- Quarterly Report (10-Q)

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 June 30, 2010


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

For the transition period from to

000-51323

(Commission File Number)

Micrus Endovascular Corporation

(Exact name of registrant as specified in its charter)


Delaware		23-2853441

(State or Other Jurisdiction of Incorporation)		(IRS 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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


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

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 August 2, 2010, there were 16,585,666 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. Financial Statements		3
Condensed Consolidated Balance Sheets as of June 30, 2010 and March 31, 2010		3
Condensed Consolidated Statements of Operations for the Three Months Ended June 30, 2010 and 2009		4
Condensed Consolidated Statements of Cash Flows for the Three Months Ended June 30, 2010 and 2009		5
Notes to Condensed Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 3. Quantitative and Qualitative Disclosures About Market Risk		24
Item 4. Controls and Procedures		25
Part II. Other Information
Item 1. Legal Proceedings		26
Item 1A. Risk Factors		26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		40
Item 3. Defaults Upon Senior Securities		40
Item 4. Reserved		40
Item 5. Other Information		41
Item 6. Exhibits		41
Signatures		42
EX-31.1
EX-31.2
EX-32

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

MICRUS ENDOVASCULAR CORPORATION

Condensed Consolidated Balance Sheets

(unaudited)
(In thousands, except share and per share amounts)


	June 30,			March 31,
	2010			2010
ASSETS
Current Assets:
Cash and cash equivalents	$	34,664		$	30,072
Accounts receivable, net of allowance for doubtful accounts of $200 and $217 at June 30, 2010 and March 31, 2010, respectively		15,968			15,454
Inventories		13,743			13,769
Prepaid expenses and other current assets		1,475			1,760

Total current assets		65,850			61,055
Property and equipment, net		5,615			5,841
Goodwill		7,169			7,169
Intangible assets, net		5,092			5,394
Deferred tax assets		516			312
Other assets		459			465

Total assets	$	84,701		$	80,236


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable	$	1,718		$	1,902
Accrued payroll and other related expenses		4,731			6,080
Income tax payable		452			417
Deferred tax liabilities		169			138
Accrued liabilities		5,918			5,917

Total current liabilities		12,988			14,454
Other non-current liabilities		405			446

Total liabilities		13,393			14,900

Commitments and contingencies (Note 7)
Stockholders’ equity:
Preferred stock, $0.01 par value;
Authorized: 1,000,000 shares; none issued and outstanding		—			—
Common stock, $0.01 par value;
Authorized: 50,000,000 shares
Issued and outstanding: 16,582,745 shares and 16,423,452 shares at June 30, 2010 and March 31, 2010, respectively		166			164
Additional paid-in capital		141,048			138,019
Accumulated other comprehensive loss		(2,097	)		(1,961	)
Accumulated deficit		(67,809	)		(70,886	)

Total stockholders’ equity		71,308			65,336

Total liabilities and stockholders’ equity	$	84,701		$	80,236

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

MICRUS ENDOVASCULAR CORPORATION

Condensed Consolidated Statements of Operations

(unaudited)
(In thousands, except per share amounts)


	Three Months Ended June 30,
	2010			2009

Revenues	$	24,628		$	21,223
Cost of goods sold		6,227			5,564

Gross profit		18,401			15,659

Operating expenses:
Research and development		2,312			2,214
Sales and marketing		6,436			6,216
General and administrative		5,872			5,266

Total operating expenses		14,620			13,696

Income from operations		3,781			1,963
Interest income		11			16
Interest expense		—			(36	)
Other income (expense), net		(474	)		769

Income before income taxes		3,318			2,712
Provision for income taxes		241			448

Net income	$	3,077		$	2,264

Net income per share
Basic	$	0.19		$	0.14
Diluted	$	0.17		$	0.14
Weighted-average number of shares used in per share calculations:
Basic		16,522			15,830
Diluted		17,607			16,140

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

MICRUS ENDOVASCULAR CORPORATION

Condensed Consolidated Statements of Cash Flows

(unaudited)
(In thousands)


	Three Months Ended
	June 30,
	2010			2009 (1)
Cash flows from operating activities:
Net income	$	3,077		$	2,264
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		758			742
Provision for doubtful accounts		(15	)		2
Loss on disposal of equipment		2			45
Provision for excess and obsolete inventories		300			327
Stock-based compensation		1,289			1,868
Effect of foreign exchange rate changes on intercompany balances		150			(1,116	)
Deferred income taxes		(170	)		135
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		(620	)		638
Inventories		(341	)		(282	)
Prepaid expenses and other current assets		280			98
Other assets		3			5
Accounts payable		(176	)		(408	)
Accrued payroll and other related expenses		(1,323	)		(1,480	)
Accrued liabilities		357			611
Other non-current liabilities		(36	)		(297	)

Net cash provided by operating activities		3,535			3,152


Cash flows from investing activities:
Restricted cash in connection with forward contracts		—			(135	)
Acquisition of property and equipment		(236	)		(39	)
Earn-out payment in connection with acquisition of VasCon, LLC		(309	)		(882	)

Net cash used in investing activities		(545	)		(1,056	)


Cash flows from financing activities:
Proceeds from exercise of stock options		1,736			19

Net cash provided by financing activities		1,736			19


Effect of foreign exchange rate changes on cash and cash equivalents		(134	)		204
Net increase in cash and cash equivalents		4,726			2,115
Cash and cash equivalents at beginning of period		30,072			17,050

Cash and cash equivalents at end of period	$	34,664		$	19,369


(1)		Refer to Note 1 — Formation and Business of the Company regarding the revision of prior period’s cash flow presentation.

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

MICRUS ENDOVASCULAR CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1 — Formation and Business of the Company

Micrus Endovascular Corporation (the “Company”) 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. The Company’s products are used by interventional neuroradiologists, interventional neurologists, and neurosurgeons to treat both cerebral aneurysms responsible for hemorrhagic stroke and intracranial atherosclerosis, which may lead to ischemic stroke. Hemorrhagic and ischemic stroke are both significant causes of death and disability worldwide.

Interim unaudited financial information

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the annual financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting of normal recurring and out of period adjustments) considered necessary for a fair presentation of the Company’s financial position as of the date of the interim balance sheet and results of operations and cash flows for the interim periods. 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 for the fiscal year ended March 31, 2010 which was filed with the SEC on June 8, 2010. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations.

The results of operations for the interim period ended June 30, 2010 may not necessarily be indicative of the results that may be expected for the fiscal year ending March 31, 2011, or any future period.

Revision of prior periods’ cash flows presentations

The Company previously presented the remeasurement of foreign exchange differences on intercompany balances incorrectly in “Effect of foreign exchange rate changes on cash and cash equivalents” instead of as an “Adjustment to reconcile net income/(loss) to net cash provided by/(used in) operating activities.” Consequently, for prior periods presented, the Company is revising the impact by reclassifying the resulting amounts from “Effect of foreign exchange rate changes on cash and cash equivalents” to “Cash provided by/(used in) operating activities.” This revision does not impact the Company’s previously reported overall net change in cash and cash equivalents in its consolidated statements of cash flows for any period presented. The Company does not believe these adjustments are material to any of the periods impacted. This item has been adjusted in this Form 10-Q. The impact on the Company’s consolidated statements of cash flows data is as follows (in thousands):


	As Previously
	Reported			As Revised
Three months ended June 30, 2009
Net cash provided by operating activities	$	4,268		$	3,152
Effect of foreign exchange rate changes on cash and cash equivalents	$	(912	)	$	204
Net increase in cash and cash equivalents	$	3,231		$	2,115

Note 2 — Summary of Significant Accounting Policies

The Company’s significant accounting policies are fully described in Note 2 to the Consolidated Financial Statements included in the Company’s annual report filed on Form 10-K for the fiscal year ended March 31, 2010, as filed with the SEC on June 8, 2010.

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 prevailing at the balance sheet date. Revenue, expense, gain and loss accounts are translated at average exchange rates during the period. The resulting translation adjustments are recorded directly to accumulated other comprehensive income (loss).

Out of period adjustments

During the three months ended June 30, 2009, the Company recorded adjustments to cost of goods sold, operating expenses and certain balance sheet accounts to record additional expenses primarily related to stock-based compensation expense that were not properly recorded in prior periods. The net adjustments resulted in the reporting of $281,000 in additional pre-tax expenses. These adjustments reduced earnings per share by $0.02 for the three months ended June 30, 2009. These adjustments both individually and in the aggregate were not material to any of the fiscal 2010 interim or full year consolidated financial statements.

Use of estimates

Preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, and the revenues and expenses which are reported during the Company’s reporting periods. In addition, they affect the disclosure of contingent assets and liabilities, as reported on the dates of the Company’s consolidated financial statements. Actual results could differ from these estimates. These estimates and assumptions include reserves and write-downs related to accounts receivable and inventories, the recoverability and fair value of long-term assets, and deferred tax assets and related valuation allowances.

Product warranty

Once a sale has occurred, the customer has no right of return and the Company provides its customers with limited warranty privileges. To date, product returns under warranty have not been significant. The warranty accrual as of June 30, 2010 and March 31, 2010 was immaterial to the financial position of the Company and the change in the accrual for both the current-year quarter and prior-year quarter was immaterial to the Company’s results of operations and cash flows.

Foreign currency transactions

Other income (expense), net, includes foreign currency gains or losses related to a loan with the Company’s Swiss subsidiary, and currency gains or losses resulting from differences in exchange rates between the time of recording of the transaction and the cash settlement of foreign currency denominated receivables and payables. The Company recorded currency gain (losses) for the three months ended June 30, 2010 and 2009 of ($462,000) and $0.8 million, respectively.

Comprehensive income (loss)

Comprehensive income (loss) generally represents all changes in stockholders’ equity except those resulting from investments or contributions by stockholders. The Company’s foreign currency translation adjustments and the Swiss pension plan benefit adjustment represent the only components of comprehensive income (loss) excluded from reported net income. Total comprehensive income for the three months ended June 30, 2010 and 2009 was $2.9 million and $3.1 million, respectively. This included other comprehensive income (loss) of ($143,000) and $0.9 million, respectively, related to foreign currency translation adjustments.

Net income per share

Basic net income per share is computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed by giving effect to all potential dilutive common shares, including stock options and restricted stock units.

Anti-dilutive securities

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


	Three Months Ended June 30,
	2010		2009
Shares issuable upon exercise of common stock options		976		3,584
Shares issuable under employee stock purchase plan		24		51

		1,000		3,635

Stock-based compensation

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

Stock-based compensation cost is measured at the grant date based on the fair value of the award. The fair value of the option is estimated at the date of grant using the Black-Scholes option pricing model and is recognized as expense on a straight-line basis over the requisite service period, which is generally the vesting period. The Black-Scholes model requires the Company to make certain assumptions that are factored into the valuation analysis, including risk free interest rate, expected volatility, forfeiture rates, dividend yield and expected term. Risk free interest rate is based on U.S. Treasury rates appropriate for the expected term. The Company uses combined volatility including that of peer group and the historical volatility of its own stock. Forfeiture rates are based on historical factors related to the Company common stock. The assumed dividend yield is zero as the Company does not expect to declare any dividends in the foreseeable future.

Prior to fiscal 2011, the Company used the simplified method for estimating the expected term. Beginning in fiscal 2011, the Company determined that it has sufficient historical exercise data and will use this historical data on employee exercise and post-vesting employment termination behavior to estimate the expected term. The impact of changing this methodology was not material to the Company’s interim consolidated financial statements.

Some exercises result in tax deductions in excess of previously recorded benefits based on the option value at the time of grant (“windfall” tax benefits). The Company recognizes windfall tax benefits associated with the exercise of stock options directly to stockholders’ equity only when realized. Accordingly, deferred tax assets are not recognized for net operating loss carryforwards resulting from windfall tax benefits occurring from April 1, 2006 onward. A windfall tax benefit occurs when the actual tax benefit realized by the company upon an employee’s disposition of a share-based award exceeds the deferred tax asset, if any, associated with the award that the company had recorded. When assessing whether a tax benefit relating to share-based compensation has been realized, the Company has elected to follow the with-and-without approach, under which net operating loss carryforwards and other tax attributes from continuing operations are utilized before utilizing share-based compensation deductions. Also, the Company has elected to ignore the indirect tax effects of share-based compensation deductions in computing our research and development tax credit. The Company will recognize the full effect of these deductions in the statements of operations when the valuation allowance is released.

Recent accounting pronouncements

In January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity should disclose separately information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance also requires that an entity should provide fair value measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for Level 2 and Level 3 fair value measurements. The updated guidance is effective for interim or annual financial reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company adopted this guidance in the fourth quarter of fiscal 2010. The adoption of this pronouncement did not have a material impact on the Company’s consolidated financial statements.

The remaining disclosure requirements of this pronouncement will be effective for the Company’s fourth quarter of fiscal 2011. The Company is currently evaluating the impact of the adoption of the remaining disclosure requirement of this pronouncement and does not expect the adoption to have a material impact on the Company’s consolidated financial statements.

