Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND 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 June 30, 2008**                                                     |
| ** ** | ** ** | ** **                                                                                                 |
| ** ** | ** ** | **OR**                                                                                                     |
| ** ** | ** ** | ** **                                                                                                 |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES****EXCHANGE ACT OF 1934** |

 

**Forthe transition period from              to                    .**

 

**CommissionFile Number: 0-27596**

 

**CONCEPTUS, INC.**

(Exact name ofRegistrant as specified in its charter)

 

| **Delaware**                     | ** ** | **94-3170244**       |
|----------------------------------|------------|----------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer     |
| incorporation or  organization)  |       | Identification  No.) |

 

**331East Evelyn**

**MountainView, CA 94041**

(Address ofPrincipal Executive Offices) (Zip Code)

 

**(650) 962-4000**

(Registrant’sTelephone Number, Including Area Code)

 

 

(Former Name,Former Address and Former Fiscal Year, if Changed Since Last Report)

 

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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon accelerated filer or a smaller reporting company. See definition of “largeaccelerated filer” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act

 
| Large accelerated   filer o |   | Accelerated filer x |   | Non-accelerated   filer o                  |   | Smaller reporting   company o |
|----------------------------------|--------|--------------------------|--------|-------------------------------------------------|--------|------------------------------------|
|                             |   |                     |   | (Do not check if a smaller   reporting company) |   |                               |

 

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

 

Yes  o   No  x

 

There were 30,352,661shares of Registrant’s Common Stock issued and outstanding as of August 1,2008.

 

 

 

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**CONCEPTUS,INC.**

 

**FORM 10-Qfor the Quarter Ended June 30, 2008**

 
| ** **    | ** **                                                                                                                     | **Page**   |
|---------------|--------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **    | ** **                                                                                                                     | ** ** |
| Part I.  | Financial Information                                                                                                          |       | 3 |
|          |                                                                                                                           |       |   |
| Item 1.       | Condensed Consolidated  Financial Statements (Unaudited)                                                                       |       | 3 |
|          |                                                                                                                           |       |   |
|          | a)  Condensed  Consolidated Balance Sheets as of June 30, 2008 and December 31,  2007                      |       | 3 |
|          |                                                                                                                           |       |   |
|          | b)  Condensed  Consolidated Statements of Operations for the Three and Six Months Ended  June 30, 2008 and 2007 |       | 4 |
|          |                                                                                                                           |       |   |
|          | c)  Condensed  Consolidated Statements of Cash Flows for the Six Months Ended June 30,  2008 and 2007           |       | 5 |
|          |                                                                                                                           |       |   |
|          | d) Notes to Condensed Consolidated Financial  Statements                                                                       |       | 6 |
|          |                                                                                                                           |       |   |
| Item 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                    |       | 18 |
|          |                                                                                                                           |       |   |
| Item 3.       | Quantitative  and Qualitative Disclosures About Market Risk                                                                    |       | 28 |
|          |                                                                                                                           |       |   |
| Item 4.       | Controls and  Procedures                                                                                                       |       | 28 |
|          |                                                                                                                           |       |   |
| Part II. | Other  Information                                                                                                             |       | 29 |
|          |                                                                                                                           |       |   |
| Item 1.       | Legal Proceedings                                                                                                              |       | 29 |
|          |                                                                                                                           |       |   |
| Item 1A.      | Risk Factors                                                                                                                   |       | 29 |
|          |                                                                                                                           |       |   |
| Item 4.       | Submission  of Matters to a Vote of Security Holders                                                                           |       | 30 |
|          |                                                                                                                           |       |   |
| Item 6.       | Exhibits                                                                                                                       |       | 30 |

 

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**PART I.FINANCIAL INFORMATION**

 

**1.Condensed Consolidated Financial Statements.**

 

**Conceptus, Inc.**

 

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

**(Inthousands, except number of shares)**

** **
| ** **                                           | ** ** | **June 30,** | ** **  | **December 31,** | ** ** |
|------------------------------------------------------|------------|-------------------|-------------|-----------------------|------------|
| ** **                                           | ** ** | **2008**          | ** **  | **2007**              | ** ** |
| **Assets**                                           |       |              |        |                  |       |
| Current assets:                                      |       |              |        |                  |       |
| Cash and cash  equivalents                           |       | $                 | 21,160      |                  | $          | 28,450 |   |
| Short-term  investments                              |       | —            |        | 16,700                |       |
| Accounts  receivable, net                            |       | 13,632            |        | 11,903                |       |
| Inventories                                          |       | 4,746             |        | 2,418                 |       |
| Other current  assets                                |       | 2,309             |        | 3,271                 |       |
|                                                 |       |              |        |                  |       |
| Total current  assets                                |       | 41,847            |        | 62,742                |       |
|                                                 |       |              |        |                  |       |
| Property and  equipment, net                         |       | 7,091             |        | 5,312                 |       |
| Debt issuance  costs, net                            |       | 2,245             |        | 2,555                 |       |
| Intangible  assets, net                              |       | 5,886             |        | 1,164                 |       |
| Long-term  investments                               |       | 45,835            |        | 48,800                |       |
| Goodwill                                             |       | 16,062            |        | —                |       |
| Other assets                                         |       | 158               |        | 102                   |       |
|                                                 |       |              |        |                  |       |
| **Total  assets**                                    | ** ** | **$**             | **119,124** | ** **            | **$**      | **120,675** | ** ** |
|                                                 |       |              |        |                  |       |
| **Liabilities  and stockholders’ equity**       |       |              |        |                  |       |
| Current  liabilities:                                |       |              |        |                  |       |
| Accounts payable                                     |       | $                 | 5,153       |                  | $          | 4,744 |   |
| Accrued  compensation                                |       | 5,663             |        | 3,175                 |       |
| Interest payable                                     |       | 730               |        | 733                   |       |
| Other accrued  liabilities                           |       | 3,555             |        | 3,606                 |       |
|                                                 |       |              |        |                  |       |
| Total current  liabilities                           |       | 15,101            |        | 12,258                |       |
|                                                 |       |              |        |                  |       |
| Notes payable                                        |       | 86,250            |        | 86,250                |       |
| Other accrued  liabilities                           |       | 358               |        | 240                   |       |
|                                                 |       |              |        |                  |       |
| Total  liabilities                                   |       | 101,709           |        | 98,748                |       |
|                                                 |       |              |        |                  |       |
| Stockholders’  equity:                          |       |              |        |                  |       |
| Common stock and  additional paid-in capital         |       | 263,207           |        | 257,176               |       |
| Accumulated  other comprehensive loss                |       | (2,556            | )           | —                |       |
| Accumulated  deficit                                 |       | (243,236          | )           | (235,249              | )          |
| Treasury stock,  77,863 shares, at cost              |       | —            |        | —                |       |
|                                                 |       |              |        |                  |       |
| Total  stockholders’ equity                     |       | 17,415            |        | 21,927                |       |
|                                                 |       |              |        |                  |       |
| **Total  liabilities and stockholders’ equity** | ** ** | **$**             | **119,124** | ** **            | **$**      | **120,675** | ** ** |

 

*Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.*

 

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**Conceptus, Inc.**

 

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

**(Inthousands, except per share amounts)**

 
| ** **                                       | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                       | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                       | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                        |       | $                                | 25,680     |                           | $          | 15,669 |   | $ | 46,807 |   | $ | 29,449 |   |
| Cost of goods  sold                              |       | 5,196                            |       | 4,238                          |       | 10,641 |   | 7,943 |   |
| Gross profit                                     |       | 20,484                           |       | 11,431                         |       | 36,166 |   | 21,506 |   |
| * *                                         | * *   | * *                         | * *   | * *                       | * *   | * * | * * | * * | * * |
| Operating  expenses:                             |       |                             |       |                           |       |   |   |   |   |
| Research and  development                        |       | 1,644                            |       | 1,061                          |       | 3,575 |   | 2,703 |   |
| Selling, general  and administrative             |       | 20,081                           |       | 13,172                         |       | 40,183 |   | 26,181 |   |
| Total operating  expenses                        |       | 21,725                           |       | 14,233                         |       | 43,758 |   | 28,884 |   |
|                                             |       |                             |       |                           |       |   |   |   |   |
| Operating loss                                   |       | (1,241                           | )          | (2,802                         | )          | (7,592 | ) | (7,378 | ) |
|                                             |       |                             |       |                           |       |   |   |   |   |
| Interest income                                  |       | 338                              |       | 1,309                          |       | 1,229 |   | 2,124 |   |
| Interest expense                                 |       | (641                             | )          | (647                           | )          | (1,277 | ) | (986 | ) |
| Other income  (expense)                          |       | 104                              |       | —                         |       | (179 | ) | — |   |
| Total other  income (expense)                    |       | (199                             | )          | 662                            |       | (227 | ) | 1,138 |   |
|                                             |       |                             |       |                           |       |   |   |   |   |
| Income (loss)  before provision for income taxes |       | (1,440                           | )          | (2,140                         | )          | (7,819 | ) | (6,240 | ) |
| Provision for  income taxes                      |       | 168                              |       | —                         |       | 168 |   | — |   |
| Net loss                                         |       | $                                | (1,608     | )                              | $          | (2,140 | ) | $ | (7,987 | ) | $ | (6,240 | ) |
| Basic and  diluted net loss per share            |       | $                                | (0.05      | )                              | $          | (0.07 | ) | $ | (0.27 | ) | $ | (0.21 | ) |
| Weighted-average  shares used in                 | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| computing basic  and diluted net loss per share  | ** ** | 30,217                           | ** ** | 29,420                         | ** ** | 30,076 | ** ** | 29,340 | ** ** |

 

*Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.*

 

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**Conceptus, Inc.**

 

**Condensed Consolidated Statements ofCash Flows**

**(Unaudited)**

**(Inthousands)**

** **
| ** **                                                               | ** ** | **Six months ended** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                               | ** ** | **June 30,**              | ** ** |
| ** **                                                               | ** ** | **2008**                       | ** ** | **2007** | ** ** |
| **Cash  flows from operating activities**                                |       |                           |       |   |   |
| Net loss                                                                 |       | $                              | (7,987     | ) | $ | (6,240 | ) |
| Adjustments to  reconcile net loss to net cash used in                   |       |                           |       |   |   |
| operating  activities:                                                   |       |                           |       |   |   |
| Depreciation and  amortization of property, plant and equipment          |       | 1,294                          |       | 650 |   |
| Amortization of  debt issuance costs                                     |       | 310                            |       | 232 |   |
| Amortization of  intangibles                                             |       | 390                            |       | 84 |   |
| Stock-based  compensation expense                                        |       | 3,026                          |       | 2,980 |   |
| Allowance for  doubtful accounts                                         |       | (4                             | )          | 102 |   |
| Loss on  retirement of fixed assets                                      |       | —                         |       | 19 |   |
| Changes in  operating assets and liabilities, net effect of acquisition: |       |                           |       |   |   |
| Accounts  receivable                                                     |       | (487                           | )          | (3,742 | ) |
| Inventories                                                              |       | (430                           | )          | (1,989 | ) |
| Other current  assets                                                    |       | 1,289                          |       | (432 | ) |
| Other assets                                                             |       | —                         |       | 436 |   |
| Accounts payable                                                         |       | (1,052                         | )          | 909 |   |
| Accrued  compensation                                                    |       | 111                            |       | (1,390 | ) |
| Other accrued  and long term liabilities                                 |       | 1,402                          |       | 1,598 |   |
| Net cash used in  operating activities                                   |       | (2,138                         | )          | (6,783 | ) |
|                                                                     |       |                           |       |   |   |
| **Cash  flows from investing activities**                                |       |                           |       |   |   |
| Purchase of  Conceptus SAS, net of cash acquired                         |       | (22,978                        | )          | — |   |
| Purchase of  investments                                                 |       | (5,000                         | )          | (82,100 | ) |
| Sale &  maturities of investments                               |       | 22,050                         |       | 11,450 |   |
| Capital  expenditures                                                    |       | (2,375                         | )          | (447 | ) |
| Net cash used in  investing activities                                   |       | (8,303                         | )          | (71,097 | ) |
|                                                                     |       |                           |       |   |   |
| **Cash  flows from financing activities**                                |       |                           |       |   |   |
| Proceeds from  issuance of long term debt, net of issuance costs         |       | —                         |       | 83,154 |   |
| Purchase of call  options on convertible senior notes                    |       | —                         |       | (19,372 | ) |
| Proceeds from  issuance of warrants                                      |       | —                         |       | 10,695 |   |
| Proceeds from  issuance of common stock                                  |       | 3,030                          |       | 2,532 |   |
| Net cash  provided by financing activities                               |       | 3,030                          |       | 77,009 |   |
|                                                                     |       |                           |       |   |   |
| Effect of  exchange rate on cash                                         |       | 121                            |       | — |   |
|                                                                     |       |                           |       |   |   |
| Net decrease in  cash and cash equivalents                               |       | (7,290                         | )          | (871 | ) |
| Cash and cash  equivalents at the beginning of the period                |       | 28,450                         |       | 3,238 |   |
| Cash and cash  equivalents at end of the period                          |       | $                              | 21,160     |   | $ | 2,367 |   |

 

*Theaccompanying notes are an integral part of these condensed consolidatedfinancial statements.*

 

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**Conceptus, Inc.**

 

***NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS***

 

***(Unaudited)***

 

**1.****     ****Basis of Presentation**

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesfor interim financial information and pursuant to the instructions to Form 10-Qand Article 10-01 of Regulation S-X.  Accordingly, they do notinclude all of the information and footnotes required by accounting principlesgenerally accepted in the United States for complete financial statements. Inthe opinion of management, all adjustments, consisting only of normal recurringadjustments, considered necessary for a fair statement have been included.

