UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended December 31, 2006

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

For the transition period from                     to                    

Micrus Endovascular Corporation

(Exact name of registrant as specified in its charter)

Delaware		23-2853441
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

821 Fox Lane San Jose, California		95131
(Address of principal executive offices)		(Zip Code)

(408) 433-1400
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

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

Large accelerated filer o            Accelerated filer o            Non-accelerated filer þ

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

     As of February 1, 2007, there were 15,003,607 shares of common stock, par value $0.01, of the registrant outstanding.

 

 

MICRUS ENDOVASCULAR CORPORATION
INDEX TO FORM 10-Q

		Page
		Number
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of December 31, 2006 and March 31, 2006			3
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended December 31, 2006 and 2005			4
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2006 and 2005			5
Notes to Condensed Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation			21
Item 3. Quantitative and Qualitative Disclosures about Market Risk			32
Item 4. Controls and Procedures			32
Part II. Other Information			33
Item 1. Legal Proceedings			33
Item 1A. Risk Factors			33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			49
Item 3. Defaults Upon Senior Securities			49
Item 4. Submission of Matters to a Vote of Security Holders			49
Item 5. Other Information			49
Item 6. Exhibits			49
Signatures			50
EXHIBIT 10.1
EXHIBIT 10.2
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

MICRUS ENDOVASCULAR CORPORATION

		December 31,				March 31,
		2006				2006
ASSETS
Current Assets:
Cash and cash equivalents		$	33,580			$	36,104
Short-term investments			—				984
Accounts receivable, net of allowance for doubtful accounts of $307 at December 31, 2006 and $317 at March 31, 2006			9,003				8,267
Inventories, net			7,516				4,479
Prepaid expenses and other current assets			1,190				766
Total current assets			51,289				50,600
Property and equipment, net			4,561				2,488
Goodwill			3,320				3,309
Intangible assets, net			9,882				5,417
Other assets			282				300
Total assets		$	69,334			$	62,114
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	1,697			$	2,088
Accrued payroll and other related expenses			4,373				3,147
Accrued liabilities			4,899				4,308
Total current liabilities			10,969				9,543
Other non-current liabilities			3,031				1,255
Total liabilities			14,000				10,798
Commitments and contingencies (Note 5)
Stockholders’ equity:
Common stock, $0.01 par value; Authorized: 50,000,000 shares Issued and outstanding:14,993,951 shares at December 31, 2006 and 14,190,287 shares at March 31, 2006			150				142
Additional paid-in capital			109,692				101,430
Deferred stock-based compensation			(222	)			(397	)
Accumulated other comprehensive loss			(555	)			(240	)
Accumulated deficit			(53,731	)			(49,619	)
Total stockholders’ equity			55,334				51,316
Total liabilities and stockholders’ equity		$	69,334			$	62,114

The accompanying notes are an integral part of these condensed consolidated financial statements.

MICRUS ENDOVASCULAR CORPORATION

		Three months ended								Nine months ended
		December 31,								December 31,
		2006				2005				2006				2005
Revenues		$	15,544			$	8,092			$	42,754			$	21,334
Cost of goods sold			4,192				2,416				11,348				6,264
Gross profit			11,352				5,676				31,406				15,070
Operating expenses:
Research and development			1,769				834				6,025				4,072
Sales and marketing			5,992				4,049				17,199				9,767
General and administrative			5,273				2,638				14,166				7,098
Total operating expenses			13,034				7,521				37,390				20,937
Loss from operations			(1,682	)			(1,845	)			(5,984	)			(5,867	)
Interest and investment income			426				389				1,211				900
Interest expense			(5	)			(2	)			(5	)			(11	)
Other income (expense), net			221				(132	)			554				(681	)
Loss before income taxes			(1,040	)			(1,590	)			(4,224	)			(5,659	)
Income tax provision (benefit)			(38	)			62				(112	)			62
Net loss			(1,002	)			(1,652	)			(4,112	)			(5,721	)
Accretion of redeemable convertible preferred stock to redemption value including beneficial conversion feature			—				—				—				(659	)
Net loss attributable to common stockholders		$	(1,002	)		$	(1,652	)		$	(4,112	)		$	(6,380	)
Net loss per share attributable to common stockholders:
Basic and diluted		$	(0.07	)		$	(0.12	)		$	(0.28	)		$	(0.62	)
Weighted-average number of shares used in per share calculations:
Basic and diluted			14,766				14,139				14,466				10,282

The accompanying notes are an integral part of these condensed consolidated financial statements.

MICRUS ENDOVASCULAR CORPORATION

		Nine months ended
		December 31,
		2006				2005
Cash flows from operating activities:
Net loss		$	(4,112	)		$	(5,721	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			1,364				657
Provision for doubtful accounts			(12	)			1
Loss on disposal of equipment			—				1
Provision for impairment of inventory			191				164
Increase in fair value of 2005 common stock warrants			—				158
Realized (gain) loss on investments			(4	)			5
Stock-based compensation expense			1,629				180
Changes in operating assets and liabilities net of effect of acquisitions:
Accounts receivable			(298	)			(605	)
Inventories			(2,232	)			(149	)
Prepaid expenses and other current assets			(391	)			(564	)
Other assets			27				(114	)
Accounts payable			(399	)			(1,378	)
Accrued payroll and other related expenses			1,179				808
Accrued liabilities			1,127				873
Other non-current liabilties			(139	)			512
Net cash used in operating activities			(2,070	)			(5,172	)
Cash flows from investing activities:
Proceeds from sales of available-for-sale securities			1,000				—
Purchase of VasCon, LLC, net of cash acquired			(2,736	)			—
Purchase of Neurologic UK Ltd., net of cash acquired			(11	)			(5,139	)
Payment to Biotronik AG for developed technology			(835	)			—
Acquisition of property and equipment			(967	)			(1,458	)
Net cash used in investing activities			(3,549	)			(6,597	)
Cash flows from financing activities:
Proceeds from issuance of common stock, net of issuance costs			2,043				33,871
Proceeds from exercise of preferred and common stock warrants			—				1,007
Proceeds from exercise of stock options			1,367				434
Proceeds from employee stock purchase plan			379				126
Payments of issuance costs for issuance of convertible preferred stock and warrants			—				(238	)
Net cash provided by financing activities			3,789				35,200
Effect of exchange rate changes on cash			(694	)			426
Net increase (decrease) in cash and cash equivalents			(2,524	)			23,857
Cash and cash equivalents at beginning of period			36,104				15,017
Cash and cash equivalents at end of period		$	33,580			$	38,874
Supplemental schedule of noncash investing and financing activities:
Issuance of common stock for purchase of VasCon, LLC		$	2,972			$	—
Conversion of preferred stock to common stock		$	—			$	59,227
Accretion to redemption value of redeemable convertible preferred stock including beneficial conversion feature		$	—			$	659
Reclassification of 2005 common stock warrants to equity		$	—			$	3,358

The accompanying notes are an integral part of these condensed consolidated financial statements.

MICRUS ENDOVASCULAR CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 — Formation and Business of the Company

     Micrus Endovascular Corporation (the “Company”), formerly Micrus Corporation, was incorporated under the laws of the state of Delaware in June 1996. The Company develops, manufactures and markets both implantable and disposable medical devices used in the treatment of cerebral vascular diseases.

     Interim unaudited financial information

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles”) for interim financial information and in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the annual financial statements, except for the adoption of SFAS 123R on April 1, 2006 (see Note 2). In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation. These financial statements should be read in conjunction with the audited financial statements and notes thereto for the preceding fiscal year included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on June 16, 2006.

