ZELTIQ
Zeltiq Aesthetics Inc (Form: 10-Q, Received: 07/30/2015 18:06:08)
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, 2015
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, 2015 , there were 38,756,476 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 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,
2015
 
December 31,
2014
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
37,306

 
$
28,649

Short-term investments
11,404

 
16,286

Accounts receivable, net
30,700

 
21,472

Inventory
18,372

 
15,536

Prepaid expenses and other current assets
6,239

 
7,060

Total current assets
104,021

 
89,003

Long-term investments
4,363

 
4,805

Restricted cash
563

 
560

Property and equipment, net
4,186

 
3,724

Intangible asset, net
5,430

 
5,780

Other assets
147

 
33

Total assets
$
118,710

 
$
103,905

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
8,340

 
$
5,824

Accrued liabilities
26,981

 
21,450

Deferred revenue
8,027

 
5,069

Current portion of capital lease obligations
122

 
120

Total current liabilities
43,470

 
32,463

Long-term deferred revenue
313

 
622

Long-term capital lease obligations, less current portion
201

 
262

Other non-current liabilities
476

 
39

Total liabilities
$
44,460

 
$
33,386

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, 2015, and December 31, 2014

 

Common stock, $0.001 par value: 500,000,000 shares authorized at June 30, 2015, and December 31, 2014; 38,741,143 and 38,123,998 shares issued and outstanding at June 30, 2015, and December 31, 2014, respectively
42

 
42

Additional paid-in capital
207,168

 
202,701

Accumulated other comprehensive income (loss)
(481
)
 
(696
)
Accumulated deficit
(132,479
)
 
(131,528
)
Total stockholders’ equity
74,250

 
70,519

Total liabilities and stockholders’ equity
$
118,710

 
$
103,905

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,
 
2015
 
2014
 
2015
 
2014
Revenue
$
64,431

 
$
47,061

 
$
115,989

 
$
78,036

Cost of revenue
18,116

 
13,660

 
32,494

 
22,676

Gross profit
46,315

 
33,401

 
83,495

 
55,360

Operating expenses:
 
 
 
 
 
 
 
Research and development
5,809

 
4,350

 
11,889

 
8,620

Sales and marketing
32,199

 
21,052

 
56,605

 
41,239

General and administrative
6,654

 
5,234

 
15,042

 
9,947

Total operating expenses
44,662

 
30,636

 
83,536

 
59,806

Income (loss) from operations
1,653

 
2,765

 
(41
)
 
(4,446
)
Interest income, net
13

 
14

 
26

 
33

Other expense, net
(445
)
 
(83
)
 
(865
)
 
(149
)
Income (loss) before income taxes
1,221

 
2,696

 
(880
)
 
(4,562
)
Income tax expense (benefit)
43

 
(73
)
 
71

 
6

Net income (loss)
$
1,178

 
$
2,769

 
(951
)
 
(4,568
)
Basic net income (loss) per share:
 
 
 
 
 
 
 
Net income (loss) per share, basic
$
0.03

 
$
0.07

 
$
(0.02
)
 
$
(0.12
)
Weighted average shares of common stock outstanding used in computing net income (loss) per share, basic
38,649,873

 
37,440,537

 
38,517,817

 
37,328,738

Diluted net income (loss) per share:
 
 
 
 
 
 
 
Net income (loss) per share, diluted
$
0.03

 
$
0.07

 
$
(0.02
)
 
$
(0.12
)
Weighted average shares of common stock outstanding used in computing net income (loss) per share, diluted
41,641,660

 
40,597,275

 
38,517,817

 
37,328,738

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,
 
2015
 
2014
 
2015
 
2014
Net income (loss)
$
1,178

 
$
2,769

 
$
(951
)
 
$
(4,568
)
Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
798

 
149

 
210

 
179

Changes in unrealized gains (losses) on available-for-sale securities

 
(6
)
 
5

 
(4
)
Other comprehensive income, net of tax
798

 
143

 
215

 
175

Comprehensive income (loss)
$
1,976

 
$
2,912

 
$
(736
)
 
$
(4,393
)
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,
 
2015
 
2014
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(951
)
 
$
(4,568
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
1,062

 
932

Stock-based compensation
7,233

 
4,511

Deferred income taxes

 
38

Amortization (accretion) of investment premium (discount), net
44

 
126

Provision for doubtful accounts receivable
158

 
145

Provision for excess and obsolete inventory
253

 
325

Loss on disposal and write-off of property and equipment

 
17

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(9,414
)
 
(3,781
)
Inventory
(2,994
)
 
(9,781
)
Prepaid expenses and other assets
707

 
2,022

Deferred revenue, net of deferred costs
2,645

 
2,099

Accounts payable, accrued and other non-current liabilities
8,487

 
(2,416
)
Net cash provided by (used in) operating activities
7,230

 
(10,331
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchase of investments
(6,024
)
 
(4,513
)
Proceeds from sale of investments

 
1,000

Proceeds from maturity of investments
11,310

 
10,634

Purchase of property and equipment
(1,188
)
 
(770
)
Change in restricted cash
1

 
(1
)
Net cash provided by investing activities
4,099

 
6,350

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Principal payments on capital leases
(59
)
 

Proceeds from issuance of common stock upon exercise of stock options and from employee stock purchase program
2,816

 
1,587

Tax payments related to shares withheld for vested restricted stock units
(5,599
)
 
(3,247
)
Tax effect of employee stock plans
17

 
15

Net cash used in financing activities
(2,825
)
 
(1,645
)
Effect of exchange rate changes on cash and cash equivalents
153

 
90

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
8,657

 
(5,536
)
CASH AND CASH EQUIVALENTS—Beginning of period
28,649

 
25,798

CASH AND CASH EQUIVALENTS—End of period
$
37,306

 
$
20,262

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 of ZELTIQ Aesthetics, Inc. (the "Company") 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, 2014 , 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, 2015 , results of operations for the three and six months ended June 30, 2015 and 2014 , comprehensive income (loss) for the three and six months ended June 30, 2015 and 2014 , and cash flows for the six months ended June 30, 2015 and 2014 . The interim results for the three and six months ended June 30, 2015 , are not necessarily indicative of the results that may be expected for the year ending December 31, 2015 , or for any other future annual or interim period. Certain amounts in the prior year's condensed consolidated balance sheet have been reclassified to conform to the current period's presentation. These reclassifications had no impact on previously reported condensed consolidated statements of cash flows or 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, 2014 .

