VOLC 3.31.2012 10Q
Table of Contents

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 000-52045
Volcano Corporation
(Exact name of registrant as specified in its charter)
 
Delaware
 
33-0928885
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification Number)
 
 
 
3661 Valley Centre Drive, Suite 200
San Diego, CA
 
92130
(Address of principal executive offices)
 
(Zip Code)
(800) 228-4728
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  þ    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  þ
  
Accelerated filer  ¨
  
Non-accelerated filer ¨
  
Smaller reporting company ¨
 
  
 
  
(Do not check if a smaller reporting company)
  
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
Indicate the number of shares of each of the issuer’s classes of common stock, as of the latest practicable date:
Class
  
Outstanding at April 27, 2012
Common stock, $0.001 par value
  
53,295,714
 
 
 
 
 


Table of Contents

VOLCANO CORPORATION
Quarterly Report on Form 10-Q for the quarter ended March 31, 2012
Index
 
 
 
 
 
 
 
 
 
 
 
 


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Table of Contents


PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements

VOLCANO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(unaudited)
 
 
March 31,
2012
 
December 31,
2011
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
63,444

 
$
107,016

Short-term available-for-sale investments
133,181

 
112,327

Accounts receivable, net
66,365

 
69,469

Inventories
39,258

 
41,306

Prepaid expenses and other current assets
20,342

 
19,939

Total current assets
322,590

 
350,057

Restricted cash
712

 
692

Long-term available-for-sale investments
53,022

 
30,919

Property and equipment, net
90,939

 
81,097

Intangible assets, net
15,069

 
15,245

Goodwill
2,487

 
2,487

Other non-current assets
17,170

 
16,227

Total assets
$
501,989

 
$
496,724

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
12,596

 
$
12,911

Accrued compensation
17,187

 
20,251

Accrued expenses and other current liabilities
17,222

 
16,689

Deferred revenues
7,278

 
7,077

Current maturities of long-term debt
76

 
72

Total current liabilities
54,359

 
57,000

Convertible senior notes
96,833

 
95,663

Other long-term debt
47

 
74

Deferred revenues
3,127

 
3,168

Other
1,806

 
1,582

Total liabilities
156,172

 
157,487

Commitments and contingencies (Note 4)
 
 
 
Stockholders’ equity:
 
 
 
Preferred stock, par value of $0.001; 10,000 shares authorized; no shares issued and outstanding at March 31, 2012 and December 31, 2011

 

Common stock, par value of $0.001; 250,000 shares authorized at March 31, 2012 and December 31, 2011; 53,214 and 52,651 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively
53

 
53

Additional paid-in capital
439,022

 
430,490

Accumulated other comprehensive loss
(3,605
)
 
(1,382
)
Accumulated deficit
(89,653
)
 
(89,924
)
Total stockholders’ equity
345,817

 
339,237

Total liabilities and stockholders’ equity
$
501,989

 
$
496,724

See notes to unaudited condensed consolidated financial statements.

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VOLCANO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
 
 
Three Months Ended
March 31,
 
2012
 
2011
Revenues
$
90,360

 
$
80,995

Cost of revenues, excluding amortization of intangibles
29,573

 
27,874

Gross profit
60,787

 
53,121

Operating expenses:
 
 
 
Selling, general and administrative
44,345

 
35,460

Research and development
13,649

 
13,088

Amortization of intangibles
872

 
855

Total operating expenses
58,866

 
49,403

Operating income
1,921

 
3,718

Interest income
230

 
243

Interest expense
(1,472
)
 
(2,005
)
Exchange rate loss
(175
)
 
(388
)
Other, net
(96
)
 

Income before income tax
408

 
1,568

Income tax expense
137

 
412

Net income
$
271

 
$
1,156

Net income per share:
 
 
 
Basic
$
0.01

 
$
0.02

Diluted
$

 
$
0.02

Shares used in calculating net income per share:
 
 
 
Basic
52,929

 
51,766

Diluted
54,985

 
54,215

See notes to unaudited condensed consolidated financial statements.


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VOLCANO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)
 
 
Three Months Ended
March 31,
 
2012
 
2011
Net income
$
271

 
$
1,156

Other comprehensive income (loss):
 
 
 
   Foreign currency translation adjustments
(2,263
)
 
(341
)
   Changes in unrealized gain or loss on available-for-sale investments
40

 
43

Other comprehensive loss
(2,223
)
 
(298
)
Comprehensive income (loss)
$
(1,952
)
 
$
858


See notes to unaudited condensed consolidated financial statements.


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VOLCANO CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands)
(unaudited)
 
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Loss
 
Accumulated
Deficit
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2011
52,651

 
$
53

 
$
430,490

 
$
(1,382
)
 
$
(89,924
)
 
$
339,237

Issuance of common stock under equity plans
563

 

 
4,887

 

 

 
4,887

Employee stock-based compensation cost

 

 
3,645

 

 

 
3,645

Net income

 

 

 

 
271

 
271

Other comprehensive loss

 

 

 
(2,223
)
 

 
(2,223
)
Balance at March 31, 2012
53,214

 
$
53

 
$
439,022

 
$
(3,605
)
 
$
(89,653
)
 
$
345,817

See notes to unaudited condensed consolidated financial statements.


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VOLCANO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Three Months Ended March 31,
 
2012
 
2011
Operating activities
 
 
 
Net income
$
271

 
$
1,156

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
5,791

 
5,560

Amortization of investment premium, net
269

 
736

Accretion of debt discount on convertible senior notes
1,212

 
1,138

Non-cash stock-based compensation expense
3,617

 
3,094

Other non-cash adjustments
306

 
873

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
1,394

 
(759
)
Inventories
963

 
(1,799
)
Prepaid expenses and other assets
842

 
(1,141
)
Restricted cash

 
(77
)
Accounts payable
(2,321
)
 
729

Accrued compensation
(2,965
)
 
(4,375
)
Accrued expenses and other liabilities
950

 
(5,121
)
Deferred revenues
176

 
184

Net cash provided by operating activities
10,505

 
198

Investing activities
 
 
 
Purchase of short-term and long-term available-for-sale investments
(110,762
)
 
(83,908
)
Sale or maturity of short-term and long-term available-for-sale investments
67,577

 
98,790

Capital expenditures
(14,437
)
 
(6,747
)
Cash paid for intangible assets and other investments
(758
)
 
(313
)
Proceeds from foreign currency exchange contracts

 
374

Payment for foreign currency exchange contracts

 
(817
)
Net cash (used in) provided by investing activities
(58,380
)
 
7,379

Financing activities
 
 
 
Repayment of debt
(22
)
 
(10
)
Proceeds from sale of common stock under employee stock purchase plan
1,899

 
1,755

Proceeds from exercise of common stock options
2,988

 
2,939

Net cash provided by financing activities
4,865

 
4,684

Effect of exchange rate changes on cash and cash equivalents
(562
)
 
(2,686
)
Net (decrease) increase in cash and cash equivalents
(43,572
)
 
9,575

Cash and cash equivalents, beginning of period
107,016

 
43,429

Cash and cash equivalents, end of period
$
63,444

 
$
53,004

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest
$
1,656

 
$
1,481

Cash paid for income taxes
$
1,126

 
$
1,449

See notes to unaudited condensed consolidated financial statements.

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VOLCANO CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2012
1. Summary of Significant Accounting Policies
Basis of Presentation and Nature of Operations
The unaudited condensed consolidated financial statements of Volcano Corporation (“we,” “us,” “our,” “Volcano” or the “Company”) contained in this quarterly report on Form 10-Q include our financial statements and the financial statements of our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC. Pursuant to these rules and regulations, the Company has condensed or omitted certain information and footnote disclosures it normally includes in its annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the U.S. (GAAP). In the opinion of management, the unaudited condensed consolidated financial statements include all adjustments necessary, which are of a normal and recurring nature, for the fair presentation of the Company’s financial position and of the results of operations and cash flows for the periods presented. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our annual report on Form 10-K for the year ended December 31, 2011.
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 that we believe enhance the diagnosis and treatment of vascular and structural heart disease. Our products consist of multi-modality consoles which 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. Our consoles have been designed to serve as a multi-modality platform for our phased array and rotational IVUS catheters, FFR pressure wires, image-guided therapy catheters and Medtronic's Pioneer reentry device.
Our IVUS products include single-procedure disposable phased array and rotational IVUS imaging catheters, the VIBE RX image-guided therapy device, and additional functionality options such as virtual histology tissue characterization, or VH, and ChromaFlo stent apposition analysis. Our FFR offerings can be accessed through our multi-modality platforms, and we also provide FFR-only consoles. Our FFR disposables are single-procedure disposable pressure and flow guide wires used to measure the pressure and flow characteristics of blood around plaque enabling physicians to gauge the plaque's physiological impact on blood flow and pressure. We are developing additional offerings for integration into the platform, including adenosine-free Instant wave-free ratio FFR, or iFR, forward-looking IVUS or FL.IVUS, catheters, Focal Acoustic Computed Tomography catheters and ultra-high resolution Optical Coherence Tomography, or OCT, systems and catheters.
We also develop and manufacture optical monitors for the telecommunication industry; laser and non-laser light sources, and optical engines used in the medical OCT imaging systems and advanced photonic components and sub-systems used in spectroscopy and other industrial applications.
The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the operating results for the full fiscal year or any future periods.
Reclassification
Certain reclassifications have been made to the prior year’s financial statements to conform to current year presentation.
Concentrations of Credit Risk
Financial instruments which subject us to potential credit risk consist of our cash and cash equivalents, short-term and long-term available-for-sale investments, and accounts receivable. We have established guidelines to limit our exposure to credit risk by placing our investments with high credit quality financial institutions, diversifying our investment portfolio and holding investments with maturities that maintain safety and liquidity. We also place our cash and cash equivalents with high credit quality financial institutions. Deposits with these financial institutions may exceed the amount of insurance provided; however, these deposits typically are redeemable upon demand. Therefore we believe the financial risks associated with these financial instruments are minimal.
Trade accounts receivable are recorded at the net invoice value and are not interest bearing. We consider receivables past due based on the contractual payment terms. We perform ongoing credit evaluations of our customers, and generally we do not require collateral on our accounts receivable. We estimate the need for allowances for potential credit losses based on historical collection activity and the facts and circumstances relevant to specific customers and we record a provision for uncollectible

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accounts when collection is uncertain. To date, we have not experienced significant credit-related losses.
We currently hold foreign exchange forward contracts with two counterparties. The bank counterparties in these contracts expose us to credit-related losses in the event of their nonperformance and we do not require collateral for their performance. However, to mitigate that risk, we only contract with counterparties who meet our minimum credit quality guidelines.
In connection with the issuance of our 2.875% Convertible Senior Notes, or the Notes, we purchased call options from JPMorgan Chase Bank National Association, or JPMorgan Chase. Non-performance by JPMorgan Chase under these call options would potentially expose us to dilution of our common stock to the extent our stock price exceeds the conversion price. See Note 3 “Financial Statement Details — Convertible Debt” for additional information.
Net Income per Share
Basic earnings per share is computed by dividing net income attributable to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Potential dilutive securities are excluded from the diluted earnings per share computation in loss periods as their effect would be anti-dilutive.
Our potentially dilutive shares include outstanding common stock options, restricted stock units, incremental shares issuable upon the conversion of the Notes, or exercise of the warrants relating to the Notes (See Note 3 “Financial Statement Details — Convertible Debt”). Such potentially dilutive shares are excluded when the effect would be to reduce net loss per share or increase net income per share or if the underlying obligation will be settled in cash as discussed in the following paragraph. For three months ended March 31, 2012 and 2011, potentially dilutive shares totaling 1.8 million and 1.9 million, respectively, have not been included in the computation of diluted net income per share as the result would be anti-dilutive.
Diluted net income per common share does not include any incremental shares related to the Notes for the three months ended March 31, 2012 and 2011. Because the principal amount of the Notes will be settled in cash upon conversion if a conversion occurs, only the conversion spread relating to the Notes will be included in our calculation of diluted net income per common share. As such, the Notes will have no impact on diluted net income per common share until the price of our common stock exceeds the conversion price (initially $29.64, subject to adjustments) of the Notes. In addition, the diluted net income per common share does not include any incremental shares related to the exercise of the warrants for the three months ended March 31, 2012 and 2011. The warrants will not have an impact on diluted net income per common share until the price of our common stock exceeds the strike price of the warrants (initially $34.875, subject to adjustments). When the market price of our stock exceeds the conversion price of the Notes or the strike price of the warrants, as applicable, we will include, in the diluted net income per common share calculation, the effect of the additional shares that may be issued upon conversion of the Notes or exercise of the warrants using the treasury stock method.
In addition, the call options to purchase our common stock, which we purchased to hedge against potential dilution upon conversion of the Notes (see Note 3 “Financial Statement Details — Convertible Debt”), are not considered for purposes of calculating the total dilutive weighted average shares outstanding, as their effect would be anti-dilutive. Upon exercise, the call options will mitigate the dilutive effect of the Notes.

The basic and diluted net income per share calculations for the three months ended March 31, 2012 and 2011 are as follows (in thousands, except per share data, unaudited):
 
 
Three Months Ended
March 31,
 
2012
 
2011
Net income
$
271

 
$
1,156

Weighted average common shares outstanding for basic
52,929

 
51,766

Dilutive potential common stock outstanding:
 
 
 
Stock options
1,725

 
2,061

Restricted stock units
325

 
364

Employee stock purchase plan
6

 
24

Weighted average common shares outstanding for diluted
54,985

 
54,215

Net income per share:
 
 
 
Basic
$
0.01

 
$
0.02

Diluted
$

 
$
0.02


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Recent Accounting Pronouncements

There have been no new accounting pronouncements during the three months ended March 31, 2012, as compared to the
recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011,
that are of significance, or potential significance, to us.

2. Acquisitions
CardioSpectra Acquisition
On December 18, 2007, we acquired CardioSpectra, Inc., or CardioSpectra, a privately held corporation, for an aggregate purchase price of $27.0 million. The acquisition of CardioSpectra’s OCT technology is expected to complement our existing product offerings and further enhance our position as an imaging technology leader in the field of interventional medicine. The acquisition was accounted for as an asset purchase. We have included the operating results associated with the CardioSpectra acquisition in our consolidated financial statements from the date of acquisition.
Subject to the terms of the Merger Agreement, we may be required to make milestone payments. The remaining milestone payments of up to $17.0 million may be paid upon achievement of the respective revenue targets described in the merger agreement. As of March 31, 2012, we have not achieved the respective revenue targets. Therefore, we have not recorded any liability related to these milestones. The milestone payments are payable, at our sole discretion, in cash, shares of our common stock, or a combination of both and will be accounted for if and when the milestone payments become payable. We have used and will continue to use commercially reasonable efforts to cause the milestones to occur. However, if we reasonably determine that a technical failure or commercial failure has occurred with respect to all or a part of the OCT program, we may, at our sole discretion, terminate all or part of the OCT cardiovascular program.
In connection with the CardioSpectra acquisition and milestone payments potentially payable under the Merger Agreement, certain of the former shareholders of CardioSpectra commenced litigation against the Company during the quarter ended March 31, 2012. For the details related to this litigation, see Note 4 "Commitments and Contingencies - Litigation - CardioSpectra" to our unaudited condensed consolidated financial statements.
Fluid Medical Acquisition
On August 5, 2010, we acquired all of the outstanding equity interests in Fluid Medical, Inc., or Fluid Medical, a privately held company, which is engaged in the development of imaging technology for use in various structural heart applications, including, but not limited to, mitral valve repair. The purchase price of $4.2 million consisted of $3.6 million in cash payments and $150,000 of debt forgiveness related to working capital loans we made to Fluid Medical prior to the acquisition. We retained $400,000 as a “hold-back” liability to satisfy any claims for indemnification made within 18 months following the closing, the majority of which was released in February 2012.
Assets acquired primarily included $4.1 million of IPR&D. The IPR&D asset we recorded represents an estimate of the fair value of in-process technology related to Fluid Medical’s imaging technology program, which is still in the prototype phase. As such, based on authoritative accounting guidance, amortization of the IPR&D will not occur until it reaches market feasibility. Costs incurred in connection with this project subsequent to the date of acquisition will be expensed as incurred, and the project is currently expected to be completed in 2013. In the event the project is abandoned, we will record an impairment charge accordingly.

3. Financial Statement Details
Cash and Cash Equivalents and Available-for-Sale Investments
We invest our excess funds in securities issued by the U.S. government, corporations, banks, municipalities, financial holding companies and in money market funds comprised of these same types of securities. Our cash and cash equivalents and investments are placed with high credit quality financial institutions. Additionally, we diversify our investment portfolio in order to maintain safety and liquidity. As of March 31, 2012, all of our investments will mature within 23 months. These investments are recorded at their estimated fair value including accrued interest receivable, with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss).
Fair value is defined as an exit price that would be received from the sale of an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Authoritative guidance establishes a three-level hierarchy for disclosure that is based on the extent and level of judgment used to estimate the fair value of assets and liabilities.