 

The condensedconsolidated balance sheet at December 31, 2007 has been derived from theaudited consolidated financial statements at that date, but does not includeall of the information and footnotes required by accounting principlesgenerally accepted in the United States for complete financial statements. Thisfinancial data should be reviewed in conjunction with the audited consolidatedfinancial statements and related notes included in our Annual Report on Form 10-Kfor the year ended December 31, 2007.  The results of operations forthe three and six months ended June 30, 2008 may not necessarily beindicative of the operating results for the full 2008 fiscal year or any otherfuture interim periods.

 

Our condensedconsolidated financial statements for the three and six months ended June 30,2008 include the financial results of Conceptus SAS starting on the acquisitiondate of January 7, 2008. All significant intercompany accounts and transactionshave been eliminated in consolidation.

 

We have a limited historyof operations and have incurred significant operating losses since inception.We will continue to be in a net loss position until sufficient revenues can begenerated to offset expenses. In December 2006 we filed a RegistrationStatement on Form S-3, through which we may sell from time to time anycombination of debt securities, common stock, preferred stock and warrants, inone or more offerings, with an initial offering price not to exceed$150,000,000. In February 2007, we issued an aggregate principal amount of$86,250,000 of our 2.25% convertible senior notes due 2027. If the notes areconverted, then upon conversion, holders will receive cash and, if applicable,shares of our common stock based on an initial conversion rate, subject toadjustment, of 35.8616 shares per $1,000 principal amount of notes (whichrepresents an initial conversion price of $27.89 per share), in certaincircumstances. Upon conversion, a holder would receive cash up to the principalamount of the note and our common stock in respect of such note’s conversionvalue in excess of such principal amount. This net share settlement feature ofthe notes would reduce our liquidity, and we may not have sufficient funds topay in full the cash obligation upon such conversion. In the future, dependingupon a variety of factors, we may need to raise additional funds through bankfacilities, debt or equity offerings or other sources of capital. Anyadditional equity financing may be dilutive to stockholders, and debtfinancing, if available, may involve covenants that restrict us. Additionalfunding may not be available when needed or on terms acceptable to us. If weare unable to obtain additional capital, we may be required to delay, reducethe scope of or eliminate our research and development programs or reduce oursales and marketing activities.

 

*RecentAccounting Pronouncements*

 

In September 2006,the Financial Standards Accounting Board, or FASB, issued Statement No. 157,*Fair Value Measurement,* or SFAS 157.This standard defines fair value, establishes the framework for measuring fairvalue in accounting principles generally accepted in the United States andexpands disclosure about fair value measurements. This pronouncement appliesunder other accounting standards that require or

 

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permit fair valuemeasurements. SFAS 157 is effective for financial statements issued for yearsbeginning after November 15, 2007, and interim periods of those fiscalyears. FASB Staff Position 157-2, *Effective Date of FASBStatement No. 157* delays the effective date of SFAS 157 for allnon-financial assets and non-financial liabilities, except for items that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually), until the beginning of the first quarterof 2009.  Effective January 1, 2008we adopted SFAS 157 for financial assets and liabilities carried at fair value.The adoption of SFAS 157 and SFAS 157-2 for financial assets and liabilitiesdid not have a material impact on our condensed consolidated financialstatements.  See Note 4- Fair ValueMeasurements.

 

In February 2007,FASB issued Statement No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*, or SFAS 159, whichpermits entities to choose to measure many financial instruments and certainother items at fair value that are not currently required to be measured atfair value. SFAS 159 became effective for us on January 1, 2008. Theadoption of SFAS 159 did not have a material impact on our condensedconsolidated financial statements.

 

In December 2007,FASB issued Statement No. 141 (revised 2007) *BusinessCombination,s* or SFAS 141(R), and Statement No. 160, *Noncontrolling Interests in Consolidated Financial Statements*,*or SFAS 160*, an amendment of Accounting Research Bulleting No. 51,or ARB 51. SFAS 141(R) will impact financial statements on the acquisitiondate and in subsequent periods. Some of the changes, such as the accounting forcontingent consideration, will introduce more volatility into earnings and mayimpact our acquisition strategy. SFAS 160 will change the accounting andreporting for minority interests, which will be re-characterized asnon-controlling interests and classified as a component of equity. In addition,SFAS 141(R) will be applied prospectively and SFAS 160 will requireretroactive adoption of the presentation and disclosure requirements forexisting minority interests, while the remaining requirements of SFAS 160 willbe applied prospectively. SFAS 141(R) and SFAS 160 are effective on January 1,2009. We are currently evaluating the impact of adopting SFAS 141(R) andSFAS 160 on our consolidated financial statements.

 

In March 2008, theFASB issued SFAS No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities*— an amendment of FASBStatement No. 133 or SFAS No. 161.  SFAS No. 161 requires enhanceddisclosures about how and why an entity uses derivative instruments, howderivative instruments and related hedged items are accounted for and theireffect on an entity’s financial position, financial performance, and cash flows.SFAS No. 161 will be effective in the first quarter of fiscal year2010.  We are evaluating the impact thatthis statement will have, if any, on our consolidated financial statements.

 

In April 2008, theFASB issued FASB Staff Position (“FSP”) No. 142-3, *Determinationof the Useful Life of Intangible Assets.*  FSP 142-3 amends the factors an entity shouldconsider in developing renewal or extension assumptions used in determining theuseful life of recognized intangible assets under FASB Statement No. 142,Goodwill and Other Intangible Assets. This new guidance applies prospectively to intangible assets that areacquired individually or with a group of other assets in business combinationsand asset acquisitions.  FSP 142-3 iseffective for financial statements issued for fiscal years and interim periodsbeginning after December 15, 2008. Early adoption is prohibited.  Weare evaluating the impact, if any, that FSP 142-3 will have, if any, on ourconsolidated financial statements.

 

In May 2008, the FASPissues FASB Staff Position (“FSP”) APB 14-1, *Accountingfor Convertible DebtInstruments That May Be Settled in Cash upon Conversion (Including PartialCash Settlement)* or FSP APB 14-1, which clarifies the accounting forconvertible debt instruments that may be settled in cash upon conversion,incluing parital cash settlement.  FSPAPB 14-1 specifies that an issue of such instruments should separately accountfor the liability and equity components of the instruments in a manner thatreflect the issuer’s non-convertible debt borrowing rate which interest costsare recognized in subsequent periods. FSP APB 14-1 is effective for fiscal years beginning after December 15,2008, and retrospective application is required for all periods presented.  We are currently evaluation the impact of FASAPB 14-1 and expect that the guidance will have a material impact on itsconsolidated results and operations and financial condition beginning in thefirst quarter of fiscal 2009, as we will be required to record higher non-cashinterest expense related to our outstanding convertible debt instrument.

 

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**2.****    ****Summary of SignificantAccounting Policies**

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions in certain circumstances that affect amounts reported in the accompanyingconsolidated financial statements and related footnotes. In preparing thesefinancial statements, management has made its best estimates and judgments ofcertain amounts included in the financial statements, giving due considerationto materiality. The primary estimates underlying our financial statementsinclude write-offs for obsolete and slow moving inventory, allowance fordoubtful accounts receivable, valuation of investments, product warranty,impairment of long-lived assets and stock-based compensation.

 

*FunctionalCurrency*

 

On January 7, 2008we acquired Conceptus SAS, which sells to customers in France and all ofEurope. Our condensed consolidated financial statements for the three and sixmonths ended June 30, 2008 include the financial results of Conceptus SASstarting on January 7, 2008. Sales by Conceptus SAS are denominated inEuros. In preparing our consolidated financial statements, we are required totranslate the financial statements of Conceptus SAS from the currency in whichthey keep their accounting records into U.S. Dollars.  Conceptus SAS maintains its accountingrecords in the functional currency which is also its respective local currency,the Euro. The functional currency is determined based on management’s judgmentand involves consideration of all relevant economic facts and circumstancesaffecting the subsidiary. Generally, the currency in which the subsidiarytransacts a majority of its transactions, including billing, financing, payrolland other expenditures would be considered the functional currency, but anydependency upon the parent and the nature of the subsidiary’s operations mustalso be considered. Since the functional currency of Conceptus SAS has beendetermined to be the Euro, any gain or loss associated with the translation ofConceptus SAS’ financial statements into U.S. Dollars is included as acomponent of stockholders’ equity, in accumulated other comprehensiveloss.  If in the future we determine thatthere has been a change in the functional currency of Conceptus SAS from itslocal currency to the U.S. Dollar, any translation gains or losses arisingafter the date of change would be included within our statement of operations.

 

*Goodwill*

 

Goodwillrepresents the excess of the purchase price paid over the fair value oftangible and identifiable intangible net assets acquired in businesscombinations. We will perform an annual assessment during the fourth quarter of2008 of our goodwill at the reporting unit level, or earlier if an event occursor circumstances change that would reduce the fair value of the reporting unitbelow its carrying amount. No impairment charges have been recorded as of June 30,2008.

 

**3.****     ****Long-Term Investments**

 

As of June 30, 2008,we held $48.5 million (par value) in auction rate securities backed by federaland state student loans which are variable rate debt instruments and bearinterest rates that reset approximately every 20-30 days. These auction ratesecurities are rated AAA or AA by a major credit rating agency and have contractualmaturities that range from 20 to 39 years. The securities are classified asavailable for sale and are recorded at fair value. We recorded a temporaryreduction in carrying value of $0.3 million and $2.6 million for the three andsix months ended June 30, 2008, respectively, which has been recorded asan unrealized loss in accumulated other comprehensive loss.  We have experienced failed auctions in 2008of all of our auction rate securities and there is no assurance that auctionson these auction rate securities in our investment portfolio will succeed inthe future. As a result, our ability to liquidate our investments in the nearterm may be limited, and our ability to fully recover the carrying value of ourinvestments may be limited or non-existent. An auction failure means that theparties wishing to sell securities could not carry out the transaction. If theissuers of these securities are unable to successfully close future auctions ortheir credit ratings deteriorate, we may in the future be required to record animpairment charge on these investments. It could take until the final maturityof the underlying notes (up to 39 years) to realize our investments’recorded value.

 

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Given the recentdisruptions in the credit markets and the fact that the liquidity for thesetypes of securities remains uncertain, we have classified all of our auctionrate securities as long-term investments in our condensed consolidated balancesheet as our ability to liquidate such securities in the next 12 months isuncertain. The fair value of our auction rate securities on our condensedconsolidated balance sheet as of June 30, 2008 was $45.8 million. See Note4- Fair Value Measurements for additional information concerning fair valuemeasurement of our auction rate securities.

 

**4.****     ****Fair Value Measurements**

 

As stated in Note 1-Basis of Presentation, on January 1, 2008, we adopted the methods of fairvalue as described in SFAS 157 to value our financial assets andliabilities.  As defined in SFAS 157,fair value is based on the price that would be received to sell an asset orpaid to transfer a liability in an orderly transaction between marketparticipants at the measurement date. In order to increase consistency andcomparability in fair value measurements, SFAS 157 establishes a fair valuehierarchy that prioritizes observable and unobservable inputs used to measure fairvalue into three broad levels, which are described below:

 

Level 1: Quoted prices(unadjusted) in active markets that are accessible at the measurement date forassets or liabilities. The fair value hierarchy gives the highest priority toLevel 1 inputs.

