**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                        |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                          |
| ** ** | ** ** | **For the Fiscal Quarter Ended September 30,  2005**                                                                                                                                                                     |
|       |       |                                                                                                                                                                                                                          |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                       |
| ** ** | ** ** | ** **                                                                                                                                                                                                                    |
| ** ** | ** ** | **For the transition period from                  to                .** |

 

**Commission file number:  0-27596**

 

**CONCEPTUS, INC.**

(Exact name of registrant as specified in its charter) 

 
| **Delaware**                                                    | ** ** | **94-3170244**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **1021 Howard Avenue  San Carlos, CA 94070**                    |
| (Address of principal executive offices)                        |

 

Registrant’s telephone number, including area code:**  (650)628-4700**

 

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Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for at least the past 90 days.

 

Yes   ý             No   o

 

Indicateby checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2of Exchange Act). Yes   ý       No   o

 

Indicateby checkmark whether the registrant is a shell company (as defined in Rule 12b-2of Exchange Act). Yes   o       No   ý

 

As of October 31,2005, 28,942,570 shares of the registrant’s Common Stock were outstanding.

 

 

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**CONCEPTUS, INC.**

 

**FORM 10-Q for the Quarter Ended September 30,2005**

 

**INDEX**

 
| ** **    | ** **                                                                                                                       | **Page** |
|---------------|----------------------------------------------------------------------------------------------------------------------------------|----------|
|          |                                                                                                                             |     |
| Part I.  | Financial  Information                                                                                                           | 3        |
|          |                                                                                                                             |     |
| Item 1.       | Condensed Consolidated  Financial Statements (Unaudited)                                                                         | 3        |
|          |                                                                                                                             |     |
|          | a)  Condensed Consolidated Balance Sheets as of September 30, 2005 and  December 31, 2004                              | 3        |
|          |                                                                                                                             |     |
|          | b) Condensed Consolidated  Statements of Operations for the three and nine month periods ended  September 30, 2005 and 2004 | 4        |
|          |                                                                                                                             |     |
|          | c) Condensed Consolidated  Statements of Cash Flows for the nine month periods ended September 30,  2005 and 2004           | 5        |
|          |                                                                                                                             |     |
|          | d) Notes to Condensed  Consolidated Financial Statements                                                                         | 6        |
|          |                                                                                                                             |     |
| Item 2.       | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                      | 10       |
|          |                                                                                                                             |     |
| Item 3.       | Quantitative and Qualitative  Disclosures About Market Risk                                                                      | 27       |
|          |                                                                                                                             |     |
| Item 4.       | Controls and Procedures                                                                                                          | 28       |
|          |                                                                                                                             |     |
| Part II. | Other Information                                                                                                                | 28       |
|          |                                                                                                                             |     |
| Item 1.       | Legal Proceedings                                                                                                                | 28       |
|          |                                                                                                                             |     |
| Item 2.       | Unregistered Sales of Equity  Securities and Use of Proceeds                                                                     | 29       |
|          |                                                                                                                             |     |
| Item 3.       | Defaults upon Senior  Securities                                                                                                 | 29       |
|          |                                                                                                                             |     |
| Item 4.       | Submission of Matters to a  Vote of Security Holders                                                                             | 30       |
|          |                                                                                                                             |     |
| Item 5.       | Other Information                                                                                                                | 30       |
|          |                                                                                                                             |     |
| Item 6.       | Exhibits                                                                                                                         | 30       |
|          |                                                                                                                             |     |
| Signature     |                                                                                                                             |     |

 

2

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**PART I: FINANCIAL INFORMATION**

 

**ITEM 1. Condensed Consolidated Financial Statements**

 

**Conceptus, Inc.**

 

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

(In thousands)

 
| ** **                                          | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
|                                                |       |                        |       |                       |       |
| **Assets**                                          |       |                        |       |                       |       |
| Current assets:                                     |       |                        |       |                       |       |
| Cash and cash  equivalents                          |       | $                           | 36,932     |                       | $          | 2,002 |   |
| Short-term  investments                             |       | —                      |       | 30,200                     |       |
| Restricted cash                                     |       | 69                          |       | 69                         |       |
| Accounts  receivable, net                           |       | 3,477                       |       | 2,067                      |       |
| Inventories, net                                    |       | 3,711                       |       | 2,022                      |       |
| Other current  assets                               |       | 734                         |       | 937                        |       |
|                                                |       |                        |       |                       |       |
| Total current  assets                               |       | 44,923                      |       | 37,297                     |       |
|                                                |       |                        |       |                       |       |
| Property and  equipment, net                        |       | 1,949                       |       | 1,322                      |       |
| Intangible  assets, net                             |       | 1,600                       |       | 1,750                      |       |
| Other assets                                        |       | 1,701                       |       | 1,808                      |       |
|                                                |       |                        |       |                       |       |
| **Total assets**                                    | ** ** | **$**                       | **50,173** | ** **                 | **$**      | **42,177** | ** ** |
| ** **                                          | ** ** | ** **                  | ** ** | ** **                 | ** ** |
| **Liabilities and stockholders’ equity**       |       |                        |       |                       |       |
| Current  liabilities:                               |       |                        |       |                       |       |
| Accounts payable                                    |       | $                           | 2,656      |                       | $          | 2,713 |   |
| Accrued  compensation                               |       | 2,782                       |       | 1,347                      |       |
| Other accrued  liabilities                          |       | 1,178                       |       | 1,072                      |       |
| Total current  liabilities                          |       | 6,616                       |       | 5,132                      |       |
|                                                |       |                        |       |                       |       |
| Other long-term  liabilities                        |       | —                      |       | 51                         |       |
|                                                |       |                        |       |                       |       |
| Total  liabilities                                  |       | 6,616                       |       | 5,183                      |       |
|                                                |       |                        |       |                       |       |
| Commitments and  Contingencies (Note 9)             |       |                        |       |                       |       |
|                                                |       |                        |       |                       |       |
| Stockholders’  equity:                         |       |                        |       |                       |       |
| Common stock and  additional paid-in capital        |       | 245,546                     |       | 221,960                    |       |
| Deferred  stock-based compensation                  |       | (1,257                      | )          | (1,637                     | )          |
| Accumulated  deficit                                |       | (200,732                    | )          | (183,329                   | )          |
| Treasury stock,  77,863 and 72,000 shares, at cost  |       | —                      |       | —                     |       |
|                                                |       |                        |       |                       |       |
| Total  stockholders’ equity                    |       | 43,557                      |       | 36,994                     |       |
|                                                |       |                        |       |                       |       |
| **Total liabilities and stockholders’ equity** | ** ** | **$**                       | **50,173** | ** **                 | **$**      | **42,177** | ** ** |

 

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

 

3

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**Conceptus, Inc.**

 

**Condensed Consolidated Statements of Operations**

**(Unaudited)**

(In thousands, except per share amounts)

 
| ** **                                                                      | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                      | ** ** | ** **                                  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                       |       | $                                           | 5,499      |                                       | $          | 2,840 |   | $ | 14,402 |   | $ | 7,990 |   |
|                                                                            |       |                                        |       |                                       |       |   |   |   |   |
| Cost of goods sold                                                              |       | 1,999                                       |       | 1,559                                      |       | 5,828 |   | 5,355 |   |
|                                                                            |       |                                        |       |                                       |       |   |   |   |   |
| Gross profit                                                                    |       | 3,500                                       |       | 1,281                                      |       | 8,574 |   | 2,635 |   |
|                                                                            |       |                                        |       |                                       |       |   |   |   |   |
| Operating expenses:                                                             |       |                                        |       |                                       |       |   |   |   |   |
| Research and  development                                                       |       | 1,145                                       |       | 1,045                                      |       | 3,020 |   | 3,249 |   |
| Selling, general  and administrative                                            |       | 7,618                                       |       | 6,734                                      |       | 23,568 |   | 19,403 |   |
|                                                                            |       |                                        |       |                                       |       |   |   |   |   |
| Total operating expenses                                                        |       | 8,763                                       |       | 7,779                                      |       | 26,588 |   | 22,652 |   |
|                                                                            |       |                                        |       |                                       |       |   |   |   |   |
| Operating loss                                                                  |       | (5,263                                      | )          | (6,498                                     | )          | (18,014 | ) | (20,017 | ) |
|                                                                            |       |                                        |       |                                       |       |   |   |   |   |
| Interest and other income, net                                                  |       | 260                                         |       | 158                                        |       | 611 |   | 368 |   |
|                                                                            |       |                                        |       |                                       |       |   |   |   |   |
| Net loss                                                                        |       | $                                           | (5,003     | )                                          | $          | (6,340 | ) | $ | (17,403 | ) | $ | (19,649 | ) |
|                                                                            |       |                                        |       |                                       |       |   |   |   |   |
| Basic and diluted net loss per share                                            |       | $                                           | (0.18      | )                                          | $          | (0.25 | ) | $ | (0.67 | ) | $ | (0.80 | ) |
|                                                                            |       |                                        |       |                                       |       |   |   |   |   |
| Weighted-average  shares used in computing basic and diluted net loss per share |       | 27,218                                      |       | 25,304                                     |       | 26,046 |   | 24,540 |   |

 

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

 

4

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**Conceptus, Inc.**

 

