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 |
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For the quarterly period ended June 30, 2018March 31, 2019
OR
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For the transition period from _____ to_____.
Commission file number:File Number: 000-50644
Cutera,Inc.
(Exact name of registrant as specified in its charter)
Delaware
| 77-0492262 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. |
3240BayshoreBlvd.,Brisbane,California94005
(Addressofprincipalexecutiveoffices)
(415)657-5500
(Registrant’stelephonenumber,includingareacode)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Common Stock ($0.001 par value) | CUTR | The NASDAQ Stock Market, LLC |
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)submit). Yes ☒No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”,filer,” “smaller reporting company”company,” and "emerging“emerging growth company"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 ☐ |
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 Registrant had 13,836,800number of shares of Registrant’s common stock $0.001 par value per share,issued and outstanding as of July 31, 2018.April 30, 2019, was 14,036,972.
FORM 10-Q
TABLEOFCONTENTS
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PART I | ||||
Item 1 | 3 | |||
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| Condensed Consolidated Statements of Comprehensive | 5 | ||
Condensed Consolidated Statements of | 6 | |||
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Item 2 | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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Item 3 |
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Item 4 |
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PART II | ||||
Item 1 | 32 | |||
Item 1A | 32 | |||
Item 2 | 33 | |||
Item 3 | 33 | |||
Item 4 | 33 | |||
Item 5 | 33 | |||
Item 6 | 33 | |||
33 |
In this Quarterly Report on Form 10-Q, “Cutera,” “the Company,” “we,” “us” and “our” refer to Cutera, Inc. and its consolidated subsidiaries.
This report may contain references to our proprietary intellectual property, including among others, trademarks for our systems and ancillary products, Accutip®, Coolglide®, Coolglide Excel®, enlighten®, Excel HR®, Excel V®, Excel V+®,Limelight®, MyQ®, Pearl®, Pico Genesis™, ProWave®, Solera®, Titan®, TruSculpt®, Vantage®, and Xeo®.
These trademarks and trade names are the property of Cutera or the property of our consolidated subsidiaries and are protected under applicable intellectual property laws. Solely for convenience, our trademarks and tradenames referred to in this Quarterly Report on Form 10-Q may appear without the ® or ™ symbols, but such references are not intended to indicate in any way that we will not assert, to the fullest extent under applicable law, our rights to these trademarks and tradenames.
FINANCIAL STATEMENTS (UNAUDITED) |
CONDENSED CONSOLIDATED BALANCE SHEETS
(inthousands,exceptshareandpersharedata)
(unaudited)
June 30, 2018 | December 31, 2017 | March 31, | December 31, 2018 | |||||||||||||
Assets | ||||||||||||||||
Current assets: | ||||||||||||||||
Cash and cash equivalents | $ | 18,432 | $ | 14,184 | $ | 19,158 | $ | 26,052 | ||||||||
Marketable investments | 10,573 | 21,728 | 7,939 | 9,523 | ||||||||||||
Accounts receivable, net | 22,122 | 20,777 | 19,136 | 19,637 | ||||||||||||
Inventories | 30,138 | 28,782 | 26,659 | 28,014 | ||||||||||||
Other current assets and prepaid expenses | 3,469 | 2,903 | 4,864 | 3,972 | ||||||||||||
Total current assets | 84,734 | 88,374 | 77,756 | 87,198 | ||||||||||||
Property and equipment, net | 2,632 | 2,096 | 2,407 | 2,672 | ||||||||||||
Deferred tax asset | 21,219 | 19,055 | 451 | 457 | ||||||||||||
Operating lease-right-of-use assets | 9,442 | — | ||||||||||||||
Goodwill | 1,339 | 1,339 | 1,339 | 1,339 | ||||||||||||
Other long-term assets | 5,807 | 374 | 5,960 | 5,971 | ||||||||||||
Total assets | $ | 115,731 | $ | 111,238 | $ | 97,355 | $ | 97,637 | ||||||||
Liabilities and Stockholders' Equity | ||||||||||||||||
Current liabilities: | ||||||||||||||||
Accounts payable | $ | 10,743 | $ | 7,002 | $ | 10,337 | $ | 11,279 | ||||||||
Accrued liabilities | 22,756 | 26,848 | 21,788 | 23,300 | ||||||||||||
Operating lease liabilities | 1,840 | — | ||||||||||||||
Extended warranty liability | 2,667 | 3,159 | ||||||||||||||
Deferred revenue | 9,288 | 9,461 | 10,263 | 9,882 | ||||||||||||
Total current liabilities | 42,787 | 43,311 | 46,895 | 47,620 | ||||||||||||
Deferred revenue, net of current portion | 2,519 | 2,195 | 2,828 | 2,684 | ||||||||||||
Income tax liability | 386 | 379 | 399 | 394 | ||||||||||||
Operating lease liabilities, net of current portion | 7,759 | — | ||||||||||||||
Other long-term liabilities | 665 | 460 | 354 | 553 | ||||||||||||
Total liabilities | 46,357 | 46,345 | 58,235 | 51,251 | ||||||||||||
Commitments and Contingencies (Note 14) | ||||||||||||||||
Commitments and Contingencies (Notes 12 and 13) | ||||||||||||||||
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 | ||||||||||||||
Common stock, $0.001 par value; authorized: 50,000,000 shares; issued and outstanding: 14,035,375 and 13,968,852 shares at March 31, 2019 and December 31, 2018, respectively | 14 | 14 | ||||||||||||||
Additional paid-in capital | 66,291 | 62,025 | 71,399 | 70,451 | ||||||||||||
Accumulated deficit | 3,156 | 2,947 | (32,230) | (24,010 | ) | |||||||||||
Accumulated other comprehensive loss | (87) | (92) |
| (63) | (69 | ) | ||||||||||
Total stockholders’ equity | 69,374 | 64,893 | 39,120 | 46,386 | ||||||||||||
Total liabilities and stockholders’ equity | $ | 115,731 | $ | 111,238 | $ | 97,355 | $ | 97,637 |
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 | Six Months Ended | Three Months Ended | ||||||||||||||||||||||
June 30, | June 30, | March 31, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2019 | 2018 | |||||||||||||||||||
Net revenue: | ||||||||||||||||||||||||
Products | $ | 37,650 | $ | 31,727 | $ | 66,914 | $ | 56,202 | $ | 30,762 | $ | 29,264 | ||||||||||||
Service | 4,903 | 4,662 | 9,764 | 9,486 | 5,264 | 4,861 | ||||||||||||||||||
Total net revenue | 42,553 | 36,389 | 76,678 | 65,688 | 36,026 | 34,125 | ||||||||||||||||||
Cost of revenue: | ||||||||||||||||||||||||
Products | 17,045 | 13,840 | 30,967 | 24,984 | 15,541 | 13,922 | ||||||||||||||||||
Service | 3,131 | 1,503 | 6,000 | 4,137 | 3,176 | 2,869 | ||||||||||||||||||
Total cost of revenue | 20,176 | 15,343 | 36,967 | 29,121 | 18,717 | 16,791 | ||||||||||||||||||
Gross profit | 22,377 | 21,046 | 39,711 | 36,567 | 17,309 | 17,334 | ||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||
Sales and marketing | 15,535 | 12,787 | 28,623 | 23,560 | 16,104 | 13,088 | ||||||||||||||||||
Research and development | 4,095 | 2,981 | 7,651 | 5,926 | 3,706 | 3,556 | ||||||||||||||||||
General and administrative | 4,902 | 3,548 | 10,341 | 6,764 | 5,525 | 5,439 | ||||||||||||||||||
Total operating expenses | 24,532 | 19,316 | 46,615 | 36,250 | 25,335 | 22,083 | ||||||||||||||||||
Income (loss) from operations | (2,155) | 1,730 | (6,904) | 317 | ||||||||||||||||||||
Loss from operations | (8,026) | (4,749) | ||||||||||||||||||||||
Interest and other income (expense), net | (129) | 276 | (31) | 549 | (79) | 98 | ||||||||||||||||||
Income (loss) before income taxes | (2,284) | 2,006 | (6,935) | 866 | ||||||||||||||||||||
Provision (benefit) for income taxes | (712) | 59 | (3,331) | (59) | ||||||||||||||||||||
Net income (loss) | $ | (1,572) | $ | 1,947 | $ | (3,604) | $ | 925 | ||||||||||||||||
Loss before income taxes | (8,105) | (4,651) | ||||||||||||||||||||||
Income tax expense (benefit) | 115 | (2,619) | ||||||||||||||||||||||
Net loss | $ | (8,220) | $ | (2,032) | ||||||||||||||||||||
Net income (loss) per share: | ||||||||||||||||||||||||
Basic | $ | (0.11) | $ | 0.14 | $ | (0.26) | $ | 0.07 | ||||||||||||||||
Diluted | $ | (0.11) | $ | 0.13 | $ | (0.26) | $ | 0.06 | ||||||||||||||||
Net loss per share: | ||||||||||||||||||||||||
Basic and Diluted | $ | (0.59) | $ | (0.15) |
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Weighted-average number of shares used in per share calculations: | ||||||||||||||||||||||||
Basic | 13,709 | 13,935 | 13,649 | 13,888 | ||||||||||||||||||||
Diluted | 13,709 | 14,629 | 13,649 | 14,633 | ||||||||||||||||||||
Basic and Diluted | 14,017 | 13,587 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)LOSS
(inthousands)
(unaudited)(Unaudited)
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
Net income (loss) | $ | (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 | 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 | 18 | 5 | 5 | 4 | ||||||||||||
Comprehensive income (loss) | $ | (1,554 | ) | $ | 1,952 | $ | (3,599) | $ | 929 |
Three Months Ended | ||||||||
March 31, | ||||||||
2019 | 2018 | |||||||
Net loss | $ | (8,220) | $ | (2,032) |
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Other comprehensive loss: | ||||||||
Available-for-sale investments | ||||||||
Net change in unrealized gain (loss) on available-for-sale investments | 6 | (21) | ||||||
Less: Reclassification adjustment for losses on investments recognized during the period | — | 9 | ||||||
Net change in unrealized gain (loss) on available-for-sale investments | 6 | (12) |
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Tax benefit | — | — | ||||||
Other comprehensive gain (loss), net of tax | 6 | (12) |
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Comprehensive loss | $ | (8,214) | $ | (2,044) |
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The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWSCHANGES IN STOCKHOLDERS’ EQUITY
(in thousands, except shthousands)are amounts)
(unaudited)
Three Months and Year Ended March 31, 2019 and 2018
Six Months Ended June 30, | ||||||||
2018 | 2017 | |||||||
Cash flows from operating activities: | ||||||||
Net income (loss) | $ | (3,604) | $ | 925 | ||||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||
Stock-based compensation | 3,893 | 2,626 | ||||||
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 | (25) | (42) | ||||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | (1,832) | (1,641) |
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Inventories | (1,356) | (1,936) |
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Other current assets and prepaid expenses | (569) | (545) | ||||||
Other long-term assets | (1,578) | (1) | ||||||
Accounts payable | 3,741 | 1,695 | ||||||
Accrued liabilities | (4,325) | 1,534 | ||||||
Other long-term liabilities | 70 | — | ||||||
Deferred revenue | 546 | 784 | ||||||
Income tax liability | 7 | 2 | ||||||
Net cash provided by (used in) operating activities | (6,503) | 3,890 | ||||||
Cash flows from investing activities: | ||||||||
Acquisition of property, equipment and software | (581) |
| (210) | |||||
Disposal of property and equipment | 38 | 40 | ||||||
Proceeds from sales of marketable investments | 13,044 | 6,754 | ||||||
Proceeds from maturities of marketable investments | 2,500 | 24,812 | ||||||
Purchase of marketable investments | (4,390) | (25,863) | ||||||
Net cash provided by investing activities | 10,611 | 5,533 | ||||||
Cash flows from financing activities: | ||||||||
Repurchase of common stock | — | (7,041) |
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Proceeds from exercise of stock options and employee stock purchase plan | 3,038 | 3,871 | ||||||
Taxes paid related to net share settlement of equity awards | (2,664) | (1,167) |
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Payments on capital lease obligations | (234) | (182) |
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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 | 4,248 | 4,904 | ||||||
Cash and cash equivalents at beginning of period | 14,184 | 13,775 | ||||||
Cash and cash equivalents at end of period | $ | 18,432 | $ | 18,679 | ||||
Supplemental disclosure of non-cash items: | ||||||||
Assets acquired under capital lease | $ | 533 | $ | 257 |
Common Stock | Additional Paid-in | Retained Earnings (Accumulated | Accumulated Other Comprehensive | Total Stockholders’ | ||||||||||||||||||||
Shares | Amount | Capital | Deficit) | Income (loss) | Equity | |||||||||||||||||||
Balance at December 31, 2018 | 13,968,852 | $ | 14 | $ | 70,451 | $ | (24,010 | ) | $ | (69 | ) | $ | 46,386 | |||||||||||
Exercise of stock options | 15,032 | — | 131 | — | — | 131 | ||||||||||||||||||
Issuance of common stock in settlement of restricted and performance stock units, net of shares withheld for employee taxes, and stock awards | 51,491 | — | (490 | ) | — | — | (490 | ) | ||||||||||||||||
Stock-based compensation expense | — | — | 1,307 | — | — | 1,307 | ||||||||||||||||||
Net loss | — | — | — | (8,220 | ) | — | (8,220 | ) | ||||||||||||||||
Net change in unrealized gain on available-for-sale investments | — | — | — | — | 6 | 6 | ||||||||||||||||||
Balance at March 31, 2019 | 14,035,375 | $ | 14 | $ | 71,399 | $ | (32,230 | ) | $ | (63 | ) | $ | 39,120 |
Common Stock | Additional Paid-in | Retained Earnings (Accumulated | Accumulated Other Comprehensive | Total Stockholders’ | ||||||||||||||||||||
Shares | Amount | Capital | Deficit) | Income (loss) | Equity | |||||||||||||||||||
Balance at December 31, 2017 | 13,477,973 | $ | 13 | $ | 62,025 | $ | 2,947 | $ | (92 | ) | $ | 64,893 | ||||||||||||
Adjustment to opening balance for ASC 606 adoption | — | — | — | 4,973 | — | 4,973 | ||||||||||||||||||
Exercise of stock options | 66,167 | — | 633 | — | — | 633 | ||||||||||||||||||
Issuance of common stock in settlement of restricted and performance stock units, net of shares withheld for employee taxes, and stock awards | 90,014 | 1 | (2,289 | ) | — | — | (2,288 | ) | ||||||||||||||||
Stock-based compensation expense | — | — | 1,688 | — | — | 1,688 | ||||||||||||||||||
Net loss | — | — | — | (2,032 | ) | — | (2,032 | ) | ||||||||||||||||
Net change in unrealized loss on available-for-sale investments | — | — | — | — | (12 | ) | (12 | ) | ||||||||||||||||
Balance at March 31, 2018 | 13,634,154 | $ | 14 | $ | 62,057 | $ | 5,888 | $ | (104 | ) | $ | 67,855 |
The accompanying notes are an integral part of these unaudited Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended March 31, | ||||||||
2019 | 2018 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (8,220) | $ | (2,032) | ||||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Stock-based compensation | 1,307 | 1,688 | ||||||
