ZELTIQ
Zeltiq Aesthetics Inc (Form: 10-Q, Received: 07/29/2014 17:20:44)
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 June 30, 2014
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
 
ý
Non-accelerated filer
 
¨
  
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 July 24, 2014 , there w ere 37,525,554 shares of the r egistrant’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 3:
ITEM 4:
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)
 
 
June 30,
2014
 
December 31,
2013
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
20,262

 
$
25,798

Short-term investments
18,565

 
18,840

Accounts receivable, net
13,908

 
10,221

Inventory
18,555

 
8,406

Prepaid expenses and other current assets
2,256

 
4,368

Total current assets
73,546

 
67,633

Long-term investments
4,467

 
11,442

Restricted cash
334

 
331

Property and equipment, net
2,289

 
2,158

Intangible asset, net
6,130

 
6,481

Other assets
71

 
9

Total assets
$
86,837

 
$
88,054

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
3,302

 
$
5,165

Accrued liabilities
18,519

 
18,364

Deferred revenue
3,792

 
1,674

Total current liabilities
25,613

 
25,203

Other non-current liabilities
175

 
275

Total liabilities
$
25,788

 
$
25,478

Commitments and contingencies (Note 6)

 

STOCKHOLDERS’ EQUITY:
 
 
 
Preferred stock, $0.01 par value: 50,000,000 shares authorized and no shares issued and outstanding at June 30, 2014, and December 31, 2013

 

Common stock, $0.001 par value: 500,000,000 shares authorized at June 30, 2014, and December 31, 2013; 37,518,121 and 37,038,374 shares issued and outstanding at June 30, 2014, and December 31, 2013, respectively
42

 
41

Additional paid-in capital
198,372

 
195,507

Accumulated other comprehensive income
262

 
87

Accumulated deficit
(137,627
)
 
(133,059
)
Total stockholders’ equity
61,049

 
62,576

Total liabilities and stockholders’ equity
$
86,837

 
$
88,054

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
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
47,061

 
$
26,338

 
$
78,036

 
$
46,320

Cost of revenue
13,660

 
7,878

 
22,676

 
15,226

Gross profit
33,401

 
18,460

 
55,360

 
31,094

Operating expenses:
 
 
 
 
 
 
 
Research and development
4,350

 
3,898

 
8,620

 
7,647

Sales and marketing
21,052

 
14,625

 
41,239

 
27,167

General and administrative
5,234

 
3,626

 
9,947

 
7,434

Total operating expenses
30,636

 
22,149

 
59,806

 
42,248

Income (loss) from operations
2,765

 
(3,689
)
 
(4,446
)
 
(11,154
)
Interest income, net
14

 
19

 
33

 
43

Other (expense) income, net
(83
)
 
106

 
(149
)
 
72

Income (loss) before provision for income taxes
2,696

 
(3,564
)
 
(4,562
)
 
(11,039
)
(Benefit from) provision for income taxes
(73
)
 
43

 
6

 
50

Net income (loss)
$
2,769

 
$
(3,607
)
 
(4,568
)
 
(11,089
)
Basic net income (loss) per share:
 
 
 
 
 
 
 
Net income (loss) per share, basic
$
0.07

 
$
(0.10
)
 
$
(0.12
)
 
$
(0.31
)
Weighted average shares of common stock outstanding used in computing net income (loss) per share, basic
37,440,537

 
36,045,346

 
37,328,738

 
35,968,144

Diluted net income (loss) per share:
 
 
 
 
 
 
 
Net income (loss) per share, diluted
$
0.07

 
$
(0.10
)
 
$
(0.12
)
 
$
(0.31
)
Weighted average shares of common stock outstanding used in computing net income (loss) per share, diluted
40,597,275

 
36,045,346

 
37,328,738

 
35,968,144

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 Income (Loss)
(Unaudited)
(In thousands)

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Net income (loss)
$
2,769

 
$
(3,607
)
 
$
(4,568
)
 
$
(11,089
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
149

 

 
179

 

Changes in unrealized losses on available-for-sale securities
(6
)
 
(8
)
 
(4
)
 
(16
)
Other comprehensive income (loss), net of tax
143

 
(8
)
 
175

 
(16
)
Comprehensive income (loss)
$
2,912

 
$
(3,615
)
 
$
(4,393
)
 
$
(11,105
)
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)
 
Six Months Ended
 
June 30,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(4,568
)
 
(11,089
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
932

 
850

Stock-based compensation
4,511

 
2,599

Deferred income tax provision (benefit)
38

 
(20
)
Amortization (accretion) of investment premium (discount), net
126

 
177

Provision for doubtful accounts receivable
145

 
(3
)
Provision for excess and obsolete inventory
325

 
162

Loss on disposal and write-off of property and equipment
17

 
2

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(3,781
)
 
(406
)
Inventory
(9,781
)
 
1,093

Prepaid expenses and other assets
2,022

 
150

Deferred revenue, net of deferred costs
2,099

 
(268
)
Accounts payable, accrued and other non-current liabilities
(2,416
)
 
517

Net cash used in operating activities
(10,331
)
 
(6,236
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchase of investments
(4,513
)
 
(19,093
)
Proceeds from sale of investments
1,000

 
10,550

Proceeds from maturity of investments
10,634

 
13,586

Purchase of property and equipment
(770
)
 
(306
)
Change in restricted cash
(1
)
 
145

Net cash provided by investing activities
6,350

 
4,882

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of common stock upon exercise of stock options
1,587

 
602

Tax payments related to shares withheld for vested restricted stock units
(3,247
)
 
(62
)
Tax effect of employee stock plans
15

 

Net cash (used in) provided by financing activities
(1,645
)
 
540

Effect of exchange rate on cash and cash equivalents
90

 

NET DECREASE IN CASH AND CASH EQUIVALENTS
(5,536
)
 
(814
)
CASH AND CASH EQUIVALENTS—Beginning of period
25,798

 
22,876

CASH AND CASH EQUIVALENTS—End of period
$
20,262

 
$
22,062

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

6


Notes to Condensed Consolidated Financial Statements
(Unaudited)

1. Basis of Presentation and 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 generally accepted accounting principles in the United States of America, or GAAP, and the applicable rules and regulations of the Securities and Exchange Commission, or 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, 2013 , 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 accompanying 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 June 30, 2014 , results of operations for the three and six months ended June 30, 2014 and 2013 , comprehensive loss for the three and six months ended June 30, 2014 and 2013 , and cash flows for the six months ended June 30, 2014 and 2013 . The interim results for the three and six months ended June 30, 2014 , are not necessarily indicative of the results that may be expected for the year ending December 31, 2014 , or for any other future annual or interim period. Certain amounts in the prior year's condensed consolidated statement of cash flows have been reclassified to conform to the current period's presentation. These reclassifications had no impact on previously reported consolidated balance sheets or results of consolidated statements of operations.

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, 2013 .

