This quarterly report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, particularly statements that may relate to, but are not limited to, expectations of future operating results or financial performance, capital expenditures, introduction of new products, regulatory compliance, plans for growth and future operations, as well as assumptions relating to the foregoing. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. These risks and other factors include, but are not limited to, those listed under Part II, Item 1A - "Risk Factors" and elsewhere in this report. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "could," "expect," "plan," "anticipate," "believe," "estimate," "predict," "intend," "potential," "continue" or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially and adversely.

Overview

We design, develop, manufacture and commercialize a broad suite of intravascular ultrasound, or IVUS, and functional measurement, or FM, products. We believe that these products enhance the diagnosis and treatment of vascular heart disease by improving the efficiency and efficacy of existing percutaneous interventional, or PCI, therapy procedures in the coronary or peripheral arteries. We market our products to physicians and technicians who perform PCI procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals.

Our IVUS products consist of ultrasound consoles, single-procedure disposable phased array and rotational IVUS imaging catheters and additional functionality options such as virtual histology, or VH, IVUS tissue characterization and ChromaFlo stent apposition analysis. Our IVUS consoles are marketed as stand-alone units or customized units that can be integrated into a variety of hospital-based interventional surgical suites called catheterization laboratories, or cath labs. We have developed customized cath lab versions of these consoles and are developing additional functionality options as part of our cath lab integration initiative. Our IVUS consoles have been designed to serve as a multi-modality platform for our phased array and rotational IVUS catheters, fractional flow reserve, or FFR, pressure wires and Medtronic's Pioneer reentry device. We are developing additional offerings for integration into the platform, including, forward-looking IVUS, or FLIVUS, catheters, image-guided therapy catheters and ultra-high resolution Optical Coherence Tomography, or OCT, systems and catheters.

Our FM offerings include consoles and single-procedure disposable pressure and flow guide wires used to measure the pressure and flow characteristics of blood around plaque enabling physicians to gauge the plaque's physiological impact on blood flow and pressure.

We also develop and manufacture optical monitors, lasers, and optical engines used in OCT imaging systems and advanced photonic components and subsystems used in spectroscopy and other industrial applications.

We have corporate infrastructure in the United States, Europe and Japan; direct sales capabilities in the United States; and a combination of direct sales and distribution relationships in international markets, including Japan, Europe, the Middle East, Canada, Asia Pacific and Latin America. Our corporate office is located in San Diego, California. Our worldwide manufacturing and research and development operations are located in Rancho Cordova, California. We also have additional research and development facilities in Cleveland, Ohio; Forsyth County, Georgia; San Antonio, Texas; and Andover, Massachusetts. We have sales offices in Alpharetta, Georgia and Tokyo, Japan; sales and distribution offices in Zaventem, Belgium and Woodmead, South Africa; and a third-party distribution facility in Chiba, Japan. In addition, we have facilities in Billerica, Massachusetts for the primary operations of Axsun Technologies, Inc., or Axsun, our wholly owned subsidiary.

We have focused on building our domestic and international sales and marketing infrastructure to market our products to physicians and technicians who perform PCI procedures in hospitals and to other personnel who make purchasing decisions on behalf of hospitals. At March 31, 2009, we had approximately 906 worldwide employees, including approximately 387 manufacturing employees, 226 sales and marketing employees and approximately 138 research and development employees.

In the three months ended March 31, 2009 and 2008, 33.3% and 18.8%, respectively, of our revenues and 19.5% and 15.0%, respectively, of our operating expenses were denominated in foreign currencies, primarily the Euro and the Yen. As a result, we are subject to risks related to fluctuations in foreign currency exchange rates, which could affect our operating results in the future.

