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

Show all filings for ZELTIQ AESTHETICS INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for ZELTIQ AESTHETICS INC


13-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with "Selected Financial Data" and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. In addition to historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ substantially from those referred to herein due to a number of factors, including but not limited to risks described in the section entitled Risk Factors and elsewhere in this Annual Report. Overview
We are a medical technology company focused on developing and commercializing products utilizing our proprietary controlled cooling technology platform. Our first commercial product, the CoolSculpting System, is designed to selectively reduce stubborn fat bulges that may not respond to diet or exercise. We generate revenues from sales of our CoolSculpting System and from sales of consumables when our physician customers pay for each CoolSculpting procedure they perform. We received clearance from the FDA in September 2010 to market CoolSculpting for the selective reduction of fat around the flanks, an area commonly referred to as the "love handles." In May 2012, CoolSculpting was cleared by the FDA for treatment of "belly fat" or non-surgical reduction of fat for the abdomen area. We may seek additional regulatory clearances from the FDA to expand our U.S. marketed indications for CoolSculpting to areas on the body other than the flanks and abdomen. We have received regulatory approval or are otherwise free to market CoolSculpting in 55 international markets where use of the product is generally not limited to specific treatment areas. Physicians in these markets commonly perform CoolSculpting procedures on the inner thighs, back, and chest, in addition to the flanks and abdomen.
As of December 31, 2012, our worldwide sales force consisted of 62 professionals. In the United States, Canada and four key markets in Europe (United Kingdom, Germany, France and Spain), we use our direct sales organization to selectively market


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CoolSculpting. In markets outside of North America and the four key markets in Europe, we sell CoolSculpting through a network of distributors. We intend to continue developing our international sales and marketing organization to focus on increasing sales and strengthening our physician relationships. We also intend to seek regulatory approval to market CoolSculpting in key additional international markets, including China. Revenues from markets outside of North America accounted for 26% of our total revenues for the years ended December 31, 2012 and 2011.
Our ongoing research and development activities are primarily focused on improving and enhancing our CoolSculpting System and CoolSculpting procedure. In addition to these development activities related to CoolSculpting, we are exploring additional uses of our proprietary controlled cooling technology platform for the dermatology, plastic surgery, and aesthetic markets. We are also exploring potential therapeutic uses for our platform technology, either directly or through collaborative arrangements with strategic partners. In October 2011, we completed our initial public offering, or IPO, at which time we sold a total of 7,743,000 shares of our common stock and certain of our stockholders sold 307,000 shares of our common stock. We received net proceeds of $90.7 million, net of underwriting discounts and commissions and other costs associated with the offering.
Revenues
We generate revenues from sales of our CoolSculpting System and from sales of consumables when our physician customers pay for each CoolSculpting procedure they perform. We generated revenues of $76.2 million, $68.1 million and $25.5 million for the years ended December 31, 2012, 2011 and 2010, respectively. Systems revenues. Sales of our CoolSculpting System include the CoolSculpting control unit and our CoolSculpting vacuum applicators. Some practices may purchase more than one CoolSculpting System. Our standard terms do not allow for trial or evaluation periods, rights of return, or refund payments contingent upon the customer obtaining financing or other terms that could impact the customer's obligation.
During the year ended December 31, 2012, our system sales were impacted by new product launches and trial offers by our competitors that created competition for physician capital equipment dollars. Despite this, we grew our worldwide installed base by 53% from 967 units as of December 31, 2011, to 1,483 units as of December 31, 2012.
Consumable revenues. We generate consumable revenues through sales of CoolSculpting Procedure Packs, each of which includes our consumable CoolGels and CoolLiners and a disposable computer cartridge that we market as the CoolCard. The CoolCard contains enabling software that permits our physician customer to perform a fixed number of CoolSculpting procedures. Consumable revenues accounted for approximately 49%, 32% and 17% of our total revenues for the years ended December 31, 2012, 2011 and 2010, respectively. During the years ended December 31, 2012 and December 31, 2011, we shipped approximately 300,000 and 190,000 CoolSculpting Procedure Packs to our physician customers, respectively.
Our business plan focuses on expanding our base of physician customers, and increasing our consumable revenues by driving demand for CoolSculpting procedures through our physician and consumer marketing programs. We anticipate that as we implement our business plan our consumable revenues will increase as a percentage of our total revenues.
Seasonality. Seasonal fluctuations in the number of physician customers in their offices and available to take appointments as well as their patients have affected, and are likely to continue to affect, our business. Specifically, our customers often take vacation or are on holiday during the summer months and therefore tend to perform fewer procedures, particularly in Europe. These seasonal trends have caused and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates.
Market in which we operate. The medical technology and aesthetic product markets are highly competitive and dynamic, and are characterized by rapid and substantial technological development and product innovations. We compete with many other technologies for consumer demand. Further, the aesthetic industry in which we operate is particularly vulnerable to economic trends. The decision to undergo a procedure from our systems is driven by consumer demand. Most procedures performed using our systems are elective procedures, the cost of which must be borne by the patient, and are not reimbursable through government or private health insurance. In times of economic uncertainty or recession, individuals often reduce the amount of money that they spend on discretionary items, including aesthetic procedures. The general economic difficulties being experienced and the lack of availability of consumer credit for some of our customers' patients are adversely affecting the market in which we operate. Critical Accounting Policies and Estimates Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America or GAAP. The preparation of our consolidated financial statements requires management to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the applicable


