**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

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**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 September 30, 2006** |
| ** **                                             | ** **                                                                                    |
| **OR**                                                 |
| ** **                                             | ** **                                                                                    |
| **o**                                                  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from               to                     .**

Commission File Number: **0-27596**

**CONCEPTUS, INC.**

(Exact name of Registrant as specified in itscharter)

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

 

**331 East Evelyn**

**Mountain View, CA 94041**

(Address of Principal Executive Offices) (ZipCode)

**(650) 962-4000**

(Registrant’s Telephone Number, Including AreaCode)

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

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for at least the past 90 days. Yesx No  ̈

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act (Check one)

Large accelerated filer  ̈ Accelerated Filer x Non accelerated filer  ̈

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of Exchange Act).

Yes  ̈No x

There were 29,401,430 shares ofRegistrant’s Common Stock issued and outstanding as of October 31, 2006.

 

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**CONCEPTUS, INC.**

**FORM 10-Q for the Quarter Ended September 30, 2006**
|            | ** **                                                                                                                  | **Page**   |
|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|
| ** ** | ** **                                                                                                                  | ** ** |
| Part I.    | Financial  Information                                                                                                      | 3          |
|       |                                                                                                                        |       |
| Item  1.   | Condensed  Consolidated Financial Statements (Unaudited)                                                                    | 3          |
|       |                                                                                                                        |       |
|       | a)  Condensed Consolidated Balance Sheets as of September 30, 2006  and December 31, 2005                              | 3          |
|       |                                                                                                                        |       |
|       | b)  Condensed Consolidated Statements of Operations for the three and nine month  periods ended September 30, 2006 and 2005 | 4          |
|       |                                                                                                                        |       |
|       | c)  Condensed Consolidated Statements of Cash Flows for the nine month periods  ended September 30, 2006 and 2005           | 5          |
|       |                                                                                                                        |       |
|       | d)  Notes to Condensed Consolidated Financial Statements                                                                    | 6          |
|       |                                                                                                                        |       |
| Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                 | 16         |
|       |                                                                                                                        |       |
| Item 3.    | Quantitative  and Qualitative Disclosures About Market Risk                                                                 | 24         |
|       |                                                                                                                        |       |
| Item 4.    | Controls and  Procedures                                                                                                    | 24         |
|       |                                                                                                                        |       |
| Part II.   | Other Information                                                                                                           | 25         |
|       |                                                                                                                        |       |
| Item 1.    | Legal Proceedings                                                                                                           | 25         |
|       |                                                                                                                        |       |
| Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                | 26         |
|       |                                                                                                                        |       |
| Item  6.   | Exhibits                                                                                                                    | 27         |
|       |                                                                                                                        |       |
| Signature  |                                                                                                                        | 28         |

 

2

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**PART I.FINANCIAL INFORMATION**

**ITEM 1. Condensed Consolidated Financial Statements**

**Conceptus, Inc.**

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

**(In thousands, except number of shares)**
| ** **                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| **Assets**                                          |       |                   |       |                  |       |
| Current assets:                                     |       |                   |       |                  |       |
| Cash and cash  equivalents                          |       | $                      | 3,387      |                  | $          | 12,573 |   |
| Short-term  investments                             |       | 22,300                 |       | 19,850                |       |
| Restricted cash                                     |       | 69                     |       | 69                    |       |
| Accounts  receivable, net                           |       | 6,153                  |       | 4,519                 |       |
| Inventories                                         |       | 1,079                  |       | 3,392                 |       |
| Other current  assets                               |       | 1,028                  |       | 1,110                 |       |
| Total current  assets                               |       | 34,016                 |       | 41,513                |       |
|                                                |       |                   |       |                  |       |
| Property and  equipment, net                        |       | 2,848                  |       | 2,743                 |       |
| Intangible  assets, net                             |       | 1,400                  |       | 1,550                 |       |
| Other assets                                        |       | 1,184                  |       | 1,603                 |       |
| **Total assets**                                    | ** ** | **$**                  | **39,448** |                  | **$**      | **47,409** | ** ** |
|                                                |       |                   |       |                  |       |
| **Liabilities and stockholders’  equity**      |       |                   |       |                  |       |
| Current  liabilities:                               |       |                   |       |                  |       |
| Accounts payable                                    |       | $                      | 2,417      |                  | $          | 2,798 |   |
| Accrued  compensation                               |       | 2,983                  |       | 3,052                 |       |
| Other accrued  liabilities                          |       | 1,051                  |       | 1,074                 |       |
| Total current  liabilities                          |       | 6,451                  |       | 6,924                 |       |
|                                                |       |                   |       |                  |       |
| Other accrued  liabilities                          |       | 349                    |       | 314                   |       |
| Total  liabilities                                  |       | 6,800                  |       | 7,238                 |       |
|                                                |       |                   |       |                  |       |
| Stockholders’  equity:                         |       |                   |       |                  |       |
| Common stock and  additional paid-in capital        |       | 252,334                |       | 246,359               |       |
| Deferred  stock-based compensation                  |       | —                 |       | (1,058                | )          |
| Accumulated  deficit                                |       | (219,686               | )          | (205,130              | )          |
| Treasury Stock,  79,752 and 77,863 shares, at cost  |       | —                 |       | —                |       |
| Total  stockholders’ equity                    |       | 32,648                 |       | 40,171                |       |
| **Total liabilities and stockholders’ equity** | ** ** | **$**                  | **39,448** |                  | **$**      | **47,409** | ** ** |

 

*The accompanying notes are an integral part of thesecondensed consolidated financial statements.*

3

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**Conceptus, Inc.**

**Condensed Consolidated Statements of Operations**

**(Unaudited)**

**(In thousands, except per share amounts)**
| ** **                                                                      | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                      | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales                                                                       |       | $                                | 11,013     |                            | $          | 5,499 |   | $ | 28,978 |   | $ | 14,402 |   |
| Cost of goods sold (*)                                                          |       | 3,486                            |       | 1,999                           |       | 10,020 |   | 5,828 |   |
| Gross profit                                                                    |       | 7,527                            |       | 3,500                           |       | 18,958 |   | 8,574 |   |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Operating expenses:                                                             |       |                             |       |                            |       |   |   |   |   |
| Research and  development (*)                                                   |       | 1,030                            |       | 1,145                           |       | 3,299 |   | 3,020 |   |
| Selling, general  and administrative (*)                                        |       | 10,265                           |       | 7,618                           |       | 31,200 |   | 23,568 |   |
| Total operating  expenses                                                       |       | 11,295                           |       | 8,763                           |       | 34,499 |   | 26,588 |   |
| Operating loss                                                                  |       | (3,768                           | )          | (5,263                          | )          | (15,541 | ) | (18,014 | ) |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Interest and  other income                                                      |       | 329                              |       | 260                             |       | 985 |   | 611 |   |
| Net loss                                                                        |       | $                                | (3,439     | )                               | $          | (5,003 | ) | $ | (14,556 | ) | $ | (17,403 | ) |
| Basic and diluted net  loss per share                                           |       | $                                | (0.12      | )                               | $          | (0.18 | ) | $ | (0.50 | ) | $ | (0.67 | ) |
| Weighted-average shares used in computing basic and diluted net loss  per share |       | 29,034                           |       | 27,218                          |       | 28,938 |   | 26,046 |   |

 

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(*) Includes thefollowing amounts related to stock-based compensation:
| ** **                          | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                          | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Cost of goods sold                  |       | $                                | 12         |                            | $          | 33 |   | $ | 123 |   | $ | 61 |   |
| Research and  development           |       | 162                              |       | 34                              |       | 531 |   | 105 |   |
| Selling, general and administrative |       | 1,304                            |       | 208                             |       | 3,856 |   | 619 |   |
|                                     |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

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

Net loss for thethird quarter and first nine months of 2006 included stock-based compensationexpense to non-employees in accordance with Emerging Issues Task Force Issue (“EITF”)No. 96-18 of approximately $37,000 and $137,000, respectively, and stock-basedcompensation expense under Statement of Financial Accounting Standards (“SFAS”)No. 123(R) of approximately $1,441,000 and $4,372,000 respectively, whichconsisted of stock-based compensation expense of approximately $1,117,000 and$3,407,000, respectively, related to employee stock options, employee stockpurchase plan and stock appreciation rights and stock-based compensationexpense of approximately $324,000 and $965,000, respectively, related toemployee restricted stock and restricted stock units.

Net loss for thethird quarter and first nine months of 2005 included stock-based compensationexpense to non-employees in accordance with EITF 96-18 of approximately $72,000and $154,000, respectively, and stock-based compensation expense ofapproximately $203,000 and $631,000, respectively, related to employeerestricted stock.

4

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**Conceptus, Inc.**

**CondensedConsolidated Statements of Cash Flows**

**(Unaudited)**

**(Inthousands)**
| ** **                                                                   | ** ** | **Nine months ended** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,**          | ** ** |
| ** **                                                                   | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| **Cash flows from operating  activities**                                    | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Net loss                                                                     |       | $                               | (14,556    | ) | $ | (17,403 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                            |       |   |   |
| Depreciation and  amortization of property, plant and equipment              |       | 868                             |       | 688 |   |
| Amortization of  intangibles                                                 |       | 150                             |       | 150 |   |
| Inventory  reserves                                                          |       | (166                            | )          | 42 |   |
| Stock-based  compensation expense                                            |       | 4,510                           |       | 785 |   |
| Allowance for  doubtful accounts                                             |       | 46                              |       | 41 |   |
| Loss on  retirement of fixed assets                                          |       | 4                               |       | 2 |   |
| Changes in  operating assets and liabilities:                                |       |                            |       |   |   |
| Accounts  receivable                                                         |       | (1,680                          | )          | (1,451 | ) |
| Inventories                                                                  |       | 2,479                           |       | (1,731 | ) |
| Other current  assets                                                        |       | 82                              |       | 203 |   |
| Other assets                                                                 |       | 419                             |       | 107 |   |
| Accounts payable                                                             |       | (381                            | )          | (57 | ) |
| Accrued  compensation                                                        |       | (69                             | )          | 1,435 |   |
| Long term  liabilities                                                       |       | (23                             | )          | (51 | ) |
| Other accrued  liabilities                                                   |       | 35                              |       | 86 |   |
| Net cash used in  operating activities                                       |       | (8,282                          | )          | (17,154 | ) |
|                                                                         |       |                            |       |   |   |
| **Cash flows from investing  activities**                                    | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Purchase of  investments                                                     |       | (21,450                         | )          | (36,350 | ) |
| Maturities of  investments                                                   |       | 19,000                          |       | 66,550 |   |
| Capital  expenditures                                                        |       | (977                            | )          | (1,317 | ) |
| Net cash provided by  (used in) investing activities                         |       | (3,427                          | )          | 28,883 |   |
|                                                                         |       |                            |       |   |   |
| **Cash flows from financing  activities**                                    | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Issuance of  common stock                                                    |       | 2,523                           |       | 23,201 |   |
| Net cash provided by  financing activities                                   |       | 2,523                           |       | 23,201 |   |
|                                                                         |       |                            |       |   |   |
| Net increase (decrease)  in cash and cash equivalents                        |       | (9,186                          | )          | 34,930 |   |
| Cash and cash  equivalents at the beginning of the period                    |       | 12,573                          |       | 2,002 |   |
| Cash and cash  equivalents at end of the period                              |       | $                               | 3,387      |   | $ | 36,932 |   |

 

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

5

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**Conceptus, Inc.**

***NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS***

***(Unaudited)***

**1.****              Basis ofPresentation**

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America for interim financial information and pursuant to theinstructions to Form 10-Q and Article 10-01 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements. In theopinion of management, all adjustments, consisting only of normal recurringadjustments, considered necessary for a fair statement have been included.

