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SPNC > SEC Filings for SPNC > Form 10-K on 13-Mar-2013All Recent SEC Filings

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Form 10-K for SPECTRANETICS CORP


13-Mar-2013

Annual Report


ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements and the related notes contained elsewhere in this annual report on Form 10-K and in our other SEC filings. The following discussion may contain forward-looking statements that constitute our expectations or forecasts of future events as of the date this report was filed with the SEC and are not statements of historical fact. You are cautioned not to place undue reliance on these forward-looking statements and to note that they speak only as of the date hereof. Factors that could cause actual results to differ materially from those set forth in the forward-looking statements are set forth in the risk factors listed from time to time in our filings with the SEC as well as those set forth in Item 1A, "Risk Factors." See the introduction to Part I of this annual report.

Corporate Overview

We develop, manufacture, market and distribute single-use medical devices used in minimally invasive procedures within the cardiovascular system. Our products are used to access and treat arterial blockages in the legs and heart and to remove pacemaker and defibrillator cardiac leads. During the year ended December 31, 2012, approximately 66% of our disposable product revenue was from products used in connection with our proprietary excimer laser system, the CVX-300®. Our single-use laser catheters contain up to 250 small diameter, flexible optical fibers that can access difficult to reach peripheral and coronary anatomy and produce evenly distributed laser energy at the tip of the catheter for more uniform ablation. Our excimer laser system is the only laser system approved in the United States, Europe, Japan and Canada for use in multiple minimally invasive cardiovascular procedures.

For an overview of our business, market opportunities, products and clinical trials, please see Part I, Item I, "Business" to this annual report on Form 10-K.

Results of Operations

Revenue by Product Line
                                 2012                 2011                 2010
                                                 (in thousands)
Disposable products:
Vascular Intervention     $  67,336     48 %   $  62,264     49 %   $  60,224     51 %
Lead Management              55,186     39        46,480     37        41,162     35
Total disposable products   122,522     87       108,744     85       101,386     86
Service and other revenue    10,439      7        10,122      8         9,380      8
Laser equipment               7,324      5         8,421      7         7,151      6
Total revenue             $ 140,285    100 %   $ 127,287    100 %   $ 117,917    100 %

Percentage amounts may not add due to rounding.


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Financial Results by Geographical Segment

Our two operating segments consist of United States Medical, which includes the United States and Canada, and International Medical, which includes Europe, the Middle East, Asia Pacific, Latin America and Puerto Rico. United States Medical also includes all costs for our corporate headquarters, research and development, and corporate administrative functions. The International Medical segment is engaged primarily in distribution activities, with no local manufacturing or product development functions. For the years ended December 31, 2012, 2011 and 2010, a portion of research and development and general and administrative costs incurred in the U.S. has been allocated to International Medical based on a percentage of revenue, because these costs support our ability to generate revenue in the international segment.

                                Year Ended December 31,
                     2012                 2011                 2010
                                     (in thousands)
Revenue
United States $ 117,436     84 %   $ 105,933     83 %   $ 101,008     86 %
International    22,849     16        21,354     17        16,909     14
Total revenue $ 140,285    100 %   $ 127,287    100 %   $ 117,917    100 %



                                   Year Ended December 31,
                                2012        2011        2010
                                       (in thousands)
Operating income (loss)
United States                 $  1,037    $   647    $ (7,006 )
International                    1,910        639         (40 )
Total operating income (loss) $  2,947    $ 1,286    $ (7,046 )


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Year Ended December 31, 2012 Compared with Year Ended December 31, 2011

Selected Consolidated Statements of Comprehensive Income Data

The following tables present Consolidated Statements of Comprehensive Income
data for the years ended December 31, 2012 and December 31, 2011 based on the
percentage of revenue for each line item, as well as the dollar and percentage
change of each of the items.

