UNITEDSTATES
SECURITIES ANDEXCHANGECOMMISSION
Washington, D.C. 20549
FORM10-Q
(Mark One)
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended SeptemberJune 30, 20172018
OR
☐ | TRANSITIONREPORTPURSUANTTOSECTION13OR15(d)OFTHESECURITIESEXCHANGEACTOF1934 |
For the transition period _____ to_____.
Commission file number: 000-50644
Cutera,Inc.
(Exact name of registrant as specified in its charter)
Delaware | (Stateorotherjurisdictionofincorporationororganization) | 77-0492262 |
| (I.R.S.employeridentificationno.) |
3240BayshoreBlvd.,Brisbane,California94005
(Addressofprincipalexecutiveoffices)
(415)657-5500
(Registrant’s Registrant’stelephonenumber,includingareacode)
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 registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files). Yes ☒No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer” and, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer ☐Accelerated filer ☒Non-accelerated filer ☐Smaller reporting company ☐Emerging growth company ☐ |
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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 accounting standards provided pursuant to Section 13(a) of the Exchange Act.☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ☐No ☒
The number ofRegistrant had 13,836,800 shares of Registrant’s common stock, issued and$0.001 par value per share, outstanding as of OctoberJuly 31, 2017 was 13,854,966.2018.
FORM 10-Q
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| Condensed Consolidated Statements of Comprehensive Income (Loss) | 5 | ||
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Item 1A |
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CUTERA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(inthousands,exceptshareandpersharedata)
(in thousands, except share and per share data)
(unaudited)
September 30, 2017 | December 31, 2016 | June 30, 2018 | December 31, 2017 | |||||||||||||
Assets | ||||||||||||||||
Current assets: | ||||||||||||||||
Cash and cash equivalents | $ | 14,784 | $ | 13,775 | $ | 18,432 | $ | 14,184 | ||||||||
Marketable investments | 35,692 | 40,299 | 10,573 | 21,728 | ||||||||||||
Accounts receivable, net | 19,604 | 16,547 | 22,122 | 20,777 | ||||||||||||
Inventories | 23,728 | 14,977 | 30,138 | 28,782 | ||||||||||||
Other current assets and prepaid expenses | 2,894 | 2,251 | 3,469 | 2,903 | ||||||||||||
Total current assets | 96,702 | 87,849 | 84,734 | 88,374 | ||||||||||||
Property and equipment, net | 1,842 | 1,907 | 2,632 | 2,096 | ||||||||||||
Deferred tax asset | 384 | 377 | 21,219 | 19,055 | ||||||||||||
Intangibles, net | — | 2 | ||||||||||||||
Goodwill | 1,339 | 1,339 | 1,339 | 1,339 | ||||||||||||
Other long-term assets | 381 | 380 | 5,807 | 374 | ||||||||||||
Total assets | $ | 100,648 | $ | 91,854 | $ | 115,731 | $ | 111,238 | ||||||||
Liabilities and Stockholders' Equity | ||||||||||||||||
Current liabilities: | ||||||||||||||||
Accounts payable | $ | 5,805 | $ | 2,598 | $ | 10,743 | $ | 7,002 | ||||||||
Accrued liabilities | 22,203 | 17,397 | 22,756 | 26,848 | ||||||||||||
Deferred revenue | 8,801 | 8,394 | 9,288 | 9,461 | ||||||||||||
Total current liabilities | 36,809 | 28,389 | 42,787 | 43,311 | ||||||||||||
Deferred revenue, net of current portion | 1,950 | 1,705 | 2,519 | 2,195 | ||||||||||||
Income tax liability | 171 | 168 | 386 | 379 | ||||||||||||
Other long-term liabilities | 505 | 582 | 665 | 460 | ||||||||||||
Total liabilities | 39,435 | 30,844 | 46,357 | 46,345 | ||||||||||||
Commitments and Contingencies (Note 11) | ||||||||||||||||
Commitments and Contingencies (Note 14) | ||||||||||||||||
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: 13,906,439 and 13,773,389 shares at September 30, 2017 and December 31, 2016, respectively | 14 | 14 | ||||||||||||||
Stockholders’ equity: | ||||||||||||||||
Common stock, $0.001 par value; authorized: 50,000,000 shares; issued and outstanding: 13,824,252 and 13,477,973 shares at June 30, 2018 and December 31, 2017, respectively | 14 | 13 | ||||||||||||||
Additional paid-in capital | 81,195 | 88,114 | 66,291 | 62,025 | ||||||||||||
Accumulated deficit | (19,933 | ) | (27,046 | ) | 3,156 | 2,947 | ||||||||||
Accumulated other comprehensive loss | (63 | ) | (72 | ) | (87) | (92) |
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Total stockholders’ equity | 61,213 | 61,010 | ||||||||||||||
Total stockholders’ equity | 69,374 | 64,893 | ||||||||||||||
Total liabilities and stockholders’ equity | $ | 100,648 | $ | 91,854 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 115,731 | $ | 111,238 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended | Nine Months Ended | Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||
September 30, | September 30, | June 30, | June 30, | |||||||||||||||||||||||||||||
2017 | 2016 | 2017 | 2016 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||||||
Net revenue: | ||||||||||||||||||||||||||||||||
Products | $ | 33,486 | $ | 25,493 | $ | 89,688 | $ | 65,903 | $ | 37,650 | $ | 31,727 | $ | 66,914 | $ | 56,202 | ||||||||||||||||
Service | 4,687 | 4,788 | 14,173 | 14,278 | 4,903 | 4,662 | 9,764 | 9,486 | ||||||||||||||||||||||||
Total net revenue | 38,173 | 30,281 | 103,861 | 80,181 | 42,553 | 36,389 | 76,678 | 65,688 | ||||||||||||||||||||||||
Cost of revenue: | ||||||||||||||||||||||||||||||||
Products | 13,859 | 10,160 | 38,843 | 26,804 | �� | 17,045 | 13,840 | 30,967 | 24,984 | |||||||||||||||||||||||
Service | 2,104 | 2,378 | 6,241 | 7,155 | 3,131 | 1,503 | 6,000 | 4,137 | ||||||||||||||||||||||||
Total cost of revenue | 15,963 | 12,538 | 45,084 | 33,959 | 20,176 | 15,343 | 36,967 | 29,121 | ||||||||||||||||||||||||
Gross profit | 22,210 | 17,743 | 58,777 | 46,222 | 22,377 | 21,046 | 39,711 | 36,567 | ||||||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||||||||||
Sales and marketing | 13,148 | 10,574 | 36,708 | 30,002 | 15,535 | 12,787 | 28,623 | 23,560 | ||||||||||||||||||||||||
Research and development | 3,467 | 2,914 | 9,393 | 8,335 | 4,095 | 2,981 | 7,651 | 5,926 | ||||||||||||||||||||||||
General and administrative | 3,379 | 2,716 | 10,143 | 9,933 | 4,902 | 3,548 | 10,341 | 6,764 | ||||||||||||||||||||||||
Lease termination income | (4,000 | ) | — | (4,000 | ) | — | ||||||||||||||||||||||||||
Total operating expenses | 15,994 | 16,204 | 52,244 | 48,270 | 24,532 | 19,316 | 46,615 | 36,250 | ||||||||||||||||||||||||
Income (loss) from operations | 6,216 | 1,539 | 6,533 | (2,048 | ) | (2,155) | 1,730 | (6,904) | 317 | |||||||||||||||||||||||
Interest and other income, net | 197 | 166 | 746 | 527 | ||||||||||||||||||||||||||||
Interest and other income (expense), net | (129) | 276 | (31) | 549 | ||||||||||||||||||||||||||||
Income (loss) before income taxes | 6,413 | 1,705 | 7,279 | (1,521 | ) | (2,284) | 2,006 | (6,935) | 866 | |||||||||||||||||||||||
Provision for income taxes | 225 | 61 | 166 | 115 | ||||||||||||||||||||||||||||
Provision (benefit) for income taxes | (712) | 59 | (3,331) | (59) | ||||||||||||||||||||||||||||
Net income (loss) | $ | 6,188 | $ | 1,644 | $ | 7,113 | $ | (1,636 | ) | $ | (1,572) | $ | 1,947 | $ | (3,604) | $ | 925 | |||||||||||||||
Net income (loss) per share: | ||||||||||||||||||||||||||||||||
Basic | $ | 0.44 | $ | 0.12 | $ | 0.51 | $ | (0.12 | ) | $ | (0.11) | $ | 0.14 | $ | (0.26) | $ | 0.07 | |||||||||||||||
Diluted | $ | 0.42 | $ | 0.12 | $ | 0.48 | $ | (0.12 | ) | $ | (0.11) | $ | 0.13 | $ | (0.26) | $ | 0.06 | |||||||||||||||
Weighted-average number of shares used in per share calculations: | ||||||||||||||||||||||||||||||||
Basic | 13,973 | 13,163 | 13,917 | 13,102 | 13,709 | 13,935 | 13,649 | 13,888 | ||||||||||||||||||||||||
Diluted | 14,767 | 13,544 | 14,733 | 13,102 | 13,709 | 14,629 | 13,649 | 14,633 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(inthousands)
(in thousands)
(unaudited)
Three Months Ended | Nine Months Ended | Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||
September 30, | September 30, | June 30, | June 30, | |||||||||||||||||||||||||||||
2017 | 2016 | 2017 | 2016 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||||||
Net income (loss) | $ | 6,188 | $ | 1,644 | $ | 7,113 | $ | (1,636 | ) | $ | (1,572 | ) | $ | 1,947 | $ | (3,604) | $ | 925 | ||||||||||||||
Other comprehensive income (loss): | ||||||||||||||||||||||||||||||||
Available-for-sale investments | ||||||||||||||||||||||||||||||||
Net change in unrealized gains (losses) on available-for-sale investments | 5 | (24 | ) | 13 | 56 | |||||||||||||||||||||||||||
Less: Reclassification adjustment for gains on investments recognized during the period | — | (1 | ) | (4 | ) | (1 | ) | |||||||||||||||||||||||||
Net change in unrealized gain and losses on available-for-sale investments | 5 | (25 | ) | 9 | 55 | |||||||||||||||||||||||||||
Tax provision (benefit) | — | (9 | ) | — | 20 | |||||||||||||||||||||||||||
Net change in unrealized gains (losses) on available-for-sale investments | 18 | 5 | (4) | 8 | ||||||||||||||||||||||||||||
Less: Reclassification adjustment for gains (losses) on investments recognized during the period | — | — | 9 | (4) |
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Net change in unrealized gains and losses on available-for-sale investments | 18 | 5 | 5 | 4 | ||||||||||||||||||||||||||||
Tax provision | — | — | — | — | ||||||||||||||||||||||||||||
Other comprehensive income (loss), net of tax | 5 | (16 | ) | 9 | 35 | 18 | 5 | 5 | 4 | |||||||||||||||||||||||
Comprehensive income (loss) | $ | 6,193 | $ | 1,628 | $ | 7,122 | $ | (1,601 | ) | $ | (1,554 | ) | $ | 1,952 | $ | (3,599) | $ | 929 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(inthousands)
(in thousands)
(unaudited)
Nine Months Ended September 30, | Six Months Ended June 30, | |||||||||||||||
2017 | 2016 | 2018 | 2017 | |||||||||||||
Cash flows from operating activities: | ||||||||||||||||
Net income (loss) | $ | 7,113 | $ | (1,636 | ) | $ | (3,604) | $ | 925 | |||||||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||||||||||
Stock-based compensation | 3,623 | 2,652 | 3,893 | 2,626 | ||||||||||||
Depreciation and amortization | 750 | 733 | ||||||||||||||
Depreciation of tangible assets | 544 | 492 | ||||||||||||||
Amortization of contract acquisition costs | 822 | — | ||||||||||||||
Change in deferred tax assets | (3,324) | — | ||||||||||||||
Provision for doubtful accounts receivable | 487 | (3) | ||||||||||||||
Other | (67 | ) | (45 | ) | (25) | (42) | ||||||||||
Changes in assets and liabilities: | ||||||||||||||||
Accounts receivable | (3,048 | ) | (61 | ) | (1,832) | (1,641) |
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Inventories | (8,751 | ) | (4,400 | ) | (1,356) | (1,936) |
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Other current assets and prepaid expenses | (633 | ) | (690 | ) | (569) | (545) | ||||||||||
Other long-term assets | (1 | ) | (60 | ) | (1,578) | (1) | ||||||||||
Accounts payable | 3,207 | 1,324 | 3,741 | 1,695 | ||||||||||||
Accrued liabilities | 4,757 | 886 | (4,325) | 1,534 | ||||||||||||
Other long-term liabilities | — | (247 | ) | 70 | — | |||||||||||
Deferred revenue | 652 | (1,187 | ) | 546 | 784 | |||||||||||
Income tax liability | 3 | (18 | ) | 7 | 2 | |||||||||||
Net cash provided by (used) in operating activities | 7,605 | (2,749 | ) | |||||||||||||
Net cash provided by (used in) operating activities | (6,503) | 3,890 | ||||||||||||||
Cash flows from investing activities: | ||||||||||||||||
Acquisition of property, equipment and software | (443 | ) | (311 | ) | (581) |
| (210) | |||||||||
Disposal of property and equipment | 53 | 17 | 38 | 40 | ||||||||||||
Proceeds from sales of marketable investments | 9,154 | 6,153 | 13,044 | 6,754 | ||||||||||||
Proceeds from maturities of marketable investments | 39,612 | 20,135 | 2,500 | 24,812 | ||||||||||||
Purchase of marketable investments | (44,156 | ) | (23,944 | ) | (4,390) | (25,863) | ||||||||||
Net cash provided by investing activities | 4,220 | 2,050 | 10,611 | 5,533 | ||||||||||||
Cash flows from financing activities: | ||||||||||||||||
Repurchase of common stock | (13,776 | ) | (4,873 | ) | — | (7,041) |
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Proceeds from exercise of stock options and employee stock purchase plan | 4,566 | 6,798 | 3,038 | 3,871 | ||||||||||||
Taxes paid related to net share settlement of equity awards | (1,332 | ) | (601 | ) | (2,664) | (1,167) |
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Payments on capital lease obligations | (274 | ) | (218 | ) | (234) | (182) |
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Net cash used in financing activities | (10,816 | ) | 1,106 |
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Net cash provided by (used) in financing activities | 140 | (4,519) |
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Net increase in cash and cash equivalents | 1,009 | 407 | 4,248 | 4,904 | ||||||||||||
Cash and cash equivalents at beginning of period | 13,775 | 10,868 | 14,184 | 13,775 | ||||||||||||
Cash and cash equivalents at end of period | $ | 14,784 | $ | 11,275 | $ | 18,432 | $ | 18,679 | ||||||||
Supplemental disclosure of non-cash items: | ||||||||||||||||
Assets acquired under capital lease | $ | 257 | $ | 580 | $ | 533 | $ | 257 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note1.SummaryofSignificantAccountingPolicies
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: enlighten®,excel V, excel HR, enlighten, Juliet, Secret RF, truSculpt ®, truSculpt®, excel V®, 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”(“Systems” revenue); (ii) hand piece refills applicable to Titan, truSculpt 3D ®and truSculpt iD (classified, as “Hand Piece Refills”)well as single use disposable tips applicable to Juliet, Secret RF (“Consumables” revenue); and (iii) the distribution of third party manufactured skincare products (classified as "Skincare”("Skincare” revenue); and are 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 Titan, truSculpt 3D and truSculpt iD) 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 subsidiaries 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’sCompany’s products outside of the United States. The Condensed Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All inter-company accounts, transactions and balances have been eliminated.
