**UNITEDSTATES**

 

**SECURITIESAND EXCHANGE COMMISSION**

 

**Washington,D.C. 20549**

 

**FORM10-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, 2007**                                                   |
| ** ** | ** ** | ** **                                                                                               |
| ** ** | ** ** | **OR**                                                                                                   |
| ** ** | ** ** | ** **                                                                                               |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES**

** EXCHANGE ACT OF 1934** |

 

**For thetransition period from              to                    .**

 

**CommissionFile Number: 0-27596**

 

**CONCEPTUS, INC.**

 

(Exact name of Registrantas specified in its charter)

 

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

 

**331 EastEvelyn**

**MountainView, CA 94041**

(Address of PrincipalExecutive Offices) (Zip Code)

 

**(650) 962-4000**

(Registrant’s TelephoneNumber, Including Area Code)

 

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

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for at least the past 90 days. Yes x   No o

 

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

 
| Large accelerated  filer  o |   | Accelerated Filer  x |   | Non accelerated filer  o |
|---------------------------------------|--------|--------------------------------|--------|------------------------------------|

 

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

 

Yes  o   No  x

 

There were 29,568,729shares of Registrant’s Common Stock issued and outstanding as of October 31,2007.

 

 

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**CONCEPTUS, INC.**

 

**FORM10-Q for the Quarter Ended September 30, 2007**
|      |                                                                                                                 |     |
|-----------|----------------------------------------------------------------------------------------------------------------------|----------|
|      |                                                                                                                 |     |
|      | ** **                                                                                                           | **Page** |
| Part I.   | Financial  Information                                                                                               | 3        |
|      |                                                                                                                 |     |
| Item  1.  | Condensed  Consolidated Financial Statements (Unaudited)                                                             | 3        |
|      | a)  Condensed Consolidated Balance Sheets as of September 30, 2007 and December  31, 2006                            | 3        |
|      | b)  Condensed Consolidated Statements of Operations for the three and nine months  ended September 30, 2007 and 2006 | 4        |
|      |
|      | c)  Condensed Consolidated Statements of Cash Flows for the nine months ended  September 30, 2007 and 2006           | 5        |
|      |
|      | d) Notes to Condensed Consolidated Financial  Statements                                                             | 6        |
|      |                                                                                                                 |     |
| Item 2.   | Management’s Discussion and Analysis of Financial Condition  and Results of Operations                          | 12       |
|      |                                                                                                                 |     |
| Item 3.   | Quantitative and Qualitative Disclosures About Market  Risk                                                          | 19       |
|      |                                                                                                                 |     |
| Item 4.   | Controls and Procedures                                                                                              | 19       |
|      |                                                                                                                 |     |
| Part  II. | Other  Information                                                                                                   | 20       |
|      |                                                                                                                 |     |
| Item  1.  | Legal  Proceedings                                                                                                   | 20       |
|      |                                                                                                                 |     |
| Item  1A. | Risk  Factors                                                                                                        | 20       |
|      |                                                                                                                 |     |
| Item 6.   | Exhibits                                                                                                             | 22       |

 

2

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**PART I.FINANCIAL INFORMATION**

 

**ITEM 1.Condensed Consolidated Financial Statements**

 

**Conceptus,Inc.**

 

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

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

 

| ** **                                          | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|-----------------------------------------------------|------------|-------------------|-------------|------------------|------------|
| ** **                                          | ** ** | **2007**          | ** **  | **2006**         | ** ** |
| **Assets**                                          | ** ** | ** **        | ** **  | ** **       | ** ** |
| Current assets:                                     |       |              |        |             |       |
| Cash and cash equivalents                           |       | $                 | 2,243       |             | $          | 3,238 |   |
| Short-term investments                              |       | 92,100            |        | 22,600           |       |
| Accounts receivable, net                            |       | 11,295            |        | 6,976            |       |
| Inventories                                         |       | 2,272             |        | 610              |       |
| Other current assets                                |       | 1,719             |        | 1,064            |       |
|                                                |       |              |        |             |       |
| Total current assets                                |       | 109,629           |        | 34,488           |       |
|                                                |       |              |        |             |       |
| Property and equipment, net                         |       | 3,687             |        | 2,917            |       |
| Intangible assets, net                              |       | 1,215             |        | 1,350            |       |
| Debt issuance costs, net                            |       | 2,710             |        | —           |       |
| Other assets                                        |       | 322               |        | 996              |       |
|                                                |       |              |        |             |       |
| **Total assets**                                    | ** ** | **$**             | **117,563** | ** **       | **$**      | **39,751** | ** ** |
|                                                |       |              |        |             |       |
| **Liabilities and stockholders’ equity**       | ** ** | ** **        | ** **  | ** **       | ** ** |
| Current liabilities:                                |       |              |        |             |       |
| Accounts payable                                    |       | $                 | 2,703       |             | $          | 2,903 |   |
| Accrued compensation                                |       | 3,022             |        | 3,909            |       |
| Other accrued liabilities                           |       | 4,159             |        | 1,597            |       |
|                                                |       |              |        |             |       |
| Total current liabilities                           |       | 9,884             |        | 8,409            |       |
|                                                |       |              |        |             |       |
| Notes payable                                       |       | 86,250            |        | —           |       |
| Other accrued liabilities                           |       | 265               |        | 328              |       |
|                                                |       |              |        |             |       |
| Total liabilities                                   |       | 96,399            |        | 8,737            |       |
|                                                |       |              |        |             |       |
| Stockholders’ equity:                          |       |              |        |             |       |
| Common stock and additional paid-in capital         |       | 253,656           |        | 254,631          |       |
| Accumulated deficit                                 |       | (232,492          | )           | (223,617         | )          |
| Treasury Stock, 77,863 and 91,752 shares, at cost   |       | —            |        | —           |       |
| Total stockholders’ equity                     |       | 21,164            |        | 31,014           |       |
|                                                |       |              |        |             |       |
| **Total liabilities and stockholders’ equity** | ** ** | **$**             | **117,563** | ** **       | **$**      | **39,751** | ** ** |
|                                                     |            |                   |             |                  |            |  |  |  |  |

 

 

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

 

3

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**Conceptus,Inc.**

 

**Condensed Consolidated Statements of Operations**

**(Unaudited)**

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

 

 

| ** **                                                                      | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                      | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                                                      | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales                                                                       |       | $                      | 16,430     |                  | $          | 11,013 |   | $ | 45,879 |   | $ | 28,978 |   |
| Cost of goods sold (*)                                                          |       | 4,317                  |       | 3,486                 |       | 12,260 |   | 10,020 |   |
| Gross profit                                                                    |       | 12,113                 |       | 7,527                 |       | 33,619 |   | 18,958 |   |
|                                                                            |       |                   |       |                  |       |   |   |   |   |
| Operating expenses:                                                             |       |                   |       |                  |       |   |   |   |   |
| Research and development (*)                                                    |       | 1,513                  |       | 1,030                 |       | 4,216 |   | 3,299 |   |
| Selling, general and administrative (*)                                         |       | 13,917                 |       | 10,265                |       | 40,098 |   | 31,200 |   |
| Total operating expenses                                                        |       | 15,430                 |       | 11,295                |       | 44,314 |   | 34,499 |   |
| Operating loss                                                                  |       | (3,317                 | )          | (3,768                | )          | (10,695 | ) | (15,541 | ) |
|                                                                            |       |                   |       |                  |       |   |   |   |   |
| Interest and other income                                                       |       | 682                    |       | 329                   |       | 1,820 |   | 985 |   |
| Net loss                                                                        |       | $                      | (2,635     | )                     | $          | (3,439 | ) | $ | (8,875 | ) | $ | (14,556 | ) |
| Basic and diluted net loss per share                                            |       | $                      | (0.09      | )                     | $          | (0.12 | ) | $ | (0.30 | ) | $ | (0.50 | ) |
| Weighted-average shares used in computing basic and diluted net loss  per share |       |                   |       |                  |       |   |   |   |   |
|                                                                            |       |                   |       |                  |       |   |   |   |
|                                                                            | 29,525     |                   | 29,034     |                  | 29,405     |   | 28,938 |   |
|                                                                                 |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |

----

(*)Includes the following amounts related to stock-based compensation:

 

 
| ** **                          | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                          | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Cost of goods sold                  |       | $                      | 7          |                  | $          | 12 |   | $ | 18 |   | $ | 123 |   |
| Research and development            |       | 155                    |       | 162                   |       | 376 |   | 531 |   |
| Selling, general and administrative |       | 1,529                  |       | 1,304                 |       | 4,277 |   | 3,856 |   |
|                                     |            |                        |            |                       |            |  |  |  |  |  |  |  |  |

 

 

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

 

4

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**Conceptus,Inc.**

 