                                                          For the year ended December 31,
(in thousands, except for                         % of                         % of
percentages)                        2012       revenue (1)       2011       revenue (1)     $ change      % change
Revenue
Disposable products revenue:
Vascular intervention            $ 67,336            48 %     $ 62,264          49  %      $   5,072           8  %
Lead management                    55,186            39         46,480          37             8,706          19
Total disposable products
revenue                           122,522            87        108,744          85            13,778          13
Service and other revenue          10,439             7         10,122           8               317           3
Laser revenue:
Equipment sales                     2,682             2          3,269           3              (587 )       (18 )
Rental fees                         4,642             3          5,152           4              (510 )       (10 )
Total laser revenue                 7,324             5          8,421           7            (1,097 )       (13 )
Total revenue                     140,285           100        127,287         100            12,998          10
Gross profit                      102,358            73         91,564          72            10,794          12
Operating expenses
Selling, general and
administrative                     82,254            59         70,502          55            11,752          17
Research, development and other
technology                         16,846            12         17,729          14              (883 )        (5 )
Acquisition-related costs             311             -              -           -               311          nm
Federal investigation legal and
accrued indemnification costs           -             -           (370 )         -               370          nm
Settlement costs-license
agreement dispute                       -             -          1,821           1            (1,821 )        nm
Litigation charge                       -             -            596           -              (596 )        nm
Total operating expenses           99,411            71         90,278          71             9,133          10
Operating income                    2,947             2          1,286           1             1,661         129
Other income (expense)                 13             -           (161 )         -               174        (108 )
Income before income taxes          2,960             2          1,125           1             1,835         163
Income tax expense                    734             1            231           -               503         218
Net income                       $  2,226             2 %     $    894           1  %      $   1,332         149  %

(1) Percentage amounts may not add due to rounding.

nm = not meaningful.


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Revenue and gross margin

Revenue for the year ended December 31, 2012 was $140.3 million, an increase of 10% as compared with $127.3 million for the year ended December 31, 2011. On a constant currency basis, total revenue increased 11% compared with the previous year (see the "Non-GAAP Financial Measures" section below for a discussion of our use of the constant currency financial measure). All of the $13.0 million revenue increase was in disposables product revenue, partially offset by a 4% decrease in laser and service revenue. This resulted in a slight change in our product mix year-over-year, with disposable products generating 87% of revenue in 2012 compared with 85% in 2011. Service and other revenue decreased to 7% of total revenue in 2012 compared with 8% in 2011. Revenue from laser equipment sales and rentals decreased to 5% of total revenue in 2012 compared with 7% in 2011.

Vascular Intervention (VI) revenue, which includes products used in both the peripheral and coronary vascular systems, increased 8% (9% on a constant currency basis) in 2012 compared with 2011.

VI sales include three product categories: peripheral atherectomy, which increased 15%; crossing solutions, which increased 2%; and coronary atherectomy and thrombus management, which decreased 12%, all compared with 2011. Increased peripheral atherectomy product sales were primarily related to higher sales to office based physician clinics in the U.S., which provide increased access for patients at a potentially lower cost to the healthcare system. In addition, we believe that our peripheral artery disease (PAD) awareness program contributed to the 18% increase in U.S. peripheral atherectomy sales. The growth in crossing solutions product sales was due to increased unit volumes despite a larger number of competitors. Coronary atherectomy and thrombus management are not currently a strategic priority for us, which is reflected in the decrease in revenue. In addition, our QuickCat™ product faced pricing pressures due to increased competition, and we have made the decision to discontinue sale of our ThromCat® product, which totaled $0.5 million for the year ended December 31, 2012.

Lead Management (LM) revenue, which includes excimer laser sheaths and cardiac lead management accessories for the removal of pacemaker and defibrillator cardiac leads, grew 19% (20% on a constant currency basis) in 2012 as compared with 2011. In the second quarter of 2012, we initiated a launch of GlideLight, our next generation lead extraction tool, and by year-end approximately 50% of our customers had been converted from its predecessor, the SLS II. Approximately two-thirds of the increase in LM revenue related to the SLS II/GlideLight lead extraction laser sheaths was attributable to increased volumes; the remaining one-third was due to the higher average selling price of GlideLight compared to the SLS II. We believe the volume increases are primarily a result of an expanding market for lead extractions due to increasing infection rates and increased indications for lead extraction set forth by the Heart Rhythm Society. We believe clinical data, including results from the four-year Lead Extraction in Contemporary Settings (LExICon) study published in February 2010, supports the safety and efficacy of removing pacemaker and defibrillator leads. In addition, we received reimbursement approval in Japan for the LLD® lead locking device in April 2011, which allowed us to make available our complete lead management system in Japan.

