**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-Q**

**x****                             ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the quarterly period Ended June 30, 2006**

**OR**

** ̈****                                ****TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For the transition period from               to               .**

**Commission File Number: 0-27596**

**CONCEPTUS, INC.**(Exact name of Registrant as specified in its charter)
| **Delaware**                                                    | **94-3170244**                        |
|-----------------------------------------------------------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) | (I.R.S. Employer  Identification No.) |

**331 East EvelynMountain View, CA 94041**(Address of Principal Executive Offices) (Zip Code)

**(650) 962-4000**(Registrant’s Telephone Number, Including Area Code)

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

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Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for atleast the past 90 days. Yes xNo  ̈

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” inRule 12b-2 of the Exchange Act (Check one)Large accelerated filer  ̈Accelerated Filer x Non acceleratedfiler  ̈

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of Exchange Act).Yes  ̈ No x

There were 29,275,138 shares of Registrant’s CommonStock issued and outstanding as of July 31, 2006.

 

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**CONCEPTUS, INC.**

**FORM 10-Q for the Quarter Ended June 30,2006**
|               | ** ** | ** **                                                                                                                 | ** ** | **Page**   |
|---------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **    | ** ** | ** **                                                                                                                 | ** ** | ** ** |
| Part I.  |       | Financial Information                                                                                                      |       | 3          |
|          |       |                                                                                                                       |       |       |
| Item 1.       |       | Condensed  Consolidated Financial Statements (Unaudited)                                                                   |       | 3          |
|          |       |                                                                                                                       |       |       |
|          |       | a)  Condensed Consolidated Balance Sheets as of June 30, 2006 and  December 31, 2005                             |       | 3          |
|          |       |                                                                                                                       |       |       |
|          |       | b)  Condensed Consolidated Statements of Operations for the three and six month  periods ended June 30, 2006 and 2005 |       | 4          |
|          |       |                                                                                                                       |       |       |
|          |       | c)  Condensed Consolidated Statements of Cash Flows for the six month periods  ended June 30, 2006 and 2005           |       | 5          |
|          |       |                                                                                                                       |       |       |
|          |       | d) Notes to  Condensed Consolidated Financial Statements                                                                   |       | 6          |
|          |       |                                                                                                                       |       |       |
| Item 2.       |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                |       | 15         |
|          |       |                                                                                                                       |       |       |
| Item 3.       |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                |       | 23         |
|          |       |                                                                                                                       |       |       |
| Item 4.       |       | Controls and  Procedures                                                                                                   |       | 23         |
|          |       |                                                                                                                       |       |       |
| Part II. |       | Other Information                                                                                                          |       | 24         |
|          |       |                                                                                                                       |       |       |
| Item 1.       |       | Legal Proceedings                                                                                                          |       | 24         |
|          |       |                                                                                                                       |       |       |
| Item  1A.     |       | Risk  Factors                                                                                                              | ** ** | 24         |
|          |       |                                                                                                                       | ** ** | ** ** |
| Item 2.       |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                               |       | 25         |
|          |       |                                                                                                                       |       |       |
| Item 3.       |       | Defaults  upon Senior Securities                                                                                           |       | 25         |
|          |       |                                                                                                                       |       |       |
| Item 4.       |       | Submission  of Matters to a Vote of Security Holders                                                                       |       | 25         |
|          |       |                                                                                                                       |       |       |
| Item 5.       |       | Other Information                                                                                                          |       | 25         |
|          |       |                                                                                                                       |       |       |
| Item  6.      |       | Exhibits                                                                                                                   |       | 26         |
|          |       |                                                                                                                       |       |       |
| Signature     |       |                                                                                                                       |       | 27         |

 

2

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**PART I.FINANCIAL INFORMATION**

 

**ITEM 1. Condensed Consolidated Financial Statements**

 

**Conceptus, Inc.**

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

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

 
| ** **                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| **Assets**                                          | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current assets:                                     |       |              |       |                  |       |
| Cash and cash  equivalents                          |       | $                 | 3,208      |                  | $          | 12,573 |   |
| Short-term  investments                             |       | 22,300            |       | 19,850                |       |
| Restricted cash                                     |       | 69                |       | 69                    |       |
| Accounts  receivable, net                           |       | 5,324             |       | 4,519                 |       |
| Inventories, net                                    |       | 1,806             |       | 3,392                 |       |
| Other current  assets                               |       | 860               |       | 1,110                 |       |
| Total current  assets                               |       | 33,567            |       | 41,513                |       |
|                                                |       |              |       |                  |       |
| Property and  equipment, net                        |       | 2,926             |       | 2,743                 |       |
| Intangible  assets, net                             |       | 1,450             |       | 1,550                 |       |
| Other assets                                        |       | 1,344             |       | 1,603                 |       |
|                                                |       |              |       |                  |       |
| **Total assets**                                    | ** ** | **$**             | **39,287** | ** **            | **$**      | **47,409** | ** ** |
|                                                |       |              |       |                  |       |
| **Liabilities and stockholders’  equity**      | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current  liabilities:                               |       |              |       |                  |       |
| Accounts payable                                    |       | $                 | 2,092      |                  | $          | 2,798 |   |
| Accrued  compensation                               |       | 2,623             |       | 3,052                 |       |
| Other accrued  liabilities                          |       | 1,258             |       | 1,074                 |       |
| Total current  liabilities                          |       | 5,973             |       | 6,924                 |       |
|                                                |       |              |       |                  |       |
| Other accrued  liabilities                          |       | 367               |       | 314                   |       |
|                                                |       |              |       |                  |       |
| Total  liabilities                                  |       | 6,340             |       | 7,238                 |       |
|                                                |       |              |       |                  |       |
| Stockholders’  equity:                         |       |              |       |                  |       |
| Common stock and  additional paid-in capital        |       | 249,194           |       | 246,359               |       |
| Deferred  stock-based compensation                  |       | —            |       | (1,058                | )          |
| Accumulated  deficit                                |       | (216,247          | )          | (205,130              | )          |
| Treasury Stock,  77,863 shares, at cost             |       | —            |       | —                |       |
|                                                |       |              |       |                  |       |
| Total  stockholders’ equity                    |       | 32,947            |       | 40,171                |       |
|                                                |       |              |       |                  |       |
| **Total liabilities and stockholders’ equity** | ** ** | **$**             | **39,287** | ** **            | **$**      | **47,409** | ** ** |

 

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

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* *

**Conceptus, Inc.**

**Condensed Consolidated Statements of Operations**

**(Unaudited)**

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

 
| ** **                                                                      | ** ** | **Three months ended**                                     | ** ** | **Six months ended**                                       | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **June 30,**                                                    | ** ** | **June 30,**                                                    | ** ** |
| ** **                                                                      | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| Net sales                                                                       |       | $                                                                    | 10,003     |                                                                 | $          | 5,032 |   | $ | 17,965 |   | $ | 8,903 |   |
| Cost of goods  sold (*)                                                         |       | 3,651                                                                |       | 2,102                                                                |       | 6,534 |   | 3,829 |   |
| Gross profit                                                                    |       | 6,352                                                                |       | 2,930                                                                |       | 11,431 |   | 5,074 |   |
|                                                                            |       |                                                                 |       |                                                                 |       |   |   |   |   |
| Operating  expenses:                                                            |       |                                                                 |       |                                                                 |       |   |   |   |   |
| Research and development (*)                                                    |       | 1,069                                                                |       | 909                                                                  |       | 2,269 |   | 1,875 |   |
| Selling, general and administrative (*)                                         |       | 10,935                                                               |       | 8,213                                                                |       | 20,935 |   | 15,950 |   |
| Total operating  expenses                                                       |       | 12,004                                                               |       | 9,122                                                                |       | 23,204 |   | 17,825 |   |
| Operating loss                                                                  |       | (5,652                                                               | )          | (6,192                                                               | )          | (11,773 | ) | (12,751 | ) |
|                                                                            |       |                                                                 |       |                                                                 |       |   |   |   |   |
| Interest and other income                                                       |       | 323                                                                  |       | 161                                                                  |       | 656 |   | 351 |   |
| Net loss                                                                        |       | $                                                                    | (5,329     | )                                                                    | $          | (6,031 | ) | $ | (11,117 | ) | $ | (12,400 | ) |
| Basic and  diluted net loss per share                                           |       | $                                                                    | (0.18      | )                                                                    | $          | (0.24 | ) | $ | (0.38 | ) | $ | (0.49 | ) |
| Weighted-average shares  used in computing basic and diluted net loss per share |       | 28,918                                                               |       | 25,453                                                               |       | 28,890 |   | 25,451 |   |

 

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

 
| ** **                           | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                           | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Cost of goods  sold                  |       | $                                | 71         |                           | $          | — |   | $ | 111 |   | $ | 28 |   |
| Research and  development            |       | 196                              |       | 33                             |       | 369 |   | 71 |   |
| Selling, general and  administrative |       | 1,311                            |       | 217                            |       | 2,552 |   | 412 |   |
|                                      |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |

 

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

Net loss for the second quarter and first six months of 2006 includedstock-based compensation expense to non-employees in accordance with EmergingIssues Task Force Issue (or “EITF”) No. 96-18 of $41,000 and $100,000,respectively, and stock-based compensation expense under Statement of FinancialAccounting Standards (or “SFAS”) No. 123(R) of $1,537,000 and $2,932,000,respectively, which consisted of stock-based compensation expense of $1,174,000and $2,291,000, respectively, related to employee stock options, employee stockpurchase plan and stock appreciation rights and stock-based compensationexpense of $363,000 and $641,000, respectively, related to employee restrictedstock and restricted stock units.

