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CUTR > SEC Filings for CUTR > Form 10-Q on 5-Nov-2012All Recent SEC Filings

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Form 10-Q for CUTERA INC


5-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Caution Regarding Forward-Looking Statements

The following discussion should be read in conjunction with the attached condensed consolidated financial statements and notes thereto, and with our audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2011 as contained in our annual report on Form 10-K filed with the SEC on March 15, 2012. This quarterly report, including the following sections, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Throughout this report, and particularly in this Item 2, the forward-looking statements are based upon our current expectations, estimates and projections and reflect our beliefs and assumptions based upon information available to us at the date of this report. In some cases, you can identify these statements by words such as "may," "might," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue," and other similar terms. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties, and assumptions that are difficult to predict. Our actual results, performance or achievements could differ materially from those expressed or implied by the forward-looking statements. These forward-looking statements include, but are not limited to, statements relating to our future financial performance, the ability to grow our business, increase our revenue, manage expenses, generate additional cash, achieve and maintain profitability, develop and commercialize existing and new products and applications, and improve the performance of our worldwide sales and distribution network, and the outlook regarding long term prospects. These forward-looking statements involve risks and uncertainties. The cautionary statements set forth below and those contained in Part II, Item 1A - "Risk Factors" commencing on page 25, identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. We caution you to not place undue reliance on these forward-looking statements, which reflect management's analysis and expectations only as of the date of this report. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Form 10-Q.

Introduction

The Management's Discussion and Analysis, or MD&A, is organized as follows:

? Executive Summary. This section provides a general description and history of our business, a brief discussion of our product lines and the opportunities, trends, challenges and risks we focus on in the operation of our business.

? Critical Accounting Policies and Estimates. This section describes the key accounting policies that are affected by critical accounting estimates.

? Results of Operations. This section provides our analysis and outlook for the significant line items on our Consolidated Statements of Operations.

? Liquidity and Capital Resources. This section provides an analysis of our liquidity and cash flows, as well as a discussion of our commitments.

Executive Summary

Company Description.

We are a global medical device company specializing in the design, development, manufacture, marketing and servicing of laser and light-based aesthetics systems for practitioners worldwide. We offer easy-to-use products based on seven platforms - CoolGlideŽ, XeoŽ, SoleraŽ, GenesisPlusTM, Excel VTM, myQTM, and truSculptTM, each of which enables physicians and other qualified practitioners to perform safe and effective aesthetic procedures for their customers. The Xeo and Solera platforms offer multiple hand pieces and applications, which allow customers to upgrade their systems, which we treat as Upgrade revenue. In addition to systems and Upgrade revenue, we generate revenue from the sale of post warranty service contracts, providing services for products that are out of warranty; Titan hand piece refills; and third party manufactured dermal fillers and cosmeceutical products.

In February 2012, we acquired the global aesthetic business unit of Iridex Inc., which included various laser systems (such as the VariLite and Gemini) and an installed base of customers, whose products are serviced by us.

Our corporate headquarters and U.S. operations are located in Brisbane, California, from where we conduct our manufacturing, warehousing, research and development, regulatory, sales and marketing, service, and administrative activities. In the United States, we market, sell and service our products through direct sales and service employees, and a distribution relationship with PSS World Medical Shared Services, Inc. ("PSS"), a wholly owned subsidiary of PSS World Medical which has over 700 sales representatives serving physician offices throughout the United States. We also sell certain items such as our Titan hand piece refills and marketing brochures online.


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International sales are generally made through direct sales employees and a worldwide distributor network in over 40 countries. Outside of the United States, we have a direct sales presence in Australia, Canada, France and Japan. Effective March 31, 2012, we decided to discontinue our direct operations in Spain and the United Kingdom and instead plan on seeking a distributor to market our products in these countries.

