CUTERA INC - Quarter Report: 2013 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

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FORM 10-Q

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(Mark One)

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period _____ to_____.

Commission file number: 000-50644

 

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Cutera, Inc.

(Exact name of registrant as specified in its charter)

 

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Delaware		77-0492262
(State or other jurisdiction of incorporation or organization)		(I.R.S. employer identification no.)

3240 Bayshore Blvd., Brisbane, California 94005

(Address of principal executive offices)

(415) 657-5500

(Registrant’s telephone number, including area code)

 

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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    x    No    o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x     No    o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes    o    No    x

 

The number of shares of Registrant’s common stock issued and outstanding as of October 31, 2013 was 14,121,674.

 

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CUTERA, INC.

FORM 10-Q

TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

CUTERA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CUTERA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CUTERA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CUTERA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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CUTERA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies

Description of Operations and Principles of Consolidation

Cutera, Inc. (“Cutera” or the “Company”) is a global provider of laser and other energy-based aesthetic systems for practitioners worldwide. The Company designs, develops, manufactures, and markets the CoolGlide, Xeo, Solera, GenesisPlus, ExcelV, VariLite (acquired in 2012) and truSculpt (introduced in 2012) product platforms for use by physicians and other qualified practitioners which enable them to offer safe and effective aesthetic treatments to their customers. The Company’s products offer multiple hand pieces and applications, which allow customers to upgrade their systems. The sales of systems, hand pieces, hand piece refills, upgrades, and the distribution of third party manufactured dermal fillers and cosmeceuticals are classified as Product revenue. In addition to Product revenue, the Company generates Service revenue from the sale of post-warranty service contracts, providing services for products that are out of warranty.

Headquartered in Brisbane, California, the Company has wholly-owned subsidiaries in Australia, Canada, France and Japan, that market, sell and service its products outside of the United States. The Consolidated Financial Statements include the accounts of the Company and its subsidiaries. All inter-company transactions and balances have been eliminated.

Unaudited Interim Financial Information

The financial information filed is unaudited. The Condensed Consolidated Financial Statements included in this report reflect all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for the fair statement of the results of operations for the interim periods covered and of the financial condition of the Company at the date of the interim balance sheet. The December 31, 2012 Condensed Consolidated Balance Sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles in the United States of America (“GAAP”). The results for interim periods are not necessarily indicative of the results for the entire year or any other interim period. The Condensed Consolidated Financial Statements should be read in conjunction with the Company’s financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission (the “SEC”), on March 15, 2013.

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 and disclosed in the Condensed Consolidated Financial Statements and the accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, the Company evaluates these estimates, including those related to warranty obligation, sales commission, accounts receivable and sales allowances, provision for excess and obsolete inventories, fair values of marketable investments, fair values of acquired intangible assets, useful lives of intangible assets and property and equipment, recoverability of deferred tax assets, and effective income tax rates, among others. Management bases these 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.

Note 2. Cash and Cash Equivalents and Marketable Securities

The Company considers all highly liquid investments, with an original maturity of three months or less at the time of purchase, to be cash equivalents. Investments in debt securities are accounted for as “available-for-sale” securities, carried at fair value with unrealized gains and losses reported in other comprehensive loss, held for use in current operations and classified in current assets as “Marketable investments.”

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The following tables summarize unrealized gains and losses related to our marketable investments, designated as available-for-sale (in thousands):

As of September 30, 2013 and December 31, 2012, the total gross unrealized losses were $22,000 and $7,000, respectively, and were related to interest rate changes on short-term marketable investments. The Company has concluded that it is more-likely-than-not that the securities will be held until maturity or a recovery of the cost basis. No securities were in unrealized loss positions for more than 12 months.

The following table summarizes the estimated fair value of our securities available-for-sale and classified as cash and cash equivalents and marketable investments classified by the contractual maturity date of the security as of September 30, 2013 (in thousands):

Note 3. 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. 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:

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Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities.

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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.

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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 September 30, 2013, financial assets measured and recognized at fair value on a recurring basis and classified under the appropriate level of the fair value hierarchy as described above was as follows (in thousands):

As of December 31, 2012, financial assets measured and recognized at fair value on a recurring basis and classified under the appropriate level of the fair value hierarchy as described above was as follows (in thousands):

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 September 30, 2013 is less than 36 months and all of these investments are rated by S&P and Moody’s at A or better.

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Note 4. Inventories

Inventories consist of the following (in thousands):

Note 5. Warranty

The Company provides a standard one-year warranty on all systems. Warranty coverage provided is for labor and parts necessary to repair the systems during the warranty period. The Company accounts for the estimated warranty cost of the standard warranty coverage as a charge to costs of revenue when revenue is recognized. The estimated warranty cost is based on historical product performance. To determine the estimated warranty reserve, the Company utilizes historical service costs to calculate the expected service expense per system and applies this to the equivalent number of units exposed under warranty. The Company updates these estimated charges every quarter.

The following table provides the changes in the product warranty accrual for the nine-month period ended September 30, 2013 (in thousands):

Note 6. Deferred Service Contract Revenue

Service contract revenue is recognized on a straight-line basis over the period of the applicable extended warranty contract.

The following table provides changes in deferred service contract revenue for the nine-month periods ended September 30, 2013 and 2012 (in thousands):

Costs incurred under service contracts were $5.2 million and $5.4 million for the nine-month periods ended September 30, 2013 and 2012, which were recognized as incurred.

Note 7. Stockholders’ Equity and Stock-based Compensation Expense

Share Repurchase Program

On August 5, 2013, the Company’s Board of Directors modified Cutera, Inc.’s stock buyback program, originally adopted in November 2012, to permit an additional $10 million of its issued and outstanding common shares to be repurchased. As modified, the stock buyback program permits the Company to purchase an aggregate of $20 million of its common stock through a 10b5-1 program based on predetermined pricing and volume parameters, as well as open-market purchases that are subject to management discretion and regulatory restrictions.

In the quarter ended September 30, 2013, the Company repurchased 796,919 shares of its common stock for approximately $7.6 million. As of September 30, 2013, there remained an additional $12.4 million of the Company's common stock to be purchased under the modified stock buyback program. The number of shares to be repurchased and the timing of such repurchases will be based on several factors, including the price of the Company's common stock, regulatory restrictions, and general market and business conditions.

Stock-based Compensation Expense

Stock-based compensation expense by department recognized during the three and nine-month periods ended September 30, 2013 and 2012 were as follows (in thousands):

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Under the 2004 Equity Incentive Plan, the Company issued 556,674 shares of common stock during the nine-month period ended September 30, 2013, in conjunction with stock options exercised.

During the nine-month period ended September 30, 2013, the following number of equity awards of the Company’s common stock was granted (in thousands):

As of September 30, 2013, there was $5.1 million of unrecognized compensation expense, net of projected forfeitures related to non-vested stock awards. The expense is expected to be recognized over the remaining weighted-average period of 2.8 years.

Note 8. Net Loss Per Share

Basic net loss per share is calculated by dividing net loss by the weighted-average number of common shares outstanding during the year. Diluted net loss per common share is the same as basic net loss per common share, as the effect of the potential common stock equivalents is anti-dilutive and as such is excluded from the calculations of the diluted net loss per share.

