UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2009

OR

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

Commission File Number 001-33770

Power Medical Interventions, Inc.

(Exact name of registrant as specified in its charter)

Delaware		23-3011410
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

2021 Cabot Boulevard, Langhorne, Pennsylvania 19047

(Address of principal executive offices)

(267) 775-8100

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o

(Do not check if a smaller reporting company)

Smaller reporting company x

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

The number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date, is as follows:

Class		Outstanding at August 7, 2009
Common stock, par value $0.001 per share		17,187,791

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POWER MEDICAL INTERVENTIONS, INC.

		PAGE
PART I:	FINANCIAL INFORMATION	3

Item 1.	Consolidated Financial Statements (Unaudited)	3

	Condensed Consolidated Balance Sheets as of June 30, 2009 and December 31, 2008	3

	Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2009 and 2008	4

	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2008	5

	Notes to Unaudited Condensed Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25

Item 4.	Controls and Procedures	26

PART II:	OTHER INFORMATION	27

Item 1.	Legal Proceedings	27

Item 1A.	Risk Factors	28

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	46

Item 3.	Defaults Upon Senior Securities	46

Item 4.	Submission of Matters to a Vote of Security Holders	46

Item 5.	Other Information	47

Item 6.	Exhibits	47

	Signatures	48

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PART I: FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements (Unaudited)

Power Medical Interventions, Inc.

Condensed Consolidated Balance Sheets

(Amounts in thousands, except share and per share data)

	June 30,			December 31,
	2009			2008
ASSETS
Current assets:
Cash and cash equivalents	$	4,277		$	8,384
Restricted cash	—			875
Accounts receivable, net of allowance for doubtful accounts	1,380			1,290
Inventory	7,486			8,354
Prepaid expenses and other current assets	755			1,487
Total current assets	13,898			20,390

Property and equipment, net	3,918			4,380
Intangibles, net	1,225			1,192
Deferred financing fees	425			709
Other assets	199			223
Restricted cash	1,160			1,303
Total assets	$	20,825		$	28,197

LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	1,561		$	2,661
Accrued expenses	3,697			4,039
Long term debt, current portion	24,885			71
Total current liabilities	30,143			6,771

Long-term debt, net of current portion	196			24,921
Deferred revenue, long-term	20,000			12,500
Deferred rent, net of current portion	387			493
Total liabilities	50,726			44,685

Commitments and contingencies

Stockholders’ deficit:
Common stock, $.001 par value, 200,000,000 shares authorized, 17,187,791 and 17,152,465 shares issued and outstanding, respectively	17			17
Additional paid-in capital	200,804			199,740
Accumulated other comprehensive loss	(17		)	(20		)
Accumulated deficit	(230,705		)	(216,225		)
Total stockholders’ deficit	(29,901		)	(16,488		)
Total liabilities and stockholders’ deficit	$	20,825		$	28,197

See accompanying notes to these unaudited condensed consolidated financial statements.

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Power Medical Interventions, Inc.

Condensed Consolidated Statements of Operations

(Amounts in thousands, except share and per share data)

	For the Three Months						For the Six Months
	Ended June 30,						Ended June 30,
	2009			2008			2009			2008

Sales	$	2,261		$	2,159		$	5,004		$	4,384
Cost of Sales	2,030			3,018			4,191			5,575
	231			(859		)	813			(1,191		)

Costs and expenses
Research and development	811			1,508			1,615			3,091
Sales and marketing	3,507			5,961			7,001			12,758
General and administrative	2,708			2,622			5,333			5,635
	7,026			10,091			13,949			21,484

Operating loss	(6,795		)	(10,950		)	(13,136		)	(22,675		)

Other income (expense)
Interest and other income	9			90			53			284
Interest and other expense, net	(747		)	(651		)	(1,397		)	(1,300		)
Total other income (expense)	(738		)	(561		)	(1,344		)	(1,016		)

Net loss	$	(7,533	)	$	(11,511	)	$	(14,480	)	$	(23,691	)

Net loss per common stock share:
- Basic and diluted	$	(0.44	)	$	(0.67	)	$	(0.84	)	$	(1.38	)

Weighted average number of common stock shares outstanding:
- Basic and diluted	17,180,898			17,108,716			17,177,261			17,108,282

See accompanying notes to these unaudited condensed consolidated financial statements.

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Power Medical Interventions, Inc.

Condensed Consolidated Statements of Cash Flows

(Amounts in thousands)

	For the Six Months
	Ended June 30,
	2009			2008

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(14,480	)	$	(23,691	)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization	995			876
Amortization of debt discount and deferred financing fees	408			408
(Gain) loss on disposal of property and equipment	(1		)	22
Share-based compensation	1,064			900
Changes in operating assets and liabilities:
Accounts receivable	(72		)	(43		)
Inventory	925			(1,798		)
Prepaid expenses and other assets	577			(176		)
Accounts payable	(1,134		)	(828		)
Accrued expenses	(113		)	(564		)
Deferred rent	(106		)	(93		)
Deferred revenue	7,500			—
Net cash used in operating activities	(4,437		)	(24,987		)

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(414		)	(1,057		)
Proceeds from sale of property and equipment	4			—
Patent application costs	(153		)	(160		)
Change in restricted cash	1,016			1,016
Net cash provided by (used in) investing activities	453			(201		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt	(35		)	(34		)
Net proceeds from issuance of common stock	—			72
Net cash (used in) provided by financing activities	(35		)	38

Effect of exchange rate on cash and cash equivalents	(88		)	168
Net decrease in cash and equivalents	(4,107		)	(24,982		)
Cash and equivalents, beginning of period	8,384			36,592
Cash and equivalents, end of period	$	4,277		$	11,610

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest	$	879		$	889

See accompanying notes to these unaudited condensed consolidated financial statements.

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Power Medical Interventions, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

June 30, 2009

1. Business

Power Medical Interventions, Inc. (the Company), a Delaware corporation, is a medical device company that designs, manufactures and markets a family of computer-assisted, power-actuated endomechanical surgical instruments, referred to as Intelligent Surgical Instruments™. Surgeons use Intelligent Surgical Instruments for cutting, stapling and tissue manipulation in a variety of procedures in open surgery, minimally invasive surgery, or MIS, and in the emerging field of natural orifice translumenal endoscopic surgery, or NOTES.

The Company has wholly owned subsidiaries in Germany, Power Medical Interventions Deutschland GmbH; in France, Power Medical Interventions France; and in Japan, Power Medical Interventions Japan, which conduct sales and marketing operations.

On July 28, 2009, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with United States Surgical Corporation, a Delaware corporation (Parent) and wholly owned, indirect subsidiary of Covidien plc, an Irish company, and Covidien Delaware Corp., a Delaware corporation and a wholly owned subsidiary of Parent (Merger Sub). Pursuant to the Merger Agreement, and upon the terms and subject to the conditions thereof, on August 10, 2009, Merger Sub commenced a tender offer (the Offer) to purchase all of the outstanding shares of Common Stock, par value $0.001 per share, of the Company (the Shares), for $2.08 per Share in cash (the Offer Price). Unless subsequently extended, the Offer will be open for twenty business days and is expected to be completed at 12:00 midnight at the end of September 4, 2009. The Company currently expects the transactions subject to the Merger Agreement (the Merger) to close by September 25, 2009, subject to the success of the Offer and other closing conditions. See Note 9 to the condensed consolidated financial statements of the Company for further discussion of the Merger Agreement.

The condensed consolidated financial statements of the Company have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Accordingly, the financial statements do not include any adjustments that might be necessary should the Company be unable to continue in existence. The Company incurred a net loss of approximately $14.5 million in the six months ended June 30, 2009 and net losses of approximately $42.3 million and $36.8 million for the years ended December 31, 2008, and 2007, respectively, and has an accumulated deficit of approximately $230.7 million at June 30, 2009. Losses are expected to continue at least through 2009. The Company believes that its cash and cash equivalents, together with the Company’s future sales, will be sufficient to meet its cash requirements through September 25, 2009, the latest date by which the Merger is expected to close. If the Merger does not close, the Company’s ability to meet its obligations in the normal course of business will be dependent on its securing additional external financing, increasing its customer and revenue base, and continuing to control expenses. There can be no assurance that if the Merger were not to close, such additional external financing will be available in amounts or on terms acceptable to the Company, if at all. These factors raise substantial doubt about the Company’s ability to continue as a going concern. On a stand-alone basis, the Company’s future cash requirements will depend on many factors, including its ability to increase its sales and improve its gross margins, and the success of its 2008 restructuring initiative. The Company implemented this restructuring initiative in the fourth quarter of 2008 to reduce cash used in operations through headcount reductions and other spending programs. Examples of such costs include certain sales and marketing costs, product development costs, clinical research costs, employee bonuses, and capital expenditures.

2. Summary of Significant Accounting Policies

Unaudited interim financial data

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and the requirements of Form 10-Q and Regulation S-X.

The accompanying condensed consolidated balance sheet as of June 30, 2009, the condensed consolidated statements of operations for the three and six months ended June 30, 2009 and 2008, and the condensed consolidated statements of cash flows for the six months ended June 30, 2009 and 2008 are unaudited. The unaudited interim financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to state fairly the Company’s financial position as of June 30, 2009 and the results of its operations and cash flows for the three and six months ended June 30, 2009 and 2008. The financial data and other information disclosed in these

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notes to the financial statements are unaudited. The results for the three and six months ended June 30, 2009 are not necessarily indicative of the results to be expected for any future period.

Revenue recognition

Most of the Company’s revenue historically has been derived from the sale of single-patient, disposable loading units and from the sale of reload cartridges for reusable Intelligent Surgical Instruments. Revenue related to the sale of such individual products is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed and determinable, and collectibility is reasonable assured, which is generally at the time of shipment upon delivery to a common carrier.

The Company also considers Emerging Issue Task Force, or EITF, 00-21, Revenue Arrangements with Multiple Deliverables, when recognizing its revenue. Under multiple-element arrangements involving the sale of multiple products, services and/or rights to use assets, the multiple elements are divided into separate units of accounting when certain criteria are met, including whether the delivered items have stand alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. When separate units of accounting exist, consideration is allocated among the separate elements based on their respective fair values. If such evidence of fair value for each undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value for each undelivered element does exist or until all elements of the arrangement are delivered.

The Company’s Intelligent Surgical Instrument surgical platform includes cutting and stapling devices in a variety of sizes and linear, right angle and circular configurations designed for differing surgical needs. The Company’s Intelligent Surgical Instruments are available in a reusable multiple-patient format which can be autoclaved and used in multiple cases. The Company’s reusable Intelligent Surgical Instruments use disposable cutting and stapling cartridges in various sizes, which the Company refers to as reload cartridges and digital loading units.

In certain cases, the Company offers its Intelligent Surgical Instruments at no cost in exchange for higher unit pricing on the sale of reload cartridges over a specified period of time. In these cases, the Company recognizes the revenue ratably over the period of delivery of the reload cartridges, as long as such revenue is not contingent on the delivery of the undelivered products. The Company has in certain cases agreed to transfer title to such systems to the customer upon the customer’s purchase of a specified number of disposable Intelligent Surgical Instruments although the customer is under no obligation to purchase the Intelligent Surgical Instruments. In these instances, the Company recognizes revenue attributable to the complete system as the Intelligent Surgical Instruments are delivered.

The Company has also made its i60, i45 and iDrive instruments available to customers at no charge under an “in service under evaluation” program. The evaluation period has typically been six months and the Company has derived and continues to derive recurring revenues from sales of the reload cartridges necessary for the evaluation instruments’ use. At the end of the evaluation period, customers have the option to (i) buy the equipment and continue to receive reload cartridge pricing consistent with that of the evaluation period, (ii) keep the equipment and agree to higher sales prices on the reload cartridge than was charged during the evaluation period or (iii) return the equipment with no further obligation.

The Company’s customers generally order product using standard purchase orders and payment terms are 30 days. The Company provides discounted pricing to its customers based on volume and commitment levels. Allowance for product returns are estimated based on historical experience and provisions are recorded at the time of shipment. The Company also provides limited warranties to its customers against material defects in materials and workmanship. Such warranties are generally for a one year period from the date of shipment. Historically, warranty costs have not been material.

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The Company’s revenues were derived from customers located in the following geographic regions:

	Three months ended June 30,				Six months ended June 30,
	2009		2008		2009		2008

North America	76	%	82	%	72	%	83	%
Europe	9	%	11	%	12	%	12	%
Asia	15	%	7	%	16	%	5	%

Amounts billed to customers for product shipping and handling are included in sales. Costs incurred related to product shipping and handling are included in cost of sales.

Revenue Recognition—Arrangement with Intuitive Surgical, Inc.

In September 2008, the Company entered into two agreements with Intuitive Surgical, Inc. The first agreement is a License and Development Agreement (the License and Development Agreement) under which Intuitive Surgical expects to develop a surgical stapling device which will attach to Intuitive Surgical’s da Vinci™ Surgical Systems and will utilize the Company’s patented technology. Once developed, this attachment will enable Intuitive Surgical’s da Vinci™ Surgical Systems to cut and staple tissue in a broad array of surgical applications. The second agreement is an exclusive Reload Supply Agreement whereby the Company will manufacture and will be the exclusive supplier to Intuitive Surgical of staple reloads for the newly developed device at agreed upon prices. The Company refers to the License and Development Agreement and the Reload Supply Agreement collectively as the Intuitive Agreements.

Under the terms of the Intuitive Agreements, the Company received an upfront license payment of $12.5 million in September 2008. The Company is responsible for providing, at its expense, up to an aggregate of 3,900 man hours of engineering and technical support services to Intuitive to assist Intuitive in designing and developing the new device. In February 2009, the Company received a payment of $2.5 million related to the achievement of a development milestone. In May 2009, Intuitive Surgical elected to exercise its right under the License and Development Agreement to receive an irrevocable license to certain Company intellectual property in exchange for an accelerated aggregate milestone payment of $5.0 million. The Company received the $5.0 million payment in May 2009. The Company was originally eligible to receive the $5.0 million in the form of milestone payments over the term of the License and Development Agreement if certain agreed upon development milestones were achieved. The Company’s receipt of this $5.0 million payment precludes it from receiving additional milestone payments related to these development milestones. Since inception of the Intuitive Agreements, the Company has received a total of $20.0 million in payments from Intuitive Surgical.

The Company has identified four deliverables within this arrangement: (i) the license to utilize its patented technology, (ii) consultative services during Intuitive’s development of the new device, (iii) a six-year supply arrangement to supply reload cartridges to Intuitive, including a minimum purchase obligation during the first 18 months subsequent to the first commercial sale of the device by Intuitive to a third party and (iv) a significant and incremental discount on the future purchases of reload cartridges. The Company has concluded that these deliverables should be accounted for as a single unit of accounting, with recognition of revenue for the single unit of accounting commencing upon the delivery of the final element in the arrangement (i.e., commencement of delivery of the staple reload cartridges contemplated by the Reload Supply Agreement). Accordingly, the $20.0 million the Company has received since September 2008 has been deferred and is reported in the consolidated financial statements as deferred revenue, long-term as of June 30, 2009.

Should the project reach the first commercial sale, the $20.0 million of up-front and milestone payments, as well as the guaranteed minimum amount of reload sales, will begin to be recognized as revenues over the term of the Reload Supply Arrangement (i.e., the six-year period following the date of the first commercial sale of the device to a third party). Revenues from the sale of additional reloads beyond the minimum guaranteed quantity will be recognized as such reloads are shipped.

Share-based compensation

The Company’s share-based compensation is accounted for in accordance with the fair value recognition provisions of Statements of Financial Accounting Standards, or SFAS, No. 123 (revised 2004) Share-Based Payments, or SFAS 123(R). In addition, the Company accounts for its share-based compensation to non-employees in accordance with EITF 96-18, Accounting for Equity Investments that are Issued to Other Than Employees for Acquiring, or in connection with, Selling Goods or Services, or EITF 96-18. The Company uses the Black-Scholes option-pricing model to estimate the fair value its share-based awards as of the date of grant.

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The Black-Scholes model, by its design, is highly complex and dependent upon key data inputs estimated by management. The primary data inputs with the greatest degree of judgment are generally the estimated lives of the share-based awards and the estimated volatility of the Company’s common stock price. The Black-Scholes model is sensitive to changes to these two data inputs.

Beginning in fiscal year 2006, the Company calculated the estimated life of stock options granted using a “simplified” method, based upon guidance from the Securities and Exchange Commission, or SEC, as contained in Staff Accounting Bulletin, or SAB, No. 107 permitting the initial use of this method through 2007. In December 2007, the SEC issued SAB No. 110, which was effective January 1, 2008, expressing the expectation that companies should be employing information from internal or external sources about employee stock option exercise behavior when developing estimates of expected term as they relate to stock option valuations. SAB No. 110 states that the SEC will continue to accept the use of the “simplified” method, under certain circumstances, beyond December 31, 2007. The Company evaluated the exercise behavior of its employees and determined that the exercise history was an inadequate measure of the expected term of the Company’s stock options. Therefore, the Company has continued its use of the simplified method as prescribed in SAB No. 107. Expected stock price volatility is typically based on the daily historical trading data from an appropriate point in time through the last day of the applicable period. Because the Company’s historical trading data only dates back to October 26, 2007, the first trading date subsequent to our initial public offering, the expected volatility of its common stock was calculated for each date of grant based on an alternative method (defined as “calculated value”). The Company identified similar public entities for which share price information is available and have considered the historical volatility of these entities’ share prices in estimating expected volatility.

Net loss attributable to common shares

The Company computes net loss per share in accordance with SFAS No. 128, Earnings Per Share, or SFAS No. 128. Under SFAS No. 128, basic net loss per share is computed by dividing net loss per share available to common stockholders by the weighted average number of common shares outstanding for the period and excludes the effects of any potentially dilutive securities. Diluted earnings per share, if presented, would include the dilution that would occur upon the exercise or conversion of all potentially dilutive securities into common stock using the “treasury stock” and/or “if converted” methods as applicable.