 

Level 2: Observableprices that are based on inputs not quoted on active markets, but corroboratedby market data.

 

Level 3: Unobservableinputs are used when little or no market data is available. The fair valuehierarchy gives the lowest priority to Level 3 inputs.

 

Our cash and cashequivalents are classified within Level 1 of the fair value hierarchy becausethey are valued using quoted market prices, broker or dealer quotations, oralternative pricing sources with a reasonable level of price transparency. Asof June 30, 2008 our Level 1 instruments are solely comprised of ourinvestments in money market funds.

 

On January 7, 2008,we acquired Conceptus SAS (See Note 5- Business Combinations) and therebyassumed an outstanding foreign currency forward contract to buy U.S. Dollars atfixed intervals throughout the remainder of fiscal 2008. Conceptus SAS executedthe foreign currency contract in the retail market in an over-the-counterenvironment with a relatively high level of price transparency. The counterpartyis a large regional bank located in France. Our foreign currency contractvaluation inputs are based on quoted prices and quoted pricing intervals frompublic data and do not involve management judgment. Accordingly, we haveclassified our outstanding foreign currency forward contract within Level 2 ofthe fair value hierarchy and have recorded the fair value of the contract inother accrued liabilities on our condensed consolidated balance sheet as of June 30,2008.

 

As a result of continuedauction failures, quoted prices for our auction rate securities did not existas of June 30, 2008 and, accordingly, we concluded that Level 1 inputswere not available for these assets. Brokerage statements received from ourbroker/dealer that held our auction rate securities included their estimatedmarket value as of June 30, 2008. Our broker/dealer valued our auctionrate securities at 93% of par. We made inquiries relative to the measurementsutilized to derive the estimated market values quoted on our brokeragestatements, but the broker/dealer declined to provide detailed informationrelating to their valuation methodologies. Due to the lack of transparency intothe methodologies used to determine the estimated market values, we concludedthat estimated market values provided on our brokerage statements did notconstitute valid inputs and thus we did not utilize them in measuring the fairvalue of these auction rate securities as of June 30, 2008.

 

We determined that use ofa valuation model was the best available technique for measuring the fair valueof our auction rate securities. We used a trinomial discount model weightingestimated future cash flows, quality of collateral and the probability offuture successful auctions occurring. While our valuation model was based onboth Level 2 (credit quality and interest rates) and Level 3 inputs, wedetermined that the Level 3 inputs were the most significant to the overallfair value measurement of these assets, particularly the estimates of expectedperiods of illiquidity. The valuation model also reflected our intention tohold our

 

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auction rate securitiesuntil they can be liquidated in a market that facilitates orderly transactionsand our belief that we have the ability and intent to maintain our investmentsuntil their recovery in value.

 

Fair value hierarchy ofour securities and foreign currency contract at fair value in connection withour adoption of SFAS 157 is as follows (in thousands):

** **
| ** **                          | ** ** | **June 30,** | ** ** | **Fair Value Measurements at  Reporting Date** | ** ** |
|-------------------------------------|------------|-------------------|------------|--------------------------------------------------------------------|------------|
| ** **                          | ** ** | **2008**          | ** ** | **Level 1**                                                   | ** ** | **Level 2** | ** ** |
| Assets:                             |       |              |       |                                                               |       |   |   |
| Money market  fund                  |       | $                 | 14,609     |                                                               | 14,609     |   | — |   |
| Liabilites:                         |       |              |       |                                                               |       |   |   |
| Foreign currency  forward contracts |       | $                 | 664        |                                                               | —     |   | 664 |   |

 

The following tableprovides a summary of changes in fair value of the Company’s available-for-salesecurities utilizing Level 3 inputs as of June 30, 2008 (in thousands):

 
| ** **                                                     | ** ** | **Auction Rate  Securites** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|
| Balances as of  December 31, 2007                         |       | $                                | —     |   |
| Transfers from  Level 2 to Level 3                             |       | 48,800                           |       |
| Sales of auction  rate securities                              |       | (350                             | )          |
| Unrealized loss  included in other comprehensive income (loss) |       | (2,347                           | )          |
| Balance at  March 31, 2008                                |       | $                                | 46,103     |   |
| Unrealized loss  included in other comprehensive income (loss) |       | (268                             | )          |
| Balance at  June 30, 2008                                 |       | $                                | 45,835     |   |

 

**5.****     ****Business Combination**

 

On January 7, 2008(the “Closing Date”), we entered into a Share Purchase Agreement with ConceptusSAS, in connection with the exercise of our call option under the existingShare Purchase and Call Option Agreement dated January 17, 2004 andamended on February 27, 2007 and on November 19, 2007. Pursuant tothe Share Purchase Agreement, we acquired all of the outstanding shares ofConceptus SAS on the Closing Date. As a result of this transaction, ConceptusSAS became our wholly owned subsidiary and its results of operations areconsolidated with our results of operations starting on January 7, 2008.We believe the acquisition of Conceptus SAS expands our presence ininternational markets and will increase our revenues as we will recognize salesat end user pricing as compared to the price we previously sold the *Essure* product directly to Conceptus SAS.

 

The total purchase priceof $22.5 million included $24.4 million in cash consideration and $0.3 millionin direct transaction costs, less a reduction to the purchase price of $2.2million as explained below. On February 27, 2007, we entered into anamendment to the Share Purchase and Call Option Agreement with Conceptus SASand into an amendment to the Distribution Agreement with Conceptus SAS. Pursuant to the amendment to the Share Purchase and Call Option Agreement, weagreed not to exercise the call option to acquire Conceptus SAS in 2007 andagreed to exercise our call option to acquire SAS sometime between January 1,2008 and January 2, 2009 subject to the satisfaction of certain closingconditions.  Pursuant to the amendment to the Distribution Agreement,Conceptus SAS agreed to increase the price they pay to us for the*Essure* product. The difference inprice of product under the revised Distribution Agreement compared to the

 

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previous agreement wasrecorded as a current liability in our consolidated balance sheet prior to theacquisition. The balance of this current liability of $2.2 million on the dateof acquisition was recorded as a reduction of the purchase price of ConceptusSAS.

 

The aggregate ConceptusSAS purchase price of $22.5 million was allocated to the assets acquired andliabilities assumed based on their estimated fair values at the date ofacquisition.  The estimate of the excessof purchase price over the fair value of net tangible assets acquired wasallocated to identifiable intangible assets with the remainder as goodwill. Inaccordance with generally accepted accounting principles, we have twelve monthsfrom the closing date to finalize the valuation and we will finalize anyremaining direct transaction costs and payment of outstanding liabilitieswithin this time period. The following table summarizes the allocation of thepurchase price of the assets acquired and liabilities assumed based on theirfair values:

 
| **(in thousands):**        | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------|------------|
| Cash acquired                   |       | $          | 1,689      |   |
| Inventory                       |       | 1,816      |       |
| Accounts  receivable            |       | 3,270      |       |
| Other tangible  assets acquired |       | 396        |       |
| Amoritzable  intangibles:       |       |       |       |
| Customer  relationsips          |       | 5,024      |       |
| Covenant not to  compete        |       | 71         |       |
| Goodwill                        |       | 16,062     |       |
| Liabilities  assumed            |       | (5,879     | )          |
| Total                           |       | $          | 22,449     |   |

 

The amortizableintangible assets have useful lives for customer relationships of 9 years andfor the covenant not to compete of 3 years. No amounts have been allocated toin-process research and development and approximately $16.1 million has beenallocated to goodwill. Goodwill was recorded based on the residual purchaseprice after allocating the purchase price to the fair market value of tangibleand intangible assets acquired less liabilities assumed. The goodwill arisingfrom the acquisition is not deductible for tax purposes.

 

The unaudited pro formainformation set forth below represents the net sales, net loss and earnings pershare of the Company including Conceptus SAS as if the acquisition wereeffective as of the beginning of fiscal 2007, after giving effect to certainadjustments, including the amortization of Conceptus SAS acquisition relatedintangibles and the elimination of preacquisition intercompany profits. The operatingresults for the period from January 1, 2008 to January 7, 2008 (theClosing Date) and for the comparable period of fiscal 2007 were not readilyavailable and were not considered practical to obtain. The unaudited pro formafinancial information does not necessarily reflect the results of operationsthat would have occurred had the combined businesses constituted a singleentity during such period, and is not necessarily indicative of results whichmay be obtained in the future (in thousands, except per share amounts):

 
| ** **                                             | ** ** | **Year Ended**             | ** ** |
|--------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **December 31, 2007** | ** ** |
| Pro forma total  net sales                             |       | $                               | 74,395     |   |
| Pro forma net  loss                                    |       | $                               | (9,917     | ) |
| Pro forma net  loss per share – basic and diluted |       | $                               | (0.34      | ) |
| Pro forma  weighted average basic and diluted shares   |       | 29,463                          |       |

 

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**6.****     ****Inventories**

 

Inventories are stated atthe lower of cost or market.  Cost is based on actual costs computed on afirst-in, first-out basis.  The components of inventories consist of thefollowing (in thousands):

 
| ** **      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------|------------|-------------------|------------|-----------------------|------------|
| ** **      | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Raw materials   |       | $                 | 454        |                  | $          | 177 |   |
| Work-in-process |       | 1,257             |       | 1,356                 |       |
| Finished goods  |       | 3,035             |       | 885                   |       |
| Total           | ** ** | **$**             | **4,746**  | ** **            | **$**      | **2,418** | ** ** |

 

**7.****     ****Warranty**

 

We offer warranties onour product and record a liability for the estimated future costs associatedwith warranty claims, which is based upon our historical experience and ourestimate of the level of future costs. Warranty costs are reflected in thestatement of operations as a cost of goods sold.  A reconciliation of thechanges in warranty liability for the six months ended June 30, 2008 and2007 follows (in thousands):

 
| ** **                                        | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| Warranty accrual  at the beginning of the period  |       | $                                                 | 208        |   | $ | 209 |   |
| Accruals for  warranties issued during the period |       | 115                                               |       | 230 |   |
| Settlements made  in kind during the period       |       | (126                                              | )          | (219 | ) |
| Warranty accrual  at the end of the period        | ** ** | **$**                                             | **197**    | ** ** | **$** | **220** | ** ** |

 

**8.****     ****Stock-Based Compensation**

 

Net loss for the threeand six months ended June 30, 2008 included stock-based compensationexpense under SFAS No. 123(R) , *“Share-Based Payment,”*or SFAS, 123(R) of approximately $1.4 million and $2.9 million,respectively, which consisted of stock-based compensation expense ofapproximately $1.2 million and $2.5 million, respectively, related to employeestock options, employee stock purchase plan and stock appreciation rights andstock-based compensation expense of approximately $0.2 million and $0.4million, respectively, related to employee restricted stock and restrictedstock units.

 

Net loss for the threeand six months ended June 30, 2007 included stock-based compensationexpense under SFAS 123(R) of approximately $1.5 million and $2.9million, respectively, which consisted of stock-based compensation expense ofapproximately $1.3 million and $2.4 million, respectively, related to employeestock options, employee stock purchase plan and stock appreciation rights andstock-based compensation expense of approximately $0.2 million and $0.5million, respectively,  related toemployee restricted stock and restricted stock units.

 

Stock-based compensationarrangements to non-employees are accounted for in accordance with EITF Issue No. 96-18,*Accounting for Equity Instruments That AreIssued to Other Than Employees for Acquiring, or in Conjunction with Selling,Goods or Services*, which requires that these equity instruments arerecorded at their fair value on the measurement date. The measurement ofstock-based compensation is subject to adjustment as the underlying equityinstruments vest. Stock-based compensation expense relating to non-employeeswas approximately $0.1 million for the three and six months ended June 30,2008 and 2007, respectively.