Depreciation of tangible assets | 411 | 254 | ||||||
Amortization of contract acquisition costs | 690 | 373 | ||||||
Change in deferred tax asset | 6 | (2,737) | ||||||
Provision for doubtful accounts receivable | 98 | 187 | ||||||
Other | 103 | (162) | ||||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | 403 | 915 | ||||||
Inventories | 1,355 | (2,197) |
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Other current assets and prepaid expenses | (916) | 1,753 | ||||||
Other long-term assets | (679) | (2,150) | ||||||
Accounts payable | (942) | 1,204 | ||||||
Accrued liabilities | (1,467) | (6,727) | ||||||
Extended warranty liabilities | (492) | — | ||||||
Other long-term liabilities | (140) | 35 | ||||||
Deferred revenue | 525 | (456) | ||||||
Income tax liabilities | 5 | 5 | ||||||
Net cash used in operating activities | (7,953) | (10,047) | ||||||
Cash flows from investing activities: | ||||||||
Acquisition of property, equipment and software | (65) | (104 | ) | |||||
Proceeds from sales of marketable investments | — | 13,044 | ||||||
Proceeds from maturities of marketable investments | 3,200 | — | ||||||
Purchase of marketable investments | (1,586) | (4,390 | ) | |||||
Net cash provided by investing activities | 1,549 | 8,550 | ||||||
Cash flows from financing activities: | ||||||||
Proceeds from exercise of stock options and employee stock purchase plan | 131 | 633 | ||||||
Taxes paid related to net share settlement of equity awards | (490) | (2,288) |
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Payments on finance lease obligations | (131) | (122) |
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Net cash used in financing activities | (490) | (1,777) |
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Net decrease in cash and cash equivalents | (6,894) | (3,274) |
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Cash and cash equivalents at beginning of period | 26,052 | 14,184 | ||||||
Cash and cash equivalents at end of period | $ | 19,158 | $ | 10,910 | ||||
Supplemental disclosure of non-cash items: | ||||||||
Assets acquired under capital lease | $ | 192 | $ | 284 |
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, distributes and markets laserlight and other energy-based product platforms for use by physicians and other qualified practitioners, which enableenabling them to offer safe and effective aesthetic treatments to their customers. The Company currently markets the following key system platforms: excel, V, excel HR, enlighten, Juliet, Secret RF, truSculpt and xeo. The Company’s systems offer multiple hand pieces and applications, which allowallowing customers to upgrade their systems. The sales of (i) systems, system upgrades and hand pieces (“Systems” revenue); (ii) hand piece refills applicable to Titan, truSculpt 3D and truSculpt iD, as well as single use disposable tips applicable to Juliet and Secret RF (“Consumables” revenue); and (iii) the distribution of third party manufactured skincare products ("(“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 3Dand truSculpt iD) and service labor for the repair and maintenance of products that are out of warranty, all of which isare 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. The Company’s wholly owned subsidiary in Italy is currently dormant. These active subsidiaries market, sell and service the Company’s products outside of the United States. The Condensed Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All inter-company transactions and balances have been eliminated.
Unaudited Interim Financial Information
In the opinion of the Company, the accompanying unaudited condensed consolidated financial statements included in this report reflect all adjustments (consisting of only normal recurring adjustments) necessary for a fair statement of its financial position as of June 30,March 31, 2019 and 2018, its results of operations, for the three and six months periods ended June 30, 2018, and 2017, comprehensive income (loss) for the three and six months periods ended June 30, 2018 and 2017,loss, consolidated statements of changes in equity, and cash flows for the sixthree months ended June 30, 2018,March 31, 2019, and 2017.2018. The December 31, 20172018 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 accompanying condensed consolidated financial statements should be read in conjunction with the Company’s previously filed audited financial statements and the related notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 20172018 filed with the Securities and Exchange Commission (the “SEC”) on March 26, 2018.18, 2019.
Accounting Policies
These unaudited condensed consolidated financial statements are prepared in accordance with the rules and regulations of the SEC applicable to interim financial statements. While these statements reflect all normal recurring adjustments that are, in the opinion of management, necessary for fair presentation of the results of the interim period, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the financial statement disclosures in our annual report on Form 10-K for the year ended December 31, 2018 filed with the SEC on March 18, 2019.
The Company uses the same accounting policies in preparing quarterly and annual financial statements. Notes 2 and 13 provide information about the Company’s adoption of new accounting standards for leases. Unless otherwise noted, amounts presented within the Notes to Condensed Consolidated Financial Statements refer to the Company’s continuing operations.
Use of Estimates
The preparation of interim Condensed Consolidated Financial Statements in conformity with GAAP requires the Company’s management to make estimates and assumptions that affect the amounts reported of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financialCondensed Consolidated Financial Statements and the accompanying notes, and the reported amounts of revenue and expenses during the reported periods. Actual results could differ materially from those estimates.
On an ongoing basis, the Companymanagement evaluates theirits estimates, including those related to warranty obligation,obligations, sales commission, accounts receivable and sales allowances, valuation of inventories, fair valuesvalue of goodwill, useful lives of property and equipment, incremental borrowing rates related to the Company’s leases, assumptions regarding variables used in calculating the fair value of the Company's equity awards, expected achievement of performance based vesting criteria, management performance bonuses, fair value of investments, the standalone selling price of the Company's products and services, the customer life and period of benefit used to capitalize and amortize contracts acquisition costs, variable consideration, contingent liabilities, recoverability of deferred tax assets, and effective income tax rates, among others.rates. Management bases their estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.
Risks and Uncertainties
The Company's future results of operations involve a number of risks and uncertainties. Factors that could affect the Company's future operating results and cause actual results to vary materially from expectations include, but are not limited to, rapid technological change, continued acceptance of the Company's products, stability of world financial markets, 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 and maintain regulatory approval,approvals, government regulations and oversight, patent and other litigations,types of litigation, 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.
ComparabilityRecently Adopted Accounting Pronouncements
The Company adopted the new revenue standard effective January 1, 2018, using the modified retrospective method. Prior period financial statements were not retrospectively restated. The consolidated balance sheet as of December 31, 2017 and results of operations for the three and six months ended June 30, 2017 were prepared using an accounting standard that was different than that in effect 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.
Adopted Accounting Pronouncements
In May 2014,February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” amending revenue recognition guidance2016-02, "Leases," (also known as ASC Topic 842) which requires, among other items, a lessee to recognize most leases as assets and requiring more detailedliabilities on the balance sheet. Qualitative and quantitative disclosures were enhanced to enable users of financial statements tobetter understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The amended guidance, herein referredleases. In July 2018, the FASB issued ASU 2018-11, "Targeted Improvements," which gives the option to asapply the transition provisions of ASU 2016-02 at its adoption date instead of at the earliest comparative period presented in its financial statements. In addition, ASU 2018-11 provides a practical expedient that permits lessors to not separate non-lease components from the associated lease component if certain conditions are met. Also in July 2018, the FASB issued ASU 2018-10, "Codification Improvements to ASC 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. 842, Leases," which clarifies certain aspects of ASU 2016-02.
The Company adopted the new revenue standard in the first quarterASU 2016-02, as of fiscal year 2018January 1, 2019, using the modified retrospective method.method, to all leases existing at the date of initial application. The Company recognized the cumulative effect of applying the new revenue standard as an adjustment to retained earnings. The comparative period information has not been restated and continues to be reported under the accounting standards in effect for the period presented. The new standard provides a number of optional practical expedients in transition. The Company elected the package of practical expedients permitted under the transition guidance within the new standard, which allowed the Company to carry forward the Company’s historical conclusions about lease identification, lease classification and initial direct costs. The Company also elected the practical expedient related to land easements, allowing the Company to carry forward the Company’s accounting treatment for land easements on existing agreements. The Company did not elect the practical expedient to use hindsight in determining the lease term.
The adoption of the new standard resulted in the recording of additional lease assets and lease liabilities of $10.3 million and $10.4 million, respectively, as of January 1, 2019, based on the present value of the remaining minimum rental payments under current leasing standards for existing operating leases. The difference between the additional lease assets and lease liabilities results from rent-free periods which were previously recorded as deferred rent. The Company’s accounting for finance leases remained substantially unchanged. The standard had no material impact on the Company’s condensed consolidated net earnings, results of operations, comprehensive loss, statements of changes in equity, and cash flows.
See NoteNotes 2 – Revenue Recognition,and 12 Leases for additional accounting policy and transition disclosures.disclosures regarding ASC Topic 842.
Other Accounting Pronouncements Not Yet Adopted
In June 2018, the FASB issued ASU No. 2018-07, "Compensation –Stock"Compensation-Stock Compensation (Topic 718): Improvement to Nonemployee Share-Based Payment Accounting". The new guidance changes the accounting for nonemployee awards including: (1) Equity-classifiedequity-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) Forfor 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) Thethe 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 Topic 606. The amendments in the new guidance are effective for annual 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 ASC Topic 606. The Company will adoptadopted the new standard effective January 1, 2019. The Company is still currently evaluating theThere was no material impact upon adoption of adopting the new standard.standard to the financial statements.
Other Accounting Pronouncements
Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract
In February 2016,August 2018, the FASB issued ASU No. 2016-02, "Leases"2018-15, Intangibles (Topic 842),350): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which amendsaligns the existing accounting standardsrequirements for leases. The new standard requires lesseescapitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to record a right-of-use asset and a corresponding lease liability on the balance sheet (with the exception of short-term leases). The newdevelop or obtain internal-use software. This standard also requires expanded disclosures regarding leasing arrangements.customers to amortize the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. The new standard becomes effective for the Company in the first quarter of fiscal yearafter December 15, 2019 and early adoption is permitted. The newCompany is planning to early adopt this standard on a prospective basis for applicable implementation costs, and is requiredcurrently assessing the impact of the adoption of this guidance to be adopted using the modified retrospective approach and requires applicationits financial statements.
Note 2. Effect of Adoption of the new lease standard at the beginning of the earliest comparative period presented. The Company finances its fleet of vehicles used by its field sales and service employees and has facility leases. Several of the Company’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. The 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.
Note 2. Revenue recognition(ASC Topic 842) on Condensed consolidated financial statements
The Company adopted ASC Topic 606, "Revenue from Contracts with Customers,"842, Lease, on January 1, 2018,2019, applying the modified retrospective method to all contract agreements that wereleases existing at the date of initial application. The comparative information has not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are notbeen adjusted and continuecontinues to be reported under the accounting standards in effect for the prior period. A cumulative catch up adjustment was recorded to beginning retained earnings to reflect the impact of all existing arrangements under Topic 606.
