**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 
| ý                                                                                                                                                                             |       | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                               |       | ** **                                                                                              |
| **For the Fiscal Quarter Ended June 30,  2005**                                                                                                                               |
|                                                                                                                                                                               |       | ** **                                                                                              |
| **o**                                                                                                                                                                              | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                               |       | ** **                                                                                              |
| **For the transition period from           to               .** |
| ** **                                                                                                                                                                         |
| **Commission file number: 0-27596**                                                                                                                                                |

 

**CONCEPTUS, INC.**

(Exact name of registrant as specified in itscharter) 

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

 

**1021 Howard Avenue****San Carlos, CA 94070**

(Address of principal executive offices)

 

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

 

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Indicate by check mark whetherthe 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 for atleast the past 90 days.

 
| Yes | ý | No | o |
|-----|--------|----|---|

 

Indicate by checkmark whetherthe registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).Yes  ý  No  o

 

As of July 26, 2005,25,733,941 shares of the registrant’s Common Stock were outstanding.

 

 

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**CONCEPTUS, INC.**

 

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

 

**INDEX**

 
| ** **    | ** **                                                                                                                 | **Page** |
|---------------|----------------------------------------------------------------------------------------------------------------------------|----------|
|          |                                                                                                                       |     |
| Part I.  | Financial Information                                                                                                      | 3        |
|          |                                                                                                                       |     |
| Item 1.       | Condensed Consolidated Financial Statements  (Unaudited)                                                                   | 3        |
|          |                                                                                                                       |     |
|          | a) Condensed Consolidated Balance Sheets as  of June 30, 2005 and December 31, 2004                              | 3        |
|          |                                                                                                                       |     |
|          | b) Condensed Consolidated Statements of  Operations for the three and six month periods ended June 30, 2005 and  2004 | 4        |
|          |                                                                                                                       |     |
|          | c) Condensed Consolidated Statements of  Cash Flows for the six month periods ended June 30, 2005 and 2004            | 5        |
|          |                                                                                                                       |     |
|          | d) Notes to Condensed Consolidated  Financial Statements                                                                   | 6        |
|          |                                                                                                                       |     |
| Item 2.       | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                | 10       |
|          |                                                                                                                       |     |
| Item 3.       | Quantitative and Qualitative Disclosures  About Market Risk                                                                | 26       |
|          |                                                                                                                       |     |
| Item 4.       | Controls and Procedures                                                                                                    | 27       |
|          |                                                                                                                       |     |
| Part II. | Other Information                                                                                                          | 27       |
|          |                                                                                                                       |     |
| Item 1.       | Legal Proceedings                                                                                                          | 27       |
|          |                                                                                                                       |     |
| Item 2.       | Unregistered Sales of Equity Securities and  Use of Proceeds                                                               | 28       |
|          |                                                                                                                       |     |
| Item 3.       | Defaults upon Senior Securities                                                                                            | 28       |
|          |                                                                                                                       |     |
| Item 4.       | Submission of Matters to a Vote of Security  Holders                                                                       | 28       |
|          |                                                                                                                       |     |
| Item 5.       | Other Information                                                                                                          | 29       |
|          |                                                                                                                       |     |
| Item 6.       | Exhibits                                                                                                                   | 29       |
|          |                                                                                                                       |     |
| Signature     |                                                                                                                       | 30       |

 

2

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**PART I: FINANCIAL INFORMATION**

 

**ITEM 1.****  Condensed Consolidated Financial Statements**

 

**Conceptus, Inc.**

** **

**Condensed Consolidated Balance Sheets**

**(Unaudited)**

(In thousands)

 
| ** **                                          | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
|                                                |       |                   |       |                       |       |
| **Assets**                                          |       |                   |       |                       |       |
| Current assets:                                     |       |                   |       |                       |       |
| Cash and cash equivalents                           |       | $                      | 2,000      |                       | $          | 2,002 |   |
| Short-term investments                              |       | 17,700                 |       | 30,200                     |       |
| Restricted cash                                     |       | 69                     |       | 69                         |       |
| Accounts receivable, net                            |       | 2,677                  |       | 2,067                      |       |
| Inventories, net                                    |       | 3,348                  |       | 2,022                      |       |
| Other current assets                                |       | 1,094                  |       | 937                        |       |
|                                                |       |                   |       |                       |       |
| Total current assets                                |       | 26,888                 |       | 37,297                     |       |
|                                                |       |                   |       |                       |       |
| Property and equipment, net                         |       | 1,401                  |       | 1,322                      |       |
| Intangible assets, net                              |       | 1,650                  |       | 1,750                      |       |
| Other assets                                        |       | 1,679                  |       | 1,808                      |       |
|                                                |       |                   |       |                       |       |
| **Total assets**                                    | ** ** | **$**                  | **31,618** | ** **                 | **$**      | **42,177** | ** ** |
| ** **                                          | ** ** | ** **             | ** ** | ** **                 | ** ** |
| **Liabilities and stockholders’ equity**       |       |                   |       |                       |       |
| Current liabilities:                                |       |                   |       |                       |       |
| Accounts payable                                    |       | $                      | 2,854      |                       | $          | 2,713 |   |
| Accrued compensation                                |       | 2,268                  |       | 1,347                      |       |
| Other accrued liabilities                           |       | 1,293                  |       | 1,072                      |       |
| Total current liabilities                           |       | 6,415                  |       | 5,132                      |       |
|                                                |       |                   |       |                       |       |
| Other long-term liabilities                         |       | 7                      |       | 51                         |       |
|                                                |       |                   |       |                       |       |
| Total liabilities                                   |       | 6,422                  |       | 5,183                      |       |
|                                                |       |                   |       |                       |       |
| Commitments and Contingencies (Note 9)              |       |                   |       |                       |       |
|                                                |       |                   |       |                       |       |
| Stockholders’ equity:                          |       |                   |       |                       |       |
| Common stock and additional paid-in capital         |       | 222,328                |       | 221,960                    |       |
| Deferred stock-based compensation                   |       | (1,403                 | )          | (1,637                     | )          |
| Accumulated deficit                                 |       | (195,729               | )          | (183,329                   | )          |
| Treasury Stock, 74,000 and 72,000 shares,  at cost  |       | —                 |       | —                     |       |
|                                                |       |                   |       |                       |       |
| Total stockholders’ equity                     |       | 25,196                 |       | 36,994                     |       |
|                                                |       |                   |       |                       |       |
| **Total liabilities and stockholders’ equity** | ** ** | **$**                  | **31,618** | ** **                 | **$**      | **42,177** | ** ** |

 

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

 

3

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**Conceptus, Inc.**

 

**Condensed Consolidated Statements of Operations**

**(Unaudited)**

(Inthousands, except per share amounts)

 
| ** **                                                                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                      | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Net sales                                                                       |       | $                                     | 5,032      |                                | $          | 2,769 |   | $ | 8,903 |   | $ | 5,150 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Cost of goods sold                                                              |       | 2,102                                 |       | 1,676                               |       | 3,829 |   | 3,796 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Gross profit                                                                    |       | 2,930                                 |       | 1,093                               |       | 5,074 |   | 1,354 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Operating expenses:                                                             |       |                                  |       |                                |       |   |   |   |   |
| Research and development                                                        |       | 909                                   |       | 905                                 |       | 1,875 |   | 2,204 |   |
| Selling, general and administrative                                             |       | 8,213                                 |       | 6,545                               |       | 15,950 |   | 12,669 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Total operating expenses                                                        |       | 9,122                                 |       | 7,450                               |       | 17,825 |   | 14,873 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Operating loss                                                                  |       | (6,192                                | )          | (6,357                              | )          | (12,751 | ) | (13,519 | ) |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Interest and other income, net                                                  |       | 161                                   |       | 176                                 |       | 351 |   | 210 |   |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Net loss                                                                        |       | $                                     | (6,031     | )                                   | $          | (6,181 | ) | $ | (12,400 | ) | $ | (13,309 | ) |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Basic and diluted net loss per share                                            |       | $                                     | (0.24      | )                                   | $          | (0.25 | ) | $ | (0.49 | ) | $ | (0.55 | ) |
|                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Weighted-average shares used in computing basic  and diluted net loss per share |       | 25,453                                |       | 25,207                              |       | 25,451 |   | 24,153 |   |

 

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

 

4

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**Conceptus, Inc.**

 

**Condensed Consolidated Statements of Cash Flows**

**(Unaudited)**

**(In thousands)**

 
| ** **                                                                   | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| **Cash flows from operating activities**                                     |       |                                |       |   |   |
| Net loss                                                                     |       | $                                   | (12,400    | ) | $ | (13,309 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                |       |   |   |
| Depreciation and amortization                                                |       | 571                                 |       | 687 |   |
| Stock compensation expense                                                   |       | 511                                 |       | 452 |   |
| Allowance for (recovery of) doubtful  accounts                               |       | 28                                  |       | (75 | ) |
| Provision for inventories                                                    |       | (24                                 | )          | 580 |   |
| Retirement of fixed assets                                                   |       | 2                                   |       | 43 |   |
| Changes in operating assets and  liabilities:                                |       |                                |       |   |   |
| Accounts receivable                                                          |       | (638                                | )          | 73 |   |
| Inventories                                                                  |       | (1,303                              | )          | 438 |   |
| Other current assets                                                         |       | (157                                | )          | (1,157 | ) |
| Other assets                                                                 |       | 129                                 |       | 168 |   |
| Accounts payable                                                             |       | 141                                 |       | 13 |   |
| Accrued compensation                                                         |       | 921                                 |       | (1,311 | ) |
| Other accrued liabilities                                                    |       | 200                                 |       | 268 |   |
| Long term liabilities                                                        |       | (44                                 | )          | (119 | ) |
| Net cash used in operating activities                                        |       | (12,063                             | )          | (13,249 | ) |
|                                                                         |       |                                |       |   |   |
| **Cash flows from investing activities**                                     |       |                                |       |   |   |
| Purchase of investments                                                      |       | (9,750                              | )          | (34,834 | ) |
| Maturities of investments                                                    |       | 22,250                              |       | 25,683 |   |
| Capital expenditures, net                                                    |       | (552                                | )          | (159 | ) |
| Net cash provided (used) by investing  activities                            |       | 11,948                              |       | (9,310 | ) |
|                                                                         |       |                                |       |   |   |
| **Cash flows from financing activities**                                     |       |                                |       |   |   |
| Proceeds from issuance of common stock, net                                  |       | 113                                 |       | 25,497 |   |
| Net cash provided by financing activities                                    |       | 113                                 |       | 25,497 |   |
|                                                                         |       |                                |       |   |   |
| Effect of exchange rate changes on cash                                      |       | —                              |       | 14 |   |
|                                                                         |       |                                |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                        |       | (2                                  | )          | 2,952 |   |
| Cash and cash equivalents at beginning of  period                            |       | 2,002                               |       | 5,844 |   |
| Cash and cash equivalents at end of period                                   |       | $                                   | 2,000      |   | $ | 8,796 |   |

 

*The accompanying notes are an integral part of these condensedconsolidated financial statements.*

 

5

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**Conceptus, Inc.**

 

***NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS***

***(Unaudited)***

 

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

 

The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information and pursuant to the instructions to Form 10-Qand Article 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by accounting principles generally accepted in the United States ofAmerica for complete financial statements. In the opinion of management, all adjustments, consisting only of normalrecurring adjustments, considered necessary for a fair statement have beenincluded.

