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VOLC > SEC Filings for VOLC > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for VOLCANO CORP


3-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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," "could," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "intends" or "continues" or the negative of those words and other comparable words. Forward-looking statements include, but are not limited to, statements about:
• our intentions, beliefs and expectations regarding our expenses, sales, operations and future financial performance;

• our operating results;

• our plans for future products and enhancements of existing products;

• anticipated growth and trends in our business;

• the timing of and our ability to maintain and obtain regulatory clearances or approvals;

• our belief that our cash and cash equivalents and available-for-sale investments will be sufficient to satisfy our anticipated cash requirements;

• our expectations regarding our revenues, customers and distributors;

• our beliefs and expectations regarding our market penetration and expansion efforts;

• our expectations regarding the benefits and integration of recently-acquired businesses and our ability to make future acquisitions and successfully integrate any such future-acquired businesses;

• our anticipated trends and challenges in the markets in which we operate; and

• our expectations and beliefs regarding and the impact of investigations, claims and litigation

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. 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 imaging, or IVI, comprised largely of 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 diagnostic angiograms and percutaneous interventional, or PCI, therapy procedures in the coronary arteries or peripheral arteries and veins. We are facilitating the adoption of functional PCI, in which our FFR technology is used to determine whether or not a stent is necessary, and IVUS is used to guide stent placement and optimization. We market our products to physicians, nurses and technicians who perform a variety of endovascular based coronary and peripheral interventional procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals.
Our products consist of multi-modality consoles that 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, and additional functionality options such as Virtual Histology, or VHฎ, 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, Forward-Looking Intra-Cardiac Echo, or FL.ICE, catheters, high resolution Focal Acoustic Computed Tomography, or FACT, catheters, and ultra-high resolution Optical Coherence Tomography, or OCT, systems and catheters. Our Valet microcatheter, Visions PV .035 catheter and Short Tip Eagle Eye Platinum, or EEP, products received 510(k) clearance and CE Mark approval in 2012. Our Preview™, the first generation FL.IVUS device, received CE Mark for peripheral indications in 2012.
Through Axsun Technologies, Inc., or Axsun, one of our wholly-owned subsidiaries, we also develop and manufacture optical monitors for the telecommunications industry, laser and non-laser light sources, 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. We have infrastructure in the U.S.A., Europe, Japan, Costa Rica and Israel. Our corporate office is located in California, U.S. Our manufacturing operations are located in California and Massachusetts, U.S., and Costa Rica. We have research and development facilities in California, Massachusetts, Ohio, Georgia, and Israel. We have sales and distribution offices in the U.S., Japan, Europe and South Africa.
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, 2013, we had a worldwide installed base of over 7,900 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, 2013, the sale of our single-procedure disposable catheters and guide wires accounted for $74.8 million, or 81.5% of our medical segment revenues, a $1.2 million, or 1.6% increase from the three months ended March 31, 2012, in which the sale of our single-procedure disposable catheters and guide wires accounted for $73.6 million, or 83.3% of our medical segment revenues. In the three months ended March 31, 2013 and 2012, 46.7% and 48.0%, respectively, of our revenues and 22.1% and 22.3%, respectively, of our operating expenses were denominated in various non-U.S. dollar currencies, primarily the euro and the Japanese 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. 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 increased 15.5% from 78.1 in the three months ended March 31, 2012 to 90.2 in the three months ended March 31, 2013, which resulted in a net negative impact to our operating results for the three months ended March 31, 2013 in the amount of approximately $2.6 million. The average exchange rate of one euro to U.S. dollar remained consistent in the three months ended March 31, 2013 compared with the three months ended March 31, 2012.
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. We do not carry significant inventory of transducers, substrates or scanner subassemblies. If we had to change suppliers, we expect that it would take 6 to 24 months to identify appropriate suppliers, complete design work and undertake the necessary inspections and testing before the new transducers, substrates and subassemblies would be available. External Factors
In September 2009, published findings from the Fractional Flow Reserve versus Angiography for Multivessel Evaluation, or FAME, study 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 (heart attack) compared to angiographic guidance alone. In August 2012, the results of the Fractional Flow Reserve-Guided PCI vs. Medical Therapy in Stable Coronary Disease, or FAME 2, study were published in the New England Journal of Medicine. FAME 2 showed that patients receiving PCI with proven ischemia by FFR had 66% fewer primary endpoint events including death, myocardial infarction and urgent revascularization's (e.g. coronary bypass) than those patients treated with optimal medical therapy alone. We believe these findings will continue to drive the growth and adoption of our disposable FFR wire products.
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. The Company's effective rate for this excise tax is less than the statutory rate which is primarily due to international sales. We expect our medical device excise taxes to be approximately 0.5% to 1.0% of revenue for the remainder of 2013.
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 certain regions of the world may have adverse consequences to the global economy or to our customers in certain regions, which could negatively impact our business. 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 revenue 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, 2013, we generated $93.2 million of revenues which is comprised of $91.7 million from our medical segment and $1.5 million from our industrial segment. We experienced increases in revenues related to consoles and FFR single-procedure disposables and decrease in revenues related to IVUS single-procedure disposables in the three months ended March 31, 2013 compared with the same period in prior year. In the three months ended March 31, 2013, 9.8% of our medical segment revenues were derived from the sale of our consoles, 52.3% from IVUS single-procedure disposables and 29.2% from FFR single-procedure disposables as compared with 9.2% from consoles, 60.5% from IVUS single-procedure disposables and 22.8% from FFR single-procedure disposables in the same period in prior year. Other revenues consist primarily of service and maintenance revenues, shipping and handling revenues, sales of distributed products, spare parts sales, and license fees.
We expect 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 are generated by our direct sales representatives or through independent distributors and are shipped throughout the world from facilities in California, Massachusetts, Belgium, Japan and 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 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 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 service, 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.
The new U.S. medical device excise tax on the sale of medical devices was effective January 1, 2013. The statutory rate of the medical device excise tax is 2.3% of revenues on initial sales of finished medical products sold in the United States. The Company's effective rate for this excise tax is less than the statutory rate which is primarily due to international sales. We expect our medical device excise taxes to be approximately 0.5% to 1.0% of revenue for the remainder of 2013.