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

**(Inthousands)**

 
| ** **                                                                   | ** ** | **Nine Months Ended   September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| **Cash flows from operating activities**                                     |       |                                       |       |   |   |
| Net loss                                                                     |       | $                                          | (17,403    | ) | $ | (19,649 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                       |       |   |   |
| Depreciation and  amortization                                               |       | 838                                        |       | 1,019 |   |
| Stock  compensation expense                                                  |       | 785                                        |       | 587 |   |
| Allowance for  (recovery of) doubtful accounts                               |       | 41                                         |       | (64 | ) |
| Provision for  inventories                                                   |       | 42                                         |       | 310 |   |
| Retirement of  fixed assets                                                  |       | 2                                          |       | — |   |
| Changes in  operating assets and liabilities:                                |       |                                       |       |   |   |
| Accounts  receivable                                                         |       | (1,451                                     | )          | (115 | ) |
| Inventories                                                                  |       | (1,731                                     | )          | 582 |   |
| Other current  assets                                                        |       | 203                                        |       | (578 | ) |
| Other assets                                                                 |       | 107                                        |       | 200 |   |
| Accounts payable                                                             |       | (57                                        | )          | (534 | ) |
| Accrued  compensation                                                        |       | 1,435                                      |       | (1,459 | ) |
| Other accrued  liabilities                                                   |       | 86                                         |       | 454 |   |
| Long term  liabilities                                                       |       | (51                                        | )          | (118 | ) |
| Net cash used in operating activities                                        |       | (17,154                                    | )          | (19,365 | ) |
|                                                                         |       |                                       |       |   |   |
| **Cash flows from investing activities**                                     |       |                                       |       |   |   |
| Purchase of  investments                                                     |       | (36,350                                    | )          | (52,684 | ) |
| Maturities and  sales of investments                                         |       | 66,550                                     |       | 42,434 |   |
| Capital  expenditures, net                                                   |       | (1,317                                     | )          | (271 | ) |
| Net cash provided (used) by investing activities                             |       | 28,883                                     |       | (10,521 | ) |
|                                                                         |       |                                       |       |   |   |
| **Cash flows from financing activities**                                     |       |                                       |       |   |   |
| Proceeds from  issuance of common stock, net                                 |       | 23,201                                     |       | 26,028 |   |
| Net cash provided by financing activities                                    |       | 23,201                                     |       | 26,028 |   |
|                                                                         |       |                                       |       |   |   |
| Effect of exchange rate changes on cash                                      |       | —                                     |       | 18 |   |
|                                                                         |       |                                       |       |   |   |
| Net increase (decrease) in cash and cash equivalents                         |       | 34,930                                     |       | (3,840 | ) |
| Cash and cash equivalents at beginning of period                             |       | 2,002                                      |       | 5,844 |   |
| Cash and cash equivalents at end of period                                   |       | $                                          | 36,932     |   | $ | 2,004 |   |

 

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

 

5

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**Conceptus, Inc.**

 

***NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS***

***(Unaudited)***

 

**1.****             Basisof Presentation**

 

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, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements.  In the opinion of management, alladjustments, consisting only of normal recurring adjustments, considered necessaryfor a fair statement have been included.

 

The condensedconsolidated balance sheet at December 31, 2004 has been derived from theaudited consolidated financial statements at that date, but does not includeall of the information and footnotes required by accounting principlesgenerally accepted in the United States of America for complete financialstatements. This financial data should be reviewed in conjunction with theaudited consolidated financial statements and related notes included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004.  The results of operations for the three and ninemonths ended September 30, 2005 may not necessarily be indicative of theoperating results for the full 2005 fiscal year or any other future interimperiods.

 

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

 

The Company’s significant accounting policies aredisclosed in the Company’s Annual Report on Form 10-K for the year ended December 31,2004 that was filed with the Securities and Exchange Commission on March 31,2005. The Company’s significant accounting policies have not materially changedsince December 31, 2004.

 

**3.**             **Investments**

 

TheCompany accounts for its marketable securities in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 115, “Accounting for CertainInvestments in Debt and Equity Securities” issued by the Financial AccountingStandards Board (“FASB”). Such investments are classified as “available-for-sale”and are reported at fair value in the Company’s consolidated balance sheet asof December 31, 2004. As of December 31, 2004, the amortized costbasis of the available-for-sale investments represents the fair value of theinvestments due to their short maturities. Gross realized gains and losses from the sale of securities classifiedas available-for-sale were not material for the periods ended September 30,2005 and 2004.

 

Auctionrate securities have been classified as short-term investments on the consolidatedbalance sheets as of December 31, 2004.  Auction rate securities are variable ratebonds tied to short-term interest rates with maturities on the face of thesecurities in excess of ninety days. Auction rate securities have interest rate resets through a modifiedDutch auction, at pre-determined short-term intervals, usually every seven,twenty-eight or thirty-five days.  Theytrade at par and are callable at par on any interest payment date at the optionof the issuer.  Interest paid during agiven period is based upon the interest rate determined during the priorauction.

 

Althoughthese securities are issued and rated as long-term bonds, they are priced andtraded as short-term instruments because of the liquidity provided through theinterest rate reset.  The Company hadhistorically classified these instruments as cash equivalents if the periodbetween interest rate resets was ninety days or less, which was based on theability to either liquidate the holdings or roll the investment over to thenext reset period.

 

Basedupon the Company’s re-evaluation of these securities in connection with thepreparation of its December 31, 2004 financial statements, the Companyreclassified its auction rate securities, previously classified as cashequivalents, as short-term investments on its consolidated balance sheets.  The resulting impact of this reclassificationon the statements of cash flows for the nine month period ended September 30,2004 was to increase purchases of investments by $ 35,250,000 and increase salesof investments by $ 25,000,000.

 

6

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**4.****             Inventories,Net**

 

Inventoriesare stated at the lower of cost or market. Cost is based on actual costs computed on a first-in, first-outbasis.  The components of inventoriesconsist of the following (in thousands):

 
| ** **       | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw materials    |       | $                            | 101        |                        | $          | 250 |   |
| Work-in-progress |       | 714                          |       | 1,073                       |       |
| Finished goods   |       | 2,896                        |       | 699                         |       |
| Total            | ** ** | **$**                        | **3,711**  | ** **                  | **$**      | **2,022** | ** ** |

 

**5.****             Warranty**

 

TheCompany offers warranties on its product and records a liability for theestimated future costs associated with warranty claims, which is based uponhistorical experience and the Company’s estimate of the level of future costs.  Warrantycosts are reflected in the statement of operations as a cost of goods sold.  A reconciliation of the changes in theCompany’s warranty liability for the nine months ended September 30, 2005and 2004 follows (in thousands):

 
| ** **                                       | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                       | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| Warranty accrual at the beginning of the period  |       | $                                         | 68         |   | $ | 99 |   |
| Accruals for warranties issued during the period |       | 128                                       |       | 161 |   |
| Settlements made in kind during the period       |       | (128                                      | )          | (177 | ) |
| Warranty accrual at the end of the period        | ** ** | **$**                                     | **68**     | ** ** | **$** | **83** | ** ** |

 

**6.****             Stock-BasedCompensation**

 

Aspermitted by SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFASNo. 123”), as amended by SFAS No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure, an amendment of FASB Statement No. 123,”the Company accounts for employee stock-based compensation in accordance withAccounting Principles Board Opinion No. 25 (“APB 25”), “Accounting forStock Issued to Employees,” and related interpretations in accounting for itsstock-based compensation plans.

 

TheCompany granted 23,170 shares of restricted stock to its employees anddirectors for the nine months ended September 30, 2005 and 312,020 shares duringfiscal year 2004.  From the sharesgranted in 2004 and 2005, 77,863 shares have been repurchased to date by theCompany in accordance with the provisions of the awards (72,000 sharesrepurchased in year 2004, 2,000 shares repurchased in the first quarter of 2005and 3,863 shares repurchased in the third quarter of 2005). The shares ofrestricted stock had a purchase price of $0.003 per share and the Company’srepurchase right with respect to such shares lapses either in equalinstallments over three years or at the end of the three years, depending onthe terms on the respective shares.  Certainof the grants include acceleration of vesting based upon the Company’s achievementof performance goals.

 

TheCompany is amortizing the net total deferred restricted stock expense of $2.4million, calculated based on the fair value of the stock on the date of thegrants, over the vesting term of three years on a straight-line basis.  Stock compensation expense for restrictedstock awarded to employees was $631,000 and $364,000 for the nine

 

7

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months ended September 30,2005 and 2004, respectively, and $203,000 and $123,000 for the three monthsended September 30, 2005 and 2004, respectively.

 

Thefollowing table provides a reconciliation of net loss to pro forma net loss asif the fair value method, pursuant to SFAS No. 123, had been applied toall employee awards (in thousands, except per share data):

 
| ** **                                                                                                      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                      | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss, as reported                                                                                           |       | $                                          | (5,003     | )                                         | $          | (6,340 | ) | $ | (17,403 | ) | $ | (19,649 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss                                   |       | 203                                        |       | 123                                       |       | 631 |   | 364 |   |
| Less: Total  stock-based employee compensation expense determined under fair value based  method for all awards |       | (1,406                                     | )          | (1,037                                    | )          | (4,185 | ) | (5,034 | ) |
| Pro forma net loss                                                                                              | ** ** | **$**                                      | **(6,206** | **)**                                     | **$**      | **(7,254** | **)** | **$** | **(20,957** | **)** | **$** | **(24,319** | **)** |
| Basic and diluted net loss per share                                                                            |       |                                       |       |                                      |       |   |   |   |   |
| As reported                                                                                                     |       | $                                          | (0.18      | )                                         | $          | (0.25 | ) | $ | (0.67 | ) | $ | (0.80 | ) |
| Pro forma                                                                                                       |       | $                                          | (0.23      | )                                         | $          | (0.29 | ) | $ | (0.80 | ) | $ | (0.99 | ) |

 

To comply with pro formareporting requirements of SFAS No. 123, compensation cost is alsoestimated for the fair value of the Company’s Employee Stock Purchase Plan (“ESPP”)rights, which are included in the pro forma totals above.

 

Stock-based compensationarrangements to non-employees are accounted for in accordance with SFAS No. 123and Emerging Issues Task Force Issue (“EITF”) No. 96-18, “Accounting forEquity Instruments 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.  The measurement of stock-based compensationis subject to periodic adjustment as the underlying equity instrumentsvest.  Stock-based compensation expenserelating to non-employees was $154,000 and $223,000 for the nine months ended September 30,2005 and 2004, respectively.  Stock-basedcompensation expense relating to non-employees was $72,000 and $9,000 for thethree months ended September 30, 2005 and 2004, respectively.

 

*Recent Accounting Requirements*

 

In December 2004, FASBissued SFAS No. 123(R), “Share-Based Payment” (revised 2004) (“SFAS No. 123(R)”). The provisions of SFAS No. 123(R) will require the Company tomeasure all stock-based compensation awards using a fair value method andrecord such expense in the consolidated financial statements, including grantsof employee stock options.  In addition,the adoption of SFAS No. 123(R) will require additional accounting relatedto the income tax effects and additional disclosure regarding the cash floweffects resulting from share-based payment arrangements. SFAS No. 123(R) iseffective for all public companies for annual periods beginning after June 15,2005.  The Company will adopt SFAS 123(R)effective January 1, 2006.  TheCompany has not yet determined whether the adoption of SFAS No. 123(R)will result in amounts that are similar to the current pro forma disclosuresunder SFAS No. 123.  The Company isevaluating the requirements for SFAS No. 123(R) and expects the adoptionto have a significant adverse impact on the statement of operations and netloss per share.