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periods. Management bases its estimates, assumptions, and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our financial statements, which, in turn, could materially change our results from those reported. Management evaluates its estimates, assumptions, and judgments on an ongoing basis. Historically, our critical accounting estimates have not differed materially from actual results. However, if our assumptions change, we may need to revise our estimates, or take other corrective actions, either of which may also have a material adverse effect on our statements of operations, liquidity, and financial condition.
The consolidated financial statements include the accounts of ZELTIQ and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated.
We believe the following critical accounting policies involve significant areas where management applies judgments and estimates in the preparation of our financial statements.
Revenue Recognition
Our revenues are derived from the sales of the CoolSculpting System, consisting of a control unit and applicators; and from Procedure Packs, consisting of consumables and CoolCards. Embedded software exists in the CoolCard product to permit our physician customers to perform a fixed number of CoolSculpting procedures. This software is not marketed separately from the CoolSculpting System or from the CoolCard. Rather, the functionality that the software provides is part of the overall CoolCard product. The CoolSculpting System is marketed as a non-invasive aesthetic device for the reduction of fat, not for its embedded software attributes included in the CoolCard that enable its use. We do not provide rights to upgrades and enhancements or post contract customer support for the embedded software. In addition, we do not incur significant software development costs or capitalize our software development costs. Based on this assessment, we consider the embedded software in the CoolCard incidental to the CoolCard product as a whole and determined that revenue recognition should not be governed by the provisions of Topic 985 of the FASB Accounting Standards Codification, or ASC. We earn revenue from the sale of our products to physicians and to distributors. We recognize revenue when persuasive evidence of an arrangement exists, transfer of title to the customer has occurred, the sales price is fixed or determinable, and collectability is probable. Revenues are deferred in the event that any of the revenue recognition criteria is not met.

Persuasive Evidence of an Arrangement. We use contracts or customer purchase orders to determine the existence of an arrangement.

Transfer of title. Our standard terms generally specify that title transfers upon shipment to the customer. We use third party shipping documents to verify that title has transferred.

Sales Price Fixed or Determinable. We assess whether the sales price is fixed or determinable at the time of the transaction. Sales prices are documented in the executed sales contract or purchase order received prior to shipment. Our standard terms do not allow for trial or evaluation periods, rights of return or refund, payments contingent upon the customer obtaining financing or other terms that could impact the customer's obligation.

Collectability. We assess whether collection is reasonably assured based on a number of factors, including the customer's past transaction history and credit worthiness.

