Forward-looking statements: This quarterly report on Form 10-Q ("Quarterly Report") contains forward-looking statements regarding future events and our future results that are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. In some cases, you can identify these "forward-looking statements" by words like "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of those words and other comparable words. These statements include, but are not limited to, those concerning the following: our intentions, beliefs and expectations regarding our future financial performance, anticipated growth, trends in our business, trends in the medical field related to our products and technology, and the performance and competitive advantages of our products; our beliefs with respect to the usefulness of anticipated clinical data; the timing and success of our clinical trials, data presentations, regulatory submissions and anticipated product launches; our belief that our cash and cash equivalents and available-for-sale investments will be sufficient to satisfy our anticipated cash requirements; our belief that our current and planned facilities are sufficient for our business; our operating results; timing, costs and outcomes of current or future litigation; our expectations regarding our revenues and costs of producing our products; our expectations regarding our customers and distributors; and our intentions, beliefs and expectations regarding market penetration and expansion efforts. These statements are not guarantees of future performance or events. Our actual results may differ materially from those discussed here. For a detailed discussion of the risks and uncertainties that could contribute to such differences see the "Risk Factors" section in Part II, Item 1A of this Quarterly Report and elsewhere throughout this Quarterly Report and in any other documents incorporated by reference into this Quarterly Report. Any forward-looking statement speaks only as of the date on which it is made, and except as required by law, we undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Quarterly Report.
Overview
We design, develop, manufacture and commercialize a broad suite of precision guided therapy tools including intravascular ultrasound, or IVUS, and fractional flow reserve, or FFR, 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 products consist of multi-modality consoles which 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 consoles have been designed to serve as a multi-modality platform for our phased array and rotational IVUS catheters, FFR pressure wires, image-guided therapy catheters and Medtronic's Pioneer reentry device. Our IVUS products include single-procedure disposable phased array and rotational IVUS imaging catheters, the VIBE RX image-guided therapy device, and additional functionality options such as virtual histology, or VH, IVUS tissue characterization and ChromaFlo stent apposition analysis. Our FFR offerings can be accessed through our multi-modality platforms, and we also provide FFR-only consoles. Our FFR disposables are 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 are developing additional offerings for integration into the platform, including adenosine-free Instant wave-free ratio FFR, or iFR, forward-looking IVUS, or FL.IVUS, catheters, Focal Acoustic Computed Tomography catheters and ultra-high resolution Optical Coherence Tomography, or OCT, systems and catheters. In addition, Our Valet Micro catheter received 510(k) clearance in January 2012 and CE Mark approval in May 2012.
Through Axsun Technologies, Inc., or Axsun, one of our wholly owned subsidiaries, we also develop and manufacture optical monitors for the telecommunication industry, laser and non-laser light sources, and optical engines used in the 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.
We have infrastructure in the U.S., Europe, Japan and Costa Rica. Our corporate office is located in San Diego, California. Our manufacturing operations are located in Rancho Cordova, California, Billerica, Massachusetts and Alajuela, Costa Rica. We have research and development facilities in Rancho Cordova, California, Billerica, Massachusetts, 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 third-party distribution facilities in Ota-ku and Tokyo, Japan.
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. We sell our products directly to customers in the U.S., Japan, certain European markets and South Africa. We utilize distributors in other geographic areas, who are also involved in product launch planning, education and training, physician support and clinical trial management. At March 31, 2012, we had a worldwide installed base of over 7,000 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 three months ended March 31, 2012, the sale of our single-procedure disposable catheters and guide wires accounted for $73.6 million, or 83.3% of our medical segment revenues, a $11.3 million, or 18.1% increase from the same period in 2011, in which the sale of our single-procedure disposable catheters and guide wires accounted for $62.3 million, or 80.8% of our medical segment revenues.
In the three months ended March 31, 2012 and 2011, 48.0% and 46.9 %, respectively, of our revenues and 22.3% and 21.7%, respectively, of our operating expenses were denominated in various non-U.S. dollar currencies, primarily the yen and the euro. 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. If our yen or euro denominated sales exceed our yen or euro denominated costs, and the U.S. dollar strengthens relative to the yen or euro, there is an adverse effect on our results of operations. Conversely, if the U.S. dollar weakens relative to the yen or euro, there is a positive effect on our results of operations. For example, the average exchange rate of one U.S. dollar to yen decreased 4.4% from 81.73 in the three months ended March 31, 2011 to 78.15 in the three months ended March 31, 2012, which resulted in a net positive impact to our operational results in the amount of approximately $774,000. On the other hand, the average exchange rate of one euro to U.S. dollar decreased 3.6% from 1.37 in the three months ended March 31, 2011 to 1.32 in the three months ended March 31, 2012, which resulted in a net negative impact to our operational results in the amount of approximately $299,000.
We manufacture our multi-modality and FFR consoles, IVUS catheters and FFR 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.

