**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**ý****          ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the quarterly period Ended March 31, 2006**

 

**OR**

 

**o****          ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

 

**For the transition period from                 to                 .**

 

**Commission File Number: 0-27596**

 

**CONCEPTUS, INC.**

(Exact name of Registrant as specified in its charter)

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

 

**331 East Evelyn**

**Mountain View, CA 94041**

(Address of Principal Executive Offices) (Zip Code)

 

**(650) 962-4000**

(Registrant’s Telephone Number, Including Area Code)

 

 

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

 

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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 ýNo o

 

Indicate by check mark whether the Registrant is a large acceleratedfiler, an accelerated filer, or a non accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act (Checkone)

Large accelerated filer oAccelerated Filer ý Non acceleratedfiler o

 

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

Yes o No ý

 

Therewere 29,174,506 shares of Registrant’s Common Stock issued and outstanding asof April 30, 2006.

 

 

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**CONCEPTUS, INC.**

 

**FORM 10-Q for the Quarter Ended March 31,2006**

 
| ** **    | ** **                                                                                                          | **Page** |
|---------------|---------------------------------------------------------------------------------------------------------------------|----------|
|          |                                                                                                                |     |
| Part I.  | Financial  Information                                                                                              | 3        |
|          |                                                                                                                |     |
| Item 1.       | Condensed Consolidated  Financial Statements (Unaudited)                                                            | 3        |
|          |                                                                                                                |     |
|          | a)  Condensed Consolidated Balance Sheets as of March 31, 2006 and December 31,  2005                     | 3        |
|          |                                                                                                                |     |
|          | b) Condensed Consolidated  Statements of Operations for the three month periods ended March 31,  2006 and 2005 | 4        |
|          |                                                                                                                |     |
|          | c) Condensed Consolidated  Statements of Cash Flows for the three month periods ended March 31,  2006 and 2005 | 5        |
|          |                                                                                                                |     |
|          | d) Notes to Condensed  Consolidated Financial Statements                                                            | 6        |
|          |                                                                                                                |     |
| Item 2.       | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                         | 14       |
|          |                                                                                                                |     |
| Item 3.       | Quantitative and Qualitative  Disclosures About Market Risk                                                         | 21       |
|          |                                                                                                                |     |
| Item 4.       | Controls and Procedures                                                                                             | 21       |
|          |                                                                                                                |     |
| Part II. | Other Information                                                                                                   | 22       |
|          |                                                                                                                |     |
| Item 1.       | Legal Proceedings                                                                                                   | 22       |
|          |                                                                                                                |     |
| Item 1A.      | Risk Factors                                                                                                        | 22       |
|          |                                                                                                                |     |
| Item 2.       | Unregistered Sales of Equity  Securities and Use of Proceeds                                                        | 22       |
|          |                                                                                                                |     |
| Item 3.       | Defaults upon Senior  Securities                                                                                    | 23       |
|          |                                                                                                                |     |
| Item 4.       | Submission of Matters to a  Vote of Security Holders                                                                | 23       |
|          |                                                                                                                |     |
| Item 5.       | Other Information                                                                                                   | 23       |
|          |                                                                                                                |     |
| Item 6.       | Exhibits                                                                                                            | 23       |
|          |                                                                                                                |     |
| Signature     | 24                                                                                                                  |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1. Condensed ConsolidatedFinancial Statements**

 

**Conceptus, Inc.**

**Condensed Consolidated BalanceSheets**

**(Unaudited)**

**(In thousands, except number of shares)**

 
| ** **                                          | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **Assets**                                          |       |                     |       |                        |       |
| Current assets:                                     |       |                     |       |                        |       |
| Cash and cash equivalents                           |       | $                        | 2,481      |                        | $          | 12,573 |   |
| Short-term investments                              |       | 26,000                   |       | 19,850                      |       |
| Restricted cash                                     |       | 69                       |       | 69                          |       |
| Accounts receivable, net                            |       | 4,975                    |       | 4,519                       |       |
| Inventories, net                                    |       | 2,817                    |       | 3,392                       |       |
| Other current assets                                |       | 961                      |       | 1,110                       |       |
|                                                |       |                     |       |                        |       |
| Total current assets                                |       | 37,303                   |       | 41,513                      |       |
|                                                |       |                     |       |                        |       |
| Property and equipment, net                         |       | 2,884                    |       | 2,743                       |       |
| Intangible assets, net                              |       | 1,500                    |       | 1,550                       |       |
| Other assets                                        |       | 1,488                    |       | 1,603                       |       |
|                                                |       |                     |       |                        |       |
| **Total assets**                                    | ** ** | **$**                    | **43,175** | ** **                  | **$**      | **47,409** | ** ** |
|                                                |       |                     |       |                        |       |
| **Liabilities and stockholders’ equity**       |       |                     |       |                        |       |
| Current liabilities:                                |       |                     |       |                        |       |
| Accounts payable                                    |       | $                        | 2,581      |                        | $          | 2,798 |   |
| Accrued compensation                                |       | 2,583                    |       | 3,052                       |       |
| Other accrued liabilities                           |       | 1,129                    |       | 1,074                       |       |
|                                                |       |                     |       |                        |       |
| Total current liabilities                           |       | 6,293                    |       | 6,924                       |       |
|                                                |       |                     |       |                        |       |
| Other accrued liabilities                           |       | 384                      |       | 314                         |       |
|                                                |       |                     |       |                        |       |
| Total liabilities                                   |       | 6,677                    |       | 7,238                       |       |
|                                                |       |                     |       |                        |       |
| Stockholders’ equity:                          |       |                     |       |                        |       |
| Common stock and additional paid-in capital         |       | 247,416                  |       | 246,359                     |       |
| Deferred stock-based compensation                   |       | —                   |       | (1,058                      | )          |
| Accumulated deficit                                 |       | (210,918                 | )          | (205,130                    | )          |
| Treasury Stock, 77,863 shares, at cost              |       | —                   |       | —                      |       |
|                                                |       |                     |       |                        |       |
| Total stockholders’ equity                     |       | 36,498                   |       | 40,171                      |       |
|                                                |       |                     |       |                        |       |
| **Total liabilities and stockholders’ equity** | ** ** | **$**                    | **43,175** | ** **                  | **$**      | **47,409** | ** ** |

 

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

 

3

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**Conceptus, Inc.**

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

**(In thousands, except per share amounts)**

 

 
| ** **                                                                      | ** ** | **Three months ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                      | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| Net sales                                                                       |       | $                                      | 7,962      |   | $ | 3,871 |   |
| Cost of goods sold (*)                                                          |       | 2,883                                  |       | 1,727 |   |
| Gross profit                                                                    |       | 5,079                                  |       | 2,144 |   |
|                                                                            |       |                                   |       |   |   |
| Operating expenses:                                                             |       |                                   |       |   |   |
| Research and development (*)                                                    |       | 1,200                                  |       | 966 |   |
| Selling, general and administrative (*)                                         |       | 10,000                                 |       | 7,737 |   |
| Total operating expenses                                                        |       | 11,200                                 |       | 8,703 |   |
| Operating loss                                                                  |       | (6,121                                 | )          | (6,559 | ) |
|                                                                            |       |                                   |       |   |   |
| Interest and other income and expenses:                                         |       |                                   |       |   |   |
| Interest and other income                                                       |       | 333                                    |       | 190 |   |
| Net loss                                                                        |       | $                                      | (5,788     | ) | $ | (6,369 | ) |
| Basic and diluted net loss per share                                            |       | $                                      | (0.20      | ) | $ | (0.25 | ) |
| Weighted-average shares used in computing basic and  diluted net loss per share |       | 28,860                                 |       | 25,447 |   |

 

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

 
| ** **                                             | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                             | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| Cost of goods sold                                     |       | $                                      | 40         |   | $ | 28 |   |
| Research and development                               |       | 173                                    |       | 38 |   |
| Selling, general and administrative                    |       | 1,241                                  |       | 194 |   |
| Total stock-based compensation expense for all  awards |       | $                                      | 1,454      |   | $ | 260 |   |

 

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

 

Netloss for the first quarter of 2006 includes stock-based compensation expense tonon-employees in accordance with Emerging Issues Task Force Issue (or “EITF”) No. 96-18of $59,000 and stock-based compensation expense under Statement of FinancialAccounting Standards (or “SFAS”) No. 123(R) of $1,395,000, which consistsof stock-based compensation expense of $1,117,000 related to employee stockoptions, employee stock purchase plan and stock appreciation rights andstock-based compensation expense of $278,000 related to employee restrictedstock and restricted stock units.

