all potentiallydilutive securities into common stock using the “treasury stock” and/or “ifconverted” methods as applicable.

 

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The following summarizesthe potential outstanding common stock of the Company as of the end of eachperiod:

 
| ** **                                   | ** ** | **June 30, 2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Convertible  senior secured promissory notes |       | 2,643,179                   |       | 2,643,175                   |       |
| Common  stock warrants                       |       | 958,974                     |       | 1,137,864                   |       |
| Common  stock options outstanding            |       | 2,162,183                   |       | 1,728,844                   |       |
| Common  stock options available for grant    |       | 1,139,124                   |       | 643,510                     |       |
| Total                                        |       | 6,903,460                   |       | 6,153,393                   |       |

 

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.

 

*Recent Accounting Pronouncements*

 

The Company adopted Financial Accounting StandardsBoard Statement No. 157, *Fair ValueMeasurements* , or SFAS 157, effective January 1, 2008. SFAS 157 defines fair value as the price that would be received to sell anasset or paid to transfer a liability, referred to as the exit price, in anorderly transaction between market participants at the measurement date. The standard outlines a valuation framework and creates a fair valuehierarchy in order to increase the consistency and comparability of fair valuemeasurements and the related disclosures.  In determining fair value, theCompany primarily use prices and other relevant information generated by markettransactions involving identical or comparable assets, called the marketapproach. As of June 30, 2008, the fair value of all of the Company’sfinancial assets are based on level one observable inputs.  We havedetermined that our fair value measurements are in accordance with therequirements of SFAS 157, therefore, the implementation of SFAS 157 did nothave any impact on our consolidated financial condition or results ofoperations.

 

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

 

During March 2007, the Company sold$25.0 million of convertible senior secured promissory notes due March 2010(the “Convertible Notes”) which generated net proceeds to the Company of$23,298,654 ($25,000,000 less financing fees of $1,701,346). Of this amount,$3,500,000 was placed in escrow to fund the first four interest payments on theConvertible Notes. These notes are secured by substantially all of the Company’sassets and accrue interest at the rate of 7% per annum, payable semiannually inarrears.  Interest accruing on or before March 31, 2009 is payable incash, while interest accruing after March 31, 2009 is payable, at theCompany’s option, in cash or paid-in-kind in the form of additional notes (“PIKNotes”). The principal amounts of such PIK Notes will have the same maturity asthe Convertible Notes. Should the Company elect to pay interest on the ConvertibleNotes in PIK Notes, the interest rate on such PIK Notes shall be equal to thethen applicable interest rate plus 1.5%.

 

The Convertible Notes also require the payment of aterminal value that (i) will be due upon redemption or conversion of the ConvertibleNotes, (ii) will be considered part of the conversion amount for purposesof determining the conversion rate (see below) or (iii) will be due uponmaturity as part of the principal amount. In

 

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each case, the terminal value payment is defined toequal 7% per annum of the applicable principal from the closing date of theConvertible Notes in March 2007 to the first Conversion Event (which theparties acknowledged and agreed occurred on October 31, 2007, the date ofthe Company’s initial public offering).  There is no possible future scenarioin which 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.

 

Upon the occurrence of the Company’s initial publicoffering, the Convertible Notes plus any accrued interest thereon as well asthe accreted terminal value became convertible into the Company’s Common Stockat the option of the holder at any time through the maturity date of theConvertible Notes. The conversion price of the Convertible Notes was set at$10.01 per share upon the completion of the Company’s initial public offering.

 

Beginning on the date that is 180 days following theclosing of a Convertible Note Qualified IPO, the Company may, at its option,redeem the Convertible Notes in whole at any time or in part from time to time,upon 15 days prior written notice to the holder, at a redemption price payablein cash, equal to the principal amount plus any interest (including theterminal value) accrued and unpaid, subject to the satisfaction of thefollowing conditions precedent:

 

(a)          the declaration of effectiveness of a registration statement filed with the SECfor the resale of the underlying shares;

 

(b)          the average of the high and low sale price of the Common Stock, as reported onthe principal securities exchange on which the Common Stock is listed, on eachof any 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 otherantidilution events);

 

(c)          no more than $12,500,000 of outstanding Convertible Notes may be redeemedpursuant to this provision in any period of 30 consecutive trading days; and

 

(d)          any such redemption shall be effected on a pro rata basis with respect to allthen outstanding Convertible Notes (including PIK Notes).

 

**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:

 
| ** **       | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Raw  Materials   |       | $                           | 4,553,873  |                            | $          | 3,861,162 |   |
| Work  in process |       | 1,378,577                   |       | 1,066,864                       |       |
| Finished  goods  |       | 3,222,848                   |       | 2,443,179                       |       |
|             |       | $                           | 9,155,298  |                            | $          | 7,371,205 |   |

 

Duringthe three and six months ended June 30, 2008, and for the year ended December 31,2007, the company recorded inventory obsolescence charges in the amount ofapproximately $200,000, $501,000 and $506,000 respectively.  Such charges are reflected in cost of salesin the accompanying condensed consolidated statements of operations.

 

**5.  Comprehensive Loss**

 

The Company’s comprehensiveloss was as follows:

 

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| ** **                               | ** ** | **Three Months Ended  June 30,** | ** **  | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------|------------|-------------------------------------------------|-------------|-----------------------------------------------|------------|
| ** **                               | ** ** | **2008**                                        | ** **  | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net  loss applicable to common shares    |       | $                                               | (11,511,387 | )                                             | $          | (10,145,190 | ) | $ | (23,691,184 | ) | $ | (18,357,970 | ) |
| Foreign  currency translation adjustment |       | 354,244                                         |        | (45,748                                       | )          | 399,795 |   | (877 | ) |
| Comprehensive  loss                      |       | $                                               | (11,157,143 | )                                             | $          | (10,190,938 | ) | $ | (23,291,389 | ) | $ | (18,358,847 | ) |

 

**6.  Contingencies**

 

The Company has, on occasion, been named as adefendant in lawsuits alleging product failure, patent infringement, breach ofcontract and employment related claims. Management has provided reserves forthe estimated potential losses, when such losses are deemed probable andestimable.  The Company currently has a patent infringement caseoutstanding.  The Company received a favorable ruling from the Germancourts on two of the patent infringement claims and an unfavorable ruling onone of the claims.  However, the Company is in the process of appealingthe unfavorable ruling.  The Company intends to defend this claimvigorously and has concluded it is too early to determine whether or not the Companywill incur any loss under this claim.  As such, no amounts are accrued inthe accompanying consolidated balance sheets related to this claim.

 

The Company also has a product liability caseoutstanding which is currently suspended and the Company has continued tocontest the claim.  The Company has accrued $100,000 related to thismatter which represents its best estimate of the potential liability related tothis claim.

 

**7.  Stock-based Compensation**

 

As a private companyduring the first part of 2007, the Company estimated the fair value of itscommon stock by utilizing a contemporaneous third party valuation.  Grants issued during the first and secondquarter of 2008 were valued at the closing price of the Company’s publiclytraded stock. The per-share weighted average fair values on the dates of grantof the options granted was $3.31 and $4.48, during the three months ended June 30,2008 and 2007, and $4.99 and $4.48 during the six months ended June 30,2008 and 2007, using the Black-Scholes option-pricing model with the followingweighted average assumptions, which are based upon Company history or industrycomparative information:

 

| ** **                | ** ** | **Three  Months  Ended  June 30,  2008** | ** ** | **Three  Months  Ended June 30,  2007** | ** ** | **Six Months  Ended June 30,  2008** | ** ** | **Six Months  Ended June 30,  2007** | ** ** |
|---------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                | ** ** | ** **                                    | ** ** | ** **                                   | ** ** | ** **                                     | ** ** | ** **                                     | ** ** |
| Expected  dividend yield  |       | 0                                             | %          | 0                                            | %          | 0                                              | %          | 0                                              | %          |
| Expected  volatility      |       | 50.2                                          | %          | 60.1                                         | %          | 50.2                                           | %          | 60.1                                           | %          |
| Risk-free  interest rates |       | 3.45                                          | %          | 4.58                                         | %          | 3.13                                           | %          | 4.58                                           | %          |
| Expected  life            |       | 7 years                                       |       | 7 years                                      |       | 7 years                                        |       | 7 years                                        |       |

 

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 forthe three months ended June 30, 2008 related to share-based service awardswas $459,100, of which $11,983 is included in cost of sales, $49,672 isincluded in research and development, $62,284 is included in sales andmarketing and $335,161 is included in general and administrative expense in theaccompanying statements of operations. Compensation expense under SFAS No. 123(R) and EITF 96-18 forthe three months ended June 30,

 

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2007 related toshare-based service awards was $134,245 , of which $805 is included in cost ofsales, $418 is included in research and development,  $16,420 is included in sales and marketingand $116,602 is included in general and administrative expense in theaccompanying statements of operations. Compensation expense under SFAS No. 123(R) andEITF 96-18 for the six months ended June 30, 2008 related to share-basedservice awards  was $899,570, of which$22,330 is included in cost of sales, $96,195 is included in research anddevelopment, $128,258 is included in sales and marketing and $652,787 isincluded in general and administrative expense in the accompanying statementsof operations.  Compensation expenseunder SFAS No. 123(R) and EITF 96-18 for the six months ended June 30,2007 related to share-based service awards was $234,859 of which $1,422 isincluded in cost of sales, $418 is included in research and development,$31,671 is included in sales and marketing and $201,348 is included in generaland administrative expense in the accompanying statements of operations. TheCompany recognizes the compensation expense of such share-based service awardson a straight-line basis. Total unrecognized compensation cost of optionsgranted but not yet vested as of June 30, 2008 was $5,724,622, net ofestimated forfeitures, which is expected to be recognized over the weightedaverage period of 2.08 years. The Company utilized an estimated forfeiture rateof 15% for the 2007 and 2008 grants, based on the Company’s historicalforfeiture rate as well as an analysis of current market conditions.

 

The following tablesummarizes stock option activity for the six months ended June 30, 2008:

 
| ** **                           | ** ** | **Number  of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|--------------------------------------|------------|------------------------|------------|----------------------------------------|------------|
| Outstanding,  December 31, 2007 |       | 1,728,844              |       | $                                      | 8.69       |   |
| Options  granted                     |       | 715,198                |       | 9.11                                   |       |
| Options  cancelled/forfeited         |       | (266,648               | )          | 10.82                                  |       |
| Options  exercised                   |       | (16,211                | )          | 4.48                                   |       |
| Outstanding,  June 30, 2008     |       | 2,162,183              |       | $                                      | 8.66       |   |
| Exercisable,  June 30, 2008     |       | 1,024,409              |       | $                                      | 7.30       |   |

 

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**Item 2.**       **Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

*You should read the followingdiscussion in conjunction with our consolidated financial statements and notesthereto appearing elsewhere in this report. In addition to historicalconsolidated financial information, the following discussion and analysiscontains forward-looking statements that involve risks, uncertainties andassumptions. Our actual results could differ materially from those anticipatedby these forward-looking statements as a result of many factors, includingthose discussed under “Risk Factors” and elsewhere in this report.*

 

**Overview**

 

We design, manufacture and market the SurgASSIST®system of computer-assisted, power-actuated endomechanical surgical instruments,which we refer to as Intelligent Surgical InstrumentsTM. Surgeons use ourIntelligent Surgical Instruments for cutting, stapling and tissue manipulationin a variety of procedures in open surgery, minimally invasive surgery, or MIS,and in the emerging field of natural orifice translumenal endoscopic surgery,or NOTES. Our SurgASSIST system has been used in tens of thousands of surgicalprocedures in more than 350 hospitals and medical institutions worldwide.

 

Since our inception, we have devoted substantially allour resources to the development and commercialization of our SurgASSIST systemand, more recently, to the expansion of our manufacturing and direct sales andmarketing operations. We currently outsource the manufacture of components suchas machined and molded parts, mechanical sub-assemblies and circuit boards andperform the final assembly and testing of our products in our Langhorne,Pennsylvania facility. We sell our Intelligent Surgical Instruments through ourdirect sales force in the United States, parts of Europe and Japan and throughdistributors in other parts of Europe.

