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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 MARCH 31, 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 Rule 12b-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 May 12, 2006, 43,351,027 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 March 31, 2006 and December 31, 2005                          |  | 3   
|           |  |                       | 
|           |  |                       |  | Condensed Consolidated Statements of Operations for the three month periods ended March 31, 2006 and 2005 |  | 4   
|           |  |                       | 
|           |  |                       |  | Condensed Consolidated Statements of Cash Flows for the three month periods ended March 31, 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                     |  | 11  
|           |  |                       | 
|           |  | Item 3.               |  | Quantitative and Qualitative Disclosures of Market Risk                                                   |  | 15  
|           |  |                       | 
|           |  | Item 4.               |  | Controls and Procedures                                                                                   |  | 15  
|           |  |                      
|PART II.   |  | OTHER INFORMATION     |  |                                                                                                          
|           |  |                       | 
|           |  | Item 1.               |  | Legal Proceedings                                                                                         |  | 16  
|           |  |                       | 
|           |  | Item 1A.              |  | Risk Factors                                                                                              |  | 16  
|           |  |                       | 
|           |  | Item 6.               |  | Exhibits                                                                                                  |  | 23  
|           | 
|SIGNATURES |  | 23                   



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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)



|                                           |  |                |          |   |                   |   |          |  
|------------------------------------------ |  | -------------- | -------- | - | ----------------- | - | -------- | -
|                                           |  | March 31, 2006 |          |   | December 31, 2005 |  
|Assets                                     |  |                |          |   |                   |   |          |  
|Current assets:                            |  |                |          |   |                   |   |          |  
|Cash and cash equivalents                  |  | $              | 2,652    |   |                   | $ | 2,819    |  
|Marketable securities                      |  |                |         |   |                   |   | 500      |  
|Accounts receivable, net                   |  |                | 421      |   |                   |   | 747      |  
|Inventories, net                           |  |                | 608      |   |                   |   | 879      |  
|Notes receivable                           |  |                | 928      |   |                   |   |         |  
|Prepaid expenses and other current assets  |  |                | 971      |   |                   |   | 903      |  
|                                           |  |                |          |   |                   |   |          |  
|Total current assets                       |  |                | 5,580    |   |                   |   | 5,848    |  
|                                           |  |               
|Property and equipment, net                |  |                | 241      |   |                   |   | 300      |  
|Other assets                               |  |                | 259      |   |                   |   | 267      |  
|                                           |  |                |          |   |                   |   |          |  
|Total assets                               |  | $              | 6,080    |   |                   | $ | 6,415    |  
|                                           |  |                |          |   |                   |   |          |  
|Liabilities and Stockholders Equity       |  |                |          |   |                   |   |          |  
|Current liabilities:                       |  |                |          |   |                   |   |          |  
|Accounts payable                           |  | $              | 543      |   |                   | $ | 685      |  
|Accrued liabilities                        |  |                | 581      |   |                   |   | 987      |  
|Notes payable                              |  |                |         |   |                   |   | 64       |  
|                                           |  |                |          |   |                   |   |          |  
|Total current liabilities                  |  |                | 1,124    |   |                   |   | 1,736    |  
|Warrant liability                          |  |                | 1,557    |   |                   |   | 2,379    |  
|Other                                      |  |                | 55       |   |                   |   | 71       |  
|                                           |  |                |          |   |                   |   |          |  