Products

Our revenue is derived from the sale of Products, Upgrades, Service, Titan hand piece refills, and Dermal fillers and cosmeceutical products. Product revenue represents the sale of a system. A system consists of a console that incorporates a universal graphic user interface, a laser and/or light-based module, control system software and high voltage electronics; as well as one or more hand pieces. However, depending on the application, the laser or light-based module is sometimes contained in the hand piece, such as with our Pearl and Pearl Fractional applications, instead of within the console.

We offer our customers the ability to select the system that best fits their practice at the time of purchase and then to cost-effectively add applications to their system as their practice grows. This provides customers the flexibility to upgrade their systems whenever they want and provides us with a source of recurring revenue which we classify as Upgrade revenue. Service revenue relates to amortization of prepaid service contracts, direct billings for detachable hand piece replacements and revenue for parts and labor on out-of-warranty products. Titan hand piece refill revenue is associated with our Titan hand piece which requires replacement of the optical source after a set number of pulses have been used. In Japan, we distribute Merz Pharma GmbH's (Merz) RadiesseŽ dermal filler product; and Obagi Medical Products, Inc.'s (Obagi) cosmeceutical products.

Significant Business Trends

We believe that our ability to grow revenue will be primarily dependent on the following:

? Continuing to expand our product offerings ? both through internal development and sourcing from other vendors.

? Ongoing investment in our global sales and marketing infrastructure.

? Use of clinical results to support new aesthetic products and applications.

? Enhanced luminary development and reference selling efforts (to develop a location where our products can be displayed and used to assist in selling efforts).

? Customer demand for our products.

? Consumer demand for the application of our products.

? Marketing to physicians in the core dermatology and plastic surgeon specialties, as well as outside those specialties.

? Generating ongoing revenue from our growing installed base of customers through the sale of Service, Upgrade, Titan hand piece refills, and Dermal fillers and cosmeceutical products.

Geographical Revenue
Our U.S. revenue increased by $1.8 million, or 29%, in the three-month period ended September 30, 2012, and by $6.0 million or 38%, in the nine-month period ended September 30, 3012, compared to the same periods in 2011. This increase was due primarily to our recent new product introductions (Excel V and truSculpt), acquisition of Iridex's aesthetic business in February 2012, increased promotional activities and improvements in the U.S. macroeconomic environment.

For the three and nine months ended September 30, 2012, our international revenue increased by $2.4 million, or 26%, and by $7.0 million, or 27%, respectively, compared to the same periods in 2011. Recently, we have decided to shift from a direct sales model to a distributor model in Spain, U.K. and Switzerland. In addition to France, where we continue to have a direct sales and service team, our European revenue is sourced from distributors. These changes have not negatively impacted our European sourced revenue in the three and nine months ended September 30, 2012, compared to the same periods in the prior year.

Upgrade Revenue
In the past, we introduced new products that allowed existing customers to upgrade their previously purchased systems to obtain benefits from the additional capabilities, which drove our Upgrade revenue. However, since 2008 we have not introduced any new products that our customers could purchase as an upgrade to their previously purchased system. Instead, we have launched new stand alone products (GenesisPlus, Excel V, myQ, truSculpt). As a result, our Upgrade revenue has declined since 2009.


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Iridex Aesthetic Business Acquisition
We acquired Iridex's aesthetic business unit in February 2012. This acquisition was the primary driver of the $1.1 million increase in our Service revenue in the three-month period ended September 30, 2012, and the $2.5 million increase in the nine-month period ended September 30, 2012, compared to the respective periods in 2011. For the three and nine-months ended September 30, 2012, we generated $491,000 and $1.1 million, respectively of Iridex product revenue, primarily from the sale of VariLite and Gemini systems. The VariLite is a small compact vascular product that complements our Excel V and other vascular products. We believe that our Product revenue will have a favorable impact from this acquisition for the remainder of 2012.

Factors that May Impact Future Performance.