 

We have incurred net losses in each year since ourinception and have an accumulated deficit at June 30, 2008 of $197.6million. We expect our losses to continue through at least 2008  as we continue to develop and introduce ournext generation of Intelligent Surgical Instruments and build theinfrastructure necessary to support our anticipated sales growth. To date, wehave financed our operations primarily through the initial public offering ofour common stock, private placements of our preferred stock and the issuance ofdebt.

 

The principal factor driving our results of operationsin 2008 has been the continuing roll-out of our next generation wirelesstechnology.  Interest in the newtechnology among surgeons and institutions remains high, and our installed baseof i-Series instruments placed in hospitals worldwide has continued togrow. As often occurs during a major release of a new technology platform, wehave encountered challenges that have slowed the rate of adoption of our newtechnology. This has resulted in post-launch revenues that have been lower thanexpected and has affected our gross margins during the first six months of2008. We have taken significant steps toward resolving these challenges, andmeanwhile have continued to build out our i-Series product portfolio byintroducing new Intelligent Surgical Instruments as well as enhanced andimproved versions of our existing i-Series products. We expect that, overthe long term, prospects for our proprietary line of Intelligent SurgicalInstruments remain high.

 

**Financial Operations Overview**

 

The following is a description of the principalcomponents of our sales and expenses and of significant trends and challengesthat we believe are important to an understanding of our business and resultsof operations.

 

*Sales.*   Our SurgASSIST surgical platformincludes cutting and stapling devices in a variety of sizes and linear, rightangle and circular configurations designed for differing surgical needs. In theoriginal configuration of our system, our Intelligent Surgical Instruments areconnected through a flexible shaft, or FlexShaft, to a power console. Our nextgeneration products, beginning with the i60 linear stapler that we introducedin the fourth quarter of 2007, are self-contained hand-held instruments that donot require a FlexShaft or separate power console. In December 2007, wealso introduced our self-contained, wireless handheld iDrive system, which canbe used to power and control our linear, right angle and circular staplers,without the need for a separate FlexShaft or power console.

 

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Our Intelligent Surgical Instruments are available asdisposable, single-patient devices as well as in a reusable multiple-patientformat, using disposable cutting and stapling cartridges in various sizes,which we refer to as reload cartridges.

 

To date, most of our revenue has been derived from thesale of our single-patient, disposable Intelligent Surgical Instruments and, toa lesser extent, from the sale of reload cartridges for our reusableIntelligent Surgical Instruments. We expect that, as our installed base ofreusable, multiple-patient Intelligent Surgical Instruments grows, sales ofreload cartridges will become the largest component of our total sales.

 

We make power consoles and related accessories such asremote control units used with our first-generation SurgASSIST system availableto institutions at no charge. We instituted a program in 2007 to makeour PLC 60 instrument or FlexShaft available to the customer at no cost,in certain cases in exchange for a commitment by the customer to purchase aminimum number of reload cartridges at a higher unit price. We currently makeour i60 and iDrive instruments available to customers at no charge, with the expectationthat we will derive revenues from sales of the reload cartridges necessary fortheir use.

 

Our future success will depend on our ability toachieve and sustain significant growth in our sales. Our ability to grow ourrevenues will depend on many factors, including:

 

·continued growth in market acceptance of our SurgASSIST system;

 

·continued introduction of our next generation Intelligent Surgical Instrumentson a timely basis;

 

·increased usage of our installed base of multiple-use Intelligent SurgicalInstruments, resulting in recurring purchases of our reload cartridges;

 

·expansion of our sales and marketing organization and recruitment and retentionof a sufficient number of qualified sales consultants;

 

·continued improvements in our supply chain and manufacturing operations toassure the quality and adequate supply of our products; and

 

·the availability of clinical data to substantiate the long term efficacy andsafety of our products, which has not been collected to date.

 

*Cost of sales.*   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 inventoryobsolescence.

 

Our future success will depend on our ability to makesignificant improvements in our cost of sales as a percentage of sales, orgross margins. Since the introduction of our SurgASSIST system in 2001, ourgross margins have ranged from a negative gross margin of (56.9)% in 2002 to apositive gross margin of 25.6 % for the quarter ended March 31, 2007. Ourgross margin in the three months and six months ended June 30, 2008 was(39.8%) and (27.2%), respectively.  Ourhigh cost of sales has been attributable to a number of factors, includingproduct defects that have required rework by us and by our suppliers, alabor-intensive manual assembly process that has resulted in high labor costs,and excess manufacturing capacity in relation to our sales, which has resultedin inefficient absorption of manufacturing overhead.

 

Charges associated with write-offs of excess andobsolete inventory have also contributed to our high cost of sales. During thethree months and six months ended June 30, 2008, we recorded inventoryobsolescence charges of $200,000 and $501,000, constituting 6.6% and 9.0% ofour cost of sales, respectively.  Ourproduct development plans sometimes include introductions of new products thatoverlap functionally with existing products, while offering new or improvedcapabilities. We anticipate that in some cases, this may lead to a reduction indemand for, or discontinuation of, an existing product. In these circumstances,we must carefully manage our finished goods

 

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inventory toensure that we have quantities of the existing product that are sufficient tomeet customer demand pending introduction of the new product, but that do notleave us holding excess or obsolete inventory when a new product supplants theexisting one.  Changes in the design of our products can also result inthe obsolescence of our inventory of components that are not used in redesignedproducts.

 

Historically, our cost of sales has included thesubstantial cost of our power consoles and related accessories and morerecently of Intelligent Surgical Instruments that we place with customers at nocharge, which has had a significant adverse effect on our gross margins. The cost of the i60 and iDrive instruments that we currently make available tocustomers at no charge is recorded as a charge to cost of sales when the unitsare shipped to the customer.

 

In order to achieve and sustain profitability, we willneed to devote substantial resources to improving our procurement andmanufacturing processes, upgrading our management information systems, andimplementing new quality assurance, inventory and cost controls in order toreduce the cost of the components we purchase from third party vendors andimprove the efficiency of our manufacturing operations. We also intend toincrease the integration of our manufacturing operations, for example, byacquiring the capital equipment necessary to enable us to more efficientlyassemble critical components such as the reload cartridges that are used in ourreusable multiple-patient linear staplers. We believe this will enable us tosignificantly reduce the cost of these components, while also enabling us tobetter control their supply and quality. However, we cannot assure you thatmanufacturing yields or costs will not be adversely affected, at least initially,by the transition to in-house production or to new production processes.Because we have limited experience in manufacturing our products in commercialquantities, increasing our manufacturing capacity to support our planned salesgrowth while significantly improving our gross margins and maintaining productquality will involve significant challenges.

 

*Research and development expenses.*   Research and development expensesconsist primarily of salaries and related expenses and overhead for our research,development and engineering personnel, prototype materials and researchstudies. We expense our research and development costs as incurred.

 

Our research and development expenses have fluctuatedsignificantly in dollar amount and as a percentage of sales in the last fiveyears, due primarily to the timing of research and development effortsassociated with significant new product introductions. We anticipate that ourresearch and development expenses will increase as we continue to invest in thedevelopment of new products and technologies.

 

*Sales and marketing expenses.*   Sales and marketing expensesconsist primarily of salaries and related expenses, sales commissions andoverhead for personnel performing sales and marketing functions. Other significantsales and marketing expenses include travel and entertainment expense, costs ofattending medical conferences and trade shows, clinician training and otherpromotional costs and costs of demonstration systems and samples.

 

Our sales and marketing expenses have substantiallyexceeded our sales in each year since 2004, as we have invested in building thesales and marketing organization and administrative infrastructure necessary tosupport our planned sales growth. During 2008, we have taken steps to reduceour sales and marketing expenses through a reduction in the number of ourdirect sales personnel, and as a result we expect sales and marketing expensefor the balance of 2008 to remain consistent with second quarter 2008 levels.

 

*General and administrative expenses.*   General and administrativeexpenses consist primarily of salaries and related expenses and overhead forpersonnel performing executive, finance, information technology and humanresource functions. Other significant general and administrative expensesinclude consulting fees and professional fees for legal services (includingservices related to obtaining and maintaining protection of our intellectualproperty) and accounting services.

 

*Interest income.*   Interest income consists of interestearned on our cash and cash equivalents.

 

*Interest expense.*   Interest expense consists ofinterest expense on our term loans, convertible notes and equipment loans.

 

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**InternalControl over Financial Reporting**

 

Our management determined that as of June 30,2008 and December 31, 2007 we had a material weakness in our internalcontrol over financial reporting related to our financial statement closeprocess that, until remediated, results in more than a remote likelihood that amaterial misstatement to the annual or interim consolidated financialstatements could occur and not be prevented or detected by our internalcontrols in a timely manner. We concluded that there is a material weakness inour internal control over financial reporting because we do not have asufficient number of personnel with the appropriate level of experience andtechnical expertise to appropriately resolve non-routine and complex accountingmatters or to evaluate the impact of new and existing accounting pronouncementson our consolidated financial statements while completing the financialstatement close process. The material weakness resulted in the identificationof adjustments during the financial statement close process during 2007 thathave been recorded in the consolidated financial statements.  In order toremediate this material weakness, we are taking the following actions:

 

·    we are actively seeking additional accounting and finance staffmembers to augment our current staff and to improve the effectiveness of ourfinancial statement close process; and

 

·    we are expanding the training and education of our accounting and financestaff members in an effort to improve their effectiveness.

 

Notwithstanding the material weakness that existed asof June 30, 2008 and December 31, 2007, our management has concludedthat the consolidated financial statements included  present fairly, in all material respects, ourfinancial position, results of operation and cash flows in conformity with U.S.generally accepted accounting principles.

 

**CriticalAccounting Policies and Estimates**

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenue andexpenses during the reporting period. These estimates and judgments areinherently subject to uncertainty. On an ongoing basis, we re-evaluate ourjudgments and estimates, including those related to uncollectible accountsreceivable, inventories, recoverability of long-lived assets, stock-basedcompensation, accrued expenses and other contingencies. We base our estimatesand judgments on our historical experience and on other assumptions that webelieve are reasonable under the circumstances, the results of which form thebasis for making the judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultscould differ from those estimates, and material effects on our operatingresults and financial position could result.

 

For a description of those of our accounting policiesthat, in our opinion, involve the most significant application of judgment orinvolve complex estimation and which could, if different judgments or estimateswere made, materially affect our reported results of operations, see “Management’sDiscussion and Analysis of Financial Condition and Results ofOperations—Critical Accounting Policies and Estimates” in our Annual Report on Form 10-Kfor the year ended December 31, 2007, filed with the SEC on March 31,2008.

 

**RecentAccounting Pronouncements**

 

We adopted Financial Accounting Standards BoardStatement No. 157, *Fair ValueMeasurements*, or SFAS 157, effective January 1, 2008. SFAS 157 defines fair value as the price that would be received to sellan asset or paid to transfer a liability, referred to as the exit price, in anorderly transaction between market participants at the measurement date. The standard outlines a valuation framework and creates a fair valuehierarchy in order to increase the consistency and comparability of fair valuemeasurements and the related disclosures.  In determining fair value, weprimarily use prices and other relevant information generated by markettransactions involving identical or comparable assets, called the marketapproach. As of  June 30, 2008, thefair value of all of our financial 

 

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assets is based onLevel 1 observable inputs.  We havedetermined that our fair value measurements are in accordance with therequirements of SFAS 157, therefore, the implementation of SFAS 157 did nothave any impact on our consolidated financial condition or results ofoperations.

