**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM 10-Q**

**(Mark one)**

**x****                             ****QUARTERLYREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended July 2, 2006**

**o****                                ****TRANSITIONREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from                   to                   .**

**Commission file number:  000-51348**

**ev3 Inc.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                     |   | **32-0138874**                        |
|----------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of |   | (IRS Employer  Identification Number) |
| incorporation or  organization)  |   |                                  |

 

**9600 54****th Avenue North, Suite 100Plymouth, Minnesota 55442**

(Address of principal executiveoffices)

 

**(763)398-7000**

(Registrant’s telephone numberincluding area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. YES  x  NO  o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of  “accelerated filer and large acceleratedfiler” in Rule 12b-2 of the Exchange Act. (Check one):

Largeaccelerated filer:   o   Accelerated filer:   o   Non-accelerated filer:   x

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).  YES  o  NO  x

As of August 1, 2006, there were 56,892,058 shares ofcommon stock, par value $0.01 per share, of the registrant outstanding.

 

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**ev3 Inc.**

**FORM 10-Q**

**For the Quarterly Period Ended July 2, 2006**

 

**TABLE OF CONTENTS**
| Description     | ** **                                                                                  | ** **                                                                                                           | **Page** |
|-----------------|---------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------|----------|
| ** **      |                                                                                        |                                                                                                                 |
| **PART I.**     | **FINANCIAL INFORMATION**                                                                   |                                                                                                                 |
| ITEM 1.         | Financial Statements                                                                        |                                                                                                                 |
|            |                                                                                        | Consolidated Balance Sheets as of July 2, 2006  (unaudited) and December 31, 2005                                    | 1        |
|            |                                                                                        | Consolidated  Statements of Operations for the three and six months ended July 2, 2006 and  July 3, 2005 (unaudited) | 2        |
|            |                                                                                        | Consolidated Statements of Cash Flows for the six  months ended July 2, 2006 and July 3, 2005 (unaudited)            | 3        |
|            |                                                                                        | Notes to the Consolidated Financial Statements                                                                       | 4        |
| ITEM 2.         | Management’s Discussion and Analysis of Financial  Condition and Results of Operations | 19                                                                                                                   |
| ITEM 3.         | Quantitative and Qualitative Disclosures About Market  Risk                                 | 34                                                                                                                   |
| ITEM 4.         | Controls and Procedures                                                                     | 35                                                                                                                   |
| **PART II.**    | **OTHER INFORMATION**                                                                       |                                                                                                                 |
| ITEM 1.         | Legal Proceedings                                                                           | 37                                                                                                                   |
| ITEM 1A.        | Risk Factors                                                                                | 37                                                                                                                   |
| ITEM 2.         | Unregistered Sales of Equity Securities and Use of  Proceeds                                | 38                                                                                                                   |
| ITEM 3.         | Defaults Upon Senior Securities                                                             | 39                                                                                                                   |
| ITEM 4.         | Submission of Matters to a Vote of Security Holders                                         | 39                                                                                                                   |
| ITEM 5.         | Other Information                                                                           | 39                                                                                                                   |
| ITEM 6.         | Exhibits                                                                                    | 39                                                                                                                   |
| SIGNATURE  PAGE | 41                                                                                          |
| Exhibit  Index  | 42                                                                                          |

 

*This reportcontains not only historical information, but also forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933, as amended,and Section 21E of the Securities Exchange Act of 1934, as amended, and aresubject to the safe harbor created by those sections.  We refer you to the information under theheading “Part I. Item 2. Management’s Discussion and Analysis of FinancialCondition and Results of Operations—Forward-Looking Statements.”*

*In thisreport, references to “ev3,” the “company,” “we,” “our” or “us,” unless thecontext otherwise requires, refer to ev3 Inc. and its subsidiaries.*

*All trademarks or trade names referred to inthis report are the property of their respective owners.*

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**PART I:         FINANCIAL INFORMATION**

**ITEM I:          FINANCIAL STATEMENTS**

 

**ev3Inc.CONSOLIDATED BALANCE SHEETS(Dollars in thousands, except per share amounts)**
| ** **                                                                                                                                                                      | ** **   | **July 2,**2006 | ** **   | **December 31,  2005** | ** **   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|----------------------|--------------|-----------------------------|--------------|
| ** **                                                                                                                                                                      | ** **   | **(unaudited)**      | ** **   | ** **                  | ** **   |
| **Assets**                                                                                                                                                                      | ** **   | ** **           | ** **   | ** **                  | ** **   |
| ***Current  assets***                                                                                                                                                           | *** *** | *** ***         | *** *** | *** ***                | *** *** |
| Cash and cash  equivalents                                                                                                                                                      |         | $                    | 28,783       |                        | $            | 69,592 |   |
| Short-term  investments                                                                                                                                                         |         | 18,450               |         | 12,000                      |         |
| Accounts  receivable, less allowance of $3,664 and $3,607, respectively                                                                                                         |         | 35,962               |         | 28,519                      |         |
| Inventories                                                                                                                                                                     |         | 33,982               |         | 32,987                      |         |
| Prepaid expenses  and other assets                                                                                                                                              |         | 8,773                |         | 7,042                       |         |
| Other  receivables                                                                                                                                                              |         | 1,168                |         | 1,535                       |         |
| *Total  current assets*                                                                                                                                                         |         | 127,118              |         | 151,675                     |         |
| Restricted cash                                                                                                                                                                 |         | 3,232                |         | 3,102                       |         |
| Property and  equipment, net                                                                                                                                                    |         | 22,534               |         | 17,877                      |         |
| Goodwill                                                                                                                                                                        |         | 149,160              |         | 94,456                      |         |
| Other intangible  assets, net                                                                                                                                                   |         | 45,722               |         | 26,230                      |         |
| Other assets                                                                                                                                                                    |         | 3,060                |         | 3,488                       |         |
| *Total  assets*                                                                                                                                                                 |         | $                    | 350,826      |                        | $            | 296,828 |   |
| ** **                                                                                                                                                                      | ** **   | ** **           | ** **   | ** **                  | ** **   |
| **Liabilities and stockholders’  equity**                                                                                                                                  | ** **   | ** **           | ** **   | ** **                  | ** **   |
| ***Current  liabilities***                                                                                                                                                      | *** *** | *** ***         | *** *** | *** ***                | *** *** |
| Accounts payable                                                                                                                                                                |         | $                    | 11,078       |                        | $            | 11,716 |   |
| Accrued  compensation and benefits                                                                                                                                              |         | 13,092               |         | 14,612                      |         |
| Accrued  liabilities                                                                                                                                                            |         | 13,058               |         | 11,343                      |         |
| Total current  liabilities                                                                                                                                                      |         | 37,228               |         | 37,671                      |         |
| Other long-term  liabilities                                                                                                                                                    |         | 615                  |         | 852                         |         |
| *Total  liabilities*                                                                                                                                                            |         | 37,843               |         | 38,523                      |         |
| * *                                                                                                                                                                        | * *     | * *             | * *     | * *                    | * *     |
| Minority  interest                                                                                                                                                              |         | —               |         | 12,850                      |         |
| *** ***                                                                                                                                                                    | *** *** | *** ***         | *** *** | *** ***                | *** *** |
| ***Stockholders’  equity***                                                                                                                                                | *** *** | *** ***         | *** *** | *** ***                | *** *** |
| Common stock,  $0.01 par value, 100,000,000 shares authorized, shares issued  and outstanding: 56,813,670 shares at July 2, 2006 and 49,350,647 at  December 31, 2005 |         | 568                  |         | 493                         |         |
| Additional paid  in capital                                                                                                                                                     |         | 910,063              |         | 807,032                     |         |
| Accumulated  deficit                                                                                                                                                            |         | (597,531             | )            | (562,207                    | )            |
| Accumulated  other comprehensive income (loss)                                                                                                                                  |         | (117                 | )            | 137                         |         |
| * *                                                                                                                                                                        |         |                 |         |                        |         |
| *Total  stockholders’ equity*                                                                                                                                              |         | 312,983              |         | 245,455                     |         |
| *Total liabilities and  stockholders’ equity*                                                                                                                              |         | $                    | 350,826      |                        | $            | 296,828 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

1

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**ev3 Inc.CONSOLIDATED STATEMENTS OF OPERATIONS(Dollars in thousands, except per share amounts)**

**(unaudited)**

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                   | ** ** | **July 2, 2006**       | ** ** | **July 3, 2005**     | ** ** | **July 2, 2006** | ** ** | **July 3, 2005** | ** ** |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Net sales                                                    |       | $                                | 50,620     |                           | $          | 31,540 |   | $ | 92,857 |   | $ | 59,222 |   |
| Operating  expenses:                                         |       |                             |       |                           |       |   |   |   |   |
| Cost of goods sold (a)                                       |       | 18,179                           |       | 12,785                         |       | 34,667 |   | 24,894 |   |
| Sales, general and administrative (a)                        |       | 35,808                           |       | 32,297                         |       | 73,669 |   | 64,157 |   |
| Research and development (a)                                 |       | 6,047                            |       | 11,891                         |       | 12,821 |   | 22,217 |   |
| Amortization of intangible assets                            |       | 4,282                            |       | 2,548                          |       | 8,525 |   | 5,203 |   |
| (Gain) loss on sale of assets, net                           |       | (46                              | )          | 111                            |       | 124 |   | 164 |   |
| Acquired in-process research and development                 |       | —                           |       | 868                            |       | 1,786 |   | 868 |   |
| Total operating expenses                                     |       | 64,270                           |       | 60,500                         |       | 131,592 |   | 117,503 |   |
| Loss from  operations                                        |       | (13,650                          | )          | (28,960                        | )          | (38,735 | ) | (58,281 | ) |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Other (income)  expense:                                     |       |                             |       |                           |       |   |   |   |   |
| Gain on sale of investments, net                             |       | (1,063                           | )          | (878                           | )          | (1,063 | ) | (4,611 | ) |
| Interest (income) expense, net                               |       | (514                             | )          | 6,078                          |       | (1,213 | ) | 11,786 |   |
| Minority interest in loss of subsidiary                      |       | —                           |       | (705                           | )          | — |   | (726 | ) |
| Other (income) expense, net                                  |       | (1,327                           | )          | 1,828                          |       | (1,381 | ) | 2,920 |   |
| Loss before income taxes                                     |       | (10,746                          | )          | (35,283                        | )          | (35,078 | ) | (67,650 | ) |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Income tax expense (benefit)                                 |       | 77                               |       | (61                            | )          | 246 |   | (59 | ) |
| Net loss                                                     |       | (10,823                          | )          | (35,222                        | )          | (35,324 | ) | (67,591 | ) |
| Accretion of preferred membership units to  redemption value |       | —                           |       | 5,635                          |       | — |   | 12,061 |   |
| Net loss  attributable to common holders                     |       | $                                | (10,823    | )                              | $          | (40,857 | ) | $ | (35,324 | ) | $ | (79,652 | ) |
| Net loss per  common share (basic and diluted)(b)       |       | $                                | (0.19      | )                              | (4.60      | ) | $ | (0.63 | ) | (13.95 | ) |
| Weighted average shares  outstanding(b)                      |       | 56,698,043                       |       | 8,877,898                      |       | 56,319,427 |   | 5,711,852 |   |

 

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| (a) Includes  stock based compensation charges of: |   |   |   |   |   |   |   |   |   |
|----------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
|                                               |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                 |   | $      | 155    |   | $      | 135    |   | $      | 369    |   | $ | 247 |   |
| Sales, general and administrative                  |   | 1,799  |   | 591    |   | 3,165  |   | 1,045  |   |
| Research and development                           |   | 158    |   | 189    |   | 372    |   | 434    |   |
|                                               |   | $      | 2,112  |   | $      | 915    |   | $      | 3,906  |   | $ | 1,726 |   |

 

(b)         Netloss per common share attributable to common holders and the weighted averagecommon shares outstanding reflect the June 21, 2005 one-for-sixreverse stock split for all periods presented.

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**ev3 Inc.CONSOLIDATED STATEMENTS OF CASH FLOWS(Dollars in thousands, except per share amounts)**

**(unaudited)**

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **July 2, 2006**     | ** ** | **July 3, 2005** | ** ** |
| **Operating  activities**                                                          | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net loss                                                                           |       | $                              | (35,324    | ) | $ | (67,591 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities        |       |                           |       |   |   |
| Depreciation and amortization                                                      |       | 11,097                         |       | 7,340 |   |
| Provision for bad debts and sales returns                                          |       | 234                            |       | 746 |   |
| Provision for inventory obsolescence                                               |       | 1,739                          |       | 1,156 |   |
| Acquired in-process research and development                                       |       | 1,786                          |       | 868 |   |
| Loss on disposal of assets                                                         |       | 124                            |       | 157 |   |
| Gain on sale of investments                                                        |       | (1,063                         | )          | (4,611 | ) |
| Stock compensation expense                                                         |       | 3,906                          |       | 1,726 |   |
| Minority interest in loss of subsidiary                                            |       | —                         |       | (726 | ) |
| Change in  operating assets and liabilities:                                       |       |                           |       |   |   |
| Accounts receivable                                                                |       | (7,435                         | )          | (4,384 | ) |
| Inventories                                                                        |       | (2,070                         | )          | (6,980 | ) |
| Prepaids and other assets                                                          |       | (83                            | )          | 102 |   |
| Accounts payable                                                                   |       | (700                           | )          | 3,024 |   |
| Accrued expenses and other liabilities                                             |       | (3,654                         | )          | 2,509 |   |
| Accrued interest on notes payable                                                  |       | —                         |       | (24,319 | ) |
| Net cash used in operating activities                                              |       | (31,443                        | )          | (90,983 | ) |
| ** **                                                                         | ** ** | ** **                     | ** ** | ** ** | ** ** |
| **Investing  activities**                                                          | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Purchase of short-term investments                                                 |       | (6,750                         | )          | — |   |
| Proceeds from sale of short-term investments                                       |       | 300                            |       | — |   |
| Purchase of property and equipment                                                 |       | (7,360                         | )          | (6,119 | ) |
| Purchase of patents and licenses                                                   |       | (500                           | )          | (982 | ) |
| Proceeds from sale of property and equipment                                       |       | 68                             |       | 8 |   |
| Proceeds from sale of minority investment                                          |       | 1,063                          |       | 4,611 |   |
| Acquisitions, net of cash acquired                                                 |       | (170                           | )          | (1,626 | ) |
| Change in restricted cash                                                          |       | (108                           | )          | (221 | ) |
| Other                                                                              |       | —                         |       | 894 |   |
| Net cash used in investing activities                                              |       | (13,457                        | )          | (3,435 | ) |
| **Financing  activities**                                                          | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Issuance of demand notes payable                                                   |       | —                         |       | 49,100 |   |
| Payments on capital lease obligations                                              |       | (60                            | )          | — |   |
| Proceeds from exercise of stock options                                            |       | 3,890                          |       | 660 |   |
| Proceeds from issuance of subsidiary stock to  minority shareholders               |       | —                         |       | 227 |   |
| Proceeds from initial public offering                                              |       | —                         |       | 152,713 |   |
| Net cash provided by financing activities                                          |       | 3,830                          |       | 202,700 |   |
| Effect of  exchange rate changes on cash                                           |       | 261                            |       | (14 | ) |
| Net (decrease)  increase in cash and cash equivalents                              |       | (40,809                        | )          | 108,268 |   |
| Cash and cash  equivalents, beginning of period                                    |       | 69,592                         |       | 20,131 |   |
| Cash and cash  equivalents, end of period                                          |       | $                              | 28,783     |   | $ | 128,399 |   |
|                                                                               |       |                           |       |   |   |
| Supplemental  non-cash disclosure:                                                 |       |                           |       |   |   |
| Net assets  acquired in conjunction with MTI step acquisition (see Note 5)         |       | $                              | 95,438     |   | $ | 7,536 |   |
| Financed  insurance policies (see Note 12)                                         |       | $                              | 3,500      |   | — |   |
| Contribution of  demand notes payable upon initial public offering                 |       | —                         |       | $ | 324,230 |   |
| Preferred membership  units converted to common stock upon initial public offering |       | —                         |       | $ | 266,089 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

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**ev3 Inc.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.**                 Description ofBusiness

ev3 Inc. (“we,” “our” or “us”)is a global medical device company focused on catheter-based, or endovascular,technologies for the minimally invasive treatment of vascular diseases anddisorders.  We develop, manufacture andmarket a wide range of products that include stents, embolic protectiondevices, thrombectomy devices, balloon angioplasty catheters, foreign objectretrieval devices, guidewires, embolic coils, liquid embolics, microcathetersand occlusion balloon systems.  We marketour products in the United States, Europe, Canada and Japan through a directsales force, and in certain other international markets through distributors.

**2.**                 Basis ofPresentation

The accompanyingunaudited consolidated financial statements have been prepared by us inaccordance with accounting principles generally accepted in the United Statesof America (U.S.) for interim financial information and pursuant to theinstructions to Form 10-Q and Article 10 of Regulation S-X of theSecurities and Exchange Commission. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal, recurring adjustments) considerednecessary for a fair presentation have been included.  The results of operations for any interimperiod may not be indicative of results for the full year.  These unaudited consolidated financialstatements and notes should be read in conjunction with the auditedconsolidated financial statements and the notes thereto included in our annualreport on Form 10-K for the year ended December 31, 2005.

We were formed as ev3 LLCin September 2003 to hold the ownership interests of two companies: ev3Endovascular, Inc. (“Endovascular”) and Micro Investment, LLC (“MII”), aholding company that owned a controlling interest in MicroTherapeutics, Inc. (“MTI”) at the time of formation.    At the time of ev3 LLC’s formation, MTI wasa publicly traded operating company. ev3 LLC’s majority equity holder, Warburg,Pincus Equity Partners, L.P. and certain of its affiliates (“Warburg Pincus”),owned a majority, controlling interest in both Endovascular and MII at the timeof ev3 LLC’s formation. In accordance with Financial Accounting Standards BoardStatement (“SFAS”) 141, *BusinessCombinations* and Financial Technical Bulletin (“FTB”) 85-5, *Issues related to Accounting for BusinessCombinations*, ev3 LLC accounted for the transaction as a combinationof entities under common control. The combination was accounted for on ahistorical cost basis as the ownership interests in the combining companieswere substantially the same before and after the transaction. OnJanuary 28, 2005, we were formed as a subsidiary of ev3 LLC. Immediatelyprior to the consummation of our initial public offering on June 21, 2005,ev3 LLC was merged with and into us, and we became the holding company for allof ev3 LLC’s subsidiaries. These consolidated financial statements present thecombined operations of ev3 LLC for the period from September 1, 2003 untilthe merger on June 21, 2005, and our consolidated operations thereafter.

Prior to the consummationof our initial public offering on June 21, 2005, we amended and restatedour certificate of incorporation to authorize 100,000,000 shares of commonstock, par value $0.01 per share, and 100,000,000 shares of preferred stock,par value $0.01 per share. On June 21, 2005, immediately prior to ourinitial public offering, we completed a one-for-six reverse stock split of ouroutstanding common stock. All share and per share amounts for all periodspresented in these consolidated financial statements reflect this split.