Thecondensed consolidated balance sheet at December 31, 2005 has been derived fromthe audited consolidated financial statements at that date, but does notinclude all of the information and footnotes required by accounting principlesgenerally accepted in the United States of America for complete financialstatements. This financial data should be reviewed in conjunction with theaudited consolidated financial statements and related notes included in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2005.  The results of operations for the three andnine months ended September 30, 2006 may not necessarily be indicative of theoperating results for the full 2006 fiscal year or any other future interimperiods.

*Recent Accounting Pronouncements*

InSeptember 2006, the Securities and Exchange Commission (“SEC”) issued StaffAccounting Bulletin (“SAB”) No. 108 regarding the process of quantifyingfinancial statement misstatements. SAB No. 108 states that registrants shoulduse both a balance sheet approach and an income statement approach whenquantifying and evaluating the materiality of a misstatement. Theinterpretations in SAB No. 108 contain guidance on correcting errors under thedual approach, as well as provide transition guidance for correcting errors.This interpretation does not change the requirements within SFAS No. 154, “AccountingChanges and Error Corrections — a replacement of APB No. 20 and FASB StatementNo. 3” for the correction of an error on financial statements. SAB No. 108 iseffective for annual financial statements covering the first fiscal year endingafter November 15, 2006. The Company will be required to adopt thisinterpretation by December 31, 2006. We are currently evaluating therequirements of SAB No. 108 and the impact this interpretation may have on ourfinancial statements.

InSeptember 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS157”). This standard defines fair value, establishes the framework formeasuring fair value in accounting principles generally accepted in the UnitedStates of America and expands disclosure about fair value measurements. Thispronouncement applies under other accounting standards that require or permitfair value measurements. Accordingly, this statement does not require any newfair value measurement. This statement is effective for fiscal years beginningafter November 15, 2007 and interim periods within those fiscal years. TheCompany will be required to adopt SFAS No. 157 in the first quarter of 2008.Management is currently evaluating the requirements of SFAS No. 157 and has notyet determined the impact on the consolidated financial statements.

**2.****              Summary ofSignificant Accounting 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. Inpreparing 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 the Company’sfinancial statements include reserves for obsolete and slow moving inventory,allowance for doubtful accounts receivable, product warranty, impairment oflong-lived assets and stock-based compensation.

6

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The Company’s significant accounting policies aredisclosed in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2005 that was filed with the Securities and Exchange Commission onMarch 16, 2006. Except as stated Note 5, Stock Based Compensation, and in theCompany’s Critical Accounting Estimates section, the significant accountingpolicies of the Company have not materially changed since December 31, 2005.

**3.****              Inventories**

Inventories arestated at the lower of cost or market. Cost is based on actual costs computed on a first-in, first-outbasis.  The components of inventoriesconsist of the following (in thousands):
|                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------|------------|------------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Raw materials    |       | $                      | 118        |                  | $          | 122 |   |
| Work-in-progress |       | 521                    |       | 1,940                 |       |
| Finished goods   |       | 440                    |       | 1,330                 |       |
| **Total**        | ** ** | **$**                  | **1,079**  | ** **            | **$**      | **3,392** | ** ** |

 

**4.****              Warranty**

TheCompany offers warranties on its product and records a liability for theestimated future costs associated with warranty claims, which is based uponhistorical experience and the Company’s estimate of the level of future costs.  Warrantycosts are reflected in the statement of operations as a cost of goodssold.  A reconciliation of the changes inthe Company’s warranty liability for the nine months ended September 30, 2006and 2005 follows (in thousands):
|                                                   | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| Balance at the  beginning of the period           |       | $                                                       | 70         |   | $ | 68 |   |
| Accruals for warranties  issued during the period |       | 282                                                     |       | 128 |   |
| Settlements made in  kind during the period       |       | (206                                                    | )          | (128 | ) |
| **Balance at the end of the period**              | ** ** | **$**                                                   | **146**    | ** ** | **$** | **68** | ** ** |

 

**5.****              Stock-BasedCompensation**

Effective January 1, 2006, the Company adopted theprovisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-BasedPayment”, which establishes accounting for stock-based awards exchanged foremployee services. Accordingly, stock-based compensation cost is measured atgrant date, based on the fair value of the award, and is recognized on astraight line basis as expense over the employee requisite service period,which is generally the vesting period. The Company previously appliedAccounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issuedto Employees,” and related Interpretations and provided the required pro formadisclosures of SFAS No. 123, “Accounting for Stock-Based Compensation”.

The Company elected to adopt the modified prospectiveapplication method as provided by SFAS No. 123(R). Accordingly, during theperiod ended September 30, 2006, the Company recorded stock-based compensationfor shares granted prior to, but not yet vested as of the adoption date basedon the grant date fair value estimated in accordance with the originalprevisions of SFAS No. 123, and therefore, the Company did not restatepreviously reported amounts. Stock-based compensation expense for allshare-based payment awards granted on or after January 1, 2006 is based on the grantdate fair value estimated in accordance with the provisions of SFAS No. 123(R).

7

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***Priorto the adoption of SFAS No. 123(R)***

Prior to the adoption of SFAS No. 123(R), theCompany accounted for employee stock-based compensation in accordance withAccounting Principles Board Opinion No. 25 (or “APB 25”), “Accounting for StockIssued to Employees,” and related interpretations in accounting for itsstock-based compensation plans, as permitted by SFAS No. 123, “Accounting forStock-Based Compensation,” (or “SFAS No. 123”) and as amended by SFAS No. 148, “Accountingfor Stock-Based Compensation-Transition and Disclosure, an amendment of FASBStatement No. 123”. The pro-forma information for the three and nine monthsended September 30, 2005 was as follows (in thousands):
|                                                                                                                     | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                                                          | ** ** | **2005**                         | ** ** | **2005**                        | ** ** |
| Net loss, as reported                                                                                               |       | $                                | (5,003     | )                               | $          | (17,403 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss                                       |       | 203                              |       | 631                             |       |
| Less: Total  stock-based employee compensation expense determined under the fair value  based method for all awards |       | (1,406                           | )          | (4,185                          | )          |
| Pro forma net loss                                                                                                  | ** ** | **$**                            | **(6,206** | **)**                           | **$**      | **(20,957** | **)** |
|                                                                                                                |       |                             |       |                            |       |
| Basic and diluted net  loss per share                                                                               |       |                             |       |                            |       |
| As reported                                                                                                         | ** ** | **$**                            | **(0.18**  | **)**                           | **$**      | **(0.67** | **)** |
| Pro forma                                                                                                           | ** ** | **$**                            | **(0.23**  | **)**                           | **$**      | **(0.80** | **)** |

 

The Companycalculated the fair value of each option on the date of grant using theBlack-Scholes method as prescribed by SFAS No. 123. The assumptions used wereas follows:
|                                  | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|----------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                       | ** ** | **2005**                         | ** ** | **2005**                        | ** ** |
| Expected term (in  years)        |       | 4.0                              |       | 4.0                             |       |
| Average risk-free  interest rate |       | 4.01                             | %          | 4.18                            | %          |
| Average-volatility  factor       |       | 55.7                             | %          | 56.0                            | %          |
| Dividend yield                   |       | —                           |       | —                          |       |

 

***Impactof the adoption of SFAS No. 123(R)***

TheCompany elected to adopt the modified prospective application method asprovided by SFAS No. 123(R). Accordingly, compensation expense recognized forthe three and nine months ended September 30, 2006 reflects the quarter andnine months’ share of: (a) compensation cost for all share-based paymentsgranted prior to, but not yet vested as of January 1, 2006, based on the grantdate fair value estimated in accordance with the original provisions of SFASNo. 123, (b) compensation cost for all share-based payments granted subsequentto December 31, 2005, based on the grant-date fair value estimated inaccordance with the provisions of SFAS No. 123(R) and (c) compensation cost forstock-based awards granted to non-employees. Previously reported amounts havenot been restated.

Thefollowing table sets forth the total stock-based compensation expense resultingfrom stock options, nonvested stock awards, stock appreciation rights and the 1995Employee Stock Purchase Plan (the “Plan”) included in the CondensedConsolidated Statements of Operations (in thousands):

8

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|                                                     | ** ** | **Three months**             | ** ** | **Nine months**              | ** ** |
|-----------------------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                                          | ** ** | **ended September 30,** | ** ** | **ended September 30,** | ** ** |
| ** **                                          | ** ** | **2006**                          | ** ** | **2006**                          | ** ** |
| Cost of goods sold                                  |       | $                                 | 12         |                              | $          | 123 |   |
| Research and  development                           |       | 162                               |       | 531                               |       |
| Selling, general and  administrative                |       | 1,304                             |       | 3,856                             |       |
| **Total stock-based compensation  expense**         | ** ** | **$**                             | **1,478**  |                              | **$**      | **4,510** | ** ** |
| **Effect on basic and diluted net  loss per share** | ** ** | **$**                             | **(0.05**  | **)**                             | **$**      | **(0.16** | **)** |

 

Noincome tax benefit has been recognized relating to stock-based compensation expenseand no tax benefits have been realized from exercised stock options. There wasno cash flow impact from the adoption of SFAS 123(R) in the three and ninemonths ended September 30, 2006.