The following number of shares outstanding, prior to the application of the treasury stock method, were excluded from the computation of diluted net loss per common share for the periods presented because including them would have had an anti-dilutive effect (in thousands):

Note 9. Income Taxes

For the three months ended September 30, 2013 and 2012, the Company’s tax benefit was $169,000 and $64,000, respectively. For the nine months ended September 30, 2013 and 2012, the Company’s tax benefit was $97,000 and tax expense was $122,000 respectively. The Company’s income tax benefit for the three and nine-month periods ended September 30, 2013 was primarily attributable to a release of uncertain tax position reserves, partially offset by income taxes of the Company’s international operations. The Company’s income tax benefit for the three-month period ended September 30, 2012 was primarily related to gains and losses on marketable and long term investments recorded in other comprehensive loss partially offset by income taxes of the Company’s international operations.  The Company’s tax expense for the nine-month period ended September 30, 2012 was primarily related to income taxes of the Company’s international operations partially offset by benefits for income taxes related to gains and losses on marketable and long term investments recorded in other comprehensive loss.

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 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 September 30, 2013 and December 31, 2012, the Company had a 100% valuation allowance against its U.S. deferred tax assets. Significant management judgment is required in determining any valuation allowance recorded against deferred tax assets. In evaluating the ability to recover deferred tax assets, the Company considered available positive and negative evidence giving greater weight to its recent cumulative losses and its ability to carry-back losses against prior taxable income and lesser weight to its projected financial results due to the challenges of 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.

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On January 2, 2013, the President signed into law The American Taxpayer Relief Act of 2012, or ATRA. Under prior law, a taxpayer was entitled to a research tax credit for qualifying amounts incurred through December 31, 2011. The ATRA extends the research credit for two years for qualified research expenditures incurred through the end of 2013. The extension of the research credit is retroactive and includes amounts incurred after 2011. The benefit of the reinstated credit did not impact the Company’s statement of operations for the three and nine months ended September 30, 2013, as the research and development credit carryforwards are offset by a full valuation allowance.

Note 10. Commitments and Contingencies

Capital Lease Obligation

During 2013, the Company financed vehicles for some of its sales employees in North America. As of September 30, 2013 the gross capitalized value of the leased vehicles was $487,000 and the related accumulated depreciation was $64,000. As of September 30, 2013 the minimum lease payments are as follows (in thousands):

Litigation and Litigation Settlements

The Company is named from time to time as a party to product liability and contractual lawsuits in the normal course of business. The Company routinely assesses the likelihood of any adverse judgments or outcomes related to legal matters and claims, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after analysis of each known issue, historical experience, whether it is more likely than not that the Company shall incur a loss, and whether the loss is estimable. As of September 30, 2013, the Company had accrued approximately $0.1 million related to pending product liability and contractual lawsuits.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Caution Regarding Forward-Looking Statements

The following discussion should be read in conjunction with the attached condensed consolidated financial statements and notes thereto, and with our audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2012 as contained in our annual report on Form 10-K filed with the SEC on March 15, 2013. This quarterly report, including the following sections, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Throughout this report, and particularly in this Item 2, the forward-looking statements are based upon our current expectations, estimates and projections and reflect our beliefs and assumptions based upon information available to us at the date of this report. In some cases, you can identify these statements by words such as “may,” “might,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue,” and other similar terms. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties, and assumptions that are difficult to predict. Our actual results, performance or achievements could differ materially from those expressed or implied by the forward-looking statements. These forward-looking statements include, but are not limited to, statements relating to our future financial performance, the ability to grow our business, increase our revenue, manage expenses, generate additional cash, achieve and maintain profitability, develop and commercialize existing and new products and applications, and improve the performance of our worldwide sales and distribution network, and the outlook regarding long term prospects. These forward-looking statements involve risks and uncertainties. The cautionary statements set forth below and those contained in Part II, Item 1A – “Risk Factors” commencing on page 22 identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. We caution you to not place undue reliance on these forward-looking statements, which reflect management’s analysis and expectations only as of the date of this report. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Form 10-Q.

Introduction

The Management’s Discussion and Analysis, or MD&A, is organized as follows:

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Executive Summary. This section provides a general description and history of our business, a brief discussion of our product lines and the opportunities, trends, challenges and risks we focus on in the operation of our business.

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Critical Accounting Policies and Estimates. This section describes the key accounting policies that are affected by critical accounting estimates.

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Results of Operations. This section provides our analysis and outlook for the significant line items on our Consolidated Statements of Operations.

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Liquidity and Capital Resources. This section provides an analysis of our liquidity and cash flows, as well as a discussion of our commitments.

Executive Summary

Company Description.

We are a leading medical device company specializing in the research, development, manufacture, marketing and servicing of laser and other energy-based aesthetics systems for practitioners worldwide. We offer easy-to-use, products which enable physicians and other qualified practitioners to perform safe and effective aesthetic procedures, including vascular and benign pigmented lesions, hair-removal, skin rejuvenation, body contouring, skin resurfacing, tattoo removal and toenail fungus. Our platforms are designed to be easily upgradeable to add additional applications and hand pieces, which provide flexibility for our customers as they expand their practices. In addition to systems and upgrade revenue, we generate revenue from the sale of post warranty service contracts, providing services for products that are out of warranty, hand piece refills, and third-party manufactured dermal fillers and cosmeceuticals.

Our corporate headquarters and U.S. operations are located in Brisbane, California, from where we conduct our manufacturing, warehousing, research and development, regulatory, sales and marketing, service, and administrative activities. We market, sell and service our products through direct sales and service employees in the United States, Canada, Japan, France and Australia. Sales and Service outside of these direct markets are made through a worldwide distributor network in over 60 countries.

Products

Our Product revenue is derived from the sale of Products and upgrades, Service, Titan and truSculpt hand piece refills, and Dermal fillers and cosmeceuticals. Product revenue includes the sales of systems. A system consists of a console that incorporates a universal graphic user interface, a laser and/or other energy-based module, control system software, high voltage electronics and one or more hand pieces.

Our broad portfolio of Product brands include:

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ExcelVTM

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Xeo®

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GenesisPlusTM

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truSculptTM

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CoolGlide®

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Solera®

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myQTM

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VariLiteTM

We offer our 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, resulting in Upgrade revenue.  Service revenue relates to amortization of prepaid service contracts, direct billings for detachable hand piece replacements (except for Titan and truSculpt) and revenue for parts and labor on out-of-warranty products. For our Titan and truSculpt hand pieces, after a set number of treatments have been performed, the customer is required to send the hand piece back to the factory for refurbishment, which we refer to as “refilling” the hand piece. In Japan, we distribute Merz Pharma GmbH’s (“Merz”) Radiesse® dermal filler product and Obagi Medical Products, Inc.’s (“Obagi”) cosmeceutical products. We have entered into a contract with ZO Medical Health Inc. (“ZO”) and with effect from the fourth quarter of 2013, plan to discontinue sales of some of the Obagi cosmeceutical products in favor of comparable ZO products.

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Significant Business Trends

We believe that our ability to grow revenue will be primarily dependent on the following:

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Consumer demand for the application of our products.

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Continuing to expand our product offerings ─ both through internal development and sourcing from other vendors.

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Ongoing investment in our global sales and marketing infrastructure.