Unaudited Interim Financial Information
The interimIn the opinion of the Company, the accompanying unaudited condensed consolidated financial information included in this report is unaudited. The Condensed Consolidated Financial Statementsstatements included in this report reflect all adjustments (consisting of only of normal recurring adjustments) that the Company considers necessary for thea fair presentationstatement of theits financial position as of June 30, 2018, its results of operations for the interimthree and six months periods coveredended June 30, 2018, and of2017, comprehensive income (loss) for the financial condition ofthree and six months periods ended June 30, 2018 and 2017, and cash flows for the Company at the date of the interim balance sheet.six months ended June 30, 2018, and 2017. The December 31, 2016 Condensed Consolidated Balance Sheet2017 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’sCompany’s previously filed audited financial statements and the related notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 20162017 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 Condensed Consolidated Financialdate of the condensed consolidated financial Statements and the accompanying notes. These estimates are based on management's best knowledgenotes, and the reported amounts of current eventsrevenue and actions we may undertake inexpenses during the future.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,goodwill, useful lives of 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
Recent Accounting Pronouncements Not Yet AdoptedThe 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, cybersecurity breaches and other disruptions that could compromise the Company’s information or results, 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.
Revenue RecognitionComparability
In May 2014,The Company adopted the Financial Accounting Standards Board ("FASB”), jointly with the International Accounting Standards Board, issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers. This new revenue standard will replace most of the existing revenue recognition guidance in GAAP when it becomes effective and permits the use of either the retrospective orJanuary 1, 2018, using the modified retrospective method (or cumulativemethod. Prior period financial statements were not retrospectively restated. The consolidated balance sheet as of December 31, 2017 and results of operations for the three and six months ended June 30, 2017 were prepared using an accounting standard that was different than that in effect transition method).for the three and six months ended June 30, 2018. As a result the consolidated balance sheets as of June 30, 2018 and December 31, 2017 are not directly comparable, nor are the condensed consolidated statement of operations for the three and six months ended June 30, 2018 and June 30, 2017.
The standard's core principle is that a reporting entity will recognize revenue when it transfers promised goods or services to customers in an amount that reflectsAdopted Accounting Pronouncements
In May 2014, the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying this new guidance to contracts within its scope, an entity will: (1) identify the contract(s)Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with a customer, (2) identify the performance obligation in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. Additionally, this new guidance would require significantly expanded disclosures about revenue. The new standard is effective for annual reporting periods (including interim reporting periods within those annual periods) beginning after December 15, 2017. Entities have the option of using either a full retrospective or a modified retrospective approach to adopt this new standard.
While the Company has not completed its evaluation, the Company currently plans to adopt this accounting standard in the first quarter of fiscal year 2018 using the modified retrospective method. Based on the analysis performed through the third quarter of 2017, the Company believes that the timing and measurement ofCustomers,” amending revenue recognition under its contracts with customers for its Productsguidance and Services will not change significantly. However, the basis of revenue recognition will changerequiring more detailed disclosures to one based on the transfer of control of products and services. Also based on the analysis performed, the Company expects that incremental contract acquisition costs of obtaining revenue generating contracts, such as sales commissions paid in connection with system sales with multi-year post-warranty service contracts, would be capitalized and amortized over the customer relationship period. Under the current guidance, the Company expenses such costs when incurred. The Company is in the process of calculating the adjustment that would be required for capitalizing the sales commissions to accumulated deficit and completing the analysis and documentation required for the implementation of ASC 606 upon adoption of the standard on January 1, 2018.
The new revenue standard is principle-based and interpretation of those principles may vary from company to company based on their unique circumstances. It is possible that interpretation, industry practice, and guidance may evolve as companies and the accounting profession work to implement this new standard. As the Company completes its evaluation of this new standard, new information may arise that could change the Company’s current understanding of the impact to revenue and expense recognized. Additionally, the Company will continue to monitor industry activities and any additional guidance provided by regulators, standards setters, or the accounting profession and adjust the Company’s assessment and implementation plans accordingly.
The new standard requires comprehensive disclosures of quantitative and qualitative information that enablesenable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The amended guidance, herein referred to as Topic 606, is effective for annual and interim reporting periods beginning after December 15, 2017, with early adoption permitted for public companies effective for annual and interim reporting periods beginning after December 15, 2016. The Company isadopted the new revenue standard in the processfirst quarter of preparingfiscal year 2018 using the expanded disclosures requiredmodified retrospective method. The Company recognized the cumulative effect of applying the new revenue standard as an adjustment to retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in effect for the period presented.
See Note 2 – Revenue Recognition, for additional accounting policy and transition disclosures.
Other Accounting Pronouncements Not Yet Adopted
In June 2018, the FASB issued ASU No. 2018-07, "Compensation –Stock Compensation (Topic 718): Improvement to Nonemployee Share-Based Payment Accounting". The new guidance changes the accounting for nonemployee awards including: (1) Equity-classified share-based payment awards issued to nonemployees will be measured on the grant date, instead of the previous requirement to remeasure the awards through the performance completion date, (2) For performance conditions, compensation cost associated with the award will be recognized when the achievement of the performance condition is probable, rather than upon achievement of the performance condition, and (3) The current requirement to reassess the classification (equity or liability) for nonemployee awards upon vesting will be eliminated, except for awards in the form of convertible instruments. The new guidance also clarifies that any share-based payment awards issued to customers should be evaluated under ASC 606.
Accounting The amendments in the new guidance are effective for Leasesannual and interim reporting periods beginning after December 15, 2018, with early adoption permitted for public companies, but no earlier than an entity’s adoption date of Topic 606. The Company will adopt the new standard effective January 1, 2019. The Company is still currently evaluating the impact of adopting the new standard.
In February 2016, the FASB issued ASU No. 2016-02, Leases"Leases" (Topic 842), which amends the existing accounting standards for leases. The new standard requires lessees to record a right-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 the Company in the first quarter of fiscal year 2019 and early adoption is permitted. The new standard is required to be adopted using the modified retrospective approach and requires application of the new standard at the beginning of the earliest comparative period presented. The Company generally does not finance purchasesfinances its fleet of equipment or other capital, but does lease some ofvehicles used by its facilities.field sales and service employees and has facility leases. Several of the Company’sCompany’s customers finance purchases of its system products through third party lease companies and not directly with the Company. The Company does not believe that the new standard will change customer buying patterns or behaviors for its products. TheThe Company will adopt the new standard effective January 1, 2019. The Company expects that upon adoption, right-of-use assets and lease liabilities will be recognized in the balance sheet in amounts that will be material.
Accounting for Income TaxesNote 2. Revenue recognition
In October 2016,The Company adopted ASC Topic 606, "Revenue from Contracts with Customers," on January 1, 2018, applying the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfermodified retrospective method to all contract agreements that were not completed as of Assets Other than Inventory, which requiresJanuary 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 recognitionaccounting 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 incomeTopic 606, the Company recorded an increase to retained earnings, net of deferred tax consequencesliability of an intra-entity transfer$3.8 million (Note 12) for contracts still in force as of an asset, other than inventory, when the transfer occurs. This ASU will be effectiveJanuary 1, 2018 for the Companyfollowing items in the first quarterand second quarters of 2018. This ASU is required to be adopted using2018:
● | $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 will be amortized over the period of anticipated support renewals. The Company expensed such costs when incurred under the prior guidance. |
● | $1.2 million deferred tax liability related to the direct tax effect of the ASC 606 adoption. |
The Company’s revenue consists of product and service revenue resulting from the modified retrospective approach,sale of systems, training on the systems, extended service contracts, consumables and other accessories. The Company accounts for a contract with a cumulative catch-up adjustmentcustomer 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 retained earningsthe Company’s customers, in an amount that reflects the consideration that the Company expects 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 adoption. The Company does not believe that adopting this ASU will have a material impact onservice commences at the financial Statements.
Adopted Accounting Pronouncement
Beginning fiscal year 2017, the Company adopted ASU No. 2016-09, Improvements to Employee Share-based Payment Accounting, which changes among other things, how the tax effects of share-based awards are recognized. ASU No. 2016-09 requires excess tax benefits and tax deficiencies to be recognized in the provision for income taxes as discrete items in the period when the awards vest or are settled, whereas previously such income tax effects were generally recorded as part of additional paid-in capital. The provision for income taxes for the three and nine months ended September 30, 2017, included excess tax benefits of $50,000 and $160,000, respectively. The recognized excess tax benefits resulted from share-based compensation awards primarily associated with employee equity plans that were vested or settled in the three and nine months ended September 30, 2017. This ASU also eliminates the requirement to reclassify cash flows related to excess tax benefits from operating activities to financing activities on the consolidated statements of cash flows. The Company also excluded the related tax benefits when applying the treasury stock method for computing diluted shares outstanding on a prospective basis as required by this ASU. In addition, the Company elected to continue its current practice of estimating expected forfeitures. The amount of excess tax benefits and deficiencies recognized in the provision for income taxes will fluctuate from period to period based on the priceexpiration of the Company’s stock,standard warranty offered at the volumetime of share-based instruments settled or vested,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 service contracts and marketing services (which are satisfied over time), the value assigned to share-based instruments under GAAP.Company generally satisfies all of the performance obligations at a point in time. Systems, system accessories (hand pieces), training, and time and material services are also sold on a stand-alone basis.
The following table summarizes the effects of adopting Topic 606 on the Company’s condensed consolidated balance sheet as of June 30, 2018:
As reported under Topic 606 | Adjustments | Balances under Prior GAAP | ||||||||||
(In thousands) | ||||||||||||
Other long-term assets | $ | 5,807 | $ | 5,325 | $ | 482 | ||||||
Deferred tax asset | 21,219 | (1,160) | 22,379 | |||||||||
Accrued liabilities | 22,756 | (111) | 22,867 | |||||||||
Deferred revenue | 11,807 | (255) | 11,552 | |||||||||
Retained earnings (deficit) | 3,156 | 4,530 | (1,374) |
The following table summarizes the effects of adopting Topic 606 on the Company’s condensed consolidated income statement for the three months ended June 30, 2018:
As reported under Topic 606 | Adjustments | Balances under Prior GAAP | ||||||||||
(In thousands) | ||||||||||||
Products revenue | $ | 37,650 | $ | 55 | $ | 37,595 | ||||||
Service revenue | 4,903 | 69 | 4,834 | |||||||||
Sales and marketing | 15,535 | (463) | 15,998 | |||||||||
Interest and other income, net* | (129) | (64) | (65) |
The following table summarizes the effects of adopting Topic 606 on Company’s condensed consolidated income statement for the six months ended June 30, 2018:
As reported under Topic 606 | Adjustments | Balances under Prior GAAP | ||||||||||
(In thousands) | ||||||||||||
Products revenue | $ | 66,914 | $ | 65 | $ | 66,849 | ||||||
Service revenue | 9,764 | 133 | 9,631 | |||||||||
Sales and marketing | 28,623 | (648 | ) | 29,271 | ||||||||
Interest and other income, net* | (31 | ) | (129 | ) | 98 |
* Significant Accounting PoliciesIncluded in interest and other income, net, is the estimated interest expense for advance payment related to service contracts under the new revenue standard.