Note 3 — Fair Value Measurements

The FASB’s authoritative guidance for fair value measurement and disclosure for financial assets and liabilities defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The guidance also provides a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value:


Level 1		Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2		Quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability.

Level 3		Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable.

The Company’s cash equivalents are classified within Level 1 of the fair value hierarchy because they are invested in money market funds and valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.

The Company enters into foreign currency forward contracts to buy U.S. dollars at fixed intervals in the retail market in an over-the-counter environment. As of June 30, 2010, the Company had foreign currency forward contracts to sell 1.2 million euros in exchange for approximately $1.5 million U.S. dollars maturing in July through September 2010. The counterparty to these contracts is UBS AG. The Company’s foreign currency forward contracts are classified within Level 2 as the valuation inputs are based on quoted prices of similar instruments in active markets and do not involve management judgment. The Company recorded the fair value of the contracts in current assets on its consolidated balance sheet as of June 30, 2010. The Company recorded a net realized gain of approximately $9,000 for the three months ended June 30, 2010.

The Swiss pension plan unfunded benefit obligation is classified within Level 3 since there is no observable market for the asset or liability and requires the Company to develop its relevant assumptions.

The following table presents assets and liabilities measured at fair value on a recurring basis at June 30, 2010 (in thousands):


	Level 1		Level 2		Level 3		Total

Assets:
Money market funds	$	21,385	$	—	$	—	$	21,385
Foreign currency forward contracts		—		8		—		8

	$	21,385	$	8	$	—	$	21,393


Liabilities:
Swiss pension plan unfunded benefit obligation	$	—	$	—	$	152	$	152

The following table presents assets and liabilities measured at fair value on a recurring basis at March 31, 2010 (in thousands):


	Level 1		Level 2		Level 3		Total

Assets:
Money market funds	$	21,378	$	—	$	—	$	21,378

Liabilities:
Swiss pension plan unfunded benefit obligation	$	—	$	—	$	155	$	155

The following table presents a reconciliation of liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended June 30, 2010 (in thousands):


	Level 3
Fair value at beginning of fiscal year	$	155
Change due to foreign currency translation		(3	)

Fair value at end of period	$	152

Note 4 — Balance Sheet Components

Inventories

Inventories consisted of the following (in thousands):


	June 30,		March 31,
	2010		2010
Raw materials	$	2,149	$	2,058
Work-in-progress		2,281		1,894
Finished goods		2,770		3,290
Consigned inventory		6,543		6,527

	$	13,743	$	13,769

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 purchased by the customer, generally when used in a medical procedure.

Property and equipment, net

Property and equipment, net, consisted of the following (in thousands):


	June 30,			March 31,
	2010			2010
Computer equipment and software	$	1,860		$	1,814
Furniture, fixtures and equipment		7,919			7,707
Leasehold improvements		2,166			2,168
Construction in progress		184			218

Total cost		12,129			11,907
Less accumulated depreciation and amortization		(6,514	)		(6,066	)

	$	5,615		$	5,841

Goodwill

Activity related to goodwill consisted of the following (in thousands):


	June 30,		March 31,
	2010		2010
Balance at beginning of fiscal year	$	7,169	$	6,762
Foreign currency translation		—		407

Balance at end of period	$	7,169	$	7,169

All of the Company’s goodwill has been allocated to the United Kingdom reporting unit.

Intangible assets, net

Intangible assets, net, consisted of the following (in thousands):


			Gross Carrying Amount						Accumulated Amortization											Net
	Useful				Foreign										Foreign
	Life		March 31,		currency		June 30,		March 31,						currency		June 30,			June 30,		March 31,
	(Years)		2010		translation		2010		2010			(Additions)			translation		2010			2010		2010
Existing process technology		7	$	4,590	$	—	$	4,590	$	(2,186	)	$	(164	)	$	—	$	(2,350	)	$	2,240	$	2,404
Distribution agreements		5		1,651		—		1,651		(1,556	)		(50	)		—		(1,606	)		45		95
Capitalized license fee		7		3,565		—		3,565		(783	)		(55	)		—		(838	)		2,727		2,782
Patents — microcoil		10		1,100		—		1,100		(1,100	)		—			—		(1,100	)		—		—
Non-compete agreements		6		470		—		470		(395	)		(13	)		—		(408	)		62		75
Customer relationships		5		647		—		647		(609	)		(20	)		—		(629	)		18		38

			$	12,023	$	—	$	12,023	$	(6,629	)	$	(302	)	$	—	$	(6,931	)	$	5,092	$	5,394

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


	Three Months Ended June 30,
	2010		2009

Cost of goods sold	$	219	$	220
Operating expenses		83		111

	$	302	$	331

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


For Years Ending March 31,	Amortization
2011 (remaining 9 months)	$	760
2012		1,189
2013		1,165
2014		835
2015		1,143

	$	5,092

Accruals

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


	June 30,		March 31,
	2010		2010
Accrued bonuses	$	457	$	1,226
Accrued salaries		948		1,444
Accrued vacation		2,423		2,169
Accrued commissions		540		767
Accrued payroll taxes		363		474

	$	4,731	$	6,080

Accrued liabilities consisted of the following (in thousands):


	June 30,		March 31,
	2010		2010
Milestone payments to The Cleveland Clinic	$	1,500	$	1,500
Professional fees		638		936
Sales tax and VAT payable		568		506
Raw material inventory receipts not invoiced		554		345
Employee Stock Purchase Plan		398		57
Travel and entertainment		397		305
Earn-out payment in connection with acquisition of VasCon		—		309
Other		1,863		1,959

	$	5,918	$	5,917

The Company is required to pay The Cleveland Clinic Foundation (“The Cleveland Clinic”) up to $5.0 million in payments upon the achievement of certain milestones set forth in the Stock Purchase Agreement with The Cleveland Clinic dated October 26, 2007 (the “ReVasc Agreement”), with minimum milestone payments of at least $2.0 million due to the Cleveland Clinic by October 2010. The Company paid a $0.5 million milestone payment in March 2008. The Company has accrued an additional $1.5 million as of June 30, 2010 for the remaining milestone payments that will become due by October 26, 2010, regardless of whether the related milestones are achieved.

Other non-current liabilities

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


	June 30,		March 31,
	2010		2010
Swiss pension plan unfunded benefit obligation	$	152	$	155
Income taxes payable		94		95
Deferred revenue from Goodman Co., Ltd. distribution agreement		28		56
Other non-current liabilities		131		140

	$	405	$	446

Note 5— Line of Credit

On November 5, 2008, the Company entered into a credit agreement with Wells Fargo Bank to provide the Company with a revolving line of credit (the “Credit Agreement”). The Credit Agreement provides for maximum borrowings in an amount up to $15.0 million. If borrowings under the Credit Agreement exceed $7.5 million, all borrowings are subject to a borrowing base which is based on eligible accounts receivable. Borrowings are collateralized by a first priority security interest in all of the Company’s assets (except for certain permitted liens that are senior to Wells Fargo Bank’s security interest).

At the Company’s option, borrowings bear interest at either 2.25% over the bank’s prime rate or 3.50% over the one-month, two-month or three-month LIBOR. The interest rate on the borrowings as of March 31, 2010 was 4.0%. The Credit Agreement requires that the Company comply with certain financial and other covenants for borrowings to be permitted. The more significant financial covenants include (i) a minimum modified quick ratio and (ii) a minimum profitability, excluding certain non-cash items. On May 20, 2009, the Company amended the Credit Agreement with Wells Fargo Bank extending the maturity date to August 1, 2010 and adjusting the minimum limits for the financial covenants based on the Company’s financial forecast for fiscal 2010.

At June 30, 2010, the Company had no outstanding borrowings under the line of credit and was in compliance with all covenants of the Credit Agreement.

Note 6 — Income Taxes

The Company recorded a provision for income taxes of approximately $241,000 for the three months ended June 30, 2010.

As of March 31, 2010, the Company had federal, state and foreign net operating loss carryforwards (“NOLs”) of approximately $36.9 million, $28.8 million and $2.1 million, respectively. The federal NOLs will expire at various dates beginning in 2022, the state NOLs expire beginning in 2015 and the foreign NOLs will expire beginning in 2016. The benefit of approximately $12.4 million and $8.4 million of federal and state loss carryforwards, respectively, will be credited to equity when realized. The Company also had federal and state research and development tax credit carryforwards of approximately $1.9 million and $1.7 million, respectively, as of March 31, 2010. The federal credits will expire beginning in 2019 and the state credits can be carried forward indefinitely. The Company has recorded a full valuation allowance against its U.S. federal and state gross deferred tax assets, as the Company’s history of losses and all other evidence available provide uncertainty as to whether it is more likely than not that its U.S. federal and state gross deferred tax assets will be realized.

Since the adoption of the FASB’s authoritative guidance for accounting for uncertainty in income taxes (ASC 740-10-5-6, formerly known as “FIN48”), the Company has recognized a $444,000 increase in its unrecognized tax benefits. The Company does not expect its unrecognized tax benefits to change significantly over the next twelve months. At June 30, 2010, the Company had $22,000 of accrued interest or penalties related to tax contingencies.

Note 7 — 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.

Merger Agreement

On July 13, 2010, a plaintiff filed a putative class action entitled Robert Sauser v. Micrus Endovascular Corporation et al. , Case No. 110-CV-176769, in the Superior Court of the State of California, Santa Clara County. The defendants are the Company and the members of its board of directors. The complaint alleges that the individual defendants breached their fiduciary duties to the Company’s stockholders in connection with the merger agreement and the transactions contemplated thereby. Specifically, the complaint alleges, among other things, that the proposed transaction arises out of a flawed process and that the individual defendants engaged in self-dealing in relation to the merger agreement, which resulted in a failure to maximize shareholder value. The suit further alleges that the Company aided and abetted the individual defendants’ breaches of fiduciary duties and that the consideration offered in the merger does not fairly reflect the Company’s true value. The plaintiff seeks, among other things, an order enjoining the consummation of the merger, attorneys’ fees and costs.

On July 19, 2010, a plaintiff filed a putative class action entitled Claire Houston v. John Kilcoyne et al ., Case No. 110-CV-177667, in the Superior Court of the State of California, Santa Clara County. The defendants are the Company and the members of its board of directors (together with the Company, the “Micrus Defendants”), Johnson & Johnson and Cope Acquisition Corp. (a wholly owned subsidiary of Johnson & Johnson, and together with Johnson & Johnson, the “J&J Defendants”). This action alleges that the individual defendants breached their fiduciary duties to the Company’s stockholders in connection with the merger. Specifically, the complaint alleges, among other things, that the proposed transaction arises out of a flawed process, that the individual defendants failed to maximize shareholder value and that the consideration offered in the merger is inadequate and does not fairly reflect the Company’s true value. The plaintiff also alleges that the individual defendants agreed to no-solicitation and termination provisions in the merger agreement in violation of our board’s fiduciary duties. The suit further alleges that the Company and the J&J Defendants aided and abetted the individual defendants’ breaches of fiduciary duties. The plaintiff seeks, among other things, an order enjoining the Micrus Defendants and the J&J Defendants from consummating the merger, damages in the event the merger is consummated prior to the court’s entry of a final judgment, and attorneys’ fees and costs.

The Company believes that the lawsuits are wholly without merit and intends to defend vigorously against them. However, because the litigation is in the early stages, the Company cannot predict the outcome at this time, and cannot provide assurance that the actions will not delay the consummation of the merger or result in substantial costs; even a meritless lawsuit may potentially delay consummation of the merger.

Other General

The Company is participating in other litigation and responding to other claims arising in the ordinary course of business. The Company intends to defend itself vigorously in these matters. The Company’s management believes that it is unlikely that the outcome of these matters will have a material adverse effect on the Company’s financial statements, although there can be no assurance in this regard.

Note 8 — 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 stock option program critical to its operations and productivity. As of June 30, 2010, the Company had two stock option plans: the 1998 Stock Plan (the “1998 Plan”) and the 2005 Equity Incentive Plan (the “2005 Plan”). Currently, the Company grants options from the 2005 Plan, which permits the Company to grant options to all employees, including executive officers, and outside consultants, and directors. Effective June 16, 2005, no new options were granted under the 1998 Plan.

As of June 30, 2010, there were 826,729 outstanding options under the 1998 Plan. As of June 30, 2010, there were 5,192,386 remaining shares reserved for issuance under the 2005 Plan, of which 2,066,086 were available for grant and 3,126,300 shares were subject to outstanding options. Stock options issued under the Company’s stock option plans generally vest based on 4 years of continuous service and have 10-year contractual terms.

2005 Employee Stock Purchase Plan

The 2005 Employee Stock Purchase Plan (the “Purchase Plan”) became effective upon the Company’s initial public offering. The Purchase Plan provides employees with an opportunity to purchase the Company’s common stock through accumulated payroll deductions. As of June 30, 2010, there were 863,689 shares reserved for issuance under the Purchase Plan.

