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 June 30, 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 July 31, 2012 was 14,125,094.
 
 
 
 
 
CUTERA, INC.

FORM 10-Q

TABLE OF CONTENTS

 
 
Page
PART I
FINANCIAL INFORMATION
 
 
 
 
Item 1
3
 
3
 
4
 
5
 
6
 
7
Item 2
14
Item 3
23
Item 4
23
 
 
 
PART II
OTHER INFORMATION
 
 
 
 
Item 1
24
Item 1A
24
Item 2
35
Item 3
35
Item 4
35
Item 5
35
Item 6
36
 
37

 
2

PART I. FINANCIAL INFORMATION

ITEM 1.

CUTERA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)
 
 
 
June 30,
2012
(unaudited)
 
 
December
31, 2011
(audited)
 
Assets
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 
$
17,788
 
 
$
14,020
 
Marketable investments
 
 
62,794
 
 
 
74,666
 
Accounts receivable, net
 
 
6,203
 
 
 
5,193
 
Inventories
 
 
12,722
 
 
 
10,729
 
Deferred tax asset
 
 
52
 
 
 
55
 
Other current assets and prepaid expenses
 
 
1,443
 
 
 
1,432
 
Total current assets
 
 
101,002
 
 
 
106,095
 
 
 
 
 
 
 
 
 
 
Property and equipment, net
 
 
946
 
 
 
853
 
Long-term investments
 
 
840
 
 
 
3,027
 
Deferred tax asset, net of current portion
 
 
463
 
 
 
446
 
Intangibles, net
 
 
3,186
 
 
 
446
 
Goodwill
    
1,339
      
—
  
Other long-term assets
 
 
539
 
 
 
486
 
Total assets
 
$
108,315
 
 
$
111,353
 
 
 
 
 
 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
Accounts payable
 
$
2,199
 
 
$
2,573
 
Accrued liabilities
 
 
9,382
 
 
 
9,262
 
Deferred revenue
 
 
6,285
 
 
 
5,185
 
Total current liabilities
 
 
17,866
 
 
 
17,020
 
 
 
 
 
 
 
 
 
 
Deferred rent
 
 
1,400
 
 
 
1,448
 
Deferred revenue, net of current portion
 
 
905
 
 
 
840
 
Income tax liability
 
 
469
 
 
 
478
 
Total liabilities
 
 
20,640
 
 
 
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: 14,124,678 and 13,948,395 shares at June 30, 2012 and December 31, 2011, respectively
 
 
14
 
 
 
14
 
Additional paid-in capital
 
 
98,044
 
 
 
95,719
 
Accumulated deficit
 
 
(10,058
)
 
 
(3,325
 )
Accumulated other comprehensive loss
 
 
(325
)
 
 
(841
)
Total stockholders’ equity
 
 
87,675
 
 
 
91,567
 
Total liabilities and stockholders’ equity
 
$
108,315
 
 
$
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
 
 
Six Months Ended
 
 
 
June 30,
 
 
June 30,
 
 
 
2012
 
 
2011
 
 
2012
 
 
2011
 
Net revenue:
 
    
 
 
    
 
 
    
 
 
    
 
Products
 
$
15,156
 
 
$
11,301
 
 
$
27,010
 
 
$
19,594
 
Service
 
  
4,435
 
 
  
3,594
 
 
  
8,308
 
 
 
6,922
 
Total net revenue
 
 
19,591
 
 
 
14,895
 
 
 
35,318
 
 
 
26,516
 
Cost of revenue:
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
Products
 
 
6,968
 
 
 
4,210
 
 
 
12,619
 
 
 
7,498
 
Service
 
 
2,306
 
 
 
2,266
 
 
 
4,500
 
 
 
4,202
 
Total cost of revenue
 
 
9,274
 
 
 
6,476
 
 
 
17,119
 
 
 
11,700
 
Gross profit
 
 
10,317
 
 
 