Stock Options andStock Appreciation Rights: During the nine months endedSeptember 30, 2006, the Company granted 523,500 stock options and stockappreciation rights, with an estimated total grant-date fair value ofapproximately $3,322,000 and a grant date weighted-average fair value of $6.34per share. During the nine months ended September 30, 2006, the Companyrecorded stock-based compensation expense of approximately $2,450,000 for allunvested options granted prior to the adoption of SFAS 123(R) and $781,000 foroptions and stock appreciation rights granted in the nine months endedSeptember 30, 2006.

During the threemonths ended September 30, 2006, the Company granted 51,500 stock options andstock appreciation rights, with an estimated total grant-date fair value ofapproximately $295,000 and a grant date weighted-average fair value of $5.72per share. During the three months ended September 30, 2006, the Companyrecorded stock-based compensation expense related to stock options ofapproximately $531,000 for all unvested options granted prior to the adoption ofSFAS 123(R) and $538,000 for options and stock appreciation rights granted inthe three months ended September 30, 2006.

During the ninemonths ended September 30, 2005, the Company granted 94,500 stock options, forwhich stock-based compensation expense was not recognized during that period.

Employee StockPurchase Plan (ESPP): The compensation cost in connectionwith the plan for the nine months ended September 30, 2006 was approximately$176,000 and during the three months ended September 30, 2006, the samecompensation cost was approximately $48,000. This cost is amortized on astraight-line basis over the relevant subscription period. The grant dateweighted-average fair value was $3.79 per share. During the nine months endedSeptember 30, 2005, the Company issued 100,729 shares under the ESPP, for whichstock-based compensation expense was not recognized.

Restricted Sharesand Restricted Stock Units: In connection with restrictedshares and restricted stock units granted, the Company recorded stock compensationrepresenting the difference between the exercise price of the shares and thefair market value of the Company’s common shares on the dates the awards weregranted. This stock compensation is being recorded as compensation expense on astraight-line basis over the vesting periods of the underlying stock awards.During the nine months ended September 30, 2006, the Company recordedapproximately $965,000 of such compensation expense. The grant dateweighted-average fair value was $13.75 per share. During the three months endedSeptember 30, 2006, the Company recorded approximately $324,000 of suchcompensation expense. The grant date weighted-average fair value was $13.19 pershare. During the nine months ended September 30, 2005 the Company recorded approximately$631,000 of restricted stock compensation expense and during the three monthsended September 30, 2005, the Company recorded approximately $203,000 of suchcompensation expense.

***Valuationassumptions***

The fair value ofstock-based awards was estimated using the Black-Scholes model with thefollowing weighted-average assumptions for the three months ended September 30,2006:

9

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|                                  | ** ** | **Three months ended September 30, 2006**              | ** ** |
|----------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **Stock Option and Stock  Appreciation Right   Plans** | ** ** | **Employee Stock   Purchase Plan** | ** ** |
| Expected term (in  years)        |       | 3.67                                                                            |       | 0.50 |   |
| Average risk-free  interest rate |       | 4.87                                                                            | %          | 5.27 | % |
| Average volatility  factor       |       | 51.5                                                                            | %          | 43.4 | % |
| Dividend yield                   |       | —                                                                          |       | — |   |

 

The fair value ofstock-based awards was estimated using the Black-Scholes model with thefollowing weighted-average assumptions for the nine months ended September 30,2006:
|                                  | ** ** | **Nine months ended September 30, 2006**                     | ** ** |
|----------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **Stock Option and Stock   Appreciation Right   Plans** | ** ** | **Employee Stock   Purchase Plan** | ** ** |
| Expected term (in  years)        |       | 3.68                                                                                  |       | 0.50 |   |
| Average risk-free  interest rate |       | 4.80                                                                                  | %          | 5.17 | % |
| Average volatility  factor       |       | 54.2                                                                                  | %          | 45.0 | % |
| Dividend yield                   |       | —                                                                                |       | — |   |

 

*Expected Term:* The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards and vesting schedules.

*Expected Volatility:* The Company used historical volatility based on the expected term of the awards, which is consistent with the Company’s assessment that the historical volatility for such period is more representative of future stock price trends than any other type of volatility. The calculation was based on a simple-average method, using a reasonably sufficient number of price observations, in accordance with SFAS No. 123(R) and Staff Accounting Bulleting No. 107, “Share-Based Payment” (“SAB 107”).

*Expected Dividends:*The Company has not paid and does not anticipate paying any dividends in the near future.

*Risk-Free Interest Rate:* The Company bases the risk-free interest rate on the U.S. Treasury yield curve in effect at the time of grant based on the expected term of the underlying option.

As stock-based compensation expense recognized in the Condensed Consolidated Statement of Operations for the first nine months of fiscal year 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience. In the Company’s pro forma information required under SFAS No. 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

Employee Stock Purchase Plan 

In November 1995, the Company’s Board of Directors adopted the ESPP. The ESPP became effective November 29, 1995. At that time, 200,000 shares were reserved for issuance under the ESPP. The ESPP permits participants to purchase common stock through payroll deductions of up to 10% of an employee’s annual base earnings. The purchase price per share is equal to 85% of the fair market value per share on the participant’s entry date into the offering period or, if lower, 85% of the fair market value per share on the semi-annual purchase date. In March 2004, the Board of Directors approved an amendment to the ESPP to increase the number of shares of common stock reserved for issuance by 150,000 shares. The stockholders approved this amendment in June 2004, to 

10

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be effective July 1, 2004. In March 2006, the Company’s Board of Directors approved an amendment to the ESPP to increase the number of shares of Common Stock reserved for issuance by 160,000 shares. This amendment was approved by the stockholders in June 2006.  As of September 30, 2006, 343,292 shares had been issued under the ESPP and 166,708 shares were available for future issuance.

Company Stock Option Plans

In August 2002, the Board of Directors approved the 2002 Non-Qualified Stock Option Plan (“2002 Plan”) and amendments to the 2002 Plan were approved by the Board in March 2003. Under the Amended and Restated 2002 Plan, non-qualified stock options and stock purchase rights may be granted only to the following classes of persons: (i) except as provided in (ii) below, consultants and employees who are not officers or directors of the Company, and (ii) newly hired employees (including employees who will become officers or directors of the Company) and who have not previously been employed by the Company and with respect to whom options are to be granted as an inducement essential to such employees’ entering into employment contracts with the Company. The 2002 Plan was enacted to address the increased hiring done during the second half of 2002, primarily in the Company’s U.S. sales, professional education and marketing functions. The maximum aggregate number of shares that may be issued upon exercise of options or stock purchase rights is 1,000,000 shares. In December 2005, the Board of Directors approved an amendment and restatement of the 2002 Plan to provide a fair market value established upon the closing price on the day of the grant rather than the previous trading day. This amendment became effective immediately after approval and did not require stockholder approval.

Under the terms of the 2002 Plan, options may be granted with different vesting terms from time to time and all options under the 2002 Plan expire ten years after grant. The options may include provisions permitting exercise of the option prior to full vesting. As of September 30, 2006, there were no shares that were exercised prior to full vesting.

In March 2001, the Board of Directors approved the 2001 Equity Incentive Plan (“2001 Plan”) allowing granting of stock options and restricted stock to employees, directors and consultants. The 2001 Plan provides for the grant issuance of options, restricted stock, stock appreciation rights, performance share awards, dividend equivalents awards, stock payment awards, stock purchase rights and restricted stock unit awards to employees, directors and consultants of the Company. The 2001 Plan was originally adopted by the Board of Directors on March 21, 2001 with a total of 1,000,000 shares of common stock reserved for issuance thereunder, and was approved by the stockholders in May 2001. In March 2002, the Board of Directors approved an amendment and restatement of the 2001 Plan to increase the shares of reserved for issuance thereunder by an additional 1,000,000 shares, bringing the aggregate number reserved for issuance to 2,000,000 shares of common stock, and to provide for automatic grants of non-qualified stock options to non-employee directors as had been provided under the 1995 Director’s Stock Option Plan. The stockholders approved this amendment and restatement in May 2002. In April 2003, the Board of Directors approved the Second Amended and Restated 2001 Plan to increase the size of the formula grants to non-employee directors and to prohibit repricing. The stockholders approved this amendment and restatement in June 2003. In March 2004, the Board of Directors approved the Third Amended and Restated 2001 Plan to reduce the size of the automatic grants of stock options to non-employee directors and to provide for automatic grants of restricted stock to non-employee directors and to increase the shares of Common Stock reserved for issuance thereunder by an additional 500,000 shares, bringing the aggregate number reserved for issuance to 2,500,000 shares of common stock. The stockholders approved this amendment and restatement in June 2004. In November 2004, the Board of Directors approved the Fourth Amended and Restated 2001 Plan to provide for the grant of restricted stock units and stock appreciation rights. In January 2005, the Board of Directors approved the Fifth Amended and Restated 2001 Plan to provide for a change in the number of shares to be automatically granted to non-employee directors under the plan. In December 2005, the Board of Directors approved the Sixth Amended and Restated 2001 Plan to establish that the price of future grants be based on the closing price of the Company’s stock on the date of grant, rather than the previous trading day. In February 2006, the Board of Directors approved the Seventh Amended and Restated 2001 Plan to provide for the increase the annual grant of restricted stock for directors from 2,000 shares to 2,500 shares. In April 2006, the Board of Directors approved the amendment to the Eighth Amended and Restated 2001 Plan to increase the shares of Common Stock reserved for issuance thereunder by an additional 1,500,000 shares, bringing the aggregate number reserved for issuance to 4,000,000 shares of Common Stock. This amendment was approved by the stockholders in June 2006.