 

The condensed consolidated balance sheet at December 31,2004 has been derived from the audited consolidated financial statements atthat date, but does not include all of the information and footnotes requiredby accounting principles generally accepted in the United States of America forcomplete financial statements. This financial data should be reviewed inconjunction with the audited consolidated financial statements and relatednotes included in the Company’s Annual Report on Form 10-K for theyear ended December 31, 2004.  Theresults of operations for the three and six months ended June 30, 2005 maynot necessarily be indicative of the operating results for the full 2005 fiscalyear or any other future interim periods.

 

The information included in this form 10-Qshould be read in conjunction with the Management’s Discussion and Analysis ofFinancial Condition and Results of Operations section.

 

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

 

The Company’s significant accounting policies aredisclosed in the Company’s Annual Report on Form 10-K for the yearended December 31, 2004 that was filed with the Securities and Exchange Commissionon March 31, 2005. The Company’s significant accounting policies have notmaterially changed since December 31, 2004.

 

**3.**                                      **Investments**

 

The Company accounts for its marketable securities in accordance withStatement of Financial Accounting Standards (“SFAS”) No. 115, “Accountingfor Certain Investments in Debt and Equity Securities” issued by the FinancialAccounting Standards Board (“FASB”). Such investments are classified as “available-for-sale”and are reported at fair value in the Company’s condensed consolidated balancesheets.

 

At June 30, 2005 and December 31, 2004, the amortized costbasis of the available-for-sale investments represents the fair value of theinvestments due to their short maturities. Gross realized gains and losses from the sale of securities classifiedas available-for-sale were not material for the periods ended June 30,2005 and 2004.

 

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

 

Although these securities are issued and rated as long-term bonds, theyare priced and traded as short-term instruments because of the liquidityprovided through the interest rate reset. The Company had historically classified these instruments as cashequivalents if the period between interest rate resets was ninety days or less,which was based on the ability to either liquidate the holdings or roll theinvestment over to the next reset period.

 

Based upon the Company’s re-evaluation of these securities inconnection with the preparation of its December 31, 2004 financialstatements, the Company has reclassified its auction rate securities,previously

 

6

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classified as cash equivalents, asshort-term investments on its consolidated balance sheets.  The resulting impact of this reclassificationon the statements of cash flows for the six month period ended June 30,2004 was to increase purchases of investments by $ 17,400,000 and increasesales of investments by $ 18,200,000.

 

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

 

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

 
| ** **      | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------|------------|-------------------------|------------|-----------------------------|------------|
| Raw materials   |       | $                       | 150        |                        | $          | 250 |   |
| Work-in-process |       | 2,960                   |       | 1,073                       |       |
| Finished goods  |       | 238                     |       | 699                         |       |
| Total           |       | $                       | 3,348      |                        | $          | 2,022 |   |

 

**5.****                                      Warranty**

 

The Company offers warranties on its product and records a liabilityfor the estimated future costs associated with warranty claims, which is basedupon historical experience and the Company’s estimate of the level of futurecosts.  Warranty costs are reflected in the statement of operations as acost of goods sold.  A reconciliation ofthe changes in the Company’s warranty liability for the six months ended June 30,2005 and 2004 follows (in thousands):

 
| ** **                                        | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                                        | ** ** | **2005**                           | ** ** | **2004** | ** ** |
| Warranty accrual at the beginning of the  period  |       | $                                  | 68         |   | $ | 99 |   |
| Accruals for warranties issued during the  period |       | 99                                 |       | 99 |   |
| Settlements made in kind during the period        |       | (99                                | )          | (124 | ) |
| Warranty accrual at the end of the period         |       | $                                  | 68         |   | $ | 74 |   |

 

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

 

As permitted by SFAS No. 123, “Accounting for Stock-Based Compensation,”(“SFAS No. 123”), as amended by SFAS No. 148, “Accounting forStock-Based Compensation-Transition and Disclosure, an amendment of FASBStatement No. 123,” the Company accounts for employee stock-basedcompensation in accordance with Accounting Principles Board Opinion No. 25(“APB 25”), “Accounting for Stock Issued to Employees,” and relatedinterpretations in accounting for its stock-based compensation plans.

 

The Company granted 13,500 shares of restricted stock to its employeesand directors for the six months ended June 30, 2005 and 312,020 shares duringfiscal year 2004.  From the latter,74,000 shares have been repurchased to date by the Company in accordance withthe provisions of the grants (2,000 shares repurchased in March 2005).  The shares of restricted stock had a purchaseprice of $0.003 per share and the Company’s repurchase right with respect tosuch shares lapses either in equal installments over three years or at the endof the three years, depending on the terms on the respective shares.  Certain of the grants include acceleration ofvesting based upon the Company’s achievement of performance goals.

 

The Company is amortizing the net total deferred restricted stockexpense of $2.3 million, calculated based on the fair value of the stock on thedate of the grants, less the purchase price of the repurchased shares, over thevesting term of three years on a straight-line basis.  Of the total deferred restricted stockexpense of $2.3 million, $0.4 million will relate to research and developmentand $1.9 million will relate to selling, general and administrative activities. Stock compensation expense relating toemployees was $428,000 and $237,000 for the six months ended June 30, 2005and 2004, respectively.

 

7

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The following table provides a reconciliation of net loss to pro formanet loss as if the fair value method, pursuant to SFAS No. 123, had beenapplied to all employee awards (in thousands, except per share data):

 
| ** **                                                                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                     | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                           |       |                                  |       |                                |       |   |   |   |   |
| Net loss, as  reported                                                                                         |       | $                                     | (6,031     | )                                   | $          | (6,181 | ) | $ | (12,400 | ) | $ | (13,309 | ) |
| Add: Stock based compensation expense  included in reported net loss                                           |       | 244                                   |       | 168                                 |       | 428 |   | 237 |   |
| Less: Total stock-based employee  compensation expense determined under fair value based method for all awards |       | (1,434                                | )          | (1,345                              | )          | (2,779 | ) | (3,997 | ) |
| Pro forma net loss                                                                                             |       | $                                     | (7,221     | )                                   | $          | (7,358 | ) | $ | (14,751 | ) | $ | (17,069 | ) |
|                                                                                                           |       |                                  |       |                                |       |   |   |   |   |
| Basic and diluted net loss per share                                                                           |       |                                  |       |                                |       |   |   |   |   |
| As reported                                                                                                    |       | $                                     | (0.24      | )                                   | $          | (0.25 | ) | $ | (0.49 | ) | $ | (0.55 | ) |
| Pro forma                                                                                                      |       | $                                     | (0.28      | )                                   | $          | (0.29 | ) | $ | (0.58 | ) | $ | (0.71 | ) |

 

To comply with pro forma reporting requirements ofSFAS No. 123, compensation cost is also estimated for the fair value ofthe Company’s Employee Stock Purchase Plan (ESPP) rights, which are included inthe pro forma totals above.

 

Stock-based compensation arrangements to non-employeesare accounted for in accordance with SFAS No. 123 and Emerging Issues TaskForce Issue (EITF) No. 96-18, “Accounting for Equity InstrumentsThat Are Issued to Other Than Employees for Acquiring, or in Conjunction withSelling, Goods or Services,” which requires that these equity instruments arerecorded at their fair value on the measurement date.  The measurement of stock-based compensationis subject to periodic adjustment as the underlying equity instrumentsvest.  Stock-based compensation expenserelating to non-employees was $83,000 and $217,000 for the six months ended June 30,2005 and 2004, respectively.  Stock-basedcompensation expense relating to non-employees was $6,000 and $81,000 for thethree months ended June 30, 2005 and 2004, respectively.

 

*RecentAccounting Requirements*

 

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

 

In March 2005,the SEC issued Staff Accounting Bulletin (“SAB”) No. 107 (“SAB 107”). SAB107 provides guidance for the implementation of SFAS 123(R) with respect tovaluation techniques, expected volatility and expected term for valuingemployee stock options among other matters. The provisions of SAB 107 will beeffective for the Company at the time the Company adopts SFAS 123(R).

 

In May 2005,the FASB issued SFAS 154, “Accounting Changes and Error Corrections – areplacement of APB Opinion No. 20 and FASB Statement No. 3”. SFAS 154requires retrospective application to prior periods’ financial statements ofchanges in accounting principle, unless it is impracticable to determine eitherthe period-specific effects or the cumulative effect of the change.  APB 20 previously required that mostvoluntary changes in

 

8

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accountingprinciple be recognized by including in net income of the period of the changethe cumulative effect of the changing to the new accounting principle. Thestatement is effective for fiscal years beginning after December 15,2005.  The Company has evaluated theimpact of the adoption of SFAS 154, and does not believe the impact will besignificant to the Company’s overall results of operations or financialposition.

 

**7.****                                      Computationof Net Loss Per Share**

 

Basic net loss per share excludes any potential dilutive effects ofoptions and common stock shares subject to repurchase.  Diluted net loss per share includes theimpact of potentially dilutive securities. However, due to the Company’s net loss position, basic and diluted netloss per share are equivalent and are computed using the weighted averagenumber of common shares outstanding.