Net loss for the second quarter and first six months of 2005 includedstock-based compensation expense to non-employees in accordance with EITF 96-18of $6,000 and $83,000, respectively, and stock-based compensation expense of$244,000 and $428,000, respectively, related to employee restricted stock.

4

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**Conceptus, Inc.**

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)(In thousands)**
| ** **                                                                   | ** ** | **Six months ended** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                   | ** ** | **June 30,**              | ** ** |
| ** **                                                                   | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| **Cash  flows from operating activities**                                    | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net loss                                                                     |       | $                              | (11,117    | ) | $ | (12,400 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                           |       |   |   |
| Depreciation and amortization of property, plant and  equipment              |       | 540                            |       | 471 |   |
| Amortization of intangibles                                                  |       | 100                            |       | 100 |   |
| Inventory reserves                                                           |       | (134                           | )          | (24 | ) |
| Stock-based compensation expense                                             |       | 3,032                          |       | 511 |   |
| Allowance for doubtful accounts                                              |       | 42                             |       | 28 |   |
| Loss on retirement of fixed assets                                           |       | 6                              |       | 2 |   |
| Changes in operating assets and liabilities:                                 |       |                           |       |   |   |
| Accounts receivable                                                          |       | (847                           | )          | (638 | ) |
| Inventories                                                                  |       | 1,720                          |       | (1,303 | ) |
| Other current assets                                                         |       | 250                            |       | (157 | ) |
| Other assets                                                                 |       | 259                            |       | 129 |   |
| Accounts payable                                                             |       | (706                           | )          | 141 |   |
| Accrued compensation                                                         |       | (429                           | )          | 921 |   |
| Other accrued liabilities                                                    |       | 237                            |       | 156 |   |
| Net cash used in  operating activities                                       |       | (7,047                         | )          | (12,063 | ) |
|                                                                         |       |                           |       |   |   |
| **Cash  flows from investing activities**                                    | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Purchase of investments                                                      |       | (21,450                        | )          | (9,750 | ) |
| Maturities of investments                                                    |       | 19,000                         |       | 22,250 |   |
| Capital expenditures                                                         |       | (729                           | )          | (552 | ) |
| Net cash  provided by (used in) investing activities                         |       | (3,179                         | )          | 11,948 |   |
|                                                                         |       |                           |       |   |   |
| **Cash  flows from financing activities**                                    | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Issuance of common stock                                                     |       | 861                            |       | 113 |   |
| Net cash  provided by financing activities                                   |       | 861                            |       | 113 |   |
|                                                                         |       |                           |       |   |   |
| Net decrease in  cash and cash equivalents                                   |       | (9,365                         | )          | (2 | ) |
| Cash and cash  equivalents at the beginning of the period                    |       | 12,573                         |       | 2,002 |   |
| Cash and cash  equivalents at end of the period                              |       | $                              | 3,208      |   | $ | 2,000 |   |

 

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

5

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**Conceptus, Inc.**

***NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)***

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

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States of America for interim financial information and pursuantto the instructions to Form 10-Q and Article 10-01 of RegulationS-X.  Accordingly, they do not includeall of the information and footnotes required by accounting principlesgenerally accepted in the United States of America for complete financialstatements. In the opinion of management, all adjustments, consisting only ofnormal recurring adjustments, considered necessary for a fair statement havebeen included.

The condensed consolidated balance sheet at December 31, 2005 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 of America forcomplete financial statements. This financial data should be reviewed inconjunction with the audited consolidated financial statements and relatednotes included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2005.  Theresults of operations for the three and six months ended June 30, 2006 maynot necessarily be indicative of the operating results for the full 2006 fiscalyear or any other future interim periods.

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

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

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

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

Inventories are stated at the lower of cost ormarket.  Cost is based on actual costscomputed on a first-in, first-out basis. The components of inventories consist of the following (in thousands):

|                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------|------------|-------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Raw materials    |       | $                 | 123        |                  | $          | 122 |   |
| Work-in-progress |       | 530               |       | 1,940                 |       |
| Finished goods   |       | 1,153             |       | 1,330                 |       |
| **Total**        | ** ** | **$**             | **1,806**  | ** **            | **$**      | **3,392** | ** ** |

**4.****              Warranty**

The Company offers warranties on its product andrecords a liability for the estimated future costs associated with warrantyclaims, which is based upon historical experience and the Company’s estimate ofthe level 

6

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offuture costs.  Warranty costs are reflected in the statement of operationsas a cost of goods sold.  Areconciliation of the changes in the Company’s warranty liability for the sixmonths ended June 30, 2006 and 2005 follows (in thousands):

|                                                   | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| Warranty accrual  at the beginning of the period  |       | $                                                 | 70         |   | $ | 68 |   |
| Accruals for  warranties issued during the period |       | 179                                               |       | 99 |   |
| Settlements made  in kind during the period       |       | (136                                              | )          | (99 | ) |
| **Warranty accrual at the end of  the period**    | ** ** | **$**                                             | **113**    | ** ** | **$** | **68** | ** ** |

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

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

The Company elected to adopt the modified prospective applicationmethod as provided by SFAS No. 123(R). Accordingly, during the periodended June 30, 2006, the Company recorded stock-based compensation forshares granted prior to, but not yet vested as of the adoption date based onthe grant date fair value estimated in accordance with the original previsionsof SFAS No. 123, and therefore, the Company did not restate previouslyreported amounts. Stock-based compensation expense for all share-based paymentawards granted on or after January 1, 2006 is based on the grant date fairvalue estimated in accordance with the provisions of SFAS No. 123(R).

***Prior to the adoption of SFAS No. 123(R)***

Prior to the adoption of SFAS No. 123(R), the Company accountedfor employee stock-based compensation in accordance with Accounting PrinciplesBoard Opinion No. 25 (or “APB 25”), “Accounting for Stock Issued toEmployees,” and related interpretations in accounting for its stock-basedcompensation plans, as permitted by SFAS No. 123, “Accounting forStock-Based Compensation,” (or “SFAS No. 123”) and as amended by SFASNo. 148, “Accounting for Stock-Based Compensation-Transition andDisclosure, an amendment of FASB Statement No. 123”. The pro-formainformation for the three and six months ended June 30, 2005 was asfollows:
|                                                                                                                    | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                         | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                                                         | ** ** | **2005**                         | ** ** | **2005**                       | ** ** |
| Net loss, as  reported                                                                                             |       | $                                | (6,031     | )                              | $          | (12,400 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss                                      |       | 244                              |       | 428                            |       |
| Less: Total stock-based employee compensation  expense determined under the fair value based method for all awards |       | (1,434                           | )          | (2,779                         | )          |
| Pro forma net  loss                                                                                                | ** ** | **$**                            | **(7,221** | **)**                          | **$**      | **(14,751** | **)** |
|                                                                                                               |       |                             |       |                           |       |
| Basic and  diluted net loss per share                                                                              |       |                             |       |                           |       |
| As reported                                                                                                        | ** ** | **$**                            | **(0.24**  | **)**                          | **$**      | **(0.49** | **)** |
| Pro forma                                                                                                          | ** ** | **$**                            | **(0.28**  | **)**                          | **$**      | **(0.58** | **)** |

 

7

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

|                                  | ** ** | **Six months ended** | ** ** |
|----------------------------------|------------|--------------------------------|------------|
| ** **                       | ** ** | **June 30,**              | ** ** |
| ** **                       | ** ** | **2005**                       | ** ** |
| Expected term  (in years)        |       | 4.0                            |       |
| Average  risk-free interest rate |       | 3.63                           | %          |
| Average-volatility  factor       |       | 54.4                           | %          |
| Dividend yield                   |       | —                         |       |

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

The Company elected to adopt the modified prospectiveapplication method as provided by SFAS No. 123(R). Accordingly,compensation expense recognized for the three and six months endedJune 30, 2006 reflects the quarter and six months’ proportional share of:(a) compensation expense for all employee share-based payments grantedprior to, but not yet vested as of January 1, 2006, based on the grantdate fair value estimated in accordance with the original provisions of SFASNo. 123, (b) compensation expense for all employee share-basedpayments granted subsequent to December 31, 2005, based on the grant-datefair value estimated in accordance with the provisions of SFAS No. 123(R)and (c) compensation expense for stock-based awards granted tonon-employees. Previously reported amounts have not been restated.

