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ZLTQ > SEC Filings for ZLTQ > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for ZELTIQ AESTHETICS INC

Form 10-K for ZELTIQ AESTHETICS INC


26-Feb-2014

Annual Report


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

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with "Selected Financial Data" and our consolidated financial statements and the notes thereto 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 in this Annual Report on Form 10-K.
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 cycles in the form of consumable procedure packs 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 the abdomen area. We may seek additional regulatory clearances from the FDA to expand our United States 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 as well as 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%, 26% and 26% of our total revenue for the years ended December 31, 2013, 2012 and 2011, 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. In October 2011, we completed our initial public offering, or IPO, at which time we received net proceeds of $90.7 million, net of underwriting discounts and commissions and other costs associated with the offering. Revenue
We generate revenue from sales of our CoolSculpting system and from sales of consumables to our customers. We generated revenue of $111.6 million; $76.2 million and $68.1 million for the years ended December 31, 2013, 2012 and 2011, 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 55%, 51% and 68% of our total revenue for the years ended December 31,


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2013, 2012 and 2011, respectively. Our worldwide installed base grew by 47% from 1,483 units as of December 31, 2012, to 2,175 units as of December 31, 2013. Consumable revenue. We generate consumable revenue through sales of cycles in the form of consumable 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 customers to perform a fixed number of CoolSculpting cycles. Consumable revenue accounted for approximately 45%, 49% and 32% of our total revenue for the years ended December 31, 2013, 2012 and 2011, respectively. We shipped 426,912, 300,692 and 190,314 CoolSculpting cycles to our customers during the years ended December 31, 2013, 2012 and 2011, respectively.
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 targeted 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 patients seeking treatments and the availability of our customers 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 consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America, or GAAP. The preparation of our consolidated financial statements requires management to make judgments and estimates 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. 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.

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
We derive our revenue from the sales of the CoolSculpting system, consisting of a control unit and applicators, and from the sale of cycles in the form of consumable procedure packs, each of which includes our consumable CoolGels and CoolLiners and a disposable computer cartridge that we market as the CoolCard. Embedded software exists in the CoolCard product to permit our customers to perform a fixed number of CoolSculpting procedures, or cycles. We do not market this software separately from the CoolSculpting system or from the CoolCard. Rather, the functionality that the software provides is part of the overall CoolCard product. We market the CoolSculpting system 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 our customers


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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. We defer revenue 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. We base the relative selling prices for control units, applicators, CoolCards and extended warranty 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. We expense shipping and handling costs as incurred and include them in cost of revenue. In those cases where we bill shipping and handling costs to customers, we classify the amounts billed as revenue.

Accruals for Customer Programs
We record an accrued liability for cooperative marketing arrangements and customer incentive programs. The estimated cost of these programs is recorded as a reduction of revenue or as an operating expense, if we receive a separately identifiable benefit from the customer and can reasonably estimate the fair value of that benefit. Significant management judgment and estimates must be used to determine the cost of these programs in any accounting period.

Cooperative Marketing Arrangements. We offer cooperative marketing programs to our North American customers, allowing the customer to receive partial reimbursement for qualifying advertising expenditures which promote our product and brand. Customer participation, as well as reimbursement amounts, is predicated upon purchase levels of CoolCards. The objective of these arrangements is to encourage advertising and promotional events to increase sales of our products. Accruals for these marketing arrangements are recorded at the time of sale, or time of commitment, based on the related program parameters, review of related advertising and historical experience.

Customer Incentive Programs. Our customer incentive program consists of rebates for our North American customers based on purchase levels of CoolCards. Estimated costs of consumer rebates and similar incentives are recorded at the time the incentive is offered, based on the specific terms and conditions of the program.


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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. We report realized gains and losses from maturities of all such securities in earnings and computed using the specific identification cost method. We report realized gains or losses and charges for other-than-temporary declines in value, if any, on available-for-sale securities in other income (expense), net as incurred. We periodically evaluate these investments for other-than-temporary impairment. Product Warranty

Effective in the second quarter of 2013, we provide a standard limited warranty on our products of generally one year for both control units and applicators for our direct customers. Prior to this change, we provided a standard limited warranty on our products of generally three years for control units and one year for applicators, while for direct customers in Europe, we offered a one year standard warranty on control units. For indirect customers in our international markets, we provide a standard limited warranty on our products of generally three years for control units and one year for applicators.
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 $0.7 million and $0.9 million as of December 31, 2013 and 2012, respectively, for future warranty expense. We offer an extended warranty on both our CoolSculpting control units and CoolSculpting applicators. We recognize the revenue 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 we expect 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, 2013, we had a $51.0 million valuation allowance against $51.1 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, 2013, will significantly increase or decrease in the next 12 months.
We assess all material positions taken in any income tax return, including all significant uncertain tax 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


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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. We have assessed the application of Internal Revenue Code Section 382, during the fourth quarter of 2013, and concluded no limitation currently applies, and we will continue to monitor activities in the future. 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
Revenue (in thousands, except for percentages):

                                      Year Ended
                                     December 31,
                      2013        2012       $ Change     % Change
Revenue
System revenue     $  61,359    $ 39,145    $  22,214        57 %
Consumable revenue    50,267      37,049       13,218        36 %
Total revenue      $ 111,626    $ 76,194    $  35,432        47 %


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

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. System revenue. We experienced incremental growth in system revenue for the year ended December 31, 2013, as compared to the year ended December 31, 2012, as a result of increased North American 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. Our North American system sales increased while maintaining consistent average selling price. International direct system sales increased, offset by a slight decline in average selling price for these sales as we continue to focus on market penetration in these key markets. 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.
The system revenue decreased in the year ended December 31, 2012, as compared to the year ended December 31, 2011, as we 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. International systems sales were impacted by the transition to a direct sales model.
Consumable revenue. The increase in consumable revenue for the year ended December 31, 2013, as compared to the year ended December 31, 2012, was primarily due to the growth of our worldwide installed base of CoolSculpting systems, and an increased number of consumable procedure packs shipped to our customers driven by our targeted 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.


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The increase in consumable revenue for the year ended December 31, 2012, as compared to the year ended December 31, 2011, was primarily due to the growth of our installed base of worldwide CoolSculpting systems, and an increased number of CoolSculpting procedures performed by our customers driven by our targeted marketing programs.

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

                                      Year Ended
                                     December 31,
                      2013         2012       $ Change     % Change
Cost of revenue    $ 34,189       25,506     $   8,683        34 %
% of total revenue       31 %         33 %
Gross profit       $ 77,437     $ 50,688     $  26,749        53 %
Gross profit %           69 %         67 %


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

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 year ended December 31, 2013, as compared to the year ended December 31, 2012, was primarily attributable to higher overall sales volumes while maintaining consistent average selling prices with the prior year, as well due to our increase in consumable revenue which carries higher margins than our systems. We also achieved increased gross profit due to 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. These increases were offset in part due to the inclusion of the 2.3% Medical Device Excise Tax on all equipment sales in the United States as part of the Patient Protection and Affordable Care Act of 2010 which went into effect on January 1, 2013. The increase in gross profit as a percentage of revenue for the year ended December 31, 2012, as compared to the year ended December 31, 2011, was driven by an increase in consumable revenue as a percentage of total revenue 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
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