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Level 1 – Valuations based on quoted prices for identical assets or liabilities in active markets at the measurement date. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment. Our Level 1 assets consist of money market funds and U.S. Treasury and agency debt securities.
Level 2 – Valuations based on quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data, such as alternative pricing sources with reasonable levels of price transparency. Our Level 2 assets consist of corporate debt securities including commercial paper, corporate bonds, certificates of deposit and foreign currency forward contracts.
Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement. We have not measured the fair value of any of our assets using Level 3 inputs.
We utilize a third-party pricing service to assist us in obtaining fair value pricing for our investments. Pricing for securities is based on proprietary models. Inputs are documented in accordance with the fair value disclosure hierarchy. We utilize a third-party financial institution to assist us in obtaining fair value pricing for our foreign currency forward contracts.
During the three months ended March 31, 2012 and 2011, no transfers were made into or out of the Level 1, 2, or 3 categories. We will continue to review our fair value inputs on a quarterly basis.
Financial assets and liabilities measured at fair value on a recurring basis are summarized below at March 31, 2012 and December 31, 2011 (in thousands):
 
 
Fair Value Measurements at March 31, 2012
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
Current:
 
 
 
 
 
 
 
Cash
$
55,898

 
$
55,898

 
$

 
$

Money market funds
7,546

 
7,546

 

 

Sub-total cash and cash equivalents
63,444

 
63,444

 

 

Corporate debt securities
129,161

 

 
129,161

 

U.S. Treasury and agency debt securities
4,020

 
4,020

 

 

Sub-total short-term investments
133,181

 
4,020

 
129,161

 

Foreign currency forward contracts
2,057

 

 
2,057

 

Long Term:
 
 
 
 
 
 
 
Corporate debt securities
25,985

 

 
25,985

 

U.S. Treasury and agency debt securities
27,037

 
27,037

 

 

Sub-total long-term investments
53,022

 
27,037

 
25,985

 

Total Assets
$
251,704

 
$
94,501

 
$
157,203

 
$



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Fair Value Measurements at December 31, 2011
 
Total
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
Current:
 
 
 
 
 
 
 
Cash
$
41,744

 
$
41,744

 
$

 
$

Money market funds
65,272

 
65,272

 

 

Sub-total cash and cash equivalents
107,016

 
107,016

 

 

Corporate debt securities
74,274

 

 
74,274

 

U.S. Treasury and agency debt securities
38,053

 
38,053

 

 

Sub-total short-term investments
112,327

 
38,053

 
74,274

 

Foreign currency forward contracts
92

 

 
92

 

Long Term:
 
 
 
 
 
 
 
Corporate debt securities
20,898

 

 
20,898

 

U.S. Treasury and agency debt securities
10,021

 
10,021

 

 

Sub-total long-term investments
30,919

 
10,021

 
20,898

 

Total Assets
$
250,354

 
$
155,090

 
$
95,264

 
$

Liabilities:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
71

 
$

 
$
71

 
$


Our investments have been classified as available-for-sale. At March 31, 2012 and December 31, 2011, available-for-sale investments are detailed as follows (in thousands):
 
 
At March 31, 2012
 
Amortized
Cost
 
Gross Unrealized
Gains
 
Gross Unrealized
Losses
 
Estimated
Fair Value
Short-term:
 
 
 
 
 
 
 
Corporate debt securities
$
129,127

 
$
60

 
$
26

 
$
129,161

U.S. Treasury and agency debt securities
4,019

 
1

 

 
4,020

Short-term available-for-sale investments
$
133,146

 
$
61

 
$
26

 
$
133,181

Long-term:
 
 
 
 
 
 
 
Corporate debt securities
$
25,966

 
$
22

 
$
3

 
$
25,985

U.S. Treasury and agency debt securities
27,034

 
3

 

 
27,037

Long-term available for sale investments
$
53,000

 
$
25

 
$
3

 
$
53,022

 
 
At December 31, 2011
 
Amortized
Cost
 
Gross Unrealized
Gains
 
Gross Unrealized
Losses
 
Estimated
Fair Value
Short-term:
 
 
 
 
 
 
 
Corporate debt securities
$
74,233

 
$
44

 
$
3

 
$
74,274

U.S. Treasury and agency debt securities
38,050

 
4

 
1

 
38,053

Short-term available-for-sale investments
$
112,283

 
$
48

 
$
4

 
$
112,327

Long-term:
 
 
 
 
 
 
 
Corporate debt securities
$
20,930

 
$
1

 
$
33

 
$
20,898

U.S. Treasury and agency debt securities
10,017

 
4

 

 
10,021

Long-term available for sale investments
$
30,947

 
$
5

 
$
33

 
$
30,919

Available-for-sale investments that are in an unrealized loss position at March 31, 2012 and December 31, 2011 are detailed as follows (in thousands):
 

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At March 31, 2012
 
Estimated
Fair Value
 
Gross Unrealized
Losses
Corporate debt securities
$
58,983

 
$
29

 
$
58,983

 
$
29


 
At December 31, 2011
 
Estimated
Fair Value
 
Gross Unrealized
Losses
Corporate debt securities
$
27,664

 
$
36

U.S. Treasury and agency debt securities
$
9,502

 
$
1

 
$
37,166

 
$
37

Derivative Financial Instruments
Our derivative financial instruments are composed of foreign currency forward contracts. We record derivative financial instruments as either assets or liabilities in our unaudited condensed consolidated balance sheets and measure them at fair value. At March 31, 2012 and December 31, 2011, notional amounts of our outstanding contracts were $58.8 million and $59.3 million, respectively. At March 31, 2012, the outstanding derivatives had maturities of 198 days or less. At March 31, 2012 and December 31, 2011, the fair value of our foreign currency forward contracts of $2.1 million and $92,000 was included in prepaid and other current assets and $0 and $71,000 was included in accrued expenses and other current liabilities in our unaudited condensed consolidated balance sheets. For the three months ended March 31, 2012 and 2011, $2.1 million and $281,000 of net gains related to our derivative financial instruments are included in exchange rate gain in our unaudited condensed consolidated statements of operations.
In connection with our convertible debt offering (discussed in more detail below) we purchased call options on our common stock from JPMorgan Chase. The call options give us the right to purchase up to approximately 3.9 million shares of our common stock at $29.64 per share subject to certain adjustments that generally correspond to the adjustments to the conversion rate for the underlying debt. Additionally, we sold warrants to JPMorgan Chase, which give JPMorgan Chase the right to purchase up to approximately 3.9 million shares of our common stock at $34.875 per share, subject to certain adjustments. In accordance with the authoritative guidance, we concluded that the call options and warrants were indexed to our stock. Therefore, the call options and warrants were classified as equity instruments and are not being marked to market prospectively as long as they continue to meet the conditions for equity classification.

Inventories
Inventories consist of the following (in thousands):
 
 
March 31,
2012
 
December 31,
2011
Finished goods (1)
$
14,103

 
$
17,770

Work-in-process
11,784

 
9,419

Raw materials
13,371

 
14,117

 
$
39,258

 
$
41,306

 _______________________ 
(1)
Finished goods inventory includes consigned inventory of $4.7 million and $4.9 million at March 31, 2012 and December 31, 2011, respectively.
Property and Equipment
Property and equipment consists of the following (in thousands):
 

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March 31,
2012
 
December 31,
2011
Medical diagnostic equipment
$
63,247

 
$
64,375

Other equipment
34,635

 
33,953

Leasehold improvements
9,151

 
8,514

Purchased software
5,243

 
5,113

Land
3,046

 
3,046

Construction-in-progress (1)
43,642

 
31,123

 
158,964

 
146,124

Accumulated depreciation and amortization
(68,025
)
 
(65,027
)
 
$
90,939

 
$
81,097

 _______________________ 
(1)
Construction-in-progress at March 31, 2012 and December 31, 2011 includes $1.8 million and $1.2 million, respectively, of capitalized interest related to the construction of our manufacturing facility in Costa Rica and ERP system implementation worldwide.
Intangible Assets
Intangible assets consist of developed technology, licenses, customer relationships, patents and trademarks, and assembled workforce which are amortized using the straight-line method over periods ranging from three to 20 years, representing the estimated useful lives of the assets. IPR&D consists of in-process technology related to Fluid Medical’s imaging program, which is still in the prototype phase and, therefore, amortization will not begin until such technology reaches market feasibility.
At March 31, 2012, intangible assets by major class consist of the following (in thousands):
 
 
March 31, 2012
 
Cost
 
Accumulated
Amortization
 
Net
 
Weighted-
Average Life
(in years) (1)
Intangible assets subject to amortization
 
 
 
 
 
 
 
Developed technology
$
22,651

 
$
16,327

 
$
6,324

 
8.2

Licenses
7,195

 
6,217

 
978

 
10.0

Customer relationships
4,088

 
3,339

 
749

 
3.3

Patents and trademarks
4,709

 
1,741

 
2,968

 
10.6

Assembled workforce
274

 
274

 

 
4.0

 
38,917

 
27,898

 
11,019

 
7.5

Intangible assets not yet subject to amortization
 
 
 
 
 
 
 
In-process research and development (2)
4,050

 

 
4,050

 
n/a

 
$
42,967

 
$
27,898

 
$
15,069

 
 
At December 31, 2011, intangible assets by major class consist of the following (in thousands):
 

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December 31, 2011
 
Cost
 
Accumulated
Amortization
 
Net
 
Weighted-
Average Life
(in years) (1)
Intangible assets subject to amortization
 
 
 
 
 
 
 
Developed technology
$
22,651

 
$
15,995

 
$
6,656

 
8.2

Licenses
7,195

 
6,054

 
1,141

 
10.0

Customer relationships
4,082

 
3,067

 
1,015

 
3.3

Patents and trademarks
4,015

 
1,632

 
2,383

 
9.0

Assembled workforce
274

 
274

 

 
4.0

 
38,217

 
27,022


11,195

 
7.3

Intangible assets not yet subject to amortization
 
 
 
 
 
 
 
In-process research and development (2)
4,050

 

 
4,050

 
n/a

 
$
42,267

 
$
27,022

 
$
15,245

 
 
 _______________________ 
(1)
Weighted average life of intangible assets is presented excluding fully amortized assets.
(2)
IPR&D represents an estimate of fair value of in-process technology related to Fluid Medical’s imaging technology program, which is still in the prototype phase. As such, based on authoritative guidance, amortization of the IPR&D will not occur until it reaches market feasibility. In the event the project is abandoned, we will record an impairment charge for this amount.

At March 31, 2012, future amortization expense associated with our intangible assets is expected to be as follows (in thousands):
 
2012 (remaining nine months)
$
2,153

2013
2,229

2014
1,573

2015
1,157

2016
998

Thereafter
2,909

 
$
11,019

Convertible Debt
In September 2010, we issued $115.0 million aggregate principal amount of 2.875% Convertible Senior Notes due September 1, 2015, or the Notes, in an offering registered under the Securities Act of 1933, as amended. Interest is payable semiannually in arrears on March 1 and September 1, commencing on March 1, 2011.
The Notes are general unsecured obligations that rank pari passu with our other existing and future unsecured obligations. Prior to June 1, 2015, the Notes are convertible only upon certain events specified in the indenture governing the Note. The initial conversion rate for the Notes is 33.7339 shares of common stock per $1,000 principal amount of the Notes, representing an initial effective conversion price of approximately $29.64 per share of common stock. The conversion rate is subject to adjustment for certain events as outlined in the indenture governing the Notes but will not be adjusted for accrued and unpaid interest.
We received proceeds of $100.5 million from issuance of the Notes, net of debt issuance costs ($4.4 million) and net payments related to our hedge transactions ($10.0 million) which are described in more detail below. We recorded total debt issuance costs (including broker fees) of approximately $4.4 million, which were allocated on a pro-rata basis to the debt ($3.5 million) and equity ($866,000) components of the transaction. The debt component is primarily included in non-current liabilities and is being accreted to interest expense over five years, the term of the Notes. The equity component was netted against the proceeds and included in additional paid-in capital.
We may not redeem the Notes prior to maturity. However, in the event of a fundamental change, as defined in the indenture, the holders of the Notes may require us to purchase all or a portion of their Notes at a purchase price equal to 100% of the principal amount of the Notes, plus accrued and unpaid interest, if any, to the repurchase date. Holders who convert their Notes in connection with a make-whole fundamental change, as defined in the indenture, may be entitled to a make-whole premium in

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the form of an increase in the conversion rate.

In connection with the offering of the Notes, to hedge against potential dilution upon conversion of the Notes, we also purchased call options on our common stock from JPMorgan Chase. The call options give us the right to purchase up to approximately 3.9 million shares of our common stock at $29.64 per share subject to certain adjustments that generally correspond to the adjustments to the conversion rate for the Notes. We paid an aggregate of $27.2 million to purchase these call options. The call options will expire on September 1, 2015, unless earlier terminated or exercised. To reduce the cost of the hedge, in a separate transaction we sold warrants to JPMorgan Chase. These warrants give JPMorgan Chase the right to purchase up to approximately 3.9 million shares of our common stock at $34.875 per share, subject to certain adjustments. These warrants will be exercisable and will expire in equal installments for a period of 50 trading days beginning on December 1, 2015. We received an aggregate of $17.1 million from the sale of these warrants. In accordance with the applicable authoritative guidance, we concluded that the call options and warrants were indexed to our stock. Therefore, the call options and warrants were classified as equity instruments and will not be marked to market prospectively as long as they continue to meet the condition for equity classification. The net amount of $10.0 million paid to JPMorgan Chase was recorded as a reduction to additional paid-in capital. The settlement terms of the call options provide for net share settlement and the settlement terms of the warrants provide for net share or cash settlement at our option. The carrying values of the liability and equity components of the Notes are reflected in our unaudited condensed consolidated balance sheets as follows (in thousands):
 
 
March 31,
2012
 
December 31,
2011
Liabilities:
 
 
 
Principal amount of the 2.875% Convertible Senior Notes
$
115,000

 
$
115,000

Unamortized discount of liability component
(16,245
)
 
(17,275
)
Unamortized debt issuance costs
(1,922
)
 
(2,062
)
Carrying value of liability component
$
96,833

 
$
95,663

Equity — net carrying value
$
22,263

 
$
22,263

The fair value of the Notes at March 31, 2012 was $134.6 million.
Other Long-Term Debt
The amounts outstanding for other long-term debt at March 31, 2012 and December 31, 2011 relate to capital leases.

4. Commitments and Contingencies
Litigation — LightLab
On January 7, 2009, LightLab Imaging, Inc., or LightLab, filed a complaint against us and our wholly owned subsidiary, Axsun, in the Superior Court of Massachusetts, Suffolk County, seeking injunctive relief and unspecified damages (the Massachusetts Action). LightLab develops and sells OCT products for cardiovascular imaging and other medical uses. On July 6, 2010, LightLab was acquired by St. Jude Medical, Inc., or St. Jude.
Prior to our acquisition of Axsun, Axsun had entered into a development and supply agreement, or the Agreement, with LightLab, in which, among other things, Axsun agreed to supply tunable lasers to LightLab for use in LightLab’s OCT imaging products until April 2016, with exclusivity in the field of coronary artery imaging expiring in April 2014. Since the acquisition, Axsun has continued to supply lasers to LightLab. The complaint includes allegations that Volcano interfered with the Agreement and with LightLab’s advantageous business relationship with Axsun, that Axsun breached the Agreement, that Axsun and Volcano misappropriated LightLab’s confidential information and trade secrets, and violated Chapter 93A, a Massachusetts statute that provides for recovery of up to three times damages plus attorneys fees (93A).
The Judge ordered that the trial in the Massachusetts Action proceed in separate phases, with a jury trial first on liability, followed by a jury trial on damages, and then non-jury hearings on liability under 93A and on injunctive relief. The jury trial on liability commenced on January 4, 2010 and the jury returned a verdict on February 4, 2010 that included findings that the contract specifications for the lasers Axsun supplies and previously supplied to LightLab are trade secrets of LightLab, that Axsun agreed not to sell any tunable lasers to Volcano for any purpose or to third parties for use in cardiology imaging during the exclusivity period in the contract, and that Axsun breached its contract with LightLab. The jury further found that Volcano intentionally interfered with LightLab’s advantageous business relationship with Axsun.