The following table sets forth the total stock-basedcompensation expense resulting from stock options, restricted stock, restrictedstock units, stock appreciation rights and ESPP included in the CondensedConsolidated Statements of Operations (in thousands):

|                                                     | ** ** | **Three months**        | ** ** | **Six months**          | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                          | ** ** | **ended June 30,** | ** ** | **ended June 30,** | ** ** |
| ** **                                          | ** ** | **2006**                     | ** ** | **2006**                     | ** ** |
| Cost of goods  sold                                 |       | $                            | 71         |                         | $          | 111 |   |
| Research and  development                           |       | 196                          |       | 369                          |       |
| Selling, general  and administrative                |       | 1,311                        |       | 2,552                        |       |
| **Total  stock-based compensation expense**         | ** ** | **$**                        | **1,578**  | ** **                   | **$**      | **3,032** | ** ** |
| **Effect on basic and diluted net  loss per share** | ** ** | **$**                        | **(0.05**  | **)**                        | **$**      | **(0.10** | **)** |

Noincome tax benefit has been recognized relating to stock-based compensationexpense and no tax benefits have been realized from exercised stock options.There was no cash flow impact from the adoption of SFAS 123(R) in the three andsix months ended June 30, 2006.

StockOptions and Stock Appreciation Rights: During the six monthsended June 30, 2006, the Company granted 472,000 stock options and stockappreciation rights, with an estimated total grant-date fair value ofapproximately $3,053,000 and a grant date weighted-average fair value of $6.41per share. During the six months ended June 30, 2006, the Company recordedstock-based compensation expense of approximately $1,920,000 related to stockoptions granted prior to January 1, 2006 and unvested as of the adoptiondate of SFAS No. 123(R) and $243,000 for options granted in the six monthsended June 30, 2006.

Duringthe three months ended June 30, 2006, the Company granted 82,000 stockoptions and stock appreciation rights, with an estimated total grant-date fairvalue of approximately $379,000 and a grant date weighted-average fair value of$4.31 per share. During the three months ended June 30, 2006, the Companyrecorded stock-based compensation expense related to stock options of approximately$934,000 related to stock options granted prior to January 1, 2006 andunvested as of the adoption date of SFAS No. 123(R) and $174,000 foroptions granted in the three months ended June 30, 2006.

8

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Duringthe six months ended June 30, 2005, the Company granted 355,600 stockoptions, for which stock-based compensation expense was not recognized duringthat period.

EmployeeStock Purchase Plan (ESPP): The compensation cost inconnection with the plan for the six months ended June 30, 2006 wasapproximately $128,000. This cost is amortized on a straight-line basis overthe relevant subscription period. The grant date weighted-average fair valuewas $4.34 per share. During the six months ended June 30, 2005, theCompany issued 15,040 shares under the ESPP, for which stock-based compensationexpense was not recognized.

RestrictedShares and Restricted Stock Units: In connection withrestricted shares and restricted stock units granted, the Company recordedstock compensation representing the difference between the exercise price ofthe shares and the fair market value of the Company’s common shares on thedates the awards were granted. This stock compensation is being amortized on astraight-line basis over the vesting periods of the underlying stock awards.During the six months ended June 30, 2006, the Company recordedapproximately $641,000 of such compensation expense. The grant dateweighted-average fair value was $14.45 per share. During the three months endedJune 30, 2006, the Company recorded approximately $363,000 of suchcompensation expense. The grant date weighted-average fair value was $13.54 pershare. During the six months ended June 30, 2005 the Company recorded $641,000of restricted stock compensation expense.

***Valuation assumptions***

The fair value of stock-based awards was estimatedusing the Black-Scholes model with the following weighted-average assumptionsfor the six months ended June 30, 2006:

|                                  | ** ** | **Six months ended June 30, 2006**               | ** ** |
|----------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **Stock Option and Stock  Appreciation Right  Plans** | ** ** | **Employee Stock  Purchase Plan** | ** ** |
| Expected term  (in years)        |       | 3.68                                                                      |       | 0.75 |   |
| Average  risk-free interest rate |       | 4.79                                                                      | %          | 4.77 | % |
| Average  volatility factor       |       | 54.5                                                                      | %          | 55.0 | % |
| Dividend yield                   |       | —                                                                    |       | — |   |
| Weighted-average fair  value     |       | $                                                                         | 6.41       |   | $ | 4.34 |   |
|                                  |            |                                                                           |            |  |  |  |  |

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

*Expected Volatility:* The Company used historical volatility based on the expected term of the awards. The calculation was based on a simple-average method, using a reasonably sufficient number of price observations, in accordance with SFAS No. 123(R) and Staff Accounting Bulleting No. 107, “Share-Based Payment” (or “SAB 107”).

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

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

As stock-based compensation expense recognized in the Condensed Consolidated Statement of Operations for the first six months of fiscal year 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical 

9

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experience. In the Company’s pro forma information required under SFAS No. 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

Employee Stock Purchase Plan 

In November 1995, the Company’s Board of Directors adopted the1995 Employee Stock Purchase Plan (the “ESPP”). The ESPP became effectiveNovember 29, 1995. At that time, 200,000 shares were reserved for issuanceunder the ESPP. The ESPP permits participants to purchase common stock throughpayroll deductions of up to 10% of an employee’s annual base earnings. Thepurchase price per share is equal to 85% of the fair market value per share onthe participant’s entry date into the offering period or, if lower, 85% of the fairmarket value per share on the semi-annual purchase date. In March 2004,the Board of Directors approved an amendment to the ESPP to increase the numberof shares of common stock reserved for issuance by 150,000 shares. Thestockholders approved this amendment in June 2004, to be effectiveJuly 1, 2004. In March 2006, the Company’s Board of Directorsapproved an amendment to the ESPP to increase the number of shares of CommonStock reserved for issuance by 160,000 shares. This amendment was approved by thestockholders in June 2006.  As ofJune 30, 2006, 295,803 shares had been issued under the ESPP and 214,197shares were available for future issuance.

Company Stock Option Plans

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

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

In March 2001, the Board of Directors approved the 2001 Equity Incentive Plan (or “2001 Plan”) allowing granting of stock options and restricted stock to employees, directors and consultants. The 2001 Plan provides for the grant issuance of options, restricted stock, stock appreciation rights, performance share awards, dividend equivalents awards, stock payment awards, stock purchase rights and restricted stock unit awards to employees, directors and consultants of the Company. The 2001 Plan was originally adopted by the Board of Directors on March 21, 2001 with a total of 1,000,000 shares of common stock reserved for issuance thereunder, and was approved by the stockholders in May 2001. In March 2002, the Board of Directors approved an amendment and restatement of the 2001 Plan to increase the shares of reserved for issuance thereunder by an additional 1,000,000 shares, bringing the aggregate number reserved for issuance to 2,000,000 shares of common stock, and to provide for automatic grants of non-qualified stock options to non-employee directors as had been provided under the 1995 Director’s Stock Option Plan. The stockholders approved this amendment and restatement in May 2002. In April 2003, the Board of Directors approved the Second Amended and Restated 2001 Plan to increase the size of the formula grants to non-employee directors and to prohibit repricing. The stockholders approved this amendment and restatement in June 2003. In March 2004, the Board of Directors approved the Third Amended and Restated 2001 Plan to reduce the size of the automatic grants of stock options to non-employee directors and to provide for automatic grants of restricted stock to non-employee directors and to increase the shares of Common Stock reserved for issuance thereunder by an additional 500,000 shares, bringing the aggregate number reserved for issuance to 2,500,000 shares of common stock. The stockholders approved this amendment and restatement in June 2004. In November 2004, the 

10

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Board of Directors approved the Fourth Amended and Restated 2001 Plan to provide for the grant of restricted stock units and stock appreciation rights. In January 2005, the Board of Directors approved the Fifth Amended and Restated 2001 Plan to provide for a change in the number of shares to be automatically granted to non-employee directors under the plan. In December 2005, the Board of Directors approved the Sixth Amended and Restated 2001 Plan to establish that the price of future grants be based on the closing price of the Company’s stock on the date of grant, rather than the previous trading day. In February 2006, the Board of Directors approved the Seventh Amended and Restated 2001 Plan to provide for the increase the annual grant of restricted stock for directors from 2,000 shares to 2,500 shares. In April 2006, the Board of Directors approved the amendment to the Eighth Amended and Restated 2001 Plan to increase the shares of Common Stock reserved for issuance thereunder by an additional 1,500,000 shares, bringing the aggregate number reserved for issuance to 4,000,000 shares of Common Stock. This amendment was approved by the stockholders in June 2006.

Under the terms of the 2001 Plan, incentive stockoptions may be granted only to employees with exercise prices not lessthan the fair market value of the common stock on the date of grant. Stockoptions and stock appreciation rights may be granted with different vestingterms from time to time but generally provide for vesting of at least 20% ofthe total number of shares per year. All options and stock appreciation rightsunder the 2001 Plan expire ten years after grant, and five years in the case ofa grant to a 10% stockholder. Stock appreciation rights are to be settled instock. Stock options may include provisions permitting exercise of theoption prior to full vesting. As of June 30, 2006, there were no sharesthat were exercised prior to fully vesting. To the extent that the aggregatefair market value of the shares subject to a holder’s incentive stock optionsexceeds $100,000, the excess options will be treated as non-qualified stockoptions.