Service and other revenue increased 3%, to $10.4 million in 2012 from $10.1 million in 2011, due primarily to our increased installed base of laser systems.

Laser equipment revenue decreased to $7.3 million in 2012 from $8.4 million in 2011. Equipment sales revenue, which is included in laser equipment revenue, decreased 18% as compared with 2011. We sold 19 laser systems in 2012 compared with 29 in 2011. Rental revenue decreased 10% in 2012 as compared with the prior year, primarily because higher disposables purchases by certain customers under volume-based rental agreements led to lower rent due.

We placed 125 laser systems with new customers during 2012 compared with 129 during the prior year. Of those new laser placements in 2012, 70 laser systems were direct transfers from the existing installed base or were deployments of remanufactured lasers from our factory compared with 60 transfers/remanufactured systems in 2011.


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The new placements brought our worldwide installed base of laser systems to 1,066 (799 in the U.S.) at December 31, 2012, compared to 1,011 (770 in the U.S.) at December 31, 2011.

On a geographic basis, revenue in the U.S. was $117.4 million in 2012, an increase of 11% from the prior year. International revenue was $22.8 million, an increase of 7% from 2011 and an increase of 13% on a constant currency basis. The increase in international revenue was primarily due to an increase in international LM revenue and crossing solutions revenue, primarily in Europe and Japan.

Gross margin in 2012 was 73% compared with 72% in 2011 and 71% in 2010. The increase was due to a combination of changes in product mix, improved pricing from our GlideLight product, improved manufacturing efficiencies and higher production volumes. Our net revenue increase over the prior year was due to increased disposable product revenue, which carries a significantly higher gross margin percentage than laser equipment or service revenue.

Operating expenses

Operating expenses were $99.4 million in 2012, an increase of 10% from $90.3 million in 2011. Operating expenses represented 71% of total revenue in both 2012 and 2011. Operating expenses in 2012 included $0.3 million of acquisition-related costs and in 2011 included $2.0 million of litigation and settlement costs which are separately disclosed components within operating expenses in our statement of comprehensive income (loss), further described below.

Selling, general and administrative. Selling, general and administrative (SG&A) expenses increased 17% compared with 2011. As a percentage of revenue, SG&A expenses increased to 59% of revenue in 2012 compared with 55% in 2011.

Within SG&A, marketing and selling expenses increased $8.1 million, or 15%, year-over-year, due primarily to the following:

• A $5.1 million increase in VI and LM marketing expense, primarily due to
(1) the hiring of PAD awareness managers in selected VI sales territories, whose objective is to increase awareness of PAD in the communities they serve, (2) the expansion of our marketing capabilities to include strategy and product portfolio management and (3) costs associated with the launch of the GlideLight lead extraction laser sheath and increased marketing and physician training events.

• A $3.0 million increase in VI, LM and international field sales expense, primarily due to increased incentive compensation on higher revenue and additional field sales positions.

Also within SG&A, general and administrative expenses increased $3.6 million, or 24%, with increased personnel expenses primarily due to the hiring of our chief executive officer in August 2011 and other senior executives in 2011 and 2012, an increase in stock compensation expense, an increase in outside consulting costs associated with regulatory compliance and an increase in company-wide performance-based incentive compensation expense tied to achievement of goals established at the beginning of the year.

Research, development and other technology. Research, development and other technology expenses of $16.8 million in 2012 decreased $0.9 million, or 5%, from $17.7 million in 2011. As a percentage of revenue, research, development and other technology expenses decreased to 12% of revenue in 2012 from 14% of revenue in 2011. Costs included within research, development and other technology expenses are product development costs, clinical studies costs and royalty costs associated with various license agreements with third-party licensors. We expect these expenses to increase as a percentage of revenue in 2013 as we increase headcount and otherwise expand our overall product development activities. Fluctuations in these costs were as follows:


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• Royalty expenses decreased by $1.4 million compared with 2011 due to the termination of a royalty agreement in the first quarter of 2012, slightly offset by increases in ongoing royalties paid based on increased sales of products incorporating licensed technology;

• Product development costs decreased by $0.8 million compared with 2011 due to a temporary decrease in project activity, as project teams transitioned from completed projects to new projects; and

• Clinical studies costs increased by approximately $1.3 million compared with 2011 primarily due to costs related to the EXCITE ISR trial.