     The results of operations for the interim periods ended December 31, 2006 may not necessarily be indicative of the results that may be expected for the fiscal year ended March 31, 2007, or any future period.

Note 2 — Summary of Significant Accounting Policies

Principles of consolidation

     The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

     The Company’s international subsidiaries use their local currency as the functional currency. Assets and liabilities are translated at exchange rates in effect at the balance sheet date. Revenue, expense, gain and loss accounts are translated at average exchange rates during the period. Resulting translation adjustments are recorded directly to accumulated other comprehensive income (loss).

Use of estimates

     The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. These estimates and assumptions include reserves and write-downs related to accounts receivable and inventories, the recoverability of long-term assets, deferred tax assets and related valuation allowances and valuation of stock-based compensation and equity instruments.

Comprehensive income ( loss)

     Total comprehensive loss for the nine months ended December 31, 2006 and 2005 was $4.4 million and $6.2 million, respectively. This included other comprehensive income (loss) of ($315,000) and $165,000, respectively related to the Company’s unrealized gains and losses on its available-for-sale securities and foreign currency translation.

Cost of goods sold

     The Company’s cost of goods sold includes the cost of products sold to customers including materials, direct labor, depreciation, overhead costs associated with manufacturing, impairments of inventory and warranty expenses. Also, beginning with the quarter ended December 31, 2006, cost of goods sold includes amortization of capitalized license technology in connection with the Biotronik agreement and acquired intangible assets in connection with the acquisition of VasCon, LLC (“VasCon”).

Net loss per common share

     Basic net loss per share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by giving effect to all potential dilutive common shares, including options, restricted stock units, warrants and redeemable convertible preferred shares. There is no difference between basic and diluted net loss per share for all periods presented due to the Company’s net losses. A reconciliation of the numerator and denominator used in the calculation of basic and diluted net loss per share follows (in thousands):

		Three months ended								Nine months ended
		December 31,								December 31,
		2006				2005				2006				2005
Numerator:
Net loss		$	(1,002	)		$	(1,652	)		$	(4,112	)		$	(5,721	)
Beneficial conversion feature of preferred stock			—				—				—				(383	)
Accretion of redeemable convertible preferred stock to redemption value			—				—				—				(276	)
Net loss attributable to common stockholders		$	(1,002	)		$	(1,652	)		$	(4,112	)		$	(6,380	)
Weighted-average number of common shares outstanding used in computing basic and diluted net loss per share			14,766				14,139				14,466				10,282
Net loss per share basic and diluted		$	(0.07	)		$	(0.12	)		$	(0.28	)		$	(0.62	)

     Anti-dilutive securities

     The following outstanding stock options and restricted stock units were excluded from the computation of diluted net loss per common share for the periods presented because their impact would have been anti-dilutive (in thousands):

		Periods ended
		December 31,
		2006				2005
Shares issuable upon exercise of common stock options			3,204				2,559
Shares issuable upon settlement of restricted stock units			10				—
Shares issuable under employee stock purchase plan			20				—
			3,234				2,559

     Stock-based compensation

     The Company has adopted various stock plans that provide for the grant of stock awards to employees, non-employee directors and consultants. The Company also has an employee stock purchase plan, which enables employees to purchase the Company’s common stock.

     On April 1, 2006, the Company adopted the provisions of, and accounts for stock-based compensation in accordance with, the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards No. 123 – revised 2004 (“SFAS 123R”), “Share-Based Payment” which replaced Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees.”

Under the fair value recognition provisions of SFAS 123R, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is generally the vesting period. The Company elected the modified-prospective method, under which prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123R apply to new grants and to grants that were outstanding prior to the effective date and are subsequently modified. Estimated compensation for grants that were outstanding as of the effective date will be recognized over the remaining service period using the compensation cost estimated for the SFAS 123 pro forma disclosures, excluding pre-IPO options for which the fair value was determined using the minimum value method. For these grants, any remaining unamortized deferred compensation expenses will continue to be accounted for under the intrinsic value method of APB 25.

     The adoption of SFAS 123R had and will have a material impact on our consolidated financial position and results of operations. See Note 6 for further information regarding stock-based compensation assumptions and expenses, including pro forma disclosures for prior periods as if stock-based compensation expense had been recorded.

Recent accounting pronouncements

     In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109”, which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that the Company recognize in its financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of the beginning of the Company’s 2008 fiscal year, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact of adopting FIN 48 on its financial statements.

     In September 2006, the FASB issued FASB Statement No. 157 (“SFAS 157”), “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. The provisions of SFAS 157 are effective as of the beginning of the Company’s 2008 fiscal year. The Company is currently evaluating the impact of SFAS 157, but does not expect the adoption of SFAS 157 to have a material impact on its consolidated financial position, results of operations or cash flows.

     In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, (“SAB 108”), which provides guidance on quantifying and evaluating the materiality of unrecorded misstatements. SAB 108 is effective for annual financial statements covering the first fiscal year ending after November 15, 2006, with earlier application encouraged for any interim period of the first fiscal year ending after November 15, 2006, filed after the publication of SAB 108 (September 13, 2006). The Company is currently evaluating the impact of SAB 108, but does not expect the adoption of SAB 108 to have a material impact on its consolidated financial position, results of operations or cash flows.

Note 3 — Business Combination

     On November 30, 2006, the Company completed the acquisition of VasCon, a privately held company engaged in the development and manufacture of vascular access and delivery devices. The acquisition of VasCon is intended to add expertise in developing clinically advanced access and catheter systems to the Company’s core competencies and provide the Company with manufacturing capabilities that are expected to lead to significant cost reductions for a wide range of the Company’s products. Micrus Design Technology Inc., a newly formed subsidiary of the Company, will develop and manufacture neurovascular access and delivery products for the Company, including the Company’s steerable catheter. VasCon’s existing cardio and peripheral vascular products will continue to be sold through non-Micrus distribution channels.

     The acquisition consideration consisted of an up-front payment and additional contingent earn-out payments as described below. The up-front payment consisted of the payment of approximately $2.5 million in cash, the issuance of 156,666 shares of the Company’s common stock having an aggregate value of approximately $3.0 million calculated based on the average closing price two days before and the day of the acquisition, and $329,000 in acquisition-related closing costs. The final purchase price is subject to certain post-closing working capital adjustments. Additionally, VasCon may receive certain earn-out payments in an amount not to exceed $10 million based on sales and manufacturing performance as set forth in the asset purchase agreement entered into by the parties. The common stock portion of the up-front payment was placed in escrow to satisfy certain indemnification obligations of VasCon and its members as described in such asset purchase agreement.

     The preliminary consideration paid was comprised of (in thousands):

Initial cash payment		$	2,500
Common stock			2,972
Acquistion-related closing costs			329
Total preliminary purchase price		$	5,801

     The acquisition of VasCon was accounted for using the purchase method of accounting and, accordingly, the results of operations are included in the accompanying consolidated statements of operations for all periods or partial periods subsequent to the acquisition date. The purchase price was allocated to the net tangible and identifiable intangible assets acquired and the liabilities assumed based on their estimated fair values at the date of acquisition as determined by management. The fair value of the net assets acquired exceeded the up-front purchase consideration resulting in negative goodwill in the amount of $1.8 million. Because the acquisition involves contingent consideration, the negative goodwill has been recorded as a deferred credit (non-current liability) in the consolidated balance sheet and will be reduced by the contingent consideration of up to $10 million that will be paid over the next three years, with any additional contingent consideration being recorded as goodwill. The preliminary consideration paid was allocated as follows (in thousands):

Inventories		$	769
Fixed assets			1,654
Other acquired net assets			76
Intangible assets			5,150
Contingent purchase price			(1,848	)
Total preliminary purchase price		$	5,801

     The Company acquired certain intangibles assets in the amount of $5.2 million in connection with the acquisition of VasCon. These intangible assets are comprised of existing process technology of $4.6 million, existing product technology of $260,000 and patents of $300,000. Purchased intangible assets are being amortized on a straight-line basis over a weighted-average period of approximately seven years.