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

**(Inthousands)**

 

| ** **                                                                    | ** ** | **Nine months ended** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                    | ** ** | **September 30,**     | ** ** |
| ** **                                                                    | ** ** | **2007**              | ** ** | **2006** | ** ** |
| **Cash flows from operating activities**                                      | ** ** | ** **            | ** ** | ** ** | ** ** |
| Net loss                                                                      |       | $                     | (8,875     | ) | $ | (14,556 | ) |
| Adjustments to reconcile net loss to net cash used in   operating activities: |       |                  |       |   |   |
|                                                                          |       |                  |       |   |
| Depreciation and amortization of property, plant and equipment                |       | 1,022                 |       | 868 |   |
| Amortization of debt issuance costs                                           |       | 387                   |       | — |   |
| Amortization of intangibles                                                   |       | 135                   |       | 150 |   |
| Inventory provision                                                           |       | 132                   |       | (166 | ) |
| Stock-based compensation expense                                              |       | 4,671                 |       | 4,510 |   |
| Allowance for doubtful accounts                                               |       | 262                   |       | 46 |   |
| Loss on retirement of fixed assets                                            |       | 19                    |       | 4 |   |
| Changes in operating assets and liabilities:                                  |       |                  |       |   |   |
| Accounts receivable                                                           |       | (4,581                | )          | (1,680 | ) |
| Inventories                                                                   |       | (1,794                | )          | 2,479 |   |
| Other current assets                                                          |       | (655                  | )          | 82 |   |
| Other assets                                                                  |       | 674                   |       | 419 |   |
| Accounts payable                                                              |       | (201                  | )          | (381 | ) |
| Accrued compensation                                                          |       | (667                  | )          | (69 | ) |
| Other accrued and long term liabilities                                       |       | 2,498                 |       | 12 |   |
| Net cash used in operating activities                                         |       | (6,973                | )          | (8,282 | ) |
|                                                                          |       |                  |       |   |   |
| **Cash flows from investing activities**                                      | ** ** | ** **            | ** ** | ** ** | ** ** |
| Purchase of investments                                                       |       | (87,600               | )          | (21,450 | ) |
| Maturities of investments                                                     |       | 18,100                |       | 19,000 |   |
| Capital expenditures                                                          |       | (1,811                | )          | (977 | ) |
| Net cash used in investing activities                                         |       | (71,311               | )          | (3,427 | ) |
|                                                                          |       |                  |       |   |   |
| **Cash flows from financing activities**                                      | ** ** | ** **            | ** ** | ** ** | ** ** |
| Proceeds from issuance of long term debt                                      |       | 86,250                |       | — |   |
| Payment of debt issuance costs                                                |       | (3,097                | )          | — |   |
| Purchase of call options on convertible senior notes                          |       | (19,372               | )          | — |   |
| Proceeds from issuance of warrants                                            |       | 10,695                |       | — |   |
| Proceeds from exercise of stock options                                       |       | 2,813                 |       | 2,523 |   |
| Net cash provided by financing activities                                     |       | 77,289                |       | 2,523 |   |
|                                                                          |       |                  |       |   |   |
| Net decrease in cash and cash equivalents                                     |       | (995                  | )          | (9,186 | ) |
| Cash and cash equivalents at the beginning of the period                      |       | 3,238                 |       | 12,573 |   |
| Cash and cash equivalents at end of the period                                |       | $                     | 2,243      |   | $ | 3,387 |   |

 

 

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

 

5

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**Conceptus,Inc.**

 

***NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS***

 

***(Unaudited)***

 

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

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesfor interim financial information and pursuant to the instructions to Form 10-Qand Article 10-01 of Regulation S-X.  Accordingly, they do not include allof the information and footnotes required by accounting principles generallyaccepted in the United States for complete financial statements. In the opinionof management, all adjustments, consisting only of normal recurringadjustments, considered necessary for a fair statement have been included.

 

The condensedconsolidated balance sheet at December 31, 2006 has been derived from theaudited consolidated financial statements at that date, but does not includeall of the information and footnotes required by accounting principlesgenerally accepted in the United States for complete financial statements. Thisfinancial data should be reviewed in conjunction with the audited consolidatedfinancial statements and related notes included in our Annual Report on Form10-K for the year ended December 31, 2006.  The results of operations forthe three and nine months ended September 30, 2007 may not necessarily beindicative of the operating results for the full 2007 fiscal year or any otherfuture interim periods.

 

*Recent Accounting Pronouncements*

 

In July 2006, theFinancial Standards Accounting Board (or “FASB”) issued FinancialInterpretation No. 48, “*Accounting for Uncertaintyin Income Taxes—an interpretation of FASB Statement No. 109*” or FIN48, which is a change in accounting for income taxes. FIN 48 specifies how taxbenefits for uncertain tax positions are to be recognized, measured andderecognized in financial statements; requires certain disclosures of uncertaintax matters; specifies how reserves for uncertain tax positions should beclassified on the balance sheet; and provides transition and interim-periodguidance, among other provisions. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006 and we adopted FIN 48 beginning fiscal year2007. The adoption of the provisions of FIN 48 did not have a material impacton our financial position or results of operations.

 

In September 2006, theFASB issued Statement No. 157, “*Fair Value Measurement*”or SFAS 157. This standard defines fair value, establishes the framework formeasuring fair value in accounting principles generally accepted in the UnitedStates and expands disclosure about fair value measurements. This pronouncementapplies under other accounting standards that require or permit fair valuemeasurements. Accordingly, this statement does not require any new fair valuemeasurement. This statement is effective for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. We will berequired to adopt SFAS 157 in the first quarter of 2008. We are currentlyevaluating the requirements of SFAS 157 and have not yet determined the impacton our consolidated financial statements. On October 17, 2007, the FASB agreedto consider delaying the effective date for certain entities that may includesmaller public companies (as yet undefined) and all entities with respect tonon-financial instruments. To that end, the FASB asked its staff to developrecommendations on whether a delay would be appropriate and, if so, to whom andto what it should apply. The staff’s recommendations will be presented to theFASB and discussed at a future meeting. We are unable to assess at this timethe impact, if any, of the FASB decisions to be agreed at the next meeting.

 

In February 2007, theFASB issued Statement No. 159, “*The Fair Value Option forFinancial Assets and Financial Liabilities*”, or SFAS 159, whichpermits entities to choose to measure many financial instruments and certainother items at fair value that are not currently required to be measured atfair value. SFAS 159 will be effective for us on January 1, 2008. We arecurrently evaluating the impact of adopting SFAS 159 on our consolidatedfinancial statements.

 

On July 25, 2007, theFASB held a meeting to discuss, among other things, the accounting method fornet share settled securities, such as our convertible senior notes.  As aresult of the meeting, the FASB voted to adopt a method for accounting for netshare settled securities under which the debt and equity components of thesecurity would be bifurcated and accounted for separately. The effect ofthis proposal is that the equity component would be included in thepaid-in-capital section of stockholders’ equity on our balance sheet and thevalue of the equity component would be treated as original issue discount forpurposes of accounting for the debt component of the notes. As a result,net loss attributable to our common stockholders would be higher as a result ofthe recognition of the accretion of the discounted carrying value of ourconvertible senior notes to their face amount as additional interestexpense. The diluted earnings per share calculation would continue to becalculated based on the treasury stock method. In addition, the FASB mayrequire that the new method be implemented retrospectively. The FASB has notyet reached its final decision with respect to this proposed change toaccounting treatment so there remains 

 

6

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uncertainty as to the full impact of this accounting change. We cannotpredict the outcome of the FASB deliberations and whether the FASB is proposingthat net share settled securities be accounted for under the existing method,the proposed method described above or some other method, and when any changewould be implemented or whether it would be implemented retrospectively orprospectively.

 

**2.****             ****Summary of Significant AccountingPolicies**

 

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 ourfinancial statements include write-offs for obsolete and slow moving inventory,allowance for doubtful accounts receivable, product warranty, impairment oflong-lived assets and stock-based compensation.

 

Our significantaccounting policies are disclosed in our Annual Report on Form 10-K for theyear ended December 31, 2006 that was filed with the Securities and ExchangeCommission on March 15, 2007. Our significant accounting policies have notmaterially changed since December 31, 2006.

