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UNITED
        STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





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FORM 10-K





(Mark One)


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




| |  |  | For the fiscal year ended December 31, 2002 | 
| |  |  | ------------------------------------------- | 




OR





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




Commission file number: 000-31519





CURON MEDICAL, INC.


(Exact name of registrant as specified in its charter)





Delaware

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

(I.R.S. Employer
Identification No.)





735 Palomar Avenue


Sunnyvale, CA 94085


(Address of principal executive offices, including zip code)





(408) 733-9910


(Registrants telephone number, including area code)





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Securities registered pursuant to Section 12(b) of the Act:





Title of each class:

Name of each exchange on which registered:None

N/A





Securities registered pursuant to Section 12(g) of the Act:





Common Stock, $0.001 par value


(Title of Class)





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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants
        knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x





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





The aggregate value of stock held by non-affiliates of the registrant, based upon the closing
       sale price of the Common Stock on June 28, 2002 (which is the last business day of the registrant's most
        recently completed second fiscal quarter), as reported on the NASDAQ SmallCap Market, was
        approximately $34.4 million.





The number of shares of Common Stock outstanding as of March 12, 2003: 19,993,384 shares.





DOCUMENTS
        INCORPORATED BY REFERENCE





Items 10, 11, 12 and 13 of Part III of this Form 10-K incorporates information by reference from
        the registrants definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year.





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CURON MEDICAL, INC.





FORM 10-K





TABLE OF CONTENTS





PagePART IItem 1.

Business

1Item 2.

Properties

22Item 3.

Legal Proceedings

22Item 4.

Submission of Matters to a Vote of Security Holders

23PART IIItem 5.

Market for Registrants Common Equity and Related Stockholder Matters

24Item 6.

Selected Financial Data

26Item 7.

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

27Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

33Item 8.

Financial Statements and Supplementary Data

35Report of Independent Accountants

36Consolidated Balance Sheets at December 31, 2002 and December 31, 2001

37Consolidated Statements of Operations for each of the Three Years in the Period Ended December 31, 2002

38Consolidated Statements of Stockholders Equity (Deficit) for each of the Three Years in the Period Ended December 31, 2002

39Consolidated Statements of Cash Flows for each of the Three Years in the Period Ended December 31, 2002

40Notes to Consolidated Financial Statements

41Quarterly Results of Operations (Unaudited)

57Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

58PART IIIItem 10.

Directors and Executive Officers of the Registrant

58Item 11.

Executive Compensation

58Item 12.

Security Ownership of Certain Beneficial Owners and Management

58Item 13.

Certain Relationships and Related Transactions

58Item 14.

Controls and Procedures

59PART IVItem 15.

Exhibits, Financial Statements Schedules, and Reports on Form 8-K

60







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This Report on Form 10-K
contains certain forward-looking statements regarding future events. These
statements include statements relating to our expectations as to the timing and
success of our clinical trials and regulatory submissions, the mix of our sales
and revenues derived from generators and handpieces, the rate of growth and
success of our international sales and marketing efforts, our expectations
regarding increased operating expenses and net losses as our business expands,
the timing of new product introductions, and our ability to maintain current and
planned operations through at least the next 12 months without raising
additional funds. These forward-looking statements involve risks and
uncertainties. The cautionary statements set forth throughout this Report and,
specifically, those contained in Additional Risk Factors, commencing
on page 13, identify important factors that could cause actual results to differ
materially from those predicted in any such forward-looking statements. Such
factors include, but are not limited to, failure to obtain regulatory approvals
as anticipated, a slower rate of market acceptance of our products than
expected, increased competition, continued adverse changes in general economic
conditions in the United States and internationally, including adverse changes
in the specific markets for our products, adverse changes in customer order
patterns, pricing pressures, risks associated with foreign operations, failure
to reduce costs or improve operating efficiencies, and our ability to attract,
hire and retain key and qualified employees.

# PART I

## Item
1.   Business

## Company
Overview

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

Our first product, the
Stretta® System, received United States Food and Drug Administration
(FDA) clearance in April 2000 for the treatment of gastroesophageal
reflux disease, or GERD, which affects approximately 14 million U.S. adults on a
daily basis. In patients with GERD, acidic stomach contents reflux backward from
the stomach into the esophagus, causing a wide range of symptoms and
complications, including, most commonly, persistent heartburn and chest pain.
Unlike medication, which temporarily suppresses GERD symptoms, our Stretta
System applies radiofrequency energy to treat the causes of GERD. Our Stretta
System consists of a disposable catheter with needle electrodes and our control
module, which is a radiofrequency energy generator. Using the Stretta System,
the physician delivers temperature-controlled radiofrequency energy to the
muscle of the lower esophageal sphincter and upper portion of the stomach. The
delivery of this energy creates thermal lesions that reabsorb over time causing
tissue contraction. Clinical studies 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 December 31, 2002, we have sold 194
control modules in the United States and approximately 3,500 patients have been
treated with the Stretta Procedure.

Our second product, the
Secca® System, is a radiofrequency energy-based system for
treatment of fecal incontinence. Fecal incontinence is caused by damage to the
anal sphincter from childbirth, surgery, neurological disease, injury or age,
and affects up to 16 million adults in the United States. Using the Secca
System, physicians deliver radiofrequency energy to the muscle of the anal
canal. Clinical studies have shown a reduction in fecal incontinence symptoms
and improvement in general quality of life. In March 2002, we received 510(k)
clearance from the FDA to market the Secca System for the treatment of fecal
incontinence in patients who have failed more conservative therapies such as
diet modification and biofeedback. We launched the Secca System commercially in
June 2002.

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, there are
approximately 4,000 general surgeons and 9,000 gastroenterologists who actively
perform endoscopy. We market the Secca System primarily to colon and rectal
surgeons and to those general surgeons who perform colorectal surgery. There are
approximately 1,000 colon and rectal surgeons and up to 2,000 general surgeons
that perform colorectal surgery in the United States.



1




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Our Stretta System has
also received European, Australian and Canadian regulatory approval, and our
Secca System has also received regulatory approval in Europe. We opened an
office in Belgium in March 2001 to manage distribution of our products in
Europe. In the quarter ended December 31, 2002, we entered into distribution
agreements for the Stretta System in Switzerland, Austria, and the Netherlands,
and to date have international distribution agreements for the Stretta System in
17 countries. The Secca System will also be sold through distributors in Europe.
The first European Secca Procedures were performed in Germany, Denmark and Italy
in March 2002. We do not expect to significantly expand our sales coverage
beyond the United States and Europe before 2004.

We have recently
experienced several changes in our senior management team. In July 2002, John
Morgan resigned as the Companys President and CEO. Board member Michael
Berman became interim CEO and a search for a permanent CEO was commenced. In
July 2002, our Vice President, Sales, James Goode, and our Vice President,
Marketing, Carol Chludzinski, resigned from the Company. Larry Heaton joined the
Company as President and CEO in January 2003, and also became a member of the
Board of Directors. We are currently searching for a Vice President of Sales and
Marketing.

## Business
Strategy

Our strategy is to
establish our Stretta and Secca Systems as standard treatment options for
patients with GERD and fecal incontinence, respectively. We believe that our
products offer substantial improvements over the current treatment options in
the care of patients with either disorders.

The typical Stretta patient
has not achieved adequate symptom control on, or is intolerant of, escalated
medical therapy, or does not wish to continue indefinite anti-secretory
medication use. Until recently, the only option for these patients has been a
surgical anti-reflux procedure. We believe that the Stretta System offers
several significant benefits over anti-reflux surgery, including that it is most
commonly an outpatient procedure rather than inpatient surgery, that it is
typically performed under conscious sedation rather than general anesthesia, and
that it has a lower incidence of side effects and complications. Patients also
return to normal activities faster after the Stretta Procedure than after
anti-reflux surgery. Due to these features, the Stretta Procedure is
significantly less expensive than anti-reflux surgery, and thus insurance
companies benefit through cost savings.

The Secca Procedure offers
a treatment option for patients with fecal incontinence who have failed more
conservative therapies such as diet modification and biofeedback. Currently,
fecal incontinence patients have few treatment options. These options include
fiber therapy, anti-diarrheal medications, biofeedback therapy, and major
surgery, which may involve reconstruction of the sphincter muscle or
implantation of a continence device. These therapies have only modest
effectiveness, and we believe that there is a need for a minimally invasive
treatment option that may be offered to patients as an alternative to major
surgery. We believe that the Secca Procedure has several significant benefits
over surgery, including that it is most commonly an outpatient procedure rather
than inpatient surgery, that it is typically performed under conscious sedation
rather than general anesthesia, and that it has a lower incidence of side
effects and complications. Recovery after incontinence surgery may take several
months, whereas recovery from a Secca Procedure is significantly shorter.

We have established a
direct sales and distribution network in the United States to target the
approximately 4,000 hospital endoscopy suites and approximately 4,000 ambulatory
treatment centers. We are also developing a network of distributors in selected
European countries. In the United States, we have ten salespeople, two regional
sales managers, and three clinical applications specialists. In Europe and other
selected countries, we have distributors covering 17 countries. We may hire
additional salespeople or enter new distributor relationships to increase market
penetration of our products.

We have acquired and may
continue to acquire complementary technologies. We have a license agreement with
Gyrus Group PLC (formerly Somnus Medical Technologies, Inc) for the use of
technology related to Gyrus radiofrequency generator. We also have entered
into license agreements with the University of Kansas Medical Institute and with
Messrs. Shadduck and Baker relating to applying radiofrequency energy to tissue.
We may enter into license agreements with other persons or companies covering
technology relating to gastrointestinal tract diseases.



2




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## GERD: The
problem and conventional treatment options

GERD is the frequent
backward flow, or reflux, of stomach contents into the esophagus, the muscular
tube that connects the mouth to the stomach. In the lower part of the esophagus,
there is an area of thickened muscle known as the lower esophageal sphincter
which, when functioning properly, acts as a one-way valve, allowing food to pass
down from the esophagus into the stomach, but preventing reflux. In GERD
patients, the lower esophageal sphincter does not function properly and allows
chronic reflux to occur. Stomach acid, enzymes and bile irritate the esophagus
and cause a wide range of symptoms and complications, most commonly persistent
severe heartburn and chest pain. In some GERD sufferers, the pain is acute
enough to require an emergency room visit. People with GERD often have
difficulty sleeping due to increased reflux and heartburn when they lie down.
Also, damage to the esophagus caused by reflux may result in more serious
complications, such as erosion or ulceration of the esophagus, build-up of scar
tissue that can narrow and obstruct the esophagus, and Barretts
epithelium, a condition that increases the risk of esophageal cancer.

Prescription medication is
the primary treatment option for patients with GERD. The most widely prescribed
medications from the proton pump inhibitor drug class, such as Prilosec, have
annual U.S. sales of approximately $6 billion. Although these medications
temporarily ease heartburn symptoms by reducing stomach acid, they do not
prevent reflux or treat the underlying causes of GERD. Side effects may include
diarrhea, headaches, dizziness and nausea. Taken regularly, these medications
are expensive, costing an estimated average of $2,300 per year, based solely on
retail prices for medication requirements of the patients in our clinical trial.
Many GERD patients do not want to be dependent on medications and have
difficulty complying with prescribed lifestyle modifications that require
ongoing fundamental changes in eating, drinking and sleeping behavior.

The most common corrective
treatment for GERD is an anti-reflux surgical procedure. This inpatient surgical
procedure costs approximately $11,250, involves a prolonged recovery period, and
exposes the patient to a significant risk of serious side effects. Consequently,
physicians may be reluctant to refer otherwise healthy patients for the surgery.
An estimated 70,000 to 75,000 patients undergo anti-reflux surgery in the United
States each year, and an estimated additional 200,000 are referred for this
surgery who are either unsuitable for, or unwilling to undergo, the procedure.

## The Stretta
System: Treatment of GERD

Our proprietary Stretta System
provides physicians with the tools to perform a minimally invasive, outpatient,
and cost-effective procedure for the treatment of GERD. Unlike medication, the
Stretta Procedure treats GERD, rather than simply managing the symptoms by
inhibiting acid secretion into the stomach. Unlike anti-reflux surgery, the
Stretta Procedure is most commonly an outpatient procedure with minimal side
effects. The Stretta Procedure, which typically costs between $3,000 and $5,000,
takes less than an hour, and utilizes techniques commonly used by general
surgeons and gastroenterologists who perform endoscopy. Most treated patients
have been able to return to normal activities within one day of treatment and
reduce or eliminate medication use shortly thereafter. We believe that the
Stretta Procedures effectiveness and relatively low cost, combined with
the absence of significant discomfort and side effects, makes it a clinically
and economically attractive GERD treatment for those patients with
unsatisfactory symptom control on drugs, who are considering an anti-reflux
surgical procedure.

The Stretta System consists
of the Stretta Catheter, which is a disposable flexible catheter with needle
electrodes, and the Curon Control Module, which is a radiofrequency energy
generator. Using these devices, the physician delivers temperature-controlled
radiofrequency energy to create thermal lesions in the muscle of the lower
esophageal sphincter and upper stomach. These lesions reabsorb over several
weeks and cause tissue contraction, which increases the ability of the lower
esophageal sphincter to act as a barrier to reflux.



3




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## The Secca
System: Treatment of Fecal Incontinence

The Secca System is
designed to treat fecal incontinence, a condition that affects up to 16 million
U.S. adults. Fecal incontinence is caused by damage to the anal sphincter from
childbirth, surgery, neurological disease, injury or age. It is a life-altering
condition that, unlike GERD, lacks minimally invasive corrective treatment
alternatives. The most common treatment options control, but do not correct, the
condition, and include the use of protective undergarments, diet modification
and over-the-counter dietary supplements. Current corrective treatment options
include major surgery and are rarely utilized.

The Secca System provides a
minimally-invasive, outpatient, and cost-effective procedure for the treatment
of fecal incontinence. The Secca Procedure utilizes the same technology and
treatment concepts as the Stretta System. Using our Curon Control Module and our
handheld disposable device called the Secca Handpiece, physicians deliver
radiofrequency energy into the muscle of the anal sphincter to improve its
barrier function. We completed a U.S. clinical trial of the Secca System in
April 2001, and submitted the results to the FDA in December 2001. In March
2002, we received 510(k) clearance from the FDA to market the Secca System for
the treatment of fecal incontinence in patients who have failed more
conservative therapies such as diet modification and biofeedback.

## Product
Description

We have developed a suite
of products incorporating proprietary design features for use in the Stretta and
Secca Procedures. These products consist of a disposable catheter and a
disposable handpiece for delivery of controlled radiofrequency energy to tissue,
and a radiofrequency generator, known as the Curon Control Module. Both our
current products and products under development utilize proprietary software to
interface with our Curon Control Module.

Single-use disposable
        devices


Both the Stretta Catheter
and the Secca Handpiece are disposable products incorporating innovative designs
that enable a physician to easily access the treatment site and accurately
deliver radiofrequency energy into the tissue. Features include:

| |  |  | Four electrode needles,
which are deployed into the tissue at the treatment site for delivery of
radiofrequency energy;                                            
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | Irrigation ports located at the base of each electrode,
which deliver water to the surface tissue during treatment;                                                
| |  |  | Thermocouples
located at each needle tip and base, which provide continuous temperature
readings to the Curon Control Module, enabling precise temperature control;
| |  |  | A balloon in the Stretta Catheter, which is inflated once the Stretta Catheter
reaches the lower esophageal sphincter to maintain catheter positioning; and        
| |  |  | An illuminated clear
window in the Secca Handpiece that enables the physician to view the treatment
site.                                                          




Curon Control Module


The Stretta System and the
Secca System both incorporate our radiofrequency energy generator, the Curon
Control Module. The Curon Control Module has four channels, each of which
independently control the four needle electrodes on the Stretta Catheter and
Secca Handpiece. The generator uses continuous data feedback to achieve precise
tissue temperatures at the treatment site. The generator tracks surface tissue
temperatures from each electrode, and if temperatures at either the treatment
site or surface tissue exceed pre-set safe levels, the generator automatically
stops delivering energy to that electrode. An integrated pump delivers water to
surface tissue during the procedure. The Stretta System and the Secca System
each utilize proprietary software installed onto the Curon Control Module. The
software provides a distinct graphical user interface and the functions and
parameters that are required for the particular procedure.



