---




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, 2003





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)





---




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  ̈





Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
  Yes   ̈
  No  x





As of August 7, 2003, 20,104,880 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, 2003 and December 31, 2002

3Condensed Consolidated Statements of Operations for the three and six month periods ended June 30, 2003 and 2002

4Condensed Consolidated Statements of Cash Flows for the six month periods ended June 30, 2003 and 2002

5Notes to Condensed Consolidated Financial Statements

6Item 2.

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

11Item 3.

Quantitative and Qualitative Disclosures of Market Risk

26Item 4.

Controls and Procedures

26PART II.

OTHER INFORMATIONItem 1.

Legal Proceedings

26Item 4.

Submission of Matters to a Vote of Security Holders

27Item 5.

Other Information

27Item 6.

Exhibits and Reports on Form 8-K

28SIGNATURES





29






-2-




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PART I    FINANCIAL INFORMATION





Item 1.    Financial Statements





CURON
MEDICAL, INC.





CONDENSED CONSOLIDATED BALANCE SHEETS





(Unaudited, in thousands)


June 30, 2003


December 31, 2002AssetsCurrent assets:Cash and cash equivalents

$
8,715


$
8,570Marketable securities


8,773



14,397Accounts receivable, net


626



688Inventories, net


1,154



1,295Prepaid expenses and other current assets


1,082



972Total current assets


20,350



25,922Long term investments






528Property and equipment, net


608



766Other assets


20



20Total assets

$
20,978


$
27,236Liabilities and Stockholders EquityCurrent liabilities:Accounts payable

$
340


$
191Accrued liabilities


1,038



882Notes payable


265



42Total current liabilities


1,643



1,115Other liabilities


14



18Total liabilities


1,657



1,133Contingencies (Note 4)Stockholders equity:Common stock


20



20Additional paid-in capital


90,133



90,128Deferred stock compensation


(47
)


(125
)Accumulated deficit


(70,572
)


(63,732
)Treasury stock


(234
)


(234
)Accumulated other comprehensive income


21



46Total stockholders equity


19,321



26,103Total liabilities and stockholders' equity

$
20,978


$
27,236





See accompanying notes to condensed consolidated financial statements




-3-




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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, 2003


June 30, 2002


June 30, 2003


June 30, 2002Revenues

$
868


$
877


$
1,577


$
1,816Cost of goods sold


1,046



1,039



2,029



2,022Gross loss


(178
)


(162
)


(452
)


(206
)Operating expenses:Research and development


464



842



917



1,631Clinical and regulatory


320



429



635



847Sales and marketing


1,852



1,982



3,254



3,860General and administrative


829



1,027



1,749



1,999Total operating expenses


3,465



4,280



6,555



8,337Operating loss


(3,643
)


(4,442
)


(7,007
)


(8,543
)Interest income


66



203



161



481Other income, net


2



4



6



2Net loss

$
(3,575
)

$
(4,235
)

$
(6,840
)

$
(8,060
)Net loss per share, basic and diluted

$
(0.18
)

$
(0.22
)

$
(0.34
)

$
(0.41
)Shares used in computing net loss per share, basic and diluted


20,055



19,509



20,016



19,458





See accompanying notes to condensed consolidated financial statements




-4-




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CURON MEDICAL, INC.





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS





(Unaudited, in thousands)







For the Six Months Ended,June 30, 2003


June 30, 2002Cash Flows From Operating ActivitiesNet loss

$
(6,840
)

$
(8,060
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


269



348Amortization of acquired technology






133Amortization of stock-based compensation


34



257(Gain) loss on sale of property and equipment


(6
)


24Amortization of premium (accretion of discount) on securities, net


172



(56
)Changes in assets and liabilities:Accounts receivable, net


62



(111
)Inventories, net


141



56Prepaid expenses and other current assets


(110
)


111Accounts payable


149



(67
)Accrued liabilities


156



(27
)Other long-term assets and liabilities


(4
)


2Net cash used in operating activities


(5,977
)


(7,390
)Cash Flows From Investing ActivitiesPurchase of property and equipment


(111
)


(195
)Sale of property and equipment


6



Purchase of marketable securities


(6,591
)


(13,199
)Proceeds from maturities of marketable securities


12,546



20,704Net cash provided by investing activities


5,850



7,310Cash Flows From Financing ActivitiesPrincipal payments on notes payable


(86
)


(229
)Proceeds from issuance of notes payable


309



148Proceeds from related party notes receivable






143Payments of related party notes receivable






(51
)Proceeds from issuance of common stock


49



152Net cash provided by financing activities


272



163Net increase in cash and cash equivalents


145



83Cash and cash equivalents at beginning of period


8,570



7,509Cash and cash equivalents at end of period

$
8,715


$
7,592





See accompanying notes to the condensed consolidated financial statements






-5-




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# CURON MEDICAL, INC.

# NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

## June 30, 2003

## 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 financings and future revenues. The Company currently has
enough cash to fund operations for at least the next twelve months. Should
additional funding be required at any point in the future, alternative financing
will be sought 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,
stockholders may experience dilution, and such securities may have rights,
preferences or privileges senior to those of the holders of common stock. There
can be no assurance that the Company will be able to obtain such financing, or
to obtain it on acceptable terms.

## 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, 2002, as filed with the SEC.



-6-




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## Net Loss Per
Share

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







Three Months Ended June 30,


Six Months Ended June 30,2003


2002


2003


2002Numerator:Net loss

$
(3,575
)

$
(4,235
)

$
(6,840
)

$
(8,060
)Denominator:Weighted average shares outstanding


20,066



19,718



20,030



19,684Weighted average unvested common shares subject to repurchase


(11
)


(209
)


(14
)


(226
)Weighted average shares used in basic and diluted net loss per share


20,055



19,509



20,016



19,458Net loss per share

$
(0.18
)

$
(0.22
)

$
(0.34
)

$
(0.41
)




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 vesting schedule as the original 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, 2003

June 30, 2002Unvested common shares (shares subject to repurchase)

10

198Shares issuable upon exercise of stock options

3,499

2,061Shares issuable upon exercise of warrants

569

569Total

4,078

2,828




-7-




---




## Stock Based
Compensation

The Company accounts for
its stock-based compensation using the method prescribed by APB No. 25. Had the
Company determined its stock-based compensation based on the fair value at the
grant dates for the awards under a method prescribed by SFAS No. 123, the
Companys net loss would have been increased to the FAS 123 (as amended by
SFAS No. 148) adjusted amounts indicated below:

Three Months Ended June 30,


Six Months Ended June 30,2003


2002


2003


2002Net loss, as reported

$
(3,575
)

$
(4,235
)

$
(6,840
)

$
(8,060
)Add:
Stock-based employee compensation expense in reorted net income


(10
)


80



34



257Deduct:
Total stock-based employee compensation expense determined under fair value based method for all awards


(184
)


(354
)


(426
)


(725
)Net lossFAS 123 adjusted

$
(3,769
)

$
(4,509
)

$
(7,232
)

$
(8,528
)Net loss per shareas reportedBasic and diluted

$
(0.18
)

$
(0.22
)

$
(0.34
)

$
(0.41
)Net loss per shareFAS 123 adjustedBasic and diluted

$
(0.19
)

$
(0.23
)

$
(0.36
)

$
(0.44
)


## Product
Warranty

The Company generally
warrants its products against defects for a period of one year and records a
liability for such product warranty obligations at the time of sale based upon
historical experience. The Company also sells separately priced extended
warranties to provide additional warranty coverage and recognizes the related
revenue on a straight-line basis over the extended warranty period, which is
generally one to four years. Costs associated with services performed under the
extended warranty obligation are expensed as incurred.

Changes in product warranty
obligations, including separately priced extended warranty obligations, for the
six months ended June 30, 2003 are as follows:

Balance as of December 31, 2002

$
44Add:Accruals for warranties issued



52Cost incurred under separately priced extended warranty obligations


Less:Settlements made



(28
)Revenue recognized under separately priced extended warranty



(3
)Balance as of June 30, 2003


$
65




-8-




---




## Recent
Accounting Pronouncements

In May 2003, the FASB
issued SFAS No 150. Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. SFAS No. 150 requires that
certain financial instruments, which under previous guidance could be accounted
for as equity, be classified as liabilities in the statement of financial
position. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003. The Company does not expect the adoption of SFAS
150 to have a significant impact on the Companys financial statements.

## NOTE
2.   Inventories

June 30, 2003

December 31, 2002Inventories:Raw materials

$
853

$
888Work-in-process


112


97Finished goods


189


310$
1,154

$
1,295


## 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 30,2003


2002


2003


2002Cost of goods sold

$
3


$
(30
)

$
8


$
(12
)Research and development


5



18



17



46Clinical and regulatory


5



14



11



32Sales and marketing


(25
)


(18
)


(8
)


5General and administrative


2



96



6



186$
(10
)

$
80


$
34


$
257


## 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 vagal 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 been provided with an
approved Informed Consent form and counseling by the physician. Prior to
treatment, the subject provided consent to proceed. Plaintiff is seeking a trial
by jury and unspecified damages. Trial date is currently set in August 2004. The
Company believes Plaintiffs claim is without merit.



-9-




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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 been provided with an
approved Informed Consent form and counseling by the physician. Prior to
treatment, the subject provided consent to proceed. 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. Although the
case was moved to the United States District Court for the Eastern District of
Pennsylvania, it has since been moved back to State Court on appeal. The Company
believes Plaintiffs claim against the Company is without merit.