 

**Resultsof Operations**

 

**Threemonth periods ended June 30, 2008 and June 30, 2007**

 

*Sales.*   Our sales in the three monthsended June 30, 2008 decreased by 9% to $2.2 million compared with $2.4million during the corresponding period in 2007, and were flat sequentially incomparison to the first quarter of 2008. Included in the second quarter 2008sales was approximately $444,000 of i60 reload revenues, compared withapproximately $478,000 in the first quarter of 2008. Our second quarter saleswere adversely affected by the previously disclosed delays in the commerciallaunch of the i60 product, and also by our decision during the quarter to upgradethe articulation joint of our i60 and i45 instruments to address concerns overpremature wear that was reducing the useful life of the instrument anddeterring surgeons from using the device. The enhanced i60, which incorporatesa new, banded articulating joint, was not available until July of 2008. In theinterim, we made available to customers a modified “straight” version of thei60 instrument without the articulating joint, and reload revenue during thesecond quarter of 2008 was attributable primarily to usage of this modifiedversion of the i60. Shipments of the improved i60 instrument incorporating the upgradedarticulation joint resumed during the third quarter of 2008.

 

*Cost of sales and gross profit.*   Our cost of sales in the threemonths ended June 30, 2008 increased by 55%, to $3.0 million compared with$1.9 million during the corresponding period in 2007.  Our gross profitdecreased to $(0.9) million, or (40)% of sales, in the three months ended June 30,2008 from $0.4 million, or 18% of sales, during the corresponding period in2007.  The decrease in our gross profit and our gross margin percentage isattributable to increased cost of sales, including approximately $494,000 ofcosts related to the i60 and iDrive devices that we placed with hospitalsduring the second quarter, an increase of $364,000 in cost of sales associatedwith the write-off of scrap and obsolete inventory as a result of thetransition to the new wireless platform and an increase in cost of sales of $241,000related to engineering samples used for validation testing. ** **Our gross margins arelikely to fluctuate from period to period until we are able to realize furthereconomies of scale in our purchasing and manufacturing process throughincreased manufacturing capacity utilization and automation.

 

*Research and development expenses.*   Our research and developmentexpenses in the three months ended June 30, 2008 decreased by 3% to $1.5million compared with $1.6 million during the corresponding period in 2007 dueto a decrease in materials and components used for new productdevelopment.   Research and developmentcosts increased as a percentage of sales to 70% in the three months ended June 30,2008, compared with 65% of sales during the corresponding period in 2007.

 

*Sales and marketing expenses.*   Our domestic and internationalsales and marketing expenses in the three months ended June 30, 2008increased by 55%, to $6.0 million, compared with $3.8 million during thecorresponding period in 2007, and increased as a percentage of sales to 276% ofsales in the three months ended June 30, 2008.  This compares to 162%of sales during the corresponding period in 2007.  The increase in bothdollar amount and percentage of sales was due to sales force expansion,training and planned increases in marketing expense associated with trade showsand conventions. During 2008, we have taken steps to reduce our sales andmarketing expenses through a reduction in the number of our direct salespersonnel, and as a result we expect sales and marketing expense for thebalance of 2008 to remain consistent with second quarter 2008 levels.

 

*General and administrative expenses.*   Our general and administrativeexpenses in the three months ended June 30, 2008 increased by 24%, to $2.6million compared with $2.1 million during the corresponding period in 2007, andincreased as a percentage of sales to 121% in the three months ended June 30,2008, compared to 89% during the corresponding period in 2007.  Theincrease in dollar amount and percentage of sales was due to higher,stock-based compensation expense and higher professional fees associated withour being a public company.

 

*Interest income.*   Our interest income in the threemonths ended June 30, 2008 decreased by 70% to $90,000 compared with$294,000 during the corresponding period in 2007, due to lower average cashbalances and lower interest rates.

 

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*Interest expense.*   Our interest expense in the threemonths ended June 30, 2008 decreased to $0.6 million compared with $1.1million during the corresponding period in 2007. The decrease was the result oflower interest expense related to our convertible debt issued in March 2007,as the 7% terminal value of such convertible debt was charged to interestexpense only prior to the completion of our initial public offering in October 2007.

 

**Six month periods ended June 30,2008 and June 30, 2007**

 

*Sales.*   Our sales in the six months endedJune 30, 2008 increased by 5% to $4.4 million compared with $4.2 millionduring the corresponding period in 2007, primarily due to the introduction inlate 2007 of our next generation i60 and iDrive products.  Also, our sales in the first six months of2007 were negatively affected by limited availability of demonstration unitsand sales collateral for the then newly introduced PLC 60 linear stapler, andby the fact that in 2007 we had a limited inventory of the linear staplerproducts that the PLC 60 was intended to replace.

 

*Cost of sales and gross profit.*   Our cost of sales in the sixmonths ended June 30, 2008 increased by 69%, to $5.6 million compared with$3.3 million during the corresponding period in 2007.  Our gross profitdecreased to $(1.2) million, or (27)% of sales, in the six months ended June 30,2008 from $0.9 million, or 21% of sales, during the corresponding period in2007.  The decrease in our gross profit and our gross margin percentage isattributable to increased cost of sales, including approximately $740,000 ofcosts of the i60 and iDrive devices that we placed with hospitals during thesix month period, an increase of $1.1 million in cost of sales associated withthe write-off of components and finished goods inventory that became obsoletedue to a design enhancement of the i60 device and as a result of the transitionto the new wireless platform, and an increase in cost of sales of $336,000related to engineering samples used for validation testing.

 

*Research and development expenses.*   Our research and developmentexpenses in the six months ended June 30, 2008 increased by 21% to $3.1million compared with $2.6 million during the corresponding period in 2007 dueto an increase in personnel, stock compensation expense and prototype costsassociated with new product development.  Research and development costs increased as a percentage of sales to 71%in the six months ended June 30, 2008, compared with 61% of sales duringthe corresponding period in 2007.

 

*Sales and marketing expenses.*   Our domestic and internationalsales and marketing expenses in the six months ended June 30, 2008increased by 79%, to $12.8 million, compared with $7.1 million during thecorresponding period in 2007, and increased as a percentage of sales to 291% ofsales in the six months ended June 30, 2008.  This compares to 170%of sales during the corresponding period in 2007.  The increase in bothdollar amount and percentage of sales was due to domestic and internationalsales force expansion, training and planned increases in marketing expenseassociated with trade shows and conventions.

 

*General and administrative expenses.*   Our general and administrativeexpenses in the six months ended June 30, 2008 increased by 30%, to $5.6million compared with $4.3 million during the corresponding period in 2007, andincreased as a percentage of sales to 129% in the six months ended June 30,2008, compared to 103% during the corresponding period in 2007.  Theincrease in dollar amount and percentage of sales was due to higher,stock-based compensation expense and higher professional fees associated withbeing a public company.

 

*Interest income.*   Our interest income in the sixmonths ended June 30, 2008 decreased by 22% to $285,000 compared with$365,000 during the corresponding period in 2007, due to lower average cashbalances and lower interest rates.

 

*Interest expense.*   Our interest expense in the sixmonths ended June 30, 2008 increased by 19% to $1.3 million compared with$1.1 million during the corresponding period in 2007. The increase was theresult of full six months of interest expense and amortization of financingfees during 2008 related to our convertible debt issued in March 2007.

 

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**Liquidityand Capital Resources**

 

Since our inception, we have financed our operationsprimarily through private placements of our preferred stock, unsecuredborrowings from our stockholders, a credit facility and, more recently, theissuance in March 2007 of our convertible notes in the aggregate principalamount of $25.0 million and our initial public offering in October 2007,in which we received net proceeds, after underwriting discounts and offeringexpenses, of approximately $42 million. Our principal sources of liquidity asof June 30, 2008 consisted of our cash and cash equivalents of $11.6million and our accounts receivable balance of $1.6 million.

 

In the first six months of 2008, our operating activitiesused $25.0 million in cash, due primarily to our net operating loss of $23.7million. We used cash of $1.4 million to reduce third party  accounts payable balances and accruedexpenses and we used cash of $1.8 million to increase inventory, primarily rawmaterials and components required for assembly of our newly introduced i60 andiDrive instruments and related reload cartridges to support expected demand forthese products. ** **Ournon-cash expenses were approximately $2.2 million consisting of $0.9 millionstock compensation expense, depreciation and amortization of $0.9 million, andthe amortization of debt discount of $0.4 million. We used $201,000 in ourinvesting activities, primarily consisting of purchases of property andequipment of $1.1 million, related primarily to the purchase of our automatedreload machine and $160,000 for patent application costs, offset by a decreasein restricted cash of $1.0 million.  Ourfinancing activities generated cash of $38,000 related to proceeds of optionexercises, offset by $34,000 used for repayment on our long-term debt.

 

We believe that our cash and cash equivalents will besufficient to meet our anticipated cash requirements through the middle ofNovember 2008, however, there can be no assurance in this regard. If necessary,we have the intent and ability to reduce spending in 2008 by controlling coststhat are within management’s discretion. Such costs include certain sales andmarketing costs, clinical research costs, employee bonuses, professional education,and capital expenditures. Our future cash requirements will depend on manyfactors, including our rate of sales growth, if any, the timing and extent ofspending to support new product development efforts, the expansion of our salesand marketing activities, the timing and introductions of new products and theamount and timing of capital investments we make and cost we incur to expandour manufacturing capacity. Our ability to meet our obligations in the normalcourse of business beyond the middle of November 2008 will be dependent on ourincreasing our customer and revenue base, controlling expenses and securingadditional external financing which we are actively pursuing through variousstructures. We have no arrangements to obtain additional financing, and therecan be no assurance that such financing, if required or desired, will beavailable in amounts or on terms acceptable to us, if at all. ** **These conditionsraise substantial doubt about our ability to continue as a going concern. Ourindependent registered public accounting firm has modified its audit report onour consolidated financial statements for the year ended December 31, 2007to include an explanatory paragraph regarding this contingency.

 

**Item 3.****           ****Quantitative andQualitative Disclosures About Market Risk.**

 

We do not utilize derivative financial instruments,derivative commodity instruments or other market risk sensitive instruments,positions or transactions.

 

We are exposed to market risk in the ordinary courseof business, which consists primarily of interest rate risk associated with ourcash and cash equivalents and debt and foreign exchange rate risk.

 

*Interest rate risk.*   At June 30, 2008, we had$11.6 million of cash and cash equivalents. These amounts were invested primarilyin certificates of deposit. The primary objective of our investment activity isto preserve principal, provide liquidity and maximize income without increasingrisk.  Our investments have limited exposure to market risk. The interestrates are variable and fluctuate with current market conditions. The riskassociated with fluctuating interest rates is limited to our investments incertificates of deposit, and we do not believe that a 10% change in interestrates would have a material impact on our financial position or results ofoperations.

 

The interest rate on our 7% convertible senior securedpromissory notes is fixed and therefore exposes us to limited market risk.

 

*Foreign currency risk.*   To date, our internationalcustomer agreements have been denominated primarily in the local currency ofthe international customer.  The functional currency of our foreignoperations in Europe and

 

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Japan is the localcurrency and, as a result, any fluctuation in the exchange rates of these netassets, denominated in local currency, would be reflected in the translationgains or losses, which are accounted for in other comprehensive income in ourstatements of changes in equity. We do not believe that a change of 10% inforeign currency exchange rates would have a material impact on our financialposition or results of operations.

 

**Item 4.****           ****Controls and Procedures.**

 

(a)           Our chief executive officer and chieffinancial officer have performed an evaluation of the effectiveness of thedesign and operation of our disclosure controls and procedures as of June 30,2008.  Based on that evaluation, our chief executive officer and chieffinancial officer concluded that, as of June 30, 2008, our disclosurecontrols and procedures were ineffective, due to the material weaknesses in ourinternal control over financial reporting previously described in our AnnualReport on Form 10-K for the year ended December 31, 2007, filed withthe SEC on March 31, 2008, which identified the following materialweakness that has not been fully remediated as of June 30, 2008:

 

Our management has determined that we have a materialweakness in our internal control over financial reporting related to ourfinancial statement close process that, until remediated, results in areasonable possibility that a material misstatement to the annual or interimconsolidated financial statements could occur and not be prevented or detectedby our internal controls in a timely manner. We have concluded that there is amaterial weakness in our internal control over financial reporting because wedo not have a sufficient number of personnel with the appropriate level ofexperience and technical expertise to appropriately resolve non-routine andcomplex accounting matters or to evaluate the impact of new and existingaccounting pronouncements on our consolidated financial statements whilecompleting the financial statement close process. The material weaknessresulted in the identification of adjustments during the financial statementclose process during 2007 that have been recorded in the consolidated financialstatements. In order to remediate this material weakness, we are taking thefollowing actions:

 

·we are actively seeking additional accounting and finance staff members toaugment our current staff and to improve the effectiveness of our financialstatement close process; and

 

·we are expanding the training and education of our accounting and finance staffmembers in an effort to improve their effectiveness.

