ZELTIQ
Zeltiq Aesthetics Inc (Form: 10-Q, Received: 11/08/2012 15:41:17)
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________
FORM 10-Q
____________________________________________
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period             to             .
Commission file number: 001-35318
____________________________________________
ZELTIQ Aesthetics, Inc.
(Exact name of registrant as specified in its charter)
____________________________________________
Delaware
 
27-0119051
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. employer
identification no.)
4698 Willow Road, Suite 100
Pleasanton, CA 94588
(Address of principal executive offices and Zip Code)
(925) 474-2500
(Registrant’s telephone number, including area code)
____________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   ý     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   ý     No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
 
Large accelerated filer
 
¨
  
Accelerated filer
 
¨
Non-accelerated filer
 
ý
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes   ¨     No   ý
As of November 1, 2012 , there were 35,746,776 shares of the registrant’s common stock, par value $0.001 per share, outstanding.
 


Table of Contents

ZELTIQ Aesthetics, Inc.
INDEX
 
 
 
PAGE
NUMBER
PART I
FINANCIAL INFORMATION
 
ITEM 1:
 
 
 
 
 
 
ITEM 2:
ITEM 3:
ITEM 4:
 
 
 
PART II
OTHER INFORMATION
 
ITEM 1:
ITEM 1A:
ITEM 2:
ITEM 5:
ITEM 6:
 

2

Table of Contents

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
ZELTIQ Aesthetics, Inc.
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands, except share and per share data)
 
 
September 30,
2012
 
December 31,
2011
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
22,172

 
$
83,908

Short-term investments
29,022

 

Accounts receivable, net
7,043

 
4,941

Inventory
7,679

 
4,476

Prepaid expenses and other current assets
3,374

 
2,385

Total current assets
69,290

 
95,710

Long-term investments
15,715

 

Restricted cash
386

 
255

Property and equipment, net
2,085

 
2,144

Intangible asset, net
7,357

 
7,882

Other assets
89

 
8

Total assets
$
94,922

 
$
105,999

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
3,937

 
$
4,061

Accrued liabilities
12,223

 
6,878

Deferred revenue
1,119

 
375

Current portion of notes payable

 
310

Total current liabilities
17,279

 
11,624

Other non-current liabilities
184

 
72

Total liabilities
$
17,463

 
$
11,696

Commitments and contingencies (Note 9)

 

STOCKHOLDERS’ EQUITY:
 
 
 
Preferred stock, $0.01 par value: 50,000,000 shares authorized and no shares issued and outstanding at September 30, 2012 and December 31, 2011

 

Common stock, $0.001 par value: 500,000,000 shares authorized at September 30, 2012 and December 31, 2011; 35,577,442 and 33,997,809 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively
38

 
37

Additional paid-in capital
184,647

 
178,122

Notes receivable from a stockholder

 
(245
)
Accumulated other comprehensive income
13

 

Accumulated deficit
(107,239
)
 
(83,611
)
Total stockholders’ equity
77,459

 
94,303

Total liabilities and stockholders’ equity
$
94,922

 
$
105,999

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


3

Table of Contents

ZELTIQ Aesthetics, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)
(In thousands, except share and per share data)
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Revenues
$
17,928

 
$
17,720

 
$
57,597

 
$
49,346

Cost of revenues
5,953

 
7,283

 
19,096

 
19,632

Gross profit
11,975

 
10,437

 
38,501

 
29,714

Operating expenses:
 
 
 
 
 
 
 
Research and development
2,450

 
2,933

 
9,217

 
7,540

Sales and marketing
10,881

 
7,104

 
39,632

 
18,672

General and administrative
3,760

 
3,209

 
13,169

 
7,240

Total operating expenses
17,091

 
13,246

 
62,018

 
33,452

Loss from operations
(5,116
)
 
(2,809
)
 
(23,517
)
 
(3,738
)
Interest income (expense), net
11

 
(24
)
 
100

 
(84
)
Other income (expense), net
(44
)
 
(17
)
 
(108
)
 
(412
)
Loss before provision for income taxes
(5,149
)
 
(2,850
)
 
(23,525
)
 
(4,234
)
Provision for income taxes
33

 

 
103

 

Net loss
(5,182
)
 
(2,850
)
 
(23,628
)
 
(4,234
)
Cumulative dividends on convertible preferred stock

 
(1,564
)
 

 
(4,691
)
Net loss attributable to common stockholders
$
(5,182
)
 
$
(4,414
)
 
$
(23,628
)
 
$
(8,925
)
Net loss per share attributable to common stockholders, basic and diluted
$
(0.15
)
 
$
(3.17
)
 
$
(0.69
)
 
$
(6.72
)
Weighted average shares of common stock outstanding used in computing net loss attributable to common stockholders—basic and diluted
35,068,076

 
1,391,049

 
34,444,680

 
1,327,143

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


4

Table of Contents

ZELTIQ Aesthetics, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(Unaudited)
(In thousands)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Net loss
$
(5,182
)
 
$
(2,850
)
 
$
(23,628
)
 
$
(4,234
)
Other comprehensive income
 
 
 
 
 
 
 
Changes in unrealized gains (losses) on available-for-sale securities
28

 

 
13

 

Other comprehensive income
28

 

 
13

 

Comprehensive loss
$
(5,154
)
 
$
(2,850
)
 
$
(23,615
)
 
$
(4,234
)
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


5

Table of Contents

ZELTIQ Aesthetics, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
 
 
Nine Months Ended
 
September 30,
 
2012
 
2011
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(23,628
)
 
$
(4,234
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
1,182

 
580

Stock-based compensation
3,922

 
1,309

Change in fair value of preferred stock warrant liability

 
384

Amortization of debt discount

 
36

Issuance of common stock for services

 
19

Amortization of premiums and accretion of discounts on investments
122

 

Provision for excess and obsolete inventory
(26
)
 
86

Loss on disposal of property and equipment
192

 
227

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(2,102
)
 
(5,018
)
Inventory
(3,177
)
 
(2,215
)
Prepaid expenses and other assets
(1,070
)
 
229

Deferred revenue
744

 
(145
)
Accounts payable, accrued and other non-current liabilities
5,298

 
3,544

Net cash used in operating activities
(18,543
)
 
(5,198
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchase of investments
(52,596
)
 

Sale or maturity of investments
7,750

 

Purchase of property and equipment
(755
)
 
(1,329
)
Restricted cash
(131
)
 
170

Net cash used in investing activities
(45,732
)
 
(1,159
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repayment of notes payable
(310
)
 
(1,192
)
Proceeds from repayment of note receivable by a stockholder
245

 

Deferred initial public offering costs

 
(1,162
)
Proceeds from issuance of common stock
2,604

 
176

Net cash provided by (used in) financing activities
2,539

 
(2,178
)
NET DECREASE IN CASH AND CASH EQUIVALENTS
(61,736
)
 
(8,535
)
CASH AND CASH EQUIVALENTS—Beginning of period
83,908

 
12,667

CASH AND CASH EQUIVALENTS—End of period
$
22,172

 
$
4,132

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.


6

Table of Contents

Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Overview
ZELTIQ Aesthetics, Inc. (“we” or the “Company”) was incorporated in the state of Delaware on March 22, 2005 . The Company was founded to develop and commercialize a non-invasive product for the selective reduction of fat. Our first commercial product, the CoolSculpting System, is designed to selectively reduce stubborn fat bulges that may not respond to diet or exercise. CoolSculpting is based on the scientific principle that fat cells are more sensitive to cold than the overlying skin and surrounding tissues. CoolSculpting utilizes precisely controlled cooling to reduce the temperature of fat cells in the treated area, which leads to fat cell elimination through a natural biological process known as apoptosis, without causing scar tissue or damage to the skin, nerves, or surrounding tissues. We generate revenues from sales of our CoolSculpting System and from procedure fees our physician customers pay for each CoolSculpting procedure.
In August 2011 , the Company incorporated ZELTIQ Limited as a wholly owned subsidiary in the United Kingdom to serve as its direct sales office.
Reverse Stock Split
On October 13, 2011 , the Company filed a certificate of amendment to the Company’s amended and restated certificate of incorporation that effected a reverse stock split of the Company’s common stock in which each 3.670069 shares of common stock outstanding or held in treasury immediately prior to such time was combined into one share of common stock. The par value of the common stock remained $0.001 per share. Accordingly, all share and per share amounts for all periods presented in these condensed consolidated financial statements and notes thereto, have been adjusted retroactively, where applicable, to reflect this reverse stock split.
Initial Public Offering
On October 24, 2011 , the Company completed its initial public offering (“IPO”) of 8,050,000 shares of common stock at an offering price of $13.00 per share, of which 7,743,000 shares were sold by the Company and 307,000 shares were sold by existing stockholders. The Company received net proceeds of approximately $90.7 million , after deducting underwriting discounts, commissions and offering related transaction costs. In connection with the IPO, the Company’s outstanding shares of convertible preferred stock were automatically converted into 24,415,965 shares of common stock.

2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying interim condensed consolidated financial statements are unaudited. These interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the applicable rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The December 31, 2011 condensed consolidated balance sheet was derived from the audited financial statements as of that date, but does not include all of the information and footnotes required by GAAP for complete financial statements.
The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments of a normal recurring nature considered necessary to state fairly the Company's financial position as of September 30, 2012 , results of operations for the three and nine months ended September 30, 2012 and 2011 , comprehensive loss for the three and nine months ended September 30, 2012 and 2011 , and cash flows for the nine months ended September 30, 2012 and 2011 . The interim results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012 or for any other future annual or interim period. Certain amounts in prior year's consolidated balance sheet have been reclassified to conform to the current period's presentation. These reclassifications had no impact on previously reported results of consolidated operations or consolidated stockholders' equity.
The information included in this Quarterly Report on Form 10-Q should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures About Market Risk” and the Consolidated Financial Statements and notes thereto included in Items 7, 7A and 8, respectively, in the Company's Annual Report on Form 10-K for the year ended December 31, 2011 .

7



Principles of Consolidation
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with US GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. The primary estimates underlying our financial statements include the product warranty, inventory valuation, allowance for doubtful accounts receivable, assumptions regarding variables used in calculating the fair value of our equity awards, fair value of investments, useful lives of intangibles, income taxes and contingent liabilities. Actual results could differ from those estimates.
Summary of Significant Accounting Policies
There have been no material changes to the Company’s significant accounting policies during the nine months ended September 30, 2012 as compared to the significant accounting policies described in the Company’s Form 10-K for the year ended December 31, 2011 , except for the investments policy noted below.
Investments
The Company invests its excess cash balances primarily in certificates of deposit, commercial paper, corporate bonds, and U.S. Government agency securities. Investments with original maturities greater than 90 days that mature less than one year from the consolidated balance sheet date are classified as short-term investments. The Company classifies all of its investments as available-for-sale and records such assets at estimated fair value in the consolidated balance sheets, with unrealized gains and losses, if any, reported as a component of accumulated other comprehensive income (loss) in stockholders' equity. Realized gains and losses from maturities of all such securities are reported in earnings and computed using the specific identification cost method.  Realized gains or losses and charges for other-than-temporary declines in value, if any, on available-for-sale securities are reported in other income (expense) as incurred.  The Company periodically evaluates these investments for other-than-temporary impairment.
Revenue Recognition
The Company’s revenues are derived from the sales of the CoolSculpting System, consisting of a control unit and applicators, and from procedure packs, consisting of consumables and CoolCards. Embedded software exists in the CoolCard product to permit the Company’s physician customers to perform a fixed number of CoolSculpting procedures. This software is not marketed separately from the CoolSculpting System or from the CoolCard. Rather, the functionality that the software provides is part of the overall CoolCard product. The CoolSculpting System is marketed as a non-invasive aesthetic device for the reduction of fat, not for its embedded software attributes included in the CoolCard that enable its use. The Company does not provide rights to upgrades and enhancements or post-contract customer support for the embedded software. In addition, the Company does not incur significant software development costs or capitalize its software development costs. Based on this assessment, the Company considers the embedded software in the CoolCard incidental to the CoolCard product as a whole and determined that revenue recognition should not be governed by the provisions of Topic 985 of the FASB Accounting Standards Codification. The Company earns revenue from the sale of its products to physicians and to distributors. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery to the customer has occurred, the sales price is fixed or determinable, and collectability is probable. Revenues are deferred in the event that one of the revenue recognition criteria is not met.
Warranty. The Company includes a standard warranty of three years on the control unit and one year on the applicators. In addition, the Company offers an extended warranty of up to two years on both control units and applicators and recognizes the associated extended warranty revenues over the extended warranty coverage period.
Persuasive Evidence of an Arrangement. The Company uses contracts and/or customer purchase orders to determine the existence of an arrangement.
Delivery. The Company uses shipping documents to verify that delivery has occurred.
CoolSculpting Systems & Procedure Packs. Delivery occurs upon shipment.
Multiple-Element Arrangements. Typically, all products sold to a customer are delivered at the same time. If a partial delivery occurs as authorized by the customer, the Company allocates revenue to the various products based on their vendor-specific

8


objective evidence of fair value (“VSOE”) if VSOE exists according to ASC 605-25 as the basis of determining the relative selling price of each element. If VSOE does not exist, the Company may use third party evidence of fair value (“TPE”) to determine the relative selling price of each element. If neither VSOE nor TPE exists, the Company may use management’s best estimate of the sales price (“ESP”) of each element to determine the relative selling price. The relative selling prices for control units, applicators and CoolCards are based on established price lists and separate, stand-alone sales of these elements. The Company establishes best estimates within a range of selling prices considering multiple factors including, but not limited to, factors such as size of transaction, pricing strategies and market conditions. The Company believes the use of the best estimate of selling price allows revenue recognition in a manner consistent with the underlying economics of the transaction. The Company’s products do not require maintenance or support.
Sales Price Fixed or Determinable. The Company assesses whether the sales price is fixed or determinable at the time of the transaction. Sales prices are documented in the executed sales contract or purchase order received prior to shipment. The Company’s standard terms do not allow for trial or evaluation periods, rights of return or refund, payments contingent upon the customer obtaining financing or other terms that could impact the customer’s obligation.
Collectability. The Company assesses whether collection is reasonably assured based on a number of factors, including the customer’s past transaction history and credit worthiness.
Advertising costs
The cost of advertising and media is expensed as incurred. For the three months ended September 30, 2012 and 2011 , advertising costs totaled $2.5 million and $104,000 , respectively. For the nine months ended September 30, 2012 and 2011 , advertising costs totaled $9.6 million and $186,000 , respectively.
Recent Accounting Pronouncements
In May 2011, the FASB issued new guidance for fair value measurements to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between US GAAP and International Financial Reporting Standards. The guidance changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements. The Company adopted this guidance effective January 1, 2012, and the adoption did not have an impact on its consolidated financial statements.
In June 2011, the FASB amended its guidance related to comprehensive income to increase the prominence of items reported in other comprehensive income. Accordingly, the Company can present all non-owner changes in stockholders’ equity (deficit) either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company adopted this guidance effective January 1, 2012 and has presented a new consolidated statement of comprehensive loss.