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Radiofrequency energy


Our products are based on
radiofrequency energy delivery, which has a long history of use in medical
applications. Radiofrequency energy has been cleared by the FDA for many
therapies involving tissue heating, tissue remodeling and nerve pathway
interruption, including:

| |  |  | Shrinking prostatic
tissue to treat enlarged prostates;                             
| | - |  | ------------------------------------------------------------------------------------
| |  |  | Interrupting nerve pathways in the heart
to treat irregular heartbeats;             
| |  |  | Shrinking tissue in the shoulder joint to
prevent repeated shoulder dislocation; and
| |  |  | Shrinking tissue in the base of the
tongue to alleviate obstructive sleep apnea.    

## Clinical and
Regulatory Status

Stretta clinical studies


In April 2000, we received
510(k) clearance from the FDA to market the Stretta System for the treatment of
GERD. To evaluate the Stretta System, we conducted an open label multi-center
U.S. clinical trial with leading investigators at 14 institutions, in which 131
patients were treated. We measured how well the procedure eliminated the need
for heartburn medication, improved symptoms, improved quality of life, and
reduced the amount of acid detected in the esophagus. Results from the initial
47 patients treated were submitted to the FDA. Six-month data was available for
44 of the 47 treated patients because three patients did not participate in the
voluntary follow-up testing. The follow-up data indicated that the Stretta
Procedure led to significant improvement in both objective and subjective
measurements. Twelve-month data for 118 of the 131 patients was published
in Gastrointestinal Endoscopy in 2002.

Patients in our trials
experienced no persistent side effects or other significant complications during
the treatment and follow-up period. Most patients resumed normal levels of
activity on the day after treatment. A few patients reported difficulty
swallowing, increased flatulence or mild abdominal discomfort for a period of
days. These symptoms were significantly milder and shorter in duration than
those typically experienced after anti-reflux surgery.

We have conducted an
eight-center, double-blind, randomized sham-controlled trial of the Stretta
System in the United States, treating 64 patients. A paper on this trial was
presented at the Digestive Disease Week Conference in May 2002. This trial
demonstrated significant improvements in GERD symptom scores and satisfaction
that were not present in the sham (control) group. Further, there were
significant improvements in acid exposure in the Stretta treated group at 12
months. We are using the data generated for future peer-reviewed publications
and for presentations at national scientific meetings and expect that this data
will influence physician adoption rates, facilitate reimbursement approvals and
enhance marketing activity.

Secca clinical studies


In November 1999, we
conducted a pilot study at a leading medical institution in Mexico City. Ten
patients with fecal incontinence were treated with the Secca System. Two years
following the procedure, most patients showed significant improvements in fecal
incontinence symptoms, incontinence-related quality of life and general quality
of life, each as measured by validated questionnaires. We have received no
reports of persistent complications or persistent side effects. The two-year
data regarding these pilot patients was presented at the 2002 Meeting of the
American Society of Colon and Rectal Surgeons, demonstrating durability of the
effect of Secca Procedure on improving fecal incontinence symptoms.



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Based on these encouraging
preliminary results, we further evaluated the Secca System in a multi-center
U.S. clinical study involving six sites and 50 patients. The data from this
study was compiled and submitted to the FDA, and in March 2002 we received
510(k) clearance 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. The results of this clinical trial were
presented at the 2002 Meeting of the American Society of Colon and Rectal
Surgeons. The study demonstrated that the Secca Procedure resulted in
significant improvements in fecal incontinences scores, fecal incontinence
related quality of life, and general quality of life.

## Research and
Development

Our research and
development activities are conducted internally by a research and development
staff and are focused on design changes intended to reduce manufacturing cost as
well as evaluation of existing product alternatives. In addition to working on
new products, our research and development organization is developing products
and fixtures that are designed to reduce the time to manufacture, improve
quality and reduce cost of products. Our research and development expenditures
were $2.7 million in 2002, $2.8 million in 2001 and $4.2 million in 2000.
Amortization of stock-based compensation included in these numbers was $66,000
in 2002, $205,000 in 2001 and $629,000 in 2000. Pilot manufacturing costs
included in research and development were $235,000 in 2002 for the Secca System.
Stretta pre-commercialization expense was $1.1 million in 2000, representing the
cost of our entire manufacturing organization for the first five months of that
year.

## Manufacturing

We manufacture, assemble
and test our products in-house. The manufacturing process consists primarily of
assembling internally manufactured and externally purchased components and
sub-assemblies in an environmentally controlled area. After assembly, each
Stretta Catheter and Secca Handpiece are inspected and then sent out for
sterilization by a sub-contractor. We manufacture the Curon Control Module
primarily by in-house assembly and testing of components ordered from outside
manufacturers.

In December 2000, we
voluntarily withdrew certain of our catheters from the market because of
manufacturing issues. In February 2003, we voluntarily recalled a limited number
of our catheters, which contained nonconforming material. We took corrective
action with regard to each of these occurrences and no patient injuries were
sustained as a result of the use of the recalled items.

We purchase various
materials and components from qualified suppliers that are subject to stringent
quality specifications and inspections. We conduct quality audits of our key
suppliers, several of which are experienced in the supply of components to
manufacturers of medical devices. Most purchased components and services are
available from more than one supplier. For the few components for which
relatively few alternate supply sources exist, we have identified back-up
suppliers. The qualification of these back-up suppliers may require regulatory
approval, which may or may not be available on a timely basis or at all.

Currently, only one supply
source exists for the peristaltic pump. This pump is manufactured by our
supplier in accordance with our specifications. We have contracted with this
supplier for ongoing supply, but we would need additional time to locate and
qualify a new pump supplier should our current supplier fail to fulfill our
needs. If a new pump is incorporated into the Control Module, then the Control
Module may require regulatory clearance under the FDAs 510(k) process,
which could take several months or more. Also, a computer chip in the Control
Module is no longer manufactured. This chip is currently available from multiple
suppliers, but we cannot assure you that it will be available in the future. We
have purchased an inventory of these chips sufficient to meet our projected
manufacturing needs for at least the next 18 months and we are currently working
on developing a revision to our current generator that will use newer chip
technology. As with the pump, we cannot incorporate a new chip into the
generator without regulatory clearance under the FDAs 510(k) process,
which could take several months or more.



6




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Our manufacturing facility
is subject to periodic inspection by regulatory authorities. Our quality
assurance systems are subject to FDA regulations. These regulations require that
we conduct our product design, testing, manufacturing, and control activities in
conformance with these regulations and that we maintain our documentation of
these activities in a prescribed manner. Our manufacturing facility is licensed
by the California Department of Health Services, Food and Drug Branch. In
addition, our facility has received ISO 9001/EN46001/ISO13485 certification and
the European Union Certificate pursuant to the European Union Medical Device
Directive 93/42/EEC, allowing us to CE mark our products after assembling
appropriate documentation. ISO 9001/EN46001/ISO13485 certification standards for
quality operations have been developed to ensure that companies know the
standards of quality on a worldwide basis. Failure to maintain the CE mark will
preclude us from selling our products in Europe. We cannot assure you that we
will be successful in maintaining certification requirements in Europe or
elsewhere.

## Patents and
Proprietary Technology

We have an aggressive
program to obtain or license intellectual property in the United States, Europe
and Asia for our medical advances. We are building a portfolio of apparatus and
method patents covering aspects of our current and future technology.

As of December 31, 2002, we
had 23 issued or allowed U.S. patents and 23 pending U.S. patent applications.
We intend to continue to file for patents for our technologies to strengthen our
position. We require our employees, consultants and advisors to execute
confidentiality agreements in connection with their employment, consulting or
advisory relationships with us. We also require employees, consultants and
advisors who work on our products to agree to disclose and assign to us all
inventions conceived during the work day, using our property or which relate to
our business. Despite any measures taken to protect our intellectual property,
unauthorized parties may attempt to copy aspects of our products or to obtain
and use information that we regard as proprietary.

Certain aspects of our
products incorporate technology subject to patents that we have licensed from
others. As of December 31, 2002, we had licensed in 20 issued and allowed U.S.
patents and 15 pending U.S. patent applications. We have a license
with Gyrus Group PLC (formerly, Somnus Medical Technologies, Inc.) for their
generator technology. The non-exclusive license gives us the right to
manufacture, have manufactured, use, offer to sell, sell and import Gyrus
radiofrequency generator technology for use in the treatment of GERD and other
medical disorders of the digestive tract. The license expires on October 6,
2017. During the term of the license, we are obligated to pay a royalty to Gyrus
for our sale of generators that incorporate the licensed technology. We have
also licensed patented technology from the University of Kansas Medical Research
Institute relating to applying radiofrequency energy to tissue. This is an
exclusive, worldwide and royalty-bearing license allowing us to incorporate the
patented technology in our products to treat medical disorders throughout the
gastrointestinal tract. The license expires on September 17, 2013 and may be
terminated earlier for breach. We have also licensed other patents that we
believe may apply to our current business or that we may incorporate into future
products. We intend to continue to license technologies to strengthen our
competitive position.

The medical device industry
is characterized by the existence of a large number of patents and frequent
litigation based on allegations of patent infringement. As the number of
entrants into our market increases, the possibility of an infringement claim
against us grows. 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 U.S. patents
held by them. In addition, our competitors may assert that future products we
may market infringe their patents.

## Competition

The medical device industry
is subject to intense competition. To be successful, we must establish our
products, and the procedures in which our products are used, as attractive
alternatives to currently available treatments. We will also have to compete
with a number of companies that have significantly greater resources than we do.



7




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Our primary competitors in
the GERD market are manufacturers and marketers of existing pharmaceutical and
surgical treatments for GERD, and manufacturers focused on innovative outpatient
treatments. We compete with manufacturers of medications, such as Zantac,
Pepcid, Aciphex, Prilosec, Nexium, and others. These manufacturers and
manufacturers of generic medication equivalents have significantly greater
resources than we do. These companies may market products more aggressively,
gain influence among opinion leaders, or lower their prices, all of which may
affect the adoption of, and the market for, our products. We also compete with
manufacturers of devices and equipment used in laparoscopic anti-reflux surgery.
Increased publicity regarding these procedures or advantageous pricing may
adversely affect the market for our products. Both medication treatment and
anti-reflux surgery are established GERD therapies with well-defined
reimbursement profiles.

We also compete with a
number of companies that are working on GERD treatments that eliminate or reduce
the need for medication but are less invasive than surgery. For example, C.R.
Bard has developed an endoscopic suturing system that places a suture in the
upper stomach during an outpatient procedure. The device used in this procedure
received FDA marketing clearance in March 2000. We compete with several
companies that are developing bulking agents to be injected into the muscle of
the lower esophageal sphincter. For example, Enteric Medical, recently acquired
by Boston Scientific, has developed a liquid polymer for injection into the
lower esophageal sphincter. This product was recently reviewed by an FDA
Gastroenterology and Urology Devices Panel, which recommended that FDA approve
commercial use of the device. We expect the product to receive final approval
from FDA in 2003. Endonetics, recently acquired by Medtronic, is also developing
an injectable bulking agent. Another company, NDO, delivers a stapled fold in
the upper portion of the stomach in an attempt to mimic the action of
anti-reflux surgery. There may also be other companies developing innovative
therapies for minimally invasive treatment of GERD.

In the fecal incontinence
market, we consider our primary competitors to be American Medical Systems, who
received FDA clearance in December 2001 to market their Artificial Bowel
Sphincter (ABS) for the treatment of severe fecal incontinence, and Medtronic,
which is developing an implantable nerve stimulation device for treatment of
incontinence. There are also a small number of companies pursuing injectable
therapies for fecal incontinence.

## Government
Regulation

Our products are medical
devices subject to extensive regulation by the FDA and other regulatory bodies.
FDA regulations govern, among other things, the following activities that we
will perform:

| |  |  | Product development;            
| | - |  | --------------------------------
| |  |  | Product testing;                
| |  |  | Product labeling;               
| |  |  | Product storage;                
| |  |  | Premarket clearance or approval;
| |  |  | Advertising and promotion; and  
| |  |  | Product sales and distribution. 

In April 2000, we received
510(k) premarket clearance from the FDA for the Stretta System for the treatment
of GERD, and in March 2002 we received 510(k) premarket clearance from the FDA
for the Secca System for the treatment of fecal incontinence in patients who
have failed more conservative therapies such as diet modification and
biofeedback.



8




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FDA's premarket clearance and approval requirements


Each medical device that we
wish to commercially distribute in the United States will likely require either
prior 510(k) clearance or prior PMA approval from the U.S. Food and Drug
Administration under the Federal Food, Drug, and Cosmetic Act. Devices deemed to
pose relatively minimal risk are placed in either Class I or II, which requires
the manufacturer to submit a premarket notification requesting permission for
commercial distribution; this is known as 510(k) clearance. Some low risk
devices are exempted from this requirement. Devices deemed by the FDA to pose
the greatest risk, such as life-sustaining, life-supporting or implantable
devices, or devices deemed not substantially equivalent to a previously 510(k)
cleared device or a preamendment Class III device for which PMA applications
have not been called, are placed in Class III, requiring PMA approval.

510(k) Clearance Pathway::    
To obtain 510(k) clearance for one of our products, we must submit a premarket notification
demonstrating that the proposed device is substantially equivalent in intended use and in safety and effectiveness to a previously
510(k) cleared device or a device that was in commercial distribution before May 28, 1976, for which the FDA has not yet called for
submission of PMA applications. The FDA's 510(k) clearance pathway usually takes from four to 12 months, but it can last longer.

After a device receives
510(k) clearance, any modification that could significantly affect its safety or
effectiveness, or that would constitute a major change in its intended use,
requires a new 510(k) clearance or could require a PMA approval. The FDA
requires each manufacturer to make this determination in the first instance, but
the FDA can review any such decision. If the FDA disagrees with a
manufacturers decision not to seek a new 510(k) clearance, the agency may
retroactively require the manufacturer to seek 510(k) clearance or PMA approval.
The FDA also can require the manufacturer to cease marketing and/or recall the
modified device until 510(k) clearance or PMA approval is obtained.

PMA Approval Pathway:    If the FDA denies 510(k) clearance for one of our
products, the product must follow the PMA approval pathway, which requires proof
of the safety and effectiveness of the device to the FDAs satisfaction. A
PMA application must provide extensive preclinical and clinical trial data and
also information about the device and its components regarding, among other
things, device design, manufacturing and labeling. After approval of a PMA, a
new PMA or PMA supplement is required in the event of a modification to the
device, its labeling or its manufacturing process. The PMA approval pathway is
much more costly, lengthy and uncertain than 510(k) clearance. It generally
takes from one to three years or even longer.

Clinical Trials:    A clinical trial is almost always required to
support a PMA application and is sometimes required for a 510(k) premarket
notification. Such trials generally require submission of an application for an
Investigational Device Exemption, or IDE. The IDE application must be supported
by appropriate data, such as animal and laboratory testing results, showing that
it is safe to test the device in humans and that the testing protocol is
scientifically sound. The FDA must approve the IDE in advance for a specified
number of patients unless the product is deemed a non-significant risk device
eligible for more abbreviated IDE requirements. Clinical trials may begin once
the IDE application is approved by the FDA and the appropriate institutional
review boards at the clinical trial sites. In June 2000, we received IDE
approval allowing us to commence a multicenter clinical trial of the Secca
System. We began the trial in July 2000. In April 2001, we completed this trial
and the results were submitted to the FDA in December 2001.

In April 2000, we received
510(k) premarket clearance from the FDA for the Stretta System for the treatment
of GERD, and in March 2002 we received 510(k) premarket clearance from the FDA
for the Secca System for the treatment of fecal incontinence in patients who
have failed more conservative therapies such as diet modification and
biofeedback. We cannot assure you that the FDA will not deem one or more of our
future products to be a class III device subject to the more burdensome PMA
approval process.



9




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Pervasive and continuing FDA regulation


After a device is placed on
the market, numerous regulatory requirements apply. These include: the quality
system regulation, or QSR, which requires manufacturers to follow elaborate
design, testing, control, documentation and other quality assurance procedures
during the manufacturing process; labeling regulations; the FDAs general
prohibition against promoting products for unapproved or off-label uses; and the
Medical Device Reporting regulation, which requires that manufacturers report to
the FDA if their device may have caused or contributed to a death or serious
injury or malfunctioned in a way that would likely cause or contribute to a
death or serious injury if it were to recur. Class II devices also can have
special controls such as performance standards, postmarket surveillance, patient
registries, and FDA guidelines that do not apply to Class I devices.
Unanticipated changes in existing regulatory requirements or adoption of new
requirements could hurt our business, financial condition and results of
operations.