 

(b)           There was no change in our internalcontrol over financial reporting during our most recent fiscal quarter that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PART II:****                ****OTHER INFORMATION**

 

**Item 1:****  ****Legal Proceedings.**

 

Not applicable

 

**Item 1A.****           ****Risk Factors.**

 

In addition to theother information set forth in this report, you should carefully consider thefactors discussed below, which could materially affect our business, financialcondition or future results and could cause actual events to differ materiallyfrom the forward-looking statements in this report. There has been no materialchange in the risk factors described in Item 1A. “Risk Factors” in our AnnualReport on Form 10-K for the year ended December 31, 2007, except asfollows:

 

·                  The risk factor under the heading “*The success of our business is dependent on our ability to develop newand innovative products...”* has been revised to update the discussionof delays in the commercial launch of our i60 product and their impact on ouroperations.

 

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·                  The risk factor under the heading *“We assembleour Intelligent Surgical Instruments using our own customized equipment...”*hasbeen revised to disclose that our automated reload assembly system has not yetattained operational status.

 

·                  The risk factor under the heading *“Any failurein our training efforts could result in lower than expected product sales...”*hasbeen revised to include a discussion of our strategy to have a PMI salesrepresentative present in the operating room during each firing of our i60 andiDrive products during the initial period of use by any institution.

 

·                  The risk factors under theheadings *“If we are unable to manage our expected growth,our performance may suffer”*and *“If we deliver productswith defects, our credibility may be harmed...”* have been revised todisclose that we have reorganized our operating functions and are undertakingnecessary improvements in our quality control, quality assurance and supply chainoperations.

 

·                  The risk factor under the heading *“We may need substantial additional funding...”* has beenrevised to disclose that we believe that we will require additional funding by themiddle of November 2008.

 

·                  The risk factors under the headings “*We must upgrade and correct deficiencies in our regulatory complianceoperations...”* and *“Our failure to meetstrict regulatory requirements could require us to pay fines, incur other costsor even close our facilities”* have been expanded to disclose theresults of recent FDA inspections of our facilities in Langhorne, Pennsylvania.

 

**RisksRelated to Our Business**

 

**Wehave incurred losses since inception and anticipate that we will incurcontinued losses for the foreseeable future.**

 

We are a company with a limited operating history andhave sustained net losses since our inception, including a net loss of $36.8million for the year ended December 31, 2007 and a net loss of $23.7million for the six months ended June 30, 2008. We have an accumulateddeficit of $197.6 million at June 30, 2008. We expect to continue to incursignificant operating losses at least through 2008, as we invest in thedevelopment of our business. Our losses have had and will continue to have anadverse effect on our stockholders’ equity and working capital.

 

**Weare dependent on the success of our SurgASSIST platform and, in particular, ofthe next generation wireless handheld technology incorporated in our recentlyreleased i60 and iDrive products, and we cannot be certain that our technologyand our products will achieve the broad market acceptance necessary to developa sustainable, profitable business.**

 

Historically, most of our revenue has been derivedfrom the sale of our single-patient, disposable Intelligent SurgicalInstruments and, to a lesser extent, from the sale of reload cartridges for ourreusable Intelligent Surgical Instruments. We expect that sales of our firstgeneration products will continue to account for most of our sales for at leastthe next six months. However, we expect that, as our installed base ofreusable, multiple-patient Intelligent Surgical Instruments grows and thenumber of firings of our instruments increases, sales of reload cartridges willbecome the largest component of our total sales. It is difficult to predict thepenetration, future growth rate or size of the market for our SurgASSISTplatform or the rate at which our installed base of instruments will be fired.

 

The commercial success of our various IntelligentSurgical Instruments will require broad acceptance of the SurgASSIST platformby the surgeons who specialize in the procedures we target, a limited number ofwhom may be able to influence device selection and purchasing decisions. If theconcept of computer-assisted power-actuated devices for tissue manipulation,cutting and stapling is not broadly accepted and perceived as havingsignificant advantages over manually-actuated devices, then we will not meet ourbusiness objectives. Broad acceptance of our SurgASSIST platform will require adetermination by hospitals and surgeons that our products are safe,cost-effective and represent acceptable methods of treatment. In addition,certain components of our SurgASSIST platform in its current configuration maybe considered to be capital purchases that require administrative proceduresand approvals from senior hospital management, the result of which can be anextended sales cycle requiring multiple individuals to believe in theadvantages of our products. We cannot assure that our existing relationshipsand arrangements with hospitals and surgeons can be maintained or that newrelationships will be established in support of our products. In addition, ourcompetitors may develop new technology for tissue manipulation, cutting andstapling that is more attractive to surgeons and hospitals. If surgeons do notconsider our 

 

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products to besuitable for application in the procedures we are targeting and an improvementover the use of competing products, our business goals will not be realized.

 

**Thesuccess of our business is dependent on our ability to develop new andinnovative products and to enhance our existing products. We have experiencedsignificant delays in new product introduction and if we do not achieve ourcurrent development goals in the time frames we expect, the commercializationof our new products may be delayed and, as a result, our operations may beadversely affected.**

 

The success of our business is dependent on ourability to develop new products, to introduce enhancements to our existingproducts and to develop these new technologies within targeted time frames.These target estimates are based on a variety of assumptions. The actual timingof these milestones can vary dramatically compared to our estimates for reasonsthat may or may not be within our control. For example, the commercial releaseof our PLC 60 linear stapler in 2006 was delayed almost nine months due toproduct design flaws and supply chain problems, and our ability to generaterevenue from the PLC 60 staplers that we placed in hospitals beginning in December 2006was adversely affected due to the unavailability in 2007 of certain reloadcartridges for the device.

 

Similarly, our ability to generate revenue from thenew i60 and iDrive products that we introduced in late 2007 has beenadversely affected delays in availability of green reload cartridges and byproblems with the initial quality of units delivered to customers and otherissues. Some early users of our i60 instruments have experienced difficulties,such as problems in consistently operating its articulation feature and inproperly seating reload cartridges. Although these difficulties may in part beattributable to inadequate training or incorrect technique, they have led insome cases to a negative perception of product quality. We decided during thesecond quarter of 2008 to upgrade the articulation joint of our i60 and i45instruments to address concerns over premature wear that was reducing theiruseful life and deterring surgeons from using the devices. Improved productsincorporating the new, stronger banded articulation joint were not availableuntil the third quarter, which resulted in lower than expected reload revenuesin the second quarter of 2008. Additionally, training of our sales force andthe clinical personnel of our customers has taken longer than expected.Although green reloads became available during the second quarter of 2008 and upgradedi60 and i45 products incorporating an improved articulation joint becameavailable in the third quarter of 2008, the unavailability of these productsearlier in the year resulted in lost revenue opportunities and, together withthe other factors described above, has slowed the rate of adoption of our i60and iDrive products.

 

We performed a thorough review of our operations in April whichresulted in a reorganization with the goal of enhancing our quality processesand controls.  A determination was madethat there were gaps in quality control, quality assurance and supply chainmanagement, that once addressed would increase customer satisfaction.  In order to address these issues, we hiredseveral new  senior level executives toenhance the operations including inventory and supply chain management, manufacturingand product development.* * In addition, to further support product quality,we have implemented our Quality is Caring program which is an  internal quality assurance plan to ensurethat all of our products meet the rigorous expectations of the operating room.

 

Delays in other planned product releases, or ourinability to quickly resolve perceived quality issues and other factorsaffecting the success of our i60 product launch, could have a material adverseeffect on our revenues and results of operations. Customers may foregopurchases of our existing products and purchase our competitors’ products as aresult of delays in the introduction of our new products and enhancements,failure by us to choose correctly among technical alternatives or failure by usto offer innovative products or enhancements at competitive prices and in atimely manner. In addition, announcements of new products by us or bycompetitors may result in a delay in or cancellation of purchasing decisions inanticipation of such new products. Any such losses could impair the value ofyour investment.

 

**Wehave limited manufacturing experience, have experienced significantmanufacturing problems in the past, and may encounter difficulties inincreasing production to provide an adequate supply to customers.**

 

The manufacture of our products is a complex andcostly operation involving a number of separate processes and components. Todate, our manufacturing activities have consisted primarily of assemblinglimited quantities of our products. We have considered, and will continue toconsider as appropriate, manufacturing components that are currently providedby third parties, as well as implementing new production processes. We do nothave experience in manufacturing our products in the commercial quantities thatmight be required to market our products in the United States, Europe andJapan. We have experienced significant difficulties in our supply chain andmanufacturing operations, which have impaired our ability to ship our productson a timely basis and had a material adverse impact on our results ofoperations.  Manufacturing of ourproducts in commercial quantities will 

 

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require us toexpand 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 additional tooling and equipment. Wemay encounter difficulties in increasing our manufacturing capacity and inmanufacturing commercial quantities, including:

 

·maintaining product yields;

 

·maintaining quality control and assurance;

 

·providing component and service availability;

 

·maintaining adequate control policies and procedures; and

 

·hiring and retaining qualified personnel.

 

Difficulties encountered in increasing ourmanufacturing capacity could impact our ability to adequately supply ourcustomers.

 

**Inorder to achieve and sustain profitability, we must substantially improve ourgross margins.**

 

The historical unit costs for our products, based onlimited manufacturing volumes, have been very high in relation to our sales,resulting in low or negative gross margins. It will be necessary for us toachieve substantial further reductions in our cost of sales as a percentage ofsales in order to become profitable. The transition to in-house production orto new production processes may initially have a negative effect on our manufacturingyields or costs, which would materially and adversely affect our business,financial condition and results of operations. Certain of our manufacturingprocesses are labor intensive, and achieving significant cost reductions willdepend in part upon reducing the time required to perform these processes. Wecannot assure you that we will be able to achieve the significant costreductions in the manufacture of our products necessary for our business toachieve profitability.

 

**Ifour products are not considered to be a safe and effective alternative toexisting technologies, we will not be commercially successful.**

 

Our Intelligent Surgical Instruments rely on newtechnology, and our success depends upon acceptance of this technology by themedical community as safe, clinically effective and cost effective and apreferred device as compared to products of our competitors. We have notcollected, and are not aware that others have collected, long-term dataregarding efficacy, safety and clinical outcomes associated with the use of ourproducts. Any data that is generated in the future may not be positive orconsistent with our current, largely anecdotal data, which would negativelyaffect market acceptance and the rate at which our Intelligent Surgical Instrumentsare adopted. Equally important will be physicians’ perceptions of the safety ofour products. Our technology is relatively new in surgery, and the results ofshort-term clinical experience with our SurgASSIST system do not necessarilypredict long-term clinical benefits as compared to the products of ourcompetitors. If, over the long term, our SurgASSIST system does not meetsurgeons’ expectations as to safety, efficacy and ease of use, the SurgASSISTsystem may not become widely adopted.

 

Even if the data collected from future clinicalstudies or clinical experience indicates positive results, each surgeon’sactual experience with our device outside the clinical study setting may vary.Consequently, both short- and long-term results reported in any future clinicalstudies may be significantly more favorable than typical results of otherpracticing surgeons, which could negatively affect rates of adoption andnegatively affect our results.

 

**Becauseour markets are highly competitive, customers may choose to purchase ourcompetitors’ products, which would result in reduced sales and harm ourfinancial results.**

 

Our SurgASSIST system is a new technology and mustcompete with the more established manual devices of our competitors, such asCovidien and Ethicon Endo-Surgery, Inc. Conventional manual devices arewidely 

 

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accepted in themedical community, have a long history of use and do not require the purchaseof additional, expensive capital equipment. We cannot be certain that surgeonswill use our products to replace or supplement established treatments or thatour products will be competitive with current or future products andtechnologies.

