ENDOLOGIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

See accompanying notes

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ENDOLOGIX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying notes

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ENDOLOGIX, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (Continued)
(Unaudited)

1. Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles 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 generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair statement of the results of the periods presented have been included. Operating results for the unaudited three-month period ended March 31, 2005 are not necessarily indicative of results that may be expected for the year ending December 31, 2005 or any other period. For further information, including information on significant accounting policies and use of estimates, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

For the three months ended March 31, 2005, the Company incurred a net loss of $3,296. As of March 31, 2005, the Company had an accumulated deficit of approximately $86,898. Historically, the Company has relied on the sale and issuance of equity securities to provide a significant portion of funding for its operations. In July 2003 and March 2004, the Company completed two private placements of its common stock, resulting in aggregate net proceeds of $23,744.

At March 31, 2005, the Company had cash, cash equivalents and marketable securities available for sale of $17,564. The Company expects to continue to incur substantial costs and cash outlays in 2005 to support Powerlink System research and development, manufacturing capability development, a facility relocation, and the U.S. market launch of the Powerlink System. While the Company believes that current cash and cash equivalents and marketable securities will be sufficient to meet anticipated cash needs for operations, capital expenditures, and increases in working capital through at least March 31, 2006, given the difficulty of predicting future capital requirements, the Company may be required to seek additional financing to support our operations and the ongoing commercial launch of the Powerlink System. The Company may not be able to obtain such financing on reasonable terms or at all, which would adversely affect the operations of its business.

2. Stock-Based Compensation

The Company has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations in accounting for its employee stock options because the alternative fair value accounting provided for under Statement of Finanical Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” and amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” requires use of option valuation models that were not developed for use in valuing employee stock options. Under the provisions of APB 25, the Company recognizes compensation expense only to the extent that the exercise price of the Company’s employee stock options is less than the market price of the underlying stock on the date of grant. SFAS No. 123 requires the presentation of pro forma information as if the Company had accounted for its employee stock options granted under the

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fair value method. The fair value for these options was estimated at the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility.

In calculating the pro forma information, the fair value was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: risk-free interest rate of 4.2% and 2.3%; a dividend yield of 0% and 0%; volatility of the expected market price of the Company’s common stock of 78.0% and 79.0%; and a weighted-average expected life of the options of 5.0 years and 5.0 years for the first quarter of 2005 and 2004, respectively.

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The Company’s pro forma information for the quarters ended March 31, 2005 and 2004 is as follows:

The Company accounts for non-employee stock-based awards, in which goods or services are the consideration received for the stock options issued, in accordance with the provisions of SFAS No. 123 and EITF 96-18 “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” Compensation expense for non-employee stock-based awards is recognized in accordance with FASB Interpretation 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Options or Award Plans, an Interpretation of APB Opinions No. 15 and 25” (“FIN 28”). The Company records compensation expense based on the then-current fair values of the stock options at each financial reporting date. Compensation recorded during the service period is adjusted in subsequent periods for changes in the stock options’ fair value until the options vest.

During the quarter ended March 31, 2005, the Company granted Performance Units under its 2004 Performance Compensation Plan (the “Performance Plan”). Under the Performance Plan, these units are granted at a discount to the fair market value (as defined in the Performance Plan) of the Company’s common stock on the grant date (“Base Value”). The Performance Units vest over three-years; one-third vests at the end of the first year, and the remainder vests ratably on a quarterly basis. The difference between the closing market price of the Company’s common stock and the Base Value of the vested Performance Unit will be payable in cash at the first to occur of (a) a change of control (as defined in the Performance Plan), (b) the termination of employment for any reason other

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than Cause, or (c) upon exercise of the Performance Unit, which cannot occur until eighteen months from the grant date.

The Company granted a total of 140 and 90 Performance Units at a weighted average Base Value of $3.44 and $1.98, during the first quarter of 2005 and 2004, respectively. The total accrued compensation expense as of March 31, 2005 was $562 and there were 488 total Performance Units outstanding. The Company recorded $40 and $49 in the first quarter of 2005 and 2004, respectively, in compensation expense in accordance with FIN 28. The expense was included in marketing and sales expense in the consolidated statements of operations. The Company will record changes in the estimated compensation expense over the vesting period of the Performance Units, and once fully vested, will record the difference between the closing market price of the Company’s common stock and the Base Value as compensation expense each period until exercised.

3. Net Income (Loss) Per Share

Net income (loss) per common share is computed using the weighted average number of common shares outstanding during the periods presented. Certain options with an exercise price below the average market price for the first quarter of 2005 and 2004 have been excluded from the calculation of diluted earnings per share, as they are anti-dilutive. If anti-dilutive stock options were included for the first quarter of 2005 and 2004, the number of shares used to compute diluted net loss per share would have been increased by approximately 726 shares and 696 shares, respectively. In addition, options to purchase 233 shares and 134 shares, respectively, with an exercise price above the average market price for the first quarter of 2005 and 2004, respectively, were excluded from the computation of diluted loss per share because the effect would also have been anti-dilutive.

