Summary of MAKO SURGICAL CORP.

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
In this report, "MAKO Surgical", "MAKO", the "Company," "we," "us" and "our" refer to MAKO Surgical Corp.
The following discussion and analysis of our financial condition and results of operations should be read together with our condensed financial statements and related notes appearing elsewhere in this report. This report contains forward-looking statements regarding, among other things, statements related to expectations, goals, plans, objectives and future events. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 21E of the Securities Exchange Act of 1934 and the Private Securities Reform Act of 1995. In some cases, you can identify forward-looking statements by the following words: "may," "will," "could," "would," "should," "expect," "intend," "plan," "anticipate," "believe," "estimate," "predict," "project," "potential," "continue," "ongoing" or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. Examples of such statements include, but are not limited to, statements about the timing and number of planned new product introductions, market acceptance of the MAKOplasty solution, the future availability of implants and components of our Tactile Guidance System, or TGS, from third-party suppliers, including single-source suppliers, the anticipated adequacy of our capital resources to meet the needs of our business, our ability to sustain, and our goals for, sales and earnings growth and our success in achieving timely approval or clearance of products with domestic and foreign regulatory entities. These statements are based on the current estimates and assumptions of our management as of the date of this report and are subject to risks, uncertainties, changes in circumstances, assumptions and other factors that may cause actual results to differ materially from those indicated by forward-looking statements, many of which are beyond our ability to control or predict. Such factors, among others, may have a material adverse effect on our business, financial condition and results of operations and may include changes in competitive conditions and prices in our markets, decreases in sales of our principal product lines, increases in expenditures related to increased governmental regulation of our business, loss of key management and other personnel or inability to attract such management and other personnel, unanticipated intellectual property expenditures required to develop and market our products and unanticipated issues in securing regulatory clearance or approvals for upgrades or changes to our products. These and other risks are described in greater detail under Item 1A, "Risk Factors," contained in our annual report on Form 10-K, or Form 10-K, filed with the Securities and Exchange Commission, or SEC, on March 31, 2008. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We do not undertake any obligation to release any revisions to these forward-looking statements publicly to reflect events or circumstances in the future, even if new information becomes available.
"MAKOplasty®," "Tactile Guidance System" and "TGS," as well as the "MAKO" logo, whether standing alone or in connection with the words "MAKO Surgical Corp." are trademarks of MAKO Surgical Corp.
Overview
We are a medical device company that markets our advanced robotic-arm solution and orthopedic implants for minimally invasive orthopedic knee procedures. We offer MAKOplasty, an innovative, restorative surgical solution that enables orthopedic surgeons to consistently, reproducibly and precisely treat patient-specific, early to mid-stage osteoarthritic knee disease. In February 2008, our common stock began trading on The NASDAQ Global Market under the ticker symbol "MAKO" and we closed our initial public offering, or IPO. Through June 30, 2008, our revenue was primarily generated from the sale of our implants and disposable products utilized in MAKOplasty procedures. In accordance with our revenue recognition policy, upon customer acceptance of the sale of our TGS, we defer recognition of the related revenue and cost of revenue until delivery of version 2.0 of the TGS, which is anticipated in the first half of 2009, subject to regulatory clearances or approvals. We have incurred net losses in each year since our inception and, as of June 30, 2008, we had an accumulated deficit of $59.2 million. We expect to continue to incur significant operating losses as we increase our sales and marketing activities and otherwise continue to invest capital in the development and expansion of our products and our business generally. We also expect that our general and administrative expenses will increase due to additional operational and regulatory costs and burdens associated with operating as a public company and due to the rapid expansion of our operations.

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Recent key milestones and goals in the development of our business through June 30, 2008 include the following:
• In January 2008, we obtained 510(k) marketing clearance from the FDA for version 1.2 of our TGS and commercially launched version 1.2 of our TGS in the first quarter of 2008.

• In February 2008, we completed the IPO of our common stock, issuing a total of 5.1 million shares at an issue price of $10.00 per share, resulting in net proceeds to the Company of approximately $43.7 million, after underwriting discounts and commissions of $3.6 million and expenses of approximately $3.7 million.

