10-K 1 volc1231201310-k.htm 10-K VOLC 12.31.2013 10-K


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
(Mark One)
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                    
Commission file number 000-52045
 
Volcano Corporation
(Exact Name of Registrant as Specified in its Charter)
 
Delaware
 
33-0928885
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification Number)
3721 Valley Centre Drive, Suite 500
 
 
San Diego, California
 
92130
(Address of Principal Executive Offices)
 
(Zip Code)
Registrant’s telephone number, including area code:
(800) 228-4728
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, $0.001 per share par value
 
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.     Yes  x    No  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x
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  x    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  x    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨
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.
Large accelerated filer
x
 
Accelerated filer
¨
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes   ¨    No  x
The aggregate market value of the voting common equity held by non-affiliates of the registrant, based upon the closing price of a share of the registrant’s common stock on June 30, 2013 (which is the last business day of registrant’s most recently completed second fiscal quarter), as reported on the NASDAQ Global Select Market was approximately $981.5 million. Approximately 452,321 shares of common stock held by executive officers and directors on June 30, 2013 have been excluded in that such persons may be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
At February 14, 2014, 51,926,493 shares of Common Stock, par value $0.001, of the registrant were outstanding.
 

DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K incorporates information by reference to portions of the registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on June 3, 2014. Such definitive Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2013.

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VOLCANO CORPORATION
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2013
TABLE OF CONTENTS
 
 
 
PART I
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
PART II
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
PART III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
PART IV
 
Item 15.
 


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Forward-looking statements: This annual report on Form 10-K (“Annual Report”) contains forward-looking statements regarding future events and our future results that are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. In some cases, you can identify these “forward-looking statements” by words like “may,” “will,” “should,” "could," “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” "intends" or “continues” or the negative of those words and other comparable words. Forward-looking statements include, but are not limited to, statements about:

our intentions, beliefs and expectations regarding our expenses, sales, operations and future financial performance;
our operating results;
our plans for future products and enhancements of existing products;
anticipated growth and trends in our business;
the timing of and our ability to maintain and obtain regulatory clearances or approvals;
our belief that our cash and cash equivalents and short-term available-for-sale investments will be sufficient to satisfy our anticipated cash requirements;
our expectations regarding our revenues, customers and distributors;
our beliefs and expectations regarding our market penetration and expansion efforts;
our expectations regarding the benefits and integration of recently-acquired businesses and our ability to make future acquisitions and successfully integrate any such future-acquired businesses;
our anticipated trends and challenges in the markets in which we operate; and
our expectations and beliefs regarding and the impact of investigations, claims and litigation

These statements are not guarantees of future performance or events. Our actual results may differ materially from those discussed here. For a detailed discussion of the risks and uncertainties that could contribute to such differences see the “Risk Factors” section in Part I, Item 1A of this Annual Report as well as the discussion in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere throughout this Annual Report and in any other documents incorporated by reference into this Annual 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 Annual Report.
Volcano has registered and common law trademarks in the U.S. and elsewhere in the world including, but not limited to, Aim®, Axsun®, Bi-Trieval, Centriq, ChromaFlo®, ComboMap®, ComboWire®, Core, Crux®, Crux Biomedical®, Define, Eagle Eye®, ETNA, FACT, FloMap®, FloWire®, Ginko, GlyDx®, Hi-Q, iFR®, In-Line Digital®, Instant Wave-Free Ratio, Intentio, Octave, pcFM®, Precision Guided Therapy, PreView, PrimeWire®, PrimeWire Prestige®, ReFlow, Revolution®, SlyDx, s5i®, SmartMap®, SpinVision®, Sync-Rx, Trak Back®, Valet®, Verrata, VH®, VIBE®, Virtual Histology®, Visions®, Volcano®, Wavewire®, Xtract® and Zuum. Other brand names or trademarks appearing in this Annual Report are the property of their respective holders.
PART I
 
Item 1.
Business
Overview
We design, develop, manufacture and commercialize a broad suite of precision guided therapy tools including intravascular ultrasound, or IVUS, and fractional flow reserve, or FFR, products. We believe that these products enhance the diagnosis and treatment of coronary and peripheral vascular disease by improving the efficiency and efficacy of existing diagnostic angiograms and percutaneous coronary interventional, or PCI, and endovascular procedures in the coronary arteries or peripheral arteries and veins. We are facilitating the adoption of functional PCI, in which our FFR technology is used to help determine whether or not a stent is necessary, and IVUS is used as an adjunct to angiography to guide stent placement and optimization. We market our products to physicians, nurses and technicians who perform a variety of endovascular based coronary and peripheral interventional procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals.
Our products consist of consoles that are marketed as stand-alone units or as units that can be integrated into a variety of hospital-based interventional surgical suites called catheterization laboratories, or cath labs. We have developed customized cath lab versions of these consoles and are developing additional functionality options as part of our cath lab integration initiative. Our consoles have been designed to serve as a multi-modality platform for our phased array and rotational IVUS catheters, FFR pressure and flow wires and image-guided therapy catheters, such as the Pioneer Plus reentry device acquired from Medtronic, Inc., or Medtronic, on August 30, 2013.

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Our IVUS products include single-procedure disposable phased array and rotational IVUS imaging catheters, and additional functionality options such as ChromaFlo® stent apposition analysis. Our FFR offerings can be accessed through our multi-modality platforms, and we also provide FFR-only consoles. Our FFR disposables are single-procedure disposable pressure and flow guide wires used to measure the pressure and flow characteristics of blood around plaque enabling physicians to gauge the plaque's physiological impact on blood flow and pressure. We have developed additional offerings for integration into the platform, including adenosine-free Instant Wave-Free Ratio FFR, or iFR®. We are currently developing high resolution Focal Acoustic Computed Tomography, or FACT, catheters, co-registration with IVUS and an IVUS-guided Crux VCF system featuring our inferior vena cava, or IVC, filter. Our Valet microcatheter, Visions® PV .035 catheter and Eagle Eye® Platinum ST short tip catheter, or EEP, products received 510(k) clearance and CE Mark approval in 2012 and their commercial launch occurred in 2013. In addition, we initiated the commercial launch of our Verrata pressure guide wire, our fifth new pressure wire in five years, during 2013.
Through Axsun Technologies, Inc., or Axsun, one of our wholly-owned subsidiaries, we also develop and manufacture optical monitors for the telecommunications industry, laser and non-laser light sources, optical engines used in medical optical coherence topography, or OCT, imaging systems and advanced photonic components and sub-systems used in spectroscopy and other industrial applications. We believe Axsun's proprietary OCT technology will provide us competitive advantages in the invasive imaging sector, as well as for applications in ophthalmology and dental.
We believe the market segments relevant to Volcano will grow from approximately $1.3 billion in 2012 to approximately $1.7 billion by 2017, representing a compound annual growth rate, or CAGR, of approximately six percent. Within this broader market, we estimate that the current market for our IVUS products, FFR products and Axsun industrial products is approximately $900 million. We base our estimated market sizes in part on discussion with market analysts and on our internal assessment of our historical and projected sales and those of our competitors. We believe the intravascular imaging market is growing at approximately five percent annually and the FFR market is growing at approximately 10 percent annually, and we expect that these markets, together with the market for our Axsun industrial products, could grow to more than $1.1 billion in the next five years. In addition, we have a number of products in our emerging business segment, including IVUS-guided therapies, such as our Pioneer Plus Re-entry catheter, our Crux IVC filter, Axsun medical and ophthalmology products, SyncVision (co-registration with IVUS) and iFR. Many of these products leverage our existing platform technology and represent an aggregate estimated current market opportunity of approximately $400 million, which we expect to grow at approximately eight percent on a CAGR basis to approximately $600 million by 2017.
We have focused on building our domestic and international sales and marketing infrastructure to market our products to physicians and technicians who perform diagnostic angiography, PCI and endovascular procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals. We sell our products directly to customers in the United States, Japan, certain European markets and South Africa. We utilize distributors in other geographic areas, which are also involved in product launch planning, education and training, physician support and clinical study management.
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 multi-modality and FFR consoles and our IVUS and FFR single-use disposables. Our industrial segment derives revenues related to the sales of micro-optical spectrometers and optical channel monitors by Axsun to telecommunication and industrial companies. We continue building direct sales capabilities in the U.S., certain parts of Europe, South Africa, and Japan. During the year ended December 31, 2013, we generated worldwide revenues of $393.7 million, which is comprised of $385.2 million from our medical segment and $8.4 million from our industrial segment, and had an operating loss of $29.9 million. Our total assets as of December 31, 2013 were $831.9 million. Our revenue, operating income (loss) and other financial results for the last three fiscal years are described in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the “Consolidated Financial Statements” sections contained in this Annual Report. At December 31, 2013, we had a worldwide installed base of more than 7,000 consoles, excluding our legacy In-Vision Gold systems. We intend to grow and leverage this installed base of consoles to drive recurring sales of our single-use disposable catheters and guide wires, which accounted for approximately 79.7% of our medical segment revenues during the year ended December 31, 2013. In 2013, approximately 48.2% of our revenues were generated in the U.S., approximately 27.8% were generated in Japan, and approximately 18.0% were generated in Europe, the Middle East and Africa, with the balance of sales occurring in other international markets.
Our Strategy
Our long-term growth strategy incorporates expansion of our existing businesses, commercialization of new products and markets and licensing or acquiring new technologies. We believe our continued product innovation and expansion of our direct distribution sales programs will enable us to expand market penetration and share, as well as broaden the clinical indications that our products can address. The core of this strategy is offering a multi-modality platform that seeks to deliver all of the benefits associated with conventional IVUS and FFR devices, while providing enhanced functionality and proprietary features

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that address the limitations associated with conventional forms of these technologies. We are seeking to make precision-guided, functional PCI a standard of care and to position us as a leading provider of precision-guided therapy. We believe that recent clinical data from studies involving IVUS and FFR, as well as updated clinical guidelines elevating the use of these technologies, will help drive market adoption. For example, two-year data released in 2013 from the ADAPT-DES study (Assessment of Platelet Therapy with Drug-Eluting Stents), the largest study conducted with IVUS guidance to date, indicated IVUS guidance was associated with reductions in certain serious patient events, including stent thrombosis and myocardial infarction, and that IVUS guidance was associated with a change in procedure 74% of the time. In addition, we have a number of new offerings under development that will further leverage our multi-modality platform. Factors driving our strategy include:

Accelerating the trend toward less invasive procedures. Our IVUS products offer continuous, real-time three-dimensional imaging, plaque visualization, color-coded identification of plaque composition, and automatic drawing of lumen and vessel borders allowing for automatic vessel sizing. Our FFR products offer physicians a simple pressure and flow based method to determine whether stenting or additional PCI is required. This strategy complements our focus on precision-guided therapy by providing sophisticated guidance tools that enhance the value of minimally invasive procedures.

Enhancing the outcomes of PCI and endovascular procedures. We believe our products enabled with novel technological enhancements provide clinically significant information that improves the outcomes of current and increasingly complex PCI and endovascular procedures.

Providing documentation for necessity of procedures. Increasingly, hospitals and third-party payors are requesting proof of necessity for PCIs. We believe our IVUS and FFR technologies can assist clinicians in documenting the clinical necessity of these procedures.

Decreasing the number of interventional devices used per procedure and optimizing their usage. Our FFR products offer the opportunity to physiologically assess lesion severity and determine whether stents are needed. Additionally, our IVUS products provide intravascular imaging. As a result, our IVUS and FFR products have the potential to reduce the number of devices deployed by identifying the appropriate lesion for stenting and ensuring that stents are placed and expanded correctly, thereby enhancing patient outcomes and lowering treatment costs.

Improving ease of use of IVUS and FFR technologies to drive market adoption. We have designed our console offerings to be “always there, always on, and easy to use.” Our consoles are easily integrated into an existing or newly constructed cath lab facility.

Improving the diagnosis of cardiovascular disease. We believe our IVUS and FFR products can significantly improve the diagnosis of cardiovascular disease by addressing the limitations of diagnostic angiography, and allowing clinicians to better identify patients and lesions at risk for future adverse coronary vascular system events.

Enabling new procedures to treat coronary artery, and peripheral vascular disease. Currently, the treatment of a number of cardiovascular and peripheral vascular diseases is limited by conventional technologies, including angiography. Because our technologies address many of these current limitations, we believe our products provide physicians the potential to diagnose and optimally treat these diseases percutaneously.
Our primary goal is to establish our IVUS and FFR products as the standard of care for a variety of procedures including diagnostic, PCI and endovascular procedures and expand the use of IVUS and FFR for these procedures. The key elements of our strategy for achieving this goal are to:
Grow existing IVUS and FFR markets globally. We believe that most PCI and endovascular procedures today, particularly those of a more complex nature, benefit greatly from more precise guidance than angiography alone can provide. We believe that by making our devices easier to use and enabling faster, more comprehensive interpretation of images, investing in thoughtful clinical studies and registries that support the benefits of our technologies, educating physicians and hospital executives on the clinical need for our products and existing guidelines, training staff on the procedural use of our products, and providing access to all patients through the expansion of our installed base, we can continue to grow and cultivate the current PCI market which represents, on an annual basis, more than three million procedures worldwide as well as the current endovascular market. We also plan to develop a portfolio of image guided therapy devices.


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Increase market share in existing IVUS and FFR markets. We continue to introduce product enhancements to meet physicians’ needs for improved visualization, characterization, and ease of use. We believe these enhancements make our products easier to use than competing products and provide substantially more and better information to improve procedural outcomes, thereby driving greater usage of our IVUS and FFR products within the existing PCI and endovascular markets. We believe we are the IVUS market leader and intend to implement several strategies to increase our penetration in the FFR market. First, we have addressed certain limitations of conventional IVUS such as difficulty in use, lack of automation and grayscale imaging by developing technologies and introducing features such as automatic real-time drawing of lumen and vessel borders, color-coded identification of plaque composition, and automatic vessel sizing. Second, we developed PC-based IVUS and FFR consoles that can be integrated easily into cath labs, thereby making it easier for physicians to adopt and use our products. Third, we have increased the size of our direct sales force and initiated direct distribution strategies in key geographies. We have also entered into distribution and marketing agreements with leading cath lab equipment and stent manufacturers. We intend to grow and leverage our installed base of IVUS and FFR consoles to drive recurring sales of our single-procedure disposable catheters and guide wires.

Expand our existing technologies to serve new markets. We plan to utilize our existing diagnostic technologies, including FFR and IVUS, to address new markets. The nearest term opportunity is in the peripheral vasculature, where we believe IVUS and FFR enable enhanced decision-making by clinicians versus the use of angiography alone. Current and potential IVUS applications include stenting in the iliac, femoral and below-the-knee arteries, atherectomy, AV Fistula/graft revascularization, endovascular aneurysm repair, thoracic endovascular aortic repair, inferior vena cava, or IVC, filter placement, and compressive and thrombotic venous disease. We believe FFR has several applications as well, including the assessment of gradients in lower limb arteries to determine treatment needs. As we pursue opportunities in this market, we plan to develop new IVUS and FFR products and develop or acquire therapeutic products that have clinical synergies with our diagnostic technologies. In addition, we plan to explore product development and marketing partnerships with other leading companies in the sector.

Enhance product capabilities and introduce new products through collaborations or acquisitions. We have a successful track record of acquiring and licensing technologies and collaborating with third parties to create synergistic product offerings. For instance, we license the iFR technology from Imperial College London and FACT technology from The Cleveland Clinic Foundation. Since December 2007, we have acquired, among others, Impact Medical Technologies, LLC; Axsun; Sync-Rx Ltd.; Crux Biomedical, Inc.; and the Pioneer Plus Reentry Catheter from Medtronic. The technologies obtained from these acquisitions form the foundation of many of the new technologies and products we expect to introduce. We believe there will be additional opportunities to leverage these capabilities through select technology or company acquisitions as well as collaborations that enhance our capabilities or complement our market strategies.
Our Products
Our multi-modality consoles are marketed as stand-alone units or units that can be integrated into cath labs. We offer consoles that combine IVUS and FFR technology, which are designed to allow the user to switch seamlessly between each modality. We also offer systems with either IVUS or FFR independently. The significantly expanded functionality of our offering enables the networking of patient information, control of IVUS and FFR information at both the operating table and in the cath lab control room, as well as the capability for images to be displayed on standard cath lab monitors. Our products include IVUS catheters, FFR guide wires and various options that provide additional functionality. We expect to continue developing new products and technologies to expand the market adoption of our offering, and also expect our platform will support IVUS integrated with other interventional devices in the future.
Consoles
We design, develop, manufacture and commercialize multi-modality consoles that are proprietary, high-speed electronic systems that process the signals received from our IVUS catheters and FFR wires. These consoles generate high-resolution images that can be displayed on a monitor and can be permanently stored on the system or another medium. Our consoles are mobile, proprietary and high speed electronic systems with different functionalities and sizes designed and manufactured to process the signals received only from our catheters and guide wires. Our market strategy includes offering devices to clinicians that are easy to use, reduce procedure times and provide a higher level of information. Our consoles are offered as stand-alone or customized and integrated versions and are smaller and lighter, provide enhanced functionality and are less expensive to manufacture than our prior console offerings. The current family of consoles includes:


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Stand-Alone Version: We believe this portable and mobile console is the lightest product on the market and has a simple user interface.

