UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 20172018
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.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’sRegistrant’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 ☒ No ☐
Indicate by check mark whether the registrantregistrant 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 ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large“large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ | Accelerated filer ☒ | Non-accelerated filer ☐ | Smaller reporting company ☐ | Emerging growth company ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accountingaccounting standards provided pursuant to Section 13(a) of the Exchange Act.☐
IndicateIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ☐ No ☒
The number of shares of Registrant’sRegistrant’s common stock issued and outstanding as of April 30, 20172018, was 13,858,651.13,634,482
CUTERA, INC.
FORM 10-Q
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PART I |
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Item 1 | 3 | |
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| Condensed Consolidated Statements of Comprehensive | 5 |
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Item 2 |
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Item 3 |
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Item 4 |
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PART II |
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Item 1 |
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Item 1A |
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Item 2 |
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Item 3 |
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Item 4 |
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Item 5 |
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Item 6 |
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FINANCIAL STATEMENTS |
CUTERA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands,, except share and per share datadata))
(unaudited)
March 31, 2017 | December 31, 2016 | March 31, | December 31, 2017 | |||||||||||||
Assets | ||||||||||||||||
Current assets: | ||||||||||||||||
Cash and cash equivalents | $ | 11,443 | $ | 13,775 | $ | 10,910 | $ | 14,184 | ||||||||
Marketable investments | 36,990 | 40,299 | 13,062 | 21,728 | ||||||||||||
Accounts receivable, net | 17,859 | 16,547 | 19,862 | 20,777 | ||||||||||||
Inventories | 15,672 | 14,977 | 30,979 | 28,782 | ||||||||||||
Other current assets and prepaid expenses | 2,403 | 2,251 | 2,601 | 2,903 | ||||||||||||
Total current assets | 84,367 | 87,849 | 77,414 | 88,374 | ||||||||||||
Property and equipment, net | 1,802 | 1,907 | 2,214 | 2,096 | ||||||||||||
Deferred tax asset | 394 | 377 | 21,792 | 19,055 | ||||||||||||
Intangibles, net | — | 2 | ||||||||||||||
Goodwill | 1,339 | 1,339 | 1,339 | 1,339 | ||||||||||||
Other long-term assets | 389 | 380 | 5,367 | 374 | ||||||||||||
Total assets | $ | 88,291 | $ | 91,854 | $ | 108,126 | $ | 111,238 | ||||||||
Liabilities and Stockholders' Equity | ||||||||||||||||
Current liabilities: | ||||||||||||||||
Accounts payable | $ | 3,089 | $ | 2,598 | $ | 8,206 | $ | 7,002 | ||||||||
Accrued liabilities | 14,950 | 17,397 | 20,083 | 26,848 | ||||||||||||
Deferred revenue | 8,275 | 8,394 | 8,847 | 9,461 | ||||||||||||
Total current liabilities | 26,314 | 28,389 | 37,136 | 43,311 | ||||||||||||
Deferred revenue, net of current portion | 1,801 | 1,705 | 2,168 | 2,195 | ||||||||||||
Income tax liability | 169 | 168 | 384 | 379 | ||||||||||||
Other long-term liabilities | 565 | 582 | 583 | 460 | ||||||||||||
Total liabilities | 28,849 | 30,844 | 40,271 | 46,345 | ||||||||||||
Commitments and Contingencies (Note 10) | ||||||||||||||||
Commitments and Contingencies (Note 12) | ||||||||||||||||
Stockholders’ equity: | ||||||||||||||||
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: 13,909,182 and 13,773,389 shares at March 31, 2017 and December 31, 2016, respectively | 14 | 14 | ||||||||||||||
Common stock, $0.001 par value; authorized: 50,000,000 shares; issued and outstanding: 13,634,154 and 13,477,973 shares at March 31, 2018 and December 31, 2017, respectively | 14 | 13 | ||||||||||||||
Additional paid-in capital | 87,569 | 88,114 | 62,057 | 62,025 | ||||||||||||
Accumulated deficit | (28,068 | ) | (27,046 | ) | ||||||||||||
Retained earnings | 5,888 | 2,947 | ||||||||||||||
Accumulated other comprehensive loss | (73 | ) | (72 | ) | (104 | ) | (92 | ) | ||||||||
Total stockholders’ equity | 59,442 | 61,010 | ||||||||||||||
Total stockholders’ equity | 67,855 | 64,893 | ||||||||||||||
Total liabilities and stockholders’ equity | $ | 88,291 | $ | 91,854 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 108,126 | $ | 111,238 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
CUTERA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended | Three Months Ended | |||||||||||||||
March 31, | March 31, | |||||||||||||||
2017 | 2016 | 2018 | 2017 | |||||||||||||
Net revenue: | ||||||||||||||||
Products | $ | 24,475 | $ | 17,956 | $ | 29,264 | $ | 24,475 | ||||||||
Service | 4,824 | 4,467 | 4,861 | 4,824 | ||||||||||||
Total net revenue | 29,299 | 22,423 | 34,125 | 29,299 | ||||||||||||
Cost of revenue: | ||||||||||||||||
Products | 11,144 | 7,648 | 13,922 | 11,144 | ||||||||||||
Service | 2,634 | 2,301 | 2,869 | 2,634 | ||||||||||||
Total cost of revenue | 13,778 | 9,949 | 16,791 | 13,778 | ||||||||||||
Gross profit | 15,521 | 12,474 | 17,334 | 15,521 | ||||||||||||
Operating expenses: | ||||||||||||||||
Sales and marketing | 10,773 | 8,716 | 13,088 | 10,773 | ||||||||||||
Research and development | 2,945 | 2,709 | 3,556 | 2,945 | ||||||||||||
General and administrative | 3,216 | 3,220 | 5,439 | 3,216 | ||||||||||||
Total operating expenses | 16,934 | 14,645 | 22,083 | 16,934 | ||||||||||||
Loss from operations | (1,413 | ) | (2,171 | ) | (4,749 | ) | (1,413 | ) | ||||||||
Interest and other income, net | 273 | 144 | 98 | 273 | ||||||||||||
Loss before income taxes | (1,140 | ) | (2,027 | ) | (4,651 | ) | (1,140 | ) | ||||||||
Provision (benefit) for income taxes | (118 | ) | 24 | |||||||||||||
Benefit for income taxes | (2,619 | ) | (118 | ) | ||||||||||||
Net loss | $ | (1,022 | ) | $ | (2,051 | ) | $ | (2,032 | ) | $ | (1,022 | ) | ||||
Net loss per share: | ||||||||||||||||
Basic and Diluted | $ | (0.07 | ) | $ | (0.16 | ) | $ | (0.15 | ) | $ | (0.07 | ) | ||||
Weighted-average number of shares used in per share calculations: | ||||||||||||||||
Basic and Diluted | 13,840 | 13,010 | 13,587 | 13,840 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
CUTERA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)
Three Months Ended | Three Months Ended | |||||||||||||||
March 31, | March 31, | |||||||||||||||
2017 | 2016 | 2018 | 2017 | |||||||||||||
Net loss | $ | (1,022 | ) | $ | (2,051 | ) | $ | (2,032 | ) | $ | (1,022 | ) | ||||
Other comprehensive income (loss): | ||||||||||||||||
Other comprehensive loss: | ||||||||||||||||
Available-for-sale investments | ||||||||||||||||
Net change in unrealized gain (loss) on available-for-sale investments | 3 | 69 | (21 | ) | 3 | |||||||||||
Less: Reclassification adjustment for gains on investments recognized during the year | (4 | ) | — | |||||||||||||
Net change in unrealized gain (loss) on available-for-sale investments | (1 | ) | 69 | |||||||||||||
Tax provision (benefit) | — | — | ||||||||||||||
Other comprehensive income (loss), net of tax | (1 | ) | 69 | |||||||||||||
Less: Reclassification adjustment for (gains) losses on investments recognized during the period | 9 | (4 | ) | |||||||||||||
Net change in unrealized loss on available-for-sale investments | (12 | ) | (1 | ) | ||||||||||||
Tax loss (benefit) | — | — | ||||||||||||||
Other comprehensive loss, net of tax | (12 | ) | (1 | ) | ||||||||||||
Comprehensive loss | $ | (1,023 | ) | $ | (1,982 | ) | $ | (2,044 | ) | $ | (1,023 | ) |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
CUTERA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended March 31, | Three Months Ended March 31, | |||||||||||||||
2017 | 2016 | 2018 | 2017 | |||||||||||||
Cash flows from operating activities: | ||||||||||||||||
Net loss | $ | (1,022 | ) | $ | (2,051 | ) | $ | (2,032 | ) | $ | (1,022 | ) | ||||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||||||||||
Stock-based compensation | 1,395 | 1,332 | 1,688 | 1,395 | ||||||||||||
Depreciation and amortization | 248 | 240 | ||||||||||||||
Depreciation of tangible assets | 254 | 248 | ||||||||||||||
Amortization of contract acquisition costs | 373 | — | ||||||||||||||
Change in deferred tax asset | (2,737) | (17 | ) | |||||||||||||
Other | (51 | ) | 12 | 25 | (34) | |||||||||||
Changes in assets and liabilities: | ||||||||||||||||
Accounts receivable | (1,305 | ) | 472 | 915 | (1,305 | ) | ||||||||||
Inventories | (695 | ) | (1,397 | ) | (2,197 | ) | (695 | ) | ||||||||
Other current assets and prepaid expenses | (158 | ) | (230 | ) | 1,753 | (158 | ) | |||||||||
Other long-term assets | (9 | ) | (35 | ) | (2,150 | ) | (9 | ) | ||||||||
Accounts payable | 491 | 611 | 1,204 | 491 | ||||||||||||
Accrued liabilities | (2,657 | ) | (2,758 | ) | (6,727 | ) | (2,657 | ) | ||||||||
Deferred revenue | (456 | ) | (23 | ) | ||||||||||||
Other long-term liabilities | — | (82 | ) | 40 | 1 | |||||||||||
Deferred revenue | (23 | ) | (103 | ) | ||||||||||||
Income tax liability | 1 | (55 | ) | |||||||||||||
Net cash used in operating activities | (3,785 | ) | (4,044 | ) | (10,047 | ) | (3,785 | ) | ||||||||
Cash flows from investing activities: | ||||||||||||||||
Acquisition of property, equipment and software | (69 | ) | (97 | ) | (104 | ) | (69 | ) | ||||||||
Disposal of property and equipment | 25 | — | — | 25 | ||||||||||||
Proceeds from sales of marketable investments | 5,255 | 1,800 | 13,044 | 5,255 | ||||||||||||
Proceeds from maturities of marketable investments | 14,035 | 3,975 | — | 14,035 | ||||||||||||
Purchase of marketable investments | (15,972 | ) | (6,399 | ) | (4,390 | ) | (15,972 | ) | ||||||||
Net cash provided by (used in) investing activities | 3,274 | (721 | ) | |||||||||||||
Net cash provided by investing activities | 8,550 | 3,274 | ||||||||||||||
Cash flows from financing activities: | ||||||||||||||||
Repurchase of common stock | (2,700 | ) | (279 | ) | — | (2,700 | ) | |||||||||
Proceeds from exercise of stock options and employee stock purchase plan | 1,751 | 744 | 633 | 1,751 | ||||||||||||
Taxes paid related to net share settlement of equity awards | (784 | ) | (233 | ) | (2,288 | ) | (784 | ) | ||||||||
Payments on capital lease obligations | (88 | ) | (70 | ) | (122 | ) | (88 | ) | ||||||||
Net cash (used in) provided by financing activities | (1,821 | ) | 162 | |||||||||||||
Net cash used in financing activities | (1,777 | ) | (1,821 | ) | ||||||||||||
Net decrease in cash and cash equivalents | (2,332 | ) | (4,603 | ) | (3,274 | ) | (2,332 | ) | ||||||||
Cash and cash equivalents at beginning of period | 13,775 | 10,868 | 14,184 | 13,775 | ||||||||||||
Cash and cash equivalents at end of period | $ | 11,443 | $ | 6,265 | $ | 10,910 | $ | 11,443 | ||||||||
Supplemental disclosure of non-cash items: | ||||||||||||||||
Repurchase of common stock acquired but not settled | $ | 207 | $ | 27 | — | $ | 207 | |||||||||
Assets acquired under capital lease | $ | 80 | $ | 51 | $ | 284 | $ | 80 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
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 other energy-based aesthetic systems for practitioners worldwide. The Company designs, develops, manufactures, and markets laser and other energy-based product platforms for use by physicians and other qualified practitioners which enable them to offer safe and effective aesthetic treatments to their customers. The Company currently markets the following key system platforms: enlightenTM,excel V, excel HR, enlighten, Juliet, Secret RF, truSculpt TM, truSculptTMand , excel VTM,and xeo®. The Company’s systems offer multiple hand pieces and applications, which allow customers to upgrade their systems. The sales of (i) systems, system upgrades and hand pieces (classified as “Systems” revenue); (ii) hand piece refills (applicableapplicable to Titan® and truSculpt 3D, as well as single use disposable tips applicable to truSculptJuliet, Secret RF (classified as “Consumables”); and (iii) the distribution of third party manufactured skincare products are(classified as "Skincare” revenue); and collectively classified as “Products” revenue. In addition to Products revenue, the Company generates revenue from the sale of post-warranty service contracts, parts, detachable hand piece replacements (except for TitanandtruSculpt3D) and service labor for the repair and maintenance of products that are out of warranty, all of which is classified as “Service” revenue.
Headquartered in Brisbane, California, the Company has wholly-owned subsidiariessubsidiaries that are currently operational in Australia, Belgium, Canada, France, Germany, Hong Kong, Japan, Spain, Switzerland and the United Kingdom. These subsidiaries market, sell and service the Company’s products outside of the United States. The Condensed Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All inter-company transactions and balances have been eliminated.
Unaudited Interim Financial Information
The interim financial information filed is unaudited. TheIn the opinion of the Company, the accompanying unaudited Condensed Consolidated Financial Statements included in this report reflect all adjustments (consisting of only of normal recurring adjustments) that the Company considers necessary for thea fair statement of theits financial position as of March 31, 2018, its results of operations for the interim periods covered three months period ended March 31, 2018, and of2017, comprehensive loss for the financial condition ofthree months period ended March 31, 2018 and 2017, and cash flows for the Company at the date of the interim balance sheet.three months ended March 31, 2018, and 2017. The December 31, 2016 2017 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 Statementsaccompanying condensed consolidated financial statements should be read in conjunction with the Company’s previously filed audited financial statements and the related notes thereto included in the Company’s annual report on Form 10-K10-K for the year ended December 31, 2016 2017 filed with the Securities and Exchange Commission (the “SEC”) on March 15, 2017.26, 2018.
Use of Estimates
The preparation of interim Condensed Consolidated Financial Statements in conformity with GAAP requires the Company’sCompany’s management to make estimates and assumptions that affect the amounts reported of assets and disclosed inliabilities and disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements and the accompanying notes.notes, and the reported amounts of revenue and expenses during the reported periods. Actual results could differ materially from those estimates.
On an ongoing basis, the Company evaluates thesetheir estimates, including those related to revenue elements, warranty obligations,obligation, sales commissions,commission, accounts receivable and sales allowances, provision for excess and obsoletevaluation of inventories, fair values of marketable investments, fair values of acquired intangible assets,goodwill, useful lives of intangible assets and property and equipment, assumptions regarding variables used in calculating the fair valuesvalue of the Company's equity awards, expected achievement of performance stock unitsbased vesting criteria, fair value of investments, the standalone selling price of the Company's products and optionsservices, the customer life and period of benefit used to purchase the Company’s stock,capitalize and amortize contracts acquisition costs, variable consideration, contingent liabilities, recoverability of deferred tax assets, legal matters and claims, and effective income tax rates, among others. Management bases thesetheir 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.
Risks and Uncertainties
The Company's future results of operations involve a number of risks and uncertainties. Factors that could affect the Company's future operating results and cause actual results to vary materially from expectations include, but are not limited to, rapid technological change, continued acceptance of the Company's products, stability of world financial markets, management of international activities, competition from substitute products and larger companies, ability to obtain regulatory approval, government regulations, patent and other litigations, ability to protect proprietary technology from counterfeit versions of the Company's products, strategic relationships and dependence on key individuals. If the Company fails to adhere to ongoing Food and Drug Administration (the "FDA") Quality System Regulation, the FDA may withdraw its market clearance or take other action. The Company's manufacturers and suppliers may encounter supply interruptions or problems during manufacturing due to a variety of reasons, including failure to comply with applicable regulations, including the FDA's Quality System Regulation, equipment malfunction and environmental factors, any of which could delay or impede the Company's ability to meet demand.
RecentComparability
The Company adopted the new revenue standard effective January 1, 2018, using the modified retrospective method. Prior period financial statements were not retrospectively restated. The consolidated balance sheet as of December 31, 2017 and results of operations for the three months ended March 31, 2017 were prepared using accounting standards that were different than those in effect for the three months ended March 31,2018. As a result the consolidated balance sheets as of March 31,2018 and December 31, 2017 are not directly comparable, nor are the results of operations for the three months ended March 31,2018 and March 31, 2017.