On May 19, 2008, we and Goodman Company, Ltd., or Goodman, mutually terminated the Exclusive Distribution Agreement, dated September 27, 2004, pursuant to which Goodman distributed our IVUS products in Japan. Also on May 19, 2008, the oral agreement between us and Goodman, related to the exclusive distribution of our FM products in Japan, was terminated. We did not pay and we are not obligated to pay a termination fee in connection with this termination. Upon termination of our agreements with Goodman, we monitor the credit risk associated with Goodman as well as other general economic conditions and, accordingly, we have made and continue to make adjustments to the credit terms that are extended to Goodman. On June 30, 2008, Goodman transferred to us all marketing authorization and other regulatory approvals, or SHONINs, for all specified products held by Goodman or its affiliates. Although Goodman currently continues to distribute our rotational IVUS and FM products in Japan on a non-exclusive, purchase order basis, we have accelerated our direct sales strategy in Japan and currently expect to place and sell our products in Japan directly through an internal sales force beginning in the second quarter of 2009. Accordingly, as we implement this direct sales strategy, we expect to reduce distribution of our products through Goodman during the second and third quarters of 2009. We are currently discussing with Goodman the terms of our transition and currently cannot ascertain the timing and the impact of the transition on our operating expenses and subsequent net income. There is no assurance that we will reach an agreement with Goodman. Regardless of whether we reach an agreement with Goodman relating to the transition, our efforts to implement a direct sales strategy in Japan may adversely impact our revenues, results of operations and financial condition and cause us to incur additional expenses sooner than initially planned.

At March 31, 2009, we had a worldwide installed base of over 3,500 IVUS consoles and over 800 FM consoles. We intend to grow and leverage this installed base to drive recurring sales of our single-procedure disposable catheters and guide wires. In the three months ended March 31, 2009, the sale of our single-procedure disposable catheters and guide wires accounted for $35.4 million, or 72.3% of our revenues, a $6.7 million, or 23.5% increase from 2008, in which the sale of our single-procedure disposable catheters and guide wires accounted for $28.6 million, or 78.1% of our revenues.

We manufacture our IVUS and FM consoles, IVUS catheters and FM guide wires at our facility in Rancho Cordova, California. We use third-party manufacturing partners to produce circuit boards and mechanical sub-assemblies used in the manufacture of our consoles. We also use third-party manufacturing partners for certain proprietary components used in the manufacture of our single-procedure disposable products. We perform incoming inspection on these circuit boards, mechanical sub-assemblies and components, assemble them into finished products, and test the final product to assure quality control.

On December 18, 2007, we acquired CardioSpectra, Inc., or CardioSpectra. Through CardioSpectra, we are developing innovative OCT technology, which is expected to complement our existing product offerings and further enhance our position as an imaging technology leader in the field of interventional medicine. OCT technology enables high resolution imaging of highly detailed structures in the vasculature, including vessel wall defects, intra-luminal thrombus and stent struts. Our long term goal is to integrate this OCT functionality into our s5i integrated imaging suite of products.

On May 15, 2008, we acquired Novelis, Inc., or Novelis, a company with proprietary ultrasonic visualization and therapy technology for minimally invasive diagnostic and therapeutic devices. Novelis' proprietary FLIVUS technology platform is expected to build upon our existing suite of products and further enhance our position as an imaging technology leader in the field of interventional medicine by enabling FLIVUS and associated therapies in the interventional cardiology market. We expect to add the Novelis products and capability onto our s5i multi-modality integrated platform/hub.

On December 24, 2008, we acquired Axsun, a company that develops and manufactures optical monitors for telecommunications, lasers and optical engines used in medical OCT imaging systems and advanced photonic components and subsystems used in spectroscopy and other industrial applications. We believe Axsun's proprietary OCT technology will provide us competitive advantages in the invasive imaging sector. In connection with the Axsun acquisition, we and Axsun were sued by LightLab Imaging, Inc., or LightLab. LightLab is a wholly owned subsidiary of Goodman, a distributor of our IVUS and FM products in Japan, and LightLab develops and sells OCT products for cardiovascular imaging and other medical uses. We believe the complaint is without merit and we intend to defend ourselves vigorously.

Economic conditions have continued to deteriorate significantly in many countries and regions, including without limitation the United States, and may remain depressed for the foreseeable future. If our customers do not obtain or do not have access to the necessary capital to operate their businesses, or are otherwise adversely affected by the deterioration in national and worldwide economic conditions, this could result in reductions in the sales of our products, longer sales cycles and slower adoption of new technologies by our customers, which would materially and adversely affect our business. In addition, our customers' and suppliers' liquidity, capital resources and credit may be adversely affected by the current financial and credit crisis, which could adversely affect our ability to collect on our outstanding invoices and lengthen our collection cycles, or limit our timely access to important sources of raw materials necessary for the manufacture of our consoles and catheters. There can be no assurances that government responses to the disruptions in the financial or credit markets will improve the national and worldwide economic conditions in the near term.

