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** **

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

** **

**Washington, D.C. 20549**

** **

**FORM 10-Q**

 
| **ý**                                                  | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| ** **                                                  | ** ** | ** **                                                                                               |
| **For the quarterly period ended  September 30, 2008** |
| ** **                                                  | ** ** | ** **                                                                                               |
| **OR**                                                      |
| ** **                                                  | ** ** | ** **                                                                                               |
| **o**                                                       | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

** Forthe transition period from              to                    .**

** **

**Commission File Number: 0-27596**

 

**CONCEPTUS, INC.**

(Exact name of Registrant as specified in itscharter)

 

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

 

**331 East Evelyn**

**Mountain View, CA 94041**

(Address of Principal Executive Offices) (ZipCode)

 

**(650) 962-4000**

(Registrant’s Telephone Number, IncludingArea Code)

 

 

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

 

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

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non accelerated filer or a smaller reportingcompany. See definition of “large accelerated filer” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act

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

 

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

 

Yes  o   No  x

 

There were 30,353,626 shares of Registrant’s Common Stock issued andoutstanding as of October 31, 2008.

 

 

 

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**CONCEPTUS, INC.**

** **

**FORM 10-Q for the Quarter Ended September 30,2008**

 
| ** **    | ** **                                                                                                                 | **Page**   |
|---------------|----------------------------------------------------------------------------------------------------------------------------|------------|
| ** **    | ** **                                                                                                                 | ** ** |
| Part I.  | Financial Information                                                                                                      | 1          |
|          |                                                                                                                       |       |
| Item 1.       | Condensed Consolidated Financial  Statements (Unaudited)                                                                   | 1          |
|          | a)  Condensed Consolidated Balance Sheets as of September 30, 2008 and  December 31, 2007                        | 1          |
|          | b)  Condensed Consolidated Statements of Operations for the Three and Nine Months  Ended  September 30, 2008 and 2007 | 2          |
|          | c)  Condensed Consolidated Statements of Cash Flows for the Nine Months Ended  September 30, 2008 and 2007            | 3          |
|          | d) Notes to Condensed Consolidated Financial  Statements                                                                   | 4          |
|          |                                                                                                                       |       |
| Item  2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                | 16         |
|          |                                                                                                                       |       |
| Item  3.      | Quantitative  and Qualitative Disclosures About Market Risk                                                                | 24         |
|          |                                                                                                                       |       |
| Item 4.       | Controls and  Procedures                                                                                                   | 25         |
|          |                                                                                                                       |       |
| Part II. | Other Information                                                                                                          | 25         |
|          |                                                                                                                       |       |
| Item 1.       | Legal Proceedings                                                                                                          | 25         |
|          |                                                                                                                       |       |
| Item 1A.      | Risk Factors                                                                                                               | 25         |
|          |                                                                                                                       |       |
| Item 6.       | Exhibits                                                                                                                   | 27         |

 

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**PART I. FINANCIAL INFORMATION**

** **

**1. Condensed Consolidated FinancialStatements.**

** **

**Conceptus, Inc.**

** **

**CondensedConsolidated Balance Sheets**

**(Unaudited)**

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

** **
| ** **                                          | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                          | ** ** | **2008**               | ** **  | **2007**              | ** ** |
| **Assets**                                          |       |                   |        |                  |       |
| Current assets:                                     |       |                   |        |                  |       |
| Cash and cash equivalents                           |       | $                      | 23,804      |                  | $          | 28,450 |   |
| Short-term investments                              |       | —                 |        | 16,700                |       |
| Accounts receivable, net                            |       | 14,214                 |        | 11,903                |       |
| Inventories                                         |       | 4,702                  |        | 2,418                 |       |
| Other current assets                                |       | 2,893                  |        | 3,271                 |       |
| Total current assets                                |       | 45,613                 |        | 62,742                |       |
|                                                |       |                   |        |                  |       |
| Property and equipment, net                         |       | 8,118                  |        | 5,312                 |       |
| Debt issuance costs, net                            |       | 2,090                  |        | 2,555                 |       |
| Intangible assets, net                              |       | 5,598                  |        | 1,164                 |       |
| Long-term investments                               |       | 45,608                 |        | 48,800                |       |
| Goodwill                                            |       | 15,892                 |        | —                |       |
| Other assets                                        |       | 153                    |        | 102                   |       |
|                                                |       |                   |        |                  |       |
| **Total assets**                                    | ** ** | **$**                  | **123,072** | ** **            | **$**      | **120,675** | ** ** |
|                                                |       |                   |        |                  |       |
| **Liabilities and stockholders’ equity**       |       |                   |        |                  |       |
| Current liabilities:                                |       |                   |        |                  |       |
| Accounts payable                                    |       | $                      | 4,795       |                  | $          | 4,744 |   |
| Accrued compensation                                |       | 5,945                  |        | 3,175                 |       |
| Other accrued liabilities                           |       | 4,298                  |        | 4,339                 |       |
| Total current liabilities                           |       | 15,038                 |        | 12,258                |       |
|                                                |       |                   |        |                  |       |
| Notes payable                                       |       | 86,250                 |        | 86,250                |       |
| Other accrued liabilities                           |       | 471                    |        | 240                   |       |
|                                                |       |                   |        |                  |       |
| Total liabilities                                   |       | 101,759                |        | 98,748                |       |
|                                                |       |                   |        |                  |       |
| Stockholders’ equity:                          |       |                   |        |                  |       |
| Common stock and additional paid-in capital         |       | 264,735                |        | 257,176               |       |
| Accumulated other comprehensive loss                |       | (3,161                 | )           | —                |       |
| Accumulated deficit                                 |       | (240,261               | )           | (235,249              | )          |
| Treasury stock, 77,863 shares, at cost              |       | —                 |        | —                |       |
| Total stockholders’ equity                     |       | 21,313                 |        | 21,927                |       |
| **Total liabilities and stockholders’ equity** | ** ** | **$**                  | **123,072** | ** **            | **$**      | **120,675** | ** ** |

 

*The accompanying notes are an integral partof these condensed consolidated financial statements.*

 

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**Conceptus, Inc.**

** **

**CondensedConsolidated Statements of Operations**

**(Unaudited)**

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

 
| ** **                                       | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales                                        |       | $                                                    | 26,645     |                                                | $          | 16,430 |   | $ | 73,452 |   | $ | 45,879 |   |
| Cost of goods sold                               |       | 5,090                                                |       | 4,317                                               |       | 15,731 |   | 12,260 |   |
| Gross profit                                     |       | 21,555                                               |       | 12,113                                              |       | 57,721 |   | 33,619 |   |
|                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Operating expenses:                              |       |                                                 |       |                                                |       |   |   |   |   |
| Research and development                         |       | 1,611                                                |       | 1,513                                               |       | 5,186 |   | 4,216 |   |
| Selling, general and administrative              |       | 16,363                                               |       | 13,917                                              |       | 56,546 |   | 40,098 |   |
| Total operating expenses                         |       | 17,974                                               |       | 15,430                                              |       | 61,732 |   | 44,314 |   |
|                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Operating income (loss)                          |       | 3,581                                                |       | (3,317                                              | )          | (4,011 | ) | (10,695 | ) |
|                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Interest income                                  |       | 361                                                  |       | 1,335                                               |       | 1,590 |   | 3,460 |   |
| Interest expense                                 |       | (643                                                 | )          | (653                                                | )          | (1,920 | ) | (1,640 | ) |
| Other expense                                    |       | (211                                                 | )          | —                                              |       | (390 | ) | — |   |
| Total other income (loss)                        |       | (493                                                 | )          | 682                                                 |       | (720 | ) | 1,820 |   |
|                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Income (loss) before provision for income  taxes |       | 3,088                                                |       | (2,635                                              | )          | (4,731 | ) | (8,875 | ) |
|                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Provision for income taxes                       |       | 113                                                  |       | —                                              |       | 281 |   | — |   |
|                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Net income (loss)                                |       | $                                                    | 2,975      |                                                | $          | (2,635 | ) | $ | (5,012 | ) | $ | (8,875 | ) |
|                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Basic net income (loss) per share:               |       |                                                 |       |                                                |       |   |   |   |   |
| Net income (loss)                                |       | $                                                    | 0.10       |                                                | $          | (0.09 | ) | $ | (0.17 | ) | $ | (0.30 | ) |
| Shares used in per share amounts                 |       | 30,342                                               |       | 29,525                                              |       | 30,165 |   | 29,405 |   |
|                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Diluted net income (loss) per share:             |       |                                                 |       |                                                |       |   |   |   |   |
| Net income (loss)                                |       | $                                                    | 0.10       |                                                | $          | (0.09 | ) | $ | (0.17 | ) | $ | (0.30 | ) |
| Shares used in per share amounts                 |       | 31,207                                               |       | 29,525                                              |       | 30,165 |   | 29,405 |   |

 

*The accompanying notes are an integral partof these condensed consolidated financial statements.*

 

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**Conceptus, Inc.**

** **

**CondensedConsolidated Statements of Cash Flows**

**(Unaudited)**

**(In thousands)**

 
| ** **                                                                   | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| **Cash flows from operating activities**                                     |       |                                                |       |   |   |
| Net loss                                                                     |       | $                                                   | (5,012     | ) | $ | (8,875 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                                |       |   |   |
| Depreciation and amortization of property  and equipment                     |       | 1,947                                               |       | 1,022 |   |
| Amortization of debt issuance costs                                          |       | 465                                                 |       | 387 |   |
| Amortization of intangibles                                                  |       | 591                                                 |       | 135 |   |
| Stock-based compensation expense                                             |       | 4,414                                               |       | 4,671 |   |
| Allowance for doubtful accounts                                              |       | 21                                                  |       | 262 |   |
| Loss on retirement of fixed assets                                           |       | 1                                                   |       | 19 |   |
| Changes in operating assets and  liabilities, net effect of acquisition:     |       |                                                |       |   |   |
| Accounts receivable                                                          |       | (1,473                                              | )          | (4,581 | ) |
| Inventories                                                                  |       | (404                                                | )          | (1,662 | ) |
| Other current assets                                                         |       | 675                                                 |       | (655 | ) |
| Other assets                                                                 |       | —                                              |       | 674 |   |
| Accounts payable                                                             |       | (823                                                | )          | (201 | ) |
| Accrued compensation                                                         |       | 501                                                 |       | (667 | ) |
| Other accrued and long term liabilities                                      |       | 1,434                                               |       | 2,498 |   |
| Net cash provided by (used in) operating  activities                         |       | 2,337                                               |       | (6,973 | ) |
|                                                                         |       |                                                |       |   |   |
| **Cash flows from investing activities**                                     |       |                                                |       |   |   |
| Purchase of Conceptus SAS, net of cash  acquired                             |       | (22,978                                             | )          | — |   |
| Purchase of investments                                                      |       | (5,000                                              | )          | (87,600 | ) |
| Sale & maturity of investments                                      |       | 22,050                                              |       | 18,100 |   |
| Capital expenditures                                                         |       | (4,149                                              | )          | (1,811 | ) |
| Net cash used in investing activities                                        |       | (10,077                                             | )          | (71,311 | ) |
|                                                                         |       |                                                |       |   |   |
| **Cash flows from financing activities**                                     |       |                                                |       |   |   |
| Proceeds from issuance of long term debt,  net of issuance costs             |       | —                                              |       | 86,250 |   |
| Payment of debt issuance cost                                                |       | —                                              |       | (3,097 | ) |
| Purchase of call options on convertible  senior notes                        |       | —                                              |       | (19,372 | ) |
| Proceeds from issuance of warrants                                           |       | —                                              |       | 10,695 |   |
| Proceeds from exercise of stock options                                      |       | 3,191                                               |       | 2,813 |   |
| Net cash provided by financing activities                                    |       | 3,191                                               |       | 77,289 |   |
|                                                                         |       |                                                |       |   |   |
| Effect of exchange rates on cash                                             |       | (97                                                 | )          | — |   |
|                                                                         |       |                                                |       |   |   |
| Net decrease in cash and cash equivalents                                    |       | (4,646                                              | )          | (995 | ) |
| Cash and cash equivalents at the beginning  of the period                    |       | 28,450                                              |       | 3,238 |   |
| Cash and cash equivalents at end of the  period                              |       | $                                                   | 23,804     |   | $ | 2,243 |   |

 

*The accompanying notes are an integral partof these condensed consolidated financial statements.*

 

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**Conceptus, Inc.**

 

***NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS***

 

***(Unaudited)***

 

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

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States for interim financial information and pursuant to theinstructions to Form 10-Q and Article 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes requiredby accounting principles generally accepted in the United States for completefinancial statements. In the opinion of management, all adjustments, consistingonly of normal recurring adjustments, considered necessary for a fair statementhave been included.