 

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For the three and six months ended June 30, 2008and 2007, we calculated the fair value of each option on the date of grantusing the Black-Scholes model as prescribed by SFAS 123(R). The assumptionsused were as follows:

 
| ** **                      | ** ** | **Stock Option and Stock Appreciation Right Plans** | ** ** |
|---------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **                      | ** ** | **Three months**                                                             | ** ** | **Six months** | ** ** |
| ** **                      | ** ** | **ended June 30, 2008**                                            | ** ** | **ended June 30, 2008** | ** ** |
| Expected term (in years)        |       | 4.66                                                                              |       | 4.66 |   |
| Average risk-free interest rate |       | 3.07                                                                              | %          | 2.71 | % |
| Average volatility factor       |       | 46.3                                                                              | %          | 47.7 | % |
| Dividend yield                  |       | —                                                                            |       | — |   |

 
| ** **                      | ** ** | **Stock Option and Stock Appreciation Right Plans** | ** ** |
|---------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **                      | ** ** | **Three months**                                                             | ** ** | **Six months** | ** ** |
| ** **                      | ** ** | **ended June 30, 2007**                                            | ** ** | **ended June 30, 2007** | ** ** |
| Expected term (in years)        |       | 3.66                                                                              |       | 3.58 |   |
| Average risk-free interest rate |       | 4.76                                                                              | %          | 4.71 | % |
| Average volatility factor       |       | 47.1                                                                              | %          | 48.1 | % |
| Dividend yield                  |       | —                                                                            |       | — |   |

 

*ExpectedTerm:* Ourexpected term represents the period that our stock-based awards are expected tobe outstanding and was determined based on historical exercise experience ofsimilar awards, giving consideration to the contractual terms of thestock-based awards and vesting schedules.

 

*ExpectedVolatility:* Weused historical volatility based on the expected term of the awards, which isconsistent with our assessment that the historical volatility for such periodis more representative of future stock price trends than any other type ofvolatility.

 

*ExpectedDividends:* Wehave not paid and do not anticipate paying any dividends in the near future.

 

*Risk-FreeInterest Rate:* Webase the risk-free interest rate on the U.S. Treasury yield curve in effect atthe time of grant based on the expected term of the underlying option.

 

*Forfeitures:* As stock-based compensation expenserecognized in the condensed consolidated statement of operations for the sixmonths ended June 30, 2008 is based on awards ultimately expected to vest,it has been reduced for estimated forfeitures. SFAS 123(R) requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates.Forfeitures were estimated based on historical experience.

 

No income tax benefit hasbeen recognized relating to stock-based compensation expense and no taxbenefits have been realized from exercised stock options.

 

*StockOptions and Stock Appreciation Rights*: During the three and six months ended June 30,2008, we granted stock appreciation rights for 115,616 and 832,410 shares,respectively of common stock, with an estimated total grant date fair value ofapproximately $0.9 million and $6.3 million, respectively and a grant dateweighted-average fair value of $7.73 and $7.55 per share, respectively.  During the three and sixmonths ended June 30, 2007, we granted stock appreciation rights for283,490 and 834,990 shares of common stock, with an estimated total grant datefair value of approximately $2.2 million and $6.2 million, respectively and agrant date weighted average fair value of $7.61and $7.42 per share, respectively.

 

As of June 30, 2008,there was unrecognized compensation cost of approximately $10.6 million fortotal stock-based compensation related to stock options and stock appreciationrights, before forfeitures. This cost is expected to be recognized over aweighted-average amortization period of 2.97 years.

 

*Employee Stock Purchase Plan(ESPP):* Thecompensation cost in connection with the ESPP for the six months ended June 30,2008 was approximately $0.1 million with a grant date weighted-average fair valueof $5.32. During the six months ended June 30, 2007, the compensation costwas approximately $0.2 million,

 

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with a grant dateweighted average fair value of $5.07. This cost is amortized on a straight-linebasis over the relevant subscription period.

 

We calculated the fairvalue of each share under the ESPP on the date of grant using the Black-Scholesmodel as prescribed by SFAS 123(R). The assumptions used were as follows:

 
| ** **                       | ** ** | **Six months ended  June 30, 2008** | ** ** |
|----------------------------------|------------|---------------------------------------------------------|------------|
| Expected term  (in years)        |       | 0.50                                                    |       |
| Average  risk-free interest rate |       | 2.15                                                    | %          |
| Average  volatility factor       |       | 43.9                                                    | %          |
| Dividend yield                   |       | —                                                  |       |

 

For the six months ended June 30,2007, we calculated the fair value of each share on the date of grant using theBlack-Scholes model as prescribed by SFAS 123(R). The assumptions used were asfollows:

 
| ** **                       | ** ** | **Six months ended  June 30, 2007** | ** ** |
|----------------------------------|------------|---------------------------------------------------------|------------|
| Expected term  (in years)        |       | 0.78                                                    |       |
| Average  risk-free interest rate |       | 5.07                                                    | %          |
| Average  volatility factor       |       | 42.0                                                    | %          |
| Dividend yield                   |       | —                                                  |       |

 

*RestrictedStock Units*: Inconnection with restricted stock units and restricted stock awards granted, werecord stock compensation representing the fair market value of our commonshares on the dates the awards were granted. Compensation expense is beingrecorded on a straight-line basis over the vesting periods of the underlyingstock awards. During the three and six months ended June 30, 2008, wegranted zero and 41,000 shares, respectively of restricted stock units, with agrant-date fair value of approximately $0.7 million and a grant-date weightedaverage fair value of $17.45.  During thethree and six months ended June 30, 2007, we granted 15,500 and 60,550shares, respectively of restricted stock units, with a grant-date fair value ofapproximately $0.3 million and $1.1 million, respectively and a grant-dateweighted-average fair value of $19.17 and $18.35, respectively.

 

As of June 30,2008, there was an unrecognized compensation cost of approximately $1.2 millionrelated to nonvested restricted stock awards and restricted stock units, beforeforfeitures. This cost is expected to be recognized over a weighted-averageamortization period of 2.31 years.

 

**9.    ConvertibleSenior Notes**

 

In February 2007, weissued an aggregate principal amount of $86,250,000 of our 2.25% convertiblesenior notes due 2027. These notes bear a 2.25% interest per annum on theprincipal amount, payable semiannually in arrears on February 15 and August 15of each year, beginning on August 15, 2007.

 

The notes will mature on February 15,2027, unless earlier redeemed, repurchased or purchased by us or converted, andare convertible into cash and, if applicable, shares of our common stock basedon an initial conversion rate, subject to adjustment, of 35.8616 shares per$1,000 principal amount of notes (which represents an initial conversion priceof approximately $27.89 per share), in certain circumstances. Upon conversion,a holder would receive cash up to the principal amount of the note and ourcommon stock in respect of such note’s conversion value in excess of suchprincipal amount. The notes are convertible only in the followingcircumstances: (1) if the closing sale price of our common stock exceeds120% of the

 

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conversion price during aperiod as defined in the indenture; (2) if the average trading price per$1,000 principal amount of the notes is less than or equal to 97% of theaverage conversion value of the notes during a period as defined in theindenture; (3) upon the occurrence of specified corporate transactions; (4) ifwe call the notes for redemption and (5) at any time on or after December 15,2011 up to and including February 15, 2012 and anytime on or after February 15,2025. Upon a change in control or termination of trading, holders of the notesmay require us to repurchase all or a portion of their notes for cash at arepurchase price equal to 100% of the principal amount, plus any accrued andunpaid interest. We may not have sufficient funds to pay the interest, purchaseprice, repurchase price or principal return when conversion is triggered or anote becomes payable under the above terms.

 

In connection with thesale and issuance of the notes we incurred debt issuance costs of$3.1 million which is being amortized to interest expense over a five yearperiod.

 

We concluded that theembedded stock conversion option is not considered a derivative under SFAS No. 133,*Accounting for Derivative Instruments andHedging Activities,* or SFAS 133, because the embedded stockconversion option would be recorded in stockholders’ equity if it were afreestanding instrument per Emerging Issues Task Force EITF Issue No. 00-19,*Accounting for Derivative FinancialInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock,*or EITF 00-19. We concluded that the notes are accounted for similar totraditional convertible debt (that is, as a combined instrument) because theembedded stock conversion option meets the requirements of EITF No. 00-19,including the provisions contained in paragraphs 12-32 of EITF 00-19. Accordingly, the embedded stock conversion option is not separated as aderivative.

 

In connection with theoffering, we entered into convertible note hedge transactions with affiliatesof the initial purchasers. These transactions are intended to reduce thepotential dilution to our Company’s stockholders upon any future conversion ofthe notes. The call options, which cost an aggregate $19.4 million, wererecorded as a reduction of additional paid-in capital. We also entered intowarrant transactions concurrently with the offering, pursuant to which we soldwarrants to purchase approximately 3.1 million shares of our common stock tothe same counterparties that entered into the convertible note hedgetransactions. The convertible note hedge and warrant transactions effectively increasedthe conversion price of the convertible notes to approximately $36.47 per shareof our common stock. Proceeds received from the issuance of the warrantstotaled approximately $10.7 million and were recorded as an addition toadditional paid-in capital.

 

EITF 00-19 provides thatcontracts are initially classified as equity if (1) the contract requiresphysical settlement or net-share settlement, or (2) the contract gives thecompany a choice of net-cash settlement or settlement in its own shares (physicalsettlement or net-share settlement). The settlement terms of our purchased calloptions and sold warrant contracts require net-share settlement. Based on theguidance in EITF 00-19 and SFAS 133, the purchased call option contractswere recorded as a reduction of equity and the warrants were recorded as anaddition to equity as of the trade date. SFAS 133 states that a reportingentity shall not consider contracts to be derivative instruments if thecontract issued or held by the reporting entity is both indexed to its ownstock and classified in stockholders’ equity in its statement of financialposition. We concluded the purchased call option contracts and the warrantcontracts should be accounted for in stockholders’ equity.

 

**10.****     ****Income Taxes**

 

We adopted the provisionsof FASB Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes*, or FIN 48 on January 1, 2007.  Theadoption of the provisions of FIN 48 did not have a material impact on ourfinancial position and results of operations. We have not been audited by theInternal Revenue Service or any state income or franchise tax agency. As of June 30,2008, our federal returns for the years ended 2004 through the current periodand most state returns for the years ended 2003 through the current period arestill open to examination. In addition, all of the net operating losses andresearch and development credit carryforwards that may be used in future yearsare still subject to inquiry given that the statute of limitation for theseitems would be from the year of the utilization.

 

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As of June 30, 2008,we recorded approximately $0.2 million of income tax expense attributable toour French subsidiary.

 

The amount ofunrecognized tax benefits at December 31, 2007, was $1.9 million, which,if ultimately recognized, will reduce our annual effective tax rate.

 

We do not expect ourunrecognized tax benefits to change significantly over the next 12 months.  In connection with the adoption of FIN 48, werecognize interest and penalties accrued on any unrecognized tax benefits as acomponent of income tax expense.

 

**11.****     ****Computation of Net LossPer Share**

 

Basic net loss per shareexcludes any potential dilutive effects of options and common stock sharessubject to repurchase. Diluted net loss per share includes the impact ofpotentially dilutive securities.  However, due to our net loss position, basicand diluted net loss per share are both computed using the weighted averagenumber of common shares outstanding.

 

The following tableprovides a reconciliation of weighted-average number of common sharesoutstanding to the weighted-average number common shares outstanding used incomputing basic and diluted net loss per common share (in thousands):

 
| ** **                                                                                                        | ** ** | **Three months ended   June 30,** | ** ** | **Six months ended   June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **2008**                                              | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Denominator:                                                                                                      |       |                                                  |       |                                                |       |   |   |   |   |
| Weighted-average  number of common shares outstanding                                                             |       | $                                                     | 30,232     |                                                | $          | 29,457 |   | 30,092 |   | $ | 29,393 |   |
| Less:  Weighted-average unvested and restricted common shares                                                     |       | (15                                                   | )          | (37                                                 | )          | (16 | ) | (53 | ) |
| Weighted-average  number common shares outstanding used in computing basic and diluted net loss  per common share | ** ** | $                                                     | 30,217     | ** **                                          | $          | 29,420 | ** ** | $ | 30,076 | ** ** | $ | 29,340 | ** ** |
|                                                                                                                   |            |                                                       |            |                                                     |            |  |  |  |  |  |  |  |  |

 

The following outstandingoptions, potential employee stock purchase plan shares, warrants, stockappreciation rights, restricted stock units and shares were excluded from thecomputation of diluted net loss per share, as their effect would have beenantidilutive (in thousands):

 
| ** **                                                | ** ** | **At June 30,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                | ** ** | **2008**                  | ** ** | **2007** | ** ** |
| Outstanding  options and stock appreciation rights        |       | 4,223                     |       | 4,096 |   |
| Restricted stock  awards                                  |       | 9                         |       | 29 |   |
| Restricted stock  units                                   |       | 103                       |       | 288 |   |
| Warrants issued  in connection with our convertible notes |       | 3,093                     |       | 3,093 |   |
| Total                                                     |       | 7,428                     |       | 7,506 |   |

 

Our 2.25% seniorconvertible notes are not included in the calculation of net loss per sharebecause their effect is anti-dilutive. In addition, our senior convertiblenotes were excluded from the diluted net income per share calculation in thethree and six months ended June 30, 2008 because the conversion price wasgreater than the average market price of our stock during the period.