On May 26, 2005,Warburg Pincus and The Vertical Group, L.P. and certain of its affiliates (“Vertical”)contributed shares of MTI’s common stock to ev3 LLC in exchange for commonmembership units. In accordance with SFAS 141, the contribution of theshares by Warburg Pincus has been accounted for as a transfer of assets betweenentities under common control, resulting in the retention of historical basedaccounting. These consolidated financial statements give effect to thecontribution of MTI shares owned by Warburg Pincus as though such contributionoccurred in 2003 and 2004 when Warburg Pincus acquired its interest in MTI. Thecontribution of the MTI shares by Vertical has been accounted for under thepurchase method of accounting on the contribution date.

 

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At July 3, 2005 and December 31, 2005, there was a minorityinterest of 30% in MTI. As described in Note 5, on January 6, 2006, weacquired the outstanding shares of MTI that we did not already own through amerger of MII with and into MTI. MTI was the surviving entity and, as a resultof this merger, became our wholly owned subsidiary.  MTI is now known as ev3 Neurovascular.  All significant intercompany accounts andtransactions have been eliminated in consolidation.

 

On January 1, 2006, weadopted the provisions of Statement of Financial Accounting Standards No. 151, “InventoryCosts an amendment of ARB No. 43, Chapter 4”. This Statement amends the guidance in ARB No. 43, Chapter 4, “InventoryPricing,” to clarify the accounting for abnormal amounts of idle facilityexpense, freight, handling costs, and wasted material (spoilage).  Duringfirst quarter 2006, we began production of a new product line.  We incurred approximately $300 thousand ofabnormal scrap related to this new product line in the three months ended April2, 2006, which was required to be charged to expense in that period and isincluded in our reported cost of goods sold for the six months ended July 2,2006.

We operate on amanufacturing calendar with our fiscal year ending on December 31.  Each quarter is 13 weeks, consisting of onefive-week and two four-week periods. Accordingly, the second fiscal quarters of 2006 and 2005 ended onJuly 2 and July 3, respectively.

**3.**                 Stock-BasedCompensation

We have severalstock-based compensation plans under which stock options and other equityincentive awards have been granted. Under the ev3 Inc. Amended and Restated 2005 Incentive Stock Plan,eligible employees, outside directors and consultants may be awarded options,stock grants, stock units or stock appreciation rights.  The terms and conditions of an option, stockgrant, stock unit or stock appreciation right (including any vesting orforfeiture conditions) are set forth in the certificate evidencing thegrant.  Subject to adjustment as providedin the plan, 6,000,000 shares of our common stock are available for issuanceunder the plan.  During the six monthsended July 2, 2006, a restricted stock grant of 5,000 shares, unrestrictedstock grants of 28,341 shares and options to purchase an aggregate of 1,041,768shares of our common stock were granted under the plan.

Options, other than thosegranted to outside consultants, generally vest over a four-year period andexpire within a period of not more than ten years from the date of grant.Vested options generally expire ninety days after termination of employment.Options granted to outside consultants generally vest over the term of theirconsulting contract and generally expire 90 days after termination of theconsulting relationship. The exercise price per share for each option is set bythe board of directors or the compensation committee at the time of grant andpursuant to the terms of the plan may not be less than the fair market valueper share on the grant date.

Upon consummation of ourinitial public offering, the ev3 LLC 2003 Incentive Plan was terminated withrespect to options available for grant that were not granted prior to theoffering.  Prior to our January 6, 2006acquisition of the remaining outstanding shares of MTI that we did not alreadyown, MTI had a 1993 Incentive Stock Option, Nonqualified Stock Option andRestricted Stock Purchase Plan and a 1996 Stock Incentive Plan.  As a result of the merger of MII with andinto MTI, the outstanding options issued under these MTI plans were convertedinto options to purchase an aggregate of 2,449,905 shares of our commonstock.  MTI also had an Employee StockPurchase Plan, which was terminated effective December 31, 2005 (See Note 5).

In addition to our 2005Incentive Stock Plan, we maintain the ev3 Inc. Employee Stock Purchase Plan (“ESPP”).  The maximum number of shares of our commonstock available for issuance under the ESPP is 750,000 shares, subject toadjustment as provided in the ESPP. The ESPP provides for six-month offeringperiods beginning on January 1 and July 1 of each year; provided, however, thatthe compensation committee of the board of directors may decide in its solediscretion when to commence the first offering period so long as such offeringperiod is commenced within 12 months of the date the ESPP was first approved bythe board of directors, which was on February 13, 2006.   An offeringperiod has not yet been commenced under the ESPP.  The purchase price of the shares will be 85%of the lower of the fair market value of our common stock at the beginning orend of the offering period. This discount may not exceed the maximum discountrate permitted for plans of this type under Section 423 of the Internal RevenueCode of 1986, as amended.   Weexpect the ESPP to be compensatory for financial reporting purposes.

 

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On January 1, 2006, we adopted the provisions of Statement ofFinancial Accounting Standards No. 123(R), “Share-Based Payment” (SFAS 123(R))using the modified prospective method. SFAS 123(R) requires companies to measure and recognize the cost ofemployee services received in exchange for awards of equity instruments basedon the grant date fair value of those awards. Compensation cost under SFAS 123(R) is recognized ratably using thestraight-line attribution method over the expected vesting period.  In addition, pursuant to SFAS 123(R), we arerequired to estimate the amount of expected forfeitures when calculating thecompensation costs, instead of accounting for forfeitures as incurred, whichwas our previous method.  All of ouroptions previously awarded were classified as equity instruments and continueto maintain their equity classification under SFAS 123(R).

 

Prior to January 1, 2006and since the beginning of 2003, we accounted for share-based awards under therecognition provisions of SFAS 123, “Accounting for Stock-Based Compensation”using the modified prospective method of adoption described inSFAS 148.  We used the minimum valuepricing model for measuring the fair value of our options granted through thefirst quarter 2005, which does not take into consideration volatility. Inaccordance with SFAS 123, subsequent to April 5, 2005, the date ofour initial filing of the registration statement relating to our initial publicoffering with the Securities and Exchange Commission, we used the Black-Scholesmethod, including an estimated volatility assumption, to estimate the fairvalue of all option grants. Expense previously recognized related to optionsthat were cancelled or forfeited prior to vesting was reversed in the period ofthe cancellation or forfeiture, as allowed under SFAS 123.

The fair value of optionsare estimated at the date of grant using the Black-Scholes option pricing modelwith the assumptions listed below.  Riskfree interest rate is based on U.S. Treasury rates appropriate for the expectedterm.  Expected volatility and forfeiturerates are based on historical factors related to our common stock since ourJune 2005 initial public offering which are substantially equivalent tovolatility rates as measured against a set of guideline companies.  The guideline companies consist of public andrecently public medical technology companies. Dividend yield is zero as we do not expect to declare any dividends inthe foreseeable future.  The expectedterm is based on the weighted average time between grant and employeeexercise.  The fair value of stockgranted to employees is based upon the closing market value of our common stockon the date of grant.
|                                  | ** ** | **July 2, 2006** | ** ** | **July 3, 2005** | ** ** | **July 3, 2005** | ** ** |
|----------------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| **Three Months Ended** | ** ** | **ev3 Inc.**          | ** ** | **ev3 Inc.**          | ** ** | **MTI**                    | ** ** |
| Risk free  interest rate         |       | 4.9                        | %          | 3.8                        | %          | 3.6                        | %          |
| Forfeiture rate                  |       | 4.5                        | %          | —                     |       | —                     |       |
| Expected  dividend yield         |       | 0.0                        | %          | 0.0                        | %          | 0.0                        | %          |
| Expected  volatility             |       | 51.2                       | %          | 50.0                       | %          | 44.9                       | %          |
| Expected option term             |       | 4 years                    |       | 4 years                    |       | 4 years                    |       |

 
|                                | ** ** | **July 2, 2006** | ** ** | **July 3, 2005** | ** ** | **July 3, 2005** | ** ** |
|--------------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| **Six Months Ended** | ** ** | **ev3 Inc.**          | ** ** | **ev3 Inc.**          | ** ** | **MTI**                    | ** ** |
| Risk free  interest rate       |       | 4.5                        | %          | 3.8                        | %          | 3.9                        | %          |
| Forfeiture rate                |       | 4.5                        | %          | —                     |       | —                     |       |
| Expected  dividend yield       |       | 0.0                        | %          | 0.0                        | %          | 0.0                        | %          |
| Expected  volatility           |       | 50.0                       | %          | 50.0                       | %          | 56.9                       | %          |
| Expected option term           |       | 4 years                    |       | 4 years                    |       | 4 years                    |       |

 

In November 2005, theFASB issued FASB Staff Position No. 123(R)-3 (FSP 123(R)-3), “TransitionElection Related to Accounting for the Tax Effects of Share-Based PaymentAwards”.  FSP 123(R)-3 provides anelective alternative transition method for calculating the pool of excess taxbenefits available to absorb tax deficiencies recognized subsequent to theadoption of SFAS 123(R).  Companies maytake up to one year from the effective date of FSP 123(R)-3 to evaluate theavailable transition alternatives and make a one-time election as to whichmethod to adopt.  We are currently in theprocess of evaluating the alternative methods.

In accordance with theprovisions of SFAS 123(R) and Emerging Issues Task Force Issue 96-18,“Accounting for Equity Instruments that are Issued to Other than Employees forAcquiring, or in Conjunction with Selling, Goods or Services”, we account fornon-employee equity-based awards, in which goods or services are theconsideration received for the equity instruments issued, at their fair value.

 

6

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As of July 2, 2006, the total compensation cost for nonvested awardsnot yet recognized in our statements of operations was $16.8 million, net ofestimated forfeitures.  This amount isexpected to be recognized over a weighted average period of 2.7 years.

 

*A summary of activity for all plans*(dollars in thousands, except per shareamounts) during the three and six months ended July 2, 2006 is asfollows:
|                                                                 | ** ** | **Awarded  Shares  Outstanding** | ** ** | **Weighted-Average  Exercise Price Per  Share** | ** ** | **Aggregate**IntrinsicValue | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------|------------|
| Balance at  January 1, 2006                                |       | 3,823,309                        |       | $                                                         | 11.41      |                        |       |   |
| MTI options converted to ev3 options as a result of  the merger |       | 2,449,905                        |       | $                                                         | 9.75       |                        |       |   |
| Granted:                                                        |       |                             |       |                                                      |       |                        |       |
| Restricted stock                                                |       | 5,000                            |       | —                                                    |       |                        |       |
| Exercise price equal to market price at date of  grant(1)       |       | 761,664                          |       | $                                                         | 16.18      |                        |       |   |
| Exercised                                                       |       | (135,818                         | )          | $                                                         | 8.71       |                        |       |   |
| Cancelled/Forfeited                                             |       | (313,774                         | )          | $                                                         | 11.95      |                        |       |   |
| Balance at April  2, 2006                                       |       | 6,590,286                        |       | $                                                         | 11.45      |                        | $          | 41,071 |   |
|                                                            |       |                             |       |                                                      |       |                        |       |
| Granted:                                                        |       |                             |       |                                                      |       |                        |       |
| Unrestricted stock grant, net of shares repurchased             |       | 19,073                           |       | —                                                    |       |                        |       |
| Exercise price equal to market price at date of  grant(2)       |       | 280,104                          |       | $                                                         | 16.15      |                        |       |   |
| Exercised                                                       |       | (323,213                         | )          | $                                                         | 8.70       |                        |       |   |
| Cancelled/Forfeited                                             |       | (311,634                         | )          | $                                                         | 11.87      |                        |       |   |
| Balance at July  2, 2006                                        |       | 6,254,616                        |       | $                                                         | 11.86      |                        | $          | 21,617 |   |
| Options exercisable  at April 2, 2006                           |       | 2,739,238                        |       | $                                                         | 10.10      |                        | $          | 21,818 |   |
| Options exercisable at  July 2, 2006                            |       | 2,915,697                        |       | $                                                         | 10.49      |                        | $          | 14,421 |   |

 

----

(1)             Theweighted average fair value for options granted at market was $7.05.

(2)             Theweighted average fair value for options granted at market was $7.27.

As of July 2,2006, we had 190,000 shares of restricted stock outstanding.  The value of these shares of restricted stockwas measured at the closing market price of our common stock on the grant date.  The unamortized compensation expense forthese awards was $2.4 million as of July 2, 2006, which will be recognized overthe remaining vesting period of approximately 3.4 years.

During the quarterended July 2, 2006, we issued 28,341 shares of unrestricted stock to keyemployees in the form of unrestricted stock grants.  Of the 28,341 shares of common stock issuedto these employees as stock grants, we immediately repurchased 9,268 shares topay the employees’ withholding or employment-related tax obligations due inconnection with the issuance of the stock grants.  The value of these stock grants was measuredat the closing market price of our common stock on the date of grant.  The resulting compensation expense of $393thousand was recorded during the quarter.

The intrinsic valueof a stock option award is the amount by which the fair market value of theunderlying stock exceeds the exercise price of the award.  The total intrinsic value of optionsexercised was $2.3 million and $3.3 million during the three and six monthsended July 2, 2006, respectively, and $9 thousand and $441 thousand during thethree and six months ended July 3, 2005, respectively.

 

7

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*For options outstanding and exercisable at July 2,2006, the exercise price ranges and average remaining lives were as follows:*

 
| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                                | ** ** |
|---------------------------------------------|------------|------------------------------|------------|-------------------------------------------------------------|------------|
| **Exercise Price Per Share** | ** ** | **Number  Outstanding**      | ** ** | **Weighted-  Average  Per Share  Exercise Price** | ** ** | **Weighted-  Average  Remaining  Contractual Life** | ** ** | **Number  Exercisable** | ** ** | **Weighted-  Average  Exercise Price  Per Share** | ** ** |
| $0.36-$8.81                                 |       | 1,188,742                    |       | $                                                           | 6.91       |   | 7.3 years |   | 796,663 |   | $ | 6.50 |   |
| $8.82                                       |       | 1,561,349                    |       | $                                                           | 8.82       |   | 7.4 years |   | 1,064,010 |   | $ | 8.82 |   |
| $8.94-$14.70                                |       | 2,143,619                    |       | $                                                           | 13.47      |   | 8.4 years |   | 764,789 |   | $ | 12.95 |   |
| $14.93-$17.32                               |       | 813,331                      |       | $                                                           | 16.16      |   | 8.7 years |   | 114,233 |   | $ | 16.09 |   |
| $17.30-$229.02                              |       | 338,502                      |       | $                                                           | 21.15      |   | 6.1 years |   | 176,002 |   | $ | 24.39 |   |
|                                        |       | 6,045,543                    |       | $                                                           | 11.77      |   | 7.9 years |   | 2,915,697 |   | $ | 10.49 |   |

 

During 2000 and 2001,Warburg Pincus and certain of our employees and directors entered into loanagreements in order for certain employees and directors to buy ownershipinterests in us. These outstanding loans are considered to be a part of a stockcompensation arrangement. Modifications are measured for compensation expense.Additional compensation expense, if any, is recognized over the remaining lifeof the loan. The total outstanding principal balance and accrued interest onthe notes held by Warburg Pincus and issued by certain of our employees anddirectors at July 2, 2006 and December 31, 2005 was $5.3 million and $5.2million, respectively.

**4.**                 Liquidity andCapital Resources

Since inception, we havegenerated significant operating losses. Historically, our liquidity needs havebeen met through a series of preferred investments and by demand notes payableissued to Warburg Pincus and Vertical. On June 21, 2005, we completed an initial public offering in whichwe sold 11,765,000 shares of our common stock at $14.00 per share for net cashproceeds of $152.7 million, net of underwriting discounts and other offeringcosts.  Immediately prior to the consummationof the offering, ev3 LLC merged with and into ev3 Inc. and 24,040,718Class A preferred membership units, 41,077,336 Class B preferredmembership units, and 18,799,962 common membership units of ev3 LLC wereconverted into 83,918,016 shares of common stock of ev3 Inc. (on a pre-splitbasis).  Immediately thereafter, wecompleted a one-for-six reverse stock split whereby the 83,918,016 shares ofcommon stock were converted into 13,986,350 shares of common stock.  Prior to the consummation of the offering,and subsequent to the reverse stock split, we also issued 21,964,815 and1,194,489 shares of common stock to Warburg Pincus and Vertical, respectively,in exchange for their contribution of $324.2 million aggregate principal amountof demand notes and accrued and unpaid interest thereon.  The remaining balance of the accrued andunpaid interest on the demand notes, totaling $36.5 million, was repaid usingproceeds from the offering.  OnJuly 20, 2005, we sold an additional 205,800 shares of common stockpursuant to the over-allotment option granted to the underwriters in connectionwith the initial public offering.  Ournet proceeds from this sale totaled $2.2 million, after deducting underwritingdiscounts and other offering expenses. The total net cash proceeds we receivedfrom our initial public offering were $154.9 million.

On June 28, 2006, our operating subsidiaries, ev3Endovascular, Inc., ev3 International, Inc. and Micro Therapeutics, Inc.(collectively, the “Borrowers”), entered into a Loan and Security Agreement (“LoanAgreement”) with Silicon Valley Bank (“SVB”), consisting of a two-year $30.0million revolving line of credit and a 48-month $7.5 million equipmentfinancing line.  Pursuant to the terms ofthe Loan Agreement, and subject to specified reserves, we may borrow under therevolving line of credit up to $12 million without any borrowing baselimitations. Aggregate borrowings under the revolving line of credit thatexceed $12 million will subject the revolving line to borrowing base limitations.  These limitations allow us to borrow, subjectto specified reserves, up to 80% of eligible domestic and foreign accountsreceivables plus up to 30% of eligible inventory.  Additionally, borrowings against the eligibleinventory may not exceed the lesser of 33% of the amount advanced againstaccounts receivable or $7.5 million. Borrowings under the revolving line bear interest at a variable rateequal to SVB’s prime rate.  Borrowingsunder the equipment line bear interest at a variable rate equal to SVB’s primerate plus 1.0%.  Accrued interest on anyoutstanding balance under the revolving line is payable monthly inarrears.  Amounts outstanding under theequipment line as of December 31, 2006 will be payable in 42 consecutive equalmonthly installments of principal, beginning on January 31, 2007.

 

8

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Both the revolving line of credit and equipment financing are securedby a first priority security interest in substantially all of our assets,excluding intellectual property, which is subject to a negative pledge, and areguaranteed by ev3 Inc. and all of our domestic direct and indirectsubsidiaries. The Loan Agreement requires the Borrowers to maintain a specifiedliquidity ratio and a tangible net worth level. The Loan Agreement imposes certain limitations on the Borrowers, theirsubsidiaries and ev3, including without limitation, on their ability to: (i)transfer all or any part of their business or properties; (ii) permit or suffera change in control; (iii) merge or consolidate, or acquire any entity; (iv)engage in any material new line of business; (v) incur additional indebtednessor liens with respect to any of their properties; (vi) pay dividends or makeany other distribution on or purchase of, any of their capital stock; (vii)make investments in other companies; or (viii) engage in related partytransactions, subject in each case to certain exceptions and limitations.  The Loan Agreement requires us to maintain ondeposit or invested with SVB or its affiliates the lesser of $15.0 million or 50%of our aggregate cash and cash equivalents. The Borrowers are required to pay customary fees with respect to thefacility, including a fee on the average unused portion of the revolving line.

 

The Loan Agreement contains customary events ofdefault, including the failure to make required payments, the failure to complywither certain covenants or other agreements, the occurrence of a materialadverse change, failure to pay certain other indebtedness and certain events ofbankruptcy or insolvency. Upon the occurrence and continuation of an event ofdefault, amounts due under the Loan Agreement may be accelerated.