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Our ability to hire, train and retain sales and other key employees.

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Use of clinical results to support new aesthetic products and applications.

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Enhanced luminary development and reference selling efforts (to develop a location where our products can be displayed and used to assist in selling efforts).

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Marketing to physicians in the core dermatology and plastic surgeon specialties, as well as outside those specialties.

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Customer demand for our products.

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Generating ongoing revenue from our growing installed base of customers through the sale of Service, Upgrade, Titan and truSculpt hand piece refills, and Dermal fillers and cosmeceuticals.

Our U.S. revenue decreased by $795,000, or 10%, in the three-month period ended September 30, 2013, and decreased by $792,000, or 4%, in the nine-month period ended September 30, 2013, compared to the same periods in 2012. The decrease in the three and nine-month periods ended September 30, 2013, compared to the same periods 2012, was due primarily to a decline in the U.S. product revenue. These declines were due primarily to:

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Reduction in our GenesisPlus revenue due in part to the disruption caused by the reorganization and consolidation of the podiatry sales team into the general aesthetics sales force;

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Decline of our truSculpt product revenue during the quarter ended September 30, 2013, compared to the same period in 2012;

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Reduced productivity of our U.S. sales force, caused in part by field sales and sales management turnover; which was partially offset by

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Continued improvement in revenue from our ExcelV product.

Our international revenue decreased by $1.8 million, or 16%, in the three-month period ended September 30, 2013, and decreased by $1.6 million, or 5%, in the nine-month period ended September 30, 2013, compared to the respective periods in 2012. These revenue declines resulted primarily from lower sales in Canada, Australia and Japan, offset in part by higher revenue from several of our Asian and European distributor countries and our direct operations in France. The decline in the Japanese Yen versus the U.S. Dollar in each of the three quarters ended September 30, 2013, compared to the respective periods in 2012, was the primary driver of the reduced revenue sourced from our Japanese customers. In the three and nine month periods ended September 30, 2013, compared to the respective periods in 2012, our Japanese sourced revenue was negatively impacted by approximately $0.6 million and $1.4 million, respectively.

Significant changes in revenue by product category were:

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An increase in our worldwide Service revenue by 5% in the nine months ended September 30, 2013, compared to the same period in 2012. This was primarily due to an expanded customer base as well as there being nine months of service revenue for the Iridex aesthetic business in 2013, versus eight months in 2012, as the acquisition of the Iridex aesthetic business occurred in February 2012;

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A decline in our product and upgrade revenue as a result of reduced revenue from GenesisPlus by approximately $1.0 million in the three months and $2.8 million in the nine months ended September 30, 2013, compared to the same periods in 2012. In addition, our truSculpt revenue declined in the three months ended September 30, 2013. These declines were partialy offset by the continued improvement in revenue from our ExcelV product;

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Reduced revenue from Dermal filler and cosmeceutical products in Japan, due primarily to the decline in the Japanese Yen versus the U.S. Dollar;

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Decline in Titan and truSculpt refill revenue in the three and nine months ended September 30, 2013, due to decline in the Japanese Yen versus the U.S. Dollar as well as the repositioning of our truSculpt product. We have repositioned our truSculpt product to include hand piece refills to be covered as part of our system warranty and service contracts, enabling our customers unlimited hand piece refills.

Factors that May Impact Future Performance.

Our industry is impacted by numerous competitive, regulatory, macroeconomic and other significant factors. Our industry is highly competitive and our future performance depends on our ability to compete successfully. Additionally, our future performance is dependent upon our ability to continue to expand our product offerings, develop innovative technologies, obtain regulatory clearances for our products, protect the proprietary technology of our products and our manufacturing processes, manufacture our products cost-effectively, and successfully market and distribute our products in a profitable manner. If we fail to execute on the aforementioned initiatives, our business would be adversely affected. A detailed discussion of these and other factors that could impact our future performance are provided in Part II, Item 1A “Risk Factors” section below.

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Critical Accounting Policies and Estimates.

The preparation of our Condensed Consolidated Financial Statements and related disclosures in conformity with GAAP requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. These estimates, judgments and assumptions are based on historical experience and on various other factors that we believe are reasonable under the circumstances. We periodically review our estimates and make adjustments when facts and circumstances dictate. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected.

Critical accounting estimates, as defined by the SEC are those that are most important to the portrayal of our financial condition and results of operations and require our management’s most difficult and subjective judgments and estimates of matters that are inherently uncertain. The accounting policies and estimates that we consider to be critical, subjective, and requiring judgment in their application are summarized in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC on March 15, 2013. There have been no significant changes to the accounting policies and estimates disclosed in our Form 10-K.

Results of Operations

The following table sets forth selected consolidated financial data for the periods indicated, expressed as a percentage of total revenue, net. Percentages in this table and throughout our discussion and analysis of financial condition and results of operations may reflect rounding adjustments.

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Total Net Revenue

 

Discussion of Revenue by Product Type:

As explained in more detail in the Products section of the Executive Summary above, some of our products consist of a configurable system platform that includes a console and one or more hand pieces. Each product is configured to give our customers the ability to select the combination of platform and hand pieces that provides the applications that best fit their practice.

Product and upgrade revenue decreased by $2.1 million, or 17%, in the three-month period ended September 30, 2013, compared to the same period in 2012, and by $1.6 million, or 5%, in the nine-month period ended September 30, 2013, compared to the same period in 2012. The declines were attributable primarily to:

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Reduced revenue from GenesisPlus by approximately $1.0  million and $2.8  million in the three and nine months ended September 30, 2013, compared to the same periods in 2013, respectively, due in part to the distraction caused by the sales employee attrition in the podiatry sales team and the consolidation of the remaining podiatry sales employees into the aesthetic sales team;

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Decline in revenue due to the devaluation of the Japanese Yen versus the U.S. Dollar;

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Decline in our truSculpt product revenue during the quarter ended September 30, 2013, compared to the same period in 2012;

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Reduction in revenue from our legacy products caused in part by competitive pricing declines; which was offset partially by

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The continued improvement in revenue from our ExcelV product.

Our Titan and truSculpt hand piece refill revenue decreased by $299,000, or 24%, in the three-month period ended September 30, 2013, compared to the same period in 2012, and by $349,000, or 10%, in the nine-month period ended September 30, 2013, compared to the same period in 2012. This decrease was due primarily to declines in Titan hand piece refill revenue caused partially by reduced utilization and partly due to the decline in the Japanese Yen versus the U.S. Dollar, which was offset in part by an increase in revenue from truSculpt refills that started shipping from the fourth quarter ended December 31, 2012. Commencing with the third quarter of 2013 we have repositioned our truSculpt product to include hand piece refills to be covered as part of our system warranty and service contracts, enabling our customers unlimited hand piece refills.

Our dermal filler and cosmeceuticals revenue decreased by $255,000, or 19%, in the three-month period ended September 30, 2013, compared to the same period in 2012, and by $1.1 million, or 26%, in the nine-month period ended September 30, 2013, compared to the same period in 2012. This decrease was due primarily to the weakening of the Japanese Yen, versus the U.S. Dollar, and some volume discounting.