 

 

**3.****             ****Inventories**

 

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

 
| ** **       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------|------------|-------------------|------------|------------------|------------|
| ** **       | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| Raw materials    |       | $                 | 284        |             | $          | 159 |   |
| Work-in-progress |       | 572               |       | 292              |       |
| Finished goods   |       | 1,416             |       | 159              |       |
| **Total**        | ** ** | **$**             | **2,272**  | ** **       | **$**      | **610** | ** ** |

 

 

 

**4.****             ****Warranty**

 

We offer warranties onour product and record a liability for the estimated future costs associatedwith warranty claims, which is based upon our historical experience and ourestimate of the level of future costs. Warranty costs are reflected in thestatement of operations as a cost of goods sold.  A reconciliation of thechanges in warranty liability for the nine months ended September 30, 2007 and2006 follows (in thousands):

 
| ** **                                       | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                       | ** ** | **2007**                            | ** ** | **2006** | ** ** |
| Balance at the beginning of the period           |       | $                                   | 209        |   | $ | 70 |   |
| Accruals for warranties issued during the period |       | 369                                 |       | 282 |   |
| Settlements made in kind during the period       |       | (337                                | )          | (206 | ) |
| **Balance at the end of the period**             | ** ** | **$**                               | **241**    | ** ** | **$** | **146** | ** ** |

 

 

 

**5.****             ****Stock-Based Compensation**

 

Net loss for the threeand nine months ended September 30, 2007 included stock-based compensationexpense under SFAS 123(R) of $1.6 million and $4.5 million, respectively,which consisted of stock-based compensation expense of $1.4 million and $3.8million, respectively, related to employee stock options, employee stockpurchase plan and stock appreciation rights and stock-based compensationexpense of $0.2 million and $0.7 million, respectively, related to employeerestricted stock and restricted stock units.

 

Net loss for the threeand nine months ended September 30, 2006 included stock-based compensationexpense under SFAS 123(R) of $1.4 million and $4.4 million, respectively,which consisted of stock-based compensation expense of $1.1 

 

7

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million and $3.4 million, respectively, related to employee stockoptions, employee stock purchase plan and stock appreciation rights andstock-based compensation expense of $0.3 million and $1.0 million,respectively, related to employee restricted stock and restricted stock units.

 

Stock-based compensationarrangements to non-employees are accounted for in accordance with EITF IssueNo. 96-18, “*Accounting for Equity Instruments That Are Issuedto Other Than Employees for Acquiring, or in Conjunction with Selling, Goods orServices*,” which requires that these equity instruments are recordedat their fair value on the measurement date. The measurement of stock-basedcompensation is subject to adjustment as the underlying equity instrumentsvest. Stock-based compensation expense relating to non-employees wasapproximately $56,000 and $37,000 for the three months ended September 30, 2007and 2006, respectively, and $174,000 and $137,000 for the nine months endedSeptember 30, 2007 and 2006, respectively.

 

We calculated the fairvalue of each option on the date of grant using the Black-Scholes model asprescribed by SFAS 123(R). The assumptions used were as follows:

 
| ** **                      | ** ** | **Stock Option and Stock  Appreciation Right Plan** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|
| ** **                      | ** ** | **Three months**                                    | ** ** | **Nine months** | ** ** |
| ** **                      | ** ** | **ended September 30, 2007**                        | ** ** | **ended September 30, 2007** | ** ** |
| Expected term (in years)        |       | 3.00                                                |       | 3.55 |   |
| Average risk-free interest rate |       | 4.41                                                | %          | 4.69 | % |
| Average volatility factor       |       | 46.4                                                | %          | 48.0 | % |
| Dividend yield                  |       | —                                              |       | — |   |

 

 

 

For the three and ninemonths ended September 30, 2006, we calculated the fair value of each option onthe date of grant using the Black-Scholes model as prescribed by SFAS 123(R).The assumptions used were as follows:

 
| ** **                      | ** ** | **Stock Option and Stock  Appreciation Right Plans** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|
| ** **                      | ** ** | **Three months**                                     | ** ** | **Nine months** | ** ** |
| ** **                      | ** ** | **ended September 30, 2006**                         | ** ** | **ended September 30, 2006** | ** ** |
| Expected term (in years)        |       | 3.67                                                 |       | 3.68 |   |
| Average risk-free interest rate |       | 4.87                                                 | %          | 4.80 | % |
| Average volatility factor       |       | 51.5                                                 | %          | 54.2 | % |
| Dividend yield                  |       | —                                               |       | — |   |

 

 

 

*Expected Term:* Our expected term represents the periodthat our stock-based awards are expected to be outstanding and was determinedbased on historical exercise experience of similar awards, giving considerationto the contractual terms of the stock-based awards and vesting schedules.

 

*Expected Volatility:* We used historical volatility based onthe expected term of the awards, which is consistent with our assessment thatthe historical volatility for such period is more representative of futurestock price trends than any other type of volatility.

 

*Expected Dividends:* We have not paid and do not anticipatepaying any dividends in the near future.

 

*Risk-Free Interest Rate:* We base the risk-free interest rate onthe U.S. Treasury yield curve in effect at the time of grant based on theexpected term of the underlying option.

 

*Forfeitures:* As stock-based compensation expenserecognized in the Condensed Consolidated Statement of Operations for the ninemonths ended September 30, 2007 is based on awards ultimately expected to vest,it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeituresto be estimated at the time of grant and revised, if necessary, in subsequentperiods if actual forfeitures differ from those estimates. Forfeitures wereestimated based on historical experience.

 

No income tax benefit has been recognized relating tostock-based compensation expense and no tax benefits have been realized fromexercised stock options.

 

8

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Stock Options and Stock Appreciation Rights: During the three months ended September30, 2007, we granted stock options and stock appreciation rights for 49,000shares of common stock to employees and 5,000 shares of common stock toconsultants. The shares granted to employees had an estimated total grant-datefair value of approximately $0.3 million and a grant date weighted-average fairvalue of $6.42 per share. The 5,000 shares of common stock granted toconsultants were accounted for inaccordance with EITF 96-18. During the threemonths ended September 30, 2006, we granted stock options and stockappreciation rights for 51,500 shares of common stock, with an estimated totalgrant-date fair value of approximately $0.3 million and a grant dateweighted-average fair value of $5.72 per share.

 

As of September 30, 2007, there was unrecognizedcompensation cost of approximately $10.0 million for total stock-basedcompensation related to stock options and stock appreciation rights, beforeforfeitures. This cost is expected to be recognized over a weighted-averageamortization period of 2.6 years.

 

Employee Stock Purchase Plan (ESPP): The compensation cost in connectionwith the ESPP for the three months ended September 30, 2007 was approximately $82,000with a grant-date weighted-average fair value of $5.29. During the three monthsended September 30, 2006, the compensation cost was approximately $48,000, witha grant-date weighted-average fair value of $3.79. This cost is amortized on astraight-line basis over the relevant subscription period.

 

We calculated the fair value of each share under theESPP on the date of grant using the Black-Scholes model as prescribed by SFASNo. 123(R). The assumptions used were as follows:

 

 
| ** **                      | ** ** | **Three months ended September  30, 2007** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| Expected term (in years)        |       | 0.50                                       |       |
| Average risk-free interest rate |       | 4.60                                       | %          |
| Average volatility factor       |       | 40.5                                       | %          |
| Dividend yield                  |       | —                                     |       |

 

For the three months ended September 30, 2006, theESPP assumptions were as follows:

 
| ** **                      | ** ** | **Three months ended  September 30, 2006** | ** ** |
|---------------------------------|------------|--------------------------------------------|------------|
| Expected term (in years)        |       | 0.50                                       |       |
| Average risk-free interest rate |       | 5.27                                       | %          |
| Average volatility factor       |       | 43.4                                       | %          |
| Dividend yield                  |       | —                                     |       |

 

Restricted Shares and Restricted Stock Units: In connection with restricted sharesand restricted stock units granted, we recorded stock compensation representingthe difference between the exercise price of the shares and the fair marketvalue of our common shares on the dates the awards were granted. Compensationexpense is being recorded on a straight-line basis over the vesting periods ofthe underlying stock awards. During the three months ended September 30, 2007,we did not grant shares of restricted stock or restricted stock units. Duringthe three months ended September 30, 2006, we granted 2,500 shares ofrestricted stock and 1,000 shares of restricted stock units, with a grant-datefair value of approximately $46,000 and a grant-date weighted-average fairvalue of $13.19.

 

As of September 30, 2007, there was an unrecognizedcompensation cost of approximately $1.4 million related to nonvested restrictedshares and restricted stock units, before forfeitures. This cost is expected tobe recognized over a weighted-average amortization period of 1.4 years forrestricted stock awards and 1.9 years for restricted stock units.

 

 

**6.****             ****Notes Payable**

 

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

 

The notes are convertible into cash and, if applicable, shares of ourcommon stock based on an initial conversion rate, subject to adjustment, of35.8616 shares per $1,000 principal amount of notes (which represents aninitial conversion price of approximately $27.89 per share), in certaincircumstances described in the next paragraph. Upon conversion, a holder wouldreceive cash up to the principal amount of the note and shares of our commonstock in respect of such note’s conversion value in excess of such principalamount.

