CUTERA, INC. This Management's Discussion and Analysis should be read in conjunction with the Company's financial condition and results of operations in conjunction with the Company's unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and the Company's audited financial statements and notes thereto for the year endedDecember 31, 2021 , included in its annual report on Form 10-K filed with theU.S. Securities and Exchange Commission ("SEC") onMarch 1, 2022 .
Unless otherwise indicated, all results presented are prepared in a manner that
complies, in all material respects, with accounting principles generally
accepted in
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, the Company undertakes no obligation to
update any forward-looking statements to reflect events or circumstances after
the date of such statements.
Introduction
The Management's Discussion and Analysis, or MD&A, is organized as follows:
•Executive Summary. This section provides a general description and history of the Company's business, a brief discussion of its product lines and the opportunities, trends, challenges and risks the Company focuses on in the operation of its business. •Critical Accounting Policies and Estimates. This section describes the key accounting policies that are affected by critical accounting estimates. •Results of Operations. This section provides the Company's analysis and outlook for the significant line items on its condensed consolidated statements of operations. •Liquidity and Capital Resources. This section provides an analysis of the Company's liquidity and cash flows, as well as a discussion of its commitments that existed as ofSeptember 30, 2022 .
Executive Summary
Company Description
The Company is a leading provider of aesthetic and dermatology solutions for
practitioners worldwide. In addition to internal development of products, the
Company distributes third party sourced products. The Company offers easy-to-use
products that enable medical practitioners to perform safe and effective
procedures, including treatment for acne, body contouring, skin resurfacing and
revitalization, tattoo removal, removal of benign pigmented lesions, vascular
conditions, and hair removal. The Company's platforms are designed to be easily
upgraded to add additional applications and hand pieces, which provide
flexibility for the Company's customers as they expand their practices. In
addition to systems and upgrade revenue, the Company generates revenue from the
sale of post warranty service contracts, providing services for products that
are out of warranty, hand piece refills and other per procedure related revenue
on select systems and distribution of third-party manufactured skincare
products. The Company also expands its revenues from sales of third-party
skincare products by utilizing its network and relationships with physicians and
practitioners.
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The Company's ongoing research and development activities primarily focus on developing new products, as well as improving and enhancing the Company's portfolio of existing products. The Company also explores ways to expand the Company's product offerings through alternative arrangements with other companies, such as distribution arrangements. The Company introduced Secret RF, a fractional RF microneedling device for skin revitalization, inJanuary 2018 , enlighten SR inApril 2018 , truSculpt iD inJuly 2018 , excel V+ inFebruary 2019 , truSculpt flex inJune 2019 , Secret PRO inJuly 2020 , excel V+III during the fourth quarter of 2020, and AviClear inApril 2022 . The Company's corporate headquarters andU.S. operations are located inBrisbane, California , 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 inNorth America (includingCanada ),Australia ,Austria ,Belgium ,France ,Germany ,Hong Kong ,Japan ,Netherlands ,Spain ,Switzerland and theUnited Kingdom . Sales and Services outside of these direct markets are made through a worldwide distributor network in over 42 countries. Products and Services The Company derives revenue from the sale of Products and Services. Product revenue includes revenue from the sale of systems, hand pieces and upgrade of systems (collectively "Systems" revenue), replacement hand pieces, truSculpt iD cycle refills, and truSculpt flex cycle refills, as well as single use disposable tips applicable to Secret RF and Secret PRO ("Consumables" revenue), and the sale of third party manufactured skincare products ("Skincare" revenue). 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. 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 the Company with a source of additional Systems revenue. The Company's primary system platforms include excel, enlighten, Secret RF, truSculpt and xeo.