Our industry is impacted by numerous competitive, regulatory, macroeconomic and other significant factors. Our industry is highly competitive and our future performance depends on our ability to compete successfully. Additionally, our future performance is dependent upon our ability to continue to expand our product offerings, develop innovative technologies, obtain regulatory clearances for our products, protect the proprietary technology of our products and our manufacturing processes, manufacture our products cost-effectively, and successfully market and distribute our products in a profitable manner. If we fail to execute on the aforementioned initiatives, our business would be adversely affected. A detailed discussion of these and other factors that could impact our future performance are provided in Part II, Item 1A "Risk Factors" section below.

Critical Accounting Policies and Estimates.

The preparation of our Condensed Consolidated Financial Statements and related disclosures in conformity with generally accepted accounting principles in the United States, or GAAP, requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. These estimates, judgments and assumptions are based on historical experience and on various other factors that we believe are reasonable under the circumstances. We periodically review our estimates and make adjustments when facts and circumstances dictate. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected.

Critical accounting estimates, as defined by the Securities and Exchange Commission (SEC), are those that are most important to the portrayal of our financial condition and results of operations and require our management's most difficult and subjective judgments and estimates of matters that are inherently uncertain. The accounting policies and estimates that we consider to be critical, subjective, and requiring judgment in their application are summarized in "Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC on March 15, 2012. There have been no significant changes to the accounting policies and estimates disclosed in our Form 10-K, except for the following:

Long-Lived Assets Impairment:
In February 2012, we acquired the global aesthetic business unit of IRIDEX Corporation, which included various laser systems (such as the VariLite and Gemini) and an installed base of customers, whose products are being serviced by us. This acquisition was considered a business combination for accounting purposes, and as such, in addition to valuing all the assets, we recorded goodwill associated with the expected synergies from leveraging the customer relationships and integrating new product offerings into our business. The fair values of the assets acquired were determined to be $4.8 million of net tangible and intangible assets and $1.3 million of goodwill. Long-lived assets, such as property and equipment, intangible assets and goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not ultimately be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its ultimate disposition. If the sum of the expected future cash flows is less than the carrying amount of those assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. Through September 30, 2012, there have been no such impairments.


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Results of Operations

The following table sets forth selected consolidated financial data for the
periods indicated, expressed as a percentage of total revenue, net. Percentages
in this table and throughout our discussion and analysis of financial condition
and results of operations may reflect rounding adjustments.

                                   Three Months Ended           Nine Months Ended
                                      September 30,               September 30,
                                   2012            2011         2012           2011

Net revenue                           100 %          100 %         100 %         100 %
Cost of revenue                        45 %           44 %          47 %          44 %
Gross margin                           55 %           56 %          53 %          56 %

Operating expenses:
Sales and marketing                    36 %           42 %          39 %          45 %
Research and development               11 %           16 %          12 %          17 %
General and administrative             13 %           15 %          16 %          17 %
Total operating expenses               60 %           73 %          67 %          79 %

Loss from operations                   (5 )%         (17 )%        (14 )%        (23 )%
Interest and other income, net          -              -             -             1 %
Loss before income taxes               (5 )%         (17 )%        (14 )%        (22 )%
Provision for income taxes              -             (2 )%          -             -
Net loss                               (5 )%         (19 )%        (14 )%        (22 )%



Total Net Revenue
                              Three Months Ended September 30,                   Nine Months Ended September 30,
(Dollars in
thousands)                  2012            % Change          2011            2012            % Change          2011
Revenue mix by
geography:
United States           $      7,796                29 %    $   6,037     $     21,941                38 %    $  15,941
International                 11,630                26 %        9,195           32,803                27 %       25,807
Consolidated total
revenue                 $     19,426                28 %    $  15,232     $     54,744                31 %    $  41,748