Integrated Version: This console is made up of components that can be customized to each cath lab’s specifications and integrated into virtually any cath lab while retaining full functionality. When the integrated version is integrated into the cath lab, it works seamlessly with the workflow of the cath lab in terms of acquiring and archiving patient images and data.
Both platforms support digital and rotational IVUS, FFR and our ChromaFlo and VH® IVUS functionality. Most recent versions of our consoles are intended to support, or can be upgraded to support, our planned future offerings.
Our IVUS Products
Catheters. Our single-use disposable catheters operate and interface solely with our family of consoles. We are the only company that offers both digital and rotational catheters. We believe this allows us to meet the needs of a greater number of physicians than our competitors. Our IVUS catheters vary in their principal uses, frequencies, shaft sizes, shaft lengths, guide wire compatibility and distal tip lengths. These differences allow for the use of different catheters in various portions of the vascular system.
We launched our latest generation digital catheter, the Eagle Eye Platinum Digital IVUS Catheter, commercially in May 2010. In September 2012, we introduced a new, short tip version of the Eagle Eye Platinum IVUS catheter that enables clinicians to get closer to a chronic total occlusion. We now also offer three IVUS catheters that are optimized for use in peripheral vessels. During 2014, we expect to obtain clearance from the U.S. Food and Drug Administration, or FDA, for and begin commercial sales of our FACT catheter, which is designed to provide a higher level of ultrasound resolution imaging than is available with current IVUS ultrasound catheters.
Additional Functionality. Our IVUS products incorporate key features that add valuable clinical functionality addressing a number of the historical limitations of conventional IVUS. We intend to develop additional functionality in the future. Currently, we offer:
ChromaFlo. Angiography alone does not always identify malapposed stents because the contrast injection that makes the lumen visible on x-ray can flow inside the stent, and in between the stent and vessel wall. When this occurs, the stent struts are too small to compete with the dark lumen of the x-ray, leaving the two dimensional image inconclusive or misleading. Our ChromaFlo stent apposition analysis technology uses sequential IVUS frames to differentiate circulating blood from stationary or anchored tissue. ChromaFlo can be particularly important when assessing stent placement as the detailed cross-sectional image clearly identifies moving blood inside and outside of the stent lumen, prompting physicians in many cases to expand the stent until all of the blood appears inside of the stent lumen. ChromaFlo can also help with the identification of luminal structures such as lumen border, bifurcations, dissections, and thrombus.
SyncVision. In November 2012, we acquired Sync-Rx Ltd, or Sync-Rx, an Israel-based company that develops advanced software applications designed to optimize and facilitate trans-catheter cardiovascular interventions using automated online image processing. We believe that the SyncVision technology will provide us with a platform on which to build a range of advanced software features that will aid clinical decision-making by providing angiography and intra-body image enhancement, measurement and non-invasive imaging and intravascular co-registration capabilities, and create future opportunities in physiology and peripheral therapy guidance.
Our FFR Products
Our FFR products consist of pressure and flow consoles and single-procedure disposable pressure and flow guide wires. We believe we are the only company that offers a full line of pressure and flow guide wires as well as a guide wire that can measure both pressure and flow. In addition, our FFR products are integrated with our multi-modality consoles. We have a strong track record of innovation in the development of pressure and flow guide wires and in 2013 we launched Verrata-our fifth new pressure guide wire in five years-that is designed to be more durable and faster and easier to use. In addition, we believe we are the only company to have developed iFR functionality, which is an FFR technology that does not require the administration of adenosine, used to widen blood vessels prior to the procedure. As a result, by enabling cardiologists to perform FFR without adenosine, iFR functionality has the potential to expand the patient population that could be diagnosed using FFR, and reduce the costs and time associated with its use. During 2013, we launched our iFR product in Europe and Japan, and filed for regulatory approval in the U.S.
We believe that favorable trial data relating to the measurement of FFR in addition to angiography will lead to further adoption of FFR technology by clinicians. In September 2009, published findings from the Fractional Flow Reserve versus

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Angiography for Multivessel Evaluation, or FAME, study demonstrated that patients in the study with multi-vessel coronary artery disease who were treated by FFR guidance had a 34% reduction in death and myocardial infarction (heart attack) compared to angiographic guidance alone. In August 2012, the results of the Fractional Flow Reserve-Guided PCI vs. Medical Therapy in Stable Coronary Disease, or FAME 2, study were published in the New England Journal of Medicine. FAME 2 showed that patients receiving PCI with proven ischemia (restriction of blood flow) by FFR had 66% fewer primary endpoint events including death, myocardial infarction and urgent revascularizations (e.g. coronary bypass) than those patients treated with optimal medical therapy alone. We believe these findings will continue to drive the growth and adoption of our disposable FFR wire products.
Product Expansion
We have recently introduced or have under development a number of products designed to leverage our existing platform technology that we believe will expand our presence in interventional medicine and related markets. Our product pipeline includes:
Crux VCF System
In December 2012, we acquired Crux Biomedical, Inc., or Crux, a private company developing a number of products designed to capture emboli (blood vessel package) and other debris through the vasculature. These include the Crux VCF System, featuring the Crux IVC filter, a retrievable filter intended to prevent recurrent pulmonary embolism (blockage of main artery of the lung). The Crux VCF System received a CE Mark in December 2011 and 510(k) clearance in July 2012. We launched the Crux VCF System in 2013 and also received 510(k) clearance for our Crux Snare Retrieval Set in January 2014. We believe the Crux IVC filter product can add significant clinical and economical value to our customers and patients.
Pioneer Plus Re-Entry Catheter

During 2013, we acquired the Pioneer Plus Re-Entry Catheter designed to enable the crossing of sub-total, total and chronic total occlusions within the peripheral vasculature. Volcano’s IVUS technology is used to direct the guidewire past stenotic lesions prior to additional interventions. We believe we can significantly expand the market for the Pioneer device in both the U.S. and international markets.
Sales, Marketing and Distribution
We sell consoles and disposables through our own direct sales force and distributors. In addition, we sell our consoles through our supply and distribution agreements with third parties. Our strategy is to leverage our installed base of consoles to drive recurring sales of our proprietary disposables. We provide training and clinical support to users of our products to increase their familiarity with product features and benefits, thereby increasing usage.
We have direct sales capability in the U.S., certain parts of Europe, Japan and South Africa. We intend to continue to increase our direct sales personnel over time. At December 31, 2013, we had over 320 direct sales and support professionals, including 181 in the U.S., 80 in Japan, 59 in Europe and the remaining in other geographies. In addition, we have numerous distributor relationships in Europe, Canada, Asia and Latin America. In the fourth quarter of 2013, we reorganized our sales force in order to provide us a greater presence within our key markets and enable us to dedicate additional resources to the IVUS peripheral market.
All of our business in Japan is served by the Company’s direct sales force and we currently support our Japanese customers through our Tokyo-based subsidiary, Volcano Japan Co., Ltd., or Volcano Japan. In addition, we distribute third party products in the coronary and peripheral markets through our direct sales channel in Japan. In Europe, we distribute our IVUS and FFR products through our subsidiary, Volcano Europe, B.V.B.A., or Volcano Europe. We sell our products directly to customers in certain European markets and utilize distributors in other geographic markets.
We have marketing agreements with leading healthcare company partners or their affiliates, including Medtronic, General Electric Company, Siemens AG, and Philips Medical Systems Nederland B.V. These agreements allow us to coordinate our marketing efforts with our strategic partners while still dealing directly with the customer.
At December 31, 2013, our global marketing team was comprised of 57 individuals, covering product management, corporate communications and programs, clinical support, and education and training. We devote significant resources to training and educating physicians in the use and benefits of our products. We also promote our products through medical society meetings attended by interventionists.

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Our relationships with physician thought leaders in interventional cardiology are an important component of our selling and marketing efforts. These relationships are typically built around research collaborations that enable us to better understand and articulate the most useful features and benefits of our products, and to develop new solutions to challenges in PCI medicine.
Financial Information About Geographic Areas
The following table sets forth our revenues by geography expressed as dollar amounts (in thousands):
 
 
 
Years Ended December 31,
 
Percentage Change (2)
 
 
2013
 
2012
 
2011
 
2012 to 2013
 
2011 to 2012
Revenues (1):
 
 
 
 
 
 
 
 
 
 
United States
 
$
189,748

 
$
177,992

 
$
157,412

 
6.6
 %
 
13.1
 %
Japan
 
109,492

 
123,558

 
105,892

 
(11.4
)
 
16.7

Europe, the Middle East and Africa
 
71,018

 
57,913

 
60,249

 
22.6

 
(3.9
)
Rest of world
 
23,420

 
22,403

 
19,993

 
4.5

 
12.1

 
 
$
393,678

 
$
381,866

 
$
343,546

 
3.1
 %
 
11.2
 %
(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.
(2)
For a year-over-year comparison analysis, refer to "Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations" in this Annual Report on Form 10-K.
At December 31, 2013, approximately 49% of our long-lived assets, excluding financial assets, were located in the U.S., approximately 39% were located in Costa Rica, approximately 8% were located in Japan, and approximately 4% were located elsewhere.
At December 31, 2012, approximately 42% of our long-lived assets, excluding financial assets, were located in the U.S., approximately 42% were located in Costa Rica, approximately 12% were located in Japan, and approximately 4% were located elsewhere.
At December 31, 2011, approximately 45% of our long-lived assets, excluding financial assets, were located in the U.S., approximately 30% were located in Costa Rica, approximately 21% were located in Japan and approximately 4% were located elsewhere.
Our international operations expose us and our representatives, agents, and distributors to risks inherent in operating in foreign jurisdictions, including the risks described in “Risk Factors—The risks inherent in our international operations may adversely impact our revenues, results of operations and financial condition.”
Competition
We compete primarily on the basis of our ability to assist in the diagnosis and treatment of vascular diseases safely and effectively, with ease and predictability of product use, adequate third-party reimbursement, brand name recognition and cost. We believe that we compete favorably with respect to these factors, although there can be no assurance that we will be able to continue to do so in the future or that new products that perform better than those we offer will not be introduced. We believe that our continued success depends on our ability to:
innovate and maintain scientifically advanced technology;
apply our technology across products and markets;
successfully market our products;
develop proprietary products;
successfully conduct clinical studies that expand our markets;
obtain and maintain patent protection for our products;
secure and preserve regulatory approvals;
achieve manufacturing efficiencies;

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attract and retain skilled personnel; and
successfully add complementary offerings and technology through acquisitions, licensing agreements and strategic partnerships.
Our primary imaging competitors globally are Boston Scientific, Inc., or Boston Scientific, with its IVUS offering and St. Jude Medical, Inc., or St. Jude with its OCT offering. In Japan, we also compete with Terumo Corporation, which offers both IVUS and OCT. In the FFR market, our primary competitor is St. Jude. Because of the size of the vascular market opportunities, competitors and potential competitors have dedicated and will continue to dedicate significant resources to aggressively promote their products. New product developments that could compete with us more effectively are likely because the vascular disease market is characterized by extensive research efforts and technological progress. Competitors may develop technologies and products that are safer, more effective, easier to use or less expensive than ours.
We have encountered and expect to continue to encounter potential physician customers who, due to existing relationships with our competitors, are committed to or prefer the products offered by these competitors.
Through the Axsun subsidiary we compete on the basis of leading technology, high quality and the enhanced productivity that our products offer to customers in a variety of industries, including telecommunications, pharmaceutical manufacturing, high-speed industrial process control, chemical and petrochemical processing, medical diagnostics, and scientific discovery. Products developed by competitors based on lower performance tunable filter technology could compete on the basis of lower cost. In addition, customers may build similar functionality directly into their products. Our primary competitors in the telecommunications market include Optoplex Corporation, II-VI Incorporated and BaySpec, Inc.
We expect that competitive pressures may result in price reductions and reduced margins over time for our products. Our products may be rendered obsolete or uneconomical by technological advances developed by one or more of our competitors.
Additional information regarding the risks associated with our competitive position and environment is described in “Risk Factors—Risks Related to Our Business and Industry.”
Intellectual Property
We believe that in order to maintain a competitive advantage in the marketplace, we must develop and maintain the proprietary aspects of our technologies. We rely on a combination of patent, trademark, trade secret, copyright and other intellectual property rights and measures to aggressively protect our intellectual property.
We require our employees and consultants to execute confidentiality agreements in connection with their employment or consulting relationships with us. We also require our employees and consultants who work on our products to agree to disclose and assign to us all inventions conceived during the term of their employment, while using our property or which relate to our business. Despite measures taken to protect our intellectual property, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, our competitors may independently develop similar technologies.
The medical device industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. As the number of entrants into our market increases, the risk of an infringement claim against us grows. While we attempt to ensure that our products and methods do not infringe other parties’ patents and proprietary rights, our competitors may assert that our products, and the methods we employ, are covered by patents held by them. In addition, our competitors may assert that future products and methods we may employ infringe their patents. If third parties claim that we infringe upon their intellectual property rights, we may incur liabilities and costs and may have to redesign or discontinue selling the affected product. For example, in July 2010, St. Jude sued us for patent infringement alleging products that have been on the market for more than ten years infringe upon St. Jude’s patents. Additional information regarding our litigation with St. Jude is provided in Note 4 “Commitments and Contingencies – Litigation” to our consolidated financial statements and risks related to our intellectual property rights are described in “Risk Factors—Risks Related to Our Intellectual Property and Litigation.”
Patents and Trademarks
We continue to expand and protect our intellectual property position. At December 31, 2013, we had a broad portfolio of over 546 owned or licensed U.S. and international patents and over 550 pending applications for owned or licensed patents. We intend to continue to expand our intellectual property position to protect the design and use of our products, principally in the areas of IVUS, FFR, peripheral imaging and image guided therapies for the diagnosis and guidance of treatment of vascular heart disease. We continue to invest in internal research and development of concepts within our current markets and within other potential future markets. This enables us to continue to build our patent portfolio in areas of company interest.

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Additionally, we utilize trademarks, trade names or logos in conjunction with the sale of our products. We currently have registered and common law trademarks in the U.S. and elsewhere in the world including, but not limited to, Aim®, Axsun®, Bi-Trieval, Centriq, ChromaFlo®, ComboMap®, ComboWire®, Core, Crux®, Crux Biomedical®, Define, Eagle Eye®, ETNA, FACT, FloMap®, FloWire®, Ginko, GlyDx®, Hi-Q, iFR, In-Line Digital®, Instant Wave-Free Ratio, Intentio, Octave, pcFM®, Precision Guided Therapy, PreView, PrimeWire®, PrimeWire Prestige®, ReFlow, Revolution®, SlyDx, s5i®, SmartMap®, SpinVision®, Sync-Rx, Trak Back®, Valet®, Verrata, VH®, VIBE®, Virtual Histology®, Visions®, Volcano®, Wavewire®, Xtract® and Zuum.
Research and Development
Our research efforts are directed towards the development of new products and technologies that expand our existing platform of capabilities and applications in support of PCI and endovascular procedures. At December 31, 2013, our research and development staff consisted of 178 full-time engineers and technicians. We have research and development staff in Rancho Cordova, California; San Diego, California; Billerica, Massachusetts; and Netanya, Israel. Our research and development staff is focused on the development of new multi-modality systems and related software, FFR consoles and guide wires, image-guided therapy systems and additional clinical applications that support our core business objectives.
Our product development process incorporates teams organized around each of our core technologies, with each team having representatives from research and development, marketing, regulatory, quality, clinical affairs and manufacturing. Our team sets development priorities based on communicated customer needs. The feedback received from beta testing is incorporated into successive design iterations until a new product is ready for release.
    
Our clinical studies are generally post-marketing studies using FDA-cleared and/or CE-marked products intended to provide data regarding diagnostic effectiveness and disease treatment outcomes, as well as the potential value of our products in providing therapy in markets and indications such as stent placement and optimization, plaque assessment and therapy guidance in the coronary and carotid arteries.
Our research and development expenses were $69.2 million, $55.5 million, and $53.1 million in 2013, 2012 and 2011, respectively. These totals include expenses related to research and development, clinical and regulatory affairs.
During 2013, we announced a strategic reprioritization initiative that included the discontinuation of development programs for our Forward-Looking IVUS, Forward-Looking Intra-Cardiac Echo and OCT intravascular programs.
Manufacturing
Our manufacturing facilities are located in Coyol, Costa Rica, and Rancho Cordova, California. In Costa Rica we manufacture IVUS catheters and FFR guide wires. In California, we produce multi-modality consoles, FFR consoles, IVUS catheters and FFR guide wires. We are in the process of transitioning all of our disposable manufacturing activities to our Costa Rica facility. In addition, we have a manufacturing facility in Billerica, Massachusetts that produces our optical monitors, laser and non-laser light sources, and optical engines used in OCT imaging systems as well as micro-optical spectrometers and optical channel monitors.
Our console manufacturing strategy is to use third-party manufacturing partners to produce circuit boards and mechanical sub-assemblies. We perform incoming inspection, final assembly and product testing to assure quality control. Our manufacturing strategy for our single-procedure disposable products is to use third-party manufacturing partners for certain proprietary components used in the final assembly. We perform incoming inspection on these components, assemble them into finished devices and test the final product to assure quality control. A portion of the scanner and sensor manufacturing is performed at third party contractors’ facilities using automated assembly processes and equipment. We are dependent on these third parties for day-to-day control and protection of their systems. We conduct the remaining process operations including final testing on the scanners and sensors at our Rancho Cordova facility. We aim to continuously improve our manufacturing processes to reduce costs and improve margins. We believe that by moving to PC-based consoles and improving our manufacturing processes through broad adoption of lean principles, selective use of automation and continuous design enhancements, we will be able to continue to reduce the cost to manufacture our consoles and single-procedure disposable products.
We manufacture our products in accordance with FDA required global regulations. We believe we are in material compliance with the U.S., European, Japanese, and Costa Rican regulations. The FDA and the European Union Notified Body have both inspected our manufacturing facilities in Rancho Cordova during the last 20 months. The European Union Notified Body inspected our manufacturing facilities in Costa Rica in 2012. The control systems for our optical and laser products are certified under ISO 9001:2008.