ThereAdoption of the standard had no impact on 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 no additional newone year or material changesless; (iii) not to the significant accounting policies discussedrecast revenue for contracts that begin and end in the Company’s Annual Report on Form 10-K forsame fiscal year; and (iv) not to assess whether promised goods or services are performance obligations if they are immaterial in the fiscal year ended December 31, 2016, that arecontext of significance or potential significance to the Company.contract with the customer.
Note 2. Note 3. Cash, Cash EquivalentsEquivalent and Marketable 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 maturity of three months or less at the time of purchase, to be cash equivalents. Investments withstated maturities of greater than three months are 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 areand re-evaluates such designation at each balance sheet date. The Company’s marketable securities have been classified and accounted for as “available-for-sale,”available-for-sale securities. Investments with remaining maturities of 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 condensed 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,stockholders’ 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 tables summarize the components, and the unrealized gains and losses position, related to the Company’sCompany’s cash, cash equivalents and marketable investments (in thousands): as of June 30, 2018 and December 31, 2017:
September 30, 2017 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Market Value | ||||||||||||||||||||||||||||
June 30, 2018 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Market Value | ||||||||||||||||||||||||||||
Cash and cash equivalents: | ||||||||||||||||||||||||||||||||
Cash | $ | 6,703 | $ | — | $ | — | $ | 6,703 | $ | 15,545 | $ | — | $ | — | $ | 15,545 | ||||||||||||||||
Money market funds | 1,636 | — | — | 1,636 | 2,887 | — | — | 2,887 | ||||||||||||||||||||||||
Commercial paper | 6,445 | — | — | 6,445 | ||||||||||||||||||||||||||||
Total cash and cash equivalents | 14,784 | — | — | 14,784 | 18,432 | — | — | 18,432 | ||||||||||||||||||||||||
Marketable investments: | ||||||||||||||||||||||||||||||||
U.S. government notes | 5,133 | — | (4 | ) | 5,129 | 6,012 | — | (8 | ) | 6,004 | ||||||||||||||||||||||
U.S. government agencies | — | — | — | — | ||||||||||||||||||||||||||||
Municipal securities | 201 | — | — | 201 | 200 | — | (1 | ) | 199 | |||||||||||||||||||||||
Commercial paper | 15,942 | 1 | (1 | ) | 15,942 | |||||||||||||||||||||||||||
Corporate debt securities | 14,419 | 9 | (8 | ) | 14,420 | 4,388 | — | (18 | ) | 4,370 | ||||||||||||||||||||||
Total marketable investments | 35,695 | 10 | (13 | ) | 35,692 | 10,600 | — | (27 | ) | 10,573 | ||||||||||||||||||||||
Total cash, cash equivalents and marketable investments | $ | 50,479 | $ | 10 | $ | (13 | ) | $ | 50,476 | $ | 29,032 | $ | — | $ | (27 | ) | $ | 29,005 |
December 31, 2016 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Market Value | ||||||||||||
Cash and cash equivalents: | ||||||||||||||||
Cash | $ | 6,672 | $ | — | $ | — | $ | 6,672 | ||||||||
Money market funds | 6,053 | — | — | 6,053 | ||||||||||||
Commercial paper | 1,050 | — | — | 1,050 | ||||||||||||
Total cash and cash equivalents | 13,775 | — | — | 13,775 | ||||||||||||
Marketable investments: | ||||||||||||||||
U.S. government notes | 8,403 | 4 | (9 | ) | 8,398 | |||||||||||
U.S. government agencies | 3,918 | — | (2 | ) | 3,916 | |||||||||||
Municipal securities | 1,325 | — | — | 1,325 | ||||||||||||
Commercial paper | 12,299 | 2 | (2 | ) | 12,299 | |||||||||||
Corporate debt securities | 14,366 | 3 | (8 | ) | 14,361 | |||||||||||
Total marketable investments | 40,311 | 9 | (21 | ) | 40,299 | |||||||||||
Total cash, cash equivalents and marketable investments | $ | 54,086 | $ | 9 | $ | (21 | ) | $ | 54,074 |
December 31, 2017 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Market Value | ||||||||||||
Cash and cash equivalents: | ||||||||||||||||
Cash | $ | 14,058 | $ | — | $ | — | $ | 14,058 | ||||||||
Money market funds | 126 | — | — | 126 | ||||||||||||
Total cash and cash equivalents | 14,184 | — | — | 14,184 | ||||||||||||
Marketable investments: | ||||||||||||||||
U.S. government notes | 11,885 | — | (15 | ) | 11,870 | |||||||||||
Municipal securities | 201 | — — | (1 | ) | 200 | |||||||||||
Commercial paper | 1,836 | — | (3 | ) | 1,833 | |||||||||||
Corporate debt securities | 7,838 | 2 | (15 | ) | 7,825 | |||||||||||
Total marketable investments | 21,760 | 2 | (34 | ) | 21,728 | |||||||||||
Total cash, cash equivalents and marketable investments | $ | 35,944 | $ | 2 | $ | (34 | ) | $ | 35,912 |
As of SeptemberJune 30, 20172018 and December 31, 2016, total gross2017, net unrealized losses were $13,000$27,000 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’sCompany’s available-for-sale securities, classified as marketable investments as of SeptemberJune 30, 20172018 (in thousands):
Amount | Amount | |||||||
Due in less than one year | $ | 30,410 | $ | 9,573 | ||||
Due in 1 to 3 years | 5,282 | 1,000 | ||||||
Total marketable investments | $ | 35,692 | $ | 10,573 |
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) market participant assumptions developed based on market data obtained from independent sources (observable(observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs)(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(Level 1) and the lowest priority to unobservable inputs (Level(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 SeptemberJune 30, 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):
June 30, 2018 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
Cash equivalents: | ||||||||||||||||
Money market funds | $ | 2,887 | $ | — | $ | — | $ | 2,887 | ||||||||
Marketable investments: | ||||||||||||||||
Available-for-sale securities | — | 10,573 | — | 10,573 | ||||||||||||
Total assets at fair value | $ | 2,887 | $ | 10,573 | $ | — | $ | 13,460 |
As of December 31, 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 were as follows (in thousands):
September 30, 2017 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
Cash equivalents: | ||||||||||||||||
Money market funds | $ | 1,636 | $ | — | $ | — | $ | 1,636 | ||||||||
Commercial paper | — | 6,445 | — | 6,445 | ||||||||||||
Marketable investments: | ||||||||||||||||
Available-for-sale securities | — | 35,692 | — | 35,692 | ||||||||||||
Total assets at fair value | $ | 1,636 | $ | 42,137 | $ | — | $ | 43,773 |
As of December 31, 2016, 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 | — | 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-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 SeptemberJune 30, 20172018 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 June 30, 2018 and December 31, 2017, respectively.
Note 4. 5.BalanceSheetDetails
Inventories
As of SeptemberJune 30, 20172018 and December 31, 2016,2017, inventories consist of the following (in thousands):
September 30, 2017 | December 31, 2016 | June 30, 2018 | December 31, 2017 | |||||||||||||
Raw materials | $ | 18,201 | $ | 10,966 | $ | 17,875 | $ | 19,160 | ||||||||
Work in progress | 2,846 | 2,744 | ||||||||||||||
Finished goods | 5,527 | 4,011 | 9,417 | 6,878 | ||||||||||||
Total | $ | 23,728 | $ | 14,977 | $ | 30,138 | $ | 28,782 |
Accrued Liabilities
As of SeptemberJune 30, 20172018 and December 31, 2016,2017, accrued liabilities consist of the following (in thousands):
September 30, 2017 | December 31, 2016 | June 30, 2018 | December 31, 2017 | |||||||||||||
Accrued payroll and related expenses | $ | 10,869 | $ | 9,036 | $ | 10,712 | $ | 12,567 | ||||||||
Sales and marketing programs | 3,060 | 706 | ||||||||||||||
Sales and marketing accruals | 2,283 | 3,710 | ||||||||||||||
Warranty liability | 2,940 | 2,461 | 3,561 | 3,508 | ||||||||||||
Sales tax | 2,206 | 2,373 | 2,388 | 2,920 | ||||||||||||
Other | 3,128 | 2,821 | 3,812 | 4,143 | ||||||||||||
Total | $ | 22,203 | $ | 17,397 | $ | 22,756 | $ | 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 itthe Company does not have a direct presence, the Company provides service through a network of distributors and third-party service providers.
After the original warranty 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 and ninesix months ended SeptemberJune 30, 20172018 and 20162017 (in thousands):
Three Months Ended | Nine Months Ended | Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||
September 30, | September 30, | June 30, | June 30, | |||||||||||||||||||||||||||||
2017 | 2016 | 2017 | 2016 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||||||
Beginning Balance | $ | 2,877 | $ | 2,000 | $ | 2,461 | $ | 1,819 | $ | 3,373 | $ | 2,735 | $ | 3,508 | $ | 2,461 | ||||||||||||||||
Add: Accruals for warranties issued during the period | 959 | 1,202 | 5,038 | 3,634 | 2,311 | 1,944 | 4,575 | 4,079 | ||||||||||||||||||||||||
Less: Warranty related expenses during the period | (896 | ) | (1,102 | ) | (4,559 | ) | (3,353 | ) | ||||||||||||||||||||||||
Less: Settlements made during the period | (2,123) | (1,802) |
| (4,522) | (3,663) |
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Ending Balance | $ | 2,940 | $ | 2,100 | $ | 2,940 | $ | 2,100 | $ | 3,561 | $ | 2,877 | $ | 3,561 | $ | 2,877 |
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 9% of the Company’s total revenue for the six months ended June 30, 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 service contracts and marketing services (which are satisfied over time), the Company generally satisfies all of the performance obligations at a point in time. System, system accessories (hand pieces), training, time and material services are also sold on a stand-alone basis, and related performance obligations are satisfied at a point in time. 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 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 has concluded that the system or upgrade and the right to use the embedded software represent a single performance obligation as the software license is integral to the functionality of the system or upgrade.
The Company considers set-up or installation an immaterial promise as set-up or installation for systems other than enlighten systems takes only a short time. The related costs to complete set-up or installation are immaterial to the Company. The enlighten system is one performance obligation and the calibration or installation service is a separate performance obligation.
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 international direct end-customer sales that have not been credit approved, after satisfying all remaining obligations of 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 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.
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. Skincare products are typically sold in contracts in which the skincare products represent the sole performance obligations. The Company recognizes revenue for skincare products at a point in time, generally upon shipment.
Consumables (Other accessories)
The Company treats its customers' purchase of replacement Titan, truSculpt 3D and truSculpt iD 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 accounted for in accordance with the Company’s standard warranty and service contract policies.
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 for a term of one, two, or three years, 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 immediately benefit from the training due to the fact that the customer already has the system. Training is also sold separately from systems. The Company recognizes revenue for training when the training is provided. Training is not required for customers to use the systems.
Customer Marketing Support
In North America, the Company offers marketing and consulting phone support to its customers who purchase its truSculpt 3D and truSculpt iD systems. These customer marketing support services include a practice development model and marketing training, performed remotely with ongoing phone consultations for six months from date of purchase. The Company considers customer marketing support 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. Revenue recognition under Topic 606 for the Company’s arrangements may be dependent on contract-specific terms.
The enlighten system includes the related software license as one performance obligation and the calibration/installation services are accounted for as separate performance obligations. 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 and the related costs to complete set-up or installation are immaterial.
Note 6. Deferred Service Contract Revenue
Judgment is required to determine the standalone selling price ("SSP") for each distinct performance obligation. The Company estimates SSPs for each performance obligation as follows:
Systems: The SSPs for systems are based on directly observable sales in similar circumstances to similar customers. When SSP is not directly observable, the Company estimates SSP using the expected cost plus margin approach.
Training: SSP is based on observable price when sold on a standalone basis.
Extended warranty: SSP is based on observable price when sold on a standalone basis (by customer type).
Marketing program: SSP is estimated based on cost plus margin.
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.
Deferred Sales Commissions
Incremental costs of obtaining a contract, including sales commissions, are capitalized and amortized on a straight-line basis over the expected customer relationship period if the Company expects to recover those costs. The Company uses the portfolio method to recognize the amortization expense related to these capitalized costs related to initial contracts 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.