 

The condensed consolidated balance sheet at December 31, 2007 hasbeen derived from the audited consolidated financial statements at that date,but does not include all of the information and footnotes required byaccounting principles generally accepted in the United States for completefinancial statements. This financial data should be reviewed in conjunctionwith the audited consolidated financial statements and related notes includedin our Annual Report on Form 10-K for the year ended December 31,2007.  The results of operations for the three and nine months ended September 30,2008 may not necessarily be indicative of the operating results for the full2008 fiscal year or any other future interim periods.

 

Our condensed consolidated financial statements for the three and ninemonths ended September 30, 2008 include the financial results of ConceptusSAS starting on the acquisition date of January 7, 2008. All significantintercompany accounts and transactions have been eliminated in consolidation.

 

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

 

*Recent Accounting Pronouncements*

 

In September 2006, the Financial Standards Accounting Board, orFASB, issued Statement No. 157, *Fair Value Measurement,*or SFAS 157. This standard defines fair value, establishes the framework formeasuring fair value in accounting principles generally accepted in the UnitedStates and expands disclosure about fair value measurements. This pronouncementapplies under other accounting standards that require or permit fair valuemeasurements. SFAS 157 is effective for financial statements issued for yearsbeginning after November 15, 2007, and interim periods of those fiscalyears. FASB Staff Position, or FSP, No. 157-2, *EffectiveDate of FASB Statement No. 157* delays the effective date of SFAS157 for all non-financial assets and non-financial liabilities, except foritems that are recognized or disclosed at fair value in the financialstatements on a recurring basis (at least annually), until the beginning of thefirst quarter of 2009.  Effective January 1,2008 we adopted SFAS 157 for financial assets and liabilities carried at fairvalue. The adoption of SFAS 157 for financial assets and liabilities did nothave a material impact on our condensed consolidated financial statements.  See Note 4 - Fair Value Measurements.

 

In February 2007, FASB issued Statement No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*,or SFAS 159, which permits entities to choose to measure many financialinstruments and certain other items at fair value that are not currentlyrequired to be measured at fair value. SFAS 159 became effective for us on January 1,2008. The adoption of SFAS 159 did not have a material impact on our condensedconsolidated financial statements.

 

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In December 2007, FASB issued Statement No. 141 (revised2007), *Business Combinations,* or SFAS 141(R),and Statement No. 160, *Noncontrolling Interestsin Consolidated Financial Statements*, or SFAS 160, an amendment ofAccounting Research Bulleting No. 51, or ARB 51. SFAS 141(R) willimpact financial statements on the acquisition date and in subsequent periods.Some of the changes, such as the accounting for contingent consideration, willintroduce more volatility into earnings and may impact our acquisitionstrategy. SFAS 160 will change the accounting and reporting for minorityinterests, which will be re-characterized as non-controlling interests andclassified as a component of equity. In addition, SFAS 141(R) will beapplied prospectively and SFAS 160 will require retroactive adoption of thepresentation and disclosure requirements for existing minority interests, whilethe remaining requirements of SFAS 160 will be applied prospectively. SFAS 141(R) andSFAS 160 are effective on January 1, 2009. We are currently evaluating theimpact of adopting SFAS 141(R) and SFAS 160 on our consolidated financialstatements.

 

In March 2008, the FASB issued SFAS No. 161, *Disclosures about Derivative Instruments and Hedging Activities - anamendment of FASB Statement No. 133*, or SFAS 161.  SFAS 161 requires enhanced disclosures abouthow and why an entity uses derivative instruments, how derivative instrumentsand related hedged items are accounted for and their effect on an entity’sfinancial position, financial performance and cash flows. SFAS 161 will beeffective in the first quarter of fiscal year 2010.  We are evaluating the impact that thisstatement will have, if any, on our consolidated financial statements.

 

In April 2008, the FASB issued FSP No. 142-3, *Determination of the Useful Life of Intangible Assets*, orFSP 142-3.  FSP 142-3 amends the factorsan entity should consider in developing renewal or extension assumptions usedin determining the useful life of recognized intangible assets under FASBStatement No. 142, *Goodwill and OtherIntangible Assets*.  This newguidance applies prospectively to intangible assets that are acquired individuallyor with a group of other assets in business combinations and assetacquisitions.  FSP 142-3 is effective forfinancial statements issued for fiscal years and interim periods beginningafter December 15, 2008.  Earlyadoption is prohibited.  We areevaluating the impact, if any, that FSP 142-3 will have on our consolidatedfinancial statements.

 

In May 2008, the FASB issued FSP APB 14-1, *Accountingfor Convertible DebtInstruments That May Be Settled in Cash upon Conversion (Including PartialCash Settlement)*, orFSP APB 14-1, which clarifies the accounting for convertible debt instrumentsthat may be settled in cash upon conversion, including partial cashsettlement.  FSP APB 14-1 specifies thatan issue of such instruments should separately account for the liability andequity components of the instruments in a manner that reflect the issuer’snon-convertible debt borrowing rate which interest costs are recognized insubsequent periods.  FSP APB 14-1 iseffective for fiscal years beginning after December 15, 2008, andretrospective application is required for all periods presented.  We are evaluating the impact, if any, thatFAS APB 14-1 will have on our consolidated financial statements.

 

In October 2008, the FASB issued FSP No. 157-3, *Determining the Fair Value of a Financial Asset When the Market forThat Asset is Not Active*, or FSP 157-3, to clarify the applicationof the provisions of SFAS 157 in an inactive market and how an entity woulddetermine fair value in an inactive market. FSP 157-3 is effective immediatelyand applies to our September 30, 2008 financial statements. Theapplication of the provisions of FSP 157-3 did not have a material impact onour condensed consolidated financial statements.

 

**2.****              Summary of Significant Accounting Policies**

 

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

 

*Functional Currency*

 

On January 7, 2008 we acquired Conceptus SAS, which sells tocustomers in France and all of Europe. Our condensed consolidated financialstatements for the three and nine months ended September 30, 2008 includethe financial results of Conceptus SAS starting on January 7, 2008. Salesby Conceptus SAS are denominated in Euros. In preparing our consolidatedfinancial statements, we are required to translate the financial statements ofConceptus SAS from the currency in which they keep their accounting recordsinto U.S. Dollars.  Conceptus SASmaintains its accounting records in the functional currency which is also itsrespective local currency, the Euro. The functional currency is determined basedon management’s judgment and involves consideration of all relevant economicfacts and circumstances affecting the subsidiary. Generally, the currency in

 

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which the subsidiary transactsa majority of its transactions, including billing, financing, payroll and otherexpenditures would be considered the functional currency, but any dependencyupon the parent and the nature of the subsidiary’s operations must also beconsidered. Since the functional currency of Conceptus SAS has been determinedto be the Euro, any gain or loss associated with the translation of ConceptusSAS’ financial statements into U.S. Dollars is included as a component ofstockholders’ equity, in accumulated other comprehensive loss.  If in the future we determine that there hasbeen a change in the functional currency of Conceptus SAS from its localcurrency to the U.S. Dollar, any translation gains or losses arising after thedate of change would be included within our statement of operations.

 

*Goodwill*

 

Goodwill represents the excess of thepurchase price paid over the fair value of tangible and identifiable intangiblenet assets acquired in business combinations. We will perform an annualassessment during the fourth quarter of 2008 of our goodwill at the reportingunit level, or earlier if an event occurs or circumstances change that wouldreduce the fair value of the reporting unit below its carrying amount. Noimpairment charges have been recorded as of September 30, 2008.

 

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

 

As of September 30, 2008, we held $48.5 million (par value) inauction rate securities backed by federal and state student loans which arevariable rate debt instruments and bear interest rates that reset approximatelyevery 20-30 days.  These auction ratesecurities are rated AAA or AA by a major credit rating agency and havecontractual maturities that range from 20 to 39 years. The securities areclassified as available for sale and are recorded at fair value.  We recorded a temporary reduction in carryingvalue of $2.8 million for the nine months ended September 30, 2008, whichhas been recorded as an unrealized loss in accumulated other comprehensiveloss.  We have experienced failedauctions in 2008 of all of our auction rate securities and there is noassurance that auctions on these auction rate securities in our investmentportfolio will succeed in the future.  Anauction failure means that the parties wishing to sell securities could notcarry out the transaction.  As a resultof these auction failures, our ability to liquidate our investments in the nearterm may be limited, and our ability to fully recover the carrying value of ourinvestments may be limited or non-existent. If the issuers of these securities are unable to successfully closefuture auctions or their credit ratings deteriorate, we may in the future berequired to record an impairment charge on these investments.  It could take until the final maturity of theunderlying notes (up to 39 years) to realize our investments’ recordedvalue.

 

UBS Investment Bank holds 100% of our auction rate securities.  During October 2008, UBS Investment Bankinformed us that they have designed a settlement process that will give UBS’sclients the opportunity to sell all auction rate securities at par by June 2010,unless they are redeemed by the issuer sooner. We received confirmation from UBS Investment Bank in October thatall the auction rate securities that we currently hold are eligible toparticipate in this process and be redeemed at par.  We intend to participate in the settlementprocess and therefore expect all our auction rate securities to be settled atfull par value.

 

Given the recent disruptions in the credit markets and the fact thatthe liquidity for these types of securities remains uncertain, we haveclassified all of our auction rate securities as long-term investments in ourcondensed consolidated balance sheet as our ability to liquidate suchsecurities in the next 12 months is uncertain. The fair value of our auctionrate securities on our condensed consolidated balance sheet as of September 30,2008 was $45.6 million. See Note 4 – Fair Value Measurements for additionalinformation concerning fair value measurement of our auction rate securities.

 

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

 

As stated in Note 1 – Basis of Presentation, on January 1, 2008,we adopted the methods of fair value as described in SFAS 157 to value ourfinancial assets and liabilities.  Asdefined in SFAS 157, fair value is based on the price that would be received tosell an asset or paid to transfer a liability in an orderly transaction betweenmarket participants at the measurement date. In order to increase consistencyand comparability in fair value measurements, SFAS 157 establishes a fair valuehierarchy that prioritizes observable and unobservable inputs used to measurefair value into three broad levels, which are described below:

 

Level 1: Quoted prices (unadjusted) in active markets that are accessibleat the measurement date for assets or liabilities. The fair value hierarchygives the highest priority to Level 1 inputs.