On November 29, 1995, the Board of Directorsapproved the 1995 Director’s Stock Option Plan (or “Directors’ Plan”), whichallows the granting of options for up to 100,000 shares of common stock tooutside directors. Stock options may be granted to outside directors withexercise prices of not less than fair market value. The options expire tenyears from date of grant. Options granted under the Directors’ Plan vest overone or three years. The options are only exercisable while the outside directorremains a director.

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

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

As of June 30, 2006, 41,706 shares remained as available for grant under the 2002 Plan, 1,674,098 shares remained as available for grant under the 2001 Plan, no shares remained available for grant under the 1993 Plan and no shares remained available for grant under the Director’s Plan.

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

11

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A summary of the activity for the six months ended June 30, 2006 of the Company’s 1993, 2001 and 2002 Plans, the 1995 Directors’ Plan and stand-alone grant activity is as follows:
| ** **                                             | ** ** | ** **                                | ** ** | **Awards Outstanding** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | **Shares Available  For Grant** | ** ** | **Awards  Outstanding**     | ** ** | **Weighted-Average  Exercise Price** | ** ** |
| Balance  outstanding at December 31, 2005         |       | 704,312                                   |       | 3,513,751                   |       | $ | 10.62 |   |
| Additional  authorized                                 |       | 1,500,000                                 |       | —                      |       | $ | — |   |
| Options granted                                        |       | (472,000                                  | )          | 472,000                     |       | 14.37 |   |
| Restricted stock  and restricted stock units granted   |       | (102,499                                  | )          | 102,499                     |       | — |   |
| Restricted stock  issued                               |       | —                                    |       | (26,000                     | )          | — |   |
| Options  exercised                                     |       | —                                    |       | (100,673                    | )          | 6.21 |   |
| Options  cancelled                                     |       | 42,531                                    |       | (42,531                     | )          | 15.57 |   |
| Options  forfeited                                     |       | 62,644                                    |       | (62,644                     | )          | 11.68 |   |
| Restricted stock  and restricted stock units cancelled |       | —                                    |       | (6,610                      | )          | — |   |
| Options expired                                        |       | (19,184                                   | )          | —                      |       | 15.57 |   |
| Balance outstanding at  June 30, 2006             |       | 1,715,804                                 |       | 3,849,792                   |       | $ | 11.13 |   |

Asummary of the activity for the three months ended June 30, 2006 of theCompany's 1993, 2001 and 2002 Plans, the 1995 Directors' Plan and stand-alonegrant activity is as follows:
| ** **                                             | ** ** | ** **                                | ** ** | **Awards Outstanding** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | **Shares Available  For Grant** | ** ** | **Awards  Outstanding**     | ** ** | **Weighted-Average  Exercise Price** | ** ** |
| Balance  outstanding at March 31, 2006            |       | 279,723                                   |       | 3,866,136                   |       | $ | 11.03 |   |
| Additional  authorized                                 |       | 1,500,000                                 |       | —                      |       | — |   |
| Options granted                                        |       | (88,000                                   | )          | 88,000                      |       | 13.36 |   |
| Restricted stock  and restricted stock units granted   |       | (22,500                                   | )          | 22,500                      |       | — |   |
| Restricted stock  issued                               |       | —                                    |       | (14,000                     | )          | — |   |
| Options  exercised                                     |       | —                                    |       | (46,503                     | )          | 4.29 |   |
| Options  cancelled                                     |       | 13,475                                    |       | (13,475                     | )          | 14.95 |   |
| Options  forfeited                                     |       | 46,456                                    |       | (46,456                     | )          | 12.65 |   |
| Restricted stock  and restricted stock units cancelled |       | —                                    |       | (6,410                      | )          | — |   |
| Options expired                                        |       | (13,350                                   | )          | —                      |       | — |   |
| Balance outstanding at  June 30, 2006             |       | 1,715,804                                 |       | 3,849,792                   |       | $ | 11.13 |   |

A summary of the activity for the six months ended June 30, 2006 of stock options and stock appreciation rights is as follows:

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|                                                | ** ** | **Options**        | ** ** | ** **              | ** ** | ** **    | ** ** |
|------------------------------------------------|------------|--------------------|------------|-------------------------|------------|---------------|------------|
| ** **                                     | ** ** | **and Stock** | ** ** | ** **              | ** ** | ** **    | ** ** |
| ** **                                     | ** ** | **Appreciation**   | ** ** | **Weighted-**           | ** ** | **Aggregate** | ** ** |
| ** **                                     | ** ** | **Rights**         | ** ** | **Average**             | ** ** | **Intrinsic** | ** ** |
| ** **                                     | ** ** | **Outstanding**    | ** ** | **Exercise Price** | ** ** | **Value**     | ** ** |
| Balance  outstanding at December 31, 2005 |       | 3,513,751          |       | $                       | 10.62      |          |       |   |
| Grants                                         |       | 472,000            |       | 14.37                   |       |          |       |
| Exercises                                      |       | (100,673           | )          | 6.21                    |       |          |       |
| Forfeitures                                    |       | (62,644            | )          | 11.68                   |       |          |       |
| Cancellations                                  |       | (42,531            | )          | 15.57                   |       |          |       |
| Balance  outstanding at June 30, 2006     |       | 3,779,903          |       | 11.13                   |       | $             | 11,351,830 |   |
| Exercisable at  June 30, 2006             |       | 2,193,156          |       | $                       | 10.94      |          | $          | 7,342,698 |   |

A summary of the activity for the three months ended June 30, 2006 of stock options and stock appreciation rights is as follows:
|                                             | ** ** | **Options**        | ** ** | ** **              | ** ** | ** **    | ** ** |
|---------------------------------------------|------------|--------------------|------------|-------------------------|------------|---------------|------------|
| ** **                                  | ** ** | **and Stock** | ** ** | ** **              | ** ** | ** **    | ** ** |
| ** **                                  | ** ** | **Appreciation**   | ** ** | **Weighted-**           | ** ** | **Aggregate** | ** ** |
| ** **                                  | ** ** | **Rights**         | ** ** | **Average**             | ** ** | **Intrinsic** | ** ** |
| ** **                                  | ** ** | **Outstanding**    | ** ** | **Exercise Price** | ** ** | **Value**     | ** ** |
| Balance  outstanding at March 31, 2006 |       | 3,798,337          |       | $                       | 11.03      |          |       |   |
| Grants                                      |       | 88,000             |       | 13.36                   |       |          |       |
| Exercises                                   |       | (46,503            | )          | 4.29                    |       |          |       |
| Forfeitures                                 |       | (46,456            | )          | 12.65                   |       |          |       |
| Cancellations                               |       | (13,475            | )          | 14.95                   |       |          |       |
| Balance outstanding  at June 30, 2006  |       | 3,779,903          |       | 11.13                   |       | $             | 11,351,830 |   |
| Exercisable at  June 30, 2006          |       | 2,193,156          |       | $                       | 10.94      |          | $          | 7,342,698 |   |

The following table summarizes information about stock options outstanding and exercisable at June 30, 2006:

 
|                                         | ** ** | ** **                   | ** ** | ** **                       | ** ** | ** **          | ** ** | **Options Vested** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|----------------------------------|------------|---------------------|------------|-------------------------|------------|
| ** **                              | ** ** | **Options Outstanding** | ** ** | **and Exercisable**         | ** ** |
| ** **                              | ** ** | ** **                   | ** ** | **Weighted**                     | ** ** | **Weighted**        | ** ** | **Options**             | ** ** | **Weighted** | ** ** |
| ** **                              | ** ** | ** **                   | ** ** | **Average**                      | ** ** | **Average**         | ** ** | **Vested**              | ** ** | **Average** | ** ** |
| **Range of  Exercise Prices** | ** ** | **Options  Outstanding**     | ** ** | **Remaining  Life (years)** | ** ** | **Exercise  Price** | ** ** | **and  Exercisable**    | ** ** | **Exercise  Price** | ** ** |
| $1.25                                   | -          | $7.55                        |       | 395,746                          |       | 5.02                |       | $                       | 4.59       |   | 339,722 |   | $ | 4.27 |   |
| $7.58                                   | -          | $8.32                        |       | 267,630                          |       | 8.51                |       | $                       | 8.02       |   | 101,057 |   | $ | 8.04 |   |
| $8.40                                   | -          | $8.94                        |       | 431,937                          |       | 8.39                |       | $                       | 8.92       |   | 163,873 |   | $ | 8.92 |   |
| $9.00                                   | -          | $9.76                        |       | 278,625                          |       | 4.94                |       | $                       | 9.43       |   | 222,830 |   | $ | 9.46 |   |
| $9.95                                   | -          | $9.95                        |       | 630,000                          |       | 6.80                |       | $                       | 9.95       |   | 399,000 |   | $ | 9.95 |   |
| $9.96                                   | -          | $13.11                       |       | 502,021                          |       | 7.65                |       | $                       | 12.33      |   | 298,884 |   | $ | 12.30 |   |
| $13.29                                  | -          | $14.12                       |       | 390,300                          |       | 7.73                |       | $                       | 13.52      |   | 172,286 |   | $ | 13.66 |   |
| $14.15                                  | -          | $14.76                       |       | 529,375                          |       | 8.67                |       | $                       | 14.61      |   | 164,083 |   | $ | 14.33 |   |
| $14.95                                  | -          | $21.27                       |       | 329,269                          |       | 5.82                |       | $                       | 17.05      |   | 306,421 |   | $ | 17.18 |   |
| $21.80                                  | -          | $21.80                       |       | 25,000                           |       | 5.45                |       | $                       | 21.80      |   | 25,000 |   | $ | 21.80 |   |
| $1.25                                   | -          | $21.80                       |       | 3,779,903                        |       | 7.16                |       | $                       | 11.13      |   | 2,193,156 |   | $ | 10.94 |   |

 

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As of June 30, 2006, there was unrecognized compensation cost of approximately $7,482,000 related to stock options and stock appreciation rights, net of forfeitures. This cost is expected to be recognized over a weighted-average period of 1.3 years.