|Total liabilities                          |  |                | 2,736    |   |                   |   | 4,186    |  
|                                           |  |               
|Contingencies and commitments (Note 5)     |  |                |          |   |                   |   |          |  
|                                           |  |               
|Stockholders equity:                      |  |                |          |   |                   |   |          |  
|Common stock                               |  |                | 43       |   |                   |   | 43       |  
|Additional paid-in capital                 |  |                | 108,183  |   |                   |   | 107,982  |  
|Accumulated deficit                        |  |                | (104,648 | ) |                   |   | (105,562 | )
|Treasury stock                             |  |                | (234     | ) |                   |   | (234     | )
|                                           |  |                |          |   |                   |   |          |  
|Total stockholders equity                 |  |                | 3,344    |   |                   |   | 2,229    |  
|                                           |  |                |          |   |                   |   |          |  
|Total liabilities and stockholders equity |  | $              | 6,080    |   |                   | $ | 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 EndedMarch 31, |       
|                                                              |  | 2006                                |        |   | 2005 |  
|Revenues                                                      |  | $                                   | 536    |   |      | $ | 857    |  
|Cost of goods sold                                            |  |                                     | 669    |   |      |   | 982    |  
|                                                              |  |                                     |        |   |      |   |        |  
|Gross loss                                                    |  |                                     | (133   | ) |      |   | (125   | )
|                                                              |  |                                     |        |   |      |   |        |  
|Operating expenses:                                           |  |                                     |        |   |      |   |        |  
|Research and development                                      |  |                                     | 202    |   |      |   | 293    |  
|Clinical and regulatory                                       |  |                                     | 103    |   |      |   | 200    |  
|Sales and marketing                                           |  |                                     | 1,257  |   |      |   | 1,785  |  
|General and administrative                                    |  |                                     | 1,162  |   |      |   | 939    |  
|                                                              |  |                                     |        |   |      |   |        |  
|Total operating expenses                                      |  |                                     | 2,724  |   |      |   | 3,217  |  
|                                                              |  |                                     |        |   |      |   |        |  
|Operating loss                                                |  |                                     | (2,857 | ) |      |   | (3,342 | )
|                                                              |  |                                    
|Interest income                                               |  |                                     | 23     |   |      |   | 17     |  
|Interest expense and other income (expense), net              |  |                                     | (2     | ) |      |   | 21     |  
|Sale of intellectual property rights                          |  |                                     | 2,928  |   |      |   |       |  
|Decrease in warrant obligation                                |  |                                     | 822    |   |      |   | 338    |  
|                                                              |  |                                     |        |   |      |   |        |  
|Net income (loss)                                             |  | $                                   | 914    |   |      | $ | (2,966 | )
|                                                              |  |                                     |        |   |      |   |        |  
|Net income (loss) per share, basic and diluted                |  | $                                   | 0.02   |   |      | $ | (0.12  | )
|                                                              |  |                                     |        |   |      |   |        |  
|Shares used in computing net income (loss) per share, basic   |  |                                     | 43,351 |   |      |   | 24,810 |  
|                                                              |  |                                     |        |   |      |   |        |  
|Shares used in computing net income (loss) per share, diluted |  |                                     | 43,463 |   |      |   | 24,810 |  
|                                                              |  |                                     |        |   |      |   |        |  