In February 2003, a civil
action was filed against the Company in the District Court of Dallas County, in
the State of Texas, alleging that the Plaintiff sustained serious injuries
during a Stretta Procedure performed in February 2001, caused by the device
being in a defective condition. Since the original filing, both the treating
physician and his institution have been added to the complaint. Plaintiff
alleges that the procedure caused damaging atrial fibrillation and severe
esophageal burns despite a contradicting physician report filed at the time of
the procedure. The Company believes Plaintiffs claim to be without merit.

In April 2003, a civil
action was filed against the Company in United States District Court for the
Northern District of California by Federal Insurance Corporation, the
Companys insurance carrier, for rescission, reformation, and restitution
in connection with the Companys liability insurance policy. This policy
covers, among other things, product liability claims made against the Company by
people treated with the Companys product. Because the carrier seeks to
rescind the policy, an adverse outcome of this litigation could have a material
adverse impact on the Company in part due to the June 2002 Pennsylvania suit
described above, which is currently being defended by Federal Insurance. The
Company believes the claims by Federal Insurance are without merit and is
preparing its defense of the matter.

The above matters are
pending and the Company cannot predict whether they will, individually or
collectively, have a material effect on its business, financial position,
results of operations or cash flows.

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 a
procedure utilizing the Stretta System, caused by defects in design and
manufacture. This matter was amicably resolved in July 2003 without material
financial impact to the Company.

## NOTE
6.   Subsequent Event

The Company signed a
noncancelable operating lease on July 3, 2003 for office, research and
development, and manufacturing space in Fremont, California. This lease has a
term of 38 months and will begin September 1, 2003. Future minimum lease
payments, relating to this lease as of its inception, are as follows:

Remainder of 2003

$
2004


3092005


3772006


318Total future minimum operating lease payments

$
1,004




-10-




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## Item 2.  
Managements Discussion and Analysis of Financial Condition and Results of
Operations
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, 2002.

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 of
new distributor and product introductions, the timing and extent of clinical
trial efforts, our ability to maintain current and planned operations through at
least the next 12 months without raising additional funds and the availability
of funding, if needed. 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
15, 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

Curon Medical, Inc was
incorporated in Delaware in May 1997. We develop, manufacture and market
innovative proprietary products for the treatment of gastrointestinal disorders.
Our products consist of radiofrequency generators and single-use disposable
devices for use with our radiofrequency generators.

Our first product, the
Stretta® System, received United States Food and Drug Administration
(FDA) clearance in April 2000 for the treatment of gastroesophageal
reflux disease, or GERD, which affects approximately 14 million U.S. adults on a
daily basis. In patients with GERD, acidic stomach contents reflux backward from
the stomach into the esophagus, causing a wide range of symptoms and
complications, including, most commonly, persistent heartburn and chest pain.
Unlike medication, which temporarily suppresses GERD symptoms, our Stretta
System applies radiofrequency energy to treat the causes of GERD. Our Stretta
System consists of a disposable catheter with needle electrodes and our Stretta
control module, which is a radiofrequency energy generator. Using the Stretta
System, the physician delivers temperature-controlled radiofrequency energy to
the muscle of the lower esophageal sphincter and upper portion of the stomach.
The delivery of this energy creates thermal lesions that reabsorb over time
causing tissue contraction. Clinical studies have shown a significant reduction
in GERD symptom scores, esophageal acid exposure, and use of anti-secretory
medications following treatment with the Stretta System.

Our second product, the
Secca® System, is a radiofrequency energy-based system for
treatment of fecal incontinence. Fecal incontinence is caused by damage to the
anal sphincter from childbirth, surgery, neurological disease, injury or age,
and affects up to 16 million adults in the United States. The Secca System
consists of a disposable handpiece with needle electrodes and the Secca control
module, which is a radiofrequency energy generator. Using the Secca System,
physicians deliver radiofrequency energy to the muscle of the anal canal.
Clinical studies have shown a reduction in fecal incontinence symptoms and
improvement in quality of life following treatment with the Secca System. In
March 2002, we received 510(k) clearance from the FDA to market the Secca System
for the treatment of fecal incontinence in patients who have failed more
conservative therapies such as diet modification and biofeedback. In June 2002,
we started a limited commercial release of the Secca System and, in June 2003, we
launched the Secca System on a full commercial basis.



-11-




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We market the Stretta
System, as an alternative to anti-reflux surgery, primarily to high volume
gastroenterologists and general surgeons who actively perform endoscopy. In the
United States, we estimate that there are approximately 4,000 general surgeons
and 9,000 gastroenterologists who actively perform endoscopy. We market the
Secca System primarily to colon and rectal surgeons and to those general
surgeons who perform colorectal surgery. We estimate that there are
approximately 1,000 colon and rectal surgeons and approximately 2,000 general
surgeons who perform colorectal surgery in the United States.

In addition to a direct
sales force, in the second quarter of 2003 we added a new sales channel by
engaging 14 Manufacturer Representative firms, which have added 37 salespeople
to sell and market our products, on a part time basis, across the United States.