Upon adoption of the Topic 606, the Company recorded an increase to retained earnings, net of deferred tax liability of $3.8 million (Note 12) for contracts still in force as of January 1, 2018 for the following items in the first and second quarters of 2018:
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The Company’s revenue consists of product and service revenue resulting from the sale of systems, training on the systems, extended service contracts, consumables and other accessories. The Company accounts for a contract with a customer when there is a legally enforceable contract between the Company and the customer, the rights of the parties are identified, the contract has commercial substance, and collectability of the contract consideration is probable. Revenues are recognized when control of the promised goods or services are transferred to the 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 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. 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 606842 on the Company’s condensed consolidated balance sheetsheets as of June 30, 2018:January 1, 2019 (in thousands):
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) |
As reported under Topic 842 | Adjustments | Balances under Prior GAAP | ||||||||||
Operating lease right-of-use assets | $ | 10,049 | $ | 10,049 | $ | — | ||||||
Operating lease liabilities | (2,430) | (2,430) | — | |||||||||
Other long-term liabilities* | — | 140 | 140 | |||||||||
Operating lease liabilities, net of current portion | (7,759) | (7,759) | — |
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:
*Deferred rent included in other long-term liabilities
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
Note 3. Note 3. Cash, Cash EquivalentEquivalents 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 debt securities. 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 stated 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 itsthe Company's 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 and re-evaluates such designation at each balance sheet date. The Company’s marketable securities have been classified and accounted for as 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. Any realized gains or losses on the sale of marketable securities are determined on a specific identification method, and such gains and losses are reflected as 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’s cash, cash equivalents and marketable investments (in thousands) as of June 30, 2018 and December 31, 2017::
June 30, 2018 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Market Value | ||||||||||||
Cash and cash equivalents: | ||||||||||||||||
Cash | $ | 15,545 | $ | — | $ | — | $ | 15,545 | ||||||||
Money market funds | 2,887 | — | — | 2,887 | ||||||||||||
Total cash and cash equivalents | 18,432 | — | — | 18,432 | ||||||||||||
Marketable investments: | ||||||||||||||||
U.S. government notes | 6,012 | — | (8 | ) | 6,004 | |||||||||||
Municipal securities | 200 | — | (1 | ) | 199 | |||||||||||
Corporate debt securities | 4,388 | — | (18 | ) | 4,370 | |||||||||||
Total marketable investments | 10,600 | — | (27 | ) | 10,573 | |||||||||||
Total cash, cash equivalents and marketable investments | $ | 29,032 | $ | — | $ | (27 | ) | $ | 29,005 |
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 | ||||||||||||||||||||||||||||
March 31, 2019 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Market Value | ||||||||||||||||||||||||||||
Cash and cash equivalents | $ | 19,158 | $ | — | $ | — | $ | 19,158 | ||||||||||||||||||||||||
Marketable investments: | ||||||||||||||||||||||||||||||||
U.S. government notes | 11,885 | — | (15 | ) | 11,870 | 1,405 | — | — | 1,405 | |||||||||||||||||||||||
U.S. government agencies | 2,694 | — | — | 2,694 | ||||||||||||||||||||||||||||
Municipal securities | 201 | — — | (1 | ) | 200 | 202 | — | — | 202 | |||||||||||||||||||||||
Commercial paper | 1,836 | — | (3 | ) | 1,833 | 2,437 | — | — | 2,437 | |||||||||||||||||||||||
Corporate debt securities | 7,838 | 2 | (15 | ) | 7,825 | 1,204 | — | (3 | ) | 1,201 | ||||||||||||||||||||||
Total marketable investments | 21,760 | 2 | (34 | ) | 21,728 | 7,942 | — | (3 | ) | 7,939 | ||||||||||||||||||||||
Total cash, cash equivalents and marketable investments | $ | 35,944 | $ | 2 | $ | (34 | ) | $ | 35,912 | $ | 27,100 | $ | — | $ | (3 | ) | $ | 27,097 |
December 31, 2018 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Market Value | ||||||||||||
Cash and cash equivalents | $ | 26,052 | $ | — | $ | — | $ | 26,052 | ||||||||
Marketable investments: | ||||||||||||||||
U.S. government notes | 1,397 | — | — | 1,397 | ||||||||||||
U.S. government agencies | 2,677 | — | — | 2,677 | ||||||||||||
Municipal securities | 200 | — | — | 200 | ||||||||||||
Commercial paper | 2,433 | — | — | 2,433 | ||||||||||||
Corporate debt securities | 2,825 | — | (9 | ) | 2,816 | |||||||||||
Total marketable investments | 9,532 | — | (9 | ) | 9,523 | |||||||||||
Total cash, cash equivalents and marketable investments | $ | 35,584 | $ | — | $ | (9 | ) | $ | 35,575 |
As of June 30, 2018March 31, 2019 and December 31, 2017,2018, the net unrealized losses were $27,000$3,000 and $34,000,$9,000, respectively, and were related to interest rate changes on available-for-sale marketable investments. The Company has concluded that it is more-likely-than-not that the securities will be held until maturity or the recovery of their cost basis. No securities were in an unrealized loss position for more than 12 months.
The following table summarizes the contractual maturities of the Company’s available-for-sale securities, classified as marketable investments as of June 30, 2018March 31, 2019 (in thousands):
Amount | Amount | |||||||
Due in less than one year | $ | 9,573 | $ | 7,939 | ||||
Due in 1 to 3 years | 1,000 | — | ||||||
Total marketable investments | $ | 10,573 | $ | 7,939 |
Note 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 theThe Company’s financial instruments includinginclude cash equivalents, marketable investments, accounts receivable, accounts payable and accrued liabilities,liabilities. Carrying amounts of the Company's financial instruments approximate their fair values as of the balance sheet dates because ofgiven their generally short maturities. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below in accordance towith 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.
In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value.
As of June 30, 2018,March 31, 2019, 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 | ||||||||||||||||||||||||||||
March 31, 2019 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||||||||||
Cash equivalents: | ||||||||||||||||||||||||||||||||
Money market funds | $ | 2,887 | $ | — | $ | — | $ | 2,887 | $ | 3,061 | $ | — | $ | — | $ | 3,061 | ||||||||||||||||
Commercial paper | — | 2,693 | — | 2,693 | ||||||||||||||||||||||||||||
Marketable investments: | ||||||||||||||||||||||||||||||||
Available-for-sale securities | — | 10,573 | — | 10,573 | — | 7,939 | — | 7,939 | ||||||||||||||||||||||||
Total assets at fair value | $ | 2,887 | $ | 10,573 | $ | — | $ | 13,460 | $ | 3,061 | $ | 10,632 | $ | — | $ | 13,693 |
As of December 31, 2017,2018, financial assets measured and recognized at fair value on a recurring basis and classified under the appropriate level of the fair value hierarchy as described above werewas as follows (in thousands):
December 31, 2017 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
Cash equivalents: | ||||||||||||||||
Money market funds | $ | 126 | $ | — | $ | — | $ | 126 | ||||||||
Marketable investments: | ||||||||||||||||
Available-for-sale securities | — | 21,728 | — | 21,728 | ||||||||||||
Total assets at fair value | $ | 126 | $ | 21,728 | $ | — | $ | 21,854 |
December 31, 2018 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
Cash equivalents: | ||||||||||||||||
Money market funds | $ | 3,036 | $ | — | $ | — | $ | 3,036 | ||||||||
Commercial paper | — | 1,047 | — | 1,047 | ||||||||||||
Marketable investments: | ||||||||||||||||
Available-for-sale securities | — | 9,523 | — | 9,523 | ||||||||||||
Total assets at fair value | $ | 3,036 | $ | 10,570 | $ | — | $ | 13,606 |
The Company’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 average remaining maturity of the Company’s Level 2 investments as of June 30, 2018March 31, 2019 is less than 7 months and all of these investments are rated by S&P and Moody’s at 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, 2018March 31, 2019 and December 31, 2017,2018, respectively.
Note5. BalanceSheetDetails
Inventories
As of June 30, 2018March 31, 2019 and December 31, 2017,2018, inventories consist of the following (in thousands):
June 30, 2018 | December 31, 2017 | March 31, 2019 | December 31, 2018 | |||||||||||||
Raw materials | $ | 17,875 | $ | 19,160 | $ | 16,864 | $ | 16,991 | ||||||||
Work in progress | 2,846 | 2,744 | ||||||||||||||
Work in process | 1,325 | 2,306 | ||||||||||||||
Finished goods | 9,417 | 6,878 | 8,470 | 8,717 | ||||||||||||
Total | $ | 30,138 | $ | 28,782 | $ | 26,659 | $ | 28,014 |
Accrued Liabilities
Liabilities
As of June 30, 2018March 31, 2019 and December 31, 2017,2018, accrued liabilities consist of the following (in thousands):
June 30, 2018 | December 31, 2017 | March 31, 2019 | December 31, 2018 | |||||||||||||
Accrued payroll and related expenses | $ | 10,712 | $ | 12,567 | $ | 8,892 | $ | 9,377 | ||||||||
Sales and marketing accruals | 2,283 | 3,710 | 2,089 | 2,379 | ||||||||||||
Warranty liability | 3,561 | 3,508 | 4,064 | 4,666 | ||||||||||||
Sales tax | 2,388 | 2,920 | 2,970 | 2,935 | ||||||||||||
Other | 3,812 | 4,143 | 3,773 | 3,943 | ||||||||||||
Total | $ | 22,756 | $ | 26,848 | $ | 21,788 | $ | 23,300 |
Product Remediation Liability
During the fourth quarter of 2018, the Company recognized a liability for a product remediation plan related to one of its legacy systems. This was related to a voluntary action initiated by the Company to replace a component in one of the Company’s legacy products. The remediation plan consists primarily of replacement of a component in the system. The accrued liability consisted of cost of materials and labor to replace the component in all units that are under the Company's standard warranty or are covered under the existing extended warranty contracts. The Company recorded approximately $5.0 million related to this remediation, of which $1.1 million was utilized in the fourth quarter of 2018. Approximately $0.7 million of the remaining unutilized balance was related to product warranty and included in accrued liabilities and $3.2 million was separately recorded as Extended warranty liability.
In the three months ended March 31, 2019, the Company utilized $0.1 million related to product warranty and $0.5 million related to extended warranty liability. As of March 31, 2019, product warranty and extended warranty liability were $0.6 million and $2.7 million, respectively.
Note 6. Warranty and Extended Service ContractsContract
The Company has a direct field service organization in the U.S.North America (including Canada). Internationally, the Company provides direct service support through its wholly-owned subsidiaries in Australia, Belgium, Canada, France, Germany, Hong Kong, Japan, Spain and Switzerland, as well as through third-party service providers in Spain and the United Kingdom. In several other countries, where the 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 aan extended service contract basis or on a time and materials basis. The Company provides for the estimated cost to repair or replace products under standard warranty at the time of sale. Costs incurred in connection with extended service contracts are recognized at the time when costs are incurred, except the one-time extended service contracts charge of $3.2 million in December 31, 2018, related to the cost to replace a component in one of the Company's legacy products.
The following table provides the changes in the product standard warranty accrual for the three and six months ended June 30,March 31, 2019 and 2018 and 2017 (in thousands):
Three Months Ended | Six Months Ended | Three Months Ended | ||||||||||||||||||||||
June 30, | June 30, | March 31, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2019 | 2018 | |||||||||||||||||||
Beginning Balance | $ | 3,373 | $ | 2,735 | $ | 3,508 | $ | 2,461 | $ | 4,668 | $ | 3,508 | ||||||||||||
Add: Accruals for warranties issued during the period | 2,311 | 1,944 | 4,575 | 4,079 | 1,444 | 2,264 | ||||||||||||||||||
Less: Settlements made during the period | (2,123) | (1,802) |
| (4,522) | (3,663) |
| (2,048) | (2,399) |
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Ending Balance | $ | 3,561 | $ | 2,877 | $ | 3,561 | $ | 2,877 | $ | 4,064 | $ | 3,373 |
The $2.0 million settlements as of March 31, 2019 exclude cost related to extended service contract cost of $0.5 million to replace a component in one of the Company's legacy products (See Note 5).
Note 7. Deferred Revenue
The Company records deferred revenue when revenue is to be recognized subsequent to invoicing. For extended service contracts, the Company generally invoices customers at the beginning of the extended service contract term. The Company’s extended service contracts typically have one, two or three year terms. Deferred revenue also includes payments for installation, training and extended marketing support service. Approximately 78% of the Company’s deferred revenue balance of $13.1 million as of March 31, 2019 will be recognized over the next 12 months.
The following table provides changes in the deferred service contract revenue balance for the three months ended March 31, 2019 and 2018 (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2019 | 2018 | |||||||
Beginning Balance | $ | 11,855 | $ | 10,719 | ||||
Add: Payments received | 4,142 | 2,995 | ||||||
Less: Revenue recognized | (3,522) | (3,347) | ||||||
Ending Balance | $ | 12,475 | $ | 10,367 |
Costs for extended service contracts were $2.0 million and $1.9 million, for the three months ended March 31, 2019 and 2018, respectively.
Note 7.8. 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%15% and 14% of the Company’s total revenue for the sixthree months ended June 30, 2018.March 31, 2019 and 2018, respectively.
The Company'sCompany has certain system sale arrangements generallythat 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. The Company’s products and services 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 itthe product or service on its own or with other resources that are readily available to the customer.customer, and if the Company’s promise to transfer the products or service to the customer is separately identifiable from other promises in the contract. 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, (whichwhich are satisfied over time),time, the Company generally satisfies all of the performance obligations at a point in time. System,Systems, system accessories (hand pieces), training, time and materialmaterials 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.basis.
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 usthe Company with a source of additional Systems revenue.