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Government Regulation
Our medical device products are subject to extensive and rigorous regulation by the FDA, as well as other federal and state regulatory bodies in the U.S. and comparable authorities in other countries. We currently market our products in the U.S. under authorizations from the FDA, which are based on clearances of pre-market notification submissions, or 510(k), or approval of premarket approval applications, or PMA. If we seek to market new products, or to market new indications for our existing products, we will be required to obtain 510(k) clearance or PMA approval, as applicable. In 2011, the FDA recommended reforms to the 510(k) pre-market notification process. Although the FDA made some limited changes 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, additional reforms are likely. These reforms, when implemented, could impose additional regulatory requirements upon us which could delay our ability to obtain new clearances, increase the costs of compliance, or restrict our ability to maintain our current clearances.
FDA regulations govern the following activities that we perform, or that are performed on our behalf, to ensure that medical products distributed domestically or exported internationally are safe and effective for their intended uses:
product design, development and manufacture;
product safety, testing, labeling and storage;
clinical trials;
record keeping;
product marketing, sales and distribution; and
post-marketing safety surveillance, complaint handling, investigating reports of adverse events and malfunctions, reporting of serious injuries, including deaths, repairs, and recall of products.
Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may be preceded by notices of deficiencies or noncompliance via inspectional observations on form FDA-483, or 483s, general correspondence known as “Untitled Letters,” and more formal letters called “Warning Letters.” If we do not adequately and appropriately address the cited deficiencies or noncompliance, including the repair, replacement or recall of affected products if necessary, within a reasonable period of time, the FDA may take any one or more the following actions, which could adversely affect our business:
order a mandatory recall;
physically seize the affected products;
seek a court-ordered injunction and consent decree that could include, but may not be limited to, operating restrictions, additional government oversight of our operations, specific corrective and preventative actions, and partial suspension or total shutdown of production;
suspend review or refuse to clear pending 510(k) submissions or approvals pending for new products, new intended uses, or modifications to existing products;
after notice and an opportunity for a hearing, withdraw 510(k) clearances or PMA approvals that have already been granted;
impose civil monetary penalties; and
initiate criminal prosecution.
See “Risk Factors—Risks Related to Government Regulation.”
Employees
At December 31, 2013, we had over 1,800 full time employees. None of our employees are represented by a labor union and we believe our employee relations are good.
Seasonality
Our business is generally seasonal in nature and, historically, demand for our products has been the highest in the fourth quarter. Our working capital requirements vary from period to period depending on manufacturing volumes, the timing of deliveries and the payment cycles of our customers.
Corporate Information

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We were incorporated in the state of Delaware in January 2000. Our principal executive offices are located at 3721 Valley Centre Drive, Suite 500, San Diego, California, 92130. Our phone number is (800) 228-4728 and our website address is www.volcanocorp.com.
Available Information
Our corporate website is www.volcanocorp.com and our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission, or SEC. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding us, at www.sec.gov. These reports and other information concerning the company may also be accessed at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The contents of these websites are not incorporated into this filing. Further, our references to the URLs for these websites are intended to be inactive textual references only.
 
Item 1A.
Risk Factors
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 IVUS and 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 United States 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 (if any) 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 in the United States and other countries; 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 or maintain market acceptance among physicians, healthcare payors and the medical community due to factors such as:
the lack of perceived benefit from 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 benefit from 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;

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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 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 or continue to gain wide market acceptance, we may not be able to achieve our anticipated growth, revenues or profitability and our results of operations would suffer.
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 outside the United States will accept our products, services and business practices. Further, we purchase and 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 in connection with our international operations 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 in connection with our international operations 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 or otherwise exercising remedies (including by foreclosing on the applicable products sold) against defaulting counterparties 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 (see, for example, the discussion under “-Risks related to government regulation-We may be subject to federal, state and foreign healthcare fraud and abuse laws and regulations, and a finding of failure to comply with such laws and regulations could have a material adverse effect on our business.”);
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, President Obama's administration has announced 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 fewer PCI procedures. For example, recently the number of PCI procedures declined in the United States and Japan, in part due to concerns regarding the efficacy of therapeutic treatment options, the long-term efficacy of drug-eluting stents, economic

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constraints, reduced rates of restenosis 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 only achieved profitability in 2010, 2011 and 2012. We cannot assure you that we will achieve and sustain profitability in 2014 or in future periods.
We were formed in January 2000 and have been profitable, on a full-year basis, only in 2010, 2011 and 2012. 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, devote resources to our sales, marketing and research and development activities and satisfy our debt service obligations. If we are unable to increase our revenues or reduce our cost of revenues and our operating expenses, we may not achieve profitability in 2014 or in the future. 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 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, transitioning from distributor arrangements to a direct sales force in different markets, satisfying 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 $485.0 million in aggregate principal amount of indebtedness under our 2.875% Convertible Senior Notes due 2015, or the 2015 Notes ($25.0 million), and our 1.75% Convertible Notes due 2017, or the 2017 Notes ($460.0 million). Our ability to make payments on, and to refinance, our indebtedness, including the 2015 Notes and the 2017 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 2015 Notes and the 2017 Notes or on their maturity or in connection with a transaction involving us that constitutes a fundamental change under the indenture governing the 2015 Notes or the 2017 Notes, or to fund our liquidity needs, we may be forced to refinance all or a portion of our indebtedness, including the 2015 Notes and 2017 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 2015 Notes or the 2017 Notes, the holders and/or the trustee under the indenture governing the 2015 Notes or the 2017 Notes, as applicable, may accelerate our payment obligations under the applicable notes, which could have a material adverse effect on our business, financial condition and results of operations. Any such acceleration may also trigger an event of default under the other series of notes. 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 indentures governing the 2015 Notes and the 2017 Notes, the risks related to our business and our ability to service our indebtedness would increase.

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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;
successfully market our products;
develop proprietary products;
successfully conduct clinical studies that expand our markets;
obtain and maintain patent protection for our products;
secure and preserve regulatory approvals;
achieve manufacturing efficiencies;
attract and retain skilled personnel; and
successfully add complementary offerings and technology through acquisitions, licensing agreements and strategic partnerships.
With respect to our IVUS products, our primary competitor is Boston Scientific, Inc. 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.
We have encountered and expect to continue to encounter potential physician customers who, due to existing relationships with our competitors, are committed to or prefer the products offered by these competitors.
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.

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We also develop and manufacture laser and non-laser light sources, optical engines used in OCT imaging systems as well as micro-optical spectrometers and optical channel monitors with applications in telecommunications, pharmaceutical manufacturing, high-speed industrial process control, and chemical and petrochemical processing, medical diagnostics, and scientific discovery. 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 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.
Delays or failures 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 and failures 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 has in the past resulted, and may again in the future result, in longer developmental timelines than we initially anticipated or our discontinuing our development or commercialization efforts with respect to the acquired products and technologies. Any delays in our product launches or our discontinuing our development or commercialization efforts with respect to any product candidates or products 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

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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 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.
In connection with our recent acquisitions we may experience difficulty with integration, and if we choose to acquire any 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 recently acquired Sync-Rx, Ltd., or Sync-Rx, and Crux Biomedical, Inc., or Crux, as well as the Pioneer Plus re-entry catheter product line, or Pioneer, from Medtronic, Inc. We can provide no assurance that the expected benefits of the Sync-Rx, Crux or Pioneer acquisitions will be realized. Furthermore, we have agreed in the merger agreement with Crux that, in the event that we have not achieved the applicable commercial launch for one of the Crux products by June 30, 2016 (which date may be extended upon a specified payment by us to June 30, 2017), we will license back to the former Crux stockholders certain intellectual property rights relating to that product, which could adversely affect our business. We do not know if we will identify or complete any

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additional acquisitions, or whether we will be able to successfully integrate any acquired business, product or technology or retain key employees, including in connection with our acquisitions of Sync-Rx and Crux, or Pioneer. 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 United States 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 filed against us in federal district court on March 27, 2012 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, including write-offs relating to goodwill and other intangible assets, 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 in the development of 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, or PROSPECT, 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 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.
Even though we engage in foreign currency hedging arrangements for certain of our foreign currency exchange exposures, foreign currency fluctuations may adversely affect our revenues and earnings. During the year ended December 31, 2013, 26.8% and 17.8% of our revenues were denominated in Japanese yen and euro, respectively, and 10.5% and 9.3% of our operating expenses were denominated in yen and euro, respectively. We enter into derivative financial instruments, principally forward contracts, to manage a portion of the foreign currency risk related to transactions in non-functional currencies. Commencing in April 2013, we initiated a hedging program that broadened our use of foreign currency forward contracts to manage portions of our foreign currency risk related to certain forecasted intercompany inventory transactions with our foreign subsidiaries and expand the application of forward contracts to additional non-functional currency transactions worldwide. 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 yen and the euro, 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 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 United States, Japan, Europe, the Middle East and Africa, where we have generated most of our revenues. In the United States, the recovery from the recent recession has been below historic averages and the unemployment rate is expected to remain high for some time. 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. 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

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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 in the U.S. and in sales of our non-medical products to telecommunications and industrial companies during 2013 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 or otherwise exercise remedies (including by foreclosing on the applicable products sold) against a defaulting customer or distributor, adversely affect our ability to 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 a portion of 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.
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, field corrective actions, 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 6 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 sole source suppliers for these and other materials, components, products and processing 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 securing 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.

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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; and
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 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 may encounter a number of challenges relating to the management and operation of our newly constructed Costa Rica 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.
In 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. Prior to 2012, we had never operated manufacturing facilities outside the United States, and cannot assure you that we will be able to successfully operate these facilities in an efficient or profitable manner. In addition, we are continuing to transfer our manufacturing processes, technology and know-how to our Costa Rica facilities. If we are unable to 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.
During 2012 we received regulatory approval to ship product from our Costa Rica facility to the United States, Japan and certain countries in Europe. We will need to obtain a number of additional regulatory approvals prior, and subsequent, to shipping products from this facility to other geographies. Our ability to obtain these 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.
The expansion of the manufacturing facilities has and will continue to increase our fixed costs. 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 operations 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 operations of our 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

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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 have 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 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 2015 Notes and the 2017 Notes and to make payments of principal upon conversion or maturity. We may also be required to purchase the 2015 Notes or the 2017 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 or their affiliates, including Medtronic, Inc., The Cleveland Clinic Foundation, Siemens AG, Philips Medical Systems Nederland B.V. and General Electric Company. 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.

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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 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 offerings of the 2015 Notes and the 2017 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 2015 Notes or the 2017 Notes are triggered, we could be required under applicable accounting standards to reclassify all or a portion of the outstanding principal of the 2015 Notes or the 2017 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. In addition, with respect to any entity that we have acquired or may in the future acquire, the ability of those entities to use net operating loss carryforwards, if any, to reduce future income tax obligations may be limited or reduced due to changes in ownership of such entities occurring prior to or as a result of our acquisition of such entities.
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 recently completed our company-wide implementation of a new enterprise resource planning, or ERP, system to further enhance operating efficiencies and provide more effective management of our business operations. 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.

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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.
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. 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. In addition, our devices may be targeted and/or adversely affected by cybersecurity attacks, including malware. Although we have implemented various safeguards to prevent unauthorized access or modification to our products, we cannot assure you that these safeguards are or will continue to be effective. 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. Furthermore, as a result of cybersecurity vulnerabilities and incidents that could directly impact medical devices, in June 2013 the FDA issued draft guidance which may result in additional regulation in the medical device industry, which could, among other things, impact our ability to obtain regulatory approval of new products.
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 employment contracts or similar agreements with R. Scott Huennekens and our Chief Financial Officer, John T. Dahldorf, 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

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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.
Risks Related to Government Regulation
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 Select Market rules, are creating uncertainty for companies such as ours. As one example, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC has promulgated rules regarding disclosure of the presence in a company's products of certain metals, known as “conflict minerals,” which are metals mined from the Democratic Republic of the Congo and adjoining countries, as well as procedures regarding a manufacturer's efforts to identify the sourcing of those minerals from this region. Complying with these rules will require investigative efforts, which will cause us to incur associated costs, and could adversely affect the sourcing, supply, and pricing of materials used in our products, or result in process or manufacturing modifications, all of which could adversely affect our results of operations.
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.
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. For example, the FDA has been reviewing its 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. FDA has also issued, and may in the future issue, 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. Such changes could adversely affect our business.
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

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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 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 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.
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 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 cause serious adverse health consequences or death. Manufacturers may, under their own initiative, recall a product if any

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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. PPACA includes, among other things, the following measures:
a deductible 2.3% excise tax, with limited exceptions, on the sale of certain medical devices by the manufacturer of the device;
a Patient-Centered Outcomes Research Institute intended to oversee, identify priorities in and conduct comparative clinical effectiveness research, along with funding for such research;
requirements to report certain financial arrangements with physicians and teaching hospitals, as defined in the PPACA and its implementing regulations, including reporting any payment or “transfer of value” made or distributed to teaching hospitals, prescribers, and other healthcare providers and reporting any ownership and investment interests held by physicians and their immediate family members in applicable manufacturers during the preceding calendar year, with data collection required beginning August 1, 2013 and reporting to the U.S. Department of Health and Human Services required by March 31, 2014 and the 90th day of each subsequent calendar year, and with disclosure of such information by the U.S. Department of Health and Human Services on a publicly available website beginning by September 2014; and
other measures designed to control Medicare spending.
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, sales of certain of our products became subject to the 2.3% excise tax beginning in 2013. It is unclear whether and to what extent, if at all, other anticipated developments resulting from the federal healthcare reform legislation, such as an increase in the number of people with health insurance and an increased focus on preventive medicine, may provide us additional revenue to offset this excise tax. If additional revenue does not materialize, or if our efforts to offset

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the excise tax through spending cuts or other actions are unsuccessful, the increased tax burden would adversely affect our financial performance, which in turn could cause the price of our stock to decline. In addition, a number of foreign governments are also considering or have adopted proposals to reform their healthcare systems. Because a significant portion of our revenues from our operations is derived internationally, if significant reforms are made to the healthcare systems in other jurisdictions, our sales and results of operations may be materially and adversely impacted.
We intend to market our products in a number of international markets. Although certain of our IVUS products have been approved for commercialization in Japan and in the EEA, in order to market our products in other foreign jurisdictions, we have had to, and will need to in the future, obtain separate regulatory approvals. The approval procedure varies among jurisdictions and can involve substantial additional testing. Approval or clearance of a device by the FDA does not ensure approval by regulatory authorities in other jurisdictions, and approval by one foreign regulatory authority does not ensure marketing authorization by regulatory authorities in other foreign jurisdictions or by the FDA. The foreign regulatory approval process may include all of the risks associated with obtaining FDA approval in addition to other risks. In addition, the time required to obtain foreign approval may differ from that required to obtain FDA approval, and we may not obtain foreign regulatory approvals on a timely basis, if at all. We may not be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products in any foreign market other than in the EEA and Japan.
We may be subject to federal, state and foreign healthcare fraud and abuse laws and regulations, and a finding of failure to comply with such laws and regulations could have a material adverse effect on our business.
Our operations may be directly or indirectly affected by various broad federal, state or foreign healthcare fraud and abuse laws. In particular, the federal healthcare program Anti-Kickback Statute prohibits any person from knowingly and willfully offering, paying, soliciting or receiving remuneration, directly or indirectly, in return for or to induce the referring, ordering, leasing, purchasing or arranging for or recommending the ordering, purchasing or leasing of an item or service, for which payment may be made under federal healthcare programs, such as the Medicare and Medicaid programs. This statute has been interpreted to apply to arrangements between device manufacturers on one hand and prescribers and purchasers on the other. For example, the government has sought to apply the Anti-Kickback Statute to device manufacturers' financial relationships with physician consultants. Among other theories, the government has alleged that such relationships are payments to induce the consultants to arrange for or recommend the ordering, purchasing or leasing of the manufacturers' products by the hospitals, medical institutions and other entities with whom they are affiliated. Although there are a number of statutory exemptions and regulatory safe harbors protecting certain common activities from prosecution or other regulatory sanctions, the exemptions and safe harbors are drawn narrowly, and arrangements that involve remuneration that could induce prescribing, purchases, or recommendations may be subject to government scrutiny if they do not qualify for an exemption or a safe harbor. We are also subject to the federal Health Insurance Portability and Accountability Act of 1996 (HIPAA), which created federal criminal laws that prohibit executing a scheme to defraud any health care benefit program or making false statements relating to health care matters, and federal “sunshine” requirements to report certain financial arrangements with physicians and teaching hospitals, as defined in the PPACA and its implementing regulations, including reporting any payment or “transfer of value” made or distributed to teaching hospitals, prescribers, and other healthcare providers and reporting any ownership and investment interests held by physicians and their immediate family members in applicable manufacturers.
Also, the federal False Claims Act prohibits persons from knowingly filing, or causing to be filed, a false claim to, or the knowing use of false statements to obtain payment from the federal government. Suits filed under the False Claims Act, known as “qui tam” actions, can be brought by any individual on behalf of the government and such individuals, commonly known as “whistleblowers,” may share in any amounts paid by the entity to the government in fines or settlement. When an entity is determined to have violated the False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties for each separate false claim. Various states have also enacted laws modeled after the federal False Claims Act.
In addition, several states have adopted laws similar to each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third-party payor, including commercial insurers as well as laws that restrict our marketing activities with physicians, and require us to report consulting and other payments to physicians. Some states, such as California, Connecticut, Massachusetts and Nevada, mandate implementation of commercial compliance programs to ensure compliance with these laws.
The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Moreover, recent health care reform legislation has strengthened these laws. For example, the recently enacted PPACA, among other things, amends the intent requirement of the federal anti-kickback and criminal health care fraud statutes; a person or entity no longer needs to have actual knowledge of this statute or specific intent to violate it. In addition, the PPACA provides that a claim including items or services resulting from a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the False Claims Act. Further, we expect there will continue to be federal and state laws and/or

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regulations, proposed and implemented, that could impact our operations and business. The extent to which future legislation or regulations, if any, relating to health care fraud abuse laws and/or enforcement, may be enacted or what effect such legislation or regulation would have on our business remains uncertain. If our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from participating in governmental health care programs, and the curtailment or restructuring of our operations, any of which could adversely affect our ability to operate our business and our financial results. We also are subject to foreign fraud and abuse laws, which vary by country. For instance, in the European Union, legislation on inducements offered to physicians and other healthcare workers or hospitals differ from country to country. Breach of the laws relating to such inducements may expose us to the imposition of criminal sanctions. It may also harm our reputation, which could in turn affect sales.
In November 2012, we became aware through newspaper reports in the Italian media that a former employee of ours was under criminal investigation for an alleged violation of Italian anti-bribery laws. The Italian public prosecutor is alleging that the approximately 5,000 euro that we paid to an Italian state-employed physician for conducting a training session was paid in an effort to influence the outcome of a clinical trial. Although we dispute these allegations, if we are unsuccessful in our defense, we may be faced with fines, penalties and a debarment from creating new contractual relationships with hospitals that are part of the Italian national health system. As a result, we cannot assure you that the outcome of this investigation would not have material adverse effects to our business in Italy, or harm our reputation in Europe generally, which could negatively affect our sales.
If our customers are unable to obtain coverage of or sufficient reimbursement for procedures performed with our products, it is unlikely that our products will be widely used.
Successful sales of our products depend on the availability of coverage and adequate reimbursement from third-party payors. Healthcare providers that purchase medical devices for treatment of their patients generally rely on third-party payors to reimburse all or part of the costs and fees associated with the procedures performed with these devices. Both public and private insurance coverage and reimbursement plans are central to new product acceptance. Customers are unlikely to use our products if they do not receive reimbursement adequate to cover the cost of our products and related procedures.
To the extent we sell our products internationally, market acceptance may depend, in part, upon the availability of coverage and reimbursement within prevailing healthcare payment systems. Coverage, reimbursement, and healthcare payment systems in international markets vary significantly by country, and by region in some countries, and include both government-sponsored healthcare and private insurance. We may not obtain international reimbursement approvals in a timely manner, if at all. Our failure to receive international coverage or reimbursement approvals would negatively impact market acceptance of our products in the international markets in which those approvals are sought.
To date, our products have generally been covered as part of procedures for which reimbursement has been available. However, in the United States, as well as in foreign countries, government-funded programs (such as Medicare and Medicaid) or private insurance programs, together commonly known as third-party payors, pay the cost of a significant portion of a patient's medical expenses. Coverage of and reimbursement for medical technology can differ significantly from payor to payor.
All third-party coverage and reimbursement programs, whether government funded or insured commercially, whether inside the United States or outside, are developing increasingly sophisticated methods of controlling healthcare costs. Such cost-containment programs adopted by third-party payors, including legislative and regulatory changes to coverage and reimbursement policies, could potentially limit the amount which healthcare providers are willing to pay for medical devices, or related testing, which could adversely impact our business. The Centers for Medicare & Medicaid Services has announced various efforts to reduce costs in connection with the Medicare program that could have spillover into our business, including for example: (1) a three-year demonstration project that began September 2012, to allow Medicare recovery auditors to audit Medicare payments for procedures prior to Medicare making payment for the procedure, versus following Medicare payment for the procedure as has historically been Medicare's process, and (2) a proposed process to adjust provider payments amounts (with adjustments beginning January 2016) for certain laboratory tests based on changes in technology (historically, the payment for such tests would not typically be adjusted except for annual inflationary and productivity adjustments).
We believe that future coverage of and reimbursement for our products may be subject to increased restrictions both in the U.S. and in international markets. For example, on August 2, 2011, President Obama signed the Budget Control Act of 2011, which imposed significant cuts in federal spending over the next decade. Such cuts in federal spending could impact entitlement programs such as Medicare and aid to states for Medicaid programs. Third-party reimbursement and coverage for our products may not be available or adequate in either the U.S. or international markets. Future legislation, regulations, coverage or reimbursement policies adopted by third-party payors may adversely affect the growth of the markets for our products, reduce the demand for our existing products or our products currently under development and limit our ability to sell our products on a profitable basis.