United States as a
percentage of total
revenue                           40 %                             40 %             40 %                             38 %
International as a
percentage of total
revenue                           60 %                             60 %             60 %                             62 %
Revenue mix by
product category:
Products                $     12,047                34 %    $   8,975     $     32,170                43 %    $  22,462
Upgrades                         487               (29 %)         687            2,109               (11 %)       2,364
Service                        4,298                33 %        3,227           12,606                24 %       10,149
Titan hand piece
refills                        1,226                19 %        1,031            3,572                 7 %        3,336
Dermal fillers and
cosmeceuticals                 1,368                 4 %        1,312            4,287                25 %        3,437
Consolidated total
revenue                 $     19,426                28 %    $  15,232     $     54,744                31 %    $  41,748

Discussion of Revenue by Product Type:

Product Revenue
As explained in more detail in the Products section of the Executive Summary above, some of our products consist of a configurable system platform that includes a console and one or more hand pieces. Each product is configured to give our customers the ability to select the combination of platform and hand pieces that provides the applications that best fit their practice.

Product revenue increased by $3.1 million or 34% in the three-month period ended September 30, 2012, compared to the same period in 2011, and by $9.7 million or 43% in the nine-month period ended September 30, 2012, compared to the same period in 2011. These increases in revenue were due primarily to Excel V shipments which began in the second quarter of 2011, the commencement of truSculpt shipments in August of 2012, incremental revenue from the Iridex aesthetic acquisition in February 2012 and improvement in the U.S. macroeconomic environment.

Upgrade Revenue
As explained in more detail in the Products section of the Executive Summary above, our configurable system platforms allow customers to add applications to their existing systems to meet the changing needs of their practices. In some cases, when certain applications are desired that are only available on a platform other than the one owned by the customer, the Upgrade revenue will include a platform exchange and additional hand pieces.


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Upgrade revenue decreased by $200,000, or 29%, in the three-month period ended September 30, 2012, and by $255,000, or 11%, in the nine-month period ended September 30, 2012, compared to the same periods in 2011. In the past, we introduced new products that allowed existing customers to upgrade their previously purchased systems to take advantage of the additional capabilities, which drove our Upgrade revenue. However, recently we have launched stand alone products (GenesisPlus, Excel V, myQ and truSculpt) versus products that can be an upgrade to an existing system, which has resulted in a decline of our upgrade revenue.

Service Revenue
Our worldwide Service revenue increased by $1.1 million, or 33%, in the three-month period ended September 30, 2012, compared to the same period in 2011, and by $2.5 million, or 24%, in the nine-month period ended September 30, 2012, compared to the same period in 2011. This increase was primarily the result of Service revenue from the Iridex business acquisition.

Titan Hand Piece Refill Revenue
Our Titan hand piece refill revenue increased by $195,000 or 19% in the three-month period ended September 30, 2012, and by $236,000, or 7%, in the nine-month period ended September 30, 2012, compared to the same periods in 2011. This increase was due primarily to the continued growth in Titan refill revenue in Japan and improvements in the U.S.

Dermal Filler and Cosmeceuticals Revenue Our dermal filler and cosmeceuticals revenue increased by $56,000 or 4%, in the three-month period ended September 30, 2012 and by $850,000, or 25%, in the nine-month period ended September 30, 2012, compared to the same periods in 2011. This increase was due primarily to the higher number of customers purchasing Obagi and Merz distributed products in Japan, and due to the expansion of product lines being distributed.

Discussion of Revenue by Geography:

U.S. Revenue
Our U.S. revenue increased by $1.8 million, or 29%, in the three-month period ended September 30, 2012, and by $6.0 million or 38%, in the nine-month period ended September 30, 3012, compared to the same periods in 2011. This increase was primarily attributable to an increase in Product revenue due to the:

? Continued growth of Excel V shipments, which began shipping in the second quarter of 2011;

? Commencement of truSculpt shipments in August 2012;

? Incremental revenue from the Iridex aesthetic acquisition in February 2012; and

? Improvements in the U.S. macroeconomic environment.