A trial in the Massachusetts Action with respect to damages was set to commence on April 7, 2010 (Damages Trial). In lieu of

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conducting the Damages Trial, the parties agreed and stipulated that the sum of $200,000 would be treated as if it were the jury’s verdict against the defendants in the Damages Trial (the Stipulation).
Upon the entry of the Stipulation, LightLab waived its rights, if any, to make any additional claims for special damages relating to lasers received in 2009 that do not meet the version 6 specification, for special damages claimed by LightLab in prior pleadings, and for the repair and/or replacement of any of the lasers specified in the Stipulation. In addition, Axsun waived its rights, if any, to make any claim for recovery from LightLab for certain engineering charges in connection with a development and supply agreement with LightLab, and for return by LightLab of any of the lasers specified in the Stipulation.
Under the Stipulation, all parties expressly reserved their otherwise properly preserved rights of appeal. These rights include LightLab’s appellate rights, if any, regarding its claim for alleged lost profits in excess of the above-referenced $200,000 stipulated amount to the extent LightLab is able to establish that it has properly preserved such rights.
The injunctive relief phase of the Massachusetts Action commenced on April 12, 2010. In a ruling issued October 5, 2010, the Court rejected LightLab’s claims for protection of five alleged trade secrets relating to laser technologies, and denied all of LightLab’s requests for permanent injunctions with respect to those trade secrets. The ruling followed a two-week trial on five of a number of trade secret claims alleged by LightLab.
In a summary judgment ruling issued January 26, 2011, the Court rejected the remainder of LightLab’s claims for protection of its remaining trade secrets, and denied all of LightLab’s claims for permanent injunctions with respect to those trade secrets. This judgment completed the trade secret portion of the Massachusetts Action.
In a ruling issued January 28, 2011, the Court found that Volcano and Axsun violated 93A, and awarded LightLab additional damages of $400,000 and reasonable attorneys’ fees.
On February 10, 2011, and on April 7, 2011, the Court entered a Final Judgment and an Amended Final Judgment, respectively, in the Massachusetts Action: a) in favor of Volcano and Axsun on LightLab’s claims for trade secret misappropriation on items 1-30 on LightLab’s list of alleged trade secrets, b) ordered Volcano and Axsun to collectively pay $600,000 in damages (which amount includes the $200,000 agreed to in the Stipulation and the $400,000 ordered in the 93A ruling) and $4.5 million in attorneys’ fees, (resulting in a total of $4.9 million recorded to selling, general and administrative expense and accrued in other current liabilities during the fourth quarter of 2010), c) in favor of LightLab on its claims against Axsun for breach of contract, breach of implied covenant of good faith and fair dealing, for violation of 93A, and misappropriation of trade secrets for disclosing three particular items to Volcano in December 2008 – the specifications for the two lasers provided by Axsun to LightLab and one Axsun laser prototype made in 2008, d) in favor of LightLab on its claims against Volcano for intentional interference with a contract and advantageous business relationship, unjust enrichment, violation of 93A, and misappropriation of trade secrets for the same three trade secrets described above. In addition, the Court denied a majority of LightLab’s requested injunctions, and entered limited injunctive relief, none of which management believes have a material effect upon Volcano. The Final Judgment and Amended Final Judgment are substantially similar. The Amended Final Judgment corrects non-substantive clerical errors. On April 15, 2011, LightLab filed a notice of appeal, with respect to various decisions of the Court, including, a) the Court’s decisions adverse to LightLab’s claims for trade secret misappropriation in items 1-30 of LightLab’s alleged list of trade secrets, including the Court’s post-trial finding of fact and rulings of law adverse to LightLab on items 1 – 5, the Court’s two summary judgment decisions adverse to LightLab on items 6 – 23 and 25 – 30 (item 24 having been voluntarily dismissed by LightLab), and various rulings requiring evidence of use or intent to use as a prerequisite for injunctive relief; b) the Court’s post-trial decisions denying permanent injunctive relief that LightLab requested as terms of the Final Judgment; c) the Court’s pre-trial rulings excluding certain lost profits damages evidence that LightLab sought to introduce at trial; d) various discovery and pre-trial orders denying LightLab discovery about Axsun’s work for Volcano; e) the Court’s order barring LightLab from claiming that the sale of Axsun to Volcano itself constituted a breach of the LightLab-Axsun supply contract; and f) the denial of LightLab’s motion to alter or amend the Final Judgment, which motion sought to obtain additional declaratory relief barring Axsun from “supplying” tunable lasers to Volcano. Volcano and Axsun do not intend to cross appeal the Amended Final Judgment, and on July 5, 2011, Volcano and Axsun satisfied their payment obligations under the Amended Final Judgment by making a payment to Lightlab in the amount of approximately $5.4 million.
On February 5, 2010, Volcano and our wholly owned subsidiary, Axsun, commenced an action in the Delaware Chancery Court, or the Chancery Court Action, against LightLab seeking a declaration of Volcano and Axsun’s rights with respect to certain OCT technology, the High Definition Swept Source. The complaint was served on LightLab on March 19, 2010. LightLab then filed a counter-claim that included a claim against Axsun and Volcano for violations of 93A. Volcano and Axsun moved to dismiss LightLab’s 93A counter-claim, and LightLab responded to that motion by amending its 93A counter-claim. The 93A counterclaim has been stayed pending further action by the Chancery Court. This case has been stayed until such time as Volcano has achieved certain development and regulatory milestones.


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Additionally, on May 24, 2011, LightLab commenced a separate action in Delaware Chancery Court, or the Second Chancery Court Action, against Volcano and Axsun alleging that Axsun is inappropriately assisting Volcano in the development of a third-party laser. The complaint seeks injunctive relief and unspecified damages. After Volcano and Axsun moved to dismiss the Second Chancery Court Action, LightLab filed an amended complaint against Volcano and Axsun, adding additional allegations regarding misappropriation of trade secrets. Volcano and Axsun have submitted an answer to the amended complaint. In addition, Volcano and Axsun moved for judgment on the pleadings, seeking to dismiss a portion of LightLab’s amended complaint, and have filed an additional motion to stay the remainder of the Second Chancery Court Action. A hearing on these motions is scheduled for May 29, 2012.
Litigation — St. Jude
On July 27, 2010, St. Jude filed a lawsuit against Volcano in federal district court in Delaware (collectively, with the counterclaims described below, the Delaware Patent Action), alleging that our pressure guide wire products infringe five patents owned by St. Jude. St. Jude is seeking injunctive relief and monetary damages. This action does not involve OCT technology and is separate from the Massachusetts Action.
On September 20, 2010, Volcano filed its response, in which we denied the allegations that our PrimeWire® products infringe any valid claim of St. Jude’s asserted patents. In addition, Volcano filed a counterclaim in which we have alleged that St. Jude’s PressureWire® products and its RadiAnalyzer® Xpress product infringe three Volcano patents. In our counterclaim, Volcano is seeking injunctive relief and monetary damages. A trial has been scheduled for October 15, 2012 for the Delaware Patent Action.
On April 9, 2012, St. Jude Medical, Cardiology Division, Inc., St. Jude Medical Systems AB and St. Jude Medical S.C. filed a sealed complaint in the United States District Court for the District of Delaware alleging that Volcano Corporation infringes United States Patent No. 6565514. Volcano's answer, motion or other response is due on or before May 31, 2012.

Litigation - CardioSpectra
On March 27, 2012, Christopher E. Banas, et al., filed a lawsuit against Volcano in federal district court in the Northern District of California, alleging claims for breach of contract, breach of fiduciary duty, and breach of the implied covenant of good faith and fair dealing based on Volcano's acquisition of CardioSpectra in 2007. Specifically, plaintiffs assert that Volcano has failed to comply with the terms and the alleged implied obligations of the Merger Agreement relating to potential milestone payments. CardioSpectra was in the business of developing OCT technology, however, this litigation is separate from the Massachusetts Action.
Volcano's answer, motion, or other response is due May 14, 2012. Volcano intends to deny the allegations asserted and is considering the possibility of filing counterclaims. A trial date has not yet been scheduled in this matter.
Litigation — Other
We may also be a party to various other claims in the normal course of business. Legal fees and other costs associated with such actions are expensed as incurred and were not material in any period reported. Additionally, we assess, in conjunction with our legal counsel, the need to record a liability for litigation and contingencies. Reserve estimates are recorded when and if it is determined that a loss related matter is both probable and reasonably estimable. We are not able to predict or estimate the ultimate outcome or range of possible losses relating to the Massachusetts Action, the Chancery Court Action, the Delaware Patent Action, the Second Chancery Court Action, the CardioSpectra case or any of the other lawsuits, claims or counterclaims described above. However, we believe that the ultimate disposition of these matters, individually and in the aggregate, including the matters discussed above, will not have a material impact on our consolidated results of operations, financial position or cash flows. Our evaluation of the likely impact of these matters could change in the future and unfavorable outcomes and/or defense costs, depending upon the amount and timing, could have a material adverse effect on our results of operations or cash flows in future periods.
Operating Leases
Rent expense for our facilities leases is being recognized on a straight-line basis over the respective minimum lease terms.
Purchase Commitments
We have obligations under non-cancelable purchase commitments. The majority of these obligations relate to inventory, primarily raw materials. At March 31, 2012, the future minimum payments under these non-cancelable purchase commitments totaled $52.4 million, of which $29.3 million will require payments at various dates through June 30, 2012. The remaining

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amount will require payments at various dates through 2016.
In October 2007, we signed a clinical research support agreement with a third party in which the third party will conduct clinical studies concerning drug eluting stents. We have agreed to provide a total of $4.6 million to fund clinical study activities. At March 31, 2012, we have a remaining obligation of up to $2.4 million and we will be billed as services are performed under the agreement. In addition, we have entered into agreements with other third parties to sponsor clinical studies. Generally, we contract with one or more clinical research sites for a single study and no one agreement is material to our consolidated results of operations or financial condition. We are usually billed as services are performed based on enrollment and are required to make payments over periods ranging from less than one year up to three years. Our actual payments under these agreements will vary based on enrollment.
In 2010, we acquired a parcel of land and commenced construction of a 140,000 square foot manufacturing facility in Costa Rica. The estimated cost of the construction, including the land purchase is approximately $30.5 million, of which $26.7 million has been paid at March 31, 2012, including $5.1 million that was paid during the three months ended March 31, 2012.

Indemnification
Our supplier, distributor and collaboration agreements generally include certain provisions for indemnification against liabilities if our products are recalled, infringe a third party’s intellectual property rights or cause bodily injury due to alleged defects in our products. In addition, we have agreements with our present and former directors and executive officers indemnifying them against liabilities arising from service in their respective capacities to Volcano. We maintain directors’ and officers’ insurance policies that may limit our exposure to such liabilities. To date, we have not incurred any material costs as a result of such indemnifications and have not accrued any liabilities related to such obligations in the accompanying unaudited condensed consolidated financial statements.
Sole source suppliers
We rely on a number of sole source suppliers to supply transducers, substrates and processing for our scanners used in our catheters. We are not parties to supply agreements with these suppliers but instead use purchase orders as needed.

5. Stockholders’ Equity
Stock Benefit Plans
Our 2005 Amended and Restated Equity Compensation Plan, or 2005 Amended Plan, provides for an aggregate of 16,212,558 shares of our common stock that may be issued or transferred to our employees, non-employee directors and consultants, including increases of 2,050,000 and 2,500,000 shares which were approved by our stockholders on July 29, 2009 and May 2, 2011, respectively. Commencing July 29, 2009, the number of shares of common stock available for issuance under the 2005 Amended Plan was reduced by one share for each share of stock issued pursuant to a stock option or a stock appreciation right and one and sixty-three hundredths (1.63) shares for each share of common stock issued pursuant to a restricted stock award, restricted stock unit award, or RSU, performance-based RSU or other stock award. Commencing May 2, 2011, the number of shares of common stock available for issuance under the 2005 Amended Plan was reduced by one share for each share of stock issued pursuant to a stock option or a stock appreciation right and two and twelve hundredths (2.12) shares for each share of common stock issued pursuant to an restricted stock award, RSU, performance-based RSU or other stock award. Shares net exercised or retained to cover a participant’s minimum tax withholding obligations do not again become available for issuance under the 2005 Amended Plan.
At March 31, 2012, we have granted stock options, RSUs and performance-based RSUs under the 2005 Amended Plan. Stock options previously granted under the 2000 Long Term Incentive Plan that are cancelled or expired will increase the shares available for grant under the 2005 Amended Plan. In addition, employees have purchased shares of the Company’s common stock under the 2007 Employee Stock Purchase Plan, or the Purchase Plan. At March 31, 2012, 3,188,782 shares and 335,512 shares remained available to grant under the 2005 Amended Plan and the Purchase Plan, respectively.
On February 27, 2012, our Section 162(m) Committee adopted, under the terms of the 2005 Amended Plan, the 2012 Long Term Incentive Plan, or LTI, and granted 61,003 shares of performance-based RSUs under the terms of the LTI. The Committee established the LTI plan to align key management and senior leadership with stockholders' interests and to retain key employees. The measurement period for the LTI Plan is our fiscal 2012 year. If pre-determined performance goals are met, shares of stock subject to the performance-based RSUs granted to the recipient will begin to vest, with one third vesting on the date of certification of achievement of the pre-determined performance goals, and the remaining two thirds vesting evenly on each of December 31, 2013 and December 31, 2014, contingent upon the recipient’s continued service to the Company on each such date. Recipients of the performance-based RSU awards have the ability to receive up to 150% of the target number of shares.

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Fair Value Assumptions
The fair value of each stock option is estimated on the date of grant using the Black-Scholes-Merton option-pricing, or Black-Scholes, model utilizing the following weighted-average assumptions:
 
 
Three Months Ended
March 31,
 
2012
 
2011
Risk-free interest rate
0.8
%
 
2.2
%
Expected life (years)
4.0

 
4.5

Estimated volatility
47.2
%
 
48.0
%
Expected dividends

 

Weighted-average grant date fair value
10.79

 
11.47

The risk-free interest rate for periods within the contractual life of the stock option is based on the implied yield available on U.S. Treasury constant maturity securities with the same or substantially equivalent remaining terms at the time of grant.
We use our historical stock option exercise experience to estimate the expected term of our stock options.

We utilize the volatility of our own common stock in determining the grant date fair value.
We use a zero value for the expected dividend value factor since we have not declared any dividends in the past and we do not anticipate declaring any dividends in the foreseeable future.
The fair value of each purchase option under the Purchase Plan is estimated at the beginning of each purchase period using the Black-Scholes model utilizing the following weighted-average assumptions:
 
 
Three Months Ended
March 31,
 
2012
 
2011
Risk-free interest rate
0.10
%
 
0.20
%
Expected life (years)
0.5

 
0.5

Estimated volatility
40.6
%
 
37.2
%
Expected dividends

 

Fair value of purchase right
7.48

 
6.07

The computation of the expected volatility assumption used in the Black-Scholes model for purchase rights is based on the trading history of our common stock. The expected life assumption is based on the six-month term of each offering period. The risk-free interest rate is based on U.S. Treasury constant maturity securities with the same or substantially equivalent remaining term in effect at the beginning of the offering period. We use a zero value for the expected dividend value factor since we have not declared any dividends in the past and we do not anticipate declaring any dividends in the foreseeable future.
Stock-Based Compensation Expense
With the exception of performance-based RSUs, stock-based compensation expense is recognized on a straight-line basis over the requisite service period of the entire award, which is generally the vesting period.
We recognize the estimated compensation cost of performance-based RSUs, net of estimated forfeitures. The performance-based RSUs are earned upon attainment of identified performance goals, some of which contain discretionary metrics. As such, these award are re-valued based on our traded stock price at the end of each reporting period. If the discretion is removed, the award will be classified as a fixed equity award. The fair value of the awards will be based on the measurement date, which is the date the award becomes fixed. Expense is recognized on a straight-line basis over the requisite service period for each vesting tranche of the award.
The following table sets forth stock-based compensation expense included in our unaudited condensed consolidated statements of operations (in thousands):
 

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Three Months Ended
March 31,
 
2012
 
2011
Cost of revenues
$
152

 
$
163

Selling, general and administrative
2,996

 
2,589

Research and development
469

 
342

 
$
3,617

 
$
3,094

Included in our stock-based compensation expense is $0, and $115,000 of stock-based compensation expense related to non-employees in the three months ended March 31, 2012 and 2011, respectively. Stock-based compensation expense of $619,000 and $274,000 related to the Purchase Plan was also recorded in the three months ended March 31, 2012 and 2011, respectively. At March 31, 2012 and December 31, 2011, there was $230,000 and $202,000, respectively, of total stock-based compensation cost capitalized in inventories.
We estimate forfeitures and only recognize expense for those shares expected to vest. Our estimated forfeiture rates in the three months ended March 31, 2012 and 2011 are based on our historical forfeiture experience.

6. Segment and Geographic Information
Our chief operating decision-maker reviews financial information presented on a consolidated basis, accompanied by disaggregated information about segment revenues by product and geographic region for purposes of making operating decisions and assessing financial performance. We have two reporting segments: medical segment and industrial segment. The medical segment includes the manufacture, sale, discovery, development and commercialization of precision guided therapy tools for the diagnosis of atherosclerosis in the coronary arteries and peripheral vascular system. The industrial segment includes the discovery, development, manufacture and sale of micro-optical spectrometers and optical channel monitors to telecommunications and other industrial companies.

We do not assess the performance of our segments on other measures of income or expense, such as depreciation and amortization, operating income or net income. We do not produce reports for, or measure the performance of, our segments on any asset-based metrics. Therefore, segment information is presented only for revenues by product.
The following table sets forth our revenues by segment and product (in thousands) :
 
 
Three Months Ended
March 31,
 
Percentage
Change
 
2012
 
2011
 
2011 to 2012
Medical segment:
 
 
 
 
 
Consoles
$
8,116

 
$
9,931

 
(18.3
)%
Single-procedure disposables:
 
 
 
 
 
IVUS
53,484

 
47,618

 
12.3
 %
FM
20,138

 
14,700

 
37.0
 %
Other
6,620

 
4,864

 
36.1
 %
Sub-total medical segment
88,358

 
77,113

 
14.6
 %
Industrial segment
2,002

 
3,882

 
(48.4
)%
 
$
90,360

 
$
80,995

 
11.6
 %
The following table sets forth our revenues by geography expressed as dollar amounts (in thousands):
 

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Three Months Ended
March 31,
 
Percentage
Change
 
2012
 
2011
 
2011 to 2012
Revenues (1):
 
 
 
 
 
United States
$
41,377

 
$
36,335

 
13.9
 %
Japan
30,789

 
24,712

 
24.6
 %
Europe, the Middle East and Africa
13,664

 
14,076

 
(2.9
)%
Rest of world
4,530

 
5,872

 
(22.9
)%
 
$
90,360

 
$
80,995

 
11.6
 %
_______________________ 
(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.
At March 31, 2012, approximately 42.7% of our long-lived assets, excluding financial assets, were located in the U.S., approximately 36.4% were located in Costa Rica, 16.8% were located in Japan and less than 5.0% were located in our remaining geographies. At December 31, 2011, approximately 44.8% of our long-lived assets, excluding financial assets, were located in the U.S., approximately 30.2% are located in Costa Rica, 20.7% were located in Japan, and less than 5.0% were located in our remaining geographies.