The following summarizes the potential outstanding common stock of the Company as of the end of each period (in thousands):

	June 30,	December 31,
	2009	2008
Convertible Notes	2,643	2,643
Common stock warrants	854	959
Common stock options outstanding	2,760	2,456
Common stock options available for grant	510	844
Total	6,767	6,902

If the outstanding options, warrants, and convertible notes were exercised or converted into common stock, the result would be anti-dilutive. Accordingly, basic and diluted net loss attributable to common stockholders per share are identical for all periods presented in the accompanying consolidated statements of operations.

Recent Accounting Pronouncements

In May 2009, the FASB issued SFAS No. 165, Subsequent Events, or SFAS No. 165, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement sets forth the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements. SFAS 165 also requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date—that is, whether that date represents the date the financial statements were issued or were available to be issued. This statement is effective for interim or annual reporting periods ending after June 15, 2009. During the second quarter of 2009, the Company adopted SFAS 165. The adoption of SFAS 165 did not have a significant impact on the Company’s consolidated financial statements or related footnotes. See Note 9 — Subsequent Events to our consolidated financial statements.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP 107-1”), which the Company adopted for the second quarter of 2009. FSP 107-1 requires an entity to provide the

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annual disclosures required by FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, in its interim financial statements. The adoption of FSP 107-1 had no material impact on the Company’s consolidated financial statements.

The Company adopted SFAS No. 157, Fair Value Measurements, or SFAS No. 157, effective January 1, 2008, for financial assets and liabilities. In addition, effective January 1, 2009, the Company adopted SFAS No. 157 as it relates to nonfinancial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on at least an annual basis. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability, referred to as the exit price, in an orderly transaction between market participants at the measurement date. The standard outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. In determining fair value of financial assets, the Company primarily uses prices and other relevant information generated by market transactions involving identical or comparable assets, called the market approach. As of June 30, 2009 and December 31, 2008, the fair value of all of the Company’s financial assets was based on level one observable inputs. The implementation of SFAS No. 157 for nonfinancial assets and liabilities did not have an impact on the Company’s consolidated financial statements as of June 30, 2009. The provisions of SFAS No. 157 will be applied at such time a fair value measurement of a nonfinancial asset or liability is required, which may result in a fair value that is materially different than would have been calculated prior to the adoption of SFAS No. 157.

In February 2007, the FASB issued SFAS No. 159, Fair Value Option for Financial Assets and Liabilities, or SFAS No. 159. SFAS No. 159 allows companies to choose, at specific election dates, to measure eligible financial assets and liabilities that are not otherwise required to be measured at fair value, at fair value. Under SFAS No. 159, companies would report unrealized gains and losses for which the fair value option has been elected in earnings at each subsequent reporting date, and recognize up-front costs and fees related to those items in earnings as incurred. SFAS No. 159 became effective for fiscal years beginning after November 15, 2007. The Company did not elect the fair value option for any financial assets or liabilities and, therefore, adoption of the provisions of SFAS No. 159 did not have a material effect on its consolidated financial statements.

In May 2008, the Financial Accounting Standards Board, or FASB, issued Staff Position No. Accounting Principles Board 14-1, or FSP No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement). FSP No. APB 14-1 requires that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer’s nonconvertible debt borrowing rate. The Company adopted FSP No. APB 14-1 effective January 1, 2009. The adoption of APB 14-1 did not have an impact on the Company’s consolidated financial statements as of and for the three and six months ended June 30, 2009.

In June 2008, the FASB issued EITF 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock, or EITF 07-5. EITF 07-5 provides guidance in assessing whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock for purposes of determining whether the appropriate accounting treatment falls under the scope of SFAS No. 133, Accounting For Derivative Instruments and Hedging Activities, or SFAS No. 133, and/or EITF 00-19, Accounting For Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, or EITF 00-19. EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company adopted EITF 07-5 effective January 1, 2009. The fair value of certain of the Company’s outstanding warrants to which this guidance applies was not material as of June 30, 2009. As such, the Company’s adoption of EITF 07-5 did not have a material impact on its consolidated financial statements as of and for the three and six months ended June 30, 2009.

3. License, Development and Supply Agreement with Intuitive Surgical

In September 2008, the Company entered into two agreements with Intuitive Surgical, Inc. The first agreement is a License and Development Agreement under which Intuitive Surgical expects to develop a surgical stapling device that will attach to Intuitive Surgical’s da Vinci™ Surgical Systems and will utilize the Company’s patented technology. Once developed, this attachment will enable Intuitive Surgical’s da Vinci™ Surgical Systems to cut and staple tissue in a broad array of surgical applications. The second agreement is an exclusive Reload Supply Agreement whereby the Company will manufacture and be the exclusive supplier to Intuitive Surgical of staple reloads for the newly developed device at agreed upon prices.

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receipt of this $5.0 million payment precludes it from receiving additional milestone payments related to these development milestones.

See Note 2 to the condensed consolidated financial statements for a description of the Company’s revenue recognition treatment of consideration it has received under the Intuitive Agreements.

4. Long-Term Debt

During March 2007, the Company sold $25.0 million of 7% Convertible Senior Secured Notes, or Convertible Notes, which generated net proceeds to the Company of $23.3 million (net of financing fees). Of this amount, $3.5 million was placed in escrow to fund the first four interest payments on the Convertible Notes. The Convertible Notes accrue interest initially at the rate of 7% per annum, payable semiannually in arrears, and were subject to an increase to 8.5% per annum in the event that a qualified initial public offering, or a Convertible Note Qualified IPO, did not occur by December 31, 2007. The contingent adjustable interest feature in the Convertible Notes is a derivative requiring bifurcation under SFAS No. 133. The value of the derivative was not deemed material during 2007 and the Company completed its initial public offering in October 2007, which met the requirements of a Convertible Note Qualified IPO. Interest that accrued on or before March 31, 2009 was payable in cash, while interest accruing after March 31, 2009 is payable, at the Company’s option, in cash or paid-in-kind in the form of additional notes, or the PIK Notes. The principal amounts of any such PIK Notes would have the same maturity as the Convertible Notes. Should the Company elect to pay interest on the Convertible Notes in PIK Notes, the interest rate on such PIK Notes shall be equal to the then applicable interest rate plus 1.5%. As of June 30, 2009 the Company had not yet determined whether it will exercise its option to make its next interest payment to the holders of the Convertible Notes in cash or in the form of PIK Notes. However, during the three months ended June 30, 2009, the Company accrued interest on the Convertible Notes at a rate of 8.5%, the interest rate that would be in effect if the Company elected to pay interest in the form of PIK Notes. Accrued interest of approximately $531 thousand and $438 thousand is recorded in the Company’s consolidated balance sheets as accrued expenses as of June 30, 2009 and December 31, 2008, respectively.

The Convertible Notes also require the payment of a terminal value that (i) will be due upon redemption or conversion of the Convertible Notes, (ii) will be considered part of the conversion amount for purposes of determining the conversion rate (see below) or (iii) will be due upon maturity as part of the principal amount. In each case, the terminal value payment which, as amended, is defined to equal 7% per annum of the applicable principal from the closing date of the Convertible Notes in March 2007 to October 31, 2007, the date of the Company’s initial public offering). This amount totals approximately $1.0 million. There is no possible future scenario in which the accrued terminal value would not be required to be paid to the holders of the Convertible Notes or realized by such holders upon conversion of the Convertible Notes. The accrued terminal value of approximately $1.0 million is included in accrued expenses in the accompanying balance sheets at June 30, 2009 and December 31, 2008.

The Convertible Notes were not convertible until the occurrence of a conversion event, which is defined as a Convertible Note Qualified IPO described above or a qualified sale of the Company. The Company’s initial public offering constituted a Convertible Note Qualified IPO. Upon the occurrence of the Company’s initial public offering, the Convertible Notes plus any accrued interest thereon as well as the accreted terminal value became convertible into the Company’s common stock at the option of the holder at any time from the date of the conversion event through the maturity date of the notes. In addition, upon the occurrence of the Convertible Note Qualified IPO, which constituted a conversion event, the Convertible Notes became unsecured by assets of the Company and subordinated to all existing and future indebtedness of the Company.

The conversion price of the notes was set at $10.01 per share upon the completion of the Company’s initial public offering. The conversion price is subject to adjustment from time to time as follows:

i) Upon a stock dividend, stock distribution, stock split, reverse stock split or recapitalization, the conversion price shall be adjusted so that the holder of the Convertible Notes will be entitled to receive the number of shares of common stock that they would have owned if they had converted the note immediately prior to such event.

ii) Upon a distribution of rights, options or warrants to substantially all holders of common stock entitling them to subscribe for or purchase shares of common stock for a period of time at a price per share (or having a conversion, exercise or exchange price per share) less than the current market price per share of common stock, the conversion price shall be adjusted so that the conversion price would be reduced to a price equal to the conversion price currently in effect multiplied by a fraction, the numerator of which is equal to the number of shares outstanding immediately prior to the distribution of rights, options or warrants plus the number of shares of common stock which the aggregate offering price of the total number of shares of common stock so offered (or the aggregate conversion, exercise or exchange price so offered) would purchase at the current market price per share, and the denominator of which is equal to the number of shares of common stock outstanding

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immediately prior to such adjustment plus the number of additional shares of common stock offered (or into which the securities so offered are convertible, exchangeable or exercisable).

iii) Upon a distribution to all or substantially all holders of common stock any shares of capital stock of the Company (other than common stock), evidence of indebtedness or other non-cash assets, the conversion price shall be adjusted so that the conversion price would be reduced to a price equal to the conversion price currently in effect multiplied by a fraction, the numerator of which is equal to the current market price per share of the common stock on the record date of the distribution, less the fair market value per share on such record date of the capital stock, evidence of indebtedness or other non-cash assets distributed, and the denominator of which shall be the current market price per share of common stock on such record date.

iv) Upon a cash distribution to all or substantially all holders of common stock, the conversion price shall be decreased so that the conversion price would equal the conversion price in effect multiplied by a fraction, the numerator of which is equal to the current market price per share of the common stock on the date of the distribution less the per share amount of the distribution, and the denominator of which is the current market price per share of common stock on the date of the distribution.

v) Upon the purchase of any shares by the Company or any of its subsidiaries by means of a tender offer, the conversion price shall be decreased so that the conversion price would equal the conversion price in effect immediately prior to the close of the tender offer, multiplied a fraction, the numerator of which is the product of the number of shares of common stock outstanding immediately prior to the closing of the tender offer multiplied by the current market price per share of the common stock, and the denominator of which shall be the sum of the aggregate consideration payable to the stockholders based on the acceptance of the tender offer and the product of the number of shares of common stock outstanding immediately prior to the close of the tender offer and the current market price per share of common stock.

Beginning on the date that is 180 days following the closing of a Convertible Note Qualified IPO, the Company may, at its option, redeem the Convertible Notes in whole at any time or in part from time to time, upon 15 days prior written notice to the holder, at a redemption price payable in cash, equal to the principal amount plus any interest (including the terminal value) accrued and unpaid, subject to the satisfaction of the following conditions precedent:

(a) the declaration of effectiveness of a registration statement filed with the SEC for the resale of the underlying shares;

(b) the average of the high and low sale price of the common stock, as reported on the principal securities exchange on which the common stock is listed, on each of any 20 trading days during any period of 30 consecutive trading days ending within 45 days prior to the Redemption Date (so long as, during the entire 30 trading day period, the aforementioned registration statement has been effective and there has been no suspension of trading of the common stock), having been equal to or greater than 140% of the initial public offering price in the Convertible Notes Qualified IPO (in each case, with prices adjusted for stock splits, reverse splits, stock dividends, share combination and other antidilution events); and

(c) no more than $12,500,000 of outstanding Convertible Notes may be redeemed pursuant to this provision in any period of 30 consecutive trading days; and

(d) any such redemption shall be effected on a pro rata basis with respect to all then outstanding Convertible Notes (including PIK Notes).

In accounting for the Convertible Notes, the Company did not elect the fair value option for any financial assets or liabilities as permissible under the provisions of SFAS No. 159. However, as of June 30, 2009 the fair value of the $25.0 million of Convertible Notes, which are due in March 2010 and are no longer secured by the assets of the Company, is significantly lower than the carrying amount due to the Company’s current liquidity issues. See Note 9 to the condensed consolidated financial statements for disclosure regarding the Company’s recent announcement of the Merger Agreement. If the Merger is completed in September 2009 as currently anticipated, the fair value of the Convertible Notes would be positively impacted.

5. Inventory

Inventory is stated at the lower of cost or market value, with cost being determined on a first-in, first-out (FIFO) basis and market value based on the lower of replacement cost, or the estimated net realizable value, reduced by an allowance for normal profit margin. Inventory consists of the following (in thousands):

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	As of		As of
	June 30, 2009		December 31, 2008
Raw Materials	$	3,796	$	4,478
Work in process	799		463
Finished goods	2,891		3,413
	$	7,486	$	8,354

During the three months ended June 30, 2009 and 2008, the Company recorded inventory obsolescence charges in the amount of approximately $195 thousand and $200 thousand, respectively. During the six months ended June 30, 2009 and 2008, the Company recorded inventory obsolescence charges totaling $374 thousand and $501 thousand, respectively.

6. Comprehensive Loss

The Company’s comprehensive loss was as follows (in thousands):

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2009		2008		2009		2008

Net loss	(7,533	)	(11,511	)	(14,480	)	(23,691	)
Foreign currency translation adjustment	51		354		3		400
Comprehensive loss	(7,482	)	(11,157	)	(14,477	)	(23,291	)

7. Contingencies

The Company has, on occasion, been named as a defendant in lawsuits alleging product failure, patent infringement, and breach of contract. These cases are routinely handled by external counsel. Based on the advice of counsel, management has provided reserves for the estimated potential losses, when such losses are deemed probable and estimable. The Company currently has a patent infringement case outstanding. The Company received a favorable ruling from the German courts on two of the patent infringement claims and an unfavorable ruling on one of the claims. However, the Company is in the process of appealing the ruling. The Company intends to defend this claim vigorously and has concluded it is too early to determine whether or not the Company will incur any loss under this claim. As such, no amounts are accrued in the accompanying consolidated balance sheets related to this claim.

The Company also has a product liability case outstanding which is currently suspended and the Company has continued to contest the claim. The Company has accrued $100,000 related to this matter which represents its best estimate of the potential liability related to this claim.

In August 2008, the Company’s former Belgian distributor, Duo-Med, S.A., initiated a breach of contract action against the Company in the Commercial Court of Brussels in Belgium. The complaint alleges that the Company breached its distribution agreement with Duo-Med by failing to provide proper notice when the Company terminated that agreement in May 2007 and that, as the result of problems with the Company’s products, Duo-Med was unable to sell its existing inventory. The complaint asserts damages totaling approximately €460,000. The Company believes that the allegations in this matter are without merit and intends to vigorously defend against them. The Company has not accrued any amount in its financial statements as of June 30, 2009 for this matter.

The Merger Agreement contains customary termination provisions for the Company and Parent and provides that, in connection with the termination of the Merger Agreement under specified circumstances involving competing transactions or a change in the recommendation of the Company’s Board of Directors or certain breaches of the Merger Agreement, the Company may be required to pay Parent a termination fee of approximately $2.3 million.

8. Share-based Compensation

The fair value of the Company’s equity awards were estimated at the date of grant using the Black-Scholes option-pricing model with the following range of assumptions:

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	2009		2008
Dividend yield	0	%	0	%
Expected volatility	61-62	%	50	%
Risk-free interest rate	1.64-3.24	%	3.13-3.45	%
Expected life (years)	5.50		7.00

Compensation expense under SFAS No. 123(R) and EITF 96-18 for the three and six months ended June 30, 2009 and 2008 was recorded in the accompanying condensed consolidated financial statements as follows (in thousands):

	Three Months Ended June 30,				Six Months Ended June 30,
	2009		2008		2009		2008
Cost of sales	$	14	$	12	$	28	$	22
Research and development	55		49		111		96
Sales and marketing	119		62		224		128
General and administrative	351		335		701		654
Total share-based compensation expense	$	539	$	458	$	1,064	$	900

As of June 30, 2009, there was approximately $4.8 million of unrecognized compensation costs, net of estimated forfeitures, related to stock option grants which are expected to be recognized over a weighted average period of 1.8 years. There were no cash proceeds from option exercises during the three and six months ended June 30, 2009.

9. Subsequent Events

On July 28, 2009, the Company entered into the Merger Agreement with Parent and Merger Sub. Pursuant to the Merger Agreement, and upon the terms and subject to the conditions thereof, on August 10, 2009, Merger Sub commenced the Offer to purchase all of the outstanding Shares for $2.08 per Share in cash (the Offer Price). Unless subsequently extended, the Offer will be open for twenty business days and is expected to be completed at 12:00 midnight at the end of September 4, 2009. The Company currently expects the Merger to close by September 25, 2009, subject to the success of the Offer and other closing conditions.

Pursuant to the Merger Agreement, after the consummation of the Offer, and subject to the satisfaction or waiver of certain conditions set forth in the Merger Agreement, Merger Sub will merge with and into the Company (the Merger), with the Company surviving as a wholly-owned subsidiary of Parent. Upon completion of the Merger, each Share outstanding immediately prior to the effective time of the Merger (excluding those Shares that are held by Parent, Merger Sub and the Company) will be cancelled and converted into the right to receive the Offer Price in cash (without interest and subject to applicable withholding taxes). If Merger Sub holds 90% or more of the outstanding Shares immediately prior to the Merger, it may effect a “short-form” merger under the Delaware General Corporation Law, without additional approval by the Company’s stockholders. Otherwise, the Company may hold a special stockholders’ meeting to obtain stockholders’ approval of the Merger.

Subject to the terms and conditions of the Merger Agreement, the Company has granted Merger Sub an irrevocable one-time option (the Top-Up Option) to purchase an aggregate number of newly issued Shares that, when added to the number of Shares owned by Parent and Merger Sub at the time of such exercise, constitutes one Share more than 90% of the Shares then outstanding, subject to there being authorized Shares available for issuance. The Top-Up Option is exercisable only after Shares have been accepted for payment pursuant to the Offer. Merger Sub will pay the Offer Price for each Share acquired upon exercise of the Top-Up Option.