 

Netloss for the first quarter of 2005 included stock-based compensation expense tonon-employees in accordance with EITF 96-18 of $77,000 and stock-basedcompensation expense of $183,000 related to employee restricted stock.

 

4

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**Conceptus, Inc.**

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

**(Inthousands)**

 
| ** **                                                                   | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| **Cash flows from operating activities**                                     |       | $                                                | (5,788     | ) | $ | (6,369 | ) |
| Net loss                                                                     |       |                                             |       |   |   |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                                             |       |   |   |
| Depreciation and amortization of property, plant and  equipment              |       | 254                                              |       | 237 |   |
| Amortization of intangibles                                                  |       | 50                                               |       | 50 |   |
| Inventory reserves                                                           |       | (80                                              | )          | (24 | ) |
| Stock compensation expense                                                   |       | 1,454                                            |       | 260 |   |
| Allowance for doubtful accounts                                              |       | 43                                               |       | 12 |   |
| Loss on retirement of fixed assets                                           |       | —                                           |       | 2 |   |
| Changes in operating assets and liabilities:                                 |       |                                             |       |   |   |
| Accounts receivable                                                          |       | (499                                             | )          | (47 | ) |
| Inventories                                                                  |       | 655                                              |       | (904 | ) |
| Other current assets                                                         |       | 149                                              |       | (473 | ) |
| Other assets                                                                 |       | 115                                              |       | 56 |   |
| Accounts payable                                                             |       | (217                                             | )          | (872 | ) |
| Accrued compensation                                                         |       | (469                                             | )          | 344 |   |
| Other accrued liabilities                                                    |       | 125                                              |       | (64 | ) |
| Net cash used in operating activities                                        |       | (4,208                                           | )          | (7,792 | ) |
|                                                                         |       |                                             |       |   |   |
| **Cash flows from investing activities**                                     |       |                                             |       |   |   |
| Purchase of investments                                                      |       | (21,450                                          | )          | (5,700 | ) |
| Maturities of investments                                                    |       | 15,300                                           |       | 13,400 |   |
| Capital expenditures                                                         |       | (395                                             | )          | (272 | ) |
| Net cash provided by (used in) investing activities                          |       | (6,545                                           | )          | 7,428 |   |
|                                                                         |       |                                             |       |   |   |
| **Cash flows from financing activities**                                     |       |                                             |       |   |   |
| Issuance of common stock                                                     |       | 661                                              |       | 113 |   |
| Net cash provided by financing activities                                    |       | 661                                              |       | 113 |   |
|                                                                         |       |                                             |       |   |   |
| Net decrease in cash and cash equivalents                                    |       | (10,092                                          | )          | (251 | ) |
| Cash and cash equivalents at the beginning of the  period                    |       | 12,573                                           |       | 2,002 |   |
| Cash and cash equivalents at end of the period                               |       | $                                                | 2,481      |   | $ | 1,751 |   |

 

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

 

5

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**Conceptus, Inc.**

 

***NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS***

***(Unaudited)***

 

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

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America for interim financial information and pursuant to the instructionsto Form 10-Q and Article 10-01 of Regulation S-X. Accordingly, theydo not include all of the information and footnotes required by accountingprinciples generally accepted in the United States of America for completefinancial statements. In the opinion of management, all adjustments, consistingonly of normal recurring adjustments, considered necessary for a fair statementhave been included.

 

The condensedconsolidated balance sheet at December 31, 2005 have been derived from theaudited consolidated financial statements at that date, but do not include all ofthe information and footnotes required by accounting principles generallyaccepted in the United States of America for complete financial statements.This financial data should be reviewed in conjunction with the auditedconsolidated financial statements and related notes included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2005. Theresults of operations for the three months ended March 31, 2006 may notnecessarily be indicative of the operating results for the full 2006 fiscalyear or any other future interim periods.

 

**2.****     Summary ofSignificant Accounting Policies**

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions in certain circumstances that affect amounts reportedin the accompanying consolidated financial statements and related footnotes. Inpreparing these financial statements, management has made its best estimatesand judgments of certain amounts included in the financial statements, givingdue consideration to materiality. The primary estimates underlying the Company’sfinancial statements include reserves for obsolete and slow moving inventory,allowance for doubtful accounts receivable, product warranty, impairment oflong-lived assets and stock-based compensation.

 

The Company’s significant accounting policies aredisclosed in the Company’s Annual Report on Form 10-K for the year ended December 31,2005 that was filed with the Securities and Exchange Commission on March 16,2006. Except as stated below for stock-based compensation, the significantaccounting policies of the Company have not materially changed since December 31,2005.

 

**3.****     Inventories, Net**

 

Inventoriesare stated at the lower of cost or market. Cost is based on actual costscomputed on a first-in, first-out basis. The components of inventories consistof the following (in thousands):

 

| ** **       | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------|------------|--------------------------|------------|-----------------------------|------------|
| Raw materials    |       | $                        | 146        |                        | $          | 122 |   |
| Work-in-progress |       | 1,111                    |       | 1,940                       |       |
| Finished goods   |       | 1,560                    |       | 1,330                       |       |
| **Total**        | ** ** | **$**                    | **2,817**  | ** **                  | **$**      | **3,392** | ** ** |

 

**4.****     Warranty**

 

TheCompany offers warranties on its product and records a liability for theestimated future costs associated with warranty claims, which is based uponhistorical experience and the Company’s estimate of the level

 

6

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of future costs. Warrantycosts are reflected in the statement of operations as a cost of goods sold. Areconciliation of the changes in the Company’s warranty liability for the threemonths ended March 31, 2006 and 2005 follows (in thousands):

 
| ** **                                       | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                       | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Warranty accrual at the beginning of the period  |       | $                                                    | 70         |   | $ | 68 |   |
| Accruals for warranties issued during the period |       | 85                                                   |       | 25 |   |
| Settlements made in kind during the period       |       | (58                                                  | )          | (36 | ) |
| **Warranty accrual at the end of the period**    | ** ** | **$**                                                | **97**     | ** ** | **$** | **57** | ** ** |

 

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

 

EffectiveJanuary 1, 2006, the Company adopted the provisions of Statement ofFinancial Accounting Standards (or “SFAS”) No. 123(R), “Share-BasedPayment”, which establishes accounting for stock-based awards exchanged foremployee services. Accordingly, stock-based compensation cost is measured atgrant date, based on the fair value of the award, and is recognized on astraight line basis as expense over the employee requisite service period,which is generally the vesting period. The Company previously appliedAccounting Principles Board (APB) Opinion No. 25, “Accounting for StockIssued to Employees,” and related Interpretations and provided the required proforma disclosures of SFAS No. 123, “Accounting for Stock-BasedCompensation”.

 

The Company elected to adopt the modified prospectiveapplication method as provided by SFAS No. 123(R). Accordingly, during theperiod ended March 31, 2006, the Company recorded stock-based compensationfor shares granted prior to, but not yet vested as of the adoption date basedon the grant date fair value estimated in accordance with the originalprevisions of SFAS No. 123, and therefore, the Company did not restatepreviously reported amounts. Stock-based compensation expense for allshared-based payment awards granted on or after January 1, 2006 is basedon the grant date fair value estimated in accordance with the provisions ofSFAS No. 123(R).

 

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

 

Priorto the adoption of SFAS No. 123(R), the Company accounted for employeestock-based compensation in accordance with Accounting Principles Board OpinionNo. 25 (or “APB 25”), “Accounting for Stock Issued to Employees,” andrelated interpretations in accounting for its stock-based compensation plans,as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation,” (or“SFAS No. 123”) and as amended by SFAS No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure, an amendment of FASB Statement No. 123”.The pro-forma information for the three months ended March 31, 2005 was asfollows:

 
| ** **                                                                                                         | ** ** | **Three months ended  March 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Net loss, as reported                                                                                              |       | $                                                      | (6,369     | ) |
| Add: Stock-based employee compensation expense  included in reporeted net loss                                     |       | 183                                                    |       |
| Less: Total stock-based employee compensation  expense determined under the fair value based method for all awards |       | (1,344                                                 | )          |
| Pro forma net loss                                                                                                 | ** ** | **$**                                                  | **(7,530** | **)** |
|                                                                                                               |       |                                                   |       |
| Basic and diluted net loss per share                                                                               |       |                                                   |       |
| As reported                                                                                                        | ** ** | **$**                                                  | **(0.25**  | **)** |
| Pro forma                                                                                                          | ** ** | **$**                                                  | **(0.30**  | **)** |

 

7

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TheCompany calculated the fair value of each option on the date of grant using theBlack-Scholes method as prescribed by SFAS No. 123. The assumptions used wereas follows:

 
| ** **                      | ** ** | **Three months ended  March 31,  2005** | ** ** |
|---------------------------------|------------|--------------------------------------------------------|------------|
| Expected life (in years)        |       | 4.0                                                    |       |
| Average risk-free interest rate |       | 4.05                                                   | %          |
| Volatility factor               |       | 54.7                                                   | %          |
| Dividends                       |       | —                                                 |       |

 

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

 

TheCompany elected to adopt the modified prospective application method asprovided by SFAS No. 123(R). Accordingly, compensation cost recognized forthe three months ended March 31, 2006 reflects the quarter’s proportionalshare of: (a) compensation cost for all share-based payments granted priorto, but not yet vested as of January 1, 2006, based on the grant date fairvalue estimated in accordance with the original provisions of SFAS No. 123,and (b) compensation cost for all share-based payments granted subsequent toDecember 31, 2005, based on the grant-date fair value estimated inaccordance with the provisions of Statement 123(R). Previously reported amountshave not been restated.