In
AviClear is a laser treatment that offers a safe, prescription-free solution for acne. In addition to reducing existing acne, clinical trials show that future breakout episodes are shorter, less intense, and more infrequent following the AviClear procedure. Further, acne clearance results continue to improve over time, demonstrating the long-term efficacy of this novel treatment. Importantly, no pain mitigation was utilized or required by any clinical study participant. Acne vulgaris is a nearly universal skin disease, with approximately 50 million North American teens and young adults seeking treatment each year. Overproduction of sebum by the sebaceous glands is one of the leading causes of acne. AviClear tackles acne at the source by selectively targeting the sebocytes and suppressing sebum production. This product is a 1726 nm laser device designed to treat inflammatory acne vulgaris. AviClear delivers optimal therapeutic energy in conjunction with the AviCool feature to ensure safety and scalability of the procedure across all skin types and acne severities. AviClear is currently available in a limited commercial capacity in theU.S. and the Company expects a full commercial launch by the end of the current calendar year. Skincare revenue relates to the distribution of ZO's skincare products inJapan . The skincare products are purchased from a third-party manufacturer and sold to medical offices and licensed physicians. The Company acts as the principal in this arrangement, as the Company determines the price to charge customers for the skincare products and controls the products before they are transferred to the customer.
Service revenue includes prepaid service contracts, customer marketing support and labor on out-of-warranty products.
Significant Business Trends
The Company believes that its ability to grow revenue will be primarily
dependent on the following:
•the successful commercialization of AviClear
•continuing to expand the Company's product offerings, both through internal
development and sourcing from other vendors;
•ongoing investment in the Company's global sales and marketing infrastructure;
•use of clinical results to support new aesthetic products and applications;
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•enhanced physician development and reference selling efforts (to develop a
location where Company's products can be displayed and used to assist in selling
efforts);
•customer demand for the Company's products;
•consumer demand for the application of the Company's products;
•marketing to those practitioners focused on aesthetic and dermatological
conditions; and
•generating recurring revenue from the Company's growing installed base of
customers through the sale of system upgrades, services, hand piece
refills, truSculpt cycles, skincare products and replacement tips for the
Secret RF product.
For a detailed discussion of the significant business trends impacting its 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.
The Company supports any reasonable 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) the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 - Part I, Item 1A "Risk Factors," and (2) other announcements the Company makes from time to time.
Risks and Uncertainties
The COVID-19 outbreak and related variants have negatively affectedthe United States and global economies. The Company cannot presently predict the scope and severity of any impacts in future periods from business shutdowns or disruptions due to the COVID-19 pandemic, but the impact on economic activity including the possibility of recession or financial market instability could have a material adverse effect on the Company's business, revenue, operating results, cash flows and financial condition. In addition, the world is currently experiencing widespread inflation. Household budgets are tight and cash is generally being conserved and spent on essential items like housing, gas, food, clothing and healthcare. Given the inflationary environment, fewer funds may be spent on aesthetic treatments, which may translate into less demand for our products and less revenue as a result. The Company continues to assess whether any impairment of its goodwill or its long-lived assets has occurred and has determined that no charges were necessary during the three and nine months endedSeptember 30, 2022 . The Company will continue to monitor future conditions important to its assessment of potential impairment of its long-lived assets and goodwill. In 2021, the Company experienced a significant increase in sales of skincare products under the exclusive distribution agreement withZO Skin Health, Inc. , which allows the Company to sell ZO's skincare products inJapan . The Company relies on ZO as the sole supplier for skincare products. The reason for the increase in skincare products sales may have been the result of the COVID-19 pandemic changing customers' spending habits, resulting in customers purchasing aesthetic treatments that were able to be applied at home, due to limitations on in-person aesthetic procedures. Future growth in sales of skincare products depends on customers maintaining spending habits adopted during the COVID-19 pandemic. If customers revert to original spending habits after the COVID-19 pandemic, such changes may have a material adverse effect on the Company's revenue, operating results, and cash flows.