Completion of the Offer is subject to customary conditions, including (i) that there shall have been validly tendered and not validly withdrawn prior to the expiration of the Offer, when added to the number of Shares directly or indirectly owned by Parent or Merger Sub, a majority of the Shares then outstanding (determined on a “fully diluted basis” as defined in the Merger Agreement), (ii) subject to certain exceptions, the accuracy of the representations and warranties in the Merger Agreement and (iii) the absence of any material adverse effect on the Company.

The Merger Agreement contains representations, warranties and covenants of the parties customary for transactions of this type. Subject to certain limited exceptions in the Merger Agreement, the Company has also agreed not to solicit or initiate discussions with third parties regarding other proposals to acquire the Company and it has agreed to certain restrictions on its ability to respond to such proposals, subject to the fulfillment of certain fiduciary requirements of the Company’s Board of Directors. The Merger Agreement also contains customary termination provisions for the Company and Parent and provides that, in connection with the termination of the Merger Agreement under specified circumstances involving competing transactions or a change in the recommendation of the Company’s Board of Directors or certain breaches of the Merger Agreement, the Company may be required to pay Parent a termination fee of approximately $2.3 million.

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The Merger Agreement provides that all unexercised options issued under each of the Company’s 1999 Stock Option Plan, 2000 Stock Option Plan, 2004 Stock Incentive Plan and 2007 Equity Incentive Plan shall be cancelled immediately prior to the Merger and be of no further force or effect. Holders of options for which the Offer Price exceeds the exercise price of such options shall be paid an amount equal to the difference between the Offer Price and the exercise price for each such option. The Company has agreed to seek to terminate its outstanding warrants prior to the closing of the Merger. Each warrant that is not terminated prior to the closing of the Merger shall become a warrant to acquire the merger consideration which the warrant holder would have been entitled to receive had such holder exercised such warrant prior to such closing. All outstanding convertible notes shall be amended to provide such notes shall be convertible into the portion of the merger consideration receivable by a holder of that number of Shares into which the holder would have received had such holder converted such notes prior to the closing of the Merger. Following the completion of the Offer and in accordance with the terms of the notes, Merger Sub shall make an offer to purchase such notes at a price equal to the outstanding principal amount (including any applicable “termination value” (as defined in the notes) plus accrued and unpaid interest (including any “additional payment amounts” (as defined in the notes), if any).

In connection with the Offer, Parent, Merger Sub and each of the Company’s directors and executive officers entered into Tender and Voting Agreements (each, a Tender and Voting Agreement). The outstanding Shares subject to the Tender and Voting Agreements represent approximately 13% of the total outstanding Shares. Pursuant to each Tender and Voting Agreement, the applicable director or executive officer has agreed, among other things, subject to the termination of such Tender and Voting Agreement (i) to tender in the Offer (and not to withdraw) all Shares beneficially owned or subsequently acquired by them, (ii) to vote such Shares in support of the Merger in the event stockholder approval is required to consummate the Merger, (iii) to appoint Parent as his, her or its proxy to vote such shares in connection with the Merger Agreement and (iv) not to otherwise transfer any of his, her or its Shares. Each Tender and Voting Agreement will terminate upon the termination of the Merger Agreement.

The Company evaluated subsequent events through August 11, 2009, the date on which the financial statements were issued.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this report. In addition to historical consolidated financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under “Risk Factors” and elsewhere in this report.

Overview

We design, manufacture and market a family of computer-assisted, power-actuated endomechanical surgical instruments, which we refer to as Intelligent Surgical Instruments™. Surgeons use our Intelligent Surgical Instruments for cutting, stapling and tissue manipulation in a variety of procedures in open surgery, minimally invasive surgery, or MIS, and in the emerging field of natural orifice translumenal endoscopic surgery, or NOTES. We believe that, compared to conventional endomechanical devices, our Intelligent Surgical Instruments offer greater precision and consistency, superior compressive force, improved access to anatomical sites and enhanced ease of use. To our knowledge, we are the only company to apply digital technology to the field of endomechanical surgical instruments. Endomechanical devices are used in millions of surgical procedures each year to cut tissue, close wounds and reconnect tubular anatomical structures. We believe that conventional, manually operated endomechanical devices have inherent shortcomings that can limit their efficacy and adversely affect clinical outcomes. We founded our company to address these shortcomings and to improve surgical outcomes by introducing the next generation of endomechanical instruments, designed specifically for the rapidly evolving field of minimally invasive surgery.

Our Merger Agreement with Covidien

On July 28, 2009, we entered into the Merger Agreement with Parent and Merger Sub. Pursuant to the Merger Agreement, and upon the terms and subject to the conditions thereof, on August 10, 2009, Merger Sub commenced the Offer to purchase all of the outstanding Shares for $2.08 per Share in cash (the Offer Price). Unless subsequently extended, the Offer will be open for twenty business days and is expected to be completed at 12:00 midnight at the end of September 4, 2009. We filed with the SEC a solicitation/recommendation statement on Schedule 14D-9 on August 10, 2009. We currently expect the Merger to close by September 25, 2009, subject to the success of the Offer and other closing conditions.

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holds 90% or more of the outstanding Shares immediately prior to the Merger, it may effect a “short-form” merger under the Delaware General Corporation Law, without additional approval by our stockholders. Otherwise, we may hold a special stockholders’ meeting to obtain stockholders’ approval of the Merger.

Subject to the terms and conditions of the Merger Agreement, we have granted Merger Sub an irrevocable one-time option (the Top-Up Option) to purchase an aggregate number of newly issued Shares that, when added to the number of Shares owned by Parent and Merger Sub at the time of such exercise, constitutes one Share more than 90% of the Shares then outstanding, subject to there being authorized Shares available for issuance. The Top-Up Option is exercisable only after Shares have been accepted for payment pursuant to the Offer. Merger Sub will pay the Offer Price for each Share acquired upon exercise of the Top-Up Option.

The Merger Agreement contains representations, warranties and covenants of the parties customary for transactions of this type. Subject to certain limited exceptions in the Merger Agreement, we have also agreed not to solicit or initiate discussions with third parties regarding other proposals to acquire us and we have agreed to certain restrictions on our ability to respond to such proposals, subject to the fulfillment of certain fiduciary requirements of our Board of Directors. The Merger Agreement also contains customary termination provisions for us and Parent and provides that, in connection with the termination of the Merger Agreement under specified circumstances involving competing transactions or a change in the recommendation of our Board of Directors or certain breaches of the Merger Agreement, we may be required to pay Parent a termination fee of approximately $2.3 million.

The Merger Agreement provides that all unexercised options issued under each of our 1999 Stock Option Plan, 2000 Stock Option Plan, 2004 Stock Incentive Plan and 2007 Equity Incentive Plan shall be cancelled immediately prior to the Merger and be of no further force or effect. Holders of options for which the Offer Price exceeds the exercise price of such options shall be paid an amount equal to the difference between the Offer Price and the exercise price for each such option. We have agreed to seek to terminate our outstanding warrants prior to the closing of the Merger. Each warrant that is not terminated prior to the closing of the Merger shall become a warrant to acquire the merger consideration which the warrant holder would have been entitled to receive had such holder exercised such warrant prior to such closing. All outstanding convertible notes shall be amended to provide such notes shall be convertible into the portion of the merger consideration receivable by a holder of that number of Shares into which the holder would have received had such holder converted such notes prior to the closing of the Merger. Following the completion of the Offer and in accordance with the terms of the notes, Merger Sub shall make an offer to purchase such notes at a price equal to the outstanding principal amount (including any applicable “termination value” (as defined in the notes) plus accrued and unpaid interest (including any “additional payment amounts” (as defined in the notes), if any).

We have made customary representations, warranties and covenants in the Merger Agreement. Consummation of the Merger is subject to customary conditions, including success of the Offer and the absence of any law or order prohibiting the consummation of the Merger.

Our Future as a Stand-Alone Company

As of June 30, 2009, we had cash and cash equivalents of approximately $4.3 million. In addition, as of June 30, 2009, we had total liabilities of $50.7 million, including $25.0 million of Convertible Notes due to be paid in March 2010. Our operations to date have required significant cash expenditures. We have incurred net losses in each year since our inception and have an accumulated deficit at June 30, 2009 of approximately $230.7 million. We believe that our current cash and cash equivalents, together with our expected near-term future sales, will be sufficient to meet our anticipated cash requirements through September 25, 2009, the latest date by which the Merger is expected to close.

If we do not consummate the Merger and we remain an independent company, in order to continue our operations we will need to raise additional capital from one or a combination of approaches. We may raise additional funds through license and development agreements with corporate partners or public and private offerings of securities, including debt or equity financings. Given the recent and continued turmoil in the capital markets, there are a number of risks and uncertainties related to our attempts to complete a financing or strategic partnering arrangement that are outside our control. There can be no assurance that such financing will be available in amounts or on terms acceptable to us, if at all. In addition, we may enter into arrangements to extend the maturity

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of, purchase, redeem, replace or otherwise modify the terms of the Convertible Notes, and any such arrangements may require us to expend additional cash. These conditions raise substantial doubt about our ability to continue as a going concern. Our independent registered public accounting firm has modified its audit report on our consolidated financial statements to include an explanatory paragraph regarding this contingency.

Historically, we have financed our operations and internal growth primarily through private placements of equity securities and debt and, more recently, our initial public offering. If we do not consummate the Merger and we remain an independent company, we cannot be certain that additional public or private financing will be available in amounts acceptable to us, or at all. If we raise additional funds by issuing equity securities or debt, significant dilution may occur. Debt financing, if available, may involve restrictive covenants. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. Our ability to obtain additional debt financing will be limited by certain covenants we have made to holders of our Convertible Notes. In addition, if we default in the payment of our obligations under our Convertible Notes, our noteholders will be entitled to exercise their rights as creditors.

If we do not consummate the Merger and we remain an independent company and are unable to raise additional funds when needed, we will need to:

· delay, scale-back or eliminate some or all of our research and product development programs;

· license third parties to develop and commercialize products or technologies that we would otherwise seek to develop and commercialize ourselves;

· attempt to sell our company;

· cease operations; or

· declare bankruptcy.

If we take any of the above actions, the value of your investment in us could be materially impaired or eliminated.

Our Business

Our first Intelligent Surgical Instruments were introduced during the fourth quarter of 2007. We introduced the i60 linear cutter and our iDriveC hand-held power and control unit. The i60 offers precise control and powerful, consistent cutting and stapling action. The iDriveC and iDriveS power and control our suite of linear cutter, right-angle linear cutter, and circular stapler instruments. We also launched the i45 articulating 45mm linear stapler, and the i45V—an articulating linear stapler for vascular applications, in the third quarter of 2008. During the first quarter of 2009, we announced that we received FDA 510(k) marketing clearance for our patented i60R Intelligent Surgical Instrument. The i60R Intelligent Surgical Instrument is the world’s first reverse pivot linear cutter, designed to improve medical outcomes by providing surgeons with greater access to important anatomical sites that are currently difficult to reach. This unique instrument will be used to address surgical procedures performed throughout the digestive tract. During the second quarter of 2009, we received FDA 510(k) marketing clearance for our iDrive Intelligent Power Unit™, detachable Intelligent Surgical Instruments and iConsole™. A first-of-its-kind breakthrough in operating room instrumentation, the iDrive is designed to support a variety of minimally invasive procedures by offering surgeons a broad range of cutting and stapling configurations combined with increased flexibility, access and precision. The iDrive is a novel hand-held, computer-controlled power unit to which any of the company’s Intelligent Surgical Instruments can be attached. This innovation allows all of PMI’s Intelligent Surgical Instruments to be driven by a single power unit. As a result, hospitals may be able to acquire PMI’s advanced technology platform at less than half of the current cost, which may lead to significant savings for hospitals. The potential now exists for a comprehensive surgical solution that may be significantly less expensive than manual surgical stapling devices. In addition, the iDrive is reusable, easy to use, cost effective, and less wasteful, potentially leading to savings for hospitals and health networks.

We currently focus our marketing and sales efforts on selected surgical procedures in minimally invasive colorectal, bariatric and thoracic surgery. We target those procedures in which we believe the limitations of existing cutting and stapling technology are most acute, where the number of procedures performed is growing rapidly and where clinicians have readily recognized the benefits of our Intelligent Surgical Instruments. We intend to promote the use of our Intelligent Surgical Instruments in other surgical specialties. In the future, as surgical techniques continue to evolve beyond current MIS procedures to even less invasive techniques such as natural orifice translumenal endoscopic surgery, or NOTES, we believe our instruments may become a key enabling technology.

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In May 2009, we announced that we received notification from the NASDAQ Listing Qualifications Panel, or the Panel, stating that the Panel has determined to delist the Shares from The NASDAQ Capital Market, effective with the open of business on May 22, 2009. The determination followed our announcement in March 2009 that the Panel had granted our request for conditional listing, through May 20, 2009, to satisfy the $2.5 million stockholders’ equity requirement for continued listing on The NASDAQ Capital Market. The delisting was the result of our non-compliance with the minimum stockholders’ equity requirement as of May 20, 2009. Effective with the open of business on May 22, 2009, the Shares began trading on the Over-the-Counter Bulletin Board, or the OTCBB, an electronic quotation service maintained by the Financial Industry Regulatory Authority, or the FINRA. Our trading symbol will remain PMII, however for certain quote publication websites, investors may be required to key PMII.OB to obtain quotes. The liquidity, trading market and price of our common stock may be adversely affected by our listing on the OTCBB.

Financial Operations Overview

The following is a description of the principal components of our sales and expenses and of significant trends and challenges that we believe are important to an understanding of our business and results of operations.

Sales. Our first generation SurgASSIST surgical platform includes cutting and stapling devices in a variety of sizes and linear, right angle and circular configurations designed for differing surgical needs. In the original configuration of our system, our Intelligent Surgical Instruments were connected through a flexible shaft, or FlexShaft, to a power console. Our next generation products, beginning with the i60 linear stapler that we introduced in the fourth quarter of 2007, are self-contained hand-held instruments that do not require a FlexShaft or separate power console. In December 2007, we also introduced our self-contained, wireless handheld iDrive system, which can be used to power and control our linear, right angle and circular staplers, without the need for a separate FlexShaft or power console. Further, in the third quarter of 2008, we introduced our i45 reusable, autoclavable linear stapler and reload cartridge.

Our Intelligent Surgical Instruments are available as disposable, single-patient devices as well as in a reusable multiple-patient format, using disposable cutting and stapling cartridges in various sizes, which we refer to as reload cartridges and digital loading units.

Our revenue is derived from the sale of our single-patient, disposable Intelligent Surgical Instruments and from the sale of reload cartridges for our reusable Intelligent Surgical Instruments. We expect that as our installed base of reusable, multiple-patient Intelligent Surgical Instruments grows, sales of reload cartridges will become the largest component of our total sales.

We have made our i60, i45 and iDrive instruments available to customers at no charge under an “in service under evaluation” program. The evaluation period is typically six months and we have derived recurring revenues from sales of the reload cartridges necessary for their use. At the end of the evaluation period, customers have the option to (i) buy the equipment and continue to receive reload cartridge pricing consistent with that of the evaluation period, (ii) keep the equipment and agree to higher sales prices on the reload cartridge than was charged during the evaluation period or (iii) return the equipment with no further obligation.

Our future success will depend on our ability to achieve and sustain significant growth in our sales. In the immediate term, our ability to grow our revenues will depend on many factors, including:

· increased usage of our installed base of multiple-use Intelligent Surgical Instruments, resulting in recurring purchases of our reload cartridges;

· continued growth in market acceptance of our Intelligent Surgical Instruments;

· continued improvements in our supply chain and manufacturing operations to assure the quality and adequate supply of our products; and

· successful commercialization by Intuitive of the device being developed under the License and Development Agreement, enabling us to realize the benefits of the Supply Agreement whereby we will manufacture and be the exclusive supplier to Intuitive of staple reloads for the device.

Cost of sales. Cost of sales includes the cost of raw materials and components that we purchase from third parties and use in the assembly and manufacturing of our products. Cost of sales also includes personnel costs and overhead related to our assembly and test operations, related occupancy, equipment depreciation, shipping costs and charges for inventory obsolescence.

Our future success will depend on our ability to make significant improvements in our cost of sales as a percentage of sales, or gross margins. In prior years, we experienced high cost of sales, which were attributable to a number of factors, including product

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defects that have required rework by us and by our suppliers, a labor-intensive manual assembly process that has resulted in high labor costs, and excess manufacturing capacity in relation to our sales, which has resulted in inefficient absorption of manufacturing overhead. In 2008, we began to integrate our manufacturing operations by acquiring the automated equipment necessary to enable us to assemble the reload cartridges used in our multiple-use linear staplers. This system has had, and is expected to continue to have, a positive effect on our ability to better control the quality, cost and supply of our products and to more rapidly develop, prototype and commercialize new products.

Charges associated with write-offs of excess and obsolete inventory have also contributed to our high cost of sales. During the three months ended June 30, 2009 and 2008, we recorded inventory obsolescence charges of approximately $195 thousand and $200 thousand, respectively. During the six months ended June 30, 2009 and 2008, we recorded inventory obsolescence charges of approximately $374 thousand and $501 thousand, respectively. Our product development plans sometimes include introductions of new products that overlap functionally with existing products, while offering new or improved capabilities. We anticipate that in some cases, this may lead to a reduction in demand for, or discontinuation of, an existing product. In these circumstances we must carefully manage our finished goods inventory so that we have quantities of the existing product that are sufficient to meet customer demand pending introduction of the new product, but that do not leave us holding excess or obsolete inventory when a new product supplants the existing one.

In order to facilitate market acceptance of our first generation Intelligent Surgical Instruments, in certain circumstances, we made the power consoles and certain related accessories necessary for the use of our instruments available to institutions at no charge. We included deprecation expense in cost of sales for power consoles and related accessories loaned to customers for their use at no charge. In addition, we have made our i60, i45 and iDrive products available to our customers at no cost under our “in service under evaluation” program. The cost for these instruments is amortized to cost of sales over the evaluation period, which is generally six months.

