UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2005

Commission file number 000-50856

NEUROMETRIX, INC.

(Exact name of registrant as specified in its charter)

(781) 890-9989

(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 twelve (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 ninety (90) days.

Yes ý    No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes o    No ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o    No ý

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

12,205,825 shares of common stock, par value $0.0001 per share, were outstanding as of November 7, 2005

NEUROMETRIX, INC.

FORM 10-Q

INDEX

NeuroMetrix, Inc.

Balance Sheets

(Unaudited)

The accompanying notes are an integral part of these financial statements.

1

NeuroMetrix, Inc.

Statements of Operations

(Unaudited)

The accompanying notes are an integral part of these financial statements.

2

NeuroMetrix, Inc.

Statements of Cash Flows

(Unaudited)

The accompanying notes are an integral part of these financial statements.

3

NeuroMetrix, Inc.

Notes to Financial Statements

1.     Nature of the Business and Basis of Presentation

NeuroMetrix, Inc. (the “Company”), a Massachusetts corporation, was formed in June 1996 and reincorporated in Delaware in May 2001.  The Company designs, develops and sells proprietary medical devices used to diagnose neuropathies. Neuropathies are diseases of the peripheral nerves and parts of the spine that frequently are caused by or associated with diabetes, low back pain and carpal tunnel syndrome, as well as other clinical disorders. The Company operates in one business segment.

On July 27, 2004, the Company completed an initial public offering (“IPO”) of 3,000,000 shares of its common stock at $8.00 per share, for gross consideration of $24 million.  All of the shares were sold by the Company.  In connection with the IPO, the Company granted the underwriters a 30-day over-allotment option to purchase up to an additional 450,000 shares of common stock from the Company, which the underwriters exercised in full on August 17, 2004.  The Company’s shares trade on The Nasdaq National Market under the symbol “NURO.”

On July 27, 2004, upon completion of the Company’s IPO, all shares of the Company’s redeemable convertible preferred stock outstanding on that date converted into 7,488,758 shares of common stock and the outstanding warrant to purchase redeemable convertible preferred stock converted into a warrant to purchase 100,000 shares of common stock.  This warrant was exercised in full on June 13, 2005.

The accompanying unaudited balance sheet as of September 30, 2005 and unaudited statements of operations for the three and nine month periods ended September 30, 2005 and 2004 and the unaudited statements of cash flows for the nine month periods ended September 30, 2005 and 2004 have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair statement of the results of operations have been included. Operating results for the nine month period ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005 or any other period. These financial statements and notes should be read in conjunction with the financial statements for the year ended December 31, 2004 included in the Company’s Annual Report on Form 10-K (File No. 000-50856). The accompanying balance sheet as of December 31, 2004 has been derived from audited financial statements prepared at that date, but does not include all disclosures required by accounting principles generally accepted in the United States.

Use of 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 the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Recent Accounting Pronouncements

In March 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, which is an interpretation of Statement of Financial Accounting Standards (“SFAS”) No. 143, Accounting for Asset Retirement Obligations. The interpretation requires a liability for the fair value of a conditional asset retirement obligation be recognized if the fair value of the liability can be reasonably estimated. The interpretation is effective for fiscal years ending after December 15, 2005. The interpretation did not have a material impact on our results of operations or financial position.

In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment (SFAS 123(R)), which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123), and supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and SFAS 148 Accounting for Stock-Based Compensation — Transition and Disclosure.  This statement requires that the cost resulting from all share-based payment transactions be recognized in the financial statements. This statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair value based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans. As a result, beginning January 1, 2006, the Company will adopt SFAS 123(R) and begin reflecting the stock compensation expense determined under fair value based methods in

4

the income statement rather than as pro forma disclosure in the notes to the financial statements. The Company is currently reviewing the effect of this statement on its financial statements and expects there to be a material impact on the Company’s results of operations.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets (SFAS 153), an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.  SFAS 153 requires that exchanges of nonmonetary assets be measured based on the fair value of the assets exchanged.  Further, it expands the exception for nonmonetary exchanges of similar productive assets to nonmonetary assets that do not have commercial substance.  The provisions of this Statement are effective for nonmonetary asset exchanges beginning after June 15, 2005.  The adoption of the provisions of SFAS 153 did not have a material impact on the Company’s financial position or results of operations.

