Forward-Looking Statements

The following discussion and analysis of the financial condition and results of operations of the Company should be read in conjunction with the condensed consolidated financial statements and the related notes included elsewhere in this report, and with other factors described from time to time in our other filings with the SEC. In addition to current and historical information, this Quarterly Report on Form 10-Q contains forward-looking statements as defined in
Section 27.A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended that involve risks and uncertainties. These statements can, in some cases, be identified by the use of terms such as "may," "will," "expects," "anticipates," "estimates," "predicts," "continues," "plans," "believes," "projects," "should," "could," "would," "intends" or statements concerning "potential" or "opportunity," and any variations thereof, comparable terminology or the negative thereof. Actual results and the timing of events may differ materially from those contained in the forward-looking statements due to a number of factors, including those discussed in Part II, Item 1A "Risk Factors" in this Quarterly Report on Form 10-Q. We do not intend, and undertake no obligation, to update any of our forward-looking statements after the date of this Quarterly Report to reflect actual results or future events or circumstances.

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 endovascular 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. We plan on growing our business by continuing to penetrate our existing hemorrhagic and ischemic stroke markets, bringing new products and technologies to interventional neuroradiologists, interventional neurologists and endovascular neurosurgeons, and by entering new geographic territories in Asia Pacific where we commenced selling our products in Japan through our distribution partner, Goodman, Co., Ltd. ("Goodman"), in March 2006. We also plan to market our products in China upon receiving regulatory and reimbursement approvals.

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 5% and 4% of our revenues in the first quarter of fiscal 2010 and 2009, respectively. Geographically, our revenues are generally from sales to customers in the Americas, Europe and Asia Pacific. Our products are shipped primarily from our facilities in the United States and a logistics facility in the Netherlands, to either hospitals or distributors. 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 select hospitals, our products are held on consignment, and remain on site, free of charge until used. 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 nine new products in the last 24 months, including microcoils, stents, microcatheters and guidewires. 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. We intend to continue to pursue this non-embolic product line expansion with the goal of increasing our revenue opportunity per procedure. 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 for commercial distribution in the European Union and all other countries recognizing the CE Mark. The PHAROS™ Vitesse™ is our second generation balloon-expandable stent for intracranial ischemic stenosis and wide-neck aneurysm treatment. We have received from the U.S. Food and Drug Administration ("FDA") conditional approval of our investigational device exemption for the PHAROS™ Vitesse Intracranial Stent Study for Ischemic Therapy ("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 the third quarter of fiscal 2010, we plan to launch the DeltaPlush™ microcoil which has been designed to be our softest finishing coil, enabling more efficient and safe aneurysm treatment. The DeltaPlush™ microcoil combines our exclusive Delta Wind™ technology with our softest platinum wire. The result is a microcoil with the softness and flexibility to find and fill empty gaps and open spaces, helping to provide superior finishing at the aneurysm neck. It is available in bare platinum and Cerecyte®. Later in the fiscal year we expect to introduce our family of Ascent™ balloon catheters, which will be used to assist interventionalists when delivering coils for the treatment of aneurysms.

We intend to continue to expand our direct sales force in North America, Europe and Asia Pacific as necessary and further increase our presence in the Asia Pacific markets through distributors. 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 $3.4 million in the first quarter of fiscal 2010 and $9.3 million, $6.3 million and $8.7 million in fiscal 2009, 2008 and 2007, 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 recognize revenues from sales in China during the first quarter of fiscal 2010 and we may not recognize revenues from China this fiscal year.

We have incurred annual net losses since our inception, including net losses of $11.1 million, $16.3 million, and $5.5 million in fiscal 2009, 2008, and 2007, respectively. However, in the fourth quarter of fiscal 2009 we achieved our first profitable quarter with $0.6 million of net income and in the first quarter of fiscal 2010 we reported our second profitable quarter with $2.3 million of net income, which we achieved as result of our continued revenue growth and expense management. We expect to achieve profitability for the full year in fiscal 2010. There is no assurance that we will continue to be profitable in the foreseeable future as we expand our research and development, manufacturing, and sales activities and expand geographically. As of June 30, 2009, we had an accumulated deficit of $80.2 million.

As of June 30, 2009, we had cash and cash equivalents of $19.4 million. We believe that our current cash position and the cash expected to be generated from operations will be sufficient to meet our working capital and capital expenditure requirements through the fiscal year ending March 31, 2010. We have a revolving line of credit with Wells Fargo Bank that provides for maximum borrowings of $15.0 million with a maturity date of August 1, 2010, amended as of May 20, 2009. As of June 30, 2009, Micrus had outstanding borrowings of $2.5 million under the line of credit, unchanged from March 31, 2009.

