This quarterly report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, particularly statements that may relate to, but are not limited to, expectations of future operating results or financial performance, capital expenditures, introduction of new products, regulatory compliance, plans for growth and future operations, as well as assumptions relating to the foregoing. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. These risks and other factors include, but are not limited to, those listed under Part II, Item 1A - "Risk Factors" and elsewhere in this report. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "could," "expect," "plan," "anticipate," "believe," "estimate," "predict," "intend," "potential," "continue" or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially and adversely.

Overview

We design, develop, manufacture and commercialize a broad suite of intravascular ultrasound, or IVUS, and functional measurement, or FM, products. We believe that these products enhance the diagnosis and treatment of vascular heart disease by improving the efficiency and efficacy of existing percutaneous interventional, or PCI, therapy procedures in the coronary or peripheral arteries. We market our products to physicians and technicians who perform PCI procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals.

Our IVUS products consist of ultrasound consoles, single-procedure disposable phased array and rotational IVUS imaging catheters and additional functionality options such as virtual histology, or VH, IVUS tissue characterization and ChromaFlo stent apposition analysis. Our IVUS consoles are marketed as stand-alone units or as customized units that can be integrated into a variety of hospital-based interventional surgical suites called catheterization laboratories, or cath labs. We have developed customized cath lab versions of these consoles and are developing additional functionality options as part of our cath lab integration initiative. Our IVUS consoles have been designed to serve as a multi-modality platform for our phased array and rotational IVUS catheters, fractional flow reserve, or FFR, pressure wires and Medtronic's Pioneer reentry device. We are developing additional offerings for integration into the platform, including, forward-looking IVUS, or FLIVUS, catheters, image-guided therapy catheters and ultra-high resolution Optical Coherence Tomography, or OCT, systems and catheters.

Our FM offerings include consoles and single-procedure disposable pressure and flow guide wires used to measure the pressure and flow characteristics of blood around plaque enabling physicians to gauge the plaque's physiological impact on blood flow and pressure.

We also develop and manufacture optical monitors, lasers, and optical engines used in OCT imaging systems as well as micro-optical spectrometers and optical channel monitors used in the telecommunications industry.

We have corporate infrastructure in the United States, Europe and Japan; direct sales capabilities in the United States; and a combination of direct sales and distribution relationships in international markets, including Japan, Europe, the Middle East, Canada, Asia Pacific and Latin America. Our corporate office is located in San Diego, California. Our worldwide manufacturing and research and development operations are located in Rancho Cordova, California. We also have additional research and development facilities in Cleveland, Ohio, Forsyth County, Georgia and San Diego, California. We have sales offices in Alpharetta, Georgia and Tokyo, Japan; sales and distribution offices in Zaventem, Belgium and Woodmead, South Africa; and a third-party distribution facility in Chiba, Japan. In addition, we have facilities in Billerica, Massachusetts for the manufacturing and operations of Axsun Technologies, Inc., or Axsun, our wholly owned subsidiary, and the research and development of OCT and FLIVUS technology. In June 2009, we implemented a restructuring plan to close our facility in San Antonio, Texas and consolidate our OCT resources into our Billerica, Massachusetts facility which we expect to complete by March 31, 2010.

We have focused on building our domestic and international sales and marketing infrastructure to market our products to physicians and technicians who perform PCI procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals. At September 30, 2009, we had approximately 962 employees worldwide, including approximately 420 manufacturing employees, 250 sales and marketing employees and 119 research and development employees.

In the nine months ended September 30, 2009 and 2008, 40.1% and 23.5%, respectively, of our revenues and 21.1% and 14.4%, respectively, of our operating expenses were denominated in various non-U.S. dollar currencies, primarily the euro and the yen. We expect that a significant portion of our revenue and operating expenses will continue to be denominated in non-U.S. dollar currencies. As a result, we are subject to risks related to fluctuations in foreign currency exchange rates, which could affect our operating results in the future.

At September 30, 2009, we had a worldwide installed base of over 3,900 IVUS consoles and over 800 FM consoles. We intend to grow and leverage this installed base to drive recurring sales of our single-procedure disposable catheters and guide wires. In the nine months ended September 30, 2009, the sale of our single-procedure disposable catheters and guide wires accounted for $113.1 million, or 72.1% of our revenues, a $23.5 million, or 26.2% increase from 2008, in which the sale of our single-procedure disposable catheters and guide wires accounted for $89.6 million, or 73.3% of our revenues.