 

In March 2005, theSEC issued Staff Accounting Bulletin (“SAB”) No. 107 (“SAB 107”). SAB 107provides guidance for the implementation of SFAS 123(R) with respect tovaluation techniques, expected volatility

 

8

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and expected term for valuing employee stock options,among other matters. The provisions of SAB 107 will be effective for theCompany at the time the Company adopts SFAS 123(R).

 

In May 2005, theFASB issued SFAS 154, “Accounting Changes and Error Corrections – a replacementof APB Opinion No. 20 and FASB Statement No. 3”. SFAS 154 requiresretrospective application to prior periods’ financial statements of changes inaccounting principle, unless it is impracticable to determine either theperiod-specific effects or the cumulative effect of the change.  APB 20 previously required that mostvoluntary changes in accounting principle be recognized by including in net incomeof the period of the change the cumulative effect of the changing to the newaccounting principle. The statement is effective for fiscal years beginningafter December 15, 2005.  TheCompany has evaluated the impact of the adoption of SFAS 154, and does notbelieve the impact will be significant to the Company’s overall results ofoperations or financial position.

 

**7.****             Computationof Net 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 includes the impact of potentially dilutivesecurities.  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  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Denominator:                                                                                                      |       |                                       |       |                                      |       |   |   |   |   |
| Weighted-average number of common shares outstanding                                                              |       | 27,471                                     |       | 25,547                                    |       | 26,291 |   | 24,743 |   |
| Less:  Weighted-average unvested common shares                                                                    |       | 253                                        |       | 243                                       |       | 245 |   | 203 |   |
| Weighted-average  number common shares outstanding used in computing basic and diluted net loss  per common share | ** ** | **27,218**                                 | ** ** | **25,304**                                | ** ** | **26,046** | ** ** | **24,540** | ** ** |

 

Thefollowing outstanding options, potential employee stock purchase plan sharesand restricted stock shares, which could potentially dilute basic net loss pershare in the future were excluded from the computation of diluted net loss pershare, as their effect would have been antidilutive (in thousands):

 

 
| ** **                   | ** ** | **At September 30,** | ** ** |
|------------------------------|------------|---------------------------|------------|
| ** **                   | ** ** | **2005**                  | ** ** | **2004** | ** ** |
| Outstanding options          |       | 3,611                     |       | 3,626 |   |
| Restricted stock             |       | 254                       |       | 216 |   |
| Employee Stock Purchase Plan |       | 31                        |       | 6 |   |
| **Total**                    | ** ** | **3,896**                 | ** ** | **3,848** | ** ** |

 

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**8.****            ****Stockholders’ Equity**

 

In thefirst and third quarters of 2005, the Company repurchased 2,000, and 3,863respectively shares of restricted common stock at par value in accordance withthe terms of the restricted stock agreements. These shares are recorded as treasury stock, and with the 72,000 sharesrepurchased in fiscal 2004, the Company now holds a total of 77,863 shares oftreasury stock, valued at a cost basis of $234.

 

On February 25,2004, the Company completed a private placement of approximately 3,000,000shares of common stock at $8.50 per share. The net proceeds to the Company, after fees and other offering coststotaling $1,600,000, were approximately $23,900,000.

 

On August 11,2005, the Company closed the sale of a private placement of approximately 3,200,000shares of newly issued common stock at $7.20 per share to institutionalinvestors and $8.10 per share to officers and directors. The net proceeds tothe Company, after fees and other offering costs totaling approximately $116,000were approximately $22,890,000.

 

**9**.             **Other Commitments and Contingencies**

 

On June 28, 2005, the Company entered into aSublease Agreement with Verisity Design, Inc. for the relocation of itsheadquarters to 331 East Evelyn, Mountain View, California. The agreement wassubject to the Master Landlord’s consent within 45 days after delivery of andreceipt by Master Landlord of the executed Sublease. On July 19, 2005,SFERS Real Estate, the Master Landlord, and Verisity Design, Inc. signed aLandlord Consent Agreement allowing the Sublease Agreement between the Companyand Verisity Design, Inc.

 

Aggregate minimum annualrental commitments under the new lease agreement are as follows (in thousands):

 

| 2005                                 |       | $     | 0         |       |
|--------------------------------------|------------|-------|-----------|------------|
| 2006                                 |       | 472   |      |
| 2007                                 |       | 582   |      |
| 2008                                 |       | 599   |      |
| 2009                                 |       | 305   |      |
| **Total  minimum rental commitment** | ** ** | **$** | **1,958** | ** ** |

 

The Company will recognizethe operating lease expense on a straight-line basis.

 

From time to time theCompany is involved in legal proceedings arising in the ordinary course ofbusiness.  The Company believes there isno litigation pending that could have, individually or in the aggregate, amaterial adverse effect on its financial position, result of operations or cashflows.

 

**Item2.  Management’s Discussion and Analysisof 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 contains forward-looking statements, includingreferences to 2005 revenues, increased product adoption, expanded sales forceand other forecasted items, that involve risks and uncertainties such aslimited operating and sales history; the uncertainty of market acceptance ofour product; dependence on obtaining and maintaining reimbursement;effectiveness and safety of our product over the long-term; our ability toobtain and maintain the necessary governmental clearances or approvals tomarket our product; our ability to develop and maintain proprietary aspects ofour technology; our ability to manage our expansion; our limited history ofmanufacturing our product; our dependence on single source suppliers, third partymanufacturers and co-marketers; intense competition in the medical deviceindustry; the inherent risk of exposure to product liability claims and productrecalls and other factors referenced in this*

 

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*Form 10-Q.  Our actual results could differ materiallyfrom those expressed or implied in these forward-looking statements as a resultof various factors, including those discussed in “Risk Factors” and elsewherein 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 (“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 prohibitsthe egg from traveling through the fallopian tubes and therefore preventsfertilization.

 

*The Essure Procedure*

 

The *Essure*procedure is typically performed as an outpatient procedure and is intended tobe a less invasive and a less costly alternative to tubal ligation, the leadingform of birth control in the United States and worldwide.  Laparoscopictubal ligation and tubal ligation by laparotomy typically involve abdominalincisions and/or punctures, general or regional anesthesia, four to ten days ofnormal recovery time and the risks associated with an incisionalprocedure.  The *Essure*procedure does not require cutting or penetrating the abdomen, which lowers thelikelihood of post-operative pain due to the incisions/punctures, and it can beperformed in an outpatient setting without general or regionalanesthesia.  In the Pivotal trial of the *Essure*system, the total procedure time averaged 35 minutes, with an average of 13minutes of hysteroscopic 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*system is effective without drugs or hormones.  There is a three-monthwaiting period after the procedure during which the woman must use another formof birth control while tissue in-growth occurs.  At 90 days following theprocedure, the patient completes a follow-up examination called ahysterosalpingogram (“HSG”), which can determine whether the device was placedsuccessfully and whether the fallopian tubes are occluded.

 

We believe that the *Essure*system is also an attractive alternative to tubal ligation for physicians,hospitals and payers.  The *Essure* systemis a less invasive permanent birth control option for physicians to offer totheir patients; hospitals are able to utilize their facilities more costeffectively with the *Essure*procedure compared with tubal ligation, and payers are able to experience costreductions resulting from the elimination of overhead and procedural costsrelated to anesthesia and post-operative hospital stays associated with tuballigations.  We also believe the *Essure* systemis a viable alternative to other temporary methods of birth control being used whenthere is no intention of having children in the future.  In addition, payersmay also benefit from the reduction of unplanned pregnancies associated withnon-permanent methods of birth control used by patients who have chosen toavoid the drawbacks of traditional permanent birth control methods but who mayelect to use the *Essure* system.

 

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

 

The *Essure* systemis currently being marketed in multiple countries.  In November 2002we received approval from the FDA to market the *Essure*system in the United States.  In 2001, 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 December 2004, we made the decision toterminate our direct subsidiary operations in Australia and convert to anindependent distributor.  This decision was largely a cost reductionmeasure in lieu of the small size of the Australian market and our inability tomanage a direct operation to a cash-flow positive position.  We haveentered into a distribution agreement and the transition was completed in January 2005.  In Canada, we received clearance from Health Canada tomarket the *Essure* system in Canada in November 2001.  We now have distributors in Australia, Canada,New Zealand and France, which covers Europe, Middle East, Africa, Mexico,Central America and South America.

 

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*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 late January 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 of thetotal 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 September 30,2005, Conceptus has trained or is in the process of training 2,531 physiciansin the United States on the *Essure*procedure.  This represents an increase of 850 physicians over the numberof physicians at December 31, 2004 and an increase of 1,130 physiciansover the number of physicians at September 30, 2004.  The level ofsales for the *Essure* system, particularly inthis early 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 within prevailinghealthcare payment systems.  We believe that physician advocacy of ourproduct will be required to continue to obtain reimbursement.  As of September 30,2005, we have received positive reimbursement decisions for the *Essure* procedure from most private insurers and 22 of the 50Medicaid programs in the country. The most significant private payer that hasnot given a coverage decision is CIGNA, which represents about 6% of theinsured population in the United States that would be a candidate for the *Essure* procedure. We intend to continue our effort toeducate payers of the cost-effectiveness of our product, and to establishfurther programs to help physicians to navigate reimbursement issues.

 

In July 2005, the UnitedHealthcare Groupapproved the *Essure* procedure forreimbursement. As with all healthcare plans, coverage will vary and isdependent upon the individual’s specific benefit plan.

 

In early November 2004, the Centers for Medicareand Medicaid Services (“CMS”) released the Final Rule for the 2005Physician Fee schedule.  For the *Essure* CPTcode, the CMS has provided for a national physician payment of $2,198.34 forprocedures performed in the office and $458.94 for physician payment when theprocedure is performed in the hospital.  This compares to a CPT codephysician payment of $361.16 for a laparoscopic tubal ligation, the currentstandard of care for permanent female sterilization.  In addition, the CMSreleased the Final Rule for the 2005 OPPS, which assigns hospitaloutpatient reimbursement amounts.  The *Essure* CPT codewas assigned a 2005 payment level of $2,260.37, which is consistent withpayments by CMS to hospitals when they perform a

 

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laparoscopictubal ligation, normally performed in a higher cost hospital operatingroom.  We believe these values are very favorable for the *Essure* procedure and will help in establishing increasedutilization of the device amongst doctors.  We expect that the new code,once the process to establish it at all private payers that have given afavorable coverage decision is complete, will significantly ease the burden ona physician’s office in obtaining reimbursement for the *Essure*procedure, and accelerate the coverage of the *Essure*procedure by private insurance companies and Medicaid.  This process isnot automatic following 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.

