##### Table of Contents

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UNITED STATES SECURITIES AND
EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





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FORM 10-Q





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|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------




FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002





OR





| ̈ |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------




FOR THE TRANSITION PERIOD FROM              TO
            .





COMMISSION FILE NO. 000-31519





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CURON MEDICAL, INC.


(Exact name of registrant as specified in its charter)





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Delaware

77-0470324(State or other jurisdiction of incorporation or organization)

(I.R.S. EmployerIdentification No.)





735 Palomar Avenue


Sunnyvale, CA 94085


(Address of principal executive offices, including zip code)





(408) 733-9910


(Registrants
telephone number, including area code)





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





As of August 13, 2002,
19,840,338 shares of the Registrants Common Stock were outstanding.





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CURON MEDICAL, INC.





INDEX





PagePART I.

FINANCIAL INFORMATIONItem 1.

Financial Statements (unaudited)Condensed Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001

3Condensed Consolidated Statements of Operations for the three and six month periods ended June 30, 2002 and 2001

4Condensed Consolidated Statements of Cash Flows for the six month periods ended June 30, 2002 and 2001

5Notes to Condensed Consolidated Financial Statements

6Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

9Item 3.

Quantitative and Qualitative Disclosures of Market Risk

20PART II.

OTHER INFORMATIONItem 1.

Legal Proceedings

21Item 2.

Changes in Securities and Use of Proceeds

21Item 4.

Submission of Matters to a Vote of Security Holders

21Item 5.

Other Information

22Item 6.

Exhibits and Reports on Form 8-K

22SIGNATURES





23




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PART I    FINANCIAL INFORMATION





Item 1.    Financial Statements





CURON
MEDICAL, INC.





CONDENSED CONSOLIDATED BALANCE SHEETS





(Unaudited, in thousands)


June 30, 2002


December 31, 2001AssetsCurrent assets:Cash and cash equivalents

$
7,592


$
7,509Marketable securities


22,085



27,619Accounts receivable, net of allowance for doubtful accounts of $40 and $20, respectively


777



666Inventories, net


1,354



1,410Related party notes receivable


406



144Prepaid expenses and other current assets


772



883Total current assets


32,986



38,231Long term investments


1,008



3,048Related party notes receivable






354Property and equipment, net


1,039



1,216Intangible assets, net of amortization of $903 and $770, respectively






133Other assets


92



91Total assets

$
35,125


$
43,073Liabilities and Stockholders EquityCurrent liabilities:Accounts payable

$
382


$
449Accrued liabilities


1,050



1,077Notes payable


126



207Total current liabilities


1,558



1,733Other liabilities


55



52Total liabilities


1,613



1,785Contingencies (Note 4)Stockholders equity:Common stock


19



19Additional paid-in capital


90,323



90,368Deferred stock compensation


(502
)


(956
)Accumulated deficit


(56,351
)


(48,291
)Accumulated other comprehensive income


23



148Total stockholders equity


33,512



41,288Total liabilities and stockholders' equity

$
35,125


$
43,073





See accompanying notes to condensed consolidated financial statements




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CURON MEDICAL, INC.





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS





(Unaudited)


(in thousands, except per
share amounts)







For the Three Months Ended


For the Six Months EndedJune 30, 2002


June 30, 2001


June 30, 2002


June 30, 2001Revenues

$
877


$
568


$
1,816


$
1,786Cost of goods sold


1,135



1,183



2,218



2,482Gross loss


(258
)


(615
)


(402
)


(696
)Operating expenses:Research and development


842



581



1,631



1,324Clinical and regulatory


333



464



651



954Sales and marketing


1,982



2,138



3,860



3,461General and administrative


1,027



1,129



1,999



2,253Total operating expenses


4,184



4,312



8,141



7,992Operating loss


(4,442
)


(4,927
)


(8,543
)


(8,688
)Interest income, net


207



584



483



1,385Net loss

$
(4,235
)

$
(4,343
)

$
(8,060
)

$
(7,303
)Net loss per share, basic and diluted

$
(0.22
)

$
(0.23
)

$
(0.41
)

$
(0.39
)Shares used in computing net loss per share, basic and diluted


19,509



19,081



19,458



18,887





See accompanying notes to condensed consolidated financial statements




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CURON MEDICAL, INC.





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS





(Unaudited, in thousands)







For the Six Months Ended,June 30, 2002


June 30, 2001Cash Flows From Operating ActivitiesNet loss

$
(8,060
)

$
(7,303
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


348



387Amortization of acquired technology


133



225Amortization of stock-based compensation


257



706Accretion of discount on securities, net


(56
)


(99
)Loss on disposal of fixed assets


24



Changes in assets and liabilities:Accounts receivable, net


(111
)


(255
)Inventories


56



(787
)Prepaid expenses and other current assets


111



138Accounts payable


(67
)


(76
)Accrued liabilities


(27
)


(349
)Other long-term assets and liabilities


2



15Net cash used in operating activities


(7,390
)


(7,398
)Cash Flows From Investing ActivitiesPurchase of property and equipment


(195
)


(424
)Purchase of marketable securities


(13,199
)


(27,721
)Proceeds from maturities of marketable securities


20,704



27,928Net cash provided by (used in) investing activities


7,310



(217
)Cash Flows From Financing ActivitiesPrincipal payments on notes payable


(229
)


Proceeds from issuance of notes payable


148



(Payments) proceeds from related party notes receivable, net


92



(20
)Proceeds from issuance of common stock, net of issuance costs


152



244Net cash provided by financing activities


163



224Net increase (decrease) in cash and cash equivalents


83



(7,391
)Cash and cash equivalents at beginning of period


7,509



16,759Cash and cash equivalents at end of period

$
7,592


$
9,368





See accompanying notes to the condensed consolidated financial statements




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CURON MEDICAL, INC.





NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





(Unaudited, tabular amounts in
thousands, except share and per share data)





June 30, 2002







NOTE 1.    The Company and Summary of Significant Accounting Policies








The Company





Curon Medical, Inc. (the Company) was incorporated in the State of Delaware on May 1, 1997. The Company develops, manufactures and markets proprietary products
for the treatment of gastrointestinal disorders.





The Company has sustained operating losses and negative cash
flows from operations and expects such losses to continue in the foreseeable future. The Company intends to finance its operations primarily through its cash and cash equivalents, marketable securities, future financing and future revenues, however,
there can be no assurance that such efforts will succeed or that sufficient funds will be made available.





Basis of Presentation





The condensed consolidated financial statements include the accounts of the Company and its wholly-owned
subsidiaries after elimination of all intercompany balances and transactions. Certain reclassifications have been made to prior year amounts in order to conform to current year presentation.





The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the
United States of America for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X promulgated by the Securities and Exchange Commission (SEC). Accordingly, they do not include all
of the information and footnotes required by generally accepted accounting principles for complete financial statements. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the annual
consolidated financial statements and, in the opinion of management, contain all adjustments (all of which are normal and recurring in nature) necessary to present fairly the financial position, results of operations and cash flows of the Company
for the periods indicated. Interim results of operations are not necessarily indicative of the results to be expected for the full year or any other interim periods.





These condensed consolidated financial statements should be read in conjunction with the audited financial statements included in the Annual Report on Form 10-K for the
year ended December 31, 2001, as filed with the SEC.





Net Loss Per Share





Basic and diluted net loss per share is calculated as follows:








Three Months Ended June 30,


Six Months Ended June 30,2002


2001


2002


2001Numerator:Net loss

$
(4,235
)

$
(4,343
)

$
(8,060
)

$
(7,303
)Demoninator:Weighted average shares outstanding


19,718,000



19,462,000



19,684,000



19,353,000Weighted average unvested common shares subject to repurchase


(209,000
)


(381,000
)


(226,000
)


(466,000
)Weighted average shares used in basic and diluted net loss per share


19,509,000



19,081,000



19,458,000



18,887,000Net loss per share

$
(0.22
)

$
(0.23
)

$
(0.41
)

$
(0.39
)




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During 1999, the Company granted to certain employees and non-employees, options
which were immediately exercisable into common stock, subject to repurchase by the Company based on the same remaining vesting schedule as the related option. Shares are subject to repurchase at the original option exercise price.