11

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Underthe terms of the 2001 Plan, incentive stock options may be granted only toemployees with exercise prices not less than the fair market value of thecommon stock on the date of grant. Stock options and stock appreciation rightsmay be granted with different vesting terms from time to time butgenerally provide for vesting of at least 20% of the total number of shares peryear. All options and stock appreciation rights under the 2001 Plan expire tenyears after grant, and five years in the case of a grant to a 10% stockholder.Stock appreciation rights are to be settled in stock. Stock optionsmay include provisions permitting exercise of the option prior to fullvesting. As of September 30, 2006, there were no shares that wereexercised prior to fully vesting. To the extent that the aggregate fair marketvalue of the shares subject to a holder’s incentive stock options exceeds$100,000, the excess options will be treated as non-qualified stock options.

OnNovember 29, 1995, the Board of Directors approved the 1995 Director’sStock Option Plan (the “Directors’ Plan”), which allows the granting of optionsfor up to 100,000 shares of common stock to outside directors. Stock optionsmay be granted to outside directors with exercise prices of not less thanfair market value. The options expire ten years from date of grant. Optionsgranted under the Directors’ Plan vest over one or three years. The options areonly exercisable while the outside director remains a director.

In July 1993, the Board of Directors adopted the 1993 Stock Plan (the “1993 Plan”), and amendments to the 1993 Plan were adopted by the Board of Directors in March 1994, May 1995, October 1995, February 1997 and April 2000 and approved by the stockholders in March 1994, January 1996, May 1997 and May 2000 to allow granting of options up to 3,075,000 shares of common stock in the aggregate. Stock options granted under the 1993 Plan may be either incentive stock options or non-qualified stock options and can be granted to employees, distributors, consultants and directors. Incentive stock options may be granted to employees with exercise prices of no less than the fair market value and non-qualified options may be granted at exercise prices of no less than 85% of the fair market value of the common stock on the date of grant, as determined by the Board of Directors. The options expire no more than 10 years after the date of grant. Options may be granted with different vesting terms from time to time but generally provide for vesting of at least 25% of the total number of shares per year. The options may include provisions permitting exercise of the option prior to full vesting. Any unvested shares so purchased shall be subject to repurchase by the Company at the original exercise price of the option. Such repurchase rights generally lapse at a minimum rate of 25% per year from the date the option was granted. As of September 30, 2006, there were no shares that are subject to repurchase.

In April 2004, the Board of Directors approved a nonqualified stock option grant for 125,000 shares of the Company’s common stock and a grant of 36,000 shares of restricted stock for Mr. Ulric E. Cote as a stand-alone inducement grant in connection with his initial commencement of employment with the Company as Vice President, Sales. In December 2005, the Board of Directors approved a nonqualified stock option grant of 100,000 shares of the Company’s common stock for Ms. Patricia Gray as a stand-alone inducement grant in connection with her initial commencement of employment with the Company as Vice President, R&D and Operations. Stockholder approval was not required for any of these grants.

As of September 30, 2006, 44,286 shares remained available for grant under the 2002 Plan, 1,666,654 shares remained available for grant under the 2001 Plan, no shares remained available for grant under the 1993 Plan and no shares remained available for grant under the Director’s Plan.

The Company issues new shares of common stock upon exercise of stock options.

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A summary of the activity for the nine months ended September 30, 2006 of all the Company’s stock plans activity is as follows:
| ** **                                             | ** ** | ** **                                      | ** ** | **Awards Outstanding**   | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------|------------|
| ** **                                             | ** ** | **Shares Available   For Grant** | ** ** | **Awards   Outstanding** | ** ** | **Weighted-Average   Exercise Price** | ** ** |
| Balance  outstanding at December 31, 2005              |       | 704,312                                         |       | 3,513,751                     |       | $ | 10.62 |   |
| Additional  authorized                                 |       | 1,500,000                                       |       | —                        |       | — |   |
| Options granted                                        |       | (523,500                                        | )          | 523,500                       |       | 14.34 |   |
| Restricted stock  and restricted stock units granted   |       | (105,999                                        | )          | 105,999                       |       | — |   |
| Restricted stock  issued                               |       | —                                          |       | (28,500                       | )          | — |   |
| Options exercised                                      |       | —                                          |       | (217,816                      | )          | 9.18 |   |
| Options  cancelled                                     |       | 61,611                                          |       | (61,611                       | )          | 15.48 |   |
| Options  forfeited                                     |       | 94,811                                          |       | (178,145                      | )          | 12.71 |   |
| Restricted stock  and restricted stock units cancelled |       | —                                          |       | (7,510                        | )          | — |   |
| Options expired                                        |       | (22,184                                         | )          | —                        |       | 16.47 |   |
| Shares  repurchased                                    |       | 1,889                                           |       | —                        |       | — |   |
| Balance outstanding at  September 30, 2006             |       | 1,710,940                                       |       | 3,649,668                     |       | $ | 11.06 |   |

 

A summary of the activity for the three months ended September 30, 2006 of all the Company’s stock plans activity is as follows:
| ** **                                             | ** ** | ** **                                      | ** ** | **Awards Outstanding**   | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------|------------|
| ** **                                             | ** ** | **Shares Available   For Grant** | ** ** | **Awards   Outstanding** | ** ** | **Weighted-Average   Exercise Price** | ** ** |
| Balance  outstanding at June 30, 2006                  |       | 1,715,804                                       |       | 3,849,792                     |       | $ | 11.13 |   |
| Options granted                                        |       | (51,500                                         | )          | 51,500                        |       | 14.05 |   |
| Restricted stock  and restricted stock units granted   |       | (3,500                                          | )          | 3,500                         |       | — |   |
| Restricted stock  issued                               |       | —                                          |       | (2,500                        | )          | — |   |
| Options  exercised                                     |       | —                                          |       | (117,143                      | )          | 11.74 |   |
| Options  cancelled                                     |       | 19,080                                          |       | (19,080                       | )          | 15.28 |   |
| Options  forfeited                                     |       | 32,167                                          |       | (115,501                      | )          | 13.26 |   |
| Restricted stock  and restricted stock units cancelled |       | —                                          |       | (900                          | )          | — |   |
| Options expired                                        |       | (3,000                                          | )          | —                        |       | 19.15 |   |
| Shares  repurchased                                    |       | 1,889                                           |       | —                        |       | — |   |
| Balance outstanding at  September 30, 2006             |       | 1,710,940                                       |       | 3,649,668                     |       | $ | 11.06 |   |

 

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A summary of the activity for the nine months ended September 30, 2006 of stock options and stock appreciation rights is as follows:
|                                            | ** ** | **Options**        | ** ** | ** **              | ** ** | ** **    | ** ** |
|--------------------------------------------|------------|--------------------|------------|-------------------------|------------|---------------|------------|
| ** **                                 | ** ** | **and Stock** | ** ** | ** **              | ** ** | ** **    | ** ** |
| ** **                                 | ** ** | **Appreciation**   | ** ** | **Weighted-**           | ** ** | **Aggregate** | ** ** |
| ** **                                 | ** ** | **Rights**         | ** ** | **Average**             | ** ** | **Intrinsic** | ** ** |
| ** **                                 | ** ** | **Outstanding**    | ** ** | **Exercise Price** | ** ** | **Value**     | ** ** |
| Balance  outstanding at December 31, 2005  |       | 3,513,751          |       | $                       | 10.62      |          |       |   |
| Grants                                     |       | 523,500            |       | 14.34                   |       |          |       |
| Exercises                                  |       | (217,816           | )          | 9.18                    |       |          |       |
| Forfeitures                                |       | (178,145           | )          | 12.71                   |       |          |       |
| Cancellations                              |       | (61,611            | )          | 15.48                   |       |          |       |
| Balance  outstanding at September 30, 2006 |       | 3,579,679          |       | 11.06                   |       | $             | 24,030,834 |   |
| Exercisable at  September 30, 2006         |       | 2,273,791          |       | $                       | 10.94      |          | $          | 15,647,689 |   |

 

A summary of the activity for the three months ended September 30, 2006 of stock options and stock appreciation rights is as follows:
|                                            | ** ** | **Options**        | ** ** | ** **              | ** ** | ** **    | ** ** |
|--------------------------------------------|------------|--------------------|------------|-------------------------|------------|---------------|------------|
| ** **                                 | ** ** | **and Stock** | ** ** | ** **              | ** ** | ** **    | ** ** |
| ** **                                 | ** ** | **Appreciation**   | ** ** | **Weighted-**           | ** ** | **Aggregate** | ** ** |
| ** **                                 | ** ** | **Rights**         | ** ** | **Average**             | ** ** | **Intrinsic** | ** ** |
| ** **                                 | ** ** | **Outstanding**    | ** ** | **Exercise Price** | ** ** | **Value**     | ** ** |
| Balance  outstanding at June 30, 2006      |       | 3,779,903          |       | $                       | 11.13      |          |       |   |
| Grants                                     |       | 51,500             |       | 14.05                   |       |          |       |
| Exercises                                  |       | (117,143           | )          | 11.74                   |       |          |       |
| Forfeitures                                |       | (115,501           | )          | 13.26                   |       |          |       |
| Cancellations                              |       | (19,080            | )          | 15.28                   |       |          |       |
| Balance outstanding  at September 30, 2006 |       | 3,579,679          |       | 11.06                   |       | $             | 24,030,834 |   |
| Exercisable at  September 30, 2006         |       | 2,273,791          |       | $                       | 10.94      |          | $          | 15,647,689 |   |

 