We are subject to
inspection and marketing surveillance by the FDA to determine our compliance
with regulatory requirements. If the FDA finds that we have failed to comply,
the Agency can institute a wide variety of enforcement actions against us,
ranging from a public Warning Letter to more severe sanctions such as:

| |  |  | Fines, injunctions, and civil penalties;                                   
| | - |  | ---------------------------------------------------------------------------
| |  |  | Recall or seizure of our products;                                         
| |  |  | Operating restrictions,
partial suspension or total shutdown of production;
| |  |  | Refusing our requests for
510(k) clearance or PMA approval of new products;
| |  |  | Withdrawing 510(k) clearance
or PMA approvals already granted; and         
| |  |  | Criminal prosecution.                                                      

The FDA also has the
authority to require repair, replacement or refund of the cost of any medical
device manufactured or distributed by us. Our failure to comply with applicable
requirements could lead to an enforcement action that may have an adverse effect
on our financial condition and results of operations.

We have been an FDA
registered medical device facility since January 1999 and we obtained our
manufacturing license from the California Department of Health Services, or
CDHS, in September 1999. We are subject to inspection by both the FDA and CDHS
for compliance with the quality systems regulations and other applicable
regulations.

Other U.S. regulation


We also must comply with
numerous federal, state and local laws relating to such matters as safe working
conditions, manufacturing practices, environmental protection, fire hazard
control and hazardous substance disposal. We may be required to incur
significant costs to comply with such laws and regulations in the future and
such laws and regulations may hurt our business, financial condition and results
of operations. We are subject to quarterly audits performed by Underwriters
Laboratories to ensure that our Control Module production continues to comply
with the original requirements. Failure to comply could result in production
delays, and potential product recall.

Foreign regulation


Our products are also
regulated as medical devices outside the United States by government agencies
and are subject to registration requirements in many of the foreign countries in
which we plan to sell our products. Our Stretta and Secca Systems carry a CE
Mark, which is required for European product sales. The Stretta System carries a
Therapeutic Goods Administration license, which is required for product sales in
Australia, and a license issued by Health Canada, which allows commercialization
in Canada. Our facility has been audited and certified to be
ISO9001/EN46001/ISO13485 compliant, which allows us to sell our products in
Europe. Our facility is subject to inspection by TUV/Essen. We plan to seek
approval to sell the Stretta and Secca Systems in additional foreign countries.
The time and cost required to obtain clearance required by foreign countries may
be longer or shorter than that required for FDA clearance, and requirements for
licensing a product in a foreign country may differ significantly from FDA
requirements.



10




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## Third Party
Reimbursement

In the United States,
health care providers generally rely on third-party payers, principally private
health insurance plans, Medicare and Medicaid, to reimburse all or part of the
cost of procedures in which medical devices are used. Medicare reimburses
hospital outpatient clinics on a prospectively determined fixed amount for the
costs associated with an outpatient procedure. Individual outpatient procedures
are assigned Ambulatory Payment Classification (APC) codes. Effective October 1,
2001, the Center for Medicare and Medicaid Services, CMS (formerly HCFA),
designated a code for the Stretta System. Further, CMS has also provided
guidance on the use of existing physician CPT codes for Stretta. However, as
this coding direction does not constitute a coverage decision, and we cannot
assure you that the Stretta Procedure will be reimbursed or that the amounts
reimbursed under this code will be adequate.

The current cost reduction
orientation of the third-party payer community makes it exceedingly difficult
for new medical devices and surgical procedures to obtain reimbursement. Often,
it is necessary to convince these payers that the new devices or procedures will
establish an overall cost savings compared to currently reimbursed devices and
procedures. We believe that the Stretta System may offer an opportunity for
payers to reduce the cost of treating GERD patients by possibly eliminating or
reducing the costs of medication or anti-reflux surgery. While we believe that
the Stretta System possesses economic advantages that will be attractive to
payers, we cannot assure you that they will make reimbursement decisions based
upon these advantages.

Reimbursement by
third-party payers is often positively influenced by the existence of
peer-reviewed publications of long-term safety and efficacy data. We have
collected data on six-month results after treatment with the Stretta System, and
this information was published in a peer-reviewed journal in 2001. We have
collected and published data on twelve-month results, and this information was
published in a peer-reviewed journal in 2002. Follow-up data in the form of a
Stretta Registry, supporting the durability of the procedure for up to 33
months, was published in a peer-reviewed journal in December 2002. While we
cannot assure you that our products will be reimbursed without publications of
longer-term data, we are actively encouraging ongoing research studies to
evaluate and publish the long-term safety and efficacy of the Stretta System. In
addition, many third-party payers require that randomized studies be conducted
to determine the effect of the procedure versus placebo or another standard of
care. We have completed a double-blind, randomized, sham-controlled,
multi-center study to generate this data, and these results were presented in
May 2002 at the Digestive Disease Week Conference. We cannot assure you that
results of this study will be published in a timely manner or at all, or that
such publication will benefit our marketing and reimbursement efforts.

To facilitate reimbursement
for the Stretta and Secca Systems, we have established a dedicated reimbursement
department. The department trains physicians and physician office staff in
obtaining pre-determination (agreement upon medical necessity) from insurance
carriers prior to treating patients with the Stretta or Secca Procedure. In
addition to assisting physicians with case-by-case pre-determination for
coverage, we are actively involved in pursuit of local coverage decisions. The
first two carriers to implement positive coverage policies for the Stretta
Procedure are Medicare of Georgia and Wellmark Blue Cross and Blue Shield of
Iowa.

We believe that achieving
reimbursement for the Stretta Procedure is one of the major impediments to
growth in sales. We believe that we are making progress toward wider
reimbursement of the procedure. However, while we are actively pursuing
reimbursement through case-by-case approvals and by pursuing coverage decisions
by local carriers, we cannot guarantee the speed or the scale to which payers
will approve reimbursement of the Stretta Procedure. While the Secca Procedure
has been on the market a shorter amount of time, we anticipate similar
challenges in achieving reimbursement for this product.

Reimbursement systems in
international markets vary significantly by country and, within some countries,
by region. Reimbursement approvals must be obtained on a country-by-country
basis or a region-by-region basis. In addition, reimbursement systems in
international markets may include both private and government sponsored
insurance. We have so far obtained limited international reimbursement
approvals.We cannot assure you that we will obtain any further approvals
in a timely manner, if at all. If we fail to receive international reimbursement
approvals at all, or in acceptable amounts, market acceptance of our products
would be adversely affected.



11




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## Employees

As of December 31, 2002, we
had 69 employees, with 29 employees in operations, seven employees in research
and development, 22 employees in sales and marketing, seven employees in general
and administrative, two employees in reimbursement and two employees in clinical
and regulatory affairs. We believe that our future success will depend in part
on our continued ability to attract, hire and retain qualified personnel. None
of our employees is represented by a labor union, and we believe our employee
relations are good.

## Available
Information

We are subject to the reporting
requirements under the Securities Exchange Act of 1934. Consequently, we are
required to file reports and information with the Securities and Exchange
Commission (SEC), including reports on the following forms: annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934. These reports and other
information concerning the company may be accessed through the SECs
website at http://www.sec.gov.

You may also find on our
website (http://www.curonmedical.com) electronic copies of our annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Securities Exchange Act of 1934. Such filings are placed
on our website as soon as reasonably possible after they are filed with the SEC.



12




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## Additional
Risk Factors

## We may never
achieve or maintain significant revenues or profitability.

We have only a limited
operating history upon which you can evaluate our business. We have incurred
losses every year since we began operations. In particular, we incurred net
losses of $15.4 million in 2002, $15.4 million in 2001, and $15.8 million in
2000. As of December 31, 2002, we had an accumulated deficit of approximately
$63.7 million. We have generated limited revenues from the sale of our products,
and it is possible that we will never generate significant revenues from product
sales in the future. Even if we do achieve significant revenues from our product
sales, we expect to incur significant net losses over the next several years and
these losses may increase. It is possible that we will never achieve profitable
operations.

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

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

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

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

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

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



13




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

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

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

We commercially introduced
our Stretta System, which consists of a radiofrequency generator and a
disposable handheld device, in May 2000. We are highly dependent on Stretta
System sales because we anticipate that the Stretta System will account for
substantially all our revenue through at least 2003. To achieve increasing
sales, our product must continue to gain recognition and adoption by physicians
who treat gastrointestinal disorders. The Stretta System represents a
significant departure from conventional GERD treatment methods. We believe that,
generally, physicians will not adopt our Stretta System unless they determine,
based on published peer-reviewed journal articles, long-term clinical data and
their professional experience, that the Stretta System provides an effective and
attractive alternative to conventional means of treatment for GERD. Currently,
there are 11 peer-reviewed journal articles and we are awaiting publication of
the Stretta randomized trial. Physicians are traditionally slow to adopt new
products and treatment practices, partly because of perceived liability risks
and uncertainty of third-party reimbursement. For example, we believe that
physician adoption rates have been negatively impacted by adverse events and a
voluntary market withdrawal, all of which occurred early in the launch of the
Stretta System. Future adverse events or recalls would also impact future
acceptance rates. If we cannot achieve increasing physician adoption rates of
our Stretta System, we may never achieve significant revenues or profitability.

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

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



14




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

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

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

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

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

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

Companies that have
well-established products, reputations and resources dominate the market for the
treatment of GERD. When our primary marketing strategy was directed at
gastroenterologists, we competed directly with large pharmaceutical
manufacturers of anti-secretory drugs. Because we have shifted our marketing
focus to general surgeons, our primary competitors are now large medical device
manufacturers such as Ethicon Endosurgical and United States Surgical,
manufacturers of instrumentation for anti-reflux surgery, and C.R. Bard, which
manufactures an endoscopic sewing device for GERD. Other large, established
companies have experimental products that may, in the future, provide
competition for the Stretta Procedure. These include Boston Scientific and
Medtronic, who have experimental injectable products being studied for the
treatment of GERD. Other, yet undisclosed, competitive devices may be developed.

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

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



15




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We do not feel that we
compete directly with large pharmaceutical companies, such as AstraZeneca,
Takeda Abbott Pharmaceutical, Wyeth Laboratories and Eisai, because candidate
patients for Stretta have, by definition, failed, or only partially responded
to, drug therapy. However, these companies have an established relationship with
the gastroenterology community and over $6 billion in annual U.S. revenues from
the proton pump inhibitor drug class. We could be adversely affected if one or
more pharmaceutical companies elects to market aggressively against our product,
or if a new, more effective, pharmaceutical product is developed. For example,
AstraZeneca has developed a new proton pump inhibitor, Nexium, for the treatment
of GERD, which doctors may prescribe in lieu of recommending the Stretta
Procedure. Further, less expensive, generic drugs will be introduced to treat
GERD as AstraZenecas patent for Prilosec, the leading prescription
medication for the treatment of GERD, expired in 2001. If we cannot compete
effectively in this highly competitive market, we may not be able to achieve our
expected revenue growth.

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

We have limited sales and
marketing experience. As December 31, 2002, we relied on ten direct sales
employees to sell our Stretta System in the United States. We must manage this
sales team over the next 24 months to achieve our market share and revenue
growth goals. Since we have only recently launched the Secca System, our sales
force has little experience marketing the product, and we cannot predict how
successful they will be in selling the product. There are significant risks
involved in building and managing our sales force and marketing our products,
including our:

| |  |  | Inability to hire a sufficient number of qualified sales people with the skills
and understanding to sell the Stretta and Secca Systems effectively;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | Failure to adequately train our sales force in the use and benefits of our products, making them less effective promoters;
         and             
| |  |  | Failure to accurately
price our products as attractive alternatives to conventional treatments.                                                     

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

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

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

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

Because we have only
limited experience in manufacturing our products in commercial quantities, we
may encounter unforeseen situations that would result in delays or shortfalls.
For example, in December 2000, we voluntarily withdrew certain of our catheters
from the market because of manufacturing issues. In February 2003, we
voluntarily recalled a limited number of our catheters, which contained
non-conforming material. This material formed part of the catheter shaft and
showed a tendency to degrade over time. The problem was identified, corrected,
and the outside vendor was changed. If the material were to fail during use,
there would be a remote possibility of superficial injury to the patients
esophageal or pharyngeal lining. No injuries have been reported and all unused
catheters in the affected lots have been recovered.



16




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

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

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

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

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

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

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



17




---




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

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

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

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

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

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

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



18




---




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

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

| |  |  | Product design, development, manufacture and testing;
| | - |  | -----------------------------------------------------
| |  |  | Product labeling;                                    
| |  |  | Product storage;                                     
| |  |  | Premarket clearance or approval;                     
| |  |  | Advertising and promotion; and                       
| |  |  | Product sales and distribution.                      

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

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

In the quarter ended
December 31, 2002, we entered into distribution agreements in Switzerland,
Austria, and the Netherlands, and to date have international distribution
agreements in 17 countries. We are training these distributors and only began
selling our products in international markets in April 2001. To successfully
market our products internationally, we must address many issues with which we
have little or no experience. We have obtained regulatory clearance to market
the Stretta System in the European Union, Australia and Canada and to market the
Secca System in the European Union, but we have not obtained any other
international regulatory approvals for other markets or products. We cannot
assure you that we will be able to obtain or maintain such approvals.
Furthermore, although contracts already signed with European distributors
specify payment in U.S. dollars, future international sales may be made in
currencies other than the U.S. dollar. As a result, currency fluctuations may
impact the demand for our products in countries where the U.S. dollar has
increased compared to the local currency. Engaging in international business
involves the following additional risks:

| |  |  | Export restrictions,
tariff and trade regulations, and foreign tax laws;
| | - |  | ------------------------------------------------------------------------
| |  |  | Customs duties, export
quotas or other trade restrictions;              
| |  |  | Economic or political instability;                                      
| |  |  | Shipping delays; and                                                    
| |  |  | Longer payment cycles.                                                  

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



19




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

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

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

As of December 31, 2002, we
had 43 issued or allowed U.S. patents and 38 pending U.S. patent applications;
this includes 20 issued U.S. patents and 15 pending U.S. patent applications
licensed in from third-parties. We rely on patent, copyright, trade secret and
trademark laws to protect our products, including our Stretta Catheter, our
Secca Handpiece and our Curon Control Module, from being duplicated by
competitors. However, these laws afford only limited protection. Our patent
applications and the notices of allowance we have received may not issue as
patents or, if issued, may not issue in a form that will be advantageous to us.
Patents we have obtained and may obtain in the future may be challenged,
invalidated or legally circumvented by third parties. We may not be able to
prevent the unauthorized disclosure or use of our technical knowledge or other
trade secrets by consultants, vendors, former employees or current employees,
despite the existence of nondisclosure and confidentiality agreements and other
contractual restrictions. Furthermore, the laws of foreign countries may not
protect our intellectual property rights to the same extent as the laws of the
United States. If our intellectual property rights do not adequately protect our
commercial products, our competitors could develop new products or enhance
existing products to compete more directly and effectively with us and harm our
product sales and market position.

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

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

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



20




---




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

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

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

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

We believe our future
success will depend upon our ability to successfully manage our employees, which
includes attracting and retaining engineers and other highly skilled personnel.
Our employees are at-will employees and are not subject to employment contracts.
The loss of services of one or more key employees could materially adversely
affect our growth. In addition, our stock price is depressed and the results of
our operations have been less successful than anticipated. This history of
performance may make it difficult to attract and retain qualified personnel.
Failure to attract and retain personnel, particularly management and technical
personnel, would materially harm our ability to grow our business rapidly and
effectively. Because of recent changes in our management structure, we do not
have a Vice President of Sales and Marketing. As long as this position remains
unfilled, existing employees whose job descriptions would not ordinarily include
certain sales and marketing activities will be required to perform those
functions. Placing such additional responsibilities on existing staff members
may strain resources, distract employees, or disrupt our operations, all of
which would have an adverse effect on our business.

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

During the quarter ended
September 30, 2002, our stock began trading under $1.00. The continued listing
standards for inclusion of our stock on the NASDAQ National Market, required
that our stock not close below $1.00 for 30 consecutive trading days. As we
could not meet this standard, we chose to move our listing to the NASDAQ
SmallCap Market, and on March 10, 2003, NASDAQ advised us that we were again in
compliance with minimum bid requirements. The move to the NASDAQ SmallCap Market
could adversely affect the liquidity and price of our stock. As a result, there
may be less demand for our stock and we may be unable to raise sufficient
capital to fund our operations.



