##### 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, 2006

OR



| ̈ | TRANSITION 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. Employer Identification No.)

46117 Landing Parkway

Fremont, CA 94538

(Address of principal executive offices, including zip
code)

(510) 661-1800

(Registrants telephone number, including area code)



---

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of
accelerated filer and large accelerated filer in Rule12b-2 of the Exchange Act).

Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer   x

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

As of July 28, 2006, 10,837,733 shares of the
Registrants Common Stock were outstanding.



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##### Table of Contents

CURON MEDICAL, INC.

INDEX



|           |  |                       |  |                                                                                                                  |  |     
|---------- |  | --------------------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----
|           |  |                       |  |                                                                                                                  |  | Page
|PART I.    |  | FINANCIAL INFORMATION |  |                                                                                                                 
|           |  |                       | 
|           |  | Item 1.               |  | Financial Statements (unaudited)                                                                                 |  |     
|           |  |                       | 
|           |  |                       |  | Condensed Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005                                  |  | 3   
|           |  |                       | 
|           |  |                       |  | Condensed Consolidated Statements of Operations for the three and six month periods ended June 30, 2006 and 2005 |  | 4   
|           |  |                       | 
|           |  |                       |  | Condensed Consolidated Statements of Cash Flows for the six month periods ended June 30, 2006 and 2005           |  | 5   
|           |  |                       | 
|           |  |                       |  | Notes to Condensed Consolidated Financial Statements                                                             |  | 6   
|           |  |                       | 
|           |  | Item 2.               |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                            |  | 12  
|           |  |                       | 
|           |  | Item 3.               |  | Quantitative and Qualitative Disclosures of Market Risk                                                          |  | 17  
|           |  |                       | 
|           |  | Item 4.               |  | Controls and Procedures                                                                                          |  | 17  
|           |  |                      
|PART II.   |  | OTHER INFORMATION     |  |                                                                                                                 
|           |  |                       | 
|           |  | Item 1.               |  | Legal Proceedings                                                                                                |  | 18  
|           |  |                       | 
|           |  | Item 1A.              |  | Risk Factors                                                                                                     |  | 18  
|           |  |                       | 
|           |  | Item 4.               |  | Submission of Matters to a Vote of Security Holders                                                              |  | 25  
|           |  |                       | 
|           |  | Item 6.               |  | Exhibits                                                                                                         |  | 25  
|           |  |                      
|SIGNATURES |  |                       |  | 26                                                                                                              



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##### Table of Contents

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

CURON MEDICAL, INC.

Condensed Consolidated Balance Sheets

(Unaudited, in thousands)



|                                                                                                                                                                                                                                          |  |              |          |   |                  |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                                                                                                                          |  | June 30,2006 |          |   | December 31,2005 |  
|Assets                                                                                                                                                                                                                                    |  |              |          |   |                  |   |          |  
|Current assets:                                                                                                                                                                                                                           |  |              |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                                                                                                                 |  | $            | 1,659    |   |                  | $ | 2,819    |  
|Marketable securities                                                                                                                                                                                                                     |  |              |         |   |                  |   | 500      |  
|Accounts receivable, net of allowance for doubtful accounts of $146 and $96 respectively                                                                                                                                                  |  |              | 765      |   |                  |   | 747      |  
|Inventories, net of reserves of $29 and $23 respectively                                                                                                                                                                                  |  |              | 483      |   |                  |   | 879      |  
|Notes receivable                                                                                                                                                                                                                          |  |              | 951      |   |                  |   |         |  
|Prepaid expenses and other current assets                                                                                                                                                                                                 |  |              | 919      |   |                  |   | 903      |  
|                                                                                                                                                                                                                                          |  |              |          |   |                  |   |          |  
|Total current assets                                                                                                                                                                                                                      |  |              | 4,777    |   |                  |   | 5,848    |  
|                                                                                                                                                                                                                                          |  |             
|Property and equipment, net                                                                                                                                                                                                               |  |              | 182      |   |                  |   | 300      |  
|Other assets                                                                                                                                                                                                                              |  |              | 233      |   |                  |   | 267      |  
|                                                                                                                                                                                                                                          |  |              |          |   |                  |   |          |  
|Total assets                                                                                                                                                                                                                              |  | $            | 5,192    |   |                  | $ | 6,415    |  
|                                                                                                                                                                                                                                          |  |              |          |   |                  |   |          |  
|Liabilities and Stockholders Equity                                                                                                                                                                                                      |  |              |          |   |                  |   |          |  
|Current liabilities:                                                                                                                                                                                                                      |  |              |          |   |                  |   |          |  
|Accounts payable                                                                                                                                                                                                                          |  | $            | 591      |   |                  | $ | 685      |  
|Accrued liabilities                                                                                                                                                                                                                       |  |              | 671      |   |                  |   | 987      |  
|Notes payable                                                                                                                                                                                                                             |  |              | 263      |   |                  |   | 64       |  
|                                                                                                                                                                                                                                          |  |              |          |   |                  |   |          |  
|Total current liabilities                                                                                                                                                                                                                 |  |              | 1,525    |   |                  |   | 1,736    |  
|                                                                                                                                                                                                                                          |  |             
|Warrant obligation                                                                                                                                                                                                                        |  |              | 389      |   |                  |   | 2,379    |  
|Other                                                                                                                                                                                                                                     |  |              | 32       |   |                  |   | 71       |  
|                                                                                                                                                                                                                                          |  |              |          |   |                  |   |          |  
|Total liabilities                                                                                                                                                                                                                         |  |              | 1,946    |   |                  |   | 4,186    |  
|                                                                                                                                                                                                                                          |  |             
|Contingencies and commitments (Note 5)                                                                                                                                                                                                    |  |              |          |   |                  |   |          |  
|                                                                                                                                                                                                                                          |  |             
|Stockholders equity:                                                                                                                                                                                                                     |  |              |          |   |                  |   |          |  
|Preferred stock, $0.001 par value; 5,000,000 shares authorized at June 30, 2006 and December 31, 2005, respectively, no shares
issued and outstanding at June 30, 2006 and December 31, 2005.                                             |  |              |         |   |                  |   |         |  
|Common stock, $0.001 par value; 100,000,000 shares authorized at June 30, 2006 and December 31, 2005; 10,837,733 and 43,349,465
shares issued and outstanding at June 30, 2006 (unaudited) and December 31, 2005, (audited) respectively. |  |              | 11       |   |                  |   | 43       |  
|Additional paid-in capital                                                                                                                                                                                                                |  |              | 108,392  |   |                  |   | 107,982  |  
|Accumulated deficit                                                                                                                                                                                                                       |  |              | (104,923 | ) |                  |   | (105,562 | )
|Treasury stock, 81,333 and 325,335 shares at June 30, 2006 and December 31, 2005, respectively, held at cost                                                                                                                              |  |              | (234     | ) |                  |   | (234     | )
|                                                                                                                                                                                                                                          |  |              |          |   |                  |   |          |  
|Total stockholders equity                                                                                                                                                                                                                |  |              | 3,246    |   |                  |   | 2,229    |  
|                                                                                                                                                                                                                                          |  |              |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                                                                |  | $            | 5,192    |   |                  | $ | 6,415    |  
|                                                                                                                                                                                                                                          |  |              |          |   |                  |   |          |  

See accompanying notes to condensed consolidated financial statements



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##### Table of Contents

CURON MEDICAL, INC.

Condensed Consolidated Statements of Operations

(Unaudited)

(in thousands, except
per share amounts)