     The following unaudited pro forma information presents a summary of consolidated results of operations of the Company and VasCon as if the acquisition had occurred April 1, 2004. The unaudited pro forma information was derived from the historical financial statements of Micrus Endovascular and VasCon.

     The following table presents pro forma financial information for the combined entity of Micrus Endovascular and VasCon for the three and nine months ended December 31, 2006 and 2005, as if the acquisition had occurred at the beginning of each of the periods presented after giving effect to certain pro forma adjustments (in thousands except for per share data).

		Three months ended								Nine months ended
		December 31,								December 31,
		2006				2005				2006				2005
Revenues		$	15,713			$	8,218			$	43,546			$	25,146
Net loss		$	(1,380	)		$	(2,563	)		$	(5,850	)		$	(5,824	)
Net loss per share — basic and diluted		$	(0.09	)		$	(0.18	)		$	(0.40	)		$	(0.56	)

Note 4 — Balance Sheet Components

Inventories

     Inventories consisted of the following (in thousands):

		December 31,				March 31,
		2006				2006
Raw materials		$	2,334			$	507
Work-in-progress			639				504
Finished goods			1,685				1,294
Consigned inventory			3,709				2,874
Inventory held by Latin American distributors			232				230
Gross inventory			8,599				5,409
Less inventory allowances			(1,083	)			(930	)
		$	7,516			$	4,479

     Consigned inventory is held at customer locations, primarily hospitals, and is under the physical control of the customer. The Company retains title to the inventory until used and purchased by the customer, generally when used in a medical procedure

Intangible assets

     Intangible assets consisted of the following as of December 31, 2006 (in thousands):

		Useful				Gross CarryingAmount												Accumulated Amortization												Net
		Life				March 31,								December 31,				March 31,								December 31,				December 31,				March 31,
		(years)				2006				Additions				2006				2006				Additions				2006				2006				2006
Existing process technology			7			$	—			$	4,590			$	4,590			$	—			$	(54	)		$	(54	)		$	4,536			$	—
Distribution agreements			5				2,300				—				2,300				(234	)			(355	)			(589	)			1,711				2,066
Capitalized license fee			7				1,462				103				1,565				—				(56	)			(56	)			1,509				1,462
Patents - microcoil			10				1,100				—				1,100				(660	)			(83	)			(743	)			357				440
Non-compete agreements			6				700				—				700				(59	)			(89	)			(148	)			552				641
Customer relationships			5				900				—				900				(92	)			(137	)			(229	)			671				808
Patents - catheter			7				—				300				300				—				(4	)			(4	)			296				—
Existing product technology			2				—				260				260				—				(10	)			(10	)			250				—
						$	6,462			$	5,253			$	11,715			$	(1,045	)		$	(788	)		$	(1,833	)		$	9,882			$	5,417

Amortization of intangible assets included in the results of operations is as follows (in thousands):

		Three months ended								Nine months ended
		December 31,								December 31,
		2006				2005				2006				2005
Cost of goods sold		$	124			$	—			$	124			$	—
Operating expenses			217				210				664				285
Total		$	341			$	210			$	788			$	285

     The amortization expense of the intangible assets related to existing technology in the manufacturing process and design of products resulting from the acquisition of VasCon in the amount of $68,000 is included in cost of goods sold for the three and nine months ended December 31, 2006.

     The Company started generating revenue from the stent product associated with the capitalized license technology in the third quarter of fiscal 2007. The amortization expense related to the capitalized license technology in the amount of $56,000 is included in cost of goods sold for the three and nine months ended December 31, 2006.

     The expected future amortization of intangible assets is as follows (in thousands):

For Years Ended March 31,		Amortization
2007 (remaining 3 months)		$	477
2008			1,908
2009			1,870
2010			1,793
2011			1,345
2012 and beyond			2,489
Total		$	9,882

Accruals

     Accrued payroll and other related expenses consisted of the following (in thousands):

		December 31,				March 31,
		2006				2006
Accrued bonuses		$	1,772			$	1,157
Accrued salaries			299				478
Accrued vacation			1,109				804
Accrued commissions			668				392
Accrued payroll taxes			525				316
		$	4,373			$	3,147

     Accrued liabilities consisted of the following (in thousands):

		December 31,				March 31,
		2006				2006
Accrued professional fees		$	1,377			$	709
Development costs			551				—
Earn-out payment in connection with Neurologic acquistion			—				1,403
Biotronik milestone payment			—				732
Other			2,971				1,464
		$	4,899			$	4,308

Other non-current liabilities

Other non-current liabilities consisted of the following (in thousands):

		December 31,				March 31,
		2006				2006
Contingent purchase price (Note 3)		$	1,848			$	—
Deferred tax liability			613				641
Deferred revenue from Japan distribution agreement			413				525
Other non-current liabilities			157				89
		$	3,031			$	1,255

     On September 30, 2005, the Company entered into a five-year, exclusive distribution agreement with Goodman, CO., LTD (“Goodman”). Under the terms of the distribution agreement, Goodman will promote and market the Company’s products in Japan. In connection with the distribution agreement, Goodman paid the Company an up-front cash payment of $750,000 which has been recorded as deferred revenue. The Company is recognizing the deferred revenue on a straight-line basis over the five year term of the agreement.

Note 5 — Commitments and Contingencies

  Indemnification

     In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties and provide for general indemnification. The Company’s exposure under these agreements is unknown because it involves claims that may be made against the Company in the future, but have not yet been made. To date, the Company has not paid any claims or been required to defend any action related to its indemnification obligations, and accordingly, the Company has not accrued any amounts for such indemnification obligations. However, the Company may record charges in the future as a result of these indemnification obligations.

  Litigation

     The Company is from time to time subject to various lawsuits. The Company does not believe that it is probable that resolution of pending litigation will have a material adverse effect on the Company’s consolidated financial statements; however the outcome of litigation is inherently uncertain.

  FCPA investigation

     In August 2004, the Company identified certain payments made to physicians located in France, Germany, Spain and Turkey that may likely have violated the Foreign Corrupt Practices Act (“FCPA”) and the laws of certain foreign countries. In September 2004, the Company voluntarily disclosed to the United States Department of Justice (“DOJ”) factual information obtained in the Company’s internal investigation of potential violations of the FCPA. In February 2005, the DOJ and the Company entered into an agreement pursuant to which the DOJ agreed not to prosecute the Company for conduct disclosed to the DOJ, provided that the Company accepted responsibility for the actions of its employees and officers, paid a monetary penalty of $450,000, continues to cooperate with the DOJ in its investigation, including the waiver of legal privileges, establishes policies and procedures to assure compliance with the FCPA and other relevant bribery laws, retains and pays for an independent monitor, which shall report to the DOJ for a period of three years to assure compliance with the agreement with the DOJ and the Company’s implementation and adherence to FCPA compliance policies and procedures, and cooperates fully with the DOJ, the independent monitor and the Securities and Exchange Commission (“SEC”). The Company must remain in compliance with these conditions for a period of two years following February 28, 2005 or face the filing of a criminal complaint by the DOJ. The monetary penalty was accrued in fiscal 2005 and was paid in April 2005. The ongoing cost of compliance with the DOJ agreement is being recorded as expenses are incurred.