The following table summarizes information about stock options outstanding and exercisable at September 30, 2006:
|                                                                         | ** ** | ** **                   | ** ** | ** **               | ** ** | ** **   | ** ** | **Options Vested** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------|------------|--------------------------|------------|--------------|------------|-------------------------|------------|
| ** **                                                              | ** ** | **Options Outstanding** | ** ** | **and Exercisable** | ** ** |
| ** **                                                              | ** ** | ** **                   | ** ** | **Weighted**             | ** ** | ** **   | ** ** | ** **              | ** ** | ** ** | ** ** |
| ** **                                                              | ** ** | ** **                   | ** ** | **Average**              | ** ** | **Weighted** | ** ** | **Options**             | ** ** | **Weighted** | ** ** |
| ** **                                                              | ** ** | ** **                   | ** ** | **Contractual**          | ** ** | **Average**  | ** ** | **Vested**              | ** ** | **Average** | ** ** |
| **Range of**                                                       | ** ** | **Options**                  | ** ** | **Remaining**            | ** ** | **Exercise** | ** ** | **and**                 | ** ** | **Exercise** | ** ** |
| **Exercise Prices**                                                | ** ** | **Outstanding**              | ** ** | **Life (years)**    | ** ** | **Price**    | ** ** | **Exercisable**         | ** ** | **Price** | ** ** |
|   $1.25   -     $7.55 |       | 372,371                      |       | 4.73                     |       | $            | 4.60       |                    | 328,928    |   | $ | 4.35 |   |
|   $7.58   -     $8.75 |       | 286,943                      |       | 8.27                     |       | $            | 8.08       |                    | 124,415    |   | $ | 8.09 |   |
|   $8.94   -     $8.94 |       | 405,322                      |       | 8.17                     |       | $            | 8.94       |                    | 180,528    |   | $ | 8.94 |   |
|   $9.00   -     $9.76 |       | 267,620                      |       | 4.63                     |       | $            | 9.43       |                    | 222,207    |   | $ | 9.46 |   |
|   $9.95   -     $9.95 |       | 630,000                      |       | 6.55                     |       | $            | 9.95       |                    | 430,499    |   | $ | 9.95 |   |
|   $9.96   -   $13.11            |       | 480,000                      |       | 7.42                     |       | $            | 12.33      |                    | 308,779    |   | $ | 12.34 |   |
| $13.29   -   $14.20                       |       | 371,716                      |       | 7.24                     |       | $            | 13.58      |                    | 220,316    |   | $ | 13.67 |   |
| $14.28   -   $14.76                       |       | 412,125                      |       | 8.77                     |       | $            | 14.69      |                    | 129,268    |   | $ | 14.59 |   |
| $14.95   -   $21.27                       |       | 328,582                      |       | 5.71                     |       | $            | 16.98      |                    | 303,851    |   | $ | 17.07 |   |
| $21.80   -   $21.80                       |       | 25,000                       |       | 5.20                     |       | $            | 21.80      |                    | 25,000     |   | $ | 21.80 |   |
|   $1.25   -   $21.80            |       | 3,579,679                    |       | 6.90                     |       | $            | 11.06      |                    | 2,273,791  |   | $ | 10.94 |   |

 

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As of September 30, 2006, there was unrecognized compensation cost of approximately $6,295,000 for total stock-based compensation related to stock options and stock appreciation rights, net of forfeitures. This cost is expected to be recognized over a weighted-average amortization period of 1.2 years.

Restricted stock and restricted stock unit activity for the nine months ended September 30, 2006, is as follows:
|                                                   | ** ** | ** **         | ** ** | **Weighted-**       | ** ** |
|---------------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                        | ** ** | ** **         | ** ** | **Average**         | ** ** |
| ** **                                        | ** ** | **Shares**         | ** ** | **Grant Date** | ** ** |
| ** **                                        | ** ** | **and Units** | ** ** | **Fair Value** | ** ** |
| Nonvested stock  outstanding at December 31, 2005 |       | 254,848            |       | $                   | 9.44       |   |
| Grants                                            |       | 105,999            |       | 11.33               |       |
| Vested                                            |       | (7,178             | )          | 7.65                |       |
| Cancellations                                     |       | (9,399             | )          | —              |       |
| Nonvested stock  oustanding at September 30, 2006 |       | 344,270            |       | $                   | 9.70       |   |

 

Restricted stock and restricted stock unit activity for the three months ended September 30, 2006, is as follows:
|                                                   | ** ** | ** **         | ** ** | **Weighted-**       | ** ** |
|---------------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                        | ** ** | ** **         | ** ** | **Average**         | ** ** |
| ** **                                        | ** ** | **Shares**         | ** ** | **Grant Date** | ** ** |
| ** **                                        | ** ** | **and Units** | ** ** | **Fair Value** | ** ** |
| Nonvested stock  outstanding at June 30, 2006     |       | 343,559            |       | $                   | 9.68       |   |
| Grants                                            |       | 3,500              |       | 11.90               |       |
| Cancellations                                     |       | (2,789             | )          | —              |       |
| Nonvested stock  oustanding at September 30, 2006 |       | 344,270            |       | $                   | 9.70       |   |

 

As of September 30, 2006, there was an unrecognized compensation cost of approximately $1,353,000 related to nonvested restricted shares and restricted stock units, net of forfeitures. This cost is expected to be recognized over a weighted-average amortization period of 0.6 years for restricted stock awards and 1.7 years for restricted stock units.

*Stock-based Compensation to Non-employees*

Stock-based compensation arrangements to non-employees are accounted for in accordance with Emerging Issues Task Force (“EITF”) Issue No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” which requires that these equity instruments are recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the underlying equity instruments vest. Stock-based compensation expense relating to non-employees was approximately $137,000 and $154,000 for the nine months ended September 30, 2006 and 2005, respectively. Stock-based compensation expense relating to non-employees was $37,000 and $72,000 for the three months ended September 30, 2006 and 2005, respectively.

**6.****              Computation of NetLoss Per Share**

Basicnet loss per share excludes any potential dilutive effects of options andcommon stock shares subject to repurchase. Diluted net loss per share includes the impact of potentially dilutivesecurities.  However, due to the 

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Company’s net lossposition, basic and diluted net loss per share are both computed using theweighted average number of common shares outstanding.

Thefollowing table provides a reconciliation of weighted-average number of commonshares outstanding to the weighted-average number common shares outstandingused in computing basic and diluted net loss per common share (in thousands):
| ** **                                                                                                           | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                           | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                                                           | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Denominator:                                                                                                         |       |                             |       |                            |       |   |   |   |   |
| Weighted-average  number of common shares outstanding                                                                |       | 29,308                           |       | 27,471                          |       | 29,206 |   | 26,291 |   |
| Less: Weighted-average unvested and restricted  common shares                                                        |       | (274                             | )          | (253                            | )          | (268 | ) | (245 | ) |
| **Weighted-average number common  shares oustanding used in computing basic and diluted net loss per common  share** | ** ** | **29,034**                       | ** ** | **27,218**                      | ** ** | **28,938** | ** ** | **26,046** | ** ** |

 

Thefollowing outstanding options, potential employee stock purchase plan shares,stock appreciation rights and restricted stock shares, which could potentiallydilute basic net loss per share in the future were excluded from thecomputation of diluted net loss per share, as their effect would have beenantidilutive (in thousands):
|                               | ** ** | **At September 30,** | ** ** |
|-------------------------------|------------|--------------------------------|------------|
| ** **                    | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| Outstanding  options and SARs |       | 3,580                          |       | 3,611 |   |
| Restricted stock              |       | 274                            |       | 254 |   |
| Restricted stock  units       |       | 70                             |       | — |   |
| Employee Stock  Purchase Plan |       | 17                             |       | 31 |   |
| **Total**                     | ** ** | **3,941**                      | ** ** | **3,896** | ** ** |

 

**7.****              Stockholders’ Equity**

TheCompany holds 79,752 shares of treasury stock as a result of repurchasingshares of restricted common stock at par value in 2004, 2005 and 2006, inaccordance with the terms of the restricted stock agreements. These shares hada purchase price of $0.003 per share and are recorded as treasury stock.

Inthe nine months ended September 30, 2006, the Company reversed the balance ofdeferred stock based compensation of approximately $1,058,000 into AdditionalPaid in Capital upon the adoption of SFAS No. 123(R).

**Item2.  Management’s Discussion and Analysisof 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 2006 revenues, increased product adoption, productimprovements, expanded sales force and other forecasted items, that involverisks and uncertainties such as our limited operating and sales history; the uncertaintyof market acceptance of our product; dependence on obtaining and maintainingreimbursement; effectiveness and safety of our product over the long-term; ourability to obtain and maintain the necessary governmental clearances orapprovals to market our product; our ability to develop and maintainproprietary aspects of our technology; our ability to manage our expansion; ourlimited history of manufacturing our product; our dependence on single*

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* source suppliers, third party manufacturersand co-marketers; intense competition in the medical device industry and in thecontraception market ; the inherent risk of exposure to product liabilityclaims and product recalls and other factors referenced in this Form 10-Q.  Our actual results could differ materiallyfrom those expressed or implied in these forward-looking statements as a resultof various factors, including those discussed in our Annual Report as ofDecember 31, 2005 on Form 10-K filed with the Securities and ExchangeCommission on March 16, 2006 and those included elsewhere in this Form 10-Q.*

**Overview**

We develop, manufacture and market the *Essure*® Permanent Birth Control system, an innovativeand proprietary medical device for women that was approved for marketing in theUnited States in November 2002 by the United States Food and DrugAdministration or FDA.  The *Essure* systemuses a soft and flexible micro-insert that is delivered into a woman’sfallopian tubes to provide permanent birth control by causing a benign tissuein-growth that blocks the fallopian tubes.  A successfully placed *Essure* micro-insert and the subsequent tissue growthprohibits the egg from traveling through the fallopian tubes and thereforeprevents fertilization.

*TheEssure Procedure*

The *Essure*procedure is typically performed as an outpatient procedure and is intended tobe a less invasive and a less costly alternative to tubal ligation, the leadingform of birth control in the United States and worldwide. Laparoscopic tuballigation and tubal ligation by laparotomy typically involve abdominal incisionsand/or punctures, general or regional anesthesia, four to ten days of normalrecovery time and the risks associated with an incisional procedure. The *Essure* procedure does not require cutting or penetrating theabdomen, which lowers the likelihood of post-operative pain due to theincisions/punctures, and it can be performed in an outpatient setting withoutgeneral or regional anesthesia.  In the Pivotal trial of the *Essure* system, the total procedure time averaged 35 minutes,with an average of 13 minutes of hysteroscopic time to place the *Essure* micro-insert. A patient is typically dischargedapproximately 45 minutes after the *Essure*procedure. No overnight hospital stay is required.  Furthermore, the *Essure* system is effective without drugs orhormones. 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, the patient completes afollow-up examination called a hysterosalpingogram or HSG, which can determinewhether the device was placed successfully and whether the fallopian tubes areoccluded.