Stock-based compensation

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 employee stock options and employee stock purchase plan shares has been estimated using the following weighted-average valuation assumptions:


	Three Months Ended June 30,
	2010		2009
Employee Stock Option Plans
Expected term (in years)		5		6
Volatility		49%		44%
Risk-free interest rate		2.2%		2.6%
Expected dividend yield		0%		0%
Weighted average fair value at date of grant	$	8.39	$	3.91

Employee Stock Purchase Plan
Expected term (in years)		0.5		0.5
Volatility		33%		83%
Risk-free interest rate		0.2%		0.6%
Expected dividend yield		0%		0%

The fair value of each purchase right granted under the Company’s Purchase Plan during the three months ended June 30, 2010 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 the results of operations is as follows (in thousands):


	Three Months Ended June 30,
	2010		2009

Cost of goods sold	$	139	$	131
Research and development		172		242
Sales and marketing		318		509
General and administrative		660		986

	$	1,289	$	1,868

Approximately $14,000 and $55,000 in stock-based compensation expense has been capitalized in inventory for the three months ended June 30, 2010 and 2009, respectively.

As of June 30, 2010, there was approximately $6.6 million of total stock-based compensation expense, after estimated forfeitures, related to unvested employee stock options, which is expected to be recognized over an estimated weighted-average amortization period of 2.3 years for employee stock options.

General stock option information

The following table sets forth the summary of stock options activity for the three months ended June 30, 2010:


						Weighted-
				Weighted-		Average
				Average		Remaining		Aggregate
				Exercise		Contractual		Intrinsic
	Shares			Price		Term		Value
	(In thousands)					(In years)		(In thousands)
Options outstanding at March 31, 2010		4,074		$	12.50
Options granted		77		$	18.98
Options exercised		(159	)	$	10.91
Options forfeited		(19	)	$	12.13
Options expired		(20	)	$	23.39

Options outstanding at June 30, 2010		3,953		$	12.63		6.8	$	32,909


Options exercisable at June 30, 2010		2,759		$	12.24		6.1	$	24,128

The total aggregate intrinsic value of options exercised during the three months ended June 30, 2010 and 2009 was $1.3 million and $163,000, respectively. The closing market value per share of the Company’s common stock as of June 30, 2010 was $20.79 per share as reported by The NASDAQ Stock Market.

Note 9 — Segment and Geographic Information

Revenues from unaffiliated customers by geographic area, based on the customer’s shipment locations were as follows (in thousands):


	Three Months Ended June 30,
	2010		2009

United States	$	10,747	$	10,083
Japan		4,120		3,364
United Kingdom		1,682		1,754
Rest of the world		8,079		6,022

	$	24,628	$	21,223

The Company’s long lived assets, excluding goodwill and intangible assets, by geographic area were as follows (in thousands):


	June 30,		March 31,
	2010		2010
United States	$	5,391	$	5,602
United Kingdom		58		57
Rest of the world		166		182

	$	5,615	$	5,841

The Company identifies its operating segments based on how management views and evaluates the Company’s operations, which are primarily based on geographic location. The Company has determined it operates in three business segments: the Americas, Europe and Asia Pacific. The products and services 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 June 30,
	2010		2009

Revenues:
Americas	$	12,644	$	11,156
Europe		7,491		6,362
Asia Pacific		4,493		3,705

	$	24,628	$	21,223


Gross Profit:
Americas	$	9,865	$	8,610
Europe		5,216		4,507
Asia Pacific		3,320		2,542

	$	18,401	$	15,659

Total assets by operating segment were as follows (in thousands):


	June 30,		March 31,
	2010		2010
Americas	$	63,379	$	60,525
Europe		21,322		19,711

	$	84,701	$	80,236

Note 10 — Subsequent Events

On July 6, 2010, the Company elected to extend the Exclusive License and Option Agreement with Bay Street Medical, Inc. for six months and paid an additional $0.5 million.

On July 11, 2010, the Company, Johnson & Johnson (“J&J”) and Cope Acquisition Corp. (a wholly-owned subsidiary of J&J) entered into a definitive agreement whereby the Company will be acquired for $23.40 per share in cash. The boards of directors of J&J and the Company have approved the transaction, which is subject to clearance under the Hart-Scott-Rodino Antitrust Improvements Act, similar regulation in other countries, the Company’s stockholder approval and other customary closing conditions.

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

Forward-Looking Statements

Some of the statements under the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, and 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 SEC. Forward-looking statements are typically identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “estimate,” “predict,” “project,” “plan,” “believe,” “target,” “forecast,” “should,” “could,” “would,” “intends” and other words and terms of similar meaning.

The Company cautions that forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date they are made, and, subject to applicable law, the Company assumes no duty to and does not undertake to update forward-looking statements. Actual results could differ materially from those anticipated in forward-looking statements and future results could differ materially from historical performance. In addition to factors previously disclosed in the Company’s documents filed with or furnished to the SEC, and those identified elsewhere in this Quarterly Report on Form 10-Q, the following factors, among others, could cause actual results to differ materially from forward-looking statements or historical performance:

	•		the occurrence of any event, change or other circumstances that could give rise to the termination of the merger agreement;

	•		the cost or outcome of any legal proceedings that have been or may be instituted against Mircus and others relating or unrelated to the merger;

	•		the inability to complete the merger due to the failure to obtain stockholder approval, governmental or regulatory clearances or the failure to satisfy other conditions to the closing of the merger;

	•		the failure of the merger to be completed for any other reason;

	•		required governmental and regulatory approvals may delay the merger or result in the imposition of conditions that could cause the parties to abandon the merger;

	•		risks that the proposed merger disrupts current plans and operations and the potential difficulties in employee retention as a result of the merger;

	•		the effect of the announcement of the merger on the Company’s business relationships, operating results and business generally;

	•		the amount of the costs, fees, expenses and charges related to the merger;

	•		adverse developments in general business, economic, regulatory and political conditions or any outbreak or escalation of hostilities on a national, regional or international basis;

	•		the impact of healthcare reform and any other changes to applicable governmental laws and regulations;

	•		the timing of receipt of regulatory approvals;

	•		our failure to comply with regulations and any changes in regulations;

	•		the loss of any of our senior management;

	•		the expected weighted-average remaining period for recognition of compensation costs, which may be affected by the acceleration of stock options if the proposed merger is consummated;

	•		changes in factors impacting our estimates of market growth, the timing of launch of our products or their introduction into new markets;

	•		changes in our working capital and capital expenditure requirements;

	•		changes in the percentage of our revenues denominated in currencies other than the U.S. dollar; and

	•		other risks detailed in our current filings with the SEC, including our Annual Report on Form 10-K for the fiscal year ended March 31, 2010, and this Quarterly Report on Form 10-Q.

You should not place undue reliance on forward-looking statements. We cannot guarantee any future results, levels of activity, performance or achievements.

Overview

We develop, manufacture and market implantable and disposable medical devices used in the treatment of cerebral vascular diseases. Our products are used by interventional neuroradiologists, interventional neurologists and endovascularly trained neurosurgeons to treat both cerebral aneurysms responsible for hemorrhagic stroke and intracranial atherosclerosis which may lead to ischemic stroke. Hemorrhagic and ischemic stroke are both significant causes of death and disability 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 that our products provide a safe and reliable alternative to more invasive neurosurgical procedures for treating aneurysms. Our proprietary three-dimensional, embolic coils anatomically conform and rapidly deploy within an aneurysm, forming a scaffold that conforms to a wide diversity of aneurysm shapes and sizes. We also supply accessories for use with our microcoils and other products for the treatment of neurovascular disease including microcatheters, balloon catheters, guidewires and stents.

Our revenues are derived primarily from sales of our microcoils. We also sell stents, access products and accessories for use with our microcoils, which accounted for approximately 8% and 5% of our revenues in the first quarter of fiscal 2011 and 2010, respectively. Geographically, our revenues are generally from sales to customers in the Americas, Europe and Asia Pacific. Our products are shipped from our facilities in the United States and a logistics facility in the Netherlands, to either hospitals or distributors. In select hospitals, our products are held on consignment, and remain on site, free of charge until used. Revenue is generally recognized upon shipment after the receipt of a purchase order. In arrangements which specify the title transfer upon delivery, revenue is not recognized until the product is delivered. In the case of consigned goods, revenue is recognized when a replenishment order is made.

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 gross margin percentage may also decrease in those quarters in which we have a higher proportion of sales to distributors with lower average selling prices.

Our product development efforts are primarily focused on expanding our product offerings for the hemorrhagic and ischemic stroke markets. In August 2004, we introduced our Cerecyte ^® microcoil product line and we have launched eight new products in the last 24 months, including microcoils, stents, microcatheters, guidewires and balloon catheters. During fiscal 2009, we launched the Neuropath ^® guide catheter, which combines robust proximal support with a highly flexible and visible tip designed to facilitate atraumatic vascular access. The Neuropath ^® guide catheter is used as a conduit for delivery of the microcatheter or other devices, such as coils, stents and balloons, to the aneurysm.

In fiscal 2009, we also launched Cerecyte and stretch resistant versions of our DeltaPaq ^® microcoil system for the treatment of cerebral aneurysms. Our DeltaPaq microcoil system is designed to enable physicians to achieve greater coil packing density within the aneurysm which may reduce the rate of recanalization and the need for re-treatment. The DeltaPaq microcoil system supplements our framing and finishing coils in the filling segment of the coil market. Additionally, we launched the PHAROS ^® Vitesse™ intracranial stent, our second generation balloon-expandable stent for the treatment of intracranial ischemic stenosis and in wide-neck aneurysms for commercial distribution in the European Union and all other countries recognizing the CE Mark. We have received U.S. FDA conditional approval of our investigational device exemption for the PHAROS VISSIT study. The VISSIT study is the first industry sponsored, randomized, prospective clinical trial designed to compare the clinical outcomes between patients who are stented for intracranial ischemic stenosis versus treated with medical therapy. We are in the process of initiating study sites in the United States, Europe and China.

In January 2010, we launched our DeltaPlush ^® microcoil which has been designed to be our softest finishing coil, enabling more efficient and safer aneurysm treatment. The DeltaPlush microcoil system incorporates our exclusive Delta Wind™ technology resulting in a microcoil with the softness and flexibility to find and fill gaps, helping to provide superior finishing at

the aneurysm neck. It is available in bare platinum and Cerecyte ^® . In January 2010, we launched our Ascent ^® Occlusion Balloon Catheter which is intended for use in the blood vessels of the peripheral and neurovasculature where temporary occlusion is desired. The Ascent balloon catheter offers a vessel selective technique of temporary arterial occlusion which is useful in selectively stopping or controlling blood flow.

In March 2006, we launched our sales and marketing efforts in Japan through our distribution partner, Goodman. In December 2007, we received regulatory approval to sell our stretch-resistant microcoils in Japan, and in July 2008, we received regulatory approval to sell our Cerecyte microcoils in Japan. We recorded product sales to Goodman of $4.1 million in the first quarter of fiscal 2011 and $11.0 million, $9.3 million and $6.3 million in fiscal 2010, 2009 and 2008, respectively. We plan to begin selling our products in China upon receiving regulatory and reimbursement approvals. The timing of these approvals is uncertain. We did not have any sales in China during the first quarter of fiscal 2011.

We introduced our first proprietary, three-dimensional microcoil in May 2000. Our revenues have grown from $1.8 million in fiscal 2001 to $91.1 million in fiscal 2010. We achieved our first profitable year in fiscal 2010, with a profit of $11.5 million as a result of our revenue growth and effective cost management, and we expect to achieve another profitable year in fiscal 2011. Net income for the first quarter of fiscal 2011 was $3.1 million. As of June 30, 2010, we had cash and cash equivalents of $34.7 million and an accumulated deficit of $67.8 million.

Recent Developments

On July 11, 2010, we entered into a definitive agreement with J&J and Cope Acquisition Corp. (a wholly-owned subsidiary of J&J) whereby we will be acquired for $23.40 per share in cash. The boards of directors of J&J and the Company have approved the transaction, which is subject to clearance under the Hart-Scott-Rodino Antitrust Improvements Act, similar regulation in other countries, our stockholders approval and other customary closing conditions.

Results of Operations

The following table sets forth the results of our operations, expressed as percentages of revenues, for the three months ended June 30, 2010 and 2009:


	Three Months Ended June 30,
	2010		2009
Consolidated Statements of Operations Data:
Revenues		100%		100%
Cost of goods sold		25%		26%

Gross profit		75%		74%

Operating expenses:
Research and development		9%		11%
Sales and marketing		26%		29%
General and administrative		24%		25%

Total operating expenses		59%		65%

Income from operations		16%		9%
Interest income		0%		0%
Interest expense		0%		0%
Other income (expense), net		(2)%		4%

Income before income taxes		14%		13%
Provision for income taxes		1%		2%

Net income		13%		11%

Three Months Ended June 30, 2010 and 2009

Revenues


	Three Months Ended
	June 30,				Change
	2010		2009		$		%
	(In thousands, except percentages)
Americas	$	12,644	$	11,156	$	1,488		13%
Europe		7,491		6,362		1,129		18%
Asia Pacific		4,493		3,705		788		21%

	$	24,628	$	21,223	$	3,405		16%

Our revenues are derived primarily from sales of our microcoils used in the treatment of cerebral vascular diseases. The overall increase in revenues in the first quarter of fiscal 2011 compared to the first quarter of fiscal 2010 was primarily due to an increase in the number of microcoil products sold. Factors driving the increase included growth in the procedure volumes, continued market penetration of the DeltaPaq and DeltaPlush microcoils along with the revenues generated from sales of new non-embolic products such as the PHAROS Vitesse intracranial stent and the Ascent Occlusion Balloon Catheter.

