Edgar Filing: CUTERA INC

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

¨	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	Financial Statements (unaudited)	3
	Condensed Consolidated Balance Sheets	3
	Condensed Consolidated Statements of Operations	4
	Condensed Consolidated Statements of Comprehensive Income (Loss)	5
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3	Quantitative and Qualitative Disclosures About Market Risk	21
Item 4	Controls and Procedures	21

PART II	OTHER INFORMATION

Item 1	Legal Proceedings	21
Item 1A	Risk Factors	22
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	32
Item 3	Defaults Upon Senior Securities	33
Item 4	Mine Safety Disclosures	33
Item 5	Other Information	33
Item 6	Exhibits	34
	Signature	35

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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.

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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.

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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.

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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.

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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.”

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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

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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

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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

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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.

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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

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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.

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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.

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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.

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Results of Operations

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

	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.

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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.

Internat