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Based on an evaluation of economic facts and circumstances together with the functional currency analysis prescribed in Accounting Standards Codification Topic 830, Foreign Currency Matters , on October 1, 2013, the Company changed the functional and reporting currency of its foreign subsidiary from the U.S. Dollar to the British Pound. Such change did not have a material impact on the consolidated financial statements of the Company.

All assets and liabilities of these foreign operations are translated to U.S. Dollars at current period end exchange rates, and revenue and expenses are translated to U.S. Dollars using average exchange rates in effect during the period. The gains and losses from the foreign currency translation of this subsidiary's financial statements are included as a separate component of stockholders' equity under "Accumulated other comprehensive income". Gains or losses arising from currency exchange rate fluctuations on transactions denominated in a currency other than the local functional currency are included in other income (expense), net.

7



Use of Estimates

The preparation of financial statements in conformity with 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 revenue and expenses during the reported periods. The primary estimates underlying the Company's financial statements include the value of revenue elements, product warranty, inventory valuation, allowance for doubtful accounts receivable, assumptions regarding variables used in calculating the fair value of the Company's equity awards, fair value of investments, useful lives of intangibles, income taxes and contingent liabilities. Actual results could differ from those estimates.

Critical Accounting Policies

There have been no material changes to the Company’s critical accounting policies during the six months ended June 30, 2014 , as compared to the critical accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 .

Recent Accounting Pronouncements

On May 28, 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2014-10, Revenue from Contracts with Customers. The objective of this update is to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability within industries, across industries, and across capital markets. This standard update contains principles that the Company will apply to determine the measurement of revenue and timing of when it is recognized. The Company will adopt this guidance effective January 1, 2017, and is currently assessing the impact it may have on the Company's consolidated financial statements.

2. 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 June 30, 2014 .

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):
 

8


 
As of June 30, 2014
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
Financial Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
4,092

 
$

 
$

 
$
4,092

Short-term investments:
 
 
 
 
 
 
 
U.S. Agency securities

 
9,217

 

 
9,217

U.S. Treasury

 
2,010

 

 
2,010

Corporate bonds

 
5,020

 

 
5,020

Commercial paper

 
1,000

 

 
1,000

Certificates of deposit
1,318

 

 

 
1,318

Long-term investments:
 
 
 
 
 
 
 
U.S. Agency securities

 
500

 

 
500

U.S. Treasury

 
501

 

 
501

Corporate bonds

 
3,020

 

 
3,020

Certificates of deposit
446

 

 

 
446

Total
$
5,856

 
$
21,268

 
$

 
$
27,124


 
As of December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
Financial Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
12,796

 
$

 
$

 
$
12,796

Short-term investments:
 
 
 
 
 
 

U.S. Agency securities

 
6,772

 

 
6,772

U.S. Treasury

 
1,001

 

 
1,001

Corporate bonds

 
8,870

 

 
8,870

Commercial paper

 
999

 

 
999

Certificates of deposit
1,198

 

 

 
1,198

Long-term investments:
 
 
 
 
 
 

U.S. Agency securities

 
6,956

 

 
6,956

U.S. Treasury

 
1,014

 

 
1,014

Corporate bonds

 
2,795

 

 
2,795

Certificates of deposit
677

 

 

 
677

Total
$
14,671

 
$
28,407

 
$

 
$
43,078


During the three and six months ended June 30, 2014 and 2013 , the Company 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 as of June 30, 2014 , and December 31, 2013 .

The carrying amounts of the Company’s cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximate fair value due to their relatively short maturities.


9


3. Balance Sheet Components

Investments

The Company's short-term and long-term investments as of June 30, 2014 , are as follows (in thousands):
Short-term
 
 
 
 
 
 
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Agency securities
$
9,213

 
$
4

 
$

 
$
9,217

U.S. Treasury
2,008

 
2

 

 
2,010

Corporate bonds
5,019

 
2

 
(1
)
 
5,020

Commercial paper
1,000

 

 

 
1,000

Certificates of deposit
1,318

 

 

 
1,318

Total
$
18,558

 
$
8

 
$
(1
)
 
$
18,565

 
 
 
 
 
 
 
 
Long-term
 
 
 
 
 
 
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Agency securities
$
499

 
$
1

 
$

 
$
500

U.S. Treasury
500

 
1

 

 
501

Corporate bonds
3,023

 
2

 
(5
)
 
3,020

Certificates of deposit
446

 

 

 
446

Total
$
4,468

 
$
4

 
$
(5
)
 
$
4,467


The Company's short-term and long-term investments as of December 31, 2013 , are as follows (in thousands):

Short-term
 
 
 
 
 
 
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Agency securities
$
6,771

 
$
2

 
$
(1
)
 
$
6,772

U.S. Treasury
1,000

 
1

 

 
1,001

Corporate bonds
8,867

 
3

 

 
8,870

Commercial paper
999

 

 

 
999

Certificates of deposit
1,198

 

 

 
1,198

Total
$
18,835

 
$
6

 
$
(1
)
 
$
18,840

 
 
 
 
 
 
 
 
Long-term
 
 
 
 
 
 
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Agency securities
$
6,957

 
$
2

 
$
(3
)
 
$
6,956

U.S. Treasury
1,013

 
1

 

 
1,014

Corporate bonds
2,790

 
5

 

 
2,795

Certificates of deposit
677

 

 

 
677

Total
$
11,437

 
$
8

 
$
(3
)
 
$
11,442



10


For each of the three and six months ended June 30, 2014 and 2013 , gains or losses realized on the sale of investments were insignificant.

The contractual maturities of the Company's short-term and long-term investments as of June 30, 2014 , are as follows (in thousands):

 
June 30, 2014
 
Amortized Cost
 
Fair Value
Due in one year or less
$
18,558

 
$
18,565

Due in one year to five years
4,468

 
4,467

 
$
23,026

 
$
23,032


When evaluating the investments for other-than-temporary impairment, the Company reviews 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. The Company believes that the unrealized losses are not other-than-temporary. The Company does not have a foreseeable need to liquidate the portfolio and anticipates recovering the full cost of the securities either as market conditions improve, or as the securities mature.

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.

The components of inventory consist of the following (in thousands):
 
 
June 30,
2014
 
December 31,
2013
Raw materials
$
11,688

 
$
4,520

Finished goods
6,867

 
3,886

          Total inventory
$
18,555

 
$
8,406


Property and equipment, net

Property and equipment, net comprised the following (in thousands):
 
 
June 30,
2014
 
December 31,
2013
Lab equipment, tooling and molds
$
2,356

 
$
2,071

Computer software
1,754

 
1,562

Computer equipment
827

 
801

Leasehold improvements
980

 
743

Furniture and fixtures
402

 
334

Vehicles
35

 
35

Total property and equipment
6,354

 
5,546

Less: Accumulated depreciation and amortization
(4,178
)
 
(3,594
)
Construction in progress
113

 
206

Property and equipment, net
$
2,289

 
$
2,158


Depreciation expense was $0.3 million and $0.6 million for the three and six months ended June 30, 2014 , respectively. Depreciation expense was $0.2 million and $0.5 million for the three and six months ended June 30, 2013 , respectively.