|                                                                            |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|--------------------------------------------------------------------------- |  | ---------------------------------- | ------ | - | -------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                            |  | For the Three Months EndedJune 30, |        |   | For the Six Months EndedJune 30, |  
|                                                                            |  | 2006                               |        |   | 2005                             |   |        | 2006 |  |   | 2005   |  
|Revenues                                                                    |  | $                                  | 1,108  |   |                                  | $ | 1,152  |      |  | $ | 1,644  |   |  | $ | 2,009  |  
|Cost of goods sold                                                          |  |                                    | 763    |   |                                  |   | 1,013  |      |  |   | 1,432  |   |  |   | 1,995  |  
|                                                                            |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Gross margin                                                                |  |                                    | 345    |   |                                  |   | 139    |      |  |   | 212    |   |  |   | 14     |  
|                                                                            |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Operating expenses:                                                         |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Research and development                                                    |  |                                    | 141    |   |                                  |   | 301    |      |  |   | 343    |   |  |   | 594    |  
|Clinical and regulatory                                                     |  |                                    | 139    |   |                                  |   | 320    |      |  |   | 242    |   |  |   | 520    |  
|Sales and marketing                                                         |  |                                    | 1,201  |   |                                  |   | 2,509  |      |  |   | 2,458  |   |  |   | 4,294  |  
|General and administrative                                                  |  |                                    | 1,053  |   |                                  |   | 929    |      |  |   | 2,215  |   |  |   | 1,868  |  
|                                                                            |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Total operating expenses                                                    |  |                                    | 2,534  |   |                                  |   | 4,059  |      |  |   | 5,258  |   |  |   | 7,276  |  
|                                                                            |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Operating loss                                                              |  |                                    | (2,189 | ) |                                  |   | (3,920 | )    |  |   | (5,046 | ) |  |   | (7,262 | )
|                                                                            |  |                                    |        |  
|Interest income                                                             |  |                                    | 23     |   |                                  |   | 32     |      |  |   | 46     |   |  |   | 49     |  
|Change in fair value of warrant liability                                   |  |                                    | 1,168  |   |                                  |   | 153    |      |  |   | 1,990  |   |  |   | 491    |  
|Sale of intellectual property rights                                        |  |                                    | 673    |   |                                  |   |       |      |  |   | 3,601  |   |  |   |       |  
|Other income (expense), net                                                 |  |                                    | 50     |   |                                  |   | (11    | )    |  |   | 48     |   |  |   | 10     |  
|                                                                            |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss)                                                           |  | $                                  | (275   | ) |                                  | $ | (3,746 | )    |  | $ | 639    |   |  | $ | (6,712 | )
|                                                                            |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Net income (loss) per share, basic and diluted                              |  | $                                  | (0.03  | ) |                                  | $ | (0.45  | )    |  | $ | 0.06   |   |  | $ | (0.92  | )
|                                                                            |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  
|Shares used in computing net income (loss) per share, basic and diluted (1) |  |                                    | 10,838 |   |                                  |   | 8,417  |      |  |   | 10,838 |   |  |   | 7,316  |  
|                                                                            |  |                                    |        |   |                                  |   |        |      |  |   |        |   |  |   |        |  

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|(1) | On May 26, 2006, the Company effected one-for-four reverse stock split, which has been applied retroactively for all periods presented
|--- | --------------------------------------------------------------------------------------------------------------------------------------

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, |       
|                                                                                     |  | 2006                               |        |   | 2005 |  
|Cash Flows From Operating Activities                                                 |  |                                    |        |   |      |   |        |  
|Net income (loss)                                                                    |  | $                                  | 639    |   |      | $ | (6,712 | )
|Adjustments to reconcile net income (loss) to net cash used in operating activities: |  |                                    |        |   |      |   |        |  
|Depreciation and amortization                                                        |  |                                    | 125    |   |      |   | 148    |  
|Non-cash portion of gain on sale of IP, net                                          |  |                                    | (951   | ) |      |   |       |  
|Decrease of warrant liability                                                        |  |                                    | (1,990 | ) |      |   | (491   | )
|Stock-based compensation expense                                                     |  |                                    | 378    |   |      |   | (16    | )
|Amortization of premium on securities, net                                           |  |                                    |       |   |      |   | 28     |  
|Changes in current assets and liabilities:                                           |  |                                    |        |   |      |   |        |  
|Accounts receivable, net                                                             |  |                                    | (18    | ) |      |   | (121   | )
|Inventories, net                                                                     |  |                                    | 396    |   |      |   | (234   | )
|Prepaid expenses and other current assets                                            |  |                                    | (16    | ) |      |   | (120   | )
|Other assets                                                                         |  |                                    | 34     |   |      |   | 5      |  
|Accounts payable                                                                     |  |                                    | (94    | ) |      |   | 58     |  
|Accrued liabilities                                                                  |  |                                    | (316   | ) |      |   | 115    |  
|Other long-term liabilities                                                          |  |                                    | (39    | ) |      |   | (23    | )
|                                                                                     |  |                                    |        |   |      |   |        |  
|Net cash used in operating activities                                                |  |                                    | (1,852 | ) |      |   | (7,363 | )
|                                                                                     |  |                                    |        |   |      |   |        |  
|Cash Flows From Investing Activities                                                 |  |                                    |        |   |      |   |        |  
|Purchase of property and equipment                                                   |  |                                    | (7     | ) |      |   | (51    | )
|Purchase of marketable securities                                                    |  |                                    |       |   |      |   | (2,108 | )
|Proceeds from maturities of marketable securities                                    |  |                                    | 500    |   |      |   | 5,500  |  
|                                                                                     |  |                                    |        |   |      |   |        |  
|Net cash provided by investing activities                                            |  |                                    | 493    |   |      |   | 3,341  |  
|                                                                                     |  |                                    |        |   |      |   |        |  
|Cash Flows From Financing Activities                                                 |  |                                    |        |   |      |   |        |  
|Proceeds from issuance of common stock and warrants, net of issuance costs           |  |                                    |       |   |      |   | 10,981 |  
|Proceeds from issuance of notes payable                                              |  |                                    | 263    |   |      |   | 675    |  
|Principal payments on notes payable                                                  |  |                                    | (64    | ) |      |   | (288   | )
|Exercise of stock options and ESPP                                                   |  |                                    |       |   |      |   | 82     |  
|                                                                                     |  |                                    |        |   |      |   |        |  
|Net cash provided by financing activities                                            |  |                                    | 199    |   |      |   | 11,450 |  
|                                                                                     |  |                                    |        |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                                 |  |                                    | (1,160 | ) |      |   | 7,428  |  
|Cash and cash equivalents at beginning of period                                     |  |                                    | 2,819  |   |      |   | 374    |  
|                                                                                     |  |                                    |        |   |      |   |        |  
|Cash and cash equivalents at end of period                                           |  | $                                  | 1,659  |   |      | $ | 7,802  |  
|                                                                                     |  |                                    |        |   |      |   |        |  
|Supplemental disclosure of significant non cash operating activities:                |  |                                    |        |   |      |   |        |  
|Sale of intellectual property rights                                                 |  | $                                  | 951    |   |      | $ |       |  

See accompanying notes to the condensed consolidated financial statements



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##### Table of Contents

CURON MEDICAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

NOTE 1 THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company

Curon Medical, Inc. (the Company) was incorporated in the State of Delaware in May 1997 as Conway-Stuart Medical Inc. and changed its name to
Curon Medical Inc., in March 2000. The Company develops, manufactures and markets proprietary products for the treatment of gastrointestinal disorders.

Going Concern

In the course of its operations, the Company has sustained operating losses and negative cash flows from
operations and expects such losses to continue in the foreseeable future. As of June 30, 2006 the Company had cash and cash equivalents on hand of $1.7 million, working capital of $3.3 million, and an accumulated deficit of approximately $104.9
million. To continue operations, the Company must raise additional funds through the issuance of equity or debt securities in the public or private markets, or sell certain of its assets. No assurance can be given that the Company will be successful
in obtaining funds from any of these transactions on acceptable terms, if at all, or if secured, that such funding would be sufficient to continue to fund its operations. In the absence of funding, the Company will be required to scale back or
terminate operations. The Company believes that its cash balances will not be sufficient to fund planned expenditures in the fourth quarter of 2006. This raises substantial doubt about the Companys ability to continue as a going concern. The
condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Basis of
Presentation

The unaudited condensed consolidated interim financial statements include the accounts of the Company and its wholly owned
subsidiaries after elimination of all intercompany balances and transactions. The Company operates in one reportable segment.

The
accompanying unaudited condensed consolidated interim 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 state 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.

The unaudited condensed consolidated
interim 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, 2005, as filed with the SEC.

Recent Developments

On May 15, 2006, the
Company received a Nasdaq Staff Determination indicating that the Company had not regained compliance with the requirements for continued listing set forth in Marketplace Rule 4310(c)(4), and that the Companys common stock was, therefore,
subject to delisting from The Nasdaq Capital Market at the opening of business on May 24, 2006. The applicable rule provides that if the closing bid price of a companys stock is below $1.00 for more than thirty consecutive trading days,
the company faces possible delisting. On May 24, 2006, the Companys common stock was delisted from the Nasdaq Capital Market and was quoted on the Pink Sheets under the symbol CRNM.PK. On July 27, 2006, the
Over-the-Counter Bulletin Board began quotation of the Companys common stock under the symbol CRNM.OB.

Reverse Stock Split

On May 26, 2006, the Company effected a one-for-four reverse stock split. The reverse stock split caused every four shares of the Companys
outstanding common stock to convert automatically into one share of common stock. As a result, upon the effective time of the stock split, the number of the Companys shares outstanding decreased to one-fourth of the number previously
outstanding and the price of the common stock immediately after the reverse stock split increased by four times. Effective upon the opening of the market on June 9, 2006, the shares of common stock were quoted on a post-split basis on the Pink
Sheets. Except as otherwise indicated, all amounts in the accompanying consolidated financial statements (except for shares of authorized common stock) have been restated to give effect to the stock split.



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##### Table of Contents

Net Income (Loss) Per Share

Basic net income (loss) per share is computed using the weighted average number of common shares outstanding for the period. Diluted net income (loss) per share is based upon the weighted average common shares
outstanding for the period plus the impact of dilutive potential common shares, including stock options using the treasury stock method.