2. Accounting for Stock-Based Compensation

Employee stock awards granted under the Company’s compensation plans are accounted for in accordance with APB 25 and related interpretations. The Company has not adopted the fair value method of accounting for stock-based compensation prescribed by SFAS 123. Accordingly, compensation expense is recorded for options issued to employees to the extent that the fair value of the Company’s common stock exceeds the exercise price of the option at the date granted and all other criteria for fixed accounting have been met. All stock-based awards granted to non-employees are accounted for at their fair value and the resulting compensation expense is generally recognized over the period of service.

If compensation expense for the Company’s stock-based compensation plan had been determined based on the fair value at the grant dates as calculated in accordance with SFAS 123, the Company’s net loss attributable to common stockholders and net loss per common share would approximate the pro forma amounts below:

Because additional stock-based compensation grants are expected to be made each year, the above pro forma disclosures are not representative of the pro forma effect of reported net income for future years.

5

Prior to the July 2004 IPO, the Company established the fair value of common stock by reference to the previously issued redeemable convertible preferred stock and by reference to an expected IPO price. The Company has estimated the fair value of its granted stock options by using the Black Scholes option pricing model with the following weighted average assumptions:

Prior to May 13, 2004, the Company applied the minimum value method and did not consider expected volatility of the underlying stock.  Subsequent to this date, the Company has computed volatility based on the actual performance of the stock.

The Company amortizes employee stock-based compensation on a straight-line basis over the applicable vesting period, generally four years.

3. Earnings (Loss) Per Common Share

The Company accounts for and discloses net income (loss) per common share in accordance with SFAS No. 128, Earnings Per Share.  Basic net income (loss) per common share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding. Diluted net income (loss) per common share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares and dilutive potential common share equivalents then outstanding. Potential common shares consist of shares issuable upon the exercise of stock options and warrants (using the treasury stock method) and, in 2004, the weighted average conversion of the redeemable convertible preferred stock into shares of common stock (using the if-converted method).

6

The following potentially dilutive common share equivalents were excluded from the calculation of diluted net income (loss) per common share because their effect was antidilutive for each of the periods presented:

4.     Inventory

Inventory consists of the following:

5.      Other Balance Sheet Items

Accrued expenses consist of the following:

Product Warranty Costs

Estimated product warranty costs are accrued at the time of sale and are included in cost of sales in the statements of operations. The amount of the accrued warranty liability is based on historical information including past experience, user error, variability in physiology and anatomy of customers’ patients, product failure rates, number of units repaired and estimated cost of material and labor. The Company’s accrued warranty liability is included in accrued expenses in the accompanying balance sheets.

The following is a rollforward of the Company’s accrued warranty liability for the three and nine month periods ended September 30, 2005 and 2004:

7

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

You should read the following discussion of our financial condition and results of operations in conjunction with our condensed financial statements and the accompanying notes to those financial statements included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth under the section of this Quarterly Report on Form 10-Q titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Important Factors that May Affect Future Operating Results”, our actual results may differ materially from those anticipated in these forward-looking statements.

Overview

NeuroMetrix was founded in June 1996. We design, develop and sell proprietary medical devices used to diagnose neuropathies. Our proprietary technology provides physicians with an in-office diagnostic system, the NC-stat System, that enables physicians to make rapid and accurate diagnoses of neuropathies. The NC-stat System is comprised of: (1) disposable NC-stat biosensors that are placed on the patient’s body; (2) the NC-stat monitor and related components; and (3) the NC-stat docking station, an optional device that enables the physician’s office to transmit data to our onCall Information System. Each component of the NC-stat System is also sold separately. The sensitivity of the nervous system to metabolic and mechanical damage, compounded by its limited regenerative ability, creates a market opportunity for a medical device that can assist in point-of-service diagnoses of neuropathies in a manner that is cost-effective for the patient and third-party payer. We believe the ease of use, accuracy and convenience provided by the NC-stat System position it to become a standard of care for the assessment of neuropathies at the point-of-service.