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 Three Months Ended,March 31, |      
|                                                                                     |  | 2006                                 |       |   | 2005 |  
|Cash Flows From Operating Activities                                                 |  |                                      |       |   |      |   |        |  
|Net income (loss)                                                                    |  | $                                    | 914   |   |      | $ | (2,966 | )
|Adjustments to reconcile net income (loss) to net cash used in operating activities: |  |                                      |       |   |      |   |        |  
|Depreciation and amortization                                                        |  |                                      | 65    |   |      |   | 75     |  
|Non-cash portion of gain on sale of IP, net                                          |  |                                      | (928  | ) |      |   |       |  
|Decrease of warrant obligation                                                       |  |                                      | (822  | ) |      |   | (338   | )
|Stock-based compensation expense                                                     |  |                                      | 201   |   |      |   | (11    | )
|Amortization of premium on securities, net                                           |  |                                      |      |   |      |   | 28     |  
|Changes in current assets and liabilities:                                           |  |                                      |       |   |      |   |        |  
|Accounts receivable, net                                                             |  |                                      | 326   |   |      |   | 19     |  
|Inventories, net                                                                     |  |                                      | 271   |   |      |   | (86    | )
|Prepaid expenses and other current assets                                            |  |                                      | (68   | ) |      |   | 304    |  
|Other assets                                                                         |  |                                      | 8     |   |      |   | 31     |  
|Accounts payable                                                                     |  |                                      | (141  | ) |      |   | (45    | )
|Accrued liabilities                                                                  |  |                                      | (406  | ) |      |   | 71     |  
|Other long-term liabilities                                                          |  |                                      | (16   | ) |      |   | (1     | )
|                                                                                     |  |                                      |       |   |      |   |        |  
|Net cash used in operating activities                                                |  |                                      | (596  | ) |      |   | (2,919 | )
|                                                                                     |  |                                      |       |   |      |   |        |  
|Cash Flows From Investing Activities                                                 |  |                                      |       |   |      |   |        |  
|Purchase of property and equipment                                                   |  |                                      | (7    | ) |      |   | (35    | )
|Proceeds from maturities of marketable securities                                    |  |                                      | 500   |   |      |   | 5,500  |  
|                                                                                     |  |                                      |       |   |      |   |        |  
|Net cash provided by investing activities                                            |  |                                      | 493   |   |      |   | 5,465  |  
|                                                                                     |  |                                      |       |   |      |   |        |  
|Cash Flows From Financing Activities                                                 |  |                                      |       |   |      |   |        |  
|Principal payments on notes payable                                                  |  |                                      | (64   | ) |      |   | (57    | )
|Exercise of stock options and ESPP                                                   |  |                                      |      |   |      |   | 45     |  
|                                                                                     |  |                                      |       |   |      |   |        |  
|Net cash used in financing activities                                                |  |                                      | (64   | ) |      |   | (12    | )
|                                                                                     |  |                                      |       |   |      |   |        |  
|Net (decrease) increase in cash and cash equivalents                                 |  |                                      | (167  | ) |      |   | 2,534  |  
|Cash and cash equivalents at beginning of period                                     |  |                                      | 2,819 |   |      |   | 374    |  
|                                                                                     |  |                                      |       |   |      |   |        |  
|Cash and cash equivalents at end of period                                           |  | $                                    | 2,652 |   |      | $ | 2,908  |  
|                                                                                     |  |                                      |       |   |      |   |        |  
|Supplemental disclosure of significant non cash operating activities:                |  |                                      |       |   |      |   |        |  
|Sale of intellectual property rights                                                 |  | $                                    | 928   |   |      | $ |       |  

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 March 31, 2006 the Company had cash and cash equivalents on hand of $2.7 million, working capital of $4.5 million, and an accumulated deficit of approximately
$104.6 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 our 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 our 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 third 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.

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.



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##### Table of Contents

The following table sets forth the computation of basic and diluted net income (loss) per share for the
three months ended March 31, 2006 and 2005.



|                                                         |  |                                      |        |      |   |        |  
|-------------------------------------------------------- |  | ------------------------------------ | ------ | ---- | - | ------ | -
|                                                         |  | For the Three Months Ended
March 31, |       
|                                                         |  | 2006                                 |        | 2005 |  
|Net income (loss)                                        |  | $                                    | 914    |      | $ | (2,966 | )
|                                                         |  |                                      |        |      |   |        |  
|Shares used to compute basic net income (loss) per share |  |                                      | 43,351 |      |   | 24,810 |  
|Dilutive potential common shares:                        |  |                                      |        |      |   |        |  
|Stock options                                            |  |                                      | 112    |      |   |       |  
|                                                         |  |                                      |        |      |   |        |  
|Shares used to compute diluted net income per share      |  |                                      | 43,463 |      |   | 24,810 |  
|                                                         |  |                                      |        |      |   |        |  
|Basic net income (loss) per share                        |  | $                                    | 0.02   |      | $ | (0.12  | )
|                                                         |  |                                      |        |      |   |        |  
|Diluted net income (loss) per share                      |  | $                                    | 0.02   |      | $ | (0.12  | )
|                                                         |  |                                      |        |      |   |        |  

