UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2009

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

For the transition period from to

Commission File Number 001-34078

Northstar Neuroscience, Inc.

(Exact Name of Registrant as Specified in its Charter)

Washington

91-1976637

(State or Other Jurisdiction

of Incorporation)

(IRS Employer

Identification No.)

2401 Fourth Avenue, Suite 300

Seattle, WA 98121

(Address of Principal Executive Offices, Including Zip Code)

(206) 300-0204

(Registrant’s Telephone Number, Including Area Code)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act):

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company x

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

The registrant had 26,588,195 shares of Common Stock, $0.001 par value per share, outstanding as of April 24, 2009.

NORTHSTAR NEUROSCIENCE, INC.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2009

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION		3

Item 1.	Financial Statements	3

	Balance Sheets as of March 31, 2009 (unaudited) and December 31, 2008	3

	Statements of Operations for the three-month periods ended March 31, 2009 and 2008 and period from inception (May 18, 1999) to March 31, 2009 (unaudited)	4

	Statements of Cash Flows for the three-month periods ended March 31, 2009 and 2008 and period from inception (May 18, 1999) to March 31, 2009 (unaudited)	5

	Notes to Financial Statements (unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	13

Item 4.	Controls and Procedures	14

PART II. OTHER INFORMATION		15

Item 1.	Legal Proceedings	15

Item 1A.	Risk Factors	15

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	23

Item 6.	Exhibits	24

Signatures		25

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

NORTHSTAR NEUROSCIENCE, INC.

(A Development Stage Company)

BALANCE SHEETS

(in thousands, except share and per share data)


	March 31, 2009			December 31, 2008
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	23,666		$	8,616
Investments, short-term		35,537			56,105
Other current assets		543			781
Property and equipment, held for sale		55			—

Total current assets		59,801			65,502
Investments, long-term		1,014			2,021
Property and equipment, net		—			705
Other assets		—			93

Total assets	$	60,815		$	68,321

Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	307		$	478
Accrued liabilities		1,573			1,657
Other current liabilities		—			176

Total current liabilities		1,880			2,311
Other long-term liabilities		—			321
Commitments and contingencies		—			—
Shareholders’ equity:
Preferred stock, $0.001 par value; 5,000,000 shares authorized, no shares issued or outstanding		—			—
Common stock, $0.001 par value; 100,000,000 shares authorized, 26,581,314 and 26,121,138 shares issued and outstanding at March 31, 2009 and December 31, 2008, respectively		27			26
Additional paid-in capital		204,596			202,267
Deficit accumulated during the development stage		(145,819	)		(136,921	)
Accumulated other comprehensive income		131			317

Total shareholders’ equity		58,935			65,689

Total liabilities and shareholders’ equity	$	60,815		$	68,321

See accompanying notes.

NORTHSTAR NEUROSCIENCE, INC.

(A Development Stage Company)

STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except share and per share data)


	Three-month Period Ended March 31,						Period from Inception (May 18, 1999) to March 31, 2009
	2009			2008			Period from Inception (May 18, 1999) to March 31, 2009
Revenue	$	—		$	—		$	463
Cost of goods sold		—			—			956

Gross margin		—			—			(493	)
Operating expenses:
Research and development		122			3,978			96,843
General and administrative		8,413			2,374			63,580
Impairment on property and equipment		650			—			650

Total operating expenses		9,185			6,352			161,073

Operating loss		(9,185	)		(6,352	)		(161,566	)
Interest income, net		287			922			13,915
Other income, net		—			—			1,832

Net loss		(8,898	)		(5,430	)		(145,819	)
Preferred stock accretion		—			—			(21,406	)

Net loss applicable to common shareholders	$	(8,898	)		(5,430	)	$	(167,225	)

Basic and diluted net loss per share applicable to common shareholders	$	(0.34	)	$	(0.21	)

Shares used in computation of basic and diluted net loss per share applicable to common shareholders		26,228,881			25,893,657

See accompanying notes.

NORTHSTAR NEUROSCIENCE, INC.

(A Development Stage Company)

STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)


	Three-month Period Ended March 31,						Period from Inception (May 18, 1999) to March 31, 2009
	2009			2008			Period from Inception (May 18, 1999) to March 31, 2009
Operating activities
Net loss	$	(8,898	)	$	(5,430	)	$	(145,819	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		—			83			2,416
Share-based compensation		1,895			601			9,957
Amortization of securities discount		(158	)		(301	)		(2,165	)
Impairment on property and equipment		650			—			742
Other non-cash items		(8	)		(10	)		(1,686	)
Changes in operating assets and liabilities:
Other assets		331			256			(543	)
Liabilities		(752	)		(1,170	)		978

Net cash used in operating activities		(6,940	)		(5,971	)		(136,120	)
Investing activities
Purchases of property and equipment		—			(57	)		(3,763	)
Proceeds from sale of assets		—			—			4,750
Purchases of investment securities		(5,995	)		(31,698	)		(511,790	)
Sales of investment securities		—			—			10,583
Maturities of investment securities		27,550			37,683			466,874

Net cash provided by (used in) investing activities		21,555			5,928			(33,346	)
Financing activities
Proceeds from initial public offering, net of offering costs		—			—			111,979
Proceeds from sale of redeemable convertible preferred stock, net of offering costs		—			—			79,790
Proceeds from exercise of stock options, net of common stock repurchases		435			15			1,498
Proceeds from issuance of debt, net of offering costs		—			—			5,811
Proceeds from issuance of warrants		—			—			1,090
Principal payments on debt and capital lease obligations		—			—			(7,036	)

Net cash provided by financing activities		435			15			193,132

Net increase (decrease) in cash and cash equivalents		15,050			(28	)		23,666
Cash and cash equivalents at beginning of period		8,616			10,212			—

Cash and cash equivalents at end of period	$	23,666		$	10,184		$	23,666

Supplemental schedule of non-cash activities
Deferred share-based compensation	$	—		$	(45	)	$	1,239

See accompanying notes.

NORTHSTAR NEUROSCIENCE, INC.

(A Development Stage Company)

Notes to Financial Statements

(unaudited)

1.	Nature of the Business

Northstar Neuroscience, Inc. is a development stage medical device company headquartered in Seattle, Washington, focused on developing novel neurostimulation therapies for a broad range of neurological diseases and disorders. We incorporated in the State of Washington on May 18, 1999 and have devoted substantially all of our resources to development and commercialization of medical technologies utilizing electrical stimulation to treat neurological diseases and disorders.

On January 5, 2009, after a period of evaluating the options available to Northstar and its shareholders, our board of directors concluded that it appeared unlikely that a business combination transaction at a valuation materially in excess of the estimated liquidation value could be achieved in the near term. Based on these and other factors, our board of directors concluded that a statutory dissolution and liquidation was the preferred strategy among the alternatives available to Northstar and adopted a Plan of Complete Liquidation and Dissolution, or Plan of Dissolution, and recommended approval of the Plan of Dissolution to our shareholders. The Plan of Dissolution is subject to approval at a special meeting of our shareholders, which is scheduled for May 14, 2009.

We continue to report as a development stage company, since planned principal operations have not commenced. We have not changed our basis of accounting as a result of the board of director’s approval of the Plan of Dissolution as it is subject to shareholder approval. We operate in a single segment and management uses one measure of financial performance and does not segment its business for internal reporting.

2.	Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited balance sheets, statements of operations and cash flows have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, 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 GAAP for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair statement of the results of operations have been included. Operating results for the three-month period ended March 31, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009 or any other period. These financial statements and notes thereto should be read in conjunction with the audited financial statements for the year ended December 31, 2008 included in our Annual Report on Form 10-K. The accompanying balance sheet as of December 31, 2008 has been derived from the audited financial statements as of that date, but is not accompanied by all disclosures required by GAAP.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States, or GAAP, requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates are used for, but not limited to, accruals for clinical trial activities and the assumptions used in determining share-based compensation expenses. Actual results could differ from management’s estimates and assumptions.

Comprehensive Loss

Comprehensive loss is comprised of net loss and the unrealized gains and losses on the portfolio of securities available-for-sale. Unrealized gains (losses) for the three-month periods ended March 31, 2009 and 2008 were $187,000 and $107,000, respectively. The total comprehensive loss for the three-month periods ended March 31, 2009 and 2008 was $8.7 million and $5.3 million, respectively.

Property and Equipment and Impairment of Long-Lived Assets

As part of the board of director’s Plan of Dissolution, our property and equipment were held for sale and recorded at the lower of cost, net of accumulated depreciation, or current fair value, less costs to sell. During the quarter ended March 31, 2009, impairment losses were recorded for the full carrying amount of leasehold improvements as we executed a Lease Termination Agreement and will abandon all leasehold improvements. Capitalized software costs were considered abandoned as no resale value is expected to be realized. Our office equipment, lab equipment, furniture and fixtures were recorded as available for sale at the lower of cost, net of accumulated depreciation or current fair value, less costs to sell. As a result of the classification of our property and equipment as assets held for sale, we did not recognize depreciation expense during the three-month period ended March 31, 2009.

Recent Accounting Pronouncements

Effective January 1, 2009, we adopted FSP 157-2, Effective Date of FASB Statement No. 157, or FSP 157-2. FSP 157-2 delayed the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis, until the beginning of the first quarter of fiscal 2009. The adoption of SFAS 157 with respect to non-financial assets and liabilities did not have a significant impact on our financial statements.

3.	Investments

We classify our cash equivalents and investment securities as available for sale and report them at fair value with temporary changes in value recorded as a component of other comprehensive income. Declines in fair value are assessed each reporting period for each individual security, with other-than-temporary declines recorded as expense as a component of interest income, net. In evaluating whether declines in fair value are other-than-temporary, we consider all available evidence, including market declines subsequent to the period-end.