At March 31, 2012 and December 31, 2011, goodwill of $2.5 million has been allocated entirely to our medical segment and relates to our U.S. operations.

7. Income Taxes

Income taxes are determined using an estimated annual effective tax rate applied against income, and then adjusted for the tax impacts of certain discrete items. The Company recorded income tax expense of $137,000 and $412,000 for the three months ended March 31, 2012 and 2011, respectively. The effective income tax rate for the three months ended March 31, 2012 was 33.58%. The Company updates its annual effective income tax rate each quarter and if the estimated effective income tax rate changes, a cumulative adjustment is made. The annual effective income tax rate for 2012 is expected to be higher than the U.S. federal statutory rate of 35% primarily due to state income taxes, net of federal benefit, estimates for certain non-deductible expenses and foreign rate differentials. At the end of 2011, the federal research and development credit expired and has not yet been extended for 2012. If the research and development credit is extended, the annual effective tax rate for 2012 is expected to be lower than the U.S. federal statutory rate of 35%. There was no material change to the Company's unrecognized tax benefits and interest accrued related to unrecognized tax benefits during the three months ended March 31, 2012.

8. Subsequent Events
None.


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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,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of those words and other comparable words. These statements include, but are not limited to, those concerning the following: our intentions, beliefs and expectations regarding our future financial performance, anticipated growth, trends in our business, trends in the medical field related to our products and technology, and the performance and competitive advantages of our products; our beliefs with respect to the usefulness of anticipated clinical data; the timing and success of our clinical trials, data presentations, regulatory submissions and anticipated product launches; our belief that our cash and cash equivalents and available-for-sale investments will be sufficient to satisfy our anticipated cash requirements; our belief that our current and planned facilities are sufficient for our business; our operating results; timing, costs and outcomes of current or future litigation; our expectations regarding our revenues and costs of producing our products; our expectations regarding our customers and distributors; and our intentions, beliefs and expectations regarding market penetration and expansion efforts. 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 and elsewhere throughout this Quarterly Report and in any other documents incorporated by reference into 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 vascular heart disease by improving the efficiency and efficacy of existing percutaneous interventional, or PCI, therapy procedures in the coronary or peripheral arteries. We 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.
Our products consist of multi-modality consoles which are marketed as stand-alone units or as customized units that can be integrated into a variety of hospital-based interventional surgical suites called catheterization laboratories, or cath labs. We have developed customized cath lab versions of these consoles and are developing additional functionality options as part of our cath lab integration initiative. Our consoles have been designed to serve as a multi-modality platform for our phased array and rotational IVUS catheters, FFR pressure wires, image-guided therapy catheters and Medtronic's Pioneer reentry device. Our IVUS products include single-procedure disposable phased array and rotational IVUS imaging catheters, the VIBE RX image-guided therapy device, and additional functionality options such as virtual histology, or VH, IVUS tissue characterization and ChromaFlo stent apposition analysis. Our FFR offerings can be accessed through our multi-modality platforms, and we also provide FFR-only consoles. Our FFR disposables are single-procedure disposable pressure and flow guide wires used to measure the pressure and flow characteristics of blood around plaque enabling physicians to gauge the plaque's physiological impact on blood flow and pressure. We are developing additional offerings for integration into the platform, including adenosine-free Instant wave-free ratio FFR, or iFR, forward-looking IVUS, or FL.IVUS, catheters, Focal Acoustic Computed Tomography catheters and ultra-high resolution Optical Coherence Tomography, or OCT, systems and catheters. In addition, Our Valet Micro catheter received 510(k) clearance in January 2012 and CE Mark approval in May 2012.
Through Axsun Technologies, Inc., or Axsun, one of our wholly owned subsidiaries, we also develop and manufacture optical monitors for the telecommunication industry, laser and non-laser light sources, and optical engines used in the medical OCT imaging systems and advanced photonic components and sub-systems used in spectroscopy and other industrial applications. We believe Axsun's proprietary OCT technology will provide us competitive advantages in the invasive imaging sector.
We have infrastructure in the U.S., Europe, Japan and Costa Rica. Our corporate office is located in San Diego, California. Our manufacturing operations are located in Rancho Cordova, California, Billerica, Massachusetts and Alajuela, Costa Rica. We have research and development facilities in Rancho Cordova, California, Billerica, Massachusetts, Cleveland, Ohio, Forsyth County, Georgia and San Diego, California. We have sales offices in Alpharetta, Georgia and Tokyo, Japan; sales and distribution offices in Zaventem, Belgium and Woodmead, South Africa; and third-party distribution facilities in Ota-ku and Tokyo, Japan.
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

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behalf of hospitals. We sell our products directly to customers in the U.S., Japan, certain European markets and South Africa. We utilize distributors in other geographic areas, who are also involved in product launch planning, education and training, physician support and clinical trial management.
At March 31, 2012, we had a worldwide installed base of over 7,000 consoles. We intend to grow and leverage this installed base to drive recurring sales of our single-procedure disposable catheters and guide wires. In the three months ended March 31, 2012, the sale of our single-procedure disposable catheters and guide wires accounted for $73.6 million, or 83.3% of our medical segment revenues, a $11.3 million, or 18.1% increase from the same period in 2011, in which the sale of our single-procedure disposable catheters and guide wires accounted for $62.3 million, or 80.8% of our medical segment revenues.
In the three months ended March 31, 2012 and 2011, 48.0% and 46.9 %, respectively, of our revenues and 22.3% and 21.7%, respectively, of our operating expenses were denominated in various non-U.S. dollar currencies, primarily the 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 decreased 4.4% from 81.73 in the three months ended March 31, 2011 to 78.15 in the three months ended March 31, 2012, which resulted in a net positive impact to our operational results in the amount of approximately $774,000. On the other hand, the average exchange rate of one euro to U.S. dollar decreased 3.6% from 1.37 in the three months ended March 31, 2011 to 1.32 in the three months ended March 31, 2012, which resulted in a net negative impact to our operational results in the amount of approximately $299,000.
We manufacture our multi-modality and FFR consoles, IVUS catheters and FFR guide wires at our facility in Rancho Cordova, California. 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.

The Patient Protection and Affordable Care Act and Health Care and Education Affordability Reconciliation Act were enacted into law in the U.S. on March 23, 2010. The legislation imposes on medical device manufacturers a 2.3 percent excise tax on U.S. sales of Class I, II and III medical devices beginning January 1, 2013. While we are continuing to evaluate this legislation and its potential impact on the Company, it may adversely affect our business and results of operations.
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 the Middle East may have adverse consequences to the global economy or to our customers in the Middle East, which could negatively impact our business. The challenging global economic conditions have also led to concerns over the solvency of certain European Union member states, including Greece, Ireland, Italy, Portugal and Spain. 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 revenues and expenses.
Revenues. We derive our revenues from two reporting segments: medical and industrial. Our medical segment represents our core business, in which we derive revenues primarily from the sale of our consoles and single-procedure disposables. Our industrial segment derives revenues related to the sales of Axsun’s micro-optical spectrometers and optical channel monitors to telecommunication and other industrial companies. In the three months ended March 31, 2012, we generated $90.4 million of revenues which is composed of $88.4 million from our medical segment and $2.0 million from our industrial segment. In the three months ended March 31, 2012, 9.2% of our medical segment revenues were derived from the sale of our consoles, as

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compared with 12.9% in the three months ended March 31, 2011. In the three months ended March 31, 2012, IVUS single-procedure disposables accounted for 60.5% of our medical segment revenues, compared to 61.8% during the same period in 2011, while in the three months ended March 31, 2012, 22.8% of our medical segment revenues were derived from the sale of our FFR single-procedure disposables, as compared with 19.1% in the three months ended March 31, 2011. Other revenues consist primarily of revenue from Axsun’s medical segment, service and maintenance revenues, rental revenues, shipping and handling revenues, sales of distributed products, spare parts sales, and license fees.
We expect to continue 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 in the U.S. are generated by our direct sales representatives and our products are shipped to customers throughout the U.S. from our facilities in Rancho Cordova, California and Billerica, Massachusetts. Our medical segment international sales are generated by our direct sales representatives or through independent distributors and are shipped throughout the world from facilities in Rancho Cordova, California; Billerica, Massachusetts; Zaventem, Belgium; Ota-ku and Tokyo, Japan; and Woodmead, South Africa. Our industrial segment sales are generated by our direct sales representatives or through independent distributors and these products are shipped primarily to telecommunications and industrial companies domestically and abroad from our facility in Billerica, Massachusetts.
Cost of Revenues. Cost of revenues consists primarily of material costs for the products that we sell and other costs associated with our manufacturing process, such as personnel costs, rent, depreciation related to our manufacturing equipment and utilities. In addition, cost of revenues includes depreciation of company-owned consoles, royalty expenses for licensed technologies included in our products, service costs, provisions for warranty, distribution, freight and packaging costs and stock-based compensation expense related to manufacturing employees. We expect a trend of further 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 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 acquired developed technology, licenses, customer relationships, assembled workforce, patents and trademarks, using the straight-line method over their estimated useful lives of up to 20 years. These assets are regularly tested for impairment and abandonment.
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 primarily comprised of interest expense related to our convertible debt, including coupon interest, accretion of debt discount, and amortization of issuance costs, offset by interest capitalization related to the Costa Rica plant construction and global ERP system implementation.
Exchange Rate Loss. Exchange rate loss is comprised of foreign currency transaction and remeasurement gains and losses, net, and the effect of changes in value and net settlements of our foreign currency 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, 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.

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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, 2012 and 2011, presented in both absolute dollars (in thousands) and as a percentage of revenues:
 
 
Three Months Ended March 31,
 
Changes
 
2012
 
2011
 
$
 
%
Revenues
$
90,360

 
100.0
 %
 
$
80,995

 
100.0
 %
 
$
9,365

 
11.6
 %
Cost of revenues, excluding amortization of intangibles
29,573

 
32.7

 
27,874

 
34.4

 
1,699

 
6.1

Gross profit
60,787

 
67.3

 
53,121

 
65.6

 
7,666

 
14.4

Operating expenses:
 
 
 
 
 
 
 
 
 
 


Selling, general and administrative
44,345

 
49.1

 
35,460

 
43.8

 
8,885

 
25.1

Research and development
13,649

 
15.1

 
13,088

 
16.2

 
561

 
4.3

Amortization of intangibles
872

 
1.0

 
855

 
1.1

 
17

 
2.0

Total operating expenses
58,866

 
65.2

 
49,403

 
61.1

 
9,463

 
19.2

Operating income
1,921

 
2.1

 
3,718

 
4.6

 
(1,797
)
 
(48.3
)
Interest income
230

 
0.3

 
243

 
0.3

 
(13
)
 
(5.3
)
Interest expense
(1,472
)
 
(1.6
)
 
(2,005
)
 
(2.5
)
 
533

 
(26.6
)
Exchange rate loss
(175
)
 
(0.2
)
 
(388
)
 
(0.5
)
 
213

 
(54.9
)
Other, net
(96
)
 
(0.1
)
 

 

 
(96
)
 

Income before income taxes
408

 
0.5

 
1,568

 
1.9

 
(1,160
)
 
(74.0
)
Income tax expense
137

 
0.2

 
412

 
0.5

 
(275
)
 
(66.7
)
Net income
$
271

 
0.3
 %
 
$
1,156

 
1.4
 %
 
$
(885
)
 
(76.6
)%

The following table sets forth our revenues by segment and product expressed as dollar amounts (in thousands) and the changes in revenues between the specified periods expressed as percentages:
 
 
Three Months Ended
March 31,
 
Change
 
2012
 
2011
 
$
 
%
Medical segment:
 
 
 
 
 
 
 
Consoles
$
8,116

 
$
9,931

 
$
(1,815
)
 
(18.3
)%
Single-procedure disposables:
 
 
 
 
 
 
 
IVUS
53,484

 
47,618

 
5,866

 
12.3

FM
20,138

 
14,700

 
5,438

 
37.0

Other
6,620

 
4,864

 
1,756

 
36.1

Sub-total medical segment
88,358

 
77,113

 
11,245

 
14.6

Industrial segment
2,002

 
3,882

 
(1,880
)
 
(48.4
)
 
$
90,360

 
$
80,995

 
$
9,365

 
11.6
 %
The following table sets forth our revenues by geography expressed as dollar amounts (in thousands) and the changes in revenues in the specified periods expressed as percentages:
 
 
Three Months Ended
March 31,
 
Change
 
2012
 
2011
 
$
 
%
Revenues (1):
 
 
 
 
 
 
 
United States
$
41,377

 
$
36,335

 
$
5,042

 
13.9
 %
Japan
30,789

 
24,712

 
6,077

 
24.6

Europe, the Middle East and Africa
13,664

 
14,076

 
(412
)
 
(2.9
)
Rest of world
4,530

 
5,872

 
(1,342
)
 
(22.9
)
 
$
90,360

 
$
80,995

 
$
9,365

 
11.6
 %

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 _______________________ 
(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, 2012 and 2011
Revenues. Overall, the increase in the medical segment revenue in the three months ended March 31, 2012 compared with the three months ended March 31, 2011 were driven by increased demand for our disposables, as well as higher revenues resulting from our direct sales efforts in Japan and favorable impacts of foreign exchange rates related to the yen. Additionally, the increases in FFR disposable revenues were primarily due to the broader availability of FFR technology as this functionality has been incorporated into our multi-modality console, and in conjunction with an increased adoption of the technology based on clinical study data. The revenue decreases related to our consoles resulted from decreased sales of console units, which is due to the timing of hospital capital equipment purchasing decisions and negative impact of the slowing economy in Europe. The decrease in industrial segment revenues results from lower sales to our international telecommunication customers due to the telecommunications industry's cyclical nature. The increase in other revenues is primarily due to higher sales of third-party products and higher service contract and rental revenues. We recognized increases in revenues in the United States and Japan markets. The Japanese market's growth is due to the continued success of our direct sales efforts and the favorable impact of foreign currency exchange related to the yen. The decrease in the European markets relates to the slowing economy in Europe, primarily Spain, and unfavorable impacts of foreign currency exchange rates to the euro. The decrease in the rest of the world primarily relates to the decline in our industrial segment revenues to customers in Europe.
Cost of Revenues. The increase in the cost of revenues in the three months ended March 31, 2012 compared with the three months ended March 31, 2011 was primarily due to higher sales volume. Gross margin was 67.3% of revenues in the three months ended March 31, 2012, increasing from 65.6% of revenues in the three months ended March 31, 2011. This favorable gross margin was primarily the result of favorable product mix for IVUS and FFR disposable products, a decrease in the production costs of IVUS and FFR disposable products from ongoing cost reduction initiatives, and favorable impacts of foreign currency exchange rates to the gross margin related to the yen.

Selling, General and Administrative. The increase in the three months ended March 31, 2012 as compared with the three months ended March 31, 2011 was primarily due to the expansion of our Costa Rica general and administrative activities during the pre-production phase, expansion of U.S., Japan, and Europe sales and marketing organizations, including continued growth in our Japan operation to support our direct sales efforts there, and increased information technology and infrastructure expenses to support company growth.
Research and Development. The increase in research and development expenses in the three months ended March 31, 2012 as compared with the three months ended March 31, 2011 was primarily due to increased spending on various product development projects and activities supporting other acquired technologies.
Amortization of Intangibles. The amortization expense in the three months ended March 31, 2012 as compared with the three months ended March 31, 2011 remained consistent.
Interest Income. The interest income in the three months ended March 31, 2012 as compared with the three months ended March 31, 2011 remained consistent.
Interest Expense. The decrease in interest expenses in the three months ended March 31, 2012 as compared with the three months ended March 31, 2011 was mainly due to more interest being capitalized during the three months ended March 31, 2012 as compared with the same period in 2011. The interest capitalization is related to the Costa Rica plant construction and global ERP system implementation.
Exchange Rate Loss. During the three months ended March 31, 2012 and 2011 the impact of fluctuations in exchange rates was mitigated by our hedging practices. Through our hedging program we reduce the volatility of our exchange rate gains and losses resulting from the remeasurement of our intercompany receivable balances at current exchange rates.
Provision for Income Taxes. We recorded an income tax provision in the three months ended March 31, 2012 of $137,000, compared to a provision of $412,000 for the three months ended March 31, 2011. The decrease is mainly due to the decrease of income before income taxes.

