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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**x****      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

** **

**Forthe quarterly period ended March 31, 2010**

** **

**OR**

** **

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

 

**Forthe transition period from             to              .**

**CommissionFile Number: 0-27596**

 

**CONCEPTUS, INC.**

(Exact name ofRegistrant as specified in its charter)

 

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

 

**331East Evelyn**

**MountainView, CA 94041**

(Address ofPrincipal Executive Offices) (Zip Code)

 

**(650) 962-4000**

(Registrant’sTelephone Number, Including Area Code)

 

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(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 forthe past 90 days. Yes  x    No  o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes  o    No  o

 

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

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 ofExchange Act). Yes  o   No  x

 

There were 31,032,306shares of Registrant’s Common Stock issued and outstanding as of May 1,2010.

 

 

 

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**CONCEPTUS, INC.**

 

**Form 10-Qfor the Quarter Ended March 31, 2010**

 
| ** **    | ** **                                                                                  | ** **                                                                                                   | ** ** | **Page** |
|---------------|---------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------|------------|----------|
| Part I.  | Financial Information                                                                       |                                                                                                         |       |
|          |                                                                                        |                                                                                                         |       |     |
| Item 1.       | Condensed Consolidated  Financial Statements (Unaudited)                                    |                                                                                                         |       |
|          |                                                                                        |                                                                                                         |       |     |
|          |                                                                                        | a) Condensed Consolidated  Balance Sheets as of March 31, 2010 and December 31, 2009               |       | 3        |
|          |                                                                                        | b) Condensed Consolidated  Statements of Operations for the Three Months Ended March 31, 2010 and  2009 |       | 4        |
|          |                                                                                        | c) Condensed Consolidated  Statements of Cash Flows for the Three Months Ended March 31, 2010 and  2009 |       | 5        |
|          |                                                                                        | d) Notes to  Condensed Consolidated Financial Statements                                                     |       | 6        |
|          |                                                                                        |                                                                                                         |       |     |
| Item 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |                                                                                                         | 19         |
|          |                                                                                        |                                                                                                         |       |     |
| Item 3.       | Quantitative  and Qualitative Disclosures About Market Risk                                 |                                                                                                         | 27         |
|          |                                                                                        |                                                                                                         |       |     |
| Item 4.       | Controls and  Procedures                                                                    |                                                                                                         | 28         |
|          |                                                                                        |                                                                                                         |       |     |
| Part II. | Other Information                                                                           |                                                                                                         |       |
|          |                                                                                        |                                                                                                         |       |     |
| Item 1.       | Legal Proceedings                                                                           |                                                                                                         | 29         |
|          |                                                                                        |                                                                                                         |       |     |
| Item 1A.      | Risk Factors                                                                                |                                                                                                         | 29         |
|          |                                                                                        |                                                                                                         |       |     |
| Item 6.       | Exhibits                                                                                    |                                                                                                         | 33         |

 

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**PART I.FINANCIAL INFORMATION**

 

**Item 1.Condensed Consolidated Financial Statements.**

 

**Conceptus, Inc.**

 

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

**(Inthousands)**

** **
| ** **                                           | ** ** | **March 31,** | ** **  | **December 31,** | ** ** |
|------------------------------------------------------|------------|--------------------|-------------|-----------------------|------------|
| ** **                                           | ** ** | **2010**           | ** **  | **2009**              | ** ** |
| **Assets**                                           |       |               |        |                  |       |
| Current assets:                                      |       |               |        |                  |       |
| Cash and cash equivalents                            |       | $                  | 29,544      |                  | $          | 61,658 |   |
| Short-term investments                               |       | 52,642             |        | 40,626                |       |
| Put option                                           |       | 3,203              |        | 2,933                 |       |
| Accounts receivable, net                             |       | 17,687             |        | 17,315                |       |
| Inventories                                          |       | 5,123              |        | 4,908                 |       |
| Prepaids                                             |       | 3,316              |        | 1,897                 |       |
| Other current assets                                 |       | 2,088              |        | 1,540                 |       |
| Total current assets                                 |       | 113,603            |        | 130,877               |       |
|                                                 |       |               |        |                  |       |
| Property and equipment, net                          |       | 9,970              |        | 9,782                 |       |
| Debt issuance costs, net                             |       | 871                |        | 987                   |       |
| Intangible assets, net                               |       | 26,637             |        | 27,687                |       |
| Long-term investments                                |       | 13,903             |        | —                |       |
| Restricted cash                                      |       | 362                |        | 360                   |       |
| Goodwill                                             |       | 16,257             |        | 17,318                |       |
| Other assets                                         |       | 119                |        | 128                   |       |
| **Total assets**                                     | ** ** | **$**              | **181,722** | ** **            | **$**      | **187,139** | ** ** |
|                                                 |       |               |        |                  |       |
| **Liabilities and stockholders’  equity**       |       |               |        |                  |       |
| Current liabilities:                                 |       |               |        |                  |       |
| Accounts payable                                     |       | $                  | 5,390       |                  | $          | 5,878 |   |
| Accrued compensation                                 |       | 5,767              |        | 8,208                 |       |
| Line of credit                                       |       | 25,670             |        | 29,240                |       |
| Other accrued liabilities                            |       | 3,968              |        | 4,012                 |       |
| Total current liabilities                            |       | 40,795             |        | 47,338                |       |
|                                                 |       |               |        |                  |       |
| Deferred tax liability                               |       | 1,155              |        | 1,277                 |       |
| Notes payable                                        |       | 77,615             |        | 76,531                |       |
| Other accrued liabilities                            |       | 1,121              |        | 1,135                 |       |
| Total liabilities                                    |       | 120,686            |        | 126,281               |       |
|                                                 |       |               |        |                  |       |
| Stockholders’ equity:                           |       |               |        |                  |       |
| Common stock and additional paid-in capital          |       | 299,833            |        | 296,191               |       |
| Accumulated other comprehensive loss                 |       | (2,106             | )           | (993                  | )          |
| Accumulated deficit                                  |       | (236,691           | )           | (234,340              | )          |
| Treasury stock, 77,863 shares, at cost               |       | —             |        | —                |       |
| Total stockholders’ equity                      |       | 61,036             |        | 60,858                |       |
|                                                 |       |               |        |                  |       |
| **Total liabilities and  stockholders’ equity** | ** ** | **$**              | **181,722** | ** **            | **$**      | **187,139** | ** ** |

 

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

 

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**Conceptus, Inc.**

 

**Condensed Consolidated Statements of Operations**

**(Unaudited)**

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

 
| ** **                                                                      | ** ** | **Three months ended** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                      | ** ** | **March 31,**     | ** ** |
| ** **                                                                      | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                                                                            | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net sales                                                                       |       | $                      | 33,358     |   | $ | 27,151 |   |
| Cost of goods sold                                                              |       | 6,391                  |       | 5,756 |   |
| Gross profit                                                                    |       | 26,967                 |       | 21,395 |   |
|                                                                            |       |                   |       |   |   |
| Operating expenses:                                                             |       |                   |       |   |   |
| Research and development                                                        |       | 1,746                  |       | 1,407 |   |
| Selling, general and administrative                                             |       | 25,979                 |       | 22,570 |   |
| Total operating expenses                                                        |       | 27,725                 |       | 23,977 |   |
|                                                                            |       |                   |       |   |   |
| Operating loss                                                                  |       | (758                   | )          | (2,582 | ) |
|                                                                            |       |                   |       |   |   |
| Interest income                                                                 |       | 273                    |       | 356 |   |
| Interest expense                                                                |       | (1,756                 | )          | (1,718 | ) |
| Other income (expense), net                                                     |       | 24                     |       | (250 | ) |
| Total interest income and expense and other income  (expense), net              |       | (1,459                 | )          | (1,612 | ) |
|                                                                            |       |                   |       |   |   |
| Loss before provision for income taxes                                          |       | (2,217                 | )          | (4,194 | ) |
|                                                                            |       |                   |       |   |   |
| Provision for income taxes                                                      |       | 134                    |       | 141 |   |
| Net loss                                                                        |       | $                      | (2,351     | ) | $ | (4,335 | ) |
|                                                                            |       |                   |       |   |   |
| Basic and diluted net loss per share                                            |       | $                      | (0.08      | ) | $ | (0.14 | ) |
|                                                                            |       |                   |       |   |   |
| Weighted-average shares used in computing basic and  diluted net loss per share | ** ** | 30,930                 | ** ** | 30,438 | ** ** |

 

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

 

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**Conceptus, Inc.**

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

**(Inthousands)**

** **
| ** **                                                                   | ** ** | **Three months ended** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                   | ** ** | **March 31,**     | ** ** |
| ** **                                                                   | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                                                                         |       |                   |       |   |   |
| **Cash flows from operating  activities**                                    |       |                   |       |   |   |
| Net loss                                                                     |       | $                      | (2,351     | ) | $ | (4,335 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                   |       |   |   |
| Depreciation and amortization of property and  equipment                     |       | 1,097                  |       | 1,013 |   |
| Amortization of debt issuance costs                                          |       | 116                    |       | 116 |   |
| Accretion of notes payable                                                   |       | 1,084                  |       | 1,025 |   |
| Amortization of intangible assets                                            |       | 819                    |       | 180 |   |
| Amortization and accretion of discount and premium  on investments           |       | 126                    |       | — |   |
| Loss (gain) on put option                                                    |       | (270                   | )          | 177 |   |
| Loss (gain) on trading securities                                            |       | 274                    |       | (155 | ) |
| Stock-based compensation expense                                             |       | 1,729                  |       | 1,347 |   |
| Loss (gain) on disposal of property and equipment                            |       | 11                     |       | (12 | ) |
| Changes in operating assets and liabilities:                                 |       |                   |       |   |   |
| Accounts receivable                                                          |       | (727                   | )          | (459 | ) |
| Inventories                                                                  |       | (155                   | )          | 1,014 |   |
| Other current assets                                                         |       | (2,006                 | )          | (375 | ) |
| Accounts payable                                                             |       | 92                     |       | 1,195 |   |
| Accrued compensation                                                         |       | (2,279                 | )          | (1,321 | ) |
| Other accrued and long term liabilities                                      |       | (42                    | )          | (115 | ) |
| Net cash used in operating activities                                        |       | (2,482                 | )          | (705 | ) |
|                                                                         |       |                   |       |   |   |
| **Cash flows from investing  activities**                                    |       |                   |       |   |   |
| Sales and maturities of investments                                          |       | 5,175                  |       | — |   |
| Purchase of investments                                                      |       | (31,539                | )          | — |   |
| Capital expenditures                                                         |       | (1,393                 | )          | (848 | ) |
| Net cash used in investing activities                                        |       | (27,757                | )          | (848 | ) |
|                                                                         |       |                   |       |   |   |
| **Cash flows from financing  activities**                                    |       |                   |       |   |   |
| Proceeds from line of credit                                                 |       | 1,828                  |       | 1,067 |   |
| Repayment of line of credit                                                  |       | (5,398                 | )          | (97 | ) |
| Proceeds from issuance of common stock                                       |       | 1,843                  |       | 225 |   |
| Net cash (used in) provided by financing activities                          |       | (1,727                 | )          | 1,195 |   |
|                                                                         |       |                   |       |   |   |
| Effect of exchange rate changes on cash and cash  equivalents                |       | (148                   | )          | (121 | ) |
|                                                                         |       |                   |       |   |   |
| Net decrease in cash and cash equivalents                                    |       | (32,114                | )          | (479 | ) |
| Cash and cash equivalents at beginning of the  period                        |       | 61,658                 |       | 54,720 |   |
| Cash and cash equivalents at end of the period                               |       | $                      | 29,544     |   | $ | 54,241 |   |

 

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

 

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**Conceptus, Inc.**

 

***NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS***

 

***(Unaudited)***

 

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

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesfor interim financial information and pursuant to the instructions to Form 10-Qand Article 10-01 of Regulation S-X.  Accordingly, they do notinclude all of the information and footnotes required by accounting principlesgenerally accepted in the United States for complete financial statements. Inthe opinion of management, all adjustments, consisting only of normal recurringadjustments, considered necessary for a fair statement have been included.

 

The condensedconsolidated balance sheet as of December 31, 2009 has been derived fromthe audited consolidated financial statements at that date, but does notinclude all of the information and footnotes required by accounting principlesgenerally accepted in the United States for complete financial statements. Thisfinancial data should be read in conjunction with the audited consolidatedfinancial statements and related notes included in our Annual Report on Form 10-Kfor the year ended December 31, 2009.  The results of operations forthe three months ended March 31, 2010 may not necessarily be indicative ofthe operating results for the full 2010 fiscal year or any other future interimperiods.

 

Wehave a limited history of operations with the *Essure*system and since our inception in 1992, we have incurred cumulative operatinglosses until we experienced our first operating profit in Fiscal 2009.  In December 2006, we filed aRegistration Statement on Form S-3, through which we may sell from time totime any combination of debt securities, common stock, preferred stock andwarrants, in one or more offerings, with an initial offering price not toexceed $150,000,000. In February 2007, we issued an aggregate principalamount of $86,250,000 of our 2.25% convertible senior notes due 2027.  The notes can be convertible into shareswithin certain time periods, without having to meet the other contingentconvertibility conditions as outlined in Note 9 — Convertible SeniorNotes.  The first period is the windowbetween December 15, 2011 and February 15, 2010.  The second period is anytime after February 15,2025 up until maturity at February 15, 2027.   If the notes are converted, then uponconversion (“net shares settlement”), holders will receive cash and in certaincircumstances, shares of our common stock based on an initial conversion rate,subject to adjustment, of 35.8616 shares per $1,000 principal amount of notes(which represents an initial conversion price of $27.89 per share). Uponconversion, a holder would receive cash up to the principal amount of the noteand our common stock in respect of such note’s conversion value in excess ofsuch principal amount. This net share settlement feature of the notes wouldreduce our liquidity, and we may not have sufficient funds to pay in full thecash obligation upon such conversion. In the future, depending upon a varietyof factors, we may need to raise additional funds through bank facilities, debtor equity offerings or other sources of capital. Any additional equityfinancing may be dilutive to stockholders, and debt financing, if available,may involve covenants that restrict us. Additional funding may not be availablewhen needed 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 ourresearch and development programs or reduce our sales and marketing activities.