As of March 31, 2009, our cash equivalents and investment securities consisted of money market funds, government and government agency debt, and domestic corporate debt. Amounts are recorded at fair value. The following table summarizes, by major security type, the values of our cash equivalents and investment securities (in thousands):


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Gross Realized Losses		Total at Fair Value
Money market funds	$	5,925	$	—	$	—		$	—	$	5,925
Government and agency debt		37,897		105		(4	)		—		37,998
Domestic corporate debt		15,246		30		—			—		15,276

	$	59,068	$	135	$	(4	)	$	—	$	59,199

4.	Property and Equipment

Pursuant to the Plan of Dissolution approved by our board of directors, all of our remaining recorded furniture, fixtures and equipment are to be sold or disposed in their present condition. As such, we have taken impairment losses with respect to all asset categories. Leasehold improvements have been impaired for their full carrying value as we have abandoned substantially all of our facility, and have terminated our facility lease. Capitalized software costs have been charged off as no value is expected to be realized. Our office equipment, lab equipment, furniture and fixtures are classified as held for sale, and are recorded at the lower of cost, net of accumulated depreciation or current fair value. As a result of the impairment of all of our assets, we have recorded a $650,000 charge to impairment losses and reduced the carrying value of our assets to $55,000, and have not recorded any depreciation for the three-month period ended March 31, 2009.

5.	Fair Value Measurement

Pursuant to the provisions of SFAS 157, we disclose information on all assets and liabilities reported at fair value to enable an assessment of the inputs used in determining the reported values. The SFAS 157 fair value hierarchy prioritizes valuation inputs used in determining the reported fair value of our investments based on the observable nature of those inputs. The SFAS 157 fair value hierarchy applies only to the valuation inputs and is not a measure of the investment credit quality. The hierarchy defines three levels of valuation inputs:


Level 1 inputs		defined as quoted prices in active markets;

Level 2 inputs		generally include inputs with other observable qualities, such as quoted prices in active markets for similar assets or quoted prices for identical assets in inactive markets; and

Level 3 inputs		valuations based on unobservable inputs.

The following table summarizes our assets that were measured at fair value as of March 31, 2009 (in thousands):


	Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Financial Assets at Fair Value March 31, 2009
Government and government agency debt	$	—	$	37,998	$	—	$	37,998
Domestic corporate debt		—		15,276		—		15,276
Property and equipment, held for sale		—		49		—		49

Total	$	—	$	53,323	$	—	$	53,323

Property and equipment held for sale, including office equipment, furniture and fixtures, with a carrying amount of $252,000 were written down to their fair value of $49,000, less costs to sell of $6,000, resulting in an impairment charge of $209,000 included in the impairment loss category in our statement of operations. An additional impairment charge of $441,000 was recorded against the carrying amount for leasehold improvements and capitalized software during the current quarter. No adjustments were recorded to the carrying amount for electronic equipment of $12,000, as the fair value exceeded the cost of such assets.

The following table summarizes our assets that were measured at fair value at December 31, 2008 (in thousands):


	Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Financial Assets at Fair Value December 31, 2008
Government and government agency debt	$	—	$	40,712	$	—	$	40,712
Domestic corporate debt		—		20,419		—		20,419

Total	$	—	$	61,131	$	—	$	61,131

6.	Leases

In March 2009 as a result of our board of director’s adoption of the Plan of Dissolution, we entered into a Lease Termination Agreement with the lessor of our corporate headquarters resulting in a net lease termination charge of $2.1 million. Pursuant to the terms of the Lease Termination Agreement, effective February 2009, we were released from making future payments to the lessor in exchange for a cash payment of $2.4 million, the surrender of our previously paid $93,000 security deposit, and assignment of our July 2008 sublease. Upon executing the Lease Termination Agreement, we released, without additional cash payments, previously recorded liabilities relating to straight-line lease expense recognition and sublease loss accruals totaling $467,000 and remaining expenses associated with the lease buy-out were recorded as part of operating expenses during the current quarter.

As a result of the Lease Termination Agreement and payment made, our lease payments obligations of $4.0 million from 2009 into 2012 have been eliminated.

7.	Share-based Compensation

As of March 31, 2009, we had one active share-based compensation plan, the 2006 Performance Incentive Plan, and one terminated plan, the 1999 Stock Option Plan. We recorded total share-based compensation expense for stock options and restricted stock awards, or RSAs, as follows (in thousands):


	Three-month Period Ended March 31,
	2009		2008
Research and development	$	—	$	225
General and administrative		1,895		376

	$	1,895	$	601

Unrecognized share-based compensation expense as of March 31, 2009 totaled $3.0 million and will be recognized over the remaining vesting periods of the awards, which generally vest over one to four years.

We estimated the fair value of stock options using the Black-Scholes option-pricing model using the following assumptions:


	Three-month Period Ended March 31,
	2009		2008
Risk-free interest rate	0.17	%	2.5	%
Dividend yield	0.0	%	0.0	%
Expected/contractual term (in years)	0.42		5.0-6.1
Volatility	20	%	40	%

A summary of our stock option activity and related information for the three-month period ended March 31, 2009 is as follows:


	Options			Weighted- Average Exercise Price
Outstanding at December 31, 2008		3,561,651		$	5.03
Granted at fair value		45,000			1.91
Exercised		(1,216,869	)		1.55
Cancelled		(157,122	)		11.52

Outstanding at March 31, 2009		2,232,660		$	6.41

Outstanding options vested and exercisable, but not subject to repurchase at March 31, 2009		1,960,193		$	5.89
Intrinsic value of in-the-money outstanding options	$	512,000
Intrinsic value of in-the-money outstanding options vested and exercisable	$	503,000
Weighted-average fair value of options granted during the period	$	0.10

The total intrinsic values of options exercised, determined as of the date of exercise, during the three-month period ended March 31, 2009 was $439,000.

To date, we have issued 211,000 RSAs which completed vesting during the three-month period ended March 31, 2009. We estimated the fair value of RSAs based on the closing price of our common stock on the date of grant.

The following table summarizes our RSA activity for the three-month period ended March 31, 2009:


	Restricted Stock Awards		Weighted- Average Grant Date Fair Value
Unvested RSAs at December 31, 2008	107,066		$	1.70
Granted	—			—
Vested	(72,111	)		1.70
Forfeited	(34,955	)		1.70

Outstanding at March 31, 2009	—			—

8.	Loss Per Common Share

Basic net loss per share applicable to common shareholders is calculated by dividing the net loss applicable to common shareholders by the weighted-average number of unrestricted common shares outstanding for the period, without consideration of common stock equivalents. Diluted net loss per share applicable to common shareholders is computed by dividing the net loss applicable to common shareholders by the weighted-average common shares and dilutive common share equivalents outstanding for the period, determined using the treasury-stock method and the as-if-converted method. For purposes of this calculation, stock options and warrants are considered to be common stock equivalents and are excluded from the calculation of diluted net loss per share, as their effect is antidilutive.

The following table presents the computation of basic and diluted net loss per share applicable to common shareholders (in thousands, except share and per share data):


	Three-month Period Ended March 31,
	2009			2008
Numerator:
Net loss applicable to common shareholders	$	(8,898	)	$	(5,430	)

Denominator:
Weighted-average shares used in computation of basic and diluted net loss applicable to common shareholders		26,228,881			25,893,657

Basic and diluted net loss per share applicable to common shareholders	$	(0.34	)	$	(0.21	)

Antidilutive securities excluded from diluted net loss applicable to common shareholders:
Warrants, RSAs and options outstanding		2,303,939			2,457,418

9.	Restructuring

On January 22, 2008, we announced that our EVEREST pivotal trial failed to meet its primary endpoint. In response to the results of the EVEREST trial, on February 15, 2008, we implemented a cost reduction plan that included the elimination of costs associated with our planned commercial product launch, modifications to our clinical and development programs, and reduction of our workforce of permanent and contract personnel by approximately 32%, including 19 permanent employees. On July 31, 2008, we revised our strategic plan to focus our research and development efforts exclusively on our depression therapy and in conjunction with this revised plan we announced further cost reduction efforts. These efforts included suspending our stroke research program, the elimination of an additional 20 permanent employees, and the sublease of approximately 40% of our headquarters facility.

On January 5, 2009, our board of directors adopted the Plan of Dissolution. The Plan of Dissolution is subject to approval of our shareholders at a special meeting of shareholders which is scheduled for May 14, 2009. As a result of the pending Plan of Dissolution, we have implemented a reduction of our workforce of approximately 83% leaving us with five employees as of May 1, 2009. As of March 31, 2009, we had substantially reduced our work force, terminated our facility lease, ceased substantially all of our operations, and commenced activities to terminate all of our ongoing clinical trials.

The Plan of Dissolution contemplates an orderly windup of our business and operations. If our shareholders approve the Plan of Dissolution, we intend to file articles of dissolution, satisfy or resolve our remaining liabilities and obligations, including but not limited to contingent liabilities and claims, ongoing clinical trial obligations, , severance for terminated employees, and costs associated with the liquidation and dissolution, and make one or more distributions to our shareholders of cash available for distribution, subject to applicable legal requirements. Following shareholder approval of the Plan of Dissolution and the filing of articles of dissolution, we anticipate delisting our common stock from NASDAQ.

In March 2009, we entered into a Lease Termination Agreement with the lessor of our corporate headquarters. Pursuant to the terms of the Lease Termination Agreement, we were released from making future payments to the lessor in exchange for a payment of $2.4 million, the surrender of our security deposit of $93,000, and assignment of our July 2008 sublease. Upon executing the Lease Termination Agreement, we released previously recorded liabilities relating to straight-line lease expense recognition and sublease loss accruals totaling $467,000.

In connection with our cost reduction efforts, we recorded restructuring costs in general and administrative expenses as follows (in thousands):


	Three-month period ended March 31, 2009
	G&A
Severance and benefits	$	2,027
Stock compensation associated with acceleration of unvested equity awards		1,597
Lease termination expense, net		2,055

Total	$	5,679

Additionally, as a result of our reduction in force related to the Plan of Dissolution, we expect to incur additional charges of $377,000 related to termination benefits for employees who were impacted by our restructuring but had termination dates after March 31, 2009.

Continuation of medical benefits afforded to affected employees were primarily expensed at the time of each workforce reduction and a liability was established for future termination and benefit costs. The following table summarizes the 2009 restructuring costs liability activity, including payments of severance amounts and the remaining amount accrued as of March 31, 2009 (in thousands):


Accrued restructuring liability as of December 31, 2008	$	307
Severance and benefit expenses for the three-month period ended March 31, 2009		2,027
Lease termination expense, net		2,055
Adjustments to liability, net		(53	)
Cash payments made during the three-month period ended March 31, 2009		(3,544	)

Accrued restructuring liability as March 31, 2009	$	792

10.

