form10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-Q 

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

For the quarterly period ended March 31, 2012

OR

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

For the transition period _____ to_____.

Commission file number: 000-50644
 

Cutera, Inc.
(Exact name of registrant as specified in its charter)

 
Delaware
 
77-0492262
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. employer identification no.)

3240 Bayshore Blvd., Brisbane, California 94005
(Address of principal executive offices)

(415) 657-5500
(Registrant’s telephone number, including area code)
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes    x    No    ¨

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

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

Large accelerated filer  ¨
Accelerated filer  x
Non-accelerated filer  ¨
Smaller reporting company ¨

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

The number of shares of Registrant’s common stock issued and outstanding as of March 31, 2012 was 14,033,155
 


 
 

 
 
CUTERA, INC.

FORM 10-Q

TABLE OF CONTENTS

 
 
 
 
Page
PART I
 
FINANCIAL INFORMATION
 
 
 
 
 
 
 
Item 1
 
 
3
 
 
 
3
 
 
 
4
 
 
 
5
 
 
 
6
 
 
 
7
Item 2
 
 
13
Item 3
 
 
21
Item 4
 
 
21
 
 
 
 
 
PART II
 
OTHER INFORMATION
 
 
 
 
 
 
 
Item 1
 
 
21
Item 1A
 
 
22
Item 2
 
 
32
Item 3
 
 
33
Item 4
 
 
33
Item 5
 
 
33
Item 6
 
 
34
 
 
 
35

 
2


PART I. FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS

CUTERA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

 
 
March 31,
2012
 
 
December 31,
2011
 
Assets
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 
$
12,787
 
 
$
14,020
 
Marketable investments
 
 
66,137
 
 
 
74,666
 
Accounts receivable, net
 
 
4,496
 
 
 
5,193
 
Inventories
 
 
13,434
 
 
 
10,729
 
Deferred tax asset
 
 
50
 
 
 
55
 
Other current assets and prepaid expenses
 
 
1,363
 
 
 
1,432
 
Total current assets
 
 
98,267
 
 
 
106,095
 
 
 
 
 
 
 
 
 
 
Property and equipment, net
 
 
1,019
 
 
 
853
 
Long-term investments
 
 
2,928
 
 
 
3,027
 
Goodwill and other intangible assets, net
 
 
4,843
 
 
 
446
 
Deferred tax asset, net of current portion
   
450
     
446
 
Other long-term assets
 
 
458
 
 
 
486
 
Total assets
 
$
107,965
 
 
$
111,353
 
 
 
 
 
 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
Accounts payable
 
$
2,674
 
 
$
2,573
 
Accrued liabilities
 
 
8,936
 
 
 
9,262
 
Deferred revenue
 
 
5,770
 
 
 
5,185
 
Total current liabilities
 
 
17,380
 
 
 
17,020
 
 
 
 
 
 
 
 
 
 
Deferred rent
 
 
1,450
 
 
 
1,448
 
Deferred revenue, net of current portion
 
 
917
 
 
 
840
 
Income tax liability
 
 
469
 
 
 
478
 
Total liabilities
 
 
20,216
 
 
 
19,786
 
 
 
 
 
 
 
 
 
 
Commitments and Contingencies (Note 12)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stockholders’ equity:
 
 
 
 
 
 
 
 
Convertible preferred stock, $0.001 par value; authorized: 5,000,000 shares; none issued and outstanding
 
 
 
 
 
 
Common stock, $0.001 par value; authorized: 50,000,000 shares; issued and outstanding: 14,033,155 and 13,948,395 shares at March 31, 2012 and December 31, 2011, respectively
 
 
14
 
 
 
14
 
Additional paid-in capital
 
 
97,043
 
 
 
95,719
 
Accumulated deficit
 
 
(8,592
)
 
 
(3,325
 )
Accumulated other comprehensive loss
 
 
(716
)
 
 
(841
)
Total stockholders’ equity
 
 
87,749
 
 
 
91,567
 
Total liabilities and stockholders’ equity
 
$
107,965
 
 
$
111,353
 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 
3

 
CUTERA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)
 
 
 
Three Months Ended
 
 
 
March 31,
 
 
 
2012
 
 
2011
 
Net revenue:
 
   
 
 
   
 
Products
 
$
11,854
 
 
$
8,293
 
Service
 
 
3,873
 
 
 