     The payments made to physicians in France, Germany, Spain and Turkey also may likely have violated the applicable laws in those foreign jurisdictions and may possibly have violated laws in Switzerland, where our Swiss subsidiary is located. The Company is not able to determine at this time what penalties or other actions, if any, authorities in France, Germany, Spain, or Turkey may impose as a result of such violations. Such amounts could be material to the financial position, results of operations or cash flows of the Company. The Company has been notified by the Swiss Federal Prosecutor that it does not intend to bring any action or impose any penalties on the Company.

  Patent litigation

     In September 2004, Boston Scientific Corporation and Target Therapeutics, Inc., a subsidiary of Boston Scientific Corporation (collectively “Boston Scientific”), filed a patent infringement suit in the United States District Court for the Northern District of California, alleging that the Company’s embolic coil products infringe two patents held by Boston Scientific and that this infringement is willful. In November 2004, the Company answered Boston Scientific’s complaint and counterclaimed, alleging that Boston Scientific’s embolic coil products, and their use, infringed three of the Company’s patents. On November 10, 2006, the Company withdrew one of its three asserted patents from the litigation to pursue a reissue application filed with the United States Trademark and Patent Office. Each party is seeking an injunction preventing manufacture, sale, offer for sale, use and importation of the other’s embolic coil products in the United States, damages for past infringement, which may be trebled, and its legal fees and costs. In addition, each party seeks a declaration that the patents of the other are invalid and not infringed and has alleged that certain of the asserted patents of the other are unenforceable due to inequitable conduct.

     Boston Scientific is also a party in two other lawsuits against Cordis Corporation and ev3/Micro Therapeutics, Inc. in which the Boston Scientific patents which are the basis of Boston Scientific’s suit against Micrus are also at issue. In October 2004, Cordis requested ex parte reexamination of certain claims in those patents. The Company and Boston Scientific have negotiated a schedule that permits discovery and claim construction proceedings to proceed for the both patents while still undergoing reexamination and reissue proceedings. Discovery is ongoing in the case and a claim construction hearing is scheduled to occur in March 2007.

     The Company is unable at this time to determine the outcome of any such litigation. If the litigation is protracted or results in an unfavorable outcome to the Company, the impact to the financial position, results of operations or cash flows of the Company could be material.

Note 6 — Stock-based Compensation

  Stock options

     The Company’s stock option program is a long-term retention program that is intended to attract, retain and provide incentives for talented employees, officers and directors, and to align stockholder and employee interests. The Company considers the option program critical to its operations and productivity. Currently, the Company grants options from the 2005 Equity Incentive Plan (the “2005 Plan”), under which options could be granted to all employees, including executive officers, and outside consultants. In addition, the Company’s stock option program includes 1) shares under the 1996 Stock Option Plan that became available for grant under the 2005 Plan and 2) shares under the 1998 Stock Plan that became available for grant under the 2005 Plan. Stock options issued under the above plans generally vest based on 4 years of continuous service and have 10-year contractual terms.

  1996 Stock Option Plan

     Upon the effectiveness of the Company’s initial public offering in June 2005 (“IPO”), 14,633 shares available for grant under the 1996 Stock Option Plan (the “1996 Plan”) became available for grant under the 2005 Plan. There were no options outstanding under the 1996 Plan as of the Company’s IPO.

  1998 Stock Plan

     Upon the effectiveness of the Company’s IPO, 158,167 shares available for grant under the 1998 Stock Option Plan (the “1998 Plan”) became available for grant under the 2005 Plan. All options previously granted under the 1998 Plan continue to be administered under the 1998 Plan. As of December 31, 2006, options to purchase 1,438,739 shares of common stock were outstanding under the 1998 Plan.

  2005 Equity Incentive Plan

     The 2005 Equity Incentive Plan (the “2005 Plan”) became effective upon the Company’s IPO. The 2005 Plan provides for the issuance of nonstatutory stock options, stock appreciation rights, stock awards and cash awards. The Company initially reserved a total of 2,222,220 shares of its common stock for issuance under the 2005 Plan. In addition, the 2005 Plan provides for an automatic

annual increase in the number of shares reserved for issuance thereunder by an amount equal to the lesser of (i) 5% of the Company’s total number of outstanding shares; (ii) 666,666 shares, or (iii) a number of shares determined by the Company’s Board of Directors. The shares reserved under the 2005 Plan will also be increased as a result of the cancellation of unexercised options under the 1998 Plan. As of December 31, 2006, there were 3,131,385 shares reserved for issuance under the 2005 Plan, of which 1,340,058 were available for grant, 1,766,092 shares were subject to outstanding options and 10,000 shares were subject to outstanding restricted stock units.

  Employee stock purchase plan

     The 2005 Employee Stock Purchase Plan (the “Purchase Plan”) became effective upon the Company’s IPO. The Purchase Plan provides employees with an opportunity to purchase the Company’s common stock through accumulated payroll deductions.

     The Company initially reserved a total of 222,222 shares of common stock for issuance under the Purchase Plan. The Purchase Plan provides for annual increases in the total number of shares available for issuance under this plan on April 1 of each year beginning on April 1, 2006, by a number of shares that is equal to the lesser of: (1) 2% of the outstanding shares of the Company’s common stock on the immediately preceding March 31; (2) 222,222 shares; or (3) a lesser number determined by the Company’s Board of Directors. As of December 31, 2006, there were 444,444 shares reserved for issuance under the Purchase Plan of which 83,287 shares were issued and outstanding.

     The Purchase Plan permits participants to purchase the Company’s common stock through payroll deductions of up to 15% of the participant’s compensation, up to a maximum of $25,000 per year, and up to a maximum of 1,111 shares per purchase period. Amounts deducted and accumulated for the participant’s account are used to purchase shares of the Company’s common stock on the last trading day of each purchase period at a price of at least 85% of the lesser of the fair market values of the common stock at the beginning of the offering period or at the end of the purchase period.

     The Purchase Plan provides for offering periods of 12 months and purchase periods of 6 months or such shorter period as may be established by the Company’s Board of Directors. The offering periods start on April 1 and October 1 of each year.

  Stock-based compensation

     On April 1, 2006, the Company adopted the provisions of SFAS 123R. Under the fair value recognition provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is generally the vesting period. The Company transitioned to SFAS 123R using the modified-prospective method, under which prior periods have not been revised for comparative purposes. The Company’s financial statements as of and for the nine months ended December 31, 2006 reflect the impact of SFAS 123R. The valuation provisions of SFAS 123R apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified. Estimated compensation for grants that were outstanding as of the effective date will be recognized over the remaining service period using the compensation cost previously estimated for the Company’s SFAS 123 pro forma disclosures, excluding pre-IPO options, for which the fair value was determined using the minimum value method. For these grants, any remaining unamortized deferred compensation expenses will continue to be accounted for under the intrinsic value method of APB 25.

     Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest. Recognized stock-based compensation expense includes compensation expense for share-based payment awards granted prior to, but not yet vested as of April 1, 2006, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 for options granted after the Company’s IPO. Compensation expense for the share-based payment awards granted subsequent to April 1, 2006 is based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. Stock-based compensation charges also include the amortization of unrecognized deferred compensation charges as deferred under APB 25 for all options granted prior to the Company’s IPO. The estimated fair value of the Company’s equity-based awards, less expected forfeitures, is amortized over the awards’ vesting periods on a straight-line basis. In the Company’s pro forma information required to be disclosed under SFAS 123 for the periods prior to April 1, 2006, the Company accounted for forfeitures as they occurred.

     The Company currently uses the Black-Scholes option pricing model to determine the fair value of employee stock options and employee stock purchase plan shares. The determination of the fair value of stock-based payment awards on the date of grant using an

option pricing model is affected by the Company’s stock price as well as by assumptions regarding a number of complex and subjective variables. These variables include the Company’s expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

     Because there is insufficient historical information available to estimate the expected term of the stock-based awards, the Company adopted the simplified method for estimating the expected term pursuant to Staff Accounting Bulletin No. 107 (“SAB 107”). On this basis, the Company estimated the expected term of options granted by taking the average of the vesting term and the contractual term of the option.

     The expected volatility used in the valuation model is based on the Company’s peer group in the industry in which it does business and the Company’s historical volatility since its IPO.

     The risk-free interest rate is based on the yield on zero-coupon U.S. Treasury securities with remaining terms similar to the expected term on the employee stock option and employee stock purchase plan awards.

     The Company does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option valuation model.

     The Company is required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. All stock-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.

     The determination of the fair value of employee stock options and employee stock purchase plan shares has been estimated using the following weighted-average assumptions:

		Three months ended								Nine months ended
		December 31,								December 31,
		2006				2005				2006				2005
Employee Stock Option Plans
Expected term (in years)			6.0				4.0				6.0				4.0
Volatility			45	%			43	%			45	%			43	%
Risk-free interest rate			4.55	%			4.36	%			4.74	%			4.32	%
Dividend yield			0	%			0	%			0	%			0	%
Weighted average fair value at date of grant		$	8.54			$	7.18			$	7.69			$	7.18
Employee Stock Purchase Plan
Expected term (in years)			0.5								0.5
Volatility			49	%							42	%
Risk-free interest rate			5.11	%							5.11	%
Dividend yield			0	%							0	%

     The fair value of each purchase right granted under the Company’s Employee Stock Purchase Plan during the nine months ended December 31, 2006 and 2005 was estimated at the date of grant using the Black-Scholes option pricing model, and is not subject to revaluation as a result of subsequent stock price fluctuations.

Stock-based compensation expense included in results of operations is as follows (in thousands):

		Three months ended								Nine months ended
		December 31,								December 31,
		2006				2005				2006				2005
Cost of goods sold		$	64			$	6			$	145			$	19
Research and development			55				(2	)			135				7
Sales and marketing			190				2				578				22
General and administrative			418				50				771				132
Total		$	727			$	56			$	1,629			$	180

     As of December 31, 2006, there was approximately $5.7 million of total stock-based compensation expense, after estimated forfeitures, related to unvested employee stock options and restricted stock units, which is expected to be recognized over an estimated weighted average amortization period of 2.9 years.

     The table below summarizes the effect of recording share-based compensation expense under SFAS 123R included charges related to option modifications for the three and nine months ended December 31, 2006 which is allocated as follows:

		Three months				Nine months
		ended				ended
		December 31, 2006				December 31, 2006
Cost of goods sold		$	58			$	126
Research and development			55				117
Sales and marketing			178				467
General and administrative			366				628
Total		$	657			$	1,338

     Additionally, approximately $61,000 in stock-based compensation expense related to SFAS 123R has been capitalized in inventory as of December 31, 2006. The tax benefit, and the resulting effect on cash flows from operations and financial activities, related to stock-based compensation expense was not recognized as the Company currently provides a full valuation allowance for all of its deferred tax assets.

     Stock-based compensation expense recognized for the three months ended December 31, 2006 and 2005 related to the amortization of deferred stock-based compensation was $56,000 and $57,000, respectively. For the nine months ended December 31, 2006 and 2005, the amortization of deferred stock based compensation expense was $168,000 and $172,000, respectively.

     Additionally, the expected future amortization of deferred compensation is as follows (in thousands):

Fiscal Year 2007 (remaining 3 months)		$	56
Fiscal Year 2008			166
		$	222

     The stock-based compensation expense will be reduced in the period of forfeiture for any accrued but unvested compensation arising from early termination of an option holder’s services.

     In previous years, certain stock options were issued to non-employees, generally in exchange for consulting services related to patient studies or marketing analysis. The stock options are recorded at their fair value on the date of vesting and recognized over the respective service or vesting period. The fair value of the stock options granted was calculated at each reporting date using the Black-Scholes option pricing model using the following assumptions:

		Three months ended								Nine months ended
		December 31,								December 31,
		2006				2005				2006				2005
Expected lives (in years)			5.0				6.0				5.0				6.0
Volatility			43	%			48	%			43	%			48	%
Risk-free interest rate			4.71	%			4.39	%			4.71	%			4.39	%
Dividend yield			0.0	%			0.0	%			0.0	%			0.0	%

     Stock-based compensation expense (income) recognized for the three months ended December 31, 2006 and 2005 related to non-employee options was $14,000 and ($1,000), respectively. For the nine months ended December 31, 2006 and 2005, stock-based compensation expense related to non-employee options was $123,000 and $8,000, respectively. The non-employee stock-based compensation expense will fluctuate as the fair market value of the common stock fluctuates.

  Periods prior to the adoption of SFAS 123R

     SFAS 123R requires the Company to present pro forma information for the comparative period prior to the adoption as if it had accounted for all of its stock options under the fair value method of SFAS 123.

     The following table sets forth the pro forma amounts regarding the effect on net loss and net loss per share for the three and nine months ended December 31, 2005 that would have resulted if the Company had accounted for its employee stock plans under the fair value provisions of SFAS 123:

		Three months				Nine months
		ended				ended
		December 31, 2005				December 31, 2005
Net loss attributable to common stockholders (as reported)		$	(1,652	)		$	(6,380	)
Add: Stock-based employee compensation expenses included in reported net loss			57				172
Deduct: Total stock-based employee compensation expenses determined under fair value based method for all awards			(100	)			(389	)
Adjusted net loss attributable to common stockholders		$	(1,695	)		$	(6,597	)
Net loss per common share attributable to common stockholders, basic and diluted:
As reported		$	(0.12	)		$	(0.62	)
Adjusted		$	(0.12	)		$	(0.63	)

General stock option information

     The following table sets forth the summary of option and restricted stock unit activity for the nine months ended December 31, 2006:

										Weighted-
										Average
						Weighted-				Remaining
						Average				Contractual				Aggregate
						Exercise				Term				Intrinsic Value
		Shares				Price				(in years)				(in thousands)
Options outstanding at March 31, 2006			2,804			$	6.54
Options granted			1,015			$	15.25
Restricted stock units issued			10			$	—
Options exercised			(398	)		$	3.44
Options forfeited			(211	)		$	9.56
Options expired			(6	)		$	11.78
Options and restricted stock units outstanding at December 31, 2006			3,214			$	9.47				8.4			$	30,822
Options exercisable at December 31, 2006			1,165			$	5.82				7.2			$	15,448

     The weighted average per share fair value of options granted during the nine months ended December 31, 2006 was $8.54 per share. The total intrinsic value of options exercised during the three and nine months ended December 31, 2006 was $4.0 million and $5.2 million, respectively. The intrinsic value as of December 31, 2006 is calculated as the difference between the market value as of December 31, 2006 of the shares of common stock to be issued upon exercise of the stock option and the exercise price of the options. The market value of a share of the Company’s common stock as of December 31, 2006 was $19.08 per share as reported by the National Stock Market.