Restricted stock and restricted stock unit activity for the six months ended June 30, 2006, is as follows:

|                                                        | ** ** | ** **         | ** ** | **Weighted-**       | ** ** |
|--------------------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                             | ** ** | ** **         | ** ** | **Average**         | ** ** |
| ** **                                             | ** ** | **Shares**         | ** ** | **Grant Date** | ** ** |
| ** **                                             | ** ** | **and Units** | ** ** | **Fair Value** | ** ** |
| Nonvested stock  outstanding at December 31, 2005 |       | 254,848            |       | $                   | 9.44       |   |
| Grants                                                 |       | 102,499            |       | 11.28               |       |
| Vested                                                 |       | (7,178             | )          | 7.65                |       |
| Cancellations                                          |       | (6,610             | )          | —              |       |
| Nonvested stock  oustanding at June 30, 2006      |       | 343,559            |       | $                   | 9.68       |   |

Restricted stock and restricted stock unit activity for the three months ended June 30, 2006, is as follows:

|                                                     | ** ** | ** **         | ** ** | **Weighted-**       | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                          | ** ** | ** **         | ** ** | **Average**         | ** ** |
| ** **                                          | ** ** | **Shares**         | ** ** | **Grant Date** | ** ** |
| ** **                                          | ** ** | **and Units** | ** ** | **Fair Value** | ** ** |
| Nonvested stock  outstanding at March 31, 2006 |       | 334,647            |       | $                   | 9.68       |   |
| Grants                                              |       | 22,500             |       | 13.29               |       |
| Vested                                              |       | (7,178             | )          | 7.65                |       |
| Cancellations                                       |       | (6,410             | )          | —              |       |
| Nonvested stock  oustanding at June 30, 2006   |       | 343,559            |       | $                   | 9.68       |   |

As of June 30, 2006, there was unrecognized compensation cost of approximately $1,683,000 related to nonvested restricted shares and restricted stock units, net of forfeitures. This cost is expected to be recognized over a weighted-average period of 0.8 years for restricted stock awards and 2 years for restricted stock units.

*Stock-based Compensation to Non-employees*

Stock-based compensation arrangements to non-employees are accounted for in accordance with Emerging Issues Task Force Issue (or “EITF”) No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” which requires that these equity instruments are recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the underlying equity instruments vest. Stock-based compensation expense relating to non-employees was $100,000 and $83,000 for the six months ended June 30, 2006 and 2005, respectively. Stock-based compensation expense relating to non-employees was $41,000 and $6,000 for the three months ended June 30, 2006 and 2005, respectively.

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

Basic net loss per share excludes any potentialdilutive effects of options and common stock shares subject to repurchase.  Diluted net loss per share includes theimpact of potentially dilutive securities. However, due to the Company’s net loss position, basic and diluted netloss per share are both computed using the weighted average number of commonshares outstanding.

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The following table provides a reconciliation ofweighted-average number of common shares outstanding and the weighted-averagenumber common shares outstanding used in computing basic and diluted net lossper common share (in thousands):
| ** **                                                                                                          | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                          | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| Denominator:                                                                                                        |       |                                                |       |                                              |       |   |   |   |   |
| Weighted-average number  of common shares outstanding                                                               |       | 29,185                                              |       | 25,695                                            |       | 29,154 |   | 25,691 |   |
| Less:  Weighted-average unvested restricted common shares                                                           |       | (267                                                | )          | (242                                              | )          | (264 | ) | (240 | ) |
| **Weighted-average number common shares oustanding  used in computing basic and diluted net loss per common share** | ** ** | **28,918**                                          | ** ** | **25,453**                                        | ** ** | **28,890** | ** ** | **25,451** | ** ** |

 

The following outstanding options, potential employeestock purchase plan shares, stock appreciation rights and restricted stockshares, which could potentially dilute basic net loss per share in the futurewere excluded from the computation of diluted net loss per share, as theireffect would have been antidilutive (in thousands):

|                               | ** ** | **At June 30,** | ** ** |
|-------------------------------|------------|---------------------------|------------|
| ** **                    | ** ** | **2006**                  | ** ** | **2005** | ** ** |
| Outstanding options and  SARs |       | 3,780                     |       | 3,599 |   |
| Restricted stock              |       | 274                       |       | 248 |   |
| Restricted stock units        |       | 70                        |       | — |   |
| Employee Stock Purchase  Plan |       | 45                        |       | 30 |   |
| **Total**                     | ** ** | **4,169**                 | ** ** | **3,877** | ** ** |

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

The Company holds 77,863 shares of treasury stock as aresult of repurchasing shares of restricted common stock at par value in 2004 and 2005, in accordance with the termsof the restricted stock agreements. These shares had a purchase price of $0.003per share and are recorded as treasury stock.

As of January 1, 2006, the Company reclassified theoutstanding Deferred Stock-Based Compensation balance of approximately$1,058,000 into Additional Paid in Capital as required in SFAS No. 123(R).

**Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

*The followingdiscussion of our financial condition and results of operations should be readin conjunction with our consolidated financial statements and related notesthereto. This discussion contains forward-looking statements, includingreferences to 2006 revenues, increased product adoption, expanded sales forceand other forecasted items, that involve risks and uncertainties such as ourlimited operating and sales history; the uncertainty of market acceptance ofour product; dependence on obtaining and maintaining reimbursement;effectiveness and safety of our product over the long-term; our ability toobtain and maintain the necessary governmental clearances or approvals tomarket our product; our ability to develop and maintain proprietary aspects ofour technology; our ability to manage our expansion; our limited history ofmanufacturing our product; our dependence on single source suppliers, thirdparty manufacturers and co-marketers; intense competition in the medical deviceindustry; the inherent risk of exposure to product liability claims and productrecalls and other factors referenced in this Form 10-Q.  Our actual results could differ materiallyfrom those expressed or implied in these forward-looking*

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*statementsas a result of various factors, including those discussed in “Risk Factors” andelsewhere in this Form 10-Q.*

**Overview**

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

*TheEssure Procedure*

The *Essure*procedure is typically performed as an outpatient procedure and is intended tobe a less invasive and a less costly alternative to tubal ligation, the leadingform of birth control in the United States and worldwide. Laparoscopic tuballigation and tubal ligation by laparotomy typically involve abdominal incisionsand/or punctures, general or regional anesthesia, four to ten days of normalrecovery time and the risks associated with an incisional procedure. The *Essure* procedure does not require cutting or penetrating theabdomen, which lowers the likelihood of post-operative pain due to theincisions/punctures, and it can be performed in an outpatient setting withoutgeneral or regional anesthesia.  In the Pivotal trial of the *Essure* system, the total procedure time averaged 35 minutes,with an average of 13 minutes of hysteroscopic time to place the *Essure* micro-insert. A patient is typically dischargedapproximately 45 minutes after the *Essure*procedure. No overnight hospital stay is required.  Furthermore, the *Essure* system is effective without drugs orhormones. There is a three-month waiting period after the procedure duringwhich the woman must use another form of birth control while tissue in-growthoccurs. At 90 days following the procedure, the patient completes afollow-up examination called a hysterosalpingogram (or “HSG”), which candetermine whether the device was placed successfully and whether the fallopiantubes are occluded.

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

Published reportsestimate that 700,000 tubal ligation procedures are performed each year in theUnited States. We intend to tap into this market and establish the *Essure* procedure as the gold standard for permanent birthcontrol.

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

*Effectivenessof the Essure System*

In July 2005, wereceived approval from the FDA to extend effectiveness data on the *Essure* product labeling. The PMA supplement filed inJanuary 2005 supports an extension of the effectiveness rate of the *Essure*

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system to 99.80% after four years and 99.74% afterfive years of follow-up, from the previously approved 99.80% at three years.The five-year effectiveness was demonstrated in a portion of the womenundergoing clinical studies.