Critical accounting policies, significant judgments and use of estimates
The preparation of the Company's consolidated financial statements and related
notes requires the Company to make judgments, estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. The Company has based
its estimates on historical experience and on various other assumptions that the
Company believes to be reasonable under the circumstances. The Company
periodically reviews its
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estimates and makes adjustments when facts and circumstances dictate. To the extent that there are material differences between these estimates and actual results, its financial condition or results of operations will be affected. An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the consolidated financial statements. The Company believes that its critical accounting policies reflect the more significant estimates and assumptions used in the preparation of its audited consolidated financial statements. The accounting policies and estimates that the Company considers to be critical, subjective, and requiring judgment in their application are summarized in "Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations" in its Annual Report on Form 10-K for the year endedDecember 31, 2021 filed with theSEC onMarch 1, 2022 . There have been no new or material changes to the significant accounting policies discussed in the Company's Annual Report on Form 10-K that are of significance, or potential significance, to the Company.
The Company established new accounting policies to account for the 2.25% Convertible Senior Notes due 2026 (the "2026 Notes" and, together with the 2028 Notes, the "Convertible Notes") and related transactions during the first quarter of 2021.
The Company issued$138.3 million of 2026 Notes in a private placement offering inMarch 2021 . InMay 2022 , the Company issued an additional$240.0 million of convertible notes in a further private placement offering. Also inMay 2022 , the Company extinguished$69.1 million of the$138.3 million principal balance of the convertible notes issued in 2021. The notes issued in 2021 and 2022 each bear interest at a rate of 2.25% per year. In accordance with ASU 2020-06, the Company recorded the Convertible Notes in long-term debt with no separation between the notes and the conversion option. Each reporting period, the Company will determine whether any criteria are met for the note holders to have the option to redeem the notes early. To the extent there are any conversion requests, the Company intends to settle such conversion requests in shares of common stock. Therefore, the convertible notes have been included as Long-term debt on the condensed consolidated balance sheet. The issuance costs related to the Convertible Notes are presented in the balance sheet as a direct deduction from the carrying amount of the Convertible Notes. See Note 14 of the unaudited condensed consolidated financial statements included in Item I, Part 1 of this Quarterly Report on Form 10-Q. 33
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Results of Operations
The following table sets forth selected consolidated financial data for the
periods indicated, expressed as a percentage of total net revenue. Percentages
in this table and throughout its discussion and analysis of financial condition
and results of operations may reflect rounding adjustments.
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
Net revenue 100 % 100 % 100 % 100 %
Cost of revenue 45 % 42 % 45 % 43 %
Gross margin 55 % 58 % 55 % 57 %
Operating expenses:
Sales and marketing 42 % 33 % 42 % 32 %
Research and development 10 % 10 % 11 % 9 %
General and administrative 17 % 14 % 19 % 14 %
Total operating expenses 70 % 57 % 72 % 55 %
(Loss) income from operations (15) % 1 % (18) % 2 %
Amortization of debt issuance costs (1) % - % - % - %
Interest on convertible notes (3) % (1) % (2) % (1) %
Loss on extinguishment of convertible notes - % - % (19) % - %
Gain on extinguishment of PPP loan - % - % - % 4 %
Other expense, net 0 % (1) % (1) % (1) %
(Loss) income before income taxes (18) % (2) % (40) % 4 %
Income tax expense 1 % 1 % - % 1 %
Net (loss) income (19) % (2) % (40) % 4 %
Revenue
The timing of the Company's revenue is significantly affected by the mix of
system products, training, consumables and extended service contracts. The
revenue generated in any given period is also impacted by whether the revenue is
recognized over time or at a point in time. For an additional description on
revenue, see Note 1 in the notes to consolidated financial statements on the
Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2021
and Note 8 to the unaudited condensed consolidated financial statements included
in Item I, Part 1 of this Quarterly Report on Form 10-Q.
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 7% and 12% of the Company's total revenue for the
nine months ended September 30, 2022 and 2021, respectively. Revenue recognized
over time relates to revenue from the Company's extended service contracts and
marketing services. Revenue recognized upon delivery is primarily generated by
the sales of systems, consumables and skincare.
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