From our inception until May 1999, we had devoted substantially all of our efforts to designing and developing the NC-stat System and other potential products, raising capital and recruiting personnel. We believe that one of our strengths is our ability to develop and commercialize innovative products for neurological applications. In May 1999, we shipped our first NC-stat System. At that time we sold one type of biosensor for the testing of the median motor nerve. In 2000, we introduced an additional biosensor for the testing of the ulnar motor nerve. In 2002, we introduced our second-generation NC-stat System, as well as two additional biosensors. In 2003, we added to our product line two biosensors with higher functionality that have the ability to test both motor and sensory nerves. In 2004, we introduced two new NC-stat biosensors as well as components for the NC-stat monitor to utilize these new biosensors. The first new biosensor is used to test the ulnar nerve at the elbow and the second to test the sural nerve. In the first nine months of 2005, our revenues grew 97.3% from the same period in 2004, generating $24.0 million in revenues, of which 87.9% was attributable to sales of NC-stat biosensors. Our gross margin percentage in the first nine months of 2005 was 74.0%.

We derive our revenues from the sale of NC-stat biosensors, monitors and docking stations directly to end users, which are generally physician practice groups. Our NC-stat biosensors are disposable products that are used once and inactivated after use. The NC-stat monitor is an electronic instrument that is used with the NC-stat biosensors to perform nerve conduction studies for the purpose of diagnosing neuropathies. The NC-stat monitor displays the pertinent results of nerve conduction studies on an LCD screen immediately at the conclusion of each study. The NC-stat docking station is an optional device that is used to transmit to the onCall Information System data generated by the nerve conduction study performed with the NC-stat monitor. The onCall Information System formulates the data it receives for each test into a detailed report that is provided to the customer through facsimile or e-mail.

Diagnostic device revenues include revenues derived from the sale of our NC-stat monitors and NC-stat docking stations. Biosensor revenues include revenues derived from the sale of various types of disposable biosensors used to perform nerve conduction studies with the NC-stat monitor. Our revenue recognition policy is to recognize revenue from our monitors and biosensors upon shipment if the fee is fixed and determinable, persuasive evidence of an arrangement exists, collection of the resulting receivable is reasonably assured and product returns are reasonably estimable. Revenues from our docking station are deferred and recognized over the shorter of the estimated customer relationship period or the estimated useful life of the product, currently three years.

Reimbursement from third-party payers is an important element of success for medical products companies.  Generally, we believe that the nerve conduction studies performed by our customers with the NC-stat System have been satisfactorily covered by third-party payers.  As our presence in the market expands and the use of the NC-stat System increases, we have experienced and are likely to continue to experience an increased focus from third-party payers regarding the reimbursement of nerve conduction studies performed using the NC-stat System and an increased focus from third-party payers regarding the professional requirements for performing nerve conduction studies in general. Widespread adoption of the NC-stat System by the medical community is unlikely to occur if physicians do not receive satisfactory reimbursement from third-party payers for procedures performed with the NC-stat System.

8

One of the primary challenges we face in our business is successfully expanding the market for nerve conduction studies. A successful market expansion will depend upon, in part, our targeting of primary care and specialty physicians who traditionally have not been targeted by companies selling equipment used to perform nerve conduction studies and our ability to alter physicians’ practices relating to the diagnosis of neuropathies. In order to successfully implement this growth strategy, we have increased our sales force to 31 regional sales managers as of September 30, 2005 and plan to add 10-15 additional regional sales managers with the hiring process planned for the first quarter of 2006.  We also will participate in various industry conferences in order to accelerate the market awareness and adoption of our products.  These efforts, as well as the overall expansion of our business, will provide challenges to our organization and may increase the burden on our management and operations. We are focused on monitoring our business as it grows and appropriately acquiring and allocating resources to address these issues, with a goal of achieving and sustaining profitability.

In March 2005, we entered into an education and development program agreement with Eli Lilly and Company (“Lilly”). Through this agreement, our Company and Lilly expect to conduct a broad series of up to 84 educational and development programs across the country during 2005 and 2006. The focus of each program is on educating physicians regarding the treatment and diagnosis of diabetic peripheral neuropathy (“DPN”), nerve conduction studies, our NC-stat System and its application in DPN and the benefits to physicians and patients of using the NC-stat System.  During the second quarter of 2005, the first series of programs were conducted as originally planned.  Lilly has a significant presence in the diabetes market, including drugs targeted at DPN.  Lilly has a drug known as Cymbalta approved by the Food and Drug Administration (“FDA”) for the treatment of pain associated with DPN and they have a drug known as ruboxistaurin (or Arxxant) that is in Phase III clinical trials for the treatment of the underlying disease state in patients with DPN.  On August 2, 2005, Lilly announced that it completed a Phase III trial to determine the effect of ruboxistaurin on treatment of sensory symptoms associated with DPN.  Lilly announced that, in this study, statistical comparison of the change in sensory symptom scores between the placebo and ruboxistaurin-treated group did not demonstrate significant differences and did not meet the studies’ primary endpoints and, consequently, do not support a new drug application filing.  However, Lilly also announced that it was continuing an ongoing, three-year, placebo-controlled trial evaluating ruboxistaurin for the treatment of nerve dysfunction of DPN, scheduled to complete in 2007.  For this three-year trial, change in a composite of objective nerve function measures, including nerve conduction studies, is the primary outcome.  As a result of these developments, we will be discussing with Lilly our plans with regard to the series of educational and development programs that we were to jointly conduct with Lilly.  We cannot assure you that these programs will resume in this timeframe or at all.