3,328
 
Total net revenue
 
 
15,727
 
 
 
11,621
 
Cost of revenue:
 
 
 
 
 
 
 
 
Products
 
 
5,651
 
 
 
3,288
 
Service
 
 
2,194
 
 
 
1,936
 
Total cost of revenue
 
 
7,845
 
 
 
5,224
 
Gross profit
 
 
7,882
 
 
 
6,397
 
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
Sales and marketing
 
 
7,437
 
 
 
5,946
 
Research and development
 
 
2,216
 
 
 
2,130
 
General and administrative
 
 
3,495
 
 
 
2,328
 
Total operating expenses
 
 
13,148
 
 
 
10,404
 
Loss from operations
 
 
(5,266
)
 
 
(4,007
)
Interest and other income, net
 
 
96
 
 
 
184
 
Loss before income taxes
 
 
(5,170
)
 
 
(3,823
)
Provision for income taxes
 
 
97
 
 
 
32
 
Net loss
 
$
(5,267
)
 
$
(3,855
)
 
 
 
 
 
 
 
 
 
Net loss per share:
 
 
 
 
 
 
 
 
Basic and Diluted
 
$
(0.38
)
 
$
(0.28
)
 
 
 
 
 
 
 
 
 
Weighted-average number of shares used in per share calculations:
 
 
 
 
 
 
 
 
Basic and Diluted
 
 
13,960
 
 
 
13,667
 
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 
4


CUTERA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)
 
 
 
Three Months Ended
 
 
 
March 31,
 
 
 
2012
 
 
2011
 
Net loss
 
$
(5,267
)
 
$
(3,855
)
Other comprehensive income:
 
 
 
 
 
 
 
 
Net change in unrealized gain on available-for sale-securities
 
 
164
 
 
 
180
 
Provision for income taxes related to items of other comprehensive income
 
 
38
 
 
 
 
Other comprehensive income, net of tax
 
 
126
 
 
 
180
 
Comprehensive loss
 
$
(5,141
)
 
$
(3,675
)
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 
5

 
CUTERA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)
 
(unaudited)
 
 
 
Three Months Ended
 
 
 
March 31,
 
 
 
2012
 
 
2011
 
Cash flows from operating activities:
 
 
 
 
 
 
Net loss
 
$
(5,267
)
 
$
(3,855
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
 
 
 
 
Stock-based compensation
 
 
738
 
 
 
886
 
Depreciation and amortization
 
 
343
 
 
 
157
 
Other
 
 
14
 
 
 
44
 
Changes in assets and liabilities:
 
 
 
 
 
 
 
 
Accounts receivable
 
 
640
 
 
 
883
 
Inventories
 
 
(1,153
)
 
 
(820
)
Other current assets and prepaid expenses
 
 
444
 
 
 
1,509
 
Other long-term assets
   
28
     
 
Accounts payable
 
 
101
 
 
 
249
 
Accrued liabilities
 
 
(661
)
 
 
(353
)
Deferred rent
 
 
27
 
 
 
(3
)
Deferred revenue
 
 
(118
)
 
 
(204
)
Income tax liability
 
 
(9
)
 
 
2
 
Net cash provided by (used in) operating activities
 
 
(4,873
)
 
 
(1,505
)
 
 
 
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
 
 
Acquisition of property and equipment
 
 
(277
)
 
 
(180
)
Business acquisition
   
(5,091
)
   
 
Proceeds from sales of marketable and long-term investments
 
 
10,729
 
 
 
4,241
 
Proceeds from maturities of marketable investments
 
 
11,135
 
 
 
12,125
 
Purchase of marketable investments
 
 
(13,442
)
 
 
(14,778
)
Net cash provided by investing activities
 
 
3,054
 
 
 
1,408
 
 
 
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
 
 
 
Proceeds from exercise of stock options and employee stock purchase plan
 
 
586
 
 
 
742
 
Net cash provided by financing activities
 
 
586
 
 
 
742
 
 
 
 
 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
 
 
(1,233
)
 
 
645
 
Cash and cash equivalents at beginning of period
 
 
14,020
 
 
 