The following table sets forth the computation of basic and diluted net income (loss) per share for the three months and six ended June 30, 2006 and 2005.



|                                              |  |                            |        |   |                          |   |        |      |  |      |        |  |   |        |  
|--------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | ---- | ------ |  | - | ------ | -
|                                              |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                              |  | 2006                       |        |   | 2005                     |   |        | 2006 |  | 2005 |       
|Net income (loss) (numerator):                |  |                            |        |   |                          |   |        |      |  |      |        |  |   |        |  
|Net income (loss)                             |  | $                          | (275   | ) |                          | $ | (3,746 | )    |  | $    | 639    |  | $ | (6,712 | )
|                                              |  |                            |        |   |                          |   |        |      |  |      |        |  |   |        |  
|Shares (denominator):                         |  |                            |        |   |                          |   |        |      |  |      |        |  |   |        |  
|Weighted average shares outstanding           |  |                            | 10,838 |   |                          |   | 8,417  |      |  |      | 10,838 |  |   | 7,316  |  
|                                              |  |                            |        |   |                          |   |        |      |  |      |        |  |   |        |  
|Net income (loss) per share-basic and diluted |  | $                          | (0.03  | ) |                          | $ | (0.45  | )    |  | $    | 0.06   |  | $ | (0.92  | )
|                                              |  |                            |        |   |                          |   |        |      |  |      |        |  |   |        |  

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:



|                                               |  |                                  |  |      
|---------------------------------------------- |  | -------------------------------- |  | -----
|                                               |  | For the Six Months EndedJune 30,
|                                               |  | 2006                             |  | 2005 
|Shares issuable through ESPP                   |  |                                 |  | 5    
|Shares issuable upon exercise of stock options |  | 1,348                            |  | 1,121
|Shares issuable upon exercise of warrants      |  | 2,721                            |  | 2,863
|                                               |  |                                  |  |      
|Total                                          |  | 4,069                            |  | 3,989
|                                               |  |                                  |  |      

Stock-Based Compensation

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment
(SFAS 123(R)), using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock-based compensation expense for the three and six month ended June 30, 2006
includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provision of SFAS No. 123,
Accounting for Stock-Based Compensation (SFAS 123). Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date fair value estimated in
accordance with the provisions of SFAS 123(R). For grants made subsequent to the adoption of FAS 123(R) stock-based compensation costs are recognized on a straight-line basis over the requisite service period of the award, which is generally the
option vesting term of four years. For grants made prior to the adoption of SFAS 123(R), the Company recognizes stock-based compensation expense using an accelerated method over the service period. Prior to the adoption of SFAS 123(R), the Company
recognized stock-based compensation expense in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). In March 2005, the Securities and
Exchange Commission (the SEC) issued Staff Accounting Bulletin No. 107 (SAB 107) regarding the SECs interpretation of SFAS 123(R) and the valuation of share-based payments for public companies. The
Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R). See Note 2 to the Condensed Consolidated Financial Statements for a further discussion on stock-based compensation.



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Product Warranty

The Company generally warrants its capital equipment 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, 2006 and 2005 are as follows:



|                                                                         |  |                                  |    |   |      |   |    |  
|------------------------------------------------------------------------ |  | -------------------------------- | -- | - | ---- | - | -- | -
|                                                                         |  | For the Six Months EndedJune 30, |   
|                                                                         |  | 2006                             |    |   | 2005 |  
|Balance as of the beginning of the period                                |  | $                                | 98 |   |      | $ | 83 |  
|Add: Accruals for warranties issued                                      |  |                                  | 1  |   |      |   | 14 |  
|Less: Settlements made                                                   |  |                                  | (1 | ) |      |   | (5 | )
|Revenue recognized under separately priced extended warranty obligations |  |                                  | (4 | ) |      |   | (4 | )
|                                                                         |  |                                  |    |   |      |   |    |  
|Balance of the end of the period                                         |  | $                                | 94 |   |      | $ | 88 |  
|                                                                         |  |                                  |    |   |      |   |    |  

NOTE 2 STOCK-BASED COMPENSATION

On January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123(R),
Share-Based Payment, which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees based on estimated fair values. SFAS No. 123(R) supersedes previous accounting
under Accounting Principles Board Opinion No. 25 (APB No.25), Accounting for Stock Issued to Employees for periods beginning in fiscal 2006. In March 2005, the SEC issued Staff Accounting Bulletin (SAB)
No. 107, providing supplemental implementation guidance for SFAS 123(R). The Company has applied the provisions of SAB No. 107 in its adoption of SFAS No. 123(R).

SFAS No. 123(R) requires companies to estimate the fair value of stock-based payment awards on the date of grant using an option pricing model.
The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods. The Company adopted SFAS No. 123(R) using the modified prospective application, which requires the
application of the standard starting from January 1, 2006, the first day of the Companys fiscal year 2006. The Companys condensed consolidated financial statements for the three and six months ended June 30, 2006 reflect the
impact of SFAS No. 123(R). Stock-based compensation expense recognized during a period is based on the value of the portion of stock-based awards that is ultimately expected to vest during the period. Stock-based compensation expense
recognized in the three and six months ended June 30, 2006 included compensation expense for (1) stock-based payment awards granted prior to, but not yet vested as of January 1, 2006, based on the fair value on the grant date
estimated in accordance with the pro forma provisions of SFAS No. 123 and (2) stock-based payment awards granted subsequent to January 1, 2006, based on the fair value on the grant date estimated in accordance with the provisions
of SFAS No. 123(R). As stock-based compensation expense recognized for the three and six month ended June 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures.
SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.



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Total share-based compensation expense, related to all of our share-based awards, recognized under SFAS
123(R) was comprised of the following:



|                                                                    |  |                                |      |                              |   |     
|------------------------------------------------------------------- |  | ------------------------------ | ---- | ---------------------------- | - | ----
|                                                                    |  | Three-monthsendedJune 30, 2006 |      | Six-monthsendedJune 30, 2006
|Cost of sales                                                       |  | $                              | 14   |                              | $ | 16  
|Research and development                                            |  |                                | 19   |                              |   | 67  
|Clinical and regulatory                                             |  |                                | 1    |                              |   | 4   
|Sales and marketing                                                 |  |                                | 62   |                              |   | 134 
|General and administrative                                          |  |                                | 81   |                              |   | 157 
|                                                                    |  |                                |      |                              |   |     
|Share-based compensation expense before taxes                       |  | $                              | 177  |                              | $ | 378 
|Related income tax benefits                                         |  |                                |     |                              |   |    
|Effect of share-based compensation on net income                    |  |                                | 177  |                              |   | 378 
|                                                                    |  |                                |      |                              |   |     
|Share-based compensation expense per basic and diluted common share |  | $                              | 0.02 |                              | $ | 0.03
|                                                                    |  |                                |      |                              |   |     

The Company has not recognized, and does not expect to recognize in the near future, any tax
benefit related to employee stock based compensation cost as a result of the full valuation allowance on the Companys net deferred tax assets and the net operating loss carryforwards. As of June 30, 2006, total unamortized stock-based
compensation cost related to non-vested stock options was $428,000 net of expected forfeitures, which is expected to be recognized over a weighted period of 0.6 years.

Stock Option Plans

During 1997, the Company adopted the 1997 Stock Plan (the 1997 Plan).
The 1997 Plan provides for the granting of stock options to employees and consultants of the Company. Options granted under the 1997 Plan may be either incentive stock options or non statutory stock options. Incentive stock options (ISO) may be
granted only to Company employees (including officers and directors who are also employees). Non statutory stock options (NSO) may be granted to Company employees, officers, directors, and consultants. The Company reserved 669,750 of common stock
for issuance under the 1997 Plan. The first options were issued in 1998. No further options will be granted under the 1997 Plan. The remaining shares reserved for issuance under this plan are being used for grant under the 2000 Stock Plan.

During 2000, the 2000 Stock Plan (the 2000 Plan) was adopted by the Board of Directors and became effective on
September 21, 2000. The terms of this plan are generally the same as under the 1997 Plan. At June 30, 2006, there were 1,487,522 shares authorized for issuance under this plan.

Under both plans, options are granted for a period of up to ten years and that (i) the exercise price of an ISO and NSO shall not be less than 100%
and 85% of the estimated fair value of the shares on the date of grant, respectively, and (ii) the exercise price of an ISO and NSO granted to a 10% shareholder shall not be less than 110% of the fair market value of the shares on the date of
grant. Options generally vest 25% one year from the vest start date and ratably over the next 36 months and expire 10 years from the date of grant.

With effect from June 16, 2004, the 2000 Stock Option Plan was amended to include each non-employee director elected to the Board of Directors for the first time following the Annual Meeting will receive upon election an initial grant
of options to purchase 3,750 shares of common stock at fair market value on the date of grant as well as an annual grant of options to purchase 3,750 shares for each year during the directors term. All of the foregoing options have a ten-year
term. The initial option grants as well as the annual grants are fully vested and immediately exercisable on the day of grant. All grants issued to outside Board members will be exercisable for up to a year from the date of such Board members
termination of service with the Company.