3. Investments
The Company's short-term and long-term investments as of September 30, 2012 are as follows (in thousands):
Short-term
 
 
 
 
 
 
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Agency securities
$
14,522

 
$
2

 
$

 
$
14,524

Corporate bonds
10,422

 
6

 

 
10,428

Commercial paper
2,998

 

 

 
2,998

Certificates of deposit
1,072

 

 

 
1,072

Total
$
29,014

 
$
8

 
$

 
$
29,022

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Long-term
 
 
 
 
 
 
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Agency securities
$
11,323

 
$
5

 
$

 
$
11,328

Corporate bonds
4,387

 
2

 
(2
)
 
4,387

Total
$
15,710

 
$
7

 
$
(2
)
 
$
15,715



9


For the three and nine months ended September 30, 2012 , gains or losses realized on the sale of investments were insignificant.
The Company had no short-term and long-term investments as of December 31, 2011 .
When evaluating the investments for other-than-temporary impairment, we review factors such as the length of time and extent to which fair value has been below the amortized cost basis, review of current market liquidity, interest rate risk, the financial condition of the issuer, as well as credit rating downgrades.  We believe that the unrealized losses are not other-than-temporary. We do not have a foreseeable need to liquidate the portfolio and anticipate recovering the full cost of the securities either as market conditions improve, or as the securities mature.

4. Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. The accounting guidance establishes a three-tiered hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1—Quoted prices in active markets for identical assets or liabilities.
Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The Company did not hold any Level 3 assets or liabilities at September 30, 2012 .
The categorization of a financial instrument within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The Company classifies its cash equivalents and investments within Level 1 and Level 2, as it uses quoted market prices or alternative pricing sources and models utilizing market observable inputs. The following tables set forth the fair value of the Company’s financial assets and liabilities by level within the fair value hierarchy (in thousands):
 
 
As of September 30, 2012
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
Financial Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
16,155

 
$

 
$

 
$
16,155

Short-term investments:
 
 
 
 
 
 
 
U.S. Agency securities

 
14,524

 

 
14,524

Corporate bonds

 
10,428

 

 
10,428

Commercial paper

 
2,998

 

 
2,998

Certificates of deposit
1,072

 

 

 
1,072

Long-term investments:
 
 
 
 
 
 
 
U.S. Agency securities

 
11,328

 

 
11,328

Corporate bonds

 
4,387

 

 
4,387


$
17,227

 
$
43,665

 
$

 
$
60,892


 
As of December 31, 2011
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
Financial Assets
 
 
 
 
 
 
 
Money market funds
$
81,022

 
$

 
$

 
$
81,022


During the three and nine months ended September 30, 2012 , we did not have any transfers of financial assets measured at fair value on a recurring basis to or from Level 1, Level 2 or Level 3.
The Company did not hold any Level 3 assets or liabilities at September 30, 2012 and at December 31, 2011 . The changes in the fair value of the Company’s Level 3 financial liabilities during the year ended December 31, 2011 are summarized below (in thousands):

10


 
December 31, 2011
Fair value of convertible preferred stock warrant liability—beginning of period
$
257

Change in fair value of the convertible preferred stock warrant liability
664

Reclassification of value of convertible preferred stock warrants to additional paid-in
 
capital upon initial public offering
(921
)
Fair value of convertible preferred stock warrant liability—end of period
$

The changes in fair value of the convertible preferred stock warrant liability are recognized as other income (expense), net.
The carrying amounts of the Company’s financial instruments, including cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximate fair value due to their relatively short maturities. The carrying amount of convertible preferred stock warrant liability represents its estimated fair value.
5. Balance Sheet Components
Inventory
Inventory is stated at the lower of cost (which approximates actual cost on a first-in, first-out basis) or market, computed on a standard cost basis. Inventory that is obsolete or in excess of forecasted usage is written down to its estimated net realizable value based on assumptions about future demand and market conditions. Inventory write-downs are charged to cost of revenues and establish a new cost basis for the inventory. The components of inventory consist of the following (in thousands):
 
 
September 30,
2012
 
December 31,
2011
Raw materials
$
3,337

 
$
2,336

Finished goods
4,342

 
2,140

Total inventory
$
7,679

 
$
4,476

Property and equipment, net
Property and equipment, net comprise the following (in thousands):
 
 
September 30,
2012
 
December 31,
2011
Lab equipment, tooling and molds
$
1,743

 
$
1,314

Computer equipment
597

 
476

Computer software
1,158

 
1,064

Furniture and fixtures
288

 
260

Leasehold improvements
528

 
329

Vehicles
35

 
35

Total property and equipment
4,349

 
3,478

Less: Accumulated depreciation and amortization
(2,384
)
 
(1,802
)
Construction in progress
120

 
468

Property and equipment, net
$
2,085

 
$
2,144

Accrued Liabilities
The following table shows the components of accrued liabilities (in thousands):
 

11


 
September 30,
2012
 
December 31,
2011
Accrued payroll and employee related expenses
$
3,831

 
$
2,708

Accrued royalty
1,322

 
1,307

Accrued warranty
863

 
742

Accrued legal expenses
1,846

 
864

Sales and other taxes payable
970

 
652

Accrued marketing expenses
3,021

 
364

Other accrued liabilities
370

 
241

Total accrued liabilities
$
12,223

 
$
6,878

6. Intangible Asset, Net
The intangible asset consists of an exclusive license agreement with Massachusetts General Hospital (“MGH”) for commercializing patents and other technology. All milestone payments payable by the Company pursuant to the terms of the agreement subsequent to the date of the FDA approval are capitalized as purchased technology when paid, and are subsequently amortized into cost of revenues using the straight-line method over the estimated remaining useful life of the technology, not to exceed the term of the agreement or the life of the patent.
Intangible asset, net comprises the following (in thousands):
 
 
September 30,
2012
 
December 31,
2011
Purchased technology
$
8,050

 
$
8,050

Less: Accumulated amortization
(693
)
 
(168
)
     Intangible asset, net
$
7,357

 
$
7,882


The amortization expense of the intangible asset was $0.1 million and $ 0.5 million for the three and nine months ended September 30, 2012 , respectively. The total estimated annual future amortization expense of this intangible asset as of September 30, 2012 is as follows (in thousands):

Fiscal Year
 
2012 (remaining 3 months)
$
175

2013
701

2014
701

2015
701

2016
701

Thereafter
4,378

Total
$
7,357


7. Notes Payable
On January 14, 2009 , the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank. The Loan Agreement provided for total borrowings of $5.0 million to be made available to the Company in three separate tranches. Tranche A, for $1.5 million , was received by the Company in January 2009. Tranche B, for $2.0 million , was received by the Company on April 30, 2009 , and Tranche C, for $1.5 million , was available until September 30, 2009 and was not drawn upon. The notes payable were collateralized by substantially all the assets of the Company, excluding intellectual property. The notes carried an interest rate of 7.28%  per annum. The repayment of principal, plus interest, was via monthly installments over a 36-month period for each tranche, beginning with the disbursement date of each tranche.
On January 14, 2009 , in accordance with the Loan Agreement, the Company issued a warrant to Silicon Valley Bank to purchase 47,683 shares of Series C preferred stock at $3.67 per share. The fair value of this warrant was recorded as a debt discount at issuance and has been amortized to interest expense over the term of the notes.
During the quarter ended March 31, 2012 , the remaining loan balance of $0.3 million and the final payment of 5.75% of the

12


advanced amount, or $0.2 million , were paid in full to Silicon Valley Bank.
8. Related Party Transactions
Notes Receivable from a Stockholder
In December 2007 , the Company issued 445,509 shares of its common stock to an executive in exchange for full recourse promissory notes in the aggregate amount of approximately $245,000 . The promissory notes bore interest from the date of issuance until January 1, 2010 at a rate of 4.72%  per annum compounded annually and last bore interest at a rate of 4%  per annum, and were collateralized by the related common stock and the executive’s assets. The executive separated from the Company on December 3, 2010 . The promissory notes were due and payable in full (all accrued and unpaid interest) upon nine months following the Company’s initial public offering of its common stock. These notes receivable were related to a prior exercise of stock options and were recorded as a contra stockholders’ equity account.
In July 2012, the promissory notes were paid in full.
Brazilian Distribution Agreement
The Company entered into a distribution agreement with ADVANCE Medical, Inc., or ADVANCE, dated March 18, 2011 and amended on February 27, 2012 and September 4, 2012 , appointing ADVANCE as the exclusive distributor of CoolSculpting in Brazil and Mexico. ADVANCE is required to purchase a minimum quantity of the Company’s products each calendar quarter throughout the term of the distribution agreement. Venrock, a principal stockholder of the Company, owns a significant equity interest in ADVANCE Medical, Ltd., the parent company of ADVANCE. Dr. Bryan E. Roberts, who is a member of the Company's Board of Directors, is also a partner of Venrock Associates. The revenue recognized by the Company under this distribution agreement for the three and nine months ended September 30, 2012 was $0.6 million and $1.9 million , respectively, and the accounts receivable balance as of September 30, 2012 was $0.3 million .
9. Commitments and Contingencies
Lease Commitments
The Company’s facility lease agreement was amended in August 2012 to extend the lease term through December 31, 2014 for the Company's facility in Pleasanton, California. The Company also leases a manufacturing facility and a warehouse in Dublin, California and an office space in Gatwick, United Kingdom as well as in Dubai, United Arab Emirates. Rent expense for non-cancellable operating leases with scheduled rent increases is recognized on a straight-line basis over the lease term. Rent expense for the three months ended September 30, 2012 and 2011 was $0.3 million and $0.2 million , respectively. Rent expense for the nine months ended September 30, 2012 and 2011 was $0.9 million and $0.6 million , respectively.
Future minimum lease payments under the noncancelable operating leases as of September 30, 2012 are as follows (in thousands):

Year Ending December 31:
 
2012 (remaining 3 months)
$
249

2013
1,168

2014
1,198

     Total future minimum lease payments
$
2,615

Purchase Commitments
The Company had noncancelable purchase obligations to contract manufacturers and suppliers for $6.2 million and $5.4 million at September 30, 2012 and December 31, 2011 , respectively.

Warranty
The Company provides a limited warranty on its products, generally three years for control units and one year for applicators. The Company accrues for the estimated future costs of repair or replacement upon shipment. The warranty accrual is recorded to cost of revenues and is based upon historical and forecasted trends in the volume of product failures during the warranty period and the cost to repair or replace the equipment. The Company bases product warranty costs on related freight, material, technical support labor, and overhead costs. The estimated product warranty costs are assessed by considering historical costs and applying the experienced failure rates to the outstanding warranty period for products sold. The Company exercises judgment in estimating the expected product warranty costs, using data such as the actual and projected product failure rates,

13


and average repair costs, including freight, material, technical support labor, and overhead costs, for products returned under warranty.
The estimated product warranty accrual was as follows (in thousands):
 
 
Nine Months Ended
 
September 30,
 
2012
Balance at the beginning of the period
$
742

Accruals for warranties issued
633

Adjustments to pre-existing warranties
168

Settlements of warranty claims
(680
)
Balance at the end of the period
$
863


Legal Matters
From time to time, the Company may be involved in legal and administrative proceedings and claims of various types. The Company records a liability in its consolidated financial statements for these matters when a loss is known and considered probable and the amount can be reasonably estimated. Management reviews these estimates in each accounting period as additional information becomes known and adjusts the loss provision when appropriate. If the loss is not probable or cannot be reasonably estimated, a liability is not recorded in the consolidated financial statements. If a loss is probable but the amount of loss cannot be reasonably estimated, the Company discloses the loss contingency and an estimate of possible loss or range of loss (unless such an estimate cannot be made). The Company does not recognize gain contingencies until they are realized. Legal costs incurred in connection with loss contingencies are expensed as incurred.
On March 13, 2012 , an alleged purchaser of the Company's publicly traded common stock, filed a securities class action in the Superior Court of California, County of Alameda, entitled Marcano v. Nye, et al., Case No. RG12621290.  The complaint alleges that the Company made false and misleading statements or omitted to state facts necessary to make the disclosures not misleading in its Form S-1, and the amendments thereto, issued in connection with the Company's initial public offering.  The claims are asserted under Sections 11 and 15 of the Securities Act of 1933.  On March 15, 2012 , April 3, 2012 , and May 24, 2012 , three additional and substantially similar lawsuits were filed in the same court, some adding the Company's underwriters as defendants.  All four cases were consolidated and a consolidated complaint was deemed operative.  On August 24, 2012 , the Company filed a demurrer to the consolidated complaint.  Since that time, Plaintiffs have agreed to dismiss the Company's outside directors and its underwriters from the litigation without prejudice. The Company believes the lawsuit to be without merit and intends to vigorously defend it.  The Company believes there is no sufficient evidence to indicate that a probable loss had been incurred as of September 30, 2012 .
Severance
Effective April 3, 2012 , the Company's Vice President of North American Sales resigned from the Company.  On April 18, 2012 , the Company's President and CEO resigned from the positions he held with the Company. As a result of these resignations, the Company incurred $0.9 million in termination benefits and $0.7 million in costs related to the modification of the employees' stock options, which were recorded during the nine months ended September 30, 2012 .  As of September 30, 2012 , approximately $0.4 million of the termination benefits had been paid.  The Company's liability related to these costs as of September 30, 2012 was $0.5 million .  No similar costs were incurred during three and nine months ended September 30, 2011