We manufacture our IVUS and FM consoles, IVUS catheters and FM guide wires at our facility in Rancho Cordova, California. We use third-party manufacturing partners to produce circuit boards and mechanical sub-assemblies used in the manufacture of our consoles. We also use third-party manufacturing partners for certain proprietary components used in the manufacture of our single-procedure disposable products. We perform incoming inspection on these circuit boards, mechanical sub-assemblies and components, assemble them into finished products, and test the final product to assure quality control.

On December 18, 2007, we acquired CardioSpectra, Inc., or CardioSpectra. As a result, we are developing innovative OCT technology, which is expected to complement our existing product offerings and further enhance our position as an imaging technology leader in the field of interventional medicine. OCT technology enables high resolution imaging of highly detailed structures in the vasculature, including vessel wall defects, intra-luminal thrombus and stent struts. Our long term goal is to integrate this OCT functionality into our s5 family of imaging products.

On May 15, 2008, we acquired Novelis, Inc., or Novelis, a company with proprietary ultrasonic visualization and therapy technology for minimally invasive diagnostic and therapeutic devices. Our acquisition of Novelis' proprietary FLIVUS technology platform is expected to help us build upon our existing suite of products and further enhance our position as an imaging technology leader in the field of interventional medicine by enabling FLIVUS and associated therapies in the interventional cardiology market. We expect to add these products and capability onto our s5 family of imaging products.

On December 24, 2008, we acquired Axsun, a company that develops and manufactures optical monitors for telecommunications, lasers and optical engines used in medical OCT imaging systems and advanced photonic components and sub-systems used in spectroscopy and other industrial applications. We believe Axsun's proprietary OCT technology will provide us competitive advantages in the invasive imaging sector. In connection with the Axsun acquisition, we and Axsun were sued by LightLab Imaging, Inc., or LightLab. LightLab is a wholly owned subsidiary of Goodman Company, Ltd., or Goodman, which was a distributor of our IVUS and FM products in Japan until that relationship was terminated in July 2009 (see Note 1 "Summary of Significant Accounting Policies" to our unaudited consolidated financial statements). LightLab develops and sells OCT products for cardiovascular imaging and other medical uses. We believe the complaint is without merit and we are defending ourselves vigorously.

Economic conditions have continued to deteriorate significantly in many countries and regions, including without limitation the United States, and may remain depressed for the foreseeable future. If our customers do not obtain or do not have access to the necessary capital to operate their businesses, or are otherwise adversely affected by the deterioration in national and worldwide economic conditions, this could result in reductions in the sales of our products, longer sales cycles and slower adoption of new technologies by our customers, which would materially and adversely affect our business. In addition, our customers' and suppliers' liquidity, capital resources and credit may be adversely affected by the current financial and credit crisis, which could adversely affect our ability to collect on our outstanding invoices and lengthen our collection cycles, or limit our timely access to important sources of raw materials necessary for the manufacture of our consoles and catheters. There can be no assurances that government responses to the disruptions in the financial or credit markets will improve the national and worldwide economic conditions in the near term.

Recent Developments

PROSPECT Study Results. In September 2009, results from the Providing Regional Observations to Study Predictors of Events in the Coronary Tree, or PROSPECT, trial, a natural history study sponsored by Abbott Vascular and co-funded by us, demonstrated that the measurements made using grayscale and VH IVUS had a statistically significant impact on study participants in determining the likelihood of a particular lesion type to cause a major adverse cardiac event, or MACE. Specifically, the highest risk PROSPECT plaque type, VH Thin Cap Fibroatheromas, or VH-TCFAs, with a minimum lumen area of less than or equal to 4mm2 and plaque burden greater than or equal to 70% were identified as having a 17.2% chance of causing a MACE within three years. We believe the results of the PROSPECT study demonstrate that VH IVUS has positive predictive value to identify high-risk plaques which supports more stenting in lesions not currently stented and negative predictive value to identify low-risk plaques which reduces stenting for those particular lesions. We believe this predictive value enables more targeted procedures and will contribute to the further adoption of our IVUS products.

