Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

We caution stockholders that, in addition to the historical financial information included herein, this Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are based on management’s beliefs, as well as on assumptions made by and information currently available to management. All statements other than statements of historical fact included in this Report on Form 10-Q, including without limitation, statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and statements located elsewhere herein regarding our financial position and business strategy, may constitute forward-looking statements. In addition, you generally can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “may,” “will,” “expects,” “intends,” “estimates,” “anticipates,” “plans,” “seeks,” or “continues,” or the negative thereof or variations thereon or similar terminology. Such forward-looking statements involve known and unknown risks, including, but not limited to, economic and market conditions, the regulatory environment in which we operate, the availability of third party payor medical reimbursements, competitive activities or other business conditions. We cannot assure you that our actual results, performance or achievements will not differ materially from any future results, performance or achievements expressed or implied from such forward-looking statements. Important factors that could cause actual results to differ materially from our expectations (“Cautionary Statements”) are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2003, but not limited to, those discussed in “Risk Factors.” All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these Cautionary Statements. We disclaim any obligation to update information contained in any forward-looking statement.

Overview

Organizational History

        We were formed in 1992, and our common stock began trading publicly in 1996. The current Endologix, Inc. resulted from the May 2002 acquisition of all of the capital stock of a private company, Endologix, Inc., (“former Endologix”), and the subsequent change of our company name from Radiance Medical Systems, Inc. to Endologix, Inc. The terms of the merger are described below under the caption “Merger with Endologix, Inc.” and also Note 9 to the unaudited Condensed Consolidated Financial Statements.

Our Business

        Endologix is engaged in the development, manufacture, sales and marketing of minimally invasive therapies for the treatment of vascular disease. Our primary focus is the development of the Powerlink System, a catheter-based alternative treatment to surgery for abdominal aortic aneurysms, or AAA. AAA is a weakening of the wall of the aorta, the largest artery of the body. Once AAA develops, it continues to enlarge and if left untreated becomes increasingly susceptible to rupture. The overall patient mortality rate for ruptured abdominal aortic aneurysms is approximately 75%, making it the 13th leading cause of death in the United States.

        The Powerlink System is a catheter and endoluminal graft, or ELG system. The self-expanding stainless steel cage is covered by ePTFE, a commonly-used surgical graft material. The

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Powerlink ELG is implanted in the abdominal aorta by gaining access through the femoral artery. Once deployed into its proper position, the blood flow is shunted away from the weakened or “aneurismal” section of the aorta, reducing pressure and the potential for the aorta to rupture. We believe that implantation of the Powerlink System will reduce the mortality and morbidity rates associated with conventional AAA surgery.

        We are currently selling the Powerlink System in Europe. We received Ministry of Health (“MOH”) approval to market the Powerlink System in France, which requires regulatory approval separate from the rest of Europe, in the first quarter of 2003 and are seeking reimbursement for the device, which we expect to receive in the second half of 2004. We completed Japanese clinical trials for our AAA technology in November 2001 and have submitted for Japanese MOH approval to commercialize the product. We believe that Japanese MOH review should be completed in the second half of 2004 and will file for reimbursement for the device thereafter. We anticipate approval for reimbursement for the device in Japan and the start of sales there in the second half of 2005.

        We completed enrollment in the first quarter of 2003 for the infrarenal arm of our two arm Phase II U.S. clinical trial and filed a pre-market approval, or PMA, application with the FDA in order to market the infrarenal Powerlink System in the United States in January 2004. We anticipate approval for our infrarenal device in the second half of 2004. We will not be able to market the Powerlink system in the United States until our PMA application is approved by the FDA.

        We are in the patient enrollment phase for the suprarenal study arm of the Powerlink System. The difference between the infrarenal and suprarenal devices is that the wire stent in the suprarenal device extends above the graft material to allow the physician to anchor the top of the device above the renal arteries without obstructing them. As of June 30, 2004, we have enrolled a total of 81 patients of the targeted 193 total patient enrollment in the suprarenal arm of the study.