Out of period adjustment  

During the three months ended  June 30, 2015 , the Company recorded and corrected an adjustment related to inventory that served to increase cost of revenue by $0.2 million . The adjustment to cost of revenue and inventory resulted from the reserve and write-off of certain inventory held by vendors starting in the fiscal year ended December 31, 2011 through the first quarter of 2015. Of the total amount of this adjustment to cost of revenue,  $0.1 million  related to the fiscal year ending  December 31, 2012 , $23,000 related to the fiscal year ended December 31, 2013 and $42,000 related to the fiscal year ended December 31, 2014 . The error caused the overstatement of inventory and the understatement of cost of revenue in prior periods. The Company does not believe that such amounts are material to current and previously reported consolidated financial statements.

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.

The functional currency of the Company’s international subsidiaries is evaluated on a case-by-case basis and has been determined to be the respective local currency. 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 the foreign subsidiaries' financial statements are included as a separate component of stockholders' equity under "Accumulated other comprehensive income (loss)." 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 expense, net.

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

7


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.

Concentration of Credit Risk

As of June 30, 2015 , one individual customer, which is a large aesthetic chain, accounted for 30% of accounts receivable. As of June 30, 2014 , no individual customer accounted for 10% or more of the Company's accounts receivable. During the three and six months ended June 30, 2015 , one individual customer accounted for 17% and 14% of total revenue, respectively. During the three and six months ended June 30, 2014 , no individual customer accounted for 10% or more of total revenue.

Critical Accounting Policies

There have been no material changes to the Company’s critical accounting policies during the six months ended June 30, 2015 , as compared to the critical accounting policies described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 .

Recent Accounting Pronouncements

On May 28, 2014 , the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2014-09, 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. This guidance allows for two methods of adoption: (a) full retrospective adoption, meaning the guidance is applied to all periods presented, or (b) modified retrospective adoption, meaning the cumulative effect of applying this guidance is recognized as an adjustment to the fiscal 2018 opening Accumulated deficit balance. The Company will adopt this guidance effective January 1, 2018 , and is currently evaluating the two adoption methods as well as the impact this new guidance will have on the consolidated financial statements and related disclosures.

In August 2014 , the FASB issued Accounting Standards Update No. 2014-15, Disclosure of Uncertainties About an Entity's Ability to Continue as a Going Concern. This standard update provides guidance around management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. The new guidance is effective for all annual and interim periods ending after December 15, 2016 . The new guidance will not have an impact on the Company's consolidated financial statements.

In April 2015 , the FASB issued Accounting Standards Update No. 2015-05 regarding Subtopic 350-40, “Intangibles - Goodwill and Other - Internal-Use Software.” This standard provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendments are effective for annual and interim periods beginning after December 15, 2015 . Early adoption is permitted. The amendments may be applied either prospectively to all arrangements entered into or materially modified after the effective date or retrospectively. The Company is currently evaluating the impact this new guidance will have on the consolidated financial statements and related disclosures.

In June 2015 , the FASB issued Accounting Standards Update No. 2015-10, Technical Corrections and Improvements. The standard covers a wide range of Topics in the Codification. The amendments in this standard represent changes to clarify the Codification, correct unintended application of guidance, or make minor improvements to the Codification that are not expected to have a significant effect on current accounting practice or create a significant administrative cost on most entities. The amendments are effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2015 . The Company does not anticipate that the adoption of this standard will have a material impact on its consolidated financial statements and footnote disclosures. The Company is currently evaluating the impact this new guidance will have on the consolidated financial statements and related disclosures.

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, 2015 .

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.


8


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 June 30, 2015
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
Financial Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
5,930

 
$

 
$

 
$
5,930

Short-term investments:
 
 
 
 
 
 
 
U.S. Agency securities

 
3,251

 

 
3,251

U.S. Treasury

 
501

 

 
501

Corporate bonds

 
6,472

 

 
6,472

Certificates of deposit
1,180

 

 

 
1,180

Long-term investments:
 
 
 
 
 
 
 
U.S. Agency securities

 
600

 

 
600

Corporate bonds

 
1,207

 

 
1,207

Certificates of deposit
2,556

 

 

 
2,556

Total
$
9,666

 
$
12,031

 
$

 
$
21,697


 
As of December 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Fair Value
Financial Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
6,062

 
$

 
$

 
$
6,062

Short-term investments:
 
 
 
 
 
 

U.S. Agency securities

 
5,240

 

 
5,240

U.S. Treasury

 
1,004

 

 
1,004

Corporate bonds

 
7,774

 

 
7,774

Commercial paper

 
1,349

 

 
1,349

Certificates of deposit
919

 

 

 
919

Long-term investments:
 
 
 
 
 
 

U.S. Agency securities

 
999

 

 
999

U.S. Treasury

 
500

 

 
500

Corporate bonds

 
750

 

 
750

Certificates of deposit
2,556

 

 

 
2,556

Total
$
9,537

 
$
17,616

 
$

 
$
27,153


During the three and six months ended June 30, 2015 and 2014 , 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, 2015 , and December 31, 2014 .