 

In mid-August 2004, the Australian Department ofHealth, Medical Services Advisory Committee (MSAC) division recommended againstpublic funding for the *Essure*procedure, citing insufficient evidence for safety, effectiveness and costeffectiveness.  The overall market for female sterilization in Australiais very small and we believe that our market penetration will remain limited bythe MSAC decision until such time as we are able to submit sufficient long-termdata to obtain public funding.

 

*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 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.  Ineither instance, 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 thephysician and his/her staff the tools to ensure that claims will ultimately bepaid and thereby encourages the physician to continue performing the *Essure* procedure despite reimbursement issues.  Thistactical reimbursement group is generally targeting specific accounts with theaim of eventually meeting with all of our accounts so as to provide them withthe knowledge of how to file and follow up on claims on a payer by payer basis.

 

Second, we are expanding our sales territories andchannels of distribution so as to increase our call frequency onphysicians.  Since January 1, 2005,we have added 19 sales positions and are expecting to add more before the endof the year.  Also, we have included regionaldistributors of women’s gynecology products to our marketing efforts. Amongother responsibilities, our sales representatives are attempting to increaseutilization of the *Essure*procedure in the office environment.

 

Third, we have entered into certain strategic agreementsin the past and we may explore such opportunities in the future.  We intend for these agreements to provide uswith the ability to increase awareness, gain market presence and credibility,accelerate our ability to train doctors, as well as expand our marketopportunity by driving adoption among a group of physicians not previouslytargeted by our marketing programs. The success of these joint marketingcampaigns will depend upon the effectiveness of our sales force trainingprograms, market demand for *Essure*procedures in conjunction with the products marketed by strategic partners andthe efforts and commitment of strategic partners to the program.  We cannot be certain how successful theseprograms will be, if at all.

 

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Fourth, we are attempting to increase patientawareness, so as to increase the number of women that will ask for informationabout the *Essure* procedure.  In late July 2004 we announced that weinitiated an extensive direct to consumer advertising campaign in the Chicago,Illinois metropolitan area which commenced in August 2004 and ran for 6months. The campaign involved radio, direct mail and print media (magazine)advertisements aimed at increasing consumer awareness.  In February 2005, the radio portion ofthe campaign was extended through August 2005.  Depending on the successof this marketing effort, we will be evaluating additional major metropolitanmarkets in which to conduct a similar advertising campaign in the future. This program was partially responsible for the increase in selling, general andadministration expense during the last half of 2004.  Applying this program to additional marketswill therefore result in further increases in our expenses.

 

Lastly, as appropriate we intend to make labelingimprovements to our product as well as physical product enhancements to enhancethe adoption of the *Essure* procedure.This may involve working with the various regulatory agencies around the worldthat regulate the sale and labeling of medical devices to provide updates toclaims such as effectiveness and placement rates. Where appropriate, we willmake physical improvements to the product for improved manufacturability or forthe ease of use by the physician.

 

We have experienced significant operating losses sinceinception and, as of September 30, 2005, had an accumulated deficit of $200.7million.  We expect our operating losses to continue until at least the endof calendar year 2006 as we continue to expend substantial resources in theselling and marketing of the *Essure* systemin the United States and abroad.  Due to the unpredictable nature of theseactivities, we do not know whether we will achieve or sustain profitability inthe future.  We will continue to be in anet loss position until sufficient revenues can be generated to offsetexpenses.  In August 2005, wecompleted a private placement of common stock, which generated cash to helpfund our operations.  In the future,depending upon a variety of factors, we may need to raise additional fundsthrough bank facilities, debt or equity offerings or other sources of capital.Additional financing may not be available when needed or on terms acceptable tous.

 

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**Results ofOperations - Three and Nine Months Ended September 30, 2005 and 2004**

 

*Net Sales*

 

Netsales were $5.5 million for the three months ended September 30, 2005 ascompared to $2.8 million for the three months ended September 30,2004, an increase of $2.7 million, or 94%. Net sales for the nine months ended September 30, 2005 were $ 14.4million as compared to $8.0 million for the nine months ended September 30,2004.  The increase of $6.4 million, or 80%,in net sales is the result of the continued commercialization of the *Essure* system worldwide and a U.S. price increaseestablished in January of 2005 of 17%. Unit volume growth for the thirdquarter of 2005 compared to the third quarter of 2004 increased 81% while unitvolume growth for the nine months ended September 30, 2005 increased 70%over the comparable period of last year. Our worldwide average selling price increased from $763 for the year in2004 to $799 for the first nine months of 2005, due to the increase in oursales price in January 2005, as well as the increase in the level ofdomestic sales, which has a higher price than sales to our European distributor.

 

We expect net sales toincrease in the last quarter of fiscal year 2005 and have put in place salesand marketing programs and have pursued reimbursement with payers to help us toreach our revenue goal.  However, as wehave noted elsewhere in this Form 10-Q, our expected revenue growth isdependant on market acceptance of the *Essure* systemand third party reimbursement for the device, which involves factors that areoutside of our control.

 

For the three monthsended September 30,2004 and 2005, no single customer accounted for 10% ormore of total consolidated net sales. Net sales to a distributor were 11% forthe nine months ending September 30, 2005, while no single customeraccounted for more than 10% for the same period ending September 30, 2004.Accounts receivable from a customer and a distributor accounted for 12% and 18%respectively of our total net accounts receivable outstanding as of September 30,2005. At September 30, 2004, accounts receivable from one distributor were25% of our total net accounts receivable outstanding.

 

Net product sales bygeographic region as a percentage of net sales for the three and six monthsended September 30, 2005 and 2004 are as follows:

 
| ** **               | ** ** | **Three Months Ended   September 30,** | ** ** | **Nine Months Ended   September 30,** | ** ** |
|--------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **               | ** ** | **2005**                                    | ** ** | **2004**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| United States of America |       | 92                                          | %          | 88                                         | %          | 87 | % | 85 | % |
| Europe                   |       | 7                                           | %          | 9                                          | %          | 11 | % | 11 | % |
| Other                    |       | 1                                           | %          | 3                                          | %          | 2 | % | 4 | % |

 

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

 

As of September 30,2005, we have a total of 2,531 doctors in the United States that have eithercompleted or are in the process of completing preceptorship.  This represents an increase of 850 physiciansover the number of physicians at December 31, 2004 and an increase of 1,130physicians over the number of physicians at September 30, 2004.  Our accomplishment in obtaining the number ofphysicians trained is very important because it not only provides us with astrong referral base within major metropolitan areas we have targeted, but itwill also create the leverage to help us gain additional reimbursementcoverage.  We understand that a strongbase of trained physicians does not necessarily correlate to an increase inrevenue proportionately.  Furthermore,there are no revenuesassociated with the training activities. The Company does not charge a fee forthe activity and no commitment arises for the physician from the preceptorship.Physician training is provided upfront and the Company has no obligationsubsequent to the initial training. Training costs have not been significant tothe Company life to-date.

 

We areworking closely with private payers and physicians across the U.S. to implementthe CPT code into their systems and establish payment schedules.  This is important in order for physicians tobe able to utilize the benefits of the CPT code in filing claims electronicallyrather than manually.  It is expectedthat electronic filing will

 

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result in fewer claimdenials or incorrect payments and increase the physician’s confidence in theprocedure. At September 30, 2005, we estimate that approximately 85% ofall the payers that have given a coverage decision for the *Essure*procedure have loaded the CPT code and a fee schedule into their paymentsystems for electronic processing of pre-authorizations and claims.

 

In October 2005, weannounced our expected net sales for 2005 to be approximately $20.4 million to$20.6 million, which represents more than 76% growth from 2004.  This increase in revenues includes the effectof the 17% price increase we announced in January 2005 for customers inthe United States.  We expect net salesfrom the United States will continue to be the major contributor of our globalnet sales.  We have established fiveprimary goals to achieve our revenue growth. We expect to complete the implementation of the new CPT code and obtainadditional payer coverage decisions, increase sales coverage and physicianutilization of the *Essure*procedure, work with hysteroscopic equipment strategic partners, build patientawareness and bring labeling/product improvements to market.  We believe our revenue growth in 2005 will besignificantly influenced by how successful we are in achieving thoseobjectives.

 

*GrossProfit*

 

Costof goods sold for the three months ended September 30, 2005 was $2.0 millionas compared to $1.6 million for the three months ended September 30,2004.  The increase of $0.4 million, or 28%,is caused by the increase in net sales, partially offset by reductions inmanufacturing cost due to higher volume and the outsourcing of production to athird-party manufacturer in 2004.  Grossprofit margin improved from 45% for the quarter ended September 30, 2004to 64% for the quarter ended September 30, 2005, which is the result ofour domestic price increase and lower manufacturing costs.  For the nine months ended September 30,2005, cost of goods sold was $5.8 million, which represents an increase of $0.5million compared to the same period of last year, even though sales increased 80%year over year. This result has led to significant improvement in our grossprofit, as a result of the transition of the manufacturing outsourcing.  We expect gross margin to continue improvingduring the remainder of 2005 due to all of the above factors, as well as animprovement in the channel mix, with international sales, which carry a lowerselling price and gross profit, representing a smaller portion of our overallsales volume.

 

*OperatingExpenses*

 

Research and developmentexpenses, which include expenditures related to product development, clinicalresearch and regulatory affairs, were $1.1 million for the three months ended September 30,2005 and $1.0 million for the three months ended September 30, 2004.  For the nine months ended September 30,2005, research and development expenses decreased $0.2 million, or 7%, to $3.0million, from $3.2 million in the same period of 2004. Research and developmentexpenditures fluctuate in relation to product development, clinical affairs andregulatory activities.