12,519
 
Cash and cash equivalents at end of period
 
$
12,787
 
 
$
13,164
 
 
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
 
 
6

 
CUTERA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies

Description of Operations and Principles of Consolidation.
Cutera, Inc. (Cutera or the Company) is a global provider of laser and light-based aesthetic systems for practitioners worldwide. The Company designs, develops, manufactures, and markets the CoolGlide, Xeo, Solera, GenesisPlus and Excel V product platforms for use by physicians and other qualified practitioners to allow its customers to offer safe and effective aesthetic treatments to their customers. The Xeo and Solera platforms offer multiple hand pieces and applications, which allow customers to upgrade their systems (Upgrade revenue). In addition to systems and Upgrade revenue, the Company generates revenue from the sale of post warranty service contracts, providing services for products that are out of warranty, and Titan hand piece refills.  In Japan the Company also distributes third party manufactured dermal fillers, cosmeceuticals and a Q-switched laser system called myQ.

In February 2012, the Company acquired the global aesthetic business unit of IRIDEX Corporation (or Iridex), which included various laser systems (such as the VariLite and Gemini) and an installed base of customers, whose products will be serviced by the Company.

Headquartered in Brisbane, California, the Company has wholly-owned subsidiaries in Australia, Canada, France, Japan, Spain, and the United Kingdom that market, sell and service its products outside of the United States. Effective March 31, 2012, the Company decided to discontinue its direct operations in Spain and the United Kingdom and instead plans on seeking a distributor to market its products in these countries. The Condensed Consolidated Financial Statements include the accounts of the Company and its subsidiaries and all inter-company transactions and balances have been eliminated.

Unaudited Interim Financial Information
The financial information filed is unaudited. The Condensed Consolidated Financial Statements included in this report reflect all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for the fair statement of the results of operations for the interim periods covered and of the financial condition of the Company at the date of the interim balance sheet. The December 31, 2011 Condensed Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles in the United States of America (GAAP). The results for interim periods are not necessarily indicative of the results for the entire year or any other interim period. The Condensed Consolidated Financial Statements should be read in conjunction with the Company’s financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission, or SEC, on March 15, 2012.

Use of Estimates
The preparation of interim Condensed Consolidated Financial Statements in conformity with GAAP requires the Company’s management to make estimates and assumptions that affect the amounts reported and disclosed in the Condensed Consolidated Financial Statements and the accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, the Company evaluates these estimates, including those related to warranty obligation, sales commission, accounts receivable and sales allowances, provision for excess and obsolete inventories, fair values of marketable and long-term investments, fair values of acquired intangible assets, useful lives of intangible assets and property and equipment, recoverability of deferred tax assets, and effective income tax rates, among others. Management bases these estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.

Note 2. Cash and Cash Equivalents, Marketable Securities and Long-Term Investments

The Company considers all highly liquid investments, with an original maturity of three months or less at the time of purchase, to be cash equivalents. Investments in debt securities are accounted for as “available-for-sale” securities, carried at fair value with unrealized gains and losses reported in other comprehensive loss, held for use in current operations and classified in current assets as “Marketable investments” and in long term assets as “Long-term investments.”
 
 
7


The following tables summarize unrealized gains and losses related to our marketable investments and long-term investments, both designated as available-for-sale (in thousands):

March 31, 2012
 
Amortized
Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Market Value
 
Cash and cash equivalents:
 
   
 
 
   
 
 
   
 
 
   
 
Cash
 
$
2,004
 
 
$
 
 
$
 
 
$
2,004
 
Money market funds
 
 
7,308
 
 
 
 
 
 
 
 
 
7,308
 
Commercial paper
 
 
3,475
 
 
 
 
 
 
 
 
 
3,475
 
Total cash and cash equivalents
 
 
 12,787
 
 
 
 
 
 
 
 
 
 12,787
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Marketable securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government notes
 
 
3,657
 
 
 
5
 
 
 
 
 
 
3,662
 
U.S. government agencies
 
 
32,653
 
 
 
51
 
 
 
(4
)
 
 
32,700
 
Municipal securities
 
 
6,108
 
 
 
49
 
 
 
 
 
 
6,157
 
Commercial paper
 
 
4,924
 
 
 
1
 
 
 
(1
)
 
 
4,924
 
Corporate debt securities
 
 
18,669
 
 
 
33
 
 
 
(8
)
 
 
18,694
 
Total marketable investments
 
 
66,011
 
 
 
139
 
 
 
(13
)
 