Subsequent to these resignations, during the second quarter of 2012 , the Company's management made a decision to terminate several employees. As a result of these terminations, the Company incurred approximately $0.8 million in costs associated with the termination benefits, which were recorded as part of operating expenses in the Company's consolidated statement of operations.  As of September 30, 2012 , approximately $0.5 million of the termination benefits had been paid.  The Company's liability related to these costs as of September 30, 2012 was $0.3 million .  No similar costs were incurred during three and nine months ended September 30, 2011 .
10. Convertible Preferred Stock Warrants
In connection with obtaining a credit facility (see Note 7), the Company issued a warrant to Silicon Valley Bank to purchase 47,683 shares of Series C convertible preferred stock at $3.67 per share. These warrants were issued on January 14, 2009 and expire on the 10-year anniversary after the issue date. The fair value of the warrants on the date of issuance was $0.1 million . The exercise price and number of warrants were subject to change upon the closing of a Series D-1 convertible preferred stock

14


financing agreement. Upon the issuance of Series D-1 convertible preferred stock at $2.68 per share, the warrants were automatically adjusted to instead be exercisable for 65,319 shares of Series D-1 convertible preferred stock with the warrants price adjusted to record the per share purchase price of Series D-1 convertible preferred stock.
Upon the closing of the Company’s IPO in October 2011 , the convertible preferred stock warrants were automatically converted into common stock warrants to purchase 65,319 shares of common stock. In addition, the fair value of the convertible preferred stock warrants as of October 24, 2011 , estimated to be $0.9 million using the Black-Scholes option pricing model, was reclassified to additional paid in capital. These warrants were exercised in December 2011 .
The Company determined the fair value of the preferred stock warrants at October 24, 2011 (the final valuation date of the preferred stock warrants before they converted to common stock warrants) using the Black-Scholes option pricing model with the following assumptions:
Fair Value of Series D-1 Convertible Preferred Stock. The fair value of the shares of Series D-1 convertible preferred stock underlying the preferred stock warrants has historically been determined by the Board of Directors. Because there has been no public market for the Company’s convertible preferred stock, the Board of Directors has determined fair value of the Series D-1 convertible preferred stock at each balance sheet date by considering a number of objective and subjective factors including valuation of comparable companies, sales of convertible preferred stock to unrelated third parties, operating and financial performance, the lack of liquidity of capital stock, and general and industry specific economic outlook, among other factors. To determine the fair value of the preferred stock warrant at October 24, 2011 , the Company made an assumption that the fair value per share of the Series D-1 convertible preferred stock approximated the closing price per share of the Company’s common stock on October 24, 2011 .
Remaining Contractual Life. The Company derived the remaining contractual life based on the time from the balance sheet date until the preferred stock warrant’s expiration date, the 10-year anniversary from the issue date.
Volatility. Since the Company was a private entity with no historical data regarding the volatility of its preferred stock, the expected volatility used is based on volatility of a group of similar entities, referred to as “guideline” companies. In evaluating similarity, the Company considered factors such as industry, stage of life cycle and size.
Risk-Free Interest Rate. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options.
Dividend Yield. The Company has never paid any dividends and does not plan to pay dividends in the foreseeable future, and, therefore, used an expected dividend yield of zero in the valuation model.
The Company re-measured the convertible preferred stock warrant liability to fair value using the Black-Scholes option-pricing model with the following assumptions:

 
 
October 24, 2011
Remaining contractual life (in years)
7.2

Risk-free interest rate
1.8
%
Expected volatility
59.3
%
Expected dividend rate
0
%
11. Stock-Based Compensation Expense
Stock Option Activity
Activity under the Company’s stock option plans is set forth below:
 

15


 
 
Shares
Available
for Grant
 
Number of
Stock Options
Outstanding
 
Weighted-
Average
Exercise
Price
Balance, December 31, 2011
57,437

 
4,847,972

 
$
3.00

Additional shares reserved
3,199,890

 

 

Options granted
(2,374,279
)
 
2,374,279

 
6.03

Restricted stock awards granted
(4,083
)
 

 

Restricted stock units granted
(1,263,917
)
 

 

Options exercised

 
(1,419,184
)
 
1.70

Options canceled
1,763,418

 
(1,763,418
)
 
3.68

Restricted stock units canceled
261,687

 

 

Restricted stock awards canceled
2,342

 

 

Balance, September 30, 2012
1,642,495

 
4,039,649

 
$
4.94

Stock-based Compensation Expense
The stock-based compensation expense related to all of our stock-based awards and employee stock purchases was allocated as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Cost of revenues
$
33

 
$
15

 
$
92

 
$
32

Research and development
205

 
179

 
658

 
335

Sales and marketing
289

 
171

 
797

 
352

General and administrative
897

 
211

 
2,375

 
590

Total stock-based compensation
$
1,424

 
$
576

 
$
3,922

 
$
1,309


The stoc k-based compensation expense for the three and nine months ended September 30, 2012 includes $0.1 million in charges related to market-performance based stock options and restricted stock units granted to the Company's chief executive officer.
The stock-based compensation expense for the nine months ended September 30, 2012 includes $0.7 million in modification charges incurred in connection with the severance packages to the Company's former executives.
Employee Stock–Based Compensation
Stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense on a straight-line basis over the requisite service period. The fair value of stock-based awards to employees is estimated using the Black-Scholes option pricing model. The Company estimates its forfeiture rate based on an analysis of its actual forfeitures and will continue to evaluate the adequacy of the forfeiture rate assumption based on actual forfeitures, analysis of employee turnover, and other related factors.
During the three months ended September 30, 2012 and 2011 , the Company granted 1,528,704 and 692,014 stock options, respectively, to employees with a weighted average grant date fair value of $2.79 and $5.71 per share, respectively. During the nine months ended September 30, 2012 and 2011 , the Company granted 2,245,927 and 1,272,474 stock options, respectively, to employees with a weighted average grant date fair value of $3.24 and $5.64 per share, respectively. As of September 30, 2012 , there were unrecognized compensation costs of $8.1 million related to the stock options granted to employees. The Company expects to recognize those costs over a weighted average period of 3.32 years . Future option grants will increase the amount of compensation expense to be recorded in these periods.
During the three months ended September 30, 2012 , the Company granted 715,548 restricted stock units to employees. During the nine months ended September 30, 2012 , the Company granted 1,135,566 restricted stock units to employees. As of September 30, 2012 , the unrecognized compensation cost related to restricted stock units was $3.8 million , which will be recognized using the straight-line attribution method over 3.78 years. There were no restricted stock units approved or issued during the three and nine months ended September 30, 2011 .
The Company issued 51,749 shares under its ESPP for the nine months ended September 30, 2012 . As of September 30, 2012 ,

16


the unrecognized compensation cost related to ESPP shares was $48,000 , which will be recognized using the straight-line attribution method over 0.17 years.
Stock-Based Compensation for Non-employees
Stock-based compensation expense related to stock-based awards granted to non-employees is recognized as the stock-based awards are earned. The Company believes that the fair value of the stock-based awards is more reliably measurable than the fair value of the services received. The fair value of the stock options granted is calculated at each reporting date using the Black-Scholes option pricing model. During the nine months ended September 30, 2012 , the Company granted 128,352 stock options and 128,351 restricted stock units to a non-employee. These stock options and restricted stock units are vesting over 0.5 years. There were no restricted stock units approved or issued during the three months ended September 30, 2012 . The Company recorded a total of $0.4 million and $0.8 million in stock-based compensation expense related to these non-employee grants during the three and nine months ended September 30, 2012 . Stock-based compensation expense for non-employees was insignificant during the three and nine months ended September 30, 2011 .
12. Net Loss per Share of Common Stock
Basic net loss per share of common stock is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period. Diluted net loss per share of common stock is computed by giving effect to all potentially dilutive securities outstanding during the period, including options, warrants, and convertible preferred stock. Basic and diluted net loss per share attributable to common stockholders was the same for all periods presented as the inclusion of all potentially dilutive securities outstanding were anti-dilutive. As such, the numerator and the denominator used in computing both basic and diluted net loss are the same for each period presented.
A reconciliation of the numerator and denominator used in the calculation of the basic and diluted net loss per share is as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Historical net loss per share:
 
 
 
 
 
 
 
Numerator
 
 
 
 
 
 
 
Net loss attributable to common stockholders (in thousands)
$
(5,182
)
 
$
(4,414
)
 
$
(23,628
)
 
$
(8,925
)
Denominator
 
 
 
 
 
 
 
Weighted average shares of common stock outstanding used in computing net loss per share attributable to common stockholders - basic and diluted
35,068,076

 
1,391,049

 
34,444,680

 
1,327,143

Basic and diluted net loss per share attributable to common stockholders
$
(0.15
)
 
$
(3.17
)
 
$
(0.69
)
 
$
(6.72
)

The following outstanding shares of potentially dilutive securities were excluded from the computation of diluted net loss per share of common stock for the periods presented, because including them would have been anti-dilutive:
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Convertible preferred stock (on an as-if converted basis)

 
24,415,965

 

 
24,415,965

Convertible preferred stock warrants

 
65,319

 

 
65,319

Options to purchase common stock
4,039,649

 
5,205,481

 
4,039,649

 
5,205,481

Restricted stock units
47,658

 

 
90,634

 

Common stock issuable pursuant to the ESPP
10,709

 

 
6,334

 

Total
4,098,016

 
29,686,765

 
4,136,617

 
29,686,765

13. Segment Information
Operating segments are defined as components of an enterprise about which separate financial information is available that is

17


evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is its chief executive officer and its board of directors. The Company has one business activity and there are no segment managers who are held accountable for operations. Accordingly, the Company has a single reportable segment structure. All of the Company’s principal operations and decision-making functions are located in the United States.
The Company’s revenues by geographic region, based on the location to where the product was shipped, are summarized as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
North America
$
13,691

 
$
12,498

 
$
43,342

 
$
35,940

Rest of world
4,237

 
5,222

 
14,255

 
13,406

     Total
$
17,928

 
$
17,720

 
$
57,597

 
$
49,346

North America includes the United States and Canada. Revenues for the United States were $13.0 million and $11.9 million for the three months ended September 30, 2012 and 2011 , respectively. Revenues for the United States were $41.4 million and $33.6 million for the nine months ended September 30, 2012 and 2011 , respectively.
The following table sets forth revenue by product expressed as dollar amounts (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Systems
$
8,507

 
$
13,220

 
$
29,528

 
$
35,265

Procedure fees
9,421

 
4,500

 
28,069

 
14,081

     Total
$
17,928

 
$
17,720

 
$
57,597

 
$
49,346

Substantially all of the Company’s long-lived assets are located in the United States of America.


18



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and with our Management's Discussion and Analysis of Financial Condition and Results of Operations and financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission on March 15, 2012.
In addition, the following discussion contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “should,” “estimate,” or “continue,” and similar expressions or variations. Forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to the differences include, but are not limited to, those discussed in the section titled “Risk Factors,” set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q. The forward-looking statements in this Quarterly Report on Form 10-Q represent our views as of the date of this Quarterly Report on Form 10-Q. We anticipate that subsequent events and developments will cause our views to change. However, while we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable law. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this Quarterly Report on Form 10-Q.
Overview
We are a medical technology company focused on developing and commercializing products utilizing our proprietary controlled-cooling technology platform. Our first commercial product, the CoolSculpting System, is designed to selectively reduce stubborn fat bulges that may not respond to diet or exercise. We generate revenues from sales of our CoolSculpting System and from procedure fees our physician customers pay for each CoolSculpting procedure they perform. We received clearance from the FDA in September 2010 to market CoolSculpting for the selective reduction of fat around the flanks, an area commonly referred to as the “love handles.” In May 2012, CoolSculpting was cleared by the FDA for treatment of "belly fat" or non-surgical reduction of fat for the abdomen area. We intend to seek additional regulatory clearances from the FDA to expand our U.S. marketed indications for CoolSculpting to areas on the body other than the flanks and abdomen. We have received regulatory approval or are otherwise free to market CoolSculpting in 55 international markets where use of the product is generally not limited to specific treatment areas. Physicians in these markets commonly perform CoolSculpting procedures on the inner thighs, back, and chest, in addition to the flanks and abdomen.
As of September 30, 2012 , our worldwide sales force consisted of 74 professionals. In the United States, Canada and four key markets in Europe (England, Germany, France and Spain), we use our direct sales organization to selectively market CoolSculpting. In markets outside of North America and the four key markets in Europe, we sell CoolSculpting through a network of distributors. We intend to continue developing our international sales and marketing organization to focus on increasing sales and strengthening our physician relationships. We also intend to seek regulatory approval to market CoolSculpting in key additional international markets, including China. Revenues from markets outside of North America accounted for 25% and 27% of our total revenues for the nine months ended September 30, 2012 and 2011 , respectively.
Our ongoing research and development activities are primarily focused on improving and enhancing our CoolSculpting System and CoolSculpting procedure. In addition to these development activities related to CoolSculpting, we are exploring additional uses of our proprietary controlled-cooling technology platform for the dermatology, plastic surgery, and aesthetic markets. We are also exploring potential therapeutic uses for our platform technology, either directly or through collaborative arrangements with strategic partners.
Revenues
We generate revenues from sales of our CoolSculpting System and from procedure fees our physician customers pay for each CoolSculpting procedure they perform. We generated revenues of $57.6 million and $49.3 million for the nine months ended September 30, 2012 and 2011 , respectively.
Systems revenues.  Sales of our CoolSculpting System include the CoolSculpting control unit and our CoolSculpting vacuum applicators. We are targeting 4,000 to 5,000 physician practice sites on a global basis that have our target characteristics. Some of our target practices may purchase more than one CoolSculpting System. Our standard terms do not allow for trial or evaluation periods, rights of return, or refund payments contingent upon the customer obtaining financing or other terms that could impact the customer’s obligation.

