**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**WASHINGTON, D.C.20549

**FORM 10-Q**

**(Mark one)**
| **x**                                                                                                                                                                                                                                                                                      | ** ** | **QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|
| **For the  quarterly period ended October 1, 2006**                                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                                                                                       |       |                                                                                    |   |   |
| **o**                                                                                                                                                                                                                                                                                      | ** ** | **TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                                                                                       |
| **For the  transition period from                      to                      .** |

 

**Commission file number:  000-51348**

**ev3 Inc.**

(Exact name of registrant as specified in its charter)

 

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

 

**9600 54****th**** Avenue North, Suite 100**

**Plymouth, Minnesota 55442**

(Address of principal executive offices)

 

**(763) 398-7000**

(Registrant’s telephone number including 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 file such reports), and (2) has beensubject to such filing requirements for the past 90 days. YES  x  NO o

Indicate by check mark whether the registrant is a largeaccelerated 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):

Large accelerated 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 November 1, 2006, there were 57,330,253 shares of common 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 October 1, 2006**

 

**TABLE OF CONTENTS**
| Description    | ** ** | ** **                                                                                                                  | ** ** | **Page**   |
|----------------|------------|-----------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **     | ** ** | ** **                                                                                                                  | ** ** | ** ** |
| **PART I.**    | ** ** | **FINANCIAL INFORMATION**                                                                                                   | ** ** | ** ** |
| ITEM 1.        |       | Financial Statements                                                                                                        |       |       |
|           |       | Consolidated  Balance Sheets as of October 1, 2006 (unaudited) and December 31, 2005                                        |       | 1          |
|           |       | Consolidated  Statements of Operations for the three and nine months ended October 1, 2006  and October 2, 2005 (unaudited) |       | 2          |
|           |       | Consolidated  Statements of Cash Flows for the nine months ended October 1, 2006 and  October 2, 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                                                                                                     |       | 34         |
|           |       |                                                                                                                        |       |       |
| **PART  II.**  | ** ** | **OTHER  INFORMATION**                                                                                                      | ** ** | ** ** |
| ITEM  1.       |       | Legal  Proceedings                                                                                                          |       | 36         |
| ITEM 1A.       |       | Risk Factors                                                                                                                |       | 36         |
| ITEM 2.        |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                |       | 36         |
| ITEM 3.        |       | Defaults Upon Senior Securities                                                                                             |       | 37         |
| ITEM 4.        |       | Submission of Matters to a Vote of Security Holders                                                                         |       | 37         |
| ITEM  5.       |       | Other  Information                                                                                                          |       | 37         |
| ITEM 6.        |       | Exhibits                                                                                                                    |       | 37         |
| SIGNATURE PAGE |       | 38                                                                                                                          |
| Exhibit Index  |       |                                                                                                                        |       | 39         |

 

*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 Financial Conditionand 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.*

*Alltrademarks or trade names referred to in this report are the property of theirrespective owners.*

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**PART I:****        ****FINANCIAL INFORMATION**

**ITEM I:****         ****FINANCIAL STATEMENTS**

 

**ev3 Inc.**CONSOLIDATED BALANCE SHEETS(Dollars in thousands, except per share amounts)
| ** **                                                                                                                                                                         | ** **   | **October 1,  2006** | ** **   | **December 31,  2005** | ** **   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|---------------------------|--------------|-----------------------------|--------------|
| ** **                                                                                                                                                                         | ** **   | **(unaudited)**           | ** **   | ** **                  | ** **   |
| **Assets**                                                                                                                                                                         | ** **   | ** **                | ** **   | ** **                  | ** **   |
| ***Current  assets***                                                                                                                                                              | *** *** | *** ***              | *** *** | *** ***                | *** *** |
| Cash and cash  equivalents                                                                                                                                                         |         | $                         | 26,528       |                        | $            | 69,592 |   |
| Short-term  investments                                                                                                                                                            |         | 18,450                    |         | 12,000                      |         |
| Accounts  receivable, less allowance of $3,810 and $3,607, respectively                                                                                                            |         | 39,447                    |         | 28,519                      |         |
| Inventories                                                                                                                                                                        |         | 36,925                    |         | 32,987                      |         |
| Prepaid expenses  and other assets                                                                                                                                                 |         | 7,369                     |         | 7,042                       |         |
| Other receivables                                                                                                                                                                  |         | 2,070                     |         | 1,535                       |         |
| *Total  current assets*                                                                                                                                                            |         | 130,789                   |         | 151,675                     |         |
| Restricted cash                                                                                                                                                                    |         | 2,205                     |         | 3,102                       |         |
| Property and  equipment, net                                                                                                                                                       |         | 23,892                    |         | 17,877                      |         |
| Goodwill                                                                                                                                                                           |         | 149,061                   |         | 94,456                      |         |
| Other intangible  assets, net                                                                                                                                                      |         | 43,550                    |         | 26,230                      |         |
| Other assets                                                                                                                                                                       |         | 2,271                     |         | 3,488                       |         |
| *Total  assets*                                                                                                                                                                    |         | $                         | 351,768      |                        | $            | 296,828 |   |
|                                                                                                                                                                               |         |                      |         |                        |         |
| **Liabilities and stockholders’  equity**                                                                                                                                     | ** **   | ** **                | ** **   | ** **                  | ** **   |
| ***Current  liabilities***                                                                                                                                                         | *** *** | *** ***              | *** *** | *** ***                | *** *** |
| Accounts payable                                                                                                                                                                   |         | $                         | 11,952       |                        | $            | 11,716 |   |
| Accrued  compensation and benefits                                                                                                                                                 |         | 15,165                    |         | 14,612                      |         |
| Accrued  liabilities                                                                                                                                                               |         | 10,524                    |         | 11,343                      |         |
| Current portion  of long-term debt                                                                                                                                                 |         | 1,607                     |         | —                      |         |
| Total current  liabilities                                                                                                                                                         |         | 39,248                    |         | 37,671                      |         |
| Long-term debt                                                                                                                                                                     |         | 5,893                     |         | —                      |         |
| Other long-term  liabilities                                                                                                                                                       |         | 564                       |         | 852                         |         |
| *Total  liabilities*                                                                                                                                                               |         | 45,705                    |         | 38,523                      |         |
| * *                                                                                                                                                                           | * *     | * *                  | * *     | * *                    | * *     |
| Minority interest                                                                                                                                                                  |         | —                    |         | 12,850                      |         |
|                                                                                                                                                                               |         |                      |         |                        |         |
| ***Stockholders’  equity***                                                                                                                                                   | *** *** | *** ***              | *** *** | *** ***                | *** *** |
| Common stock,  $0.01 par value, 100,000,000 shares authorized, shares issued  and outstanding: 57,283,737 shares at October 1, 2006 and 49,350,647 at  December 31, 2005 |         | 572                       |         | 493                         |         |
| Additional paid  in capital                                                                                                                                                        |         | 915,471                   |         | 807,032                     |         |
| Accumulated  deficit                                                                                                                                                               |         | (609,998                  | )            | (562,207                    | )            |
| Accumulated  other comprehensive income                                                                                                                                            |         | 18                        |         | 137                         |         |
| *Total  stockholders’ equity*                                                                                                                                                 |         | 306,063                   |         | 245,455                     |         |
| *Total  liabilities and stockholders’ equity*                                                                                                                                 |         | $                         | 351,768      |                        | $            | 296,828 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

1

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

**(unaudited)**

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                   | ** ** | **October 1, 2006**    | ** ** | **October 2, 2005**   | ** ** | **October 1, 2006** | ** ** | **October 2, 2005** | ** ** |
|                                                         |       |                             |       |                            |       |   |   |   |   |
| Net sales                                                    |       | $                                | 51,906     |                            | $          | 33,500 |   | $ | 144,763 |   | $ | 92,722 |   |
| Operating expenses:                                          |       |                             |       |                            |       |   |   |   |   |
| Cost of goods  sold (a)                                      |       | 17,666                           |       | 13,590                          |       | 52,333 |   | 38,484 |   |
| Sales, general  and administrative (a)                       |       | 35,498                           |       | 30,666                          |       | 109,167 |   | 94,823 |   |
| Research and  development (a)                                |       | 7,036                            |       | 8,436                           |       | 19,857 |   | 30,653 |   |
| Amortization of  intangible assets                           |       | 4,483                            |       | 2,674                           |       | 13,008 |   | 7,877 |   |
| Loss on sale of  assets, net                                 |       | 18                               |       | 40                              |       | 142 |   | 204 |   |
| Acquired  in-process research and development                |       | —                           |       | —                          |       | 1,786 |   | 868 |   |
| Total operating  expenses                                    |       | 64,701                           |       | 55,406                          |       | 196,293 |   | 172,909 |   |
| Loss from operations                                         |       | (12,795                          | )          | (21,906                         | )          | (51,530 | ) | (80,187 | ) |
| Other (income) expense:                                      |       |                             |       |                            |       |   |   |   |   |
| Gain on sale of  investments, net                            |       | —                           |       | —                          |       | (1,063 | ) | (4,611 | ) |
| Interest  (income) expense, net                              |       | (258                             | )          | (953                            | )          | (1,471 | ) | 10,833 |   |
| Minority  interest in loss of subsidiary                     |       | —                           |       | (486                            | )          | — |   | (1,212 | ) |
| Other (income)  expense, net                                 |       | (152                             | )          | (8                              | )          | (1,533 | ) | 2,912 |   |
| Loss before  income taxes                                    |       | (12,385                          | )          | (20,459                         | )          | (47,463 | ) | (88,109 | ) |
| Income tax  expense (benefit)                                |       | 82                               |       | (2                              | )          | 328 |   | (61 | ) |
| Net loss                                                     |       | (12,467                          | )          | (20,457                         | )          | (47,791 | ) | (88,048 | ) |
| Accretion of  preferred membership units to redemption value |       | —                           |       | —                          |       | — |   | 12,061 |   |
| Net loss attributable  to common holders                     |       | $                                | (12,467    | )                               | $          | (20,457 | ) | $ | (47,791 | ) | $ | (100,109 | ) |
| Net loss per common  share (basic and diluted) (b)      |       | $                                | (0.22      | )                               | (0.42      | ) | $ | (0.85 | ) | (4.99 | ) |
| Weighted average common  shares outstanding (b)              |       | 57,032,677                       |       | 49,099,357                      |       | 56,556,305 |   | 20,069,139 |   |

 

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| (a) Includes  stock-based compensation charges of: |   |   |   |   |   |   |   |   |   |
|----------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

 
| Cost of goods  sold                |   | $     | 127    |   | $      | 198   |   | $     | 496    |   | $ | 445   |   |
|------------------------------------|--------|-------|--------|--------|--------|-------|--------|-------|--------|--------|---|-------|--------|
| Sales, general  and administrative |   | 1,389 |   | 859    |   | 4,554 |   | 1,904 |   |
| Research and development           |   | 151   |   | 295    |   | 523   |   | 729   |   |
|                               |   | $     | 1,667  |   | $      | 1,352 |   | $     | 5,573  |   | $ | 3,078 |   |

 

(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 notes are an integral part of these consolidatedfinancial statements.

2

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

**(unaudited)**

** **
| ** **                                                                         | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **October 1,  2006**       | ** ** | **October 2,  2005** | ** ** |
| **Operating activities**                                                           | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Net loss                                                                           |       | $                               | (47,791    | ) | $ | (88,048 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities        |       |                            |       |   |   |
| Depreciation and  amortization                                                     |       | 17,024                          |       | 10,790 |   |
| Provision for  bad debts and sales returns                                         |       | 414                             |       | 393 |   |
| Provision for  inventory obsolescence                                              |       | 2,647                           |       | 1,775 |   |
| Acquired  in-process research and development                                      |       | 1,786                           |       | 868 |   |
| Loss on disposal  of assets                                                        |       | 142                             |       | 217 |   |
| Gain on sale of  investments                                                       |       | (1,063                          | )          | (4,611 | ) |
| Stock  compensation expense                                                        |       | 5,573                           |       | 3,078 |   |
| Amortization of  debt issuance costs                                               |       | 7                               |       | — |   |
| Minority  interest in loss of subsidiary                                           |       | —                          |       | (1,212 | ) |
| Change in operating  assets and liabilities:                                       |       |                            |       |   |   |
| Accounts  receivable                                                               |       | (11,358                         | )          | (5,854 | ) |
| Inventories                                                                        |       | (5,930                          | )          | (11,318 | ) |
| Prepaids and  other assets                                                         |       | (261                            | )          | 2,474 |   |
| Accounts payable                                                                   |       | 77                              |       | 3,012 |   |
| Accrued expenses  and other liabilities                                            |       | (1,951                          | )          | 1,984 |   |
| Accrued interest  on notes payable                                                 |       | —                          |       | (24,319 | ) |
| Net cash used in  operating activities                                             |       | (40,684                         | )          | (110,771 | ) |
| **Investing activities**                                                           | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Purchase of  short-term investments                                                |       | (6,750                          | )          | (12,000 | ) |
| Proceeds from  sale of short-term investments                                      |       | 300                             |       | — |   |
| Purchase of  property and equipment                                                |       | (10,168                         | )          | (9,913 | ) |
| Purchase of  patents and licenses                                                  |       | (2,822                          | )          | (1,150 | ) |
| Proceeds from  sale of property and equipment                                      |       | 69                              |       | 8 |   |
| Proceeds from  sale of minority investment                                         |       | 1,063                           |       | 4,611 |   |
| Acquisitions,  net of cash acquired                                                |       | (70                             | )          | (1,626 | ) |
| Change in  restricted cash                                                         |       | 921                             |       | (527 | ) |
| Other                                                                              |       | —                          |       | 830 |   |
| Net cash used in  investing activities                                             |       | (17,457                         | )          | (19,767 | ) |
| **Financing activities**                                                           | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Proceeds from issuance  of debt                                                    |       | 7,500                           |       | 49,100 |   |
| Debt issuance  costs                                                               |       | (113                            | )          | — |   |
| Payments on  capital lease obligations                                             |       | (91                             | )          | — |   |
| Proceeds from  exercise of stock options                                           |       | 7,636                           |       | 931 |   |
| Proceeds from  issuance of subsidiary stock to minority shareholders               |       | —                          |       | 294 |   |
| Proceeds from  initial public offering                                             |       | —                          |       | 154,946 |   |
| Other                                                                              |       | (129                            | )          | — |   |
| Net cash  provided by financing activities                                         |       | 14,803                          |       | 205,271 |   |
| Effect of exchange rate  changes on cash                                           |       | 274                             |       | (102 | ) |
| Net (decrease) increase  in cash and cash equivalents                              |       | (43,064                         | )          | 74,631 |   |
| Cash and cash  equivalents, beginning of period                                    |       | 69,592                          |       | 20,131 |   |
| Cash and cash  equivalents, end of period                                          |       | $                               | 26,528     |   | $ | 94,762 |   |
|                                                                               |       |                            |       |   |   |
| Supplemental non-cash  disclosure:                                                 |       |                            |       |   |   |
| Net assets acquired in  conjunction with MTI step acquisition (see Note 6)         |       | $                               | 95,438     |   | $ | 7,536 |   |
| Financed insurance  policies (see Note 16)                                         |       | $                               | 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 notes are an integral part of these consolidatedfinancial statements.

3

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**ev3 Inc.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**1.**                 Description of Business

ev3Inc. (“we,” “our” or “us”) is a global medical device company focused oncatheter-based technologies for the endovascular treatment of vascular diseasesand disorders.  We develop, manufactureand/or market a wide range of products that include stents, embolic protectiondevices, thrombectomy devices, balloon angioplasty catheters, foreign objectretrieval devices, guidewires, embolic coils, liquid embolics, microcatheters andocclusion balloon systems.  We market ourproducts in the United States, Europe and Canada through a direct sales force,and in certain other international markets through distributors.

**2.**                 Basis of Presentation

Theaccompanying unaudited consolidated financial statements have been prepared byus in accordance with accounting principles generally accepted in the UnitedStates of 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 (“SEC”). 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)considered necessary 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 financial statementsand notes should be read in conjunction with the audited consolidated financialstatements and the notes thereto included in our annual report on Form 10-K forthe year ended December 31, 2005.

Wewere formed as ev3 LLC in September 2003 to hold the ownership interestsof two companies: ev3 Endovascular, Inc. (“Endovascular”) and MicroInvestment, LLC (“MII”), a holding company that owned a controlling interest inMicro Therapeutics, 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 combination ofentities 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. On January 28,2005, we were formed as a subsidiary of ev3 LLC. Immediately prior to theconsummation of our initial public offering on June 21, 2005, ev3 LLC wasmerged with and into us, and we became the holding company for all of ev3 LLC’ssubsidiaries. These consolidated financial statements present the combinedoperations of ev3 LLC for the period from September 1, 2003 until themerger on June 21, 2005, and our consolidated operations thereafter.

