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CYNO > SEC Filings for CYNO > Form 10-K on 17-Mar-2014All Recent SEC Filings

Show all filings for CYNOSURE INC

Form 10-K for CYNOSURE INC


17-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and the related notes and other financial data included elsewhere in this Annual Report. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review Item 1A of this Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Company Overview

We develop and market aesthetic treatment systems that enable plastic surgeons, dermatologists and other medical practitioners to perform non-invasive and minimally invasive procedures to remove hair, treat vascular and benign pigmented lesions, remove multi-colored tattoos, revitalize the skin, liquefy and remove unwanted fat through laser lipolysis, reduce cellulite, clear nails infected by toe fungus and ablate sweat glands. We also have developed in conjunction with our development agreement with Unilever a laser treatment system for the home use market.

We were incorporated in July 1991. In 2005, we completed our initial public offering of our Class A common stock. In November 2012, we completed a public offering pursuant to which we issued and sold 2,840,000 shares of our Class A common stock.

Our product portfolio is composed of a broad range of energy sources including Alexandrite, diode, Nd:YAG, picosecond, pulse dye, and Q-switched lasers and intense pulsed light. We believe that we are one of only a few companies that currently offer aesthetic treatment systems utilizing Alexandrite and pulse dye lasers, which are particularly well suited for some applications and skin types. We offer single energy source systems as well as workstations that incorporate two or more different types of lasers or pulsed light technologies. We offer multiple technologies and system alternatives at a variety of price points depending primarily on the number and type of energy sources included in the system. Our products are designed to be easily upgradeable to add additional energy sources and handpieces, which provide our customers with technological flexibility as they expand their practices.

We focus our development and marketing efforts on offering leading, or flagship, products for the following high volume applications:

• our Elite product line for hair removal and treatment of facial and leg veins and pigmentations;

• our SmartLipo product line for LaserBodySculptingS for the removal of unwanted fat;

• our Cellulaze product line for the treatment of cellulite;

• our SmoothShapes XV product line for the temporary reduction in the appearance of cellulite;

• our Affirm/SmartSkin product line for anti-aging applications, including treatments for wrinkles, skin texture, skin discoloration and skin tightening;

• our Cynergy product line for the treatment of vascular lesions;

• our Accolade, MedLite C6 and RevLite product lines for the removal of benign pigmented lesions, as well as multi-colored tattoos; and

• our PicoSure product line for the treatment of tattoos and benign pigmented lesions.

On June 24, 2013, we acquired Palomar. The acquisition complemented and broadened our product lineup with the addition of Palomar's intense pulsed light, fractional laser and diode laser aesthetic systems, doubled the number of patents in our portfolio and enhanced our global distribution network. As a result of the transaction,


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former Palomar stockholders, in the aggregate, received for their shares of Palomar common stock $145.8 million in cash and 6.0 million shares of our Class A common stock. The total consideration is valued at $287.2 million, based upon the closing price of our Class A common stock on June 24, 2013. The main aesthetic laser products which have been added to our portfolio as a result of the acquisition include:

• the Palomar Icon Aesthetic System provides a comprehensive suite of the most popular treatments from hair removal to wrinkle reduction to scar and stretch mark treatment;

• the StarLux laser and pulsed light system for hair removal, skin resurfacing and skin rejuvenation; and

• the Vectus diode laser for high volume hair removal.

A key element of our business strategy is to launch innovative new products and technologies into high-growth aesthetic applications. Our research and development team builds on our existing broad range of laser and light-based technologies to develop new solutions and products to target unmet needs in significant aesthetic treatment markets. Innovation continues to be a strong contributor to our strength.

In March 2013, we commenced commercialization of our PicoSure® system, our picosecond laser technology platform for the treatment of tattoos and benign pigmented lesions. The PicoSure system is the first commercially available picosecond Alexandrite aesthetic laser platform. Picosecond lasers deliver pulses that are measured in trillionths of a second, in contrast with nanosecond technology, such as our MedLite® and RevLite™ products, which deliver pulses in billionths of a second. FDA clearance to market the PicoSure laser was received in November 2012. In October 2013, we launched the PicoSure FOCUS Lens Array which microscopically concentrates the PicoSure laser pulse to a precise depth and exposes less than 10% of the skin to areas of high fluence while the surrounding skin is exposed to a low background fluence. In July 2013, we received marketing authorization for our PicoSure system in Canada. In November 2013, we received marketing authorization for our PicoSure system in Australia. In January 2014, we received marketing authorization for our PicoSure system in Korea and Taiwan.

In 2012, we received FDA clearance in the United States to market an at home device for the treatment of wrinkles that we have developed in partnership with Unilever. In January 2014, we received a second FDA clearance. Unilever has advised us that it expects to launch the product commercially in the first half of 2014.