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, 2015 , are as follows (in thousands):
Short-term
 
 
 
 
 
 
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Agency securities
$
3,251

 
$

 
$

 
$
3,251

U.S. Treasury
500

 
1

 

 
501

Corporate bonds
6,474

 
1

 
(3
)
 
6,472

Certificates of deposit
1,180

 

 

 
1,180

Total
$
11,405

 
$
2

 
$
(3
)
 
$
11,404

 
 
 
 
 
 
 
 
Long-term
 
 
 
 
 
 
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Agency securities
$
600

 
$

 
$

 
$
600

Corporate bonds
1,208

 

 
(1
)
 
1,207

Certificates of deposit
2,556

 

 

 
2,556

Total
$
4,364

 
$

 
$
(1
)
 
$
4,363


The Company's short-term and long-term investments as of December 31, 2014 , are as follows (in thousands):

Short-term
 
 
 
 
 
 
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Agency securities
$
5,240

 
$
1

 
$
(1
)
 
$
5,240

U.S. Treasury
1,003

 
1

 

 
1,004

Corporate bonds
7,778

 
2

 
(6
)
 
7,774

Commercial paper
1,349

 

 

 
1,349

Certificates of deposit
919

 

 

 
919

Total
$
16,289

 
$
4

 
$
(7
)
 
$
16,286

 
 
 
 
 
 
 
 
Long-term
 
 
 
 
 
 
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
U.S. Agency securities
$
1,000

 
$

 
$
(1
)
 
$
999

U.S. Treasury
500

 

 

 
500

Corporate bonds
752

 

 
(2
)
 
750

Certificates of deposit
2,556

 

 

 
2,556

Total
$
4,808

 
$

 
$
(3
)
 
$
4,805


For each of the three and six months ended June 30, 2015 and 2014 , gains or losses realized on the sale of investments were insignificant.


10


The contractual maturities of the Company's short-term and long-term investments as of June 30, 2015 , are as follows (in thousands):

 
June 30, 2015
 
Amortized Cost
 
Fair Value
Due in one year or less
$
11,405

 
$
11,404

Due in one year to five years
4,364

 
4,363

 
$
15,769

 
$
15,767


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, new production introductions and market conditions.

The components of inventory consist of the following (in thousands):
 
 
June 30,
2015
 
December 31,
2014
Raw materials
$
8,987

 
$
7,692

Finished goods
9,385

 
7,844

          Total inventory
$
18,372

 
$
15,536


Property and equipment, net

Property and equipment, net comprised the following (in thousands):
 
 
June 30,
2015
 
December 31,
2014
Lab equipment, tooling and molds
$
2,959

 
$
2,766

Computer software
2,081

 
1,337

Computer equipment
1,308

 
984

Leasehold improvements
1,525

 
1,452

Furniture and fixtures
681

 
494

Vehicles
35

 
35

Total property and equipment
8,589

 
7,068

Less: Accumulated depreciation and amortization
(4,788
)
 
(4,111
)
Construction in progress
385

 
767

Property and equipment, net
$
4,186

 
$
3,724


The table above includes property and equipment acquired under capital leases which totaled $0.4 million as of both June 30, 2015 and December 31, 2014 .

Depreciation and amortization expense related to property and equipment was $0.4 million and $0.7 million for the three and six months ended June 30, 2015 , respectively. Depreciation and amortization expense related to property and equipment was $0.3 million and $0.6 million for the three and six months ended June 30, 2014 , respectively.

11



Accrued Liabilities

The following table shows the components of accrued liabilities (in thousands):
 
 
June 30,
2015
 
December 31,
2014
Accrued payroll and employee related expenses
$
10,150

 
$
8,386

Accrued marketing expenses
4,438

 
2,959

Accrued royalty
4,581

 
3,612

Sales and other taxes payable
2,222

 
2,123

Advance payments from customers
1,295

 
1,908

Accrued warranty
339

 
569

Accrued legal expenses
2,556

 
592

Other accrued liabilities
1,400

 
1,301

Total accrued liabilities
$
26,981

 
$
21,450


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. Changes in the warranty accrual are 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 product warranty accrual was as follows (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Balance at the beginning of the period
$
440

 
$
660

 
$
569

 
$
676

Change in accruals for warranties issued
(134
)
 
159

 
(163
)
 
198

Settlements of warranty claims
33

 
(78
)
 
(67
)
 
(133
)
Balance at the end of the period
$
339

 
$
741

 
$
339

 
$
741


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, clearance were 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,
2015
 
December 31,
2014
Purchased technology
$
8,050

 
$
8,050

Less: Accumulated amortization
(2,620
)
 
(2,270
)
     Intangible asset, net
$
5,430

 
$
5,780


Amortization expense of the intangible asset was $0.2 million for both the three months ended June 30, 2015 and 2014 , and $0.4 million for both the six months ended June 30, 2015 and 2014 .

The total estimated annual future amortization expense of this intangible asset as of June 30, 2015 , is as follows (in thousands):

Fiscal Year
 
2015 (remaining 6 months)
$
351

2016
701

2017
701

2018
701

2019
701

Thereafter
2,275

Total
$
5,430


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 , as our exclusive distributor of CoolSculpting in Brazil and Mexico, as amended on August 29, 2011 , February 27, 2012 , and September 4, 2012 . The distribution agreement was further amended on August 15, 2014 , whereby ADVANCE is no longer a distributor in Mexico effective November 2014 . As the exclusive distributor in Brazil, 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. ADVANCE purchases product with payment terms up to 180 days , and to date no amounts have been determined to be unrecoverable. The revenue recognized by the Company under this distribution agreement was $0.3 million and $1.6 million for the three and six months ended June 30, 2015 , respectively, compared to $0.1 million and $1.1 million for the three and six months ended June 30, 2014 , respectively. The accounts receivable balance under this distribution agreement was $1.0 million and $0.2 million as of June 30, 2015 , and December 31, 2014 , respectively.