Adopted Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB"(“FASB”) issued Accounting Standards UpdatesUpdate (“ASU”) No. 2014-09, Revenue2014-09, “Revenue from Contracts with Customers,, outlining a single comprehensive model for entities to utilize to recognize” amending revenue when it transfers goods or services to customers in an amount that reflects the consideration that will be received in exchange for the goodsrecognition guidance and services. Additionalrequiring more detailed disclosures will also be required to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. In 2016, the FASB issued accounting standards updatesThe amended guidance, herein referred to address implementation issuesas Topic 606, is effective for annual and to clarify the guidance for identifying performance obligations, licenses and determining if a company is the principal or agent in a revenue arrangement. In August 2015, the FASB deferred the effective date of this standards update to fiscal yearsinterim reporting periods beginning after December 15, 2017, with early adoption permitted on the originalfor public companies effective date of fiscal yearsfor annual and interim reporting periods beginning after December 15, 2016. The Company adopted the new revenue standard permitsin the usefirst quarter of either a retrospective orfiscal year 2018 using the modified retrospective application.method. The Company is evaluatingrecognized the effectscumulative effect of applying the new guidancerevenue standard as an adjustment to retained earnings. The comparative information has not been restated and have not yet selected a transition method or determinedcontinues to be reported under the potential effects of adoption onaccounting standards in effect for the consolidated financial statements.period presented.
See Note 2 – Revenue Recognition, for additional accounting policy and transition disclosures.
In FebruaryAugust 2016, the FASB issued ASU 2016-02, Leases.2016-15, Statement of Cash Flows (Topic 230), which intends to reduce diversity in practice in how certain cash receipts and cash payments are classified in the statement of cash flows. This guidance establishes a right-of-use (“ROU”is effective for the Company in the first quarter of 2018. The Company adopted the standard in the first quarter of fiscal year 2018. The adoption did not have any material impact on the Company’s consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 320) model that, which amended the guidance on the classification and presentation of restricted cash in the statement of cash flow. The amendment requires a lesseeentities to include restricted cash and restricted cash equivalents in its cash and cash equivalents in the statement of cash flow. The amendment is effective for the Company in the first quarter of 2018 and is required to be adopted retrospectively. The Company adopted the standard in the first quarter of fiscal year 2018. The adoption did not have any material impact on the Company’s consolidated financial statements.
Other Accounting Pronouncements
In February 2016, the FASB issued ASU No.2016-02, Leases (Topic 842), which amends the existing accounting standards for leases. The new standard requires lessees to record a ROUright-of-use asset and a corresponding lease liability on the balance sheet (with the exception of short-term leases). The new standard also requires expanded disclosures regarding leasing arrangements. The new standard becomes effective for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognitionCompany in the Consolidated Statementfirst quarter of Operations.fiscal year 2019 and early adoption is permitted. The mandatory adoption date of thisnew standard is for fiscal years beginning after December 15, 2018. Arequired to be adopted using the modified retrospective transition approach is required for leases existingand requires application of the new standard at or entered into, after the beginning of the earliest comparative period presented inpresented. The Company finances its fleet of vehicles used by its field sales and service employees and has facility leases. Several of the financial statements,Company’s customers finance purchases of its system products through third party lease companies and not directly with certain practical expedients available. the Company. The Company does not believe that the new standard will change customer buying patterns or behaviors for its products. The Company will adopt the new standard effective January 1, 2019. The Company expects that upon adoption, ROUright-of-use assets and lease liabilities will be recognized in the balance sheet in amounts that will be material.
Note 2. Revenue recognition
The Company adopted ASC Topic 606, Revenue from Contracts with Customers, on January 1, 2018, applying the modified retrospective method to all contract agreements that were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior period. A cumulative catch up adjustment was recorded to beginning retained earnings to reflect the impact of all existing arrangements under Topic 606.
Upon adoption of the Topic 606, the Company recorded an increase to retained earnings of $5.0 million for contracts still in force as of January 1, 2018 for the following items in the first quarter of 2018:
● | $237,000 reduction in deferred revenue balances for the differences in the amount of revenue recognition for the Company’s revenue streams as a result of allocation of revenue based on standalone selling prices to the Company’s various performance obligations. |
● | $151,000 increase in deferred revenue balances, related to the accretion of financing costs for multi-year post-warranty service contracts for customers who pay more than one year in advance of receiving the service. The Company estimated interest expense for such advance payments under the new revenue standard. |
● | $210,000 for variable consideration on sale transactions. | |
● | $4.7 million for the capitalization of the incremental contract acquisition costs, such as sales commissions paid in connection with system sales. These contract acquisition costs were capitalized and amortized over the period of anticipated support renewals. Under the prior guidance, the Company expensed such costs when incurred. |
The Company’s revenue consists of product and service revenue resulting from the sale of systems, training on the systems, extended service contracts, consumables and other accessories. The Company accounts for a contract with a customer when there is a legally enforceable contract between the Company and the customer, the rights of the parties are identified, the contract has commercial substance, and collectability of the contract consideration is probable. Revenues are recognized when control of the promised goods or services are transferred to our customers, in an amount that reflects the consideration that we expect to receive in exchange for those goods or services.
The Company's system sale arrangements generally contain multiple products and services. For these bundled sale arrangements, the Company accounts for individual products and services as separate performance obligations if they are distinct, which is if a product or service is separately identifiable from other items in the bundled package, and if a customer can benefit from it on its own or with other resources that are readily available to the customer. The Company’s system sale arrangements include a combination of the following performance obligations: The System and software license (considered as one performance obligation), system accessories (hand pieces), training, other accessories, extended service contracts and marketing services. For the Company’s system sale arrangements that include an extended service contract, the period of service commences at the expiration of the Company’s standard warranty offered at the time of the system sale. The Company considers the extended service contracts terms in the arrangements that are legally enforceable to be performance obligations. Other than service and training, the Company generally satisfies all of the performance obligations at a point in time. System, system accessories (hand pieces), training, and service are also sold on a stand-alone basis, and related performance obligations are satisfied over time as the services are performed.
The following table summarizes the effects of adopting Topic 606 on the Company’s condensed consolidated balance sheet as of March 31,2018:
As reported under Topic 606 | Adjustments | Balances under Prior GAAP | ||||||||||
(In thousands) | ||||||||||||
Other long-term assets | 5,367 | 4,862 | 505 | |||||||||
Accrued Liabilities | 20,083 | (111 | ) | 20,194 | ||||||||
Deferred revenue | 11,015 | (194 | ) | 10,821 | ||||||||
Retained earnings | 5,888 | 5,167 | 721 |
The following table summarizes the effects of adopting Topic 606 on Company’s condensed consolidated income statement for the three months ended March 31,2018:
As reported under Topic 606 | Adjustments | Balances under Prior GAAP | ||||||||||
(In thousands, except per share amounts) | ||||||||||||
Products revenue | $ | 29,264 | $ | 10 |
| $ | 29,254 | |||||
Service revenue | 4,861 | 64 | 4,797 | |||||||||
Sales and marketing | 13,088 | (185 | ) | 13,273 | ||||||||
Interest and other income, net* | 98 | (65 | ) | 163 |
* Included in interest and other income, net is the estimated interest expense for advance payment related to contract services under the new revenue standard going forward. Adoption of the standard had no impact to total net cash from or used in operating, investing, or financing activities within the Condensed Consolidated Statements of Cash Flows.
As part of the Company's adoption of ASC 606, the Company elected to use the following practical expedients (i) not to adjust the promised amount of consideration for the effects of a significant financing component when the Company expects, at contract inception, that the period between the Company's transfer of a promised product or service to a customer and when the customer pays for that product or service will be one year or less; (ii) to expense costs as incurred for costs to obtain a contract when the amortization period would have been one year or less; (iii) not to recast revenue for contracts that begin and end in the same fiscal year; and (iv) not to assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer.
,Note 3.Cash, Cash Equivalents andMarketable Investments
The Company invests its cash primarily in money market funds and in highly liquid debt instruments of U.S. federal and municipal governments and their agencies, commercial paper and corporate notes and bonds, municipal bonds, and debt securities issued by the U.S. government and its agencies. The Company considerssecurities. All highly liquid investments with stated maturities of three months or less from date of purchase are classified as cash equivalents; all highly liquid investments with an original maturitystated maturities of greater than three months or lessare classified as marketable investments. The majority of the Company’s cash and investments are held in U.S. banks and its foreign subsidiaries maintain a limited amount of cash in their local banks to cover their short term operating expenses.
The Company determines the appropriate classification of its investments in marketable securities at the time of purchase to be cash equivalents. Investments with maturities of greater than three monthsand re-evaluates such designation at the time of purchase areeach balance sheet date. The Company’s marketable securities have been classified and accounted for as “available-for-sale,”available-for-sale. Investments with remaining maturities more than one year are viewed by the Company as available to support current operations, and are classified as current assets under the caption marketable investments in the accompanying Consolidated Balance Sheets. Investments in marketable securities are carried at fair value, with the unrealized gains and losses reported as a component of stockholders’ equity,equity. Any realized gains or losses on the sale of marketable securities are held for use in current operationsdetermined on a specific identification method, and such gains and losses are classified in current assetsreflected as “marketable investments.”a component of interest and other income, net.
The following tablestables summarize the components, and the unrealized gains and losses position, related to the Company’s cash, cash equivalents and marketable investments (in thousands):
March 31, 2017 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Market Value | ||||||||||||||||||||||||||||
March 31, 2018 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Market Value | ||||||||||||||||||||||||||||
Cash and cash equivalents: | ||||||||||||||||||||||||||||||||
Cash | $ | 6,918 | $ | — | $ | — | $ | 6,918 | $ | 10,579 | $ | — | $ | — | $ | 10,579 | ||||||||||||||||
Money market funds | 1,026 | — | — | 1,026 | 331 | — | — | 331 | ||||||||||||||||||||||||
Commercial paper | 3,499 | — | — | 3,499 | ||||||||||||||||||||||||||||
Total cash and cash equivalents | 11,443 | — | — | 11,443 | 10,910 | — | — | 10,910 | ||||||||||||||||||||||||
Marketable investments: | ||||||||||||||||||||||||||||||||
U.S. government notes | 4,453 | — | (11 | ) | 4,442 | 7,110 | — | (14 | ) | 7,096 | ||||||||||||||||||||||
U.S. government agencies | 2,002 | — | (2 | ) | 2,000 | |||||||||||||||||||||||||||
Municipal securities | — | — | — | — | 201 | — | (1 | ) | 200 | |||||||||||||||||||||||
Commercial paper | 17,243 | 3 | (1 | ) | 17,245 | |||||||||||||||||||||||||||
Corporate debt securities | 13,305 | 7 | (9 | ) | 13,303 | 5,795 | 1 | (30 | ) | 5,766 | ||||||||||||||||||||||
Total marketable investments | 37,003 | 10 | (23 | ) | 36,990 | 13,106 | 1 | (45 | ) | 13,062 | ||||||||||||||||||||||
Total cash, cash equivalents and marketable investments | $ | 48,446 | $ | 10 | $ | (23 | ) | $ | 48,433 | $ | 24,016 | $ | 1 | $ | (45 | ) | $ | 23,972 |
December 31, 2016 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Market Value | ||||||||||||||||||||||||||||
December 31, 2017 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Market Value | ||||||||||||||||||||||||||||
Cash and cash equivalents: | ||||||||||||||||||||||||||||||||
Cash | $ | 6,672 | $ | — | $ | — | $ | 6,672 | $ | 14,058 | $ | — | $ | — | $ | 14,058 | ||||||||||||||||
Money market funds | 6,053 | — | — | 6,053 | 126 | — | — | 126 | ||||||||||||||||||||||||
Commercial paper | 1,050 | — | — | 1,050 | ||||||||||||||||||||||||||||
Total cash and cash equivalents | 13,775 | — | — | 13,775 | 14,184 | — | — | 14,184 | ||||||||||||||||||||||||
Marketable investments: | ||||||||||||||||||||||||||||||||
U.S. government notes | 8,403 | 4 | (9 | ) | 8,398 | 11,885 | — | (15 | ) | 11,870 | ||||||||||||||||||||||
U.S. government agencies | 3,918 | — | (2 | ) | 3,916 | |||||||||||||||||||||||||||
Municipal securities | 1,325 | — | — | 1,325 | 201 | — | (1 | ) | 200 | |||||||||||||||||||||||
Commercial paper | 12,299 | 2 | (2 | ) | 12,299 | 1,836 | — | (3 | ) | 1,833 | ||||||||||||||||||||||
Corporate debt securities | 14,366 | 3 | (8 | ) | 14,361 | 7,838 | 2 | (15 | ) | 7,825 | ||||||||||||||||||||||
Total marketable investments | 40,311 | 9 | (21 | ) | 40,299 | 21,760 | 2 | (34 | ) | 21,728 | ||||||||||||||||||||||
Total cash, cash equivalents and marketable investments | $ | 54,086 | $ | 9 | $ | (21 | ) | $ | 54,074 | $ | 35,944 | $ | 2 | $ | (34 | ) | $ | 35,912 |
As of March 31, 2017 2018 and December 31, 2016, total gross2017, the net unrealized losses were $23,000$45,000 and $21,000,$34,000, respectively, and were related to interest rate changes on available-for-sale marketable investments. The Company has concluded that it is more-likely-than-notmore-likely-than-not that the securities will be held until maturity or the recovery of their cost basis. No securities were in an unrealized loss position for more than 12 months.
The following table summarizes the contractual maturities of the Company’s available-for-sale securities, classified as marketable investments as of March 31, 2017 (in2018 (in thousands):
Amount | Amount | |||||||
Due in less than one year | $ | 33,230 | $ | 11,867 | ||||
Due in 1 to 3 years | 3,760 | 1,195 | ||||||
Total marketable investments | $ | 36,990 | $ | 13,062 |
Note 3.4. 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. 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. Carrying amounts of the Company’s financial instruments, including cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximate their fair values as of the balance sheet dates because of their generally short maturities. The fair value hierarchy distinguishes between (1)(1) market participant assumptions developed based on market data obtained from independent sources (observable(observable inputs) and (2)(2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs)(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)(Level 1) and the lowest priority to unobservable inputs (Level 3)(Level 3). The three levels of the fair value hierarchy are described below:below in accordance to ASC 820:
● 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. |
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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, 2017, 2018, 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 were as follows (in thousands):
March 31, 2017 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||||||||||
March 31, 2018 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||||||||||
Cash equivalents: | ||||||||||||||||||||||||||||||||
Money market funds | $ | 1,026 | $ | — | $ | — | $ | 1,026 | $ | 331 | $ | — | $ | — | $ | 331 | ||||||||||||||||
Commercial paper | — | 3,499 | — | 3,499 | ||||||||||||||||||||||||||||
Marketable investments: | ||||||||||||||||||||||||||||||||
Available-for-sale securities | — | 36,990 | — | 36,990 | ||||||||||||||||||||||||||||
Marketable investments: | ||||||||||||||||||||||||||||||||
Available-for-sale securities | — | 13,062 | — | 13,062 | ||||||||||||||||||||||||||||
Total assets at fair value | $ | 1,026 | $ | 40,489 | $ | — | $ | 41,515 | $ | 331 | $ | 13,062 | $ | — | $ | 13,393 |
As of December 31, 2016, 2017, 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, 2016 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||||||||||
December 31, 2017 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||||||||||
Cash equivalents: | ||||||||||||||||||||||||||||||||
Money market funds | $ | 6,053 | $ | — | $ | — | $ | 6,053 | $ | 126 | $ | — | $ | — | $ | 126 | ||||||||||||||||
Commercial paper | — | 1,050 | — | 1,050 | — | — | — | — | ||||||||||||||||||||||||
Marketable investments: | ||||||||||||||||||||||||||||||||
Available-for-sale securities | — | 40,299 | — | 40,299 | ||||||||||||||||||||||||||||
Marketable investments: | ||||||||||||||||||||||||||||||||
Available-for-sale securities | — | 21,728 | — | 21,728 | ||||||||||||||||||||||||||||
Total assets at fair value | $ | 6,053 | $ | 41,349 | $ | — | $ | 47,402 | $ | 126 | $ | 21,728 | $ | — | $ | 21,854 |
The Company’sCompany’s Level 1 financial assets are money market funds with fair values that are based on quoted market prices. 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-sidedtwo-sided markets, benchmark securities, bids, offers and reference data including market research publications. The weighted average remaining maturity of the Company’s Level 2 investments as of March 31, 2017 2018 is less than 1 year7 months and all of these investments are rated by S&P and Moody’s at A-A or better. The Company recognizes transfers between levels of the fair value hierarchy as of the end of the reporting period. There were no transfers within the hierarchy during the quarter and year ended March 31, 2018 and December 31, 2017 respectively.
Note 4.5. Balance Sheet Details
Inventories
As of March 31, 2017 2018 and December 31, 2016, 2017, inventories consist of the following (in thousands):
March 31, 2017 | December 31, 2016 | March 31, 2018 | December 31, 2017 | |||||||||||||
Raw materials | $ | 11,543 | $ | 10,966 | $ | 18,735 | $ | 19,160 | ||||||||
Work in process | 2,813 | 2,744 | ||||||||||||||
Finished goods | 4,129 | 4,011 | 9,431 | 6,878 | ||||||||||||
Total | $ | 15,672 | $ | 14,977 | $ | 30,979 | $ | 28,782 |
Accrued Liabilities
As of March 31, 2017 2018 and December 31, 2016, 2017, accrued liabilities consist of the following (in thousands):
March 31, 2017 | December 31, 2016 | March 31, 2018 | December 31, 2017 | |||||||||||||
Accrued payroll and related expenses | $ | 7,113 | $ | 9,036 | $ | 9,003 | $ | 12,567 | ||||||||
Sales and marketing accruals | 2,136 | 3,710 | ||||||||||||||
Warranty liability | 2,735 | 2,461 | 3,373 | 3,508 | ||||||||||||
Sales tax | 1,644 | 2,373 | 1,718 | 2,920 | ||||||||||||
Other | 3,458 | 3,527 | 3,853 | 4,143 | ||||||||||||
Total | $ | 14,950 | $ | 17,397 | $ | 20,083 | $ | 26,848 |
Note 5.6. Warranty
The Company provides a standard one-year warranty on all systems. For direct sales to end customers, warranty coverage provided is for labor and parts necessary to repair the systems during the warranty period. For sales to distributors, we provide a 14 to 16 month warranty for parts only. The distributor provides the labor to their end customer.Service Contracts
The Company has a direct field service organization in the U.S. Internationally, the Company provides direct service support through its wholly-owned subsidiaries in Australia, Belgium, Canada, France,, Hong Kong, Japan, and Switzerland, as well as through third-party service providers in Spain and the United Kingdom. In several other countries, where it does not have a direct presence, the Company provides service through a network of distributors and third-partythird-party service providers.
