Spectranetics (SPNC) 10-Q 2011 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED

September 30, 2011

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM ______    TO ______   

Commission file number 0-19711

The Spectranetics Corporation

(Exact name of Registrant as specified in its charter)

Delaware	84-0997049
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

9965 Federal Drive

Colorado Springs, Colorado 80921

(719) 633-8333

(Address of principal executive offices and telephone number)

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 shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o	Accelerated filer x
Non-accelerated filer o	Smaller reporting company o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

As of November 2, 2011 there were 33,677,408 outstanding shares of Common Stock. 

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
ITEM 1.	Financial Statements
	Consolidated Balance Sheets	1
	Consolidated Statements of Operations	2
	Condensed Consolidated Statements of Cash Flows	3
	Notes to Condensed Consolidated Financial Statements	4
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	29
ITEM 4.	Controls and Procedures	29
PART II — OTHER INFORMATION
ITEM 1.	Legal Proceedings	30
ITEM 1A.	Risk Factors	30
ITEM 6.	Exhibits	30
	Signatures	31

ii

Part I—FINANCIAL INFORMATION

Item 1.       Financial Statements

THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

(In Thousands, Except Share and Per Share Amounts)

	September 30, 2011			December 31, 2010
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	36,154		$	29,335
Investment securities available for sale	—			4,327
Trade accounts receivable, less allowance for doubtful accounts and sales returns of $639 and $790, respectively	17,226			15,664
Inventories, net	7,501			8,054
Deferred income taxes, net	43			163
Prepaid expenses and other current assets	2,345			1,568
Total current assets	63,269			59,111
Property and equipment, net	28,040			28,669
Goodwill	5,569			5,569
Other intangible assets, net	141			300
Other assets	281			46
Total assets	$	97,300		$	93,695
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,902		$	1,392
Accrued liabilities	14,717			14,916
Deferred revenue	2,283			2,291
Total current liabilities	18,902			18,599
Accrued liabilities, net of current portion	624			598
Total liabilities	19,526			19,197
Commitments and contingencies (Note 12)
Shareholders’ equity:
Preferred stock, $.001 par value; authorized 5,000,000 shares; none issued	—			—
Common stock, $.001 par value; authorized 60,000,000 shares; issued and outstanding 33,671,971 and 33,190,732 shares, respectively	33			33
Additional paid-in capital	174,705			171,890
Accumulated other comprehensive loss	(523		)	(445		)
Accumulated deficit	(96,441		)	(96,980		)
Total shareholders’ equity	77,774			74,498
Total liabilities and shareholders’ equity	$	97,300		$	93,695

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

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THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

Consolidated Statements of Operations

(In Thousands, Except Share and Per Share Amounts)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Revenue	$	32,127		$	29,577		$	94,763		$	88,612
Cost of products sold	8,683			8,486			26,923			25,393
Gross profit	23,444			21,091			67,840			63,219
Operating expenses:
Selling, general and administrative	17,716			15,963			52,707			51,436
Research, development and other technology	4,729			3,577			13,663			10,884
Litigation charge	596			—			596			—
Federal investigation legal and accrued indemnification costs	—			6,527			—			6,820
Asset impairment charge	—			939			—			939
Employee termination costs	—			664			—			664
Total operating expenses	23,041			27,670			66,966			70,743
Operating income (loss)	403			(6,579		)	874			(7,524		)
Other income (expense):
Litigation-related interest expense	(230		)	—			(230		)	—
Interest income, net	17			36			68			181
Other, net	(1		)	(21		)	65			(21		)
Total other income (expense)	(214		)	15			(97		)	160
Income (loss) before income taxes	189			(6,564		)	777			(7,364		)
Income tax expense	(80		)	(6,145		)	(238		)	(6,212		)
Net income (loss)	$	109		$	(12,709	)	$	539		$	(13,576	)
Net income (loss) per share —
Basic	$	0.00		$	(0.38	)	$	0.02		$	(0.41	)
Diluted	$	0.00		$	(0.38	)	$	0.02		$	(0.41	)
Weighted average common shares outstanding —
Basic	33,546,412			33,122,742			33,370,254			33,094,133
Diluted	34,390,829			33,122,742			34,271,029			33,094,133

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

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THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(In Thousands)

(Unaudited)

	Nine Months Ended September 30,
	2011			2010
Cash flows from operating activities:
Net income (loss)	$	539		$	(13,576	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization	7,527			7,484
Stock-based compensation expense	1,742			1,932
Provision for excess and obsolete inventories	304			236
Accrued indemnification costs	(1,939		)	6,500
Deferred income taxes	120			6,110
Asset impairment charge	—			939
Net change in operating assets and liabilities	(4,601		)	(5,275		)
Net cash provided by operating activities	3,692			4,350
Cash flows from investing activities:
Proceeds from sale, redemption or maturity of investment securities	4,360			5,416
Purchases of investment securities	—			(760		)
Capital expenditures	(2,222		)	(3,164		)
Decrease in restricted cash	—			817
Net cash provided by investing activities	2,138			2,309
Cash flows from financing activities:
Proceeds from the exercise of stock options and employee stock purchase plan	1,047			74
Net cash provided by financing activities	1,047			74
Effect of exchange rate changes on cash	(58		)	(77		)
Net increase in cash and cash equivalents	6,819			6,656
Cash and cash equivalents at beginning of period	29,335			19,010
Cash and cash equivalents at end of period	$	36,154		$	25,666
Supplemental disclosures of cash flow information
Cash paid for interest	$	271		$	9
Cash paid for income taxes	$	90		$	132

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

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THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 — GENERAL

The accompanying condensed consolidated financial statements include the accounts of The Spectranetics Corporation, a Delaware corporation, its wholly-owned subsidiary, Spectranetics International, B.V., and its wholly-owned subsidiary, Spectranetics Deutschland GmbH (collectively, the Company). All intercompany balances and transactions have been eliminated in consolidation.

The Company develops, manufactures, markets and distributes single-use medical devices used in minimally invasive procedures within the cardiovascular system. The Company’s Vascular Intervention products include a range of peripheral and cardiac laser catheters for ablation of occluded arteries above and below the knee (peripheral atherectomy) and within coronary arteries (coronary atherectomy). The Company also markets aspiration and thrombectomy catheters for the removal of thrombus (thrombus management) and support catheters to facilitate crossing of coronary and peripheral arterial blockages (crossing solutions).  The Company’s Lead Management products include excimer laser sheaths and cardiac lead management accessories for the removal of pacemaker and defibrillator cardiac leads.

The Company prepares its condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (US GAAP). As such, management is required to make certain estimates, judgments and assumptions based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. Significant items subject to such estimates and assumptions include the carrying amount of property and equipment, intangible assets and goodwill; valuation allowances and reserves for receivables, inventories and deferred income tax assets; stock-based compensation; accrued indemnification costs; estimated outsourcing expense for clinical trials; and loss contingencies, including those related to litigation. Actual results could differ from those estimates.

The information included in the accompanying condensed consolidated interim financial statements is unaudited and should be read in conjunction with the audited financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. In the opinion of management, all adjustments necessary for a fair presentation of the assets, liabilities and results of operations for the interim periods presented have been reflected herein and are of a normal, recurring nature. The results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year.  Certain prior period amounts have been reclassified to conform to the current period presentation.

NOTE 2 — NEW ACCOUNTING STANDARDS

In October 2009, an update was made to ASC 605, Revenue Recognition — Multiple Deliverable Revenue Arrangements. This update establishes a selling price hierarchy for determining the selling price of a deliverable. It also replaces references to “fair value” with “selling price” to distinguish from the fair value measurements required under the Fair Value Measurements and Disclosures guidance, eliminates the use of the residual method for allocation, and expands the ongoing disclosure requirements. This update was effective for the Company beginning January 1, 2011, and could be applied prospectively or retrospectively. The adoption of this guidance did not have a material impact on the Company’s financial position, results of operations or cash flows.

In June 2011, the FASB amended guidance for presenting comprehensive income. The amendment will require the Company to present the components of net income and comprehensive income either as one continuous statement or as two consecutive statements. There will no longer be the option to present items of other comprehensive income in the statement of stockholders’ equity. The amended guidance is effective for the Company beginning January 1, 2012, on a retrospective basis. The adoption of this amendment will not have a material effect on the Company’s financial position, results of operations or cash flows.

In September 2011, the FASB issued updated guidance on the periodic testing of goodwill for impairment. This guidance will allow companies to assess qualitative factors to determine if it is more-likely-than-not that goodwill might be

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THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

impaired and whether it is necessary to perform the two-step goodwill impairment test required under current accounting standards. This guidance will be effective for the Company’s fiscal year ending December 31, 2012, with early adoption permitted. The adoption of this guidance is not expected to have a material effect on the Company’s financial position, results of operations or cash flows.

The Company has considered all other recently issued accounting pronouncements and does not believe that such pronouncements are of significance, or potential significance, to the Company.

NOTE 3 — INVESTMENT SECURITIES

Investment securities consisted of the following (in thousands):

	September 30, 2011		December 31, 2010
Current investments:
Certificates of deposit	$	—	$	761
Auction rate securities	—		3,566
Total current investment securities	$	—	$	4,327

The Company’s investments in certificates of deposit at December 31, 2010 were stated at cost as their carrying value approximated fair value because of their short maturities. The fair value of the auction rate securities at December 31, 2010 was recorded at $3.6 million, or approximately 90% of par. In the first quarter of 2011, the Company sold its two remaining auction rate security positions, representing $4 million par value, at approximately 91% of par. The Company recognized a gain of $31,000 on these sales, which is included in “Other, net” in the Company’s consolidated statement of operations.