Our Stretta System has also
received European, Australian and Canadian regulatory approval, and our Secca
System has also received regulatory approval in Europe. We incorporated a
subsidiary company in Belgium in March 2001 to manage distribution of our
products in Europe, the Middle East and Africa. In March 2003, we entered into
an agreement with a distributor for the Far East, giving us representation in
the countries of the Peoples Republic of China, Taiwan, Hong Kong, South Korea,
Singapore, Malaysia, Indonesia, Vietnam, Thailand, India and the Philippines. To
date, we have international distribution agreements for the Stretta System in 16
European and Middle Eastern countries and in South Africa. The Secca System will
also be sold through distributors in Europe. The first European Secca Procedures
were performed in Germany, Denmark and Italy in March 2002, as part of our
clinical trials. The first commercial European Secca procedure was performed in
March 2003.

The American Medical
Association recently issued a Category III CPT code for the Stretta procedure to
take effect January 1, 2004, which will make it easier for physicians to code
for the procedure from that date, and we anticipate that a CPT I code will be
published in July 2004 to take effect in January 2005.

We have recently
experienced several changes in our senior management team. Larry C. Heaton II
joined the Company as President and CEO in January 2003, and also became a
member of the Board of Directors. In April 2003, David Smith became our Senior
Vice President of Sales and Marketing.

## RESULTS OF
OPERATIONS

## Periods of three
and six months ended June 30, 2003 and 2002.

Revenues


Revenues for the quarter
ended June 30, 2003 were $868,000, compared to $877,000 for the same quarter in
2002. Stretta System products accounted for 90% and Secca System products 10% of
the quarters revenues. In the second quarter of 2002, Stretta System
products accounted for 94%, and the first commercial sales of Secca System
products were 6% of the quarters revenues. The Stretta Control Module and
Catheter accounted for 46% and 50%, respectively, of the Stretta product line
sales for the quarter ended June 30, 2003, compared to 50% and 46%,
respectively, for the same period in 2002. International sales accounted for
$61,000 in the quarter ended June 30, 2003, compared to $121,000 in the same
quarter of 2002. Revenues for the six months ended June 30, 2003 were
$1,577,000, compared to $1,816,000 for the same period in 2002. The decrease in
revenues for both the three and six months periods ending June 30, 2003, as
compared to the same periods in 2002, was primarily due to our ongoing
challenges in receiving favorable coverage decisions from both public and
private carriers on a state-by-state basis for the Stretta procedure. Stretta
System products accounted for 90% and Secca System products 10% of the revenues
for the six months ended June 30, 2003, as compared to 97% and 3%, respectively,
for the same period in 2002. The Stretta Control Module and Catheter accounted
for 43% and 53%, respectively, of the Stretta product line sales for the six
months ended June 30, 2003, as compared to 55% and 42%, respectively, for the
same period in 2002. International sales accounted for $131,000 in the six
months ended June 30, 2003, compared to $231,000 for the same period in 2002.
The international sales in 2002 are higher due to the sale of demonstration equipment to
new distributors during that year.



-12-




---




Cost of goods sold


Our costs of goods sold
represent the cost of producing generators and disposable devices. We also
license a technology used in the generators we sell, and 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. Cost
of goods sold was $1.0 million in the quarters ended June 30, 2003 and 2002. For
the six months ended June 30, 2003 and 2002, cost of goods sold was $2.0
million. Our sales have not yet reached a level that would absorb our
manufacturing capacity to the extent that we would experience positive gross
profit. For the quarter and six months ended June 30, 2003, cost of goods sold
decreased due to increased production efficiencies and lower component costs, as
compared to the same periods in 2002. For the quarter and six months ended June
30, 2002, $84,000 and $235,000, respectively, of excess manufacturing capacity
was used to support Secca Pilot manufacturing, prior to product
commercialization in June 2002. This manufacturing spending was therefore
charged to research and development, as compared to the same periods in 2003,
when all manufacturing spending was directly related to production or production
capacity.

Research and development expenses


Research and development
expenses consist primarily of personnel costs, professional services, patent
application and maintenance costs, materials, supplies and equipment. Research
and development expenses were $464,000 in the quarter ended June 30, 2003, and
$842,000 for the same period in 2002. Expenses were lower in the quarter ended
June 30, 2003, as compared to the same period in 2002, due primarily to $84,000
of pilot manufacturing expensed in 2002, patent spending decreases of $154,000
and cost reduction strategies. For the six months ended June 30, 2003, research
and development expenses were $917,000, and $1.6 million for the same period in
2002. Expenses were lower in the first six months of 2003, as compared to the
same period in 2002, due primarily to $235,000 of Secca pilot manufacturing
expensed in 2002, patent spending decreases of $205,000 and cost reduction
strategies.