 

*Recent Accounting Pronouncements*

 

InJanuary 2010, the FASB issued updated guidance related to fair valuemeasurements and disclosures, which requires a reporting entity to discloseseparately the amounts of significant transfers in and out of Level 1 and Level2 fair value measurements and to describe the reasons for the transfers. Inaddition, in the reconciliation for fair value measurements using significantunobservable inputs, or Level 3, a reporting entity should disclose separatelyinformation about purchases, sales, issuances and settlements (that is, on agross basis rather than one net number). The updated guidance also requiresthat and entity should provide fair value measurement disclosures for eachclass of assets and liabilities and disclosures about the valuation techniquesand inputs used to measure fair value for both recurring and non-recurring fairvalue measurements for Level 2 and Level 3 fair value measurements. The updatedguidance is effective for interim or annual financial reporting periodsbeginning after December 15, 2009, except for the disclosures aboutpurchases, sales, issuances and settlements in the roll forward activity inLevel 3 fair value measurements, which are effective for fiscal years beginningafter December 15, 2010 and for interim periods within those fiscal years.We have adopted this guidance in the first quarter of 2010.  See Note 4 — Fair Value Measurement.

 

In February 2010,the FASB issued amended guidance on subsequent events. Under this amendedguidance, SEC filers are no longer required to disclose the date through whichsubsequent events have been evaluated in originally issued and 

 

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revised financialstatements. We adopted this guidance in the first quarter of fiscal 2010 andthe adoption did not have a material impact on our financial condition, resultsof operations, or cash flows.

 

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

 

*Use of Estimates*

 

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires us to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. The primary estimates underlying our financial statementsinclude the write-off of obsolete and slow moving inventory, allowance fordoubtful accounts receivable, product warranty, the fair value of ourinvestment portfolio, assumptions regarding variables used in calculating thefair value of our equity awards, impairment of goodwill, intangibles and otherlong-lived assets, income taxes and contingent liabilities. Actual resultscould differ from those estimates.

 

*Principles of Consolidation*

 

Thecondensed consolidated financial statements include the accounts of the Companyand its wholly-owned subsidiaries. All significant intercompany accounts andtransactions have been eliminated.

 

*Functional Currency*

 

OnJanuary 7, 2008, we acquired Conceptus SAS, which sells to customersthroughout Europe.  Sales by ConceptusSAS are denominated in Euros. On December 15, 2008, we incorporatedConceptus Medical Limited (“CML”) as our United Kingdom subsidiary.  In preparing our condensed consolidatedfinancial statements, we are required to translate the financial statements ofConceptus SAS and CML from the currency in which they keep their accountingrecords into U.S. Dollars.  Conceptus SASand CML both maintain their accounting records in the functional currency whichis also their local currency. The functional currency of CML is the BritishPound and the functional currency of Conceptus SAS is the Euro.  The functional currency is determined basedon management’s judgment and involves consideration of all relevant economicfacts and circumstances affecting the subsidiary. Generally, the currency inwhich the subsidiary transacts a majority of its transactions, includingbilling, financing, payroll and other expenditures would be considered thefunctional currency, but any dependency upon the parent and the nature of thesubsidiary’s operations must also be considered. Since the functional currencyof Conceptus SAS and CML has been determined to be their local currency, anygain or loss associated with the translation of Conceptus SAS’s and CML’sfinancial statements into U.S. Dollars is included as a component ofstockholders’ equity, in accumulated other comprehensive loss.  If in the future we determine that there hasbeen a change in the functional currency of Conceptus SAS or CML from its localcurrency to the U.S. Dollar, any translation gains or losses arising after thedate of change would be included within our statement of operations.

 

*Goodwill and Other Intangible Assets*

 

Goodwill represents the excess of the purchase price paid over the fairvalue of tangible and identifiable intangible net assets acquired in businesscombinations. We will perform an annual assessment during the fourth quarter of2010 of our goodwill at the reporting unit level or earlier if an event occursor circumstances change that would reduce the fair value of the reporting unitbelow its carrying amount. No impairment charges have been recorded as of March 31,2010.

 

Otherintangible assets include patents, customer relationships, license agreementsand non-compete agreements. They are amortized using the straight-line methodover their respective estimated useful lives.

 

*Impairment of Long-Lived Assets*

 

Weaccount for the impairment of long-lived assets in accordance with ASC 350, *Goodwill and Other.* We evaluate the carrying value of our long-lived assets, consistingprimarily of our property and equipment, the**patents acquired inconnection with our purchase of the intellectual property assets from OvionInc, and intangible assets acquired in connection with our acquisitionof Conceptus SAS, whenever certain events or changes in circumstances indicatethat the carrying amount of the assets may not be recoverable (see Note 5 — Goodwill and Intangible Assets). * *Suchevents or circumstances include a prolonged industry downturn, a significantdecline in our market value or significant reductions in projected future cashflows.

 

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Significantjudgments and assumptions are required in the forecast of future operatingresults used in the preparation of the estimated future cash flows, includingprofit margins, long-term forecasts of the amounts and timing of overall marketgrowth and our percentage of that market, groupings of assets, discount ratesand terminal growth rates. In addition, significant estimates and assumptionsare required in the determination of the fair value of our tangible long-livedassets, including replacement cost, economic obsolescence, and the value thatcould be realized in orderly liquidation. Changes in these estimates could havea material adverse effect on the assessment of our long-lived assets, therebyrequiring us to write down the assets.

 

**3.  Investments**

 

Asof March 31, 2010, we held $38.4 million (par value) in auction ratesecurities, or ARS, backed by federal and state student loans which arevariable rate debt instruments and bear interest rates that reset approximatelyevery 20-30 days. These ARS have a contractual maturity ranging from 2028through 2047.

 

OurARS are short-term debt instruments backed by student loans, a substantialportion of which are guaranteed by the United Statesgovernment.  Prior to 2008, our ARS were highly liquid, using a Dutchauction process that resets the applicable interest rate at predetermined intervals,typically every 20-30 days, to provide liquidity at par.  Wehave experienced failed auctions since 2008 on most of our ARS.   The failures of these auctions do not affectthe value of the collateral underlying the ARS, and we continue to earn andreceive interest on our ARS at a pre-determined formula with spreads tied toparticular interest rate indexes.

 

InNovember 2008, we accepted an offer from UBS AG, providing us with rightsrelated to our ARS (the “Rights”).  The Rights permit us torequire UBS to purchase our ARS at par value, which is defined as the priceequal to the liquidation preference of the ARS plus accrued but unpaiddividends or interest, at any time during the period of June 2010 through July 2012.  Conversely,UBS has the right, in its discretion, to purchase or sell our ARS at any timeuntil July 2012, so long as we receive payment at par value upon any saleor disposition.  We expect to sell our ARS under the Rights at parvalue.  However, if the Rights are not exercised before July 2012they will expire and UBS will have no further rights or obligation to buy ourARS.  So long as we hold our ARS, they will continue to accrueinterest as determined by the auction process or the terms of the ARS if theauction process fails.  We had settlementsof our ARS in the three months ended March 31, 2010 of $5.2 million atfull par value and recorded a loss of $0.3 million which represents thedecrease in the fair value of the ARS. The fair value of the ARS at March 31, 2010 is $35.2 million.

 

UBS’sobligations under the Rights are not secured by its assets and do not requireUBS to obtain any financing to support its performance obligations under theRights.  UBS has disclaimed any assurance that it will havesufficient financial resources to satisfy its obligations under the Rights.

 

Wehave accounted for the Rights as a freestanding financial instrument andelected to record the value of the Rights under the fair value option of ASC825 *Financial Instruments. *As a result of our election torecord the Rights at fair value, unrealized gains and losses have been includedin earnings.    We estimated the fair value of the Rights usingthe expected value that we will receive from UBS which was calculated as thedifference between the anticipated recognized loss and par value of the ARS asof the option exercise date. This value was discounted by using a UBS creditdefault rate to account for the consideration of UBS credit risk. For the threemonths ended March 31, 2010, we recorded an additional gain of $0.3million which represents the increase in the fair value of the put option.

 

Priorto accepting the UBS offer, we recorded our ARS as available-for-saleinvestments.  We recorded unrealized gains and losses on ouravailable-for-sale securities, in accumulated other comprehensive income (loss)in the stockholders’ equity section of our balance sheets.  Such anunrealized loss did not change net income (loss) for the applicable accountingperiod.

 

Inconnection with our acceptance of the UBS offer in November 2008,resulting in our right to require UBS to purchase our ARS at par valuebeginning on June 2010, we transferred our ARS from available-for-sale totrading securities in accordance with ASC 320 *Investments —Debt and Equity Securities*.   The transfer to tradingsecurities reflected our intent to exercise our put option during the thirdquarter of 2010.   Prior to our agreement with UBS, our intent was tohold our ARS until we realized the par value.

 

InNovember 2008, we entered into a revolving credit line agreement with UBS,payable on demand, in an amount equal to 75% of fair value of our auction ratesecurities at net no cost, meaning that the interest we pay on the credit linewill not exceed the interest that we receive on the ARS that we have pledged assecurity for the credit line. Additionally, under the terms of the settlementagreement, if UBS is able to sell our ARS at par, proceeds would be utilized tofirst repay any 

 

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outstandingbalance under the revolving credit line. We are still able to sell the ARS, butin such a circumstance, if we sold at less than par value, we would not beentitled to recover the par value support from UBS.   See Note 10 — Credit Line.

 

As of March 31, 2010we had short and long-term investments of $31.4 million recorded at fair valuein addition to the $35.2 million of ARS. Our investments consist of time deposits, U.S. treasurybills, U.S. government bonds and corporate bonds.  We will sell certain or all investments asneeded to meet the cash flow needs of our business.  Hence our investments are classified asavailable-for-sale securities in accordance with ASC 320 *Investments —Debt and Equity Securities*. Investments are classified as short-term or long-term based on theunderlying investments maturity date.

 

Thefollowing table summarized our amortized cost, unrealized gains and loss, andthe fair value of our available-for-sales investments, as of March 31,2010 (in thousands):

 
| ** **              | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **     | ** ** |
|-------------------------|------------|---------------|------------|----------------|------------|----------------|------------|----------------|------------|
| ** **              | ** ** | **Cost**      | ** ** | **Gain**       | ** ** | **Loss**       | ** ** | **Fair Value** | ** ** |
| **Investments:**        |       |          |       |           |       |           |       |           |       |
| Corporate  bonds        |       | $             | 19,670     |           | $          | 6              |       | $              | (43        | ) | $ | 19,633 |   |
| U.S.  government bonds  |       | 6,510         |       | 3              |       | (8             | )          | 6,505          |       |
| U.S.  treasury bills    |       | 3,987         |       | —         |       | (1             | )          | 3,986          |       |
| Time  deposits          |       | 1,245         |       | —         |       | (1             | )          | 1,244          |       |
|                    |       |          |       |           |       |           |       |           |       |
| Total                   |       | $             | 31,412     |           | $          | 9              |       | $              | (53        | ) | $ | 31,368 |   |
|                    |       |          |       |           |       |           |       |           |       |
| **Reported as:**        |       |          |       |           |       |           |       |           |       |
| Short-term  investments |       | $             | 17,482     |           | $          | 2              |       | $              | (19        | ) | $ | 17,465 |   |
| Long-term  investments  |       | 13,930        |       | 7              |       | (34            | )          | 13,903         |       |
|                    |       |          |       |           |       |           |       |           |       |
| Total                   |       | $             | 31,412     |           | $          | 9              |       | $              | (53        | ) | $ | 31,368 |   |

 

We had several investmentsthat were in an unrealized loss position as of March 31, 2010.  We have determined that (i) we do nothave the intent to sell any of these investments, and (ii) it is morelikely than not that we will not be required to sell any of these investmentsbefore recovery of the entire amortized cost basis.  We review our investments to identify andevaluate investments that have an indication of possible impairment.  As of March 31, 2010 we anticipate thatwe will recover the entire carrying value of such investments and havedetermined that no other-than-temporary impairments associated with creditlosses were required to be recognized during the three months ended March 31,2010.