21




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

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

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

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

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

## Item 2.  
Properties

We are headquartered in
Sunnyvale, California, where we lease one building with approximately 20,000
square feet of office, research and development, and manufacturing space under
leases expiring September 30, 2003. We are currently in the process of
identifying a new headquarters to move into before September 30, 2003.

## Item 3. Legal
Proceedings

In June 2001, a civil
action was filed against us in the United States District Court, Western
District of Kentucky, Louisville Division, in which the plaintiff alleges that
he sustained a nerve injury and damage to his gastrointestinal tract during a
Stretta Procedure caused by the defective design and manufacture of our product.
Plaintiffs allegations against us include strict liability for a product
that was in a defective and unreasonably dangerous condition, negligence in the
design and manufacturing of the product, breach of implied warranty of
merchantability, and loss of consortium. Plaintiff was a subject in a randomized
clinical trial and had been provided with an approved Informed Consent form and
counseling by the physician. Prior to treatment, Plaintiff provided consent to
proceed. Plaintiff is seeking a trial by jury and unspecified damages. The trial
date is currently set in September 2003. We believe Plaintiffs claim is
without merit.

In September 2001, a civil
action was filed against a number of defendants, including Curon, in the
Superior Court of the State of California in and for the City and County of
Santa Clara, alleging that the plaintiff sustained injury when undergoing a
procedure utilizing the Stretta System, caused by defects in design and
manufacture. Plaintiff also alleges negligence in the design, manufacture,
advertising and sale of the Stretta System and that its warnings, instructions
and directions for use were inadequate. Additional defendants include the
treating physicians and the associated medical institutions, who, it is alleged,
were medically negligent in treatment of Plaintiff. Plaintiff is seeking
unspecified damages. On January 24, 2003 we filed a Motion for Summary Judgment,
which will be heard on April 22, 2003.



22




---




In June 2002, a civil
action was filed against a number of defendants, including Curon, in the Court
of Common Pleas, Philadelphia County, in the State of Pennsylvania, alleging
that the plaintiff sustained injury during a Secca Procedure caused by the
device being defective and/or in an unreasonably dangerous condition. Plaintiff
was a subject in a clinical trial and had been provided with an approved
Informed Consent form and counseling by the physician. Prior to treatment,
Plaintiff provided consent to proceed. Additional defendants include the
treating physician, the associated medical institution who, it is alleged, were
medically negligent in treatment of Plaintiff, and the members of the
Institutional Review Board who approved the protocol for the clinical trial.
Plaintiff has demanded a trial by jury and unspecified damages. The case has
since been moved to the United States District Court for the Eastern District of
Pennsylvania. We believe Plaintiffs claim against us is without merit.

In February 2003, a civil
action was filed against us in the District Court of Dallas County, in the State
of Texas, alleging that the plaintiff sustained serious injuries during a
Stretta Procedure performed in February 2001, caused by the device being in a
defective condition. We have no further information on this claim, and believe
it to be without merit.

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

Not applicable.



23




---




# PART II

## Item 5.  Market
for Registrants Common Equity and Related Stockholder Matters

Our Common Stock trades
under the symbol CURN. As of December 9, 2002, our Common Stock is currently
quoted on the NASDAQ SmallCap Market. Until that date, our Common Stock had been
quoted on the NASDAQ National Market since our initial public offering on
September 22, 2000. The following table shows the high and low sales prices for
the Companys Common Stock for the periods indicated, as reported on the
NASDAQ SmallCap or National Markets.

Common Stock PriceHigh

LowYear Ended December 31, 2001First Quarter

$
6.94

$
2.38Second Quarter


4.52


1.95Third Quarter


3.02


1.93Fourth Quarter


4.40


2.24Year Ended December 31, 2002First Quarter


4.64


2.55Second Quarter


3.95


2.90Third Quarter


3.22


0.56Fourth Quarter


0.90


0.46


As of March 11, 2003, the
last reported sales price of our Common Stock on the NASDAQ SmallCap Market was
$1.17 per share, and the number of beneficial common stockholders was
approximately 1,500. We currently intend to retain any earnings for use in our
business and do not anticipate paying any cash dividends in the foreseeable
future.

On September 26, 2000, we
completed the sale of 5,000,000 shares of our common stock at a per share price
of $11.00 in a firm commitment underwritten public offering. The offering was
effected pursuant to a Registration Statement on Form S-1 (Registration No.
333-378666), which the United States Securities and Exchange Commission declared
effective on September 21, 2000. On October 24, 2000, we completed the sale of
an additional 475,000 shares of our common stock at a per share price of $11.00
pursuant to the exercise of the over-allotment option by the underwriters. All
shares sold were shares of our common stock, $0.001 par value per share. UBS
Warburg LLC, CIBC World Markets, and SG Cowen were the managing underwriters of
the IPO. Aggregate gross proceeds to us from the IPO (prior to deduction of
underwriting discounts and commissions and expenses of the offering) were $60.2
million. There were no selling stockholders in the IPO.

We paid underwriting
discounts and commissions of approximately $4.2 million and other expenses of
approximately $1.2 million in connection with the IPO. The total expenses paid
by us in the IPO were approximately $5.5 million and the net proceeds to us in
the IPO were approximately $54.8 million.

Of the approximately $54.8
million in net offering proceeds, through December 31, 2002, we have used
approximately $12.0 million for the repayment of debt and accrued interest, $7.0
million for research and development, $8.8 million for the manufacture of
products, $4.0 million for clinical expense and reimbursement efforts, $14.0
million for sales and marketing initiatives to support the commercialization of
the Stretta System and $9.0 million for general corporate purposes. We have now
used the entire balance of our net IPO proceeds. From time to time, we have
discussed potential strategic acquisitions and investments with third parties.
To date, we do not have any agreements or commitments to complete any such
transactions.



24




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The Board of Directors
approved a stock repurchase program in July 2002 pursuant to which up to
1,000,000 shares of our outstanding common stock may be repurchased from time to
time. The duration of the repurchase program is open-ended. Under the program,
we may purchase shares of common stock through open market transactions at
prices deemed appropriate by management. The timing and amount of repurchase
transactions under this program will depend on market conditions and corporate
and regulatory considerations. The purchases will be funded from available
working capital. As of December 31, 2002, we have repurchased approximately
325,300 shares pursuant to this repurchase program.



25




---




## Item 6.
  Selected Financial Data

The following tables
reflect selected summary financial data for each of the last five fiscal years.
This data should be read in conjunction with the financial statements and notes
thereto, and with Item 7, Managements Discussion and Analysis of Results
of Operations and Financial Condition in this Annual Report on Form 10-K. The
information provided below is in thousands, except for per share data.

Years ended December 31,2002


2001


2000


1999


1998Statement of operations data:Revenues

$
3,403


$
3,317


$
1,156


$



$
Cost of goods sold


4,491



4,994



2,102







Gross loss


(1,088
)


(1,677
)


(946
)






Operating expenses:Research and development


2,668



2,825



4,161



8,961



1,581Clinical and regulatory


1,373



1,745



1,805



2,012



335Sales and marketing


7,065



6,973



3,461



940



General and administrative


4,023



4,443



4,181



2,345



95915,129



15,986



13,608



14,258



2,875Operating loss


(16,217
)


(17,663
)


(14,554
)


(14,258
)


(2,875
)Interest income


751



2,240



1,330



258



8Interest expense


(8
)


(4
)


(4,083
)


(89
)


(86
)Other


33



(2
)


(68
)






Loss before extraordinary item


(15,441
)


(15,429
)


(17,375
)


(14,089
)


(2,953
)Extraordinary gain










1,596







Net loss

$
(15,441
)

$
(15,429
)

$
(15,779
)

$
(14,089
)

$
(2,953
)Net loss per share, basic and diluted

$
(0.79
)

$
(0.81
)

$
(2.27
)

$
(6.94
)

$
(2.01
)Shares used in computing net loss per share, basic and diluted (1)


19,653



19,075



6,945



2,030



1,472Balance sheet data:Cash, cash equivalents and marketable securities

$
22,967


$
35,128


$
39,206


$
9,498


$
4,502Working capital


24,807



36,498



39,916



8,176



4,223Long-term investments


528



3,048



12,882







Total assets


27,236



43,073



56,617



11,686



5,842Long-term obligations














227



459Convertible preferred stock and warrants














21,808



7,713Total stockholders equity (deficit)


26,103



41,288



54,930



(12,099
)


(2,877
)


---

|(1) |  | The per share data have been restated to reflect the 0.57 to 1 reverse stock split effective September 22, 2000.
|--- |  | ----------------------------------------------------------------------------------------------------------------



26




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## Item 7.  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 for the fiscal years ended December 31, 2002, 2001, and 2000.

## Overview

We were incorporated in May
1997. Business activities before January 1998 were negligible. Prior to December
31, 2000 we were in the development stage and until that time, we had devoted
substantially all of our efforts to raising capital and developing, marketing
and selling our products.

In 1998, our primary
activity was developing the Curon Control Module and Stretta Catheter for the
treatment of gastroesophageal reflux disease, or GERD. In October 1999, we
received CE Mark approval of the Stretta System, indicating that the Stretta
System meets Euro standards allowing us to market it within the European Union.
We received 510(k) clearance from the FDA in April 2000 and commercially
launched in the United States in May 2000.

In April 1999, we began
developing our second set of products, the Secca System, for the treatment of
fecal incontinence. In November 1999, we conducted a 10-patient human clinical
pilot study outside the United States and, in July 2000, we began a U.S.
multi-center clinical trial of the Secca System under an Investigational Device
Exemption. In September 2001, we received CE Mark approval of the Secca System,
indicating that the Secca System meets European medical device standards,
allowing us to market it within the European Union. Our multi-center clinical
trial was completed, and the results were used to support a 510(k) submission to
the FDA in December 2001. We received 510(k) clearance from the FDA in March
2002 to market the system for the treatment of fecal incontinence in patients
who have failed more conservative therapies such as diet modification and
biofeedback. We made our first sales of the Secca System in June 2002.

We are focusing our sales
efforts in the United States through a direct sales force. In international
markets, we rely primarily on third-party distributors. In November 2000, we
incorporated a subsidiary company in Belgium and hired a European manager to
support European distributors sales, marketing and clinical efforts. As of
December 31, 2002, this subsidiary had three employees. In the quarter ended
December 31, 2002, we entered into distribution agreements in Switzerland,
Austria, and the Netherlands, giving us a total of 17 international
distributors, who have all received shipments of product. Our gross margins on
sales through international third-party distributors will be lower than our
gross margins on U.S. sales as a result of distributor discounts.

To date, we have generated
limited revenues. Our revenues are, and will be, derived from the sale of
radiofrequency generators and our disposable devices, such as the Stretta
Catheter and Secca Handpiece. We expect that disposable sales will continue to
form the basis of a recurring revenue stream. However, domestic disposable sales
continue to grow more slowly than expected primarily due to difficulties
encountered by our physician customers in easily obtaining reimbursement for the
Stretta Procedure on a case-by-case basis. Some of our customers also find the
45 minutes necessary to perform a Stretta Procedure to be a limiting issue, as
their endoscopy unit schedule is typically dominated by short diagnostic
procedures. Although disposable sales from outside the United States are
increasing, they are not yet sufficient to offset the current domestic
situation. Our strategies of pursuing national reimbursement coverage, focusing
on entrenching the therapy to promote repeat catheter sales and incorporating
technical improvements to our systems to reduce treatment times are designed to
address these issues and we expect that our revenue from disposables will
increase on implementation.

Through December 31, 2002,
we recorded limited product sales while incurring cumulative net losses of $63.7
million. In addition to increasing expenditures related to continuing selling
activities of the Stretta and Secca Systems, we anticipate that our expenses
will increase as we continue to develop new products, conduct clinical trials,
commercialize our products and acquire additional technologies as opportunities
arise. As a result, we expect our operating expenses and cumulative net losses
to increase.



27




---




We have recently
experienced several changes in our senior management team. In July 2002, John
Morgan resigned as the Companys President and CEO. Board member Michael
Berman became interim CEO and a search for a permanent CEO was commenced. In
July, 2002, our Vice President Sales, James Goode, and our Vice President,
Marketing, Carol Chludzinski, resigned from the Company. Larry Heaton joined the
Company as President and CEO in January 2003, and also became a member of the
Board of Directors.

## Critical
Accounting Polices and Estimates

Managements
Discussion and Analysis of Financial Condition and Results of Operations
discusses our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period.

We believe the following
critical accounting policies, among others, affect its more significant
judgments and estimates in the preparation of its consolidated financial
statements:

| |  |  | Revenue Recognition and Accounts ReceivableWe recognize revenue in
accordance with SEC Staff Accounting Bulletin No. 101 Revenue Recognition in
Financial Statements (SAB 101), as amended. SAB 101 requires that four criteria
must be met before revenue can be recognized: (1) persuasive evidence of an
arrangement exists; (2) delivery has occurred or service rendered; (3) the fee
is fixed and determinable; and (4) collectibility is reasonably assured. Revenue
from product sales is recognized on product shipment against a signed purchase
order or sales quote provided no significant obligations remain and collection
of the receivables is deemed probable for both sales of control modules and
catheters. We also provide customers with training and assistance in obtaining
reimbursement, and to the extent that these remaining obligations are not
considered inconsequential or perfunctory to the sales arrangement, we will
defer the recognition of the revenue until fulfillment of the obligation. Any
change in our selling process or post-sale training and customer support could
result in deferred revenue.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |   |  | We
assess collection based on historical experience and the credit-worthiness of
the customer. Based on managements on-going analysis of accounts
receivable balances, and after the initial recognition of the revenue, if an
event occurs which adversely affects the ultimate collectibility of the related
receivable, management will record an allowance for bad debts. To date, bad
debts have not had a significant impact on our financial position, results of
operations and cash flows.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |   |  | Revenues
for extended warranty contracts are deferred and recognized over the extended warranty period. To date, post-sale customer
support and training have not been significant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| |  |  | InventoriesInventories are stated at the lower of standard cost (which
approximates average cost) or market. We record adjustments to the value of the
inventory based on sales forecasts, physical condition, and potential
obsolescence due to technological advancements in its products. These
adjustments are estimates that could be materially different from actual results
if future market conditions as they relate to our product differ from our
expectations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  |  | Accounting for Income TaxesOur income tax policy records the estimated
future tax effects of temporary differences between the tax basis of assets and
liabilities and amounts reported in the accompanying consolidated balance
sheets, as well as operating loss and tax credit carryforwards. We have recorded
a full valuation allowance to reduce its deferred tax asset, as based on
available objective evidence, it is more likely than not that the deferred tax
asset will not be realized. While we have considered potential future taxable
income and ongoing prudent and feasible tax planning strategies in assessing the
need for the full valuation allowance, in the event that we were to determine
that it would be able to realize its deferred tax assets in the future, an
adjustment to the deferred tax asset would increase income in the period such
determination was made.                                                                                                                                                                                                                                            



28




---




|
|
|
|
|



29




---




## RESULTS OF
OPERATIONS

Revenue


Revenues were $3.4 million,
$3.3 million, and $1.2 million in the twelve months ended December 31, 2002,
2001, and 2000, respectively. Sales have increased successively over all three
years, although increases in 2002 were lower than anticipated, primarily due to
the sales and marketing efforts involved in repositioning the Stretta System as
an alternative to anti-reflux surgery, which required us to refocus our sales
force to target surgeons as opposed to gastroenterologists. Stretta System
products accounted for 97% of total 2002 revenues as compared to Secca System
products, which accounted for 3% of 2002 revenues. There were no Secca System
sales in prior years so revenue was entirely derived through sales of the
Stretta System. The Stretta Control Module and Catheter accounted for 51% and
46%, respectively, of the Stretta product line sales for the year ended December
31, 2002, compared to 50% and 45%, respectively, for the same period in 2001,
and 65% and 32%, respectively, in 2000. International sales accounted for
$423,000 for the year ended December 31, 2002, compared to $134,000 for the same
period in 2001, and none in 2000. Commercial shipments of the Stretta System
began in the United States in June 2000.

