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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-K



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(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, 2005

OR



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

Commission file number: 000-31519



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CURON MEDICAL, INC.

(Exact name of
registrant as specified in its charter)



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|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Delaware                                                      |  | 77-0470324                         
|(State or other jurisdiction ofincorporation or organization) |  | (I.R.S. EmployerIdentification No.)

46117 Landing Parkway

Fremont, CA 94538

(Address of principal executive offices, including zip
code)

(510) 661 1800

(Registrants telephone number, including area code)



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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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.    Yes ̈No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act.    Yes ̈No  x

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

Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer  x

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

The aggregate market value of stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on June 30, 2005
(which is the last business day of Registrants most recently completed second fiscal quarter), as reported on the NASDAQ Capital Market, was approximately $10.8 million.

The number of shares of Common Stock outstanding as of March 24, 2006: 43,351,027 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Items 10, 11, 12, 13 and 14 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.

ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS



|         |  |                                                                                                              |  |     
|-------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|         |  |                                                                                                              |  | Page
|PART I   |  |                                                                                                              |  |     
|Item 1.  |  | Business                                                                                                     |  | 3   
|Item 1A. |  | Risk Factors                                                                                                 |  | 15  
|Item 1B. |  | Unresolved Staff Comments                                                                                    |  | 24  
|Item 2.  |  | Properties                                                                                                   |  | 24  
|Item 3.  |  | Legal Proceedings                                                                                            |  | 24  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                          |  | 24  
|         |  |                                                                                                             
|PART II  |  |                                                                                                              |  |     
|Item 5.  |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 25  
|Item 6.  |  | Selected Financial Data                                                                                      |  | 26  
|Item 7.  |  | Managements Discussion and Analysis of Results of Operations and Financial Condition                        |  | 27  
|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 34  
|Item 8.  |  | Financial Statements and Supplementary Data                                                                  |  | 35  
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 56  
|Item 9A. |  | Controls and Procedures                                                                                      |  | 56  
|Item 9B. |  | Other Information                                                                                            |  | 56  
|         |  |                                                                                                             
|PART III |  |                                                                                                              |  |     
|Item 10. |  | Directors and Executive Officers of the Registrant                                                           |  | 57  
|Item 11. |  | Executive Compensation                                                                                       |  | 57  
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management                                               |  | 57  
|Item 13. |  | Certain Relationships and Related Transactions                                                               |  | 57  
|Item 14. |  | Principal Accountant Fees and Services                                                                       |  | 57  
|         |  |                                                                                                             
|PART IV  |  |                                                                                                              |  |     
|Item 15. |  | Exhibits and Financial Statements Schedules                                                                  |  | 58  
|         |  | Signatures                                                                                                   |  | 61  



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PART I

IMPORTANT NOTE ABOUT FORWARD-LOOKING STATEMENTS

This Form 10-K contains forward-looking statements
within the meaning of the federal securities laws. These statements may generally be identified by the use of such words as expect, anticipate, believe, intend, plan, will, or
shall, or the negative of those terms. These statements include, but are not limited to, those relating to our beliefs and expectations regarding our expenses and our operating results, the mix of our sales and revenues derived from
generators and handpieces, our beliefs and expectations regarding our future growth, our beliefs concerning our cash position and our anticipated cash needs; and the timing and extent of any reimbursement approval. These forward-looking statements
involve risks and uncertainties. The cautionary statements set forth throughout this Report and, specifically, those contained in Risk Factors, commencing on page 15, identify important factors that could cause actual results to differ
materially from those predicted in any such forward-looking statements. We caution the reader not to place undue reliance on these forward- looking statements, which reflect managements analysis only as of the date of this Form 10-K. We
undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Form 10-K.

Item 1.    
Business

Company Overview

Curon Medical, Inc. was incorporated in the State of Delaware in May 1997 as Conway-Stuart Medical Inc. and changed its name to Curon Medical Inc., in March 2000. We develop, manufacture and market innovative
proprietary products for the treatment of gastrointestinal disorders. Our products consist of radiofrequency generators and single-use disposable devices.

Our first product, the Stretta® System, received United States Food and Drug Administration (FDA) clearance in April 2000 for the treatment of gastroesophageal reflux disease, or GERD, which affects approximately 15 million U.S.
adults on a daily basis. In patients with GERD, acidic stomach contents reflux backward from the stomach into the esophagus, causing a wide range of symptoms and complications, including, most commonly, persistent heartburn and chest pain. Unlike
medication, which addresses GERD symptoms, our Stretta System applies radiofrequency energy to treat the causes of GERD. The Stretta System consists of a disposable catheter with needle electrodes and our control module, which is a radiofrequency
energy generator. Using the Stretta System, the physician delivers temperature-controlled radiofrequency energy to the muscle of the lower esophageal sphincter and upper portion of the stomach. The delivery of this energy creates heat, causing
tissue contraction and creating thermal lesions that resorb over time, resulting in improved sphincter function. Clinical studies show a significant reduction in GERD symptom scores, esophageal acid exposure, and use of anti-secretory medications.

We commercially launched the Stretta System in May 2000. As of December 31, 2005, we have sold 348 control modules and estimate that,
based on the quantity of catheters both sold and used in our clinical trials, some 9,000 patients have been treated with the Stretta Procedure.

Our second product, the Secca® System, is
a radiofrequency energy-based system for the treatment of bowel incontinence (formerly and clinically referred to as Fecal incontinence). Bowel incontinence is caused by damage to the anal sphincter from childbirth, surgery, neurological
disease, injury or age, and affects up to 16 million adults in the United States. Using the Secca System, physicians deliver radiofrequency energy to the sphincter muscle in the anal canal. Clinical studies have shown a reduction in bowel
incontinence symptoms and improvement in general quality of life. In March 2002, we received 510(k) clearance from the FDA to market the Secca System for the treatment of fecal incontinence in patients who have failed more conservative therapies
such as diet modification and biofeedback and who are not candidates for or amenable to surgery. We undertook



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a limited test launch of Secca in June 2002, and fully launched the product commercially in May 2003. As of December 31, 2005, we have sold 55 control
modules and estimate that, based on the quantity of handpieces both sold and used in our clinical trials, some 1,300 patients have been treated with the Secca Procedure.

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

Our Stretta System has also received regulatory approval in the European Union under their Medical Device Directive, or MDD, from the Therapeutic Goods
Administration in Australia and the Canadian Standards Administration in Canada. We incorporated a subsidiary in Belgium in November 2000 to manage distribution and provide training in Europe, the Middle East and Africa. We have entered into
international distribution agreements in the following countries presented in alphabetical order, all of which cover the sale of both Stretta and Secca products: Argentina, Austria, Belgium, Brazil, China (PRC), China (Republic of), China (Hong
Kong), Costa Rica, Denmark, Egypt, Finland, France, Germany, Greece, India, Indonesia, Ireland, Israel, Italy, Malaysia, The Netherlands, Norway, Philippines, Poland, Portugal, Singapore, South Africa, Saudi Arabia, South Korea, Spain, Sweden,
Switzerland, Thailand, Turkey, United Arab Emirates, United Kingdom, Vietnam, Some agreements cover more than one country. From time to time national distributors are replaced or terminated and there may be times when we may have no representation
in one or more of the above countries. Regulatory controls in certain countries prevent sales being made until the distributor completes the approval process. We are organized into a single reportable segment consisting of the development,
manufacture, marketing and sale of proprietary products for the treatment of gastrointestinal disorders. We use one measure of profitability and do not disaggregate our business for internal reporting. In the United States, the Center for Medicare
and Medicaid Studies, CMS, has issued our Stretta procedure both APC and CPT1 codes and our Secca procedure an APC code. We believe that a Level I CPT code for the Secca procedure will be effective either from January 1, 2007, or
January 1, 2008 depending upon the timing of meeting of the necessary pre-conditions. Reimbursement for our international business varies by country.

Business Strategy

Our strategy is to establish our Stretta and Secca Systems as standard treatment options for patients
with GERD and bowel incontinence, respectively. We believe that our products offer substantial improvements over the current treatment options in the care of patients with these 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, 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 may benefit through cost
savings.

The Secca procedure offers a treatment option for patients with bowel incontinence who have failed more conservative therapies
such as diet modification and biofeedback. Currently, bowel 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, at best, only modest effectiveness, and we believe that there is a need for a minimally



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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 patients who have the Secca procedure may usually return to their normal daily activities the following day.

We have established both a direct and indirect 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 currently have eight direct sales territories, a domestic sales manager, and a vice president of sales and marketing. In addition, we have an indirect sales channel comprised of 10
Manufacturer Representative firms, with 26 salespeople to sell and market our products, on a part time basis, across the United States. We may hire additional salespeople or enter new distributor relationships to increase market penetration of our
products, both domestically and internationally.

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.

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 is associated with an elevated 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 or Nexium, have annual U.S. sales of approximately $10 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 generally known as a laparoscopic Nissen fundoplication where the
fundus of the stomach is wrapped around the lower esophageal sphincter and sutured in position to provide a mechanical barrier to reflux. This inpatient surgical procedure costs between $11,000 and $15,000, involves a hospital stay of several days
and a prolonged recovery period, and has a significant morbidity risk. We believe that approximately 250,000 patients are referred for this procedure annually, of which up to 100,000 actually undergo the anti-reflux surgery. The remainder of those
referred who do not undergo the procedure are either contra-indicated or choose not to proceed after learning the details of the surgery.



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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 neutralizing or inhibiting acid secretion in 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.

The Secca System: Treatment of Bowel Incontinence

The Secca System is designed to treat bowel incontinence, a condition
that affects up to 16 million U.S. adults. Bowel 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 effective 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, limited to those patients with a specific anatomic sphincter defect, and are rarely utilized.

The Secca System
provides a minimally invasive, outpatient, and cost-effective procedure for the treatment of bowel incontinence. The Secca procedure utilizes the same radiofrequency 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 bowel 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:



| |  |  | A balloon in the Stretta Catheter, which is inflated once the Stretta Catheter reaches the lower esophageal sphincter to maintain catheter positioning;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Four electrode needles, which are deployed into the tissue at the treatment site for delivery of radiofrequency energy;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | Thermocouples located at each needle tip and base, which provide continuous temperature readings to the Curon Control Module, enabling precise temperature control;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Irrigation ports located at the base of each electrode, which deliver water to the surface tissue during treatment; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | An illuminated clear window in the Secca Handpiece that enables the physician to view the treatment area.
| | - |  | ---------------------------------------------------------------------------------------------------------

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 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.

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;
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| |  |  | 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. The follow-up data indicated that the
Stretta procedure led to significant improvement in both objective and subjective measurements. Six and 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.



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We have conducted an eight-center, clinical trial of the Stretta System in the United States, treating 64
patients. Results of this trial were published in Gastroenterology in September 2003. 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 versus baseline.

To date, twenty-seven peer-
reviewed clinical articles and meeting presentations have been published, augmenting the knowledgebase associated with the Stretta procedure, symptom response, and long-term results, and supporting the use of the Stretta system for patients with
GERD. We 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 bowel
incontinence were treated with the Secca System. Six months and two years following the procedure, most patients showed significant improvements in bowel incontinence symptoms, incontinence-related quality of life and general quality of life, each
as measured by validated questionnaires, without persistent complications or side effects. The six-month data demonstrating improved incontinence scores was published in Diseases of the Colon & Rectum in July 2002. The two-year data
demonstrating durability of the effect of Secca procedure on improving bowel incontinence symptoms was presented at the 2002 Meeting of the American Society of Colon and Rectal Surgeons, and was published in Diseases of the Colon &
Rectum in March 2003.

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 bowel incontinence in patients who
have failed more conservative therapies such as diet modification and biofeedback. The results of this clinical trial were published in Diseases of the Colon and Rectum in December 2003. The study demonstrated that the Secca procedure
resulted in significant improvements in bowel incontinences scores, bowel incontinence related quality of life, and general quality of life. In June 2002, we started a limited commercial release of the Secca System and in June 2003, we launched the
Secca System on a full commercial basis.

Research and Development

Our research and development activities are conducted internally by a research and development staff and are focused on continuing improvements to design changes of existing product alternatives and product
accessories. In addition to working on new products, our research and development organization is improving products and developing fixtures that are designed to reduce the time to manufacture, improve quality and reduce cost of products. Our
research and development expenditures were $1.3 million in 2005, $1.7 million in 2004 and $1.8 million in 2003.

Manufacturing

On October 31, 2005, we entered into an outsourced contract manufacturing agreement with Life Science Outsourcing, Inc., or LSO. Under the Agreement,
we outsource the manufacturing of our disposable products to LSO. The Agreement has a term of one year and will be renewed on an annual basis unless otherwise mutually agreed by both parties. We manufacture, assemble and test the Curon Control
Module in-house.

We purchase materials and components from qualified suppliers that are subject to stringent quality specifications. We
conduct quality audits of our key suppliers on scheduled intervals. 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.



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Currently, only one supply source exists for the peristaltic pump. Our supplier in accordance with our
specifications manufactures this pump. 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. We
have purchased an inventory of these chips sufficient to meet our projected manufacturing needs in conjunction with completed for at least the next 12 months and have developed a revision to our current generator that has incorporated an updated
version of this chip with a planned release within the year.

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, 2005, we had 40
issued or allowed U.S. patents and 28 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, 2005, we had licensed in 17 issued and allowed U.S. patents and 2 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.

On March 16, 2006, we entered
into an assignment and license agreement with BÂRRX Medical, Inc. of Sunnyvale, California. Pursuant to the terms of the agreement, we granted BÂRRX an assignment of United



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States Patent No. 6,872,206 and a worldwide, exclusive license of certain patents pertaining to methods and/or apparatuses, including ablation devices,
sizing balloons and generators, for the BÂRRX field of use, primarily the treatment of Barretts esophagus. In exchange for the agreement, we received $2.0 million in cash and a $1.0 million note payable upon the earlier of
BÂRRXs next equity financing or by December 31, 2006.

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

Companies that have well-established products, reputations and resources dominate the market for the treatment of GERD. Our primary competitors are large medical device manufacturers such as Ethicon Endo Surgery and United States Surgical,
manufacturers of instrumentation for anti-reflux surgery and NDO Surgical, which manufactures an endoscopic sewing device for treating GERD. Other competitive devices may be developed.

Most of these competitors are larger companies that enjoy several competitive advantages over us, which may include:



| |  |  | Existing anti-reflux surgical procedures and devices for the treatment of GERD;
| | - |  | -------------------------------------------------------------------------------



| |  |  | Established reputations within the surgical and gastroenterological community;
| | - |  | ------------------------------------------------------------------------------



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



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



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

We do not feel that we compete with large pharmaceutical companies, such as AstraZeneca, Takeda Abbott Pharmaceutical, Wyeth Laboratories and Eisai, because candidate patients for Stretta are primarily intolerant to
drug therapy or have failed, or only partially responded to, drug therapy. However, these companies have an established relationship with the gastroenterology community and generate over $10 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. Further, less expensive generic drugs
have been introduced to treat GERD as AstraZenecas patent for Prilosec, the leading prescription medication for the treatment of GERD, expired in 2001. Prilosec, formerly a prescription medication, is now available over the counter.