 
66,137
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Long-term investment in ARS
 
 
3,700
 
 
 
 
 
 
(772
)
 
 
2,928
 
Total cash, cash equivalents, marketable investments and long-term investments
 
$
82,498
 
 
$
139
 
 
$
(785
)
 
$
81,852
 
 
December 31, 2011
 
Amortized
Cost
 
Gross
Unrealized Gains
 
Gross
Unrealized Losses
 
Fair Market Value
 
Cash and cash equivalents:
 
   
 
 
   
 
 
   
 
 
   
 
Cash
 
$
2,153
 
 
$
 
 
$
 
 
$
2,153
 
Money market funds
 
 
7,318
 
 
 
 
 
 
 
 
 
7,318
 
Commercial paper
 
 
4,549
 
 
 
 
 
 
 
 
 
4,549
 
Total cash and cash equivalents
 
 
14,020
 
 
 
 
 
 
 
 
 
14,020
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Marketable securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government notes
 
 
3,655
 
 
 
10
 
 
 
 
 
 
3,665
 
U.S. government agencies
 
 
41,535
 
 
 
44
 
 
 
(14
)
 
 
41,565
 
Municipal securities
 
 
6,091
 
 
 
44
 
 
 
(1
)
 
 
6,134
 
Commercial paper
 
 
4,747
 
 
 
1
 
 
 
(1
)
 
 
4,747
 
Corporate debt securities
 
 
18,574
 
 
 
15
 
 
 
(34
)
 
 
18,555
 
Total marketable investments
 
 
74,602
 
 
 
114
 
 
 
(50
)
 
 
74,666
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Long-term investment in ARS
 
 
3,900
 
 
 
 
 
 
(873
)
 
 
3,027
 
Total cash, cash equivalents, marketable investments and long-term investments
 
$
92,522
 
 
$
114
 
 
$
(923
)
 
$
91,713
 

As of March 31, 2012 and December 31, 2011, the total gross unrealized losses were $785,000 and $923,000 respectively and were primarily related to long-term investments in ARS, which were in an unrealized loss position for 12 months or greater. No other securities were in unrealized loss positions for more than 12 months. The unrealized losses in the ARS securities are not attributed to changes in credit risk and the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity.
 
Since February 2008, uncertainties in the credit markets affected the majority of ARS investments and auctions for the Company's investments in these securities have failed to settle on their respective settlement dates. However, since 2009 $9.7 million of ARS were redeemed at full par value. Maturity dates for the ARS investments in the Company's portfolio range from 2032 to 2041.

The following table summarizes the estimated fair value of our marketable investments and long-term investments classified by the contractual maturity date of the security as of March 31, 2012 (in thousands):

 
 
Amount
 
Due in less than one year
 
$
38,845
 
Due in 1 to 3 years
 
 
27,292
 
Due in 3 to 5 years
 
 
 
Due in 5 to 10 years
 
 
 
Due in greater than 10 years
 
 
2,928
 
 
 
$
69,065
 

 
8

 
Note 3. Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:

·
Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities.
·
Level 2: Directly or indirectly observable inputs as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data from actively quoted markets for substantially the full term of the financial instrument.
·
Level 3: Unobservable inputs that are supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value.

As of March 31, 2012, financial assets measured and recognized at fair value on a recurring basis and classified under the appropriate level of the fair value hierarchy as described above was as follows (in thousands):

March 31, 2012
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
Total
 
Cash equivalents:
 
   
 
     
 
     
 
     
 
Money market funds
 
$
 7,308
 
 
 
 
 
 
 
 
$
 7,308
 
Commercial paper
 
 
 
 
 
3,475
 
 
 
 
 
 
3,475
 
Short-term marketable investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government notes
 
 
 
 
 
3,662
 
 
 
 
 
 
3,662
 
U.S. government agencies
 
 
 
 
 
 32,700
 
 
 
 
 
 
 32,700
 
Municipal securities
 
 
 
 
 
6,157
 
 
 
 
 
 
6,157
 
Commercial paper
 
 
 
 
 
 4,924
 
 
 
 
 
 
 4,924
 
Corporate debt securities
 
 
 
 
 
18,694
 
 
 
 
 
 
18,694
 
Long-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale ARS
 
 
 
 
 
 
 
 
2,928
 
 
 