Financial Operations Overview

The following is a description of the primary components of our revenues and expenses.

Revenues. We generate revenues from two reporting segments: medical and telecom. Our medical segment represents our core business, in which we derive revenues primarily from the sale of our IVUS and FM consoles and single-procedure disposables. Our telecom segment derives revenues related to the sales of Axsun's advanced photonic components and subsystems to telecommunication companies. In the three months ended March 31, 2009, we generated $49.0 million of revenues which is composed of $45.6 million from our medical segment and $3.4 million from our telecom segment. In the three months ended March 31, 2009, 82.3% of our medical segment revenues were derived from the sale of our IVUS consoles and IVUS single-procedure disposables, as compared with 86.2% in the three months ended March 31, 2008. In the three months ended March 31, 2009, 13.9% of our medical segment revenues were derived from the sale of our FM consoles and FM single-procedure disposables, as compared with 10.3% in the three months ended March 31, 2008. Other revenues consist primarily of service and maintenance revenues, shipping and handling revenues, sales of distributed products, spare parts sales, and license fees.

Our medical segment sales in the United States are generated by our direct sales representatives and our products are shipped to hospitals throughout the United States from our facility in Rancho Cordova, California. Our medical segment international sales are generated by our direct sales representatives or through independent distributors and are shipped throughout the world from our facilities in Rancho Cordova, California; Billerica, Massachusetts; Zaventem, Belgium; Chiba, Japan; and Woodmead, South Africa. Our telecom segment sales are generated by our direct sales representatives or through independent distributors and these products are shipped to telecommunications companies domestically and abroad.

We expect to continue to experience variability in our quarterly revenues from IVUS and FM consoles due in part to the timing of hospital capital equipment purchasing decisions. Further, we expect variability of our revenues based on the timing of our new product introductions, which may cause our customers to delay their purchasing decisions until the new products are commercially available. Alternatively, we may include in our arrangements with customers future deliverables, such as unspecified hardware upgrades or training. In these cases, we would be required to defer associated revenues from these customers until we have met our future deliverables obligation.

Cost of Revenues. Cost of revenues consists primarily of material costs for the products that we sell and other costs associated with our manufacturing process, such as personnel costs, rent and depreciation. In addition, cost of revenues includes depreciation of company-owned consoles, royalty expenses for licensed technologies included in our products, service costs, provisions for warranty, distribution, freight and packaging costs and stock-based compensation expense. We expect our gross margin for IVUS and FM products to improve over time if we are successful in our ongoing efforts to streamline and improve our manufacturing processes and increase production volumes. We expect our overall gross margins to decrease due to the acquisition of Axsun and the lower gross margin on their product lines.

Selling, General and Administrative. Selling, general and administrative expenses consist primarily of salaries and other related costs for personnel serving the sales, marketing, executive, finance, information technology and human resource functions. Other costs include travel and entertainment expenses, facility costs, trade show, training and other promotional expenses, professional fees for legal and accounting services and stock-based compensation expense. We expect that our selling, general and administrative expenses will increase as we continue to expand our sales force and marketing efforts and invest in the necessary infrastructure to support our continued growth.

Research and Development. Research and development expenses consist primarily of salaries and related expenses for personnel, consultants, prototype materials, clinical studies, depreciation, regulatory filing fees, certain legal costs related to our intellectual property and stock-based compensation expense. We expense research and development costs as incurred. We expect our research and development expenses to increase as we continue to develop our products, technologies and applications.

In-process Research and Development. In-process research development, or IPR&D, consists of our projects acquired in connection with acquisitions that had not reached technological feasibility and had no alternative future uses as of each acquisition date. Certain additional payments that may be required in connection with our acquisitions could result in future charges to IPR&D.