19

Table of Contents

During the nine months ended September 30, 2012 , our system sales were impacted by new product launches and trial offers by our competitors that created competition for physician capital equipment dollars. Despite this, we grew our worldwide installed base by 68% from 812 units as of September 30, 2011 to 1,363 units as of September 30, 2012 .
Procedure fees revenues.  We generate revenues from procedure fees through sales of CoolSculpting procedure packs, each of which includes our consumable CoolGels and CoolLiners and a disposable computer cartridge that we market as the CoolCard. The CoolCard contains enabling software that permits our physician customer to perform a fixed number of CoolSculpting procedures. Procedure fees accounted for approximately 49% and 29% of our total revenues for the nine months ended September 30, 2012 and 2011 , respectively. During the nine months ended September 30, 2012 , we shipped approximately 225,000 CoolSculpting procedures to our physician customers.
Our business plan focuses on expanding our base of physician customers, and increasing our procedure fees revenues by driving demand for CoolSculpting procedures through our physician and consumer marketing programs. We anticipate that as we implement our business plan our revenues from procedure fees will increase as a percentage of our total revenues.
Seasonality. Seasonal fluctuations in the number of physician customers in their offices and available to take appointments as well as their patients have affected, and are likely to continue to affect, our business. Specifically, our customers often take vacation or are on holiday during the summer months and therefore tend to perform fewer procedures, particularly in Europe. These seasonal trends have caused and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates. In order of revenue significance throughout the year, historically our strongest to weakest quarters were as follows: fourth quarter, third quarter, second quarter and first quarter. We expect during fiscal 2012 our strongest to weakest quarters will be as follows: fourth quarter, second quarter, third quarter and first quarter. 
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America or GAAP. The preparation of our consolidated financial statements requires management to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the applicable periods. Management bases its estimates, assumptions, and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our financial statements, which, in turn, could materially change our results from those reported. Management evaluates its estimates, assumptions, and judgments on an ongoing basis. Historically, our critical accounting estimates have not differed materially from actual results. However, if our assumptions change, we may need to revise our estimates, or take other corrective actions, either of which may also have a material adverse effect on our statements of operations, liquidity, and financial condition.
There have been no material changes to our significant accounting policies during the nine months ended September 30, 2012 , as compared to the significant accounting policies described in our Form 10-K for the year ended December 31, 2011 , except as described below.
During the nine months ended September 30, 2012 , we purchased available-for-sale securities and have accounted for such investments in accordance with the following investments policy:
Investments
We invest our excess cash balances primarily in certificates of deposit, commercial paper, corporate bonds, and U.S. Government agency securities. Investments with original maturities greater than 90 days that mature less than one year from the consolidated balance sheet date are classified as short-term investments. We classify all of our investments as available-for-sale and record such assets at estimated fair value in the consolidated balance sheets, with unrealized gains and losses, if any, reported as a component of accumulated other comprehensive income (loss) in stockholders' equity. Realized gains and losses from maturities of all such securities are reported in earnings and computed using the specific identification cost method.  Realized gains or losses and charges for other-than-temporary declines in value, if any, on available-for-sale securities are reported in other income (expense) as incurred.  We periodically evaluate these investments for other-than-temporary impairment.
Results of Operations
Revenues (in thousands, except for percentages):

20

Table of Contents

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
Revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Systems
$
8,507

 
$
13,220

 
$
(4,713
)
 
(36
)%
 
$
29,528

 
$
35,265

 
$
(5,737
)
 
(16
)%
Procedure fees
9,421

 
4,500

 
4,921

 
109
 %
 
28,069

 
14,081

 
13,988

 
99
 %
Total revenues
$
17,928

 
$
17,720

 
$
208

 
1
 %
 
$
57,597

 
$
49,346

 
$
8,251

 
17
 %
Total revenues increased by $0.2 million , or 1% , to $17.9 million in the three months ended September 30, 2012 compared to $17.7 million during the same period in 2011 . Total revenues increased by $8.3 million , or 17% , to $57.6 million in the nine months ended September 30, 2012 compared to $49.3 million during the same period in 2011 .
Systems revenues.  Systems revenues decreased by $4.7 million to $8.5 million in the three months ended September 30, 2012 compared to $13.2 million during the same period in 2011 . Systems revenues represented 47% and 75% of total revenues for the three months ended September 30, 2012 and 2011 , respectively. During the third quarter of 2012 , as anticipated, our systems revenues were impacted by seasonal trends due to vacations taken by our physician customers and their patients during the summer months. New product launches and trial offers by our competitors, that created competition for physician capital equipment dollars, continued to negatively impact system sales volume.
Systems revenues decreased by $5.7 million to $29.5 million in the nine months ended September 30, 2012 compared to $35.3 million during the same period in 2011 . Systems revenues represented 51% and 71% of total revenues for the nine months ended September 30, 2012 and 2011 , respectively. The systems revenues in the first nine months of 2012 were impacted by new product launches and trial offers by our competitors that created competition for physician capital equipment dollars as well as by changes in our sales force in the North American Franchise. Our rest of the world systems sales were impacted by the transition to a direct sales model.
Procedure fees revenues.  Procedure fees revenues increased by $4.9 million to $9.4 million in the three months ended September 30, 2012 compared to $4.5 million during the same period in 2011 . Procedure fees revenues represented 53% and 25% of total revenues for the three months ended September 30, 2012 and 2011 , respectively. The increase in procedure fees revenues was primarily due to the growth of our installed base of worldwide CoolSculpting Systems, and an increased number of procedures performed by our physician customers driven by our targeted physician and consumer marketing programs.
Procedure fees revenues increased by $14.0 million to $28.1 million in the nine months ended September 30, 2012 compared to $14.1 million during the same period in 2011 . Procedure fees revenues represented 49% and 29% of total revenues for the nine months ended September 30, 2012 and 2011 , respectively. The increase in procedure fees revenues was primarily due to the growth of our installed base of worldwide CoolSculpting Systems, and an increased number of procedures performed by our physician customers driven by our targeted physician and consumer marketing programs.

Cost of Revenues and Gross Profit (in thousands, except for percentages):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
Cost of revenues
$
5,953

 
$
7,283

 
$
(1,330
)
 
(18
)%
 
$
19,096

 
$
19,632

 
$
(536
)
 
(3
)%
% of total revenues
33
%
 
41
%
 
 
 
 
 
33
%
 
40
%
 
 
 
 
Gross profit
$
11,975

 
$
10,437

 
$
1,538

 
15
 %
 
$
38,501

 
$
29,714

 
$
8,787

 
30
 %
Gross profit %
67
%
 
59
%
 
 
 
 
 
67
%
 
60
%
 
 
 
 
Cost of revenues decreased by $1.3 million , or 18% , to $6.0 million in the three months ended September 30, 2012 compared to $7.3 million during the same period in 2011 . Cost of revenues decreased by $0.5 million , or 3% , to $19.1 million in the nine months ended September 30, 2012 compared to $19.6 million during the same period in 2011 . The quarter-over-quarter and year-over-year decrease in cost of revenues was primarily due to lower direct material costs driven by our continued focus on product cost reductions and negotiations with suppliers.
Gross profit was $12.0 million , or 67% of revenues, in the third quarter of 2012 , compared to gross profit of $10.4 million , or

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59% of revenues, in the third quarter of 2011 . Gross profit was $38.5 million , or 67% of revenues, for the nine months ended September 30, 2012 , compared to gross profit of $29.7 million , or 60% of revenues, for the same period in 2011 . The increase in gross profit as a percentage of revenues was driven by an increase in procedure fees revenues as a percentage of total revenues and a decrease in the per unit manufacturing cost of systems mainly due to lower direct material costs.
 
Operating Expenses (in thousands, except for percentages):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
$
2,450

 
$
2,933

 
$
(483
)
 
(16
)%
 
$
9,217

 
$
7,540

 
$
1,677

 
22
%
% of total revenues
14
%
 
17
%
 
 
 
 
 
16
%
 
15
%
 
 
 
 
Sales and marketing
$
10,881

 
$
7,104

 
$
3,777

 
53
 %
 
$
39,632

 
$
18,672

 
$
20,960

 
112
%
% of total revenues
61
%
 
40
%
 
 
 
 
 
69
%
 
38
%
 
 
 
 
General and administrative
$
3,760

 
$
3,209

 
$
551

 
17
 %
 
$
13,169

 
$
7,240

 
$
5,929

 
82
%
% of total revenues
21
%
 
18
%
 
 
 
 
 
23
%
 
15
%
 
 
 
 
Total operating expenses
$
17,091

 
$
13,246

 
$
3,845

 
29
 %
 
$
62,018

 
$
33,452

 
$
28,566

 
85
%

Research and development.  Research and development expenses decreased by $0.5 million , or 16% , to $2.5 million in the three months ended September 30, 2012 compared to $2.9 million in the same period in 2011 . The decrease in research and development expenses was primarily due to a decrease of $0.2 million in tooling costs for our control units, $0.1 million in consulting costs and $0.1 million in payroll related costs.
Research and development expenses increased by $1.7 million , or 22% , to $9.2 million in the nine months ended September 30, 2012 compared to $7.5 million in the same period in 2011 . The increase in research and development expenses was primarily due to an increase of $0.8 million in payroll related costs and a higher stock-based compensation expense by approximately $0.3 million. The increase in payroll related costs was attributed to a higher headcount and severance costs incurred during the nine months ended September 30, 2012 .
Sales and marketing.  Sales and marketing expenses increased by $3.8 million , or 53% , to $10.9 million in the three months ended September 30, 2012 compared to $7.1 million for the same period in 2011 . The increase in sales and marketing expenses was mostly due to a $2.4 million increase in advertising expenses incurred in conjunction with our sales and marketing initiatives, undertaken to improve brand awareness and increase procedure fee revenues, a $1.0 million increase in payroll related costs and a $0.6 million increase in sales commission expenses. The increase in these payroll related expenses is directly related to the growth of our sales and marketing organization. The overall increase was partially offset by lower marketing collateral development costs of $0.5 million. Higher marketing collateral costs in the third quarter of 2011 were driven by special marketing programs and launch of new patient brochures.
Sales and marketing expenses increased by $21.0 million , or 112% , to $39.6 million in the nine months ended September 30, 2012 compared to $18.7 million for the same period in 2011 . The increase in sales and marketing expenses was mostly due to a $9.4 million increase in advertising expenses incurred in conjunction with our direct marketing campaign and other sales and marketing initiatives, a $4.9 million increase in payroll related costs, which include approximately $0.7 million in severance costs recognized during the nine months ended September 30, 2012 , a $1.6 million increase in sales commission expenses driven by higher sales levels and a $1.5 million increase in marketing costs mostly related to public relations, web site maintenance, marketing materials production and distribution. The remaining increase is attributed to higher stock-based compensation expenses, higher travel expenses and higher public relations expenses during the nine months ended September 30, 2012 . The increase in these expenses is directly related to the growth of our sales and marketing organization.
General and administrative.  General and administrative expenses increased by $0.6 million , or 17% , to $3.8 million for the three months ended September 30, 2012 compared to $3.2 million for the same period in 2011 . The increase in general and administrative expenses was primarily due to $0.9 million increase in legal expenses mostly related to our ongoing litigation and IP enforcement activities and higher stock-based compensation expenses by $0.7 million. The increase was partially offset by lower accounting fees by approximately $0.9 million incurred during the three months ended September 30, 2012 compared to the prior period. Higher accounting fees during the three months ended September 30, 2011 were incurred in the preparation

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for our initial public offering.
General and administrative expenses increased by $5.9 million , or 82% , to $13.2 million for the nine months ended September 30, 2012 compared to $7.2 million for the same period in 2011 . The increase in general and administrative expenses was primarily due to a $2.2 million increase in payroll related costs, a $2.8 million increase in legal expenses primarily related to our ongoing litigation and IP enforcement activities and higher stock-based compensation expenses by $1.8 million. Consulting, recruiting and travel expenses also increased during the current period. The increase was partially offset by lower accounting fees of $1.4 million incurred during the nine months ended September 30, 2012 compared to the prior period. Higher accounting fees during the nine months ended September 30, 2011 were incurred in the preparation for our initial public offering. The increase in payroll related costs was attributed to a higher headcount and severance costs recognized during the nine months ended September 30, 2012 . The stock-based compensation expense for the nine months ended September 30, 2012 included $0.7 million in modification charges incurred in connection with the severance packages to our former executives.

