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, 2020 , included in its annual report on Form 10-K filed with theU.S. Securities and Exchange Commission ("SEC") onMarch 23, 2021 . Unless otherwise indicated, all results presented are prepared in a manner that complies, in all material respects, with accounting principles generally accepted inthe 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, 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 the 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 ofJune 30, 2021 . Executive Summary Company Description The Company is a leading medical device company specializing in the research, development, manufacture, marketing and servicing of light and other energy-based aesthetics systems for practitioners worldwide. In addition to internal development of products, the Company distributes third party sourced products under the Company's own brand names. The Company offers easy-to-use products which enable practitioners to perform safe and effective aesthetic procedures, including treatment for body contouring, skin resurfacing and revitalization, tattoo removal, removal of benign pigmented lesions, vascular conditions, hair removal, toenail fungus and women'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's customers as they expand their practices. 28 -------------------------------------------------------------------------------- Table of Contents 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. 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 Juliet, a product for women's intimate health, inDecember 2017 , 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 and excel V+III during the fourth quarter of 2020. 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 ,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 Juliet and Secret RF ("Consumables" revenue), the sale of third party manufactured skincare products ("Skincare" revenue); and the leasing of equipment through a membership program. 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 the Company 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 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, enlighten installation, 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: •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; •enhanced luminary 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 physicians in the core dermatology and plastic surgeon specialties, as well as outside those specialties; 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 Juliet and Secret RF products. 29 -------------------------------------------------------------------------------- Table of Contents 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 PerformanceThe 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, 2020 - Part I, Item 1A "Risk Factors," and (2) other announcements the Company makes from time to time. Impact of COVID-19 on Company's business and operations InMarch 2020 , theWorld Health Organization declared the COVID-19 outbreak a pandemic. The COVID-19 outbreak, and lately the Delta variant, has negatively affectedthe United States and global economies. The spread of the coronavirus, which caused a broad impact in 2020 globally, including restrictions on travel, shifting work force to work remotely and quarantine policies put into place by businesses and governments, had a material economic effect on the Company's business during the year endedDecember 31, 2020 . Notably, healthcare facilities in many countries effectively banned elective procedures. Many of the Company's products are used in aesthetic elective procedures and as such, the bans on elective procedures substantially reduced the Company's sales and marketing efforts in the early months of the pandemic and led the Company to implement cost control measures. Although the Company's operation and results of operations have significantly improved as the economic outlook due to the COVID-19 pandemic improves in 2021, the COVID-19 outbreak continues to be fluid and the aftermath of the business and economic disruptions due to the COVID-19 is still uncertain, making it difficult to forecast the final impact it could have on the Company's future operations, including disruptions in the Company's supply chain and contract manufacturing operations. The Company cannot presently predict the scope and severity of any impacts in future periods from the 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. The Company continues to assess whether any impairment of its goodwill or its long-lived assets has occurred, and has determined that no charges other than an impairment loss of$0.2 million on capitalized implementation costs of cloud-based CRM software during the six months endedJune 30, 2021 . The Company's assumptions about future conditions important to its assessment of potential impairment of its long-lived assets, and goodwill, including the impacts of the COVID-19 pandemic and other ongoing impacts to its business, are subject to uncertainty, and the Company will continue to monitor these conditions in future periods as new information becomes available, and will update its analyses accordingly. The Company has 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 reason for the increase in skincare products sales may have been the result of changes in customers' spending habits as customers purchased more aesthetic treatments that were able to be applied at home, due to limitations on in-person aesthetic procedures, social distancing and mask wearing requirements due to the COVID-19 pandemic. Future growth in sales of skincare products depends on customers' spending habits, which may 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 30 -------------------------------------------------------------------------------- Table of Contents 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, 2020 filed with theSEC onMarch 23, 2021 . Except the new policies explained below, 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 Convertible notes and related transactions during the first quarter of 2021. The Company issued$138.3 million of convertible senior notes in a private placement offering onMarch 5, 2021 . The notes bear interest at a rate of 2.25% per year. In accordance with ASU 2020-06, the Company recorded the 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, which will result in a change in the classification of the notes to current liabilities. 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. In connection with issuance of the notes, the Company entered into capped call transactions with certain option counterparties. The capped call transactions are generally designated to reduce the potential dilution of the Company's common stock upon any conversion of the notes. The capped calls were purchased for$16.1 million and recorded as a reduction to stockholders' equity Basic income (loss) per share of common stock is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the respective period in accordance with ASC 260. Diluted loss per common share reflects the potential dilution that would occur if contracts to issue common stock were exercised or converted into common stock. See Note 9 the unaudited condensed consolidated financial statements included in Item I, Part 1 of this Quarterly Report on Form 10-Q. 31 -------------------------------------------------------------------------------- Table of Contents 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 Six Months Ended June 30, June 30, 2021 2020 2021 2020 Net revenue 100 % 100 % 100 % 100 % Cost of revenue 42 % 56 % 43 % 56 % Gross margin 58 % 44 % 57 % 44 % Operating expenses: Sales and marketing 31 % 42 % 31 % 44 % Research and development 8 % 11 % 8 % 12 % General and administrative 14 % 32 % 15 % 28 % Total operating expenses 54 % 86 % 54 % 84 % Income (loss) from operations 4 % (41) % 3 % (39) % Amortization of debt issuance costs - % - % - % - % Interest on Convertible notes (1) % - % (1) % - % Gain on extinguishment of PPP loan 12 % - % 7 % - % Other income (expense), net (1) % - % (1) % - % Income (loss) before income taxes 13 % (41) % 7 % (40) % Income tax expense - % 2 % - % 1 % Net income (loss) 13 % (43) % 7 % (41) % Revenue 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 upon completion of delivery. 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 endedDecember 31, 2020 and Note 7 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 12% and 18% of the Company's total revenue for the six months endedJune 30, 2021 and 2020, 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. 32
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