8,419
 
 
 
18,199
 
 
 
14,816
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
 
 
7,112
 
 
 
6,348
 
 
 
14,549
 
 
 
12,294
 
Research and development
 
 
1,872
 
 
 
2,346
 
 
 
4,088
 
 
 
4,476
 
General and administrative
 
 
2,854
 
 
 
2,588
 
 
 
6,349
 
 
 
4,916
 
Total operating expenses
 
 
11,838
 
 
 
11,282
 
 
 
24,986
 
 
 
21,686
 
Loss from operations
 
 
(1,521
)
 
 
(2,863
)
 
 
(6,787
)
 
 
(6,870
)
Interest and other income, net
 
 
144
 
 
 
199
 
 
 
240
 
 
 
383
 
Loss before income taxes
 
 
(1,377
)
 
 
(2,664
)
 
 
(6,547
)
 
 
(6,487
)
Provision (benefit) for income taxes
 
 
89
  
 
 
(208
)
 
 
186
  
 
 
(176
)
Net loss
 
$
(1,466
)
 
$
(2,456
)
 
$
(6,733
)
 
$
(6,311
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic and Diluted
 
$
(0.10
)
 
$
(0.18
)
 
$
(0.48
)
 
$
(0.46
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted-average number of shares used in per share calculations:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic and Diluted
 
 
14,095
 
 
 
13,765
 
 
 
14,027
 
 
 
13,716
 
 
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
 
 
Six Months Ended
 
 
 
June 30,
 
 
June 30,
 
 
 
2012
 
 
2011
 
 
2012
 
 
2011
 
Net loss
 
$
(1,466
)
 
$
(2,456
)
 
$
(6,733
)
 
$
(6,311
)
Other comprehensive income:
 
    
 
 
    
 
 
    
 
 
    
 
Net change in unrealized gain on available-for-sale securities
 
  
373
 
 
  
510
 
 
  
536
 
 
 
690
 
Provision (benefit) for income taxes related to items of other comprehensive income
 
 
(17
)
 
 
68
 
 
 
20
 
 
 
68
 
Other comprehensive income, net of tax
 
 
390
 
 
 
442
 
 
 
516
 
 
 
622
 
Comprehensive loss
 
$
(1,076
)
 
$
(2,014
)
 
$
(6,217
)
 
$
(5,689
)
 
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)
 
 
 
Six Months Ended
 
 
 
June 30,
 
 
 
2012
 
 
2011
 
Cash flows from operating activities:
 
 
 
 
 
 
Net loss
 
$
(6,733
)
 
$
(6,311
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
 
 
 
 
Stock-based compensation
 
 
1,525
 
 
 
2,211
 
    Tax benefit from stock-based compensation    
—
        16  
    Excess tax benefit related to stock-based compensation    
—
        (16 ) 
Depreciation and amortization
 
 
768
 
 
 
319
 
Other
 
 
—
  
 
 
(35
)
Changes in assets and liabilities:
 
 
 
 
 
 
 
 
Accounts receivable
 
 
(1,057
)
 
 
936
  
Inventories
 
 
(441
)
 
 
(1,853
)
Other current assets and prepaid expenses
 
 
503
 
 
 
1,439
 
Other long-term assets
    
(53
)
    
—
  
Accounts payable
 
 
(374
)
 
 
884
 
Accrued liabilities
 
 
(241
)
 
 
675
  
Deferred rent
 
 
3
  
 
 
(6
)
Deferred revenue
 
 
385
  
 
 
(548
)
Income tax liability
 
 
(9
)
 
 
17
  
Net cash used in operating activities
 
 
(5,724
)
 
 
(2,272
)
 
 
 
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
 
 
Acquisition of property and equipment
 
 
(311
)
 
 
(397
)
Business acquisition
    
(5,091
)
    
—
  
Proceeds from sales of marketable and long-term investments
 
 
17,795
 
 
 