Cost of goods sold


Our costs of goods sold
represent the cost of producing generators and disposable devices. We also
license a technology used in the generators that we sell. We are required to pay
licensing fees based on the sales price of the units. We believe that there are
alternative technologies that could be utilized should we choose to do so. Cost
of goods sold was $4.5 million, $5.0 million and $2.1 million in the twelve
months ended December 31, 2002, 2001, and 2000, respectively. As sales volume
increases, we expect gross profit to become positive and increase accordingly.
Our sales have not yet reached a level that would absorb our manufacturing
capacity to the extent that we would experience positive gross profit. In
addition to various cost reduction strategies, the decrease in 2002 as compared
to 2001 was due to $235,000 of manufacturing capacity related to Secca pilot
manufacturing that was charged to research and development prior to the product
commercialization in June 2002. In 2000, $1.1 million of manufacturing expense
for the first five months of that year was charged to research and development
related to pilot manufacturing of the Stretta System, which was commercialized
in June 2000.

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 $2.7 million, $2.8 million, and $4.2 million in
the twelve months ended December 31, 2002, 2001, and 2000, respectively.
Spending levels in 2002 and 2001 are relatively comparable. The decrease in
expenses in 2001 compared to 2000 was due to the completion of Stretta pilot
manufacturing activities in the second quarter of 2000, when commercialization
occurred. Amortization of stock-based compensation accounted for $66,000,
$205,000, and $629,000 in the twelve months ended December 31, 2002, 2001, and
2000, respectively. During the quarter ended September 30, 2002, we reduced the
number of research and development personnel from ten to seven. Costs associated
with terminating these individuals were $83,000.

Clinical and regulatory expenses


Clinical and regulatory
expenses consist primarily of expenses associated with the costs of clinical
trials, clinical support personnel, the collection and analysis of the results
of these trials, and the costs of submission of the results to the FDA. Clinical
and regulatory expenses were $1.4 million, $1.7 million, and $1.8 million in the
twelve months ended December 31, 2002, 2001, and 2000, respectively. Spending
decreased in 2002 as compared to 2001 due to the costs involved in the U.S.
Secca trial and the Stretta randomized control trial, which were both ongoing in
2001, and were completed in that year. Spending on the Secca randomized control
trial, begun in May 2002, has been limited to date. Spending levels in 2001 and
2000 are relatively comparable. Clinical trial costs include payments to
hospitals, and the related travel expense for Curon employees. Amortization of
stock-based compensation accounted for $51,000, $121,000, and $174,000 in the
twelve months ended December 31, 2002, 2001, and 2000, respectively. During the
quarter ended September 30, 2002, we reduced the number of clinical personnel
from four to three. Costs associated with terminating these individuals were
$13,000.



30




---




Sales and marketing expenses


Sales and marketing
expenses consist of personnel related costs, advertising, public relations and
attendance at selected medical conferences. Sales and marketing expenses were
$7.1 million, $7.0 million, and $3.5 million in the twelve months ended December
31, 2002, 2001, and 2000, respectively. Spending increases in each year are
primarily due to increases in expenditures for activities to promote
reimbursement for our products. In addition, headcount increases for field sales
personnel occurred between 2001 and 2000, related to the commercialization of
Stretta in June 2000. Amortization of stock-based compensation accounted for
$47,000, $250,000, and $418,000 in the twelve months ended December 31, 2002,
2001, and 2000, respectively. During the quarter ended September 30, 2002, we
reduced the number of sales and marketing personnel from 28 to 26. Costs
associated with terminating these individuals were $147,000.

General and administrative expenses


General and administrative
expenses consist primarily of the cost of corporate operations and personnel,
legal, accounting and other general operating expenses of our company. General
and administrative expenses were $4.0 million, $4.4 million, and $4.2 million in
the twelve months ended December 31, 2002, 2001, and 2000, respectively. After
eliminating the stock-based compensation and termination costs noted below,
spending in 2002 is comparable to 2001. Spending increased in 2001 as compared
to 2000 due to higher costs related to being a publicly held company, including
legal, accounting, insurance and investor relations; 2001 was our first full
year as a public company. Amortization of stock-based compensation accounted for
$186,000, $670,000, and $1.3 million in the twelve months ended December 31,
2002, 2001, and 2000, respectively. During the quarter ended September 30, 2002,
we reduced the number of general and administrative personnel from nine to
seven. Costs associated with terminating these individuals were $555,000.

Interest income and expense


Interest income was
$751,000, $2.2 million, and $1.3 million in the twelve months ended December 31,
2002, 2001, and 2000, respectively. Interest income has decreased in 2002 as
compared to 2001, due to a declining balance of marketable securities. Average
cash and investment balances in 2001 were $45.1 million, compared to the 2002
average of $30.8 million. Earnings have also been affected by declining interest
rates through 2001 and 2002. The increase in interest income in 2001 as compared
to 2000 was due to earnings on a greater marketable securities balance obtained
as a result of our initial public offering in September 2000.

Interest expense was
$8,000, $4,000, and $4.1 million in the twelve months ended December 31, 2002,
2001, and 2000, respectively. In 2002 and 2001, minimal notes payable related to
insurance policies generated interest expense. Interest expense in 2000 was
primarily related to the warrants and beneficial conversion feature on the
convertible debt, and as such was not a cash expenditure; this debt was
extinguished in the third quarter of 2000.

Income taxes


As a result of our net
losses, we did not incur any income tax obligations in each of the twelve-month
periods ended December 31, 2002, 2001 and 2000.



31




---




# LIQUIDITY
AND CAPITAL RESOURCES

Since inception, we have
funded our operations and capital investments from gross proceeds from our
initial public offering completed in September 2000 totaling $55.0 million, from
the partial exercise of the underwriters over-allotment provision totaling
$5.2 million, from the private sale of equity securities totaling $22.0 million,
from the issuance of convertible notes totaling $11.8 million and from bank
equipment line financing totaling $780,000. At December 31, 2002, we had $24.8
million in working capital and our primary source of liquidity was $23.0 million
in cash and cash equivalents and marketable securities. In addition, we had
$528,000 invested in long-term securities at that date. We intend to finance our
operations primarily through our cash and cash equivalents, marketable
securities, future financing and future revenues. We believe we have enough cash
to fund operations for at least 18 to 24 months, and that alternative financing
is available, if needed, however, there can be no assurance that such efforts
will succeed or that sufficient funds will be made available.

Cash used in operating
activities was $14.4 million in the twelve months ended December 31, 2002,
compared to $14.3 million for the same period in 2001. Losses in each year were
$15.4 million. In 2002, inventory balances declined, providing $115,000 of cash,
compared to 2001, when $544,000 of cash was used to increase inventory balances.
This decreasing investment in inventories was due to implementation of system
and process improvements in materials management. Cash from interest income has
decreased by $1.5 million. Cash from selling activities has increased to $3.4
million in 2002 as compared to $2.9 million in 2001.

Cash provided by investing
activities was $15.6 million in the twelve months ended December 31, 2002,
compared to $4.7 million for the same period in 2001. This reflects the fact
that we used our investments to fund operations of the company during 2002,
while in 2001, the higher balance of cash and cash equivalents at December 31,
2000 offset the need to reduce investment balances in 2001.

Cash used by financing
activities was $76,000 for the twelve months ended December 31, 2002. This use
was primarily due to payments on the notes payable used to finance insurance
policies. During 2002, sales of stock through employee stock plans were offset
by purchases of treasury stock. Cash provided by financing activities was
$439,000 in the twelve months ended December 31, 2001, primarily related to
sales of stock through employee stock plans, and the note payable used to
finance the Directors and Officers insurance policy. The Company has no
significant outstanding long-term obligations except operating lease
commitments.

The Company leases office
space under noncancelable operating leases expiring in September 2003. Future
minimum payments due under operating leases are $409,000 for 2003.

## Recent
Accounting Pronouncements

In June 2002, The Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 146 (SFAS 146), Accounting for Costs Associated with Exit or
Disposal Activities, which supersedes EITF Issue No. 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). This new standard
requires companies to recognize costs associated with exit or disposal
activities when the costs are incurred rather than at the date of a commitment
to an exit disposal plan. Costs covered by the standard include lease
termination costs and certain employee severance costs that are associated with
a restructuring, discontinued operations, plant closing, or other exit or
disposal activity. This standard is effective for exit or disposal activities
that are initiated after December 31, 2002. We will adopt SFAS No. 146 as of
January 1, 2003 and we do not believe that the adoption will have a significant
impact on the financial position or results of operations.



32




---




In November 2002, the
Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 45 (FIN45), Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN 45 requires that a liability be recorded in
the guarantors balance sheet upon issuance of a guarantee. In addition,
FIN 45 requires disclosures about the guarantees that an entity has issued,
including a reconciliation of changes in the entitys product warranty
liabilities. The initial recognition and initial measurement provisions of FIN
45 are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002, irrespective of the guarantors fiscal year-end. The
disclosure requirements of FIN 45 are effective for financial statements of
interim or annual periods ending after December 15, 2002. We believe that the
adoption of this standard will have no material impact on our financial
statements.

In November 2002, the
Emerging Issues Task Force (EITF) reached a consensus on Issue No.
00-21, Revenue Arrangements with Multiple Deliverables. EITF Issue
No. 00-21 provides guidance on how to account for arrangements that involve the
delivery or performance of multiple products, services and/or rights to use
assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003.
Management believes that the adoption of this standard will have no material
impact on its financial statements.

In December 2002, the FASB
issued SFAS No. 148, Accounting for Stock-Based Compensation, Transition
and Disclosure. SFAS No. 148 provides alternative methods of transition
for a voluntary change to the fair value based method of accounting for
stock-based employee compensation. SFAS No. 148 also requires that disclosures
of the pro forma effect of using the fair value method of accounting for
stock-based employee compensation be displayed more prominently and in a tabular
format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect
in interim financial statements. The transition and annual disclosure
requirements of SFAS No. 148 are effective for fiscal years ended after December
15, 2002. The interim disclosure requirements are effective for interim periods
beginning after December 15, 2002. The adoption of this standard did not have a
material impact on our financial statements.

In January 2003, the FASB
issued FASB Interpretation No. 46 (FIN 46), Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46
requires certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective
immediately for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period beginning after June 15, 2003. We do not have any ownership in
any variable interest entities as of December 31, 2003. We will apply the
consolidation requirement of FIN 46 in future periods if we should own any
interest in any variable interest entity.

## Item 7A.
  Quantitative and Qualitative Disclosure About Market Risk

The primary objective of
our investment activities is to preserve principal while at the same time
maximizing the income we receive from our investments without significantly
increasing risk. Some of the securities that we invest in may have market risk.
That means that a change in prevailing interest rates may cause the fair value
of the principal amount of an investment to fluctuate. For example, if we hold a
security that was issued with a fixed interest rate at the then-prevailing rate
and the prevailing rate rises, the fair value of the principal amount of our
investment will probably decline. To minimize this risk in the future, we intend
to maintain our portfolio of cash equivalents and short-term investments in a
variety of securities, including commercial paper, money market funds,
government and non-government debt securities. The average duration of all of
our investments has generally been less than eighteen months. Due to the
short-term nature of these investments, we believe we have no material exposure
to interest rate risk arising from our investments.

Our exposure to market risk
for changes in interest rates relates primarily to the increase or decrease in
the amount of interest income we can earn on our available funds for investment.
We do not plan to use derivative financial instruments in our investment
portfolio. We plan to ensure the safety and preservation of our invested
principal funds by limiting default risks, market risk and reinvestment risk. We
plan to mitigate default risk by investing in high-credit quality securities.



33




---




All of our revenue is
realized in U.S. dollars. Therefore, we do not believe that we currently have
any significant direct foreign currency exchange rate risk.



34




---







Item 8.    

        Financial Statements and Supplementary Data





Report of Independent Accountants

36Consolidated Balance Sheets at December 31, 2002 and December 31, 2001

37Consolidated Statements of Operations for each of the Three Years in the Period Ended

        December 31, 2002

38Consolidated Statements of Stockholders Equity (Deficit) for each of the Three Years in the Period Ended December 31,
        2002

39Consolidated Statements of Cash Flows for each of the Three Years in the Period Ended

        December 31, 2002

40Notes to Consolidated Financial Statements

41Quarterly Financial Data (unaudited)

57




35




---




REPORT OF INDEPENDENT ACCOUNTANTS





To the Board of Directors and Stockholders of Curon Medical, Inc.







In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of stockholders'
equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Curon Medical, Inc. and its
subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally
accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for
our opinion.







PRICEWATERHOUSECOOPERS LLP





San Jose, California




January 31, 2003
Except for Note 13, as to which the date is February 21, 2003




36




---







CURON MEDICAL, INC.





CONSOLIDATED BALANCE SHEETS


(in thousands, except shares and per share data)





December 31,2002


2001ASSETSCurrent assets:Cash and cash equivalents

$
8,570


$
7,509Marketable securities


14,397



27,619Accounts receivable, net of allowance for doubtful accounts of $34 and $20, respectively


688



666Inventories, net


1,295



1,410Related party notes receivable






144Prepaid expenses and other current assets


972



883Total current assets


25,922



38,231Long-term investments


528



3,048Related party notes receivable






354Property and equipment, net


766



1,216Intangible assets, net of accumulated amortization of $904 and $771, respectively






133Other assets


20



91Total assets

$
27,236


$
43,073LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
191


$
449Accrued liabilities


882



1,077Notes payable


42



207Total current liabilities


1,115



1,733Other liabilities


18



52Total liabilities


1,133



1,785Commitments and contingencies (Note 5)Stockholders equity:Preferred stock, $.001 par value: 5,000,000 shares authorizedIssued and outstanding: none






Common stock, $.001 par value: 50,000,000 shares authorizedIssued and outstanding: 19,993,000 and 19,641,000, respectively


20



19Additional paid-in capital


90,128



90,368Deferred stock compensation


(125
)


(956
)Accumulated deficit


(63,732
)


(48,291
)Treasury stock, at cost326,000 shares at December 31, 2002


(234
)


Accumulated other comprehensive income


46



148Total stockholders equity


26,103



41,288Total liabilities and stockholders equity

$
27,236


$
43,073





See accompanying notes to consolidated financial statements




37




---







CURON MEDICAL, INC.





CONSOLIDATED STATEMENTS OF OPERATIONS


(in thousands, except per share amounts)





For the Year Ended December 31,2002


2001


2000Revenues

$
3,403


$
3,317


$
1,156Cost of goods sold


4,491



4,994



2,102Gross loss


(1,088
)


(1,677
)


(946
)Operating expenses:Research and development


2,668



2,825



4,161Clinical and regulatory


1,373



1,745



1,805Sales and marketing


7,065



6,973



3.461General and administrative


4,023



4,443



4,181Total operating expenses


15,129



15,986



13,608Operating loss


(16,217
)


(17,663
)


(14,554
)Interest income


751



2,240



1,330Interest expense


(8
)


(4
)


(4,083
)Other income (expense)


33



(2
)


(68
)Loss before extraordinary item


(15,441
)


(15,429
)


(17,375
)Extraordinary gainearly extinguishment of debt










1,596Net loss

$
(15,441
)

$
(15,429
)

$
(15,779
)Net loss per common share, basic and diluted:Loss before extraordinary item

$
(0.79
)

$
(0.81
)

$
(2.50
)Extraordinary gainearly extinguishment of debt

$
0.00


$
0.00


$
0.23Net loss per share, basic and diluted

$
(0.79
)

$
(0.81
)

$
(2.27
)Shares used in computing net loss per share, basic and diluted


19,653



19,075



6,945








See accompanying notes to consolidated financial
        statements




38




---







CURON MEDICAL, INC.