 

The following table presentsour available-for-sale investments that are in an unrealized loss position asof March 31, 2010 (in thousands):

 
| ** **             | ** ** | **Less than 12 Months** | ** ** | **12 Months or Greater** | ** ** | **Total** | ** ** |
|------------------------|------------|-------------------------|------------|--------------------------|------------|-----------|------------|
| ** **             | ** ** | **Fair**                | ** ** | **Unrealized**           | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **             | ** ** | **Value**               | ** ** | **Loss**                 | ** ** | **Value** | ** ** | **Loss** | ** ** | **Value** | ** ** | **Loss** | ** ** |
|                   |       |                    |       |                     |       |      |       |   |   |   |   |   |   |
| Corporate  bonds       |       | $                       | 7,724      |                     | $          | (17       | )          | $ | 7,474 |   | $ | (26 | ) | $ | 15,198 |   | $ | (43 | ) |
| U.S.  treasury bills   |       | 3,987                   |       | (1                       | )          | —    |       | — |   | 3,987 |   | (1 | ) |
| U.S.  government bonds |       | —                  |       | —                   |       | 1,992     |       | (8 | ) | 1,992 |   | (8 | ) |
| Time  deposits         |       | 1,244                   |       | (1                       | )          | —    |       | — |   | 1,244 |   | (1 | ) |
|                   |       |                    |       |                     |       |      |       |   |   |   |   |   |   |
|                   |       | $                       | 12,955     |                     | $          | (19       | )          | $ | 9,466 |   | $ | (34 | ) | $ | 22,421 |   | $ | (53 | ) |

 

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

 

OnJanuary 1, 2008, we adopted the methods of fair value as described in ASC820 *Fair Value Measurement and Disclosure*(“ASC820”) to value our financial assets and liabilities.  As defined in ASC 820, fair value is based onthe price that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants at themeasurement date. In order to increase consistency and comparability in fairvalue measurements, ASC 820 establishes a

 

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fairvalue hierarchy that prioritizes observable and unobservable inputs used tomeasure fair value into three broad levels, which are described below:

 

Level1: Quoted prices (unadjusted) in active markets that are accessible at themeasurement date for assets or liabilities. The fair value hierarchy gives thehighest priority to Level 1 inputs.

 

Level2: Observable prices that are based on inputs not quoted on active markets, butcorroborated by market data.

 

Level3: Unobservable inputs are used when little or no market data is available. Thefair value hierarchy gives the lowest priority to Level 3 inputs.

 

**Fair value of Assets**

 

Ourcash and cash equivalents and investments, other than ARS, are classifiedwithin Level 1 of the fair value hierarchy because they are valued using quotedmarket prices, broker or dealer quotations, or alternative pricing sources witha reasonable level of price transparency. As of March 31, 2010, our Level1 instruments were investments in money market funds, time deposits, U.S.treasury bills, U.S. government bonds and corporate bonds.

 

Asa result of continued auction failures, quoted prices for our ARS did not existas of March 31, 2010 and, accordingly, we concluded that Level 1 inputswere not available for these assets. Brokerage statements received from ourbroker/dealer that held our ARS included their estimated market value as of March 31,2010. Our broker/dealer valued our ARS at 89% of par. We made inquiriesrelative to the measurements utilized to derive the estimated market valuesquoted on our brokerage statements, but the broker/dealer declined to providedetailed information relating to their valuation methodologies. Due to the lackof transparency into the methodologies used to determine the estimated marketvalues, we concluded that estimated market values provided on our brokeragestatements did not constitute valid inputs and thus we did not utilize them inmeasuring the fair value of these ARS as of March 31, 2010.

 

Wedetermined that use of a valuation model was the best available technique formeasuring the fair value of our ARS. We used a trinomial discount modelweighting estimated future cash flows, quality of collateral and theprobability of future successful auctions occurring. While our valuation modelwas based on both Level 2 (credit quality and interest rates) and Level 3inputs, we determined that the Level 3 inputs were the most significant to theoverall fair value measurement of these assets, particularly the estimates ofexpected periods of illiquidity. In determining a discount factor for each ARS,the model weights various factors, including assessments of credit quality,duration, insurance wraps, portfolio composition, discount rates, overallcapital market liquidity and comparable securities, if any.

 

Theput option is a free standing asset separate from the ARS, and represents ourcontractual right to require our broker, UBS, to purchase our ARS at par valueduring the period of June 2010 through July 2012.  The put option is classified as short-termbecause we intend to is to sell our ARS under the Rights at the inception ofthe Rights period in the third quarter of 2010. See Note 3 — Investments.

 

Periodically,during the three months ended March 31, 2010 we entered into forwardcontracts to buy U.S dollars at fixed intervals in the retail market in anover-the-counter environment.  As of March 31,2010, we had foreign currency forward contracts to sell 5.2 million Euros inexchange for $7.4 million maturing in April 2010 through July 2010.  As of March 31, 2010 these forwardcontracts are recorded at their fair value of $0.5 million in other currentassets on our condensed consolidated balance sheet.  We have outstanding short-term intercompanyreceivables of $7.4 million as of March 31, 2010.  We expect the changes in the fair value ofthe intercompany receivables to be materially offset by the changes in the fairvalue of the forward contracts.

 

Thepurpose of these forward contracts is to minimize the risk associated withforeign exchange rate fluctuations.  Wehave developed a foreign currency exchange policy to govern our forwardcontracts.  These foreign currencycontracts do not qualify as cash flow hedges and all changes in fair value arereported in earnings as part of other income and expenses.  We have not entered into any other types ofderivative financial instruments for trading or speculative purpose.  Our foreign currency forward contracts valuationinputs are based on quoted prices and quoted pricing intervals from public dataand do not involve management judgment. Accordingly, we have classified our outstanding foreign currency forwardcontracts within Level 2 of the fair value hierarchy and have recorded the fairvalue of the contracts in other current assets on our condensed consolidatedbalance sheet as of March 31, 2010.

 

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Assetsmeasured at fair value on a recurring basis at March 31, 2010 are asfollows (in thousands):

 
| ** **                         | ** ** | ** **        | ** ** | **Fair Value Measurements at Reporting Data**                   | ** ** |
|------------------------------------|------------|-------------------|------------|-----------------------------------------------------------------|------------|
| ** **                         | ** ** | **March 31** | ** ** | **Quoted Price in  Active Markets  for Identical  Instruments** | ** ** | **Significant  Other  Observable  Inputs** | ** ** | **Significant  Unobservable  Inputs** | ** ** |
| ** **                         | ** ** | **2010**          | ** ** | **Level 1**                                                     | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|                               |       |              |       |                                                            |       |   |   |   |   |
| Assets:                            |       |              |       |                                                            |       |   |   |   |   |
| Auction  rate securities           |       | 35,177            |       | —                                                          |       | — |   | 35,177 |   |
| Money  market funds                |       | 23,179            |       | 23,179                                                          |       | — |   | — |   |
| Corporate  bonds                   |       | 19,633            |       | 19,633                                                          |       | — |   | — |   |
| U.S.  government bonds             |       | 6,505             |       | 6,505                                                           |       | — |   | — |   |
| U.S.  treasury bills               |       | 3,986             |       | 3,986                                                           |       | — |   | — |   |
| Put  option                        |       | 3,203             |       | —                                                          |       | — |   | 3,203 |   |
| Time  deposits                     |       | 1,244             |       | 1,244                                                           |       | — |   | — |   |
| Foreign  currency forward contract |       | 451               |       | —                                                          |       | 451 |   | — |   |
| Total  assets                      |       | $                 | 93,378     |                                                            | $          | 54,547 |   | $ | 451 |   | $ | 38,380 |   |
|                                    |            |                   |            |                                                                 |            |  |  |  |  |  |  |  |  |

 

Assetsmeasured at fair value on a recurring basis at December 31, 2009 are asfollows (in thousands):

 
| ** **                         | ** ** | ** **           | ** ** | **Fair Value Measurements at Reporting Data**  | ** ** |
|------------------------------------|------------|----------------------|------------|------------------------------------------------|------------|
| ** **                         | ** ** | **December 31** | ** ** | **Active Markets  for Identical  Instruments** | ** ** | **Significant Other  Observable  Inputs** | ** ** | **Significant  Unobservable  Inputs** | ** ** |
| ** **                         | ** ** | **2010**             | ** ** | **Level 1**                                    | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|                               |       |                 |       |                                           |       |   |   |   |   |
| Assets:                            |       |                 |       |                                           |       |   |   |   |   |
| Money  market funds                |       | $                    | 54,884     |                                           | $          | 54,884 |   | $ | — |   | $ | — |   |
| Auction  rate securities           |       | 40,626               |       | —                                         |       | — |   | 40,626 |   |
| Put  option                        |       | 2,933                |       | —                                         |       | — |   | 2,933 |   |
| Foreign  currency forward contract |       | 145                  |       | —                                         |       | 145 |   |   |   |
| Total  assets                      |       | $                    | 98,588     |                                           | $          | 54,884 |   | $ | 145 |   | $ | 43,559 |   |

 

Thefollowing table presents a reconciliation of all assets and liabilitiesmeasured at fair value on a recurring basis, excluding accrued interestcomponents, using significant unobservable inputs (Level 3) for the threemonths ended March 31, 2010 (in thousands):

 
| ** **                         | ** ** | ** **     | ** ** | **Auction Rate** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------|------------|------------------|------------|------------|------------|
| ** **                         | ** ** | **Put Option** | ** ** | **Securities**   | ** ** | **Total**  | ** ** |
| Balance  at December 31, 2009 |       | $              | 2,933      |             | $          | 40,626     |       | $ | 43,559 |   |
| Sales  of auction rate securities  |       | —         |       | (5,175           | )          | (5,175     | )          |
| Loss  on auction rate securities   |       | —         |       | (274             | )          | (274       | )          |
| Gain  on put option                |       | 270            |       | —           |       | 270        |       |
| Balance  at March 31, 2009    |       | $              | 3,203      |             | $          | 35,177     |       | $ | 38,380 |   |

 

**Fair value of Liabilities**

 

Thefair value of the Convertible Senior Notes (see Note 9 — Convertible SeniorNotes) was estimated using quoted market prices. Accordingly, we haveclassified our convertible senior notes within Level 1 of the fair valuehierarchy and have recorded the carrying value of the notes in long-termliabilities on our condensed consolidated balance sheet as of March 31,2010.

 

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Thefollowing table summarizes the principal outstanding and estimated fair valuesof our debt (in thousands):

 
| ** **                | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|---------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                | ** ** | **Carrying Value**      | ** ** | **Fair Value**             | ** ** | **Carrying Value** | ** ** | **Fair Value** | ** ** |
|                      |       |                    |       |                       |       |   |   |   |   |
| Convertible  senior notes |       | $                       | 77,615     |                       | $          | 84,189 |   | $ | 76,531 |   | $ | 81,075 |   |
|                           |            |                         |            |                            |            |  |  |  |  |  |  |  |  |

 

**5.****           ****Goodwilland Intangible Assets**

 

Goodwillis tested for impairment on an annual bases or more frequent upon theoccurrence of circumstances that indicate that goodwill assets might beimpaired.  We did not record anyimpairment of goodwill during the three months ended March 31, 2010.

 

Thechanges in carrying amount of goodwill for the three months ended March 31,2010 is as follows (in thousands):

 
| ** **                      | ** ** | **Three Months**         | ** ** |
|---------------------------------|------------|--------------------------|------------|
| ** **                      | ** ** | **Ended March 31,** | ** ** |
| ** **                      | ** ** | **2010**                 | ** ** |
| Goodwill,  beginning of period  |       | $                        | 17,318     |   |
| Effect  of currency translation |       | (1,061                   | )          |
| Goodwill,  end of period        |       | $                        | 16,257     |   |

 

The following table provides additional informationconcerning intangible assets (in thousands):

 

Intangible assets are being amortized overstraight-line periods ranging from 3 to 9 years.

 
| ** **               | ** ** | ** **                                     | ** ** | **March 31, 2010**     | ** ** | **December 31,  2009**   | ** ** |
|--------------------------|------------|------------------------------------------------|------------|-----------------------------|------------|-------------------------------|------------|
| ** **               | ** ** | **Weighted  average  remaining life  (years)** | ** ** | **Gross  carrying  amount** | ** ** | **Accumulated  amortization** | ** ** | **Cumulative  effect of  currency  translation** | ** ** | **Net book  value** | ** ** | **Net book value** | ** ** |
|                     |       |                                           |       |                        |       |                          |       |   |   |   |   |   |   |
| Patent  and Licenses     |       | 8.5                                            |       | $                           | 25,750     |                          | $          | (2,578 | ) | $ | — |   | $ | 23,172 |   | $ | 23,854 |   |
| Customer  relationships  |       | 6.8                                            |       | 5,024                       |       | (1,208                        | )          | (368 | ) | 3,448 |   | 3,809 |   |
| Covenant  not to compete |       | 0.8                                            |       | 71                          |       | (51                           | )          | (3 | ) | 17 |   | 24 |   |
|                     |       |                                           |       |                        |       |                          |       |   |   |   |   |   |   |
| Total  intangibles       |       |                                           |       | $                           | 30,845     |                          | $          | (3,837 | ) | $ | (371 | ) | $ | 26,637 |   | $ | 27,687 |   |

 

**6.****    ****Inventories**

 

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

 
| ** **       | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------|------------|--------------------|------------|-----------------------|------------|
| ** **       | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| Raw  materials   |       | $                  | 20         |                  | $          | 92 |   |
| Work-in-progress |       | 1,164              |       | 1,577                 |       |
| Finished  goods  |       | 3,939              |       | 3,239                 |       |
| Total            |       | $                  | 5,123      |                  | $          | 4,908 |   |

 

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**7.****    ****Warranty**

 

We offer warranties onour product and record a liability for the estimated future costs associatedwith warranty claims, which is based upon our historical experience and ourestimate of the level of future costs. Warranty costs are reflected in thestatement of operations as a cost of goods sold.  A reconciliation of thechanges in warranty liability for the three months ended March 31, 2010and 2009 are as follows (in thousands):

 
| ** **                                        | ** ** | **Three months ended March 31,** | ** ** |
|---------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                        | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Balance  at the beginning of the period           |       | $                                     | 277        |   | $ | 272 |   |
| Accruals  for warranties issued during the period |       | 160                                   |       | 59 |   |
| Settlements  made in kind during the period       |       | (143                                  | )          | (99 | ) |
| Balance  at the end of the period                 |       | $                                     | 294        |   | $ | 232 |   |

 

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

 

Net loss for the firstquarter of 2010 included stock-based compensation expense under ASC 718, *Compensation — Stock Compensation* (“ASC 718”), of approximately $1.7 million, whichconsisted of stock-based compensation expense of approximately $1.5million related to employee stock options, employee stock purchase plan andstock appreciation rights and stock-based compensation expense of approximately$0.2 million related to employee restricted stock and restricted stock units.