Total capitalized costs as of June 30, 2018 were $5.3 million and are included in other long-term assets in the Company’s condensed consolidated balance sheet. Amortization of this asset was $0.4 million and $0.8 million, respectively, during the three and six months ended June 30, 2018 and is included in sales and marketing expense in the Company’s condensed consolidated statements of operations.
Note 8. 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 deferred revenue on the Company’s condensed consolidated balance sheet. The advance payments under these contracts are recorded in deferred revenue, and the Company recognizes the revenue when earned. Contracted but unsatisfied performance obligations were approximately $11.8 million as of June 30, 2018, of which the Company expects to recognize approximately 78% of the revenue over the next 12 months and the remainder thereafter.
The Company's deferred contract revenue consists of service revenue, training and product revenue. Deferred contract revenue balance is comprised mainly of Service 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 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 and nine monthsix months ended SeptemberJune 30, 20172018 and 20162017 (in thousands):
Three Months Ended | Nine Months Ended | Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||
September 30, | September 30, | June 30, | June 30, | |||||||||||||||||||||||||||||
2017 | 2016 | 2017 | 2016 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||||||
Beginning Balance | $ | 10,013 | $ | 10,223 | $ | 9,431 | $ | 10,469 | $ | 11,015 | $ | 9,555 | $ | 11,656 | $ | 9,431 | ||||||||||||||||
Add: Payments received | 3,178 | 2,517 | 10,290 | 8,825 | 4,739 | 3,721 | 8,416 | 7,112 | ||||||||||||||||||||||||
Less: Revenue recognized | (3,233 | ) | (3,447 | ) | (9,763 | ) | (10,001 | ) | (3,947) | (3,263) |
| (8,265) | (6,530) |
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Ending Balance | $ | 9,958 | $ | 9,293 | $ | 9,958 | $ | 9,293 | $ | 11,807 | $ | 10,013 | $ | 11,807 | $ | 10,013 |
Costs incurred by the Company for servicing extended service contracts were $1.2 million and $1.7 million for the three and six months ended SeptemberJune 30, 2017 and 2016, respectively; and $4.22018, were $2.0 million and $4.93.9 million, for the nine months ended September 30, 2017 and 2016, respectively.
Note 7. Stockholders’ Equity9. Stockholders’ Equity and Stock-based Compensation Expense
AmendedIn 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 Restatedconsultants. 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
The Company’s Board included shares reserved but un-issued under the 1998 Plan and shares returned to the 1998 Plan as the result of Directors (“Board”) andtermination of options or the repurchase of shares. In 2012 the stockholders approved a “fungible share” provision whereby each full-value award issued under the amendment and restatement of the 2004 equity incentive plan (“Amended and Restated 2004 Equity Incentive Plan”)Plan results in April and June 2017, respectively. The amendments includeda requirement to subtract 2.12 shares from the extension ofshares reserved under the term ofPlan.
Activity under the plan to the date of the annual meeting of the Company’s stockholders in 2022, an increase in the number of shares available for future grant by 1,600,000 shares, and other terms of the plan. The Amended and Restated 2004 Equity Incentive Plan, provides for the grant of incentive stock options, non-statutory stock options, restricted stock, restricted stock units ("RSUs"), stock appreciation rights, performance stock units ("PSUs"), performance shares, and other stock or cash awards.
Activity under the Company’s Amended and Restated 2004 Equity Incentive Plan for the nine months ended September 30, 2017as 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 as of December 31, 2016 | 721,657 | 1,116,472 | $ | 9.56 | ||||||||||||||||||||
Additional shares reserved | 1,600,000 | |||||||||||||||||||||||
Balance, December 31, 2017 | 1,494,865 | 839,919 | $ | 16.46 | ||||||||||||||||||||
Options granted | (154,000 | ) | 154,000 | 21.82 | (21,010) | 21,010 | 50.65 | |||||||||||||||||
Stock awards granted(1) (2) | (558,694 | ) | ||||||||||||||||||||||
Stock awards granted(1) | (395,511) | — | — | |||||||||||||||||||||
Options exercised | — | (447,673 | ) | 8.90 | — | (188,859) | 9.98 | |||||||||||||||||
Options canceled | 53,393 | (53,393 | ) | 16.58 | 43,833 | (43,833) | 20.33 | |||||||||||||||||
Stock awards canceled(1) | 110,278 | 93,390 | — | — | ||||||||||||||||||||
Balance as of September 30, 2017 | 1,772,634 | 769,406 | $ | 11.91 | ||||||||||||||||||||
Balance, June 30, 2018 | 1,215,567 | 628,237 | $ | 19.28 |
(1) | The |
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Under the 2004 Equity Incentive Plan, as amended, the Company issued 346,279 shares of common stock during the six months ended June 30, 2018, in conjunction with stock options exercised and the vesting of RSUs and PSUs.
As of SeptemberJune 30, 2017,2018, there was approximately $19.8 million of unrecognized compensation expense, net of projected forfeitures, related to non-vested equity awards issued under the Company’s Amendedfor stock options and Restated 2004 Equity Incentive Plan and the 2004 Employee Stock Purchase Plan (“ESPP”), was approximately $4.9 million. Thisstock awards. The expense is expected to be recognized over the remaining weighted-average period of 1.882.5 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 granted PSUs.PSUs granted.
PursuantNon-Employee Stock-Based Compensation
The Company granted 3,384 RSUs and 3,384 PSUs to non-employees during the six months ended June 30, 2018, and 7,745 stock options and 2,478 RSUs during the year ended December 31, 2017. The stock options vest over 4 years at 25% on the first anniversary of the grant date and 1/48th each month thereafter. The RSUs vest over 4 years at 25% on each anniversary of the grant date, whiles vesting of the PSUs is subject to the Company’s Amendedrecipient's continued service and Restated 2004 Equity Incentive Planachievement of pre-established metrics. 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 ESPP, the Company issued the following number of shares of common stock during the three and nine months ended September 30, 2017 and 2016:underlying equity instruments vest.
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2017 | 2016 | 2017 | 2016 | |||||||||||||
Stock options | 77,511 | 413,588 | 447,673 | 706,522 | ||||||||||||
Stock awards, net of shares withheld to satisfy employees’ minimum income tax withholding | 9,881 | 8,107 | 152,972 | 114,832 | ||||||||||||
ESPP | — | — | 51,185 | 41,980 | ||||||||||||
Total stock issued | 87,392 | 421,695 | 651,830 | 863,334 |
Stock Repurchase Program
On February 8, 2016, the Company announced that Board 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 and July 28, 2017 the Company’s Board of Directors approved the expansion of its Stock Repurchase Program by an additional $5 million and $25 million, respectively.
In the three and nine months ended September 30, 2017, the Company repurchased 184,536 and 518,780 shares of its common stock for approximately $6.7 million and $13.8 million, respectively. As of September 30, 2017, there remained an additional $21.4 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 and ninesix months ended SeptemberJune 30, 20172018 and 2016,2017 were as follows (in thousands):
Three Months Ended | Nine Months Ended | Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||
September 30, | September 30, | June 30, | June 30, | |||||||||||||||||||||||||||||
2017 | 2016 | 2017 | 2016 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||||||
Cost of revenue | $ | 101 | $ | 73 | $ | 377 | $ | 254 | $ | 227 | $ | 147 | $ | 380 | $ | 276 | ||||||||||||||||
Sales and marketing | 394 | 239 | 1,215 | 844 | ||||||||||||||||||||||||||||
Employee | 660 | 401 | 1,112 | 821 | ||||||||||||||||||||||||||||
Non-Employee | 55 | — | 92 | — | ||||||||||||||||||||||||||||
Research and development | 157 | 131 | 633 | 416 | 262 | 239 | 453 | 476 | ||||||||||||||||||||||||
General and administrative | 345 | 127 | 1,398 | 1,138 | 1,002 | 444 | 1,856 | 1,053 | ||||||||||||||||||||||||
Total stock-based compensation expense | $ | 997 | $ | 570 | $ | 3,623 | $ | 2,652 | $ | 2,206 | $ | 1,231 | $ | 3,893 | $ | 2,626 |
Note 8. Lease Termination Income
On May 2, 2017, the Company entered into a building lease with the intent to relocate its corporate headquarters to a new facility in Fremont, California. On July 6, 2017, the Company agreed to terminate this lease in return for a lump sum receipt from the lessor of $4.0 million. Simultaneously with the execution of the lease termination, the Company entered into an amendment to its existing lease agreement for the Company to maintain its corporate headquarters in its current facility in Brisbane, California. This amendment extends the term of the lease from December 31, 2017 to January 31, 2023. The $4.0 million is reported as “Lease termination income,” as a component of operating expenses, in the Company’s Condensed Consolidated Statements of Operations for the three and nine month periods ending September 30, 2017.
Note 9.10. Net Income (Loss)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. UnderIn accordance with ASC 260, the assumed proceeds under the treasury stock method include the amountaverage unrecognized compensation expense of in-the money stock options and restricted stock units. This results in the employee must pay forassumed buyback of additional shares, thereby reducing the dilutive impact of equity award, and the amount of compensation cost for future service that the Company has not yet recognized, are all assumed to be used to repurchase shares. 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 | Nine Months Ended | Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||
September 30, | September 30, | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||||||||
2017 | 2016 | 2017 | 2016 | |||||||||||||||||||||||||||||
Numerator | ||||||||||||||||||||||||||||||||
Net income (loss) | $ | 6,188 | $ | 1,644 | $ | 7,113 | $ | (1,636 | ) | $ | (1,572) | $ | 1,947 | $ | (3,604) | $ | 925 | |||||||||||||||
Denominator | ||||||||||||||||||||||||||||||||
Weighted average shares of common stock outstanding used in computing net income (loss) per share, basic | 13,973 | 13,163 | 13,917 | 13,102 | ||||||||||||||||||||||||||||
Weighted average shares of common stock outstanding used in computing net | ||||||||||||||||||||||||||||||||
income (loss) per share, basic | 13,709 | 13,935 | 13,649 | 13,888 | ||||||||||||||||||||||||||||
Dilutive effect of incremental shares and share equivalents | 794 | 381 | 816 | — | — | 694 | — | 745 | ||||||||||||||||||||||||
Weighted average shares of common stock outstanding used in computing net income (loss) per share, diluted | 14,767 | 13,544 | 14,733 | 13,102 | 13,709 | 14,629 | 13,649 | 14,633 | ||||||||||||||||||||||||
Net income (loss) per share: | ||||||||||||||||||||||||||||||||
Net income (loss) per share, basic | $ | 0.44 | $ | 0.12 | $ | 0.51 | $ | (0.12 | ) | $ | (0.11) | $ | 0.14 | $ | (0.26) | $ | 0.07 | |||||||||||||||
Net income (loss) per share, diluted | $ | 0.42 | $ | 0.12 | $ | 0.48 | $ | (0.12 | ) | $ | (0.11) | $ | 0.13 | $ | (0.26) | $ | 0.06 |
The following numbers of weighted shares outstanding, prior to the application of the treasury stock method, were excluded from the computation of diluted net income (loss) per common share for the period presented because including them would have had an anti-dilutive effect (in thousands):
Three Months Ended | Nine Months Ended | Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||
September 30, | September 30, | June 30, | June 30, | |||||||||||||||||||||||||||||
2017 | 2016 | 2017 | 2016 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||||||
Options to purchase common stock | 42 | 1,740 | 31 | 1,952 | 710 | 66 | 758 | 53 | ||||||||||||||||||||||||
Restricted stock units | — | 334 | 6 | 395 | 449 | 3 | 422 | 2 | ||||||||||||||||||||||||
Performance stock units | — | 64 | — | 81 | 49 | — | 36 | — | ||||||||||||||||||||||||
Employee stock purchase plan shares | — | 40 | — | 83 | 73 | — | 73 | — | ||||||||||||||||||||||||
Total | 42 | 2,178 | 37 | 2,511 | 1,281 | 69 | 1,289 | 55 |
Note 10.11. 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. InThe income tax benefits for the quarter ended December 31, 2016, the Company adopted ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. As a result of the adoption of the ASU No. 2016-09, the ninethree and six months ended SeptemberJune 30, 2017 tax provision includes the discrete accounting of the net2018 reflect a projected income tax benefit of excess compensation cost (“windfalls”). In the periods priorfor U.S. and non-U.S. operations resulting in an annual effective tax rate applied to the adoption of ASU No. 2016-09, theyear-to-date ordinary loss. This tax benefit of windfallsis increased by excess tax benefits generated by stock deductions exercised or vested in the three and tax deficiencies (“shortfalls”) were recorded in equity to the extent of previous windfalls, and then to the income statement.six months ended June 30, 2018.
For the nine- month periodthree and six months ended SeptemberJune 30, 2016,2018, the Company used a discrete effectiveCompany's income tax rate methodbenefit was $712,000 and $3,331,000 respectively, compared 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 nine-month period ended September 30, 2016.