NOTE 4 — COMPOSITION OF CERTAIN FINANCIAL STATEMENT ITEMS

Inventories

Inventories, net, consisted of the following (in thousands): 

	September 30, 2011			December 31, 2010
Raw materials	$	2,025		$	2,576
Work in process	2,231			1,870
Finished goods	4,000			4,387
Less: Inventory reserve	(755		)	(779		)
	$	7,501		$	8,054

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THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Property and Equipment

Property and equipment, net, consisted of the following (in thousands): 

	September 30, 2011			December 31, 2010
Equipment held for rental or loan	$	37,326		$	35,002
Manufacturing equipment and computers	20,937			19,973
Leasehold improvements	4,578			4,452
Furniture and fixtures	1,839			1,674
Building and improvements	1,245			1,245
Land	270			270
Less: accumulated depreciation and amortization	(38,155		)	(33,947		)
	$	28,040		$	28,669

Accrued Liabilities

Accrued liabilities consisted of the following (in thousands): 

	September 30, 2011			December 31, 2010
Accrued payroll and employee related expenses	$	6,301		$	5,082
Accrued indemnification costs (see Note 12)	3,767			5,304
Accrued royalty expense	1,267			826
Deferred rent	593			561
Accrued legal costs	522			938
Accrued sales and value added taxes	455			531
Employee stock purchase plan liability	233			326
Other accrued expenses	2,203			1,946
Less: long-term portion	(624		)	(598		)
Accrued liabilities: current portion	$	14,717		$	14,916

NOTE 5 — STOCK-BASED COMPENSATION

The Company maintains stock option plans which provide for the grant of incentive stock options, nonqualified stock options, restricted stock, restricted stock units and stock appreciation rights. The plans provide that stock options be granted with exercise prices not less than the fair market value at the date of grant. Options granted through September 30, 2011 generally vest over three to four years and expire ten years from the date of grant. Options granted to the Board of Directors generally vest over three years from date of grant and expire ten years from the date of grant. Restricted stock awards granted to the Board of Directors generally vest over one year. Restricted stock units granted to certain officers of the Company generally vest over four years. At September 30, 2011, there were 0.4 million shares available for future issuance under these plans. 

Valuation and Expense Information

Stock-based compensation expense recognized for the three months ended September 30, 2011 and 2010 was $0.7 million and $0.7 million, respectively, and for the nine months ended September 30, 2011 and 2010 was $1.7 million and $1.9 million, respectively.  This expense consisted of compensation expense related to (1) employee stock options based on the value of share-based payment awards vested during the period, (2) restricted stock awards issued to certain of the Company’s

6

THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

directors, (3) restricted stock units issued to certain of the Company’s officers, and (4) the estimated value to be realized by employees related to shares expected to be issued under the Company’s employee stock purchase plan (described below). Stock-based compensation expense is recognized based on awards ultimately expected to vest and is reduced for estimated forfeitures. The Company recognizes compensation cost for these awards on a straight-line basis over the service period. Cash received from the exercise of options and for the purchase of shares through the employee stock purchase plan was $1.0 million and $0.1 million for the nine months ended September 30, 2011 and 2010, respectively.

��

For all options which are not subject to a market condition, the fair value of each share option award is estimated on the date of grant using the Black-Scholes pricing model based on assumptions noted in the following table. The Company’s employee stock options have various restrictions including vesting provisions and restrictions on transfers and hedging, among others, and are often exercised prior to their contractual maturity. Expected volatilities used in the fair value estimate are based on the historical volatility of the Company’s stock. The Company uses historical data to estimate share option exercises, expected term and employee departure behavior used in the Black-Scholes pricing model. The risk-free rate for periods within the contractual term of the share option is based on the U.S. Treasury yield in effect at the time of grant. The following is a summary of the assumptions used for the stock options granted during the three and nine months ended September 30, 2011 and 2010, respectively, using the Black-Scholes pricing model :

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Expected life (years)	5.89		5.99		5.95		5.98
Risk-free interest rate	0.96	%	1.28	%	1.36	%	1.79	%
Expected volatility	66.56	%	65.87	%	66.06	%	66.20	%
Expected dividend yield	None		None		None		None

Certain options granted by the Company embody a market condition performance target. For such grants, the valuation must consider the likelihood that the market condition will be satisfied. Accordingly, a trinomial lattice model was used to estimate the fair value of the Company’s options containing a market condition since a lattice model is designed to accommodate dynamic assumptions of expected volatility and exercise behaviors over the option's term and the probability of the market condition being satisfied in the future. Compensation cost is recognized over the requisite service period, which is based on the longer of the derived service period (using a lattice model to calculate a range of possible future stock prices for the Company) or the explicit service period. Compensation cost is required to be recognized regardless of when, if ever, the market condition is met.

The weighted average grant date fair value of options granted during the the three and nine months ended September 30, 2011 was $1.48 and $2.23, respectively, and during the the three and nine months ended September 30, 2010 was $3.02 and $3.46, respectively.

7

THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table summarizes stock option activity during the nine months ended September 30, 2011: 

	Shares		Weighted Average Exercise Price		Weighted Avg. Remaining Contractual Term (In Years)	Aggregate Intrinsic Value
Options outstanding at January 1, 2011	3,985,303		$	5.26
Granted	806,800		5.29
Exercised	(328,970	)	2.49
Canceled	(728,660	)	5.26
Options outstanding at September 30, 2011	3,734,473		$	5.51	5.93	$	8,486,410
Options exercisable at September 30, 2011	1,699,745		$	6.49	4.22	$	3,388,150

The aggregate intrinsic value in the preceding table represents the total pre-tax intrinsic value, based on the Company’s closing stock price of $7.14 on September 30, 2011, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of September 30, 2011 was approximately 1.1 million.  The total intrinsic value of options exercised during the nine months ended September 30, 2011 and 2010 was $1.1 million and $0.1 million, respectively.

The following table summarizes restricted stock award activity during the nine months ended September 30, 2011: 

	Shares		Weighted Average Grant-Date Fair Value
Restricted stock awards outstanding at January 1, 2011	54,000		$	5.04
Awarded	74,030		5.84
Vested/Released	(34,000	)	5.22
Awards outstanding at September 30, 2011	94,030		$	5.60

The following table summarizes restricted stock unit activity during the nine months ended September 30, 2011: 

	Shares		Weighted Average Grant-Date Fair Value
Restricted stock units outstanding at January 1, 2011	60,000		$	5.76
Awarded	161,800		5.15
Vested/Released	(15,000	)	5.76
Units outstanding at September 30, 2011	206,800		$	5.28

As of September 30, 2011 there was $4.0 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s stock option plans. This cost is based on an assumed future forfeiture rate of approximately 16.21% per year for Company employees and is expected to be recognized over a weighted-average period of approximately 3.0 years.

Employee Stock Purchase Plan

In June 2010, shareholders approved the Spectranetics Corporation 2010 Employee Stock Purchase Plan (ESPP).  The ESPP provides for the sale of up to 300,000 shares of common stock to eligible employees, limited to the lesser of 2,500 shares per employee per six-month period or a fair market value of $25,000 per employee per calendar year. Stock purchased under the ESPP is restricted from sale for one year following the date of purchase. Stock can be purchased from amounts accumulated through payroll deductions during each six-month period, and the ultimate purchase price is equal to 85% of the lower of the fair market value of the Company’s common stock at the beginning or end of the respective six-month offering period.  This

8

THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

discount does not exceed the maximum discount rate permitted for plans of this type under Section 423 of the Internal Revenue Code of 1986, as amended.  The ESPP is compensatory for financial reporting purposes.

The fair value of the July 2011 offering under the ESPP was determined on the date of grant using the Black-Scholes option-pricing model. The expected term of six months was based upon the offering period of the ESPP. Expected volatility was determined based on the historical volatility from daily share price observations for the Company’s stock covering a period commensurate with the expected term of the ESPP. The risk-free interest rate was based on the six-month U.S. Treasury daily yield rate. The expected dividend yield was based on the Company’s historical practice of electing not to pay dividends to its stockholders. For the three and nine months ended September 30, 2011, the Company recognized $45,000 and $134,000 of compensation expense related to its ESPP, respectively.

NOTE 6 — NET INCOME (LOSS) PER SHARE

Basic income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding. Shares issued during the period and shares reacquired during the period are weighted for the portion of the period that they were outstanding. Diluted income (loss) per share is computed in a manner consistent with that of basic income (loss) per share while giving effect to all potentially dilutive common shares outstanding during the period, which include the assumed exercise of stock options and the assumed vesting of restricted stock using the treasury stock method.

For the three and nine months ended September 30, 2011, options to purchase 2.1 million and 2.0 million weighted average shares, respectively, were excluded from the computation of diluted earnings per share due to their anti-dilutive effect. Diluted net loss per share is the same as basic net loss per share for the three and nine months ended September 30, 2010 as shares issuable upon the exercise of stock options were anti-dilutive as a result of the net losses incurred for those periods.  As a result, all of the stock options outstanding to purchase 3.9 million weighted average shares at September 30, 2010 were excluded from the diluted net loss per share calculation because their inclusion would have been anti-dilutive.