The Patient Protection and Affordable Care Act and Health Care and Education Affordability Reconciliation Act were enacted into law in the U.S. on March 23, 2010. The legislation imposes on medical device manufacturers a 2.3 percent excise tax on U.S. sales of Class I, II and III medical devices beginning January 1, 2013. While we are continuing to evaluate this legislation and its potential impact on the Company, it may adversely affect our business and results of operations.
The economic conditions in many countries and regions where we generate our revenues remain uncertain. 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 any 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 their relative ability or inability to obtain capital and credit, 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. In addition, the political unrest in the Middle East may have adverse consequences to the global economy or to our customers in the Middle East, which could negatively impact our business. The challenging global economic conditions have also led to concerns over the solvency of certain European Union member states, including Greece, Ireland, Italy, Portugal and Spain. Uncertainty about future economic conditions may make it more difficult for us to forecast operating results and to make decisions about future investments. For further discussion, see "Risk Factors-General national and worldwide economic conditions may materially and adversely affect our financial performance and results of operations."
Financial Operations Overview
The following is a description of the primary components of our revenues and expenses.
Revenues. We derive our revenues from two reporting segments: medical and industrial. Our medical segment represents our core business, in which we derive revenues primarily from the sale of our consoles and single-procedure disposables. Our industrial segment derives revenues related to the sales of Axsun's micro-optical spectrometers and optical channel monitors to telecommunication and other industrial companies. In the three months ended March 31, 2012, we generated $90.4 million of revenues which is composed of $88.4 million from our medical segment and $2.0 million from our industrial segment. In the three months ended March 31, 2012, 9.2% of our medical segment revenues were derived from the sale of our consoles, as

compared with 12.9% in the three months ended March 31, 2011. In the three months ended March 31, 2012, IVUS single-procedure disposables accounted for 60.5% of our medical segment revenues, compared to 61.8% during the same period in 2011, while in the three months ended March 31, 2012, 22.8% of our medical segment revenues were derived from the sale of our FFR single-procedure disposables, as compared with 19.1% in the three months ended March 31, 2011. Other revenues consist primarily of revenue from Axsun's medical segment, service and maintenance revenues, rental revenues, shipping and handling revenues, sales of distributed products, spare parts sales, and license fees. We expect to continue to experience variability in our quarterly revenues from console sales 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.