 

Level 2: Observable prices that are based on inputs not quoted onactive markets, but corroborated by market data.

 

Level 3: Unobservable inputs are used when little or no market data isavailable. The fair value hierarchy gives the lowest priority to Level 3inputs.

 

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Our cash and cash equivalents are classified within Level 1 of the fairvalue hierarchy because they are valued using quoted market prices, broker ordealer quotations, or alternative pricing sources with a reasonable level ofprice transparency. As of September 30, 2008, our Level 1 instruments aresolely comprised of our investments in money market funds.

 

On January 7, 2008, we acquired Conceptus SAS (See Note 5 –Business Combination) and thereby assumed an outstanding foreign currencyforward contract to buy U.S. Dollars at fixed intervals with a term through December 18,2008. Conceptus SAS executed the foreign currency contract in the retail marketin an over-the-counter environment with a relatively high level of pricetransparency. The counterparty is a large regional bank located in France. Ourforeign currency contract valuation inputs are based on quoted prices andquoted pricing intervals from public data and do not involve managementjudgment. Accordingly, we have classified our outstanding foreign currencyforward contract within Level 2 of the fair value hierarchy and have recordedthe fair value of the contract in other accrued liabilities on our condensedconsolidated balance sheet as of September 30, 2008.

 

As a result of continued auction failures, quoted prices for ourauction rate securities did not exist as of September 30, 2008 and,accordingly, we concluded that Level 1 inputs were not available for theseassets. Brokerage statements received from our broker/dealer that held ourauction rate securities included their estimated market value as of September 30,2008. Our broker/dealer valued our auction rate securities at 91% of par. Wemade inquiries relative to the measurements utilized to derive the estimatedmarket values quoted on our brokerage statements, but the broker/dealerdeclined to provide detailed information relating to their valuationmethodologies. Due to the lack of transparency into the methodologies used todetermine the estimated market values, we concluded that estimated marketvalues provided on our brokerage statements did not constitute valid inputs andthus we did not utilize them in measuring the fair value of these auction ratesecurities as of September 30, 2008.

 

We determined that use of a valuation model was the best availabletechnique for measuring the fair value of our auction rate securities. We useda trinomial discount model weighting estimated future cash flows, quality ofcollateral and the probability of future successful auctions occurring. Whileour valuation model was based on both Level 2 (credit quality and interestrates) and Level 3 inputs, we determined that the Level 3 inputs were the mostsignificant to the overall fair value measurement of these assets, particularlythe estimates of expected periods of illiquidity. The valuation model alsoreflected our intention to hold our auction rate securities until they can beliquidated in a market that facilitates orderly transactions and our beliefthat we have the ability and intent to maintain our investments until theirrecovery in value.  See Note 15 –Subsequent Events.

 

Fair value hierarchy of our securities and foreign currency contract atfair value in connection with our adoption of SFAS 157 is as follows (in thousands):

 
| ** **                        | ** ** | **September 30,** | ** ** | **Fair Value Measurements at  Reporting Data** | ** ** |
|-----------------------------------|------------|------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                        | ** ** | **2008**               | ** ** | **Level 1**                                                   | ** ** | **Level 2** | ** ** |
|                              |       |                   |       |                                                               |       |   |   |
| Assets:                           |       |                   |       |                                                               |       |   |   |
| Money market fund                 |       | $                      | 17,416     |                                                               | 17,416     |   | — |   |
| Liabilities:                      |       |                   |       |                                                               |       |   |   |
| Foreign currency forward contract |       | $                      | 66         |                                                               | —     |   | 66 |   |

 

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The following table provides a summary of changes in fair value of ouravailable-for-sale securities utilizing Level 3 inputs as of September 30,2008 (in thousands):

 
| ** **                                            | ** ** | **Auction Rate** | ** ** |
|-------------------------------------------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | **Securities**        | ** ** |
| Balance at December 31, 2007                     |       | $                     | —     |   |
| Transfers from Level 2 to Level 3                     |       | 48,800                |       |
| Sales of auction rate securities                      |       | (350                  | )          |
| Unrealized loss included in other  comprehensive loss |       | (2,347                | )          |
| Balance at March 31, 2008                        |       | $                     | 46,103     |   |
| Unrealized loss included in other  comprehensive loss |       | (268                  | )          |
| Balance at  June 30, 2008                        |       | $                     | 45,835     |   |
| Unrealized loss included in other  comprehensive loss |       | (227                  | )          |
| Balance at September 30, 2008                    |       | $                     | 45,608     |   |

 

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

 

On January 7, 2008 (the “Closing Date”), we acquired all of theoutstanding shares of Conceptus SAS on the Closing Date. As a result of thistransaction, Conceptus SAS became our wholly owned subsidiary and its resultsof operations are consolidated with our results of operations starting on January 7,2008. We believe the acquisition of Conceptus SAS expands our presence ininternational markets and will increase our revenues as we will recognize salesat end user pricing as compared to the price at which we previously sold the *Essure* product directly to ConceptusSAS.  Our condensed consolidatedfinancial statements for the three and nine months ended September 30,2008 include the financial results of Conceptus SAS beginning from theacquisition date of January 7, 2008.

 

The total purchase price of $22.5 million included $24.4 million incash consideration and $0.3 million in direct transaction costs, less areduction to the purchase price of $2.2 million as explained below. On February 27,2007, we entered into an amendment to the Share Purchase and Call OptionAgreement with Conceptus SAS and into an amendment to the DistributionAgreement with Conceptus SAS.  Pursuant to the amendment to the SharePurchase and Call Option Agreement, we agreed not to exercise the call optionto acquire Conceptus SAS in 2007 and agreed to exercise our call option toacquire SAS sometime between January 1, 2008 and January 2, 2009subject to the satisfaction of certain closing conditions.  Pursuant tothe amendment to the Distribution Agreement, Conceptus SAS agreed to increasethe price they pay to us for the*Essure* product.The difference in price of product under the revised Distribution Agreementcompared to the previous agreement was recorded as a current liability in ourconsolidated balance sheet prior to the acquisition. The balance of thiscurrent liability of $2.2 million on the date of acquisition was recorded as areduction of the purchase price of Conceptus SAS.

 

The aggregate Conceptus SAS purchase price of $22.5 million wasallocated to the assets acquired and liabilities assumed based on theirestimated fair values at the date of acquisition.  The estimate of the excess of purchase priceover the fair value of net tangible assets acquired was allocated toidentifiable intangible assets with the remainder as goodwill. In accordancewith generally accepted accounting principles, we have twelve months from theclosing date to finalize the valuation and we will finalize any remaining directtransaction costs and payment of outstanding liabilities within this timeperiod. The following table summarizes the allocation of the purchase price ofthe assets acquired and liabilities assumed based on their fair values on thedate of acquisition:

 
| **(in thousands):**       | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------|------------|
| Cash acquired                  |       | $          | 1,689      |   |
| Inventory                      |       | 1,816      |       |
| Accounts receivable            |       | 3,270      |       |
| Other tangible assets acquired |       | 396        |       |
| Amoritzable intangibles:       |       |       |       |
| Customer relationsips          |       | 5,024      |       |
| Covenant not to compete        |       | 71         |       |
| Goodwill                       |       | 16,210     |       |
| Liabilities assumed            |       | (6,027     | )          |
| Total                          |       | $          | 22,449     |   |

 

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The amortizable intangible assets have useful lives for customer relationshipsof 9 years and for the covenant not to compete of 3 years. No amounts have beenallocated to in-process research and development and approximately $16.2million has been allocated to goodwill. Goodwill was recorded based on theresidual purchase price after allocating the purchase price to the fair marketvalue of tangible and intangible assets acquired less liabilities assumed. Thegoodwill arising from the acquisition is not deductible for tax purposes.

 

The unaudited pro forma information set forth below represents the netsales, net loss and earnings per share of the Company including Conceptus SASas if the acquisition were effective as of the beginning of fiscal 2007, aftergiving effect to certain adjustments, including the amortization of ConceptusSAS acquisition related intangibles and the elimination of preacquisitionintercompany profits. The operating results for the period from January 1,2008 to January 7, 2008 (the Closing Date) and for the comparable periodof fiscal 2007 were not readily available and were not considered practical toobtain. The unaudited pro forma financial information does not necessarilyreflect the results of operations that would have occurred had the combinedbusinesses constituted a single entity during such period, and is notnecessarily indicative of results which may be obtained in the future (inthousands, except per share amounts):

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

 

**6.****              Inventories**

 

Inventories are stated at the lower of cost or market.  Cost isbased on actual costs computed on a first-in, first-out basis.  Thecomponents of inventories consist of the following (in thousands):

 
| ** **       | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------|------------|------------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Raw materials    |       | $                      | 289        |                  | $          | 177 |   |
| Work-in-progress |       | 2,509                  |       | 1,356                 |       |
| Finished goods   |       | 1,904                  |       | 885                   |       |
| **Total**        | ** ** | **$**                  | **4,702**  | ** **            | **$**      | **2,418** | ** ** |

 

**7.****              Warranty**

 

We offer warranties on our product and record a liability for theestimated future costs associated with warranty claims, which is based upon ourhistorical experience and our estimate of the level of future costs. Warrantycosts are reflected in the statement of operations as a cost of goodssold.  A reconciliation of the changes in warranty liability for the ninemonths ended September 30, 2008 and 2007 follows (in thousands):

 
| ** **                                        | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                        | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| Balance at the beginning of the period            |       | $                                                       | 208        |   | $ | 209 |   |
| Accruals for warranties issued during the  period |       | 205                                                     |       | 369 |   |
| Settlements made in kind during the period        |       | (183                                                    | )          | (337 | ) |
| **Balance at the end of the period**              | ** ** | **$**                                                   | **230**    | ** ** | **$** | **241** | ** ** |

 

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

 

Net income (loss) for the three and nine months ended September 30,2008 included stock-based compensation expense under SFAS No. 123(R) ,*Share-Based Payment,* or SFAS 123(R), ofapproximately $1.4 million and $4.3 million, respectively, which consisted ofstock-based compensation expense of approximately $1.2 million and $3.7million,

 

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respectively, related toemployee stock options, employee stock purchase plan and stock appreciationrights and stock-based compensation expense of approximately $0.2 million and$0.6 million, respectively, related to employee restricted stock and restrictedstock units.

 

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

 

Stock-based compensation arrangements to non-employees are accountedfor in accordance with EITF Issue No. 96-18, *Accounting for Equity Instruments That Are Issued to Other ThanEmployees for Acquiring, or in Conjunction with Selling, Goods or Services*,which requires that these equity instruments are recorded at their fair valueon the measurement date. The measurement of stock-based compensation is subjectto adjustment as the underlying equity instruments vest.  Net income (loss) for the three and ninemonths ended September 30, 2008 included stock-based compensation expenserelating to non-employees of approximately $0.1 million and $0.2 million,respectively. Net loss for the three and nine months ended September 30,2007 for non-employees was $0.1 million and $0.2 million, respectively.