Equity instruments that could dilute basic earnings per share in the future, that were not included in the computation of
diluted earnings per share as their effect is antidilutive, are as follows:





June 30, 2002

June 30, 2001Unvested common shares (shares subject to repurchase)

198,000

349,000Shares issuable upon exercise of stock options

2,061,000

1,888,000Shares issuable upon exercise of warrants

569,000

569,000Total

2,828,000

2,806,000





Revenue Recognition





Revenue from product sales is recognized on product shipment against a signed purchase order or sales quote provided no significant obligations remain and collection of the
receivables is deemed probable for both sales of control modules and catheters. Revenues for extended warranty contracts are recognized over the extended warranty period. To date, post-sale customer support and training have not been significant.





The Company may sell products under a purchase commitment, with delivery of the control module at inception of
the contract and catheters generally delivered over a period of six months. Revenue for the control module is deferred and recognized ratably over shipment of catheters under contract. Revenue on the catheters is recognized upon shipment at an
amount representing their fair value based on verifiable objective evidence of such.





Shipping and handling costs
charged to customers are recognized as revenue and the associated costs incurred by the Company are expensed under cost of goods sold.





Recent Accounting Pronouncements





In July 2002, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 146 (SFAS 146), Accounting for Costs Associated with Exit or Disposal Activities. This Statement addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, (Issue 94-3) Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring). This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as defined in Issue 94-3 was
recognized at the date of an entitys commitment to an exit plan. This Statement also establishes that fair value is the objective for initial measurement of the liability. SFAS 146 is effective for exit or disposal activities that are
initiated after December 31, 2002. The Company is currently evaluating the impact, if any, on the Companys financial position or results of operations.





NOTE 2.    Inventories








June 30, 2002

December 31, 2001Inventories:Raw material

$
781

$
1,033Work-in-process


127


7Finished goods


446


370$
1,354

$
1,410




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NOTE 3.    Deferred Stock Compensation





Stock-based compensation included in the Condensed Consolidated Statements of Operations is as follows:





Three Months Ended June 30,


Six Months Ended June 30,2002


2001


2002


2001Cost of goods sold

$
(30
)

$
26


$
(12
)

$
56Research and development


18



(14
)


46



59Clinical and regulatory


14



22



32



64Sales and marketing


(18
)


66



5



173General and administrative


96



169



186



354$
80


$
269


$
257


$
706





NOTE 4.    Contingencies





In June 2001, a civil action was filed against the Company in the United States District Court, Western District of Kentucky, Louisville
Division, alleging that the Plaintiff sustained a nerve injury and damage to his gastrointestinal tract during a Stretta procedure caused by the defective design and manufacture of the Companys product. Plaintiffs allegations against the
Company include strict liability for a product that was in a defective and unreasonably dangerous condition, negligence in the design and manufacturing of the product, breach of implied warranty of merchantability, and loss of consortium. Plaintiff
was a subject in a randomized clinical trial and had given Informed Consent to the treating institution for the procedure. Plaintiff is seeking a trial by jury and unspecified damages. The Company believes Plaintiffs claim is without merit.





In September 2001, a civil action was filed against a number of defendants, including the Company, in the
Superior Court of the State of California in and for the City and County of Santa Clara, alleging that the Plaintiff sustained injury when undergoing surgery utilizing the Stretta System, caused by defects in design and manufacture. Plaintiff also
alleges negligence in the design, manufacture, advertising and sale of the Stretta System and that its warnings, instructions and directions for use were inadequate. Additional defendants include the treating physicians and the associated medical
institutions, which it is alleged, were medically negligent in treatment of Plaintiff. Plaintiff is seeking unspecified damages. The Company believes Plaintiffs claim is without merit.





In June 2002, a civil action was filed against a number of defendants, including the Company, in the Court of Common Pleas, Philadelphia County in the State of
Pennsylvania, alleging that the Plaintiff sustained injury during a Secca procedure caused by the device being defective and/or in an unreasonably dangerous condition. Plaintiff was a subject in a clinical trial and had given Informed Consent to the
treating institution for the procedure. Additional defendants include the treating physician, the associated medical institution who, it is alleged, were medically negligent in treatment of Plaintiff, and the members of the Institutional Review
Board who approved the protocol for the clinical trial. Plaintiff has demanded a trial by jury and unspecified damages. The Company believes Plaintiffs claim against the Company is without merit.





These matters are currently in the early stages and the Company believes that the resolution of any of these matters will not have a
material effect, if any, on its business, financial position, and results of operations and cash flows.





NOTE
5.    Notes Payable





The Company has a short-term note payable in the amount of $126,000
at June 30, 2002. This relates to a note financing the 2002 renewal of corporate insurance policies in the amount of $140,000 in June 2002. The remaining balance on the previous insurance note payable was paid in full in June 2002.





NOTE 6.    Subsequent Events





On July 17, 2002, John W. Morgan announced his resignation as the Companys Chief Executive Officer, President and Board member. Michael Berman, Chairman of the Board, has assumed the position of
interim Chief Executive Officer while the Company conducts a search for a new President and Chief Executive Officer. Under the terms of the severance agreement, Mr. Morgan received a $275,000 lump sum payment, six months accelerated vesting of
his stock options, and the loan and accrued interest receivable from Mr. Morgan, in the amount of $272,000, was forgiven. This will result in a estimated total operating charge of $547,000 in the third quarter of 2002.




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In July, the Company announced a 17% reduction in work force. The ultimate
financial effect of this action has yet to be determined.





|Item |  | 2.    Managements Discussion and Analysis of Financial Condition and Results of Operations
|---- |  | -------------------------------------------------------------------------------------------




The following discussion should be read in conjunction with the attached financial statements
and notes thereto, and with our audited financial statements and notes thereto for the fiscal year ended December 31, 2001.





This quarterly report, including the following sections, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include statements relating to our expectations
as to the timing and success of our clinical trials and regulatory submissions, the mix of our sales and revenues derived from generators and disposable devices, the rate of growth and success of our international sales and marketing efforts, our
expectations regarding increased operating expenses and net losses as our business expands, the timing of new product introductions, and our ability to maintain current and planned operations through at least the next 12 months without raising
additional funds. These forward-looking statements involve risks and uncertainties. The cautionary statements set forth below and those contained in Factors That May Affect Future Results, commencing on page 12, identify important
factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. Such factors include, but are not limited to, failure to obtain regulatory approvals as anticipated, a slower rate of market
acceptance of our products than expected, increased competition, continued adverse changes in general economic conditions in the United States and internationally, including adverse changes in the specific markets for our products, adverse changes
in customer order patterns, pricing pressures, risks associated with foreign operations, failure to reduce costs or improve operating efficiencies, and our ability to attract, hire and retain key and qualified employees.





Overview





We were
incorporated in May 1997. Business activities before January 1998 were negligible. In 1998, our primary activity was developing the Curon Control Module and Stretta Catheter for the treatment of gastroesophageal reflux disease (GERD).
Prior to December 31, 2000 we were in the development stage and until that time, we had devoted substantially all of our efforts to raising capital and developing, marketing and selling our products.





In early 1999, we began a multi-center clinical trial of the Stretta ® System in the United States. We also developed our manufacturing capability to support the production of Stretta Catheters
and Curon Control Modules for the clinical trial. Based on the data acquired in the trial, we submitted a 510(k) notification to the FDA in January 2000 for clearance to market the Stretta System for treatment of GERD. We received 510(k) clearance
in April 2000. In October 1999, we received CE Mark approval of the Stretta System, indicating that the Stretta System meets European medical device standards allowing us to market it within the European Union. In May 2000, we launched the Stretta
System commercially at Digestive Disease Week, a large professional gastroenterology conference. Also, in May 2000, we initiated a randomized controlled trial of the Stretta System in the United States. In this trial, patients received either the
Stretta procedure or a placebo procedure, and results were compared. The data generated is being used to influence physician adoption rates, facilitate reimbursement approvals and enhance marketing activity. The active clinical portion of this trial
was completed in the quarter ended March 31, 2001. The abstracted data was presented in a plenary session at the Digestive Disease Week Conference in May 2002.