        Prior to the acquisition of former Endologix and the restructuring that occurred during the third and fourth quarters of 2001 (see below under the caption “Merger with Endologix, Inc.”), we were researching, developing and marketing a radiation therapy catheter for the treatment of blockages in arteries after angioplasty, or restenosis. Prior to that we developed, manufactured and marketed other catheter and stent products for treatment of cardiovascular disease.

        Since 1999, our source of revenues shifted gradually from direct sales of catheter and stent products to royalties from licenses of our stent delivery technology. In June 1998, we licensed Guidant Corporation rights to manufacture and distribute products using our Focus technology for the delivery of stents. In exchange, we received milestone payments based upon the transfer of know-how to Guidant, and continue to receive royalty payments based upon the sale of products by Guidant using the Focus technology. The payments under the Guidant license have been the primary source of our existing revenues. See Note 6 to the unaudited Condensed Consolidated Financial Statements for more information on the Guidant agreement.

        Following the introduction by Guidant of non-licensed products to replace some licensed products in 2002, and we believe, more importantly, the introduction by Guidant’s competitors of drug-coated stents, which compete with licensed products, in 2003 and 2004, the license royalties we receive have been materially decreasing. Following the acquisition of former Endologix in May 2002, sales of Powerlink System products have somewhat offset reductions in Guidant license royalties. We anticipate that Guidant license royalties will continue to materially decrease during

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2004 and that Powerlink System product sales will become our major, and only material source of revenues in the first half of 2005.

        We have experienced an operating loss for each of the last five years and expect to continue to incur annual operating losses through at least December 31, 2005 due especially to spending to build our sales, marketing and distribution capability. Our results of operations have varied significantly from quarter to quarter, and we expect that our results of operations will continue to vary significantly in the future. Our quarterly operating results depend upon several factors, including:

Merger with former Endologix, Inc.

Reasons for the Merger

        In September 2001, as part of a restructuring plan driven by the success of drug-coated stents, we began investigating other medical device technologies for commercialization. In the fourth quarter of 2001, we began discussions with former Endologix, a privately held developer and manufacturer of the Powerlink System. We believed that the Powerlink System was a novel device for treatment of AAA, and that clinical results to date indicated that the Powerlink System had several features and benefits that may provide a better clinical outcome in comparison to devices then on the market. We believed that the acquisition of former Endologix’s technology would provide us with a new and unique medical device technology for a promising and potentially lucrative market.

Merger Transaction

        In May 2002, we acquired all of the capital stock of former Endologix. We paid stockholders of former Endologix $0.75 cash for each share of former Endologix common stock, for an aggregate of $8.4 million, and issued one share of our common stock for each share of former Endologix common stock, for an aggregate of 11,140,541 shares.

        In addition, we agreed to pay contingent consideration in the amount of $2.8 million in the event pre-market approval, or PMA, is received in the U.S. for the Powerlink System on or before June 30, 2004. PMA approval was not obtained on or before June 30, 2004 and, as such, no contingent consideration is due.

        We accounted for the acquisition was accounted for as a purchase under SFAS No. 141, “Business Combinations.” In accordance with SFAS No. 141, we allocated the purchase price based on the fair value of the assets acquired and liabilities assumed. See Note 9 to the unaudited Condensed Consolidated Financial Statements for further description of the accounting for the merger.

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Results of Operations

Comparison of the Three Months Ended June 30, 2004 and 2003

        Product Revenue. Product revenue increased 192% to $860,000 in the three months ended June 30, 2004 from $295,000 in the three months ended June 30, 2003. Product revenue increased primarily due to sales to Edwards Lifesciences AG (“Edwards”), one of our European distributors for our Powerlink System, and higher U.S. clinical trial sales.

        We are primarily spending our resources on U.S. clinical trials and preparation of a launch in the U.S. of our infrarenal Powerlink system in the second half of 2004. We market in Europe primarily through distributors and, in the second quarter of 2004, we signed an exclusive distribution agreement for certain European markets with Edwards, which included distribution for Germany and France. As a result of this new distribution agreement and the anticipated approval of our infrarenal Powerlink system in the U.S., we believe that product revenue for the remaining six months of the year will be materially higher in 2004 than in the same period of 2003.