Multiple-Element Arrangements. Typically, all products sold to a customer are delivered at the same time. If a partial delivery occurs as authorized by the customer, we allocate revenue to the various products based on their vendor-specific objective evidence of fair value, or VSOE, if VSOE exists according to ASC 605-25 as the basis of determining the relative selling price of each element. If VSOE does not exist, we may use third party evidence of fair value, or TPE, to determine the relative selling price of each element. If neither VSOE nor TPE exists, we may use management's best estimate of the sales price, or ESP, of each element to determine the relative selling price. The relative selling prices for control units, applicators and CoolCards are based on established price lists and separate, stand-alone sales of these elements. We establish best estimates within a range of selling prices considering multiple factors including, but not limited to, factors such as size of transaction, pricing strategies and market conditions. We believe the use of the ESP allows revenue recognition in a manner consistent with the underlying economics of the transaction. Our products do not require maintenance or support.

Shipping and handling costs. Shipping and handling costs are expensed as incurred and included in cost of revenues. In those cases where we bill shipping and handling costs to customers, the amounts billed are classified as revenue.


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Investments
We invest our excess cash balances primarily in certificates of deposit, commercial paper, corporate bonds, and U.S. Government agency securities. Investments with original maturities greater than 90 days that mature less than one year from the consolidated balance sheet date are classified as short-term investments. We classify all of our investments as available-for-sale and record such assets at estimated fair value in the consolidated balance sheets, with unrealized gains and losses, if any, reported as a component of accumulated other comprehensive income (loss) in stockholders' equity. Realized gains and losses from maturities of all such securities are reported in earnings and computed using the specific identification cost method. Realized gains or losses and charges for other-than-temporary declines in value, if any, on available-for-sale securities are reported in other income (expense) as incurred. We periodically evaluate these investments for other-than-temporary impairment.
Product Warranty
For 2012, we provided a three-year standard warranty on our CoolSculpting control units and a one-year warranty on our CoolSculpting applicators. In addition to these product warranties, we offered two years of extended warranty service on our control units and applicators. For our direct customers in Europe, we offered a one-year standard warranty on our CoolSculpting control units and applicators with an option for two years of extended warranty service on both. In 2013, we will transition to offering a one-year standard warranty on all of our CoolSculpting control units worldwide.In the event of a warranty claim, our Customer Care department arranges for a prompt service call. Our goal is to minimize the disruption caused by a service event, and we strive to repair a customer's CoolSculpting System or provide the customer with a replacement CoolSculpting System promptly after notifying us of a problem. In markets outside of North America, our CoolSculpting System is serviced and supported through our independent distributors and certified third-party service providers.
We estimate and provide for future costs for initial product warranties upon shipment. We base product warranty costs on related freight, material, technical support labor, and overhead costs. We provide for the estimated product warranty costs by considering our historical costs and applying the experience rates to each product sold over the outstanding warranty period. We must exercise judgment in estimating our expected product warranty costs. If actual product failure rates, freight, material, technical support, labor, and overhead costs differ from our estimates, we will be required to revise our estimated warranty liability. We have recorded a liability of $0.9 million and $0.7 million as of December 31, 2012 and 2011, respectively, for future warranty expense. We offer an extended warranty of up to two years on both our CoolSculpting control units and CoolSculpting vacuum applicators. We recognize the revenues from the sale of an extended warranty over the extended warranty coverage period. Our revenue and related obligations from sale of extended warranties to date has not been significant.
Stock-Based Compensation
We recognize stock-based compensation cost for only those shares ultimately expected to vest on a straight-line basis over the requisite service period of the award. We estimate the fair value of stock options using a Black-Scholes valuation model, which requires the input of highly subjective assumptions, including the option's expected term and stock price volatility. In addition, judgment is also required in estimating the number of stock-based awards that are expected to be forfeited. Forfeitures are estimated based on historical experience at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The assumptions used in calculating the fair value of share-based payment awards represent management's best estimates, but these estimates involve inherent uncertainties and the application of management's judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.
Income Taxes
We are subject to income taxes in multiple jurisdictions, including but not limited to the United States and United Kingdom, and we use estimates in determining our provision for income taxes. We use the asset and liability method of accounting for income taxes. Under this method, we calculate deferred tax asset or liability account balances at the balance sheet date using current tax laws and rates in effect for the year in which the differences are expected to affect our taxable income.
Recognition of deferred tax assets is appropriate when realization of such assets is more likely than not. We recognize a valuation allowance against our net deferred tax assets if it is more likely than not that some portion of the deferred tax assets will not be fully realizable. This assessment requires judgment as to the likelihood and amounts of future taxable income by tax jurisdiction. At December 31, 2012, we had a $44.9 million valuation allowance against $45.0 million of deferred tax assets.
We follow the accounting guidance for uncertainties in income taxes, which prescribes a recognition threshold and measurement process for recording uncertain tax positions taken, or expected to be taken in a tax return, in the consolidated financial statements. None of our currently unrecognized tax benefits would affect our effective income tax rate if recognized, due to the valuation allowance that currently offsets our deferred tax assets. We do not anticipate the total amount of unrecognized income tax benefits relating to tax positions existing at December 31, 2012, will significantly increase or decrease in the next 12 months.


