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Article by DailyStocks_admin    (04-24-12 12:58 AM)

Description

Enteromedics In. 10% Owner KEVIN DOUGLAS bought 2271705 shares on 4-16-2012 at $ 2.22

BUSINESS OVERVIEW

Overview

We are a clinical development stage medical device company with approvals to commercially launch our product in Australia and the European Economic Area. We are focused on the design and development of devices that use neuroblocking technology to treat obesity, metabolic diseases and other gastrointestinal disorders. Our proprietary neuroblocking technology, which we refer to as VBLOC therapy, is designed to intermittently block the vagus nerve using high-frequency, low-energy, electrical impulses. The vagus nerve regulates many activities in the human body, affecting digestion, energy metabolism, blood pressure regulation and activities of the stomach, intestine and pancreas, providing direct two-way communication between the brain and body. Our initial product is the Maestro System, which uses VBLOC therapy to affect metabolic regulatory control, limit the expansion of the stomach, help control hunger sensations between meals, reduce the frequency and intensity of stomach contractions and produce a feeling of early and prolonged fullness. Based on our understanding of vagal nerve function and nerve blocking from our preclinical studies and the results of our clinical trials, we believe the Maestro System may offer obese patients a minimally-invasive treatment that has the potential to result in significant and sustained weight loss. In addition, data from sub-group analyses demonstrate that VBLOC therapy may hold promise in improving obesity-related co-morbidities such as diabetes and hypertension.

We continue to evaluate the Maestro System in human clinical trials in the United States, Australia, Mexico, Norway and Switzerland. To date, we have not observed any mortality related to our device or any unanticipated adverse device effects in these clinical trials. We have also not observed any long-term problematic clinical side effects in any patients, including in those patients who have been using the Maestro System for more than one year.

In October 2010, we received an unconditional Investigational Device Exemption (IDE) Supplement approval from the U.S. Food and Drug Administration (FDA) to conduct a randomized, double-blind, parallel-group, multicenter pivotal clinical trial, called the ReCharge trial, testing the effectiveness and safety of VBLOC therapy utilizing our second generation Maestro Rechargeable (RC) System. Enrollment and implantation in the ReCharge trial was completed in December 2011 in 233 patients at 10 centers. All patients in the study received an implanted device and were randomized in a 2:1 allocation to treatment or control groups. The control group received a non-functional device during the study period. All patients are expected to participate in a weight management counseling program. The primary endpoints of efficacy and safety will be evaluated at 12 months, or around December 2012. Assuming we achieve favorable results, we plan to use data from the trial to support a premarket approval (PMA) application for the Maestro Rechargeable System. If the FDA grants us approval, we anticipate we will be able to commercialize the Maestro Rechargeable System in the United States in 2014.

If and when we obtain FDA approval of our Maestro Rechargeable System we intend to market our products in the United States through a direct sales force supported by field technical and marketing managers who provide training, technical and other support services to our customers. Outside the United States we intend to use direct, dealer and distributor sales models as the targeted geography best dictates. To date, we have relied on third-party manufacturers and suppliers for the production of our Maestro System. We currently anticipate that we will continue to rely on third-party manufacturers and suppliers for the production of the Maestro System.

We obtained European CE Mark approval for our Maestro Rechargeable System in March 2011. In January 2012, the Maestro Rechargeable System components were listed on the Australian Register of Therapeutic Goods (ARTG) by the Therapeutic Goods Administration (TGA). We have been working closely with our Australian distributor, Device Technologies Australia Pty Limited, to bring the Maestro Rechargeable System to the Australian market through a controlled commercial launch in 2012 and expect our first commercial sales to occur during the first half of 2012. We also continue to explore additional select international markets to commercialize the Maestro Rechargeable System, including Europe and the Middle East. The method of assessing conformity with applicable regulatory requirements varies depending on the class of the device, but for our Maestro System (which is considered an Active Implantable Medical Device (AIMD) in Australia and the European Economic Area, and falls into Class III within the United States), the method involves a combination of self-assessment by the manufacturer of the safety and performance of the device, and a third-party assessment by a Notified Body, usually of the design of the device and of the manufacturer’s quality system. We use DEKRA Certification B.V. (formerly known as KEMA Quality) in the Netherlands as the Notified Body for our CE marking approval process.

The Obesity and Metabolic Disease Epidemic

Obesity is a disease that has been increasing at an alarming rate with significant medical repercussions and associated economic costs. Overweight and obesity are the fifth leading risk for global deaths and more than 1 in 10 of the world’s adult population are obese. Currently, as many as 500 million people worldwide are estimated to be obese and 1.5 billion adults are estimated to be overweight, according to the World Health Organization (WHO). At least 2.8 million adults die each year as a result of being overweight or obese.

Many people with obesity also have severe and complex problems related to their disease, including Type 2 diabetes and hypertension, often referred to collectively as metabolic disease. 44% of the diabetes burden, 23% of the heart disease burden and between 7% and 41% of certain cancer burdens are attributable to overweight and obesity. WHO predicts that approximately 2.3 billion adults will be overweight and more than 700 million people worldwide will be obese by 2015.

Obesity has been identified by the U.S. Surgeon General as the fastest growing cause of disease and death in the United States. Currently, the Centers for Disease Control and Prevention (CDC) estimates that 33.8% of U.S. adults are obese, having a Body Mass Index (BMI) of 30 or higher. BMI is calculated by dividing a person’s weight in kilograms by the square of their height in meters. It is estimated that by 2015, over 40% of American adults could be obese. According to data from the U.S. Department of Health and Human Services, almost 80% of adults with a BMI above 30 have an obesity-related disease or disorder, also called a co-morbidity, and almost 40% have two or more of these co-morbidities. According to The Obesity Society (formerly the North American Association for the Study of Obesity) and the CDC, obesity is associated with many significant weight-related co-morbidities including Type 2 diabetes, high blood-pressure, sleep apnea, certain cancers, high cholesterol, coronary artery disease, osteoarthritis and stroke. In addition, a number of disorders involving the central nervous system may be complicated by obesity, such as anxiety, bipolar disorder, agoraphobia, depression and insomnia. In 2008, medical costs associated with obesity were estimated at $147 billion; the medical costs paid by third-party payors for people who are obese were $1,429 higher than those of normal weight.

In Australia, 62% of all adults are either overweight (37%) or obese (25%) and if the trend continues at current levels, by 2020, 80% of all Australian adults will be overweight or obese. In 2008, the total annual cost of obesity to Australia, including health system costs, loss of productivity costs and carers’ costs, was estimated at around $58 billion. Approximately 900,000 million people suffer from diabetes in Australia. The tripling of the rate of diabetes in the past 20 years is mostly attributed to excessive weight gain. Obesity has become the single biggest threat to public health in Australia and therefore the current Federal Minister has elevated obesity to a national priority.