        License Revenue. License revenue decreased 51% to $342,000 in the three months ended June 30, 2004 from $694,000 in the three months ended June 30, 2003. We believe that the reduction in license revenue is due primarily to the introduction of non-royalty bearing products by Guidant and sales of drug-coated stents, a competing technology, in the U.S. We also believe that license revenue will continue to decrease during 2004 compared with the comparable periods of 2003 due to increasing acceptance of drug-coated stents. The agreement with Guidant expires in 2008, unless terminated sooner, and provides for minimum annual royalties of $250,000.

        Cost of Product Revenue. The cost of product revenue increased 284% to $415,000, or 48% of product revenue, in the three months ended June 30, 2004 from $108,000, or 37% of product revenue, in the three months ended June 30, 2003. Cost of product revenue increased due primarily to higher Powerlink sales. During the second quarter of 2003, a $39,000 favorable inventory reserve adjustment lowered the cost of product revenue as a percentage of product revenue.

        During the second quarter of 2004, we began significant development efforts to improve and expand on our manufacturing capability. Although we believe that we have sufficient capacity and resources to support the production we are forecasting through June 2005, we plan to develop our manufacturing capability to support our sales plans thereafter. See Liquidity and Capital Resources, below for more information about our manufacturing development projects.

        Research, Development and Clinical. Research, development and clinical expenses were $1.7 million in the three months ended June 30, 2004 and June 30, 2003. A reduction of $121,000 in expenditures for clinical studies of our legacy radiation therapy system, the RDX System, was offset by an increase in expenditures for the development of the Powerlink System in the second quarter of 2004.

        We are continuing to conduct new product research and development for our Powerlink System product line, anticipate continuing enrollment in the suprarenal arm of our pivotal U.S. clinical trials throughout 2004 and expect to begin enrollment in a third arm of our pivotal U.S. clinical trials for a study of a large diameter cuff in the third quarter of 2004. We believe we will be able to treat a broader patient population, using a large diameter cuff with our Powerlink System stent grafts.

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         As a result of the completion of enrollment in the infrarenal arm of our U.S. pivotal clinical trials in the first quarter of 2003, we anticipate that total research and development expenses for the second quarter of 2004 will be somewhat lower than the expenses for the same period of 2003. For the rest of 2004, due to the start up of enrollment in the large diameter cuff trial and expenses to improve our manufacturing capability, we anticipate that the expenses will be comparable or somewhat higher in the second half of 2004 to those in the second half of 2003.

        Marketing and Sales. Marketing and sales expenses increased 212% to $481,000 in the three months ended June 30, 2004 from $154,000 in the three months ended June 30, 2003. The increase in costs for second quarter 2004 marketing and sales expenses resulted because of the increase in U.S. sales and marketing staffing in anticipation of a second half 2004 launch of our infrarenal Powerlink System. We anticipate that marketing and sales expenses over the remaining six month period of 2004 will be materially higher than those for the same period of 2003, and will be more than double the expense for the first half of 2004, as we plan to devote more resources to build a U.S. team of five to eight sales persons for an initial, focused launch of our products following FDA approval.

        General and Administrative. General and administrative expenses totaled $753,000 in the three months ended June 30, 2004, compared to $697,000 in the three months ended June 30, 2003. An increase in outside service charges primarily from $109,000 in consulting charges for the review of our internal controls over financial reporting, as required under section 404 of the Sarbanes-Oxley Act, in 2004, was offset by a reduction in other outside service costs, including strategic advisor fees, which were incurred in the second quarter of 2003. We anticipate that general and administrative expenses over the remaining six month period of 2004 will be higher than those for the same period of 2003.

        Other Income (Expense). Other income increased 103% to $67,000 in the three months ended June 30, 2004, compared to $33,000 in the same period of 2003. The increase in other income for the second quarter of 2004 compared with the same period of 2003 was due primarily to an increase in interest income of $37,000 resulting from a 250% higher average cash balance, including $15.4 million in proceeds from a private offering of common stock in March 2004, somewhat offset by the effect of an average lower interest rate for the invested cash.