The Company’s income tax expense of $225,000$59,000 and $166,000income tax benefit of $59,000 for the same periods in 2017. The income tax benefits for the three and ninesix months ended SeptemberJune 30, 2017, respectively, related primarily to the Company’s U.S. and non-U.S. operations based on the annual effective tax rate method. In addition, it included2018 include a tax benefit for excess tax deductions of approximately $50,000$1.14 million and $160,000$2.6 million, respectively, recorded discretely in the three and nine months ended September 30, 2017, respectively. The Company’s income tax expense for the three and nine months ended September 30, 2016 was $61,000 and $115,000, respectively, and related primarily to income taxes of the Company’s non-U.S. operations.reporting period.
The Company utilizes the asset and liability method of accounting for income taxes, under which deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using 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 December 31, 2017, the Company released its valuation allowance against U.S. federal and all other domestic state net deferred tax assets except for California and Massachusetts. The Company maintained this valuation allowance position through June 30, 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 all available positive and negative evidence giving greater weight to its recent historical financial results and lesser weight to its projected financial results, due to the subjectivity involved in forecasting future periods.evidence. 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. Asstrategies and the impact of Septemberthe Tax Cuts and Jobs Act of 2017 (the “2017 Tax Act”).
Note 12. Correction of Prior Period Immaterial Error
During the three months ended June 30, 2017 and December 31, 20162018, management discovered that the Company had a 100% valuation allowance against its U.S.not recorded the tax effect of the adoption of ASC 606 in the balance sheet of the unaudited condensed consolidated financial statements as of March 31, 2018. 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. The tax effect of the 606 adoption was $1.2 million.
The Company evaluated the impact of the error on prior period and determined that the effect was not material to the financial statements as of and for the three months ended March 31, 2018 and six months ended June 30, 2018. The Company corrected the error in the unaudited condensed consolidated financial statements as of and for the six months ended June 30, 2018. The correction of the error increased deferred tax assets. Inliability by $1.2 million and decreased retained earnings by $1.2 million (Note 2) as of January 1, 2018.
The Company’s condensed consolidated statements of operations, comprehensive income (loss) and cash flows for the near future, asthree months ended March 31, 2018, and when the Company concludes that sufficient positive evidence, including its estimate of future taxable income, exists to support a reversal of all or a portionthree and six months ended June 30, 2018 were not affected by this correction of the valuation allowance, thenerror. Accordingly, the Company expectsCompany's loss per share for the three months ended March 31, 2018, and the three and six months ended June 30, 2018 remains unchanged.
Note 13. Segment reporting
Segment reporting is based on the “management approach,” following the method that a significant portion of any releasemanagement 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 Chief Executive Officer ("CEO"), who makes decision on allocating resources and in assessing performance. The CEO 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 valuation allowance will be recorded as an income tax benefit atCompany’s principal operations and decision-making functions are located in the timeU.S. The Company’s CEO viewed its operations, managed its business, and used one measurement of release,profitability for the one operating segment — which will havesells 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 material impact onsummary of revenue by geography for the financial statements. Thereafter,three months ended June 30, 2018 and 2017 (in thousands):
Three Months Ended June 30, | ||||||||
2018 | 2017 | |||||||
Revenue mix by geography: | ||||||||
United States | $ | 28,132 | $ | 24,239 | ||||
Japan | 3,946 | 3,710 | ||||||
Asia, excluding Japan | 4,231 | 2,830 | ||||||
Europe | 1,803 | 1,219 | ||||||
Rest of the world | 4,441 | 4,391 | ||||||
Total consolidated revenue | $ | 42,553 | $ | 36,389 | ||||
Revenue mix by product category: | ||||||||
Products | $ | 35,291 | $ | 30,115 | ||||
Consumables | 1,057 | 649 | ||||||
Skincare | 1,302 | 963 | ||||||
Total product revenue | $ | 37,650 | $ | 31,727 | ||||
Service | 4,903 | 4,662 | ||||||
Total consolidated revenue | $ | 42,553 | $ | 36,389 |
The following table presents a summary of revenue by geography for the income tax expense recorded in future quarters could also be significantly higher than it has been since fiscal year 2009, when we recorded a valuation allowance for our U.S. deferred tax assets.six months ended June 30, 2018 and 2017 (in thousands):
Six Months Ended June 30, | ||||||||
2018 | 2017 | |||||||
Revenue mix by geography: | ||||||||
United States | $ | 49,268 | $ | 40,783 | ||||
Japan | 7,501 | 7,590 | ||||||
Asia, excluding Japan | 7,074 | 6,014 | ||||||
Europe | 4,373 | 3,445 | ||||||
Rest of the World | 8,462 | 7,856 | ||||||
Total consolidated revenue | $ | 76,678 | $ | 65,688 | ||||
Revenue mix by product category: | ||||||||
Products | $ | 62,530 | $ | 53,107 | ||||
Consumables | 1,826 | 1,148 | ||||||
Skincare | 2,558 | 1,947 | ||||||
Total product revenue | $ | 66,914 | $ | 56,202 | ||||
Service | 9,764 | 9,486 | ||||||
Total consolidated revenue | $ | 76,678 | $ | 65,688 |
Note 1114. Commitments and Contingencies
Operating Leases
Leases
The Company leases space for operations in the United States, Spain, Japan and France. Future minimum lease commitments under the Company’s facility operating leases as of September 30, 2017 were as follows (in thousands):
Year Ending September 30, | Amount | |||||||
Year Ending December 31 | Amount | |||||||
2018 | $ | 2,446 | $ | 1,494 | ||||
2019 | 2,677 | 2,971 | ||||||
2020 | 2,743 | 2,913 | ||||||
2021 | 2,593 | 2,525 | ||||||
2022 | 2,477 | 2,495 | ||||||
2023 and beyond | 838 | 214 | ||||||
Total future minimum lease payments | $ | 13,774 | ||||||
Total future minimum lease payments | $ | 12,612 |
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 thecapital leases. The remaining committed lease payments are not material.as of June 30, 2018 was $1.15 million.
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. Asconsidered 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 September 30, 2017, there were 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 exposures beyondloss is reasonably possible, but not probable and can be reasonably estimated, the amounts accruedestimated loss or range of loss is disclosed in the Company'snotes to the consolidated financial statements. The Company expenses legal fees as incurred.
As of June 30, 2018 and December 31, 2017, the Company had accrued $137,000 and $91,000, respectively related to various pending contractual and product liability lawsuits. The Company does not believe that a material loss in excess of accrued amounts is not currently a party to any material legal proceedings.reasonably possible.
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Caution Regarding Forward-Looking StatementsNote 15. Debt
ThisLoan and Security Agreement
On May 30, 2018, the Company and Wells Fargo Bank, N.A. (“Wells Fargo”) entered into a Loan and Security Agreement (the “Revolving Line of Credit”) in the original principal amount of $25,000,000. The Revolving Line of Credit terminates on May 30, 2021. The purpose of the Revolving Line of Credit is to provide working capital and to fund the Company’s general business requirements.
The Revolving Line of Credit bears interest at a variable interest rate equal to the LIBOR Rate plus a defined LIBOR Rate Margin based on the then-current Leverage Ratio (a ratio of funded debt to the Trailing Twelve Month ("TTM") Adjusted EBITDA).
The Revolving Line of Credit provides for borrowing limits that range from $5,000,000 to a maximum of $25,000,000 during the term of the Revolving Line of Credit. Additionally, the Company agrees to pay a variable unused commitment fee to Wells Fargo equal to (a) 0.25% per annum if the Leverage Ratio is less than 1.0 to 1.0, (b) 0.30% per annum if the Leverage Ratio is equal to or greater than 1.0 to 1.0, but less than 2.0 to 1.0, and (c) 0.35% per annum if the Leverage Ratio is equal to or greater than 2.0 to 1.0.
The Revolving Line of Credit is secured by a pledge of security interest in all the shares of each material subsidiary, together with all proceeds, all cash, stock and other moneys and property paid thereon, all rights to subscribe for securities declared or granted, and all other cash and noncash proceeds, as security for the performance of the obligations. As of June 30, 2018, there were no borrowings under the Revolving Line of Credit.
Covenants
The Loan and Security Agreement contains financial and other covenants as well as the maintenance of a leverage ratio not to exceed 2.5 to 1.0 and a TTM adjusted EBITDA of not less than $10 million. A violation of any of the covenants could result in a default under the Loan and Security Agreement that would permit the lenders to restrict the Company’s ability to further access the revolving line of credit for loans and letters of credit and require the immediate repayment of any outstanding loans under the Loan and Security Agreement. As of June 30, 2018, the Company is in compliance with all financial covenants.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following management’s discussion and analysis of the Company’s financial condition and results of operations in conjunction with the Company’s unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q (“and with the audited financial statements and notes thereto for the year ended December 31, 2017, included in the annual report on Form 10-Q”)10-K filed on March 26, 2018 with the U.S. Securities and Exchange Commission (SEC).
Special note regarding forward-looking statements
This report contains forward-looking statements that involve risks and uncertainties. The Company’s actual results could differ materially from those discussed in the forward-looking statements. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”("the Exchange Act"). The Private Securities Litigation Reform ActForward-looking statements are often identified by the use of 1995 provides a “safe harbor” for certain forward-looking statements. The words such as, but not limited to, “anticipate,” “believe,” “potential,“can,” “forecast,“continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “expect,” “anticipate,” “plan,” “intend,” “foresee,“seek,” “should,” “would,“strategy,” “could,“target,” “may,“will,” “estimate,” “project” or other“would” and similar expressions areor variations intended to identify forward-lookingforward- looking statements. These forward-looking statements are based on our current expectationsthe beliefs and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those that we anticipate. All discussion concerning our expectations for future revenues and operating results areassumptions of the Company’s management based on our forecasts for our existing operations. Theseinformation currently available to management. Such forward-looking statements involve significantare subject to risks, uncertainties and uncertainties (someother important factors that could cause actual results and the timing of whichcertain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are beyond our control)not limited to, those identified below and assumptions. Theythose discussed in the section titled “Risk Factors” included under Part II, Item 1A below.
Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. The statements are subject to change based on various factors, including but not limited to the risks and uncertainties summarized below:
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Other factors that could cause our actual results to differ from our projected results are described in (1) “Part II, Item 1A. Risk Factors” and elsewhere in this Form 10-Q, (2) our Annual Report on Form 10-K for the period ended December 31, 2016 (“2016 Form 10-K”), (3) our reports and registration statements filed and furnished from time to time with the U.S. Securities and Exchange Commission (“SEC”) and (4) other announcements we make from time to time.
Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this report. We undertake no obligation to update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise. You should read the following discussion and analysis in conjunction with our unaudited Condensed Consolidated Financial Statements and related notes included elsewhere in this report. Operating results for the three and nine months ended September 30, 2017 are not necessarily indicative of future results, including the full fiscal year. You should also refer to our “Annual Consolidated Financial Statements,” “Notes” thereto, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” contained in our 2016 Form 10-K.
Introduction
The Management’sManagement’s Discussion and Analysis, or MD&A, is organized as follows:
● | ExecutiveSummary.This section provides a general description and history of |
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Executive Summary
Company 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 the Company’s 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 removal and toenail fungus treatment. Ourand vaginal health. The Company’s platforms are designed to be easily upgraded to add additional applications and hand pieces, which provide flexibility for ourthe Company’s 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.
OurThe Company’s ongoing research and development activities are primarily focused on improving and enhancing the Company’s portfolio of products. The Company is exploring ways to expand the Company’s product offerings through the launch of new products. The Company introduced Juliet, a product for women’s health, in December 2017, SecretRF, a fractional RF microneedling device for skin rejuvenation, in January 2018, enlighten SR in April 2018, and truSculpt iD in July 2018.
The Company’s corporate headquarters and U.S. operations are located in Brisbane, California, from where we conduct ourthe Company conducts manufacturing, warehousing, research and development, regulatory, sales and marketing, service, and administrative activities. We have wholly-owned subsidiaries locatedThe Company markets, sells and services the Company’s 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
OurThe Company’s revenue is derived from the sale of Products and Services. Our ProductsProduct revenue is derived from the sale of Systems, Hand Piece Refills (applicablesystems, hand pieces and upgrade of systems (“Systems” revenue), sale of replacement hand pieces, as well as single use disposable tips applicable to TitanJuliet, Secret RF and truSculpt)(“Consumables” revenue), and the distributionsale of third party manufactured Skincare products. Systems revenue includes the sales of new systems and additional applications that customers purchase as their practice grows.skincare products (“Skincare” revenue). 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, andas well as one or more hand pieces. OurHowever, 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 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.
The Company’s 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®, and a third-party sourced system called myQ® 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 “refilling” the hand piece. In Japan, we also distribute ZO Medical Health Inc. (“ZO”) skincare products.and xeo.
Service revenue relates to amortization of prepaid service contracts, training, enlighten installation, direct billings for detachable hand piece replacements (except for Titan and truSculpt) and revenue for parts and labor on out-of-warranty products.
Significant Business Trends
We believeThe Company believes that ourthe ability to grow revenue will be primarily dependent on the following:
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For a detailed discussion of the significant business trends impacting ourthe Company’s business, please see the section titled “Results of Operations” below.