 

For the threeand nine months ended September 30, 2008 and 2007, we calculated the fairvalue of each option on the date of grant using the Black-Scholes model asprescribed by SFAS 123(R). The assumptions used were as follows:

 
| ** **                      | ** ** | **Stock Option and Stock Appreciation Right Plans** | ** ** |
|---------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **                      | ** ** | **Three months ended**                                                  | ** ** | **Nine months ended** | ** ** |
| ** **                      | ** ** | **September 30, 2008**                                                  | ** ** | **September 30, 2008** | ** ** |
| Expected term (in years)        |       | 4.06                                                                              |       | 4.56 |   |
| Average risk-free interest rate |       | 2.87                                                                              | %          | 2.74 | % |
| Average volatility factor       |       | 45.1                                                                              | %          | 47.2 | % |
| Dividend yield                  |       | —                                                                            |       | — |   |

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

 

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

 

*Expected Volatility:*We used historical volatility based on the expected term of the awards, whichis consistent with our assessment that the historical volatility for suchperiod is more representative of future stock price trends than any other typeof volatility.

 

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

 

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

 

*Forfeitures:* Asstock-based compensation expense recognized in the condensed consolidated statementof operations for the nine months ended September 30, 2008 is based onawards ultimately expected to vest, it has been reduced for estimatedforfeitures. SFAS 123(R) requires forfeitures to be estimated at the timeof grant and revised, if necessary, in subsequent periods if actual forfeituresdiffer from those estimates.  Forfeitureswere estimated based on historical experience.

 

No income tax benefit has been recognized relating to stock-basedcompensation expense and no tax benefits have been realized from exercisedstock options.

 

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*Stock Options and Stock Appreciation Rights*:During the three and nine months ended September 30, 2008, we grantedstock appreciation rights for 180,500 and 1,012,910 shares, respectively, ofcommon stock, with an estimated total grant date fair value of approximately$1.2 million and $7.5 million, respectively, and a grant date weighted-averagefair value of $6.82 and $7.42 per share, respectively.  During the three and nine months ended September 30,2007, we granted stock appreciation rights for 49,000 and 881,990 shares ofcommon stock, with an estimated total grant date fair value of approximately$0.3 million and $6.5 million, respectively, and a grant date weighted averagefair value of $6.42 and $7.37 per share, respectively.

 

As of September 30, 2008, there was unrecognized compensation costof approximately $10.6 million for total stock-based compensation related tostock options and stock appreciation rights, before forfeitures. This cost isexpected to be recognized over a weighted-average amortization period of 2.88years.

 

*Employee Stock Purchase Plan (ESPP):* The compensationcost in connection with the ESPP for the nine months ended September 30,2008 was approximately $0.2 million with a grant date weighted-average fairvalue of $5.17. During the nine months ended September 30, 2007, thecompensation cost was approximately $0.2 million, with a grant date weightedaverage fair value of $5.42. This cost is amortized on a straight-line basisover the relevant subscription period.

 

We calculated the fair value of each share under the ESPP on the dateof grant using the Black-Scholes model as prescribed by SFAS 123(R). Theassumptions used were as follows:

 
| ** **                      | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|
| ** **                      | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| Expected term (in years)        |       | 0.50                                                |       | 0.50 |   |
| Average risk-free interest rate |       | 2.01                                                | %          | 4.73 | % |
| Average volatility factor       |       | 42.6                                                | %          | 40.9 | % |
| Dividend yield                  |       | —                                              |       | — |   |

 

*Restricted Stock Units*: In connection with restricted stock units and restricted stock awardsgranted, we record stock compensation representing the fair market value of ourcommon shares on the dates the awards were granted. Compensation expense isbeing recorded on a straight-line basis over the vesting periods of theunderlying stock awards. During the three and nine months ended September 30,2008, we granted 1,000 and 42,000 restricted stock units, respectively, with agrant-date fair value of approximately $19,000 and $0.7 million, respectivelyand a grant-date weighted average fair value of $18.58 and $17.48,respectively.  During the three monthsended September 30, 2007, we granted no restricted stock units.  During the nine months ended September 30,2007, we granted 60,550 restricted stock units, with a grant-date fair value ofapproximately $1.1 million and a grant-date weighted-average fair value of$18.35.

 

As of September 30, 2008, there was an unrecognized compensationcost of approximately$1.1 million related to nonvested restricted stock awardsand restricted stock units, before forfeitures. This cost is expected to berecognized over a weighted-average amortization period of 2.09 years.

 

**9.     ConvertibleSenior Notes**

 

In February 2007, we issued an aggregate principal amount of$86,250,000 of our 2.25% convertible senior notes due 2027. These notes bear a2.25% interest per annum on the principal amount, payable semiannually inarrears on February 15 and August 15 of each year, beginning on August 15,2007.

 

The notes will mature on February 15, 2027, unless earlierredeemed, repurchased or purchased by us or converted, and are convertible intocash and, if applicable, shares of our common stock based on an initialconversion rate, subject to adjustment, of 35.8616 shares per $1,000 principalamount of notes (which represents an initial conversion price of approximately$27.89 per share), in certain circumstances. Upon conversion, a holder wouldreceive cash up to the principal amount of the note and our common stock inrespect of such note’s conversion value in excess of such principal amount. Thenotes are convertible only in the following circumstances: (1) if theclosing sale price of our common stock exceeds 120% of the conversion priceduring a period as defined in the indenture; (2) if the average tradingprice per $1,000 principal amount of the notes is less than or equal to 97% ofthe average conversion value of the notes during a period as defined in theindenture;

 

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(3) upon the occurrence ofspecified corporate transactions; (4) if we call the notes for redemptionand (5) at any time on or after December 15, 2011 up to and includingFebruary 15, 2012 and anytime on or after February 15, 2025. Upon achange in control or termination of trading, holders of the notes may requireus to repurchase all or a portion of their notes for cash at a repurchase priceequal to 100% of the principal amount, plus any accrued and unpaid interest. Wemay not have sufficient funds to pay the interest, purchase price, repurchaseprice or principal return when conversion is triggered or a note becomespayable under the above terms.

 

In connection with the sale and issuance of the notes we incurred debtissuance costs of $3.1 million which is being amortized to interestexpense over a five year period.

 

We concluded that the embedded stock conversion option is notconsidered a derivative under SFAS No. 133, *Accounting for Derivative Instruments and Hedging Activities,*or SFAS 133, because the embedded stock conversion option would be recorded instockholders’ equity if it were a freestanding instrument per Emerging IssuesTask Force EITF Issue No. 00-19, *Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock,* or EITF 00-19. We concluded that the notes areaccounted for similar to traditional convertible debt (that is, as a combinedinstrument) because the embedded stock conversion option meets the requirementsof EITF No. 00-19, including the provisions contained in paragraphs 12-32of EITF 00-19.  Accordingly, the embeddedstock conversion option is not separated as a derivative.

 

In connection with the offering, we entered into convertible note hedgetransactions with affiliates of the initial purchasers. These transactions areintended to reduce the potential dilution to our Company’s stockholders uponany future conversion of the notes. The call options, which cost an aggregate$19.4 million, were recorded as a reduction of additional paid-in capital. Wealso entered into warrant transactions concurrently with the offering, pursuantto which we sold warrants to purchase approximately 3.1 million shares of ourcommon stock to the same counterparties that entered into the convertible notehedge transactions. The convertible note hedge and warrant transactionseffectively increased the conversion price of the convertible notes toapproximately $36.47 per share of our common stock. Proceeds received from theissuance of the warrants totaled approximately $10.7 million and were recordedas an addition to additional paid-in capital.

 

EITF 00-19 provides that contracts are initially classified as equityif (1) the contract requires physical settlement or net-share settlement,or (2) the contract gives the company a choice of net-cash settlement orsettlement in its own shares (physical settlement or net-share settlement). Thesettlement terms of our purchased call options and sold warrant contractsrequire net-share settlement. Based on the guidance in EITF 00-19 and SFAS133, the purchased call option contracts were recorded as a reduction of equityand the warrants were recorded as an addition to equity as of the trade date.SFAS 133 states that a reporting entity shall not consider contracts to bederivative instruments if the contract issued or held by the reporting entityis both indexed to its own stock and classified in stockholders’ equity in its statementof financial position. We concluded the purchased call option contracts and thewarrant contracts should be accounted for in stockholders’ equity.

 

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

 

We adopted the provisions of FASB Interpretation No. 48, *Accounting for Uncertainty in Income Taxes*, or FIN 48, on January 1,2007.  The adoption of the provisions of FIN 48 did not have a materialimpact on our financial position and results of operations. We have not beenaudited by the Internal Revenue Service or any state income or franchise taxagency and are not under examination in any foreign jurisdiction. As of September 30,2008, our federal returns for the years ended 2005 through the current periodand most state returns for the years ended 2004 through the current period arestill open to examination. In addition, all of the net operating losses andresearch and development credit carryforwards that may be used in future yearsare still subject to inquiry given that the statute of limitation for theseitems would be from the year of the utilization.

 

As of September 30, 2008, we recorded approximately $0.3 millionof income tax expense attributable to our French subsidiary.

 

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

 

We do not expect our unrecognized tax benefits to change significantlyover the next 12 months.  In connectionwith the adoption of FIN 48, we recognize interest and penalties accrued on anyunrecognized tax benefits as a component of income tax expense.

 

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**11.****       Computation of Net Income (Loss) Per Share**

 

Basic net income (loss) per share excludes any potential dilutiveeffects of options and common stock shares subject to repurchase.  Dilutednet income (loss) per share includes the impact of potentially dilutivesecurities.  In net loss periods presented, basic and diluted net loss pershare are both computed using the weighted average number of common sharesoutstanding.

 

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

 
| ** **                                                                                                              | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                              | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Numerator:                                                                                                              | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Numerator for diluted earnings per share -   Income (loss) available to common stockholders                             | ** ** | **$**                                                | **2,975**  | ** **                                          | **$**      | **(2,635** | **)** | **$** | **(5,012** | **)** | **$** | **(8,875** | **)** |
| ** **                                                                                                              | ** ** | ** **                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Denominator:                                                                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Denominator for basic earnings per share -   Weighted-average number of common shares outstanding                       |       | 30,347                                               |       | 29,546                                              |       | 30,177 |   | 29,445 |   |
| Less: weighted-average unvested and  restricted common shares                                                           |       | (5                                                   | )          | (21                                                 | )          | (12 | ) | (40 | ) |
| Weighted-average number common shares  outstanding used in share computing basic net income (loss) per common share     |       | 30,342                                               |       | 29,525                                              |       | 30,165 |   | 29,405 |   |
| Effect of dilutive securities:                                                                                          |       |                                                 |       |                                                |       |   |   |   |   |
| Diluted options & stock  appreciation rights                                                                   |       | 823                                                  |       | —                                              |       | — |   | — |   |
| Diluted stock awards                                                                                                    |       | 42                                                   |       | —                                              |       | — |   | — |   |
| Weighted-average number common shares  outstanding used in share computing dilutive net income (loss) per common  share |       | **31,207**                                           |       | **29,525**                                          |       | **30,165** |   | **29,405** |   |
|                                                                                                                         |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 

The following outstanding options, potential employee stock purchaseplan shares, warrants, stock appreciation rights, restricted stock units andshares were excluded from the computation of diluted net income (loss) pershare, as their effect would have been antidilutive (in thousands):

 
| ** **                                                | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Outstanding options and stock appreciation  rights        |       | 1,835                            |       | 4,115                           |       | 4,278 |   | 4,115 |   |
| Restricted stock awards                                   |       | —                           |       | 17                              |       | 5 |   | 17 |   |
| Restricted stock units                                    |       | 1                                |       | 287                             |       | 104 |   | 287 |   |
| Employee stock purchase plan                              |       | —                           |       | 16                              |       | 17 |   | 16 |   |
| Warrants issued in connection with our  convertible notes |       | 3,093                            |       | 3,093                           |       | 3,093 |   | 3,093 |   |
| **Total**                                                 | ** ** | **4,929**                        | ** ** | **7,528**                       | ** ** | **7,497** | ** ** | **7,528** | ** ** |

 

Our 2.25% senior convertible notes are not included in the calculationof net loss per share because their effect is anti-dilutive. In addition, oursenior convertible notes were excluded from the diluted net income per sharecalculation in the three and nine months ended September 30, 2008 becausethe conversion price was greater than the average market price of our stockduring the period.