 

Net loss for the firstquarter of 2009 included stock-based compensation expense under ASC 718 ofapproximately $1.3 million, which consisted of stock-based compensation expenseof approximately $1.1 million related to employee stock options, employee stockpurchase plan and stock appreciation rights and stock-based compensationexpense of approximately $0.2 million related to employee restricted stock andrestricted stock units.

 

Stock-based compensationarrangements to non-employees are accounted for in accordance with ASC 505-50 *Equity Based Payments to Non-Employees*, which requires thatthese equity instruments are recorded at their fair value on the measurementdate. The measurement of stock-based compensation is subject to adjustment asthe underlying equity instruments vest. Stock-based compensation expenserelating to non-employees was approximately $32,000 and $0 for the three monthsended March 31, 2010 and 2009, respectively.

 

For the three months ended March 31, 2010 and2009, we calculated the fair value of each stock option and stock appreciationright on the date of grant using the Black-Scholes model as prescribed by ASC718.  The assumptions used were asfollows:

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------|------------|---------------------------------------|------------|
| ** **                       | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Expected  term (in years)        |       | 4.15                                  |       | 4.35 |   |
| Average  risk-free interest rate |       | 1.97                                  | %          | 1.61 | % |
| Average  volatility factor       |       | 51.4                                  | %          | 52.6 | % |
| Dividend  yield                  |       | —                                |       | — |   |

 

*StockOptions and Stock Appreciation Rights*: During the three months ended March 31, 2010,we granted stock appreciation rights for 457,500 shares of common stock, withan estimated total grant date fair value of approximately $3.8 million and agrant date weighted-average fair value of $8.31 per share.  During the three months ended March 31,2009, we granted stock appreciation rights for 842,057 shares of common stock,with an estimated total grant date fair value of approximately $4.2 million anda grant date weighted-average fair value of $4.99 per share.

 

*RestrictedStock Units*: Inconnection with restricted stock units granted, we recorded stock compensationexpense representing the fair market value of our common shares on the datesthe awards were granted. Compensation expense is being recorded on astraight-line basis over the vesting periods of the underlying stock awards.During the three months ended March 31, 2010, we granted 58,437 restrictedstock units, with a grant-date fair value of approximately $1.1 million and agrant-date weighted-average fair value of $19.52.  During the three months ended March 31,2009, we granted 24,489 restricted stock units, with a grant-date fair value ofapproximately $0.3 million and a grant-date weighted-average fair value of$12.25.

 

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**9.****    ****Convertible Senior Notes**

 

InFebruary 2007, we issued an aggregate principal amount of $86.3 million ofour 2.25% convertible senior notes due 2027. These notes bear a 2.25% interestper annum on the principal amount, payable semiannually in arrears on February 15and August 15 of each year, beginning on August 15, 2007.

 

Thenotes will mature on February 15, 2027, unless earlier redeemed, repurchasedor purchased by us or converted, and are convertible into cash and, ifapplicable, shares of our common stock based on an initial conversion rate,subject to adjustment, of 35.8616 shares per $1,000 principal amount of notes(which represents an initial conversion price of approximately $27.89 pershare), in certain circumstances. Upon conversion, a holder would receive cashup to the principal amount of the note and our common stock in respect of suchnote’s conversion value in excess of such principal amount. The notes areconvertible only in the following circumstances: (1) if the closing saleprice of our common stock exceeds 120% of the conversion price during a periodas defined in the indenture; (2) if the average trading price per $1,000principal amount of the notes is less than or equal to 97% of the averageconversion value of the notes during a period as defined in the indenture; (3) uponthe occurrence of specified corporate transactions; (4) if we call thenotes for redemption and (5) at any time on or after December 15,2011 up to and including February 15, 2012 and anytime on or after February 15,2025. Upon a change in control or termination of trading, holders of the notesmay require us to repurchase all or a portion of their notes for cash at arepurchase price equal to 100% of the principal amount, plus any accrued andunpaid interest. We may not have sufficient funds to pay the interest, purchaseprice, repurchase price or principal return when conversion is triggered or anote becomes payable under the above terms.

 

Weconcluded that the embedded stock conversion option is not considered aderivative under ASC 815 *Derivative and*Hedging(“ASC 815”), because the embedded stock conversion option would be recorded instockholders’ equity if it were a freestanding instrument.

 

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

 

ASC815 provides that contracts are initially classified as equity if (1) thecontract requires physical settlement or net-share settlement, or (2) thecontract gives the company a choice of net-cash settlement or settlement in itsown shares (physical settlement or net-share settlement). The settlement termsof our purchased call options and sold warrant contracts require net-sharesettlement. Based on the guidance in ASC 815, the purchased call optioncontracts were recorded as a reduction of equity and the warrants were recordedas an addition to equity as of the trade date. ASC 815 states that a reportingentity shall not consider contracts to be derivative instruments if thecontract issued or held by the reporting entity is both indexed to its ownstock and classified in stockholders’ equity in its statement of financialposition. We concluded the purchased call option contracts and the warrantcontracts should be accounted for in stockholders’ equity.

 

*Adoption of*ASC 470-20

 

ASC470-20 *Debt with Conversion and Other Options*(“ASC470-20”) clarifies the accounting for convertible debt instruments that may besettled in cash upon conversion, including partial cash settlement.  ASC 470-20 specifies that an issuer of suchinstruments should separately account for the liability and equity componentsof the instruments in a manner that reflect the issuer’s non-convertible debtborrowing rate which interest costs are recognized in subsequent periods.  ASC 470-20 is effective for fiscal yearsbeginning after December 15, 2008, and retrospective application isrequired for all periods presented.  Weadopted ASC 470-20 in the first quarter of fiscal 2009.

 

Theeffect of the adoption of ASC 470-20 was to bifurcate the debt and equitycomponents of our convertible notes. The note payable principal balance at thedate of issuance of $86.3 million in February 2007 was bifurcated into thedebt component of $65.1 million and the equity component of $21.2 million.  The difference between the note payableprincipal balance of $86.3 million and the $65.1 million value of the debtcomponent is being accreted to interest expense over a period of 5 years, whichis the expected term of our notes payable. We reclassified $0.8 million of debt issuance costs to additional paidin capital.  The debt component wasrecognized at the present value of its cash flows discounted using a 5.51%discount rate, our borrowing rate at the date of the issuance of the Debenturefor a similar debt instrument without the conversion feature.

 

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Interest expenseassociated with the Convertible Senior Notes consisted of the following (inthousands):

 
| ** **                                   | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                   | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| ** **                                   | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Contractual  coupon rate of interest         |       | $                                     | 478        |   | $ | 478 |   |
| Accretion  of notes payable                  |       | 1,084                                 |       | 1,025 |   |
| Interest  expense - convertible senior notes |       | $                                     | 1,562      |   | $ | 1,503 |   |

 

Thecarrying amounts of the Convertible Senior Notes are as follows (in thousands):

 
| ** **                 | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| ** **                 | ** ** | ** **         | ** ** | ** **            | ** ** |
| Beginning  carrying amount |       | $                  | 76,531     |                  | $          | 72,344 |   |
| Accretion  of note payable |       | 1,084              |       | 4,187                 |       |
| Carrying  amount           |       | $                  | 77,615     |                  | $          | 76,531 |   |

 

**10.****    ****Credit Line**

 

InNovember 2008 we entered into a revolving credit line agreement with UBS,payable on demand, in an amount equal to 75% of the fair value of our ARS at anet no cost, meaning that the interest we pay on the credit line will notexceed the interest that we receive on the ARS that we have pledged as securityfor the credit line. Additionally, if UBS is able to sell our ARS at par value,proceeds would be utilized to first repay any outstanding balance under therevolving credit line. We are still able to sell the ARS, but in such acircumstance, if we sold the ARS at less than par, we would not be entitled torecover the par value support from UBS. During the three months ended March 31, 2010 we borrowed anadditional $1.8 million, and repaid $5.4 million under this line of credit, andour loan balance as of March 31, 2010 was $25.7 million.  Our loan balance as of December 31, 2009was $29.2 million.  We intend to repaythis line of credit in entirety when we exercise our Right to have UBS purchasethe underlying ARS at full par value in June 2010.  Our line of credit is payable on demand andwe classify as short term.  We believethe fair value equals the balance sheet value. See Note 3 — Investments.

 

**11.**** ****Income Taxes**

 

Weadopted the provisions of ASC 740 *Income Taxes* or(“ASC 740”) on January 1, 2007.  The adoption of the provisions, didnot have a material impact on our financial position and results ofoperations.   We have not been audited by the Internal RevenueService or any state income or franchise tax agency.   As of March 31,2010, our federal returns for the years ended 2006 through the current periodand most state returns for the years ended 2005 through the current period arestill open to examination.  In addition,all of the net operating losses and research and development creditcarryforwards that may be used in future years are still subject to inquirygiven that the statute of limitation for these items would be from the year ofthe utilization. The tax returns for Conceptus SAS for the years ended 2005 to2007 were examined and closed by the French tax authorities in 2008.

 

Forthe three months ended March 31, 2010 and 2009, we recorded approximately$0.1 million of income tax expense.

 

Theamount of unrecognized tax benefits at March 31, 2010 was approximately$2.4 million, of which, if ultimately recognized, approximately$0.7 million would decrease the effective tax rate in the period in whichthe benefit is recognized. The remaining amount would be offset by the reversalof related deferred tax assets on which a valuation allowance is placed.

 

Wedo not expect our unrecognized tax benefits to change significantly over thenext 12 months.  In connection with the adoption of ASC 740 we recognizeinterest and penalties accrued on any unrecognized tax benefits as a componentof income tax expense.

 

Inpreparing our condensed consolidated financial statements we are required toestimate our income taxes in each of the jurisdictions in which we operate.This process involves estimating our actual current tax exposure together withassessing temporary differences resulting from differing treatment of items fortax and accounting purposes. These differences result in deferred tax assetsand liabilities, which are included within our condensed consolidated balancesheet. We must then assess

 

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thelikelihood that our deferred tax assets will be recovered from future taxableincome and to the extent to which we believe that recovery is not likely, wemust establish a valuation allowance. To the extent we establish a valuationallowance or increase this allowance in a period, we must include an expensewithin the tax provision in the statement of operations. Due to experiencingonly a short history of fiscal profitability and a loss for the three monthsended March 31, 2010, management believes that there is sufficientuncertainty regarding the realization of deferred tax assets and a fullvaluation allowance is appropriate. Management reviews its assumptionsregarding the realization of deferred tax assets on an ongoing basis. Continuedprofitability and future changes in management’s assumptions may result in apartial or full release of the deferred tax valuation allowance. A release ofthe valuation allowance would have a favorable impact on the tax provisionwithin the statement of operations.

 

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

 

Basicnet loss per share excludes any potential dilutive effects of options, unvestedrestricted shares and restricted stock units and common stock shares subject torepurchase.  Diluted net loss per share includes the impact of potentiallydilutive securities.  In net loss periods presented, basic and diluted netloss per share are both computed using the weighted average number of commonshares outstanding.

 

The following tableprovides a reconciliation of weighted-average number of common sharesoutstanding to the weighted-average number common shares outstanding used incomputing basic and diluted net loss per common share (in thousands):

 
| ** **                                                                                                        | ** ** | **Three months ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                        | ** ** | **March 31,**     | ** ** |
| ** **                                                                                                        | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Numerator:                                                                                                        | ** ** | ** **             | ** ** | ** ** | ** ** |
| Numerator  for diluted earning per share - Loss available to common stockholders                                  |       | $                      | (2,351     | ) | $ | (4,335 | ) |
|                                                                                                              |       |                   |       |   |   |
| Denominator:                                                                                                      |       |                   |       |   |   |
| Weighted-average  number of common shares outstanding                                                             |       | 30,930                 |       | 30,442 |   |
| Less:  Weighted-average unvested and restricted common shares                                                     |       | —                 |       | (4 | ) |
| Weighted-average  number common shares outstanding used in computing basic and diluted net loss  per common share |       | 30,930                 |       | 30,438 |   |
|                                                                                                                   |            |                        |            |  |  |  |  |

 

The following outstandingoptions, potential employee stock purchase plan shares, warrants, stockappreciation rights, restricted stock units and shares were excluded from thecomputation of diluted net loss per share, as their effect would have beenantidilutive (in thousands):

 
| ** **                                                | ** ** | **At March 31,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                | ** ** | **2010**              | ** ** | **2009** | ** ** |
| Outstanding  options and stock appreciation rights        |       | 5,209                 |       | 4,826 |   |
| Restricted  stock awards                                  |       | —                |       | 4 |   |
| Restricted  stock units                                   |       | 157                   |       | 101 |   |
| Employee  stock purchase plan                             |       | 22                    |       | 19 |   |
| Warrants  issued in connection with our convertible notes |       | 3,093                 |       | 3,093 |   |
| Total                                                     |       | 8,481                 |       | 8,043 |   |

 

InFebruary 2007, we issued an aggregate principal amount of $86.3 million ofour 2.25% convertible senior notes due 2027. The notes are not included in the calculation of net loss per sharebecause their effect is anti-dilutive. In addition, our senior convertiblenotes were excluded from the diluted net income per share calculation becausethe conversion price was greater than the average market price of our stockduring the period.