A summary of the net income (loss) per share calculation is shown below (in thousands, except per share amounts):

	Three Months Ended September 30,					Nine Months Ended September 30,
	2011		2010			2011		2010
Net income (loss)	$	109	$	(12,709	)	$	539	$	(13,576	)
Common shares outstanding:
Historical common shares outstanding at beginning of period	33,382		33,119			33,137		33,064
Weighted average common shares issued	164		4			233		30
Weighted average common shares outstanding — basic	33,546		33,123			33,370		33,094
Effect of dilution — stock options	845		—			901		—
Weighted average common shares outstanding — diluted	34,391		33,123			34,271		33,094
Net income (loss) per share — basic	$	0.00	$	(0.38	)	$	0.02	$	(0.41	)
Net income (loss) per share — diluted	$	0.00	$	(0.38	)	$	0.02	$	(0.41	)

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THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 7 — COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) includes foreign currency translation gains and losses and, in 2010, unrealized losses on the Company’s investment securities that were classified as available for sale securities. The difference between net income (loss) and comprehensive income (loss) for each of these periods is as follows (in thousands): 

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Net income (loss)	$	109		$	(12,709	)	$	539		$	(13,576	)
Other comprehensive income (loss):
Foreign currency translation (loss) gain	(403		)	537			(78		)	(313		)
Unrealized loss on investment securities				—						(43		)
Comprehensive (loss) income	$	(294	)	$	(12,172	)	$	461		$	(13,932	)

Total accumulated other comprehensive loss and its components were as follows (in thousands): 

	Foreign currency translation loss			Accumulated Other Comprehensive Loss
Beginning balance, January 1, 2011	$	(445	)	$	(445	)
Current period change	(78		)	(78		)
Ending balance, September 30, 2011	$	(523	)	$	(523	)

NOTE 8 — SEGMENT REPORTING

The Company operates in one distinct line of business consisting of developing, manufacturing, marketing and distributing a proprietary excimer laser system and disposable products for the treatment of certain coronary and vascular conditions.

Within this line of business, the Company has identified two reportable segments, which were identified on a geographic basis: (1) U.S. Medical and (2) International Medical. U.S. Medical and International Medical offer the same products and services but operate in different geographic regions, have different distribution networks and different regulatory environments. Within U.S. Medical, the Company aggregates its two business units, Vascular Intervention and Lead Management, based on their similar economic, operational and regulatory characteristics, consistent with the authoritative guidance on segment reporting.

Additional information regarding each reportable segment is shown below.

U. S. Medical

Products offered by this reportable segment include fiber-optic delivery devices and other non-fiber-optic products (disposables), an excimer laser system (equipment), and the service of the excimer laser system (service). The Company is subject to product approvals from the Food and Drug Administration (FDA). At September 30, 2011, FDA-approved products were used in multiple vascular procedures, including coronary and peripheral atherectomy, aspiration and thrombectomy and the removal of infected, defective or abandoned cardiac lead wires from patients with pacemakers and cardiac defibrillators. This segment’s customers are primarily located in the United States and Canada.

U.S. Medical is also corporate headquarters for the Company. All manufacturing, research and development as well as corporate administrative functions are performed within this reportable segment. As of September 30, 2011 and 2010, a portion

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THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

of product development and administrative costs incurred in the U.S. has been allocated to International Medical, as these costs support the Company’s ability to generate revenue in the International Medical segment.

Manufacturing activities are performed entirely within the U.S. Medical segment. Revenue associated with intersegment product transfers to International Medical was $1.7 million and $1.0 million for the three months ended September 30, 2011 and 2010, respectively, and $4.9 million and $2.9 million for the nine months ended September 30, 2011 and 2010, respectively.  Revenue is based upon transfer prices, which provide for intersegment profit that is eliminated upon consolidation.

International Medical

The International Medical segment headquarters is located in the Netherlands, and serves Europe as well as the Middle East, Asia Pacific and Latin America (including Puerto Rico). Products offered by this reportable segment are substantially the same as those offered by U.S. Medical.  The International Medical segment is engaged primarily in distribution activities, with no local manufacturing or product development functions. Certain U.S. incurred product development and administrative costs have been allocated to International Medical.

Summary financial information relating to reportable segment operations is shown below. Intersegment transfers as well as intercompany assets and liabilities are excluded from the information provided (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Revenue:
U.S. Medical:
Disposable products:
Vascular Intervention	$	13,736	$	12,942	$	40,019	$	40,553
Lead Management	9,417		8,704		27,691		25,332
Service and other, net of provision for sales returns	2,174		2,089		6,488		6,105
Equipment sales and rentals	1,509		1,716		4,685		4,299
Subtotal	26,836		25,451		78,883		76,289
International Medical:
Disposable products:
Vascular Intervention	2,124		1,627		6,368		5,608
Lead Management	2,383		1,913		6,896		5,233
Service and other, net of provision for sales returns	343		236		1,093		823
Equipment sales and rentals	441		350		1,523		659
Subtotal	5,291		4,126		15,880		12,323
Total revenue	$	32,127	$	29,577	$	94,763	$	88,612

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011		2010
Segment operating income (loss):
U.S. Medical	$	822		$	(6,625	)	$	865	$	(7,281	)
International Medical	(419		)	46			9		(243		)
Total operating income (loss)	$	403		$	(6,579	)	$	874	$	(7,524	)

11

THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

	September 30, 2011		December 31, 2010
Segment assets:
U.S. Medical	$	87,002	$	83,262
International Medical	10,298		10,433
Total assets	$	97,300	$	93,695

In the first nine months of 2011 and 2010, no individual customer represented 10% or more of consolidated revenue.  There were no individual countries, other than the United States, that represented at least 10% of consolidated revenue in the first nine months of 2011 or 2010.

NOTE 9 — INCOME TAXES

As a result of the Company’s decision in the third quarter of 2010 to increase, to 100%, its valuation allowance against its U.S. deferred asset, the Company does not expect to record a federal tax provision or benefit against its pretax income (loss) in 2011, and did not record any U.S. federal tax provision or benefit in the first nine months of 2011.

In the third quarter of 2010, the Company evaluated its net deferred tax assets for recoverability and considered the relative impact of negative and positive evidence, including historical losses and projections of future taxable income. Due to certain events, primarily related to the third quarter 2010 indictment of former employees, the related $6.5 million accrual for indemnification costs for these employees, and the possibility that such costs could exceed the estimated accrual, the Company concluded that it no longer met the accounting criteria for recognizing a portion of its deferred tax asset; that is, estimated future taxable income and certain tax planning strategies no longer constituted sufficient positive evidence to conclude that it is more likely than not that its net deferred tax assets would be realizable in the foreseeable future. Therefore, during the three months ended September 30, 2010, the Company increased, to 100%, its valuation allowance against its U.S. deferred tax asset. The Company does not expect to reduce the valuation allowance against its U.S. deferred tax asset to below 100% of its gross amount until it has a sufficient historical trend of taxable income and can predict future income with a higher degree of certainty.

Income tax expense for the three and nine months ended September 30, 2011 included approximately $40,000 and $118,000, respectively, of state and German income taxes payable from profitable operations in those jurisdictions. For the nine months ended September 30, 2011, the Company also recorded $120,000 of Dutch income tax provision related to the statutory profits recorded at Spectranetics B.V. which reduced the foreign deferred tax asset by approximately 75% from December 31, 2010. The Company has a remaining foreign deferred tax asset of $43,000 related to net operating losses in the Netherlands that the Company expects to utilize against taxable income in the Netherlands prior to their expiration at the end of 2011.

NOTE 10 — RELATED PARTY TRANSACTIONS

During the three and nine months ended September 30, 2011, the Company paid $25,000 and $78,000 , respectively, to a director of the Company under an agreement whereby the director provides training services to outside physicians on behalf of the Company.  During the three and nine months ended September 30, 2011, the Company also paid $-0- and $48,000, respectively, to a director of the Company for royalties based on the sale of the Company’s QuickCat™ product, related to a patent purchased from the director in 2007. An amendment to the Patent Purchase Agreement for this patent was executed in June 2011, which documents that the patent has been fully paid up as it relates to sales of the QuickCat product. Accordingly, there will be no future royalty payments to the director.

12

THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 — LINE OF CREDIT

On February 25, 2011, the Company entered into a Credit and Security Agreement (“Credit Agreement”) with Wells Fargo Bank, National Association (“Wells Fargo”), acting through its Wells Fargo Business Credit (“WFBC”) operating division, for a three-year $15.0 million revolving line of credit.  Pursuant to the terms of the Credit Agreement, the Company may borrow under the revolving line of credit subject to borrowing base limitations.  These limitations allow the Company to borrow, subject to specified reserves, up to 85% of eligible domestic accounts receivable, defined as receivables aged less than 90 days from the invoice date along with specific exclusions for contra-accounts, concentrations, and other accounts otherwise deemed ineligible by WFBC.  Borrowings under the revolving line bear interest at a variable rate equal to the lesser of the Wells Fargo prime rate plus 0.25% or the daily three month LIBOR plus 3.25%.  The margins on the base interest rates are subject to reduction if the Company achieves certain annual net income levels. Accrued interest on any outstanding balance under the revolving line is payable monthly in arrears. 

The revolving line of credit is secured by a first priority security interest in substantially all of the Company’s assets. The Credit Agreement requires the Company to maintain a minimum of $10.0 million cash and investments at Wells Fargo and requires a lockbox arrangement. The Company is required to pay customary fees with respect to the facility, including a 0.25% fee on the average unused portion of the revolving line. If there are borrowings under the revolving line of credit, the Company will be subject to certain financial covenants including rolling 12-month adjusted EBITDA and minimum book net worth covenants. 