FAME Study Results. In September 2009, published findings from the Fractional Flow Reserve versus Angiography for Multivessel Evaluation, or FAME, study demonstrated the potential of FFR in improving patient outcomes and reducing hospital costs. The FAME study's results over a two year period demonstrated that patients in the study with multi-vessel coronary artery disease who were treated by FFR guidance had a 34% reduction in death and myocardial infarction compared to angiographic guidance alone. The FAME study also demonstrated that adhering to an FFR-guided regimen for multi-vessel disease can potentially provide cost benefits to the hospital and payers by reducing procedural costs and lowering average length of hospitalization. We believe these findings will continue to drive the growth and adoption of our disposable FFR wire products.

Goodman Termination. Historically, we sold our products in Japan primarily through distributors. During the third quarter of 2009, we accelerated our direct sales strategy in Japan and began to place and sell our products in Japan directly through an internal sales force. In connection with this direct sales strategy, we formally ended our distribution relationship with Goodman, a distributor of our IVUS and FM products in Japan. On July 8, 2009, we entered into a Distributor Termination Agreement, or Termination Agreement, with Goodman that terminates certain agreements between us and Goodman effective August 31, 2009, and provides for the transition of the distribution of Volcano products in Japan to Volcano Japan Co. Ltd., or Volcano Japan. We believe that the termination of this relationship enables us to provide more focused service and support to the Japanese market, creates more favorable economics, including higher operating margins on the sale of Volcano products in Japan, and provides the ability for us to direct our own sales and marketing initiatives in Japan. Under the Termination Agreement, we paid Goodman 350 million Japanese yen and consumption tax (a total of approximately $3.9 million) during the three months ended September 30, 2009 and Goodman transferred title to consoles owned by Goodman. In addition, we agreed to pay to Goodman commissions of at a minimum 310 million Japanese yen (approximately $3.3 million) which will be paid at various dates through

January 31, 2010. Our efforts to implement a direct sales strategy in Japan may adversely impact our revenues, results of operations and financial condition and cause us to incur additional expenses sooner than initially planned. See the risk factor "If our transition to a direct sales force in Japan is not successful, then our business and results of operations may be materially and adversely affected" in Part II Item 1A "Risk Factors." The aforementioned amounts related to the Termination Agreement have been converted to U.S. dollars from Japanese yen based on average exchange rates in effect during the three months ended September 30, 2009.

Financial Operations Overview

The following is a description of the primary components of our revenues and expenses.

Revenues. We generate revenues from two reporting segments: medical and telecom. Our medical segment represents our core business, in which we derive revenues primarily from the sale of our IVUS and FM consoles and single-procedure disposables. Our telecom segment derives revenues from sales of Axsun's micro-optical spectrometers and optical channel monitors to telecommunication companies. In the nine months ended September 30, 2009, we generated $156.9 million of revenues which is composed of $145.7 million from our medical segment and $11.2 million from our telecom segment. In the nine months ended September 30, 2009, 81.2% of our medical segment revenues were derived from the sale of our IVUS consoles and IVUS single-procedure disposables, as compared with 85.9% in the nine months ended September 30, 2008. In the nine months ended September 30, 2009, 14.5% of our medical segment revenues were derived from the sale of our FM consoles and FM single-procedure disposables, as compared with 10.7% in the nine months ended September 30, 2008. Other revenues consist primarily of service and maintenance revenues, shipping and handling revenues, sales of distributed products, spare parts sales, and license fees.

Our medical segment sales in the United States are generated by our direct sales representatives and our products are shipped to hospitals throughout the United States from our facility in Rancho Cordova, California. Our medical segment international sales are generated by our direct sales representatives or through independent distributors and are shipped throughout the world from our facilities in Rancho Cordova, California; Billerica, Massachusetts; Zaventem, Belgium; Chiba, Japan; and Woodmead, South Africa. Our telecom segment sales are generated by our direct sales representatives or through independent distributors and these products are shipped to telecommunications companies domestically and abroad from our facility in Billerica, Massachusetts.