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We may be subject to health information privacy and security standards that include penalties for noncompliance.
The Health Insurance Portability and Accountability Act of 1996, or HIPAA, and its implementing regulations safeguard the privacy and security of individually-identifiable health information. Certain of our operations may be subject to these requirements. Penalties for noncompliance with these rules include both criminal and civil penalties. In addition, the Health Information Technology for Economic and Clinical Health Act, or HITECH Act, expanded federal health information privacy and security protections. Among other things, HITECH makes certain of HIPAA's privacy and security standards directly applicable to “business associates”-independent contractors or agents of covered entities that create, receive, maintain or transmit protected health information in connection with providing a service for or on behalf of a covered entity. HITECH also set forth new notification requirements for health data security breaches, increased the civil and criminal penalties that may be imposed against covered entities, business associates and possibly other persons, and gave state attorneys general new authority to enforce HIPAA and seek attorney's fees and costs associated with pursuing federal civil actions. While we do not believe we are a covered entity or a business associate under HIPAA, occasionally our field service representatives enter into “field service agreements” which obligate us to protect any protected health information that we may receive in the field in accordance with HIPAA and HITECH.
Compliance with environmental laws and regulations could be expensive, and failure to comply with these laws and regulations could subject us to significant liability.
We use hazardous materials in our research and development and manufacturing processes, including specifically the sterilization processes conducted at our Costa Rica facility. We are subject to foreign, federal, state and local regulations governing use, storage, handling and disposal of these materials and associated waste products. We are currently licensed to handle such materials, but there can be no assurance that we will be able to retain these licenses in the future or obtain licenses under new regulations if and when they are required by governing authorities. We cannot completely eliminate the risk of contamination, injury, or even death resulting from such hazardous materials, and we may incur liability as a result of any such contamination, injury or death. In the event of an accident, we could be held liable for damages or penalized with fines, and the liability could exceed our resources and any applicable insurance. We have also incurred and may continue to incur expenses related to compliance with environmental laws. Such future expenses or liability could have a significant negative impact on our business, financial condition and results of operations. Further, we cannot assure that the cost of compliance with these laws and regulations will not materially increase in the future. We may also incur expenses related to ensuring that our operations comply with environmental laws related to our operations, and those of prior owners or operators of our properties, at current or former manufacturing sites where operations have previously resulted in spills, discharges or other releases of hazardous substances into the environment. We could be held strictly liable under U.S. environmental laws for contamination of property that we currently or formerly owned or operated without regard to fault or whether our actions were in compliance with law at the time. Our liability could also increase if other responsible parties, including prior owners or operators of our facilities, fail to complete their clean-up obligations or satisfy indemnification obligations to us. Similarly, if we fail to ensure compliance with applicable environmental laws in foreign jurisdictions in which we operate, we may not be able to offer our products and may be subject to civil or criminal liabilities.
The use, misuse or off-label use of our products may result in injuries that could lead to product liability suits, which could be costly to our business.
Our currently marketed products have been cleared by the relevant regulatory authority in each jurisdiction where we market them. There may be increased risk of injury if physicians attempt to use our products in procedures outside of those indications cleared or approved for use, known as off-label use. Our sales force is trained according to company policy not to promote our products for off-label uses, and in our instructions for use in all markets we specify that our products are not intended for use outside of those indications cleared for use. However, we cannot prevent a physician from using our products for off-label applications. Our catheters and guide wires are intended to be single-procedure products. In spite of clear labeling and instructions against reuse, we are aware that certain physicians have elected to reuse our products. Reuse of our catheters and guide wires may increase the risk of product liability claims. Reuse may also subject the party reusing the product to regulatory authority inspection and enforcement action. Physicians may also misuse our product if they are not adequately trained, potentially leading to injury and an increased risk of product liability. If our products are defectively designed, manufactured or labeled, contain defective components or are misused, we may become subject to costly litigation by our customers or their patients. Product liability claims could divert management's attention from our core business, be expensive to defend and result in sizable damage awards against us.
  Risks Related to our Intellectual Property and Litigation
Our ability to protect our intellectual property and proprietary technology through patents and other means is uncertain.
Our success depends significantly on our ability to protect our intellectual property and proprietary technologies. Our policy is to obtain and protect our intellectual property rights. We rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, and nondisclosure, confidentiality and other contractual restrictions to protect our

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proprietary technology. However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. Our pending U.S. and foreign patent applications may not issue as patents or may not issue in a form that will be advantageous to us. Any patents we have obtained or will obtain may be challenged by re-examination, inter partes or other post-grant review, opposition or other administrative proceeding, or in litigation. Such challenges could result in a determination that the patent is invalid. Some of our older patents have expired or will expire in the near future. In addition, competitors may be able to design alternative methods or devices that avoid infringement of our patents. To the extent our intellectual property protection offers inadequate protection, or is found to be invalid, we are exposed to a greater risk of direct competition. If our intellectual property does not provide adequate protection against our competitors' products, our competitive position could be adversely affected, as could our business. Both the patent application process and the process of managing patent disputes can be time consuming and expensive. Furthermore, the laws of some foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States.
In addition to pursuing patents on our technology, we have taken steps to protect our intellectual property and proprietary technology by entering into confidentiality agreements and intellectual property assignment agreements with our employees, consultants, corporate partners and, when needed, our advisors. Such agreements may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements, and we may not be able to prevent such unauthorized disclosure. Monitoring unauthorized disclosure is difficult, and we do not know whether the steps we have taken to prevent such disclosure are, or will be, adequate.
 
In the event a competitor infringes upon our patent or other intellectual property rights, litigation to enforce our intellectual property rights or to defend our patents against challenge, even if successful, could be expensive and time consuming and could require significant time and attention from our management. We may not have sufficient resources to enforce our intellectual property rights or to defend our patents against challenges from others.
The medical device industry is characterized by patent and other intellectual property litigation, and we could become subject to litigation that could be costly, result in the diversion of our management's time and efforts, require us to pay damages or prevent us from selling our products.
The medical device industry is characterized by extensive litigation and interference and other administrative proceedings over patent and other intellectual property rights. Whether or not a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. Our competitors may assert that they own U.S. or foreign patents containing claims that cover our products, their components or the methods we employ in the manufacture or use of our products. For example, we are currently involved with St. Jude Medical in patent litigation regarding our FFR products and whether these products infringe a St. Jude Medical patent. Because patent applications can take many years to issue and in many instances at least 18 months to publish, there may be applications now pending of which we are unaware, which may later result in issued patents that contain claims that cover our products. There could also be existing patents, of which we are unaware, that contain claims that cover one or more components of our products. As the number of participants in our industry increases, the possibility of patent infringement claims against us also increases.
Any interference proceeding, litigation or other assertion of claims against us, including our current patent litigation with St. Jude Medical, may cause us to incur substantial costs, could place a significant strain on our financial resources, divert the attention of our management from our core business and harm our reputation. If the relevant patents asserted against us were upheld as valid and enforceable and were found to be infringed, we could be required to pay substantial damages and/or royalties and could be prevented from selling our products unless we could obtain a license or were able to redesign our products to avoid infringement. Any such license may not be available on reasonable terms, if at all. If we fail to obtain any required licenses or make any necessary changes to our products or technologies, we may be unable to make, use, sell or otherwise commercialize one or more of our products in the affected country. In addition, if we are found to infringe willfully, we could be required to pay treble damages and attorney fees, among other penalties.
We expect to enter new product fields in the future. Entering such additional fields may subject us to claims of infringement. Defending any infringement claims would be expensive and time consuming.
We are aware of certain third-party U.S. patents in fields that we are targeting for development. We do not have licenses to these patents nor do we believe that such licenses are required to develop, commercialize or sell our products in these areas. However, the owners of these patents may initiate a lawsuit alleging infringement of one or more of these or other patents. If they do, we may be required to incur substantial costs related to patent litigation, which could place a significant strain on our financial resources and divert the attention of management from our business and harm our reputation. Adverse determinations in such litigation could cause us to redesign or prevent us from manufacturing or selling our products in these areas, which would have an adverse effect on our business by limiting our ability to generate revenues through the sale of these products.
From time to time in the ordinary course of business, we receive letters from third parties advising us of third-party patents that may relate to our business. The letters do not explicitly seek any particular action or relief from us. Although these

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letters do not threaten legal action, these letters may be deemed to put us on notice that continued operation of our business might infringe intellectual property rights of third parties. We do not believe we are infringing any such third-party rights, and, other than the matters described in Note 4 "Commitments and Contingencies - Litigation" to our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K, we are unaware of any litigation or other proceedings having been commenced against us asserting such infringement. We cannot assure you that such litigation or other proceedings asserting infringement by us may not be commenced against us in the future.
Our rights to a worldwide license of certain IVUS patents owned or licensed by Boston Scientific may be challenged.
The marketing and sale of our current rotational IVUS catheters and pullback products depend on a license for IVUS-related patents owned or licensed by Boston Scientific. Boston Scientific was required to transfer the related intellectual property rights pursuant to a 1995 order of the Federal Trade Commission. We obtained rights to the license in 2003 through our former wholly-owned subsidiary, Pacific Rim Medical Ventures, which merged into us on December 30, 2004. In the event Boston Scientific disputes our rights to the license or seeks to terminate the license, we may be required to expend significant time and resources defending our rights. An adverse determination could cause us to redesign or prevent us from manufacturing or selling our rotational IVUS catheters and pullback products, which would have an adverse effect on our business. Additionally, in the event that the chain of title from the 1995 transfer of rights from Boston Scientific through the 2003 transfer to us is successfully challenged, we may have fewer rights to the technology than our business requires which will negatively impact our ability to continue our development of rotational IVUS catheters and pullback products or subject us to disputes with Boston Scientific or others with respect to the incorporation of this intellectual property into our products.
Our VH IVUS business depends on a license from The Cleveland Clinic Foundation, the loss of which would severely impact our business.
The marketing and sale of our VH IVUS functionality for IVUS depends on an exclusive license to patents owned by The Cleveland Clinic Foundation, the license to which we obtained in April 2002. We are aware that maintenance of the license depends upon certain provisions being met by us including payment of royalties, commercialization of the licensed technology and obtaining regulatory clearances or approvals. If The Cleveland Clinic Foundation were to claim that we committed a material breach or default of these provisions and we were not able to cure such breach or default, The Cleveland Clinic Foundation would have a right to terminate the agreement. The loss of the rights granted under the agreement could require us to redesign our VH IVUS functionality or prevent us from manufacturing or selling our IVUS products containing VH IVUS in countries covered by these patents. In addition, our exclusive license will become non-exclusive if we fail to obtain regulatory clearances or approvals to commercialize the licensed technology within a proscribed time period. The cost of redesigning or an inability to sell our VH IVUS products would have a negative impact on our ability to grow our business and achieve our expected revenues.
Risks Related to our Common Stock
We expect that the price of our common stock will fluctuate substantially.
The market price of our common stock could be subject to significant fluctuation. Factors that could cause volatility in the market price of our common stock include the following:
changes in earnings estimates, investors' perceptions, recommendations by securities analysts or our failure to achieve analysts' earnings estimates;
changes in foreign currency exchange rates;
quarterly variations in our or our competitors' results of operations;
changes in governmental regulations or in the status of our regulatory clearance or approvals;
changes in availability of third-party reimbursement in the United States or other countries;
the announcement of new products or product enhancements by us or our competitors or other developments involving our respective products;
the announcement of an acquisition or other business combination or strategic transaction;
possible sales of our common stock by investors who view the 2015 Notes and the 2017 Notes as a more attractive means of equity participation in us;
the conversion of some or all of the 2015 Notes or the 2017 Notes and any sales in the public market of shares of our common stock issued upon conversion of the 2015 Notes or the 2017 Notes;
hedging or arbitrage trading activity that may develop involving our common stock, including in connection with the convertible note hedge transactions and warrant transactions we entered into in connection with the offerings of our 2015 Notes and 2017 Notes, and arbitrage strategies employed or that may be employed by investors in our 2015 Notes and 2017 Notes;
announcements related to patents issued to us or our competitors;
the announcement of pending or threatened litigation and developments in litigation involving us;

32



sales of large blocks of our common stock, including sales by our executive officers and directors; and
general market and economic conditions and other factors unrelated to our operating performance or the operating performance of our competitors.
These factors may materially and adversely affect the market price of our common stock.
Additional equity issuances or a sale of a substantial number of shares of our common stock may cause the market price of our common stock to decline.
If our existing stockholders sell a substantial number of shares of our common stock or the public market perceives that existing stockholders might sell shares of our common stock, the market price of our common stock could decline. In addition, sales of a substantial number of shares of our common stock could make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate. Because we may need to raise additional capital in the future to continue to expand our business and develop new products, we may, among other things, conduct additional equity offerings. These future equity issuances, together with any additional shares of our common stock issued or issuable in connection with past or any future acquisitions, would result in further dilution to investors and could depress the market price of our common stock.
No prediction can be made regarding the number of shares of our common stock that may be issued or the effect that the future sales of shares of our common stock will have on the market price of our shares.
Our directors, officers and principal stockholders have significant voting power and may take actions that may not be in the best interests of our other stockholders.
As of December 31, 2013, our directors, officers and principal stockholders (those holding more than 5% of our common stock) collectively controlled a significant portion of our outstanding common stock. To the extent our directors, officers and principal stockholders continue to hold a significant portion of our outstanding common stock, these stockholders, if they act together, would be able to exert significant influence over the management and affairs of our company and most matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control, might adversely affect the market price of our common stock and may not be in the best interests of our other stockholders.
Anti-takeover provisions in our amended and restated certificate of incorporation and bylaws and other agreements and in Delaware law could discourage a takeover.
Our amended and restated certificate of incorporation and bylaws and Delaware law contain provisions that might enable our management to resist a takeover. These provisions include:
a classified board of directors;
advance notice requirements to stockholders for matters to be brought at stockholder meetings;
a supermajority stockholder vote requirement for amending certain provisions of our amended and restated certificate of incorporation and bylaws; and
the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer.
We are also subject to the provisions of Section 203 of the Delaware General Corporation Law that, in general, prohibit any business combination or merger with a beneficial owner of 15% or more of our common stock unless the holder's acquisition of our stock was approved in advance by our board of directors. These provisions might discourage, delay or prevent a change in control of our company or a change in our management. The existence of these provisions could adversely affect the voting power of holders of common stock and limit the price that investors might be willing to pay in the future for shares of our common stock.
We have adopted a stockholder rights plan that may discourage, delay or prevent a change of control and make any future unsolicited acquisition attempt more difficult. Under the rights plan:
the rights will become exercisable only upon the occurrence of certain events specified in the plan, including the acquisition of 20% of our outstanding common stock by a person or group, with limited exceptions;
each right will entitle the holder, other than an acquiring person, to acquire shares of our common stock at a discount to the then prevailing market price;
our board of directors may redeem outstanding rights at any time prior to a person becoming an acquiring person at a minimal price per right; and
prior to a person becoming an acquiring person, the terms of the rights may be amended by our board of directors without the approval of the holders of the rights.

33



In addition, the terms of our 2015 Notes and 2017 Notes may require us to purchase those notes for cash in the event of a takeover of our company. The indentures governing the Notes also prohibit us from engaging in certain mergers or acquisitions unless, among other things, the surviving entity assumes our obligations under such notes. These and other provisions applicable to the 2015 Notes and 2017 Notes may have the effect of delaying or preventing a takeover of our company that would otherwise be beneficial to our stockholders
We have not paid dividends in the past and do not expect to pay dividends in the future.
We have never declared or paid cash dividends on our capital stock. We currently intend to retain all future earnings for the operation and expansion of our business and, therefore, do not anticipate declaring or paying cash dividends in the foreseeable future. The payment of dividends will be at the discretion of our board of directors and will depend on our results of operations, capital requirements, financial condition, prospects, contractual arrangements, any limitations on payments of dividends present in our current and future debt agreements, and other factors our board of directors may deem relevant. If we do not pay dividends, a return on our common stock will only occur if our stock price appreciates.
Item 1B.
Unresolved Staff Comments
None

Item 2.
Properties
The following table summarizes our principal facilities under lease as of December 31, 2013, the location and size of each such facility and their designed use.
 