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, 2009 and 2008:

                                                  Three Months Ended June 30,
                                                 2009                    2008
Consolidated Statements of Operations Data:
Revenues                                              100 %                   100 %
Cost of goods sold                                     26 %                    25 %
Gross profit                                           74 %                    75 %
Operating expenses:
   Research and development                            11 %                    17 %
   Sales and marketing                                 29 %                    44 %
   General and administrative                          25 %                    52 %
       Total operating expenses                        65 %                   113 %
Income (loss) from operations                           9 %                   (38 ) %
   Interest income                                      0 %                     1 %
   Interest expense                                    (0 ) %                   0 %
   Other income (expense), net                          4 %                     0 %
Income (loss) before income taxes                      13 %                   (37 ) %
   Provision (benefit) for income taxes                 2 %                    (1 ) %
Net income (loss)                                      11 %                   (36 ) %

Three Months Ended June 30, 2009 and 2008

Revenues

                   Three Months Ended June 30,              Change
                    2009                 2008             $          %
                          (In thousands, except percentages)
Americas       $       11,156       $       10,533     $   623        6 %
Europe                  6,362                5,645         717       13 %
Asia Pacific            3,705                2,146       1,559       73 %
               $       21,223       $       18,324     $ 2,899       16 %

Our revenues are derived primarily from sales of our microcoils used in the treatment of cerebral vascular diseases. Our total revenues in the first quarter of fiscal 2010 increased as compared with the first quarter of fiscal 2009. This increase was primarily due to an increase in the number of microcoil products sold. Factors driving the increase included growth in the overall market for embolic coils, an increase in market share in both the Americas, Europe and Asia Pacific, and the introduction of new embolic coil products such as DeltaPaq™ and Cashmere™ microcoil systems along with the revenues generated from sales of new nonembolic products such as Neuropath® and PHAROS™ Vitesse™.

Revenues from the Americas increased 6% to $11.2 million compared with the first quarter of fiscal 2009. Revenues from Europe increased 13% to $6.4 million compared with the first quarter of fiscal 2009 which was partially offset by the unfavorable impact of foreign currency exchange rates, most notably the weakening of the British pound against the U.S. dollar. Revenues from Asia Pacific increased to $3.7 million in the first quarter of fiscal 2010 and included product sales to our distributor in Japan of $3.4 million, compared with revenues of $2.1 million in the first quarter of fiscal 2009, which included sales to our distributor in Japan of $1.9 million. We will also begin selling our products in China upon receiving regulatory and reimbursement approvals. We did not recognize revenues from sales to China during the first quarter of fiscal 2010, and we may not recognize revenues from sales in China this fiscal year.

Revenues from the Americas include product sales to our distributors in Latin America. Revenue from Latin America decreased to $0.6 million in the first quarter of fiscal 2010 compared with revenues of $1.3 million in the first quarter of fiscal 2009 due to a change in our revenue recognition policy in the first quarter of fiscal 2009 for sales made to Latin American distributors from a cash collection basis to upon shipment basis (see Note 2 - Summary of Significant Accounting Policies of the "Notes to Condensed Consolidated Financial Statements," which are included in "Part I, Item 1 - Condensed Consolidated Financial Statements (unaudited)"). As a result of the change in our revenue recognition policy for sales made to Latin American distributors, we recognized approximately $0.7 million of Latin American deferred revenue in the first quarter of fiscal 2009.

Revenues from sales of embolic products increased by 15% to $20.2 million for the first quarter of fiscal 2010 as compared to the first quarter of fiscal 2009 primarily due to increased market penetration of the DeltaPaq™, the Cashmere™ and the Cerecyte® microcoil systems, partially offset by the unfavorable impact of foreign currency exchange rates, most notably the weakening of the British pound against the U.S. dollar. Sales of non-embolic products during the first quarter of fiscal 2010 were approximately 5% of total revenues. We expect our embolic and non-embolic sales to increase in the future as a result of market growth and continued market penetration of products released during the past two years, including our launch of the next-generation DeltaPaq™ microcoil system.

New products continue to represent an important component of our growth strategy, with 27% of our revenues in the first quarter of fiscal 2010 coming from products introduced in the past 24 months. Among these, our Cashmere™ microcoil line represented 8% of the quarter's total. We are also pleased with the strong reception for our DeltaPaq™ microcoil system, which comprised 15% of first quarter revenues. New products such as our DeltaPaq™ filling microcoil with proprietary Delta Wind™ technology are important to our growth. In the third quarter we plan to launch our extra-soft finishing DeltaPlush™ microcoil, which also incorporates our proprietary Delta Wind™ technology. Later in the fiscal year, we expect to introduce our family of Ascent™ balloon catheters, which will be used to assist interventionalists when delivering coils for the treatment of aneurysms. With the launch of the Neuropath® guide catheter and the launch of the Ascent™ balloon catheter later this fiscal year, we will be in a position to capture an increased percentage of the hemorrhagic procedural revenue opportunity.

Gross Profit

                         Three Months Ended June 30,              Change
                          2009                 2008             $          %
                                (In thousands, except percentages)
Cost of goods sold   $        5,564       $        4,593     $   971       21 %
Gross profit         $       15,659       $       13,731     $ 1,928       14 %

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 products and royalties related to certain access device products. The increase in cost of goods sold during the first quarter of fiscal 2010 as compared to the first quarter of fiscal 2009 was primarily related to the increase in sales of our products as well as an increase of $295,000 in inventory provisions primarily related to excess inventories for certain slow moving products.