Our worldwide Service revenue increased by $50,000, or 1%, in the three-month period ended September 30, 2013, compared to the same period in 2012, and by $693,000, or 5%, in the nine-month period ended September 30, 2013, compared to the same period in 2012. This increase was primarily due to an expanded customer base as well as one additional month of service revenue in 2013 relating to the acquisition of the Iridex aesthetic business in February 2012.

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Discussion of Revenue by Geography:

Refer to the discussion of Revenue by Geography in Significant Business Trends above.

Gross Profit

		Three Months Ended September 30,												Nine Months Ended September 30,
(Dollars in thousands)		2013				% Change				2012				2013				% Change				2012
Gross profit		$	9,177				(13	%)		$	10,598			$	28,845				—	%		$	28,797
Gross margin (Gross profit as a percentage of total net revenue)			55	%							55	%			55	%							53	%

 

Our cost of revenue consists primarily of material, personnel expenses, royalty expense, warranty, amortization of intangibles and manufacturing overhead expenses.

Gross margin remained flat at 55% in the three-month period ended September 30, 2013, compared to the same period in 2012. The gross margin was 55% in the nine-month period ended September 30, 2013, compared to 53% for the same period in 2012. This improvement was due primarily to:

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a partial shift in product mix towards higher margin products;

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improved gross margin from our Service business, due primarily to reduced material expenses resulting from improved reliability of our products;

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results of cost reduction initiatives; and

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reduced amortization of intangibles related to the acquisition of Iridex’s aesthetic business.

Sales and Marketing

Sales and marketing expenses consist primarily of personnel expenses, expenses associated with customer-attended workshops and trade shows, post-marketing studies, and advertising. Sales and marketing expenses decreased by $460,000, and represented 39% of total net revenue, in the three-month period ended September 30, 2013, compared to 36% in the same period in 2012. The $460,000 decrease was due primarily to:

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$451,000 of decreased North American sales commission expenses, resulting from the reduced revenue;

·

$269,000 of decreased Japan expenses resulting primarily from the appreciation of the U.S. Dollar against the Japanese Yen; offset by

·

$213,000 of increased North American product demonstration, promotional and marketing expenses

Sales and marketing expenses decreased by $1.4 million, and represented 39% of total net revenue in the nine-month periods ended September 30, 2013 and 2012. The $1.4 million decrease was due primarily to:

·

$852,000 of decreased North American  sales commission expenses resulting from the reduced revenue;

·

$615,000 of decreased Japan expenses resulting primarily from the appreciation of the U.S. Dollar against the Japanese Yen.

Research and Development (R&D)

R&D expenses consist primarily of personnel expenses, clinical research, regulatory and material costs. R&D expenses increased by $223,000, and represented 15% of total net revenue, in the three-month period ended September 30, 2013, compared to 11% for the same period in 2012. The increase was due primarily to:

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·

$555,000 of increased material spending, which is project timing dependent, related to new product development; partially offset by

·

$315,000 of decreased personnel related expenses.

R&D expenses increased by $473,000, and represented 13% of total net revenue, in the nine-month period ended September 30, 2013 compared to 12% in the same period in 2012. The increase was due primarily to:

·

$803,000 of increased material spending, which is project timing dependent, related to new product development; partially offset by

·

$349,000 of decreased personnel related expenses.

General and Administrative (G&A)

G&A expenses consist primarily of personnel expenses, legal fees, accounting, audit and tax consulting fees, U.S. medical device excise tax (from January 1, 2013) and other general and administrative expenses. G&A expenses decreased $315,000, and represented 13% of total net revenue, in the three-month periods ended September 30, 2013 and 2012. This decrease was due primarily to $285,000 of decreased variable personnel related expenses.

G&A expenses decreased $2.0 million, and represented 13% of total net revenue, in the nine-month period ended September 30, 2013, compared to 16% for the same period in 2012. This decrease was due primarily to:

·

$644,000 of decreased variable personnel related expenses;

·

$600,000 of decrease legal fees and expenses;

·

$527,000 of non-recurring acquisition related expenses incurred in first quarter of 2012;

·

$360,000 of decreased accounting fees; partially offset by

·

$213,000 increase in expenses due to the commencement of the U.S. medical device excise tax from January 1, 2013.

Interest and Other Income, Net

 

Interest and other income, net consist of the following:

Interest and other income, net, decreased $12,000 for the three-month period ended September 30, 2013, and decreased by $42,000 for the nine-month period ended September 30, 2013, compared to the same periods in 2012. The decreases in both the three-month and nine-month periods ended September 30, 2013, compared to the same periods in 2012, are primarily attributable to a reduction in the invested cash balance.

Provision (Benefit) for Income Taxes

For the three-month periods ended September 30, 2013 and 2012, we recorded an income tax benefit of $169,000 and $64,000, respectively. For the nine-month period ended September 30, 2013, we recorded an income tax benefit of $97,000, compared to an income tax expense of $122,000 for the same period in 2012. Our income tax benefit for the three and nine-month periods ended September 30, 2013 was primarily attributable to a release of uncertain tax position reserves, partially offset by income taxes of our international operations. Our income tax benefit for the three-month period ended September 30, 2012 was primarily related to gains and losses on marketable and long term investments recorded in other comprehensive loss partially offset by income taxes of our international operations.  Our tax expense for the nine-month period ended September 30, 2012 was primarily related to income taxes of our international operations partially offset by benefits for income taxes related to gains and losses on marketable and long term investments recorded in other comprehensive loss.

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Liquidity and Capital Resources

Liquidity is the measurement of our ability to meet potential cash requirements, fund the planned expansion of our operations and acquire businesses. Our sources of cash include operations and stock option exercises. We actively manage our cash usage and investment of liquid cash to ensure the maintenance of sufficient funds to meet our daily needs. The majority of our cash and investments are held in U.S. banks and our foreign subsidiaries maintain a limited amount of cash in their local banks to cover their short-term operating expenses.

Cash, Cash Equivalents and Marketable Investments

The following table summarizes our cash and cash equivalents, marketable investments and long-term investments:

Cash Flows

Cash Flows from Operating Activities

Net cash generated by operating activities in the nine-month period ended September 30, 2013 was $1.1 million, which was due primarily to:

·

$1.1 million used due to the net loss of $4.5 million, after adjusting for non-cash related items of $3.4 million consisting primarily of stock-based compensation expense of $2.4 million and depreciation and amortization expenses of $973,000;

·

$1.9 million used to pay down the high year-end balance relating primarily to personnel expenses associated with a strong fourth quarter revenue and profit position; offset by

·

$1.9 million generated by an increase in deferred service revenue, resulting primarily from the sale of service contracts to an increasing installed base of customers;

·

$1.4 million generated from the collection of cash from the high accounts receivable balance as of December 31, 2012; and

·

$693,000 generated by a reduction in inventories.

Net cash used in operating activities in the nine-month period ended September 30, 2012 was $6.0 million, which was due primarily to:

·

$4.2 million used due to the net loss of $7.6 million, after adjusting for non-cash related items of $3.4 million consisting primarily of stock-based compensation expense of $2.3 million and depreciation and amortization expenses of $1.2 million;

·

$2.7 million used as a result of an increase in accounts receivable, primarily due to higher revenue, which was within normal payment terms;

·

$276,000 used to reduce accounts payable;

·

$196,000 used to increase inventory relating primarily to higher raw materials and finished goods associated with our increased revenue levels and higher demonstration inventories as a result of increased sales personnel;

·

$163,000 used to reduce accrued liabilities; offset by

·

$905,000 generated by an increase in deferred service revenue primarily as a result of the Iridex acquisition; and

·

$717,000 generated by a reduction of other current assets, primarily relating to a $728,000 reduction in discounts and purchased interest with respect to our marketable investments.