11



Accrued Liabilities

The following table shows the components of accrued liabilities (in thousands):
 
 
June 30,
2014
 
December 31,
2013
Accrued payroll and employee related expenses
$
7,530

 
$
7,863

Accrued marketing expenses
2,039

 
3,739

Accrued royalty
3,312

 
2,458

Sales and other taxes payable
1,584

 
1,787

Accrued warranty
741

 
676

Accrued legal expenses
645

 
284

Other accrued liabilities
2,668

 
1,557

Total accrued liabilities
$
18,519

 
$
18,364


Product Warranty

The Company provides a standard limited warranty on its products of generally one year for both control units and applicators for its direct customers. For indirect customers in international markets, the Company provides a standard limited warranty on its products of 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 revenue 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, 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):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Balance at the beginning of the period
$
660

 
$
742

 
$
676

 
$
902

Accruals for warranties issued
159

 
55

 
198

 
97

Settlements of warranty claims
(78
)
 
(71
)
 
(133
)
 
(273
)
Balance at the end of the period
$
741

 
$
726

 
$
741

 
$
726


4. Intangible Asset, Net

The intangible asset consists of an exclusive license agreement with Massachusetts General Hospital, or 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 Food and Drug Administration, or FDA, approval are capitalized as purchased technology when paid, and are subsequently amortized into cost of revenue 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.

12



Intangible asset, net comprised the following (in thousands):
 
 
June 30,
2014
 
December 31,
2013
Purchased technology
$
8,050

 
$
8,050

Less: Accumulated amortization
(1,920
)
 
(1,569
)
     Intangible asset, net
$
6,130

 
$
6,481


Amortization expense of the intangible asset was $0.2 million and $0.4 million for both the three and six months ended June 30, 2014 and 2013 , respectively.

The total estimated annual future amortization expense of this intangible asset as of June 30, 2014 , is as follows (in thousands):

Fiscal Year
 
2014 (remaining 6 months)
$
349

2015
701

2016
701

2017
701

2018
701

Thereafter
2,977

Total
$
6,130


5. Related Party Transactions

Brazilian Distribution Agreement

The Company entered into a distribution agreement with ADVANCE Medical, Inc. and its wholly-owned subsidiaries, 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 which expires on December 31, 2018 . Venrock, a principal stockholder of the Company, owns an 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 was $0.1 million and $1.1 million for the three and six months ended June 30, 2014 , respectively, compared to $0.5 million and $0.8 million for the three and six months ended June 30, 2013 , respectively. The accounts receivable balance under this distribution agreement was $0.3 million and $0.2 million as of June 30, 2014 , and December 31, 2013 , respectively.

6. Commitments and Contingencies

Lease Commitments

The Company recently renewed and extended its leases in California. Specifically, the Company occupies a facility in Pleasanton, California, under a lease which extends through March 2019 , a manufacturing facility in Dublin, California, under a lease which extends through December 2015 , and a warehouse space in Livermore, California, under a lease which extends through December 2015 . The Company also occupies office and warehouse space in Gatwick, United Kingdom, under a lease which extends through December 2018 , as well as office space in Taipei, Taiwan, under a lease which extends through August 2014 , and Seoul, South Korea, under a lease which extends through October 2014 . Rent expense for non-cancellable operating leases with scheduled rent increases is recognized on a straight-line basis over the lease term. Rent expense was $0.4 million and $0.7 million for the three and six months ended June 30, 2014 , respectively, compared to $0.3 million and $0.7 million for the three and six months ended June 30, 2013 , respectively.

13



Future minimum lease payments under the non-cancellable operating leases as of June 30, 2014 , are as follows (in thousands):

Year Ending December 31,
Amount
2014 (remaining 6 months)
$
670

2015
1,696

2016
1,467

2017
1,512

2018
1,551

Thereafter
383

     Total future minimum lease payments
$
7,279


Purchase Commitments

The Company had non-cancellable purchase obligations to contract manufacturers and suppliers for $3.2 million and $6.0 million at June 30, 2014 , and December 31, 2013 , respectively.

Unrecognized Tax Benefits

The Company's gross liability for unrecognized tax benefits totaled $11,000 , including estimated interest and penalties, as of June 30, 2014 , and is classified in long-term income taxes payable. The Company is unable to make a reasonably reliable estimate of the timing of payments in individual years due to uncertainties in the timing of tax audits, if any, or their outcomes.

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.

Indemnifications

In the normal course of business, the Company enters into contracts that contain a variety of representations and warranties and provide for general indemnifications. The Company's exposure under these agreements is unknown because it involves claims that may be made against the Company in the future, but have not yet been made. To date, the Company has not paid any claims, and the Company believes that the estimated fair value of these indemnification obligations is minimal and it has not accrued any amounts for these obligations.

Severance and Separation Agreements

Effective December 3, 2013 , the Company's Chief Scientific Officer and Senior Vice President of Clinical entered into a separation agreement with the Company. As a result of this separation agreement, the Company incurred $0.3 million in termination benefits and $0.7 million in costs related to the modification of the employee's stock-based compensation, which were recorded during the year ended December 31, 2013 . The amount outstanding related to this separation agreement was $0.1 million as of June 30, 2014 .

No similar costs were incurred during the three and six months ended June 30, 2014 and 2013 .


14


7. Stock-Based Compensation Expense

Stock-Based Compensation Activity

Activity under the Company’s stock-based compensation plans is set forth below:
 
 
 
 
 
Options Outstanding
 
 
Shares
Available
for Grant
 
Number of
Stock Options
Outstanding
 
Weighted-
Average
Exercise
Price
Balance, December 31, 2013
1,086,737

 
3,598,385

 
$
5.36

Additional shares reserved
1,851,794

 

 

Options granted
(255,000
)
 
255,000

 
18.42

Restricted stock units granted
(379,175
)
 

 

Options exercised

 
(176,239
)
 
4.67

Options canceled
13,543

 
(13,543
)
 
4.80

Restricted stock units canceled
90,212

 

 

Restricted stock units withheld for tax
176,854

 

 

Balance, June 30, 2014
2,584,965

 
3,663,603

 
$
6.31


Restricted Stock Activity

Activity related to restricted stock units and awards is set forth below:

 
 
Number of Units and Awards
 
Weighted-
Average
Grant Date Fair Value
Balance, December 31, 2013
1,906,696

 
$
5.60

Restricted stock units granted
379,175

 
18.26

Restricted stock units released
(429,158
)
 
5.27

Restricted stock units canceled
(90,212
)
 
5.76

Balance, June 30, 2014
1,766,501

 
$
8.39


During the three and six months ended June 30, 2014 , 109,576 and 429,158 shares vested, respectively, subject to previously granted restricted stock units. A majority of these vested restricted stock units were net share settled. During the three and six months ended June 30, 2014 , the Company withheld 42,018 and 176,854 shares, respectively, based upon the Company's closing stock price on the vesting date to settle the employee's minimum statutory obligation for the applicable income and other employment taxes. During the three and six months ended June 30, 2013 , 40,838 and 67,999 shares vested, respectively, subject to previously granted restricted stock units. A majority of these vested restricted stock units were net share settled. During the three and six months ended June 30, 2013 , the Company withheld 13,735 and 15,705 shares, respectively, based upon the Company's closing stock price on the vesting date to settle the employee's minimum statutory obligation for the applicable income and other employment taxes.