Since our inception in 1996, we have incurred losses every quarter, with the exception of the third quarter of 2005. We incurred net losses of approximately $8.7 million in 2001, $4.8 million in 2002, $3.7 million in 2003 and $4.3 million in 2004 and recorded net income of $133,000 in the first nine months of 2005. We do not know whether we will be able to sustain the profitability achieved in the first nine months of 2005. As of September 30, 2005, we had an accumulated deficit of approximately $57.3 million. Historically, we have primarily financed our operations through the public and private placement of equity securities and through debt facilities. As of September 30, 2005, we had received net proceeds of $43.5 million from the issuance of redeemable convertible preferred stock and $24.0 million in net proceeds from our initial public offering (“IPO”).

Our financial objective is to achieve and sustain profitable growth. Our efforts in 2005 will continue to focus primarily on expanding our sales and marketing for the NC-stat System and continuing our ongoing program of making enhancements and improvements to the NC-stat System, with the goal of increasing our market penetration.  During the first nine months of 2005 we increased our direct sales force to 31 regional sales managers and we expect to add 10-15 additional regional sales managers with the hiring process planned for the first quarter of 2006.   During the first nine months of 2005 we continued efforts on improvements to our biosensors, on the development of new biosensors and on the development of a third generation monitor and docking station. We are also in the early stages of designing a drug delivery system for the minimally invasive treatment of neuropathies by both primary care and specialist physicians. We believe that the accomplishment of these goals will have a positive impact on our progress toward the objective of achieving profitability.

9

Results of Operations

The following table presents certain statement of operations information stated as a percentage of total revenues:

Comparison of Three Months Ended September 30, 2005 and September 30, 2004

Revenues

The following tables present a breakdown of our customers, biosensor units used and revenues:

($ in thousands)

Diagnostic device revenues were $1.1 million and $614,600 for the three months ended September 30, 2005 and September 30, 2004, respectively, an increase of $518,800, or 84.4%. Of this increase, approximately $366,900 is attributable to a greater number of units sold, primarily as a result of an increase in the number of regional sales managers and expanded clinical uses for the NC-stat System.  In addition, approximately $152,000 of this increase is attributable to an increase in the list price of our NC-stat monitors and docking stations from $3,500 to $4,000 effective January 1, 2005, which resulted in a higher average selling price during the three months ended September 30, 2005 as compared to the same period in 2004. Diagnostic device revenues accounted for 12.4% and 12.8% of our total revenues for the three months ended September 30, 2005 and September 30, 2004, respectively.

10

Biosensor revenues were $8.0 million and $4.2 million for the three months ended September 30, 2005 and September 30, 2004, respectively, an increase of $3.8 million, or 89.7%. The increase was primarily due to an increased customer base for our biosensors, increased frequency of testing by our customers and the introduction of new biosensors, including the sural biosensor in the fourth quarter of 2004.  Biosensor revenues accounted for 87.6% and 87.2% of our total revenues for the three months ended September 30, 2005 and September 30, 2004, respectively.

Our customers used 187,900 biosensor units in the three months ended September 30, 2005, compared to 96,800 units for the same period in 2004, an increase of 91,100 units, or 94.1%.  This increase in biosensor usage is primarily the result of the increase in the customer base, increased usage by customers and the introduction of new biosensors, including the sural biosensor in the fourth quarter of 2004.  The sural biosensor is an important additional biosensor for our customers’ use of the NC-stat System for low back pain and DPN and we believe that its introduction is contributing to the growth in biosensor usage for these clinical indications.