In December 2007, we acquired the OCT project in connection with our acquisition of CardioSpectra, which was valued at $26.3 million. In-vivo testing and regulatory approval remained to be completed as of the acquisition date at an estimated cost of $7.2 million. In addition, milestone payments of up to $38.0 million may be paid in connection with successful and timely regulatory approvals and commercialization. The OCT project was expected to be commercialized by late 2008. Our initial assessment of the stage of completion of the OCT project at the acquisition date was underestimated. As of March 31, 2009, the OCT project in-vivo testing had begun and commercialization was behind schedule by approximately two years. In addition, we expect to incur approximately $10.0 million of costs to complete the OCT project for a revised estimated total of approximately $15.3 million. If the OCT project is not completed in a timely manner, such as if we experience delays associated with significant design changes that result from unsuccessful human trials or discoveries during human trials, we may jeopardize a potential competitive advantage, experience difficulties in obtaining our forecasted revenues and associated market share and we may not be required to pay some or all of the milestone payments.

In May 2008, we acquired the FLIVUS project in connection with our acquisition of Novelis, which was valued at $12.2 million. In-vivo testing and regulatory approval protocols remained to be completed for the FLIVUS project as of the acquisition date, at an estimated cost of $3.9 million. We expected the FLIVUS project to receive regulatory approvals and be commercialized during 2009. As of March 31, 2009, the project was behind schedule by approximately one year. In addition, we expect to incur approximately $5.7 million of costs to complete the FLIVUS project for a revised estimated total of approximately $7.2 million. If the FLIVUS project is not completed in a timely manner, such as if we experience delays associated with significant design changes that result from unsuccessful human trials or discoveries during human trials, we may jeopardize a potential competitive advantage and experience a potential loss of revenues and associated market share and we may not be required to pay the milestone payment.

In November 2008, we acquired an IPR&D project in connection with our acquisition of Impact Medical Technologies, LLC, a minor acquisition, valued at approximately $300,000.

The following table summarizes our significant IPR&D projects:

                                             Estimated Cost to Complete,
            Project Name     Fair Value        as of Acquisition Date
            OCT            $ 26.3 million   $                 7.2 million
            FLIVUS           12.2 million                     3.9 million

Amortization of Intangibles. Intangible assets, which consist of our developed technology, licenses, customer relationships, assembled workforce and patents and trademarks, are amortized using the straight-line method over their estimated useful lives ranging from three to ten years.

Interest Income. Interest income is comprised of interest income earned from our cash and cash equivalents and our short-term available-for-sale investments.

Interest Expense. Interest expense is comprised primarily of interest expense on our capital lease obligations.

Exchange Rate (Loss) Gain. Exchange rate gain (loss) is comprised of foreign currency transaction and remeasurement gains and losses, net.

Provision for Income Taxes. Provision for income taxes is comprised of federal alternative minimum tax and state, local and foreign income taxes. We have evaluated our ability to fully utilize the net deferred tax assets on an individual jurisdiction basis. For those jurisdictions in which we believe there is sufficient uncertainty surrounding the realization of deferred tax assets through future taxable income, we have provided a full valuation allowance and no current benefit has been recognized for the net operating loss and other deferred tax assets.

Results of Operations

The following table sets forth items derived from our consolidated statements of
operations for the three months ended March 31, 2009 and 2008, presented in both
absolute dollars (in thousands) and as a percentage of revenues:



                                                    Three Months Ended March 31,
                                                    2009                    2008
    Revenues                                 $ 48,959     100.0 %    $ 36,647     100.0 %
    Cost of revenues                           20,649      42.2        13,629      37.2

    Gross profit                               28,310      57.8        23,018      62.8
    Operating expenses:
    Selling, general and administrative        25,080      51.2        22,059      60.2
    Research and development                    8,769      17.9         5,637      15.4
    In-process research and development            -         -            175       0.5
    Amortization of intangibles                 1,052       2.2           773       2.1

    Total operating expenses                   34,901      71.3        28,644      78.2

    Operating loss                             (6,591 )   (13.5 )      (5,626 )   (15.4 )
    Interest income                               301       0.6         1,833       5.0
    Interest expense                               (2 )      -             (4 )      -
    Exchange rate (loss) gain                  (1,128 )    (2.3 )       1,679       4.6

    Loss before provision for income taxes     (7,420 )   (15.2 )      (2,118 )    (5.8 )
    Provision for income taxes                    194       0.4           208       0.5

    Net loss                                 $ (7,614 )   (15.6 )%   $ (2,326 )    (6.3 )%