In April 1999, we began developing the Secca ® System for the treatment of fecal incontinence. In November 1999, we conducted a 10-patient human clinical pilot study outside the United States and, in July 2000, we began a U.S. multi-center clinical trial of the Secca
System under an Investigational Device Exemption. In September 2001, we received CE Mark approval of the Secca System, indicating that the Secca System meets European medical device standards allowing us to market it within the European Union. Our
multi-center clinical trial was completed, and the results were used to support a 510(k) submission to the FDA in December 2001. We received 510(k) clearance from the FDA in March 2002 to market the system for the treatment of fecal incontinence in
patients who have failed more conservative therapies such as diet modification and biofeedback. In May 2002, we initiated a randomized controlled trial in the U.S for the Secca System. In this trial, patients will receive either the Secca procedure
or a placebo procedure, and results will be compared. The data generated will be used to influence physician adoption rates, facilitate reimbursement approvals and enhance marketing activity. We made our first sales of the Secca System in June 2002.





To date, we have generated limited revenues. Our revenues are, and will be, derived from the sale of
radiofrequency generators and our disposable devices, such as the Stretta Catheter and Secca Handpiece. We expect that disposable sales will form the basis of a recurring revenue stream. However, domestic disposable sales continue to grow more
slowly than expected primarily due to difficulties encountered by our physician customers in easily obtaining reimbursement for the Stretta procedure on a case-by-case




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basis. Some of our customers also find the 45 minutes necessary to perform a Stretta procedure to be a limiting issue in that their endoscopy unit schedule is typically dominated by short
diagnostic procedures. Although disposable sales from outside the United States are increasing, they are not yet sufficient to offset the current domestic situation. Our strategies of pursuing national reimbursement coverage and incorporating
technical improvements to our systems to reduce treatment times are designed to address these issues and we expect that our revenue from disposables will increase on implementation.





Initially, we are focusing our sales efforts in the United States through a direct sales force. In international markets, we rely primarily on third-party distributors. In
November 2000, we incorporated a subsidiary company in Belgium and hired a European manager to support European distributors sales, marketing and clinical efforts. At June 30, 2002, this subsidiary had four employees. We do not expect the
number of employees to increase in 2002. During the first quarter of 2001, we entered into distribution agreements covering sales in Belgium, the Netherlands, Germany, Italy and Greece. In August 2001, we entered into a distribution agreement in
South Africa, and in December 2001, we entered into distribution agreements covering sales in Portugal, Sweden, Denmark, Norway and Finland. In March and June 2002, we entered into distribution agreements in Egypt and Israel, respectively. First
shipments have been made to all distributors. Our gross margins on sales through international third-party distributors will be lower than our gross margins on U.S. sales as a result of distributor discounts.





Our costs of revenues represent the cost of producing generators and disposable devices. We also license a technology used in the
generators that we sell. In addition to the up-front payment to license the technology, we are required to pay licensing fees based on the sales price of the units. We believe that there are alternative technologies that could be utilized should we
choose to do so. Research and development expenses consist primarily of personnel costs, professional services, patent application and maintenance costs, materials, supplies and equipment. Clinical and regulatory expenses consist primarily of
expenses associated with the costs of clinical trials, clinical support personnel, the collection and analysis of the results of these trials, and the costs of submission of the results to the FDA. Sales and marketing expenses consist of personnel
related costs, advertising, public relations and attendance at selected medical conferences. General and administrative expenses consist primarily of the cost of corporate operations and personnel, legal, accounting and other general operating
expenses of our company. Through June 30, 2002, we recorded limited product sales while incurring cumulative net losses of $56.4 million. In addition to increasing expenditures related to continuing selling activities of the Stretta System, we
anticipate that our expenses will increase as we continue to develop new products, conduct clinical trials, commercialize our products and acquire additional technologies as opportunities arise. As a result, we expect our operating expenses and
cumulative net losses to increase.





RESULTS OF OPERATIONS





Periods of three and six months ended June 30, 2002 and 2001.





Revenues





Revenues for the quarter ended June 30, 2002, were $877,000, compared to $568,000 for the same quarter in
2001. The increase in sales was related primarily to volume increases. Stretta Control Module and Catheter sales accounted for 48% and 41% of gross sales, respectively in the quarter ended June 30, 2002, as compared to 56% and 43%, respectively, for
the same period in 2001. International sales accounted for approximately $125,000 in the second quarter of 2002, compared to $59,000 for the same quarter in 2001. For the six months ended June 30, 2002, revenues were $1.8 million, and $1.8 million
for the same period in 2001. Stretta Control Module and Catheter sales accounted for 54% and 38% of gross sales, respectively in the six months ended June 30, 2002, as compared to 55% and 44%, respectively, for the same period in 2001. International
sales accounted for approximately $203,000 in the first six months of 2002, compared to $75,000 for the same period in 2001. Secca revenue for the three months ended June 30, 2002 was $48,000, which represents the first sales of this product.
Revenues have not grown according to the Companys previous expectations primarily due to difficulties encountered by our physician customers in easily obtaining reimbursement for the Stretta procedure on a case-by-case basis. Some of our
customers also find the 45 minutes necessary to perform a Stretta procedure to be a limiting issue in that their endoscopy unit schedule is typically dominated by short diagnostic procedures. Although disposable sales from outside the United States
are increasing, they are not yet sufficient to offset the current domestic situation. Our strategies of pursuing national reimbursement coverage and incorporating technical improvements to our systems to reduce treatment times are designed to
address these issues and we expect that our revenue from disposables will increase on implementation.





Cost of goods sold





In the quarter ended June 30, 2002, cost of goods sold was $1.1 million, compared to $1.2 million for the
same quarter in 2001. For the six months ended June 30, 2002, cost of goods sold was $2.2 million, and $2.5 million for the same period in 2001. As sales volume increases, we expect gross profit to become positive and increase accordingly. Our sales
have not yet reached a level which absorbs our manufacturing capacity to the extent that we would experience positive gross profit. Amortization of stock-based compensation was a benefit of $30,000 in the quarter ended June 30, 2002, and an expense
of $26,000 for the same period in 2001. For




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the six months ended June 30, 2002, amortization of stock-based compensation was a benefit of $12,000, and an expense of $56,000 for the same period in 2001.





Research and development expenses





Research and development expenses were $842,000 in the quarter ended June 30, 2002, and $581,000 for the same period in 2001. For the six months ended June 30, 2002, research and development expenses were $1.6 million, and
$1.3 million for the same period in 2001. Research and development expense increased primarily due to increases in patent and trademark legal expense of $207,000 for the quarter ended June 30, 2002 as compared to the same period in 2001, and
$230,000 for the six months ended June 30, 2002 as compared to the same period in 2001. In addition, pilot manufacturing expenses related to the Secca System were $85,000 for the quarter ended June 30, 2002 and $235,000 for the six months ended June
30, 2002. There was no pilot manufacturing of new products in 2001. The Secca System was commercialized in June of 2002, with the first sales being made in that month. Amortization of stock-based compensation accounted for $18,000 in the quarter
ended June 30, 2002, and a benefit of $14,000 for the same period in 2001. For the six months ended June 30, 2002, amortization of stock-based compensation was $46,000, and $59,000 for the same period in 2001.





Clinical and regulatory expenses





Clinical and regulatory expenses were $333,000 in the quarter ended June 30, 2002, and $464,000 for the same period in 2001. For the six months ended June 30, 2002, clinical and regulatory expenses were $651,000, and
$954,000 for the same period in 2001. The decrease in spending in 2002 over 2001 was due to costs involved in the U.S. Secca trial and the Stretta randomized control trial, which were both ongoing in 2001, and have been completed as of 2002.
Clinical trial costs include payments to hospitals, and the related travel expense for Curon employees. Clinical efforts on the Secca randomized trial began in May 2002, and the related spending has been limited to date. Amortization of stock-based
compensation accounted for $14,000 in the quarter ended June 30, 2002, and $22,000 for the same period in 2001. For the six months ended June 30, 2002, amortization of stock-based compensation was $32,000, and $64,000 for the same period in 2001.