International Revenue
International revenue increased by $2.4 million, or 26%, in the three-month period ended September 30, 2012, compared to the same period in 2011, and by $7.0 million, or 27%, in the nine-month period ended September 30, 2012, compared to the same period in 2011. This increase was primarily attributable to:

? Higher Product revenue from Canada, France, Japan and many distributor countries in our Asia Pacific region; and

? An increase in our Dermal filler and cosmeceuticals revenue in Japan, due primarily to additional Obagi and Merz product lines being added and a higher number of customers purchasing such products from Cutera.

Gross Profit
                               Three Months Ended September 30,                     Nine Months Ended September 30,
(Dollars in
thousands)                  2012             % Change           2011            2012             % Change           2011
Gross profit            $      10,598                25 %     $   8,460     $     28,797                 24 %     $  23,276
As a percentage of
total net revenue                  55 %                              56 %             53 %                               56 %

Our cost of revenue consists primarily of material, personnel expenses, royalty expense, warranty, amortization of intangibles and manufacturing overhead expenses.

Gross margin (which is gross profit divided by net revenue) was 55% in the three-month period ended September 30, 2012, compared to 56% for the same period in 2011. Gross margin was 53% in the nine-month period ended September 30, 2012, compared to 56% for the same period in 2011. This decline was due primarily to:

? A product mix shift towards lower margin products; and

? An increase in sales through our distributors, which typically have a lower margin than our direct revenue.


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Sales and Marketing
                               Three Months Ended September 30,                     Nine Months Ended September 30,
(Dollars in
thousands)                 2012               % Change          2011             2012               % Change        2011
Sales and marketing      $      7,014                  9 %     $    6,426      $     21,563                 15 %   $  18,720
As a percentage of
total net revenue                  36 %                                42 %              39 %                             45 %

Sales and marketing expenses consist primarily of personnel expenses, expenses associated with customer-attended workshops and trade shows, post-marketing studies, and advertising. Sales and marketing expenses increased $588,000, and represented 36% of total net revenue, in the three-month period ended September 30, 2012, compared to 42% in the same period in 2011. The $588,000 increase was due primarily to:

? $618,000 of higher personnel expenses attributable primarily to higher headcount and sales commission expenses associated with the higher revenue;

? $187,000 of higher product demonstration related expenses; offset by

? $81,000 of decreased travel, entertainment and sales meeting expenses; and

? $71,000 of decreased promotional spending.

Sales and marketing expenses increased $2.8 million, and represented 39% of total net revenue, in the nine-month period ended September 30, 2012, compared to 45% in the same period in 2011. The $2.8 million increase was due primarily to:

? $1.6 million of higher personnel expenses attributable primarily to higher headcount and sales commission expenses associated with the higher revenue;

? $751,000 of higher product demonstration related expenses;

? $344,000 of increased travel, entertainment and sales meeting expenses due to higher headcount; and

? $208,000 of increased promotional and marketing expenses.

Research and Development (R&D)
                               Three Months Ended September 30,                    Nine Months Ended September 30,
(Dollars in
thousands)                 2012            % Change             2011           2012            % Change            2011
Research and
development             $     2,217                (6 %)      $   2,352     $     6,305                (8 %)     $   6,828
As a percentage of
total net revenue                11 %                                16 %            12 %                               17 %

R&D expenses consist primarily of personnel expenses, clinical research, regulatory and material costs. R&D expenses decreased by $135,000, and represented 11% of total net revenue, in the three-month period ended September 30, 2012, compared to 16% for the same period in 2011. The decrease was due primarily to $117,000 of reduced prototype material expenses resulting from the timing of product development activities.

R&D expenses decreased by $523,000, and represented 12% of total net revenue, in the nine-month period ended September 30, 2012, compared to 17% for the same period in 2011. The decrease in expenses was due primarily to:

? $289,000 of reduced prototype material expenses resulting from the timing of product development activities;

? $110,000 of reduced personnel expenses due to lower headcount partially offset by severance expense; and

? $93,000 of reduced travel and entertainment expenses.


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General and Administrative (G&A)
                                 Three Months Ended September 30,                     Nine Months Ended September 30,
. . .
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