 

Thefollowing table sets forth the total employee stock-based compensation expenseresulting from stock options, nonvested stock awards, stock appreciation rightsand ESPP included in the Condensed Consolidated Statements of Operations (inthousands): 

 
| ** **                                         | ** ** | **Three months ended  March 31,  2006** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------------|------------|
| Cost of goods sold                                 |       | $                                                      | 40         |   |
| Research and development                           |       | 147                                                    |       |
| Selling, general and administrative                |       | 1,208                                                  |       |
| **Total stock-based compensation expense**         | ** ** | **$**                                                  | **1,395**  | ** ** |
| **Effect on basic and diluted net loss per share** | ** ** | **$**                                                  | **(0.05**  | **)** |

 

Noincome tax benefit has been recognized relating to stock-based compensationexpense and no tax benefits have been realized from exercised stock options.There was no cash flow impact from the adoption of SFAS 123(R) in the threemonths ended March 31, 2006.

 

Stock Options andStock Appreciation Rights: During the three months ended March 31,2006, the Company granted 384,000 stock options and stock appreciation rights,with an estimated total grant-date fair value of approximately $2,635,000, netof forfeitures and a grant date weighted-average fair value of $6.86 per share.During the three months ended March 31, 2006, the Company recordedstock-based compensation related to stock options of approximately $986,000 forall unvested options granted prior to the adoption of SFAS 123(R) and $70,000for options granted in the three months ended March 31, 2006. During the threemonths ended March 31, 2005, the Company granted 240,600 stock options, forwhich stock-based compensation expense was not recognized.

 

Employee StockPurchase Plan (ESPP): The compensation cost in connectionwith the plan for the three months ended March 31, 2006 was approximately $61,000.This cost is amortized on a straight-line basis over the relevant subscriptionperiod. The grant date weighted-average fair value was $4.34 per share. During thethree months ended March 31, 2005, the Company issued 15,040 shares under theplan, for which stock-based compensation expense was not recognized.

 

Restricted Sharesand Restricted Stock Units: In connection with restrictedshares and restricted stock units granted, the Company recorded stockcompensation which presented the difference between the exercise price of the sharesand the fair market value of the Company’s common shares on the dates theawards were granted. This stock compensation is being amortized on a straight-linebasis over the vesting periods of the underlying stock awards. During the threemonths ended March 31, 2006, the Company recorded approximately $278,000of such

 

8

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compensation expense. Thegrant date weighted-average fair value was $14.76 per share. During the threemonths ended March 31, 2005 the Company recorded $183,000 of restrictedstock compensation expense.

 

***Valuationassumptions***

 

Thefair value of stock-based awards was estimated using the Black-Scholes modelwith the following weighted-average assumptions for the three months ended March 31,2006:

 
| ** **               | ** ** | **Three months ended March 31, 2006** | ** ** |
|--------------------------|------------|----------------------------------------------------------------|------------|
| ** **               | ** ** | **Stock Option Plans**                               | ** ** | **Employee Stock Purchase Plan** | ** ** |
| Expected life (in years) |       | 4.00                                                           |       | 0.75 |   |
| Interest rate            |       | 4.73                                                           | %          | 4.77 | % |
| Volatility               |       | 54.7                                                           | %          | 55.0 | % |
| Dividend yield           |       | —                                                         |       | — |   |

 

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

 

*Expected Volatility:* The Company used historical volatility for the four years and one year ended March 31, 2006, for stock options and employee stock purchase plan shares, respectively, which is consistent with the Company’s assessment that the historical volatility for such period is more representative of future stock price trends than any other type of volatility. The calculation was based on a simple-average method, using a reasonably sufficient number of price observations, in accordance with SFAS No. 123(R) and Staff Accounting Bulleting No. 107, “Share-Based Payment” (or “SAB 107”).

 

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

 

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

 

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

 

***Incentiveand Stock Plans***

 

Employee Stock Purchase Plan 

 

In November 1995, the Company’s Board of Directors adopted the 1995 Employee Stock Purchase Plan (the “ESPP”). The ESPP became effective November 29, 1995. At that time, 200,000 shares were reserved for issuance under the ESPP. The ESPP permits participants to purchase common stock through payroll deductions of up to 10% of an employee’s annual base earnings. The purchase price per share is equal to 85% of the fair market value per share on the participant’s entry date into the offering period or, if lower, 85% of the fair market value per share on the semi-annual purchase date. In March 2004, the Board of Directors approved an amendment to the ESPP to increase the number of shares of common stock reserved for issuance by 150,000 shares. The stockholders approved this amendment in June 2004, to be effective July 1, 2004. 

 

9

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As of March 31, 2006,295,803 shares had been issued under the ESPP and 54,197 shares were availablefor future issuance.

 

Company Stock Option Plans 

 

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

 

Under the terms of the 2002 Plan, options may be granted with different vesting terms from time to time and all options under the 2002 Plan expire ten years after grant. The options may include provisions permitting exercise of the option prior to full vesting. As of March 31, 2006, there were no shares that were exercised prior to full vesting.

 

In March 2001,the Board of Directors approved the 2001 Equity Incentive Plan (or “2001 Plan”)allowing granting of stock options and restricted stock to employees, directorsand consultants. The 2001 Plan provides for the grant issuance of options,restricted stock, stock appreciation rights, performance share awards, dividendequivalents awards, stock payment awards, stock purchase rights and restrictedstock unit awards to employees, directors and consultants of the Company. The2001 Plan was originally adopted by the Board of Directors on March 21,2001 with a total of 1,000,000 shares of common stock reserved for issuancethereunder, and was approved by the stockholders in May 2001. In March 2002,the Board of Directors approved an amendment and restatement of the 2001 Planto increase the shares of Common Stock reserved for issuance thereunder by anadditional 1,000,000 shares, bringing the aggregate number reserved forissuance to 2,000,000 shares of common stock, and to provide for automaticgrants of non-qualified stock options to non-employee directors as had beenprovided under the 1995 Director’s Stock Option Plan. The stockholders approvedthis amendment and restatement in May 2002. In April 2003, the Boardof Directors approved the Second Amended and Restated 2001 Plan to increase thesize of the formula grants to non-employee directors and to prohibit repricingunder the 2001 Plan. The stockholders approved this amendment and restatementin June 2003. In March 2004, the Board of Directors approved theThird Amended and Restated 2001 Plan to reduce the size of the automatic grantsof stock options to non-employee directors and to provide for automatic grantsof restricted stock to non-employee directors and to increase the shares ofCommon Stock reserved for issuance thereunder by an additional 500,000 shares,bringing the aggregate number reserved for issuance to 2,500,000 shares of commonstock. The stockholders approved this amendment and restatement in June 2004.In November 2004, the Board of Directors approved the Fourth Amended andRestated 2001 Plan to provide for the grant of restricted stock units and stockappreciation rights. In January 2005, the Board of Directors approved theFifth Amended and Restated 2001 Plan to provide for a change in the number ofshares to be automatically granted to non-employee directors under the plan. InDecember 2005, the Board of Directors approved the Sixth Amended andRestated 2001 Plan to establish that the price of future grants be based on theclosing price of the Company’s stock on the date of grant, rather than theprevious trading day. In February 2006, the Board of Directors approvedthe Seventh Amended and Restated 2001 Plan to provide for the increase theannual grant of restricted stock for directors from 2,000 shares to 2,500shares.