Revenues

We generate revenues primarily from sales of our products and parts and accessories and from services, including product warranty revenues, and royalty payments received from our licensees. During the year ended December 31, 2013, we derived approximately 83% of our revenues from sales of our products and 17% of our revenues from parts, accessories, service and royalty revenues. During the year ended December 31, 2012, we derived approximately 84% of our revenues from the sale of products and 16% of our revenues from parts, accessories and service revenues. Generally, we recognize revenues from the sales of our products upon delivery to our customers, revenues from service contracts and extended product warranties ratably over the coverage period and revenues from service in the period in which the service occurs.

We recognize royalty revenues when we can reliably estimate such amounts and collectability is reasonably assured. As such, we recognize royalty revenues in the quarter reported to us by our licensees, or one quarter following the quarter in which sales by our licensees occurred. Royalty revenues also include amounts due from settlements with licensees for back-owed royalties from prior periods. These settlement amounts are considered revenue, when collectability is reasonably assured, because they constitute our ongoing major or central operations.

In December 2013, we completed a comprehensive settlement agreement with Tria which ended the patent infringement litigation between Tria and Palomar. Under the agreement, we are entitled to receive $10.0 million plus future royalty payments. We will pay approximately $2.0 million of this revenue to MGH under an exclusive


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license agreement between Palomar and MGH, which will be recorded as cost of revenues within our consolidated statement of operations. We recognized $4.0 million of this revenue in the year ended December 31, 2013, which is recorded as royalty revenues within our consolidated statement of operations. We recognized $1.0 million in cost of revenues in the year ended December 31, 2013 for legal and license fees related to this settlement.

We sell our products through a direct sales force in North America, France, Spain, the United Kingdom, Germany, Australia Korea, China, Japan and Mexico, and use distributors to sell our products in other countries where we do not have a direct presence. During the year ended December 31, 2013 and 2012, we derived 48% and 51% of our total revenues, respectively, from sales outside North America. As of December 31, 2013, including expansion from the acquisition of Palomar, we had 78 sales employees covering North America and 63 sales employees in France, Spain, the United Kingdom, Germany, Korea, China, Japan and Australia. We utilize a global distribution network covering approximately 120 countries.

The following table provides revenue data by geographical region for the years ended December 31, 2013, 2012 and 2011:

                                         Percentage of Revenues
                                        Year Ended December 31,
                                      2013          2012       2011
                    Region
                    North America         52 %         49 %       44 %
                    Europe                17           19         25
                    Asia/Pacific          23           26         25
                    Other                  8            6          6

                    Total                100 %        100 %      100 %

See Note 7 to our consolidated financial statements included in this Annual Report for revenues and asset data by geographic region.

Cost of Revenues

Our cost of revenues consists primarily of material, labor and manufacturing overhead expenses and includes the cost of components and subassemblies supplied by third party suppliers. Cost of revenues also includes royalties incurred on certain products sold by us and our licensees, costs incurred in connection with our efforts to litigate or settle additional third party license agreements, service and warranty expenses, as well as salaries and personnel-related expenses, including stock-based compensation, for our operations management team, purchasing and quality control.

Sales and Marketing Expenses

Our sales and marketing expenses consist primarily of salaries, commissions and other personnel-related expenses, including stock-based compensation, for employees engaged in sales, marketing and support of our products, trade show, promotional and public relations expenses and management and administration expenses in support of sales and marketing. We expect our sales and marketing expenses to increase in absolute dollars but remain consistent as a percentage of revenues in 2014.

Research and Development Expenses

Our research and development expenses consist of salaries and other personnel-related expenses, including stock-based compensation, for employees primarily engaged in research, development and engineering activities, materials used and other overhead expenses incurred in connection with the design and development of our


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products and, from time to time, expenses associated with collaborative research and development agreements that we may enter into. We expense all of our research and development costs as incurred. We expect our research and development expenditures to increase in absolute dollars but decrease as a percentage of revenues in 2014, due to increased revenue as a result of the Palomar acquisition.

General and Administrative Expenses

Our general and administrative expenses consist primarily of salaries and other personnel-related expenses, including stock-based compensation for executives, accounting and administrative personnel, acquisition related expenses, professional fees and other general corporate expenses. We expect our general and administrative expenses to decrease in absolute dollars and decrease as a percentage of revenues in 2014, due to a reduction in acquisition-related costs.

Interest (Expense) Income, net

Interest (expense) income consists primarily of interest charges on capital lease obligations, and interest earned on our short and long-term marketable securities consisting of state and municipal bonds, U.S. government agencies and treasuries, corporate obligations and commercial paper. We expect interest expense to increase in 2014 as a result of interest charges incurred on our U.S. operating facility, which we are accounting for as a capital lease.