• We are finalizing development of a TGS software application to enable a single MAKO-branded unicompartmental implant system, combining our inlay and onlay system. We expect to commercially introduce this software version 1.3 of our TGS and the MAKO-branded implant by the end of 2008. We have received a 510(k) clearance for the MAKO-branded implant, and we do not anticipate that TGS version 1.3 will require a 510(k) clearance. The functionality to support the use of the MAKO-branded implant with the TGS was included and cleared as part of version 1.2 of our TGS.

• We are currently developing version 2.0 of our TGS and our modular bicompartmental knee implant system, which would enable both unicompartmental and bicompartmental knee resurfacing procedures. We anticipate that we will commercially introduce version 2.0 of the TGS and the bicompartmental implant system in the first half of 2009, subject to regulatory clearances or approvals. If we were to be denied such clearances or approvals, if such clearances or approvals were delayed or if the required development is unsuccessful or delayed, it could have a material adverse impact on our results of operations.

• In the second quarter of 2008, we filed a 510(k) submission with the FDA for version 2.0 of our TGS. We also received a 510(k) clearance for our unicompartmental implant and a 510(k) clearance for our patellofemoral implant, components of the intended bicompartmental implant system.

We believe that the key to growing our business is expanding the application of MAKOplasty to bicompartmental resurfacing procedures by offering implants that address mid-stage, bicompartmental degeneration. To successfully commercialize our products and grow our business, we must gain market acceptance for MAKOplasty.
Factors Which May Influence Future Results of Operations The following is a description of factors which may influence our future results of operations, including significant trends and challenges that we believe are important to understanding our business and results of operations. Revenue
Revenue is generated from unit sales of our TGS, including installation services, training and upgrades and enhancements, from sales of implants and disposable products, and by providing extended warranty services. To date, we have generated revenue primarily from the sale of implants and disposable products utilized in MAKOplasty procedures, the majority of which was from several significant customers. Recognition of revenue associated with the sale of TGS units in our statements of operations is dependent upon satisfying all related revenue recognition criteria, which include the delivery of version 2.0 of the TGS, which is anticipated to be in the first half of 2009, subject to regulatory clearances or approvals, as more fully described in Item 1, Financial Statements, Note 2 to the Condensed Financial Statements.

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Future revenue from sales of our products is difficult to predict and we expect that it will only modestly reduce our continuing and increasing losses resulting from selling, general and administrative expenses, research and development and other activities for the next several years.
The generation of recurring revenue through sales of our implants, disposable products and service contracts are an important part of the MAKOplasty business model. We anticipate that recurring revenue will constitute an increasing percentage of our total revenue as we leverage each new installation of our TGS to generate recurring sales of implants and disposable products and as we expand our implant product offering.
Cost of Revenue
Cost of revenue primarily consists of the direct costs associated with the manufacture of TGS units, implants and disposable products for which revenue has been recognized in accordance with our revenue recognition policy. Costs associated with providing services are expensed as incurred. Cost of revenue also includes the cost associated with establishing at the time of installation an accrual for the TGS standard one-year warranty liability and royalties related to the sale of products covered by licensing arrangements.
The cost of revenue associated with the sale of TGS units is deferred until the recognition of the related revenue. In addition, we expect that deferred costs of revenue associated with the sale of TGS will be higher during the deferral period due to the additional costs associated with providing hardware enhancements and upgrades through and including the anticipated delivery of version 2.0 of our TGS.
The Company is developing a single MAKO-branded unicompartmental implant system which is expected to launch by the end of 2008. In conjunction with the launch of the new implant system, the Company anticipates discontinuing portions of its current implant line. Depending on the timing of the launch, which is dependant on supply chain and launch strategy, a future write-off of the discontinued implant inventory is possible. Currently, the Company cannot reasonably estimate the amount of the charge, if any, relating to the potential write-off of such inventory; however, depending on the timing of the launch of the new implant system, a charge of up to $600,000 may be required. No write-off was recorded as of June 30, 2008.
Selling, General and Administrative Expenses Our selling, general and administrative expenses consist primarily of compensation, including stock-based compensation, for sales, marketing, operations, regulatory, quality, executive, finance, legal and administrative personnel. Other significant expenses include costs associated with sales and marketing activities, marketing and advertising materials, professional fees for legal and accounting services, consulting fees, travel expenses, facility and related operating costs, and recruiting expenses. Our selling, general and administrative expenses are expected to continue to increase due to the cost associated with the expected commercial launch of version 2.0 of our TGS, our bicompartmental implant system and disposable products, an increased number of employees necessary to support our continued growth in operations, and the additional operational and regulatory burdens and costs associated with operating as a publicly traded company. In addition, we are currently taking preliminary steps to investigate the feasibility of establishing clinical sites outside the United States, which may also increase our selling, general and administrative expenses, and we expect to incur additional costs associated with protecting our intellectual property rights as necessary to support our future product offerings.
Research and Development Expenses
Costs related to research, design and development of products are charged to research and development expense as incurred. These costs include direct salary costs for research and development employees including stock-based compensation, cost for materials used in research and development activities and costs for outside services. Research and development expenses are expected to continue to increase as we develop version 2.0 of our TGS and our bicompartmental implant system.