After the original warrantywarranty period, maintenance and support are offered on a service contract basis or on a time and materials basis. The Company provides for the estimated cost to repair or replace products under warranty at the time of sale. The following table provides the changes in the product warranty accrual for the three months ended March 31, 2017 2018 and 20162017 (in thousands):
Three Months Ended | Three Months Ended | |||||||||||||||
March 31, | March 31, | |||||||||||||||
2017 | 2016 | 2018 | 2017 | |||||||||||||
Beginning Balance | $ | 2,461 | $ | 1,819 | $ | 3,508 | $ | 2,461 | ||||||||
Add: Accruals for warranties issued during the period | 2,135 | 1,254 | 2,264 | 2,135 | ||||||||||||
Less: Settlements made during the period | (1,861 | ) | (1,254 | ) | (2,399 | ) | (1,861 | ) | ||||||||
Ending Balance | $ | 2,735 | $ | 1,819 | $ | 3,373 | $ | 2,735 |
Note 7. Revenue
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 14% of the Company’s total revenue for the three months ended March 31,2018.
The Company's system sale arrangements generally contain multiple products and services. For these bundled sale arrangements, the Company accounts for individual products and services as separate performance obligations if they are distinct, which is if a product or service is separately identifiable from other items in the bundled package, and if a customer can benefit from it on its own or with other resources that are readily available to the customer. The Company’s system sale arrangements include a combination of the following performance obligations: The system and software license (considered as one performance obligation), system accessories (hand pieces), training, other accessories, extended service contracts and marketing services.
For the Company’s system sale arrangements that include an extended service contract, the period of service commences at the expiration of the Company’s standard warranty offered at the time of the system sale. The Company considers the extended service contracts terms in the arrangements that are legally enforceable to be performance obligations. Other than extended contract services and training, the Company satisfies all of the performance obligations at a point in time. System, system accessories (hand pieces), training, and services are also sold on a stand-alone basis, and related performance obligations are satisfied over time as the services are performed. For contracts with multiple performance obligations, the Company allocates the transaction price of the contract to each performance obligation, on a relative basis using its standalone selling price. The stated contract value is the transaction price to be allocated to the separate performance obligations.
Nature of Products and Services
Systems
System revenue represents the sale of a system or an upgrade of an existing system. 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 such as with the Company’s Pearl and Pearl Fractional applications instead of within the console.
The Company considers system and software license as one performance obligation. The system and the software are highly interrelated and interdependent. Both are necessary for the system to work as designed. The customer cannot benefit from the system without the license to the embedded software. 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 us with a source of additional Systems revenue.
The Company considers set-up or installation an immaterial promise as set-up or installation for systems other than enlighten system takes only a short time. The related costs to complete set-up or installation are immaterial to the Company. The enlighten system includes the related software license as one performance obligation and the calibration or installation service as a separate performance obligation since a third party could perform this service.
For systems sold directly to end-customers that are credit approved, revenue is recognized when the Company transfers control to the end customer, which occurs when the product is shipped to the customer or when the customer receives the product, depending on the nature of the arrangement. The Company recognizes revenue on cash basis for system sales to other international direct end-customer sales that have not been credit approved, and after satisfying all remaining obligations on the agreement. For systems sold through credit approved distributors, revenue is recognized at the time of shipment. The Company’s system arrangements generally do not provide a right of return. The Company provides a standard one-year warranty coverage for all systems sold to end-customers, to cover parts and service, and offer extended service plans that vary by the type of product and the level of service desired.
The Company typically receives payment for its system consoles and other accessories within 30 days of shipment. Certain international distributor arrangements allow for longer payment terms because of the volume of purchases by these distributors.
Skincare products
The Company sells third-party manufactured skincare products in Japan. The Company purchases and inventories these third-party skincare products from the manufacturers and sells them to licensed physicians. The Company acts as the principal in this arrangement as it determines the price to charge customers for the skincare products, and controls the products before they are transferred to the customer. The Company warrants that the cosmeceuticals will be free of significant defects in workmanship and materials for 90 days from shipment. Skincare products are typically sold in a separate contract as the only performance obligations. The Company recognizes revenue for skincare products at a point in time, generally upon shipment or delivery.
Consumables (Other accessories)
The Company treats its customer’s purchase of replacement Titan and truSculpt 3D hand pieces as “consumable” revenue, which provides the Company with a source of recurring revenue from existing customers. The Company’s recently launched Juliet and Secret RF products have single use disposable tips which need to be replaced after every treatment. Sale of these consumable tips further enhance the Company’s recurring revenue stream. Hand piece refills of the Company’s legacy truSculpt product are includedin the standard warranty and service contract offerings for this product.
Extended contract services
The Company offers post-warranty services to its customers through extended service contracts that cover preventive maintenance and or replacement parts and labor, or by direct billing for detachable hand piece replacements, parts and labor. These post-warranty services serve as additional sources of recurring revenue from the Company’s installed product base. Service revenue is recognized over time as the customers benefit from the service throughout the service period. Revenue related to services performed on a time-and-materials basis is recognized when performed. For the Company's performance obligations recognized over time, revenue is generally recognized using a time-based measure of progress reflecting generally consistent efforts to satisfy those performance obligations throughout the arrangement term.
Training
Sales of system to customers include training on the system to be provided within 90 days of purchase. The Company considers training as a separate performance obligation as customers can benefit from readily available resources due to the fact that the customer already has the system. If training occurred before the system was delivered, the customer would not have readily available resources and could not benefit from the training. Training is also sold separately from the system. This occurs when customers hire new employees and want the Company to train them on a system the customer already owns. The training is useful in providing an enhanced approach to using the System, so the training also has benefit. The Company recognizes revenue for training over time as the training is provided. As training is not required for customers to use the systems, the Company concludes that it has no effect on the Company’s evaluation of when the risks and rewards of ownership transfer to customers.
Customer Marketing Support
In North America, the Company offers marketing and consulting phone support to its customers who purchase its truSculpt 3D system. This includes a unique marketing program and a customizable practice support kit to help customers inform, inspire and engage their current and prospective patients. This is a personalized program designed to help customers jump-start their practice with truSculpt 3D. It includes a business model and marketing training performed remotely with ongoing phone consultations for six months from date of purchase.
The Company considers this a separate performance obligation, and allocates and recognizes revenue over the six-month term of support. The Company determines the standalone selling price based on cost plus a margin.
Significant Judgments
More judgments and estimates are required under Topic 606 than were required under the previous revenue recognition guidance, Topic 605. Due to the nature of certain contracts, the actual revenue recognition treatment required under Topic 606 for the Company’s arrangements may be dependent on contract-specific terms and may vary in some instances.
The Company’s contract agreement with customers for system purchases includes the delivery of the system and a nonexclusive, nontransferable license to use such software and/or firmware in connection with customer’s use of the product. The tangible product, including the embedded software, are delivered to the customer at the time of sale. In some circumstances, in conjunction with the purchase of a system or upgrade, customers purchase service contracts for one or more years to cover their products. For these transactions, the following multiple-element arrangement exists: a tangible product delivered to the customer at the inception of the revenue arrangement; and a service contract for delivery of services to the customer over a contractually stated period of time defined in the service contract.
Determining whether licenses and services are distinct performance obligations that should be accounted for separately, or not distinct and thus accounted for together, requires significant judgment. The system and the software are highly interrelated and interdependent. Both are necessary for the system to work as designed. The customer cannot benefit from one without the other. The Company has concluded that systems and the related software license are one performance obligation. The enlighten system includes the related software license as one performance obligation and the calibration/installation service as a separate performance obligation. The calibration/installation is a separate performance obligation for the enlighten system because a knowledgeable third-party could perform this service.
The Company has however concluded that set-up or installation for all other systems (excluding the enlighten system) is perfunctory as the set-up or installation for systems other than enlighten take only a short time, the related costs to complete set-up or installation are immaterial.
Sales of Products to customers include training on the products to be provided within 90 days of purchase. Training is considered a separate performance obligation.
Extended warranty, if included in the agreement, requires the Company to provide extended warranty services for one, two or three years. The Company considers extended warranty as a separate performance obligation.
Skincare products are typically sold in a separate contract as the only performance obligations.
Judgment is required to determine the standalone selling price ("SSP") for each distinct performance obligation. The Company rarely licenses or sells products on a standalone basis, so the Company estimates SSPs for each performance obligation as follows:
enlighten system: SSP is estimated from observable inputs, if available, and if not available, the Company estimates the SSP using cost plus margin.
All other systems: For systems other than truSculpt 3D with marketing program, and other marketing support, SSP is estimated from observable inputs, if available, and if not available, the Company estimates the SSP using cost plus margin. The Company estimates SSP for truSculpt 3D with marketing support using cost plus margin approach; for truSculpt 3D without marketing support, the Company estimates SSP from observable inputs, if available, and if not available, SSP is estimated using cost plus margin.
Training: SSP is estimated from observable inputs when sold on a standalone basis.
Extended warranty: SSP is estimated from observable inputs when sold on a standalone basis (by customer type).
Marketing program (excluding third-party marketing support, which is not considered a performance obligation.): SSP is estimated based on cost plus a margin.
Skincare products: Skincare products are the only performance obligation in the contracts. All product is delivered at the same time, therefore the Company does not have to allocate the transaction price for skincare products.
The Company allocates transaction price and discount to each performance obligation (i.e., system, extended warranty, training) based on the relative SSP of the performance obligation in the contract.
The Company recognizes revenue for all products (systems, accessories, etc.) at a point in time. The software license embedded in the system is a functional license giving the customer the right to use the software as it exists at the time of shipment. Therefore, revenue related to the software license is recognized at a point in time – upon shipment, and the software license does not change the timing of revenue recognition for the system. The Company concluded that it should recognize revenue for extended warranty over the service period on a straight-line basis. The Company also concluded that it should recognize the revenue for the marketing support (excluding third-party marketing) over the committed period for the service. The Company plans to use the invoice practical expedient for services provided on a time and materials basis (i.e., recognize the revenue for services as the time and materials are incurred and invoiced to the customer).
The Company will combine two or more contracts entered into at or near the same time with the same customer (or related parties of the customer) and account for the contracts as a single contract. If a group of agreements are so closely related that they are, in effect, part of a single arrangement, such agreements are deemed to be one arrangement for revenue recognition purposes. The Company exercises significant judgment to evaluate the relevant facts and circumstances in determining whether the separate agreements should be accounted for separately or as, in substance, a single arrangement. The Company’s judgments about whether a group of contracts comprise a single arrangement can affect the allocation of consideration to the distinct performance obligations, which could have an effect on results of operations for the periods involved.
The Company is required to estimate the total consideration expected to be received from contracts with customers. In limited circumstances, the consideration expected to be received is variable based on the specific terms of the contract or based on the Company’s expectations of the term of the contract. Generally, the Company has not experienced significant returns or refunds to customers. These estimates require significant judgment and the change in these estimates could have an effect on its results of operations during the periods involved.
Contract balance
The Company’s service contracts include an upfront payment for the one, two or three-year contract terms. The timing of receipt of payment and timing of performance of the services create timing differences that result in contract liabilities (deferred revenue) on the Company’s condensed consolidated balance sheet. The advance payments under these contracts are recorded in deferred revenue (contract liability), and the Company recognizes the revenue on a straight-line basis over the period of the applicable contract. Contracted but unsatisfied performance obligations were approximately $11.0 million as of March 31, 2018, of which the Company expects to recognize approximately 80% of the revenue over the next 12 months and the remainder thereafter.
Deferred Sales Commissions
The Company records a contract asset for the incremental costs of obtaining a contract with a customer, including direct sales commissions that are earned upon execution of the contract for its post-warranty service contracts that are capitalized and amortized over the estimated customer relationship period.
The Company uses the portfolio method to capitalize and recognize the amortization expense related to these capitalized costs related to initial contracts and renewals and such expense is recognized over a period associated with the revenue of the related portfolio, which is generally two to three years for the Company’s product and service arrangements. The Company determined that it would apply the one-year practical expedient to sales commissions on systems sales and training because the revenue for these items would be recognized at a point in time (systems) or shortly after the sale is completed (training).
Incremental costs related to initial contracts and renewals are amortized over the same period because the commissions paid on both the initial contract and renewals are commensurate with one another. Total capitalized costs as of March 31,2018 were $4.9 million and are included in other assets in the Company’s condensed consolidated balance sheet. Amortization of these assets was $0.4 million during the three months ended March 31, 2018 and is included in sales and marketing expense in the Company’s condensed consolidated income statement.
Note 68. Deferred Service Contract Revenue
The Company generates Service revenue from the sale of extended service contracts and from time and material services provided to customers who are not under a warranty or extended service contract. Service contract revenue is recognized on a straight-line basis over the period of the applicable contract. Service revenue from customers whose systems are not under a service contract,time and material services is recognized as the services are provided.
The following table provides changes in the deferred service contract revenue balance for the three months ended March 31, 2017 2018 and 20162017 (in thousands):
Three Months Ended | Three Months Ended | |||||||||||||||
March 31, | March 31, | |||||||||||||||
2017 | 2016 | 2018 | 2017 | |||||||||||||
Beginning Balance | $ | 9,431 | $ | 10,469 | $ | 10,719 | $ | 9,431 | ||||||||
Add: Payments received | 3,391 | 3,263 | 2,995 | 3,391 | ||||||||||||
Less: Revenue recognized | (3,267 | ) | (3,220 | ) | (3,347 | ) | (3,267 | ) | ||||||||
Ending Balance | $ | 9,555 | $ | 10,512 | $ | 10,367 | $ | 9,555 |
Costs for extended service contracts were $1.9 million and $1.6$1.9 million for the three months ended March 31, 2017 2018 and 2016,2017, respectively.
*The Company recognized $0.8 million related to training, marketing assistance and installation for the enlighten system related to revenue deferred in 2017 and recognized during the first quarter of 2018.
Note 7. 9.Stockholders’ Equity and Stock-based Compensation Expense
Share Repurchase ProgramIn 1998, the Company adopted the 1998 Stock Plan, or 1998 Plan, under which 4,650,000 shares of the Company’s common stock were reserved for issuance to employees, directors and consultants. On January 12, 2004, the Board of Directors adopted the 2004 Equity Incentive Plan. A total of 1,750,000 shares of common stock were originally reserved for issuance pursuant to the 2004 Equity Incentive Plan. In addition, the shares reserved for issuance under the 2004 Equity Incentive Plan included shares reserved but un-issued under the 1998 Plan and shares returned to the 1998 Plan as the result of termination of options or the repurchase of shares. In 2012 the stockholders approved a “fungible share” provision whereby each full-value award issued under the 2004 Equity Incentive Plan results in a requirement to subtract 2.12 shares from the shares reserved under the Plan.
On February 8, 2016, the Company announced that its Board of Directors approved the expansion of its Stock Repurchase Program by $10 million, under which the Company is authorized to repurchase shares of its common stock. As of December 31, 2016, there remained an additional $5.1 million in the Stock Repurchase Program to use for repurchasing the Company's common stock. On February 13, 2017 the Company’s Board of Directors approved the expansion of its Stock Repurchase Program by an additional $5 million.
In the three months ended March 31, 2017, the Company repurchased 140,400 shares of its common stock for approximately $2.9 million. As of March 31, 2017, there remained an additional $7.2 million available in the Stock Repurchase Program to repurchase shares of common stock. All shares repurchased were retired and returned to authorized but unissued status.
Stock-based Compensation Expense
Stock-based compensation expense by department recognized during the three months ended March 31, 2017 and 2016 were as follows (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2017 | 2016 | |||||||
Cost of revenue | $ | 129 | $ | 141 | ||||
Sales and marketing | 420 | 376 | ||||||
Research and development | 237 | 180 | ||||||
General and administrative | 609 | 635 | ||||||
Total stock-based compensation expense | $ | 1,395 | $ | 1,332 |
Activity under the Company’s Company’s 2004 Equity Incentive Plan, as amended, is summarized as follows:
Options Outstanding | Options Outstanding | |||||||||||||||||||||||
Shares Available for Grant | Number of Stock Options Outstanding | Weighted- Average Exercise Price | Shares Available for Grant | Number of Stock Options Outstanding | Weighted- Average Exercise Price | |||||||||||||||||||
Balance, December 31, 2016 | 721,657 | 1,116,472 | $ | 9.56 | ||||||||||||||||||||
Balance, December 31, 2017 | 1,494,866 | 839,919 | $ | 16.46 | ||||||||||||||||||||
Options granted | (52,000 | ) | 52,000 | 18.18 | (14,500 | ) | 14,500 | 53.90 | ||||||||||||||||
Stock awards granted(1) (2) | (449,440 | ) | — | — | ||||||||||||||||||||
Stock awards granted(1) | (310,275 | ) | — | — | ||||||||||||||||||||
Options exercised | — | (201,686 | ) | 8.68 | — | (66,167 | ) | 9.57 | ||||||||||||||||
Options canceled | 11,352 | (11,352 | ) | 17.39 | 32,438 | (32,438 | ) | 15.87 | ||||||||||||||||
Stock awards canceled(1) | 94,113 | — | — | |||||||||||||||||||||
Balance, March 31, 2017 | 325,682 | 955,434 | $ | 10.12 | ||||||||||||||||||||
Stock awards canceled(1) | 43,990 | — | — | |||||||||||||||||||||
Balance, March 31, 2018 | 1,246,519 | 755,814 | $ | 17.81 |
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Under the 2004 Equity Incentive Plan, as amended,, the Company issued 316,203156,181 shares of common stock during the three months ended March 31, 2017, 2018, in conjunction with stock options exercised and the vesting of RSUs and PSUs.