Priorto the consummation of our initial public offering on June 21, 2005, weamended and restated our certificate of incorporation to authorize 100,000,000shares of common stock, par value $0.01 per share, and 100,000,000 shares ofpreferred stock, par value $0.01 per share. On June 21, 2005, immediatelyprior to our initial public offering, we completed a one-for-six reverse stocksplit of our outstanding common stock. All share and per share amounts for allperiods presented in these consolidated financial statements reflect thissplit.

OnMay 26, 2005, Warburg Pincus and The Vertical Group, L.P. and certain ofits affiliates (“Vertical”) contributed shares of MTI’s common stock to ev3 LLCin exchange for common membership units. In accordance with SFAS 141, thecontribution of the shares by Warburg Pincus has been accounted for as atransfer of assets between entities under common control, resulting in theretention of historical based accounting. These consolidated financialstatements give effect to the contribution of MTI shares owned by WarburgPincus as though such contribution occurred in 2003 and 2004 when WarburgPincus acquired its interest in MTI. The contribution of the MTI shares byVertical has been accounted for under the purchase method of accounting on thecontribution date.

AtDecember 31, 2005, there was a minority interest of approximately 30% inMTI. As described in Note 6, on January 6, 2006, we acquired theoutstanding shares of MTI that we did not already own through a merger of MIIwith and into MTI.

4

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MTIwas the surviving entity and, as a result of this merger, became our whollyowned subsidiary.  MTI is now known asev3 Neurovascular.    All significantintercompany accounts and transactions have been eliminated in consolidation.

On January 1, 2006, we adopted the provisionsof Statement of Financial Accounting Standards No. 151, “Inventory Costs anamendment of ARB No. 43, Chapter 4”. This Statement amends the guidance in ARB No. 43, Chapter 4,"Inventory Pricing," to clarify the accounting for abnormal amountsof idle facility expense, freight, handling costs, and wasted material(spoilage).  During first quarter 2006, we began production of a newproduct line.  We incurred approximately$300 thousand of abnormal scrap related to this new product line in the threemonths ended April 2, 2006, which was required to be charged to expense in thatperiod and is included in our reported cost of goods sold for the nine monthsended October 1, 2006.

 

Weoperate on a manufacturing calendar with our fiscal year ending onDecember 31.  Each quarter is 13 weeks,consisting of one five-week and two four-week periods.  Accordingly, the third fiscal quarters of2006 and 2005 ended on October 1 and October 2, respectively.

**3.**                 Stock-Based Compensation

Wehave several stock-based compensation plans under which stock options and otherequity incentive 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 the grant.  Subject to adjustment as provided in theplan, 6,000,000 shares of our common stock are available for issuance under theplan.  During the nine months endedOctober 1, 2006, multiple grants of restricted stock totaling 22,500 shares,grants of unrestricted stock totaling 28,341 shares and options to purchase anaggregate of 1,161,600 shares of our common stock were issued under the plan.

Options,other than those granted to outside consultants, generally vest over afour-year period and expire within a period of not more than ten years from thedate of grant. Vested options generally expire 90 days after termination ofemployment. Options granted to outside consultants generally vest over the termof their consulting contract and generally expire 90 days after termination ofthe consulting relationship. The exercise price per share for each option isset by the board of directors or the compensation committee at the time ofgrant and pursuant to the terms of the plan may not be less than the fairmarket value per share on the grant date.

Uponconsummation of our initial public offering, the ev3 LLC 2003 Incentive Planwas terminated with respect to options available for grant that were notgranted prior to the offering.  Prior toour January 6, 2006 acquisition of the remaining outstanding shares of MTI thatwe did not already own, MTI had a 1993 Incentive Stock Option, NonqualifiedStock Option and Restricted Stock Purchase Plan and a 1996 Stock IncentivePlan.  As a result of the merger of MIIwith and into MTI, the outstanding options issued under these MTI plans wereconverted into options to purchase an aggregate of 2,449,905 shares of ourcommon stock.  MTI also had an EmployeeStock Purchase Plan, which was terminated effective December 31, 2005 (See Note6).

Inaddition to our 2005 Incentive Stock Plan, we maintain the ev3 Inc. EmployeeStock Purchase Plan (“ESPP”).  Themaximum number of shares of our common stock available for issuance under theESPP is 750,000 shares, subject to adjustment as provided in the ESPP. The ESPPprovides for six-month offering periods beginning on January 1 and July 1 ofeach year; provided, however, that the compensation committee of the board ofdirectors may decide in its sole discretion when to commence the first offeringperiod so long as such offering period is commenced within 12 months of thedate the ESPP was first approved by the board of directors, which was onFebruary 13, 2006.   An offering period has not yet been commenced underthe ESPP.  The purchase price of theshares will be 85% of the lower of the fair market value of our common stock atthe beginning or end of the offering period. This discount may not exceed themaximum discount rate permitted for plans of this type under Section 423 of theInternal Revenue Code of 1986, as amended.   We expect the ESPP to be compensatory forfinancial reporting purposes.

OnJanuary 1, 2006, we adopted the provisions of Statement of FinancialAccounting Standards No. 123(R), “Share-Based Payment” (SFAS 123(R)) using themodified prospective method.  SFAS 123(R)requires companies to measure and recognize the cost of employee servicesreceived in exchange for awards of equity instruments based on the grant datefair value of those awards.  Compensationcost under SFAS 123(R) is recognized ratably using the straight-line attributionmethod over the expected vesting period, which is considered to be therequisite service period.  In addition,pursuant to SFAS 123(R), we are required to estimate the amount of expectedforfeitures when calculating the compensation costs,

5

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insteadof accounting for forfeitures as incurred, which was our previous method.    All of our options previously awarded wereclassified as equity instruments and continue to maintain their equityclassification under SFAS 123(R).

Priorto January 1, 2006 and since the beginning of 2003, we accounted forshare-based awards under the recognition provisions of SFAS 123,“Accounting for Stock-Based Compensation” using the modified prospective methodof adoption described in SFAS 148. We used the minimum value pricing model for measuring the fair value ofour options granted through the first quarter 2005, which does not take intoconsideration volatility. In accordance with SFAS 123, subsequent toApril 5, 2005, the date of our initial filing of the registrationstatement relating to our initial public offering with the Securities andExchange Commission, we used the Black-Scholes method, including an estimatedvolatility assumption, to estimate the fair value of all option grants. Expensepreviously recognized related to options that were cancelled or forfeited priorto vesting was reversed in the period of the cancellation or forfeiture, asallowed under SFAS 123.

Thefair value of options are estimated at the date of grant using theBlack-Scholes option pricing model with the assumptions listed below.  Risk free interest rate is based on U.S.Treasury rates appropriate for the expected term.  Expected volatility and forfeiture rates arebased on a combination of historical factors related to our common stock sinceour June 2005 initial public offering and the volatility rates of a set ofguideline companies.  The guidelinecompanies consist of public and recently public medical technology companies.  Dividend yield is zero as we do not expect todeclare any dividends in the foreseeable future.  The expected term is based on the weightedaverage time between grant and employee exercise.  The fair value of stock granted to employeesis based upon the closing market value of our common stock on the date ofgrant.
|                                  | ** ** | **October 1, 2006** | ** ** | **October 2, 2005** | ** ** | **October 2, 2005** | ** ** |
|----------------------------------|------------|-------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| **Three Months Ended** | ** ** | **ev3 Inc.**             | ** ** | **ev3 Inc.**             | ** ** | **MTI**                       | ** ** |
| Risk free  interest rate         |       | 5.0                           | %          | 4.0                           | %          | 3.9                           | %          |
| Forfeiture rate                  |       | 4.5                           | %          | —                        |       | —                        |       |
| Expected  dividend yield         |       | 0.0                           | %          | 0.0                           | %          | 0.0                           | %          |
| Expected volatility              |       | 49.1                          | %          | 50.0                          | %          | 45.9                          | %          |
| Expected option term             |       | 4 years                       |       | 4 years                       |       | 4 years                       |       |

 
|                                 | ** ** | **October 1, 2006** | ** ** | **October 2, 2005** | ** ** | **October 2, 2005** | ** ** |
|---------------------------------|------------|-------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| **Nine 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            |       | 50.3                          | %          | 50.0                          | %          | 55.8                          | %          |
| Expected option term            |       | 4 years                       |       | 4 years                       |       | 4 years                       |       |

 

InNovember 2005, the FASB issued FASB Staff Position No. 123(R)-3 (FSP 123(R)-3),“Transition Election Related to Accounting for the Tax Effects of Share-BasedPayment Awards”.  FSP 123(R)-3 providesan elective alternative transition method for calculating the pool of excesstax benefits 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.

Inaccordance with the provisions of SFAS 123(R) and Emerging Issues TaskForce Issue 96-18, “Accounting for Equity Instruments that are Issued toOther than Employees for Acquiring, or in Conjunction with Selling, Goods orServices”, we account for non-employee equity-based awards, in which goods orservices are the consideration received for the equity instruments issued, attheir fair value.

Asof October 1, 2006, the total compensation cost for nonvested options not yetrecognized in our statements of operations was $16.1 million, net of estimatedforfeitures.  This amount is expected tobe recognized over a weighted average period of 2.5 years.

6

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*A summary of activity for allplans (dollars in thousands, except per share amounts) during the nine monthsended October 1, 2006 is as follows:*

|                                                                 | ** ** | **Awarded  Shares  Outstanding** | ** ** | **Weighted-Average  Exercise Price Per  Share** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|---------------------------------|------------|
| 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                                                |       | 22,500                           |       | —                                                    |       |                            |       |
| Unrestricted stock grant, net of shares repurchased             |       | 19,073                           |       | —                                                    |       |                            |       |
| Options to purchase common stock (1)                            |       | 1,161,600                        |       | $                                                         | 16.12      |                            |       |   |
| Exercised                                                       |       | (918,351                         | )          | $                                                         | 8.32       |                            |       |   |
| Cancelled/forfeited                                             |       | (736,491                         | )          | $                                                         | 11.88      |                            |       |   |
| Balance at  October 1, 2006                                     |       | 5,821,545                        |       | $                                                         | 12.18      |                            | $          | 28,470 |   |
|                                                            |       |                             |       |                                                      |       |                            |       |
| 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 |   |
| Options exercisable at  October 1, 2006                         |       | 2,701,263                        |       | $                                                         | 10.96      |                            | $          | 17,620 |   |

 

----

(1)             The weighted average fair value for optionsgranted at market was $7.10.

As of October 1, 2006, we had 207,500 shares of restricted stockoutstanding.  The value of these sharesof restricted stock was measured at the closing market price of our commonstock on the grant date.  The unamortizedcompensation expense for these awards was $2.5 million as of October 1, 2006,which will be recognized over the remaining weighted average vesting period ofapproximately 3.1 years.

During the nine months ended October 1, 2006, we issued an aggregate of28,341 shares of stock to key employees in the form of unrestricted stockgrants.  Of the 28,341 shares of commonstock issued to these employees as stock grants, we immediately repurchased anaggregate of 9,268 shares to pay the employees’ withholding oremployment-related tax obligations due in connection with the issuance of thestock grants.  The value of these stockgrants was measured at the closing market price of our common stock on the dateof grant.  The resulting compensationexpense of $393 thousand was recorded during the second quarter 2006.

The intrinsic value of a stock option award is the amount by which thefair market value of the underlying stock exceeds the exercise price of theaward.  The total intrinsic value ofoptions exercised was $3.8 million and $7.1 million during the three and ninemonths ended October 1, 2006, respectively, and $339 thousand and $780 thousandduring the three and nine months ended October 2, 2005, respectively.

*For options outstanding andexercisable at October 1, 2006, the exercise price ranges and average remaininglives 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                                 |       | 900,676                      |       | $                                                           | 7.04       |   | 7.1 years |   | 588,441 |   | $ | 6.58 |   |
| $8.82                                       |       | 1,424,274                    |       | $                                                           | 8.82       |   | 7.2 years |   | 1,013,650 |   | $ | 8.82 |   |
| $8.94-$14.70                                |       | 2,066,249                    |       | $                                                           | 13.55      |   | 8.3 years |   | 809,103 |   | $ | 13.19 |   |
| $14.93-$17.01                               |       | 794,793                      |       | $                                                           | 16.13      |   | 8.7 years |   | 93,589 |   | $ | 15.87 |   |
| $17.06-$229.02                              |       | 408,980                      |       | $                                                           | 20.52      |   | 6.1 years |   | 196,480 |   | $ | 23.63 |   |
|                                        |       | 5,594,972                    |       | $                                                           | 12.18      |   | 7.7 years |   | 2,701,263 |   | $ | 10.96 |   |

 

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During2000 and 2001, Warburg Pincus and certain of our employees and directorsentered into loan agreements in order for certain employees and directors tobuy ownership interests in us. These outstanding loans are considered to be apart of a stock compensation arrangement. Modifications are measured forcompensation expense. Additional compensation expense, if any, is recognizedover the remaining life of the loan and is immaterial for the nine months endedOctober 1, 2006. The total outstanding principal balance and accrued intereston the notes held by Warburg Pincus and issued by certain of our employees anddirectors at October 1, 2006 and December 31, 2005 was an aggregate of$4.9 million and $5.2 million, respectively.

**4.**                 New Accounting Pronouncements

In June 2006, the FASB issuedFASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes” (FIN 48).  FIN 48 clarifies whentax benefits should be recorded in financial statements, requires certaindisclosures of uncertain tax matters and indicates how any tax reserves shouldbe classified in a balance sheet. FIN 48 is effective for us on January 1,2007. We have not yet determined the impact, if any, that the implementation ofFIN 48 will have on our results of operations and financial condition.

 

In September 2006, the FASBissued SFAS 157, “Fair ValueMeasurement”.  The standard provides guidance for using fair valueto measure assets and liabilities.  SFAS 157 clarifies the principle thatfair value should be based on the assumptions market participants would usewhen pricing an asset or liability and establishes a fair value hierarchy thatprioritizes the information used to develop those assumptions. Under thestandard, fair value measurements would be separately disclosed by level withinthe fair value hierarchy. The statement is effective for us beginning in 2008;however, early adoption is permitted.  We have not yet determined theimpact, if any, that the implementation of SFAS 157 will have on our results ofoperations and financial condition.

 

In September 2006, the SECissued Staff Accounting Bulletin No. 108 “Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements”**(SAB 108).  SAB 108 provides interpretiveguidance on how the effects of the carryover or reversal of prior yearmisstatements should be considered in quantifying a current year misstatement.The SEC staff believes that registrants should quantify errors using both abalance sheet and an income statement approach and evaluate whether eitherapproach results in quantifying a misstatement that, when all relevantquantitative and qualitative factors are considered, is material. SAB 108 iseffective for fiscal years ending on or after November 15, 2006, withearly application encouraged.  We do not expect the adoption of thisstandard to have any impact on our consolidated financial statements.

 

**5.**                 Liquidity and Capital Resources

Sinceinception, we have generated significant operating losses. Historically, ourliquidity needs have been met through a series of preferred investments and bydemand notes payable issued to Warburg Pincus and Vertical.  On June 21, 2005, we completed aninitial public offering in which we sold 11,765,000 shares of our common stockat $14.00 per share for net cash proceeds of $152.7 million, net ofunderwriting discounts and other offering costs.  Immediately prior to the consummation of theoffering, ev3 LLC merged with and into ev3 Inc. and 24,040,718 Class Apreferred membership units, 41,077,336 Class B preferred membership units,and 18,799,962 common membership units of ev3 LLC were converted into83,918,016 shares of common stock of ev3 Inc. (on a pre-split basis).  Immediately thereafter, we completed aone-for-six reverse stock split whereby the 83,918,016 shares of common stockwere 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 stock pursuantto the over-allotment option granted to the underwriters in connection with theinitial public offering.  Our netproceeds 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.