 The Credit Agreement contains customary events of default, including the failure to make required payments, the failure to comply wither certain covenants or other agreements, the occurrence of a material adverse change, failure to pay certain other indebtedness and certain events of bankruptcy or insolvency. Upon the occurrence and continuation of an event of default, amounts due under the Credit Agreement may be accelerated.

As of the date of this report, the Company had no events of default and no borrowings under the revolving line of credit.

NOTE 12 — COMMITMENTS AND CONTINGENCIES

Indemnification of former officers and employees

The Company is generally obligated to indemnify its present and former directors, officers and employees against certain losses and to advance their reasonable legal defense expenses including in connection with a federal investigation. The Company maintains insurance for claims of this nature, which does not apply in all such circumstances, may be denied or may not be adequate to cover the legal costs or any settlement or judgment in connection with those proceedings.

The indictment in August 2010 of three former employees with whom the Company has indemnification obligations significantly increased the likelihood that the former employees’ future defense costs will be substantial and ongoing, and that the Company’s indemnification obligations to these employees will exceed the limits of its insurance coverage. Therefore, at September 30, 2010, the Company accrued a $6.5 million charge reflecting the low end of its estimate of the range of its contingent liability under the indemnification obligations. The Company currently estimates that the legal fees in this matter for the Federal District Court stage of these proceedings could range from $6.5 million to $11.5 million through trial and that these costs would be paid over the course of the court proceedings. The estimate was developed with the assistance of outside legal counsel familiar with court proceedings similar in nature to the proceedings related to the Company’s indemnification obligations.

In May 2011, the United States government issued a second superceding indictment narrowing certain of the claims against the defendants. In September 2011, the judge granted a motion for a separate trial for one of the defendants, then set a February 2012 trial date for the other two. No trial date has been set for the individual who will be tried separately. Through September 30, 2011, the Company had received invoices for such legal fees and costs of $2.7 million, of which $2.4 million was paid. Taking into consideration the $2.7 million of costs already incurred and the recent developments in this matter, the

13

THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Company continues to believe that $6.5 million remains the best estimate of the low end of the range of its liability; therefore the Company has made no adjustment to the accrued amount. The actual expenses may be higher or lower than the estimate depending upon final resolution of the matter. Factors that may cause the Company to determine that the $6.5 million accrual needed to be increased would include, but not be limited to: (i) a substantial delay in the first trial date; (ii) a longer than expected second trial; and (iii) the length of an appeals process, if any.

Litigation

The Company is from time to time subject to, and is presently involved in, various pending or threatened legal actions and proceedings, including those that arise in the ordinary course of its business. Such matters are subject to many uncertainties and to outcomes and the financial impacts of which are not predictable with assurance and that may not be known for extended periods of time. The Company records a liability in its consolidated financial statements for costs related to claims, settlements and judgments, where management has assessed that a loss is probable and an amount can be reasonably estimated. The Company’s significant legal proceedings are discussed below. The costs associated with such proceedings could have a material adverse effect on the Company’s consolidated results of operations, financial position or cash flows of a future period.

Fox/Sopkin

There were no material developments in the Fox matter in the first nine months of 2011. Please refer to our 2010 Annual Report on Form 10-K for a description of this matter. However, in May 2011, the Company was served with a lawsuit that names the Company and Spectranetics B.V., the Company’s Dutch subsidiary, as defendants. The lawsuit was brought in the District Court of Utrecht, the Netherlands, by Barbara Joy Sopkin. Ms. Sopkin claims royalties on a license agreement, certain rights to which were allegedly transferred to her, which claims are similar in nature to the claims of Mr. Fox in his litigation. Ms. Sopkin claims damages of approximately $2 million and also claims interest on that amount from January 1, 2011. The proceedings commenced in July 2011 with an administrative hearing. The Company intends to vigorously defend against Ms. Sopkin’s claims in this matter.

Cardiomedica

The Company has been engaged in a dispute with Cardiomedica S.p.A. (Cardiomedica), an Italian company, over the existence of a distribution agreement between Cardiomedica and Spectranetics. Cardiomedica originally filed the suit in July 1999. The lower court’s judgment was rendered on April 3, 2002. In June 2004, the Court of Appeal of Amsterdam affirmed the lower court’s opinion that an exclusive distributor agreement for the Italian market was entered into between the parties for the three-year period ending December 31, 2001, and that Cardiomedica may exercise its right to compensation from Spectranetics B.V. for its loss of profits during such three-year period. The appellate court awarded Cardiomedica the costs of the appeal, which approximated $20,000, and referred the case back to the lower court for determination of the loss of profits. Cardiomedica had asserted lost profits of approximately 1.3 million euros, which was based on their estimate of potential profits during the three-year period. In December 2006, the court made an interim judgment which narrowed the scope of Cardiomedica’s claim from their original claim of lost profits associated with 10 hospitals down to lost profits on two hospitals during the period from 1999 to 2001. On July 1, 2009, the Court issued a ruling in favor of Cardiomedica for an amount equal to $0.6 million, which included a judgment for lost profits, interest thereon, and certain costs assessed by the Court related to the proceedings.  Such amount was paid in July 2009.

In September 2009, Cardiomedica appealed the ruling of the District Court, seeking additional damages of 1.4 million euros, consistent with its initial claim for damages at the outset of the lawsuit.  In September 2011, the Dutch Court of Appeal issued a ruling in favor of Cardiomedica, requiring the Company to pay to Cardiomedica an additional $0.8 million in damages, which amount includes interest through September 2011, arising out of Cardiomedica’s appeal. Such amount was paid and expensed in September 2011. The Company is currently evaluating whether it will appeal this ruling, and has until December 2011 to file an appeal.

14

THE SPECTRANETICS CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Other

The Company is involved in other legal proceedings in the normal course of business and does not expect them to have a material adverse effect on its business.

Kensey Nash milestone payments

On May 30, 2008, the Company acquired the endovascular product lines of Kensey Nash Corporation (KNC) for approximately $10.7 million in cash. Under the terms of the agreements, the Company agreed to pay KNC an additional $14 million based on product development, regulatory and sales milestones.

Of the $14 million, up to $8 million is payable based on various product development and regulatory milestones associated with the acquired products. As of September 30, 2011, the Company has paid $2.5 million of the product development and regulatory milestones. Most of the remaining product development and regulatory milestone payments will be payable over the next one to two years, subject to completion by KNC of product development and regulatory approval milestones for the ThromCat device.

The remaining $6 million is based on a sales milestone and is payable once cumulative sales of the acquired products reach $20 million. As of September 30, 2011, cumulative sales of the acquired products totaled $19.3 million. The Company expects to achieve the milestone in the fourth quarter of 2011 and the $6 million payment will be due in the first quarter of 2012. The milestone payments to KNC will be recorded as additional goodwill.

15

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

Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Such statements are based on current assumptions that involve risks and uncertainties that could cause actual outcomes and results to differ materially.  For a description of such risks and uncertainties, which could cause the actual results, performance or achievements of the Company to be materially different from any anticipated results, performance or achievements, please see the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2010, filed on March 14, 2011.  Readers are urged to carefully review and consider the various disclosures made in this report and in our other reports filed with the SEC that advise interested parties of certain risks and factors that may affect our business.  This analysis should be read in conjunction with our consolidated financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2010 Form 10-K.  Spectranetics disclaims any intention or obligation to update or revise any financial projections or forward-looking statements due to new information or other events.

Corporate Overview

We develop, manufacture, market and distribute single-use medical devices used in minimally invasive procedures within the cardiovascular system. Our products are sold in over 40 countries and are used to treat arterial blockages in the heart and legs as well as the removal of pacemaker and defibrillator leads. Approximately 60% of our disposable product revenue is from products used in connection with our proprietary excimer laser system, the CVX-300^®. Our single-use laser catheters contain up to 250 small diameter, flexible optical fibers that can access difficult to reach peripheral and coronary anatomy and produce evenly distributed laser energy at the tip of the catheter for more uniform ablation. We believe that our excimer laser system is the only laser system approved in the United States, Europe, Japan and Canada for use in multiple, minimally invasive cardiovascular procedures.

Our Vascular Intervention business unit includes a range of peripheral and cardiac laser catheters for ablation of occluded arteries above and below the knee (peripheral atherectomy) and within coronary arteries (coronary atherectomy). We also market aspiration and thrombectomy catheters for the removal of thrombus (thrombus management) and support catheters to facilitate crossing of coronary and peripheral arterial blockages (crossing solutions). Our Lead Management business unit includes excimer laser sheaths and cardiac lead management accessories for the removal of pacemaker and defibrillator cardiac leads.

Recent Developments

Current and Pending Clinical Trials

During the second quarter of 2011, the FDA granted full approval for an investigational device exemption (IDE) related to a multi-center, randomized trial for in-stent restenosis (ISR) in the United States under the study name EXCITE ISR. The study compares laser ablation followed by adjunctive balloon angioplasty with balloon angioplasty alone, using our Turbo-Tandem^® and Turbo Elite^® laser ablation devices. The first enrollment in the study occurred in June 2011. The planned enrollment is 353 subjects at up to 30 sites in the U.S. Subjects enrolled will be followed at 1, 6 and 12 months after the procedure. Data will be submitted to the FDA via a 510(k) after the subjects have had their 6 month follow-up. Currently, 19 sites are approved to enroll in the study and 10 patients have been enrolled to date.