In order to achieve and sustain profitability, we will need to continue to improve our procurement and manufacturing processes, upgrade our management information systems, and implement new quality assurance, inventory and cost controls in order to further reduce the cost of the components we purchase from third party vendors and improve the efficiency of our manufacturing operations.

Research and development expenses. Research and development expenses consist primarily of salaries and related expenses and overhead for our research, development and engineering personnel, prototype materials and research studies. In October 2008, as part of a cost-reducing restructuring initiative, we reduced our headcount in this area and our research and development efforts have been redeployed with a focus on fulfilling our obligations under our agreements with Intuitive. We expense our research and development costs as incurred.

Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries and related expenses, sales commissions and overhead for personnel performing sales and marketing functions. Other significant sales and marketing expenses include travel and entertainment expense, costs of attending medical conferences and trade shows, clinician training and other promotional costs and costs of demonstration systems and samples.

Our sales and marketing expenses have substantially exceeded our sales in each year since 2004, as we have invested in building the sales and marketing organization and administrative infrastructure necessary to support our planned sales growth. During 2008, we took steps, including the implementation of a restructuring plan in October 2008, to reduce our future sales and marketing expenses through a reduction in the number of our direct sales personnel, and as a result we do not expect these expenses to grow in 2009 at the same rate they have in recent years.

General and administrative expenses. General and administrative expenses consist primarily of salaries and related expenses and overhead for personnel performing executive, finance, information technology and human resource functions. Other significant general and administrative expenses include consulting fees and professional fees for legal services (including services related to obtaining and maintaining protection of our intellectual property) and accounting services.

Interest income. Interest income consists of interest earned on our cash and cash equivalents.

Interest expense. Interest expense consists primarily of interest costs incurred on our Convertible Notes that we issued in March 2007.

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Liquidity and Capital Resources

Since our inception, we have financed our operations primarily through private placements of equity securities, unsecured borrowings from our stockholders, a credit facility and, more recently, the issuance in March 2007 of our Convertible Notes in the aggregate principal amount of $25.0 million, and our initial public offering in October 2007, which generated proceeds of approximately $42.0 million. In addition, we have received $20.0 million under our agreements with Intuitive Surgical. Our principal source of liquidity as of June 30, 2009 consisted of our cash and cash equivalents of $4.3 million and our accounts receivable balance of approximately $1.4 million.

Net cash used in operating activities

Net cash used in operating activities for the six months ended June 30, 2009 were primarily related to cash used to fund our efforts to expand our customer base and our products’ acceptance within that customer base, to develop and introduce our next generation of Intelligent Surgical Instruments, and to further integrate our manufacturing processes, offset by $7.5 million in payments we received under our agreements with Intuitive in 2009. Had we not received these payments, our net cash used in operating activities would have been approximately $11.9 million.

Net cash provided by investing activities

Net cash provided by investing activities for the six months ended June 30, 2009 was primarily attributable to reductions in restricted cash balances as of June 30, 2009 offset by cash used for capital expenditures related to the integration of our manufacturing process and patent application costs.

Net cash used in financing activities

Net cash used in financing activities was primarily attributable to debt repayments on equipment loans during the six months ended June 30, 2009.

Liquidity and Capital Resources Outlook

Our operations to date have required significant cash expenditures. Although we significantly reduced our operating expenses through the restructuring plan we implemented in the fourth quarter of 2008, our operations continue to require significant cash expenditures, and we must raise additional capital to be able to fund them. We believe that our current cash and cash equivalents, together with our future sales will be sufficient to meet our anticipated cash requirements through September 25, 2009, the latest date by which the Merger is expected to close.

If we do not consummate the Merger and we remain an independent company, in order to continue our operations and to satisfy our obligations under the Convertible Notes, we will need to raise additional capital from one or a combination of approaches. We may raise funds through license and development agreements with corporate partners or public and private offerings of securities, including debt or equity financings. We may enter into arrangements to extend the maturity of, purchase, redeem, replace or otherwise modify the terms of the Convertible Notes, and any such arrangements may require us to expend additional cash. Given the recent and continued turmoil in the capital markets, there are a number of risks and uncertainties related to our attempts to complete a financing or strategic partnering arrangement that are outside our control. There can be no assurance that such financing will be available in amounts or on terms acceptable to us, if at all. These conditions raise substantial doubt about our ability to continue as a going concern. Our independent registered public accounting firm has modified its audit report on our consolidated financial statements for the year ended December 31, 2008 to include an explanatory paragraph regarding this contingency.

Historically, we have financed our operations and internal growth primarily through private placements of equity securities and debt, through our initial public offering and more recently, through licensing arrangements with corporate partners. If we do not consummate the Merger and we remain an independent company, we cannot be certain that additional public or private financing will be available in amounts acceptable to us, or at all. If we raise additional funds by issuing equity securities or debt, significant dilution may occur. Debt financing, if available, may involve restrictive covenants. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. Our ability to obtain additional debt financing will be limited by certain covenants we have made to holders of our Convertible Notes. In addition, if we default in the payment of our obligations under our Convertible Notes, our noteholders will be entitled to exercise their rights as creditors.

If we do not consummate the Merger and we remain an independent company and are unable to raise additional funds when needed, we will need to:

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· delay, scale-back or eliminate some or all of our research and product development programs;

· license third parties to develop and commercialize products or technologies that we would otherwise seek to develop and commercialize ourselves;

· attempt to sell our company;

· cease operations; or

· declare bankruptcy.

If we take any of the above actions, the value of your investment in us could be materially impaired or eliminated.

Additionally, if we default in the payment of our Convertible Notes, our noteholders will be entitled to exercise their rights under the Convertible Notes and immediately accelerate repayment of the Convertible Notes, which could materially impair our ability to continue to operate our business.

We have incurred and expect to further incur significant costs related to the Merger, including investment banking fees, legal fees, and other costs necessary to complete the Merger. Many of these costs have been or will be incurred irrespective of whether or not the Merger is consummated. In addition, the Merger Agreement contains customary termination provisions for us and Parent and provides that, in connection with the termination of the Merger Agreement under specified circumstances involving competing transactions or a change in the recommendation of our Board of Directors or certain breaches of the Merger Agreement, we may be required to pay Parent a termination fee of approximately $2.3 million.

In May 2009, we announced that we received notification from the NASDAQ Listing Qualifications Panel, or the Panel, stating that the Panel has determined to delist the Shares from the NASDAQ Capital Market, effective with the open of business on May 22, 2009. The determination follows our announcement in March 2009 that the Panel had granted our request for conditional listing, through May 20, 2009, to satisfy the $2.5 million stockholders’ equity requirement for continued listing on the NASDAQ Capital Market. The delisting is the result of our non-compliance with the minimum stockholders’ equity requirement as of May 20, 2009. Effective with the open of business on May 22, 2009, the Shares began trading on the OTCBB, an electronic quotation service maintained by the FINRA. Our trading symbol will remain PMII, however for certain quote publication websites, investors may be required to key PMII.OB to obtain quotes. The liquidity, trading market and price of our common stock may be adversely affected by our listing on the OTCBB.

If we do not consummate the Merger and are unable to raise additional funds when needed, we may have to delay or reduce the scope of or eliminate some or all of our development programs or we may be forced to seek protection under applicable bankruptcy laws. Any restructuring or bankruptcy could materially impair your investment.

Results of Operations

Three month periods ended June 30, 2009 and 2008

Sales. Our sales in the three months ended June 30, 2009 increased by 5% to $2.3 million compared with $2.2 million during the corresponding period in 2008. This increase related primarily to sales growth in Japan, which accounted for 15% of sales in the three months ended June 30, 2009 compared with 7% of sales in the corresponding period in 2008. Sales of reload cartridges totaled approximately $1.2 million during the three months ended June 30, 2009 compared to approximately $0.4 million during the three months ended June 30, 2008.

Cost of sales and gross profit. Our cost of sales in the three months ended June 30, 2009 decreased by 33%, to $2.0 million compared with $3.0 million during the corresponding period in 2008. Our cost of sales included inventory obsolescence charges of approximately $0.2 million during each of the three month periods ended June 30, 2009 and 2008, respectively. Our gross margin was $0.2 million, or 10% of sales, in the three months ended June 30, 2009 compared to a gross margin of ($0.9 million) or (40%) of sales, during the corresponding period in 2008. Our gross margins in 2009 improved versus 2008 due to improvements in our manufacturing process, including our Reload Automation Machine, or RAM. However, gross margins are likely to fluctuate from period to period until we are able to realize further economies of scale in our purchasing and manufacturing process through increased manufacturing capacity utilization and automation.

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Research and development expenses. Our research and development expenses in the three months ended June 30, 2009 decreased by 46% to $0.8 million, compared with $1.5 million during the corresponding period in 2008 due to our restructuring initiative that was implemented in the fourth quarter of 2008. The restructuring initiative included headcount reductions and a redeployment of much of our available resources to our engineering and technical support obligations under the Intuitive Agreements. Research and development costs decreased as a percentage of sales to 36% in the three months ended June 30, 2009, compared with 70% of sales during the corresponding period in 2008.

Sales and marketing expenses. Our domestic and international sales and marketing expenses in the three months ended June 30, 2009 decreased by 41%, to $3.5 million, compared with $6.0 million during the corresponding period in 2008, and decreased as a percentage of sales to 155% of sales in the three months ended June 30, 2009, compared with 276% of sales during the corresponding period in 2008. The decrease in dollar amount in 2009 was primarily due to a reduction in our sales force and improved efficiencies in our sales and marketing department.

General and administrative expenses. Our general and administrative expenses in the three months ended June 30, 2009 increased by 3%, to $2.7 million, compared with $2.6 million during the corresponding period in 2008, but decreased as a percentage of sales to 120% in the three months ended June 30, 2009, compared to 121% during the corresponding period in 2008. The increase in general and administrative expenses related primarily to increased consulting costs and share-based compensation costs offset by cost reductions related to the restructuring initiative that was implemented in the fourth quarter of 2008.

Interest and other income. Our interest and other income in the three months ended June 30, 2009 decreased by 90% to $9 thousand compared with $90 thousand during the corresponding period in 2008, due to significantly lower average cash balances and lower interest rates.

Interest expense. Our interest expense in the three months ended June 30, 2009 and 2008 totaled approximately $0.7 million for each period and relates primarily to our Convertible Notes issued in March 2007.

Results of Operations

Six month periods ended June 30, 2009 and 2008

Sales. Our sales in the six months ended June 30, 2009 increased by 14% to $5.0 million compared with $4.4 million during the corresponding period in 2008. This increase related primarily to sales growth in Japan, which accounted for 16% of sales in the six months ended June 30, 2009 compared with 5% of sales in the corresponding period in 2008. Sales of reload cartridges totaled approximately $2.5 million during the six months ended June 30, 2009 compared to approximately $0.9 million during the six months ended June 30, 2008.

Cost of sales and gross profit. Our cost of sales in the six months ended June 30, 2009 decreased by 25%, to $4.2 million compared with $5.6 million during the corresponding period in 2008. Our cost of sales included inventory obsolescence charges of approximately $0.4 million and $0.5 million during the six months ended June 30, 2009 and 2008, respectively. Our gross margin was $0.8 million, or 16% of sales, in the six months ended June 30, 2009 compared to a gross margin of ($1.2 million) or (27%) of sales, during the corresponding period in 2008. Our gross margins in 2009 improved versus 2008 due to improvements in our manufacturing process, including our Reload Automation Machine, or RAM. However, gross margins are likely to fluctuate from period to period until we are able to realize further economies of scale in our purchasing and manufacturing process through increased manufacturing capacity utilization and automation.

Research and development expenses. Our research and development expenses in the six months ended June 30, 2009 decreased by 48% to $1.6 million, compared with $3.1 million during the corresponding period in 2008 due to our restructuring initiative that was implemented in the fourth quarter of 2008. The restructuring initiative included headcount reductions and a redeployment of much of our available resources to our engineering and technical support obligations under the Intuitive Agreements. Research and development costs decreased as a percentage of sales to 32% in the six months ended June 30, 2009, compared with 71% of sales during the corresponding period in 2008.

Sales and marketing expenses. Our domestic and international sales and marketing expenses in the six months ended June 30, 2009 decreased by 45%, to $7.0 million, compared with $12.8 million during the corresponding period in 2008, and decreased as a percentage of sales to 140% of sales in the six months ended June 30, 2009, compared with 291% of sales during the corresponding period in 2008. The decrease in dollar amount in 2009 was primarily due to a reduction in our sales force and improved efficiencies in our sales and marketing department.

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General and administrative expenses. Our general and administrative expenses in the six months ended June 30, 2009 decreased by 5%, to $5.3 million, compared with $5.6 million during the corresponding period in 2008, and decreased as a percentage of sales to 107% in the six months ended June 30, 2009, compared to 129% during the corresponding period in 2008. The decrease in general and administrative expenses related primarily to the restructuring initiative that was implemented in the fourth quarter of 2008, offset by an increase consulting costs and costs related to share-based compensation.

Interest and other income. Our interest and other income in the six months ended June 30, 2009 decreased by 81% to $53 thousand compared with $284 thousand during the corresponding period in 2008, due to significantly lower average cash balances and lower interest rates.

Interest expense. Our interest expense in the six months ended June 30, 2009 and 2008 totaled approximately $1.4 million and $1.3 million, respectively, and relates primarily to our Convertible Notes issued in March 2007.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make 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 the reported amounts of revenue and expenses during the reporting period. These estimates and judgments are inherently subject to uncertainty. On an ongoing basis, we re-evaluate our judgments and estimates, including those related to uncollectible accounts receivable, inventories, recoverability of long-lived assets, stock-based compensation, accrued expenses and other contingencies. We base our estimates and judgments on our historical experience and on other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates, and material effects on our operating results and financial position could result. The accounting policies described below are those which, in our opinion, involve the most significant application of judgment or involve complex estimation, and which could, if different judgments or estimates were made, materially affect our reported results of operations.

Revenue recognition. Most of our revenue historically has been derived from the sale of single-patient, disposable loading units and from the sale of reload cartridges for reusable Intelligent Surgical Instruments. Revenue related to the sale of such individual products is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed and determinable, and collectibility is reasonably assured, which is generally at the time of shipment upon delivery to a common carrier.

We also consider the provisions of EITF, 00-21, Revenue Arrangements with Multiple Deliverables, when recognizing revenue. Under multiple-element arrangements involving the sale of multiple products, services and/or rights to use assets, the multiple elements are divided into separate units of accounting when certain criteria are met, including whether the delivered items have stand alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. When separate units of accounting exist, consideration is allocated among the separate elements based on their respective fair values. If such evidence of fair value for each undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value for each undelivered element does exist or until all elements of the arrangement are delivered.

Our Intelligent Surgical Instrument surgical platform includes cutting and stapling devices in a variety of sizes and linear, right angle and circular configurations designed for differing surgical needs. Our Intelligent Surgical Instruments are available in a reusable multiple-patient format which can be autoclaved and used in multiple cases. Our reusable Intelligent Surgical Instruments use disposable cutting and stapling cartridges in various sizes, which we refer to as reload cartridges and digital loading units.

In certain cases, we offer such Intelligent Surgical Instruments at no cost in exchange for higher unit pricing on the sale of reload cartridges over a specified period of time. In these cases, we recognize revenue ratably over the period of delivery of the reload cartridges, as long as such revenue is not contingent on the delivery of the undelivered products. We have in certain cases agreed to transfer title to such systems to the customer upon the customer’s purchase of a specified number of disposable Intelligent Surgical Instruments although the customer is under no obligation to purchase the Intelligent Surgical Instruments. In these instances, we recognize revenue attributable to the complete system as the Intelligent Surgical Instruments are delivered.

We have also made our i60, i45 and iDrive instruments available to customers at no charge under an “in service under evaluation” program. The evaluation period has typically been six months and we have derived recurring revenues from sales of the reload cartridges necessary for the evaluation instruments’ use. At the end of the evaluation period, customers have the option to (i) buy the equipment and continue to receive reload cartridge pricing consistent with that of the evaluation period, (ii) keep the equipment and agree to higher sales prices on the reload cartridge than was charged during the evaluation period or (iii) return the equipment with no further obligation.

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Revenue Recognition—Arrangement with Intuitive Surgical, Inc.

In September 2008, we entered into two agreements with Intuitive Surgical. The first agreement is a License and Development Agreement under which Intuitive Surgical expects to develop a surgical stapling device which will attach to its da Vinci™ Surgical Systems and will utilize our patented technology. Once developed, this attachment will enable the da Vinci™ Surgical System to cut and staple tissue in a broad array of surgical applications. The second agreement is an exclusive Reload Supply Agreement whereby we will manufacture and be the exclusive supplier to Intuitive Surgical of staple reloads for the newly developed device at agreed upon prices.

Under the terms of the Intuitive Agreements, we received an upfront license payment of $12.5 million in September 2008. We are responsible for providing, at our expense, up to an aggregate of 3,900 man hours of engineering and technical support services to Intuitive to assist Intuitive in designing and developing the new device. In February 2009, we received a payment of $2.5 million related to the achievement of a development milestone. In May 2009, Intuitive Surgical elected to exercise its right under the License and Development Agreement to receive an irrevocable license to certain of our intellectual property in exchange for an accelerated aggregate milestone payment of $5.0 million. We received the $5.0 million payment in May 2009. We were originally eligible to receive the $5.0 million in the form of milestone payments over the term of the License and Development Agreement if certain agreed upon development milestones were achieved. Our receipt of this $5.0 million payment precludes us from receiving additional milestone payments related to these development milestones. Since inception of the Intuitive Agreements, we have received a total of $20.0 million in payments from Intuitive Surgical.