OnJune 28, 2006, our operating subsidiaries, ev3 Endovascular, Inc., ev3International, Inc. and Micro Therapeutics, Inc. (collectively, the“Borrowers”), entered into a Loan and Security Agreement (“Loan Agreement”)with Silicon Valley Bank (“SVB”), consisting of a two-year $30.0 millionrevolving line of credit and a 48-month $7.5 million equipment financingline.  Pursuant to the terms of the LoanAgreement, and subject to specified reserves, we may borrow under the revolvingline of credit up to $12 million without any borrowing base limitations.Aggregate borrowings under the revolving line of credit that exceed $12 millionwill subject the revolving line to borrowing base limitations.  These

8

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limitationsallow us to borrow, subject to specified reserves, up to 80% of eligibledomestic and foreign accounts receivables plus up to 30% of eligibleinventory.  Additionally, borrowingsagainst the eligible inventory may not exceed the lesser of 33% of the amountadvanced 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 bear interestat 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 October 1, 2006, we had $7.5 million inoutstanding borrowings under the equipment line and no outstanding borrowingsunder the revolving line of credit; however, we had  approximately $1 million of outstandingletters of credit issued by SVB, which reduces the amount available under ourrevolving line of credit to approximately $29 million.

Both therevolving line of credit and equipment financing are secured by a firstpriority security interest in substantially all of our assets, excluding intellectualproperty, which is subject to a negative pledge, and are guaranteed by ev3 Inc.and all of our domestic direct and indirect subsidiaries. The Loan Agreementrequires the Borrowers to maintain a specified liquidity ratio and a tangiblenet worth level.  The Loan Agreementimposes certain limitations on the Borrowers, their subsidiaries and ev3 Inc.,including without limitation, on their ability to: (i) transfer all or any partof their business or properties; (ii) permit or suffer a change in control;(iii) merge or consolidate, or acquire any entity; (iv) engage in any materialnew line of business; (v) incur additional indebtedness or liens with respectto any of their properties; (vi) pay dividends or make any other distributionon or purchase of, any of their capital stock; (vii) make investments in othercompanies; or (viii) engage in related party transactions, subject in each caseto certain exceptions and limitations. The Loan Agreement requires us to maintain on deposit or invested withSVB or its affiliates the lesser of $15.0 million or 50% of our aggregate cashand cash equivalents.  The Borrowers arerequired to pay customary fees with respect to the facility, including a fee onthe average unused portion of the revolving line of credit.

The Loan Agreement containscustomary loan covenants and events of default, including the failure to makerequired payments, the failure to comply with certain covenants or otheragreements, the occurrence of a material adverse change, failure to pay certainother indebtedness and certain events of bankruptcy or insolvency. Upon theoccurrence and continuation of an event of default, amounts due under the LoanAgreement may be accelerated.  As ofOctober 1, 2006, we were in compliance with all loan covenants under the LoanAgreement.

Ourfuture liquidity and capital requirements will be influenced by numerousfactors, including clinical research and product development programs, workingcapital to support our sales growth, receipt of and time required to obtainregulatory clearances and approvals, sales and marketing programs and theacceptance of our products in the marketplace. We believe that our current resources, together with funds availableunder our revolving line of credit, are sufficient to cover our liquidityrequirements through at least the next twelve months.  However, there is no assurance thatadditional funding will not be needed. Further, if additional funding wereneeded, there is no assurance that such funding will be available to us or oursubsidiaries on acceptable terms, or at all. If we require additional working capital but are not able to raiseadditional funds, we may be required to significantly curtail or cease ongoingoperations.

*Thefollowing summarizes the changes in stockholders’ 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 |       | —                |       | —                       |       | 5,180           |       | —                                |       | —                        |         | 5,180 |   |
| Exercise of  options                                  |       | 916,663               |       | 9                            |       | 7,627           |       | —                                |       | —                        |         | 7,636 |   |
| MTI acquisition                                       |       | 6,997,354             |       | 70                           |       | 95,368          |       | —                                |       | —                        |         | 95,438 |   |
| Unrestricted  stock grants                            |       | 28,341                |       | —                       |       | 393             |       | —                                |       | —                        |         | 393 |   |
| Shares  repurchased                                   |       | (9,268                | )          | —                       |       | (129            | )          | —                                |       | —                        |         | (129 | ) |
| Comprehensive  (loss):                                |       |                  |       |                         |       |            |       |                                  |       |                          |         |   |   |
| Net loss                                              |       |                  |       |                         |       |            |       | (47,791                               | )          | —                        |         | (47,791 | ) |
| Cumulative translation adjustment                     |       |                  |       |                         |       |            |       | —                                |       | (119                          | )            | (119 | ) |
| Comprehensive (loss)                                  |       | —                |       | —                       |       | —          |       | (47,791                               | )          | (119                          | )            | (47,910 | ) |
| **Balance October 1, 2006**                           | ** ** | **57,283,737**        | ** ** | **$**                        | **572**    | ** **      | **$**      | **915,471**                           | ** ** | **$**                         | **(609,998** | **)** | **$** | **18** | ** ** | **$** | **306,063** | ** ** |

 

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**6.**                 MTI Step Acquisition

OnJanuary 6, 2006, we completed the acquisition of the outstanding shares ofMTI that we did not already own through the merger of MII with and into MTI,with MTI continuing as the surviving corporation and a wholly owned subsidiaryof ev3 Inc. As a result of the merger, each share of common stock of MTIoutstanding at the effective time of the merger was automatically convertedinto the right to receive 0.476289 of a share of our common stock (the“Exchange Ratio”) and cash in lieu of any fractional share of our common stock.We issued approximately 7.0 million new shares of our common stock to MTI’spublic stockholders in the merger.  Fairvalue of the shares issued was measured as the average closing price per shareof our stock on the NASDAQ National Market System for the five day tradingperiod centered around the date that the terms of the acquisition were agreedto and announced.  In addition, eachoutstanding option to purchase shares of MTI common stock was converted into anoption to purchase shares of our common stock on the same terms and conditions(including vesting) as were applicable under such MTI option. The exerciseprice and number of shares for which each such MTI option is (or will become)exercisable was adjusted based on the Exchange Ratio.   The fair value of the replacement stockoptions was estimated at the closing date. The unvested portion of the replacement stock options will be recognizedas compensation expense over the remaining service period.

Theinvestment was accounted for using the step acquisition method prescribed byARB 51, Consolidated Financial Statements. Step acquisition accountingrequires the allocation of the excess purchase price to the fair value of netassets acquired. The excess purchase price is determined as the differencebetween the cash paid and the historical book value of the interest in netassets acquired.  The effects of theacquisition do not materially change our results of operations.  Therefore, pro forma disclosures are notincluded.

*The following table presentsthe purchase price for the 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 theallocation of the excess purchase price over historical book values (inthousands) arising from the acquisition:*
|                                               | ** ** | **2006** | ** ** |
|-----------------------------------------------|------------|----------|------------|
| Inventory                                     |       | $        | 668        |   |
| Developed  technology                         |       | 15,548   |       |
| Customer  relationships                       |       | 9,964    |       |
| Trademarks and  tradenames                    |       | 2,029    |       |
| Acquired  in-process research and development |       | 1,786    |       |
| Goodwill                                      |       | 54,605   |       |
| Accrued  liabilities                          |       | (2,012   | )          |
| Total                                         |       | $        | 82,588     |   |

 

Theweighted average life of the acquired intangibles, excluding goodwill, wasseven years.  The acquired in-processresearch and development charge was estimated considering an appraisal andrepresents the estimated fair value of the in-process projects at the date ofacquisition of the MTI shares.  As of theacquisition date, the in-process projects had not yet reached technologicalfeasibility and had no alternative use. The primary basis for determining technological feasibility of theseprojects is obtaining regulatory approval to market the products.  Accordingly, the value attributable to theseprojects, which had yet to obtain regulatory approval, was expensed inconjunction with the acquisition.  If theprojects are not successful, or completed in a timely manner, we may notrealize the financial benefits expected from these projects.

The income approach was used to determine the fair value of the acquiredin-process research and development. This approach establishes fair value by estimating the after-tax cashflows attributable to any in-process project over its useful life and thendiscounting these after-tax cash flows back to the present value.  The costs to complete each project were basedon estimated direct project expenses as well as the remaining labor hours andrelated overhead costs.  In arriving atthe value of acquired in-process research and development projects, weconsidered the project’s stage of completion, the complexity of the work to becompleted, the costs already incurred, the remaining costs to complete theproject, the contribution of core technologies, the expected introduction dateand the estimated useful life of the technology.  The

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discount rate used to arrive at the present value of acquired in-processresearch and development as of the acquisition date was based on the time valueof 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 thirdparty would pay for the project.

**7.**                    Short-Term Investments

Short-terminvestments consist of debt securities, which have investment grade creditratings.  The debt securities areclassified and accounted for as available-for-sale and are reported at fairvalue with unrealized gains and losses excluded from earnings and reported inother comprehensive income.  Managementdetermines the appropriate classification of its investments in securities atthe time of purchase and reevaluates such determination at each balance sheet date.  The short-term investments consist offloating rate taxable municipal bonds with maturities from 2019 to 2036.  We have the option to put the bonds to theremarketing agent who is obligated to repurchase the bonds at par.  As of October 1, 2006, our cost approximatedfair value related to these investments.

**8.**                 Inventories

*Inventory consists of the following (in thousands):*
|                    | ** ** | **October 1, 2006** | ** ** | **December 31, 2005** | ** ** |
|--------------------|------------|-------------------------------|------------|---------------------------------|------------|
| Raw materials      |       | $                             | 6,302      |                            | $          | 5,823 |   |
| Work in-progress   |       | 2,510                         |       | 1,944                           |       |
| Finished goods     |       | 32,644                        |       | 29,195                          |       |
|               |       | 41,456                        |       | 36,962                          |       |
| Inventory  reserve |       | (4,531                        | )          | (3,975                          | )          |
| Inventory, net     |       | $                             | 36,925     |                            | $          | 32,987 |   |

** **

**9.**                 Property and Equipment, Net

*Property and equipment consists of the following (inthousands):*
|                                            | ** ** | **October 1, 2006** | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------------|------------|-------------------------------|------------|---------------------------------|------------|
| Machinery and  equipment                   |       | $                             | 18,600     |                            | $          | 14,222 |   |
| Office furniture  and equipment            |       | 11,123                        |       | 10,669                          |       |
| Leasehold  improvements                    |       | 8,547                         |       | 6,596                           |       |
| Construction in  progress                  |       | 3,622                         |       | 2,916                           |       |
|                                       |       | 41,892                        |       | 34,403                          |       |
| Less:                                      |       |                          |       |                            |       |
| Accumulated  depreciation and amortization |       | (18,000                       | )          | (16,526                         | )          |
| Property and equipment,  net               |       | $                             | 23,892     |                            | $          | 17,877 |   |

 

Total depreciation expense for property andequipment was $1.4 million and $4.0 million for the three and nine months endedOctober 1, 2006, respectively, and $776 thousand and $2.9 million for the threeand nine months ended October 2, 2005, respectively.

 

**10.**          Goodwill and Other Intangible Assets

*The changes in the carrying amount of goodwill by operatingsegment for the nine months ended October 1, 2006 were as follows (inthousands):   *
| ** **                                           | ** ** | **Cardio  Peripheral** | ** ** | **Neurovascular** | ** ** | **Total** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-------------------|------------|-----------|------------|
| Balance as of  January 1, 2006                       |       | $                      | 71,307     |              | $          | 23,149    |       | $ | 94,456 |   |
| Goodwill related  to acquisition of MTI common stock |       | —                 |       | 54,605            |       | 54,605    |       |
| Balance as of October  1, 2006                       |       | $                      | 71,307     |              | $          | 77,754    |       | $ | 149,061 |   |

 

11

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*Other intangible assets consist of the following (inthousands):*
| ** **                 | ** ** | **Weighted**                                   | ** ** | **October 1, 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                                            |       | $                             | 10,885     |                            | $          | (3,763 | ) | $ | 7,122 |   | $ | 8,390 |   | $ | (3,300 | ) | $ | 5,090 |   |
| Developed  technology      |       | 6.0                                            |       | 63,616                        |       | (37,759                         | )          | 25,857 |   | 48,068 |   | (29,951 | ) | 18,117 |   |
| Trademarks and  tradenames |       | 7.0                                            |       | 5,122                         |       | (2,406                          | )          | 2,716 |   | 3,093 |   | (1,721 | ) | 1,372 |   |
| Customer  relationships    |       | 5.0                                            |       | 16,094                        |       | (8,239                          | )          | 7,855 |   | 6,131 |   | (4,480 | ) | 1,651 |   |
| Other intangible assets    |       |                                           |       | $                             | 95,717     |                            | $          | (52,167 | ) | $ | 43,550 |   | $ | 65,682 |   | $ | (39,452 | ) | $ | 26,230 |   |

 

Intangibleassets are amortized using methods which approximate the benefit provided bythe utilization of the assets.  Patentsand licenses, developed technology and trademarks and tradenames are amortizedon a straight 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.

Totalamortization of other intangible assets was $4.5 million and $13.0 million forthe three and nine months ended October 1, 2006, respectively, and $2.7 millionand $7.9 million for the three and nine months ended October 2, 2005,respectively.  The estimated amortizationexpense (inclusive of amortization expense already recorded for the nine monthsended October 1, 2006) for the next five years ending December 31 is asfollows (in thousands):
| 2006 |   | $      | 17,022 |   |
|------|--------|--------|--------|--------|
| 2007 |   | 11,265 |   |
| 2008 |   | 7,681  |   |
| 2009 |   | 4,951  |   |
| 2010 |   | 3,811  |   |

 

**11.**          Investments

Wehad a licensing agreement and an approximate 14% interest in GenyxMedical, Inc. (“Genyx”).  Thecarrying value of our investment in Genyx was fully written off and reduced to$0 as of December 31, 2004, and we had no obligation to fund Genyx’s operations.  In January 2005, we sold our interest inGenyx and recorded a gain of $3.7 million. During the second quarter 2006, we received a $153 thousand milestonepayment related to the sale of our investment in Genyx.  During the second quarter 2006, we alsoreceived a milestone payment of $910 thousand related to the 2002 sale of ourinvestment in Enteric Medical Technologies, Inc. (“Enteric”). This is the finalmilestone payment related to the sale of our investment in Enteric. During thesecond quarter 2005, we received an $878 thousand milestone payment related tothe 2002 sale of our investment in Enteric.

**12.**          Accrued Liabilities

*Accrued liabilities consist of thefollowing (in thousands):*
|                                | ** ** | **October 1, 2006** | ** ** | **December 31, 2005** | ** ** |
|--------------------------------|------------|-------------------------------|------------|---------------------------------|------------|
| Accrued  professional services |       | $                             | 3,169      |                            | $          | 1,043 |   |
| Financed  insurance policies   |       | 1,163                         |       | 368                             |       |
| Accrued clinical  studies      |       | 411                           |       | 3,633                           |       |
| Office closure                 |       | 378                           |       | 391                             |       |
| Accrued other                  |       | 5,403                         |       | 5,908                           |       |
| Total accrued  liabilities     |       | $                             | 10,524     |                            | $          | 11,343 |   |

** **

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** **

**13.**          Long-Term Debt

*Long-term debt consists of thefollowing (in thousands):*
|                       | ** ** | **October 1, 2006** | ** ** | **December 31, 2005** | ** ** |
|-----------------------|------------|-------------------------------|------------|---------------------------------|------------|
| Equipment term  loan  |       | $                             | 7,500      |                            | $          | — |   |
| Less: current portion |       | (1,607                        | )          | —                          |       |
| Total long-term  debt |       | $                             | 5,893      |                            | $          | — |   |

** **

On June 28, 2006, our operating subsidiaries,ev3 Endovascular, Inc., ev3 International, Inc. and Micro Therapeutics, Inc.,entered into a Loan and Security Agreement, with Silicon Valley Bank, or SVB,consisting of a two-year $30.0 million revolving line of credit and a 48-month$7.5 million equipment financing line. 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 (See Note 5).

 

*Annual maturities of our long-termdebt at October 1, 2006 are as follows (in thousands):*
| 2007  |   | $     | 2,143  |   |
|-------|--------|-------|--------|--------|
| 2008  |   | 2,143 |   |
| 2009  |   | 2,143 |   |
| 2010  |   | 1,071 |   |
| Total |   | $     | 7,500  |   |

 

**14.**          Interest (Income) Expense

*Interest (income) expense consists of the following (in thousands):   *
|                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **October 1,  2006**        | ** ** | **October 2,  2005**       | ** ** | **October 1,  2006** | ** ** | **October 2,  2005** | ** ** |
| Interest expense                      |       | $                                | 354        |                            | $          | 20 |   | $ | 455 |   | $ | 12,211 |   |
| Interest  (income)                    |       | (612                             | )          | (973                            | )          | (1,926 | ) | (1,378 | ) |
|                                  |       |                             |       |                            |       |   |   |   |   |
| Total interest  (income) expense, net |       | $                                | (258       | )                               | $          | (953 | ) | $ | (1,471 | ) | $ | 10,833 |   |

 

**15.**          Other Comprehensive Income (Loss)

*The following table provides a reconciliation of net loss tocomprehensive income (loss) (in thousands):   *
|                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **October 1,  2006**        | ** ** | **October 2,  2005**       | ** ** | **October 1,  2006** | ** ** | **October 2,  2005** | ** ** |
| Net loss                                 |       | $                                | (12,467    | )                               | $          | (20,457 | ) | $ | (47,791 | ) | $ | (88,048 | ) |
| Gain on change  in ownership % of MTI    |       | —                           |       | 2                               |       | — |   | 151 |   |
| Changes in  foreign currency translation |       | 136                              |       | 111                             |       | (119 | ) | 1,524 |   |
|                                     |       |                             |       |                            |       |   |   |   |   |
| Total  comprehensive income (loss)       |       | $                                | (12,331    | )                               | $          | (20,344 | ) | $ | (47,910 | ) | $ | (86,373 | ) |

** **

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** **

**16.**          Commitments and Contingencies

*Letters of Credit*

Asof October 1, 2006, we had $2.6 million of outstanding letters of credit, whichwere collateralized by $1.8 million of restricted cash.