 

The following table provides a reconciliation of weighted-averagenumber of common shares outstanding and the weighted-average of unvested commonshares (in thousands):

 
| ** **                                                                                                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                          | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Denominator:                                                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Weighted-average common shares outstanding                                                                          |       | 25,695                                |       | 25,481                              |       | 25,691 |   | 24,336 |   |
| Less: Weighted-average unvested common  shares                                                                      |       | (242                                  | )          | (274                                | )          | (240 | ) | (183 | ) |
| Weighted-average number of common shares  outstanding used in computing basic and diluted net loss per common share |       | 25,453                                |       | 25,207                              |       | 25,451 |   | 24,153 |   |

 

The following outstanding options, potential employee stock purchaseplan shares and restricted stock shares, which could potentially dilute basicnet loss per share in the future were excluded from the computation of dilutednet loss per share, as their effect would have been antidilutive (inthousands):

 
| ** **                   | ** ** | **At June 30,** | ** ** |
|------------------------------|------------|----------------------|------------|
| ** **                   | ** ** | **2005**             | ** ** | **2004** | ** ** |
| Outstanding options          |       | 3,599                |       | 4,007 |   |
| Restricted stock             |       | 248                  |       | 283 |   |
| Employee Stock Purchase Plan |       | 30                   |       | 12 |   |
| Total                        |       | 3,877                |       | 4,302 |   |

 

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

 

In March 2005, the Company repurchased 2,000 shares of restrictedcommon stock at par value in accordance with the terms of a restricted stockagreement.  These shares are recorded astreasury stock, and with the 72,000 shares repurchased in fiscal 2004, theCompany now holds a total of 74,000 shares of treasury stock, valued at a costbasis of $222.

 

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

 

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

 

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

 

Aggregate minimum annual rental commitments under thenew lease agreement are as follows (in thousands):

 

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

 

The Company will recognize the operating lease expenseon a straight-line basis per the provisions set forth by FAS No. 13.

 

From time to time the Company is involved in legalproceedings arising in the ordinary course of business.  The Company believes there is no litigationpending that could have, individually or in the aggregate, a material adverse effecton its financial position, result of operations or cash flows.

 

**Item 2.****  Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

*Thefollowing discussion of our financial condition and results of operationsshould be read in conjunction with our consolidated financial statements andrelated notes thereto.  This discussioncontains forward-looking statements, including references to 2005 revenues andother forecasted items, that involve risks and uncertainties such as 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, thirdparty manufacturers and co-marketers; intense competition in the medical deviceindustry; the inherent risk of exposure to product liability claims and productrecalls and other factors referenced in this Form 10-Q.  Our actual results could differ materiallyfrom those expressed or implied in these forward-looking statements as a resultof various factors, including those discussed in “Risk Factors” and elsewherein this Form 10-Q.*

 

**OVERVIEW**

 

We develop, manufacture and market the Essure®Permanent Birth Control system, an innovative and proprietary medical devicefor women that was approved for marketing in the United States in November 2002by the United States Food and Drug Administration (“FDA”).  The Essuresystem uses a soft and flexible micro-insert that is delivered into a woman’sfallopian tubes to provide permanent birth control by causing a benign tissuein-growth that blocks the fallopian tubes.  A successfully placed Essuremicro-insert prohibits the egg from traveling through the fallopian tubes andtherefore prevents fertilization.

 

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*The Essure Procedure*

 

The Essure procedure is typically performed as anoutpatient procedure and is intended to be a less invasive and a less costlyalternative to tubal ligation, the leading form of birth control in the UnitedStates and worldwide.  Laparoscopic tubal ligation and tubal ligation bylaparotomy typically involve abdominal incisions and/or punctures, general orregional anesthesia, four to ten days of normal recovery time and the risksassociated with an incisional procedure.  The Essure procedure does notrequire cutting or penetrating the abdomen, which lowers the likelihood ofpost-operative pain due to the incisions/punctures, and is typically performedin an outpatient setting without general or regional anesthesia.  In thePivotal trial of the Essure system, the total procedure time averaged 35minutes, with an average of 13 minutes of hysteroscopic time to place theEssure micro-insert.  A patient is typically discharged approximately 45minutes after the Essure procedure.  No overnight hospital stay isrequired.  Furthermore, the Essure system is effective without drugs orhormones.  There is a three-month waiting period after the procedureduring which the woman must use another form of birth control while tissuein-growth occurs.  At 90 days following the procedure, the patientcompletes a follow-up examination called a hysterosalpingogram (“HSG”), whichcan determine whether the device was placed successfully and whether thefallopian tubes are occluded.

 

We believe that the Essure system is also anattractive alternative to tubal ligation for physicians, hospitals andpayers.  The Essure system is a less invasive permanent birth controloption for physicians to offer to their patients; hospitals are able to utilizetheir facilities more cost effectively with the Essure procedure compared withtubal ligation, and payers are able to experience cost reductions resultingfrom the elimination of overhead and procedural costs related to anesthesia andpost-operative hospital stays associated with tubal ligations.  We alsobelieve the Essure system is a viable alternative to other temporary methods ofbirth control being used when there is no intention of having children in thefuture.  In addition, payers may also benefit from the reduction ofunplanned pregnancies associated with non-permanent methods of birth controlused by patients who have chosen to avoid the drawbacks of traditional permanentbirth control methods but who may elect to use the Essure system.

 

Published reports estimate that 700,000 tuballigation procedures are performed each year in the United States.  Weintend to tap into this market and establish the Essure procedure as thestandard of care for permanent birth control.

 

The Essure system is currently being marketed inmultiple countries.  In November 2002 we received approval from theFDA to market the Essure system in the United States.  In 2001, we weregiven approval to affix the CE Mark to the Essure system, indicating that theEssure system is certified for sale throughout the European Union, subject tocompliance with local regulations such as registration with health ministriesand/or particular requirements regarding labeling or distribution.  In1999, the Essure Permanent Birth Control system was listed with Australia’sTherapeutic Goods Administration, which allows us tomarket and sell the Essure system inAustralia.  In December 2004, we made the decision to terminateour direct subsidiary operations in Australia and convert to an independentdistributor.  This decision was largely a cost reduction measure in lieuof the small size of the Australian market and our inability to manage a directoperation to a cash-flow positive position.  We have entered into adistribution agreement and the transition was completed in January 2005.  InCanada, we received clearance from Health Canada to market the Essure system inCanada in November 2001.  We nowhave distributors in Australia, Canada, New Zealand and France, which coversEurope, Middle East, Africa, Mexico, Central America and South America.

 

*Effectiveness of the Essure System*

 

In July 2005, we received approval from the FDAto extend effectiveness data on the Essure product labeling. The PMA supplementfiled in late January supports an extension of the effectiveness rate ofthe Essure system to 99.80% after four years and 99.74% after five years offollow-up, from the previously approved 99.80% at three years. The five-yeareffectiveness was demonstrated in a portion of the women undergoing clinicalstudies and follow-up of the remaining clinical trial patients is ongoing.

 

*Penetration*

 

Doctors are required to be preceptored for between 3and 5 cases by a certified trainer before they can perform proceduresindependently.  As of June 30, 2005, Conceptus has trained or is inthe process of training 2,182 physicians in the United States on the Essureprocedure.  This represents an increase of 501 physicians over the

 

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number of physicians at December 31, 2004 and an increase of 949physicians over the number of physicians at June 30, 2004.  The levelof sales for the Essure system, particularly in this early period of adoption,is highly dependent on the number of physicians trained to perform theprocedure.

 

There are no revenues associated with the training.The Company does not charge a fee for the activity and no commitment arises forthe physician from the preceptorship. Physician training is provided upfrontand the Company has no obligation subsequent to the initial training.

 

*Reimbursement of the EssureProcedure*

 

Market acceptance of the Essure system depends inpart upon the availability of reimbursement within prevailing healthcarepayment systems.  We believe that physician advocacy of our product willbe required to continue to obtain reimbursement.  As of June 30,2005, we have received positive reimbursement decisions for the Essureprocedure from most private insurers and 21 of the 50 Medicaid programs in thecountry. The most significant private payer that has not given a coveragedecision is CIGNA, which represents about 6% of the insured population in theUnited States that would be a candidate for the *Essure*procedure. We intend to continue our effort to educate payers of thecost-effectiveness of our product, and to establish further programs to helpphysicians to navigate reimbursement issues.

 

In July 2005, the UnitedHealthcare Groupapproved the Essure procedure for reimbursement. As with all healthcare plans,coverage will vary and is dependent upon the individual’s specific benefitplan.

 

In early November 2004, the Centers forMedicare and Medicaid Services (“CMS”) released the Final Rule for the 2005Physician Fee schedule.  For the Essure CPT code, the CMS has provided fora national physician payment of $2,198.34 for procedures performed in theoffice and $458.94 for physician payment when the procedure is performed in thehospital.  This compares to a CPT code physician payment of $361.16 for alaparoscopic tubal ligation, the current standard of care for permanent femalesterilization.  In addition, the CMS released the Final Rule for the2005 OPPS, which assigns hospital outpatient reimbursement amounts. The Essure CPT code was assigned a 2005 payment level of $2,260.37, which isconsistent with payments by CMS to hospitals when they perform a laparoscopictubal ligation, normally performed in a higher cost hospital operating room. We believe these values are very favorable for the Essure procedure and willhelp in establishing increased utilization of the device amongst doctors.  We expect that the new code, once the processto establish it at all private payers that have given a favorable coveragedecision is complete, will significantly ease the burden on a physician’soffice in obtaining reimbursement for the Essure procedure, and accelerate thecoverage of the Essure procedure by private insurance companies andMedicaid.  This process is not automatic following receipt of the new CPTcode, however, and we anticipate continuing to focus on reimbursement issuesfor sometime in the future both to secure our code and payment schedule intothe payers’ databases, as well as to help the physician negotiate a favorablecontract for payment off that schedule.

 

In mid-August 2004, the Australian Departmentof Health, Medical Services Advisory Committee (MSAC) division recommendedagainst public funding for the Essure procedure, citing insufficient evidencefor safety, effectiveness and cost effectiveness.  The overall market forfemale sterilization in Australia is very small and we believe that our marketpenetration will remain limited by the MSAC decision until such time as we areable to submit sufficient long-term data to obtain public funding.