As of March 31, 2017, 2018, there was approximately $5.9$15.7 million of unrecognized compensation expense, net of projected forfeitures, related to non-vested equityfor stock options and stock awards. The expense is expected to be recognized over the remaining weighted-average period of 1.802.51 years. The actual expense recorded in the future may be higher or lower based on a number of factors, including, actual forfeitures experienced and the degree of achievement of the performance goals related to the PSUs granted.
2004Employee Stock Purchase Plan
On January 12, 2004, the Board of Directors adopted the 2004 Employee Stock Purchase Plan. Under the 2004 Employee Stock Purchase Plan, or 2004 ESPP, eligible employees are permitted to purchase common stock at a discount through payroll deductions. The 2004 ESPP offering and purchase periods are for approximately six months. The 2004 ESPP has an evergreen provision based on which shares of common stock eligible for purchase are increased on the first day of each fiscal year by an amount equal to the lesser of:
i. 600,000 shares;
ii. 2.0% of the outstanding shares of common stock on such date; or
iii. an amount as determined by the Board of Directors.
Non-Employee Stock-Based Compensation
The Company granted 1,640 RSUs and 1,640 PSUs to one non-employee during the quarter ended March 31, 2018, and 7,745 stock options and 2,478 RSUs during the year ended December 31, 2017. The 7,745 stock options vests over 4 years at 25% on the first anniversary of the grant date and 1/48th each month thereafter.
The 4,118 RSUs vests over 4 years at 25% each anniversary of the grant date, whiles the 1,640 PSUs vesting is subject to the recipient's continued service and achievement of pre-established goals. These RSUs/PSUs and stock options were granted in exchange for consulting services to be rendered and are measured and recognized as they are earned. The Company revalues stock options granted to non-employees at each reporting date as the underlying equity instruments vest.
Stock-based Compensation Expense
Stock-based compensation expense by department recognized during the three months ended March 31, 2018 and 2017 were as follows (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2018 | 2017 | |||||||
Cost of revenue | $ | 154 | $ | 129 | ||||
Sales and marketing | ||||||||
Employee | 452 | 420 | ||||||
Non-employee | 37 | - | ||||||
Research and development | 191 | 237 | ||||||
General and administrative | 854 | 609 | ||||||
Total stock-based compensation expense | $ | 1,688 | $ | 1,395 |
Note 810. Net Loss Per Share
Basic net income (loss) per share is computed using the weighted-average number of shares outstanding during the period. In periods of net income, diluted shares outstanding include the dilutive effect of in-the-money equity awards (stock options, restricted stock units, performance stock units and employee stock purchase plan contributions), which is calculated based on the average share price for each fiscal period using the treasury stock method. In accordance with ASC 718, the assumed proceeds under the treasury stock method include the average unrecognized compensation expense of in-the money stock options and restricted stock units. This results in the assumed buyback of additional shares, thereby reducing the dilutive impact of equity awards.
Diluted earnings per share is the same as basic earnings per share for the periods in which the Company had a net loss because the inclusion of outstanding common stock equivalents would be anti-dilutive.
The following table sets forth the computation of basic and diluted net income (loss) and the weighted average number of shares used in computing basic and diluted net income (loss) per share (in thousands, except per share data):
Three months ended March 31, 2018 | Three months ended March 31, 2017 | |||||||
Numerator: | ||||||||
Net loss | $ | (2,032 | ) | $ | (1,022 | ) | ||
Denominator: | ||||||||
Weighted-average shares outstanding in basic calculation | 13,587 | 13,840 | ||||||
Add: dilutive effect of potential common shares | — | — | ||||||
Weighted-average shares used in computing diluted net income per share | 13,587 | 13,840 | ||||||
Net loss per share: | ||||||||
Net loss per share, basic and diluted | $ | (0.15 | ) | $ | (0.07 | ) |
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 numbersnumbers 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 period presented because including them would have had an anti-dilutive effect (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2017 | 2016 | |||||||
Options to purchase common stock | 1,088 | 3,191 | ||||||
Restricted stock units | 384 | 405 | ||||||
Performance stock units | 164 | 158 | ||||||
Employee stock purchase plan shares | 49 | 42 | ||||||
Total | 1,685 | 3,796 |
Three Months Ended | ||||||||
March 31, | ||||||||
2018 | 2017 | |||||||
Options to purchase common stock | 807 | 1,088 | ||||||
Restricted stock units | 396 | 384 | ||||||
Performance stock units | 23 | 164 | ||||||
Employee stock purchase plan shares | 34 | 49 | ||||||
Total | 1,260 | 1,685 |
Note N9ote 11. Income Taxes
The Company calculates the provision for income taxes during interim reporting periods by applying an estimate of the annual effective tax rate for the full fiscal year to "ordinary""ordinary" income or loss (pretax income or loss excluding unusual or infrequently occurring discrete items) for the reporting period. When applicable, the year-to-date tax provision reflects adjustments from discrete tax items. However, for the fiscal three -month period ended March 31, 2016, the Company used a discrete effective tax rate method to calculate the provision for income taxes. The Company determined that since small changes in estimated "ordinary" income would result in significant changes in the estimated annual effective tax rate, the historical method would not provide a reliable estimate for the fiscal three-month period ended March 31, 2016. The Company's income tax benefit for the three months ended March 31, 2017 relates primarily to2018 reflects a projected income tax expense for U.S. alternative minimum taxes and income taxes of the Company's non-U.S. operations based on theresulting in an annual effective tax rate method. The Company's incomeapplied to the year-to-date ordinary loss. This tax expense forbenefit is increased by excess tax benefit generated by stock deductions exercised or vested in the three months ended March 31, 2016 relates primarily to income taxes of the Company's non-U.S. operations. The Company's U.S. operation continues to be in a loss position and the Company maintains a 100% valuation allowance against its U.S. deferred tax assets. 2018. For the three months ended March 31, 2017, 2018, the Company's income tax benefit was $118,000,$2,619,000, compared to a tax expensebenefit of $24,000$118,000 for the same period in 2016.2017. The income tax benefit for the three months ended March 31, 2017 2018 includes a tax benefit for excess tax deductions of approximately $51,000,$1,460,000, recorded discretely in the reporting period.
The Company utilizes the asset and liability method of accounting for income taxes, under which deferred taxes are determined based onon the temporary differences between the financial statement and tax basis of assets and liabilities using enacted 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 MarchDecember 31, 2017, and December 31, 2016, the Company had a 100%released its valuation allowance against its U.S. Federal and all other domestic state net deferred tax assets. assets except for California and Massachusetts. The Company maintained this valuation allowance position through March 31, 2018. 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 lossesprofits and lesser weight to its projected financial results due to the subjectivity involved in 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.strategies and the impact of the Tax Cuts and Jobs Act of 2017 (the “2017 Tax Act”).
Note 12. Segment reporting
Segment reporting is based on the “management approach,” following the method that management organizes the company’s reportable segments for which separate financial information is made available to, and evaluated regularly by, the chief operating decision maker in allocating resources and in assessing performance. The Company’s chief operating decision maker ("CODM") is its CEO, and makes decision on allocating resources and in assessing performance. The CODM reviews the Company's consolidated results as one operating segment. In making operating decisions, the CEO primarily considers consolidated financial information, accompanied by disaggregated information about revenues by geography and product. All of the Company’s principal operations and decision-making functions are located in the United States. The Company’s chief operating decision maker viewed its operations, managed its business, and used one measurement of profitability for the one operating segment - which sells aesthetic medical equipment and services, and distributes skincare products, to qualified medical practitioners. Substantially all of the Company’s long-lived assets are located in the U.S.
The following table presents a summary of revenue by geography for the three months ended March 31, 2018 and 2017:
Three Months Ended March 31, | ||||||||
Revenue mix by geography: | 2018 | 2017 | ||||||
United States | $ | 21,136 | $ | 16,544 | ||||
Japan | 3,555 | 3,880 | ||||||
Asia, excluding Japan | 2,843 | 3,184 | ||||||
Europe | 2,570 | 2,225 | ||||||
Rest of the world | 4,021 | 3,466 | ||||||
Total consolidaed revenue | $ | 34,125 | $ | 29,299 | ||||
Revenue mix by product category: | ||||||||
Products | $ | 27,239 | $ | 22,992 | ||||
Consumables (Hand Piece Refills) | 769 | 499 | ||||||
Skincare | 1,256 | 984 | ||||||
Total product revenue | $ | 29,264 | $ | 24,475 | ||||
Service | 4,861 | 4,824 | ||||||
Total consolidated revenue | $ | 34,125 | $ | 29,299 |
Note 10.13. Commitments and Contingencies
Operating Leases
The Company leases space for operations in United States, Japan and France. Future minimum lease commitments under the Company’s facility operating leases as of March 31, 2018 were as follows (in thousands):
Year Ending March 31, | Amount | |||
2018 | $ | 2,266 | ||
2019 | 3,002 | |||
2020 | 2,937 | |||
2021 | 2,529 | |||
2022 | 2,495 | |||
2023 and beyond | 213 | |||
Total future minimum lease payments | $ | 13,442 |
In addition to the above facility leases, the Company also routinely leases automobiles for certain sales and field service employees under operating leases for which the remaining committed lease payments are not material.
Contingencies
The Company is named from time to time as a party to other legal proceeds product liability,, commercial disputes, employee disputes, and contractual lawsuits and other general corporate matters in the normal course of business. The Company routinely assessesA liability and related charge are recorded to earnings in the likelihood of any adverse judgments or outcomes related toCompany’s consolidated financial statements for 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 whetherwhen the loss is estimable.considered probable and the amount can be reasonably estimated. The assessment is re-evaluated each accounting period and is based on all available information, including discussion with outside legal counsel. If a reasonable estimate of a known or probable loss cannot be made, but a range of probable losses can be estimated, the low-end of the range of losses is recognized if no amount within the range is a better estimate than any other. If a material loss is reasonably possible, but not probable and can be reasonably estimated, the estimated loss or range of loss is disclosed in the notes to the consolidated financial statements. The Company expenses legal fees as incurred.
As of March 31, 2018 and December 31, 2017, the Company had accrued $40,000 and $91,000 respectively, related to various pending contractual and product liability lawsuits. The Company isdoes not currently believe that a party to any material legal proceedings.loss in excess of accrued amounts is reasonably possible.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Caution Regarding Forward-Looking Statements
TheYou should read the following management’s discussion should be readand analysis of our financial condition and results of operations in conjunction with the attached Condensed Consolidated Financial Statements our unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2016 as contained2017, included in our annual report on Form 10-K filed on March 26, 2018 with the SEC on March U.S. Securities and Exchange Commission (SEC).15, 2017.
Special note regarding forward-looking statements
This quarterly report includingcontains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed in the following sections, containsforward-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 Private Securities Litigation ReformAct and Section 21E of the Securities Exchange Act of 1995. Throughout this report,1934, as amended, or 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 particularly in this Item 2, thesimilar expressions or variations intended to identify forward-looking statements. These statements are based upon our current expectations, estimates and projections and reflect ouron the beliefs and assumptions of our management based uponon information currently 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. Thesemanagement. Such 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 21identifyother important factors that could cause actual results and the timing of certain events to differ materially from those predicted in anyfuture results expressed or implied by such forward-looking statements. We caution youFactors that could cause or contribute to such differences include, but are not place undue reliance on theselimited 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 which reflect management’s analysis and expectationsspeak only as of the date of this report. WeExcept as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances occurring after the date of this Form 10-Q.such statements. The statements are subject to change based on various factors, including but not limited to the risks and uncertainties summarized below:
● | changes in our common stock price; | |
● | the ability of our sales force to effectively market and promote our products, and the extent to which those products gain market acceptance; | |
● | the existence and timing of any product approvals or changes; | |
● | the rate and size of expenditures incurred on our clinical, manufacturing, sales, marketing and product development efforts; | |
● | our ability to obtain and retain personnel; | |
● | the availability of key components, materials and contract services, which depends on our ability to forecast sales, among other things; | |
● | investigations of our business and business-related activities by regulatory or other governmental authorities; | |
● | variations in timing and quantity of product orders; | |
● | temporary manufacturing interruptions or disruptions; | |
● | the timing and success of new product and new market introductions, as well as delays in obtaining domestic or foreign regulatory approvals for such introductions; | |
● | increased competition, patent expirations or new technologies or treatments; | |
● | product recalls or safety alerts; | |
● | litigation, including product liability, patent, employment, securities class action, stockholder derivative, general commercial and other lawsuits; | |
● | continued volatility in the global market and worldwide economic conditions, including, but not limited to, the impact of events such as Brexit; | |
● | changes in tax laws, including changes due to Brexit, or exposure to additional income tax liabilities; | |
● | the financial health of our customers and their ability to purchase our products in the current economic environment; and | |
● | other unusual or non-operating expenses, such as expenses related to mergers or acquisitions, may cause operating result variations. |
Introduction
The Management’sManagement’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. |
| ● | Results of Operations. This section provides our analysis and outlook for the significant line items on our Condensed 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 |
Executive
Executive Summary
Company Description.Description
We are a leading medical device company specializing in the research, development, manufacture, marketing and servicing of laser and other energy-basedenergy based aesthetics systems for practitioners worldwide. In addition to internal development of products, we distribute third party sourced products under our own brand names. We offer easy-to-use products which enable physicians and other qualified practitioners to perform safe and effective aesthetic procedures, including treatment of vascular conditionsfor body contouring, skin resurfacing and rejuvenation, tattoo removal, removal of benign pigmented lesions, vascular conditions, hair removal, skin rejuvenation, body contouring, skin resurfacing, tattoo removaltoenail fungus and toenail fungus.vaginal health. Our platforms are designed to be easily upgraded to add additional applications and hand pieces, which provide flexibility for our customers as they expand their practices. The sales of systems, system upgrades, hand pieces, hand piece refills (applicable to Titan and truSculpt) and the distribution of third party manufactured skincare products are classified as “Products” revenue. In addition to Productssystems and upgrade revenue, we generate revenue from the sale of post-warrantypost warranty service contracts, parts, detachable hand piece replacements (exceptproviding services forTitan and truSculpt) and service labor for the repair and maintenance of products that are out of warranty, allhand piece refills, and distribution of which is classified as “Service” revenue.third-party manufactured skincare products.
Our ongoing research and development activities are primarily focused on improving and enhancing our portfolio of products. We are exploring ways to expand our product offerings through the launch of new products. We introduced Juliet, a product for women’s health, in December 2017, and Secret RF, a fractional RF microneedling device for skin rejuvenation, in January 2018. Enlighten SR also began sales in the first quarter of 2018.
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. We have wholly-owned subsidiariesmarket, sell and service our products through direct sales and service employees in the U.S., Australia, Belgium, Canada, France, Hong Kong, Japan, Spain, Switzerland and the United Kingdom. We market, sellSales and service our productsService outside of the United Statesthese direct markets are made through our direct employees, third party service providers, as well as a globalworldwide distributor network in over 40 countries.
Products and Services
Our revenue is derived from the sale of Products and Services. Our ProductsProduct revenue is derived from the sale and upgrade of Systems, Hand piece refills (applicablesystems (classified as “Systems” revenue), sale of replacement hand pieces, as well as single use disposable tips applicable to TitanJuliet, Secret RF® and truSculpt (classified as “Consumables”), and the distributionsale of third party manufactured Skincare products. Systemsskincare products (classified as “Skincare” revenue). System revenue includesrepresents the salessale of new systems and additional applications that customers purchase as their practice grows.a system or an upgrade of a system. A system consists of a console that incorporates a universal graphic user interface, a laser and/or other energy-basedenergy based module, control system software and high voltage electronics andelectronics; 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 such as with our Pearl and PearlFractional applications instead of within the console.
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 us with a source of additional Systems revenue.
Skincare revenue relates to the distribution of ZO’s skincare products in Japan.
Our primary system platforms include:
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Other than the above mentioned five primary systems, we continue to generate revenue from our legacy products such as GenesisPlusTM, CoolGlide®, solera®, and a third-party sourced system called myQTM for the Japanese market. We have renewed our distribution contract for the sale of myQ in Japan on a non-exclusive basis through September 30, 2018. For our Titan and excel V, excel HR, enlighten, Juliet, Secret RF, truSculpt hand pieces, after a set number of treatments have been performed, the customer is required to send the hand piece back to the factory for refurbishment, which we refer to as “andrefilling xeo.” the hand piece. In Japan, we distribute ZO Medical Health Inc. (“ZO”) skincare products.
Service revenue relates to amortization of prepaid service contracts, training, enlighten installation, direct billings for detachable hand piece replacements (except for Titanand truSculpt) and revenue for parts and labor on out-of-warranty products.
Significant Business Trends
We believe that our ability to grow revenue will be primarily dependent on the following:
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● | consumer demand for the application of our products; |
● | marketing to physicians in the core dermatology and plastic |
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For a detailed discussion of the significant business trends impacting our business, please see the section titled “Results of Operations” below.
Factors that May Impact Future Performance.Performance
Our industry is impacted by numerous competitive, regulatory macroeconomic and other significant factors. 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 developwith 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,I, Item 1A “Risk Factors” section below.and elsewhere in this Form 10-Q, (1) our 2017 Form 10-K, (2) our reports and registration statements filed and furnished from time to time with the SEC, and (3) other announcements we make from time to time.