Commitments and Contingencies

In July 2008, a putative class action complaint was filed against our board of directors in the King County Washington Superior Court. The lawsuit was filed by one of our alleged shareholders, on behalf of himself and all others similarly situated. The complaint alleges, among other things, that our board of directors breached its fiduciary duties to shareholders in connection with two alleged proposed acquisition offers. The complaint seeks, among other things, injunctive relief and attorneys’ fees and costs, but does not seek direct monetary damages from us. Both we and our board of directors believe that the allegations in the complaint are without merit and we intend to vigorously defend the matter.

11.

Subsequent Events

Subsequent to March 31, 2009, we sold substantially all of our non-core assets, including office equipment, lab equipment, furniture and fixtures, and received $114,000, net of selling costs, resulting in a $60,000 gain on sale.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The statements contained in this Quarterly Report on Form 10-Q, including under this section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including, without limitation, statements regarding our or our management’s expectations, hopes, beliefs, intentions, or strategies regarding the future. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “plan,” and similar expressions may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking. The forward-looking statements contained in this Quarterly Report on Form 10-Q are based on our current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those that we have anticipated, or that the results of our engagement of a financial advisor, or our analysis of strategic alternatives will result in any transaction or arrangement with a third party. These forward-looking statements involve a number of risks, uncertainties, or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements. These risks and uncertainties include those factors described in greater detail in Item 1A of Part II, “Risk Factors.” Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those anticipated in these forward-looking statements. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as may be required under applicable securities laws.

Overview

Management’s discussion and analysis provides additional insight into Northstar Neuroscience, Inc. and is provided as a supplement to, and should be read in conjunction with, our audited financial statements and accompanying footnotes thereto.

Northstar Neuroscience, Inc. is a development stage medical device company incorporated in the State of Washington on May 18, 1999. Historically we have focused our operations on developing and commercializing innovative neuromodulation therapies to restore function and quality of life for people suffering from neurological diseases and disorders. Our proprietary Renova™ Cortical Stimulation System is designed to deliver targeted electrical stimulation to the cortex, the outermost layer of the brain, in a process called cortical stimulation.

During the past three years, we conducted research investigating cortical stimulation therapy for the treatment of treatment resistant depression, or TRD, stroke related upper extremity hemiparesis, and tinnitus using our Renova system. The PROSPECT and SAHALE studies were our first feasibility trials evaluating cortical stimulation therapy in patients with TRD and tinnitus, respectively. EVEREST was our pivotal clinical trial for patients suffering from upper extremity hemiparesis, impairment of the hand and arm, resulting from stroke. On January 22, 2008, we announced that our EVEREST pivotal clinical trial evaluating the use of cortical stimulation in conjunction with rehabilitation therapy for the treatment of hand and arm impairment following a stroke did not meet its primary efficacy endpoint. We subsequently concluded that additional analysis of the EVEREST trial data would not support an effort to pursue marketing approval from the FDA based on EVEREST data alone. In response to the results of our EVEREST pivotal trial, we implemented cost reduction plans and considered the broader implications of the EVEREST trial results to our business, including revisions to our business plan focusing on treating depression and available strategic alternatives to enhance shareholder value.

To assist in their evaluation of strategic alternatives available to Northstar, our board of directors engaged Leerink Swann to serve as a financial advisor to the board of directors and to coordinate the process of reviewing strategic alternatives. During the third and fourth quarters of 2008, our board of directors, with the assistance of management and Leerink Swann, evaluated the options available to Northstar and its shareholders including, among others, continuing to pursue commercialization of the Renova system for one or more indications, business combinations, strategic transactions or partnering arrangements, liquidation, and other means by which to derive enhanced value for our shareholders. On January 5, 2009 our board of directors concluded that it appeared unlikely that a business combination transaction at a valuation materially in excess of the estimated liquidation value could be achieved in the near term. This conclusion was based on the lack of success, despite concerted efforts through the third and forth quarters of 2008, to identify a business combination transaction or other strategic transaction that would provide value to our shareholders or mitigate the risks of our ongoing operations, including the risks associated with technology in a relatively early stage of development, the time and cash requirements associated with trying to bring our Renova system to market, the need for additional financing to complete commercialization, and the highly uncertain and currently unfavorable financing and economic climate. Based on these and other factors, our board of directors concluded that a statutory dissolution and liquidation was the preferred strategy among the alternatives available to Northstar and adopted a Plan of Complete Liquidation and Dissolution, or Plan of Dissolution, and recommended approval of the Plan of Dissolution to our shareholders.

The Plan of Dissolution requires approval of our shareholders at a special meeting of shareholders which is scheduled for May 14, 2009. If our shareholders approve our Plan of Dissolution, we will pursue a revenue clearance certificate from the Washington State Department of Revenue, and once the revenue clearance certificate is received, we will file Articles of Dissolution with the State of Washington Secretary of State. Thereafter, we will not engage in any business activities except for the purpose of preserving the value of our assets, prosecuting and defending lawsuits by or against us, winding up our business and affairs, selling and monetizing our non-cash assets, including our intellectual property and other intangible assets, paying or otherwise settling our liabilities, including contingent liabilities, terminating agreements and relationships, and preparing to make distributions to our shareholders, in accordance with the Plan of Dissolution.

If our shareholders do not approve our Plan of Dissolution, our board of directors will explore the alternatives then available to Northstar. We believe the potential value that could be derived from our ongoing business operations has been materially and adversely impacted by the announcement of the Plan of Dissolution, as we have substantially reduced our work force, ceased substantially all of our operations and commenced activities to terminate all of our ongoing clinical trials pending our shareholders’ vote on the Plan of Dissolution. Therefore, if our shareholders do not approve our dissolution and plan of liquidation, we will not be able to continue to operate our business as it existed prior to our board of director’s approval of the Plan of Dissolution and may not be able to operate our business at all.

Critical Accounting Policies and Significant Judgments and Estimates

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of 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 reported expenses during the reporting periods. We periodically evaluate our estimates, including, but not limited to those related to share-based compensation and clinical trial accruals. We base our estimates on historical experience and on other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions. Our critical accounting policies and estimates have not changed significantly from those policies and estimates disclosed under the heading “Critical Accounting Policies and Significant Judgments and Estimates” in our Form 10-K for the fiscal year ended December 31, 2008, filed with the Securities and Exchange Commission on March 17, 2009.

As part of the Plan of Dissolution, our property and equipment are held as available for sale and recorded at the lower of cost, net of accumulated depreciation, or current fair value, less costs to sell. During the quarter ended March 31, 2009, impairment losses were recorded for the full carrying amount of leasehold improvements as we executed a Lease Termination Agreement. Capitalized software costs were considered abandoned as no resale value is expected to be realized. Our office equipment, lab equipment, furniture and fixtures were recorded as held for sale at the lower of cost, net of accumulated depreciation or current fair value, less costs to sell. As a result of the impairment identified on all of our assets, we did not recognize depreciation expense during the three month period ended March 31, 2009.

Effective January 1, 2009, we adopted FSP 157-2, Effective Date of FASB Statement No. 157, or FSP 157-2. FSP 157-2 delayed the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis, until the beginning of the first quarter of fiscal 2009. The adoption of SFAS 157 to non-financial assets and liabilities did not have a significant impact on our financial statements.

Financial Overview

Research and Development Expenses

Our research and development expenses consist primarily of direct costs incurred to conduct clinical trials, engineering development costs associated with our Renova Cortical Stimulation System, and regulatory compliance activities. We expense research and development costs during the period in which they are incurred. In accordance with EITF No. 07-3, nonrefundable advance payments related to future research and development activities are deferred and recognized as expense in the period that the related goods are delivered or services are performed. From our inception through March 31, 2009, we have incurred $96.8 million in research and development expenses.

We expect minimal research and development expenditures during 2009 as we windup our clinical trials and research and development activities.

General and Administrative Expenses

Our general and administrative expenses include current year restructuring costs for employee severance and ongoing benefits, termination of our facility lease, continued compensation for remaining staff, including share-based compensation and other significant expenses including professional fees for accounting and legal services, including legal services associated with our efforts to obtain and maintain protection for the intellectual property related to our cortical stimulation system.

We expect decreased general and administrative expenditures during 2009 as we windup our operations.

Financial Condition

Property and equipment, net

Property and equipment, held for sale, was $55,000 as of March 31, 2009 compared to property and equipment of $705,000 as of December 31, 2008. The decrease was the result of an impairment charge of $650,000, included in the statement of operations, for assets classified as held for sale through the three-month period ended March 31, 2009. Subsequent to March 31, 2009, we sold substantially all of our non-core assets, including office equipment, lab equipment, furniture and fixtures, and received $114,000, net of selling costs, resulting in a $60,000 gain on sale.

Other current liabilities and other long-term liabilities

Our total other liabilities were zero as of March 31, 2009 compared to $497,000 as of December 31, 2008. The two other liabilities categories on our balance sheet consist of liabilities relating to straight-line lease expense recognition and sublease loss accruals both of which decreased during the three-month period ended March 31, 2009 primarily due to the release of liabilities associated with our Lease Termination Agreement.

Results of Operations

Three-month Periods Ended March 31, 2009 and 2008

Research and Development Expenses

Research and development expenses were $122,000 for the three-month period ended March 31, 2009, compared to $4.0 million for the three-month period ended March 31, 2008. The decrease of $3.9 million, or 97%, is due to the adoption of the Plan of Dissolution, which resulted in the termination of all current research and development activities, and the cessation of all personnel related costs as they relate to development, including severance and benefit charges, which were charged to general and administrative expense.

General and Administrative Expenses

General and administrative expenses were $8.4 million for the three-month period ended March 31, 2009, compared to $2.4 million for the three-month period ended March 31, 2008. The increase of $6.0 million, or 250%, was primarily due to one time restructuring charges of $2.1 million associated with the termination of our facility lease, $2.0 million in one-time employee severance and benefit charges, and $1.9 million in stock compensation expenses, of which $1.7 million was primarily associated with the acceleration of options.