Our medical segment sales in the U.S. are generated by our direct sales representatives and our products are shipped to customers throughout the U.S. from our facilities in Rancho Cordova, California and Billerica, Massachusetts. Our medical segment international sales are generated by our direct sales representatives or through independent distributors and are shipped throughout the world from facilities in Rancho Cordova, California; Billerica, Massachusetts; Zaventem, Belgium; Ota-ku and Tokyo, Japan; and Woodmead, South Africa. Our industrial segment sales are generated by our direct sales representatives or through independent distributors and these products are shipped primarily to telecommunications and industrial companies domestically and abroad from our facility in Billerica, Massachusetts.
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, depreciation related to our manufacturing equipment and utilities. 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 related to manufacturing employees. We expect a trend of further improvement in our gross margin for IVUS and FFR products if we are successful in our ongoing efforts to streamline and improve our manufacturing processes, increase production volumes and transition certain manufacturing operations to Costa Rica.
Selling, General and Administrative. Selling, general and administrative expenses consist primarily of salaries and other related costs for personnel serving the sales, administrative and marketing functions. Other costs include stock-based compensation expense, professional fees for legal and accounting services, travel and entertainment expenses, facility costs, trade show, training and other promotional expenses. Due to ongoing litigation, legal expenses tend to be somewhat unpredictable in their timing and amount. 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. Due to product development timelines, research and development costs tend to be distributed unevenly between the periods. We expect our research and development expenses to increase as we continue to develop our products and technologies.
Amortization of Intangibles. We amortize intangible assets, consisting of our acquired developed technology, licenses, customer relationships, assembled workforce, patents and trademarks, using the straight-line method over their estimated useful lives of up to 20 years. These assets are regularly tested for impairment and abandonment.
Interest Income. Interest income is comprised of interest income earned from our cash and cash equivalents and our short-term and long-term available-for-sale investments.
Interest Expense. Interest expense is primarily comprised of interest expense related to our convertible debt, including coupon interest, accretion of debt discount, and amortization of issuance costs, offset by interest capitalization related to the Costa Rica plant construction and global ERP system implementation.
Exchange Rate Loss. Exchange rate loss is comprised of foreign currency transaction and remeasurement gains and losses, net, and the effect of changes in value and net settlements of our foreign currency forward contracts. Provision for Income Taxes. Our effective tax rate is a blended rate resulting from the composition of taxable income in the global jurisdictions in which we conduct business. We apply the "with and without method - direct effects only", in accordance with authoritative guidance, with respect to recognition of stock option excess tax benefits within stockholders equity (additional paid in capital). Therefore, provision for domestic income taxes is determined utilizing projected federal and state taxable income before the application of deductible excess tax benefits attributable to stock option exercises.

Results of Operations
The following table sets forth items derived from our unaudited condensed
consolidated statements of operations for the three months ended March 31, 2012
and 2011, presented in both absolute dollars (in thousands) and as a percentage
of revenues:

                                              Three Months Ended March 31,                  Changes
                                              2012                    2011                $          %
Revenues                              $ 90,360     100.0  %   $ 80,995     100.0  %   $ 9,365      11.6  %
Cost of revenues, excluding
amortization of intangibles             29,573      32.7        27,874      34.4        1,699       6.1
Gross profit                            60,787      67.3        53,121      65.6        7,666      14.4
Operating expenses:
Selling, general and administrative     44,345      49.1        35,460      43.8        8,885      25.1
Research and development                13,649      15.1        13,088      16.2          561       4.3
Amortization of intangibles                872       1.0           855       1.1           17       2.0
Total operating expenses                58,866      65.2        49,403      61.1        9,463      19.2
Operating income                         1,921       2.1         3,718       4.6       (1,797 )   (48.3 )
Interest income                            230       0.3           243       0.3          (13 )    (5.3 )
Interest expense                        (1,472 )    (1.6 )      (2,005 )    (2.5 )        533     (26.6 )
Exchange rate loss                        (175 )    (0.2 )        (388 )    (0.5 )        213     (54.9 )
Other, net                                 (96 )    (0.1 )           -         -          (96 )       -
Income before income taxes                 408       0.5         1,568       1.9       (1,160 )   (74.0 )
Income tax expense                         137       0.2           412       0.5         (275 )   (66.7 )
Net income                            $    271       0.3  %   $  1,156       1.4  %   $  (885 )   (76.6 )%

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

                                 Three Months Ended             Change
                                     March 31,
                                  2012         2011          $           %
Medical segment:
Consoles                      $     8,116    $  9,931    $ (1,815 )   (18.3 )%
Single-procedure disposables:
IVUS                               53,484      47,618       5,866      12.3
FM                                 20,138      14,700       5,438      37.0
Other                               6,620       4,864       1,756      36.1
Sub-total medical segment          88,358      77,113      11,245      14.6
Industrial segment                  2,002       3,882      (1,880 )   (48.4 )
                              $    90,360    $ 80,995    $  9,365      11.6  %

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

                                      Three Months Ended             Change
                                          March 31,
                                       2012         2011          $          %
Revenues (1):
United States                      $    41,377    $ 36,335    $ 5,042      13.9  %
Japan                                   30,789      24,712      6,077      24.6
Europe, the Middle East and Africa      13,664      14,076       (412 )    (2.9 )
Rest of world                            4,530       5,872     (1,342 )   (22.9 )
                                   $    90,360    $ 80,995    $ 9,365      11.6  %