The Company has concludedconcludes 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 ordoes not identify calibration and installation anservices for systems other than enlighten as performance obligations because such services are immaterial promise as set-up orin the context of the contract. The related costs to complete calibration and installation for systems other than enlightenare immaterial. Calibration and installation services for 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 aidentified as separate performance obligation.obligations.
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 salesend-customers that have not been credit approved, after satisfying all remainingwhen the performance obligations ofin the agreement.contract are satisfied. 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 are purchased from the third-party manufacturers and sells themsold 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' purchasepurchases 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 Julietand Secret RFproducts have single use disposable tips which need tomust be replaced after every treatment. SaleSales of these consumable tips further enhance the Company’s recurring revenue stream.revenue. Hand piece refills of the Company’s legacy truSculptproduct 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 billingyears. Service contract revenue is recognized over time, using a time based measure of progress, as the customers benefit from the service throughout the service period. The Company also offers services on a time-and-materials basis for systems and detachable hand piece replacements, parts and labor. Revenue related to services performed on a time-and-materials basis is recognized when performed. 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
Training
Sales of systemsystems to customers include training on the use of the system to be provided within 90180 days of purchase. The Company considers training as a separate performance obligation as customers can immediately benefit from the training due totogether with the fact that the customer already has thecustomer’s 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.across all system platforms. 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.contracts.
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.
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 combinecombines two or more contracts entered into at or near the same time with the same customer (or related parties of the customer) and accountaccounts for the contracts as a single contract. IfThe contracts are negotiated as a group of agreements are so closely related that they are, in effect, part ofpackage with a single arrangement, such agreements are deemed to be one arrangement for revenue recognition purposes.commercial objective. The Company exercises significant judgment to evaluatedetermine whether each separate contract in 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 ofcombined contracts comprise a single arrangement can affect the allocation of consideration to thecontains 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, theThe Company has not experienced significant returns or refunds to customers. These estimates requireEstimating consideration expected to be received from contracts with customers requires significant judgment and the change in these estimates could have an effect on its results of operations during the periods involved.
The Company determines standalone selling price ("SSP") 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/Service contracts: SSP is based on observable price when sold on a standalone basis (by customer type). |
● | Customer Marketing Support: SSP is estimated based on cost plus a margin. |
● | Set-up /Installation: Set-up or installation for all other systems, excluding the enlighten system, is immaterial in the context of the contract. The related costs to complete set-up or installation are immaterial. |
The calibration and installation service of the enlighten system are treated as separate performance obligations because the Company regularly sells enlighten systems without the calibration and installation service.
Loyalty Program
The Company launched a customer loyalty program during the third quarter of 2018 for qualified customers located in the U.S. and Canada. Under the programs, customers accumulate points based on their purchasing levels. Once a loyalty program member achieves a certain tier level, the member earns a reward. A customer’s account has to be in good standing in order to receive the benefits of the rewards program. Rewards are given on a quarterly basis and must be used in the following quarter. Customers receive a notification regarding their rewards tier by the fifth (5th) day of the following quarter. All unused rewards are forfeited. The fair value of the reward earned by loyalty program members is included in accrued liabilities and recorded as a reduction of net revenue at the time the reward is earned.
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.period. 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.years.
Total net capitalized costs as of June 30, 2018March 31, 2019 were $5.3$5.1 million and are included in other long-term assets in the Company’s condensed consolidated balance sheet. Amortization of this assetthese assets was $0.4$0.7 million and $0.8 million, respectively, during the three and six months ended June 30, 2018March 31, 2019 and is included in sales and marketing expense in the Company’s condensed consolidated statementsstatement 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 contract revenue balance for the three and six months ended June 30, 2018 and 2017 (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
Beginning Balance | $ | 11,015 | $ | 9,555 | $ | 11,656 | $ | 9,431 | ||||||||
Add: Payments received | 4,739 | 3,721 | 8,416 | 7,112 | ||||||||||||
Less: Revenue recognized | (3,947) | (3,263) |
| (8,265) | (6,530) |
| ||||||||||
Ending Balance | $ | 11,807 | $ | 10,013 | $ | 11,807 | $ | 10,013 |
Costs for extended service contracts for the three and six months ended June 30, 2018, were $2.0 million and 3.9 million, respectively.
Note 9. Stockholders’ EquityEquity and Stock-based Compensation Expense
As of March 31, 2019, the Company had the following stock-based employee compensation plans:
2004 Equity Incentive Plan and 1998 Stock Plan
In 1998, the Company adopted the 1998 Stock Plan, or 1998 Plan, under which 4,650,000 shares of the Company’s common stock were reserved for issuance to employees, directors and consultants. On January 12, 2004, the Board of Directors adopted the 2004 Equity Incentive Plan, or 2004 Plan. A total of 1,750,000 shares of common stock were originally reserved for issuance pursuant to the 2004 Equity Incentive Plan. In addition, the shares reserved for issuance under the 2004 Equity Incentive Plan included shares reserved but un-issued under the 1998 Plan and shares returned to the 1998 Plan as the result of termination of options or the repurchase of shares. In 2012, the stockholders approved a “fungible share” provision whereby each full-value award issued under the 2004 Equity Incentive Plan results in a requirement to subtract 2.12 shares from the shares reserved under the 2004 Plan.
ActivityOptions granted under the Company’s Amended1998 Plan and Restated 2004 EquityPlan may be incentive stock options or non-statutory stock options. Stock purchase rights may also be granted under the 2004 Plan. Incentive stock options may only be granted to employees. The Board of Directors determines the period over which options become exercisable. Options granted under the 2004 Plan as amended, is summarized as follows:to employees generally vest over a four-year term from the vesting commencement date and become exercisable 25% on the first anniversary of the vesting commencement date and an additional 1/48th monthly anniversary date until all of the shares have become exercisable.
Options Outstanding | ||||||||||||
Shares Available for Grant | Number of Stock Options Outstanding | Weighted- Average Exercise Price | ||||||||||
Balance, December 31, 2017 | 1,494,865 | 839,919 | $ | 16.46 | ||||||||
Options granted | (21,010) | 21,010 | 50.65 | |||||||||
Stock awards granted(1) | (395,511) | — | — | |||||||||
Options exercised | — | (188,859) | 9.98 | |||||||||
Options canceled | 43,833 | (43,833) | 20.33 | |||||||||
Stock awards canceled(1) | 93,390 | — | — | |||||||||
Balance, June 30, 2018 | 1,215,567 | 628,237 | $ | 19.28 |
The Company issued 19,892 Restricted Stock Units (“RSUs”) to its non-employee directors during the quarter ended March 31, 2019. The Company’s Board of Directors granted its executive officers, senior management and certain employees 307,355 Performance Stock Units (“PSUs”) during the quarter ended March 31, 2019. The PSUs granted in quarter ended March 31, 2019 vest subject to the recipients continued service and to the achievement of certain operational goals for the Company’s 2019 fiscal year which consist of the achievement of revenue targets for consumable products, implementation of the new enterprise resource planning (“ERP”) system for North America and the achievement of specific product milestones.
The Company’s Board of Directors also granted its executive officers, senior management and certain employees 245,782 RSUs during the quarter ended March 31, 2019. The annual RSUs granted vest over four years at 25% on each anniversary of the grant date. |
|
Under the 2004 Equity Incentive Plan, as amended, the Company issued 346,27966,523 shares of common stock during the sixthree months ended June 30, 2018,March 31, 2019, in conjunction with stock options exercised and the vesting of RSUs and PSUs.
As of June 30, 2018,March 31, 2019, there was approximately $19.8$14.9 million of unrecognized compensation expense, net of projected forfeitures, for stock options and stock awards. The expense is expected to be recognized over the remaining weighted-average period of 2.51.9 years. The actual expense recorded in the future may be higher or lower based on a number of factors, including, actual forfeitures experienced and the degree of achievement of the performance goals related to the PSUs granted.
Activity under the 1998 and 2004 Plans are summarized as follows:
Options Outstanding | ||||||||||||
Shares Available for Grant | Number of Stock Options Outstanding | Weighted- Average Exercise Price | ||||||||||
Balance, December 31, 2018 | 1,141,305 | 507,705 | $ | 20.52 | ||||||||
Stock awards granted* | (1,259,808) | — | — | |||||||||
Options exercised | — | (16,644) | 7.87 | |||||||||
Options canceled | 22,198 | (22,198) | 21.19 | |||||||||
Stock awards canceled* | 265,261 | — | — | |||||||||
Balance, March 31, 2019 | 168,956 | 468,863 | $ | 20.94 |
*The Company has a “fungible share” provision in its 2004 Plan whereby for each full-value award (RSU/PSU) issued or canceled under the Plan requires the subtraction or add back of 2.12 shares from or to the Shares Available for Grant, respectively. In the Company’s 2019 Proxy Statement, filed on April 30, 2019, the Company is seeking stockholder approval to remove the “fungible share” provision for awards granted on or after June 14, 2019.
Non-Employee Stock-Based Compensation
The Company granted 3,3849,303 RSUs and 3,38411,920 PSUs to non-employees during the six monthsquarter ended June 30, 2018,March 31, 2019, and 7,745 stock options and 2,4783,384 RSUs during the year ended December 31, 2017.2018. The stock optionsPSUs granted to non-employee vest over 4 years at 25% on the first anniversary of the grant date and 1/48th each month thereafter.a year subject to same performance criteria as employees. The RSUsPSUs granted in quarter ended March 31, 2019 vest over 4 years at 25% on each anniversary of the grant date, whiles vesting of the PSUs is subject to the recipient'srecipients continued service and to the achievement of pre-established metrics. These RSUs/PSUscertain operational goals for the Company’s 2019 fiscal year which consist of the achievement of revenue targets for international system revenue, implementation of the new ERP system for North America and stock options were granted in exchange for consulting services to be rendered and are measured and recognized as they are earned. The Company revalues stock options granted to non-employees at each reporting date as the underlying equity instruments vest.achievement of specific product milestones.
Stock-based Compensation Expense
Stock-based compensation expense by department recognized during the three and six months ended June 30,March 31, 2019 and 2018 and 2017 were as follows (in thousands):
Three Months Ended | Six Months Ended | Three Months Ended | ||||||||||||||||||||||
June 30, | June 30, | March 31, | ||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2019 | 2018 | |||||||||||||||||||
Cost of revenue | $ | 227 | $ | 147 | $ | 380 | $ | 276 | $ | 269 | $ | 154 | ||||||||||||
Sales and marketing | 718 | 489 | ||||||||||||||||||||||
Employee | 660 | 401 | 1,112 | 821 | ||||||||||||||||||||
Non-Employee | 55 | — | 92 | — | ||||||||||||||||||||
Research and development | 262 | 239 | 453 | 476 | 263 | 191 | ||||||||||||||||||
General and administrative | 1,002 | 444 | 1,856 | 1,053 | 57 | 854 | ||||||||||||||||||
Total stock-based compensation expense | $ | 2,206 | $ | 1,231 | $ | 3,893 | $ | 2,626 | ||||||||||||||||
Total stock-based compensation expense* | $ | 1,307 | $ | 1,688 |
*Included in the stock-based compensation expense is the charge in connection with the accelerated vesting of 4,667 shares of the Company’s former CEO, in accordance with his separation agreement dated January 4, 2019.
Note 10.10. Net Loss Per Share
Basic net income (loss) per share is computed using the weighted-average number of shares outstanding during the period. In periods of net income, diluted shares outstanding include the dilutive effect of in-the-money equity awards (stock options, restricted stock units, performance stock units and employee stock purchase plan contributions), which is calculated based on the average share price for each fiscal period using the treasury stock method. In accordance with ASC 260, the assumed proceeds under the treasury stock method include the average unrecognized compensation expense of in-the money stock options and restricted stock units. This results in the assumed buyback of additional shares, thereby reducing the dilutive impact of equity awards.
Diluted earnings per share is the same as basic earnings per share for the periods in which the Company had a net loss because the inclusion of outstanding common stock equivalents would be anti-dilutive.
The following table sets forth the computation of basic and diluted net income (loss) and the weighted average number of shares used in computing basic and diluted net income (loss) per share (in thousands, except per share data):
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
Net income (loss) | $ | (1,572) | $ | 1,947 | $ | (3,604) | $ | 925 | ||||||||
Denominator | ||||||||||||||||
Weighted average shares of common stock outstanding used in computing net | ||||||||||||||||
income (loss) per share, basic | 13,709 | 13,935 | 13,649 | 13,888 | ||||||||||||
Dilutive effect of incremental shares and share equivalents | — | 694 | — | 745 | ||||||||||||
Weighted average shares of common stock outstanding used in computing net income (loss) per share, diluted | 13,709 | 14,629 | 13,649 | 14,633 | ||||||||||||
Net income (loss) per share: | ||||||||||||||||
Net income (loss) per share, basic | $ | (0.11) | $ | 0.14 | $ | (0.26) | $ | 0.07 | ||||||||
Net income (loss) per share, diluted | $ | (0.11) | $ | 0.13 | $ | (0.26) | $ | 0.06 |
Three Months Ended March 31, 2019 | Three Months Ended March 31, 2018 | |||||||
Numerator: | ||||||||
Net loss | $ | (8,220) | $ | (2,032) | ||||
Denominator: | ||||||||
Weighted average shares of common stock outstanding used in computing net income (loss) per share, basic | 14,017 | 13,587 | ||||||
Dilutive effect of incremental shares and share equivalents | — | — | ||||||
Weighted average shares of common stock outstanding used in computing net income (loss) per share, diluted | 14,017 | 13,587 | ||||||
Net income (loss) per share: | ||||||||
Net income (loss) per share, basic and diluted | $ | (0.59) | $ | (0.15) |
The following numbers of 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 | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
Options to purchase common stock | 710 | 66 | 758 | 53 | ||||||||||||
Restricted stock units | 449 | 3 | 422 | 2 | ||||||||||||
Performance stock units | 49 | — | 36 | — | ||||||||||||
Employee stock purchase plan shares | 73 | — | 73 | — | ||||||||||||
Total | 1,281 | 69 | 1,289 | 55 |
Three Months Ended | ||||||||
March 31, | ||||||||
2019 | 2018 | |||||||
Options to purchase common stock | 485 | 807 | ||||||
Restricted stock units | 366 | 396 | ||||||
Performance stock units | 21 | 23 | ||||||
Employee stock purchase plan shares | 66 | 34 | ||||||
Total | 938 | 1,260 |
Note 11.Note 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 interim reporting period. When applicable, the year-to-date tax provision reflects adjustments from discrete tax items.