We expect to continue to experience variability in our quarterly revenues from IVUS and FM consoles due in part to the timing of hospital capital equipment purchasing decisions. Further, we expect variability of our revenues based on the timing of our new product introductions, which may cause our customers to delay their purchasing decisions until the new products are commercially available. Alternatively, we may include in our arrangements with customers future deliverables, such as unspecified hardware upgrades or training. In these cases, we would be required to defer associated revenues from these customers until we have met our future deliverables obligation.

Cost of Revenues. Cost of revenues consists primarily of material costs for the products that we sell and other costs associated with our manufacturing process, such as personnel costs, rent and depreciation. In addition, cost of revenues includes depreciation of company-owned consoles, royalty expenses for licensed technologies included in our products, service costs, provisions for warranty, distribution, freight and packaging costs and stock-based compensation expense. We expect our gross margin for IVUS and FM products to improve over time if we are successful in our ongoing efforts to streamline and improve our manufacturing processes and increase production volumes. We expect our overall gross margins to decrease due to the acquisition of Axsun and the lower gross margin generated by their product lines.

Selling, General and Administrative. Selling, general and administrative expenses consist primarily of salaries and other related costs for personnel serving the sales, marketing, executive, finance, information technology and human resource functions. Other costs include travel and entertainment expenses, facility costs, trade show, training and other promotional expenses, professional fees for legal and accounting services and stock-based compensation expense. We expect that our selling, general and administrative expenses will increase as we continue to expand our sales force and marketing efforts and invest in the necessary infrastructure to support our continued growth.

Research and Development. Research and development expenses consist primarily of salaries and related expenses for personnel, consultants, prototype materials, clinical studies, depreciation, regulatory filing fees, certain legal costs related to our intellectual property and stock-based compensation expense. We expense research and development costs as incurred. We expect our research and development expenses to increase as we continue to develop our products, technologies and applications.

In-process Research and Development. In-process research and development, or IPR&D, consists of our projects acquired in connection with acquisitions that had not reached technological feasibility and had no alternative future uses as of each acquisition date. Certain additional payments that may be required in connection with our acquisitions could result in future charges to IPR&D.

In December 2007, we acquired the OCT project in connection with our acquisition of CardioSpectra, which was valued at $26.3 million. In-vivo testing and regulatory approval remained to be completed as of the acquisition date at an estimated cost of $7.2 million. In addition, milestone payments of up to $38.0 million may be paid in connection with successful and timely regulatory approvals and commercialization. The OCT project was expected to be commercialized by late 2008. The OCT project was at an earlier stage of development than our initial assessment indicated. As of September 30, 2009, the OCT project in-vivo testing had begun and commercialization is expected in early 2011. In addition, we expect to incur approximately $7.9 million of costs to complete the OCT project for a revised estimated total of approximately $15.4 million. If the OCT project is not completed in a timely manner, such as if we experience delays associated with significant design changes that result from unsuccessful human trials or discoveries during human trials, we may jeopardize a potential competitive advantage, experience difficulties in obtaining our forecasted revenues and associated market share and we may not be required to pay some or all of the milestone payments.

In May 2008, we acquired the FLIVUS project in connection with our acquisition of Novelis, which was valued at $12.2 million. In-vivo testing and regulatory approval protocols remained to be completed for the FLIVUS project as of the acquisition date, at an estimated cost of $3.9 million. We expected the FLIVUS project to receive regulatory approvals and be commercialized during 2009. As of September 30, 2009, the project was behind schedule by approximately one year. In addition, we expect to incur approximately $4.4 million of costs to complete the FLIVUS project for a revised estimated total of approximately $7.2 million. If the FLIVUS project is not completed in a timely manner, such as if we experience delays associated with significant design changes that result from unsuccessful human trials or discoveries during human trials, we may jeopardize a potential competitive advantage and experience a potential loss of revenues and associated market share and we may not be required to pay the milestone payment.

In November 2008, we acquired an IPR&D project in connection with our acquisition of Impact Medical Technologies, LLC, a minor acquisition, valued at approximately $300,000.