Gross margin was 74% in the first quarter of fiscal 2010 and 75% in the first quarter of fiscal 2009. The decrease was primarily due to higher levels of distributor sales of lower margin products primarily in Japan and certain European markets as well as additional inventory provisions recorded in the first quarter of fiscal 2010. We expect our gross margin to fluctuate in future periods based on the mix of our product sales.

Operating Expenses

Research and Development

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 decreased in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 primarily due to a decrease of $354,000 in personnel costs, a decrease of $322,000 in consulting expenses and a decrease of $107,000 in material and supplies expenses.

Sales and Marketing

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 decreased in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 primarily due to a decrease of $0.9 million in travel, personnel and sales incentives costs and a decrease of $0.6 million in tradeshow, meeting and conference costs.

General and Administrative

General and administrative expenses consist primarily of compensation and related costs for finance, human resources, regulatory, 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 decreased in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 due primarily to a $3.1 million reduction in expenses related to the settlement of the patent litigation with Boston Scientific and legal and professional fees related to the conclusion of the United States Department of Justice monitorship, a decrease of $0.6 million in personnel and travel costs, a decrease of $196,000 in grants and sponsorships, a decrease of $110,000 related to Sarbanes-Oxley Act compliance, as well as a decrease of $122,000 due to lower amortization of intangible assets. The lower amortization of intangible assets in the first quarter of fiscal 2010 is due to an impairment charge of $462,000 that was recorded in the fourth quarter of fiscal 2009 related to the intangible assets resulting from the acquisition of Neurologic UK Limited ("Neurologic") in September 2005 as a result of the decline in the estimated fair value.

Out of Period Adjustments

For the three months ended June 30, 2009, we 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 appropriately recorded in prior periods. The net adjustments resulted in our reporting $281,000 in additional pre-tax expenses. These adjustments both individually and in the aggregate were not material to any of the fiscal 2009 interim or full year consolidated financial statements nor are they expected to be material to full year fiscal 2010 results.

Other Income (Expense), Net

                                        Three Months Ended June 30,             Change
                                        2009                  2008            $          %
                                              (In thousands, except percentages)
Interest and investment income      $          16         $         110     $ (94 )     (85 )%
Interest expense                              (36 )                  (4 )     (32 )     800 %
Other income (expense), net                   769                    (2 )     771         - %
Total other income (expense), net   $         749         $         104     $ 645       620 %

Interest and investment income consists of interest earned on interest bearing accounts. Interest and investment income decreased by $94,000 in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 due to lower average cash and investment balances earning interest and lower interest rates.

Interest expense consists of finance charges in connection with our line of credit at Wells Fargo Bank and other financing arrangements. Interest expense increased in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 primarily due to interest charges from the outstanding borrowings of $2.5 million under the line of credit.

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 increased by $0.8 million in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009. This increase is primarily due to foreign exchange gains resulting from the re-measurement of foreign currency transactions, most notably the impact of the strengthening of the British pound against the U.S. dollar.

Income Taxes

                           Three Months Ended June 30,
                          2009                     2008
                     (In thousands, except percentages)
Income tax benefit   $           448          $         (216 )
Effective tax rate                17 %                    (3 )%

We recorded an income tax expense of approximately $448,000 on operating profits for the first quarter of fiscal 2010.

As of March 31, 2009, we had federal, state and foreign net operating loss carryforwards ("NOLs") of approximately $40.5 million, $30.5 million and $4.6 million, respectively. The federal NOLs will expire at various dates beginning in 2012 and the state and foreign NOLs will expire beginning in 2013. We also have federal and state research and development tax credit carryforwards of approximately $1.3 million and $1.3 million, respectively, as of March 31, 2009. The federal credits will expire beginning in 2012. The state tax credit carryforwards can be carried forward indefinitely. We have recorded a full valuation allowance against our U.S. federal and state gross deferred tax assets, as our history of losses and all other evidence available to us provide uncertainty as to whether it is more likely than not that our U.S. federal and state gross deferred tax assets will be realized.

Liquidity and Capital Resources

                                                                   Three Months Ended June 30,
                                                                    2009                 2008
Cash flow activities:                                                    (In thousands)
Net cash provided by (used in) operating activities            $        4,268       $       (4,291 )
Net cash used in investing activities                          $       (1,056 )     $       (4,675 )
Net cash provided by financing activities                      $           19       $          302

Since our inception, we have funded our operations primarily through issuances of stock and related warrants, and product sales. As of June 30, 2009, we had cash and cash equivalents of $19.4 million, compared to $17.1 million at March 31, 2009. We believe that our current cash position and the cash expected to be generated from operations will be sufficient to meet our working capital and capital expenditure requirements through the fiscal year ending March 31, 2010.

Net cash provided by operating activities was $4.3 million during the first quarter of fiscal 2010 compared to net cash used in operating activities of $4.3 million during the first quarter of fiscal 2009. Net cash provided by operating activities during the first quarter of fiscal 2010 resulted primarily from operating income adjusted by 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, and 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 . . .