Location
 
Purpose (1)
 
Square Feet
(Approximate)
 
Lease Expiration Dates
San Diego, California (2)
 
Principal executive offices and research and development
 
92,602

 
August 2023
Rancho Cordova, California
 
Manufacturing operations, product distribution, research and development and administrative functions
 
155,421

 
December 2014
Billerica, Massachusetts
 
Axsun operations and administrative functions, research and development
 
64,784

 
October 2021
Zaventem, Belgium
 
Europe administrative functions, sales and product distribution
 
18,600

 
May 2021
Tokyo, Japan
 
Japan sales operations and administrative functions
 
19,331

 
January 2015
Costa Rica
 
Manufacturing operations
 
140,000

 
Owned

(1)
All facilities are utilized for activities in our medical segment. The Billerica, Massachusetts facility is utilized for activities both in our medical and industrial segments.

34



(2)
In December 2012, we agreed to lease a facility in San Diego, California to serve as our new corporate headquarters, which is comprised of 92,602 square feet with a lease expiration date of August 2023. We relocated our principal executive offices to the new facility in August 2013.
We also lease facilities in Alpharetta, Georgia for limited research and development activities and sales administration activities; Netanya, Israel for research and development activities and administrative functions; and Woodmead, South Africa and Warsaw, Poland for sales and distribution activities. Collectively, these facilities represent approximately 18,000 square feet of space.
We believe that our current and planned facilities are adequate to meet our needs for the foreseeable future.
Item 3.
Legal Proceedings
The information set forth under Note 4 “Commitments and Contingencies – Litigation” to our consolidated financial statements included in Part II, Item 8 of this Annual Report, is incorporated herein by reference.
Item 4.
Mine Safety Disclosures
Not applicable.
PART II
 
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
We completed our initial public offering on June 15, 2006. Our common stock is traded on the NASDAQ Global Select Market under the symbol “VOLC”. The following table sets forth the high and low sales price of our common stock for the periods indicated.
 
 
 
Price Range
 
 
Low
 
High
Year Ended December 31, 2013
 
 
 
 
First Quarter
 
$
22.26

 
$
26.07

Second Quarter
 
16.58

 
22.41

Third Quarter
 
18.04

 
23.99

Fourth Quarter
 
18.95

 
24.36

Year Ended December 31, 2012
 
 
 
 
First Quarter
 
$
21.98

 
$
29.91

Second Quarter
 
25.12

 
29.95

Third Quarter
 
25.01

 
30.59

Fourth Quarter
 
23.08

 
30.15

Holders
At February 14, 2014, the closing price of our common stock on the NASDAQ Global Select Market was $21.49 per share, and we had 32 stockholders of record.

35





Performance Graph
The following performance graph and related information shall not be deemed “soliciting material” or “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.
The graph below compares total stockholder return on our common stock from December 31, 2008 through December 31, 2013 with the cumulative total return of (a) the NASDAQ Composite Index and (b) the NASDAQ Medical Equipment Index assuming a $100 investment made in each on December 31, 2008. Each of the three measures of cumulative total return assumes reinvestment of dividends, if any. The stock performance shown on the graph below is based on historical data and is not indicative of, or intended to forecast, possible future performance of our common stock.
Securities Authorized for Issuance under Equity Compensation Plans
For information concerning prior stockholder approval of and other matters relating to our equity incentive plans, see Item 12 in this Annual Report on Form 10-K.
Recent Sales of Unregistered Securities
None
Purchases of Equity Securities by the Issuer and Affiliated Purchasers

36



Period
 
Total Number of Shares Purchased
 
Average
Price Paid Per Share (2)
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)
 
Maximum Approximate
Dollar Value of
Shares that May Yet Be Purchased Under the Plans or Programs(1)
10/01/2013 - 10/31/2013
 

 
$

 

 
$

11/01/2013 - 11/30/2013
 

 

 

 

12/01/2013 - 12/31/2013
 
3,557,137

 
28.11

 
3,557,137

 
100,000,000

Total
 
3,557,137

 
$
28.11

 
3,557,137

 
$
100,000,000

(1) On December 2, 2013, we announced that our board of directors authorized a $200 million share repurchase program, which will expire on June 30, 2014. Pursuant to this approval, we entered into a $100 million accelerated share repurchase, or ASR, program with a counterparty, and received 3,557,137 shares of our common stock, which represents a substantial majority of the total number of shares expected to be repurchased under the ASR program. The final number of shares to be repurchased by us under this ASR program will be determined at the completion of the ASR program and will be based generally on the daily volume-weighted average share price of our common stock during a period of up to approximately four months, less an agreed-to discount. Refer to "Item 8, Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements, Note 5 - Stockholders' Equity" in this Annual Report on Form 10-K.
(2) Average price per share for the period December 1, 2013 to December 31, 2013 is calculated by dividing the total cost for the ASR program of $100 million, which was paid in December 2013, by the total number of shares repurchased under the ASR program as of December 31, 2013. This average price per share will be adjusted once the ASR program is completed and the final number of shares repurchased by us is determined. The final number of shares to be repurchased by us under this ASR will be determined at the completion of the ASR program and will be based generally on the daily volume-weighted average share price of our common stock during a period of up to approximately four months, less an agreed-to discount. Refer to "Item 8, Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements, Note 5 - Stockholders' Equity" in this Annual Report on Form 10-K.
Dividends
We have never declared or paid any cash dividends on our capital stock. We currently intend to retain any future earnings to fund the development and expansion of our business, and therefore we do not anticipate paying cash dividends on our common stock in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors. None of our outstanding capital stock is entitled to any dividends.
 
Item 6.
Selected Financial Data
The selected financial data set forth below are derived from our consolidated financial statements. The consolidated statement of operations data for the years ended December 31, 2013, 2012 and 2011, and the consolidated balance sheet data at December 31, 2013 and 2012 are derived from our consolidated financial statements included elsewhere in this report. The consolidated statement of operations data for the years ended December 31, 2010 and 2009 and the consolidated balance sheet data at December 31, 2011, 2010 and 2009 are derived from our consolidated financial statements which are not included herein.
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and the related footnotes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this report (in thousands, except per share data):

37



 
 
Years Ended December 31,
 
 
2013
 
2012
 
2011
 
2010
 
2009
Consolidated Statement of Operations Data:
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
393,678

 
$
381,866

 
$
343,546

 
$
294,146

 
$
227,867

Cost of revenues, excluding amortization of intangibles
 
143,302

 
128,915

 
114,533

 
108,860

 
91,489

Gross profit
 
250,376

 
252,951

 
229,013

 
185,286

 
136,378

Operating expenses:
 

 

 

 
 
 
 
Selling, general and administrative
 
182,950

 
172,794

 
147,057

 
132,990

 
111,598

Research and development
 
69,159

 
55,469

 
53,098

 
42,517

 
37,372

Amortization of intangibles
 
3,832

 
3,240

 
3,447

 
2,559

 
4,224

Acquisition-related items
 
4,964

 
1,858

 

 
184

 

Restructuring charges
 
19,374

 

 

 

 

In-process research and development
 

 

 

 
(2,935
)
 
14,030

Total operating expenses
 
280,279

 
233,361

 
203,602

 
175,315

 
167,224

Operating (loss) income
 
(29,903
)
 
19,590

 
25,411

 
9,971

 
(30,846
)
Interest income
 
1,287

 
902

 
908

 
477

 
756

Interest expense
 
(26,908
)
 
(7,975
)
 
(7,107
)
 
(2,192
)
 
(5
)
Exchange rate gain (loss)
 
(1,156
)
 
(576
)
 
(997
)
 
(904
)
 
2,328

Loss from debt extinguishment
 

 
(4,969
)
 

 

 

Other, net
 
5,856

 
2,717

 
(112
)
 
(25
)
 

(Loss) income before income taxes
 
(50,824
)
 
9,689

 
18,103

 
7,327

 
(27,767
)
Income tax (benefit) expense (1)
 
(16,330
)
 
1,667

 
(19,990
)
 
2,087

 
1,187

Net (loss) income
 
$
(34,494
)
 
$
8,022

 
$
38,093

 
$
5,240

 
$
(28,954
)
Net (loss) income per share:
 

 

 

 
 
 
 
Basic
 
$
(0.63
)
 
$
0.15

 
$
0.73

 
$
0.10

 
$
(0.60
)
Diluted
 
$
(0.63
)
 
$
0.15

 
$
0.70

 
$
0.10

 
$
(0.60
)
Shares used in calculating net (loss) income per share:
 

 

 

 
 
 
 
Basic
 
54,341

 
53,475

 
52,300

 
50,551

 
48,400

Diluted
 
54,341

 
55,195

 
54,596

 
53,281

 
48,400

 
 
At December 31,
 
 
2013
 
2012
 
2011
 
2010
 
2009
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
107,159

 
$
330,635

 
$
107,016

 
$
43,429

 
$
56,055

Short-term available-for-sale investments
 
231,864

 
140,960

 
112,327

 
175,283

 
66,028

Working capital
 
420,344

 
546,790

 
293,057

 
264,937

 
158,668

Intangible assets, net (2)
 
58,108

 
50,657

 
15,245

 
17,103

 
11,623

Total assets
 
831,919

 
902,344

 
496,724

 
431,566

 
276,734

Short and long-term debt, including current maturities
 
402,332

 
383,472

 
95,809

 
91,292

 
160

Total stockholders’ equity (3)
 
299,802

 
408,345

 
339,237

 
274,336

 
214,815

These historical results are not necessarily indicative of results expected for any future period.
(1)
During the quarter ended December 31, 2013, we concluded that it was more likely than not that we would not be able to realize the benefit of our remaining state and select foreign deferred tax assets in the future. Therefore, we increased the valuation allowance on our state and foreign deferred income tax assets by $3.8 million.
During the quarter ended December 31, 2012, we concluded that it was more likely than not that we would be able to realize the benefit of a significant portion of our foreign deferred tax assets in the future. Therefore, we reversed $4.9 million of the valuation allowance on certain of our net foreign deferred income tax assets.     

38



During the quarter ended December 31, 2011, we concluded that it was more likely than not that we would be able to realize the benefit of a significant portion of our deferred tax assets in the future. Therefore, we reversed $22 million of the valuation allowance on our net federal and certain state deferred income tax assets.     
(2)
Includes the effects of the Sync-Rx, Ltd. and Crux Biomedical, Inc. acquisitions in 2012 and the acquisition of the Pioneer Plus re-entry catheter product line from Medtronic, Inc. in 2013.
(3)
On December 2, 2013, our board of directors authorized a $200 million share repurchase program. Pursuant to this approval, we entered into a $100 million accelerated share repurchase, or ASR, program with a counterparty, and received 3,557,137 shares of Volcano's common stock. All of our repurchases were treated as effective retirements of the purchased shares and therefore reduced reported shares issued and outstanding by the number of shares repurchased. In addition, we recorded the excess of the purchase price over the par value of the common stock as a reduction to additional paid-in capital.

39




Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with “Selected Financial Data” and our consolidated financial statements and notes thereto included elsewhere in this Annual Report.
Overview
We design, develop, manufacture and commercialize a broad suite of precision guided therapy tools including intravascular ultrasound, or IVUS, and fractional flow reserve, or FFR, products. We believe that these products enhance the diagnosis and treatment of coronary and peripheral vascular disease by improving the efficiency and efficacy of existing diagnostic angiograms and percutaneous coronary interventional, or PCI, and endovascular procedures in the coronary arteries or peripheral arteries and veins. We are facilitating the adoption of functional PCI, in which our FFR technology is used to help determine whether or not a stent is necessary, and IVUS is used as an adjunct to angiography to guide stent placement and optimization. We market our products to physicians, nurses and technicians who perform a variety of endovascular based coronary and peripheral interventional procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals.
Our products consist of consoles that are marketed as stand-alone units or as units that can be integrated into a variety of hospital-based interventional surgical suites called catheterization laboratories, or cath labs. We have developed customized cath lab versions of these consoles and are developing additional functionality options as part of our cath lab integration initiative. Our consoles have been designed to serve as a multi-modality platform for our phased array and rotational IVUS catheters, FFR pressure and flow wires and image-guided therapy catheters, such as the Pioneer Plus reentry device acquired from Medtronic, Inc., or Medtronic, on August 30, 2013.
Our IVUS products include single-procedure disposable phased array and rotational IVUS imaging catheters, and additional functionality options such as ChromaFlo® stent apposition analysis. Our FFR offerings can be accessed through our multi-modality platforms, and we also provide FFR-only consoles. Our FFR disposables are single-procedure disposable pressure and flow guide wires used to measure the pressure and flow characteristics of blood around plaque enabling physicians to gauge the plaque's physiological impact on blood flow and pressure. We have developed additional offerings for integration into the platform, including adenosine-free Instant Wave-Free Ratio FFR, or iFR®. We are currently developing high resolution Focal Acoustic Computed Tomography, or FACT, catheters, co-registration with IVUS and an IVUS-guided Crux VCF system featuring our inferior vena cava, or IVC, filter. Our Valet microcatheter, Visions® PV .035 catheter and Eagle Eye® Platinum ST short tip catheter, or EEP, products received 510(k) clearance and CE Mark approval in 2012 and their commercial launch occurred in 2013. In addition, we initiated the commercial launch of our Verrata pressure guide wire, our fifth new pressure wire in five years, during 2013.
Through Axsun Technologies, Inc., or Axsun, one of our wholly-owned subsidiaries, we also develop and manufacture optical monitors for the telecommunications industry, laser and non-laser light sources, optical engines used in medical optical coherence topography, or OCT, imaging systems and advanced photonic components and sub-systems used in spectroscopy and other industrial applications. We believe Axsun's proprietary OCT technology will provide us competitive advantages in the invasive imaging sector, as well as for applications in ophthalmology and dental.
We have infrastructure in the U.S., Europe, Japan and Costa Rica. Our corporate office is located in California, U.S. Our manufacturing facilities are located in Coyol, Costa Rica, and Rancho Cordova, California. In Costa Rica we manufacture IVUS catheters and FFR guide wires. In California, we produce multi-modality consoles, FFR consoles, IVUS catheters, FFR guide wires and our Crux IVC filters. We are in the process of transitioning all of our disposable manufacturing activities to our Costa Rica facility. In addition, we have a manufacturing facility in Billerica, Massachusetts that produces our optical monitors, laser and non-laser light sources, and optical engines used in OCT imaging systems as well as micro-optical spectrometers and optical channel monitors. We have research and development facilities in U.S. and Israel. We have sales offices in the U.S. and Japan; sales and distribution offices in Belgium and South Africa; and third-party distribution facilities in Japan. At December 31, 2013, we had over 1,800 full time employees worldwide, including over 900 manufacturing employees, over 370 sales and marketing employees and over 170 research and development employees.
We have focused on building our domestic and international sales and marketing infrastructure to market our products to physicians and technicians who perform diagnostic angiography, PCI and endovascular procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals. We sell our products directly to customers in the United States, Japan, certain European markets and South Africa. We utilize distributors in other geographic areas, which are also involved in product launch planning, education and training, physician support and clinical study management.

40



At December 31, 2013, we had a worldwide installed base of over 7,000 consoles, excluding our legacy In-Vision Gold systems. We intend to grow and leverage this installed base to drive recurring sales of our single-procedure disposable catheters and guide wires. In the year ended December 31, 2013, the sale of our single-procedure disposable catheters and guide wires accounted for $306.9 million, or 79.7% of our medical segment revenues, a $6.2 million, or 2.1% increase from the year ended December 31, 2012, in which the sale of our single-procedure disposable catheters and guide wires accounted for $300.7 million, or 81.0% of our medical segment revenues.
Our revenues have increased from $343.5 million in 2011 to $381.9 million in 2012 and to $393.7 million in 2013. We had operating loss of $29.9 million during 2013, and operating income of $19.6 million and $25.4 million during 2012 and 2011, respectively. The 2013 operating loss includes $5.0 million of acquisition-related items and $19.4 million of restructuring charges. The 2012 operating income included $1.9 million of acquisition-related expenses.
During 2013, our management approved two restructuring plans: (1) to consolidate and transition our manufacturing resources related to the manufacture of disposables to Costa Rica, (2) to reprioritize and reallocate our resources within our distribution, research and development, and clinical programs that we believe better advance our key strategies. The key elements under the second restructuring plan include the discontinuation of development programs for our Forward-Looking IVUS, or FL.IVUS, Forward-Looking Intra-Cardiac Echo, or FL.ICE, and Optical Coherence Tomography, or OCT, intravascular coronary imaging development programs, the termination of the commercial sale of our ReFLOW Aspiration Catheter, or ReFLOW product line, and a modest reorganization of several functional areas and business units within the Company. We recorded $19.4 million of restructuring charges during 2013. Refer to "Item 8, Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements, Note 3 Financial Statements Details - Restructuring Activity" in this Annual Report on Form 10-K.
In the years ended December 31, 2013, 2012 and 2011, 44.6%, 46.3% and 47.3%, respectively, of our revenues and 19.8%, 22.7% and 22.5%, respectively, of our operating expenses were denominated in various non-U.S. dollar currencies, primarily the Japanese yen and the euro. We expect that a significant portion of our revenue and operating expenses will continue to be denominated in non-U.S. dollar currencies. As a result, we are subject to risks related to fluctuations in foreign currency exchange rates, which could affect our operating results in the future. If our yen or euro denominated sales exceed our yen or euro denominated costs, and the U.S. dollar strengthens relative to the yen or euro, there is an adverse effect on our results of operations. Conversely, if the U.S. dollar weakens relative to the yen or euro, there is a positive effect on our results of operations. For example, the average exchange rate of one U.S. dollar to yen increased 21.5% from 79.3 in 2012 to 96.4 in 2013, which resulted in a net negative impact to our operational results for 2013 in the amount of approximately $14.1 million. The average exchange rate of one euro to U.S. dollar increased 2.8% from 1.29 in 2012 to 1.33 in 2013, which resulted in a net positive impact to our operational results for 2013 in the amount of approximately $1.2 million.
We use third-party manufacturing partners to produce circuit boards and mechanical sub-assemblies used in the manufacture of our consoles. We also use third-party manufacturing partners for certain proprietary components used in the manufacture of our single-procedure disposable products. We perform incoming inspection on these circuit boards, mechanical sub-assemblies and components, assemble them into finished products, and test the final product to assure quality control. We do not carry significant inventory of transducers, substrates or scanner subassemblies. If we had to change suppliers, we expect that it would take 6 to 24 months to identify appropriate suppliers, complete design work and undertake the necessary inspections and testing before the new transducers, substrates and subassemblies would be available.
External Factors
In September 2009, published findings from the Fractional Flow Reserve versus Angiography for Multivessel
Evaluation, or FAME, study demonstrated that patients in the study with multi-vessel coronary artery disease who were treated by FFR guidance had a 34% reduction in death and myocardial infarction (heart attack) compared to angiographic guidance alone. In August 2012, the results of the Fractional Flow Reserve-Guided PCI vs. Medical Therapy in Stable Coronary Disease, or FAME 2, study were published in the New England Journal of Medicine. FAME 2 showed that patients receiving PCI with proven ischemia by FFR had 66% fewer primary endpoint events including death, myocardial infarction and urgent revascularization's (e.g. coronary bypass) than those patients treated with optimal medical therapy alone. We believe these findings will continue to drive the growth and adoption of our disposable FFR wire products.
With respect to IVUS, two-year data released in 2013 from the ADAPT-DES study (Assessment of Platelet Therapy with Drug-Eluting Stents), the largest study conducted with IVUS guidance to date, indicated IVUS guidance was associated with reductions in certain serious patient events, including stent thrombosis and myocardial infarction, and that IVUS guidance was associated with a change in procedure 74% of the time. These data suggest that IVUS guidance can play an important role in helping to improve patient outcomes.