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Critical Accounting Policies
A summary of our critical accounting policies is included in our Form 10-K, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations." There have been no changes to those policies for the six months ended June 30, 2008.
Results of Operations
Comparison of the Three Months Ended June 30, 2008 to the Three Months Ended June 30, 2007
Revenue. Revenue was $704,000 for the three months ended June 30, 2008, compared to $106,000 for the three months ended June 30, 2007, and was primarily generated from the sale of implants and disposable products utilized in MAKOplasty procedures. The increase in revenue of $598,000 was primarily due to an increase in MAKOplasty procedures performed during the three months ended June 30, 2008 as compared with the three months ended June 30, 2007. There were 140 procedures performed during the three months ended June 30, 2008 compared to 21 procedures performed during the three months ended June 30, 2007. The increase was also attributable to a $116,000 increase in other revenue, which consists primarily of service revenue on extended warranty services and net royalty revenue. We expect our revenue to increase as the number of MAKOplasty procedures performed increases in future periods. The deferred revenue balance was $6.5 million and $696,000 as of June 30, 2008 and 2007, respectively. The deferred revenue balance primarily consisted of the deferred revenue associated with the sale of ten and one unit sales of our TGS, as of June 30, 2008 and 2007, respectively. Deferred revenue related to unit sales of our TGS will be recognized in our statement of operations if and when we have satisfied all related revenue recognition criteria. The criteria include the delivery of version 2.0 of the TGS, which is anticipated to be in the first half of 2009, subject to regulatory clearances or approvals.
Cost of Revenue. Cost of revenue was $480,000 for the three months ended June 30, 2008, compared to $47,000 for the three months ended June 30, 2007. The increase in cost of revenue of $433,000 was primarily due to an increase in MAKOplasty procedures performed, the establishment of warranty accruals on sales of TGS units and royalties incurred on sales of TGS units during the three months ended June 30, 2008. We expect our cost of revenue to increase as the number of MAKOplasty procedures performed increases in future periods. In addition, anticipated increases in sales of our TGS units will result in an increase in royalty and warranty expense. The deferred cost of revenue balance was $2.2 million and $212,000 as of June 30, 2008 and 2007, respectively. The increase in the deferred cost of revenue balance is primarily related to unit sales of our TGS during 2008 and 2007. Deferred cost of revenue related to unit sales of our TGS will be recognized in our statement of operations if and when we have satisfied all related revenue recognition criteria. The criteria include the delivery of version 2.0 of the TGS, which is anticipated to be in the first half of 2009, subject to regulatory clearances or approvals.
Selling, General and Administrative. Selling, general and administrative expense was $5.1 million for the three months ended June 30, 2008, compared to $2.4 million for the three months ended June 30, 2007. The increase of $2.7 million, or 116%, was primarily due to an increase in sales, marketing and operations costs associated with the commercialization of our products and an increase in general and administrative costs to support growth and costs associated with operating as a public company. Selling, general and administrative expense for the second quarter of 2008 also included $484,000 of stock-based compensation expense compared with $53,000 for the comparable quarter of 2007. The increase in stock-based compensation expense was primarily due to additional option and restricted stock grants made in 2008 and 2007. We expect our selling, general and administrative expense to continue to increase substantially due to our planned increase in the number of employees necessary to support the sales and marketing efforts associated with the growing commercialization of MAKOplasty, the anticipated commercial launch of version 2.0 of our TGS in the first half of 2009, continued growth in operations and the costs associated with operating as a public company.
Research and Development. Research and development expense was $2.5 million for the three months ended June 30, 2008, compared to $1.6 million for the three months ended June 30, 2007. The increase of $841,000, or 51%, was primarily due to an increase in research and development activities associated with on-going development of versions 1.2 and 2.0 of our TGS and the MAKO implant systems. We expect our research and development expense to continue to increase as we continue to expand our research and development activities, including the development of version 2.0 of our TGS and our implant systems.