The following table sets forth our revenues by product expressed as dollar amounts (in thousands) and the changes in revenues between the specified periods expressed as percentages:

                                          Three Months Ended      Percentage
                                              March 31,             Change
                                           2009         2008     2008 to 2009
         Medical segment:
         IVUS:
         Consoles                       $     8,411   $  6,372           32.0 %
         Single-procedure disposables        29,120     25,203           15.5
         FM:
         Consoles                                85        343          (75.2 )
         Single-procedure disposables         6,260      3,434           82.3
         Other                                1,705      1,295           31.7

         Sub-total medical segment           45,581     36,647           24.4
         Telecom segment                      3,378         -             n/a

                                        $    48,959   $ 36,647           33.6

The following table sets forth our revenues by geography expressed as dollar amounts (in thousands) and the changes in revenues in the specified periods expressed as percentages:

                                           Three Months Ended
                                               March 31,          Percentage Change
                                            2009         2008       2008 to 2009
    Revenues (1):
    United States                        $    24,210   $ 18,228                32.8 %
    Japan                                     11,684     10,089                15.8
    Europe, the Middle East and Africa         9,636      6,861                40.4
    Rest of world                              3,429      1,469               133.4

                                         $    48,959   $ 36,647                33.6

(1) Revenues are attributed to geographies based on the location of the customer, except for shipments by original equipment manufacturers, which are attributed to the country of the origin of the equipment distributed.

Comparison of Three Months Ended March 31, 2009 and 2008

Revenues. Revenues increased $12.3 million, or 33.6%, to $49.0 million in the three months ended March 31, 2009, as compared to revenues of $36.6 million in the three months ended March 31, 2008. In the three months ended March 31, 2009, IVUS revenues increased $6.0 million, or 18.9%, as compared to the three months ended March 31, 2008, which is comprised of a $3.9 million, or 15.5%, increase in sales of our single-procedure disposable IVUS products and an increase of $2.0 million, or 32.0%, from sales of our IVUS consoles. In the three months ended March 31, 2009, FM revenues increased $2.6 million, or 68.0%, as compared to the three months ended March 31, 2008, which is comprised of an increase of $2.8 million, or 82.3%, in sales of our single-procedure disposable FM products, which was partially offset by a decrease of $258,000, or 75.2%, in sales of our FM consoles. Telecom revenues were $3.4 million in the three months ended March 31, 2009. We had no telecom revenues in the three months ended March 31, 2008 as we did not acquire Axsun until December 2008. Other revenues increased $410,000, or 31.7%, in the three months ended March 31, 2009, as compared to the three months ended March 31, 2008, due primarily to the inclusion of other Axsun revenue in the period ending March 31, 2009. The increases in FM disposable revenues were primarily due to increased adoption of the technology based on recent clinical study data. In addition, revenues in the three months ended March 31, 2009 were also unfavorably impacted by $1.3 million in Euro foreign currency translation. Increases in revenues were realized across all of our key geographic markets.

Cost of Revenues. Cost of revenues increased $7.0 million, or 51.5%, to $20.6 million, or 42.2% of revenues in the three months ended March 31, 2009, from $13.6 million, or 37.2% of revenues in the three months ended March 31, 2008. Gross margin was 57.8% of revenues in the three months ended March 31, 2009, decreasing from 62.8% of revenues in the three months ended March 31, 2008. The increase in the cost of revenues was primarily due to higher sales volume. The decrease in gross margin resulted primarily from the addition of lower margin products from Axsun and was also impacted by services performed under software maintenance agreements and depreciation costs partially offset by a decrease in the production costs of IVUS and FM disposable products due to ongoing cost reduction initiatives and higher manufacturing capacity utilization combined with the unfavorable foreign currency translation impact on revenue as discussed above.

Selling, General and Administrative. Selling, general and administrative expenses increased $3.0 million, or 13.7%, to $25.1 million, or 51.2% of revenues in the three months ended March 31, 2009, as compared to $22.1 million, or 60.2% of revenues in the three months ended March 31, 2008. The increase in the three months ended March 31, 2009 as compared with the three months ended March 31, 2008 was primarily due to growth in our Japan operation to support our direct sales efforts, legal expenses related to the LightLab litigation, . . .