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



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| |  |  | Product testing;
| | - |  | ----------------



| |  |  | Product labeling;
| | - |  | -----------------



| |  |  | Product storage;
| | - |  | ----------------



| |  |  | Premarket clearance or approval;
| | - |  | --------------------------------



| |  |  | Advertising and promotion; and
| | - |  | ------------------------------



| |  |  | Product sales and distribution.
| | - |  | -------------------------------

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.



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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 bowel 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.

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 products continue to comply with the applicable requirements. Failure to comply could result in production delays, and potential product recall.



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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 is subject to inspection by a TUV notified body for compliance with the quality system and other applicable regulations. Our facility has been audited and certified to be
ISO9001/EN46001/ISO13485 compliant, which allows us to sell our products in Europe. 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.

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, which pays the hospital component of the procedure cost, including the cost of the disposable device. In 2003, CMS reassigned the Stretta procedure to a new APC, which maintained essentially the same
payment rate of $1,850. In 2004, CMS announced a revision downwards of the APC value from $1,850 to $1,264.79. CMS published its April 2005 Hospital Outpatient Prospective Payment System update on March 18, 2005, in which they indicated that
the previously published APC reimbursement rate for the Stretta procedure was incorrect. In its Addendum A published subsequently, the new national payment rate for the Stretta procedure is set at $1,335.65 retroactive to January 1, 2005. This
translates to a range of actual reimbursement amounts, depending on the geographic adjustments, of between $977.43 and $2,583.55. Effective January 2006, the national payment rate was increased to $1,431.39, with a range of actual reimbursement
amounts of between $1,047.49 and $2,768.74.

Effective January 1, 2004 the American Medical Association issued a Category III CPT code
for the Stretta procedure. Effective January 1, 2005, the Stretta procedure was awarded a Level I CPT code by the AMA with a current associated national average payment of $291.59. CPT codes are used to specify the physician component of the
procedure cost.

Effective July 1, 2004, CMS designated an APC code for the Secca System, which pays the hospital component of the
procedure $1,750 including the cost of the disposable device. Private insurers set their own reimbursement levels that are typically higher than the Medicare level.

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



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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. Subsequently, data has been presented at physician society medical meetings demonstrating positive
durability of the Stretta procedure to four years. 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-blinded,
randomized, sham-controlled, multi-center study to generate this data, and these results were published in September 2003.

To facilitate
reimbursement for the Stretta and Secca Systems, we continue to maintain a dedicated reimbursement department. The department assists physicians with case-by-case pre-determination for coverage and appeals of denied claims, and actively pursues
local coverage decisions. For the Stretta procedure, Curon Medical has established numerous Medicare coverage policies, as well as individual case-by-case Medicare coverage in various states. In addition, an increasing number of private payors have
issued policies or are covering procedures on an individual basis.

We believe that achieving appropriate reimbursement for the Stretta
procedure removes 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.

Employees

As of December 31, 2005, we employed 32 people worldwide, of which 2 are in Europe and 30 are in the U.S. which includes five employees in
operations, one employee in research and development, 12 employees in sales and marketing, 9 employees in general and administrative, two employees in reimbursement and one employee in clinical and regulatory affairs. None of our employees are
represented by a labor union, and we believe our employee relations are good.

Available Information

Our Web Site is http://www.curonmedical.com. We make available free of charge, on or through our Web Site, our annual, quarterly and current
reports, as well as any amendments to these reports, as soon as reasonably practicable after electronically filing these reports with the Securities and Exchange Commission. Information contained on our Web Site is not a part of this report. We have
adopted a code of ethics applicable to our principal executive, financial and accounting officers. We make available free of charge, on or through our Web Sites investor relations page, our code of ethics.

The SEC maintains an Internet site at http://www.sec.gov that contains our reports, proxy and information statements. All reports that we file
with the SEC may be read and copied at the SECs Public Reference Room at 450 Fifth Street, N.W., Washington, DC 20549. Information about the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330.



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Item 1A.    
Risk Factors

We have limited capital resources and we will need to raise additional funds if we want to continue our current
level of operations, which we may not be able to do.

As of December 31, 2005, we had cash and cash equivalents on hand of $3.3
million and working capital of $4.1 million. To continue operations, we must raise additional funds through the issuance of equity or debt securities in the public or private markets, or sell certain of our assets. No assurance can be given that we
will be successful in obtaining funds from any of these transactions on acceptable terms, if at all, or if secured, that such funding would be sufficient to continue our operations. Any future equity financing could result in substantial dilution to
our stockholders. If we raise additional funds by issuing debt, we may be subject to limitations on our operations, through debt covenants or other restrictions. In the absence of funding, we will be required to scale back or terminate operations.
We believe that our cash balances will not be sufficient to fund planned expenditures in the third quarter of 2006. This raises substantial doubt about our ability to continue as a going concern.

We are not in compliance with the minimum bid price requirement of the Nasdaq Capital Market. We may consequently be delisted in the near future. This may adversely
affect trading in our stock and our ability to raise capital.

We have failed to comply with the minimum $1.00 per share bid price
requirement for continued listing. The Nasdaq staff has notified us that we have until May 11, 2006 to demonstrate compliance with the minimum bid price requirement, or the Nasdaq staff will provide notification that our stock will be delisted.

To achieve compliance with the minimum bid price requirement, our stockholders have authorized up to a 1-for-4 reverse stock split on our
stock. Should we implement a reverse stock split, the number of our shares being traded will be reduced and volatility in the trading of our stock may increase. Further, there are no assurances that a reverse stock split will ensure compliance with
the minimum bid price requirement. There are also no assurances that our stock price after a reverse stock split will be above $1.00 per share at all (which would be the case if, prior to the split, our stock price is below $0.25 per share), nor
that it will maintain a $1.00 per share price for at least ten consecutive trading daysthe requirement to remedy the minimum bid price deficiency. To achieve compliance with the stockholders equity requirement, we must either raise
additional funds through the issuance of equity or debt securities in the public or private markets, sell certain of our assets, or otherwise increase stockholders equity through operations.

If we receive a notice of delisting, we may appeal the decision but there are no assurances that we will be successful in remaining listed. If we are
ultimately delisted, trading in our common stock could be subject to the so-called penny stock rules that impose additional sales practice and market making requirements on broker-dealers who sell and/or make a market in those
securities. Consequently, removal from the Nasdaq Capital Market, if it were to occur, could affect the ability or willingness of broker-dealers to sell and/or make a market on our common stock and the ability of purchasers of our common stock to
sell their securities in the secondary market. These rules could further limit the market liquidity of our common stock. If we are delisted from the Nasdaq Capital Market, our stock price is likely to decline significantly.

If we fail to comply with Nasdaqs stockholders equity requirement, our stock will be subject to delisting.

We have recently failed to comply with the minimum $2.5 million stockholders equity requirement of the Nasdaq Capital Market. Due to this
deficiency, the Nasdaq staff notified us that it was reviewing our eligibility for continued listing on the Nasdaq Capital Market. To remedy this deficiency, we sold certain of our unutilized intellectual property assets for $3 million to increase
our stockholders equity. While we believe that our actions were sufficient to remedy our deficiency, there are no assurances that our stockholders equity will remain above Nasdaqs $2.5 million minimum. If we continue to operate our
business in the same manner as we had done prior to our sale of assets, we will either have to raise our stockholders equity, for example, by selling more assets or



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equity, or we will fall below Nasdaqs requirement and our stock will once again be subject to delisting. Furthermore, if we fail to comply with this
requirement upon the filing of our Form 10-Q for the quarter ending March 31, 2006, our stock will be immediately delisted.

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 $11.0 million in 2005, $15.3 million in 2004, and $15.6 million in 2003. As of December 31, 2005, we had an accumulated deficit of
approximately $105.6 million. Our revenues are, and will be, derived from the sale of radiofrequency generators and our disposable devices, such as the Stretta Catheter and Secca Handpiece. We have generated limited revenues, and it is possible that
we will never generate significant revenue from product sales. Even if we do achieve significant revenues from our product sales, we expect to incur significant net losses over the next several years and these losses may increase. It is possible
that we will never achieve profitable operations.

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

In order to reduce our operating costs, we have recently implemented a restructuring initiative primarily to implement the outsourcing
of our disposable component manufacturing. This resulted in a significant reduction in employee headcount from 71 to 32. We entered into a contract for the outsourced manufacturing of our disposable products. These actions significantly change our
operations and could have adverse results, including:



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



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



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

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

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



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



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



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

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



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Our internal controls may not be sufficient to ensure timely and reliable financial information.

We restated our financial results for the quarter ended March 31, 2004 to reflect adjustments to our previously reported financial information. The
restatements arose, in part, out of an internal investigation by the Audit Committee. As a result of the investigation, management and the Audit Committee determined that certain sales employees had improperly offered rights of return and exchange
in violation of our revenue recognition policy, and a manufacturers representative had not actually made sales that it had reported to us. As a result of this investigation, we were also unable to timely file the Form 10-Q for the quarter
ended June 30, 2004. In connection with the restatement of our financial results for the quarter ended March 31, 2004, our independent registered public accounting firm identified material weaknesses in our internal controls and
procedures.

Our Audit Committee, with the assistance of independent legal and accounting advisors, evaluated the effectiveness of our
disclosure controls and procedures. As a result of this evaluation, our Board of Directors directed management to implement and management implemented additional measures designed to ensure that information required to be disclosed in our periodic
reports is recorded, processed, summarized and reported accurately. These measures include the adoption of a Disclosure Committee Charter, the adoption of a written revenue recognition policy, further controls on shipment of products for revenue
transactions, and additional training of our sales and marketing staff to minimize the risk of revenue recognition errors. Given the additional measures adopted by us, we believe that our disclosure controls and procedures are now effectively
designed to ensure that information we are required to disclose in reports that we file or submit to the SEC is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
However, the effectiveness of our controls and procedures are still limited by a variety of factors including:



| |  |  | Faulty human judgment and simple errors, omissions or mistakes;
| | - |  | ---------------------------------------------------------------



| |  |  | Fraudulent action of an individual or collusion of two or more people;
| | - |  | ----------------------------------------------------------------------



| |  |  | Inappropriate management override of procedures; and
| | - |  | ----------------------------------------------------



| |  |  | The possibility that our enhanced controls and procedures may still not be adequate to assure timely and accurate financial information.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------

If we fail to have effective internal control over financial reporting in place, we could be unable to provide timely and accurate financial information
and be subject to delisting, and civil or criminal sanctions.

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

Our physician customers continue to
encounter difficulties in readily obtaining reimbursement for the Stretta procedure on a case-by-case basis, and this continues to impact our ability to generate revenue. We have not been successful at addressing these difficulties with our
strategies of pursuing state-by-state and also selected national reimbursement coverage, focusing on promoting repeat catheter sales and incorporating technical improvements to our systems to reduce treatment times.

Physicians, hospitals and other health care providers are unlikely to purchase our products if they are not adequately reimbursed for the Stretta
procedure or the products. For 2006, the new national payment rate for the Stretta procedure is set at $1,431.39. This translates to a range of actual reimbursement amounts, depending on the geographic adjustments, of between $1,047.49 and
$2,768.74. Even with this amount it may still be difficult to convince hospitals and other health care providers to offer the Stretta procedure to their patients. Some private payers may refuse adequate reimbursement even though significant
peer-reviewed data has been published. If users of our products cannot obtain sufficient reimbursement from health care payers for the Stretta procedure or the Stretta System disposables, then it is unlikely that our products will ever achieve
increased market acceptance.



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Although the Secca procedure has been awarded an APC code by the CMS, it has not received a CPT code and
there is little data yet regarding the willingness of third-party health care payers to reimburse the costs of the procedure. While we believe that a Level 1CPT code will be issued for the Secca procedure effective either from January 1, 2007,
or January 1, 2008, depending upon the timing of meeting of the necessary pre-conditions we cannot assure you that the procedure will ever be reimbursed, or that in the event there is reimbursement, that such reimbursement will be adequate.
Failure to achieve adequate reimbursement may have a serious negative effect on our ability to grow our revenues.

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

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

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

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

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

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

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

We received clearance from the FDA for the use of the Secca System to treat bowel incontinence, for patients who
have failed more conservative treatments such as diet modification or biofeedback. This clearance was based upon the study of 50 patients. Safety and efficacy data presented to the FDA for the Secca System was



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

Failure in our physician education efforts could significantly reduce
product sales.

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

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

Companies that have well-established products, reputations and resources dominate the market for the treatment of
GERD. Our primary competitors are large medical device manufacturers such as Ethicon Endo Surgery and United States Surgical, manufacturers of instrumentation for anti-reflux surgery and NDO Surgical, which manufactures an endoscopic sewing device
for treating GERD. Other competitive devices may be developed.

Some of these competitors are larger companies that enjoy several
competitive advantages over us, which may include:



| |  |  | Existing anti-reflux surgical procedures and devices for the treatment of GERD;
| | - |  | -------------------------------------------------------------------------------



| |  |  | Established reputations within the surgical and gastroenterological community;
| | - |  | ------------------------------------------------------------------------------



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



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



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

We do not feel that we compete with large pharmaceutical companies, such as AstraZeneca, Takeda Abbott Pharmaceutical, Wyeth Laboratories and Eisai, because candidate patients for Stretta are intolerant to drug
therapy or have failed, or only partially responded to, drug therapy. However, these companies have an established relationship with the gastroenterology community and generate over $12 billion in annual U.S. revenues from the proton pump inhibitor
drug class. We could be adversely affected if one or more pharmaceutical companies elects to market aggressively against our product, or if a new, more effective, pharmaceutical product is developed.

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

We have limited sales and marketing resources. Currently we rely on a limited number of direct sales representatives for the sale of
our products in the United States. We also deploy an indirect sales channel of a limited number of manufacturers representatives firms who we use to cover, in general, less populated areas of



19



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the United States. The success of this channel will depend upon a number of factors, many of which are beyond our control. These factors include, but are not
limited to, the willingness of such representatives to prioritize the sale of our products and their effectiveness in such sales efforts.

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



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



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



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



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

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

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

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

We depend on the suppliers who provide the
materials and components used in our products, and if we lose our relationship with any individual suppliers, we will face regulatory requirements with regard to replacement suppliers that could delay the manufacture of our products.

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

If we, or our suppliers, fail to comply with the FDA Quality System Regulation, manufacturing operations could be delayed and our business could be harmed.

Our manufacturing processes are required to comply with the Quality System Regulation, or QSR, which covers the methods and documentation of the design,
testing, production, control, quality assurance, labeling, packaging and shipping of our products. The FDA enforces the QSR through inspections. Our first QSR inspection was in March 2001, and we were also inspected in July 2003. There were no
significant findings from either inspection. If we fail any future QSR inspections, our operations could be disrupted and our manufacturing delayed. Failure to take appropriate corrective action in response to a QSR inspection could force a
shut-down of our manufacturing operations, a recall of our products, and potentially a revocation of the FDA 510(k) clearance of our products, which would have a material adverse effect on our product sales, revenues, expected revenues and
profitability. Furthermore, we cannot assure you that our key component suppliers are, or will continue to be, in compliance with applicable regulatory requirements, will not encounter any manufacturing difficulties, or will be able to maintain
compliance with regulatory requirements. Any such event could have a material adverse effect on our available inventory and product sales.