 

*Adoption of the Essure system*

 

The Essure system is a novel product in thecontraception market, which is dominated by procedures that are wellestablished among physicians and patients and are routinely taught to newphysicians.  As a result, we believe that recommendations and endorsementsby physicians will be essential for market acceptance of our product. Physicians are traditionally slow to adopt new products and treatmentpractices, partly because of perceived liability risks.  Our biggestchallenge is to speed up the adoption process to make the Essure procedure thestandard of care for permanent birth control.  The following discussionsummarizes our program in the United States to increase adoption of the Essureprocedure.

 

First, we have developed a field based tacticalreimbursement group aimed at educating the physician and office staff regardingpayer procedures following a declined claim, including appeals and petitioningprocedures.

 

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Typicallya newly covered product will go through a period where claims are eitherinadvertently declined or are paid at the incorrect amount.  In eitherinstance, the physician is reluctant to perform additional procedures untilpayment has been secured for earlier cases, causing a decline inutilization.  Our tactical reimbursement focus is intended to give thephysician and his/her staff the tools to ensure that claims will ultimately bepaid and thereby encourages the physician to continue performing the Essureprocedure despite reimbursement issues.  This tactical reimbursement groupis generally targeting specific accounts with the aim of eventually meetingwith all of our accounts so as to provide them with the knowledge of how tofile and follow up on claims on a payer by payer basis.

 

Second, we are expanding our sales territories andchannels of distribution so as to increase our call frequency onphysicians.  In 2005 we have added 13sales positions and are expecting to add another 7 before the end of theyear.  Also, we have engaged regionaldistributors of women’s gynecology products to market and sell the Essuresystem. Among other responsibilities, our sales representatives are attemptingto increase utilization of the Essure procedure in the office environment.

 

Third, we have entered into certain strategicagreements in the past and we intend to explore such opportunities in thefuture. These agreements include the co-promotion agreement with GYNECARE WorldwideDivision of Ethicon, Inc, a Johnson & Johnson company, and withOlympus America, Inc., a manufacturer of hysteroscopy equipment. Inaddition, in July 2005 we announced that we had entered into twoagreements with manufacturers of hysteroscopic equipment which is used duringthe Essure procedure.  We intend forthese agreements to provide us with the ability to increase awareness, gainmarket presence and credibility, accelerate our ability to train doctors, aswell as expand our market opportunity by driving adoption among a group ofphysicians not previously targeted by our marketing programs. The successof these joint marketing campaigns will depend upon the effectiveness of oursales force training programs, market demand for Essure in conjunction with theproducts marketed by the strategic partner and the efforts and commitment ofthe strategic partner to the program.  Wecannot be certain how successful these programs will be, if at all.

 

Fourth, we are attempting to increase patientawareness, so as to increase the number of women that will ask for informationabout the Essure procedure.  In late July 2004we announced that we initiated an extensive direct to consumer advertisingcampaign in the Chicago, Illinois metropolitan area which commenced in August 2004and ran for 6 months. The campaign involved radio, direct mail and print media(magazine) advertisements aimed at increasing consumer awareness.  In February 2005, the radio portion ofthe campaign was extended through the end of 2005.  Depending on thesuccess of this marketing effort, we will be evaluating additional majormetropolitan markets in which to conduct a similar advertising campaign in2005.  This program was partially responsible for the increase inselling, general and administration expense during the last half of 2004.  Applying this program to additional marketswill therefore result in further increases in our expenses**.**

 

We have experienced significant operating lossessince inception and, as of June 30, 2005, had an accumulated deficit of$195.7 million.  We expect our operating losses to continue into at leastthe calendar year 2006 as we continue to expend substantial resources in theselling and marketing of the Essure system in the United States and abroad. Due to the unpredictable nature of these activities, we do not know whether wewill achieve or sustain profitability in the future.  We will continue to be in a net lossposition until sufficient revenues can be generated to offset expenses.  In February 2004, we completed a privateplacement of common stock to generate enough cash to help fund ouroperations.  In the future, dependingupon a variety of factors, we will likely need to raise additional fundsthrough bank facilities, debt or equity offerings or other sources of capital.Additional financing may not be available when needed or on terms acceptable tous.

 

**Results of Operations - Three and Six Months Ended June 30, 2005and 2004**

 

*Net Sales*

 

Net sales were $5.0 million for the three months ended June 30, 2005as compared to $2.8 million for the three months ended June 30,2004, an increase of $2.2 million, or 82%. Net sales for the six months ended June 30, 2005 were $8.9 millionas compared to $5.2 million for the six months ended June 30, 2004.  The increase of $3.7 million, or 73%, in netsales is the result of the continued commercialization of the Essure systemworldwide and a U.S. price increase established in January of 2005 of 17%.Unit volume growth for the second quarter of 2005

 

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comparedto the second quarter of 2004 increased 62% while unit volume growth for thesix months ended June 30, 2005 increased 65% over the comparable period oflast year.  While we raised prices in theU.S. in January 2005 by 17%, our worldwide average selling price decreasedfrom $763 for the year in 2004 to $760 for the first six months of 2005, due tothe significant level of sales to our European distributor, which has a loweraverage selling price.

 

We expect netsales to increase on a quarterly basis during fiscal 2005 and have put in placesales and marketing programs and have pursued reimbursement with payers to helpus to reach our revenue goal.  However,as we have noted elsewhere in this Form 10-Q, our expected revenuegrowth is dependant on market acceptance of the Essure system and third partyreimbursement for the device, which involves factors that are outside of ourcontrol.

 

For the threemonths ended June 30, 2005, net sales to one distributor accounted for 12%of our total consolidated net sales. For the three months ended June 30,2004, net sales to one distributor accounted for 11% of our total consolidatednet sales. Net sales to one distributor were 13% for the six months ending June 30,2005 and 12% for the same period ending June 30, 2004. Accounts receivablefrom one distributor accounted for 21% of our total net accounts receivableoutstanding as of June 30, 2005. At June 30, 2004, accountsreceivable from one distributor were 22% of our total net accounts receivableoutstanding.

 

Net productsales by geographic region as a percentage of net sales for the three and sixmonths ended June 30, 2005 and 2004 are as follows:

 
| ** **               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **               | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **               | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States of America |       | 86                                    | %          | 85                                  | %          | 85 | % | 83 | % |
| Europe                   |       | 12                                    |       | 12                                  |       | 12 |   | 13 |   |
| Other                    |       | 2                                     |       | 3                                   |       | 3 |   | 4 |   |

 

Net sales areattributed to region based on the shipping location of the external customers.

 

As of June 30, 2005, we have a total of2,182 doctors in the United States that have either completed or are in theprocess of completing preceptorship. This represents an increase of 949 doctors over the number of doctors atJune 30, 2004.  Our accomplishmentin obtaining the number of physicians trained is very important because it notonly provides us with a strong referral base within major metropolitan areas wehave targeted, but it will also create the leverage to help us gain additionalreimbursement coverage.  We understandthat a strong base of trained physicians does not necessarily correlate to anincrease in revenue proportionately. Furthermore, there are no revenues associated with the trainingactivities. The Company does not charge a fee for the activity and nocommitment arises for the physician from the preceptorship. Physician trainingis provided upfront and the Company has no obligation subsequent to the initialtraining.

 

We are working closely with private payers and physicians across theU.S. to implement the CPT code into their systems and establish paymentschedules.  This is important in orderfor physicians to be able to utilize the benefits of the CPT code in filingclaims electronically rather than manually. It is expected that electronic filing will result in fewer claim denialsor incorrect payments and increase the physician’s confidence in the procedure.At June 30, 2005, we estimate that approximately 70% of all the payersthat have given a coverage decision for the Essure procedure have loaded theCPT code and a fee schedule into their payment systems for electronicprocessing of pre-authorizations and claims.

 

In July 2005,we announced our expected net sales for 2005 to be approximately $19.0 millionto $20.0 million, which represents more than 64% growth from 2004.  This increase in revenues includes the effectof the 17% price increase we announced in January 2005 for customers inthe United States.  We expect net salesfrom the United States will continue to be the major contributor of our globalnet sales.  We have established threeprimary goals to achieve our revenue growth. We expect to complete the implementation of the new CPT code, increasesales coverage and physician utilization of the Essure procedure and work withstrategic partners.  We believe our revenuegrowth in 2005 will be significantly influenced by how successful we are inachieving those objectives.

 

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*Gross Profit*

 

Cost of goods sold for the three months ended June 30, 2005 was$2.1 million as compared to $1.7 million for the three months ended June 30,2004.  The increase of $ 0.4 million, or25%, is caused by the increase in net sales, partially offset by reductions inmanufacturing cost due to higher volume and the outsourcing of production to athird-party manufacturer in 2004.  Grossprofit margin improved from 39% for the quarter ended June 30, 2004 to 58%for the quarter ended June 30, 2005, which is the result of our domesticprice increase and lower manufacturing costs. For the six months ended June 30, 2005, cost of goods sold was $3.8million, which represents a similar amount for the same period of last yeareven though sales have increased 73% year over year. This result has led tosignificant improvement in our gross profit, as a result of the transition ofthe manufacturing outsourcing.  We expectgross margin to continue improving during the remainder of 2005 due to all ofthe above factors, as well as an improvement in the channel mix, withinternational sales, which carry a lower selling price and gross profit,representing a smaller portion of our overall sales volume.

 

*Operating Expenses*

 

Research anddevelopment expenses, which include expenditures related to productdevelopment, clinical research and regulatory affairs, were $0.9 million forthe three months ended June 30, 2005 and 2004.  For the six months ended June 30, 2005,research and development expenses decreased $0.3 million, or 15%, to $1.9million, from $2.2 million in the same period of 2004. Research and developmentexpenditures fluctuate in relation to product development, clinical affairs andregulatory activities.