Our future liquidity andcapital requirements will be influenced by numerous factors, including clinicalresearch and product development programs, working capital to support our salesgrowth, receipt of and time required to obtain regulatory clearances andapprovals, sales and marketing programs and the acceptance of our products inthe marketplace.  We believe that ourcurrent resources, together with funds available under our revolving creditfacility, are sufficient to cover our liquidity requirements through at leastthe next twelve months.  However, thereis no assurance that additional funding will not be needed. Further, ifadditional funding were needed, there is no assurance that such funding will beavailable to us or our subsidiaries on acceptable terms, or at all.  If we require additional working capital butare not able to raise additional funds, we may be required to significantly curtailor cease ongoing operations.

 

9

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*The following summarizes the changes instockholders’ equity (dollars in thousands) since December 31, 2005:*

 
| ** **                                           | ** ** | **Common Stock** | ** ** | **Additional  Paid in** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Total  Stockholders’** | ** **   |
|------------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|-----------------|------------|---------------------------------------|------------|-------------------------------|--------------|
| ** **                                           | ** ** | **Shares**            | ** ** | **Amount**                   | ** ** | **Capital**     | ** ** | **Deficit**                           | ** ** | **Income (Loss)**        | ** **   | **Equity** | ** ** |
| **Balance  December 31, 2005**                       | ** ** | **49,350,647**        | ** ** | **$**                        | **493**    | ** **      | **$**      | **807,032**                           | ** ** | **$**                         | **(562,207** | **)** | **$** | **137** | ** ** | **$** | **245,455** | ** ** |
| Compensation expense on options and restricted stock |       | —                |       | —                       |       | 1,794           |       | —                                |       | —                        |         | 1,794 |   |
| Exercise of options                                  |       | 176,876               |       | 2                            |       | 1,183           |       | —                                |       | —                        |         | 1,185 |   |
| MTI acquisition                                      |       | 6,997,354             |       | 70                           |       | 95,368          |       | —                                |       | —                        |         | 95,438 |   |
| Comprehensive income (loss):                         |       |                  |       |                         |       |            |       |                                  |       |                          |         |   |   |
| Net loss                                             |       |                  |       |                         |       |            |       | (24,501                               | )          | —                        |         | (24,501 | ) |
| Cumulative translation adjustment                    |       |                  |       |                         |       |            |       | —                                |       | 92                            |         | 92 |   |
| Comprehensive income                                 |       | —                |       | —                       |       | —          |       | (24,501                               | )          | 92                            |         | (24,409 | ) |
| **Balance  April 2, 2006**                           | ** ** | **56,524,877**        | ** ** | **$**                        | **565**    | ** **      | **$**      | **905,377**                           | ** ** | **$**                         | **(586,708** | **)** | **$** | **229** | ** ** | **$** | **319,463** | ** ** |
|                                                 |       |                  |       |                         |       |            |       |                                  |       |                          |         |   |   |
| Compensation expense on options and restricted stock |       | —                |       | —                       |       | 1,719           |       | —                                |       | —                        |         | 1,719 |   |
| Exercise of options                                  |       | 269,720               |       | 3                            |       | 2,702           |       | —                                |       | —                        |         | 2,705 |   |
| Unrestricted stock grants                            |       | 28,341                |       | —                       |       | 393             |       | —                                |       | —                        |         | 393 |   |
| Shares Repurchased                                   |       | (9,268                | )          | —                       |       | (128            | )          | —                                |       | —                        |         | (128 | ) |
| Comprehensive income (loss):                         |       |                  |       |                         |       |            |       |                                  |       |                          |         |   |   |
| Net loss                                             |       |                  |       |                         |       |            |       | (10,823                               | )          | —                        |         | (10,823 | ) |
| Cumulative translation Adjustment                    |       |                  |       |                         |       |            |       | —                                |       | (346                          | )            | (346 | ) |
| Comprehensive (loss)                                 |       | —                |       | —                       |       | —          |       | (10,823                               | )          | (346                          | )            | (11,169 | ) |
| **Balance July 2, 2006**                             | ** ** | **56,813,670**        | ** ** | **$**                        | **568**    | ** **      | **$**      | **910,063**                           | ** ** | **$**                         | **(597,531** | **)** | **$** | **(117** | **)** | **$** | **312,983** | ** ** |

 

**5.**                 MTI StepAcquisition

On January 6, 2006,we completed the acquisition of the outstanding shares of MTI that we did notalready own through the merger of MII with and into MTI, with MTI continuing asthe surviving corporation and a wholly owned subsidiary of ev3 Inc. As a resultof the merger, each share of common stock of MTI outstanding at the effectivetime of the merger was automatically converted into the right to receive0.476289 of a share of our common stock (the “Exchange Ratio”) and cash in lieuof any fractional share of our common stock. We issued approximately 7.0million new shares of our common stock to MTI’s public stockholders in themerger.  Fair value of the shares issuedwas measured as the average closing price per share of our stock on the NASDAQNational Market System for the five day trading period centered around the datethat the terms of the acquisition were agreed to and announced.  In addition, each outstanding option topurchase shares of MTI common stock was converted into an option to purchaseshares of our common stock on the same terms and conditions (including vesting)as were applicable under such MTI option. The exercise price and number ofshares for which each such MTI option is (or will become) exercisable wasadjusted based on the Exchange Ratio.  The fair value of the replacement stock options was estimated at theclosing date.  The unvested portion ofthe replacement stock options will be recognized as compensation expense overthe remaining service period.

The investment wasaccounted for using the step acquisition method prescribed by ARB 51,Consolidated Financial Statements. Step acquisition accounting requires theallocation of the excess purchase price to the fair value of net assetsacquired. The excess purchase price is determined as the difference between thecash paid and the historical book value of the interest in net assetsacquired.  The effects of the acquisitiondo not materially change our results of operations.  Therefore, pro forma disclosures are notincluded.

 

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*The following table presents the purchase price forthe acquisition (in thousands) on January 6, 2006:*

 

|                                                    | ** ** | **2006** | ** ** |
|----------------------------------------------------|------------|----------|------------|
| Fair value of  shares/options issued               |       | $        | 95,438     |   |
| Interest  acquired in historical book value of MTI |       | (12,850  | )          |
| Excess purchase price over historical book values  |       | $        | 82,588     |   |

 

*The following summarizes the allocation of the excesspurchase price over historical book values (in thousands) arising from theacquisition:*
|                                               | ** ** | **2006** | ** ** |
|-----------------------------------------------|------------|----------|------------|
| Inventory                                     |       | $        | 668        |   |
| Developed  technology                         |       | 15,548   |       |
| Customer  relationships                       |       | 9,964    |       |
| Trademarks and  tradenames                    |       | 2,029    |       |
| Acquired  in-process research and development |       | 1,787    |       |
| Goodwill                                      |       | 54,704   |       |
| Accrued  liabilities                          |       | (2,112   | )          |
| Total                                         |       | $        | 82,588     |   |

 

The weighted average lifeof the acquired intangibles, excluding goodwill, was seven years.  The acquired in-process research anddevelopment charge was estimated considering an appraisal and represents theestimated fair value of the in-process projects at the date of acquisition ofthe MTI shares.  As of the acquisitiondate, the in-process projects had not yet reached technological feasibility andhad no alternative use.  The primarybasis for determining technological feasibility of these projects is obtainingregulatory approval to market the products. Accordingly, the value attributable to these projects, which had yet toobtain regulatory approval, was expensed in conjunction with theacquisition.  If the projects are notsuccessful, or completed in a timely manner, we may not realize the financialbenefits expected from these projects.

The incomeapproach was used to determine the fair value of the acquired in-processresearch and development.  This approachestablishes fair value by estimating the after-tax cash flows attributable toany in-process project over its useful life and then discounting theseafter-tax cash flows back to the present value. The costs to complete each project were based on estimated directproject expenses as well as the remaining labor hours and related overheadcosts.  In arriving at the value ofacquired in-process research and development projects, we considered theproject’s stage of completion, the complexity of the work to be completed, thecosts already incurred, the remaining costs to complete the project, thecontribution of core technologies, the expected introduction date and theestimated useful life of the technology. The discount rate used to arrive at the present value of acquiredin-process research and development as of the acquisition date was based on thetime value of money and medical technology investment risk factors.  The discount rate used was approximately14%.  We believe that the estimatedacquired in-process research and development amount determined represents thefair value at the date of acquisition and does not exceed the amount a third partywould pay for the project.

**6.**                    Short-Term Investments

Short-term investmentsconsist of debt securities, which have investment grade credit ratings.  The debt securities are classified andaccounted for as available-for-sale and are reported at fair value withunrealized gains and losses excluded from earnings and reported in othercomprehensive income.  Managementdetermines the appropriate classification of its investments in securities atthe time of purchase and reevaluates such determination at each balance sheetdate.  The short-term investments consistof floating rate taxable municipal bonds with maturities from 2019 to2036.  We have the option to put thebonds to the remarketing agent who is obligated to repurchase the bonds at par.  As of July 2, 2006, our cost approximatedfair value related to these investments.

 

11

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**7.**                 Inventories

*Inventoryconsists of the following (in thousands):*

|                    | ** ** | **July 2, 2006** | ** ** | **December 31, 2005** | ** ** |
|--------------------|------------|----------------------------|------------|---------------------------------|------------|
| Raw materials      |       | $                          | 6,184      |                            | $          | 5,823 |   |
| Work in-progress   |       | 1,781                      |       | 1,944                           |       |
| Finished goods     |       | 30,268                     |       | 29,195                          |       |
|               |       | 38,233                     |       | 36,962                          |       |
| Inventory  reserve |       | (4,251                     | )          | (3,975                          | )          |
| Inventory, net     |       | $                          | 33,982     |                            | $          | 32,987 |   |

 

**8.**                 Goodwill andOther Intangible Assets

*Thechanges in the carrying amount of goodwill by operating segment for the sixmonths ended July 2, 2006 were as follows (in thousands):   *
| ** **                                           | ** ** | **Cardio  Peripheral** | ** ** | **Neurovascular** | ** ** | **Total** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-------------------|------------|-----------|------------|
| Balance as of January  1, 2006                       |       | $                      | 71,307     |              | $          | 23,149    |       | $ | 94,456 |   |
| Goodwill related to  acquisition of MTI common stock |       | —                 |       | 54,704            |       | 54,704    |       |
| Balance as of July 2, 2006                           |       | $                      | 71,307     |              | $          | 77,853    |       | $ | 149,160 |   |

 

*Otherintangible assets consist of the following (in thousands):*
| ** **                 | ** ** | **Weighted**                                   | ** ** | **July 2, 2006**  | ** ** | **December 31, 2005** | ** ** |
|----------------------------|------------|------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | **Average  Useful Life  (in years)** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization**   | ** ** | **Net  Carrying  Amount** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** |
| Patents and licenses       |       | 5.0                                            |       | $                           | 8,744      |                            | $          | (3,534 | ) | $ | 5,210 |   | $ | 8,390 |   | $ | (3,300 | ) | $ | 5,090 |   |
| Developed technology       |       | 6.0                                            |       | 63,616                      |       | (35,156                         | )          | 28,460 |   | 48,068 |   | (29,951 | ) | 18,117 |   |
| Trademarks and  tradenames |       | 7.0                                            |       | 5,122                       |       | (2,178                          | )          | 2,944 |   | 3,093 |   | (1,721 | ) | 1,372 |   |
| Customer relationships     |       | 5.0                                            |       | 16,094                      |       | (6,986                          | )          | 9,108 |   | 6,131 |   | (4,480 | ) | 1,651 |   |
| Other intangible assets    |       |                                           |       | $                           | 93,576     |                            | $          | (47,854 | ) | $ | 45,722 |   | $ | 65,682 |   | $ | (39,452 | ) | $ | 26,230 |   |

 

Intangible assets areamortized using methods which approximate the benefit provided by theutilization of the assets.  Patents andlicenses, developed technology and trademarks and tradenames are amortized on astraight line basis.  Customerrelationships are amortized using accelerated methods.  We continually evaluate the amortizationperiod and carrying basis of intangible assets to determine whether events andcircumstances warrant a revised estimated useful life or reduction in value.

Total amortization ofother intangible assets was $4.3 million and $8.5 million for the three and sixmonths ended July 2, 2006, respectively, and $2.5 million and $5.2 million forthe three and six months ended July 3, 2005, respectively.  The estimated amortization expense (inclusiveof amortization expense already recorded for the six months ended July 2, 2006)for the five years ending December 31 is as follows (in thousands):
| 2006 |   | $      | 16,551 |   |
|------|--------|--------|--------|--------|
| 2007 |   | 11,088 |   |
| 2008 |   | 7,348  |   |
| 2009 |   | 4,628  |   |
| 2010 |   | 3,491  |   |

 

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**9.**                 Investments

We had a licensingagreement and an approximate 14% interest in Genyx Medical, Inc. (“Genyx”).  The carrying value of our investment in Genyxwas fully written off and reduced to $0 as of December 31, 2004, and wehad no obligation to fund Genyx’s operations. In January 2005, we sold our interest in Genyx and recorded a gainof $3.7 million.  During the secondquarter of 2006, we received a $153 thousand milestone payment related to thesale of our investment in Genyx Medical, Inc. During the second quarter of 2006 we also received a  milestone payment of $910 thousand related tothe 2002 sale of our investment in Enteric Medical Technologies, Inc. (“Enteric”)  This is the final milestone payment relatedto the sale of our investment in Enteric.. During the second quarter of 2005,we received a $878 thousand milestone payment related to the 2002 sale of ourinvestment in Enteric.

**10.**          Accrued Liabilities

*Accruedliabilities consist of the following (in thousands):*
|                                | ** ** | **July 2, 2006** | ** ** | **December 31, 2005** | ** ** |
|--------------------------------|------------|----------------------------|------------|---------------------------------|------------|
| Accrued  professional services |       | $                          | 2,515      |                            | $          | 1,043 |   |
| Financed  insurance policies   |       | 3,285                      |       | 368                             |       |
| Accrued clinical  studies      |       | 417                        |       | 3,633                           |       |
| Office closure                 |       | 380                        |       | 391                             |       |
| Accrued other                  |       | 6,461                      |       | 5,908                           |       |
| Total accrued  liabilities     |       | $                          | 13,058     |                            | $          | 11,343 |   |

 

**11.**          Interest (Income)Expense

*Interest(income) expense consists of the following (in thousands):   *
|                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                            | ** ** | **July 2, 2006**       | ** ** | **July 3, 2005**     | ** ** | **July 2, 2006** | ** ** | **July 3, 2005** | ** ** |
| Interest expense                      |       | $                                | 67         |                           | $          | 6,346 |   | $ | 101 |   | $ | 12,191 |   |
| Interest  (income)                    |       | (581                             | )          | (268                           | )          | (1,314 | ) | (405 | ) |
|                                  |       |                             |       |                           |       |   |   |   |   |
| Total interest  (income) expense, net |       | $                                | (514       | )                              | $          | 6,078 |   | $ | (1,213 | ) | $ | 11,786 |   |

 

**12.**          Commitments andContingencies

*Lettersof Credit*

As of July 2, 2006, wehad $3.2 million of outstanding letters of credit.  These outstanding commitments are fullycollateralized by restricted cash.

*FinancedInsurance Policies*

Weroutinely enter into agreements to finance insurance premiums for periods notto exceed the terms of the related insurance policies.  In the three months ended July 2, 2006, weentered into an agreement to finance $3.5 million in insurance-related premiumsassociated with the annual renewal of certain of our insurance policies.  The amount financed accrues interest at a6.4% annual rate and is payable in monthly installments over an 11 monthperiod.  As of July 2, 2006, theoutstanding balance under the agreement was $3.3 million and is included inaccrued liabilities on our consolidated balance sheet.

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*Earn-Out Contingencies*

 

Under the terms of thestock purchase agreement we entered into in connection with our acquisition ofDendron in September 2000, we may be required to make additional payments whichare contingent upon Dendron products achieving certain revenue targets between2003 and 2008. In 2003, the $4.0 million revenue target for sales of Dendronproducts during 2003 was met. Accordingly, an additional payment to the formerDendron stockholders of $3.75 million was made in 2004. In 2004, the $5.0million revenue target for sales of Dendron products during 2004 was met.Accordingly, a payment to the former Dendron stockholders of $3.75 million wasaccrued in 2004 and was paid during the second quarter of 2005. We may berequired to make a final payment of $7.5 million, which is contingent uponDendron products achieving annual revenues of $25 million in any year duringthe period between 2003 and 2008. Any such final payment would be due in theyear following the year of target achievement.

*Contingencies*

We are from time to timesubject to, and are presently involved in, litigation or other legalproceedings.

In September 2000,Dendron, which was acquired by MTI in 2002, was named as the defendant in threepatent infringement lawsuits brought by the Regents of the University ofCalifornia, as the plaintiff, in the District Court (Landgericht) inDusseldorf, Germany.  The complaintsrequested a judgment that Dendron’s EDC I coil device infringed three Europeanpatents held by the plaintiff and asked for relief in the form of an injunctionthat would prevent Dendron from producing and selling the devices, as well asan award of damages caused by Dendron’s alleged infringement, and other costs,disbursements and attorneys’ fees.  InAugust 2001, the court issued a written decision that EDC I coil devices didinfringe the plaintiff’s patents, enjoined Dendron from producing and sellingthe devices, and requested that Dendron disclose the individual products’ costsas the basis for awarding damages.  InSeptember 2001, Dendron appealed the decision. In addition, Dendron instituted challenges to the validity of each ofthese patents by filing opposition proceedings with the European Patent Office,or EPO, against one of the patents (MTI joined Dendron in this action inconnection with its acquisition of Dendron), and by filing nullity proceedingswith the German Federal Patents Court against the German component of the othertwo patents.  The opposition proceedingswith the EPO on the one patent are complete, and the EPO has rejected theopposition and has upheld the validity of the one patent.  Dendron retains the right to file a nullityaction in Germany against the patent. All three appeal proceedings are currently stayed on the basis of thevalidity challenges brought by Dendron.

On July 4, 2001, theUniversity of California filed another suit against Dendron alleging that theEDC I coil device infringed another European patent held by the plaintiff.  The complaint was filed in the District Courtof Dusseldorf, Germany seeking additional monetary and injunctive relief.  In April 2002, the court found that EDC Icoil devices did infringe the plaintiff’s patent.  The patent involved is the same patent thatwas involved in the case before the English Patents Court discussed below andthat was ruled by a Dutch court to be invalid, also as discussed below.  The opposition proceedings on the patent arecomplete, and the EPO has rejected the opposition and has upheld the validityof the patent.  Dendron has now filed adomestic German nullity action against that patent.  The infringement case is under appeal.  The appeal has been stayed pending theoutcome of the nullity action filed against the patent.

An accrual for thematters discussed above was included in the balance sheet of Dendron as of thedate of its acquisition by MTI.  As ofJuly 2, 2006, approximately $826 thousand was recorded in accrued liabilitiesin our consolidated financial statements included in this report.  Dendron ceased all activities with respect tothe EDC I coil device prior to MTI’s October 2002 acquisition of Dendron.