     The cash proceeds from the exercise of stock options were $1.1 million and $1.4 million in the three and nine months ended December 31, 2006, respectively.

     The following table sets forth the summary of the Company’s nonvested shares activity for the nine months ended December 31, 2006:

		Shares
Nonvested at March 31, 2006			1,646
Options granted			1,015
Restricted stock units awarded			10
Options vested			(405	)
Options forfeited and expired			(217	)
Nonvested at December 31, 2006			2,049

     Information regarding stock option awards outstanding at December 31, 2006 is summarized below:

		Options outstanding												Options exercisable
						Weighted
						average				Weighted								Weighted
						remaining				average								average
Range of		Number				contractual life				exercise				Number				exercise
exercise prices		outstanding				(years)				price				exercisable				price
$  0.68 - $  1.15			405				5.3			$	0.91				371			$	0.89
$  5.63			767				8.0			$	5.63				444			$	5.63
$  6.51 - $  9.44			479				9.0			$	8.64				92			$	8.45
$  9.50 - $12.38			472				9.0			$	10.74				92			$	10.61
$12.48 - $13.73			500				8.7			$	13.10				160			$	13.10
$13.75 - $19.03			510				9.7			$	16.73				6			$	17.68
$19.40 - $19.94			71				9.9			$	19.62				—			$	—
$  0.68 - $19.94			3,204				8.4			$	9.47				1,165			$	5.82

Note 7 — Common Stock

     On July 19, 2006, Micrus completed a secondary public offering in which certain stockholders sold 1,270,211 shares of common stock at the public offering price of $11.89 per share. On July 19, 2006, the underwriters purchased 190,531 shares of common stock from the Company pursuant to the exercise of their over-allotment option. The Company did not receive any proceeds from the sale of common stock by the selling stockholders. The total cash proceeds from the exercise of the over-allotment option were approximately $2.0 million, net of the underwriting discount and offering expenses. Common stock offering expenses of $0.6 million were incurred by the Company on behalf of the selling stockholders and were expensed to general and administrative expense in the second quarter of fiscal 2007.

  2005 Common Stock Warrants

     In conjunction with the Series E preferred stock financing in February and March of 2005, the Company issued warrants to purchase common stock of the Company (the “2005 common stock warrants”). The 2005 common stock warrants were not initially exercisable, but were to become exercisable for an aggregate of 671,614 shares of common stock at $9.00 per share if the Company had not closed the IPO prior to December 31, 2005, or for an adjusted number of shares (calculated based on the IPO price) with an exercise price of $0.000225 if the IPO closed prior to December 31, 2005 at a price less than $13.50 per share. Based on the closing of the IPO at a price of $11.00 per share in June 2005, the 2005 common stock warrants became exercisable for an aggregate of 305,272 shares of common stock at an exercise price of $0.000225 per share.

     As of December 31, 2006, all of these warrants have been exercised. Warrants covering an aggregate of 281,013 shares of common stock were exercised without cash. In most cases the aggregate purchase price was offset by the value of fractional shares payable upon exercise of such warrants; however an aggregate of 2 shares were withheld in payment of the aggregate exercise price of one warrant resulting in a net issue of 281,011 shares. Warrants covering an additional 24,259 shares of common stock were exercised for cash. There were no warrants to purchase common stock outstanding at December 31, 2006.

Note 8 — Segment and Geographic Information

     The Company’s significant operations outside the United States include two sales subsidiaries in Europe (located in Switzerland and the United Kingdom). Revenues from unaffiliated customers by geographic area, based on the customer’s shipment locations were as follows (in thousands):

		Three months ended								Nine months ended
		December 31								December 31
		2006				2005				2006				2005
United States		$	7,824			$	4,107			$	20,743			$	10,449
Japan			2,420				—				7,479				—
United Kingdom			1,508				1,307				4,464				2,625
Rest of the world			3,792				2,678				10,068				8,260
Total revenues		$	15,544			$	8,092			$	42,754			$	21,334

     The Company identifies its operating segments based on how management views and evaluates the Company’s operations, which is primarily based on geographic location. For all periods presented, the Company operated in the following three business segments: the Americas, Europe and Asia Pacific. The products sold by each segment are substantially the same and the Company evaluates performance and allocates resources primarily based on revenues and gross profit. Revenues and gross profit for these segments were as follows (in thousands):

		Three months ended								Nine months ended
		December 31								December 31
		2006				2005				2006				2005
Revenues:
Americas		$	8,457			$	4,644			$	22,554			$	12,021
Europe			4,423				3,291				12,115				8,836
Asia Pacific			2,664				157				8,085				477
Total		$	15,544			$	8,092			$	42,754			$	21,334
Gross Profit:
Americas		$	6,596			$	3,419			$	18,211			$	9,178
Europe			3,089				2,182				8,085				5,672
Asia Pacific			1,667				75				5,110				220
Total		$	11,352			$	5,676			$	31,406			$	15,070

     The gross profit amounts by geographic segments for the three and nine months ended December 31, 2005 have been revised from that previously reported to correct a misallocation among the three segments as follows (in thousands):

		Three months ended								Nine months ended
		December 31, 2005								December 31, 2005
						As previously								As previously
		As revised				reported				As revised				reported
Gross Profit:
Americas		$	3,419			$	3,826			$	9,178			$	10,739
Europe			2,182				1,850				5,672				4,331
Asia Pacific			75				—				220				—
Total		$	5,676			$	5,676			$	15,070			$	15,070

     The above revisions had no impact on the consolidated results of operations, cash flows, or the financial position of the Company.

     The Company’s long lived assets by segment were as follows (in thousands):

		December 31,				March 31,
		2006				2006
Americas		$	11,206			$	4,147
Europe			6,557				7,067
Asia Pacific			—				—
		$	17,763			$	11,214

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations.

     The following discussion and analysis of the financial condition and results of operations of the Company should be read in conjunction with the condensed consolidated financial statements and the related notes included elsewhere in this report, and with other factors described from time to time in our other filings with the Securities and Exchange Commission. This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. Actual results and the timing of events may differ materially from those contained in the forward-looking statements due to a number of factors, including those discussed in Part II, Item 1A “Risk Factors” in this Quarterly Report on Form 10-Q.

Overview

     We develop, manufacture and market both implantable and disposable medical devices used in the treatment of cerebral vascular diseases. We also are developing products for the treatment of ischemic disease and have recently launched our first product in this market. Our products are used by interventional neuroradiologists and neurosurgeons to treat cerebral aneurysms responsible for hemorrhagic stroke. Both hemorrhagic and ischemic stroke are significant causes of death worldwide. Our product lines consist of endovascular systems that enable a physician to gain access to the brain in a minimally invasive manner through the vessels of the arterial system. We believe our products provide a safe and reliable alternative to more invasive neurosurgical procedures for treating aneurysms. Our proprietary three-dimensional, embolic coils are unique in that they automatically and rapidly deploy within an aneurysm, forming a scaffold that conforms to a wide diversity of aneurysm shapes and sizes. We also supply access devices and products including microcatheters and guidewires used to deliver microcoils and stents for the treatment of cerebral vascular disease. We plan on growing our business by continuing to penetrate our existing markets, bringing new products and technologies to interventional neuroradiologists and neurosurgeons, and by entering new geographic territories such as Asia where we introduced our products in Japan through a distributor. We commenced selling our products in Japan in March 2006.