 

The notes are convertible only in the followingcircumstances: (1) during any calendar quarter after the quarter ending March31, 2007 if the closing sale price of our common stock for each of 20 or moretrading days in a period of 30 consecutive trading days ending on the lasttrading day of the immediately preceding calendar quarter exceeds 120% of theconversion price; (2) during the five consecutive business days immediatelyafter any five consecutive trading day period in which if the average tradingprice per $1,000 principal amount of the notes is less than or equal to 97% ofthe average conversion value of 

 

9

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the notes during such five-day period; (3) upon the occurrence ofspecified corporate transactions; (4) if we call the notes for redemption and(5) at anytime on or after December 15, 2011 to and including February 15, 2012and anytime on or after February 15, 2025. Upon a change in control ortermination of trading, holders of the notes may require us to repurchase allor a portion of their notes for cash at a repurchase price equal to 100% of theprincipal amount, plus any accrued and unpaid interest.

 

In addition, in connection with the issuance of thenotes, we entered into separate convertible note hedge transactions andseparate warrant transactions to reduce the potential dilution upon conversionof the notes ( “Call Spread Transactions”). As a result of the Call SpreadTransactions, we do not anticipate experiencing an increase in the total sharesoutstanding from the conversion of the notes unless the price of our commonstock appreciates above $36.47 per share, effectively increasing the conversionpremium to $36.47. We purchased call options to cover approximately 3.1 millionshares of our common stock, which is the number of shares underlying the notes.In addition, we sold warrants permitting the purchasers to acquire up toapproximately 3.1 million shares of our common stock. See Note 9, Stockholders’Equity.

 

 

**7.****             ****Income Taxes**

 

We adopted the provisions of FIN 48 on January 1,2007.  The adoption of the provisions of FIN 48 did not have a materialimpact on our financial position and results of operations. We have not beenaudited by the Internal Revenue Service or any state income or franchise taxagency. As of September 30, 2007, our federal returns for the years ended 2004through the current period and most state returns for the years ended 2003through the current period are still open to examination. In addition, all ofthe net operating losses and research and development credit carryforwards thatmay be used in future years are still subject to inquiry given that the statuteof limitation for these items would be from the year of the utilization.

 

 

**8.****             ****Computation of Net Loss Per Share**

 

Basic net loss per share excludes any potential dilutiveeffects of options and common stock shares subject to repurchase. Dilutednet loss per share includes the impact of potentially dilutivesecurities.  However, due to our net loss position, basic and diluted netloss per share are both computed using the weighted average number of commonshares outstanding.

 

The following table provides a reconciliation ofweighted-average number of common shares outstanding to the weighted-averagenumber common shares outstanding used in computing basic and diluted net lossper common share (in thousands):

 
| ** **                                                                                                           | ** ** | **Three months ended September  30,** | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2007**                              | ** ** | **2006**                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| Denominator:                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Weighted-average number of common shares oustanding                                                                  |       | 29,546                                |       | 29,308                              |       | 29,445 |   | 29,206 |   |
| Less: Weighted-average unvested and restricted common shares                                                         |       | (21                                   | )          | (274                                | )          | (40 | ) | (268 | ) |
| **Weighted-average number common shares  outstanding used in computing basic and diluted net loss per common share** | ** ** | **29,525**                            | ** ** | **29,034**                          | ** ** | **29,405** | ** ** | **28,938** | ** ** |

 

10

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The following outstanding options, potential employeestock purchase plan shares, warrants, stock appreciation rights, restrictedstock units and shares were excluded from the computation of diluted net lossper share, as their effect would have been antidilutive (in thousands):

 
| ** **                                               | ** ** | **As of September 30,** | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|
| ** **                                               | ** ** | **2007**                | ** ** | **2006** | ** ** |
| Outstanding options and SARs                             |       | 4,115                   |       | 3,580 |   |
| Restricted stock                                         |       | 17                      |       | 274 |   |
| Restricted stock units                                   |       | 287                     |       | 70 |   |
| Employee Stock Purchase Plan                             |       | 16                      |       | 17 |   |
| Warrants issued in connection with our convertible notes |       | 3,093                   |       | — |   |
| **Total**                                                | ** ** | **7,528**               | ** ** | **3,941** | ** ** |

 

 

 

Our 2.25% senior convertible notes are not included inthe calculation of net loss per share because their effect is anti-dilutive.

 

 

**9.****             ****Stockholders’ Equity**

 

As of September 30, 2007, we hold 77,863 shares oftreasury stock as a result of repurchasing shares of restricted common stock atpar value in accordance with the terms of the restricted stock agreements.These shares had a purchase price of $0.003 per share and are recorded astreasury stock.

 

In connection with the issuance of our seniorconvertible notes (see Note 6) in February 2007, we entered into the CallSpread Transactions, which have the effect of reducing the potential dilutionupon conversion of the notes. We purchased call options in private transactionsto cover approximately 3.1 million shares of our common stock at a strike priceof $27.89 per share (subject to adjustment in certain circumstances) forapproximately $19.4 million. The call options generally will allow us toreceive shares of common stock from counterparties equal to the number ofshares of common stock payable to the holders of our senior convertible notesupon conversion. These call options will terminate the earlier of the maturitydates of the related senior convertible notes or the first day all of therelated senior convertible notes are no longer outstanding due to conversion orotherwise. In addition, we sold warrants permitting the purchasers to acquireup to approximately 3.1 million shares of our common stock at an exercise priceof $36.47 per share (subject to adjustments in certain circumstances) inprivate transactions for total proceeds of approximately $10.7 million. Thewarrants provide for net share settlement. We have analyzed the Call SpreadTransactions under EITF Issue No. 00-19, “Accounting for Derivative FinancialInstruments Indexed to, and Potentially Settled In, a Company’s Own Stock,” anddetermined that they meet the criteria for classification as equitytransactions. As a result, in the nine months ended September 30, 2007, werecorded the purchase of the call options of $19.4 million as a reduction inadditional paid-in capital and the proceeds of the warrants of $10.7 million asan addition to paid-in capital, and we will not recognize subsequent changes infair value of the agreements.

 

 

**10.****      ****Commitments and Contingencies**

 

On February 27, 2007, we entered into an amendment tothe Share Purchase and Call Option Agreement dated January 17, 2004 with ConceptusSAS, (or “SAS”) and into an amendment to the Distribution Agreement with SAS,dated January 17, 2004.  Pursuant to the amendment to the Share Purchaseand Call Option Agreement, we agreed not to exercise the call option to acquireSAS in 2007 and agreed to exercise our call option to acquire SAS sometimebetween January 1, 2008 and January 2, 2009 subject to the satisfaction ofcertain closing conditions.  Pursuant to the amendment to the DistributionAgreement, SAS agreed to increase the price they pay to us for the*Essure* product. The difference in price of the revised Distribution Agreementcompared to the previous agreement is being recorded as a current liability inour consolidated balance sheet. As of September 30, 2007, the balance of thiscurrent liability was $1.7 million.

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial 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 2007 revenues and gross margins, increased productadoption, product improvements, expanded sales force and other forecasteditems, that involve risks and uncertainties such as our limited operating andsales history; the uncertainty of market acceptance of our product; dependenceon obtaining and maintaining reimbursement; effectiveness and safety of ourproduct over the long-term; our ability to obtain and maintain the necessarygovernmental clearances or approvals to market our product; our ability todevelop and maintain proprietary aspects of our technology; our ability to manageour expansion; our limited history of manufacturing our product; our dependenceon single source suppliers, third party manufacturers and co-marketers;intense competition in the medical device industry and in the contraceptionmarket; the inherent risk of exposure to product liability claims and productrecalls and other factors referenced in this Form 10-Q. Our actual resultscould differ materially from those expressed or implied in theseforward-looking statements as a result of various factors, including thosediscussed in our Annual Report on Form 10-K for the year ended December 31,2006 filed with the Securities and Exchange Commission on March 15, 2007 andthose included elsewhere in this Form 10-Q.*

 

 

**Overview**

 

We develop, manufacture and market the*Essure*® Permanent Birth Controlsystem, an innovative and proprietary medical device for women that wasapproved for marketing in the United States in November 2002 by the UnitedStates Food and Drug Administration or FDA. The*Essure* system uses a soft and flexible micro-insert that isdelivered into a woman’s fallopian tubes to provide permanent birth control bycausing a benign tissue in-growth that blocks the fallopian tubes. Asuccessfully placed *  Essure*  micro-insert and the subsequent tissue growthprohibits the egg from traveling through the fallopian tubes and thereforeprevents fertilization.

 

 

*The Essure 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. Laparoscopictubal ligation and tubal ligation by laparotomy typically involve abdominalincisions and/or punctures, general or regional anesthesia, four to ten days ofnormal recovery time and the risks associated with an incisionalprocedure. The*Essure*procedure does not require cutting or penetrating the abdomen, which lowers thelikelihood of post-operative pain due to the incisions/punctures, and it can beperformed in an outpatient setting without general or regionalanesthesia.  In the Pivotal trial of the*Essure* system, the total procedure time averaged 35 minutes, with anaverage of 13 minutes of hysteroscopic time to place the *Essure* micro-insert. A patient is typically discharged approximately 45minutes after the*Essure*procedure. No overnight hospital stay is required.  Furthermore, the*Essure* system is effective without drugs or hormones. There is athree-month waiting period after the procedure during which the woman must useanother form of birth control while tissue in-growth occurs. At 90 daysfollowing the procedure, the patient completes a follow-up examination called ahysterosalpingogram, or HSG, which can determine whether the device was placedsuccessfully and whether the fallopian tubes are occluded.