We believe that this epidemic will continue to grow worldwide given dietary trends in developed nations that favor highly processed sugars, larger meals and fattier foods, as well as increasingly sedentary lifestyles. Despite the growing obesity rate, increasing public interest in the obesity epidemic and significant medical repercussions and economic costs associated with obesity, there continues to be a significant unmet need for more effective treatments. We believe existing options for the treatment of obesity have seen limited adoption to date due to patient concerns and potential side effects including morbidity. The principal treatment alternatives available today for obesity include:

Behavioral modification . Behavioral modification, which includes diet and exercise, is an important component in the treatment of obesity; however, most obese patients find it difficult to achieve and maintain significant weight loss with a regimen of diet and exercise alone.

Pharmaceutical therapy . Pharmaceutical therapies often represent a first option in the treatment of obese patients within lower BMI ranges but carry significant safety risks and may present troublesome side effects.

Bariatric surgery . In more severe cases of obesity, patients may pursue more aggressive surgical treatment options such as gastric bypass, sleeve gastrectomy and gastric banding. These procedures promote weight loss by surgically restricting the stomach’s capacity and outlet size. While largely effective, these procedures generally result in major lifestyle changes including dietary restrictions and food intolerances and they may present substantial side effects and carry short- and long-term safety risks that have limited their adoption.

VBLOC Therapy

Several studies of the vagus nerve and its effect on the digestive system have focused on the effects of surgical vagotomy, the permanent severing of the vagus nerve at the level of the junction between the esophagus and the stomach. Given the role of the vagus nerve in regulating the release of gastric acid, early researchers originally used vagotomy as a treatment for peptic ulcers. They discovered that their patients often experienced weight loss or, at a minimum, failure to gain weight following vagotomy. However, weight loss after vagotomy alone, particularly over the long-term, likely dissipates as the body compensates for, or circumvents, the anatomical disruption by partial restoration of nervous system function.

VBLOC therapy is designed to block the gastrointestinal effects of the vagus nerve by replicating a vagotomy using high-frequency, low-energy electrical impulses to intermittently interrupt naturally occurring neural impulses on the vagus nerve between the brain and the digestive system. Our therapy is designed to affect metabolic regulatory control, control hunger sensations between meals, limit the expansion of the stomach and reduce the frequency and intensity of stomach contractions, leading to earlier fullness. In addition, we believe VBLOC therapy also reduces the absorption of calories by decreasing the secretion of digestive enzymes. The resulting physiologic effects of VBLOC therapy are intended to produce a feeling of early and prolonged fullness following smaller meal portions. By intermittently blocking the vagus nerve and allowing it to return to full function between therapeutic episodes, we believe we have limited the body’s natural tendency to circumvent the therapy, which can result in long-term weight loss.

Drive the Adoption and Endorsement of VBLOC Therapy Through Obesity Therapy Experts. Our clinical development strategy is to collaborate closely with regulatory bodies, obesity therapy experts, patients and their advocates and scientific experts. We have established credible and open relationships with obesity therapy experts and scientific experts and we believe these obesity therapy experts and scientific experts will be important in promoting patient awareness and gaining widespread adoption if the Maestro System is approved and commercialized.

Commercialize Our Products using a Distribution Network outside the United States. We plan to utilize specialized third-party medical device distributors in Australia and other non-U.S. markets to call directly on key opinion leaders and bariatric surgeons, which we believe will enable us to target them effectively. We expect that our distributor’s sales force will promote the Maestro System to physicians, work with our surgeon partners, provide training and maintain regulatory required records. They will also work with patients who have concerns with current bariatric surgical procedures. We also plan to call on physicians, weight-management specialists and nurses who influence patient adoption.

Commercialize Our Products using a Direct Sales and Marketing Effort within the United States. We plan to build a sales force to call directly on key opinion leaders and bariatric surgeons, primarily within bariatric Centers of Excellence. We believe this currently represents over 450 facilities within the United States, which we believe will enable us to target them effectively with a small sales force. We expect that our direct sales force will promote the Maestro System to physicians and patients who have concerns with current bariatric surgical procedures. We also plan to call on physicians, weight-management specialists and nurses who influence patient adoption.

Identify Appropriate Coding, Obtain Coverage and Payment for the Maestro Rechargeable System . While payors are not our direct customers, their coverage and reimbursement policies influence patient and physician selection of obesity treatment. We plan to employ a focused campaign to obtain payor support for VBLOC therapy. We plan to seek specific and appropriate coding, coverage and payment for our Maestro Recharegeable System from the Australia Medical Services Advisory Committee (MSAC) and the U.S. Centers for Medicare and Medicaid Services (CMS) and from private insurers. We have applied for several unique CPT Category III codes with the American Medical Association’s CPT Advisory Committee for a Vagus Nerve Blocking Therapy procedure. We were recently informed that six of the CPT Category III codes were approved and will be listed in the July edition of the CPT billing codes. We intend to use these categories to build evidence for a possible application for a CPT Category I Code at a later date.

Expand and Protect Our Intellectual Property Position. We believe that our issued patents and our patent applications encompass a broad platform of neuromodulation therapies, including vagal blocking and combination therapy focused on obesity, diabetes, hypertension and other gastrointestinal disorders. We intend to continue to pursue further intellectual property protection through U.S. and foreign patent applications.

Leverage our VBLOC Technology for Other Disease States. We intend to continue to conduct research and development for other potential applications for our VBLOC therapy and believe we have a broad technology platform that will support the development of additional clinical applications and therapies for other metabolic and gastrointestinal disorders in addition to obesity.

Clinical Development

We are developing our Maestro System to deliver VBLOC therapy for the long-term treatment of obesity and obesity related co-morbidities. Based on our preclinical and clinical findings, we believe that our Maestro System has the potential to offer a compelling combination of efficacy and safety. We are continuing to evaluate the Maestro System in human clinical studies conducted in the United States and internationally. We announced on October 2, 2009 that based on an initial analysis, our EMPOWER trial did not meet its primary and secondary comparative efficacy endpoints. We also announced that there were no therapy-related serious adverse events reported during the study. After meeting with the FDA in January 2010 to discuss the EMPOWER trial results and the regulatory process going forward, we submitted a supplemental IDE application for a clinical trial using the second generation Maestro RC System in the treatment of morbid obesity. In October 2010, we received an unconditional approval from the FDA for this trial, the ReCharge trial, and completed enrollment and implantation in December 2011.

Preclinical Experience

We have completed several preclinical animal studies, primarily in pigs and rats, to evaluate the safety of our Maestro System and to refine our implantation procedure. These studies have also shown that VBLOC therapy could completely block activated nerve signals, with the nerve regaining normal function within minutes after each intermittent application of therapy. Over a 12-week period of VBLOC therapy, over 91% of all nerve axons showed normal histology and the animals demonstrated unimpaired heart rate, respiration, blood pressure and glucose regulation. Additionally, we observed that VBLOC therapy resulted in a greater than 80% reduction in pancreatic exocrine secretions, which are composed of digestive enzymes, water and bicarbonate that facilitate food digestion and caloric intake.

As a result of the findings of our preclinical studies, we were able to refine the implant technique, demonstrate the biocompatibility of our Maestro System in animals and collect the data necessary to begin human clinical trials. Several publications resulting from these preclinical studies were peer-reviewed and accepted for podium presentation at the Digestive Disease Week meeting in 2006, the American Society for Bariatric Surgery meeting in 2006 and the International Federation for Surgery of Obesity meeting in 2006.