We believe that the *Essure*system is an attractive alternative to tubal ligation for physicians, hospitalsand payers.  The *Essure* systemis a less invasive permanent birth control option for physicians to offer totheir patients; hospitals are able to utilize their facilities more costeffectively with the *Essure*procedure compared with tubal ligation, and payers are able to experience costreductions resulting from the elimination of overhead and procedural costsrelated to anesthesia and post-operative hospital stays associated with tuballigations. We also believe the *Essure* systemis a viable alternative to other temporary methods of birth control being usedwhen there is no intention of having children in the future. In addition,payers may also benefit from the reduction of unplanned pregnancies associatedwith non-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 reports estimate that 700,000 tubal ligationprocedures are performed each year in the United States. We intend to establishthe *Essure* procedure as the gold standardfor permanent birth control.

The *Essure* systemis currently being marketed in multiple countries. In November 2002 we receivedapproval from the FDA to market the *Essure* systemin the United States. In 2001, we were given approval to affix the CE Markto the *Essure* system, indicating that the *Essure* system is certified for sale throughout the EuropeanUnion, subject to compliance with local regulations such as registration withhealth ministries and/or particular requirements regarding labeling ordistribution. In 1999, the *Essure*Permanent Birth Control system was listed with Australia’s Therapeutic GoodsAdministration, which allows us tomarket and sell the *Essure*system in Australia. In Canada, we received clearance from Health Canada tomarket the *Essure* system in Canada in November2001. We now have distributors in Australia, Canada, France, which coversEurope, Middle East, Africa, Mexico, Central America and South America.

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*Effectivenessof the Essure System*

In July 2005, we received approval from the FDA toextend effectiveness data on the *Essure* productlabeling. The PMA supplement filed in January 2005 supports an extension of theeffectiveness rate of the *Essure* systemto 99.80% after four years and 99.74% after five years of follow-up, from thepreviously approved 99.80% at three years. The five-year effectiveness wasdemonstrated in a portion of the women undergoing clinical studies.

In September 2005, we received approval from the FDAto terminate the Company’s post-approval study with physicians who were newlytrained in performing the *Essure*procedure due to the positive placement data obtained. The purpose of thepost-approval study, required by the FDA as a condition of the November 2002approval of the *Essure* system, was to determinethe rate of successful bilateral 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 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 had been re-classified as a Final Report, asthe results of the post-approval study demonstrated an improvement in placementrates from those obtained in the pivotal study. In late 2005, we submitted anew PMA Supplement to integrate the post-approval study data into the Physicianlabeling (Instructions for Use) and Patient labeling (Patient InformationBrochure). We subsequently received approval from the FDA in October 2006 tomodify and update the *Essure*Physician and Patient labeling with data on the improved first-attemptbilateral placement rate of 94.6%.

*Penetration*

Conceptus requires that a hospital have at least onephysician preceptored for generally between 3 and 5 cases by a certifiedtrainer before being able to perform the procedure independently.  As of September30, 2006, we had a total of 4,157 doctors in the United States that have eithercompleted or are in the process of completing preceptorship. This represents anincrease of 1,275 physicians over the number of physicians at December 31, 2005and an increase of 1,626 physicians over the number of physicians at September30, 2005.  The level of sales for the *Essure* system, particularly in this early period ofadoption, is highly dependent on the number of physicians trained to performthe procedure.

*Reimbursementof the Essure Procedure*

Market acceptance of the *Essure*system depends in part upon the availability of reimbursement within prevailinghealthcare payment systems. We believe that physician advocacy of ourproduct will be required to continue to obtain reimbursement.  As ofSeptember 30, 2006, we have received positive reimbursement decisions for the *Essure* procedure from most private insurers and 37 of the 51Medicaid programs in the country. We intend to continue our effort to educatepayers of the cost-effectiveness of our product and to establish furtherprograms to help physicians to navigate reimbursement issues.

In 2005 we received positive responses relating toreimbursement, which we believe will help us speed up the acceptance of the *Essure* device by doctors and patients. Such is the case ofthe UnitedHealthcare Services, Inc., or UHC, a member of UnitedHealthcareGroup, which approved reimbursement for the *Essure*procedure in July 2005. In addition, in February 2006, we received coveragefrom CIGNA Corporation, or Cigna. As with all healthcare plans, coverage willvary and is dependent upon the individual’s specific benefit plan.

Effective January 1, 2006, the Centers for Medicareand Medicaid Services, or CMS, released the Final Rule for the 2006 PhysicianFee schedule. For the Current Procedural Terminology or CPT code applicable tothe *Essure* procedure, the CMS has providedfor a national physician payment of $2,095.01 for procedures performed in theoffice and $438.47 for physician payment when the procedure is performed in thehospital. This compares to a Medicare national average payment for tuballigation, the current standard of care for permanent female sterilization, of$345.50. In addition, the CMS released the Final Rule for the 2006 OutpatientProspective Payment System, which assigns hospital outpatient reimbursementamounts. This CPT code was also assigned a 2006 payment level of $2,454.00. Webelieve these values are very favorable for the *Essure*procedure and will help in establishing increased utilization of the deviceamongst doctors. We expect that the new code, once the process to establish itat all private and public payers that have given a favorable coverage decisionis complete, will significantly ease the burden on a physician’s office inobtaining reimbursement for the *Essure*procedure and accelerate the coverage of the *Essure*procedure by private insurance companies and Medicaid. This process is notautomatic following receipt of the new CPT code, however, and we anticipatecontinuing to focus on reimbursement issues for sometime in the

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future, both to secure our code and payment scheduleinto the payers’ databases, as well as to help the physician negotiate a favorablecontract for payment off that schedule.

*Adoption of the Essure system*

The *Essure* systemis a novel product in the contraception market, which is dominated byprocedures that are well established among physicians and patients and areroutinely taught to new physicians. As a result, we believe thatrecommendations and endorsements by physicians will be essential for marketacceptance of our product.  Physicians are traditionally slow to adopt newproducts and treatment practices, partly because of perceived liabilityrisks. Our biggest challenge is to speed up the adoption process to makethe *Essure* procedure the standard of carefor permanent birth control. The following discussion summarizes ourprogram in the United States to increase adoption of the *Essure*procedure.

First, we are expandingour sales territories and channels of distribution so as to increase our callfrequency on physicians. Since January 1, 2006, we added 20 sales positions andare expecting to add more during the remainder of 2006. Also, we have includedregional distributors of women’s gynecology products to 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 the office environment.

Second, we are attemptingto increase patient awareness, so as to increase the number of women that willask for information about the *Essure*procedure. This may involve efforts directed to marketing programs, such asadvertising, practice development and in-office support, as well as websiteoptimization since the internet is a primary source of information on permanentbirth control for couples.

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. Until such time as the code is completely implemented andall major payers have provided a coverage decision, we have developed a fieldbased tactical reimbursement group aimed at educating the physician and officestaff regarding payer procedures following a declined claim, including appealsand petitioning procedures. Typically a newly covered product will go through aperiod where claims are either inadvertently declined or are paid at theincorrect amount. In either instance, the physician is reluctant to performadditional procedures until payment has been secured for earlier cases, causinga decline in utilization. Our tactical reimbursement focus is intended to givethe physician and his/her staff the tools to ensure that claims will ultimatelybe paid and thereby encourages the physician to continue performing the *Essure* procedure despite reimbursement issues. This tacticalreimbursement group is generally targeting specific accounts with the aim ofeventually meeting with all of our accounts so as to provide them with theknowledge of how to file and follow up on claims on a payer by payer basis.

Lastly, we intend to makeimprovements to the *Essure* devicein both ease of use and clinical performance. The Company maintains an activeproduct development function, that expects to complete a third generationdevice for launch in 2007 and a fourth generation device for launch sometimeafter 2007. While the *Essure* productalready performs very well in the market, these incremental improvements aremeant to maintain our market superiority during a time that may see competitionenter the market. We also expect this third generation device will also have asan advantage a substantially lower cost.

We have experienced significant operating losses sinceinception and, as of September 30, 2006, had an accumulated deficit of $219.7million. We expect our operating losses to continue as we continue to expendsubstantial resources in the selling and marketing of the *Essure*system in the United States and abroad. Due to the unpredictable nature ofthese activities, we do not know whether we will achieve or sustainprofitability in the future. We will continue to be in a net loss positionuntil sufficient revenues can be generated to offset expenses. In the future,depending upon a variety of factors, we may need to raise funds through bankfacilities, debt or equity offerings or other sources of capital. Additionalfinancing may not be available when needed or on terms acceptable to us.

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**Results of Operations - Three and Nine MonthsEnded September 30, 2006 and 2005**

*Net Sales*

Net sales were $11.0million for the three months ended September 30, 2006 as compared to $5.5million for the three months ended September 30, 2005, an increase of $5.5million, or 100%.  Net sales for the ninemonths ended September 30, 2006 were $29.0 million as compared to $14.4 millionfor the nine months ended September 30, 2005. The increase of $14.6 million, or 101%, was the result of the continuedcommercialization of the *Essure* systemworldwide. Unit volume growth for the third quarter of 2006 compared to thesame quarter of 2005 increased 86%. Our worldwide average selling priceincreased from $814 at the end of the year 2005 to $904 for the first ninemonths of 2006, due to an increase in the level of domestic sales, which has ahigher price than sales to our European distributor, as well as an increase inour U.S. sales price of 8.3% in January 2006, partially mitigated by lowerinternational prices.

We expect net sales toincrease in the fourth quarter of fiscal year 2006 and have put in place salesand marketing programs and have pursued reimbursement with payers to help us toreach our revenue goal.  However, as wehave noted elsewhere in this Form 10-Q, our expected revenue growth is dependenton market acceptance of the *Essure* systemand third party reimbursement for the device, which involves factors that areoutside of our control.

For the three monthsended September 30, 2006 and 2005, no single customer accounted for 10% or moreof total consolidated net sales. No single customer accounted for 10% or moreof our total consolidated net sales for the nine months ended September 30,2006, while net sales to a distributor were 11% for the nine months ended September30, 2005. Accounts receivable from one distributor accounted for 12% of our netaccounts receivable balance as of September 30, 2006. Accounts receivable froma customer and a distributor accounted for 12% and 18% respectively of ourtotal net accounts receivable outstanding as of September 30, 2005.