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 Three Months Ended
March 31,
|                                               |  | 2006                                 |  | 2005 
|Shares issuable through ESPP                   |  |                                     |  | 44   
|Shares issuable upon exercise of stock options |  | 5,552                                |  | 3,380
|Shares issuable upon exercise of warrants      |  | 10,884                               |  | 1,475
|                                               |  |                                      |  |      
|Total                                          |  | 16,436                               |  | 4,899
|                                               |  |                                      |  |      

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 first quarter of fiscal 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.

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.



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##### Table of Contents

Changes in product warranty obligations, including separately priced extended warranty obligations, for
the three months ended March 31, 2006 and 2005 are as follows:



|                                                                         |  |                                      |    |   |      |   |    |  
|------------------------------------------------------------------------ |  | ------------------------------------ | -- | - | ---- | - | -- | -
|                                                                         |  | For the Three Months Ended
March 31, |   
|                                                                         |  | 2006                                 |    |   | 2005 |  
|Balance as of the beginning of the period                                |  | $                                    | 98 |   |      | $ | 83 |  
|Add:  Accruals for warranties issued                                     |  |                                      | 1  |   |      |   | 6  |  
|Less:  Settlements made                                                  |  |                                      |   |   |      |   |   |  
|Revenue recognized under separately priced extended warranty
obligations |  |                                      | (2 | ) |      |   | (2 | )
|                                                                         |  |                                      |    |   |      |   |    |  
|Balance of the end of the period                                         |  | $                                    | 97 |   |      | $ | 87 |  
|                                                                         |  |                                      |    |   |      |   |    |  

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 months ended March 31, 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 months ended March 31, 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 first quarter of fiscal 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.

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



|                                                                    |  |                                   |    
|------------------------------------------------------------------- |  | --------------------------------- | ---
|                                                                    |  | Three Months Ended March 31, 2006
|Cost of sales                                                       |  | $                                 | 2  
|Research and development                                            |  |                                   | 48 
|Clinical and regulatory                                             |  |                                   | 3  
|Sales and marketing                                                 |  |                                   | 72 
|General and administrative                                          |  |                                   | 76 
|                                                                    |  |                                   |    
|Share-based compensation expense before taxes                       |  | $                                 | 201
|Related income tax benefits                                         |  |                                   |   
|Effect of share-based compensation on net income                    |  | $                                 | 201
|                                                                    |  |                                   |    
|Share-based compensation expense per basic and diluted common share |  | $                                 |   
|                                                                    |  |                                   |    

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 March 31, 2006, total unamortized stock-based
compensation cost related to non-vested stock options was $603,000 net of expected forfeitures, which is expected to be recognized over a weighted period of 0.8 years.



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##### Table of Contents

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 2,679,000 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 March 31, 2006, there were 5,950,091 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 16th 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 15,000 shares of common stock at fair market value on the date of grant as well as an annual grant of options to purchase 15,000 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.



|                         |  |                                      |   |  |      |  
|------------------------ |  | ------------------------------------ | - |  | ---- | -
|                         |  | For the Three Months Ended
March 31, |  
|                         |  | 2006                                 |   |  | 2005 |  
|Expected volatility      |  | 105                                  | % |  | 110  | %
|Risk-free interest rate  |  | 4.8                                  | % |  | 4.0  | %
|Expected life (in years) |  | 5.5                                  |   |  | 4.0  |  
|Expected dividend yield  |  |                                     |   |  |     |  



