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ZLTQ > SEC Filings for ZLTQ > Form 10-Q on 31-Oct-2013All Recent SEC Filings

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Form 10-Q for ZELTIQ AESTHETICS INC


31-Oct-2013

Quarterly Report


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

You should read the following discussion of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and with our Management's Discussion and Analysis of Financial Condition and Results of Operations and financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012. 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 in this Quarterly Report on Form 10-Q.

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. We generate revenue from sales of our CoolSculpting system and from sales of consumables to our customers. We received clearance from the Food and Drug Administration, or 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 numerous international markets where use of the product is generally not limited to specific treatment areas. Customers in these markets commonly perform CoolSculpting procedures on the inner thighs, back, and chest, in addition to the flanks and abdomen.

In the United States and related territories and Canada we use our direct sales organization to selectively market CoolSculpting. In markets outside of North America, including Asia Pacific and Europe, we sell CoolSculpting through a direct sales organization as well as a network of distributors. We intend to continue developing our international sales and marketing organization to focus on increasing sales and strengthening our customer relationships. We also intend to seek regulatory approval to market CoolSculpting in key additional international markets, including China. Revenue from markets outside of North America accounted for 20% and 19% of our total revenue for the three and nine months ended September 30, 2013, respectively, compared to 24% and 25% of our total revenue for the three and nine months ended September 30, 2012, respectively.

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.

Revenue

We generate revenue from sales of our CoolSculpting system and from sales of consumables to our customers. We generated revenue of $29.5 million and $75.8 million for the three and nine months ended September 30, 2013, respectively, compared to $17.9 million and $57.6 million for the three and nine months ended September 30, 2012, respectively.

System revenue. Sales of our CoolSculpting system include the CoolSculpting control unit and our CoolSculpting 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. System revenue represented 54% and 53% of our total revenue for the three and nine months ended September 30, 2013, respectively, compared to 47% and 51% of our total revenue for the three and nine months ended September 30, 2012, respectively. Our worldwide installed base grew by 40% from 1,363 units as of September 30, 2012, to 1,912 units as of September 30, 2013.

Consumable revenue. We generate consumable revenue 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 customer to perform a fixed number of CoolSculpting cycles. Consumable revenue represented 46% and 47% of our total revenue for the three and nine months ended September 30, 2013, respectively, compared to 53% and 49% of our total revenue for the three and nine months ended September 30, 2012, respectively. We shipped 114,768 and 305,121 CoolSculpting cycles to our customers during the three and nine months ended September 30, 2013, respectively, compared to 77,500 and 225,520 CoolSculpting cycles during the three and nine months ended September 30, 2012, respectively.


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Our business plan focuses on expanding our installed base of systems at customers, and increasing our consumable revenue by driving demand for CoolSculpting procedures through our customer and consumer marketing programs. We anticipate that as we implement our business plan our consumable revenue will increase as a percentage of our total revenue.

Seasonality. Seasonal fluctuations in the number of 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. 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 could adversely affect the markets in which we operate.

Critical Accounting Policies and Estimates

Our critical accounting policies are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012.

Our critical accounting policies have not materially changed during the nine months ended September 30, 2013. Furthermore, the preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Our management believes that we consistently apply these judgments and estimates and the consolidated financial statements and accompanying notes fairly represent all periods presented. However, any differences between these judgments and estimates and actual results could have a material impact on our consolidated statements of income and financial position.

Critical accounting estimates, as defined by the Securities and Exchange Commission, are those that are most important to the portrayal of our consolidated financial condition and results of operations and require our management's most difficult and subjective judgments and estimates of matters that are inherently uncertain. Our critical accounting estimates include those regarding (1) revenue recognition and the fair value of revenue elements,
(2) investments, including the fair value of such investments, (3) warranty accruals, (4) valuation and recognition of stock-based compensation, and (5) provision for income taxes, tax liabilities and valuation allowance for deferred tax assets. For a discussion of our critical accounting estimates, see Item 7:
"Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates" in our Annual Report on Form 10-K for the year ended December 31, 2012.