 

Most of our competitors enjoy competitive advantagesover us, including:

 

·significantly greater name recognition;

 

·longer operating histories;

 

·established relationships with healthcare professionals, customers andthird-party payers;

 

·established distribution networks;

 

·additional lines of products and the ability to offer rebates or bundleproducts to offer higher discounts or incentives to gain a competitiveadvantage;

 

·greater experience in conducting research and development, manufacturing,clinical trials, obtaining regulatory clearance for products and marketingapproved products; and

 

·greater financial and human resources for product development, sales andmarketing and patent litigation.

 

In addition, our SurgASSIST system in its originalconfiguration has certain perceived disadvantages compared to conventionalmanual endomechanical devices. Prior to the introduction of our new i60 linearstapler and our iDrive wireless handheld power and control system, ourIntelligent Surgical Instruments had to be tethered by a flexible shaft to apower console which is located outside the sterile field. Some surgeons andoperating room personnel found this to be cumbersome and not well suited forall procedures. This factor may initially have limited market acceptance of ourSurgASSIST platform. Our next generation untethered self-contained IntelligentSurgical Instruments are designed to eliminate this disadvantage of ourSurgASSIST system, but we may need to overcome an initial negative perceptionby clinicians of our first-generation tethered technology.

 

Our future success depends upon maintaining acompetitive position in the development of products and technologies in ourareas of focus. Our competitors may:

 

·develop technologies and products that are more effective than our products orthat render our technologies or products obsolete or noncompetitive;

 

·obtain patent protection or other intellectual property rights that wouldprevent us from developing or enhancing our products; or

 

·obtain regulatory approval for the commercialization of their products morerapidly or effectively than we do.

 

Additional competitors also may enter our market. As aresult, we cannot assure you that we will be able to compete successfullyagainst existing or new competitors. Our sales would be reduced or eliminatedif our competitors develop and market products that are more effective and lessexpensive than our products. Volatility in the demand for our products could, amongother things, make it more difficult to gauge the manufacturing capacitynecessary to meet our demand, decrease our manufacturing efficiency andincrease our working capital requirements. If any of these occur, yourinvestment in our common stock may decrease in value.

** **

**Weassemble our Intelligent Surgical Instruments using our own customizedequipment and plan to undertake a new manufacturing process, making usvulnerable to production and supply problems that could negatively impact oursales.**

 

 

 

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We engaged a third party to develop and fabricate anautomated system to enable us to assemble the reload cartridges forour PLC 60 and i60 linear staplers, which we currently assemble manually.The design, manufacture and installation of this highly complex system hastaken longer than we expected. The system has now been installed at ourfacility and we are in the process of conducting initial testing of the system.We currently expect the system to be operational in the third quarter of2008.  While we believe the use of this new system should reduce our riskof supply problems, the automated system must be capable of manufacturing atour anticipated volume. However, there is no guarantee that the automatedsystem will function at the capacity we require. The automated system will belocated at our facility in Langhorne, Pennsylvania, which requires us to beresponsible for the day-to-day control and protection of the system. Delay inthe availability of, or unanticipated problems in our utilization of, thisautomated system could jeopardize our initiatives to improve our gross margins.

 

**Weare dependent upon a number of key suppliers, including sole source suppliers,the loss of which would materially harm our business.**

 

We rely upon sole source suppliers for a number of keycomponents and services used in manufacturing our products and, in general, wedo not have long-term contracts with these suppliers. We cannot assure you thatwe will be able to obtain sufficient quantities of such components or servicesin the future. Because we do not have long-term contracts, our suppliersgenerally are not required to provide us with any guaranteed minimum productionlevels.

 

In addition, our reliance on third parties involves anumber of risks, including, among other things:

 

·suppliers may fail to comply with regulatory requirements or make errors inmanufacturing components that could negatively affect the efficacy or safety ofour products or cause delays in shipments of our products;

 

·we may not be able to respond to unanticipated changes and increases incustomer orders;

 

·we may be subject to price fluctuations due to a lack of long-term supplyarrangements for key components;

 

·we may experience delays in delivery by our suppliers due to changes in demandfrom us or their other customers;

 

·we may lose access to critical services and components, resulting in an interruptionin the manufacture, assembly and shipment of our systems;

 

·fluctuations in demand for products that our suppliers manufacture for othersmay affect their ability or willingness to deliver components to us in a timelymanner;

 

·our suppliers may wish to discontinue supplying components or services to usfor risk management reasons;

 

·we may not be able to find new or alternative components or reconfigure oursystem and manufacturing processes in a timely manner if the necessarycomponents become unavailable; and

 

·our suppliers may encounter financial hardships unrelated to our demand forcomponents, which could inhibit their ability to fulfill our orders and meetour requirements.

 

If any of these risks materialize, it couldsignificantly increase our costs and impact our ability to meet demand for ourproducts.

 

We cannot quickly replace suppliers or establishadditional new suppliers for some of these components, due to both the complexnature of the manufacturing process used by our suppliers and the time andeffort that may be required to obtain regulatory clearance or approval to usematerials from alternative suppliers. Any significant 

 

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supplyinterruption or capacity constraints affecting our facilities or those of oursuppliers would impair our ability to manufacture our products.

 

**Ifwe are unable to manage our expected growth, our performance may suffer.**

 

As of June 30, 2008, we had approximately 178employees, compared with 227 at December 31, 2007. We will need to expand ourmanagerial, operational, financial and other resources to manage and fund ouroperations, continue our research and development activities, increase thesales force and develop our products. Transitions in our senior management teamhave in the past complicated the task of effectively managing our growingoperations and implementing required systems improvements. In March 2008, ourchief operations officer, who was one of our three executive officers and wasresponsible for our manufacturing operations as well as for our regulatorycompliance operations, resigned. Following his departure, we undertook adetailed review of our operations. We concluded that gaps existed in qualitycontrol, quality assurance, and supply chain management. Due to the technicalnature of our manufacturing requirements and to provide focus at the functionallevel and to increase feedback from our customers into the manufacturingprocess, we determined that we would be better served to divide our operationsactivity into three functional areas, consisting of operations (includinginventory and supply chain management); manufacturing (comprising the manufacturingand assembly processes); and product development (the process of transferring aproduct from R&D through manufacturing ramp-up, including verification andvalidation). We have assigned experienced senior executives to directly manageeach of these functional areas. We believe that this reorganization of ouroperations functions, which was completed in the second quarter of 2008, willresult in improved efficiency, product quality and customer satisfaction.However, there can be no assurance that this reorganization will achieve itsintended goals, and it is possible that our management, finance, technical andregulatory personnel, systems and facilities currently in place may not beadequate to support our expected future growth. Our need to effectively manageour operations, growth and programs requires that we continue to improve oursystems and procedures 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.

 

**Wemust upgrade and correct deficiencies in our regulatory compliance operations,and our failure to do so could impair our ability to market our products orlead to regulatory enforcement action against us.**

 

We are subject to extensive regulation in the UnitedStates and other countries, including by the United States Food and DrugAdministration, or FDA. We maintain an organization of managers, engineers andadministrative personnel, consisting of 13 persons at June 30, 2008, whoseresponsibility it is to ensure that our products, facilities and operationscomply with applicable regulatory requirements. However, we have from time totime experienced shortages of qualified regulatory compliance staff due toturnover and other factors, and we need to upgrade and carefully manage ourregulatory compliance operations in order to accommodate our expected growth.The senior vice president of regulatory affairs and quality assurance whom wehired in the fourth quarter of 2007 resigned in January 2008., and wedivided his responsibilities among several of our current employees. Our chiefoperations officer, to whom our senior vice president of regulatory affairs andquality assurance reported, also resigned in March 2008.

 

In May 2008, following an inspection of ourfacilities, the FDA issued a Notice of Inspectional Observations, or Form 483,which included ten inspectional observations relating to management controls,medical device reporting, design controls, and corrective and preventiveaction.  We were also inspected by theFDA in 2002, 2003, 2005 and 2007, and some of the observations in the FDA’s May 2008Form 483 are similar to those we received in earlier inspections. As aresult of these events, we concluded that there were significant deficienciesin our regulatory compliance operations, and are taking steps to make 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 hired a third-party expertto oversee our medical device reporting process for six months and have alsorequested a meeting with FDA’s Office of Surveillance and Biometrics to furtherdiscuss the MDR reporting criteria.

 

If we are not successful in identifying and recruitingqualified personnel to manage and staff our regulatory compliance operations orin implementing necessary process improvements on a timely basis, we could besubject to regulatory enforcement actions which could damage our reputation,impair our ability to obtain regulatory clearances for new products, prevent usfrom manufacturing and selling our products and harm our business.

 

**Wehave a material weakness in our internal control over financial reporting, andif we are unable to achieve and maintain effective internal control overfinancial reporting, investors could lose confidence in our financialstatements and our company, which could have a material adverse effect on ourbusiness and stock price.**

 

 

 

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We have concluded that there is a material weakness inour internal control over financial reporting because we do not have asufficient number of personnel with the appropriate level of experience andtechnical expertise to appropriately resolve non-routine and complex accountingmatters or to evaluate the impact of new and existing accounting pronouncementson our consolidated financial statements while completing the financialstatement close process. The material weakness resulted in the identificationof adjustments during the financial statement close process in 2007 that havebeen recorded in our consolidated financial statements. A material weakness isa control deficiency, or a combination of control deficiencies, in internalcontrol over financial reporting, such that there is a reasonable possibilitythat a material misstatement of annual or interim financial statements wouldnot be prevented or detected. Until this design deficiency in our internalcontrol over financial reporting is remediated, there is reasonable possibilitythat a material misstatement to our annual or interim consolidated financial statementscould occur and not be prevented or detected by our internal controls in atimely manner.

 

Pursuant to Section 404 of the Sarbanes-Oxley Actof 2002, when we file our Annual Report on Form 10-K for the fiscal yearending December 31, 2008, we must assess the effectiveness of our internalcontrol over financial reporting as of the end of our 2008 fiscal year. Thisassessment must include disclosure of any material weaknesses in our internalcontrol over financial reporting that are identified by management. If we areunable at that time to assert that our internal control over financialreporting is effective because the material weakness identified above has notbeen remediated, or for any other reason, investors could lose confidence inthe accuracy and completeness of our financial reports, which could have anadverse effect on our stock price.

 

**Anyfailure in our training efforts could result in lower than expected productsales and potential liabilities.**

 

A critical component of our sales and marketingefforts is the training of a sufficient number of surgeons, other cliniciansand hospital staff to properly use our SurgASSIST system. In order to operateeffectively, our internal sales force must also be trained on the benefits andproper utilization of our technology, including newly introduced products. Inconnection with the introduction of our i60 and iDrive products, we have foundthat it takes longer than we expected to adequately train our internal salesforce and customers’ clinical personnel on the use and care of theseinstruments, due in part to their novelty and to the need to employ newsterilization techniques. Additionally, the number of i60 and iDrivedemonstration units available for use by our sales force was limited during theearly phases of our i60 product launch. As a result, it has taken longer forour sales force to become fully effective in selling these new products, andthe rate of adoption of our new technology has been adversely affected. Anyfurther delays in adequately training our internal sales force or our customers’clinical personnel on these or other products could harm our business.

 

Additionally, we rely on clinicians and hospital staffto devote adequate time to learn to use our products. If surgeons or hospitalstaff are not properly trained in the use of our Intelligent SurgicalInstruments, they may misuse or ineffectively use our products. For example,during 2007, we received reports of incomplete firings of our reusable PLC60 instrument that we believed were attributable to improper installation ofreload cartridges by our customers’ medical personnel. More recently, we havereceived similar reports relating to the seating of reload cartridges in ouri60 and PLC 75 linear staplers. We initiated improvements in our trainingprocedures to alert customers to the need to properly seat the reloadcartridges, and designed a new version of the reload cartridge to incorporate apositive locking feature to make this error less likely to occur. However, insufficient training may result in unsatisfactory patient outcomes,patient injury and related liability or negative publicity, which could have anadverse effect on our product sales.