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##### Table of Contents

A summary of option activity under our plan as of March 31, 2006 is presented below:



|                                 |  |        |   |  |                                 |      |                                                   |      |                           |   |   
|-------------------------------- |  | ------ | - |  | ------------------------------- | ---- | ------------------------------------------------- | ---- | ------------------------- | - | --
|                                 |  | Shares |   |  | Weighted Average Exercise Price |      | Weighted Average Remaining Contractual Term
(Yrs) |      | Aggregate Intrinsic Value
|Outstanding at December 31, 2005 |  | 5,826  |   |  | $                               | 1.16 |                                                   |      |                           |   |   
|Granted                          |  | 100    |   |  |                                 | 0.43 |                                                   |      |                           |   |   
|Exercised                        |  | (2     | ) |  |                                 | 0.19 |                                                   |      |                           |   |   
|Forfeited/Expired                |  | (260   | ) |  |                                 | 1.21 |                                                   |      |                           |   |   
|                                 |  |        |   |  |                                 |      |                                                   |      |                           |   |   
|Outstanding at March 31, 2006    |  | 5,664  |   |  | $                               | 1.15 |                                                   | 8.03 |                           | $ | 14
|                                 |  |        |   |  |                                 |      |                                                   |      |                           |   |   
|Exercisable at March 31, 2006    |  | 2,285  |   |  | $                               | 2.0  |                                                   | 6.31 |                           | $ | 14
|                                 |  |        |   |  |                                 |      |                                                   |      |                           |   |   

The weighted average grant-date fair value of options granted during the quarters ended
March 31, 2006 and 2005 were $0.43 per share and $1.23 per share. The total intrinsic value of options exercised during the quarters ended March 31, 2006 and 2005 were $1 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).

The following table illustrates the pro forma net income and earnings per share for the three months ended March 31, 2005 as if
compensation expense for stock options issued to employees had been determined consistent with SFAS No. 123:



|                                                                         |  |                                   |        |  
|------------------------------------------------------------------------ |  | --------------------------------- | ------ | -
|                                                                         |  | Three Months Ended March 31, 2005 |       
|Net loss, as reported                                                    |  | $                                 | (2,966 | )
|Less: stock based compensation expense determined under fair value based |  |                                   | (186   | )
|                                                                         |  |                                   |        |  
|Net loss - SFAS 123 adjusted                                             |  | $                                 | (3,152 | )
|                                                                         |  |                                   |        |  
|Net loss per share  as reported  Basic and diluted                     |  | $                                 | (0.12  | )
|                                                                         |  |                                   |        |  
|Net loss per share  SFAS 123 adjusted  Basic and diluted               |  | $                                 | (0.13  | )
|                                                                         |  |                                   |        |  

NOTE 3 INVENTORIES



|                |  |               |     |                  |   |    
|--------------- |  | ------------- | --- | ---------------- | - | ---
|                |  | March 31,2006 |     | December 31,2005
|Inventories:    |  |               |     |                  |   |    
|Raw materials   |  | $             | 403 |                  | $ | 494
|Work-in-process |  |               | 15  |                  |   | 69 
|Finished goods  |  |               | 190 |                  |   | 316
|                |  |               |     |                  |   |    
|                |  | $             | 608 |                  | $ | 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



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##### Table of Contents

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 $2,928,000 has been recognized in the quarter ended March 31, 2006. The resulting discount of approximately $80,000 is being accreted as an addition to interest 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 May 12, 2006, the Company entered into a license agreement with Novasys Medical, Inc. Pursuant to the
agreement, the Company granted a worldwide, exclusive license 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 to Novasys Medical, Inc. in
exchange for $650,000.

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 16, 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 FDA, clearance in April 2000 for the treatment of gastroesophageal reflux disease, or GERD, which affects approximately 15 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 March 31, 2006, we have sold 353 control modules and approximately more than 9,000
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
(formerly and clinically 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



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##### Table of Contents

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 and who are not candidates for or amenable to surgery. We undertook a limited test launch of Secca in June 2002, and fully launched the product commercially in May 2003. As of March 31, 2006,
we have sold 57 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 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 up to 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, 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 APC and CPT1 codes and our Secca procedure an APC code. We believe that a Level I CPT code for the Secca procedure will be effective either from January 1,
2007, or January 1, 2008 depending upon the timing of meeting of 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 March 31, 2006, we had cash and cash equivalents on hand of $2.7 million and working capital of $4.5 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. 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 third quarter of 2006. This raises substantial doubt about our ability to
continue as a going concern.