6. Commitments and Contingencies

Operating Lease Obligations
 
The Company leases facilities under non-cancellable operating leases with various expiration dates. 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 May 2017 , and a warehouse space in Livermore, California, under a lease which extends through May 2017 . The Company also occupies office and warehouse space near Gatwick, United Kingdom, under a lease which extends through December 2018 , as well as office space in London, United Kingdom, under a lease which extends through October 2015 , Taipei, Taiwan, under a lease which extends through August 2016 , Seoul, South Korea, under a lease which extends through October 2015 , Reston, Virginia, under a lease which extends through September 2020 , and Dublin, Ireland under a month-to-month lease. 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 $0.6 million and $1.1 million for the three and six months ended June 30, 2015 , respectively, compared to $0.4 million and $0.7 million for the three and six months ended June 30, 2014 , respectively.

13



Future minimum lease payments under the non-cancellable operating leases as of June 30, 2015 , are as follows (in thousands):

Year Ending December 31,
Amount
2015 (remaining 6 months)
$
1,102

2016
2,219

2017
1,995

2018
1,848

2019
694

Thereafter
228

Total future minimum lease payments
$
8,086


Capital Lease Obligations

The Company has entered into certain capital lease obligations to purchase equipment for operations which include a bargain purchase option. The underlying assets and related depreciation are included in the appropriate property and equipment category and related accumulated depreciation account.

Property and equipment includes amounts under leases that have been capitalized as follows (dollars in thousands):

 
Useful life (Years)
 
June 30, 2015
 
December 31,
2014
Computer equipment
3
 
$
382

 
$
382

Total capital leased equipment
 
 
382

 
382

Less: Accumulated depreciation and amortization
 
 
(85
)
 
(21
)
Capital leased equipment, net
 
 
$
297

 
$
361


Total amortization of assets acquired under capital leases was $32,000 and $0.1 million for the three and six months ended June 30, 2015 , respectively, which is included in total depreciation and amortization expense. There were no such arrangements during the three and six months ended June 30, 2014 .

Future minimum payments required under capital leases as of June 30, 2015 , are as follows (in thousands):
 
Year Ending December 31,
Amount
2015 (remaining 6 months)
$
66

2016
132

2017
141

     Total future payments
$
339

 
 
Less: Amount representing interest
$
16

Present value of future minimum payments
323

Less: Current portion
122

Long term portion
$
201


Purchase Commitments

The Company had non-cancellable purchase obligations to contract manufacturers and suppliers of $10.0 million and $4.0 million at June 30, 2015 , and December 31, 2014 , respectively. The $6.0 million increase in contract obligations from December 31, 2014 to June 30, 2015 was mainly due to inventory purchase commitments relating to our launch of the CoolSmooth PRO and in contemplation of future demand and sales levels.

14



Unrecognized Tax Benefits

The Company's gross liability for unrecognized tax benefits totaled $29,000 , including estimated interest and penalties, as of June 30, 2015 , 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.

The Company is not currently a defendant in any litigation or claims that are expected to have a material impact on the Company's condensed consolidated financial statements.

Product Liability Contingencies

The Company has historically been and continues to be predominantly self-insured for any product liability losses related to its products. The Company obtains third-party insurance to limit our exposure to these claims, but this insurance is subject to a cap on reimbursement. Future product liability losses are, by their nature, uncertain and are based upon complex judgments and probabilities. The Company accrues for certain probable product liabilities to the extent they can be reasonably estimated. The Company estimates these accruals for probable losses based on various factors, including historical claims and settlement experience. The total value of self-insured product liability claims settled in the three and six months ended June 30, 2015 and 2014 , respectively, are not material. The value of known and reasonably estimable self-insured product liability claims pending was $0.8 million as of June 30, 2015 . Such estimated claims were not material as of December 31, 2014 .

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.


15


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, 2014
2,685,209

 
3,242,421

 
$
6.47

Additional shares reserved
1,000,000

 

 

Options granted
(45,622
)
 
45,622

 
34.65

Restricted stock units granted
(426,972
)
 

 

Options exercised

 
(311,522
)
 
5.30

Options canceled
17,599

 
(17,599
)
 
6.52

Restricted stock units canceled
108,727

 

 

Restricted stock units withheld for tax
174,867

 

 

Balance, June 30, 2015
3,513,808

 
2,958,922

 
$
7.03


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, 2014
1,533,081

 
$
10.08

Restricted stock units granted
426,972

 
31.56

Restricted stock units vested
(431,608
)
 
9.18

Restricted stock units canceled
(108,727
)
 
11.70

Balance, June 30, 2015
1,419,718

 
$
16.63


During the three and six months ended June 30, 2015 , 101,407 and 431,608 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, 2015 , the Company withheld 41,832 and 174,867 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, 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.

Subsequently, the Company remitted cash to the appropriate taxing authorities. Total payments for employee's tax obligations to the relevant taxing authority was $1.3 million and $5.6 million for the three and six months ended June 30, 2015 , respectively. Total payments for employee's tax obligations to the relevant taxing authority was $0.7 million and $3.2 million for the three and six months ended June 30, 2014 , respectively. The payments were for taxes related to the net share settlements of restricted stock units.

16



Stock-Based Compensation Expense

Stock-based compensation related to all of the Company's stock-based awards and employee stock purchases was recorded as an expense or a reduction to revenue and categorized as follows (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Revenue
$
68

 
$

 
$
148

 
$

Cost of revenue
149

 
117

 
283

 
210

Research and development
392

 
263

 
742

 
469

Sales and marketing
1,345

 
998

 
2,896

 
1,934

General and administrative
1,129

 
1,028

 
3,164

 
1,898

Total stock-based compensation
$
3,083

 
$
2,406

 
$
7,233

 
$
4,511


As of June 30, 2015 , the total unrecognized compensation costs related to outstanding stock options, awards and employee stock purchases was $20.1 million , which is expected to be recognized using the straight-line attribution method over 1.6 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 $2.0 million for the three and six months ended June 30, 2015 , respectively, compared to $0.5 million and $1.0 million for the three and six months ended June 30, 2014 , respectively.