Factors that May Impact Future Performance
OurThe Company’s industry is impacted by numerous competitive, regulatory macroeconomic and other significant factors. OurThe Company’s industry is highly competitive and ourthe Company’s future performance depends on ourthe Company’s ability to compete successfully. Additionally, ourthe Company’s future performance depends on our is dependent upon the ability to continue to expand ourthe Company’s product offerings developwith innovative technologies, obtain regulatory clearances for ourthe Company’s products, protect the proprietary technology of ourthe products and our manufacturing processes, manufacture ourthe products cost-effectively, and successfully market and distribute ourthe products in a profitable manner. If we failthe Company fails to execute on the aforementioned initiatives, ourthe Company’s business couldwould be adversely affected. A detailed discussion of these and other factors that could impact ourthe Company’s future performance are provided in (1) “Part II,Part I, Item 1A. Risk1A “Risk Factors” and elsewhere in this Form 10-Q, (2) our 2016the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, (3) ourthe Company’s reports and registration statements filed and furnished from time to time with the SEC, and (4) other announcements we makethe Company makes from time to time.
Critical Accounting Policiesaccounting policies, significant judgments and Estimatesuse of estimates
The Company's management discussion and analysis of financial condition and results of operations are based upon the Company’s unaudited condensed consolidated financial statements. For the three and six months ended June 30, 2018, the Company’s income tax benefit was $712,000 and $3,331,000, respectively, compared to income tax expense of $59,000 and income tax benefit of $59,000 for the same periods in 2017. In the six months ended June 30, 2018, the Company calculated the provision for income taxes for interim reporting periods by applying an estimate of the "annual effective tax rate" for the full year to ordinary income or loss for the reporting period. The Company’s income tax benefit for the six months ended June 30, 2018 reflects a projected income tax benefit for U.S. and non-U.S. 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 six months ended June 30, 2018.
For the Company’s income tax provision in the six months ended June 30, 2017, the tax benefit 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 net operating loss carryforwards. However, the tax effect of such utilization was offset by a change in valuation allowance for the six months ended June 30, 2017 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 the Company’s critical accounting policies and estimates. The Company based the estimates judgments and assumptions are based on historical experience and on various other factorsassumptions that we believethe Company believes 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, ourconditions. The Company’s significant accounting policies are more fully described in Note 1 of the accompanying unaudited condensed consolidated financial condition or results of operations will be affected.
Critical accounting estimates, as defined by the SEC, are those that are most importantstatements and in Note 2 to the portrayalCompany’s audited consolidated financial statements contained in the Annual Report on Form 10-K filed on March 26, 2018 with the SEC. With the exception of our financial conditionthe change in revenue recognition as a result of the adoption of ASC Topic 606, (see Notes 2 and results of operations and require our management’s most difficult and subjective judgments and estimates of matters that are inherently uncertain. The7) there have been no new or material changes to the critical accounting policies and estimates discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017, that we consider to be critical, subjective, and requiring judgment in their application are summarized in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2016 Form 10-K. There have been no significant changessignificance, 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 net total revenue.revenue, net. Percentages in this table and throughout ourthe Company’s discussion and analysis of financial condition and results of operations may reflect rounding adjustments.
Three Months Ended | Nine Months Ended | Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||
September 30, | September 30, | June 30, | June 30, | |||||||||||||||||||||||||||||
2017 | 2016 | 2017 | 2016 | 2018 | 2017 | 2018 | 2017 | |||||||||||||||||||||||||
Net revenue | 100 | % | 100 | % | 100 | % | 100 | % | 100% | 100% |
| 100% | 100% |
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Cost of revenue | 42 | % | 41 | % | 43 | % | 42 | % | 47% | 42% |
| 48% | 44% |
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Gross margin | 58 | % | 59 | % | 57 | % | 58 | % | 53% | 58% |
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Operating expenses: | ||||||||||||||||||||||||||||||||
Sales and marketing | 34 | % | 35 | % | 35 | % | 37 | % | 37% | 35% |
| 37% | 36% |
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Research and development | 9 | % | 10 | % | 9 | % | 11 | % | 10% | 8% |
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General and administrative | 9 | % | 9 | % | 10 | % | 12 | % | 12% | 10% |
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Lease termination income | (10 | )% | — | (3 | )% | — | ||||||||||||||||||||||||||
Total operating expenses | 42 | % | 54 | % | 51 | % | 60 | % | 59% | 53% |
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Income (loss) from operations | 16 | % | 5 | % | 6 | % | (2 | )% | (5)% | 5% |
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Interest and other income, net | 1 | % | 1 | % | 1 | % | — | |||||||||||||||||||||||||
Interest and other income (expense), net | — | 1% |
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Income (loss) before income taxes | 17 | % | 6 | % | 7 | % | (2 | )% | (5)% | 6% |
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Provision for income taxes | 1 | % | — | % | — | % | — | % | ||||||||||||||||||||||||
Provision (benefit) for income taxes | — | — | (4)% | — | ||||||||||||||||||||||||||||
Net income (loss) | 16 | % | 6 | % | 7 | % | (2 | )% | (5)% | 6% |
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Revenue
The Company primarily generates revenue from the sale of systems, training on the systems, extended service contracts, consumables and other accessories. The timing of the Company’s 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 in the accompanying unaudited condensed consolidated financial statements.
As of June 30, 2018, approximately 9% 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 relates to revenue from the Company’s extended service contracts and customer marketing support. Revenue recognized upon delivery is primarily generated by the sales of system, consumables and skincare.
During the first and second quarters of fiscal year 2018, the Company recognized revenue based on the ASU No.2014-09, “Revenue from Contracts with Customers (Topic 606),” but revenue for the three and six months ended June 30, 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 the Company’s revenue, see Notes 2 and 7 in the accompanying unaudited condensed consolidated financial statements.
Total Net Revenue
Three Months Ended September 30, | Nine Months Ended September 30, | Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||||||||||
(Dollars in thousands) | 2017 | % Change | 2016 | 2017 | % Change | 2016 | 2018 | % Change | 2017 | 2018 | % Change | 2017 | ||||||||||||||||||||||||||||||||||||
Revenue mix by geography: | ||||||||||||||||||||||||||||||||||||||||||||||||
United States | $ | 23,275 | 52 | % | $ | 15,356 | $ | 64,058 | 52 | % | $ | 42,216 | $ | 28,132 | 16% | $ | 24,239 | $ | 49,268 | 21% |
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Rest of World | 14,898 | — |
| 14,925 | 39,803 | 5 | % | 37,965 | ||||||||||||||||||||||||||||||||||||||||
International | 14,421 | 19% | 12,150 | 27,410 | 10% |
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Consolidated total revenue | $ | 38,173 | 26 | % | $ | 30,281 | $ | 103,861 | 30 | % | $ | 80,181 | $ | 42,553 | 17% | $ | 36,389 | $ | 76,678 | 17% |
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United States as a percentage of total revenue | 61 | % | 51 | % | 62 | % | 53 | % | 66% |
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Rest of World as a percentage of total revenue | 39 | % | 49 | % | 38 | % | 47 | % | ||||||||||||||||||||||||||||||||||||||||
International as a percentage of total revenue | 34% |
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Systems – North America | $ | 21,869 | 57 | % | $ | 13,896 | $ | 58,955 | 60 | % | $ | 36,808 | ||||||||||||||||||||||||||||||||||||
Systems – International | 9,993 | — |
| 9,983 | 26,014 | 6 | % | 24,448 | ||||||||||||||||||||||||||||||||||||||||
Systems | ||||||||||||||||||||||||||||||||||||||||||||||||
- North America | $ | 25,886 | 14% | $ | 22,626 | $ | 44,830 | 21% |
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- Rest of World | 9,405 | 26% | 7,489 | 17,700 | 10% |
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Total Systems | 31,862 | 33 | % | 23,879 | 84,969 | 39 | % | 61,256 | 35,291 | 17% | 30,115 | 62,530 | 18% |
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Consumables | 1,057 | 63% | 649 | 1,826 | 59% |
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Skincare | 1,302 | 35% | 963 | 2,558 | 31% |
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Total Products | 37,650 | 19% | 31,727 | 66,914 | 19% |
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Service | 4,687 | (2 | )% | 4,788 | 14,173 | (1 | )% | 14,278 | 4,903 | 5% | 4,662 | 9,764 | 3% | 9,486 | ||||||||||||||||||||||||||||||||||
Hand Piece Refills | 595 | (1 | )% | 602 | 1,743 | (8 | )% | 1,886 | ||||||||||||||||||||||||||||||||||||||||
Skincare | 1,029 | 2 | % | 1,012 | 2,976 | 8 | % | 2,761 | ||||||||||||||||||||||||||||||||||||||||
Consolidated total revenue | $ | 38,173 | 26 | % | $ | 30,281 | $ | 103,861 | 30 | % | $ | 80,181 | ||||||||||||||||||||||||||||||||||||
Total Net Revenue | $ | 42,553 | 17% | $ | 36,389 | $ | 76,678 | 17% |
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Total Net Revenue:
Our totalThe Company’s revenue increased by $7.9 million, or 26%, and $23.7 million, or 30%, in17% for the three and ninesix months periods ended SeptemberJune 30, 2017, respectively,2018, compared to the same periods in 2016,2017, due primarily to an increase in the volume of systems sold.increased system revenues.
Revenue by Geography:
OurThe Company’s U.S. revenue increased by $7.9$3.9 million, or 52%16%, and by $21.8$8.5 million, or 52%, in21% respectively for the three and ninesix months ended SeptemberJune 30, 2017, respectively,2018, compared to the same periods in 2016.2017. This growthincrease was due primarily to an increasenew products introduced into the market in January 2018.
The Company’s international revenue increased $2.3 million, or 19%, and $2.5 million, or 10% for the volume of truSculpt systems sold as a result of the launch of our truSculpt 3D in the second quarterthree and six months ended June 30, 2017, as well as increased sales headcount, marketing and promotional activities.
Our revenue outside the U.S. was $14.9 million for each of the three month periods ended September 30, 2017 and September 30, 2016. For the nine months ended September 30, 2017,2018, compared to the same periodperiods in 2016, revenue outside the U.S. increased by $1.8 million, or 5%. This growth2017. The increase was primarily attributabledue to revenue growth in Japan, Australia, andthe Company’s business in Europe, the Middle East offset in part by a decline in revenue from Latin America.and Asia including Japan.
Revenue by Product Type:
SystemsRevenue
Systems revenue in North America increased by $7.9$3.3 million, or 57%14%, and by $22.2$7.7 million, or 60%21% , inrespectively, for the three and ninesix months ended SeptemberJune 30, 2018, compared to the same periods in 2017, due to strong sales in the U.S. and new products launched since the second quarter of 2017. The Rest of the World systems revenue increased by $2.0 million or 26%, and $1.7 million, or 10%, respectively. The increase in Rest of the World revenue was primarily a result of increase in the Company’s direct business in Asia, including Japan, as well as increases in the Company’s distributor business in the Middle East and Europe, partially offset by decreases in the Company’s direct business in Australia and Europe.
ConsumablesRevenue
Consumables revenue increased by $408,000, or 63%, and $678,000, or 59% for the three and six months ended June 30, 2018, respectively, compared to the same periods in 2016. This growth was primarily attributable to an2017. The increase in consumables revenue fromwas due to the introduction of truSculpt 3D in May 2017, 3D, enlighten III, xeoSecret RF and excel HR Julietproducts, offset by a small decline in revenue from excel V. In addition, the North America revenue growth was the result during January 2018, each of increased sales headcount, higher productivity of our field sales representatives, and the impact of additional marketing and promotional activities.which have consumable elements.