Other Income, net

Other income, net consists primarily of foreign currency remeasurement gains or losses and other miscellaneous income and expense items.

(Benefit) Provision for Income Taxes

As of December 31, 2013, we have a partial valuation allowance on the net deferred tax assets in the United States as we have benefitted our U.S. deferred tax assets to the extent we have taxable income in a carryback year and existing taxable temporary differences. A full valuation allowance is maintained on the net deferred tax assets of our subsidiaries in Japan, Mexico, Australia as well as Palomar Spain and Palomar Germany.

Valuation allowances are provided if, based on the weight of available evidence, it is more-likely-than-not that some or all of the deferred tax assets will not be realized. We will continue to monitor the need for valuation allowances in each jurisdiction, and may adjust our positions in the future based on actual results.


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Results of Operations

Year Ended December 31, 2013 and 2012

The following table contains selected statement of operations data, which serves
as the basis of the discussion of our results of operations for the years ended
December 31, 2013 and 2012:



                                                 Year Ended                                  Year Ended                               Change
                                              December 31, 2013                           December 31, 2012                        2012 to 2013
                                                           As a % of                                   As a % of
                                       Amount            Total Revenues             Amount           Total Revenues         $ Change          % Change
                                                                                   (Dollars in thousands)
Product revenues                     $   188,271                      83 %       $    128,513                     84 %      $  59,758                46 %
Parts, accessories, service and
royalty revenues                          37,739                      17               24,980                     16           12,759                51

Total revenues                           226,010                     100              153,493                    100           72,517                47
Cost of revenues                          95,730                      42               64,567                     42           31,163                48

Gross profit                             130,280                      58               88,926                     58           41,354                47
Operating expenses:
Sales and marketing                       64,347                      28               47,543                     31           16,804                35
Research and development                  17,473                       8               12,972                      8            4,501                35
Amortization of intangible
assets acquired                            2,114                       1                1,368                      1              746                55
General and administrative                52,173                      23               14,910                     10           37,263               250

Total operating expenses                 136,107                      60               76,793                     50           59,314                77

(Loss) income from operations             (5,827 )                    (2 )             12,133                      8          (17,960 )            (148 )
Interest (expense) income, net               (23 )                    -                    60                     -               (83 )            (138 )
Other income, net                            313                      -                   532                     -              (219 )             (41 )

(Loss) income before (benefit)
provision for income taxes                (5,537 )                    (2 )             12,725                      8          (18,262 )            (144 )
(Benefit) provision for income
taxes                                     (3,890 )                    (1 )              1,764                      1           (5,654 )            (321 )

Net (loss) income                    $    (1,647 )                    (1 )%      $     10,961                      7 %      $ (12,608 )            (115 )%

Revenues

Total revenue for the year ended December 31, 2013 increased by $72.5 million,
or 47%, to $226.0 million, as compared to the year ended December 31, 2012
revenues of $153.5 million (in thousands, except for percentages):



                                                        Year Ended
                                                       December 31,
                                                   2013           2012         $ Change        % Change
Product sales in North America                   $  97,022      $  64,910      $  32,112              49 %
Product sales outside North America                 91,249         63,603         27,646              43
Parts, accessories, service and royalty sales       37,739         24,980         12,759              51

Total Revenues                                   $ 226,010      $ 153,493      $  72,517              47 %

The increase in revenue was attributable to a number of factors:

• Revenues from the sale of products in North America increased by approximately $32.1 million, or 49%, from the 2012 period, primarily due to an increase in average selling prices and number of units sold attributable to the introduction of additional products, including PicoSure, Vectus and Palomar Icon.


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• Revenues from the sales of products outside of North America increased by approximately $27.6 million, or 43%, from the 2012 period, primarily due to an increase in average selling prices and number of units sold attributable to the introduction of additional products, including PicoSure, Elite Plus, Vectus and Palomar Icon.

• Revenues from the sale of parts, accessories, services and royalties increased by approximately $12.8 million, or 51%, from the 2012 period, primarily due to an increase in revenues generated from performing service on laser systems, including our newly acquired Palomar product lines. Royalty revenues, attributable to the Palomar business, contributed $5.4 million for the year ended December 31, 2013, which includes a $4.0 million settlement with Tria in the fourth quarter of 2013.