 

It has always been a key component of our sales andmarketing strategy that for at least the first 18 to 24 months followingadoption by any institution of our next generation products we seek to have aPMI sales representative present in the operating room for every firing of theIntelligent Surgical Instrument. While this places an additional burden on thelimited resources of our internal sales force, we believe that it is importantto our ability to encourage the adoption of our Intelligent SurgicalInstruments and adequately train hospital staff in their use. In the near term,we believe that we have a sufficient number of sales representatives to carryout this strategy and support our current 2008 revenue plan. However, in thelonger term, the continued implementation of this strategy will likely requireus to increase the size of our direct sales force, and our failure to do socould constrain our revenue growth and the rate of adoption of our IntelligentSurgical Instruments.

 

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**Theuse of our products could result in product liability claims that could beexpensive, divert management’s attention and harm our reputation and business.**

 

Our business exposes us to significant risks ofproduct liability claims that are inherent in the testing, manufacturing andmarketing of medical devices. The medical device industry has historically beensubject to extensive product liability litigation. We have in the past been,and in the future may be, subject to claims by consumers, healthcare providers,third-party payers or others selling our products if the use of our productswere to cause, or merely appear to cause, injury or death. We are currently thesubject of a product liability suit in Belgium. Any weakness in training andservice associated with our products may also result in product liabilitylawsuits. Additionally, we may be unable to maintain our existing productliability insurance in the future at satisfactory rates or adequate amounts. Aproduct liability claim, regardless of its merit or eventual outcome or theavailability 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.

 

**Ifwe deliver products with defects, our credibility may be harmed and marketacceptance of our products may decrease.**

 

The manufacturing and marketing of our productsinvolve an inherent risk of product liability claims. In addition, our productdevelopment and production processes are complex and could expose our productsto defects. Additionally, problems experienced by our customers, such asimproper operation of the articulation joint or difficulty in consistentlyseating our reload cartridges, may be perceived by them as quality defects. Weperformed a thorough review of our operations in April which resulted in areorganization with the goal of enhancing our quality processes andcontrols.  We determined that there weregaps in quality control, quality assurance and supply chain management, thatonce addressed would increase customer satisfaction.  In order to address these issues, we hiredseveral new  senior level executives toenhance the operations including inventory and supply chain management,manufacturing and product development.* * In addition, to further support productquality, we have implemented our Quality is Caring program, which is an  internal quality assurance plan to ensurethat all of our products meet the rigorous expectations of the operating room.

 

Our SurgASSIST system also incorporates sophisticatedcomputer software. Complex software frequently contains errors, especially whenfirst introduced. We cannot assure you that our software will not experienceerrors or performance problems in the future.

 

If our products have, or are perceived to have,mechanical defects or software errors or have performance problems, we wouldlikely experience:

 

· loss of sales;

 

· delay in market acceptance of our products;

 

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· damage to our reputation;

 

· additional regulatory filings;

 

· product recalls;

 

· increased service or warranty costs; or

 

·product liability claims.

 

**Wemay need substantial additional funding and we may be unable to raise capitalwhen needed, which would force us to delay, reduce or eliminate our productdevelopment programs or commercialization efforts.**

 

We believe that our existing cash and cash equivalentbalances will be sufficient to meet our anticipated cash requirements through themiddle of November of 2008. Our ability to meet our obligations in the normalcourse of business beyond the middle of November 2008 will be dependent on ourincreasing our customer and revenue base, controlling expenses and securingadditional external financing which we are actively pursuing through variousstructures. We have no arrangements to obtain additional financing, and therecan be no assurance that such financing, if required or desired, will beavailable in amounts or on terms acceptable to us, if at all. These conditionsraise substantial doubt about our ability to continue as a going concern. Ourindependent registered public accounting firm has modified its audit report onour consolidated financial statements to include an explanatory paragraphregarding this contingency. However, our actual capital requirements willdepend on many factors, many of which are outside our control, including:

 

· future revenue generation;

 

· 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 regulatoryapprovals;

 

· expenses of future clinical studies, ifany;

 

· the effect of competing technological andmarket developments;

 

· licensing technologies for future development;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 andinternal growth primarily through private placements of equity securities anddebt and, more recently, our initial public offering. We cannot be certain thatadditional public or private financing will be available in amounts acceptableto us, or at all. If we raise additional funds by issuing equity securities,dilution may occur. Debt financing, if available, may involve restrictivecovenants. Any debt financing or additional equity that we raise may containterms that are not favorable to us or our stockholders. Substantially all ourassets are subject to a security interest in favor of the holders of ourconvertible notes, which may limit our ability to obtain additional debtfinancing. Additionally, if we default in the payment of our convertible notes,our noteholders will be entitled to exercise their rights as secured creditors,which include the right to foreclose on the assets we have provided ascollateral, which could materially impair our ability to continue to operateour business.

 

If we are unable to raise additional funds whenneeded, we may have to delay or reduce the scope of or eliminate some or all ofour development programs or we may be forced to seek protection underapplicable bankruptcy laws. Any restructuring or bankruptcy could materiallyimpair your investment.

 

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**Wesell our systems internationally and are subject to various risks relating tothese international activities, which could adversely affect our business,financial condition and results of operations.**

 

During the three months ended June 30, 2008, 82%of our sales were derived from customers located in North America and 18% werederived from customers in Europe and Asia. During the three months ended June 30,2007, 77% of our sales were derived from customers located in North America and23% were derived from customers in Europe and Asia.  For the six monthsended June 30, 2008 and 2007, sales occurring in international marketswere 17% and 23%, respectively.  By doing business in internationalmarkets, we are exposed to risks separate and distinct from those we face inour domestic operations. Our international business may be adversely affectedby changing economic conditions in foreign countries. Because most of ourinternational sales are denominated in the functional currency of the countrywhere the product is being shipped, increases or decreases in the value of theU.S. dollar relative to foreign currencies could affect our results ofoperations. Engaging in international business inherently involves a number ofother difficulties and risks, including:

 

· export restrictions and controls relatingto technology 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,tariffs and other trade barriers;

 

· international terrorism and anti-Americansentiment;

 

· difficulties and costs of staffing andmanaging foreign operations; and

 

· difficulties in enforcing intellectualproperty rights.

 

Our exposure to each of these risks may increase ourcosts, impair our ability to market and sell our products and requiresignificant management attention. We cannot assure you that one or more ofthese factors will not harm our business.

 

**Ifwe choose to acquire or invest in new and complementary businesses, products ortechnologies instead of developing them ourselves, such acquisitions orinvestments could disrupt our business.**

 

We may attempt to expand our business throughacquisitions. To the extent we grow our business through acquisitions, ourfuture success may be partially dependent upon our ability to effectivelyintegrate acquired businesses with our own. There can be no assurance that ouracquisitions will be successfully integrated or that any such acquisitions willotherwise be successful. If our acquisitions are unsuccessful for any reason,our business may be harmed and the value of your investment may decline.

 

**Weare dependent upon key personnel, the loss of any of which could harm ourbusiness.**

 

Our future business and operating results dependsignificantly on the continued contributions of our key technical personnel andsenior management, particularly those of our co-founder, Chief ExecutiveOfficer and

 

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President, MichaelP. Whitman. These individuals and the services they provide would be difficultor impossible to replace. While we are subject to certain severance obligationsto Mr. Whitman, either he or we may terminate his employment at any timeand for any lawful reason or for no reason. Our business and future operatingresults also depend significantly on our ability to attract and retainqualified management, manufacturing, technical, regulatory, marketing, salesand support personnel for our operations. Competition for such personnel isintense, and there can be no assurance that we will be successful in attractingor retaining such personnel.

 

Although we have key-person life insurance in theamount of $2.0 million on the life of Mr. Whitman, this amount wouldnot fully compensate us for the loss of Mr. Whitman’s services. The lossof key employees, the failure of any key employee to perform or our inabilityto attract and retain skilled employees, as needed, could harm our business.

 

**Lackof third-party coverage and reimbursement for our products could delay or limittheir adoption.**

 

We may experience limited sales growth resulting fromlimitations on reimbursements made to purchasers of our products by third-partypayers, and we cannot assure you that our sales will not be impeded and ourbusiness harmed if third-party payers fail to provide reimbursement thathospitals view as adequate.

 

In the United States, our products are purchasedprimarily by medical institutions, which then bill various third-party payers,such as the Centers for Medicare and Medicaid Services, or CMS, whichadministers the Medicare program, and other government programs and privateinsurance plans, for the healthcare services provided to their patients. Theprocess involved in applying for coverage and incremental reimbursement fromCMS is lengthy and expensive. Moreover, many private payers look to CMS insetting their reimbursement policies and amounts. If CMS or other agencieslimit coverage for procedures utilizing our SurgASSIST system or decrease orlimit reimbursement payments for doctors and hospitals, this may affectcoverage and reimbursement determinations by many private payers.

 

If a medical device does not receive incrementalreimbursement from CMS, then a medical institution would have to absorb thecost of our products as part of the cost of the procedure in which the productsare used. Acute care hospitals are now generally reimbursed by CMS forinpatient operating costs under a Medicare hospital inpatient prospectivepayment system. Under the Medicare hospital inpatient prospective paymentsystem, acute care hospitals receive a fixed payment amount for each covered hospitalizedpatient based upon the Diagnosis-Related Group, or DRG, to which the inpatientstay is assigned, regardless of the actual cost of the services provided. Atthis time, we do not know the extent to which medical institutions wouldconsider insurers’ payment levels adequate to cover the cost of our products.Failure by hospitals and surgeons to receive an amount that they consider to beadequate reimbursement for procedures in which our products are used coulddeter them from purchasing our products and limit our sales growth. Inaddition, pre-determined DRG payments may decline over time, which could determedical institutions from purchasing our products. If medical institutions areunable to justify the costs of our products, they may refuse to purchase them,which would significantly harm our business.

 

**Ouroperations are currently conducted primarily at a single location that may beat risk from fire, earthquakes, terror attacks or other disasters.**

 

We currently conduct all of our manufacturing andmanagement activities and certain research and development activities at asingle location in Langhorne, Pennsylvania. We have taken precautions tosafeguard our facilities, including insurance, health and safety protocols andoff-site storage of computer data. However, a casualty due to fire or naturaldisaster, such as an earthquake, storm or terrorist attack, could causesubstantial delays in our operations, damage or destroy our equipment orinventory and cause us to incur additional expenses. A disaster could seriouslyharm our business and results of operations. Our insurance does not coverearthquakes and floods and may not be adequate to cover our losses in anyparticular case.

 

**RisksRelated to Our Intellectual Property**

 

**Ifwe fail to adequately enforce or defend our intellectual property rights, ourbusiness may be harmed.**

 

 

 

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Much of the technology used in the markets in which wecompete is covered by patents, and our commercial success will depend in largepart on our ability to obtain and maintain patent and trade secret protectionfor our products and methods. We currently hold 24 issued United Statespatents, eight granted European patents and four other foreign patents, morethan 100 pending United States and foreign patent applications and two licensedpatents that cover key aspects of our technology. Our issued patents expire atvarious dates beginning in 2019. The loss of our patents could reduce the valueof the related products. In addition, the cost to litigate infringements of ourpatents or the cost to defend ourselves against patent infringement actions byothers could be substantial.

 

Our ability to obtain additional patents is uncertainand the legal protection afforded by these patents is limited and may notadequately protect our rights or permit us to gain or keep any competitiveadvantage. In addition, the specific content required of patents and patentapplications that is necessary to support and interpret patent claims is highlyuncertain due to the complex nature of the relevant legal, scientific andfactual issues. Changes in either patent laws or in interpretations of patentlaws in the United States or elsewhere may diminish the value of ourintellectual property or narrow the scope of our patent protection. Even ifpatents are issued regarding our products and methods, our competitors maychallenge the validity of those patents. Patents also will not protect ourproducts and methods if competitors devise ways of making competitive productswithout infringing our patents.