Our sales have declined substantially during the three months ended March 31, 2006 compared to the same
period in 2005. We believe that the decline in sales is in part due to our recent outsourcing of the manufacturing of our disposable products and the inability of the outsourced supplier to deliver adequate quantities of disposable products.
$106,000 of decline was attributable to the inability of the outsourced vendor to produce sufficient quantities to fill certain of our orders and $215,000 was attributable to the decrease in unit sales.

RESULTS OF OPERATIONS

Periods of three months ended
March 31, 2006 and 2005.

Revenues

Our revenues are comprised of sales of our Stretta and Secca generators and disposable devices. Revenues for the quarter ended March 31, 2006 were $536,000, compared to $857,000 for the same quarter in 2005. The
decrease compared to 2005 was due primarily to a decline in sales of our Stretta System products of $167,000, and Secca System products of $155,000. In the first quarter of 2006, Stretta System products accounted for $315,000, or 59% of the
quarters revenues, and Secca System products accounted for $210,000, or 39%, of the quarters revenues. In the first quarter of 2005, Stretta System products accounted for $483,000, or 57% of



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the quarters revenues, and Secca System products were $365,000, or 43%, of the quarters revenues. The Stretta
Control Module and Catheter accounted for $21,000, or 7%, and $274,000, or 87%, respectively, of the Stretta product line sales for the quarter ended March 31, 2006, compared to $103,000, or 21%, and $341,000, or 71%, respectively, for the same
period in 2005. The Secca Control Module and Hand-pieces accounted for $42,000, or 20%, and $160,000, or 76%, respectively, of the Secca product line sales for the quarter ended March 31, 2006, compared to $92,000 or 25%, and $261,000, or 71%,
respectively, for the same period in 2005. International sales accounted for $155,000 in the quarter ended March 31, 2006, compared to $135,000 in the same quarter 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 $313,000, or 32%, to $669,000 in the quarter ended March 31, 2006 compared to $982,000 for the same period in 2005. This decrease is attributable to two factors: a decrease in unit sales volume
and 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. The decrease in sales resulted in a 41% reduction in direct cost of sales and 59% of the reduction in indirect expenses related to the outsourcing of our disposable products. 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. Research and development expenses were $202,000 for the three months ended March 31, 2006, a decrease of $91,000 or 31% from research and development expenses of $293,000 for the three months ended March 31, 2005.
The decrease in spending for the three months ended March 31, 2006 was due primarily to the reduced spending in our research and development department. Stock-based compensation expense related to research and development was approximately
$48,000 in the first quarter of 2006 and $0 in the first quarter of 2005. The increase in stock-based compensation expense related to research and development was due to our adoption of SFAS 123(R) 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 $103,000 for the three months ended March 31, 2006, a decrease of $97,000 or 49% over clinical and regulatory expenses of $200,000 for the three months ended March 31, 2005. The decrease in
spending for the three months ended March 31, 2006 was due primarily to the reduced headcount in our clinical and regulatory department, as compared to the first quarter of 2005. Stock-based compensation expense related to clinical and
regulatory expense was approximately $3,000 in the first quarter of 2006 and ($9,000) in the first quarter of 2005. The increase in stock-based compensation expense related to clinical and regulatory was due to our adoption of SFAS 123(R) 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 March 31,
2006 were $1,257,000, a decrease of $528,000 or 30% over sales and marketing expenses of $1,785,000 for the three months ended March 31, 2005. The decrease of $447,000 from 2005 to 2006 was primarily attributable to reduced headcount in our
sales and marketing department and a reduction of commission expenses due to lower sales. We also reduced our spending on consulting, travel, trade shows and recruitment in the first quarter 2006 compared to 2005. Sales and marketing expenses will
fluctuate primarily as a result of both commission expenses that are related to sales levels and timing of various medical conferences that we attend. Stock-based compensation expense related to sales and marketing expenses was $72,000 in the first
quarter of 2006 and ($2,000) in the first quarter of 2005. The increase in stock-based compensation expense related to sales and marketing was due to our adoption of SFAS 123(R) 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 March 31, 2006 were
$1,162,000, an increase of $223,000 or 24% over general and administrative expenses of $939,000 for the three months ended March 31, 2005. The increase 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