10,441
 
Proceeds from maturities of marketable investments
 
 
19,835
 
 
 
28,436
 
Purchase of marketable investments
 
 
(23,536
)
 
 
(32,125
)
Net cash provided by investing activities
 
 
8,692
 
 
 
6,355
 
 
 
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
 
 
 
Proceeds from exercise of stock options and employee stock purchase plan
 
 
800
 
 
 
865
 
Excess tax benefit related to stock-based compensation
 
 
—
 
 
 
16
 
Net cash provided by financing activities
 
 
800
 
 
 
881
 
 
 
 
 
 
 
 
 
 
Net increase in cash and cash equivalents
 
 
3,768
 
 
 
4,964
  
Cash and cash equivalents at beginning of period
 
 
14,020
 
 
 
12,519
 
Cash and cash equivalents at end of period
 
$
17,788
 
 
$
17,483
 
 
 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 ExcelV 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):

June 30, 2012
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Market Value
 
Cash and cash equivalents:
 
    
 
 
    
 
 
    
 
 
    
 
Cash
 
$
2,244
 
 
$
—
 
 
$
—
 
 
$
2,244
 
Money market funds
 
  
12,919
 
 
  
—
 
 
  
—
 
 
  
12,919
 
Commercial paper
 
 
2,625
 
 
 
—
 
 
 
—
 
 
 
2,625
 
Total cash and cash equivalents
 
 
17,788
 
 
 
—
 
 
 
—
 
 
 
17,788
 
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
Marketable securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government notes
 
 
1,600
 
 
 
2
 
 
 
—
 
 
 
1,602
 
U.S. government agencies
 
 
32,376
 
 
 
43
 
 
 
(4
)
 
 
32,415
 
Municipal securities
 
 
5,733
 
 
 
38
 
 
 
(1
)
 
 
5,770
 
Commercial paper
 
 
3,926
 
 
 
1
 
 
 
—
 
 
 
3,927
 
Corporate debt securities
 
 
19,072
 
 
 
21
 
 
 
(13
)
 
 
19,080
 
Total marketable investments
 
 
62,707
 
 
 
105
 
 
 
(18
)
 
 
62,794
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Long-term investment in auction rate securities
 
 
1,200
 
 
 
—
 
 
 
(360
)
 
 
840
 
Total cash, cash equivalents, marketable investments and long-term investments
 
$
81,695
 
 
$
105
 
 
$
(378
)
 
$
81,422
 
 
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 auction rate securities
 
 
3,900
 
 
 
—
 
 
 
(873
)
 
 
3,027
 
Total cash, cash equivalents, marketable investments and long-term investments
 
$
92,522
 
 
$
114
 
 
$
(923
)
 
$
91,713
 

As of June 30, 2012 and December 31, 2011, the total gross unrealized losses were $378,000 and $923,000 respectively and were primarily related to long-term investments in auction rate securities (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 $12.2 million of ARS were redeemed at full par value. The maturity date for the one remaining ARS investment in the Company’s portfolio is 2041.
 
 
8

The following table summarizes the estimated fair value of our securities available-for-sale and classified as cash and cash equivalents, marketable investments and long-term investments classified by the contractual maturity date of the security as of June 30, 2012 (in thousands):
 
 
 
Amount
 
Due in less than one year
 
$
33,044
 
Due in 1 to 3 years
 
 
32,375
 
Due in 3 to 5 years
 
 
—
 
Due in 5 to 10 years
 
 
—
 
Due in greater than 10 years
 
 
840
 
 
 
$
66,259
 

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 June 30, 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):

June 30, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Cash equivalents:
 
    
 
 
    
 
 
    
 
 
    
 
Money market funds
 
$
12,919
 
 
 
—
 
 
 
—
 
 
$
12,919
 
Commercial paper
 
 
—
 
 
 
2,625
 
 
 