 

**12.****     ****Comprehensive Income(Loss)**

 

Comprehensive income(loss) generally represents all changes in stockholders’ equity except thoseresulting from investments or contributions by stockholders. Our comprehensiveincome (loss) consists of unrealized losses on available-for-sale securitiesoffset by cumulative translation adjustments. A summary of

 

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the comprehensive income(loss) for the periods indicated is as follows (in thousands):

 
| ** **                                             | ** ** | **Three months ended June  30,** | ** ** | **Six months ended June  30,** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                        | ** ** | **2007**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net Loss                                               |       | $                                               | (1,608     | )                                             | $          | (2,140 | ) | $ | (7,987 | ) | $ | (6,240 | ) |
| Other  comprehensive loss                              |       |                                            |       |                                          |       |   |   |   |   |
| Foreign currency  translation adjustment, net of taxes |       | 2                                               |       | —                                        |       | 59 |   | — |   |
| Unrealized gain  loss on available-for-sale securites  |       | (268                                            | )          | —                                        |       | (2,615 | ) | — |   |
| Comprehensive  loss                                    |       | $                                               | (1,874     | )                                             | $          | (2,140 | ) | $ | (10,543 | ) | $ | (6,240 | ) |

 

The balances of eachcomponent of accumulated other comprehensive income (loss), net of taxes, as ofJune 30, 2008 and December 31, 2007 consist of the following (inthousands):

 
| ** **                            | ** ** | **Unrealized Gain (Loss)  on Available-for-Sale  Securities** | ** ** | **Foreign Currency  Translation** | ** ** | **Accumulated Other  Comprehensive Income  (Loss)** | ** ** |
|---------------------------------------|------------|------------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------------------------------|------------|
|                                  |       |                                                                         |       |                                   |       |                                                          |       |
| Balance as of  December 31, 2007 |       | $                                                                            | —     |                                   | $          | —                                                        |       | $ | — |   |
| Net change  during six months period  |       | (2,615                                                                       | )          | 59                                     |       | (2,556                                                        | )          |
| Balance as of  June 30, 2008     |       | $                                                                            | (2,615     | )                                      | $          | 59                                                            |       | $ | (2,556 | ) |
|                                       |            |                                                                              |            |                                        |            |                                                               |            |  |  |  |  |  |  |

 

**13.****     ****Segment Information**

 

We operate in onebusiness segment, which encompasses all geographical regions. We use onemeasurement of profitability and do not segregate our business for internalreporting.

 

Net sales by geographicregion, based on shipping location of our customer, are as follows (inthousands, except percentages):

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales (in  thousands) |       | $                                | 25,680     |                           | $          | 15,669 |   | $ | 46,807 |   | $ | 29,449 |   |
| United States of  America |       | 78                               | %          | 89                             | %          | 77 | % | 90 | % |
| France                    |       | 14                               | %          | 10                             | %          | 14 | % | 9 | % |
| Europe                    |       | 7                                | %          | 0                              | %          | 8 | % | 0 | % |
| Other                     |       | 1                                | %          | 1                              | %          | 1 | % | 1 | % |
|                           |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |

 

Nocustomer accounted for more than 10% of total revenue for the three and sixmonths ended June 30, 2008 and 2007. No customer had a balance in excess of 10% of our net accountsreceivable at June 30, 2008. Accounts receivable from one customer accounted for26% of our net accounts receivable balance at June 30, 2007.

 

**14.****     ****Stockholders’ Equity**

 

As of June 30, 2008,we hold 77,863 shares of treasury stock as a result of repurchasing shares ofrestricted common stock at par value in accordance with the terms of therestricted stock agreements. These shares had a purchase price of $0.003 pershare and are recorded as treasury stock.

 

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

 

*Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with our consolidated financial statements andrelated notes thereto. This discussion contains forward-looking statements,including references to 2008 revenues and gross margins, increased productadoption, product improvements, expanded sales force and other forecasted itemsthat involve risks and uncertainties such as our limited operating and saleshistory; the uncertainty of market acceptance of our product; dependence onobtaining and maintaining reimbursement; effectiveness and safety of ourproduct over the long-term; our ability to obtain and maintain the necessarygovernmental clearances or approvals to market our product; our ability todevelop and maintain proprietary aspects of our technology; our ability tomanage our expansion; our limited history of manufacturing our product; ourdependence on single source suppliers, third party manufacturers andco-marketers; intense competition in the medical device industry and in thecontraception market; the inherent risk of exposure to product liability claimsand product recalls and other factors referenced in this Form 10-Q. Ouractual results could differ materially from those expressed or implied in theseforward-looking statements as a result of various factors, including thosediscussed in our Annual Report on Form 10-K for the year ended December 31,2007 filed with the Securities and Exchange Commission on March 14, 2008and those included elsewhere in this Form 10-Q.*

 

**Overview**

 

We develop, manufactureand market the*Essure*® permanentbirth control system, an innovative and proprietary medical device for womenthat was approved for marketing in the United States in November 2002 bythe United States Food and Drug Administration, or FDA. The*Essure* system uses a soft and flexiblemicro-insert that is delivered into a woman’s fallopian tubes to providepermanent birth control by causing a benign tissue in-growth that blocks thefallopian tubes. A successfully placed*Essure* micro-insert and the subsequent tissue growth prohibits theegg from traveling through the fallopian tubes and therefore preventsfertilization.

 

On January 7, 2008,we entered into a Share Purchase Agreement with Conceptus SAS, in connectionwith the exercise of our call option under the existing Share Purchase and CallOption Agreement dated January 17, 2004 and amended on February 27,2007 and on November 19, 2007. Pursuant to the Share Purchase Agreement,we acquired all of the outstanding shares of Conceptus SAS on the Closing Date.As a result of this transaction, Conceptus SAS became our wholly ownedsubsidiary and its results of operations are consolidated with our results ofoperations starting on January 7, 2008. We believe the acquisition ofConceptus SAS expands our presence in international markets and will increaseour revenues as we will recognize sales at end user pricing as compared to theprice at which we previously sold the *Essure*product directly to Conceptus SAS.  Ourcondensed consolidated financial statements for the three and six months ended June 30,2008 include the financial results of Conceptus SAS beginning from theacquisition date of January 7, 2008.

 

*The Essure Procedure*

 

The*Essure* procedure is typically performedas an outpatient procedure and is intended to be a less invasive and a lesscostly alternative to tubal ligation, the leading form of birth control in theUnited States and worldwide. Laparoscopic tubal ligation and tubal ligation bylaparotomy typically involve abdominal incisions and/or punctures, general orregional anesthesia, four to ten days of normal recovery time and the 

 

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risks associated with anincisional procedure. The*Essure*procedure does not require cutting or penetrating the abdomen, which lowers thelikelihood of post-operative pain due to the incisions/punctures, and it can beperformed in an outpatient setting without general or regional anesthesia. Inthe Pivotal trial of the*Essure*system, the total procedure time averaged 35 minutes, with an average of 13minutes of hysteroscopic time to place the*Essure* micro-insert. A patient is typically discharged approximately45 minutes after the*Essure*procedure. No overnight hospital stay is required. Furthermore, the*Essure* system is effective without drugsor hormones. There is a three-month waiting period after the procedure duringwhich the woman must use another form of birth control while tissue in-growthoccurs. At 90 days following the procedure, U.S. patients complete a follow-upexamination called a hysterosalpingogram, or HSG, which can determine whetherthe device was placed successfully and whether the fallopian tubes areoccluded. Outside of the United States, patients are required to return for apelvic X-ray at three months post-procedure with a subsequent HSG if devicelocation on the initial radiographic image appears suspicious.

 

We believe that the*Essure* system is also an attractivealternative to tubal ligation for physicians, hospitals and payers. The*Essure* system is a less invasivepermanent birth control option for physicians to offer to their patients;hospitals are able to utilize their facilities more cost effectively with the*Essure* procedure compared with tuballigation; and payers are able to experience cost reductions resulting from theelimination of overhead and procedural costs related to anesthesia andpost-operative hospital stays associated with tubal ligations. We also believethe*Essure* system is a viablealternative to other temporary methods of birth control being used when thereis no intention of having children in the future. In addition, payers may alsobenefit from the reduction of unplanned pregnancies associated withnon-permanent methods of birth control used by patients who have chosen toavoid the drawbacks of traditional permanent birth control methods but who mayelect to use the*Essure* system.

 

Published reportsestimate that 700,000 tubal ligation procedures are performed each year in theUnited States. We intend to tap into this market and establish the*Essure* procedure as the gold standard forpermanent birth control.

 

The*Essure* system is currently being marketedin multiple countries. In November 2002 we received approval from the FDAto market the*Essure* system inthe United States. In 2001, we were given approval to affix the CE Mark to the*Essure* system, indicating that the*Essure* system is certified for salethroughout the European Union, subject to compliance with local regulationssuch as registration with health ministries and/or particular requirementsregarding labeling or distribution. In 1999, the*Essure* Permanent Birth Control system was listed withAustralia’s Therapeutic Goods Administration, which allows us to market andsell the*Essure* system inAustralia. In Canada, we received clearance from Health Canada to market the*Essure* system in Canada in November 2001. InFrance, the “Haute Autorité de santé” lifted in October 2007 all restrictions,thereby putting the *Essure*procedure on an equal footing with tubal ligations. Following this decision,the *Essure* procedure is coveredin France for all women, regardless of medical status.  In addition, the CEPS in France ruled in November 2007that the reimbursement for the *Essure*device will remain at the then current levels of 700 Euros for the next 5years.

 

We currently havedistributors in Australia, Canada, Puerto Rico and Spain.  In January 2008, we acquired all of theoutstanding shares of Conceptus SAS, our distributor in France, and as a resultConceptus SAS is operating as our wholly owned subsidiary.  Conceptus SAS sells directly in France andutilizes distributors to sell *Essure*throughout the rest of European region.

 

*Effectivenessof the Essure System*

 

In July 2005, wereceived approval from the FDA to extend effectiveness data on the*Essure* product labeling. The PremarketApproval, or PMA, supplement filed in late January 2005 supports anextension of the effectiveness rate of the*Essure* system to 99.80% after four years and 99.74% after five yearsof follow-up, from the previously approved 99.80% at three years. The five-yeareffectiveness was demonstrated in a small portion of the women undergoingclinical studies.  Five year follow up ofall patients in clinical trials is currently complete.  A PMA supplement to update the productlabeling incorporating the results of the follow-up data will be submitted toFDA.

 

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In September 2005,we received approval from the FDA to terminate our post-approval study withphysicians who were newly trained in performing the*Essure* procedure due to the positive placement dataobtained. The purpose of the post-approval study, required by the FDA as acondition of the November 2002 approval of the*Essure* system, was to determine the rate of successfulbilateral placements of the*Essure*micro-inserts at first attempt with a large number of newly trained physicianswho were not part of the previous clinical studies. Although treatment of thetotal number of patients required by the FDA had not been completed, the dataobtained to date provided us with the opportunity to request that the FDApermit an early termination of the study. Because of the FDA ruling, the PMASupplement submitted in March 2005 has been re-classified as a FinalReport. The results of the post-approval study demonstrated an improvement inplacement rates from those obtained in the pivotal study. In November 2005,we filed a PMA supplement with the FDA in order to obtain approval to modifythe*Essure* Physician and Patientlabeling to reflect a 94.6% first procedure bilateral placement rate based onresults of the post-approval study. In October 2006, we received suchapproval from the FDA. In March 2006, we filed a PMA supplement with theFDA in order to obtain approval for a modified delivery system andmicro-insert, and new valved introducer. We received such approval from the FDA in June 2007. Apost-approval study is being conducted to investigate the bilateral placementrate at first attempt for the modified delivery system and micro-insert, and isexpected to be similar for the newest model of the *Essure* system.

 

*Penetration*

 

We require physicians tobe preceptored for between 3 and 5 cases by a certified trainer before beingable to perform the procedure independently. In the first half of 2008 wecontinued to see an increase in the number of physicians becoming trained orthat are in the process of training. The level of sales for the*Essure* system, particularly in this earlyperiod of adoption, is highly dependent on the number of physicians trained toperform the procedure. However, we understand that a strong base of trainedphysicians does not necessarily correlate to an increase in revenueproportionately. Furthermore, there are no revenues associated with thetraining activities. We do not charge a fee for the activity and no commitmentarises for the physician from the preceptorship. Physician training is providedupfront and we have no obligation subsequent to the initial training. Trainingcosts have not been significant from inception to-date.