We plan to support a physician-sponsored pilot study evaluating the use of laser ablation followed by a paclitaxel-coated angioplasty balloon (PTX PTA) compared with the use of PTX PTA alone in the treatment of in-stent lesions in above-the-knee arteries. This pilot study, Photoablation Followed by a Paclitaxel-Coated Balloon to Inhibit Restenosis in Instent Femoro-popliteal Obstructions (PHOTOPAC), is not intended to be used to gain an indication in the U.S. for the use of PTX PTA with laser, but to determine whether the use of laser with PTX PTA provides a benefit over PTX PTA alone and to provide data for potential future studies. The planned enrollment for the PHOTOPAC trial is 50 patients, who will be followed at 1, 6 and 12 months after the procedure. Our support of the PHOTOPAC trial will be in the form of an unrestricted research grant. The pilot study will be conducted at up to four sites in Germany.

16

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

Product approval in Japan

On April 6, 2011, we announced that the Japanese Ministry of Health, Labor and Welfare (MHLW) granted approval for the LLD^® lead locking device, which is used for the removal of pacemaker and defibrillator cardiac leads. The LLD secures leads along the entire length of their hollow inner lumen, permitting physicians to apply steady traction on the lead during the removal process. The approval of LLD complements the prior product and hospital reimbursement approvals in Japan for the Spectranetics Laser Sheath (SLS^® II). We now have regulatory and reimbursement approval for our complete lead management system in Japan.

Office-based reimbursement and laser placements

For 2011, the Centers for Medicare and Medicaid Services established payments for lower extremity endovascular revascularization procedures when performed in the office setting.  Reimbursement by Medicare is now available not only for hospital outpatient lower extremity atherectomy procedures when performed in conjunction with angioplasty and/or stent but reimbursement is also available for procedures performed in a properly licensed physician’s office. In the first nine months of 2011, we placed 33 laser systems in office-based settings.

Appointment of President and Chief Executive Officer

In July 2011, we announced the appointment of Scott Drake as President and Chief Executive Officer, effective August 10, 2011. Mr. Drake was appointed to the Board of Directors in September 2011. Mr. Drake joined Spectranetics from DaVita, Inc., where he held a senior executive position since November 2009. Mr. Drake also held several positions of increasing responsibility within various medical device business units at Covidien, Plc over a period of 17 years. From 2001 to 2009 at Covidien, he held president and general manager positions at three medical device business units, ranging in size from $150 million to $1.5 billion in revenue.

17

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

Results of Operations

Financial Results by Geographical Segment

Our two reporting segments consist of United States Medical, which includes the United States and Canada, and International Medical, which includes Europe, the Middle East, Asia Pacific and Latin America (including Puerto Rico). United States Medical also includes all costs for our corporate headquarters, research and development, and corporate administrative functions. The International Medical segment is engaged primarily in distribution activities, with no local manufacturing or product development functions. As of September 30, 2011 and 2010, a portion of product development and administrative costs incurred in the U.S. has been allocated to International Medical, as these costs support our ability to generate revenue in the international segment.

	Three Months Ended September 30,								Nine Months Ended September 30,
(in thousands)	2011				2010				2011				2010
Revenue
United States	$	26,836	84	%	$	25,451	86	%	$	78,883	83	%	$	76,289	86	%
International	5,291		16		4,126		14		15,880		17		12,323		14
Total revenue	$	32,127	100	%	$	29,577	100	%	$	94,763	100	%	$	88,612	100	%

	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands)	2011			2010			2011			2010
Net income (loss)
United States	$	816		$	(12,737	)	$	910		$	(13,298	)
International	(707		)	28			(371		)	(278		)
Total net income (loss)	$	109		$	(12,709	)	$	539		$	(13,576	)

18

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

Selected Consolidated Statements of Operations Data

The following table presents Consolidated Statements of Operations data for the three months ended September 30, 2011 and September 30, 2010 based on the percentage of revenue for each line item, as well as the dollar and percentage change of each of the items.

Three Months Ended September 30, 2011 Compared with Three Months Ended September 30, 2010

	Three Months Ended September 30,
(in thousands, except for percentages and laser placements)	2011			% of rev (1)		2010			% of rev (1)		$ change 2011-2010			% change 2011-2010
Revenue
Disposable products revenue:
Vascular Intervention	$	15,860		49	%	$	14,569		49	%	$	1,291		9	%
Lead Management	11,800			37		10,617			36		1,183			11
Total disposable products revenue	27,660			86		25,186			85		2,474			10
Service and other revenue	2,517			8		2,325			8		192			8
Laser equipment revenue:
Equipment sales	719			2		799			3		(80		)	(10	)
Rental fees	1,231			4		1,267			4		(36		)	(3	)
Total laser equipment revenue	1,950			6		2,066			7		(116		)	(6	)
Total revenue	32,127			100		29,577			100		2,550			9
Gross profit	23,444			73		21,091			71		2,353			11
Operating expenses
Selling, general and administrative	17,716			55		15,963			54		1,753			11
Research, development and other technology	4,729			15		3,577			12		1,152			32
Litigation charge	596			2		—			—		596			—
Federal investigation legal and accrued indemnification costs	—			—		6,527			22		(6,527		)	(100	)
Asset impairment charge	—			—		939			3		(939		)	(100	)
Employee termination costs	—			—		664			2		(664		)	(100	)
Total operating expenses	23,041			72		27,670			94		(4,629		)	(17	)
Operating income (loss)	403			1		(6,579		)	(22	)	6,982			(106	)
Other income (expense)
Litigation-related interest expense	(230		)	(1	)	—			—		(230		)	—
Interest income, net	17			—		36			—		(19		)	(53	)
Other income, net	(1		)	—		(21		)	—		20			(95	)
Income (loss) before income taxes	189			1		(6,564		)	(22	)	6,753			(103	)
Income tax expense	(80		)	—		(6,145		)	(21	)	6,065			(99	)
Net income (loss)	$	109		—	%	$	(12,709	)	(43	)%	$	12,818		(101	)%
Worldwide installed base of laser systems	994					934					60

___________________________________

 (1) Percentage amounts may not add due to rounding.

Revenue for the three months ended September 30, 2011 was $32.1 million, a 9% increase as compared with $29.6 million for the quarter ended September 30, 2010.  The increase was primarily due to increased Lead Management (LM) and Vascular Intervention (VI) disposables revenue and increased service and other revenue, partially offset by a 6% decline in

19

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

laser equipment revenue compared with the year-ago quarter. Of the 9% increase, $0.4 million, or 2%, was related to changes in foreign currency exchange rates. Our product mix changed slightly year-over-year, with 86% of revenue coming from disposables in the third quarter of 2011 compared with 85% from disposables in the third quarter of 2010.  Service and other revenue remained stable at 8% of total revenue in the third quarter of 2011 and 2010. Revenue from laser equipment sales and rentals decreased to 6% of total revenue in the third quarter of 2011 compared with 7% of revenue in the third quarter of 2010. 

VI disposables revenue, which includes products used in both the peripheral and coronary vascular systems, increased 9% to $15.9 million in the third quarter of 2011 as compared with $14.6 million in the third quarter of 2010.  This year-over-year increase reversed a trend of year-over-year declines we had experienced since the second quarter of 2010, primarily due to improving atherectomy revenue. Peripheral atherectomy revenue has strengthened in the first half of 2011 due in part to the recent reimbursement ruling related to office-based atherectomy procedures discussed in Recent Developments above. VI sales include three product categories — atherectomy, which increased 17%; crossing solutions, which decreased 4%; and thrombectomy, which increased 3%, all compared with the third quarter of 2010.  The decrease in crossing solutions product sales was due primarily to increased competition. The slight increase in thrombectomy revenue is due to an increase in sales of the QuickCat™, offsetting a decline of sales of ThromCat^® products.

LM revenue grew 11% for the three months ended September 30, 2011 as compared with the 2010third quarter.  We continue to believe our LM revenue is increasing primarily as a result of: (1) clinical data supporting the safety and efficacy of removing pacemaker and defibrillator leads, including results from the four-year Lead Extraction in Contemporary Settings (LExICon) study published in the February 9, 2010 issue of the Journal of the American College of Cardiology, (2) expanded guidelines set forth by the Heart Rhythm Society for lead extractions, (3) an expanding market for lead extractions due primarily to increasing infection rates and an increase in the number of malfunctioning leads, and (4) our expanded sales organization, which was initially established in 2008. LM revenue increased significantly in Japan, where recent reimbursement approvals have allowed us to make available our complete lead management system.

Laser equipment revenue was $2.0 million and $2.1 million for the three months ended September 30, 2011 and 2010, respectively.  We sold seven laser systems in the third quarter of 2011 (four sales from inventory and three sale conversions from rental systems) as compared with six laser system sales in the same period of the prior year; however, average selling prices were lower in 2011 due to the lower sales price of sale conversions.  Rental revenue decreased 3% year-over-year, primarily due to a decrease in Cap-Free (fee per procedure) revenue. Service and other revenue increased 8% at $2.5 million in the third quarter of 2011 compared with $2.3 million in the third quarter of 2010.

We placed 29 laser systems with new customers during the quarter ended September 30, 2011 compared with 25 during the third quarter of last year.  Of these laser placements, ten were transfers from the existing installed base, compared with six transfers in the third quarter of 2010. In recent quarters, we have placed more focus on redeploying laser systems from hospitals with low laser-based catheter utilization to hospitals or offices where we believe utilization will be higher, in order to increase productivity per laser system. The new placements this quarter bring our worldwide installed base of laser systems to 994 (757 in the U.S.) at September 30, 2011. 