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4. Marketable Securities Available-For-Sale

The Company accounts for its investments pursuant to SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.

The Company has classified its entire investment portfolio as available-for-sale. Available-for-sale securities are stated at fair value with unrealized gains and losses recorded in accumulated other comprehensive income, net of realized gains and losses. Management evaluates the classification of its securities based on the Company’s short-term cash needs. The cost of securities sold is based on the specific identification method. During the first quarter of 2005 and 2004, the Company did not have any realized gains or losses.

The Company’s investments in debt securities are diversified among high credit quality securities in accordance with the Company’s investment policy. A major financial institution manages the Company’s investment portfolio. As of March 31, 2005, $11,754 and $1,507 of the Company’s debt securities had contractual maturities more than 90 days and less than one year, and between one to two years, respectively. As of December 31, 2004, $16,335 and $750 of the Company’s debt securities had contractual maturities more than 90 days and less than one year, and between one to two years, respectively.

5. Inventories

Inventories are stated at the lower of cost, determined on a first in, first out basis, or market value. Inventories consist of the following:

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6. License Revenue

In June 1998, the Company licensed to Guidant Corporation, an international interventional cardiology products company, the right to manufacture and distribute stent delivery products using the Company’s Focus technology. The Company receives royalty payments based upon the sale of products by Guidant using the Focus technology. The agreement includes minimum annual royalties of $250 and expires in 2008. During the first quarter of 2005 and 2004, the Company recorded $60 and $412 respectively, in license revenue due on product sales by Guidant. At March 31, 2005 and December 31, 2004, $60 and $100, respectively, due under this agreement are included in other receivables on the condensed consolidated balance sheets.

7. Product Sales by Geographic Region

The Company had product sales based on the locations of the customer by region as follows:

8. Concentrations of Credit Risk and Significant Customers

During the first quarter of 2005, revenues from Edwards Lifesciences AG and Bolton Medical Distribution S.A. were $504 and $160, which represented 36% and 11% of total revenues, respectively. During the first quarter of 2004, revenues from Bolton Medical Distribution S.A. were $86, which represented 10% of total revenues. No other single customer in the first quarter of 2005 or 2004 represented more than 10% of total revenues.

As of March 31, 2005 and December 31, 2004, accounts receivable from Bolton Medical Distribution S.A. amounted to $134 and $142, respectively. Additionally, as of December 31, 2004, accounts receivable from Edwards Lifesciences and Comesa Polska Sp. amounted to $73 and $35 respectively. No other single customer accounted for more than 10% of the Company’s accounts receivable balance at March 31, 2005 or December 31, 2004.

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9. Comprehensive Loss

The Company’s comprehensive loss included the following:

10. Merger

In May 2002, the Company acquired all of the capital stock of former Endologix. The acquisition was accounted for as a purchase under SFAS No. 141, “Business Combinations.” In accordance with SFAS No. 141, the Company allocated the purchase price based on the fair value of the assets acquired and liabilities assumed. In the merger, the Company acquired, in addition to the net tangible assets of the business, intangible assets such as the Powerlink and PowerWeb (an earlier version of the Powerlink) technologies, both developed and in-process, the Endologix trade name and Powerlink and PowerWeb trademarks, and goodwill.

The Company determined the fair value of developed technology at the merger date to be $14,050, which represents the acquired, aggregate fair value of individually identified technologies that were fully developed at the time of the merger. The Company also determined a value of $2,708 for trademarks and tradenames and a residual amount of $3,602 was allocated to goodwill. The trademarks and tradenames have an indefinite life and the developed technology is being amortized over ten years. The Company recognized amortization expense on intangible assets of $352 and $352 during the first quarter of 2005 and 2004, respectively. Estimated amortization expense for the remainder of 2005 and the five succeeding fiscal years is as follows:

Other intangibles consisted of the following:

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11. Commitments and Contingencies

Sole-Source, Related-Party Supplier Agreement

        In February 1999, the former Endologix entered into a supply agreement with Bard Peripheral Vascular Systems, a subsidiary of C.R. Bard, Inc. to purchase a key component for its Powerlink product. The agreement expires in December 2007 and then automatically renews for additional one year periods, unless a party provides notice not to renew at least thirty days prior to the renewal period. Under the terms of the agreement, the Company purchases certain unit quantities of the component, with defined annual quantity increases The agreement further provided for a significant price increase upon receipt of FDA approval of the Powerlink System, which occurred in October 2004.

        During the first quarter of 2005 and 2004, the Company purchased approximately $515 and $140, respectively, of such materials, toward fulfilling its 2005 and 2004 purchase commitments. The Company estimates that it will complete its 2005 commitment by purchasing an additional $2,660 of the material.

        The Company is economically dependent on this vendor, which is the sole source for this key component.