The fair value of each option granted is estimated on the date of grant using a Black-Scholes
option-pricing model that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of the Companys common stock for the previous five years. The expected term of options granted is based on
the simplified method in accordance with the SECs Staff Accounting Bulletin No. 107 (SAB 107) as our historical share option exercise experience does not provide a reasonable basis for estimation. The risk-free interest rates
are based on the U.S. Treasury yield for a period consistent with the expected term of the option in effect at the time of the grant.



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|                         |  |                            |   |  |                          |   |  |      |   |  |      |  
|------------------------ |  | -------------------------- | - |  | ------------------------ | - |  | ---- | - |  | ---- | -
|                         |  | Three Months EndedJune 30, |   |  | Six Months EndedJune 30, |  
|                         |  | 2006                       |   |  | 2005                     |   |  | 2006 |   |  | 2005 |  
|Expected volatility      |  | 117                        | % |  | 100                      | % |  | 110  | % |  | 100  | %
|Risk-free interest rate  |  | 5.1                        | % |  | 3.7                      | % |  | 4.9  | % |  | 3.7  | %
|Expected life (in years) |  | 5.0                        |   |  | 3.8                      |   |  | 5.3  |   |  | 3.8  |  
|Expected dividend yield  |  |                           |   |  |                         |   |  |     |   |  |     |  

A summary of option activity under our plan as of June 30, 2006 is presented below:



|                                 |  |        |   |  |                              |      |                                               |      |                         |  
|-------------------------------- |  | ------ | - |  | ---------------------------- | ---- | --------------------------------------------- | ---- | ----------------------- | -
|                                 |  | Shares |   |  | WeightedAverageExercisePrice |      | WeightedAverageRemainingContractualTerm (Yrs) |      | AggregateIntrinsicValue
|Outstanding at December 31, 2005 |  | 1,456  |   |  | $                            | 4.64 |                                               |      |                         |  
|Granted                          |  | 40     |   |  |                              | 1.27 |                                               |      |                         |  
|Exercised                        |  |       |   |  |                              |     |                                               |      |                         |  
|Forfeited / Expired              |  | (148   | ) |  |                              | 4.48 |                                               |      |                         |  
|                                 |  |        |   |  |                              |      |                                               |      |                         |  
|Outstanding at June 30, 2006     |  | 1,348  |   |  |                              | 4.56 |                                               | 7.74 |                         | 
|                                 |  |        |   |  |                              |      |                                               |      |                         |  
|Exercisable at June 30, 2006     |  | 640    |   |  |                              | 7.22 |                                               | 6.35 |                         | 
|                                 |  |        |   |  |                              |      |                                               |      |                         |  

The weighted average grant-date fair value of options granted during the six months ended
June 30, 2006 and 2005 were $1.27 per share and $2.78 per share. The total intrinsic value of options exercised during the six months ended June 30, 2006 and 2005 were $0 and $139.

Prior to the adoption of SFAS No. 123(R), the Company accounted for stock-based awards to employees using the intrinsic value method in
accordance with APB No. 25, as allowed under SFAS No. 123, Accounting for Stock-Based Compensation. Under the intrinsic value method, no stock-based compensation expense for employee stock options had been recognized in
the Companys consolidated statements of operations because the exercise price of the Companys stock options granted to employees equaled the fair market value of the underlying stock at the date of grant. In accordance with the modified
prospective transition method the Company used in adopting SFAS No. 123(R), the Companys results of operations prior to fiscal 2006 have not been restated to reflect, and do not include, the impact of SFAS No. 123(R).



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The following table illustrates the pro forma net loss and earnings per share for the three and six
months ended June 30, 2005 as if compensation expense for stock options issued to employees had been determined consistent with SFAS No. 123:



|                                                                         |  |                                |        |   |                              |   |        |  
|------------------------------------------------------------------------ |  | ------------------------------ | ------ | - | ---------------------------- | - | ------ | -
|                                                                         |  | Three-monthsendedJune 30, 2005 |        |   | Six-monthsendedJune 30, 2005 |  
|Net loss as reported                                                     |  | $                              | (3,746 | ) |                              | $ | (6,712 | )
|Less: stock-based compensation expense determined under fair value based |  |                                | (225   | ) |                              |   | (411   | )
|                                                                         |  |                                |        |   |                              |   |        |  
|Net loss -SFAS adjusted                                                  |  | $                              | (3,971 | ) |                              | $ | (7,123 | )
|                                                                         |  |                                |        |   |                              |   |        |  
|Net loss per share - as reported - Basic and diluted                     |  | $                              | (0.45  | ) |                              | $ | (0.92  | )
|                                                                         |  |                                |        |   |                              |   |        |  
|Net loss per share - SFAS 123 adjusted - Basic and diluted               |  | $                              | (0.47  | ) |                              | $ | (0.97  | )
|                                                                         |  |                                |        |   |                              |   |        |  

NOTE 3 INVENTORIES



|                |  |              |     |                  |   |    
|--------------- |  | ------------ | --- | ---------------- | - | ---
|                |  | June 30,2006 |     | December 31,2005
|Inventories:    |  |              |     |                  |   |    
|Raw materials   |  | $            | 281 |                  | $ | 494
|Work-in-process |  |              | 33  |                  |   | 69 
|Finished goods  |  |              | 169 |                  |   | 316
|                |  |              |     |                  |   |    
|                |  | $            | 483 |                  | $ | 879
|                |  |              |     |                  |   |    

NOTE 4 NOTE RECEIVABLE

On March 16, 2006, the Company entered into an assignment and license agreement with BARRX Medical, Inc. of Sunnyvale, California. Pursuant to the terms of the agreement, the Company granted BÂRRX an
assignment of United States Patent No. 6,872,206 and a worldwide, exclusive license of certain patents pertaining to methods and/or apparatuses, including ablation devices, sizing balloons and generators, for the BÂRRX field of use,
primarily the treatment of Barretts esophagus. In exchange for the agreement, the Company received $2.0 million in cash and a $1.0 million non-interest bearing note payable upon the earlier of BÂRRX next equity financing or by
December 31, 2006. The note payable was discounted at a rate of 10% through December 31, 2006. A non-operating gain of $2,951,000 has been recognized for the six months ended June 30, 2006. The resulting discount of approximately
$49,000 is being accreted as an addition to income over the term of note.

NOTE 5 CONTINGENCIES

The Company is involved in routine legal and administrative proceedings that arise from the normal conduct of business. Management believes that the
ultimate disposition of these matters will not have a material adverse effect on the financial results or condition of the Company.

In
February 2006, the Company filed a suit against Woodruff-Sawyer & Co., a former insurance broker, seeking compensatory damages arising out of its failure to obtain adequate and reasonable insurance coverage for the Company, failure to
properly advise the Company in securing adequate insurance coverage and failure to tender a claim to the appropriate insurance company. The case is currently pending in the Superior Court of the State of California in San Francisco County.

NOTE 6SUBSEQUENT EVENTS

On
July 17, 2006, the Company received $1.0 million in cash as payment in full of a note payable by BARRX Medical, Inc. as more fully disclosed in Note 4 above, thereby terminating the note obligation.



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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, 2005.

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, but are not limited to, those relating to our beliefs and expectations regarding our expenses and our operating results, the mix of our sales and revenues derived from generators and handpieces, our
beliefs and expectations regarding our future sales, our beliefs concerning our cash position and our anticipated cash needs; and the timing and extent of any reimbursement approval. These forward-looking statements involve risks and uncertainties.
The cautionary statements set forth below and those contained in Risk Factors, commencing on page 18, identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking
statements.

Overview

We were
incorporated in Delaware in May 1997 as Conway-Stuart Medical Inc. and changed our name to Curon Medical Inc., in March 2000. 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.

Our first product, the Stretta system, received United
States Food and Drug Administration, or FDA, clearance in April 2000 for the treatment of gastroesophageal reflux disease, or GERD, which affects approximately 19 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 addresses GERD symptoms, our Stretta system
applies radiofrequency energy to treat the causes of GERD. The Stretta system consists of a disposable catheter with needle electrodes and our 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 heat, causing tissue contraction and creating thermal lesions that resorb
over time, resulting in improved sphincter function. Clinical studies show a significant reduction in GERD symptom scores, esophageal acid exposure, and use of anti-secretory medications.

We commercially launched the Stretta system in May 2000. As of June 30, 2006, we have sold 366 control modules and estimate that, based on the
quantity of catheters both sold and used in clinical trials, some 10,000 patients have been treated with the Stretta procedure.

Our second
product, the Secca system, is a radiofrequency energy-based system for the treatment of bowel incontinence (also referred to as fecal incontinence). Bowel 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. Using the Secca system, physicians deliver radiofrequency energy to the sphincter muscle in the anal canal. Clinical studies have shown a reduction
in bowel incontinence symptoms and improvement in general quality of life. 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. We undertook a limited test launch of Secca in June 2002, and fully launched the product commercially in May 2003. As of June 30, 2006, we have sold 61 control modules and estimate that,
based on the quantity of handpieces both sold and used in our clinical trials, some 1,600 patients have been treated with the Secca procedure.