20



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

Our products are medical devices and are therefore subject to extensive
regulation in the United States and in foreign countries where we intend to do business. Unless an exemption applies, each new Class II or III medical device that we wish to market in the United States must first receive either 510(k) clearance or
premarket approval from the FDA. Either process can be lengthy and expensive. The FDAs 510(k) clearance process usually takes from four to twelve months, but may take longer. The premarket application, or PMA, approval process is much more
costly, lengthy and uncertain. It generally takes from one to three years or even longer. Delays in obtaining regulatory clearance or approval will adversely affect our ability to generate revenues and profitability from new products. We cannot
assure you that the FDA will ever grant 510(k) clearance or premarket approval for any new product we propose to market. If the FDA withdraws or refuses to grant approvals, we will be unable to market such products in the United States.

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

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

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

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

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

To date we have international distribution agreements for various countries around the world. While we
have obtained regulatory clearance to market the Stretta and Secca Systems in some of the countries, or others regulatory approval is pending. We cannot assure you that we will be able to obtain or maintain such approvals. Furthermore, although
contracts already signed with European distributors specify payment in U.S. dollars, future international sales may be made in currencies other than the U.S. dollar. As a result, currency fluctuations may impact the demand for our products in
countries where the U.S. dollar has increased compared to the local currency. Engaging in international business involves the following additional risks:



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



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



21



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| |  |  | Economic or political instability;
| | - |  | ----------------------------------



| |  |  | Shipping delays; and
| | - |  | --------------------



| |  |  | Longer payment cycles.
| | - |  | ----------------------

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

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

The development, manufacture and sale
of medical products involves a significant risk of product liability claims. The use of any of our products may expose us to liability claims, which could divert managements attention from our core business, could be expensive to defend, and
could result in substantial damage awards against us. For example, we are currently a party to a product liability lawsuit where there are allegations that our products are defectively designed and that we were negligent in manufacturing our
products.

We maintain product liability insurance at coverage levels we believe to be commercially acceptable, and we re-evaluate annually
whether we need to obtain additional product liability insurance. However there can be no assurance that product liability or other claims will not exceed such insurance coverage limits or that such insurance will continue to be available on the
same or substantially similar terms, or at all.

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

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

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

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



22



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

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

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

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

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

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

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



23



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Item 1B.
    Unresolved Staff Comments

None.

Item 2.
    Properties

We are headquartered in Fremont, California, where we lease one building
with approximately 35,000 square feet of office, research and development, and manufacturing space under leases expiring October 31, 2006. We believe that the facility is suitable and adequate for our current and future needs for the
foreseeable future. We are currently utilizing approximately 54% of the facilitys total space.

Item 3.
    Legal Proceedings

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

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

No matters were submitted to a vote
of security holders during the quarter ended December 31, 2005.



24



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PART II

Item 5.
    Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our Common Stock trades under the symbol CURN. As of December 9, 2002, our Common Stock has been quoted on the NASDAQ Capital 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 our Common Stock for the periods indicated, as reported on the NASDAQ Capital Market.



|                             |  |                    |      |     |   |     
|---------------------------- |  | ------------------ | ---- | --- | - | ----
|                             |  | Common Stock Price
|                             |  | High               |      | Low
|Year Ended December 31, 2004 |  |                    |      |     |   |     
|First Quarter                |  | $                  | 5.44 |     | $ | 2.32
|Second Quarter               |  | $                  | 2.95 |     | $ | 1.43
|Third Quarter                |  | $                  | 1.57 |     | $ | 0.76
|Fourth Quarter               |  | $                  | 1.84 |     | $ | 0.90
|Year Ended December 31, 2005 |  |                    |      |     |   |     
|First Quarter                |  | $                  | 2.02 |     | $ | 0.95
|Second Quarter               |  | $                  | 1.00 |     | $ | 0.46
|Third Quarter                |  | $                  | 0.74 |     | $ | 0.34
|Fourth Quarter               |  | $                  | 0.44 |     | $ | 0.25

As of March 10, 2006, the last reported sales price of our Common Stock on the NASDAQ Capital
Market was $0.37 per share, and the number of beneficial common stockholders was approximately 1,600. 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 April 8 and June 3, 2005, we raised approximately $12.0 million in gross proceeds from the private placement of common stock
and warrants to several institutional investors. Net proceeds after offering costs and expenses were approximately $11.0 million. We paid to the parties that acted as agents in connection with this private placement fees of $859,000 in cash and
issued warrants to purchase 553,352 shares of its common stock as additional consideration. The terms of these warrants are identical to those issued to the investors. The transaction was completed in two closings, and involved the sale of an
aggregate of 18,445,078 newly issued shares of our common stock at a price of $0.65 per share and warrants to purchase an aggregate of 9,222,539 shares of common stock with an exercise price of $1.00 per share. In the first closing, we issued
4,962,614 shares of common stock and warrants to purchase 2,481,298 shares of common stock, for gross proceeds to us of approximately $3.2 million. In the second closing, we issued 13,482,464 shares of common stock and warrants to purchase
6,741,241 shares of common stock, for gross proceeds to us of approximately $8.8 million. The common stock warrants have a five-year term and became exercisable on October 8, 2005 and December 3, 2005, respectively. In addition, as
detailed in the common stock purchase warrant agreement, the warrants include a provision whereby we could be required to repurchase these warrants upon the occurrence of certain Fundamental Transactions defined in the agreement. If the
Fundamental Transaction is consummated by us after the second anniversary of the issuance of the warrants and the consideration received by the warrant holder is less than 30% in excess of the warrants exercise price, we (or the Companys
successor) must purchase the warrant from a holder. The purchase price of the warrant will be equal to the Black-Scholes value of the unexercised portion of the warrant as of the date the request to purchase is made.

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



25



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transactions under this program will depend on market conditions and corporate and regulatory considerations. The purchases will be funded from available
working capital. No repurchases were made in either 2004 or 2005, and as of December 31, 2005, we hold approximately 325,300 shares pursuant to this repurchase program.

The information required by this Item regarding securities authorized for issuance under equity compensation plans is incorporated by reference to the
information set forth in Item 12 of this Annual Report on this Form 10-K.

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, |        
|                                                                                                          |  | 2005                     |         |   | 2004 |   |         | 2003 |  |   | 2002    |   |  | 2001 |        
|Statement of operations data:                                                                             |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Revenues                                                                                                  |  | $                        | 3,776   |   |      | $ | 3,709   |      |  | $ | 3,421   |   |  | $    | 3,403   |   |  | $ | 3,317   |  
|Cost of goods sold                                                                                        |  |                          | 4,234   |   |      |   | 4,358   |      |  |   | 4,322   |   |  |      | 4,080   |   |  |   | 4,604   |  
|                                                                                                          |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Gross loss                                                                                                |  |                          | (458    | ) |      |   | (649    | )    |  |   | (901    | ) |  |      | (677    | ) |  |   | (1,287  | )
|                                                                                                          |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Operating expenses:                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Research and development                                                                                  |  |                          | 1,261   |   |      |   | 1,736   |      |  |   | 1,823   |   |  |      | 2,668   |   |  |   | 2,825   |  
|Clinical and regulatory                                                                                   |  |                          | 976     |   |      |   | 1,096   |      |  |   | 1,497   |   |  |      | 1,784   |   |  |   | 2,135   |  
|Sales and marketing                                                                                       |  |                          | 7,680   |   |      |   | 8,083   |      |  |   | 6,825   |   |  |      | 7,065   |   |  |   | 6,973   |  
|General and administrative                                                                                |  |                          | 3,583   |   |      |   | 5,073   |      |  |   | 3,505   |   |  |      | 4,023   |   |  |   | 4,443   |  
|Litigation charge                                                                                         |  |                          |        |   |      |   |        |      |  |   | 1,250   |   |  |      |        |   |  |   |        |  
|                                                                                                          |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                                                          |  |                          | 13,500  |   |      |   | 15,988  |      |  |   | 14,900  |   |  |      | 15,540  |   |  |   | 16,376  |  
|                                                                                                          |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Operating loss                                                                                            |  |                          | (13,958 | ) |      |   | (16,637 | )    |  |   | (15,801 | ) |  |      | (16,217 | ) |  |   | (17,663 | )
|                                                                                                          |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Interest income                                                                                           |  |                          | 162     |   |      |   | 132     |      |  |   | 234     |   |  |      | 751     |   |  |   | 2,240   |  
|Interest expense and other income (expense), net                                                          |  |                          | (4      | ) |      |   | (15     | )    |  |   | 12      |   |  |      | 25      |   |  |   | (6      | )
|Decrease in warrant liability                                                                             |  |                          | 2,845   |   |      |   | 1,200   |      |  |   |        |   |  |      |        |   |  |   |        |  
|                                                                                                          |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loss                                                                                                  |  | $                        | (10,955 | ) |      | $ | (15,320 | )    |  | $ | (15,555 | ) |  | $    | (15,441 | ) |  | $ | (15,429 | )
|                                                                                                          |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loss per common share attributable to common shareholders, basic and diluted                          |  | $                        | (0.30   | ) |      | $ | (0.64   | )    |  | $ | (0.77   | ) |  | $    | (0.79   | ) |  | $ | (0.81   | )
|Shares used in computing net loss per common share attributable to common shareholders, basic and diluted |  |                          | 36,364  |   |      |   | 24,037  |      |  |   | 20,076  |   |  |      | 19,653  |   |  |   | 19,075  |  
|                                                                                                          |  |                          |         |   |     
|Balance sheet data:                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Cash, cash equivalents and marketable securities                                                          |  | $                        | 3,319   |   |      | $ | 5,892   |      |  | $ | 10,134  |   |  | $    | 22,967  |   |  | $ | 35,128  |  
|Working capital                                                                                           |  |                          | 4,112   |   |      |   | 6,625   |      |  |   | 9,963   |   |  |      | 24,807  |   |  |   | 36,498  |  
|Long-term investments                                                                                     |  |                          |        |   |      |   |        |      |  |   |        |   |  |      | 528     |   |  |   | 3,048   |  
|Total assets                                                                                              |  |                          | 6,415   |   |      |   | 9,157   |      |  |   | 13,854  |   |  |      | 27,236  |   |  |   | 43,073  |  
|Total stockholders equity                                                                                |  |                          | 2,229   |   |      |   | 6,913   |      |  |   | 10,808  |   |  |      | 26,103  |   |  |   | 41,288  |  



26



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Item 7.
    Managements Discussion and Analysis of Financial Condition and Results of Operations

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 MDD 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, otherwise known as bowel
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 bowel 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 market the Stretta System, as a complement
to anti-reflux surgery, primarily to high volume gastroenterologists and general surgeons who actively perform endoscopy. In the United States, we estimate that there are approximately 4,500 general surgeons and 7,000 gastroenterologists who
actively perform endoscopy. We market the Secca System primarily to colon and rectal surgeons and to those general surgeons who perform colorectal surgery. We estimate that there are approximately 1,200 colon and rectal surgeons and approximately
3,000 general surgeons who perform colorectal surgery in the United States.

We are focusing our sales efforts in the United States through
a direct sales force, supplemented by selected independent manufacturing representatives. In international markets, we rely wholly on third-party distributors. In November 2000, we incorporated a subsidiary company in Belgium to support European
distributors sales, marketing and clinical efforts and to provide training in the use of the equipment to these distributors and their customers. As of December 31, 2005, this subsidiary had two employees. To date, we have international
distribution agreements in 35 countries, of which 13 are in the European Union. 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. Additionally, the Secca procedure has not yet been granted physician reimbursement. Some of our
customers 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 state and 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.



27



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Through December 31, 2005, we recorded limited product sales while incurring cumulative net losses
of $105.6 million. In the fourth quarter of 2005, we initiated a restructuring of our operations intended to reduce the cost of product sales, produce a positive gross profit and reduce operating expenses. We outsourced assembly of our disposable
products which allowed us to reduce our total headcount from 71 on November 15, 2005, to 28 on March 31, 2006. Most of the headcount reduction occurred prior to December 31, 2005. We anticipate that this will cause our expenses to
decrease. As a result, we expect our gross loss to decrease and our operating expenses to decrease in 2006.

We believe that the slow
adoption of our products has been accounted for specifically by the lack of economic benefit to physician users caused by unfavorable reimbursement rates and coverage and the lack of patient pressure on physicians due to lack of patient knowledge of
the availability of both procedures. We believe this is largely caused by our lack of resources to devote to direct-to-patient advertising.

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. 104, Revenue Recognition in Financial
Statements (SAB 104), as amended. SAB 104 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 or 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 disposables. 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 related to these services 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
products 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
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



28



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| | accompanying consolidated balance sheets, as well as operating loss and tax credit carryforwards. We have recorded a full valuation allowance to reduce the
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 we would be able to realize our deferred tax assets in the future, an adjustment to the deferred tax asset would increase income in the
period such determination was made.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Stock-Based CompensationIn December 2004, the FASB issued a revision of Statement of Financial Accounting Standards (or FAS) No. 123, Accounting for
Stock Based Compensation. The revision is referred to as FAS 123RShare-Based Payment (or FAS 123R), which supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, (or APB 25)
and will require companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments including stock options and stock issued under our employee plans. We adopted FAS 123R using the modified
prospective basis on January 1, 2006. Since we now must include the cost of stock-based employee compensation in the financial statements, our operating results are expected to decline based on the fair value of the stock-based employee
compensation.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Accounting for Common Stock WarrantsWe consider EITF 00-19 Accounting for derivative financial instruments indexed to, and potentially settled in a Companys own
stock and SFAS No. 150 Accounting for certain financial instruments with characteristics of both liabilities and equity to properly classify and value issued financial instruments. On February 6, 2004, April 8, 2005
and June 3, 2005 we issued warrants to several institutional investors in connection with the private placements of common stock. The common stock warrants have a five-year term and became exercisable on August 6, 2004, October 8,
2005 and December 3, 2005, respectively. The aggregate fair value of the warrants were recorded as a liability. The warrants were valued on February 6, 2004, April 8, 2005 and June 3, 2005 using the Black-Scholes model.
The fair value of the warrants and the corresponding liability is re-measured at the end of each reporting period utilizing current inputs to the Black-Scholes model, with any change in fair value being recorded as a non-operating item in the
statement of operations.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Legal Proceedings and Loss ContingenciesWe are involved in routine legal and administrative matters that arise from the normal conduct of business. Other matters contain
allegations that are not routine and involve compensatory, punitive, and treble damages. The outcome of these proceedings which are not within our control, are often difficult to predict and often are resolved over long periods of time. We also
maintain product liability insurance with third parties to mitigate any loss that is related to product liability claims. We record loss contingencies as liabilities in the financial statements when it is determined that we have incurred a loss that
is probable and the amount of the loss is reasonably estimable, in accordance with SFAS 5 Accounting for Contingencies.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

RESULTS OF OPERATIONS

Comparison of years ended December 31, 2005, 2004 and 2003

Revenue

Total revenues for the year ended
December 31, 2005 were $3,776,000, essentially flat compared to total revenues of $3,709,000 for the year ended December 31, 2004. Stretta sales declined in both module sales and catheter sales in 2005 compared to 2004. However, Secca
sales increased in 2005 compared to 2004, which made up for the Stretta shortfall. Total revenues for the year ended December 31, 2004 were $3,709,000, an increase of $288,000 or 8% over total revenues of $3,421,000 for the year ended
December 31, 2003. This increase was due primarily to increased sales of Secca product, which accounted for $505,000 of the increase.