 

*Reimbursementof the Essure Procedure*

 

Market acceptance of the*Essure* system depends in part upon theavailability of reimbursement within prevailing healthcare paymentsystems. We believe that physician advocacy of our product will berequired to continue to obtain reimbursement. As of June 30, 2008, we havereceived positive reimbursement decisions for the *Essure* procedure from most private insurers and from 46 ofthe 51 Medicaid programs in the United States. We continue to receive positiveresponses relating to reimbursement, which we believe will help increase theadoption of the *Essure*device bydoctors and patients. We intend to continue our effort to educate payers of thecost-effectiveness of our product and to establish further programs to helpphysicians to navigate reimbursement issues. As with all healthcare plans,coverage will vary and is dependent upon the individual’s specific benefitplan.

 

Effective January 1,2008, the Centers for Medicare and Medicaid Services, or CMS, the MedicareNational unadjusted average payment for hysteroscopic sterilization, the CPTcode, is $420 when performed in a hospital and $2,024 when performed in aphysician’s office. In addition, in the CMS Final Rule for the 2008Outpatient Prospective Payment System or OPPS, which assigns hospital outpatientreimbursement amounts, the CPT code was assigned a Medicare National Average of$2,720. In 2008, the Medicare national average payment for hysteroscopicsterilization in the ambulatory surgery center is $1,446, which includes thecost of the implant. We believe these values are very favorable for the Essureprocedure and will help in establishing increased utilization of the deviceamongst doctors.

 

Effective May 15,2008, California’s state fee-for-service Medicaid program will cover the *Essure* procedure for beneficiaries that are 21 years of ageor older. Physicians may perform the Essure procedure in the physician’soffice, the ambulatory surgery center or the hospital outpatient department.Medi-Cal is expected to pay $2,282 as a global fee for an in-officeprocedure.  We believe these values arevery favorable for the Essure procedure and will continue to help inestablishing increased utilization for devices amongst doctors.

 

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*Adoption of the Essure System*

 

The*Essure* system is a novel product in thecontraception market, which is dominated by procedures that are wellestablished among physicians and patients and are routinely taught to newphysicians. As a result, we believe that recommendations and endorsements byphysicians will be essential for market acceptance of our product. Physiciansare traditionally slow to adopt new products and treatment practices, partlybecause of perceived liability risks. Our biggest challenge is to speed up theadoption process to make the*Essure*procedure the standard of care for permanent birth control. The followingdiscussion summarizes our program in the United States to increase adoption ofthe*Essure* procedure.

 

First, we are attemptingto increase patient awareness, so as to increase the number of women that willask for information about the*Essure*procedure. During 2008 we expect to spend more than $9 million on buildingpatient awareness. The largest part of this expenditure will be a direct toconsumer (DTC) pilot program in eight cities, incorporating television, radioand print media advertising. These programs commenced during 2008 withexpenditures of approximately $6.5 million to date. We hope through theseprograms to drive patient awareness of the *Essure*procedure.

 

Second, we are expandingour sales territories and channels of distribution so as to increase our callfrequency on physicians. During the first half of 2008 we added a number of inoffice specialists and sales positions. Also, we have included targetingregional distributors of women’s gynecology products in our marketing efforts.Among other responsibilities, our sales representatives are attempting toincrease penetration and utilization of the*Essure* procedure, as well as to facilitate the movement of the*Essure* procedure to the in-officeenvironment.

 

Third, we are focused onobtaining favorable coverage decisions from payers representing the privatepaying and state-paying Medicaid systems. We are also focused on getting theCPT code and payment schedule implemented at all of the payers that have givena coverage decision.  Our tacticalreimbursement focus is intended to give the physician and his/her staff thetools to ensure that claims will ultimately be paid and thereby encourages thephysician to continue performing the*Essure*procedure despite reimbursement issues. This tactical reimbursement team isgenerally targeting specific accounts with the aim of eventually meeting withall of our accounts so as to provide them with the knowledge of how to file andfollow up on claims on a payer by payer basis.

 

Fourth, we intend tocontinue making labeling improvements to our product as well as physicalproduct enhancements to increase the adoption of the*Essure* procedure. This may involve working with the variousregulatory agencies around the world that regulate the sale and labeling ofmedical devices to provide updates to claims such as effectiveness andplacement rates. Where appropriate, we will make physical improvements to theproduct for improved manufacturability, for the ease of use by the physician orto improve the clinical performance of our product.

 

We have experiencedsignificant operating losses since inception and, as of June 30, 2008, hadan accumulated deficit of $243.2 million. While we expect to be profitable inthe third and fourth quarter of 2008, there is a risk that we may not achieveprofitability by that time or sustain it thereafter.  We will continue to expend substantialresources in the selling and marketing of the*Essure* system in the United States and abroad. We will continue tobe in a net loss position unless sufficient revenues can be generated to offsetexpenses.

 

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**Resultsof Operations - Three and Six months Ended June 30, 2008 and 2007 2008 results compared to 2007 (in thousands, except percentages)**

** **
| ** **                                    | ** ** | **Three Months Ended   June 30,** | ** ** | **Six Months Ended   June 30,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | **2008**                                              | ** ** | **2007**                                            | ** ** | **2008 -2007** | ** ** | **2008** | ** ** | **2007** | ** ** | **2008 -2007** | ** ** |
| ** **                                    | ** ** | **Amount**                                            | ** ** | **% (a)**                                      | ** ** | **Amount** | ** ** | **% (a)** | ** ** | **% Change** | ** ** | **Amount** | ** ** | **% (a)** | ** ** | **Amount** | ** ** | **% (a)** | ** ** | **% Change** | ** ** |
| Net sales                                     |       | $                                                     | 25,680     |                                                | 100%       |   | $ | 15,669 |   | 100% |   | 64% |   | $ | 46,807 |   | 100% |   | $ | 29,449 |   | 100% |   | 59% |   |
| Gross profit                                  |       | 20,484                                                |       | 80%                                                 |       | 11,431 |   | 73% |   | 79% |   | 36,166 |   | 77% |   | 21,506 |   | 73% |   | 68% |   |
| Research and  development expenses            |       | 1,644                                                 |       | 6%                                                  |       | 1,061 |   | 7% |   | 55% |   | 3,575 |   | 8% |   | 2,703 |   | 9% |   | 32% |   |
| Selling, general  and administrative expenses |       | 20,081                                                |       | 78%                                                 |       | 13,172 |   | 84% |   | 52% |   | 40,183 |   | 86% |   | 26,181 |   | 89% |   | 53% |   |
| Net loss                                      |       | (1,608                                                | )          | (6)%                                                |       | (2,140 | ) | (14)% |   | (25)% |   | (7,987 | ) | (17)% |   | (6,240 | ) | (21)% |   | 28% |   |
|                                               |            |                                                       |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(a) Expressedas a percentage of total net sales

 

*NetSales*

 

         Net sales were $25.7 million for the three months ended June 30,2008 as compared to $15.7 million for the three months ended June 30,2007, representing an increase of $10.0 million, or 64%. Net sales for thesix months ended June 30, 2008 were $46.8 million, as compared to $29.4million for the six months ended June 30, 2007, an increase of $17.4million, or 59%.  The increase in net sales is the result ofcontinued commercialization of the *Essure*system worldwide. International sales for the year comprised 22% of our totalsales in the second quarter of 2008 reflecting revenues realized from ouracquisition of Conceptus SAS and the recognition of sales at higher end-userpricing.  The net sales increase alsoreflects a domestic revenue increase of 43% in the three months ended June 30,2008 compared to the three months ended June 2007.  Net sales also increased due to theincreasing number of physicians entering and completing training in the use ofthe procedure. We recognize that a strong base of trained physicians does notnecessarily correlate to an increase in revenue proportionately. Furthermore,there are no revenues associated with the training activities. We do not chargea fee for the activity and no commitment arises for the physician from thepreceptorship. Physician training is provided upfront and we have no obligationsubsequent to the initial training. Training costs have not been significant tous from inception to date.

 

         Net sales by geographic region, based on shipping locationof our customer, are as follows (in thousands, except percentages):

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales (in  thousands) |       | $                                | 25,680     |                           | $          | 15,669 |   | $ | 46,807 |   | $ | 29,449 |   |
|                      |       |                             |       |                           |       |   |   |   |   |
| United States of  America |       | 78%                              |       | 89%                            |       | 77% |   | 90% |   |
| France                    |       | 14%                              |       | 10%                            |       | 14% |   | 9% |   |
| Europe                    |       | 7%                               |       | 0%                             |       | 8% |   | 0% |   |
| Other                     |       | 1%                               |       | 1%                             |       | 1% |   | 1% |   |
|                           |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |

 

         No customer accounted for more than 10%of total revenue for the three and six months ended June 30, 2008 and2007. No customer had a balance in excess of 10% of our net accounts receivableat June 30, 2008. Accounts receivable from one customer accountedfor 26% of our net accounts receivable balance at June 30, 2007.

 

         We expect our net sales for 2008 to be approximately $102million to $105 million, which would represent 58% to 63% growth from net salesin 2007 as we continue to increase the number of sales representatives in orderto provide even greater depth of physician coverage, which in turn we expectwill increase physician utilization and the number of physicians performing the*Essure* procedure. We will also continueour programs aimed at raising patient awareness of the*Essure* procedure, such as radio, printand television advertising. Additionally, we will see an increase in ourinternational sales with the completion of the acquisition of our Europeandistributor in January 2008. We believe our revenue growth in 2008 andbeyond will be significantly influenced by how successful we are in achievingour objectives. However, as we have noted elsewhere in this Form 10-Q andrisk factors from our Form 10-K, our expected revenue growth involves manyrisk factors, some of which are not entirely within our control, such as marketacceptance of the*Essure* systemand third party reimbursement for the device.

 

*GrossProfit*

 

Cost of goods sold forthe three months ended June 30, 2008 was $5.2 million as compared to $4.2million for the three months ended June 30, 2007. This increase of $1.0million, or 23% was caused by higher volumes of sales.  Gross profit margin was 80% for the threemonths ended June 30, 2008 and 73% for the three months ended June 30,2007.  For the six months ended June 30,2008, gross profit margin was 77%, which represents an improvement from a grossprofit margin of 73% for the six months ended June 30, 2007.  The year-over-year increase in gross margin is related to higheraverage selling prices into the European market that were achieved after theacquisition of Conceptus SAS, lower manufacturing costs associated with higherunit volume, the introduction of the Company’s third generation device and adomestic price

 

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increaseimplemented during the first quarter of 2008. We anticipate gross margins will remain in the 79% to 81% rangefor the remainder of 2008 due to the lower per-unit costs on greater volume andthe increased margin obtained from end user sales by Conceptus SAS; however,our gross profit margin will vary as our sales mix changes. Increases in salesof our devices through distributors in international markets will tend todecrease our overall gross profit margin.

 

*Researchand Development Expenses*

 

Research and developmentexpenses are substantially related to the ongoing development and associatedregulatory approvals of our technology and were $1.6 million and $1.1 millionfor the three months ended June 30, 2008 and 2007, respectively. Our goalis to continue our product enhancements over the coming years, which areintended to result in improved ease of use and clinical performance. We expectto identify and hire additional research and development personnel in thefuture to staff our planned research and development activities, and we expectthat these costs will increase as we seek to maintain our leading position inthe market for permanent female birth control. To support these initiatives inthe second quarter of 2008 we increased payroll and payroll relatedexpenditures by $0.3 million, consulting and outside service expenses by $0.2million and clinical trial expenses by $0.1 million compared to the threemonths ended June 30, 2007. Research and development expenses were $3.6 million and $2.7 million forthe six months ended June 30, 2008 and 2007, respectively. The increaseresults primarily from payroll and payroll related expenditures of $0.6million, consulting and outside service expenses of $0.6 million and clinicaltrial expenses of $0.2 million, offset by a reduction in supplier charges andequipment purchases of $0.3 million.