Clinical Experience

We began evaluating VBLOC therapy with our initial Maestro System, the RF1 system, in a clinical trial in February 2006. The first generation RF2 system is distinguished from the RF1 system by an improved user interface, improvements in the energy management within the neuroregulator and a more robust transmission link for delivering energy from the coil to the neuroregulator in the RF2 system. The second generation system, the RC system, has a fully implanted battery and requires the user to charge it less frequently than with the RF System. Our early clinical experience has shown that VBLOC therapy using the Maestro System offers physicians a programmable method to selectively and reversibly block the vagus nerve and results in clinically and statistically significant excess weight loss. Excess weight represents the difference between a patient’s actual weight and the patient’s weight assuming a BMI of 25, which is considered healthy. Excess weight loss (EWL) is reported as the percentage of excess weight that is lost by the patient.

We have not observed any mortality related to our device or any unanticipated adverse device effects in any of our completed or ongoing studies. Reported events include those associated with laparoscopic surgery or any implantable electronic device. The effects of VBLOC therapy include changes in appetite, and, in some patients, effects that may be expected with decreased intra-abdominal vagus nerve activity, such as temporary abdominal discomfort and short episodes of belching, bloating, cramping or nausea.

Findings from our clinical feasibility trials have resulted in more than 30 publications peer-reviewed and accepted for presentation between 2006 and 2011 at the following meetings: Digestive Disease Week, American Society for Metabolic and Bariatric Surgery, International Federation for Surgery of Obesity, Obesity Surgery Society of Australia & New Zealand and The Obesity Society (formerly the North American Association for the Study of Obesity).

Below is a summary of our planned and ongoing clinical studies.

VBLOC-RF2 Trial

Enrollment of 38 patients in the VBLOC-RF2 trial began in November 2006. This trial is designed to evaluate the safety and efficacy of the Maestro RF2 System in treating patients with obesity over a period of 60 months. The trial is an international, open-label, prospective, multi-center study. We implemented weight management programs and evaluated the efficacy of VBLOC therapy by measuring average percentage EWL at one month, three, six and 12 months and longer. We are using results from this trial to further optimize selection of VBLOC therapy parameters. Preliminary data indicate that the RF2 system improvements have resulted in improved therapy delivery and improved weight loss compared to the first generation Maestro RF System. To date, no deaths related to our device or unanticipated adverse device effects have been reported during the VBLOC-RF2 trial. As announced in October 2010, the VBLOC-RF2 trial, showed an EWL of 23.0% at 24 months of VBLOC therapy in 18 RF2 patients. At that time, the most recent results for the prior follow-up periods demonstrated an EWL of 28.3% in 18 RF2 patients at 18 months and an EWL of 22.6% in 26 RF2 patients at 12 months of VBLOC therapy.

CEO BACKGROUND

Luke Evnin, Ph.D. , age 48, has served as one of our directors since 2002. Dr. Evnin has served as a Managing Director at MPM Capital since he co-founded MPM’s asset management business in 1997. Prior to joining MPM, Dr. Evnin was at Accel Partners for over seven years including four as a General Partner. He was involved in biopharmaceutical, medical device and healthcare service companies for Accel’s funds III, IV and V. Dr. Evnin currently serves as a director of Pacira Pharmaceuticals, Inc., a publicly-held company that develops and commercializes new pharmaceutical products based on its proprietary drug delivery technology, and has served on the Board of Directors of several public companies, including Metabasis Therapeutics, Inc. (acquired by Ligand Pharmaceuticals, Inc.), Oscient Pharmaceuticals Corp. and Restore Medical, Inc. (acquired by Medtronic, Inc.). Dr. Evnin is currently or has been a director of several private healthcare companies in both the medical device and biopharmaceutical sectors.

Areas of Relevant Experience: Dr. Evnin’s experience managing venture investment funds, including co-founding a fund that was one of the initial investors in EnteroMedics, as well as his experience working with companies in the medical device and biopharmaceutical industries, makes him well-suited to serve as a member of the Board of Directors.





Bobby I. Griffin , age 74, has served as one of our directors since September 2006. In 1998, Mr. Griffin retired from a 25 year career with Medtronic, Inc., where he held various positions, including Executive Vice President from 1985 to 1998 and President of Medtronic’s Pacemaker Business from 1991 to 1998. Since his retirement, Mr. Griffin has been a private investor, managing his own fund of companies as well as serving on the advisory boards of Affinity Capital Management Fund III and IV and Sapient Capital Management Fund, in which he also invests. In addition, Mr. Griffin has served on the Board of Directors of several public companies, including MTS Systems Corporation and Urologix, Inc., and is currently a director of several private companies.

Areas of Relevant Experience: Mr. Griffin’s lengthy career in the biomedical industry and senior leadership positions at a leading global implantable medical device company, as well as his experience with managing venture investments, makes him well-suited to serve as a member of the Board of Directors.

Paul H. Klingenstein , age 56, has served as one of our directors since July 2006. Mr. Klingenstein has served as Managing Partner of Aberdare Ventures since he founded it in 1999. Formerly, he served as a General Partner of Accel Partners, as a consultant to the Rockefeller Foundation, and as an employee of E.M. Warburg, Pincus & Co. Mr. Klingenstein currently serves as a director of Anacor Pharmaceuticals, Inc., a publicly-held company that develops and commercializes novel small molecule therapeutics derived from its novel boron chemistry platform, and Clovis Oncology, Inc., a publicly-held company focused on acquiring, developing and commercializing innovative cancer agents. He also has served on the Board of Directors of several public companies, including Aviron, Isis Pharmaceuticals, Inc., Pharmion Corporation and Xomed Surgical Products, Inc. Mr. Klingenstein currently serves on the boards and audit committees of several private companies.

Areas of Relevant Experience: Mr. Klingenstein’s experience managing venture investment funds, including founding a fund that was an early investor in EnteroMedics, as well as his accounting and financial reporting background, makes him well-suited to serve as a member of the Board of Directors.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

We are a development stage medical device company with approvals to commercially launch our product in Australia and the European Economic Area. We are focused on the design and development of devices that use neuroblocking technology to treat obesity, metabolic diseases and other gastrointestinal disorders. Our proprietary neuroblocking technology, which we refer to as VBLOC therapy, is designed to intermittently block the vagus nerve using high frequency, low energy, electrical impulses. We have a limited operating history and currently, we only have regulatory approval to sell our product in Australia and the European Economic Area and do not have any other source of revenue. Our initial product is the Maestro System, which uses VBLOC therapy to affect metabolic regulatory control, limit the expansion of the stomach, help control hunger sensations between meals, reduce the frequency and intensity of stomach contractions and produce a feeling of early and prolonged fullness. We were formerly known as Beta Medical, Inc. and were incorporated in Minnesota on December 19, 2002. We later reincorporated in Delaware on July 22, 2004. Since inception, we have devoted substantially all of our resources to the development and commercialization of our Maestro System.