 

Under the terms of the 2001 Plan, incentive stock options may be granted only to employees with exercise prices not less than the fair market value of the common stock on the date of grant. Stock options and stock appreciation rights may be granted with

 

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different vesting termsfrom time to time but generally provide for vesting of at least 20% of thetotal number of shares per year. All options and stock appreciation rights underthe 2001 Plan expire ten years after grant, and five years in the case of agrant to a 10% stockholder. Stock appreciation rights are to be settled instock. Stock options may include provisions permitting exercise of theoption prior to full vesting. As of March 31, 2006, there were no sharesthat were exercised prior to fully vesting. To the extent that the aggregatefair market value of the shares subject to a holder’s incentive stock optionsexceeds $100,000, the excess options will be treated as non-qualified stockoptions.

 

On November 29, 1995, the Board of Directors approved the 1995 Director’s Stock Option Plan (or “Directors’ Plan”), which allows the granting of options for up to 100,000 shares of common stock to outside directors. Stock options may be granted to outside directors with exercise prices of not less than fair market value. The options expire ten years from date of grant. Options granted under the Directors’ Plan vest over one or three years. The options are only exercisable while the outside director remains a director.

 

In July 1993, the Board of Directors adopted the 1993 Stock Plan (or “1993 Plan”), and amendments to the 1993 Plan were adopted by the Board of Directors in March 1994, May 1995, October 1995, February 1997 and April 2000 and approved by the stockholders in March 1994, January 1996, May 1997 and May 2000 to allow granting of options up to 3,075,000 shares of common stock in the aggregate. Stock options granted under the 1993 Plan may be either incentive stock options or non-qualified stock options and can be granted to employees, distributors, consultants and directors. Incentive stock options may be granted to employees with exercise prices of no less than the fair market value and non-qualified options may be granted at exercise prices of no less than 85% of the fair market value of the common stock on the date of grant, as determined by the Board of Directors. The options expire no more than 10 years after the date of grant. Options may be granted with different vesting terms from time to time but generally provide for vesting of at least 25% of the total number of shares per year. The options may include provisions permitting exercise of the option prior to full vesting. Any unvested shares so purchased shall be subject to repurchase by the Company at the original exercise price of the option. Such repurchase rights generally lapse at a minimum rate of 25% per year from the date the option was granted. As of March 31, 2006, there were no shares that are subject to repurchase.

 

In April 2004, the Board of Directors approved a nonqualified stock option grant for 125,000 shares of the Company’s common stock and a grant of 36,000 shares of restricted stock for Mr. Ulric E. Cote as a stand-alone inducement grant in connection with his initial commencement of employment with the Company as Vice President, Sales. In December 2005, the Board of Directors approved a nonqualified stock option grant of 100,000 shares of the Company’s common stock and a grant of 12,000 shares of restricted stock for Ms. Patricia Gray as a stand-alone inducement grant in connection with her initial commencement of employment with the Company as Vice President, R&D and Operations. Stockholder approval was not required for any of these grants.

 

As of March 31, 2006, 29,914 shares remained as available for grant under the 2002 Plan, 249,809 shares remained as available for grant under the 2001 Plan, no shares remained available for grant under the 1993 Plan and no shares remained available for grant under the Director’s Plan. 

 

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

 

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A summary of the activity for the three months ended March 31, 2006 of awards granted under the Company’s 1993, 2001 and 2002 Plans, the 1995 Directors’ Plan and stand-alone grant activity is as follows:

 
| ** **                                             | ** ** | ** **                      | ** ** | **Shares Outstanding**  | ** ** |
|--------------------------------------------------------|------------|---------------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | **Shares Available  For Grant** | ** ** | **Shares  Outstanding** | ** ** | **Weighted-Average  Exercise Price** | ** ** |
| Balance outstanding at December 31, 2005               |       | 704,312                         |       | 3,591,614               |       | $ | 10.62 |   |
| Options granted                                        |       | (384,000                        | )          | 384,000                 |       | $ | 14.60 |   |
| Restricted stock and restricted stock units granted    |       | (79,999                         | )          | 79,999                  |       | — |   |
| Restricted stock and restricted stock units issued     |       | —                          |       | (12,000                 | )          | — |   |
| Options exercised                                      |       | —                          |       | (54,170                 | )          | $ | 7.85 |   |
| Options cancelled                                      |       | 29,056                          |       | (29,056                 | )          | $ | 15.86 |   |
| Options forfeited                                      |       | 16,188                          |       | (16,188                 | )          | $ | 8.91 |   |
| Restricted stock and restricted stock units  cancelled |       | —                          |       | (200                    | )          | — |   |
| Options expired                                        |       | (5,834                          | )          | —                  |       | — |   |
| Balance outstanding at March 31, 2006                  |       | 279,723                         |       | 3,943,999               |       | $ | 11.03 |   |

 

A summary of the activity for the three months ended March 31, 2006 ofstock options and stock appreciation rights is as follows:

 
| ** **                               | ** ** | **Options  Outstanding** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------------|------------|--------------------------|------------|----------------------------------------|------------|---------------------------------|------------|
| Balance outstanding at December 31, 2005 |       | 3,513,751                |       | $                                      | 10.62      |                            |       |   |
| Grants                                   |       | 384,000                  |       | $                                      | 14.60      |                            |       |   |
| Exercises                                |       | (54,170                  | )          | $                                      | 7.85       |                            |       |   |
| Forfeitures                              |       | (16,188                  | )          | $                                      | 8.91       |                            |       |   |
| Cancellations                            |       | (29,056                  | )          | $                                      | 15.86      |                            |       |   |
| Balance outstanding at March 31, 2006    |       | 3,798,337                |       | $                                      | 11.03      |                            | $          | 10,440,315 |   |
| Exercisable at March 31, 2006            |       | 2,084,305                |       | $                                      | 10.84      |                            | $          | 6,489,962 |   |

 

The following table summarizes information about stock options and stock appreciation rights outstanding and exercisable at March 31, 2006:

 
| ** **                              | ** ** | **Options Outstanding** | ** ** | **Options Vested  and Exercisable**       | ** ** |
|-----------------------------------------|------------|------------------------------|------------|-----------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Options  Outstanding**     | ** ** | **Weighted  Average  Remaining  Life (years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Options  Vested  and  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $1.25                                   | -          | $6.98                        |       | 386,100                                             |       | 4.73 |   | $ | 4.10 |   | 340,033 |   | $ | 3.82 |   |
| $6.99                                   | -          | $8.75                        |       | 352,434                                             |       | 8.61 |   | $ | 7.96 |   | 112,657 |   | $ | 7.95 |   |
| $8.94                                   | -          | $8.94                        |       | 405,322                                             |       | 8.67 |   | $ | 8.94 |   | 128,654 |   | $ | 8.94 |   |
| $9.00                                   | -          | $9.76                        |       | 287,312                                             |       | 5.23 |   | $ | 9.42 |   | 226,552 |   | $ | 9.46 |   |
| $9.95                                   | -          | $9.95                        |       | 630,000                                             |       | 7.05 |   | $ | 9.95 |   | 367,499 |   | $ | 9.95 |   |
| $9.96                                   | -          | $13.11                       |       | 501,500                                             |       | 7.85 |   | $ | 12.31 |   | 274,531 |   | $ | 12.28 |   |
| $13.34                                  | -          | $14.20                       |       | 446,550                                             |       | 7.45 |   | $ | 13.73 |   | 233,674 |   | $ | 13.86 |   |
| $14.35                                  | -          | $14.76                       |       | 428,000                                             |       | 9.29 |   | $ | 14.70 |   | 71,894 |   | $ | 14.48 |   |
| $14.95                                  | -          | $21.27                       |       | 336,119                                             |       | 5.90 |   | $ | 17.12 |   | 303,811 |   | $ | 17.30 |   |
| $21.80                                  | -          | $21.80                       |       | 25,000                                              |       | 5.70 |   | $ | 21.80 |   | 25,000 |   | $ | 21.80 |   |
| $1.25                                   | -          | $21.80                       |       | 3,798,337                                           |       | 7.29 |   | $ | 11.03 |   | 2,084,305 |   | $ | 10.84 |   |

 

As of March 31, 2006, there was an unamortized balanceof approximately $9,602,000 of total stock-based compensation related to stockoptions and stock appreciation rights. This cost is expected to be recognized over a weighted-average amortizationperiod of 1.4 years.