Revenues from the Americas increased 13% to $12.6 million and revenues from Europe increased 18% to $7.5 million for the first quarter of fiscal 2011, both compared to the first quarter of fiscal 2010. Our revenues increased in the Americas and Europe primarily due to continued market penetration of the DeltaPaq and the DeltaPlush microcoils. Revenues from Asia Pacific increased 21% to $4.5 million in the first quarter of fiscal 2011 and included sales to our distributor in Japan of $4.1 million, compared with revenues of $3.7 million for the first quarter of fiscal 2010 which included sales to our distributor in Japan of $3.4 million.

Revenues from embolic coils increased 13% to $22.7 million for the first quarter of fiscal 2011 as compared to the first quarter of fiscal 2010 primarily due to increased in procedure volumes and market penetration of the DeltaPaq and the DeltaPlush microcoil system. Revenues from our non-embolic and accessories products increased to $2.0 million in the first quarter of fiscal 2011 compared with revenues of $1.1 million in the first quarter of fiscal 2010 primarily due to continued market penetration of our PHAROS Vitesse stent and Ascent Occlusion Balloon Catheter.

New products continue to represent an important component of our growth strategy, with 46% of our revenues in the first quarter of fiscal 2011 coming from products introduced in the past 24 months. Among these, our DeltaPaq microcoil line represented 18% of the total revenue for the first quarter of fiscal 2011. Our newly launched DeltaPlush microcoil system comprised 21% of the first quarter of fiscal 2011 revenues.

Gross Profit


	Three Months Ended
	June 30,				Change
	2010		2009		$		%
	(In thousands, except percentages)
Cost of goods sold	$	6,227	$	5,564	$	663		12%
Gross profit	$	18,401	$	15,659	$	2,742		18%

Cost of goods sold consists primarily of materials, direct labor, depreciation, overhead costs associated with manufacturing, impairments of inventory, warranty expenses, amortization of intangible assets that were acquired by us as part of the acquisition of VasCon, amortization of capitalized license technology associated with our PHAROS stent product and royalties related to certain access device products. The increase in cost of goods sold during the first quarter of fiscal 2011 as compared to the first quarter of fiscal 2010 was primarily related to the increase in sales of our embolic and non-embolic products.

Our gross margin was 75% in the first quarter of fiscal 2011 as compared to 74% in the first quarter of fiscal 2010. The increase was primarily due to sales of higher margin products partially offset by higher levels of distributor sales of lower margin products primarily in Japan and Latin America.

Operating Expenses

Research and Development


	Three Months Ended
	June 30,				Change
	2010		2009		$		%
	(In thousands, except percentages)
Research and development	$	2,312	$	2,214	$	98		4%

Research and development expenses consist primarily of costs associated with the design, development, and testing of new 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 first quarter of fiscal 2011 compared to the first quarter of fiscal 2010 primarily due to an increase of $240,000 in personnel and travel expenses. These increases were partially offset by a decrease of $157,000 in material and supplies expenses.

Sales and Marketing


	Three Months Ended
	June 30,				Change
	2010		2009		$		%
	(In thousands, except percentages)
Sales and marketing	$	6,436	$	6,216	$	220		4%

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 first quarter of fiscal 2011 compared to the first quarter of fiscal 2010 primarily due to an increase of $209,000 in meetings and conference expenses, an increase of $138,000 in travel expenses and an increase of $104,000 in sales incentives resulting from the higher level of sales during the quarter. These increases were partially offset by a decrease of $191,000 in stock-based compensation expenses.

General and Administrative


	Three Months Ended
	June 30,				Change
	2010		2009		$		%
	(In thousands, except percentages)
General and administrative	$	5,872	$	5,266	$	606		12%

General and administrative expenses consist primarily of compensation and related costs for finance, human resources, facilities, information technology, insurance, and professional services. Professional services principally relate to fees for outside legal, audit and compliance with the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”). General and administrative expenses increased in the first quarter of fiscal 2011 compared to the first quarter of fiscal 2010 primarily due to an increase of $0.5 million in primarily legal expenses related to the acquisition agreement with J&J (see Note 10, Subsequent Events, in the Notes to Condensed Consolidated Financial Statements), an increase of $160,000 in consulting fees and an increase of $134,000 in bonus expenses. These increases were partially offset by a decrease of $326,000 in stock-based compensation expenses.

Other Income (Expense), Net


	Three Months Ended
	June 30,						Change
	2010			2009			$			%
	(In thousands, except percentages)
Interest income	$	11		$	16		$	(5	)		(31)%
Interest expense		—			(36	)		36			0%
Other income (expense), net		(474	)		769			(1,243	)		(162)%

Total other income (expense), net	$	(463	)	$	749		$	(1,212	)		(162)%

There was no interest expense in the first quarter of fiscal 2011 as we paid off our borrowings of $2.5 million in March 2010.

Other income (expense), net, consists primarily of foreign exchange gains and losses resulting from differences in exchange rates between the time of recording of the transaction and the settlement of foreign currency denominated receivables and payables. Other income (expense), net, decreased by $1.2 million in the first quarter of fiscal 2011 compared to the first quarter of fiscal 2010 primarily due to losses resulting from the remeasurement of foreign currency transactions in the first quarter of fiscal 2011.

Income Taxes


	Three Months Ended
	June 30,
	2010		2009
	(In thousands, except percentages)
Provision for income taxes	$	241	$	448
Effective tax rate		7%		17%

We provide for income taxes during interim periods based on our estimate of the effective tax rate for the year. Discrete items and changes in our estimate of the annual effective tax rate are recorded in the period in which they occur. The provision for income taxes we calculated differs from the amount if computed by applying the statutory United States federal tax rate principally due to the utilization of previously reserved net operating losses.

The decrease in the effective tax rate for the first quarter of fiscal 2011 as compared to the same period of the prior year primarily results from a reduction in the U.S. federal income tax due to recently passed legislation enabling the Company to utilize additional net operating loss carryforwards for Alternative Minimum Tax purposes.

Liquidity and Capital Resources


	Three Months Ended
	June 30,
	2010			2009
	(In thousands)
Cash flow activities:
Net cash provided by operating activities	$	3,535		$	3,152
Net cash used in investing activities	$	(545	)	$	(1,056	)
Net cash provided by financing activities	$	1,736		$	19

As of June 30, 2010, we had cash and cash equivalents of $34.7 million, compared to $30.1 million at March 31, 2010.

Net cash provided by operating activities was $3.5 million during the first quarter of fiscal 2011 compared to net cash provided by operating activities of $3.2 million during the first quarter of fiscal 2010. Net cash provided by operating activities during the first quarter of fiscal 2011 resulted primarily from net income adjusted by non-cash items such as stock-based compensation expense, depreciation and amortization, provision for excess and obsolete inventories, deferred income taxes, the effect of foreign exchange rate changes on intercompany balances; a decrease in prepaid expenses and other current assets and an increase in accrued liabilities. These factors were partially offset by an increase in accounts receivable resulting from higher level of sales, an increase in inventory due to a ramp up in production, a decrease in accounts payable due to the timing of payments made to our vendors, and a decrease in accrued payroll and related expenses attributable primarily to the payment of fiscal 2010 employee cash bonuses in the first quarter of fiscal 2011.

Net cash provided by operating activities during the first quarter of fiscal 2010 resulted primarily from operating income, a decrease in accounts receivable due to improved receivables collection, an increase in accrued liabilities due to a change in classification of contingent purchase price liability from long-term to short-term. These factors were partially offset by an increase in inventory due to an increase in the number of consignment locations and an increase in the number of units in existing consignment locations due to new products released, a decrease in accounts payable due to the timing of payments made to our vendors, a decrease in accrued payroll and related expenses attributable primarily to the payment of fiscal 2009 employee cash bonuses in the first quarter of fiscal 2010 and a decrease in other non-current liabilities primarily due to a change in classification of contingent purchase price liability from long-term to short-term and non-cash items such as stock-based compensation expense related to SFAS 123R, depreciation and amortization, provision for excess and obsolete inventories and deferred income taxes.

Net cash used in investing activities was $0.5 million during the first quarter of fiscal 2011 compared to $1.1 million during the first quarter of fiscal 2010. Net cash used in investing activities during the first quarter of fiscal 2011 was related to the earn-out payment associated with the purchase of VasCon and the purchase of capital equipment.

Net cash used in investing activities during the first quarter of fiscal 2010 was related to the earn-out payment associated with the purchase of VasCon, an increase in restricted cash due to a pledged asset requirement in connection with forward contracts and the purchase of capital equipment.

Net cash provided by financing activities was $1.7 million during the first quarter of fiscal 2011 compared to $19,000 during the first quarter of fiscal 2010. Net cash provided by financing activities during the first quarter of fiscal 2011 and fiscal 2010 consisted of proceeds from the exercise of stock options.

To the extent that existing cash and cash generated from operations are insufficient to fund our future activities, we would seek to borrow funds under our credit facility. We have a revolving line of credit with Wells Fargo Bank with a maximum borrowing in the amount up to $15.0 million.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues and expenses, as well as related disclosure of contingent assets and liabilities. In many cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss below. Our management has reviewed our critical accounting policies and estimates with our accounting advisors, audit committee and board of directors.

Our critical accounting policies and estimates are fully described in Critical Accounting Policies and Estimates in our annual report on Form 10-K for the fiscal year ended March 31, 2010, that was filed with the SEC on June 8, 2010. There were no significant changes in our critical accounting policies or estimates since March 31, 2010.

Recent Accounting Pronouncements

In January 2010, the FASB issued updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity should disclose separately information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance also requires that an entity should provide fair value measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for Level 2 and Level 3 fair value measurements. The updated guidance is effective for interim or annual financial reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. We adopted this guidance in the fourth quarter of fiscal 2010. The adoption of this pronouncement did not have a material impact on our consolidated financial statements.

The remaining disclosure requirements of this pronouncement will be effective for us in the fourth quarter of fiscal 2011. We are currently evaluating the impact of the adoption of the remaining disclosure requirement of this pronouncement and do not expect the adoption to have a material impact on our consolidated financial statements.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements as of June 30, 2010.

Contractual Obligations

We have obligations under non-cancelable operating leases with various expiration dates through 2013 and purchase commitments for inventory, capital equipment and operating expenses, such as materials for research and development and consulting.

As of June 30, 2010, our contractual commitments were as follows (in thousands):


	Payments due by period
			Less than		1-3		3-5		More than
Contractual obligations:	Total		1 year		Years		Years		5 years
Non-cancelable operating lease obligations	$	5,446	$	1,072	$	2,470	$	1,048	$	856
Purchase obligations		3,048		3,048		—		—		—
Milestone payments to The Cleveland Clinic		1,500		1,500		—		—		—
Royalty payments to Vascular FX, LLC		833		250		583		—		—

Total	$	10,827	$	5,870	$	3,053	$	1,048	$	856

We are required to pay The Cleveland Clinic up to $5.0 million in payments upon the achievement of certain milestones set forth in the ReVasc Agreement. We paid a $0.5 million milestone payment in March 2008 and an additional $2.0 million milestone payment in January 2010. We have accrued an additional $1.5 million as of June 30, 2010 for milestone payments that will become due on October 26, 2010, regardless of whether the related milestones are achieved.

We are required to pay Vascular FX, LLC (“Vascular FX”) a royalty equal to 25% of the greater of (i) the applicable aggregate mandatory minimum sales of $1.0 million or (ii) the actual net sales of our Courier ^® Enzo ^® deflectable catheter product, both on an annual basis. The royalty period is six years beginning in November 2007. As of June 30, 2010, we had accrued royalty payments of approximately $153,000 to Vascular FX.

We are required to pay Biotronik royalties equal to 15% of the actual net sales of our PHAROS stent on a quarterly basis.

We are required to pay FSS up to $2.0 million in payments upon the achievement of certain milestones set forth in the FSS Agreement and royalties on potential future product sales. The additional milestone payments are contingent on certain events. We did not accrue any milestone payment to FSS as of June 30, 2010 since the dates upon which these milestones will be achieved are not certain at this time.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exchange Risks. We are exposed to risks from fluctuations in currency exchange rates due to intercompany loans made to Micrus Endovascular SA (“Micrus SA”), our Swiss subsidiary, in 2001 in connection with its incorporation. These loans are denominated in Swiss francs and will fluctuate in value against the U.S. dollar, causing us to recognize foreign exchange gains and losses. The functional currency of our Swiss subsidiary is the Swiss franc. The functional currency of Micrus Endovascular UK Limited (“Micrus UK”), our UK subsidiary, is the British pound. In Europe, our revenues are denominated in the Swiss franc, euro, British pound and other currencies. Accordingly, we are exposed to market risk related to changes between these currencies. For example, if the Swiss franc appreciates against the currencies in which our receivables are denominated, we will recognize foreign currency losses. For the preparation of our consolidated financial statements, the financial results of our subsidiaries are translated into U.S. dollars based on average exchange rates during the applicable period. A hypothetical 10% decline in the value of the Swiss franc versus the U.S. dollar would cause us to recognize a loss of $187,000 related to our loan with Micrus SA and a $22,000 increase in our comprehensive loss from our investment in Micrus SA as of June 30, 2010.