*Financed Insurance 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.  During the third quarter 2006,we agreed to pay a portion of the insurance premiums directly to the carrierthereby reducing the amount financed by $1.4 million.  The remainingoutstanding balance under the agreement was $1.2 million and $368 thousand asof October 1, 2006 and December 31, 2005, respectively, and is included inaccrued liabilities on our consolidated balance sheet.

*Earn-Out Contingencies*

Underthe terms of the stock purchase agreement we entered into in connection withour acquisition of Dendron in September 2000, we may be required to makeadditional payments which are contingent upon Dendron products achievingcertain revenue targets between 2003 and 2008. In 2003, the $4.0 millionrevenue target for sales of Dendron products during 2003 was met. Accordingly,an additional payment to the former Dendron stockholders of $3.75 million wasmade in 2004. In 2004, the $5.0 million revenue target for sales of Dendronproducts during 2004 was met. Accordingly, a payment to the former Dendronstockholders of $3.75 million was accrued in 2004 and was paid during thesecond quarter 2005. We may be required to make a final payment of $7.5million, which is contingent upon Dendron products achieving annual revenues of$25 million in any year during the period between 2003 and 2008. Any such finalpayment would be due in the year following the year of target achievement.

*Contingencies*

Weare from time to time subject to, and are presently involved in, litigation orother legal proceedings.

InSeptember 2000, Dendron, which was acquired by MTI in 2002, was named as thedefendant in three patent infringement lawsuits brought by the Regents of theUniversity of California, as the plaintiff, in the District Court (Landgericht)in Dusseldorf, 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.

OnJuly 4, 2001, the University of California filed another suit against Dendronalleging that the EDC I coil device infringed another European patent held bythe plaintiff.  The complaint was filedin the District Court of Dusseldorf, Germany seeking additional monetary and injunctiverelief.  In April 2002, the court foundthat EDC I coil 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.

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Dendronhas now filed a domestic 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.

Anaccrual for the matters discussed above was included in the balance sheet ofDendron as of the date of its acquisition by MTI.  As of October 1, 2006, approximately $834thousand was recorded in accrued liabilities in our consolidated financialstatements included in this report. Dendron ceased all activities with respect to the EDC I coil deviceprior to MTI’s October 2002 acquisition of Dendron.

Concurrentwith MTI’s acquisition of Dendron, MTI initiated a series of legal actionsrelated to our Sapphire coils in the Netherlands and the United Kingdom, whichincluded a cross-border action that was heard by a Dutch court, as furtherdescribed below.  The primary purpose ofthese actions was to assert both invalidity and non-infringement by MTI ofcertain patents held by others.  Therange of patents at issue are held by the Regents of the University ofCalifornia, with Boston Scientific Corporation subsidiaries named as exclusivelicensees, collectively referred to as the “patent holders,” related todetachable coils and certain delivery catheters.

InOctober 2003, the Dutch court ruled the three patents at issue related todetachable coils are valid and that our Sapphire coils do infringe suchpatents.  The Dutch court also ruled thatthe patent holders’ patent at issue related to the delivery catheter wasinvalid.  Pursuant to the court’s ruling,we have been enjoined by the patent holders from engaging in infringingactivities related to our Sapphire coils in most countries within the EuropeanUnion, and may be liable for then-unspecified monetary damages for ouractivities since September 27, 2002.  InFebruary 2005, we received an initial claim from the patent holders withrespect to monetary damages, amounting to €3.6 million, or approximately $4.6million as of October 1, 2006, with which we disagree.  Court hearings will be held regarding theseclaims and are currently scheduled for June 2007.  We have filed an appeal with the Dutch court,and believe that since the date of injunction in each separate country we arein compliance with the Dutch court’s injunction. On September 5, 2006, wereceived a letter from the patent holders’ counsel stating that, pursuant to arecent decision in the European Court dated July 13, 2006, they are no longerenforcing the injunction outside of The Netherlands.   A decision on the appeal is expected in thefirst half of  2007.  The patent holders have requested a delay inthe hearing on claims damages until a decision on the appeal has been rendered.Because we believe that we have valid legal grounds for appeal, we havedetermined that a loss is not probable at this time as defined by SFAS 5,“Accounting for Contingencies”.  However,there can be no assurance that the ultimate resolution of this matter will notresult in a material adverse effect on our business, financial condition orresults of operations.

InJanuary 2003, we initiated a legal action in the English Patents Court seekinga declaration that a patent held by the patent holders related to deliverycatheters was invalid, and that our products did not infringe this patent.  The patent in question was the U.K. designationof the same patent that was found by the Dutch court in October 2003 to beinvalid, as discussed above.  The patentholders counterclaimed for alleged infringement by us.  In February 2005, the court approved aninterim settlement between the parties under which the patent holders were requiredto surrender such patent to the U.K. Comptroller of Patents, and to pay ourcosts 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 2005.  Theparties initiated proceedings before a costs judge regarding payment by thepatent holders of the remaining costs incurred by us in such litigation.  We have reached a final settlement with thepatent holders and on October 31, 2006, subsequent to the end of our thirdfiscal quarter, received the final payment of £600 thousand (equivalent toapproximately $1.1 million), which we recorded as a reduction of litigationexpense in the fourth quarter 2006.  As aresult of the settlement, we anticipate that we will no longer be involved inlitigation on this matter in the United Kingdom, although no assurance can begiven that no other litigation involving us may arise in the United Kingdom.

Inthe United States, concurrent with the FDA’s marketing clearance of ourSapphire line of embolic coils received in July 2003, we, through oursubsidiary MTI, initiated a declaratory judgment action against the patentholders in the United States District Court for the Western District ofWisconsin.  The action includedassertions of non-infringement by us and invalidity of a range of patents heldby the patent holders related to detachable coils and certain deliverycatheters.  In October 2003, the courtdismissed our actions for procedural reasons without prejudice and withoutdecision as to the merits of the parties’ positions.  In December 2003, the University ofCalifornia filed an action against us in the United States District Court forthe Northern District of California alleging infringement by us with respect toa range of patents held by the University of California related to detachablecoils and certain delivery systems.  Wefiled a counterclaim against the University of California assertingnon-infringement by us, invalidity of the patents and inequitable conduct inthe procurement of certain patents.  Inaddition, we filed a claim against the University of California and BostonScientific

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Corporationfor violation of federal antitrust laws, with the result that the court hassubsequently decided to add Boston Scientific as a party to thelitigation.  Motions for summary judgmentmade by all parties, have been denied by the court.  A trial date has been set for June 2007.  In addition, there are various relatedactions, such as requests for re-examination and reissues, pending from time totime in the U.S. Patent and Trademark Office that may or may not have amaterial effect on these actions.  Wecannot estimate the possible loss or range of loss, if any, associated with theresolution of these matters.  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.

OnMarch 30, 2005, we were served with a complaint by Boston ScientificCorporation and one of its affiliates which claims that some of our products,including our SpideRX Embolic Protection Device, infringe certain of BostonScientific’s patents.  This action wasbrought in the United 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 tradesecrets.  We intend to vigorously defendand prosecute respectively the claims in this action.  Because these matters are in early stages andbecause of the complexity of the case, we cannot estimate the possible loss orrange 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.

Theacquisition agreement relating to our acquisition of Appriva Medical, Inc.contains four milestones to which payments relate.  The first milestone was required by its termsto be achieved by January 1, 2005 in order to trigger a payment equal to $50million.  We have determined that thefirst milestone was not achieved by January 1, 2005 and that the firstmilestone is not payable.  On May 20,2005, Michael Lesh, as an individual seller of Appriva stock and purporting torepresent certain other sellers of Appriva stock, filed a complaint in theSuperior Court of the State of Delaware with individually specified damagesaggregating $70 million and other unspecified damages for several allegations,including that we, along with other defendants, breached the acquisitionagreement and an implied covenant of good faith and fair dealing by willfullyfailing to take the steps necessary to meet the first milestone under theagreement, and thereby also failing to meet certain other milestones, andfurther that one milestone was actually met. The complaint also alleges fraud, negligent misrepresentation andviolation of state securities laws in connection with the negotiation of theacquisition agreement.  We believe theseallegations are without merit and intend to vigorously defend this action.  We filed a motion to dismiss the complaint,which the court granted in June 2006 on standing grounds.  The plaintiff filed a petition forreargument, which was denied on October 31, 2006. Prior to October 31, 2006,the plaintiff filed an appeal of the court’s dismissal ruling, which appeal wassubsequently voluntarily dismissed by the plaintiff since it was procedurallypremature in light of the previously filed petition for reargument.

Onor about November 21, 2005, a second lawsuit was filed in Delaware SuperiorCourt relating to the acquisition of Appriva Medical, Inc.  The named plaintiff is Appriva ShareholderLitigation Company, LLC, which according to the complaint was formed for thepurpose of pursuing claims against us. The complaint alleges that Erik van der Burg and three unidentifiedinstitutional investors have assigned their claims as former shareholders ofAppriva to Appriva Shareholder Litigation Company, LLC.  The complaint alleges specified damages inthe form of the second milestone payment ($25 million), which is claimed to bedue and payable, and further alleges unspecified damages to be proven attrial.  The complaint alleges thefollowing claims:  misrepresentation,breach of contract, breach of the implied covenant of good faith and fairdealing and declaratory relief.  We believethese allegations and claims are without merit and intend to vigorously defendthis action.  We filed a motion todismiss the complaint.    On August 24,2006, the trial court converted our motion to dismiss into a motion for summaryjudgment, which motion was granted.  Thetrial court ruled that Appriva Shareholder Litigation Company, LLC did not havestanding.  The trial court did notaddress the merits of the claims. Appriva Shareholder Litigation Company, LLC has filed a notice of appealof the trial court’s ruling.

Becauseboth of these Appriva acquisition related matters are in early stages, wecannot estimate the possible loss or range of loss, if any, associated withtheir resolution.  However, there can beno assurance that the ultimate resolution of these matters will not result in amaterial adverse effect on our business, financial condition or results ofoperations.

OnOctober 11, 2005, a purported stockholder class action lawsuit purportedly onbehalf of MTI’s minority shareholders was filed in the Delaware Court ofChancery against MTI, MTI’s directors and us challenging our previouslyannounced exchange offer with MTI.  Thecomplaint alleged the then-proposed transaction constituted a breach ofdefendants’ fiduciary duties.  Thecomplaint sought an injunction preventing the completion of the transactionwith MTI or, if the transaction were to be completed, rescission of thetransaction or rescissory damages, unspecified damages, costs and attorneys’fees and expenses.  On January 6, 2006,we completed an acquisition of the publicly held shares of MTI through a mergertransaction.  We believe this lawsuit iswithout merit and plan to defend it vigorously if the plaintiff decides to

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pursueit.  However, there can be no assurancethat the ultimate resolution of this matter will not result in a materialadverse effect on our business, financial condition or results of operations.

**17.    Segment and Geographic Information**

Wereport and manage our operations in two reportable business segments based onsimilarities in the products sold, customer base and distribution system. Thecardio peripheral operating segment includes cardiovascular products which areused to treat coronary artery disease, atrial fibrillation and other disordersin the heart and peripheral vascular products which are used to treat vasculardisease in the legs, kidney (or renal), neck (or carotid), and generally allvascular diseases other than in the brain or the heart. The neurovascularoperating segment includes products that are used to treat vascular disease anddisorders in the brain, including aneurysms and arterial-venous malformations.Management measures segment profitability on the basis of gross profitcalculated as net sales less cost of goods sold excluding amortization ofintangible assets. Other operating expenses are not allocated to individualoperating segments for internal decision making activities.

*The following is segment information (in thousands):*
|                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **October 1, 2006**    | ** ** | **October 2, 2005**   | ** ** | **October 1, 2006** | ** ** | **October 2, 2005** | ** ** |
| ** **                               | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  sales**                           | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Cardio  Peripheral:**                  | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Stents                                   |       | $                                | 16,525     |                            | $          | 9,913 |   | $ | 45,591 |   | $ | 25,792 |   |
| Thrombectomy and embolic protection |       | 5,750                            |       | 2,949                           |       | 15,429 |   | 9,410 |   |
| Procedural support and other        |       | $                                | 8,894      |                            | 6,981      |   | $ | 26,062 |   | 20,690 |   |
| Total Cardio Peripheral                  |       | $                                | 31,169     |                            | $          | 19,843 |   | $ | 87,082 |   | $ | 55,892 |   |
|                                     |       |                             |       |                            |       |   |   |   |   |
| **Neurovascular:**                       | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Embolic products                         |       | 10,177                           |       | 6,220                           |       | 26,972 |   | 14,417 |   |
| Neuro access and delivery products  |       | 10,560                           |       | 7,437                           |       | 30,709 |   | 22,413 |   |
| Total Neurovascular                      |       | $                                | 20,737     |                            | $          | 13,657 |   | $ | 57,681 |   | $ | 36,830 |   |
|                                     |       |                             |       |                            |       |   |   |   |   |
| Total net sales                          |       | $                                | 51,906     |                            | $          | 33,500 |   | $ | 144,763 |   | $ | 92,722 |   |
|                                     |       |                             |       |                            |       |   |   |   |   |
| **Gross  profit**                        | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cardio Peripheral                        |       | $                                | 18,514     |                            | $          | 10,343 |   | $ | 48,649 |   | $ | 29,344 |   |
| Neurovascular                            |       | 15,726                           |       | 9,567                           |       | 43,781 |   | 24,894 |   |
| Total                                    |       | $                                | 34,240     |                            | $          | 19,910 |   | $ | 92,430 |   | $ | 54,238 |   |
|                                     |       |                             |       |                            |       |   |   |   |   |
| Gross profit                             |       | $                                | 34,240     |                            | $          | 19,910 |   | $ | 92,430 |   | $ | 54,238 |   |
| Operating  expense                       |       | 47,035                           |       | 41,816                          |       | 143,960 |   | 134,425 |   |
| Loss from  operations                    |       | $                                | (12,795    | )                               | $          | (21,906 | ) | $ | (51,530 | ) | $ | (80,187 | ) |

 
|                   | ** ** | **October 1, 2006** | ** ** | **December 31,   2005** | ** ** |
|-------------------|------------|-------------------------------|------------|-----------------------------------|------------|
| **Total  assets** |       |                          |       |                              |       |
| Cardio Peripheral |       | $                             | 227,913    |                              | $          | 239,255 |   |
| Neurovascular     |       | 123,855                       |       | 57,573                            |       |
| Total             |       | $                             | 351,768    |                              | $          | 296,828 |   |

* *

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* *

*The following table presents net sales and long-livedassets by geographic area as of and for the three and nine months ended October1, 2006 and October 2, 2005 (dollars in thousands):*
|                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **           | ** ** | **October 1,  2006**        | ** ** | **October 2,  2005**       | ** ** | **October 1,**

**2006** | ** ** | **October 2,  2005** | ** ** |
| ** **           |       |                             |       |                            |       |   |   |   |   |
| **Geographic  Data** |       |                             |       |                            |       |   |   |   |   |
| **Net  Sales**       |       |                             |       |                            |       |   |   |   |   |
| United States        |       | $                                | 31,127     |                            | $          | 19,081 |   | $ | 86,590 |   | $ | 49,141 |   |
| International        |       | 20,779                           |       | 14,419                          |       | 58,173 |   | 43,581 |   |
| Total net sales      |       | $                                | 51,906     |                            | $          | 33,500 |   | $ | 144,763 |   | $ | 92,722 |   |

 
|                          | ** ** | **October 1,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------|------------|---------------------------|------------|-----------------------------|------------|
| **Long-lived  Assets**   |       |                      |       |                        |       |
| United States            |       | $                         | 23,258     |                        | $          | 17,198 |   |
| International            |       | 634                       |       | 679                         |       |
| Total long-lived  assets |       | $                         | 23,892     |                        | $          | 17,877 |   |

** **

**18.**          Net Loss Per Share

Thefollowing outstanding options were excluded from the computation of diluted netloss per share as they had an antidilutive effect.  
| ** ** | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** ** | ** ** | **October 1,  2006**        | ** ** | **October 2,  2005**       | ** ** | **October 1,  2006** | ** ** | **October 2,  2005** | ** ** |
| Options    |       | 5,594,972                        |       | 3,470,407                       |       | 5,594,972 |   | 3,470,407 |   |

** **

18

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**ITEM 2.**                 MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

ThisManagement’s Discussion and Analysis provides material historical andprospective disclosures intended to enable investors and other users to assessour results of operations and financial condition. Statements that are nothistorical are forward-looking and involve risks and uncertainties discussedunder the heading “Forward-Looking Statements” below. The following discussionof our results of operations and financial condition should be read inconjunction with our consolidated financial statements and related notesthereto included elsewhere in this report.