Gross Profit Three Months Ended September 30, Nine Months Ended September 30, Three Months Ended June 30, Six Months Ended June 30, (Dollars in thousands) 2017 % Change 2016 2017 % Change 2016 2018 % Change 2017 2018 % Change 2017 Gross profit % % As a percentage of total net revenue % % % % Gross International Systems revenue was $10 million for eachService SkincareRevenueOur worldwide ServiceThe Company’s revenue was relatively flatfrom Skincare products in Japan increased by $339,000, or 35%, and $611,000, or 31% for the three and ninesix months ended SeptemberJune 30, 2017,2018, respectively, compared to the same periods in 2016.2017. This increase was due primarily to increased marketing and promotional activities.Hand Piece Refills ServiceRevenueRevenue from our Hand Piece Refills was flat duringThe Company’s Service revenue increased by $241,000, or 5%, and $278,000, or 3% for the three and six months ended SeptemberJune 30, 2017, and declined by $143,000 or 8%, in the nine months ended September 30, 2017,2018, respectively, compared to the same periods in 2016. This decrease was primarily due to reduced utilization of the Titan hand pieces.Skincare RevenueRevenue from our Skincare products in Japan was flat during the three months ended September 30, 2017, and increased by $215,000, or 8%, in the nine months ended September 30, 2017, compared to the same periods in 2016.2017. This increase was due primarily dueto increased sales of system parts to the launchCompany's network of new product lines as well as increased marketing and promotional activities for this distributed product.international distributors. $ 22,210 25 $ 17,743 $ 58,777 27 $ 46,222 $ 22,377 6% $ 21,046 $ 39,711 9% $ 36,567 58 59 57 58 53% 58% 52% 56% OurThe Company’s cost of revenue consists primarily of material, personnel expenses, product warranty costs, and manufacturing overhead expenses.marginmargins in the three and ninesix months ended SeptemberJune 30, 2017,2018 decreased by 5% and 4% respectively, compared to the same period in 2017. In each of the three and six month periods, a higher percentage of product revenue came from our distributor network in 2016, declined slightlyRest of the World. Reduced gross margins were due primarily due to:
● | In the three months ended June 30, 2018, Rest of World product revenue generated from distributors increased to 65% from 50% for the same period in 2017; |
● | In the six months ended June 30, 2018, Rest of World product revenue generated from distributors increased to 60% from 49% for the same period in 2017; |
● | Slightly lower average system pricing across the legacy portfolio. The Company experienced continued pricing pressure on the average selling price of the Company’s enlighten system due to ongoing sales programs and normal business activities; and |
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Sales and Marketing
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
(Dollars in thousands) | 2017 | % Change | 2016 | 2017 | % Change | 2016 | ||||||||||||||||||
Sales and marketing | $ | 13,148 | 24 | % | $ | 10,574 | $ | 36,708 | 22 | % | $ | 30,002 | ||||||||||||
As a percentage of total net revenue | 34 | % | 35 | % | 35 | % | 37 | % |
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(Dollars in thousands) | 2018 | % Change | 2017 | 2018 | % Change | 2017 | ||||||||||||||||||
Sales and marketing | $ | 15,535 | 21 | % | $ | 12,787 | $ | 28,623 | 21 | % | $ | 23,560 | ||||||||||||
As a percentage of total net revenue | 37% |
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Sales and marketing expenses consist primarily of personnel expenses, expenses associated with customer-attended workshops and trade shows, post-marketing studies, advertising and advertising. Sales and marketing expenses as a percentage of revenue declined to 34% and 35% during the three and nine months ended September 30, 2017, respectively, compared to 35% and 37% during the three and nine months ended September 30, 2016, respectively. The reduction in sales and marketing expense as a percent of revenue was due primarily to improved leverage of our sales and marketing expenses, as well as an increase in our direct sales employee productivity.training.
The $2.6$2.7 million or 24%, increase in sales and marketing expenses during the three months ended SeptemberJune 30, 2017,2018, compared to the same period in 2016,2017, was due primarily to:
● | $ |
● | $ |
● | $0.3 million of higher travel related expenses in North America, resulting from greater related activity and increased headcount; and |
● | $0.4 million of higher promotional and product demonstration expenses, primarily in North |
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SalesThe $5.1 million increase in sales and marketing expenses increased by $6.7 million, or 22%, induring the ninesix months ended SeptemberJune 30, 2017,2018, compared to the same period in the prior year,2017, was due primarily to:
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● | $1.1 million of higher promotional and product demonstration expenses, primarily in North America. |
Research and Development (“R&D”)
Three Months Ended September 30, | Nine Months Ended September 30, | Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||||||||||
(Dollars in thousands) | 2017 | % Change | 2016 | 2017 | % Change | 2016 | 2018 | % Change | 2017 | 2018 | % Change | 2017 | ||||||||||||||||||||||||||||||||||||
Research and development | $ | 3,467 | 19 | % | $ | 2,914 | $ | 9,393 | 13 | % | $ | 8,335 | $ | 4,095 | 37% |
| $ | 2,981 | $ | 7,651 | 29% |
| $ | 5,926 | ||||||||||||||||||||||||
As a percentage of total net revenue | 9 | % | 10 | % | 9 | % | 11 | % | 10% |
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R&D expenses consist primarily of personnel expenses, clinical research, regulatory and material costs. R&D expenses increased by $553,000,$1.1 million or 37%, and represented 9%10% of total net revenue, in the three months ended SeptemberJune 30, 2017,2018, compared to 10%8% of total net revenue for the same period in 2016.2017. This increase in expense was due primarily to:to $1.1 million of increased personnel and consulting related expenses.
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R&D expenses increased by $1.1$1.7 million or 29%, and represented 9%10% of total net revenue, in the ninesix months ended SeptemberJune 30, 2017,2018, compared to 11%9% of total net revenue for the same period in 2016.2017. This increase in expense was due primarily to:to $1.7 million of increased personnel (including $0.6 million of stock-based compensation, due to headcount increase) and consulting related expenses.
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General and Administrative (“G&A”)
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| Three Months Ended September 30, |
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General and administrative |
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| $ | 3,548 | $ | 10,341 | 53% |
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G&A expenses consist primarily of personnel expenses, legal fees, accounting, audit and tax consulting fees, and other general and administrative expenses. G&A expenses increased by $663,000$1.4 million or 38%, and represented 9%12% of total net revenue in both the three months ended SeptemberJune 30, 2017 and 2016. The increase in G&A expenses was due primarily to:
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G&A expenses increased by $210,000 and represented 10% of total net revenue in the ninesame period in 2017, due primarily to $1.4 million of increased personnel related expenses, including $1.0 million of stock-based compensation, due to headcount increase.
G&A expenses increased by $3.6 million, and represented 13% of total net revenue in the six months ended SeptemberJune 30, 2017,2018, compared to 12%10% of total net revenue in the same period in 2016,2017, due primarily to:
● | $ |
● | $1.8 million of stock based compensation due to headcount increase; |
● | $0.2 million of increased other personnel related expenses due |
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Lease Termination Income
In July 2017, we agreed to terminate the building lease for a new facility in Fremont, California, which was entered into in May 2017. In conjunction with this lease termination, we received a lump sum termination payment of $4.0 million from the landlord.
Interest and Other Income (expense), Net
Interest and other income, (net),net, consists of the following:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
(Dollars in thousands) | 2017 | % Change | 2016 | 2017 | % Change | 2016 | ||||||||||||||||||
Interest income | $ | 145 | 81 | % | $ | 80 | $ | 388 | 65 | % | $ | 235 | ||||||||||||
Other income (expense), net | 52 | (40 | )% | 86 | 358 | 23 | % | 292 | ||||||||||||||||
Total interest and other income, net | $ | 197 | 19 | % | $ | 166 | $ | 746 | 42 | % | $ | 527 |
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | 2018 | % Change | 2017 | ||||||||||||||||||
Total interest and other income (expense), net | $ | (129 | ) | (147)% |
| $ | 276 | $ | (31) | (106)% |
| $ | 549 | |||||||||||
As a percentage of total net revenue | 0% | 1% | 0% | 1% |
Interest and other income, net, increased $31,000decreased $405,000 or (147)% and $580,000 or (106)%, respectively, in the three and six months ended SeptemberJune 30, 2017,2018, compared to the same period in 2016.2017. This decrease was due primarily to an increase in net foreign exchange losses as well as a decrease in interest income from ourthe Company’s marketable investments resulting from highera decrease in the investment balances as well as higher rates of return, partially offset by a reduction in net foreign exchange gains.balance.
Provision for Income Taxes Three Months Ended September 30, Nine Months Ended September 30, Three Months Ended June 30, Six Months Ended June 30, (Dollars in thousands) 2017 % Change 2016 2017 % Change 2016 2018 % Change 2017 2018 % Change 2017 Income (loss) before income taxes % % ) Provision for income taxes % % Provision (benefit) for income taxes For the three and six months ended 2017. In the three and The income tax provision (benefit) for the three and six months ended June 30, 2017 related primarily to U.S. alternative minimum taxes as Interest and other income (net) increased $219,000 in the nine months ended September 30, 2017, compared to the same period in 2016. This was due primarily to an increase in interest income from our marketable investments resulting from higher investment balance as well as higher rates $ 6,413 276 $ 1,705 $ 7,279 579 $ (1,521 $ (2,284) (214)% $ 2,006 $ (6,935) (901)% $ 866 225 269 61 166 44 115 (712) (1,307)% 59 (3,331) 5,546% (59) SeptemberJune 30, 2017, our2018, the Company’s income tax benefits were $712,000 and $3,331,000, compared to income tax expense was $225,000, compared to $61,000of $59,000 and income tax benefits of $59,000 in the same periodperiods in 2016. For the nine months ended September 30, 2017, our income tax expense was $166,000, compared to $115,000 in the same period in 2016.ninesix months ended SeptemberJune 30, 2017, we2018, the Company 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.income or loss for the reporting period. The resultCompany’s income tax benefit for the three and six months ended June 30, 2018 reflect a projected income tax benefit for U.S. and non-U.S. 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 and six months ended June 30, 2018.we arethe Company was able to utilize ourthe net operating losses brought forward.forward against the Company’s projected income for fiscal year 2017. In addition, wethe Company recorded discretely the net tax benefit of excess equity compensation costs (“windfalls”) of approximately $50,000$59,000 and $160,000$110,000 in the three and ninesix months ended SeptemberJune 30, 2017, respectively.
For our income tax provision in the three and nine months ended September 30, 2016, the tax expense was primarily related to income taxes of our non-U.S. operations as our U.S. operations were in a loss position and we had a 100% valuation allowance against them. We did not record a year-to-date tax benefit associated with the projected 2016 U.S. tax expense due to historical losses and uncertainties related to the projected income.
Due to the uncertainty regarding the timing and extent of our future profitability, we continue to record a full valuation allowance to offset our U.S. deferred tax assets, which primarily represent future income tax benefits associated with our operating losses because we do not currently believe that the positive evidence outweighs the negative evidence. In the near future, if we conclude that sufficient positive evidence (including our estimate of future taxable income) exists to support a reversal of all or a portion of the valuation allowance, we expect that a significant portion of any release of the valuation allowance will be recorded as an income tax benefit at the time of release, which will have a material impact on our financial statements. In addition, as and when we discontinue recording a valuation allowance against our deferred tax assets, we expect that our income tax expense recorded in future quarters will also be significantly higher than it has been since fiscal year 2009, when we recorded a valuation allowance for our U.S. deferred tax assets.
Liquidity and Capital Resources
Liquidity is the measurement of ourthe Company’s ability to meet potential cash requirements, fund the planned expansion of ourthe Company’s operations and acquire businesses. OurThe Company’s sources of cash include operating activities,operations, sales and maturity of marketable investments, stock option exercises, ESPP contributions, and the liquidation of marketable investments. Weemployee stock purchases. The Company actively manage ourmanages the cash usage and investment of liquid cash to ensure the maintenance of sufficient funds to meet ourthe Company’s daily needs. The majority of ourthe Company’s cash and investments are held in U.S. banks and ourthe Company’s foreign subsidiaries maintain a limited amount of cash in their local banks to cover their short-term operating expenses.