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We assess all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the position's sustainability and is measured at the largest amount of benefit that is greater than 50% likely to be realized upon ultimate settlement. As of each balance sheet date, unresolved uncertain tax positions must be reassessed, and we will determine whether the factors underlying the sustainability assertion have changed and whether the amount of the recognized tax benefit is still appropriate. The recognition and measurement of tax benefits requires significant judgment. Our judgments concerning the recognition and measurement of a tax benefit might change as new information becomes available.

Utilization of net operating losses and tax credit carryforwards may be limited by "ownership change" rules, as defined in Section 382 of the Internal Revenue Code. Similar rules may apply under state tax laws. In the event we experience any subsequent changes in ownership, the amount of net operating losses and research and development credit carryovers available in any taxable year could be limited and may expire unutilized.
Results of Operations
Comparison of Years Ended December 31, 2012 and 2011 Revenues (in thousands, except for percentages):

                                        Year Ended
                                       December 31,
                        2012        2011       $ Change     % Change
Revenues
Systems               $ 39,145    $ 46,552    $ (7,407 )     (16 )%
Consumable revenues     37,049      21,592      15,457        72  %
Total revenues        $ 76,194    $ 68,144    $  8,050        12  %

Total revenues increased by $8.1 million, or 12%, to $76.2 million in 2012 compared to $68.1 million in 2011.
Systems revenues. Systems revenues decreased by $7.4 million to $39.1 million in 2012 compared to $46.6 million in 2011. Systems revenues represented 51% and 68% of total revenues for the years ended December 31, 2012 and 2011, respectively. The systems revenues in 2012 were impacted by new product launches and trial offers by our competitors that created competition for physician capital equipment dollars as well as by changes in our sales force in the North American market. Our rest of the world systems sales were impacted by the transition to a direct sales model.
Consumable revenues. Consumable revenues increased by $15.5 million to $37.0 million in 2012 compared to $21.6 million in 2011. Consumable revenues represented 49% and 32% of total revenues for the years ended December 31, 2012 and 2011, respectively. The increase in consumable revenues was primarily due to the growth of our installed base of worldwide CoolSculpting Systems, and an increased number of procedures performed by our physician customers driven by our targeted physician and consumer marketing programs.