We have a direct sales force and independent representatives to market and sell our products in the United States. We market the Stretta system as an alternative to anti-reflux surgery, primarily to high volume general surgeons and
gastroenterologists. In the United States, we estimate that there are approximately 4,500 general surgeons and 7,000 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 1,200 colon and rectal surgeons and over 3,000 general surgeons that routinely perform colorectal surgery in the United States.

Our Stretta system has also received regulatory approval in the European Union under their Medical Device Directive, or MDD, from the Therapeutic Goods
Administration in Australia and the Canadian Standards Administration in Canada. We incorporated a subsidiary in Belgium in November 2000 to manage distribution and provide training in Europe, the Middle East and Africa. We have entered into
international distribution agreements in the following countries presented in alphabetical order, all of which cover the sale of both Stretta and Secca products: Argentina, Austria, Belgium, Brazil, China (PRC), China (Republic of), China (Hong
Kong), Costa Rica, Denmark, Egypt, Finland, France, Germany, Greece, India, Indonesia, Ireland, Israel, Italy, Japan,



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Malaysia, The Netherlands, Norway, Philippines, Poland, Portugal, Singapore, South Africa, Saudi Arabia, South Korea,
Spain, Sweden, Switzerland, Thailand, Turkey, United Arab Emirates, United Kingdom and Vietnam. Some agreements cover more than one country. From time to time national distributors are replaced or terminated and there may be times when we may have
no representation in one or more of the above countries. Regulatory controls in certain countries prevent sales being made until the distributor completes the approval process. We are organized into a single reportable segment consisting of the
development, manufacture, marketing and sale of proprietary products for the treatment of gastrointestinal disorders. We use one measure of profitability and do not disaggregate our business for internal reporting.

In the United States, the Center for Medicare and Medicaid Studies, CMS, has issued our Stretta procedure both an APC and a Level 1CPT code and our Secca
procedure an APC code. We believe that a Level I CPT code for the Secca procedure will be effective January 1, 2008 depending upon meeting the necessary pre-conditions. Reimbursement for our international business varies by country.

Significant Business Trends

We have incurred
losses every year since we began operations. We have generated limited revenues, and it is possible that we will never generate significant revenue from our product sales. As of June 30, 2006, we had cash and cash equivalents on hand of $1.7
million and working capital of $3.3 million. To continue operations, we must raise additional funds through the issuance of equity or debt securities in the public or private markets, or sell certain of our assets. There are no assurances that we
can be successful in raising additional funds. Any future equity financing could 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. In the absence of additional funding, we will be required to scale back or cease operations. We believe that our cash balances will not be sufficient to fund planned expenditures in the fourth quarter of 2006. This
raises substantial doubt about our ability to continue as a going concern.

Our sales have declined during the three and six months ended
June 30, 2006 compared to the same periods in 2005. We believe that the decline in sales is in part due to the inability of our outsourced supplier to deliver adequate quantities of disposable products during the first quarter of 2006 and in
other part due to decline in unit sales during the first and second quarter of 2006.

One of our key contract manufactures experienced a
delay in its ISO re-certification process, which consequently caused the delay of our own ISO re-certification. Our ISO certification lapsed on July 31, 2006. We are in the process of re-certification. We presently expect to be re-certified by
September 2006, but there are no assurances that the re-certification will occur in a timely manner. Prior to re-certification, we may continue to fulfill orders from customers within any of the 25 European Union member countries using inventory
manufactured prior to the lapse of our certification. We presently expect to be able to fulfill demand from customers in the European Union in the near future using our existing certified inventory.

Recent Developments

On May 15, 2006, we
received a Nasdaq Staff Determination indicating that we had not regained compliance with the requirements for continued listing set forth in Marketplace Rule 4310(c)(4), and that our common stock was, therefore, subject to delisting from The Nasdaq
Capital Market at the opening of business on May 24, 2006. On May 24, 2006, our common stock was delisted from the Nasdaq Capital Market and was quoted on the Pink Sheets under the stock symbol CRNM.PK. Commencing on
July 27, 2006, our share became quoted on the Over-the-Counter Bulletin Board under the stock symbol CRNM.OB.

Reverse Stock Split

On May 26, 2006, we effected a one-for-four reverse stock split. The reverse stock split caused every four shares of our outstanding common stock
to convert automatically into one share of common stock. Effective upon the opening of the market on June 9, 2006, our shares of common stock were quoted on a post-split basis on the Pink Sheets and commencing on July 27, 2006 on the
Over-the-Counter Bulletin Board. Except as otherwise indicated, all amounts in the accompanying consolidated financial statements (except for shares of authorized common stock) have been restated to give effect to the stock split.



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RESULTS OF OPERATIONS

Periods of three and six months ended June 30, 2006 and 2005.

Revenues

Our revenues are comprised of sales of our Stretta and Secca generators and disposable devices. Revenues for the quarter ended June 30, 2006 declined
by $44,000, or 4%, to $1,108,000 from $1,152,000 for the same quarter in 2005. In the second quarter of 2006, Stretta system products accounted for $719,000, or 66% of the quarters revenues, and Secca system products accounted for $376,000, or
34%, of the quarters revenues. In the second quarter of 2005, Stretta system products accounted for $593,000, or 52% of the quarters revenues, and Secca system products were $544,000, or 48%, of the quarters revenues. The Stretta
control module and catheter products accounted for $307,000, or 43%, and $389,000, or 54%, respectively, of the Stretta product line sales for the quarter ended June 30, 2006, compared to $187,000, or 32%, and $372,000, or 63%, respectively,
for the same period in 2005. The Secca control module and hand-pieces accounted for $112,000, or 30%, and $249,000, or 66%, respectively, of the Secca product line sales for the quarter ended June 30, 2006, compared to $194,000 or 36%, and
$324,000, or 59%, respectively, for the same period in 2005. International sales accounted for $481,000 in the quarter ended June 30, 2006, compared to $146,000 in the same quarter of 2005.

Revenues for the six months ended June 30, 2006 declined by $365,000, or 18%, to $1,644,000, compared to $2,009,000 for the same period in 2005. The
decrease compared to 2005 was due primarily to decreased sales of Secca system products of $322,000. Stretta system products accounted for $1,034,000, or 64%, and Secca system products $586,000, or 36% of the revenues for the six months ended
June 30, 2006, as compared to $1,061,000, or 54% and $908,000, or 46%, respectively, for the same period in 2005. The Stretta control module and catheter products accounted for $328,000, or 32%, and $663,000, or 64%, respectively, of the
Stretta system product sales for the six months ended June 30, 2006, compared to $290,000, or 27%, and $713,000, or 67%, respectively, for the same period in 2005. The Secca control module and handpieces accounted for $154,000, or 26%, and
$409,000, or 70%, respectively, of the Secca system product sales for the six months ended June 30, 2006, compared to $286,000, or 31%, and $584,000, or 64%, respectively, for the same period in 2005. International sales accounted for $636,000
in the six month ended June 30, 2006, compared to $281,000 in the same period of 2005.

Cost of goods sold

Our costs of goods sold represent the cost of producing generators and purchasing disposable devices. Cost of goods sold decreased $250,000, or 25%, to
$763,000 in the quarter ended June 30, 2006 compared to $1,013,000 for the same period in 2005. For the six months ended June 30, 2006, cost of goods sold were $1,432,000, a decrease of $563,000 or 28% over the cost of goods sold of
$1,995,000 for the same period in 2005. This decrease is attributable to a decrease in cost of manufacturing of our disposable products. On October 31, 2005, we entered into a contract manufacturing agreement with Life Science Outsourcing,
Inc., or LSO under which we outsource the manufacturing of our disposable products. This resulted in a decrease of 70% and 64% in indirect expenses related to the outsourcing of our disposable products for the three and six months ended
June 30, 2006, respectively compared to the same periods in 2005. Indirect expenses primarily include depreciation, rent, supplies, indirect salaries for manufacturing support personnel, and scrapped materials.

Research and development expenses

Research
and development expenses consist primarily of personnel costs, professional services, patent application and maintenance costs, materials, supplies and equipment. For the three and six months ended June 30, 2006, we reduced spending in our
research and development department activities. Research and development expenses were $141,000 for the three months ended June 30, 2006, a decrease of $160,000 or 53% from research and development expenses of $301,000 for the three months
ended June 30, 2005. For the six months ended June 30, 2006, research and development expenses were $343,000, a decrease of $251,000 or 42% over research and development expenses of $594,000 for the same period in 2005. Stock-based
compensation expense related to research and development for the three and six months ended June 30, 2006 were approximately $19,000 and $67,000, respectively and $0 in the three months and six months ended June 30, 2005. The increase in
stock-based compensation expense related to research and development was due to our adoption of SFAS 123(R) beginning in the first quarter of 2006.