 

We believe that the*Essure* system is also an attractive alternative to tubal ligationfor physicians, hospitals and payers. The *Essure*  system is a lessinvasive permanent birth control option for physicians to offer to theirpatients; hospitals are able to utilize their facilities more cost effectivelywith the*Essure* procedurecompared with tubal ligation, and payers are able to experience cost reductionsresulting from the elimination of overhead and procedural costs related toanesthesia and post-operative hospital stays associated with tubal ligations.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 tapinto this market and establish the*  Essure*  procedure as the gold standard for permanentbirth control.

 

The*Essure*system is currently being marketed in multiple countries. In November 2002we received approval from the FDA to market the*  Essure*  system in the United States. In 2001, wewere given approval to affix the CE Mark to the*  Essure*  system, indicating that the*  Essure*  system is certified for sale throughout theEuropean Union, subject to compliance with local regulations such asregistration with health ministries and/or particular requirements regardinglabeling or distribution. In Canada, we received clearance from HealthCanada to market the*  Essure*  system in Canada in November 2001. Wecurrently have distributors in Australia, Canada and France, which coverEurope, Middle East, Africa, Mexico, Central America and South America.

 

On February 27, 2007, we entered into an amendment tothe Share Purchase and Call Option Agreement dated January 17, 2004 betweenConceptus, Conceptus SAS, or SAS, and the Purchasers party thereto and anamendment to the Distribution Agreement with SAS, dated January 17, 2004. Pursuant to the amendment to the Share Purchase and Call Option Agreement, weagreed not to exercise the call option to acquire SAS in 2007 and agreed toexercise our call option to acquire SAS sometime between January 1, 2008 andJanuary 2, 2009 subject to the satisfaction of certain closing conditions. Thepurchase price will be determined as a multiplier of yearly sales. Pursuant tothe amendment to the Distribution Agreement, SAS agreed to increase 

 

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the price they pay to us for the*  Essure*  product. The difference in price of therevised Distribution Agreement compared to the previous agreement is beingrecorded as a current liability in our consolidated balance sheet. As ofSeptember 30, 2007, the balance of this current liability was $1.7 million.

 

*Effectiveness of the Essure System*

 

In July 2005, we received approval from the FDA toextend effectiveness data on the*Essure*product labeling. The Premarket Approval, or PMA, supplement filed in lateJanuary 2005 supports an extension of the effectiveness rate of the *  Essure*  system to 99.80% after four years and 99.74%after five years of follow-up, from the previously approved 99.80% at threeyears. The five-year effectiveness was demonstrated in a small portion of thewomen undergoing clinical studies. Five year follow up of all patients inclinical trials is ongoing.

 

In September 2005, we received approval from the FDAto terminate our post-approval study with physicians who were newly trained inperforming the*Essure* proceduredue to the positive placement data obtained. The purpose of the post-approvalstudy, required by the FDA as a condition of the November 2002 approval of the*  Essure*  system, was to determine the rate ofsuccessful bilateral placements of the*  Essure*  micro-inserts at first attempt with a largenumber of newly trained physicians who were not part of the previous clinicalstudies. Although treatment of the total number of patients required by FDA hadnot been completed, the data obtained to date provided us with the opportunityto request that the FDA permit an early termination of the study. Because ofthe FDA ruling, the PMA Supplement submitted in March 2005 has been re-classifiedas a Final Report. The results of the post-approval study demonstrated animprovement in placement rates from those obtained in the pivotal study and wewill seek to obtain a new placement rate claim for the product using this newdata. In November 2005, we filed a PMA supplement with the FDA in order toobtain approval to modify the*  Essure*  Physician and Patient labeling to reflect a94.6% first procedure bilateral placement rate based on results of thepost-approval study.  In October 2006, we received such approval from theFDA. In addition, the FDA has recently approved the third generation of the*Essure* product for sale in the UnitedStates.

 

*Penetration*

 

Physicians are required to be preceptored for between3 and 5 cases by a certified trainer before being able to perform the procedureindependently. As of September 30, 2007, the increase of physicians that havebeen trained or that are in the process of training has been commensurate withthe increase in sales. 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. However, we understand that a strong base of trained physiciansdoes not necessarily correlate to an increase in revenue proportionately.Furthermore, there are no revenues associated with the training activities. Wedo not charge a fee for the activity and no commitment arises for the physicianfrom the preceptorship. Physician training is provided upfront and we have noobligation subsequent to the initial training. Training costs have not beensignificant from inception to-date.

 

*Reimbursement of the EssureProcedure*

 

Market acceptance of the*Essure* system depends in part upon the availability ofreimbursement within prevailing healthcare payment systems. We believe thatphysician advocacy of our product will be required to continue to obtainreimbursement. As of September 30, 2007, we have received positivereimbursement decisions for the*  Essure*  procedure from most private insurers and 43of the 51 Medicaid programs in the country. We intend to continue our effort toeducate payers of the cost-effectiveness of our product, and to establishfurther programs to help physicians to navigate reimbursement issues.

 

In July 2005, the UnitedHealthcare Group, or UHC,approved the*Essure* procedure forreimbursement. In addition, in February 2006, we received coverage from CIGNACorporation, or Cigna. As with all healthcare plans, coverage will vary and isdependent upon the individual’s specific benefit plan.

 

Effective January 1, 2007, the Centers for Medicareand Medicaid Services, or CMS, the Medicare National unadjusted average paymentfor hysteroscopic sterilization, the CPT code, is $433 when performed in ahospital and $2,017 when performed in a physician’s office. This compares to aMedicare national average payment for tubal ligation, the current standard ofcare for permanent female sterilization, of $370. In addition, in the CMS FinalRule for the 2007 Outpatient Prospective Payment System (or OPPS), whichassigns hospital outpatient reimbursement amounts, the CPT code was assigned aMedicare National Average of $2,642. In 2007, the CPT code was moved from Group4 which had a national average reimbursement of $633 to Group 9 which has anational average reimbursement of $1,339. We believe these values are veryfavorable for the*  Essure* procedure and will help inestablishing increased utilization of the device amongst doctors. We expectthat the new code, once the process to establish it at all private payers thathave given a favorable coverage decision is complete, will significantly easethe burden on a physician’s office in obtaining reimbursement for the*  Essure*  procedure and accelerate the coverage of the*Essure* procedure by private insurance companies and Medicaid. This process isnot automatic following 

 

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receipt of the new CPT code, however, and we anticipate continuing tofocus on reimbursement issues for sometime in the future, both to secure ourcode and payment schedule into the payers’ databases, as well as to help thephysician negotiate a favorable contract for payment off that schedule.

 

*Adoption of the Essure system*

 

The*Essure*system is 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 liability risks.Our biggest challenge is to speed up the adoption process to make the*  Essure*  procedure the standard of care for permanentbirth control. The following discussion summarizes our program in the UnitedStates to increase adoption of the*  Essure*  procedure.

 

First, we are expanding our sales territories andchannels of distribution so as to increase our call frequency on physicians.During the nine months ended September 30, 2007, we added a substantial numberof sales positions and are expecting to add more in the remaining of 2007.Also, we have included regional distributors of women’s gynecology products toour marketing efforts. Among other responsibilities, our sales representativesare attempting to increase penetration and utilization of the*Essure* procedure, as well as tofacilitate the movement of the*Essure*procedure to the in the office environment.

 

Second, we are attempting to increase patientawareness, so as to increase the number of women that will ask for informationabout the*Essure*  procedure. We may achieve this through radiocampaigns, direct mail and print media (magazine) advertisements aimed atincreasing consumer awareness.

 

Third, we are focused on obtaining favorable coveragedecisions from the remaining payers representing the private paying andstate-paying Medicaid systems that have not given a coverage decision. It isour intention to maintain our field based tactical reimbursement group aimed atobtaining coverage decisions and educating the physician and office regardingpayer procedures.

 

Fourth, we have entered into certain strategicagreements in the past and we may explore such opportunities in the future. Weintend for these agreements to provide us with the ability to increaseawareness, gain market presence and credibility, accelerate our ability totrain doctors, as well as expand our market opportunity by driving adoptionamong a group of physicians not previously targeted by our marketing programs.The success of these campaigns will depend upon the effectiveness of our salesforce training programs, market demand for*Essure* procedures in conjunction with the products marketed bystrategic partners and the efforts and commitment of strategic partners to theprogram. We cannot be certain how successful these programs will be, if at all.