 

**13.**** ****Comprehensive Loss**

 

Comprehensive lossrepresents all changes in stockholders’ equity except those resulting frominvestments or

 

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contributions by stockholders. Our comprehensive lossconsists of cumulative translation adjustments. A summary of the comprehensiveloss for the periods indicated is as follows (in thousands):

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **March 31,**     | ** ** |
| ** **                                                  | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Net  loss                                                   |       | $                      | (2,351     | ) | $ | (4,335 | ) |
| Other  comprehensive loss                                   |       |                   |       |   |   |
| Foreign  currency translation adjustment, net of tax        |       | (1,069                 | )          | (1,483 | ) |
| Change  to unrealized loss on available-for-sale securities |       | (44                    | )          | — |   |
| Comprehensive  loss                                         |       | $                      | (3,464     | ) | $ | (5,818 | ) |

 

The balance of eachcomponent of accumulated other comprehensive loss, net of taxes, as of March 31,2010 and December 31, 2009 consist of the following (in thousands):

 
| ** **                                | ** ** | **Foreign Currency  Translation** | ** ** | **Unrealized Gains  (Loss) on Available-  For-Sale Securities** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------------------|------------|---------------------------------------------|------------|
| Balance  as of December 31, 2009     |       | $                                 | (993       | )                                                               | $          | —                                      |       | $ | (993 | ) |
| Net  change during the three month period |       | (1,069                            | )          | (44                                                             | )          | (1,113                                      | )          |
| Balance  as of March 31, 2010        |       | $                                 | (2,062     | )                                                               | $          | (44                                         | )          | $ | (2,106 | ) |

 

**14.**** ****Segment Information**

 

We operate in onebusiness segment, which encompasses all geographical regions. We use onemeasurement of profitability and do not segregate our business for internalreporting.

 

Net sales by geographicregion, based on shipping location of our customer, are as follows (inthousands, except percentages):

 
| ** **               | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------|------------|---------------------------------------|------------|
| ** **               | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Net sales (in thousands) |       | $                                     | 33,358     |   | $ | 27,151 |   |
|                     |       |                                  |       |   |   |
| United States of America |       | 76                                    | %          | 78 | % |
| France                   |       | 21                                    | %          | 15 | % |
| Rest of Europe           |       | 1                                     | %          | 6 | % |
| Other                    |       | 2                                     | %          | 1 | % |
|                          |            |                                       |            |  |  |  |  |

 

No customer accounted formore than 10% of total revenue for the three months ended March 31, 2010and 2009.  One customer accounted for 11%of our total gross accounts receivable at March 31, 2010.

 

**15. ****LegalProceedings**

 

OnMay 22, 2009, we filed a lawsuit in the United States District Court,Northern District of California against Hologic, Inc., (“Hologic”) seekingdeclaratory judgment by the Court that Hologic’s planned importation, use, saleor offer to sell of its forthcoming Adiana Permanent Contraception system willinfringe several U.S. patents owned by us including U.S. Patent Nos. 6,634,361,6,709,667, 7,237,552, 7,428,904 and 7,506,650, and an injunction prohibitingHologic from importing, using, selling or offering to sell its Adiana system inthe United States.  Upon FDA approval of the Adiana PermanentContraception system, we filed an Amended Complaint in July 2009 seeking ajudgment that Hologic’s importation, use, sale and/or offer to sell the systeminfringes the same patents mentioned above and requested an injunction againstsuch activity.  On August 13, 2009, the Company filed a motion forpreliminary injunction, requesting the Court to enjoin the Adiana system in theUnited States pending final judgment in the action. On August 25,2009, Hologic filed its answer and asserted

 

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counterclaimsagainst the Company that it was violating the Lanham Act and the CaliforniaStatutory Unfair Competition Law. On October 14, 2009, the Companyanswered with its own counterclaims asserting that Hologic was violating theLanham Act and the California Statutory Unfair Competition Law through itsselling practices. A hearing was held on that motion on November 4,2009 and an order denying the motion was issued on November 6, 2009, uponstipulation of the parties, on January 19, 2010, all claims relating tothree of the five asserted patents were dismissed with prejudice. A claimconstruction hearing was held on March 10, 2010. The Claim ConstructionOrder was issued on March 24, 2010 with all but one of five termsfavorably construed to the Company.  On April 21,2010 the court issued an order denying the Company’s Motion to Compel andgranted the Company’s Motion to Amend its Complaint to assert counterclaimsagainst Defendant that the Defendant had engaged in unfair competition againstthe Company and had violated the Lanham Act. A trial date on the patent claims and unfair competition claims isscheduled for February 28, 2011.

 

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

 

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

 

*Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with our condensed consolidated financialstatements and related notes thereto. This discussion contains forward-lookingstatements, including references to 2010 revenues and gross margins, increasedproduct adoption, product improvements, expanded sales force and otherforecasted items that involve risks and uncertainties such as our limitedoperating and sales history; the uncertainty of market acceptance of ourproduct; dependence on obtaining and maintaining reimbursement; effectivenessand safety of our product over the long-term; our ability to obtain andmaintain the necessary governmental clearances or approvals to market ourproduct; our ability to develop and maintain proprietary aspects of ourtechnology; our ability to manage our expansion; our limited history ofmanufacturing our product; our dependence on single source suppliers,third party manufacturers and co-marketers; intense competition in the medicaldevice industry and in the contraception market; the inherent risk of exposureto product liability claims and product recalls and other factors referenced inthis Form 10-Q. Our actual results could differ materially from thoseexpressed or implied in these forward-looking statements as a result of variousfactors, including those discussed in our Annual Report on Form 10-K forthe year ended December 31, 2009 filed with the Securities and ExchangeCommission on March 13, 2010 and those included elsewhere in this Form 10-Q.*

 

***Overview***

 

Wedevelop, manufacture and market the*Essure*® permanentbirth control system, an innovative and proprietary medical device for women.   The*Essure* system delivers a soft and flexible insert into a woman’sfallopian tubes, causing benign tissue in-growth which blocks the fallopiantubes. A successfully placed*Essure*micro-insert and the subsequent tissue growth prohibits the egg from travelingthrough the fallopian tubes, preventing conception. The effectiveness rate ofthe*Essure* procedure determinedin our clinical study is 99.8% after four years of follow-up.  We obtained approval to market *Essure* in the European Union in February 2001 andobtained the U.S. Food and Drug Administration, or FDA, approval for *Essure* in November 2002.  Over 370,000 women worldwide have undergonethe *Essure*procedure.

 

OnJanuary 7, 2008, we acquired all of the outstanding shares of ConceptusSAS, based in Versailles, France.  As aresult of this transaction, Conceptus SAS became a wholly-owned subsidiary, andthrough it we sell *Essure* directlyin France and through a network of distributors throughout the rest of Europe. This acquisition expanded ourpresence in international markets and has increased our revenues as we nowrecognize sales at end-user pricing.

 

OnDecember 15, 2008, we incorporated Conceptus Medical Limited (“CML”) as awholly owned subsidiary in the United Kingdom to serve as our direct salesoffice in the United Kingdom after terminating our distributor relationshipwith our previous distributor during the fourth quarter of 2008.  This incorporation further expanded ourpresence in international markets and has increased our revenues as we nowrecognize sales at end-user pricing in United Kingdom.

 

During2009 we received a National Institute for Health and Clinical Excellence (“NICE”)positive recommendation in the United Kingdom and an approval for the *Essure* procedure from the Brazilian National HealthService.  During 2009, we sold the *Essure*system in twenty two countries.  For financial information about geographicareas and for segment information with respect to net sales, refer to theinformation set forth in Note 14 — Summary of Significant Accounting Policiesin the Notes to Condensed Consolidated Financial Statements.

 

Wewere incorporated in the state of Delaware on September 18, 1992.  We maintain three websites located atwww.conceptus.com, www.essuremd.com and www.essure.com. We make available freeof charge on or through our www.conceptus.com website, our annual report on Form 10-K,our quarterly reports on Form 10-Q, current reports on Form 8-K andamendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Exchange Act as soon as reasonably practicable after weelectronically file or furnish such material to the Securities and ExchangeCommission (SEC).

 

***The Essure Procedure***

 

The*Essure* micro-insert is designed to beplaced into each fallopian tube during a single procedure using a hysteroscope,an instrument that allows visual examination of the cervix and uterine cavity,and our minimally invasive delivery system. The delivery system is a disposableplastic handle that is connected to our proprietary guidewire and cathetersystem. The micro-insert is constructed of a stainless steel inner coil, adynamic outer coil made from a nickel titanium alloy, called Nitinol, and alayer of polyethylene terephthalate, or polyester fibers, wound between the innercoils. Using the hysteroscope for guidance, the delivery catheter is guidedthrough the uterus and into the opening of the fallopian tube. Once thephysician has properly positioned the delivery system in the fallopian tube,the physician releases the micro-insert. When released, the micro-insertautomatically expands to the contours of the fallopian tube and anchors itselfin place.  Over a three-month time 

 

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frame,the polyester fibers within the micro-insert elicit a localized, benign tissuein-growth that occludes, or blocks, the fallopian tubes, thereby preventingconception.

 

Currently,local anesthesia is used as the predominate method of controlling discomfortduring the *Essure*procedure*. * General anesthesia is not typically usedunless required by hospital protocol, if requested by the patient, or based onthe experience and comfort level of the physician.   The Essure procedure can be performed in thecomfort of a physician’s office in less than ten minutes (averagehysteroscopic time) without hormones, cutting, burning or the risks associatedwith general anesthesia or tubal ligation.  A patient is typically dischargedapproximately 45 minutes after the*Essure*procedure. No overnight hospital stay is required. Furthermore, the*Essure* procedure is effective withoutdrugs or hormones. There is a three-month waiting period after the *Essure* procedure is completed during which the patient mustcontinue to use her current form of birth control or an alternative form whiletissue in-growth occurs.  After threemonths, U.S. patients complete a confirmation test called a hysterosalpingogram,or HSG, which provides confirmation to both the doctor and the patient of theplacement of the inserts and the occlusion of the fallopian tubes. Outside ofthe United States, the confirmation test is a standard flat plate pelvic X-rayconducted three months after completion of the procedure, with a subsequent HSGif device location on the initial radiographic image appears suspicious.

 

***The Essure Procedure Benefits***

 

With99.8% effectiveness based on four years of follow up, the *Essure*procedure is the most effective form of permanent contraception on the marketbased on a comparison of four-year clinical trial data.  We developed the*Essure* procedure in response to the market need for a lessinvasive and more cost effective solution for women whose families arecomplete.  The *Essure*procedure is typically performed in an office setting without generalanesthesia and women typically can return to their daily activities within oneday.  Other permanent birth controlprocedures, such as tubal ligation or vasectomy, are done in a hospitalsetting, entail general anesthesia and require additional recovery time.

 

Benefits for the patients:

·                  Proven: four-year effectiveness rate of99.8%;

·                  Performed in the comfort of the doctor’soffice in less than 10 minutes;

·                  No risks associated with incisions,general anesthesia or RF energy (common in other permanent birth controlprocedures);

·                  No hormones;

·                  Short recovery time.  Most women are discharged within 45 minutesand they return to normal activities within 24 hours;

·                  Confirmation: A**confirmationtest provides women with certainty that they are protected against unplannedpregnancy;

·                  Convenience: No recurring management ofcontraception usage after the confirmation test, which is performed 90 daysafter the initial procedure.

 

Benefitsto the physician and healthcare system:

·                  More cost effective and efficientsolution: Due to savings related to cost and time such as:

·                  Elimination of overhead,

·                  Indirect and procedural costs related toanesthesia,

·                  Post-operative care and hospital staysassociated with tubal ligations;

·                  Short procedure time and relative ease ofperforming the procedure;

·                  Ability to visually confirm properplacement of micro-insert during the procedure:

·                  No risks associated with: incisions,thermal injuries, bowel injuries or dilutional hyponatremia, glycine, orgeneral anesthesia and;

·                  Less resource-intensive environment:While *Essure* procedures may beperformed in various settings including the physician office, hospitaloperating room and an ambulatory surgery center, the majority of *Essure* procedures now take place inphysicians’ offices.

 

Benefits to the payers:

·                  Lower cost procedure:  Due toreduced use of general or regional anesthesia and reduced number ofpost-operative hospital stays;

·                  Elimination of costs:  Nooperating room expenses because the procedure can be performed in the physician’soffice; and

·                  Cost savings resulting from the potentialreduction of unplanned pregnancies.

·                  Most effective form of permanent birthcontrol based on 4 years of clinical studies.

 

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***Physician Penetration***

 

Werequire physicians to be preceptored for between 3 and 5 cases by a certifiedtrainer before being able to perform the procedure independently. We continueto see an increase in the number of physicians becoming trained or who are inthe process of training to perform the *Essure*procedure. The level of sales for the*Essure*system is highly dependent on the number of physicians trained to perform theprocedure. However, we understand that a strong base of trained physicians doesnot necessarily correlate to an increase in revenue proportionately.Furthermore, there are no revenues associated with the training activities. Wedo not charge a fee for the activity and no commitment arises for the physicianfrom the preceptorship.

 

***Reimbursement of the Essure Procedure***

 

Marketacceptance of the*Essure* systemdepends in part upon the availability of reimbursement within prevailinghealthcare payment systems. We believe that physician advocacy of ourproduct will be required to continue to obtain reimbursement. As of March 31,2010 we have received positive coverage decisions for the *Essure* procedure from most privateinsurers and from all of the 51 Medicaid programs and favorable office reimbursementsin 26 states (defined as $1,800 or more) in the United States. We continue toreceive positive responses relating to reimbursement, which we believe willhelp increase the adoption of the *Essure*deviceby doctors and patients. We intend to continue our effort to educate payers ofthe cost-effectiveness of our product and to establish further programs to helpphysicians to navigate reimbursement issues. As with all healthcare plans,coverage will vary and is dependent upon the individual’s specific benefitplan.