Sales and marketing expenses





Sales and marketing expenses were $2.0 million in the quarter ended June 30, 2002, and $2.1 million for the same period in 2001. The decrease in spending for the quarter was primarily due to a decrease
in recruiting costs of $189,000 from 2001 to 2002, partially offset by an increase in personnel costs of $84,000. For the six months ended June 30, 2002, sales and marketing expenses were $3.9 million, and $3.5 million for the same period in 2001.
Spending for the first six months of 2002 has increased over the same period in 2001 due to increased personnel costs of $506,000, partially offset by a recruiting decrease of $210,000. Compared to the same period in 2001, spending for the first six
months of 2002 reflects higher personnel costs related to the expansion of our direct U.S. sales force, with a decrease in the related recruiting costs. Amortization of stock-based compensation accounted for a benefit of $18,000 in the quarter ended
June 30, 2002, and an expense of $66,000 for the same period in 2001. For the six months ended June 30, 2002, amortization of stock-based compensation was $5,000, and $173,000 for the same period in 2001.





General and administrative expenses





General and administrative expenses were $1.0 million in the quarter ended June 30, 2002 and $1.1 million for the same period in 2001. For the six months ended June 30, 2002, general and administrative expenses were $2.0
million, and $2.3 million for the same period in 2001. Amortization of stock-based compensation was a $96,000 in the quarter ended June 30, 2002, and $169,000 for the same period in 2001. For the six months ended June 30, 2002, amortization of
stock-based compensation was $186,000, and $354,000 for the same period in 2001.





Interest Income, net





During the quarter ended June 30, 2002, compared to the quarter ended June 30, 2001, net interest income decreased by $377,000.
The decrease was due to an approximate cash and investment decrease of $14.0 million, and a decrease in investment yields from approximately 7% to 4%. For the six months ended June 30, 2002, compared to the same period in 2001, net interest income
decreased by $902,000. Interest expense was not material.





LIQUIDITY AND CAPITAL RESOURCES





Since inception, we have funded our operations and capital investments with the proceeds from our initial public offering completed in
September 2000 totaling $55.0 million, the partial exercise of the underwriters over-allotment provision totaling $5.2 million, the private sale of equity securities totaling $22.0 million, the issuance of convertible notes totaling $11.8
million




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and bank equipment line financing totaling $780,000. At June 30, 2002, we had $31.4 million in working capital and our primary source of liquidity was $29.7 million in cash and cash equivalents
and marketable securities. In addition, we had $1.0 million invested in long term securities at that date. We intend to finance our operations primarily through our cash and cash equivalents, marketable securities, future financing and future
revenues. We believe we have enough cash to fund operations for at least two years, and that alternative financing is available, if needed, however, there can be no assurance that such efforts will succeed or that sufficient funds will be made
available.





Cash used in operating activities was $7.4 million in the six month period ended June 30, 2002, and
also $7.4 million for the same period in 2001. Our loss for the first six months of 2002 was $8.1 million, compared to a loss of $7.3 million for the same period in 2001. Cash spent on operations has remained relatively stable between the two years,
with interest income being the primary difference in total loss.





The Company leases office space under
noncancelable operating leases expiring in September 2003. Future minimum payments due under operating leases are as follows:


Remainder of 2002

$2712003

409Total future minimum operating lease payments

$680





Cash provided by investing activities amounted to $7.3 million in
the six months ended June 30, 2002, which consisted primarily of proceeds from net maturities and sales of marketable securities of $7.5 million, partially offset by expenditures of $195,000 for property and equipment. As of June 30, 2002, we had no
material commitments for capital expenditures. For the six months ended June 30, 2001, net cash used by investing activities was $217,000, which consisted primarily of expenditures of $424,000 for property and equipment, partially offset by $207,000
provided by net maturities and sales of marketable securities. Higher property and equipment investment in 2001 was related to the headcount increases in the sales department.





Cash provided by financing activities was $163,000 in the six months ended June 30, 2002, primarily related to $152,000 from the sale of stock through both the Employee
Stock Purchase Plan and Stock Option Plan and $92,000 of net proceeds received on related party notes receivable, offset by net payments on notes payable of $81,000. For the six months ended June 30, 2001, net cash provided by financing activities
was $224,000, primarily related to $244,000 from sale of stock through the Employee Stock Purchase Plan and Stock Option Plan, offset by net increases in related party notes receivable of $20,000. Related party notes receivable are loans to officers
of the Company.





We expect to acquire additional capital equipment on an ongoing basis as we increase capacity and
improve capabilities. We have not planned any significant capital expenditures during fiscal 2002. We expect that our existing capital resources and interest income will enable us to maintain current and planned operations through at least the next
12 months. In the event that we require additional funding at any point in the future, we will seek to raise such additional funding from other sources, including the public equity market, private financings, collaborative arrangements and debt. If
additional capital is raised through the issuance of equity or securities convertible into equity, our stockholders may experience dilution, and such securities may have rights, preferences or privileges senior to those of the holders of our common
stock. Additional financing may not be available to us on favorable terms, if at all. If we are unable to obtain financing, or to obtain it on acceptable terms, we may be unable to execute our business plan.





Factors That May Affect Future Results





We may never achieve or maintain significant revenues or profitability.





We have only a
limited operating history upon which you can evaluate our business. We have incurred losses every year since we began operations. In particular, we incurred net losses of $15.4 million in 2001, $15.8 million in 2000, $14.1 million in 1999 and $8.1
million for the six months ended June 30, 2002. As of June 30, 2002, we had an accumulated deficit of approximately $56.4 million. We have generated limited revenues from the sale of our products, and it is possible that we will never generate
significant revenues from product sales in the future. Even if we do achieve significant revenues from our product sales, we expect to incur significant net losses over the next several years and these losses may increase. It is possible that we
will never achieve profitable operations.





Recent changes in our management and workforce may negatively impact our ability to manage
our business.





Since the resignation of our former chief executive officer on July 17, 2002, our interim chief
executive officer and board of directors have been searching for a new chief executive officer. The search for a new chief executive officer could divert




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managements resources away from running the business and could negatively affect our operating results. Once a new chief executive officer is identified, the transition to new management
could be disruptive to our business. In addition, we recently announced costs saving actions, which included a reduction in our workforce and additional operating expense cuts, as part of our effort to achieve operational savings throughout the
organization. We can provide no assurance that the actions taken to cut costs will result in the anticipated savings. A reduction in our workforce and reallocation of employee duties also may make it difficult to motivate and retain existing
employees which would affect our ability to deliver products and negatively impact our revenues.





If we fail to take adequate action
to remedy problems that have adversely affected our operations our future performance may be harmed.





In the
past, we became aware of some issues that negatively impacted our earnings. For example, we learned that it is time consuming to obtain purchase commitments for our products because of the number of individuals at hospitals who need to approve the
purchase. As a result, we changed our sales and marketing models to more effectively address this issue. We also became aware of misinformation in the marketplace regarding past adverse events associated with our procedure. In response, we dedicated
resources to educating physicians regarding the use of our products to combat this misinformation. Our efforts to rectify these situations may not be sufficient. In addition, the cost of our efforts in addressing these matters diverts resources that
could be allocated to increasing revenues. In the future, we may experience similar problems and if we are unable to take appropriate action and take it quickly our results of operations and our financial performance will be harmed.





We may fail to meet the Nasdaq continued listing standards which would result in a listing on a lesser known market within Nasdaq or a delisting
altogether. Any change in market listing may adversely affect our ability to raise capital.





Our stock is
currently trading at less than $1.00. Under the continued listing standards for inclusion of our stock on the Nasdaq National Market, our stock cannot close below $1.00 for 30 consecutive trading days. We can give no assurance that our stock will
trade above $1.00 in the future. If we cannot maintain Nasdaq maintenance standards we may be transferred from the Nasdaq National Market to the Nasdaq Small Cap or pink sheets or delisted altogether. If our stock is removed from the Nasdaq National
Market, the liquidity and price of our stock may be adversely affected. As a result, there may be less demand for our stock and we may be unable to raise sufficient capital to fund our operations.





The Stretta System is currently our primary marketed product. If physicians do not generally adopt our Stretta System, we will not achieve future sales
growth.





