CUTERA INC MANAGEMENT REPORT AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS (Form 10-Q)
This Management's Discussion and Analysis should be read in conjunction with the Company's financial condition and results of operations in conjunction with the Company's unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and the Company's audited financial statements and notes thereto for the year ended
December 31, 2021, included in its annual report on Form 10-K filed with the U.S. Securities and Exchange Commission("SEC") on March 1, 2022.
Unless otherwise indicated, all reported results are prepared in a manner that conforms, in all material respects, to generally accepted accounting principles in
Special note regarding forward-looking statements
This report contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed in the forward-looking statements. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended, ("the Exchange Act"). Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "plan," "project," "seek," "should," "strategy," "target," "will," "would" and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of the Company's management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section titled "Risk Factors" included under Part II, Item 1A below. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, the Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Introduction
The management report, or management report, is organized as follows:
•Executive Summary. This section provides a general description and history of the Company's business, a brief discussion of its product lines and the opportunities, trends, challenges and risks the Company focuses on in the operation of its 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 the Company's analysis and outlook for the significant line items on its condensed consolidated statements of operations. •Liquidity and Capital Resources. This section provides an analysis of the Company's liquidity and cash flows, as well as a discussion of its commitments that existed as of
June 30, 2022.
The Company is a leading provider of aesthetic and dermatology solutions for practitioners worldwide. In addition to internal development of products, the Company distributes third party sourced products. The Company offers easy-to-use products that enable medical practitioners to perform safe and effective procedures, including treatment for acne, body contouring, skin resurfacing and revitalization, tattoo removal, removal of benign pigmented lesions, vascular conditions, and hair removal. The Company's platforms are designed to be easily upgraded to add additional applications and hand pieces, which provide flexibility for the Company's customers as they expand their practices. 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, hand piece refills and other per procedure related revenue on select systems and distribution of third-party manufactured skincare products. The Company also expands its revenues from sales of third-party skincare products by utilizing its network and relationships with physicians and practitioners. 29
The Company's ongoing research and development activities primarily focus on developing new products, as well as improving and enhancing the Company's portfolio of existing products. The Company also explores ways to expand the Company's product offerings through alternative arrangements with other companies, such as distribution arrangements. The Company introduced Secret RF, a fractional RF microneedling device for skin revitalization, in
January 2018, enlighten SR in April 2018, truSculpt iD in July 2018, excel V+ in February 2019, truSculpt flex in June 2019, Secret PRO in July 2020, excel V+III during the fourth quarter of 2020, and AviClear in April 2022. The Company's corporate headquarters and U.S.operations are located in Brisbane, California, where the Company conducts manufacturing, warehousing, research and development, regulatory, sales and marketing, service, and administrative activities. The Company markets sells and services the Company's products through direct sales and service employees in North America(including Canada), Australia, Austria, Belgium, France, Germany, Hong Kong, Japan, Netherlands, Spain, Switzerlandand the United Kingdom. Sales and Services outside of these direct markets are made through a worldwide distributor network in over 42 countries. Products and Services The Company derives revenue from the sale of Products and Services. Product revenue includes revenue from the sale of systems, hand pieces and upgrade of systems (collectively "Systems" revenue), replacement hand pieces, truSculpt iD cycle refills, and truSculpt flex cycle refills, as well as single use disposable tips applicable to Secret RF and Secret PRO ("Consumables" revenue), and the sale of third party manufactured skincare products ("Skincare" revenue). A system consists of a console that incorporates a universal graphic user interface, a laser and or other energy-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 other energy-based module is sometimes contained in the hand piece. The Company offers 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 choose and provides the Company with a source of additional Systems revenue. The Company's primary system platforms include excel, enlighten, Secret RF, truSculpt and xeo.
AviClear is a laser treatment that offers a safe, prescription-free solution for acne. In addition to reducing existing acne, clinical trials show that future breakout episodes are shorter, less intense, and more infrequent following the AviClear procedure. Further, acne clearance results continue to improve over time, demonstrating the long-term efficacy of this novel treatment. Importantly, no pain mitigation was utilized or required by any clinical study participant. Acne vulgaris is a nearly universal skin disease, with approximately 50 million North American teens and young adults seeking treatment each year. Overproduction of sebum by the sebaceous glands is one of the leading causes of acne. AviClear tackles acne at the source by selectively targeting the sebocytes and suppressing sebum production. This product is a 1726 nm laser device designed to treat inflammatory acne vulgaris. AviClear delivers optimal therapeutic energy in conjunction with the AviCool feature to ensure safety and scalability of the procedure across all skin types and acne severities. AviClear is currently available in a limited commercial capacity in the
U.S.and the Company expects a full commercial launch by the end of the current calendar year. Skincare revenue relates to the distribution of ZO's skincare products in Japan. The skincare products are purchased from a third-party manufacturer and sold to medical offices and licensed physicians. The Company acts as the principal in this arrangement, as the Company determines the price to charge customers for the skincare products and controls the products before they are transferred to the customer.