 

EffectiveJanuary 1, 2010, the Centers for Medicare and Medicaid Service (“CMS”),the Medicare Physician Fee Schedule national average payment for hysteroscopicsterilization (“CPT code”) is $423.05 when performed in a hospital (facility)and $1,822.41 (non-facility) when performed in a physician’s office. Inaddition, in the CMS Final Rule for the 2010 Outpatient ProspectivePayment System, or OPPS, which assigns hospital outpatient reimbursementamounts, CPT 58565 maps to APC 202 which is assigned a Medicare NationalAverage of $3,032.56, which under Medicare includes the cost of theimplant.  In 2010, the Medicare nationalaverage payment for hysteroscopic sterilization in the Ambulatory Surgery Center(“ASC”) is $1,671.96, which includes the cost of the implant. We believe thesevalues are favorable for the *Essure*procedure and will help in establishing increased utilization of the deviceamongst doctors.

 

Reimbursementsystems vary significantly by country and sometimes by region, andreimbursement approvals must be obtained on a country-by-country basis. Manyinternational markets have government-managed healthcare systems that determinereimbursement for new devices and procedures. In most markets, there areprivate insurance systems as well as government-managed systems.

 

Duringthe last several years, we received several positive responses from governmentand private agencies relating to reimbursement, which we believe will help usto speed up the acceptance of the*Essure*procedureby doctors and patients. In Europe, we are developing a strategic plan toobtain reimbursement in a number of European countries. In France, we haveobtained official reimbursement with the Haute Autorité de Santé (“HAS”). The *Essure* procedure is covered in France for allage-appropriate women, regardless of their medical status.  The Economic Committee for Healthcare Devicesin France ruled in November 2007 that the reimbursement for the *Essure* device will remain at the then current levels of 663Euros, net of value added tax, for the next five years.

 

Wehave experienced significant cumulative operating losses since inception and,as of March 31, 2010, had an accumulated deficit of $236.7 million.Although we were profitable in 2009, we experienced a net loss in the firstquarter of 2010 and there is a risk that we may not sustain profitability.   We will continue to expend substantialresources in the selling and marketing of the*Essure* system in the United States and abroad. We will be in a netloss position unless sufficient revenues can be generated to offset expenses.

 

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**Resultsof Operations - Three Months Ended March 31, 2010 and 2009**

**(inthousands, except percentages)**

** **
| ** **                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                    | ** ** | **2010**                              | ** ** | **2009** | ** ** | **2010-  2009  %** | ** ** |
| ** **                                    | ** ** | **Amount**                            | ** ** | **% (a)** | ** ** | **Amount** | ** ** | **% (a)** | ** ** | **Change** | ** ** |
| Net  sales                                    |       | $                                     | 33,358     |   | 100 | % | $ | 27,151 |   | 100 | % | 23 | % |
| Gross  profit                                 |       | 26,967                                |       | 81 | % | 21,395 |   | 79 | % | 26 | % |
| Research  and development expenses            |       | 1,746                                 |       | 5 | % | 1,407 |   | 5 | % | 24 | % |
| Selling,  general and administrative expenses |       | 25,979                                |       | 78 | % | 22,570 |   | 83 | % | 15 | % |
| Net  loss                                     |       | (2,351                                | )          | -7 | % | (4,335 | ) | -16 | % | 46 | % |
|                                               |            |                                       |            |  |  |  |  |  |  |  |  |  |  |

 

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**(a) **Expressed as a percentage of total netsales.

 

*Net Sales*

 

Netsales were $33.4 million for the three months ended March 31, 2010 ascompared to $27.2 million for the three months ended March 31, 2009,representing an increase of approximately $6.2 million or 23%.  The increase is the result of continuedcommercialization and marketing of the*Essure* system worldwide and reflects the increasing numbers ofphysicians entering and completing training in the use of the procedure.  The increase also reflects continuation ofour programs aimed at raising consumer and physician awareness of the *Essure* procedure.

 

Internationalsales comprised 24% of our total net sales in the three months ended March 31,2010.  International sales increased 33%compared to the three months ended March 31, 2009.  The increase in international sales reflectsour continued focus on growing our current markets such as France and theexpansion into new markets.  The netsales increase also reflects a domestic revenue increase of 20% in the threemonths ended March 31, 2010 as compared to the similar period in 2009.

 

Net sales by geographicregion, based on shipping location of our customer, are as follows (in thousands,except percentages):

 
| ** **               | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------|------------|---------------------------------------|------------|
| ** **               | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Net sales (in thousands) |       | $                                     | 33,358     |   | $ | 27,151 |   |
|                     |       |                                  |       |   |   |
| United States of America |       | 76                                    | %          | 78 | % |
| France                   |       | 21                                    | %          | 15 | % |
| Rest of Europe           |       | 1                                     | %          | 6 | % |
| Other                    |       | 2                                     | %          | 1 | % |
|                          |            |                                       |            |  |  |  |  |

 

No customer accounted formore than 10% of total revenue for the three months ended March 31, 2010and 2009.  One customer accounted for 11%of our total gross accounts receivable at March 31, 2010.

 

Weexpect our net sales for 2010 to be in the range of approximately $160.0 millionto $165.0 million, which would represent 22% to 26% growth from net sales in2009 as we continue to increase the number of physicians performing the*Essure* procedure. We will also continueour programs aimed at raising patient awareness of the*Essure* procedure, such as radio, printand television advertising. We believe our revenue growth in 2010 and beyondwill be significantly influenced by how successful we are in achieving ourpatient awareness objectives and physicians entering and completing training.However, as we have noted elsewhere in this Form 10-Q and risk factorsfrom our Form 10-K, our expected revenue growth involves many riskfactors, some of which are not entirely within our control.

 

*Gross Profit*

 

Costof goods sold for thethree months ended March 31, 2010 was $6.4 million as compared to $5.8million for the three months ended March 31, 2009, this represents anincrease of $0.6 million, or 11%.  Grossmargin for the three months ended March 31, 2010 was 81% as compared to79% for the comparable period in 2009. The quarter-over-quarterincrease in gross

 

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marginis related to lower manufacturing costs associated with higher unit volume anda domestic price increase implemented during the latter part of the firstquarter of 2010.  Our gross profitmargin will vary as our geographic mix changes. Increases in sales of ourdevices through distributors in international markets will tend to decrease ouroverall gross profit margin.

 

*Research and Development Expenses*

 

Research and developmentexpenses, which include expenditures related to product development, clinicalresearch and regulatory affairs, were $1.7 million and $1.4 million for thethree months ended March 31, 2010 and 2009, respectively, which representsan increase of $0.3 million, or 24%. As a percentage of revenues, research anddevelopment expenses for the three months ended March 31, 2010 and 2009represented 5%, respectively.  Theprimary reason for the increase is due to higher cost related to consultingexpenses and payroll related expenses for the next generation of *Essure* device.

 

Research and developmentexpenses reflect clinical expenditures and product development, which aresubstantially related to the ongoing development and associated regulatoryapprovals of our technology. Our goal is to continue our product enhancementsover the coming years, which are intended to result in improved ease of use andclinical performance. We expect to identify and hire additional research anddevelopment personnel in the future to staff our planned research anddevelopment activities, and we expect that these costs will increase as we seekto maintain our leading position in the market for permanent female birthcontrol.

 

*Selling, General and AdministrativeExpenses*

 

Selling, general andadministrative spending for the three months ended March 31, 2010 were$26.0 million as compared to $22.6 million for the three months ended March 31,2009, which represents an increase of $3.4 million, or 15%.  As a percentage of revenues, selling, generaland administrative expenses for the three months ended March 31, 2010 and2009 represented 78% and 83%, respectively.

 

The increases wereprimarily the result of payroll and stock compensation expenses ofapproximately $1.3 million, primarily due to the expansion of the U.S. fieldsales force.  Legal fees increased byapproximately $0.8 million due to the litigation associated with defense of ourpatents.  Advertising expendituresincreased by approximately $0.4 million primarily for our consumer-awarenesscampaign.  The increase also reflects thefollowing:  increased rent, insurance andbusiness taxes of approximately $0.3 million; increased travel related expensesof approximately $0.2 million; increased market research related expenses ofapproximately $0.2 million; and increased bad debt and banking fees ofapproximately $0.2 million.  We expectselling, general and administrative expenses to increase in the second quarterof 2010 as we expect to hire additional sales professionals and to continue ourconsumer-awareness campaign in targeted markets.

 

*Total interest income and expenses and other income and expenses,net*

 

Totalinterest income and expenses and otherincome and expenses, net for the three months ended March 31, 2010was a net expense of $1.5 million as compared to a net expense of $1.6 millionfor the three months ended March 31, 2009, which represents a decrease of$0.1 million or 9%.

 

Totalinterest income, including the net amortization and accretion of premiums anddiscounts, in the three months ended March 31, 2010 was lower by 23%compared with the three months ended March 31, 2009.  Interest income, without the net amortizationand accretion of premiums and discounts of approximately $0.1 million,increased by 12% due to the interest earned in available-for-sale investments such as timedeposits, U.S. treasury bills, U.S. Government bonds and corporate bondspurchased during the first quarter of 2010.

 

Otherincome and expense, net increased by $0.3 million for the three months ended March 31,2010 as compared to the three months ended March 31, 2009 primarily due tothe foreign exchange loss in 2009.

 

*Provision for income taxes*

 

Inaccordance with ASC 740 Income Taxes or (“ASC 740”), the provision for incometaxes is computed using the asset and liability method, under which deferredtax assets and liabilities are recognized for the expected future taxconsequences of temporary differences between the financial reporting and taxbases of assets and liabilities, and for operating losses and tax creditcarryforwards.  Deferred tax assets and liabilities are measured using thecurrently enacted tax rates that apply to taxable income in effect for theyears in which those tax assets are expected to be realized or settled. We record a valuation allowance to reduce deferred tax assets to theamount that is believed more likely than not to be realized. We evaluate theneed for a valuation allowance for our deferred tax assets. Due to ourcumulative pre-tax U.S. losses and the current

 

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uncertainty of our ability torealize our U.S. deferred tax assets, a valuation allowance in an amount equalto our U.S. deferred tax assets has been recorded.

 

We adoptedthe provisions of ASC 740, on January 1, 2007.  The adoption of ASC740 with respect to uncertain tax positions did not have a material impact onour financial position and results of operations.   We have not beenaudited by the Internal Revenue Service or any state income or franchise taxagency.   As of March 31, 2010, our federal returns for theyears ended 2006 through the current period and most state returns for theyears ended 2005 through the current period are still open toexamination.  The tax returns of Conceptus SAS for the years end 2005 to 2007were examined and closed by the French tax authorities in 2008.  Inaddition, all of the net operating losses and research and development creditcarryforwards that may be used in future years are still subject to inquirygiven that the statute of limitation for these items would be from the year ofthe utilization.

 

Forthe three months ended March 31, 2010 and 2009, we recorded approximately$0.1 million of income tax expense.

 

Theamount of unrecognized tax benefits at March 31, 2010 was approximately $2.4million, of which, if ultimately recognized, approximately $0.7 millionwould decrease the effective tax rate in the period in which the benefit isrecognized. The remaining amount would be offset by the reversal of relateddeferred tax assets on which a valuation allowance is placed.

 

Wedo not expect our unrecognized tax benefits to change significantly over thenext 12 months.  In connection with the adoption of ASC 740 we recognizeinterest and penalties accrued on any unrecognized tax benefits as a componentof income tax expense.

 

Inpreparing our condensed consolidated financial statements we are required toestimate our income taxes in each of the jurisdictions in which we operate.This process involves estimating our actual current tax exposure together withassessing temporary differences resulting from differing treatment of items fortax and accounting purposes. These differences result in deferred tax assetsand liabilities, which are included within our condensed consolidated balancesheet. We must then assess the likelihood that our deferred tax assets will berecovered from future taxable income and the extent we believe that recovery isnot likely, we must establish a valuation allowance. To the extent we establisha valuation allowance or increase this allowance in a period, we must includean expense within the tax provision in the statement of operations. Due toexperiencing only a short history of fiscal profitability and a loss for thethree months ended March 31, 2010, management believes that there issufficient uncertainty regarding the realization of deferred tax assets and afull valuation allowance is appropriate. Management reviews its assumptionsregarding the realization of deferred tax assets on an ongoing basis. Continuedprofitability and future changes in management’s assumptions may result in apartial or full release of the deferred tax valuation allowance. A release ofthe valuation allowance would have a favorable impact on the tax provisionwithin the statement of operations.

 

**Liquidity and Capital Resources**

 

Wehave experienced significant cumulative operating losses since inception and,as of March 31, 2010, had an accumulated deficit of $236.7 million.Although we were profitable in 2009, we experienced a net loss in the firstquarter of 2010 and there is a risk that we may not sustain profitability.   We will continue to expend substantialresources in the selling and marketing of the *Essure*system worldwide.  We will remain in anaccumulated deficit position unless sufficient revenues can be generated tooffset expenses.

 

Asof March 31, 2010, we also held $38.4 million (par value) in auction ratesecurities (“ARS”) backed by federal and state student loans which are variablerate debt instruments and bear interest rates that reset approximately every20-30 days. The fair value of ARS as of March 31, 2010 is $35.2million.  These ARS have a contractualmaturity ranging from 2028 through 2047. Our ARS are classified short-term debt instruments.  Prior to2008, our ARS were highly liquid, using a Dutch auction process that resets theapplicable interest rate at predetermined intervals, typically every20-30 days, to provide liquidity at par.  We have experiencedfailed auction in 2009 on some of our ARS.  The failures of these auctions do not affect the value of the collateralunderlying the ARS, and we continue to earn and receive interest on our ARS ata pre-determined formula with spreads tied to particular interest rate indexes.