2,928
 
Total assets at fair value
 
$
7,308
 
 
$
69,612
 
 
$
2,928
 
 
$
79,848
 

As of December 31, 2011, financial assets measured and recognized at fair value on a recurring basis and classified under the appropriate level of the fair value hierarchy as described above was as follows (in thousands):

December 31, 2011
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
Total
 
Cash equivalents:
 
   
 
     
 
     
 
     
 
Money market funds
 
$
7,318
 
 
 
 
 
 
 
 
$
7,318
 
Commercial paper
 
 
 
 
 
4,549
 
 
 
 
 
 
4,549
 
Short-term marketable investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government notes
 
 
 
 
 
3,665
 
 
 
 
 
 
3,665
 
U.S. government agencies
 
 
 
 
 
41,565
 
 
 
 
 
 
41,565
 
Municipal securities
 
 
 
 
 
6,134
 
 
 
 
 
 
6,134
 
Commercial paper
 
 
 
 
 
4,747
 
 
 
 
 
 
4,747
 
Corporate debt securities
 
 
 
 
 
18,555
 
 
 
 
 
 
18,555
 
Long-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale ARS
 
 
 
 
 
 
 
 
3,027
 
 
 
3,027
 
Total assets at fair value
 
$
7,318
 
 
$
79,215
 
 
$
3,027
 
 
$
89,560
 

 
9


At March 31, 2012, observable market information was not available to determine the fair value of the Company’s ARS investments. Therefore, the fair value is based on broker-provided valuation models that relied on Level 3 inputs including those that are based on expected cash flow streams and collateral values, assessments of counterparty credit quality, default risk underlying the security, market discount rates and overall capital market liquidity. The expected future cash flows of the ARS were discounted using a risk adjusted discount rate that compensated for the illiquidity. Projected future cash flows over the economic life of the ARS (of approximately 10.0 – 12.5 years) were modeled based on the contractual penalty rates for the security added to a tax adjusted LIBOR interest rate curve. The discount rates that were applied to the cash flows were based on a premium over the projected yield curve and included an adjustment for credit, illiquidity, and other risk factors. The valuation of the Company’s ARS investment portfolio is subject to uncertainties that are difficult to predict. Factors that may impact the valuations in the future include changes to credit ratings of the securities, as well as to the underlying assets supporting those securities, rates of default of the underlying assets, underlying collateral value, discount rates, counterparty risk and ongoing strength and quality of market credit and liquidity. These financial instruments are classified within Level 3 of the fair value hierarchy.

The table presented below summarizes the change in carrying value associated with Level 3 financial assets, which represents the Company’s investment in long term ARS, for the three months ended March 31, 2012 (in thousands):

 
 
 
 
Balance at December 31, 2011
 
$
3,027
 
Total gains or losses included in other comprehensive loss
 
 
101
 
Settlements     (200
Balance at March 31, 2012
 
$
2,928
 

Note 4. Inventories
Inventories consist of the following (in thousands):

 
 
March 31,
2012
 
 
December 31,
2011
 
Raw materials
 
$
8,542
 
 
$
6,587
 
Finished goods
 
 
4,892
 
 
 
4,142
 
Total
 
$
13,434
 
 
$
10,729
 

Note 5. Acquisition

On February 2, 2012, Cutera acquired certain assets and liabilities of Iridex’s global aesthetics business unit for $5.1 million in cash. This business is engaged in developing, manufacturing, marketing and servicing laser-based medical systems and delivery devices. The business purpose of this transaction was to acquire access to an expanded installed base of customers, add to Cutera’s product offerings and acquire a recurring stream of service revenue. This acquisition was considered a business combination for accounting purposes, and as such, in addition to valuing all the assets, the Company recorded goodwill associated with the expected synergies from leveraging the customer relationships and integrating new product offerings into the Company’s 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. The customer relationship intangible assets are being amortized over 5 years on a straight-line basis. Other intangible assets are being amortized over 11 months to 5 years on a straight-line basis.
 
The recorded purchase price amounts are preliminary and subject to change as the Company is awaiting additional information related to inventory valuation.
 