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 developed technology, licenses, customer relationships, patents and trademarks, and covenant-not-to-compete, using the straight-line method over their estimated useful lives of up to 20 years. These assets are regularly tested for impairment and abandonment.
Acquisition-related items. Acquisition-related items consists of acquisition transaction costs and subsequent revision, if any, to the contingent consideration related to acquisitions.
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 comprised of interest expense related to our convertible senior notes, including coupon interest, accretion of debt discount, and amortization of issuance costs, and interest expense related to our long term debt to the Israeli government resulting from the Sync-RX acquisition, offset by interest capitalization related to the Costa Rica plant construction, before the plant was placed into service in the second quarter of 2012, and our global Enterprise Resource Planning, or ERP, system implementation.
Exchange Rate Gain (Loss). Exchange rate gain (loss) is comprised of foreign currency transaction and remeasurement gains and losses, and the effect of changes in value and net settlements of our foreign exchange 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, the 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 consolidated statements of operations for the three months ended March 31, 2013 and 2012 presented in both absolute dollars (in thousands) and as a percentage of revenues, with the dollar and percentage change year over year:

                                           Three Months Ended March 31,                    Changes
                                           2013                    2012                $             %
Revenues                           $ 93,231     100.0  %   $ 90,360     100.0  %   $  2,871          3.2  %
Cost of revenues, excluding
amortization of intangibles          33,127      35.5        29,573      32.7         3,554         12.0
Gross profit                         60,104      64.5        60,787      67.3          (683 )       (1.1 )
Operating expenses:
Selling, general and
administrative                       43,829      47.0        44,345      49.1          (516 )       (1.2 )
Research and development             15,651      16.8        13,649      15.1         2,002         14.7
Amortization of intangibles             834       0.9           872       1.0           (38 )       (4.4 )
Acquisition related items             1,578       1.7             -         -         1,578            -
Total operating expenses             61,892      66.4        58,866      65.2         3,026          5.1
Operating income                     (1,788 )    (1.9 )       1,921       2.1        (3,709 )     (193.1 )
Interest income                         338       0.4           230       0.3           108         47.0
Interest expense                     (6,545 )    (7.0 )      (1,472 )    (1.6 )      (5,073 )      344.6
Exchange rate loss                     (778 )    (0.8 )        (175 )    (0.2 )        (603 )      344.6
Other, net                            1,898       2.0           (96 )    (0.1 )       1,994     (2,077.1 )
Income before income tax             (6,875 )    (7.4 )         408       0.5        (7,283 )   (1,785.0 )
Income tax (benefit) expense         (3,714 )    (4.0 )         137       0.2        (3,851 )   (2,810.9 )