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 regulatory agencies. Clinical and regulatory expenses were $139,000 for the three months
ended June 30, 2006, a decrease of $181,000 or 57% over



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clinical and regulatory expenses of $320,000 for the three months ended June 30, 2005. For the six months ended
June 30, 2006, clinical and regulatory expenses were $242,000, a decrease of $278,000 or 53% over clinical and regulatory expenses of $520,000 for the same period in 2005. The decrease in spending for the three and six months ended
June 30, 2006 was due primarily to the reduced headcount in our clinical and regulatory department combined with reduced clinical trial activity, as compared to the same periods in 2005. Stock-based compensation expense related to clinical and
regulatory expense for the three and six months ended June 30, 2006 were approximately $1,000 and $4,000, respectively and ($4,000) and ($13,000) for the same period in 2005. The increase in stock-based compensation expense related to clinical
and regulatory was due to our adoption of SFAS 123(R) beginning in the first quarter of 2006.

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 for the three months ended June 30, 2006 were $1,201,000, a decrease of $1,308,000 or 52% over sales and marketing expenses of $2,509,000 for the three months ended June 30, 2006. $469,000 of the decrease was
attributable to reduced headcount in our sales and marketing department, $344,000 of the decrease was attributable to reduced spending on trade shows and medical conferences and $224,000 of the decrease was attributable to reduced consulting and
other outside services. For the six months ended June 30, 2006, sales and marketing expenses were $2,458,000, a decrease of $1,836,000 or 43% over sales and marketing expenses of $4,294,000 for the same period in 2005. $916,000 of the decrease
was attributable to reduced headcount in our sales and marketing department, $457,000 of the decrease was attributable to reduced spending on trade shows and medical conferences and $264,000 of the decrease was attributable to reduced travel
expenses. Stock-based compensation expense related to sales and marketing expenses for the three and six months ended June 30, 2006 were approximately $62,000 and $134,000, respectively and ($1,000) and ($3,000) for the same period in 2005. The
increase in stock-based compensation expense related to sales and marketing was due to our adoption of SFAS 123(R) beginning in the first quarter of 2006.

General and administrative expenses

General and administrative expenses consist primarily of the cost of corporate
operations and personnel, legal, accounting and our other general operating expenses. General and administrative expenses for the three months ended June 30, 2006 were $1,053,000, an increase of $124,000 or 13% over general and administrative
expenses of $929,000 for the three months ended June 30, 2005. For the six months ended June 30, 2006, general and administrative expenses were $2,215,000, an increase of $347,000 or 19% over general and administrative expenses of
$1,868,000. The increase for the three and six months ended June 30, 2006 was due primarily to the costs formerly allocated to other Company functions that could no longer be so treated due to our reorganization and reduction in force. Those
costs were all allocated to our general and administrative expenses. Stock-based compensation expense related to general and administrative expense for the three and six months ended June 30, 2006 were approximately $81,000 and $157,000,
respectively and $0 in the three months and six months ended June 30, 2005. The increase in stock-based compensation expense related to general and administrative was due to our adoption of SFAS 123(R) beginning in the first quarter of 2006.

Interest income, net

During
the quarter ended June 30, 2006, compared to the quarter ended June 30, 2006, net interest income decreased by $9,000, or 28%, to $23,000, compared to $32,000 for the same period in 2005. For the six months ended June 30, 2006,
compared to the same period in 2005, net interest income decreased by $3,000, or 6% to $46,000 compared to $49,000 for the same period in 2005. The decrease in interest income is due to a decrease in total average cash and investment balance,
partially offset by an increase in investment yields to approximately 4.9% from 3.2%. Interest expense was not material for any period presented.

Decrease in warrant obligation

Our sale of 4,611,269 newly issued shares on April 8 and June 3, 2005
included warrants to purchase an additional 620,324 and 1,685,310 respectively, shares of common stock to investors and warrants to purchase 138,338 shares of common stock to our placement agent. These warrants provide for cash redemption by the
holders upon the occurrence of certain events outside our control. As a result, the aggregate fair value of the warrants of $1,430,000 and $3,325,000, respectively, determined using the Black-Scholes model, was recorded as a liability on the
issuance dates with subsequent changes to the fair value of the warrants being recorded as a non-operating item through the statement of operations.

Our sale of 1,006,250 newly issued shares on February 6, 2004, included warrants to purchase an additional 226,406 shares of common stock. In accordance with the warrant purchase agreement and following the first
closing of our 2005 financing, we notified holders of common stock warrants issued in February 2004 that the exercise price of the warrants decreased from $18.84 to $15.40



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and the number of common stock shares to purchase upon exercise of warrants increased from 226,406 to 276,980, so that
the aggregate exercise price of $4,265,494 remains unchanged. Similar to our 2005 warrants, these warrants also provide for cash redemption by the holders upon the occurrence of certain events outside our control. As a result, the aggregate fair
value of the warrants of $1,669,000, determined using the Black-Scholes model, was recorded as a liability at the time of sale with subsequent changes to the fair value of the warrants being recorded as a non-operating item through the statement of
operations.

The following table shows the decreases to the fair value of the warrant obligations recorded as a non-operating income
through the statement of operations for the three and six month ended June 30, 2006 and 2005:



|                    |  |                                   |       |      |                                 |     |      |  |      |       |  |   |     |  
|------------------- |  | --------------------------------- | ----- | ---- | ------------------------------- | --- | ---- |  | ---- | ----- |  | - | --- | -
|                    |  | For the ThreeMonths EndedJune 30, |       |      | For the SixMonths EndedJune 30, |    
|Warrant issue dates |  | 2006                              |       | 2005 |                                 |     | 2006 |  | 2005 |      
|June 3, 2005        |  | $                                 | 849   |      | $                               | (96 | )    |  | $    | 1,457 |  | $ | (96 | )
|April 8, 2005       |  |                                   | 318   |      |                                 | 189 |      |  |      | 527   |  |   | 189 |  
|February 6, 2004    |  |                                   | 1     |      |                                 | 60  |      |  |      | 6     |  |   | 398 |  
|                    |  |                                   |       |      |                                 |     |      |  |      |       |  |   |     |  
|                    |  | $                                 | 1,168 |      | $                               | 153 |      |  | $    | 1,990 |  | $ | 491 |  
|                    |  |                                   |       |      |                                 |     |      |  |      |       |  |   |     |  

Sale of intellectual property rights

On March 16, 2006, we entered into an assignment and license agreement with BÂRRX Medical, Inc. of Sunnyvale, California. Pursuant to the terms
of the agreement, we granted BÂRRX an assignment of United States Patent No. 6,872,206 and a worldwide, exclusive license of certain patents pertaining to methods and/or apparatuses, including ablation devices, sizing balloons and
generators, for the BÂRRX field of use, primarily the treatment of Barretts esophagus. As consideration for our execution of the agreement, we received $2.0 million in cash and a $1.0 million note payable upon the earlier of
BÂRRXs next equity financing or by December 31, 2006. The note payable was discounted at a rate of 10% through December 31, 2006. The resulting discount of approximately $49,000 at June 30, 2006 is being accreted as an
addition to income over the term of note. Subsequently on July 17, 2006, we received full payment against the $1.0 million note payable, thereby terminating the note agreement.

On May 12, 2006, we entered into a license agreement with Novasys Medical, Inc. Pursuant to the agreement, we granted a worldwide, exclusive license
to Novasys Medical, Inc. of United States Patent No. 6,971,395 and certain related intellectual property for use in the treatment of Genito-Urinary Conditions in males and females in exchange for $650,000.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30,
2006, we had cash and cash equivalents on hand of $1.7 million and working capital of $3.3 million. To continue operations, we must raise additional funds through the issuance of equity or debt securities in the public or private markets, or sell
certain of our assets. No assurance can be given that we will be successful in obtaining funds from any of these transactions on acceptable terms, if at all, or if secured, that such funding would be sufficient to continue to fund our operations.
Any future equity financing could 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. In the absence of
funding, we will be required to scale back or terminate operations. We believe that our cash balances will not be sufficient to fund planned expenditures in the fourth quarter of 2006. This raises substantial doubt about our ability to continue as a
going concern.

Cash used in operating activities was $1.9 million in the six month period ended June 30, 2006, and $7.4 million in
the same period in 2005. On March 16, 2006, we entered into an assignment and license agreement with BARRX Medical, Inc. of Sunnyvale, California. Pursuant to the terms of the agreement, we granted BÂRRX an assignment of United States
Patent No. 6,872,206 and a worldwide, exclusive license of certain patents pertaining to methods and/or apparatuses, including ablation devices, sizing balloons and generators, for the BÂRRX field of use, primarily the treatment of
Barretts esophagus. In exchange for the agreement, we received $2.0 million in cash and a $1.0 million note payable upon the earlier of BÂRRX next equity financing or by December 31, 2006. On July 17, 2006, we received full
payment against the $1.0 million note, thereby discharging the note. On May 12, 2006, we entered into a license agreement with Novasys Medical, Inc. Pursuant to the agreement, we granted a worldwide, exclusive license to Novasys Medical, Inc.
for United States Patent No. 6,971,395 and certain related intellectual property for use in the treatment of Genito-Urinary Conditions in males and females in exchange for $650,000. The decrease in cash used in operating activities from 2005 to
2006 is due primarily to a decrease in net loss, due to our substantial reduction in cash used in sales and marketing, clinical and regulatory spending, and reduction in staff headcount, and offset by cash provided by the BÂRRX license and
Novasys Medical, Inc. assignment.