Cost of Revenues



                                                   Year Ended

                                                  December 31,
                                              2013            2012          $ Change         % Change
Cost of revenues (in thousands)             $ 95,730        $ 64,567        $  31,163               48 %
Cost of revenues (as a percentage of
total revenues)                                   42 %            42 %

Total cost of revenues increased $31.2 million, or 48%, to $95.7 million in 2013, as compared to $64.6 million in 2012. The increase was primarily associated with the 47% increase in total revenues. Cost of revenues includes approximately $1.0 million in costs incurred in connection with the settlement of the patent infringement litigation against Tria, along with a purchase accounting charge of $2.4 million associated with the step up in fair value of finished goods inventory acquired through our acquisition of Palomar and sold during the period. Our total cost of revenues as a percentage of total revenues remained consistent at 42% for the years ended December 31, 2013 and 2012.

Sales and Marketing



                                                   Year Ended

                                                  December 31,
                                              2013            2012          $ Change         % Change
Sales and marketing (in thousands)          $ 64,347        $ 47,543        $  16,804               35 %
Sales and marketing (as a percentage of
total revenues)                                   28 %            31 %

Sales and marketing expenses increased $16.8 million, or 35% for the year ended December 31, 2013, as compared with the year ended December 31, 2012. This increase was primarily due to sales and marketing expenses of $7.7 million attributable to the integration of the Palomar sales and marketing team for the year ended December 31, 2013. The increase also included commission expense of $3.8 million due to increased product revenues, personnel costs of $3.4 million due to an increase in the number of our sales employees, and $1.4 million due to increased workshops, trade shows and other promotional efforts. Sales and marketing expenses for the year ended December 31, 2013 decreased as a percentage of total revenues to 28%, due to increased revenue and continued operating leverage.

Research and Development



                                                   Year Ended

                                                  December 31,
                                              2013            2012           $ Change         % Change
Research and development (in thousands)     $ 17,473        $ 12,972        $    4,501               35 %
Research and development (as a
percentage of total revenues)                      8 %             8 %

Research and development expenses increased $4.5 million, or 35% for the year ended December 31, 2013 as compared with the year ended December 31, 2012. This increase was primarily due to research and development expenses of $3.6 million attributable to the integration of the Palomar research and development team for the year ended December 31, 2013, as well as an increase of $0.6 million in personnel and professional services costs associated with the development of new products.


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Amortization of Intangible Assets Acquired



                                                    Year Ended

                                                   December 31,
                                               2013           2012          $ Change         % Change
Amortization of intangible assets
acquired (in thousands)                       $ 2,114        $ 1,368        $     746               55 %
Amortization of intangible assets
acquired (as a percentage of total
revenues)                                           1 %            1 %

Amortization of intangible assets acquired increased $0.7 million, or 55%, for the year ended December 31, 2013, as compared with the year ended December 31, 2012. The increase resulted from an increase in amortization expense for the identifiable intangible assets from the Palomar acquisition for the year ended December 31, 2013.

General and Administrative



                                                    Year Ended
                                                   December 31,
                                               2013            2012          $ Change        % Change
General and administrative (in
thousands)                                   $ 52,173        $ 14,910        $  37,263             250 %
General and administrative (as a
percentage of total revenues)                      23 %            10 %

General and administrative expenses increased $37.3 million, or 250%, for the year ended December 31, 2013, as compared with the year ended December 31, 2012. The increase is primarily due to $31.7 million in costs associated with the acquisition of Palomar during the year ended December 31, 2013, including $24.2 million in compensation expense in connection with change of control severance arrangements, $2.6 million in employee termination payments and $1.9 million in professional services fees. Excluding acquisition costs, general and administrative expenses increased due to increased headcount associated with our Palomar acquisition. We expect to incur approximately $1.5 million in general and administrative expenses related to the Palomar acquisition in the first half of 2014.

Interest (Expense) Income, net

Year Ended

December 31,
2013 2012 $ Change % Change
Interest (expense) income, net (in thousands) $ (23 ) $ 60 $ (83 ) (138 )%

The increase in interest (expense) income, net was primarily due to increased interest charges associated with the capital lease of our U.S. operating facility. In the fourth quarter of 2013, we amended our lease agreement in Westford, MA, extending the term and the rentable space. We are treating the buildings portion of the lease as a capital lease and incurring interest charges accordingly. We expect interest charges to approximate $1.5 million in 2014.

Other Income, net

Year Ended
December 31,
2013 2012 $ Change % Change
Other income, net (in thousands) $ 313 $ 532 $ (219 ) (41 )%

The decrease in other income, net was primarily a result of selling certain equipment under capital lease agreements during 2012, which generated income. Net foreign currency remeasurement gains remained consistent for the years ended December 31, 2013 and 2012.


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(Benefit) Provision for Income Taxes

                                                  Year Ended
                                                 December 31,
                                              2013           2012          $ Change          % Change
(Benefit) Provision for income taxes
(in thousands)                              $ (3,890 )      $ 1,764        $  (5,654 )            (321 )%
. . .
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