 

Selling,general and administrative spending for the three months ended June 30,2005 was $8.2 million as compared to $6.5 million for the three months ended June 30,2004 which represents an increase of $1.7 million, or 25%.  For the six months ended June 30, 2005,selling, general and administrative expenses were $16.0 million, whichrepresents an increase of $3.3 million, or 26%, from $12.7 million for the sixmonths ended June 30, 2004.  Theprimary reason for the increases in selling, general and administrative forboth the quarter and year to date periods results from the expansion of ourU.S. field sales force from approximately 19 sales people in the 2004 timeperiod to 32 sales people at June 30, 2005. The expansion of our U.S.sales force is meant to provide us with more selling time to focus on physicianutilization and penetration. Additionally, increases in selling, general andadministrative expenses came from activities related to consulting and auditfor Sarbanes-Oxley compliance, as well as employee compensation, in partrelated to new hires. For 2005, we expect to have limited internationalexpenditures since we completed the divestiture of our French subsidiary in January 2004and the closure of our direct operations in Australia in January 2005.  We recorded expenses of approximately$205,000 in December 2004 related to the closing down of our Australiaoperations, which included $183,000 of severance costs and $22,000 forimpairment of fixed assets.  Allseverance costs were completely paid out at end of January 2005 and thedisposal of fixed assets was completed by the end of March 2005.

 

Netinterest and other income for the three months ended June 30, 2005 wasapproximately $0.2 million, which represents a similar figure for the threemonths period ended June 30, 2004. For the six months ended June 30,2005, net interest and other income was $0.4 million and $0.2 million for thesix months ended June 30, 2004.

 

*Restricted Stock*

 

In March 2005, the Company repurchased 2,000 shares of restrictedcommon stock at par value in accordance with the terms of a restricted stockagreement.  These shares are recorded astreasury stock, and with the 72,000 shares repurchased in fiscal 2004, theCompany now holds a total of 74,000 shares of treasury stock.

 

In addition, the Company granted 13,500 shares of restricted stock toits employees and directors for the six months ended June 2005 and 312,020shares during fiscal year 2004.  From thelatter, 74,000 shares have been repurchased to date by the Company inaccordance with the provisions of the grants (2,000 shares repurchased in March 2005).The shares of restricted stock had a purchase price of $0.003 per share and theCompany’s repurchase right with respect to such shares lapses either in equalinstallments over three years or at the end of the three years, depending onthe terms on the respective shares. Certain of the grants include acceleration of vesting based upon theCompany’s achievement of performance goals.

 

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**Liquidity and Capital Resources**

 

We have experienced significant operating losses since inception.  As of June 30, 2005 we had anaccumulated deficit of $195.7 million. We have financed our operations since inception primarily through equityfinancings.  In February 2004 wecompleted a private placement of approximately 3.0 million shares of commonstock at $8.50 per share.  Our netproceeds from the private placement were approximately $23.9 million, afterdeducting offering costs and commissions. The proceeds are being used to fundoperations to help us reach profitability. Once we reach profitability, we expect to finance our operation throughcash received from sales of our product. In the future, depending upon a variety of factors, we will likely needto raise additional funds through bank facilities, debt or equity offerings orother sources of capital.

 

As of June 30, 2005, we had cash, cashequivalents, restricted cash and short-term investments of $19.8 million,compared with $32.3 million at December 31, 2004.  The decrease of $12.5 million is primarilydue to $12.1 million of cash used in operating activities and $0.5 million usedfor capital expenditures, partially offset by the proceeds of $0.1 million fromthe issuance of common stock. Additional financing may not be available whenneeded or on terms acceptable to us.

 

*Operating Activities*

 

Net cash usedin operating activities was $12.1 million in the six months ended June 30,2005, primarily as a result of our net loss of $12.4 million adjusted fornon-cash related items of $1.1 million relating to depreciation andamortization and stock compensation expense. Other major items that contributed to net cash used in operatingactivities were related to a planned increase in inventories of $1.3 million,an increase in accounts receivable of $0.6 million related to our sales growthand an increase in other current assets of $0.2 million, offset by an increasein accrued compensation of $0.9 million and an increase in other accruedliabilities of $0.3 million. We expect cash usage in operating activities inthe future to decrease, as we expect revenue growth on a sequential quarterlybasis.

 

As of June 30,2005, our worldwide days sales outstanding in accounts receivable was 50 days,which represents a decrease of 3 days compared to December 31, 2004.  We have credit policies that help us tomonitor our collection activities and reduce our credit loss exposure.  We continue to improve and modify thosepolicies as our business evolves. Our goal is to consistently improve our days sales outstanding. We may not be able to maintain our current ratio or we may experienceless than satisfactory performance in collection due to factors outside of ourcontrol such as changes in economic climates.

 

The $1.3million increase in inventories was due to a planned build up in inventorylevels to support expected future growth in sales. We expect to manage ourinventory levels through the rest of the year to support our forecasted sales.

 

Net cash usedin operating activities for the six months ended June 30, 2004 was $13.2million, primarily as a result of our net loss of $13.3 million, adjusted fornon-cash related items of $1.6 million relating to depreciation andamortization, stock compensation expenses, provision for bad debt allowance andinventories.  Other major items thatcontributed to net cash used in operating activities were related to anincrease in other current assets of $1.2 million primarily from prepaidinsurance premiums and pay down of accrued compensation and other liabilitiesof $1.0 million, offset by a decrease in inventories of $0.4 million andchanges in other assets of $0.2 million.

 

*InvestingActivities*

 

Net cashprovided by investing activities for the six months ended June 30, 2005was $11.9 million, from sales of short-term investments of $22.3 million,partially offset by purchases of investments of $9.8 million and capitalexpenditures of $0.6 million.  Net cashused in investing activities for the six months ended June 30, 2004 was$9.3 million from the purchase of investments of $34.8 million and capitalexpenditures of $0.2 million, partially offset by the maturity of $25.7 millionof investments**.**

 

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*FinancingActivities*

 

Net cashprovided by financing activities was $0.1 million for the six months ended June 30,2005, primarily from the exercise of stock options.  Net cash provided by financing activities was$25.5 million for the six months ended June 30, 2004, primarily from theissuance of our common stock in a private placement completed in February 2004.  Our net proceeds from the issuance ofapproximately 3.0 million shares of our common stock at $8.50 per share in theprivate placement were approximately $23.9 million, after deducting offeringcosts and commissions totaling $1.6 million. We also received $1.6 million from the exercises of stock options in thefirst six months of 2004.

 

We expect to have negative cash flows from operations into at least2006 and we estimate that our existing capital resources will be sufficient tomeet our cash requirements for at least the next 12 months.  The successful achievement of our businessobjectives may require additional financing and therefore, we may in the futureseek to raise additional funds through bank facilities, debt or equityofferings or other sources of capital. Any additional equity financing may bedilutive to stockholders, and debt financing, if available, may involverestrictive covenants.  Additionalfunding may not be available when needed or on terms acceptable to us. If weare unable to obtain additional capital, we may be required to delay, reducethe scope of or eliminate our sales and marketing activities.  Our future liquidity and capital requirementswill depend upon many factors, including, among others:

 

•                                          Resourcesdevoted to establish sales, marketing and distribution capabilities;

•                                          Therate of product adoption by doctors and patients; and

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

 

*FutureCommitments*

 

On June 28, 2005, the Company entered into aSublease Agreement with Verisity Design, Inc. for the premises located at331 East Evelyn, Mountain View, California. The agreement was subject to theMaster Landlord’s consent within 45 days after delivery of and receipt byMaster Landlord of the executed Sublease. On July 19, 2005, SFERS Real Estate,the Master Landlord, and Verisity Design, Inc. signed a Landlord ConsentAgreement allowing the Sublease Agreement between the Company and VerisityDesign, Inc.

 

Aggregate minimum annual rental commitments under thenew lease agreement are as follows (in thousands):

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

 

The Company will recognize the operating lease expenseon a straight-line basis per the provisions set forth by FAS No. 13.

 

**Recent Accounting Pronouncements**

 

In December 2004,FASB issued SFAS No. 123(R), “Share-BasedPayments” (revised 2004). The provisions of SFAS No. 123(R) will requireus to measure all stock-based compensation awards using a fair value method andrecord such expense in the consolidated financial statements, including grantsof employee stock options.  In addition,the adoption of SFAS No. 123(R) will require additional accounting relatedto the income tax effects and additional disclosure regarding the cash floweffects resulting from share-based payment arrangements.  SFAS No. 123(R) is effective for allpublic companies for annual periods beginning after June 15, 2005.  We will adopt SFAS No. 123 (R) effective January 1,2006.  We have not yet determined whetherthe adoption of SFAS No. 123(R) will result in amounts that are similar tothe current pro forma disclosures under SFAS No. 123.  We are

 

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evaluatingthe requirements for SFAS No. 123(R) and expect the adoption to have asignificant adverse impact on our statement of operations and net loss pershare.

 

In March 2005,the SEC issued Staff Accounting Bulletin (“SAB”) No. 107 (“SAB 107”). SAB107 provides guidance for the implementation of SFAS 123(R) with respect tovaluation techniques, expected volatility and expected term for valuingemployee stock options among other matters. The provisions of SAB 107 will beeffective for the Company at the time the Company adopts SFAS 123(R).

 

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

 

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**RiskFactors**

** **

*In additionto the other information in this Form 10-Q, the following factors should beconsidered carefully in evaluating Conceptus and our business.  This Form 10-Q contains forward-lookingstatements within the meaning of section 27A of the Securities Act of 1933, asamended and section 21E of the Securities Exchange Act of 1934, as amended.Some of the forward-looking statements can be identified by use offorward-looking words such as “believes,” “expects,” “anticipates,” “may,”“will,” “should,” “seeks,” “approximates,” “intends,” “plans,” or “estimates,”or the negative of these words, or other comparable terminology. The discussionof financial trends, strategy, plans or intentions may also includeforward-looking statements. Forward-looking statements involve risks anduncertainties that could cause actual results to differ materially from thoseprojected. Although it is not possible to predict or identify all such risksand uncertainties, they may include, but are not limited to, the followingfactors. The readers should not consider this list to be a complete statementof all potential risks and uncertainties.*

* *

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

 

We have a limited historyof operation with the Essure system and have incurred significant operatinglosses since our inception in 1992, including operating losses of $12.8 millionfor the six months ended June 30, 2005, $26.6 million in fiscal 2004, $40.2million in fiscal 2003, and $33.1 million in fiscal 2002. We expect to continueto incur significant operating expenses and net losses as we continue sales andmarketing efforts in the United States.  Our net losses will continueuntil sufficient revenues can be generated to offset these expenses. We may notbe able to generate these revenues, and we may never achieve profitability. Ourfailure to achieve and sustain profitability would negatively impact the marketprice of our common stock.