The Company's income tax benefitsexpense for the three and six months ended June 30, 2018 reflect a projectedMarch 31, 2019 relates primarily to income tax benefit for U.S. andtaxes of the Company's non-U.S. operations resulting in anbased on the annual effective tax rate appliedmethod. The Company's U.S. operations continue to be in a loss position and the year-to-date ordinary loss. ThisCompany maintains a 100% valuation allowance against its U.S. deferred tax benefit is increased by excess tax benefits generated by stock deductions exercised or vested in the three and six months ended June 30, 2018.assets.
For the three and six months ended June 30, 2018,March 31, 2019, the Company's income tax benefitexpense was $712,000 and $3,331,000 respectively,$115,000 compared to incomea tax expensebenefit of $59,000 and$2.6 million for the same period in 2018. The income tax benefit of $59,000 for the same periods in 2017. The income tax benefits for the three and six months ended June 30,March 31, 2018 includeincludes a tax benefit for excess tax deductions of approximately $1.14$1.5 million, and $2.6 million, respectively, recorded discretely in the reporting period.
The Company utilizes the asset and liability method of accounting for income taxes, under which deferred taxes are determined based 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 March 31, 2019, and December 31, 2017,2018, the Company released itshad a 100% valuation allowance against its U.S. federal and all other domestic state net deferred tax assets except for California and Massachusetts. The Company maintained thisassets. There was no valuation allowance position through June 30, 2018. during the three months ended March 31, 2018 other than the California jurisdiction.
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.evidence giving greater weight to its recent cumulative losses and lesser weight to its projected financial results due to the subjectivity involved in forecasting future periods. The Company also considered, commensurate with its objective verifiability, the forecast of future taxable income including the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies and the impact of the Tax Cuts and Jobs Act of 2017 (the “2017 Tax Act”).strategies.
Note 12. Correction of Prior Period Immaterial ErrorLeases
DuringThe Company has operating and finance leases for vehicles, office space and storages. The Company’s material operating leases consist of office space, as well as storage facilities. The Company’s leases generally have remaining terms of 1 to 10 years, some of which include options to renew the three months ended June 30, 2018, management discovered thatleases for up to 5 years. The Company leases space for operations in the United States, Japan and France. In addition to the above facility leases, the Company hadalso routinely leases automobiles for certain sales and field service employees under operating leases.
The Company determines if a contract contains a lease at inception. Operating lease assets and liabilities are recognized at the lease commencement date. Operating lease liabilities represent the present value of lease payments not recordedyet paid. Operating lease assets represent the tax effectright to use an underlying asset and are based upon the operating lease liabilities adjusted for prepayments or accrued lease payments, initial direct costs, lease incentives, and impairment of operating lease assets. To determine the present value of lease payments not yet paid, the Company estimates the incremental secured borrowing rates corresponding to the maturities of the adoptionleases. The Company based the rate estimates on prevailing financial market conditions, credit analysis, and management judgment.
The Company recognizes expense for these leases on a straight-line basis over the lease term. Additionally, tenant incentives used to fund leasehold improvements are recognized when earned and reduce our right-of-use asset related to the lease. These are amortized through the right-of-use asset as reductions of ASC 606 inexpense over the lease term.
Supplemental balance sheet of the unaudited condensed consolidated financial statementsinformation related to leases was as follows:
Leases (in thousands) | Classification | March 31, 2019 | |||
Assets | |||||
Right-of-use assets | Operating lease assets | $ | 9,442 | ||
Finance lease | Property and equipment, net* | 842 | |||
Total leased assets | $ | 10,284 |
*Finance leases assets included in Property and equipment, net. |
Liabilities | |||||
Operating lease liabilities | |||||
Operating lease liabilities, current | Operating lease liabilities | 1,840 | |||
Operating lease liabilities , non-current | Operating lease liabilities, net of current portion | 7,759 | |||
Total Operating lease liabilities | $ | 9,599 | |||
Finance lease liabilities | |||||
Finance lease liabilities, current | Accrued liabilities* | 614 | |||
Finance lease liabilities, non-current | Operating lease liabilities | 354 | |||
Total Finance lease liabilities | $ | 968 |
* Finance lease liabilities included in Accrued liabilities
Lease cost 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 force2019 were as of January 1, 2018. The tax effect of the 606 adoption was $1.2 million.follows:
The Company evaluated the impact of the error on prior periodFinance lease cost: Total amortization expense and determined that the effect was not material to the financial statements as of andinterest for finance lease during the three months ended March 31, 20182019 were $183 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 liability by $1.2 million and decreased retained earnings by $1.2 million (Note 2) as of January 1, 2018.$19, respectively.
The Company’s condensed consolidated statements of operations, comprehensive income (loss) and cash flows forOperating lease cost: Total operating lease expense during the three months ended March 31, 2018, and2019 was $724.
Cash paid for amounts included in the three and six months ended June 30, 2018 were not affected by this correctionmeasurement of the error. Accordingly, the Company's loss per share forlease liabilities during the three months ended March 31, 2019 were as follows:
Operating cash flow from finance leases for the three months was $19.
Financing cash flow from finance leases for the three months was $131.
Operating cash flow from operating leases for the three months was $705.
Maturities of lease liabilities
Maturities of lease liabilities were as follows as of March 31, 2019 (in thousands):
Year Ending March 31, | Amount | |||
Remainder of 2019 | $ | 2,113 | ||
2020 | 2,852 | |||
2021 | 2,591 | |||
2022 | 2,559 | |||
2023 and thereafter | 282 | |||
Total lease payments | 10,397 | |||
Less: imputed interest | 798 | |||
Present value of lease liabilities | $ | 9,599 |
Vehicle Leases
As of March 31, 2019, the Company was committed to minimum lease payments for vehicles leased under long-term non-cancelable capital leases as follows (in thousands):
Year Ending March 31, | Amount | |||
Remainder of 2019 | $ | 573 | ||
2020 | 296 | |||
2021 | 161 | |||
2021 | 7 | |||
Total lease payments | 1,037 | |||
Less: imputed interest | 69 | |||
Present value of lease liabilities | $ | 968 |
As previously disclosed in our 2018 Annual Report on Form 10-K and under the previous lease accounting, maturities of lease liabilities were as follows as of December 31, 2018:
Facility Leases
As of December 31, 2018, the Company was committed to minimum lease payments for facilities and other leased assets under long-term non-cancelable operating leases as follows (in thousands):
Year Ending December 31, | Amount | |||
2019 | $ | 3,011 | ||
2020 | 2,939 | |||
2021 | 2,564 | |||
2022 | 2,495 | |||
2023 and thereafter | 214 | |||
Future minimum rental payments | $ | 11,223 |
Vehicle Leases - US
As of December 31, 2018, the Company was committed to minimum lease payments for vehicles leased under long-term non-cancelable capital leases as follows (in thousands):
Year Ending December 31, | Amount | |||
2019 | $ | 576 | ||
2020 | 287 | |||
2021 | 152 | |||
Future minimum lease payments | $ | 1,015 |
Weighted-average remaining lease term and discount rate, as of March 31, 2019, were as follows:
Lease Term and Discount Rate | March 31, 2019 | |||
Weighted-average remaining lease term (years) | ||||
Operating leases | 3.7 | |||
Finance leases | 3.0 | |||
Weighted-average discount rate | ||||
Operating leases | 4.4 | % | ||
Finance leases | 5.6 | % |
Note 13. Contingencies
The Company is named from time to time as a party to other legal proceedings, product liability, commercial disputes, employee disputes, and contractual lawsuits in the normal course of business. A liability and related charge are recorded to earnings in the Company’s consolidated financial statements for legal contingencies when the loss is considered probable and the threeamount can be reasonably estimated. The assessment is re-evaluated each accounting period and six months ended June 30,is based on all available information, including discussion with outside legal counsel. If a reasonable estimate of a known or probable loss cannot be made, but a range of probable losses can be estimated, the low-end of the range of losses is recognized if no amount within the range is a better estimate than any other. If a material loss is reasonably possible, but not probable and can be reasonably estimated, the estimated loss or range of loss is disclosed in the notes to the consolidated financial statements. The Company expenses legal fees as incurred.
As of March 31, 2019 and December 31, 2018, remains unchanged.the Company had accrued Nil and $171,000 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 reasonably possible.
Note 14. Debt
On May 30, 2018, the Company and Wells Fargo Bank, N.A. (“Wells Fargo”) entered into a Loan and Security Agreement (the “Original Revolving Line of Credit”) in the original principal amount of $25 million. The Original Revolving Line of Credit terminates on May 30, 2021.
On or about November 2, 2018, the Company entered into a First Amendment and Waiver to the Loan and Security Agreement with Wells Fargo (the “First Amended Revolving Line of Credit”). The First Amended Revolving Line of Credit provided for an original principal amount of $15 million, with the ability to request an additional $10 million, and a waiver of any existing defaults under the Original Revolving Line of Credit as long as the Company is in compliance with the terms of the First Amended Revolving Line of Credit.
On or about, March 11, 2019, the Company entered into a Second Amendment and Waiver to the Loan and Security Agreement with Wells Fargo (the “Second Amended Revolving Line of Credit”). The Second Amended Revolving Line of Credit requires the Company to maintain a minimum cash balance of $15 million at Wells Fargo, but removes all other covenants so long as no money is drawn on the line of credit. The Company may draw down on the line of credit at the time it reaches and maintains trailing twelve months ("TTM") adjusted EBITDA of not less than $10 million, and a leverage ratio not to exceed 2.5 to 1.0.
As of March 31, 2019, the Company had not drawn on the Revolving Line of Credit and the Company is in compliance with all financial covenants of the Original Revolving Line of Credit, as amended by the First Amended Revolving Line of Credit and the Second Amended Revolving Line of Credit.
Note 13.15. Segment reporting
Segment reporting is based on the “management approach,” following the method that management organizes the company’s reportable segments for which separate financial information is made available to, and evaluated regularly by, the chief operating decision maker in allocating resources and in assessing performance. The Company’s chief operating decision maker ("CODM") is its Chief Executive Officer ("CEO"), who makes decisiondecisions 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 Company’s principal operations and decision-making functions are located in the U.S. The Company’s CEO viewedviews its operations, managedmanages its business, and useduses one measurement of profitability for the one operating segment —- which sells aesthetic medical equipment and services, and distributes skincare products, to qualified medical practitioners. Substantially all of the Company’s long-lived assets are located in the U.S.
The following table presents a summary of revenue by geography for the three months ended June 30,March 31 2019 and 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 six months ended June 30, 2018 and 2017 (in thousands):
Six Months Ended June 30, | Three Months Ended March 31, | |||||||||||||||
2018 | 2017 | 2019 | 2018 | |||||||||||||
Revenue mix by geography: | ||||||||||||||||
United States | $ | 49,268 | $ | 40,783 | $ | 20,400 | $ | 21,136 | ||||||||
Japan | 7,501 | 7,590 | 5,294 | 3,555 | ||||||||||||
Asia, excluding Japan | 7,074 | 6,014 | 3,095 | 2,843 | ||||||||||||
Europe | 4,373 | 3,445 | 2,736 | 2,570 | ||||||||||||
Rest of the World | 8,462 | 7,856 | ||||||||||||||
Rest of the world | 4,501 | 4,021 | ||||||||||||||
Total consolidated revenue | $ | 76,678 | $ | 65,688 | $ | 36,026 | $ | 34,125 | ||||||||
Revenue mix by product category: | ||||||||||||||||
Products | $ | 62,530 | $ | 53,107 | $ | 27,209 | $ | 27,239 | ||||||||
Consumables | 1,826 | 1,148 | 1,945 | 769 | ||||||||||||
Skincare | 2,558 | 1,947 | 1,608 | 1,256 | ||||||||||||
Total product revenue | $ | 66,914 | $ | 56,202 | $ | 30,762 | $ | 29,264 | ||||||||
Service | 9,764 | 9,486 | 5,264 | 4,861 | ||||||||||||
Total consolidated revenue | $ | 76,678 | $ | 65,688 | $ | 36,026 | $ | 34,125 |
Note 14. Commitments and Contingencies
Operating 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 were as follows (in thousands):
Year Ending December 31 | Amount | |||
2018 | $ | 1,494 | ||
2019 | 2,971 | |||
2020 | 2,913 | |||
2021 | 2,525 | |||
2022 | 2,495 | |||
2023 and beyond | 214 | |||
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 capital leases. The remaining committed lease payments 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 in the normal course of business. A liability and related charge are recorded to earnings in the Company’s consolidated financial statements for legal contingencies when the loss is considered probable and the amount can be reasonably estimated. The assessment is re-evaluated each accounting period and is based on all available information, including discussion with outside legal counsel. If a reasonable estimate of a known or probable loss cannot be made, but a range of probable losses can be estimated, the low-end of the range of losses is recognized if no amount within the range is a better estimate than any other. If a material loss is reasonably possible, but not probable and can be reasonably estimated, the estimated loss or range of loss is disclosed in the notes to the consolidated financial statements. The Company expenses legal fees as incurred.