Impairment on property and equipment

Impairment on property and equipment was $650,000 for the three-month period ended March 31, 2009. The current period charge was the result of impairment losses taken related to the write-down of held for sale and abandoned property and equipment values to the lower of cost, net of accumulated depreciation, or the fair value, less costs to sell.

Interest Income, Net

Interest income, net, was $287,000 for the three-month period ended March 31, 2009, compared to $922,000 for the three-month period ended March 31, 2008. The decrease of $635,000, or 69%, reflects reduced interest earned on cash and investments attributable primarily to lower average cash and investment balances and decreased interest rates stemming from general market conditions.

Liquidity and Capital Resources

We have incurred losses since our inception in May 1999 and, as of March 31, 2009, we had a deficit accumulated during the development stage of $145.8 million. We have funded our operations to date from public and private placements of equity securities and stock option exercises, raising net proceeds of $193.3 million through March 31, 2009. As of March 31, 2009, we had $60.2 million in cash, cash equivalents, and investments.

On January 5, 2009 our board of directors approved the Plan of Dissolution. If our shareholders approve our Plan of Dissolution, we will not engage in any business activities except for the purpose of preserving the value of our assets, prosecuting and defending lawsuits by or against us, winding up our business and affairs, selling and liquidating our assets, including our intellectual property and other intangible assets, paying or otherwise settling our liabilities, including contingent liabilities, terminating all agreements and relationships and preparing to make distributions to our shareholders, in accordance with the plan of liquidation. We believe that our cash, cash equivalents, investments, and related interest income would be sufficient to meet our anticipated cash requirements under this Plan of Dissolution.

If our shareholders do not approve our Plan of Dissolution, our board of directors will explore the alternatives then available to Northstar. We believe that our existing cash, cash equivalents, investments, and related interest income would be sufficient to recommence our business operations and meet our anticipated cash requirements into 2010, if needed.

Cash flow information for the three-month period ended March 31, 2009 is as follows (in millions):


	2009			2008
Cash provided by (used in):
Operating activities	$	(6.9	)	$	(6.0	)
Investing activities	$	21.6		$	5.9
Financing activities	$	0.4		$	0.0

Net Cash Used in Operating Activities

Net cash used in operating activities was $6.9 million and $6.0 million for the three-month periods ended March 31, 2009 and 2008, respectively. The net cash used in these periods primarily reflects the net loss for those periods, partially offset by non-cash operating expenses including depreciation, amortization of premiums on investments, share-based compensation, and changes in operating assets and liabilities.

Net Cash Provided by Investing Activities

Net cash provided by investing activities was $21.6 million and $5.9 million for the three-month periods ended March 31, 2009 and 2008, respectively primarily reflecting the net of purchases, sales and maturities of investments.

Net Cash Provided by Financing Activities

Net cash provided by financing activities during the three-month period ended March 31, 2009 reflects the exercises of stock options.

Operating Capital and Capital Expenditure Requirements

To date, we have not commercialized any product based on our cortical stimulation technology and we have not achieved profitability. We do not anticipate generating any product revenue.

On January 5, 2009 our board of directors approved the Plan of Dissolution. If our shareholders approve our Plan of Dissolution, we will not engage in any business activities except for the purpose of preserving the value of our assets, prosecuting and defending lawsuits by or against us, winding up our business and affairs, selling and liquidating our assets, including our intellectual property and other intangible assets, paying or otherwise settling our liabilities, including contingent liabilities, terminating all agreements and relationships and preparing to make distributions to our shareholders, in accordance with the Plan of Dissolution. We believe that our cash, cash equivalents, investments, and related interest income would be sufficient to meet our anticipated cash requirements under this Plan of Dissolution.

Off-Balance Sheet Arrangements

As of March 31, 2009, we did not have any off-balance sheet financing arrangements.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk related to changes in interest rates primarily due to our investment portfolio. We maintain an investment portfolio consisting mainly of money market, federal and state government obligations, municipal obligations, and corporate obligations. We have the ability to hold our fixed income investments until maturity; therefore, we do not anticipate that changes in market interest rates will have a material impact on our operating results or cash flows.

Our investment strategy is governed by a Cash and Investment Policy that strives to preserve capital and is reviewed with our board of directors periodically. The provisions of our Cash and Investment Policy as of March 31, 2009 include, among other provisions:

•

all investments must be rated as investment grade by a recognized rating agency;

•

investment securities from a single issuer that is not guaranteed by the good faith and credit of the United States government is limited to 5%;

•

expected maturity is limited to 36 months and the average maturity of the portfolio is limited to 18 months; and

•

derivatives, synthetics or similar instruments and instruments accounted for off-balance sheet are specifically prohibited without prior authorization from the board of directors.

Consistent with general market conditions, our investment portfolio is subject to credit and interest rate risks with the investment securities held. We manage our investments pursuant to provisions of our Cash and Investment Policy, in an effort to minimize exposures to credit quality, changes in credit quality, and individual security positions. Since our portfolio is comprised of income-generating securities yielding returns based on stated interest rates, as interest rates change our portfolio value may change materially and future rates of return may diminish as interest rates decline. We do not use derivative or other instruments to hedge our risks associated with changes in interest rates.

Management has reviewed the composition of the investment portfolio and believes that as of March 31, 2009, the portfolio was in compliance with the Cash and Investment Policy.

Item 4.

Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that material information required to be disclosed in our periodic reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and to ensure that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer as appropriate, to allow timely decisions regarding required disclosure. Based on an evaluation of our disclosure controls and procedures as of the end of the period covered by this report conducted by our management, with the participation of our chief executive and chief financial officers, the chief executive and chief financial officers believe that these controls and procedures are effective to ensure that we are able to collect, process, and disclose the information we are required to disclose in the reports we file with the SEC within the required time periods.

There were no changes in our internal control over financial reporting during the first quarter of fiscal 2009 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II: Other Information

Item 1.

Legal Proceedings

In July 2008, a putative class action complaint was filed against our board of directors in the King County Washington Superior Court. The lawsuit was filed by one of our alleged shareholders, on behalf of himself and all others similarly situated. The complaint alleges, among other things, that the Board breached its fiduciary duties to shareholders in connection with two alleged proposed acquisition offers. The complaint seeks, among other things, injunctive relief and attorneys’ fees and costs, but does not seek direct monetary damages from us. Both we and our board of directors believe that the allegations in the complaint are without merit and we intend to vigorously defend the matter.

Item 1A.

Risk Factors

The following important factors, among others, could cause our stock price to fall and our financial condition and operating results to differ materially from those indicated or suggested by forward-looking statements made in this Quarterly Report on Form 10-Q or presented elsewhere by management from time to time.

On January 5, 2009 our board of directors approved the Plan of Dissolution. The Plan of Dissolution is subject to approval by our shareholders. If our shareholders approve the Plan of Dissolution, we will pursue a revenue clearance certificate from the Washington State Department of Revenue and, once received, file Articles of Dissolution with the State of Washington Secretary of State. The risks described below under the caption “Risks Related to the Plan of Dissolution” address risks we and our shareholders face if the Plan of Dissolution is approved.

Risks Related to the Plan of Dissolution

The amount we distribute to our shareholders pursuant to the Plan of Dissolution may be substantially less than the amount we currently estimate if the amounts of our liabilities, other obligations and expenses and claims against us are higher than we currently anticipate.

The amount of cash ultimately distributed to shareholders pursuant to the Plan of Dissolution depends on the amount of our liabilities, obligations and expenses and claims against us, and contingency reserves that we establish, during the liquidation process, and the amount we generate from the sale of our remaining non-cash assets, consisting primarily of our Renova ™ Cortical Stimulation System and related intellectual property. We have attempted to estimate reasonable reserves for such liabilities, obligations, expenses and claims against us. However, those estimates may be inaccurate. Factors that could impact our estimates include the following:

•

If any of the estimates regarding the Plan of Dissolution, including the net proceeds from the sale of our Renova ™ Cortical Stimulation System, which, given the current macroeconomic conditions, for purposes of our estimates of proceeds expected to be distributed to shareholders, we have assigned no value, and the expense of satisfying outstanding obligations, liabilities and claims during the liquidation process, are inaccurate, the amount we distribute to our shareholders may be substantially less than the amount we currently estimate. For instance, if claims are asserted against us, including any claims related to the termination of our clinical trials or the removal of our Renova ™ Cortical Stimulation System from patients in our clinical trials, we will have to defend or resolve such claims before making distributions to our shareholders, which will reduce amounts otherwise available for distribution to our shareholders. In addition, an assignor of certain of our intellectual property has asserted that he is entitled to reversion of such intellectual property upon our dissolution, which may adversely affect our ability to sell such intellectual property in a timely manner, although we do not believe that he has rights in any of our intellectual property;

•

We have made estimates regarding the expense of personnel required and other operating expenses (including legal, accounting and other professional fees) necessary to dissolve and liquidate Northstar. Our actual expenses could vary significantly and depend on the timing and manner of the sale of our non-cash assets. If the timing differs from our plans, we may incur additional expenses above our current estimates, which could substantially reduce funds available for distribution to our shareholders; and

•

We have assumed that all material contract rights can be effectively transferred to third parties. If we are unable to obtain any required consents with the counterparties to those contracts, our ability to transfer such rights may be impaired.

We will continue to incur the expenses of complying with public company reporting requirements, which may be economically burdensome.

Whether or not the Plan of Dissolution is approved, we have an obligation to continue to comply with the applicable reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, even though compliance with such reporting requirements may be economically burdensome and of minimal value to our shareholders. If the Plan of Dissolution is approved by our shareholders, in order to curtail expenses, we intend, on or about the effective date of our Articles of Dissolution, or the Effective Date, to seek relief from the SEC to suspend our reporting obligations under the Exchange Act, and ultimately to terminate the registration of our common stock. We anticipate that, if granted such relief, we would continue to file current reports on Form 8-K to disclose material events relating to our dissolution and liquidation along with any other reports that the SEC might require. To the extent that we are unable to suspend our obligation to file periodic reports with the SEC, we will be obligated to continue complying with the applicable reporting requirements of the Exchange Act and, as a result, will be required to continue to incur the expenses associated with these reporting requirements, which will reduce the cash available for distribution to our shareholders. These expenses include, among others, those costs relating to:

•

the preparation, review, filing and dissemination of SEC filings;

•

maintenance of effective internal controls over financial reporting; and

•

audits, attestations and reviews conducted by our independent registered public accountants.