 

***We are presently a one-product company and if our productfails to gain market acceptance, our business will suffer.***

 

We are attempting tointroduce a novel product into the contraception market, which is dominated byprocedures that are well established among physicians and patients and areroutinely taught to new physicians. As a result, we believe thatrecommendations and endorsements by physicians will be essential for marketacceptance of our product.  We do not know whether physicians and patientswill accept our product or whether we will be able to obtain theirrecommendations or endorsements in sufficient amounts to be profitable.  Webelieve that physicians will not use a product unless they determine, based onclinical data and other factors, that it is an attractive alternative to othermeans of contraception and that it offers clinical utility in a cost-effectivemanner. Physicians are traditionally slow to adopt new products and treatmentpractices, partly because of perceived liability risks.  We are dependent on the Essure system, whichis currently our only commercial product.  If the Essure system does not achievesignificant market acceptance among physicians, patients and healthcare payers,even if reimbursement levels are sufficient and necessary United States andinternational regulatory approvals are maintained, we may never achievesignificant revenues or profitability.

 

***Our future liquidity and capital requirements are uncertain.***

 

As we commercialize theEssure system on a wide-scale basis, we may require additional financing andtherefore may in the future seek to raise additional funds through bankfacilities, debt or equity offerings or other sources of capital. Anyadditional equity financing may be dilutive to stockholders, and debtfinancing, if available, may involve restrictive covenants and interest expensethat will affect our financial results. 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 ourselling and marketing activities.  We expect to have negative cash flowsfrom operations into at least calendar 2006. Our future liquidity and capitalrequirements will depend upon many factors, including, among others:

 

•                       the rate of product adoption by doctorsand patients;

 

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

•                       the liquidity of private insurancesystems, as well as the timeliness of payments of government-managementreimbursement systems;

•                       our ability to improve our days salesoutstanding;

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

•                       our ability to reduce our cost of sales;

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

•                       the progress and cost of productdevelopment programs; and

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

 

***If the effectiveness and safety of our product are notsupported by long-term data, we may not achieve market acceptance and we couldbe subject to liability.***

 

The Pivotal trial of theEssure system was designed to support a PMA application and to have five yearsof post-market follow-up.  In addition, patients in the Phase II studywill be followed to five years. The long-term results of using the Essuremicro-inserts will not be available for several years. If long-term studies orclinical experience indicate that the Essure system is less effective or lesssafe than our current data suggest, we may not achieve or sustain marketacceptance and/or we could be subject to significant liability.

 

***Our agreements and contracts entered into with partners andother third parties may not be successful.***

 

We signed inthe past and may pursue in the future contracts and agreements with thirdparties that would assist our marketing, manufacturing, selling anddistribution efforts.  We may not be ableto comply with obligations or performance clauses that could lead us tosignificant liability and our partners may not be able to achieve theprovisions established in these contracts and agreements.

 

***Our Co-Promotion Agreement with GYNECARE may not besuccessful.***

 

On October 30,2003, we announced the signing of an exclusive U.S. co-promotion agreement withGYNECARE for marketing the Essure system in the United States in combinationwith the GYNECARE THERMACHOICE Uterine Balloon Therapy endometrial ablationsystem. With the FDA’s approval of marketing and labeling claims regardingcompatibility of the Essure system and the THERMACHOICE device in July 2004,marketing has commenced. However, the success of the joint marketing campaignwill depend upon the effectiveness of our GYNECARE sales team trainingprograms, market demand for the Essure system in conjunction with the THERMACHOICEtreatment, the efforts and commitment of GYNECARE to this new program and theresults of the required 50 patient post-approval clinical study.  This agreement includes certain performanceclauses that, if not met, could lead to the termination of the agreement byConceptus in July 2005.

 

***We have limited sales and marketing experience and minimaldistribution capabilities, and if we are unable to develop our sales andmarketing capabilities or be successful in our marketing agreements withexternal parties, we may be unsuccessful in commercializing the Essure system.***

 

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

 

***Our direct-to-consumer advertising campaign may not besuccessful***

 

In August 2004, weinitiated a six-month advertising campaign in the Chicago, Illinoismetropolitan area involving radio, direct mail, and print media (magazine) andwe have continued to extend the campaign to date.

 

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Such advertising programs aimed at increasing consumerawareness for our product are expensive and may have limited success, ifany.  Such campaigns require consumers to make contact with an Essurephysician, often involving a referral from their primary care physician andthen to be provided information regarding birth control options by thephysician, be pre-authorized for insurance reimbursement and then be scheduledfor the procedure.  Many of these steps are not within our control, andthe program may not result in revenue generation commensurate with its costs.

 

***We depend on our contract manufacturer to supply ourcommercial product requirements and we may experience disruption in supply ifthey are not in compliance with FDA and other health authority regulations orif our manufacturer’s business fails to succeed.***

 

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

 

***Government or third party reimbursement for the Essureprocedure may not be available or may be inadequate, which would limit ourfuture product revenues and delay or prevent our profitability.***

 

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

 

***We may not maintain regulatory approvals for the Essure system,our only product, which would delay or prevent us from generating productrevenues, and would harm our business and force us to curtail or ceaseoperations.***

 

Numerous governmentauthorities, both in the United States and internationally, regulate themanufacture and sale of medical devices, including the Essure system.  Inthe United States, the principal regulatory authorities are the FDA andcorresponding state agencies, such as the California Department of HealthServices. The process of obtaining and maintaining required regulatoryclearances is lengthy, expensive and uncertain.

 

We have received FDAapproval to market the Essure system in the United States.  If we losethat approval or fail to comply with existing or future regulatory requirements,it would delay or prevent us from generating further product revenues.

 

Sales of medical devicesoutside of the United States are subject to international regulatoryrequirements that vary widely from country to country. The time required toobtain clearance required by foreign countries may be longer or shorter thanthat required for FDA clearance, and requirements for licensing may differsignificantly from FDA requirements. Many countries in which we currentlymarket or intend to market the Essure system either do not currently regulatemedical devices or have minimal registration requirements; however, thesecountries may develop more extensive regulations in the future, which coulddelay or prevent us from marketing the Essure system in these countries.

 

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The FDA and certainforeign regulatory authorities impose numerous requirements with which medicaldevice manufacturers must comply in order to maintain regulatory approvals. FDAenforcement policy strictly prohibits the promotion of approved medical devicesfor uses other than those for which the device is specifically approved by theFDA. We will be required to adhere to applicable FDA regulations, such as theQuality System Regulation, and similar regulations in other countries, whichinclude testing, control and documentation requirements. Ongoing compliancewith the Quality System Regulation and other applicable regulatory requirementswill be monitored through periodic inspections by federal and state agencies,including the FDA and the California Department of Health Services, and bycomparable agencies in other countries. If we fail to comply with applicableregulatory requirements, we may be subject to, among other things, warningletters, fines, injunctions, civil penalties, recall or seizure of products,total or partial suspension of production, refusal of the government to grantpre-market clearance or pre-market approval for devices, withdrawal ofapprovals and criminal prosecution, any of which could negatively impact ourbusiness.

 

***Our intellectual property rights may not provide meaningfulcommercial protection for our product, which could enable third parties to useour technology, or very similar technology, and could impair our ability tocompete in the market.***

 

We rely on patent,copyright, trade secret and trademark laws to limit the ability of others tocompete with us using the same or similar technology in the United States andother countries. However, as described below, these laws afford only limitedprotection and may not adequately protect our rights to the extent necessary tosustain any competitive advantage we may have. The laws of some foreigncountries do not protect proprietary rights to the same extent as the laws of theUnited States, and many companies have encountered significant problems inprotecting their proprietary rights abroad. These problems can be caused by theabsence of rules and methods for defending intellectual property rights.

 

We will be able toprotect our technology from unauthorized use by third parties only to theextent that they are covered by valid and enforceable patents or areeffectively maintained as trade secrets. The patent positions ofcompanies developing medical devices,including our patent position, generally are uncertain and involve complexlegal and factual questions concerning the enforceability of such patentsagainst alleged infringement. Recent judicial decisions have established newcase law and a reinterpretation of previous patent case law, and consequentlywe cannot ensure that historical legal standards surrounding the questions ofinfringement and validity will be applied in future cases. In addition,legislation may be pending in Congress that, if enacted in its present form,may limit the ability of medical device manufacturers in the future to obtainpatents on surgical and medical procedures that are not performed by, or as apart of, devices or compositions that are themselves patentable. Our ability toprotect our proprietary methods and procedures may be compromised by theenactment of this legislation or any other limitation or reduction in thepatentability of medical and surgical methods and procedures. Changes in eitherthe patent laws or in interpretations of patent laws in the United States andother countries may therefore diminish the value of our intellectual property.

 

We own, or controlthrough licenses, a variety of issued patents and pending patent applications.However, the patents on which we rely may be challenged and invalidated, andour patent applications may not result in issued patents. Moreover, our patentsand patent applications may not be sufficiently broad to prevent others frompracticing our technologies or from developing competing products. We also facethe risk that others may independently develop similar or alternativetechnologies or design around our patented technologies.

 

We have taken securitymeasures to protect our proprietary information, especially proprietaryinformation that is not covered by patents or patent applications. Thesemeasures, however, may not provide adequate protection of our trade secrets orother proprietary information. We seek to protect our proprietary informationby entering into confidentiality agreements with employees, collaborators andconsultants. Nevertheless, employees, collaborators or consultants could stilldisclose our proprietary information and we may not be able to protect ourtrade secrets in a meaningful way. If we lose any employees we may not be ableto prevent the unauthorized disclosure or use of our technical knowledge orother trade secrets by those former employees despite the existence of anondisclosure and confidentiality agreement and other contractual restrictionsdesigned and intended to protect our proprietary technology. In addition,others may independently develop substantially equivalent proprietaryinformation or techniques or otherwise gain access to our trade secrets.

 

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Our ability to competeeffectively will depend substantially on our ability to develop and maintainproprietary aspects of our technology. Our issued patents, any future patentsthat may be issued as a result of our United States or foreign patentapplications, or the patents under which we have license rights may not offerany degree of protection against competitive products. Any patents that may beissued or licensed to us or any of our patent applications could be challenged,invalidated or circumvented in the future.