 

*Selling,General and Administrative Expenses*

 

Selling, general andadministrative spending for the three months ended June 30, 2008 were$20.1 million as compared to $13.2 million for the three months ended June 30,2007, which represents an increase of $6.9 million, or 52%.  Payroll and payroll related expendituresincreased $2.8 million, primarily due to the expansion of our U.S. field salesforce, which is meant to provide us with more selling time to focus onphysician penetration. Additionally, we increased total advertising expenses by$2.0 million, primarily relating to our direct to consumer advertising campaignthat was launched during the first quarter of 2008. In connection with ouracquisition of Conceptus SAS we incurred $1.7 million of operating expensesrepresenting the normal operating expenses of running that business.Additionally, increases in selling, general and administrative expenses were aresult of higher outside service expenses of $0.4 million.

 

Selling, general andadministrative spending for the six months ended June 30, 2008 were $40.2million as compared to $26.2 million for the six months ended June 30,2007, which represents an increase of $14.0 million, or 53%.  The increases were primarily the result ofpayroll and payroll related expenditures of $4.3 million, advertising expenseof $4.5 million, consulting expenses of $0.6 million and Conceptus SASoperating expenses of $3.3 million. We expect selling, general and administrativeexpenses to decrease in the third quarter of 2008 as compared to the secondquarter of 2008 primarily due to a decrease in expenses associated with ourdirect to consumer campaign.

 

*TotalOther Income (Expense)*

 

Total other income(expense) for the three months ended June 30, 2008 was a net expense of$0.2 million as compared to a net income of $0.7 million for the three monthsended June 30, 2007. Interestincome in the three months ended June 30, 2008 was lower by $1.0 millioncompared with the three months ended June 30, 2007. Interest income wasnegatively impacted due to lower interest rates on the Company’s long terminvestment portfolio, which consists of auction rate securities that arecurrently earning below market rates of interest.  For the six months ended June 30,2008, total other income (expense) was a net expense of $0.2 million ascompared to net income of $1.1 million for the same period ended June 30,2007, primarily due to auction rate securities earning below market rates ofreturn and foreign currency losses on our outstanding hedge contract of $0.5million offset by exchange gains of $0.3 million.

 

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*Provisionfor income tases*

 

We adopted the provisionsof FASB Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes*, or FIN 48 on January 1, 2007.  Theadoption of the provisions of FIN 48 did not have a material impact on ourfinancial position and results of operations. We have not been audited by theInternal Revenue Service or any state income or franchise tax agency. As of June 30,2008, our federal returns for the years ended 2004 through the current periodand most state returns for the years ended 2003 through the current period arestill open to examination. In addition, all of the net operating losses andresearch and development credit carryforwards that may be used in future yearsare still subject to inquiry given that the statute of limitation for theseitems would be from the year of the utilization.

 

As of June 30, 2008,we recorded approximately $0.2 million of income tax expense attributable toour French subsidiary.

 

The amount ofunrecognized tax benefits at December 31, 2007, was $1.9 million, which,if ultimately recognized, will reduce our annual effective tax rate.

 

We do not expect ourunrecognized tax benefits to change significantly over the next 12 months.  In connection with the adoption of FIN 48, werecognize interest and penalties accrued on any unrecognized tax benefits as acomponent of income tax expense.

 

**Liquidityand Capital Resources**

 

We have experienced significant operating losses since inception. As of June 30,2008, we had an accumulated deficit of $243.3 million. We have financedour operations since inception primarily through equity and debt financings. InDecember 2006, we filed a shelf Registration Statement on Form S-3,through which we may sell from time to time any combination of debt securities,common stock, preferred stock and warrants, in one or more offerings. Theaggregate initial offering price of all securities sold will not exceed $150,000,000. After the sale of oursenior convertible notes described below, we had $63,750,000 remainingavailable for sale.

 

In February 2007,we issued and sold under the shelf Registration Statement an aggregateprincipal amount of $86,250,000 of our 2.25% convertible senior notes due 2027.These notes bear a 2.25% interest per annum on the principal amount, payablesemiannually in arrears on February 15 and August 15 of each year,beginning on August 15, 2007. Interest accrual on the notes commenced on February 12,2007. The notes will mature on February 15, 2027, unless earlier redeemed,repurchased or purchased by us or converted.

 

The notes will beconvertible into cash and, if applicable, shares of our common stock based onan initial conversion rate, subject to adjustment, of 35.8616 shares per $1,000principal amount of notes (which represents an initial conversion price ofapproximately $27.89 per share), in certain circumstances. Upon conversion, aholder would receive cash up to the principal amount of the note and our commonstock in respect of such note’s conversion value in excess of such principalamount.

 

The notes areconvertible only in the following circumstances: (1) during any calendarquarter after the quarter ended March 31, 2007 if the closing sale priceof our common stock for each of 20 or more trading days in a period of 30consecutive trading days ending on the last trading day of the immediatelypreceding calendar quarter exceeds 120% of the conversion price; (2) duringthe five consecutive business days immediately after any five consecutivetrading day period if the average trading price per $1,000 principal amount ofthe notes is less than or equal to 97% of the average conversion value of thenotes during such five-day period; (3) upon the occurrence of specifiedcorporate 

 

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transactions; (4) ifwe call the notes for redemption and (5) at anytime on or after December 15,2011 up to and including February 15, 2012 and anytime on or after February 15,2025. Upon a change in control or termination of trading, holders of the notesmay require us to repurchase all or a portion of their notes for cash at arepurchase price equal to 100% of the principal amount, plus any accrued andunpaid interest.

 

In addition, inconnection with the issuance of the notes, we entered into separate convertiblenote hedge transactions and separate warrant transactions to reduce thepotential dilution upon conversion of the notes (“Call Spread Transactions”).As a result of the Call Spread Transactions, we do not anticipate experiencingan increase in the total shares outstanding from the conversion of the notesunless the price of our common stock appreciates above $36.47 per share,effectively increasing the conversion premium to us to $36.47. We purchasedcall options to cover approximately 3.1 million shares of our commonstock, which is the number of shares underlying the notes. In addition, we soldwarrants permitting the purchasers to acquire up to approximately3.1 million shares of our common stock.

 

As of June 30,2008, we held $48.5 million (par value) in auction rate securities backed byfederal and state student loans which are variable rate debt instruments andbear interest rates that reset approximately every 20-30 days. The auction ratesecurities were rated AAA and AA by a major credit rating agency. Theunderlying securities have contractual maturities which are generally greaterthan ten years. The securities are classified as available for sale and arerecorded at fair value. We recorded a temporary reduction in carrying value of$2.6 million for the six-month period ended June 30, 2008, which has beenrecorded as an unrealized loss in accumulated other comprehensive income. Giventhe recent disruptions in the credit markets and the fact that the liquidityfor these types of securities remains uncertain, we have classified all of ourauction rate securities as long-term investments in our condensed consolidatedbalance sheet as our ability to liquidate such securities in the next 12 monthsis uncertain. The carrying value of our auction rate securities on ourcondensed consolidated balance sheet as of June 30, 2008 was $45.8million. During the first quarter of 2008 we successfully liquidated $22.1million of our investments in auction rate securities, however, $48.5 million(par value) of our investments in auction rate securities failed. Based on ourability to access our cash and other short-term investments, our expectedoperating cash flows, and our other sources of cash, we do not anticipate thecurrent lack of liquidity on these investments will affect our ability tooperate our business during the next twelve months from the date of thisreport.

 

In the future, dependingon a variety of factors, we may need to raise additional funds through bankfacilities, debt or equity offerings or other sources of capital.  Additional financing may not be availablewhen needed or on terms acceptable to us.

 

As of June 30, 2008,we had cash, cash equivalents and short-term investments of $21.2 million,compared to $45.2 million at December 31, 2007. The decrease of $24.0million is primarily due to our acquisition of Conceptus SAS in January 2008.We expect cash usage in operating activities to decrease in the future as ournet loss decreases.  We believe that ourexisting cash and cash equivalents will be sufficient to meet our cashrequirements for the next twelve months.

 

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*OperatingActivities*

 

Net cash used inoperating activities was $2.1 million in the six months ended June 30,2008, as compared to $6.8 million in the six months ended June 30, 2007.Net cash used in operating activities in the six months ended June 30,2008 was primarily related to:

 

·      netloss of $8.0 million; and

·      non-cash related items of $4.9 millioncorresponding primarily to stock based compensation and depreciation andamortization of fixed assets, debt issuance costs and intangibles;

 

We monitor our accountsreceivable turnover closely to ensure that receivables are collected timely andhave an established a credit and collection policy to facilitate our collectionprocess and reduce our credit loss exposure.

 

We expect cash usage inoperating activities in the future to decrease as our revenues grow.

 

*InvestingActivities*

 

Net cash used ininvesting activities for the six months ended June 30, 2008 was $8.3million, from sales and maturity of short-term investments of $22.1 million,offset by the purchase of Conceptus SAS, net of cash acquired of $23.0 million,purchases of investments of $5.0 million and capital expenditures of $2.4million. Net cash used in investing activities for the six months ended June 30,2007 was $71.1 million, from sales and maturity of short-term investments of$11.5 million, offset by purchases of investments of $82.1 million and capitalexpenditures of $0.4 million.

 

*FinancingActivities*

 

Net cash provided byfinancing activities in the six months ended June 30, 2008 was $3.0million from the issuance of common stock for our stock option programs. Netcash provided by financing activities was $77.0 million for the six months endedJune 30, 2007 primarily due to the net proceeds of $83.2 million from ourissuance of senior convertible notes in February 2007, the proceeds of$10.7 million for the issuance of warrants in connection with our seniorconvertible notes and the proceeds of $2.5 million for the issuance of commonstock for our stock option programs, offset by $19.4 million for the cost ofour purchase of call options on our convertible senior notes.

 

**CRITICALACCOUNTING ESTIMATES AND POLICIES**

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions in certain circumstances that affect amounts reported in theaccompanying consolidated financial statements and related footnotes. Adescription of our critical accounting estimates and policies is included inour Annual Report on Form 10-K for the year ended December 31, 2007.In preparing these financial statements, management has made its best estimatesand judgments of certain amounts included in the financial statements, givingdue consideration to materiality. The primary estimates underlying ourfinancial statements include reserves for obsolete and slow moving inventory,allowance for doubtful accounts receivable, product warranty, impairment forlong-lived assets, income taxes, stock-based compensation and contingentliabilities. Other accounting policies are described in section “CriticalAccounting Estimates and Policies” in our Financial Statements included in ourAnnual Report on Form 10-K for the year ended December 31, 2007.Application of these policies involves the exercise of judgment and use ofassumptions as to future uncertainties and, as a result, actual results coulddiffer from these estimates.

 

*RecentAccounting Pronouncements*

 

In September 2006,the Financial Standards Accounting Board, or FASB, issued Statement No. 157,*Fair Value Measurement,* or SFAS 157.This standard defines fair value, establishes the framework for measuring fairvalue in accounting principles generally accepted in the United States andexpands disclosure about fair value measurements. This pronouncement appliesunder other accounting standards that require or permit fair valuemeasurements. SFAS 157 is effective for financial statements issued for yearsbeginning 

 

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after November 15,2007, and interim periods of those fiscal years. FASB Staff Position 157-2, *Effective Date of FASB Statement No. 157* delays theeffective date of SFAS 157 for all non-financial assets and non-financialliabilities, except for items that are recognized or disclosed at fair value inthe financial statements on a recurring basis (at least annually), until thebeginning of the first quarter of 2009. Effective January 1, 2008 we adopted SFAS 157 for financial assetsand liabilities carried at fair value. The adoption of SFAS 157 and SFAS 157-2for financial assets and liabilities did not have a material impact on ourcondensed consolidated financial statements. See Note 4- Fair Value Measurements.

 

In February 2007,FASB issued Statement No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities*, or SFAS 159, whichpermits entities to choose to measure many financial instruments and certainother items at fair value that are not currently required to be measured atfair value. SFAS 159 became effective for us on January 1, 2008. The adoptionof SFAS 159 did not have a material impact on our condensed consolidatedfinancial statements.

 

In December 2007,FASB issued Statement No. 141 (revised 2007) *BusinessCombination,s* or SFAS 141(R), and Statement No. 160, *Noncontrolling Interests in Consolidated Financial Statements*,*or SFAS 160*, an amendment of Accounting Research Bulleting No. 51,or ARB 51. SFAS 141(R) will impact financial statements on the acquisitiondate and in subsequent periods. Some of the changes, such as the accounting forcontingent consideration, will introduce more volatility into earnings and mayimpact our acquisition strategy. SFAS 160 will change the accounting andreporting for minority interests, which will be re-characterized asnon-controlling interests and classified as a component of equity. In addition,SFAS 141(R) will be applied prospectively and SFAS 160 will requireretroactive adoption of the presentation and disclosure requirements forexisting minority interests, while the remaining requirements of SFAS 160 willbe applied prospectively. SFAS 141(R) and SFAS 160 are effective on January 1,2009. We are currently evaluating the impact of adopting SFAS 141(R) andSFAS 160 on our consolidated financial statements.