Net product sales bygeographic region as a percentage of net sales for the three and nine monthsended September 30, 2006 and 2005 are as follows:
|                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales (in  thousands) |       | $                                | 11,013     |                            | $          | 5,499 |   | $ | 28,978 |   | $ | 14,402 |   |
| United States of  America |       | 93                               | %          | 92                              | %          | 91 | % | 87 | % |
| Europe                    |       | 7                                | %          | 7                               | %          | 8 | % | 11 | % |
| Other                     |       | 0                                | %          | 1                               | %          | 1 | % | 2 | % |
|                           |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

Net sales are attributed to region based on theshipping location of the external customers.

As of September 30, 2006, wehad a total of 4,157 doctors in the United States that have either completed orare in the process of completing preceptorship. This represents an increase of1,275 physicians over the number of physicians at December 31, 2005 and anincrease of 1,626 physicians over the number of physicians at September 30,2005.  Our accomplishment in obtainingthe number of physicians trained is very important because it provides us witha strong referral base within major metropolitan areas we have targeted. Weunderstand that a strong base of trained physicians does not necessarilycorrelate to an increase in revenue proportionately. Furthermore, there are no revenues associated with the trainingactivities. We do not charge a fee for the activity and no commitment arisesfor the physician from the preceptorship. Physician training is providedupfront and we have no obligation subsequent to the initial training. Trainingcosts have not been significant to us from inception to-date.

In October 2006, weannounced our expected net sales for 2006 to be approximately $41.0 million,which would represent 94% growth from net sales in 2005. We expect net salesfrom the United States will continue to be the major contributor of our globalnet sales.  We have established fourprimary goals to achieve our revenue growth. We expect to increase sales coverage and with that increase physicianpenetration and utilization of the *Essure* device,build patient awareness through targeted advertising and internet programs,obtain additional payer coverage decisions or otherwise improve the public andprivate payer coverage for the *Essure*procedure, and bring product improvements to the *Essure*device to the market. We believe our revenue growth in 2006 and beyond will besignificantly influenced by how successful we are in achieving thoseobjectives.

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*Gross Profit*

Costof goods sold for the three months ended September 30, 2006 was $3.5 million ascompared to $2.0 million for the three months ended September 30, 2005. Thisincrease of $1.5 million, or 74%, was caused by the increase in net sales,partially offset by reductions in manufacturing costs due to the impact ofhigher volumes on relatively fixed manufacturing costs, as well as to lowercontractual prices from our third-party manufacturer beginning in fiscal year2006. Gross profit margin improved from 64% for the three months endedSeptember 30, 2005 to 68% for the same period ended September 30, 2006, which wasthe result of increased average selling prices primarily from channel mix andlower manufacturing costs. For the nine months ended September 30, 2006, costof goods sold was $10.0 million, as compared to $5.8 million for the ninemonths ended September 30, 2005. The increase of $4.2 million, or 72% wascaused by the same factors explained for the three month period. We expectgross margin to improve somewhat during the remainder of 2006 due to all of theabove factors.

*Operating Expenses*

Research and developmentexpenses, which include expenditures related to product development, clinicalresearch and regulatory affairs, were $1.0 million and $1.1 million for thethree months ended September 30, 2006 and 2005, respectively. Expenses for thethree months ended September 30, 2006, include the effect of SFAS 123(R)stock-based compensation expense of $0.2 million. For the nine months endedSeptember 30, 2006, research and development expenses increased $0.3 million,or 9%, to $3.3 million, from $3.0 million in the same period of 2005, whichincludes the impact of stock-based compensation expense of $0.6 million. Ourgoal through Research and Development is to launch product enhancements overthe coming years, which are intended to result in improved ease of use andclinical performance of the *Essure* systemand lower cost of goods.

Selling, general andadministrative spending for the three months ended September 30, 2006 was $10.3million as compared to $7.6 million for the three months ended September 30,2005, which represents an increase of $2.6 million, or 35%. For the nine monthsended September 30, 2006, selling, general and administrative expenses were$31.2 million, which represents an increase of $7.6 million, or 32%, from $23.6million for the nine months ended September 30, 2005. The primary reasons forthe increase in selling, general and administrative expenses result from theadditional stock-based compensation expense of $3.2 million and the expansionof our U.S. field sales force of $3.2 million. The latter is meant to provideus with more selling time to focus on physician utilization and penetration.Additionally, increases in selling, general and administrative expenses weredue to higher spending in marketing campaigns to support our increase in salesand increased traveling and consulting expenses. We expect selling, general andadministrative expenses to increase in the future as we increase sales.

Net interest income andother income for the three months ended September 30, 2006 was approximately$0.3 million, compared to the same amount for three months ended September 30,2005. For the nine months ended September 30, 2006, net interest and otherincome was $1.0 million and $0.6 million for the nine months ended September30, 2005.

**Liquidity and Capital Resources**

Wehave experienced significant operating losses since inception. As of September30, 2006 we had an accumulated deficit of $219.7 million. We have financed ouroperations since inception primarily through equity financings. In February2004 we completed a private placement of approximately 3.0 million shares ofcommon stock at $8.50 per share. Our net proceeds from the private placementwere approximately $23.9 million, after deducting offering costs andcommissions. In addition, in August 2005, we completed a private placement ofapproximately 3.2 million shares of common stock at a price of $7.20 and $8.10per share. Our net proceeds from the private placement were approximately $22.9million, after deducting offering costs. The proceeds are being used to fund operations.  In the future, depending upon a variety offactors, we may need to raise additional funds through bank facilities, debt orequity offerings or other sources of capital. Additional funding may not beavailable when needed or on terms acceptable to us.

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As of September 30, 2006, wehad cash, cash equivalents, restricted cash and short-term investments of $25.8million, compared to $32.5 million at December 31, 2005. The decrease of $6.7million is primarily due to cash used in our operating activities. We expectcash balances to increase in the future as our revenues grow.

*Operating Activities*

Net cash used inoperating activities was $8.3 million in the nine months ended September 30,2006, primarily as a result of our net loss of $14.6 million adjusted fornon-cash related items of $5.4 million related primarily to depreciation andamortization and stock compensation expense. Other major items that contributed to net cash used in operatingactivities were related to $2.5 million of a planned decrease in inventoriesconsistent with our increase in sales and a decrease in other assets and othercurrent assets of $0.5 million, offset by an increase in accounts receivable of$1.7 million, which is consistent with our increase in sales and a decrease inaccounts payable of $0.4 million. We expect cash usage in operating activitiesin the future to decrease as we expect revenue growth on a sequential quarterlybasis.

As of September 30, 2006,our worldwide days sales outstanding in accounts receivable was 52 days, whichrepresents a decrease of 3 days compared to December 31, 2005.  We have credit policies that help us tomonitor our collection activities and reduce our credit loss exposure. Wecontinue to improve and modify those policies as our business evolves. Our goalis to consistently improve our days sales outstanding. We may not be able tomaintain our current ratio or we may experience less than satisfactoryperformance in collection due to factors outside of our control such as changesin economic climates.

Netcash used in operating activities was $17.2 million in the nine months endedSeptember 30, 2005, primarily as a result of our net loss of $17.4 millionadjusted for non-cash related items of $1.6 million related to depreciation andamortization and stock compensation expense. Other major items that contributed to net cash used in operatingactivities were related to a planned increase in inventories of $1.7 millionand an increase in accounts receivable of $1.5 million related to our salesgrowth, offset by an increase in accrued compensation of $1.4 million and adecrease in other assets of $0.3 million.

# *InvestingActivities*

Net cash used ininvesting activities for the nine months ended September 30, 2006 was $3.4million, from sales and maturity of short-term investments of $19.0 million,offset by purchases of investments of $21.4 million and capital expenditures of$1.0 million**.**Net cash provided by investingactivities for the nine months ended September 30, 2005 was $28.9 million, fromsales of short-term investments of $66.6 million, from which $35.0 million wereconverted to commercial paper with a maturity of less than 90 days, partiallyoffset by purchases of investments of $36.4 million and capital expenditures of$1.3 million.

# *FinancingActivities*

Net cash provided byfinancing activities was $2.5 million for the nine months ended September 30,2006 from the exercise of stock options. Net cash provided by financingactivities was $23.2 million for the nine months ended September 30, 2005,primarily from the exercise of stock options for $0.3 million and from aprivate placement completed in August 2005. Our net proceeds from the issuanceof approximately 3.2 million shares of our common stock at a price of $7.20 and$8.10 per share were approximately $22.9 million, after deducting offeringcosts and commissions totaling $0.1 million.

Thesuccessful achievement of our business objectives may require additionalfinancing and therefore, we may in the future seek to raise additional fundsthrough bank facilities, debt or equity offerings or other sources of capital.Any additional equity financing may be dilutive to stockholders, and debtfinancing, if available, may involve restrictive covenants.  Additional funding may not be available whenneeded or on terms acceptable to us. If we are unable to obtain additionalcapital, we may be required to delay, reduce the scope of or eliminate oursales and marketing activities.  Ourfuture liquidity and capital requirements will depend upon many factors,including, among others:

·              Resourcesdevoted to establish sales, marketing and distribution capabilities;

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·              Therate of product adoption by doctors and patients; and

·              The insurance payer community’sacceptance of and reimbursement for the *Essure*procedure.

**CRITICAL ACCOUNTING ESTIMATES ANDPOLICIES**

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. A descriptionof our critical accounting estimates and policies is included in our AnnualReport on Form 10-K as of December 31, 2005. In preparing these financialstatements, management has made its best estimates and judgments of certainamounts included in the financial statements, giving due consideration tomateriality. The primary estimates underlying the Company’s financialstatements include reserves for obsolete and slow moving inventory, allowancefor doubtful accounts receivable, product warranty, impairment for long-livedassets, income taxes, stock-based compensation and contingent liabilities.Other accounting policies are described in Note 2, “Summary of SignificantAccounting Policies” to our Financial Statements included in our Annual Reporton Form 10-K as of December 31, 2005. Application of these policies involvesthe exercise of judgment and use of assumptions as to future uncertainties and,as a result, actual results could differ from these estimates.