A hypothetical 10% decline in the value of the British pound versus the U.S. dollar would cause us to recognize a $0.5 million increase in our comprehensive loss from our investment in Micrus UK as of June 30, 2010. A hypothetical 10% decline in the value of the euro versus the Swiss franc would cause us to recognize a loss of $367,000 based on our foreign denominated receivables as of June 30, 2010.

In the first quarter of fiscal 2011, approximately 33% of our revenues were denominated in currencies other than the U.S. dollar. In future periods, we believe that a greater portion of our revenues could be denominated in currencies other than the U.S. dollar, thereby increasing our exposure to exchange rate gains and losses on non-U.S. currency transactions.

In the first quarter of fiscal 2011, we continued to enter into foreign currency forward contracts to buy U.S. dollars to minimize the impact of the currency movements on intercompany payables for our Micrus SA subsidiary. The use of foreign currency forward contracts allows us to offset exposure to rate fluctuations because the gains or losses incurred on the derivative instruments will offset, in whole or in part, losses or gains on the underlying foreign currency exposure. We use derivative instruments only for risk management purposes and do not use them for speculation or for trading.

As of June 30, 2010, we had outstanding foreign currency forward contracts to sell 1.2 million euros for approximately $1.5 million, expiring through September 24, 2010. If we were to settle our euro-based contracts at the reporting date, an immaterial unrealized income or expense would need to be recognized. A sensitivity analysis of changes in the fair value of our euro forward contracts at June 30, 2010 indicates that, if the U.S. dollar uniformly strengthened/weakened by 10% against the euro, the fair value of these contracts would decrease/increase by $147,000, respectively.

Interest Rate Risk. Our cash is invested in bank deposits and money market funds denominated in U.S. dollars. The carrying value of these cash equivalents approximates fair market value. Our investments in marketable securities are subject to interest rate risk, which is the risk that our financial condition and results of operations could be adversely affected due to movements in interest rates.

At June 30, 2010, our cash and cash equivalent balance was $34.7 million. Based on our annualized average interest rate, a 10% decrease in the interest rate on such balances would result in a reduction in interest income of approximately $6,000 on an annual basis.

As of June 30, 2010, we do not invest in or trade market risk sensitive instrument or have any debt subject to interest rate fluctuations.

Item 4. Controls and Procedures

(1) Disclosure Controls and Procedures

With the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), management has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our CEO and CFO have concluded that, as of the end of such period, our disclosure controls and procedures are effective.

(2) Changes in Internal Controls Over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II — OTHER INFORMATION

Item 1. Legal Proceedings.

Merger Agreement

On July 13, 2010, a plaintiff filed a putative class action entitled Robert Sauser v. Micrus Endovascular Corporation et al. , Case No. 110-CV-176769, in the Superior Court of the State of California, Santa Clara County. The defendants are the Company and the members of our board of directors. The complaint alleges that the individual defendants breached their fiduciary duties to our stockholders in connection with the merger agreement and the transactions contemplated thereby. Specifically, the complaint alleges, among other things, that the proposed transaction arises out of a flawed process and that the individual defendants engaged in self-dealing in relation to the merger agreement, which resulted in a failure to maximize shareholder value. The suit further alleges that we aided and abetted the individual defendants’ breaches of fiduciary duties and that the consideration offered in the merger does not fairly reflect our true value. The plaintiff seeks, among other things, an order enjoining the consummation of the merger, attorneys’ fees and costs.

On July 19, 2010, a plaintiff filed a putative class action entitled Claire Houston v. John Kilcoyne et al ., Case No. 110-CV-177667, in the Superior Court of the State of California, Santa Clara County. The defendants are the Company and the members of our board of directors (together with the Company, the “Micrus Defendants”), Johnson & Johnson and Cope Acquisition Corp. (a wholly owned subsidiary of Johnson & Johnson, and together with Johnson & Johnson, the “J&J Defendants”). This action alleges that the individual defendants breached their fiduciary duties to our stockholders in connection with the merger. Specifically, the complaint alleges, among other things, that the proposed transaction arises out of a flawed process, that the individual defendants failed to maximize shareholder value and that the consideration offered in the merger is inadequate and does not fairly reflect our true value. The plaintiff also alleges that the individual defendants agreed to no-solicitation and termination provisions in the merger agreement in violation of our board’s fiduciary duties. The suit further alleges that we and the J&J Defendants aided and abetted the individual defendants’ breaches of fiduciary duties. The plaintiff seeks, among other things, an order enjoining the Micrus Defendants and the J&J Defendants from consummating the merger, damages in the event the merger is consummated prior to the court’s entry of a final judgment, and attorneys’ fees and costs.

We believe that the lawsuits are wholly without merit and intend to defend vigorously against them. However, because the litigation is in the early stages, we cannot predict the outcome at this time, and we cannot provide assurance that the actions will not delay the consummation of the merger or result in substantial costs; even a meritless lawsuit may potentially delay consummation of the merger.

Other General

We are participating in other litigation and responding to other claims arising in the ordinary course of business. We intend to defend ourselves vigorously in these matters. Our management believes that it is unlikely that the outcome of these matters will have a material adverse effect on our financial statements, although there can be no assurance in this regard.

Item 1A. Risk Factors.

In addition to the other information set forth in this report, you should consider the risk factors discussed in Part I “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended March 31, 2010, which could materially affect our business, financial condition or future results. The risk factors in our Form 10-K have not materially changed. The risk factors set forth below and those described in our Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial conditions and/or operating results.

Failure to complete, or delay in completing, the merger with Johnson & Johnson could materially and adversely affect our results of operations and our stock price.

On July 11, 2010, we entered into a definitive merger agreement with Johnson & Johnson and Cope Acquisition Corp. (a wholly-owned subsidiary of Johnson & Johnson). Consummation of the merger is subject to customary closing conditions such as the adoption of the merger agreement by our stockholders and various regulatory approvals and clearances. We cannot assure you that the necessary approvals will be obtained, or that regulatory approvals will not subject us to additional regulatory obligations, or that we will be able to consummate the merger as currently contemplated under the merger agreement. Risks related to the proposed merger include the following:

•

we will remain liable for significant transaction costs, including legal, accounting, financial advisory and other costs

			relating to the merger if it does not close;

	•		under specified circumstances, we may have to pay a termination fee to Johnson & Johnson in the amount of $13,250,000;

	•		the attention of our management and our employees may be diverted from day-to-day operations;

	•		the customer sales process may be disrupted by customer and salesperson uncertainty over when or if the merger will be consummated;

	•		our supply chain process may be disrupted by the uncertainty of our third party service providers over when or if the merger will be consummated; and

	•		our ability to attract new employees and retain existing employees may be difficult as a result of uncertainties associated with the merger.

The occurrence of any of these events individually or in combination could reduce our revenues, increase our expenses, and harm our stock price. In addition, our stock price rose upon announcement of our proposed merger with Johnson & Johnson and any failure to consummate the merger could result in a drop in our stock price.

We have been named as a defendant in two putative shareholder class action lawsuits, which could cause our business, financial condition, results of operations and cash flows to suffer.

We and certain of our officers and directors are named defendants in two putative class action lawsuits that allege breaches of fiduciary duty under state law, a description of which can be found in Item 1, Legal Proceedings , under Part II in this report for further information. Subject to certain limitations, we are obligated to indemnify our current and former directors, officers and employees in connection with such lawsuits. While we have director and officer insurance, amounts under the policy may not be sufficient to cover our indemnification obligations. Regardless of the outcome, these lawsuits, and any other litigation that may be brought against us or our directors and officers, could be time consuming, result in significant expense, and divert the attention and resources of our management and other key employees. An unfavorable outcome in any such litigation could delay or prohibit consummation of our merger with Cope Acquisition Corp, a wholly-owned subsidiary of Johnson & Johnson, or otherwise have a material adverse effect on our business, financial condition, results of operations and cash flows.

Current worldwide economic conditions may adversely affect our business, operating results and financial condition, as well as further decrease our stock price.

General worldwide economic conditions have experienced a downturn due to the effects of the subprime lending crisis, European sovereign debt crisis, general credit market crisis, collateral effects on the finance and banking industries, concerns about inflation, slower economic activity, decreased consumer confidence, reduced corporate profits and capital spending, adverse business conditions and liquidity concerns. Our business is not immune. Some of the procedures that use our products are elective and therefore can be deferred by patients. In light of the current economic conditions, patients who do not have insurance covering the total cost of elective procedures may choose to defer or forego them. In addition, in the U.S. and other countries where healthcare coverage is heavily dependent on employment status, increasing numbers of patients may have no or reduced healthcare coverage. Furthermore, government instability may cause certain governments to delay, withhold or reduce reimbursement for our products which could adversely affect our revenues.

The worldwide economic downturn also may have other adverse implications for our business. For example, our customers’ and distributors’ ability to borrow money from their existing lenders, or to obtain credit from other sources to purchase our products may be impaired. Though we maintain allowances for doubtful accounts that are sufficient to cover estimated losses which may occur when customers cannot make their required payments and though such estimated losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same loss rates that we have in the past, especially given the current turmoil in the worldwide economy. A significant change in the liquidity or financial condition of our customers or those governments that reimburse our customers for our products could cause unfavorable trends in our receivable collections and additional allowances may be required, thus adversely affecting our operating results. In addition, the worldwide economic crisis may adversely impact our suppliers’ ability to provide us with materials and components, which could adversely affect our business and operating results.

Our future success is dependent on the continued growth in embolic coiling procedures and our ability to convince a concentrated customer base of neurointerventionalists to use our products as an alternative to other available products.

Our future success and revenue growth are significantly dependent upon an increase in the use of embolic coiling as a procedure to treat cerebral aneurysms. If the number of embolic coiling procedures does not increase or if a new procedure that does not employ our products becomes a more acceptable alternative among neurointerventionalists, our business would be seriously harmed.

The number of interventional neuroradiologists and neurosurgeons trained to conduct embolic coiling procedures is relatively small, both in the United States and abroad. There are currently approximately 300-400 neurointerventionalists in the United States who perform embolic coiling procedures. We believe that less than one-third of these physicians perform a substantial majority of the total number of embolic coiling procedures per year. For the first quarter of fiscal 2011, a substantial portion of our product sales in the United States were to an estimated 111 hospitals. The growth in the number of interventional neuroradiologists and neurosurgeons in the United States is constrained by the lengthy training programs required to educate these physicians. Accordingly, our revenue growth will be primarily dependent on our ability to increase sales of our products to our existing customers and to increase sales of products to trained neurointerventionalists that currently use products offered by our competitors. We believe that neurointerventionalists who do not currently use our products will not widely adopt our products unless they determine, based on experience, clinical data and published peer reviewed journal articles, that our products provide benefits or an attractive alternative to the clipping of aneurysms or the use of competitors’ products. We believe that neurointerventionalists base their decision to use an alternative procedure or product on the following criteria, among others:

	•		extent of clinical and multi-center trial evidence supporting patient benefits;

	•		their level of experience with the alternative product;

	•		perceived liability risks generally associated with the use of new products and procedures;

	•		availability of reimbursement within healthcare payment systems; and

	•		costs associated with the purchase of new products and equipment.

In addition, we believe that recommendations and support of our products by influential physicians are essential for market acceptance and adoption. That support may be influenced by the results of clinical studies of our products or those of our competitors. If we do not receive continued support from such influential physicians, neurointerventionalists and hospitals may not use our products. In such circumstances, we may not achieve expected revenue levels and our business will suffer.

The results of clinical trials could negatively impact our business.

We believe that neurointerventionalists base their decision to use an alternative procedure or product in part on the result of clinical evidence supporting patient benefits. Consequently, results of clinical research and trials on our existing products and new products in development, as well as those of our competitors, will influence demand for our products. To the extent that clinical trials report negative news about our products or positive news about our competitors products we may lose sales.

For example, we recently announced some interim data from an ongoing clinical study comparing results of coiling with our Cerecyte ^® microcoils against Micrus bare platinum microcoils. Dr. Molyneux, the principal investigator of the trial, has presented interim data demonstrating that, based on the core lab assessment of angiographic success, the Cerecyte ^® and Micrus bare platinum groups are superior to those of the ISAT study and that the safety outcomes for Micrus Cerecyte ^® and Micrus bare platinum coils are also superior to the coiling results reported in the ISAT study, as well as all other published randomized data. In addition, Dr. Molyneux has advised us that due to the strong performance of Micrus bare platinum coils, it is unlikely that the data will demonstrate a statistically significant difference in angiographic outcome between the two groups. Our Cerecyte ^® coils are more expensive than our bare platinum coils, although we believe that our bare platinum coils are priced lower than many of our large competitors. It is unclear whether the impact of this study will result in a decline in our sales of Cerecyte ^® coils or an increase in our overall sales as a result of the superior performance of our coils generally. If we experience a decline in sales of our Cerecyte ^® coils which is not offset by increases in revenue generated from our bare platinum coils our operating results will be harmed.