 

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

 

Comprehensive income (loss) generally represents all changes instockholders’ equity except those resulting from investments or contributionsby stockholders. Our comprehensive income (loss) consists of unrealized losseson available-for-sale securities and cumulative translation adjustments. A summaryof the comprehensive income (loss) for the periods indicated is as follows (inthousands):

 
| ** **                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income (loss)                                      |       | $                                                    | 2,975      |                                                | $          | (2,635 | ) | $ | (5,012 | ) | $ | (8,875 | ) |
| Other comprehensive loss                               |       |                                                 |       |                                                |       |   |   |   |   |
| Foreign currency translation adjustment,  net of tax   |       | (1,823                                               | )          | —                                              |       | (319 | ) | — |   |
| Unrealized gain loss on available-for-sale  securities |       | (227                                                 | )          | —                                              |       | (2,842 | ) | — |   |
| Comprehensive income (loss)                            |       | $                                                    | 925        |                                                | $          | (2,635 | ) | $ | (8,173 | ) | $ | (8,875 | ) |

 

The balances of each component of accumulated other comprehensiveincome (loss), net of taxes, as of September 30, 2008 and December 31,2007 consist of the following (in thousands):

 
| ** **                              | ** ** | **Unrealized Gain  (Loss) on  Available-for-  Sale Securities** | ** ** | **Foreign  Currency  Translation** | ** ** | **Accumulated Other  Comprehensive  Income (Loss)** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------------------------|------------|------------------------------------|------------|---------------------------------------------------------------|------------|
| Balance as of December 31, 2007    |       | —                                                                         |       | —                             |       | —                                                        |       |
| Net change during the nine month period |       | (2,842                                                                         | )          | (319                               | )          | (3,161                                                        | )          |
| Balance as of September 30, 2008   |       | $                                                                              | (2,842     | )                                  | $          | (319                                                          | )          | $ | (3,161 | ) |
|                                         |            |                                                                                |            |                                    |            |                                                               |            |  |  |  |

 

In the third quarter of 2008, we recorded an adjustment to othercomprehensive loss, to record foreign currency translation adjustments relatedto goodwill and intangibles acquired as part of the acquisition of ConceptusSAS in the first quarter of 2008, which had not been properly translated athistorical exchange rates as of March 31, 2008 and June 30, 2008.Amounts related to those prior periods are not considered material to theconsolidated financial statements taken as a whole, but have been corrected.The effects on other comprehensive loss for both the three months ended March 31,2008 and the six month ended June 30, 2008 were an overstatement of $1.5million. The effects on goodwill as of March 31, 2008 and June 30,2008 were an understatement of $1.1 million and $1.2 million,respectively.  The effects on intangibleassets as of March 31, 2008 and June 30, 2008 were an understatementof $0.4 million and $0.3 million, respectively. The revisions did not affectthe previously reported statement of operations, net loss per share or cashflows.  

 

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

 

We operate in one business segment, which encompasses all geographicalregions. We use one measurement of profitability and do not segregate ourbusiness for internal reporting.

 

Net sales by geographic region, based on shipping location of ourcustomer, are as follows (in thousands, except percentages):

 
| ** **               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales (in thousands) |       | $                                                    | 26,645     |                                                | $          | 16,430 |   | $ | 73,452 |   | $ | 45,879 |   |
|                     |       |                                                 |       |                                                |       |   |   |   |   |
| United States of America |       | 80                                                   | %          | 94                                                  | %          | 78 | % | 91 | % |
| France                   |       | 13                                                   | %          | 5                                                   | %          | 14 | % | 8 | % |
| Europe                   |       | 6                                                    | %          | 0                                                   | %          | 7 | % | 0 | % |
| Other                    |       | 1                                                    | %          | 1                                                   | %          | 1 | % | 1 | % |
|                          |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 

No customer accounted for more than 10% oftotal revenue for the three and nine months ended September 30, 2008 and2007.  Accounts receivable from onecustomer accounted for 10% of our gross accounts receivable balance at September 30,2008. Accounts receivable from another customer accounted for 23%of our gross accounts receivable balance at September 30, 2007.

 

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

 

As of September 30, 2008, we hold 77,863 shares of treasury stockas a result of repurchasing shares of restricted common stock at par value inaccordance with the terms of the restricted stock agreements. These shares hada purchase price of $0.003 per share and are recorded as treasury stock.

 

**15.****       Subsequent Events**

 

UBS Investment Bank holds 100% of our auction rate securities.  During October 2008, UBS Investment Bankinformed us that they have designed a settlement process that will give UBS’sclients the opportunity to sell all auction rate securities at par by June 2010,unless they are redeemed by the issuer sooner. We received confirmation from UBS Investment Bank in October thatall the auction rate securities that we currently hold are eligible toparticipate in this process and be redeemed at par.  We intend to participate in the settlementprocess and therefore expect all our auction rate securities to be settled atfull par value.

 

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**Item2.  Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

*The following discussion of our financial condition andresults of operations should be read in conjunction with our consolidatedfinancial statements and related notes thereto. This discussion containsforward-looking statements, including references to 2008 revenues and grossmargins, increased product adoption, product improvements, and other forecasteditems that involve risks and uncertainties such as our limited operating andsales history; the uncertainty of market acceptance of our product; dependenceon obtaining and maintaining reimbursement; effectiveness and safety of ourproduct over the long-term; our ability to obtain and maintain the necessarygovernmental clearances or approvals to market our product; our ability todevelop and maintain proprietary aspects of our technology; our ability tomanage our expansion; our limited history of manufacturing our product; our dependenceon single source suppliers, third party manufacturers and co-marketers;intense competition in the medical device industry and in the contraceptionmarket; the inherent risk of exposure to product liability claims and productrecalls and other factors referenced in this Form 10-Q. Our actualresults could differ materially from those expressed or implied in theseforward-looking statements as a result of various factors, including thosediscussed in our Annual Report on Form 10-K for the year ended December 31,2007 filed with the Securities and Exchange Commission on March 14, 2008and those included elsewhere in this Form 10-Q.**These statements are only effective as of the date they are made and weundertake no duty to publicly revise or update these forward-lookingstatements, whether as a result of new information, future developments orotherwise.*

 

**Overview**

 

We develop, manufacture and market the*Essure*® permanent birth control system, an innovative andproprietary medical device for women that was approved for marketing in theUnited States in November 2002 by the United States Food and DrugAdministration, or FDA. The*Essure*system uses a soft and flexible micro-insert that is delivered into a woman’sfallopian tubes to provide permanent birth control by causing a benign tissuein-growth that blocks the fallopian tubes. A successfully placed*Essure* micro-insert and the subsequenttissue growth prohibits the egg from traveling through the fallopian tubes andtherefore prevents fertilization.

 

On January 7, 2008 (the “Closing Date”), we acquired all of theoutstanding shares of Conceptus SAS on the Closing Date. As a result of thistransaction, Conceptus SAS became our wholly owned subsidiary and its resultsof operations are consolidated with our results of operations starting on January 7,2008. We believe the acquisition of Conceptus SAS expands our presence ininternational markets and will increase our revenues as we will recognize salesat end user pricing as compared to the price at which we previously sold the *Essure* product directly to ConceptusSAS.  Our condensed consolidatedfinancial statements for the three and nine months ended September 30,2008 include the financial results of Conceptus SAS beginning from theacquisition date of January 7, 2008.

 

*The Essure Procedure*

 

The*Essure* procedure istypically performed as an outpatient procedure and is intended to be a lessinvasive and a less costly alternative to tubal ligation, the leading form ofbirth control in the United States and worldwide. Laparoscopic tubal ligationand tubal ligation by laparotomy typically involve abdominal incisions and/orpunctures, general or regional anesthesia, four to ten days of normal recoverytime and the risks associated with an incisional procedure. The*Essure* procedure does not require cuttingor penetrating the abdomen, which lowers the likelihood of post-operative paindue to the incisions/punctures, and it can be performed in an outpatientsetting without general or regional anesthesia. In the Pivotal trial of the*Essure* system, the total procedure timeaveraged 35 minutes, with an average of 13 minutes of hysteroscopic time toplace the*Essure* micro-insert. Apatient is typically discharged approximately 45 minutes after the*Essure* procedure. No overnight hospitalstay is required. Furthermore, the*Essure*system is effective without drugs or hormones. There is a three-month waitingperiod after the procedure during which the woman must use another form ofbirth control while tissue in-growth occurs. At 90 days following theprocedure, U.S. patients complete a follow-up examination called ahysterosalpingogram, or HSG, which can determine whether the device was placedsuccessfully and whether the fallopian tubes are occluded. Outside of theUnited States, patients are required to return for a pelvic X-ray at threemonths post-procedure with a subsequent HSG if device location on the initialradiographic image appears suspicious.

 

We believe that the*Essure*system is a better alternative to tubal ligation for physicians, hospitals andpayers. The*Essure* system is aless invasive permanent birth control option for physicians to offer to theirpatients; hospitals are able to utilize their facilities more cost effectivelywith the*Essure* procedurecompared with tubal ligation; and payers are able to experience cost reductionsresulting from the elimination of overhead and procedural costs related toanesthesia and post-operative hospital stays associated with tubal ligations.

 

Published reports estimate that 700,000 tubal ligation procedures areperformed each year in the United States. We intend to tap into this market andestablish the*Essure* procedure asthe gold standard for permanent birth control.

 

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We also believe the*Essure*system is a better alternative to temporary methods of birth control being usedwhen there is no intention of having children in the future. In addition,payers may also benefit from the reduction of unplanned pregnancies associatedwith non-permanent methods of birth control used by patients who have chosen toavoid the drawbacks of traditional permanent birth control methods but who mayelect to use the*Essure* system.

 

The*Essure* system iscurrently being marketed in multiple countries. In November 2002, wereceived approval from the FDA to market the*Essure* system in the United States. In 2001, we were given approvalto affix the CE Mark to the*Essure*system, indicating that the*Essure*system is certified for sale throughout the European Union, subject tocompliance with local regulations such as registration with health ministriesand/or particular requirements regarding labeling or distribution. In1999, the*Essure* Permanent BirthControl system was listed with Australia’s Therapeutic Goods Administration,which allows us to market and sell the*Essure* system in Australia. In Canada, we received clearance fromHealth Canada to market the*Essure*system in Canada in November 2001. In France, the “Haute Autorité desanté” lifted in October 2007 all restrictions, thereby putting the *Essure* procedure on an equal footing withtubal ligations. Following this decision, the *Essure*procedure is covered in France for all women, regardless of medicalstatus.  In addition, the CEPS in Franceruled in November 2007 that the reimbursement for the *Essure* device will remain at the thencurrent levels of 700 Euros for the next 5 years.

 

In January 2008, we acquired all of the outstanding shares ofConceptus SAS, our distributor in France, and as a result Conceptus SAS isoperating as our wholly owned subsidiary. Conceptus SAS sells directly in France and utilizes distributors to sell*Essure* throughout the rest of Europe.