 

Selling, general andadministrative spending for the three months ended September 30, 2005 was $7.6million as compared to $6.7 million for the three months ended September 30,2004 which represents an increase of $0.9 million, or 13%.  For the nine months ended September 30,2005, selling, general and administrative expenses were $23.6 million, whichrepresents an increase of $4.2 million, or 21%, from $19.4 million for the ninemonths ended September 30, 2004.  Theprimary reason for the increase in selling, general and administrative expensesfor both the quarter and the year to date periods results from the expansion ofour U.S. field sales force from approximately 19 sales people in the 2004 timeperiod to 38 sales people at September 30, 2005. The expansion of our U.S.sales force is meant to provide us with more selling time to focus on physicianutilization and penetration. Additionally, increases in selling, general andadministrative expenses came from activities related to consulting and auditfor Sarbanes-Oxley compliance, as well as employee compensation, in partrelated to new hires. For 2005, we expect to have limited internationalexpenditures since we completed the divestiture of our French subsidiary in January 2004and the closure of our direct operations in Australia in January 2005.  We recorded expenses of approximately$205,000 in December 2004 related to the closing down of our Australiaoperations, which included $183,000 of severance costs and $22,000 forimpairment of fixed assets.  Allseverance costs were completely paid out at the end of January 2005 andthe disposal of fixed assets was completed by the end of March 2005.

 

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Net interest and other income for the three monthsended September 30, 2005 was approximately $0.3 million, compared to $0.2million for three months ended September 30, 2004. For the nine monthsended September 30, 2005, net interest and other income was $0.6 million comparedto $0.4 million for the nine months ended September 30, 2004.

 

**Liquidityand Capital Resources**

 

Wehave experienced significant operating losses since inception.  As of September 30, 2005 we had anaccumulated deficit of $200.7 million. We have financed our operations since inception primarily through equityfinancings. In February 2004 we completed a private placement ofapproximately 3.0 million shares of common stock at $8.50 per share.  Our net proceeds from the private placementwere approximately $23.9 million, after deducting offering costs andcommissions. In August 2005, we completed a private placement ofapproximately 3.2 million shares of common stock at a price of $7.20 and $8.10per share. Our net proceeds from the private placement were approximately $22.9million, after deducting offering costs.  The proceeds are being used to fundoperations.  In the future, dependingupon a variety of factors, we may need to raise additional funds through bankfacilities, debt or equity offerings or other sources of capital.

 

As of September 30,2005, we had cash, cash equivalents, restricted cash and short-term investmentsof $37.0 million, compared with $32.3 million at December 31, 2004.  The increase of $4.7 million is primarily dueto the proceeds of approximately $22.9 million from the private placement ofcommon stock and $0.3 million from the exercise of options to purchase commonstock, partially offset by $17.2 million of cash used in operating activitiesand capital expenditures of $1.3 million. Additional financing may not beavailable when needed or on terms acceptable to us.

 

*RestrictedStock*

 

In thefirst and third quarters of 2005, the Company repurchased 2,000 and 3,863respectively shares of restricted common stock at par value in accordance withthe terms of the restricted stock agreements. These shares are recorded astreasury stock, and with the 72,000 shares repurchased in fiscal 2004, theCompany now holds a total of 77,863 shares of treasury stock. The shares ofrestricted stock had a purchase price of $0.003 per share and the Company’srepurchase right with respect to such shares lapses either in equalinstallments over three years or at the end of the three years, depending onthe terms on the respective shares.

 

Inaddition, the Company granted 23,170 shares of restricted stock to itsemployees and directors for the nine months ended September 30, 2005 and312,020 shares during fiscal year 2004. Certain of the grants includeacceleration of vesting based upon the Company’s achievement of performancegoals.

 

TheCompany is amortizing the net total deferred restricted stock expense of $2.4million, calculated based on the fair value of the stock on the date of thegrants, over the vesting term of three years on a straight-line basis. Of thetotal deferred restricted stock expense of $2.4 million, $0.4 million willrelate to research and development and $2.0 million will relate to selling,general and administrative activities, assuming employees will not changedepartments.

 

*Operating Activities*

 

Net cash used inoperating activities was $17.2 million in the nine months ended September 30,2005, primarily as a result of our net loss of $17.4 million adjusted fornon-cash related items of $1.6 million related to depreciation and amortizationand stock compensation expense.  Othermajor items that contributed to net cash used in operating activities wererelated to a planned increase in inventories of $1.7 million and an increase inaccounts receivable of $1.5 million related to our sales growth, offset by anincrease in accrued compensation of $1.4 million and a decrease in other assetsof $0.3 million. We expect cash usage in operating activities in the future todecrease.

 

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As of September 30,2005, our worldwide days sales outstanding in accounts receivable was 49 days,which represents a decrease of 4 days compared to December 31, 2004.  We have credit policies that help us tomonitor our collection activities and reduce our credit loss exposure.  We continue to improve and modify thosepolicies as our business evolves. Our goal is to consistently improve our dayssales outstanding.  We may not be able tomaintain our current ratio or we may experience less than satisfactoryperformance in collection due to factors outside of our control such as changesin economic climates.

 

The $1.7 million increasein inventories was due to a planned build up in inventory levels to supportexpected future growth in sales. We expect to manage our inventory levelsthrough the rest of the year to support our forecasted sales.

 

For the nine months endedSeptember 30, 2004, net cash used in operating activities was $19.4million, primarily as a result of the net loss of $19.6 million adjusted fornon-cash related items of $1.9 million relating to depreciation andamortization, stock compensation expense, provisions for bad debt allowance andinventories.  Other major items thatcontributed to net cash used in operating activities were related to anincrease in other current assets of $0.6 million primarily from prepaidinsurance premiums, pay down of accrued compensation of $1.5 million and paydown of accounts payable of $0.5 million, offset by a decrease in inventoriesof $0.6 million, changes in other assets of $0.2 million and an increase inother accrued liabilities of $0.5 million.

 

*Investing Activities*

 

Net cash provided byinvesting activities for the nine months ended September 30, 2005 was $28.9million, from sales of short-term investments of $66.6 million, from which $35.0million were converted to commercial paper with a maturity of less than 90 days,partially offset by purchases of investments of $36.4 million and capitalexpenditures of $1.3 million**.  **Net cash used in investingactivities for the nine months ended September 30, 2004 was $10.5 millionfrom the purchase of investments of $52.7 million and capital expenditures of$0.2 million, partially offset by the sales and maturity of $42.4 million ofinvestments**.**

 

*Financing Activities*

 

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

 

Net cash provided byfinancing activities was $26.0 million for the nine months ended September 30,2004, primarily from the issuance of our common stock in a private placementcompleted in February 2004.  Our netproceeds from the issuance of approximately 3.0 million shares of our commonstock at $8.50 per share in a private placement were approximately $23.9million, after deducting offering costs and commissions totaling $1.6million.  We also received $1.6 million fromthe exercises of stock options in the first six months of 2004.

 

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

 

•              Resourcesdevoted to establish sales, marketing and distribution capabilities;

•              Therate of product adoption by doctors and patients; and

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

 

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*Future Commitments*

 

On June 28, 2005,the Company entered into a Sublease Agreement with Verisity Design, Inc.for the premises located at 331 East Evelyn, Mountain View, California. Theagreement was subject to the Master Landlord’s consent within 45 days afterdelivery of and receipt by Master Landlord of the executed Sublease. On July 19,2005, SFERS Real Estate, the Master Landlord, and Verisity Design, Inc.signed a Landlord Consent Agreement allowing the Sublease Agreement between theCompany and Verisity Design, Inc.

 

Aggregate minimum annualrental commitments under the new lease agreement are as follows (in thousands):

 

| 2005                                 |       | $     | 0         |       |
|--------------------------------------|------------|-------|-----------|------------|
| 2006                                 |       | 472   |      |
| 2007                                 |       | 582   |      |
| 2008                                 |       | 599   |      |
| 2009                                 |       | 305   |      |
| **Total  minimum rental commitment** | ** ** | **$** | **1,958** | ** ** |

 

The Company recognizesthe operating lease expense on a straight-line basis per the provisions setforth by FAS No. 13.

 

**RecentAccounting Pronouncements**

 

In December 2004,FASB issued SFAS No. 123(R), “Share-Based Payments” (revised 2004). The provisionsof SFAS No. 123(R) will require us to measure all stock-based compensationawards using a fair value method and record such expense in the consolidatedfinancial statements, including grants of employee stock options.  In addition, the adoption of SFAS No. 123(R)will require additional accounting related to the income tax effects andadditional disclosure regarding the cash flow effects resulting fromshare-based payment arrangements.  SFAS No. 123(R)is effective for all public companies for annual periods beginning after June 15,2005.  We will adopt SFAS No. 123(R) effective January 1, 2006.  Wehave not yet determined whether the adoption of SFAS No. 123(R) willresult in amounts that are similar to the current pro forma disclosures underSFAS No. 123.  We are evaluating therequirements for SFAS No. 123(R) and expect the adoption to have asignificant adverse impact on our statement of operations and net loss pershare.

 

In March 2005, theSEC issued Staff Accounting Bulletin (“SAB”) No. 107 (“SAB 107”). SAB 107provides guidance for the implementation of SFAS 123(R) with respect tovaluation techniques, expected volatility and expected term for valuingemployee stock options among other matters. The provisions of SAB 107 will beeffective for the Company at the time the Company adopts SFAS 123(R).

 

In May 2005, theFASB issued SFAS 154, “Accounting Changes and Error Corrections – a replacementof APB Opinion No. 20 and FASB Statement No. 3”. SFAS 154 requiresretrospective application to prior periods’ financial statements of changes inaccounting principle, unless it is impracticable to determine either theperiod-specific effects or the cumulative effect of the change.  APB 20 previously required that most voluntarychanges in accounting principle be recognized by including in net income of theperiod of the change the cumulative effect of the changing to the newaccounting principle. The statement is effective for fiscal years beginningafter December 15, 2005.  TheCompany has evaluated the impact of the adoption of SFAS 154, and does notbelieve the impact will be significant to the Company’s overall results ofoperations or financial position.