 

Lastly, as appropriate we intend to make labelingimprovements to our product as well as physical product enhancements to enhancethe adoption of the*Essure*procedure. This may involve working with the various regulatory agencies aroundthe world that regulate the sale and labeling of medical devices to provideupdates to claims such as effectiveness and placement rates. Where appropriate,we will make physical improvements to the product for improvedmanufacturability or for the ease of use by the physician. The FDA hasrecently approved the third generation of the*Essure* product for sale in the United States.

 

We have experienced significant operating losses sinceinception and, as of September 30, 2007, have an accumulated deficit of $232.5million. We intend to continue to expend substantial resources in the sellingand marketing of the*Essure*  system in the United States and abroad. Wewill continue to be in a net loss position until sufficient revenues can begenerated to offset expenses. In December 2006, we filed a RegistrationStatement on Form S-3, through which we may sell from time to time anycombination of debt securities, common stock, preferred stock and warrants, inone or more offerings, with an initial offering price not to exceed$150,000,000. In February 2007, we used the shelf to complete a convertibledebt offering for an aggregate principal amount of $86,250,000 of our 2.25%convertible senior notes due 2027. 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 financing may not beavailable when needed or on terms acceptable to us.

 

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**Resultsof Operations - Three and Nine Months Ended September 30, 2007 and 2006**

 

**2007results compared to 2006 (in thousands, except percentages)**

** **
| ** **                                   | ** ** | **Three Months Ended September  30,** | ** ** | **Nine Months Ended June 30,** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **2007**                              | ** ** | **2006**                       | ** ** | **2007-  2006  %** | ** ** | **2007** | ** ** | **2006** | ** ** | **2007-  2006  %** | ** ** |
| ** **                                   | ** ** | **Amount**                            | ** ** | **% (a)**                      | ** ** | **Amount** | ** ** | **% (a)** | ** ** | **Change** | ** ** | **Amount** | ** ** | **% (a)** | ** ** | **Amount** | ** ** | **% (a)** | ** ** | **Change** | ** ** |
| Net sales                                    |       | $                                     | 16,430     |                           | 100        | % | $ | 11,013 |   | 100 | % | 49 | % | $ | 45,879 |   | 100 | % | $ | 28,978 |   | 100 | % | 58 | % |
| Gross profit                                 |       | 12,113                                |       | 74                             | %          | 7,527 |   | 68 | % | 61 | % | 33,619 |   | 73 | % | 18,958 |   | 65 | % | 77 | % |
| Research and development expenses            |       | 1,513                                 |       | 9                              | %          | 1,030 |   | 9 | % | 47 | % | 4,216 |   | 9 | % | 3,299 |   | 11 | % | 28 | % |
|                                         |       |                                  |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative expenses |       | 13,917                                |       | 85                             | %          | 10,265 |   | 93 | % | 36 | % | 40,098 |   | 87 | % | 31,200 |   | 108 | % | 29 | % |
| Net loss                                     |       | (2,635                                | )          | -16                            | %          | (3,439 | ) | -31 | % | -23 | % | (8,875 | ) | -19 | % | (14,556 | ) | -50 | % | -39 | % |
|                                              |            |                                       |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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**(a)** Expressed as a percentage of total net sales.

 

*Net Sales*

 

Net sales were $16.4 million for the three monthsended September 30, 2007 as compared to $11.0 million for the three monthsended September 30, 2006, representing an increase of $5.4 million, or 49%. Netsales for the nine months ended September 30, 2007 were $45.9 million, ascompared to $29.0 million for the nine months ended September 30, 2006, anincrease of $16.9 million, or 58%. The increase in net sales is the resultof continued commercialization of the *Essure*system worldwide, and reflects the increasing number of physicians entering andcompleting training in the use of the procedure and higher utilization bytrained physicians. As of September 30, 2007, the increase of physicians thathave been trained or that are in the process of training has been commensuratewith the increase in sales. Our accomplishment in obtaining the number ofphysicians trained is very important because it provides us with a strongreferral base within major metropolitan areas we have targeted. We understandthat a strong base of trained physicians does not necessarily correlate to anincrease in revenue proportionately. Furthermore, there are no revenuesassociated with the training activities. We do not charge a fee for theactivity and no commitment arises for the physician from the preceptorship.Physician training is provided upfront and we have no obligation subsequent tothe initial training. Training costs have not been significant to us frominception to-date.

 

Net product sales by geographic region as a percentageof net sales for the three and nine months ended September 30, 2007 and 2006are as follows (in thousands, except percentages):

 
| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                   | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales (in thousands, except percentages) |       | $                      | 16,430     |                  | $          | 11,013 |   | $ | 45,879 |   | $ | 28,978 |   |
| United States of America                     |       | 94                     | %          | 93                    | %          | 91 | % | 91 | % |
| Europe                                       |       | 5                      | %          | 7                     | %          | 8 | % | 8 | % |
| Other                                        |       | 1                      | %          | 0                     | %          | 1 | % | 1 | % |
|                                              |            |                        |            |                       |            |  |  |  |  |  |  |  |  |

 

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

 

No single customer accounted for 10% or more of ournet sales during the three and nine months ended September 30, 2007 andSeptember 30, 2006.  Accounts receivable from one customer accounted for23% of our gross accounts receivable balance as of September 30, 2007. Accountsreceivable from one customer accounted for 12% of our gross accounts receivablebalance as of September 30, 2006.

 

We expect our net sales for 2007 to be approximately$63.4 million to $64.4 million, which would represent 51% to 54% growth fromnet sales in 2006. We expect net sales from the United States will continue tobe the major contributor of our global net sales. We have established fourprimary goals to achieve our revenue growth. We expect to increase salescoverage and with that increase physician penetration and utilization of the*Essure* device in both the hospital andthe office setting.  In addition, we willcontinue to increase our programs aimed at raising patient awareness of the*Essure* procedure, such as advertisingwith physicians and internet marketing, we will obtain additional payercoverage decisions or otherwise improve 

 

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the public and private payer coverage for the *Essure* procedure, and bring productimprovements to the*Essure* deviceto the market. We believe our revenue growth in 2007 and beyond will besignificantly influenced by how successful we are in achieving theseobjectives. However, as we have noted elsewhere in this Form 10-Q and riskfactors from our Form 10-K referenced herein, our expected revenue growthinvolves factors that are outside of our control, such as market acceptance ofthe*Essure* system and third party reimbursement for thedevice.

 

 

*Gross Profit*

 

Cost of goods sold for the three months endedSeptember 30, 2007 was $4.3 million as compared to $3.5 million for the threemonths ended September 30, 2006. This increase of $0.8 million, or 24%, wascaused by the increase in net sales, partially offset by reductions in manufacturingcosts due to the impact of higher volumes of sales on relatively fixedmanufacturing costs, offset by decreased unit costs of the next-generationdevice and to a domestic price increase implemented during the first quarter of2007. For the nine months ended September 30, 2007, cost of goods sold was$12.3 million, as compared to $10.0 million for the nine months ended September30, 2006. The increase of $2.2 million, or 22%, was caused by the same factors.Gross profit margin improved from 68% for the three months ended September 30,2006 to 74 % for the same period ended September 30, 2007. For the nine monthsended September 30, 2007, gross profit margin was $33.6 million, or 73 %, whichrepresents an improvement from a gross profit margin of 65 % from the ninemonths ended September 30, 2006. We anticipate gross margins will improve inthe remainder of 2007 due to lower per-unit costs on greater volume; however,our gross profit margin will vary as our sales mix changes. Increases in salesof our devices through distributors in international markets will tend todecrease our overall gross profit margin.

 

*Operating Expenses*

 

Research and development expenses, which includeexpenditures related to product development, clinical research and regulatoryaffairs, were $1.5 million for the three months ended September 30, 2007 ascompared to $1.0 million for the for the three months ended September 30, 2006.Research and development expenses were $4.2 million and $3.3 million for thenine months ended September 30, 2007 and 2006, respectively. The primary reasonfor the increase in research and development expenses was due to ongoingproduct development. We intend to continue to focus our research anddevelopment efforts on the development of new or alternative product designsalong with management of the on-going clinical trials. It is our goal to launchnew product designs over the coming years, which are intended to result in alower cost of the device, improved ease of use of the*Essure* system and simplified packaging systems.

 

Selling, general and administrative spending for thethree months ended September 30, 2007 was $13.9 million as compared to $10.3million for the three months ended September 30, 2006, which represents anincrease of $3.7 million, or 36 %. The primary reason for the increase washigher payroll expenditures of $1.9 million, primarily due to the expansion ofour U.S. field sales force, which we intend will generate more selling time andfocus on physician penetration. Additionally, increases in selling, general andadministrative expenses were a result of increased consulting and professionalexpenses of $0.6 million, increased insurance and taxes of $0.4 million, highermarket research in $0.2 million, increased stock compensation of $0.2 millionas a result in our increase in headcount and higher travel expenses of $0.1million. The remainder is due to general corporate expenses to support ourgrowing infrastructure.