At June 30, 2018 and December 31, 2017, the Company had $41.2 million and $45.1 million of working capital, respectively, and the Company’s cash and cash equivalents and marketable investments totaled $29.0 million and $35.9 million as of June 30, 2018 and December 31, 2017 respectively. The Company’s combined cash and cash equivalents and marketable investments balance decreased by $6.9 million for the six months ended June 30, 2018 principally due to the settlement of accounts payable, accrued liabilities, increased inventory purchases related to the increasing demand of the Company’s products, and an increase in investments in sales, service and other management headcount to facilitate continued revenue expansion. The following table summarizes the Company’s cash and cash equivalents and marketable investments:
Cash, Cash Equivalents and Marketable Investments
The following table summarizes our cash, cash equivalents, marketable investments and marketablerestricted investments:
(Dollars in thousands) | September 30, | December 31, 2016 | Change | June 30, | December 31, 2017 | Change | ||||||||||||||||||
Cash and cash equivalents | $ | 14,784 | $ | 13,775 | $ | 1,009 | $ | 18,432 | $ | 14,184 | $ | 4,248 | ||||||||||||
Marketable investments | 35,692 | 40,299 | (4,607 | ) | 10,573 | 21,728 | (11,155) |
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Total | $ | 50,476 | $ | 54,074 | $ | (3,598 | ) | $ | 29,005 | $ | 35,912 | $ | (6,907) |
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Cash Flows
Nine Months Ended September 30, | Six Months Ended June 30, | |||||||||||||||
(Dollars in thousands) | 2017 | 2016 | 2018 | 2017 | ||||||||||||
Net cash flow provided by (used in): | ||||||||||||||||
Operating activities | $ | 7,605 | $ | (2,749 | ) | $ | (6,503) | $ | 3,890 | |||||||
Investing activities | 4,220 | 2,050 | 10,611 | 5,533 | ||||||||||||
Financing activities | (10,816 | ) | 1,106 | 140 | (4,519) | |||||||||||
Net increase (decrease) in cash and cash equivalents | $ | 1,009 |
| $ | 407 | |||||||||||
Net increase in cash and cash equivalents | $ | 4,248 | $ | 4,904 |
Cash Flows from Operating Activities
Net cash generated fromused in operating activities was $6.5 million in the ninesix months ended SeptemberJune 30, 20172018, which was $7.6 million, due primarily to:
● | $ |
● | $3.7 million generated from an increase in accounts payable due primarily to increased material purchases; |
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● | $2.2 million cash used to increase pre-paid expenses and other long term assets.; |
● | $1.8 million used as a result of increased accounts receivables; |
● | $1.4 million used to increase inventories; and |
● | $0.5 million generated from an increase in deferred revenue. |
Net cash provided by operating activities was $3.9 million in the six months ended June 30, 2017, which was due primarily to:
● | $4.0 million generated due to the net income of $925,000 increased by non-cash related items of $3.1 million consisting primarily of stock-based compensation expense of $2.6 million and depreciation and amortization expenses of $492,000; |
● | $1.7 million generated from an increase in accounts payable due primarily to increased material purchases; |
● | $1.5 million generated from an increase in accrued liabilities |
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● | $1.9 million used to increase inventories; |
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Net cash used in operating activities in the nine months ended September 30, 2016 was $2.7 million, which was due primarily to:
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Cash Flows from Investing Activities
We generated netNet cash of $4.2provided by investing activities was $10.6 million in our investing activities in the ninesix months ended SeptemberJune 30, 2017, which was attributable primarily to:
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We generated net cash of $2.1 million in our investing activities in the nine months ended September 30, 2016,2018, which was attributable primarily to:
● | $ |
● | $4.4 million of cash used to purchase marketable investments; and |
● | $0.6 million of cash used to purchase property, equipment and software. |
Net cash provided by investing activities was $5.5 million in the six months ended June 30, 2017, which was attributable primarily to:
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● | $25.9 million of cash used to purchase marketable investments; and |
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Cash Flows from Financing Activities
Net cash used inprovided by financing activities was $10.8 million$140,000 in the ninesix months ended SeptemberJune 30, 2017,2018, which was primarily due to:
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● | $ | |
● | $0.2 million of cash used to pay capital lease obligations. |
Net cash used in financing activities was $4.5 million in the six months ended June 30, 2017, which was primarily due to:
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● | $1.2 million of cash used for taxes paid related to net share settlement of equity awards; |
● | $0.2 million used to pay down our capital lease obligations; partially offset by |
● | $ |
Net cash provided by financing activities was $1.1 million in the nine months ended September 30, 2016, which was primarily due to:
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Adequacy of Cash Resources to Meet Future Needs
WeThe Company had cash, cash equivalents, and marketable investments of $50.5$29.0 million as of SeptemberJune 30, 2017.2018. For the ninefirst six months ended September 30, 2017, we financed our operationsof 2018, the Company’s principal source of liquidity is cash from maturity and stock repurchases through cash generated by our operating activities, sales and maturities of marketable investments and cash generated from the saleissuance of common stock due to employees exercising theirthrough exercise of stock options and the Company’s employee stock purchasing stock through the ESPP program.
As of September 30, 2017, we had $21.4 million remaining under our Board approved Stock Repurchase Program. We believe The Company believes that the existing capitalcash resources including cash, cash equivalents and investments of $50.5 million, are sufficient to meet our operatingthe Company’s anticipated cash needs for working capital and capital requirementsexpenditures for at least the next several years, and enable us to repurchase stock pursuant to our Stock Repurchase Program.
In July 2017, we agreed to terminate the building lease for a new facility in Fremont, California, entered into in May 2017. In conjunction with this lease termination, we received a lump sum termination payment of $4.0 million from the landlord. Except for the foregoing, cash used to fund our operating activities in certain historical quarters, 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.years.
Loan and Security Agreement
On May 30, 2018, the Company and Wells Fargo Bank, N.A. (“Wells Fargo”) entered into a Loan and Security Agreement (the “Revolving Line of Credit”) in the original principal amount of $25,000,000. The Revolving Line of Credit terminates on May 30, 2021. The purpose of the Revolving Line of Credit is to provide working capital and to fund the Company’s general business requirements. The Revolving Line of Credit bears interest at a variable interest rate equal to the LIBOR Rate plus a defined LIBOR Rate Margin based on the then-current Leverage Ratio (a ratio of funded debt to the Trailing Twelve Month ("TTM") Adjusted EBITDA).
The Revolving Line of Credit provides for borrowing limits that range from $5,000,000 to a maximum of $25,000,000 during the term of the Revolving Line of Credit. Additionally, the Company agrees to pay a variable unused commitment fee to Wells Fargo equal to (a) 0.25% per annum if the Leverage Ratio is less than 1.00 to 1.00, (b) 0.30% per annum if the Leverage Ratio is equal to or greater than 1.00 to 1.00, but less than 2.00 to 1.00, and (c) 0.35% per annum if the Leverage Ratio is equal to or greater than 2.00 to 1.00.
The Revolving Line of Credit is secured by a pledge of security interest in all the shares of each material subsidiary, together with all proceeds, all cash, stock and other moneys and property paid thereon, all rights to subscribe for securities declared or granted, and all other cash and noncash proceeds, as security for the performance of the Obligations. As of June 30, 2018, there were no borrowings under the Revolving Line of Credit.
Covenants
The Loan and Security Agreement contains financial and other covenants as well as the maintenance of a leverage ratio not to exceed 2.5:1.0 and a TTM adjusted EBITDA not less than $10 million. A violation of any of the covenants could result in a default under the Loan and Security Agreement that would permit the lenders to restrict the Company’s ability to further access the revolving line of credit for loans and letters of credit and require the immediate repayment of any outstanding loans under the Loan and Security Agreement. As of June 30, 2018, the Company is in compliance with all financial covenants.
Commitments and Contingencies
Contractual Obligations
The following are our contractual obligations, consisting of future minimum lease commitments related to facility leases as of SeptemberDuring the six months ended June 30, 2017:
Payments Due by Period ($’000’s) | ||||||||||||||||||||
Contractual Obligations | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | |||||||||||||||
Operating leases Operating leases Operating leases | 13,774 | 2,446 | $ | 5,420 | $ | 5,070 | $ | 838 |
In addition to the above facility leases, we also routinely lease automobiles for certain sales and field service employees under operating leases for which the remaining committed lease payments are not material.
Except as set forth above,2018, there have beenwere no material changes to ourthe Company’s commitments and contingencies from those discloseddescribed under Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2016the Annual Report on Form 10-K.10-K for the year ended December 31, 2017, filed with the SEC on March 26, 2018.
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There have been no material changes toITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A summary of the Company’skey market risk duringrisks facing the nine months ended September 30, 2017.Company is disclosed below. For a detailed discussion, please see the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on March 26, 2018.
Interest Rate Fluctuations
The Company holds cash equivalents as well as short-term and long-term fixed income securities. The Company’s investment portfolio includes fixed and floating rate securities. Changes in interest rates could impact the Company’s anticipated interest income. Fixed rate securities may have their fair market value adversely impacted due to fluctuations in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, the Company’s future investment income may fall short of expectation due to changes in interest rates or we may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rates. The primary objective of the Company’s investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest in 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 the Company’s exposure to market risk, referany 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.
As at June 30, 2018, the Company had not drawn on the Revolving Line of Credit. Overall interest rate sensitivity is primarily influenced by any amount borrowed on the line of credit and the prevailing interest rate on the line of credit facility. The effective interest rate on the line of credit facility is based on a floating per annum rate equal to the LIBOR rate. The LIBOR rate was 2.09% as of June 30, 2018, and accordingly the Company may incur additional expenses if the Company has an outstanding balance on the line of credit and the LIBOR rate increase in future periods.
Inflation
The Company does not believe that inflation has had a material effect on the Company’s business, financial condition, or results of operations. If the Company’s costs were to become subject to significant inflationary pressures, the Company may not be able to fully offset such higher costs through price increases. The Company’s inability or failure to do so could harm the Company’s 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 the Company’s 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 the Company’s results of operations upon translation of the Company’s revenue denominated in these currencies, as well as the remeasurement of the Company’s international subsidiaries’ financial statements into U.S. dollars.
The Company has historically not engaged in hedging activities relating to the Company’s market risk disclosures set forth in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk”foreign currency denominated transactions, given the Company has a natural hedge resulting from the Company’s foreign cash receipts being utilized to fund the respective local currency expenses.
ITEM 4.CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
An evaluation as of June 30, 2018 was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of the Company’s “disclosure controls and procedures.” Rule 13a-15(e) under 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 CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure. Based upon that evaluation, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures were effective at June 30, 2018.
Attached as exhibits to this Quarterly Report are certifications of our Chief Executive Officer (“CEO”)the Company’s CEO and consultant Chief Financial Officer (“CFO”),CFO, which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (“Exchange Act”).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 defined 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.
Definition of Disclosure ControlsChanges in Internal Control over Financial Reporting
Disclosure Controls are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Exchange Act, such as this Report, is recorded, processed, summarized and reported within the time periods specifiedThere were no changes 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 ofCompany’s internal control over financial reporting which consists of control processes designedthat occurred the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to provide reasonable assurance regardingmaterially affect, 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 ourCompany’s internal control over financial reporting are included within Disclosure Controls, they are included in the scope of our annual controls evaluation.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, the realitiesCompany’s disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that judgments in decision making can be faulty 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 overrideobjectives of the controls. The designCompany’s disclosure control system are met. As set forth above, the Company’s Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of any systemthe end of the period covered by this report, that the Company’s 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 because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Becauseobjectives of the inherent limitations in a cost-effectiveCompany’s 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.
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We are named from
From 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.
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The Company’s business faces many risks. Any of the risks referenced in this Form 10-Q or ourthe Company’s other SEC filings could have a material impact on ourthe Company’s business and consolidated financial position or results of operations. Additional risks and uncertainties not presently known to usthe Company or that wethe Company currently believebelieves to be immaterial may also impair ourthe Company’s business operations.
There have been no material changes in the 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 be understood by any investor contemplating investment in ourthe Company’s stock, please refer to “Part I.Part I, Item 1A. Risk Factors”1A, "Risk Factors" in our 2016the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on March 26, 2018 and elsewhere in this Form 10-Q.
Our ability to reverse all or any part of the valuation allowance against our U.S. deferred tax assets is uncertain.
We have recorded a full valuation allowance against our U.S. deferred tax assets due to the uncertainty of the ultimate realization of the future benefits of those assets. To the extent we determine that all, or a portion of, our valuation allowance is no longer necessary, we will reverse the valuation allowance and recognize an income tax benefit in the reported financial statement earnings in that period. Once the valuation allowance is eliminated or reduced, its reversal will no longer be available to offset our current financial statement tax provision in future periods. We believe that there is a possibility that, within the next 3-12 months, sufficient positive evidence may become available to allow us to reach a conclusion that a significant portion of the valuation allowance will no longer be needed. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded. However, the exact timing and amount of the valuation allowance release are subject to change on the basis of the level of profitability that we are able to actually achieve. Due to significant estimates used to determine the valuation allowance and the potential for changes in facts and circumstances, the Company cannot guarantee that it will be able to reverse all or any of the valuation allowance or that the Company will not need to increase its deferred tax asset valuation allowance in the future.
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The following table summarizes the activity related to stock repurchases for the three months ended September 30, 2017 (in thousands except per share data)ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS:
Period |
| Total Number |
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| Average Price Paid per Share |
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| Total Number of Publicly Announced |
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| Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Program |
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July 1-31, 2017 | — | — | — | 28,110 | ||||||||||||
August 1-31, 2017 | 109 | 34.71 | 109 | 24,340 | ||||||||||||
September 1-30, 2017 | 76 | 38.99 | 76 | 21,380 | ||||||||||||
July 1, 2017 - September 30, 2017 |
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| 185 |
| $ | 36.47 |
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| 185 |
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| $ | 21,380 |
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None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
None.
None.
As of December 31, 2016, we had $5.1 million available in our Stock Repurchase Program. On February 13, 2017 and July 28, 2017, our Board of Directors approved an incremental $5 million and $25 million, respectively, to be added to the Stock Repurchase Program.
In the three months ended September 30, 2017, we repurchased 184,536 shares for approximately $6.7 million, or $36.47 per share, and retired and returned them to an authorized but unissued status. As of September 30, 2017, $21.4 million remained available for future repurchases of our stock.
Exhibit No. |
| Description |
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3.1 |
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3.2 |
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4.1 |
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10.18 |
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31.1 |
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31.2 |
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32.1 |
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| XBRL Instance Document |
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| XBRL Taxonomy Extension Schema Document |
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| XBRL Taxonomy Extension Calculation Linkbase Document |
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| XBRL Taxonomy Extension Definition |
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| XBRL Taxonomy Extension Label Linkbase Document |
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| XBRL Taxonomy Extension Presentation Linkbase Document |
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Pursuant to the requirements of Section 13 or 15(d) of theThe 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 7th day of November, 2017.August, 2018.
| CUTERA, INC. | |
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| /S/SANDRAA.GARDINER | |
| Sandra A. Gardiner | |
ExecutiveVicePresidentandChiefFinancialOfficer (PrincipalFinancialandAccountingOfficer) |
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