If the amount of our contingency reserve is insufficient to satisfy the aggregate amount of our liabilities and other obligations and is determined to be unreasonable, each shareholder may be liable to our creditors for the amount of liquidating distributions received by such shareholder under the Plan of Dissolution, which could also have adverse tax consequences.

After the Effective Date, our corporate existence will continue, but we will not be able to carry on any business except for the purpose of winding up the business and affairs of Northstar. Following the Effective Date, we will pay or make reasonable provision to pay all claims and obligations, including all contingent, conditional or unmatured contractual or statutory claims, known to us. We also may obtain and maintain insurance coverage or establish and set aside a reasonable amount of cash or other assets as a contingency reserve to satisfy claims against and obligations of Northstar. In the event that the amount of the contingency reserve, insurance and other measures calculated to provide for the satisfaction of liabilities and claims are insufficient to satisfy the aggregate amount ultimately found payable in respect of our liabilities and claims against us and are determined to be unreasonable, each shareholder could be held liable for amounts due to creditors up to the amounts distributed to such shareholder under the Plan of Dissolution. In such event, a shareholder could be required to return all amounts received as distributions pursuant to the Plan of Dissolution and ultimately could receive nothing under the Plan of Dissolution. Moreover, for U.S. federal income tax purposes, payments made by a shareholder in satisfaction of our liabilities not covered by the cash or other assets in our contingency reserve or otherwise satisfied through insurance or other reasonable means generally would produce a capital loss for such shareholder in the year the liabilities are paid. The deductibility of any such capital loss generally would be subject to limitations under the Internal Revenue Code of 1986, as amended, or the Code.

Liquidating distributions to our shareholders could be delayed or diminished.

All or a portion of any distributions to our shareholders could be delayed, depending on many factors, including, without limitation:

•

if a creditor or other third party seeks an injunction against the making of distributions to our shareholders on the ground that the amounts to be distributed are needed to provide for the satisfaction of our liabilities or other obligations;

•

if we become a party to lawsuits or other claims asserted by or against us, including any claims or litigation arising in connection with the termination of our clinical trials or the removal of our Renova ™ Cortical Stimulation System from patients in our clinical trials;

•

if we are unable to sell our remaining non-cash assets or if such sales take longer than expected;

•

if we are unable to resolve claims with creditors or other third parties, or if such resolutions take longer than expected; or

•

if the anticipated audit of our State of Washington tax obligations, identifies unanticipated obligations or takes more time than expected, the issuance of the revenue clearance certificate required to file our articles of dissolution with the Secretary of State may be delayed.

Any of the foregoing could delay or substantially diminish the amount available for distribution to our shareholders. In addition, under the Washington Corporate law, claims and demands may be asserted against us at any time during the three years following the Effective Date. Accordingly, our board of directors may obtain and maintain insurance coverage or establish and set aside a reasonable amount of cash or other assets as a contingency reserve to satisfy claims against and obligations of Northstar that may arise during the three-year period following the Effective Date. As a result of these factors, we may retain for distribution at a later date, if at all, some or all of the estimated amounts that we expect to distribute to shareholders.

Shareholders will lose the opportunity to capitalize on potential growth opportunities from the continuation of our business.

Although our board of directors believes that the Plan of Dissolution is more likely to result in greater returns to shareholders than if we continued the status quo or pursued other alternatives, if the Plan of Dissolution is approved, shareholders will lose the opportunity to capitalize on potential business and possible future growth opportunities that may have arisen if we had continued our cortical stimulation business or pursued other alternatives. It is possible that these opportunities could prove to be more valuable than the liquidating distributions our shareholders would receive pursuant to the Plan of Dissolution.

Shareholders may not be able to recognize a loss for U.S. federal income tax purposes until they receive a final distribution from us.

As a result of our dissolution and liquidation, for U.S. federal income tax purposes, our shareholders generally will recognize gain or loss equal to the difference between (i) the sum of the amount of cash and the fair market value (at the time of distribution) of property, if any, distributed to them, and (ii) their tax basis for their shares of our common stock. Liquidating distributions pursuant to the Plan of Dissolution may occur at various times and in more than one tax year. Any loss generally will be recognized by a shareholder only when the shareholder receives our final liquidating distribution to shareholders, and then only if the aggregate value of all liquidating distributions with respect to a share is less than the shareholder’s tax basis for that share.

Recordation of transfers of our common stock on our stock transfer books will be restricted as of a future date that our board of directors will determine, and thereafter it generally will not be possible for shareholders to change record ownership of our stock.

Our board of directors may direct that our stock transfer books be closed and recording of transfers of common stock discontinued as of the earliest of (x) the close of business on the record date fixed by our board of directors for the first or any subsequent installment of any liquidating distribution, (y) the close of business on the date on which our remaining assets are transferred to a liquidating trust, or (z) the date on which we file our articles of dissolution under the Washington law. We expect that our board of directors will close our stock transfer books on or around the Effective Date. The Effective Date will be determined following the receipt of a revenue clearance certificate from the Washington State Department of Revenue and will be announced as soon as reasonably practicable after that time. Thereafter, certificates representing shares of our common stock will not be assignable or transferable on our books except by will, intestate succession or operation of law, and we will not issue any new stock certificates, other than replacement certificates. In addition, we anticipate that we will request that our common stock be delisted from the NASDAQ Global Market at the close of business on the Effective Date.

Further shareholder approval may not be required in connection with the implementation of the Plan of Dissolution, including for the sale of all or substantially all of our non-cash assets as contemplated in the Plan of Dissolution.

The approval of the Plan of Dissolution by our shareholders also will authorize, without further shareholder action, our board of directors to do and perform, or to cause our officers to do and perform, any and all acts and to make, execute, deliver or adopt any and all agreements, resolutions, conveyances, certificates and other documents of every kind that our board of directors deems necessary, appropriate or desirable, in the absolute discretion of the board of directors, to implement the Plan of Dissolution and the transactions contemplated thereby, including, without limitation, all filings or acts required by any state or federal law or regulation to wind up its affairs. Accordingly, depending on the timing of a shareholder vote on the Plan of Dissolution, we may dispose of our Renova ™ Cortical Stimulation System, related intellectual property and any and all other non-cash assets without further shareholder approval. As a result, our board of directors may authorize actions in implementing the Plan of Dissolution, including the terms and prices for the sale of our Renova ™ Cortical Stimulation System and related intellectual property, with which our shareholders may not agree.

Our board of directors may revoke implementation of the Plan of Dissolution, even if it is approved by our shareholders .

Even if our shareholders approve the Plan of Dissolution at the special meeting, if for any reason our board of directors determines that such action would be in the best interests of Northstar or our shareholders, our board of directors may, in its sole discretion and without requiring further shareholder approval, revoke the Plan of Dissolution and all action contemplated there under, to the extent permitted by the Washington law, at any time within 120 days of the Effective Date. A revocation of the Plan of Dissolution would result in our shareholders not receiving any liquidating distributions pursuant to the Plan of Dissolution.

If our shareholders do not approve the Plan of Dissolution, our resources may diminish completely.

If our shareholders do not approve the Plan of Dissolution, our board of directors will explore what, if any, alternatives are available for the future of Northstar, particularly in light of the fact that we have terminated substantially all of our employees, are in the process of terminating all of our ongoing clinical trials, informed the U.S. Food and Drug Administration, or FDA, of such intention to terminate and commenced the process of winding up our business and will continue to incur net losses for the foreseeable future. We took these steps in the interest of preserving cash available for distribution to shareholders and in recognition of the expectation that the announcement of approval of the Plan of Dissolution would adversely affect our ability to proceed with our PROSPECT clinical trials. There is currently no active business left to operate, and rehiring employees and recommencing our PROSPECT clinical trials would take several months at a cost we are unable to estimate.

Possible alternatives include selling all of our stock or assets, changing our business focus, distributing cash to shareholders pursuant to an extraordinary dividend, conducting an issuer tender offer, continuing our efforts to identify a merger partner or a reverse merger partner, or seeking voluntary dissolution at a later time and with diminished assets. At this time, our board of directors does not know which alternatives it might consider, or what impact any alternative might have on shareholder value. If our shareholders do not approve the Plan of Dissolution, we expect that our cash resources will continue to diminish and we would face risks related to continuing our historical business described in this Form 10-Q. These risks could materially and adversely affect our business, financial condition or operating results and the value of our common stock, and our shareholders may lose all or part of their investment. Moreover, any alternative we select may have unanticipated negative consequences.

If our shareholders do not approve the Plan of Dissolution, our stock price may be adversely affected.

On January 2, 2009, the trading day immediately prior to our announcement that our board of directors had approved the Plan of Dissolution, the closing sales price of our common stock on the NASDAQ Global Market was $1.28. If our shareholders do not approve the Plan of Dissolution, our stock price may be adversely affected due to the market’s doubt as to our ability to restart and operate successfully our cortical stimulation business or to pursue successfully other strategic alternatives, and we may not be able to retain our listing on the NASDAQ Global Market.

Risks Related to Our Continuing Business Operations if the Plan of Dissolution is Not Approved by Our Shareholders

The risks below describe the risks related to our business if the Plan of Dissolution is not approved and we continue to pursue a strategy of using our cash on hand, any cash generated from financing activities, and any cash that may be generated by our cortical stimulation business to support our continued operations while we continue to explore whether there may be opportunities to realize potential value from our remaining business assets.

The risks and uncertainties described below are not the only ones facing Northstar, and our risks and uncertainties may change if the Plan of Dissolution is not approved and we alter our business strategy. Additional considerations not presently known to us or that we currently believe are immaterial may also impair our business operations. If any of the following risks actually occurs, our business, financial condition or operating results could be materially and adversely affected, the value of our common stock could decline and our shareholders may lose all or part of their investment.