41



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 imposed 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.
The economic conditions in many countries and regions where we generate our revenues remain uncertain. If our customers do not obtain or do not have access to the necessary capital to operate their businesses, or are otherwise adversely affected by any deterioration in national and worldwide economic conditions, this could result in reductions in the sales of our products, longer sales cycles and slower adoption of new technologies by our customers, which would materially and adversely affect our business. In addition, our customers’ and suppliers’ liquidity, capital resources and credit may be adversely affected by their relative ability or inability to obtain capital and credit, which could adversely affect our ability to collect on our outstanding invoices and lengthen our collection cycles, or limit our timely access to important sources of raw materials necessary for the manufacture of our consoles and catheters.
In addition, the political unrest in certain regions of the world may have adverse consequences to the global economy or to our customers in certain regions, which could negatively impact our business. Uncertainty about future economic conditions may make it more difficult for us to forecast operating results and to make decisions about future investments. For further discussion, see “Risk Factors—General national and worldwide economic conditions may materially and adversely affect our financial performance and results of operations.”
Financial Operations Overview
The following is a description of the primary components of our revenue and expenses.
Revenues. We derive our revenues from two 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 year ended December 31, 2013, we generated $393.7 million of revenues which is comprised of $385.2 million from our medical segment and $8.4 million from our industrial segment. We experienced increases in revenues related to consoles and FFR single-procedure disposables and decrease in revenues related to IVUS single-procedure disposables in 2013 compared with 2012. In the year ended December 31, 2013, 11.3% of our medical segment revenues were derived from the sale of our consoles, 50.4% from IVUS single-procedure disposables and 29.2% from FFR single-procedure disposables as compared with 11.0% from consoles, 55.5% from IVUS single-procedure disposables and 25.6% from FFR single-procedure disposables in the year ended December 31, 2012. Other revenues consist primarily of service and maintenance revenues, shipping and handling revenues, sales of distributed products, sales of medical products manufactured by our Axsun subsidiary, spare parts sales, and license fees.
We expect to continue experiencing variability in our quarterly revenues from console sales due in part to the timing of hospital capital equipment purchasing decisions. Further, we expect variability of our revenues based on the timing of our new product introductions, which may cause our customers to delay their purchasing decisions until the new products are commercially available.
Our medical segment sales are generated by our direct sales representatives or through independent distributors and are shipped throughout the world from facilities in the United States, Belgium, Japan and South Africa. Our industrial segment sales are generated by our direct sales representatives or through independent distributors and these products are shipped primarily to telecommunications and industrial companies domestically and abroad from the United States.
Cost of Revenues. Cost of revenues consists primarily of material costs for the products that we sell and other costs associated with our manufacturing process, such as personnel costs, rent, depreciation related to our manufacturing equipment and utilities. In addition, cost of revenues includes depreciation of company-owned consoles, royalty expenses for licensed technologies included in our products, service costs, provisions for warranty, distribution, freight and packaging costs and stock-based compensation expense related to manufacturing employees. We expect a trend of improvement in our gross margin for IVUS and FFR products if we are successful in our ongoing efforts to streamline and improve our manufacturing processes, increase production volumes and transition certain manufacturing operations to Costa Rica.
Selling, General and Administrative. Selling, general and administrative expenses consist primarily of salaries and commissions and other related costs for personnel serving the sales, administrative and marketing functions. Other costs include stock-based compensation expense, professional fees for legal and accounting services, travel and entertainment expenses, facility costs, trade show, training and other promotional expenses. Due to ongoing litigation, legal expenses tend to be somewhat unpredictable in their timing and amount. We expect that our selling, general and administrative expenses will increase as we continue to expand our sales force and marketing efforts and invest in the necessary infrastructure to support our continued growth.

42



Included in selling, general and administrative expense is the U.S. medical device excise tax on the sale of medical devices that was effective January 1, 2013. The statutory rate of the medical device excise tax is 2.3% of revenues on initial sales of finished medical products sold in the United States. Our medical device excise tax is 0.71% of our total revenue for 2013. Our effective rate for this excise tax is less than the statutory rate which is primarily due to international sales.
Research and Development. Research and development expenses consist primarily of salaries and related expenses for personnel, consultants, prototype materials, clinical studies, depreciation, regulatory filing fees, certain legal costs related to our intellectual property and stock-based compensation expense. We expense research and development costs as incurred. Due to product development timelines, research and development costs tend to be distributed unevenly between the periods. We expect our research and development expenses to increase as we continue to develop our products and technologies.
Amortization of Intangibles. We amortize intangible assets, consisting of our developed technology, licenses, customer relationships, patents and trademarks, and covenants-not-to-compete, using the straight-line method over their estimated useful lives of up to 20 years. These assets are regularly tested for impairment and abandonment.
Acquisition-related items. Acquisition-related items consists of acquisition transaction costs, subsequent accretion of and revision, if any, to the fair value of the contingent consideration related to acquisitions and other expenses directly associated with acquisitions.
Restructuring Charges. Restructuring charges consist of employee termination benefits, asset impairments and other related charges associated with restructuring activities.
In-process Research and Development. In-process Research and Development, or IPR&D, consists of our projects acquired in connection with acquisitions that had not reached technological feasibility and had no alternative future uses as of each acquisition date. Certain additional payments that may be required in connection with our acquisitions could result in future charges to IPR&D.
OCT. In December 2007, we acquired certain OCT IPR&D assets in connection with our acquisition of CardioSpectra, Inc., or CardioSpectra, which were valued at $26.3 million. At the acquisition date, the estimated costs to complete the project were $7.2 million. We incurred a total of $31.3 million for the OCT project since acquisition.
FL.IVUS. In May 2008, we acquired the FL.IVUS IPR&D assets in connection with our acquisition of Novelis, which was valued at $12.2 million. At the acquisition date, the estimated costs to complete the project were $3.9 million. We incurred a total of $19.6 million for the FL.IVUS project since acquisition.
FL.ICE. In August 2010 we acquired the FL.ICE project in connection with our acquisition of Fluid Medical Inc., or Fluid Medical. This project was recorded as an IPR&D asset and was valued at $4.1 million. At the acquisition date, the estimated costs to complete the project were $5.9 million. We incurred a total of $8.5 million for the FL.ICE project since acquisition.
During 2013, our management evaluated various development projects, product lines and functional areas in an effort to reprioritize and reallocate our resources within our distribution, research and development, and clinical programs to focus on development and commercial efforts that we believe better advance our key strategies. The key elements under this restructuring plan include the discontinuation of development programs for our FL.IVUS, FL.ICE and OCT intravascular coronary imaging development programs. Refer to "Item 8, Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements, Note 3 Financial Statements Details - Restructuring Activity" in this Annual Report on Form 10-K.
CO-REGISTRATION. In November 2012, in connection with our acquisition of Sync-Rx Ltd, or Sync-Rx, we acquired Sync-Rx's co-registration technology, which was still under development. This technology was recorded as an IPR&D asset and was valued at $1.3 million. At the acquisition date, the estimated costs to complete the project were approximately $4.4 million. At December 31, 2013, this project is substantially completed and we incurred a total of $3.2 million of expenses related to this project.
IVC FILTER & RETRIEVAL KIT. In December 2012, in connection with our acquisition of Crux Biomedical, Inc., or Crux, we acquired Crux's IVC filter and retrieval kit technologies, which were still under development at acquisition. These technologies were recorded as IPR&D assets and were valued at $28.4 million, of which $24.1 million was for the IVC filter technology and $4.3 million was for the IVC retrieval kit technology. At the acquisition date, the estimated costs to complete the development of the IVC filter were $4.7 million and the estimated costs to complete the development of the IVC retrieval kit were $1.7 million with estimated completion during 2014.
During the fourth quarter of 2013, we substantially completed the IVC filter development and launched the product to a limited market. The $24.1 million IPR&D associated with the IVC filter was transfered to developed technology and we began

43



amortizing this developed technology in December 2013. We incurred a total of $2.2 million of expenses related to the IVC filter project since acquisition.
We are continuing the development of the IVC retrieval kit and the following table summarizes this IPR&D project (in millions) at December 31, 2013:
 
 
As of Acquisition Date
 
Costs Incurred
Since Acquisition
 
Estimated Cost to
Complete, as of
December 31, 2013
 
Total Estimated
Costs to Complete
since Acquisition
Date
Project Name
 
Fair Value
 
Estimated Cost to Complete
 
IVC retrieval kit
 
$
4.3

 
$
1.7

 
$
1.0

 
$
0.7

 
$
1.7

Interest Income. Interest income is comprised of interest income earned from our cash and cash equivalents and our short-term and long-term available-for-sale investments.
Interest Expense. Interest expense is comprised of interest expense related to our convertible senior notes, including coupon interest, accretion of debt discount, and amortization of issuance costs, and interest expense related to the long-term debt acquired with Sync-Rx, offset by interest capitalization related to the Costa Rica plant construction, before the plant was placed into service in the second quarter of 2012, and our global Enterprise Resource Planning, or ERP, system implementation, before the ERP system was placed into service in the fourth quarter of 2013.
Exchange Rate Gain (Loss). Exchange rate gain (loss) is comprised of foreign currency transaction and remeasurement gains and losses, and the effect of changes in value and net settlements of our foreign exchange forward contracts.
Provision for Income Taxes. Our effective tax rate is a blended rate resulting from the composition of taxable income in the global jurisdictions in which we conduct business. We apply the “with and without method—direct effects only”, in accordance with authoritative guidance, with respect to recognition of stock option excess tax benefits within stockholders equity (additional paid in capital). Therefore, the provision for domestic income taxes is determined utilizing projected federal and state taxable income before the application of deductible excess tax benefits attributable to stock option exercises.
For the years ended December 31, 2013, 2012 and 2011, the provision for income taxes is comprised of federal, foreign and various state and local income taxes. Our tax rate is affected by recurring items, such as tax rates in foreign jurisdictions and the relative amount of income we earn in jurisdictions, which we expect to continue to fluctuate as we increase foreign manufacturing and distribution operations. It is also affected by discrete items that may occur in any given year, but are not consistent from year to year. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income by jurisdiction during the periods in which those temporary differences become deductible. To the extent we establish or change the valuation allowance in a period, the tax effect will generally flow through the statement of operations. In the case of an acquired or merged entity, we will record a valuation allowance on a deferred asset through purchase accounting as an adjustment to goodwill at the acquisition date if it is more likely than not that all or a portion of the acquired deferred tax assets will not be recognized in the future. Any subsequent change to a valuation allowance established during purchase accounting within the measurement period of the acquisition (not to exceed twelve months) will also be recorded as an adjustment to goodwill, provided that such change relates to new information about the facts and circumstances that existed on the acquisition date.
During the fourth quarter of 2013, we concluded that it was more likely than not that we would not be able to realize a $3.8 million benefit related to our state and select foreign deferred tax assets. Further, in 2013, we completed our purchase accounting analysis and concluded that it was more likely than not that $1.4 million of foreign deferred tax assets related to the Sync-Rx, Ltd. acquisition and $1.1 million of state deferred tax assets related to the Crux Biomedical, Inc. acquisition are not realizable. This resulted in a net increase in valuation allowance against these deferred tax assets, which was recorded as a reduction to goodwill.
During the fourth quarter of 2012, we concluded that it was more likely than not that we would be able to realize the benefit of a significant portion of our foreign deferred tax assets in the future. We expect that our operations in the respective foreign jurisdictions will generate sufficient taxable income in future periods to realize the tax benefit associated with the related deferred tax assets. As a result, we released $4.9 million of the valuation allowance on our foreign deferred tax assets.
During the fourth quarter of 2011, we concluded that it was more likely than not that we would be able to realize the benefit of a significant portion of our federal and state deferred tax assets in the future as a result of cumulative profitability and expected future taxable income. Therefore, we reversed $22.0 million of the valuation allowance on our net federal and certain state deferred income tax assets.
Results of Operations

44



The following table sets forth items derived from our consolidated statements of operations for the years ended December 31, 2013, 2012 and 2011 presented in both absolute dollars (in thousands) and as a percentage of revenues, with the dollar and percentage change year over year:
 
 
 
Years Ended December 31,
 
Changes 2013 vs.
2012
 
Changes 2012 vs.
2011
 
 
2013
 
2012
 
2011
 
$
 
%
 
$
 
%
Revenues
 
$
393,678

 
100.0
 %
 
$
381,866

 
100.0
 %
 
$
343,546

 
100.0
 %
 
$
11,812

 
3.1
 %
 
$
38,320

 
11.2
 %
Cost of revenues, excluding amortization of intangibles
 
143,302

 
36.4

 
128,915

 
33.8

 
114,533

 
33.3

 
14,387

 
11.2

 
14,382

 
12.6

Gross profit
 
250,376

 
63.6

 
252,951

 
66.2

 
229,013

 
66.7

 
(2,575
)
 
(1.0
)
 
23,938

 
10.5

Operating expenses:
 

 

 

 


 

 


 

 

 

 

Selling, general and administrative
 
182,950

 
46.5

 
172,794

 
45.2

 
147,057

 
42.8

 
10,156

 
5.9

 
25,737

 
17.5

Research and development
 
69,159

 
17.6

 
55,469

 
14.5

 
53,098

 
15.5

 
13,690

 
24.7

 
2,371

 
4.5

Amortization of intangibles
 
3,832

 
1.0

 
3,240

 
0.8

 
3,447

 
1.0

 
592

 
18.3

 
(207
)
 
(6.0
)
Acquisition-related items
 
4,964

 
1.3

 
1,858

 
0.5

 

 

 
3,106

 
167.2

 
1,858

 

Restructuring charges
 
19,374

 
4.9

 

 

 

 

 
19,374

 

 

 

Total operating expenses
 
280,279

 
71.2

 
233,361

 
61.1

 
203,602

 
59.3

 
46,918

 
20.1

 
29,759

 
14.6

Operating (loss) income
 
(29,903
)
 
(7.6
)
 
19,590

 
5.1

 
25,411

 
7.4

 
(49,493
)
 
(252.6
)
 
(5,821
)
 
(22.9
)
Interest income
 
1,287

 
0.3

 
902

 
0.2

 
908

 
0.3

 
385

 
42.7

 
(6
)
 
(0.7
)
Interest expense
 
(26,908
)
 
(6.8
)
 
(7,975
)
 
(2.1
)
 
(7,107
)
 
(2.1
)
 
(18,933
)
 
237.4

 
(868
)
 
12.2

Exchange rate loss
 
(1,156
)
 
(0.3
)
 
(576
)
 
(0.2
)
 
(997
)
 
(0.3
)
 
(580
)
 
100.7

 
421

 
(42.2
)
Loss from debt extinguishment
 

 

 
(4,969
)
 
(1.3
)
 

 

 
4,969

 
(100.0
)
 
(4,969
)
 

Other, net
 
5,856

 
1.5

 
2,717

 
0.7

 
(112
)
 

 
3,139

 
115.5

 
2,829

 
(2,525.9
)
(Loss) income before income tax
 
(50,824
)
 
(12.9
)
 
9,689

 
2.5

 
18,103

 
5.3

 
(60,513
)
 
(624.6
)
 
(8,414
)
 
(46.5
)
Income tax (benefit) expense
 
(16,330
)
 
(4.1
)
 
1,667

 
0.4

 
(19,990
)
 
(5.8
)
 
(17,997
)
 
(1,079.6
)
 
21,657

 
(108.3
)
Net (loss) income
 
$
(34,494
)
 
(8.8
)%
 
$
8,022

 
2.1
 %
 
$
38,093

 
11.1
 %
 
$
(42,516
)
 
(530.0
)%
 
$
(30,071
)
 
(78.9
)%
The following table sets forth our revenues by segment and product (in thousands) and the changes in revenues between the specified periods:
 
 
Years Ended December 31,
 
Changes 2013 vs.
2012
 
Changes 2012 vs.
2011
 
 
2013
 
2012
 
2011
 
$
 
%
 
$
 
%
Medical segment:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consoles
 
$
43,602

 
$
40,687

 
$
40,954

 
$
2,915

 
7.2
 %
 
$
(267
)
 
(0.7
)%
Single-procedure disposables:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
IVUS
 
194,225

 
205,843

 
200,970

 
(11,618
)
 
(5.6
)%
 
4,873

 
2.4
 %
FFR
 
112,643

 
94,885

 
67,082

 
17,758

 
18.7
 %
 
27,803

 
41.4
 %
Other
 
34,775

 
29,716

 
23,530

 
5,059

 
17.0
 %
 
6,186

 
26.3
 %
Sub-total medical segment
 
385,245

 
371,131

 
332,536

 
14,114

 
3.8
 %
 
38,595

 
11.6
 %
Industrial segment
 
8,433

 
10,735

 
11,010

 
(2,302
)
 
(21.4
)%
 
(275
)
 