Interest Income (Expense), Net and Other Income (Expense), Net (in thousands, except for percentages):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
Interest income (expense), net
$
11

 
$
(24
)
 
$
35

 
(146
)%
 
$
100

 
$
(84
)
 
$
184

 
(219
)%
% of total revenues
 %
 
 %
 
 
 
 
 
 %
 
 %
 
 
 
 
Other income (expense), net
$
(44
)
 
$
(17
)
 
$
(27
)
 
159
 %
 
$
(108
)
 
$
(412
)
 
$
304

 
(74
)%
% of total revenues
 %
 
 %
 
 
 
 
 
 %
 
(1
)%
 
 
 
 
Interest income (expense), net.  Interest income (expense), net was an income of $11,000 for the three months ended September 30, 2012 compared to an expense of $24,000 for the same period in 2011 . Interest income (expense), net was an income of $0.1 million for the nine months ended September 30, 2012 compared to an expense of $84,000 for the same period in 2011 . During 2012, interest income was earned on our available-for-sale securities. During 2011, interest expense was incurred in relation to our note payable that was paid in full in the quarter ended March 31, 2012.
Other income (expense), net.  Other income (expense), net, for the three months ended September 30, 2012 was an expense of $44,000 compared to $17,000 of expense in 2011 . Other income (expense), net, for the nine months ended September 30, 2012 was an expense of $0.1 million compared to $0.4 million of expense in 2011 . Higher expense in prior year was related to the loss incurred on the change in the fair value of the convertible preferred stock warrant.
Liquidity and Capital Resources

Since our inception, we have financed our operations to date primarily through private placements of convertible preferred stock, promissory notes, borrowings under a loan agreement, product sales and the proceeds from our IPO.

As of September 30, 2012 , we had $66.9 million of cash and cash equivalents, short-term and long-term investments. The following table summarizes our working capital, cash and cash equivalents, short-term and long-term investments as of September 30, 2012 and December 31, 2011 as follows (in thousands):


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September 30,
 
December 31,
 
2012
 
2011
Cash and cash equivalents
$
22,172

 
$
83,908

Short-term investments
29,022

 

Long-term investments
15,715

 

Total
$
66,909

 
$
83,908

 
 
 
 
Working capital
$
52,011

 
$
84,086


Summary Statement of Cash Flows
The following table summarizes our cash flows for the nine months ended September 30, 2012 and 2011 (in thousands):
 
 
Nine Months Ended
 
September 30,
 
2012
 
2011
Net cash used in operating activities
$
(18,543
)
 
$
(5,198
)
Net cash used in investing activities
(45,732
)
 
(1,159
)
Net cash provided by (used in) financing activities
2,539

 
(2,178
)
Net decrease in cash and cash equivalents
$
(61,736
)
 
$
(8,535
)

Cash Flows for the Nine Months Ended September 30, 2012 and 2011
Operating activities.  Net cash used in operating activities was $18.5 million during the nine months ended September 30, 2012 and consisted of a net loss of $23.6 million and a net change in operating assets and liabilities of $0.3 million , offset by non-cash items of $5.4 million . Non-cash items for the nine months ended September 30, 2012 consisted primarily of a stock-based compensation expense of $3.9 million , a depreciation and amortization expense of $1.2 million and a loss on disposal of property and equipment of $0.2 million . The significant items in the change in operating assets and liabilities include an increase in inventory of $3.2 million and an increase in accounts receivable of $2.1 million offset by an increase of $5.3 million in accounts payable, accrued and other non-current liabilities. The increase in accounts receivable was attributed to a larger number of customers with credit terms during the first nine months of 2012 compared to the same period in prior year. The increase in inventory was mostly due to purchases of inventory components parts and finished goods to fulfill anticipated customer orders in the quarter and beyond. The increase in accounts payable and accrued liabilities resulted from higher accrued payroll related expenses driven by higher headcount and severance related expenses incurred during the first nine months of 2012 and accrued customer rebates that resulted from the sales and marketing program introduced during the third quarter of 2012 , higher accrued advertising costs as well as higher legal costs.
Net cash used in operating activities was $5.2 million during the nine months ended September 30, 2011 and consisted of a net loss of $4.2 million and a net change in operating assets and liabilities of $3.6 million, offset by non-cash items of $2.6 million. Non-cash items for the nine months ended September 30, 2011 consisted primarily of a stock-based compensation expense of $1.3 million , a change in fair value of preferred stock warrant liability of $0.4 million , a depreciation and amortization expense of $0.6 million and a loss on disposal of property and equipment of $0.2 million . The significant items in the change in operating assets and liabilities include an increase in accounts receivable of $5.0 million attributed to a larger number of customers with extended credit terms as well as timing delays with processing customer credit card purchases and transactions financed by third party financial institutions and an increase in inventory of $2.2 million that reduced our cash flow from operating activities, partially offset by an increase in accounts payable, accrued and other non-current liabilities of $3.5 million due to purchases and expenses incurred as a result of the growth in our business activities and preparation for the IPO and a decrease of $0.2 million in prepaid expenses and other assets that increased our cash flow from operating activities.
Investing activities.  Net cash used in investing activities was $45.7 million and $1.2 million for the nine months ended September 30, 2012 and 2011 , respectively. During the nine months ended September 30, 2012 , we made net purchases of $44.8 million in short-term and long-term investments. Purchases of property and equipment amounted to $0.8 million and $1.3 million for the nine months ended September 30, 2012 and 2011 , respectively. The restricted cash balance increased by

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$0.1 million during the nine months ended September 30, 2012 due to a deposit requirement for an international bank account. The restricted cash balance decreased by $0.2 million during the nine months ended September 30, 2011 , as the certificate of deposit to collateralize our credit for our corporate credit cards was no longer required.
Financing activities.  Net cash provided by financing activities during the nine months ended September 30, 2012 of $2.5 million consisted of $2.6 million proceeds received from the issuance of common stock upon the exercise of stock options and $0.2 million proceeds from the payment of the note receivable by a stockholder, offset by the repayment of notes payable of $0.3 million to Silicon Valley Bank. Net cash used in financing activities during the nine months ended September 30, 2011 of $2.2 million consisted of the payment of notes payable of $1.2 million and deferred initial public offering costs of $1.2 million offset by $0.2 million received for the issuance of common stock upon the exercise of stock options.
Contractual Obligations and Commitments
MGH Royalty Payments
In May 2005, we entered into an agreement with Massachusetts General Hospital to obtain an exclusive license to develop and commercialize the patent and the core technology that underlies our CoolSculpting System. As defined in the agreement, we are obligated to pay a 7% royalty on net sales of CoolSculpting.
Lease Commitments
Our facility lease agreement was amended in August 2012 to extend the lease term through December 31, 2014 for our facility in Pleasanton, California. We also lease a manufacturing facility and a warehouse in Dublin, California and an office space in Gatwick, United Kingdom as well as in Dubai, United Arab Emirates. Rent expense for non-cancellable operating leases with scheduled rent increases is recognized on a straight-line basis over the lease term. Rent expense for the nine months ended September 30, 2012 and 2011 was $0.9 million and $0.6 million , respectively.
Future minimum lease payments under the noncancelable operating leases as of September 30, 2012 are as follows (in thousands):
Year Ending December 31,
 
Amount
2012 (remaining 3 months)
 
$
249

2013
 
1,168

2014
 
1,198

     Total future minimum lease payments
 
$
2,615


  Purchase Commitments
We had noncancelable purchase obligations to contract manufacturers and suppliers for $6.2 million and $5.4 million at September 30, 2012 and December 31, 2011 , respectively.
Warranty
We provide a limited warranty on our products, generally three years for control units and one year for applicators. We accrue for the estimated future costs of repair or replacement upon shipment. The warranty accrual is recorded to cost of revenues and is based upon historical and forecasted trends in the volume of product failures during the warranty period and the cost to repair or replace the equipment. We base product warranty costs on related freight, material, technical support labor, and overhead costs. The estimated product warranty costs are assessed by considering historical costs and applying the experienced failure rates to the outstanding warranty period for products sold. We exercise judgment in estimating the expected product warranty costs, using data such as the actual and projected product failure rates, and average repair costs, including freight, material, technical support labor, and overhead costs, for products returned under warranty.
The estimated product warranty accrual was as follows (in thousands):
 

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Nine Months Ended
 
 
September 30,
 
 
2012
Balance at the beginning of the period
 
$
742

Accruals for warranties issued
 
633

Adjustments to pre-existing warranties
 
168

Settlements of warranty claims
 
(680
)
Balance at the end of the period
 
$
863


Legal Matters
On March 13, 2012, an alleged purchaser of our publicly traded common stock, filed a securities class action in the Superior Court of California, County of Alameda, entitled Marcano v. Nye, et al., Case No. RG12621290.  The complaint alleges that we made false and misleading statements or omitted to state facts necessary to make the disclosures not misleading in our Form S-1, and the amendments thereto, issued in connection with our initial public offering.  The claims are asserted under Sections 11 and 15 of the Securities Act of 1933.  On March 15, 2012, April 3, 2012, and May 24, 2012, three additional and substantially similar lawsuits were filed in the same court, some adding our underwriters as defendants.  All four cases were consolidated and a consolidated complaint was deemed operative.  On August 24, 2012 , we filed a demurrer to the consolidated complaint.  Since that time, Plaintiffs have agreed to dismiss our outside directors and our underwriters from the litigation without prejudice. We believe the lawsuit to be without merit and intend to vigorously defend ourselves.  We believe there is no sufficient evidence to indicate that a probable loss had been incurred as of September 30, 2012 .
Severance
Effective April 3, 2012 , our Vice President of North American Sales resigned from our company.  On April 18, 2012 , our President and CEO resigned from the positions he held with us. As a result of these resignations, we incurred $0.9 million in costs associated with the termination benefits and $0.7 million in costs related to the modification of the employees' stock options, which were recorded during the nine months ended September 30, 2012 .  As of September 30, 2012 , approximately $0.4 million of the termination benefits had been paid.  The liability related to these costs as of September 30, 2012 was $0.5 million .  No similar costs were incurred during three and nine months ended September 30, 2011 .

Subsequent to these resignations, during the second quarter of 2012 , we made a decision to terminate several employees. As a result of these terminations, we incurred approximately $0.8 million in termination benefits, which were recorded as part of operating expenses in our consolidated statement of operations. As of September 30, 2012 approximately $0.5 million of the termination benefits had been paid.  The liability related to these costs as of September 30, 2012 was $0.3 million .  No similar costs were incurred during three and nine months ended September 30, 2011 .

Recent Accounting Pronouncements
In May 2011, the FASB issued new guidance for fair value measurements to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between US GAAP and International Financial Reporting Standards. The guidance changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements. We adopted this guidance effective January 1, 2012, and the adoption did not have an impact on our consolidated financial statements.
In June 2011, the FASB amended its guidance related to comprehensive income to increase the prominence of items reported in other comprehensive income. Accordingly, we can present all non-owner changes in stockholders’ equity (deficit) either in a single continuous statement of comprehensive income or in two separate but consecutive statements. We adopted this guidance effective January 1, 2012 and have presented a new consolidated statement of comprehensive loss.
Off-balance Sheet Arrangements
As of September 30, 2012 and December 31, 2011 , we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

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In the normal course of business, we enter into contracts that contain a variety of representations and warranties and provide for general indemnifications. Our exposure under these agreements is unknown because it involves claims that may be made against us in the future, but have not yet been made. To date, we have not paid any claims or been required to defend any action related to our indemnification obligations, and accordingly, we believe that the estimated fair value of these indemnification obligations is minimal and we have not accrued any amounts for these obligations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risks in the ordinary course of our business. These risks primarily include interest rate fluctuations and inflation. We are not exposed to foreign currency exchange risk in that we invoice revenues in U.S. dollars and receive payments in U.S. dollars.
Interest Rate Fluctuations
We hold cash equivalents as well as short-term and long-term fixed income securities. All maturities are less than two years. Our holdings include fixed and floating rate securities. Changes in interest rates could impact our anticipated interest income. The fair market value of our holdings may be adversely impacted due to a rise in interest rates; as a result, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rates.  As of September 30, 2012 , we had approximately $44.7 million invested in available-for-sale short-term and long-term investments. An immediate 10% change in interest rates would not have a material adverse impact on our future operating results and cash flows.
We do not have interest bearing liabilities as of September 30, 2012 and therefore, we are not subject to risks from immediate interest rate decreases.
Inflation
We do not believe that inflation has had a material effect on our business, financial condition, or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition, and results of operations.
Foreign Exchange
Our exposure to foreign currency exchange risk has been insignificant because the majority of our revenues and our expenses are incurred and paid in U.S. dollars.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2012 .
Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting during the quarterly period ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II. OTHER INFORMATION
Item 1. Legal Proceedings