Liquidity and Capital Resources
Sources of Liquidity

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Historically, our sources of cash have included:
issuance of equity and debt securities, including underwritten public offerings of our common stock and convertible bonds; cash generated from the exercise of stock options and participation in our employee stock purchase plan;
cash generated from operations, primarily from product sales.
Our historical cash outflows have primarily been associated with:
cash used for operating activities such as the purchase and growth of inventory, expansion of our sales and marketing and research and development infrastructure and other working capital needs;
expenditures related to increasing our manufacturing capacity and improving our manufacturing efficiency;
capital expenditures related to the acquisition of equipment that we own and place at our customer premises and other fixed assets;
cash used for interest expense related to our debt obligations; and
cash used for acquisitions.
Fluctuations in our working capital due to timing differences of our cash receipts and cash disbursements also impact our cash inflows and outflows.
On September 20, 2010, we issued $115.0 million principal amount of 2.875% Convertible Senior Notes (the Notes) in an offering registered under the Securities Act of 1933, as amended. To hedge against potential dilution upon conversion of the Notes, we purchased call options on our common stock from JPMorgan Chase Bank, National Association, or JPMorgan Chase. In addition, to reduce the cost of the hedge, under separate transactions we sold warrants to JPMorgan Chase. We received proceeds of $100.5 million from issuance of the Notes, net of issuance costs of $4.4 million and net payments related to our hedge transactions of $10.0 million.
At March 31, 2012, our cash and cash equivalents and investments totaled $249.6 million, as compared to $250.3 million at December 31, 2011. We invest our excess funds in short-term and long-term securities issued by corporations, banks, the U.S. government, municipalities, and financial holding companies and in money market funds comprised of U.S. Treasury and agency securities.
At March 31, 2012, our accumulated deficit was $89.7 million, as compared to $89.9 million at December 31, 2011. We achieved profitability in the years ended December 31, 2011 and 2010. During the three months ended March 31, 2012 and 2011, our business generated approximately $10.5 million and $198,000 in cash flows from operating activities, respectively.
Cash Flows (in thousands)
 
 
Three Months Ended
March 31,
 
 
2012
 
2011
Net cash provided by operating activities
 
10,505

 
198

Net cash (used in) provided by investing activities
 
(58,380
)
 
7,379

Net cash provided by financing activities
 
4,865

 
4,684

Effect of exchange rate changes on cash and cash equivalents
 
(562
)
 
(2,686
)
Net change in cash and cash equivalents
 
(43,572
)
 
9,575

Cash Flows for the Three months Ended March 31, 2012 and 2011
Cash Flows from Operating Activities. Cash provided by operating activities of $10.5 million for the three months ended March 31, 2012 reflected our net income of $271,000, adjusted for non-cash expenses, consisting primarily of $6.1 million of depreciation and amortization, including amortization or accretion of investment premium or discount, $3.6 million of stock-based compensation expense and $1.2 million of accretion of debt discount on convertible notes. Additional sources of cash include a decrease in accounts receivable of $1.4 million, decrease of inventories and prepaid expenses and other assets of $1.8 million and increase of accrued expenses and other liabilities of $1.0 million. Uses of cash primarily included a decrease in accounts payable of $2.3 million and decrease of accrued compensation of $3.0 million.
Cash provided by operating activities of $198,000 for the three months ended March 31, 2011 reflected our net income of $1.2 million, adjustments for non-cash expenses, consisting primarily of $6.3 million of depreciation and amortization, including amortization or accretion of investment premium or discount, $3.1 million of stock-based compensation expense and $1.1 million of accretion of debt discount on convertible notes. Uses of cash primarily included a decrease in accrued expenses of $5.1 million primarily related to payments made to Fukuda Denshi Co., Ltd. pursuant to an agreement which terminated our distributor relationship with them during the fourth quarter of 2010, accrued compensation of $4.4 million, and increases in

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inventories of $1.8 million primarily related to an anticipated increase in sales demand.
Cash Used in Investing Activities. Cash used in investing activities was $58.4 million in the three months ended March 31, 2012, resulting from approximately $110.8 million used to purchase investments, $14.4 million used for capital expenditures, including construction of our Costa Rica plant, capital expenditures for medical diagnostic equipment, manufacturing equipment and ERP system, and $758,000 used for acquisition of intangible assets and other investments. Sources of cash included the sale or maturity of investments of $67.6 million.
Cash provided by investing activities was $7.4 million in the three months ended March 31, 2011, resulting from the sale or maturity of available-for-sale investments of $98.8 million, partially offset by approximately $83.9 million used to purchase available-for-sale investments, and $6.7 million used for capital expenditures primarily related to costs for the Costa Rica plant, and IT infrastructure.

Cash Provided by Financing Activities. Cash provided by financing activities was $4.9 million in the three months ended March 31, 2012, resulting primarily from proceeds of $3.0 million from employee exercises of common stock options and $1.9 million from the issuance of stock under our employee stock purchase plan.

Cash provided by financing activities was $4.7 million in the three months ended March 31, 2011, resulting primarily from proceeds of $2.9 million from the exercise of common stock options and $1.8 million from the issuance of stock under our employee stock purchase plan.
Future Liquidity Needs
At March 31, 2012, we believe our current cash and cash equivalents and our available-for-sale investments will be sufficient to fund working capital requirements, capital expenditures (including the expansion of our manufacturing operations into Costa Rica and the implementation of a new enterprise resource planning system), and operations for at least the next 12 months. We intend to retain any future earnings to support operations and to finance the growth and development of our business, and we do not anticipate paying any dividends in the foreseeable future.
Our future liquidity and capital requirements will be influenced by numerous factors, including the level and timing of future sales and expenditures, the results and scope of ongoing research and product development programs, working capital required to support our sales growth, funds required to service our debt, the receipt of and time required to obtain regulatory clearances and approvals, our sales and marketing programs, our need for infrastructure to support our sales growth, the continuing acceptance of our products in the marketplace, competing technologies and changes in the market and regulatory environment and cash that may be required to settle our foreign currency hedges.
Our ability to fund our longer-term cash needs is subject to various risks, many of which are beyond our control—See Part II, Item 1A—”Risk Factors” set forth in this document and Part I, Item 1A in our annual report on Form 10-K for the fiscal year ended December 31, 2011. Should we require additional funding, such as additional capital investments, we may need to raise the required additional funds through bank borrowings or public or private sales of debt or equity securities. We cannot assure you that such funding will be available in needed quantities or on terms favorable to us, if at all.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are discussed in our annual report on Form 10-K for the fiscal year ended December 31, 2011.
Off-Balance Sheet Arrangements
At March 31, 2012, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Contractual Obligations

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At March 31, 2012, there were no additional material contractual obligations other than the items detailed in Note 4 - “Commitments and Contingencies–Purchase Commitments” and those disclosed in Part II, Item 7 of our annual report on Form 10-K for the year ended December 31, 2011.

Item 3.
Quantitative and Qualitative Disclosures About Market Risk 
Market risk primarily represents the risk of changes in the value of market risk sensitive instruments caused by fluctuations in interest rates, foreign currency exchange rates and commodity prices. Changes in these factors could cause fluctuations in our results of operations and cash flows. In the ordinary course of business, we are exposed to interest rate and foreign currency exchange risk. Fluctuations in interest rates and the rate of exchange between the U.S. dollar and foreign currencies, primarily the euro and yen, could adversely affect our financial results.

We do not carry significant inventory of transducers, substrates or scanner subassemblies. If we had to change suppliers, we expect that it would take six 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.
Interest Rate Risk
Our exposure to interest rate risk at March 31, 2012 is related to the investment of our excess cash into highly liquid financial investments as well as our convertible debt which has a fixed rate. Fixed rate investments and borrowing may have their fair market values adversely impacted from changes in interest rates.
We invest in cash and cash equivalents and available-for-sale investments in accordance with our investment policy. The primary objectives of our investment policy are to preserve principal, maintain proper liquidity to meet operating needs and maximize yields consistent with our tolerance for investment risk. Our investment policy specifies credit quality standards for our investments. Due to the generally short-term nature of our investments, we have assessed that there is no material exposure to interest rate risk arising from them.
Foreign Currency Exchange Risk
We are exposed to foreign currency exchange risk related to our international sales and European and Japanese operations. Fluctuations in the rate of exchange between the U.S. dollar and foreign currencies, primarily the euro and the yen, could adversely affect our financial results. During the three months ended March 31, 2012, 33.7% and 14.3% of our revenues were denominated in the yen and euro, respectively, and 13.3% and 9.0% of our operating expenses were denominated in the yen and euro, respectively. 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 decreased 4.4% from 81.73 in the three months ended March 31, 2011 to 78.15 in the three month ended March 31, 2012, which resulted in a net positive impact to our operational results in the amount of approximately $774,000. On the other hand, the average exchange rate of one euro to U.S. dollar decreased 3.6% from 1.37 in the three months ended March 31, 2011 to 1.32 in the three month ended March 31, 2012, which resulted in a net negative impact to our operational results in the amount of approximately $299,000.
We use foreign currency forward contracts to manage a portion of the foreign currency exposure risk for foreign subsidiaries with monetary assets and liabilities denominated in the yen and the euro. We only use derivative instruments to reduce the risk that our earnings and cash flows will be adversely affected by changes in exchange rates; we do not hold any derivative financial instruments for trading or speculative purposes. We primarily use foreign currency forward contracts to hedge foreign currency exposures, and they generally have terms of one year or less. Realized and unrealized gains or losses on the value of financial contracts used to hedge the exchange rate exposure of these monetary assets and liabilities are also included in the determination of net income, as these transactions have not been designated for hedge accounting treatment. These contracts effectively fix the exchange rate at which these specific monetary assets and liabilities will be settled so that gains or losses on the forward contracts offset the gains or losses from changes in the value of the underlying monetary assets and liabilities. These contracts contain net settlement features. If we experience unfavorable changes in foreign exchange rates, we may be required to use material amounts of cash to settle the transactions which may adversely affect the operating results that we report with respect to the corresponding period. During the three months ended March 31, 2012 and 2011, we recorded exchange rate gains of $2.1 million and $281,000, respectively, related to our foreign exchange forward contracts.
We currently hold foreign currency forward contracts with two counterparties. The bank counterparties in these contracts expose us to credit-related losses in the event of their nonperformance. However, to mitigate that risk, we only contract with counterparties who meet our minimum credit quality guidelines.

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Market Price Sensitive Instruments
In order to reduce the potential equity dilution as a result of our Notes, we entered into a convertible note hedge transaction (the Hedge) entitling us to purchase up to 3.9 million shares of our common stock at an initial stock price of $29.64 per share, subject to adjustment. Upon conversion of our Notes, the Hedge is expected to reduce the equity dilution if the daily volume-weighted average price per share of our common stock exceeds the strike price of the Hedge. We also entered into warrant transactions with the counterparties of the Hedge entitling them to acquire up to 3.9 million shares of our common stock, subject to adjustment, at an initial strike price of $34.875 per share, subject to adjustment. The warrant transactions could have a dilutive effect on our earnings per share to the extent that the price of our common stock during a given measurement period (the quarter or year to date period) at maturity of the warrants exceeds the strike price of the warrants. In addition, non-performance by the counterparties under the Hedge would potentially expose us to dilution of our common stock to the extent our stock price exceeds the conversion price. See Note 3 to our unaudited condensed consolidated financial statements “Financial Statement Details—Convertible Debt” for additional information.

Item 4.
Controls and Procedures 
Evaluation of disclosure controls and procedures
Under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act. Based on that evaluation, our chief executive officer and our chief financial officer have concluded that, at March 31, 2012, our disclosure controls and procedures were effective.
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.
Changes in internal control over financial reporting
Under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, we carried out an evaluation of any potential changes in our internal control over financial reporting during the fiscal quarter covered by this quarterly report on Form 10-Q.
There were no changes in our internal control over financial reporting during the quarter ended March 31, 2012 that our certifying officers concluded materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION
Item 1.
Legal Proceedings 
The information set forth under Note 4 - “Commitments and Contingencies– Litigation” of our notes to unaudited condensed consolidated financial statements, included in Part I, Item 1 of this Report, is incorporated herein by reference.

Item 1A.
Risk Factors
The risk factors set forth below with an asterisk (*) next to the title contain changes to the description of the risk factors previously disclosed in Item 1A to our annual report on Form 10-K.
Risks related to our business and industry
We are dependent on the success of our consoles and catheters and cannot be certain that IVUS and FFR technology or our IVUS and FFR products will achieve the broad acceptance necessary for us to sustain a profitable business.
Our revenues are primarily derived from sales of our intravascular ultrasound, or IVUS, and fractional flow reserve, or FFR, products, which include our multi-modality consoles and our single-procedure disposable catheters and fractional flow reserve wires. IVUS technology is widely used in Japan for determining the placement of stents in patients with coronary disease but the penetration rate in the U.S. and Europe for the same type of procedure is relatively low. Our wires are used to measure the pressure and flow characteristics of blood around plaque, enabling physicians to gauge the physiological impact of blood flow and pressure. We expect that sales of our IVUS and FFR products will continue to account for a majority of our revenues for the foreseeable future, however it is difficult to predict the penetration and future growth rate or size of the market for IVUS and FFR technology. The expansion of the IVUS and FFR markets depends on a number of factors, such as:
physicians accepting the benefits of the use of IVUS and FFR in conjunction with angiography;
physician experience with IVUS and FFR products either used alone or jointly used in a single percutaneous coronary intervention, or PCI;
the availability of training necessary for proficient use of IVUS and FFR products, as well as willingness by physicians to participate in such training;
the additional procedure time required for use of IVUS and FFR compared to the perceived benefits;
the perceived risks generally associated with the use of our products and procedures, especially our new products and procedures;
the placement of our products in treatment guidelines published by leading medical organizations;
the availability of alternative treatments or procedures that are perceived to be or are more effective, safer, easier to use or less costly than IVUS and FFR technology;
hospitals’ willingness, and having sufficient budgets, to purchase our IVUS and FFR products;
the size and growth rate of the PCI, market in the major geographies in which we operate;
the availability of adequate reimbursement; and
the success of our marketing efforts and publicity regarding IVUS and FFR technology.
Even if IVUS and FFR technology gain wide market acceptance, our IVUS and FFR products may not adequately address market requirements and may not continue to gain market acceptance among physicians, healthcare payors and the medical community due to factors such as:
the lack of perceived benefits of information related to plaque composition available to the physician through use of our IVUS products, including the ability to identify calcified and other forms of plaque;
the lack of perceived benefits of information related to pressure and flow characteristics of blood around plaque available to the physician through the use of our FFR products;
the actual and perceived ease of use of our IVUS and FFR products;
the quality of the images rendered by our IVUS products;
the quality of the measurements provided by our FFR products;
the cost, performance, benefits and reliability of our IVUS and FFR products relative to competing products and services;
the lack of perceived benefit of integration of our IVUS and FFR products into the catheterization laboratory, or cath lab; and
the extent and timing of technological advances.
If IVUS and FFR technology generally, or our IVUS and FFR products specifically, do not gain wide market acceptance, we may not be able to achieve our anticipated growth, revenues or profitability and our results of operations would suffer.