We commercially introduced our Stretta System, which consists of a radiofrequency generator and a
disposable handheld device, in May 2000. We are highly dependent on Stretta System sales because we anticipate that the Stretta System will account for substantially all our revenue through at least 2002. To achieve increasing sales, our product
must continue to gain recognition and adoption by physicians who treat gastrointestinal disorders. The Stretta System represents a significant departure from conventional GERD treatment methods. We believe that physicians will not use our Stretta
System unless they determine, based on published peer-reviewed journal articles, long-term clinical data and their professional experience, that the Stretta System provides an effective and attractive alternative to conventional means of treatment
for GERD. Currently, there are eight peer-reviewed journal articles, limited peer-reviewed clinical reports and 12-month clinical follow-up data on our Stretta System. Physicians are traditionally slow to adopt new products and treatment practices,
partly because of perceived liability risks and uncertainty of third-party reimbursement. For example, we believe that physician adoption rates were negatively impacted by adverse events and a voluntary market withdrawal, which occurred early in the
launch of the Stretta System. Future adverse events or recalls would also impact future acceptance rates. If physicians do not adopt our Stretta System, we may never achieve significant revenues or profitability.





If the effectiveness and safety of our products are not supported by long-term data, our sales could decline and we could be subject to liability.





If we do not produce clinical data supported by the independent efforts of clinicians, our products may never
be accepted. We received clearance from the FDA for the use of the Stretta System to treat GERD based upon the study of 47 patients. Safety and efficacy data presented to the FDA for the Stretta System was based on six month follow-up studies on 44
of these patients. Although the twelve-month follow-up data supports the six-month data, we may find that data from longer-term patient follow-up studies is inconsistent with those indicated by our relatively short-term data. However, if longer-term
patient studies or clinical experience indicate that treatment with the Stretta System does not provide patients with sustained benefits or that treatment with our product is less effective or less safe than our current data suggests, our sales
could decline and we could be subject to significant liability. Further, we may find that our data is not substantiated in studies involving more patients, in which case we may never achieve significant revenues or profitability.





We received clearance from the FDA for the use of the Secca System to treat fecal incontinence, for patients who have failed




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more conservative treatments such as diet modification or biofeedback. This clearance was based upon the study of 50 patients. Safety and efficacy data presented to the FDA for the Secca System
was based on six month follow-up studies on these patients. We may find that data from longer-term patient follow-up studies is inconsistent with those indicated by our relatively short-term data. However, if longer-term patient studies or clinical
experience indicate that treatment with the Secca System does not provide patients with sustained benefits or that treatment with our product is less effective or less safe than our current data suggests, our sales could decline and we could be
subject to significant liability. Further, we may find that our data is not substantiated in studies involving more patients, in which case we may never achieve significant revenues or profitability. If patient studies or clinical experience do not
meet our expectations regarding the benefits of the Secca System, our expected revenues from this product may never materialize.





Any
failure in our physician education efforts could significantly reduce product sales.





It is important to the
success of our sales efforts to educate physicians in the techniques of using our products. We rely on physicians to spend their time and money to attend our pre-sale educational sessions. Positive results using the Stretta and Secca Systems are
highly dependent upon proper physician technique. If physicians use either system improperly, they may have unsatisfactory patient outcomes or cause patient injury, which may give rise to negative publicity or lawsuits against us, any of which could
have a material adverse effect on our sales and profitability.





If health care providers are not adequately reimbursed for the
procedures that use our products, or for the products themselves, we may never achieve significant revenues.





Although the Center for Medicare and Medicaid Services, or CMS, granted a new specific APC code providing higher reimbursement levels for the Stretta Procedure for Medicare purposes on October 1, 2001, there is no assurance that
private, third-party payors will conform to this. Physicians, hospitals and other health care providers are unlikely to purchase our products if they are not adequately reimbursed for the Stretta procedure or the products. To date, only a limited
number of private third-party payors have agreed to reimburse for the cost of the Stretta procedure or products. Until a sufficient amount of positive peer-reviewed clinical data has been published, insurance companies and other payors may refuse to
provide reimbursement for the cost of the Stretta procedure or may reimburse at levels that are not acceptable to providers. Some payors may refuse adequate reimbursement even upon publication of peer-reviewed data. If users of our products cannot
obtain sufficient reimbursement from health care payors for the Stretta procedure or the Stretta System disposables, then it is unlikely that our product will ever achieve significant market acceptance. The Secca procedure has not yet received any
coding decision and no tests have yet been made of the willingness of third party health care payors to reimburse the costs of the procedure. We cannot assure you that the procedure will ever be reimbursed. Failure to achieve reimbursement will have
a serious negative effect on our revenues.





Reimbursement from third-party health care payors is uncertain due to factors beyond our
control and changes in third-party health care payors policies could adversely affect our sales growth.





Even if third-party payors provide adequate reimbursement for the Stretta procedure, adverse changes in third-party payors policies toward reimbursement could preclude market acceptance for our products and have a material
adverse effect on our sales and revenue growth. We are unable to predict what changes will be made in the reimbursement methods used by third-party health care payors.





For example, some health care payors are moving toward a managed care system in which providers contract to provide comprehensive health care for a fixed cost per person.
We cannot assure you that in a prospective payment system, which is used in many managed care systems, the cost of our products will be incorporated into the overall payment for the procedure or that there will be adequate reimbursement for our
products separate from reimbursement for the procedure.





Internationally, market acceptance of our products will
be dependent upon the availability of adequate reimbursement within prevailing health care payment systems. Reimbursement and health care payment systems in international markets vary significantly by country and include both government-sponsored
health care and private insurance. Although we are seeking international reimbursement approvals, we cannot assure you that any such approvals will be obtained in a timely manner or at all. If foreign third-party payors do not adequately reimburse
providers for the Stretta procedure and the products used with it, then our sales and revenue growth may be limited.





We face
competition from more established GERD treatments and from competitors with greater resources, which will make it difficult for us to achieve significant market penetration.





Companies that have well-established products, reputations and resources dominate the market for the treatment of GERD. We primarily compete with large pharmaceutical
companies such as AstraZeneca, Takeda Abbott Pharmaceuticals and Merck, which collectively generate over $6 billion in annual U.S. revenues from sales of medication for the treatment of GERD symptoms. We




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also compete with large medical device companies such as Johnson & Johnson/Ethicon, which makes instrumentation for fundoplication surgery, and C.R. Bard, which received FDA clearance for an
endoscopic suturing device for the treatment of GERD in April 2000. Boston Scientific has recently signed an agreement with Enteric to market a liquid polymer that is injected into the lower esophageal sphincter for the treatment of GERD. In
December 2001, Medtronic announced that it had purchased Endonetics, Inc., a developer of biomaterial that can be endoscopically placed in the wall of the lower esophagus, improving performance of the esophageal sphincter for treatment of GERD.





These larger companies enjoy several competitive advantages over us, which may include:





| |  |  | existing widely-adopted medications and procedures for the treatment of GERD;
| | - |  | -----------------------------------------------------------------------------




| |  |  | established reputations within the medical community;
| | - |  | -----------------------------------------------------




| |  |  | established distribution networks that permit these companies to introduce new products and have such products accepted by the medical community promptly;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | established relationships with health care providers and payors that can be used to facilitate reimbursement for new treatments; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------




| |  |  | greater resources for product development and sales and marketing.
| | - |  | ------------------------------------------------------------------




At any time, these competitors or other companies may develop new competitive products that are more effective or less expensive than ours. For example, AstraZeneca has
developed a new product, Nexium, for the treatment of GERD, which doctors may prescribe in lieu of recommending our Stretta Procedure. Less expensive, generic drugs will be introduced to treat GERD as AstraZenecas patent for Prilosec, the
leading prescription medication for the treatment of GERD, expired in 2001, although pending lawsuits may delay the significant availability of competition until later in 2002. If we cannot compete effectively in this highly competitive market, we
may not be able to achieve our expected revenue growth.





We have limited sales and marketing experience, and failure to continue to
build and manage our sales force or to market and distribute our products effectively will hurt our revenues and profits.