 

In March 2008, theFASB issued SFAS No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities*— an amendment of FASBStatement No. 133 or SFAS No. 161. SFAS No. 161 requires enhanced disclosures about how and why anentity uses derivative instruments, how derivative instruments and relatedhedged items are accounted for and their effect on an entity’s financialposition, financial performance, and cash flows. SFAS No. 161 will beeffective in the first quarter of fiscal year 2010.  We are evaluating the impact that thisstatement will have, if any, on our consolidated financial statements.

 

In April 2008, theFASB issued FASB Staff Position (“FSP”) No. 142-3, *Determinationof the Useful Life of Intangible Assets.*  FSP 142-3 amends the factors an entity shouldconsider in developing renewal or extension assumptions used in determining theuseful life of recognized intangible assets under FASB Statement No. 142,Goodwill and Other Intangible Assets. This new guidance applies prospectively to intangible assets that areacquired individually or with a group of other assets in business combinationsand asset acquisitions.  FSP 142-3 iseffective for financial statements issued for fiscal years and interim periodsbeginning after December 15, 2008. Early adoption is prohibited.  Weare evaluating the impact, if any, that FSP 142-3 will have, if any, on ourconsolidated financial statements.

 

In May 2008, theFASP issues FASB Staff Position (“FSP”) APB 14-1, *Accountingfor Convertible DebtInstruments That May Be Settled in Cash upon Conversion (Including PartialCash Settlement)* or FSP APB 14-1, which clarifies the accounting forconvertible debt instruments that may be settled in cash upon conversion,incluing parital cash settlement.  FSPAPB 14-1 specifies that an issue of such instruments should separately accountfor the liability and equity components of the instruments in a manner thatreflect the issuer’s non-convertible debt borrowing rate which interest costsare recognized in subsequent periods. FSP APB 14-1 is effective for fiscal years beginning after December 15,2008, and retrospective application is required for all periods presented.  We are currently evaluation the impact of FASAPB 14-1 and expect that the guidance will have a material impact on itsconsolidated results and operations and financial condition beginning in thefirst quarter of fiscal 2009, as we will be required to record higher non-cashinterest expense related to our outstanding convertible debt instrument.

 

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**Item3. Quantitative and Qualitative Disclosures About Market Risk**

 

The following discussesour exposure to market risk related to changes in interest rates and foreigncurrency exchange rates. These exposures may change over time as businesspractices evolve and could have a material adverse impact on our financialresults.

 

*InterestRate Risk*:  We have been exposed to interest rate riskthrough interest earned on holdings of available-for-sale marketablesecurities. We have experienced failed auctions in 2008 of all our auction ratesecurities and there is no assurance that auctions on these auction ratesecurities in our investment portfolio will succeed in the future. As a result,our ability to liquidate our investments in the near term may be limited, andour ability to fully recover the carrying value of our investments may belimited or non-existent. An auction failure means that the parties wishing tosell securities could not carry out the transaction. If the issuers of thesesecurities are unable to successfully close future auctions or their creditratings deteriorate, we may in the future be required to record an impairmentcharge on these investments. It could take until the final maturity of theunderlying notes (up to 39 years) to realize our investments’ recordedvalue. As of June 30, 2008 we held $48.5 million (par value) inauction rate securities which are variable rate debt instruments and bear interestrates that reset approximately every 20-30 days. All of these auction ratesecurities were classified as long term investments in our condensedconsolidated balance sheet at June 30, 2008 with an expected maturity ofgreater than one year. Due in part to these factors, our future investmentincome may fall short of expectations due to changes in interest rates or wemay suffer losses in principal if forced to sell securities that have declinedin market value due to changes in interest rates. Interest rates that mayaffect these items in the future will depend on market conditions and maydiffer from the rates we have experienced in the past.

 

*ForeignCurrency Exchange Risk:*    Historically,all of our expenses and our revenues were typically denominated in UnitedStates dollars. On January 7, 2008, we acquired all the outstanding sharesof Conceptus SAS.  As a result of thistransaction, Conceptus SAS became a wholly owned subsidiary and its results ofoperations have been consolidated with our results of operations for financialreporting purposes as of the acquisition date. The functional currency ofConceptus SAS is the Euro; therefore, we are now exposed to changes in foreignexchange rates. We are exposed to foreign exchange rate fluctuations as wetranslate the financial statements of Conceptus SAS into U.S. dollars inconsolidation. If there is a change in foreign currency exchange rates, thetranslation of Conceptus SAS’ financial statements into U.S. dollars will leadto translation gains or losses which are recorded net as a component ofaccumulated other comprehensive loss. We will seek to manage our foreignexchange risk through operational means, including managing same currencyrevenues in relation to same currency expenses, and same currency assets inrelation to same currency liabilities. In connection with the acquisition ofConceptus SAS, we assumed a forward exchange contract to hedge dollardenominated estimated accounts payable in 2008. We have recorded the changes ofthe fair value of the hedge contract in our results of operations for the sixmonths ended June 30, 2008.  In2007, we did not enter into forward exchange contracts to hedge exposuredenominated in foreign currencies or any other derivative financial instrumentsfor trading or speculative purposes.

 

**Item4. Controls and Procedures**

 

*Evaluationof Disclosure Controls and Procedures:*

 

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our Exchange Act reports is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow for timely decisions regardingrequired disclosure. In designing and evaluating the disclosure controls andprocedures, management recognized that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and in reaching a reasonable level ofassurance, management is required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

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As of June 30, 2008,the end of our most recent fiscal quarter, we carried out an evaluation, underthe supervision and with the participation of our management, including ourChief Executive Officer and our Chief Financial Officer, of the effectivenessof the design and operation of our disclosure controls and procedures. Based onthe foregoing, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were effective.

 

*Changesin Internal Control Over Financial Reporting:*

 

There was no change inour internal control over financial reporting during our most recent fiscalquarter that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

*InherentLimitations of Internal Controls*

 

Internal control overfinancial reporting cannot provide absolute assurance of achieving financialreporting objectives because of its inherent limitations.  Internalcontrol over financial reporting is a process that involves human diligence andcompliance and is subject to lapses in judgment and breakdowns resulting fromhuman failures. Internal control over financial reporting also can becircumvented by collusion or improper management override. Because of suchlimitations, there is a risk that material misstatements may not be preventedor detected on a timely basis by internal control over financial reporting.However, these inherent limitations are known features of the financialreporting process. Therefore, it is possible to design into the processsafeguards to reduce, though not eliminate, this risk.

 

**PART II. OTHER INFORMATION**

 

**Item1. Legal Proceedings**

 

From time to time, we areinvolved in legal proceedings arising in the ordinary course of business. We believe there is no litigation pending that could have, individually or inthe aggregate, a material adverse effect on our financial position, result ofoperations or cash flows.

 

**Item1A. Risk Factors**

 

*Therisk factors included in our Annual Report as of December 31, 2007 on Form 10-Kfiled with the Securities and Exchange Commission on March 14, 2008 shouldbe considered while evaluating Conceptus and our business. In addition to thosefactors and to other information in this Form 10-Q, updates to thefollowing risk factors as of June 30, 2008 should be considered carefullywhile evaluating Conceptus and our business.*

 

***Our investment portfolio is investedin auction rate securities. Failures in the auctions for these securitiesaffect our liquidity, while deterioration in credit ratings of issuers of suchsecurities and/or third parties insuring such investments may require us toadjust the carrying value of our investment through an impairment of earnings.***

 

As of August 1,2008, approximately $48.5 million (par value) of investments consistedentirely of auction rate securities backed by federal and state student loanssecurities with maturity of underlying notes up to 39 years.  These investments have characteristicssimilar to short-term investments, because at pre-determined intervals,generally ranging from 20 to 30 days, there is a new auction processat which the interest rates for these securities are reset to currentinterest rates. At the end of each such period, we historically have eitherchosen to roll-over these securities or redeem the securities for cash.

 

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                We have experienced failed auctions in 2008 of ourauction rate securities and there is no assurance that auctions on thesesecurities in our investment portfolio will succeed in the future. As a result,our ability to liquidate our investments in the near term may be limited, andour ability to fully recover the carrying value of our investments may belimited or non-existent. An auction failure means that the parties wishing tosell securities could not carry out the transaction. If the issuers of thesesecurities are unable to successfully close future auctions or their creditratings deteriorate, we may in the future be required to record an impairmentcharge on these investments. It could take until the final maturity of theunderlying notes (up to 39 years) to realize our investments’ recordedvalue. Based on our ability to access our cash and cash equivalents, expectedoperating cash flows, and our other sources of cash, we do not anticipate thatthe current lack of liquidity on these investments will affect our ability tocontinue to operate our business in the ordinary course. However, we canprovide no assurance as to when these investments will again become liquid oras to whether we may ultimately have to recognize an impairment charge in ourresults of operations with respect to these investments.

 

**Item4. Submission of Matter to a Vote of Security Holders**

 

                On June 4,2008, the Annual Meeting of Stockholders of Conceptus, Inc. was held inMountain View, California.  The mattersvoted upon and approved at the meeting, and the number of affirmative andnegative votes cast with respect of each matter were as follows:

 
| ** **                          | ** ** | **Votes for** | ** ** | **Votes**    | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|--------------------|------------|--------------|------------|------------|------------|------------|------------|
| ** **                          | ** ** | **Nominee**        | ** ** | **Withheld** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proposal I                          |       |               |       |         |       |       |       |       |       |
| Election of  Class I Directors |       |               |       |         |       |       |       |       |       |
| Elected:                            |       |               |       |         |       |       |       |       |       |
| - Michael A.  Baker                 |       | 23,633,122         |       | 4,673,789    |       |       |       |       |       |
| - Peter L.  Wilson                  |       | 22,831,366         |       | 5,475,545    |       |       |       |       |       |

 
| ** **                                                                                                                                                                       | ** ** | **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **No-Vote** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Proposal II                                                                                                                                                                      |       |       |       |        |       |        |       |        |       |
| To ratify the  Tenth Amended and Restated 2001 Equity                                                                                                                            |       |       |       |        |       |        |       |        |       |
| Incentive Plan                                                                                                                                                                   |       | 20,201,745 |       | 4,673,789   |       | 20,856      |       | 3,410,521   |       |
|                                                                                                                                                                             |       |       |       |        |       |        |       |        |       |
| Proposal III                                                                                                                                                                     |       |       |       |        |       |        |       |        |       |
| To ratify the  the Fourth Amendment to the 1995 Employee                                                                                                                         |       |       |       |        |       |        |       |        |       |
| Stock Plan                                                                                                                                                                       |       | 24,687,237 |       | 195,468     |       | 13,685      |       | 3,410,521   |       |
|                                                                                                                                                                             | ** ** | ** ** | ** ** | ** **  |       |        |       |        |       |
| Proposal IV                                                                                                                                                                      |       |       |       |        |       |        |       |        |       |
| To ratify the  appointment of PricewaterhouseCoopers LLP as the independent registered  public accounting firm of the Company for the fiscal year ending  December 31, 2008 |       | 28,273,509 |       | 33,194      |       | 208         |       |        |       |

 

**Item6. Exhibits**

 
| **Number** | ** ** | **Description**                                                                                            |
|------------|------------|------------------------------------------------------------------------------------------------------------|
| 31.1       |       | Certification of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
| 31.2       |       | Certification of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
| 32.1       |       | Certification of Chief  Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002. |
| 32.2       |       | Certification of Chief  Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002. |

 

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**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

 
| Date: August 7,  2008           |   |
|--------------------------------------|--------|
|                                 |   |
|                                 |   |
| /s/ Gregory E.  Lichtwardt           |   |
| Gregory E. Lichtwardt                |   |
| Executive Vice  President, Treasurer |   |
| and Chief Financial  Officer         |   |

 

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**EXHIBITINDEX**

** **
| **Number** | ** ** | **Description**                                                                                            |
|------------|------------|------------------------------------------------------------------------------------------------------------|
| 31.1       |       | Certification of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
| 31.2       |       | Certification of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
| 32.1       |       | Certification of Chief  Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002. |
| 32.2       |       | Certification of Chief  Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002. |

 

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