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Cash provided by investing activities was $0.5 and $3.3 million in the six months ended June 30,
2006 and 2005 respectively, which consisted primarily of cash provided by net proceeds from net maturities of marketable securities used to fund operations partially offset by the cash used in purchase of property and equipment. As of June 30,
2006, we had no material commitments for capital expenditures.

Cash provided by financing activities was $0.2 million in the six months
ended June 30, 2006, primarily related to net cash provided by financing of business insurance. For the same period in 2005 cash provided by financing activities was $11.5 million , due to the private placement of common stock and common stock
warrants to investors in the net amount of $11.0 million, in addition to $0.1 million from exercise of stock options and the Employee Stock Purchase Plan, and net cash provided by financing of business insurance in the amount of $0.4 million.

Contractual Obligations

The following
table sets forth our contractual obligations at June 30, 2006 and the years in which such obligations are expected to be settled.



|                                 |  |      |     |      |   |       |  |   |    
|-------------------------------- |  | ---- | --- | ---- | - | ----- |  | - | ---
|                                 |  | 2006 |     | 2007 |   | Total
|Future minimum lease commitments |  | $    | 140 |      | $ | 14    |  | $ | 154
|Inventory purchase commitments   |  |      | 203 |      |   |      |  |   | 203
|                                 |  |      |     |      |   |       |  |   |    
|                                 |  | $    | 343 |      | $ | 14    |  | $ | 357
|                                 |  |      |     |      |   |       |  |   |    

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. Shares have not been
repurchased under this plan since 2002.

Recent Accounting Pronouncements

Effective January 1, 2006, we adopted SFAS 123(R), using the modified-prospective-transition method. As a result, we have included stock-based
compensation costs in its results of operations for the three months ended March 31, 2006. See Note 2 to our Condensed Consolidated Financial Statements entitled Stock-Based Compensation.

In July 2006, the FASB issued FASB Interpretation, FIN 48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement
109. FIN 48 prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file in a
particular jurisdiction. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently assessing the impact of FIN 48 on our consolidated financial position and results of operations.

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 at least
six 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

Evaluation of Disclosure Controls and Procedures. Based on their
evaluation as of June 30, 2006, our President and Chief Executive Officer and our Vice President of Finance and Chief Financial Officer, have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended) were sufficiently effective to ensure that the information required to be disclosed by us in this Quarterly Report on Form 10-Q was recorded, processed, summarized and reported within the time periods
specified in the SECs rules and instructions for Form 10-Q.



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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 Report 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 February 2006, we filed suit against Woodruff-Sawyer & Co., our
former insurance broker, seeking compensatory damages arising out of its failure to obtain adequate and reasonable insurance coverage for us, failure to properly advise us in securing adequate insurance coverage and failure to tender a claim to the
appropriate insurance company. The case is currently being heard by the Superior Court of the State of California in San Francisco County. The court is requiring the parties to mediate the case by no later then October 6, 2006. To date, the
parties have not yet entered into mediation.

Item 1A. Risk Factors

We have limited capital resources and we will need to terminate our operations by the fourth
quarter of 2006 unless we are able to raise additional funds.

As of June 30, 2006, we had cash and cash equivalents on hand of
$1.7 million and working capital of $3.3 million. We believe that our cash balances will not be sufficient to fund planned expenditures in the fourth quarter of 2006. This raises substantial doubt about our ability to continue as a going concern. We
will need to terminate our operations by the fourth quarter of 2006 unless we are able to raise additional funds through the issuance of equity or debt securities in the public or private markets, or the sale of certain of our assets. No assurance
can be given that we will be successful in obtaining funds from any of these transactions on acceptable terms, if at all, or if secured, that such funding would be sufficient to continue our operations. Any future equity financing would result in
substantial dilution to our stockholders if we were to raise adequate funds for us to maintain our operations for at least 12 months. If we raise additional funds by issuing debt, we may be subject to limitations on our operations, through debt
covenants or other restrictions. In the absence of funding, we will be required to scale back or terminate operations.

We are experiencing a delay in
our ISO re-certification. If we are not re-certified in a timely manner, we may encounter difficulty in fulfilling customer orders from European Union member countries in the future.

Our ISO certification lapsed on July 31, 2006. We are in the process of re-certification. We presently expect to be re-certified by September 2006,
but there are no assurances that re-certification will occur in a timely manner. Prior to re-certification, we may continue to fulfill orders from customers within any of the 25 European Union member countries using inventory manufactured prior to
the lapse of our certification. While we presently expect to be able to fulfill demand from customers in the European Union in the near future using our existing certified inventory, to the extent we are not re-certified in a timely manner, we will
be unable to fulfill orders from customers in European Union member countries.

Our common stock is currently traded on the over-the-counter market, and
the liquidity of our stock may be seriously limited.

We have been delisted from the Nasdaq Capital Market. Our common stock is
currently traded on the over-the-counter bulletin board. Trading on the over-the-counter bulletin board may adversely impact our stock price and liquidity, and the ability of our stockholders to purchase and sell our shares in an orderly manner.
Furthermore, the delisting of our shares could damage our general business reputation and impair our ability to raise additional funds.

We have certain
significant contractual obligations, and the payment of them in the near future will adversely affect our operations.

We have potential
obligations which are not readily apparent from our financial statements. In particular, we have offered retention bonuses to certain of our employees at the beginning of this year in the aggregate of $580,000. These bonuses are payable upon an
employees involuntary termination on or prior to December 31, 2006. In addition, we have contractual severance obligations for two of our executive officers totaling $286,000. These payments together represent a potential aggregate
obligation of $866,000. In light of our low cash balances, payment for any or all of these obligations will have a material adverse effect on our ability to continue as a going concern.



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We may never achieve or maintain significant revenues or profitability.

We have incurred losses every year since we began operations. In particular, we incurred net losses of $11.0 million in 2005, $15.3 million in 2004, and
$15.6 million in 2003. As of June 30, 2006, we had an accumulated deficit of approximately $104.9 million. 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 have generated limited revenues, and it is possible that we will never generate significant revenue from product sales. 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.

We
have recently undergone a restructuring, which could adversely impact our business.

In order to reduce our operating costs, we have
recently implemented a restructuring initiative primarily to implement the outsourcing of our disposable component manufacturing. This resulted in a significant reduction in employee headcount from 71 to 23. We entered into a contract for the
outsourced manufacturing of our disposable products. These actions significantly change our operations and could have adverse results, including:



| |  |  | Potential customers may choose not to purchase our products due to concerns over the stability of our organization;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | We may encounter difficulties in retaining key employees; and
| | - |  | -------------------------------------------------------------



| |  |  | The reduction of our operating costs may not achieve the goal of producing materially stronger financial results than we have historically experienced.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------

We have outsourced the manufacturing of our disposable products to a single contract manufacturer, and if that manufacturer is unable or unwilling to produce our
product requirements in quality and quantity to our satisfaction, our business will be harmed.

We now rely on a single contract
manufacturer to manufacture our disposable products. We have no prior history with this supplier and cannot predict how well they will perform in meeting our quality and quantity requirements. We believe that this shift away from direct
manufacturing will reduce our operating expenses, but unforeseeable difficulties in the outsourced manufacturing could negatively impact operating expense reduction expectations. Our reliance on this single contract manufacturer subjects us to a
number of risks outside of our control that could impact our ability to meet demand for our disposable products and harm our business, including:



| |  |  | Inability of our contract manufacturer to manufacture the product at the quality and quantity levels we require;
| | - |  | ----------------------------------------------------------------------------------------------------------------



| |  |  | Delays or interruption of production due to production problems; and
| | - |  | --------------------------------------------------------------------



| |  |  | Unanticipated delays in delivery by our contract manufacturer due to changes in demand from us or their other customers.
| | - |  | ------------------------------------------------------------------------------------------------------------------------

By way of illustration, during the quarter ended March 31, 2006, our contract manufacturer experienced difficulties in manufacturing disposable
products in sufficient quantities to fill certain of our orders. Consequently, we were unable to fill those orders on a timely basis which negatively impacted our revenues by approximately $106,000. There are no assurances that our contract
manufacturer will be able to consistently produce disposable products in the amount and at the time when they are needed in the future.

We
have yet to identify an alternate contract manufacturer to manufacture our disposable products. Identifying and qualifying additional or replacement contract manufacturers, if required, may not be accomplished quickly or at all and could involve
significant additional costs. Any interruption from our existing contract manufacturer would limit our ability to manufacture our disposable products and could therefore have a material adverse effect on our business, financial condition and results
of operations.