 

Restricted stock and restricted stock unit activity for the three months ended March 31, 2006, is as follows (in thousands, except per share amounts):

 
| ** **                                   | ** ** | ** **                         | ** ** | **Shares and units granted** | ** ** |
|----------------------------------------------|------------|------------------------------------|------------|------------------------------|------------|
| ** **                                   | ** ** | **Shares  and Units  Outstanding** | ** ** | **Shares  and Units**        | ** ** | **Weighted-  Average  Grant Date  Fair Value** | ** ** |
| Nonvested stock balance at December 31, 2005 |       | 77,863                             |       | 254,848                      |       | $ | 9.44 |   |
| Grants                                       |       | 79,999                             |       | 79,999                       |       | $ | 14.76 |   |
| Issuances                                    |       | (12,000                            | )          | —                       |       |   |   |
| Cancellations                                |       | (200                               | )          | (200                         | )          | **$** | **—** | ** ** |
| Nonvested stock balance at March 31, 2006    |       | 145,662                            |       | 334,647                      |       | $ | 9.68 |   |

 

As of March 31,2006, there was an unamortized balance of approximately $1,953,000 of totalstock-based compensation related to nonvested restricted shares and restrictedstock units. This cost is expected to be recognized over an amortization periodfrom 10 months to 4 years.

 

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*Stock-based Compensation toNon-employees*

 

Stock-based compensationarrangements to non-employees are accounted for in accordance with EmergingIssues Task Force Issue (or “EITF”) No. 96-18, “Accounting for EquityInstruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services,” which requires that these equityinstruments are recorded at their fair value on the measurement date. Themeasurement of stock-based compensation is subject to periodic adjustment asthe underlying equity instruments vest. Stock-based compensation expenserelating to non-employees was $59,000 and $77,000 for the three months ended March 31,2006 and 2005, respectively.

 

**6.****     Computation ofNet Loss Per Share**

 

Basicnet loss per share excludes any potential dilutive effects of options andcommon stock shares subject to repurchase. Diluted net loss per share includesthe impact of potentially dilutive securities. However, due to the Company’snet loss position, basic and diluted net loss per share are both computed usingthe weighted average number of common shares outstanding.

 

Thefollowing table provides a reconciliation of weighted-average number of commonshares outstanding and the weighted-average of unvested common shares (inthousands):

 
| ** **                                                                                                           | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| Denominator:                                                                                                         |       |                                                 |       |   |   |
| Weighted-average number of common shares outstanding                                                                 |       | 29,121                                               |       | 25,687 |   |
| Less: Weighted-average unvested and restricted  common shares                                                        |       | 261                                                  |       | 240 |   |
| **Weighted-average number common shares  outstanding used in computing basic and diluted net loss per common share** | ** ** | **28,860**                                           | ** ** | **25,447** | ** ** |

 

Thefollowing outstanding options, potential employee stock purchase plan shares,stock appreciation rights and restricted stock shares, which could potentiallydilute basic net loss per share in the future were excluded from thecomputation of diluted net loss per share, as their effect would have beenantidilutive (in thousands):

 

| ** **                   | ** ** | **At March 31,** | ** ** |
|------------------------------|------------|----------------------------|------------|
| ** **                   | ** ** | **2006**                   | ** ** | **2005** | ** ** |
| Outstanding options and SARs |       | 3,798                      |       | 3,600 |   |
| Restricted stock             |       | 267                        |       | 238 |   |
| Restricted stock units       |       | 68                         |       | 0 |   |
| Employee Stock Purchase Plan |       | 34                         |       | 13 |   |
| **Total**                    | ** ** | **4,167**                  | ** ** | **3,851** | ** ** |

 

**7.****     Stockholders’Equity**

 

TheCompany holds 77,863 shares of treasury stock as a result of repurchasing sharesof restricted  common stock at par valuein 2004 and 2005, in accordance with the terms of the restricted stockagreements. These shares had a purchase price of $0.003 per share and arerecorded as treasury stock.

 

In thethree months ended March 31, 2006, the Company reversed the balance ofapproximately $1,058,000 in Deferred Stock-Based Compensation and reflected itas Additional Paid in Capital as set forth by SFAS No. 123(R).

 

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

 

*The following discussion of our financial conditionand results of operations should be read in conjunction with our consolidatedfinancial statements and related notes thereto. This discussion containsforward-looking statements, including references to 2006 revenues, increasedproduct adoption, expanded sales force and other forecasted items, that involverisks and uncertainties such as limited operating and sales history; theuncertainty of market acceptance of our product; dependence on obtaining and maintainingreimbursement; effectiveness and safety of our product over the long-term; ourability to obtain and maintain the necessary governmental clearances orapprovals to market our product; our ability to develop and maintainproprietary aspects of our technology; our ability to manage our expansion; ourlimited history of manufacturing our product; our dependence on single sourcesuppliers, third party manufacturers and co-marketers; intense competition inthe medical device industry; the inherent risk of exposure to product liabilityclaims and product recalls and other factors referenced in this Form 10-Q.Our actual results could differ materially from those expressed or implied inthese forward-looking statements as a result of various factors, includingthose discussed in “Risk Factors” and elsewhere in this Form 10-Q.*

* *

**Overview**

 

We develop, manufacture and market the *Essure*® Permanent Birth Control system, aninnovative and proprietary medical device for women that was approved formarketing in the United States in November 2002 by the United States Foodand Drug Administration (or “FDA”). The *Essure* system usesa soft and flexible micro-insert that is delivered into a woman’s fallopiantubes to provide permanent birth control by causing a benign tissue in-growththat blocks the fallopian tubes. A successfully placed *Essure*micro-insert and the subsequent tissue growth prohibits the egg from travelingthrough the fallopian tubes and therefore prevents 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 regional anesthesia. Inthe Pivotal trial of the *Essure* system,the total procedure time averaged 35 minutes, with an average of 13 minutes ofhysteroscopic time to place the *Essure*micro-insert. A patient is typically discharged approximately 45 minutesafter the *Essure* procedure. No overnighthospital stay is required. Furthermore, the *Essure* systemis effective without drugs or hormones. There is a three-month waitingperiod after the procedure during which the woman must use another form ofbirth control while tissue in-growth occurs. At 90 days following theprocedure, the patient completes a follow-up examination called ahysterosalpingogram (or “HSG”), which can determine whether the device wasplaced successfully and whether the fallopian tubes are occluded.

 

We believe that the *Essure*system is also an attractive alternative to tubal ligation for physicians,hospitals and payers. The *Essure* system isa less invasive permanent birth control option for physicians to offer to theirpatients; hospitals are able to utilize their facilities more cost effectivelywith the *Essure* procedure compared with tuballigation, and payers are able to experience cost reductions resulting from theelimination of overhead and procedural costs related to anesthesia andpost-operative hospital stays associated with tubal ligations. We alsobelieve the *Essure* system is a viable alternative toother temporary methods of birth control being used when there is no intentionof having children in the future. In addition, payers may alsobenefit from the reduction of unplanned pregnancies associated withnon-permanent methods of birth control used by patients who have chosen to avoidthe drawbacks of traditional permanent birth control methods but who may electto use the *Essure* system.

 

Published reports estimate that 700,000 tubal ligationprocedures are performed each year in the United States. We intend to tap intothis market and establish the *Essure*procedure as the gold standard for permanent birth control.

 

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The *Essure* systemis currently being marketed in multiple countries. In November 2002 wereceived approval from the FDA to market the *Essure*system in the United States. In 2001, we were given approval to affix theCE Mark to the *Essure* system, indicating that the*Essure* system is certified for salethroughout the European Union, subject to compliance with local regulationssuch as registration with health ministries and/or particular requirementsregarding labeling or distribution. In 1999, the *Essure*Permanent Birth Control system was listed with Australia’s Therapeutic GoodsAdministration, which allows us tomarket and sell the *Essure*system in Australia. In Canada, we received clearance from Health Canada tomarket the *Essure* system in Canada in November 2001.We now have distributors in Australia, Canada and France, which covers Europe,Middle East, Africa, Mexico, Central America and South America.

 

*Effectiveness of the Essure System*

 

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

 

In September 2005, we received approval from theFDA to terminate the Company’s post-approval study with physicians who were newlytrained in performing the *Essure*procedure due to the positive placement data obtained. The purpose of thepost-approval study, required by the FDA as a condition of the November 2002approval of the *Essure* system, was to determinethe rate of successful bilateral placements of the *Essure*micro-inserts at first attempt with a large number of newly trained physicianswho were not part of the previous clinical studies. Although treatment ofthe total number of patients required by FDA had not been completed, the dataobtained to date provided the Company with the opportunity to request that theFDA permit an early termination of the study. Because of the FDA ruling, thePMA Supplement submitted in March 2005 has been re-classified as a FinalReport. The results of the post-approval study demonstrated an improvement inplacement rates from those obtained in the pivotal study and the Company willseek to obtain a new placement rate claim for the product using this new data. Thiswill require the Company to submit a new PMA Supplement for the bilateralplacement rate claims for which it is seeking FDA approval in order to updatethe labeling for the *Essure* system.