**Overview**

Weare a global medical device company focused on catheter-based technologies forthe endovascular treatment of vascular diseases and disorders.  Our broad product portfolio is focused onapplications in each of the three sub-markets of the endovascular devicemarket: the peripheral vascular, neurovascular and cardiovascular markets..  We sell over 100 products consistingof over 1,000 SKUs in these markets. From 2000 to 2002, our investor group acquired certain of the assets inour cardio peripheral division to build the foundation of our currentperipheral and cardiovascular product portfolios.  During this period, our investor group alsopurchased certain neurovascular assets to expand our neurovascular productportfolio and, through a series of investments, obtained a controllinginvestment in Micro Therapeutics, Inc., or MTI.  MTI was previously our majority ownedsubsidiary, with the remaining shares being publicly held. InJanuary 2006, we acquired the remaining shares of MTI’s common stock notowned by us, as a result of which MTI became our wholly owned subsidiary and isnow known as ev3 Neurovascular.  We havededicated significant capital and management effort to advance our acquiredtechnologies and broaden our product lines in order to execute our strategies.

Webelieve the overall market for endovascular devices will grow as the demand forminimally invasive treatment of vascular diseases and disorders continues toincrease.  We intend to capitalize onthis market opportunity 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.

Wewere formed on January 28, 2005 as a subsidiary of ev3 LLC.  Immediately prior to the consummation of ourinitial public offering on June 21, 2005, ev3 LLC was merged with and into usand we completed a one-for-six reverse stock split of our outstanding commonstock.  For additional informationregarding our formation and the related transactions, see Note 2 to ourconsolidated financial 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.

Wereport and manage our operations in two reportable business segments based onsimilarities in the products 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.

Wehave corporate infrastructure and direct sales capabilities in the UnitedStates, Canada and Europe and have established distribution relationships inother international markets.  BeginningOctober 1, 2006, we established a distribution arrangement with MedtronicInternational Trading Inc. — Japan Branch, a subsidiary of Medtronic, Inc.,pursuant to which Medtronic distributes all of our products in Japan.  Asa result of this new arrangement, we ceased our direct sales operations in Japanand our third quarter 2006 net sales included a $1.1 million stocking orderplaced by Medtronic.  Our corporateheadquarters and our manufacturing, research and development, and U.S. salesoperations for our peripheral vascular and cardiovascular product lines arelocated in Plymouth, Minnesota.  Ourmanufacturing, research and development, and U.S. sales operations for ourneurovascular product lines are located in Irvine, California.  Outside of the United States, our primaryoffice is in Paris, France.  During thethree and nine months ended October 1, 2006, approximately 40.0% and 40.2% ofour net sales, respectively, were generated outside of the United States, as aresult of which we are sensitive to risks related to fluctuation in exchangerates and other risks associated with international operations, which couldaffect our business results.  Changes inforeign currency exchange rates had a positive impact of approximately $450thousand on third quarter 2006 net sales compared to the third quarter 2005.

19

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Sinceour inception, we have focused on building our U.S. and international directsales and marketing infrastructure that includes a worldwide sales force ofapproximately 215 representatives as of October 1, 2006 in the United States,Canada and Europe.  Our direct salesrepresentatives accounted for approximately 86% and 88% of our net sales duringeach of the three and nine months ended October 1, 2006, respectively, 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$610.0 million at October 1, 2006. Consequently, we have financed ouroperations through debt and equity offerings. We expect to continue to generate operating losses for at least the nexttwelve months.

Ourcash, cash equivalents and short-term investments available to fund our currentoperations were $45.0 million at October 1, 2006.  We completed an initial public offering ofour common stock on June 21, 2005 in which we sold 11,765,000 shares ofour common stock at $14.00 per share, resulting in net proceeds to us ofapproximately $152.7 million, after deducting underwriting discounts andcommissions and offering expenses.  Weused $36.5 million of these net proceeds to repay a portion of the accrued andunpaid interest on certain demand notes held by Warburg, Pincus EquityPartners, L.P. and certain of its affiliates, which we refer to collectively asWarburg Pincus, and The Vertical Group L.P. and certain of its affiliates,which we refer to collectively as Vertical. In addition, on July 20, 2005,we sold 205,800 shares of common stock pursuant to an over-allotment optiongranted to the underwriters which resulted in net proceeds to us of $2.2million, after deducting underwriting discounts and commissions and offeringexpenses.  We invested the remainingportion of the net proceeds in short-term, investment-grade, interest bearingsecurities.  We have used these funds forgeneral corporate purposes since our initial public offering, and expect tocontinue to do so.  We expect our cashbalances to decrease as we continue to use cash to fund our operations.

OnJune 28, 2006, our operating subsidiaries, ev3 Endovascular, Inc., ev3International, Inc. and Micro Therapeutics, Inc., entered into a Loan andSecurity Agreement with Silicon Valley Bank, consisting of a two-year $30.0million revolving line of credit and a 48-month $7.5 million equipmentfinancing line.  As of October 1, 2006,we had $7.5 million in outstanding borrowings under the equipment line and nooutstanding borrowings under the revolving line of credit; however, we had  approximately $1 million of outstandingletters of credit issued by SVB, which reduces the amount available under ourrevolving line of credit to approximately $29 million.

We believe our cash, cashequivalents, short-term investments and funds available under our revolvingline of credit will be sufficient to meet our liquidity requirements through atleast the next twelve months.

20

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**Results of Operations**

Thefollowing table sets forth, for the periods indicated, our results ofoperations expressed as dollar amounts (in thousands), and the changes betweenthe specified periods expressed as percent increases or decreases:
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | ** **                | ** ** | **Nine Months Ended** | ** ** | ** **                | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|---------------------------|------------|---------------------------------|------------|---------------------------|------------|
| **Results of Operations:**                         | ** ** | **October 1,  2006**        | ** ** | **October 2,  2005** | ** ** | **Percent  Change**             | ** ** | **October 1,  2006** | ** ** | **October 2,  2005** | ** ** | **Percent  Change** | ** ** |
| Net sales                                                    |       | $                                | 51,906     |                      | $          | 33,500                          |       | 54.9                      | %          | $ | 144,763 |   | $ | 92,722 |   | 56.1 | % |
| Operating  expenses:                                         |       |                             |       |                      |       |                            |       |                      |       |   |   |   |   |
| Cost  of goods sold (a)                                      |       | 17,666                           |       | 13,590                    |       | 30.0                            | %          | 52,333                    |       | 38,484 |   | 36.0 | % |
| Sales,  general and administrative (a)                       |       | 35,498                           |       | 30,666                    |       | 15.8                            | %          | 109,167                   |       | 94,823 |   | 15.1 | % |
| Research  and development (a)                                |       | 7,036                            |       | 8,436                     |       | (16.6                           | )%         | 19,857                    |       | 30,653 |   | (35.2 | )% |
| Amortization  of intangible assets                           |       | 4,483                            |       | 2,674                     |       | 67.7                            | %          | 13,008                    |       | 7,877 |   | 65.1 | % |
| Loss  on sale of assets, net                                 |       | 18                               |       | 40                        |       | (55.0                           | )%         | 142                       |       | 204 |   | (30.4 | )% |
| Acquired  in-process research and development                |       | —                           |       | —                    |       | NM                              |       | 1,786                     |       | 868 |   | 105.8 | % |
| Total  operating expenses                                    |       | 64,701                           |       | 55,406                    |       | 16.8                            | %          | 196,293                   |       | 172,909 |   | 13.5 | % |
| Loss from operations                                         |       | (12,795                          | )          | (21,906                   | )          | (41.6                           | )%         | (51,530                   | )          | (80,187 | ) | (35.7 | )% |
| Other (income) expense:                                      |       |                             |       |                      |       |                            |       |                      |       |   |   |   |   |
| Gain  on sale of investments, net                            |       | —                           |       | —                    |       | NM                              |       | (1,063                    | )          | (4,611 | ) | (76.9 | )% |
| Interest  (income) expense, net                              |       | (258                             | )          | (953                      | )          | (72.9                           | )%         | (1,471                    | )          | 10,833 |   | 113.6 | % |
| Minority  interest in loss of subsidiary                     |       | —                           |       | (486                      | )          | NM                              |       | —                    |       | (1,212 | ) | NM |   |
| Other  (income) expense, net                                 |       | (152                             | )          | (8                        | )          | NM                              |       | (1,533                    | )          | 2,912 |   | NM |   |
| Loss before income taxes                                     |       | (12,385                          | )          | (20,459                   | )          | (39.5                           | )%         | (47,463                   | )          | (88,109 | ) | (46.1 | )% |
| Income  tax expense (benefit)                                |       | 82                               |       | (2                        | )          | NM                              |       | 328                       |       | (61 | ) | NM |   |
| Net loss                                                     |       | (12,467                          | )          | (20,457                   | )          | (39.1                           | )%         | (47,791                   | )          | (88,048 | ) | (45.7 | )% |
| Accretion  of preferred membership units to redemption value |       | —                           |       | —                    |       | NM                              |       | —                    |       | 12,061 |   | NM |   |
| Net loss attributable to  common holders                     |       | $                                | (12,467    | )                         | $          | (20,457                         | )          | (39.1                     | )%         | $ | (47,791 | ) | $ | (100,109 | ) | (52.3 | )% |
| Net loss per common  share (basic and diluted) (b)           |       | $                                | (0.22      | )                         | $          | (0.42                           | )          |                      |       | $ | (0.85 | ) | $ | (4.99 | ) |   |   |
| Weighted average common shares outstanding (b)               |       | 57,032,677                       |       | 49,099,357                |       |                            |       | 56,556,305                |       | 20,069,139 |   |   |   |
|                                                              |            |                                  |            |                           |            |                                 |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 

----

 

(a)          Includes stock-basedcompensation charges of:

 
| Cost of goods sold                 |   | $     | 127    |   | $      | 198    |   |   |   | $     | 496    |   | $      | 445   |   |   |   |
|------------------------------------|--------|-------|--------|--------|--------|--------|--------|--------|--------|-------|--------|--------|--------|-------|--------|--------|--------|
| Sales, general and  administrative |   | 1,389 |   | 859    |   |   |   | 4,554  |   | 1,904 |   |   |   |
| Research and  development          |   | 151   |   | 295    |   |   |   | 523    |   | 729   |   |   |   |
|                               |   | $     | 1,667  |   | $      | 1,352  |   |   |   | $     | 5,573  |   | $      | 3,078 |   |   |   |

 

(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** | ** ** | ** **                | ** ** | **Nine Months Ended** | ** ** | ** **                | ** ** |
|------------------------------------------|------------|----------------------------------|------------|---------------------------|------------|---------------------------------|------------|---------------------------|------------|
| **NET SALES BY SEGMENT:** | ** ** | **October 1,  2006**        | ** ** | **October 2,  2005** | ** ** | **Percent  Change**             | ** ** | **October 1,  2006** | ** ** | **October 2,  2005** | ** ** | **Percent  Change** | ** ** |
| **Cardio Peripheral:**                   |       |                             |       |                      |       |                            |       |                      |       |   |   |   |   |
| Stents                                   |       | $                                | 16,525     |                      | $          | 9,913                           |       | 66.7                      | %          | $ | 45,591 |   | $ | 25,792 |   | 76.8 | % |
| Thrombectomy and  embolic protection     |       | 5,750                            |       | 2,949                     |       | 95.0                            | %          | 15,429                    |       | 9,410 |   | 64.0 | % |
| Procedural support                       |       | 8,894                            |       | 6,981                     |       | 27.4                            | %          | 26,062                    |       | 20,690 |   | 26.0 | % |
| Total Cardio Peripheral                  |       | $                                | 31,169     |                      | $          | 19,843                          |       | 57.1                      | %          | $ | 87,082 |   | $ | 55,892 |   | 55.8 | % |
|                                     |       |                             |       |                      |       |                            |       |                      |       |   |   |   |   |
| **Neurovascular:**                       |       |                             |       |                      |       |                            |       |                      |       |   |   |   |   |
| Embolic products                         |       | 10,177                           |       | 6,220                     |       | 63.6                            | %          | 26,972                    |       | 14,417 |   | 87.1 | % |
| Neuro access and  delivery products      |       | 10,560                           |       | 7,437                     |       | 42.0                            | %          | 30,709                    |       | 22,413 |   | 37.0 | % |
| Total Neurovascular                      |       | $                                | 20,737     |                      | $          | 13,657                          |       | 51.8                      | %          | $ | 57,681 |   | $ | 36,830 |   | 56.6 | % |
|                                     |       |                             |       |                      |       |                            |       |                      |       |   |   |   |   |
| Total                                    |       | $                                | 51,906     |                      | $          | 33,500                          |       | 54.9                      | %          | $ | 144,763 |   | $ | 92,722 |   | 56.1 | % |
|                                          |            |                                  |            |                           |            |                                 |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                      | ** ** | **Three Months Ended** | ** ** | ** **                | ** ** | **Nine Months Ended** | ** ** | ** **                | ** ** |
|---------------------------------|------------|----------------------------------|------------|---------------------------|------------|---------------------------------|------------|---------------------------|------------|
| **NET SALES BY GEOGRAPHY:**     | ** ** | **October 1,  2006**        | ** ** | **October 2,  2005** | ** ** | **Percent  Change**             | ** ** | **October 1,  2006** | ** ** | **October 2,  2005** | ** ** | **Percent  Change** | ** ** |
| United States                   |       | $                                | 31,127     |                      | $          | 19,081                          |       | 63.1                      | %          | $ | 86,590 |   | $ | 49,141 |   | 76.2 | % |
| International                   |       |                             |       |                      |       |                            |       |                      |       |   |   |   |   |
| Before foreign exchange  impact |       | 20,330                           |       | 14,419                    |       | 41.0                            | %          | 58,880                    |       | 43,581 |   | 35.1 | % |
| Foreign exchange impact         |       | 449                              |       | —                    |       | —                          |       | (707                      | )          | — |   | — |   |
| Total                           |       | 20,779                           |       | 14,419                    |       | 44.1                            | %          | 58,173                    |       | 43,581 |   | 33.5 | % |
| Total                           |       | $                                | 51,906     |                      | $          | 33,500                          |       | 54.9                      | %          | $ | 144,763 |   | $ | 92,722 |   | 56.1 | % |
|                                 |            |                                  |            |                           |            |                                 |            |                           |            |  |  |  |  |  |  |  |  |  |  |

 

***Comparison of the Three Months EndedOctober 1, 2006 to the Three Months Ended October 2, 2005***

*Net sales*.  Net sales increased 54.9% to$51.9 million in the three months ended October 1, 2006 compared to $33.5million in the three months ended October 2, 2005, primarily as a result ofcontinued improvements in sales force productivity and increased marketpenetration of products introduced during the past 18 months.  Third quarter 2006 net sales also included$1.1 million related to the initial stocking order placed by our newdistributor in Japan.