     Our revenues are derived primarily from sales of our microcoils. We also sell access devices, which currently do not account for a significant portion of our revenues. Geographically, our revenues are generally from sales to customers in the Americas, Europe and Asia. Our products are shipped from our facilities in the United States, Switzerland, United Kingdom, and a logistics facility in the Netherlands, to either hospitals or distributors. We invoice our customers upon shipment. In select hospitals, our products are held on consignment, and remain on site, free of charge until used.

     We anticipate that our cost of goods sold will generally increase in absolute dollars during those quarters in which our sales increase or we incur additional manufacturing costs in anticipation of the commercial introduction of new products. Furthermore, our gross margin percentage may decrease in those quarters in which we initiate sales of new products or product lines, or enter new geographic territories.

     Our product development efforts are primarily focused on expanding our current line of microcoils and broadening our product offerings. In August 2004, we introduced our Cerecyte microcoil product line and since June 2005 we have launched seven new products, including microcoils, stents, microcatheters and guidewires. We intend to continue this product line expansion with the goal of continuing to increase our per-procedure revenue.

     We also intend to continue to expand our direct sales force in the United States and Europe as necessary and enter the Asian markets through distributors. In March 2006, we launched our sales and marketing efforts in Japan through our distribution partner, Goodman. We recorded product sales of $2.2 million to Goodman in March 2006 and $7.5 million in the first nine months of fiscal 2007.

     We currently anticipate that the broadening of our product line, the worldwide expansion of our direct sales force and our entry into the Asian market will be primarily funded with our currently available cash.

     We introduced our first proprietary, three-dimensional microcoil in May 2000. Our revenues have grown from $1.8 million in fiscal 2001 to $32.8 million in fiscal 2006. Our revenues were $42.8 million in the first nine months of fiscal 2007.

     Since inception, we have been unprofitable. We incurred net losses of $2.0 million in fiscal 2004, $6.7 million in fiscal 2005, $8.3 million in fiscal 2006 and $4.1 million in the first nine months of fiscal 2007. As of December 31, 2006, we had cash and marketable securities of $33.6 million. We believe that our current cash position and the cash expected to be generated from product sales will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months. We expect to incur net losses for the foreseeable future as we expand our manufacturing and sales activities and expand geographically. As of December 31, 2006, we had an accumulated deficit of $53.7 million.

Recent Developments

     On April 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards No. 123 – revised 2004 (“SFAS 123R”). Under the fair value recognition provisions of this Statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is generally the vesting period. We transitioned to SFAS 123R using the modified-prospective method, under which prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123R apply to new grants and to grants that were outstanding prior to the effective date and are subsequently modified. Estimated compensation for grants that were outstanding as of the effective date will be recognized over the remaining service period using the compensation cost estimated for the SFAS 123 pro forma disclosures, excluding pre-IPO options for which the fair value was determined using the minimum value method. For these grants, any remaining unamortized deferred compensation expenses will continue to be accounted for under the intrinsic value method of APB 25.

     The adoption of SFAS 123R had and will have a material impact on our consolidated financial position and results of operations. See Note 6 to the condensed consolidated financial statements for further discussion regarding the SFAS 123R disclosures.

     On November 30, 2006, we completed the acquisition of VasCon, LLC (“VasCon”), a privately held company engaged in the development and manufacture of vascular access and delivery devices. The acquisition of VasCon is intended to add expertise in developing clinically advanced access and catheter systems to our core competencies and provide us with manufacturing capabilities that are expected to lead to significant cost reductions for a wide range of our products. Micrus Design Technology Inc., a newly formed subsidiary, will develop and manufacture neurovascular access and delivery products for us, including our steerable catheter. VasCon’s existing cardio and peripheral vascular products will continue to be sold through non-Micrus distribution channels.

     The acquisition consideration consisted of an up-front payment and additional contingent earn-out payments as described below. The up-front payment consisted of the payment of approximately $2.5 million in cash, the issuance of 156,666 shares of our common stock having an aggregate value of approximately $3.0 million, and $329,000 in acquisition-related closing costs. The final purchase price is subject to certain post-closing working capital adjustments. Additionally, VasCon may receive certain earn-out payments in an amount not to exceed $10 million based on sales and manufacturing performance as set forth in the asset purchase agreement entered into by the parties. The common stock portion of the up-front payment was placed in escrow to satisfy certain indemnification obligations of VasCon and its members as described in the asset purchase agreement.

     On July 19, 2006 we completed a secondary public offering in which certain stockholders sold 1,270,211 shares of common stock at the public offering price of $11.89 per share. On July 19, 2006, the underwriters purchased 190,531 shares of common stock from us pursuant to the exercise of their over-allotment option. We did not receive any proceeds from the sale of common stock by the selling stockholders. The total cash proceeds from the exercise of the over-allotment option were approximately $2.0 million, net of the underwriting discount and offering expenses. Common stock offering expenses of $0.6 million were incurred by us on behalf of the selling stockholders and were expensed to general and administrative expense in the second quarter of fiscal 2007.

Results of Operations

     The following table sets forth the results of our operations, expressed as percentages of revenues, for the three and nine months ended December 31, 2006 and 2005:

		Three months ended								Nine months ended
		December 31,								December 31,
		2006				2005				2006				2005
			%				%				%				%
Consolidated Statement of Operations Data:
Revenues			100	%			100	%			100	%			100	%
Cost of goods sold			27	%			30	%			27	%			29	%
Gross profit			73	%			70	%			73	%			71	%
Operating expenses:
Research and development			11	%			10	%			14	%			19	%
Sales and marketing			39	%			50	%			40	%			46	%
General and administrative			34	%			33	%			33	%			33	%
Total operating expenses			84	%			93	%			87	%			98	%
Loss from operations			(11	%)			(23	%)			(14	%)			(27	%)
Interest and investment income			3	%			5	%			3	%			4	%
Interest expense			0	%			0	%			0	%			0	%
Other income (expense), net			2	%			(2	%)			1	%			(3	%)
Loss before income taxes			(6	%)			(20	%)			(10	%)			(26	%)
Income tax provision (benefit)			0	%			1	%			0	%			0	%
Net loss			(6	%)			(21	%)			(10	%)			(26	%)
Accretion of redeemable convertible preferred stock to redemption value including beneficial conversion feature			0	%			0	%			0	%			(3	%)
Net loss attributable to common stockholders			(6	%)			(21	%)			(10	%)			(29	%)

Three Months Ended December 31, 2006 and 2005

Revenues

		Three months ended
		December 31,								Change
(Dollars in thousands)		2006				2005				$				%
Americas		$	8,457			$	4,644			$	3,813				82	%
Europe			4,423				3,291				1,132				34	%
Asia Pacific			2,664				157				2,507				1597	%
Total Revenues		$	15,544			$	8,092			$	7,452				92	%

     Our revenues are derived primarily from sales of our microcoils and to a lesser extent sales of accessory devices used in the treatment of cerebral vascular diseases. The increase in total revenues in the third quarter of fiscal 2007 compared to the third quarter of fiscal 2006 was primarily due to an increase in the number of microcoil products sold during this period. Factors driving the increase included growth in the overall market for embolic coils, an increase in our share of both the domestic and foreign markets in which we participate, expansion of our direct and distributor sales force and the introduction of new products. Additionally, the increase in revenues was partially due to higher average selling prices as a result of increased Cerecyte product sales in the third quarter of fiscal 2007 as a percentage of our overall product sales. The increase in revenues from Asia Pacific in the third quarter of

fiscal 2007 compared to the third quarter of fiscal 2006 was primarily due to product sales of $2.4 million during the quarter to our distributor in Japan. In February 2006, we received regulatory clearance to sell our products in Japan through our distributor, and the sale of our products in Japan commenced in March 2006.