—
 
 
 
2,625
 
Short-term marketable investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government notes
 
 
—
 
 
 
1,602
 
 
 
—
 
 
 
1,602
 
U.S. government agencies
 
 
—
 
 
 
32,415
 
 
 
—
 
 
 
32,415
 
Municipal securities
 
 
—
 
 
 
5,770
 
 
 
—
 
 
 
5,770
 
Commercial paper
 
 
—
 
 
 
3,927
 
 
 
—
 
 
 
3,927
 
Corporate debt securities
 
 
—
 
 
 
19,080
 
 
 
—
 
 
 
19,080
 
Long-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Available-for-sale auction rate securities
 
 
—
 
 
 
—
 
 
 
840
 
 
 
840
 
Total assets at fair value
 
$
12,919
 
 
$
65,419
 
 
$
840
 
 
$
79,178
 
 
 
9
 
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 auction rate securities
 
 
—
 
 
 
—
 
 
 
3,027
 
 
 
3,027
 
Total assets at fair value
 
$
7,318
 
 
$
79,215
 
 
$
3,027
 
 
$
89,560
 
 
The Company’s Level 2 investments include U.S. government-backed securities and corporate securities that are valued based upon observable inputs that may include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data including market research publications. The average remaining maturity of the Company’s Level 2 investments as of June 30, 2012 is less than 36 months and all of these investments are rated by S&P and Moody’s at A or better except for one security with a fair value of $450,000 which was rated as A when purchased but was downgraded and rated as BBB+.

At June 30, 2012, observable market information was not available to determine the fair value of the Company’s ARS investments. Therefore, the fair value was 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 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 is subject to uncertainties that are difficult to predict. Factors that may impact the valuation in the future include changes to credit ratings of the security, as well as to the underlying assets supporting that security, rates of default of the underlying assets, underlying collateral value, discount rates, counterparty risk and ongoing strength and quality of market credit and liquidity. This financial instrument is 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 June 30, 2012 (in thousands):

 
 
  
 
Balance at December 31, 2011
 
$
3,027
 
Total gains and losses included in other comprehensive loss
 
 
513
 
Settlements
 
  
(2,700
)
Balance at June 30, 2012
 
$
840
 

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

 
 
June 30, 2012
 
 
December 31, 2011
 
Raw materials
 
$
7,533
 
 
$
6,587
 
Finished goods
 
 
5,189
 
 
 
4,142
 
Total
 
$
12,722
 
 
$
10,729
 
 
 
10
 
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 from the date of acquisition 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 and experience with respect to inventory usage.
 
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
 

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):

 
 
June 30, 2012
 
 
 
Gross
Carrying
Amount
 
 
Accumulated
Amortization
Amount
 
 
Net
Carrying
Amount
 
Patent sublicense
  
$
1,218
    
$
862
    
$
356
  
Technology sublicense
 
  
538
 
 
  
538
 
 
  
—
 
Customer relationship intangible related to acquisition
    
2,510
      
209
      
2,301
  
Other identified intangible assets related to acquisition
    
780
      
251
      
529
  
Goodwill
 
 
1,339
 
 
 
—
 
 
 
1,339
 
Total
 
$
6,385
 
 
$
1,860
 
 
$
4,525
 
 
 
11
 
 
 
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 $549,000 and $96,000 for the six-month periods ended June 30, 2012 and 2011 respectively.

Based on intangible assets recorded at June 30, 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)
 
$
620
 
2013
 
 
696
 
2014
 
 
696
 
2015
 
 
569
 
2016
 
 
558
 
Thereafter
 
 
47
 
Total
 
$
3,186
 

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.

The following table provides the changes in the product warranty accrual for the six-month period ended June 30, 2012 (in thousands):

Beginning Balance – December 31, 2011
 
$
1,121
 
Add: Accruals for warranties issued during the period
 
 
1,743
 
Add: Warranties assumed with business acquisition
    
310
  
Less: Settlements made during the period
 
 
(1,935
)
Ending Balance –June 30, 2012
 
$
1,239
  

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.
 