Our total revenues were $9.1 million and $4.8 million for the three months ended September 30, 2005 and September 30, 2004, respectively, an increase of $4.3 million, or 89.0%. During the 12-month period ending September 30, 2005, a total of 2,969 customers used our NC-stat System compared to 2,064 customers for the same period ending September 30, 2004. This represents a 43.8% year-over-year increase in the number of customers that used our NC-stat System.

We expect revenues to continue to increase in 2005 as a result of the recent expansion of our sales force, which grew from 22 regional sales managers as of December 31, 2004 to 31 regional sales managers at the end of the third quarter of 2005, an increase in the number of active customer accounts and increased usage per customer account.  However, our revenues could be negatively impacted by a variety of factors, including the level of demand for nerve conduction studies, potential for changes in third-party reimbursement for nerve conduction studies, the overall economy and competitive factors.

Costs and expenses

The following table presents our costs and expenses and net income (loss):

11

(1)                                  Includes non-cash stock-based compensation of:

Gross Margin

Diagnostic device gross margin percentage was 75.2% and 68.5% for the three months ended September 30, 2005 and September 30, 2004, respectively. The increase in the gross margin percentage in the third quarter of 2005 compared to the same period in 2004 is primarily attributable to an increase in the list price of our NC-stat System from $3,500 to $4,000 effective January 1, 2005.

Biosensor gross margin percentage increased to 74.5% for the three months ended September 30, 2005 from 73.9% for the same period in 2004.  The increase in biosensor gross margin percentage is primarily due to manufacturing cost reductions realized for several of our biosensors, offset in part by a change in the mix of biosensors resulting from the introduction of new biosensors in the second half of 2004 which have modestly lower gross margins.

Our overall gross margin percentage was 74.6% for the three months ended September 30, 2005 compared to 73.2% for the same period in 2004.  At the beginning of 2005, we raised the list price of our diagnostic devices. The list price increase should continue to result in a higher diagnostic device gross margin percentage in 2005 when compared to 2004. We anticipate our overall gross margin percentage will remain relatively consistent for the remainder of 2005.  However, if sales volumes do not increase, if the mix of sales shifts further toward lower margin biosensors, if pricing pressures increase or if the cost of biosensors and diagnostic devices through our third-party manufacturers increases, then gross margin may be negatively impacted in future quarters.

Our biosensors are manufactured by the Parlex Polymer Flexible Circuits division (“PPFC”) of Parlex Corporation.  Johnson Electric, a Hong Kong based manufacturing company, announced in September 2005 their plans to acquire Parlex Corporation, including PPFC, and that the acquisition was expected to be completed in November 2005.  Currently, we are not aware of any significant anticipated changes in the operations of PPFC or the nature of our relationship with PPFC as a result of the proposed acquisition; however, we cannot assure you that the acquisition will not result in adverse changes in our relationship with PPFC.

The manufacturing of NC-stat monitors and docking stations is being transitioned from Advanced Electronics, Inc (“AEI”) to Sunburst EMS, Inc. as a result of a decision by AEI to shut down its operations.  We expect this transition to be completed in November 2005.  Several AEI employees who were involved in the manufacturing of our devices have been hired by Sunburst and we do not anticipate any interruptions during the transition.  However, we cannot assure you that the transition will proceed smoothly or that Sunburst will be able to manufacture the NC-stat monitors and docking stations with the same level of quality and on the same delivery schedule as AEI.

Research and Development

Our research and development, or R&D, expenses include expenses associated with our research, product development, clinical, regulatory and quality assurance departments.

R&D expenses decreased $13,000, or 1.4%, to $929,900 for the three months ended September 30, 2005 from $942,900 for the same period in 2004. As a percentage of revenues, R&D expenses were 10.2% and 19.6% for the three months ended September 30, 2005 and September 30, 2004, respectively. The decrease in expenses was primarily due to a decrease of $116,900 in product development costs.  Product development costs in 2004 included costs related to the development of the sural biosensor, which was introduced in the fourth quarter of 2004.  This decrease was offset in part by a $92,000 increase in employee compensation and benefit costs resulting from the hiring of additional employees in our R&D department, particularly in product development.

For the remainder of 2005, we expect our spending on R&D will increase due to additional consulting services and the hiring of several additional employees to support product development efforts as well as increased clinical study costs. We expect R&D expenses, as a percentage of total revenues, to continue to decrease slightly due to an expected increase in revenue. This percentage may vary, however, depending primarily on our revenues for the remainder of 2005.

Sales and Marketing