Based on our understanding of vagal nerve function and nerve blocking from our preclinical studies and the results of our clinical trials, we believe the Maestro System may offer obese patients a minimally-invasive treatment that has the potential to result in significant and sustained weight loss. We believe that our Maestro System will allow bariatric surgeons to help obese patients who are concerned about the risks and complications associated with gastric banding and gastric bypass surgery. In addition, data from our VBLOC-DM2 ENABLE trial outside the United States demonstrate that VBLOC therapy may hold promise in improving obesity-related co-morbidities such as diabetes and hypertension. We are conducting, or plan to conduct, further studies in each of these co-morbidities to assess VBLOC therapy’s potential in addressing multiple indications.

We continue to evaluate the Maestro System in human clinical trials in the United States, Australia, Mexico, Norway and Switzerland. To date, we have not observed any mortality related to our device or any unanticipated adverse device effects in these clinical trials. We have also not observed any long-term problematic clinical side effects in any patients, including in those patients who have been using the Maestro System for more than one year.

In October 2010, we received an unconditional Investigational Device Exemption (IDE) Supplement approval from the U.S. Food and Drug Administration (FDA) to conduct a randomized, double-blind, parallel-group, multicenter pivotal clinical trial, called the ReCharge trial, testing the effectiveness and safety of VBLOC therapy utilizing our second generation Maestro Rechargeable (RC) System. Enrollment and implantation in the ReCharge trial was completed in December 2011 in 233 patients at 10 centers. All patients in the study received an implanted device and were randomized in a 2:1 allocation to treatment or control groups. The control group received a non-functional device during the study period. All patients are expected to participate in a weight management counseling program. The primary endpoints of efficacy and safety will be evaluated at 12 months, or around December 2012. Assuming we achieve favorable results, we plan to use data from the trial to support a premarket approval (PMA) application for the Maestro Rechargeable System. If the FDA grants us approval, we anticipate we will be able to commercialize the Maestro Rechargeable System in the United States in 2014.

If and when we obtain FDA approval of our Maestro Rechargeable System we intend to market our products in the United States through a direct sales force supported by field technical and marketing managers who provide training, technical and other support services to our customers. Outside the United States we intend to use direct, dealer and distributor sales models as the targeted geography best dictates. To date, we have relied on third-party manufacturers and suppliers for the production of our Maestro System. We currently anticipate that we will continue to rely on third-party manufacturers and suppliers for the production of the Maestro System.

We obtained European CE Mark approval for our Maestro Rechargeable System in March 2011. In January 2012, the final Maestro Rechargeable System components were listed on the Australian Register of Therapeutic Goods (ARTG) by the Therapeutic Goods Administration (TGA). We have been working closely with our Australian distributor, Device Technologies Australia Pty Limited, to bring the Maestro Rechargeable System to the Australian market through a controlled commercial launch in 2012 and expect our first commercial sales to occur during the first half of 2012. We also continue to explore additional select international markets to commercialize the Maestro Rechargeable System, including Europe and the Middle East. The method of assessing conformity with applicable regulatory requirements varies depending on the class of the device, but for our Maestro System (which is considered an Active Implantable Medical Device (AIMD) in Australia and the European Economic Area, and falls into Class III within the United States), the method involves a combination of self-assessment by the manufacturer of the safety and performance of the device, and a third-party assessment by a Notified Body, usually of the design of the device and of the manufacturer’s quality system. We use DEKRA Certification B.V. (formerly known as KEMA Quality) in the Netherlands as the Notified Body for our CE marking approval process.

To date, we have generated no revenue from the sale of products, and we have incurred net losses in each year since our inception. As of December 31, 2011, we had experienced net losses during the development stage of $176.6 million. Although we recently received ARTG listings to sell our Maestro Rechargeable System in Australia and European CE Mark to sell our Maestro Rechargeable System in the European Economic Area and expect to commence commercial sales in the first half of 2012, we expect to incur significant sales and marketing expenses prior to recording sufficient revenue to offset these expenses. We expect our general and administrative expenses to increase as we continue to add the infrastructure necessary to support our initial commercial sales, operate as a public company and develop our intellectual property portfolio. For these reasons, we expect to continue to incur significant and increasing operating losses for the next several years. We have financed our operations to date principally through the sale of capital stock, debt financing and interest earned on investments.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported expenses during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. Actual results may differ materially from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K, we believe that the following accounting policies and estimates are most critical to a full understanding and evaluation of our reported financial results.

Inventory

Since inception, inventory related purchases have been used for research and development related activities and have accordingly been expensed as incurred. In December 2011, we began receiving ARTG listings for components of the Maestro Rechargeable System from the Australian TGA, with the final components being listed on the ARTG in January 2012. As a result, we determined certain assets were recoverable as inventory beginning in December 2011 and recorded a current inventory balance of approximately $1.1 million as of December 31, 2011. We account for inventory at the lower of cost or market and record any long-term inventory as other assets in the consolidated balance sheets.

Stock-Based Compensation

Prior to January 1, 2006, we accounted for stock-based employee compensation arrangements using the intrinsic value method and recognizing the expense over the option vesting period. The intrinsic value method is calculated as the difference, if any, between the fair value of our common stock and the exercise price on the date of the grant. We also followed the minimum value disclosure provisions. Using the intrinsic value method, we were not required to recognize stock-based compensation expense for employee stock options granted from inception through 2005 as the exercise prices, for financial reporting purposes, were determined to be at or above the deemed fair value of the underlying common stock on the date of grant. The fair value of our common stock was assessed and approved by our board of directors, the members of which have extensive experience in the life sciences industry and all but one of whom are nonemployee directors. In determining the appropriateness of the fair value of our common stock, the board of directors considered several factors, such as our life cycle, results of research and development, recent financings and financial projections.

Effective January 1, 2006, we adopted the fair value method of accounting for share-based payments, which superseded the previous accounting method, and requires compensation expense to be recognized using a fair-value-based method for costs related to all share-based payments including stock options. Companies are required to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. We adopted the new provisions using the prospective transition method. Under this method, compensation cost is recognized for all share-based payments granted or modified subsequent to December 31, 2005. All option grants valued after January 1, 2006 are expensed on a straight-line basis over the vesting period.

Calculating stock-based compensation expense requires the input of highly subjective assumptions, which represent our best estimates and involve inherent uncertainties and the application of management’s judgment. Estimates of stock-based compensation expenses are significant to our consolidated financial statements, but these expenses are based on the Black-Scholes pricing model and will never result in the payment of cash by us.

The application of share-based payment principles may be subject to further interpretation and refinement over time. There are significant differences among option valuation models, and this may result in a lack of comparability with other companies that use different models, methods and assumptions. If factors change and we employ different assumptions in the application of share-based payment accounting in future periods, or if we decide to use a different valuation model, the compensation expense that we record in the future may differ significantly from what we have recorded in the current period and could materially affect our operating loss, net loss and net loss per share.

The fair value method is applied to all share-based payment awards issued to employees and where appropriate, nonemployees, unless another source of literature applies. When determining the measurement date of a nonemployee’s share-based payment award, the Company measures the stock options at fair value and remeasures such stock options to the current fair value until the performance date has been reached. For stock options granted to nonemployees, the fair value of the stock options is estimated using the Black-Scholes valuation model. This model utilizes the estimated fair value of common stock and requires that, at the date of grant and each subsequent reporting period until the services are completed or a significant disincentive for nonperformance occurs, we make assumptions with respect to the expected term of the option, the volatility of the fair value of our common stock, risk free interest rates and expected dividend yields of our common stock. Different estimates of volatility and expected life of the option could materially change the value of an option and the resulting expense.