We have identified four deliverables within this arrangement: (i) the license to utilize our patented technology, (ii) consultative services during Intuitive Surgical’s development of the new device, (iii) a six-year supply arrangement to supply reload cartridges to Intuitive Surgical, including a minimum purchase obligation during the first 18 months subsequent to the first commercial sale of the device by Intuitive Surgical to a third party and (iv) a significant and incremental discount on the future purchases of reload cartridges. We have concluded that these deliverables should be accounted for as a single unit of accounting, with recognition of revenue for the single unit of accounting commencing upon the delivery of the final element in the arrangement (i.e., commencement of delivery of the staple reload cartridges contemplated by the Reload Supply Agreement). Accordingly, the $20.0 million we have received since September 2008 has been deferred and is reported in the consolidated financial statements as deferred revenue as of June 30, 2009.

Share-based compensation

Our share-based compensation is accounted for in accordance with the fair value recognition provisions of SFAS No. 123 (revised 2004) Share-Based Payments, or SFAS 123(R). In addition, we account for our share-based compensation to non-employees in accordance with EITF 96-18. We use the Black-Scholes option-pricing model to estimate the fair value our share-based awards as of the date of grant. The Black-Scholes model, by its design, is highly complex and dependent upon key data inputs estimated by management. The primary data inputs with the greatest degree of judgment are generally the estimated lives of the share-based awards and the estimated volatility of our common stock price. The Black-Scholes model is sensitive to changes to these two data inputs.

Beginning in fiscal year 2006, we calculated the estimated life of stock options granted using a “simplified” method, based upon guidance from the SEC as contained in SAB No. 107 permitting the initial use of this method through 2007. In December 2007, the SEC issued SAB No. 110, which was effective January 1, 2008, expressing the expectation that companies should be employing information from internal or external sources about employee stock option exercise behavior when developing estimates of expected term as they relate to stock option valuations. SAB No. 110 states that the SEC will continue to accept the use of the “simplified” method, under certain circumstances, beyond December 31, 2007. We evaluated the exercise behavior of our employees and determined that the exercise history was an inadequate measure of the expected term of our stock options. Therefore, we have continued our use of the simplified method as prescribed in SAB No. 107. Expected stock price volatility is typically based on the daily historical trading data from an appropriate point in time through the last day of the applicable period. Because our historical trading data only dates back to October 26, 2007, the first trading date subsequent to our initial public offering, the expected volatility of our common stock was calculated for each date of grant based on an alternative method (defined as “calculated value”). We identified similar public entities for which share price information is available and have considered the historical volatility of these entities’ share prices in estimating expected volatility.

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Recent Accounting Pronouncements

In May 2009, the FASB issued SFAS No. 165, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This statement sets forth the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements. SFAS 165 also requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date—that is, whether that date represents the date the financial statements were issued or were available to be issued. This statement is effective for interim or annual reporting periods ending after June 15, 2009. During the second quarter of 2009, we adopted SFAS 165. The adoption of SFAS 165 did not have a significant impact on our consolidated financial statements or related footnotes. See Note 9 — Subsequent Events to our consolidated financial statements.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP 107-1”), which we adopted for the second quarter of 2009. FSP 107-1 requires an entity to provide the annual disclosures required by FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, in its interim financial statements. The adoption of FSP 107-1 had no material impact on our consolidated financial statements.

We adopted SFAS No. 157, effective January 1, 2008, for financial assets and liabilities. In addition, effective January 1, 2009, we adopted SFAS No. 157 as it relates to nonfinancial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on at least an annual basis. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability, referred to as the exit price, in an orderly transaction between market participants at the measurement date. The standard outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. In determining fair value of financial assets, we primarily use prices and other relevant information generated by market transactions involving identical or comparable assets, called the market approach. As of June 30, 2009 and December 31, 2008, the fair value of all of our financial assets was based on level one observable inputs. The implementation of SFAS No. 157 for nonfinancial assets and liabilities did not have an impact on the Company’s consolidated financial statements as of June 30, 2009. The provisions of SFAS No. 157 will be applied at such time a fair value measurement of a nonfinancial asset or liability is required, which may result in a fair value that is materially different than would have been calculated prior to the adoption of SFAS No. 157.

In February 2007, the FASB issued SFAS No. 159, Fair Value Option for Financial Assets and Liabilities or SFAS No. 159. SFAS No. 159 allows companies to choose, at specific election dates, to measure eligible financial assets and liabilities that are not otherwise required to be measured at fair value, at fair value. Under SFAS No. 159, companies would report unrealized gains and losses for which the fair value option has been elected in earnings at each subsequent reporting date, and recognize up-front costs and fees related to those items in earnings as incurred. SFAS No. 159 became effective for fiscal years beginning after November 15, 2007. We did not elect the fair value option for any financial assets or liabilities and, therefore, adoption of the provisions of SFAS No. 159 did not have a material effect on our consolidated financial statements.

In May 2008, the FASB issued Staff Position No. Accounting Principles Board 14-1, or FSP No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement). FSP No. APB 14-1 requires that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer’s nonconvertible debt borrowing rate. We adopted FSP No. APB 14-1 effective January 1, 2009. The adoption of APB 14-1 did not have an impact on our consolidated financial statements as of and for the three and six months ended June 30, 2009.

In June 2008, the FASB issued EITF 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock, or EITF 07-5. EITF 07-5 provides guidance in assessing whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock for purposes of determining whether the appropriate accounting treatment falls under the scope of SFAS No. 133 and/or EITF 00-19. EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008. We adopted EITF 07-5 effective January 1, 2009. The fair value of certain of our outstanding warrants to which this guidance applies was not material as of June 30, 2009. As such, our adoption of EITF 07-5 did not have a material impact on our consolidated financial statements as of and for the three and six months ended June 30, 2009.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We are exposed to market risk in the ordinary course of business, which consists primarily of interest rate risk associated with our cash and cash equivalents and debt and foreign exchange rate risk.

Interest rate risk. The primary objective of our investment activity is to preserve principal, provide liquidity and maximize income without increasing risk. Our investments have limited exposure to market risk. To minimize this risk, we maintain our

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portfolio of cash and cash equivalents in a variety of investments, consisting primarily of bank deposits, money market funds and short-term government funds. The interest rates are variable and fluctuate with current market conditions. The risk associated with fluctuating interest rates is limited to this investment portfolio, and we do not believe that a 10% change in interest rates would have a material impact on our financial position or results of operations.

The interest rates on our Convertible Notes are not subject to market fluctuations and therefore our market risk is limited.

Foreign currency risk. To date, our international customer agreements have been denominated primarily in the local currency of the international customer. The functional currency of our foreign operations in Europe and Japan is the local currency and, as a result, any fluctuation in the exchange rates of these net assets, denominated in local currency, would be reflected in the translation gains or losses, which are accounted for in other comprehensive income in our statements of changes in equity. We do not believe that a change of 10% in the foreign currency exchange rates would have a material impact on our financial position or results of operations.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30,2009. Based on that evaluation, our chief executive officer and chief financial officer concluded that, as of June 30, 2009, our disclosure controls and procedures were ineffective due to the material weaknesses described in our Annual Report on Form 10-K, as amended, for the year ended December 31, 2008, filed with the SEC on April 9, 2009, which identified the material weakness listed below that had not been fully remediated at June 30, 2009.

Our management determined that we have a material weakness in our internal control over financial reporting related to not having a sufficient number of personnel with the appropriate level of experience and technical expertise to appropriately resolve non-routine and complex accounting matters or to evaluate the impact of new and existing accounting pronouncements on our consolidated financial statements while completing the financial statement close process. The material weakness resulted in the identification of adjustments during the financial statement close process in 2008 that have been recorded in the consolidated financial statements. Until this design deficiency in our internal control over financial reporting is remediated, there is a reasonable possibility that a material misstatement to our annual or interim consolidated financial statements could occur and not be prevented or detected by our internal controls in a timely manner.

Our efforts to remediate this material weakness in our internal controls over financial reporting through the hiring and training of additional qualified financial and accounting personnel are currently in process, and consist of the following:

· in addition to our hiring of Brian Posner, an experienced chief financial officer in January 2009, we hired a vice president of financial reporting with experience preparing SEC reports for a publicly traded company required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and further, we hired a director of financial planning and analysis in the first quarter of 2009; and

· we will also expand the training and education of our accounting and finance staff members, including Sarbanes-Oxley compliance training, in an effort to improve their effectiveness.

In addition, our management determined that we have a material weakness in our entity-level controls as we did not have a control to prevent loans to executive officers. In connection with the review of our internal controls, management noted that in October 2008 we made an advance of salary of approximately $24,000 to our president and chief executive officer, Michael Whitman. Such advance was made by us on Mr. Whitman’s behalf to Mr. Whitman’s brokerage account to enable Mr. Whitman to satisfy a margin call requirement in cash rather than in shares of our common stock, which would have resulted in sales of our stock during a restricted trading period. This advance was approved by our then chief financial officer and was repaid by Mr. Whitman in full in December 2008.

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terminated our consulting arrangement with our former chief financial officer. Our chief executive officer and president is now aware of this requirement of the Sarbanes-Oxley Act of 2002 and will ensure that he avoids any violation thereof in the future. In response to this matter, the Board of Directors has instructed our current chief financial officer to undertake a thorough review of our internal controls and procedures with the intention of expanding and formalizing our policies and procedures to avoid future violations of the Sarbanes-Oxley Act of 2002, and other applicable laws, rules and regulations. This review by our chief financial officer is in process. The Board of Directors intends to institute mandatory corporate governance and Sarbanes-Oxley Act of 2002 training for management and our accounting staff.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

Item 1: Legal Proceedings.

Product liability suit in Belgium. In early December 2004, we were made a party to a lawsuit filed in a Belgian court on September 30, 2004 by a patient and his co-habitating female partner against the insurer for a Belgian surgeon and hospital as well as against PMI’s former Belgian distributor. The complaint alleged that the patient suffered injuries as a result of a surgery performed using one of our surgical instruments. The complaint alleged that our instrument was “deficient” and claimed estimated damages in the amount of €100,000 with “reservation for modification during the proceedings.” We have notified our insurance carrier of the lawsuit and the carrier has not disclaimed coverage. We intend to continue to contest the claim with the assistance of U.S. and Belgian counsel. We have accrued $100,000 in our consolidated financial statements as of June 30, 2009 for this matter, which represents our best estimate of the potential liability related to this claim.

Patent litigation against Ethicon Endo-Surgery in Germany. In March 2005, Ethicon Endo-Surgery initiated three patent infringement lawsuits against us and our German subsidiary in district court in Düsseldorf, Germany. The lawsuits allege that certain of our products infringe the German parts of three European patents owned by Ethicon Endo-Surgery, which we refer to as the Hooven, Clark and Rothfuss patents. We hired German counsel to defend the patent infringement cases and to seek revocation of Ethicon Endo-Surgery’s patents in nullity proceedings before a separate court in Munich, Germany.

We prevailed in the Hooven patent infringement action, and the products in question were found not to infringe this patent. Ethicon Endo-Surgery did not appeal the infringement decision and the case is closed. In the related nullity action, the Hooven patent was upheld in a modified form. No appeal was taken and the case is now closed.

We prevailed in both the infringement and nullity actions related to the Clark patent. The products in question were found not to infringe this patent and the nullity court declared the asserted patent revoked. Ethicon Endo-Surgery is appealing both the infringement and nullity decisions. The infringement appeal has been stayed by the appellate court until the final outcome of the nullity proceedings, which is not expected before 2010. We lost the infringement action related to the Rothfuss patent, which concerns a particular stapling cartridge that can be used in our surgical instruments. We are appealing that infringement decision. We prevailed in the nullity action related to the Rothfuss patent and the nullity court declared the asserted patent revoked. Ethicon has appealed this decision.

In the Rothfuss infringement action, Ethicon Endo Surgery asserts that it is entitled to collect damages of approximately €526,000 and has instituted damages proceedings for part of its claim, asking the Düsseldorf court for a partial damages award of at least €142,000, or alternatively, €263,000.

We introduced a redesigned stapling product that would not infringe the Rothfuss patent even if the patent and the infringement decision were upheld. Subsequently, the appeal court stayed the provisional enforcement of the district court ruling in Ethicon Endo-Surgery’s favor in the Rothfuss patent infringement litigation and we re-introduced the product accused of infringement in that case.

Ethicon Endo-Surgery is appealing the Rothfuss patent nullity decision. The courts before which the Rothfuss infringement appeal and the damages action are pending stayed those proceedings until final resolution of the Rothfuss nullity action, which is not expected before 2010.

In the event Ethicon Endo-Surgery was to prevail in its appeals of the Clark patent decisions or in its appeal of the Rothfuss nullity action decision, we may be precluded from selling certain of our products in Germany.

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We have not accrued any amount in our consolidated financial statements as of June 30, 2009 for these matters.

Duo-Med litigation in Belgium. In August 2008, our former Belgian distributor, Duo-Med, S.A., initiated a breach of contract action against us in the Commercial Court of Brussels in Belgium. The complaint alleges that we breached our distribution agreement with Duo-Med by failing to provide proper notice when we terminated that agreement in May 2007 and that, as the result of problems with our products, Duo-Med was unable to sell its existing inventory. The complaint asserts damages totaling approximately €460,000. We believe that the allegations in this matter are without merit and intend to vigorously defend against them. We have not accrued any amount in our consolidated financial statements as of June 30, 2009 for this matter.

Item 1A. Risk Factors.

Risks Related to Our Business as a Stand-Alone Company

If we are unable to consummate the Merger with Covidien, we will be required to raise additional capital. If we cannot raise such capital, we will be forced to curtail operations, consummate transactions with respect to our assets that we might not otherwise enter into, attempt to sell our company, cease operations or declare bankruptcy.

As June 30, 2009, we had cash and cash equivalents of approximately $4.3 million. In addition, as of June 30, 2009, we had total liabilities of approximately $50.7 million, including approximately $25.0 million of Convertible Notes due to be paid in March 2010.

Our operations to date have required significant cash expenditures. We have incurred net losses in each year since our inception and have an accumulated deficit at June 30, 2009 of $230.7 million. We believe that our current cash and cash equivalents, together with our expected near-term future sales, will be sufficient to meet our anticipated cash requirements through September 25, 2009, the latest date by which the Merger is expected to close.

If we do not consummate the Merger, our actual capital requirements will depend on many factors, many of which are outside our control, including:

· future revenue generation;

· the cost of filing and prosecuting patent applications and defending and enforcing our patent and other intellectual property rights;

· the cost of defending, in litigation or otherwise, any claims that we infringe third party patent or other intellectual property rights;

· the cost and timing of regulatory approvals;

· expenses of future clinical studies, if any;

· the effect of competing technological and market developments; and

· licensing technologies for future development.

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consummate the Merger and we remain an independent company, we cannot be certain that additional public or private financing will be available in amounts acceptable to us, or at all. If we raise additional funds by issuing equity securities or debt, significant dilution may occur. Debt financing, if available, may involve restrictive covenants. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. Our ability to obtain additional debt financing will be limited by certain covenants we have made to holders of our Convertible Notes. In addition, if we default in the payment of our obligations under our Convertible Notes, our noteholders will be entitled to exercise their rights as creditors.

If we do not consummate the Merger and we remain an independent company and are unable to raise additional funds when needed, we will need to:

· delay, scale-back or eliminate some or all of our research and product development programs;

· license third parties to develop and commercialize products or technologies that we would otherwise seek to develop and commercialize ourselves;

· attempt to sell our company;

· cease operations; or

· declare bankruptcy.

If we take any of the above actions, the value of your investment in us could be materially impaired or eliminated.

As of June 30, 2009, there were approximately 2.8 million stock options and approximately 0.9 million warrants outstanding. These equity instruments represent approximately 21% of our shares outstanding at June 30, 2009. The significant dilution represented by our outstanding warrants and equity compensation awards may make it more difficult for us to raise additional capital.

We have incurred losses since inception and anticipate that we will incur continued losses for the foreseeable future.

We are a company with a limited operating history and have sustained net losses since our inception, including a net loss of $14.5 million in the six months ended June 30, 2009 and net losses of $42.3 million and $36.8 million for the years ended December 31, 2008 and 2007, respectively. We had an accumulated deficit of $230.7 million at June 30, 2009. We expect to continue to incur significant operating losses at least through 2009. Our losses have had and will continue to have an adverse effect on our stockholders’ equity and working capital and could cause us to take actions that could materially impair or eliminate the value of your investment in us.

We are dependent on our next generation wireless handheld technology incorporated in our i60, i45 and iDrive products, and we cannot be certain that our technology and our products will achieve the broad market acceptance necessary to develop a sustainable, profitable business.

Historically, most of our revenue has been derived from the sale of our single-patient, disposable Intelligent Surgical Instruments and, to a lesser extent, from the sale of reload cartridges for our reusable Intelligent Surgical Instruments. We expect that as our installed base of reusable, multiple-patient Intelligent Surgical Instruments grows and the number of firings of our instruments increases, sales of reload cartridges will become the largest component of our total sales. It is difficult to predict the penetration, future growth rate or size of the market for our next generation of wireless handheld products.

The commercial success of our various Intelligent Surgical Instruments will require broad acceptance of our technology platform by the surgeons who specialize in the procedures we target, a limited number of whom may be able to influence device selection and purchasing decisions. If the concept of computer-assisted power-actuated devices for tissue manipulation, cutting and stapling is not broadly accepted and perceived as having significant advantages over manually-actuated devices, then we will not meet our business objectives. Such broad acceptance will require a determination by hospitals and surgeons that our products are safe, cost-effective and represent acceptable methods of treatment. We cannot assure that our existing relationships and arrangements with hospitals and surgeons can be maintained or that new relationships will be established in support of our products. In addition, our competitors may develop new technology for tissue manipulation, cutting and stapling that is more attractive to surgeons and hospitals. If surgeons do not consider our products to be suitable for application in the procedures we are targeting and an improvement over the use of competing products, our business goals will not be realized.

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Our Convertible Notes contain certain covenants that, if we violate, could result in an event of default. If we are in default, our noteholders will be entitled to exercise their rights under the Convertible Notes and immediately accelerate payment, which could materially impair our ability to continue to operate our business.