The following table summarizes the fair value as of February 2, 2012 of the net assets acquired (in thousands):

Purchase price paid
 
$
5,091
 
         
Assets (liabilities acquired)
 
 
 
 
Inventory
 
 
1,552
 
Customer relationship intangible assets
 
 
2,510
 
Other identified intangible assets
   
780
 
Goodwill
 
 
1,339
 
Deferred service revenue
 
 
(780
)
Accrued warranty liability
 
 
(310
)
Total
 
$
5,091
 

 
10

 
Disclosure of the amounts of revenue and earnings of the asset and liabilities of the acquired Iridex aesthetics business is not practicable because the acquired business has been immediately integrated into Cutera's operations.

Note 6. Goodwill and Other Intangible Assets

Goodwill and other intangible assets comprise a patent sublicense acquired from Palomar in 2006; a technology sublicense acquired in 2002; and, intangible assets and goodwill related to the acquisition of Iridex’s aesthetic business unit. The components of intangible assets were as follows (in thousands):

 
 
March 31, 2012
 
 
 
Gross Carrying
Amount
 
 
Accumulated
Amortization
Amount
 
 
Net
Carrying
Amount
 
Patent sublicense
 
$
1,218
   
$
827
   
$
391
 
Technology sublicense
 
 
538
 
 
 
531
 
 
 
7
 
Customer relationship intangible related to acquisition
   
2,510
     
84
     
2,426
 
Other identified intangible assets related to acquisition
   
780
     
100
     
680
 
Goodwill
 
 
1,339
 
 
 
 
 
 
1,339
 
Total
 
$
6,385
 
 
$
1,542
 
 
$
4,843
 

 
 
December 31, 2011
 
 
 
Gross Carrying
Amount
 
 
Accumulated
Amortization
Amount
 
 
Net
Carrying
Amount
 
Patent sublicense
 
$
1,218
 
 
$
793
 
 
$
425
 
Technology sublicense
 
 
538
 
 
 
517
 
 
 
21
 
Total
 
$
1,756
 
 
$
1,310
 
 
$
446
 

Amortization expense for intangible assets was $232,000 and $48,000 for the three-month periods ended March 31, 2012 and 2011 respectively.

Based on intangible assets recorded at March 31, 2012, and assuming no subsequent additions to, or impairment of the underlying assets, the remaining estimated annual amortization expense is expected to be as follows (in thousands):

Fiscal Year Ending December 31,
 
Amount
 
2012 (remainder)
 
$
938
 
2013
 
 
696
 
2014
 
 
696
 
2015
 
 
569
 
2016
 
 
558
 
Thereafter
 
 
47
 
Total
 
$
3,504
 

Note 7. Warranty

The Company provides a standard one-year warranty on all systems. Warranty coverage provided is for labor and parts necessary to repair the systems during the warranty period. The Company accounts for the estimated warranty cost of the standard warranty coverage as a charge to costs of revenue when revenue is recognized. The estimated warranty cost is based on historical product performance. To determine the estimated warranty reserve, the Company utilizes actual service records to calculate the average service expense per system and applies this to the equivalent number of units exposed under warranty. The Company updates these estimated charges every quarter.
 
 
11


The following table provides the changes in the product warranty accrual for the three-month period ended March 31, 2012 (in thousands):

Beginning Balance – January 1, 2012
 
$
1,121
 
Add: Accruals for warranties issued during the period
 
 
754
 
Add: Warranties assumed with business acquisition
   
310
 
Less: Settlements made during the period
 
 
(851
)
Ending Balance –March 31, 2012
 
$
1,334
 

Note 8. Deferred Service Contract Revenue

Service contract revenue is recognized on a straight-line basis over the period of the applicable extended warranty contract.

The following table provides changes in deferred service contract revenue for the three-month period ended March 31, 2012 and 2011 (in thousands):

 
 
March 31
 
 
 
2012
   
2011
 
Beginning Balance
  $ 5,838     $ 6,765  
Add:           Payments received
    2,495       2,192  
Add:           Contract revenue assumed with business acquisition
    780        
Less:           Revenue recognized
    (2,571 )     (2,376 )
Ending Balance
  $ 6,542     $ 6,581  

Costs incurred under service contracts were $1.7 million for the three-month period ended March 31, 2012 and $1.1 million for the three-month period ended March 31, 2011 and are recognized as incurred.