Common Stock Warrant Liability

Effective January 1, 2009, we adopted new authoritative accounting guidance regarding the financial reporting for outstanding equity-linked financial instruments. This adoption required certain warrants issued by us to be recorded as a liability and recorded at fair value. Calculating the fair value of the warrant liability requires the input of highly subjective assumptions, which requires our best estimates, and involves inherent uncertainties and the application of management’s judgment. The common stock warrant liability and related changes in fair value are significant to our consolidated financial statements and is based on a weighted-average Black-Scholes valuation model, however the warrant liability will never result in the payment of cash by us.

Net Operating Losses and Tax Credit Carryforwards

At December 31, 2011, we had federal net operating loss carryforwards of approximately $60.2 million. Of this amount, approximately $12.5 million are available for utilization after the application of Section 382 limitations, discussed below. These net operating loss carryforwards will expire in varying amounts from 2022 through 2031, if not utilized. The Internal Revenue Code imposes restrictions on the utilization of various carryforward tax attributes in the event of a change in ownership of the Company, as defined by IRC Section 382. In addition, IRC Section 382 may limit the Company’s built-in items of deduction, including capitalized start-up costs and research and development costs. During 2011, we completed an IRC Section 382 review and the results of this review indicate ownership changes have occurred which would cause a limitation on the utilization of carryforward attributes. The Company’s gross net operating loss carryforwards, start-up costs and research and development credits are all subject to limitation. Under these tax provisions, the limitation is applied first to any built in losses, then to any net operating losses and then to any general business credits. The Section 382 limitation and accompanying recognized built-in loss limitation is currently estimated to result in the expiration of $47.7 million of our gross federal net operating loss carryforward, as well as a write-off of $5.9 million of capitalized start-up costs, $30.7 million of capitalized research and development costs, $1.5 million of property and equipment and $2.4 million of research and development credits. A valuation allowance has been established to reserve for the potential benefits of the remaining carryforwards and tax credits in our consolidated financial statements to reflect the uncertainty of future taxable income required to utilize available tax loss carryforwards and other deferred tax assets.

Financial Overview

Revenue

To date, we have not commercialized any products and we have not generated any revenue. We have received the European CE Mark for our Maestro Rechargeable System, which enables the eventual commercialization in the European Economic Area. In January 2012, the final Maestro Rechargeable System components were listed on the ARTG by the Australian TGA and we have been working closely with our Australian distributor to bring the Maestro Rechargeable System to the Australian market through a controlled commercial launch in 2012. We also continue to explore additional select international markets to commercialize the Maestro Rechargeable System.

In the United States, we completed enrollment and device implantation in our ReCharge pivotal trial for obesity in December 2011. The primary endpoints of efficacy and safety will be evaluated at 12 months, or around December 2012. Assuming we achieve favorable results, we plan to use data from that trial to pursue a PMA from the FDA to allow us to commence sales in the United States. If the FDA grants us approval, we anticipate we will be able to commercialize the Maestro Rechargeable System in the United States in 2014. Any revenue from initial sales of a new product in the United States or internationally is difficult to predict and in any event will only modestly reduce our continued losses resulting from our research and development and other activities.

Research and Development Expenses

Our research and development expenses primarily consist of engineering, product development and clinical and regulatory expenses, incurred in the development of our Maestro System. Research and development expenses also include employee compensation, including stock-based compensation, consulting services, outside services, materials and supplies, including those related to our various clinical trials, depreciation and travel. We expense research and development costs as they are incurred. From inception through December 31, 2011, we have incurred a total of $116.8 million in research and development expenses. With the completion of enrollment and device implantation in our ReCharge pivotal trial for obesity in late 2011, we expect research and development expenditures to decrease in 2012 as we turn our primary focus to supporting this new clinical trial in addition to the continued follow-up on existing trials, such as VBLOC-DM2 ENABLE and EMPOWER.

Selling, General and Administrative Expenses

Our selling, general and administrative expenses consist primarily of compensation for executive, finance, market development and administrative personnel, including stock-based compensation. Other significant expenses include costs associated with attending medical conferences, professional fees for legal, including legal services associated with our efforts to obtain and maintain broad protection for the intellectual property related to our products, and accounting services, cash management fees, consulting fees and travel expenses. From inception through December 31, 2011, we have incurred $48.2 million in selling, general and administrative expenses. We expect selling, general and administrative expenses to increase modestly in 2012 as we begin a controlled commercial launch in Australia and possibly other select international markets.

Results of Operations

Comparison of the Years Ended December 31, 2011 and 2010

Research and Development Expenses. Research and development expenses were $16.7 million for the year ended December 31, 2011, compared to $8.5 million for the year ended December 31, 2010. The increase of $8.2 million, or 96.2%, is primarily due to increases of $6.8 million, $964,000 and $225,000 in professional services, device costs and travel, respectively. The increases are primarily due to efforts in support of the ReCharge trial, including patient recruiting and the completion of enrollment and implantation in 233 patients during 2011.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $8.6 million for the year ended December 31, 2011, compared to $7.7 million for the year ended December 31, 2010. The increase of $905,000, or 11.8%, is primarily due to increases of $275,000, $271,000 and $255,000 in employee stock-based compensation, professional services and compensation and benefits expense, respectively. The increase in employee stock-based compensation is primarily the result of granting 2.0 million stock options during 2011 with a weighted average fair value of $2.13 per share. The increase in professional services and compensation and benefits was due to commercialization efforts in Australia and additional select international markets.

Interest Expense . Interest expense was $723,000 for the year ended December 31, 2011, compared to $1.3 million for the year ended December 31, 2010. The decrease of $536,000, or 42.6%, was the result of a decrease in the gross principal balance outstanding from approximately $6.3 million on December 31, 2010 to approximately $5.4 million on December 31, 2011 and a modification to the loan agreement with Silicon Valley Bank (SVB) that reduced our annual interest rate from 11.0% to 6.25% effective March 1, 2011.

Change in Value of Warrant Liability . There was no warrant liability during the year ended December 31, 2011. The value of the warrant liability decreased $159,000 for the year ended December 31, 2010. In 2010 the warrant liability consisted of warrants issued to Compass Horizon Funding Company LLC (Horizon). The fair market value of the remaining 141,025 warrants, with a weighted-average exercise price of $3.90, was $313,000 as of May 18, 2010, the date on which the warrants’ down round protection expired. The fair market value for these remaining warrants was calculated using the Black-Scholes valuation model, which resulted in a decrease of $159,000 for the year ended December 31, 2010 as our stock price decreased from $3.36 on December 31, 2009 to $2.46 on May 18, 2010.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Overview

We are a development stage medical device company focused on the design and development of devices that use neuroblocking technology to treat obesity, metabolic diseases and other gastrointestinal disorders. Our proprietary neuroblocking technology, which we refer to as VBLOC therapy, is designed to intermittently block the vagus nerve using high frequency, low energy, electrical impulses. We have a limited operating history and we currently have no products approved for sale in the United States. We have received CE Mark certification in the European Union. Our initial product under development is the Maestro System, which delivers VBLOC therapy. We believe VBLOC therapy limits the expansion of the stomach, helps control hunger sensations between meals, reduces the frequency and intensity of stomach contractions and produces a feeling of early and prolonged fullness. We were formerly known as Beta Medical, Inc. and were incorporated in Minnesota on December 19, 2002. We later reincorporated in Delaware on July 22, 2004. Since inception, we have devoted substantially all of our resources to the development and commercialization of our Maestro System.