Subsequently, the Company remitted cash to the appropriate taxing authorities. Total payments for employee's tax obligations to the relevant taxing authority were $0.7 million and $3.2 million for the three and six months ended June 30, 2014 , respectively. Total payments for employee's tax obligations to the relevant taxing authority were $55,000 and $62,000 for the three and six months ended June 30, 2013 , respectively. The payments were for taxes related to the net share settlements of restricted stock units.

15



Stock-Based Compensation Expense

Stock-based compensation expense related to all of the Company's stock-based awards and employee stock purchases was allocated as follows (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Cost of revenue
$
117

 
$
62

 
$
210

 
$
108

Research and development
263

 
225

 
469

 
423

Sales and marketing
998

 
486

 
1,934

 
659

General and administrative
1,028

 
707

 
1,898

 
1,409

Total stock-based compensation
$
2,406

 
$
1,480

 
$
4,511

 
$
2,599


As of June 30, 2014 , the total unrecognized compensation costs related to outstanding stock options, awards and employee stock purchases was $16.5 million , which is expected to be recognized using the straight-line attribution method over 2.3 years .

Performance-Based Awards

Stock-based compensation expense includes charges related to performance-based stock options and restricted stock units granted to certain executives. Stock-based compensation expense related to these stock options and restricted stock units was $0.5 million and $1.0 million for the three and six months ended June 30, 2014 , respectively, compared to $0.3 million and $0.5 million for the three and six months ended June 30, 2013 , respectively.

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.

The fair value of employee stock options was estimated using the following weighted-average assumptions:
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Expected term (in years)
4.4

 
4.8

 
4.4

 
4.8

Expected volatility
43
%
 
52
%
 
43
%
 
52
%
Risk-free interest rate
1.30
%
 
0.90
%
 
1.21
%
 
0.91
%
Expected dividend yield
%
 
%
 
%
 
%

During the three and six months ended June 30, 2014 , the Company granted 180,000 and 250,000 stock options, respectively, to employees with a weighted-average grant date fair value of $6.42 and $6.77 per share, respectively. During the three and six months ended June 30, 2013 , the Company granted 285,000 and 375,000 stock options, respectively, to employees with a weighted-average grant date fair value of $2.33 and $2.20 per share, respectively.

During the three and six months ended June 30, 2014 , the Company granted 185,375 and 369,175 restricted stock units, respectively, to employees with a weighted-average grant date fair value of $15.79 and $18.28 per share, respectively. During the three and six months ended June 30, 2013 , the Company granted 198,950 and 953,000 restricted stock units, respectively, to employees with a weighted-average grant date fair value of $4.71 and $4.15 per share, respectively.

As of June 30, 2014 , the unrecognized compensation cost related to the Company's employee stock purchase plan, or ESPP, was $0.3 million , which will be recognized using the straight-line attribution method over 0.4 years .

16



Stock-Based Compensation for Non-employees

Stock-based compensation expense related to stock-based awards to non-employees is recognized as the stock-based awards are earned, generally through the provision of services. 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 granted stock-based awards is calculated at each reporting date using the Black-Scholes option pricing model. During the year ended December 31, 2013 , the Company granted stock-based awards to a non-employee which vest over 2 years . Additionally, during the three months ended March 31, 2014 , the Company granted additional stock-based awards to a non-employee which will vest over 2 years . Stock-based compensation expense related to non-employee grants was $21,000 and $0.1 million for the three and six months ended June 30, 2014 , respectively. Stock-based compensation expense for non-employees was $0.1 million for both the three and six months ended June 30, 2013 .

8. Net Income (Loss) per Share of Common Stock

Basic net income (loss) per share of common stock is calculated by dividing the net income (loss) by the weighted-average number of shares of common stock outstanding for the period. Diluted net income (loss) per share of common stock is computed by giving effect to all potentially dilutive securities outstanding during the period, including stock options, restricted stock units and common stock issuable pursuant to the ESPP.

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
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Numerator
 
 
 
 
 
 
 
Net income (loss) (in thousands)
$
2,769

 
$
(3,607
)
 
$
(4,568
)
 
$
(11,089
)
Denominator
 
 
 
 
 
 
 
Weighted average shares of common stock outstanding used in computing net income (loss) per share, basic
37,440,537

 
36,045,346

 
37,328,738

 
35,968,144

Dilutive effect of incremental shares and share equivalents
3,156,738

 

 

 

Weighted average shares of common stock outstanding used in computing net income (loss) per share, diluted
40,597,275

 
36,045,346

 
37,328,738

 
35,968,144

Net income (loss) per share:
 
 
 
 
 
 
 
Net income (loss) per share, basic
$
0.07

 
$
(0.10
)
 
$
(0.12
)
 
$
(0.31
)
Net income (loss) per share, diluted
$
0.07

 
$
(0.10
)
 
$
(0.12
)
 
$
(0.31
)

The following outstanding potentially dilutive securities were excluded from the computation of diluted net income (loss) per share of common stock for the periods presented, because including them would have been anti-dilutive:
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Options to purchase common stock
188,297

 
3,204,054

 
3,663,603

 
3,160,424

Restricted stock units
141,871

 
149,441

 
1,766,501

 
189,380

Common stock issuable pursuant to the ESPP

 

 
2,633

 

Total
330,168

 
3,353,495

 
5,432,737

 
3,349,804



17


9. Income Taxes

The Company recorded a (benefit from) provision for income taxes of $(0.1) million and $6,000 for the three and six months ended June 30, 2014 , respectively, compared to an income tax provision of $43,000 and $0.1 million for the three and six months ended June 30, 2013 , respectively. The (benefit from) provision for income taxes for the three and six months ended June 30, 2014 and 2013 , reflects the mixture and distribution of pre-tax income in the Company's operating jurisdictions. The Company continues to maintain a valuation allowance for its U.S. federal and state deferred tax assets.