 

Proprietary trade secrets and unpatented know-how arealso very important to our business. We rely on trade secrets to protectcertain aspects of our technology, especially where we do not believe thatpatent protection is appropriate or obtainable. However, trade secrets aredifficult to protect. Our employees, consultants, contractors, outside clinicalcollaborators and other advisors may unintentionally or willfully disclose ourconfidential information to competitors, and confidentiality agreements may notprovide an adequate remedy in the event of unauthorized disclosure ofconfidential information. Enforcing a claim that a third party illegallyobtained and is using our trade secrets is expensive and time consuming, andthe outcome is unpredictable. Moreover, our competitors may independentlydevelop equivalent knowledge, methods and know-how. Failure to obtain ormaintain trade secret protection could adversely affect our competitivebusiness position.

 

**Ifwe infringe intellectual property rights of third parties, it may increase ourcosts or prevent us from being able to sell our existing products or commercializenew products.**

 

There is a risk that we are infringing the proprietaryrights of third parties under patents and pending applications belonging tothird parties that may exist in the United States and elsewhere in the worldand that relate to the products we market and develop. Because the patentapplication process can take several years to complete, there may be currentlypending applications, unknown to us, which may result in issued patents thatcover the production, manufacture, commercialization or use of our products. Inaddition, the production, manufacture, commercialization or use of our productcandidates may infringe existing patents of which we are not aware.

 

There has been substantial litigation and otherproceedings regarding patent and other intellectual property rights in themedical device industry. Defending ourselves against third-party claims,including litigation in particular, would be costly and time consuming andwould divert management’s attention from our business, which could lead todelays in our development or commercialization efforts. Currently, we areinvolved in two appeal proceedings in Germany in connection with two of threepatent-infringement lawsuits against us. The lawsuits alleged that certain ofour products infringe three European patents held by Ethicon Endo-Surgery. Weprevailed in two of the three infringement actions and the products in questionwere found not to infringe the Ethicon Endo-Surgery patents, and EthiconEndo-Surgery is appealing one of those decisions. We lost the otherinfringement action and are appealing that decision. If third parties aresuccessful in their claims, we might have to pay substantial damages or takeother actions that are adverse to our business. As a result of intellectual propertyinfringement claims, or to avoid potential claims, 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

 

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· be required to redesign a product so itdoes not infringe, which may not be possible or could require substantial fundsand time.

 

**Wemay be subject to damages resulting from claims that our employees or we havewrongfully used or disclosed alleged trade secrets of their former employers.**

 

Many of our employees were previously employed atuniversities or other medical device companies, including our competitors orpotential competitors. We could in the future be subject to claims that theseemployees, or we, have inadvertently or otherwise used or disclosed tradesecrets or other proprietary information of their former employers. Litigationmay be necessary to defend against these claims. If we fail in defendingagainst such claims, a court could order us to pay substantial damages andprohibit us from using technologies or features that are essential to ourproducts, if such technologies or features are found to incorporate or bederived from the trade secrets or other proprietary information of the formeremployers. In addition, we may lose valuable intellectual property rights orpersonnel. A loss of key research personnel or their work product could hamperor prevent our ability to commercialize certain potential products, which couldseverely harm our business. Even if we are successful in defending againstthese claims, such litigation could result in substantial costs and be adistraction to management.

 

**RisksRelated to Regulatory Compliance**

 

**Ourfailure to meet strict regulatory requirements could require us to pay fines,incur other costs or even close our facilities.**

 

Our facilities and manufacturing techniques generallymust conform to standards that are established by the United States Food andDrug Administration, or FDA, and other government agencies, including those ofEuropean and other foreign governments. These regulatory agencies may conductperiodic audits or inspections of our facilities or our processes to monitorour compliance with applicable regulatory standards. If a regulatory agencyfinds that we have failed to comply with the appropriate regulatory standards,it may impose fines on us, delay or withdraw pre-market clearances or otherregulatory approvals or, if such a regulatory agency determines that ournon-compliance is severe, it may close our facilities. Any adverse action by anapplicable regulatory agency could impair our ability to produce our productsin a cost-effective and timely manner in order to meet our customers’ demands.We may also be required to bear other costs or take other actions that may havea negative impact on our future sales and our ability to generate profits.

 

Since2002, the FDA has conducted five inspections of our facilities. Each of thoseinspections resulted in the issuance of a Notice of Inspectional Observations,or Form 483. The most recent inspection concluded in May 2008 andresulted in ten observations related to management controls, medical devicereporting, design control and corrective and preventive action. For each Form 483,we have prepared and submitted a response to the FDA, which included ourproposed corrective actions to address the FDA’s observations. The FDA issuedan Establishment Inspection Report, or EIR, which officially closed the FDA’sinspection for inspections conducted between 2002 and 2005. As of this date theFDA has not provided an EIR for its 2007 or 2008 inspections.  Whether the FDA will accept our response tothe 2007 and 2008 Form 483s is uncertain, particularly in light of thesimilar nature of the current inspectional observations to the previousobservations. If the FDA does not agree with our proposed corrective actions,or accepts them but finds that we have not implemented them adequately, if theFDA is concerned about the repetitive nature of the inspectional observations,or if we otherwise fail to comply with applicable regulatory requirements, theFDA could initiate an enforcement action, including any of the followingsanctions:

 

· 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 partialsuspension or total shutdown of production;

 

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· refusing or delaying our requests for 510(k) clearanceor 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.

 

**Wemay be subject, directly or indirectly, to federal and state healthcare fraudand abuse laws and regulations and could face substantial penalties if we areunable to fully comply with such laws.**

 

The federal anti-kickback laws and several similarstate laws prohibit payments that are intended to induce physicians or otherseither to refer patients to acquire or arrange for or recommend the acquisitionof healthcare products or services. These laws affect our sales, marketing andother promotional activities by limiting the kinds of financial arrangementsand sales programs we may have with hospitals, physicians or other potentialpurchasers or users of medical devices. In particular, these laws influence howwe structure our sales, customer support, education and training programs andphysician consulting and other service arrangements. Although we seek tostructure such arrangements in compliance with applicable requirements, theselaws are broadly written and it is difficult to determine precisely how theselaws will be applied in specific circumstances. We could be subject to a claimunder these anti-kickback laws for our consulting arrangements with surgeons,grants for training and other education, grants for research and otherinteractions with doctors which have come under scrutiny by federal and stateregulators and law enforcement entities. Anti-kickback laws prescribe civil,criminal and administrative penalties for noncompliance, which can besubstantial. Due to the breadth of the statutory provisions and the lack ofguidance in the form of regulations or court decisions addressing some industryactivities, it is possible that our sales, marketing and promotional activitiespractices might be challenged under anti-kickback or related laws. Even anunsuccessful challenge to or investigation into our practices could causeadverse publicity and thus could harm our business and results of operations.

 

Foreign sales of our products also subject us tosimilar fraud and abuse laws, including application of the U.S. Foreign CorruptPractices Act. If our operations, including any consulting arrangements we mayenter into with physicians who use our products, are found to be in violationof these laws, we or our officers may be subject to civil or criminalpenalties, including large monetary penalties, damages, fines, imprisonment andexclusion from Medicare and Medicaid program participation. If enforcementaction were to occur, our business and financial condition would be harmed.

 

**Modificationsto our products may require new regulatory clearances or approvals or mayrequire us to recall or cease marketing our products until clearances orapprovals are obtained.**

 

Modifications to our products may require newregulatory approvals or clearances, including 510(k) clearances orpremarket approvals, or require us to recall or cease marketing the modifieddevices until these clearances or approvals are obtained. The FDA requiresdevice manufacturers to initially make and document a determination of whetheror not a modification requires a new approval, supplement or clearance. Amanufacturer may determine that a modification could not significantly affectsafety or efficacy and does not represent a major change in its intended use,so that no new 510(k) clearance is necessary. However, the FDA can reviewa manufacturer’s decision and may disagree. The FDA may also on its owninitiative determine that a new clearance or approval is required. We have mademodifications to our products in the past and may make additional modificationsin the future that we believe do not or will not require additional clearancesor approvals. If the FDA disagrees and requires new clearances or approvals forthe modifications, we may be required to recall and to stop marketing ourproducts as modified, which could require us to redesign our products and harmour operating results. In these circumstances, we may be subject to significantenforcement actions.

 

If a manufacturer determines that a modification to anFDA-cleared device could significantly affect its safety or efficacy, or wouldconstitute a major change in its intended use, then the manufacturer must filefor a new 510(k) clearance or possibly a premarket approval application.Where we determine that modifications to our

 

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products require anew 510(k) clearance or premarket approval application, we may not be ableto obtain those additional clearances or approvals for the modifications oradditional indications in a timely manner, or at all. For those products soldin the European Union, we must notify Orion Registrar, Inc., or Orion, ourE.U. Notified Body, if significant changes are made to the products or if thereare substantial changes to our quality assurance systems affecting thoseproducts. Obtaining clearances and approvals can be a time consuming process,and failure to obtain or delays in obtaining required future clearances orapprovals would adversely affect our ability to introduce new or enhancedproducts in a timely manner, which in turn would harm our future growth.

 

**Thereis no guarantee that the FDA will grant 510(k) clearance or PMA approvalof our emerging technologies and failure to obtain necessary clearances orapprovals for our future products would adversely affect our ability to growour business.**

 

Some of our new products will require FDA clearance ofa 510(k), or may even require FDA approval of a PMA. We are in the process ofdeveloping our regulatory strategies for obtaining clearance or approval ofthese new products. The FDA may not approve or clear these products for theindications that are necessary or desirable for successful commercialization.Indeed, the FDA may refuse our requests for 510(k) clearance or premarketapproval of new products, new intended uses or modifications to existingproducts. Failure to receive clearance or approval for our new products wouldhave an adverse effect on our ability to expand our business.

 

**Ifwe or our contract manufacturers fail to comply with the FDA’s Quality SystemRegulations, our manufacturing operations could be interrupted and our productsales and operating results could suffer.**

 

Our finished goods manufacturing processes, and thoseof some of our contract manufacturers, are required to comply with the FDA’sQuality System Regulations, or QSRs, which cover the procedures anddocumentation of the design, testing, production, control, quality assurance,labeling, packaging, sterilization, storage and shipping of our devices. TheFDA enforces its QSRs through periodic inspections of manufacturing facilities.We and our contract manufacturers have been, and anticipate in the futurebeing, subject to such inspections. If our manufacturing facilities or those ofany of our contract manufacturers fail to take satisfactory corrective actionin response to an adverse QSR inspection, the FDA could take enforcementaction, including any of the following sanctions, which could have a materialimpact 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 partialsuspension or total shutdown of production;

 

· refusing or delaying our requests for 510(k) clearanceor 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.

 

**Ourproducts may in the future be subject to product recalls that could harm ourreputation, business and financial results.**

 

The FDA and similar foreign governmental authoritieshave the authority to require the recall of commercialized products in theevent of material deficiencies or defects in design or manufacture. In the caseof the FDA, the authority to require a recall must be based on an FDA findingthat there is a reasonable probability that the device would cause seriousinjury or death. In addition, foreign governmental bodies have the authority torequire the recall of our products in the event of material deficiencies ordefects in design or manufacture. Manufacturers may, under their own initiative,recall a product if any material deficiency in a device is found. A government-

 

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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 partialsuspension or total shutdown of production;

 

· refusing or delaying requests for 510(k) clearanceor premarket approval 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.

 

**Ifour products, or malfunction of our products, cause or contribute to a death ora serious injury, we will be subject to medical device reporting regulations,which can result in voluntary corrective actions or agency enforcement actions.**

 

Under the FDA medical device reporting regulations,medical device manufacturers are required to report to the FDA information thata device has or may have caused or contributed to a death or serious injury orhas malfunctioned in a way that would likely cause or contribute to a death orserious injury if the malfunction of the device or one of our similar deviceswere to recur. All manufacturers placing medical devices in the market in theEuropean Union are legally bound to report any serious or potentially seriousincidents involving devices they produce or sell to the Competent Authority inwhose jurisdiction the incident occurred. Were this to happen to us, therelevant Competent Authority would file an initial report, and there would thenbe a further inspection or assessment if there are particular issues. Thiswould be carried out either by the Competent Authority or it could require thatOrion, as the Notified Body, carry out the inspection or assessment.