 

Selling, general and administrative spending for thenine months ended September 30, 2007 was $40.1 million as compared to $31.2million for the nine months ended September 30, 2006, which represents anincrease of $8.9 million, or 29%. The primary reason for the increase washigher payroll expenditures of $3.9 million, primarily due to the expansion ofour U.S. field sales force, which we intend will generate more selling time andfocus on physician penetration. Additionally, increases in selling, general andadministrative expenses were a result of increased advertising expenditures of$1.0 million, higher travel expenses of $0.8 million, increased consultingexpenditures of $0.7 million, higher professional and legal fees of $0.7million, increased insurance and taxes of $0.4 million, increased stockcompensation of $0.4 million as a result in our increase in headcount andhigher recruiting expenses of $0.2 million. The remainder is due to generalcorporate expenses to support our growing infrastructure.

 

Interest and other income and expenses of $0.7 millionincreased by $0.4 million in the three months ended September 30, 2007,compared to $0.3 million in the same period ended September 30, 2006. Forthe nine months ended September 30, 2007, interest and other income and expensewas $1.8 million, compared to $1.0 million for the same period ended September30, 2006, which represents an increase of $0.8 million, or 85 %. The increaseis due to higher interest income in the first nine months of 2007 and theincrease in funds as a result of investing of proceeds from our convertiblesenior note offering completed in February 2007, offset by amortization of debtissuance costs and interest expense on our convertible debt. For thesereasons, we expect higher interest income in 2007 compared to the previousfiscal year.

 

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**Liquidity and Capital Resources**

 

We have experienced significant operating losses sinceinception. As of September 30, 2007 we had an accumulated deficit of $232.5million. We have financed our operations since inception primarily throughequity financings and debt. In December 2006 we filed a shelf RegistrationStatement on Form S-3, through which we may sell from time to time anycombination of debt securities, common stock, preferred stock and warrants, inone or more offerings. The aggregate initial offering price of all securitiessold will not exceed $150,000,000. After the sale of our senior convertiblenotes described below, we had $63,750,000 remaining available for sale.

 

In February 2007, we issued and sold under the shelfRegistration Statement an aggregate principal amount of $86,250,000 of our2.25% convertible senior notes due 2027. These notes bear a 2.25% interest perannum on the principal amount, payable semiannually in arrears on February 15and August 15 of each year, beginning on August 15, 2007. Interest accrual onthe notes commenced on February 12, 2007. The notes will mature on February 15,2027, unless earlier redeemed, repurchased or purchased by us or converted.

 

The notes will be convertible into cash and, ifapplicable, shares of our common stock based on an initial conversion rate,subject to adjustment, of 35.8616 shares per $1,000 principal amount of notes(which represents an initial conversion price of approximately $27.89 pershare), in certain circumstances. Upon conversion, a holder would receive cashup to the principal amount of the note and our common stock in respect of suchnote’s conversion value in excess of such principal amount.

 

The notes are convertible only in the followingcircumstances: (1) during any calendar quarter after the quarter ending March31, 2007 if the closing sale price of our common stock for each of 20 or moretrading days in a period of 30 consecutive trading days ending on the lasttrading day of the immediately preceding calendar quarter exceeds 120% of theconversion price; (2) during the five consecutive business days immediatelyafter any five consecutive trading day period in which if the average tradingprice per $1,000 principal amount of the Notes is less than or equal to 97% ofthe average conversion value of the notes during such five-day period; (3) uponthe occurrence of specified corporate transaction; (4) if we call the notes forredemption and (5) at anytime on or after December 15, 2011 to and includingFebruary 15, 2012 and anytime on or after February 15, 2025. Upon a change incontrol or termination of trading, holders of the notes may require us torepurchase all or a portion of their notes for cash at a repurchase price equalto 100% of the principal amount, plus any accrued and unpaid interest.

 

In addition, in connection with the issuance of thenotes, we entered into separate convertible note hedge transactions andseparate warrant transactions to reduce the potential dilution upon conversionof the notes ( “Call Spread Transactions”). As a result of the Call SpreadTransactions, we do not anticipate experiencing an increase in the total sharesoutstanding from the conversion of the notes unless the price of our commonstock appreciates above $36.47 per share, effectively increasing the conversionpremium to us to $36.47. We purchased call options to cover approximately 3.1million shares of our common stock, which is the number of shares underlyingthe notes. In addition, we sold warrants permitting the purchasers to acquireup to approximately 3.1 million shares of our common stock.

 

As of September 30, 2007, we had cash, cashequivalents and short-term investments of $94.3 million, compared to $25.8million at December 31, 2006. The increase of $68.5 million is primarily due tothe proceeds from of the sale of our senior convertible notes in February 2007and cash used in our operating and investing activities. We expect cash usagein operating activities to decrease in the future as our net loss decreases.

 

*Operating Activities*

 

Net cash used in operating activities was $7.0 millionin the nine months ended September 30, 2007, as compared to $8.3 million in thenine months ended September 30, 2006. Net cash used in operating activities inthe nine months ended September 30, 2007 was primarily related to:

 

•                  net loss of $8.9 million;

 

•                  non-cash related items of $6.6 millioncorresponding primarily to stock based compensation and depreciation andamortization of fixed assets;

 

•                  planned increase of inventories of $1.8million to support our projected growth in sales; and

 

•                  increase in accounts receivable of $4.6million resulting from our increase in sales.

 

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We monitor our accounts receivable turnover closely toensure that receivables are collected timely and have established a credit andcollection policy to facilitate our collection process and reduce our creditloss exposure.

 

We expect cash usage in operating activities in thefuture to decrease as our revenues grow.

 

*Investing Activities*

 

Net cash used in investing activities for the ninemonths ended September 30, 2007 was $71.3 million, from sales and maturity ofshort-term investments of $18.1 million, offset by purchases of investmentsconstituting auction rate securities and commercial paper of $87.6 million andcapital expenditures of $1.8 million. Net cash used in investing activities forthe nine months ended September 30, 2006 was $3.4 million, from sales andmaturity of short-term investments of $19.0 million, offset by purchases ofinvestments of $21.4 million and capital expenditures of $1.0 million

 

*Financing Activities*

 

Net cash provided by financing activities in the ninemonths ended September 30, 2007 was $77.3 million, primarily due to the netproceeds of $83.2 million from our issuance of senior convertible notes inFebruary 2007, the proceeds of $10.7 million for the issuance of warrants inconnection with our senior convertible notes and the proceeds of $2.8 millionfor the issuance of common stock for our stock option programs and the ESPP,offset by $19.4 million for the cost of our purchase of call options on ourconvertible senior notes. Net cash provided by financing activities was $2.5million for the nine months ended September 30, 2006 from the exercise of stockoptions.

 

**CRITICAL ACCOUNTING ESTIMATES ANDPOLICIES**

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions in certain circumstances thataffect amounts reported in the accompanying consolidated financial statementsand related footnotes. A description of our critical accounting estimates andpolicies is included in our Annual Report on Form 10-K for the year ended December31, 2006. In preparing these financial statements, management has made its bestestimates and judgments of certain amounts included in the financialstatements, giving due consideration to materiality. The primary estimatesunderlying our financial statements include reserves for obsolete and slowmoving inventory, allowance for doubtful accounts receivable, product warranty,impairment for long-lived assets, income taxes, stock-based compensation andcontingent liabilities. Other accounting policies are described in section “CriticalAccounting Estimates and Policies” in our Financial Statements included in ourAnnual Report on Form 10-K for the year ended December 31, 2006. Application ofthese policies involves the exercise of judgment and use of assumptions as tofuture uncertainties and, as a result, actual results could differ from theseestimates.

 

*Recent Accounting Pronouncements*

 

In July 2006, theFinancial Standards Accounting Board (or “FASB”) issued FinancialInterpretation No. 48, “*Accounting for Uncertaintyin Income Taxes—an interpretation of FASB Statement No. 109*” or FIN48, which is a change in accounting for income taxes. FIN 48 specifies how taxbenefits for uncertain tax positions are to be recognized, measured andderecognized in financial statements; requires certain disclosures of uncertaintax matters; specifies how reserves for uncertain tax positions should beclassified on the balance sheet; and provides transition and interim-periodguidance, among other provisions. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006 and we adopted FIN 48 beginning fiscal year2007. The adoption of the provisions of FIN 48 did not have a material impacton our financial position or results of operations.