As of 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 reasonably possible.
Note 15. Debt
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 1.0 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.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YouThis Management’s Discussion and Analysis should be read in conjunction with the following management’s discussion and analysis of the CompanyCompany’s ’s financial condition and results of operations in conjunction withwith the Company’s unaudited condensed consolidatedconsolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with the Company’s audited financial statements and notes thereto for the year ended December 31, 2017,2018, included in theits annual report on Form 10-K filed on March 26, 201818, 2019 with the U.S. Securities and Exchange Commission (SEC).
Unless otherwise indicated, all results presented are prepared in a manner that complies, in all material respects, with accounting principles generally accepted in the United States of America (“GAAP”). Additionally, unless otherwise indicated, all changes identified for the current-period results represent comparisons to results for the prior corresponding fiscal period.
Special note regarding forward-looking statements
This report contains forward-looking statements that involve risks and uncertainties. The Company’s actual results could differ materially from those discussed in the forward-looking statements. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended, ("the Exchange Act"). Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “seek,” “should,” “strategy,” “target,” “will,” “would” and similar expressions or variations intended to identify forward- looking statements. These statements are based on the beliefs and assumptions of the Company’s management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the section titled “Risk Factors” included under Part II, Item 1A below.
Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertakethe Company undertakes 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:
● | changes in |
|
|
● | the ability of the Company’s sales force to effectively market and promote the Company’s products, and the extent to which those products gain market acceptance; |
● | the existence and timing of any product approvals or changes; | |
● | the inability to meet the Company's debt repayment obligations under the Loan and Security Agreement with Wells Fargo Bank, N.A. due to insufficient cash; | |
● | the possibility that cybersecurity breaches, data breaches, and other disruptions could compromise our information or result in the unauthorized disclosure of confidential information; |
● | the existence and timing of any product approvals or changes; |
● | the rate and size of expenditures incurred on |
● |
|
● | the availability of key components, materials and contract services, which depends on |
● | investigations of |
● | variations in timing and quantity of product orders; |
● | temporary manufacturing interruptions or disruptions; |
● | the timing and success of new product and new market introductions, as well as delays in obtaining domestic or foreign regulatory approvals for such introductions; |
● | increased competition, patent expirations or new technologies or treatments; |
● | impact of the FDA communication letter regarding “vaginal rejuvenation” procedures using energy-based devices on sales of the Company's products; | |
● | product recalls or safety alerts; |
● | litigation, including product liability, patent, employment, securities class action, stockholder derivative, general commercial and other lawsuits; |
● |
|
● | changes in tax laws, including |
● | the impact of the new |
● | the financial health of |
● | other unusual or non-operating expenses, such as expenses related to mergers or acquisitions, may cause operating result variations. |
Introduction
The Management’s Discussion and Analysis, or MD&A, is organized as follows:
● | Executive Summary |
● | CriticalAccountingPoliciesandEstimates.This section describes the key accounting policies that are affected by critical accounting estimates. |
● | Results of Operations |
● | Liquidity and Capital Resources |
Executive Summary
Company Description
We areThe Company is a leading medical device company specializing in the research, development, manufacture, marketing and servicing of laserlight and other energy based aesthetics systems for practitioners worldwide. In addition to internal development of products, we distributethe Company distributes third party sourced products under the Company’sour own brand names. We offerThe Company offers easy-to-use products which enable physicians and other qualified practitioners to perform safe and effective aesthetic procedures, including treatment for body contouring, skin resurfacing and rejuvenation,revitalization, tattoo removal, removal of benign pigmented lesions, vascular conditions, hair removal, toenail fungus and vaginalwomen's intimate health. The Company’s platforms are designed to be easily upgraded to add additional applications and hand pieces, which provide flexibility for the Company’sour customers as they expand their practices. In addition to systems and upgrade revenue, we generatethe Company generates revenue from the sale of post warranty service contracts, providing services for products that are out of warranty, hand piece refills and other per procedure related revenue on select systems, and distribution of third-party manufactured skincare products.
The Company’s ongoing research and development activities are primarily focusedfocus on developing new products, as well as improving and enhancing the Company’s portfolio of existing products. The Company is exploringalso explores ways to expand the Company’s product offerings through the launch of new products.alternative arrangements with other companies, such as distribution arrangements. The Company introduced Juliet, a product for women’s intimate health, in December 2017, SecretRF, a fractional RF microneedling device for skin rejuvenation,revitalization, in January 2018, enlightenenlighten SRin April 2018, and truSculpt iDin July 2018.2018 and excel V+ in February 2019.
The Company’s corporate headquarters and U.S. operations are located in Brisbane, California, from where the Company conducts manufacturing, warehousing, research and development, regulatory, sales and marketing, service, and administrative activities. The Company markets, sells and services the Company’s products through direct sales and service employees in the U.S.North America (including Canada), Australia, Austria, Belgium, Canada, France, Germany, Hong Kong, Japan, Spain, Switzerland and the United Kingdom. Sales and ServiceServices outside of these direct markets are made through a worldwide distributor network in over 40 countries.
Products and Services
The Company’sCompany derives revenue is derived from the sale of Products and Services. Product revenue is derivedincludes revenue from the sale of systems, hand pieces and upgrade of systems (“Systems”(collectively “Systems” revenue), sale of replacement hand pieces,truSculpt iD cycle refills, as well as single use disposable tips applicable to Juliet and Secret RF(“ (“Consumables” revenue), and the sale of skincare products (“Skincare” revenue). A system consists of a console that incorporates a universal graphic user interface, a laser and/orand (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 Fractionalapplications 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’s primary system platforms include: excel, enlighten, Juliet, Secret RF, truSculpt and xeo.
Skincare revenue relates to the distribution of ZO’s skincare products in Japan.
The Company’s primary system platforms include: excel V, excel HR, enlighten, Juliet, Secret RF, truSculpt and xeo.
Service revenue relates to amortization ofincludes prepaid service contracts, training services, enlighten installation, direct billings for detachable hand piece replacements and revenue for parts, customer marketing support and labor on out-of-warranty products.
Significant Business Trends
The Company believes that theits ability to grow revenue will be primarily dependent on the following:
● | continuing to expand |
● | ongoing investment in |
● | use of clinical results to support new aesthetic products and applications; |
● | enhanced luminary development and reference selling efforts (to develop a location where |
● | customer demand for |
● |
|
● | consumer demand for the application of |
● | marketing to physicians in the core dermatology and plastic surgeon specialties, as well as outside those specialties; and |
● | generating recurring revenue from |
For a detailed discussion of the significant business trends impacting the Company’sour business, please see the section titled “Results of Operations” below.
Factors that May Impact Future Performance
The Company’s industry is impacted by numerous competitive, regulatory and other significant factors. The Company’s industry is highly competitive and the Company’s future performance depends on the Company’s ability to compete successfully. Additionally, the Company’s future performance is dependent upon the ability to continue to expand the Company’s product offerings with innovative technologies, obtain regulatory clearances for the Company’s products, protect the proprietary technology of the products and manufacturing processes, manufacture the products cost-effectively, and successfully market and distribute the products in a profitable manner. If the Company fails to execute on the aforementioned initiatives, the Company’s business would be adversely affected.
On July 30, 2018, the FDA issued a public statement and sent letters to a number of companies in the medical aesthetics industry expressing concerns regarding “vaginal rejuvenation” procedures using energy-based devices. The Company was not named in the announcement, and the Company has not received a letter from the agency, however the Company’s Juliet device is promoted and used by physicians in procedures that are the subject of the FDA’s public statement. The Company is not aware of any adverse events resulting from the use of Juliet, and believes that Juliet’s development and promotion is based on science and clinical evidence. Notwithstanding, the Company experienced a significant slowdown in the sale of Juliet systems in the third and fourth quarters of 2018 and first quarter of 2019. The Company believes this relates to the safety letter, given the timing.
The Company supports any action that helps ensure patient safety going forward. The Company has a robust, multi-functional process that reviews its promotional claims and materials to ensure they are truthful, not misleading, fair and balanced, and supported by sound scientific evidence.
A detailed discussion of these and other factors that could impact the Company’s future performance are provided in (1) Part I, Item 1A “Risk Factors” and elsewhere in this Form 10-Q, (2) the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, (3)2017- Part I, Item 1A “Risk Factors,” (2) the Company’s reports and registration statements filed and furnished from time to time with the SEC, and (4)(3) other announcements the Company makes from time to time.
Critical accounting policies, significant judgments and use of estimates
The Company's management discussion and analysispreparation of financial condition and results of operations are based upon the Company’s unaudited condensed consolidated financial statements. For the threeCondensed Consolidated Financial Statements 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 periodsrelated disclosures 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 accordanceconformity with accounting principles generally accepted in the United States of America, (“U.S. GAAP”). The preparation of these condensed consolidated financial statementsGAAP requires us to make estimates, judgments and judgmentsassumptions that affect the reported amounts of assets, liabilities, revenue and expenses. On an ongoing basis, we evaluate the Company’s critical accounting policiesThese estimates, judgments and estimates. The Companyassumptions are based the estimates on historical experience and on various other assumptionsfactors that we believe are reasonable under the circumstances. The Company believesperiodically reviews its estimates and make adjustments when facts and circumstances dictate. To the extent that there are material differences between these estimates and actual results, the Company’s financial condition or results of operations will be affected.
The Company adopted ASU 2016-02 in the first quarter of fiscal year 2019 using the modified retrospective method, to all leases existing at the date of initial application. The comparative information has not been restated and continues to be reasonablereported under the accounting standards in effect for the period presented. The adoption of the new standard resulted in the circumstances, the resultsrecording of which form the basis for making judgments about the carrying values ofadditional net lease assets and lease liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptionsof $10.3 million and conditions. The Company’s significant accounting policies are more fully described in Note$10.4 million, respectively, as of January 1, 2019, based on the present value of the accompanyingremaining minimum rental payments under current leasing standards for existing operating leases. The difference between the additional lease assets and lease liabilities, was recorded as deferred rent. The standard had no material impact on the Company’s condensed consolidated statements of operations, comprehensive loss, statements of changes in equity, and cash flows. Refer to notes 2 and 12 to the unaudited condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional accounting policy and in Note 2transition disclosures.
Critical accounting estimates, as defined by the SEC, are those that are most important to the Company’s audited consolidatedportrayal of our financial statements containedcondition and results of operations and require our management’s most difficult and subjective judgments and estimates of matters that are inherently uncertain. The accounting policies and estimates that the Company considers to be critical, subjective, and requiring judgment in thetheir application are summarized in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2018 filed with the SEC on March 26, 2018 with the SEC.18, 2019. With the exception of the change in revenue recognitionfor the accounting of leases as a result of the adoption of ASC Topic 606, (see Notes 2 and 7)842, there have been no new or material changes to the criticalsignificant accounting policies and estimates discussed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017, that are of significance, or potential significance, to the Company.
Results of Operations
The following table sets forth selected consolidated financial data for the periods indicated, expressed as a percentage of total revenue, net. Percentages in this table and throughout the Company’sour discussion and analysis of financial condition and results of operations may reflect rounding adjustments.
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | |||||||||||||
Net revenue | 100% | 100% |
| 100% | 100% |
| ||||||||||
Cost of revenue | 47% | 42% |
| 48% | 44% |
| ||||||||||
Gross margin | 53% | 58% |
| 52% | 56% |
| ||||||||||
Operating expenses: | ||||||||||||||||
Sales and marketing | 37% | 35% |
| 37% | 36% |
| ||||||||||
Research and development | 10% | 8% |
| 10% | 9% |
| ||||||||||
General and administrative | 12% | 10% |
| 13% | 10% |
| ||||||||||
Total operating expenses | 59% | 53% |
| 60% | 55% |
| ||||||||||
Income (loss) from operations | (5)% | 5% |
| (9) | 1% |
| ||||||||||
Interest and other income (expense), net | — | 1% |
| — | 1% |
| ||||||||||
Income (loss) before income taxes | (5)% | 6% |
| (9) | 2% |
| ||||||||||
Provision (benefit) for income taxes | — | — | (4)% | — | ||||||||||||
Net income (loss) | (5)% | 6% |
| (5)% | 2% |
|
Three Months Ended | ||||||||
March 31, | ||||||||
2019 | 2018 | |||||||
Net revenue | 100% |
| 100% |
| ||||
Cost of revenue | 52% |
| 49% |
| ||||
Gross margin | 48% |
| 51% |
| ||||
Operating expenses: | ||||||||
Sales and marketing | 45% |
| 38% |
| ||||
Research and development | 10% |
| 10% |
| ||||
General and administrative | 15% |
| 16% |
| ||||
Total operating expenses | 70% |
| 64% |
| ||||
Loss from operations | (22)% |
| (14)% |
| ||||
Interest and other income, net | —% |
| —% |
| ||||
Loss before income taxes | (22)% |
| (14)% |
| ||||
Benefit for income taxes | —% |
| (8)% |
| ||||
Net loss | (22)% |
| (6)% |
|
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 21 in the notes to consolidated financial statements on the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 20172018 and Notes 2 and 7 inNote 8 to the accompanying unaudited condensed consolidated financial statements.statements included in Item I, Part 1 of this Quarterly Report on Form 10-Q.