Our Convertible Notes include certain covenants that, among other things, require that we materially comply with all applicable laws; pay all material taxes, assessments and governmental levies; furnish certain financial statements to our noteholders; and maintain insurance in the amounts customarily maintained by companies in the same or similar businesses. Our ability to comply with these and other provisions of the Convertible Notes may be impacted by changes in economic or business conditions, results of operations or events beyond our control. The breach of any of these covenants could result in an event of default. Upon an event of default, our noteholders will be entitled to exercise their rights under the Convertible Notes and immediately accelerate repayment of the Convertible Notes, which could materially impair our ability to continue to operate our business.

The success of our business is dependent on our ability to develop new and innovative products and to enhance our existing products. In recent years, we experienced significant delays in the introduction of our new products, and if we do not achieve our current development goals in the time frames we expect, the commercialization of our new products may be delayed and, as a result, our operations may be adversely affected.

The success of our business is dependent on our ability to develop new products, to introduce enhancements to our existing products and to develop these new technologies within targeted timeframes. These target estimates are based on a variety of assumptions. The actual timing of these milestones can vary dramatically compared to our estimates for reasons that may or may not be within our control. Delays in product releases, or our inability to quickly resolve quality issues, both real and perceived, and other factors affecting the success of our product launches, could have a material adverse effect on our revenues and results of operations. Customers may forego purchases of our existing products and purchase our competitors’ products as a result of delays in the introduction of our new products and enhancements, failure by us to choose correctly among technical alternatives or failure by us to offer innovative products or enhancements at competitive prices and in a timely manner. In addition, announcements of new products by us or by competitors may result in a delay in or cancellation of purchasing decisions in anticipation of such new products. Any such losses could impair the value of your investment.

We have limited manufacturing experience, have experienced significant manufacturing problems in the past and may encounter difficulties in increasing production to provide an adequate supply to customers.

The manufacture of our products is a complex and costly operation involving a number of separate processes and components. To date, our manufacturing activities have consisted primarily of assembling limited quantities of our products. We have considered, and will continue to consider as appropriate, manufacturing components that are currently provided by third parties, as well as implementing new production processes. We do not have experience in manufacturing our products in the commercial quantities that might be required to market our products in the United States, Europe and Japan. Manufacturing of our products in commercial quantities will require us to expand our manufacturing capabilities and to hire and train additional personnel. We expect that any expansion would be achieved through modified space utilization in our current leased facilities, improved efficiencies, increased automation and acquisition of additional tooling and equipment. We may encounter difficulties in increasing our manufacturing capacity and in manufacturing commercial quantities, including:

· maintaining product yields;

· maintaining quality control and assurance;

· providing component and service availability;

· maintaining adequate control policies and procedures; and

· hiring and retaining qualified personnel.

Difficulties encountered in increasing our manufacturing capacity could impact our ability to adequately supply our customers.

In order to achieve and sustain profitability, we must substantially improve our gross margins.

The historical unit costs for our products, based on limited manufacturing volumes, have been very high in relation to our sales, resulting in low or negative gross margins. It will be necessary for us to achieve substantial reductions in our cost of sales as a

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percentage of sales in order to become profitable. The transition to in-house production or to new production processes initially had a negative effect on our manufacturing yields or costs, which adversely affected our gross margins in the first half of 2008. While we have seen improvements to our gross margins since June 2008, due to these new production processes, we may not be able to maintain such margins as new products are introduced to the market. Certain of our manufacturing processes are labor intensive, and achieving significant cost reductions will depend in part upon reducing the time required to perform these processes. We cannot assure you that we will be able to achieve the significant cost reductions in the manufacture of our products necessary for our business to achieve profitability.

If our products are not considered to be a safe and effective alternative to existing technologies, we will not be commercially successful.

Our success depends upon acceptance of our technology by the medical community as safe, clinically effective and cost effective and a preferred device as compared to products of our competitors. We have not collected, and are not aware that others have collected, long-term data regarding efficacy, safety and clinical outcomes associated with the use of our products. Any data that is generated in the future may not be positive or consistent with our current, largely anecdotal data, which would negatively affect market acceptance and the rate at which our Intelligent Surgical Instruments are adopted. Equally important will be physicians’ perceptions of the safety of our products. Our technology is relatively new in surgery, and the results of short-term clinical experience with our Intelligent Surgical Instruments do not necessarily predict long-term clinical benefits as compared to the products of our competitors. If, over the long term, our Intelligent Surgical Instruments do not meet surgeons’ expectations as to safety, efficacy and ease of use, our Intelligent Surgical Instruments may not become widely adopted. Even if the data collected from future clinical studies or clinical experience indicates positive results, each surgeon’s actual experience with our device outside the clinical study setting may vary. Consequently, both short- and long-term results reported in any future clinical studies may be significantly more favorable than typical results of other practicing surgeons, which could negatively affect rates of adoption and negatively affect our results.

Because our markets are highly competitive, customers may choose to purchase our competitors’ products, which would result in reduced sales and harm our financial results.

Our Intelligent Surgical Instruments rely on new technology and must compete with the more established manual devices of our competitors. Conventional manual devices are widely accepted in the medical community, have a long history of use and do not require the purchase of additional, expensive capital equipment. We cannot be certain that surgeons will use our products to replace or supplement established treatments or that our products will be competitive with current or future products and technologies.

The medical industry is highly competitive. In recent years, there have been changes in technological innovation achieved in short periods of time, and it is possible that future technological change and discoveries by others could negatively impact our products. Most of our competitors enjoy competitive advantages over us, including:

· significantly greater name recognition;

· greater financial and human resources for product development, sales and marketing and patent litigation;

· longer operating histories;

· established relationships with healthcare professionals, customers and third-party payors;

· established distribution networks;

· additional lines of products and the ability to offer rebates or bundle products to offer higher discounts or incentives to gain a competitive advantage; and

· greater experience in conducting research and development, manufacturing, clinical trials, obtaining regulatory clearance for products and marketing approved products.

In addition, our first generation SurgASSIST system in its original configuration had certain perceived disadvantages compared to conventional manual endomechanical devices. Prior to the introduction of our new i60 and i45 linear staplers and our iDrive wireless handheld power and control system, our Intelligent Surgical Instruments had to be tethered by a flexible shaft to a power console which is located outside the sterile field. Some surgeons and operating room personnel found this to be cumbersome and not well suited for all procedures. This factor may initially have limited market acceptance of our SurgASSIST platform. Our next

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generation untethered self-contained Intelligent Surgical Instruments are designed to eliminate this disadvantage of our SurgASSIST system, but we may need to overcome an initial negative perception by clinicians of our first-generation tethered technology.

Our future success depends upon maintaining a competitive position in the development of products and technologies in our areas of focus. Our competitors may:

· develop technologies and products that are more effective than our products or that render our technologies or products obsolete or noncompetitive;

· obtain patent protection or other intellectual property rights that would prevent us from developing or enhancing our products; or

· obtain regulatory approval for the commercialization of their products more rapidly or effectively than we do.

Additional competitors also may enter our market. As a result, we cannot assure you that we will be able to compete successfully against existing or new competitors. Our sales would be reduced or eliminated if our competitors develop and market products that are more effective and less expensive than our products. Volatility in the demand for our products could, among other things, make it more difficult to gauge the manufacturing capacity necessary to meet our demand, decrease our manufacturing efficiency and increase our working capital requirements. If any of these occur, your investment in our common stock may decrease in value.

We assemble our Intelligent Surgical Instruments using our own customized equipment and are currently implementing a new manufacturing process, making us vulnerable to production and supply problems that could negatively impact our sales.

We presently use customized equipment for certain steps in the assembly of our Intelligent Surgical Instruments. Because of the customized nature of our equipment, we cannot rely on third parties to find new parts or replace the equipment. As a result, we are responsible for maintaining the equipment and for locating spare parts. If the equipment malfunctions and we are unable to locate spare parts or hire qualified personnel to repair the equipment, we may encounter delays in the manufacture of our Intelligent Surgical Instruments and reloads and may not have sufficient inventory to meet our customers’ demands, which could adversely affect our business, financial condition and results of operations.

We integrated an automated system that enables us to assemble the reload cartridges for our PLC 60 and i60 linear staplers. There is no guarantee that the automated system will function at the capacity we require. The automated system is located at our facility in Langhorne, Pennsylvania, which requires us to be responsible for the day-to-day control and protection of the system. While we expect this automated system to manufacture at our anticipated volume, unanticipated problems in our utilization of this automated system could jeopardize our initiatives to improve our gross margins.

We are dependent upon a number of key suppliers, including certain sole source suppliers, the loss of which would materially harm our business.

While we generally no longer rely upon sole source suppliers for key components and services used in manufacturing our products, we do not have long-term contracts with our suppliers. We cannot assure you that we will be able to obtain sufficient quantities of the components or services we use in our manufacturing in the future. Because we do not have long-term contracts, our suppliers generally are not required to provide us with any guaranteed minimum production levels.

In addition, our reliance on third parties involves a number of risks, including, among other things:

· suppliers may fail to comply with regulatory requirements or make errors in manufacturing components that could negatively affect the efficacy or safety of our products or cause delays in shipments of our products;

· we may not be able to respond to unanticipated changes and increases in customer orders;

· we may be subject to price fluctuations due to a lack of long-term supply arrangements for key components;

· we may experience delays in delivery by our suppliers due to changes in demand from us or their other customers;

· we may lose access to critical services and components, resulting in an interruption in the manufacture, assembly and shipment of our systems;

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· fluctuations in demand for products that our suppliers manufacture for others may affect their ability or willingness to deliver components to us in a timely manner;

· our suppliers may wish to discontinue supplying components or services to us for risk management reasons;

· we may not be able to find new or alternative components or reconfigure our system and manufacturing processes in a timely manner if the necessary components become unavailable; and

· our suppliers may encounter financial hardships unrelated to our demand for components, which could inhibit their ability to fulfill our orders and meet our requirements.

If any of these risks materialize, it could significantly increase our costs and impact our ability to meet demand for our products.

We cannot quickly replace suppliers or establish additional new suppliers for some of these components, due to both the complex nature of the manufacturing process used by our suppliers and the time and effort that may be required to obtain regulatory clearance or approval to use materials from alternative suppliers. Any significant supply interruption or capacity constraints affecting our facilities or those of our suppliers would impair our ability to manufacture our products.

If we are unable to manage our expected growth, our performance may suffer.

In October 2008, we implemented a restructuring plan aimed at reducing costs, primarily through headcount reductions. As of June 30, 2009, we had approximately 122 employees globally, compared with 178 in June 2008. It is possible that our management, finance, technical and regulatory personnel, systems and facilities currently in place may not be adequate to support our expected future growth. Our need to effectively manage our operations, growth and programs requires that we continue to improve our systems and procedures in each of these areas and to attract and retain sufficient numbers of talented employees. We may be unable to successfully implement these tasks on a larger scale and, accordingly, may not achieve our research, development and growth goals.

We have concluded that there are material weaknesses in our internal controls over financial reporting, and if we are unable to achieve and maintain effective internal controls over financial reporting, investors could lose confidence in our financial statements and our company, which could have a material adverse effect on our business and stock price.

We determined that we have a material weakness in our internal control over financial reporting related to not having a sufficient number of personnel with the appropriate level of experience and technical expertise to appropriately resolve non-routine and complex accounting matters or to evaluate the impact of new and existing accounting pronouncements on our consolidated financial statements while completing the financial statement close process. The material weakness resulted in the identification of adjustments during the financial statement close process in 2008 that have been recorded in the consolidated financial statements. Until this design deficiency in our internal control over financial reporting is remediated, there is a reasonable possibility that a material misstatement to our annual or interim consolidated financial statements could occur and not be prevented or detected by our internal controls in a timely manner.

· we will also expand the training and education of our accounting and finance staff members, including Sarbanes-Oxley compliance training, in an effort to improve their effectiveness.

In addition, we determined that we have a material weakness in our entity-level controls as we did not have a control to prevent loans to executive officers. In connection with the review of our internal controls, we noted that in October 2008 we made an advance of salary of approximately $24,000 to our president and chief executive officer, Michael Whitman. Such advance was made by us on Mr. Whitman’s behalf to Mr. Whitman’s brokerage account to enable Mr. Whitman to satisfy a margin call requirement in cash rather than in shares of our common stock, which would have resulted in sales of our stock during a restricted trading period. This advance was approved by our then chief financial officer and was repaid by Mr. Whitman in full in December 2008.

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Following an investigation by the Audit Committee of the Board of Directors, our Board of Directors, with our chief executive officer and president having removed himself from its deliberations, determined that the advance was an inadvertent violation of Section 402 of the Sarbanes-Oxley Act of 2002 which our internal controls and procedures did not prevent. Our then chief financial officer, did not consider that short term salary advances are deemed to be loans under the provisions of Section 402 of the Sarbanes-Oxley Act and therefore was unaware of the Section’s prohibitions on such advances to executive officers. Our Board of Directors determined that this matter was an isolated incident and required the payment of imputed interest calculated based on an annual interest rate of 2.19% on the amounts of salary advanced, which Mr. Whitman has paid. In addition, the Board of Directors has terminated our consulting arrangement with our former chief financial officer. Our chief executive officer and president is now aware of this requirement of the Sarbanes-Oxley Act of 2002 and will ensure that he avoids any violation thereof in the future. In response to this matter, the Board of Directors has instructed our current chief financial officer to undertake a thorough review of our internal controls and procedures with the intention of expanding and formalizing our policies and procedures to avoid future violations of the Sarbanes-Oxley Act of 2002, and other applicable laws, rules and regulations. This review by our chief financial officer is in process. The Board of Directors intends to institute mandatory corporate governance and Sarbanes-Oxley Act of 2002 training for management and our accounting staff.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we must assess the effectiveness of our internal control over financial reporting. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting that are identified by management. If we are unable at that time to assert that our internal control over financial reporting is effective because the material weakness identified above has not been remediated, or for any other reason, or if our independent registered public accounting firm is unable to express an opinion on the effectiveness of our internal controls when it is required to do so in the future, investors could lose confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.

Any failure in our training efforts could result in lower than expected product sales and potential liabilities.

A critical component of our sales and marketing efforts is the training of a sufficient number of surgeons, other clinicians and hospital staff to properly use our Intelligent Surgical Instruments. In order to operate effectively, our internal sales force must also be trained on the benefits and proper utilization of our technology, including newly introduced products. In connection with the introduction of our i60, i45, i45v and iDrive products, we have found that it takes longer than we expected to adequately train our internal sales force and customers’ clinical personnel on the use and care of these instruments, due in part to their novelty and to the need to employ new sterilization techniques. Additionally, the number of i60 and iDrive demonstration units available for use by our sales force was limited during the early phases of our i60 product launch. As a result, it has taken longer for our sales force to become fully effective in selling these new products, and the rate of adoption of our new technology has been adversely affected. Any further delays in adequately training our internal sales force or our customers’ clinical personnel on these or other products could harm our business.

Additionally, we rely on clinicians and hospital staff to devote adequate time to learn to use our products. If surgeons or hospital staff are not properly trained in the use of our Intelligent Surgical Instruments, they may misuse or ineffectively use our products. Insufficient training may result in unsatisfactory patient outcomes, patient injury and related liability or negative publicity, which could have an adverse effect on our product sales.

The use of our products could result in product liability claims that could be expensive, divert management’s attention and harm our reputation and business.

Our business exposes us to significant risks of product liability claims that are inherent in the testing, manufacturing and marketing of medical devices. The medical device industry has historically been subject to extensive product liability litigation. We have in the past been, and in the future may be, subject to claims by consumers, healthcare providers, third-party payors or others selling our products if the use of our products were to cause, or merely appear to cause, injury or death. We are currently the subject of a product liability suit in Belgium. Any weakness in training and service associated with our products may result in other product liability lawsuits. Additionally, we may be unable to maintain our existing product liability insurance in the future at satisfactory rates or adequate amounts. A product liability claim, regardless of its merit or eventual outcome or the availability of insurance coverage, could result in:

· decreased demand for our products;

· injury to our reputation;

· diversion of management’s attention;

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· significant costs of related litigation;

· substantial monetary awards to patients;

· product recalls or market withdrawals;

· loss of sales; and

· the inability to successfully commercialize our products that are under development.

If we deliver products with defects, our credibility may be harmed and market acceptance of our products may decrease.

The manufacturing and marketing of our products involve an inherent risk of product liability claims. In addition, our product development and production processes are complex and could expose our products to defects. Additionally, problems experienced by our customers, such as difficulty in consistently seating our reload cartridges, may be perceived by them as quality defects. Our Intelligent Surgical Instruments also incorporate sophisticated computer software. Complex software frequently contains errors, especially when first introduced. We cannot assure you that our software will not experience errors or performance problems in the future. If our products have, or are perceived to have, mechanical defects or software errors or have performance problems, we would likely experience:

· loss of sales;

· delay in market acceptance of our products;

· damage to our reputation;

· additional regulatory filings;

· product recalls;

· increased service or warranty costs; or

· product liability claims.

We sell our systems internationally and are subject to various risks relating to these international activities, which could adversely affect our business, financial condition and results of operations.

During the three months ended June 30, 2009 and 2008, sales in international markets totaled 24% and 18%, respectively, of our total sales. During the six months ended June 30, 2009 and 2008, sales in international markets totaled 28% and 17%, respectively, of our total sales. By doing business in international markets, we are exposed to risks separate and distinct from those we face in our domestic operations. Our international business may be adversely affected by changing economic conditions in foreign countries. Because most of our international sales are denominated in the functional currency of the country where the product is being shipped, increases or decreases in the value of the U.S. dollar relative to foreign currencies could affect our results of operations. Engaging in international business inherently involves a number of other difficulties and risks, including:

· export restrictions and controls relating to technology and government regulation;

· the availability and level of reimbursement within prevailing foreign healthcare payment systems;

· pricing pressure that we may experience internationally;

· required compliance with existing and changing foreign regulatory requirements and laws;

· laws and business practices favoring local companies;

· longer payment cycles;

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· difficulties in enforcing agreements and collecting receivables through certain foreign legal systems;

· political and economic instability;

· potentially adverse tax consequences, tariffs and other trade barriers;

· international terrorism and anti-American sentiment;

· difficulties and costs of staffing and managing foreign operations; and

· difficulties in enforcing intellectual property rights.