Concurrent with MTI’sacquisition of Dendron, MTI initiated a series of legal actions related to ourSapphire coils in the Netherlands and the United Kingdom, which included across-border action that was heard by a Dutch court, as further describedbelow.  The primary purpose of theseactions was to assert both invalidity and non-infringement by MTI of certainpatents held by others.  The range ofpatents at issue are held by the Regents of the University of California, withBoston Scientific Corporation subsidiaries named as exclusive licensees,collectively referred to as the “patent holders,” related to detachable coilsand certain delivery catheters.

In October 2003, theDutch court ruled the three patents at issue related to detachable coils arevalid and that our Sapphire coils do infringe such patents.  The Dutch court also ruled that the patentholders’ patent at issue related to

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the delivery catheter was invalid. Pursuant to the court’s ruling, we have been enjoined by the patentholders from engaging in infringing activities related to our Sapphire coils inmost countries within the European Union, and may be liable forthen-unspecified monetary damages for our activities since September 27,2002.  In February 2005, we received aninitial claim from the patent holders with respect to monetary damages,amounting to €3.6 million, or approximately $4.5 million as of July 2, 2006,with which we disagree.  Court hearingswill be held regarding these claims and are currently scheduled for June2007.  We have filed an appeal with theDutch court, and believe that since the date of injunction in each separatecountry we are in compliance with the Dutch court’s injunction and we intend tocontinue such compliance.  Because webelieve that we have valid legal grounds for appeal, we have determined that aloss is not probable at this time as defined by SFAS 5, “Accounting forContingencies”.  However, there can be noassurance that the ultimate resolution of this matter will not result in amaterial adverse effect on our business, financial condition or results ofoperations.

 

In January 2003, weinitiated a legal action in the English Patents Court seeking a declarationthat a patent held by the patent holders related to delivery catheters wasinvalid, and that our products did not infringe this patent.  The patent in question was the U.K.designation of the same patent that was found by the Dutch court in October2003 to be invalid, as discussed above. The patent holders counterclaimed for alleged infringement by us.  In February 2005, the court approved aninterim settlement between the parties under which the patent holders wererequired to surrender such patent to the U.K. Comptroller of Patents, and topay our costs associated with the legal action, including interest.  As a result, the patent was surrendered andwe received interim payments from the patent holders aggregating £500 thousand(equivalent to approximately $900 thousand based on the dates of receipt),which we recorded as a reduction of litigation expense upon receipt of suchfunds during the first quarter of 2005. The parties are now in proceedings before a costs judge regardingpayment by the patent holders of the remaining costs incurred by us in suchlitigation, with a hearing expected later this year.  As a result of the interim settlement, weanticipate that we will no longer be involved in litigation on this matter inthe United Kingdom, although no assurance can be given that no other litigationinvolving us may arise in the United Kingdom.

In the United States,concurrent with the FDA’s marketing clearance of our Sapphire line of emboliccoils received in July 2003, we, through our subsidiary MTI, initiated adeclaratory judgment action against the patent holders in the United StatesDistrict Court for the Western District of Wisconsin.  The action included assertions ofnon-infringement by us and invalidity of a range of patents held by the patentholders related to detachable coils and certain delivery catheters.  In October 2003, the court dismissed ouractions for procedural reasons without prejudice and without decision as to themerits of the parties’ positions.  InDecember 2003, the University of California filed an action against us in theUnited States District Court for the Northern District of California alleginginfringement by us with respect to a range of patents held by the University ofCalifornia related to detachable coils and certain delivery systems.  We filed a counterclaim against theUniversity of California asserting non-infringement by us, invalidity of thepatents and inequitable conduct in the procurement of certain patents.  In addition, we filed a claim against theUniversity of California and Boston Scientific Corporation for violation offederal antitrust laws, with the result that the court has subsequently decidedto add Boston Scientific as a party to the litigation.  Motions for summary judgment made by allparties, have been denied by the court. A trial date has been set for June 2007. In addition, there are various related actions, such as requests forre-examination and reissues, pending from time to time in the U.S. Patent andTrademark Office that may or may not have a material effect on theseactions.  We cannot estimate the possibleloss or range of loss, if any, associated with the resolution of thesematters.  There  can be no assurance that the ultimateresolution of these matters will not result in a material adverse effect on ourbusiness, financial condition or results of operations.

In March 2005, Medtronic,Inc. contacted us to express its view that our Protégé stents infringe on oneor more of its patents.  We informedMedtronic that we disagreed with Medtronic’s assertions, and subsequently hadseveral discussions with Medtronic.  Nolawsuit with respect to this matter has been filed.

On March 30, 2005, we wereserved with a complaint by Boston Scientific Corporation and one of itsaffiliates which claims that some of our products, including our SpideRXEmbolic Protection Device, infringe certain of Boston Scientific’spatents.  This action was brought in theUnited States District Court for the District of Minnesota.  Subsequently, we added counterclaims forinfringement of three of our patents, Boston Scientific has added two patentsinto its claims, as well as a claim against us for misappropriation of trade secrets.  We intend to vigorously defend and prosecuterespectively the claims in this action. Because these matters are in early stages, we cannot estimate thepossible loss or range of loss, if any, associated with their resolution.  However, there can be no

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assurance that the ultimate resolution of these matters will not resultin a material adverse effect on our business, financial condition or results ofoperations.

 

The acquisition agreementrelating to our acquisition of Appriva Medical, Inc. contains four milestonesto which payments relate.  The firstmilestone was required by its terms to be achieved by January 1, 2005 in orderto trigger a payment equal to $50 million. We have determined that the first milestone was not achieved by January1, 2005 and that the first milestone is not payable.  On May 20, 2005, Michael Lesh, as anindividual seller of Appriva stock and purporting to represent certain othersellers of Appriva stock, filed a complaint in the Superior Court of the Stateof Delaware with individually specified damages aggregating $70 million andother unspecified damages for several allegations, including that we, alongwith other defendants, breached the acquisition agreement and an impliedcovenant of good faith and fair dealing by willfully failing to take the stepsnecessary to meet the first milestone under the agreement, and thereby alsofailing to meet certain other milestones, and further that one milestone wasactually met.  The complaint also allegesfraud, negligent misrepresentation and violation of state securities laws inconnection with the negotiation of the acquisition agreement.  We believe these allegations are withoutmerit and intend to vigorously defend this action.  The parties have not engaged in anydiscovery. We filed a motion to dismiss the complaint, which the court grantedin June 2006 on standing grounds.  Theplaintiff filed a petition for reargument, which is pending before the trialcourt. In addition, the plaintiff filed an appeal of the court’s dismissalruling, which appeal was subsequently voluntarily dismissed by the plaintiffsince it was procedurally premature in light of the previously filed petitionfor reargument.

On or about November 21,2005, a second lawsuit was filed in Delaware Superior Court relating to theacquisition of Appriva Medical, Inc.  Thenamed plaintiff is Appriva Shareholder Litigation Company, LLC, which accordingto the complaint was formed for the purpose of pursuing claims against us.  The complaint alleges that Erik van der Burgand three unidentified institutional investors have assigned their claims asformer shareholders of Appriva to Appriva Shareholder Litigation Company,LLC.  The complaint alleges specifieddamages in the form of the second milestone payment ($25 million), which isclaimed to be due and payable, and further alleges unspecified damages to beproven at trial.  The complaint allegesthe following claims:  misrepresentation,breach of contract, breach of the implied covenant of good faith and fairdealing and declaratory relief.  Webelieve these allegations and claims are without merit and intend to vigorouslydefend this action.  We have filed amotion to dismiss the complaint.    Themotion is still pending before the court. The plaintiff has served us an initial set of written discovery, and wefiled a motion to stay discovery which motion has been granted, pending theresolution of our motion to dismiss.

Because both of theseAppriva acquisition related matters are in early stages, we cannot estimate thepossible loss or range of loss, if any, associated with their resolution.  However, there can be no assurance that theultimate resolution of these matters will not result in a material adverseeffect on our business, financial condition or results of operations.

On October 11, 2005, apurported stockholder class action lawsuit purportedly on behalf of MTI’sminority shareholders was filed in the Delaware Court of Chancery against MTI,MTI’s directors and us challenging our previously announced exchange offer withMTI.  The complaint alleged thethen-proposed transaction constituted a breach of defendants’ fiduciaryduties.  The complaint sought aninjunction preventing the completion of the transaction with MTI or, if thetransaction were to be completed, rescission of the transaction or rescissorydamages, unspecified damages, costs and attorneys’ fees and expenses.  On January 6, 2006, we completed thetransaction with MTI.  We believe thislawsuit is without merit and plan to defend it vigorously.  However, there can be no assurance that theultimate resolution of this matter will not result in a material adverse effecton our business, financial condition or results of operations.

**13.    Segmentand Geographic Information**

We report and manage ouroperations in two reportable business segments based on similarities in theproducts sold, customer base and distribution system. The cardio peripheraloperating segment includes cardiovascular products which are used to treatcoronary artery disease, atrial fibrillation and other disorders in the heartand peripheral vascular products which are used to treat vascular disease inthe legs, kidney (or renal), neck (or carotid), and generally all vasculardiseases other than in the brain or the heart. The neurovascular operatingsegment includes products that are used to treat vascular disease and disordersin the brain, including aneurysms and arterial-venous malformations. Managementmeasures segment profitability on the basis of gross profit calculated as netsales less

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cost of goods sold excluding amortization of intangible assets. Otheroperating expenses are not allocated to individual operating segments forinternal decision making activities.

 

*Thefollowing is segment information (in thousands):*
|                                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                               | ** ** | **July 2, 2006**       | ** ** | **July 3, 2005**     | ** ** | **July 2, 2006** | ** ** | **July 3, 2005** | ** ** |
| ** **                               | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  sales**                           | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Cardio  Peripheral:**                  | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Stents                                   |       | $                                | 16,020     |                           | $          | 8,781 |   | $ | 29,066 |   | $ | 15,879 |   |
| Thrombectomy and embolic protection |       | 5,642                            |       | 3,223                          |       | 9,679 |   | 6,461 |   |
| Procedural support and other        |       | $                                | 8,919      |                           | 7,204      |   | $ | 17,168 |   | 13,709 |   |
| Total Cardio Peripheral                  |       | $                                | 30,581     |                           | $          | 19,208 |   | $ | 55,913 |   | $ | 36,049 |   |
| ** **                               | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Neurovascular:**                       | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Embolic products                         |       | 9,412                            |       | 4,219                          |       | 16,795 |   | 8,197 |   |
| Neuro access and delivery products  |       | 10,627                           |       | 8,113                          |       | 20,149 |   | 14,976 |   |
| Total Neurovascular                      |       | $                                | 20,039     |                           | $          | 12,332 |   | $ | 36,944 |   | $ | 23,173 |   |
|                                     |       |                             |       |                           |       |   |   |   |   |
| Total net sales                          |       | $                                | 50,620     |                           | $          | 31,540 |   | $ | 92,857 |   | $ | 59,222 |   |
|                                     |       |                             |       |                           |       |   |   |   |   |
| **Gross  profit**                        | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cardio Peripheral                        |       | $                                | 17,208     |                           | $          | 10,314 |   | $ | 30,135 |   | $ | 19,001 |   |
| Neurovascular                            |       | 15,233                           |       | 8,441                          |       | 28,055 |   | 15,327 |   |
| Total                                    |       | $                                | 32,441     |                           | $          | 18,755 |   | $ | 58,190 |   | $ | 34,328 |   |
|                                     |       |                             |       |                           |       |   |   |   |   |
| Gross profit                             |       | $                                | 32,441     |                           | $          | 18,755 |   | $ | 58,190 |   | $ | 34,328 |   |
| Operating  expense                       |       | 46,091                           |       | 47,715                         |       | 96,925 |   | 92,609 |   |
| Loss from operations                     |       | $                                | (13,650    | )                              | $          | (28,960 | ) | $ | (38,735 | ) | $ | (58,281 | ) |

 
|                   | ** ** | **July 2, 2006** | ** ** | **Dec. 31, 2005** | ** ** |
|-------------------|------------|----------------------------|------------|-----------------------------|------------|
| **Total  assets** | ** ** | ** **                 | ** ** | ** **                  | ** ** |
| Cardio Peripheral |       | $                          | 223,404    |                        | $          | 239,255 |   |
| Neurovascular     |       | 127,422                    |       | 57,573                      |       |
| Total             |       | $                          | 350,826    |                        | $          | 296,828 |   |

* *

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*The following table presents net sales andlong-lived assets by geographic area as of and for the three and six months ended July 2, 2006 and July 3, 2005(dollars in thousands):*

 
|                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **           | ** ** | **July 2, 2006**       | ** ** | **July 3, 2005**     | ** ** | **July 2, 2006** | ** ** | **July 3, 2005** | ** ** |
| ** **           | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Geographic  Data** | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  Sales**       | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States        |       | $                                | 30,689     |                           | $          | 15,939 |   | $ | 55,463 |   | $ | 30,060 |   |
| International        |       | 19,931                           |       | 15,601                         |       | 37,394 |   | 29,162 |   |
| Total net sales      |       | $                                | 50,620     |                           | $          | 31,540 |   | $ | 92,857 |   | $ | 59,222 |   |

 
|                          | ** ** | **July 2, 2006** | ** ** | **Dec. 31, 2005** | ** ** |
|--------------------------|------------|----------------------------|------------|-----------------------------|------------|
| **Long-lived  Assets**   | ** ** | ** **                 | ** ** | ** **                  | ** ** |
| United States            |       | $                          | 21,883     |                        | $          | 17,198 |   |
| International            |       | 651                        |       | 679                         |       |
| Total long-lived  assets |       | $                          | 22,534     |                        | $          | 17,877 |   |

 

**14.**          Net Loss Per Share

The following outstanding options were excluded fromthe computation of diluted net loss per share as they had an antidilutive effect.  
| ** ** | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** ** | ** ** | **July 2, 2006**       | ** ** | **July 3, 2005**     | ** ** | **July 2, 2006** | ** ** | **July 3, 2005** | ** ** |
| Options    |       | 6,045,543                        |       | 3,493,961                      |       | 6,045,543 |   | 3,493,961 |   |

 

**15.**          Subsequent Event

As described in note 4, on June 28, 2006, ouroperating subsidiaries, ev3 Endovascular, Inc., ev3 International, Inc. andMicro Therapeutics, Inc., entered into a Loan and Security Agreement withSilicon Valley Bank, consisting of a two-year $30.0 million revolving line ofcredit and a 48-month $7.5 million equipment financing line.  As of July 2, 2006, we had no borrowingsoutstanding under the revolving line of credit or the equipment line.  However, on July 7, 2006, subsequent to theend of the second fiscal quarter, we borrowed $7.5 million under the equipmentline.

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**ITEM 2.**       MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’sDiscussion and Analysis provides material historical and prospectivedisclosures intended to enable investors and other users to assess our results ofoperations and financial condition. Statements that are not historical areforward-looking and involve risks and uncertainties discussed under the heading“Forward-Looking Statements” below. The following discussion of our results ofoperations and financial condition should be read in conjunction with ourconsolidated financial statements and related notes thereto included elsewherein this report.

**Overview**

We are a global medicaldevice company focused on catheter-based, or endovascular, technologies for theminimally invasive treatment of vascular diseases and disorders.  Our broad product portfolio is focused onapplications in each of the three sub-markets of the endovascular devicemarket: peripheral vascular, cardiovascular and neurovascular.  We sell over 100 products consisting of over1,000 SKUs in these markets.  From 2000to 2002, our investor group acquired certain of the assets in our cardioperipheral division to build the foundation of our current peripheral andcardiovascular product portfolios. During this period, our investor group also purchased certainneurovascular assets to expand our neurovascular product portfolio and, througha series of investments, obtained a controlling investment in MicroTherapeutics, Inc., or MTI.  MTI waspreviously our majority owned subsidiary, with the remaining shares beingpublicly held. In January 2006, we acquired the remaining shares of MTI’scommon stock not owned by us, as a result of which MTI became our wholly ownedsubsidiary.  We have dedicatedsignificant capital and management effort to advance our acquired technologiesand broaden our product lines in order to execute our strategies.

We believe the overallmarket for endovascular devices will grow as the demand for minimally invasivetreatment of vascular diseases and disorders continues to increase.  We intend to capitalize on this marketopportunity by the continued introduction of new products.  We expect to originate these new productsprimarily through our internal research and development and clinical efforts,but we may supplement them with acquisitions or other externalcollaborations.  Additionally, our growthhas been, and will continue to be, impacted by our expansion into newgeographic markets and the expansion of our direct sales organization inexisting geographic markets.

We were formed on January28, 2005 as a subsidiary of ev3 LLC. Immediately prior to the consummation of our initial public offering onJune 21, 2005, ev3 LLC was merged with and into us and we completed a one-for-sixreverse stock split of our outstanding common stock.  For additional information regarding ourformation and the related transactions, see Note 2 to our consolidatedfinancial statements included elsewhere in this report.  All share and per share amounts for allperiods presented in this report reflect the reverse stock split of our commonstock.

We report and manage ouroperations in two reportable business segments based on similarities in theproducts sold, customer base and distribution system.  Our cardio peripheral segment containsproducts that are used in both cardiovascular and peripheral vascularprocedures by cardiologists, radiologists and vascular surgeons.  Our neurovascular segment contains productsthat are used primarily by neuroradiologists and neuro surgeons.  Our sales activities and operations arealigned closely with our business segments. We generally have dedicated cardio peripheral sales teams in the UnitedStates and Europe that target customers who often perform procedures in bothanatomic areas (cardiovascular and peripheral vascular).  We generally have separate, dedicatedneurovascular sales teams in the United States and Europe that are specificallyfocused on our neurovascular business customer base.

We have corporate infrastructureand direct sales capabilities in the United States, Canada, Europe and Japanand have established distribution relationships in other internationalmarkets.  Our corporate headquarters andour manufacturing, research and development, and U.S. sales operations for ourperipheral vascular and cardiovascular product lines are located in Plymouth,Minnesota.  Our manufacturing, researchand development, and U.S. sales operations for our neurovascular product linesare located in Irvine, California. Outside of the United States, our primary offices are in Paris, Franceand Tokyo, Japan.  During the three andsix months ended July 2, 2006, approximately 39.4% and 40.3% of our net sales,respectively, were generated outside of the United States, as a result of whichwe are sensitive to risks related to fluctuation in exchange rates and otherrisks associated with international operations, which could affect our businessresults.  Changes in foreign currencyexchange rates had  a negligible impacton second quarter 2006 net sales compared to the second quarter of 2005.

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Since our inception, we have focused on building our U.S. andinternational direct sales and marketing infrastructure that includes aworldwide sales force of approximately 210 representatives as of July 2, 2006in the United States, Canada, Europe and Japan. Our direct sales representatives accounted for approximately 89% of ournet sales during each of the three and six months ended July 2, 2006, with thebalance generated by independent distributors. In order to drive sales growth, we have invested heavily throughout ourhistory in new product development, clinical trials to obtain regulatoryapprovals and the expansion of our global distribution system.  As a result, our costs and expenses havesignificantly exceeded our net sales, resulting in an accumulated deficit of$597.5 million at July 2, 2006. Consequently, we have financed our operationsthrough debt and equity offerings.  Weexpect to continue to generate operating losses for at least the next twelvemonths.