Clinical and regulatory expenses


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. Clinical
and regulatory expenses were $320,000 in the quarter ended June 30, 2003, and
$429,000 for the same period in 2002. For the six months ended June 30, 2003,
clinical and regulatory expenses were $635,000, and $847,000 for the same period
in 2002. Cost reduction strategies and reduced clinical trial activity have
reduced expenses in the quarter and six months ended June 30, 2003, as compared
to the same periods in 2002. Clinical efforts on the Secca randomized trial
began in May 2002, and the related spending has been limited to date, but is
anticipated to increase later in the year.

Sales and marketing expenses


Sales and marketing
expenses consist of personnel related costs, advertising, public relations and
attendance at selected medical conferences. Sales and marketing expenses were
$1.9 million in the quarter ended June 30, 2003 and $2.0 million for the same
period in 2002. For the six months ended June 30, 2003, sales and marketing
expenses were $3.3 million and $3.9 million for the same period in 2002. Cost
reduction strategies have reduced expenses in the quarter and six months ended
June 30, 2003, as compared to the same periods in 2002.



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General and administrative expenses


General and administrative
expenses consist primarily of the cost of corporate operations and personnel,
legal, accounting and other general operating expenses of our company. General
and administrative expenses were $829,000 in the quarter ended June 30, 2003,
and $1.0 million for the same period in 2002. For the six months ended June 30,
2003, general and administrative expenses were $1.7 million, and $2.0 million
for the same period in 2002. For the six months ended June 30, 2003,
amortization of stock-based compensation was $6,000, and $186,000 for the same
period in 2002. We have similarly implemented cost reduction strategies in the
general and administrative area, but decreased spending has been offset by
expense increases for the relocation of our new CEO, in the amount of $190,000
for the six months ended June 30, 2003.

Interest Income, net


During the quarter ended
June 30, 2003, compared to the quarter ended June 30, 2002, net interest income
decreased by $137,000. For the six months ended June 30, 2003, compared to the
same period in 2002, net interest income decreased by $320,000. The decrease was
due to a cash and investment decrease of approximately $13.9 million, and a
decrease in investment yields from approximately 4% to 2%. Interest expense was
not material for any period presented.

## LIQUIDITY AND
CAPITAL RESOURCES

At June 30, 2003, we had
$18.7 million in working capital and our primary source of liquidity was $17.5
million in cash and cash equivalents and marketable securities, compared to
$24.8 million and $23.0 million as of December 31, 2002, respectively, with an
additional $528,000 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 12 months, 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 $6.0 million in the six month period ended June 30, 2003, and
$7.4 million for the same period in 2002. Our loss for the first six months of
2003 was $6.8 million, compared to a loss of $8.1 million for the same period in
2002. Due to various cost reduction strategies, our operating expenses for the
six months ended June 30, 2003 have decreased by $1.8 million, as compared to
the same period in 2002, and this cash savings was offset by the decrease in
interest income of $320,000 and a decrease in sales of $239,000 over the same
periods.

Cash provided by investing
activities was $5.9 million in the six months ended June 30, 2003, which
consisted primarily of proceeds from net maturities and sales of marketable
securities, and was reduced by investment in property and equipment of $111,000.
As of June 30, 2003, we had no material commitments for capital expenditures.
For the six months ended June 30, 2002, net cash provided by investing
activities was $7.3 million, which consisted primarily of proceeds from net
maturities and sales of marketable securities, reduced by investment in property
and equipment of $195,000.

Cash provided by financing
activities was $272,000 in the six months ended June 30, 2003, related to the
financing of our business insurance in the amount of $309,000 and sales of stock
through employee stock compensation plans of $49,000, offset by payments of
notes payable in the amount of $86,000. For the same period in 2002, cash
provided by financing activities was $163,000, primarily related to sales of
stock in the amount of $152,000 and net payments on notes payable of $81,000
offset by net payment of notes receivable of $92,000.



-14-




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We lease office, research
and development, and manufacturing space under noncancelable operating leases
expiring in September 2003, with future minimum payments due of $138,000. In
July 2003, we signed a 38 month, noncancelable operating lease for new office,
research and development, and manufacturing space, which will commence on
September 1, 2003. Rental rates for the new lease are 60% of the expiring lease,
and provide 60% additional space. Future minimum payments under this new lease
are as follows:

Remainder of 2003

$
2004


3092005


3772006


318Total future minimum operating lease payments

$
1,004


We will incur capital
expenditures during fiscal 2003 related to our move to new facilities in the
third quarter of the year. 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.

In August 2002, we
announced that our Board of Directors had authorized a stock repurchase program
permitting the purchase of up to 1,000,000 shares of our Common Stock in open
market transactions at prices deemed appropriate by management, and administered
pursuant to Rule 10b-18 of the Securities Exchange Act of 1934. We have not
repurchased any shares in 2003.

## Recent
Accounting Pronouncements

In May 2003, the FASB
issued SFAS No 150. Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. SFAS No. 150 requires that
certain financial instruments, which under previous guidance could be accounted
for as equity, be classified as liabilities in the statement of financial
position. SFAS 150 is effective for financial instruments entered into or
modified after May 31, 2003. We do not expect the adoption of SFAS 150 to have a
significant impact on our financial statements.