In all three years, our revenues have been impacted by our ongoing challenges in receiving favorable reimbursement coverage decisions from both public and private carriers on a state-by-state basis for the Stretta procedures.



29



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Stretta System products accounted for 57% and Secca System products accounted for 41% of the revenues for
the year ended December 31, 2005, as compared to 74% and 24%, respectively, for the same period in 2004 and 87% and 11% respectively in 2003. The Stretta Control Module and Catheter accounted for 32% and 62%, respectively, of the Stretta
product line sales for the year ended December 31, 2005, compared to 38% and 58%, respectively, for the same period in 2004, and 43% and 54%, respectively, in 2003. The Secca Control Module and Handpieces accounted for 28% and 69%,
respectively, of the Secca product line sales for the year ended December 31, 2005, compared to 32% and 64%, respectively, for the same period in 2004, and 52% and 41%, respectively, in 2003. International sales accounted for $623,000 for the
year ended December 31, 2005, compared to $179,000 for the same period in 2004, and $226,000 in 2003. International sales were higher in 2005 due to the sale of capital equipment to new distributors. We expect to realize growth in new sales of
both control modules and disposable components in Europe and rest of the world.

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 $4,234,000, $4,358,000, and $4,322,000 in
the twelve months ended December 31, 2005, 2004, and 2003, respectively.

During the fourth quarter of fiscal 2005 we outsourced the
manufacturing of our disposable products to a contract manufacturer and implemented a restructuring initiative primarily to implement the outsourcing of our disposable component manufacturing. The total expenses included in the cost of sales in
connection with the initiative totaled approximately $339,000. These expenses include approximately $146,000 for severance and $193,000 for transition costs of the manufacturing from Fremont, California to Brea, California including freight,
calibration costs, pilot lots and training and travel associated therewith. The outsourcing of the assembly of our disposables was intended to reduce our cost of product by eliminating production overhead.

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 $1,261,000, $1,736,000, and $1,823,000 in the
twelve months ended December 31, 2005, 2004, and 2003, respectively. The decrease in expenses in 2005 compared to 2004 was due to cost reduction strategies and decreased headcount. In September 2004, we reduced the level of research activities
and reduced headcount by 5 employees. Costs associated with terminating these individuals were $138,000. As a result of this action spending for research and development expenses in 2005 is lower than 2004. The decrease in expenses in 2004 compared
to 2003 was due to the scaling back of disposables development activities. Stock-based compensation accounted for $27,000, and $66,000 in the twelve months ended December 31, 2004, and 2003, respectively.

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 $976,000, $1,096,000, and $1,497,000 in the twelve months ended December 31, 2005, 2004, and 2003, respectively. Spending decreased in 2005 as compared to 2004 and 2003. Our clinical and regulatory costs fluctuate
depending on the number of clinical trial patients treated in any period. Spending during 2005 and 2004 has been further reduced compared to 2003 due to decreased headcount. Clinical trial costs include payments to hospitals, and the related travel
expense for Curon employees. Stock-based compensation accounted for $(18,000), $29,000, and $142,000 in the twelve months ended December 31, 2005, 2004, and 2003, respectively.



30



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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 $7,680,000, $8,083,000, and $6,825,000
in the twelve months ended December 31, 2005, 2004, and 2003, respectively. The decrease in selling expenses in the twelve months ended December 2005 as compared to the same period in 2004 was primarily due to reductions in payroll related
expenses of $0.2 million, reductions in trade shows, travel and advertising expenses of $0.5 million, partially offset by a $0.3 million increase in other outside and consulting service. Spending increased in the twelve months ended December 2004 as
compared to the same period in 2003 as we positioned our sales, marketing and reimbursement teams for projected increased sales volumes. Implementation of cost reduction strategies realized lower spending for the twelve months ended
December 31, 2003. Stock-based compensation accounted for $(4,000), $12,000, and $14,000 in the twelve months ended December 31, 2005, 2004, and 2003, respectively.

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 $3,583,000, $5,073,000, and $3,505,000 in the twelve months ended December 31, 2005,
2004, and 2003, respectively. The primary reason for the decrease for the twelve months ended December 31, 2005 compared to 2004 and the increase for the twelve months ended December 31, 2004 compared to 2003, was due to the cost
associated with the investigation related to our revenue recognition policy in 2004, amounting to $1.2 million. Apart from the Audit Committee investigation, higher spending is related to an increase in insurance rates, legal spending and investor
relations.

Litigation charge

We
incurred a non-recurring litigation charge accrued in 2003 and paid in 2004 related to a settlement of $1,250,000 for litigation against us, in which the Plaintiff alleged injury during a Secca procedure caused by the device being defective and/or
in an unreasonably dangerous condition. The Plaintiff was a subject in a clinical trial. This is related to the lawsuit in the state of Pennsylvania, and also to the Chubb insurance suit.

Interest income and expense

Interest income was
$162,000, $132,000, and $234,000 in the twelve months ended December 31, 2005, 2004, and 2003, respectively. Interest income has decreased in 2005 and 2004 as compared to 2003, due to a declining balance of marketable securities. Average cash
and investment balances in 2005 were $4.6 million, compared to 2004 average of $8.0 million, and $16.8 million in 2003. Earnings have also been affected by declining interest rates through 2003 and 2004 and increasing interest rates in 2005.

Interest expense was $9,000, $6,000, and $5,000 in the twelve months ended December 31, 2005, 2004, and 2003, respectively. In all
three years, interest expense is related to notes payable related to insurance policies.

Decrease in warrant liability

Our sale of 18,445,078 newly issued shares on April 8 and June 3, 2005 included warrants to purchase an additional 2,481,298 and 6,741,241
respectively, shares of common stock to investors and warrants to purchase 553,352 shares of common stock to our placement agent. These warrants provide for cash redemption by the holders upon the occurrence of certain events outside our control. As
a result, the aggregate fair value of the warrants of $1,430,000 and $3,325,000, respectively, determined using the Black-Scholes model, was recorded as a liability on the issuance dates with subsequent changes to the fair value of the warrants
being recorded as a non-operating item through the statement of operations.



31



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Our sale of 4,025,000 newly issued shares on February 6, 2004, included warrants to purchase an
additional 905,625 shares of common stock. In accordance with the warrant purchase agreement and following the first closing of our 2005 financing, we notified holders of common stock warrants issued in February 2004 that the exercise price of the
warrants decreased from $4.71 to $3.85 and the number of common stock shares to purchase upon exercise of warrants increased from 905,625 to 1,107,920, so that the aggregate exercise price of $4,265,494 remains unchanged. Similar to our 2005
warrants, these warrants also provide for cash redemption by the holders upon the occurrence of certain events outside our control. As a result, the aggregate fair value of the warrants of $1,669,000, determined using the Black-Scholes model, was
recorded as a liability at the time of sale with subsequent changes to the fair value of the warrants being recorded as a non-operating item through the statement of operations. As at December 31, 2004, the fair value of the warrants decreased
from $1,669,000 on February 6, 2004, to $469,000 at December 31, 2004, resulting in us recording a benefit of $1,200,000 in the twelve months ended December 31, 2004.

The following table shows the changes to the fair value of the warrant obligations recorded as a non-operating (income) expense through the statement of
operations for the twelve months ended December 31, 2005 and 2004:



|                     |  |              |        |   |      |   |        |  
|-------------------- |  | ------------ | ------ | - | ---- | - | ------ | -
|                     |  | December 31, |       
|                     |  | 2005         |        |   | 2004 |  
|Warrant issue dates: |  |              |        |   |      |   |        |  
|June 3, 2005         |  | $            | (1,580 | ) |      | $ |       |  
|April 8, 2005        |  |              | (803   | ) |      |   |       |  
|February 6, 2004     |  |              | (462   | ) |      |   | (1,200 | )
|                     |  |              |        |   |      |   |        |  
|                     |  | $            | (2,845 | ) |      | $ | (1,200 | )
|                     |  |              |        |   |      |   |        |  

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, 2005, 2004 and 2003.

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 $47.5 million, from the issuance of convertible notes totaling $11.8 million and from bank equipment line financing totaling $780,000. On March 16, 2006, we entered into an assignment
and license agreement with BARRX Medical, Inc. of Sunnyvale, California. Pursuant to the terms of the agreement, we granted BÂRRX an assignment of United States Patent No. 6,872,206 and a worldwide, exclusive license of certain patents
pertaining to methods and/or apparatuses, including ablation devices, sizing balloons and generators, for the BÂRRX field of use, primarily the treatment of Barretts esophagus. In exchange for the agreement, we received $2.0 million in
cash and a $1.0 million note payable upon the earlier of BÂRRX next equity financing or by December 31, 2006. As of December 31, 2005, we had cash and cash equivalents on hand of $3.3 million and working capital of $4.1 million. To
continue operations, we must raise additional funds through the issuance of equity or debt securities in the public or private markets, or sell certain of our assets. No assurance can be given that we will be successful in obtaining funds from any
of these transactions on acceptable terms, if at all, or if secured, that such funding would be sufficient to continue to fund our operations. Any future equity financing could result in substantial dilution to our stockholders. If we raise
additional funds by issuing debt, we may be subject to limitations on our operations, through debt covenants or other restrictions. In the absence of funding, we will be required to scale back or terminate operations. We believe that our cash
balances will not be sufficient to fund planned expenditures in the third quarter of 2006. This raises substantial doubt about our ability to continue as a going concern.



32



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Cash used in operating activities was $13,558,000 in the twelve months ended December 31, 2005,
compared to $16,668,000 and $12,499,000 for the same period in 2004 and 2003 respectively. The decrease in cash use from 2004 to 2005 is primarily driven by the decrease in net loss, net of non-cash related expenses. The increase in cash used in
operating activities in 2003 to 2004 was due to the $1,250,000 cash paid for the settlement of a lawsuit and the costs of the Audit Committee investigation totaling $1,200,000.

Cash provided by or used in investing activities relate to purchases, and sales and maturities of investments and capital expenditures. Cash provided by
investing activities was $4,959,000 in the twelve months ended December 31, 2005, compared to cash used in investing activities of $941,000 and provided by investing activities of $8,722,000 for the same period in 2004 and 2003 respectively.

Cash provided by financing activities was $11,044,000 in the twelve months ended December 31, 2005, related to the private placement
of common stock to a group of institutional investors in the net amount of $10,955,000, in addition to $82,000 from exercise of stock options and the Employee Stock Purchase Plan, and net cash provided by financing of business insurance in the
amount net amount of $7,000. Cash provided by financing activities was $13,118,000 in the twelve months ended December 31, 2004, related to the private placement of common stock to a group of institutional investors in the net amount of
$12,628,000, in addition to $433,000 from exercise of stock options and the Employee Stock Purchase Plan, and net cash provided by financing of business insurance in the amount net amount of $57,000. Cash provided by financing activities was $72,000
for the twelve months ended December 31, 2003, primarily related to sales of common stock and proceeds from notes payable to finance insurance policies, offset by payments on those notes payable.

Contractual Obligations

The following table sets
forth our contractual obligations as of December 31, 2005 and the years in which such obligations are expected to be settled.



|                                 |  |      |     |      |   |       |  |   |    
|-------------------------------- |  | ---- | --- | ---- | - | ----- |  | - | ---
|                                 |  | 2006 |     | 2007 |   | Total
|Future minimum lease commitments |  | $    | 346 |      | $ | 13    |  | $ | 359
|Inventory purchase commitments   |  |      | 408 |      |   |      |  |   | 408
|                                 |  |      |     |      |   |       |  |   |    
|                                 |  | $    | 754 |      | $ | 13    |  | $ | 767
|                                 |  |      |     |      |   |       |  |   |    

Recent Accounting Pronouncements

In December 2004, the FASB issued a revision of Statement of Financial Accounting Standards (or FAS) No. 123, Accounting for
Stock-Based Compensation. The revision is referred to as FAS 123RShare-Based Payment (or FAS 123R), which supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, (or APB
25) and will require companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments including stock options and stock issued under our employee stock plans. We adopted FAS 123R using the
modified prospective basis on January 1, 2006. Our adoption of FAS 123R is expected to result in compensation expense that will increase net loss per share by approximately $0.01 to $0.02 per share for 2006. However, our estimate of future
stock-based compensation expense is affected by our stock price, the number of stock-based awards our board of directors may grant in 2006, as well as a number of complex and subjective valuation assumptions and the related tax effect. These
valuation assumptions include, but are not limited to, the volatility of our stock price and employee stock option exercise behaviors.

In
May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error CorrectionsA Replacement of APB Opinion No. 20 and FASB Statement No. 3, (SFAS 154). SFAS 154
primarily requires retrospective application to prior periods financial statements for the direct effects of changes in accounting principle, unless it is impracticable to determine either the period-specific



33



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effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after
December 15, 2005, and early adoption is permitted. We adopted the provision of SFAS 154, as applicable, beginning in fiscal 2006.

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.

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.



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Item 8.
    Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

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

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the
financial position of Curon Medical, Inc. (the Company) and its subsidiaries at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in
conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a) (2) presents fairly, in all material
respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards 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.

The accompanying financial statements have been prepared assuming that the Company will
continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses and negative cash flows from operations and has limited cash and working capital, which raise substantial doubt about its
ability to continue as a going concern. Managements plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/    PRICEWATERHOUSECOOPERS LLP

San Jose, California

March 29, 2006



35



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CURON MEDICAL, INC.