On a geographic basis, revenue in the United States was $26.8 million during the quarter ended September 30, 2011, an increase of 5% from the prior year third quarter.  International revenue totaled $5.3 million, an increase of 28% from the third quarter of 2010.  The increase in international revenue was across nearly all product lines, and was primarily due to an 86% increase in atherectomy revenue, as well as a 25% increase in LM revenue. The increases in disposables revenue included increases in both Europe and Asia-Pacific/Latin America (APLA). Fluctuations in foreign exchange rates also contributed $0.4 million to the current year third quarter revenue increase compared with the prior year period.

Gross margin percentage for the third quarter of 2011 was 73% and in the third quarter of 2010 was 71%. The increase was due primarily to improved manufacturing efficiencies as well as a more margin-favorable product mix, with a higher percentage of sales of laser disposables, which generally carry higher gross margins than non-laser catheters, in the third quarter of 2011 compared with the third quarter of 2010. Margins can fluctuate quarter to quarter based on a number of factors, including manufacturing efficiencies and product mix.

20

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

Operating expenses

Operating expenses of $23.0 million in the third quarter of 2011 decreased 17% compared with $27.7 million in the third quarter of 2010. Operating expenses represented 72% of total revenue in the third quarter of 2011 as compared with 94% of total revenue in the third quarter of 2010.  Operating expenses for the third quarter of 2011 included a litigation charge of $0.6 million, further described below. Operating expenses for the third quarter of 2010 included a number of special items, totaling $8.1 million, which are separately disclosed components within operating expenses in our statement of operations, also further described below.

Selling, general and administrative. Selling, general and administrative (SG&A) expenses increased 11% compared with the year ago quarter.  SG&A expenses represented 55% of revenue in the third quarter of 2011 compared with 54% of revenue in the third quarter of 2010.

Within SG&A, marketing and selling expenses increased 4% year-over-year, with increases in both VI and LM sales and marketing, due to increased commissions expense related to the higher revenue, additional marketing personnel and increased marketing and training events in the United States. In addition, international sales expense increased due to new hires as well as foreign currency fluctuations. General and administrative expenses increased 19% year-over-year, primarily due to increased company-wide performance-based incentive compensation and legal expense.

Research and development. Research, development and other technology expenses of $4.7 million for the third quarter of 2011 increased 32% compared with the third quarter of 2010. As a percentage of revenue, research and development costs increased to 15% in the third quarter of 2011 from 12% in the third quarter of 2010, due to our investments primarily in new product development projects and the EXCITE ISR clinical trial. Costs included within research, development and other technology expenses are product development costs, clinical studies costs and royalty costs associated with various license agreements with third-party licensors.  Fluctuations in these costs are as follows:

• Product development costs increased by nearly $0.9 million compared with the third quarter of 2010, due to an increase in headcount and in expenses, primarily materials, related to new product development projects. 

• Clinical studies expense increased by approximately $0.2 million due primarily to costs related to the randomized clinical EXCITE ISR trial.

Litigation charge. We have been engaged in a dispute since 1999 with Cardiomedica S.p.A. (Cardiomedica), an Italian company, over the existence of a distribution agreement between Cardiomedica and Spectranetics. In 2009, the Court issued a ruling in favor of Cardiomedica, requiring us to pay $0.6 million, which ruling Cardiomedica appealed. In September 2011, the Dutch Court of Appeal issued a ruling in favor of Cardiomedica, requiring us to pay to Cardiomedica an additional $0.6 million in damages plus $0.2 million in interest. Such amount was paid and expensed in September 2011. See Note 12, “Commitments and Contingencies” to the condensed consolidated financial statements included in this report for further discussion of this matter.

Federal investigation legal and accrued indemnification costs. In the third quarter of 2010, we recorded a $6.5 million charge to accrue the low end of our estimate of the range of our contingent liability under indemnification obligations we have with certain former employees who were indicted on charges related to the subjects of a federal investigation. At that time, we estimated that the legal fees in this matter could range from $6.5 million to $11.5 million through trial, developing the estimate with the assistance of outside legal counsel familiar with court proceedings similar in nature to the proceedings related to our indemnification obligations. A portion of these expenses have been actually incurred through September 30, 2011 and the proceedings are ongoing. We continue to believe that the total actual expenses will fall in the $6.5 to $11.5 million range, and therefore we made no additional accrual for these expenses in the quarter ended September 30, 2011. The actual expenses may be higher or lower than the estimate depending upon final resolution of the matter. See Note 12, “Commitments and Contingencies” to the condensed consolidated financial statements included in this report for further discussion of this matter.

Asset impairment charge. In the third quarter of 2010, we wrote off a capital project in process which was no longer expected to be completed and utilized, due to an EPA ruling which effectively limited the useful life of the asset.

21

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

Employee termination costs. In the third quarter of 2010, we terminated 14 employees, primarily within the Vascular Intervention sales organization, as a result of a strategic re-alignment of certain sales territories designed to improve sales productivity. As a result, we recorded severance obligations totaling $0.7 million in the third quarter of 2010.

Interest income (expense)

Litigation related interest expense. As discussed above, in September 2011, the Dutch Court of Appeal issued a ruling in favor of Cardiomedica, requiring us to pay to Cardiomedica $0.6 million for lost profits plus $0.2 million in interest. Such amount was paid and expensed in September 2011.

Interest income, net. Interest income decreased 53% to $17,000 in the third quarter of 2011 from $36,000 in the third quarter of 2010. The decrease in interest income in 2011 is due primarily to a lower investment portfolio balance and to lower interest rates on our invested balances.

Income (loss) before income taxes

 Pre-tax income for the three months ended September 30, 2011 was $0.2 million, compared with a pre-tax loss of $6.6 million for the three months ended September 30, 2010.

Income taxes

As a result of our decision in the third quarter of 2010 to increase, to 100%, our valuation allowance against our U.S. deferred asset, we do not expect to record a U.S. federal tax provision or benefit against our pretax income (loss) in 2011, and did not record any U.S. federal tax provision or benefit in the third quarter of 2011.

In the third quarter of 2010, we increased to 100% our valuation allowance against our U.S. deferred tax asset. We do not contemplate decreasing the valuation allowance against our U.S. deferred tax asset until we have a historical trend of taxable income and can predict future income with more certainty. See Note 9, “Income Taxes” to our condensed consolidated financial statements for further discussion.

Income tax expense for the three months ended September 30, 2011 included approximately $40,000 of state and German income taxes payable from profitable operations in those jurisdictions. We also recorded $40,000 of Dutch income tax provision related to the statutory profits recorded at Spectranetics B.V. which reduced the foreign deferred tax asset by approximately 25% for the quarter.

Net income (loss)

 We recorded net income for the three months ended September 30, 2011 of $0.1 million, or $0.00 per share, compared with a net loss of $12.7 million, or $(0.38) per share, in the three months ended September 30, 2010.

Functional currency

The functional currency of Spectranetics International B.V. and Spectranetics Deutschland GmbH is the euro.  All revenue and expenses are translated to U.S. dollars in the consolidated statements of operations using weighted average exchange rates during the period.  Fluctuation in currency rates during the three months ended September 30, 2011 as compared with the prior year period caused an increase in consolidated revenue of approximately $0.4 million and an increase in consolidated net income of approximately $0.1 million.

22

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

Selected Consolidated Statements of Operations Data

The following table presents Consolidated Statements of Operations data for the nine months ended September 30, 2011 and September 30, 2010 based on the percentage of revenue for each line item, as well as the dollar and percentage change of each of the items.

Nine Months Ended September 30, 2011 Compared with Nine Months Ended September 30, 2010

	Nine Months Ended September 30,
(in thousands, except for percentages and laser placements)	2011			% of rev (1)		2010			% of rev (1)		$ change 2011-2010			% change 2011-2010
Revenue
Disposable products revenue:
Vascular Intervention	$	46,387		49	%	$	46,161		52	%	$	226		—	%
Lead Management	34,587			36		30,565			34		4,022			13
Total disposable products revenue	80,974			85		76,726			87		4,248			6
Service and other revenue	7,581			8		6,928			8		653			9
Laser equipment revenue:
Equipment sales	2,360			2		1,112			1		1,248			112
Rental fees	3,848			4		3,846			4		2			—
Total laser equipment revenue	6,208			7		4,958			6		1,250			25
Total revenue	94,763			100		88,612			100		6,151			7
Gross profit	67,840			72		63,219			71		4,621			7
Operating expenses
Selling, general and administrative	52,707			56		51,436			58		1,271			2
Research, development and other technology	13,663			14		10,884			12		2,779			26
Litigation charge	596			1		—			—		596			—
Federal investigation legal and accrued indemnification costs	—			—		6,820			8		(6,820		)	(100	)
Asset impairment charge	—			—		939			1		(939		)	(100	)
Employee termination costs	—			—		664			1		(664		)	(100	)
Total operating expenses	66,966			71		70,743			80		(3,777		)	(5	)
Operating income (loss)	874			1		(7,524		)	(8	)	8,398			(112	)
Other income (expense)
Litigation-related interest expense	(230		)	—		—			—		(230		)	—
Interest income, net	68			—		181			—		(113		)	(62	)
Other income, net	65			—		(21		)	—		86			(410	)
Income (loss) before income taxes	777			1		(7,364		)	(8	)	8,141			(111	)
Income tax expense	(238		)	—		(6,212		)	(7	)	5,974			(96	)
Net income (loss)	$	539		1	%	$	(13,576	)	(15	)%	$	14,115		(104	)%
Worldwide installed base of laser systems	994					934					60

___________________________________

 (1) Percentage amounts may not add due to rounding.