Critical Accounting Policiesaccounting policies, significant judgments and Estimates.use of estimates
The Company's management discussion and analysis of financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, (“U.S. GAAP”). The preparation of our Condensed Consolidated Financial Statements and related disclosures in conformity with GAAPthese condensed consolidated financial statements requires us to make estimates judgments and assumptionsjudgments that affect the reported amounts of assets, liabilities revenue and expenses. TheseOn an ongoing basis, we evaluate our critical accounting policies and estimates. We base our estimates judgments and assumptions are based on historical experience and on various other factorsassumptions that we believe to be reasonable in the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that 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 betweennot readily apparent from other sources. Actual results may differ from these estimates under different assumptions and actual results,conditions. Our significant accounting policies are more fully described in Note 1 of the accompanying unaudited condensed consolidated financial statements and in Note 2 to our audited consolidated financial conditionstatements contained in the Annual Report on Form 10-K filed on March 26, 2018 with the Securities Exchange Commission, or resultsthe SEC. With the exception of operations will be affected.
Critical accounting estimates,the change in revenue recognition as defined bya result of the SEC, are those that are most importantadoption of ASC 606, (see Notes 2 and 7) there have been no new or material changes 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. Thecritical 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”discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 filed with the SEC on March 15, 2017. There have been no significant changes2017, that are of significance, or potential significance to the accounting policies and estimates disclosed in our Form 10-K.Company.
Results of Operations
The following table sets forth selected consolidated financial data for the periods indicated, expressed as a percentage of total revenue, net. Percentages in this table and throughout our discussion and analysis of financial condition and results of operations may reflect rounding adjustments.
Three Months Ended | Three Months Ended | |||||||||||||||
March 31, | March 31, | |||||||||||||||
2017 | 2016 | 2018 | 2017 | |||||||||||||
Net revenue | 100 | % | 100 | % | 100 | % | 100 | % | ||||||||
Cost of revenue | 47 | % | 44 | % | 49 | % | 47 | % | ||||||||
Gross margin | 53 | % | 56 | % | 51 | % | 53 | % | ||||||||
Operating expenses: | ||||||||||||||||
Sales and marketing | 37 | % | 39 | % | 38 | % | 37 | % | ||||||||
Research and development | 10 | % | 12 | % | 10 | % | 10 | % | ||||||||
General and administrative | 11 | % | 14 | % | 16 | % | 11 | % | ||||||||
Total operating expenses | 58 | % | 65 | % | 64 | % | 58 | % | ||||||||
Loss from operations | (5 | )% | (9 | )% | (14 | )% | (5 | )% | ||||||||
Interest and other income, net | 1 | % | — | % | — | % | 1 | % | ||||||||
Loss before income taxes | (4 | )% | (9 | )% | (14 | )% | (4 | )% | ||||||||
Benefit (provision) for income taxes | — | % | — | % | ||||||||||||
Benefit for income taxes | (8 | )% | — | % | ||||||||||||
Net loss | (4 | )% | (9 | )% | (6 | )% | (4 | )% |
Total Net Revenue
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2017 | % Change | 2016 | |||||||||
Revenue mix by geography: | ||||||||||||
United States | $ | 16,544 | 50 | % | $ | 11,054 | ||||||
International | 12,755 | 12 | % | 11,369 | ||||||||
Consolidated total revenue | $ | 29,299 | 31 | % | $ | 22,423 | ||||||
United States as a percentage of total revenue | 56 | % | 49 | % | ||||||||
International as a percentage of total revenue | 44 | % | 51 | % | ||||||||
Revenue mix by product category: | ||||||||||||
Systems – North America | $ | 14,460 | 60 | % | $ | 9,024 | ||||||
Systems – International | 8,532 | 14 | % | 7,489 | ||||||||
Total Systems | 22,992 | 39 | % | 16,513 | ||||||||
Hand Piece Refills | 499 | (12 | )% | 564 | ||||||||
Skincare | 984 | 12 | % | 879 | ||||||||
Service | 4,824 | 8 | % | 4,467 | ||||||||
Consolidated total revenue | $ | 29,299 | 31 | % | $ | 22,423 |
Revenue
The Company primarily generate revenue from the sale of systems, training on the systems, extended service contracts, consumables and other accessories. The timing of our revenue is significantly affected by the mix of system products, installation, training, consumables and extended contract services. The revenue generated in any given period is also impacted by whether the revenue is recognized over time or at a point in time, upon completion of delivery. For an additional description on revenue, see Note 2 in the notes to consolidated financial statements on the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 and notes 2 and 7 to the condensed consolidated financial statements.
As of March 31, 2018, approximately 14% of the Company’s revenue is recognized over time, and the remainder of the revenue is recognized upon completion of delivery. Revenue recognized over time includes revenue from the Company’s extended contract services, training, and Installation of the Enlighten systems. Revenue recognized upon delivery is primarily generated by the sales of system products, consumables and skincare.
During the first quarter of fiscal 2018, we recognized revenue based on the ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” but revenue for the three months ended March 31, 2017 was recognized based on Topic 605. Therefore, the periods are not directly comparable. For additional information on the impact of the new accounting standard on our revenue, see Notes 2 and 7 in the notes to condensed consolidated financial statements.
Total Net Revenue
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | |||||||||
Revenue mix by geography: | ||||||||||||
United States | $ | 21,136 | 28 | % | $ | 16,544 | ||||||
International | 12,989 | 2 | % | 12,755 | ||||||||
Consolidated total revenue | $ | 34,125 | 16 | % | $ | 29,299 | ||||||
United States as a percentage of total revenue | 62 | % | 56 | % | ||||||||
International as a percentage of total revenue | 38 | % | 44 | % | ||||||||
Revenue mix by product category: | ||||||||||||
Systems – North America | $ | 18,944 | 31 | % | $ | 14,460 | ||||||
Systems – Rest of World | 8,295 | (3 | )% | 8,532 | ||||||||
Total Systems | 27,239 | 18 | % | 22,992 | ||||||||
Consumables | 769 | 54 | % | 499 | ||||||||
Skincare | 1,256 | 28 | % | 984 | ||||||||
Total Products | 29,264 | 20 | % | 24,475 | ||||||||
Service | 4,861 | 1 | % | 4,824 | ||||||||
Total Net Revenue | $ | 34,125 | 16 | % | $ | 29,299 |
:Total Net Revenue:
OurThe Company’s revenue increased by 31%16% in the three month period ended March 31, 2017,2018, compared to the same period in 2016,2017, due primarily to increased system revenues.
Revenue by Geography:
OurThe Company’s U.S. revenue increased by $5.5 million, or 50% in the three months ended March 31, 2017, compared to the same period in 2016. This increase was due primarily to increased headcount as well as additional marketing and promotional activities.
Our international revenue increased by $1.4$4.6 million, or 12% in the three months ended March 31, 2017, compared to the same period in 2016. This increase was due primarily to growth in our direct business in Europe, Australia and Hong Kong, partially offset by a decline in our direct business in Japan.
Revenue by Product Type:
Systems Revenue
Systems revenue in North America increased by $5.4 million, or 60%28%, in the three months ended March 31, 2017,2018, compared to the same period in 2016.2017. This increase was due primarily to increased headcount and additional marketing and promotional activities, resultingnew products introduced into the market in increased enlighten, xeo, truSculpt and excel HR revenue, which was partially offset by declines in revenue from excel V.January 2018.
Systems
The Company’s international revenue outside of North America (“International”) increasedwas relatively flat, increasing by $1.0 million,$234,000, or 14%2%, in the three months ended March 31, 2017,2018, compared to the same period in 2016. This2017. The increase was attributable primarilydue to increased revenue from xeo growth in the Company’s business in Europe and excel HR,the Middle East, partially offset by declinesdecline in revenue from sales in Asia including Japan.
enlighten and
excel VRevenue by Product Type:.
Hand Piece RefillsSystems Revenue
Our Hand Piece RefillsSystems revenue decreasedin North America increased by $65,000,$4.5 million, or 12%31%, in the three months ended March 31, 2017,2018, compared to the same period in 2016. This decrease was caused primarily by reduced utilization2017 due to strong sales in Canada and the new products launched during the first quarter of 2018. The rest of the world systems revenue decreased by $237,000 or 3%. The decrease in rest of world revenue was primarily a result of a decline in revenue from the Company’s direct business in Asia, including Japan, partially offset by increases in our direct business in Australia, as well as increases in our distributor business in the Middle East, and Europe.
TitanConsumables Revenue
Consumables revenue increased by $270,000, or 54%, in the three months ended March 31, 2018, compared to the same period in 2017. The increase in consumables was due to the introduction of Secret RF hand pieces.and Juliet during January 2018, all of which have consumable elements.
Skincare Revenue
OurThe Company’s revenue from Skincare products in Japan increased by $105,000,$272,000, or 12%28%, in the three months ended March 31, 2017,2018, compared to the same period in 2016.2017. This increase was due primarily to increased marketing and promotional activities for this distributed product.
Service Revenue
Our worldwideThe Company’s Service revenue increased by $357,000,$37,000, or 8%1%, in the three months ended March 31, 2017,2018, compared to the same period in 2016.2017. This increase was due primarily to increased sales of system parts to ourthe Company's network of international distributors.
Gross Profit
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | |||||||||
Gross profit | $ | 17,334 | 12 | % | $ | 15,521 | ||||||
As a percentage of total net revenue | 51 | % | 53 | % |
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2017 | % Change | 2016 | |||||||||
Gross profit | $ | 15,521 | 24 | % | $ | 12,474 | ||||||
As a percentage of total net revenue | 53 | % | 56 | % |
OurThe Company’s cost of revenue consists primarily of material, personnel expenses, product warranty costs, amortization of intangibles and manufacturing overhead expenses.
Gross margin decreasedThe gross profit as a percentage of total revenues was 51% in 2018, compared to 53% in the three months ended March 31, 2017, compared to 56% in the same period in 2016. This decrease was due primarily to:to increased material, manufacturing and warranty costs, as well as higher Service personnel costs due to an investments in additional headcount to fuel future growth.
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Sales and Marketing
Three Months Ended March 31, | Three Months Ended March 31, | |||||||||||||||||||||||
(Dollars in thousands) | 2017 | % Change | 2016 | 2018 | % Change | 2017 | ||||||||||||||||||
Sales and marketing | $ | 10,773 | 24 | % | $ | 8,716 | $ | 13,088 | 21 | % | $ | 10,773 | ||||||||||||
As a percentage of total net revenue | 37 | % | 39 | % | 38 | % | 37 | % |
Sales and marketing expenses consist primarily of personnel expenses, expenses associated with customer-attended workshops and trade shows, post-marketing studies, and advertising. Sales and marketing expenses increased by $2.1$2.3 million, and represented 37%38% of total net revenue in the three months ended March 31, 2017,2018, compared to 39%37% in the same period in 2016.2017. The $2.1$2.3 million increase was due primarily to:
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Research and Development ((“R&D”)“R&D”)
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | |||||||||
Research and development | $ | 3,556 | 21 | % | $ | 2,945 | ||||||
As a percentage of total net revenue | 10 | % | 10 | % |
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2017 | % Change | 2016 | |||||||||
Research and development | $ | 2,945 | 9 | % | $ | 2,709 | ||||||
As a percentage of total net revenue | 10 | % | 12 | % |
R&D expenses consist primarily of personnel expenses, clinical research,, regulatory and material costs. R&D expenses increased by $236,000,$611,000, and represented 10% of total net revenue, in the three months ended March 31, 2017,2018, compared to 12%10% for the same period in 2016.2017. This increase in expense was due primarily to:to increased material and regulatory expenses, as well as personnel and consulting related expenses.
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General and Administrative ((“G&A”)“G&A”)
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | |||||||||
General and administrative | $ | 5,439 | 69 | % | $ | 3,216 | ||||||
As a percentage of total net revenue | 16 | % | 11 | % |
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2017 | % Change | 2016 | |||||||||
General and administrative | $ | 3,216 | — | % | $ | 3,220 | ||||||
As a percentage of total net revenue | 11 | % | 14 | % |
G&A&A expenses consist primarily of personnel expenses, legal fees, accounting, higher audit and tax consulting fees, and other general and administrative expenses. G&A expenses decreasedincreased by $4,000$2.2 million and represented 11%16% of total net revenue in the three months ended March 31, 2017,2018, compared to 14%11% in the same period in 2016.2017. This increase is primarily attributable to higher audit and tax fees related to the adoption of ASC 606, as well as increased personnel costs related to increased headcount.
Interest and Other Income, Net
Interest and other income, net,, consists of the following:
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2017 | % Change | 2016 | |||||||||
Interest income | $ | 119 | 55 | % | $ | 77 | ||||||
Other income (expense), net | 154 | 130 | % | 67 | ||||||||
Total interest and other income, net | $ | 273 | 90 | % | $ | 144 |
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | |||||||||
Interest and other income, net | $ | 98 | (64 | %) | $ | 273 |
Interest and other income, net, increased $129,000decreased $175,000 in the three months ended March 31, 2017,2018, compared to the same period in 2016.2017. This increasedecrease was due primarily to a reductionincrease in net foreign exchange losses, interest expense on multi-year contracts with customers related to the adoption of ASC 606 as well as an increasea decrease in interest income from our marketable investments.
Provision for Income Taxes
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | |||||||||
Loss before income taxes | $ | (4,651 | ) | 308% |
| $ | (1,140 | ) | ||||
Benefit for income taxes | (2,619 | ) | 2119% |
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Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2017 | % Change | 2016 | |||||||||
Loss before income taxes | $ | (1,140 | ) | (43 | )% | $ | (2,027 | ) | ||||
Provision (benefit) for income taxes | (118 | ) | (592 | )% | 24 |
For the three months ended March 31, 2017,2018, our income tax benefit was $118,000,$2,619,000, compared to a tax expensebenefit of $24,000$118,000 in the same period in 2016.2017. In the three months ended March 31, 2017,2018, we calculated the provision for income taxes for interim reporting periods by applying an estimate of the "annual effective tax rate" for the full fiscal year to ordinary income or loss.loss for the reporting period. Our income tax benefit for the three months ended March 31, 2017 relates primarily to U.S. alternative minimum taxes as we are able to utilize our net operating losses brought forward against our projected income for fiscal 2017. In addition, our income tax benefit for the three months ended March 31, 20172018 reflects a projected income tax expense for ourU.S. and non-U.S. operations.operations resulting in an annual effective tax rate applied to the year-to-date ordinary loss. The income tax benefit includes excess tax benefits generated by stock deductions exercised or vested in the three months ended March 31, 2018.
For our income tax provision in the three months ended March 31, 2016,2017, the tax expensebenefit was primarily related to projected U.S. alternative minimum taxes and income taxes from non-U.S. operations. The income tax benefit resulted from applying the annual effective tax rate by the year-to-date ordinary loss. The projected income tax reflected utilization of our non-U.S. operations as our U.S. operations werenet operating loss carryforwards. However, the tax effect of such utilization was offset by a change in a loss position and we had a 100% valuation allowance against them. We did not record a year-to-date tax benefit associated withfor the projected 2016 U.S. tax expense as ofthree months ended March 31, 2016 due to historical losses and uncertainties related to the projected income. We continue to maintain a 100% valuation allowance against our U.S. deferred tax assets in fiscal 2016 and 2017.
Liquidity and Capital Resources
Liquidity is the measurement of our ability to meet potential cash requirements, fund the planned expansion of our operations and acquire businesses. Our sources of cash include operations, stock option exercises, Employee Stock Purchase Plan contributions, and the liquidation of marketable investments.employee stock purchases. We actively manage our cash usage and investment of liquid cash to ensure the maintenance of sufficient funds to meet our daily needs. The majority of our cash and investments are held in U.S. banks and our foreign subsidiaries maintain a limited amount of cash in their local banks to cover their short-term operating expenses.