Based on our understanding of vagal nerve function and nerve blocking from our preclinical studies and the results of our initial clinical trials, we believe the Maestro System may offer obese patients a minimally-invasive treatment alternative that has the potential to result in significant and sustained weight loss. We believe that our Maestro System will allow bariatric surgeons to help obese patients who are concerned about the risks and complications associated with gastric banding and gastric bypass surgery. In addition, data from our VBLOC-DM2 ENABLE trial outside the United States demonstrate that VBLOC therapy may hold promise in improving the obesity-related co-morbidities of diabetes and hypertension. We are conducting, or plan to conduct, further studies in each of these co-morbidities to assess VBLOC therapy’s potential in addressing multiple indications.

We are currently evaluating the Maestro System in human clinical trials conducted in the United States, Australia, Mexico, Norway and Switzerland. To date, we have not observed any mortality related to our device or any unanticipated adverse device effects in these clinical trials. We have also not observed any long-term problematic clinical side effects in any patients, including in those patients who have been using the Maestro System for more than one year.

On October 2, 2009, we announced preliminary results from our first pivotal clinical study, the EMPOWER trial, a multi-center, randomized, double-blind, prospective, placebo-controlled pivotal study being conducted in the United States and selected international centers. Initial results from the trial indicated that the study did not meet its primary and secondary comparative efficacy endpoints in that the weight loss for the treatment arm was not statistically different from the control arm in which therapy was turned off. The study did meet its safety endpoint. Our further review of the data suggests that: (i) patients that used the device for the prescribed amount of time ( Âł 9 hours) had clinically meaningful weight-loss; (ii) both the treatment and control arm subjects experienced comparable, significant, dose-dependent excess weight loss (EWL) at 12 months; and (iii) there was an unanticipated therapeutic effect in the control group.

In October 2010, we received an unconditional approval from the U.S. Food and Drug Administration (FDA) for a pivotal trial using our second generation fully implantable Maestro Rechargeable (RC) System, the ReCharge trial, a randomized, double-blind, parallel-group, multicenter pivotal clinical trial in approximately 234 patients at up to 12 U.S. centers. All patients in the study will receive an implanted device and will be randomized in a 2:1 allocation to treatment or control groups. The control group will receive a non-functional device during the study period. All patients are expected to participate in a weight management counseling program.

We have begun the enrollment process for the ReCharge trial and in May 2011 announced that the first patient had been implanted. We expect completion of implants by the end of 2011. Assuming that we successfully enroll and implant the trial, conclude the 12-month blinding period at the end of 2012 and achieve favorable results, we plan to use data from that trial to support a premarket approval (PMA) application for the Maestro System, which we expect to submit after analyzing and compiling the clinical data. We anticipate that we will be able to commercialize the Maestro System in the United States in late 2013 at the earliest.

We have begun to take the initial steps necessary to commercialize the Maestro RC System in Australia and other countries, which includes applying for European CE Mark certification and Australian Therapeutic Goods Administration (TGA) approval. During the first quarter of 2011 we received European CE Mark certification of the Maestro RC System and are currently in the application process with the TGA for supply in Australia of the Maestro RC System and intend to commercialize the device following receipt of that approval, which we anticipate to occur during the fourth quarter of 2011. We also continue to explore select European and other international markets to commercialize the Maestro RC System.

On March 28, 2011, we entered into a multi-year distribution agreement with Device Technologies Australia Pty Limited (Device Technologies) appointing Device Technologies as our exclusive distributor of the Maestro RC System in Australia and New Zealand during the term of the agreement.

We are working with a network (Australian Institute of Weight Control (AIWC)) of bariatric surgeons and clinics specializing in laparoscopic weight loss surgery and clinical research for the morbidly obese. With this relationship, we have designated these and associated surgeons and clinics as authorized training and implantation centers for our products. These surgeons will be the first in Australia to implant the Maestro System when it has received approval by the TGA. These surgeons will work with us to provide research, communications, training and accreditation support related to the Maestro RC System in Australia and other international territories. In addition, the surgeons are working with us toward TGA approval of the Maestro RC System, will collaborate on subsequent marketing and distribution efforts in Australia and will support our efforts in gaining reimbursement for the private sector through the Medical Services Advisory Committee (MSAC) in Australia.

We received European CE Mark approval for our Maestro RC System in March 2011 and for our Maestro RF System in March 2009. The method of assessing conformity with applicable regulatory requirements varies depending on the class of the device, but for our Maestro System (which falls into Class III), the method involved a combination of self-assessment by the manufacturer of the safety and performance of the device, and a third-party assessment by a Notified Body, usually of the design of the device and of the manufacturer’s quality system. We use DEKRA Certification Inc. (formerly known as KEMA Quality) in the Netherlands as the Notified Body for our CE marking approval process.

If and when we obtain FDA approval of our Maestro System we intend to market our products in the United States through a direct sales force supported by field technical and marketing managers who provide training, technical and other support services to our customers. Outside the United States we intend to use direct, dealer and distributor sales models as the targeted geography best dictates. To date, we have relied on third-party manufacturers and suppliers for the production of our Maestro System. We currently anticipate that we will continue to rely on third-party manufacturers and suppliers for the production of the Maestro System.

To date, we have generated no revenue from the sale of products, and we have incurred net losses in each year since our inception. As of September 30, 2011, we had experienced net losses during the development stage of $168.5 million. We expect our losses to continue as we continue our development activities. We have financed our operations to date principally through the sale of capital stock, debt financing and interest earned on investments.

Financial Overview

Revenue

To date, we have not commercialized any products and we have not generated any revenue. We received European CE Mark certification for our Maestro RC System in March 2011 and are continuing to take the necessary steps to commercialize the Maestro RC System in Australia, which includes the filing of an application with the TGA for supply in Australia, and select European markets. In the United States, we have begun the enrollment process for the ReCharge trial, a pivotal trial using the Maestro RC System, and expect completion of implants by the end of 2011. Assuming that we successfully enroll and implant the trial, conclude the 12-month blinding period at the end of 2012 and achieve favorable results, we plan to use data from that trial to support a PMA application, which we expect to submit after analyzing and compiling the clinical data. As such, we do not expect to generate revenue in the United States until late 2013 at the earliest. Any revenue from initial sales of a new product in the United States or internationally is difficult to predict and in any event will only modestly reduce our continued losses resulting from our research and development and other activities.