In September 2005,we received approval from the FDA to terminate the Company’s post-approval studywith physicians who were newly trained in performing the *Essure*procedure due to the positive placement data obtained. The purpose of thepost-approval study, required by the FDA as a condition of theNovember 2002 approval of the *Essure* system,was to determine the rate of successful bilateral placements of the *Essure* micro-inserts at first attempt with a large number ofnewly trained physicians who were not part of the previous clinical studies.Although treatment of the total number of patients required by FDA had not beencompleted, the data obtained to date provided us with the opportunity torequest that the FDA permit an early termination of the study. Because of theFDA ruling, the PMA Supplement submitted in March 2005 has been re-classifiedas a Final Report. The results of the post-approval study demonstrated animprovement in placement rates from those obtained in the pivotal study and weare seeking to obtain a new placement rate claim for the product using this newdata. In late 2005, we submitted a new PMA Supplement for the bilateralplacement rate claims for which it is seeking FDA approval in order to updatethe labeling for the *Essure* system.An amendment to the Supplement was filed in April 2006 and we expect FDAapproval of the new placement rate labeling by September 2006.

*Penetration*

Conceptus requires that ahospital have at least one physician preceptored for generally between 3 and 5cases by a certified trainer before being able to perform the procedureindependently.  As of June 30, 2006, we had a total of 3,683 doctorsin the United States that have either completed or are in the process ofcompleting preceptorship. This represents an increase of 801 physicians overthe number of physicians at December 31, 2005 and an increase of 1,501physicians over the number of physicians at June 30, 2005.  The level of sales for the *Essure* system, particularly in this early period ofadoption, is highly dependent on the number of physicians trained to performthe procedure.

*Reimbursementof the Essure Procedure*

Market acceptance of the *Essure* system depends in part upon the availability ofreimbursement within prevailing healthcare payment systems. We believethat physician advocacy of our product will be required to continue to obtainreimbursement.  As of June 30, 2006, we have received positivereimbursement decisions for the *Essure*procedure from most private insurers and 37 of the 51 Medicaid programs in thecountry. We intend to continue our effort to educate payers of thecost-effectiveness of our product and to establish further programs to helpphysicians to navigate reimbursement issues.

In 2005 we receivedpositive responses relating to reimbursement, which we believe will help usspeed up the acceptance of the *Essure* deviceby doctors and patients. Such is the case of the UnitedHealthcareServices, Inc., or UHC, a member of UnitedHealthcare Group, which approvedreimbursement for the *Essure*procedure in July 2005. In addition, in February 2006, we receivedcoverage from CIGNA Corporation, or Cigna. As with all healthcare plans,coverage will vary and is dependent upon the individual’s specific benefitplan.

Effective January 1,2006, the Centers for Medicare and Medicaid Services, or CMS, released theFinal Rule for the 2006 Physician Fee schedule. For the Current ProceduralTerminology (or “CPT”) code applicable to the *Essure*procedure, the CMS has provided for a national physician payment of $2,095.01for procedures performed in the office and $438.47 for physician payment whenthe procedure is performed in the hospital. This compares to a Medicarenational average payment for tubal ligation, the current standard of care forpermanent female sterilization, of $345.50. In addition, the CMS released theFinal Rule for the 2006 Outpatient Prospective Payment System, whichassigns hospital outpatient reimbursement amounts. This CPT code was alsoassigned a 2006 payment level of $2,454.00. We believe these values are veryfavorable for the *Essure* procedure and will help inestablishing increased utilization of the device amongst doctors. We expectthat the new code, once the process to establish it at all private and publicpayers that have given a favorable coverage decision is complete, willsignificantly ease the burden on a physician’s office in obtainingreimbursement for the *Essure*procedure and accelerate the coverage of the *Essure*procedure by private insurance companies and Medicaid. This process is notautomatic following receipt of the new CPT code, however, and we anticipatecontinuing to focus on reimbursement issues for sometime in the future, both tosecure our code and payment schedule into the payers’ databases, as wellas to help the physician negotiate a favorable contract for payment off thatschedule.

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*Adoptionof the Essure system*

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

First, we are expandingour sales territories and channels of distribution so as to increase our callfrequency on physicians. Since January 1, 2006, we added 18 salespositions and are expecting to add more during 2006. Also, we have includedregional distributors of women’s gynecology products to our marketing efforts.Among other responsibilities, our sales representatives are attempting toincrease penetration and utilization of the *Essure*procedure, as well as to facilitate the movement of the *Essure*procedure to the in the office environment.

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

Third, we are focused onobtaining favorable coverage decisions from payers representing the privatepaying and state-paying Medicaid systems. We are also focused on getting theCPT code and payment schedule implemented at all of the payers that havegiven a coverage decision. Until such time as the code is completelyimplemented and all major payers have provided a coverage decision, we havedeveloped a field based tactical reimbursement group aimed at educating thephysician and office staff regarding payer procedures following a declinedclaim, including appeals and petitioning procedures. Typically a newly coveredproduct will go through a period where claims are either inadvertently declinedor are paid at the incorrect amount. In either instance, the physician isreluctant to perform additional procedures until payment has been secured forearlier cases, causing a decline in utilization. Our tactical reimbursementfocus is intended to give the physician and his/her staff the tools to ensurethat claims will ultimately be paid and thereby encourages the physician tocontinue performing the *Essure*procedure despite reimbursement issues. This tactical reimbursement group 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.

Lastly, we intend to makeimprovements to the *Essure* devicein both ease of use and clinical performance. The Company maintains an activeproduct development function, that expects to complete a third generationdevice for launch in 2007 and a fourth generation device for launch in late2008. While the *Essure* product already performsvery well in the market, these incremental improvements are meant to maintainour market superiority during a time that may see competition enter the market.This third generation device will also have as an advantage a substantiallylower price.

We have experiencedsignificant operating losses since inception and, as of June 30, 2006, hadan accumulated deficit of $216.2 million. We expect our operating losses tocontinue as we continue to expend substantial resources in the selling andmarketing of the *Essure* system in the UnitedStates and abroad. Due to the unpredictable nature of these activities, we donot know whether we will achieve or sustain profitability in the future. Wewill continue to be in a net loss position until sufficient revenues can begenerated to offset expenses. In the future, depending upon a variety offactors, we may need to raise funds through bank facilities, debt or equityofferings or other sources of capital. Additional financing may not beavailable when needed or on terms acceptable to us.

**Resultsof Operations - Three and Six Months Ended June 30, 2006 and 2005**

*Net Sales*

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Net sales were$10.0 million for the three months ended June 30, 2006 as compared to $5.0million for the three months ended June 30, 2005, an increase of $5.0million, or 99%.  Net sales for the sixmonths ended June 30, 2006 were $18.0 million as compared to $8.9 million forthe six months ended June 30, 2005. The increase of $9.1 million, or 102%, was the result of the continuedcommercialization of the *Essure* systemworldwide and a U.S. price increase established in January of 2006 of8.3%. Unit volume growth for the second quarter of 2006 compared to the samequarter of 2005 increased 76%. Our worldwide average selling price increasedfrom $814 at the end of the year 2005 to $865 for the first six months of 2006,due to the increase in our sales price in January 2006, as well as theincrease in the level of domestic sales, which has a higher price than sales toour European distributor.

We expect netsales to increase in the third quarter of fiscal year 2006 and have put inplace sales and marketing programs and have pursued reimbursement with payersto help us to reach our revenue goal. However, as we have noted elsewhere in this Form 10-Q, our expectedrevenue growth is dependent on market acceptance of the *Essure*system and third party reimbursement for the device, which involves factorsthat are outside of our control.

For the threemonths ended June 30, 2006, net sales to one distributor accounted for 9%of our total consolidated net sales. For the three months ended June 30,2005, net sales to one distributor accounted for 12% of our total consolidatednet sales. Net sales to one distributor were 9% of our consolidated net salesfor the six months ending June 30, 2006 and 13% for the same period endingJune 30, 2005. Accounts receivable from one distributor accounted for 16%of our net accounts receivable balance as of June 30, 2006. AtJune 30, 2005, accounts receivable from one distributor were 21% of ournet accounts receivable balance.

Net product salesby geographic region as a percentage of net sales for the three and six monthsended June 30, 2006 and 2005 are as follows:

|                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net sales (in  thousands) |       | $                                               | 10,003     |                                          | $          | 5,032 |   | $ | 17,965 |   | $ | 8,903 |   |
| United States of  America |       | 90                                              | %          | 86                                            | %          | 90 | % | 85 | % |
| Europe                    |       | 9                                               | %          | 12                                            | %          | 9 | % | 12 | % |
| Other                     |       | 1                                               | %          | 2                                             | %          | 1 | % | 3 | % |
|                           |            |                                                 |            |                                               |            |  |  |  |  |  |  |  |  |

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

As of June 30, 2006,we had a total of 3,683 doctors in the United States that have either completedor are in the process of completing preceptorship. This represents an increaseof 801 physicians over the number of physicians at December 31, 2005 andan increase of 1,501 physicians over the number of physicians at June 30,2005.  Our accomplishment in obtainingthe number of physicians trained is very important because it provides us witha strong referral base within major metropolitan areas we have targeted. Weunderstand that a strong base of trained physicians does not necessarilycorrelate to an increase in revenue proportionately. Furthermore, there are norevenues associated with the training activities. The Company does not charge afee for the activity and no commitment arises for the physician from thepreceptorship. Physician training is provided upfront and the Company has noobligation subsequent to the initial training. Training costs have not beensignificant to the Company from inception to-date.