Our exposure to each of these risks may increase our costs, impair our ability to market and sell our products and require significant management attention. We cannot assure you that one or more of these factors will not harm our business.

We are dependent upon key personnel, the loss of any of which could harm our business.

Our future business and operating results depend significantly on the continued contributions of our key technical personnel and senior management, particularly those of Mr. Whitman. These individuals and the services they provide would be difficult to replace. While we are subject to certain severance obligations to Mr. Whitman, either he or we may terminate his employment at any time and for any lawful reason or for no reason. Our business and future operating results also depend significantly on our ability to attract and retain qualified management, manufacturing, technical, regulatory, marketing, sales and support personnel for our operations. Competition for such personnel is intense, and there can be no assurance that we will be successful in attracting or retaining such personnel.

Although we have key-person life insurance in the amount of $2.0 million on the life of Mr. Whitman, this amount would not fully compensate us for the loss of Mr. Whitman’s services. The loss of key employees, the failure of any key employee to perform or our inability to attract and retain skilled employees, as needed, could harm our business.

Lack of third-party coverage and reimbursement for our products could delay or limit their adoption.

We may experience limited sales growth resulting from limitations on reimbursements made to purchasers of our products by third-party payors, and we cannot assure you that our sales will not be impeded and our business harmed if third-party payors fail to provide reimbursement that hospitals view as adequate.

In the United States, our products are purchased primarily by medical institutions, which then bill various third-party payors, such as the Centers for Medicare and Medicaid Services, or CMS, which administers the Medicare and Medicaid programs, and other government programs and private insurance plans, for the healthcare services provided to their patients. The process involved in applying for coverage and incremental reimbursement from CMS is lengthy and expensive.

Moreover, many private payors look to CMS in setting their reimbursement policies and amounts. If CMS or other agencies limit coverage for procedures utilizing our Intelligent Surgical Instruments or decrease or limit reimbursement payments for doctors and hospitals, this may affect coverage and reimbursement determinations by many private payors.

If a medical device does not receive incremental reimbursement from CMS, then a medical institution would have to absorb the cost of our products as part of the cost of the procedure in which the products are used. Acute care hospitals are now generally reimbursed by CMS for inpatient operating costs under a Medicare hospital inpatient prospective payment system. Under the Medicare hospital inpatient prospective payment system, acute care hospitals receive a fixed payment amount for each covered hospitalized patient based upon the Diagnosis-Related Group, or DRG, to which the inpatient stay is assigned, regardless of the actual cost of the services provided. At this time, we do not know the extent to which medical institutions would consider insurers’ payment levels adequate to cover the cost of our products. Failure by hospitals and surgeons to receive an amount that they consider to be adequate reimbursement for procedures in which our products are used could deter them from purchasing our products and limit our sales growth. In addition, pre-determined DRG payments may decline over time, which could deter medical institutions from purchasing our products. If medical institutions are unable to justify the costs of our products, they may refuse to purchase them, which would significantly harm our business.

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Our operations are currently conducted primarily at a single location that may be at risk from fire, earthquakes, terror attacks or other disasters.

We currently conduct all of our manufacturing and management activities and certain research and development activities at a single location in Langhorne, Pennsylvania. We have taken precautions to safeguard our facilities, including insurance, health and safety protocols and off-site storage of computer data. However, a casualty due to fire or natural disaster, such as an earthquake, storm or terrorist attack, could cause substantial delays in our operations, damage or destroy our equipment or inventory and cause us to incur additional expenses. A disaster could seriously harm our business and results of operations. Our insurance does not cover earthquakes and floods and may not be adequate to cover our losses in any particular case.

Risks Related to the Merger

The Merger is subject to closing conditions that could result in the completion of the Merger being delayed or not consummated, which could negatively impact our stock price and future business and operations.

Completion of the Merger is conditioned upon Parent and us satisfying closing conditions, including success of the Offer, all as set forth in the Merger Agreement. The required conditions to closing may not be satisfied in a timely manner, if at all, or, if permissible, waived, and the Merger may not be consummated. Failure to consummate the Merger could negatively impact our stock price, future business and operations, and financial condition. Any delay in the consummation of the Merger or any uncertainty about the consummation of the Merger may adversely affect our future business, growth, revenue and results of operations.

Failure to complete the Merger could negatively impact the market price of our common stock and our future business and financial results.

If the Merger is not completed for any reason, our ongoing business may be adversely affected and will be subject to a number of risks, including:

· we will be required to raise additional capital. If we cannot raise such capital, we will be forced to curtail operations, consummate transactions with respect to our assets that we might not otherwise enter into, attempt to sell our company, cease operations or declare bankruptcy

· we may be required, under some circumstances, to pay Parent a termination fee of approximately $2.3 million;

· the diversion of management’s attention, the reduction in capital spending and acquisitions, the suspension of planned hiring and other affirmative and negative covenants in the Merger Agreement restricting our business;

· failure to pursue other beneficial opportunities as a result of the focus of management on the Merger, without realizing any of the anticipated benefits of the Merger;

· the market price our common stock may decline to the extent that the current market price reflects a market assumption that the Merger will be completed;

· we may experience negative reactions to the termination of the Merger from licensors, suppliers, or other strategic partners; and

· our costs incurred related to the Merger, such as legal and accounting fees, must be paid even if the Merger is not completed.

If the Merger Agreement is terminated and our board of directors seeks another merger or business combination, our stockholders cannot be certain that we will be able to find a party willing to pay a price equivalent to or more attractive than the price Parent has agreed to pay in the Merger.

During the pendency of the Merger, we may not be able to enter into certain business combinations with other parties because of restrictions in the Merger Agreement.

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Covenants in the Merger Agreement impede our ability to make certain acquisitions or complete other transactions that are not, among other things, in the ordinary course of business pending completion of the Merger. As a result, if the Merger is not completed, we may be at a disadvantage to our competitors.

The Merger Agreement limits our ability to pursue alternatives to the Merger.

The Merger Agreement contains ‘‘no shop’’ provisions that, subject to limited exceptions, preclude us, whether directly or indirectly through our subsidiaries, officers, directors, agents or other representatives, from soliciting, initiating, knowingly facilitating, encouraging or inducing, any inquiry with respect to, or the making, submission or announcement of, any acquisition proposal, participating in any discussions or negotiations, or furnishing any nonpublic information with respect to any acquisition proposal, or taking any other action to facilitate any inquiries or proposal that would be reasonably expected to result in an acquisition proposal, approving, endorsing or recommending any acquisition proposal, or entering into any agreement contemplating or otherwise relating to any acquisition proposal. Under certain circumstances, the Merger Agreement also provides that we will be required to pay a termination fee of approximately $2.3 million to Parent upon termination of the Merger Agreement. These provisions might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of us from considering or proposing an acquisition even if it were prepared to pay consideration with a higher per share market price than that proposed in the Merger, or might result in a potential competing acquirer proposing to pay a lower per share price to acquire us than it might otherwise have proposed to pay.

Risks Related to Ownership of Our Common Stock

We expect that the price of our common stock will fluctuate substantially based on a number of factors, many of which are beyond our control.

Until our initial public offering in October 2007, there was no public market for shares of our common stock. Since our initial public offering, the closing market price of our common stock has ranged from $0.22 at its low point in December 2008 to $14.40 at its high point in February 2008. The closing market price of our common stock during the six months ended June 30, 2009 ranged from $0.24 at its low point in January 2009 to $1.00 at its high point in May 2009. The market price for our common stock is likely to continue to fluctuate as a result of a number of factors, including:

· whether the Merger is consummated;

· if the Merger is not consummated, developments relating to our efforts to obtain additional financing to fund our operations or our issuance of additional debt or equity securities;

· if the Merger is not consummated, and we are unable to obtain such additional financing or issue such debt or equity securities, our consequent need to:

- delay, scale-back or eliminate some or all of our research and product development programs;

- license third parties to develop and commercialize products or technologies that we would otherwise seek to develop and commercialize ourselves;

- attempt to sell our company;

- cease operations; or

- declare bankruptcy;

· actual or anticipated announcements of technological innovations;

· introduction by us or by others of new commercial products;

· actual or anticipated changes in laws and governmental regulations;

· disputes relating to patents or proprietary rights;

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· changes in business practices;

· announcements by us regarding transactions with potential strategic partners;

· changes in industry trends or conditions;

· trading volume of our common stock;

· changes in earnings estimates or recommendations by securities analysts, failure to obtain analyst coverage of our common stock or our failure to achieve analysts’ earnings estimates;

· developments in our industry; and

· general market conditions and other factors unrelated to our operating performance or the operating performance of our competitors or potential competitors.

Stock prices of many companies in the medical device industry have experienced wide fluctuations that have often been unrelated to the operating performance of these companies. In the past, securities class action litigation often has been initiated against a company following a period of volatility in the market price of the company’s securities. If securities class action litigation is initiated against us, we will incur substantial costs and our management’s attention will be diverted from our operations. All of these factors may materially and adversely affect the market price of our common stock, and you may lose some or all of your investment.

Securities analysts may not initiate or continue coverage for our common stock or may issue negative reports, and this may have a negative impact on the market price of our common stock.

Securities analysts may elect not to provide research coverage of our common stock, and if a sufficient number of securities analysts do not cover our common stock, the lack of research coverage may adversely affect the market price of our common stock. The trading market for our common stock may be affected in part by the research and reports that industry or financial analysts publish about us or our business. If one or more of the analysts who elect to cover us downgrades our stock, our stock price could decline. If one or more of these analysts ceases coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline. In addition, rules mandated by the Sarbanes-Oxley Act and a global settlement reached in 2003 between the SEC, other regulatory agencies and a number of investment banks have led to a number of fundamental changes in how analysts are reviewed and compensated. In particular, many investment banking firms will be required to contract with independent financial analysts for their stock research. It may be difficult for companies such as ours, with smaller market capitalizations, to attract independent financial analysts that will cover our common stock. This could have a negative effect on the market price of our stock.

Our principal stockholders, directors and management own a large percentage of our voting stock, which allows them to exercise significant influence over matters subject to stockholder approval.

Our executive officers, directors and stockholders holding 5% or more of our outstanding common stock beneficially own or control approximately 33% of the outstanding shares of our common stock, assuming no exercise of outstanding options and warrants or conversion of our Convertible Notes. Accordingly, these executive officers, directors and principal stockholders, acting as a group, will have substantial influence over the outcome of corporate actions requiring stockholder approval, including consummation of the Merger, the election of directors, any other merger or consolidation or sale of all or substantially all of our assets or any other significant corporate transaction. These stockholders may also delay or prevent a change of control or otherwise discourage a potential acquirer from attempting to obtain control of our company, even if such a change of control would benefit our other stockholders. This significant concentration of stock ownership may adversely affect the trading price of our common stock due to investors’ perception that conflicts of interest may exist or arise.

Anti-takeover provisions in our charter documents and Delaware law could prevent or delay a change in control of our company.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws, as well as provisions of Delaware law, may discourage, delay or prevent a merger, acquisition or change of control. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors and take other corporate actions. These provisions include:

· advance notice requirements for stockholder proposals and nominations;

· limitations on convening stockholder meetings;

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· the elimination of stockholder action by written consent;

· the elimination of cumulative voting; and

· a classified board of directors.

In addition, we are subject to Section 203 of the Delaware General Corporation Law, which imposes certain restrictions on mergers and other business combinations between us and any holder of 15% or more of our common stock.

Risks Related to Our Intellectual Property

If we fail to adequately enforce or defend our intellectual property rights, our business may be harmed.

Much of the technology used in the markets in which we compete is covered by patents. Our commercial success will depend in large part on our ability to obtain and maintain patent and trade secret protection for our products and methods. We currently hold 24 issued United States patents, five granted European patents, more than 100 pending United States and foreign patent applications and two licensed patents that cover key aspects of our technology. Our issued patents expire at various dates beginning in 2019. The loss of our patents could reduce the value of the related products. In addition, the cost to litigate infringements of our patents or the cost to defend ourselves against patent infringement actions by others could be substantial.

Our ability to obtain additional patents is uncertain and the legal protection afforded by these patents is limited and may not adequately protect our rights or permit us to gain or keep any competitive advantage. In addition, the specific content required of patents and patent applications that is necessary to support and interpret patent claims is highly uncertain due to the complex nature of the relevant legal, scientific and factual issues. Changes in either patent laws or in interpretations of patent laws in the United States or elsewhere may diminish the value of our intellectual property or narrow the scope of our patent protection. Even if patents are issued regarding our products and methods, our competitors may challenge the validity of those patents. Patents also will not protect our products and methods if competitors devise ways of making competitive products without infringing our patents.

Proprietary trade secrets and unpatented know-how are also very important to our business. We rely on trade secrets to protect certain aspects of our technology, especially where we do not believe that patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. Our employees, consultants, contractors, outside clinical collaborators and other advisors may unintentionally or willfully disclose our confidential information to competitors, and confidentiality agreements may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. Enforcing a claim that a third party illegally obtained and is using our trade secrets is expensive and time consuming, and the outcome is unpredictable. Moreover, our competitors may independently develop equivalent knowledge, methods and know-how. Failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

If we infringe intellectual property rights of third parties, it may increase our costs or prevent us from being able to sell our existing products or commercialize new products.

There is a risk that we are infringing the proprietary rights of third parties under patents and pending applications belonging to third parties that may exist in the United States and elsewhere in the world and that relate to the products we market and develop. Because the patent application process can take several years to complete, there may be currently pending applications, unknown to us, which may result in issued patents that cover the production, manufacture, commercialization or use of our products. In addition, the production, manufacture, commercialization or use of our product candidates may infringe existing patents of which we are not aware.

There has been substantial litigation and other proceedings regarding patent and other intellectual property rights in the medical device industry. Defending ourselves against third-party claims, including litigation in particular, would be costly and time consuming and would divert management’s attention from our business, which could lead to delays in our development or commercialization efforts. Currently, we are involved in two appeal proceedings in Germany in connection with two of three patent-infringement lawsuits against us. The lawsuits alleged that certain of our products infringe three European patents held by Ethicon Endo-Surgery. We prevailed in two of the three infringement actions and the products in question were found not to infringe the Ethicon Endo-Surgery patents, and Ethicon Endo-Surgery is appealing one of those decisions. We lost the other infringement action and are appealing that decision. If third parties are successful in their claims, we might have to pay substantial damages or take other actions that are adverse to our business. As a result of intellectual property infringement claims, or to avoid potential claims, we might:

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· be prohibited from selling or licensing any of our current products or any product that we may develop unless the patent holder licenses the patent to us, which it is not required to do;

· be required to pay substantial royalties or grant a cross license to our patents to another patent holder; or

· be required to redesign a product so it does not infringe, which may not be possible or could require substantial funds and time.

We may be subject to damages resulting from claims that our employees or we have wrongfully used or disclosed alleged trade secrets of their former employers.

Many of our employees were previously employed at universities or other medical device companies, including our competitors or potential competitors. We could in the future be subject to claims that these employees, or we, have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. If we fail in defending against such claims, a court could order us to pay substantial damages and prohibit us from using technologies or features that are essential to our products, if such technologies or features are found to incorporate or be derived from the trade secrets or other proprietary information of the former employers. In addition, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to commercialize certain potential products, which could severely harm our business. Even if we are successful in defending against these claims, such litigation could result in substantial costs and be a distraction to management.

Risks Related to Regulatory Compliance

Our failure to meet strict regulatory requirements could require us to pay fines, incur other costs or even close our facilities.

Our facilities and manufacturing techniques generally must conform to standards that are established by the United States Food and Drug Administration, or FDA, and other government agencies, including those of European and other foreign governments. These regulatory agencies may conduct periodic audits or inspections of our facilities or our processes to monitor our compliance with applicable regulatory standards. If a regulatory agency finds that we have failed to comply with the appropriate regulatory standards, it may impose fines on us, delay or withdraw pre-market clearances or other regulatory approvals or, if such a regulatory agency determines that our non-compliance is severe, it may close our facilities. Any adverse action by an applicable regulatory agency could impair our ability to produce our products in a cost-effective and timely manner in order to meet our customers’ demands. We may also be required to bear other costs or take other actions that may have a negative impact on our future sales and our ability to generate profits.

Between February 2007 and May 2008, the FDA conducted two inspections of our facilities. Each of those inspections resulted in the issuance of a Notice of Inspectional Observations, or Form 483. Certain observations regarding our processes for handling customer complaints and submitting medical device reports were identified by the FDA as areas of possible non-compliance with the FDA regulations. For each of the Form 483s issued by the FDA, we submitted a timely response which identified our proposed corrective action plans to address these inspectional observations. The FDA has not issued an Establishment Inspection Report, or EIR, which officially closes an inspection, for either the 2007 or 2008 inspections. Regarding the most recent inspection, which occurred from April 7, through May 21, 2008, we submitted to the FDA a written response to the Form 483 on May 30, 2008. That response described the corrective actions that we were taking to address the inspectional observations identified in the Form 483. We also submitted various follow up letters to the FDA regarding the status of our ongoing corrective actions. On October 21, 2008, the FDA issued a warning letter to us. The warning letter listed the same inspectional observations identified in the Form 483. The warning letter also acknowledged the FDA’s receipt of our Form 483 response and indicated that the agency would verify that we have taken such corrective actions during a future inspection. On November 5, 2008, we submitted a written response to the warning letter which updated the agency on the status of our ongoing corrective actions. The FDA acknowledged receipt of our warning letter response on January 27, 2009. In that letter, the FDA stated that the adequacy of our corrective actions will be determined during the FDA’s next inspection. We also have provided the FDA with regular updates regarding the status of our corrective actions. We expect to be re-inspected by the FDA in 2009. If the FDA finds additional inspectional observations, or if the FDA is not satisfied with our corrective actions to the 2008 inspection and warning letter, we could be subject to sanctions, including:

· untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties;

· unanticipated expenditures to address or defend such actions;

· customer notifications for repair, replacement, refunds;

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· recall, detention or seizure of our products;

· operating restrictions or partial suspension or total shutdown of production;

· refusing or delaying our requests for 510(k) clearance or premarket approval of new products or modified products;

· withdrawing 510(k) clearances on PMA approvals that have already been granted;

· refusal to grant export approval for our products; and

· criminal prosecution.