We have limited sales and marketing experience. As of June 30, 2002, we relied on 11 direct sales employees to sell our Stretta System in the United States. We must manage this sales team over the next 24 months to achieve our market
share and revenue growth goals. Since we have only recently launched the Secca System, our sales force has little experience marketing the product, and we cannot predict how successful they will be in selling the product. There are significant risks
involved in building and managing our sales force and marketing our products, including our:





| |  |  | Inability to hire a sufficient number of qualified sales people with the skills and understanding to sell the Stretta and Secca Systems effectively;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Failure to adequately train our sales force in the use and benefits of our products, making them less effective promoters; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------




| |  |  | Failure to accurately price our products as attractive alternatives to conventional treatments.
| | - |  | -----------------------------------------------------------------------------------------------




Internationally, we rely on third-party distributors to sell our products, and we cannot assure you that these distributors will commit the necessary
resources to effectively market and sell our products or that they will be successful in selling our products.





Internationally, we rely on a network of distributors to sell our products. We depend on these distributors in such markets and we will need to attract additional distributors to grow our business and expand the territories into
which we sell our products. Distributors may not commit the necessary resources to market and sell our products to the level of our expectations. If current or future distributors do not perform adequately, we may not realize expected international
revenue growth.





We have limited experience manufacturing our products in commercial quantities, which could adversely impact the rate
at which we grow.





Because we have only limited experience in manufacturing our products in commercial
quantities, we may encounter unforeseen situations that would result in delays or shortfalls. For example, in December 2000, we voluntarily withdrew certain of our catheters from the market because of manufacturing issues. We may encounter
difficulties and delays in manufacturing our




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products for the following additional reasons:





| |  |  | We have limited experience manufacturing our products in compliance with the FDAs Quality System Regulation;
| | - |  | -------------------------------------------------------------------------------------------------------------




| |  |  | To increase our manufacturing output significantly, we will have to attract and retain qualified employees, who are in short supply, for the assembly and
testing operations; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Some of the components and materials necessary for manufacturing our products are currently provided by a single supplier.
| | - |  | --------------------------------------------------------------------------------------------------------------------------




Although we believe that our current manufacturing facility will be adequate to support our commercial manufacturing activities
for the foreseeable future, we may be required to expand our manufacturing facilities to begin large-scale manufacturing. If we are unable to provide customers with high-quality products in a timely manner, we may not be able to achieve market
acceptance for our Stretta or Secca Systems. Our inability to successfully manufacture or commercialize our devices could have a material adverse effect on our product sales.





If we lose our relationship with any individual suppliers of product components, we will face regulatory requirements with regard to replacement suppliers that could delay the manufacture of our
products.





Third-party suppliers provide materials and components used in our products. If these suppliers
become unwilling or unable to supply us with our requirements, replacement or alternative sources might not be readily obtainable due to regulatory requirements applicable to our manufacturing operations. Obtaining components from a new supplier may
require a new or supplemental filing with applicable regulatory authorities and clearance or approval of the filing before we could resume product sales. This process may take a substantial period of time, and we cannot assure you that we would be
able to obtain the necessary regulatory clearance or approval. This could create supply disruptions that would reduce our product sales and revenue.





If we or our suppliers fail to comply with the FDA quality system regulation, manufacturing operations could be delayed and our business could be harmed.





Our manufacturing processes are required to comply with the quality system regulation, or QSR, which covers the methods and documentation of the design, testing,
production, control, quality assurance, labeling, packaging and shipping of our products. The FDA enforces the QSR through inspections. In May 2001, we received the report on our first QSR inspection, which was completed in March 2001. There were no
significant findings. If we fail any future QSR inspections, our operations could be disrupted and our manufacturing delayed. Failure to take corrective action in response to a QSR inspection could force a shut-down of our manufacturing operations
and a recall of our products, which would have a material adverse effect on our product sales, revenues, and expected revenues and profitability. Furthermore, we cannot assure you that our key component suppliers are, or will continue to be, in
compliance with applicable regulatory requirements, will not encounter any manufacturing difficulties, or will be able to maintain compliance with regulatory requirements. Any such event could have a material adverse effect on our available
inventory and product sales.





Our failure to obtain or maintain necessary FDA clearances or approvals could hurt our ability to
commercially distribute and market our products in the United States.





Our products are considered medical
devices and are subject to extensive regulation in the United States and in foreign countries where we intend to do business. Unless an exemption applies, each medical device that we wish to market in the United States must first receive either
510(k) clearance or premarket approval from the FDA. Either process can be lengthy and expensive. The FDAs 510(k) clearance process usually takes from four to twelve months, but may take longer. The premarket application (PMA)
approval process is much more costly, lengthy and uncertain. It generally takes from one to three years or even longer. Delays in obtaining regulatory clearance or approval will adversely affect our revenues and profitability.





Although we have obtained 510(k) clearance for both the Stretta System, for use in treating GERD, and the Secca System, for
treatment of fecal incontinence in patients who have failed more conservative therapies such as diet modification and biofeedback, our clearance can be revoked if postmarketing data demonstrates safety issues or lack of effectiveness. Moreover, we
will need to obtain 510(k) clearance or PMA approval to market any other new products. We cannot assure you that the FDA will not impose the more burdensome PMA approval process upon this technology in the future. More generally, we cannot assure
you that the FDA will ever grant 510(k) clearance or premarket approval for any product we propose to market. If the FDA withdraws or refuses to grant approvals, we will be unable to market such products in the United States.





If we market our products for uses that the FDA has not approved, we could be subject to FDA enforcement action.




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Our Stretta and Secca Systems are cleared by the FDA; the Stretta System for the
treatment of GERD and the Secca System for the treatment of fecal incontinence in patients who have failed more conservative therapies such as diet modification and biofeedback. FDA regulations prohibit us from promoting or advertising either
system, or any future cleared or approved devices, for uses not within the scope of our clearances or approvals, and prohibit us from making unsupported safety and effectiveness claims. These determinations can be subjective, and the FDA may
disagree with our promotional claims. If the FDA requires us to revise our promotional claims or takes enforcement action against us based upon our labeling and promotional materials, our sales could be delayed, our profitability could be harmed and
we could be required to pay significant fines or penalties.





Modifications to our marketed devices may require new 510(k) clearances
or PMA approvals or require us to cease marketing or recall the modified devices until such clearances are obtained.





Any modification to an FDA 510(k)-cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, requires a new FDA 510(k) clearance or, possibly, PMA
approval. The FDA requires every manufacturer to make this determination in the first instance, but the FDA can review any such decision. We have modified aspects of our Stretta System, but we believe that new 510(k) clearances are not required. We
may modify future products after they have received clearance or approval, and, in appropriate circumstances, we may determine that new clearance or approval is unnecessary. We cannot assure you that the FDA would agree with any of our decisions not
to seek new clearance or approval. If the FDA requires us to seek 510(k) clearance or PMA approval for any modification to a previously cleared product, we also may be required to cease marketing or recall the modified device until we obtain such
clearance or approval. Also, in such circumstances, we may be subject to significant regulatory fines or penalties.





Complying with
FDA and other regulations is an expensive and time-consuming process, and any failure to comply could result in substantial penalties.





Our products are medical devices that are subject to extensive regulation. FDA regulations are wide-ranging and govern, among other things:





| |  |  | product design, development, manufacture and testing;
| | - |  | -----------------------------------------------------




| |  |  | product labeling;
| | - |  | -----------------




| |  |  | product storage;
| | - |  | ----------------




| |  |  | premarket clearance or approval;
| | - |  | --------------------------------




| |  |  | advertising and promotion; and
| | - |  | ------------------------------




| |  |  | product sales and distribution.
| | - |  | -------------------------------




Noncompliance with applicable regulatory requirements can result in enforcement action which may include recalling products, ceasing product marketing, paying significant fines and penalties, and
similar FDA actions which could limit product sales, delay product shipment, and adversely affect our profitability.





We face risks
related to our international operations, including the need to obtain necessary foreign regulatory approvals.