AsRevenue is recognized upon transfer of June 30, 2018,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%15.0% of the Company’s total revenue is recognized over time,for the three months ended March 31, 2019 and the remainder of the revenue is recognized upon completion of delivery.March 31, 2018, respectively. Revenue recognized over time relates to revenue from the Company’s extended service contracts and customer marketing support.services. Revenue recognized upon delivery is primarily generated by the sales of system,systems, consumables and skincare.
During the first and second quarters
Total Net Revenue
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | 2018 | % Change | 2017 | ||||||||||||||||||
Revenue mix by geography: | ||||||||||||||||||||||||
United States | $ | 28,132 | 16% | $ | 24,239 | $ | 49,268 | 21% |
| $ | 40,783 | |||||||||||||
International | 14,421 | 19% | 12,150 | 27,410 | 10% |
| 24,905 | |||||||||||||||||
Consolidated total revenue | $ | 42,553 | 17% | $ | 36,389 | $ | 76,678 | 17% |
| $ | 65,688 | |||||||||||||
United States as a percentage of total revenue | 66% |
| 67% |
| 64% |
| 62% |
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International as a percentage of total revenue | 34% |
| 33% |
| 36% |
| 38% |
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Revenue mix by product category: | ||||||||||||||||||||||||
Systems | ||||||||||||||||||||||||
- North America | $ | 25,886 | 14% | $ | 22,626 | $ | 44,830 | 21% |
| $ | 37,086 | |||||||||||||
- Rest of World | 9,405 | 26% | 7,489 | 17,700 | 10% |
| 16,021 | |||||||||||||||||
Total Systems | 35,291 | 17% | 30,115 | 62,530 | 18% |
| 53,107 | |||||||||||||||||
Consumables | 1,057 | 63% | 649 | 1,826 | 59% |
| 1,148 | |||||||||||||||||
Skincare | 1,302 | 35% | 963 | 2,558 | 31% |
| 1,947 | |||||||||||||||||
Total Products | 37,650 | 19% | 31,727 | 66,914 | 19% |
| 56,202 | |||||||||||||||||
Service | 4,903 | 5% | 4,662 | 9,764 | 3% | 9,486 | ||||||||||||||||||
Total Net Revenue | $ | 42,553 | 17% | $ | 36,389 | $ | 76,678 | 17% |
| $ | 65,688 |
Total Net Revenue:
Three Months Ended March 31, | ||||||||||||
(Dollars in thousands) | 2019 | % Change | 2018 | |||||||||
Revenue mix by geography: | ||||||||||||
United States | $ | 20,400 | (3)% | $ | 21,136 | |||||||
International | 15,626 | 20% | 12,989 | |||||||||
Consolidated total revenue | $ | 36,026 | 6% | $ | 34,125 | |||||||
United States as a percentage of total revenue | 57% | 62% | ||||||||||
International as a percentage of total revenue | 43% | 38% | ||||||||||
Revenue mix by product category: | ||||||||||||
Systems – North America | $ | 17,580 | (7)% | $ | 18,944 | |||||||
Systems – International | 9,629 | 16% | 8,295 | |||||||||
Total Systems | 27,209 | 0% | 27,239 | |||||||||
Consumables | 1,945 | 153% | 769 | |||||||||
Skincare | 1,608 | 28% | 1,256 | |||||||||
Total Products | 30,762 | 5% | 29,264 | |||||||||
Service | 5,264 | 8% | 4,861 | |||||||||
Total Net Revenue | $ | 36,026 | 6% | $ | 34,125 |
The Company’s revenue increased by 17% for6% in the three and six months periodsmonth period ended June 30, 2018,March 31, 2019, compared to the same periodsperiod in 2017,2018, due primarily to increasedstrong growth in the Company’s international revenue, and demand for the Company’s new products – the truSculptiD, Secret RF, and the newly launched excel V+ system, revenues.offset by softness in the overall women’s health market, competitive trends affecting certain legacy system pricing, and greater than expected turnover in our North American salesforce in the fourth quarter of 2018 that continues to have an impact during the first quarter of 2019.
Revenue by Geography:Geography
The Company’s U.S. revenue increaseddecreased by $3.9$0.7 million, or 16%3%, and $8.5 million, or 21% respectively forin the three and six months ended June 30, 2018,March 31, 2019, compared to the same periodsperiod in 2017.2018. This increasedecrease was due primarily to new products introduced intosoftness in the overall women’s health market, competitive trends affecting certain legacy system pricing, and greater than expected turnover in January 2018.our North American salesforce in the fourth quarter on 2018 that continued to have an impact through the first quarter of 2019.
The Company’s international revenue increased $2.3by $2.6 million, or 19%20%, and $2.5 million, or 10% forin the three and six months ended June 30, 2018,March 31, 2019, compared to the same periodsperiod in 2017.2018. The increase was due to growth in the Company’s business in Japan, Asia excluding Japan, and Europe, partially offset by decline in sales in the Middle East and Asia including Japan.East.
Revenue by Product Type:Type
SystemsRevenue
Systems revenue in North America increaseddecreased by $3.3$1.4 million, or 14%7%, and $7.7 million, or 21% , respectively, forin the three and six months ended June 30, 2018,March 31, 2019, compared to the same periodsperiod in 2017,2018 due to strong salesthe softness in the U.S.overall women’s health market, competitive trends affecting certain legacy system pricing, and new products launched sincegreater than expected turnover in our North American salesforce in the secondfourth quarter of 2017.2018 that continued to have an impact through the first quarter of 2019. The Rest of the World systems revenue increased by $2.0 million or 26%16%, and $1.7 million, or 10%, respectively.for the three months ended March 31, 2019, compared to same period in 2018. The increase in Rest of the World revenue was primarily a result of an increase in the Company’s direct business in Japan, Asia includingexcluding Japan, as well as increasesand Europe, partially offset by a decline 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.East.
ConsumablesRevenue
Consumables revenue increased by $408,000, or 63%153%, and $678,000, or 59% for the three and six months ended June 30, 2018, respectively,March 31, 2019, compared to the same periodsperiod in 2017.2018. The increase in consumables revenue was due to the introduction of truSculpt 3D in May 2017, Secret RFand Juliet during January 2018, and truSculpt iD in July 2018, each of which have consumable elements.
SkincareRevenue
The Company’s revenue from Skincare products in Japan increased by $339,000, or 35%28%, and $611,000, or 31% for the three and six months ended June 30, 2018, respectively,March 31, 2019, compared to the same periodsperiod in 2017.2018. This increase was due primarily to increased marketing and promotional activities.
ServiceRevenue
The Company’s Service revenue increased by $241,000,$0.4 million, or 5%8%, and $278,000, or 3% for the three and six months ended June 30, 2018, respectively,March 31, 2019, compared to the same periods in 2017.2018. This increase was due primarily to increased sales of system partsservice contracts, support and maintenance services provided on a time and materials basis to the Company's network of international distributors.
Gross Profit
Three Months Ended June 30, | Six Months Ended June 30, | Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | 2018 | % Change | 2017 | 2019 | % Change | 2018 | |||||||||||||||||||||||||||
Gross profit | $ | 22,377 | 6% |
| $ | 21,046 | $ | 39,711 | 9% |
| $ | 36,567 | $ | 17,309 | —% |
| $ | 17,334 | ||||||||||||||||||
As a percentage of total net revenue | 53% |
| 58% |
| 52% |
| 56% |
| 48% |
| 51% |
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The Company’s cost of revenue consists primarily of material, personnel expenses, product warranty costs, and manufacturing overhead expenses. The Company also continues to make investments in its international direct service support, as well as operational improvement activities.
Gross margins inmargin for the three and six months ended June 30, 2018 decreased by 5% and 4% respectively,March 31, 2019 declined 3%, 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 Rest of the World. Reduced2018. The reduced gross margins wereduring 2019 was due primarily to:to lower average system pricing across the legacy portfolio, including continued pricing pressure on the enlighten system.
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Sales and Marketing
Three Months Ended June 30, | Six Months Ended June 30, | Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | 2018 | % Change | 2017 | 2019 | % Change | 2018 | |||||||||||||||||||||||||||
Sales and marketing | $ | 15,535 | 21 | % | $ | 12,787 | $ | 28,623 | 21 | % | $ | 23,560 | $ | 16,104 | 23% | $ | 13,088 | |||||||||||||||||||
As a percentage of total net revenue | 37% |
| 35% |
| 37% |
| 36% |
| 45% | 38% |
Sales and marketing expenses consist primarily of personnel expenses, expenses associated with customer-attended workshops and trade shows, post-marketing studies, advertising and training.
The $2.7$3.0 million increase in sales and marketing expenses duringfor the three months ended June 30, 2018,March 31, 2019 compared to the same period in 2017,2018 was due primarily to:
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The $5.1 million increase in sales and marketing expenses during the six months ended June 30, 2018, compared to the same period in 2017, was due primarily to:
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● | $0.5 million of |
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Research and Development (“R&D”)
Three Months Ended June 30, | Six Months Ended June 30, | Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | 2018 | % Change | 2017 | 2019 | % Change | 2018 | |||||||||||||||||||||||||||
Research and development | $ | 4,095 | 37% |
| $ | 2,981 | $ | 7,651 | 29% |
| $ | 5,926 | $ | 3,706 | 4% | $ | 3,556 | |||||||||||||||||||
As a percentage of total net revenue | 10% |
| 8% |
| 10% |
| 9% |
| 10% | 10% |
R&D expenses consist primarily of personnel expenses, clinical research, regulatory and material costs. R&D expenses increased by $1.1 million or 37%,$150,000, and represented 10% of total net revenue, in the three months ended June 30, 2018,March 31, 2019, compared to 8% of total net revenue10% for the same period in 2017.2018. This increase in expense was due primarily to $1.1 million of increased material expenses, as well as higher personnel expenses driven primarily by an increase in headcount and consulting related expenses.
R&D expenses increased by $1.7 million or 29%, and represented 10% of total net revenue, in the six months ended June 30, 2018, compared to 9% of total net revenue for the same period in 2017. This increase in expense was due primarily to $1.7 million of increased personnel (including $0.6 million of stock-based compensation, due to headcount increase) and consulting related expenses.
General and Administrative (“G&A”)
Three Months Ended June 30, | Six Months Ended June 30, | Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | 2018 | % Change | 2017 | 2019 | % Change | 2018 | |||||||||||||||||||||||||||
General and administrative | $ | 4,902 | 38% |
| $ | 3,548 | $ | 10,341 | 53% |
| $ | 6,764 | $ | 5,525 | 2% | $ | 5,439 | |||||||||||||||||||
As a percentage of total net revenue | 12% |
| 10% |
| 13% |
| 10% |
| 15% | 16% |
G&A expenses consist primarily of personnel expenses, legal, fees, accounting, audit and tax consulting fees, andas well as other general and administrative expenses. G&A expenses increasedwere relatively flat, increasing by $1.4 million$86,000, or 38%2%, and represented 12%15% of total net revenue in the three months ended June 30, 2018,March 31, 2019, compared to 10% of total net revenue16% in the same 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,2018. Reductions in legal and represented 13% of total net revenueaccounting fees in the sixthree months ended June 30, 2018,March 31, 2019, compared to 10% of total net revenue in the same period in 2017, due primarily to:2018, were offset by costs incurred related to the implementation of a new Enterprise Resource Planning solution.
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Interest and Other Income, (expense), Net
Interest and other income (expense), net, consists of the following:
Three Months Ended June 30, | Six Months Ended June 30, | Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | 2018 | % Change | 2017 | 2019 | % Change | 2018 | |||||||||||||||||||||||||||
Total interest and other income (expense), net | $ | (129 | ) | (147)% |
| $ | 276 | $ | (31) | (106)% |
| $ | 549 | |||||||||||||||||||||||
Interest and other income, net | $ | (79) | (181)% | $ | 98 | |||||||||||||||||||||||||||||||
As a percentage of total net revenue | 0% | 1% | 0% | 1% | —% | —% |
Interest and other income (expense), net, decreased $405,000$177,000 or (147)% and $580,000 or (106)%, respectively,181% in the three and six months ended June 30, 2018,March 31, 2019, compared to the same period in 2017.2018. This decrease was due primarily to an increase in net foreign exchange losses, as well as a decrease in interest income from the Company’s marketable investments resulting from a decrease in the investment balance.