Results of Operations

Revenue (in thousands, except for percentages):

                                   Three Months Ended                                   Nine Months Ended
                                     September 30,                                        September 30,
                      2013         2012       $ Change      % Change       2013         2012       $ Change      % Change
System revenue     $ 15,889     $  8,507     $   7,382         87 %     $ 39,939     $ 29,528     $  10,411         35 %
Consumable revenue   13,576        9,421         4,155         44 %       35,846       28,069         7,777         28 %
Total revenue      $ 29,465     $ 17,928     $  11,537         64 %     $ 75,785     $ 57,597     $  18,188         32 %

Overall, we experienced an increase in revenue driven primarily by the expansion of our sales force into new and existing key markets, increased focus and prioritization of our business through our revamped sales team structure and training, a larger percentage of total revenue contribution from North America revenue which has a higher average selling price, the introduction of new applicators and an increase in our installed base of CoolSculpting systems.


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System revenue. We experienced incremental growth in system revenue for both the three and nine months ended September 30, 2013, as compared to the same periods in 2012, as a result of increased North America system sales due to the reasons stated above and to a lesser extent increased international sales as result of the launch of our international direct sales organization during the second quarter of 2012. We also continue to experience a high rate of new system placements. Additionally, our system revenue increased as result of the launch of our CoolCurve+ applicator during the third quarter of 2012 and the launch of our CoolFit applicator during the first quarter of 2013, which increased the number of applicators included in each standard CoolSculpting system. We also experienced increased sales of applicators, primarily of our CoolFit applicator and some CoolCurve+ applicators, to existing customers, as our customers look to optimize their existing system to fit different body shapes and sizes.

Consumable revenue. The increase in consumable revenue was primarily due to the growth of our worldwide installed base of CoolSculpting systems, and an increased number of cycles shipped to our customers driven by our targeted customer and consumer marketing programs. Our installed base increased primarily in North America and to a lesser extent in Europe resulting from the launch of our international direct sales organization during the second quarter of 2012. This increase was partially offset by rebates associated with the Crystal Rewards Program, our customer loyalty program related to consumable purchases, that was launched in the third quarter of 2012.

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

                                   Three Months Ended                                    Nine Months Ended
                                      September 30,                                        September 30,
                      2013         2012        $ Change      % Change       2013         2012       $ Change      % Change
Cost of revenue    $  8,236     $  5,953     $    2,283         38 %     $ 23,462     $ 19,096     $   4,366         23 %
% of total revenue       28 %         33 %                                     31 %         33 %
Gross profit       $ 21,229     $ 11,975     $    9,254         77 %     $ 52,323     $ 38,501     $  13,822         36 %
Gross profit %           72 %         67 %                                     69 %         67 %

Gross profit as a percentage of revenue typically fluctuates with product and regional mix, selling prices, material costs and revenue levels. The increase in gross profit as a percentage of revenue for the three and nine months ended September 30, 2013, as compared to the same periods in 2012, was primarily attributable to higher overall sales volumes and higher average selling prices, as well as our continued focus on cost reduction across our product portfolio and the completion of the in-sourced manufacturing structure during the second quarter of 2013. Specifically, higher production from higher sales led to better utilization on a relatively fixed base of overhead costs. We also experienced an increase in gross profit as result of a decrease in warranty charges as we continue to experience a reduction in product failure rates. Gross profit was reduced in part due to the inclusion of the 2.3% Medical Device Excise Tax on all U.S. sales as part of the Patient Protection and Affordable Care Act of 2010 which went into effect on January 1, 2013.

Operating Expenses (in thousands, except for percentages):

                                 Three Months Ended                                    Nine Months Ended
                                    September 30,                                        September 30,
                    2013         2012        $ Change      % Change       2013         2012       $ Change     % Change
Operating
expenses
Research and
development      $  4,257     $  2,450     $    1,807         74 %     $ 11,904     $  9,217     $  2,687         29  %
% of total
revenue                14 %         14 %                                     16 %         16 %
Sales and
marketing        $ 15,487     $ 10,881     $    4,606         42 %     $ 42,654     $ 39,632     $  3,022          8  %
% of total
revenue                53 %         61 %                                     56 %         69 %
General and
administrative   $  4,374     $  3,760     $      614         16 %     $ 11,808     $ 13,169     $ (1,361 )      (10 )%
% of total
revenue                15 %         21 %                                     16 %         23 %
Total operating
expenses         $ 24,118     $ 17,091     $    7,027         41 %     $ 66,366     $ 62,018     $  4,348          7  %


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Research and development. Research and development expenses increased for the three months ended September 30, 2013, compared to the same period in 2012, primarily due to a $1.1 million increase in payroll related costs attributed to higher headcount and an increase in performance-based compensation, as well as a $0.4 million increase in consulting, development and clinical costs, as we continue to explore ways to leverage our proprietary cooling platform for additional applications and indications.