In February 2001, we entered into a total of four distribution agreements: one each in Germany, Italy, and Greece and one covering sales in the region of Belgium, the Netherlands, and Luxembourg (Benelux). In August 2001, we entered
into a distribution agreement in South Africa, and in December 2001, we entered into distribution agreements in Portugal and one covering sales in the region of Denmark, Sweden, Norway and Finland (Scandinavia). In March 2002, we entered into a
distribution agreement in Egypt. In June 2002, we entered into a distribution agreement in Israel. We are training these distributors and only began selling our products in international markets in April 2001. To successfully market our products
internationally, we must address many issues with which we have little or no experience. We have obtained regulatory clearance to market the Stretta System in the European Union, Australia and Canada and to market the Secca System in the European
Union, but we have not obtained any other international regulatory approvals for other markets or products. We cannot assure you that we will be able to obtain or maintain such approvals. Furthermore, although contracts already signed with European
distributors specify payment in U.S. dollars, future international sales may be made in currencies other than the U.S. dollar. As a result, currency fluctuations may impact the demand for our products in countries where the U.S. dollar has increased
compared to the local currency. Engaging in international business involves the following additional risks:





| |  |  | export restrictions, tariff and trade regulations, and foreign tax laws;
| | - |  | ------------------------------------------------------------------------




| |  |  | customs duties, export quotas or other trade restrictions;
| | - |  | ----------------------------------------------------------




| |  |  | economic or political instability;
| | - |  | ----------------------------------



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| |  |  | shipping delays; and
| | - |  | --------------------




| |  |  | longer payment cycles.
| | - |  | ----------------------




In addition, contracts may be difficult to enforce and receivables difficult to collect through a foreign countrys legal system, and the protection of intellectual property in foreign countries may be more difficult to
enforce. Once we begin selling our products internationally, any of these factors could cause our international sales to decline, which would impact our expected sales and growth rates.





Product liability suits against us could result in expensive and time-consuming litigation, payment of substantial damages and an increase in our insurance rates.





The development, manufacture and sale of medical products involves a significant risk of product liability claims. The use of
any of our products may expose us to liability claims, which could divert managements attention from our core business, be expensive to defend, and result in sizable damage awards against us. For example, we are currently a party to three
product liability lawsuits where there are allegations that our products are defectively designed and that we were negligent in manufacturing our products. We maintain product liability insurance at coverage levels which we believe to be
commercially acceptable; however there can be no assurance that product liability or other claims will not exceed such insurance coverage limits or that such insurance will continue to be available on the same or substantially similar terms, or at
all. We re-evaluate annually whether we need to obtain additional product liability insurance. Even if we obtain additional product liability insurance there can be no assurance that it would not have a material adverse effect on our business,
financial condition, and results of operations. Any product liability claims brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing any coverage in the future. Even in the absence
of a claim, our insurance rates may rise in the future to a point where we decide not to carry any insurance.





We have limited
protection for our intellectual property. If our intellectual property does not sufficiently protect our products, third parties will be able to compete against us more directly and more effectively.





As of June 30, 2002, we had 43 issued or allowed U.S. patents and 37 pending U.S. patent applications; this includes 20 issued U.S.
patents and 16 pending U.S. patent applications licensed in from third-parties. We rely on patent, copyright, trade secret and trademark laws to protect our products, including our Stretta Catheter, our Secca Handpiece and our Curon Control Module,
from being duplicated by competitors. However, these laws afford only limited protection. Our patent applications and the notices of allowance we have received may not issue as patents or, if issued, may not issue in a form that will be advantageous
to us. Patents we have obtained and may obtain in the future may be challenged, invalidated or legally circumvented by third parties. We may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets
by consultants, vendors, former employees or current employees, despite the existence of nondisclosure and confidentiality agreements and other contractual restrictions. Furthermore, the laws of foreign countries may not protect our intellectual
property rights to the same extent as the laws of the United States. If our intellectual property rights do not adequately protect our commercial products, our competitors could develop new products or enhance existing products to compete more
directly and effectively with us and harm our product sales and market position.





Because, in the United States,
patent applications are secret unless and until issued as patents, or corresponding applications are published in other countries, and because publication of discoveries in the scientific or patent literature often lags behind actual discoveries, we
cannot be certain that we were the first to file patent applications for such inventions. Litigation or regulatory proceedings, which could result in substantial cost and uncertainty, may also be necessary to enforce patent or other intellectual
property rights or to determine the scope and validity of other parties proprietary rights. There can be no assurance that we will have the financial resources to defend our patents from infringement or claims of invalidity.





Because of our reliance on unique technology to develop and manufacture innovative products, we depend on our ability to operate without infringing
or misappropriating the proprietary rights of others.





There is a substantial amount of litigation over patent
and other intellectual property rights in the medical device industry. Because we rely on unique technology to develop and manufacture innovative products, we are especially sensitive to the risk of infringing intellectual property rights. While we
attempt to ensure that our products do not infringe other parties patents and proprietary rights, our competitors may assert that our products and the methods they employ may be covered by patents held by them or invented by them before they
were invented by us. Although we may seek to obtain a license or other agreement under a third partys intellectual property rights to bring an end to certain claims or actions asserted against us, we may not be able to obtain such an agreement
on reasonable terms or at all. If we were not successful in obtaining a license or redesigning our products, our product sales and profitability could suffer, and we could be subject to litigation and potentially sizable damage awards.




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Also, one or more of our products may now be infringing inadvertently on existing
patents. As the number of competitors in our markets grows, the possibility of a patent infringement claim against us increases. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often
uncertain. Infringement and other intellectual property claims, with or without merit, can be expensive and time-consuming to litigate and divert managements attention from our core business. If we lose in this kind of litigation, a court
could require us to pay substantial damages or grant royalties, and prohibit us from using technologies essential to our products. This kind of litigation is expensive to all parties and consumes large amounts of managements time and
attention. In addition, because patent applications can take many years to issue, there may be applications now pending of which we are unaware and which may later result in issued patents that our products may infringe.





If we lose our rights to intellectual property that we have licensed we may be forced to develop new technology and we may not be able to develop that
technology or may experience delays in manufacturing as a result.





Our license with Gyrus Group PLC, a public
company incorporated and existing under the laws of England and Wales, allows us to manufacture and sell our products using their radiofrequency generator technology. In addition, the University of Kansas license allows us to apply radiofrequency
energy to tissue. To the extent these license interests become jeopardized through termination or material breach of the license agreements, our operations may be harmed. We may have to develop new technology or license other technology. We cannot
provide any assurance that we will be able to develop such technology or that other technology will be available for license. Even if such technology is available, we may experience delays in our manufacturing as we transition to a different
technology.





If we are unable to attract and retain qualified personnel, we will be unable to expand our business.





We believe our future success will depend upon our ability to successfully manage our growth, including attracting and
retaining engineers and other highly skilled personnel. Our employees are at-will employees and are not subject to employment contracts. The loss of services of one or more key employees could materially adversely affect our growth. In addition,
hiring qualified management and technical personnel will be difficult due to the intense competition for qualified professionals within the medical device industry. In the past, we have experienced difficulty in recruiting qualified personnel.
Failure to attract and retain personnel, particularly management and technical personnel, would materially harm our ability to grow our business rapidly and effectively.





Our directors, executive officers and principal stockholders have significant voting power and may take actions that may not be in the best interests of our other stockholders.





Our officers, directors and principal stockholders holding more than 5% of our common stock together control over 50% of our
outstanding common stock. As a result, these stockholders, if they act together, will be able to control the management and affairs of our company and all matters requiring stockholder approval, including the election of directors and approval of
significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the
best interest of our other stockholders.





Our stockholder rights plan, certificate of incorporation, bylaws and Delaware law contain
provisions that could discourage a takeover.





In November 2001, we adopted a stockholder rights plan. The
purpose of the plan is to assure fair value in the event of a future unsolicited business combination or similar transaction involving Curon. If an individual or entity accumulates 15% of our stock, or 20% in the case of certain existing
stockholders, the rights become exercisable for additional shares of our common stock or, if followed by a merger or other business combination where Curon does not survive, additional shares of the acquirors common stock. The intent of these
rights is to force a potential acquiror to negotiate with the Board to increase the consideration paid for our stock. The existence of this plan, however, may deter a potential acquiror, which could negatively impact shareholder value.





In addition, our basic corporate documents and Delaware law contain provisions that might enable our management to resist a
takeover. Any of the above provisions might discourage, delay or prevent a change in the control of our company or a change in our management. The existence of these provisions could adversely affect the voting power of holders of common stock and
limit the price that investors might be willing to pay in the future for shares of our common stock.





We expect that the price of our
common stock will fluctuate substantially.