Cash, Cash EquivalentsAt March 31, 2018 and Marketable InvestmentsDecember 31, 2017, we had 40.3 million and $45.1 million of working capital, and our cash and cash equivalents and marketable investments totaled $23.9 and $35.9 million as of March 31, 2018 and December 31, 2017 respectively. Our combined cash and cash equivalents and marketable investments balance decreased by $11.9 million in the quarter end March 31, 2018 principally due to the settlement of Accrued liabilities, increased inventory purchases related to the increasing demand of our products, and an increase in investments in sales, service and other management headcount to facilitate continued revenue expansion. The following table summarizes our cash and cash equivalents and marketable investments:
TheCash, Cash Equivalents and Marketable Investments
The following table summarizes our cash, cash equivalents and marketable investments:
(Dollars in thousands) | March 31, 2017 | December 31, 2016 | Change | March 31, 2018 | December 31, 2017 | Change | ||||||||||||||||||
Cash and cash equivalents | $ | 11,443 | $ | 13,775 | $ | (2,332 | ) | $ | 10,910 | $ | 14,184 | $ | (3,274 | ) | ||||||||||
Marketable investments | 36,990 | 40,299 | (3,309 | ) | 13,062 | 21,728 | (8,666 | ) | ||||||||||||||||
Total | $ | 48,433 | $ | 54,074 | $ | (5,641 | ) | $ | 23,972 | $ | 35,912 | $ | (11,940 | ) |
Cash Flows
Three Months Ended March 31, | Three Months Ended March 31, | |||||||||||||||
(Dollars in thousands) | 2017 | 2016 | 2018 | 2017 | ||||||||||||
Net cash flow provided by (used in): | ||||||||||||||||
Operating activities | $ | (3,785 | ) | $ | (4,044 | ) | $ | (10,047 | ) | $ | (3,785 | ) | ||||
Investing activities | 3,274 | (721 | ) | 8,550 | 3,274 | |||||||||||
Financing activities | (1,821 | ) | 162 | (1,777 | ) | (1,821 | ) | |||||||||
Net decrease in cash and cash equivalents | $ | (2,332 | ) | $ | (4,603 | ) | $ | (3,274 | ) | $ | (2,332 | ) |
Cash Flows from Operating Activities
Net cash used in operating activities in the three months ended March 31, 20172018 was $3.8$10.0 million, which was due primarily to:
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Net cash used in operating activities in the three months ended March 31, 2016 was $4.0 million, which was due primarily to:
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● | $0.4 million used to increase prepaid expenses and other assets ( includes capitalized commission costs of $4.7 million less other increase in prepaid and other expenses); and |
● | $0.4 million related to decrease in |
Cash Flows from Investing Activities
We The Company generated net cash of $3.3$8.6 million in our investing activities in the three months ended March 31, 2017,2018, which was attributable primarily to:
● $13.0 million in net proceeds from the sales of marketable investments; partially offset by ● $4.4 million of cash used to purchase marketable investments. |
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We used net cash of $721,000 in our investing activities in the three months ended March 31, 2016, which was attributable primarily to:
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Cash Flows from Financing Activities
Net cash used in financing activities was $1.8 million in the three months ended March 31, 2017,2018, which was primarily due to:
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Net cash provided by financing activities was $162,000 in the three months ended March 31, 2016, which was primarily due to:
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Adequacy of CCash RResources to MMeet FFuture NNeedseeds
We had cash, cash equivalents, and marketable investments of $48.4$24.0 million as of March 31, 2017.2018. For the first three months of 2017,2018, we financed our operations through the sales and maturities of marketable investments and cash from the sale of stock due to employees exercising their stock options. We believe thethat our existing capitalcash resources including cash, cash equivalents and marketable investments of $48.4 million, are sufficient to meet our operatinganticipated cash needs for working capital and capital requirementsexpenditures for at least the next several years, and enable us to repurchase the remaining $7.2 million of stock pursuant to our Share Repurchase Program.years.
Except for the recent trend of cash used to fund our operating activities, purchase fixed assets and repurchase our common stock, we are unaware of any other known trends or any known demands, commitments, events or uncertainties, including collectability of our accounts receivable, that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way.
Commitments and Contingencies
There have beenDuring the three months ended March 31, 2018, there were no material changeschanges to our commitments and contingencies from those discloseddescribed under Management’s Discussion and Analysis of Financial Condition and Results of Operations in ourthe Annual Report on Form 10-K for the year ended December 31, 2016,2017, filed with the SEC on March 15, 2017.26, 2018.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
A summary of the key market risks facing the Company is disclosed below. For a detailed discussion, please see our Annual Report on Form 10-K for the year ended December 31, 2016,2017, filed with the SEC on March 15, 2017.26, 2018.
Interest Rate Fluctuations:Fluctuations
Our exposure to interest rate risk relates primarily to ourThe Company holds cash equivalents as well as short-term and long-term fixed income securities. The Company’s investment portfolio which includes primarily debt instruments of the U.S. Governmentfixed and its agencies, municipal bonds, corporate debt securities and commercial paper.floating rate securities. Changes in interest rates could impact our anticipated interest income. Fixed rate securities may have their fair market value adversely impacted if there is an increasedue to fluctuations in interest rates. While it isrates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our intentfuture investment income may fall short of expectation due to hold these securities to maturity,changes in interest rates or we may suffer losses in principal if for some reason we needforced to sell a security that hassecurities which have declined in market value due to changes in interest rates, thenrates. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we may suffer lossesinvest in principal.debt instruments of the U.S. Government and its agencies and municipal bonds, high grade corporate bonds, commercial paper, CDs and money markets, and, by policy, restrict our exposure to any single type of investment or issuer by imposing concentration limits. To minimize the exposure due to adverse shifts in interest rates, we maintain investments at a weighted average maturity of generally less than eighteen months. Based on discounted cash flow modeling with respect to our total investment portfolio as of March 31, 2017,2018, assuming a hypothetical increase in interest rates of one percentage point, (or 100 basis points), the fair value of our total investment portfolio would have potentially declineddecline by approximately $163,000.$66,000.
Inflation
The Company does not believe that inflation has had a material effect on our business, financial condition, or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition, and results of operations.
Foreign Exchange Fluctuations:
The Company generates revenue in Japanese Yen, Euros, Australian Dollars, Canadian Dollars, British Pounds and Swiss Francs. Additionally, a portion of our operating expenses and assets and liabilities are denominated in each of these currencies. Therefore, fluctuations in these currencies against the U.S. dollar could materially and adversely affect our results of operations upon translation of The Company’s revenue denominated in these currencies, as well as the remeasurement of our international subsidiaries’ financial statements into U.S. dollars
Foreign Exchange Fluctuations:
We doThe Company has historically not actively hedgeengaged in hedging activities relating to our exposure to currency rate fluctuations. Although a significant proportion of our revenue and costs are denominated in U.S. Dollars, we are exposed to foreign currency fluctuations in countries wheredenominated transactions, given we have a direct operation. The three major currencies that we have exposurenatural hedge resulting from our foreign cash receipts being utilized to and have assets and liabilities denominated infund our respective local currencies in, are Japanese Yen, Euro and Australian Dollar.currency expenses
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
An evaluation as of March 31, 2018 was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our “disclosure controls and procedures.” Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, or the “Exchange Act,” defines “disclosure controls and procedures” as controls and other procedures of a company that are designed to ensure that the information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at March 31, 2018.
Attached as exhibits to this Quarterly Report are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (“Exchange Act”). This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications, and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.
We conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as definedChanges in the Rules 13a-15(e) and 15d-15(e) under the Exchange Act) (“Disclosure Controls”) as of the end of the period covered by this Report required by Exchange Act Rules 13a-15(b) or 15d-15(b). The controls evaluation was conducted under the supervision and with the participation of our management, including the CEO and CFO. Based on this evaluation, the CEO and CFO have concluded that as of the end of the period covered by this report the disclosure controls and procedures were effective at a reasonable assurance level.Internal Control over Financial Reporting
Definition of Disclosure Controls
Disclosure Controls are controls and procedures designed to reasonably assure that information required to be disclosedThere were no changes in our reports filed under the Exchange Act, such as this Report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure Controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Our Disclosure Controls include components of internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of its financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles in the U.S. To the extent that components of our internal control over financial reporting during the three-month period ended March 31, 2018 that have materially affected, or are included within Disclosure Controls, they are included in the scope ofreasonably likely to materially affect, our annual controls evaluation.internal control over financial reporting.
Limitations on the Effectiveness of Controls
Our management, including the CEO and CFO, does not expect that our disclosure controls or internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designedconceived and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further,of the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, and instances of fraud, if any, within a company have been detected. These inherent limitations includeAccordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the realities that judgments in decision making can be faultyobjectives of our disclosure control system are met. As set forth above, our Chief Executive Officer and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management overrideChief Financial Officer have concluded, based on their evaluation as of the controls. The designend of any system ofthe period covered by this report, that our disclosure controls is based in part on certain assumptions about the likelihood of future events, and there can be noprocedures were effective to provide reasonable assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate becausethe objectives of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effectiveour disclosure control system misstatements due to error or fraud may occur and not be detected.were met.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
LEGAL PROCEEDINGS |
We are named fromFrom time to time, asThe Company may be involved in legal and administrative proceedings and claims of various types. For a partydescription of The Company’s material pending legal and regulatory proceedings and settlements refer to product liabilityNote 12 to the Company’s consolidated financial statements entitled “Litigation and contractual lawsuitsRelated Matters,” in the normal course of business. We routinely assessAnnual Report on Form 10-K for the likelihood of any adverse judgments or outcomes related to legal matters and claims, as well as ranges of probable losses. A determination ofyear ended December 31, 2017, filed with 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 we shall incur a loss, and whether the loss is estimable. We are not currently a party to any material legal proceedings.SEC on March 26, 2018.
RISK FACTORS |
We operate in a rapidly changing economic and technological environment that presents numerousThe Company’s business faces many risks. Any of the risks many of which are driven by factors that we cannot control or predict. Our business, financial condition and results of operations may be impacted by a number of factors. In addition to the factors discussed elsewherereferenced in this report,Form 10-Q or the following risks and uncertaintiesCompany’s other SEC filings could materially harmhave a material impact on our business and consolidated financial conditionposition or results of operations, including causing our actual results to differ materially from those projected in any forward-looking statements. The following list of significant risk factors is not all-inclusive or necessarily in order of importance.operations. Additional risks and uncertainties not presently known to us or that we currently deembelieve to be immaterial may also may materially adversely affect usimpair our business operations.
There have been no material changes in future periods. Youthe risk factors set forth in Part I, Item 1A, “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. For detailed discussion of risk factors that should carefully consider these risks and uncertainties before investingbe understood by any investor contemplating investment in our securities.
If our product mix does not improve towards more favorable higher margin products, or if our cost of revenue does not decrease as a percentage of our revenue, our gross margins and operating margins may be adversely impacted, it could have a material adverse effect on our profitability, cash flow from operations, assets and on our stock, price.
Our gross margin (revenue less cost of revenue) declinedplease refer to 53% in the three months ended March 31, 2017, compared to 56% in the same period in 2016. Our gross margin is impacted by the revenue that we generate and the costs incurred to generate the revenue. Our first quarter 2017 revenue was negatively impacted by our product mix towards a higher percentage of revenue being sourced from our enlighten and excel HR products, that have lower gross margins than our legacy products. Our gross margin from the enlighten product was adversely impacted by the sale of discounted enlighten III products and upgrades due in part to market seeding during the early launch phase of this new product. In addition, our initial cost of production and warranty of the enlighten III product were higher than expected.
In order to improve our gross margins for our enlighten products, we need to be able to increase the average selling prices ("ASPs"), as well as reduce its cost of production and servicing. While we are in the process of implementing initiatives to improve our enlighten III product margin, there can be no assurance given that we will be successful in doing so.
Our future gross margin may also be affected by a number of other factors including, the competitive market environment in which we operate, a decrease in ASPs achieved for our product sales, a shift“Part I. Item 1A. Risk Factors” in our product mix towards products with lower ASPs or lower margins, or a decrease2017 Form 10-K and elsewhere in our ASPs as a result of bundling products to achieve higher revenue, or a decrease in the number of applications per system purchased by customers. In addition, our cost of revenue may also be adversely impacted by various factors such as increased expenses associated with the repair of defective products covered by our warranty program, utilization of our relatively fixed manufacturing costs, a shift in our product mix towards products that have a higher cost of manufacturing, and obsolescence of our inventory.
If our product mix towards higher margin products does not improve, or if our ASPs do not improve, or if our cost of revenue increases by a greater percentage than our revenue, or if we are not able to reduce expenses in the event of a decline in revenue, we may continue to experience a decline in our gross margins, compared to the same period in the prior year, which could have a material adverse effect on our profitability, cash flow from operations, assets and on our stock price.
We may be unable to maintain profitability.
Although we had profitable third and fourth quarters in 2016, we gave financial guidance that we expect to be in a loss position in the first quarter of 2017 but profitable for the full year of 2017, there can be no assurance that we will be able to achieve or maintain profitability for the remainder of fiscal 2017. Given our recent operating history of few profitable quarters, we cannot be certain that we will be able to maintain profitability in the future and you should not rely on our operating results for any prior quarterly or annual periods as an indication of our future operating performance. Any predictions about the performance of our operations in the future may not be as accurate as they could be if we had a longer history of profitability.
Revenue growth in our business is driven by several factors and one such factor is new product introductions. Our ability to sustain profitability depends on our ability to introduce new products that are adopted by our customers and on the extent to which we can increase revenue and control our costs to be able to leverage our expenses. In addition, we need to be able to counter any unforeseen difficulties, complications, product delays or other unknown factors that may require additional expenditures. Because of the numerous risks and uncertainties associated with our growth prospects, product development, sales and marketing and other efforts, unforeseen litigation expenses, etc., we are unable to predict the extent of our future profitability or losses.
We rely heavily on our sales professionals to market and sell our products worldwide. If we are unable to hire, effectively train, manage, improve the productivity of, and retain our sales professionals, our business will be harmed, which would impair our future revenue and profitability.
Our success largely depends on our ability to hire, train, manage and improve the productivity levels of our sales professionals worldwide. Because of our focus on non-core practitioners in the past, several of our sales professionals do not have established relationships with the core market, consisting of dermatologists and plastic surgeons, or where those relationships exist, they are not very strong.
We have experienced direct sales employee and sales management turnover in North America, Japan, and Europe. Competition for sales professionals who are familiar and trained to sell in the aesthetic equipment market continues to be strong. As a result, we have lost some of our sales people to our competitors. Our industry is characterized by a few established companies that compete vigorously for talented sales professionals. Further, as the economy in North America has rebounded from the recent recession, some of those sales professionals have left our company for jobs that they perceive to be better opportunities, both within and outside of the aesthetic industry. However, we have also hired a record number of new sales people, including several from our competitors. Several of our sales employees and sales management have been recently hired or recently transferred into different roles, and it will take time for them to be fully trained to improve their productivity. In addition, due to the competition for sales professionals in our industry, we have recruited sales professionals from outside the industry. Sales professionals from outside the industry take longer to train and to become familiar with our products and the procedures in which they are used. As a result of a lack of industry knowledge, these sales professionals may take longer to become productive members of our sales force.
We train our existing and recently recruited sales professionals to better understand our existing and new product technologies and how they can be positioned against our competitors’ products. These initiatives are intended to improve the productivity of our sales professionals and our revenue and profitability. It takes time for the sales professionals to become productive following their training and there can be no assurance that the recently recruited sales professionals will be adequately trained in a timely manner, or that our direct sales productivity will improve, or that we will not experience significant levels of attrition in the future.
Measures we implement in an effort to recruit, retain, train and manage our sales professionals, strengthen their relationships with core market physicians, and improve their productivity may not be successful and may instead contribute to instability in our operations, additional departures from our sales organization, or further reduce our revenue and harm our business. If we are not able to improve the productivity and retention of our North American and international sales professionals, then our total revenue, profitability and stock price may be adversely impacted.this Form 10-Q.
The aesthetic equipment market is characterized by rapid innovation. To compete effectively, we must develop and/or acquire new products, market them successfully, and identify new markets for our technology.
We have created products to apply our technology to body contouring, hair removal, treatment
To successfully expand our product offerings, we must, among other things:
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Historically, product introductions have been a significant component of our financial performance. To be successful in the aesthetics industry, we need to continue to innovate. Our business strategy has therefore been based, in part, on our expectation that we will continue to increase our product offerings. We need to continue to devote substantial research and development resources to make new product introductions, which can be costly and time consuming to our organization.
We also believe that, to increase revenue from sales of new products, we need to continue to develop our clinical support, further expand and nurture relationships with industry thought leaders and increase market awareness of the benefits of our new products. However, even with a significant investment in research and development, we may be unable to continue to develop, acquire or effectively launch and market new products and technologies regularly, or at all. If we fail to successfully commercialize new products, our business may be harmed.
While we attempt to protect our products through patents and other intellectual property, there are few barriers to entry that would prevent new entrants or existing competitors from developing products that compete directly with ours. We expect that any competitive advantage we may enjoy from current and future innovations may diminish over time as companies successfully respond to our, or create their own, innovations. Consequently, we believe that we will have to continuously innovate and improve our products and technology to compete successfully. If we are unable to innovate successfully, our products could become obsolete and our revenue could decline as our customers and prospects purchase our competitors’ products.
Demand for our products in any of our markets could be weakened by several factors, including:
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If we do not achieve anticipated demand for our products, there could be a material adverse effect on our total revenue, profitability, employee retention and stock price.
We depend on skilled and experienced personnel to operate our global business effectively. Changes to management or the inability to recruit, hire, train and retain qualified personnel, could harm our ability to successfully manage, develop and expand our business, which would impair our future revenue and profitability.
Our success largely depends on the skills, experience and efforts of our officers and other key employees. The loss of any of our executive officers could weaken our management expertise and harm our business, and we may not be able to find adequate replacements on a timely basis, or at all. Except for Change of Control and Severance Agreements for our executive officers and a few key employees, we do not have employment contracts with any of our officers or other key employees. Any of our officers and other key employees may terminate their employment at any time and their knowledge of our business and industry would be difficult to replace. We do not have a succession plan in place for each of our officers and key employees. In addition, we do not maintain “key person” life insurance policies covering any of our employees.
We recently hired a new Chief Executive Officer and President (“CEO”), who also is on our Board of Directors. His prior experience is primarily with medical device companies, but not within the aesthetics industry specifically. In addition, he has never been a public company CEO. Recently hired executives may view the business differently than prior members of management, and over time may make changes to the existing personnel and their responsibilities, our strategic focus, operations or business plans. We can give no assurances that we will be able to properly manage any such shift in focus, or that any changes to our business, would ultimately prove successful. In addition, leadership transitions and management changes can be inherently difficult to manage and may cause uncertainty or a disruption to our business or may increase the likelihood of turnover in key officers and employees. Our success depends in part on having a successful leadership team. If we cannot effectively manage the leadership transitions and management changes, it could make it more difficult to successfully operate our business and pursue our business goals. We cannot ensure that we will be able to retain the services of any members of our executive officers or other key employees. If we do not succeed in attracting well-qualified employees, retaining and motivating existing employees or integrating new executives and employees, our business could be materially and adversely affected.
Our ability to retain our skilled labor force and our success in attracting and hiring new skilled employees are critical factors in determining whether we will be successful in the future. We may not be able to meet our future hiring needs or retain existing personnel. The staff we hire to perform administrative functions may become stretched due to our increased growth and they may not be able to perform their jobs effectively or efficiently as a result.