At June 30, 2014 , the Company had $1.2 million of unrecognized tax benefits, of which $8,000 , if recognized, would affect the effective tax rate due to the valuation allowance that currently offsets deferred tax assets. During the quarter, the Company revised its estimate of previously unrecognized tax benefits by $1.7 million for credits more likely than not to be realized as a result of
the completion of an analysis of the deferred tax assets related to research and development credits. Such deferred tax assets continue to have a full valuation allowance, therefore such release did not affect the Company’s consolidated balance sheet or statement of operations. The Company recognizes interest and penalties related to uncertain tax positions as part of the income tax provision. To date, such interest and penalties have not been material.

The utilization of the net operating loss ("NOL") carryforwards is subject to annual limitations under Section 382 of the Internal Revenue Code. Section 382 imposes limitations on a corporation’s ability to utilize its NOL carryforwards if it experiences an “ownership change.” In general terms, an ownership change results from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50% over a three-year period. Once an ownership change is deemed to have occurred under Section 382, a limitation on the annual utilization of NOL carryforwards is imposed and, therefore, a portion of the tax loss carryforwards would be subject to the limitation under Section 382. The Company assessed the application of Section 382 during the first quarter of 2014 and concluded that an ownership change had occurred. The annual limitations under Section 382 are not expected to adversely impact the Company's ability to utilize its net operating losses prior to their expiration.

The Company files annual income tax returns in multiple taxing jurisdictions around the world, including the U.S. federal jurisdiction, California and the United Kingdom. A number of years may elapse before an uncertain tax position is audited and finally resolved. While it is often difficult to predict the final outcome or the timing of resolution of any particular uncertain tax position, the Company believes that its reserves for income taxes reflect the most likely outcome. The Company adjusts these reserves, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular position could require the use of cash. As of  June 30, 2014 , changes to the Company's uncertain tax positions in the next 12 months that are reasonably possible are not expected to have a significant impact on the Company's financial position or results of operations.

10. Segment Information

Operating segments are defined as components of an enterprise about which separate financial information is available that is 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. 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 revenue by geographic region, based on the location to where the product was shipped, is summarized as follows (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
North America
$
37,077

 
$
21,178

 
$
59,864

 
$
37,795

International
9,984

 
5,160

 
18,172

 
8,525

     Total
$
47,061

 
$
26,338

 
$
78,036

 
$
46,320


North America includes the United States and related territories, as well as Canada. International is the rest of the world. Revenue for the United States was $34.9 million and $55.8 million for the three and six months ended June 30, 2014 , respectively, compared to $19.9 million and $35.9 million for the three and six months ended June 30, 2013 , respectively.


18


The following table sets forth revenue by product expressed as dollar amounts (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
System revenue
$
25,383

 
$
12,978

 
$
39,844

 
$
24,050

Consumable revenue
21,678

 
13,360

 
38,192

 
22,270

     Total
$
47,061

 
$
26,338

 
$
78,036

 
$
46,320


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


19


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with 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, 2013 . In addition to historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ substantially from those referred to herein due to a number of factors, including but not limited to risks described in the section entitled Risk Factors in this 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. We generate revenue from sales of our CoolSculpting system, add-on applicators and from sales of cycles in the form of consumable procedure packs to our customers. Our CoolSculpting system comprises a CoolSculpting control unit and our CoolSculpting applicators which are designed to allow a physician to treat a different size and shape fat bulge. With the launch of our CoolSmooth applicator in April 2014, we now offer five CoolSculpting applicators for use with our CoolSculpting system.
We received clearance from the Food and Drug Administration, or FDA, in September 2010 to market CoolSculpting for the selective reduction of fat around the flanks, an area commonly referred to as the “love handles.” In May 2012, CoolSculpting was cleared by the FDA for treatment of the abdomen area. Most recently, in April 2014, CoolSculpting was cleared by the FDA for treatment of the thigh area. We may seek additional regulatory clearances from the FDA to expand our United States marketed indications for CoolSculpting to areas on the body other than the flanks, abdomen and thighs. We have received regulatory approval or are otherwise free to market CoolSculpting in numerous international markets where use of the product is generally not limited to specific treatment areas. Customers in these markets commonly perform CoolSculpting procedures on the back and chest, in addition to the flanks, abdomen and thighs.
In the United States and related territories, as well as Canada, we use our direct sales organization to selectively market CoolSculpting. In markets outside of North America, including Asia Pacific and Europe, we sell CoolSculpting through a direct sales organization as well as a network of distributors. We intend to continue developing our international sales and marketing organization to focus on increasing sales and strengthening our customer relationships. We also intend to seek regulatory approval to market CoolSculpting in key additional international markets, including markets in Asia and Europe. Revenue from markets outside of North America accounted for 21% and 23% of our total revenue for the three and six months ended June 30, 2014 , respectively, compared to 20% and 18% of our total revenue for the three and six months ended June 30, 2013 , 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.

Revenue

We generate revenue from sales of our CoolSculpting system and from sales of consumables to our customers. We generated revenue of $47.1 million and $78.0 million for the three and six months ended June 30, 2014 , respectively, compared to $26.3 million and $46.3 million for the three and six months ended June 30, 2013 , respectively.

System revenue.  Sales of our CoolSculpting system include the CoolSculpting control unit and our CoolSculpting applicators. Sales of systems can include sales of systems to new customers that include our entire suite of applicators, as well as multi-system sales to new customers or sales to existing customers which may not include the entire suite of applicators.  Additionally, some practices may purchase additional applicators, or add-on applicators, for existing systems. Our standard terms do not allow for trial or evaluation periods, rights of return, or refund payments contingent upon the customer obtaining financing or other terms that could impact the customer’s obligation. System revenue represented 54% and 51% of our total revenue for the three and six months ended June 30, 2014 , respectively, compared to 49% and 52% of our total revenue for the three and six months ended June 30, 2013 , respectively. Our worldwide installed base grew by 48% from 1,731 units as of June 30, 2013 , to 2,562 units as of June 30, 2014 .


20

Table of Contents

Consumable revenue.  We generate consumable revenue through sales of cycles in the form of consumable procedure packs, each of which includes our consumable CoolGels, CoolLiners, and in the case of our CoolSmooth procedure packs, disposable securement accessories, all of which are used by our customer during treatments. In addition, each consumable procedure pack includes a disposable computer cartridge that we market as the CoolCard. The CoolCard contains enabling software that permits our customers to perform a fixed number of CoolSculpting procedures, or cycles. Consumable revenue accounted for 46% and 49% of our total revenue for the three and six months ended June 30, 2014 , respectively, compared to 51% and 48% of our total revenue for the three and six months ended June 30, 2013 , respectively. We shipped 166,116 and 292,175 CoolSculpting revenue cycles to our customers during the three and six months ended June 30, 2014 , respectively, compared to 101,657 and 169,585 CoolSculpting revenue cycles during the three and six months ended June 30, 2013 , respectively.

Our business plan focuses on expanding our installed base of systems at customers, and increasing our consumable revenue by driving demand for CoolSculpting procedures through our targeted marketing programs. We anticipate that as we implement our business plan our consumable revenue will increase as a percentage of our total revenue.