The following table summarizes our significant IPR&D projects (in millions):

                                                                                                                    Total Estimated Costs to
                              Estimated Cost to Complete,      Costs Incurred       Estimated Cost to Complete,          Complete since
Project Name   Fair Value       as of Acquisition Date        Since Acquisition      as of September 30, 2009           Acquisition Date
OCT            $      26.3   $                         7.2   $               7.5   $                         7.9   $                     15.4
FLIVUS                12.2                             3.9                   2.8                             4.4                          7.2

Amortization of Intangibles. Intangible assets, which consist of our developed technology, licenses, customer relationships, assembled workforce and patents and trademarks, are amortized using the straight-line method over their estimated useful lives ranging from three to ten years.

Interest Income. Interest income is comprised of interest income earned from our cash and cash equivalents and our short-term available-for-sale investments.

Interest Expense. Interest expense is comprised primarily of interest expense on our capital lease obligations.

Exchange Rate Gain (Loss). Exchange rate gain (loss) is comprised of foreign currency transaction and remeasurement gains and losses, net.

Provision for Income Taxes. Provision for income taxes is comprised of local and foreign income taxes. We have evaluated our ability to fully utilize our net deferred tax assets on an individual jurisdiction basis. For those jurisdictions in which we believe there is sufficient uncertainty surrounding the realization of deferred tax assets through future taxable income, we have provided a full valuation allowance and no current benefit has been recognized for the net operating loss and other deferred tax assets.

Results of Operations

The following table sets forth items derived from our consolidated statements of
operations for the three and nine months ended September 30, 2009 and 2008,
presented in both absolute dollars (in thousands) and as a percentage of
revenues:



                                            Three Months Ended September 30,                     Nine Months Ended September 30,
                                             2009                      2008                      2009                       2008
Revenues                              $ 53,852      100.0 %     $ 44,118      100.0 %    $ 156,853      100.0 %     $ 122,242      100.0 %
Cost of revenues                        21,778       40.4         16,581       37.6         64,913       41.4          45,915       37.6

Gross profit                            32,074       59.6         27,537       62.4         91,940       58.6          76,327       62.4
Operating expenses:
Selling, general and administrative     28,272       52.5         19,546       44.3         79,805       50.9          62,405       51.1
Research and development                 9,181       17.0          6,879       15.6         27,816       17.7          18,823       15.4
In-process research and development         -          -              -          -              -          -           12,407       10.1
Amortization of intangibles              1,058        2.0            786        1.8          3,163        2.0           2,337        1.9

Total operating expenses                38,511       71.5         27,211       61.7        110,784       70.6          95,972       78.5

Operating (loss) income                 (6,437 )    (11.9 )          326        0.7        (18,844 )    (12.0 )       (19,645 )    (16.1 )
Interest income                            142        0.3          1,109        2.5            640        0.4           4,206        3.5
Interest expense                            (1 )       -              (2 )       -              (4 )       -               (8 )       -
Exchange rate gain (loss)                2,419        4.5           (441 )     (1.0 )        2,162        1.4           1,091        0.9

(Loss) income before provision for
income taxes                            (3,877 )     (7.1 )          992        2.2        (16,046 )    (10.2 )       (14,356 )    (11.7 )
Provision for income taxes                 121        0.3            248        0.5            833        0.6             707        0.6

Net (loss) income                     $ (3,998 )     (7.4 )%    $    744        1.7 %    $ (16,879 )    (10.8 )%    $ (15,063 )    (12.3 )%

The following table sets forth our revenues by product expressed as dollar amounts (in thousands) and the changes in revenues between the specified periods expressed as percentages:

                                      Three Months Ended      Percentage          Nine Months Ended      Percentage
                                        September 30,           Change              September 30,          Change
                                       2009         2008     2008 to 2009         2009        2008      2008 to 2009
Medical segment:
IVUS:
Consoles                            $     8,413   $ 10,556          (20.3 )%    $  26,119   $  27,468           (4.9 )%
Single-procedure disposables             31,260     27,173           15.0          92,188      77,534           18.9
FM:
Consoles                                    141        450          (68.7 )           248       1,045          (76.3 )
Single-procedure disposables              7,442      4,506           65.2          20,911      12,064           73.3
Other                                     2,395      1,433           67.1           6,189       4,131           49.8

Sub-total medical segment                49,651     44,118           12.5         145,655     122,242           19.2
Telecom segment                           4,201         -             n/a          11,198          -             n/a
. . .