Our industry is experiencing increased scrutiny by governmental authorities, which has led to increased compliance costs and potentially more rigorous regulation.

The medical device industry is subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities. These authorities have been increasing their scrutiny of certain activities of medical device companies,

including their conduct of clinical trials, their handling of conflicts of interests and financial arrangements with health care providers (“HCPs”) and their product promotional practices. We are about to commence our first human clinical trials which will require us to comply with patient safety and enrollment regulations. We anticipate that government authorities will continue to scrutinize our industry closely and we may be subject to more rigorous regulation by governmental authorities in the future. This increased government scrutiny has led us to incur increased costs on compliance, human resources costs and the diversion of management and employee focus and we anticipate that such costs will continue to increase. We have adopted a number of compliance procedures and provide regular compliance training to our employees who interact with HCPs but we cannot assure that our activities will not be subject to inquiry or greater action or oversight by governmental authorities or that we will be able to comply with any new regulations. Any failure by us to adopt appropriate compliance procedures and ensure that our employees and agents comply with applicable laws and regulations could result in substantial penalties and/or restrictions in our business activities and the sales of our products.

We have been profitable in the last fiscal year, but there is no assurance that we will continue to be profitable in the future.

We were incorporated in the State of Delaware in 1996, and began commercial sales of our microcoil products in 2000. In fiscal 2010 we reported our first profitable fiscal year with $11.5 million of net income. Net income for the first quarter of fiscal 2011 was $3.1 million. At June 30, 2010, we reduced our accumulated deficit to approximately $67.8 million. There is no assurance that we will continue to be profitable in the future. We expect our operating expenses to increase as we, among other things:

	•		grow our internal and third-party sales and marketing forces to expand the sales of our products in the United States and internationally;

	•		increase our research and development efforts to improve upon our existing products and develop new products;

	•		perform clinical research and trials on our existing products and product candidates;

	•		expand our regulatory resources in order to obtain governmental approvals for our existing product enhancements and new products;

	•		acquire and/or license new technologies; and

	•		expand manufacturing.

As a result of these activities, we may not be able to sustain or increase profitability on an ongoing basis.

Our quarterly operating and financial results and our gross margins are likely to fluctuate significantly in future periods.

Our quarterly operating and financial results are difficult to predict and may fluctuate significantly from period to period. The level of our revenues, gross margins and results of operations at any given time will be based primarily on the following factors:

	•		neurointerventionalist and patient acceptance of our products;

	•		changes in the number of embolic coiling procedures performed to treat cerebral aneurysms;

	•		the seasonality of our product sales;

	•		the mix of our products sold;

	•		stocking patterns for distributors;

	•		the development of new procedures to prevent and treat hemorrhagic and ischemic stroke;

	•		results of clinical research and trials on our existing products and products in development or those of our competitors;

	•		demand for, and pricing of, our products;

	•		levels of third-party reimbursement for our products;

	•		timing of new product offerings, acquisitions, licenses or other significant events involving us or our competitors;

	•		increases in the costs of manufacturing and selling our products;

	•		the amount and timing of our operating expenses;

	•		potential litigation expenses;

	•		fluctuations in foreign currency exchange rates;

	•		regulatory approvals and legislative changes affecting the products we may offer or those of our competitors;

	•		the effect of competing technological and market developments;

	•		changes in our ability to obtain and maintain FDA and other domestic and foreign regulatory approval or clearance for our products;

	•		inventory adjustments we may have to make in any quarter;

	•		interruption in the manufacturing or distribution of our products;

	•		our ability to maintain and expand our sales force and operational personnel;

	•		developments related to our announced definitive agreement with J&J;

	•		the ability of our suppliers to timely provide us with an adequate supply of materials and components; and

	•		amount and timing of capital expenditures and other costs relating to any potential expansion of our operations.

Many of the products we may seek to develop and introduce in the future will require FDA approval or clearance and will be required to meet similar regulatory requirements in other countries where we seek to market our products, without which we cannot begin to commercialize them. Forecasting the timing of sales of our products is difficult due to the delay inherent in seeking FDA and other clearance or approval, or the failure to obtain such clearance or approval. In addition, we will be increasing our operating expenses as we build our commercial capabilities. Accordingly, we may experience significant, unanticipated quarterly losses. Because of these factors, our operating results in one or more future quarters may fail to meet the expectations of securities analysts or investors, which could cause our stock price to decline significantly.

We may not be able to develop new products or product enhancements that will be accepted by the market.

Our success will depend in part on our ability to develop and introduce new products and enhancements to our existing products. We cannot assure that we will be able to successfully develop or market new products or that any of our future products will be accepted by the neurointerventionalists who use our products or the payors who reimburse for many of the procedures performed with our products. The success of any new product offering or enhancement to an existing product will depend on several factors, including:

	•		our ability to properly identify and anticipate neurointerventionalist and patient needs;

	•		our ability to develop new products or enhancements in a timely manner;

	•		our ability to leverage the results of clinical and multi-center trial evidence supporting patient benefits;

	•		our ability to obtain the necessary regulatory approvals for new products or product enhancements;

	•		our ability to provide adequate training to potential users of our products;

	•		our ability to receive adequate reimbursement for our procedures;

	•		results of clinical research and trials on our existing products and products in development and those of our competitors;

	•		demand for, and pricing of, our products;

	•		levels of third-party reimbursement for our products; and

	•		our ability to develop an effective marketing and distribution network.

If we do not develop new products or product enhancements in time to meet market demand or if there is insufficient demand for our products or enhancements, we may not achieve expected revenue levels and our business will suffer.

Our relationships with physicians and other consultants require us to comply with a number of United States and international regulations.

We are required to comply with a number of United States and international laws and regulations related to our financial relationships with physicians and other healthcare providers. In addition, we must comply with the Foreign Corrupt Practices Act (“FCPA”) which prohibits United States companies or their agents and employees from providing anything of value to a foreign official for the purposes of influencing him or her to help obtain or retain business, direct business to any person or corporate entity, or obtain any unfair advantage. While we have taken numerous steps to ensure compliance with these laws and regulations, they are subject to evolving interpretations, making it difficult to ensure compliance. If we are found to be in violation of any of these laws or regulations, we may face serious consequences, including civil and criminal penalties for us and our officers and directors, exclusion of our products from government-funded healthcare programs, termination of customer contracts, and reputational harm.

We operate in a highly competitive market segment, face competition from large, well-established medical device manufacturers with significant resources, and may not be able to increase penetration in our markets or otherwise compete effectively.

The market for medical devices for treatment of cerebral vascular diseases is intensely competitive, subject to rapid change and significantly affected by new product introductions and other market activities of industry participants. We compete primarily with the neurovascular division of Boston Scientific, the market leader, as well as Codman Neurovascular, ev3, a division of Covidien plc and MicroVention. At any time, other companies may develop alternative treatments, products or procedures for the treatment of cerebral aneurysms that compete directly or indirectly with our products. If alternative treatments prove to be superior to our microcoil or other products, continued use or adoption of our products could be negatively affected and our future revenues could suffer.

In addition, most of our current and potential competitors are either large publicly traded companies or divisions or subsidiaries of large publicly traded companies and enjoy several competitive advantages over us, including:

	•		greater financial and personnel resources;

	•		greater name recognition;

	•		established relationships with neurointerventionalists;

	•		established distribution networks;

	•		greater experience in obtaining and maintaining FDA, and other regulatory approvals for products and product enhancements, and greater experience in developing compliance programs for compliance with numerous federal, state, local and similar laws in non-United States jurisdictions;

	•		greater resources for product research and development;

	•		greater experience in, and resources for, launching, marketing, distributing and selling products; and

	•		broader product lines.

Except for our agreements with our distributors, we have no material long-term purchase agreements with our customers, who

may at any time switch to the use of our competitors’ products.

For these reasons, we may not be able to compete successfully against our current or potential future competitors and sales of our products and our revenues may decline.

Our sales in international markets subject us to foreign currency exchange and other risks and costs that could harm our business.

A substantial portion of our revenues are derived from outside the United States. For the fiscal years ended March 31, 2010, 2009 and 2008, revenues from customers outside the United States represented approximately 51%, 50% and 51%, respectively, of our revenues. For the first quarter of fiscal 2011, revenues from customers outside the United States represented approximately 56% of our revenues, We anticipate that revenues from international customers will continue to represent a substantial portion of our revenues as we continue to expand in new international markets including China and Japan. Because we generate revenues in foreign currencies, we are subject to the effects of exchange rate fluctuations. For the first quarter of fiscal 2011, approximately 33% of our revenues were denominated in currencies other than the U.S. dollar. The functional currency of our Swiss subsidiary is the Swiss franc. The functional currency of our UK subsidiary is the British pound.

In Europe, our revenues are denominated in Swiss francs, euros, British pounds and U.S. dollars. Accordingly, we are exposed to market risk related to changes between those currencies in which we conduct business. For the preparation of our consolidated financial statements, the financial results of our Swiss and UK subsidiaries are translated into U.S. dollars based on average exchange rates during the applicable period. If the U.S. dollar appreciates against the Swiss franc and British pound, the revenues we recognize from sales by our European subsidiaries will be adversely impacted.

Historically, we have also been exposed to risks from fluctuations in currency exchange rates due to intercompany loans made to Micrus Endovascular SA (“Micrus SA”), our Swiss subsidiary, in 2001 in connection with its incorporation. These loans are denominated in Swiss francs and will fluctuate in value against the U.S. dollar, causing us to recognize foreign exchange gains and losses. Foreign exchange gains or losses as a result of exchange rate fluctuations in any given period could harm our operating results and negatively impact our revenues. Additionally, if the effective price of our products were to increase as a result of fluctuations in foreign currency exchange rates, demand for our products could decline and adversely affect our results of operations and financial condition.

We are subject to various additional risks as a consequence of doing business internationally which could harm our business, including the following:

	•		unexpected delays or changes in regulatory requirements;

	•		local economic and political instability or other potentially adverse conditions;

	•		lack of experience in certain geographical markets;

	•		increased difficulty in collecting accounts receivables in certain foreign countries;

	•		delays and expenses associated with tariffs and other trade barriers;

	•		difficulties and costs associated with attracting and maintaining third party distributors;

	•		compliance with foreign laws and regulations; and

	•		adverse tax consequences or overlapping tax structures.

If we fail to increase our direct sales force in a timely manner, our business could suffer.

We have a limited domestic and international direct sales force. We also have a distribution network for sales in the major markets in Europe, Latin America, Asia Pacific and the Middle East. As we launch new products and increase our marketing efforts with respect to existing products, we will need to expand the number of our direct sales personnel on a worldwide basis. The establishment and development of a more extensive sales force will be expensive and time consuming. There is significant competition for sales personnel experienced in interventional medical device sales. If we are unable to attract, motivate and retain qualified sales personnel and thereby increase our sales force, we may not be able to increase our revenues.

If we fail to properly manage our anticipated growth, our business could suffer.

We have experienced, and may continue to experience, periods of rapid growth and expansion, which have placed, and will likely continue to place, a significant strain on our limited personnel and other resources. In particular, the expansion of our fabrication facility and the continuing expansion of our direct sales force will require significant management, technical and administrative resources. Any failure by us to manage our growth effectively could have an adverse effect on our ability to achieve our development and commercialization goals.

To achieve our revenue goals, we must successfully increase production in our fabrication facility as required by customer demand. We may in the future experience difficulties in increasing production, including problems with production yields and quality control and assurance and in satisfying and maintaining compliance with regulatory requirements. These problems could result in delays in product availability and increases in expenses. Any such delay or increased expense could adversely affect our ability to generate revenues.

Future growth will also impose significant added responsibilities on management, including the need to identify, recruit, train and integrate additional employees. In addition, rapid and significant growth will place a strain on our administrative and operational infrastructure. In order to manage our operations and growth we will need to continue to improve our operational, financial and management controls, reporting systems and procedures. If we are unable to manage our growth effectively, it may be difficult for us to execute our business strategy and our operating results and business could suffer.

We are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act and are exposed to future risks of non- compliance.

Pursuant to Section 404 of the Sarbanes-Oxley Act (“Section 404”), we are required to furnish a report by our management on our internal control over financial reporting. The report contains, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. The report must also contain a statement that our independent registered public accounting firm has issued an attestation report on the effectiveness of internal control over financial reporting.