 

Any such adverse event involving our products couldresult in future voluntary corrective actions, such as recalls or customernotifications, or agency action, such as inspection or enforcement action.Adverse events involving our products have been reported to us in the past, andwe cannot guarantee that they will not occur in the future. Any correctiveaction, whether voluntary or involuntary, as well as defending ourselves in alawsuit, will require the dedication of our time and capital, distractmanagement from operating our business, and may harm our reputation andfinancial results. Failure to report such adverse events to appropriategovernment authorities on a timely basis, or at all, could result in anenforcement action against us.

 

**Failureto obtain regulatory approval in additional foreign jurisdictions will preventus from expanding the commercialization of our products abroad.**

 

We intend to market our products in a number ofinternational markets. Although certain of our products have been approved forcommercialization in Japan and in the European Union, in order to market ourproducts in other foreign jurisdictions we must obtain separate regulatoryapprovals. The approval procedure varies among

 

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jurisdictions andcan involve substantial additional testing. Approval or clearance by the FDAdoes not ensure approval by regulatory authorities in other jurisdictions, andapproval by one foreign regulatory authority does not ensure approval byregulatory authorities in other foreign jurisdictions or by the FDA. Theforeign regulatory approval process may include all of the risks associatedwith obtaining FDA approval in addition to other risks. In addition, the timerequired to obtain foreign approval may differ from that required to obtain FDAapproval, and we may not obtain foreign regulatory approvals on a timely basis,if at all. We may not be able to file for regulatory approvals and may notreceive necessary approvals to commercialize our products in any foreign marketother than in the European Union and Japan.

 

**Wemay be subject to fines, penalties or injunctions if we are determined to bepromoting the use of our products for unapproved or “off-label” uses.**

 

Our promotional materials and training methods forsurgeons must comply with FDA and other applicable laws and regulations. Manyof our products are cleared by the FDA for use in various surgical applications.We believe that the specific surgical procedures for which our products aremarketed fall within the scope of the surgical applications that have beencleared by the FDA. However, the FDA could disagree and require us to stoppromoting our products for those specific procedures until we obtain FDAclearance or approval for them. In addition, if the FDA determines that ourpromotional materials or training constitutes promotion of an unapproved use,it could request that we modify our training or promotional materials orsubject us to regulatory or enforcement actions, including the issuance of anuntitled letter, a warning letter, injunction, seizure, civil fine and criminalpenalties. It is also possible that other federal, state or foreign enforcementauthorities might take action if they consider our promotional or trainingmaterials to constitute promotion of an unapproved use, which could result insignificant fines or penalties under other statutory authorities, such as lawsprohibiting false claims for reimbursement. In that event, our reputation couldbe damaged and adoption of the products would be impaired.

 

**Federalregulatory reforms may adversely affect our ability to sell our productsprofitably.**

 

From time to time, legislation is drafted and introducedin Congress that could significantly change the statutory provisions governingthe clearance or approval, manufacture and marketing of a medical device. Inaddition, FDA regulations and guidance are often revised or reinterpreted bythe agency in ways that may significantly affect our business and our products.It is impossible to predict whether legislative changes will be enacted or FDAregulations, guidance or interpretations changed, and what the impact of suchchanges, if any, may be.

 

Without limiting the generality of the foregoing,Congress has recently enacted, and the President has signed into law, the Foodand Drug Administration Amendments Act of 2007. The amendments require, amongother things, that FDA propose, and ultimately implement, regulations that willrequire manufacturers to label medical devices with unique identifiers unless awaiver is received from FDA. Once implemented, compliance with thoseregulations may require us to take additional steps in the manufacture of ourproducts and labeling. These steps may require additional resources and couldbe costly. In addition, the law, as amended, will require us to, among otherthings, pay annual establishment registration fees to the FDA for each of ourFDA registered facilities.

 

**RisksRelated to Ownership of Our Common Stock**

 

**Weexpect that the price of our common stock will fluctuate substantially.**

 

Since our initial public offering in October 2007,the market price of our common stock has ranged from $3.71 to $14.79. Themarket price for our common stock is likely to continue to fluctuate as aresult of a number of factors, including:

 

· actual or anticipated announcements oftechnological innovations;

 

· introduction by us or by others of newcommercial products;

 

· actual or anticipated changes in laws andgovernmental regulations;

 

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· 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.

 

Stock prices of many companies in the medical deviceindustry have experienced wide fluctuations that have often been unrelated tothe operating performance of these companies. In the past, securities classaction litigation often has been initiated against a company following a periodof volatility in the market price of the company’s securities. If securitiesclass action litigation is initiated against us, we will incur substantialcosts and our management’s attention will be diverted from our operations. Allof these factors may materially and adversely affect the market price of ourcommon stock, and you may lose some or all of your investment.

 

**Securitiesanalysts may not initiate or continue coverage for our common stock or mayissue negative reports, and this may have a negative impact on the market priceof our common stock.**

 

Securities analysts may elect not to provide researchcoverage of our common stock, and if a sufficient number of securities analystsdo not cover our common stock, the lack of research coverage may adverselyaffect the market price of our common stock. The trading market for our commonstock may be affected in part by the research and reports that industry orfinancial analysts publish about us or our business. If one or more of theanalysts who elect to cover us downgrades our stock, our stock price coulddecline. If one or more of these analysts ceases coverage of our company, wecould lose visibility in the market, which in turn could cause our stock priceto decline. In addition, rules mandated by the Sarbanes-Oxley Act and aglobal settlement reached in 2003 between the Securities and ExchangeCommission, or SEC, other regulatory agencies and a number of investment bankshave led to a number of fundamental changes in how analysts are reviewed andcompensated. In particular, many investment banking firms will be required tocontract with independent financial analysts for their stock research. It maybe difficult for companies such as ours, with smaller market capitalizations,to attract independent financial analysts that will cover our common stock.This could have a negative effect on the market price of our stock.

 

**Ourprincipal stockholders, directors and management own a large percentage of ourvoting stock, which allows them to exercise significant influence over matterssubject to stockholder approval.**

 

Our executive officers, directors and stockholdersholding 5% or more of our outstanding common stock beneficially own or controlapproximately 40.8% of the outstanding shares of our common stock, assuming noexercise of outstanding options and warrants or conversion of our convertiblenotes. Accordingly, these executive officers, directors and principalstockholders, acting as a group, will have substantial influence over theoutcome of corporate actions requiring stockholder approval, including theelection of directors, any merger, consolidation or sale of all orsubstantially all of our assets or any other significant corporate transaction.These stockholders may also delay or prevent a change of control or otherwisediscourage a potential acquirer from attempting to obtain control of ourcompany, even if such a change of control would benefit our other stockholders.This significant

 

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concentration ofstock ownership may adversely affect the trading price of our common stock dueto investors’ perception that conflicts of interest may exist or arise.

 

**Anti-takeoverprovisions in our charter documents and Delaware law could prevent or delay achange in control of our company.**

 

Provisions in our amended and restated certificate ofincorporation and amended and restated bylaws, as well as provisions ofDelaware law, may discourage, delay or prevent a merger, acquisition or changeof control. These provisions could also discourage proxy contests and make itmore difficult for stockholders to elect directors and take other corporateactions. These provisions include:

 

· advance notice requirements for stockholderproposals and nominations;

 

· limitations on convening stockholdermeetings;

 

· the elimination of stockholder action bywritten consent;

 

· the elimination of cumulative voting; and

 

· a classified board of directors.

 

In addition, we are subject to Section 203 of theDelaware General Corporation Law, which imposes certain restrictions on mergersand other business combinations between us and any holder of 15% or more of ourcommon stock.

 

**Salesof a substantial number of shares of our common stock in the public market, orthe perception that they may occur, may depress the market price of our commonstock.**

 

If our existing stockholders sell substantial amountsof our common stock in the public market, or the public market perceives thatexisting stockholders might sell substantial shares of common stock, the marketprice of our common stock could decline significantly. These sales might alsomake it more difficult for us to sell equity securities at a time and pricethat we deem appropriate.

 

Approximately 2.6 million shares of our common stockthat are issuable upon conversion of the convertible notes that we issued in March 2007are now eligible for resale under Rule 144. Approximately17.1 million additional shares of our common stock are outstanding,assuming no exercise of outstanding options or warrants or conversion of ourconvertible notes.  If the holders of these shares sell them or areperceived by the market as intending to sell them, 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.

 

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**Item2.            Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

(a)          *Salesof Unregistered Securities:*

 

None.

 

(b)          *Useof Proceeds from Public Offering of Common Stock*

 

Our initial public offering of common stock waseffected through a Registration Statement on Form S-1 (File No. 333-142926)that was declared effective by the Securities and Exchange Commission on October 25,2007. The net offering proceeds to us, after deducting underwriting discountsand offering expenses, were approximately $42 million.  We invested the$42 million in net proceeds from the offering in U.S. Treasury bills andcertificates of deposit pending their use.  Through June 30, 2008, wehave used approximately $34.8 million of the net proceeds from the offering forgeneral working capital purposes.  We intend to continue to use theproceeds for general corporate purposes, including working capital,continuation of our research and development efforts, expansion of ourmanufacturing capabilities and purchases of capital equipment.

 

(c)          *Purchasesof Equity Securities by the Issuer and Affiliated Purchasers:*

 

None.

 

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**Item3.****                                  ****Defaults Upon SeniorSecurities.**

 

None.

 

**Item4.****                                  ****Submission of Matters toa Vote of Security Holders.**

 

Our stockholders adoptedthe following proposals at our Annual Meeting of Stockholders held on May 14,2008:

 
| ** **                                                                                                       | ** **           | **For** | ** ** | **Withhold** |
|------------------------------------------------------------------------------------------------------------------|----------------------|---------|------------|--------------|
| 1.  To elect two member to the board of  directors to serve for three-year terms as Class I directors: |                 |    |       |         |
|                                                                                                             | David R. Murray      |    | 13,061,432 |         | 57,467 |
|                                                                                                             | Charles W.  Federico |    | 13,061,432 |         | 57,217 |

 
| ** **                                                                                                                                                | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|
| 2.  To approve an amendment to our 2007 equity  incentive plan increasing the shares of our common stock issuable under the  plan by 945,164 shares: |       | 12,162,574 |       | 226,872     |       | 12,314      |

 
| ** **                                                                                                                                      | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|
| 3.  To ratify the selection of Ernst &  Young LLP as our independent auditors for the fiscal year ending  December 31, 2008: |       | 13,088,771 |       | 27,806      |       | 2,632       |

 

**Item5.****                                  ****Other Information.**

 

None.

 

**Item6.****                                  ****Exhibits.**

 
| **Exhibit** | ** ** | ** **                                                                                                | ** ** | **Filed with  this Form** | ** ** | **Incorporated by Reference** |
|-------------|------------|-----------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------------|
| **No.**     | ** ** | **Description**                                                                                           | ** ** | **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**                               |       |                                    |   |   |   |   |

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|                  |      | POWER MEDICAL  INTERVENTIONS, INC.     |
|-----------------------|-----------|----------------------------------------|
|                  |      | (Registrant)                           |
|                  |      |                                   |
| August 14,  2008 |  By: | /s/ Michael P.  Whitman                |
|                  |      | Michael P.  Whitman                    |
|                  |      | President and  Chief Executive Officer |
|                  |      |                                   |
|                  |      | POWER MEDICAL  INTERVENTIONS, INC.     |
|                  |      | (Registrant)                           |
|                  |      |                                   |
| August 14,  2008 |  By: | /s/ John P.  Gandolfo                  |
|                  |      | John P. Gandolfo                       |
|                  |      | Chief Financial  Officer               |

 

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**Exhibit Index**

 
| **Exhibit** | ** ** | ** **                                                                                                    | ** ** | **Filed with  this Form** | ** ** | **Incorporated by Reference** |
|-------------|------------|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|-----------------------------------------|
| **No.**     | ** ** | **Description**                                                                                               | ** ** | **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**                               |       |                                    |   |   |   |   |

 

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