Continuing to pursue the commercialization of our Renova ^TM Cortical Stimulation System would require significant changes to our current operations, which may not be possible to implement in a timely manner, if at all.

If our shareholders do not approve the Plan of Dissolution and our board of directors determines that we should pursue our historical business model of seeking to commercialize our Renova ^TM Cortical Stimulation System for the treatment of major depressive disorder, we will need to significantly change our current operations. We have terminated substantially all of our employees, are in the process of terminating all of our ongoing clinical trials, informed the FDA of such intention to terminate and commenced the process of winding up our business. We took these steps in the interest of preserving cash available for distribution to shareholders and in recognition of the expectation that the announcement of approval of the Plan of Dissolution would adversely affect our ability to proceed with our PROSPECT clinical trials. There is currently no active business left to operate, and rehiring employees and recommencing our PROSPECT clinical trials would take several months at a cost we are unable to estimate. Pursuing the commercialization of our Renova ^TM Cortical Stimulation System would require us to:

•

attract and retain additional personnel, including a senior management team and other key employees;

•

restart our PROSPECT clinical trials, including re-engaging with the U.S. Food and Drug Administration, or FDA, clinical sites and medical professionals necessary to carry out clinical trials; and

•

resume our other clinical efforts and clinical support functions.

Implementing the changes necessary to pursue the commercialization of our Renova ^TM Cortical Stimulation System will require time and resources, and the parties with whom we must do business may be reluctant to work with us given our announced intention to wind up our trials, business and affairs. We may not be able to implement these changes in a timely manner, if at all, which would have a material and adverse effect on our ability to pursue our historical business model.

If we are unable to commercialize our Renova ™ Cortical Stimulation System for any reason, our ability to generate revenue will be significantly harmed and our stock price will likely decline.

Since June 2003 we have invested substantially all of our financial resources and our research and product development efforts in our Renova ™ Cortical Stimulation System. We do not anticipate generating any revenue for several years and may never become profitable. Prior to January 2009, we had focused substantially all of our workforce, clinical and research efforts, and financial assets on the continued development of a therapy for major depressive disorder. The commercial success of our Renova ™ Cortical Stimulation System depends upon:

•

restarting and completing our PROSPECT clinical trials and successfully demonstrating the safety and efficacy of our system for the treatment of major depressive disorder;

•

completing future trials, including a pivotal trial, that successfully demonstrate the safety and efficacy of our system for the treatment of major depressive disorder;

•

obtaining approval from the FDA to market our Renova ™ Cortical Stimulation System in the U.S.;

•

manufacturing our system in commercial quantities;

•

the commercial launch and market acceptance of our system; and

•

obtaining levels of reimbursement by governmental and other third party payors, such as the Medicare and Medicaid programs and private healthcare insurers.

If we do not achieve each of these objectives, we may be unable to commercialize our Renova ™ Cortical Stimulation System or generate any revenue, which would materially and adversely affect our financial position, operating results, and stock price and could force us to cease operations.

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

We are a development stage company with a limited operating history and no revenue from the sale of our cortical stimulation product. We have incurred losses in each year since our formation in 1999. If we continue to operate our business, we currently do not have, and do not expect to have for several years, any products approved for commercialization or any source of revenue. We have been engaged in research and development since our inception and have invested substantially all of our time and resources in developing our Renova ™ Cortical Stimulation System. Development of a new medical device, including conducting clinical trials and seeking regulatory approvals, is a long, expensive, and uncertain process. We expect to continue incurring significant operating losses for at least the next several years. These losses have had, and will continue to have, an adverse effect on our shareholders’ equity and working capital.

We expect to incur significant clinical and regulatory expenses in connection with our clinical trials and trials that we may initiate in the future. We also expect our product development expenses to continue in connection with our product development initiatives. In addition, if the FDA approves our Renova ™ Cortical Stimulation System for the treatment of major depressive disorder, we would incur significant corporate infrastructure and sales and marketing expenses, prior to recording sufficient revenue to offset these expenses. If we are unable to successfully develop, receive regulatory approval for, and commercialize, our Renova ™ Cortical Stimulation System, we may never generate revenue or be profitable and we may have to cease operations. Because of the numerous risks and uncertainties associated with developing new medical devices, we are unable to predict the extent of any future losses or when we will become profitable, if ever.

Our Renova™ Cortical Stimulation System is based on novel technology.

We are subject to the risks of failure inherent in the development of products based on new technologies. The use of our Renova ™ Cortical Stimulation System to treat neurological diseases and disorders, including major depressive disorder, is a novel application of neurostimulation therapy that has not previously been investigated to any meaningful extent. The novel nature of our treatment results in significant technical, scientific, and regulatory challenges related to product development and system optimization, government regulation, third-party reimbursement, and market acceptance. Accordingly, our Renova ™ Cortical Stimulation System may not become a viable commercial alternative to other therapies, including those based on electrical stimulation of other parts of the brain or nervous system. These challenges may prevent us from developing and commercializing our Renova ™ Cortical Stimulation System on a timely and profitable basis, or at all.

We will need substantial additional funding and may not be able to raise capital when needed, which would force us to delay, reduce or eliminate our product development efforts.

Until the time, if ever, when we can generate a sufficient amount of product revenue, we expect to finance our future cash needs through public or private equity offerings, debt financings, corporate collaboration, or licensing arrangements, as well as through income earned on cash and investment balances.

Additional capital may not be available when needed on terms favorable to us, if at all. If we raise additional funds by issuing equity securities, our shareholders will experience dilution. Debt financing, if available, would likely involve restrictive covenants or additional security interests in our assets. Any additional debt or equity financing may contain terms that are not favorable to our shareholders or us. If we raise additional funds through collaboration or licensing arrangements with third parties, it may be necessary to relinquish rights to our technologies or products, or grant licenses on terms that are not favorable to us. If we are unable to raise adequate funds, we may have to delay, reduce the scope of, or eliminate some or all of, our development programs, or liquidate some or all of our assets.

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

•

the scope, rate of progress, and cost of our clinical trials;

•

clinical trial results;

•

costs of ongoing research and development related to depression;

•

the costs and timing of regulatory approvals;

•

the working capital required for general and administrative expenses;

•

the cost and timing of establishing sales, marketing and distribution capabilities;

•

the cost of establishing clinical and potential commercial supplies of our Renova ™ Cortical Stimulation System and any other products that we may develop;

•

the rate of market acceptance of our device;

•

the effect of competing products and market developments;

•

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

•

the cost of defending other litigation or disputes with or claims by third parties; and

•

the extent to which we acquire or invest in businesses, products, and technologies.

If we are unable to complete, or experience delays in completing, our clinical trials, or if our clinical trial results are insufficient in meeting clinical or regulatory objectives, our ability to commercialize our Renova™ Cortical Stimulation System and our financial position will be impaired.

Conducting clinical trials is a long, expensive, complex, and uncertain process. Conducting clinical trials involves screening, assessing, testing, treating, and monitoring patients at clinical sites, coordinating with patients and clinical institutions as well as with neurologists, neurosurgeons, psychiatrists, radiologists, and other medical specialists. Our board of directors approved the Plan of Dissolution immediately prior to the enrollment of the first patient in our expanded PROSPECT clinical trial, which would have been our second clinical study of our Renova™ Cortical Stimulation System for the treatment of major depressive disorder. We have informed the FDA of our intention to terminate all of our ongoing clinical trials. Therefore, to complete our PROSPECT clinical trials we would have to attract and retain additional personnel, including a senior management team and other key employees, re-engage with the FDA and obtain approval to restart our clinical trials, re-engage with the six clinical trial sites and restart our enrollment efforts. As a result, even if we were able to restart our PROSPECT clinical trials, we would experience significant obstacles in completing our clinical trials, and they could be delayed or cancelled for several reasons, including:

•

we may not be able to attract and retain sufficient additional personnel to support the clinical trials;

•

patients may not enroll, randomize, or complete the clinical trials at the rate we expect;

•

patient attrition rates may significantly exceed our expected attrition rates;

•

patients may experience serious device or procedure-related adverse reactions, causing us, a clinical site Institutional Review Board, the study Data and Safety Monitoring Board, the FDA, or other regulatory authorities to suspend or terminate the clinical trial;

•

clinical trial sites and investigators previously engaged to conduct our clinical trials may elect not to re-engage;

•

clinical investigators may not perform the trial on schedule or consistent with the trial protocol, regulations, and good clinical practices; and

•

regulatory inspections of the trial or manufacturing facilities may require us to undertake corrective action or suspend or terminate our clinical trial if inspectors have concerns regarding our compliance with regulatory requirements.

If our clinical trials are delayed, it will take longer to commercialize related products and achieve revenue. In addition, our research and development costs will likely increase if we experience material delays in our clinical trials or if we need to perform more or larger clinical trials than planned.

The use of our Renova™ Cortical Stimulation System for treatment of major depressive disorder will require sustained delivery of electrical stimulation, which involves additional risks.

The use of our cortical stimulation therapy system for the treatment of major depressive disorder will require a long-term implant and sustained delivery of electrical stimulation to the cortex. Long-term implants and sustained delivery of stimulation may involve additional challenges and risks, including the following:

•

the battery in our current implantable pulse generator, or IPG, is not rechargeable, and IPG replacements in patients may be necessary to support sustained electrical stimulation;

•

the therapeutic effect on the patient may not be sustained;

•

the clinical trials necessary to support FDA approval of a long-term implantable device that delivers sustained electrical stimulation may require longer term follow-up data; and

•

the FDA may require additional data.

We have chosen to optimize the treatment of major depressive disorder with our cortical stimulation therapy system by implanting an electrode below the dura, the outermost membrane covering the brain, which involves additional risks.

To achieve the maximum benefit from our cortical stimulation therapy system, we believe that, for the treatment of major depressive disorder, the electrode through which cortical stimulation is provided may require implant below the dura. In previous clinical trials, the electrode is or has been implanted on the dura. For our PROSPECT II clinical trial, we had planned to place the electrode below the dura. Implanting the electrode below the dura involves additional risks, including the potential more serious infections than if the electrode were implanted on the dura, the risk of a subdural hemorrhage, and cerebral spinal fluid leaks. These additional risks may adversely affect the willingness of potential patients to participate in our PROSPECT clinical trials, and the safety profile of our product for the treatment of major depressive disorder, which could make regulatory approval and market acceptance less likely.