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)


For the Years Ended December 31, 2002, 2001, and 2000


(in thousands)





Common Stock

Additional
Paid-in
Capital


Deferred
Stock
Compensation


Accumulated
Deficit


Treasury
Stock


Accumulated
Other
Comprehensive
Income

Total
Stockholders
Equity (Deficit)Shares


AmountBalance at January 1, 2000

2,819


$
3

$
8,644


$
(3,663
)

$
(17,083
)


$



$


$
(12,099
)Net loss
















(15,779
)









(15,779
)Change in unrealized gain on investment
























75


75Total comprehensive loss




























(15,704
)Issuance of common stock in exchange for patent license

        agreements

86






831



















831Issuance of 12,000 stock options in exchange for services








40


















40Issuance of common stock in exchange for consulting services received

17






203


















203Issuance of common stock pursuant to initial public offering and exercise of overallotment shares, net of issuance costs
        of $5,453

5,475



5


54,767



















54,772Conversion of Series A, B and C preferred stock and warrants to common stock and common stock warrants upon consummation of initial
        public offering and exercise of overallotment shares

9,597



10


23,898


















23,908Issuance of common stock upon exercise of stock options

1,164



1


283


















284Deferred stock compensation








1,483



(1,483
)














Amortization of deferred stock compensation












2,695















2,695Balance at December 31, 2000

19,158



19


90,149



(2,451
)


(32,862
)







75


54,930Net loss
















(15,429
)










(15,429
)Change in unrealized gain on investment
























73


73Total comprehensive loss



























(15,356
)Issuance of common stock upon exercise of warrants

124

























Issuance of common stock upon exercise of stock options

220






45


















45Issuance of common stock through Employee Stock Purchase Plan

139






333


















333Deferred stock compensation








(159
)


159














Amortization of deferred stock compensation












1,336














1,336Balance at December 31, 2001

19,641



19


90,368



(956
)


(48,291
)






148


41,288Net loss
















(15,441
)










(15,441
)Change in unrealized gain on investment
























(102
)

(102
)Total comprehensive loss



























(15,543
)Issuance of common stock upon exercise of stock options

212






49


















49Issuance of common stock through Employee Stock Purchase Plan

140



1


185


















186Deferred stock compensation








(474
)


474














Amortization of deferred stock compensation












357














357Repurchase of common stock




















(234
)





(234
)Balance at December 31, 2002

19,993


$
20

$
90,128


$
(125
)

$
(63,732
)

$
(234
)

$
46

$
26,103





See accompanying notes to the consolidated financial statements




39




---







CURON MEDICAL, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


(in thousands)





|                                                                            |  | For the Year Ended December 31, |        
|--------------------------------------------------------------------------- |  | ------------------------------- | -------
|                                                                            |  | 2002                            |        
|Cash Flows From Operating Activities                                        |  |                                 |        
|Net loss                                                                    |  | $                               | (15,441
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                 |        
|Depreciation and amortization                                               |  |                                 | 702    
|Loss on forgiveness of related party receivables                            |  |                                 | 410    
|Amortization of acquired technology                                         |  |                                 | 133    
|Extraordinary gain on extinguishment of debt, net                           |  |                                 |       
|Note payable issued in exchange for services received                       |  |                                 |       
|Loss on disposal of fixed assets                                            |  |                                 | 21     
|Amortization of stock-based compensation                                    |  |                                 | 357    
|Amortization of discounts on notes payable                                  |  |                                 |       
|Stock issued in exchange for services and intellectual property received    |  |                                 |       
|Stock options issued in exchange for services received                      |  |                                 |       
|Accretion of discount on securities, net                                    |  |                                 | (185   
|Changes in current assets and liabilities:                                  |  |                                 |        
|Accounts receivable, net                                                    |  |                                 | (22    
|Inventories                                                                 |  |                                 | 115    
|Prepaid expenses and other current assets                                   |  |                                 | (89    
|Other assets                                                                |  |                                 | 71     
|Accounts payable                                                            |  |                                 | (258   
|Accrued liabilities                                                         |  |                                 | (195   
|Other long-term liabilities                                                 |  |                                 | (34    
|                                                                            |  |                                 |        
|Net cash used in operating activities                                       |  |                                 | (14,415
|                                                                            |  |                                 |        
|                                                                           
|Cash Flows From Investing Activities                                        |  |                                 |        
|Purchase of property and equipment                                          |  |                                 | (343   
|Sale of property and equipment                                              |  |                                 | 70     
|Purchase of marketable securities                                           |  |                                 | (20,376
|Proceeds from maturities of marketable securities                           |  |                                 | 36,201 
|Purchase of acquired technology                                             |  |                                 |       
|                                                                            |  |                                 |        
|Net cash provided by (used in) investing activities                         |  |                                 | 15,552 
|                                                                            |  |                                 |        
|                                                                           
|Cash Flows From Financing Activities                                        |  |                                 |        
|Proceeds from issuance of notes payable                                     |  |                                 | 140    
|Proceeds from issuance of convertible notes payable                         |  |                                 |       
|Repayment of convertible notes                                              |  |                                 |       
|Principal payments on notes payable                                         |  |                                 | (305   
|Proceeds from related party notes receivable                                |  |                                 | 143    
|Payments of related party notes receivable                                  |  |                                 | (55    
|Proceeds from issuance of common stock, net of issuance costs               |  |                                 | 235    
|Purchase of treasury stock                                                  |  |                                 | (234   
|                                                                            |  |                                 |        
|Net cash provided by (used in) financing activities                         |  |                                 | (76    
|                                                                            |  |                                 |        
|Net increase (decrease) in cash and cash equivalents                        |  |                                 | 1,061  
|Cash and cash equivalents at beginning of period                            |  |                                 | 7,509  
|                                                                            |  |                                 |        
|Cash and cash equivalents at end of period                                  |  | $                               | 8,570  
|                                                                            |  |                                 |        
|                                                                           
|Supplemental Disclosure of Cash Flow Information                            |  |                                 |        
|Cash paid for interest                                                      |  | $                               | 8      
|                                                                           
|Supplemental Disclosure of Non-Cash Investing and Financing Information     |  |                                 |        
|Issuance of warrants with debt                                              |  | $                               |       
|Issuance of common stock in exchange for intangible assets                  |  | $                               |       
|Conversion of preferred stock to common stock                               |  | $                               |       




See accompanying notes to the consolidated financial statements




40




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

# (Tabular amounts
in thousands, except share and per share data)

## NOTE
1FORMATION AND BUSINESS OF THE COMPANY:

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

In the course of its
development activities, the Company has sustained operating losses and negative
cash flows from operations and expects such losses to continue in the
foreseeable future. The Company intends to finance its operations primarily
through its cash and cash equivalents, marketable securities, future financing
and future revenues. The Company believes it has enough cash to fund operations
for at least 18 to 24 months. The Company also believes alternative financing is
available, if needed, however, there can be no assurance that such efforts will
succeed or that sufficient funds will be made available.

## NOTE
2SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

## Basis of
Presentation

The accompanying
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in preparation of the consolidated financial
statements.

## Use of
Estimates

The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States of America requires management to make certain estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.

## Certain Risks
and Uncertainties

The Companys products
and services are currently concentrated in a single segment of the
gastrointestinal treatment field, which is characterized by increasing
technological advances and changes in customer requirements. The success of the
Company depends on managements ability to anticipate or to respond quickly
and adequately to technological developments in its industry, changes in
customer requirements or industry standards. Failure to obtain or maintain
necessary FDA clearances or approvals could hurt the Companys ability to
commercially distribute and market its products in the United States. Any
significant delays in the development or introduction of products or services
could have a material adverse effect on the Companys business and
operating results. The Company has two products that it is currently marketing:
radio-frequency generators and single use disposable devices. A single supplier
currently provides some components and materials necessary for manufacturing of
products. Any technical or quality problems in the manufacturing of these
components, changes to the product specifications, changes in rights to
currently licensed intellectual property, or lack of essential equipment by
suppliers, could have a significant impact on the Companys financial
condition and results of operations.



41




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

## Stock Split

In September 2000, the
Companys Board of Directors effected a 0.57 for 1 reverse stock split. All
share and per share amounts in the accompanying financial statements have been
restated to reflect the effect of this reverse stock split.

## Cash and Cash
Equivalents

The Company considers all highly
liquid investments purchased with remaining maturities of three months or less
at the date of purchase to be cash equivalents. The Companys cash and cash
equivalents include deposit funds, money market funds and commercial paper.

## Marketable
Securities

Investments consist
primarily of marketable corporate bonds, commercial paper and government agency
securities with a remaining maturity at the date of purchase of greater than
three months. Investments with maturities beyond 2003 are classified as
long-term investments and those maturing during 2003 are shown as current
marketable securities. These investments are classified as available-for-sale
securities and are stated at market value, with any temporary differences
between an investments amortized cost and its market value recorded as a
separate component of stockholders equity (deficit) until such gains or
losses are realized. Gains or losses on the sales of securities are determined
on a specific identification basis. The following is a summary of investments at
December 31, 2002 and 2001, respectively:

Cost

Gross
Unrealized
Holding Gains

Gross
Unrealized
Holding Losses


Fair
ValueMaturities under one yearGovernment obligations

$
6,604

$
29

$



$
6,633Corporate obligations


7,748


16






7,764Total


14,352


45






14,397Maturities between one and two yearsGovernment obligations


-


-


-



-Corporate obligations


527


1


-



528Total


527


1


-



528Total at December 31, 2002

$
14,879

$
46

$
-


$
14,925Maturities under one yearGovernment obligations

$
5,545

$
30

$



$
5,575Corporate obligations


21,940


104






22,044Total


27,485


134






27,619Maturities between one and two yearsGovernment obligations


2,006


1


(4
)


2,003Corporate obligations


1,028


17






1,045Total


3,034


18


(4
)


3,048Total at December 31, 2001

$
30,519

$
152

$
(4
)

$
30,667




42




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

## Inventories

Inventories are stated at
the lower of standard cost (which approximates average cost) or market.

## Property and
Equipment

Property and equipment are
stated at cost less accumulated depreciation and amortization. Depreciation is
computed using the straight-line method over the estimated useful lives of the
assets. Fixed assets are depreciated over a life of three to five years.
Leasehold improvements are amortized using the straight-line method over the
estimated useful life of the improvement, or the lease term, if shorter. Upon
retirement or sale, the cost and related accumulated depreciation are removed
from the balance sheet and the resulting gain or loss is reflected in
operations. Maintenance and repairs are charged to operations as incurred.

## Intangible
Assets

Intangible assets consist
of technology licenses, which are being amortized on a straight-line basis over
their estimated useful lives of two years.

## Impairment of
Long-Lived Assets

Long-lived assets and
certain identifiable intangible assets to be held and used are reviewed for
impairment when events or changes in circumstances indicate the carrying amount
of an asset may not be recoverable, or its estimated useful life has changed
significantly. When an assets expected future undiscounted cash flows are
less than its carrying value, an impairment loss is recognized and the asset is
written down to its estimated fair value. Long-lived assets and certain
identifiable intangible assets to be disposed of are reported at the lower of
the carrying amount or fair value less cost to dispose. There have been no
impairment charges recorded.

## Revenue
Recognition

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

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

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



43




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

## Product
Warranty

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

Changes in product warranty
obligations, including separately priced extended warranty obligations, for the
year ended December 31, 2002 is as follows:

Balance as of January 1, 2002

$
33Add:Accruals for warranties issued



25Cost incurred under separately priced extended warranty obligations


5Less:Settlements made



(14
)Revenue recognized under separately priced extended warranty



(5
)$
44


## Research and
Development

Research and development costs
are expensed as incurred. Legal expenses related to patent development costs are
expensed as incurred.

## Advertising
Costs

Advertising costs are
expensed as incurred and were $348,000 in 2002 and $428,000 in 2001, and
$287,000 in 2000.

## Income Taxes

The Company accounts for
income taxes under the liability method whereby deferred tax asset or liability
account balances are calculated at the balance sheet date using current tax laws
and rates in effect for the year in which the differences are expected to affect
taxable income. Valuation allowances are established when necessary to reduce
deferred tax assets to the amounts expected to be realized.

## Accounting for
Stock-Based Compensation

The Company accounts for
stock-based employee compensation arrangements in accordance with provisions of
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (APB No. 25) and complies with the disclosure provisions of
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123), as amended by SFAS No. 148, Accounting for
Stock-Based Compensation, Transition and Disclosure. Under APB No. 25,
unearned stock compensation is based on the difference, if any, on the date of
grant, between the fair value of the Companys common stock and the
exercise price.



44




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

The Company accounts for
equity instruments issued to non-employees in accordance with the provisions of
SFAS No. 123 and Emerging Issues Task Force No. 96-18, Accounting for Equity
Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services. The equity instruments are valued
using the Black-Scholes Model. All unvested shares are marked to market until
such options vest.

All deferred stock
compensation is amortized and expensed in accordance with FASB Interpretation
No. 28, an accelerated vesting model.

## Net Loss per
Share

Basic net loss per share is
calculated based on the weighted-average number of common shares outstanding
during the period excluding those shares that are subject to repurchase. Diluted
net loss per share would give effect to the dilutive effect of common stock
equivalents consisting of stock options, warrants, and common stock subject to
repurchase (calculated using the treasury stock method). Potentially dilutive
securities have been excluded from the diluted net loss per share computations
as they have an antidilutive effect due to the Companys net loss.

## Fair Value of
Financial Instruments

The carrying value of the Companys
financial instruments, including cash and cash equivalents, trade accounts
receivable, related party receivables, and accounts payable approximate fair
value. Based on borrowing rates currently available to the Company for loans
with similar terms, the carrying value of obligations approximates fair value.

## Segments

The Company operates in one
segment, using one measurement of profitability to manage its business. All
long-lived assets are maintained in the United States.

## Reclassification

Certain reclassifications
have been made to prior year balances in order to conform to the current year
presentation.

## Recent
accounting pronouncements

In June 2002, The Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 146 (SFAS 146), Accounting for Costs Associated with Exit or
Disposal Activities, which supersedes EITF Issue No. 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). This new standard
requires companies to recognize costs associated with exit or disposal
activities when the costs are incurred rather than at the date of a commitment
to an exit disposal plan. Costs covered by the standard include lease
termination costs and certain employee severance costs that are associated with
a restructuring, discontinued operations, plant closing, or other exit or
disposal activity. This standard is effective for exit or disposal activities
that are initiated after December 31, 2002. The Company will adopt SFAS No. 146
as of January 1, 2003 and does not believe that the adoption will have a
significant impact on the financial position or results of operations.



45




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

In November 2002, the
Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 45 (FIN45), Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN 45 requires that a liability be recorded in
the guarantors balance sheet upon issuance of a guarantee. In addition,
FIN 45 requires disclosures about the guarantees that an entity has issued,
including a reconciliation of changes in the entitys product warranty
liabilities. The initial recognition and initial measurement provisions of FIN
45 are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002, irrespective of the guarantors fiscal year-end. The
disclosure requirements of FIN 45 are effective for financial statements of
interim or annual periods ending after December 15, 2002. The Company believes
that the adoption of this standard will have no material impact on its financial
statements.

In November 2002, the
Emerging Issues Task Force (EITF) reached a consensus on Issue No.
00-21, Revenue Arrangements with Multiple Deliverables. EITF Issue
No. 00-21 provides guidance on how to account for arrangements that involve the
delivery or performance of multiple products, services and/or rights to use
assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
Company believes the adoption of this standard will have no material impact on
the Companys financial statements.

In December 2002, the FASB
issued SFAS No. 148, which provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. SFAS No. 148 also requires that disclosures of the pro
forma effect of using the fair value method of accounting for stock-based
employee compensation be displayed more prominently and in a tabular format.
Additionally, SFAS No. 148 requires disclosure of the pro forma effect in
interim financial statements. The transition and annual disclosure requirements
of SFAS No. 148 are effective for fiscal years ended after December 15, 2002.
The interim disclosure requirements are effective for interim periods beginning
after December 15, 2002. The adoption of this standard did not have a material
impact on the Companys financial statements.

In January 2003, the FASB
issued FASB Interpretation No. 46 (FIN 46), Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46
requires certain variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective
immediately for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period beginning after June 15, 2003. The Company does not have any
ownership in any variable interest entities as of December 31, 2002. The Company
will apply the consolidation requirement of FIN 46 in future periods if we
should own any interest in any variable interest entity.



46




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

## NOTE
3BALANCE SHEET COMPONENTS:

December 31, 2002


December 31, 2001Inventories:Raw materials

$
888

$
1,033Work-in-process


97


7Finished goods


310


370$
1,295

$
1,410


December 31, 2002


December 31, 2001Property & Equipment:Computer and office equipment

$
566


$
575Equipment


1,551



1,596Furniture and fixtures


166



161Leasehold improvements


354



354Software


245



2342,882



2,920Less: Accumulated depreciation and amortization


(2,116
)


(1,704
)$
766


$
1,216December 31, 2002


December 31, 2002Accrued Liabilities:Compensation and benefits

$
486


$
701Clinical trials


99



110Professional fees


49



142Other accrued expenses


248



124$
882


$
1,077


## NOTE 4NOTES
PAYABLE:

The Company had short-term
notes payable at December 31, 2002 and 2001 in the amounts of $42,000 and
$207,000, respectively. In 2002, the note relates to the financing of corporate
insurance policies in the amount of $140,000, excluding Directors and
Officers Liability Insurance. The note bears interest at 5.75%, with final
payment due in March 2003. In 2001, the note related to financing of the
Directors and Officers Liability Insurance policy in the amount of
$308,000 in October 2001. The note had interest at 6% per annum, and was paid in
full in June 2002.