Manufacturing Equipment Development Agreement

        In June 2004, the Company entered into an agreement under which a third party will develop, install and test manufacturing equipment for the expansion of the Company’s manufacturing capability. The project is estimated to cost $2,100, and be completed in March 2006. Of this amount, $565 was incurred in 2004, and $220 during the first quarter of 2005. These amounts are presented as construction in process and are included in property and equipment. The Company can terminate the agreement on 15 days notice, in which case it would be responsible to pay for the costs incurred prior to the date of termination.

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Legal Matters

        On September 15, 1999, EndoSonics Corporation, which was a wholly-owned subsidiary of Jomed N.V. until July 2003, filed a complaint for declaratory relief in the Superior Court in Orange County, California, claiming that under a May 1997 agreement between the parties, EndoSonics had rights to combine the Company’s Focus balloon technology with an EndoSonics’ ultrasound imaging transducer on the same catheter with a coronary vascular stent. In February 2001 the court ruled in the Company’s favor, ruling that Jomed-EndoSonics had no such rights to include a stent with the Focus balloon and ultrasound imaging transducer. Under the judgment, the Company was entitled to recover approximately $468 of its legal fees and costs it had previously expensed, plus interest. In May 2001, Jomed-EndoSonics appealed the judgment, and in January 2003 the appeals court upheld the judgment in the favor of the Company. In February 2003, the Company agreed to accept payment of the judgment for legal fees and costs of $468, which was recorded as a reduction to general and administrative expenses, and interest due of $94, all of which was collected by March 31, 2003.

        In July 2002, the Company terminated its contracts with two of its European distributors of Powerlink products for non-performance. In October 2002, the Company commenced an arbitration proceeding against the distributors to recover delinquent receivables of $376. In response, the distributors filed counterclaims for breach of contract, intentional and negligent misrepresentation and concealment of material facts in which they claim damages of $1,000. In February 2003, the parties agreed to a mutual release of claims made in the arbitration action and signed a new distribution agreement. The European distributors paid $320 to the Company in full settlement of delinquent receivables, net of product returns for $47 and expense reimbursement of $17. The Company also accepted a one-time exchange of products valued at $80.

        A state court productions liability action was served on the Company on October 7, 2003, in the Circuit Court of Cook County, Illinois. Plaintiff seeks damages for pain and suffering, disability and disfigurement, loss of enjoyment of life and loss of capacity to earn a living. Plantiff claims these injuries arose on or about October 1, 2001, following an abdominal aortic aneurysm repair with a graft designed, manufactured and distributed by the Company. Compensatory damages together with interest, costs and disbursements are sought. Punitive damages are not sought. The Company maintains insurance for compensating damages for claims of this nature. Management contests the case vigorously. The parties are currently engaged in oral discovery. At the present stage of this matter, management is unable to estimate possible minimum or maximum amounts of loss contingencies, direct or indirect, in regard to this lawsuit. The Company views the prospect of an unfavorable outcome as possible at this time, accordingly, the Company has not accrued a loss contingency as of March 31, 2005.

        The Company is a party to ordinary disputes arising in the normal course of business. Management believes that the outcome of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flow.

12. Treasury Stock

        In July 2002, the board of directors authorized a program for repurchases of the Company’s outstanding common stock of up to $1,500 under certain parameters. As of March 31, 2005, we have

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repurchased an aggregate of 495 shares for $661, with the last such purchase in the quarter ended June 30, 2003.

13. Sale of Stock

On March 10, 2004, the Company announced the completion of its private placement of 3,200 shares of its common stock at a purchase price of $5.10 per share. The proceeds of the private placement, net of issuance costs, amounted to $15,389.

14. Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board issued SFAS 123(R), Share-Based Payment. This Statement is a revision to SFAS 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires the measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost will be recognized over the period during which an employee is required to provide service in exchange for the award. No compensation cost is recognized for equity instruments for which employees do not render service. The Company will adopt SFAS 123(R) on January 1, 2006, requiring compensation cost to be recorded as an expense for the portion of outstanding unvested awards, based on the grant-date fair value of those awards calculated using the Black-Scholes option pricing model under SFAS 123 for pro forma disclosures. Based on unvested stock options currently outstanding, the impact of potential new stock option grants, and the expense that will be associated with the Employee Stock Purchase Plan, the Company expects that compliance with SFAS 123(R) will have a material effect on the Company’s financial position and results of operations.

In November 2004, the FASB issued SFAS 151, Inventory Costs, which revised ARB 43, relating to inventory costs. This revision is to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). SFAS 151 requires that these items be recognized as a current period charge regardless of whether they meet the criterion specified in ARB 43. In addition, SFAS 151 requires the allocation of fixed production overheads to the costs of conversion be based on normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not believe the adoption of SFAS 151 will have a material impact on the Company’s financial statements.

The FASB issued SFAS 153, Exchanges of Nonmonetary Assets, which changes the guidance in APB Opinion 29, Accounting for Nonmonetary Transactions. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 is effective during fiscal years beginning after June 15, 2005. The Company does not believe the adoption of SFAS 153 will have a material impact on the Company’s financial statements.

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