We may be unable to retain management and other personnel we need to succeed.

Our success as an operating entity would depend substantially on the services of a senior management team and other key employees. As of May 1, 2009, we had only 5 employees and expect this number to decline significantly over the coming months. Accordingly, to recommence an operating business, we would need to rehire a senior management team and other key employees, and the loss of the services of one or more of these employees could have a material adverse effect on our business.

The medical device and pharmaceutical industries are highly competitive and subject to rapid technological change. Products that are safer or more effective than our products for the treatment of depression may exist or be developed which could reduce or eliminate our commercial opportunities.

The medical device and pharmaceutical industries are highly competitive and subject to rapid technological change. In particular, the neuromodulation industry in which we operate has grown significantly in recent years, and is expected to continue to expand as technology continues to evolve and awareness of neuromodulation as an effective or potential therapy expands. We face potential competition from other neuromodulation technologies, off-label use of current technologies, and currently available, non-invasive therapies that are medically accepted for treating large populations of patients affected by neurological diseases and disorders for which reimbursement levels are already or may be established. Many of our competitors have significantly greater financial resources and expertise in research and development, manufacturing, clinical trials, obtaining regulatory approvals, and marketing approved products than we do. Smaller or early-stage companies may also prove to be significant competitors, particularly if they pursue competing solutions through collaborative arrangements with large and established companies. Our competitors may:

•

develop and patent processes or products earlier than us;

•

obtain regulatory approvals for competing products more rapidly than us; or

•

develop more effective, safer, less-invasive, or less-expensive products or technologies.

The field of human therapeutics is characterized by large public and private investment in existing and new technologies, constant evolution, and occasional breakthrough products that revolutionize treatment of a particular disease or disorder. It is possible that, even if we successfully commercialize a product, subsequent or existing pharmaceutical or medical device breakthroughs would render our product non-competitive or obsolete.

We may not secure regulatory approval for our Renova™ Cortical Stimulation System, even if we believe our clinical trial results demonstrate the efficacy of our cortical stimulation therapy.

We cannot market our products in the U.S. unless the FDA has approved, or cleared, them. Even if we submit an application to the FDA with clinical data that we believe justifies marketing approval for our Renova ™ Cortical Stimulation System, the FDA may not approve our submission, or may request additional information, including data from additional clinical trials. The FDA may also approve our system for very limited purposes with many restrictions on its use, may delay approval, or ultimately may not grant marketing approval for our system. Because our system represents a novel way to treat neurological diseases and disorders such as depression and there are large populations of patients who might be eligible for treatment, it is possible that the FDA and other regulatory bodies will review an application for approval of our Renova ™ Cortical Stimulation System with greater scrutiny, thereby causing the regulatory review process to be lengthier and more involved than that for products without such characteristics. The FDA may not approve our Renova ™ Cortical Stimulation System for the treatment of any indication, even if the clinical trial data meets or exceeds our anticipated levels of safety and efficacy.

The manufacturing facilities of our suppliers must comply with applicable regulatory requirements. If these manufacturing facilities do not maintain or receive regulatory approval, our business and our results of operations would be harmed.

Completion of our clinical trials and commercialization of our Renova ™ Cortical Stimulation System require access to manufacturing facilities that meet applicable regulatory standards to manufacture a sufficient supply of our products. We rely primarily on third parties to manufacture, assemble, and sterilize our system. The FDA must determine that compliance is satisfactory at facilities that manufacture our products. Suppliers of some components of our products must also comply with FDA regulation, which often requires significant time, money, and record-keeping and quality assurance efforts, and subjects us and our suppliers to potential regulatory inspections and stoppages. Our suppliers may not satisfy these requirements. If the FDA finds their compliance status to be unsatisfactory, completion of our clinical trials could be delayed, or our ability to manufacture our system for commercial purposes could be impaired, which would harm our business and our results of operations.

Our Renova™ Cortical Stimulation System may never achieve market acceptance or adequate levels of reimbursement even if we obtain regulatory approvals.

Market acceptance of our Renova ™ Cortical Stimulation System for the treatment of major depressive disorder will depend on successfully communicating the benefits of our cortical stimulation therapy to each of the different constituencies involved in deciding whether to treat a particular patient using cortical stimulation therapy, including:

•

the patients and their families;

•

the various healthcare providers, and other specialists who treat patients who suffer from depression;

•

institutions such as hospitals as well as opinion leaders in these institutions; and

•

third party payors, such as private healthcare insurers, Medicaid or Medicare, which would ultimately bear most of the costs for the various providers and medical devices involved in the procedures.

Marketing to each of these constituencies requires a different approach, and we must convince each of these groups of the efficacy and utility of using our Renova ™ Cortical Stimulation System to treat major depressive disorder to be successful. Our ability to market our system successfully to each of these constituencies will depend on a number of factors, including:

•

the perceived effectiveness and long-term results of our therapy;

•

the level of education and awareness concerning our therapy among physicians and potential patients and their families;

•

acceptance of the measures used to assess the efficacy of our therapy;

•

the price of our system and the associated costs of the surgical procedure and treatment;

•

the availability of sufficient third party coverage or reimbursement;

•

the frequency and severity of any side effects;

•

the willingness of patients to undergo surgery; and

•

the viability and perceived advantages and disadvantages of alternative treatments.

If our cortical stimulation therapy does not achieve an adequate level of acceptance by the relevant constituencies, we may not generate significant product revenue and may not become profitable.

We depend on a limited number of manufacturers and single source suppliers of various key components for our Renova™ Cortical Stimulation System. The loss of any of these manufacturer or supplier relationships could delay our clinical trials of our Renova™ Cortical Stimulation System.

We have relied primarily on third parties to manufacture our Renova ™ Cortical Stimulation System and to supply us with all of the key components of our system, including our IPGs, cortical stimulation leads and handheld programmers. We have entered into multi-year agreements with our manufacturers and primary suppliers that generally require us to fulfill all of our manufacturing needs and purchase all of our worldwide requirements for components from these parties. These agreements expire during 2010. There is no overlap among these suppliers, insofar as we obtain each of our components from a single supplier. There are a limited number of alternative suppliers that are capable of

manufacturing the components of our system, and the terms of our agreements significantly limit our ability to work with other suppliers to ensure backup sources of our components. If any of our existing suppliers were unable or unwilling to meet our demand for product components, or if the components or finished products that they supply do not meet quality and other specifications, our clinical trials could be delayed and the development of our Renova ™ Cortical Stimulation System could be delayed or prevented.

If we have to switch to a replacement manufacturer or replacement supplier for any of our product components, we may face additional regulatory delays, and the manufacture and delivery of our system could be interrupted for an extended period of time, which could delay completion of our clinical trials. In addition, we may be required to obtain regulatory approval from the FDA to use different suppliers or components. To date, our component requirements have consisted only of the limited quantities that we need to conduct our clinical trials.

We face the risk of product liability claims and may not be able to obtain adequate insurance.

Our business exposes us to a risk of product liability claims that is inherent in the testing, manufacturing, and marketing of medical devices. We may be subject to product liability claims if our Renova ™ Cortical Stimulation System, causes, or appears to have caused, an injury. We have a product liability insurance policy, which covers the use of our products in our clinical trials, of which the amount we believe is appropriate. Our current product liability insurance may not continue to be available to us on acceptable terms, if at all, and, if available, the coverage may not be adequate to protect us against any future product liability claims. If we are unable to obtain insurance at an acceptable cost and on acceptable terms for an adequate coverage amount or otherwise to protect against potential product liability claims, we could be exposed to significant liabilities, which may harm our business. A product liability claim, recall, or other claim with respect to uninsured liabilities or for amounts in excess of insured liabilities could have a material adverse effect on our business, financial condition and results of operations. Defending a suit, regardless of merit, could be costly, could divert management attention and might result in adverse publicity, which could result in the withdrawal of, or inability to recruit, clinical trial volunteers. We may be subject to product liability claims even if it appears that the claimed injury is due to the actions of others. For example, we rely on the expertise of surgeons, other physicians, and other medical personnel to perform the medical procedures to implant and remove our Renova ™ Cortical Stimulation System and participate in other facets of our therapies. If these medical personnel are not properly trained or are negligent, the therapeutic effect of our system may be diminished or the patient may suffer critical injury, which may subject us to liability. In addition, an injury that is caused by the negligence of one of our suppliers could be the basis for a claim against us.

The financial reporting obligations of being a public company and other laws and regulations relating to corporate governance matters place significant demands on our management and cause increased costs.

The laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and new rules adopted or proposed by the SEC, will result in ongoing costs to us as we comply with new and existing rules and regulations and respond to requirements under such rules and regulations. We are required to comply with many of these rules and regulations, and will be required to comply with additional rules and regulations in the future. As an early development stage company with limited capital and human resources, management’s time and attention will be diverted from our business in order to ensure compliance with these regulatory requirements. This diversion of management’s time and attention as well as ongoing legal and compliance costs may have a material adverse effect on our business, financial condition and results of operations.

Failure of our internal control over financial reporting could harm our business and financial results.

Our management is responsible for establishing and maintaining effective internal control over financial reporting. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of financial reporting for external purposes in accordance with accounting principles generally accepted in the U.S. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to report financial results accurately and timely or to detect and prevent fraud. A significant financial reporting failure could cause an immediate loss of investor confidence in our management and a decline in the market price of our common stock.

If we do not achieve our projected business goals in the time frames we announce and expect, our stock price may decline.

From time to time, we estimate and publicly announce expectations for future financial results and the anticipated timing of the accomplishment of various clinical, regulatory and product development goals. These statements, which are forward-looking statements, include but are not limited to our estimates regarding cash use, projected cashflow and other financial forecasts, operating losses, patient enrollment in our clinical trials, when we expect to complete our clinical trials, when trial data will be publicly disclosed, when we expect to obtain FDA approval for or begin to receive revenue from any of our products, or the results of our strategic alternatives analysis. These estimates are, and must necessarily be, based on a variety of assumptions. The timing of the actual achievement of these milestones may vary dramatically compared to our estimates, in some cases for reasons beyond our control. Our failure to meet any publicly-announced goals may be perceived negatively by the public markets, and, as a result, our stock price may decline.