Research and Development Expenses

Our research and development expenses primarily consist of engineering, product development and clinical and regulatory expenses, incurred in the development of our Maestro System. Research and development expenses also include employee compensation, including stock-based compensation, consulting services, outside services, materials, supplies, depreciation and travel. We expense research and development costs as they are incurred. From inception through September 30, 2011, we have incurred a total of $111.0 million in research and development expenses. We expect research and development expense to increase during 2011 in support of the ReCharge clinical trial, in addition to continued follow-up on existing trials, including VBLOC-DM2 ENABLE and EMPOWER.

Selling, General and Administrative Expenses

Our selling, general and administrative expenses consist primarily of compensation for executive, finance, market development and administrative personnel, including stock-based compensation. Other significant expenses include costs associated with attending medical conferences, professional fees for legal, including legal services associated with our efforts to obtain and maintain broad protection for the intellectual property related to our products, and accounting services, cash management fees, consulting fees and travel expenses. From inception through September 30, 2011, we have incurred $46.1 million in selling, general and administrative expenses.

Results of Operations

Comparison of the Three Months Ended September 30, 2011 and 2010

Research and Development Expenses . Research and development expenses were $4.8 million for the three months ended September 30, 2011, compared to $2.3 million for the three months ended September 30, 2010. The increase of $2.4 million, or 104.0%, is primarily due to increases of $1.9 million, $394,000 and $79,000 in professional services, device costs, and compensation and benefits expense, respectively, which are all the result of increased efforts in support of the ReCharge trial.

Selling , General and Administrative Expenses . Selling, general and administrative expenses were $2.4 million for the three months ended September 30, 2011, compared to $1.8 million for the three months ended September 30, 2010. The increase of $603,000, or 34.4%, is primarily due to an increase of $339,000, $106,000, and $86,000 in professional services, compensation and benefits expense and travel, respectively, which are all the result of our international commercialization efforts.

Interest Expense . Interest expense was $168,000 for the three months ended September 30, 2011, compared to $286,000 for the three months ended September 30, 2010. The decrease of $119,000, or 41.4%, was the result of a decrease in the gross principal balance outstanding from approximately $6.3 million on September 30, 2010 to approximately $5.9 million on September 30, 2011 and a modification to the Loan Agreement that reduced our annual interest rate from 11.0% to 6.25% effective March 1, 2011.

Comparison of the Nine Months Ended September 30, 2011 and 2010

Research and Development Expenses . Research and development expenses were $10.9 million for the nine months ended September 30, 2011, compared to $7.1 million for the nine months ended September 30, 2010. The increase of $3.8 million, or 54.1%, is primarily due to increases of $2.4 million and $1.5 million in professional services and device costs, respectively, primarily as a result of increased efforts in support of the ReCharge trial. These increases were offset by a Minnesota Research and Development tax credit of $169,000 recorded during 2011.

Selling , General and Administrative Expenses . Selling, general and administrative expenses were $6.5 million for the nine months ended September 30, 2011, compared to $5.5 million for the nine months ended September 30, 2010. The increase of $993,000, or 18.1%, is primarily due to increases of $641,000, $198,000, and $112,000 in professional services, compensation and benefits expense and travel, respectively, which are all the result of our international commercialization efforts.

Interest Expense . Interest expense was $564,000 for the nine months ended September 30, 2011, compared to $975,000 for the nine months ended September 30, 2010. The decrease of $412,000, or 42.2%, was the result of a decrease in the gross principal balance outstanding from approximately $6.3 million on September 30, 2010 to approximately $5.9 million on September 30, 2011 and a modification to the Loan Agreement that reduced our annual interest rate from 11.0% to 6.25% effective March 1, 2011.

Change in Value of Warrant Liability. There was no warrant liability during the nine months ended September 30, 2011. The value of the warrant liability decreased $159,000 for the nine months ended September 30, 2010. For the nine months ended September 30, 2010 the warrant liability consisted of warrants issued to Horizon. The fair market value of the remaining 141,025 warrants, with a weighted-average exercise price of $3.90, was $313,000 as of May 18, 2010, the date on which the warrants’ down round protection expired. The fair market value for these remaining warrants was calculated using the Black-Scholes valuation model, which resulted in a decrease of $159,000 for the nine months ended September 30, 2010 as our stock price decreased from $3.36 on December 31, 2009 to $2.46 on May 18, 2010.

Liquidity and Capital Resources

We have incurred losses since our inception in December 2002 and, as of September 30, 2011 we had experienced net losses during the development stage of $168.5 million. We have financed our operations to date principally through the sale of capital stock, debt financing and interest earned on investments. Through December 31, 2010, we had received net proceeds of $160.5 million from the sale of common stock and preferred stock, including $39.1 million from our initial public offering in November 2007 and $58.2 million from a public offering, private placements and registered direct offerings in 2010 and 2009. In addition, through December 31, 2010, we had received $35.8 million in debt financing, $746,000 to finance equipment purchases and $35.0 million to finance working capital. On September 28, 2011, we completed the sale of 8,800,000 shares of common stock, together with warrants to purchase an additional 1,760,000 shares of common stock with an exercise price of $1.90 per share, in a public offering at an aggregate price of $1.65 per share and corresponding warrant. We received gross proceeds of $14.5 million before deducting offering expenses.

As of September 30, 2011, we had $35.6 million in cash, cash equivalents, restricted cash and short-term investments. Of this amount $30.4 million was invested in short-term money market funds that are not considered to be bank deposits and are not insured or guaranteed by the federal deposit insurance company or other government agency. These money market funds seek to preserve the value of the investment at $1.00 per share; however, it is possible to lose money investing in these funds. Cash in excess of immediate requirements is invested in accordance with our investment policy, primarily with a view to liquidity and capital preservation. At times, such deposits may be in excess of insured limits. We have not experienced any losses on our deposits of cash and cash equivalents. We believe that the cash, cash equivalents, restricted cash and short-term investments balance as of September 30, 2011, together with any interest income we earn on these balances, will be sufficient to fund operations into 2013, assuming our planned commercialization and we do not receive any other additional funds.

On March 3, 2011 we entered into a Fourth Amendment (the Fourth Amendment) to the Loan Agreement with SVB. The Fourth Amendment modified the repayment terms of the Term Loan such that beginning April 1, 2011 through September 30, 2011, we were only required to make monthly payments of interest only on the Term Loan. Then, beginning on October 1, 2011, the remaining balance due on the Term Loan amortizes over 30 equal payments of principal and interest, which is payable monthly. In addition, the Fourth Amendment amended the interest rate due effective March 1, 2011 on the remaining principal amount of the Term Loan from 11.0% to a fixed annual rate of 6.25% if the liquidity ratio is greater than 1.50:1.00 and no Event of Default (as defined in the Loan Agreement) has occurred or is continuing or 9.00% if the liquidity ratio is less than 1.50:1.00 or an Event of Default has occurred or is continuing, payable monthly. The Fourth Amendment also reinstated the financial covenant related to the liquidity ratio, which is not permitted to be less than 1.00:1.00, and adds an EBITDA test should the liquidity ratio fall below 1.50:1.00. The EBITDA test requires that the trailing 90 day actual EBITDA be more favorable than 110% of the projected EBITDA for the same period if the projected EBITDA for such period was less than zero or at least 90% of the projected EBITDA for the same period if the projected EBITDA for such period was greater than or equal to zero. In addition, the Fourth Amendment amended the prepayment terms of the Loan Agreement such that a Make-Whole Premium equal to 1% of the amount of the Term Loan being prepaid will be due for any voluntary or required prepayment of the Term Loan occurring before the first anniversary of the Fourth Amendment, unless the Term Loan is being voluntary prepaid and replaced with a new SVB facility. Lastly, the Fourth Amendment eliminated SVB’s springing lien on our intellectual property, the New Capital Transactions requirement and the requirement of the Third Amendment to maintain a blocked cash collateral account with funds equal to the principal balance outstanding.