We completed our assessment of our internal control over financial reporting as required by Section 404 for the fiscal year ended March 31, 2010. Our assessment, testing and evaluation resulted in our conclusion that as of March 31, 2010, our internal control over financial reporting was effective. Our independent registered accounting firm has also expressed the opinion that our internal controls over financial reporting were effective during that period. However, our controls may not prove to be adequate for future periods, and we cannot predict the outcome of our testing in future periods. If our internal controls are deemed to be ineffective in future periods, our financial results and the market price of our stock could be adversely affected. In any event, we will incur additional expenses and commitment of management’s time in connection with further evaluations, which may adversely affect our future operating results and financial condition.

Our future capital needs are uncertain and we may need to raise additional funds in the future, and such funds may not be available on acceptable terms or at all.

We believe that our current cash position, together with the cash to be generated from expected product sales and the funds available under our credit facility (subject to compliance with conditions and covenants of the credit agreement) will be sufficient to meet our projected operating requirements for at least the next 12 months. However, after such period we may be required to seek additional funds from public and private stock or debt offerings, borrowings under lease lines or other sources. Our capital requirements will depend on many factors, including:

	•		the revenues generated by sales of our products;

	•		the costs associated with expanding our sales and marketing efforts;

	•		the expenses we incur in manufacturing and selling our products;

	•		the costs of developing and acquiring new products or technologies;

	•		the cost of obtaining and maintaining FDA and other domestic and foreign approval or clearance of our products and products in development;

	•		the expenses we incur related to compliance with the United States FCPA and laws and regulations in non-United States jurisdictions;

	•		costs associated with compliance with the Sarbanes-Oxley Act and rules and regulations affecting public companies promulgated by the SEC and The NASDAQ Stock Market;

	•		the costs associated with our facilities expansion, if any; and

	•		the costs associated with increased capital expenditures.

As a result of these factors, we may need to raise additional funds, and such funds may not be available on favorable terms, or at all. Furthermore, if we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish valuable rights to our potential products or proprietary technologies, or grant licenses on terms that are not favorable to us. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products, execute our business plan, take advantage of future opportunities, or respond to competitive pressures or unanticipated customer requirements. In these events, our ability to achieve our development and commercialization goals would be adversely affected.

If we choose to acquire new and complementary businesses, products or technologies instead of developing them ourselves, we may be unable to complete these acquisitions or to successfully integrate them in a cost-effective and non-disruptive manner.

Our success depends on our ability to continually enhance and broaden our product offerings in response to changing customer demands, competitive pressures and technologies. We may in the future pursue the acquisition of additional complementary businesses, products or technologies instead of developing them ourselves. We do not know if we will be able to successfully complete any such acquisitions, or whether we will be able to successfully integrate any acquired business, product or technology or retain any key employees. Integrating any business, product or technology we acquire could be expensive and time consuming, disrupt our ongoing business, distract our management and expose us to unanticipated liabilities. If we are unable to integrate any acquired businesses, products or technologies effectively, our business will suffer. In addition, any amortization or charges resulting from the costs of acquisitions could harm our business and operating results.

Our operations are subject to environmental, health and safety, and other laws and regulations, with which compliance is costly and which expose us to penalties for non-compliance.

Our business, properties and products are subject to foreign, federal, state and local laws and regulations relating to the protection of the environment, natural resources and worker health and safety and the use, management, storage, and disposal of hazardous substances, wastes, and other regulated materials. Because we operate real property, various environmental laws may also impose liability on us for the costs of cleaning up and responding to hazardous substances that may have been released on our property, including releases unknown to us. These environmental laws and regulations also could require us to pay for environmental remediation and response costs at third-party locations where we disposed of or recycled hazardous substances. The costs of complying with these various environmental requirements, as they now exist or may be altered in the future, could adversely affect our financial condition and operating results.

We are dependent on a single source supplier for components and materials used in our devices, and the loss of any of these suppliers, or their inability to supply us with an adequate supply of materials, could harm our business.

We rely on third-party suppliers for components and materials used in our products and rely on a single source for many of the microcoil and delivery system components, including tubing and connectors. Our dependence on third-party suppliers involves several risks, including limited control over pricing, availability, quality, delivery schedules and supplier compliance with regulatory requirements. Any delays in delivery of such components or provision of such services or shortages of such components could cause delays in the shipment of our products, which could significantly harm our business. We generally acquire our single source components pursuant to purchase orders placed in the ordinary course of business, and we have no guaranteed supply arrangements with any of our single source suppliers. Because of our reliance on these vendors, we may also be subject to increases in component costs. These increases could significantly harm our business. For us to be successful, our third-party suppliers must also be able to provide us with the materials and components of our products in substantial quantities, in compliance with regulatory requirements, in accordance with agreed upon specifications, at acceptable cost and on a timely basis. Our anticipated growth may strain the ability of suppliers to deliver an increasingly large supply of materials and components.

If we are unable to obtain sufficient quantities of high quality components and materials to meet customer demand on a timely basis, we could lose customers, our reputation may be harmed and our business could suffer. If any one or more of our third-party suppliers cease to provide us with sufficient quantities of our materials or components in a timely manner or on terms acceptable to us, we would have to seek alternative sources of supply. We could incur delays while we locate and engage alternative qualified suppliers and we might be unable to engage alternative suppliers on favorable terms. Any such disruption or increased expenses could harm our commercialization efforts and adversely affect our ability to generate revenues.

We rely on independent contract manufacturers for the manufacture and assembly of certain of our products and components. Reliance on independent contract manufacturers involves several risks, including the potential inadequacy of capacity, the unavailability of or interruptions in access to certain process technologies and reduced control over product quality, compliance with regulatory requirements, delivery schedules, manufacturing yields and costs. Such manufacturers have possession of and at times title to molds for certain manufactured components of our products. Shortages of raw materials, production capacity constraints or delays by our contract manufacturers could negatively affect our ability to meet our production obligations and result in increased prices for affected parts. Any such reduction, constraint or delay may result in delays in shipments of our products or increases in the prices of components, either of which could have a material adverse effect on our business, operating results and financial condition. We have no supply agreements with our current contract manufacturers and utilize purchase orders which are subject to supplier acceptance. The unanticipated loss of any of our contract manufacturers could cause delays in our ability to deliver product while we identify and qualify a replacement manufacturer. If our current or future independent contract manufacturers are unable to meet our requirements for manufactured components, our business could suffer.

Our operations are currently conducted at several locations that may be at risk from earthquakes or other natural disasters.

We currently conduct our manufacturing, development and management activities in San Jose, California, near known earthquake fault zones, and in Miramar, Florida, where there is a risk of hurricanes. We have taken precautions to safeguard our facilities, including insurance, health and safety protocols, and off-site storage of computer data. However, any future natural disaster, such as an earthquake or hurricane, could cause substantial delays in our operations, damage or destroy our equipment or inventory, and cause us to incur additional expenses. A disaster could seriously harm our business and results of operations.

If we are unable to effectively manage our inventory held on consignment by our intended customers, we will not achieve our expected results.

A significant portion of our inventory is held on consignment by hospitals that purchase the inventory as they use it. In these consignment locations, we do not have physical possession of the consigned inventory. We therefore have to rely on information from our customers as well as periodic inspections by our sales personnel to determine when our products have been used. We have in the past experienced problems managing appropriate consigned inventory levels and as a result we recorded an impairment of inventory for anticipated obsolescence in fiscal 2004 and an impairment of excess inventory in both fiscal 2004 and 2005. If we are not able to effectively manage appropriate consigned inventory levels, we may suffer inventory losses that will reduce our gross profit levels. There can be no assurance that any efforts to strengthen our monitoring and management of consigned inventory will be adequate to meaningfully reduce the risk of inventory loss.

We are dependent on our senior management team, key clinical advisors and scientific personnel, and the loss of any of them could harm our business.

Our continued success depends in part upon the continued availability and contributions of our senior management team and the continued participation of our key clinical advisors. We have entered into agreements with certain members of our senior management team, but none of these agreements guarantee the services of the individual for a specified period of time. We also rely on the skills and talents of our scientific personnel because of the complexity of our products. The loss of members of our senior management, key clinical advisors or scientific personnel, or our inability to attract or retain other qualified personnel or advisors could have a material adverse effect on our results of operations and financial condition.

We face certain litigation risks that could harm our business.

At any given time we are likely to have one or more lawsuits filed against us asserting various claims. We have been named as defendant in two putative shareholder class action lawsuits, described above. The results of complex legal proceedings are difficult to predict. Moreover, many of the complaints filed against us do not specify the amount of damages that plaintiffs seek, and we therefore are unable to estimate the possible range of damages that might be incurred should these lawsuits be resolved against us. An unfavorable outcome or settlement of one or more of these lawsuits could have a material adverse effect on our financial condition, liquidity and results of operations. Even if these lawsuits are not resolved against us, the uncertainty and

expense associated with unresolved lawsuits could seriously harm our business, financial condition and reputation. Litigation is costly, time-consuming and disruptive to normal business operations. The costs of defending lawsuits have been significant, will continue to be costly and may not be covered by our insurance policies. The defense of these lawsuits could also result in continued diversion of our management’s time and attention away from business operations, which could harm our business.

The medical device industry is characterized by patent litigation, which could be costly, result in the diversion of management’s time and efforts and require us to pay damages.

The medical device industry is characterized by extensive litigation and administrative proceedings over patent and other intellectual property rights. Accordingly, we may in the future be subject to further litigation and administrative proceedings over such rights with other companies in our industry. Our competitors may assert that at least one of our products, its components, or the methods we employ in the use or manufacture of our products are covered by and infringe the competitors’ United States or foreign patents held by them. In addition, should our patents or applications have claims that encompass the same scope as claims pending or issued to a third party competitor, that third party may claim that its claims have priority over ours because they invented the claimed subject matter first. Because patent applications generally take many years to issue, there may be third party applications presently pending of which we are unaware, that may in the future result in issued patents that at least one of our products, its components, or the methods we employ in the use or manufacture of our product(s) may infringe. There could also be issued patents that one or more components of our products may inadvertently be infringing, of which we are unaware. As the number of participants in the market for cerebral vascular treatments and the number of issued patents in this technology area grows, the possibility of being charged with patent infringement increases.

Any infringement claims against us may cause us to incur substantial costs, could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. If the relevant patent claims are upheld as valid and enforceable and we are found to infringe, we could be required to pay substantial damages and/or royalties and could be prevented from selling our products unless we could obtain a license or were able to redesign our products to avoid infringement. Any such license may not be available on reasonable terms, if at all. If we fail to obtain any required licenses or make any necessary changes to our products or technologies, we may be unable to commercialize one or more of our products or practice the methods we employ in the use or manufacture of our products.

Our ability to protect our intellectual property and proprietary technology through patents and other means is uncertain.

Our success depends significantly on our ability to procure proprietary rights to the technologies used in our products. We rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, and nondisclosure, confidentiality and other contractual restrictions to protect our proprietary technology. However, these legal means afford only limited protection and may not be sufficient to adequately protect our intellectual property or permit us to gain or keep any competitive advantage. For example, any of our pending United States or foreign patent applications may ultimately not issue as a patent or, alternatively, may issue with claims that are of little or no value to us. In addition, once issued, a valuable patent may be challenged successfully by third parties and invalidated. In addition, our patent protection for material aspects of our products and methods is presently being pursued with applications that have been filed but not issued, such that these material aspects are not presently protected by patents. Competitors may further be able to get around having to license our technology in order to avoid infringement by designing around our issued and published patent claims, thereby staying clear of our proprietary rights. Similarly, competitors may develop products and methods that are equivalent or superior to ours. Our confidentiality agreements and intellectual property assignment agreements with our employees, consultants and advisors may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements. Furthermore, the laws of some foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States. Both the process of procuring patent rights and the process of managing patent disputes can be time consuming and expensive.

In the event a competitor infringes upon our patent or other intellectual property rights, enforcing those rights may be difficult and time consuming. Even if successful, litigation to enforce our intellectual property rights or to defend our patents against challenge could be prolonged, costly and could divert our management’s attention. We may not have sufficient resources to enforce our intellectual property rights or to defend our patents against a challenge.

If we fail to obtain, or experience significant delays in obtaining, FDA clearances or approvals for our future products or product enhancements, or to comply with similar regulatory requirements in other countries where we market our products, our ability to commercially distribute and market our products could suffer.

Our medical devices are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities. Our failure to comply with such regulations could lead to the imposition of injunctions, suspensions or

loss of regulatory clearances or approvals, product recalls, termination of distribution or product seizures or the need to invest substantial resources to comply with various existing or new requirements. In the more egregious cases, criminal sanctions, civil penalties, disgorgement of profits or closure of our manufacturing facilities are possible. The process of obtaining regulatory clearances or approvals to market a medical device, particularly from the FDA, can be costly and time consuming, and there can be no assurance that such clearances or approvals will be granted on a timely basis, if at all. In particular, the FDA permits commercial distribution of most new medical devices only after the device has received 510(k) clearance or is the subject of an approved pre-market approval application, or PMA. The FDA will clear the marketing of a medical device through the 510(k) process if it is demonstrated that the new product has the same intended use, is substantially equivalent to another legally marketed device, including a 510(k)-cleared product, and otherwise meets the FDA’s requirements. The PMA approval process is more costly, lengthy and uncertain than the 510(k) clearance process and requires the development and submission of clinical studies supporting the safety and effectiveness of the device. Product modifications may also require the submission of a new 510(k) clearance, or the approval of a PMA before the modified product can be marketed. Changes in labeling and manufacturing site for a PMA approved device may require the submission and approval of a PMA supplement. Any products we develop that require regulatory clearance or approval may be delayed, if approved at all. In addition, we believe that some of our new products will require an approved PMA before we can commercially distribute the device and we cannot assure that any new products or any product enhancements we develop will be subject to the shorter 510(k) clearance process instead of the more lengthy PMA requirements. Additionally, certain of our products under development may involve both device and drug or biologic regulation and we will need to comply with drug and biologic regulations in addition to medical device requirements.