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Cash Flows from Investing Activities

We used net cash of $6.5 million in our investing activities in the nine-month period ended September 30, 2013, which was attributable primarily to:

We generated net cash of $15.5 million from investing activities in the nine-month period ended September 30, 2012, which was attributable primarily to:

·

$60.1 million in net proceeds from the sales and maturities of marketable investments; partially offset by

·

$39.9 million of cash used to purchase marketable investments; and

·

$5.1 million of cash used for the Iridex acquisition.

Cash Flows from Financing Activities

Net cash used in financing activities was $3.0 million in the nine-month period ended September 30, 2013, which was primarily due to:

·

the repurchase of common stock for $7.6 million, partially offset by

·

proceeds from the issuance of common stock due to employees exercising their stock options and shares issued pursuant to our employee stock purchase plan of $4.6 million.

Net cash provided by financing activities was $812,000 in the nine-month period ended September 30, 2012, which primarily resulted from the issuance of common stock due to employees exercising their stock options and shares issued pursuant to our employee stock purchase plan.

Adequacy of cash resources to meet future needs

We had cash, cash equivalents, and marketable investments, of $82.3 million as of September 30, 2013. For the first nine months of 2013, we financed our operations through the sales and maturities of marketable investments and cash from the sale of stock due to employees exercising their stock options and shares issued pursuant to our employee stock purchase plan. We believe the existing capital resources, including cash and cash equivalents and marketable investments of $82.3 million, are sufficient to meet our operating and capital requirements for the next several years, as well as repurchase up to the remaining $12.4 million of our stock pursuant to the $20 million share buy-back program approved by our Board.

Except for the recent trend of cash used to fund our operating activities, purchase fixed assets and repurchase our common stock, we are unaware of any other known trends or any known demands, commitments, events or uncertainties, including collectability of our accounts receivable, that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way.

Commitments and Contingencies

There have been no material changes to our commitments and contingencies from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 15, 2013, except for those noted in Legal Proceedings in Part II, Item 1 below.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes to our market risks from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 15, 2013, except for the following.

We do not actively hedge our exposure to currency rate fluctuations. While we transact business primarily in U.S. Dollars, and a significant proportion of our revenue is denominated in U.S. Dollars, a portion of our costs and revenue is denominated in other currencies, such as the Euro, Japanese Yen, Australian Dollar and Canadian Dollar. As a result, changes in the exchange rates of these currencies to the U.S. Dollar will affect our results from operations.

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In the three and nine-month periods ended September 30, 2013, versus the same periods in 2012, the average exchange rate of the Japanese Yen versus the U.S. Dollar declined by approximately 26% and 22%, respectively. While the effect of this foreign exchange rate decline was not significant to our net operating results, it negatively impacted our Japanese Yen denominated revenue, which was offset by a favorable impact on our cost of goods sold and operating expenses.

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Attached as exhibits to this Quarterly Report are certifications of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (“Exchange Act”). This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications, and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.

We conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in the Rules 13a-15(e) and 15d-15(e) under the Exchange Act) (“Disclosure Controls”) as of the end of the period covered by this Report required by Exchange Act Rules 13a-15(b) or 15d-15(b). The controls evaluation was conducted under the supervision and with the participation of our management, including the CEO and CFO. Based on this evaluation, the CEO and CFO have concluded that as of the end of the period covered by this report the disclosure controls and procedures were effective at a reasonable assurance level.

Definition of Disclosure Controls

Disclosure Controls are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Exchange Act, such as this Report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure Controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Our Disclosure Controls include components of internal control over financial reporting, which consists of control processes designed to provide reasonable assurance regarding the reliability of its financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles in the U.S. To the extent that components of our internal control over financial reporting are included within Disclosure Controls, they are included in the scope of our annual controls evaluation.

Limitations on the Effectiveness of Controls

Our management, including the CEO and CFO, does not expect that our disclosure controls or internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

We are named from time to time as a party to product liability and contractual lawsuits in the normal course of business. We routinely assess the likelihood of any adverse judgments or outcomes related to legal matters and claims, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after analysis of each known issue, historical experience, whether it is more likely than not that we shall incur a loss, and whether the loss is estimable. As of September 30, 2013, we had accrued approximately $0.1 million related to pending product liability and contractual lawsuits.

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ITEM 1A.

RISK FACTORS

We operate in a rapidly changing economic and technological environment that presents numerous risks, many of which are driven by factors that we cannot control or predict. The following discussion, as well as our discussion in Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 7), highlights some of these risks. The risks described below are not exhaustive and you should carefully consider these risks and uncertainties before investing in our securities.

 

In the three- and nine-month periods ended September 30, 2013, our U.S. revenue decreased by approximately 10% and 4% respectively, compared to the same periods in 2012. Unless our U.S. revenue improves, we could experience a material adverse effect on our total revenue, profitability, employee retention and stock price.

 

Though our U.S. quarterly revenue grew in the nine quarters ended March 31, 2013, compared to the respective quarters in the prior years, it declined by 2% in the second quarter and 10% in the third quarter of 2013, compared to the same periods in 2012. Our U.S. revenue has continued to decline due to several factors, including:

 

·

Lower product and upgrade average selling prices (“ASPs”) as a result of customers purchasing fewer applications for systems and lower pricing resulting from competitive discounting.

·

In the nine months ended September 30, 2013, due in part to the softness experienced in the Podiatry market into which we sell our GenesisPlus product, we experienced turnover in our specialty podiatry sales force. As a result, our revenue from this product line declined and we have consolidated the sales employees into our aesthetic products sales group.

·

Historically, following a new product introduction, we experienced revenue growth, compared to the same period in the prior year. However, even though we have experienced increased revenue from our ExcelV and truSculpt products, this revenue increase has not offset declines in some of our legacy product and upgrade business, as well as the lower ASPs.

·

Sales force turnover was a distraction and negatively impacted our revenue and employee productivity in the three and nine months ended September 30, 2013.

There can be no assurance that we will continue to introduce new products each year, or that the new product introductions will translate into increased revenue in the long term in the U.S, or that the new direct sales employees and management hired to replace the recently departed sales employees will be effective and result in improved sales productivity. Further, if the current economic recovery does not continue, or there is another recession in the U.S., our future revenue would be adversely impacted.

 

If our U.S. revenue does not improve, we could experience a material adverse effect on our total revenue, profitability, employee retention and stock price.

 

In the past five years we have only had two profitable quarters and we are unable to predict whether we will return to sustained quarterly profits in the future.

 

Although we had a profitable fourth quarter in 2009 and 2012, in the first three quarters of 2013 we had a net loss. There is no guarantee that we will be profitable in the future and you should not rely on our operating results for any prior quarterly or annual periods as an indication of our future operating performance. Any predictions about the performance of our operations in the future may not be as accurate as they could be if we had a longer history of sales from some of our newer products. For example, we launched our truSculpt product in August 2012 and we have not been able to gain the market share in this market to the degree we had expected. We are making several product improvements, adding new applicators to this platform and plan to seek additional regulatory approvals for new indications for this product to address the shortfall in expected revenue. If our revenue from the truSculpt product does not improve, our overall revenue may be adversely affected and we may not be able to become profitable in future quarters.