 

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**Risk Factors**

 

*Inaddition to the other information in this Form 10-Q, the following factorsshould be considered carefully in evaluating Conceptus and our business.  This Form 10-Q contains forward-lookingstatements within the meaning of section 27A of the Securities Act of1933, as amended and section 21E of the Securities Exchange Act of 1934,as amended. Some of the forward-looking statements can be identified by use offorward-looking words such as “believes,” “expects,” “anticipates,” “may,” “will,”“should,” “seeks,” “approximates,” “intends,” “plans,” or “estimates,” or thenegative of these words, or other comparable terminology. The discussion offinancial trends, strategy, plans or intentions may also includeforward-looking statements. Forward-looking statements involve risks anduncertainties 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 followingfactors. The readers should not consider this list to be a complete statementof all potential risks and uncertainties.*

 

***We have a limitedhistory of operation with the Essure system and have incurred significantoperating losses since inception.  We expect to incur significantoperating losses for the foreseeable future and we may never achieve ormaintain profitability.***

 

We have a limited history of operation with the *Essure* system and have incurred significant operating lossessince our inception in 1992, including operating losses of $18.0 million forthe nine months ended September 30, 2005, $26.6 million in fiscal 2004,$40.2 million in fiscal 2003, and $33.1 million in fiscal 2002. We expect tocontinue to incur significant operating expenses and net losses as we continuesales and marketing efforts in the United States.  Our net losses willcontinue until sufficient revenues can be generated to offset these expenses.We may not be able to generate these revenues, and we may never achieveprofitability. Our failure to achieve and sustain profitability wouldnegatively impact the market price of our common stock.

 

***We are presently aone-product company and if our product fails to gain market acceptance, ourbusiness will suffer.***

 

We are attempting to introduce a novel product intothe contraception market, which is dominated by procedures that are wellestablished among physicians and patients and are routinely taught to newphysicians. As a result, we believe that recommendations and endorsements byphysicians will be essential for market acceptance of our product.  We donot know whether physicians and patients will accept our product or whether wewill be able to obtain their recommendations or endorsements in sufficientamounts to be profitable.  We believe that physicians will not use a productunless they determine, based on clinical data and other factors, that it is anattractive alternative to other means of contraception and that it offersclinical utility in a cost-effective manner. Physicians are traditionally slowto adopt new products and treatment practices, partly because of perceivedliability risks.  We are dependent on the*Essure* system, which is currently ouronly commercial product.  If the *Essure* system does not achieve significant market acceptanceamong physicians, patients and healthcare payers, even if reimbursement levelsare sufficient and necessary United States and international regulatoryapprovals are maintained, we may never achieve significant revenues orprofitability.

 

***Our futureliquidity and capital requirements are uncertain.***

 

As we commercialize the *Essure*system on a wide-scale basis, we may require additional financing and thereforemay in the future seek to raise additional funds through bank facilities, debtor equity offerings or other sources of capital. Any additional equityfinancing may be dilutive to stockholders, and debt financing, if available,may involve restrictive covenants and interest expense that will affect ourfinancial results. Additional funding may not be available when needed or on termsacceptable to us. If we are unable to obtain additional capital, we may berequired to delay, reduce the scope of or eliminate our selling and marketingactivities.  Our future liquidity and capital requirements will dependupon many factors, including, among others:

 

•      the rate of product adoption by doctorsand patients;

•      obtaining government and third-partyreimbursement for the *Essure*procedure;

 

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•      the liquidity of private insurance systems,as well as the timeliness of payments of government-management reimbursementsystems;

•      our ability to improve our days salesoutstanding;

•      the resources devoted to increasingmanufacturing capacity to meet commercial demands;

•      our ability to reduce our cost of sales;

•      the resources devoted to developing andconducting sales and marketing and distribution programs;

•      the progress and cost of productdevelopment programs; and

•      the potential requirement to make royaltypayments subject to the Ovion-Conceptus settlement agreement.

 

***If theeffectiveness and safety of our product are not supported by long-term data, wemay not achieve market acceptance and we could be subject to liability.***

 

In September 2005, the Company received from theU.S. Food and Drug Administration (FDA) approval to terminate the Company’spost-approval study with physicians newly trained in performing the *Essure* procedure due to the positive placement data obtainedto date. The purpose of the post-approval study, required by FDA as a conditionof the November 2002 approval of the *Essure* system,was to determine the rate of successful bilateral placements of the *Essure* micro-inserts at first attempt with a large number ofnewly trained physicians who were not part of the previous clinical studies.Although treatment of the total number of patients required by FDA had not beencompleted, the data obtained to date provided the Company with the ability torequest an early termination of the study.

 

Nevertheless, the long-term results of using the *Essure* micro-inserts will not be available for severalyears. If long-term studies or clinical experience indicate that the *Essure* system is less effective or less safe than ourcurrent data suggest, we may not achieve or sustain market acceptance and/or wecould be subject to significant liability.

 

***Our agreements and contracts entered intowith partners and other third parties may not be successful.***

 

Wesigned in the past and may pursue in the future contracts and agreements withthird parties that would assist our marketing, manufacturing, selling anddistribution efforts. We may not be able to comply with obligations orperformance clauses that could lead us to significant liability and ourpartners may not be able to achieve the provisions established in thesecontracts and agreements.

 

On October 30,2003, we announced the signing of an exclusive U.S. co-promotion agreement withGynecare for marketing the Essure system in the United States in combinationwith the Gynecare Thermachoice Uterine Balloon Therapy endometrial ablationsystem. As filed with the Securities and Exchange Commission on Form 8-Kon August 10, 2005, the Company and Gynecare Worldwide mutually agreed toterminate, effective August 4, 2005, the Exclusive Co-Promotion Agreemententered into by the companies on October 30, 2003.

 

***We have limitedsales and marketing experience and minimal distribution capabilities, and if weare unable to develop our sales and marketing capabilities or be successful inour marketing agreements with external parties, we may be unsuccessful incommercializing the Essure system.***

 

In order to market, sell and distribute the *Essure* system, we will need to maintain and continue todevelop a sales force and marketing group with relevant experience.  Developing a marketing and sales force isexpensive and time consuming and can impact the effectiveness of our productlaunch.  If we fail to establish adequate marketing and salescapabilities, we may be unable to commercialize the *Essure*system successfully.  Furthermore, certain factors in our relationshipwith external parties are outside of our control, such as the number of salespersons, their compensation and the number of products they are selling, whichcould adversely impact the revenues and market development.

 

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***Our advertisingcampaigns may not be successful***

 

Advertising programs, which are aimed at increasingconsumer awareness for our product, are generally expensive and may havelimited success, if any.  Such campaigns require consumers to make contactwith an *Essure* physician, often involving areferral from their primary care physician and then to be provided informationregarding birth control options by the physician, be pre-authorized forinsurance reimbursement and then be scheduled for the procedure.  Many ofthese steps are not within our control, and the program may not result inrevenue generation commensurate with its costs.

 

***We depend on ourcontract manufacturer to supply our commercial product requirements and we mayexperience disruption in supply if they are not in compliance with FDA andother health authority regulations or if our manufacturer’s business fails tosucceed.***

 

In April 2004, we received FDA approval to beginmanufacturing the *Essure* product at Accellent,formerly named Venusa, our third-party subcontractor located in Mexico. We transitioned almost all of our internal manufacturing operations toAccellent by the end of 2004 to manufacture the components and assemble ourproduct.  If Accellent does not complywith FDA and other health authority regulations or encounters manufacturingdifficulties, this could negatively impact sales of the *Essure*system.

 

***Government or thirdparty reimbursement for the Essure procedure may not be available or may beinadequate, which would limit our future product revenues and delay or preventour profitability.***

 

Market acceptance of the *Essure*system in the United States and in international markets will depend in partupon the availability of reimbursement within prevailing healthcare paymentsystems. Reimbursement systems in international markets vary significantly bycountry and sometimes by region, and reimbursement approvals must be obtainedon a country-by-country basis. Many international markets havegovernment-managed health care systems that determine reimbursement for newdevices and procedures. In most markets, there are private insurance systems aswell as government-managed systems. Regardless of the type of reimbursementsystem, we believe that physician advocacy of our product will be required toobtain reimbursement. Availability and extent of continued reimbursement willdepend, at least in part, on the clinical and cost effectiveness of ourproduct. We cannot ensure that reimbursement for our product will continue tobe available in the United States or in international markets under eithergovernment or private reimbursement systems, or that physicians will supportand advocate reimbursement for use of our product for all indications intendedby us.  We may be unable to obtain ormaintain reimbursement in any country within a particular time frame, for aparticular amount, or at all, which would limit our future product revenues anddelay or prevent our profitability.

 

***We may not maintainregulatory approvals for the Essure system, our only product, which would delayor prevent us from generating product revenues, and would harm our business andforce us to curtail or cease operations.***

 

Numerous government authorities, both in the UnitedStates and internationally, regulate the manufacture and sale of medicaldevices, including the *Essure* system. In the United States, the principal regulatory authorities are the FDA andcorresponding state agencies, such as the California Department of HealthServices. The process of obtaining and maintaining required regulatoryclearances is lengthy, expensive and uncertain.

 

We have received FDA approval to market the *Essure* system in the United States.  If we lose thatapproval or fail to comply with existing or future regulatory requirements, itwould delay or prevent us from generating further product revenues.

 

Sales of medical devices outside of the United Statesare subject to international regulatory requirements that vary widely fromcountry to country. The time required to obtain clearance required by foreigncountries may be longer or shorter than that required for FDA clearance, andrequirements for licensing may differ significantly from FDA requirements. Manycountries in which we currently market or intend to market the *Essure* system either do not currently regulate medicaldevices or have minimal registration requirements; however, these countries maydevelop more extensive regulations in the future, which could delay or preventus from marketing the *Essure* systemin these countries.

 

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The FDA and certain foreign regulatory authoritiesimpose numerous requirements with which medical device manufacturers mustcomply in order to maintain regulatory approvals. FDA enforcement policystrictly prohibits the promotion of approved medical devices for uses otherthan those for which the device is specifically approved by the FDA. We will berequired to adhere to applicable FDA regulations, such as the Quality SystemRegulation, and similar regulations in other countries, which include testing,control and documentation requirements. Ongoing compliance with the QualitySystem Regulation and other applicable regulatory requirements will be monitoredthrough periodic inspections by federal and state agencies, including the FDAand the California Department of Health Services, and by comparable agencies inother countries. If we fail to comply with applicable regulatory requirements,we may be subject to, among other things, warning letters, fines, injunctions,civil penalties, recall or seizure of products, total or partial suspension ofproduction, refusal of the government to grant pre-market clearance orpre-market approval for devices, withdrawal of approvals and criminalprosecution, any of which could negatively impact our business.