Accordingly, we anticipate that the regulatory review and approval process for some of our future products or product enhancements may take significantly longer than anticipated or what we have experienced in the past. We will also be required to pay a medical device user fee and may also be required to pay a drug or biologic user fee. There is no assurance that the FDA will not require that a certain new product or product enhancement go through the lengthy and expensive PMA approval process.

We have no experience in obtaining PMA approval. We also have no experience in obtaining drug or biologic approval, and will need to rely on third party assistance in navigating the regulatory approval pathway for future combination products.

Further, pursuant to FDA regulations, we can only market our products for cleared or approved uses. Certain of our products may be used by physicians for indications other than those cleared or approved by the FDA, but we cannot promote the products for such off-label uses.

Modifications to our marketed products may require new 510(k) clearances or pre-market approvals, or may require us to cease marketing or recall the modified products until clearances are obtained.

Any modification to a 510(k)-cleared device that could significantly affect its safety or effectiveness, or that would constitute a change in its intended use, requires a new 510(k) clearance or, possibly, PMA approval. The FDA requires every manufacturer to make this determination in the first instance, but the FDA may review a manufacturer’s decision. The FDA may not agree with any of our past or future decisions regarding whether new clearances or approvals are necessary. If the FDA requires us to seek 510(k) clearance or PMA approval for any modification to a previously cleared product, we may be required to cease marketing and/or to recall the modified product until we obtain clearance or approval, and we may be subject to significant regulatory fines or penalties. Further, our products could be subject to recall if the FDA determines that our products are not safe for any reason including but not limited to new safety data from use of the product, or manufacturing defects. Any recall or FDA requirement that we seek additional approvals or clearances could result in delays, fines, costs associated with modification of a product, loss of revenue and potential operating restrictions imposed by the FDA.

If we or our suppliers fail to comply with the FDA’s quality system regulations, the manufacture of our products could be delayed.

We and our suppliers are required to comply with the FDA’s quality system regulations, which cover the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, storage and shipping of our products. The FDA enforces these quality system regulations through unannounced inspections. If we or one of our suppliers fail a quality system regulations inspection or if any corrective action plan is not sufficient, or is very expensive or time consuming to implement, the manufacture of our products could be delayed until satisfactory corrections are made, or in the event we are unable to correct the problems we may not be able to continue manufacturing and distributing the particular device or devices. Such a delay could potentially disrupt our business, harm our reputation and adversely affect our sales and revenues.

If hospitals are unable to obtain sufficient reimbursement for procedures performed with our products, it is unlikely that our products will be widely used.

Successful sales of our products will depend on the availability of adequate reimbursement from third-party payors. Healthcare institutions that purchase medical devices for treatment of their patients generally rely on third-party payors to cover the use of the product for the particular procedure and reimburse all or part of the costs and fees associated with the procedures performed with these devices. Currently, the costs of our products distributed domestically are being reimbursed by third party payors. There is no guarantee that coverage and adequate reimbursement will be available in the future for our existing and/or new products. Both public and private insurance reimbursement plans are central to new product acceptance. Hospitals are unlikely to use our products if they do not receive reimbursement adequate to cover the cost of our products and related procedures.

In international markets, market acceptance may depend, in part, upon the availability of reimbursement within prevailing healthcare payment systems. Reimbursement and healthcare payment systems in international markets vary significantly by country, and include both government sponsored healthcare and private insurance. Currently, the costs of our products distributed internationally, other than in some Latin American countries, are being reimbursed by public and private healthcare insurers. We may not obtain international reimbursement approvals in a timely manner, if at all, and our failure to receive international reimbursement approvals would negatively impact market acceptance of our products in the international markets in which those approvals are sought.

In addition, in certain countries, such as France, Germany, China and Japan, we are required to obtain regulatory clearance for our products to be eligible for reimbursements by third party payors, even though reimbursement for embolic coiling procedures is already in place.

Healthcare costs have risen significantly over the past decade. There have been and continue to be proposals by legislators, regulators and third-party payors to keep these costs down. Certain proposals, if passed, may impose limitations on the amounts of reimbursement available for our products from governmental agencies or third-party payors, or additional taxes on medical devices. These proposals could have a negative impact on the demand for our products and services, and therefore on our financial position and results of operations.

In March 2010, President Obama signed into law major health care reform legislation under the Patient Protection and Affordable Health Care Act of 2010 (the “PPACA”), which was modified by the Health Care and Education Reconciliation Act. The PPACA imposes a 2.3% excise tax on domestic sales of medical devices beginning on January 1, 2013. PPACA also implements provisions that could affect the way in which physicians and hospitals are compensated for performing medical procedures involving our products in the future. The PPACA also expands the scope of the Federal False Claims act and increases fraud and abuse penalties and other government enforcement tools, which could adversely impact healthcare companies, including us. Various healthcare reform proposals also have emerged at the state level. We cannot predict what healthcare initiatives, if any, will be implemented at the state level or the exact effect newly enacted laws or any future legislation or regulation will have on us. However, an expansion in government’s role in the U.S. healthcare industry may lower reimbursements for our products, reduce medical procedure volumes and adversely affect our business and results of operations, possibly materially. In addition, the enacted excise tax on medical devices could materially and adversely affect our operating results.

Future reimbursement may be subject to increased restrictions both in the United States and in international markets. Third-party reimbursement and coverage may not be available or adequate in either the United States or international markets. Future legislation, regulation or reimbursement policies of third-party payors may adversely affect, possibly materially, the demand for our existing products or our products currently under development and limit our ability to sell our products on a profitable basis.

Changes to existing accounting pronouncements or taxation rules or practices may affect how we conduct our business and affect our reported results of operations.

New accounting pronouncements or tax rules and varying interpretations of accounting pronouncements or taxation practice have occurred and may occur in the future. A change in accounting pronouncements or interpretations or taxation rules or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. Changes to existing rules and pronouncements, future changes, if any, or the questioning of current practices or interpretations may adversely affect our reported financial results or the way we conduct our business.

We may become subject to product liability claims which could require us to pay damages that exceed our insurance coverage.

Our business exposes us to potential product liability claims that are inherent in the testing, manufacture and sale of medical devices for neurointerventional procedures. These procedures involve significant risk of serious complications, including intracranial bleeding, brain injury, paralysis and even death. Any product liability claim brought against us, with or without merit, could result in the increase of our product liability insurance rates or the inability to secure coverage in the future. In addition, we

could have to pay an amount in excess of policy limits, which would have to be paid out of cash reserves. If longer-term patient results and experience indicate that our products or any component cause tissue damage, motor impairment or other adverse effects, we could be subject to significant liability. Finally, even a meritless or unsuccessful product liability claim could harm our reputation in the industry, lead to significant legal fees and could result in the diversion of management’s attention from managing our business.

We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of their former employers.

Many of our employees were previously employed at other medical device companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees have wrongfully used or disclosed alleged trade secrets of their former employers or that we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to commercialize product candidates, which could severely harm our business.

The price of our common stock has fluctuated and we expect will continue to fluctuate substantially and you may not be able to sell your shares at or above your purchase price.

The market price of our common stock has been and we expect will continue to be highly volatile and may fluctuate substantially due to many factors, including:

	•		developments related to our announced definitive agreement with J&J;

	•		volume and timing of orders for our products;

	•		the outcome of clinical and multi-center trial evidence supporting patient benefits;

	•		the introduction of new products or product enhancements by us or our competitors;

	•		disputes or other developments with respect to intellectual property rights;

	•		our ability to develop, obtain regulatory clearance for, and market, new and enhanced products on a timely basis;

	•		product liability claims or other litigation;

	•		quarterly variations in our or our competitors’ results of operations;

	•		sales of large blocks of our common stock, including sales by our executive officers and directors;

	•		changes in governmental regulations or in the status of our regulatory approvals or applications;

	•		changes in the availability of third-party reimbursement in the United States or other countries;

	•		the results of clinical research and trials on our existing products and products in development or those of our competitors;

	•		changes in revenues or earnings estimates or recommendations by securities analysts; and

	•		general market conditions and other factors, including factors unrelated to our operating performance or the operating performance of our competitors.

Furthermore, to the extent there is an inactive market for our common stock, the value of your shares and your ability to sell your shares at the time you wish to sell them may be impaired. An inactive market may also impair our ability to raise capital by selling shares and may impair our ability to acquire other companies, products or technologies by using our shares as consideration.

Because of their significant stock ownership, our executive officers, directors and principal stockholders may be able to exert control over us and our significant corporate decisions.

Based on shares outstanding at June 30, 2010, our executive officers, directors, and stockholders holding more than 5% of our outstanding common stock and their affiliates, in the aggregate, beneficially owned approximately 40.8% of our outstanding common stock. As a result, these stockholders, acting together, may have the ability to determine the outcome of matters submitted to our stockholders for approval, including the election and removal of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentration of ownership may harm the market price of our common stock by, among other things:

	•		delaying, deferring or preventing a change in control of our company;

	•		impeding a merger, consolidation, takeover or other business combination involving our company; or

	•		causing us to enter into transactions or agreements that are not in the best interests of all stockholders.

Future sales of our common stock may depress our stock price.

Our current stockholders hold a substantial number of shares of our common stock that they are able to sell in the public market. A significant portion of these shares are held by a small number of stockholders. Sales by our current stockholders of a substantial number of shares could significantly reduce the market price of our common stock. Moreover certain holders of our common stock have the right to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or other stockholders.

We have registered 8,527,739 shares of common stock that we may issue under our 1998 Stock Plan (“1998 Plan”), 2005 Equity Incentive Plan (“2005 Plan”) and 2005 Employee Stock Purchase Plan (“Purchase Plan”). These shares can be freely sold in the public market upon issuance. The sale by any of these holders of a large number of securities in the public market could reduce the trading price of our common stock and impede our ability to raise future capital.

We do not intend to pay cash dividends.

We have never declared or paid cash dividends on our capital stock. We currently intend to retain all available funds and any future earnings for us in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. In addition, the terms of any future debtor credit facility may preclude us from paying any dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of potential gain for the foreseeable future.

We may become involved in securities class action litigation that could divert management’s attention and harm our business.

The stock market in general, The NASDAQ Stock Market and the market for medical device companies in particular, continues to experience extreme price and volume fluctuations that are unrelated or disproportionate to companies’ operating performance. Further, the market prices of securities of medical device companies have been particularly volatile. These broad market and industry factors may materially harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Litigation often is expensive and diverts management’s attention and resources, which could materially harm our financial condition and results of operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Reserved

None.

Item 5. Other Information

None.

Item 6. Exhibits

See the Index to Exhibits on Page 43 of this report.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	MICRUS ENDOVASCULAR CORPORATION
Date: August 6, 2010	By:	/s/ John T. Kilcoyne
		John T. Kilcoyne
		Chairman and Chief Executive Officer


Date: August 6, 2010	By:	/s/ Gordon T. Sangster
		Gordon T. Sangster
		Chief Financial Officer

INDEX TO EXHIBITS


Exhibit
Number		Description
3.1		Certificate of Incorporation (incorporated by reference to Exhibit 3.2 of Amendment No. 3 to the Registrant’s Registration Statement on Form S-1 filed on May 17, 2005 Registration No. 333-123154) (“Amendment No. 3”)

3.2		Amended and Restated Bylaws (incorporated by reference to Exhibit 3.4 of Amendment No. 3)

4.1		Specimen Stock Certificate (incorporated by reference to Exhibit 4.1 of the Registrant’s Registration Statement on Form S-1 filed on March 4, 2005 (Registration No. 333-123154) (“Form S-1”)

4.2		Warrant dated as of December 11, 2000 among the Registrant and Roberts Mitani Capital, LLC (incorporated by reference to Exhibit 4.2 of Form S-1)

4.3		Amended and Restated Stockholders’ Rights Agreement dated as of February 21, 2005 among the Registrant and the parties listed therein (incorporated by reference to Exhibit 4.3 of Form S-1)

4.4		Form of Common Stock Warrant issued in connection with the Series E Preferred Stock and Warrant Purchase Agreement dated February 21, 2005, among the Registrant and the purchasers of the Registrant’s Series E Preferred Stock (incorporated by reference to Exhibit 4.4 of Form 10-Q filed on February 14, 2006)

31.1#		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2#		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32#		Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002