The market price for the common stock may be affected by a number
of factors, including:




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| |  |  | the announcement of new products or product enhancements by us or our competitors;
| | - |  | ----------------------------------------------------------------------------------




| |  |  | quarterly variations in our or our competitors results of operations;
| | - |  | ----------------------------------------------------------------------




| |  |  | changes in earnings estimates or recommendations by securities analysts, or our failure to achieve analyst earnings estimates;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------




| |  |  | developments in our industry; and
| | - |  | ---------------------------------




| |  |  | general market conditions and other factors, including factors unrelated to our operating performance or the operating performance of our competitors.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------




In addition, the stock prices of many companies in the medical device industry have
experienced wide fluctuations that have often been unrelated to the operating performance of such companies. Such factors and fluctuations may materially and adversely affect the market price of our common stock, which, in turn, may negatively
affect our ability to raise capital and to acquire technologies in the future.





A sale of a substantial number of shares of our common
stock may cause the price of our common stock to decline.





If our stockholders sell substantial amounts of our
common stock in the public market, including shares issued upon the exercise of outstanding options, the market price of our common stock could fall. Such sales also might make it more difficult for us to sell equity or equity-related securities in
the future at a time and price that we deem reasonable or appropriate.





Item 3.    Quantitative and Qualitative Disclosures of Market Risk





We invest our excess cash primarily in U.S. government securities and marketable debt securities of financial institutions and corporations with strong credit ratings. These instruments have maturities of eighteen months or less when
acquired, with an average maturity date of less than three months. We do not utilize derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions in any material fashion.
Accordingly, we believe that while the instruments we hold are subject to changes in the financial standing of the issuer of such securities, we are not subject to any material risks arising from changes in interest rates, foreign currency exchange
rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments.




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PART II    OTHER INFORMATION





Item 1.    Legal Proceedings





In June 2001, Hershel E. Fancher et al (Fancher) filed a civil action against us in the United
States District Court, Western District of Kentucky, Louisville Division, alleging that he sustained a nerve injury and damage to his gastrointestinal tract during a Stretta procedure caused by the defective design and manufacture of our product.
Fanchers allegations against us include strict liability for a product that was in a defective and unreasonably dangerous condition, negligence in the design and manufacturing of the product, breach of implied warranty of merchantability, and
loss of consortium. Fancher was a subject in a randomized clinical trial and had given Informed Consent to the treating institution for the procedure. Fancher is seeking a trial by jury and unspecified damages. We believe Fanchers claim is
without merit.





In September 2001, Diana Conklin (Conklin) filed a civil action against a number of
defendants, including Curon, in the Superior Court of the State of California in and for the City and County of Santa Clara, alleging that she sustained injury when undergoing surgery utilizing the Stretta System, caused by defects in design and
manufacture. Conklin also alleges negligence in the design, manufacture, advertising and sale of the Stretta System and that its warnings, instructions and directions for use were inadequate. Additional defendants include the treating physicians and
the associated medical institutions, who, it is alleged, were medically negligent in treatment of Conklin. Conklin is seeking unspecified damages. We believe Conklins claim against us is without merit.





In June 2002, Eileen Guckin et al (Guckin) filed a civil action against a number of defendants, including Curon, in the Court
of Common Pleas, Philadelphia County in the State of Pennsylvania, alleging that she sustained injury during a Secca procedure caused by the device being defective and/or in an unreasonably dangerous condition. Guckin was a subject in a clinical
trial and had given Informed Consent to the treating institution for the procedure. Additional defendants include the treating physician, the associated medical institution who, it is alleged, were medically negligent in treatment of Guckin, and the
members of the Institutional Review Board who approved the protocol for the clinical trial. Guckin has demanded a trial by jury and unspecified damages. We believe Guckins claim against us is without merit.





Item 2.    Changes in Securities and Use of Proceeds





On September
26, 2000, we completed the sale of 5,000,000 shares of our common stock at a per share price of $11.00 in a firm commitment underwritten public offering. The offering was effected pursuant to a Registration Statement on Form S-1 (Registration No.
333-37866), which the United States Securities and Exchange Commission declared effective on September 21, 2000. On October 24, 2000, we completed the sale of an additional 475,000 shares of our common stock at a per share price of $11.00 pursuant
to the exercise of the over-allotment option by the underwriters. Of the approximately $54.8 million in net offering proceeds, through June 30, 2002, we have used approximately $12.0 million for the repayment of debt and accrued interest, $6.4
million for research and development, $6.9 million for the manufacture of products, $2.6 million for clinical expense and reimbursement efforts, $11.1 million for sales and marketing initiatives to support the commercialization of the Stretta System
and $7.3 million for general corporate purposes. All amounts represent estimates of direct or indirect payments of amounts to third parties.





We had a loan of $259,000 to John W. Morgan, our former President and Chief Executive Officer. As a result of Mr. Morgans severance agreement, the loan and accrued interest was forgiven, in the
total amount of $272,000. In January 2001, we issued a $150,000 loan to David S. Utley, M.D., our Chief Medical Officer. Amounts due under the loan are forgiven over time based upon Dr. Utleys continued employment, and forgiven in full on
January 4, 2003 or upon an earlier change in control. Other than these loans, no amounts were paid directly or indirectly for the above purposes to directors or officers of the Company, to persons owning ten percent or more of any class of equity
securities of the Company, or to affiliates of the Company, other than amounts related to the repayment of debt and accrued interest, which amounts matured less than one year from the date of issuance. The use of proceeds described above do not
represent a material change in the use of proceeds describe in the Offering prospectus.





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





We
held an annual meeting on May 14, 2002. The first item of business was the election of Class II directors. The following nominees for Class II directors were elected by a majority of votes present at the meeting: Alan L. Kaganov and Rob F. Kuhling,
Jr.





Name

VotesFor

Votes Withheld

Votes AgainstAlan L. Kaganov

10,397,190

12,888

0Rob Kuhling, Jr

10,397,190

12,888

0




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Class I and Class III directors that continued their term a directors with the
Company are David I. Fann and John W. Morgan (who subsequently resigned), and Michael Berman and Fred L. Brown, respectively.





The appointment of PricewaterhouseCoopers, LLP as our independent accountants for the year ended December 31, 2002, was ratified with 10,405,469 votes in favor, 3,159 against and 1,450 abstentions. There were no votes withheld.





Item 5.    Other Information





On July 17, 2002, John W. Morgan
announced his resignation as the Companys Chief Executive Officer, President and Board member. Michael Berman, Chairman of the Board, has assumed the position of interim Chief Executive Officer while the Company conducts a search for a new
President and Chief Executive Officer. Under the terms of the severance agreement, Mr. Morgan received a $275,000 lump sum payment and six months accelerated vesting of his stock options, and his loan and accrued interest, in the amount of
$272,000, was forgiven.





In accordance with Section 10A(i)(2) of the Securities Exchange Act of 1934, as added by
Section 202 of the Sarbanes-Oxley Act of 2002 (the Act), we are required to disclose the non-audit services approved by our Audit Committee to be performed by PricewaterhouseCoopers LLP, our external auditor. Non-audit services are
defined in the Act as services other than those provided in connection with an audit or a review of the financial statements of a company. The Audit committee has approved the engagement of PricewaterhouseCoopers LLP for the following non-audit
services: the preparation of federal and state tax returns.





Item 6.    Exhibits and Reports on Form 8-K





|(a)    Exhibits: |  | 
|---------------- |  | 




Exhibit 10.20

Severance Agreement with John W. Morgan dated July 19, 2002.Exhibit 99.1

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, filed herewith.Exhibit 99.2

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, filed herewith.





|(b) |  | There were no reports on Form 8-K during the quarter ended June 30, 2002.
|--- |  | -------------------------------------------------------------------------



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CURON MEDICAL, INC.





SIGNATURES





Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.





CURON MEDICAL, INC. (Registrant)Date: August 13, 2002



By:

/s/    MICHAEL
BERMANMichael Berman Interim Chief
Executive Officer (Principal Executive Officer)


By:

/s/    ALISTAIR F.
MCLARENAlistair F. McLaren Vice
President of Finance Chief Financial Officer and Chief Information Officer (Principal Financial Officer)




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