 

***Our intellectualproperty rights may not provide meaningful commercial protection for ourproduct, which could enable third parties to use our technology, or very similartechnology, and could impair our ability to compete in the market.***

 

We rely on patent, copyright, trade secret andtrademark laws to limit the ability of others to compete with us using the sameor similar technology in the United States and other countries. However, asdescribed below, these laws afford only limited protection and may notadequately protect our rights to the extent necessary to sustain anycompetitive advantage we may have. The laws of some foreign countries do notprotect proprietary rights to the same extent as the laws of the United States,and many companies have encountered significant problems in protecting theirproprietary rights abroad. These problems can be caused by the absence of rules andmethods for defending intellectual property rights.

 

We will be able to protect our technology fromunauthorized use by third parties only to the extent that they are covered byvalid and enforceable patents or are effectively maintained as trade secrets.The patent positions ofcompanies developing medical devices, including our patent position,generally are uncertain and involve complex legal and factual questionsconcerning the enforceability of such patents against alleged infringement.Recent judicial decisions have established new case law and a reinterpretationof previous patent case law, and consequently we cannot ensure that historicallegal standards surrounding the questions of infringement and validity will beapplied in future cases. In addition, legislation may be pending in Congressthat, if enacted in its present form, may limit the ability of medical devicemanufacturers in the future to obtain patents on surgical and medicalprocedures that are not performed by, or as a part of, devices or compositionsthat are themselves patentable. Our ability to protect our proprietary methodsand procedures may be compromised by the enactment of this legislation or anyother limitation or reduction in the patentability of medical and surgicalmethods and procedures. Changes in either the patent laws or in interpretationsof patent laws in the United States and other countries may therefore diminishthe value of our intellectual property.

 

We own, or control through licenses, a variety ofissued patents and pending patent applications. However, the patents on whichwe rely may be challenged and invalidated, and our patent applications may notresult in issued patents. Moreover, our patents and patent applications may notbe sufficiently broad to prevent others from practicing our technologies orfrom developing competing products. We also face the risk that others mayindependently develop similar or alternative technologies or design around ourpatented technologies.

 

We have taken security measures to protect ourproprietary information, especially proprietary information that is not coveredby patents or patent applications. These measures, however, may not provideadequate protection of our trade secrets or other proprietary information. Weseek to protect our proprietary information by entering into confidentialityagreements with employees, collaborators and consultants. Nevertheless,employees, collaborators or consultants could still disclose our proprietaryinformation and we may not be able to protect our trade secrets in a meaningfulway. If we lose any employees, we may not be able to prevent the unauthorizeddisclosure or use of our technical knowledge or other trade secrets by thoseformer employees despite the existence of a nondisclosure and confidentialityagreement and other contractual restrictions designed and intended to protectour proprietary technology. In addition, others may independently developsubstantially equivalent proprietary information or techniques or otherwisegain access to our trade secrets.

 

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Our ability to compete effectively will dependsubstantially on our ability to develop and maintain proprietary aspects of ourtechnology. Our issued patents, any future patents that may be issued as aresult of our United States or foreign patent applications, or the patentsunder which we have license rights may not offer any degree of protectionagainst competitive products. Any patents that may be issued or licensed to usor any of our patent applications could be challenged, invalidated orcircumvented in the future.

 

***If we cannotoperate our business without infringing third-party intellectual propertyrights, our prospects will suffer.***

 

Our success will depend in part on our ability tooperate without infringing or misappropriating the proprietary rights ofothers. We may be exposed to future litigation by third parties based on claimsthat our product infringes the intellectual property rights of others. Thereare numerous issued patents in the medical device industry and, as described inthe next risk factor, the validity and breadth of medical device patentsinvolve complex legal and factual questions for which important legalprinciples remain unresolved. Our competitors may assert that our product andthe methods we employ may be covered by United States or foreign patents heldby them. In addition, because patent applications can take many years to issue,there may be currently pending patent applications of which we are unaware thatmay later result in issued patents that our product may infringe. There couldalso be existing patents of which we are unaware that our product mayinadvertently infringe. If we lose a patent infringement lawsuit, we could beprevented from selling our product unless we can obtain a license to usetechnology or ideas covered by that patent or are able to redesign the productto avoid infringement. A license may not be available to us on terms acceptableto us, or at all, and we may not be able to redesign our product to avoid any infringement.If we are not successful in obtaining a license or redesigning our product, wemay be unable to sell our product and our business would suffer.

 

***We have been, andmay be in the future, a party to patent litigation, which could be expensiveand divert our management’s attention.***

 

The medical device industry has been characterized byextensive litigation regarding patents and other intellectual property rights,and companies in the industry have used intellectual property litigation togain a competitive advantage. We may become a party to patent infringementclaims and litigation or interference proceedings declared by the United StatesPatent and Trademark Office (“PTO”), to determine the priority of inventions.The defense and prosecution of these matters are both costly and timeconsuming. We may need to commence proceedings against others to enforce ourpatents, to protect our trade secrets or know-how or to determine theenforceability, scope and validity of the proprietary rights of others. Theseproceedings would result in substantial expense to us and significant diversionof effort by our technical and management personnel.

 

A third party, Ovion, Inc. (“Ovion”), which isnow a subsidiary of American Medical Systems (“AMS”), brought to our attentiona patent and certain claims from a pending patent application owned byit.  Ovion indicated that it believes that the claims of its patent andapplication cover the *Essure* systemand its use. On October 23, 2003, we entered into a settlement agreementwith Ovion pursuant to which we received a sole, worldwide license to Ovion’spatent rights relative to the *Essure* system,and Ovion may not grant any additional such licenses to other parties. The settlement agreement provided for the payment of a royalty to Ovion thatwill be equal to 3.25% of the cumulative net sales of the *Essure*system in excess of $75.0 million for a period of no longer than tenyears.  In addition, the settlement agreement provided for a cash paymentof $2.0 million in the fourth quarter of 2003 as a prepaid royalty, and alicense fee of $2.0 million payable in our common stock in equal installmentsin the first and second quarters of 2004.  Ovion was not granted anyrights to our intellectual property pursuant to the settlement agreement. The settlement agreement was approved by the U.S. District Court for theNorthern District of California on November 6, 2003.

 

Although we have reached a settlement agreement withOvion, we still believe that some or all of Ovion’s claims should be includedwithin our own patents and we have requested that the PTO to declare aninterference.  An interference is a proceeding within the PTO to determinewhich party was the first to invent, and which party is thereby entitled toownership of the claims. We believe that we filed our patent applications for the*Essure* system before Ovion filed theapplication that issued as its patent, and that we are entitled to anypatentable claims now appearing in their patent that cover our product. We donot know whether the PTO will declare an interference, whether we invented ourproduct prior to Ovion’s date of invention, or whether we will prevail in aninterference

 

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proceedingif it is declared by the PTO.  If the PTO declares an interference in ourfavor and we are found to have priority of invention, we may avoid having topay Ovion future royalties on the sales of our product.

 

An adverse determination in new litigation orinterference proceedings to which we are or may become a party could subject usto significant liabilities to third parties or require us to seek licenses fromthird parties. Although patent and intellectual property disputes in themedical device area have often been settled through licensing or similararrangements, costs associated with such arrangements may be substantial andcould include ongoing royalties. We may be unable to obtain necessary licenseson satisfactory terms, if at all. Adverse determinations in a judicial or administrativeproceeding or failure to obtain necessary licenses could prevent us frommanufacturing and selling the *Essure* system.

 

One of the patents included in our license from TargetTherapeutics, a division of Boston Scientific Corporation, has been the subjectof reexamination proceedings in the PTO and an infringement lawsuit by TargetTherapeutics.  We are not a party to thislawsuit.  The patent is directed tovariable stiffness catheters for use with guidewires, as might be used in ourfuture products. Although the PTO reaffirmed the patent with amended claims andthe lawsuit was settled, the patent could be challenged or invalidated in thefuture. If this patent is invalidated, our ability to prevent others from usingthis proprietary technology would be compromised.

 

***If we fail tomanage any expansion, our business could be impaired.***

 

We may in the future acquire one or more technologies,products or companies that complement our business. We may not be able toeffectively integrate these into our business and any such acquisition couldbring additional risks, exposures and challenges to our company.  If we fail to manage any acquisition, ourbusiness could be impaired.

 

***Our third-partymanufacturer and we will depend upon third party and single source suppliersfor raw materials and finished goods and we do not have forward contracts withmany of these suppliers.***

 

We and our third party manufacturer purchase both rawmaterials used in our product and finished goods from various suppliers, and werely on a single source for one component of our product, the polyester fiber.We do not have formal supply contracts with several key vendors and,accordingly, these firms may not continue to supply us or our third partymanufacturer with raw materials or finished goods in sufficient quantities, orat all. Delays associated with any future raw materials or finished goodsshortages could impair our sales of the *Essure* system,particularly as our third-party manufacturer scales up its manufacturingactivities in support of United States and international commercial sales of the*Essure* system.

 

***Health care reformmay limit our return on our product.***

 

The levels of revenue and profitability of medicaldevice companies may be affected by the efforts of government and third partypayers to contain or reduce the costs of health care through various means. Inthe United States, there have been, and we expect that there will continue tobe, a number of federal, state and private proposals to control health carecosts. These proposals may contain measures intended to control public andprivate spending on health care, as well as to provide universal public accessto the health care system. If enacted, these proposals may result in asubstantial restructuring of the health care delivery system. Significantchanges in the United States health care system are likely to have asubstantial impact over time on the manner in which we conduct our business andcould have a material adverse effect on our business, financial condition andresults of operations.

 

***We may be exposedto product liability claims, and we have only limited insurance coverage.***

 

The manufacture and sale of medical products involvean inherent risk of exposure to product liability claims and productrecalls.  We currently maintain productliability insurance with coverage limits of $10.0 million per occurrence and anannual aggregate maximum of $10.0 million, which we believe is comparable tothat maintained by other companies of similar size serving similar markets.However, we cannot ensure that product liability claims in connection withclinical trials or commercial sales of the *Essure* systemwill not exceed such insurance coverage limits or that such insurance willcontinue to be available on commercially reasonable terms, or at all. Insuranceis expensive and in the future may not be available on acceptable terms, if atall. A successful

 

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productliability claim or series of claims brought against us in excess of ourinsurance coverage, or a recall of our product, could cause our stock price tofall.