We may face particularly significant challenges and risks in hiring, training, managing and retaining engineering and sales and marketing employees. Failure to attract, train and retain personnel, particularly technical and sales and marketing personnel, would materially harm our ability to compete effectively and grow our business.
Our search for a replacement Executive Vice President and Chief Financial Officer (“CFO”), may cause uncertainty regarding the future of our operations, impact employee hiring and retention, increase the volatility in our stock price, and adversely impact our revenue, operating results, and financial condition.
On April 17, 2017, Our Executive Vice President and Chief Financial Officer notified the Company that he plans to leave the Company. However, he plans to remain in his current role and assist with an orderly transition for up to three months following the appointment of his successor. While the Company has initiated a search to identify a replacement for him, any related speculation and uncertainty in connection with the search and the appointment of a replacement CFO may cause or result in:
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If we are unable to mitigate these or other potential risks related to the uncertainty caused by the planned departure and replacement of our CFO, it may disrupt our business or adversely impact our revenue, operating results, and financial condition. Further, there can be no assurance that we will be able to attract a qualified new CFO who has the desired qualifications to lead our Company or that we can hire a replacement CFO on acceptable terms.
The lease for our corporate headquarters and manufacturing facility in Brisbane, California, U.S.A., expires on December 31, 2017. We have identified a new facility in the same general vicinity of our current facility and our Board of Directors has approved the lease for this new facility. Even though the new facility is within 40 miles of our current facility, we may experience loss of key employees, incur relocation costs and capital expenditures for furniture, fixtures and equipmen
We occupy office space in Brisbane, California, in a facility leased from a commercial landlord, with a lease that expires on December 31, 2017. There is significant demand for leased facilities in the San Francisco Bay area and leasing costs have increased significantly over the last few years. We have identified a new facility in the same general vicinity of current facility and our Board of Directors has approved the lease for the new facility.
Even though the new facility is within 40 miles of our current facility, we may experience loss of key employees, incur relocation costs and capital expenditures relating to leasehold improvements, furniture, fixtures and equipment. Further, we may incur related expenses, such as those associated with regulatory approvals or clearances to manufacture our products. While we plan to arrange for an orderly move and relocation to the new facility, we may encounter disruptions of our manufacturing and operations, may not be able to hire replacement employees on a timely basis, and incur significant costs related to the move, all of which could have an adverse effect on our financial condition, results of operations and cash flow.
Macroeconomic political and market conditions, and catastrophic events may adversely affect our business, results of operations, financial condition and stock price.
Our business is influenced by a range of factors that are beyond our control, including:
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Macroeconomic developments, like global recessions and financial crises could negatively affect our business, operating results or financial condition which, in turn, could adversely affect our stock price. A general weakening of, and related declining corporate confidence in, the global economy or the curtailment in government or corporate spending could cause current or potential customers to reduce their budgets or be unable to fund product or upgrade application purchases, which could cause customers to delay, decrease or cancel purchases of our products and services or cause customers not to pay us or to delay paying us for previously purchased products and services.
In addition, political unrest in regions like the Middle East, terrorist attacks around the globe and the potential for other hostilities in various parts of the world, potential public health crises and natural disasters continue to contribute to a climate of economic and political uncertainty that could adversely affect our results of operations and financial condition, including our revenue growth and profitability.
Macroeconomic declines, negative political developments, adverse market conditions and catastrophic events may cause a decline in our revenue, negatively affect our operating results, adversely affect our cash flow and could result in a decline in our stock price.
The price of our common stock has increased by over 73% in the six months ended March31, 2017 and may fluctuate substantially due to several factors, some of which are discussed below. Further, we have a limited number of shares of common stock outstanding, a large portion of which is held by a small number of investors, which could result in the increase in volatility of our stock price.
The price of our common stock has increased by over 73% in the six months ended March 31, 2017 due in part to our recent improved revenue and profitability performance, the acquisition of two of our competitors (Cynosure and Zeltiq) in February 2017, the financial guidance we communicated to the investor community in February 2017, repurchases of our stock, the overall rise in the stock market following the conclusion of the U.S. presidential election in November 2016 and other factors. As of December 31, 2016, approximately 50% of our outstanding shares of common stock were held by 10 institutional investors. As a result of our relatively small public float, our common stock may be less liquid than the stock of companies with broader public ownership. Among other things, trading of a relatively small volume of our common stock may have a greater impact on the trading price for our shares than would be the case if our public float were larger. The public market price of our common stock has in the past fluctuated substantially and, due to the current concentration of stockholders, may continue to do so in the future.
The market price for our common stock could also be affected by a number of other factors, including:
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Actual or perceived instability and / or volatility in our stock price could reduce demand from potential buyers of our stock, thereby causing our stock price to either remain depressed or to decline further.
In addition, if the market for medical-device company stocks or the stock market in general experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, results of operations or financial condition. The trading price of our common stock might also decline in reaction to events that affect other companies in our industry even if these events do not directly affect us. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. Any future securities litigation could result in substantial costs and divert our management’s attention and resources from our business. This could have a material adverse effect on our business, results of operations and financial condition.
We may fail to meet our publicly announced guidance or other expectations about our business and future operating results, which would cause our stock price to decline.
We may continue to provide financial guidance about our business and future operating results. In developing this guidance, our management must make certain assumptions and judgments about our future operating performance, including projected hiring of sales professionals, continued growth of revenue in the aesthetic device market, continue to increase our market share, reduce costs of production of our recently introduced products, and continued stability of the macro-economic environment in our key markets. Furthermore, analysts and investors may develop and publish their own projections of our business, which may form a consensus about our future performance. Our business results may vary significantly from such guidance or that consensus due to a number of factors, many of which are outside of our control, and which could adversely affect our operations and operating results. Furthermore, if we make downward revisions of our previously announced guidance, or if our publicly announced guidance of future operating results fails to meet expectations of securities analysts, investors or other interested parties, the price of our common stock would decline.
To successfully market and sell our products internationally, we must address many issues that are unique to our international business.
International revenue is a material component of our business strategy, and represented 45% of our total revenue in 2016 compared to 48% of our total revenue in 2015. In addition, while our international revenue in 2015 increased by 8% compared to 2014, it was negatively impacted by the appreciation of the U.S. Dollar versus the major currencies in which we transact. We depend on third-party distributors and a direct sales force to sell our products internationally, and if they underperform, we may be unable to increase or maintain our level of international revenue. For example, our direct business in Japan declined in 2015, due in part to the negative impact of foreign exchange and employee turnover, which negatively impacted our revenue from international operations.
We have experienced significant turnover of our European sales team in the past. While we continue to have a direct sales and service organization in France, Belgium, Spain, Switzerland and the United Kingdom, a significant portion of our European revenue is generated through our network of distributors. Though we continue to evaluate and replace non-performing distributors, and have recently brought greater focus on collaborating with our distributor partners, there can be no assurance given that these initiatives will result in improved European-sourced revenue or profitability in the future.
To grow our business, we will need to improve productivity in current sales territories and expand into new territories. However, direct sales productivity may not improve and distributors may not accept our business or commit the necessary resources to market and sell our products to the level of our expectations. If we are not able to increase or maintain international revenue growth, our total revenue, profitability and stock price may be adversely impacted.
We believe, as we continue to manage our international operations and develop opportunities in additional international territories, our international revenue will be subject to a number of risks, including:
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If one or more of these risks were realized, it could require us to dedicate significant resources to remedy the situation; and if we were unsuccessful at finding a solution, we may not be able to sell our products in a particular market and, as a result, our revenue may decline.
In addition, compliance with laws and regulations applicable to our international operations increases our cost of doing business in foreign jurisdictions. We may be unable to keep current with changes in foreign government requirements and laws as they change from time to time. Failure to comply with these regulations could have adverse effects on our business. In many foreign countries it is common for others to engage in business practices that are prohibited by our internal policies and procedures or United States regulations applicable to us. In addition, although we have implemented policies and procedures designed to ensure compliance with these laws and policies, there can be no assurance that all of our employees, contractors, distributors and agents will comply with these laws and policies. Violations of laws or key control policies by our employees, contractors, distributors or agents could result in delays in revenue recognition, financial reporting misstatements, fines, penalties, or the prohibition of the importation or exportation of our offerings and could have a material adverse effect on our business operations and financial results.
To successfully market and sell third party products internationally, we must address many issues that are unique to the related distribution arrangements which could reduce our available cash reserves and negatively impact our profitability.
We have entered into distribution arrangements pursuant to which we utilize our sales force and distributors to sell products manufactured by other companies. In Japan, we have a non-exclusive right to distribute a Q-switched laser product manufactured by a third party OEM. We also have an exclusive agreement with ZO to distribute certain of their proprietary skincare products in Japan. Each of these agreements requires us to purchase annual minimum dollar amounts of their products.
Each of these distribution agreements presents its own unique risks and challenges. For example, to sell skincare products we need to invest in creating a sales structure that is experienced in the sale of such products and not in capital equipment. We need to commit resources to train our sales force, obtain regulatory licenses in Japan and develop new marketing materials to promote the sale of skincare products. In addition, the minimum commitments and other costs of distributing products manufactured by these companies may exceed the incremental revenue that we derive from the sale of their products, thereby negatively impacting our profitability and reducing our available cash reserves.
If we do not make the minimum purchases required in the distribution contracts, or if the third party manufacturer revokes our distribution rights, we could lose the distribution rights of the products to physicians in Japan, which would adversely affect our future revenue, results of operations, cash flows and our stock price.
We offer credit terms to some qualified customers and also to leasing companies to finance the purchase of our products. In the event that any of these customers default on the amounts payable to us, our earnings may be adversely affected.
We generally offer credit terms of 30 to 90 days to qualified customers. In addition, from time to time, we offer certain key international distributors, with whom we have had an extended period of relationship and payment history, payment terms that are significantly longer than the regular 30 to 90 day terms. This allows such international distributor partners to have our products in stock and provide our products to customers on a timely basis. As of March 31, 2017, one international distributor partner accounted for 13% of our outstanding accounts receivable balance.
While we believe we have an adequate basis to ensure that we collect our accounts receivable, we cannot provide any assurance that the financial position of customers to whom we have provided payment terms will not change adversely before we receive payment. In the event that there is a default by any of the customers to whom we have provided credit terms, we may recognize a bad debt charge in our general and administrative expenses. If this bad debt charge is material, it could negatively affect our future results of operations, cash flows and our stock price.
Any acquisitions that we make could result in operating difficulties, dilution, and other consequences that may adversely impact our business and results of operations.
While we from time to time evaluate potential acquisitions of businesses, products and technologies, and anticipate continuing to make these evaluations, we have no present understandings, commitments or agreements with respect to any material acquisitions or collaborative projects We may not be able to identify appropriate acquisition candidates or strategic partners, or successfully negotiate, finance or integrate any businesses, products or technologies that we acquire.
We have limited experience as a team with acquiring companies and products. Furthermore, the integration of any acquisition and management of any collaborative project may divert management®€™s time and resources from our core business and disrupt our operations and we may incur significant legal, accounting and banking fees in connection with such a transaction. Acquisitions could diminish our available cash balances for other uses, result in the incurrence of debt, contingent liabilities, or amortization expenses, and restructuring charges. Also, the anticipated benefits or value of our acquisitions or investments may not materialize and could result in an impairment of goodwill and/or purchased long-lived assets, similar to the $650,000 charge we recorded in the fourth quarter of 2014 related to an acquisition completed in 2012.
Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and investments could cause us to fail to realize the anticipated benefits of such acquisitions or investments, incur unanticipated liabilities, and harm our business and our financial condition or results.
We are subject to fluctuations in the exchange rate of the U.S. Dollar and foreign currencies.
Foreign currency fluctuations could result in volatility of our revenue. We do not actively hedge our exposure to currency rate fluctuations. While we transact business primarily in U.S. Dollars, and a significant proportion of our revenue is denominated in U.S. Dollars, a portion of our costs and revenue is denominated in other currencies, such as the Euro, Japanese Yen, Australian Dollar and Canadian Dollar. As a result, changes in the exchange rates of these currencies to the U.S. Dollar will affect our results from operations. For example, in 2016 the U.S. Dollar devalued against the Japanese Yen by approximately 10%, which had a significant positive foreign exchange impact on our revenue − both from a re-measurement gain upon the conversion of our Japanese Yen denominated revenue as well as the additional positive revenue impact due to the effective price decrease for the local customers importing our U.S. Dollar denominated systems into Japan. However in 2015, as a result of the strengthening of the U.S. Dollar, relative to many other major currencies, our products priced in U.S. Dollars became more expensive relative to products of our foreign competitors. In addition, our revenue earned in foreign currencies, such as our locally generated revenue in Japan, was negatively impacted upon translation into U.S. Dollars. Both these factors had a negative impact on our international revenue in 2015, compared to 2014. Future foreign currency fluctuations could adversely impact and increase the volatility of our revenue, profitability and stock price.
Our ability to effectively compete and generate additional revenue from new and existing products depends upon our ability to distinguish our company and our products from our competitors and their products, and to develop and effectively market new and existing products. Our success is dependent on many factors, including the following:
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To compete effectively, we have to demonstrate that our new and existing products are attractive alternatives to other devices and treatments, by differentiating our products on the basis of such factors as innovation, performance, brand name, service, and price. This is difficult to do, especially in a crowded aesthetic market. Some of our competitors have newer or different products and more established customer relationships than we do, which could inhibit our market penetration efforts. For example, we have encountered, and expect to continue to encounter, situations where, due to pre-existing relationships, potential customers decided to purchase additional products from our competitors. Potential customers also may need to recoup the cost of products that they have already purchased from our competitors and may decide not to purchase our products, or to delay such purchases. If we are unable to increase our market penetration or compete effectively, our revenue and profitability will be adversely impacted.
We compete against companies that offer alternative solutions to our products, or have greater resources, a larger installed base ofcustomers and broader product offerings than ours. In addition, increased consolidation in our industry may lead to increased competition. If we are not able to effectively compete with these companies, it may harm our business.
Our industry is subject to intense competition. Our products compete against conventional non-energy-based treatments, such as electrolysis, Botox and collagen injections, chemical peels, microdermabrasion and sclerotherapy. Our products also compete against laser and other energy-based products offered by public companies, such as Cynosure (Hologic announced its intent to acquire Cynosure in February 2017), Elen (in Italy), XIO Group (acquired Lumenis in September 2015), Syneron, Zeltiq (Allergan announced its intent to acquire Zeltiq in February 2017), Valeant (acquired Solta in January 2014), as well as private companies, including Alma, Sciton, and several others. Further, other companies could introduce new products that are in direct competition with our products. Competition with these companies could result in reduced selling prices, reduced profit margins and loss of market share, any of which would harm our business, financial condition and results of operations.
Recently, there has been consolidation in the aesthetic industry leading to companies combining their resources, which increases competition and could result in increased downward pressure on our product prices. For example, in February 2017, Allergan announced its intent to acquire of Zeltiq and Hologic announced its intent to acquire Cynosure, XIO Group acquired Lumenis in September 2015, and Valeant acquired Solta in January 2014. These consolidations have resulted in increased competition and pricing pressure, as the newly-combined entities have greater financial resources, deeper sales channels and greater pricing flexibility than we do. Rumored or actual consolidation of our partners and competitors will likely cause uncertainty and disruption to our business and can cause our stock price to fluctuate.
The energy-based aesthetic market faces competition from non-energy-based medical products, such as Botox and collagen injections. Other alternatives to the use of our products include electrolysis, a procedure involving the application of electric current to eliminate hair follicles, and chemical peels. We may also face competition from manufacturers of pharmaceutical and other products that have not yet been developed.
If there is not sufficient consumer demand for the procedures performed with our products, practitioner demand for our products could be inhibited, resulting in unfavorable operating results and reduced growth potential.
Continued expansion of the global market for laser and other-energy-based aesthetic procedures is a material assumption of our business strategy. Most procedures performed using our products are elective procedures not reimbursable through government or private health insurance, with the costs borne by the patient. The decision to utilize our products may therefore be influenced by a number of factors, including:
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If, as a result of these factors, there is not sufficient demand for the procedures performed with our products, practitioner demand for our products could be reduced, which could have a material adverse effect on our business, financial condition, revenue and result of operations.
If we fail to comply with applicable regulatory requirements, it could result in enforcement action by the U.S. Food and Drug Administration (the “FDA”), federal and state agencies or international regulatory bodies.
The FDA, state authorities and international regulatory bodies have broad enforcement powers. If we fail to comply with any U.S. law or any of the applicable regulatory requirements of the FDA, or federal or state agencies, or one of the international regulatory bodies, it could result in enforcement action by the agencies, which may include any of the following sanctions:
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If we fail to obtain or maintain necessary FDA clearances for our products and indications, if clearances for future products and indications are delayed or not issued, if there are federal or state level regulatory changes or if we are found to have violated applicable FDA marketing rules, our commercial operations would be harmed.
Our products are medical devices that are subject to extensive regulation in the U.S. by the FDA for manufacturing, labeling, sale, promotion, distribution and shipping. Before a new medical device, or a new use of or labeling claim for an existing product, can be marketed in the U.S., it must first receive either 510(k) clearance or pre-market approval from the FDA, unless an exemption applies. Either process can be expensive and lengthy. In the event that we do not obtain FDA clearances or approvals for our products, our ability to market and sell them in the U.S. and revenue derived from the U.S. market may be adversely affected.
Medical devices may be marketed in the U.S. only for the indications for which they are approved or cleared by the FDA. If we fail to comply with these regulations, it could result in enforcement action by the FDA which could lead to such consequences as warning letters, adverse publicity, criminal enforcement action and/or third-party civil litigation, each of which could adversely affect us.