 

Our cash, cashequivalents and short-term investments available to fund our current operationswere $47.2 million at July 2, 2006.  Wecompleted an initial public offering of our common stock on June 21, 2005in which we sold 11,765,000 shares of our common stock at $14.00 per share,resulting in net proceeds to us of approximately $152.7 million, afterdeducting underwriting discounts and commissions and offering expenses.  We used $36.5 million of these net proceedsto repay a portion of the accrued and unpaid interest on certain demand notesheld by Warburg, Pincus Equity Partners, L.P. and certain of its affiliates,which we refer to collectively as Warburg Pincus, and The Vertical Group L.P.and certain of its affiliates, which we refer to collectively as Vertical. Inaddition, on July 20, 2005, we sold 205,800 shares of common stockpursuant to an over-allotment option granted to the underwriters which resultedin net proceeds to us of $2.2 million, after deducting underwriting discountsand commissions and offering expenses. We invested the remaining portion of the net proceeds in short-term,investment-grade, interest bearing securities. We have used these funds for general corporate purposes since ourinitial public offering, and expect to continue to do so.  We expect our cash balances to decrease as wecontinue to use cash to fund our operations.

On June 28, 2006, our operating subsidiaries, ev3Endovascular, Inc., ev3 International, Inc. and Micro Therapeutics, Inc.,entered into a Loan and Security Agreement with Silicon Valley Bank, consistingof a two-year $30.0 million revolving line of credit and a 48-month $7.5million equipment financing line.  As ofJuly 2, 2006, we had no borrowings under the revolving line of credit or theequipment line.  However, on July 7,2006, subsequent to the end of the second fiscal quarter, we borrowed $7.5million under the equipment line for planned equipment purchases related to theexpansion of our manufacturing capabilities.

We believe our cash, cash equivalents, short-terminvestments and funds available under our revolving credit facility will besufficient to meet our liquidity requirements through at least the next twelvemonths.

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**Results of Operations**

 

The following table setsforth, for the periods indicated, our results of operations expressed as dollaramounts (in thousands), and the changes between the specified periods expressedas percent increases or decreases:
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Percent**                | ** ** | **Six Months Ended** | ** ** | **Percent**                | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|----------------------------|------------|--------------------------------|------------|----------------------------|------------|
| **Results of Operations:**                         | ** ** | **July 2, 2006**       | ** ** | **July 3, 2005** | ** ** | **Change**                     | ** ** | **July 2, 2006** | ** ** | **July 3, 2005** | ** ** | **Change** | ** ** |
| Net sales                                                    |       | $                                | 50,620     |                       | $          | 31,540                         |       | 60.5                       | %          | $ | 92,857 |   | $ | 59,222 |   | 56.8 | % |
| Operating  expenses:                                         |       |                             |       |                       |       |                           |       |                       |       |   |   |   |   |
| Cost of goods  sold (a)                                      |       | 18,179                           |       | 12,785                     |       | (42.2                          | )%         | 34,667                     |       | 24,894 |   | (39.3 | )% |
| Sales, general  and  administrative (a)                      |       | 35,808                           |       | 32,297                     |       | (10.9                          | )%         | 73,669                     |       | 64,157 |   | (14.8 | )% |
| Research and  development (a)                                |       | 6,047                            |       | 11,891                     |       | 49.1                           | %          | 12,821                     |       | 22,217 |   | 42.3 | % |
| Amortization of  intangible assets                           |       | 4,282                            |       | 2,548                      |       | (68.1                          | )%         | 8,525                      |       | 5,203 |   | (63.8 | )% |
| (Gain) loss on  sale of assets, net                          |       | (46                              | )          | 111                        |       | 141.4                          | %          | 124                        |       | 164 |   | 24.4 | % |
| Acquired  in-process research and development                |       | —                           |       | 868                        |       | NM                             |       | 1,786                      |       | 868 |   | (105.8 | )% |
| Total operating  expenses                                    |       | 64,270                           |       | 60,500                     |       | (6.2                           | )%         | 131,592                    |       | 117,503 |   | (12.0 | )% |
| Loss from operations                                         |       | (13,650                          | )          | (28,960                    | )          | 52.9                           | %          | (38,735                    | )          | (58,281 | ) | 33.5 | % |
| Other (income) expense:                                      |       |                             |       |                       |       |                           |       |                       |       |   |   |   |   |
| Gain on sale of  investments, net                            |       | (1,063                           | )          | (878                       | )          | 21.1                           | %          | (1,063                     | )          | (4,611 | ) | (76.9 | )% |
| Interest  (income) expense, net                              |       | (514                             | )          | 6,078                      |       | 108.5                          | %          | (1,213                     | )          | 11,786 |   | 110.3 | % |
| Minority  interest in loss of subsidiary                     |       | —                           |       | (705                       | )          | NM                             |       | —                     |       | (726 | ) | NM |   |
| Other (income)  expense, net                                 |       | (1,327                           | )          | 1,828                      |       | 172.6                          | %          | (1,381                     | )          | 2,920 |   | 147.3 | % |
| Loss before income  taxes                                    |       | (10,746                          | )          | (35,283                    | )          | 69.5                           | %          | (35,078                    | )          | (67,650 | ) | 48.1 | % |
| Income tax expense  (benefit)                                |       | 77                               |       | (61                        | )          | NM                             |       | 246                        |       | (59 | ) | NM |   |
| Net loss                                                     |       | (10,823                          | )          | (35,222                    | )          | 69.3                           | %          | (35,324                    | )          | (67,591 | ) | 47.7 | % |
| Accretion of  preferred membership units to redemption value |       | —                           |       | 5,635                      |       | NM                             |       | —                     |       | 12,061 |   | NM |   |
|                                                         |       |                             |       |                       |       |                           |       |                       |       |   |   |   |   |
| Net loss attributable to common holders                      |       | $                                | (10,823    | )                          | $          | (40,857                        | )          | 73.5                       | %          | $ | (35,324 | ) | $ | (79,652 | ) | 55.7 | % |
| Net loss per common  share (basic and diluted) (b)           |       | $                                | (0.19      | )                          | $          | (4.60                          | )          |                       |       | $ | (0.63 | ) | $ | (13.95 | ) |   |   |
| Weighted average shares outstanding (b)                      |       | 56,698,043                       |       | 8,877,898                  |       |                           |       | 56,319,427                 |       | 5,711,852 |   |   |   |

 

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(a)   Includes stock-based compensation charges of:
| Cost of goods sold                 |   | $     | 155    |   | $      | 135    |   |   |   | $     | 369    |   | $ | 247   |   |
|------------------------------------|--------|-------|--------|--------|--------|--------|--------|--------|--------|-------|--------|--------|---|-------|--------|
| Sales, general  and administrative |   | 1,799 |   | 591    |   |   |   | 3,165  |   | 1,045 |   |
| Research and  development          |   | 158   |   | 189    |   |   |   | 372    |   | 434   |   |
|                               |   | $     | 2,112  |   | $      | 915    |   |   |   | $     | 3,906  |   | $ | 1,726 |   |

 

(b)         Net loss per common share attributable tocommon holders and the weighted average common shares outstanding reflect theJune 21, 2005 one-for-six reverse stock split for all periodspresented.

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The following tables set forth, for the periods indicated, our netsales by segment and geography expressed as dollar amounts (in thousands) andthe changes in net sales between the specified periods expressed aspercentages:

 
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Percent**                | ** ** | **Six Months Ended** | ** ** | **Percent**                | ** ** |
|------------------------------------------|------------|----------------------------------|------------|----------------------------|------------|--------------------------------|------------|----------------------------|------------|
| **NET SALES BY SEGMENT:** | ** ** | **July 2, 2006**       | ** ** | **July 3, 2005** | ** ** | **Change**                     | ** ** | **July 2, 2006** | ** ** | **July 3,2005** | ** ** | **Change** | ** ** |
| **Cardio Peripheral:**                   | ** ** | ** **                       | ** ** | ** **                 | ** ** | ** **                     | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Stents                                   |       | $                                | 16,020     |                       | $          | 8,781                          |       | 82.4                       | %          | $ | 29,066 |   | $ | 15,879 |   | 83.0 | % |
| Thrombectomy and  embolic protection     |       | 5,642                            |       | 3,223                      |       | 75.1                           | %          | 9,679                      |       | 6,461 |   | 49.8 | % |
| Procedural  support                      |       | 8,919                            |       | 7,204                      |       | 23.8                           | %          | 17,168                     |       | 13,709 |   | 25.2 | % |
| Total Cardio  Peripheral                 |       | $                                | 30,581     |                       | $          | 19,208                         |       | 59.2                       | %          | $ | 55,913 |   | $ | 36,049 |   | 55.1 | % |
|                                     |       |                             |       |                       |       |                           |       |                       |       |   |   |   |   |
| **Neurovascular:**                       | ** ** | ** **                       | ** ** | ** **                 | ** ** | ** **                     | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Embolic products                         |       | 9,412                            |       | 4,219                      |       | 123.1                          | %          | 16,795                     |       | 8,197 |   | 104.9 | % |
| Neuro access and  delivery products      |       | 10,627                           |       | 8,113                      |       | 31.0                           | %          | 20,149                     |       | 14,976 |   | 34.5 | % |
| Total  Neurovascular                     |       | $                                | 20,039     |                       | $          | 12,332                         |       | 62.5                       | %          | $ | 36,944 |   | $ | 23,173 |   | 59.4 | % |
|                                     |       |                             |       |                       |       |                           |       |                       |       |   |   |   |   |
| Total                                    |       | $                                | 50,620     |                       | $          | 31,540                         |       | 60.5                       | %          | $ | 92,857 |   | $ | 59,222 |   | 56.8 | % |

 
| ** **                                 | ** ** | **Three Months Ended** | ** ** | **Percent**                | ** ** | **Six Months Ended** | ** ** | **Percent**                | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|----------------------------|------------|--------------------------------|------------|----------------------------|------------|
| **NET SALES BY GEOGRAPHY:** | ** ** | **July 2, 2006**       | ** ** | **July 3, 2005** | ** ** | **Change**                     | ** ** | **July 2, 2006** | ** ** | **July 3, 2005** | ** ** | **Change** | ** ** |
| United States                              |       | $                                | 30,689     |                       | $          | 15,939                         |       | 92.5                       | %          | $ | 55,463 |   | $ | 30,060 |   | 84.5 | % |
| International                              |       |                             |       |                       |       |                           |       |                       |       |   |   |   |   |
| Before foreign exchange  impact            |       | 19,912                           |       | 15,601                     |       | 27.6                           | %          | 38,550                     |       | 29,162 |   | 32.2 | % |
| Foreign exchange  impact                   |       | 19                               |       | —                     |       | —                         |       | (1,156                     | )          | — |   | — |   |
| Total                                      |       | 19,931                           |       | 15,601                     |       | 27.8                           | %          | 37,394                     |       | 29,162 |   | 28.2 | % |
| Total                                      |       | $                                | 50,620     |                       | $          | 31,540                         |       | 60.5                       | %          | $ | 92,857 |   | $ | 59,222 |   | 56.8 | % |

 

***Comparison of the Three Months Ended July 2, 2006 to theThree Months Ended July 3, 2005***

*Netsales*.  Net salesincreased 60.5% to $50.6 million in the three months ended July 2, 2006compared to $31.5 million in the three months ended July 3, 2005, primarily asa result of continued improvements in sales force productivity and increasedmarket penetration of products introduced during the past 18 months.  We introduced two new products in the firstquarter 2006 and one new product in the second quarter 2006.  We expect to introduce additional newproducts during the remainder of the year.

*Netsales of cardio peripheral products*.  Net sales of cardio peripheral productsincreased 59.2% to $30.6 million in the three months ended July 2, 2006compared to $19.2 million in the three months ended July 3, 2005.  This sales growth was primarily the result ofsales growth in our stent products and sales of our SpideRX Embolic ProtectionDevice.  Net sales in our stent productline increased 82.4% to $16.0 million in the three months ended July 2, 2006compared to $8.8 million in the three months ended July 3, 2005.  This increase is attributable to increasedmarket penetration of the Protégé, Primus and ParaMount Mini families ofstents, partially offset by sales declines in older generation products.  Net sales of our thrombectomy and embolicprotection devices increased 75.1%, or $2.4 million, to $5.6 million in thethree months ended July 2, 2006 compared to the same period in 2005, largelydue to increased market penetration of the SpideRX internationally and thelaunch of SpideRX in the United States, partially offset by sales declines inolder generation products.  Net sales ofour procedural support and other products increased 23.8% to $8.9 million inthe three months ended July 2, 2006 compared to $7.2 million in the threemonths ended July 3, 2005, largely due to the increased market penetration ofPTA balloon catheters in the United States. We expect cardio peripheral net sales to increase during the remainderof 2006 as a result of new product introductions and continued marketpenetration of products released during the past 18 months.

*Netsales of neurovascular products*.  Net sales of our neurovascular productsincreased 62.5% to $20.0 million in the three months ended July 2, 2006compared to $12.3 million in the three months ended July 3, 2005, primarily asa result of increased penetration of existing products and sales growth invirtually all of our neurovascular access and delivery products. Net sales ofour embolic products increased 123.1%, or $5.2 million, to $9.4 million in thethree months ended July 2, 2006 compared to the same period in 2005, primarilydue to increased market penetration of our Nexus coil and Onyx Liquid EmbolicSystem for the treatment of brain arterial-venous malformations, partiallyoffset by sales declines in older generation products.  Sales of our neuro access and deliveryproducts increased 31.0%, or $2.5 million, to $10.6 million in the three monthsended July 2, 2006 compared to the

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same period in 2005,largely as a result of volume increases across most product lines, includingthe Echelon microcatheters, the Marathon microcatheter and theHyperForm and HyperGlide occlusion balloon systems.

*Netsales by geography*. Net sales in the United States increased 92.5% to $30.7 million in thethree months ended July 2, 2006 compared to $15.9 million in the three monthsended July 3, 2005. International net sales increased 27.8% to $19.9 million inthe three months ended July 2, 2006 compared to $15.6 million in the threemonths ended July 3, 2005 and represented 39.4% and 49.5% of our total netsales during the three months ended July 2, 2006 and July 3, 2005,respectively.

*Cost ofgoods sold*.  As apercentage of net sales, cost of goods sold decreased to 35.9% of net sales inthe three months ended July 2, 2006 compared to 40.5% of net sales in the threemonths ended July 3, 2005.  This decreasewas primarily attributable to our continued growth in sales volume, theconsolidation of  manufacturingfacilities during the second quarter of 2005 and on going investments inin-house manufacturing capabilities.  Inour cardio peripheral segment, cost of goods sold as a percent of net salesdecreased to 43.7% in the three months ended July 2, 2006 compared to 46.3% inthe three months ended July 3, 2005 primarily attributable to increased salesvolume.  In our neurovascular segment,cost of goods sold as a percent of net sales decreased to 24.0% in the threemonths ended July 2, 2006 compared to 31.6% in the three months ended July 3,2005 due in part to  the consolidation ofour neurovascular manufacturing operations into our Irvine, California facilityduring the second quarter of 2005.  Ourincreased production volumes and ongoing cost savings programs also contributedto the decrease. We expect cost of goods sold as a percentage of net sales toshow modest improvement during the remainder of 2006 due to higher volume inour manufacturing facilities and efficiency improvements from manufacturing initiatives,offset in part by anticipated conversion costs associated with new productlaunches occurring during 2006.

*Sales,general and administrative expense*.  Sales, general and administrative expensesincreased 10.9% to $35.8 million in the three months ended July 2, 2006compared to $32.3 million in the three months ended July 3, 2005.  The increase was partially due to higherselling expenses related to new product introductions, a $1.2 million increasein non-cash stock-based compensation costs and a $585 thousand increase inseverance related costs.  We expectsales, general and administrative expenses, excluding litigation relatedcharges, for each of the remaining quarters of 2006 to remain consistent or todecline slightly as compared to second quarter 2006.

*Researchand development*. Research and development expense decreased 49.1% to $6.0 million in thethree months ended July 2, 2006 compared to $11.9 million in the three monthsended July 3, 2005.  This reduction wasdue to a decreases in clinical study expenses related to the completion ofcertain clinical trials in 2005, which was partially offset by increasedspending on certain internal development efforts.  We expect research and development expense asa percentage of net sales to increase as compared to second quarter 2006.

*Amortizationof intangible assets*. Amortization of intangible assets increased 68.1% to $4.3 million in thethree months ended July 2, 2006 compared to $2.5 million in the three monthsended July 3, 2005 primarily due to increases in intangible assets recorded aspart of our acquisition of the remaining minority shares of MTI in January2006.   We expect amortization ofintangible assets for the remaining quarters of 2006 to remain consistent withfirst and second quarter 2006 levels.

*Acquiredin-process research and development*.  We did not incur charges for acquiredin-process research and development during the three months ended July 2,2006.  During the three months ended July3, 2005, we incurred a charge of $868 thousand for acquired in-process researchand development as a result of the May 2005 contribution of MTI shares to us byVertical.

*Gain onsale of investments, net*. Gain on sale of investments, net was $1.1 million in the three monthsended July 2, 2006.  We received a finalmilestone payment of $910 thousand related to the 2002 sale of our investmentin Enteric Medical Technologies, Inc. and a $153 thousand milestone paymentrelated to the 2005 sale of our investment in Genyx Medical, Inc.  Gain on sale of investments, net was $878thousand in the three months ended July 3, 2005 and was the result of ourreceipt of an earlier milestone payment relating to the 2002 sale of ourinvestment in Enteric Medical Technologies, Inc.

*Interest(income) expense, net*. Net interest income was $514 thousand in the three months ended July 2,2006 compared to net interest expense of $6.1 million in the three monthsended July 3, 2005.   A portion of theproceeds

23

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from our initial public offering in June 2005 was invested in short-term,investment-grade, interest-bearing securities contributing interest incomeduring the full second quarter of 2006 versus only a portion of the secondquarter of 2005.  We also used a portionof the proceeds to reduce our financing balance to zero resulting in thereduction of interest expense.

 

*Other(income) expense, net*. Other income was $1.3 million in the three months ended July 2, 2006compared to other expense of $1.8 million in the three months ended July 3,2005.  The other (income) expense in thethree months ended July 2, 2006 and July 3, 2005 was primarily due to foreignexchange gains and losses.

*Incometax expense(benefit)*. We incurred modest levels of income tax expense in the three monthsended July 2, 2006 and modest levels of income tax benefit in the three monthsended July 3, 2005 related to certain European sales offices.  We recorded no provision for U.S. incometaxes in either the three months ended July 2, 2006 or July 3, 2005 due to ourhistory of operating losses.

*Accretionof preferred membership units to redemption value*.  Accretion of preferred membership units toredemption value was recorded up to the date of our initial public offering inJune 2005 at which time all preferred units were converted into common shares.

***Comparison of the Six Months Ended July 2, 2006 to the SixMonths Ended July 3, 2005***

*Netsales*.  Net salesincreased 56.8% to $92.9 million in the six months ended July 2, 2006 comparedto $59.2 million in the six months ended July 3, 2005, primarily as a result ofcontinued improvements in sales force productivity and increased marketpenetration of products introduced during the past 18 months.  We introduced two new products in the firstquarter 2006 and one new product in the second quarter 2006.