Net Cash Used in Operating Activities

Net cash used in operating activities was $14.5 million and $10.1 million for the nine months ended September 30, 2011 and 2010, respectively. Net cash used in operating activities primarily reflects the net loss for those periods, which was partially offset by depreciation and amortization, change in the carrying value of warrant liability, stock-based compensation and changes in operating assets and liabilities.

Net Cash Provided by (Used in) Investing Activities

Net cash provided by investing activities was $3.1 million for the nine months ended September 30, 2011 compared to net cash used in investing activities of $2,600 for the nine months ended September 30, 2010. Net cash provided by investing activities for the nine months ended September 30, 2011 is primarily attributable to a $6.3 million decrease in the restricted cash balance as a result of the Fourth Amendment and $2.0 million in maturities of short-term investments available for sale offset by $5.0 million in purchases of short-term investments available for sale and $239,000 of property and equipment. Net cash used in investing activities during the nine months ended September 30, 2010 is attributable to the purchase of property and equipment.

CONF CALL

Greg Lea

Thank you for joining the EnteroMedics International Federation for the Surgery of Obesity Data Presentation Conference Call.

With me on the call today are Dr. Mark B. Knudson, president, CEO, and chairman and Dr. Katherine Tweden, vice president of research and interim VP of medical affairs.

As a reminder this conference call as well as the EnteroMedics SEC filings and web site at enteromedics.com contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Our actual results could differ materially from those discussed through the known and unknown risks, uncertainties and other factors. These risks an and uncertainties are described more fully in the company’s filings with the Securities and Exchange Commission, particularly those factors identified as risk factors in the company’s 10-K filed March 13. 2008. The company is providing this information as of the date of this conference call and does not undertake any obligation to update any forward-looking statements contained in this document as a result of the new information, future events, or otherwise.

With that I will turn the call over to Dr. Mark Knudson.

Mark Knudson

We are excited about the data presented today by Dr Jim Toouli, Professor of Surgery at Flinders University Medical Center in Adelaide, Australia. They were presented here at the International Federation for the Surgery of Obesity and Metabolic Disorders in Buenos Aires. Importantly, these data support our belief that the pipeline for VBLOC therapy indications can be expanded.

Specifically, I would like to discuss the results Dr. Toouli presented today and their implication for the future development of VBLOC therapy. We will then conclude the call by opening up for questions and answers.

As a reminder VBLOC therapy is designed to treat obesity by intermittently blocking the vagus nerve between the stomach and the brain with a high-frequency, low-energy electrical impulse delivered via an implantable pacemaker sized device. This mechanism of action is primarily designed to produce appetite suppression, feelings of fullness and corresponding weight loss.

EnteroMedics in conjunction with multiple centers of excellence in weight management and metabolic surgery around the globe is studying VBLOC therapy in several clinical trials including two feasibility studies VBLOC-RF1 and VBLOC-RF2. As part of our plan for these trials we have looked at specific sub-groups of patients to better understand how VBLOC therapy affects two key co-morbidities associated with obesity: those are type 2 diabetes and hypertension.

The data presented today demonstrates that the effects of VBLOC in these co-morbidities are quite substantial. There were six patients in the RF1 and the RF2 trials with type 2 diabetes. At baseline the mean BMI in this group was 41.5 and the mean hemoglobin A1C was 8.7%. Following activation of VBLOC therapy there was a rapid and marked improvement in A1C. There was as statistically significant reduction of 1.4% to an A1C level of 7.4% as early as one month of therapy and the effect was durable with a six-month statistically significant reduction of 1.7% to an A1C level of 7%. As a comparison in published trials patients treated with Amelynspiada [ph] a current diabetes drug showed a 0.8% reduction in A1C at 30 weeks.

The other sub-group that we evaluated was patients with hypertension. We analyzed data from 19 patients following activation of VBLOC therapy. We are pleased to report that both systolic and diastolic blood pressure were normalized bringing these patients to a blood pressure of close to 120/80. Specifically there were statistically significant reductions in systolic blood pressure of 19.8 and 20.4 mm of mercury at one month and six months respectively from a baseline of 144.6 mm of mercury.

Similarly diastolic pressure was statistically significantly reduced to 10.4 and 6.4 mm of mercury from a baseline of 87.9 at one month and six months respectively. Here again the effects of VBLOC therapy were both rapid and durable.

Of equal significance four of eight patients were able to either reduce or discontinue hypertension medication and there was no significant change in blood pressure observed in subjects with normal baseline systolic or diastolic blood pressure. These results demonstrate that VBLOC therapy may have great promise in improving the obesity co-morbidities of diabetes and hypertension independent of and prior to substantial weight loss.

At this meeting as well as the American Society for Metabolic and Bariatric Surgery meeting held earlier this year, the effects of obesity therapies on improving co-morbidities have been receiving more and more focus because the treatment of co-morbidities directly affects long-term outcome; specifically the morbidity, mortality and quality of life for patients with obesity. If supported by further study these findings could enrich the scope of VBLOC therapies clinical application for obesity as well as position the company with additional indications thereby potentially creating significant additional value.

We plan to expand our clinical development program with feasibility studies in each of these co-morbidities beginning with diabetes.

For diabetes we have launched a prospective, open label, single arm study know as ENABLE that will recruit up to 40 diabetic subjects at four study centers outside the United States. The study will evaluate VBLOC therapy’s effect on glucose regulation at 1, 6, and 12 months. This study is currently enrolling patients with a target date for enrollment completion this year. We will report progress of this study in early 2009 and in addition, as you recall, we are evaluating the effect of VBLOC therapy on glycemic control as part of our EMPOWER trial as well.

We are assessing similar options with regard to a US investigational device exemption for a hypertension therapy feasibility study. We anticipate reviewing those plans with you in more detail in early 2009.

In support of our development efforts in these indications we have filed patent applications for the use of VBLOC therapy in both hypertension and diabetes.

We are very excited about these new opportunities, but remain focused first and foremost on developing VBLOC therapy in obesity. This remains our most important and advanced indication with the randomized, double-blind, placebo-controlled and power pivotal study now fully enrolled and all patients having been activated. We have kept to our schedule and remain on track to lift the EMPOWER study blind approximately 12 months from now.

In summary, we are very excited about these new data and about the potential expansion of our indication pipeline. We believe that these studies will enhance VBLOC therapy’s value to the medical community, patients, and our shareholders.

That concludes our prepared remarks.

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