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The risks inherent in our international operations may adversely impact our revenues, results of operations and financial condition.
We derive, and anticipate that we will continue to derive, a significant portion of our revenues from operations in Japan and Europe. As we expand internationally, we will need to hire, train and retain qualified personnel for our manufacturing and direct sales efforts, retain distributors and train their and our manufacturing, sales and other personnel in countries where language, cultural or regulatory impediments may exist. We cannot ensure that distributors, physicians, regulators or other government agencies will accept our products, services and business practices. Further, we purchase, and in the future will manufacture, some components in foreign markets. The manufacture, sale and shipment of our products and services across international borders, as well as the purchase of components from non-U.S. sources, subject us to extensive U.S. and foreign governmental trade regulations. Current or future trade, social and environmental regulations or political issues could restrict the supply of resources used in production or increase our costs. Compliance with such regulations is costly. Any failure to comply with applicable legal and regulatory obligations could impact us in a variety of ways that include, but are not limited to, significant criminal, civil and administrative penalties, including imprisonment of individuals, fines and penalties, denial of export privileges, seizure of shipments and restrictions on certain business activities. Failure to comply with applicable legal and regulatory obligations could result in the disruption of our manufacturing, shipping and sales activities. Our international sales operations expose us and our representatives, agents and distributors to risks inherent in operating in foreign jurisdictions, including:
our ability to obtain, and the costs associated with obtaining, U.S. export licenses and other required export or import licenses or approvals;
changes in duties and tariffs, taxes, trade restrictions, license obligations and other non-tariff barriers to trade;
burdens of complying with a wide variety of foreign laws and regulations related to healthcare products;
costs of localizing product and service offerings for foreign markets;
business practices favoring local companies;
longer payment cycles and difficulties collecting receivables through foreign legal systems;
difficulties in enforcing or defending agreements and intellectual property rights;
differing local product preferences, including as a result of differing reimbursement practices;
possible failure to comply with anti-bribery laws such as the United States Foreign Corrupt Practices Act and similar anti-bribery laws in other jurisdictions, even though non-compliance could be inadvertent;
fluctuations in foreign currency exchange rates and their impact on our operating results; and
changes in foreign political or economic conditions.
In addition, we face risks associated with potential increased costs associated with overlapping tax structures, including the tax costs associated with repatriating cash. For example, the Obama Administration has announced potential legislative proposals to tax profits of U.S. companies earned abroad. We derive a significant portion of our revenues from our international operations, and while it is impossible for us to predict whether these and other proposals will be implemented, or how they will ultimately impact us, they may materially impact our results of operations if, for example, any future potential profits earned abroad are subject to U.S. income tax, or we are otherwise disallowed deductions as a result of any such profits.
We cannot ensure that one or more of these factors will not harm our business. Any material decrease in our international revenues or inability to expand our international operations would adversely impact our revenues, results of operations and financial condition.
Declines in the number of PCI procedures performed for any reason will adversely impact our business.
Our IVUS and FFR products are used in connection with procedures. Physicians may choose to perform less PCI procedures. For example, recently the number of PCI procedures declined, in part due to concerns attributed to efficacy of therapeutic treatment options, economic constraints, reduced number of restenosis, the long-term efficacy of drug-eluting stents and concerns by clinicians and payers regarding the appropriateness of conducting PCI procedures. If the number of PCI procedures continues to decline, the need for IVUS and FFR procedures could also decline, which would adversely impact our operating results and our business prospects.
We have a limited operating history, have only recently achieved profitability and cannot assure you that we will continue to achieve and sustain profitability in future periods.
We were formed in January 2000 and achieved our first and second full year of profitability in 2010 and 2011. To the extent that we are able to increase revenues, we expect our operating expenses will also increase as we expand our business to meet anticipated growing demand for our products; as we devote resources to our sales, marketing and research and development activities and as we satisfy our debt service obligations. If we are unable to reduce our cost of revenues and our operating expenses, we may not achieve sustained profitability. We expect to experience quarterly fluctuations in our revenues due to the timing of capital purchases by our customers and to a lesser degree the seasonality of disposable consumption by our

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customers. Additionally, expenses will fluctuate as we make future investments in research and development, selling and marketing and general and administrative activities, including as a result of new product introductions, transition from distributor arrangements to a direct sales force in different markets, satisfy our debt service obligations, and fund our litigation costs. This will cause us to experience variability in our reported earnings and losses in future periods. You should not rely on our operating results for any prior quarterly or annual period as an indication of our future operating performance.

We have a significant amount of indebtedness. We may not be able to generate enough cash flow from our operations to service our indebtedness, and we may incur additional indebtedness in the future, which could adversely affect our business, financial condition and results of operations.
We have a significant amount of indebtedness, including $115.0 million in aggregate principal with additional accrued interest of indebtedness under our 2.875% Convertible Senior Notes due 2015, or the Notes. Our ability to make payments on, and to refinance, our indebtedness, including the Notes, and to fund planned capital expenditures, research and development efforts, working capital, acquisitions and other general corporate purposes depends on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors, some of which are beyond our control. If we do not generate sufficient cash flow from operations or if future borrowings are not available to us in an amount sufficient to pay our indebtedness, including payments of principal upon conversion of the Notes or on their maturity or in connection with a transaction involving us that constitutes a fundamental change under the indenture governing the Notes, or to fund our liquidity needs, we may be forced to refinance all or a portion of our indebtedness, including the Notes, on or before the maturity thereof, sell assets, reduce or delay capital expenditures, seek to raise additional capital or take other similar actions. We may not be able to execute any of these actions on commercially reasonable terms or at all. Our ability to refinance our indebtedness will depend on our financial condition at the time, the restrictions in the instruments governing our indebtedness and other factors, including market conditions. In addition, in the event of a default under the Notes, the holders and/or the trustee under the indenture governing the Notes may accelerate our payment obligations under the Notes, which could have a material adverse effect on our business, financial condition and results of operations. Our inability to generate sufficient cash flow to satisfy our debt service obligations, or to refinance or restructure our obligations on commercially reasonable terms or at all, would likely have an adverse effect, which could be material, on our business, financial condition and results of operations.
In addition, our significant indebtedness, combined with our other financial obligations and contractual commitments, could have other important consequences. For example, it could:
make us more vulnerable to adverse changes in general U.S. and worldwide economic, industry and competitive conditions and adverse changes in government regulation;
limit our flexibility in planning for, or reacting to, changes in our business and our industry;
place us at a competitive disadvantage compared to our competitors who have less debt; and
limit our ability to borrow additional amounts for working capital, capital expenditures, research and development efforts, acquisitions, debt service requirements, execution of our business strategy or other purposes.
Any of these factors could materially and adversely affect our business, financial condition and results of operations. In addition, if we incur additional indebtedness, which we are not prohibited from doing under the terms of the indenture governing the Notes, the risks related to our business and our ability to service our indebtedness would increase.
Competition from companies, particularly those that have longer operating histories and greater resources than us, may harm our business.
The medical device industry, including the market for IVUS and FFR products, is highly competitive, subject to rapid technological change and significantly affected by new product introductions and market activities of other participants. As a result, even if the size of the IVUS and FFR market increases, we can make no assurance that our revenues will increase. In addition, as the markets for medical devices, including IVUS and FFR products, develop, additional competitors could enter the market. To compete effectively, we will need to continue to demonstrate that our products are attractive relative to alternative devices and treatments. We believe that our continued success depends on our ability to:
innovate and maintain scientifically advanced technology;
apply our technology across products and markets;
develop proprietary products;
successfully conduct, sponsor or participate in clinical studies that expand our markets;
obtain and maintain patent protection for our products;
obtain and maintain regulatory clearance or approvals;
manufacture cost-effectively and with consistently adequate quality;
successfully market our products; and

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attract and retain skilled personnel.
With respect to our IVUS products, our primary competitor is Boston Scientific, Inc., or Boston Scientific. Our FFR products compete with the products of St. Jude Medical, Inc., or St. Jude. We also compete in Japan with respect to IVUS products with Terumo Corporation, or Terumo. Boston Scientific, St. Jude, Terumo and other potential competitors who are or may be substantially larger than us may enjoy competitive advantages, including:
more established distribution networks;
entrenched relationships with physicians;
products and procedures that are less expensive;
broader ranges of products and services that may be sold in bundled arrangements;
greater experience in launching, marketing, distributing and selling products;
greater experience in obtaining and maintaining FDA and other regulatory clearances and approvals;
established relationships with healthcare providers and payors; and
greater financial and other resources for product development, sales and marketing, acquisitions of products and companies, and intellectual property protection.
For these and other reasons, we may not be able to compete successfully against our current or potential future competitors, and sales of our IVUS and FFR products may decline.
Failure to innovate may adversely impact our competitive position and may adversely impact our ability to drive price increases for our products and our product revenues.
Our future success will depend upon our ability to innovate new products and introduce enhancements to our existing products in order to address the changing needs of the marketplace. We also rely on new products and product enhancements to attempt to drive price increases for our products in our markets. Frequently, product development programs require assessments to be made of future clinical need and commercial feasibility, which are difficult to predict. Customers may forego purchases of our products and purchase our competitors’ products as a result of delays in introduction of our new products and enhancements, failure to choose correctly among technical alternatives or failure to offer innovative products or enhancements at competitive prices and in a timely manner. In addition, announcements of new products may result in a delay in or cancellation of purchasing decisions in anticipation of such new products. We may not have adequate resources to introduce new products in time to effectively compete in the marketplace. Any delays in product releases may negatively affect our business.
We also compete with new and existing alternative technologies that are being used to penetrate the worldwide vascular imaging market without using IVUS technology. These products, procedures or solutions could prove to be more effective, faster, safer or less costly than our IVUS products. Technologies such as angiography, angioscopy, multi-slice computed tomography, intravascular magnetic resonance imaging, or MRI, electron beam computed tomography, and MRI with contrast agents are being used in lieu of or for imaging the vascular system.
We also develop and manufacture optical monitors, laser and non-laser light sources, and optical engines used in Optical Coherence Tomography, or 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. Products developed by competitors based on tunable filter technology could compete on the basis of lower cost and other factors. In addition, customers may build similar functionality directly into their products, which in turn could decrease the demand for our OCT imaging systems and related products.
The introduction of new products, procedures or clinical solutions by competitors may result in price reductions, reduced margins, loss of market share and may render our products obsolete. We cannot guarantee that these alternative technologies will not be commercialized and become viable alternatives to our products in the future, and we cannot guarantee that we will be able to compete successfully against them if they are commercialized.
The successful continuing development of our existing and new products depends on us maintaining strong relationships with physicians.
The research, development, marketing, and sales of our products are dependent upon our maintaining working relationships with physicians. We rely on these professionals to provide us with considerable knowledge and experience regarding the development, marketing and sale of our products. If we are unable to maintain our strong relationships with these professionals and continue to receive their advice and input, our existing and new products may not be developed and marketed in line with the needs and expectations of the professionals who use or would use and support our products and the development and marketing of our products could suffer, which could have a material adverse effect on our business and results of operations.

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Delays in planned product introductions may adversely affect our business and negatively impact future revenues.
We are currently developing new products as well as product enhancements with respect to our existing products. We have in the past experienced, and may again in the future experience, delays in various phases of product development and commercial launch, including during research and development, manufacturing, limited release testing, marketing and customer education efforts. In particular, developing and integrating products and technologies of acquired businesses is time consuming and in has in the past resulted, and may again in the future result, in longer developmental timelines than we initially anticipated. We are currently engaged in ongoing litigation regarding our (a) High Definition Swept Source non-laser light source and (b) our efforts to develop and obtain a laser light source from third parties with LightLab Imaging, Inc., or LightLab, in Delaware Chancery Court. LightLab is a wholly-owned subsidiary of St. Jude. Depending on the outcome of this litigation, we may experience delays in the commercial launch of our OCT imaging systems. Any delays in our product launches may significantly impede our ability to successfully compete in our markets and may reduce our revenues.
We and our present and future collaborators may fail to develop or effectively commercialize products covered by our present and future collaborations if:
our collaborators become competitors of ours or enter into agreements with our competitors;
we do not achieve our objectives under our collaboration agreements;
we are unable to manage multiple simultaneous product discovery and development collaborations;
we develop products and processes or enter into additional collaborations that conflict with the business objectives of our other collaborators;
we or our collaborators are unable to obtain patent protection for the products or proprietary technologies we develop in our collaborations; or
we or our collaborators encounter regulatory hurdles that prevent commercialization of our products.
In addition, conflicts may arise with our collaborators, such as conflicts concerning the interpretation of clinical data, the achievement of milestones, the interpretation of financial provisions or the ownership of intellectual property developed during the collaboration. If any conflicts arise with our existing or future collaborators, they may act in their self-interest, which may be adverse to our best interest.
If we or our collaborators are unable to develop or commercialize products, or if conflicts arise with our collaborators, we will be delayed or prevented from developing and commercializing products which will harm our business and financial results.
If the clinical studies that we sponsor or co-sponsor are unsuccessful, or clinical data from studies conducted by other industry participants are negative, we may not be able to develop or increase penetration in identified markets and our business prospects may suffer.
We sponsor or co-sponsor several clinical studies to demonstrate the benefits of our products in current markets where we are trying to increase use of our products and in new markets. Implementing a study is time consuming and expensive, and the outcome is uncertain. The completion of any of these studies may be delayed or halted for numerous reasons, including, but not limited to, the following:
the death of one or more patients during a clinical study for reasons that may or may not be related to our products, including the advanced stage of their disease or other medical problems;
regulatory inspections of manufacturing facilities, which may, among other things, require us or a co-sponsor to undertake corrective action or suspend the clinical studies;
changes in governmental regulations or administrative actions;
adverse side effects in patients, including adverse side effects from our or a co-sponsor’s drug candidate or device;
the FDA institutional review boards or other regulatory authorities do not approve a clinical study protocol or place a clinical study on hold;
patients do not enroll in a clinical study or do not follow up at the expected rate;
our co-sponsors do not perform their obligations in relation to the clinical study or terminate the study;
third-party clinical investigators do not perform the clinical studies on the anticipated schedule or consistent with the clinical study protocol and good clinical practices, or other third-party organizations do not perform data collection and analysis in a timely or accurate manner; and
the interim results of the clinical study are inconclusive or negative, and the study design, although approved and completed, is inadequate to demonstrate safety and efficacy of our products.
Some of the studies that we co-sponsor are designed to study the efficacy of a third party’s drug candidate or device. Such studies are designed and controlled by the third party and the results of such studies will largely depend upon the success of the third party’s drug candidate or device. These studies may be terminated before completion for reasons beyond our control such as adverse events associated with a third-party drug candidate or device. A failure in such a study may have an adverse impact

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on our business by either the attribution of the study’s failure to our technology or our inability to leverage publicity for proper functionality of our products as part of a failed study.
Clinical studies may require the enrollment of large numbers of patients, and suitable patients may be difficult to identify and recruit. Patient enrollment in clinical studies and completion of patient follow-up depend on many factors, including the size of the patient population, the study protocol, the proximity of patients to clinical sites, eligibility criteria for the study and patient compliance. For example, patients may be discouraged from enrolling in our clinical studies if the applicable protocol requires them to undergo extensive post-treatment procedures or if they are persuaded to participate in different contemporaneous studies conducted by other parties. Delays in patient enrollment or failure of patients to continue to participate in a study may result in an increase in costs, delays or the failure of the study. Such events may have a negative impact on our business by making it difficult to penetrate or expand certain identified markets. Further, if we are forced to contribute greater financial and clinical resources to a study, valuable resources will be diverted from other areas of our business.
Negative results from clinical studies conducted by other industry participants could harm our results.
Divestitures of any of our businesses or product lines may materially adversely affect our business, results of operations and financial condition.
We continue to evaluate the performance of all of our businesses and may sell a business or product line. Any divestitures may result in significant write-offs, including those related to goodwill and other intangible assets, which could have a material adverse effect on our business, results of operations and financial condition. Divestitures could involve additional risks, including difficulties in the separation of operations, services, products and personnel, the diversion of management’s attention from other business concerns, the disruption of our business and the potential loss of key employees. We may not be successful in managing these or any other significant risks that we encounter in divesting a business or product line.
*If we choose to acquire new businesses, products or technologies, we may experience difficulty in the identification or integration of any such acquisition, and our business may suffer.
Our success depends on our ability to continually enhance and broaden our product offerings in response to changing customer demands, competitive pressures and technologies. Accordingly, we have acquired, and may in the future acquire, complementary businesses, products or technologies instead of developing them ourselves. We do not know if we will identify or complete any additional acquisitions, or whether we will be able to successfully integrate any acquired business, product or technology or retain key employees. Integrating any business, product or technology we acquire could be expensive and time consuming, disrupt our ongoing business and distract our management. If we are unable to integrate any acquired businesses, products or technologies effectively, our business will suffer. We have entered, and may in the future enter, markets through our acquisitions that we are not familiar with and have no experience managing. If we fail to integrate these operations into our business, our resources may be diverted from our core business and this could have a material adverse effect on our business, financial condition and results of operations.
Our business has become more decentralized geographically through our acquisitions and this may expose us to operating inefficiencies across these diverse locations, including difficulties and unanticipated expenses related to the integration of departments, information technology systems, and accounting records and maintaining uniform standards, such as internal controls, procedures and policies. In addition, we have, and in the future may increase, our exposure to risks related to business operations outside the U.S. due to our acquisitions.

We may also encounter risks, costs and expenses associated with any undisclosed or other unanticipated liabilities, use more cash and other financial resources on integration and implementation activities than we expect or incur significant costs and expenses related to litigation with counterparties to such transactions, such as the lawsuit recently filed against us in federal district court alleging claims for breach of contract, breach of fiduciary duty, and breach of the implied covenant of good faith and fair dealing based on our acquisition of CardioSpectra, Inc. in 2007. In addition, any amortization or other charges resulting from acquisitions could negatively impact our operating results.