 

*Effectiveness of the Essure System*

 

In July 2005, we received approval from the FDA to extendeffectiveness data on the*Essure*product labeling. The Premarket Approval, or PMA, supplement filed in late January 2005supports an extension of the effectiveness rate of the*Essure* system to 99.80% after four yearsand 99.74% after five years, from the previously approved 99.80% at threeyears. The five-year effectiveness was demonstrated in a small portion of thewomen undergoing clinical studies.  Fiveyear follow up of all patients in clinical trials is currently complete.  A PMA supplement to update the productlabeling incorporating the results of the follow-up data will be submitted tothe FDA.

 

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

 

*Penetration*

 

We require physicians to be preceptored for between 3 and 5 cases by acertified trainer before being able to perform the procedure independently. Wecontinue to see an increase in the number of physicians becoming trained orthat are in the process of training to perform the *Essure*procedure. The level of sales for the*Essure*system, particularly in this early period of adoption, is highly dependent onthe number of physicians trained to perform the procedure. However, weunderstand that a strong base of trained physicians does not necessarilycorrelate to an increase in revenue proportionately. Furthermore, there are norevenues associated with the training activities. We do not charge a fee forthe activity and no commitment arises for the physician from the preceptorship.Physician training is provided upfront and we have no obligation subsequent tothe initial training. Training costs have not been significant from inceptionto-date.

 

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*Reimbursement of the Essure Procedure*

 

Market acceptance of the*Essure*system depends in part upon the availability of reimbursement within prevailinghealthcare payment systems. We believe that physician advocacy of ourproduct will be required to continue to obtain reimbursement. As of September 30,2008, we have received positive reimbursement decisions for the *Essure* procedure from most privateinsurers and from 46 of the 51 Medicaid programs in the United States. Wecontinue to receive positive responses relating to reimbursement, which webelieve will help increase the adoption of the *Essure*device by doctors and patients. 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. As withall healthcare plans, coverage will vary and is dependent upon the individual’sspecific benefit plan.

 

Effective January 1, 2008, the Centers for Medicare and MedicaidServices, or CMS, the Medicare National unadjusted average payment forhysteroscopic sterilization (CPT code) is $420 when performed in a hospital and$2,024 when performed in a physician’s office. In addition, in the CMS Final Rule forthe 2008 Outpatient Prospective Payment System or OPPS, which assigns hospitaloutpatient reimbursement amounts, the CPT code was assigned a Medicare NationalAverage of $2,720. In 2008, the Medicare national average payment forhysteroscopic sterilization in the ambulatory surgery center is $1,446, whichincludes the cost of the implant. We believe these values are very favorablefor the Essure procedure and will help in establishing increased utilization ofthe device amongst doctors.

 

Effective May 15, 2008, California’s state fee-for-serviceMedicaid program announced coverage of the *Essure*procedure for beneficiaries that are 21 years of age or older. Physicians mayperform the Essure procedure in the physician’s office, the ambulatory surgerycenter or the hospital outpatient department. Medi-Cal is to pay $2,282 as a globalfee for an in-office procedure.  Webelieve these values are very favorable for the Essure procedure and willcontinue to help in establishing increased utilization for devices amongstdoctors.

 

*Adoption of theEssure System*

 

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

 

First, we are attempting to increase patient awareness, so as toincrease the number of women who will ask for information about the*Essure* procedure. During 2008 we havespent more than $7 million on building patient awareness. The largest part ofthis expenditure was a direct to consumer (DTC) pilot program in eight cities,incorporating television, radio and print media advertising. We hope throughthese programs to drive patient awareness of the *Essure* procedure.

 

Second, we are expanding our domestic field sales and support staff andinternational channels of distribution so as to increase our call frequency onphysicians worldwide. During 2008 we added a number of in-office specialistsand sales positions. Among other responsibilities, our sales representativesare attempting to increase penetration and utilization of the*Essure* procedure, as well as tofacilitate the movement of the*Essure*procedure to the in-office environment.

 

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

 

Fourth, we intend to continue making labeling improvements to ourproduct as well as physical product enhancements to increase the adoption ofthe*Essure* procedure. This mayinvolve working with the various regulatory agencies around the world thatregulate the sale and labeling of medical devices to provide updates to claimssuch as effectiveness and placement rates. Where appropriate, we will make physicalimprovements to the product for improved manufacturability, for the ease of useby the physician or to improve the clinical performance of our product.

 

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We have experienced significant operating losses since inception and,as of September 30, 2008, had an accumulated deficit of $240.3 million.While we were profitable in the third quarter of 2008 and expect to beprofitable in the fourth quarter of 2008, there is a risk that we may notsustain profitability.  We will continueto expend substantial resources in the selling and marketing of the*Essure* system in the United States andabroad. We will be in a net loss position unless sufficient revenues can begenerated to offset expenses.

 

**Results of Operations - Three and Nine monthsEnded September 30, 2008 and 2007**

**2008 results compared to 2007 (in thousands,except percentages)**

** **
| ** **                                    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                    | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008-2007** | ** ** | **2008** | ** ** | **2007** | ** ** | **2008-2007** | ** ** |
| ** **                                    | ** ** | **Amount**                                               | ** ** | **% (a)**                                          | ** ** | **Amount** | ** ** | **% (a)** | ** ** | **% Change** | ** ** | **Amount** | ** ** | **% (a)** | ** ** | **Amount** | ** ** | **% (a)** | ** ** | **% Change** | ** ** |
| Net sales                                     |       | $                                                        | 26,645     |                                                    | 100        | % | $ | 16,430 |   | 100 | % | 62 | % | $ | 73,452 |   | 100 | % | $ | 45,879 |   | 100 | % | 60 | % |
| Gross profit                                  |       | 21,555                                                   |       | 81                                                      | %          | 12,113 |   | 74 | % | 78 | % | 57,721 |   | 79 | % | 33,619 |   | 73 | % | 72 | % |
| Research and  development expenses            |       | 1,611                                                    |       | 6                                                       | %          | 1,513 |   | 9 | % | 6 | % | 5,186 |   | 7 | % | 4,216 |   | 9 | % | 23 | % |
| Selling, general  and administrative expenses |       | 16,363                                                   |       | 61                                                      | %          | 13,917 |   | 85 | % | 18 | % | 56,546 |   | 77 | % | 40,098 |   | 87 | % | 41 | % |
| Net profit (loss)                             |       | 2,975                                                    |       | 11                                                      | %          | (2,635 | ) | -16 | % | 213 | % | (5,012 | ) | -7 | % | (8,875 | ) | -19 | % | 44 | % |
|                                               |            |                                                          |            |                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(a) Expressed as a percentage of total net sales

 

*Net Sales*

 

Net sales were $26.6 million for the three months ended September 30,2008 as compared to $16.4 million for the three months ended September 30,2007, representing an increase of $10.2 million, or 62%. Net sales for thenine months ended September 30, 2008 were $73.5 million, as compared to$45.9 million for the nine months ended September 30, 2007, an increase of$27.6 million, or 60%.  The increase in net sales is the result ofcontinued commercialization of the *Essure*system worldwide. International sales comprised 20% of our total sales in thethird quarter of 2008, reflecting revenues realized from our acquisition ofConceptus SAS and the recognition of sales at higher end-user pricing.  The net sales increase also reflects adomestic revenue increase of 38% in the three months ended September 30,2008 compared to the three months ended September 2007.  Net sales also increased due to theincreasing number of physicians entering and completing training in the use ofthe procedure. We recognize that a strong base of trained physicians does notnecessarily correlate to an increase in revenue proportionately. Furthermore,there are no revenues associated with the training activities. We do not chargea fee for the activity and no commitment arises for the physician from thepreceptorship. Physician training is provided upfront and we have no obligationsubsequent to the initial training. Training costs have not been significant tous from inception to date.

 

Net sales by geographic region, based on shipping location of ourcustomer, are as follows (in thousands, except percentages):

 
| ** **               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net sales (in thousands) |       | $                                                    | 26,645     |                                                | $          | 16,430 |   | $ | 73,452 |   | $ | 45,879 |   |
|                     |       |                                                 |       |                                                |       |   |   |   |   |
| United States of America |       | 80                                                   | %          | 94                                                  | %          | 78 | % | 91 | % |
| France                   |       | 13                                                   | %          | 5                                                   | %          | 14 | % | 8 | % |
| Europe                   |       | 6                                                    | %          | 0                                                   | %          | 7 | % | 0 | % |
| Other                    |       | 1                                                    | %          | 1                                                   | %          | 1 | % | 1 | % |
|                          |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |

 

No customer accounted for more than 10% oftotal revenue for the three and nine months ended September 30, 2008 and2007.  Accounts receivable from onecustomer accounted for 10% of our gross accounts receivable balance at September 30,2008. Accounts receivable from one customer accounted for 23% ofour gross accounts receivable balance at September 30, 2007.

 

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We expect our net sales for 2008 to be in the range of approximately$103 million to $104 million, which would represent 60% to 61% growth from netsales in 2007 as we continue to increase the number of sales representatives inorder to provide even greater depth of physician coverage, which in turn weexpect will increase physician utilization and the number of physiciansperforming the*Essure* procedure.We will also continue our programs aimed at raising patient awareness of the*Essure* procedure, such as radio, printand television advertising. We believe our revenue growth in 2008 and beyondwill be significantly influenced by how successful we are in achieving ourobjectives. However, as we have noted elsewhere in this Form 10-Q and riskfactors from our Form 10-K, our expected revenue growth involves many riskfactors, some of which are not entirely within our control, such as marketacceptance of the*Essure* systemand third party reimbursement for the device.

 

*Gross Profit*

 

Cost of goods sold for the three months ended September 30, 2008was $5.1 million as compared to $4.3 million for the three months ended September 30,2007. This increase of $0.8 million, or 18%, was caused by higher volumes of sales.  Gross profit margin was 81% for the threemonths ended September 30, 2008 and 74% for the three months ended September 30,2007.  For the nine months ended September 30,2008, gross profit margin was 79%, which represents an improvement from a grossprofit margin of 73% for the nine months ended September 30, 2007.  The year-over-year increase in gross margin is related to higheraverage selling prices into the European market that were achieved through theacquisition of Conceptus SAS, lower manufacturing costs associated with higherunit volume, the introduction of the Company’s third generation device and adomestic price increase implemented during the first quarter of 2008.  We anticipate gross margins willremain in the 80% to 81% range in the fourth quarter of 2008; however, ourgross profit margin will vary as our sales mix changes. Increases in sales ofour devices through distributors in international markets will tend to decreaseour overall gross profit margin.

 

*Research and Development Expenses*

 

Research and development expenses are substantially related to theongoing development and associated regulatory approvals of our technology andwere $1.6 million and $1.5 million for the three months ended September 30,2008 and 2007, respectively. Our goal is to continue our product enhancementsover the coming years, which are intended to result in improved ease of use andclinical performance. We expect to identify and hire additional productdevelopment and regulatory personnel in the future to staff our planned productdevelopment and clinical activities, and we expect that these costs willincrease as we seek to maintain our leading position in the market forpermanent female birth control. To support these initiatives in the thirdquarter of 2008 we increased payroll and payroll related expenditures by $0.2million, consulting and outside service expenses by $0.1 million and decreasedclinical trial expenses by $0.1 million compared to the three months ended September 30,2007.