Seasonality. Seasonal fluctuations in the number of patients seeking treatment and the availability of our customers are likely to continue to affect, our business. Specifically, our customers often take vacation or are on holiday during the summer months and therefore tend to perform fewer procedures, particularly in Europe. These seasonal trends have caused and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates.

Market in which we operate. The medical technology and aesthetic product markets are highly competitive and dynamic, and are characterized by rapid and substantial technological development and product innovations. We compete with many other technologies for consumer demand. Further, the aesthetic industry in which we operate is particularly vulnerable to economic trends. The decision to undergo a procedure from our systems is driven by consumer demand. Procedures performed using our systems are elective procedures, the cost of which must be borne by the patient, and are not reimbursable through government or private health insurance. In times of economic uncertainty or recession, individuals often reduce the amount of money that they spend on discretionary items, including aesthetic procedures. The general economic difficulties being experienced and the lack of availability of consumer credit for some of our customers' patients could adversely affect the markets in which we operate.

Critical Accounting Policies and Estimates

Our critical accounting policies are disclosed in our Annual Report on Form 10-K for the year ended  December 31, 2013 .

Our critical accounting policies have not materially changed during the six months ended   June 30, 2014 . Furthermore, the preparation of our consolidated financial statements is in conformity with generally accepted accounting principles in the United States of America, or GAAP. The preparation of our consolidated financial statement requires management to make judgments and estimates that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Our management believes that we consistently apply these judgments and estimates and the consolidated financial statements and accompanying notes fairly represent all periods presented. However, any differences between these judgments and estimates and actual results could have a material impact on our consolidated statements of income and financial position.

Critical accounting estimates, as defined by the Securities and Exchange Commission, are those that are most important to the portrayal of our consolidated financial condition and results of operations and require our management’s most difficult and subjective judgments and estimates of matters that are inherently uncertain. Our critical accounting estimates include those regarding (1) revenue recognition and the fair value of revenue elements, (2) accruals for customer programs, including cooperative marketing arrangements and customer incentive programs, (3) investments, including the fair value of such investments, (4) warranty accruals, (5) valuation and recognition of stock-based compensation, and (6) provision for income taxes, tax liabilities and valuation allowance for deferred tax assets. For a discussion of our critical accounting estimates, see Item 7: “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended  December 31, 2013 .


21

Table of Contents

Results of Operations

Revenue (in thousands, except for percentages):

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
System revenue
$
25,383

 
$
12,978

 
$
12,405

 
96
%
 
$
39,844

 
$
24,050

 
$
15,794

 
66
%
Consumable revenue
21,678

 
13,360

 
8,318

 
62
%
 
38,192

 
22,270

 
15,922

 
71
%
Total revenue
$
47,061

 
$
26,338

 
$
20,723

 
79
%
 
$
78,036

 
$
46,320

 
$
31,716

 
68
%

Overall, we experienced an increase in revenue driven primarily by the expansion of our sales force into new and existing key markets, increased focus and prioritization of our business through our revamped sales team structure and training, and an increase in our installed base of CoolSculpting systems along with the release of our CoolSmooth applicator.

System revenue.  We experienced incremental growth in system revenue for the three and six months ended June 30, 2014 , as compared to the same periods in 2013 , as a result of increased system sales in both North America and our International markets due to the reasons stated above. Overall, we placed 208 and 387 systems in the three and six months ended June 30, 2014 , respectively, as compared to 136 and 248 systems in the three and six months ended June 30, 2013 , respectively. Additionally, we experienced an increase in average selling price for new system bundles across all regions primarily as a result of the addition of a fifth applicator. We also experienced an increase in sales of add-on applicators to existing customers in the second quarter of 2014 primarily related to the launch of our CoolSmooth applicator in April 2014, such incremental add-on applicator revenue totaling $6.4 million in the six months ended June 30, 2014 , whereas in the six months ended June 30, 2013 our incremental add-on revenue, related primarily to our CoolFit and CoolCurve+ applicators, totaled $3.6 million . Add-on applicators allow our customers to optimize their existing system to fit different body shapes and sizes, as well as different body parts or regions of the body. 

Consumable revenue.  The increase in consumable revenue was primarily due to the significant growth of our worldwide installed base of CoolSculpting systems and an increased number of consumable procedure packs shipped to our customers driven by our targeted marketing programs in the three and six months ended June 30, 2014 as compared to the same period in 2013 , as well as due the release of our CoolSmooth applicator which requires a different consumable procedure pack than our other applicators. Our consumable procedure packs carry two tiers of pricing, and the CoolSmooth consumable procedure pack is priced at the lower tier. With the introduction of the CoolSmooth applicator in April 2014, we saw a shift of sales to the lower tier pricing. Additionally, during the first quarter of 2014, we discontinued our practice of providing rebates to our customers associated with the Crystal Rewards Program, our customer loyalty program related to consumable purchases. These rebates reduced consumable revenue in periods prior to this program change.

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

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
Cost of revenue
$
13,660

 
$
7,878

 
$
5,782

 
73
%
 
$
22,676

 
$
15,226

 
$
7,450

 
49
%
% of total revenue
29
%
 
30
%
 
 
 
 
 
29
%
 
33
%
 
 
 
 
Gross profit
$
33,401

 
$
18,460

 
$
14,941

 
81
%
 
$
55,360

 
$
31,094

 
$
24,266

 
78
%
Gross profit %
71
%
 
70
%
 
 
 
 
 
71
%
 
67
%
 
 
 
 

Gross profit as a percentage of revenue typically fluctuates with product and regional mix, selling prices, material costs and revenue levels. The increase in gross profit as a percentage of revenue for the three and six months ended June 30, 2014 , as compared to the same periods in 2013, was mainly attributable to increased sales volume, as well as the fact that higher production driven by the increase in sales led to better utilization on a relatively fixed base of overhead costs. Additionally, the increase in gross profit as a percentage of revenue is attributable to our continued high rate of new system placements which continues to drive higher consumable sales as our installed base grows. These increases were offset in part by the high volume of sales of our CoolSmooth

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applicator, which currently carries a slightly lower standard margin than our other applicators and was launched with introductory pricing through the three months ended June 30, 2014. We continue to focus on cost reduction across our product portfolio, as well as experience the benefit of the completion of the in-sourced manufacturing structure during the second quarter of 2013.
 