 

In September 2006, theFASB issued Statement No. 157, “*Fair Value Measurement*”or SFAS 157. This standard defines fair value, establishes the framework formeasuring fair value in accounting principles generally accepted in the UnitedStates and expands disclosure about fair value measurements. This pronouncementapplies under other accounting standards that require or permit fair valuemeasurements. Accordingly, this statement does not require any new fair valuemeasurement. This statement is effective for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. We will berequired to adopt SFAS 157 in the first quarter of 2008. We are currentlyevaluating the requirements of SFAS 157 and have not yet determined the impacton our consolidated financial statements. On October 17, 2007, the FASB agreedto consider delaying the effective date for certain entities that may includesmaller public companies (as yet undefined) and all entities with respect tonon-financial instruments. To that end, the FASB asked its staff to developrecommendations on whether a delay would be appropriate and, if so, to whom andto what it should apply. The staff’s recommendations will be presented to theFASB and discussed at a future meeting. We are unable to assess at this timethe impact, if any, of the FASB decisions to be agreed at the next meeting.

 

In February 2007, theFASB issued Statement No. 159, “*The Fair Value Option forFinancial Assets and Financial*

 

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*Liabilities*”, or SFAS 159, which permits entities to choose tomeasure many financial instruments and certain other items at fair value thatare not currently required to be measured at fair value. SFAS 159 will beeffective for us on January 1, 2008. We are currently evaluating the impact ofadopting SFAS 159 on our consolidated financial statements.

 

On July 25, 2007, theFASB held a meeting to discuss, among other things, the accounting method fornet share settled securities, such as our convertible senior notes.  As aresult of the meeting, the FASB voted to adopt a method for accounting for netshare settled securities under which the debt and equity components of thesecurity would be bifurcated and accounted for separately. The effect ofthis proposal is that the equity component would be included in thepaid-in-capital section of stockholders’ equity on our balance sheet and thevalue of the equity component would be treated as original issue discount forpurposes of accounting for the debt component of the notes. As a result,net loss attributable to our common stockholders would be higher as a result ofthe recognition of the accretion of the discounted carrying value of ourconvertible senior notes to their face amount as additional interest expense. Thediluted earnings per share calculation would continue to be calculated based onthe treasury stock method. In addition, the FASB is expected to require thatthe new method be implemented retrospectively. The FASB has not yet reached itsfinal decision with respect to this proposed change to accounting treatment sothere remains uncertainty as to the full impact of this accounting change. Wecannot predict the outcome of the FASB deliberations and whether the FASB mayrequire that net share settled securities be accounted for under the existingmethod, the proposed method described above or some other method, and when anychange would be implemented or whether it would be implemented retrospectivelyor prospectively.

 

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

 

The following discusses our exposure to market riskrelated to changes in interest rates and foreign currency exchange rates. Theseexposures may change over time as business practices evolve and could have amaterial adverse impact on our financial results.

 

*Interest Rate Risk*: We have been exposed to interestrate risk through interest earned on holdings of available-for-sale marketablesecurities.  Interest rates that may affect these items in the future willdepend on market conditions and may differ from the rates we have experiencedin the past. The fair value of our investment portfolio or related income wouldnot be significantly impacted by changes in interest rates since we reduce thesensitivity of our results of operations to these risks by maintaining aninvestment portfolio, which is primarily comprised of highly rated, marketablesecurities. We do not hold or issue derivatives, commodity instruments or otherfinancial instruments for trading purposes.

 

The fair market value of our 2.25% senior convertible notes is subjectto interest rate risk and market risk due to their convertible feature.Generally, the fair market value of fixed interest rate debt will increase asinterest rates fall and decrease as interest rates rise. The fair market valueof our senior convertible notes will increase as the market price of our commonstock increases, and decrease as the market price falls. The interest andmarket value changes affect the fair market value of our senior convertiblenotes, but do not impact our financial position, cash flows or results ofoperations.

 

*Foreign Currency Exchange Risk*:  All of our expenses and ourrevenues are denominated in United States dollars. As a result, we have lowexposure for currency exchange risks and do not have foreign exchange losses.We do not enter into forward exchange contracts to hedge exposure denominatedin foreign currencies or any other derivative financial instruments for tradingor speculative purposes. In the future, if our assessment of our foreigncurrency exposure changes, we may consider hedging transactions for riskmitigation.

 

**Item4. Controls and Procedures**

 

*Evaluation of Disclosure Controlsand Procedures:*

 

We maintain disclosure controls and procedures that are designed toensure that information required to be disclosed in our Exchange Act reports isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowfor timely decisions regarding required disclosure. In designing and evaluatingthe disclosure controls and procedures, management recognized that any controlsand procedures, 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.

 

As of September 30, 2007, the end of our most recent fiscal quarter, wecarried out an evaluation, under the supervision and with the participation ofour management, including our Chief Executive Officer and our Chief FinancialOfficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures. Based on the foregoing, our Chief 

 

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Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective.

 

*Changes in Internal Control OverFinancial Reporting:*

 

There was no change in our internal control over financial reportingduring our most recent fiscal quarter that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

*Inherent Limitations of InternalControls*

 

Internal control over financial reporting cannot provide absoluteassurance of achieving financial reporting objectives because of its inherentlimitations.  Internal control over financial reporting is a process thatinvolves human diligence and compliance and is subject to lapses in judgmentand breakdowns resulting from human failures. Internal control over financialreporting also can be circumvented by collusion or improper managementoverride. Because of such limitations, there is a risk that materialmisstatements may not be prevented or detected on a timely basis by internalcontrol over financial reporting. However, these inherent limitations are knownfeatures of the financial reporting process. Therefore, it is possible todesign into the process safeguards to reduce, though not eliminate, this risk.

 

 

**PARTII.  OTHER INFORMATION**

 

**Item1. Legal Proceedings**

 

From time to time, we are involved in legalproceedings arising in the ordinary course of business.  We believe thereis no litigation pending that could have, individually or in the aggregate, amaterial adverse effect on our financial position, result of operations or cashflows.

 

**Item1A. Risk Factors**

 

*The risk factors included in ourAnnual Report as of December 31, 2006 on Form 10-K filed with the Securitiesand Exchange Commission on March 15, 2007 should be considered while evaluatingConceptus and our business. In addition to those factors and to otherinformation in this Form 10-Q, the following updates to the risk factors as ofSeptember 30, 2007 should be considered carefully while evaluating the Companyand our business. This Form 10-Q contains forward-looking statements within themeaning of section 27A of the Securities Act of 1933, as amended and section21E of the Securities Exchange Act of 1934, as amended. Some of the forward-lookingstatements can be identified by use of forward-looking words such as “believes,”“expects,” “anticipates,” “may,” “will,” “should,” “seeks,” “approximates,” “intends,”“plans,” or “estimates,” or the negative of these words, or other comparableterminology. The discussion of financial trends, strategy, plans or intentionsmay also include forward-looking statements. Forward-looking statements involverisks and uncertainties that could cause actual results to differ materiallyfrom those projected. Although it is not possible to predict or identify allsuch risks and uncertainties, they may include, but are not limited to, therisk factors incorporated by reference and to their updates. Readers should notconsider these lists to be a complete statement of all potential risks anduncertainties.*

 

 

***The accountingmethod for convertible debt securities with net share settlement, like thenotes, is expected  to change.***

 

On July 25, 2007, the FASB held a meeting to discuss,among other things, the accounting method for net share settled securities,such as our convertible senior notes.  As a result of the meeting, theFASB voted to adopt a method for accounting for net share settled securitiesunder which the debt and equity components of the security would be bifurcatedand accounted for separately.  The effect of this proposal is that theequity component would be included in the paid-in-capital section ofstockholders’ equity on our balance sheet and the value of the equity componentwould be treated as original issue discount for purposes of accounting for thedebt component of the notes.  As a result, net loss attributable to ourcommon stockholders would be higher as a result of the recognition of theaccretion of the discounted carrying value of our convertible senior notes tothere face amount as additional interest expense. The diluted earnings pershare calculation would continue to be calculated based on the treasury stockmethod. In addition, the FASB is proposing that the new method be implementedretrospectively.

 

The FASB has not yet reached a final decision withrespect to this proposed change to accounting treatment so there remainsuncertainty as to the full impact of this accounting change.

 

We cannot predict the outcome of the FASBdeliberations and whether the FASB will require that net share settledsecurities be accounted for under the existing method, the proposed methoddescribed above or some other method, and when any change would be implementedor whether it would be implemented retrospectively or prospectively.

 

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We also cannot predict any other changes in GenerallyAccepted Accounting Principles that may be made affecting the accounting forour convertible senior notes. Any change in the accounting of our convertiblesenior notes could have an adverse impact on our reported or future financialresults. These impacts could adversely affect the trading price of our commonstock and in turn negatively impact the trading price of the notes.

 

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**Item 6.Exhibits**

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

 

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**SIGNATURE**

 

Pursuant to 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.

 

 

Date: November 7, 2007

 
| /s/ Gregory E. Lichtwardt           |   |
|-------------------------------------|--------|
| Gregory E. Lichtwardt               |   |
| Executive Vice President, Treasurer |   |
| and Chief Financial Officer         |   |

 

 

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**EXHIBIT INDEX**

** **
| **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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