 

Research and development expenses were $5.2 million and $4.2 millionfor the nine months ended September 30, 2008 and 2007, respectively. Theincrease results primarily from payroll and payroll related expenditures of$0.7 million, consulting and outside service expenses of $0.7 million andproject material prototypes of $0.2 million, offset by a reduction in suppliercharges and equipment purchases of $0.3 million and stock-based compensation of$0.2 million.

 

*Selling, General and Administrative Expenses*

 

Selling, general and administrative expenses for the three months endedSeptember 30, 2008 were $16.4 million as compared to $14.0 million for thethree months ended September 30, 2007, which represents an increase of$2.4 million, or 18%.  The increases wereprimarily the result of the operating expenses of Conceptus SAS of $1.6million, and an increase of $1.1 million due to expansion of our U.S fieldsales force, which is meant to provide us with more selling time to focus onphysician penetration and utilization.

 

Selling, general and administrative expenses for the nine months ended September 30,2008 were $56.5 million as compared to $40.1 million for the nine months ended September 30,2007, which represents an increase of $16.4 million, or 41%.  The increases were primarily the result ofpayroll and payroll related expenditures of $5.5 million, advertising expenseof $5.0 million, consulting expenses of $0.6 million and Conceptus SASoperating expenses of $5.0 million.  

 

*Total Other Income (Expense)*

 

Total other expense for the three months ended September 30, 2008was a net expense of $0.5 million as compared to net income of $0.7 million forthe three months ended September 30, 2007. Interest income in the three months ended September 30,2008 was lower by $1.0 million compared with the three months ended September 30,2007. Interest income was negatively impacted due to lower interest rates onthe Company’s investment portfolio, which consists of auction rate securitiesand money market accounts that are currently earning lower interest ratescompared to 2007.  In addition, otherexpenses, primarily foreign exchange losses, were negatively impacted duringthree months ended September 30, 2008 due to the strengthening of the U.S.Dollar as compared to the Euro.

 

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For the nine months ended September 30, 2008, total other income(loss) was a net expense of $0.7 million as compared to net income of $1.8million for the same period ended September 30, 2007, primarily due tolower yields on investments and foreign currency losses.

 

*Provision for income taxes*

 

We adopted the provisions of FASB Interpretation No. 48, *Accounting for Uncertainty in Income Taxes*, or FIN 48, on January 1,2007.  The adoption of the provisions of FIN 48 did not have a materialimpact on our financial position and results of operations. We have not beenaudited by the Internal Revenue Service or any state income or franchise taxagency. As of September 30, 2008, our federal returns for the years ended2004 through the current period and most state returns for the years ended 2003through the current period are still open to examination. In addition, all of thenet operating losses and research and development credit carryforwards that maybe used in future years are still subject to inquiry given that the statute oflimitation for these items would be from the year of the utilization.

 

As of September 30, 2008, we recorded approximately $0. 3 millionof income tax expense attributable to our French subsidiary.

 

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

 

We do not expect our unrecognized tax benefits to change significantlyover the next 12 months.  In connectionwith the adoption of FIN 48, we recognize interest and penalties accrued on anyunrecognized tax benefits as a component of income tax expense.

 

**Liquidity and Capital Resources**

 

We have experienced significant operating losses since inception,however we experienced our first profitable quarter for the three months ended September 30,2008. As of September 30, 2008, we had an accumulated deficit of$240.3 million. We have financed our operations since inception primarilythrough equity and debt financings. In December 2006, we filed a shelfRegistration Statement on Form S-3, through which we may sell from time totime any combination of debt securities, common stock, preferred stock andwarrants, in one or more offerings. The aggregate initial offering price of allsecurities sold will not exceed $150,000,000. After the sale of our seniorconvertible notes described below, we had $63,750,000 remaining available forsale.

 

In February 2007, we issued and sold under the shelf RegistrationStatement an aggregate principal amount of $86,250,000 of our 2.25% convertiblesenior notes due 2027. These notes bear a 2.25% interest per annum on theprincipal amount, payable semiannually in arrears on February 15 and August 15of each year, beginning on August 15, 2007. Interest accrual on the notescommenced on February 12, 2007. The notes will mature on February 15,2027, unless earlier redeemed, repurchased or purchased by us or converted.

 

The notes will be convertible into cash and, if applicable, shares ofour common stock based on an initial conversion rate, subject to adjustment, of35.8616 shares per $1,000 principal amount of notes (which represents aninitial conversion price of approximately $27.89 per share), in certaincircumstances. Upon conversion, a holder would receive cash up to the principalamount of the note and our common stock in respect of such note’s conversionvalue in excess of such principal amount.

 

The notes are convertible only in the following circumstances: (1) duringany calendar quarter after the quarter ended March 31, 2007 if the closingsale price of our common stock for each of 20 or more trading days in a periodof 30 consecutive trading days ending on the last trading day of theimmediately preceding calendar quarter exceeds 120% of the conversion price; (2) duringthe five consecutive business days immediately after any five consecutivetrading day period if the average trading price per $1,000 principal amount ofthe notes is less than or equal to 97% of the average conversion value of thenotes during such five-day period; (3) upon the occurrence of specifiedcorporate transactions; (4) if we call the notes for redemption and (5) atanytime on or after December 15, 2011 up to and including February 15,2012 and anytime on or after February 15, 2025. Upon a change in controlor termination of trading, holders of the notes may require us to repurchaseall or a portion of their notes for cash at a repurchase price equal to 100% ofthe principal amount, plus any accrued and unpaid interest.

 

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In addition, in connection with the issuance of the notes, we enteredinto separate convertible note hedge transactions and separate warranttransactions to reduce the potential dilution upon conversion of the notes (“CallSpread Transactions”). As a result of the Call Spread Transactions, we do notanticipate experiencing an increase in the total shares outstanding from theconversion of the notes unless the price of our common stock appreciates above$36.47 per share, effectively increasing the conversion premium to us to$36.47. We purchased call options to cover approximately 3.1 millionshares of our common stock, which is the number of shares underlying the notes.In addition, we sold warrants permitting the purchasers to acquire up toapproximately 3.1 million shares of our common stock.

 

As of September 30, 2008, we held $48.5 million (par value) inauction rate securities backed by federal and state student loans which arevariable rate debt instruments and bear interest rates that reset approximatelyevery 20-30 days.  These auction ratesecurities are rated AAA or AA by a major credit rating agency and havecontractual maturities that range from 20 to 39 years. The securities areclassified as available for sale and are recorded at fair value.  We recorded a temporary reduction in carryingvalue of $2.8 million for the nine months ended September 30, 2008, whichhas been recorded as an unrealized loss in accumulated other comprehensiveloss.  We have experienced failedauctions in 2008 of all of our auction rate securities and there is noassurance that auctions on these auction rate securities in our investmentportfolio will succeed in the future.  Anauction failure means that the parties wishing to sell securities could notcarry out the transaction.  As a resultof these auction failures, our ability to liquidate our investments in the nearterm may be limited, and our ability to fully recover the carrying value of ourinvestments may be limited or non-existent. If the issuers of these securities are unable to successfully closefuture auctions or their credit ratings deteriorate, we may in the future berequired to record an impairment charge on these investments.  It could take until the final maturity of theunderlying notes (up to 39 years) to realize our investments’ recordedvalue.

 

UBS Investment Bank holds 100% of our auction rate securities.  During October 2008, UBS Investment Bankinformed us that they have designed a settlement process that will give UBS’sclients the opportunity to sell all auction rate securities at par by June 2010,unless they are redeemed by the issuer sooner. We received confirmation from UBS Investment Bank in October thatall the auction rate securities that we currently hold are eligible toparticipate in this process and be redeemed at par.  We intend to participate in the settlementprocess and therefore expect all our auction rate securities to be settled atfull par value.

 

In the future, depending on a variety of factors, we may need to raiseadditional funds through bank facilities, debt or equity offerings or othersources of capital.  Additional financingmay not be available when needed or on terms acceptable to us.

 

As of September 30, 2008, we had cash, cash equivalents andshort-term investments of $23.8 million, compared to $45.2 million at December 31,2007. The decrease of $21.4 million is primarily due to our acquisition ofConceptus SAS in January 2008. We expect cash usage in operatingactivities to decrease in the future primarily due to cash from net income. Webelieve that our existing cash and cash equivalents will be sufficient to meetour cash requirements for the next twelve months.

 

*Operating Activities*

 

Net cash provided by operating activities was $2.3 million in the ninemonths ended September 30, 2008, as compared to net cash used in operatingactivities of $7.0 million in the nine months ended September 30, 2007.Net cash provided by operating activities in the nine months ended September 30,2008 was primarily related to:

 

·                 netloss of $5.0 million; and

 

·                 non-cashrelated items of $7.4 million corresponding primarily to stock basedcompensation, depreciation and amortization of fixed assets, debt issuancecosts and amortization of intangibles;

 

We monitor our accounts receivable turnover closely to ensure thatreceivables are collected timely and have established a credit and collectionpolicy to facilitate our collection process and reduce our credit lossexposure.

 

We expect cash usage in operating activities in the future to decreaseas our revenues grow.

 

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*Investing Activities*

 

Net cash used in investing activities for the nine months ended September 30,2008 was $10.1 million, from sales and maturity of short-term investments of$22.1 million, offset by the purchase of Conceptus SAS, net of cash acquired of$23.0 million, purchases of investments of $5.0 million and capitalexpenditures of $4.1 million. Net cash used in investing activities for thenine months ended September 30, 2007 was $71.3 million, from sales andmaturity of short-term investments of $18.1 million, offset by purchases ofinvestments of $87.6 million and capital expenditures of $1.8 million.

 

*Financing Activities*

 

Net cash provided by financing activities in the nine months ended September 30,2008 was $3.2 million from the issuance of common stock for our stock optionprograms. Net cash provided by financing activities was $77.3 million for thenine months ended September 30, 2007 primarily due to the net proceeds of$83.2 million from our issuance of senior convertible notes in February 2007,the proceeds of $10.7 million for the issuance of warrants in connection withour senior convertible notes and the proceeds of $2.8 million for the issuanceof common stock for our stock option programs, offset by $19.4 million for thecost of our purchase of call options on our convertible senior notes.

 

**CRITICAL ACCOUNTING ESTIMATES AND POLICIES**

 

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

 

*Recent Accounting Pronouncements*

 

In September 2006, the Financial Standards Accounting Board, orFASB, issued Statement No. 157, *Fair Value Measurement,*or SFAS 157. This standard defines fair value, establishes the framework formeasuring fair value in accounting principles generally accepted in the UnitedStates and expands disclosure about fair value measurements. This pronouncementapplies under other accounting standards that require or permit fair valuemeasurements. SFAS 157 is effective for financial statements issued for yearsbeginning after November 15, 2007, and interim periods of those fiscalyears. FASB Staff Position, or FSP, 157-2, *Effective Date of FASBStatement No. 157* delays the effective date of SFAS 157 for allnon-financial assets and non-financial liabilities, except for items that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually), until the beginning of the first quarterof 2009.  Effective January 1, 2008we adopted SFAS 157 for financial assets and liabilities carried at fair value.The adoption of SFAS 157 for financial assets and liabilities did not have amaterial impact on our condensed consolidated financial statements.  See Note 4– Fair Value Measurements.

 

In February 2007, FASB issued Statement No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities*,or SFAS 159, which permits entities to choose to measure many financialinstruments and certain other items at fair value that are not currentlyrequired to be measured at fair value. SFAS 159 became effective for us on January 1,2008. The adoption of SFAS 159 did not have a material impact on our condensedconsolidated financial statements.