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Depreciation and Amortization. Depreciation and amortization expense was $425,000 for the three months ended June 30, 2008, compared to $301,000 for the three months ended June 30, 2007. The increase of $124,000, or 41%, was primarily due to an increase in depreciation of property and equipment as a result of purchases made during 2008 and 2007.
Interest and Other Income. Interest income was $241,000 for the three months ended June 30, 2008, compared to $316,000 for the three months ended June 30, 2007. The decrease of $75,000, or 24%, was primarily due to lower yields realized on our cash, cash equivalents and investments for the three months ended June 30, 2008 compared with the same period of 2007.
Interest and Other Expenses. Interest and other expenses were $1,000 for the three months ended June 30, 2008, compared to $76,000 for the three months ended June 30, 2007. Through February 2008, interest and other expense consisted primarily of the amortization of the $590,000 discount associated with a deferred payment to IBM of $4.0 million which had been fully amortized and paid upon the completion of our IPO in February 2008.
Income Taxes. No income taxes were recognized for the three months ended June 30, 2008 and 2007, due to net operating losses in each period. In addition, no current or deferred income taxes were recorded for the three months ended June 30, 2008 and 2007, as all income tax benefits were fully offset by a valuation allowance against our net deferred income tax assets. Comparison of the Six Months Ended June 30, 2008 to the Six Months Ended June 30, 2007
Revenue. Revenue was $1.2 million for the six months ended June 30, 2008, compared to $206,000 for the six months ended June 30, 2007, and was primarily generated from the sale of implants and disposable products utilized in MAKOplasty procedures. The increase in revenue of $995,000 was primarily due to an increase in MAKOplasty procedures performed during the six months ended June 30, 2008. There were 242 procedures performed during the six months ended June 30, 2008 compared to 42 procedures performed during the six months ended June 30, 2007. The increase was also attributable to a $194,000 increase in other revenue, which consists primarily of service revenue on extended warranty services and net royalty revenues.
Cost of Revenue. Cost of revenue was $851,000 for the six months ended June 30, 2008, compared to $83,000 for the six months ended June 30, 2007. The increase in cost of revenue of $768,000 was primarily due to an increase in MAKOplasty procedures performed, the establishment of warranty accruals on sales of TGS units and royalties incurred on sales of TGS units during the six months ended June 30, 2008.
Selling, General and Administrative. Selling, general and administrative expense was $9.8 million for the six months ended June 30, 2008, compared to $4.3 million for the six months ended June 30, 2007. The increase of $5.5 million, or 127%, was primarily due to an increase in sales, marketing and operations costs associated with the commercialization of our products and an increase in general and administrative costs to support growth and costs associated with operating as a public company. Selling, general and administrative expense for the six months ended June 30, 2008 also included $908,000 of stock-based compensation expense compared with $110,000 for the same period of 2007. The increase in stock-based compensation expense was primarily due to additional option and restricted stock grants made in 2008 and 2007. Research and Development. Research and development expense was $6.1 million for the six months ended June 30, 2008, compared to $3.2 million for the six months ended June 30, 2007. The increase of $2.9 million, or 93%, was primarily due to an increase in research and development activities associated with on-going development of versions 1.2 and 2.0 of our TGS and the MAKO implant systems; and a nonrecurring charge of $949,000 associated with the vesting in full, upon completion of our IPO in February 2008, of restricted common stock issued pursuant to business consultation agreements entered into in December 2004.