 

Our ability to sustain profitability depends on the extent to which we can increase revenue and control our costs in order to, among other things, counter any unforeseen difficulties, complications, product delays or other unknown factors that may require additional expenditures. Because of the numerous risks and uncertainties associated with our growth prospects, product development, sales and marketing and other efforts, we are unable to predict the extent of our future profitability or losses. If our revenue does not achieve adequate growth in the future, we may continue to incur a quarterly net loss and consume cash in our operations.

 

We rely heavily on our sales professionals to market and sell our products worldwide. If we are unable to hire, effectively train, manage, improve the productivity of, and retain the sales professionals, our business will be harmed, which would impair our future revenue and profitability.

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Our success largely depends on our ability to hire, train, manage and improve the productivity levels of our sales professionals worldwide. Because of our focus on the non-core market in the past, several of our sales professionals do not have established relationships with core market physicians (dermatologists and plastic surgeons) or where those relationships exist, they are not very strong. Our Vice President of North American Sales and our Regional Sales Manager in Canada recently left our Company and we experienced turnover in our specialty podiatry sales force, both of which impacted the revenue we derived from our products and upgrades in the three and nine-month periods ended September 30, 2013.

 

We have once again restructured our direct sales force, sales management and are in the process of increasing the number of direct sales employees in North America in response to our revenue results and changes in our sales organization.  For example, we recently consolidated our specialty podiatry sales force into our larger aesthetic sales team. However, due to the recent U.S. direct sales and management turnover in the nine months ended September 30, 2013, we had a number of vacant sales territories and are in the process of replacing the recently departed sales employees. This turnover negatively impacted our revenue and employee productivity in the three and nine months ended September 30, 2013. We are increasing our efforts to hire high quality experienced sales professionals but there can be no guarantee that we will be able to locate and employ such qualified individuals. Our industry is characterized by a few established companies that compete vigorously for talented sales professionals. Further, as the economy in North America has rebounded from the recent recession years, some of those sales professionals have left our Company for jobs that they perceive to be better opportunities both within and outside of the aesthetic industry.

 

We previously experienced significant turnover of our European sales team. In the fourth quarter of 2011 we shut down our direct sales office in Switzerland and in the first quarter of 2012 we shut down our Spain and U.K. operations. While we continue to have a direct sales and service organization in France, a significant portion of our European revenue is generated through our network of distributors. As we restructure parts of our European business towards a more distributor focus, there can be no assurance given that these initiatives will result in improved European-sourced revenue or profitability in the future.

 

We train our existing and recently recruited sales professionals to better understand our existing and new product technologies and how they can be positioned against our competitors’ products. These initiatives are intended to improve the productivity of our sales professionals, our revenue and profitability. It takes time for the sales professionals to become productive following their training and there can be no assurance that the recently recruited sales professionals will be adequately trained in a timely manner, or our direct sales productivity will improve, or that we will not experience significant levels of attrition in the future. If we are not able to improve the productivity and retention of our North American and international sales professionals, then our total revenue, profitability and stock price may be adversely impacted.

 

Measures we implement in an effort to retain, train and manage our sales professionals, strengthen their relationships with core market physicians, and improve their productivity may not be successful and may instead contribute to instability in our operations, additional departures from our sales organization, or further reduce our revenue and harm our business.

 

If our revenue does not continue to improve, or if our cost of revenue and/ or operating expenses increase by a greater percentage than our revenue, our gross margins and operating margins may be adversely impacted, our loss from operations will increase, and our cash used in operating activities will increase, which could reduce our assets and have a material adverse effect on our stock price.

 

Our gross margin (revenue less cost) improved to 55% in the nine-month period ended September 30, 2013, compared to 53% for the same period in 2012. Our gross margin is impacted by the revenue that we generate and the costs incurred to generate the revenue. To the extent that our revenue declines, it is difficult to improve our gross margins as our fixed costs must be spread over a lower revenue base. Our future revenue may be adversely affected by a number of factors including, the competitive market environment in which we operate, which may result in a decrease in the number of units sold, a decrease in the number of applications per system purchased by customers, a decrease in the average selling prices achieved for our product sales, a shift in our product mix towards products with lower average selling prices, or a shift in our product mix towards products with lower margin.

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Our cost of revenue may also be adversely impacted by various factors such as obsolescence of our inventory, increased expenses associated with repairing defective products covered by our warranty program, utilization of our relatively fixed manufacturing costs, and a shift in our product mix towards products that have a higher cost of manufacturing.

 

We have also been investing significant resources in our research and development and sales and marketing activities. We expanded our global direct sales force to 62 employees at September 30, 2013, from 54 at December 31, 2012. While we have added sales and marketing personnel, it may take time before our new sales professionals become productive and for the revenue that they generate to become accretive to our operating income. We plan to continue making such investments in order to bring new products to market and to distribute them effectively. If these investments do not yield in increased revenue, we may continue to generate losses and consume cash.

 

If our revenue does not improve, or if our cost of revenue increases by a greater percentage than our revenue, or if we are not able to reduce expenses in the event of a decline in revenue, we may continue to generate losses from operations and use cash, which could reduce our assets and have a material adverse effect on our operations and stock price.

 

The aesthetic equipment market is characterized by rapid innovation. To compete effectively, we must develop and/or acquire new products, market them successfully, and identify new markets for our technology.

 

We have created products to apply our technology to body contouring, hair removal, treatment of veins and skin rejuvenation, including the treating of diffuse redness, skin laxity, fine lines, wrinkles, skin texture, pore size and pigmented lesions, etc. In 2012, we launched truSculpt for the body contouring market and acquired VariLite for vascular and pigmented lesions. In 2011, we launched our vascular laser product – ExcelV – and began distribution of a Q-switched laser in Japan that Cutera is sourcing from a third party OEM for superficial and deep pigmented lesions (i.e., melasma), skin rejuvenation, laser skin toning and tattoo removal. Currently, these applications represent the majority of offered laser and other energy-based aesthetic procedures. In addition, since the first quarter of 2010, we have been distributing cosmeceuticals and dermal fillers in the Japanese market. To grow in the future, we must continue to develop and/or acquire new and innovative aesthetic products and applications, identify new markets, and successfully launch the newly acquired or developed product offerings.

 

To successfully expand our product offerings, we must, among other things:

 

 

Historically, product introductions have been a significant component of our financial performance. To be successful in the aesthetics industry, we need to continue to innovate. Our business strategy has therefore been based, in part, on our expectation that we will continue to increase our product offerings. We need to continue to devote substantial research and development resources to make new product introductions, which can be costly and time consuming to our organization.

 

We also believe that, to increase revenue from sales of new products, we need to continue to develop our clinical support, further expand and nurture relationships with industry thought leaders and increase market awareness of the benefits of our new products. However, even with a significant investment in research and development, we may be unable to continue to develop, acquire or effectively launch and market new products and technologies regularly, or at all. If we fail to successfully commercialize new products, our business may be harmed.