 

***If we cannot operate our business without infringingthird-party intellectual property rights, our prospects will suffer.***

 

Our success will dependin part on our ability to operate without infringing or misappropriating theproprietary rights of others. We may be exposed to future litigation by thirdparties based on claims that our product infringes the intellectual propertyrights of others. There are numerous issued patents in the medical deviceindustry and, as described in the next risk factor, the validity and breadth ofmedical device patents involve complex legal and factual questions for whichimportant legal principles remain unresolved. Our competitors may assert thatour product and the methods we employ may be covered by United States orforeign patents held by them. In addition, because patent applications can takemany years to issue, there may be currently pending patent applications ofwhich we are unaware that may later result in issued patents that our productmay infringe. There could also be existing patents of which we are unaware thatour product may inadvertently infringe. If we lose a patent infringementlawsuit, we could be prevented from selling our product unless we can obtain alicense to use technology or ideas covered by that patent or are able toredesign the product to avoid infringement. A license may not be available tous on terms acceptable to us, or at all, and we may not be able to redesign ourproduct to avoid any infringement. If we are not successful in obtaining alicense or redesigning our product, we may be unable to sell our product andour business would suffer.

 

***We have been, and may be in the future, a party to patentlitigation, which could be expensive and divert our management’s attention.***

 

The medical deviceindustry has been characterized by extensive litigation regarding patents andother intellectual property rights, and companies in the industry have usedintellectual property litigation to gain a competitive advantage. We may becomea party to patent infringement claims and litigation or interferenceproceedings declared by the United States Patent and Trademark Office (PTO), todetermine the priority of inventions. The defense and prosecution of thesematters are both costly and time consuming. We may need to commence proceedingsagainst others to enforce our patents, to protect our trade secrets or know-howor to determine the enforceability, scope and validity of the proprietaryrights of others. These proceedings would result in substantial expense to usand significant diversion of effort by our technical and management personnel.

 

A third party, Ovion,Inc. (“Ovion”), which is now a subsidiary of American Medical Systems (“AMS”),brought to our attention a patent and certain claims from a pending patentapplication owned by it.  Ovion indicated that it believes that the claimsof its patent and application cover the Essure system and its use. On October23, 2003, we entered into a settlement agreement with Ovion pursuant to whichwe received a sole, worldwide license to Ovion’s patent rights relative to theEssure system, and Ovion may not grant any additional such licenses to otherparties.  The settlement agreement provided for the payment of a royaltyto Ovion that will be equal to 3.25% of the cumulative net sales of the Essuresystem in excess of $75.0 million for a period of no longer than tenyears.  In addition, the settlement agreement provided for a cash paymentof $2.0 million in the fourth quarter of 2003 as a prepaid royalty, and a licensefee of $2.0 million payable in our common stock in equal installments in thefirst and second quarters of 2004.  Ovion was not granted any rights toour intellectual property pursuant to the settlement agreement.  Thesettlement agreement was approved by the U.S. District Court for the NorthernDistrict of California on November 6, 2003.

 

Although we have reacheda settlement agreement with Ovion, we still believe that some or all of Ovion’sclaims should be included within our own patents and we have requested that thePTO to declare an interference.  An interference is a proceeding withinthe PTO to determine which party was the first to invent, and which party isthereby entitled to ownership of the claims. We believe that we filed our patentapplications for the Essure system before Ovion filed the application thatissued as its patent, and that we are entitled to any patentable claims nowappearing in their patent that cover our product. We do not know whether thePTO will declare an interference, whether we invented our product prior toOvion’s date of invention, or whether we will prevail in an interference

 

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proceeding if it is declared by thePTO.  If the PTO declares an interference in our favor and we are found tohave priority of invention, we may avoid having to pay Ovion future royaltieson the sales of our product.

 

An adverse determinationin new litigation or interference proceedings to which we are or may become aparty could subject us to significant liabilities to third parties or requireus to seek licenses from third parties. Although patent and intellectualproperty disputes in the medical device area have often been settled throughlicensing or similar arrangements, costs associated with such arrangements maybe substantial and could include ongoing royalties. We may be unable to obtainnecessary licenses on satisfactory terms, if at all. Adverse determinations ina judicial or administrative proceeding or failure to obtain necessary licensescould prevent us from manufacturing and selling the Essure system.

 

One of the patentsincluded in our license from Target Therapeutics, a division of BostonScientific Corporation, has been the subject of reexamination proceedings inthe PTO and an infringement lawsuit by Target Therapeutics.  We are 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 be challenged or invalidated in the future. If thispatent is invalidated, our ability to prevent others from using thisproprietary technology would be compromised.

 

***If we fail to manage any expansion, our business could beimpaired.***

 

We may in the futureacquire one or more technologies, products or companies that complement ourbusiness. We may not be able to effectively integrate these into our businessand any such acquisition could bring additional risks, exposures and challengesto our company.  If we fail to manage anyacquisition, our business could be impaired.

 

***Our third-party manufacturer and we will depend upon thirdparty and single source suppliers for raw materials and finished goods and wedo not have forward contracts with many of these suppliers.***

 

We and our third partymanufacturer purchase both raw materials used in our product and finished goodsfrom various suppliers, and we rely on a single source for one component of ourproduct, the polyester fiber. We do not have formal supply contracts withseveral key vendors and, accordingly, these firms may not continue to supply usor our third party manufacturer with raw materials or finished goods insufficient quantities, or at all. Delays associated with any future rawmaterials or finished goods shortages could impair our sales of the Essuresystem, particularly as our third-party manufacturer scales up itsmanufacturing activities in support of United States and international commercialsales of the Essure system.

 

***Health care reform may limit our return on our product.***

 

The levels of revenue andprofitability of medical device companies may be affected by the efforts ofgovernment and third party payers to contain or reduce the costs of health carethrough various means. In the United States, there have been, and we expectthat there will continue to be, a number of federal, state and privateproposals to control health care costs. These proposals may contain measuresintended to control public and private spending on health care, as well as toprovide universal public access to the health care system. If enacted, theseproposals may result in a substantial restructuring of the health care deliverysystem. Significant changes in the United States health care system are likelyto have a substantial impact over time on the manner in which we conduct ourbusiness and could have a material adverse effect on our business, financialcondition and results of operations.

 

***We may be exposed to product liability claims, and we haveonly limited insurance coverage.***

 

The manufacture and saleof medical products involve an inherent risk of exposure to product liabilityclaims and product recalls.  We currentlymaintain product liability insurance with coverage limits of $10.0 million peroccurrence and an annual aggregate maximum of $10.0 million, which we believeis comparable to that maintained by other companies of similar size servingsimilar markets. However, we cannot ensure that product liability claims inconnection with clinical trials or commercial sales of the Essure system willnot exceed such insurance coverage limits or that such insurance will continueto be available on commercially reasonable terms, or at all. Insurance isexpensive and in the future may not be available on acceptable terms, if atall. A successful

 

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product liability claim or series of claims broughtagainst us in excess of our insurance coverage, or a recall of our product,could cause our stock price to fall.

 

***We may not be able to attract and retain additional keymanagement, sales and marketing and technical personnel or we may lose existingkey management, sales and marketing or technical personnel, which may delay ourdevelopment and marketing efforts.***

 

We depend on a number ofkey management, sales and marketing and technical personnel. The loss of theservices of one or more key employees could delay the achievement of ourdevelopment and marketing objectives. Our success will also depend on ourability to attract and retain additional highly qualified management, sales andmarketing and technical personnel to meet our growth goals. We face intensecompetition for qualified personnel, many of whom are often subject tocompeting employment offers, and we do not know whether we will be able toattract and retain such personnel.

 

***We face intense competition, and if we are unable to competeeffectively, demand for the Essure system may be reduced.***

 

The medical device industryis highly competitive and is characterized by rapid and significanttechnological change. The length of time required for product development andregulatory approval plays an important role in a company’s competitiveposition. As we commercialize Essure, we expect to compete with:

 

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

•                       othermethods of non-permanent contraception, including devices such as intrauterinedevices, or IUDs, vaginal rings, condoms and prescription drugs such as thebirth control pill, injectable and implantable contraceptives and patches; and

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

 

We are aware of a companythat is in the clinical stages of development for non-incisional permanentcontraception devices. In addition, high competition may arise due to mergersor acquisitions performed by external parties. Other companies may developproducts that could compete with the Essure system.  Competitive factorsmay render the Essure system obsolete or noncompetitive or reduce demand forthe Essure system.

 

***Our future quarterly results may fluctuate.***

 

Our future revenues andresults of operations may fluctuate significantly from quarter to quarter andwill depend upon, among other factors:

 

•                       the rate at which new physicians aretrained;

•                       actions relating to reimbursementmatters;

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

•                       the extent to which the Essure systemgains market acceptance;

•                       the timing and size of distributorpurchases;

•                       introduction of competitive products; and

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

 

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

 

Technology companies likeours have a history of using broad based employee stock option programs tohire, incentivize and retain our workforce in a competitive marketplace. SFASNo. 123 allowed companies the choice of either using a fair value method ofaccounting for options, which would result in expense recognition for

 

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all options granted, or using an intrinsic valuemethod, as prescribed by Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” (“APB 25”), with a pro formadisclosure of the impact on net income (loss) of using the fair value optionexpense recognition method. We had elected to apply APB 25 and accordingly wegenerally do not recognize any expense with respect to employee stock optionsas long as such options are granted at exercise prices equal to the fair valueof our common stock on the date of grant.

 

In December 2004, FASBissued, SFAS No. 123(R) “Share-Based Payments”. We will adopt this statement on January 1, 2006, which is the firstannual reporting period after June 15, 2005. This statement will have asignificant impact on our consolidated statement of operations as we will berequired to expense the fair value of our stock options rather than disclosing theimpact on our consolidated result of operations within our footnotes inaccordance with the disclosure provisions of SFAS No. 123. This will result inlower reported earnings per share or in higher reported losses per share, whichcould negatively impact our future stock price. In addition, this could impactour ability to utilize broad based employee stock plans to reward employees andcould result in a competitive disadvantage to us in the employee marketplace.