Consolidated Balance Sheets

(in thousands, except share amounts)



|                                                                                                                                             |  |              |          |   |      |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---- | - | ------- | -
|                                                                                                                                             |  | December 31, |         
|                                                                                                                                             |  | 2005         |          |   | 2004 |  
|Assets                                                                                                                                       |  |              |          |   |      |   |         |  
|Current assets:                                                                                                                              |  |              |          |   |      |   |         |  
|Cash and cash equivalents                                                                                                                    |  | $            | 2,819    |   |      | $ | 374     |  
|Marketable securities                                                                                                                        |  |              | 500      |   |      |   | 5,518   |  
|Accounts receivable, net of allowance for doubtful accounts of $96 and $54, respectively                                                     |  |              | 747      |   |      |   | 620     |  
|Inventories, net                                                                                                                             |  |              | 879      |   |      |   | 777     |  
|Prepaid expenses and other current assets                                                                                                    |  |              | 903      |   |      |   | 987     |  
|                                                                                                                                             |  |              |          |   |      |   |         |  
|Total current assets                                                                                                                         |  |              | 5,848    |   |      |   | 8,276   |  
|                                                                                                                                             |  |             
|Property and equipment, net                                                                                                                  |  |              | 300      |   |      |   | 551     |  
|Other assets                                                                                                                                 |  |              | 267      |   |      |   | 330     |  
|                                                                                                                                             |  |              |          |   |      |   |         |  
|Total assets                                                                                                                                 |  | $            | 6,415    |   |      | $ | 9,157   |  
|                                                                                                                                             |  |              |          |   |      |   |         |  
|Liabilities and Stockholders Equity                                                                                                         |  |              |          |   |      |   |         |  
|Current liabilities:                                                                                                                         |  |              |          |   |      |   |         |  
|Accounts payable                                                                                                                             |  | $            | 685      |   |      | $ | 473     |  
|Accrued liabilities                                                                                                                          |  |              | 987      |   |      |   | 1,121   |  
|Notes payable                                                                                                                                |  |              | 64       |   |      |   | 57      |  
|                                                                                                                                             |  |              |          |   |      |   |         |  
|Total current liabilities                                                                                                                    |  |              | 1,736    |   |      |   | 1,651   |  
|                                                                                                                                             |  |             
|Warrant liability                                                                                                                            |  |              | 2,379    |   |      |   | 469     |  
|Other                                                                                                                                        |  |              | 71       |   |      |   | 124     |  
|                                                                                                                                             |  |              |          |   |      |   |         |  
|Total liabilities                                                                                                                            |  |              | 4,186    |   |      |   | 2,244   |  
|                                                                                                                                             |  |             
|Contingencies and commitments (Note 5)                                                                                                       |  |              |          |   |      |   |         |  
|                                                                                                                                             |  |             
|Stockholders equity:                                                                                                                        |  |              |          |   |      |   |         |  
|Preferred stock, $.001 par value: 5,000,000 shares authorized Issued and outstanding: none                                                   |  |              |         |   |      |   |        |  
|Common stock, $.001 par value: 100,000,000 and 50,000,000, shares authorized Issued and outstanding: 43,349,000 and 24,756,000,
respectively |  |              | 43       |   |      |   | 25      |  
|Additional paid-in capital                                                                                                                   |  |              | 107,982  |   |      |   | 101,739 |  
|Accumulated deficit                                                                                                                          |  |              | (105,562 | ) |      |   | (94,607 | )
|Treasury stock, at cost 326,000 shares at December 31, 2005 and 2004                                                                         |  |              | (234     | ) |      |   | (234    | )
|Accumulated other comprehensive loss                                                                                                         |  |              |         |   |      |   | (10     | )
|                                                                                                                                             |  |              |          |   |      |   |         |  
|Total stockholders equity                                                                                                                   |  |              | 2,229    |   |      |   | 6,913   |  
|                                                                                                                                             |  |              |          |   |      |   |         |  
|Total liabilities and stockholders equity                                                                                                   |  | $            | 6,415    |   |      | $ | 9,157   |  
|                                                                                                                                             |  |              |          |   |      |   |         |  

See accompanying notes to consolidated financial statements



36



---

CURON MEDICAL, INC.

Consolidated Statements of Operations

(in thousands, except per share amounts)



|                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------------------------- |  | -------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                        |  | For the Years Ended December 31, |        
|                                                                        |  | 2005                             |         |   | 2004 |   |         | 2003 | 
|Revenues                                                                |  | $                                | 3,776   |   |      | $ | 3,709   |      |  | $ | 3,421   |  
|Cost of goods sold                                                      |  |                                  | 4,234   |   |      |   | 4,358   |      |  |   | 4,322   |  
|                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Gross loss                                                              |  |                                  | (458    | ) |      |   | (649    | )    |  |   | (901    | )
|                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Operating expenses:                                                     |  |                                  |         |   |      |   |         |      |  |   |         |  
|Research and development                                                |  |                                  | 1,261   |   |      |   | 1,736   |      |  |   | 1,823   |  
|Clinical and regulatory                                                 |  |                                  | 976     |   |      |   | 1,096   |      |  |   | 1,497   |  
|Sales and marketing                                                     |  |                                  | 7,680   |   |      |   | 8,083   |      |  |   | 6,825   |  
|General and administrative                                              |  |                                  | 3,583   |   |      |   | 5,073   |      |  |   | 3,505   |  
|Litigation charge                                                       |  |                                  |        |   |      |   |        |      |  |   | 1,250   |  
|                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Total operating expenses                                                |  |                                  | 13,500  |   |      |   | 15,988  |      |  |   | 14,900  |  
|                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Operating loss                                                          |  |                                  | (13,958 | ) |      |   | (16,637 | )    |  |   | (15,801 | )
|                                                                        |  |                                  |        
|Interest income                                                         |  |                                  | 162     |   |      |   | 132     |      |  |   | 234     |  
|Interest expense and other income (expense), net                        |  |                                  | (4      | ) |      |   | (15     | )    |  |   | 12      |  
|Decrease in warrant liability                                           |  |                                  | 2,845   |   |      |   | 1,200   |      |  |   |        |  
|                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                |  | $                                | (10,955 | ) |      | $ | (15,320 | )    |  | $ | (15,555 | )
|                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net loss per share, basic and diluted (Note 8)                          |  | $                                | (0.30   | ) |      | $ | (0.64   | )    |  | $ | (0.77   | )
|                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Shares used in computing net loss per share, basic and diluted (Note 8) |  |                                  | 36,364  |   |      |   | 24,037  |      |  |   | 20,076  |  
|                                                                        |  |                                  |         |   |      |   |         |      |  |   |         |  

See accompanying notes to consolidated financial statements



37



---

CURON MEDICAL, INC.

Consolidated Statements of Stockholders Equity And Comprehensive Loss

For the Years Ended
December 31, 2005, 2004, and 2003

(in thousands)



|                                                                                              |  |                   |  |        |    |                          |   |         |                           |  |   |                    |   |  |               |          |   |                                   |   |      |                          |  |   |     |   |  |   |         |  
|--------------------------------------------------------------------------------------------- |  | ----------------- |  | ------ | -- | ------------------------ | - | ------- | ------------------------- |  | - | ------------------ | - |  | ------------- | -------- | - | --------------------------------- | - | ---- | ------------------------ |  | - | --- | - |  | - | ------- | -
|                                                                                              |  | CommonStockShares |  | Amount |    | AdditionalPaid-inCapital |   |         | DeferredStockCompensation |  |   | AccumulatedDeficit |   |  | TreasuryStock |          |   | AccumulatedOtherComprehensiveLoss |   |      | TotalStockholdersEquity | 
|Balance at January 1, 2003                                                                    |  | 19,993            |  |        | 20 |                          |   | 90,128  |                           |  |   | (125               | ) |  |               | (63,732  | ) |                                   |   | (234 | )                        |  |   | 46  |   |  |   | 26,103  |  
|Net loss                                                                                      |  |                  |  |        |   |                          |   |        |                           |  |   |                   |   |  |               | (15,555  | ) |                                   |   |     |                          |  |   |    |   |  |   | (15,555 | )
|Change in unrealized gain on investment                                                       |  |                  |  |        |   |                          |   |        |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   | (47 | ) |  |   | (47     | )
|                                                                                              |  |                   |  |        |    |                          |   |         |                           |  |   |                    |   |  |               |          |   |                                   |   |      |                          |  |   |     |   |  |   |         |  
|Total comprehensive loss                                                                      |  |                  |  |        |   |                          |   |        |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | (15,602 | )
|Issuance of common stock upon exercise of stock options                                       |  | 64                |  |        |   |                          |   | 30      |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | 30      |  
|Issuance of common stock through Employee Stock Purchase Plan                                 |  | 152               |  |        |   |                          |   | 84      |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | 84      |  
|Deferred stock compensation                                                                   |  |                  |  |        |   |                          |   | (70     | )                         |  |   | 70                 |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   |        |  
|Amortization of deferred stock compensation                                                   |  |                  |  |        |   |                          |   | 142     |                           |  |   | 51                 |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | 193     |  
|                                                                                              |  |                   |  |        |    |                          |   |         |                           |  |   |                    |   |  |               |          |   |                                   |   |      |                          |  |   |     |   |  |   |         |  
|Balance at December 31, 2003                                                                  |  | 20,209            |  |        | 20 |                          |   | 90,314  |                           |  |   | (4                 | ) |  |               | (79,287  | ) |                                   |   | (234 | )                        |  |   | (1  | ) |  |   | 10,808  |  
|Net loss                                                                                      |  |                  |  |        |   |                          |   |        |                           |  |   |                   |   |  |               | (15,320  | ) |                                   |   |     |                          |  |   |    |   |  |   | (15,320 | )
|Change in unrealized loss on investment                                                       |  |                  |  |        |   |                          |   |        |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   | (9  | ) |  |   | (9      | )
|                                                                                              |  |                   |  |        |    |                          |   |         |                           |  |   |                    |   |  |               |          |   |                                   |   |      |                          |  |   |     |   |  |   |         |  
|Total comprehensive loss                                                                      |  |                  |  |        |   |                          |   |        |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | (15,329 | )
|Issuance of common stock upon exercise of stock options                                       |  | 346               |  |        | 1  |                          |   | 314     |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | 315     |  
|Issuance of common stock through Employee Stock Purchase Plan                                 |  | 176               |  |        |   |                          |   | 118     |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | 118     |  
|Common stock issued pursuant to private equity financing, net of issuance costs of $896,000   |  | 4,025             |  |        | 4  |                          |   | 10,955  |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | 10,959  |  
|Amortization of deferred stock compensation                                                   |  |                  |  |        |   |                          |   | 38      |                           |  |   | 4                  |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | 42      |  
|                                                                                              |  |                   |  |        |    |                          |   |         |                           |  |   |                    |   |  |               |          |   |                                   |   |      |                          |  |   |     |   |  |   |         |  
|Balance at December 31, 2004                                                                  |  | 24,756            |  |        | 25 |                          |   | 101,739 |                           |  |   |                   |   |  |               | (94,607  | ) |                                   |   | (234 | )                        |  |   | (10 | ) |  |   | 6,913   |  
|Net loss                                                                                      |  |                  |  |        |   |                          |   |        |                           |  |   |                   |   |  |               | (10,955  | ) |                                   |   |     |                          |  |   |    |   |  |   | (10,955 | )
|Change in unrealized loss on investment                                                       |  |                  |  |        |   |                          |   |        |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   | 10  |   |  |   | 10      |  
|                                                                                              |  |                   |  |        |    |                          |   |         |                           |  |   |                    |   |  |               |          |   |                                   |   |      |                          |  |   |     |   |  |   |         |  
|Total comprehensive loss                                                                      |  |                  |  |        |   |                          |   |        |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | (10,945 | )
|Issuance of common stock upon exercise of stock options                                       |  | 87                |  |        |   |                          |   | 45      |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | 45      |  
|Issuance of common stock through Employee Stock Purchase Plan                                 |  | 61                |  |        |   |                          |   | 37      |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | 37      |  
|Common stock issued pursuant to private equity financing, net of issuance costs of $1,033,000 |  | 18,445            |  |        | 18 |                          |   | 6,183   |                           |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | 6,201   |  
|Amortization of deferred stock compensation                                                   |  |                  |  |        |   |                          |   | (22     | )                         |  |   |                   |   |  |               |         |   |                                   |   |     |                          |  |   |    |   |  |   | (22     | )
|                                                                                              |  |                   |  |        |    |                          |   |         |                           |  |   |                    |   |  |               |          |   |                                   |   |      |                          |  |   |     |   |  |   |         |  
|Balance at December 31, 2005                                                                  |  | 43,349            |  | $      | 43 |                          | $ | 107,982 |                           |  | $ |                   |   |  | $             | (105,562 | ) |                                   | $ | (234 | )                        |  | $ |    |   |  | $ | 2,229   |  
|                                                                                              |  |                   |  |        |    |                          |   |         |                           |  |   |                    |   |  |               |          |   |                                   |   |      |                          |  |   |     |   |  |   |         |  

See accompanying notes to the consolidated financial statements



38



---

CURON MEDICAL, INC.

Consolidated Statements of Cash Flows

(in thousands)



|                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------- |  | -------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                            |  | For the Years Ended December 31, |        
|                                                                            |  | 2005                             |         |   | 2004 |   |         | 2003 | 
|Cash Flows From Operating Activities                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                    |  | $                                | (10,955 | ) |      | $ | (15,320 | )    |  | $ | (15,555 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                  |         |   |      |   |         |      |  |   |         |  
|Depreciation and amortization                                               |  |                                  | 285     |   |      |   | 329     |      |  |   | 517     |  
|Loss on disposal of fixed assets                                            |  |                                  |        |   |      |   | 38      |      |  |   | 17      |  
|Decrease of warrant liability                                               |  |                                  | (2,845  | ) |      |   | (1,200  | )    |  |   |        |  
|Amortization of stock-based compensation                                    |  |                                  | (22     | ) |      |   | 42      |      |  |   | 193     |  
|Amortization of premium on securities, net                                  |  |                                  | 35      |   |      |   | 499     |      |  |   | 283     |  
|Changes in current assets and liabilities:                                  |  |                                  |         |   |      |   |         |      |  |   |         |  
|Accounts receivable, net                                                    |  |                                  | (127    | ) |      |   | 214     |      |  |   | (146    | )
|Inventories, net                                                            |  |                                  | (102    | ) |      |   | 286     |      |  |   | 232     |  
|Prepaid expenses and other current assets                                   |  |                                  | 84      |   |      |   | (124    | )    |  |   | 109     |  
|Other assets                                                                |  |                                  | 63      |   |      |   | (104    | )    |  |   | (104    | )
|Accounts payable                                                            |  |                                  | 212     |   |      |   | (44     | )    |  |   | 326     |  
|Accrued liabilities                                                         |  |                                  | (134    | ) |      |   | (43     | )    |  |   | 282     |  
|(Decrease)/Increase in liability settlement reserve                         |  |                                  |        |   |      |   | (1,250  | )    |  |   | 1,250   |  
|Other long-term liabilities                                                 |  |                                  | (53     | ) |      |   | 9       |      |  |   | 97      |  
|                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net cash used in operating activities                                       |  |                                  | (13,559 | ) |      |   | (16,668 | )    |  |   | (12,499 | )
|                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Cash Flows From Investing Activities                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Purchase of property and equipment                                          |  |                                  | (34     | ) |      |   | (184    | )    |  |   | (614    | )
|Sale of property and equipment                                              |  |                                  |        |   |      |   |        |      |  |   | 10      |  
|Purchase of marketable securities                                           |  |                                  | (4,608  | ) |      |   | (11,961 | )    |  |   | (5,374  | )
|Proceeds from maturities of marketable securities                           |  |                                  | 9,601   |   |      |   | 11,204  |      |  |   | 14,700  |  
|                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) investing activities                         |  |                                  | 4,959   |   |      |   | (941    | )    |  |   | 8,722   |  
|                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Cash Flows From Financing Activities                                        |  |                                  |         |   |      |   |         |      |  |   |         |  
|Proceeds from issuance of notes payable                                     |  |                                  | 675     |   |      |   | 454     |      |  |   | 309     |  
|Principal payments on notes payable                                         |  |                                  | (668    | ) |      |   | (397    | )    |  |   | (351    | )
|Proceeds from issuance of common stock and warrants, net of issuance costs  |  |                                  | 10,956  |   |      |   | 12,628  |      |  |   |        |  
|Exercise of stock options and ESPP                                          |  |                                  | 82      |   |      |   | 433     |      |  |   | 114     |  
|                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net cash provided by financing activities                                   |  |                                  | 11,045  |   |      |   | 13,118  |      |  |   | 72      |  
|                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                        |  |                                  | 2,445   |   |      |   | (4,491  | )    |  |   | (3,705  | )
|Cash and cash equivalents at beginning of period                            |  |                                  | 374     |   |      |   | 4,865   |      |  |   | 8,570   |  
|                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of period                                  |  | $                                | 2,819   |   |      | $ | 374     |      |  | $ | 4,865   |  
|                                                                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Supplemental Disclosure Of Cash Flow Information                            |  |                                  |         |   |      |   |         |      |  |   |         |  
|Cash paid for interest                                                      |  | $                                | 9       |   |      | $ | 6       |      |  | $ | 5       |  

See accompanying notes to the consolidated financial statements



39



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

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.