In July 2006,we announced our expected net sales for 2006 to be approximately $39.0 million,which represents 84% of growth from net sales in 2005. We expect net sales fromthe United States will continue to be the major contributor of our global netsales.  We have established four primarygoals to achieve our revenue growth.  Weexpect to increase sales coverage and with that increase physician penetrationand utilization of the *Essure* device,build patient awareness through targeted advertising and internet programs,obtain additional payer coverage decisions or otherwise improve the public andprivate payer coverage for the *Essure*procedure, and bring product improvements to the *Essure*device to the market. We believe our revenue growth in 2006 will besignificantly influenced by how successful we are in achieving thoseobjectives.

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*GrossProfit*

Cost of goods sold for the three months endedJune 30, 2006 was $3.7 million as compared to $2.1 million for the threemonths ended June 30, 2005. This increase of $1.5 million, or 74%, wascaused by the increase in net sales, partially offset by reductions inmanufacturing costs due to lower manufacturing prices from an agreement signedwith our third-party manufacturer at the end of fiscal year 2005. Gross profitmargin improved from 58% for the three months ended June 30, 2005 to 64%for the same period ended June 30, 2006, which was the result of expandedcommercialization of the *Essure* systemdomestically and abroad and lower manufacturing costs, as well as our domesticprice increase. For the six months ended June 30, 2006, cost of goods soldwas $6.5 million, as compared to $3.8 million for the three months endedJune 30, 2005. The increase of $2.7 million, or 71% was caused by the samefactors explained for the three months period. We expect gross margin toimprove somewhat during the remainder of 2006 due to all of the above factors,somewhat mitigated by unfavorable channel mix with international salescomprising a large percentage of our total units sold.

*OperatingExpenses*

Research anddevelopment expenses, which include expenditures related to productdevelopment, clinical research and regulatory affairs, were $1.1 million and$0.9 million for the three months ended June 30, 2006 and 2005,respectively. Expenses for the three months ended June 30, 2006, includethe effect of SFAS 123(R) stock-based compensation expense of $0.2 million. Forthe six months ended June 30, 2006, research and development expensesincreased $0.4 million, or 21%, to $2.3 million, from $1.9 million in the sameperiod of 2005, which includes the impact of stock-based compensation expenseof $0.4 million. Our goal through Research and Development is to launch productenhancements over the coming years, which are intended to result in improvedease of use and clinical performance of the *Essure* systemand  lower cost of goods.

Selling, generaland administrative spending for the three months ended June 30, 2006 was$10.9 million as compared to $8.2 million for the three months endedJune 30, 2005, which represents an increase of $2.7 million, or 33%. Forthe six months ended June 30, 2006, selling, general and administrativeexpenses were $20.9 million, which represents an increase of $5.0 million, or31%, from $16.0 million for the six months ended June 30, 2005. Theprimary reasons for the increase in selling, general and administrativeexpenses for the six month period result from the additional stock-basedcompensation expense of $2.0 million and the expansion of our U.S. field salesforce of $1.7 million. The latter is meant to provide us with more selling timeto focus on physician utilization and penetration. Additionally, increases inselling, general and administrative expenses were due to higher spending inmarketing campaigns of $0.7 million to support our increase in sales. We expectselling, general and administrative expenses to increase in the future tosupport the expected increase in sales.

Netinterest income and other income for the three months ended June 30, 2006was approximately $0.3 million, compared to $0.2 million for three months endedJune 30, 2005. For the six months ended June 30, 2006, net interestand other income was $0.7 million and $0.4 million for the six months endedJune 30, 2005.

**Liquidityand Capital Resources**

We have experienced significant operating losses sinceinception. As of June 30, 2006 we had an accumulated deficit of $216.2million. We have financed our operations since inception primarily throughequity financings. In February 2004 we completed a private placement ofapproximately 3.0 million shares of common stock at $8.50 per share. Our netproceeds from the private placement were approximately $23.9 million, afterdeducting offering costs and commissions. In addition, in August 2005, wecompleted a private placement of approximately 3.2 million shares of commonstock at a price of $7.20 and $8.10 per share. Our net proceeds from theprivate placement were approximately $22.9 million, after deducting offeringcosts.  The proceeds are being used tofund operations.  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. Additionalfunding may not be available when needed or on terms acceptable to us.

As of June 30, 2006,we had cash, cash equivalents, restricted cash and short-term investments of$25.6 million, compared to $32.5 million at December 31, 2005. Thedecrease of $6.9 million is primarily due to cash used in our operatingactivities. We expect cash usage to decrease in the future as our revenuesgrow.

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*Operating Activities*

Net cash used inoperating activities was $7.0 million in the six months ended June 30,2006, primarily as a result of our net loss of $11.1 million adjusted fornon-cash related items of $3.6 million related primarily to depreciation andamortization and stock compensation expense. Other major items that impacted net cash used in operating activitieswere related to $1.7 million of a planned decrease in inventories consistentwith our increase in sales, a decrease in other assets and other current assetsof $0.5 million and an increase in other accrued liabilities of $0.2 million,offset by an increase in accounts receivable of $0.8 million, which isconsistent with our increase in sales, a decrease in accounts payable of $0.7million and a decrease in accrued compensation of $0.4 million. We expect cashusage in operating activities in the future to decrease as we expect revenuegrowth on a sequential quarterly basis.

As ofJune 30, 2006, our worldwide days sales outstanding in accounts receivablewas 49 days, which represents a decrease of 6 days compared toDecember 31, 2005.  We have creditpolicies that help us to monitor our collection activities and reduce ourcredit loss exposure. We continue to improve and modify those policies as ourbusiness evolves. Our goal is to consistently improve our days salesoutstanding. We may not be able to maintain our current ratio or we mayexperience less than satisfactory performance in collection due to factorsoutside of our control such as changes in economic climates.

Net cash used in operating activities was $12.1million in the six months ended June 30, 2005, primarily as a result ofour net loss of $12.4 million adjusted for non-cash related items of $1.1million relating to depreciation and amortization and stock compensationexpense.  Other major items that impactednet cash used in operating activities were related to a planned increase ininventories of $1.3 million, an increase in accounts receivable of $0.6 millionrelated to our sales growth and an increase in other current assets of $0.2million, offset by an increase in accrued compensation of $0.9 million and anincrease in other accrued liabilities of $0.2 million.

# *Investing Activities*

Net cash used ininvesting activities for the six months ended June 30, 2006 was $3.2million, from sales and maturity of short-term investments of $19.0 million,offset by purchases of investments of $21.5 million and capital expenditures of$0.7 million**. **Netcash provided by investing activities for the six months ended June 30,2005 was $11.9 million, from sales of short-term investments of $22.3 million,partially offset by purchases of investments of $9.8 million and capitalexpenditures of $0.6 million.

# *Financing Activitie**s***

Net cash providedby financing activities was $0.9 million and $0.1 million for the six monthsended June 30, 2006 and 2005, respectively, from the exercise of stockoptions.

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

·              Resources devoted to establishsales, marketing and distribution capabilities;

·              The rate of product adoption bydoctors and patients; and

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

**CRITICALACCOUNTING ESTIMATES AND POLICIES**

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires management to make estimates andassumptions in certain circumstances that affect amounts reported in theaccompanying consolidated financial statements and related footnotes. Adescription of our critical 

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accountingestimates and policies is included in our Annual Report on Form 10-K as ofDecember 31, 2005. In preparing these financial statements, management hasmade its best estimates and judgments of certain amounts included in thefinancial statements, giving due consideration to materiality. The primaryestimates underlying the Company’s financial statements include reserves forobsolete and slow moving inventory, allowance for doubtful accounts receivable,product warranty, impairment for long-lived assets, income taxes, stock-basedcompensation and contingent liabilities. Other accounting policies aredescribed in Note 2, “Summary of Significant Accounting Policies” to ourFinancial Statements included in our Annual Report on Form 10-K as ofDecember 31, 2005. Application of these policies involves the exercise ofjudgment and use of assumptions as to future uncertainties and, as a result,actual results could differ from these estimates.

*Stock-basedCompensation*

Effective January 1, 2006, we adopted theprovisions of SFAS No. 123(R), “Share-Based Payment”. SFAS No. 123(R)establishes accounting for stock-based awards exchanged for employee services.Accordingly, stock-based compensation cost is measured at grant date, based onthe fair value of the award which is computed using the Black-Scholes optionvaluation model, and is recognized as expense over the employee requisiteservice period. We previously applied Accounting Principles Board (APB) OpinionNo. 25, “Accounting for Stock Issued to Employees,” and relatedInterpretations and provided the required pro forma disclosures of SFASNo. 123, “Accounting for Stock-Based Compensation”.