Operating Expenses (in thousands, except for percentages):

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
$
4,350

 
$
3,898

 
$
452

 
12
%
 
$
8,620

 
$
7,647

 
$
973

 
13
%
% of total revenue
9
%
 
15
%
 
 
 
 
 
11
%
 
17
%
 
 
 
 
Sales and marketing
$
21,052

 
$
14,625

 
$
6,427

 
44
%
 
$
41,239

 
$
27,167

 
$
14,072

 
52
%
% of total revenue
45
%
 
56
%
 
 
 
 
 
53
%
 
59
%
 
 
 
 
General and administrative
$
5,234

 
$
3,626

 
$
1,608

 
44
%
 
$
9,947

 
$
7,434

 
$
2,513

 
34
%
% of total revenue
11
%
 
14
%
 
 
 
 
 
13
%
 
16
%
 
 
 
 
Total operating expenses
$
30,636

 
$
22,149

 
$
8,487

 
38
%
 
$
59,806

 
$
42,248

 
$
17,558

 
42
%

Research and development.  Research and development expenses increased for the three and six months ended June 30, 2014 , compared to the same periods in 2013, primarily due to an increase in payroll related costs of $0.3 million and $0.5 million for the three and six months ended June 30, 2014 , respectively, when compared to the same periods in 2013, attributed to higher headcount and an increase in performance-based compensation. We also experienced an increase in materials and clinical costs of $0.2 million and $0.3 million for the three and six months ended June 30, 2014 , respectively, when compared to the same periods in 2013, as we continue to explore ways to leverage our proprietary cooling platform for additional applications and indications.

Sales and marketing.  Sales and marketing expenses increased for the three and six months ended June 30, 2014 , compared to the same periods in 2013, primarily due to the significant increase in headcount attributable to our sales force, which increased by nearly half, as we continue to expand into new and existing markets. This growth resulted in an increase in payroll related costs of $3.4 million and $5.7 million for the three and six months ended June 30, 2014 , respectively, when compared to the same periods in 2013, resulting from higher headcount and an increase in performance-based compensation resulting from revenue growth. Stock-based compensation expense also increase by $0.5 million and $1.3 million for the three and six months ended June 30, 2014 , respectively, when compared to the same periods in 2013, attributed to grants to existing and new employees. Travel and related expenses increased by $0.7 million and $1.5 million for the three and six months ended June 30, 2014 , respectively, when compared to the same periods in 2013, associated with sales efforts in the normal course of business as well as the training of new and existing members of our sales force. We also experienced an increase in advertising, public relations and collateral production expenses of $1.5 million and $3.7 million for the three and six months ended June 30, 2014, respectively, when compared to the same periods in 2013, associated with costs incurred in conjunction with our sales and marketing initiatives. These costs were primarily related to brand and collateral development associated with our recent re-branding initiative, which was launched in the second quarter of 2014. We also incur expenses related to cooperative marketing arrangements and customer incentive programs, which allows our customers to receive partial reimbursement for qualifying advertising expenditures which promote our product and brand. The expense incurred with respect to such programs is dependent on both the number of qualifying customers as well as the amount of advertising expenditures by our customers that is determined to be reimbursable. While the expense for these cooperative marketing arrangements included in our customer incentive programs increased by $0.2 million in the six months ended June 30, 2014 as compared to the same period in the prior year, the expense for such program decreased by $0.7 million due to a change in the program during the first quarter of 2014 whereby the amount of available reimbursement was reduced and fewer customers were able to qualify for partial reimbursement on qualifying advertising expenditures.

General and administrative.  General and administrative expenses increased for the three and six months ended June 30, 2014 , compared to the same periods in 2013, primarily due to an increase in payroll related costs of $0.7 million and $1.3 million for the three and six months ended June 30, 2014 , respectively, when compared to the same periods in 2013, resulting from higher headcount in certain functions to support growth in our business. Stock-based compensation expense also increased by $0.3 million and $0.5 million for the three and six months ended June 30, 2014 , respectively, when compared to the same periods in 2013, attributed to grants to existing and new employees. Professional service fees increased by $0.2 million and $0.5 million for the

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three and six months ended June 30, 2014 , respectively, when compared to the same periods in 2013, associated with the growth of our business as well as our expansion into international markets. Additionally, we experienced a $0.6 million increase in legal expenses for both the three and six months ended June 30, 2014 , respectively, when compared to the same periods in 2013, mainly due to an increase in IP enforcement.

Interest Income and Other (Expense) Income, Net (in thousands, except for percentages):

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
Interest income, net
$
14

 
$
19

 
$
(5
)
 
(26
)%
 
$
33

 
$
43

 
$
(10
)
 
(23
)%
% of total revenue
 %
 
%
 
 
 
 
 
 %
 
%
 
 
 
 
Other (expense) income, net
$
(83
)
 
$
106

 
$
(189
)
 
(178
)%
 
$
(149
)
 
$
72

 
$
(221
)
 
(307
)%
% of total revenue
 %
 
%
 
 
 
 
 
 %
 
%
 
 
 
 

Interest income, net.  For both the three and six months ended June 30, 2014 and 2013 , interest income was earned on our available-for-sale securities. The amount of income earned varies based on the type of investments held, market conditions and other factors. The decrease in interest income is attributable to a decrease in our investments.

Other (expense) income, net. The change in other (expense) income, net for the three and six months ended June 30, 2014 , as compared to the three and six months ended June 30, 2013 was the result of proceeds received related to a favorable patent defense ruling in the prior year with no similar occurrences in the current period. Additionally, in the three and six months ended June 30, 2014 we experienced an unfavorable change in foreign exchange rates, specifically the Great British Pound.

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 initial public offering, or IPO.

The following table summarizes our working capital, cash and cash equivalents, short-term and long-term investments as of June 30, 2014 , and December 31, 2013 (in thousands):

 
June 30,
 
December 31,
 
2014
 
2013
Cash and cash equivalents
$
20,262

 
$
25,798

Short-term investments
18,565

 
18,840

Long-term investments
4,467

 
11,442

Total
$
43,294

 
$
56,080

 
 
 
 
Working capital
$
47,933

 
$
42,430



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Summary Statement of Cash Flows

The following table summarizes our cash flows for the six months ended June 30, 2014 and 2013 (in thousands):
 
 
Six Months Ended
 
June 30,
 
2014
 
2013
Net cash used in operating activities
$
(10,331
)
 
$
(6,236
)
Net cash provided by investing activities
6,350

 
4,882

Net cash (used in) provided by financing activities
(1,645
)
 
540

Effect of exchange rate on cash and cash equivalents
90

 

Net decrease in cash and cash equivalents
$
(5,536
)
 
$
(814
)

Cash Flows for the Six Months Ended June 30, 2014 and 2013

Operating activities.  Net cash used in operating activities was $10.3 million during the six months ended June 30, 2014 , and consisted of a net loss of $4.6 million and a net change in operating assets and liabilities of $11.9 million , offset by non-cash items of $6.1 million . Non-cash items for the six months ended June 30, 2014 , consisted primarily of a stock-based compensation expense of $4.5 million and depreciation and amortization expense of $0.9 million . The significant items in the change in operating assets and liabilities include cash used resulting from increases in inventory of $9.8 million , an increase in accounts receivable of $3.8 million and a decrease in accounts payable, accrued and other non-current liabilities of $2.4 million . We experienced an increase in inventory as we continued to build inventory to support expected customer demand, as well as due to an increase in purchases of materials to support demand for our recently launched CoolSmooth applicator as well as compliance requirements for products being sold in the European Union. The increase in accounts receivable is a function of the increase in sales as well as timing of payment receipts from customers. The decrease in accounts payable, accrued and other non-current liabilities was driven by the timing of invoice receipt and payments to vendors , as well as a reduction in amounts reimbursable to customers for qualifying advertising expenditures under our customer incentive programs resulting primarily from a change in the program during 2014 which reduced the number of qualifying participants in the program, as well as the amounts available for reimbursement.