 
12

The following table provides changes in deferred service contract revenue for the six-month period ended June 30, 2012 and 2011 (in thousands):
 
 
 
June 30
 
 
 
2012
 
2011
 
Beginning Balance
 
$
5,838
 
 
$
6,765
 
Add:  Payments received
 
 
6,033
  
 
 
4,226
 
Add:  Contract revenue assumed with business acquisition
 
 
780
 
 
 
—
 
Less:  Revenue recognized
 
 
(5,645
)
 
 
(4,749
)
Ending Balance
 
$
7,006
 
 
$
6,242
 

Costs incurred under service contracts were $3.6 million for the six-month period ended June 30, 2012 and $2.3 million for the six-month period ended June 30, 2011 and are recognized as incurred.

Note 9.
Stock-based Compensation Expense

Stock-based compensation expense by department recognized during the three and six-month periods ended June 30, 2012 and 2011 was as follows (in thousands):
 
 
 
Three Months Ended
 
 
Six Months Ended
 
 
 
June 30,
 
 
June 30,
 
 
 
2012
 
 
2011
 
 
2012
 
 
2011
 
Cost of revenue
 
$
168
 
 
$
183
 
 
$
311
 
 
$
326
 
Sales and marketing
 
 
159
 
 
 
177
 
 
 
299
 
 
 
415
 
Research and development
 
 
147
 
 
 
197
 
 
 
293
 
 
 
340
 
General and administrative
 
 
313
 
 
 
768
 
 
 
622
 
 
 
1,130
 
Total stock-based compensation expense
 
$
787
 
 
$
1,325
 
 
$
1,525
 
 
$
2,211
 

Under the 2004 Equity Incentive Plan, the Company issued 176,283 shares of common stock during the six-month period ended June 30, 2012, in conjunction with stock options exercised, restricted stock units released and purchases associated with the Employee Stock Purchase Plan.

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
 
 
Six Months Ended
 
 
 
June 30,
 
 
June 30,
 
 
 
2012
 
 
2011
 
 
2012
 
 
2011
 
Options to purchase common stock
 
 
3,463
 
 
 
3,520
 
 
 
3,564
 
 
 
3,430
 
Restricted stock units
 
 
51
 
 
 
65
 
 
 
53
 
 
 
65
 
Employee stock purchase plan shares
 
 
53
 
 
 
46
 
 
 
53
 
 
 
46
 
Total
 
 
3,567
 
 
 
3,631
 
 
 
3,670
 
 
 
3,541
 
 
Note 11.
Income Taxes

The Company’s income tax provision for the three and six-month periods ended June 30, 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 and six-month periods ended June 30, 2012 and 2011.
 
 
13

For the three and six months ended June 30, 2012, the Company’s income tax provision was $89,000 and $186,000, compared to a benefit of $208,000 and $176,000 for the three and six months ended June 30, 2011. The income tax benefit for the three and six-month periods ended June 30, 2011 was primarily related to the carryback of fiscal year 2010 federal losses to obtain a $246,000 refund of alternative minimum taxes paid for fiscal year 2008, reduced by the tax impact of the Company’s non-U.S. operations.

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 June 30, 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 June 30, 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 June 30, 2012.

Litigation and Litigation Settlements
The Company is named from time to time as a party to product liability and contractual lawsuits in the normal course of business. The Company routinely assesses the likelihood of any adverse judgments or outcomes related to legal matters and claims, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after analysis of each known issue, historical experience, whether it is more likely than not that the Company shall incur a loss, and whether the loss is estimable. As of June 30, 2012, the Company had accrued $449,000 related to pending product liability and contractual lawsuits.
 
ITEM 2.

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 24, 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.
 
 
14
 
Introduction

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