*Stock-basedCompensation*

EffectiveJanuary 1, 2006, we adopted the provisions of SFAS No. 123(R), “Share-BasedPayment”. SFAS No. 123(R) establishes accounting for stock-based awardsexchanged for employee services. Accordingly, stock-based compensation cost ismeasured at grant date, based on the fair value of the award which is computedusing the Black-Scholes option valuation model, and is recognized as expenseover the employee requisite service period. We previously applied AccountingPrinciples Board (APB) Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related Interpretations and provided the required pro formadisclosures of SFAS No. 123, “Accounting for Stock-Based Compensation”.

Thefair value of each option award is estimated on the date of grant using theBlack-Scholes option valuation model with the weighted average assumptionsshown in Note 5 of our Notes to Condensed Consolidated Financial Statements.The Black-Scholes option valuation model requires the input of highlysubjective assumptions, including the expected life of the stock-based awardand the stock-price volatility. The assumptions used in calculating the fairvalue of share-based compensation represent management’s best estimates, butthese estimates involve inherent uncertainties and the application of management’sjudgment. As a result, if other assumptions had been used, our stock-basedcompensation expense could have been materially different. In addition, we arerequired to estimate the expected forfeiture rate and only recognize expensefor those shares expected to vest. If our actual forfeiture rate is materiallydifferent from our estimate, the share-based compensation expense could bematerially different.

Theexpected term of the options granted is derived from historical data onemployee exercise and post-vesting employment termination behavior. Therisk-free interest rate for periods equal to the estimated life of the optionis based on the U.S. Treasury yield curve in effect at the time of grant.Expected volatility is based on historical volatility of our stock.

Asstock-based compensation expense recognized in the Condensed ConsolidatedStatement of Operations for the first nine months of fiscal year 2006 is basedon awards ultimately expected to vest, it has been reduced for estimatedforfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the timeof grant and revised, if necessary, in subsequent periods if actual forfeituresdiffer from those estimates. Forfeitures were estimated based on historicalexperience. In our pro forma information required under SFAS No. 123 for theperiods prior to fiscal 2006, we accounted for forfeitures as they occurred.

Weelected to adopt the modified prospective application method as provided bySFAS No. 123(R). Accordingly, during the period ended September 30, 2006, werecorded stock-based compensation for shares granted prior to, but not yetvested as of the adoption date based on the grant date fair value estimated inaccordance with the

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originalprevisions of SFAS No. 123, and therefore, we did not restate previouslyreported amounts. Stock-based compensation expense for all share-based paymentawards granted on or after January 1, 2006 is based on the grant date fairvalue estimated in accordance with the provisions of SFAS No. 123(R).

Referto Note 5 of our Notes to Condensed Consolidated Financial Statements for amore detailed discussion on stock-based compensation.

*Recent Accounting Pronouncements*

InSeptember 2006, the Securities and Exchange Commission (“SEC”) issued StaffAccounting Bulletin (“SAB”) No. 108 regarding the process of quantifyingfinancial statement misstatements. SAB No. 108 states that registrants shoulduse both a balance sheet approach and an income statement approach whenquantifying and evaluating the materiality of a misstatement. Theinterpretations in SAB No. 108 contain guidance on correcting errors under thedual approach, as well as provide transition guidance for correcting errors.This interpretation does not change the requirements within SFAS No. 154, “AccountingChanges and Error Corrections — a replacement of APB No. 20 and FASB StatementNo. 3” for the correction of an error on financial statements. SAB No. 108 iseffective for annual financial statements covering the first fiscal year endingafter November 15, 2006. The Company will be required to adopt thisinterpretation by December 31, 2006. We are currently evaluating therequirements of SAB No. 108 and the impact this interpretation may have on ourfinancial statements.

InSeptember 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS157”). This standard defines fair value, establishes the framework formeasuring fair value in accounting principles generally accepted in the UnitedStates of America and expands disclosure about fair value measurements. Thispronouncement applies under other accounting standards that require or permitfair value measurements. Accordingly, this statement does not require any newfair value measurement. This statement is effective for fiscal years beginningafter November 15, 2007 and interim periods within those fiscal years. TheCompany will be required to adopt SFAS No. 157 in the first quarter of 2008.Management is currently evaluating the requirements of SFAS No. 157 and has notyet determined the impact on the consolidated financial statements.

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

Thefollowing discusses our exposure to market risk related to changes in interestrates and foreign currency exchange rates. These exposures may change over timeas business practices evolve and could have a material adverse impact on ourfinancial results.

*Interest Rate Risk*:  We have been exposed to interest rate riskthrough interest earned on holdings of available-for-sale marketablesecurities.  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. The fair value of ourinvestment portfolio or related income would not be significantly impacted bychanges in interest rates since we reduce the sensitivity of our results ofoperations to these risks by maintaining an investment portfolio, which isprimarily comprised of highly rated, marketable securities. We do not hold orissue derivatives, commodity instruments or other financial instruments fortrading purposes.

*Foreign Currency Exchange Risk*:  All of our expenses and our revenues aretypically denominated in United States dollars. As a result, we have lowexposure for currency exchange risks and foreign exchange losses have beenminimal to date. We do not enter into forward exchange contracts to hedgeexposure denominated in foreign currencies or any other derivative financialinstruments for trading or speculative purposes. In the future, if our assessmentof our foreign currency exposure changes, we may consider hedging transactionsfor risk mitigation.

**Item4. Controls and Procedures**

*Evaluationof Disclosure Controls and Procedures:*

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Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in our Exchange Act reports is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms and that such informationis accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow fortimely decisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, and inreaching a reasonable level of assurance, management is required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures.

Asof September 30, 2006, the end of our most recent fiscal quarter, we carriedout an evaluation, under the supervision and with the participation of our management,including our Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures. Based on the foregoing, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective.

*Changes in Internal Control Over Financial Reporting:*

Therewas no change in our internal control over financial reporting during our mostrecent fiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

*Inherent Limitations of Internal Controls*

**Internal control over financialreporting cannot provide absolute assurance of achieving financial reportingobjectives because of its inherent limitations. Internal control over financial reporting is a process that involveshuman diligence and compliance and is subject to lapses in judgment andbreakdowns resulting from human failures. Internal control over financial reportingalso can be circumvented by collusion or improper management override. Becauseof such limitations, there is a risk that material misstatements may not beprevented or detected on a timely basis by internal control over financialreporting. However, these inherent limitations are known features of thefinancial reporting process. Therefore, it is possible to design into theprocess safeguards to reduce, though not eliminate, this risk.**

**PART II. OTHER INFORMATION**

**Item1.  Legal Proceedings**

Fromtime to time, we are involved in legal proceedings arising in the ordinarycourse of business.  We believe there isno litigation pending that could have, individually or in the aggregate, amaterial adverse effect on its financial position, result of operations or cashflows.

 

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**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds**

Inthe third quarter of 2006, the Company repurchased 1,889 shares of restrictedcommon stock at par value in accordance with the terms of a restricted stockagreement. These shares are recorded as treasury stock and the Company holds asof September 30, 2006 a total of 79,752 shares of treasury stock. The shares ofrestricted stock had a purchase price of $0.003 per share and the Company’srepurchase right with respect to such shares lapsed either in equalinstallments over three years or at the end of the three years, depending onthe terms on the respective shares grants.

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**ISSUER PURCHASES OF EQUITY SECURITIES**
| **Period**                                    | ** ** | **Total Number   of Shares   Purchased (1)** | ** ** | **Average Price   Paid per Share** | ** ** | **Total Number   of Shares   Purchased as   Part of   Publicly   Announced   Program** | ** ** | **Maximum   Number of   Shares That   May Yet Be   Purchased   Under This   Program** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                    | ** ** | ** **                                                            | ** ** | ** **                                             | ** ** | ** **                                                                                                                               | ** ** | ** **                                                                                                                                   | ** ** |
| January 1, 2006  through January 31, 2006     |       | —                                                                |       | —                                                 |       | —                                                                                                                                   |       | —                                                                                                                                       |       |
| February 1, 2006  through February 28, 2006   |       | —                                                                |       | —                                                 |       | —                                                                                                                                   |       | —                                                                                                                                       |       |
| March 1, 2006  through March 31, 2006         |       | —                                                                |       | —                                                 |       | —                                                                                                                                   |       | —                                                                                                                                       |       |
| April 1, 2006  through April 30, 2006         |       | —                                                                |       | —                                                 |       | —                                                                                                                                   |       | —                                                                                                                                       |       |
| May 1, 2006  through May 31, 2006             |       | —                                                                |       | —                                                 |       | —                                                                                                                                   |       | —                                                                                                                                       |       |
| June 1, 2006  through June 30, 2006           |       | —                                                                |       | —                                                 |       | —                                                                                                                                   |       | —                                                                                                                                       |       |
| July 1, 2006  through July 31, 2006           |       | 1,889                                                                 |       | $                                                      | 0.003      |                                                                                                                                     | —     |                                                                                                                                         | —     |   |
| August 1, 2006  through August 31, 2006       |       | —                                                                |       | —                                                 |       | —                                                                                                                                   |       | —                                                                                                                                       |       |
| September 1,  2006 through September 30, 2006 |       | —                                                                |       | —                                                 |       | —                                                                                                                                   |       | —                                                                                                                                       |       |
| **TOTAL**                                     | ** ** | **1,889**                                                             | ** ** | **—**                                             | ** ** | **—**                                                                                                                               | ** ** | **—**                                                                                                                                   | ** ** |
|                                               |            |                                                                       |            |                                                        |            |                                                                                                                                          |            |                                                                                                                                              |            |  |

 

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**(1)***TheCompany purchased a total of 1,889 shares of restricted stock during year 2006year-to-date in accordance with the terms of the Restricted Stock PurchaseAgreements relating to such shares.*

**Item6.  Exhibits**
| Exhibit 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 the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.
|                                                                  | CONCEPTUS, INC. |
|------------------------------------------------------------------|-----------------|
|                                                             |            |
|                                                             |            |
|                                                             |            | By: /s/ Gregory E. Lichtwardt |
|                                                             |            |   Gregory  E. Lichtwardt |
|                                                             |            |   Executive  Vice President, Treasurer and |
|                                                             |            |   Chief  Financial Officer |
|                                                             |            |   |
|                                                             |            |   |
| Date:       November  7, 2006 |            |   |
|                                                                  |                 |  |  |

** **

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**EXHIBIT INDEX**
| Exhibit 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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