Net cash used in operating activities was $6.2 million during the six months ended June 30, 2013, and consisted of a net loss of $11.1 million and a net change in operating assets and liabilities of $1.1 million, offset by non-cash items of $3.8 million. Non-cash items for the six months ended June 30, 2013, consisted primarily of a stock-based compensation expense of $2.6 million and depreciation and amortization expense of $0.9 million. The significant items in the change in operating assets and liabilities include cash proceeds resulting from decreases in inventory of $1.1 million and an increase in accounts payable, accrued and other non-current liabilities of $0.5 million, offset in part by cash used resulting from an increase in accounts receivable of $0.4 million. The decrease in inventory was as result of our continued focus on the management of inventory levels. The increase in accounts payable, accrued and other non-current liabilities was driven by the timing of invoice receipt and payments to vendors, while the increase in accounts receivable is driven by the increase in revenue during the first six months of 2013 as well as continued growth in the number of customers extended credit terms, offset in part by strong cash collections throughout the period.

Investing activities.  Net cash provided by investing activities was $6.4 million for the six months ended June 30, 2014 , as compared to net cash provided by investing activities of $4.9 million during the same period in 2013 . During the six months ended June 30, 2014 , we received proceeds from the sale and maturity, net of purchases, of $7.1 million of short-term and long-term investments. During the six months ended June 30, 2013 , we received proceeds from the sale and maturity, net of purchases, of $5.0 million of short-term and long-term investments. Purchases of property and equipment amounted to $0.8 million and $0.3 million for the six months ended June 30, 2014 and 2013 , respectively.

Financing activities.  Net cash used in financing activities during the six months ended June 30, 2014 , of $1.6 million consisted of tax payments related to shares withheld for vested restricted stock units of $3.2 million , offset in part by proceeds received from the issuance of common stock upon the exercise of stock options of $1.6 million . Net cash provided by financing activities during the six months ended June 30, 2013 , of $0.5 million consisted of proceeds received from the issuance of common stock upon the exercise of stock options, offset in part by tax payments related to shares withheld for vested restricted stock units.

Our cash, cash equivalents and investments declined by $12.8 million during the six months ended June 30, 2014 . We expect to continue to invest in our research and development efforts, as well as in our sales and marketing organization, to support our current and expected growth and initiatives. Based on our current plans and market conditions, we believe that our existing cash,

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cash equivalents and investments will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months. However, we cannot be certain that our planned levels of revenue, costs and expenses will be achieved. If our operating results fail to meet our expectations or if we fail to manage our inventory, accounts receivable or other assets, we could be required to seek additional funding through public or private financings or other arrangements. In such event, adequate funds may not be available when needed or may not be available on favorable or commercially acceptable terms, which could have a negative effect on our business and results of operations.

Contractual Obligations and Commitments

We have certain fixed contractual obligations and commitments that include operating lease obligations and purchase commitments. Changes in our business needs, fluctuating interest rates, and other factors may result in actual payments differing from the estimates. Our fixed contractual obligations and commitments were $10.4 million and $7.5 million at June 30, 2014 , and December 31, 2013 , respectively.

Massachusetts General Hospital Royalty Payments

In May 2005, we entered into an agreement with Massachusetts General Hospital, or MGH, to obtain an exclusive license to develop and commercialize the patent and the core technology that underlies our CoolSculpting system. We are obligated to pay a 7% royalty on net sales, as defined in the agreement, of CoolSculpting systems, applicators and procedure packs.

Lease Commitments

We recently renewed and extended certain of our leases, and as a result our leases now have lease terms that expire at various dates through March 2019 . Rent expense for non-cancellable operating leases with scheduled rent increases is recognized on a straight-line basis over the lease term. Rent expense was $0.4 million and $0.7 million for the three and six months ended June 30, 2014 , respectively, compared to $0.3 million and $0.7 million for the three and six months ended June 30, 2013 , respectively.

Future minimum lease payments under the non-cancellable operating leases as of June 30, 2014 , are as follows (in thousands):

Year Ending December 31,
Amount
2014 (remaining 6 months)
$
670

2015
1,696

2016
1,467

2017
1,512

2018
1,551

Thereafter
383

     Total future minimum lease payments
$
7,279


Purchase Commitments

We had non-cancellable purchase obligations to contract manufacturers and suppliers for $3.2 million and $6.0 million at June 30, 2014 , and December 31, 2013 , respectively.

Unrecognized Tax Benefits

Our gross liability for unrecognized tax benefits totaled $11,000 , including estimated interest and penalties, as of June 30, 2014 , and is classified in long-term income taxes payable. We are unable to make a reasonably reliable estimate of the timing of payments in individual years due to uncertainties in the timing of tax audits, if any, or their outcomes.


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Product Warranty

The estimated product warranty accrual was as follows (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Balance at the beginning of the period
$
660

 
$
742

 
$
676

 
$
902

Accruals for warranties issued
159

 
55

 
198

 
97

Settlements of warranty claims
(78
)
 
(71
)
 
(133
)
 
(273
)
Balance at the end of the period
$
741

 
$
726

 
$
741

 
$
726


Related Party Transactions

Brazilian Distribution Agreement

We entered into a distribution agreement with ADVANCE Medical, Inc. and its wholly-owned subsidiaries, 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 our products each calendar quarter throughout the term of the distribution agreement which requires on December 31, 2018. Venrock, a principal stockholder of ZELTIQ, owns an equity interest in ADVANCE Medical, Ltd., the parent company of ADVANCE. Dr. Bryan E. Roberts, who is a member of our Board of Directors, is also a partner of Venrock Associates. The revenue recognized by us under this distribution agreement was $0.1 million and $1.1 million for the three and six months ended June 30, 2014 , respectively, compared to $0.5 million and $0.8 million for the three and six months ended June 30, 2013 , respectively. The accounts receivable balance under this distribution agreement was $0.3 million and $0.2 million as of June 30, 2014 , and December 31, 2013 , respectively.

Recent Accounting Pronouncements

On May 28, 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2014-10, Revenue from Contracts with Customers. The objective of this update is to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability within industries, across industries, and across capital markets. This standard update contains principles that we will apply to determine the measurement of revenue and timing of when it is recognized. We will adopt this guidance effective January 1, 2017, and we are currently assessing the impact it may have on our consolidated financial statements.

Off-balance Sheet Arrangements

As of June 30, 2014 , and December 31, 2013 , 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. </