On March 13, 2012, an alleged purchaser of our publicly traded common stock, filed a securities class action in the Superior Court of California, County of Alameda, entitled Marcano v. Nye, et al., Case No. RG12621290.  The complaint alleges that we made false and misleading statements or omitted to state facts necessary to make the disclosures not misleading in its Form S-1, and the amendments thereto, issued in connection with our initial public offering.  The claims are asserted under Sections 11 and 15 of the Securities Act of 1933.  On March 15, 2012, April 3, 2012, and May 24, 2012, three additional and substantially similar lawsuits were filed in the same court, some adding the our underwriters as defendants.  All four cases were consolidated and a consolidated complaint was deemed operative.  On August 24, 2012 , we filed a demurrer to the consolidated complaint.  Since that time, Plaintiffs have agreed to dismiss our outside directors and our underwriters from the litigation without prejudice. We believe the lawsuit to be without merit and intend to vigorously defend ourselves.  We believe there is no sufficient evidence to indicate that a loss had been incurred as of September 30, 2012 .
Item 1A. Risk Factors
Our operations and financial results are subject to various risks and uncertainties, including those described below, which could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.
The risk factors included in our Annual Report as of December 31, 2011 on Form 10-K filed with the Securities and Exchange Commission on March 15, 2012 have not changed materially other than those marked with an asterisk(*) below.
*Economic uncertainty has reduced and may continue to reduce patient demand for our products; if there is not sufficient patient demand for the procedures for which our products are used, practitioner demand for these systems could drop, resulting in unfavorable operating results.
The aesthetic industry in which we operate is particularly vulnerable to economic trends. The decision to undergo a procedure from our systems is driven by consumer demand. Most procedures performed using our systems are elective procedures, the cost of which must be borne by the patient, and are not reimbursable through government or private health insurance. In times of economic uncertainty or recession, individuals often reduce the amount of money that they spend on discretionary items, including aesthetic procedures. The general economic difficulties being experienced by our customers and the lack of availability of consumer credit for some of our customers are adversely affecting the market in which we operate.
If the economic hardships our customers face continue or worsen, our business would be negatively impacted and our financial performance would be materially harmed in the event that any of the above factors discourage patients from seeking the procedures for which our products are used.
*If we fail to manage our exposure to global financial and securities market risk successfully, our operating results and financial statements could be materially impacted.
The primary objective of most of our investment activities is to preserve principal. To achieve this objective, a majority of our marketable investments are investment grade, liquid, fixed-income securities and money market instruments denominated in U.S. dollars. If the carrying value of our investments exceeds the fair value, and the decline in fair value is deemed to be other-than-temporary, we will be required to write down the value of our investments, which could materially harm our results of operations and financial condition. Moreover, the performance of certain securities in our investment portfolio correlates with the credit condition of the U.S. financial sector. In an current unstable credit environment, we might incur significant realized, unrealized or impairment losses associated with these investments.
Risks Related to Our Business

We have limited operating experience and a history of net losses, and we may never achieve or maintain profitability.

We have a limited operating history and have focused primarily on research and development, clinical trials, product engineering, building our manufacturing capabilities, and seeking regulatory clearances and approvals to market our first product, the CoolSculpting System. We have incurred significant net losses since our inception, including net losses of approximately $9.6 million in 2011, $13.5 million in 2010 and $17.6 million in 2009. Our net loss for the nine months ended September 30, 2012 was $23.6 million . At September 30, 2012 , we had an accumulated deficit of approximately $107.2 million . We will continue to incur significant expenses for the foreseeable future as we expand our sales and marketing, research and development, and clinical and regulatory activities. We may never generate sufficient revenues to achieve or sustain profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability. Further, because of our limited operating history and because the market for aesthetic products is rapidly evolving, we have limited insight into

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the trends or competitive products that may emerge and affect our business. We may make errors in predicting and reacting to relevant business trends, which could harm our business. We may not be able to successfully address any or all of these risks, and the failure to adequately do so could cause our business, results of operations, and financial condition to suffer.
We may not be able to correctly estimate or control our future operating expenses, which could lead to cash shortfalls.
Our operating expenses may fluctuate significantly in the future as a result of a variety of factors, many of which are outside of our control. These factors include:
our commercialization strategy and whether the revenues from sales of our CoolSculpting System and procedure fees from CoolSculpting treatments will be sufficient to offset the expenses we incur in connection with our commercialization activities;
the time, resources, and expense required to develop and conduct clinical trials and seek additional regulatory clearances and approvals for additional treatment indications for CoolSculpting and for any additional products we develop;
the costs of preparing, filing, prosecuting, defending, and enforcing patent claims and other patent related costs, including litigation costs and the results of such litigation;
any product liability or other lawsuits related to our products and the costs associated with defending them or the results of such lawsuits;
the costs to attract and retain personnel with the skills required for effective operations; and
the costs associated with being a public company.
Our budgeted expense levels are based in part on our expectations concerning future revenues from CoolSculpting. We may be unable to reduce our expenditures in a timely manner to compensate for any unexpected shortfalls in revenue. Accordingly, a significant shortfall in market acceptance or demand for CoolSculpting could have an immediate and material adverse impact on our business and financial condition.
It is difficult to forecast our future performance, which may cause our financial results to fluctuate unpredictably .
Our limited operating history and the rapid evolution of the markets for medical technologies and aesthetic products make it difficult for us to predict our future performance. A number of factors, many of which are outside of our control, may contribute to fluctuations in our financial results, such as:
physician demand for purchasing CoolSculpting Systems may vary from quarter to quarter;
the inability for physicians to obtain any necessary financing;
changes in the length of the sales process;
performance of our international distributors;
positive or negative media coverage of CoolSculpting, the procedures or products of our competitors, or our industry;
our ability to maintain our current or obtain further regulatory clearances or approvals;
delays in, or failure of, product and component deliveries by our third-party manufacturers or suppliers;
seasonal or other variations in patient demand for aesthetic procedures;
introduction of new aesthetic procedures or products that compete with CoolSculpting; and
adverse changes in the economy that reduce patient demand for elective aesthetic procedures.
We are dependent upon the success of CoolSculpting, which has a limited commercial history. If the market acceptance for CoolSculpting fails to grow significantly, our business and future prospects will be harmed.
We commenced commercial sales of CoolSculpting for the selective reduction of fat in the United States in late 2010, and expect that the revenues we generate from sales of our CoolSculpting System and from CoolSculpting procedure fees will account for substantially all of our revenues for the next several years. Accordingly, our success depends on the acceptance among physicians and patients of CoolSculpting as a preferred aesthetic treatment for the selective reduction of fat. Although we have received FDA clearance to market CoolSculpting for the selective reduction of fat in the flanks and abdomen in the United States and are approved or are otherwise free to market CoolSculpting in 55 international markets, the degree of market acceptance of CoolSculpting by physicians and patients is unproven. We believe that market acceptance of CoolSculpting will depend on many factors, including:
the perceived advantages or disadvantages of CoolSculpting compared to other aesthetic products and treatments;
the safety and efficacy of CoolSculpting relative to other aesthetic products and alternative treatments;
the price of CoolSculpting relative to other aesthetic products and alternative treatments;
our success in expanding our sales and marketing organization;
the effectiveness of our marketing, advertising, and commercialization initiatives;
our success in maintaining the premium pricing for CoolSculpting through our select distribution model and physician

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marketing initiatives;
the willingness of patients to wait up to two to four months post-treatment to notice the aesthetic results of a CoolSculpting procedure; and
our ability to obtain regulatory clearance to market CoolSculpting for additional treatment indications in the United States.
We cannot assure you that CoolSculpting will achieve broad market acceptance among physicians and patients. Because we expect to derive substantially all of our revenue for the foreseeable future from sales of CoolSculpting Systems and from fees associated with each CoolSculpting procedure, any failure of this product to satisfy physician or patient demand or to achieve meaningful market acceptance will harm our business and future prospects.
Our ability to market CoolSculpting in the United States is limited to the non-invasive reduction of fat around the flanks and abdomen, and if we want to expand our marketing claims, we will need to obtain additional FDA clearances or approvals, which may not be granted.
We currently have FDA clearance to market CoolSculpting in the United States for the non-invasive reduction of fat around the flanks, an area commonly known as the “love handles” and for the abdomen area. This clearance restricts our ability to market or advertise CoolSculpting treatment for other specific body areas, which could limit physician and patient adoption of CoolSculpting. Developing and promoting new treatment indications and protocols and new treatment applicators for our CoolSculpting System are elements of our growth strategy, but we cannot predict when or if we will receive the clearances required to so implement those elements. In addition, we will be required to conduct additional clinical trials or studies to support our applications, which may be time-consuming and expensive, and may produce results that do not result in FDA clearances. In the event that we do not obtain additional FDA clearances, our ability to promote CoolSculpting in the United States will be limited. Because we anticipate that sales in the United States will continue to be a significant portion of our business for the foreseeable future, ongoing restrictions on our ability to market CoolSculpting in the United States could harm our business and limit our revenue growth.
Our success depends on growing physician adoption and use of CoolSculpting.
Our ability to increase the number of physicians willing to make a significant capital expenditure to purchase our CoolSculpting System and make CoolSculpting a significant part of their practices depends on the success of our sales and marketing programs. We must be able to demonstrate that the cost of our CoolSculpting System and the revenue that a physician can derive from performing CoolSculpting procedures are compelling when compared to the costs and revenues associated with alternative aesthetic treatments the physician may offer. Alternative treatments may be invasive, minimally-invasive, or non-invasive and, we must, in some cases, overcome a bias against non-invasive aesthetic procedures for fat reduction, principally from plastic surgeons. In addition, we believe our marketing programs, including our co-op physician marketing programs, will be critical in driving additional CoolSculpting procedures, but these programs require physician commitment and involvement to succeed. If we are unable to increase physician adoption and use of CoolSculpting, our financial performance will be adversely affected.
If there is not sufficient patient demand for CoolSculpting procedures, our financial results and future prospects will be harmed.
The CoolSculpting procedure is an elective procedure, the cost of which must be borne by the patient, and is not reimbursable through government or private health insurance. The decision to undergo a CoolSculpting procedure is thus driven by patient demand, which may be influenced by a number of factors, such as:
the success of our sales and marketing programs, including our co-op physician marketing initiatives, as to which we have limited experience;
the extent to which our physician customers recommend CoolSculpting to their patients;
our success in attracting consumers who have not previously purchased an aesthetic procedure;
the extent to which our CoolSculpting procedure satisfies patient expectations;
our ability to properly train our physician customers in the use of CoolSculpting such that their patients do not experience excessive discomfort during treatment or adverse side effects;
the cost, safety, and effectiveness of CoolSculpting versus other aesthetic treatments;
consumer sentiment about the benefits and risks of aesthetic procedures generally and CoolSculpting in particular;
the success of any direct-to-consumer marketing efforts we initiate; and
general consumer confidence, which may be impacted by economic and political conditions.
Our financial performance will be materially harmed in the event we cannot generate significant patient demand for CoolSculpting.

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Our success depends in part upon patient satisfaction with the effectiveness of CoolSculpting.
To generate repeat and referral business, patients must be satisfied with the effectiveness of CoolSculpting. Our clinical studies demonstrate that a single CoolSculpting procedure noticeably and measurably reduces the fat layer within a treated fat bulge without requiring diet or exercise. However, we designed CoolSculpting to address the aesthetic concerns of individuals who have stubborn fat bulges but are not obese. Although there are no technical or regulatory restrictions on the use of CoolSculpting based on patient weight, we believe patients who are obese and who do not have specific fat bulges but require significant fat reduction to achieve aesthetic results are better candidates for invasive and minimally-invasive procedures. In addition, results obtained from a CoolSculpting procedure occur gradually over a period of two to four months after treatment and patient perception of their results may vary. Although we train our physician customers to select the appropriate patient candidates for a CoolSculpting procedure, explain to their patients the time period over which the results from a CoolSculpting procedure will occur, and take before and after photographs of a patient, our physician customers may not select appropriate patient candidates or CoolSculpting may produce results that may not meet patients' expectations. If patients are not satisfied with the aesthetic benefits of CoolSculpting, or feel that it is too expensive for the results obtained, our reputation and future sales will suffer.
We have limited experience with our direct sales and marketing force and any failure to build and manage our direct sales and marketing force effectively could have a material adverse effect on our business.
We rely on a direct sales force to sell CoolSculpting in the United States, Canada and four key markets in Europe (England, Germany, France and Spain). To meet our anticipated sales objectives, we expect to grow our direct sales and marketing organization in these countries significantly over the next several years and intend to opportunistically build a direct sales and marketing force in certain international markets. There are significant risks involved in building and managing our sales and marketing organization, including risks related to our ability to:
hire qualified individuals as needed;
generate sufficient leads within our target physician group for our sales force;
provide adequate training for the effective sale and marketing of CoolSculpting;
retain and motivate our direct sales and marketing professionals; and
effectively oversee geographically dispersed sales and marketing teams.
Our failure to adequately address these risks could have a material adverse effect on our ability to increase sales and use of our CoolSculpting Systems, which would cause our revenues to be lower than expected and harm our results of operations. In addition, as we transition to direct sales in certain international markets, consistent with our sales strategy, the transition may result in a slow-down of growth or even a reduction in sales in those markets during the transition process as our distributors anticipate losing the ability to sell our products. Furthermore, our transition to direct sales in certain international markets could impact the performance of distributors in otherwise unaffected international markets as distributors may anticipate that their territories may be transitioned in the future.
To market and sell CoolSculpting in markets outside of North America, we mainly depend on third-party distributors.
We currently depend on third-party distributors to sell, market, and service our CoolSculpting Systems in markets outside of North America and to train our physician customers in such markets. We may need to engage additional third-party distributors to expand in new markets outside of North America. We are subject to a number of risks associated with our dependence on these third parties, including:
we lack day-to-day control over the activities of third-party distributors;
third-party distributors may not commit the necessary resources to market, sell, and service our systems to the level of our expectations;
third-party distributors may not be as selective as we would be in choosing physicians to purchase CoolSculpting Systems or as effective in training physicians in marketing and patient selection;
third-party distributors may terminate their arrangements with us on limited, or no, notice or may change the terms of these arrangements in a manner unfavorable to us; and
disagreements with our distributors could require or result in costly and time-consuming litigation or arbitration which we could be required to conduct in jurisdictions with which we are not familiar.
If we fail to establish and maintain satisfactory relationships with our third-party distributors, our revenues and market share may not grow as anticipated, and we could be subject to unexpected costs which would harm our results of operations and financial condition.