## 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 2002, $15.4 million in 2001, $15.8 million in 2000,
and $6.8 million for the six months ended June 30, 2003. As of June 30, 2003, we
had an accumulated deficit of approximately $70.6 million. 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, however sales of our products have been below our
expectations and it is possible that we will never generate significant revenues
from product sales. Even if we do achieve significant revenues from our product
sales, we expect to incur significant net losses for the foreseeable future and
these losses may increase. It is possible that we will never achieve profitable
operations.



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

Domestic disposable sales
continue to lag, primarily due to difficulties encountered by our physician
customers in easily obtaining reimbursement for the Stretta procedure on a
case-by-case basis. Our strategies of pursuing state-by-state and also selected
national reimbursement coverage, focusing on promoting repeat catheter sales 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, but there can be no assurance that
this will occur.

Although the Center for
Medicare and Medicaid Services (CMS) granted a new specific APC Code,
designating higher facility reimbursement levels for the Stretta Procedure for
Medicare purposes on October 1, 2001, there is no assurance that local Medicare
or private payers will pay for this procedure. 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 payers 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
payers may refuse to provide reimbursement for the cost of the Stretta Procedure
or may reimburse at levels that are not acceptable to providers. Some payers may
refuse adequate reimbursement even upon publication of peer-reviewed data. If
users of our products cannot obtain sufficient reimbursement from health care
payers for the Stretta Procedure or the Stretta System disposables, then it is
unlikely that our products will ever achieve significant market acceptance. The
Secca Procedure has not yet received any coding decision and there is little
data yet regarding the willingness of third-party health care payers 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 payers is uncertain due to factors beyond our control
and changes in third-party health care payers policies could adversely
affect our sales growth.

Even if third-party payers
provide adequate reimbursement for the Stretta Procedure, adverse changes in
third-party payers 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 payers.

For example, some health
care payers 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 payers do not adequately reimburse providers for the Stretta
Procedure and the products used with it, then our sales and revenue growth may
be limited.



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If we fail to take
adequate action to remedy problems that have adversely affected our sales and
marketing efforts 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 to materially improve our earnings. In
addition, the cost of our efforts in addressing these matters diverts resources
that could be allocated towards other efforts at increasing revenues. In the
future, we may experience similar problems and if we are unable to take
appropriate action, our results of operations and our financial performance will
be harmed.

The Stretta System is
our primary marketed product. If physicians do not 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 most
of our revenue through at least 2003. 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, generally,
physicians will not adopt 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 17 peer-reviewed journal articles and we are awaiting publication of
the Stretta randomized trial in September 2003. 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 have been negatively impacted by adverse
events which occurred early in the launch of the Stretta System. Future adverse
events or recalls would also impact future acceptance rates. Additionally, some
of our customers and potential customers also find the 45 minutes necessary to
perform a Stretta procedure to be a limiting issue, as their endoscopy unit
schedule is typically dominated by short diagnostic procedures. If we cannot
achieve increasing physician adoption rates of 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.



-17-




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

Because we have only
recently shifted our marketing strategy to reposition the Stretta product as an
alternative to anti-reflux surgery, targeting surgeons in addition to
gastroenterologists, we cannot predict the effect this shift will have on our
future sales.

Because we are a young
company, we are determining how best to market our Stretta System. We initially
focused our marketing efforts toward gastroenterologists, but have recently
shifted toward selling to general surgeons. There can be no assurance that this
will result in increased sales.

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. Our primary competitors are large medical device
manufacturers such as Ethicon Endosurgical and United States Surgical,
manufacturers of instrumentation for anti-reflux surgery, and C.R. Bard, which
manufactures an endoscopic sewing device for GERD. Other large, established
companies have products that may, in the future, provide competition for the
Stretta Procedure. These include injectable products for the treatment of GERD,
one developed by Boston Scientific, which has a recently been approved by the
FDA, and another developed by Medtronic, which is still at an experimental
stage. Other competitive devices may be developed.

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

| |  |  | Existing anti-reflux surgical
procedures and devices for the treatment of GERD;                                                                             
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | Established reputations
within the surgical and gastroenterological community;                                                                              
| |  |  | Established distribution networks that permit these companies to introduce new
products and have such products accepted by the physician community promptly;
| |  |  | Established relationships with health care providers and payers that can be used
to facilitate reimbursement for new treatments; and                        
| |  |  | Greater resources for
product development and sales and marketing.                                                                                          