Revenue for the nine months ended September 30, 2011 was $94.8 million, a 7% increase as compared with $88.6 million for the nine months ended September 30, 2010.  The increase was primarily due to increased Lead Management (LM) disposables revenue and increased equipment, service and other revenue, with a slight increase in Vascular Intervention

23

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

(VI) disposables revenue compared with the year-ago period. Of the 7% increase, $0.9 million, or 1%, was related to changes in foreign currency exchange rates. Our product mix changed slightly year-over-year, with 85% of revenue coming from disposables in the first nine months of 2011 compared with 87% from disposables in the first nine months of 2010.  Service and other revenue remained stable at 8% of total revenue in the first nine months of 2011 and 2010. Revenue from laser equipment sales and rentals increased to 7% of total revenue in the first nine months of 2011 compared with 6% of revenue in the first nine months of 2010. 

VI disposables revenue, which includes products used in both the peripheral and coronary vascular systems, increased slightly to $46.4 million in the first nine months of 2011 as compared with $46.2 million in the first nine months of 2010. VI disposables revenue continued its turnaround, marked by three consecutive quarters of sequential improvement since the fourth quarter of 2010, due in part to the recent reimbursement ruling related to office-based atherectomy procedures discussed in Recent Developments above. VI sales include three product categories — atherectomy, which increased 2%; crossing solutions, which were flat; and thrombectomy, which decreased 3%, all compared with the first nine months of 2010.  Crossing solutions product sales were flat year-over-year, in spite of increased competition. The decline in thrombectomy revenue is primarily due to a reduction in sales of the ThromCat^®.

LM revenue grew 13% for the nine months ended September 30, 2011 as compared with the first nine months of 2010.  We continue to believe our LM revenue is increasing primarily as a result of: (1) clinical data supporting the safety and efficacy of removing pacemaker and defibrillator leads, including results from the four-year Lead Extraction in Contemporary Settings (LExICon) study published in the February 9, 2010 issue of the Journal of the American College of Cardiology, (2) expanded guidelines set forth by the Heart Rhythm Society for lead extractions, (3) an expanding market for lead extractions due primarily to increasing infection rates and an increase in the number of malfunctioning leads, and (4) our expanded sales organization, which was initially established in 2008. LM revenue increased significantly in Japan, where recent reimbursement approvals have allowed us to make available our complete lead management system.

Laser equipment revenue was $6.2 million and $5.0 million for the nine months ended September 30, 2011 and 2010, respectively.  We sold 21 laser systems in the first nine months of 2011 (13 sales from inventory and eight sale conversions from rental units) as compared with eight laser system sales in the same period of the prior year.  Rental revenue was flat year-over-year, with increased revenue from straight rentals offset by a decrease in volume-based and Cap-Free (fee per procedure) revenue. Service and other revenue increased 9% at $7.6 million in the first nine months of 2011 compared with $6.9 million in the first nine months of 2010, due primarily to our increased installed base of laser systems.

We placed 99 laser systems with new customers during the nine months ended September 30, 2011 compared with 62 during the same period of last year.  Of the 2011 laser placements, 33 of the new placements were with office-based physicians, primarily transfers of underperforming laser systems from hospital environments. Recent reimbursement changes for procedures conducted in an office setting enabled us to place lasers with these office-based physicians. In recent quarters, we have placed more focus on redeploying laser systems from hospitals with low laser-based catheter utilization to hospitals or offices where we believe utilization will be higher, in order to increase productivity per laser system. The new placements year-to-date bring our worldwide installed base of laser systems to 994 (757 in the U.S.) at September 30, 2011. 

On a geographic basis, revenue in the United States was $78.9 million during the nine months ended September 30, 2011, an increase of 3% from the prior year period.  International revenue totaled $15.9 million, an increase of 29% from the first nine months of 2010.  The increase in international revenue was primarily due to a 32% increase in LM revenue, with increases in both Europe and APLA, as well as a 14% increase in VI revenue. In addition, we recorded six laser system sales in the first nine months of 2011 compared with two laser system sales in the prior year period. Fluctuations in foreign exchange rates also contributed $0.9 million to the current year revenue increase compared with the prior year period.

Gross margin percentage for the first nine months of 2011 was 72% compared with 71% in the prior year period. The increase was due primarily to product mix, with a higher percentage of sales of laser disposables, which carry higher gross margins than non-laser catheters, in the first nine months of 2011 compared with the prior year period. Margins can fluctuate quarter to quarter based on a number of factors, including manufacturing efficiencies and product mix.

24

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

Operating expenses

Operating expenses of $67.0 million in the first nine months of 2011 decreased 5% compared with $70.7 million in the first nine months of 2010.  Operating expenses represented 71% of total revenue in the first nine months of 2011 as compared with 80% of total revenue in the first nine months of 2010.  Operating expenses for the first nine months of 2011 included a litigation charge of $0.6 million, further described below. Operating expenses for the first nine months of 2010 included a number of special items, totaling $8.4 million, which are separately disclosed components within operating expenses in our statement of operations, further described below and in the quarterly discussion above.

Selling, general and administrative. Selling, general and administrative (SG&A) expenses increased 2% compared with the year ago period.  SG&A expenses represented 56% of revenue in the nine months of 2011 compared with 58% of revenue in the first nine months of 2010.

Within SG&A, marketing and selling expenses increased 3% year-over-year, with a decrease in VI field sales, primarily due to the VI sales force realignment in September 2010, offset by increases in VI and LM marketing, due to new hires and increased marketing and training events, and increases in international sales expense, due in part to new hires as well as foreign currency fluctuations. General and administrative expenses were flat year-over-year, with increases in company-wide performance-based incentive compensation expense offset by a decrease in outside consulting costs associated with regulatory compliance.

Research and development. Research, development and other technology expenses of $13.7 million for the first nine months of 2011 increased 26% compared with $10.9 million in the first nine months of 2010. As a percentage of revenue, research and development costs increased to 14% in the first nine months of 2011 from 12% in the first nine months of 2010, due to our investments primarily in new product development projects and the EXCITE ISR clinical trial. Costs included within research, development and other technology expenses are product development costs, clinical studies costs and royalty costs associated with various license agreements with third-party licensors.  Fluctuations in these costs are as follows:

• Product development costs increased by nearly $1.8 million compared with the first nine months of 2010, due to an increase in headcount and in expenses, primarily materials, related to new product development projects.

• Clinical studies expense increased by approximately $0.7 million due primarily to costs associated with the randomized clinical EXCITE ISR trial.

Federal investigation legal and accrued indemnification costs. In addition to the accrued indemnification costs described above, in the nine months ended September 30, 2010 we had $0.3 million of legal costs associated with a federal investigation.

Interest income (expense)

Interest income, net. Interest income decreased 62% to $68,000 in the first nine months of 2011 from $181,000 in the first nine months of 2010. The decrease in interest income in 2011 is due to a lower investment portfolio balance and to lower interest rates on our invested balances.

Income (Loss) before income taxes

 Pre-tax income for the nine months ended September 30, 2011 was $0.8 million, compared with a pre-tax loss of $(7.4) million for the nine months ended September 30, 2010.

Income taxes

As a result of our decision in the third quarter of 2010 to increase, to 100%, our valuation allowance against our U.S. deferred asset, we do not expect to record a U.S. federal tax provision or benefit against our pretax income (loss) in 2011, and did not record any U.S. federal tax provision or benefit in the first nine months of 2011.

25

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

 In the third quarter of 2010, we increased to 100% our valuation allowance against our U.S. deferred tax asset. The effect of the valuation allowance adjustment was to increase the Company's provision for income taxes by $6.1 million for the nine months ended September 30, 2010. We do not contemplate decreasing the valuation allowance against our U.S. deferred tax asset until we have a historical trend of taxable income and can predict future income with more certainty. See Note 9, “Income Taxes” to our condensed consolidated financial statements for further discussion. Income tax expense in 2010 also included approximately $102,000 comprised of state and foreign income taxes payable for the nine months ended September 30, 2010.

Income tax expense for the nine months ended September 30, 2011 included approximately $118,000 of state and German income taxes payable from profitable operations in those jurisdictions. We also recorded $120,000 of Dutch income tax provision related to the statutory profits recorded at Spectranetics B.V. which reduced the foreign deferred tax asset by approximately 75% in the first nine months of the year.

Net income (loss)

 We recorded net income for the nine months ended September 30, 2011 of $0.5 million, or $0.02 per share, compared with a net loss of $(13.6) million, or $(0.41) per share, in the nine months ended September 30, 2010.

Functional currency

The functional currency of Spectranetics International B.V. and Spectranetics Deutschland GmbH is the euro.  All revenue and expenses are translated to U.S. dollars in the consolidated statements of operations using weighted average exchange rates during the period.  Fluctuation in currency rates during the nine months ended September 30, 2011 as compared with the prior year period caused an increase in consolidated revenue of approximately $0.9 million and an increase in consolidated net income of approximately $0.3 million.

Liquidity and Capital Resources

As of September 30, 2011, we had cash, cash equivalents and current investment securities available for sale of $36.2 million, an increase of $2.5 million from $33.7 million at December 31, 2010.

At September 30, 2011, we had no current investment securities, as we sold our short-term certificates of deposit during the third quarter of 2011. We also sold our remaining auction rate securities in the first quarter of 2011.