We must upgrade and correct deficiencies in our regulatory compliance operations and our failure to do so could impair our ability to market our products or lead to regulatory enforcement action against us.

We are subject to extensive regulatory compliance in the United States and other countries, including by the FDA. In 2007 we experienced shortages of qualified regulatory compliance staff due to turnovers in regulatory staff and senior management, among other factors. We recently enhanced the regulatory and quality assurance functions of our organization by hiring personnel with appropriate regulatory compliance experience.

To address the FDA’s inspectional observations made during on-site inspections of the Langhorne, Pennsylvania facility, we have improved our complaint handling and medical device reporting procedures to ensure our compliance with the FDA’s quality system regulations and our related controls and internal audit functions. In 2008 we engaged an independent consultant to audit our compliance with certain aspects of the FDA’s quality system regulations. While certain improvements were noted, further improvements are necessary in our corrective action and preventative action processes. We also have engaged a third-party to supervise our MDR decision making process, which will continue until the FDA clears the Warning letter it issued to us in October 2008.

If we are not successful in retaining qualified personnel to manage and staff our regulatory compliance operations or in implementing necessary process improvements on a timely basis, we could be subject to regulatory enforcement actions which could damage our reputation, impair our ability to obtain regulatory clearances for new products, prevent us from manufacturing and selling our products and harm our business.

Modifications to our products may require new regulatory clearances or approvals or may require us to recall or cease marketing our products until clearances or approvals are obtained.

Modifications to our products may require new regulatory approvals or clearances, including 510(k) clearance to market or premarket approvals, or require us to recall or cease marketing the modified devices until these clearances or approvals are obtained. The FDA requires device manufacturers to initially make and document a determination of whether or not a modification requires a new approval, supplement or clearance. A manufacturer may determine that a modification could not significantly affect safety or efficacy and does not represent a major change in its intended use, so that no new 510(k) clearance is necessary. However, the FDA can review a manufacturer’s decision and may disagree. The FDA may also on its own initiative determine that a new clearance or approval is required. We have made modifications to our products in the past and may make additional modifications in the future that we believe do not or will not require additional clearances or approvals. If the FDA disagrees and requires new clearances or approvals for the modifications, we may be required to recall and to stop marketing our products as modified, which could require us to redesign our products and harm our operating results. In these circumstances, we may be subject to significant enforcement actions.

If a manufacturer determines that a modification to an FDA-cleared device could significantly affect its safety or efficacy, or would constitute a major change in its intended use, then the manufacturer must file for a new 510(k) clearance or possibly a premarket approval application. Where we determine that modifications to our products require a new 510(k) clearance or premarket approval application, we may not be able to obtain those additional clearances or approvals for the modifications or additional indications in a timely manner, or at all. For those products sold in the European Union, we must notify Orion Registrar, Inc., or Orion, our E.U. Notified Body, if significant changes are made to the products or if there are substantial changes to our quality assurance systems affecting those products. Obtaining clearances and approvals can be a time consuming process, and failure to obtain or delays in obtaining required future clearances or approvals would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our future growth.

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There is no guarantee that the FDA will grant 510(k) clearance or PMA approval of our emerging technologies and failure to obtain necessary clearances or approvals for our future products would adversely affect our ability to grow our business.

Certain of our new products will require FDA 510(k) clearance to market or may even require FDA approval of a PMA. We will need to develop our regulatory strategies for obtaining clearance or approval of new products, as necessary. The FDA may not approve or clear such products for the indications that are necessary or desirable for successful commercialization. In addition, the FDA may refuse our requests for 510(k) clearance to market or premarket approval of new products, new intended uses or modifications to existing products. Failure to receive clearance or approval for our new products would have an adverse effect on our ability to expand our business.

If we or our contract manufacturers fail to comply with the FDA’s Quality System Regulations, our manufacturing operations could be interrupted and our product sales and operating results could suffer.

Our finished goods manufacturing processes, and those of some of our contract manufacturers, are required to comply with the FDA’s Quality System Regulations, or QSRs, which cover the procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our devices. The FDA enforces its QSRs through periodic inspections of manufacturing facilities. We and our contract manufacturers have been, and anticipate continuing to be, subject to such inspections. If our manufacturing facilities or those of any of our contract manufacturers fail to take satisfactory corrective action in response to an adverse QSR inspection, the FDA could take enforcement action, including any of the following sanctions, which could have a material impact on our operations:

· untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties;

· unanticipated expenditures to address or defend such actions;

· customer notifications for repairs, replacements or refunds;

· recall, detention or seizure of our products;

· operating restrictions or partial suspension or total shutdown of production;

· refusing or delaying our requests for 510(k) clearance or premarket approval of new or modified products;

· withdrawing 510(k) clearances on PMA approvals that have already been granted;

· refusal to grant export approval for our products; and

· criminal prosecution.

Between February 2007 and May 2008, the FDA conducted two inspections of our facilities. Each of those inspections resulted in the issuance of a Notice of Inspectional Observations, or Form 483. Certain observations regarding our processes for handling customer complaints and submitting medical device reports were identified by the FDA as areas of possible non-compliance with FDA regulations. For each of the Form 483s issued by the FDA, we submitted a timely response, which identified our proposed corrective action plans to address these inspectional observations. The FDA has not issued an Establishment Inspection Report, or EIR, which officially closes an inspection, for either the 2007 or 2008 inspections. Regarding the most recent inspection, which occurred from April 7, 2008 through May 21, 2008, we submitted to the FDA a written response to the Form 483 on May 30, 2008. That response described the corrective actions that we were taking to address the inspectional observations identified in the Form 483. We also submitted various follow up letters to the FDA regarding the status of our ongoing corrective actions. On October 21, 2008, the FDA issued a warning letter to us. The warning letter listed the same inspectional observations identified in the Form 483. The warning letter also acknowledged the FDA’s receipt of our Form 483 response and indicated that the agency would verify that we have taken such corrective actions during a future inspection. On November 5, 2008, we submitted a written response to the warning letter which updated the agency on the status of our ongoing corrective actions. The FDA acknowledged receipt of our warning letter response in a January 23, 2009. In that letter, the FDA stated that the adequacy of our corrective actions will be determined during the FDA’s next inspection. We also have provided the FDA with regular updates regarding the status of our corrective actions. We expect to be re-inspected by the FDA in 2009. If the FDA finds additional inspectional observations, or if the FDA is not satisfied with our corrective actions to the 2008 inspection and warning letter, we could be subject to various enforcement actions as identified above.

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Our products may in the future be subject to product recalls that could harm our reputation, business and financial results.

The FDA and similar foreign governmental authorities have the authority to require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture. In the case of the FDA, the authority to require a recall must be based on an FDA finding that there is a reasonable probability that the device would cause serious injury or death. In addition, foreign governmental bodies have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. Manufacturers may, under their own initiative, voluntarily recall a product if any material deficiency in a device is found. A government-mandated or voluntary recall by us or one of our distributors could occur as a result of component failures, manufacturing errors, design or labeling defects or other deficiencies and issues. Recalls of any of our products would divert managerial and financial resources and have an adverse effect on our financial condition and results of operations. The FDA requires that certain classifications of recalls be reported to FDA within 10 working days after the recall is initiated. Companies are required to maintain certain records of recalls, even if they are not reportable to the FDA. We have initiated certain voluntary recalls involving products that have been distributed to our customers and may take additional such actions in the future. We believe that certain of those recalls do not require notification of the FDA. If the FDA disagrees with our determinations, they could require us to report those actions as recalls. A future recall announcement could harm our reputation with customers and negatively affect our sales. In addition, the FDA could take enforcement action, including any of the following sanctions for failing to report the recalls when they were conducted:

· untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties;

· unanticipated expenditures to address or defend such actions

· customer notifications for repairs, replacements or refunds;

· recall, detention or seizure of our products;

· operating restrictions or partial suspension or total shutdown of production;

· refusing or delaying our requests for 510(k) clearance or premarket approval of new or modified products;

· withdrawing 510(k) clearances on PMA approvals that have already been granted;

· refusal to grant export approval for our products; and

· criminal prosecution.

If our products cause or contribute to a death or serious injury, or malfunction in certain ways, we will be subject to medical device reporting regulations, which can result in voluntary corrective actions or agency enforcement actions.

Under the FDA medical device reporting regulations, or MDR, medical device manufacturers are required to report to the FDA information that a device has or may have caused or contributed to a death or serious injury or has malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction of the device or one of our similar devices were to recur. All manufacturers placing medical devices in the market in the European Union are legally bound to report any serious or potentially serious incidents involving devices they produce or sell to the Competent Authority in whose jurisdiction the incident occurred. Were this to happen to us, the relevant Competent Authority would file an initial report, and there would then be a further inspection or assessment if there are particular issues. This would be carried out either by the Competent Authority or it could require that Orion, as the Notified Body, carry out the inspection or assessment.

Any such adverse event involving our products could result in future voluntary corrective actions, such as recalls or customer notifications, or agency action, such as inspection or enforcement action. Adverse events involving our products have been reported to us in the past, and we cannot guarantee that they will not occur in the future. Any corrective action, whether voluntary or involuntary, as well as defending ourselves in a lawsuit, will require the dedication of our time and capital, distract management from operating our business, and may harm our reputation and financial results. Failure to report such adverse events to appropriate government authorities on a timely basis, or at all, could result in an enforcement action against us.

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Failure to obtain regulatory approval in additional foreign jurisdictions will prevent us from expanding the commercialization of our products abroad.

We currently market our products and intend to market our future products in a number of international markets. Although certain of our products have been approved for commercialization in Japan and CE market in the European Union, in order to market our products in other foreign jurisdictions we must obtain separate regulatory approvals. The approval procedure varies among jurisdictions and can involve substantial additional testing. Approval or clearance by the FDA does not ensure approval by regulatory authorities in other jurisdictions, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign jurisdictions or by the FDA. The foreign regulatory approval process may include all of the risks associated with obtaining FDA approval in addition to other risks. In addition, the time required to obtain foreign approval may differ from that required to obtain FDA clearance or approval, and we may not obtain foreign regulatory approvals on a timely basis, if at all. We may not be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products in any foreign market other than our current authorizations in the European Union and Japan.

We may be subject to fines, penalties or injunctions if we are determined to be promoting the use of our products for unapproved or “off-label” uses.

Our promotional materials and training methods for surgeons must comply with FDA and other applicable laws and regulations. Many of our products are cleared by the FDA for use in various surgical applications. We believe that the specific surgical procedures for which our products are marketed fall within the scope of the surgical applications that have been cleared by the FDA. However, the FDA could disagree and require us to stop promoting our products for those specific procedures until we obtain FDA clearance or approval for them. In addition, if the FDA determines that our promotional materials or training constitutes promotion of an unapproved use, it could request that we modify our training or promotional materials or subject us to regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine and criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our promotional or training materials to constitute promotion of an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement. In that event, our reputation could be damaged and adoption of the products would be impaired.

Legislative and regulatory changes in the health care and medical devices industry could have a negative impact on our financial performance.

Health care

Changes in the health care industry in the United States and elsewhere could adversely affect the demand for our products as well as the way in which we conduct our business. Significantly, the new administration and Congressional and state leaders have expressed a strong desire to reform the U.S. health care system. Included in this reform could be laws that narrow Medicare coverage or reduce reimbursement levels for healthcare services or items provided by physicians and hospitals. Furthermore, many private payors look to Medicare’s coverage and reimbursement policies in setting their coverage policies and reimbursement amounts such that federal reforms could influence the private sector as well. Finally, many states also may attempt to reform their Medicaid programs such that either coverage for certain items or services may be narrowed or reimbursement for them could be reduced. These healthcare reforms may adversely affect our business.

Consistent with or in addition to Congressional or state reforms, CMS could change its current policies that affect reimbursement for our products. Each year, CMS re-examines the reimbursement rates for hospital inpatient and outpatient and physician office settings and could either increase or decrease the reimbursement rate for procedures utilizing our products. Overall, we are unable to predict when legislation or regulation that affects our business may be proposed or enacted in the future or what effect any such legislation or regulation would have on our business. Any such legislation, regulation or policies that affect the coverage and reimbursement of our current or future products, or the procedures utilizing our current or future products, could cause our sales to decrease and, as a result, our revenue to decline.

In addition, the requirements or restrictions imposed on us or our products may change, either as a result of administratively adopted policies or regulations or as a result of the enactment of new laws. Such changes are particular possibilities in light of the 2008 elections in the United States. There may be heightened scrutiny by federal and state regulators and legislators of the FDA’s device approval process, the agency’s efforts to assure the safety of marketed devices, and physician payments and promotional activities by manufacturers. Any new regulations or statutory provisions could result in delays or increased costs during the period of product development, clinical trials, and regulatory review and approval, as well as increased costs to assure compliance.

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Further, our success in international markets also depends upon the eligibility of reimbursement for our products through government-sponsored health care payment systems and other third-party payers. Outside of the United States, reimbursement systems vary by country. These systems are often subject to the same pressures to curb rising health care costs and control health care expenditures as those in the United States. In addition, as economies of emerging markets develop, these countries may implement changes in their health care delivery and payment systems. If adequate levels of reimbursement from third-party payers outside of the United States are not obtained, sales of our products outside of the United States may be adversely affected.

Medical Devices

From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing the clearance or approval, manufacture and marketing of a medical device. In addition, FDA regulations and guidance are often revised or reinterpreted by the agency in ways that may significantly affect our business and our products. It is impossible to predict whether legislative changes will be enacted or FDA regulations, guidance or interpretations changed, and what the impact of such changes, if any, may be.

Without limiting the generality of the foregoing, in 2007, the Food and Drug Administration Amendments Act of 2007, or the Amendments, were enacted. The Amendments require, among other things, that the FDA propose, and ultimately implement, regulations that will require manufacturers to label medical devices with unique identifiers unless a waiver is received from the FDA. Once implemented, compliance with those regulations may require us to take additional steps in the manufacture of our products and labeling. These steps may require additional resources and could be costly.

We may be subject, directly or indirectly, to federal and state healthcare fraud and abuse laws and regulations and could face substantial penalties if we are unable to fully comply with such laws.

The federal anti-kickback law and several similar state laws prohibit payments that are intended to induce physicians or others either to refer patients for, or recommend the acquisition of, healthcare products or services. These laws affect our sales, marketing and other promotional activities by limiting the kinds of financial arrangements and sales programs we may have with hospitals, physicians or other potential purchasers or users of medical devices. In particular, these laws influence how we structure our sales, customer support, education and training programs and physician consulting and other service arrangements. Although we seek to structure such arrangements in compliance with applicable requirements, these laws are broadly written and it is difficult to determine precisely how these laws will be applied in specific circumstances. We could be subject to a claim under these anti-kickback laws for our consulting arrangements with surgeons, grants for training and other education, grants for research and other interactions with doctors which have come under scrutiny by federal and state regulators and law enforcement entities. Anti-kickback laws prescribe civil, criminal and administrative penalties for noncompliance, which can be substantial. Due to the breadth of the statutory provisions and the lack of guidance in the form of regulations or court decisions addressing some industry activities, it is possible that our sales, marketing and promotional activities and practices might be challenged under anti-kickback or related laws. Even an unsuccessful challenge to or investigation into our practices could cause adverse publicity and thus could harm our business and results of operations.

Foreign sales of our products also subject us to similar fraud and abuse laws, including application of the U.S. Foreign Corrupt Practices Act. If our operations, including any consulting arrangements we may enter into with physicians who use our products, are found to be in violation of these laws, we or our officers may be subject to civil or criminal penalties, including large monetary penalties, damages, fines, imprisonment and exclusion from Medicare and Medicaid program participation. If enforcement action were to occur, our business and financial condition would be harmed.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

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

The stockholders of the Company adopted the following proposals at the Company’s Annual Meeting of Stockholders held on June 10, 2009 in Lambertville, NJ:

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	For	Withhold
1. To elect two member to the Board of Directors to serve for three-year terms as Class II directors:
James R. Locher III	11,240,236	139,757
Lon E. Otremba	11,313,007	66,986

	For	Against	Abstain
2. To ratify the selection of Ernst & Young LLP as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2009:	11,028,356	342,512	9,125

The Board of Directors of the Company withdrew the proposals in the proxy statement dated May 11, 2009 that related to (i) approval of an amendment to each of the Company’s 2000 Stock Option Plan, 2004 Stock Incentive Plan and 2007 Equity Incentive Plan, as amended, to allow for a one-time option exchange program for eligible employees and (ii) approval of a one-time option exchange program for eligible employees.

Item 5. Other Information.

None.

Item 6. Exhibits.

31.1		Certification of the Principal Executive Officer of Power Medical Interventions, Inc. pursuant to Rule 13a-l4(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)

31.2		Certification of the Principal Financial Officer and Chief Accounting Officer of Power Medical Interventions, Inc. pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)

32.1		Certification of the Principal Executive Officer of Power Medical Interventions, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)

32.2		Certification of the Principal Financial Officer and Chief Accounting Officer of Power Medical Interventions, Inc. to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)

(1) Filed herewith

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		POWER MEDICAL INTERVENTIONS, INC.


August 11, 2009	By:	/s/ Michael P. Whitman
		Michael P. Whitman
		President and Chief Executive Officer


August 11, 2009	By:	/s/ Brian M. Posner
		Brian M. Posner
		Chief Financial Officer

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Exhibit Index

31.1		Certification of the Principal Executive Officer of Power Medical Interventions, Inc. pursuant to Rule 13a-l4(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)

31.2		Certification of the Principal Financial Officer and Chief Accounting Officer of Power Medical Interventions, Inc. pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(1)

32.1		Certification of the Principal Executive Officer of Power Medical Interventions, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)

32.2		Certification of the Principal Financial Officer and Chief Accounting Officer of Power Medical Interventions, Inc. to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(1)

(1) Filed herewith

Power Medical Interventions, Inc. 10-Q