Comparison of Three Months Ended March 31, 2012 and 2011 Revenues. Overall, the increase in the medical segment revenue in the three months ended March 31, 2012 compared with the three months ended March 31, 2011 were driven by increased demand for our disposables, as well as higher revenues resulting from our direct sales efforts in Japan and favorable impacts of foreign exchange rates related to the yen. Additionally, the increases in FFR disposable revenues were primarily due to the broader availability of FFR technology as this functionality has been incorporated into our multi-modality console, and in conjunction with an increased adoption of the technology based on clinical study data. The revenue decreases related to our consoles resulted from decreased sales of console units, which is due to the timing of hospital capital equipment purchasing decisions and negative impact of the slowing economy in Europe. The decrease in industrial segment revenues results from lower sales to our international telecommunication customers due to the telecommunications industry's cyclical nature. The increase in other revenues is primarily due to higher sales of third-party products and higher service contract and rental revenues. We recognized increases in revenues in the United States and Japan markets. The Japanese market's growth is due to the continued success of our direct sales efforts and the favorable impact of foreign currency exchange related to the yen. The decrease in the European markets relates to the slowing economy in Europe, primarily Spain, and unfavorable impacts of foreign currency exchange rates to the euro. The decrease in the rest of the world primarily relates to the decline in our industrial segment revenues to customers in Europe.
Cost of Revenues. The increase in the cost of revenues in the three months ended March 31, 2012 compared with the three months ended March 31, 2011 was primarily due to higher sales volume. Gross margin was 67.3% of revenues in the three months ended March 31, 2012, increasing from 65.6% of revenues in the three months ended March 31, 2011. This favorable gross margin was primarily the result of favorable product mix for IVUS and FFR disposable products, a decrease in the production costs of IVUS and FFR disposable products from ongoing cost reduction initiatives, and favorable impacts of foreign currency exchange rates to the gross margin related to the yen.

Selling, General and Administrative. The increase in the three months ended March 31, 2012 as compared with the three months ended March 31, 2011 was primarily due to the expansion of our Costa Rica general and administrative activities during the pre-production phase, expansion of U.S., Japan, and Europe sales and marketing organizations, including continued growth in our Japan operation to support our direct sales efforts there, and increased information technology and infrastructure expenses to support company growth.
Research and Development. The increase in research and development expenses in the three months ended March 31, 2012 as compared with the three months ended March 31, 2011 was primarily due to increased spending on various product development projects and activities supporting other acquired technologies. Amortization of Intangibles. The amortization expense in the three months ended March 31, 2012 as compared with the three months ended March 31, 2011 remained consistent.
Interest Income. The interest income in the three months ended March 31, 2012 as compared with the three months ended March 31, 2011 remained consistent. Interest Expense. The decrease in interest expenses in the three months ended March 31, 2012 as compared with the three months ended March 31, 2011 was mainly due to more interest being capitalized during the three months ended March 31, 2012 as compared with the same period in 2011. The interest capitalization is related to the Costa Rica plant construction and global ERP system implementation.
Exchange Rate Loss. During the three months ended March 31, 2012 and 2011 the impact of fluctuations in exchange rates was mitigated by our hedging practices. Through our hedging program we reduce the volatility of our exchange rate gains and losses resulting from the remeasurement of our intercompany receivable balances at current exchange rates.
Provision for Income Taxes. We recorded an income tax provision in the three months ended March 31, 2012 of $137,000, compared to a provision of $412,000 for the three months ended March 31, 2011. The decrease is mainly due to the decrease of income before income taxes.

Liquidity and Capital Resources
Sources of Liquidity

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Historically, our sources of cash have included:
•            issuance of equity and debt securities, including underwritten
             public offerings of our common stock and convertible bonds; cash
             generated from the exercise of stock options and participation in
             our employee stock purchase plan;

• cash generated from operations, primarily from product sales.

Our historical cash outflows have primarily been associated with:
• cash used for operating activities such as the purchase and growth of inventory, expansion of our sales and marketing and research and development infrastructure and other working capital needs;

•            expenditures related to increasing our manufacturing capacity and
             improving our manufacturing efficiency;


•            capital expenditures related to the acquisition of equipment that we
             own and place at our customer premises and other fixed assets;

• cash used for interest expense related to our debt obligations; and

. . .