 

***We may not be ableto attract and retain additional key management, sales and marketing andtechnical personnel or we may lose existing key management, sales and marketingor technical personnel, which may delay our development and marketing efforts.***

 

We depend on a number of key management, sales andmarketing and technical personnel. The loss of the services of one or more keyemployees could delay the achievement of our development and marketingobjectives. Our success will also depend on our ability to attract and retainadditional highly qualified management, sales and marketing and technicalpersonnel to meet our growth goals. We face intense competition for qualifiedpersonnel, many of whom are often subject to competing employment offers, andwe do not know whether we will be able to attract and retain such personnel.

 

***We face intensecompetition, and if we are unable to compete effectively, demand for the Essuresystem may be reduced.***

 

The medical device industry is highly competitive andis characterized by rapid and significant technological change. The length oftime required for product development and regulatory approval plays animportant role in a company’s competitive position. As we commercialize *Essure*, we expect to compete with:

 

•      other methods of permanent contraception,in particular tubal ligation;

•      other methods of non-permanentcontraception, including devices such as intrauterine devices, or IUDs, vaginalrings, condoms and prescription drugs such as the birth control pill,injectable and implantable contraceptives and patches; and

•      other companies that may developpermanent contraception devices that are similar to or otherwise compete with the*Essure* system.

 

We are aware of a company that is in the clinicalstages of development for non-incisional permanent contraception devices. Inaddition, high competition may arise due to mergers or acquisitions performedby external parties. Other companies may develop products that could competewith the *Essure* system.  Competitive factorsmay render the *Essure* system obsolete ornoncompetitive or reduce demand for the *Essure* system.

 

***Our futurequarterly results may fluctuate.***

 

Our future revenues and results of operations mayfluctuate significantly from quarter to quarter and will depend upon, amongother factors:

 

•      the rate at which new physicians aretrained;

•      actions relating to reimbursementmatters;

•      the rate at which we establish UnitedStates and international distributors or marketing partners and the degree oftheir success;

•      the extent to which the *Essure* system gains market acceptance;

•      the timing and size of distributorpurchases;

•      introduction of competitive products; and

•      the achievement of other circumstancesincluded in this form 10-Q.

 

***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. SFAS No. 123 allowed companies thechoice of either using a fair value method of accounting for options, whichwould result in expense recognition for

 

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alloptions granted, or using an intrinsic value method, as prescribed byAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees” (“APB 25”), with a pro forma disclosure of the impact on netincome (loss) of using the fair value option expense recognition method. We hadelected to apply APB 25 and accordingly we generally do not recognize anyexpense with respect to employee stock options as long as such options aregranted at exercise prices equal to the fair value of our common stock on thedate of grant.

 

In December 2004, FASB issued, SFAS No. 123(R)“Share-Based Payments”.  We will adoptthis statement on January 1, 2006, which is the first annual reportingperiod after June 15, 2005. This statement will have a significant impacton our consolidated statement of operations as we will be required to expensethe fair value of our stock options rather than disclosing the impact on ourconsolidated result of operations within our footnotes in accordance with thedisclosure provisions of SFAS No. 123. This will result in lower reportedearnings per share or in higher reported losses per share, which couldnegatively impact our future stock price. In addition, this could impact ourability to utilize broad based employee stock plans to reward employees andcould result in a competitive disadvantage to us in the employee marketplace.

 

***Future changes infinancial accounting standards or practices or existing taxation rules orpractices may cause adverse unexpected revenue fluctuations and affect ourreported results of operations.***

 

A change in accounting standards or practices or achange in existing taxation rules or practices can have a significanteffect on our reported results and may even affect our reporting oftransactions completed before the change is effective. New accountingpronouncements and taxation rules and varying interpretations ofaccounting pronouncements and taxation practice have occurred and may occur inthe future. Changes to existing rules or the questioning of currentpractices may adversely affect our reported financial results or the way weconduct our business.

 

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

 

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

 

*Interest Rate Risk*:  We have been exposed to interest rate risk asit applies to interest earned on holdings of available-for-sale marketablesecurities.  Interest rates that mayaffect these items in the future will depend on market conditions and maydiffer from the rates we have experienced in the past. The fair value of ourinvestment portfolio or related income would not be significantly impacted bychanges in interest rates since we reduce the sensitivity of our results ofoperations to these risks by maintaining an investment portfolio, which isprimarily comprised of highly rated, marketable securities.  We do not hold or issue derivative, commodityinstruments or other financial instruments for trading purposes.

 

*Foreign Currency Exchange Risk*:  Our expenses, except for those related toAustralia, were denominated in United States dollars.  Our revenues, 0% and 2% of which weredenominated in foreign currencies in the three months ended September 30,2005 and 2004, respectively, and 0% and 3% for the nine months ended September 30,2005 and 2004, respectively, were immaterial in relation to our overallfinancial position.  As a result, we havelittle exposure for currency exchange risks and foreign exchange losses havebeen minimal to date.  We do not enterinto forward exchange contracts to hedge exposure denominated in foreigncurrencies or any other derivative financial instruments for trading orspeculative purposes.  In the future, ifwe feel our foreign currency exposure has increased, we may consider enteringinto hedging transactions to help mitigate that risk.  As of September 30, 2005, a fluctuationin exchange rates of 10% in the foreign currencies to which we are exposedwould not have a material impact on our results of operations or financialcondition.

 

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**Item 4.Controls and 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 September 30,2005, 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 at the reasonable assurance level.

 

*Changes in Internal Control Over Financial Reporting:*

 

There wasno change in our internal controls over financial reporting during our mostrecent fiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal controls 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.  Internal control over financial reporting is aprocess that involves human diligence and compliance and is subject to lapsesin judgment and breakdowns resulting from human failures. Internal control overfinancial reporting also can be circumvented by collusion or impropermanagement override. Because of such limitations, there is a risk that materialmisstatements may not be prevented or detected on a timely basis by internalcontrol over financial reporting. However, these inherent limitations are knownfeatures of the financial reporting process. Therefore, it is possible todesign into the process safeguards to reduce, though not eliminate, this risk.**

** **

**PART II.  OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

On October 23,2003, we entered a settlement agreement with Ovion, Inc. (“Ovion”). Inconnection with this agreement, we were granted a Right of First Refusal (“ROFR”)on any sale or acquisition of Ovion. On June 3, 2005, American MedicalSystems (“AMS”) announced that it had entered into a definitive agreement toacquire Ovion. The completion of this transaction was subject to our ROFR.

 

Weexercised the ROFR on Saturday, July 2, 2005 within the 30 day periodprovided for in the settlement agreement. On Tuesday, July 5, 2005, we werenotified by Ovion that it had rejected the exercise of Conceptus’ ROFR option.On July 6, 2005, Conceptus filed a motion in Delaware Chancery Court forthe issuance of a temporary restraining order to enjoin the transaction betweenOvion and AMS pending resolution of our claims against Ovion. That request fora temporary restraining order was rejected by the Chancery Court, therebyproviding clearance for the completion of the acquisition of Ovion by AMS.

 

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

 

**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds**

 

On August 11,2005, the Company closed the sale of a private placement of approximately3,200,000 shares of newly issued common stock at a price of $7.20 per share toinstitutional investors and $8.10 per share to officers and directors. The netproceeds to the Company, after fees and offering costs totaling approximately$116,000, were approximately $22,890,000.

 

In thefirst quarter of 2005, the Company repurchased 2,000 shares of restrictedcommon stock at par value in accordance with the terms of a restricted stockagreement.  In addition, in the thirdquarter of 2005, the Company repurchased 3,863 shares of restricted commonstock at par value in accordance with the terms of the restricted stockagreements.  The shares of restrictedstock had a purchase price of $0.003 per share and the Company’s repurchaseright with respect to such shares lapses either in equal installments overthree years or at the end of the three years, depending on the terms on therespective shares. These shares are recorded as treasury stock and the Companyholds as of September 30, 2005 a total of 77,863 shares of treasury stock.

 

**ISSUER PURCHASES OF EQUITY SECURITIES**

 
| **Period**                                              | ** ** | **Total Number   of Shares  Purchased (1)** | ** ** | **Average Price  Paid per Share** | ** **      | **Total Number   of Shares   Purchased as   Part of   Publicly   Announced   Program** | ** ** | **Maximum   Number of   Shares That   May Yet Be   Purchased   Under This   Program** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------|-----------------|---------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| ** **                                              | ** ** | ** **                                  | ** ** | ** **                        | ** **      | ** **                                                                                  | ** ** | ** **                                                                                 | ** ** |
| January 1, 2005 through January 31, 2005      |       | 0                                           |       | 0                                 |            | 0                                                                                           |       | 0                                                                                          |       |
| February 1, 2005 through February 28, 2005    |       | 0                                           |       | 0                                 |            | 0                                                                                           |       | 0                                                                                          |       |
| March 1, 2005 through March 31, 2005          |       | 2,000                                       |       | $                                 |  0.003     |                                                                                        | 0          |                                                                                       | 0          |   |
| April 1, 2005 through April 30, 2005          |       | 0                                           |       | 0                                 |            | 0                                                                                           |       | 0                                                                                          |       |
| May 1, 2005 through May 31, 2005              |       | 0                                           |       | 0                                 |            | 0                                                                                           |       | 0                                                                                          |       |
| June 1, 2005 through June 30, 2005            |       | 0                                           |       | 0                                 |            | 0                                                                                           |       | 0                                                                                          |       |
| July 1, 2005 through July 31, 2005            |       | 750                                         |       | $                                 |  0.003     |                                                                                        | 0          |                                                                                       | 0          |   |
| August 1, 2005 through August 31, 2005        |       | 0                                           |       | 0                                 |            | 0                                                                                           |       | 0                                                                                          |       |
| September 1, 2005 through September 30,  2005 |       | 3,113                                       |       | $                                 |  0.003     |                                                                                        | 0          |                                                                                       | 0          |   |
| **TOTAL**                                               | ** ** | **5,863**                                   | ** ** | **$**                             | ** 0.003** | ** **                                                                                  | **0**      | ** **                                                                                 | **0**      | ** ** |

 

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(1) *The Company purchased a total of 5,863 shares of restricted stockduring year 2005 year-to-date from former employees in accordance with theterms of the Restricted Stock Purchase Agreements relating to such shares.*

 

**Item3.  Defaults upon Senior Securities**

 

None.

 

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**Item4.  Submission of Matters to a Vote ofSecurity Holders**

 

None.

 

**Item 5.  Other Information**

 

None.

 

**Item 6. Exhibits**

 

(a)   Exhibits.

 
| 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:  November 9,2005

 

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