We have obtained 510(k) clearance for the indications for which we market our products. However, our clearances can be revoked if safety or effectiveness problems develop. We also are subject to Medical Device Reporting regulations, which require us to report to the FDA if our products cause or contribute to a death or serious injury, or malfunction in a way that would likely cause or contribute to a death or serious injury. Our products are also subject to state regulations, which, in many instances, change frequently. Changes in state regulations may impede sales. For example, federal regulations allow our products to be sold to, or on the order of, “licensed practitioners,” as determined on a state-by-state basis. As a result, in some states, non-physicians may legally purchase our products. However, a state could change its regulations at any time, thereby prohibiting sales to particular types of end users. We cannot predict the impact or effect of future legislation or regulations at the federal or state levels.
Federal regulatory reforms and changes occurring at the FDA could adversely affect our ability to sell our products profitably and financial condition.
From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing the clearance or approval, manufacture and marketing of a device. It is impossible to predict whether legislative changes will be enacted or FDA regulations, guidance or interpretations changed, and what the impact of such changes, if any, may be.
In addition, FDA regulations and guidance are often revised or reinterpreted by the agency in ways that may significantly affect our business and our products. Changes in FDA regulations may lengthen the regulatory approval process for medical devices and require additional clinical data to support regulatory clearance for the sale and marketing of our new products. In addition, it may require additional safety monitoring, labeling changes, restrictions on product distribution or use, or other measures after the introduction of our products to market. Either of these changes lengthen the duration to market, increase our costs of doing business, adversely affect the future permitted uses of approved products, or otherwise adversely affect the market for our products.
If we fail to comply with the FDA’s Quality System Regulation and laser performance standards, our manufacturing operations could be halted, and our business would suffer.
We are currently required to demonstrate and maintain compliance with the FDA’s Quality System Regulation (the “QSR”). The QSR is a complex regulatory scheme that covers the methods and documentation of the design, testing, control, manufacturing, labeling, quality assurance, packaging, storage and shipping of our products. Because our products involve the use of lasers, our products also are covered by a performance standard for lasers set forth in FDA regulations. The laser performance standard imposes specific record-keeping, reporting, product testing and product labeling requirements. These requirements include affixing warning labels to laser products, as well as incorporating certain safety features in the design of laser products.
The FDA enforces the QSR and laser performance standards through periodic unannounced inspections. We have had multiple quality system audits by the FDA, our Notified Body, and other foreign regulatory agencies, with the most recent inspection by the FDA occurring over three weeks in March 2014. There were no significant findings and only one observation as a result of this audit. Our response to this observation was accepted by the FDA. Failure to take satisfactory corrective action in response to an adverse QSR inspection or our failure to comply with applicable laser performance standards could result in enforcement actions, including a public warning letter, a shutdown of our manufacturing operations, a recall of our products, civil or criminal penalties, or other sanctions, such as those described in the preceding paragraph, which would cause our sales and business to suffer.
We are a sponsor of Biomedical Research. As such, we are also subject to FDA regulations relating to the design and conduct of clinical trials. We are subject to unannounced Bioresearch Monitoring Program ("BIMO") audits, with the most recent inspection by FDA occurring over 5 days in August 2016. There were no significant findings and only two observations as a result of this audit. Our responses to these observations were accepted by the FDA. Failure to take satisfactory corrective action in response to an adverse BIMO inspection or our failure to comply with Good Clinical Practices could result in us no longer being able to sponsor Biomedical Research, the reversal of 510(k) clearances previously granted based on the results of clinical trials conducted to gain clinical data to support those 510(k) clearances, or enforcement actions, including a public warning letter, civil or criminal penalties, or other sanctions, such as those described in the preceding paragraph, which would cause our sales and business to suffer.
If we modify one of our FDA-approved devices, we may need to seek re-approval, which, if not granted, would prevent us from selling our modified products or cause us to redesign our products.
Any modifications to an FDA-cleared device that would significantly affect its safety or effectiveness or that would constitute a major change in its intended use would require a new 510(k) clearance or possibly a pre-market approval. We may not be able to obtain additional 510(k) clearance or pre-market approvals for new products or for modifications to, or additional indications for, our existing products in a timely fashion, or at all. Delays in obtaining future clearance would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our revenue and future profitability.
We have made modifications to our devices in the past and may make additional modifications in the future that we believe do not or will not require additional clearance or approvals. If the FDA disagrees, and requires new clearances or approvals for the modifications, we may be required to recall and to stop marketing the modified devices, which could harm our operating results and require us to redesign our products.
We may be unable to obtain or maintain international regulatory qualifications or approvals for our current or future products and indications, which could harm our business.
Sales of our products outside the U.S. are subject to foreign regulatory requirements that vary widely from country to country. In addition, exports of medical devices from the U.S. are regulated by the FDA. Complying with international regulatory requirements can be an expensive and time-consuming process and approval is not certain. The time required for obtaining clearance or approvals, if required by other countries, may be longer than that required for FDA clearance or approvals, and requirements for such clearances or approvals may significantly differ from FDA requirements. We may be unable to obtain or maintain regulatory qualifications, clearances or approvals in other countries. We may also incur significant costs in attempting to obtain and in maintaining foreign regulatory approvals or qualifications. If we experience delays in receiving necessary qualifications, clearances or approvals to market our products outside the U.S., or if we fail to receive those qualifications, clearances or approvals, we may be unable to market our products or enhancements in international markets effectively, or at all, which could have a material adverse effect on our business and growth strategy.
Any defects in the design, material or workmanship of our products may not be discovered prior to shipment to customers, which could materially increase our expenses, adversely impact profitability and harm our business.
The design of our products is complex. To manufacture them successfully, we must procure quality components and employ individuals with a significant degree of technical expertise. If our designs are defective, or the material components used in our products are subject to wearing out, or if suppliers fail to deliver components to specification, or if our employees fail to properly assemble, test and package our products, the reliability and performance of our products will be adversely impacted.
If our products contain defects that cannot be repaired easily, inexpensively, or on a timely basis, we may experience:
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The occurrence of any one or more of the foregoing could materially increase expenses, adversely impact profitability and harm our business.
Product liability suits could be brought against us due to a defective design, material or workmanship or misuse of our products and could result in expensive and time-consuming litigation, payment of substantial damages and an increase in our insurance rates.
If our products are defectively designed, manufactured or labeled, contain defective components or are misused, we may become subject to substantial and costly litigation by our customers or their patients. Misusing our products or failing to adhere to operating guidelines could cause significant eye and skin damage, and underlying tissue damage. In addition, if our operating guidelines are found to be inadequate, we may be subject to liability. We have been involved, and may in the future be involved, in litigation related to the use of our products. Product liability claims could divert management’s attention from our core business, be expensive to defend and result in sizable damage awards against us. We may not have sufficient insurance coverage for all future claims. We may not be able to obtain insurance in amounts or scope sufficient to provide us with adequate coverage against all potential liabilities. Any product liability claims brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing continuing coverage, could harm our reputation in the industry and could reduce product sales. In addition, we historically experienced steep increases in our product liability insurance premiums as a percentage of revenue. If our premiums continue to rise, we may no longer be able to afford adequate insurance coverage.
If customers are not trained and/or our products are used by non-physicians, it could result in product misuse and adverse treatment outcomes, which could harm our reputation, result in product liability litigation, distract management and result in additional costs, all of which could harm our business.
Because we do not require training for users of our products, and sell our products at times to non-physicians, there exists an increased potential for misuse of our products, which could harm our reputation and our business. U.S. federal regulations allow us to sell our products to or on the order of “licensed practitioners.” The definition of “licensed practitioners” varies from state to state. As a result, our products may be purchased or operated by physicians with varying levels of training, and in many states, by non-physicians, including nurse practitioners, chiropractors and technicians. Outside the U.S., many jurisdictions do not require specific qualifications or training for purchasers or operators of our products. We do not supervise the procedures performed with our products, nor do we require that direct medical supervision occur. We and our distributors generally offer but do not require product training to the purchasers or operators of our products. In addition, we sometimes sell our systems to companies that rent our systems to third parties and that provide a technician to perform the procedures. The lack of training and the purchase and use of our products by non-physicians may result in product misuse and adverse treatment outcomes, which could harm our reputation and our business, and, in the event these result in product liability litigation, distract management and subject us to liability, including legal expenses.
Adverse conditions in the global banking industry and credit markets may adversely impact the value of our marketable investments or impair our liquidity.
We invest our excess cash primarily in money market funds and in highly liquid debt instruments of the U.S. government and its agencies and U.S. municipalities, in commercial paper and high grade corporate debt. As of March 31, 2017, our balance in marketable investments was $37 million. The longer the duration of a security, the more susceptible it is to changes in market interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. For example, assuming a hypothetical increase in interest rates of one percentage point, the fair value of our total investment portfolio as of March 31, 2017 would have potentially decreased by approximately $163,000, resulting in an unrealized loss that would subsequently adversely impact our earnings. As a result, changes in the market interest rates will affect our future net income (loss).
Our manufacturing operations are dependent upon third-party suppliers, making us vulnerable to supply shortages and price fluctuations, which could harm our business.
Many of the components and materials that comprise our products are currently manufactured by a limited number of suppliers. A supply interruption or an increase in demand beyond our current suppliers’ capabilities could harm our ability to manufacture our products until a new source of supply is identified and qualified. Our reliance on these suppliers subjects us to a number of risks that could harm our business, including:
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Any interruption in the supply of components or materials, or our inability to obtain substitute components or materials from alternate sources at acceptable prices in a timely manner, could impair our ability to meet the demand of our customers, which would have an adverse effect on our business.
Intellectual property rights may not provide adequate protection for some or all of our products, which may permit third parties tocompete against us more effectively.
We rely on patent, copyright, trade secret and trademark laws and confidentiality agreements to protect our technology and products. As of March 31, 2017, we had 34 issued U.S. patents. Some of our components, such as our laser module, electronic control system and high-voltage electronics, are not, and in the future may not be, protected by patents. Additionally, our patent applications may not issue as patents or, if issued, may not issue in a form that will be advantageous to us. Any patents we obtain may be challenged, invalidated or legally circumvented by third parties. Consequently, competitors could market products and use manufacturing processes that are substantially similar to, or superior to, ours. We may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by consultants, vendors, former employees or current employees, despite the existence generally of confidentiality agreements and other contractual restrictions. Monitoring unauthorized uses and disclosures of our intellectual property is difficult, and we do not know whether the steps we have taken to protect our intellectual property will be effective. Moreover, the laws of many foreign countries will not protect our intellectual property rights to the same extent as the laws of the U.S.
The absence of complete intellectual property protection exposes us to a greater risk of direct competition. Competitors could purchase one of our products and attempt to replicate some or all of the competitive advantages we derive from our development efforts, design around our protected technology, or develop their own competitive technologies that fall outside of our intellectual property rights. If our intellectual property is not adequately protected against competitors’ products and methods, our competitive position and our business could be adversely affected.
We may be involved in future costly intellectual property litigation, which could impact our future business and financial performance.
Our competitors or other patent holders may assert that our present or future products and the methods we employ are covered by their patents. In addition, we do not know whether our competitors own or will obtain patents that they may claim prevent, limit or interfere with our ability to make, use, sell or import our products. Although we may seek to resolve any potential future claims or actions, we may not be able to do so on reasonable terms, or at all. If, following a successful third-party action for infringement, we cannot obtain a license or redesign our products, we may have to stop manufacturing and selling the applicable products and our business would suffer as a result. In addition, a court could require us to pay substantial damages, and prohibit us from using technologies essential to our products, any of which would have a material adverse effect on our business, results of operations and financial condition.
We may become involved in litigation not only as a result of alleged infringement of a third party’s intellectual property rights but also to protect our own intellectual property. For example, we have been, and may hereafter become, involved in litigation to protect the trademark rights associated with our company name or the names of our products. Infringement and other intellectual property claims, with or without merit, can be expensive and time-consuming to litigate, and could divert management’s attention from our core business.
The expense and potential unavailability of insurance coverage for our customers could adversely affect our ability to sell our products, and therefore adversely affect our financial condition.
Some of our customers and prospective customers have had difficulty procuring or maintaining liability insurance to cover their operation and use of our products. Medical malpractice carriers are withdrawing coverage in certain states or substantially increasing premiums. If this trend continues or worsens, our customers may discontinue using our products and potential customers may opt against purchasing laser-based products due to the cost or inability to procure insurance coverage. The unavailability of insurance coverage for our customers and prospects could adversely affect our ability to sell our products, and that could harm our financial condition.
From time to time we may become subject to income tax audits or similar proceedings, and as a result we may incur additional costs and expenses or owe additional taxes, interest and penalties that may negatively impact our operating results.
We are subject to income taxes in the United States and certain foreign jurisdictions where we operate through a subsidiary, including Australia, Belgium, Canada, France, Hong Kong, Japan, Spain, Switzerland and the United Kingdom. Our determination of our tax liability is subject to review by applicable domestic and foreign tax authorities.
We are currently under audit for our California sales and use tax returns for the period July 2013 through June 2016, and are uncertain of the potential outcome of this audit. Also, in June 2016, we underwent an audit of our Canadian goods and services tax and harmonized sales tax returns for the period January 2013 to July 2015. Although this audit resulted in immaterial adjustments, the final timing and resolution of any future tax examinations are subject to significant uncertainty and could result in our having to pay amounts to the applicable tax authority in order to resolve examination of our tax positions, which could result in an increase or decrease of our current estimate of unrecognized tax benefits and may negatively impact our financial position, results of operations or cash flows.
We may be adversely affected by changes in U.S. tax laws, importation taxes and other changes that may be imposed by the current administration.
Congress and the current administration have indicated a desire to reform the U.S. corporate income tax. As part of any tax reform, it is possible that the current corporate income tax rate may be reduced, and there may be other potential changes including limiting or eliminating various other deductions, credits or tax preferences. In addition, if the current administration starts levying import taxes on products being sourced from Mexico and other international locations from where we source components for building our products, this could adversely affect our cost of producing our products and profitability. markAt this time, it is not possible to measure the potential impact on the value of our business, prospects or results of operations that might result upon enactment of U.S tax laws and other changes.
Anti-takeover provisions in our Amended and Restated Certificate of Incorporation and Bylaws, and Delaware law, contain provisions that could discourage a takeover.
Our Amended and Restated Certificate of Incorporation and Bylaws, and Delaware law, contain provisions that might enable our management to resist a takeover, and might make it more difficult for an investor to acquire a substantial block of our common stock. These provisions include:
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These provisions, as well as Change of Control and Severance Agreements entered into with each of our executive officers and certain key employees, might discourage, delay or prevent a change in control of our company or a change in our management. The existence of these provisions could adversely affect the voting power of holders of common stock and limit the price that investors might be willing to pay in the future for shares of our common stock. In addition, as a Delaware corporation, we are subject to Section 203 of the Delaware General Corporation Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time. Any of these provisions could, under certain circumstances, depress the market price of our common stock.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
The following table summarizes the activity related to stock repurchases for the three months ended March 31, 2017 (in thousands except per share data):
Period |
| Total Number |
| Average Price Paid per Share |
| Total Number of Purchased Publicly Announced Programs |
| Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Program |
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February 21-28, 2017 |
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| 30 |
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| 21.06 |
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| 30 |
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| 9,509 |
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March 1-31, 2017 |
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| 110 |
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| 20.57 |
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| 110 |
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| 7,238 |
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February 21-March 31, 2017 |
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| 140 |
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| 20.68 |
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| 140 |
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| 7,238 |
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On February 8, 2016, our Board of Directors approved the expansion of the Stock Repurchase Program by $10 million, under which the Company is authorized to repurchase shares of its common stock. As of December 31, 2016, there remained an additional $5.1 million to be purchased. On February 13, 2017 our Board of Directors approved the expansion of the Stock Repurchase Program by an additional $5 million. In the three months ended March 31, 2017, we repurchased 140,400 shares of our common stock for approximately $2.9 million. As of March 31, 2017, there remained an additional $7.2 million available in the Stock Repurchase Program to repurchase shares of common stock. All shares repurchased were retired and returned to authorized but unissued status.
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None.
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None.None.
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The Company's Board of Directors has approved a facility lease for a new corporate headquarter building in Fremont, California. The Company plans to contract with the landlord and move into the new facility at the end of 2017.None.
OTHER INFORMATION |
None.
Exhibit No. |
| Description |
3.2 | (1) | Amended and Restated Certificate of Incorporation of the Registrant (Delaware). |
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3.4 | (1) | |
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4.1 | (2) | |
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10.14 | (3) | Cutera, Inc. 2004 Amended and Restated Equity Incentive Plan. |
31.1 |
| Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2 |
| Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32.1 |
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101.ins |
| Instance Document |
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101.sch |
| XBRL Taxonomy Extension Schema Document |
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101.cal |
| XBRL Taxonomy Extension Calculation Linkbase Document |
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101.def |
| XBRL Taxonomy Extension Definition Linkbase Document |
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101.lab |
| XBRL Taxonomy Extension Label Linkbase Document |
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101.pre |
| XBRL Taxonomy Extension Presentation Linkbase Document |
(1) | Incorporated by reference from our Registration Statement on Form S-1 (Registration No. 333-111928) which was declared effective on March 30, 2004. |
(2) | Incorporated by reference from our Annual Report on Form 10-K filed with the SEC on March 25, 2005. |
(3) | Incorporated by reference from our Definitive Proxy Statement on Form 14A filed with the SEC on April 27, 2015. |
Pursuant to the requirements of Section 13 or 15(d) of The Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Brisbane, State of California, on the 1st9th day of May, 2017.2018.
| CUTERA, INC. |
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| /S/ |
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| Executive Vice President and Chief Financial Officer |
| (Principal Financial and Accounting Officer) |
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