Employee Stock-Based Compensation

The Company uses the Black-Scholes option pricing model to determine the fair value of stock options. The valuation model for stock-based compensation expense requires the Company to make assumptions and judgments about the variables used in the calculation including the expected term (weighted-average period of time that the options granted are expected to be outstanding), volatility of the Company's common stock, an assumed-risk-free interest rate and the estimated forfeitures of unvested stock options. During 2015, the Company modified its approach for calculating assumptions related to the expected term and volatility as detailed below.

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,
 
2015
 
2014
 
2015
 
2014
Expected term (in years)
N/A
 
4.4

 
4.8

 
4.4

Expected volatility
N/A
 
43
%
 
63
%
 
43
%
Risk-free interest rate
N/A
 
1.30
%
 
1.29
%
 
1.21
%
Expected dividend yield
N/A
 
%
 
%
 
%

Expected Term . Prior to the Company's initial public offering of its common stock, or IPO, the Company derived the expected term using the “simplified” method (the expected term is determined as the average of the time-to-vesting and the contractual life of the options), as the Company had limited historical information to develop expectations about future exercise patterns and post-vesting employment termination behavior. Subsequent to the IPO and through 2014, the expected term used was based on expected term of a group of similar entities, referred to as its “peer group.” In evaluating similarity, the Company considered factors such as industry, stage of life cycle and size. In 2015, the Company modified its approach by including its own historical data along with the expected term of the identified peer group companies. The Company will continue to apply this methodology until a sufficient amount of historical information regarding its own expected term becomes available.


17


Volatility . Prior to the IPO, because the Company was a private entity with no historical data regarding the volatility of its common stock, the expected volatility used was based on volatility of a group of similar entities, referred to as its “peer group.” In evaluating similarity, the Company considered factors such as industry, stage of life cycle and size. Subsequent to the IPO and through 2014, the Company continued to estimate its volatility based on its peer group as the Company did not have sufficient historical data regarding its specific volatility. In 2015, the Company modified its approach by including its own common stock trading history along with the volatility of the identified peer group companies. The expected stock price volatility is estimated using a combination of historical and peer group volatility to derive the expected volatility assumption. The Company believes the blended volatility is more representative of future stock price trends over the expected life of the options rather than just using historical or peer group volatility. The Company will continue to apply this methodology until a sufficient amount of historical information regarding the volatility of its own stock price becomes available.

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.

Forfeitures. The Company is required to estimate forfeitures at the time of grant, and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and to record stock-based compensation expense only for those awards that are expected to vest. To the extent actual forfeitures differ from the estimates, the difference will be recorded as a cumulative adjustment in the period that the estimates are revised.

No stock options were granted in the three months ended June 30, 2015 . During the six months ended June 30, 2015 , the Company granted 45,622 stock options to employees with a weighted-average grant date fair value of $18.19 per share. 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, 2015 , the Company granted 65,215 and 418,972 restricted stock units, respectively, to employees with a weighted-average grant date fair value of $29.42 and $31.56 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 six months ended June 30, 2015 , employees purchased 52,965 shares under the Company's employee stock purchase plan, or ESPP, at a weighted average exercise price of $22.02 . As of June 30, 2015 , the unrecognized compensation cost related to the ESPP was $0.3 million , which will be recognized using the straight-line attribution method over 0.4 years .

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 three and six months ended June 30, 2015, the Company granted stock-based awards to a non-employee that vest over one year. During the three and six months ended June 30, 2014 , the Company granted stock-based awards to a non-employee which will vest over two years . Stock-based compensation expense related to non-employee grants was $0.1 million and $0.3 million for the three and six months ended June 30, 2015 , respectively, of which $0.1 million relates to an arrangement with a non-employee customer and has been recorded as a reduction of revenue for both the three and six months ended June 30, 2015 , respectively, in the condensed consolidated statements of operations. Stock-based compensation expense for non-employees was $21,000 and $0.1 million for the three and six months ended June 30, 2014 , respectively.


18


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 income (loss) per share is as follows:
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
Numerator
 
 
 
 
 
 
 
Net income (loss) (in thousands)
$
1,178

 
$
2,769

 
$
(951
)
 
$
(4,568
)
Denominator
 
 
 
 
 
 
 
Weighted average shares of common stock outstanding used in computing net income (loss) per share, basic
38,649,873

 
37,440,537

 
38,517,817

 
37,328,738

Dilutive effect of incremental shares and share equivalents
2,991,787

 
3,156,738

 

 

Weighted average shares of common stock outstanding used in computing net income (loss) per share, diluted
41,641,660

 
40,597,275

 
38,517,817

 
37,328,738

Net income (loss) per share:
 
 
 
 
 
 
 
Net income (loss) per share, basic
$
0.03

 
$
0.07

 
$
(0.02
)
 
$
(0.12
)
Net income (loss) per share, diluted
$
0.03

 
$
0.07

 
$
(0.02
)
 
$
(0.12
)

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,
 
2015
 
2014
 
2015
 
2014
Options to purchase common stock
45,622

 
188,297

 
2,958,922

 
3,663,603

Restricted stock units
116,035

 
141,871

 
1,419,718

 
1,766,501

Common stock issuable pursuant to the ESPP

 

