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VOLC > SEC Filings for VOLC > Form 10-Q on 7-Nov-2013All Recent SEC Filings

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Form 10-Q for VOLCANO CORP


7-Nov-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, restructuring charges, 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 Pioneer PlusTM re-entry device acquired from Medtronic on August 30, 2013.
Our IVUS products include single-procedure disposable phased array and rotational IVUS imaging catheters, and additional functionality options such as Virtual Histology, or VHŽ, 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 and high resolution Focal Acoustic Computed Tomography, or FACT, catheters. We are also developing advanced software applications that will optimize and facilitate transcatheter cardiovascular interventions using automated online image processing. Through the acquisition of the Pioneer PlusTM diagnostic ultrasound transducer and percutaneous catheter, or Pioneer, from Medtronic, Inc., or Medtronic, during the third quarter of 2013, we started to offer the Pioneer re-entry catheter product, which is an interventional


medical device designed to enable the crossing of sub-total, total and chronic total occlusions within the peripheral vasculature, potentially eliminating the need for surgery.
Through Axsun Technologies, Inc., or Axsun, one of our wholly-owned subsidiaries, we also develop and manufacture laser and non-laser light sources, optical engines used in OCT imaging systems as well as micro-optical spectrometers and optical channel monitors with applications in telecommunications, pharmaceutical manufacturing, high-speed industrial process control, and chemical and petrochemical processing, medical diagnostics, and scientific discovery. Other medical device products include the recent acquisition of a FDA approved Inferior Vena Cava, or IVC, filter technology which is under development for the vascular, cardiovascular and interventional radiology markets.
We have infrastructure in the U.S., Europe, Japan, Costa Rica and Israel. Our corporate office is located in California, U.S. Our manufacturing operations are located in the U.S. and Costa Rica. We have research and development facilities in the U.S. 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 September 30, 2013, we had a worldwide installed base of over approximately 6,800 consoles, excluding our legacy In-Vision Gold systems. We intend to grow and leverage this installed base to drive recurring sales of our single-procedure disposable catheters and guide wires. In the nine months ended September 30, 2013, the sale of our single-procedure disposable catheters and guide wires accounted for $227.2 million, or 79.9% of our medical segment revenues, a $5.9 million, or 2.7% increase from the nine months ended September 30, 2012, in which the sale of our single-procedure disposable catheters and guide wires accounted for $221.3 million, or 81.6% of our medical segment revenues.
In the nine months ended September 30, 2013 and 2012, 44.8% and 46.1%, respectively, of our revenues and 20.4% and 23.1%, respectively, of our operating expenses were denominated in various non-U.S. dollar currencies, primarily the Japanese yen and the euro. We expect that a significant portion of our revenue and operating expenses will continue to be denominated in non-U.S. dollar currencies. As a result, we are subject to risks related to fluctuations in foreign currency exchange rates, which could affect our operating results in the future. If our yen or euro denominated sales exceed our yen or euro denominated costs, and the U.S. dollar strengthens relative to the yen or euro, there is an adverse effect on our results of operations. Conversely, if the U.S. dollar weakens relative to the yen or euro, there is a positive effect on our results of operations. For example, the average exchange rate of one U.S. dollar to yen increased 20.5% from 79.1 in the nine months ended September 30, 2012 to 95.3 in the nine months ended September 30, 2013, which resulted in a net negative impact to our operating results for the nine months ended September 30, 2013 in the amount of approximately $10.2 million as compared to the prior year. The average exchange rate of one euro to U.S. dollar remained consistent in the nine months ended September 30, 2013 compared with the nine months ended September 30, 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% 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 our total revenues for 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 reportable 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 nine months ended September 30, 2013, we generated $290.4 million of revenues which is comprised of $284.4 million from our medical segment and $6.0 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 nine months ended September 30, 2013 compared with the same period in the prior year. In the nine months ended September 30, 2013, 11.1% of our medical segment revenues were derived from the sale of our consoles, 50.6% from IVUS single-procedure disposables and 29.3% from FFR single-procedure disposables as compared with 10.5% from consoles, 56.7% from IVUS single-procedure disposables and 25.0% 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, sales of medical products manufactured by our Axsun subsidiary, 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 the United States, 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 the United States.
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.


Included in selling, general and administrative expense is the new U.S. medical device excise tax on the sale of medical devices that 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 our total revenues for 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, subsequent accretion of and revision, if any, to the contingent consideration related to acquisitions and other expenses directly associated with acquisitions.
Restructuring Charges. Restructuring charges consist of employee termination benefits, asset impairments and other related charges associated with restructuring activities.
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 long term debt acquired with Sync-Rx, 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 certain 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 unaudited condensed consolidated statements of operations for the three months ended September 30, 2013 and 2012, presented as a percentage of revenues, with the dollar and percentage change year over year (in thousands except for percentage):