If our products and technologies are unable to adequately identify the plaque that is most likely to rupture and cause a coronary event, we may not be able to develop a market for our vulnerable plaque products or expand the market for existing products.
We are utilizing substantial resources toward developing products and technologies to aid in the identification, diagnosis and treatment of the plaque that is most likely to rupture and cause a coronary event, or vulnerable plaque. The Providing Regional Observations to Study Predictors of Events in the Coronary Tree study demonstrated the ability of IVUS and virtual histology, or VH, to stratify lesions according to risk. However, no randomized controlled trial has been performed to assess the benefit of treating or deferring treatment in these stratified lesions. If we are unable to develop products or technologies that can identify

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vulnerable plaque, a market for products to identify vulnerable plaque may not materialize and our business may suffer.
*Fluctuations in foreign currency exchange rates could result in declines in our reported revenues and earnings.
We do not engage in foreign currency hedging arrangements for our revenues or operating expenses, and, consequently, foreign currency fluctuations may adversely affect our revenues and earnings. During the fiscal three months ended March 31, 2012, 33.7% and 14.3% of our revenues were denominated in the yen and euro, respectively, 13.3% of our operating expenses were denominated in the yen and 9.0% of our operating expenses were denominated in the euro. Commencing October 2009, we began using foreign currency forward contracts to manage a portion of the foreign currency risk related to our intercompany receivable balances with our foreign subsidiaries whose functional currencies are the euro and yen. We cannot be assured our hedges will be effective or that the costs of the hedges will not exceed their benefits. Fluctuations in the rate of exchange between the U.S. dollar and foreign currencies, primarily the euro and the yen, could result in material amounts of cash being required to settle the hedge transactions or could adversely affect our financial results. In periods of a strengthening U.S. dollar relative to the yen or a weakening U.S. dollar relative to the euro, we would record less revenue and our results of operations could be negatively impacted.
General national and worldwide economic conditions may materially and adversely affect our financial performance and results of operations.
Our operations and performance depend significantly on national and worldwide economic conditions and the resulting impact on purchasing decisions and the level of spending on our products by customers in the geographic markets in which our IVUS and FFR and other products are sold or distributed. These economic conditions remain challenging in many countries and regions, including without limitation the U.S., Japan, Europe, the Middle East and Africa, where we have generated most of our revenues. In the U.S., the recovery from the recent recession has been below historic averages and the unemployment rate is expected to remain high for some time. Inflation has fallen over the last several years, but is now rising, and central banks around the world have begun tightening monetary conditions to attempt to control inflation. The March 2011 tsunami and associated events in Japan negatively impacted many of our customers, as well as the conditions in which our Tokyo-based subsidiary operates. Such events may also result in a downturn in Japan’s economy as a whole, which may adversely affect our ability to conduct business in Japan. The challenging global economic conditions have also led to concerns over the solvency of certain European Union member states, including Greece, Ireland, Italy, Portugal and Spain. On August 5, 2011, Standard & Poor’s downgraded the U.S. credit rating to AA+ from its top rank of AAA, and the current U.S. debt ceiling and budget deficit concerns have increased the possibility of other credit-rating agency downgrades that could have a material adverse effect on the financial markets and economic conditions in the U.S. and throughout the world. Likewise, the political unrest in the Middle East may have adverse consequences to the global economy or to our customers in the Middle East, which could negatively impact our business. In any event, uncertainty about future economic conditions makes it difficult for us to forecast operating results and to make decisions about future investments. 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 the 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. We experienced declines in the number of PCI procedures performed (and related reductions in sales of our IVUS products) and in sales of our non-medical products to telecommunication and industrial companies during 2011 due to, in part, the then-prevailing economic conditions. In addition, our customers’, distributors’ 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 or lengthen our collection cycles, distribute our products or limit our timely access to important sources of raw materials necessary for the manufacture of our consoles and catheters.
We have invested our excess cash in money market funds and corporate debt securities issued by banks and corporations. The interest paid on these types of investments and the value of certain securities may decline. While our investment portfolio has experienced reduced yields, we have not yet experienced a deterioration of the credit quality of our holdings or other material adverse effects. There can be no assurances that our investment portfolio will not experience any such deterioration in credit quality or other material adverse effects in future periods, or that national and worldwide economic conditions will not worsen.
*Our transition to a direct sales force in Japan may not be successful or may cause us to incur additional expenses and experience reduced revenues sooner than initially planned. If we are not successful or incur such additional expenses sooner than expected, then our business and results of operations may be materially and adversely affected.
Historically, a significant portion of our annual revenues have been derived from sales to our Japanese distributors. We have recently completed the termination of our distributor relationships in Japan, and have fully transitioned to a direct sales force in Japan. There is no assurance that we will be successful in our transition to a direct sales force in Japan and that we will be able to continue to successfully place, sell and service our products in Japan through a direct sales force or to successfully insure the

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growth of our direct sales force that may be needed in the future. Our challenges and potential risks in connection with expanding our direct sales force in Japan include, but are not limited to, (a) the successful retention and servicing of current dealers and customers in Japan, (b) strong market adoption of our technology in Japan, (c) the achievement of our growth and market development strategies in Japan, (d) our ability to recruit, train and retain an expanded direct sales force in Japan, and (e) the effect of the 2011 earthquake, tsunami and nuclear power plant meltdown in Japan on operating conditions as well as end-user demand. In addition, we may incur significant additional expenses and reduced revenues. Our efforts to successfully expand our direct sales strategy in Japan or the failure to achieve our sales objectives in Japan may adversely impact our revenues, results of operations and financial condition and negatively impact our ability to sustain and grow our business in Japan.
Quality problems with our processes and products could harm our reputation for producing high-quality products and erode our competitive advantage, sales, and market share.
The manufacture of our products is a highly exacting and complex process, due in part to strict regulatory requirements. Failure to manufacture our products in accordance with product specifications could result in increased costs, lost revenues, customer dissatisfaction or voluntary product recalls, any of which could harm our profitability and commercial reputation. Problems may arise during manufacturing for a variety of reasons, including equipment malfunction, failure to follow specific protocols and procedures, problems with raw materials, natural disasters, and environmental factors. Quality is extremely important to us and our customers due to the serious and costly consequences of product failure. Our quality certifications are critical to the marketing success of our products. If we fail to meet these standards, our reputation could be damaged, we could lose customers, and our revenue and results of operations could decline. Aside from specific customer standards, our success depends generally on our ability to manufacture to exact tolerances precision-engineered components, subassemblies, and finished devices from multiple materials. If our components fail to meet these standards or fail to adapt to evolving standards, our reputation as a manufacturer of high-quality devices will be harmed, our competitive advantage could be damaged, and we could lose customers and market share.

Our manufacturing operations are dependent upon third-party suppliers, some of which are sole-sourced, which makes us vulnerable to supply problems, price fluctuations and manufacturing delays.
We rely on a number of sole source suppliers to supply transducers, substrates and processing for our scanners used in our catheters. We do not carry significant inventory of transducers, substrates or scanner subassemblies. If we had to change suppliers, we expect that it would take six to 24 months to identify appropriate suppliers, complete design work and undertake the necessary inspections and testing before the new transducers and substrates would be available. We are not parties to supply agreements with these suppliers but instead use purchase orders as needed.
Our reliance on these sole source suppliers subjects us to a number of risks that could impact our ability to manufacture our products and harm our business, including:
inability to obtain adequate supply in a timely manner or on commercially reasonable terms;
interruption or delayed delivery of supply resulting from our suppliers’ difficulty in accessing financial or credit markets or otherwise secure cash and capital resources;
interruption of supply resulting from modifications to, or discontinuation of, a supplier’s operations;
delays in product shipments resulting from uncorrected defects, reliability issues or a supplier’s variation in a component;
uncorrected quality and reliability defects that impact performance, efficacy and safety of products from replacement suppliers;
price fluctuations due to a lack of long-term supply arrangements with our suppliers for key components;
difficulty identifying and qualifying alternative suppliers for components in a timely manner;
production delays related to the evaluation and testing of products from alternative suppliers and corresponding regulatory qualifications; and
delays in delivery by our suppliers due to changes in demand from us or their other customers.
In addition, because we do not have long term supply agreements with some of our suppliers, we are subjected to the following risks:
unscheduled price increases;
lack of notice when the materials used to manufacture are not available;
lack of notice of discontinued operations or manufacturing.
We also utilize lean manufacturing processes that attempt to optimize the timing of our inventory purchases and supply levels of our inventories. Any significant delay or interruption in the supply of components or materials, or our inability to obtain substitute components or materials from alternate sources at acceptable prices and in a timely manner or to plan for sufficient

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inventory, could impair our ability to manufacture our products or meet the demand of our customers and harm our business. Identifying and qualifying additional or replacement suppliers for any of the components or materials used in our products, or obtaining additional inventory, if required, may not be accomplished quickly or at all and could involve significant additional costs. Any supply interruption from our suppliers or failure to obtain additional suppliers for any of the components or materials used to manufacture our products or sufficient inventory would limit our ability to manufacture our products and could therefore have a material adverse effect on our business, financial condition and results of operations.
We are constructing facilities in Costa Rica, may encounter a number of challenges relating to the construction, management and operation of such facilities, and the expansion has and will continue to increase our fixed costs, which may have a negative impact on our financial results and condition.
On September 23, 2010, we, through a wholly owned subsidiary, entered into a series of agreements to acquire real property and design and build manufacturing facilities in Costa Rica. We have never established or operated
manufacturing facilities outside the U.S., and cannot assure you that we will be able to successfully establish or operate these facilities in a timely or profitable manner, or at all. We depend upon Zona Franca Coyol, a third-party construction company, to assist us in the design, construction and validation of the manufacturing facilities. In addition, we will need to transfer our manufacturing processes, technology and know-how to our Costa Rica facilities. If we are unable to establish or operate these facilities or successfully transfer our manufacturing processes, technology and know-how in a timely and cost-effective manner, or at all, then we may experience disruptions in our operations, which could negatively impact our business and financial results.
We will need to obtain a number of permits and regulatory approvals prior, and subsequent, to commencing operations in such facilities. Our ability to obtain necessary permits and approvals may be subject to additional costs and possible delays beyond what we initially plan for. In addition, our manufacturing facilities, and those of our suppliers, must comply with applicable regulatory requirements. Failure of our manufacturing facilities to comply with regulatory and quality requirements would harm our business and our results of operations.
Our ability to operate this facility successfully will greatly depend on our ability to hire, train and retain an adequate number of employees, in particular employees with the appropriate level of knowledge, background and skills. We will compete with several other medical device companies with manufacturing facilities in Costa Rica to hire these skilled employees. Should we be unable to hire such employees, and an adequate number of them, our business and financial results could be negatively impacted.
As we continue construction on these manufacturing facilities, our fixed costs will increase. If we experience a demand in our products that exceeds our manufacturing capacity, we may not have sufficient inventory to meet our customers’ demands, which would negatively impact our revenues. If the demand for our products decreases or if we do not produce the output we plan or anticipate after the facilities are operational, we may not be able to spread a significant amount of our fixed costs over the production volume, thereby increasing our per unit fixed cost, which would have a negative impact on our financial condition and results of operations.
We also face particular commercial, jurisdictional and legal risks associated with our proposed expansion in Costa Rica. The success of this relationship and our activities in Costa Rica in general are subject to the economic, political and legal conditions or developments in Costa Rica.
Disruptions or other adverse developments during the construction and planned operations stage of our planned Costa Rica facilities could materially adversely affect our business. If our Costa Rica operations are disrupted for any reason, we may be forced to locate alternative manufacturing facilities, including facilities operated by third parties. Disruptions may include, but are not limited to: changes in the legal and regulatory environment in Costa Rica; slowdowns or work stoppages within the Costa Rican customs authorities; acts of God (including but not limited to potential disruptive effects from an active volcano near the facility or earthquakes, hurricanes and other natural disasters); and other issues associated with significant operations that are remote from our headquarters and operations centers. Additionally, continued growth in product sales could outpace the ability of our Costa Rican operation to supply products on a timely basis or cause us to take actions within our manufacturing operations which increase costs, complexity and timing. Locating alternative facilities would be time-consuming, would disrupt our production and cause shipment delays and could result in damage to our reputation and profitability. Additionally, we cannot assure you that alternative manufacturing facilities would offer the same cost structure as our Costa Rica facility.
If our facilities or systems are damaged or destroyed, we may experience delays that could negatively impact our revenues or other adverse effects.
Our facilities may be affected by natural or man-made disasters. If one of our facilities were affected by a disaster, we would be forced to rely on third-party manufacturers or to shift production to another manufacturing facility. In such an event, we would

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face significant delays in manufacturing which would prevent us from being able to sell our products. In addition, our insurance may not be sufficient to cover all of the potential losses and may not continue to be available to us on acceptable terms, or at all. Furthermore, although our computer and communications systems are protected through physical and software safeguards, they are still vulnerable to fire, storm, flood, power loss, earthquakes, telecommunications failures, physical or software break-ins, software viruses, and similar events, and any failure of these systems to perform for any reason and for any period of time could adversely impact our ability to operate our business.
We may require significant additional capital to pursue our growth strategy, and our failure to raise capital when needed could prevent us from executing our growth strategy.
We believe that our existing cash and cash equivalents and short-term and long-term available-for-sale investments will be sufficient to meet our anticipated cash needs for at least the next 12 months. However, we may need to obtain additional financing to pursue our business strategy, to respond to new competitive pressures or to act on opportunities to acquire or invest in complementary businesses, products or technologies. The timing and amount of our working capital and capital expenditure requirements may vary significantly depending on numerous factors, including:
market acceptance of our products;
the revenues generated by our products;
the need to adapt to changing technologies and technical requirements, and the costs related thereto;
the costs associated with expanding our manufacturing, marketing, sales and distribution efforts;
the existence and timing of opportunities for expansion, including acquisitions and strategic transactions; and
costs and fees associated with defending existing or potential litigation.
In addition, we are required to make periodic interest payments to the holders of the Notes and to make payments of principal upon conversion or maturity. We may also be required to purchase the Notes for cash upon the occurrence of a change of control or certain other fundamental changes involving us. If our capital resources are insufficient to satisfy our debt service or liquidity requirements, we may seek to sell additional equity or debt securities or to obtain debt financing. The sale of additional equity or debt securities, or the use of our stock in an acquisition or strategic transaction, would result in additional dilution to our stockholders. Additional debt would result in increased expenses and could result in covenants that would restrict our operations. We have not made arrangements to obtain additional financing and our significant historical losses and the current national and global financial conditions may prevent us from obtaining additional funds on favorable terms, if at all.
We are dependent on our collaborations, and events involving these collaborations or any future collaborations could delay or prevent us from developing or commercializing products.
The success of our current business strategy and our near- and long-term viability will depend on our ability to execute successfully on existing strategic collaborations and to establish new strategic collaborations. Collaborations allow us to leverage our resources and technologies and to access markets that are compatible with our own core areas of expertise. To penetrate our target markets, we may need to enter into additional collaborative agreements to assist in the development and commercialization of future products. Establishing strategic collaborations is difficult and time-consuming. Potential collaborators may reject collaborations based upon their assessment of our financial, regulatory or intellectual property position or our internal capabilities. Our discussions with potential collaborators may not lead to the establishment of new collaborations on favorable terms or at all.
We have collaborations with a number of entities, including Medtronic, Inc., The Cleveland Clinic Foundation, General Electric Company, Siemens AG, Philips Medical Systems Nederland B.V., and Abbott. In each collaboration, we combine our technology or core capabilities with those of the third party to permit either greater penetration into markets or to enhance the functionality of our current and planned products. We have limited control over the amount and timing of resources that our current collaborators or any future collaborators devote to our collaborations or potential products. These collaborators may breach or terminate their agreements with us or otherwise fail to conduct their collaborative activities successfully and in a timely manner. Further, our collaborators may not develop or commercialize products that arise out of our collaborative arrangements or devote sufficient resources to the development, manufacture, marketing or sale of these products. Moreover, in the event of termination of a collaboration agreement, we may not realize the intended benefits or we may not be able to replace the arrangement on comparable terms or at all.
If the third-party distributors that we rely on to market and sell our products are not successful, we may be unable to increase or maintain our level of revenues.
A portion of our revenue is generated by our third-party distributors, especially in international markets. If these distributors cease or limit operations or experience a disruption of their business operations, or are not successful in selling our products, we may be unable to increase or maintain our level of revenues, and any such developments could negatively affect our

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international sales strategy. Over the long term, we intend to grow our business internationally, and to do so we will need to attract additional distributors to expand the territories in which we do not directly sell our products. Our distributors may not commit the necessary resources to market and sell our products. If current or future distributors do not continue to distribute our products or do not perform adequately or if we are unable to locate distributors in particular geographic areas, we may not realize revenue growth internationally.
Our reported or future financial results could be adversely affected by the application of existing or future accounting standards.
U.S. generally accepted accounting principles and related implementation guidelines and interpretations can be highly complex and involve subjective judgments. Changes in these rules or their interpretation, the adoption of new guidance or the application of existing guidance to changes in our business could have a significant adverse effect on our financial results. For example, the accounting for convertible debt securities, and the accounting for the convertible note hedge transactions and the warrant transactions we entered into in connection with the offering of the Notes, is subject to frequent scrutiny by the accounting regulatory bodies and is subject to change. We cannot predict if or when any such change could be made and any such change could have an adverse impact on our reported or future financial results. In addition, in the event the conversion features of the Notes are triggered, we could be required under applicable accounting standards to reclassify all or a portion of the outstanding principal of the Notes as a current rather than long-term liability, which would result in a material reduction of our net working capital.
We cannot assure you that our net operating loss carryforwards will be available to reduce our tax liability.
Our ability to use our net operating loss carryforwards to reduce future income tax obligations may be limited or reduced. Generally, a change of more than 50 percentage points in the ownership of our shares, by value, over the three-year period ending on the date the shares were acquired constitutes an ownership change and may limit our ability to use our net operating loss carryforwards. Should additional ownership changes occur in the future, our ability to utilize our net operating loss carryforwards could be limited.
If we fail to properly manage our anticipated growth, our business could suffer.
Rapid growth of our business is likely to continue to place a significant strain on our managerial, operational and financial resources and systems. To execute our anticipated growth successfully, we must attract and retain qualified personnel and manage and train them effectively. We anticipate hiring additional personnel to assist in the commercialization of our current products and in the development of future products. We will be dependent on our personnel and third parties to effectively market and sell our products to an increasing number of customers. We will also depend on our personnel to develop and manufacture in anticipated increased volumes our existing products, as well as new products and product enhancements. Further, our anticipated growth will place additional strain on our suppliers resulting in increased need for us to carefully monitor for quality assurance. Any failure by us to manage our growth effectively could have an adverse effect on our ability to achieve our development and commercialization goals.
*Issues arising from the implementation of our new enterprise resource planning system could adversely affect our operating results and ability to manage our business effectively.
We have begun implementing a new enterprise resource planning, or ERP, system to further enhance operating efficiencies and provide more effective management of our business operations. The new ERP system is being deployed for use throughout our company in a number of “go live” phases, the first of which occurred during the fourth quarter of 2011 with company-wide deployment expected to be completed during the third quarter of 2012. Implementing a new ERP system is costly and involves risks inherent in the conversion to a new computer system, including loss of information, disruption to our normal operations, changes in accounting procedures and internal control over financial reporting, as well as problems achieving accuracy in the conversion of electronic data. Failure to properly or adequately address these issues could result in increased costs, the diversion of management’s and employees’ attention and resources and could materially adversely affect our operating results, internal controls over financial reporting and ability to manage our business effectively. While the ERP system is intended to further improve and enhance our information systems, large scale implementation of a new information system exposes us to the risks of starting up the new system and integrating that system with our existing systems and processes, including possible disruption of our financial reporting, which could lead to a failure to make required filings under the federal securities laws on a timely basis.
Any defects or malfunctions in the computer hardware or software we utilize in our products could cause severe performance failures in such products, which would harm our reputation and adversely affect our results of operations and financial condition.