Provision for Income Taxes
Three Months Ended June 30, | Six Months Ended June 30, | Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||
(Dollars in thousands) | 2018 | % Change | 2017 | 2018 | % Change | 2017 | 2019 | $ Change | 2018 | |||||||||||||||||||||||||||
Income (loss) before income taxes | $ | (2,284) | (214)% |
| $ | 2,006 | $ | (6,935) | (901)% |
| $ | 866 | $ | (8,105) | $ | (3,454) | $ | (4,651) | ||||||||||||||||||
Provision (benefit) for income taxes | (712) | (1,307)% |
| 59 | (3,331) | 5,546% |
| (59) | ||||||||||||||||||||||||||||
Income tax (benefit) provision | $ | 115 | $ | (2,734) | $ | (2,619) |
For the three and six months ended June 30, 2018, the Company’s income tax benefits were $712,000 and $3,331,000, compared toMarch 31, 2019, our income tax expense was $115,000 compared to a tax benefit of $59,000 and income tax benefits of $59,000$2.6 million in the same periodsperiod in 2017.2018. In the three and six months ended June 30, 2018,March 31, 2019, the Company calculated the provision for income taxes for interim reporting periods by applying an estimate of the "annualannual effective tax rate"rate for the full year to ordinary income or loss for the reporting period. The Company’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 vestedexpense in the three and six months ended June 30, 2018.
TheMarch 31, 2019 was primarily related to income taxes of our non-U.S. operations as our U.S. operations were in a loss position and the Company had a 100% valuation allowance against them. As of March 31, 2019, and December 31, 2018, the Company had a 100% valuation allowance against its U.S. deferred tax provision (benefit) forassets. There was no valuation allowance during the three and six months ended June 30, 2017 related primarily to U.S. alternative minimum taxes asMarch 31, 2018 other than the Company was able to utilize the net operating losses brought forward against the Company’s projected income for fiscal year 2017. In addition, the Company recorded discretely the net tax benefit of excess equity compensation costs (“windfalls”) of approximately $59,000 and $110,000 in the three and six months ended June 30, 2017, respectively.California jurisdiction.
Liquidity and Capital Resources
Liquidity is the measurement of the Company’s ability to meet potential cash requirements, fund the planned expansion of the Company’s operations and acquire businesses. The Company’s sourcesprincipal source of liquidity is cash include operations,from maturity and sales and maturity of marketable investments and cash generated from the issuance of common stock option exercises,through exercise of stock options and the Company’s employee stock purchases.purchasing program. The Company actively manages theits cash usage and investment of liquid cash to ensure the maintenance of sufficient funds to meet the Company’sits daily needs. The majority of the Company’s cash and investments are held in U.S. banks and the Company’sits foreign subsidiaries maintain a limited amount of cash in their local banks to cover their short-term operating expenses.
At June 30, 2018As of March 31, 2019 and December 31, 2017,2018, the Company had $41.2$30.9 million and $45.1$39.6 million of working capital, respectively, and the Company’s cashrespectively. Cash and cash equivalents andplus marketable investments totaled $29.0decreased by $8.5 million and $35.9to $27.1 million as of June 30, 2018 andMarch 31, 2019, from $35.6 million as of 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 theprimarily as a result of settlement of accounts payable and 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 restrictedmarketable investments:
(Dollars in thousands) | June 30, | December 31, 2017 | Change | March 31, 2019 | December 31, 2018 | Change | ||||||||||||||||||
Cash and cash equivalents | $ | 18,432 | $ | 14,184 | $ | 4,248 | $ | 19,158 | $ | 26,052 | $ | (6,894) |
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Marketable investments | 10,573 | 21,728 | (11,155) |
| 7,939 | 9,523 | (1,584) |
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Total | $ | 29,005 | $ | 35,912 | $ | (6,907) |
| $ | 27,097 | $ | 35,575 | $ | (8,478) |
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Cash Flows
Six Months Ended June 30, | Three Months Ended | |||||||||||||||
(Dollars in thousands) | 2018 | 2017 | 2019 | 2018 | ||||||||||||
Net cash flow provided by (used in): | ||||||||||||||||
Operating activities | $ | (6,503) | $ | 3,890 | $ | (7,953) | $ | (10,047) | ||||||||
Investing activities | 10,611 | 5,533 | 1,549 | 8,550 | ||||||||||||
Financing activities | 140 | (4,519) | (490) | (1,777) | ||||||||||||
Net increase in cash and cash equivalents | $ | 4,248 | $ | 4,904 | ||||||||||||
Net decrease in cash and cash equivalents | $ | (6,894) | $ | (3,274) |
Cash Flows from Operating Activities
Net cash used in operating activities was $6.5 million in the sixthree months ended June 30, 2018,March 31, 2019 was approximately $8.0 million, which was due primarily to:
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● | $0.5 million used to settle extended warranty liabilities; | |
● | $0.5 million generated as a result of increased deferred revenue; and | |
● | $0.4 million used as a result of increased accounts |
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Net cash provided by operating activities was $3.9 million in the six months ended June 30, 2017, which was due primarily to:
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Cash Flows from Investing Activities
Net cash provided by investing activities was $10.6$1.6 million in the sixthree months ended June 30, 2018,March 31, 2019, which was attributable primarily to:
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● | $ | |
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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Cash Flows from Financing Activities
Net cash provided byused in financing activities was $140,000$409,000 in the sixthree months ended June 30, 2018,March 31, 2019, which was primarily due to:
● | $ |
● | $ |
● | $490,000 of cash used for taxes | |
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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Adequacy of Cash Resources to Meet Future Needs
The Company had cash, cash equivalents, and marketable investments of $29.0$27.1 million as of June 30, 2018.March 31, 2019. For the first sixthree months of 2018,2019, the Company’s principal source of liquidity is cash from maturity and sales of marketable investments and cash generated from the issuance of common stock through exercise of stock options and the Company’s employee stock purchasing program. The Company believes that the existing cash resources are sufficient to meet the Company’s anticipated cash needs for working capital and capital expenditures for at least the next several 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“Original Revolving Line of Credit”) in the original principal amount of $25,000,000.$25 million. The Original Revolving Line of Credit terminates on May 30, 2021.
The purpose of theOriginal 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 containscontained financial and other covenants as well as the maintenance of a leverage ratio not to exceed 2.5:2.5 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 AgreementOriginal Revolving Line of Credit 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.
During the third quarter of 2018, the Company received notice that it was in violation of certain financial covenants in the Original Revolving Line of Credit and entered into discussions with Wells Fargo to amend and revise certain terms of the Original Revolving Line of Credit.
On or about November 2, 2018, the Company entered into a First Amendment and Waiver to the Loan and Security Agreement with Wells Fargo (the “First Amended Revolving Line of Credit”). The First Amended Revolving Line of Credit provided for a principal amount of $15 million, with the ability to request an additional $10 million, and a waiver of any existing defaults under the Original Revolving Line of Credit as long as the Company is in compliance with the terms of the First Amended Revolving Line of Credit.
On or about March 11, 2019, the Company entered into a Second Amendment and Waiver to the Loan and Security Agreement with Wells Fargo (the “Second Amended Revolving Line of Credit”). The Second Amended Revolving Line of Credit requires the Company to maintain a minimum cash balance of $15 million at Wells Fargo, but removes all other covenants so long as no money is drawn on the line of credit. The Company may draw down on the line of credit at the time it reaches and maintains TTM adjusted EBITDA of not less than $10 million, and a leverage ratio not to exceed 2.5 to 1.0.
A violation of any of the covenants could result in a default under the Second Amended Revolving Line of Credit 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 Second Amended Revolving Line of Credit.
As of June 30, 2018,March 31, 2019, the Company had not drawn on the Revolving Line of Credit and the Company is in compliance with all financial covenants.covenants of the Original Revolving Line of Credit, as amended by the First Amended Revolving Line of Credit and the Second Amended Revolving Line of Credit.
Commitments and Contingencies
DuringAs of the six months ended June 30, 2018,date of this report, other than changes related to adoption of the new lease accounting standard as described in Notes 2 and 13 to the Condensed Consolidated Financial Statements, there were no material changes to the Company’s contractual obligations and commitments and contingencies described under Management’s Discussion and Analysisoutside the ordinary course of Financial Condition and Results of Operationsbusiness since March 18, 2019, as reported in the Annual Report onCompany’s 2018 Form 10-K for the year ended December 31, 2017, filed with the SEC on March 26, 2018.10-K.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
A summary of the key market risks facing the Company is disclosed below. For a detailed discussion, please see the Company’s Annual Report on Form 10-K for the year ended December 31, 2017,2018, filed with the SEC on March 26, 2018.18, 2019.
Interest Rate Fluctuationsand Market Risk
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 yieldsthe income the Company receives from investments without significantly increasing risk. To achieve this objective, we investthe Company maintains its portfolio of cash equivalents and short- and long-term investments in a variety of high quality securities, including U.S. treasuries, U.S. government agencies, corporate debt, instruments of the U.S. Government and its agenciescash deposits, money market funds, commercial paper, non-U.S. government agency securities, and municipal bonds, high grade corporate bonds, commercial paper, CDsbonds. The securities are classified as available-for-sale and money markets, and, by policy, restrict the Company’s exposure to any single typeconsequently are recorded at fair value with unrealized gains or losses reported as a separate component of investment or issuer by imposing concentration limits. To minimize the exposure due to adverse shifts in interest rates, we maintain investments at aaccumulated other comprehensive loss. The weighted average maturity of generally less than eighteen months.the Company’s portfolio as of March 31, 2019 was approximately 0.2 years. If interest rates rise, the market value of our investments may decline, which could result in a realized loss if the Company is forced to sell an investment before its scheduled maturity. A hypothetical increase in interest rate by one percentage point would have resulted in no impact on the Company’s total investment portfolio.
The uncertain financial markets have resulted in a tightening in the credit markets, a reduced level of liquidity in many financial markets, and extreme volatility in fixed income and credit markets. The credit ratings of the securities we have invested in could further deteriorate and may have an adverse impact on the carrying value of these investments.
As at June 30, 2018,of March 31, 2019, 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%2.60% as of June 30, 2018,March 31, 2019, and accordingly the Company may incur additional expenses if the Company has an outstanding balance on the line of credit and the LIBOR rate increaseincreases 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 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, 2018March 31, 2019 was carried out under the supervision and with the participation of the Company’s management, including the Company’s Interim 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.March 31, 2019.
Attached as exhibits to this Quarterly Report are certifications of the Company’s CEO and CFO, which are required in accordance with Rule 13a-14 of the Exchange Act. This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications, and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.
Changes in Internal Control over Financial Reporting
ThereThe Company implemented certain controls related to the adoption of FASB ASC 842, effective January 1, 2019. These controls were designed and implemented to ensure the completeness and accuracy over financial reporting. With the exception of the controls implemented for FASB ASC 842, there were no changes in the Company’s internal control over financial reporting that occurredduring the Company’s most recent fiscal quarterthree months ended March 31, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’sour internal control over financial reporting.
Limitations on the Effectiveness of Controls
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Accordingly, the Company’s disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of the Company’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 the end of the period covered by this report, that the Company’s disclosure controls and procedures were effective to provide reasonable assurance that the objectives of the Company’s disclosure control system were met.
LEGAL PROCEEDINGS |
From time to time, the Company may be involved in legal and administrative proceedings and claims of various types. For a description of the Company’s material pending legal and regulatory proceedings and settlements refer to Note 1213 to the Company’s consolidated financial statements entitled “Litigation“Commitments and Related Matters,Contingencies,” in the Annual Report on Form 10-K for the year ended December 31, 2017,2018, filed with the SEC on March 26, 2018.18, 2019.
| RISK FACTORS |
There have beenare no material changes infrom 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 the Company’s stock, please refer to Part I, Item 1A, "Risk Factors"Risk Factors previously disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017,2018, filed with the SEC on March 26, 2018 and elsewhere in this Form 10-Q.18, 2019.
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
None.
DEFAULTS UPON SENIOR SECURITIES |
None.
MINE SAFETY DISCLOSURES |
None.
OTHER INFORMATION |
None.
EXHIBITS |
Exhibit No. |
| Description |
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3.4 |
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4.1 |
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10.14 | Cutera, Inc. | |
31.1 |
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31.2 |
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32.1 |
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101.ins | Instance Document | |
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101.sch |
| XBRL Taxonomy Extension Schema Document |
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101.cal |
| XBRL Taxonomy Extension Calculation Linkbase Document |
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101.def |
| XBRL Taxonomy Extension Definition Linkbase Document |
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101.lab |
| XBRL Taxonomy Extension Label Linkbase Document |
| ||
101.pre |
| XBRL Taxonomy Extension Presentation Linkbase Document |
Pursuant to the requirements of Section 13 or 15(d) of The Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Brisbane, State of California, on the 7th10th day of August, 2018.May, 2019.
| CUTERA, INC. | |
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| /S/ SANDRAA.GARDINER | |
| Sandra A. Gardiner | |
| Executive Vice President, Chief Financial Officer | |
(Principal Financial and Accounting Officer) |
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