During the first quarter of 2012, we expect two significant uses of cash. First, we expect to make a cumulative sales milestone payment of $6.0 million to Kensey Nash Corporation (KNC) in the first quarter of 2012. The milestone payment is payable when cumulative sales of the products we acquired from them in 2008 reach $20 million, and we expect to achieve the milestone in the fourth quarter of 2011. The $6.0 million will be due in the first quarter of 2012. Additional milestone payments of $5.5 million related to KNC product development and regulatory milestones may be payable over the next one to two years, subject to completion by KNC of product development and regulatory approval milestones for the ThromCat device. See further discussion of these payments in Note 12 to our condensed consolidated financial statements included in this report. Second, we currently expect to pay a substantial portion of the accrued indemnification obligations in the first quarter of 2012, to coincide with the trial date, subject to the uncertainties inherent in the $6.5 million estimate accrued in the third quarter of 2010. The cash payments for the indemnification obligations will reduce the accrued liability on our balance sheet. See further discussion of these costs in Note 12 to our condensed consolidated financial statements included in this report.

We believe that our cash and cash equivalents, anticipated funds from operations and other sources of liquidity, including potential borrowings under our revolving line of credit with Wells Fargo Bank, National Association, described below, will be sufficient to meet our liquidity requirements through at least the next twelve months. However, there is no assurance that additional funding will not be needed or sought prior to such time. In the event that we require additional working capital to fund future operations and any future acquisitions, we may enter into credit and financing arrangements with one or more independent institutional lenders, sell shares of our common stock or other equity securities, or sell debt securities.

26

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

There is no assurance that any financing transaction will be available on terms acceptable to us, or at all, or that any financing transaction will not be dilutive to our current stockholders.

Operating Activities. For the nine months ended September 30, 2011, cash provided by operating activities totaled $3.7 million.  The primary sources and uses of cash were the following:

(1) Our net income of $0.5 million included approximately $9.7 million of non-cash expenses. Non-cash expenses included $7.5 million of depreciation and amortization, $1.7 million of stock-based compensation, $0.3 million of provision for excess and obsolete inventories and a net change in deferred tax assets of $0.1 million.

(2) Cash used as a result of a net increase in operating assets and liabilities of approximately $6.5 million was due primarily to the following:

• An increase in equipment held for rental or loan of $4.5 million as a result of placement activity of our laser systems through our rental and evaluation programs;

• The payment of $1.9 million of accrued indemnification costs (see Note 12, “Commitments and Contingencies” to our consolidated financial statements included in this report);

• An increase in trade accounts receivable of $1.6 million, due primarily to higher revenue in the latter half of the third quarter of 2011 as compared to the latter half of the fourth quarter of 2010, with days sales outstanding remaining constant; and

• An increase in prepaid expenses and other current assets of $0.8 million due primarily to an increase in certain pre-payments for trade shows and other sales and marketing events scheduled for the fourth quarter of 2011 and the first quarter of 2012.

These uses of cash were partially offset by:

• An increase in accounts payable and accrued liabilities of $2.3 million, due primarily to the timing of vendor payments; and

• A decrease in inventory of $0.2 million, due primarily to the increase in laser placements and sales in the first nine months of 2011 which reduced our laser inventory at September 30, 2011 as compared with December 31, 2010.

The table below presents the change in receivables and inventory in relative terms, through the presentation of financial ratios.  Days sales outstanding are calculated by dividing the ending accounts receivable balance, net of reserves for sales returns and doubtful accounts, by the average daily sales for the quarter.  Inventory turns are calculated by dividing annualized cost of sales for the quarter by ending inventory. 

	September 30, 2011	December 31, 2010
Days Sales Outstanding	48	48
Inventory Turns	4.6	4.3

Investing Activities. For the nine months ended September 30, 2011, cash provided by investing activities was $2.1 million, consisting of proceeds from the sale and partial redemption of auction rate securities and certificates of deposit of $4.4 million, offset by capital expenditures of $2.2 million.  The capital expenditures included manufacturing equipment upgrades and replacements as well as additional capital items for research and development projects and additional computer equipment and software purchases.

27

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

Financing Activities. Cash provided by financing activities for the nine months ended September 30, 2011 was $1.0 million, comprised entirely of proceeds from the sale of common stock to employees and former employees as a result of exercises of stock options and the employee stock purchase plan.

At September 30, 2011, we had no significant debt or capital lease obligations.

Line of Credit

On February 25, 2011, we entered into a Credit and Security Agreement (“Credit Agreement”) with Wells Fargo Bank, National Association (“Wells Fargo”), acting through its Wells Fargo Business Credit (“WFBC”) operating division, for a three-year $15.0 million revolving line of credit.  Pursuant to the terms of the Credit Agreement, we may borrow under the revolving line of credit subject to borrowing base limitations.  These limitations allow us to borrow, subject to specified reserves, up to 85% of eligible domestic accounts receivable, defined as receivables aged less than 90 days from the invoice date along with specific exclusions for contra-accounts, concentrations, and other accounts otherwise deemed ineligible by WFBC.  Borrowings under the revolving line bear interest at a variable rate equal to the lesser of the Wells Fargo prime rate plus 0.25% or the daily three month LIBOR plus 3.25%.  The margins on the base interest rates are subject to reduction if we achieve certain annual net income levels. Accrued interest on any outstanding balance under the revolving line is payable monthly in arrears. 

The revolving line of credit is secured by a first priority security interest in substantially all of our assets. The Credit Agreement requires us to maintain a minimum of $10.0 million cash and investments at Wells Fargo and requires a lockbox arrangement. We are required to pay customary fees with respect to the facility, including a 0.25% fee on the average unused portion of the revolving line. If there are borrowings under the revolving line of credit, we will be subject to certain financial covenants including rolling 12-month adjusted EBITDA and minimum book net worth covenants. 

The Credit Agreement contains customary events of default, including the failure to make required payments, the failure to comply wither certain covenants or other agreements, the occurrence of a material adverse change, failure to pay certain other indebtedness and certain events of bankruptcy or insolvency. Upon the occurrence and continuation of an event of default, amounts due under the Credit Agreement may be accelerated.

As of the date of this report, we had no events of default and no borrowings under the revolving line of credit.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

We prepare our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented.  Significant items subject to estimates and assumptions include the carrying amount of property and equipment, goodwill and intangible assets; valuation allowances and reserves for receivables, inventories and deferred income tax assets; stock-based compensation; accrued indemnification costs; estimated outsourcing expense for clinical trials; and loss contingencies, including those related to litigation. Actual results could differ from those estimates.

Our critical accounting policies and estimates are included in our 2010 Annual Report on Form 10-K, filed with the SEC on March 14, 2011.  During the second quarter of 2011, we made one addition to our critical accounting policies that were disclosed in our 2010 Form 10-K, as follows:

Research and Development—Clinical Studies. It is our policy to expense research and development costs as incurred. In certain cases, substantial portions of our clinical trials are performed by third-party contract research organizations (“CROs”). These CROs generally bill monthly for services performed and bill based upon milestone achievement. For example, we have contracted with a CRO to provide clinical trial services for the EXCITE ISR study. In the event that we prepay CRO fees, we record the prepayment as a prepaid asset and amortize the asset into research and development expense over the period of time the contracted services are performed. For clinical studies, costs are expensed based upon the number of

28

Item 2.       Management’s Discussion and Analysis of Financial Condition and Results of Operations (Cont'd)

patients enrolled, “patient months” incurred and the duration of the study. We monitor patient enrollment, the progress of clinical studies and related activities to the extent possible through internal reviews of data reported to us by the CROs and correspondence with the CROs. Our estimates depend on the timeliness and accuracy of the data provided by the CROs regarding the status of the program and total program spending. We periodically evaluate our estimates to determine if adjustments are necessary or appropriate based on information we receive. If we have incomplete or inaccurate data, we may under- or overestimate activity levels associated with clinical trials at a given point in time. In this event, we could record adjustments to research and development expenses in future periods when the actual activity level becomes known.

Item 3.Quantitative and Qualitative Disclosures About Market Risk

We are exposed to a variety of risks, primarily including foreign currency fluctuations. Currently, we do not hedge these foreign currency exposures.

Our exposure to foreign currency fluctuations is primarily related to sales of our products in Europe, which are denominated primarily in the euro.  Changes in the exchange rate between the euro and the U.S. dollar could adversely affect our revenue and net income.  Exposure to foreign currency exchange rate risk may increase over time as our business evolves and our products continue to be introduced into international markets.  Currently, we do not hedge against any foreign currencies and, as a result, we could incur gains or losses.  Fluctuation in currency rates during the nine months ended September 30, 2011 as compared with the prior year period caused an increase in consolidated revenue of approximately $0.9 million and an increase in consolidated net income of approximately $0.3 million.

Item 4.Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.  In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision of and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2011.  Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

There has been no change in our internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

29

Part II—OTHER INFORMATION

Item 1.Legal Proceedings

For a discussion of the Company’s legal proceedings, please refer to Note 12, “Commitments and Contingencies” of the condensed consolidated financial statements included in Part I, Item 1 of this report.

Item 1A.   Risk Factors

There have been no material changes in our risk factors from those disclosed in Part I, Item 1A, of the Company’s 2010 Annual Report on Form 10-K.

Item 6.Exhibits

31.1	Rule 13(a)-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2	Rule 13(a)-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1	Section 1350 Certification of Chief Executive Officer.
32.2	Section 1350 Certification of Chief Financial Officer.
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	The Spectranetics Corporation
	(Registrant)
November 4, 2011		/s/ Scott Drake
		Scott Drake
		President and Chief Executive Officer
November 4, 2011		/s/ Guy A. Childs
		Guy A. Childs
		Chief Financial Officer

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