Going Concern

In the course of its
operations, the Company has sustained operating losses and negative cash flows from operations and expects such losses to continue in the foreseeable future. As of December 31, 2005 the Company had cash and cash equivalents on hand of $3.3
million, working capital of $4.1 million, and an accumulated deficit of approximately $105.6 million. To continue operations, the Company must raise additional funds through the issuance of equity or debt securities in the public or private markets,
or sell certain of our assets. No assurance can be given that the Company will be successful in obtaining funds from any of these transactions on acceptable terms, if at all, or if secured, that such funding would be sufficient to continue to fund
our operations. In the absence of funding, the Company will be required to scale back or terminate operations. The Company believes that its cash balances will not be sufficient to fund planned expenditures in the third quarter of 2006. This raises
substantial doubt about the Companys ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

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 consolidated 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



40



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



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. The Company now relies on a single contract manufacturer to manufacture our disposable products. The Company has no prior history with
this supplier and cannot predict how well they will perform in meeting our quality and quantity requirements.

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 and commercial paper with a remaining maturity at the date of purchase of
greater than three months. Investments with maturities beyond one year from the balance sheet date are classified as long-term investments and those maturing within one year 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 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, 2005 and 2004, respectively:



|                           |  |      |       |                               |   |     |           |  |   |      
|-------------------------- |  | ---- | ----- | ----------------------------- | - | --- | --------- |  | - | -----
|                           |  | Cost |       | GrossUnrealizedHolding Losses |   |     | FairValue
|Maturities under one year  |  |      |       |                               |   |     |           |  |   |      
|Corporate obligations      |  | $    | 500   |                               | $ |    |           |  | $ | 500  
|                           |  |      |       |                               |   |     |           |  |   |      
|Total at December 31, 2005 |  | $    | 500   |                               | $ |    |           |  | $ | 500  
|                           |  |      |       |                               |   |     |           |  |   |      
|Maturities under one year  |  |      |       |                               |   |     |           |  |   |      
|Corporate obligations      |  | $    | 5,528 |                               | $ | (10 | )         |  | $ | 5,518
|                           |  |      |       |                               |   |     |           |  |   |      
|Total at December 31, 2004 |  | $    | 5,528 |                               | $ | (10 | )         |  | $ | 5,518
|                           |  |      |       |                               |   |     |           |  |   |      

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. Leasehold improvements are amortized using the straight-line method over the estimated useful life of the improvement, or the lease term, if shorter. Useful lives by principal
classifications are as follows:



|                               |  |        
|------------------------------ |  | -------
|Office furniture and equipment |  | 5 years
|Computers and software         |  | 3 years
|Leasehold improvements         |  | 3 years



41



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



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.

Impairment of
Long-Lived Assets

Long-lived 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 to date.

Revenue Recognition

The Company recognizes revenue in accordance with SEC SAB 104, as amended. 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.

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
are 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 years ended December 31, 2005 and 2004 is as follows:



|                                        |  |                                                                          |    |      |    |   |      |  |     |  
|--------------------------------------- |  | ------------------------------------------------------------------------ | -- | ---- | -- | - | ---- |  | --- | -
|                                        |  |                                                                          |    | 2005 |    |   | 2004 | 
|Balance as of the beginning of the year |  | $                                                                        | 83 |      |    | $ | 58   | 
|Add:                                    |  | Accruals for warranties issued                                           |    |      | 29 |   |      |  | 26  |  
|                                        |  | Cost incurred under separately priced extended warranty obligations      |    |      |   |   |      |  | 12  |  
|Less:                                   |  | Settlements made                                                         |    |      | (6 | ) |      |  | (1  | )
|                                        |  | Revenue recognized under separately priced extended warranty obligations |    |      | (8 | ) |      |  | (12 | )
|                                        |  |                                                                          |    |      |    |   |      |  |     |  
|Balance of the end of the year          |  | $                                                                        | 98 |      |    | $ | 83   | 
|                                        |  |                                                                          |    |      |    |   |      |  |     |  



42



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



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 $354,000 in 2005 and $380,000
in 2004, and $327,000 in 2003.

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 will adopt FAS 123R as of January 1, 2006.
Through December 31, 2005, the Company followed APB 25 to account for employee stock options. Under APB 25, the intrinsic value method of accounting, no compensation expense is recognized because the exercise price of the employee stock options
equals the market price of the underlying stock on the date of grant. The Company applies FAS 123 for disclosure purposes only, and recognizes compensation expense on a straight-line basis over the vesting period of the award.

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:



|                                                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                                |  | Year Ended December 31, |        
|                                                                                                                |  | 2005                    |         |   | 2004 |   |         | 2003 | 
|Net loss, as reported                                                                                           |  | $                       | (10,955 | ) |      | $ | (15,320 | )    |  | $ | (15,555 | )
|Add: Stock-based employee compensation expense in reported net income                                           |  |                         |        |   |      |   | 4       |      |  |   | 51      |  
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards |  |                         | (675    | ) |      |   | (724    | )    |  |   | (878    | )
|                                                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Net lossFAS 123 adjusted                                                                                       |  | $                       | (11,630 | ) |      | $ | (16,040 | )    |  | $ | (16,382 | )
|                                                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss per shareas reported Basic and diluted                                                                |  | $                       | (0.30   | ) |      | $ | (0.64   | )    |  | $ | (0.77   | )
|                                                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss per shareFAS 123 adjusted Basic and diluted                                                           |  | $                       | (0.32   | ) |      | $ | (0.67   | )    |  | $ | (0.82   | )
|                                                                                                                |  |                         |         |   |      |   |         |      |  |   |         |  

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 options are adjusted to fair value until such options vest.



43



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



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

Recent accounting
pronouncements

In December 2004, the FASB issued a revision of Statement of Financial Accounting Standards (or FAS)
No. 123, Accounting for Stock Based Compensation. The revision is referred to as FAS 123RShare-Based Payment (or FAS 123R), which supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees, (or APB 25) and will require companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments including stock options and stock issued under our employee plans. The
Company will adopt FAS 123R using the modified prospective basis on January 1, 2006. The adoption of FAS 123R is expected to result in compensation expense in 2006 that will increase net loss per share by approximately $0.01 to $.02 per share
for 2006. However, the estimate of future stock-based compensation expense is affected by the Companys stock price, the number of stock-based awards the Companys board of directors may grant in 2006, as well as a number of complex and
subjective valuation assumptions and the related tax effect. These valuation assumptions include, but are not limited to, the volatility of the Companys stock price and employee stock option exercise behaviors.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error CorrectionsA Replacement
of APB Opinion No. 20 and FASB Statement No. 3, (SFAS 154). SFAS 154 primarily requires retrospective application to prior periods financial statements for the direct effects of changes in accounting principle,
unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005,
and early adoption is permitted. The Company is required to adopt the provision of SFAS 154, as applicable, beginning in fiscal 2006.



44



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



NOTE 3BALANCE SHEET COMPONENTS:



|                |  |              |     |      |   |    
|--------------- |  | ------------ | --- | ---- | - | ---
|                |  | December 31,
|                |  | 2005         |     | 2004
|Inventories:    |  |              |     |      |   |    
|Raw materials   |  | $            | 494 |      | $ | 563
|Work-in-process |  |              | 69  |      |   | 13 
|Finished goods  |  |              | 316 |      |   | 201
|                |  |              |     |      |   |    
|                |  | $            | 879 |      | $ | 777
|                |  |              |     |      |   |    



|                                                |  |              |        |   |      |   |        |  
|----------------------------------------------- |  | ------------ | ------ | - | ---- | - | ------ | -
|                                                |  | December 31, |       
|                                                |  | 2005         |        |   | 2004 |  
|Property & Equipment:                           |  |              |        |   |      |   |        |  
|Computer and office equipment                   |  | $            | 605    |   |      | $ | 593    |  
|Equipment                                       |  |              | 1,287  |   |      |   | 1,298  |  
|Furniture and fixtures                          |  |              | 145    |   |      |   | 126    |  
|Leasehold improvements                          |  |              | 319    |   |      |   | 319    |  
|Software                                        |  |              | 254    |   |      |   | 254    |  
|                                                |  |              |        |   |      |   |        |  
|                                                |  |              | 2,610  |   |      |   | 2,590  |  
|Less: Accumulated depreciation and amortization |  |              | (2,310 | ) |      |   | (2,039 | )
|                                                |  |              |        |   |      |   |        |  
|                                                |  | $            | 300    |   |      | $ | 551    |  
|                                                |  |              |        |   |      |   |        |  

Depreciation and amortization expense of property and equipment totaled $285,000, $329,000 and
$517,000 for the years ended December 31, 2005, 2004 and 2003, respectively.



|                          |  |              |     |      |   |      
|------------------------- |  | ------------ | --- | ---- | - | -----
|                          |  | December 31,
|                          |  | 2005         |     | 2004
|Accrued Liabilities:      |  |              |     |      |   |      
|Compensation and benefits |  | $            | 574 |      | $ | 496  
|Clinical trials           |  |              | 104 |      |   | 175  
|Professional fees         |  |              | 36  |      |   | 199  
|Other accrued expenses    |  |              | 273 |      |   | 251  
|                          |  |              |     |      |   |      
|                          |  | $            | 987 |      | $ | 1,121
|                          |  |              |     |      |   |      

NOTE 4NOTES PAYABLE:

The Company had short-term notes payable at December 31, 2005 and 2004 in the amount of $64,000 and $57,000 respectively. The note bears interest at 5.06% and 3.99% and is related to the financing of corporate
insurance policies in the amount of $506,000 and $454,000.



45



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



NOTE 5COMMITMENTS AND CONTINGENCIES:

Leases

The Company leases office space under a noncancelable operating leases expiring through
August 2007. Rent expense for the years December 31, 2005, 2004, and 2003 was $361,000, $348,000 and $576,000 respectively.

At
December 31, 2005, future minimum facility lease payments are as follows:



|                                    |  |   |    
|----------------------------------- |  | - | ---
|2006                                |  | $ | 346
|2007                                |  |   | 13 
|                                    |  |   |    
|Total future minimum lease payments |  | $ | 359
|                                    |  |   |    

Purchase commitments

The Company had noncancelable commitments to purchase raw material and finished goods inventory totaling $408,000 in aggregate at December 31, 2005. These purchase commitments represent outstanding purchase
orders submitted to the Companys third party suppliers for goods to be delivered to the Company in 2006.

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 and were $50,000 in 2005, $60,000 in 2004 and $66,000 in 2003.

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. As part of the February
agreement, the Company is required to pay a royalty on all revenues collected when the related licensed technology is part of the sold item.

NOTE
6STOCKHOLDERS EQUITY:

The Companys Certificate of Incorporation, as amended, authorizes the Company to issue
100,000,000 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, 2005 and 2004, there
were no shares subject to repurchase.

Issuance of Common Stock

On April 8 and June 3, 2005, the Company completed the private placement of common stock and warrants with certain institutional investors and raised approximately $12.0 million in gross proceeds. Net
proceeds after offering costs and expenses were approximately $11.0 million. The Company paid to the parties that acted as its agents in connection with this private placement fees of $859,000 in cash and issued warrants to purchase



46



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



553,352 shares of its common stock as additional consideration. The terms of these warrants are identical to those issued to the investors. The transaction
was completed in two closings, and involved the sale of an aggregate of 18,445,078 newly issued shares of the Companys common stock at a price of $0.65 per share and warrants to purchase an aggregate of 9,222,539 shares of common stock with an
exercise price of $1.00 per share. In the first closing, the Company issued 4,962,614 shares of common stock and warrants to purchase 2,481,298 shares of common stock, for gross proceeds to the Company of approximately $3.2 million. The
aggregate fair value of the warrants on the date of issuance was approximately $1.4 million. In the second closing, the Company issued 13,482,464 shares of common stock and warrants to purchase 6,741,241 shares of common stock, for gross proceeds to
the Company of approximately $8.8 million. The aggregate fair value of the warrants on the date of issuance was approximately $3.3 million. The common stock warrants have a five-year term and became exercisable on October 8, 2005 and
December 3, 2005, respectively.

On February 6, 2004, the Company completed a private placement of 4,025,000 shares of common
stock for aggregate gross proceeds of approximately $13.5 million to a group of institutional investors. The shares were purchased at a price of at a price of $3.36 per share. Net proceeds after offering costs and expenses were approximately $12.6
million. Investors received warrants with a term of five years to purchase an aggregate of 905,625 common shares at an exercise price of $4.71 per share. In accordance with the warrant purchase agreement and following the April 8, 2005 closing
of financing, the Company notified holders of common stock warrants issued in February 2004 that the exercise price of the warrants decreased from $4.71 to $3.85 and the number of common stock shares to purchase upon exercise of warrants increased
from 905,625 to 1,107,920, so that the aggregate exercise price of $4,265,494 remains unchanged.

Common Stock Warrants

On April 8, 2005 and June 3, 2005, the Company issued warrants to purchase an aggregate of 2,481,298, and 6,741,241, respectively shares of
common stock at an exercise price of $1.00 per share to several institutional investors in connection with the private placement of common stock. The common stock warrants have a five-year term and become exercisable on October 8, 2005 and
December 3, 2005, respectively. In addition, as detailed in the common stock purchase warrant agreement, the warrants include a provision whereby the Company could be required to repurchase these warrants upon the occurrence of certain
Fundamental Transactions defined in the agreement which is outside of the Companys control. If the Fundamental Transaction is consummated by the Company after the second anniversary of the issuance of the warrants and the
consideration received by the warrant holder is less than 30% in excess of the warrants exercise price, the Company (or the Companys successor) must purchase the warrant from the holder. The purchase price of the warrant will be equal to
the Black-Scholes value of the unexercised portion of the warrant as of the date the request to purchase is made. As a result, the aggregate fair value of the warrants of $1.4 and $3.3 million was recorded as a liability with the remaining net
proceeds of $6.3 million recorded as equity in the accompanying condensed consolidated balance sheet. The warrants were valued on April 8, and June 3, 2005 using the Black-Scholes model with the following assumptions: 5 year expected life,
risk free interest rate of 4.08% and 3.72%, respectively, dividend yield of zero and a volatility of 100%.