Services revenue includes prepaid service contracts, customer marketing support and labor on out-of-warranty products.
Important Business Trends
The Company believes that its ability to grow revenue will be primarily dependent on the following: •the successful commercialization of AviClear •continuing to expand the Company's product offerings, both through internal development and sourcing from other vendors; •ongoing investment in the Company's global sales and marketing infrastructure; •use of clinical results to support new aesthetic products and applications; 30 -------------------------------------------------------------------------------- Table of Contents •enhanced physician development and reference selling efforts (to develop a location where Company's products can be displayed and used to assist in selling efforts); •customer demand for the Company's products; •consumer demand for the application of the Company's products; •marketing to those practitioners focused on aesthetic and dermatological conditions; and •generating recurring revenue from the Company's growing installed base of customers through the sale of system upgrades, services, hand piece refills, truSculpt cycles, skincare products and replacement tips for the Secret RF product.
For a detailed discussion of significant business trends affecting its business, please see the section entitled “Results of Operations” below.
Factors that may affect future performance
The Company's industry is impacted by numerous competitive, regulatory and other significant factors. The Company's industry is highly competitive and the Company's future performance depends on the Company's ability to compete successfully. Additionally, the Company's future performance is dependent upon the ability to continue to expand the Company's product offerings with innovative technologies, obtain regulatory clearances for the Company's products, protect the proprietary technology of the products and manufacturing processes, manufacture the products cost-effectively, and successfully market and distribute the products in a profitable manner. If the Company fails to execute on the aforementioned initiatives, the Company's business would be adversely affected.
The Company supports any reasonable action that helps ensure patient safety in the future. The company has a robust, multi-functional process that reviews its claims and promotional materials to ensure they are truthful, not misleading, fair and balanced, and backed by solid scientific evidence.
A detailed discussion of these and other factors that could impact the Company's future performance are provided in (1) the Company's Annual Report on Form 10-K for the year ended
December 31, 2021- Part I, Item 1A "Risk Factors," and (2) other announcements the Company makes from time to time.
Risks and uncertainties
The COVID-19 outbreak and related variants have negatively affected
the United Statesand global economies. The spread of the coronavirus has impacted the global economy broadly from 2020, including restrictions on travel, shifting work forces to work remotely and quarantine policies put into place by businesses and governments, and had a material economic effect on the Company's business during the years ended December 31, 2020and 2021. Healthcare facilities in many countries effectively banned elective procedures and this had a significant impact on the Company. Many of the Company's products are used in aesthetic elective procedures and as such, the bans on elective procedures substantially reduced the Company's sales and marketing efforts during the pandemic and led the Company to implement cost control measures. Although the Company's operation and results of operations have significantly improved as the economic outlook improved in 2021 and into 2022, the COVID-19 outbreak continues to be fluid, and the aftermath of the business and economic disruptions due to the COVID-19 is still uncertain, making it difficult to forecast the final impact it could have on the Company's future operations, including disruptions in the Company's supply chain and contract manufacturing operations. The Company cannot presently predict the scope and severity of any impacts in future periods from business shutdowns or disruptions due to the COVID-19 pandemic, but the impact on economic activity including the possibility of recession or financial market instability could have a material adverse effect on the Company's business, revenue, operating results, cash flows and financial condition. In addition the world is currently experiencing widespread inflation. Household budgets are tight and cash is generally being conserved and spent on essential items like housing, gas, food, clothing and healthcare. Given the inflationary environment, fewer funds may be spent on aesthetic treatments, which may translate into less demand for our products and less revenue as a result. The Company continues to assess whether any impairment of its goodwill or its long-lived assets has occurred and has determined that no charges were necessary during the three and six months ended June 30, 2022. The Company will continue to monitor future conditions important to its assessment of potential impairment of its long-lived assets and goodwill, including the impacts of the COVID-19 pandemic and other ongoing impacts which are subject to uncertainty. In 2021, the Company experienced a significant increase in sales of skincare products under the exclusive distribution agreement with ZO Skin Health, Inc., which allows the Company to sell ZO's skincare products in Japan. The reason for the increase in skincare products sales may have been the result of the COVID-19 pandemic changing customers' spending habits, resulting in customers purchasing aesthetic treatments that were able to be applied at home, due to limitations on in-person 31
aesthetic procedures. Future growth in sales of skincare products depends on customers maintaining spending habits adopted during the COVID-19 pandemic. If customers revert to original spending habits after the COVID-19 pandemic, such changes may have a material adverse effect on the Company's revenue, operating results, and cash flows.