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To successfully market and sell CoolSculpting in markets outside of North America, we must address many issues with which we have limited experience.
Sales in markets outside of North America accounted for approximately 25% and 27% of our revenue for the nine months ended September 30, 2012 and 2011, respectively. We believe that a significant percentage of our business will continue to come from sales in markets outside of North America through increased penetration in countries where we currently market and sell CoolSculpting directly and through our third-party distributor network, combined with expansion into new international markets. However, international sales are subject to a number of risks, including:
difficulties in staffing and managing our international operations;
increased competition as a result of more products and procedures receiving regulatory approval or otherwise free to market in international markets;
longer accounts receivable payment cycles and difficulties in collecting accounts receivable;
reduced or varied protection for intellectual property rights in some countries;
export restrictions, trade regulations, and foreign tax laws;
fluctuations in currency exchange rates;
foreign certification and regulatory clearance or approval requirements;
difficulties in developing effective marketing campaigns in unfamiliar foreign countries;
customs clearance and shipping delays;
political, social, and economic instability abroad, terrorist attacks, and security concerns in general;
preference for locally produced products;
potentially adverse tax consequences, including the complexities of foreign value-added tax systems, tax inefficiencies related to our corporate structure, and restrictions on the repatriation of earnings;
the burdens of complying with a wide variety of foreign laws and different legal standards; and
increased financial accounting and reporting burdens and complexities.
If one or more of these risks were realized, it could require us to dedicate significant financial and management resources and our revenue may decline.
Our inability to effectively compete with our competitors may prevent us from achieving significant market penetration or improving our operating results.
The medical technology and aesthetic product markets are highly competitive and dynamic, and are characterized by rapid and substantial technological development and product innovations. Demand for CoolSculpting could be limited by the products and technologies offered by our competitors. We designed CoolSculpting to address the aesthetic concerns of individuals who have stubborn fat bulges that may not respond to diet or exercise. Patients who are obese and who do not have specific fat bulges but require significant fat reduction to achieve aesthetic results are candidates for invasive and minimally-invasive procedures, such as liposuction and laser-assisted liposuction. Patients who do not require significant fat reduction to achieve meaningful aesthetic results explore non-invasive fat reduction and body contouring procedures to avoid the pain, expense, downtime, and surgical risks associated with invasive and minimally-invasive procedures. In the United States, the FDA has cleared the marketing of a laser energy-based product for body contouring. The laser energy-based product, marketed by Erchonia Corporation, is used to perform a non-invasive procedure reported to be safe and easy to perform, without causing patient pain. In September 2011, the FDA cleared the marketing of an ultrasound energy-based product for body contouring offered by Solta Medical, Inc., a publicly traded company. This ultrasound energy-based product utilizes heat to non-invasively eliminate fat cells in a single procedure. We believe that plans to introduce this product continued extending the sales cycle for CoolSculpting during the first nine months of 2012 and may continue to have an impact on our sales in the near future.
Due to less stringent regulatory requirements, there are many more aesthetic products and procedures available for use in international markets than are approved for use in the United States. For example, multiple ultrasound based products have been cleared for marketing outside the United States. There are also fewer limitations on the claims our competitors in international markets can make about the effectiveness of their products and the manner in which they can market them. As a result, we face more competition in these markets than in the United States.
We also generally compete against medical technology and aesthetic companies, including those offering products and technologies unrelated to fat reduction, for physician resources and mindshare. Some of our competitors have a broad range of product offerings, large direct sales forces, and long-term customer relationships with our target physicians, which could inhibit our market penetration efforts. Our potential physician customers also may need to recoup the cost of expensive products that they have already purchased from our competitors, and thus they may decide to delay purchasing, or not to purchase, our CoolSculpting System.

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Many of our competitors are large, experienced companies that have substantially greater resources and brand recognition than we do. Competing in the medical technology and aesthetic markets could result in price-cutting, reduced profit margins, and limited market share, any of which would harm our business, financial condition, and results of operations.
We and our third-party manufacturing partners have limited experience in producing our CoolSculpting System, and if we are unable to manufacture our CoolSculpting System in high-quality commercial quantities successfully and consistently to meet demand, our growth will be limited.
Prior to receiving FDA clearance in 2009, we manufactured our CoolSculpting System in limited quantities sufficient only to meet the needs of our clinical studies. We currently manufacture our CoolSculpting System and related procedure packs, containing disposable CoolGels and CoolLiners, through a combination of direct manufacturing at our facility in Pleasanton, California and through third-party manufacturers. To manufacture our CoolSculpting System in the quantities that we believe will be required to meet anticipated market demand, we and our third-party manufacturers will need to increase manufacturing capacity, which will involve significant challenges and may require additional regulatory approvals. In addition, the development of commercial-scale manufacturing capabilities will require us and our third-party manufacturers to invest substantial additional funds and hire and retain the technical personnel who have the necessary manufacturing experience. Neither we nor our third-party manufacturers may successfully complete any required increase to existing manufacturing processes in a timely manner, or at all.
If there is a disruption to our or our third-party manufacturers' operations, we will have no other means of producing our CoolSculpting Systems until we restore the affected facilities or develop alternative manufacturing facilities. Additionally, any damage to or destruction of our or our third-party manufacturers' facilities or equipment may significantly impair our ability to manufacture CoolSculpting Systems on a timely basis.
If we or our third-party manufacturers are unable to produce CoolSculpting Systems in sufficient quantities to meet anticipated customer demand, our revenues, business, and financial prospects would be harmed. The lack of experience we and our manufacturing partners have in producing commercial quantities of our CoolSculpting System may also result in quality issues, and result in product recalls. Manufacturing delays related to quality control could negatively impact our ability to bring our CoolSculpting System and procedure packs to market, harm our reputation, and decrease our revenues. Any recall could be expensive and generate negative publicity, which could impair our ability to market our CoolSculpting System and further affect our results of operations.
We outsource the manufacturing of key elements of our CoolSculpting System to a single third-party manufacturer.
OnCore Manufacturing LLC, or OnCore, manufactures our CoolSculpting control units, our CoolMax applicators, and our CoolCards used with our CoolSculpting System. In addition, our disposable CoolLiners are manufactured by Coastline International, Inc. in Tijuana, Mexico. If the operations of third-party manufacturers, especially OnCore, are interrupted or if they are unable to meet our delivery requirements due to capacity limitations or other constraints, we may be limited in our ability to fulfill new customer orders or to repair equipment at current customer sites. Any change to another contract manufacturer would likely entail significant delay, require us to devote substantial time and resources, and could involve a period in which our products could not be produced in a timely or consistently high-quality manner, any of which could harm our reputation and results of operations.
Our manufacturing operations and those of our key third-party manufacturers are dependent upon third-party suppliers, making us vulnerable to supply shortages and price fluctuations, which could harm our business.
Our CoolSculpting System contains two critical components, the integrated circuit contained in the CoolSculpting control unit, which is manufactured by Renesas Electronics Corporation in Japan, and the connector that attaches our applicators to the control unit, which is manufactured by Hypertronics Corporation in Hudson, Massachusetts. The single source suppliers of these two critical components may not be replaced without significant effort and delay in production. We do not have supply agreements with the suppliers of these critical components beyond purchase orders and, although we maintain a safety stock inventory for these critical components equal to one year of forecasted part requirements of the integrated circuit and one month of connectors in finished assemblies at OnCore, our contract manufacturer, as well as at least three months supply of connectors to support open purchase orders, such forecasted amounts may be inaccurate and we may experience shortages as a result of serious supply problems with these manufacturers. In addition, several other non-critical components and materials that compose our CoolSculpting System are currently manufactured by a single supplier or a limited number of suppliers. In many of these cases, we have not yet qualified alternate suppliers and rely upon purchase orders, rather than long-term supply agreements. A supply interruption or an increase in demand beyond our current suppliers' capabilities could harm our ability to manufacture our CoolSculpting System until new sources of supply are identified and qualified. Our reliance on these suppliers subjects us to a number of risks that could harm our business, including:

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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;
a lack of long-term supply arrangements for key components with our suppliers;
inability to obtain adequate supply in a timely manner, or to obtain adequate supply on commercially reasonable terms;
difficulty and cost associated with locating and qualifying alternative suppliers for our components in a timely manner;
production delays related to the evaluation and testing of products from alternative suppliers, and corresponding regulatory qualifications;
delay in delivery due to our suppliers prioritizing other customer orders over ours;
damage to our brand reputation caused by defective components produced by our suppliers;
increased cost of our warranty program due to product repair or replacement based upon defects in components produced by our suppliers; and
fluctuation in delivery by our suppliers due to changes in demand from us or their other customers.
Any interruption in the supply of components or materials, or our inability to obtain substitute components or materials from alternate sources at acceptable prices in a timely manner, could impair our ability to meet the demand of our customers, which would have an adverse effect on our business.
We forecast sales to determine requirements for components and materials used in our CoolSculpting System, and if our forecasts are incorrect, we may experience delays in shipments or increased inventory costs.
We keep limited materials, components, and finished products on hand. To manage our operations with our third-party manufacturers and suppliers, we forecast anticipated product orders and material requirements to predict our inventory needs and enter into purchase orders on the basis of these requirements. Several components of our CoolSculpting System require an order lead time of six months. Our limited historical commercial experience and rapid growth may not provide us with enough data to consistently and accurately predict future demand. If our business expands, our demand for components and materials increase beyond our estimates, our manufacturers and suppliers may be unable to meet our demand. In addition, if we underestimate our component and material requirements, we may have inadequate inventory, which could interrupt, delay, or prevent delivery of our CoolSculpting System to our customers. In contrast, if we overestimate our component and material requirements, we may have excess inventory, which would increase our expenses. Any of these occurrences would negatively affect our financial performance and the level of satisfaction our physician customers have with our business.
Even though our CoolSculpting System is marketed solely to physicians, there exists a potential for misuse, which could harm our reputation and our business.
We and our independent distributors market and sell CoolSculpting solely to physicians. Under state law in the United States, our physician customers can generally allow nurse practitioners, technicians, and other non-physicians to perform CoolSculpting procedures under their direct supervision. Similarly, in markets outside of the United States, physicians can allow non-physicians to perform CoolSculpting procedures under their supervision. Although we and our distributors provide training on the use of CoolSculpting Systems, we do not supervise the procedures performed with our CoolSculpting System, nor can we be assured that direct physician supervision of procedures occurs according to our recommendations. The potential misuse of our CoolSculpting System by physicians and non-physicians may result in adverse treatment outcomes, which could harm our reputation and expose us to costly product liability litigation.
Product liability suits could be brought against us due to defective design, labeling, material, or workmanship, or misuse of our CoolSculpting System, or unanticipated adverse events, and could result in expensive and time-consuming litigation, payment of substantial damages, an increase in our insurance rates and substantial harm to our reputation.
If our CoolSculpting System is defectively designed, manufactured, or labeled, contains defective components, or is misused, we may become subject to substantial and costly litigation by our physician customers or their patients. Misusing our CoolSculpting System or failing to adhere to operating guidelines can cause skin damage and underlying tissue damage and, if our operating guidelines are found to be inadequate, we may be subject to liability. Furthermore, if a patient is injured in an unexpected manner or suffers unanticipated adverse events after undergoing a CoolSculpting procedure, even if the procedure was performed in accordance with our operating guidelines, we may be subject to product liability claims. Product liability claims could divert management's attention from our core business, be expensive to defend, and result in sizable damage awards against us. We currently have product liability insurance, but it may not be adequate to cover us against potential liability. In addition, we may not be able to maintain insurance in amounts or scope sufficient to provide us with adequate coverage against all potential liabilities. Any product liability claims brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing continuing coverage, could harm our reputation in the industry, and reduce product sales. Product liability claims in excess of our insurance coverage would be paid out of cash reserves, harming our financial condition and reducing our operating results.