*Net salesof cardio peripheral products*.  Net sales of cardio peripheral productsincreased 55.1% to $55.9 million in the six months ended July 2, 2006 comparedto $36.0 million in the six months ended July 3, 2005.  This sales growth was primarily the result ofsales growth in our stent products and sales of our PTA balloon catheters inthe United States.  Net sales in ourstent product line increased 83.0% to $29.1 million in the six months endedJuly 2, 2006 compared to $15.9 million in the six months ended July 3,2005.  This increase is attributable toincreased market penetration of the Protégé, Primus and ParaMount Mini familiesof stents, partially offset by sales declines in older generation products.  Net sales of our thrombectomy and embolicprotection devices increased 49.8%, or $3.2 million, in the six months endedJuly 2, 2006 compared to the same period in 2005, largely due to increasedmarket penetration of the SpideRX internationally and the launch of SpideRX inthe United States, partially offset by sales declines in older generationproducts.  Net sales of our proceduralsupport and other products increased 25.2% to $17.2 million in the six monthsended July 2, 2006 compared to $13.7 million in the six months ended July 3,2005, largely due to the increased market penetration of PTA balloon cathetersin the United States.

*Netsales of neurovascular products*.  Net sales of our neurovascular productsincreased 59.4% to $36.9 million in the six months ended July 2, 2006 comparedto $23.2 million in the six months ended July 3, 2005, primarily as a result ofincreased penetration of existing products and sales growth in virtually all ofour neurovascular access and delivery products. Net sales of our embolicproducts increased 104.9%, or $8.6 million, to $16.8 million in the six monthsended July 2, 2006 compared to the same period in 2005, primarily due toincreased market penetration of our Nexus coil and Onyx Liquid Embolic Systemfor the treatment of brain arterial-venous malformations, partially offset bysales declines in older generation products. Sales of our neuro access anddelivery products increased 34.5%, or $5.2 million, to $20.1 million in the sixmonths ended July 2, 2006 compared to the same period in 2005, largely as aresult of volume increases across multiple product lines, including the Echelonmicrocatheters, the Marathon microcatheter and the HyperForm andHyperGlide occlusion balloon systems.

*Netsales by geography*. Net sales in the United States increased 84.5% to $55.5 million in thesix months ended July 2, 2006 compared to $30.1 million in the six months endedJuly 3, 2005. International net sales also increased 28.2% to $37.4 million inthe six months ended July 2, 2006 compared to $29.2 million in the six monthsended July 3, 2005 and represented 40.3% and 49.2% of our total net salesduring the six months ended July 2, 2006 and July 3, 2005, respectively.

24

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*Cost of goods sold*.  As a percentage of net sales, cost of goodssold decreased to 37.3% of net sales in the six months ended July 2, 2006compared to 42.0% of net sales in the six months ended July 3, 2005.  This decrease was primarily attributable toour continued growth in sales volume, the consolidation of  manufacturing facilities during the secondquarter of 2005 and on going investments in in-house manufacturing capabilities.  In our cardio peripheral segment, cost ofgoods sold as a percent of net sales decreased to 46.1% in the six months endedJuly 2, 2006 compared to 47.3% in the six months ended July 3, 2005 primarilyattributable to increased production volumes. In our neurovascular segment,cost of goods sold as a percent of sales decreased to 24.1% in the six monthsended July 2, 2006 compared to 33.9% in the six months ended July 3, 2005 duein part to the  consolidation of ourneurovascular manufacturing operations into our Irvine, California facilityduring the second quarter of 2005.  Ourincreased production volumes and ongoing cost savings programs also contributedto the decrease.

 

*Sales,general and administrative expense*.  Sales, general and administrative expensesincreased 14.8% to $73.7 million in the six months ended July 2, 2006 comparedto $64.2 million in the six months ended July 3, 2005.  The increase was partially due to $4.1million of charges incurred during the first six months of 2006 related tolitigation and business development activities that represents a higher levelthan our historical level.  Higherselling expenses related to new product introductions and a $2.1 millionincrease in non-cash stock-based compensation costs also contributed to theincrease in the six months ended July 2, 2006.

*Researchand development*. Research and development expense decreased 42.3% to $12.8 million in thesix months ended July 2, 2006 compared to $22.2 million in the six months endedJuly 3, 2005.  This reduction was due toa $7.8 million decrease in clinical study expenses related to thecompletion of certain clinical trials in 2005, which was partially offset byincreased spending on certain internal development efforts.

*Amortizationof intangible assets*. Amortization of intangible assets increased 63.8% to $8.5 million in thesix months ended July 2, 2006 compared to $5.2 million in the six months endedJuly 3, 2005 primarily due to increases in intangible assets recorded as partof the May 2005 contribution of MTI shares and due to our acquisition of theremaining minority shares of MTI in January 2006.

*Acquiredin-process research and development*.  During the six months ended July 2, 2006, weincurred a charge of $1.8 million for acquired in-process research anddevelopment as a result of our acquisition of the outstanding shares of MTIthat we did not already own.  We incurreda charge of $868 thousand for acquired in-process research and developmentduring the six months ended July 3, 2005 related to the May 2005 contributionof MTI shares.

*Gain onsale of investments, net*. Gain on sale of investments, net was $1.1 million in the six monthsended July 2, 2006. We received a final $910 thousand milestone payment relatedto the 2002 sale of our investment in Enteric Medical Technologies, Inc. and a$153 thousand milestone payment related to the 2005 sale of our investment inGenyx Medical, Inc..  Gain on sale of investments,net was $4.6 million in the six months ended July 3, 2005 related to earliermilestone payments received from the sale of our investments in Genyx Medical,Inc. and Enteric Medical Technologies, Inc.

*Interest(income) expense, net*. Net interest income, was $1.2 million in the six months ended July 2,2006 compared to net interest expense of $11.8 million in the six monthsended July 3, 2005.   A portion of theproceeds from our initial public offering in June 2005 were invested in short-term,investment-grade, interest-bearing securities contributing interest incomeduring the full six months ended July 2, 2006 versus only a portion of the sixmonths ended July 3, 2005 .  We also useda portion of the proceeds to reduce our financing balance to zero resulting inthe reduction of interest expense.

*Other(income) expense, net*. Other income was $1.4 million in the six months ended July 2, 2006compared to other expense of $2.9 million in the six months ended July 3,2005.  The other (income) expense in thesix months ended July 2, 2006 and July 3, 2005 was primarily due to foreignexchange gains and losses.

*Incometax expense(benefit)*. We incurred modest levels of income tax in the six months ended July 2,2006 and modest levels of income tax benefit in the six months ended July 3,2005 related to certain European sales offices. We recorded no provision for U.S. income taxes in either the sixmonths ended July 2, 2006 or July 3, 2005 due to our history of operatinglosses.

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*Accretion of preferred membershipunits to redemption value*. Accretion of preferred membership units to redemption value was recordedup to the date of our initial public offering in June 2005 at which time allpreferred units were converted into common shares.

 

**Liquidity and Capital Resources**
| Balance Sheet Data     | ** ** | **July 2, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------|------------|----------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **(in thousands)**    | ** ** |
| Cash and cash  equivalents       |       | $                          | 28,783     |                            | $          | 69,592 |   |
| Short-term  investments          |       | 18,450                     |       | 12,000                          |       |
| Total current  assets            |       | 127,118                    |       | 151,675                         |       |
| Total assets                     |       | 350,826                    |       | 296,828                         |       |
| Total current  liabilities       |       | 37,228                     |       | 37,671                          |       |
| Total  liabilities               |       | 37,843                     |       | 38,523                          |       |
| Total stockholders’  equity |       | 312,983                    |       | 245,455                         |       |
|                                  |            |                            |            |                                 |            |  |  |

 

*Financinghistory.*  We havegenerated significant operating losses since our inception.  These operating losses, including cumulativenon-cash charges for acquired in-process research and development of $128.7million, have resulted in an accumulated deficit of $597.5 million as of July2, 2006. We completed an initial public offering of our common stock onJune 21, 2005 in which we sold 11,765,000 shares of our common stock at$14.00 per share, resulting in net proceeds to us of approximately $152.7million, after deducting underwriting discounts and commissions and offeringexpenses.  We used $36.5 million of thesenet proceeds to repay a portion of the accrued and unpaid interest on certaindemand notes held by Warburg Pincus and Vertical.  In addition, on July 20, 2005, we sold205,800 shares of common stock pursuant to an over-allotment option granted tothe underwriters which resulted in net proceeds to us of $2.2 million, afterdeducting underwriting discounts and commissions and offering expenses.  We invested the remaining portion of the netproceeds in short-term, investment-grade, interest-bearing securities.  We have used these funds for generalcorporate purposes since our initial public offering and expect to continue todo so.  See Part 2, Item 2 under theheading Use of Proceeds included within this report.

*Cash,cash equivalents and short-term investments.*Our cash, cashequivalents and short-term investments available to fund current operationstotaled approximately $47.2 million at July 2, 2006, a decrease of $34.4million from December 31, 2005.  Weexpect our cash balances to continue to decrease as we use cash to fund ouroperations.

*Credit facility.*  On June 28, 2006, our operating subsidiaries,ev3 Endovascular, Inc., ev3 International, Inc. and Micro Therapeutics, Inc.,which we refer to as the “borrowers”, entered into a Loan and SecurityAgreement, which we refer to as the loan agreement,  with Silicon Valley Bank, or SVB, consistingof a two-year $30.0 million revolving line of credit and a 48-month $7.5million equipment financing line. Pursuant to the terms of the Loan Agreement and subject to specifiedreserves, we may borrow under the revolving line of credit up to $12 millionwithout any borrowing base limitations. Aggregate borrowings under therevolving line of credit that exceed $12 million will subject the revolvingline to borrowing base limitations. These limitations allow us to borrow, subject to specified reserves upto 80% of eligible domestic and foreign accounts receivables plus up to 30% ofeligible inventory.  Additionally,borrowings against the eligible inventory may not exceed the lesser of 33% ofthe amount advanced against accounts receivable or $7.5 million.  Borrowings under the revolving line bearinterest at a variable rate equal to SVB’s prime rate.  Borrowings under the equipment line bearinterest at a variable rate equal to SVB’s prime rate plus 1.0%.   Accrued interest on any outstanding balanceunder the revolving line is payable monthly in arrears.  Amounts outstanding under the equipment lineas of December 31, 2006 will be payable in 42 consecutive equal monthlyinstallments of principal, beginning on January 31, 2007.   As of July 2, 2006, we had no borrowingsunder the revolving line of credit or the equipment line.  However, on July 7, 2006, subsequent to theend of the second fiscal quarter, we borrowed $7.5 million under the equipmentline for planned equipment purchases related to the expansion of ourmanufacturing capabilities.

Both the revolving line ofcredit and equipment financing are secured by a first priority securityinterest in substantially all of our assets, excluding intellectual property,which is subject to a negative pledge, and are

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guaranteed by ev3 Inc. and all of our domestic direct and indirectsubsidiaries. The loan agreement requires the borrowers to maintain a specifiedliquidity ratio and a tangible net worth level. The loan agreement imposes certain limitations on the borrowers, theirsubsidiaries and ev3, including without limitation, on their ability to: (i)transfer all or any part of their business or properties; (ii) permit or suffera change in control; (iii) merge or consolidate, or acquire any entity; (iv)engage in any material new line of business; (v) incur additional indebtednessor liens with respect to any of their properties; (vi) pay dividends or makeany other distribution on or purchase of, any of their capital stock; (vii)make investments in other companies; or (viii) engage in related partytransactions, subject in each case to certain exceptions and limitations.  The loan agreement requires us to maintain ondeposit or invested with SVB or its affiliates the lesser of $15.0 million or50% of our aggregate cash and cash equivalents. The borrowers are required to pay customary fees with respect to thefacility, including a fee on the average unused portion of the revolving line.

 

The loan agreement contains customary events ofdefault, including the failure to make required payments, the failure to complywither certain covenants or other agreements, the occurrence of a materialadverse change, failure to pay certain other indebtedness and certain events ofbankruptcy or insolvency. Upon the occurrence and continuation of an event ofdefault, amounts due under the loan agreement may be accelerated.

We believe our cash, cashequivalents, short-term investments and funds available under our revolving creditfacility will be sufficient to meet our liquidity requirements through at leastthe next 12 months.

*Operatingactivities.*  Cash usedin operations during the six months ended July 2, 2006 was $31.4 million,reflecting primarily our net loss and increased working capital requirementsduring the period.  Our net loss includedapproximately $16.8 million of non-cash charges for depreciation andamortization, acquired in-process research and development and stock-basedcompensation expense.  We expect that operationswill continue to use cash during the remainder of 2006.

*Investingactivities. *Cash usedin investing activities during the six months ended July 2, 2006 was $13.5million primarily due to the purchase of $6.8 million of short-term investmentsand the purchase of $7.4 million of property and equipment.  Historically, our capital expenditures haveconsisted of purchased manufacturing equipment, research and testing equipment,computer systems and office furniture and equipment.  We expect to continue to make investments inproperty and equipment and to incur approximately an additional $11.0 millionin capital expenditures during the balance of 2006.

*Financingactivities. *Cashprovided by financing activities was $3.8 million during the six months endedJuly 2, 2006, generated primarily from proceeds of stock option exercises.

*Contractualcash obligations. *Ourcontractual cash obligations as of December 31, 2005 are set forth in ourannual report on Form 10-K for the year ended December 31, 2005. Therehave been no material changes in our contractual cash obligations andcommercial commitments since December 31, 2005, except for additionalcommitments of approximately $2.0 million and $1.5 million in the years endedDecember 31, 2006 and 2007, respectively, for financed insurance premiums asdescribed in more detail in Note 12 to our consolidated financial statementsincluded elsewhere in this report.

*Otherliquidity information. *Theacquisition agreements relating to our purchase of MitraLife, ApprivaMedical, Inc. and Dendron GmbH require us to make additional payments tothe sellers of these businesses if certain milestones related to regulatorysteps in the product commercialization process are achieved.  The potential milestone payments total $25.0million, $175.0 million and $15.0 million with respect to the MitraLife,Appriva and Dendron acquisitions, respectively, during the period of 2003 to2009.  We do not believe it is likelythat we will have obligations with respect to the MitraLife milestones in thefuture.  We have determined that thefirst milestone with respect to the Appriva agreement was not achieved by theJanuary 1, 2005 milestone date and that the first milestone is notpayable.  On September 27, 2005, weannounced that we had decided to discontinue the development andcommercialization of our PLAATO device, which is the technology we acquired inthe Appriva transaction.  Although werecently had obtained conditional approval from the FDA for an InvestigationalDevice Exemption (“IDE”) clinical trial for the PLAATO device, we determinedthat, due to the time, cost and risk of enrollment, the trial design ultimatelymandated by the FDA was not commercially feasible for us at such time.  We continue to keep all of our options openwith regard to the future of the PLAATO technology, which may include a

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sale or licensing of the technology to third parties.  Under the terms of the stock purchaseagreement we entered into in connection with our acquisition of Dendron, we maybe required to make additional payments which are contingent upon Dendronproducts achieving certain revenue targets between 2003 and 2008. In 2003, the$4.0 million revenue target for sales of Dendron products during 2003 was met.  Accordingly, an additional payment to theformer Dendron stockholders of $3.75 million was made in 2004.  In 2004, the $5.0 million revenue target forsales of Dendron products during 2004 was met. Accordingly, a payment to theformer Dendron stockholders of $3.75 million was accrued in 2004 and was paidduring the second quarter of 2005.  Wemay be required to make a final payment of $7.5 million, which is contingentupon Dendron products achieving annual revenues of $25 million in any yearduring the period between 2003 and 2008. Any such final payment would be due in the year following the year oftarget achievement.

 

Our future liquidity andcapital requirements will be influenced by numerous factors, including extentand duration of future operating losses, the level and timing of future salesand expenditures, the results and scope of ongoing research and productdevelopment programs, working capital to support our sales growth, receipt ofand time required to obtain regulatory clearances and approvals, sales andmarketing programs, continuing acceptance of our products in the marketplacecompeting technologies, market and regulatory developments, and the futurecourse of intellectual property litigation. We believe that the resources generated from our initial publicoffering, together with funds available under our revolving credit facility,are sufficient to meet our liquidity requirements through at least the next 12months. In the event that we require additional working capital to fund futureoperations and any future acquisitions, we may negotiate a financingarrangement with an independent institutional lender, sell notes to public orprivate investors or sell additional shares of stock or other equitysecurities.  There is no assurance thatany financing transaction will be available on terms acceptable to us, or atall, or that any financing transaction will not be dilutive to our currentstockholders.  If we require additionalworking capital, but are not able to raise additional funds, we may be requiredto significantly curtail or cease ongoing operations.  From time to time, we may also sell a giventechnology or intellectual property having a development timeline ordevelopment cost that is inconsistent with our investment horizon or which doesnot adequately complement our existing product portfolio.  See Note 4 and Note 12 to our consolidatedfinancial statements included elsewhere in this report.

**Critical Accounting Policies and Estimates**

We have adopted variousaccounting policies to prepare our consolidated financial statements inaccordance with U.S. GAAP. Our most significant accounting policies aredescribed in Note 3 to our audited consolidated financial statements includedin our annual report on Form 10-K for the year ended December 31, 2005.  The preparation of our consolidated financialstatements in conformity with U.S. GAAP requires us to make estimates andassumptions that affect the amounts reported in our consolidated financialstatements and accompanying notes.  Our estimatesand assumptions, including those related to bad debts, inventories, intangibleassets, sales returns and discounts, and income taxes are updated asappropriate.

Certain of our morecritical accounting policies require the application of significant judgment bymanagement in selecting the appropriate assumptions for calculating financialestimates.  By their nature, thesejudgments are subject to an inherent degree of uncertainty.  These judgments are based on our historicalexperience, terms of existing contracts, our observance of trends in theindustry, information provided by our physician customers and informationavailable from other outside sources, as appropriate.  Different, reasonable estimates could havebeen used in the current period. Additionally, changes in accounting estimates are reasonably likely tooccur from period to period. Both of these factors could have a material impacton the presentation of our financial condition, changes in financial conditionor results of operations.

We believe that thefollowing financial estimates are both important to the portrayal of ourfinancial condition and results of operations and require subjective or complexjudgments.  Further, we believe that theitems discussed below are properly recorded in our consolidated financialstatements for all periods presented. Management has discussed the development, selection and disclosure ofour most critical financial estimates with the audit committee of our board ofdirectors and our independent registered public accounting firm.  The judgments about those financial estimatesare based on information available as of the date of our consolidated financialstatements.  Those financial estimatesinclude:

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***Revenue Recognition***

 

We recognize revenue inaccordance with SEC Staff Accounting Bulletin No. 101, Revenue Recognitionin Financial Statements, which requires that four basic criteria must be metbefore sales can be recognized: (1) persuasive evidence of an arrangementexists; (2) delivery has occurred or services have been rendered;(3) the price is fixed or determinable and (4) collectibility isreasonably assured.  These criteria aremet at the time of shipment when risk of loss and title passes to the customeror distributor, unless a consignment arrangement exists. Sales from consignmentarrangements are recognized upon written acknowledgement that the product hasbeen used by the customer indicating that a sale is complete.  Our terms of sale for regular sales aretypically FOB shipping point, net 30 days. Regular sales include orders from customers for replacement of customerstock, replenishment of consignment product used by customers, orders for ascheduled case/surgery and stocking orders.