Comparison of the Six Months Ended June 30, 2004 and 2003

        Product Revenue. Product revenue increased 53% to $1.2 million in the six months ended June 30, 2004 from $785,000 in the six months ended June 30, 2003. Product revenue increased primarily because of sales to Edwards totalling $383,000.

        License Revenue. License revenue decreased 40% to $819,000 in the six months ended June 30, 2004 from $1.4 million in the six months ended June 30, 2003. We believe that the reduction in license revenue is due primarily to the introduction of non-royalty bearing products by Guidant and sales of drug-coated stents in the U.S.

        Cost of Product Revenue. The cost of product revenue increased 80% to $658,000, or 55% of product revenue, in the six months ended June 30, 2004 from $365,000, or 46% of product revenue, in the six months ended June 30, 2003. Cost of product revenue increased primarily because of an increase in product sales. The increase in cost of product revenue, as a percentage of product revenue was due primarily to an increase in sales to distributors as a percent of total sales, which are typically at a materially lower average price than the average sale price to hospitals.

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        Research, Development and Clinical. Research, development and clinical expenses decreased 13% to $3.1 million in the six months ended June 30, 2004 from $3.6 million in the six months ended June 30, 2003. The decrease resulted primarily from a decrease of $445,000 in legacy radiation catheter technology clinical trial costs as the trials were nearly completed in 2003.

        Marketing and Sales. Marketing and sales expenses increased 100% to $872,000 in the six months ended June 30, 2004 from $437,000 in the six months ended June 30, 2003. The increase in costs for first six months of 2004 resulted because of the increase in U.S. sales and marketing staffing in anticipation of a second half 2004 launch of our infrarenal Powerlink System.

        General and Administrative. General and administrative expenses increased 83% to $1.5 million in the six months ended June 30, 2004 from $835,000 in the six months ended June 30, 2003. The increase in expenses for the first six months of 2004, compared with the same period of 2003, was due primarily to a reimbursement of $468,000 for legal and other expenses as part of a legal settlement in the first quarter of 2003 with Jomed-Endsonics, which is described in Note 10 to the unaudited Condensed Consolidated Financial Statements, and net bad debt recoveries of $50,000, combined with expenses of $109,000 for consulting services related to our review of our internal controls over financial reporting in preparation for our annual certification under Section 404 of the Sarbanes-Oxley Act.

        Other Income (Expense). Other income decreased 30% to $131,000 in the six months ended June 30, 2004, compared to $188,000 in the same period of 2003. The decrease in other income for the first six months of 2004 compared with the same period of 2003 was primarily due to a decrease in interest income of $63,000 resulting from interest income of $94,000 from the legal settlement with Jomed-Endosonics, described above, partially offset by the effect of a 132% higher average cash balance, though the average interest rate on investments was lower during the first half of 2004.

Liquidity and Capital Resources

        At June 30, 2004, we had cash, cash equivalents and marketable securities available for sale of $26.5 million. We expect to continue to incur substantial costs and cash outlays in 2004 to support Powerlink research and development and manufacturing capability development.

        In July 2002, the board of directors authorized a program for repurchases of our outstanding common stock of up to $l.5 million under certain parameters. As of June 30, 2004, we have repurchased an aggregate of 495,000 shares for $661,000, with the last such purchase in the quarter ended June 30, 2003.

        In February 1999, the former Endologix agreed to purchase a key component for its Powerlink product from Impra, Inc., a subsidiary of C.R. Bard, Inc. and then a related party, under a supplier agreement that expires in December 2007, and which then automatically renews, on a year by year basis, for additional one year periods without notice, unless a party provides notice not to renew within thirty days from the expiration of the renewal period. Under the terms of the agreement, we have agreed to purchase certain unit quantities of the component, with built in annual quantity increases, or the agreement may be canceled. In January 2002, the agreement was amended to increase the minimum quantity purchase requirements for 2002 and thereafter and increase the prices each year after 2002 according to the general increase in the Consumer Price Index. To fulfill our 2004 unit purchase commitment, which we estimated to cost approximately $1.4 million, and to purchase additional inventory in anticipation of receipt of FDA approval to commercially distribute

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devices using the component, we committed to purchasing, and the supplier agreed to provide, approximately $1.8 million in components at existing prices during 2004. If we receive FDA approval to commercially distribute devices using the component, and we have not received a commitment from the supplier to provide the component at the then current prices, the total price for the component will materially increase. We believe that U.S. commercialization could occur during the second half of 2004.