Critical Accounting Policies, Significant Judgments and Use of Estimates
The preparation of the Company's consolidated financial statements and related notes requires the Company to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company has based its estimates on historical experience and on various other assumptions that the Company believes to be reasonable under the circumstances. The Company periodically reviews its estimates and makes adjustments when facts and circumstances dictate. To the extent that there are material differences between these estimates and actual results, its financial condition or results of operations will be affected. An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. The Company believes that its critical accounting policies reflect the more significant estimates and assumptions used in the preparation of its audited consolidated financial statements. The accounting policies and estimates that the Company considers 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 its Annual Report on Form 10-K for the year ended
December 31, 2021filed with the SECon March 1, 2022. There have been no new or material changes to the significant accounting policies discussed in the Company's Annual Report on Form 10-K that are of significance, or potential significance, to the Company.
The Company has established new accounting policies to account for the 2.25% Senior Convertible Bonds due 2026 (the “2026 Bonds” and, together with the 2028 Bonds, the “Convertible Bonds”) and related transactions during the first quarter 2021.
The Company issued
$138.3 millionof 2026 Notes in a private placement offering in March 2021. In May 2022, the Company issued an additional $240.0 millionof convertible notes in a further private placement offering. Also in May 2022, the Company extinguished $69.1 millionof the $138.3 millionprincipal balance of the convertible notes issued in 2021. The notes issued in 2021 and 2022 each bear interest at a rate of 2.25% per year. In accordance with ASU 2020-06, the Company recorded the Convertible Notes in long-term debt with no separation between the notes and the conversion option. Each reporting period, the Company will determine whether any criteria are met for the note holders to have the option to redeem the notes early. To the extent there are any conversion requests, the Company intends to settle such conversion requests in shares of common stock. Therefore, the convertible notes have been included as Long-term debt on the condensed consolidated balance sheet. The issuance costs related to the Convertible Notes are presented in the balance sheet as a direct deduction from the carrying amount of the Convertible Notes. See Note 13 of the unaudited condensed consolidated financial statements included in Item I, Part 1 of this Quarterly Report on Form 10-Q. 32
The following table sets forth selected consolidated financial data for the periods indicated, expressed as a percentage of total net revenue. Percentages in this table and throughout its discussion and analysis of financial condition and results of operations may reflect rounding adjustments. Three Months Ended Six Months Ended June 30, June 30, 2022 2021 2022 2021 Net revenue 100 % 100 % 100 % 100 % Cost of revenue 45 % 42 % 45 % 43 % Gross margin 55 % 58 % 55 % 57 % Operating expenses: Sales and marketing 42 % 31 % 42 % 31 % Research and development 11 % 8 % 11 % 8 % General and administrative 18 % 14 % 20 % 15 % Total operating expenses 70 % 54 % 74 % 54 % (Loss) income from operations (16) % 4 % (19) % 3 % Amortization of debt issuance costs - % - % - % - % Interest on convertible notes (2) % (1) % (2) % (1) % Loss on extinguishment of convertible notes (54) % - % (28) % - % Gain on extinguishment of PPP loan - % 12 % - % 7 % Other expense, net (2) % (1) % (2) % (1) % (Loss) income before income taxes (74) % 13 % (51) % 7 % Income tax (benefit) expense - % - % - % - % Net (loss) income (74) % 13 % (51) % 7 % Revenue The timing of the Company's revenue is significantly affected by the mix of system products, training, consumables and extended service contracts. The revenue generated in any given period is also impacted by whether the revenue is recognized over time or at a point in time. For an additional description on revenue, see Note 1 in the notes to consolidated financial statements on the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2021and Note 7 to the unaudited condensed consolidated financial statements included in Item I, Part 1 of this Quarterly Report on Form 10-Q. Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for promised goods or services. The Company's performance obligations are satisfied either over time or at a point in time. Revenue from performance obligations that are transferred to customers over time accounted for approximately 8% and 18% of the Company's total revenue for the six months ended June 30, 2022and 2021, respectively. Revenue recognized over time relates to revenue from the Company's extended service contracts and marketing services. Revenue recognized upon delivery is primarily generated by the sales of systems, consumables and skincare. 33
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