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Depreciation and Amortization. Depreciation and amortization expense was $847,000 for the six months ended June 30, 2008, compared to $571,000 for the six months ended June 30, 2007. The increase of $276,000, or 48%, was primarily due to an increase in depreciation of property and equipment as a result of purchases made during 2008 and 2007.
Interest and Other Income. Interest income was $401,000 for the six months ended June 30, 2008, compared to $552,000 for the six months ended June 30, 2007. The decrease of $151,000, or 27%, was primarily due to lower yields realized on our cash, cash equivalents and investments for the six months ended June 30, 2008 compared with the same period of 2007.
Interest and Other Expenses. Interest and other expenses were $109,000 for the six months ended June 30, 2008, compared to $152,000 for the six months ended June 30, 2007. Through February 2008, interest and other expense consisted primarily of the amortization of the $590,000 discount associated with a deferred payment to IBM of $4.0 million which had been fully amortized and paid upon the completion of our IPO in February 2008. Interest and other expense also included the write down of our variable auction rate securities in the first quarter of 2008 as discussed below under the caption, "Liquidity and Capital Resources," and in Item 1, Financial Statements, Note 3, Short-Term and Long-Term Investments.
Income Taxes. No income taxes were recognized for the six months ended June 30, 2008 and 2007, due to net operating losses in each period. In addition, no current or deferred income taxes were recorded for the six months ended June 30, 2008 and 2007, as all income tax benefits were fully offset by a valuation allowance against our net deferred income tax assets.

Liquidity and Capital Resources

                                                    Six Months Ended June 30,
      (in thousands)                                  2008               2007
      Cash used in operating activities           $     (13,929 )     $   (7,357 )
      Cash used in investing activities                  (4,098 )        (10,149 )
      Cash provided by financing activities              46,487           29,918

      Net increase in cash and cash equivalents   $      28,460       $   12,412

We have incurred net losses and negative cash flow from operating activities for each period since our inception in November 2004. As of June 30, 2008, we had an accumulated deficit of $59.2 million and financed our operations principally through the sale of Series A, Series B and Series C redeemable convertible preferred stock and the completion of the IPO of our common stock. Through June 30, 2008, we received net proceeds of $52.2 million from the issuance of Series A, Series B and Series C redeemable convertible preferred stock. In February 2008, we completed our IPO of common stock, issuing a total of 5.1 million shares at an issue price of $10.00 per share, resulting in net proceeds to us, after expenses, of approximately $43.7 million. In conjunction with the closing of the IPO, in February 2008, all of our outstanding Series A, Series B and Series C redeemable convertible preferred stock was converted into 10,945,080 shares of common stock, as adjusted for a one-for-3.03 reverse stock split, which has been retroactively reflected in the accompanying condensed financial statements.
As of June 30, 2008, we had approximately $39.1 million in cash, cash equivalents and short-term investments. Our cash and short-term investment balances are held in a variety of interest bearing instruments, including U.S. treasury bills and certificates of deposit.
As of June 30, 2008, we held $1,025,000 par value of variable auction rate securities issued by two separate funds. In February 2008, the auction rate securities experienced failed auctions that limited the liquidity of these securities. Based on current market conditions, it is likely that auction failures will continue. The carrying value of the securities are fully collateralized by assets held by the funds and were rated AAA prior to the failed auctions of the securities. Historically the fair value of auction rate securities approximated par value due to the frequent resets through the auction rate process. The continued uncertainty in the credit markets has affected our holdings in auction rate securities, however, and the liquidity and fair value of these investments has been negatively impacted. As a result, the estimated fair value of many of these investments no longer approximate par value. As of June 30, 2008, the carrying value of the Company's auction rate securities was $962,000, which approximates the estimated fair value as of that date. An other-than-temporary impairment charge of $63,000 was recorded to reduce the value of our auction rate securities to the new fair value. In addition, as a result of the unresolved liquidity concerns, we reclassified our auction rate securities from short-term investments to long-term investments.

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Net Cash Used in Operating Activities
Net cash used in operating activities primarily reflects the net loss for those periods, which was reduced in part by depreciation and amortization, stock-based compensation and accrued interest; and was also affected by changes in operating assets and liabilities. Included in the changes in operating assets for the six months ended June 30, 2008 are approximately $3.2 million of increases to the . . .