We allow customers toreturn defective or damaged products for credit.  Our estimate for sales returns is based uponcontractual commitments and historical return experience which we analyze bygeography and is recorded as a reduction of sales for the period in which therelated sales occurred.  Historically, ourreturn experience has been low with return rates approximating 3.0% of our netsales.

***Stock-Based Compensation***

We currently use theBlack-Scholes option pricing model to determine the fair value of stock optionsand other equity incentive awards. The determination of the fair value ofstock-based compensation awards on the date of grant using an option-pricingmodel is affected by our stock price, as well as assumptions regarding a numberof complex and subjective variables which include the expected life of theaward, the expected stock price volatility over the expected life of theawards, expected dividend yield, risk-free interest rate and the forfeiturerate.

We estimate the expectedterm of options based upon our historical experience. We estimated expectedstock price volatility based upon historical volatility of our common stockwhich is substantially equivalent to volatility rates as measured against a setof guideline companies.  The guidelinecompanies consist of public and recently public medical technologycompanies.  The risk-free interest ratewas determined using U.S. Treasury rates appropriate for the expected term.Dividend yield is estimated to be zero as we have never paid dividends and haveno plans of doing so in the future.

We estimate forfeituresat the time of grant and revise those estimates in subsequent periods if actualforfeitures differ from those estimates. We use historical data to estimateforfeitures and record stock-based compensation expense only for those awardsthat are expected to vest. All stock-based compensation is amortized on astraight-line basis over the respective requisite service periods, which aregenerally the vesting periods.

If factors change and weemploy different assumptions for estimating stock-based compensation expense infuture periods, the future periods may differ significantly from what we haverecorded in the current period and could materially affect our results ofoperations. It may also result in a lack of comparability with other companiesthat use different models, methods and assumptions.

The Black-Scholesoption-pricing model was developed for use in estimating the fair value oftraded options that have no vesting restrictions and are fully transferable,characteristics not present in our option grants. Existing valuation models,including the Black-Scholes and lattice binomial models, may not providereliable measures of the fair values of our stock-based compensation.Consequently, there is a risk that our estimates of the fair values of ourstock-based compensation awards on the grant dates may bear little resemblanceto the actual values realized upon the exercise, expiration, early terminationor forfeiture of those stock-based awards in the future. Certain stock-basedpayments, such as employee stock options, may expire worthless or otherwiseresult in zero intrinsic value as compared to the fair values originallyestimated on the grant date and reported in our financial statements.Alternatively, value may be realized from these instruments that issignificantly higher than the fair values originally estimated on the grantdate and reported in our financial statements. There is not currently amarket-based mechanism or other practical application to verify the reliabilityand accuracy of the estimates stemming from these valuation models.

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The guidance in SFAS 123(R) and SAB 107 is relatively new. Theapplication of these principles may be subject to further interpretation andrefinement over time. See Note 3 to our consolidated financial statements forfurther information regarding our SFAS 123(R) disclosures.

 

***Allowance forDoubtful Accounts***

We make judgments as toour ability to collect outstanding receivables and provide allowance for aportion of receivables when collection becomes doubtful.  Provisions are made based upon a specificreview of all significant outstanding account balances and the overall qualityand age of those balances not specifically reviewed.  In determining the provision for invoices notspecifically reviewed, we analyze historical collection experience and currenteconomic trends.  If the historical dataused to calculate the allowance provided for doubtful accounts does not reflectour future ability to collect outstanding receivables or if the financialcondition of customers were to deteriorate, resulting in impairment of theirability to make payments, an increase in the provision for doubtful accountsmay be required.  We maintain a largecustomer base that mitigates the risk of concentration with one customer.  However, if the overall condition of thehealth care industry were to deteriorate, resulting in an impairment of ourcustomers’ ability to make payments, significant additional allowances could berequired.

Our accounts receivablebalance was $36.0 million and $28.5 million, net of accounts receivableallowances, comprised of both allowances for doubtful accounts and salesreturns, of $3.7 million and $3.6 million at July 2, 2006 andDecember 31, 2005, respectively.

***Excess andObsolete Inventory***

We calculate an inventoryreserve for estimated obsolescence or excess inventory based on historicalturnover and assumptions about future demand for our products and marketconditions.  Our industry ischaracterized by regular new product development, and as such, our inventory isat risk of obsolescence following the introduction and development of new orenhanced products.  Our estimate andassumptions for excess and obsolete inventory are reviewed and updated on aquarterly basis.  The estimates we usefor demand are also used for near-term capacity planning and inventorypurchasing and are consistent with our sales forecasts. Future productintroductions and related inventories may require additional reserves basedupon changes in market demand or introduction of competing technologies.  Increases in the reserve for excess andobsolete inventory result in a corresponding expense to cost of goodssold.  Our reserve for excess andobsolete inventory was $4.3 million and $4.0 million at July 2, 2006 andDecember 31, 2005, respectively.

***Valuation of AcquiredIn-Process Research and Development, Goodwill and Other Intangible Assets***

When we acquire anothercompany, the purchase price is allocated, as applicable, between acquiredin-process research and development, other identifiable intangible assets,tangible net assets and goodwill as required by U.S. GAAP.  In-process research and development isdefined as the value assigned to those projects for which the related productshave not received regulatory approval and have no alternative future use.  Determining the portion of the purchase priceallocated to in-process research and development and other intangible assetsrequires us to make significant estimates that may change over time.  During the six months ended July 2, 2006, werecorded an in-process research and development charge of $1.8 million relatedto the January 6, 2006 acquisition of the remaining minority interest in MTI.

The income approach wasused to determine the fair values of the acquired in-process research anddevelopment.  This approach establishesfair value by estimating the after-tax cash flows attributable to thein-process project over its useful life and then discounting these after-taxcash flows back to the present value. Revenue estimates were based on relative market size, expected marketgrowth rates and market share penetration. Gross margin estimates were based on the estimated cost of the productat the time of introduction and historical gross margins for similar productsoffered by us or by competitors in the marketplace.  The estimated selling, general andadministrative expenses were based on historical operating expenses of theacquired company as well as long-term expense levels based on industrycomparables.  The costs to complete eachproject were based on estimated direct project expenses as well as theremaining labor hours and related overhead costs.  In arriving at the value of acquiredin-process research and development projects, we considered the project’s stageof completion, the complexity of the work to be completed, the costs alreadyincurred, the remaining costs to complete the project, the contribution of core

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technologies, the expected introduction date and the estimated usefullife of the technology.  The discountrate used to arrive at the present value of acquired in-process research anddevelopment as of the acquisition date was based on the time value of money andmedical technology investment risk factors. We believe that the estimated acquired in-process research anddevelopment amounts determined represent the fair value at the date ofacquisition and do not exceed the amount a third party would pay for theprojects.

 

Goodwill represents theexcess of the aggregate purchase price over the fair value of net assets,including in-process research and development, of the acquired businesses.  Goodwill is tested for impairment annually,or more frequently if changes in circumstance or the occurrence of eventssuggest an impairment exists.  The testfor impairment requires us to make several estimates about fair value, most ofwhich are based on projected future cash flows. Our estimates associated with the goodwill impairment tests areconsidered critical due to the amount of goodwill recorded on our consolidatedbalance sheets and the judgment required in determining fair value amounts,including projected future cash flows. Goodwill was $149.1 million and $94.5 million at July 2, 2006 andDecember 31, 2005, respectively.

Other intangible assetsconsist primarily of purchased developed technology, patents, customerrelationships and trademarks and are amortized over their estimated usefullives, ranging from 5 to 10 years.  Wereview these intangible assets for impairment annually during our fourth fiscalquarter or as changes in circumstance or the occurrence of events suggest theremaining value may not be recoverable. Other intangible assets, net of accumulated amortization, were $45.7million and $26.2 million at July 2, 2006 and December 31, 2005, respectively.

The evaluation of assetimpairments related to goodwill and other intangible assets require us to makeassumptions about future cash flows over the life of the assets beingevaluated.  These assumptions requiresignificant judgment and actual results may differ from assumed or estimatedamounts.

***Accounting forIncome Taxes***

As part of the process ofpreparing our consolidated financial statements, we are required to determineour income taxes in each of the jurisdictions in which we operate.  This process involves estimating our actual currenttax expense together with assessing temporary differences resulting fromrecognition of items for income tax and accounting purposes.  These differences result in deferred taxassets and liabilities, which are included on our consolidated balance sheets.  We must then assess the likelihood that ourdeferred tax assets will be recovered from future taxable income and, to theextent we believe that recovery is not likely, we must establish a valuationallowance.  To the extent we establish avaluation allowance or increase this allowance in a period, we must reflectthis increase as an expense within the tax provision in our consolidatedstatement of operations.

Management’s judgment isrequired in determining our provision for income taxes, our deferred tax assetsand liabilities and any valuation allowance recorded against our net deferredtax assets.  We will continue to monitorthe realizability of our deferred tax assets and adjust the valuation allowanceaccordingly.  We have recorded a fullvaluation allowance on our net deferred tax asset as of July 2, 2006.

**Seasonality**

Our business is seasonalin nature.  Historically, demand for ourproducts has been the highest in our fourth fiscal quarter.  We traditionally experience lower salesvolumes in our third fiscal quarter than throughout the rest of the year as aresult of the European holiday schedule during the summer months.

**Off-Balance Sheet Arrangements**

We do not have anyoff-balance sheet arrangements, as defined by the rules and regulations ofthe SEC, that have or are reasonably likely to have a material effect on ourfinancial condition, changes in financial condition, revenues or expenses,results of operations, liquidity, capital expenditures or capitalresources.  As a result, we are notmaterially exposed to any financing, liquidity, market or credit risk thatcould arise if we had engaged in these arrangements.

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**Recent Accounting Pronouncement**

 

On January 1, 2006,we adopted the provisions of Statement of Financial Accounting Standards No.123(R), “Share-Based Payment” (SFAS 123(R)) using the modified prospectivemethod.  SFAS 123(R) requires companiesto measure and recognize the cost of employee services received in exchange forawards of equity instruments based on the grant date fair value of thoseawards.  Compensation cost under SFAS123(R) is recognized ratably using the straight-line attribution method overthe expected vesting period.  Inaddition, pursuant to SFAS 123(R), we are required to estimate the amount ofexpected forfeitures when calculating the compensation costs, instead ofaccounting for forfeitures as incurred, which was our previous method.     Prior periods are not restated under thistransition method.  Options previouslyawarded and classified as equity continue to maintain their equityclassification and there has been no reclassification of awards in ourconsolidated balance sheet.

Prior to January 1, 2006and since the beginning of 2003, we accounted for share-based awards under therecognition provisions of SFAS 123, “Accounting for Stock-BasedCompensation” using the modified prospective method of adoption described inSFAS 148.  We used the minimum valuepricing model for measuring the fair value of our options granted through thefirst quarter 2005, which does not take into consideration volatility. Inaccordance with SFAS 123, subsequent to April 5, 2005, the date ofour initial filing of the registration statement relating to our initial publicoffering with the Securities and Exchange Commission, we used the Black-Scholesmethod, including an estimated volatility assumption, to estimate the fairvalue of all option grants. Expense previously recognized related to optionsthat were cancelled or forfeited prior to vesting was reversed in the period ofthe cancellation or forfeiture, as allowed under SFAS 123.

In November 2005, theFASB issued FASB Staff Position No. 123(R)-3 (FSP 123(R)-3), “TransitionElection Related to Accounting for the Tax Effects of Share-Based PaymentAwards”.  FSP 123(R)-3 provides anelective alternative transition method for calculating the pool of excess taxbenefits available to absorb tax deficiencies recognized subsequent to theadoption of SFAS 123(R).  Companies maytake up to one year from the effective date of FSP 123(R)-3 to evaluate theavailable transition alternatives and make a one-time election as to whichmethod to adopt.  We are currently in theprocess of evaluating the alternative methods.

**Forward-Looking Statements**

This quarterly report onForm 10-Q contains not only historical information, but also forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933 andSection 21E of the Securities Exchange Act of 1934 and are subject to the safeharbor created by those sections.  Inaddition, we or others on our behalf may make forward-looking statements fromtime to time in oral presentations, including telephone conferences and/or webcasts open to the public, in press releases or reports, on our Internet website or otherwise.  All statements otherthan statements of historical facts included in this report or expressed by usorally from time to time that address activities, events or developments thatwe expect, believe or anticipate will or may occur in the future areforward-looking statements including, in particular, the statements about ourplans, objectives, strategies, the outcome of contingencies such as legalproceedings, and prospects regarding, among other things, our financialcondition, results of operations and business. We have identified some of these forward-looking statements in thisreport with words like “believe,” “may,” “could,” “would,”  “might,” “forecast,” “possible,” “potential,”“project,” “will,” “should,” “expect,” “intend,” “plan,” “predict,” “anticipate,”“estimate,” “approximate” or “continue” or the negative of these words or otherwords and terms of similar meaning. These forward-looking statements may be contained in the notes to ourconsolidated financial statements and elsewhere in this report, including underthe heading “Management’s Discussion and Analysis of Financial Condition andResults of Operations.”

Forward-looking statements are based on currentexpectations about future events affecting us and are subject to uncertaintiesand factors that affect all businesses operating in a global market as well asmatters specific to us.  Theseuncertainties and factors are difficult to predict and many of them are beyondour control. The following are

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some of the uncertainties and factors known to us that could cause ouractual results to differ materially from what we have anticipated in ourforward-looking statements:

 

·                  Lack of market acceptance of new products;

·                  Failure to develop innovative and successfulnew products and technologies;

·                  Exposure to assertions of intellectual propertyclaims and failure to protect our intellectual property;

·                  Disruption in our ability to manufacture ourproducts or the ability of our key suppliers to provide us products orcomponents or raw materials for products resulting in our inability to supplymarket demand for our products;

·                  Failure of our customers or patients to obtainthird party reimbursement for their purchases of our products;

·                  Effects of litigation, including threatened orpending litigation, on matters relating to patent infringement, employment, andcommercial disputes;

·                  Reliance on our management information systemsfor inventory management, distribution and other functions and to maintain ourresearch and development and clinical data;

·                  Failure to comply with applicable laws andregulations and to obtain and maintain required regulatory approvals for ourproducts in a cost-effective manner or at all;

·                  Risks inherent in operating internationally andselling and shipping our products and purchasing our products and componentsinternationally;

·                  Fluctuations in foreign currency exchange ratesand interest rates;

·                  Inability to meet performance enhancementobjectives, including efficiency and cost reduction strategies;

·                  Incurrence of additional debt, contingent liabilitiesand expenses in connection with future acquisitions;

·                  Failure to obtain additional capital whenneeded or on acceptable terms;

·                  Failure of our business strategy, which relieson assumptions about the market for our products;

·                  Dependence upon a few of our products togenerate a large portion of our net sales and exposure if drug-eluting stentsbecome a dominant therapy in the peripheral vascular stent market and we arenot able to develop or acquire a drug-eluting stent to market and sell;

·                  Exposure to product liability claims;

·                  Obligation to make significant milestonepayments not currently reflected in our financial statements;

·                  Failure to retain senior management or replacelost senior management;

·                  Ineffectiveness of our internal controls;

·                  Failure to comply with our covenants under ourloan and security agreement with Silicon Valley Bank;

·                  Delays in product introduction;

·                  Loss of customers;

·                  Disruption in the supply of products of InvatecS.r.l. that we distribute or our relationship with Invatec;

·                  Failure to integrate effectively newly acquiredoperations;

·                  Absence of expected returns from the amount ofintangible assets we have recorded;

·                  Reliance on independent sales distributors andsales associates to market and sell our products in certain foreign countries;

 

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·                  Highly competitive nature of the markets inwhich we sell our products and the introduction of competing products;

·                  Increases in prices for raw materials;

·                  Conflicts of interests due to our ownershipstructure;

·                  Employee slowdowns, strikes or similar actions;

·                  Adverse changes in applicable laws orregulations;

·                  Changes in generally accepted accountingprinciples; or

·                  Conditions andchanges in medical device industry or in general economic and businessconditions.

For more informationregarding these and other uncertainties and factors that could cause our actualresults to differ materially from what we have anticipated in ourforward-looking statements or otherwise could materially adversely affect ourbusiness, financial condition or operating results, see our annual report onForm 10-K for the fiscal year ended December 31, 2005 under the heading “Part I— Item 1A.  Risk Factors” on pages 36through 57 of such report and “Part II — Item 1A. Risk Factors” includedelsewhere in this report.

All forward-lookingstatements included in this report are expressly qualified in their entirety bythe foregoing cautionary statements.  Wewish to caution readers not to place undue reliance on any forward-lookingstatement that speaks only as of the date made and to recognize thatforward-looking statements are predictions of future results, which may notoccur as anticipated.  Actual resultscould differ materially from those anticipated in the forward-lookingstatements and from historical results, due to the uncertainties and factorsdescribed above, as well as others that we may consider immaterial or do notanticipate at this time. Although we believe that the expectations reflected inour forward-looking statements are reasonable, we do not know whether our expectationswill prove correct.  Our expectationsreflected in our forward-looking statements can be affected by inaccurateassumptions we might make or by known or unknown uncertainties and factors,including those described above.  Therisks and uncertainties described above are not exclusive and furtherinformation concerning us and our business, including factors that potentiallycould materially affect our financial results or condition, may emerge fromtime to time.  We assume no obligation toupdate, amend or clarify forward-looking statements to reflect actual resultsor changes in factors or assumptions affecting such forward-lookingstatements.  We advise you, however, toconsult any further disclosures we make on related subjects in our annual reportson Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-Kwe file with or furnish to the Securities and Exchange Commission.

**ITEM 3.          QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

We are exposed to variousmarket risks, which are potential losses arising from adverse changes in marketrates and prices, such as interest rates and foreign exchangefluctuations.  We may enter intoderivatives or other financial instruments for trading or speculative purposes;however, our policy is to only enter into contracts that can be designated asnormal purchases or sales.

***Interest Rate Risk***

Borrowings under our revolving line of credit bearinterest at a variable rate equal to SVB’s prime rate.  Borrowings under the equipment line bearinterest at a variable rate equal to SVB’s prime rate plus 1.0%.  We currently do not use interest rate swapsto mitigate the impact of fluctuations in interest rates.  As of July 2, 2006, we had no borrowingsunder our revolving line of credit or the equipment line; however, on July 7,2006, subsequent to the end of our second fiscal quarter, we borrowed $7.5million under the equipment line.  Basedupon this debt level, a 10% increase in the interest rate on such borrowingswould cause us to incur an increase in interest expense of approximately $70thousand on an annual basis.

***Foreign Currency Exchange Rate Risk***

Fluctuations in the rateof exchange between the U.S. dollar and foreign currencies could adverselyaffect our financial results.  In thethree and six months ended July 2, 2006, approximately 29.5% and 30.5%,respectively, of

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our net sales were denominated in foreign currencies.  We expect that foreign currencies willcontinue to represent a similarly significant percentage of our net sales in thefuture.  Selling, marketing andadministrative costs related to these sales are largely denominated in the samerespective currency, thereby limiting our transaction risk exposure.  However, for sales not denominated in U.S.dollars, if there is an increase in the rate at which a foreign currency isexchanged for U.S. dollars, it will require more of the foreign currency toequal a specified amount of U.S. dollars than before the rate increase.  In such cases and if we price our products inthe foreign currency, we will receive less in U.S. dollars than we did beforethe rate increase went into effect.  Ifwe price our products in U.S. dollars and competitors price their products inlocal currency, an increase in the relative strength of the U.S. dollar couldresult in our price not being competitive in a market where business istransacted in the local currency.