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##### Table of Contents

compensation expense related to general and administrative was $76,000 in the first quarter of 2006 and $0 in the first
quarter of 2005. The increase in stock-based compensation expense related to general and administrative was due to our adoption of SFAS 123(R) in the first quarter of 2006.

Interest income, net

During the quarter ended March 31, 2006, compared to the quarter
ended March 31, 2005, net interest income increased by $6,000. The increase was due to an average cash and investment decrease of approximately $1.4 million, partially offset by an increase in investment yields to approximately 4.5% from 2.4%.
Interest expense was not material for either period.

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 $80,000 is being accreted as an addition to income over
the term of note.

Decrease in warrant obligation

Our sale of 18,445,078 newly issued shares on April 8 and June 3, 2005 included warrants to purchase an additional 2,481,298 and 6,741,241 respectively, shares of common stock to investors and warrants to
purchase 553,352 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 4,025,000 newly issued shares on February 6, 2004, included warrants to purchase an additional 905,625 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
$4.71 to $3.85 and the number of common stock shares to purchase upon exercise of warrants increased from 905,625 to 1,107,920, 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 months ended March 31, 2006 and 2005:



|                     |  |           |     |      |   |    
|-------------------- |  | --------- | --- | ---- | - | ---
|                     |  | March 31,
|                     |  | 2006      |     | 2005
|Warrant issue dates: |  |           |     |      |   |    
|June 3, 2005         |  | $         | 608 |      | $ |   
|April 8, 2005        |  |           | 209 |      |   |   
|February 6, 2004     |  |           | 5   |      |   | 338
|                     |  |           |     |      |   |    
|                     |  | $         | 822 |      | $ | 338
|                     |  |           |     |      |   |    

LIQUIDITY AND CAPITAL RESOURCES

As of March 31, 2006, we had cash and cash equivalents on hand of $2.7 million and working capital of $4.5 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 third quarter of 2006. This raises substantial doubt about our ability to continue as a going concern.



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Cash used in operating activities was $0.6 million in the three month period ended March 31, 2006,
and $2.9 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. The decrease in cash use from
2005 to 2006 is primarily driven by cash provided by the BÂRRX license assignment, and a decrease in net loss, net of non-cash related expenses, due to our substantial reduction in cash used in sales and marketing, clinical and regulatory
spending, and staff headcount. On May 12, 2006, we entered into a license agreement with Novasys Medical, Inc. Pursuant to the agreement, we granted a worldwide, exclusive license 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 to Novasys Medical, Inc. in exchange for $650,000.

Cash provided by investing activities was $0.5 and $5.5 million in the three months ended March 31, 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 March 31, 2006, we had no material commitments for capital expenditures.

Cash used in financing activities was $64,000 in the three months ended March 31, 2006, primarily related to the payoff of a note payable to finance
insurance policies. For the same period in 2005 cash used in financing activities was $12,000, primarily related to the proceeds from the exercise of stock options offset by the payoff of a note payable to finance insurance policies.