Note 9. Stock-based Compensation Expense

Stock-based compensation expense by department recognized during the three-month periods ended March 31, 2012 and 2011 was as follows (in thousands):

 
 
Three Months Ended
 
 
 
March 31
 
 
 
2012
 
 
2011
 
Cost of revenue
 
$
143
 
 
$
143
 
Sales and marketing
 
 
140
 
 
 
238
 
Research and development
 
 
146
 
 
 
143
 
General and administrative
 
 
309
 
 
 
362
 
Total stock-based compensation expense
 
$
738
 
 
$
886
 
 
During the three-month period ended March 31, 2012, the Company issued 84,760 shares of common stock.
 
Note 10. Net Loss Per Share

Basic net loss per share is calculated by dividing net loss by the weighted-average number of common shares outstanding during the year. Diluted net loss per common share is the same as basic net loss per common share, as the effect of the potential common stock equivalents is anti-dilutive and as such is excluded from the calculations of the diluted net loss per share.

The following number of shares outstanding, prior to the application of the treasury stock method, were excluded from the computation of diluted net loss per common share for the periods presented because including them would have had an anti-dilutive effect (in thousands):

 
 
Three Months Ended
 
 
 
March 31
 
 
 
2012
 
 
2011
 
Options to purchase common stock
 
 
3,664
 
 
 
3,339
 
Restricted stock units
 
 
55
 
 
 
66
 
Employee stock purchase plan shares
 
 
25
 
 
 
22
 
Total
 
 
3,744
 
 
 
3,427
 

 
12


Note 11. Income Taxes

The Company’s income tax provision for the three months ended March 31, 2012 and 2011 was primarily related to income taxes of the Company’s non U.S. operations. The Company recorded a 100% valuation allowance against its U.S. deferred tax assets and as such did not record any income tax benefit related to its U.S. loss for the three-month periods ended March 31, 2012 and 2011.

For the three months ended March 31, 2012, the Company’s income tax provision was $97,000, compared to a provision of $32,000 for the three months ended March 31, 2011.

The Company utilizes the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. As of March 31, 2012 and December 31, 2011, the Company had a 100% valuation allowance against its U.S. deferred tax assets. Significant management judgment is required in determining any valuation allowance recorded against deferred tax assets. In evaluating the ability to recover deferred tax assets, the Company considered available positive and negative evidence giving greater weight to its recent cumulative losses and its ability to carry-back losses against prior taxable income and lesser weight to its projected financial results due to the challenges of forecasting future periods. The Company also considered, commensurate with its objective verifiability, the forecast of future taxable income including the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies.

As of March 31, 2012, there were no material changes to either the nature or the amounts of the uncertain tax positions previously determined and disclosed pursuant to FASB ASC Topic 740 as of December 31, 2011.

Note 12. Commitments and Contingencies

Purchase Commitments
The Company maintains certain open inventory purchase commitments with its suppliers to ensure a smooth and continuous supply for key components. The Company’s liability in these purchase commitments is generally restricted to a forecasted time-horizon as agreed between the parties. These forecasted time-horizons can vary among different suppliers. The Company’s open inventory purchase commitments with its suppliers were not significant at March 31, 2012.

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 22, 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.
 
 
13

 
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.
 
·
Recent Accounting Pronouncements. This section describes the issuance and effect of new accounting pronouncements that may be applicable to us.
 
·
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 six platforms — CoolGlide®, Xeo®, Solera®, GenesisPlusTM, Excel VTM and myQTM, 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 will be 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.

International sales are generally made through direct sales employees and a worldwide distributor network in over 35 countries. Outside of the United States, we have a direct sales presence in Australia, Canada, France, Japan, Spain, and the United Kingdom. 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) Radiesse® dermal filler product; and Obagi Medical Products, Inc.’s (Obagi) cosmeceutical products.

 
14

 
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.

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). As a result, our Upgrade revenue declined since 2009 but remained flat in the three-months ended March 31, 2012, compared to the same period in 2011.

We acquired Iridex’s aesthetic business unit in February 2012. This acquisition was the primary driver of the $545,000 increase in our Service revenue in the three-month period ended March 31, 2012, compared to the same period in 2011. We did not generate any material amount of Product revenue from this acquisition in the three months ended March 31, 2012 as we decided to discontinue the manufacturing and sale of several of the Iridex legacy product lines, except for the VariLite system. The VariLite is a small compact vascular product that complements our Excel V and other vascular products. Further, since the closing of the acquisition, we have trained our sales force and provided them with demonstration equipment for them to be able to sell this product. 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. The March 2011 earthquake and tsunami in Japan had a negative impact on our Japanese business and operations. 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.