 
722

 
2,633

Total
161,657

 
330,168

 
4,379,362

 
5,432,737


9. Income Taxes

The Company recorded income tax expense of $43,000 and $71,000 for the three and six months ended June 30, 2015 , respectively, compared to income tax (benefit) expense of $(73,000) and $6,000 for the three and six months ended June 30, 2014 , respectively. The income tax expense for the three and six months ended June 30, 2015 and 2014 , 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, 2015 , the Company had $1.5 million of unrecognized tax benefits, of which $28,000 , if recognized, would affect the effective tax rate due to the valuation allowance that currently offsets deferred tax assets. 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 Company files annual income tax returns in multiple taxing jurisdictions around the world, including the U.S. federal and state jurisdictions, Ireland, 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

19


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, 2015 , 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,
 
2015
 
2014
 
2015
 
2014
North America
$
51,436

 
$
37,077

 
$
86,665

 
$
59,864

International
12,995

 
9,984

 
29,324

 
18,172

     Total
$
64,431

 
$
47,061

 
$
115,989

 
$
78,036


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 $46.4 million and $79.5 million for the three and six months ended June 30, 2015 , respectively, compared to $34.9 million and $55.8 million for the three and six months ended June 30, 2014 , respectively.

The following table sets forth revenue by product expressed as dollar amounts (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
2015
 
2014
System revenue
$
32,047

 
$
25,383

 
$
58,203

 
$
39,844

Consumable revenue
32,384

 
21,678

 
57,786

 
38,192

     Total
$
64,431

 
$
47,061

 
$
115,989

 
$
78,036


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


20


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, 2014 . 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 primarily 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. We currently 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, the FDA cleared CoolSculpting for treatment of the abdomen area. In April 2014, the FDA cleared CoolSculpting for treatment of the thigh area, and most recently, in January 2015, the FDA cleared us to do treatments at lower temperatures which enables shorter treatment times. Currently, we are seeking FDA approval to treat other areas, including the submental fat area under the chin, and anticipate receiving FDA clearance as early as the fourth quarter of 2015. The submental area is consistently ranked as one of the top areas of concern both by consumers and physicians. We are also seeking 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.
In North America, we use our direct sales organization to selectively market CoolSculpting. In markets outside of North America, including Asia Pacific, Latin America and Europe, we sell CoolSculpting through both 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 20% and 25% of our total revenue for the three and six months ended June 30, 2015 , respectively, compared to 21% and 23% of our total revenue for the three and six months ended June 30, 2014 , 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 primarily from sales of our CoolSculpting system and from sales of consumables to our customers. We generated revenue of $64.4 million and $116.0 million for the three and six months ended June 30, 2015 , respectively, compared to $47.1 million and $78.0 million for the three and six months ended June 30, 2014 , 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 50% our total revenue for both the three and six months ended June 30, 2015 , respectively, compared to 54% and 51% of our total revenue for the three and six months ended June 30, 2014 , respectively. Our worldwide installed base grew by 53% from 2,562 units as of June 30, 2014 , to 3,910 units as of June 30, 2015 .

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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 50% of our total revenue for each of the three and six months ended June 30, 2015 , respectively, compared to 46% and 49% of our total revenue for the three and six months ended June 30, 2014 , respectively. We shipped 252,642 and 459,929 CoolSculpting revenue cycles to our customers during the three and six months ended June 30, 2015 , respectively, compared to 166,116 and 292,175 CoolSculpting revenue cycles during the three and six months ended June 30, 2014 , 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 continue to implement our business plan and expand our installed base 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. Seasonal fluctuations occur in both system revenue and consumable revenue as well as by geographic region. Specifically, our customers often take vacation or are on holiday during the summer months and therefore tend to perform fewer procedures, particularly in certain international countries. 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.

Out of period adjustment.   During the three months ended June 30, 2015, we recorded and corrected an adjustment related to inventory that served to increase cost of revenue by $0.2 million. The adjustment to cost of revenue and inventory resulted from the reserve and write-off of certain inventory held by vendors starting in the fiscal year ended December 31, 2011 through the first quarter of 2015. Of the total amount of this adjustment to cost of revenue, $0.1 million related to the fiscal year ending December 31, 2012, $23,000 related to the fiscal year ended December 31, 2013 and $42,000 related to the fiscal year ended December 31, 2014. The error caused the overstatement of inventory and the understatement of cost of revenue in prior periods. We do not believe that such amounts are material to current and previously reported consolidated financial statements.

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, 2014 .

Our critical accounting policies have not materially changed during the six months ended   June 30, 2015 . 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 statements 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 allocation of selling prices to revenue elements, (2) customer programs and payments, including accruals for customer programs, cooperative marketing arrangements, customer incentive programs and payments to customers, (3) investments, including the fair value of such investments, (4) warranty accruals, (5) valuation and recognition of

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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, 2014 .

Results of Operations

Revenue (in thousands, except for percentages):

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
Revenue
2015
 
2014
 
$ Change
 
% Change
 
2015
 
2014
 
$ Change
 
% Change
System revenue
$
32,047

 
$
25,383

 
$
6,664

 
26
%
 
$
58,203

 
$
39,844

 
$
18,359

 
46
%
Consumable revenue
32,384

 
21,678

 
10,706

 
49
%
 
57,786

 
38,192

 
19,594

 
51
%
Total revenue
$
64,431

 
$
47,061

 
$
17,370

 
37
%
 
$
115,989

 
$
78,036

 
$
37,953

 
49
%

Overall, we experienced an increase in revenue primarily as a result of 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.