(2.5
)%
 
 
$
393,678

 
$
381,866

 
$
343,546

 
$
11,812

 
3.1
 %
 
$
38,320

 
11.2
 %
The following table sets forth our revenues by geographic area (in thousands) and the changes in revenues in the specified periods:
 
 
Years Ended December 31,
 
Changes 2013 vs.
2012
 
Changes 2012 vs.
2011
 
 
2013
 
2012
 
2011
 
$
 
%
 
$
 
%
Revenues (1):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
United States
 
$
189,748

 
$
177,992

 
$
157,412

 
$
11,756

 
6.6
 %
 
$
20,580

 
13.1
 %
Japan
 
109,492

 
123,558

 
105,892

 
(14,066
)
 
(11.4
)%
 
17,666

 
16.7
 %
Europe, the Middle East and Africa
 
71,018

 
57,913

 
60,249

 
13,105

 
22.6
 %
 
(2,336
)
 
(3.9
)%
Rest of world
 
23,420

 
22,403

 
19,993

 
1,017

 
4.5
 %
 
2,410

 
12.1
 %
 
 
$
393,678

 
$
381,866

 
$
343,546

 
$
11,812

 
3.1
 %
 
$
38,320

 
11.2
 %
 

45



(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 Years Ended December 31, 2013 and 2012
Revenues. Overall, the increase in the medical segment revenue in the year ended December 31, 2013 compared with the year ended December 31, 2012 was driven by increased demand for our consoles and FFR disposable products, partially offset by the unfavorable impacts of foreign exchange rates, primarily the weakening yen. The increases in FFR disposable revenues were primarily due to the increased adoption of the technology based on clinical study data, offset by the unfavorable impact of approximately $3.8 million of foreign currency exchange related to the yen. The decrease in IVUS disposable revenues was due to the unfavorable impact of approximately $16.8 million of foreign currency exchange related to the yen and the unfavorable impact on pricing as a result of a reduction in the medical reimbursement rate in Japan, partially offset by increased demand and $2.3 million in revenue from the Pioneer Plus re-entry catheter product line acquired from Medtronic on August 30, 2013. The increase in other revenues is primarily due to higher sales of third-party products, higher service contract and rental revenues.
We recognized increases in revenues across all our key geographic markets except for Japan. The increase in Europe, the Middle East and Africa is due to the increased demand for our consoles and disposable products primarily as a result of our successful entrance into emerging markets in the Middle East and Eastern Europe. The decrease in Japan is primarily due to the unfavorable impact of approximately $22.5 million of foreign currency exchange related to the yen and the unfavorable impact on pricing as a result of a reduction in the medical reimbursement rate in Japan that became effective in the second quarter of 2012.
Our revenues have been impacted by the decline in the number of PCI procedures performed in the United States and in Japan. We believe the decline is in part due to concerns by clinicians and payers regarding the appropriateness of conducting PCI procedures, concerns regarding the efficacy of therapeutic treatment options, the long-term efficacy of drug-eluting stents, economic constraints, and reduced rates of restenosis. If the number of PCI procedures continues to decline, it may adversely impact our operating results and our business prospects.
Cost of Revenues. The increase in the cost of revenues in the year ended December 31, 2013 compared with the year ended December 31, 2012 was primarily due to higher sales volume. Gross margin was 63.6% of revenues in the year ended December 31, 2013, decreasing from 66.2% of revenues in the year ended December 31, 2012. This unfavorable change in gross margin was primarily the result of the unfavorable impacts of foreign exchange rates related to the yen, product mix, duplicate overhead costs as we transition certain manufacturing operations to Costa Rica, and unfavorable impact on pricing as a result of a reduction in the medical reimbursement rate in Japan that became effective in the second quarter of 2012.
Selling, General and Administrative. The increase in selling, general and administrative expenses in the year ended December 31, 2013 compared with the year ended December 31, 2012 was primarily due to the higher variable costs for U.S. sales driven by higher sales volumes, expansion of our Japanese and European sales and marketing organizations, including continued growth in our Japanese and European operations to support our direct sales efforts there, expansion of our peripheral marketing programs, increased information technology and infrastructure expenses to support company growth and increased expense related to corporate compliance programs. The increase was partially offset by not incurring Costa Rica start up expense in 2013, while we did incur such expense during the pre-production phase of our Costa Rica operation in the first quarter of 2012. In addition, medical device excise taxes for the year ended December 31, 2013 totaled $2.8 million, or 0.71% of revenue. This U.S. tax on the sale of medical devices was effective January 1, 2013, thus there was no corresponding amount for the year ended December 31, 2012.
Research and Development. The increase in research and development expenses in the year ended December 31, 2013 compared with the year ended December 31, 2012 was primarily due to increased spending on various product development and clinical trial programs and activities supporting other acquired technologies.
Amortization of Intangibles. The increase in amortization expense in the year ended December 31, 2013 compared with the year ended December 31, 2012 was primarily due to the addition of intangible assets acquired with Sync-Rx, Crux and Pioneer in November 2012, December 2012 and August 2013, respectively. We also reclassified the IPR&D asset related to the IVC filters from the Crux acquisition to developed technology and commenced amortization of such asset in December 2013 when the product line was launched.
Acquisition-Related Items. The acquisition-related items during the year ended December 31, 2013 primarily consist of $860,000 of transaction costs related to the Sync-Rx, Crux and Pioneer acquisitions and a $3.6 million change in fair value of the contingent consideration related to the Crux acquisition primarily as a result of the passage of time during 2013.
The acquisition-related items during the year ended December 31, 2012 consist of $1.6 million of transaction costs related to the Sync-Rx and Crux acquisitions and a $231,000 change in fair value of the contingent consideration related to the Crux acquisition as a result of the passage of time from acquisition date to December 31, 2012.

46



Restructuring Charges. Restructuring charges during the year ended December 31, 2013 consisted of $3.2 million of employee termination costs, $11.4 million for tangible and intangible asset impairments relating to the discontinuation of in-process research and development projects and termination of a product line, and $4.8 million of other restructuring charges, including our estimate of the probable contract termination costs related to our purchase and lease commitments and other costs directly related to the restructuring activities.
Interest Income. The increase in interest income for the year ended December 31, 2013 as compared to the year ended December 31, 2012 was primarily due to the increase in our available-for-sale investment balance resulting from the proceeds of our convertible debt offering that occurred in December 2012 and is discussed in Note 3 of our consolidated financial statements under "Financial Statement Details - Debt".
Interest Expense. Interest expense during the year ended December 31, 2013 was primarily related to interest and accretion of debt discount incurred on the convertible debt issued in December 2012 ($460 million aggregate principal amount during the year ended December 31, 2013) and the convertible debt issued in September 2010 ($25 million aggregate principal amount during the year ended December 31, 2013). Interest expense during the year ended December 31, 2012 was primarily related to interest and accretion of debt discount incurred on the convertible debt issued in September 2010 ($115 million aggregate principal amount until December 9, 2012, and thereafter $25 million aggregate principal amount through December 31, 2012).
Exchange Rate Gain (Loss). During the years ended December 31, 2013 and 2012, the impact of fluctuations in exchange rates was somewhat 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 non-functional currency transactions at current exchange rates.
Loss from Debt Extinguishment. During the year ended December 31, 2012, we repurchased $90.0 million of our 2.875% convertible senior notes due 2015, or the 2015 Notes, and recognized a $5.0 million loss, which is the difference between the carrying value of the liability component of the 2015 Notes, including any unamortized debt issuance costs, and the consideration attributed to the retirement of the liability component.
Other. During the year ended December 31, 2013, we recognized $5.8 million of gains in connection with the sales of long-term investments, which had been accounted for using the cost method.
Provision for Income Taxes. During the year ended December 31, 2013, we recognized income tax benefit of $16.3 million compared to an income tax expense of $1.7 million during the year ended December 31, 2012.
During the fourth quarter of 2013, we concluded that it was more likely than not that we would not be able to realize a $3.8 million benefit related to our state and select foreign deferred tax assets. Further, in 2013, we completed our purchase accounting analysis and concluded that it was more likely than not that $1.4 million of foreign deferred tax assets related to the Sync-Rx, Ltd. acquisition and $1.1 million of state deferred tax assets related to the Crux Biomedical, Inc. acquisition are not realizable. This resulted in an increase in valuation allowance against these deferred tax assets, which was recorded as a reduction to goodwill.
During the fourth quarter of 2012, we concluded that it was more likely than not that we would be able to realize the benefit of a significant portion of our foreign deferred tax assets in the future. We expect that our foreign operations in the respective jurisdictions will generate sufficient taxable income in future periods to realize the tax benefit associated with the related deferred tax assets. As a result, we released $4.9 million of the valuation allowance on our foreign deferred tax assets.
During the fourth quarter of 2011, we concluded that it was more likely than not that we would be able to realize the benefit of a significant portion of our deferred tax assets in the future as a result of cumulative profitability and expected future taxable income, resulting in the recognition of a tax benefit from the reversal of $22.0 million of the valuation allowance on our net federal and certain state deferred income tax assets.
Stock option excess tax benefits of $0 and $35,000 were credited to additional paid-in-capital during the years ended December 31, 2013 and 2012, respectively. During the year ended December 31, 2012, we repurchased $90.0 million of our 2.875% convertible note due 2015 and recognized a loss for tax purposes, which is the difference between the carrying value of the liability for tax purposes compared to the repurchase price. In addition, the deferred tax asset related to the repurchased call option and deferred tax liability related to the warrant sold were recognized. The recognition of the loss for tax purposes (to the extent it related to equity transactions) and the related deferred tax asset and liability totaling $2.5 million was credited to additional paid in capital during the year ended December 31, 2012.
Comparison of Years Ended December 31, 2012 and 2011
Revenues. Overall, the increase in the medical segment revenue in the year ended December 31, 2012 compared with the year ended December 31, 2011 was driven by increased demand for our disposable products, as well as higher revenues resulting from our continued growth in our direct sales efforts in Japan and favorable impacts of foreign exchange rates related to the yen, partially

47



offset by the decline in the medical reimbursement rate in Japan, unfavorable impacts of foreign exchange rates to the euro and decreases in our revenues in southern Europe, in particular Spain where we were in the process of transitioning from a distributor to a direct sale model. Additionally, the increases in FFR disposable revenues were primarily due to the increased adoption of the technology based on clinical study data. 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 across all our key geographic markets except for Europe. The Japanese market’s growth was 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 European markets related to the unfavorable impacts of foreign currency exchange rates related to the euro and to the slowing economy in Europe, primarily in Spain.

Cost of Revenues. The increase in the cost of revenues in the year ended December 31, 2012 compared with the year ended December 31, 2011 was primarily due to higher sales volume. Gross margin was 66.2% of revenues in the year ended December 31, 2012, decreasing from 66.7% of revenues in the year ended December 31, 2011. This unfavorable change in gross margin was primarily the result of the unfavorable impact of the foreign exchange rates to the euro and unfavorable impact on pricing as a result of a decline in the medical reimbursement rate in Japan.
Selling, General and Administrative. The increase in selling, general and administrative expenses in the year ended December 31, 2012 compared with the year ended December 31, 2011 was primarily due to the higher variable costs for U.S. sales driven by higher sales volumes, the expansion of Japan and Europe sales and marketing organizations, including continued growth in our Japan operation to support our direct sales efforts there, expansion of our Costa Rica general and administrative activities during the pre-production phase in the first two quarters of 2012, and increased information technology and infrastructure expenses to support company growth.
Research and Development. The increase in research and development expenses in the year ended December 31, 2012 compared with the year ended December 31, 2011 was primarily due to increased spending on various product development projects and activities supporting other acquired technologies.
Amortization of Intangibles. The decrease in amortization expense in the year ended December 31, 2012 compared with the year ended December 31, 2011 was primarily due to the complete amortization of customer relationships acquired in 2009.
Acquisition-Related Items. The acquisition-related items during the year ended December 31, 2012 consist of $1.6 million of transaction costs related to the Sync-Rx and Crux acquisitions and a $231,000 change in fair value of the contingent consideration related to the Crux acquisition as a result of the passage of time from acquisition date to December 31, 2012.
Interest Income. Interest income for the year ended December 31, 2012 as compared to the year ended December 31, 2011 remained consistent.
Interest Expense. The increase in interest expense during the year ended December 31, 2012 compared with the year ended December 31, 2011 was primarily related to interest incurred on the convertible debt issued in December 2012.
Exchange Rate Gain (Loss). During the years ended December 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.
Loss from Debt Extinguishment. During the year ended December 31, 2012, we repurchased $90.0 million of our 2.875% convertible senior notes due 2015, or the 2015 Notes, and recognized a $5.0 million loss, which is the difference between the carrying value of the liability component of the 2015 Notes, including any unamortized debt issuance costs, and the consideration attributed to the retirement of the liability component.
Other. During the year ended December 31, 2012, we recognized $2.8 million of gains in connection with the liquidation of a long term investment, which had been accounted for using the cost method.
Provision for Income Taxes. During the year ended December 31, 2012, we recognized income tax expense of $1.7 million compared to an income tax benefit of $20.0 million during the year ended December 31, 2011. During the quarter ended December 31, 2012, we concluded that it was more likely than not that we would be able to realize the benefit of a significant portion of our foreign deferred tax assets in the future. We expect that our foreign operations in the respective jurisdictions will generate sufficient taxable income in future periods to realize the tax benefit associated with the related deferred tax assets. As a result, we released $4.9 million of the valuation allowance on our foreign deferred tax assets. During the quarter ended December 31, 2011, we concluded that it was more likely than not that we would be able to realize the benefit of a significant portion of our deferred tax assets in the future as a result of cumulative profitability and expected future taxable income, resulting in the recognition of a tax benefit from the reversal of $22.0 million of the valuation allowance on our net federal and certain state deferred income tax assets.

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Stock option excess tax benefits of $35,000 and $165,000 were credited to additional paid-in-capital during the years ended December 31, 2012 and 2011, respectively. During the year ended December 31, 2012, we repurchased $90.0 million of our 2.875% convertible note due 2015 and recognized a loss for tax purposes, which is the difference between the carrying value of the liability for tax purposes compared to the repurchase price. In addition, the deferred tax asset related to the repurchased call option and deferred tax liability related to the warrant sold were recognized. The recognition of the loss for tax purposes (to the extent it related to equity transactions) and the related deferred tax asset and liability totaling $2.5 million was credited to additional paid in capital during the year ended December 31, 2012. The reversal of the valuation allowance related to our convertible senior notes of $1.7 million was credited to additional paid in capital during the year ended December 31, 2011.
Liquidity and Capital Resources
Sources of Liquidity
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; and
interest income.
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 to repay our debt obligations and related interest expense;
cash used for acquisitions; and
cash used to repurchase outstanding common stock.
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 million principal amount of 2.875% Notes due 2015, or the 2015 Notes, in an offering registered under the Securities Act of 1933, as amended. To hedge against potential dilution upon conversion of the 2015 Notes, we purchased call options on our common stock. In addition, to reduce the cost of the hedge, under separate transactions we sold warrants. We received proceeds of $100.5 million from issuance of the 2015 Notes, net of issuance costs ($4.4 million) and net payments related to our hedge transactions ($10.0 million).
On December 5, 2012, we issued $460.0 million principal amount of 1.75% Notes due 2017, or the 2017 Notes, in an offering registered under the Securities Act of 1933, as amended. To hedge against potential dilution upon conversion of the 2017 Notes, we purchased call options on our common stock. In addition, to reduce the cost of the hedge, under separate transactions we sold warrants. We received proceeds of $409.3 million from the issuance of the 2017 Notes, net of debt issuance costs ($14.6 million) and net payments related to our hedge transactions ($36.1 million).
Concurrently with the issuance of the 2017 Notes, we retired $90.0 million of the 2015 Notes and retired the proportionate portion of the warrants and call options related to the 2015 Notes. We paid $104.9 million to repurchase the $90.0 million face value of the 2015 Notes and received a net amount of $3.6 million related to the retirement of the proportionate warrants and call options associated with the 2015 Notes.
On December 2, 2013, our board of directors authorized a $200 million share repurchase program. Pursuant to this approval, we entered into a $100 million accelerated share repurchase, or ASR, program with a counterparty, and received 3,557,137 shares of our common stock. The final number of shares to be repurchased by us under this ASR will be determined at the completion of the ASR program and will be based generally on the daily volume-weighted average share price of our common stock during a period of up to approximately four months, less an agreed-to discount.