 

*Penetration*

 

Conceptus requires that a hospital have at least onephysician preceptored for generally between 3 and 5 cases by a certifiedtrainer before being able to perform the procedure independently. As of March 31,2006 Conceptus has trained or is in the process of training 3,252 physicians inthe United States on the *Essure*procedure. This represents an increase of 370 physicians over the numberof physicians at December 31, 2005 and an increase of 1,403 physiciansover the number of physicians at March 31, 2005. The level of sales for the*Essure* system, particularly in thisearly period of adoption, is highly dependent on the number of physicianstrained to perform the procedure.

 

*Reimbursement of the EssureProcedure*

 

Market acceptance of the *Essure*system depends in part upon the availability of reimbursement withinprevailing healthcare payment systems. We believe that physician advocacyof our product will be required to continue to obtain reimbursement. As of March 31,2006, we have received positive reimbursement decisions for the *Essure* procedure from most private insurers and 34 of the 51Medicaid programs in the country. We intend to continue our effort to educate payersof the cost-effectiveness of our product and to establish further programs tohelp physicians to navigate reimbursement issues.

 

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

 

Effective January 1, 2006, the Centers forMedicare and Medicaid Services, or CMS, released the Final Rule for the2006 Physician Fee schedule. For the Current Procedural Terminology (or “CPT”)code applicable to

 

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the *Essure*procedure, the CMS has provided for a national physician payment of $2,095.01for procedures performed in the office and $438.47 for physician payment whenthe procedure is performed in the hospital. This compares to a Medicarenational average payment for tubal ligation, the current standard of care forpermanent female sterilization, of $345.50. In addition, the CMS released the FinalRule for the 2006 Outpatient Prospective Payment System, which assignshospital outpatient reimbursement amounts. This CPT code was also assigned a2006 payment level of $2,454.00. We believe these values are very favorable forthe *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 and publicpayers that have given a favorable coverage decision is complete, willsignificantly ease the burden on a physician’s office in obtainingreimbursement for the *Essure*procedure and accelerate the coverage of the *Essure*procedure by private insurance companies and Medicaid. This process is notautomatic following receipt of the new CPT code, however, and we anticipatecontinuing to focus on reimbursement issues for sometime in the future, both tosecure our code and payment schedule into the payers’ databases, as wellas to help the physician negotiate a favorable contract for payment off thatschedule.

 

*Adoption of the Essure system*

 

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

 

First, we are expanding our sales territories andchannels of distribution so as to increase our call frequency on physicians.Since January 1, 2006, we added 10 sales positions and are expecting toadd more during 2006. Also, we have included regional distributors of women’sgynecology products to our marketing efforts. Among other responsibilities, oursales representatives are attempting to increase penetration and utilization ofthe *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. This may involveefforts directed to marketing programs, such as advertising, practicedevelopment and in-office support.

 

Third, we are focused on obtaining favorable coveragedecisions from payers representing the private paying and state-paying Medicaidsystems. We are also focused on getting the CPT code and payment schedule implementedat all of the payers that have given a coverage decision. Until such time asthe code is completely implemented and all major payers have provided acoverage decision, we have developed a field based tactical reimbursement groupaimed at educating the physician and office staff regarding payer proceduresfollowing a declined claim, including appeals and petitioning procedures.Typically a newly covered product will go through a period where claims areeither inadvertently declined or are paid at the incorrect amount. In eitherinstance, the physician is reluctant to perform additional proceduresuntil payment has been secured for earlier cases, causing a decline inutilization. Our tactical reimbursement focus is intended to give the physicianand his/her staff the tools to ensure that claims will ultimately be paid andthereby encourages the physician to continue performing the *Essure* procedure despite reimbursement issues. This tacticalreimbursement group is generally targeting specific accounts with the aim ofeventually meeting with all of our accounts so as to provide them with theknowledge of how to file and follow up on claims on a payer by payer basis.

 

Fourth, we have entered into certain strategicagreements in the past and we may explore such opportunities in thefuture. We intend for these agreements to provide us with the ability toincrease awareness, gain market presence and credibility, accelerate ourability to train 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 joint marketing campaigns will depend upon theeffectiveness of our sales force training programs, market demand for *Essure* procedures in conjunction with the products marketedby strategic partners and the efforts and commitment of strategic partners tothe program. We cannot be certain how successful these programs will be, if atall.

 

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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 agenciesaround the world that regulate the sale and labeling of medical devices toprovide updates to claims such as effectiveness and placement rates. Whereappropriate, we will make physical improvements to the product for improvedmanufacturability or for the ease of use by the physician.

 

We have experienced significant operating losses sinceinception and, as of March 31, 2006, had an accumulated deficit of $210.9million. We expect our operating losses to continue as we continue to expendsubstantial resources in the selling and marketing of the *Essure*system in the United States and abroad. Due to the unpredictable nature ofthese activities, we do not know whether we will achieve or sustainprofitability in the future. We will continue to be in a net loss positionuntil sufficient revenues can be generated to offset expenses. In the future,depending upon a variety of factors, we may need to raise funds throughbank facilities, debt or equity offerings or other sources of capital.Additional financing may not be available when needed or on terms acceptableto us.

 

**Resultsof Operations - Three Months Ended March 31, 2006 and 2005**

 

*Net Sales*

 

Netsales were $8.0 million for the three months ended March 31, 2006 ascompared to $3.9 million for the three months ended March 31, 2005,an increase of $4.1 million, or 106%. This increase in net sales was the resultof the continued commercialization of the *Essure* systemworldwide and a U.S. price increase established in January of 2006 of 8.3%.Unit volume growth for the first quarter of 2006 compared to the same quarterof 2005 increased 77%. Our worldwide average selling price increased from $814for the end of the year 2005 to $845 for the first three months of 2006, due tothe increase in our sales price in January 2006, as well as the increasein the level of domestic sales, which has a higher price than sales to our Europeandistributor.

 

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

 

For the three monthsended March 31, 2006 and 2005, net sales to one distributor accounted for 10%and 14% of our total consolidated net sales, respectively. Accounts receivablefrom a distributor accounted for 20% and 25% of our total net accountsreceivable outstanding as of March 31, 2006 and 2005, respectively.

 

Net product sales bygeographic region as a percentage of net sales for the three months ended March 31,2006 and 2005 are as follows:

 

| ** **               | ** ** | **March 31,** | ** ** |
|--------------------------|------------|--------------------|------------|
| ** **               | ** ** | **2006**           | ** ** | **2005** | ** ** |
| Net sales (in thousands) |       | $                  | 7,962      |   | $ | 3,871 |   |
| United States of America |       | 89                 | %          | 83 | % |
| Europe                   |       | 10                 | %          | 14 | % |
| Other                    |       | 1                  | %          | 3 | % |
|                          |            |                    |            |  |  |  |  |

 

Net sales are attributedto region based on the shipping location of the external customers.

 

As of March 31, 2006,we had a total of 3,252 doctors in the United States that have either completedor are in the process of completing preceptorship. This represents an increaseof 370 physicians over the number of physicians at December 31, 2005 andan increase of 1,403 physicians over the number of physicians at March 31,2005. Our accomplishment in obtaining the number of physicians trained is veryimportant because it not only provides us with a strong referral base withinmajor metropolitan areas we have targeted, but it will also create the leverageto help us gain additional reimbursement coverage. We understand that a strongbase of trained physicians

 

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does not necessarilycorrelate to an increase in revenue proportionately. Furthermore, there are norevenues associated with the training activities. The Company does not charge afee for the activity and no commitment arises for the physician from thepreceptorship. Physician training is provided upfront and the Company has noobligation subsequent to the initial training. Training costs have not beensignificant to the Company life to-date.

 

In April 2006, weannounced our expected net sales for 2006 to be approximately $36.0 million,which represents approximately 70% of growth from net sales in 2005. Thisincrease in revenues includes the effect of the 8.3% price increase announcedin January 2006 for customers in the United States. We expect net salesfrom the United States will continue to be the major contributor of our globalnet sales. We have established five primary goals to achieve our revenue growth.We expect to obtain additional payer coverage decisions, increase salescoverage and physician utilization of the *Essure*procedure, work with hysteroscopic equipment strategic partners, build patientawareness and bring labeling/product improvements to market. We believe ourrevenue growth in 2006 will be significantly influenced by how successful weare in achieving those objectives.