Gross Profit

		Three months ended
		December 31,								Change
(Dollars in thousands)		2006				2005				$				%
Cost of goods sold		$	4,192			$	2,416			$	1,776				74	%
Gross profit			11,352				5,676				5,676				100	%

     Cost of goods sold consists primarily of materials, direct labor, depreciation, overhead costs associated with manufacturing, impairments of inventory and warranty expenses. Also, for the three months ended December 31, 2006, cost of goods sold includes amortization of intangible assets that were acquired by us as part of the acquisition of VasCon. The increase in cost of goods sold during the third quarter of fiscal 2007 as compared to the third quarter of fiscal 2006 was primarily due to an increase in personnel and manufacturing costs associated with increased sales of our products as well as increased costs attributable to a general increase in salaries, benefits and overhead costs resulting from increased production (partially offset by increased manufacturing efficiencies) and the amortization of intangibles acquired from the acquisition of VasCon.

     Gross margin was 73% in the third quarter of fiscal 2007 and 70% in the third quarter of fiscal 2006. The increase was primarily due to an increase in revenue from sales of higher margin products and manufacturing efficiencies, partially offset by higher levels of distributor sales of lower margin products primarily due to our entry into the Japanese market in the fourth quarter of fiscal 2006. We expect our gross margin to fluctuate in future periods based on the mix of our product sales.

Operating Expenses

		Three months ended
		December 31,								Change
(Dollars in thousands)		2006				2005				$				%
Research and development		$	1,769			$	834			$	935				112	%

     Research and development expenses consist primarily of costs associated with the design, development, and testing of products. Such costs are expensed as they are incurred and include salaries and related personnel costs, fees paid to outside consultants, and other direct and indirect costs related to research and product development. Research and development expenses increased in the third quarter of fiscal 2007 compared to the third quarter of fiscal 2006 primarily due to an increase of $247,000 related to increased headcount and an increase of $443,000 in outside services related to new product development. As a percentage of revenues, research and development expenses were 11% in the third quarter of fiscal 2007 and 10% in the third quarter of fiscal 2006. We expect our research and development expenses to increase in absolute dollars in future periods as we hire additional development personnel, continue work on product developments, and expand our existing product line.

		Three months ended
		December 31,								Change
(Dollars in thousands)		2006				2005				$				%
Sales and marketing		$	5,992			$	4,049			$	1,943				48	%

     Sales and marketing expenses consist primarily of compensation costs of our direct sales force and marketing personnel, as well as overhead costs related to these activities. Also included are costs associated with promotional literature and videos, trade show participation, and education and training of physicians. Sales and marketing expenses increased in the third quarter of fiscal 2007 compared to the third quarter of fiscal 2006 primarily due to an increase of $537,000 associated with additional sales and marketing personnel in the United States and Europe, higher sales incentive and commission costs of $455,000 associated with increased sales in the United States and Europe, an increase of $234,000 related to outsourced consulting expenses incurred primarily due to product

marketing, an increase of $216,000 in travel expenses, an increase of $188,000 in stock-based compensation expense due primarily to the impact of the adoption of SFAS 123R, and an increase of $163,000 in market research associated with the randomized trial of our cerecyte product. As a percentage of revenues, sales and marketing expenses decreased to 39% in the third quarter of fiscal 2007 from 50% in the third quarter of fiscal 2006. The decrease was due to a faster growth rate of revenue compared to the growth rate of sales and marketing expenses. We anticipate that sales and marketing expenses will increase in absolute dollars in future periods as we continue to increase the size of our direct sales force and clinical support group, increase spending on additional sales and marketing programs and expand into additional geographic territories.

		Three months ended
		December 31,								Change
(Dollars in thousands)		2006				2005				$				%
General and administrative		$	5,273			$	2,638			$	2,635				100	%

     General and administrative expenses consist primarily of compensation and related costs for finance, human resources, facilities, information technology, insurance, and professional services. Professional services are principally comprised of outside legal, audit and information technology consulting. General and administrative expenses increased in the third quarter of fiscal 2007 compared to the third quarter of fiscal 2006 primarily due to an increase of $0.9 million in legal fees incurred primarily in connection with the patent litigation with Boston Scientific, an increase of $0.7 million related to higher finance and administrative personnel costs due to increased headcount, an increase of $368,000 in stock-based compensation expense due primarily to the impact of the adoption of SFAS 123R, and an increase of $304,000 in consulting fees due to compliance with Sarbanes-Oxley regulations. As a percentage of revenues, general and administrative expenses were 34% in the third quarter of fiscal 2007 and 33% in the third quarter of fiscal 2006. As we incur additional expenses associated with being a public company and to the extent our business expands, we expect that general and administrative expenses will increase in absolute dollars in future periods.

Other Income, Net

		Three months ended
		December 31,								Change
(Dollars in thousands)		2006				2005				$				%
Interest and investment income		$	426			$	389			$	37				10	%
Interest expense			(5	)			(2	)			(3	)			150	%
Other income (expense), net			221				(132	)			353				-267	%
Total other income (expense), net		$	642			$	255			$	387				152	%

     Other income, net consists primarily of investment income, interest expense, and foreign currency gains and losses. Total other income, net increased in the third quarter of fiscal 2007 compared to the third quarter of fiscal 2006 primarily due to foreign exchange gains resulting from differences in exchange rates between the time of the recording of the transaction and settlement of foreign currency denominated receivables and payables.

Income Taxes

     We have incurred net operating losses for both federal and state purposes since inception and, as a result, we have paid no federal or state income taxes. In the third quarter of fiscal 2007, we recorded a noncurrent tax benefit of approximately $38,000 for the tax effect of the current quarter amortization related to the intangible assets acquired in the Neurologic transaction which is not deductible. As of March 31, 2006, we had federal, state and foreign net operating loss carryforwards (“NOLs”) that are available to reduce future taxable income of approximately $27.8 million, $20.1 million and $2.1 million, respectively. The federal NOLs will expire at various dates beginning in 2012, state NOLs will expire beginning in 2007 and the foreign NOLs will expire beginning in 2009. As of March 31, 2006 we also had federal and state tax research and development credit carryforwards of approximately $0.9 million and $0.8 million, respectively. The federal tax credit carryforwards will expire beginning in 2012. The state tax credit carryforwards do not expire. Due to the uncertainty of our ability to generate sufficient taxable income to realize the carryforwards prior to their expiration, we have established a valuation allowance at December 31, 2006 to fully offset the deferred tax assets.

Nine Months Ended December 31, 2006 and 2005

  Revenues

		Nine months ended
		December 31,								Change
(Dollars in thousands)		2006				2005				$				%
Americas		$	22,554			$	12,021			$	10,533				88	%
Europe			12,115				8,836				3,279				37	%
Asia Pacific			8,085				477				7,608				1595	%
Total Revenues		$	42,754			$	21,334			$	21,420				100	%