 

While we attempt to protect our products through patents and other intellectual property, there are few barriers to entry that would prevent new entrants or existing competitors from developing products that compete directly with ours. We expect that any competitive advantage we may enjoy from current and future innovations may diminish over time as companies successfully respond to our, or create their own, innovations. Consequently, we believe that we will have to continuously innovate and improve our products and technology to compete successfully. If we are unable to innovate successfully, our products could become obsolete and our revenue could decline as our customers and prospects purchase our competitors’ products.

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Demand for our products in any of our markets could be weakened by several factors, including:

 

 

If we do not achieve anticipated demand for our products, it could have a material adverse effect on our total revenue, profitability, employee retention and stock price.

 

Macroeconomic political and market conditions, and catastrophic events may adversely affect our business, results of operations, financial condition and stock price.

 

Our business is influenced by a range of factors that are beyond our control, including:

 

Macroeconomic developments like the global recession and the debt crisis in the U.S. and certain countries in the European Union, could negatively affect our business, operating results or financial condition which, in turn, could adversely affect our stock price. A general weakening of, and related declining corporate confidence in, the global economy or the curtailment in government or corporate spending could cause current or potential customers to reduce their budgets or be unable to fund product or upgrade application purchases, which could cause customers to delay, decrease or cancel purchases of our products and services or cause customers not to pay us or to delay paying us for previously purchased products and services.

 

In addition, political unrest in regions like the Middle East, terrorist attacks around the globe and the potential for other hostilities in various parts of the world, potential public health crises and natural disasters continue to contribute to a climate of economic and political uncertainty that could adversely affect our results of operations and financial condition, including our revenue growth and profitability. For example, the March 2011 earthquake and tsunami and other collateral events in Japan adversely affected the demand for our products and services in the Japanese market.

 

Macroeconomic declines, negative political developments, adverse market conditions and catastrophic events may cause a decline in our revenue, negatively affect our operating results, adversely affect our cash flow and could result in a decline in our stock price.

 

To successfully market and sell our products internationally, we must address many issues that are unique to our international business.

 

International revenue represented 60% of our total revenue for the nine-month periods ended September 30, 2013 and 2012. International revenue is a material component of our business strategy. We depend on third-party distributors and a direct sales force to sell our products internationally, and if they underperform, we may be unable to increase or maintain our level of international revenue.

 

We have experienced significant turnover of our European sales team in the past. While we continue to have a direct sales and service organization in France, significant portion of our European revenue is generated through our network of distributors. As we restructure parts of our European business towards a more distributor focus, there can be no assurance given that these initiatives will result in improved European-sourced revenue or profitability in the future

 

To grow our business, we will need to improve productivity in current sales territories and expand into new territories. However, direct sales productivity may not improve and distributors may not accept our business or commit the necessary resources to market and sell our products to the level of our expectations. If we are not able to increase or maintain international revenue growth, our total revenue, profitability and stock price may be adversely impacted.

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We believe, as we continue to manage our international operations and develop opportunities in additional international territories, our international revenue will be subject to a number of risks, including:

 

 

If one or more of these risks were realized, it could require us to dedicate significant resources to remedy the situation; and if we were unsuccessful at finding a solution, we may not be able to sell our products in a particular market and, as a result, our revenue may decline.

 

We are subject to fluctuations in the exchange rate of the U.S. dollar and foreign currencies.

 

Foreign currency fluctuations could result in volatility of our revenue. We do not actively hedge our exposure to currency rate fluctuations. While we transact business primarily in U.S. Dollars, and a significant proportion of our revenue is denominated in U.S. Dollars, a portion of our costs and revenue is denominated in other currencies, such as the Euro, Japanese Yen, Australian Dollar and Canadian Dollar. As a result, changes in the exchange rates of these currencies to the U.S. Dollar will affect our results from operations. For example, as a result of the recent strengthening of the U.S. Dollar, relative to many other major currencies, our products priced in U.S. dollars have become more expensive relative to products of our foreign competitors. In addition, our revenue earned in foreign currencies, such as our locally generated revenue in Japan, has been negatively impacted upon translation into U.S. dollars. Both these factors had a negative impact on our international revenue for the three and nine months ended September 30, 2013, compared to the same period in 2012.

 

Future foreign currency fluctuations could adversely impact and increase the volatility of our revenue, profitability and stock price.

 

Our ability to effectively compete and generate additional revenue from new and existing products depend upon our ability to distinguish our company and our products from our competitors and their products, and to develop and effectively market new and existing products. Our success is dependent on many factors, including the following:

 

 

To compete effectively, we have to demonstrate that our new and existing products are attractive alternatives to other devices and treatments, by differentiating our products on the basis of such factors as innovation, performance, brand name, service, and price. This is difficult to do, especially in a crowded aesthetic market. Some of our competitors have newer or different products and more established customer relationships than we do, which could inhibit our market penetration efforts. For example, we have encountered, and expect to continue to encounter, situations where, due to pre-existing relationships, potential customers decided to purchase additional products from our competitors. Potential customers also may need to recoup the cost of products that they have already purchased from our competitors and may decide not to purchase our products, or to delay such purchases.

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If we are unable to increase our market penetration or compete effectively, our revenue and profitability will be adversely impacted.

 

We compete against companies that offer alternative solutions to our products, or have greater resources, a larger installed base of customers and broader product offerings than ours. If we are not able to effectively compete with these companies, it may harm our business.

 

Our industry is subject to intense competition. Our products compete against similar products offered by public companies, such as Cynosure, Elen (in Italy), Solta, Syneron, as well as private companies such as Alma, Lumenis, Sciton and several other companies. Recently, there has been consolidation in the aesthetic industry leading to companies combining their resources. For example, Cynosure acquired Palomar in June 2013 and the aesthetic laser business of HOYA ConBio in June 2011; Syneron acquired Ultrashape in March 2012 and Candela in September 2009; we acquired the aesthetic business unit of Iridex in February 2012; and Solta (previously Thermage) acquired Aesthera in February 2010 and Reliant in December 2008. We are likely to compete with new companies in the future. Competition with these companies could result in reduced selling prices, reduced profit margins and loss of market share, any of which would harm our business, financial condition and results of operations.

 

The energy-based aesthetic market faces competition from non-energy-based medical products, such as Botox, an injectable compound used to reduce wrinkles, and collagen injections. Other alternatives to the use of our products include electrolysis, a procedure involving the application of electric current to eliminate hair follicles, and chemical peels. We may also face competition from manufacturers of pharmaceutical and other products that have not yet been developed.

 

If there is not sufficient consumer demand for the procedures performed with our products, practitioner demand for our products could be inhibited, resulting in unfavorable operating results and reduced growth potential.

 

Continued expansion of the global market for laser and other-energy-based aesthetic procedures is a material assumption of our business strategy. Most procedures performed using our products are elective procedures not reimbursable through government or private health insurance, with the costs borne by the patient. The decision to utilize our products may therefore be influenced by a number of factors, including:

 

 

If, as a result of these factors, there is not sufficient demand for the procedures performed with our products, practitioner demand for our products could be reduced, which could have a material adverse effect on our business, financial condition, revenue and result of operations.

 

Healthcare reform legislation could adversely affect our future profitability and financial condition.