-18-




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We do not feel that we
compete directly with large pharmaceutical companies, such as AstraZeneca,
Takeda Abbott Pharmaceutical, Wyeth Laboratories and Eisai, because candidate
patients for Stretta have, by definition, failed, or only partially responded
to, drug therapy. However, these companies have an established relationship with
the gastroenterology community and generate over $6 billion in annual U.S.
revenues from the proton pump inhibitor drug class. We could be adversely
affected if one or more pharmaceutical companies elects to market aggressively
against our product, or if a new, more effective, pharmaceutical product is
developed. For example, AstraZeneca has developed a new proton pump inhibitor,
Nexium, for the treatment of GERD, which doctors may prescribe in lieu of
recommending the Stretta Procedure. Further, less expensive, generic drugs have
been introduced to treat GERD as AstraZenecas patent for Prilosec, the
leading prescription medication for the treatment of GERD, expired in 2001. 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 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, 2003, we relied on eight direct sales
employees to sell our Stretta System in the United States. In quarter ended June
30, 2003, we added a new sales channel by engaging on 14 Manufacturers
Representative firms, which added 37 salespeople to sell and market our products
across the United States. The success of this new sales channel will depend upon
a number of factors, many of which are beyond our control, including the
willingness of such distributors to prioritize the sale of our products, and
their effectiveness in such sales efforts. We have also hired additional senior
sales staff to manage these distributors, which will increase our operating
expenses.

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.                                                     

Our failure to adequately
address these risks will harm our ability to sell our products.

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.

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.



-19-




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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. In February 2003, we
voluntarily recalled a limited number of our catheters, which contained
non-conforming material. This material formed part of the catheter shaft and
showed a tendency to degrade over time. The problem was identified, corrected,
and the outside vendor was changed. If the material were to fail during use,
there would be a remote possibility of superficial injury to the patients
esophageal or pharyngeal lining. No injuries have been reported and all unused
catheters in the affected lots have been recovered.

We may encounter
difficulties and delays in manufacturing our products for the following
additional reasons:

| |  |  | We have limited
experience manufacturing our products in compliance with the FDAs Quality
System Regulation;                                                                          
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | Some of the electronic components used for manufacturing
our products could become obsolete and require a design modification and qualification
to accommodate any change in materials;
| |  |  | We have one supply source
for the peristaltic pump and would need time to locate and qualify a new pump
supplier;                                                                      
| |  |  | Some of the components and materials necessary for manufacturing our
products are currently provided by a single and/or sole supplier; and                                             
| |  |  | To increase our manufacturing output significantly, we will have to attract and
retain qualified employees for assembly and testing operations.                                        

Due to the termination of
the lease for our current facilities, we will relocate in August to a new
building. Although we believe that these new manufacturing facilities are
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. We cannot provide any assurance that we will be able
to establish high volume manufacturing or, if established, that we will be able
to manufacture our products in high volumes with commercially acceptable yields.
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.



-20-




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If our suppliers or we
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. Our first QSR inspection was in March
2001, and we recently were inspected in July 2003. There were no significant
findings from either inspection. 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.

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.



-21-




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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.

To date we have
international distribution agreements for Europe, Asia, and South Africa. 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;                                      
| |  |  | Shipping delays; and                                                    
| |  |  | Longer payment cycles.                                                  



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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 may 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 substantial damage awards against us. For
example, we are currently a party to four 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, and we re-evaluate annually whether we need to obtain additional
product liability insurance. 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. Our product liability insurance carrier has filed a
civil action against us asking for recision of coverage as it relates to one of
our product liability lawsuits. 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. If the carriers suit
is successful, we could be required to pay any judgment rendered against us in,
or any amounts in settlement of, the underlying product liability action,
without the aid of 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, 2003, we had
49 issued or allowed U.S. patents and 32 pending U.S. patent applications; this
includes 22 issued U.S. patents and 14 pending U.S. patent applications licensed
in from third-parties. In addition, as of June 30, 2003, we had six patent
applications pending in the European Patent Office and two patent applications
pending in the Japanese Patent Office. Curon owns all of these applications. 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.



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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 substantial damage awards.

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.

Due to our failure in
meeting the NASDAQ continued listing standards, we are now listed on the
lesser-known NASDAQ SmallCap Market. This may adversely affect our ability to
raise capital.

During the quarter ended
September 30, 2002, our stock began trading under $1.00. The continued listing
standards for inclusion of our stock on the NASDAQ National Market, required
that our stock not close below $1.00 for 30 consecutive trading days. As we
could not meet this standard, we chose to move our listing to the NASDAQ
SmallCap Market. The move to the NASDAQ SmallCap Market could adversely affect
the liquidity and price of our stock. As a result, there may be less demand for
our stock and we may be unable to raise sufficient capital to fund our
operations.



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Within the next two
years, we may have to raise additional funds to continue operations, or sell the
company. The terms of either transaction may not be favorable to our
stockholders.

Within the next two years
we expect we will raise additional funds through the issuance of equity or debt
securities, or a combination thereof, in the public or private markets in order
to continue operations, or sell the company. Additional financing and merger
opportunities may not be available, or if available, may not be on favorable
terms. The availability of financing or merger opportunities will depend, in
part, on market conditions, which have been depressed as of late. Any future
equity financing would result in substantial dilution to our stockholders. If we
raise additional funds by issuing debt, we may be subject to limitations on our
operations, through debt covenants or other restrictions.