System revenue.  We experienced incremental growth in system revenue for the three and six months ended June 30, 2015 , as compared to the same periods in 2014 , as a result of increased system sales in both North America and our International markets due to the reasons stated above. Overall, we placed 387 and 734 systems in the three and six months ended June 30, 2015 , respectively, as compared to 208 and 387 systems in the three and six months ended June 30, 2014 , respectively. We also continue to experience an increase in sales of add-on applicators to existing customers, driven by our CoolSmooth PRO applicator which we launched in April 2015 and for which we are offering an exchange program whereby customers are able to exchange their current CoolSmooth applicator for a CoolSmooth PRO applicator for a fee; revenue under the exchange program totaled $1.0 million in the three months ended June 30, 2015. We also recognized incremental add-on applicator revenue, excluding exchange program revenue, of $1.8 million and $2.5 million in the three and six months ended June 30, 2015 , respectively, whereas in the three and six months ended June 30, 2014 our incremental add-on revenue, related primarily to our CoolSmooth applicators which launched in April 2014, totaled $6.1 million and $6.4 million , respectively. 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. These increases were offset in part by the impact of increased international sales to distributors, which generally carry lower average selling prices, as well as due to volume based discounts offered on certain multiple system deals in the first half of 2015.

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, 2015 , as compared to the same periods in 2014 , offset by certain rebate programs with our international distributors. There were no significant changes in average selling price for our consumable procedures packs in the three and six months ended June 30, 2015 as compared to the same periods in 2014. Our average selling price is influenced by procedure type mix as well as region and customer type.

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

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
$ Change
 
% Change
 
2015
 
2014
 
$ Change
 
% Change
Cost of revenue
$
18,116

 
$
13,660

 
$
4,456

 
33
%
 
$
32,494

 
$
22,676

 
$
9,818

 
43
%
% of total revenue
28
%
 
29
%
 
 
 
 
 
28
%
 
29
%
 
 
 
 
Gross profit
$
46,315

 
$
33,401

 
$
12,914

 
39
%
 
$
83,495

 
$
55,360

 
$
28,135

 
51
%
Gross profit %
72
%
 
71
%
 
 
 
 
 
72
%
 
71
%
 
 
 
 


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Gross profit as a percentage of revenue typically fluctuates with product and regional mix, selling prices, material costs and revenue levels. The gross profit as a percentage of revenue for the three and six months ended June 30, 2015 remained relatively unchanged, as compared to the same periods in 2014 . Gross profit as a percentage of revenue was positively impacted by increased sales volume combined with better utilization on a fixed based of overhead costs. This was almost entirely offset by our CoolSmooth PRO exchange program which carries a lower gross profit contribution based on the reduced selling price associated with the exchange, as well as due to the impact of the increase in sales to international distributor customers and discounted sales to our high volume customers.
 
Operating Expenses (in thousands, except for percentages):

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
$ Change
 
% Change
 
2015
 
2014
 
$ Change
 
% Change
Operating expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
$
5,809

 
$
4,350

 
$
1,459

 
34
%
 
$
11,889

 
$
8,620

 
$
3,269

 
38
%
% of total revenue
9
%
 
9
%
 
 
 
 
 
10
%
 
11
%
 
 
 
 
Sales and marketing
$
32,199

 
$
21,052

 
$
11,147

 
53
%
 
$
56,605

 
$
41,239

 
$
15,366

 
37
%
% of total revenue
50
%
 
45
%
 
 
 
 
 
49
%
 
53
%
 
 
 
 
General and administrative
$
6,654

 
$
5,234

 
$
1,420

 
27
%
 
$
15,042

 
$
9,947

 
$
5,095

 
51
%
% of total revenue
10
%
 
11
%
 
 
 
 
 
13
%
 
13
%
 
 
 
 
Total operating expenses
$
44,662

 
$
30,636

 
$
14,026

 
46
%
 
$
83,536

 
$
59,806

 
$
23,730

 
40
%

Research and development.  Research and development expenses increased for the three and six months ended June 30, 2015 , as compared to the same period of 2014 , primarily due to an increase in payroll related costs of $0.5 million and $1.3 million attributed to higher headcount and an increase in performance-based compensation. We also experienced an increase in materials, operations and clinical costs of $0.6 million and $1.1 million for the three and six months ended June 30, 2015 , respectively, as we continue to explore ways to leverage our proprietary cooling platform for additional applications and indications including our recently announced CoolSmooth PRO, which we launched in the second quarter of 2015. Facilities and other allocable costs also increased by $0.2 million and $0.3 million for the three and six months ended June 30, 2015 , respectively, resulting from increased headcount and operating costs related to the growth in our business.

Sales and marketing.  Sales and marketing expenses increased for the three and six months ended June 30, 2015 , as compared to the same period of 2014 , primarily due to the significant increase in headcount attributable to our sales force, which increased by approximately 36% , as we continue to expand into new and existing markets. This growth in headcount resulted in an increase in payroll related costs of $3.7 million and $6.3 million for the three and six months ended June 30, 2015 , respectively, which includes an increase in performance-based compensation resulting primarily from revenue growth. Stock-based compensation expense also increased by $0.3 million and $1.0 million for the three and six months ended June 30, 2015 , respectively, attributed to grants to existing and new employees, including certain performance-based award grants, and due to an increase in stock price. Travel and related expenses increased by $1.0 million and $1.5 million for the three and six months ended June 30, 2015 , respectively, 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 $3.1 million and $3.8 million for the three and six months ended June 30, 2015 , respectively, when compared to the same periods in 2014, associated with costs incurred in conjunction with our sales and marketing initiatives. These costs were primarily related to our direct to consumer advertising campaign, which was launched in the first quarter of 2015. 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 these 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. The expense for these cooperative marketing arrangements included in our customer incentive programs increased by $1.8 million and $1.1 million for the three and six months ended June 30, 2015 , respectively, when compared to the same periods in 2014, primarily due to an increase in our customer base and change in the program in the current year that increased the number of eligible participants compared to the prior year.