 
15

 
Results of Operations

The following table sets forth selected consolidated financial data for the periods indicated, expressed as a percentage of total revenue, net.

 
 
Three Months Ended
 
 
 
March 31,
 
 
 
2012
 
 
2011
 
Operating Ratio:
 
 
 
 
 
 
Net revenue
 
 
100
%
 
 
100
%
Cost of revenue
 
 
50
%
 
 
45
%
Gross margin
 
 
50
%
 
 
55
%
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
Sales and marketing
 
 
47
%
 
 
51
%
Research and development
 
 
14
%
 
 
19
%
General and administrative
 
 
22
%
 
 
20
%
Total operating expenses
 
 
83
%
 
 
90
%
 
 
 
 
 
 
 
 
 
Loss from operations
 
 
(33
)%
 
 
(35
)%
Interest and other income, net
 
 
1
%
 
 
2
%
Loss before income taxes
 
 
(32
)%
 
 
(33
)%
Provision for income taxes
 
 
1
%
 
 
%
Net loss
 
 
(33
)%
 
 
(33
)%

Percentages in this table and throughout our discussion and analysis of financial condition and results of operations may reflect rounding adjustments.

Total Net Revenue
 
 
 
Three Months Ended March 31,
 
(Dollars in thousands)
 
2012
 
  % Change  
 
2011
 
Revenue mix by geography:
 
 
 
 
   
 
 
 
 
 
 
United States
 
$
6,311
 
   
50
%
 
$
4,207
 
International
 
 
9,416
 
   
27
%
 
 
7,414
 
Consolidated total revenue
 
$
15,727
 
   
35
%
 
$
11,621
 
 
 
 
 
 
   
 
 
 
 
 
 
United States as a percentage of total revenue
 
 
40
%
   
 
 
 
 
36
%
International as a percentage of total revenue
 
 
60
%
   
 
 
 
 
64
%
Revenue mix by product category:
 
 
 
 
   
 
 
 
 
 
 
Products
 
$
8,433
 
   
58
%
 
$
5,345
 
Upgrades
 
 
825
 
   
 
 
 
821
 
Service
 
 
3,873
 
   
16
%
 
 
3,328
 
Titan hand piece refills
 
 
1,130
 
   
7
%
 
 
1,057
 
Dermal fillers and cosmeceuticals
 
 
1,466
 
   
37
%
 
 
1,070
 
Consolidated total revenue
 
$
15,727
 
   
35
%
 
$
11,621
 

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 58%, in the three-month period ended March 31, 2012, compared to the same period in 2011. The increase in revenue was due primarily to the U.S. FDA clearance of our GenesisPlus system for toenail fungus in April 2011 and the commencement of Excel V shipments in the second quarter of 2011 as well as increases in Xeo sales due to promotional activity in Q1 of 2012.

 
16

 
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.

Upgrade revenue remained flat, in the three-month period ended March 31, 2012, compared to the same period in 2011. 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 and Excel V), which has resulted in a decline of our Upgrade revenue since 2009.

Service Revenue
Our worldwide Service revenue increased by $545,000, or 16%, in the three-month period ended March 31, 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 $73,000 or 7% in the three-month period ended March 31, 2012, compared to the same period in 2011. This increase was due primarily to the growth in Titan refill revenue in Japan.

Dermal Filler and Cosmeceuticals Revenue
Our Dermal fillers and cosmeceuticals revenue increased by $396,000, or 37%, in the three-month period ended March 31, 2012, compared to the same period in 2011. This increase was due primarily to the higher number of customers purchasing Obagi products, which we began distributing in Japan in the first quarter of 2010, and due to the expansion of product lines being distributed.

Discussion of Revenue by Geography:

U.S. Revenue
Our U.S. revenue increased by $2.1 million, or 50%, in the three-month period ended March 31, 2012, compared to the same period in 2011. This increase was primarily attributable to an increase in Product revenue due to the:
 
·
FDA clearance of our GenesisPlus system for onychomycosis, or toenail fungus, in April 2011;
 
·
Commencement of Excel V shipments in the second quarter of 2011; and
 
·
Increased sales of our Xeo platform.

Intern