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 employees, which
includes 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, our stock price is depressed and the results of
our operations have been less successful than anticipated. This history of
performance may make it difficult to attract and retain 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 acquirers common stock. The intent of these rights is to
force a potential acquirer to negotiate with the Board to increase the
consideration paid for our stock. The existence of this plan, however, may deter
a potential acquirer, 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.



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## 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.

## Item
4.  Controls and Procedures

(a)  Evaluation of disclosure
controls and procedures.

Our management evaluated, with the participation of our
Chief Executive Officer and our Chief Financial Officer, the effectiveness of
our disclosure controls and procedures as of the end of the period covered by
this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief
Executive Officer and our Chief Financial Officer have concluded that our
disclosure controls and procedures are effective to ensure that information we
are required to disclose in reports that we file or submit under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in Securities and Exchange Commission rules and forms.

(b)  Changes in internal control
over financial reporting.

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

## PART
II    OTHER INFORMATION

## Item 1.   Legal
Proceedings

In June 2001, a civil
action was filed against us in the United States District Court, Western
District of Kentucky, Louisville Division, in which the plaintiff alleges 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.
Plaintiff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. Plaintiff was a subject in a randomized
clinical trial and had been provided with an approved Informed Consent form and
counseling by the physician. Prior to treatment, Plaintiff provided consent to
proceed. Plaintiff is seeking a trial by jury and unspecified damages. The trial
date is currently set in August 2004. We believe Plaintiffs claim is
without merit.

In June 2002, a civil
action was filed against a number of defendants, including Curon, 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 been provided with an approved
Informed Consent form and counseling by the physician. Prior to treatment, the
subject provided consent to proceed. Additional defendants include the treating
physician, the associated medical institution whom, 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. Although the
case was moved to the United States District Court for the Eastern District of
Pennsylvania, it has since been moved back to State Court on appeal. The Company
believes Plaintiffs claim against the Company is without merit.



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In February 2003, a civil
action was filed against us in the District Court of Dallas County, in the State
of Texas, alleging that the plaintiff sustained serious injuries during a
Stretta Procedure performed in February 2001, caused by the device being in a
defective condition. Since the original filing, both the treating physician and
his institution have been added to the complaint. Plaintiff alleges that the
procedure caused damaging atrial fibrillation and severe esophageal burns
despite a contradicting physician report filed at the time of the procedure. We
believe Plaintiffs claim to be without merit.

In April 2003, a civil
action was filed against us in United States District Court for the Northern
District of California by Federal Insurance Corporation, our insurance carrier,
for rescission, reformation, and restitution in connection with the our
liability insurance policy. This policy covers, among other things, product
liability claims made against us by people treated with our product. Because the
carrier seeks to rescind the policy, an adverse outcome of this litigation could
have a material adverse impact on the Company in part due to the June 2002
Pennsylvania suit described above, which is currently being defended by Federal
Insurance. We believe the claims by Federal Insurance are without merit and we
are preparing our defense of the matter.

In September 2001, a civil
action was filed 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 the plaintiff sustained injury when undergoing a
procedure utilizing the Stretta System, caused by defects in design and
manufacture. This matter was amicably resolved in July 2003 without material
financial impact on Curon.

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

We held an annual meeting
on May 9, 2003. The first item of business was the election of one Class I
director, and two Class III directors. The nominees were elected were Larry C.
Heaton II as Class I director and Michael Berman and Fred L. Brown as Class III
directors. All nominees were elected by a majority of votes present at the
meeting as follows:

Name

ClassFor

Votes

Votes WithheldLarry C. Heaton II

I

13,106,925

138,855Michael Berman

III

13,106,925

138,855Fred L. Brown

III

13,106,925

138,855


The appointment of
PricewaterhouseCoopers, LLP as our independent accountants for the year ended
December 31, 2003, was ratified with 13,237,352 votes in favor, 7,127 against
and 1,300 abstentions. There were no votes withheld.

## Item
5.   Other Information

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.



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## Item
6.   Exhibits and Reports on Form 8-K

(a)  Exhibits.

|Exhibit
Number |  | Description                                                                                                                                                      
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1           |  | Chief Executive Officer's Certification Pursuant to 15 U.S.C. Section 7241                                                                                       
|              
|31.2           |  | Chief Financial Officer's Certification Pursuant to 15 U.S.C. Section 7241                                                                                       
|              
|32.1           |  | Certificate of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002
|              
|32.2           |  | Certificate of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002

(b)  Reports on Form 8-K.

During
the quarter ended June 30, 2003, we filed a Current Report on Form 8-K dated
April 17, 2003, reporting under Items 7 and 9 the issuance of a press release
(Exhibit 99.1 to such filing) announcing the results for the quarter ended March
31, 2003.



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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 8, 2003 | By:                
|                     |                    
|                     |                    
|                     | By:                
|                     |