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

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

As stock-based compensation expense recognized in theCondensed Consolidated Statement of Operations for the first six months offiscal year 2006 is based on awards ultimately expected to vest, it has beenreduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures tobe estimated at the time of grant and revised, if necessary, in subsequentperiods if actual forfeitures differ from those estimates. Forfeitures wereestimated based on historical experience. In the Company’s pro formainformation required under SFAS No. 123 for the periods prior to fiscal2006, the Company accounted for forfeitures as they occurred.

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

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

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** **

**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

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

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

*Foreign Currency Exchange Risk*:  Our revenues for the three and six monthsended June 30, 2006 were denominated in United States dollars. For the threeand six months ended June 30, 2005, 0% and 1%, respectively, of ourrevenues were in foreign currency. Our expenses for the three and six monthsended June 30, 2006 were denominated in United States dollars. For thethree and six months ended June 30, 2005, 1% and 2%, respectively, of ourexpenses were denominated in foreign currency. As a result, we have lowexposure for currency exchange risks and foreign exchange losses have beenminimal to date. We do not enter into forward exchange contracts to hedgeexposure denominated in foreign currencies or any other derivative financialinstruments for trading or speculative purposes. In the future, if ourassessment of our foreign currency exposure changes, we may consider hedgingtransactions for risk mitigation.

**Item 4. Controls and Procedures**

*Evaluation of Disclosure Controlsand Procedures:*

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in ourExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’srules and forms and that such information is accumulated and communicatedto our management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate, to allow for timely decisions regarding requireddisclosure. In designing and evaluating the disclosure controls and procedures,management recognized that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and in reaching a reasonable level of assurance,management is required to apply its judgment in evaluating the cost-benefitrelationship of possible controls and procedures.

As of June 30, 2006, the end of our most recentfiscal quarter, we carried out an evaluation, under the supervision and withthe participation of our management, including our Chief Executive Officer andour Chief Financial Officer, of the effectiveness of the design and operationof our 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 OverFinancial Reporting:*

There was no change in our internal control overfinancial reporting during our most recent fiscal quarter that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

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*Inherent Limitations of InternalControls*

**Internal control over financialreporting cannot provide absolute assurance of achieving financial reportingobjectives because of its inherent limitations. Internal control over financial reporting is a process that involveshuman diligence and compliance and is subject to lapses in judgment andbreakdowns resulting from human failures. Internal control over 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 legalproceedings arising in the ordinary course of business.  We believe there is no litigation pendingthat could have, individually or in the aggregate, a material adverse effect onits financial position, result of operations or cash flows.

**Item 1A.Risk Factors**

*The risk factors included in our Annual Report asof December 31, 2005 on Form 10-K filed with the Securities andExchange Commission on March 16, 2006 should be considered whileevaluating Conceptus and our business. In addition to those factors and toother information in this Form 10-Q, the following updates to the riskfactors as of June 30, 2006  shouldbe considered carefully while evaluating the Company and our business. ThisForm 10-Q contains forward-looking statements within the meaning ofsection 27A of the Securities Act of 1933, as amended and section 21Eof the Securities Exchange Act of 1934, as amended. Some of the forward-lookingstatements can be identified by use of forward-looking words such as “believes,”“expects,” “anticipates,” “may,” “will,” “should,” “seeks,” “approximates,” “intends,”“plans,” or “estimates,” or the negative of these words, or other comparableterminology. The discussion of financial trends, strategy, plans or intentionsmay also include forward-looking statements. Forward-looking statements involverisks and uncertainties that could cause actual results to differ materiallyfrom those projected. Although it is not possible to predict or identify allsuch risks and uncertainties, they may include, but are not limited to, therisk factors incorporated by reference and to their updates. Readers should notconsider these lists to be a complete statement of all potential risks anduncertainties.*

***Changes in stock option accounting rules may adverselyimpact our reported operating results prepared in accordance with generallyaccepted accounting principles, our stock price and our competitiveness in theemployee marketplace.***

Technology companies likeours have a history of using broad-based employee stock option programs tohire, incentivize and retain our workforce in a competitive marketplace.Statement of Financial Accounting Standards, or SFAS, No. 123 allowedcompanies the choice of either using a fair value method of accounting foroptions, which would result in expense recognition for all options granted, orusing an intrinsic value method, as prescribed by Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees”, or APB 25,with a pro forma disclosure of the impact on net income (loss) of using thefair value option expense recognition method. We had elected to apply APB 25and accordingly we generally did not recognize any expense with respect toemployee stock options as long as such options were granted at exercise pricesequal to the fair value of our common stock on the date of grant.

In December 2004,the Financial Accounting Standards Board, or FASB, issued SFAS No. 123(R) “Share-BasedPayments”. We adopted this statement on January 1, 2006, which is thefirst annual reporting period after June 15, 2005. This statement had asignificant impact on our consolidated statement of operations as we arerequired to expense the fair value of our stock compensation rather than disclosingthe impact through footnotes in accordance with the disclosure provisions ofSFAS No. 123. The implementation of SFAS 123(R) resulted in higherreported losses per share, which could negatively impact our future stock priceand which could lead to lower reported earnings per share at the time in whichwe become profitable. In addition, this could impact our ability to utilize 

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broad based employee stock plans to reward employeesand could result in a competitive disadvantage to us in the employeemarketplace.

**Item 2. Unregistered Sales of  EquitySecurities and Use of Proceeds**

None.

**Item 3. Defaults upon Senior Securities**

None.

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

On June 7, 2006, the Annual Meeting ofStockholders of Conceptus, Inc. was held in Mountain View, California. Thematters voted upon and approved at the meeting, and the number of affirmativeand negative votes cast with respect to each matter were as follows (votes inthousands):
|                                       | ** ** | **Votes for** | ** ** | **Votes**    | ** ** |
|---------------------------------------|------------|--------------------|------------|--------------|------------|
| ** **                            | ** ** | **Nominee**        | ** ** | **Withheld** | ** ** |
| Proposal I                            |       |               |       |         |       |
| Election of  Class III Directors |       |               |       |         |       |
| Elected:                              |       |               |       |         |       |
| - Kathryn A.  Tunstall                |       | 26,412             |       | 148          |       |
| - Robert V. Toni                      |       | 26,433             |       | 128          |       |

 
|                                                                                                                                                                                 | ** ** | **For** | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------|------------|-------------|------------|-------------|------------|
| Proposal II                                                                                                                                                                     |       |    |       |        |       |        |       |
| To ratify the appointment  of PricewaterhouseCoopers LLP as the independent registered public accounting  firm of the Company for the fiscal year ending December 31, 2006 |       | 26,435  |       | 13          |       | 114         |       |
|                                                                                                                                                                            |       |    |       |        |       |        |       |
| Proposal III                                                                                                                                                                    |       |    |       |        |       |        |       |
| To approve the Eighth  Amended and Restated 2001 Equity Incentive Plan to increase the number of  shares of Common Stock reserved for issuance thereunder by 1,500,000 shares   |       | 11,331  |       | 10,644      |       | 358         |       |
|                                                                                                                                                                            |       |    |       |        |       |        |       |
| Proposal IV                                                                                                                                                                     |       |    |       |        |       |        |       |
| To approve an amendment  to the 1995 Employee Stock Purchase Plan to increase the number of shares of  Common Stock reserved for issuance thereunder by 160,000                 |       | 21,362  |       | 616         |       | 356         |       |

**Item5.  Other Information**

None.

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** **

**Item 6. Exhibits**

| Exhibit Number | ** ** | **Description**                                                                                                                                 |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                      |
| 10.1                |       | Eighth Amended and Restated 2001 Equity Incentive  Plan. Incorporated by reference to Definitive Proxy Statement filed on  April 24, 2006. |
| 10.2                |       | Third Amendment to 1995 Employee Stock Purchase  Plan. Incorporated by reference to Definitive Proxy Statement filed on  April 24, 2006.   |
| 31.1                |       | Certification of Chief Executive Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                       |
| 31.2                |       | Certification of Chief Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                       |
| 32.1                |       | Certification of Chief Executive Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                       |
| 32.2                |       | Certification of Chief Financial Officer Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                       |

 

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SIGNATURE

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.
|        | CONCEPTUS, INC. |
|--------|-----------------|
|   |            |
|   |            |
|   |            | By: | /s/ Gregory E. Lichtwardt |
|   |            | Gregory E.  Lichtwardt |
|   |            | Executive Vice  President, Treasurer and |
|   |            | Chief Financial  Officer |

Date:   August 9, 2006

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**EXHIBIT INDEX**

| Exhibit Number | ** ** | **Description**                                                                                                                                 |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                      |
| 10.1                |       | Eighth Amended  and Restated 2001 Equity Incentive Plan. Incorporated by reference to  Definitive Proxy Statement filed on April 24, 2006. |
| 10.2                |       | Third Amendment  to 1995 Employee Stock Purchase Plan. Incorporated by reference to Definitive  Proxy Statement filed on April 24, 2006.   |
| 31.1                |       | Certification of Chief Executive Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                       |
| 31.2                |       | Certification of Chief Financial Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                       |
| 32.1                |       | Certification of Chief Executive Officer Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                       |
| 32.2                |       | Certification of Chief  Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.                                      |

** **

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