 

Approximately 70.0% and71.1% of our net sales denominated in foreign currencies in the three and sixmonths ended July 2, 2006, respectively, were derived from European Unioncountries and were denominated in the Euro. Additionally, we have significant intercompany receivables from ourforeign subsidiaries, which are denominated in foreign currencies, principallythe Euro and the Yen.  Our principalexchange rate risks therefore exist between the U.S. dollar and the Euro andbetween the U.S. dollar and the Yen. Fluctuations from the beginning to the end of any given reporting periodresult in the remeasurement of our foreign currency-denominated receivables andpayables, generating currency transaction gains or losses that impact ournon-operating income/expense levels in the respective period and are reportedin other (income) expense, net in our consolidated financial statements.  We recorded a $1.3 million and $1.4 millionforeign currency transaction gain in the three and six months ended July 2,2006, respectively, compared to a $1.9 million and $3.1 million foreigncurrency transaction loss in the three and six months ended July 3, 2005, respectively,related to the translation of our foreign denominated net receivables into U.S.dollars.  We do not currently hedge ourexposure to foreign currency exchange rate fluctuations.  We may, however, hedge such exposure toforeign currency exchange rates in the future.

**ITEM 4.          CONTROLSAND PROCEDURES**

**Evaluation ofDisclosure Controls and Procedures**

We maintain disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended) that are designed to reasonablyensure that information required to be disclosed by us in the reports we fileor submit under the Securities Exchange Act of 1934, as amended, is recorded,processed, summarized, and reported, within the time periods specified in theSecurities and Exchange Commission’s rules and forms and that such informationis accumulated and communicated to our management, including our principalexecutive and principal financial officers, or persons performing similarfunctions, as appropriate to allow timely decisions regarding requireddisclosure.  In designing and evaluatingour disclosure controls and procedures, we recognize that any controls andprocedures, no matter how well designed and operated can provide onlyreasonable assurance of achieving the desired control objectives and wenecessarily are required to apply our judgment in evaluating the cost-benefitrelationship of possible controls and procedures.  Our management evaluated, with the participationof our Chief Executive Officer and Chief Financial Officer, the effectivenessof the design and operation of our disclosure controls and procedures as of theend of the period covered in this quarterly report on Form 10-Q.  Based on that evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures were effective as of the end of such period to provide reasonableassurance that information required to be disclosed in our Exchange Act reportsis recorded, processed, summarized, and reported within the time periodsspecified in the SEC’s rules and forms, and that material information relatingto our company and our consolidated subsidiaries is made known to management,including our Chief Executive Officer and Chief Financial Officer, particularlyduring the period when our periodic reports are being prepared.

**Changes inInternal Control Over Financial Reporting**

A material weakness is acontrol deficiency or a combination of control deficiencies that results inmore than a remote likelihood that a material misstatement of the annual orinterim consolidated financial statements will not be prevented or detected.Our management concluded that as of December 31, 2005 we did not maintaineffective controls over the preparation, review and presentation and disclosureof our consolidated statements of cash flows. Specifically, we incorrectlyreported an interest payment on demand notes payable as a financing cashout-flow instead of an operating cash out-flow, in accordance with generally acceptedaccounting principles. This control

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deficiency resulted inthe restatement of our consolidated financial statements for the quarters endedJuly 3, 2005 and October 2, 2005. Additionally, this controldeficiency could result in a misstatement of the presentation and disclosure ofour operating and financing cash flows in our consolidated financial statementsthat would result in a material misstatement in our annual or interimconsolidated financial statements that would not be prevented or detected.Accordingly, management determined that this control deficiency constituted amaterial weakness in our internal control over financial reporting.

Management has takensteps to remediate the material weakness in our internal control over financialreporting relating to the presentation of our cash flows. These steps include athorough review of the classification requirements of each component line itemand the individual elements that comprise each line item of the statement ofcash flows in accordance with generally accepted accounting principles. As aresult of these measures and based upon our evaluation of the performance ofthese controls through the first two quarters of fiscal year 2006, we haveconcluded that the material weakness that existed in our internal control overfinancial reporting relating to the presentation of our cash flows as ofDecember 31, 2005 has been fully remediated as of July 2, 2006.

Except as describedabove, there was no change in our internal control over financial reportingthat occurred during our quarter ended July 2, 2006 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

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**PART II - OTHER INFORMATION**

 

**ITEM 1.          LEGALPROCEEDINGS**

A description of our legal proceedings in Note 12 ofour consolidated financial statements included within this report isincorporated herein by reference.

**ITEM 1A.**                    RISK FACTORS

We are affected by risksspecific to us as well as factors that affect all businesses operating in aglobal market. In addition to the other information set forth in this report,careful consideration should be taken of the factors described in our annualreport on Form 10-K for the fiscal year ended December 31, 2005 under theheading “Part I — Item 1A. Risk Factors,” which could materially adverselyaffect our business, financial condition or operating results.  Except for the remediation of the materialweakness described under the heading “Part I — Item 4. Controls and Procedures”and the additional risk factors set forth below, there has been no materialchange in those risk factors.

*The restrictive covenants in our loan agreement could limit our abilityto conduct our business and respond to changing economic and businessconditions and may place us at a competitive disadvantage relative to othercompanies that are subject to fewer restrictions.*

Our loan and securityagreement with Silicon Valley Bank requires our compliance with aliquidity ratio and minimum tangible net worth level. Our failure to complywith these financial covenants could adversely affect our financial condition.Our loan agreement also contains a number of limitations that limit our abilityand the ability of certain of our subsidiaries to, among other things:

·                  transfer all or any part of our business orproperties;

·                  permit or suffer a change in control;

·                  merge or consolidate, or acquire all orsubstantially all of the capital stock or property of another company;

·                  engage in new business;

·                  incur additional indebtedness or liens withrespect to any of their properties;

·                  pay dividends or make any other distribution onor purchase of, any of their capital stock;

·                  make investments in other companies; or

·                  engage in related party transactions,

subject in each case tocertain exceptions and limitations. These restrictive covenants could limit ourability, and that of certain of our subsidiaries, to obtain future financing,withstand a future downturn in our business or the economy in general orotherwise conduct necessary corporate activities. The financial and restrictivecovenants contained in the loan agreement could also adversely affect ourability to respond to changing economic and business conditions and place us ata competitive disadvantage relative to other companies that may be subject tofewer restrictions. Transactions that we may view as important opportunities,such as certain acquisitions, may be subject to the consent of Silicon ValleyBank, which consent may be withheld or granted subject to conditions specifiedat the time that may affect the attractiveness or viability of the transaction.

We cannot assure you thatwe will be able to comply with all of these restrictions and covenants at alltimes, especially the financial covenants. Our ability to comply with theserestrictions and covenants depends on the success of our business and ouroperating results and may also be affected by events beyond our control.  A breach of any of the restrictions andcovenants in our loan agreement by us or certain of our subsidiaries could leadto an event of default under the terms of the credit agreement, notwithstandingour ability to meet our debt service obligations thereunder. Upon theoccurrence of an event of default under our loan agreement, Silicon Valley Bankhas available a range of remedies customary in these circumstances, includingdeclaring all such debt, together with accrued and unpaid interest thereon, tobe due and payable, foreclosing on the assets securing the loan agreement

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and/or ceasing to provideadditional revolving loans or letters of credit, which could have a materialadverse effect on us. Although it is possible we could negotiate a waiver withour lenders of an event of default, such a waiver would likely involvesignificant costs.

**ITEM 2.****                            ****UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

**Recent Sales ofUnregistered Equity Securities**

During the three monthsended July 2, 2006, we did not issue any shares of our common stock or otherequity securities of ours that were not registered under the Securities Act of1933, as amended.

**Use of Proceeds**

On June15, 2005, our registration statement on Form S-1(Registration No. 333-123851) was declared effective.  Our initial public offering resultedin gross proceeds to us of $167.6 million. Expenses related to the initial public offering were as follows:  approximately $8.4 million for underwritingdiscounts and commissions and approximately $4.2 million for other expenses,for total expenses of approximately $12.6 million.  None of the offering expenses resulted indirect or indirect payments to any of our directors, officers or theirassociates, to persons owning 10% or more of our common stock or to any of ouraffiliates.  All of the offering expenseswere paid to others.

After deduction ofoffering expenses, we received net proceeds of approximately $154.9 million inour initial public offering, including shares sold by us pursuant to theunderwriters’ over-allotment option.  Asof July 2, 2006, the proceeds from our initial public offering and availablecash were used as follows:  $36.5 millionof the net proceeds were used to repay a portion of the accrued and unpaidinterest on the demand notes, $81.3 million for general corporate purposes andthe remaining net proceeds were invested in short-term, investment-grade,interest bearing securities.  We cannotpredict whether the proceeds will yield a favorable return.  Other than $36.5 million of the net proceedsused to repay a portion of the accrued and unpaid interest on demand notes heldby Warburg Pincus, which is our majority stockholder, and Vertical, which isone of our stockholders, none of the net proceeds from our initial publicoffering have resulted in direct or indirect payments to directors, officers ortheir associates, to persons who owned 10% or more of our common stock or toany of our affiliates.

We expect to use theremaining $37.1 million in net proceeds from our initial public offering forgeneral corporate purposes.  Ourmanagement has broad discretion as to the use of the net proceeds.  We may use a portion of the net proceeds forthe acquisition of, or investment in, technologies or products that complementour business.  As required by Securitiesand Exchange Commission regulations, we will provide further detail on our useof the net proceeds from our initial public offering in future periodicreports.

**Issuer Purchasesof Equity Securities**

The following table sets forththe information with respect to purchases made by or on behalf of ev3 or any “affiliatedpurchaser” (as defined in Rule 10b-18(a)(3) under the Securities ExchangeAct of 1934), of shares of our common stock during the three months ended July2, 2006.
| **Period**                                    | ** ** | **Total Number  of  Shares  Purchased** | ** ** | **Average Price  Paid Per  Share** | ** ** | **Total Number of Shares  Purchased as Part of  Publicly Announced  Plans or Programs (1)** | ** ** | **Maximum Number of  Shares that May Yet Be  Purchased Under the  Plans or Programs (1)** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Month # 1 (April  3, 2006 – May 2, 2006) |       | 0                                            |       | N/A                                          |       | N/A                                                                                                                                           |       | N/A                                                                                                                                              |       |
| Month # 2 (May  3, 2006 – June 2, 2006)  |       | 3,280                                        | (2)        | $                                            | 13.84      |                                                                                                                                          | N/A        |                                                                                                                                             | N/A        |   |
| Month # 3 June  3, 2006 – July 2, 2006)  |       | 5,988                                        | (2)        | $                                            | 14.00      |                                                                                                                                          | N/A        |                                                                                                                                             | N/A        |   |
| Total:                                        |       | 9,268                                        | (2)        | $                                            | 13.90      |                                                                                                                                          | N/A        |                                                                                                                                             | N/A        |   |

 

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(1)          Our Board of Directors has not authorized any repurchase plan or programfor purchase of our shares of common stock or other equity securities on theopen market or otherwise, other than an indefinite number of shares inconnection with the cashless exercise of outstanding stock options and thesurrender of shares of common stock upon the issuance or vesting of stockgrants to satisfy any required withholding or employment-related taxobligations.

(2)          Consists of shares repurchased from employees in connection with therequired payment of withholding or employment-related tax obligations due inconnection with the issuance of unrestricted stock awards.

Except as set forth inthe table above, we did not purchase any shares of our common stock or otherequity securities of ours registered pursuant to Section 12 of the SecuritiesExchange Act of 1934, as amended, during the three months ended July 2, 2006.

**ITEM 3.****                            ****DEFAULTSUPON SENIOR SECURITIES**

Notapplicable.

**ITEM 4.****                            ****SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

(a)   Our Annual Meeting of Stockholders was heldon May 9, 2006.

(b)   The results of the stockholder votes were asfollows:
| ** **                                                                                                                                                                        | ** ** | **For**    | ** ** | **Against/Withhold** | ** ** | **Abstain** | ** ** | **Broker  Non-Votes** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------------|------------|-------------|------------|-----------------------|------------|
| 1.               Election  of Directors – for terms expiring at the2009 Annual Meeting of Stockholders |       |       |       |                 |       |        |       |                  |       |
| James M. Corbett                                                                                                                                                                  |       | 52,106,267 |       | 2,063,239            |       | —      |       | —                |       |
| Thomas E. Timbie                                                                                                                                                                  |       | 52,197,183 |       | 1,972,323            |       | —      |       | —                |       |
| 2.               Approval  of ev3 Inc. Amended and Restated 2005 Incentive Stock Plan                       |       | 45,261,203 |       | 3,057,897            |       | 179,424     |       | 5,670,982             |       |
| 3.               Approval  of ev3 Inc. Employee Stock Purchase Plan                                         |       | 47,228,587 |       | 1,258,868            |       | 11,069      |       | 5,670,982             |       |
| 4.               Ratification  of Independent Registered Public Accounting Firm                             |       | 54,104,432 |       | 53,690               |       | 11,384      |       | —                |       |

 

John K. Bakewell, RichardB. Emmitt and Dale A. Spencer will continue to serve as directors of ev3 forterms expiring at our 2007 Annual Meeting of Stockholders.

Douglas W. Kohrs andElizabeth H. Weatherman will continue to serve as directors of ev3 for termsexpiring at our 2008 Annual Meeting of Stockholders.

**ITEM 5.****                            ****OTHERINFORMATION**

Not applicable.

**ITEM 6.****                            ****EXHIBITS**

The following exhibitsare being filed or furnished with this quarterly report on Form 10-Q:
| Exhibit No. | ** ** | **Description**                                                                                                                                                                                                                                |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1        |       | ev3 Inc. Amended and Restated 2005 Incentive Stock  Plan (Incorporated by reference to Exhibit 10.1 to ev3 Inc.’s Current Report  on Form 8-K as filed with the Securities and Exchange Commission on May 10, 2006  (File No. 000-51348)) |
|        |       |                                                                                                                                                                                                                                           |
| 10.2        |       | ev3 LLC Amended and Restated 2003 Incentive Plan  (Filed herewith)                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                           |
| 10.3        |       | ev3 Inc. Employee Stock Purchase Plan (Incorporated  by reference to Exhibit 10.24 to ev3 Inc.’s                                                                                                                                          |

 

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| Exhibit No. | ** ** | **Description**                                                                                                                                                                  |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       | Annual Report on Form 10-K for the fiscal year ended  December 31, 2005 (File No. 000-51348))                                                                                    |
|        |       |                                                                                                                                                                             |
| 10.4        |       | Offer Letter dated April 3, 2006 by and between ev3  Inc. and Matthew Jenusaitis (Filed herewith)                                                                                |
|        |       |                                                                                                                                                                             |
| 10.5        |       | Employment Agreement dated April 3, 2006 by and  between ev3 Inc. and Matthew Jenusaitis (Filed herewith)                                                                        |
|        |       |                                                                                                                                                                             |
| 10.6        |       | Change in Control Agreement dated April 3, 2006 by  and between ev3 Inc. and Matthew Jenusaitis (Filed herewith)                                                                 |
|        |       |                                                                                                                                                                             |
| 10.7        |       | Separation Agreement dated April 3, 2006 by and between  ev3 Inc. and Thomas C. Wilder III, as amended (Filed herewith)                                                          |
|        |       |                                                                                                                                                                             |
| 10.8        |       | Loan and Security Agreement  dated as of June 28, 2006 among Silicon Valley Bank, ev3 Endovascular, Inc.,  ev3 International, Inc. and Micro Therapeutics, Inc. (Filed herewith) |
|        |       |                                                                                                                                                                             |
| 31.1        |       | Certification of Chief Executive Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 and SEC Rule 13a-14(a) (Filed  herewith)                                     |
|        |       |                                                                                                                                                                             |
| 31.2        |       | Certification of Chief Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 and SEC Rule 13a-14(a) (Filed  herewith)                                     |
|        |       |                                                                                                                                                                             |
| 32.1        |       | Certification of Chief Executive Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (Furnished herewith)         |
|        |       |                                                                                                                                                                             |
| 32.2        |       | Certification of Chief Financial Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (Furnished herewith)         |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, hereunto dulyauthorized.
| August 8, 2006 | **ev3 Inc.** |
|----------------|--------------|
|           |         |   |
|           | By:          | /s/ James M. Corbett |
|           |         | James M. Corbett |
|           |         | President and  Chief Executive Officer |
|           |         | (principal  executive officer) |
|           |         |   |
|           | By:          | /s/ Patrick D. Spangler |
|           |         | Patrick D.  Spangler |
|           |         | Chief Financial  Officer and Treasurer |
|           |         | (principal financial and accounting officer) |

 

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**ev3 Inc.QUARTERLY REPORT ON FORM 10-QEXHIBIT INDEX**
| Exhibit No. | ** ** | **Description**                                                                                                                                                 | ** ** | **Method of Filing**                                                                                                                                                                 |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1        |       | ev3 Inc. Amended and Restated 2005 Incentive Stock  Plan                                                                                                        |       | Incorporated by  reference to Exhibit 10.1 to ev3 Inc.’s Current Report on Form 8-K as filed  with the Securities and Exchange Commission on May 10, 2006 (File No.  000-51348) |
| 10.2        |       | ev3 LLC Amended and Restated 2003 Incentive Plan                                                                                                                |       | Filed herewith                                                                                                                                                                       |
| 10.3        |       | ev3 Inc. Employee Stock Purchase Plan                                                                                                                           |       | Incorporated by reference  to Exhibit 10.24 to ev3 Inc.’s Annual Report on Form 10-K for the fiscal year  ended December 31, 2005 (File No. 000-51348)                          |
| 10.4        |       | Offer Letter dated April 3, 2006 by and between ev3  Inc. and Matthew Jenusaitis                                                                                |       | Filed herewith                                                                                                                                                                       |
| 10.5        |       | Employment Agreement dated April 3, 2006 by and  between ev3 Inc. and Matthew Jenusaitis                                                                        |       | Filed herewith                                                                                                                                                                       |
| 10.6        |       | Change in Control Agreement dated April 3, 2006 by  and between ev3 Inc. and Matthew Jenusaitis                                                                 |       | Filed herewith                                                                                                                                                                       |
| 10.7        |       | Separation Agreement dated April 3, 2006 by and  between ev3 Inc. and Thomas C. Wilder III, as amended                                                          |       | Filed herewith                                                                                                                                                                       |
| 10.8        |       | Loan and Security Agreement  dated as of June 28, 2006 among Silicon Valley Bank, ev3 Endovascular, Inc.,  ev3 International, Inc. and Micro Therapeutics, Inc. |       | Filed herewith                                                                                                                                                                       |
| 31.1        |       | Certification of Chief Executive Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 and SEC Rule 13a-14(a)                                      |       | Filed herewith                                                                                                                                                                       |
| 31.2        |       | Certification of Chief Financial Officer Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 and SEC Rule 13a-14(a)                                      |       | Filed herewith                                                                                                                                                                       |
| 32.1        |       | Certification of Chief Executive Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002             |       | Furnished  herewith                                                                                                                                                                  |
| 32.2        |       | Certification of Chief Financial Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002             |       | Furnished herewith                                                                                                                                                                   |

 

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