 

InNovember 2008, we accepted an offer from UBS AG, providing us with theRights to require UBS to purchase our ARS at par value, which is defined as theprice equal to the liquidation preference of the ARS plus accrued but unpaiddividends or interest, at any time during the period of June 2010 through July 2012.  Conversely,UBS has the right, in its discretion, to purchase or sell our ARS at any timeuntil July 2012, so long as we receive payment at par value upon any saleor disposition.  We expect to sell our ARS under the Rights at par valuein June 2010.  However, if the Rights are not exercised before July 2012they will expire and UBS will have no further rights or obligation to buy ourARS.  So long as we

 

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holdour ARS, they will continue to accrue interest as determined by the auctionprocess or the terms of the ARS if the auction process fails.  We had settlements of our ARS in the threemonths ended March 31, 2010 of $5.2 million at full par value.  UBS’s obligations under the Rights are notsecured by its assets and do not require UBS to obtain any financing to supportits performance obligations under the Rights.  UBS has disclaimed anyassurance that it will have sufficient financial resources to satisfy itsobligations under the Rights.

 

Duringthe three months ended March 31, 2010, we invested $31.5 million in timedeposits, U.S. treasury bills, U.S. government bonds and corporate bonds.  We will sell certain or all investments asneeded to meet the cash flow needs of our business.  Hence our investments in time deposits, U.S.treasury bills, U.S. government bonds and corporate bonds are classified asavailable-for-sale securities in accordance with ASC 320 *Investments —Debt and Equity Securities*. Investments are classified as short-term or long-term based on theunderlying investments maturity date.  Asof March 31, 2010 we had $17.5 million classified as short-terminvestments and $13.9 million classified as long-term investments.  See Note 3 — Investments in the Notes toCondensed Consolidated Financial Statements.

 

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

 

· Resources devoted to establish sales,marketing and distribution capabilities;

 

· The liquidity of auction rate securitiesheld in our investment portfolio;

 

· The rate of product adoption by doctors andpatients;

 

· Our determination to acquire or invest inother products, technologies and businesses;

 

· The market price of our common stock as itaffects the exercise of stock options and the conversion terms of ourconvertible debt; and

 

· The insurance payer community’s acceptanceof and reimbursement for the*Essure*system.

 

Asof March 31, 2010, we had cash and cash equivalents of $29.5 million,compared to $61.7 million at December 31, 2009. In addition we hadshort-term and long-term investments of $66.6 million as of March 31,2010, compared to $40.6 million of short-term investments at December 31,2009.  The decrease of $32.1 million ofcash and cash equivalents is primarily due to cash used in investing activitiesto purchase investments.

 

Webelieve that our existing cash and cash equivalents will be sufficient to meetour cash requirements for at least the next twelve months.

 

**Sources and Uses of Cash**

 

Ourcash flows for the three months ended March 31, 2010 and 2009 aresummarized as follows:

 
| ** **                                                    | ** ** | **Three months ended  March 31,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                    | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| Net  cash used in operating activities                        |       | $                                      | (2,482     | ) | $ | (705 | ) |
| Net  cash used in investing activities                        |       | (27,757                                | )          | (848 | ) |
| Net  cash (used in) provided by financing activities          |       | (1,727                                 | )          | 1,195 |   |
| Effect  of exchange rate changes on cash and cash equivalents |       | (148                                   | )          | (121 | ) |
| Net  decrease in cash and cash equivalents                    |       | $                                      | (32,114    | ) | $ | (479 | ) |

 

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*Operating Activities*

 

Netcash used in operating activities was $2.5 million in the three months ended March 31,2010, as compared to $0.7 million used in the three months ended March 31,2009.  Net cash used in operatingactivities in the three months ended March 31, 2010 was primarily relatedto:

 

·                  net loss of $2.4 million;

·                  non-cashrelated items such as accretion of notes payable, stock based compensation,depreciation and amortization of fixed assets, debt issuance costs amortizationand intangible amortization were $4.8 million.

 

Netcash used in the operating activities in the three months ended March 31,2009 was primarily related to:

 

·                  net loss of $4.3 million; and

·                  non-cashrelated items such as accretion of notes payable, stock based compensation,depreciation and amortization of fixed assets, debt issuance costs amortizationand intangible amortization were $3.7 million.

 

*Investing Activities*

 

Netcash used in investing activities for the three months ended March 31,2010 was $27.8 million, primarily due to investments purchases of $31.5 millionand capital expenditures primarily related to purchases of additionalhysteroscopy equipment of $1.4 million. These were offset by the settlements of our ARS for $5.2 million at fullpar value during the three months ended March 31, 2010.

 

Net cash used ininvesting activities for the three months ended March 31, 2009 was $0.8million, due to capital expenditures primarily related to purchases ofadditional hysteroscopy equipment.

 

*Financing Activities*

 

Netcash used in financing activities in the three months ended March 31, 2010was $1.7 million.  This was due to $3.7million from the issuance of common stock from our stock programs and fromproceeds from our UBS line of credit, offset by repayment of our UBS line ofcredit of $5.4 million.  See Note 10 —Credit Line in the Notes to Condensed Consolidated Financial Statements.

 

Net cash provided byfinancing activities in the three months ended March 31, 2009 was $1.2million due primarily from the issuance of common stock from our stock optionprograms and proceeds from our revolving credit line agreement with UBS.

 

**CRITICAL ACCOUNTING ESTIMATES ANDPOLICIES**

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions in certain circumstances that affect amounts reported in theaccompanying condensed consolidated financial statements and related footnotes.A description of our critical accounting estimates and policies is included inour Annual Report on Form 10-K for the year ended December 31, 2009.In preparing these financial statements, management has made its best estimatesand judgments of certain amounts included in the financial statements, givingdue consideration to materiality. The primary estimates underlying ourfinancial statements include reserves for obsolete and slow moving inventory,allowance for doubtful accounts receivable, product warranty, impairment forlong-lived assets, income taxes, stock-based compensation and contingentliabilities. Other accounting policies are described in section “CriticalAccounting Estimates and Policies” in our Financial Statements included in ourAnnual Report on Form 10-K for the year ended December 31, 2009.Application of these policies involves the exercise of judgment and use ofassumptions as to future uncertainties and, as a result, actual results coulddiffer from these estimates.

 

*Recent Accounting Pronouncements*

 

InJanuary 2010, the FASB issued updated guidance related to fair valuemeasurements and disclosures, which requires a reporting entity to discloseseparately the amounts of significant transfers in and out of Level 1and Level2 fair value measurements and to describe the reasons for the transfers. Inaddition, in the reconciliation for fair value measurements using significantunobservable inputs, or Level 3, a reporting entity should disclose separatelyinformation about purchases, sales, issuances and settlements (that is, on agross basis rather than one net number). The updated guidance also requiresthat and entity should provide fair value measurement disclosures for eachclass of assets and liabilities and disclosures about the

 

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valuationtechniques and inputs used to measure fair value for both recurring andnon-recurring fair value measurements for Level 2 and Level 3 fair valuemeasurements. The updated guidance is effective for interim or annual financialreporting periods beginning after December 15, 2009, except for thedisclosures about purchases, sales, issuances and settlements in the roll forwardactivity in Level 3 fair value measurements, which are effective for fiscalyears beginning after December 15, 2010 and for interim periods withinthose fiscal years. We have adopted this guidance in the first quarter of2010.  See Note 4 — Fair ValueMeasurement in the Notes to Condensed Consolidated Financial Statements.

 

In February 2010,the FASB issued amended guidance on subsequent events. Under this amendedguidance, SEC filers are no longer required to disclose the date through whichsubsequent events have been evaluated in originally issued and revisedfinancial statements. We adopted this guidance in the first quarter of fiscal2010 and the adoption did not have a material impact on our financialcondition, results of operations, or cash flows.

 

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

 

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

 

*Interest Rate Risk*:  We have been exposedto interest rate risk through interest earned on holdings of available-for-saleand trading marketable securities. We have experienced failed auctions in 2010and 2009 of most all of our ARS and there is no assurance that auctions onthese ARS in our investment portfolio will succeed in the future. As a result,our ability to liquidate our investments in the near term may be limited, and ourability to fully recover the carrying value of our investments may be limitedor non-existent. An auction failure means that the parties wishing to sellsecurities could not carry out the transaction. If the issuers of thesesecurities are unable to successfully close future auctions or their creditratings deteriorate, we may be required to record further impairment charges onthese investments. It could take until the final maturity of the underlyingnotes (up to 38 years) to realize our investments’ recorded value. As of March 31,2010 we held $38.4 million (par value) in ARS, $35.2 million of fair valuewhich are variable rate debt instruments and bear interest rates that are dueto reset approximately every 20-30 days. In September 2009 were-classified the ARS from long-term investments to short-term investmentsbecause our intention is to sell our ARS under the Rights at par value at theinception of the Rights period in the third quarter of 2010.   Due in part to these factors, our futureinvestment income may fall short of expectations due to changes in interestrates or we may suffer losses in principal if forced to sell securities thathave declined in market value due to changes in interest rates. Interest ratesthat may affect these items in the future will depend on market conditions andmay differ from the rates we have experienced in the past.

 

We maintain an investment portfolio of variousholdings, types, and maturities. The values of our investments are subject tomarket price volatility. Our primary objective for holding investments is toachieve an appropriate investment return consistent with preserving principaland managing risk.  As of March 31,2010 we had short and long-term available-for-sale investments of $31.4 millionrecorded at fair value.  At any time, asharp rise in interest rates could have a material adverse impact on the fairvalue of our investment portfolio, specifically investments in corporate bondsand U.S. government bonds. We had no outstanding hedging instruments for ourinvestments as of March 31, 2010. We monitor our interest rate and credit risks, including our creditexposures to specific rating categories and to individual issuers. We monitorour investment portfolio to ensure it is compliant with our internalinvestments policy.  We believe theoverall credit quality of our portfolio is strong.  There were no impairment charges on ourinvestments for the three months ended March 31, 2010.  A hypothetical 100 basedpoint change in interest rates will not have a material impact on the fairvalue of our available-for-sale investments. See Note 3 — Investments in the Notes to Condensed ConsolidatedFinancial Statements.

 

*Foreign Currency Exchange Risk:*    Aportion of our net sales are denominated in the Euro and the BritishPound.  To date the foreign currencyexchange risk related to British Pounds has been minimal due to the size ofConceptus Medical Limited.

 

Weare exposed to foreign exchange rate fluctuations as we translate the financialstatements of our foreign subsidiaries into U.S. Dollars in consolidation. Ifthere is a change in foreign currency exchange rates, the translation of theforeign subsidiaries’ financial statements into U.S. Dollars will lead totranslation gains or losses which are recorded net as a component ofaccumulated other comprehensive loss. We seek to manage our foreign exchangerisk through operational means, including managing same currency revenues inrelation to same currency expenses, and same currency assets in relation to samecurrency liabilities.  Periodically,during 2010 we entered into forward contracts to buy U.S dollars at fixedintervals in the retail market in an over-the-counter environment.  As of March 31, 2010, we had foreigncurrency forward contracts to sell 5.2 million Euros in exchange for $7.4million maturing in April 2010 through July 2010.  As of March 31, 2010 these forwardcontracts are recorded at their fair value of $0.5 million in other currentassets on our condensed

 

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consolidatedbalance sheet.  We have outstandingshort-term intercompany receivables of $7.4 million as of March 31,2010.  We expect the changes in the fairvalue of the intercompany receivables to be materially offset by the changes inthe fair value of the forward contracts. A potential loss in fair value resulting from a hypothetical10 percent strengthening in the value of the U.S. dollar/local currencyexchange rate would be approximately $0.7 million.

 

Thepurpose of these forward contracts is to minimize the risk associated withforeign exchange rate fluctuations.  Wehave developed a foreign exchange policy to govern our forward contracts.  These foreign currency contracts do notqualify as cash flow hedges and all changes in fair value are reported inearnings as part of other income and expenses. We have not entered into any other types of derivative financialinstruments for trading or speculative purpose. Our foreign currency forward contract valuation inputs are based onquoted prices and quoted pricing intervals from public data and do not involvemanagement judgment.

 

**Item4. Controls and Procedures**

 

*Evaluation of Disclosure Controlsand Procedures:*

 

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our Exchange Act reports is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow for timely decisions regardingrequired disclosure. In designing and evaluating the disclosure controls andprocedures, management recognized that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and in reaching a reasonable level ofassurance, management is required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

As of March 31,2010, the end of our most recent fiscal quarter, we carried out an evaluation,under the supervision and with the participation of our management, includingour Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures. Based on the foregoing, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective at the reasonable assurance level.

 

*Changes in Internal Control OverFinancial Reporting:*

 

There was no change inour internal control over financial reporting during our most recent fiscalquarter that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

*Inherent Limitations of InternalControls*

 

Internal control overfinancial reporting cannot provide absolute assurance of achieving financialreporting objectives because of its inherent limitations.  Internalcontrol over financial reporting is a process that involves human diligence andcompliance and is subject to lapses in judgment and breakdowns resulting fromhuman failures. Internal control over financial reporting also can becircumvented by collusion or improper management override. Because of suchlimitations, there is a risk that material misstatements may not be preventedor detected on a timely basis by internal control over financial reporting.However, these inherent limitations are known features of the financialreporting process. Therefore, it is possible to design into the processsafeguards to reduce, though not eliminate, this risk.