 

*GrossProfit*

 

Costof goods sold for the three months ended March 31, 2006 was $2.9 millionas compared to $1.7 million for the three months ended March 31, 2005. Thisincrease of $1.2 million, or 67%, was caused by the increase in net sales,partially offset by reductions in manufacturing costs due to an agreementsigned with our third-party manufacturer at the end of fiscal year 2005. Grossprofit margin improved from 55% for the three months ended March 31, 2005to 64% for the same period ended March 31, 2006, which was the result of expandedcommercialization of the *Essure* systemdomestically and abroad and lower manufacturing costs, as well as our domesticprice increase. We expect gross margin to improve somewhat during the remainderof 2006 due to all of the above factors, somewhat mitigated by unfavorablechannel mix with international sales comprising a large percentage of our totalsales.

 

*OperatingExpenses*

 

Research and developmentexpenses, which include expenditures related to product development, clinicalresearch and regulatory affairs, were $1.2 million and $1.0 million for the threemonths ended March 31, 2006 and 2005, respectively. Expenses for the threemonths ended March 31, 2006, include the effect of SFAS 123(R) expense of$0.1 million. Our goal through Research and Development is to launch productenhancements over the coming years, which are intended to result in improvedease of use and clinical performance of the *Essure* systemand  lower cost of goods.

 

Selling, general andadministrative spending for the three months ended March 31, 2006 was $10.0million as compared to $7.7 million for the three months ended March 31,2005, which represents an increase of $2.3 million, or 29%. The primary reasonsfor the increase in selling, general and administrative expenses result from theapplication of SFAS 123(R) of $1.2 million and the expansion of our U.S. fieldsales force of $1.4 million. The latter is meant to provide us with moreselling time to focus on physician utilization and penetration. Additionally,increases in selling, general and administrative expenses came from employeecompensation, in part related to new hires, as well as higher spending inadvertising of $0.4 million to support our increase in sales. These increaseswere primarily offset by a decrease in sales and marketing consulting fees of$0.6 million and lower spending in $0.1 million due to the closure of ourAustralian subsidiary in the first quarter of 2005. We expect selling, generaland administrative spending to increase in the upcoming quarter as we continueto expand our sales.

 

Net interest income and other income for the threemonths ended March 31, 2006 was approximately $0.3 million, compared to$0.2 million for three months ended March 31, 2005.

 

**Liquidityand Capital Resources**

 

Wehave experienced significant operating losses since inception. As of March 31,2006 we had an accumulated deficit of $210.9 million. We have financed ouroperations since inception primarily through equity financings. In February 2004we completed a private placement of approximately 3.0 million shares of commonstock at $8.50 per share. Our net proceeds from the private placement wereapproximately $23.9 million, after deducting offering costs and commissions. Inaddition, in August 2005, we completed a private placement of approximately3.2 million shares of common stock at a price of $7.20 and $8.10 per share. Ournet proceeds from the private placement were approximately $22.9 million, afterdeducting offering costs. The proceeds are being used to fund operations. Inthe future, depending upon a variety of factors, we may need to raiseadditional funds through

 

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bank facilities, debt orequity offerings or other sources of capital. Additional funding may notbe available when needed or on terms acceptable to us.

 

As of March 31, 2006,we had cash, cash equivalents, restricted cash and short-term investments of $28.6million, compared to $32.5 million at December 31, 2005. The decrease of $3.9million is primarily due to cash used in our operating activities. We expectcash usage to decrease in the future as our revenues grow.

 

*Operating Activities*

 

Net cash used in operating activities was $4.2 millionin the three months ended March 31, 2006, primarily as a result of our net lossof $5.8 million adjusted for non-cash related items of $1.7 million relatedprimarily to depreciation and amortization and stock compensation expense.Other major items that contributed to net cash used in operating activitieswere related to an increase in accounts receivable of $0.5 million, which isconsistent with our increase in sales, a decrease in accounts payable of $0.2million and a decrease in accrued compensation of $0.5 million, offset by $0.7million of a planned decrease in inventories, a decrease in other assets andother current assets of $0.3 million and an increase in other accruedliabilities and long-term liabilities of $0.1 million. We expect cash usage inoperating activities in the future to decrease.

 

As of March 31, 2006,our worldwide days sales outstanding in accounts receivable was 49 days, whichrepresents a decrease of 6 days compared to December 31, 2005. We havecredit policies that help us to monitor our collection activities and reduceour credit loss exposure. We continue to improve and modify those policies asour business evolves. Our goal is to consistently improve our days salesoutstanding. We may not be able to maintain our current ratio or we may experienceless than satisfactory performance in collection due to factors outside of ourcontrol such as changes in economic climates.

 

Net cash used inoperating activities was $7.8 million in the three months ended March 31,2005, primarily as a result of our net loss of $6.4 million adjusted fornon-cash related items of $0.5 million relating primarily to depreciation andamortization and stock compensation expense. Other major items that contributedto net cash used in operating activities were related to an increase ininventories of $0.9 million, an increase in other current assets of $0.5million and a decrease in accounts payable of $0.9 million, offset by anincrease in accrued compensation of $0.3 million.

 

*Investing Activities*

 

Net cash used ininvesting activities for the three months ended March 31, 2006 was $6.5million, from sales and maturity of short-term investments of $15.3 million,offset by purchases of investments of $21.4 million and capital expenditures of$0.4 million**.**Net cash provided by investingactivities for the three months ended March 31, 2005 was $7.4 million,from sales of short-term investments of $13.4 million, partially offset bypurchases of investments of $5.7 million and capital expenditures of $0.3million.

 

*FinancingActivities*

 

Net cash provided byfinancing activities was $0.7 million and $0.1 million for the three monthsended March 31, 2006 and 2005, respectively, from the exercise of stockoptions.

 

Thesuccessful achievement of our business objectives may require additionalfinancing and therefore, we may in the future seek to raise additionalfunds through bank facilities, debt or equity offerings or other sources ofcapital. Any additional equity financing may be dilutive to stockholders,and debt financing, if available, may involve restrictive covenants. Additionalfunding may not be available when needed or on terms acceptable to us. Ifwe are unable to obtain additional capital, we may be required to delay,reduce the scope of or eliminate our sales and marketing activities. Our futureliquidity and capital requirements will depend upon many factors, including,among others:

 

•              Resourcesdevoted to establish sales, marketing and distribution capabilities;

•              Therate of product adoption by doctors and patients; and

•              Theinsurance payer community’s acceptance of and reimbursement for the *Essure*procedure.

 

*Future Commitments*

 

OnJune 28, 2005, the Company entered into a Sublease Agreement with VerisityDesign, Inc. for the relocation of its headquarters to 331 East Evelyn,Mountain View, California. The agreement was subject to the Master Landlord’sconsent within 45 days after delivery of and receipt by Master Landlord of theexecuted Sublease. On July 19, 2005, SFERS Real Estate, the Master Landlord,and Verisity Design, Inc. signed a Landlord Consent Agreement allowing theSublease Agreement between the Company and Verisity Design, Inc. The Company isrecognizing the rent expense on a straight-line basis over the life of thelease.

 

Inaddition to the lease agreement for the facility located in Mountain View, theCompany has certain operating leases on a telephone system and copiers. Theseleases have terms expiring from September 2006 through November 2010.Aggregateminimum annual lease commitments under all leases are as follows (inthousands):

 
| 2006 (remaining  9 months) |       | $     | 699       |       |
|----------------------------|------------|-------|-----------|------------|
| 2007                       |       | 619   |      |
| 2008                       |       | 620   |      |
| 2009                       |       | 323   |      |
| 2010                       |       | 12    |      |
| 2011                       |       | 7     |      |
| **Total commitments**      | ** ** | **$** | **2,280** | ** ** |

 

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**CRITICAL ACCOUNTING ESTIMATES AND POLICIES**

 

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 as of December 31,2005. In preparing these financial statements, management has made its bestestimates and judgments of certain amounts included in the financial statements,giving due consideration to materiality. The primary estimates underlying theCompany’s financial statements include reserves for obsolete and slow movinginventory, 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 Note 2, “Summaryof Significant Accounting Policies” to our Financial Statements included in ourAnnual Report on Form 10-K as of December 31, 2005. 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.

 

*** Stock-based Compensation***

 

Effective January 1, 2006, we adopted theprovisions of SFAS No. 123(R), “Share-Based Payment”. SFAS No. 123(R)establishes accounting for stock-based awards exchanged for employee services. Accordingly,stock-based compensation cost is measured at grant date, based on the fair valueof the award which is computed using the Black-Scholes option valuation model,and is recognized as expense over the employee requisite service period. Wepreviously applied Accounting Principles Board (APB) Opinion No. 25, “Accountingfor Stock Issued to Employees,” and related Interpretations and provided therequired pro forma disclosures of SFAS No. 123, “Accounting forStock-Based Compensation”.