47




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

## NOTE
5COMMITMENTS AND CONTINGENCIES:

## Leases

The Company leases office
space under noncancelable operating leases expiring in September 2003. Rent
expense for the years December 31, 2002, 2001, and 2000 was $528,000, $532,000
and $546,000 respectively.

At December 31, 2002,
future minimum facility lease payments are $409,000.

## 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 June 2001, a civil
action was filed against the Company in the United States District Court,
Western District of Kentucky, Louisville Division, alleging that the Plaintiff
sustained a nerve injury and damage to his gastrointestinal tract during a
Stretta Procedure caused by the defective design and manufacture of the
Companys product. Plaintiffs allegations against the Company include
strict liability for a product that was in a defective and unreasonably
dangerous condition, negligence in the design and manufacturing of the product,
breach of implied warranty of merchantability, and loss of consortium. Plaintiff
was a subject in a randomized clinical trial and had been provided with an
approved Informed Consent form and counseling by the physician. Prior to
treatment, the subject provided consent to proceed. Plaintiff is seeking a trial
by jury and unspecified damages. Trial date is currently set in September 2003.
The Company believes Plaintiffs claim is without merit.

In September 2001, a civil
action was filed against a number of defendants, including the Company, in the
Superior Court of the State of California in and for the City and County of
Santa Clara, alleging that the Plaintiff sustained injury when undergoing a
procedure utilizing the Stretta System, caused by defects in design and
manufacture. Plaintiff also alleges negligence in the design, manufacture,
advertising and sale of the Stretta System and that its warnings, instructions
and directions for use were inadequate. Additional defendants include the
treating physicians and the associated medical institutions, which it is
alleged, were medically negligent in treatment of Plaintiff. Plaintiff is
seeking unspecified damages. On January 24, 2003, the Company filed a Motion for
Summary Judgment, which will be heard on April 22, 2003.

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

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



48




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

## Development
and Technology License Agreements

The Company licenses
certain radiofrequency technology through an agreement that gives the Company an
irrevocable license to manufacture, have manufactured, use, offer to sell, sell
and import radiofrequency generators based on the licensed technology in the
licensed field. The agreement expires on October 6, 2017. Royalties are accrued
at the time of sale, based on the revenues recognized when the related licensed
technology is part of the sold item.

In February and April 2000,
the Company entered into two separate licensing agreements for the use of
proprietary radiofrequency technologies used in certain of the Companys
products. The Company issued 86,000 shares of its common stock, valued at
$831,000 on the date of the agreements, in exchange for the right to use the
technologies. In addition, $73,000 was paid in conjunction with the licensed
technology. As part of the February agreement, the Company is also required to
pay a royalty on all revenues collected when the related licensed technology is
part of the sold item. Such payments were not significant in 2002.

## NOTE
6EXTRAORDINARY GAIN:

In May 2000, the Company
received $11.0 million in cash and $45,000 in services in exchange for
convertible notes due and payable in May 2005 with detachable warrants to
purchase 568,917 shares of common stock. The notes, which were convertible into
2,107,000 shares of preferred stock and bore interest at 8% per annum, had a
beneficial conversion feature associated with them. The value of the warrants
and value of the notes (including the value of the beneficial conversion
feature) were adjusted using their relative fair values to the face amount of
the notes. The warrants were exercisable immediately and will expire in
September 2005. Accordingly, the warrants were recorded at $2.1 million and the
beneficial conversion feature was recorded at $9.0 million, both as additional
paid-in capital and a discount on the notes. The discount associated with both
the warrants and the beneficial conversion feature were amortized to interest
expense; the warrant over the contractual life of the notes and the beneficial
conversion feature over one year, the earliest conversion date. The total amount
recorded as interest expense was $4.0 million through September 2000.

In September 2000, the
notes were repaid and a loss on the early extinguishment of debt of $1.4 million
associated with the remaining unamortized balance of the warrant discount was
recorded. Additionally, the original amount recorded as beneficial conversion
feature was reversed, resulting in a gain on the early extinguishment of debt of
$3.0 million. The net extraordinary gain associated with the early
extinguishment of the debt was $1.6 million.

## NOTE
7COMMON STOCK:

The Companys
Certificate of Incorporation, as amended, authorizes the Company to issue
50,000,000 shares of $.001 par value common stock. Certain of the shares issued
are subject to a right of repurchase by the Company, which lapses over a three
or four-year period from the issuance dates. At December 31, 2002, 2001 and 2000
there were 34,000, 280,000 and 694,000 shares subject to repurchase,
respectively.

## Common Stock
Warrants

In connection with a line
of credit agreement in 1999, the Company issued a warrant to purchase 86,000
shares of stock for $0.88 per share. The warrant expires in 2005. The aggregate
value of the warrant of $120,000, determined using a Black-Scholes valuation
model, was recorded as a discount to the related notes payable, and was expensed
as interest expense over the life of the debt. In March 2001, these, along with
certain other warrants to purchase 153,000 shares, were exercised to purchase
124,000 shares of common stock.



49




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

In May 2000, the company
issued warrants to purchase 568,917 shares of common stock in connection with
convertible notes payable (See Note 6). These warrants are exercisable
immediately and expire in 2005. The value of the warrants, $2.1 million, was
determined using the Black-Scholes option-pricing model. These warrants are
outstanding at December 31, 2002.

## Stockholder
Rights Plan

In October 2001, the
Company adopted a Preferred Stock Rights Agreement. Under this agreement, the
Company will issue a dividend of one Preferred Share Purchase Right (a
Right) for each share of common stock held by stockholders of record
as of the close of business on November 20, 2001. Each Right entitles the
registered stockholder to purchase from the Company one one-thousandth of a
share of the Companys Series A Participating Preferred Stock
(Preferred Stock) at an exercise price of $30.00. The agreement is
designed to assure stockholders fair value in the event of a future unsolicited
business combination or similar transaction.

The Rights do not have any
voting rights, and will expire upon the earlier of redemption or November 20,
2011. If the Rights are exercised, each stockholder receives one one-thousandth
of a share of Preferred Stock, which entitles the holder to one additional vote
and dividends and liquidation rights equal to that paid on common stock.

## NOTE
8STOCK OPTION PLANS AND OTHER EMPLOYEE BENEFITS:

## 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
nonstatutory stock options. Incentive stock options (ISO) may be granted only to
Company employees (including officers and directors who are also employees).
Nonstatutory 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 December 31, 2002, there were 3,939,967 shares
authorized for issuance under this plan.

Under both plans, options
are granted for a period of up to ten years and at prices no less than 85% of
the estimated fair value of the shares on the date of grant, provided, however,
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.

## Deferred Stock
Compensation

Prior to its IPO in
September 2000, the Company issued stock options under the 1997 Plan at exercise
prices, deemed by the Board of Directors at the date of grant to be equal to the
fair value of the common stock. In anticipation of the Companys initial
public offering, the Company subsequently determined that, for financial
statement purposes, the estimated value of its common stock was in excess of the
exercise prices. Accordingly, the Company has recorded deferred stock
compensation for stock options issued to both employees and non-employees.



50




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

For stock options granted
to employees (1,098,000 in 2002, 1,139,000 in 2001 and 407,000 in 2000), the
difference, if any, between the exercise price of the stock options and the fair
value of the Companys stock at the date of grant is recorded as deferred
compensation on the date of grant. For stock options granted to non-employees,
generally for future services (none in 2002, 41,000 in 2001 and 104,000 in
2000), the fair value of the options, estimated using the Black-Scholes
valuation model, is initially recorded as deferred stock compensation on the
date of grant. As the non-employee fulfills the terms of the option grants, all
relating to continued services to the Company, the Company revalues the
remaining unvested options, with the change in fair value from period to period
represented as an adjustment of compensation expense and deferred stock
compensation.

Amortization of deferred
stock compensation is as follows:

Years Ended December 31,2002

2001

2000Cost of goods sold

$
7

$
90

$
131Research and development


66


205


629Clinical and regulatory


51


121


174Sales and marketing


47


250


418General and administrative


186


670


1,343$
357

$
1,336

$
2,695


Activity under stock option
plans is as follows:

2002

2001

2000Shares
Under
Options


Weighted
Average
Exercise
Price

Shares
Under
Options


Weighted
Average
Exercise
Price

Shares
Under
Options


Weighted
Average
Exercise
PriceBeginning balance

2,083,000


$
3.11

1,283,000


$
2.83

1,982,000


$
0.21Granted

1,098,000


$
1.01

1,180,000


$
3.40

511,000


$
6.24Exercised

(212,000
)

$
0.23

(220,000
)

$
0.23

(1,165,000
)

$
0.24Cancelled

(553,000
)

$
2.61

(160,000
)

$
4.11

(45,000
)

$
2.05Ending balance

2,416,000


$
2.52

2,083,000


$
3.11

1,283,000


$
2.83Exercisable at year-end

853,000


$
3.40

719,000


$
2.56

317,000


$
0.20




51




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

The options outstanding and currently
exercisable by exercise price at December 31, 2002 are as follows:

Options Outstanding and Exercisable

ExercisableRange of
Exercise Prices

Number
Outstanding

Weighted Average
Remaining
Contractual
Life (Years)

Weighted
Average
Exercise
Price

Number
Exercisable

Weighted
Average
Exercise
Price$0.18$0.26

252,000

6.0

$
0.19

232,000

$
0.190.610.70

1,001,000

9.5


0.07

43,000


0.662.703.87

661,000

8.6


3.07

249,000


3.124.394.50

343,000

8.0


4.47

243,000


4.477.00

20,000

8.0


7.00

11,000


7.00$11.84$12.50

139,000

7.4


11.84

75,000


11.842,416,000

8.5

$
2.52

853,000

$
3.40


## Fair Value
Disclosures

The fair value of options
granted is estimated on the date of grant using the Black-Scholes option pricing
model, using the following assumptions:

Stock Option Plans


ESPP2002

2001

2000

2002

2001Assumptions:Risk-free interest rate


3.53%


4.43%


6.30%


2.07%


4.64%Expected life


4 years


4 years


4 years


0.6 years


0.5 yearsExpected volatility


99%


90%


85%


100%


90%Expected dividend yield


0.0%


0.0%


0.0%


0.0%


0.0%Weighted average fair values:Exercise price less than market price

$


$
2.40

$
8.01

$
1.12

$
2.24Exercise price equal to market price

$
0.71

$
2.25

$
6.69

$


$
Exercise price greater than market price

$


$
0.93

$


$


$



As discussed in Note 2, the
Company accounts for its stock-based compensation using the method prescribed by
APB No. 25. Had the Company determined its stock-based compensation based on the
fair value at the grant dates for the awards under a method prescribed by SFAS
No. 123, the Companys net loss would have been increased to the FAS 123
adjusted amounts indicated below, as amended by SFAS No. 148:



52




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

Year Ended December 31,2002


2001


2000Net loss, as reported

$
(15,441
)

$
(15,429
)

$
(15,779
)Add:
Stock-based employee compensation expense in reorted net income


357



1,336



2,695Deduct:
Total stock-based employee compensation expense determined under fair value based method for all awards


(2,072
)


(3,497
)


(3,359
)Net lossFAS 123 adjusted

$
(17,156
)

$
(17,590
)

$
(16,443
)Net loss per shareas reportedBasic and diluted

$
(0.79
)

$
(0.81
)

$
(2.27
)Net loss per shareFAS 123 adjustedBasic and diluted

$
(0.87
)

$
(0.92
)

$
(2.37
)


## 401(k) Savings
Plan

In October 1999, the
Company began a 401(k) savings plan (the 401(k) Plan). The 401(k)
Plan is a defined contribution plan intended to qualify under Section 401(a) and
401(k) of the Internal Revenue Code. All full-time employees of the Company are
eligible to participate in the 401(k) Plan pursuant to the terms of the Plan.
Contributions by the Company are discretionary and no contributions have been
made by the Company for the years ended December 31, 2002, 2001, or 2000.

## Employee Stock
Purchase Plan

Effective September 21,
2000, the Company adopted the 2000 Employee Stock Purchase Plan (ESPP). A total
of 400,000 shares of common stock were initially reserved for issuance under
this plan. In addition, subject to the Board of Directors discretion, on
January 1, 2001 and on each anniversary thereafter, the aggregate number of
shares reserved for issuances under the ESPP will be increased automatically by
the lesser of: 500,000 shares, 1.5% of the outstanding shares of the
Companys Common Stock, or a lesser amount determined by the Board of
Directors. During 2002 and 2001, the shares reserved for issuance under the ESPP
were increased by 295,000 and 285,000 shares, respectively.

Under the ESPP, eligible
employees may have up to 15% of their earnings withheld, subject to certain
limitations, to be used to purchase shares of the Companys common stock.
Unless the Board of Directors shall determine otherwise, each offering period
provides for consecutive 24-month periods commencing on each May 1 and November
1. Each offering period is comprised of four 6-month purchase periods. The price
at which common stock may be purchased under the ESPP is equal to 85% of the
lower of the fair market value of common stock on the commencement date of each
offering period or the fair market value on the last day of the purchase period.
During 2002, the shares purchased under the ESPP were 65,000 and 75,000 on May 1
and November 1, respectively.



53




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

## NOTE
9NET LOSS PER SHARE:

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

Year Ended December 31,2002


2001


2000Numerator:Net loss

$
(15,441
)

$
(15,429
)

$
(15,779
)Denominator:Weighted average shares outstanding


19,785,000



19,462,000



8,048,000Weighted average unvested common shares subject to repurchase


(132,000
)


(387,000
)


(1,103,000
)Weighted average shares used in basic and diluted net loss per share


19,653,000



19,075,000



6,945,000Net loss per share

$
(0.79
)

$
(0.81
)

$
(2.27
)


The Company has issued
shares to employees and non-employees that are subject to repurchase should an
employee terminate employment with the Company. The shares vest monthly and the
vesting periods range from 36 months to 48 months. Shares subject to repurchase
are excluded from the average shares used in the calculation of basic and
diluted net loss per share.

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

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

At December 31,2002

2001

2000Unvested common shares (shares subject to repurchase)

34,000

280,000

694,000Shares issuable upon exercise of stock options

2,416,000

2,083,000

1,283,000Shares issuable upon exercise of warrants

569,000

569,000

722,000Total

3,019,000

2,932,000

2,699,000




54




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

## NOTE
10GEOGRAPHIC SEGMENT INFORMATION

The Company has determined
that it has a single reportable segment consisting of the development,
manufacture, and marketing of proprietary products for the treatment of
gastrointestinal disorders. Management uses one measurement of profitability and
does not disaggregate its business for internal reporting. Operations outside
the United States primarily consist of a sales office in Belgium that is
responsible for promoting sales activities to foreign customers who are invoiced
by the Companys headquarters in the United States, and a subsidiary in
Australia that was used to coordinate Australian clinical trials in the past,
and currently is inactive. The foreign subsidiaries do not carry any significant
long-lived assets, and income and assets of the Companys foreign
subsidiaries were not significant.

Revenue from external
customers by geographic area for each of the three years in the period ended
December 31, 2002, were as follows (tabular amounts are not in thousands):

2002

2001

2000United States

$
2,980,000

$
3,183,000

$
1,156,000% of total


87.6%


96.0%


100.0%Europe

$
423,000

$
134,000

$
% of total


12.4%


4.0%


0.0%


## NOTE
11INCOME TAXES:

Deferred tax assets consist
of the following:

December 31,2002


2001Deferred tax assetsDepreciation and amortization

$
537


$
436Reserves


158



340Credits


1,015



743Capitalized start-up costs


596



895Net operating loss carryforwards


18,855



13,18121,161



15,595Valuation allowance


(21,161
)


(15,595
)Net deferred tax assets

$



$



Based on the available
objective evidence, management believes it is more likely than not that the net
deferred tax assets will not be fully realizable. Accordingly, the Company has
provided a full valuation allowance against its net deferred tax assets at
December 31, 2002 and 2001.



55




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

As of December 31, 2002,
the Company has a net operating loss carryforward of approximately $49,500,000
for federal purposes and $34,700,000 for state tax purposes. If not utilized,
these carryforwards will begin to expire beginning in 2013 for federal purposes
and 2006 for state purposes.

The Company has research
and development credit carryforwards of approximately $649,000 and $499,000 for
federal and state income tax purposes, respectively. If not utilized, the
federal carryforward will expire in various amounts beginning in 2013. The
California credit can be carried forward indefinitely.