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

Our physician customers continue to encounter difficulties in readily obtaining
reimbursement for the Stretta procedure on a case-by-case basis, and this continues to impact our ability to generate revenue. We have not been successful at addressing these difficulties with 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.



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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. For 2006, the new national payment rate for the Stretta procedure is set at $1,431.39. This translates to a range of actual reimbursement amounts, depending on the geographic
adjustments, of between $1,047.49 and $2,768.74. Even with this amount it may still be difficult to convince hospitals and other health care providers to offer the Stretta procedure to their patients. Some private payers may refuse adequate
reimbursement even though significant peer-reviewed data has been published. 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 increased market acceptance.

Although the Secca procedure has been awarded an APC code by the CMS, it
has not received a CPT code and there is little data yet regarding the willingness of third-party health care payers to reimburse the costs of the procedure. While we believe that a Level 1CPT code will be issued for the Secca procedure effective
from January 1, 2008, depending upon the meeting of the necessary pre-conditions we cannot assure you that the procedure will ever be reimbursed, or that in the event there is reimbursement, that such reimbursement will be adequate. Failure to
achieve adequate reimbursement may have a serious negative effect on our ability to grow 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.

If physicians do not adopt our products, we will not achieve future sales growth.

To achieve increasing sales, our
products must continue to gain recognition and adoption by physicians who treat gastrointestinal disorders. Our products represent a significant departure from conventional treatment methods. We believe that physicians will not increase rates of
adoption of our systems unless they determine, based on published peer-reviewed journal articles, long-term clinical data and their professional experience, that our systems provide an effective and attractive alternative to conventional means of
treatment. Currently, there are over 30 peer-reviewed journal articles on the Stretta procedure, including the results of our Stretta randomized trial, and more than six peer-reviewed journal articles on the Secca procedure. Some physicians also may
be slow to adopt our products because of perceived liability risks and inadequacy of third-party reimbursement. Future adverse events or recalls could also impact future acceptance rates. Additionally, some of our customers and potential customers
also find the 30-45 minutes necessary to perform a Stretta procedure to be a limiting issue, as their endoscopy unit schedule is typically dominated by short diagnostic procedures. Finally, due to our reduced operations, especially in our sales and
marketing efforts, and the substantial doubt about our ability to continue as a going concern due to our financial condition, we may have difficulty attracting new physicians and retaining existing physicians. If we cannot achieve increasing
physician adoption rates of our products, we may never achieve significant revenues or profitability.



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If the safety and efficacy of our products is inconsistent with the safety and efficacy data presented to the FDA, our
sales could decline and we could be subject to liability.

We received clearance from the FDA for the use of our Secca system to treat
bowel 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. If subsequent longer-term patient studies or clinical experience indicate that treatment with our Secca system is less safe or less effective than the data presented to the FDA, our sales could
decline and we could be subject to significant liability.

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.

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 Endo Surgery and United States Surgical, manufacturers of instrumentation for anti-reflux surgery, and NDO Surgical, which manufactures an endoscopic sewing device
for treating GERD. Other competitive devices may be developed.

Some of these competitors are larger companies that 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.
| | - |  | ------------------------------------------------------------------

We do not feel that we compete with large pharmaceutical companies, such as AstraZeneca, Takeda Abbott Pharmaceutical, Wyeth Laboratories and Eisai, because candidate patients for Stretta are intolerant to drug
therapy or have failed, or only partially responded to, drug therapy. However, these companies have an established relationship with the gastroenterology community and generate over $12 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. These companies may also make it difficult for us
to achieve market penetration by highlighting our financial condition and the substantial doubt about our ability to continue as a going concern.

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

We have limited sales and marketing resources. For the sale of our products in the United States we rely on a limited number of direct sales representatives along with an indirect sales channel of manufacturers
representatives firms. The success of this channel will depend upon a number of factors, many of which are beyond our control. These factors include, but are not limited to, the willingness of such representatives to prioritize the sale of our
products and their effectiveness in such sales efforts.

There are significant risks involved in building and managing our sales force and
marketing our products, including our:



| |  |  | Inability to gain market acceptance of our products and technology;
| | - |  | -------------------------------------------------------------------



| |  |  | Inability to hire or engage 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
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



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| |  |  | 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.

We depend on the suppliers who provide the
materials and components used in our products, and if we lose our relationship with any individual suppliers, 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, some of which are the single and/or sole source for the components they
provide. If any of our 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. Our first QSR inspection was in March 2001, and we were also 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 appropriate corrective action in response to a QSR inspection could force a
shut-down of our manufacturing operations, a recall of our products, and potentially a revocation of the FDA 510(k) clearance of our products, which would have a material adverse effect on our product sales, revenues, 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 medical devices and are therefore subject to extensive regulation in the United States and in foreign countries where we intend to do business. Unless an exemption applies, each new Class II or III 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, or 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
ability to generate revenues and profitability from new products. We cannot assure you that the FDA will ever grant 510(k) clearance or premarket approval for any new 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 bowel 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. 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.



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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 products, 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. Though we believe these changes fall within the acceptable scope of changes allowed for Class II devices, 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.

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 various countries around the world. While we have obtained regulatory clearance to market the Stretta and Secca systems in some of the countries, or others regulatory approval is pending. 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.
| | - |  | ----------------------

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. 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, could be expensive to defend, and
could result in substantial damage awards against us. For example, we are currently a party to a product liability lawsuit 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 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.

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.

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



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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 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.

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 4. Submission of Matters to a Vote of Security Holders

We distributed our Definitive Proxy
Statement, Proxy and Annual Report to Stockholders on or about April 17, 2006 to each stockholder of record as of April 2, 2006, for our Annual Meeting of Stockholders held on June 1, 2006. At our Annual Meeting, the stockholders were
asked to consider the election of a Class III director. The nominating committee of the Board of Directors selected a nominee, incumbent director Michael Berman, who ran unopposed. The voting results with respect the election of Mr. Berman,
was:



|               |  |              |  |            
|-------------- |  | ------------ |  | -----------
|Name           |  | Votes For ** |  | Withheld **
|Michael Berman |  | 30,191,220   |  | 2,136,325  

---

|** | The numbers set forth in this column are presented on a pre split basis.
|-- | ------------------------------------------------------------------------

Item 6. Exhibits

(a) Exhibits.



|            |  |                                                                                                                                                  
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                      
|3.3(1)      |  | Amended and Restated Certificate of Incorporation.                                                                                               
|            | 
|3.4(1)      |  | Bylaws of the registrant.                                                                                                                        
|            | 
|3.6(2)      |  | Certificate of Amendment to Amended and Restated Certificate of Incorporation.                                                                   
|            | 
|4.1(1)      |  | Specimen common stock certificate of the registrant.                                                                                             
|            | 
|4.4(3)      |  | Form of Warrant to Purchase Shares of Common Stock.                                                                                              
|            | 
|4.5(4)      |  | Form of Common Stock Purchase Warrant.                                                                                                           
|            | 
|10.28(5)    |  | Assignment and License Agreement dated as of March 16, 2006 by and between the registrant and BÂRRX Medical, Inc.                                
|            | 
|10.29       |  | Assignment and License Agreement dated as of May 12, 2006 by and between the registrant and Novasys Medical, Inc.                                
|            | 
|31.1        |  | Chief Executive Officers Certification Pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|            | 
|31.2        |  | Chief Financial Officers Certification Pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|            | 
|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. 

---

|(1) | Filed as an Exhibit to Curons Registration Statement on Form S-1 (File No. 333-37866) and incorporated herein by reference.
|--- | ----------------------------------------------------------------------------------------------------------------------------

|(2) | Filed as an Exhibit to Curons report on 8-K filing on June 1, 2005, and incorporated herein by reference.
|--- | ----------------------------------------------------------------------------------------------------------

|(3) | Filed as an Exhibit to Curons report on 8-K filing on February 6, 2004, and incorporated herein by reference.
|--- | --------------------------------------------------------------------------------------------------------------

|(4) | Filed as an Exhibit to Curons report on 8-K filing on April 20, 2005, and incorporated herein by reference.
|--- | ------------------------------------------------------------------------------------------------------------

|(5) | Filed as an Exhibit to Curons report on 8-K filing on March 22, 2006, and incorporated herein by reference.
|--- | ------------------------------------------------------------------------------------------------------------



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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 11, 2006 |  | By:                              |  | /s/ LARRY C. HEATON II                                                                                                           
|                      |  |                                  |  | Larry C. Heaton II President and Chief Executive Officer (Principal Executive Officer)                                           
|                      |  |                                 
|                      |  | By:                              |  | /s/ ALISTAIR F. MCLAREN                                                                                                          
|                      |  |                                  |  | Alistair F. McLaren Vice President of Finance Chief Financial Officer and Chief Information Officer (Principal
Financial Officer)



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