Net income $ (3,161 ) (3.4 )% $ 271 0.3 % $ (3,432 ) (1,266.4 )%


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

                                     Three Months Ended March 31,                Changes
                                         2013              2012              $               %
Medical segment:
Consoles                           $         8,959     $     8,116     $       843           10.4  %
Single-procedure disposables:
IVUS                                        47,966          53,484          (5,518 )        (10.3 )%
FFR                                         26,823          20,138           6,685           33.2  %
Other                                        7,971           6,620           1,351           20.4  %
Sub-total medical segment                   91,719          88,358           3,361            3.8  %
Industrial segment                           1,512           2,002            (490 )        (24.5 )%
                                   $        93,231     $    90,360     $     2,871            3.2  %

The following table sets forth our revenues by geographic area (in thousands) and the changes in revenues in the specified periods:

                                       Three Months Ended March 31,                Changes
                                           2013              2012              $               %
Revenues (1):
United States                        $        43,331     $    41,377     $     1,954            4.7  %
Japan                                         28,181          30,789          (2,608 )         (8.5 )%
Europe, the Middle East and Africa            16,088          13,664           2,424           17.7  %
Rest of world                                  5,631           4,530           1,101           24.3  %
                                     $        93,231     $    90,360     $     2,871            3.2  %

(1) Revenues are attributed to geographies based on the location of the customer, except for shipments to original equipment manufacturers, which are attributed to the country of origin of the equipment distributed.

Comparison of Three Months Ended March 31, 2013 and 2012 Revenues. Overall, the increase in the medical segment revenue in the three months ended March 31, 2013 compared with the three months ended March 31, 2012 was driven by increased demand for our consoles and FFR disposable products, partially offset by the unfavorable impacts of foreign exchange rates to the yen and the decreased demand for the IVUS disposable products due to a decline in the number of PCI procedures in the United States. We believe the decline is in part due to concerns by clinicians and payers regarding the appropriateness of conducting PCI procedures, concerns regarding the efficacy of therapeutic treatment options, the long-term efficacy of drug-eluting stents, economic constraints, and reduced rates of restenosis. If the number of PCI procedures continues to decline, it may adversely impact our operating results and our business prospects.
The increases in FFR disposable revenues were primarily due to the increased adoption of the technology based on clinical study data. 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 across all our key geographic markets except for Japan. The decrease in Japan is mainly due to the unfavorable impact of foreign currency exchange related to the yen and the unfavorable impact on pricing as a result of a reduction in the medical reimbursement rate in Japan that became effective in the second quarter of 2012.
Cost of Revenues. The increase in the cost of revenues in the three months ended March 31, 2013 compared with the three months ended March 31, 2012 was primarily due to higher sales volume. Gross margin was 64.5% of revenues in three months ended March 31, 2013, decreasing from 67.3% of revenues in the three months ended March 31, 2012. This unfavorable change in gross margin was primarily the result of the unfavorable impacts of foreign exchange rates related to the yen, product mix, duplicate costs related to the transition of certain manufacturing operations to Costa Rica, and unfavorable impact on pricing as a result of a reduction in the medical reimbursement rate in Japan.
Selling, General and Administrative. The decrease in selling, general and administrative expenses in the three months ended March 31, 2013 as compared with the three months ended March 31, 2012 was primarily due to the favorable impact of foreign


currency exchange related to yen and the Costa Rica start up expense during the pre-production phase in the first quarter of 2012 while there was no such expense during the first quarter of 2013. The decrease was largely offset by the higher variable costs for U.S. sales driven by higher sales volumes and expansion of Japanese and European sales and marketing organization, including continued growth in our Japanese and European operation to support our direct sales efforts there and increased information technology and infrastructure expenses to support company growth.
In addition, medical device excise taxes for the first quarter of 2013 totaled $634,000, or 0.68% of revenue. This new U.S. tax on the sale of medical devices was effective January 1, 2013, thus there was no corresponding amount for the first quarter of 2012. The statutory rate of the medical device excise tax is 2.3% of revenues on initial sales of finished medical products sold in the United States. The Company's effective rate for this excise tax is less than the statutory rate which is primarily due to international sales. We expect our medical device excise taxes to be approximately 0.5% to 1.0% of revenue for the remainder of 2013.
Research and Development. The increase in research and development expenses in the three months ended March 31, 2013 compared with the three months ended . . .

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