General and administrative.  General and administrative expenses increased for the three and six months ended June 30, 2015 , as compared to the same period of 2014 , primarily due to an increase in payroll related costs of $0.3 million and $1.1 million for the

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three and six months ended June 30, 2015 , respectively, resulting from higher headcount in certain functions to support growth in our business. Stock-based compensation expense also increased by $0.1 million and $1.3 million for the three and six months ended June 30, 2015 , respectively, attributed to grants to existing and new employees and due to an increase in stock price, as well as the expense related to certain performance-based awards for which all release criteria were achieved. Professional services fees increased $0.1 million and $0.6 million for the three and six months ended June 30, 2015 , respectively, when compared to the same periods in 2014, associated with the growth of our business as well as our expansion into international markets. Additionally, we experienced a $0.6 million and $1.8 million increase in legal and related expenses for the three and six months ended June 30, 2015 , respectively, mainly due to an increase in IP enforcement, both domestically and overseas, certain product liability and personnel cases, and to a lesser extent certain other one-time project fees.

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

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2014
 
$ Change
 
% Change
 
2015
 
2014
 
$ Change
 
% Change
Interest income, net
$
13

 
$
14

 
$
(1
)
 
(7
)%
 
$
26

 
$
33

 
$
(7
)
 
(21
)%
% of total revenue
 %
 
 %
 
 
 
 
 
 %
 
 %
 
 
 
 
Other expense, net
$
(445
)
 
$
(83
)
 
$
(362
)
 
436
 %
 
$
(865
)
 
$
(149
)
 
$
(716
)
 
481
 %
% of total revenue
(1
)%
 
 %
 
 
 
 
 
(1
)%
 
 %
 
 
 
 

Interest income, net.  For both the three and six months ended June 30, 2015 and 2014 , 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, net. The change in other expense, net for the three and six months ended June 30, 2015 , as compared to the three and six months ended June 30, 2014 , was the result of changes in foreign exchange rates, primarily the British Pound and Euro.

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 cash and cash equivalents, short-term and long-term investments, and working capital as of June 30, 2015 , and December 31, 2014 (in thousands):

 
June 30,
 
December 31,
 
2015
 
2014
Cash and cash equivalents
$
37,306

 
$
28,649

Short-term investments
11,404

 
16,286

Long-term investments
4,363

 
4,805

Total
$
53,073

 
$
49,740

Working capital
$
60,551

 
$
56,540



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Summary Statement of Cash Flows

The following table summarizes our cash flows for the six months ended June 30, 2015 and 2014 (in thousands):
 
 
Six Months Ended
 
June 30,
 
2015
 
2014
Net cash provided by (used in) operating activities
$
7,230

 
$
(10,331
)
Net cash provided by investing activities
4,099

 
6,350

Net cash used in financing activities
(2,825
)
 
(1,645
)
Effect of exchange rate changes on cash and cash equivalents
153

 
90

Net increase (decrease) in cash and cash equivalents
$
8,657

 
$
(5,536
)

Cash Flows for the Six Months Ended June 30, 2015 and 2014

Operating activities.  Net cash provided by operating activities was $7.2 million during the six months ended June 30, 2015 , and consisted of a net loss of $1.0 million and a net change in operating assets and liabilities of $0.6 million , offset by non-cash items of $8.8 million . Non-cash items for the six months ended June 30, 2015 , consisted primarily of a stock-based compensation expense of $7.2 million and depreciation and amortization expense of $1.1 million . The significant items in the change in operating assets and liabilities include cash used resulting from increases in inventory of $3.0 million and an increase in accounts receivable of $9.4 million . These uses of cash were offset in part by an increase of $2.6 million in deferred revenue and an increase in accounts payable, accrued and other non-current liabilities of $8.5 million . We experienced an increase in inventory as we continued to build inventory to support expected customer demand as well as the inventory in support of our launch of CoolSmooth PRO, which was released in the second quarter of 2015. The increase in accounts receivable is a function of the increase in sales as well as timing of payment receipts from customers. The increase in accounts payable was mainly due to inventory purchases relating to our launch of the CoolSmooth PRO and in contemplation of future demand and sales levels as well as for advertising and marketing spend in support of our recently launched direct to consumer marketing campaign. The increase in accrued and other non-current liabilities was driven by the increase accrued royalties due to the increase in sales, the increase in accruals related to our co-operative advertising program resulting from increased participation due to a change in the program in 2015 that provides eligibility to a wider population of our customers as well as the overall increase in customer sales and the increase in accrued legal expenses as we continue to enforce our IP domestically and overseas. The increase in deferred revenue is primarily a result of an increase in extended warranty sales and the deferral of revenue related to discounts on extended warranties offered in conjunction with customer incentive plans, as well as an increase in revenue deferral for customer training that has not yet occurred.

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 CoolSmooth applicator, which we began shipping to customers in the second quarter of 2014, 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.

Investing activities.  Net cash provided by investing activities was $4.1 million for the six months ended June 30, 2015 , as compared to net cash provided by investing activities of $6.4 million during the same period in 2014 . During the six months ended June 30, 2015 , we received proceeds from the sale and maturity, net of purchases, of $5.3 million of short-term and long-term investments. 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. Purchases of property and equipment amounted to $1.2 million for the six months ended June 30, 2015 , primarily as result of purchases of leasehold improvements, furniture and fixtures and certain software to support

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the growth and expansion of our business and related facilities. Purchases of property and equipment amounted to $0.8 million for the six months ended 2014 .

Financing activities.  Net cash used in financing activities during the six months ended June 30, 2015 , of $2.8 million consisted of tax payments related to shares withheld for vested restricted stock units of $5.6 million , offset in part by proceeds received from the issuance of common stock upon the exercise of stock options and issuance of ESPP shares of $2.8 million . 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 .

Our cash, cash equivalents and investments increased by $3.4 million from $49.7 million as of December 31, 2014 , to $53.1 million as of June 30, 2015 . 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, 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 $18.4 million and $11.7 million at June 30, 2015 , and December 31, 2014 , respectively. The $6.7 million increase in contract obligations from December 31, 2014 to June 30, 2015 was mainly due to inventory purchase commitments relating to our launch of the CoolSmooth PRO and in contemplation of future demand and sales levels.

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