Acquisition-related costs. In the fourth quarter of 2012, we incurred $0.3 million in legal and other costs related to our acquisition of products from Upstream Peripheral Technologies Ltd. on January 7, 2013. The base purchase price of the acquisition was $5.5 million with additional future milestone payments based on product and manufacturing transfer and one-third of revenues for 2014, 2015 and 2016. We expect the Upstream acquisition will be accounted for as a business combination and we will record the assets acquired and the estimated future contingent consideration at their respective fair values as of the acquisition date during the first quarter of 2013. In 2013 and beyond, we expect to incur additional intangible asset amortization and contingent consideration expense (accretion of the contingent consideration liability) related to the products acquired, which we estimate in the range of $1.6 million
- $2.0 million in 2013. See Note 15, "Subsequent Event-Acquisition," of the consolidated financial statements included in Part IV, Item 15 of this annual report for further discussion of this matter.

Federal investigation legal and accrued indemnification costs. In the fourth quarter of 2011, we recorded a $0.4 million reduction in our accrual for indemnification costs to reflect a change in our estimate of the range of our contingent liability for indemnification obligations we have to three former employees related to a federal investigation. See Note 14, "Commitments and Contingencies," of the consolidated financial statements included in Part IV, Item 15 of this annual report for further discussion of this matter.

Settlement costs-license agreement dispute. In the fourth quarter of 2011, we recorded a $1.8 million charge related to the termination of a license agreement which was executed in January 2012. Royalty expenses paid or accrued under the license agreement for the year ended December 31, 2011 were approximately $1.5 million; royalty expenses were not incurred subsequent to the effective date of the termination agreement. See Note 13, "Settlement costs-license agreement dispute," of the consolidated financial statements included in Part IV, Item 15 of this report for further discussion of this matter.

Litigation charge. We were engaged in a dispute since 1999 with Cardiomedica. In 2009, a Dutch court issued a ruling in favor of Cardiomedica, requiring us to pay $0.6 million, which ruling Cardiomedica appealed. In September 2011, the Dutch Court of Appeals issued a ruling in favor of Cardiomedica, requiring us to pay to Cardiomedica an additional $0.6 million in damages plus $0.2 million in interest. We paid and expensed this amount in September 2011.

Other income (expense). In 2011, other expense included litigation related interest expense of $0.2 million. As discussed above, in September 2011, the Dutch Court of Appeals issued a ruling in favor of Cardiomedica, requiring us to pay to Cardiomedica $0.6 million for lost profits plus $0.2 million in interest. We paid and expensed this amount in September 2011. Other items within other income (expense) include interest income and foreign currency transaction gains and losses. Realized gains and losses on foreign currency transactions are primarily due to the cash settlement in dollars of intercompany transactions with our Dutch subsidiary, whose functional currency is the euro.


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Income before income taxes

Pre-tax income for the year ended December 31, 2012 was $3.0 million, compared with pre-tax income of $1.1 million for the year ended December 31, 2011. The current year results included $0.3 million of acquisition related costs, and the prior year results included $2.0 million of litigation and settlement costs, as described above.

Income tax expense

We recorded income tax expense of $0.7 million in 2012, which included approximately $0.3 million of currently payable income tax expense in foreign jurisdictions and $0.1 million of state income taxes currently payable for the year ended December 31, 2012. Additionally, we recorded deferred federal and state tax expense of $0.3 million representing a deferred tax liability related to the difference between book and tax accounting for our goodwill, which is amortized over 15 years for tax purposes but not amortized for book purposes. We continue to maintain a valuation allowance for substantially all of our deferred tax assets including our U.S. net operating losses, and therefore we did not incur current U.S. federal tax expense against our pretax income during the year ended December 31, 2012.