Research and development expenses increased for the nine months ended September 30, 2013, compared to the same period in 2012, primarily due to a $1.5 million increase in payroll related costs attributed to higher headcount and an increase in performance-based compensation, as well as a $1.2 million increase in consulting, development and clinical costs, as we continue to explore ways to leverage our proprietary cooling platform for additional applications and indications.

Sales and marketing. Sales and marketing expenses increased for the three months ended September 30, 2013, compared to the same period in 2012, primarily due to a $3.0 million increase in payroll related costs resulting from higher headcount, an increase in performance-based compensation and the expansion of our sales force into new and existing markets driving growth in revenue. Sales and marketing expenses also increased by $0.7 million as result of actions taken to retrofit systems for CoolConnect, a tool used as a point of sale initiative which launched during the second quarter of 2013.

Sales and marketing expenses increased for the nine months ended September 30, 2013, compared to the same period in 2012, primarily due to a $5.2 million increase in payroll related costs resulting from higher headcount, an increase in performance-based compensation, and the expansion of our sales force into new and existing markets driving growth in revenue. Sales and marketing expenses also increased by $0.7 million as result of actions taken to retrofit systems for CoolConnect, a tool used as a point of sale initiative which launched during the second quarter of 2013. This increase was offset in part by a $4.3 million decrease in advertising expenses resulting from our shift in emphasis from Direct-to-Consumer advertising programs to a more localized co-operative marketing strategy with individual practices.

General and administrative. General and administrative expenses increased for the three months ended September 30, 2013, compared to the same period in 2012, primarily due to a $1.1 million increase in payroll related costs resulting from higher headcount in certain functions to support growth in our business and an increase in performance-based compensation, which was offset in part by a reduction in costs associated with non-recurring severance expenses. This increase was also offset in part by a$0.5 million decrease in legal expenses due to the resolution of various legal matters in 2013, including shareholder and certain IP related litigation.

General and administrative expenses decreased for the nine months ended September 30, 2013, compared to the same period in 2012, primarily due to a $1.8 million decrease in legal expenses due to the resolution of various legal matters in 2013, including shareholder and certain IP related litigation. This decrease was offset in part by a $0.6 million increase in payroll related costs resulting from higher headcount in certain functions to support growth in our business and an increase in performance-based compensation, which was offset in part by a reduction in costs associated with non-recurring severance expenses.

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

                                Three Months Ended                                 Nine Months Ended
                                  September 30,                                      September 30,
                   2013         2012       $ Change     % Change      2013         2012       $ Change    % Change
Interest income,
net              $    17     $    11      $       6         55  %   $    60     $   100      $    (40 )      (40 )%
% of total
revenue                - %         -  %                                   - %         -  %
Other income

(expense), net $ 90 $ (44 ) $ 134 (305 )% $ 162 $ (108 ) $ 270 (250 )% % of total
revenue - % - % - % - %

Interest income, net. For both the three and nine months ended September 30, 2013 and 2012, interest income was earned on our available-for-sale securities. The amount of income earned varies based on the type of investments held, market conditions and other factors.


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Other income (expense), net. The increase in other income in three months ended September 30, 2013, compared to the same period in 2012, was as a result of a favorable change in foreign exchange rates. The increase in other income in nine months ended September 30, 2013, compared to the same period in 2012, was as result of a favorable change in foreign exchange rates and proceeds received as result of a favorable patent defense ruling.

Liquidity and Capital Resources

Since our inception, we have financed our operations to date primarily through private placements of convertible preferred stock, promissory notes, borrowings under a loan agreement, product sales and the proceeds from our initial public offering, or IPO.

The following table summarizes our working capital, cash and cash equivalents, short-term and long-term investments as of September 30, 2013, and December 31, 2012 (in thousands):

                           September 30,      December 31,
                                2013              2012
Cash and cash equivalents $        24,219    $       22,876
Short-term investments             18,980            22,563
Long-term investments              12,666            13,141
Total                     $        55,865    $       58,580

Working capital           $        41,989    $       49,590

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