Cost of Revenues and Gross Profit (in thousands, except for percentages):

                                         Year Ended
                                        December 31,
                         2012         2011       $ Change    % Change
Cost of revenues      $ 25,506     $ 26,101     $   (595 )     (2 )%
% of total revenues         33 %         38 %
Gross profit          $ 50,688     $ 42,043     $  8,645       21  %
Gross profit %              67 %         62 %

Gross profit as a percentage of revenues typically fluctuates with product mix, selling prices, material costs and revenue levels. Gross profit was $50.7 million, or 67% of revenues, in 2012, compared to gross profit of $42.0 million, or 62% of revenues, in 2011. The increase in gross profit as a percentage of revenues was driven by an increase in consumable revenues as a percentage


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of total revenues and a decrease in the per unit manufacturing cost of systems primarily due to lower direct material costs driven by our continued focus on product cost reductions and negotiations with suppliers.

Operating Expenses (in thousands, except for percentages):

                                                Year Ended
                                               December 31,
                                2012         2011       $ Change     % Change
Operating expenses:
Research and development     $ 12,693     $ 10,488     $   2,205        21 %
% of total revenues                17 %         15 %
Sales and marketing          $ 51,167     $ 28,953     $  22,214        77 %
% of total revenues                67 %         42 %
General and administrative   $ 16,867     $ 11,299     $   5,568        49 %
% of total revenues                22 %         17 %
Total operating expenses     $ 80,727     $ 50,740     $  29,987        59 %

Research and development. Research and development expenses increased by $2.2 million, or 21%, to $12.7 million in 2012 compared to $10.5 million in 2011. The increase in research and development expenses was primarily due to an increase of $1.2 million in payroll related costs and higher stock-based compensation expenses by approximately $0.4 million. The increase in payroll related costs was attributed to a higher headcount and severance costs incurred during the year ended December 31, 2012, while the increase in stock-based compensation expenses were related to new grants related to the higher headcount. Such increases in headcount also resulted in additional facilities and allocation charges of $0.3 million.
Sales and marketing. Sales and marketing expenses increased by $22.2 million, or 77%, to $51.2 million in 2012 compared to $29.0 million in 2011. The increase in sales and marketing expenses was mostly due to a $10.1 million increase in advertising expenses incurred in conjunction with our direct marketing campaign and other sales and marketing initiatives, a $6.2 million increase in payroll related costs and a $1.9 million increase in sales commission expenses driven by higher sales levels. The remaining increase was attributed to higher stock-based compensation expenses, higher travel expenses and higher public relations expenses during the year ended December 31, 2012. The increase in these expenses is directly related to the growth of our sales and marketing organization. General and administrative. General and administrative expenses increased by $5.6 million, or 49%, to $16.9 million in 2012 compared to $11.3 million for the same period in 2011. The increase in general and administrative expenses was primarily due to a $2.8 million increase in legal expenses primarily related to our ongoing litigation and IP enforcement activities, a $2.3 million increase in payroll related costs and higher stock-based compensation expenses by $2.0 million. Consulting, recruiting and travel expenses also increased during the year ended December 31, 2012. The increase was partially offset by lower accounting fees of $1.2 million incurred during the year ended December 31, 2012 compared to the prior year. Higher accounting fees during the year ended December 31, 2011, were incurred in the preparation for our initial public offering, or IPO. The increase in payroll related costs was attributed to a higher headcount and severance costs recognized during the year ended December 31, 2012. The stock-based compensation expense for the year ended December 31, 2012, included $0.7 million in modification charges incurred in connection with the severance packages to our former executives.


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Interest Income (Expense) and Other Income (Expense), Net (in thousands, except for percentages):

                                                  Year Ended
                                                 December 31,
                                   2012       2011       $ Change    % Change
Interest income (expense), net   $ 129      $  (93 )    $     222      (239 )%
% of total revenues                  -  %        -  %
Other income (expense), net      $ (92 )    $ (765 )    $     673       (88 )%

% of total revenues - % (1 )%

Interest income (expense), net. Interest income (expense), net was an income of $0.1 million in 2012 compared to an expense of $0.1 million in 2011. During 2012, interest income was earned on our available-for-sale securities. During 2011, interest expense was incurred in relation to our note payable that was paid in full in the quarter ended March 31, 2012.
Other income (expense), net. Other income (expense), net, in 2012 was an expense . . .

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