49



At December 31, 2013, our cash and cash equivalents and available-for-sale investments totaled $373.9 million. We invest our excess funds in U.S. government securities, corporate fixed income securities, commercial paper, certificates of deposit and money market funds.
At December 31, 2013, our accumulated deficit was $116.4 million. Since inception, we have generated significant operating losses. During the years ended December 31, 2012 and 2011, we achieved full years of profitability. During the years ended December 31, 2013, 2012 and 2011, our business generated $13.5 million, $49.8 million and $43.6 million in cash flows from operating activities, respectively.
Cash Flows (in thousands)
 
 
Years Ended December 31,
 
 
2013
 
2012
 
2011
Net cash provided by operating activities
 
$
13,514

 
$
49,818

 
$
43,596

Net cash (used in) provided by investing activities
 
(145,691
)
 
(147,216
)
 
6,729

Net cash (used in) provided by financing activities
 
(90,126
)
 
321,756

 
13,140

Effect of exchange rate changes on cash and cash equivalents
 
(1,173
)
 
(739
)
 
122

Net change in cash and cash equivalents
 
$
(223,476
)
 
$
223,619

 
$
63,587

Cash Flows from Operating Activities. Cash provided by operating activities of $13.5 million for 2013 reflected our net loss of $34.5 million, adjusted for non-cash expenses, consisting primarily of $29.7 million of depreciation and amortization, including amortization or accretion of investment premium or discount, $16.1 million of stock-based compensation expense, $19.0 million of accretion of debt discount on convertible notes and other long-term debt, $11.4 million of asset impairment charges related to restructuring activities, and $3.6 million of accretion of contingent consideration, offset by a $5.8 million gain on sale of other long-term investments. Additional sources of cash include increases in accrued compensation ($2.7 million), accrued expenses and other liabilities ($4.0 million) and deferred revenue ($1.3 million). Uses of cash include an increase in accounts receivable of $10.4 million due to increased sales, an increase in inventories of $14.4 million related to increased forecast sales demand, and an increase in prepaid expenses and other assets of $3.9 million.
Cash provided by operating activities of $49.8 million for 2012 reflected our net income of $8.0 million, adjusted for non-cash expenses, consisting primarily of $26.8 million of depreciation and amortization, including amortization or accretion of investment premium or discount, $15.1 million of stock-based compensation expense, $5.7 million of accretion of debt discount on convertible notes and $5.0 million for the loss incurred on the extinguishment of debt. Additional sources of cash include increases in accrued compensation ($3.4 million), accrued expenses and other liabilities ($6.8 million) and deferred revenue ($4.2 million). Uses of cash include an increase in accounts receivable of $10.0 million due to increased sales and an increase in inventories of $13.3 million related to increased forecast sales demand.
Cash provided by operating activities of $43.6 million for 2011 reflected our net income of $38.1 million, adjusted for non-cash expenses, consisting primarily of $27.0 million of depreciation and amortization, including amortization or accretion of investment premium or discount, $13.0 million of stock-based compensation expense and $4.7 million of accretion of debt discount on our convertible notes, offset by $22.8 million deferred tax benefit. Additional sources of cash include increases in accrued compensation ($2.0 million) and deferred revenue ($1.9 million). Uses of cash included an increase in accounts receivable of $9.3 million due to increased sales, a decrease in accounts payable of $2.4 million and a decrease in accrued expenses and other liabilities of $6.5 million.
Cash Flows from Investing Activities. In 2013, $375.0 million was used to purchase short-term and long-term available-for-sale securities and $31.9 million was used for capital expenditures, including purchases of medical diagnostic equipment, manufacturing equipment and our ERP system. Additionally, we used $15.0 million for the acquisitions of Pioneer, $3.5 million for the acquisition of other intangible assets, including purchased technology and costs of patents, and $17.9 million for the acquisition of other long-term investments. These purchases were partially offset by $290.3 million from the sale or maturity of available-for-sale investments and $7.3 million of proceeds we received from sales of other long-term investments.
In 2012, $298.3 million was used to purchase short-term and long-term available-for-sale securities and $43.8 million was used for capital expenditures, including purchases of medical diagnostic equipment, manufacturing equipment and construction of the manufacturing facility in Costa Rica. Additionally, we used $54.5 million for the acquisitions of Sync-Rx and Crux, net of cash acquired, and $5.8 million for the acquisition of other intangible assets, including purchased technology and costs of patents. These purchases were partially offset by $252.9 million from the sale or maturity of investments.
In 2011, $310.6 million was used to purchase short-term and long-term available-for-sale securities and $43.2 million was used for the purchases of long-term assets, including facility construction in Costa Rica, and capital expenditures for medical

50



diagnostic equipment, manufacturing equipment and our ERP systems. Additionally, we used $3.5 million for the acquisition of other intangible assets and other investments, including purchased technology and costs of patents. These purchases were partially offset by $365.6 million from the sale or maturity of investments.
Cash Flows from Financing Activities. Cash provided by financing activities in 2013 consisted primarily of $6.4 million from exercises of common stock options and $3.6 million from the sale of common stock under our employee stock purchase plan. Cash used by financing activities consisted of the payment of $100.0 million for the accelerated share repurchase program we entered into in December 2013 in connection with our share repurchase program.
Cash provided by financing activities in 2012 consisted primarily of net proceeds of $409.3 million from the issuance of the 2017 Notes and related hedge transactions, $9.9 million from exercises of common stock options and $3.9 million from the sale of common stock under our employee stock purchase plan, partially offset by the net payment of $101.3 million from the repurchase of a portion of the 2015 Notes and retirement of the related proportionate hedge transaction.
Cash provided by financing activities in 2011 consisted primarily of $9.4 million from exercises of common stock options, and $3.6 million from the sale of common stock under our employee stock purchase plan.
Future Liquidity Needs
At December 31, 2013, our primary short-term needs for capital, which are subject to change, include expenditures related to:
medical diagnostic equipment that we own and place at our customers’ premises;
the acquisition of equipment and other fixed assets for use in our current and future manufacturing and research and development facilities;
support of our commercialization efforts related to our current and future products, including expansion of our direct sales force and field support resources in the U.S. and abroad, particularly in Japan where our strategy is to continue to pursue a direct sales model;
the continued advancement of research and development activities;
improvements to and increases in our manufacturing capacity and efficiency; and
acquisitions of technologies and/or businesses that enhance our capabilities or complement our markets.

Our capital expenditures are largely discretionary and within our control. We expect that our product revenue and the resulting operating income, as well as the status of each of our product development programs, will significantly impact our cash management decisions.
At December 31, 2013, we believe our current cash and cash equivalents and our available-for-sale investments will be sufficient to fund working capital requirements, debt service requirements, capital expenditures 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 extent and duration of any future operating losses, 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 “Risk Factors—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.” 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 that such funding will be available in needed quantities or on terms favorable to us, if at all.
At December 31, 2013, we have gross federal and state net operating loss carry forwards of approximately $133.6 million and $80.4 million, respectively, available to reduce future taxable income if we remain profitable. Pursuant to Internal Revenue Code Section 382, use of net operating loss carry forwards related to acquisitions of an additional approximately $20.1 million may be limited. We may have incurred one or more ownership changes under Internal Revenue Code Section 382 in 2013 and as such our net operating losses may be limited in future years. We are in the process of completing a formal Internal Revenue Code 382 study to determine the annual limitation on the use of the net operating losses. We do not expect substantial limitations. We expect to

51



utilize our available net operating loss carry forwards to reduce future tax obligations in the event we are successful in maintaining continued profitability. However, future limitations on our ability to use net operating loss carry forwards and other minimum state taxes may increase our overall tax obligations.
Off-Balance Sheet Arrangements
In conjunction with the sale of our products in the ordinary course of business, we provide standard indemnification to business partners and customers for losses suffered or incurred for patent, copyright or any other intellectual property infringement claims by any third parties with respect to our products. The term of these indemnification arrangements is generally perpetual. The maximum potential amount of future payments we could be required to make under these agreements is unlimited. At December 31, 2013, we have not incurred any costs to defend lawsuits or settle claims related to these indemnification arrangements.
Contractual Obligations
The following table summarizes our significant contractual obligations and commercial commitments at December 31, 2013 for each of the periods indicated (in thousands):
 
Contractual Obligations
 
Payments Due By Period
Total
 
Less
Than
1 Year
 
1-3
Years
 
3-5
Years
 
More
than
5 Years
Capital lease obligations (including interest)
 
$
30

 
$
18

 
$
12

 
$

 
$

Operating lease obligations (1)
 
55,452

 
8,800

 
11,574

 
10,629

 
24,449

Non-cancelable purchase obligations (2)
 
70,077

 
65,752

 
4,325

 

 

Convertible senior notes
 
485,000

 

 
25,000

 
460,000

 

Interest on convertible senior notes
 
32,727

 
8,769

 
16,579

 
7,379

 

Clinical programs (3)
 

 

 

 

 

Total (4)
 
$
643,286

 
$
83,339

 
$
57,490

 
$
478,008

 
$
24,449

 
(1)
We lease office space and have entered into other lease commitments in the U.S. as well as locations in Japan, Europe, Asia and the Middle East. Operating lease obligations include future minimum lease payments under all our non-cancelable operating leases at December 31, 2013.
(2)
Consists of non-cancelable commitments for the purchase of production materials, other inventory items and services.
(3)
We have commitments to provide funding of $4.6 million to a clinical study conducted by a third-party and at December 31, 2013, we have a remaining obligation of up to $2.1 million. 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.
(4)
The total above does not include the following contingent liabilities: a) potential payment of up to $1.9 million plus interest payable to an agency of the Israeli government; and b) potential milestone payments of an estimated $51.6 million due to the former shareholders of Crux (see Note 2 "Acquisitions" to our consolidated financial statements).
Critical Accounting Policies:
Our financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.
Critical accounting policies are those that are both important to the presentation of our financial condition and results of operations and require management’s subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. As the number of variables and assumptions affecting the possible future resolution of the uncertainties increase, those judgments become even more subjective and complex. In order to provide an understanding about how our management forms its judgments about future events, including the variables and assumptions underlying the estimates, and the sensitivity of those judgments to different circumstances, we have identified our critical accounting policies below.

Revenue Recognition

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We recognize revenues when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable and collectability is reasonably assured. Revenue from the sale of our products is generally recognized when title and risk of loss transfers to the customer, the terms of which are generally free on board, or FOB, shipping point. We use contracts and customer purchase orders to determine the existence of an arrangement. We use shipping documents and third-party proof of delivery to verify that title has transferred. We assess whether the fee is fixed or determinable based upon the terms of the agreement associated with the transaction. To determine whether collection is probable, we assess a number of factors, including past transaction history with the customer and the creditworthiness of the customer.
We recognize revenue from consignment arrangements based on product usage, which indicates that the sale is complete. Installation and training are generally not required elements of our sales transactions as most of our products do not require these services. In instances where installation and training are required elements of the sales transaction, revenue is recognized upon completion.
For an arrangement containing multiple deliverables that are considered separate units of accounting, these deliverables can consist of consoles, options for the console, single-procedure disposable products, among other items and are considered separate units of accounting. We allocate arrangement consideration based on the relative selling prices of the separate units of accounting contained within an arrangement containing multiple deliverables. Selling prices are determined using fair value, when available, or our estimate of selling price when fair value is not available. Typically, we recognize revenue for each unit of accounting upon delivery of the item and complete all obligations under an arrangement with multiple deliverables within one year.
We evaluate lease agreements entered into with customers to determine whether they are sales-type leases or operating leases. Agreements classified as operating leases result in rental revenue reported on a straight-line basis as income over the lease term as it becomes receivable according to the provisions of the lease. For leases qualifying as sales-type leases, we recognize the present value of the lease payments as revenue at the time the lease is recorded and the associated unearned interest is amortized over the term of the lease. Our sales-type lease and operating lease revenue and receivables relating to sales-type leases are not significant for the years ended 2013, 2012 and 2011.
All costs associated with the provision of service are recognized in cost of revenues as incurred. Amounts billed in excess of revenue recognized are included as deferred revenue in the consolidated balance sheets.
We sell our products through direct sales representatives in the U.S. and a combination of direct sales representatives and independent distributors in international markets. Sales to distributors are recorded when title and risk of loss transfer upon shipment (generally FOB shipping point). No direct sales customers or distributors have price protection. Estimated returns, which are historically nominal, are recorded as an allowance for sales return and as a reduction in revenues.
Fair Value
We record our short-term and long-term available-for-sale investments at fair value. At December 31, 2013, our cash and investments totaled $373.9 million. FASB ASC Topic 820, Fair Value Measurements and Disclosures, or ASC 820, establishes three levels of inputs that may be used to measure fair value (see Note 3 “Financial Statement Details” to our consolidated financial statements included in this Annual Report). Each level of input represents varying degrees of subjectivity and difficulty involved in determining fair value. Valuations using Level 1 and 2 inputs are generally based on price quotations and other observable inputs in active markets and do not require significant management judgment or estimation. We utilize a third-party pricing service to assist us in obtaining fair value pricing for these investments. While pricing for these securities is based on proprietary models, the inputs used are based on observable market information, therefore we have classified our inputs as Level 1 and Level 2.
We record our foreign exchange forward contracts at fair value. At December 31, 2013, the fair value of our foreign exchange forward contracts of $2.9 million was included in prepaid and other current assets, $81,000 was included in other non-current assets and $1.4 million was included in other current liabilities in our consolidated balance sheet. We utilize third-party financial institutions to assist us in obtaining fair value pricing for our foreign currency forward contracts and classified these fair value inputs as Level 2.
We also record contingent consideration, which consist of obligations to pay former shareholders of an acquired entity if specified events occur or conditions are met such as the achievement of certain technological milestones or the achievement of targeted revenue milestones, at fair value. At December 31, 2013, the fair value of our contingent consideration arrangements was $33.6 million (net of the $1.2 million contingent receivable). We determined the fair values of the contingent consideration, which includes payment upon FDA clearance and milestone payments based on commercial sales of Crux products, using various estimates, including revenue projections, discount rates and amount of time until the conditions of the milestone payments are met. This fair value measurement is based on significant inputs not observable in the market, representing a Level 3 measurement within the fair value hierarchy. For the fair value relative to the milestone payments based on the commercial sales of Crux products, the key assumptions in applying the income approach include a 14% discount rate and probability-weighted expected milestone

53



payment ranges from $32.8 million to $70.1 million based on projected commercial sales of Crux products ranging from $124.9 million to $279.8 million from December 2013 to 2019.
In addition, we recorded a contingent liability related to a government grant received to develop an underlying technology. The timing of repayment of the grant is contingent upon the generation of revenues derived from the technology for which grant proceeds were received. The grant was recorded as other long term debt at its present value, $1.3 million at December 31, 2013, using various estimates, including revenue projections, discount rate and estimated years of repayment. This fair value measurement is based on significant inputs not observable in the market, representing a Level 3 measurement within the fair value hierarchy. At December 31, 2013, for the fair value relative to this liability, the key assumptions in applying the income approach included an 8% discount rate and estimated commercial sales derived from the underlying technology ranging from $256.1 million to $298.3 million over the expected period of repayment of 10 to 16 years.

Inventory Valuation
Inventories are valued at the lower of first-in, first-out cost or market value. Inventory provisions are recorded for materials that have become obsolete or are no longer used in current production and for inventory that has a market value less than the carrying value in inventory. We regularly monitor potential inventory excess, obsolescence and lower market values compared to standard costs and, when necessary, reduce the carrying amount of our inventory to its market value. Specific reserves are maintained to reduce the carrying value of inventory items on hand that we know may not be used in finished goods. If our estimates for potential inventory losses prove to be too low, then our future earnings will be affected when the related additional inventory losses are recorded.
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation and amortization. Equipment and capitalized software are depreciated over the estimated useful lives of the assets, which range generally from three to ten years. Leasehold improvements are amortized over the lesser of the lease term including renewal periods that are reasonably assured or the estimated useful lives of the improvements, which are between three and ten years. The straight-line method is used for depreciation and amortization. Land is stated at cost and is not depreciated. Significant improvements which substantially extend the useful lives of assets are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred.
Assets held under capital leases are recorded at the net present value of the minimum lease payments of the leased asset at the inception of the lease. Amortization expense is computed using the straight-line method over the shorter of the estimated useful lives of the assets or the period of the related lease and is included in our depreciation expense.
Our long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Impairment is calculated as the excess of the asset’s carrying value over its fair value. Fair value is generally determined using a discounted future cash flow analysis. We recorded $2.0 million in long-lived assets impairment charges as part of our restructuring charges during 2013. See Note 3 “Financial Statement Details—Restructuring Activity" for additional information. No significant impairment of long-lived assets was identified or recorded during the years ended December 31, 2012 and 2011.
Goodwill
We allocate any excess purchase price over the fair value of the net tangible and intangible assets acquired in a business combination to goodwill. The impairment evaluation for goodwill is conducted annually as of October 1, or more frequently if events or changes in circumstances indicate the carrying value of the goodwill may not be recoverable. We test for goodwill impairment at the reporting unit level, which is the same as our operating segment level. Our goodwill at December 31, 2013 and 2012 is allocated entirely to our medical segment.
We first assess qualitative factors to determine whether it is necessary to perform the two-step impairment test. If we believe, as a result of the qualitative assessment, that it is more-likely-than-not that the fair value of our reporting unit is less than its carrying amount, the quantitative two-step impairment test is required; otherwise, no further testing is required. In the first step, we compare the fair value of our reporting unit to its carrying value. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of our reporting unit, then the second step of the impairment test is performed in order to determine the implied fair value of our reporting unit's goodwill. If the carrying value of our reporting unit's goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference. There was no impairment of goodwill during the years ended December 31, 2013, 2012 and 2011.
Intangible Assets

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Intangible assets are recorded at historical cost and amortized over their estimated useful lives. Intangible assets consist of acquired developed technology, licenses, customer relationships, patents and trademarks and covenants-not-to-compete as well as acquired in-process research and development technology. Intangible assets with a definite life are amortized using the straight-line method over their estimated useful lives of up to 20 years.
When we acquire another entity, the purchase price is allocated, as applicable, between acquired in-process research and development, or IPR&D, other identifiable intangible assets, and net tangible assets, with the remainder recognized as goodwill. IPR&D has an indefinite life and is not amortized until completion and development of the project, at which time the IPR&D becomes an amortizable asset. If the related project is not completed in a timely manner or the project is terminated or abandoned, we may have an impairment related to the IPR&D, calculated as the excess of the asset’s carrying value over its fair value. Determining the allocation of the purchase price, including the portion of the purchase price allocated to IPR&D requires us to make significant estimates. The amount of the purchase price allocated to IPR&D is determined by estimating the future cash flows of each project or technology and discounting the net cash flows back to their present values. The discount rate used is determined at the time of measurement in accordance with accepted valuation methods. These methodologies include consideration of the risk of the project not achieving commercial feasibility.
Intangible assets with definite lives are tested for impairment annually or whenever events or circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Impairment is calculated as the excess of the asset’s carrying value over its fair value. Fair value is generally determined using a discounted future cash flow analysis. We recorded $6.3 million in intangible asset impairment charges, including $4.1 million IPR&D impairment, as part of the restructuring charges during 2013. See Note 3 “Financial Statement Details—Restructuring Activity” for additional information. No impairment of intangible assets was identified or recorded during the years ended December 31, 2012 and 2011.
Stock-based Compensation
We account for stock-based compensation under the provisions of FASB ASC Topic 718, Compensation—Stock Compensation, or ASC 718, which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair values on the grant date. We estimate the fair value of stock-based awards on the date of grant using the Black-Scholes-Merton option pricing model, or Black-Scholes model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods using the straight-line method. We estimate forfeitures at the time of grant and revise our estimate in subsequent periods if actual forfeitures differ from those estimates. See Note 5 “Stockholders’ Equity” to our consolidated financial statements for a complete discussion of our equity compensation programs and the fair value assumptions used to determine our stock-based compensation expense.
We have used the Black-Scholes model to estimate fair value of our stock-based awards which requires various judgmental assumptions including estimating stock price volatility, risk-free interest rate, and expected option life. If we had made different assumptions, the amount of our deferred stock-based compensation, stock-based compensation expense, gross margin, net income (loss) and net income (loss) per share amounts could have been significantly different. We believe that we have used reasonable metho