*Net sales of cardio peripheral products*.  Netsales of cardio peripheral products increased 57.1% to $31.2 million in thethree months ended October 1, 2006 compared to $19.8 million in the threemonths ended October 2, 2005.  This salesgrowth was primarily the result of sales growth in our stent products and salesof our SpideRX Embolic Protection Device. Net sales in our stent product line increased 66.7% to $16.5 million inthe three months ended October 1, 2006 compared to $9.9 million in the threemonths ended October 2, 2005.  Thisincrease is attributable to increased market penetration of the EverFlex,Protégé GPS, Primus and ParaMount Mini families of stents, partially offset bysales declines in older generation products. Net sales of our thrombectomy and embolic protection devices increased95.0% to $5.8 million in the three months ended October 1, 2006 compared to thesame period in 2005, largely due to increased market penetration of the SpideRXinternationally and the launch of SpideRX in the United States, partiallyoffset by sales declines in older generation products.  Net sales of our procedural support and otherproducts increased 27.4% to $8.9 million in the three months ended October 1,2006 compared to $7.0 million in the three months ended October 2, 2005,largely due to the increased market penetration of PTA balloon catheters in theUnited States.  We expect cardioperipheral net sales to increase during the remainder of 2006 as a result ofnew product introductions and continued market penetration of products releasedduring the past 18 months.

*Net sales of neurovascular products*.  Netsales of our neurovascular products increased 51.8% to $20.7 million in thethree months ended October 1, 2006 compared to $13.7 million in the threemonths ended October 2, 2005, primarily as a result of increased penetration ofexisting products and sales growth in virtually all of our neurovascular accessand delivery products. Net sales of our embolic products increased 63.6% to$10.2 million in the three months ended October 1, 2006 compared to the sameperiod in 2005, primarily due to increased market penetration of our Nexus coiland Onyx Liquid Embolic System for the treatment of brain arterial-venousmalformations, partially offset by sales declines in older generationproducts.  Sales of our neuro access anddelivery products increased 42.0% to $10.5 million in the three months endedOctober 1, 2006 compared to the same period in 2005, largely as a result ofvolume increases across virtually all product lines.

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*Net sales by geography*.  Netsales in the United States increased 63.1% to $31.1 million in the three monthsended October 1, 2006 compared to $19.1 million in the three months endedOctober 2, 2005. International net sales increased 44.1% to $20.8 million inthe three months ended October 1, 2006 compared to $14.4 million in the threemonths ended October 2, 2005 and represented 40.0% and 43.0% of our total netsales during the three months ended October 1, 2006 and October 2, 2005,respectively.

*Cost of goods sold*.  As a percentage of net sales,cost of goods sold decreased to 34.0% of net sales in the three months endedOctober 1, 2006 compared to 40.6% of net sales in the three months endedOctober 2, 2005.  This decrease wasprimarily attributable to our continued growth in sales volume, ongoinginvestments in in-house manufacturing capabilities and cost savings achievedrelated to our implementation and use of lean manufacturing concepts.  In our cardio peripheral segment, cost ofgoods sold as a percent of net sales decreased to 40.6% in the three monthsended October 1, 2006 compared to 47.9% in the three months ended October 2,2005 primarily attributable to on-going investments in in-house manufacturingcapabilities and increased sales volume. In our neurovascular segment, cost of goods sold as a percent of netsales decreased to 24.2% in the three months ended October 1, 2006 compared to30.0% in the three months ended October 2, 2005 due in part to the consolidationof our neurovascular manufacturing operations into our Irvine, Californiafacility during the second quarter 2005. Our increased production volumes and on-going cost savings programs alsocontributed to the decrease. We expect cost of goods sold as a percentage ofnet sales to show modest improvement during the remainder of 2006 due to highervolume in our manufacturing facilities and efficiency improvements frommanufacturing initiatives, offset in part by anticipated conversion costsassociated with new product launches occurring during 2006.

*Sales, general and administrative expense*.   Sales, general and administrative expenses increased 15.8% to $35.5million in the three months ended October 1, 2006 compared to $30.7 million inthe three months ended October 2, 2005. The increase was partially due to higher selling expenses related to newproduct introductions, a $530 thousand increase in non-cash stock-basedcompensation costs and a $340 thousand increase in relocation relatedcosts.  General and administrativeexpenses increased approximately $1.8 million. Although sales, general and administrative expenses increased inabsolute dollars, as a percentage of net sales, sales, general andadministrative expenses decreased to 68.4% in the three months ended October 1,2006 compared to 91.5% of net sales in the three months ended October 2,2005.  We expect sales, general andadministrative expenses, excluding litigation related charges, for theremaining quarter of 2006 to decline slightly as compared to third quarter 2006driven in part by the savings we expect to realize from our reduced salesoperation in Japan.

*Research and development*.  As apercentage of net sales, research and development expense decreased to 13.6% inthe three months ended October 1, 2006 compared to 25.2% in the three monthsended October 2, 2005.  This reductionwas due to an increase in net sales and a decrease in clinical study expensesrelated to the completion of certain clinical trials in 2005, which waspartially offset by increased spending on certain internal developmentefforts.  We expect research anddevelopment expense as a percentage of net sales to increase in the fourthquarter 2006 as compared to third quarter 2006.

*Amortization of intangible assets*.  Amortizationof intangible assets increased 67.7% to $4.5 million in the three months endedOctober 1, 2006 compared to $2.7 million in the three months ended October 2,2005 primarily due to increases in intangible assets recorded as part of ouracquisition of the remaining minority shares of MTI in January 2006.   We expect amortization of intangible assetsfor the remaining quarter of 2006 to remain consistent with third quarter 2006levels.

*Interest (income) expense, net*.  Netinterest income was $258 thousand in the three months ended October 1, 2006compared to $1.0 million in the three months ended October 2, 2005.  This decrease was due primarily to areduction in our average cash equivalents and short-term investment balances inthe third quarter 2006 as compared to the same period in 2005.    We also incurred interest charges on ouroutstanding borrowings under our equipment line of credit. See Note 14 in thenotes to the consolidated financial statements included elsewhere in thisreport.

*Other (income) expense, net*.  Otherincome was $152 thousand in the three months ended October 1, 2006 compared to$8 thousand in the three months ended October 2, 2005.  The other (income) expense in the threemonths ended October 1, 2006 and October 2, 2005 was primarily due to foreignexchange gains and losses.

*Income tax expense (benefit)*.  Weincurred modest levels of income tax expense in the three months ended October1, 2006 and modest levels of income tax benefit in the three months endedOctober 2, 2005 related to certain European sales offices.  We recorded no provision or benefit forU.S. income taxes in either the three months ended October 1, 2006 orOctober 2, 2005 due to our history of operating losses.

23

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***Comparison of the Nine Months EndedOctober 1, 2006 to the Nine Months Ended October 2, 2005***

*Net sales*.  Net sales increased 56.1% to$144.8 million in the nine months ended October 1, 2006 compared to $92.7million in the nine months ended October 2, 2005, primarily as a result ofcontinued improvements in sales force productivity and increased marketpenetration of products introduced during the past 18 months.

*Net sales of cardio peripheral products*.  Netsales of cardio peripheral products increased 55.8% to $87.1 million in thenine months ended October 1, 2006 compared to $55.9 million in the nine monthsended October 2, 2005.  This sales growthwas primarily the result of sales growth in our stent products, our SpideRXEmbolic Protection Device and sales of our PTA balloon catheters in the UnitedStates.  Net sales in our stent productline increased 76.8% to $45.6 million in the nine months ended October 1, 2006compared to $25.8 million in the nine months ended October 2, 2005.  This increase is attributable to increasedmarket penetration of the EverFlex, Protégé GPS, Primus and ParaMount Minifamilies of stents, partially offset by sales declines in older generationproducts.  Net sales of our thrombectomyand embolic protection devices increased 64.0%, or $6.0 million, to $15.4million in the nine months ended October 1, 2006 compared to the same period in2005, largely due to increased market penetration of the SpideRXinternationally and the launch of SpideRX in the United States, partiallyoffset by sales declines in older generation products.  Net sales of our procedural support and otherproducts increased 26.0% to $26.1 million in the nine months ended October 1,2006 compared to $20.7 million in the nine months ended October 2, 2005,largely due to the increased market penetration of PTA balloon catheters in theUnited States.

*Net sales of neurovascular products*.  Netsales of our neurovascular products increased 56.6% to $57.7 million in thenine months ended October 1, 2006 compared to $36.8 million in the nine monthsended October 2, 2005, primarily as a result of increased penetration ofexisting products and sales growth in virtually all of our neurovascular accessand delivery products. Net sales of our embolic products increased 87.1%, or$12.6 million, to $27.0 million in the nine months ended October 1, 2006compared to the same period in 2005, primarily due to increased marketpenetration of our Nexus coil and Onyx Liquid Embolic System for the treatmentof brain arterial-venous malformations, partially offset by sales declines inolder generation products. Sales of our neuro access and delivery productsincreased 37.0%, or $8.3 million, to $30.7 million in the nine months endedOctober 1, 2006 compared to the same period in 2005, largely as a result ofvolume increases across virtually all product lines.

*Net sales by geography*.  Netsales in the United States increased 76.2% to $86.6 million in the nine monthsended October 1, 2006 compared to $49.1 million in the nine months endedOctober 2, 2005. International net sales also increased 33.5% to $58.2 millionin the nine months ended October 1, 2006 compared to $43.6 million in the ninemonths ended October 2, 2005 and represented 40.2% and 47.0% of our total netsales during the nine months ended October 1, 2006 and October 2, 2005, respectively.

*Cost of goods sold*.  As a percentage of net sales,cost of goods sold decreased to 36.2% of net sales in the nine months endedOctober 1, 2006 compared to 41.5% of net sales in the nine months ended October2, 2005.  This decrease was primarily attributableto our continued growth in sales volume, the consolidation of manufacturingfacilities during the second quarter 2005,. on going investments in in-housemanufacturing capabilities and cost savings achieved related to ourimplementation and use of lean manufacturing concepts.  In our cardio peripheral segment, cost ofgoods sold as a percent of net sales decreased to 44.1% in the nine monthsended October 1, 2006 compared to 47.5% in the nine months ended October 2,2005 primarily attributable to increased sales volumes, on-going investments inin-house manufacturing capabilities. In our neurovascular segment, cost ofgoods sold as a percent of sales decreased to 24.1% in the nine months endedOctober 1, 2006 compared to 32.4% in the nine months ended October 2, 2005 duein part to the consolidation of our neurovascular manufacturing operations intoour Irvine, California facility during the second quarter 2005.  Our increased production volumes and ongoingcost savings programs also contributed to the decrease.

*Sales, general and administrative expense*. Sales, general and administrative expenses increased 15.1% to $109.2million in the nine months ended October 1, 2006 compared to $94.8 million inthe nine months ended October 2, 2005. The increase was partially due to $7.9 million of charges incurredduring the first nine months of 2006 related to litigation and businessdevelopment activities which represents a higher level of expense than ourhistorical levels.  Higher sellingexpenses related to new product introductions and a $2.7 million increase innon-cash stock-based compensation costs also contributed to the increase in thenine months ended October 1, 2006. Although these expenses increased inabsolute dollars, as a percentage of net sales, sales, general andadministrative expenses decreased to 75.4% in the nine months ended October 1,2006 compared to 102.3% of net sales in the nine months ended October 2, 2005.

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*Research and development*.  As apercentage of net sales, research and development expense decreased to 13.7% inthe nine months ended October 1, 2006 compared to 33.1% of net sales in thenine months ended October 2, 2005.  Thisreduction was due to an increase in net sales, $8.5 million decrease inclinical study expenses related to the completion of certain clinical trials in2005, which was partially offset by increased spending on certain internaldevelopment efforts.

*Amortization of intangible assets*. Amortization of intangible assets increased 65.1% to $13.0 million inthe nine months ended October 1, 2006 compared to $7.9 million in the ninemonths ended October 2, 2005 primarily due to increases in intangible assetsrecorded as part of the May 2005 contribution of MTI shares and due to ouracquisition of the remaining minority shares of MTI in January 2006.

*Acquired in-process research and development*. During the nine months ended October 1, 2006, we incurred a charge of$1.8 million for acquired in-process research and development as a result ofour acquisition of the outstanding shares of MTI that we did not alreadyown.  We incurred a charge of $868thousand for acquired in-process research and development during the ninemonths ended October 2, 2005 related to the May 2005 contribution of MTIshares.

*Gain on sale of investments, net*.  Gainon sale of investments, net was $1.1 million in the nine months ended October1, 2006. We received a final $910 thousand milestone payment related to the2002 sale of our investment in Enteric Medical Technologies, Inc. and a $153thousand milestone payment related to the 2005 sale of our investment in GenyxMedical, Inc.  Gain on sale ofinvestments, net was $4.6 million in the nine months ended October 2, 2005related to earlier milestone payments received from the sale of our investmentsin Genyx Medical, Inc. and Enteric Medical Technologies, Inc.

*Interest (income) expense, net*.  Netinterest income, was $1.5 million in the nine months ended October 1, 2006compared to net interest expense of $10.8 million in the nine months endedOctober 2, 2005.   A portion of the netproceeds from our initial public offering in June 2005 were invested inshort-term, investment-grade, interest-bearing securities contributing interestincome during the full nine months ended October 1, 2006 versus only a portionof the nine months ended October 2, 2005. We also used a portion of the net proceeds to reduce our financingbalance to zero resulting in the reduction of interest expense.

*Other (income) expense, net*.  Otherincome was $1.5 million in the nine months ended October 1, 2006 compared toother expense of $2.9 million in the nine months ended October 2, 2005.  The other (income) expense in the nine monthsended October 1, 2006 and October 2, 2005 was primarily due to foreign exchangegains and losses.

*Income tax expense (benefit)*.  Weincurred modest levels of income tax in the nine months ended October 1, 2006and modest levels of income tax benefit in the nine months ended October 2,2005 related to certain European sales offices. We recorded no provision or benefit for U.S. income taxes in eitherthe nine months ended October 1, 2006 or October 2, 2005 due to our history ofoperating losses.

*Accretion of preferred membership units 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    | ** ** | **October 1,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **(in thousands)**   | ** ** |
| Cash and cash  equivalents      |       | $                         | 26,528     |                        | $          | 69,592 |   |
| Short-term investments          |       | 18,450                    |       | 12,000                      |       |
| Total current assets            |       | 130,789                   |       | 151,675                     |       |
| Total assets                    |       | 351,768                   |       | 296,828                     |       |
| Total current  liabilities      |       | 39,248                    |       | 37,671                      |       |
| Total liabilities               |       | 45,705                    |       | 38,523                      |       |
| Total stockholders’ equity |       | 306,063                   |       | 245,455                     |       |
|                                 |            |                           |            |                             |            |  |  |

 

*Financing history.*  We have generated significantoperating losses since our inception. These operating losses, including cumulative non-cash charges foracquired in-process research and development of $128.7 million, have resultedin an accumulated deficit of $610.0 million as of October 1, 2006. We completedan initial public offering of our common stock

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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, after deductingunderwriting 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 II, Item 2 under theheading “Use of Proceeds” included elsewhere in this report.

*Cash, cash equivalents and short-term investments.*Our cash, cash equivalents and short-terminvestments available to fund current operations totaled approximately $45.0million at October 1, 2006, a decrease of $36.6 million from December 31,2005.  We expect our cash balances tocontinue to decrease as we use cash to fund our operations.

*Credit facility.*  On June28, 2006, our operating subsidiaries, ev3 Endovascular, Inc., ev3International, Inc. and Micro Therapeutics, Inc., which we refer to as the“borrowers”, entered into a Loan and Security Agreement, which we refer to asthe loan agreement, with Silicon Valley Bank, or SVB, consisting of a two-year$30.0 million 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 baselimitations.  These limitations allow usto borrow, subject to specified reserves up to 80% of eligible domestic andforeign accounts receivables 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.   As of October 1, 2006, we had $7.5 millionin outstanding borrowings under the equipment line and no outstandingborrowings under the revolving line of credit; however, we had approximately $1million of outstanding letters of credit issued by SVB, which reduces theamount available under our revolving line of credit to approximately $29million.

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 guaranteed by ev3 Inc. and allof our domestic direct and indirect subsidiaries. The loan agreement requiresthe borrowers to maintain a specified liquidity ratio and a tangible net worthlevel.  The loan agreement imposescertain limitations on the borrowers, their subsidiaries and ev3 Inc.,including without limitation, on their ability to: (i) transfer all or any partof their business or properties; (ii) permit or suffer a change in control;(iii) merge or consolidate, or acquire any entity; (iv) engage in any materialnew line of business; (v) incur additional indebtedness or liens with respectto any of their properties; (vi) pay dividends or make any other distributionon or purchase of, any of their capital stock; (vii) make investments in othercompanies; or (viii) engage in related party transactions, subject in each caseto certain exceptions and limitations. The loan agreement requires us to maintain on deposit or invested withSVB or its affiliates the lesser of $15.0 million or 50% of our aggregate cashand cash equivalents.  The borrowers arerequired to pay customary fees with respect to the facility, including a fee onthe average unused portion of the revolving line.