Risks Related to Our Intellectual Property

If we are unable to obtain or maintain intellectual property rights relating to our technology and cortical stimulation therapy system, the commercial value of our technology and any future products will be adversely affected and our competitive position will be harmed.

We depend in part on our ability to obtain protection in the U.S. and other countries for our cortical stimulation therapy system and processes by establishing and maintaining intellectual property rights relating to or incorporated into our technology and products. While we hold a number of patents in the neurostimulation field, several other companies also hold patents in the field. In particular, there are several patents and patent applications that address neurostimulation for the treatment of depression. Our pending and future patent applications may not issue as patents or, if issued, may not issue in a form that will provide us any competitive advantage. Even if issued, existing or future patents may be challenged, narrowed, invalidated or circumvented, which could limit our ability to stop competitors from marketing similar products or limit the length of term of patent protection we may have for our products. Changes in patent laws, patent rules, or their interpretations in the U.S. and other countries could also diminish the value of our intellectual property or narrow the scope of our patent protection. In addition, the availability of patents in foreign markets, and the nature of any protection against competition that may be afforded by those patents, is often difficult to predict and vary significantly from country to country. We, our licensors, or our licensees may choose not to seek, or may be unable to obtain, patent protection in a country that could potentially be an important market for our Renova ™ Cortical Stimulation System. The confidentiality agreements that are designed to protect our trade secrets could be breached, and we might not have adequate remedies for the breach. Additionally, our trade secrets and proprietary know-how might otherwise become known or be independently discovered by others. As a result, our patent portfolio may not provide us with sufficient rights to exclude others from commercializing products similar or identical to ours. In order to preserve and enforce our patent and other intellectual property rights, we may need to make claims or file lawsuits against third parties. This can entail significant costs to us and divert our management’s attention from developing and commercializing our products.

If we infringe or are alleged to infringe the intellectual property rights of third parties, our business could be adversely affected.

Our cortical stimulation therapy may infringe or be claimed to infringe patents that we do not own or license, including patents that may issue in the future based on patent applications of which we are currently aware, as well as applications of which we are unaware. We are aware of other companies that are investigating neurostimulation, including deep brain stimulation, vagus nerve stimulation, and rTMS, as well as cortical stimulation, for the treatment of depression, and of patents and published patent applications held by companies with those technologies and in the depression field that may limit our ability to secure patent protection for our technologies. While the applicability of such patents and

patent applications to our products and technologies and the validity of these patents and patent applications are uncertain, third parties who own or control these patents and patent applications in the U.S. and abroad could bring claims against us that could cause us to incur substantial expenses and, if successfully asserted against us, could cause us to pay substantial damages and would divert management’s attention. As the number of competitors in the market for the treatment of neurological diseases and disorders, specifically with neurostimulation treatment grows, the possibility of inadvertent patent infringement by us or a patent infringement claim against us increases. Further, if a patent infringement suit were brought against us, we could be forced to delay or abandon commercialization of the product that is the subject of the suit.

As a result of patent infringement claims, or to avoid potential claims, we may choose or be required to seek a license from the third party and be required to pay license fees or royalties, or both. These licenses may not be available on acceptable terms, or at all. Even if we were able to obtain a license, the rights may be nonexclusive, which could result in our competitors gaining access to the same intellectual property. Ultimately, we could be forced to cease aspects of our business operations if, as a result of actual or threatened patent infringement claims, we are unable to enter into licenses on acceptable terms. This could harm our business significantly.

If we are unable to protect the confidentiality of our proprietary information and know-how, the value of our technology and products could be adversely affected.

In addition to patented technology, we rely on our unpatented proprietary technology, trade secrets, processes, and know-how. We generally seek to protect this information by confidentiality agreements with our employees, consultants, scientific advisors and third parties. These agreements may be breached, and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by competitors. To the extent that our employees, consultants or contractors use intellectual property owned by others in their work for us, disputes may arise as to the rights in related or resulting know-how and inventions.

Risks Related to Our Common Stock

Whether or not our shareholders approve the Plan of Dissolution, our stock price is volatile, and purchasers of our common stock could incur substantial losses.

Our stock price has been volatile and is likely to continue to be volatile. The stock market in general and the market for small healthcare companies in particular have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. In addition, we may experience additional volatility in light of the adoption of the Plan of Dissolution, subject to shareholder approval. Whether or not our shareholders approve the Plan of Dissolution, the price for our common stock may be influenced by many factors, including:

•

shareholder estimates of the amounts and timing of distributions to shareholders;

•

developments or disputes concerning patents or other proprietary rights;

•

litigation or other disputes with or claims by third parties;

•

results of our clinical trials, if restarted;

•

shareholder or third party speculation concerning our strategic alternatives and investors’ perceptions of us;

•

regulatory developments in the U.S. and foreign countries;

•

sales or anticipated sales of our common stock; and

•

general economic, industry and market conditions.

A decline in the market price of our common stock could cause investors to lose some or all of their investments. In addition, because of the past significant declines in our stock price, shareholders may initiate securities class action lawsuits against us, which may cause us to incur substantial costs and could divert the time and attention of our management.

We are at risk of securities class action litigation due to our stock price volatility.

We are at risk of being subject to securities class action lawsuits if our stock price declines substantially. Securities class action litigation has often been brought against other companies following a decline in the market price of its securities, such as the stock price decline that we experienced in late January 2008 following our announcement that our EVEREST pivotal trial did not meet its primary endpoint. Securities litigation could result in substantial costs, divert management’s attention and resources, and seriously harm our business, financial condition and results of operations.

While no securities class action claims have been brought against us directly, the members of our board of directors are currently the subject of a putative class action complaint and it is possible that additional lawsuits could be filed based on such stock price decline naming our company, directors, and officers.

If there are substantial sales of common stock, our stock price could decline.

If our existing shareholders sell a large number of shares of common stock or the public market perceives that existing shareholders might sell shares of common stock, the market price of our common stock could decline significantly.

Anti-takeover defenses that we have in place could prevent or frustrate attempts to change our direction or management.

Provisions of our articles of incorporation and bylaws and applicable provisions of Washington law may make it more difficult or impossible for a third party to acquire control of us without the approval of our board of directors. These provisions:

•

limit who may call a special meeting of shareholders;

•

provide for a classified board of directors;

•

provide that our board of directors may only be removed for cause by the affirmative vote of our shareholders;

•

establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on at shareholder meetings;

•

prohibit cumulative voting in the election of our directors; and

•

provide our board of directors the ability to designate the terms of and issue a new series of preferred stock without shareholder approval.

In addition, Washington law generally prevents us from engaging in any business combination or other transactions with persons who beneficially own 10% or more of our voting securities without the prior approval of our board of directors for a period of five years following the date such person acquires the shares, or without obtaining approval from our board of directors and holders of at least two-thirds of our common stock. We cannot “opt out” of this statute. These provisions may deprive investors of the opportunity to sell their shares to potential acquirors at a premium over prevailing prices or could prevent us from selling our assets to one or more of our 10% shareholders, even at a price that our board of directors may find favorable. This potential inability to obtain a control premium could reduce the price of our common stock.

In addition, our board of directors adopted a shareholder rights plan, pursuant to which the board of directors declared a dividend distribution of one preferred stock purchase right for each outstanding share of our common stock. The purchase rights have anti-takeover effects. The purchase rights could cause substantial dilution to a person or group who attempts to acquire us on terms not approved by our board of directors. In addition, the purchase rights may have the effect of delaying or deterring an acquisition of us.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Our initial public offering of common stock was effected through a Registration Statement on Form S-1 (File No. 333-132135), which was declared effective by the Securities and Exchange Commission on May 4, 2006, and a Registration Statement on Form S-1 filed pursuant to Rule 462 (File No. 333-133827) that also was effective on May 4, 2006.

We received net proceeds of $112.0 million from the offering and, as of March 31, 2009, $60.2 million remains invested in money market accounts and investment securities. We have used $51.8 million:

•

for direct costs to conduct and complete our clinical trials;

•

to continue the development of our Renova System;

•

to continue the development of our cortical stimulation system therapy for applications, including depression and other clinical trials and research programs; and

•

working capital and other general corporate purposes.

The amounts we actually expend in these areas may vary significantly from our expectations and will depend on a number of factors, including actual results of our clinical trials, operating costs, and capital expenditures.

Item 6.

Exhibits

Description of Document

Incorporated by Reference

Exhibit

Number

Form

File No.

Date of
First Filing

Exhibit
Number

Filed
Herewith

2.1

Plan of Complete Liquidation and Dissolution of Northstar Neuroscience, Inc. dated January 5, 2009

Schedule 14A

001-34078

2/23/2009

Annex A

10.1

Lease Termination Agreement dated March 3, 2009 between Northstar Neuroscience, Inc. and Selig Real Estate Holdings Eight

8-K

001-34078

3/5/2009

10.1

10.2

Form of First Amendment to Executive Employment Agreement by and between Northstar Neuroscience, Inc. and Brian B. Dow

8-K

001-34078

1/27/2009

10.1

31.1

Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

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


				NORTHSTAR NEUROSCIENCE, INC.

Dated: May 13, 2009				/s/ Brian B. Dow
				Brian B. Dow
				Vice President of Finance, Chief Financial Officer, and Secretary

EXHIBIT INDEX

Description of Document

Incorporated by Reference

Exhibit
Number

Form

File No.

Date of
First Filing

Exhibit
Number

Filed
Herewith

2.1

Plan of Complete Liquidation and Dissolution of Northstar Neuroscience, Inc. dated January 5, 2009

Schedule 14A

001-34078

2/23/2009

Annex A

10.1

Lease Termination Agreement dated March 3, 2009 between Northstar Neuroscience, Inc. and Selig Real Estate Holdings Eight

8-K

001-34078

3/5/2009

10.1

10.2

Form of First Amendment to Executive Employment Agreement by and between Northstar Neuroscience, Inc. and Brian B. Dow

8-K

001-34078

1/27/2009

10.1

31.1

Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Northstar Neuroscience, Inc. 10-Q