 

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**PART II. OTHER INFORMATION**

 

**Item1. Legal Proceedings**

 

OnMay 22, 2009, we filed a lawsuit in the United States District Court,Northern District of California against Hologic, Inc., (“Hologic”) seekingdeclaratory judgment by the Court that Hologic’s planned importation, use, saleor offer to sell of its forthcoming Adiana Permanent Contraception system willinfringe several U.S. patents owned by us including U.S. Patent Nos. 6,634,361,6,709,667, 7,237,552, 7,428,904 and 7,506,650, and an injunction prohibitingHologic from importing, using, selling or offering to sell its Adiana system inthe United States.  Upon FDA approval of the Adiana Permanent Contraceptionsystem, we filed an Amended Complaint in July 2009 seeking a judgment thatHologic’s importation, use, sale and/or offer to sell the system infringes thesame patents mentioned above and requested an injunction against suchactivity.  On August 13, 2009, the Company filed a motion forpreliminary injunction, requesting the Court to enjoin the Adiana system in theUnited States pending final judgment in the action. On August 25,2009, Hologic filed its answer and asserted counterclaims against the Company thatit was violating the Lanham Act and the California Statutory Unfair CompetitionLaw. On October 14, 2009, the Company answered with its own counterclaimsasserting that Hologic was violating the Lanham Act and the CaliforniaStatutory Unfair Competition Law through its selling practices. A hearingwas held on that motion on November 4, 2009 and an order denying themotion was issued on November 6, 2009, upon stipulation of the parties, onJanuary 19, 2010, all claims relating to three of the five assertedpatents were dismissed with prejudice. A claim construction hearing was held onMarch 10, 2010. The Claim Construction Order was issued on March 24,2010 with all but one of five terms favorably construed to the Company.  On April 21, 2010 the court issued anorder denying the Company’s Motion to Compel and granted the Company’s Motionto Amend its Complaint to assert counterclaims against Defendant that theDefendant had engaged in unfair competition against the Company and hadviolated the Lanham Act.  A trial date onthe patent claims and unfair competition claims is scheduled for February 28,2011.

 

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

 

**Item 1A. Risk Factors**

 

*The risk factors included in ourAnnual Report as of December 31, 2009 on Form 10-K filed with the Securitiesand Exchange Commission on March 31, 2010 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 March 31, 2010 should be considered carefully whileevaluating the Company and our business.*

 

***We could face competition, and if weare unable to compete effectively, demand for the Essure system may be reduced.***

 

Themedical device industry is highly competitive and is characterized by rapid andsignificant technological change.  Tocompete successfully, we will need to continue to demonstrate the advantages ofour *Essure* products and technologies overwell-established alternative procedures, products and technologies, and convincephysicians and other healthcare decision makers of the advantages of ourproducts and technology. As we market the*Essure* system, we expect to compete with:

 

·                  other methodsof permanent contraception, in particular tubal ligation;

 

·                  other companiesthat have developed or may be developing permanent contraception devices thatare similar to or otherwise compete with the*Essure* system;

 

·                  other methodsof non-permanent contraception, including devices such as intrauterine devices,or IUDs, vaginal rings, condoms and prescription drugs such as the birthcontrol pill, injectable and implantable contraceptives and patches; and

 

Wecompete against other surgical procedures for permanent birth control,mechanical devices and other contraceptive methods, including existing methodsof reversible birth control for both women and men.

 

The*Essure* procedure faces directcompetition from Adiana, a hysteroscopic sterilization method that ismanufactured and sold by Hologic, Inc. in Europe and the United States. Webelieve the*Essure* procedure has significantadvantages over its competitor such as its higher effectiveness rate, no risksfrom the use of RF energy and the fact that the micro-inserts are radio-opaque,which enables the physician to visually confirm that the micro-inserts havebeen properly placed in the fallopian tubes.

 

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Manyof our competitors possess a larger women’s health focused sales force and haveaccess to the greater resources required to develop and market a competitiveproduct than we do. In addition, new competition and products may arise due toconsolidation within the industry and other companies may develop products thatcould compete with the *Essure* system.Our competitive position also depends on:

 

·                  widespreadawareness, acceptance and adoption of our *Essure*product;

 

·                  our ability torespond promptly to medical and technological changes through the developmentand commercialization of new products;

 

·                  availability ofcoverage and reimbursement from third-party payers, insurance companies andothers for the *Essure*procedure;

 

·                  the manufactureand delivery of our products in sufficient volumes on time, and accuratelypredicting and controlling costs associated with manufacturing, installation,warranty and maintenance of the products;

 

·                  our ability toattract and retain qualified personnel;

 

·                  the extent ofour patent protection or our ability to otherwise develop proprietary productsand processes; and

 

·                  securingsufficient capital resources to expand our sales and marketing efforts.

 

Theseand other competitive factors may render the *Essure*system obsolete or noncompetitive or reduce demand for the *Essure*system.

 

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

 

AtMarch 31, 2010, we had cash and cash equivalents of $29.5 million(excluding our investments in auction rate securities discussed below).  This available cash and cash equivalents areheld in accounts at financial institutions and consist of invested cash andcash in our operating accounts.  Theinvested cash is invested in interest bearing money market funds managed bythird party financial institutions. These funds invest in direct obligations of the government of the UnitedStates and traditional money market funds. We can provide no assurances that access to our invested cash and cashequivalents will not be impacted by adverse conditions in the financialmarkets.

 

We maintain an investmentportfolio of various holdings, types, and maturities. These securities areclassified as available-for-sale.  As of March 31,2010 we had short and long-term investments of $31.4 million recorded at fairvalue.  Our portfolio includes time deposits,U.S. treasury bills, U.S. government bonds and corporate bonds, the values of which are subject tomarket price volatility to the extent unhedged. If such investments suffermarket significant price declines, we may recognize in earnings the decline inthe fair value of our investments below their cost basis when the decline isjudged to be other than temporary. For information regarding the sensitivity ofand risks associated with the market value of portfolio investments andinterest rates refer to the section titled “Quantitative and QualitativeDisclosures About Market Risk.”

 

Allof our cash and cash equivalents in our operating accounts are with third partyfinancial institutions.  These balancesexceed the Federal Deposit Insurance Corporation insurance limits.  While we monitor the cash balances in ouroperating accounts and adjust the cash balances as appropriate, these cashbalances could be impacted if the underlying financial institutions fail or aresubject to other adverse conditions in the financial markets.  To date we have experienced no loss or lackof access to cash in our operating accounts.

 

***A portion of our investment portfolio is in auctionrate securities.***

 

As of March 31,2009, we held approximately $38.4 million (par value), with a fair valueof $35.2 million of investments consisting entirely of auction rate securitiesbacked by federal and state student loans securities.  These auction rate securities havecontractual maturities ranging from 2028 through 2047.  These investments have characteristicssimilar to short-term investments, because at pre-determined intervals,generally ranging from 20 to 30 days, there is a new auction processat which the interest rates for these securities are reset to currentinterest rates. At the end of each such period, we historically have eitherchosen to roll-over these securities or redeem the securities for cash.

 

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During 2008 and 2009, we experienced failed auctionsof our auction rate securities and there is no assurance that auctions on thesesecurities in our investment portfolio will succeed in the future. In November 2008,we accepted an offer from UBS, thefund manager with whom we hold our auction rate securities, pursuant to whichUBS issued to us Series C-2 Auction Rate Securities Rights, or Rights,which allow us to sell the auction rate securities to UBS at par value duringthe period beginning June 2010 and ending July 2012. In exchange, theCompany released UBS from claims that it may have for damages related to theauction rate securities (other than consequential damages), and we granted UBSthe right to sell or otherwise dispose of the auction rate securities on itsbehalf (so long as we are paid the par value of the auction rate securitiesupon any disposition). We intend to sell our ARS under the Rights at theinception of the Rights period in June 2010.

 

The Rightsare subject to a number of risks. Given the substantial dislocation in thefinancial markets and among financial services companies, we cannot assure youthat UBS will ultimately have the ability to repurchase our auction ratesecurities at par, or at any other price during the put period describedabove.  We will be required to periodically assess theeconomic ability of UBS to meet that obligation in assessing the fair value ofthe Rights. Moreover,if we choose to not exercise the Rights or if UBS is unable to honor theRights, our ability to liquidate our investments in the near term may belimited, and our ability to fully recover the carrying value of our investmentsmay be limited or non-existent. If issuers of these securities are unable tosuccessfully close future auctions or their credit ratings deteriorate, we mayin the future be required to record further impairment charges on theseinvestments. It could take until the final maturity of the underlying notes (upto 38 years) to realize our investments’ recorded value. Based on ourability to access our cash and cash equivalents, expected operating cash flows,and our other sources of cash, we do not anticipate that the current lack ofliquidity on these investments will affect our ability to continue to operateour business in the ordinary course. However, we can provide no assurance as towhen these investments will again become liquid or as to whether we mayultimately have to recognize additional impairment charges in our results ofoperations with respect to these investments.

 

***Our business, financial condition, resultsof operations and cash flows could be significantly and adversely affected ifcertain types of healthcare reform programs are adopted in our key markets andother administration and legislative proposals are enacted into law.***

 

TheHealth Care Reform Legislation was signed into law March 30, 2010 andamong other provisions enacts an excise tax on medical device manufacturers onsales beginning January 1, 2013. There are numerous other provisions inthe legislation. As a result, our effective tax rate and results of operationswould be adversely affected and our ability to innovate and conduct necessaryresearch and development to remain competitive with large, global companiescould be negatively impacted.  We cannotpredict what other healthcare initiatives, if any, will be implemented at thefederal or state level, or the effect any future legislation or regulationwill have on us. However, an expansion in government’s role in the U.S.healthcare industry may lower reimbursements for our products, reduce medical procedurevolumes and adversely affect our business and results of operations, possiblymaterially.

 

***We have been, and may be in thefuture, a party to patent litigation, which could be expensive and divert ourmanagement’s attention.***

 

Themedical device industry has been characterized by extensive litigationregarding patents and other intellectual property rights, and companies in theindustry have used intellectual property litigation to gain a competitiveadvantage. We may become a party to patent infringement claims and litigationor interference proceedings declared by the U.S. Patent and Trademark Office,or PTO, to determine the priority of inventions. The defense and prosecution ofthese matters are both costly and time consuming. We may need to commenceproceedings against others to enforce our patents, to protect our trade secretsor know-how or to determine the enforceability, scope and validity of theproprietary rights of others. These proceedings would result in substantialexpense to us and significant diversion of effort by our technical andmanagement personnel.

 

Anadverse determination in new litigation or interference proceedings to whichmay become a party could subject us to significant liabilities to third partiesor require us to seek licenses from third parties. Although patent andintellectual property disputes in the medical device area have often beensettled through licensing or similar arrangements, costs associated with sucharrangements may be substantial and could include ongoing royalties. We may beunable to obtain necessary licenses on satisfactory terms, if at all. Adversedeterminations in a judicial or administrative proceeding or failure to obtainnecessary licenses could prevent us from manufacturing and selling the *Essure* system.

 

Oneof the patents included in our license from Target Therapeutics, a division ofBoston Scientific Corporation, has been the subject of reexaminationproceedings in the PTO and an infringement lawsuit by Target Therapeutics. Weare not a party to this lawsuit. The patent is directed to variable stiffnesscatheters for use with guidewires, as might be used in our future products.Although the PTO reaffirmed the patent with amended claims and the lawsuit wassettled, the patent could 

 

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bechallenged or invalidated in the future. If this patent is invalidated, ourability to prevent others from using this proprietary technology would becompromised.

 

OnMay 22, 2009, we filed a lawsuit in the United States District Court,Northern District of California against Hologic, Inc., (“Hologic”) seekingdeclaratory judgment by the Court that Hologic’s planned importation, use, saleor offer to sell of its forthcoming Adiana Permanent Contraception system willinfringe several U.S. patents owned by us including U.S. Patent Nos. 6,634,361,6,709,667, 7,237,552, 7,428,904 and 7,506,650, and an injunction prohibiting Hologicfrom importing, using, selling or offering to sell its Adiana system in theUnited States.  Upon FDA approval of the Adiana Permanent Contraceptionsystem, we filed an Amended Complaint in July 2009 seeking a judgment thatHologic’s importation, use, sale and/or offer to sell the system infringes thesame patents mentioned above and requested an injunction against suchactivity.  On August 13, 2009, the Company filed a motion forpreliminary injunction, requesting the Court to enjoin the Adiana system in theUnited States pending final judgment in the action. On August 25,2009, Hologic filed its answer and asserted counterclaims against the Companythat it was violating the Lanham Act and the California Statutory UnfairCompetition Law. On October 14, 2009, the Company answered with its owncounterclaims asserting that Hologic was violating the Lanham Act and theCalifornia Statutory Unfair Competition Law through its sellingpractices. A hearing was held on that motion on November 4, 2009 andan order denying the motion was issued on November 6, 2009, uponstipulation of the parties, on January 19, 2010, all claims relating tothree of the five asserted patents were dismissed with prejudice. A claimconstruction hearing was held on March 10, 2010. The Claim ConstructionOrder was issued on March 24, 2010 with all but one of five termsfavorably construed to the Company.  On April 21,2010 the court issued an order denying the Company’s Motion to Compel andgranted the Company’s Motion to Amend its Complaint to assert counterclaimsagainst Defendant that the Defendant had engaged in unfair competition againstthe Company and had violated the Lanham Act. A trial date on the patent claims and unfair competition claims isscheduled for February 28, 2011.

 

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**Item 6.Exhibits**

** **
| **Number** | ** ** | **Description**                                                                                                                                                                                    |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.3       |       | Amended Exhibit E  - Product Pricing to the Medical Production Manufacturing Agreement by and  between Conceptus, Inc. and Avail Medical Products, Inc. dated  April 19, 2010. |
| 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 therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

Date: May 07, 2010

 

Conceptus, Inc.

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

 

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