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Third parties may attempt to produce counterfeit versions of our products and may harm our ability to collect procedure fees, negatively affect our reputation, or harm patients and subject us to product liability.
Third parties may seek to develop counterfeit CoolCards and procedure packs that are compatible with our CoolSculpting System and available to practitioners at lower prices than our own. If security features incorporated into the design of our CoolSculpting System are unable to prevent the introduction of counterfeit CoolCards, we may not be able to monitor the number of procedures performed using our CoolSculpting System. Practitioners may be able to make unauthorized use of our CoolSculpting System and our ability to collect procedure fees may be compromised. Procedure fees revenues represented 49% and 32% of total revenues for the nine months ended September 30, 2012 and the year ended December 31, 2011 , respectively, and an inability to collect them in the future would have a material adverse affect on our results of operations.
In addition, if counterfeit products are used with or in place of our own, we could be subject to product liability lawsuits resulting from the use of damaged or defective goods and suffer damage to our reputation.
Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer.
In the ordinary course of our business, we collect and store sensitive data, including intellectual property, our proprietary business information and certain personally identifiable information of our physician customers and employees in our data centers and on our networks. The secure processing, maintenance, and transmission of this information is important to our operations and business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to malfeasance, employee error, or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost, or stolen. Any such access, disclosure, or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, damage our reputation, any of which could have a material adverse effect on our business, profitability and financial condition.
We have increased the size of our company significantly and over a short period, and difficulties managing our growth could adversely affect our business, operating results, and financial condition.
We have increased our headcount from 64 at January 1, 2010 to 197 at September 30, 2012 , and plan to continue to hire a substantial number of additional employees as we increase our commercialization activities for CoolSculpting. This growth has placed and may continue to place a strain on our management and our administrative, operational, and financial infrastructure. Our ability to manage our operations and growth requires the continued improvement of our operational, financial and management controls, reporting systems, and procedures, particularly to meet the reporting requirements of the Securities Exchange Act of 1934. If we are unable to manage our growth effectively or if we are unable to attract additional highly qualified personnel, our business, operating results, and financial condition may be harmed.
We depend on skilled and experienced personnel to operate our business effectively. If we are unable to recruit, hire, and retain these employees, our ability to manage and expand our business will be harmed, which would impair our future revenue and profitability.
Our success largely depends on the skills, experience, and efforts of our executive officers and other key employees. We do not have employment contracts with any of our executive officers or other key employees that require these officers to stay with us for any period of time. Any of our executive officers and other key employees may terminate their employment with us at any time. The loss of any of our executive officers and other key employees could weaken our management expertise and harm our business operations. We only maintain key man insurance for our chief executive officer.
In addition, our ability to retain our skilled employees 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 may not be able to meet our future hiring needs or retain our existing employees. We will face significant challenges and risks in hiring, training, managing, and retaining sales and marketing, product development, financial reporting, and regulatory compliance employees, many of whom are geographically dispersed. Failure to attract and retain personnel, particularly our sales and marketing, product development, financial reporting, and regulatory compliance personnel, would materially harm our ability to compete effectively and grow our business.
We may need to raise additional funds in the future, and such funds may not be available on a timely basis, or at all.
Until such time, if ever, as we can generate substantial revenues from sales of our CoolSculpting System and from CoolSculpting procedure fees, we will be required to finance our operations with our cash resources. We may need to raise

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additional funds in the future to support our operations. We cannot be certain that additional capital will be available as needed or on acceptable terms, or at all. If we require additional capital at a time when investment in our company, in medical technology or aesthetic product companies or the marketplace in general is limited, we may not be able to raise such funds at the time that we desire, or at all. If we do raise additional funds through the issuance of equity or convertible securities, the percentage ownership of holders of our common stock could be significantly diluted and these newly issued securities may have rights, preferences, or privileges senior to those of holders of our common stock. If we obtain debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, and the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through collaborations and licensing arrangements, we could be required to relinquish significant rights to our technologies, and products or grant licenses on terms that are not favorable to us.
Our ability to use net operating losses and tax credit carryforwards to offset future tax liabilities may be limited.
We have substantial federal net operating loss carryforwards, or NOLs, and state and federal tax credit carryforwards. A lack of future taxable income would adversely affect our ability to utilize these NOLs and tax credit carryforwards. In addition, under Section 382 of the U.S. Internal Revenue Code, or the Code, a corporation that experiences a more-than 50% ownership change over a three-year testing period is subject to limitations on its ability to utilize its pre-change NOLs and tax credit carryforwards to offset future taxable income. If we undergo an ownership change in connection with or after our initial public offering, or IPO, our ability to utilize NOLs and tax credit carryforwards could be limited by Section 382 of the Code. Future changes in our stock ownership, many of the causes of which are outside of our control, could result in an ownership change under Section 382 of the Code. Our NOLs and tax credit carryforwards may also be impaired under state law. As a result of these limitations, we may not be able to utilize a material portion of the NOLs and tax credit carryforwards.
Risks Related to Regulation
The regulatory clearance and approval process is expensive, time-consuming, and uncertain, and the failure to obtain and maintain required regulatory clearances and approvals could prevent us from commercializing our CoolSculpting System and any future products we develop.
We are investing in the research and development of new products and procedures based on our proprietary controlled-cooling technology platform. Our products are subject to 510(k) clearance by the FDA prior to their marketing for commercial use in the United States, and to any approvals required by foreign governmental entities prior to their marketing outside the United States. In addition, if we make any changes or modifications to our CoolSculpting System that could significantly affect its safety or effectiveness, or would constitute a change in its intended use, we may be required to submit a new application for 510(k) clearance or foreign regulatory approvals. For example, we will be required to submit new 510(k) applications to expand our ability to market CoolSculpting for use on other areas of the body beyond the flanks and abdomen.
The 510(k) clearance processes, as well as the process for obtaining foreign approvals, can be expensive, time-consuming, and uncertain. We anticipate that the direct clinical costs to support a 510(k) application for an additional indication for CoolSculpting will range from $0.25 million to $0.5 million. In addition to the time required to conduct clinical trials, it generally takes from four to twelve months from submission of an application to obtain 510(k) clearance; however, it may take longer, and 510(k) clearance may never be obtained. Delays in receipt of, or failure to obtain, clearances or approvals for any product enhancements or new products we develop would result in delayed, or no, realization of revenues from such product enhancements or new products and in substantial additional costs which could decrease our profitability.
In addition, we are required to continue to comply with applicable FDA and other regulatory requirements once we have obtained clearance or approval for a product. There can be no assurance that we will successfully maintain the clearances or approvals we have received or may receive in the future. Our clearances can be revoked if safety or effectiveness problems develop. Any failure to maintain compliance with FDA and applicable international regulatory requirements could harm our business, financial condition, and results of operations.
We will be subject to significant liability if we are found to have improperly promoted CoolSculpting for off-label uses.
The FDA strictly regulates the promotional claims that may be made about FDA-cleared products. In particular, a product may not generally be promoted for uses that are not approved by the FDA as reflected in the product's approved labeling. Our current FDA label only permits marketing CoolSculpting in the United States for use on the flanks and for the abdomen and restricts us from promoting it for use on other parts of the body. We are aware that CoolSculpting is used by our physician customers on other parts of the body. If we are found to have inappropriately marketed for such off-label uses, we may become subject to significant liability. The federal government has levied large civil and criminal fines against companies for alleged improper promotion and entered agreements with several companies that require cumbersome reporting and oversight of sales

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and marketing practices. The FDA has also requested that companies enter into consent decrees or permanent injunctions under which specified promotional conduct is changed or curtailed.
CoolSculpting may cause or contribute to adverse medical events that we are required to report to the FDA and if we fail to do so, we could be subject to sanctions that would materially harm our business.
FDA regulations require that we report certain information about adverse medical events if our medical devices may have caused or contributed to those adverse events. The timing of our obligation to report is triggered by the date we become aware of the adverse event as well as the nature of the event. We may fail to report adverse events we become aware of within the prescribed timeframe. We may also fail to appreciate that we have become aware of a reportable adverse event, especially if it is not reported to us as an adverse event or if it is an adverse event that is unexpected or removed in time from the use of our products. If we fail to comply with our reporting obligations, the FDA could take action including criminal prosecution, the imposition of civil monetary penalties, revocation of our device clearance or approval, seizure of our products, or delay in approval or clearance of future products.
We are currently, and in the future our contract manufacturers may be, subject to various governmental regulations related to the manufacturing of CoolSculpting, and we may incur significant expenses to comply with, experience delays in our product commercialization as a result of, and be subject to material sanctions if we or our contract manufacturers violate these regulations.
Our manufacturing processes and facilities are required to comply with the FDA's Quality System Regulation, or the QSR, which covers the procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage, and shipping of our devices. Although we believe we are compliant with the QSRs, the FDA enforces the QSR through periodic announced or unannounced inspections of manufacturing facilities. We have been, and anticipate in the future being, subject to such inspections, as well as to inspections by other federal and state regulatory agencies.
Failure to comply with applicable FDA requirements, or later discovery of previously unknown problems with our products or manufacturing processes, including our failure or the failure of one of our third-party manufacturers to take satisfactory corrective action in response to an adverse QSR inspection, can result in, among other things:
administrative or judicially-imposed sanctions;
injunctions or the imposition of civil penalties;
recall or seizure of our products;
total or partial suspension of production or distribution;
the FDA's refusal to grant pending future clearance or pre-market approval for our products;
withdrawal or suspension of marketing clearances or approvals;
clinical holds;
warning letters;
refusal to permit the import or export of our products; and
criminal prosecution of us or our employees.
Any of these actions, in combination or alone, could prevent us from marketing, distributing, or selling our products and would likely harm our business.
In addition, a product defect or regulatory violation could lead to a government-mandated or voluntary recall by us. We believe that the FDA would request that we initiate a voluntary recall or impose a mandatory recall if a product was defective or presented a risk of injury or gross deception. Regulatory agencies in other countries have similar authority to recall devices because of material deficiencies or defects in design or manufacture that could endanger health. Any recall would divert management attention and financial resources, could cause the price of our shares of common stock to decline and expose us to product liability or other claims, including contractual claims from parties to whom we sold products and harm our reputation with customers. A recall involving our CoolSculpting System would be particularly harmful to our business and financial results and, even if we remedied a particular problem, would have a lasting negative effect on our reputation and demand for our products.
Legislative or regulatory healthcare reforms may make it more difficult and costly for us to obtain regulatory clearance or approval of our products and to produce, market, and distribute our products after clearance or approval is obtained.
From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing the regulatory clearance or approval, manufacture, and marketing of regulated products or the reimbursement

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thereof. In addition, FDA regulations and guidance are often revised or reinterpreted by the FDA in ways that may significantly affect our business and our products. For example, in the future, the FDA may require more burdensome premarket approval of our procedures rather than the 510(k) clearance process we have used to date and anticipate primarily using in the future. Our CoolSculpting Platform is also subject to state regulations which are, in many instances, in flux. Any new regulations or revisions or reinterpretations of existing regulations may impose additional costs or lengthen review times of our products. We cannot determine what effect changes in regulations, statutes, legal interpretation or policies, when and if promulgated, enacted or adopted may have on our business in the future. Such changes could, among other things, require:
changes to manufacturing methods;
recall, replacement, or discontinuance of certain products; and
additional record keeping.
Each of these would likely entail substantial time and cost and could materially harm our financial results. In addition, delays in receipt of or failure to receive regulatory clearances or approvals for our new products would harm our business, financial condition, and results of operations.
Federal and state governments in the United States are also undertaking efforts to control growing health care costs through legislation, regulation, and voluntary agreements with medical care providers, and third-party payers. In March 2010, Congress enacted comprehensive health care reform legislation known as the Patient Protection and Affordable Care Act of 2010, or the PPACA. While the PPACA involves expanding coverage to more individuals, it includes new regulatory mandates and other measures designed to constrain medical costs. The PPACA also imposes significant new taxes on medical technology manufacturers that are expected to cost the medical technology industry up to $20 billion over the next decade. The PPACA imposes a 2.3% excise tax on sales of medical devices by manufacturers. There is no exemption for small companies, and we expect to begin paying the tax in 2013. The PPACA also requires manufacturers to report to the Department of Health and Human Services detailed information about financial arrangements with physicians and teaching hospitals. These reporting provisions preempt state laws that require reporting of the same information, but not those that require reports of different or additional information. Failure to comply subjects the manufacturer to significant civil monetary penalties. We expect compliance with the PPACA to impose significant administrative and financial burdens on us, which may harm our results of operation.
We may be subject to various federal and state laws pertaining to health care fraud and abuse, including anti-kickback, self-referral, false claims, and fraud laws, and any violations by us of such laws could result in fines or other penalties.
Our commercial, research, and other financial relationships with healthcare providers and institutions may be subject to various federal and state laws intended to prevent health care fraud and abuse. The federal anti-kickback statute prohibits the offer, receipt, or payment of remuneration in exchange for or to induce the referral of patients or the use of products or services that would be paid for in whole or part by Medicare, Medicaid or other federal health care programs. Remuneration has been broadly defined to include anything of value, including cash, improper discounts, and free or reduced price items and services. Many states have similar laws that apply to their state health care programs as well as private payers. Violations of the anti-kickback laws can result in exclusion from federal health care programs and substantial civil and criminal penalties.
The federal False Claims Act, or FCA, imposes liability on persons who, among other things, present or cause to be presented false or fraudulent claims for payment by a federal health care program. The FCA has been used to prosecute persons submitting claims for payment that are inaccurate or fraudulent, that are for services not provided as claimed, or for services that are not medically necessary. The FCA includes a whistleblower provision that allows individuals to bring actions on behalf of the federal government and share a portion of the recovery of successful claims. If our marketing or other arrangements were determined to violate anti-kickback or related laws, including the FCA, then our revenues could be adversely affected, which would likely harm our business, financial condition, and results of operations.
State and federal authorities have aggressively targeted medical technology companies for alleged violations of these anti-fraud statutes, based on improper research or consulting contracts with doctors, certain marketing arrangements that rely on volume-based pricing, off-label marketing schemes, and other improper promotional practices. Companies targeted in such prosecutions have paid substantial fines in the hundreds of millions of dollars or more, have been forced to implement extensive corrective action plans, and have often become subject to consent decrees severely restricting the manner in which they conduct their business. If we become the target of such an investigation or prosecution based on our contractual relationships with providers or institutions, or our marketing and promotional practices, we could face similar sanctions which would materially harm our business.
Also, the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. Some

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of our distribution partners are located in parts of the world that have experienced governmental corruption to some degree and, in certain circumstances, strict compliance with anti-bribery laws may conflict with local customs and practices. We cannot assure you that our internal control policies and procedures will protect us from reckless or negligent acts committed by our employees, distributors, partners, or agents. Violations of these laws, or allegations of such violations, could result in fines, penalties, or prosecution and have a negative impact on our business, results of operations and reputation.
We are subject to numerous environmental, health and safety laws and regulations, and must maintain licenses or permits, and non-compliance with these laws, regulations, licenses, or permits may expose us to significant costs or liabilities.
We are subject to numerous foreign, federal, state, and local environmental, health and safety laws and regulations relating to, among other matters, safe working conditions and environmental protection, including those governing the generation, storage, handling, use, transportation, and disposal of hazardous or potentially hazardous materials. Some of these laws and regulations require us to ob