Our ability to realize the benefit of our deferred tax assets will depend on the generation of future taxable income through profitable operations. Due to our history of losses and the lack of sufficient certainty of generating future taxable income, we have recorded a full valuation allowance against our deferred tax assets, as we continue to believe there is sufficient uncertainty surrounding the realization of our U.S. deferred tax assets through future taxable income. We will continue to assess the need for a valuation allowance in future periods. In the event there is a change in circumstances in the future which would affect the utilization of our deferred tax assets, the tax provision in that period would be adjusted by the amount of the assets then deemed to be realizable. We do not expect to reduce the valuation allowance against our U.S. deferred tax assets to below 100% of its gross amount until we have a sufficient historical trend of taxable income and can predict future income with a higher degree of certainty. Because we continue to maintain a full valuation allowance against our deferred tax assets, our effective tax rate is currently lower than it would be if there were no valuation allowance.

See Note 10, "Income Taxes," to our consolidated financial statements included in Part IV, Item 15 of this annual report for further discussion of our income tax provision.

Net income

We recorded net income for the year ended December 31, 2012 of $2.2 million, or $0.06 per fully diluted share, compared with net income of $0.9 million, or $0.03 per fully diluted share, for the year ended December 31, 2011.

Functional currency

The functional currency of Spectranetics International B.V., Spectranetics Deutschland GmbH and Spectranetics Austria GmbH is the euro. All revenue and expenses are translated to U.S. dollars in the consolidated statements of operations using weighted average exchange rates during the year. Fluctuations in currency rates during the year ended December 31, 2012 as compared with the year ended December 31, 2011 caused a decrease in consolidated revenue of approximately $1.2 million and a decrease in consolidated net income of approximately $0.5 million.


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Year Ended December 31, 2011 Compared with Year Ended December 31, 2010

Selected Consolidated Statements of Comprehensive Income (Loss) Data

The following tables present Consolidated Statements of Comprehensive Income
(Loss) data for the years ended December 31, 2011 and December 31, 2010 based on
the percentage of revenue for each line item, as well as the dollar and
percentage change of each of the items.

                                                    For the year ended December 31,
(in thousands, except for                      % of                    % of
percentages)                        2011      rev(1)       2010       rev(1)     $ change     % change
Revenue
Disposable products revenue:
Vascular intervention            $ 62,264       49  %   $  60,224       51  %   $  2,040           3  %
Lead management                    46,480       37         41,162       35         5,318          13
Total disposable products
revenue                           108,744       85        101,386       86         7,358           7
Service and other revenue          10,122        8          9,380        8           742           8
Laser revenue:
Equipment sales                     3,269        3          1,937        2         1,332          69
Rental fees                         5,152        4          5,214        4           (62 )        (1 )
Total laser revenue                 8,421        7          7,151        6         1,270          18
Total revenue                     127,287      100        117,917      100         9,370           8
Gross profit                       91,564       72         83,886       71         7,678           9
Operating expenses
Selling, general and
administrative                     70,502       55         66,665       57         3,837           6
Research, development and other
technology                         17,729       14         14,900       13         2,829          19
Federal investigation legal and
accrued indemnification costs        (370 )      -          6,798        6        (7,168 )      (105 )
Settlement costs-license
agreement dispute                   1,821        1              -        -         1,821          nm
Litigation charge                     596        -              -        -           596          nm
Employee termination costs              -        -          1,630        1        (1,630 )        nm
Asset impairment charge                 -        -            939        1          (939 )        nm
Total operating expenses           90,278       71         90,932       77          (654 )        (1 )
Operating income (loss)             1,286        1         (7,046 )     (6 )       8,332          nm
Other income (expense)               (161 )      -            215        -          (376 )        nm
Income (loss) before income
taxes                               1,125        1         (6,831 )     (6 )       7,956          nm
Income tax expense                    231        -          6,232        5        (6,001 )        nm
Net income (loss)                $    894        1  %   $ (13,063 )    (11 )%   $ 13,957          nm

(1) Percentage amounts may not add due to rounding.

nm = not meaningful.


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Revenue and gross margin

Revenue for the year ended December 31, 2011 was $127.3 million, an increase of 8% as compared with $117.9 million for the year ended December 31, 2010. Of the $9.4 million revenue increase, approximately 80% was in disposables product . . .

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