The loan agreement containscustomary events of default, including the failure to make required payments,the failure to comply with certain covenants or other agreements, theoccurrence of a material adverse change, failure to pay certain otherindebtedness and certain events of bankruptcy or insolvency. Upon theoccurrence and continuation of an event of default, amounts due under the loanagreement may be accelerated.

Webelieve our cash, cash equivalents, short-term investments and funds availableunder our revolving line of credit will be sufficient to meet our liquidityrequirements through at least the next 12 months.

*Operating activities.*  Cashused in operations during the nine months ended October 1, 2006 was $40.7million, reflecting primarily our net loss and increased working capitalrequirements during the period.  Our netloss included approximately $24.4 million of non-cash charges for depreciationand amortization, acquired in-process research and development and stock-basedcompensation expense.  We expect thatoperations will continue to use cash during the remainder of 2006.

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*Investing activities. *Cash used ininvesting activities during the nine months ended October 1, 2006 was $17.5million primarily due to the purchase of $6.8 million of short-term investmentsand the purchase of $10.2 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 $3.7 million incapital expenditures during the balance of 2006.

*Financing activities. *Cash providedby financing activities was $14.8 million during the nine months ended October1, 2006, generated primarily from proceeds of stock option exercises andproceeds from borrowings on our equipment term loan with Silicon Valley Bank.

*Contractual cash obligations. *Our contractual cash obligations as of December 31, 2005 are set forthin our annual report on Form 10-K for the year ended December 31, 2005.There have been no material changes in our contractual cash obligations andcommercial commitments since December 31, 2005, except for additional commitmentsof approximately $1.2 million and $830 thousand in the years ended December 31,2006 and 2007, respectively, for financed insurance premiums as described inmore detail in Note 16 to our consolidated financial statements includedelsewhere in this report and the additional commitments for principal paymentson long term debt as disclosed in more detail in Note 13 to our consolidatedfinancial statements also included elsewhere in this report.

*Other liquidity information. *The acquisitionagreements relating to our purchase of MitraLife, Appriva Medical, Inc.and Dendron GmbH require us to make additional payments to the sellers of thesebusinesses if certain milestones related to regulatory steps in the productcommercialization process are achieved. The potential milestone payments total $25.0 million, $175.0 million and$15.0 million with respect to the MitraLife, Appriva and Dendron acquisitions,respectively, during the period of 2003 to 2009.  We do not believe it is likely that we willhave obligations with respect to the MitraLife milestones in the future.  We have determined that the first milestonewith respect to the Appriva agreement was not achieved by the January 1,2005 milestone date and that the first milestone is not payable.  On September 27, 2005, we announced thatwe had decided to discontinue the development and commercialization of ourPLAATO device, which is the technology we acquired in the Apprivatransaction.  Although we recently had obtainedconditional approval from the FDA for an Investigational Device Exemption(“IDE”) clinical trial for the PLAATO device, we determined that, due to thetime, cost and risk of enrollment, the trial design ultimately mandated by theFDA 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 sale orlicensing of the technology to third parties. Under the terms of the stock purchase agreement we entered into inconnection with our acquisition of Dendron, we may be required to makeadditional payments which are contingent upon Dendron products achievingcertain revenue targets between 2003 and 2008. In 2003, the $4.0 millionrevenue 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 2005.  We maybe required 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.  Anysuch final payment would be due in the year following the year of targetachievement.

Ourfuture liquidity and capital requirements will be influenced by numerousfactors, including extent and duration of future operating losses, the leveland timing of future sales and expenditures, the results and scope of ongoingresearch and product development programs, working capital to support our salesgrowth, receipt of and time required to obtain regulatory clearances andapprovals, sales and marketing programs, continuing acceptance of our productsin the marketplace competing technologies, market and regulatory developments,and the future course of intellectual property litigation.  We believe that the resources generated fromour initial public offering, together with funds available under our revolvingcredit facility, are sufficient to meet our liquidity requirements through atleast the next 12 months. In the event that we require additional workingcapital to fund future operations and any future acquisitions, we may negotiatea financing arrangement with an independent institutional lender, sell notes topublic or private 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 5 and Note 16 to our consolidatedfinancial statements included elsewhere in this report.

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**Critical Accounting Policies and Estimates**

Wehave adopted various accounting policies to prepare our consolidated financialstatements in accordance with U.S. Generally Accepted Accounting Principles, orGAAP. Our most significant accounting policies are described in Note 3 to ouraudited consolidated financial statements included in our annual report on Form10-K for the year ended December 31, 2005. The preparation of our consolidated financial statements in conformitywith U.S. GAAP requires us to make estimates and assumptions that affect theamounts reported in our consolidated financial statements and accompanyingnotes.  Our estimates and assumptions,including those related to bad debts, inventories, intangible assets, salesreturns and discounts, and income taxes are updated as appropriate.

Certainof our more critical accounting policies require the application of significantjudgment by management in selecting the appropriate assumptions for calculatingfinancial estimates.  By their nature,these judgments 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.

Webelieve that the following financial estimates are both important to theportrayal of our financial condition and results of operations and requiresubjective or complex judgments. Further, we believe that the items discussed below are properly recordedin our consolidated financial statements for all periods presented.  Management has discussed the development,selection and disclosure of our most critical financial estimates with theaudit committee of our board of directors and our independent registered publicaccounting firm.  The judgments aboutthose financial estimates are based on information available as of the date ofour consolidated financial statements. Those financial estimates include:

***Revenue Recognition***

Werecognize revenue in accordance with SEC Staff Accounting BulletinNo. 104, Revenue Recognition, which requires that four basic criteria mustbe met before sales can be recognized: (1) persuasive evidence of anarrangement exists; (2) delivery has occurred or services have beenrendered; (3) the price is fixed or determinable and(4) collectibility is reasonably assured. These criteria are met at the time of shipment when risk of loss andtitle passes to the customer or distributor, unless a consignment arrangementexists. Sales from consignment arrangements are recognized upon writtenacknowledgement that the product has been used by the customer indicating thata sale is complete.  Our terms of salefor regular sales are typically FOB shipping point, net 30 days.  Regular sales include orders from customersfor replacement of customer stock, replenishment of consignment product used bycustomers, orders for a scheduled case/surgery and stocking orders.

Weallow customers to return 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,our return experience has been low with return rates of less than 3.0% of ournet sales.

***Stock-Based Compensation***

 

We currently use the Black-Scholes optionpricing model to determine the fair value of stock options and other equityincentive awards. The determination of the fair value of stock-basedcompensation awards on the date of grant using an option-pricing model isaffected by our stock price, as well as assumptions regarding a number ofcomplex and subjective variables which include the expected life of the award,the expected stock price volatility over the expected life of the awards,expected dividend yield, risk-free interest rate and the forfeiture rate.

 

We estimate the expected term of options basedupon our historical experience. We estimate expected volatility and forfeiturerates based on a combination of historical factors related to our common stocksince our June 2005 initial public offering and the volatility rates of a setof guideline companies. The guideline companies consist of public and recentlypublic medical technology companies.  Therisk-free interest rate is determined using U.S. Treasury rates appropriate forthe expected term. Dividend yield is estimated to be zero as we have never paiddividends and have no plans of doing so in the future.

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We estimate forfeitures at the time of grantand revise those estimates in subsequent periods if actual forfeitures differfrom those estimates. We use historical data to estimate forfeitures and recordstock-based compensation expense only for those awards that are expected tovest. All stock-based compensation is amortized on a straight-line basis overthe respective requisite service periods, which are generally the vestingperiods.

 

If factors change and we employ different assumptionsfor estimating stock-based compensation expense in future periods, the futureperiods may differ significantly from what we have recorded in the currentperiod and could materially affect our results of operations. It may alsoresult in a lack of comparability with other companies that use differentmodels, methods and assumptions.

 

The Black-Scholes option-pricing model wasdeveloped for use in estimating the fair value of traded options that have novesting restrictions and are fully transferable, characteristics not present inour option grants. Existing valuation models, including the Black-Scholes andlattice binomial models, may not provide reliable measures of the fair valuesof our stock-based compensation. Consequently, there is a risk that ourestimates of the fair values of our stock-based compensation awards on thegrant dates may bear little resemblance to the actual values realized upon theexercise, expiration, early termination or forfeiture of those stock-basedawards in the future. Certain stock-based payments, such as employee stockoptions, may expire worthless or otherwise result in zero intrinsic value ascompared to the fair values originally estimated on the grant date and reportedin our consolidated financial statements. Alternatively, value may be realizedfrom these instruments that is significantly higher than the fair valuesoriginally estimated on the grant date and reported in our consolidatedfinancial statements. There is not currently a market-based mechanism or other practicalapplication to verify the reliability and accuracy of the estimates stemmingfrom these valuation models.

 

The guidance in SFAS 123(R) and SAB 107 isrelatively new. The application of these principles may be subject to furtherinterpretation and refinement over time. See Note 3 to our consolidatedfinancial statements for further information regarding our SFAS 123(R)disclosures.

 

***Allowance for DoubtfulAccounts***

Wemake judgments as to our ability to collect outstanding receivables and provideallowance for a portion 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.

Ouraccounts receivable balance was $39.4 million and $28.5 million, net ofaccounts receivable allowances, comprised of both allowances for doubtfulaccounts and sales returns, of $3.8 million and $3.6 million at October 1,2006 and December 31, 2005, respectively.

***Excess and Obsolete Inventory***

Wecalculate an inventory reserve for estimated obsolescence or excess inventorybased on historical turnover and assumptions about future demand for ourproducts and market conditions.  Ourindustry is characterized by regular new product development, and as such, ourinventory is at risk of obsolescence following the introduction and developmentof new or enhanced products.  Ourestimate and assumptions for excess and obsolete inventory are reviewed andupdated on a quarterly basis.  Theestimates we use for demand are also used for near-term capacity planning andinventory purchasing and are consistent with our sales forecasts. Futureproduct introductions and related inventories may require additional reservesbased upon changes in market demand or introduction of competingtechnologies.  Increases in the reservefor excess and obsolete inventory result in a corresponding expense to cost ofgoods sold.  Our reserve for excess andobsolete inventory was $4.5 million and $4.0 million at October 1, 2006 andDecember 31, 2005, respectively.

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

Whenwe acquire another company, the purchase price is allocated, as applicable,between acquired in-process research and development, other identifiableintangible assets, tangible net assets and goodwill as required by U.S.GAAP.  In-process research anddevelopment is defined as the value assigned to those projects for which therelated products have not received regulatory approval and have no alternativefuture use.  Determining the portion ofthe purchase price allocated to in-process research and development and otherintangible assets requires us to make significant estimates that may changeover time.  During the nine months endedOctober 1, 2006, we recorded an in-process research and development charge of$1.8 million related to the January 6, 2006 acquisition of the remainingminority interest in MTI.

Theincome approach was used to determine the fair values of the acquiredin-process research and development. This approach establishes fair value by estimating the after-tax cashflows attributable to the in-process project over its useful life and thendiscounting these after-tax cash flows back to the present value.  Revenue estimates were based on relativemarket size, expected market growth rates and market share penetration.  Gross margin estimates were based on theestimated cost of the product at the time of introduction and historical grossmargins for similar products offered by us or by competitors in themarketplace.  The estimated selling,general and administrative expenses were based on historical operating expensesof the acquired 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 coretechnologies, the expected introduction date and the estimated useful life ofthe technology.  The discount rate usedto arrive at the present value of acquired in-process research and developmentas of the acquisition date was based on the time value of money and medicaltechnology investment risk factors.  Webelieve that the estimated acquired in-process research and development amountsdetermined represent the fair value at the date of acquisition and do notexceed the amount a third party would pay for the projects.

Goodwillrepresents the excess of the aggregate purchase price over the fair value ofnet assets, including in-process research and development, of the acquiredbusinesses.  Goodwill is tested forimpairment annually, or more frequently if changes in circumstance or the occurrenceof events suggest an impairment exists. The test for impairment requires us to make several estimates about fairvalue, most of which are based on projected future cash flows.  Our estimates associated with the goodwillimpairment tests are considered critical due to the amount of goodwill recordedon our consolidated balance sheets and the judgment required in determiningfair value amounts, including projected future cash flows.  Goodwill was $149.1 million and $94.5 millionat October 1, 2006 and December 31, 2005, respectively.

Otherintangible assets consist primarily of purchased developed technology, patents,customer relationships and trademarks and are amortized over their estimateduseful lives, ranging from 5 to 10 years. We review these intangible assets for impairment annually during ourfourth fiscal quarter or as changes in circumstance or the occurrence of eventssuggest the remaining value may not be recoverable.  Other intangible assets, net of accumulatedamortization, were $43.6 million and $26.2 million at October 1, 2006 andDecember 31, 2005, respectively.

Theevaluation of asset impairments related to goodwill and other intangible assetsrequire us to make assumptions about future cash flows over the life of theassets being evaluated.  Theseassumptions require significant judgment and actual results may differ fromassumed or estimated amounts.

***Accounting for Income Taxes***

Aspart of the process of preparing our consolidated financial statements, we arerequired to determine our income taxes in each of the jurisdictions in which weoperate.  This process involvesestimating our actual current tax expense together with assessing temporarydifferences resulting from recognition of items for income tax and accountingpurposes.  These differences result indeferred tax assets and liabilities, which are included on our consolidatedbalance sheets.  We must then assess thelikelihood that our deferred tax assets will be recovered from future taxableincome and, to the extent we believe that recovery is not likely, we mustestablish a valuation allowance.  To theextent we establish a valuation allowance or increase this allowance in aperiod, we must reflect this increase as an expense within the tax provision inour consolidated statement of operations.

Management’sjudgment is required in determining our provision for income taxes, ourdeferred tax assets and liabilities and any valuation allowance recordedagainst our net deferred tax assets.  Wewill continue to monitor the realizability of

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ourdeferred tax assets and adjust the valuation allowance accordingly.  We have recorded a full valuation allowanceon our net deferred tax asset as of October 1, 2006 and December 31, 2005.

**Seasonality**

Ourbusiness is seasonal in nature.  Historically,demand for our products 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**

Wedo not have any off-balance sheet arrangements, as defined by therules and regulations of the SEC, that have or are reasonably likely tohave a material effect on our financial condition, changes in financialcondition, revenues or expenses, results of operations, liquidity, capitalexpenditures or capital resources.  As aresult, we are not materially exposed to any financing, liquidity, market orcredit risk that could arise if we had engaged in these arrangements.

**Recent Accounting Pronouncements**

OnJanuary 1, 2006, we adopted the provisions of Statement of FinancialAccounting Standards No. 123(R), “Share-Based Payment” (SFAS 123(R)) using themodified prospective method.  SFAS 123(R)requires companies to measure and recognize the cost of employee servicesreceived in exchange for awards of equity instruments based on the grant datefair value of those awards.  Compensationcost under SFAS 123(R) is recognized ratably using the straight-lineattribution 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.     Priorperiods are not restated under this transition method.  Options previously awarded and classified asequity continue to maintain their equity classification and there has been noreclassification of awards in our consolidated balance sheet.

Priorto January 1, 2006 and since the beginning of 2003, we accounted forshare-based awards under the recognition provisions of SFAS 123,“Accounting for Stock-Based Compensation” using the modified prospective methodof adoption described in SFAS 148. We used the minimum value pricing model for measuring the fair value ofour options granted through the first quarter 2005, which does not take intoconsideration volatility. In accordance with SFAS 123, subsequent toApril 5, 2005, the date of our initial filing of the registrationstatement relating to our initial public offering with the Securities andExchange Commission, we used the Black-Scholes method, including an estimatedvolatility assumption, to estimate the fair value of all option grants. Expensepreviously recognized related to options that were cancelled or forfeited priorto vesting was reversed in the period of the cancellation or forfeiture, asallowed under SFAS 123.

In November 2005, the FASB issued FASB StaffPosition No. 123(R)-3 (FSP 123(R)-3), “Transition Election Related toAccounting for the Tax Effects of Share-Based Payment Awards”.  FSP 123(R)-3 provides an elective alternativetransition method for calculating the pool of excess tax benefits available toabsorb tax deficiencies recognized subsequent to the adoption of SFAS123(R).  Companies may take up to oneyear from the effective date of FSP 123(R)-3 to evaluate the availabletransition alternatives and make a one-time election as to which method toadopt.  We are currently in the processof evaluating the alternative methods.

 

In June 2006, the FASB issuedFASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes” (FIN 48).  FIN 48 clarifies whentax benefits should be recorded in financial statements, requires certaindisclosures of uncertain tax matters and indicates how any tax reserves shouldbe classified in a balance sheet. FIN 48 is effective for us on January 1,2007. We have not yet determined the impact, if any, that the implementation ofFIN 48 will have on our results of operations and financial condition.