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Our existing and new products depend and will depend on the continuous, effective and reliable operation of computer hardware and software. For example, our IVUS products utilize sophisticated software that analyzes in real-time plaque composition and identifies lumen and vessel borders, which are then displayed in three-dimensional, color-coded images on a computer screen. Any defect, malfunction or other failing in the computer hardware or software utilized by our IVUS or other products, including products we develop in the future, could result in inaccurate readings, misinterpretations of data, or other performance failures that could render our products unreliable or ineffective and could lead to decreased confidence in our products, damage to our reputation, reduction in our sales and product liability claims, the occurrence of any of which could have a material adverse effect on our results of operations and financial condition. Although we update the computer software utilized in our products on a regular basis, there can be no guarantee that defects do not or will not in the future exist or that unforeseen malfunctions, whether within our control or otherwise, will not occur.
*If we are unable to recruit, hire and retain skilled and experienced personnel, our ability to effectively manage and expand our business will be harmed.
Our success largely depends on the skills, experience and efforts of our officers and other key employees who may terminate their employment at any time. The loss of any of our senior management team, in particular our President and Chief Executive Officer, R. Scott Huennekens, could harm our business. We have entered into employment contracts or similar agreements with R. Scott Huennekens; our Chief Financial Officer, John T. Dahldorf; our Executive Vice President, Global Sales, Jorge J. Quinoy; and Michel Lussier, Group President,Clinical Affairs and EMEAI, but these agreements do not guarantee that they will remain employed by us in the future. The announcement of the loss of one of our key employees could negatively affect our stock price. Our ability to retain our skilled workforce and our success in attracting and hiring new skilled employees will be a critical factor in determining whether we will be successful in the future. We face challenges in hiring, training, managing and retaining employees in certain areas including clinical, technical, sales and marketing. This could delay new product development and commercialization, and hinder our marketing and sales efforts, which would adversely impact our competitiveness and financial results.
The expense and potential unavailability of insurance coverage for our company, customers or products may have an adverse effect on our financial position and results of operations.
While we currently have insurance for our business, property, directors and officers, and product liability, insurance is increasingly costly and the scope of coverage is narrower, and we may be required to assume more risk in the future. If we are subject to claims or suffer a loss or damage in excess of our insurance coverage, we will be required to cover the amounts outside of or in excess of our insurance limits. If we are subject to claims or suffer a loss or damage that is outside of our insurance coverage, we may incur significant costs associated with loss or damage that could have an adverse effect on our financial position and results of operations. Furthermore, any claims made on our insurance policies may impact our ability to obtain or maintain insurance coverage at reasonable costs or at all. We do not have the financial resources to self-insure, and it is unlikely that we will have these financial resources in the foreseeable future.
Our product liability insurance covers our products and business operations, but we may need to increase and expand this coverage commensurate with our expanding business. Any product liability claims brought against us, with or without merit, could result in:
substantial costs of related litigation or regulatory action;
substantial monetary penalties or awards;
decreased demand for our products;
reduced revenue or market penetration;
injury to our reputation;
withdrawal of clinical study participants;
an inability to establish new strategic relationships;
increased product liability insurance rates; and
an inability to secure continuing coverage.
Some of our customers and prospective customers may have difficulty in procuring or maintaining liability insurance to cover their operation and use of our products. Medical malpractice carriers are withdrawing coverage in certain regions or substantially increasing premiums. If this trend continues or worsens, our customers may discontinue using our products and potential customers may opt against purchasing our products due to the cost or inability to procure insurance coverage.
Compliance with changing corporate governance and public disclosure regulations may result in additional expenses.
Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act, new SEC regulations and Nasdaq Global

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Select Market rules, are creating uncertainty for companies such as ours. To maintain high standards of corporate governance and public disclosure, we have invested, and intend to continue to invest, in reasonably necessary resources to comply with evolving standards. These investments have resulted in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities and may continue to do so in the future.

Risks related to government regulation
If we fail to obtain or maintain, or experience significant delays in obtaining, regulatory clearances or approvals for our products or product enhancements, our ability to commercially distribute and market our products could suffer.
Our products are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities. Our failure to comply with such regulations or to make adequate, timely corrections, could lead to the imposition of injunctions, suspensions or loss of marketing clearances or approvals, product recalls, manufacturing cessation, termination of distribution, product seizures, civil penalties, or some combination of such actions. The process of obtaining regulatory authorizations to market a medical device, particularly from the FDA, can be costly and time consuming, and there can be no assurance that such authorizations will be granted on a timely basis, if at all. If regulatory clearance or approvals are received, additional delays may occur related to manufacturing, distribution, or product labeling. In addition, we cannot assure you that any new or modified medical devices we develop will be eligible for the shorter 510(k) clearance process as opposed to the PMA process. We have no experience in obtaining PMA approvals.
In the member states of the European Economic Area, or EEA, our medical devices are required to comply with the essential requirements of the EU Medical Devices Directives before they can be marketed. Our products, including their design and manufacture, have been certified by the British Standards Institute, or BSI, a United Kingdom Notified Body, as being compliant with the requirements of the Medical Devices Directives. Consequently, we are entitled to affix a CE mark to our products and their packaging and this gives us the right to sell them in the EEA. If we fail to maintain compliance with the Medical Devices Directives, our products will no longer qualify for the CE mark and the relevant devices would not be eligible for marketing in the EEA.
We currently market our IVUS and FFR products in Japan under two types of regulatory approval known as a SHONIN and a NINSHO. As the holder of the SHONINs, we have the authority to import and sell those products for which we have the SHONINs as well as those products for which we have obtained a NINSHO. Responsibility for Japanese regulatory filings and future compliance resides with us. We cannot guarantee that we will be able to adequately meet Japanese regulatory requirements. Non-compliance with Japanese regulations may result in action to prohibit further importation and sale of our products in Japan, a significant market for our products. If we are unable to sell our IVUS and FFR products in Japan, we will lose a significant part of our annual revenues, and our business will be substantially impacted.
Foreign governmental authorities that regulate the manufacture and sale of medical devices have become increasingly stringent, and to the extent we continue to market and sell our products in foreign countries, we will be subject to rigorous regulation in the future. In such circumstances, where we utilize distributors in foreign countries to market and sell our products, we would rely significantly on our distributors to comply with the varying regulations, and any failures on their part could result in restrictions on the sale of our products in foreign countries. Regulatory delays or failures to obtain and maintain marketing authorizations, including 510(k) clearances and PMA approvals, could disrupt our business, harm our reputation, and adversely affect our sales.
Modifications to our products may require new regulatory clearances or approvals or may require us to recall or cease marketing our products until clearances or approvals are obtained.
Modifications to our products may require the submission of new 510(k) notifications or PMA applications. If a modification is implemented to address a safety concern, we may also need to initiate a recall or cease distribution of the affected device. In addition, if the modified devices require the submission of a 510(k) or PMA and we distribute such modified devices without a new 510(k) clearance or PMA approval, we may be required to recall or cease distributing the devices. The FDA can review a manufacturer’s decision not to submit a modification and may disagree. The FDA may also on its own initiative determine that clearance of a new 510(k) or approval of a new PMA submission is required. We have made modifications to our products in the past and may make additional modifications in the future that we believe do not or will not require clearance of a new 510(k) or approval of a new PMA. If we begin manufacture and distribution of the modified devices and the FDA later disagrees with our determination and requires the submission of a new 510(k) or PMA for the modifications, we may also be required to recall the distributed modified devices and to stop distribution of the modified devices, which could have an adverse effect on our business. If the FDA does not clear or approve the modified devices, we may need to redesign the devices, which could also harm our business. When a device is marketed without a required clearance or approval, the FDA has the authority to bring an enforcement action, including injunction, seizure and, in egregious circumstances, criminal prosecution. The FDA considers such additional actions generally when there is a serious risk to public health or safety and the company’s corrective and

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preventive actions are inadequate to address the FDA’s concerns.
Where we determine that modifications to our products require clearance of a new 510(k) or approval of a new PMA or PMA supplement, we may not be able to obtain those additional clearances or approvals for the modifications or additional indications in a timely manner, or at all. For those products sold in the EEA, we must notify BSI, our EEA Notified Body, if significant changes are made to the products or if there are substantial changes to our quality assurance systems affecting those products. Delays in obtaining required future clearances or approvals would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our future growth.
The FDA is reviewing the 510(k) process and could change the criteria to obtain clearance which could affect our ability to obtain timely reviews and increase the resources needed to meet new criteria.
Over the past several years, concerns have been raised about whether the 510(k) program optimally achieves its intended goals. The FDA released for public comment in August 2010 a set of preliminary reports and recommendations from an internal 510(k) Working Group and Task Force on the Utilization of Science in Regulatory Decision Making. In January 2011, the FDA announced 25 action items it intends to take with respect to the pre-market notification process. Although the FDA has not detailed the specific modifications or clarifications that it intends to make to its guidance, policies and regulations pertaining to the review and regulation of devices such as ours which seek and receive market clearance through the 510(k) pre-market notification process, it has issued several draft guidance documents that, if implemented, will likely entail additional regulatory burdens. These additional regulatory burdens could delay our ability to obtain new clearances, increase the costs of compliance, or restrict our ability to maintain our current clearances. In the future, the FDA will announce which draft guidance documents it will finalize and implement, along with any other recommended improvements, and the timeline for their implementation.
If the FDA makes changes to the 510(k) program, we may be required to prepare and submit more data and information than is currently required, which could require additional resources and more expense, require more time to prepare a submission, and result in a longer review period by the FDA. Such changes could adversely affect our business.
If we or our suppliers fail to comply with the FDA’s Quality System Regulation or ISO Quality Management Systems, manufacturing of our products could be negatively impacted and sales of our products could suffer.
Our manufacturing practices must be in compliance with the FDA’s 21 CFR Part 820 Quality System Regulation, or QSR, which governs the facilities, methods, controls, procedures, and records of the design, manufacture, packaging, labeling, storage, shipping, installation, and servicing of our products intended for human use. We are also subject to similar state and foreign requirements and licenses, including the MDD—93/42/EEC and the ISO 13485 Quality Management Systems, or QMS, standard applicable to medical devices. In addition, we must engage in regulatory reporting in the case of potential patient safety risks and must make available our manufacturing facilities, procedures, and records for periodic inspections and audits by governmental agencies, including the FDA, state authorities and comparable foreign agencies. If we fail to comply with the QSR, QMS, or other applicable regulations and standards, our operations could be disrupted and our manufacturing interrupted, and we may be subject to enforcement actions if our corrective and preventive actions are not adequate to ensure compliance.
Failure to take adequate corrective action in response to inspectional observations or any notice of deficiencies from a regulatory inspection or audit could result in partial or total shut-down of our manufacturing operations unless and until adequate corrections are implemented, voluntary or FDA-ordered recall, FDA seizure of affected devices, court-ordered injunction or consent decree that could impose additional regulatory oversight and significant requirements and limitations on our manufacturing operations, significant fines, suspension or withdrawal of marketing clearances and approvals, and criminal prosecutions, any of which would cause our business to suffer. Furthermore, our key component suppliers may not currently be or may not continue to be in compliance with applicable regulatory requirements, which may result in manufacturing delays for our products and cause our revenue to decline.
The FDA, BSI, Japan’s Pharmaceutical & Medical Device Administration, or PMDA, and other regulatory agencies and bodies have previously imposed inspections and audits on us, and may in the future impose additional inspections or audits at any time which may conclude that our quality system is noncompliant with applicable regulations and standards. Such findings could potentially disrupt our business, harm our reputation and adversely affect our sales.
Our products may in the future be subject to product recalls or voluntary market withdrawals that could harm our reputation, business and financial results.
The FDA and similar foreign governmental authorities have the authority to require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture that could affect patient safety. In the case of the FDA, the authority to require a recall must be based on an FDA finding that there is a reasonable probability that the device would

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cause serious adverse health consequences or death. Manufacturers may, under their own initiative, recall a product if any material deficiency in a device is found or suspected. For example, in 2010 we recalled our Xtract™ catheter in circumstances where no patient safety incident was reported but where we had evidence that the device’s integrity could be compromised under certain storage conditions. A government-mandated recall or voluntary recall by us or one of our distributors could occur as a result of component failures, manufacturing errors, design or labeling defects or other issues. Recalls, which include corrections as well as removals, of any of our products would divert managerial and financial resources and could have an adverse effect on our financial condition, harm our reputation with customers, and reduce our ability to achieve expected revenues.
We are required to comply with medical device reporting, or MDR, requirements and must report certain malfunctions, deaths, and serious injuries associated with our products, which can result in voluntary corrective actions or agency enforcement actions.
Under the FDA MDR regulations, medical device manufacturers are required to submit information to the FDA when they receive a report or become aware that a device has or may have caused or contributed to a death or serious injury or has or may have a malfunction that would likely cause or contribute to death or serious injury if the malfunction were to recur. All manufacturers placing medical devices on the market in the EEA are legally bound to report any serious or potentially serious incidents involving devices they produce or sell to the Competent Authority in whose jurisdiction the incident occurred. Were this to happen to us, the relevant Competent Authority would file an initial report, and there would then be a further inspection or assessment if there were particular issues. This would be carried out either by the Competent Authority or it could require that the BSI, as the Notified Body, carry out the inspection or assessment.
Malfunction of our products could result in future voluntary corrective actions, such as recalls, including corrections, or customer notifications, or agency action, such as inspection or enforcement actions. Malfunctions have been reported to us in the past, and, while we investigated each of the incidents and believe we have taken the necessary corrective and preventive actions, we cannot guarantee that similar or different malfunctions will not occur in the future. If malfunctions do occur, we cannot guarantee that we will be able to correct the malfunctions adequately or prevent further malfunctions, in which case we may need to cease manufacture and distribution of the affected devices, initiate voluntary recalls, and redesign the devices; nor can we ensure that regulatory authorities will not take actions against us, such as ordering recalls, imposing fines, or seizing the affected devices. If someone is harmed by a malfunction or by product mishandling, we may be subject to product liability claims. Any corrective action, whether voluntary or involuntary, as well as defending ourselves in a lawsuit, will require the dedication of our time and capital, distract management from operating our business, and may harm our reputation and financial results.
We are subject to federal, state and foreign healthcare laws and regulations and implementation or changes to such healthcare laws and regulations could adversely affect our business and results of operations.
In an effort to contain rising healthcare costs, in March 2010, President Obama signed into law the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act, collectively, the PPACA, which may significantly affect the payment for, and the availability of, healthcare services and result in fundamental changes to federal healthcare reimbursement programs. The PPACA includes, among other things, the following measures:
a deductible 2.3% excise tax on any entity that manufactures or imports medical devices offered for sale in the U.S., with limited exceptions, effective 2013;
a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in and conduct comparative clinical effectiveness research;
new reporting and disclosure requirements on device manufacturers for any “transfer of value” made or distributed to physicians and teaching hospitals, with the first report due on March 30, 2013;
payment system reforms including a national pilot program on payment bundling to encourage hospitals, physicians and other providers to improve the coordination, quality and efficiency of certain healthcare services through bundled payment models, beginning on or before January 1, 2013; and
an independent payment advisory board that will submit recommendations to reduce Medicare spending if projected Medicare spending exceeds a specified growth rate.
We are unable to predict at this time the impact of such recently enacted federal healthcare reform legislation on the medical device industry in general, or on us in particular and what, if any, additional legislation or regulation relating to the medical device industry may be enacted in the future. An expansion in the government’s role in the U.S. healthcare industry may cause general downward pressure on the prices of medical device products, lower reimbursements for procedures using our products, reduce medical procedure volumes and adversely affect our business and results of operations. Although we cannot predict the many ways that the federal healthcare reform laws might affect our business, we will be subject to the 2.3% excise tax scheduled to take effect in 2013. It is unclear whether and to what extent, if at all, other anticipated developments resulting

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