 

***Future changes in financial accounting standards orpractices or existing taxation rules or practices may cause adverse unexpectedrevenue fluctuations and affect our reported results of operations.***

 

A change in accountingstandards or practices or a change in existing taxation rules or practices canhave a significant effect on our reported results and may even affect ourreporting of transactions completed before the change is effective. Newaccounting pronouncements and taxation rules and varying interpretations ofaccounting pronouncements and taxation practice have occurred and may occur inthe future. Changes to existing rules or the questioning of current practicesmay adversely affect our reported financial results or the way we conduct ourbusiness.

 

*These andother risks and uncertainties are described herein or in our Forms 10-K, 10-Q,8-K and other public documents filed with the Securities and ExchangeCommission. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date hereof. Weundertake no obligation to publicly release the result of any revisions tothese forward-looking statements to reflect events or circumstances after thisdate or to reflect the occurrence of unanticipated events.*

* *

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

 

The followingdiscusses our exposure to market risk related to changes in interest rates andforeign currency exchange rates.  Theseexposures may change over time as business practices evolve and could have amaterial adverse impact on our financial results.

 

*Interest Rate Risk*:  We have been exposed to interest rate risk asit applies to interest earned on holdings of short-term marketableinvestments.  Interest rates that mayaffect these items in the future will depend on market conditions and maydiffer from the rates we have experienced in the past.  A 10% change in interest rates would not bematerial to our results of operations. We reduce the sensitivity of our resultsof operations to these risks by maintaining an investment portfolio, which isprimarily comprised of highly rated, short-term investments.  We do not hold or issue derivative, commodityinstruments or other financial instruments for trading purposes.

 

*Foreign Currency Exchange Risk*:  Our expenses, except for those related toAustralia, were denominated in United States dollars.  Our revenues, 0% and 3% of which were inforeign currencies in the three months ended June 30, 2005 and 2004,respectively, and 1% and 3% for the six months ended June 30, 2005 and 2004,respectively, were immaterial in relation to our overall financialposition.  As a result, we haverelatively little exposure for currency exchange risks and foreign exchangelosses have been minimal to date.  We donot currently enter into forward exchange contracts to hedge exposuredenominated in foreign currencies or any other derivative financial instrumentsfor trading or speculative purposes.  Inthe future, if we feel our foreign currency exposure has increased, we mayconsider entering into hedging transactions to help mitigate that risk.  As of June 30, 2005, a fluctuation in 

 

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exchange rates of 10% in theforeign currencies to which we are exposed would not have a material impact on ourresults of operations or financial condition.

 

**Item4.  Controls and Procedures**

 

*Evaluation of Disclosure Controls andProcedures:*

 

We maintaindisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in our Exchange Act reports is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms and that such information is accumulatedand communicated to our management, including our Chief Executive Officer andChief Financial Officer, as appropriate, to allow for timely decisionsregarding required disclosure. In designing and evaluating the disclosurecontrols and procedures, management recognized that any controls and procedures,no matter how well designed and operated, can provide only reasonable assuranceof achieving the desired control objectives, and in reaching a reasonable levelof assurance, management is required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures. 

 

As of June 30,2005, the end of our most recent fiscal quarter, we carried out an evaluation,under the supervision and with the participation of our management, includingour Chief Executive Officer and our Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures. Based on the foregoing, our Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures were effectiveat the reasonable assurance level.

 

*Changes in Internal Control Over FinancialReporting:*

 

There was nochange in our internal controls over financial reporting during our most recentfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal controls over financial reporting. 

 

*Inherent Limitations of Internal Controls*

 

Internalcontrol over financial reporting cannot provide absolute assurance of achievingfinancial reporting objectives because of its inherent limitations.  Internal control over financial reporting isa process that involves human diligence and compliance and is subject to lapsesin judgment and breakdowns resulting from human failures. Internal control overfinancial reporting also can be circumvented by collusion or impropermanagement override. Because of such limitations, there is a risk that materialmisstatements may not be prevented or detected on a timely basis by internalcontrol over financial reporting. However, these inherent limitations are knownfeatures of the financial reporting process. Therefore, it is possible todesign into the process safeguards to reduce, though not eliminate, this risk. 

 

**Part II.  Other Information**

 

**Item1.  Legal Proceedings**

 

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

 

We exercisedthe ROFR on Saturday, July 2, 2005 within the 30 day period provided for in thesettlement agreement. On Tuesday, July 5, 2005, we were notified by Ovion thatit had rejected the exercise of Conceptus’ ROFR option. On July 6, 2005,Conceptus filed a motion in Delaware Chancery Court for the issuance of atemporary restraining order to enjoin the transaction between Ovion and AMS pendingresolution of our claims against Ovion. That request for a temporaryrestraining order was rejected by the Chancery Court, thereby providingclearance for the completion of the acquisition of Ovion by AMS. 

 

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From time totime, we are involved in legal proceedings arising in the ordinary course ofbusiness.  We believe there is nolitigation pending that could have, individually or in the aggregate, amaterial adverse effect on its financial position, result of operations or cashflows.

 

**Item 2.  Unregistered Sales ofEquity Securities and Use of Proceeds**

 

In March 2005,the Company repurchased 2,000 shares of restricted common stock at par value inaccordance with the terms of a restricted stock agreement.  These shares are recorded as treasury stock,and with the 72,000 shares repurchased in fiscal 2004, the Company now holds atotal of 74,000 shares of treasury stock.

 

**ISSUER PURCHASES OF EQUITY SECURITIES**

 
| **Period**                                 | ** ** | **Total Number  of Shares  Purchased (1)** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total  Number of  Shares  Purchased  as Part of  Publicly  Announced  Program** | ** ** | **Maximum  Number of  Shares That  May Yet Be  Purchased  Under this  Program** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|------------------------------------|------------|-----------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| January 1, 2005 through January 31, 2005   |       | —                                     |       | —                             |       | —                                                                            |       | —                                                                          |       |
| February 1, 2005 through February 28, 2005 |       | —                                     |       | —                             |       | —                                                                            |       | —                                                                          |       |
| March 1, 2005 through March 31, 2005       |       | 2,000                                      |       | $                                  | 0.003      |                                                                              | —     |                                                                            | —     |   |
| April 1, 2005 through April 30, 2005       |       | —                                     |       | —                             |       |                                                                              |       |                                                                            |       |
| May 1, 2005 through May 31, 2005           |       | —                                     |       | —                             |       |                                                                              |       |                                                                            |       |
| June 1, 2005 through June 30, 2005         |       | —                                     |       | —                             |       |                                                                              |       |                                                                            |       |
| TOTAL                                      |       | 2,000                                      |       |                               |       |                                                                              |       |                                                                            |       |
|                                            |            |                                            |            |                                    |            |                                                                                   |            |                                                                                 |            |  |

 

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(1) The Company purchased 2,000 shares ofrestricted stock from one former employee in accordance with the terms of theRestricted Stock Purchase Agreements relating to such shares.

 

**Item 3.  Defaults upon SeniorSecurities**

 

None.

 

**Item 4.  Submission of Matters toa Vote of Security Holders**

* *

On May 26,2005, the Annual Meeting of Stockholders of Conceptus, Inc. was held in RedwoodCity, California.  The matters voted uponand approved at the meeting, and the number of affirmative and negative votescast with respect to each matter were as follows (votes in thousands):

 
| ** **                       | ** ** | **Votes for  Nominee** | ** ** | **Votes  Withheld** | ** ** |
|----------------------------------|------------|------------------------|------------|---------------------|------------|
| Proposal 1                       |       |                   |       |                |       |
| Election of Class II Directors.  |       | 21,035                 |       | 390                 |       |
| Elected:                         |       |                   |       |                |       |
| -  Michael A. Baker         |       |                   |       |                |       |
| -  Marie-Helene Plais-Cotel |       |                   |       |                |       |
| -  Peter L. Wilson          |       |                   |       |                |       |

 
|                                                                                                                                                                    |   | **For** | ** ** | **Against** | ** ** | **Abstain** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------|------------|-------------|------------|-------------|--------|
| Proposal 2                                                                                                                                                              |   |    |       |        |       |        |   |
| Ratify the appointment of  PricewaterhouseCoopers LLP as the independent registered public accounting  firm of the Company for the fiscal year ending December 31, 2005 |   | 21,388  |       | 6           |       | 30          |   |

 

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**Item5.  Other Information**

 

On June 28,2005, the Company entered into a Sublease Agreement with Verisity Design, Inc.for the premises located at 331 East Evelyn, Mountain View, California. Theagreement was subject to the Master Landlord’s consent within 45 days afterdelivery of and receipt by Master Landlord of the executed Sublease. On July19, 2005, SFERS Real Estate, the Master Landlord, and Verisity Design, Inc.signed a Landlord Consent Agreement allowing the Sublease Agreement between theCompany and Verisity Design, Inc.

 

On July 27,2005, the Company entered into a Settlement and Mutual Release Agreement withDr. Florence Comite regarding the Master Consulting Agreement dated September10, 1997. The terms of the settlement contemplated a payment of $22,500 within7 days of the execution of the termination. As of the date of filing of thisQuarterly Report on form 10-Q, the Company has released the funds to complywith this clause.

 

**Item 6. Exhibits**

 

(a)                    Exhibits.

 
| 10.1 |   | Sublease Agreement for the premises located at 331 East Evelyn,  Mountain View, California           |
|------|--------|------------------------------------------------------------------------------------------------------|
| 10.2 |   | Landlord Consent to Sublease for the premises located at 331 East  Evelyn, Mountain View, California |
| 10.3 |   | Settlement and Mutual Release Agreement with Dr. Florence Comite  dated July 27, 2005                |
| 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 tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

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

 

 

Date:   July 29,2005

 

30

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EXHIBIT INDEX

 

10.1         Sublease Agreement for the premiseslocated at 331 East Evelyn, Mountain View, California

10.2         Landlord Consent to Sublease for thepremises located at 331 East Evelyn, Mountain View, California

10.3         Settlement and Mutual Release Agreementwith Dr. Florence Comite dated July 27, 2005.

31.1         Certification of Chief ExecutiveOfficer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2         Certification of Chief FinancialOfficer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1         Certification of Chief ExecutiveOfficer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2         Certification of Chief FinancialOfficer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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