The fair value of the warrants
and the corresponding liability is re-measured at the end of each reporting period utilizing current inputs to the Black-Scholes model, with any change in fair value being recorded as a non-operating item in the statement of operations. The
aggregate fair value of the warrant decreased from $1,430,000 and $3,325,000 upon issuance on April 8, 2005 and June 3, 2005, to $627,000 and $1,745,000 respectively at December 31, 2005. The warrants were valued on December 31,
2005, using the Black-Scholes model with the following assumptions: 4.3 and 4.4 year expected life, risk free interest rate of 4.3%, dividend rate of zero and volatility of 100%.



47



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



On February 6, 2004, the Company issued warrants to purchase an aggregate of 905,625 shares of
common stock an exercise price of $4.71 per share to several institutional investors in connection with the private placement of common stock. The common stock warrants have a five-year term and became exercisable on August 6, 2004. In
addition, on or after August 6, 2007, should the companys stock price close at or above 175% of the exercise price on any 15 out of 30 consecutive trading days, and other certain conditions are met as defined in the warrant agreement, the
company has the right, on one occasion, to require the holders of the common stock warrants to exercise such common stock warrants. The warrant agreement contains a provision (Section 9(c)) providing that if the Company enters into a fundamental
transaction, as defined further in the agreement (i.e. merger/consolidation, sale of substantially all of its assets, tender offer, reclassification common stock) that is consummated after the second anniversary of the date of the warrant and the
cash consideration to be received by the holder is not greater than or equal to 30% over the exercise price, then at the request of the holder, the Company shall cash settle the warrants, purchasing such warrants for cash equal to the Black-Scholes
value (assuming a 55% volatility) of the remaining unexercised portion of the warrant. As a result, the aggregate fair value of the warrants of $1,669,000 was recorded as a liability. The warrants were valued on February 6, 2004, using the
Black-Scholes model with the following assumptions: 5 year expected life, risk free interest rate of 3.23%, dividend yield of zero, volatility of 73%.

The fair value of the warrants and the corresponding liability is re-measured at the end of each reporting period utilizing current inputs to the Black-Scholes model, with any change in fair value being recorded as a
non-operating item in the statement of operations. The aggregate fair value of the warrant decreased from $1,669,000 upon issuance on February 6, 2004, to $469,000 at December 31, 2004 to $7,000 at December 31, 2005. The warrants were
valued on December 31, 2005, using the Black-Scholes model with the following assumptions: 3.1 year expected life, risk free interest rate of 4.3%, dividend rate of zero and volatility of 56%.

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 7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 non statutory stock options. Incentive stock options (ISO) may be granted only to Company employees (including officers and directors who are also employees). Non statutory stock options (NSO) may be
granted to Company employees, officers, directors, and consultants. The Company



48



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



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, 2005, there were 5,950,091
shares authorized for issuance under this plan.

Under both plans, options are granted for a period of up to ten years and 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.

With effect from June 16th 2004, the 2000 Stock Option
Plan was amended to include each non-employee director elected to the Board of Directors for the first time following the Annual Meeting will receive upon election an initial grant of options to purchase 15,000 shares of common stock at fair market
value on the date of grant as well as an annual grant of options to purchase 15,000 shares for each year during the directors term. All of the foregoing options have a ten-year term. The initial option grants as well as the annual grants are
fully vested and immediately exercisable on the day of grant. All grants issued to outside Board members will be exercisable for up to a year from the date of such Board members termination of service with the Company.

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.

For stock options granted to employees 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. No deferred compensation has been recorded in the three years ended December 31, 2005.

For stock options granted to non-employees, generally for future services (16,000 in 2005, 10,000 in 2004, and 10,000 in 2003), the fair value of the
options, was determined using the Black-Scholes valuation model. The Company records stock as the non-employee fulfills the terms of the option grants, with changes in fair value of the unvested options from period to period recorded as an
adjustment to compensation expense.



49



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



Stock compensation expense is classified as follows:



|                           |  |                          |     |   |      |   |      |  |   |    
|-------------------------- |  | ------------------------ | --- | - | ---- | - | ---- |  | - | ---
|                           |  | Years Ended December 31,
|                           |  | 2005                     |     |   | 2004 |   | 2003
|Cost of goods sold         |  | $                        |    |   |      | $ |     |  | $ | 1  
|Research and development   |  |                          |    |   |      |   | 1    |  |   | 27 
|Clinical and regulatory    |  |                          | (18 | ) |      |   | 29   |  |   | 142
|Sales and marketing        |  |                          | (4  | ) |      |   | 12   |  |   | 14 
|General and administrative |  |                          |    |   |      |   |     |  |   | 9  
|                           |  |                          |     |   |      |   |      |  |   |    
|                           |  | $                        | (22 | ) |      | $ | 42   |  | $ | 193
|                           |  |                          |     |   |      |   |      |  |   |    

Activity under stock option plans is as follows:



|                        |  |                    |   |      |                              |      |                    |           |   |                              |   |                    |  |           |                              |  |   |     
|----------------------- |  | ------------------ | - | ---- | ---------------------------- | ---- | ------------------ | --------- | - | ---------------------------- | - | ------------------ |  | --------- | ---------------------------- |  | - | ----
|                        |  | 2005               |   | 2004 |                              | 2003
|                        |  | Sharesunderoptions |   |      | Weightedaverageexerciseprice |      | Sharesunderoptions |           |   | Weightedaverageexerciseprice |   | Sharesunderoptions |  |           | Weightedaverageexerciseprice
|Beginning balance       |  | 3,526,000          |   |      | $                            | 1.94 |                    | 3,629,000 |   |                              | $ | 1.92               |  | 2,416,000 |                              |  | $ | 2.52
|Granted                 |  | 3,490,000          |   |      | $                            | 0.45 |                    | 1,165,000 |   |                              | $ | 1.65               |  | 1,671,000 |                              |  | $ | 1.07
|Exercised               |  | (88,000            | ) |      | $                            | 0.52 |                    | (346,000  | ) |                              | $ | 0.89               |  | (64,000   | )                            |  | $ | 0.47
|Cancelled               |  | (1,102,000         | ) |      | $                            | 1.45 |                    | (922,000  | ) |                              | $ | 1.87               |  | (394,000  | )                            |  | $ | 2.26
|                        |  |                    |   |      |                              |      |                    |           |   |                              |   |                    |  |           |                              |  |   |     
|Ending balance          |  | 5,826,000          |   |      | $                            | 1.16 |                    | 3,526,000 |   |                              | $ | 1.94               |  | 3,629,000 |                              |  | $ | 1.92
|                        |  |                    |   |      |                              |      |                    |           |   |                              |   |                    |  |           |                              |  |   |     
|Exercisable at year-end |  | 2,250,000          |   |      | $                            | 2.06 |                    | 1,852,000 |   |                              | $ | 2.48               |  | 1,301,000 |                              |  | $ | 2.96
|                        |  |                    |   |      |                              |      |                    |           |   |                              |   |                    |  |           |                              |  |   |     

The options outstanding and currently exercisable by exercise price at December 31, 2005 are
as follows:



|                                    |  |                   |  |                                                  |  |                              |       |                   |           |                              |   |      
|----------------------------------- |  | ----------------- |  | ------------------------------------------------ |  | ---------------------------- | ----- | ----------------- | --------- | ---------------------------- | - | -----
|Options Outstanding and Exercisable |  | Exercisable      
|Range ofExercise Prices             |  | NumberOutstanding |  | Weighted AverageRemainingContractualLife (Years) |  | WeightedAverageExercisePrice |       | NumberExercisable |           | WeightedAverageExercisePrice
|$ 0.18   $  0.19                   |  | 114,000           |  | 2.86                                             |  | $                            | 0.19  |                   | 114,000   |                              | $ | 0.19 
|0.32       0.32                    |  | 2,050,000         |  | 9.82                                             |  |                              | 0.32  |                   |          |                              |   |     
|0.39       0.68                    |  | 1,401,000         |  | 8.11                                             |  |                              | 0.65  |                   | 600,000   |                              |   | 0.68 
|0.70       0.99                    |  | 855,000           |  | 7.65                                             |  |                              | 0.76  |                   | 489,000   |                              |   | 0.72 
|1.13       3.03                    |  | 834,000           |  | 7.60                                             |  |                              | 1.95  |                   | 532,000   |                              |   | 2.16 
|3.05       4.50                    |  | 491,000           |  | 5.98                                             |  |                              | 3.95  |                   | 434,000   |                              |   | 4.03 
|4.51     12.50                     |  | 81,000            |  | 4.51                                             |  |                              | 11.82 |                   | 81,000    |                              |   | 11.82
|                                    |  |                   |  |                                                  |  |                              |       |                   |           |                              |   |      
|                                    |  | 5,826,000         |  | 8.24                                             |  | $                            | 1.16  |                   | 2,250,000 |                              | $ | 2.06 
|                                    |  |                   |  |                                                  |  |                              |       |                   |           |                              |   |      



50



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



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 |           | ESPP
|                                         |  | 2005               |           | 2004 |   | 2003      |  | 2005 |         | 2004 |   | 2003      
|Assumptions:                             |  |                    |           |      |   |           |  |      |         |      |   |            |  |   |            |  |   |          
|Risk-free interest rate                  |  |                    | 4.16%     |      |   | 3.18%     |  |      | 2.55%   |      |   | 3.34%      |  |   | 1.80%      |  |   | 1.47%    
|Expected life                            |  |                    | 3.0 years |      |   | 4.1 years |  |      | 4 years |      |   | 1.25 years |  |   | 1.25 years |  |   | 0.7 years
|Expected volatility                      |  |                    | 100.1%    |      |   | 106.6%    |  |      | 100%    |      |   | 100.0%     |  |   | 104.3%     |  |   | 100%     
|Expected dividend yield                  |  |                    | 0.0%      |      |   | 0.0%      |  |      | 0.0%    |      |   | 0.0%       |  |   | 0.0%       |  |   | 0.0%     
|                                         |  |                    |           |      |   |          
|Weighted average fair values:            |  |                    |           |      |   |           |  |      |         |      |   |            |  |   |            |  |   |          
|Exercise price less than market price    |  | $                  |          |      | $ |          |  | $    |        |      | $ | 0.39       |  | $ | 0.78       |  | $ | 0.29     
|Exercise price equal to market price     |  | $                  | 1.16      |      | $ | 1.19      |  | $    | 0.75    |      | $ |           |  | $ |           |  | $ |         
|Exercise price greater than market price |  | $                  |          |      | $ |          |  | $    |        |      | $ |           |  | $ |           |  | $ |         

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 the Company has made no contributions for the years ended
December 31, 2005, 2004, or 2003.

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 2004 and 2003, the shares reserved for issuance under the ESPP were increased by 303,000 and 300,000 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 2005, the shares purchased under the ESPP were 61,000 on May 2.



51



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



NOTE 8NET LOSS PER SHARE:

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



|                                                                     |  |                         |            |   |      |   |            |      |  |   |            |  
|-------------------------------------------------------------------- |  | ----------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                                     |  | Year Ended December 31, |           
|                                                                     |  | 2005                    |            |   | 2004 |   |            | 2003 | 
|Numerator:                                                           |  |                         |            |   |      |   |            |      |  |   |            |  
|Net loss                                                             |  | $                       | (10,955    | ) |      | $ | (15,320    | )    |  | $ | (15,555    | )
|                                                                     |  |                         |            |   |      |   |            |      |  |   |            |  
|Denominator:                                                         |  |                         |            |   |      |   |            |      |  |   |            |  
|Weighted average shares outstanding                                  |  |                         | 36,364,000 |   |      |   | 24,037,000 |      |  |   | 20,085,000 |  
|Weighted average unvested common shares subject to repurchase        |  |                         |           |   |      |   |           |      |  |   | (9,000     | )
|                                                                     |  |                         |            |   |      |   |            |      |  |   |            |  
|Weighted average shares used in basic and diluted net loss per share |  |                         | 36,364,000 |   |      |   | 24,037,000 |      |  |   | 20,076,000 |  
|                                                                     |  |                         |            |   |      |   |            |      |  |   |            |  
|Net loss per share                                                   |  | $                       | (0.30      | ) |      | $ | (0.64      | )    |  | $ | (0.77      | )
|                                                                     |  |                         |            |   |      |   |            |      |  |   |            |  

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.

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,
|                                                      |  | 2005            |  | 2004      |  | 2003     
|Unvested common shares (shares subject to repurchase) |  |                |  |          |  | 1,000    
|Shares issuable upon exercise of stock options        |  | 5,826,000       |  | 3,526,000 |  | 3,629,000
|Shares issuable through ESPP                          |  |                |  | 17,553    |  | 39,392   
|Shares issuable upon exercise of warrants             |  | 10,884,000      |  | 1,475,000 |  | 569,000  
|                                                      |  |                 |  |           |  |          
|Total                                                 |  | 16,710,000      |  | 5,018,553 |  | 4,238,392
|                                                      |  |                 |  |           |  |          

NOTE 9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.



52



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



Revenue from external customers by geographic area for each of the three years in the period ended
December 31, 2005, were as follows:



|              |  |      |       |   |      |   |       |      |  |   |       |  
|------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|              |  | 2005 |       |   | 2004 |   |       | 2003 | 
|United States |  | $    | 3,153 |   |      | $ | 3,530 |      |  | $ | 3,195 |  
|% of total    |  |      | 83.5  | % |      |   | 95.2  | %    |  |   | 93.4  | %
|Europe        |  | $    | 623   |   |      | $ | 179   |      |  | $ | 226   |  
|% of total    |  |      | 16.5  | % |      |   | 4.8   | %    |  |   | 6.6   | %

NOTE 10INCOME TAXES:

The components of net deferred tax assets and liabilities as of December 31, 2005 and 2004 are as follows:



|                                         |  |              |         |   |      |   |         |  
|---------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                         |  | December 31, |        
|                                         |  | 2005         |         |   | 2004 |  
|Deferred tax assets                      |  |              |         |   |      |   |         |  
|Depreciation and amortization            |  | $            | 420     |   |      | $ | 388     |  
|Reserves                                 |  |              | 582     |   |      |   | 275     |  
|Credits                                  |  |              | 1,150   |   |      |   | 1,150   |  
|Capitalized research & development costs |  |              | 263     |   |      |   | 305     |  
|Capitalized start-up costs               |  |              | 14      |   |      |   | 16      |  
|Net operating loss carryforwards         |  |              | 36,265  |   |      |   | 31,227  |  
|                                         |  |              |         |   |      |   |         |  
|                                         |  |              | 38,694  |   |      |   | 33,361  |  
|                                         |  |              |         |   |      |   |         |  
|Valuation allowance                      |  |              | (38,694 | ) |      |   | (33,361 | )
|                                         |  |              |         |   |      |   |         |  
|Net deferred tax assets                  |  | $            |        |   |      | $ |        |  
|                                         |  |              |         |   |      |   |         |  

Realization of deferred tax assets is dependent upon future earnings, if any, the timing and
amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. The valuation allowance is increased by $5,333,000 and $6,652,000 for the period ended December 31, 2005 and 2004
respectively.

As of December 31, 2005, the Company has a net operating loss carry forward for federal purposes of approximately $94.0
million, which expire beginning in the year 2018. The Company also has California net operating loss carry forward of approximately $66.5 million which expire beginning in the year 2008.