 

In September 2006, the FASBissued SFAS 157, “Fair ValueMeasurement”.  The standard provides guidance for using fair valueto measure assets and liabilities.  SFAS 157 clarifies the principle thatfair value should be based on the assumptions market participants would usewhen pricing an asset or liability and establishes a fair value hierarchy thatprioritizes the information used to develop those assumptions. Under thestandard, fair value measurements would be separately disclosed by level withinthe fair value hierarchy. The statement is effective for us beginning in 2008;however, early adoption is permitted.  We have not yet determined theimpact, if any, that the implementation of SFAS 157 will have on our results ofoperations and financial condition.

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In September 2006, the SECissued Staff Accounting Bulletin No. 108 *“*Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements*”*(SAB108).  SAB 108 provides interpretive guidance on how the effects of thecarryover or reversal of prior year misstatements should be considered inquantifying a current year misstatement. The SEC staff believes thatregistrants should quantify errors using both a balance sheet and an incomestatement approach and evaluate whether either approach results in quantifyinga misstatement that, when all relevant quantitative and qualitative factors areconsidered, is material. SAB 108 is effective for fiscal years ending on orafter November 15, 2006, with early application encouraged.  We do not expect the adoption of this standard to haveany impact on our consolidated financial statements.

 

**Forward-Looking Statements**

Thisquarterly report on Form 10-Q contains not only historical information, butalso forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of 1934and are subject to the safe harbor created by those sections.  In addition, we or others on our behalf maymake forward-looking statements from time to time in oral presentations,including telephone conferences and/or web casts open to the public, in pressreleases or reports, on our Internet web site or otherwise.  All statements other than statements ofhistorical facts included in this report or expressed by us orally from time totime that address activities, events or developments that we expect, believe oranticipate will or may occur in the future are forward-looking statementsincluding, in particular, the statements about our plans, objectives,strategies, the outcome of contingencies such as legal proceedings, andprospects regarding, among other things, our financial condition, results ofoperations and business.  We haveidentified some of these forward-looking statements in this report with wordslike “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 other words andterms of similar meaning.  Theseforward-looking statements may be contained in the notes to our consolidatedfinancial statements and elsewhere in this report, including under the heading“Management’s Discussion and Analysis of Financial Condition and Results ofOperations.”

Forward-looking statementsare based on current expectations about future events affecting us and aresubject to uncertainties and factors that affect all businesses operating in aglobal market as well as matters specific to us.  These uncertainties and factors are difficultto predict and many of them are beyond our control. The following are some of theuncertainties and factors known to us that could cause our actual results todiffer materially from what we have anticipated in our forward-lookingstatements:

 

·                  Lackof market acceptance of new products;

·                  Failureto develop innovative and successful new products and technologies;

·                  Exposureto assertions of intellectual property claims and failure to protect ourintellectual property;

·                  Disruptionin our ability to manufacture our products or the ability of our key suppliersto provide us products or components or raw materials for products resulting inour inability to supply market demand for our products;

·                  Failureof our customers or patients to obtain third party reimbursement for theirpurchases of our products;

·                  Effectsof litigation, including threatened or pending litigation, on matters relatingto patent infringement, employment, and commercial disputes;

·                  Relianceon our management information systems for inventory management, distributionand other functions and to maintain our research and development and clinicaldata;

·                  Failureto comply with applicable laws and regulations and to obtain and maintainrequired regulatory approvals for our products in a cost-effective manner or atall;

·                  Risksinherent in operating internationally and selling and shipping our products andpurchasing our products and components internationally;

·                  Fluctuationsin foreign currency exchange rates and interest rates;

·                  Inabilityto meet performance enhancement objectives, including efficiency and costreduction strategies;

·                  Incurrenceof additional debt, contingent liabilities and expenses in connection withfuture acquisitions;

·                  Failureto obtain additional capital when needed or on acceptable terms;

·                  Failureof our business strategy, which relies on assumptions about the market for ourproducts;

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·                  Dependenceupon a few of our products to generate a large portion of our net sales andexposure if drug-eluting stents become a dominant therapy in the peripheralvascular stent market and we are not able to develop or acquire a drug-elutingstent to market and sell;

·                  Exposureto product liability claims;

·                  Obligationto make significant milestone payments not currently reflected in our financialstatements;

·                  Failureto retain senior management or replace lost senior management;

·                  Ineffectivenessof our internal controls;

·                  Failureto comply with our covenants under our loan and security agreement with SiliconValley Bank;

·                  Delaysin product introduction;

·                  Lossof customers;

·                  Disruptionin the supply of products of Invatec S.r.l. that we distribute or ourrelationship with Invatec;

·                  Failureto integrate effectively newly acquired operations;

·                  Absenceof expected returns from the amount of intangible assets we have recorded;

·                  Relianceon independent sales distributors and sales associates to market and sell ourproducts in certain foreign countries, including most recently our reliance onMedtronic for sales of our products in Japan;

·                  Highlycompetitive nature of the markets in which we sell our products and theintroduction of competing products;

·                  Increasesin prices for raw materials;

·                  Conflictsof interests due to our ownership structure;

·                  Employeeslowdowns, strikes or similar actions;

·                  Adversechanges in applicable laws or regulations;

·                  Changesin generally accepted accounting principles; or

·                  Conditions and changes in medical deviceindustry or in general economic and business conditions.

Formore information regarding these and other uncertainties and factors that couldcause our actual results to differ materially from what we have anticipated inour forward-looking statements or otherwise could materially adversely affectour business, financial condition or operating results, see our annual reporton Form 10-K for the fiscal year ended December 31, 2005 under the heading“Part I – Item 1A.  Risk Factors” onpages 36 through 57 of such report and “Part II – Item 1A. Risk Factors”included in our quarterly report on Form 10-Q for the quarter ended July 2,2006 and included elsewhere 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 ourexpectations will prove correct.  Ourexpectations reflected in our forward-looking statements can be affected byinaccurate assumptions we might make or by known or unknown uncertainties andfactors, including those described above. The risks and uncertainties described above are not exclusive andfurther information concerning us and our business, including factors thatpotentially could materially affect our financial results or condition, mayemerge from time to time.  We assume noobligation to update, amend or clarify forward-looking statements to reflectactual results or changes in factors or assumptions affecting suchforward-looking statements.  We adviseyou, however, to consult any further disclosures we make on related subjects inour annual reports on Form 10-K, quarterly reports on Form 10-Q and currentreports on Form 8-K we file with or furnish to the Securities andExchange Commission.

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**ITEM 3.****                            ****QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

Weare exposed to various market risks, which are potential losses arising fromadverse changes in market rates and prices, such as interest rates and foreignexchange fluctuations.  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 ourrevolving line of credit bear interest at a variable rate equal to SVB’s primerate.  Borrowings under the equipmentline bear interest 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 October 1, 2006, we had no borrowingsunder our revolving line of credit and had $7.5 million in borrowings under theequipment line.  Based upon this debtlevel, a 10% increase in the interest rate on such borrowings would cause us toincur an increase in interest expense of approximately $70 thousand on anannual basis.

***Foreign Currency ExchangeRate Risk***

Fluctuationsin the rate of exchange between the U.S. dollar and foreign currencies couldadversely affect our financial results. In the three and nine months ended October 1, 2006, approximately 28.9%and 29.9%, respectively, of our net sales were denominated in foreigncurrencies.  We expect that foreigncurrencies will continue to represent a similarly significant percentage of ournet sales in the future.  Selling,marketing and administrative costs related to these sales are largelydenominated in the same respective currency, thereby limiting our transactionrisk exposure.  However, for sales notdenominated in U.S. dollars, if there is an increase in the rate at which aforeign currency is exchanged for U.S. dollars, it will require more of theforeign currency to equal a specified amount of U.S. dollars than before therate increase.  In such cases and if weprice our products in the foreign currency, we will receive less in U.S.dollars than we did before the rate increase went into effect.  If we price our products in U.S. dollars andcompetitors price their products in local currency, an increase in the relativestrength of the U.S. dollar could result in our price not being competitive ina market where business is transacted in the local currency.

Approximately65.5% and 69.2% of our net sales denominated in foreign currencies in the threeand nine months ended October 1, 2006, respectively, were derived from EuropeanUnion countries and were denominated in the Euro.  Additionally, we have significantintercompany receivables from our foreign subsidiaries, which are denominatedin foreign currencies, principally the Euro and the Yen.  Our principal exchange rate risks thereforeexist between the U.S. dollar and the Euro and between the U.S. dollar and theYen.  Fluctuations from the beginning tothe end of any given reporting period result in the remeasurement of our foreigncurrency-denominated receivables and payables, generating currency transactiongains or losses that impact our non-operating income/expense levels in therespective period and are reported in other (income) expense, net in ourconsolidated financial statements.  Werecorded a $152 thousand and $1.5 million foreign currency transaction gain inthe three and nine months ended October 1, 2006, respectively, compared to a$77 thousand foreign currency transaction gain and $3.0 million foreigncurrency transaction loss in the three and nine months ended October 2, 2005,respectively, related to the translation of our foreign denominated netreceivables into U.S. dollars.  We do notcurrently hedge our exposure to foreign currency exchange rate fluctuations.  We may, however, hedge such exposure toforeign currency exchange rates in the future.

**ITEM 4.****                            ****CONTROLS AND PROCEDURES**

**Evaluation of Disclosure 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 theparticipation of our Chief Executive Officer and

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Chief Financial Officer, theeffectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered in this quarterly report on Form10-Q.  Based on that evaluation, ourChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective as of the end of such periodto provide reasonable assurance that information required to be disclosed inour Exchange Act reports is recorded, processed, summarized, and reportedwithin the time periods specified in the SEC’s rules and forms, and thatmaterial information relating to our company and our consolidated subsidiariesis made known to management, including our Chief Executive Officer and ChiefFinancial Officer, particularly during the period when our periodic reports arebeing prepared.

**Changes in Internal Control Over Financial Reporting**

There was no change in our internal control over financialreporting that occurred during our quarter ended October 1, 2006 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

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**PART II - OTHER INFORMATION**

**ITEM 1.****                            ****LEGAL PROCEEDINGS**

A description of our legal proceedings in Note 16 ofour consolidated financial statements included within this report isincorporated herein by reference.

**ITEM 1A.**                    RISK FACTORS

Weare affected by risks specific to us as well as factors that affect allbusinesses operating in a global market. In addition to the other informationset forth in this report, careful consideration should be taken of the factorsdescribed in our annual report on Form 10-K for the fiscal year ended December31, 2005 under the heading “Part I – Item 1A. Risk Factors,” which couldmaterially adversely affect our business, financial condition or operatingresults.  Except for the remediation ofthe material weakness described under the heading “Part I – Item 4. Controlsand Procedures” in our quarterly report on Form 10-Q for the quarter ended July2, 2006 and the additional risk factors regarding the restrictive covenants inour loan agreement described under the heading “Part II – Item 1A. RiskFactors” in our quarterly report on Form 10-Q for the quarter ended July 2,2006 and except for the revised risk factor described below as a result of ournew distribution arrangement with Medtronic, there has been no material changein those risk factors.

***We rely on our independent salesdistributors and sales associates to market and sell our products outside ofthe United States, Canada and Europe.***

Salesof our products in locations outside of the United States, Canada and Europerepresented 13% of our net sales during the nine months ended October 1, 2006and 16% of our net sales during the fiscal year ended December 31, 2005.  Our success outside of the United States,Canada and Europe depends largely upon marketing arrangements with independentsales distributors and sales associates, in particular their sales and serviceexpertise and relationships with the customers in the marketplace. Independentdistributors and sales associates may terminate their relationship with us, ordevote insufficient sales efforts to our products. We do not control ourindependent distributors and they may not be successful in implementing ourmarketing plans. In addition, many of our independent distributors outside ofthe United States, Canada and Europe initially obtain and maintain foreignregulatory approval for sale of our products in their respective countries. Ourfailure to maintain our existing relationships with our independentdistributors and sales associates outside of the United States, Canada andEurope, or our failure to recruit and retain additional skilled independentsales distributors and sales associates in these locations, could have anadverse effect on our operations. We have experienced turnover with some of ourindependent distributors in the past that has adversely affected our short-termfinancial results while we transitioned to new independent distributors.  Similar occurrences could happen in thefuture. Beginning October 1, 2006, we established a distribution arrangementwith Medtronic International Trading Inc. — Japan Branch, a subsidiary ofMedtronic, Inc., pursuant to which Medtronic distributes all of our products inJapan.  As a result of this new arrangement, we ceased our direct salesoperations in Japan.  Our transition fromdirect operations to a distributor relationship in Japan could adversely affectour sales in Japan.

**ITEM 2.****                            ****UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

**Recent Sales of Unregistered Equity Securities**

Duringthe three months ended October 1, 2006, we did not issue any shares of ourcommon stock or other equity securities of ours that were not registered underthe Securities Act of 1933, as amended.

**Use of Proceeds**

On June 15, 2005, our registration statement on Form S-1(Registration No. 333-123851) was declared effective.  Our initial public offering resulted in gross proceeds to us of $167.6million.  Expenses related to the initialpublic offering were as follows: approximately $8.4 million for underwriting discounts and commissionsand approximately $4.2 million for other expenses, for total expenses ofapproximately $12.6 million.  None of theoffering expenses resulted in direct or indirect payments to any of ourdirectors, officers or their associates, to persons owning 10% or more of ourcommon stock or to any of our affiliates. All of the offering expenses were paid to others.

Afterdeduction of offering expenses, we received net proceeds of approximately$154.9 million in our initial public offering, including shares sold by uspursuant to the underwriters’ over-allotment option.  As of October 1, 2006, the

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proceedsfrom our initial public offering and available cash were used as follows:  $36.5 million of the net proceeds were usedto repay a portion of the accrued and unpaid interest on the demand notes,$96.7 million for general corporate purposes and the remaining net proceedswere invested in short-term, investment-grade, interest bearingsecurities.  We cannot predict whetherthe proceeds will yield a favorable return. Other than $36.5 million of the net proceeds used to repay a portion ofthe accrued and unpaid interest on demand notes held by Warburg Pincus, whichis our majority stockholder, and Vertical, which is one of our stockholders,none of the net proceeds from our initial public offering have resulted indirect or indirect payments to directors, officers or their associates, topersons who owned 10% or more of our common stock or to any of our affiliates.

Weexpect to use the remaining $21.7 million in net proceeds from our initialpublic offering for general corporate purposes. Our management has broad discretion as to the use of the netproceeds.  We may use a portion of thenet proceeds for the acquisition of, or investment in, technologies or productsthat complement our business.  Asrequired by Securities and Exchange Commission regulations, we will providefurther detail on our use of the net proceeds from our initial public offeringin future periodic reports.

**Issuer Purchases of Equity Securities**

Wedid not purchase any shares of our common stock or other equity securities ofours registered pursuant to Section 12 of the Securities Exchange Act of 1934,as amended, during the three months ended October 1, 2006.

**ITEM 3.****                            ****DEFAULTS UPON SENIORSECURITIES**

Not applicable.

**ITEM 4.****                            ****SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

Not applicable.

**ITEM 5.****                            ****OTHER INFORMATION**

Notapplicable.

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

Thefollowing exhibits are being filed or furnished with this quarterly report onForm 10-Q:
| Exhibit No. | ** ** | **Description**                                                                                                                                                          |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1        |       | Change in Control Agreement  dated September 19, 2006 among ev3 Inc., ev3 Endovascular, Inc. and Dale A.  Spencer (Filed herewith)                                       |
|        |       |                                                                                                                                                                     |
| 10.2        |       | Change in Control Agreement  dated September 19, 2006 among ev3 Inc., ev3 Endovascular, Inc. and James M.  Corbett (Filed herewith)                                      |
|        |       |                                                                                                                                                                     |
| 10.3        |       | Form of Change in Control  Agreement among ev3 Inc., ev3 Endovascular, Inc. or Micro Therapeutics, Inc.  and each of its executive officers (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**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned, hereuntoduly authorized.
| November  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        |       | Change in Control Agreement  dated September 19, 2006 among ev3 Inc., ev3 Endovascular, Inc. and Dale A.  Spencer                                   |       | Filed herewith       |
| 10.2        |       | Change in Control Agreement  dated September 19, 2006 among ev3 Inc., ev3 Endovascular, Inc. and James M.  Corbett                                  |       | Filed herewith       |
| 10.3        |       | Form of Change in Control  Agreement among ev3 Inc., ev3 Endovascular, Inc. or Micro Therapeutics, Inc.  and each of its executive officers         |       | 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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