 

The fair value of each option award is estimated onthe date of grant using the Black-Scholes option valuation model with theweighted average assumptions shown in Note 5 of our Notes to CondensedConsolidated Financial Statements. The Black-Scholes option valuation modelrequires the input of highly subjective assumptions, including the expectedlife of the stock-based award and the stock-price volatility. The assumptionsused in calculating the fair value of share-based compensation representmanagement’s best estimates, but these estimates involve inherent uncertaintiesand the application of management’s judgment. As a result, if other assumptionshad been used, our stock-based compensation expense could have been materiallydifferent. In addition, we are required to estimate the expected forfeiturerate and only recognize expense for those shares expected to vest. If ouractual forfeiture rate is materially different from our estimate, theshare-based compensation expense could be materially different.

 

The expected term of the options granted is derivedfrom historical data on employee exercise and post-vesting employmenttermination behavior. The risk-free interest rate for periods equal to theestimated life of the option is based on the U.S. Treasury yield curve ineffect at the time of grant. Expected volatility is based on historicalvolatility on our stock.

 

For options granted prior to January 1, 2006, werecognized option forfeitures as they occurred, as allowed by SFAS No. 123.For options granted on or after January 1, 2006, and valued in accordancewith SFAS 123(R), we estimated forfeitures and only recognized expense forthose shares expected to vest.

 

We elected to adopt the modified prospectiveapplication method as provided by SFAS No. 123(R). Accordingly, during theperiod ended March 31, 2006, the Company recorded stock-based compensation forshares granted prior to, but not yet vested as of the adoption date based onthe grant date fair value estimated in accordance with the original previsionsof SFAS No. 123, and therefore, the Company did not restate previously reportedamounts. Stock-based compensation expense for all shared-based payment awardsgranted on or after January 1, 2006 is based on the grant date fair valueestimated in accordance with the provisions of SFAS No. 123(R).

 

Refer to Note 5 of our Notes to Condensed ConsolidatedFinancial Statements for a  more detaileddiscussion on stock-based compensation.

 

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**Item 3.****    Quantitativeand Qualitative Disclosures About Market Risk**

 

Thefollowing discusses our exposure to market risk related to changes in interestrates and foreign currency exchange rates. These exposures may change overtime as business practices evolve and could have a material adverse impact onour financial results.

 

*Interest Rate Risk*:  We have been exposed to interest rate riskthrough interest earned on holdings of available-for-sale marketable securities.Interest rates that may affect these items in the future will depend onmarket conditions and may differ from the rates we have experienced in thepast. The fair value of our investment portfolio or related income would not besignificantly 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.

 

*Foreign Currency Exchange Risk*:  All of our expenses and our revenues for thethree months ended March 31, 2006 were denominated in United States dollars.One percent of our revenues were denominated in foreign currencies in the threemonths ended March 31, 2005, were nominal in relation to our overallfinancial position. As a result, we have low exposure for currency exchangerisks and foreign exchange losses have been minimal to date. We do not enterinto forward exchange contracts to hedge exposure denominated in foreigncurrencies or any other derivative financial instruments for trading or speculativepurposes. In the future, if our assessment of our foreign currency exposurechanges, we may consider hedging transactions for risk mitigation.

 

**Item 4.****    Controlsand Procedures**

 

*Evaluation of Disclosure Controls and Procedures:*

 

Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in our Exchange Act reports is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms and that 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 March 31,2006, the end of our most recent fiscal quarter, we carried out an evaluation,under the supervision and with the participation of our management, includingour Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures. Based on the foregoing, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective.

 

*Changes in Internal Control Over Financial Reporting:*

 

There wasno change in our internal control over financial reporting during our mostrecent fiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

*Inherent Limitations of Internal Controls*

 

**Internalcontrol over financial reporting cannot provide absolute assurance of achievingfinancial reporting objectives because of its inherent limitations. Internalcontrol over financial reporting is a process that involves human diligence andcompliance and is subject to lapses in judgment and breakdowns resulting fromhuman failures. Internal control over financial reporting also can becircumvented by collusion or improper management override. Because of suchlimitations, there is a risk that material misstatements may not beprevented or detected on a timely basis by internal control over financialreporting. However, these inherent limitations are known features of the**

 

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financial reportingprocess. Therefore, it is possible to design into the process safeguards toreduce, though not eliminate, this risk.

 

**PART II.OTHER INFORMATION**

 

**Item 1.****    LegalProceedings**

 

Fromtime to time, we are involved in legal proceedings arising in the ordinarycourse of business. We believe there is no litigation pending that could have,individually or in the aggregate, a material adverse effect on its financialposition, result of operations or cash flows.

 

**Item 1A. Risk Factors**

 

*The riskfactors included in our Annual Report as of December 31, 2005 on Form 10-Kfiled with the Securities and Exchange Commission on March 16, 2006 shouldbe considered while evaluating Conceptus and our business. In addition to thosefactors and to other information in this Form 10-Q, the following updatesto the risk factors as of March 31, 2006 should be considered carefully while evaluating the Company and ourbusiness. This Form 10-Q contains forward-looking statements within themeaning of section 27A of the Securities Act of 1933, as amended and section 21Eof 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 intentions may alsoinclude forward-looking statements. Forward-looking statements involve risksand uncertainties that could cause actual results to differ materially from thoseprojected. Although it is not possible to predict or identify all such risksand uncertainties, they may include, but are not limited to, the riskfactors incorporated by reference and to their updates. Readers should notconsider these lists to be a complete statement of all potential risks anduncertainties.*

 

***Changes in stockoption accounting rules may adversely impact our reported operatingresults prepared in accordance with generally accepted accounting principles,our stock price and our competitiveness in the employee marketplace.***

 

Technology companies like ours have a history of usingbroad-based employee stock option programs to hire, incentivize and retain ourworkforce in a competitive marketplace. Statement of Financial AccountingStandards, or SFAS, No. 123 allowed companies the choice of either using afair value method of accounting for options, which would result in expenserecognition for all options granted, or using an intrinsic value method, asprescribed by Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees”, or APB 25, with a pro forma disclosure of theimpact on net income (loss) of using the fair value option expense recognitionmethod. We had elected to apply APB 25 and accordingly we generally did notrecognize any expense with respect to employee stock options as long as suchoptions are granted at exercise prices equal to the fair value of our commonstock on the date of grant.

 

In December 2004, the Financial AccountingStandards Board, or FASB, issued SFAS No. 123(R) “Share-Based Payments”.We adopted this statement on January 1, 2006, which is the first annualreporting period after June 15, 2005. This statement had a significantimpact on our consolidated statement of operations as we are required toexpense the fair value of our stock compensation rather than disclosing theimpact through footnotes in accordance with the disclosure provisions of SFAS No. 123.The implementation of SFAS 123(R) resulted in higher reported losses per share,which could negatively impact our future stock price and which could lead tolower reported earnings per share at the time in which we become profitable. Inaddition, this could impact our ability to utilize broad based employee stockplans to reward employees and could result in a competitive disadvantage to usin the employee marketplace.

 

**Item 2.****    UnregisteredSales of  Equity Securities and Use ofProceeds**

 

None.

 

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**Item 3.****    Defaultsupon Senior Securities**

 

None.

 

**Item 4.****    Submissionof Matters to a Vote of Security Holders**

 

None.

 

**Item 5.****    OtherInformation**

 

None.

 

**Item 6.****    Exhibits**

 
| **Exhibit Number** | ** ** | **Description**                                                                                           |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                      |
| 10.1                    |       | Change of Control Agreement with Patricia Gray.                                                           |
| 10.2                    |       | Officer Incentive Compensation Plan. Incorporated by reference to form  8-K filed on March 14, 2006.      |
| 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

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
|   | CONCEPTUS, INC. |
|--------|----------------------|
|   |                 |
|   |                 |
|   | By:                  | /s/ Gregory E. Lichtwardt |   |
|   |                 | Gregory E. Lichtwardt |
|   |                 | Executive Vice President, Treasurer and |
|   |                 | Chief Financial Officer |
|   |                 |
|   |                 |
| Date:  | May 10,  2006   |   |
|        |                      |  |  |  |  |  |

 

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**EXHIBIT INDEX**

 
| **Exhibit Number** | ** ** | **Description**                                                                                           |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                      |
| 10.1                    |       | Change of Control Agreement with Patricia Gray.                                                           |
| 10.2                    |       | Officer Incentive Compensation Plan. Incorporated by reference to form  8-K filed on March 14, 2006.      |
| 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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