        We are economically dependent on this vendor as it is the sole source for the key component.

        For the six months ended June 30, 2004, we incurred a net loss of $4.0 million. As of June 30, 2004, we had an accumulated deficit of approximately $77.9 million. We believe that current cash and cash equivalents and marketable securities will be sufficient to meet anticipated cash needs for operating and capital expenditures through at least December 31, 2005. Failure of the FDA to approve the Powerlink Systems, failure of the market to accept our products, or failure to reduce certain discretionary expenditures, if necessary, could have a material adverse effect on our ability to achieve our intended business objectives.

        Our future capital requirements will depend on many factors, including:

        In July 2003, we completed a private placement of 4,000,000 shares of our common stock at $2.25 per share, pursuant to which we received aggregate net proceeds of $8.4 million.

        In March 2004, we completed a private placement of 3,200,000 shares of our common stock at $5.10 per share, pursuant to which we received aggregate net proceeds of $15.4 million.

        In June 2004, we entered into an agreement under which a third party will develop, install and test manufacturing equipment for the expansion of our manufacturing capability. Over a period not to exceed twenty months we anticipate spending approximately $1.7 million. The terms of the agreement also provide for estimated milestone payments totaling $520,000. During the seond quarter of 2004, we incurred costs of approximately $75,000 associated with this capital project. We can terminate the agreement on 15 days notice, and we would be reponsible for costs accrued to the date of termination.

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        Accounts Receivable. Trade accounts receivable, net, increased 111% to $505,000 at June 30, 2004 from $239,000 at December 31, 2003. The increase is due primarily to an increase in sales from Edwards, a new European distributor.

        Other Receivables. Other receivables decreased 33% to $442,000 at June 30, 2004 from $656,000 at December 31, 2003 due primarily to a $256,000 decrease of the royalty receivable from Guidant. See Comparisons of Quarters Ended June 30, 2004 and 2003 in subsections License Revenue, regarding Guidant royalty revenues, above.

        Deferred Income Taxes. Because of our continuing operating losses and the uncertainty of realization of our net, deferred income tax asset, we recorded an offsetting valuation allowance equal to the net, deferred income tax asset.

        Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses increased 27% to $1.9 million at June 30, 2004 from $1.5 million at December 31, 2003. The increase is attributable primarily to an increase of $141,000 in purchases from Impra for a key component of our Powerlink System, and increases in various other payables that increased as a result of our preparations for an anticipated launch in the U.S.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        Our financial instruments include cash and short-term investment grade debt securities. At June 30, 2004 the carrying values of our financial instruments approximated their fair values based on current market prices and rates. It is our policy not to enter into derivative financial instruments. We do not currently have material foreign currency exposure as the majority of our assets are denominated in U.S. currency and our foreign-currency based transactions are not material. Accordingly, we do not have a significant currency exposure at June 30, 2004.

Item 4. CONTROLS AND PROCEDURES

        We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our “disclosure controls and procedures” as of the end of the period covered by this report, pursuant to Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as of the end of the period covered by this report, were effective in timely alerting them to material information relating to us required to be included in our periodic SEC filings. There has been no change in our internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Part II.

OTHER INFORMATION

Items 1-5. Not applicable

Item 6. Exhibits and Reports on Form 8-K

(a)     The following exhibits are filed herewith:

(b)     Reports on Form 8-K

The Company filed a Current Report on Form 8-K on May 13, 2004 announcing the financial results for the first quarter ended March 31, 2004.

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SIGNATURES

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

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EXHIBIT INDEX

The following exhibits are filed herewith:

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