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VOLC > SEC Filings for VOLC > Form 10-Q on 5-May-2014All Recent SEC Filings

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Form 10-Q for VOLCANO CORP


5-May-2014

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 short-term 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 ultrasound, or IVUS, and fractional flow reserve, or FFR, products. We believe that these products enhance the diagnosis and treatment of coronary and peripheral vascular disease by improving the efficiency and efficacy of existing diagnostic angiograms and percutaneous coronary interventional, or PCI, and endovascular 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 help determine whether or not a stent is necessary, and IVUS is used as an adjunct to angiography 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 consoles that are marketed as stand-alone units or as 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 and flow wires and image-guided therapy catheters, such as the Pioneer Plus reentry device acquired from Medtronic, Inc., or 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 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 have developed additional offerings for integration into the platform, including adenosine-free Instant Wave-Free Ratio FFR, or iFR®, which received FDA clearance in March 2014 and SyncVision™ which co-registers IVUS with angiography.
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 optical coherence


topography, or OCT, imaging systems and advanced photonic components and sub-systems used in spectroscopy and other industrial applications. We have infrastructure in the U.S., Europe, Japan and Costa Rica. Our corporate office is located in San Diego, California. Our products are assembled or manufactured in our manufacturing facilities that are located in Coyol, Costa Rica, Rancho Cordova, California, and Billerica, Massachusetts. We have research and development facilities in the U.S. and Israel. We have sales offices in the U.S. and Japan; sales and distribution offices in Belgium and South Africa; and third-party distribution facilities in Japan.
We have focused on building our domestic and international sales and marketing infrastructure to market our products to physicians and technicians who perform diagnostic angiography, PCI and endovascular procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals. We sell our products directly to customers in the United States, Japan, certain European markets and South Africa. We utilize distributors in other geographic areas, which are also involved in product launch planning, education and training, physician support and clinical study management.
At March 31, 2014, we had a worldwide installed base of over approximately 7,000 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 three months ended March 31, 2014, the sale of our single-procedure disposable catheters and guide wires accounted for $75.4 million, or 81.1% of our medical segment revenues, a $651,000, or 0.9% increase from the three months ended March 31, 2013, in which the sale of our single-procedure disposable catheters and guide wires accounted for $74.8 million, or 81.5% of our medical segment revenues.
In the three months ended March 31, 2014 and 2013, 45.1% and 46.7%, respectively, of our revenues and 21.2% and 22.1%, respectively, of our operating expenses were denominated in various non-U.S. dollar currencies, primarily the Japanese yen, or 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 the euro, there is an adverse effect on our results of operations. Conversely, if the U.S. dollar weakens relative to the yen or the 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 14.3% from 90.2 in the three months ended March 31, 2013 to 103.1 in the three months ended March 31, 2014, which resulted in a net negative impact to our operating results for the three months ended March 31, 2014 in the amount of approximately $2.0 million as compared to the comparable period in the prior year. The average exchange rate of one euro to U.S. dollar remained consistent in the three months ended March 31, 2014 compared with the three months ended March 31, 2013. We use third-party manufacturing partners in certain areas of our manufacturing processes. We perform incoming inspection on all components manufactured by third parties and test the final products to assure quality control. We do not carry significant inventories 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.
With respect to IVUS, two-year data released in 2013 from the ADAPT-DES study (Assessment of Platelet Therapy with Drug-Eluting Stents), the largest study conducted with IVUS guidance to date, indicated IVUS guidance was associated with reductions in certain serious patient events, including stent thrombosis and myocardial infarction, and that IVUS guidance was associated with a change in procedure 74% of the time. These data suggest that IVUS guidance can play an important role in helping to improve patient outcomes.
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 three months ended March 31, 2014, we generated $94.5 million of revenues which is comprised of $93.0 million from our medical segment and $1.5 million from our industrial segment. We experienced increases in revenues related to FFR single-procedure disposables and decrease in revenues related to consoles and IVUS single-procedure disposables in the three months ended March 31, 2014 compared with the same period in the prior year. In the three months ended March 31, 2014, 9.2% of our medical segment revenues were derived from the sale of our consoles, 50.1% from IVUS single-procedure disposables and 31.0% from FFR single-procedure disposables as compared with 9.8% from consoles, 52.3% from IVUS single-procedure disposables and 29.2% from FFR single-procedure disposables in the same period in the 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 continue experiencing 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 commissions 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 services, 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.
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 covenants-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 fair value of 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 the long-term debt acquired with Sync-Rx, offset by interest capitalization related to our global Enterprise Resource Planning, or ERP, system implementation, before the ERP system was placed into service in the fourth quarter of 2013.
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 unaudited condensed consolidated statements of operations for the three months ended March 31, 2014 and 2013, presented as a percentage of revenues, with the dollar and percentage change year over year (in thousands except for percentages):