The Company has research and development credit carry forwards of approximately $715,000 and $574,000 for federal and state income tax purposes,
respectively. If not utilized, the federal carry forward will expire in various amounts beginning in 2018. 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.



53



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



Reconciliation of the statutory federal income tax to the Companys effective tax rate follows:



|                                   |  |              |   |  |       |  
|---------------------------------- |  | ------------ | - |  | ----- | -
|                                   |  | December 31, |  
|                                   |  | 2005         |   |  | 2004  |  
|Tax at federal statutory rate      |  | 34.0         | % |  | 34.0  | %
|Net operating losses not benefited |  | (40.6        | ) |  | (36.6 | )
|Accrued warrant income             |  | 8.8          |   |  | 2.6   |  
|Foreign tax benefit not provided   |  | (2.0         | ) |  | (0.9  | )
|Other                              |  | (0.2         | ) |  | 0.9   |  
|                                   |  |              |   |  |       |  
|                                   |  | 0.0          | % |  | 0.0   | %
|                                   |  |              |   |  |       |  

NOTE 11RESTRUCTURING AND REORGANIZATION:

The Company initiated a restructuring of its operations intended to reduce the cost of product sales, produce a positive gross profit and reduce operating
expenses. On October 31, 2005 the Company entered into an outsourced contract manufacturing agreement with LSO for the assembly of its disposable products. The agreement has a term of one year and will be renewed on an annual basis unless
otherwise mutually agreed by both the parties. For the year ended December 31, 2005 the Company recorded total restructuring charge of $382,000 of which $339,000 was included in cost of goods sold and $19,000 in Research and development,
$11,000 in Sales and marketing and $13,000 in General and administrative in the Consolidated Statements of Operations. These efforts allowed the Company to reduce its total headcount from 71 on November 15, 2005, to 32 on December 31,
2005. As a result the Company anticipates a positive gross profit and reduced operating expenses in 2006.

The following table summarizes
the liabilities established for the restructuring activities:



|                             |  |                |     |                  |   |       |  |   |    
|---------------------------- |  | -------------- | --- | ---------------- | - | ----- |  | - | ---
|                             |  | SeveranceCosts |     | OutsourcingCosts |   | Total
|Recorded in 2005             |  | $              | 189 |                  | $ | 193   |  | $ | 382
|Payments in 2005             |  |                | 189 |                  |   | 132   |  |   | 321
|                             |  |                |     |                  |   |       |  |   |    
|Balance at December 31, 2005 |  | $              |    |                  | $ | 61    |  | $ | 61 
|                             |  |                |     |                  |   |       |  |   |    

The Company completed the cash payments related to the outsourcing costs in January 2006.



54



---

CURON MEDICAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

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



NOTE 12QUARTERLY FINANCIAL DATA (UNAUDITED):

The following table presents certain unaudited consolidated quarterly financial information for each of the eight quarters ended December 31, 2005.
In our opinion, this quarterly information has been prepared on the same basis as the consolidated financial statements and includes all adjustments (consisting only of normal recurring adjustments, except for the litigation charge in the fourth
quarter of 2003) necessary to present fairly the information for the periods presented. The results of operations for any quarter are not necessarily indicative of results for the full year or for any future period.



|                                                               |  |          |  |                                       |              |    |          |   |              |           |  |   |              |    |  |   |              |   
|-------------------------------------------------------------- |  | -------- |  | ------------------------------------- | ------------ | -- | -------- | - | ------------ | --------- |  | - | ------------ | -- |  | - | ------------ | --
|                                                               |  |          |  | Quarter ended                         |             
|                                                               |  | Year     |  | March 31,                             |              |    | June 30, |   |              | Sept. 30, |  |   | Dec. 31,     |   
|                                                               |  |          |  | (in thousands, except per share data) |             
|                                                               |  |          |  | (unaudited)                           |             
|Net Sales                                                      |  | 20052004 |  | $                                     | 857906       |    |          | $ | 1,152931     |           |  | $ | 745862       |    |  | $ | 1,0221,010   |   
|                                                               |  |          |  |                                       |             
|Gross Loss                                                     |  | 20052004 |  |                                       | (125(116     | )) |          |   | 139(179      | )         |  |   | (97(174      | )) |  |   | (375(180     | ))
|                                                               |  |          |  |                                       |             
|Net Loss                                                       |  | 20052004 |  |                                       | (2,966(3,552 | )) |          |   | (3,746(3,211 | ))        |  |   | (716(4,348   | )) |  |   | (3,527(4,209 | ))
|                                                               |  |          |  |                                       |             
|Earnings per share, basic and diluted                          |  | 20052004 |  |                                       | (0.12(0.16   | )) |          |   | (0.11(0.13   | ))        |  |   | (0.02(0.18   | )) |  |   | (0.08(0.17   | ))
|                                                               |  |          |  |                                       |             
|Shares used in computing net loss per share, basic and diluted |  | 20052004 |  |                                       | 24,81022,659 |    |          |   | 33,66824,385 |           |  |   | 43,34924,470 |    |  |   | 43,34924,622 |   

NOTE 13SUBSEQUENT EVENTS

In February 2006, the Company filed a suit against its former insurance broker alleging failure to obtain adequate and reasonable insurance coverage,
failure to properly advise the Company in securing adequate insurance coverage and failure to tender a claim to the appropriate insurance company. These matters are currently at an early stage.

On March 16, 2006, the Company entered into an assignment and license agreement with BÂRRX Medical, Inc. of Sunnyvale, California. Pursuant to
the terms of the agreement, the Company granted BÂRRX an assignment of United States Patent No. 6,872,206 and a worldwide, exclusive license of certain patents pertaining to methods and/or apparatuses, including ablation devices, sizing
balloons and generators, for the BÂRRX field of use, primarily the treatment of Barretts esophagus. In exchange for the agreement, the Company received $2.0 million in cash and a $1.0 million note payable upon the earlier of BÂRRX
next equity financing or by December 31, 2006.



55



---

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

Not applicable.

Item 9A.
    Controls and Procedures

Evaluation of Disclosure Controls and Procedures. Based
on their evaluation as of December 31, 2005, our President and Chief Executive Officer and our Vice President of Finance and Chief Financial Officer, have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended) were sufficiently effective to ensure that the information required to be disclosed by us in this Annual Report on Form 10-K was recorded, processed, summarized and reported within the
time periods specified in the SECs rules and instructions for Form 10-K.

Changes in Internal Control Over Financial
Reporting. There was no change in the Companys internal control over financial reporting that occurred during the period covered by this Report that has materially affected, or is reasonably likely to materially affect, the Companys
internal control over-financial reporting.

Item 9B.    
Other Information

None.



56



---

PART III

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.

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.

Item 14.
    Principal Accountant Fees and Services

The information required by this item is
incorporated by reference to the section entitled Proposal Number 2Selection of Auditors, beginning with the section entitled Audit and Other Fees, but only up to and not including the section entitled
Recommendation and Vote Required of the Companys Proxy Statement for the 2006 Annual Meeting of Stockholders.



57



---

PART IV

Item 15.
    Exhibits and Financial Statement Schedules

(A)



|1. | Financial Statements
|-- | --------------------

The following documents are
filed as part of this Annual Report on Form 10-K:



|                                                                                                                                      
|--------------------------------------------------------------------------------------------------------------------------------------
|Report of Independent Registered Public Accounting Firm.                                                                              
|Consolidated Balance Sheets at December 31, 2005 and 2004.                                                                            
|Consolidated Statements of Operations, for the years ended December 31, 2005, 2004, and 2003.                                         
|Consolidated Statements of Stockholders Equity and Comprehensive Income (Loss) for the years ended December 31, 2005, 2004, and
2003.
|Consolidated Statements of Cash Flows, for the years ended December 31, 2005, 2004, and 2003.                                         
|Notes to Consolidated Financial Statements.                                                                                           
|Quarterly Financial Data (unaudited).                                                                                                 



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

The following
financial statement schedule is filed as part of this Annual Report on Form 10-K:



|                                                          
|----------------------------------------------------------
|Schedule IIValuation and Qualifying Accounts and Reserves

All other schedules have been omitted as they are not required, not applicable, or the required
information is otherwise included.



58



---

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



|              |  |                                                                                                                                                                                                                                                                                       
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                                                                                           
|              | 
|3.3(1)        |  | Amended and Restated Certificate of Incorporation.                                                                                                                                                                                                                                    
|              | 
|3.4(1)        |  | Bylaws of the registrant.                                                                                                                                                                                                                                                             
|              | 
|3.5(7)        |  | Certificate of Amendment to Amended and Restated Certificate of Incorporation.                                                                                                                                                                                                        
|              | 
|4.1(1)        |  | Specimen common stock certificate of the registrant.                                                                                                                                                                                                                                  
|              | 
|4.3(2)        |  | 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.
|              | 
|4.4(3)        |  | Form of Warrant to Purchase Shares of Common Stock.                                                                                                                                                                                                                                   
|              | 
|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.                                                                                                                                                         
|              | 
|10.8(1)       |  | 2000 Stock Option Plan.                                                                                                                                                                                                                                                               
|              | 
|10.14*(1)     |  | Technology license agreement between the registrant and Gyrus PCL (formerly 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.                                                                                                                                                      
|              | 
|10.21(4)      |  | Employment Agreement with Larry C. Heaton II, President and Chief Executive Officer.                                                                                                                                                                                                  
|              | 
|10.23(5)      |  | Lease Agreement with Hopkins Properties, LLC for 46117 & 46107 Landing Parkway, Fremont, CA 94538, dated June 26,
2003                                                                                                                                                                
|              | 
|10.24(3)      |  | Securities Purchase Agreement, dated as of February 4, 2004                                                                                                                                                                                                                           
|              | 
|10.25(6)      |  | Stock Purchase Agreement, dated as of April 7, 2005, amended as of April 19, 2005                                                                                                                                                                                                     
|              | 
|10.26(6)      |  | Form of Common Stock Purchase Warrant                                                                                                                                                                                                                                                 
|              | 
|10.27*(8)     |  | Contract Manufacturing Agreement with Life Science Outsourcing dated October 31, 2005                                                                                                                                                                                                 
|              | 
|10.28(9)      |  | Assignment and License Agreement dated as of March 16, 2006 by and between the registrant and BÂRRX Medical,
Inc.                                                                                                                                                                     
|              | 
|21.1          |  | Subsidiaries of the registrant                                                                                                                                                                                                                                                        
|              | 
|23.1          |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                                                             
|              | 
|24.1          |  | Power of Attorney (see page 51).                                                                                                                                                                                                                                                      
|              | 
|31.1          |  | Chief Executive Officers Certification Pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002                                                                                                                                      
|              | 
|31.2          |  | Chief Financial Officers Certification Pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002                                                                                                                                      



59



---

|              |  |                                                                                                                                                
|------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                    
|              | 
|32.1          |  | Certificate of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
|              | 
|32.2          |  | Certificate of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002

---

|* | 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 8-A12G filing on November 9, 2001, and incorporated by reference.
|--- | ------------------------------------------------------------------------------------------------

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

|(4) | Filed as an Exhibit to Curons report on 10-K for the year ending December 31, 2003, and incorporated herein by reference.
|--- | --------------------------------------------------------------------------------------------------------------------------

|(5) | Filed as an Exhibit to Curons report on 10-Q for the quarter ending September 30, 2003, and incorporated herein by reference.
|--- | ------------------------------------------------------------------------------------------------------------------------------

|(6) | Filed as an Exhibit to Curons report on 8-K filing on April 20, 2005, and incorporated herein by reference.
|--- | ------------------------------------------------------------------------------------------------------------

|(7) | Filed as an Exhibit to Curons report on 8-K filing on June 1, 2005, and incorporated herein by reference.
|--- | ----------------------------------------------------------------------------------------------------------

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

|(9) | Filed as an Exhibit to Curons report on 8-K filing on March 22, 2006, and incorporated herein by reference.
|--- | ------------------------------------------------------------------------------------------------------------



60



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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: March 30, 2006



CURON MEDICAL, INC.By:

/s/    LARRY C. HEATON
IILarry C. Heaton II President and Chief Executive OfficerBy:

/s/    ALISTAIR F.
MCLARENAlistair F. McLaren Chief Financial Officer and Chief Information 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/    LARRY C. HEATON
II Larry C. Heaton II         |  | President, Chief Executive Officer and Director (Principal Executive Officer)                          |  | March 30, 2006
|                                                     |  |                                                                                                       
|/s/    ALISTAIR F.
MCLAREN Alistair F. McLaren       |  | Chief Financial Officer and Vice President of Finance and Administration (Principal Financial Officer) |  | March 30, 2006
|                                                     |  |                                                                                                       
|/s/    MICHAEL
BERMAN Michael Berman                 |  | Director                                                                                               |  | March 30, 2006
|                                                     |  |                                                                                                       
|/s/    DAVID I.
FANN David I. Fann                   |  | Director                                                                                               |  | March 30, 2006
|                                                     |  |                                                                                                       
|/s/    LARRY J.
STRAUSS Larry J. Strauss             |  | Director                                                                                               |  | March 30, 2006
|                                                     |  |                                                                                                       
|/s/    ROBERT F. KUHLING,
JR. Robert F. Kuhling, Jr. |  | Director                                                                                               |  | March 30, 2006



61



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CURON MEDICAL, INC.

Schedule II

VALUATION AND QUALIFYING ACCOUNTS

Years ended December 31, 2005, 2004, and 2003

(In thousands)



|                                  |  |                            |        |           |   |            |  |   |                      |   |  |   |       
|--------------------------------- |  | -------------------------- | ------ | --------- | - | ---------- |  | - | -------------------- | - |  | - | ------
|                                  |  | Balanceat beginningof year |        | Additions |   | Deductions |  |   | Balanceat endof year
|Allowance for Doubtful Accounts:  |  |                            |        |           |   |            |  |   |                      |   |  |   |       
|December 31, 2005                 |  | $                          | 54     |           | $ | 42         |  | $ |                     |   |  | $ | 96    
|December 31, 2004                 |  |                            | 15     |           |   | 57         |  |   | (18                  | ) |  |   | 54    
|December 31, 2003                 |  |                            | 34     |           |   |           |  |   | (19                  | ) |  |   | 15    
|Inventory Reserves                |  |                            |        |           |   |            |  |   |                      |   |  |   |       
|December 31, 2005                 |  |                            | 41     |           |   |           |  |   | (18                  | ) |  |   | 23    
|December 31, 2004                 |  |                            | 39     |           |   | 16         |  |   | (14                  | ) |  |   | 41    
|December 31, 2003                 |  |                            | 39     |           |   |           |  |   |                     |   |  |   | 39    
|Deferred Tax Valuation Allowance: |  |                            |        |           |   |            |  |   |                      |   |  |   |       
|December 31, 2005                 |  |                            | 33,361 |           |   | 5,333      |  |   |                     |   |  |   | 38,694
|December 31, 2004                 |  |                            | 26,709 |           |   | 6,652      |  |   |                     |   |  |   | 33,361
|December 31, 2003                 |  |                            | 21,161 |           |   | 5,548      |  |   |                     |   |  |   | 26,709



62