 

In December 2007, FASB issued Statement No. 141 (revised2007), *Business Combinations*, or SFAS 141(R),and Statement No. 160, *Noncontrolling Interestsin Consolidated Financial Statements*, or SFAS 160, an amendment ofAccounting Research Bulleting No. 51, or ARB 51. SFAS 141(R) willimpact financial statements on the acquisition date and in subsequent periods.Some of the changes, such as the accounting for contingent consideration, willintroduce more volatility into earnings and may impact our acquisitionstrategy. SFAS 160 will change the accounting and reporting for minorityinterests, which will be re-characterized as non-controlling interests andclassified as a component of equity. In addition, SFAS 141(R) will beapplied prospectively and SFAS 160 will require retroactive adoption of thepresentation and disclosure requirements for existing minority interests, whilethe remaining requirements of SFAS 160 will be applied prospectively. SFAS 141(R) andSFAS 160 are effective on January 1, 2009. We are currently evaluating theimpact of adopting SFAS 141(R) and SFAS 160 on our consolidated financialstatements.

 

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

 

In April 2008, the FASB issued FSP No. 142-3, *Determination of the Useful Life of Intangible Assets*, orFSP 142-3*.* FSP 142-3 amends the factors an entity should consider in developingrenewal or extension assumptions used in determining the useful life ofrecognized intangible assets under FASB Statement No. 142, *Goodwill and Other Intangible Assets*.  This new guidance applies prospectively tointangible assets that are acquired individually or with a group of otherassets in business combinations and asset acquisitions.  FSP 142-3 is effective for financialstatements issued for fiscal years and interim periods beginning after December 15,2008.  Early adoption is prohibited.  We are evaluating the impact, if any, thatFSP 142-3 will have on our consolidated financial statements.

 

In May 2008, the FASB issued FSP APB 14-1, *Accountingfor Convertible DebtInstruments That May Be Settled in Cash upon Conversion (Including PartialCash Settlement)*, orFSP APB 14-1, which clarifies the accounting for convertible debt instrumentsthat may be settled in cash upon conversion, including partial cashsettlement.  FSP APB 14-1 specifies thatan issue of such instruments should separately account for the liability andequity components of the instruments in a manner that reflect the issuer’snon-convertible debt borrowing rate which interest costs are recognized insubsequent periods.  FSP APB 14-1 iseffective for fiscal years beginning after December 15, 2008, andretrospective application is required for all periods presented.  We are evaluating the impact, if any, thatFAS APB 14-1 will have on our consolidated financial statements.

 

In October 2008, the FASB issued FSP No. 157-3, *Determining the Fair Value of a Financial Asset When the Market forThat Asset is Not Active*, or FSP 157-3, to clarify the applicationof the provisions of SFAS 157 in an inactive market and how an entity woulddetermine fair value in an inactive market. FSP 157-3 is effective immediatelyand applies to our September 30, 2008 financial statements. Theapplication of the provisions of FSP 157-3 did not have a material impact onour condensed consolidated financial statements.

 

**Item 3. Quantitative and QualitativeDisclosures About Market Risk**

 

The following discusses our exposure to market risk related to changesin interest rates and foreign currency exchange rates. These exposures maychange over time as business practices evolve and could have a material adverseimpact on our financial results.

 

*Interest Rate Risk*: We have been exposed to interest rate risk through interest earned on holdingsof available-for-sale marketable securities. We have experienced failedauctions in 2008 of all our auction rate securities and there is no assurancethat auctions on these auction rate securities in our investment portfolio willsucceed in the future. As a result, our ability to liquidate our investments inthe near term may be limited, and our ability to fully recover the carryingvalue of our investments may be limited or non-existent. An auction failuremeans that the parties wishing to sell securities could not carry out thetransaction. If the issuers of these securities are unable to successfullyclose future auctions or their credit ratings deteriorate, we may in the futurebe required to record an impairment charge on these investments. It could takeuntil the final maturity of the underlying notes (up to 39 years) torealize our investments’ recorded value. As of September 30, 2008 we held$48.5 million (par value) in auction rate securities which are variablerate debt instruments and bear interest rates that are due to resetapproximately every 20-30 days. All of these auction rate securities wereclassified as long term investments in our condensed consolidated balance sheetat September 30, 2008 with an expected maturity of greater than one year.Due in part to these factors, our future investment income may fall short ofexpectations due to changes in interest rates or we may suffer losses inprincipal if forced to sell securities that have declined in market value dueto changes in interest rates. Interest rates that may affect these items in thefuture will depend on market conditions and may differ from the rates we haveexperienced in the past.

 

*Foreign Currency Exchange Risk:*  Historically,all of our expenses and our revenues were typically denominated in U. S.Dollars. On January 7, 2008, we acquired all the outstanding shares ofConceptus SAS.  As a result of thistransaction, Conceptus SAS became a wholly owned subsidiary and its results ofoperations have been consolidated with our results of operations for financialreporting purposes as of the acquisition date. The functional currency ofConceptus SAS is the Euro; therefore, we are now exposed to changes in foreignexchange rates. We are exposed to foreign exchange rate fluctuations as wetranslate the financial statements of Conceptus SAS into U.S. Dollars inconsolidation. If there is a change in foreign currency exchange rates, thetranslation of Conceptus SAS’ financial statements into U.S. Dollars will leadto translation gains or losses which are recorded net as a component ofaccumulated other comprehensive loss. We will seek to manage our foreignexchange risk through operational means, including managing same currencyrevenues in relation to same currency expenses, and same currency assets inrelation to same currency liabilities. In connection with the acquisition ofConceptus SAS, we

 

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assumed a forward exchange contract to hedge U.S. Dollar-denominatedestimated accounts payable in 2008. We have recorded the changes of the fairvalue of the hedge contract in our results of operations for the nine monthsended September 30, 2008.  In 2007,we did not enter into forward exchange contracts to hedge exposure denominatedin foreign currencies or any other derivative financial instruments for tradingor speculative purposes.

 

**Item 4. Controls and Procedures**

 

*Evaluation of Disclosure Controls andProcedures:*

 

We maintain disclosure controls and procedures that are designed toensure that information required to be disclosed in our Exchange Act reports isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowfor timely decisions regarding required disclosure. In designing and evaluatingthe disclosure controls and procedures, management recognized that any controlsand procedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, and inreaching a reasonable level of assurance, management is required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures.

 

As of September 30, 2008, the end of our most recent fiscalquarter, we carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer and ourChief Financial Officer, of the effectiveness of the design and operation ofour disclosure controls and procedures. Based on the foregoing, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures were effective.

 

*Changes in Internal Control Over FinancialReporting:*

 

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

 

*Inherent Limitations of Internal Controls*

 

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

 

**PART II.  OTHER INFORMATION**

 

**Item 1. Legal Proceedings**

 

From time to time, we are involved in legal proceedings arising in theordinary course of business.  We believe there is no litigation pendingthat could have, individually or in the aggregate, a material adverse effect onour financial position, result of operations or cash flows.

 

**Item 1A. Risk Factors**

 

*The risk factors included in our AnnualReport as of December 31, 2007 on Form 10-K filed with the Securitiesand Exchange Commission on March 14, 2008 should be considered whileevaluating Conceptus and our business. In addition to those factors and toother information in this Form 10-Q, updates to the following risk factorsas of September 30, 2008 should be considered carefully while evaluatingConceptus and our business.*

 

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***Our investmentportfolio is invested in auction rate securities. Failures in the auctions forthese securities affect our liquidity, while deterioration in credit ratings ofissuers of such securities and/or third parties insuring such investments mayrequire us to adjust the carrying value of our investment through an impairmentof earnings.***

 

As of September 30, 2008, approximately $48.5 million (parvalue) of investments consisted entirely of auction rate securities backed byfederal and state student loans securities with maturity of underlying notes upto 39 years.  These investments havecharacteristics similar to short-term investments, because at pre-determinedintervals, generally ranging from 20 to 30 days, there is a new auctionprocess at which the interest rates for these securities are reset tocurrent interest rates. At the end of each such period, we historically haveeither chosen to roll-over these securities or redeem the securities for cash.

 

We have experienced failed auctions in 2008 of our auction ratesecurities and there is no assurance that auctions on these securities in ourinvestment portfolio will succeed in the future. As a result, our ability toliquidate our investments in the near term may be limited, and our ability tofully recover the carrying value of our investments may be limited or non-existent.An auction failure means that the parties wishing to sell securities could notcarry out the transaction. If the issuers of these securities are unable tosuccessfully close future auctions or their credit ratings deteriorate, we mayin the future be required to record an impairment charge on these investments.It could take until the final maturity of the underlying notes (up to39 years) to realize our investments’ recorded value. Based on our abilityto access our cash and cash equivalents, expected operating cash flows, and ourother sources of cash, we do not anticipate that the current lack of liquidityon these investments will affect our ability to continue to operate ourbusiness in the ordinary course. However, we can provide no assurance as towhen these investments will again become liquid or as to whether we mayultimately have to recognize an impairment charge in our results of operationswith respect to these investments.

 

***Government or thirdparty reimbursement for the Essure procedure may not be available or may beinadequate, which could adversely affect consumer demand, limit our futureproduct revenues and adversely affect our 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 have governmentmanaged health care systems that determine reimbursement for new devices andprocedures. In most markets, there are private insurance systems as well asgovernment managed systems. Regardless of the type of reimbursement system, webelieve that physician advocacy of our product will be required to obtainreimbursement.

 

Availability and extent of continued reimbursement will depend, atleast in part, on the clinical and cost effectiveness of our product. We cannotassure you that reimbursement for our product will continue to be available inthe United States or in international markets under either government orprivate reimbursement systems, or that physicians will support and advocatereimbursement for use of our product for all indications intended by us. We maybe unable to obtain or maintain reimbursement in any country within aparticular time frame, for a particular amount or at all, which would limit ourfuture product revenues and delay or prevent our profitability.

 

In addition, the level of reimbursement offered by prevailinghealthcare payment systems may correspondingly affect the level of co-paymentthat is required by the patient.  As anelective procedure, a patient’s decision to have the Essure procedure may beimpacted by a decline in overall economic conditions as patients are forced toprioritize discretionary spending.

 

***Our liquidity could be adversely impacted byadverse conditions in the financial markets.***

 

At September 30, 2008 the Company had cash and cash equivalents of$23.8 million.  This available cash andcash equivalents are held in accounts managed by third party financialinstitutions and consist of invested cash and cash in our operatingaccounts.  The invested cash is investedin interest bearing money market funds managed by third party financialinstitutions.  These funds invest indirect obligations of the government of the United States and traditional moneymarket funds.  To date we haveexperienced no loss or lack of access to our invested cash or cash equivalents;however, we can provide no assurances that access to our invested cash and cashequivalents will not be impacted by adverse conditions in the financialmarkets.

 

All of our cash and cash equivalents in our operating accounts are withthird party financial institutions. These balances exceed the Federal Deposit Insurance Corporation (“FDIC”)insurance limits.  While we monitor thecash balances in our operating accounts and adjust the cash balances asappropriate, these cash balances could be impacted if the underlying financialinstitutions fail or be subject to other adverse conditions in the financialmarkets.  To date we have experienced noloss or lack of access to cash in our operating accounts.

 

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**Item 6. Exhibits**

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

 

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**SIGNATURE**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 

Date: November 7, 2008

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

 

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**EXHIBIT INDEX**

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

 

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