                                             Three Months Ended March 31,                   Changes
                                             2014                    2013                $            %
Revenues                            $  94,528     100.0  %   $ 93,231     100.0  %   $  1,297        1.4  %
Cost of revenues, excluding
amortization of intangibles            35,082      37.1        33,127      35.5        (1,955 )     (5.9 )
Gross profit                           59,446      62.9        60,104      64.5          (658 )     (1.1 )
Operating expenses:
Selling, general and
administrative                         50,311      53.2        43,829      47.0        (6,482 )    (14.8 )
Research and development               13,957      14.8        15,651      16.8         1,694       10.8
Amortization of intangibles             1,783       1.9           834       0.9          (949 )   (113.8 )
Acquisition-related items               1,036       1.1         1,578       1.7           542       34.3
Restructuring charges                     873       0.9             -         -          (873 )        -
Total operating expenses               67,960      71.9        61,892      66.4        (6,068 )     (9.8 )
Operating loss                         (8,514 )    (9.0 )      (1,788 )    (1.9 )      (6,726 )   (376.2 )
Interest income                           316       0.3           338       0.3           (22 )     (6.5 )
Interest expense                       (7,179 )    (7.6 )      (6,545 )    (7.0 )        (634 )     (9.7 )
Exchange rate gain (loss)                  84       0.1          (778 )    (0.8 )         862      110.8
Other, net                                110       0.1         1,898       2.0        (1,788 )    (94.2 )
Loss before income tax                (15,183 )   (16.1 )      (6,875 )    (7.4 )      (8,308 )   (120.8 )
Income tax benefit                     (4,280 )    (4.4 )      (3,714 )    (4.0 )         566       15.2

Net loss $ (10,903 ) (11.5 )% $ (3,161 ) (3.4 )% $ (7,742 ) (244.9 )%

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
                                     March 31,
                                  2014         2013          $          %
Medical segment:
Consoles                      $     8,543    $  8,959    $  (416 )   (4.6 )%
Single-procedure disposables:
IVUS                               46,597      47,966     (1,369 )   (2.9 )%
FFR                                28,843      26,823      2,020      7.5  %
Other                               9,044       7,971      1,073     13.5  %
Sub-total medical segment          93,027      91,719      1,308      1.4  %
Industrial segment                  1,501       1,512        (11 )   (0.7 )%
                              $    94,528    $ 93,231    $ 1,297      1.4  %

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
                                          March 31,
                                       2014         2013          $          %
Revenue (1):
United States                      $    45,103    $ 43,331    $ 1,772       4.1  %
Japan                                   23,893      28,181     (4,288 )   (15.2 )%
Europe, the Middle East and Africa      19,459      16,088      3,371      21.0  %
Rest of world                            6,073       5,631        442       7.8  %
                                   $    94,528    $ 93,231    $ 1,297       1.4  %

(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, 2014 and 2013 Revenues. Overall, the increase in medical segment revenue in the three months ended March 31, 2014 compared with the three months ended March 31, 2013 was driven by increased demand for our disposable products, largely offset by the net $2.7 million unfavorable impact of foreign currency exchange rates related primarily to the yen. The increases in FFR disposable revenues were primarily due to the increased adoption of the technology based on clinical study data, partially offset by unfavorable impacts of foreign currency exchange rates related primarily to the yen. The decrease in IVUS disposable revenues was due to the unfavorable impact of foreign currency exchange rates related primarily to the yen and the decline in market share in Japan, partially offset by increased revenue from the sale of products from the Pioneer Plus re-entry catheter product line which was acquired from Medtronic in August 2013. The increase in other revenues is primarily due to higher sales of third-party products, higher service contract and rental revenues.
We recognized year-over-year increases in revenues across all our key geographic markets except for Japan. The decrease in Japan is primarily due to the unfavorable impact of approximately $3.3 million of foreign currency exchange rates related to the yen and a decrease in IVUS disposable sales in coronary procedures due to a decline in market share.
Cost of Revenues. The increase in the cost of revenues in the three months ended March 31, 2014 compared with the three months ended March 31, 2013 was primarily due to higher sales volume. Gross margin was 62.9% of revenues in three months ended March 31, 2014, decreasing from 64.5% of revenues in the three months ended March 31, 2013. This unfavorable change in gross margin was primarily the result of the unfavorable impacts of foreign exchange rates related to the yen, product mix and duplicate overhead costs as we transition certain manufacturing operations to Costa Rica.
Selling, General and Administrative. The increase in selling, general and administrative expenses in the three months ended March 31, 2014 as compared with the three months ended March 31, 2013 was primarily due to the higher variable costs for U.S. sales driven by higher sales volumes, increased headcount in the sales organization in the U.S. and Europe, increased legal expense related to litigation matters and business development efforts, increased employee short-term and long-term incentive expense and increased facility expense related to our new corporate headquarters in San Diego, California, that we began to occupy in the third quarter of 2013.


Research and Development. The decrease in research and development expenses in the three months ended March 31, 2014 compared with the three months ended March 31, 2013 was primarily due to the discontinuation of in-process research and development projects as part of our restructuring efforts.
Amortization of Intangibles. The increase in amortization of intangibles in the three months ended March 31, 2014 as compared with the three months ended March 31, 2013 was primarily due to the amortization of intangible assets received from the Pioneer transaction in August 2013 and the commencement of amortization of the Crux intangible asset related to the IVC filter technology beginning in December 2013.
Acquisition-Related Items. Acquisition-related items during the three months ended March 31, 2014 consisted primarily of the change in fair value of the contingent consideration related to the Crux acquisition primarily as a result of the passage of time. The acquisition-related items during the three months ended March 31, 2013 consist of transaction costs related to the Sync-Rx and Crux acquisitions and the change in fair value of the contingent consideration related to the Crux acquisition primarily as a result of the passage of time. Restructuring Charges. Restructuring charges during the three months ended March 31, 2014 consisted primarily of $726,000 of tangible and intangible asset impairments related to the discontinuation of research and development programs. Interest Income. The interest income for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 remains consistent. Interest Expense. Interest expense during the three months ended March 31, 2014 and March 31, 2013 was primarily related to interest and accretion of debt discount incurred on the convertible debt issued in December 2012 ($460 million aggregate principal amount) and the convertible debt issued in September 2010 . . .

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