The Tax Reform Act of 1986
limits the use of net operating loss and tax credit carryforwards in certain
situations where changes occur in the stock ownership of a company. In the event
the Company has had a change in ownership, utilization of the carryforwards
could be restricted.

## NOTE
12RELATED PARTY TRANSACTIONS:

In 1999, the Company
entered into a three-year agreement with John Morgan, then President and CEO of
the Company, to loan him $8,500 per month as a reimbursement of housing costs.
The total amount loaned under this arrangement at December 31, 2001 was
$204,000, and was classified as a long-term related party note receivable on the
balance sheet. Upon his resignation in July 2002, this note and $13,000 of
related interest receivable were forgiven, and a total amount of $272,000 was
recognized as an expense to the Company.

During 2001, the Company
entered into three related party notes receivable arrangements with officers of
the Company: a $150,000 note receivable from the Chief Medical Officer, which
had a two-year maturity date; a $69,000 note receivable the Vice President of
Sales, which had a one year maturity date; and a $75,000 note receivable from
the Vice President of Engineering, Research and Development, which had a
nine-month maturity. Balances at December 31, 2001 related to these notes were
$144,000 as short-term receivable, and $150,000 as long term receivable. During
2002, the short-term notes were repaid, and the $150,000 note plus interest
receivable was forgiven, based on the original agreement, as amended, and the
amount of $168,000 was recognized as an expense to the Company.

## NOTE
13SUBSEQUENT EVENTS:

On February 5, 2003, a
civil action was filed against the Company in the District Court of Dallas
County, in the State of Texas, alleging that the Plaintiff sustained serious
injuries during a Stretta Procedure performed in February 2001, caused by the
device being in a defective condition. The Company has no further information on
this claim, and believes it to be without merit.

On February 21, 2003, the
Company voluntarily recalled a limited number of catheters, which contained
material, supplied by one particular, former vendor. This material formed part
of the catheter shaft and showed a tendency to degrade over time. If this were
to happen during use, there would be a remote possibility of superficial injury
to the patients esophageal or pharyngeal lining. No injuries have been
reported and all unused catheters in the affected lots have been recovered. This
recall did not have a material impact on the financial position, results of
operations or cash flows of the Company for the year ended December 31, 2002.



56




---




# CURON
MEDICAL, INC.

# NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, continued

# (Tabular amounts
in thousands, except share and per share data)

## NOTE
14QUARTERLY FINANCIAL DATA:

(UNAUDITED)

The following table
presents certain unaudited quarterly financial information for the eight
quarters ended December 31, 2002. In our opinion, this information has been
prepared on the same basis as the audited financial statements and includes all
adjustments (consisting only of normal recurring adjustments) necessary to
present fairly the unaudited quarterly results of operations set forth herein.

First
Quarter


Second
Quarter


Third
Quarter


Fourth
Quarter


Fiscal
YearNet Sales2002

$
939


$
877


$
746


$
841


$
3,4032001


1,218



568



826



705



3,317Gross Loss2002


(144
)


(258
)


(395
)


(291
)


(1,088
)2001


(81
)


(615
)


(456
)


(525
)


(1,677
)Net Loss2002


(3,825
)


(4,235
)


(4,152
)


(3,229
)


(15,441
)2001


(2,960
)


(4,343
)


(3,812
)


(4,314
)


(15,429
)Earnings per Share2002


(0.20
)


(0.22
)


(0.21
)


(0.16
)


(0.79
)2001


(0.16
)


(0.23
)


(0.20
)


(0.22
)


(0.81
)







57




---




## Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

# PART III

Certain information
required by Part III is omitted from this Report on Form 10-K in that the
registrant will file a definitive proxy statement within 120 days after the end
of our fiscal year pursuant to Regulation 14A with respect to the 2003 Annual
Meeting of Stockholders (the Proxy Statement) and certain information included
therein is incorporated herein by reference.

## Item 10.
  Directors and Executive Officers of the Registrant

Certain of the information
required by this item relating to directors is incorporated by reference to the
information under the caption Proposal No. 1Election of Directors in the
Proxy Statement and under the caption Executive Officers.

Section 16(a) of the
Securities Exchange Act of 1934, as amended, requires our directors, officers
and beneficial owners of more than 10% of our Common Stock to file with the SEC
and the National Association of Securities Dealers reports of ownership on Form
3 and reports of changes in ownership on Form 4 or Form 5. Such persons are
required by SEC regulations to furnish us with copies of all Section 16(a) forms
they file.

Based solely on our review
of the copies of such report received by us, or written representations from
reporting persons that no Forms 3, 4, or 5 were required of such persons, we
believe that during our fiscal year ended December 31, 2002, all reports were
timely filed.

## Item 11.
  Executive Compensation

The information required by
this item is incorporated by reference to the information under the caption
Executive Compensation in the Proxy Statement.

## Item 12.
  Security Ownership of Certain Beneficial Owners and Management

The information required by
this item is incorporated by reference to the information under the caption
Record Date and Stock Ownership in the Proxy Statement.

## Item 13.
  Certain Relationships and Related Transactions

The information required by
this item is incorporated by reference to the information under the caption
Certain Transactions in the Proxy Statement.



58




---




## Item 14.
  Controls and Procedures

With the participation of management, our President and Chief Executive Officer
and our Vice President of Finance and Chief Financial Officer evaluated our
disclosure controls and procedures within 90 days of the filing date of this
annual report. Based upon this evaluation, our President and Chief Executive
Officer and our Vice President of Finance and Chief Financial Officer concluded
that our disclosure controls and procedures are effective in ensuring that
material information required to be disclosed is included in our reports that we
file with the Securities and Exchange Commission.

There were no significant changes our internal controls or, to the knowledge of
our management, in other factors that could significantly affect these controls
subsequent to the evaluation date.



59




---




# PART IV

## Item 15.
  Exhibits, Financial Statement Schedules, and Reports on Form 8-K

| | (A) |  | 1.
Financial Statements
| | --- |  | -----------------------




The following Consolidated Financial Statements of Curon Medical, Inc. and Report
of PricewaterhouseCoopers LLP have been provided as Item 8, above:





| | Report |  | of PricewaterhouseCoopers LLP, Independent Accountants.
| | ------ |  | -------------------------------------------------------




| | Consolidated |  | Balance Sheets at December 31, 2002 and 2001.
| | ------------ |  | ---------------------------------------------




| | Consolidated |  | Statements of Operations, for the years ended December 31, 2002, 2001, and 2000.
| | ------------ |  | --------------------------------------------------------------------------------




| | Consolidated |  | Statements of Stockholders Equity (deficit), for the years ended December 31, 2002, 2001, and 2000.
| | ------------ |  | ----------------------------------------------------------------------------------------------------




| | Consolidated |  | Statements of Cash Flows, for the years ended December 31, 2002, 2001, and 2000.
| | ------------ |  | --------------------------------------------------------------------------------




| | Notes |  | to Financial Statements.
| | ----- |  | ------------------------




| | Quarterly |  | Financial Data (unaudited).
| | --------- |  | ---------------------------



60




---




| | 2. |  | Financial Statement Schedules
| | -- |  | -----------------------------




The financial statement schedule entitled Valuation and Qualifying Accounts is included at page

        68

        of this Form 10-K.





All other schedules are omitted because they are not applicable or the required information is shown in the Financial Statements or the notes thereto.





| | 3. |  | Exhibits
| | -- |  | --------




Refer to (c) below.





| | (B) |  | Reports on Form 8-K
| | --- |  | -------------------




None





| | (C) |  | Exhibits
| | --- |  | --------



61




---







Exhibit
Number

Description3.3(1)

Amended and Restated Certificate of Incorporation.3.4(1)

Bylaws of the Registrant.4.1(1)

Specimen common stock certificate of the registrant.4.3(5)

Preferred Stock Rights Agreement, dated as of October 30, 2001 between Curon Medical, Inc. and Mellon Investor Service, LLC
        including the Certificate of Designation, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B, and C, respectively.10.1(1)

Form of Indemnification Agreement for directors and executive officers.10.2(1)

1997 Stock Option Plan.10.3(1)

2000 Employee Stock Purchase Plan.10.5(1)

Amended and Restated Stockholder Rights Agreement dated August 30, 1999 by and among the registrant and certain
        stockholders.10.6(1)

Lease dated August 27, 1997 for office space located at 733 Palomar Avenue, Sunnyvale, California 94086.10.7(1)

Lease dated May 6, 1998 for office space located at 735 Palomar Avenue, Sunnyvale, California 94086.10.8(1)

2000 Stock Option Plan.10.9(1)

Sublease dated April 2, 1999 for office space located at 735 Palomar Avenue, Sunnyvale, California 94086.10.10(1)

Amendment to Lease, effective April 28, 1999, for office space located at 735 Palomar Avenue, Sunnyvale, California
        94086.10.14*(1)

Technology license agreement between the registrant and Somnus Medical Technologies, Inc. effective December 10,
        1998.10.15(1)

Technology license agreement between the registrant and University of Kansas Medical Research Institute effective February
        2000.10.20(6)

Severance Agreement with John W. Morgan dated July 19, 2002.10.21

Employment Agreement with Larry C. Heaton II, President and Chief Executive Officer.23.1

Consent of Independent Accountants.24.1

Power of Attorney (see page 63).


---

|* |  | Confidential treatment has been requested for certain portions of this Exhibit.
|- |  | -------------------------------------------------------------------------------

|(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 10-Q for the quarter ending March 31, 2001, and incorporated herein by reference.
|--- |  | --------------------------------------------------------------------------------------------------------------------------

|(3) |  | Filed as an Exhibit to Curons report on 10-Q for the quarter ending June 30, 2001, and incorporated herein by reference.
|--- |  | -------------------------------------------------------------------------------------------------------------------------

|(4) |  | Filed as an Exhibit to Curons report on 10-Q for the quarter ending September 30, 2001, and incorporated herein by reference.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------

|(5) |  | Filed as an Exhibit to Curons 8-A12G filing on November 9, 2001, and incorporated by reference.                         
|--- |  | -------------------------------------------------------------------------------------------------------------------------
|(6) |  | Filed as an Exhibit to Curons report on 10-Q for the quarter ending June 30, 2002, and incorporated herein by reference.



62




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SIGNATURES





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





CURON MEDICAL, INC.By:

/s/    L
ARRY
        C. H
EATON IILarry C. Heaton II
President and Chief Executive Officer





POWER OF ATTORNEY





KNOW ALL MEN AND WOMEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Larry C. Heaton II and Alistair F. McLaren, his attorneys-in-fact, each with
        the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the U.S. Securities and Exchange
        Commission, hereby ratifying and confirming all that said attorneys-in-fact, or his or their substitute or substitutes, may do or cause to be done by virtue thereof.





Pursuant to the requirements of the Securities Act of 1934, this report signed below by the following person on behalf of the Registrant and in the capacities and on the date indicated:





Signature

Title

Date/
S
        /    L
ARRY
        C.
        H
EATON II
Larry C. Heaton II

President, Chief Executive Officer and Director (Principal Executive Officer)

March 13, 2003/
S
        /    A
LISTAIR
        F.
        M
C
        L
AREN
Alistair F. McLaren

Chief Financial Officer and Vice President of Finance and Administration (Principal Financial Officer)

March 13, 2003/
S
        /    M
ICHAEL
        B
ERMAN
Michael Berman

Director

March 13, 2003/
S
        /    F
RED
        B
ROWN
Fred Brown

Director

March 13, 2003/
S
        /    D
AVID
        I. F
ANN
David I. Fann

Director

March 13, 2003/
S
        /    A
LAN
        L.
        K
AGANOV
Alan L. Kaganov

Director

March 13, 2003/
S
        /    R
OBERT
        F. K
UHLING
        ,
        J
R
        .
Robert F. Kuhling, Jr.

Director

March 13, 2003




63




---




# CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO
SECTION 13(a) OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Larry C. Heaton II, certify that:

|1. | I have reviewed this annual report on Form 10-K of Curon Medical, Inc.,                                                                                                                                                                                                                                                                                                               
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2. | Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;                                                              
|3. | Based on my knowledge, the financial statements, and other financial information
included in this annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this annual report;                                                                                 
|4. | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                       
|5. | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                       
|6. | The registrants other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|Date: March 13, 2003 | By: | /s/  LARRY C. HEATON II                                                               
|-------------------- | --- | --------------------------------------------------------------------------------------
|                     |     | Larry C. Heaton II
President and Chief Executive Officer
(Principal Executive Officer)





64




---




# CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO
SECTION 13(a) OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Alistair F. McLaren, certify that:

|1. | I have reviewed this annual report on Form 10-K of Curon Medical, Inc.,                                                                                                                                                                                                                                                                                                               
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2. | Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;                                                              
|3. | Based on my knowledge, the financial statements, and other financial information
included in this annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this annual report;                                                                                 
|4. | The registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                       
|5. | The registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the
equivalent functions):                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                       
|6. | The registrants other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.

|Date: March 13. 2003 | By: | /s/  ALISTAIR F. MCLAREN                                                                                                         
|-------------------- | --- | ---------------------------------------------------------------------------------------------------------------------------------
|                     |     | Alistair F. McLaren
Vice President of Finance
Chief Financial Officer and Chief Information Officer
(Principal Financial Officer)



65




---




# CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, Larry C. Heaton II, certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that the Annual Report of Curon Medical, Inc. on
Form 10-K for the fiscal year ended December 31, 2002 fully complies with
the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934 and that information contained in such Annual Report on Form 10-K fairly
presents in all material respects the financial condition and results of
operations of Curon Medical, Inc.

| | By: | /s/  LARRY C.HEATON II                                                                
| | --- | --------------------------------------------------------------------------------------
| |     | Larry C. Heaton II
President and Chief Executive Officer
(Principal Executive Officer)

I, Alistair F. McLaren,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that the Annual Report of Curon Medical, Inc. on
Form 10-K for the fiscal year ended December 31, 2002 fully complies with
the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934 and that information contained in such Annual Report on Form 10-K fairly
presents in all material respects the financial condition and results of
operations of Curon Medical, Inc.

| | By: | /s/  ALISTAIR F. MCLAREN                                                                                                         
| | --- | ---------------------------------------------------------------------------------------------------------------------------------
| |     | Alistair F. McLaren
Vice President of Finance
Chief Financial Officer and Chief
Information Officer
(Principal Financial Officer)



66




---




# Report of
Independent Accountants on Financial Statement Schedule

To the Board of Directors of Curon Medical, Inc.



Our audits of the
consolidated financial statements referred to in our report dated January 31,
2003, except for Note 13, as to which the date is February 21, 2003, appearing
in this Annual Report on Form 10-K also included an audit of the financial
statement schedule listed in Item 14(a) 2 on this Form 10-K. In our opinion,
this financial statement schedule presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements.

PricewaterhouseCoopers LLP





San Jose, California





January 31, 2003
Except for Note 13, as to which the date is February 21, 2003



67




---




# Schedule II

# VALUATION
AND QUALIFYING ACCOUNTS

# Years ended
December 31, 2002, 2001, and 2000

# (Dollars in Thousands)

|                                           |  | Balance at
Beginning
of Year |        | Additions
Charged to
Earnings |   | Deductions |  |   | Balance at End
of Year
|------------------------------------------ |  | ---------------------------- | ------ | ----------------------------- | - | ---------- |  | - | ----------------------
|Allowance for Doubtful Accounts:           |  |                              |        |                               |   |            |  |   |                       
|December 31, 2002                          |  | $                            | 20     |                               | $ | 20         |  | $ | (6                    
|December 31, 2001                          |  |                              | 15     |                               |   | 5          |  |   |                      
|December 31, 2000                          |  |                              |       |                               |   | 15         |  |   |                      
|                                          
|Reserve on Related Party Notes Receivable: |  |                              |        |                               |   |            |  |   |                       
|December 31, 2002                          |  |                              |       |                               |   |           |  |   |                      
|December 31, 2001                          |  |                              | 64     |                               |   |           |  |   | (64                   
|December 31, 2000                          |  |                              | 73     |                               |   |           |  |   | (9                    
|                                          
|Deferred Tax Valuation Allowance:          |  |                              |        |                               |   |            |  |   |                       
|December 31, 2002                          |  |                              | 15,595 |                               |   | 5,566      |  |   |                      
|December 31, 2001                          |  |                              | 9,873  |                               |   | 5,722      |  |   |                      
|December 31, 2000                          |  | $                            | 5,096  |                               | $ | 4,777      |  | $ |                      



68




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