Contractual Obligations

The following table sets
forth our contractual obligations at March 31, 2006 and the years in which such obligations are expected to be settled.



|                                 |  |      |     |      |   |       |  |   |    
|-------------------------------- |  | ---- | --- | ---- | - | ----- |  | - | ---
|                                 |  | 2006 |     | 2007 |   | Total
|Future minimum lease commitments |  | $    | 243 |      | $ | 13    |  | $ | 256
|Inventory purchase commitments   |  |      | 570 |      |   |      |  |   | 570
|                                 |  |      |     |      |   |       |  |   |    
|                                 |  | $    | 813 |      | $ | 13    |  | $ | 826
|                                 |  |      |     |      |   |       |  |   |    

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.

Recently Adopted 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.

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 March 31, 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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##### Table of Contents

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 pending in the Superior Court of the State of California in San Francisco County.

Item 1A. Risk Factors

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

As of March 31, 2006, we had cash and cash equivalents on hand of
$2.7 million and working capital of $4.5 million. We believe that our cash balances will not be sufficient to fund planned expenditures in the third 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 third 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 not in compliance with
the minimum bid price requirement of the Nasdaq Capital Market. We will consequently be delisted on or after May 11, 2006. This may adversely affect trading in our stock and our ability to raise capital.

We have failed to comply with the minimum $1.00 per share bid price requirement for continued listing on the Nasdaq Capital Market. The Nasdaq staff has
notified us that we have until May 11, 2006 to demonstrate compliance with the minimum bid price requirement, or the Nasdaq staff will provide notification that our stock will be delisted. We have not taken any action to remedy this deficiency.
Consequently, we will receive a notice of delisting on May 11, 2006, we may appeal the decision but there are no assurances we will pursue an appeal or that we will be successful in remaining listed. If we are ultimately delisted, trading in
our common stock could be subject to the so-called penny stock rules that impose additional sales practice and market making requirements on broker-dealers who sell and/or make a market in those securities. Consequently, removal from the
Nasdaq Capital Market, if it were to occur, could affect the ability or willingness of broker-dealers to sell and/or make a market on our common stock and the ability of purchasers of our common stock to sell their securities in the secondary
market. These rules could further limit the market liquidity of our common stock. Upon delisting from the Nasdaq Capital Market, our stock price is likely to decline significantly.

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 $566,000. 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 $852,000. 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 March 31, 2006, we had an accumulated deficit of approximately $104.6 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 32. 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.

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



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$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 either from January 1, 2007, or January 1, 2008, depending upon the timing of 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 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.

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

We
received clearance from the FDA for the use of the 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. However, if longer-term patient studies or clinical experience indicate that treatment with the Secca System does not
provide patients with sustained benefits or that treatment with our product is less effective or less safe than our current data suggests, our sales could decline and we could be subject to significant liability. Further, we may find that our data
is not substantiated in studies involving more patients, in which case we may never achieve significant revenues or profitability. If patient studies or clinical experience do not meet our expectations regarding the benefits of the Secca System, our
expected revenues from this product may never materialize.



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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. Currently we rely on a limited number of direct sales representatives for the sale of our products in the United States. We also deploy an indirect sales channel of a
limited number of manufacturers representatives firms who we use to cover, in general, less populated areas of the United States. 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 a sufficient number of qualified sales people with the skills and understanding to sell the Stretta and Secca Systems effectively;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



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



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

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

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

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



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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.

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.



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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 intellectual property rights to the same extent as the laws of the United States. If our
intellectual property rights do not adequately protect our commercial products, our competitors could develop new products or enhance existing products to compete more directly and effectively with us and harm our product sales and market position.

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



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

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

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

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

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

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 6. Exhibits

(a) Exhibits.



|            |  |                                                                                                                                                  
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                      
|3.3(1)      |  | Amended and Restated Certificate of Incorporation.                                                                                               
|            | 
|3.4(1)      |  | Bylaws of the registrant.                                                                                                                        
|            | 
|3.5(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.                                
|            | 
|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.
|--- | ------------------------------------------------------------------------------------------------------------

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: May 15, 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)



23