                                           Three Months Ended September 30,                 Changes
                                            2013                     2012                 $            %
Revenues                            $ 95,809     100.0  %   $ 93,656      100.0  %   $   2,153        2.3  %
Cost of revenues, excluding
amortization of intangibles           33,458      34.9        33,248       35.5            210        0.6
Gross profit                          62,351      65.1        60,408       64.5          1,943        3.2
Operating expenses:
Selling, general and
administrative                        45,479      47.5        40,699       43.5          4,780       11.7
Research and development              16,609      17.3        13,032       13.9          3,577       27.4
Amortization of intangibles              834       0.9           710        0.8            124       17.5
Acquisition-related items              1,253       1.3             -          -          1,253          -
Restructuring charges                  4,616       4.8             -          -          4,616          -
Total operating expenses              68,791      71.8        54,441       58.2         14,350       26.4
Operating income                      (6,440 )    (6.7 )       5,967        6.4        (12,407 )   (207.9 )
Interest income                          327       0.3           223        0.2            104       46.6
Interest expense                      (6,756 )    (7.1 )      (1,844 )     (2.0 )       (4,912 )    266.4
Exchange rate (loss) gain                 54       0.1          (218 )     (0.2 )          272     (124.8 )
Other, net                               (33 )       -           (23 )        -            (10 )     43.5
(Loss) income before income tax      (12,848 )   (13.4 )       4,105        4.4        (16,953 )   (413.0 )
Income tax (benefit) expense          (4,392 )    (4.6 )       2,130        2.3         (6,522 )   (306.2 )

Net (loss) income $ (8,456 ) (8.8 )% $ 1,975 2.1 % $ (10,431 ) (528.2 )%

The following table sets forth items derived from our unaudited condensed consolidated statements of operations for the nine months ended September 30, 2013 and 2012, presented as a percentage of revenues, with the dollar and percentage change year over year (in thousands except for percentage):

                                           Nine Months Ended September 30,                    Changes
                                            2013                     2012                 $             %
Revenues                           $ 290,384     100.0  %   $ 279,389     100.0  %   $  10,995           3.9  %
Cost of revenues, excluding
amortization of intangibles          102,624      35.3         94,797      33.9          7,827           8.3
Gross profit                         187,760      64.7        184,592      66.1          3,168           1.7
Operating expenses:
Selling, general and
administrative                       134,784      46.4        127,035      45.5          7,749           6.1
Research and development              50,214      17.3         40,560      14.5          9,654          23.8
Amortization of intangibles            2,488       0.9          2,470       0.9             18           0.7
Acquisition-related items              3,742       1.3              -         -          3,742             -
Restructuring charges                  4,874       1.7              -         -          4,874             -
Total operating expenses             196,102      67.5        170,065      60.9         26,037          15.3
Operating (loss) income               (8,342 )    (2.9 )       14,527       5.2        (22,869 )      (157.4 )
Interest income                          970       0.3            656       0.2            314          47.9
Interest expense                     (19,908 )    (6.9 )       (4,993 )    (1.8 )      (14,915 )       298.7
Exchange rate loss                    (1,025 )    (0.4 )         (319 )    (0.1 )         (706 )       221.3
Other, net                             4,144       1.4            (31 )       -          4,175     (13,467.7 )
(Loss) income before income tax      (24,161 )    (8.3 )        9,840       3.5        (34,001 )      (345.5 )
Income tax (benefit) expense         (10,156 )    (3.5 )        4,295       1.5        (14,451 )      (336.5 )
Net (loss) income                  $ (14,005 )    (4.8 )%   $   5,545       2.0  %   $ (19,550 )      (352.6 )%

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             Changes              Nine Months Ended             Changes
                              September 30,                                       September 30,
                            2013           2012          $          %          2013          2012           $           %
Medical segment:
Consoles                $    10,964     $  9,679     $ 1,285      13.3  %   $  31,469     $  28,529     $  2,940      10.3  %
Single-procedure
disposables:
IVUS                         46,024       48,574      (2,550 )    (5.2 )%     143,869       153,683       (9,814 )    (6.4 )%
FFR                          27,869       24,585       3,284      13.4  %      83,345        67,652       15,693      23.2  %
Other                         8,809        7,825         984      12.6  %      25,725        21,286        4,439      20.9  %
Sub-total medical
segment                      93,666       90,663       3,003       3.3  %     284,408       271,150       13,258       4.9  %
Industrial segment            2,143        2,993        (850 )   (28.4 )%       5,976         8,239       (2,263 )   (27.5 )%
                        $    95,809     $ 93,656     $ 2,153       2.3  %   $ 290,384     $ 279,389     $ 10,995       3.9  %

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

                            Three Months Ended             Changes              Nine Months Ended             Changes
                              September 30,                                       September 30,
                            2013           2012          $          %          2013          2012           $          %
Revenue (1):
United States           $    46,673     $ 44,083     $ 2,590       5.9  %   $ 139,076     $ 130,152     $ 8,924       6.9  %
Japan                        26,368       29,699      (3,331 )   (11.2 )%      82,292        90,025      (7,733 )    (8.6 )%
Europe, the Middle East
and Africa                   17,371       13,491       3,880      28.8  %      51,512        42,507       9,005      21.2  %
Rest of world                 5,397        6,383        (986 )   (15.4 )%      17,504        16,705         799       4.8  %
                        $    95,809     $ 93,656     $ 2,153       2.3  %   $ 290,384     $ 279,389      10,995       3.9  %

(1) Revenues are attributed to geographies based on the location of the . . .

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