 

In December 2009, the President and members of Congress passed legislation relating to healthcare reform. Our products are not reimbursed by insurance companies or federal or state governments and some of this legislation will, therefore, not affect us.

 

However, beginning in the first quarter of 2013, medical device manufacturers have to pay an excise tax of 2.3% on certain U.S. medical device revenues. Though there are some exceptions, this excise tax applies to all of our product and upgrade revenue from the U.S. and will continue to have an adverse effect on our operating profitability and financial condition.

 

The U.S. Food and Drug Administration (the “FDA”), state authorities and international regulatory bodies have broad enforcement powers. If we fail to comply with applicable regulatory requirements, it could result in enforcement action by the FDA, state agencies or international regulatory bodies.

 

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If we fail to comply with any of the applicable regulatory requirements of the FDA, or state, or one of the international regulatory bodies, it could result in enforcement action by the agencies, which may include any of the following sanctions:

 

 

If we fail to obtain or maintain necessary FDA clearances for our products and indications, if clearances for future products and indications are delayed or not issued, if there are federal or state level regulatory changes or if we are found to have violated applicable FDA marketing rules, our commercial operations would be harmed.

 

Our products are medical devices that are subject to extensive regulation in the United States by the FDA for manufacturing, labeling, sale, promotion, distribution and shipping. Before a new medical device, or a new use of or labeling claim for an existing product, can be marketed in the United States, it must first receive either 510(k) clearance or pre-marketing approval from the FDA, unless an exemption applies. Either process can be expensive and lengthy. In the event that we do not obtain FDA clearances or approvals for our products, our ability to market and sell them in the United States and revenue derived from there may be adversely affected.

 

Medical devices may be marketed in the United States only for the indications for which they are approved or cleared by the FDA. For example, up until April 2011 our recently introduced GenesisPlus product had a number of general indications for use in the U.S. that allowed us to market the product in the U.S.; however we could only market it internationally for the treatment of toenail fungus as it has a CE Mark approval. In April 2011, we received FDA clearance to market GenesisPlus in the U.S. for the clearance of nails that are infected with toenail fungus. Another example is our Pearl Fractional product which is cleared only for skin resurfacing in the U.S. and our Titan product only for deep heating for the temporary relief of muscle aches and pains in the U.S. Therefore, we are prevented from promoting or advertising Titan and Pearl Fractional in the United States for any other indications. If we fail to comply with these regulations, it could result in enforcement action by the FDA which could lead to such consequences as warning letters, adverse publicity, criminal enforcement action and/or third-party civil litigation, each of which could adversely affect us.

 

We have obtained 510(k) clearance for the indications for which we market our products. However, our clearances can be revoked if safety or effectiveness problems develop. We also are subject to Medical Device Reporting regulations, which require us to report to the FDA if our products cause or contribute to a death or serious injury, or malfunction in a way that would likely cause or contribute to a death or serious injury. Our products are also subject to state regulations, which are, in many instances frequently changing. Changes in state regulations may impede sales. For example, federal regulations allow our products to be sold to, or on the order of, “licensed practitioners,” as determined on a state-by-state basis. As a result, in some states, non-physicians may legally purchase our products. However, a state could change its regulations at any time, thereby disallowing sales to particular types of end users. We cannot predict the impact or effect of future legislation or regulations at the federal or state levels.

 

Federal regulatory reforms and changes occurring at the FDA could adversely affect our ability to sell our products profitably and financial condition.

 

From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing the clearance or approval, manufacture and marketing of a device. It is impossible to predict whether legislative changes will be enacted or FDA regulations, guidance or interpretations changed, and what the impact of such changes, if any, may be.

 

In addition, FDA regulations and guidance are often revised or reinterpreted by the agency in ways that may significantly affect our business and our products. Changes in FDA regulations may lengthen the regulatory approval process for medical devices and require additional clinical data to support regulatory clearance for the sale and marketing of our new products. In addition, it may require additional safety monitoring, labeling changes, restrictions on product distribution or use, or other measures after the introduction of our products to market. Either of these changes lengthen the duration to market, increase our costs of doing business, adversely affect the future permitted uses of approved products, or otherwise adversely affect the market for our products.

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If we fail to comply with the FDA’s Quality System Regulation and laser performance standards, our manufacturing operations could be halted, and our business would suffer.

 

We are currently required to demonstrate and maintain compliance with the FDA’s Quality System Regulation (the “QSR”). The QSR is a complex regulatory scheme that covers the methods and documentation of the design, testing, control, manufacturing, labeling, quality assurance, packaging, storage and shipping of our products. Because our products involve the use of lasers, our products also are covered by a performance standard for lasers set forth in FDA regulations. The laser performance standard imposes specific record-keeping, reporting, product testing and product labeling requirements. These requirements include affixing warning labels to laser products, as well as incorporating certain safety features in the design of laser products. The FDA enforces the QSR and laser performance standards through periodic unannounced inspections. We had a full quality system audit in 2008 and an FDA audit of compliance with laser performance standards in 2010 and a full quality system audit plus laser performance standard audit in August 2011 and a full quality system audit in October 2012. There were no significant findings as a result of these audits and our responses have been accepted by the FDA. Our failure to take satisfactory corrective action in response to an adverse QSR inspection or our failure to comply with applicable laser performance standards could result in enforcement actions, including a public warning letter, a shutdown of our manufacturing operations, a recall of our products, civil or criminal penalties, or other sanctions, such as those described in the preceding paragraph, which would cause our sales and business to suffer.

 

If we modify one of our FDA-approved devices, we may need to seek re-approval, which, if not granted, would prevent us from selling our modified products or cause us to redesign our products.

 

Any modifications to an FDA-cleared device that would significantly affect its safety or effectiveness or that would constitute a major change in its intended use would require a new 510(k) clearance or possibly a pre-market approval. For example, we designed a larger 40cm² hand piece for our truSculpt product and had to get that approved by the FDA before we could market it, which approval was received in January 2012. We may not be able to obtain additional 510(k) clearance or pre-market approvals for new products or for modifications to, or additional indications for, our existing products in a timely fashion, or at all. Delays in obtaining future clearance would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our revenue and future profitability.

 

We have made modifications to our devices in the past and may make additional modifications in the future that we believe do not or will not require additional clearance or approvals. If the FDA disagrees, and requires new clearances or approvals for the modifications, we may be required to recall and to stop marketing the modified devices, which could harm our operating results and require us to redesign our products.

 

We may be unable to obtain or maintain international regulatory qualifications or approvals for our current or future products and indications, which could harm our business.

 

Sales of our products outside the United States are subject to foreign regulatory requirements that vary widely from country to country. In addition, exports of medical devices from the United States are regulated by the FDA. Complying with international regulatory requirements can be an expensive and time-consuming process and approval is not certain. The time required for obtaining clearance or approvals, if required by other countries, may be longer than that required for FDA clearance or approvals, and requirements for such clearances or approvals may significantly differ from FDA requirements. We may be unable to obtain or maintain regulatory qualifications, clearances or approvals in other countries. We may also incur significant costs in attempting to obtain and in maintaining foreign regulatory approvals or qualifications. If we experience delays in receiving necessary qualifications, clearances or approvals to market our products outside the United States, or if we fail to receive those qualifications, clearances or approvals, we may be unable to market our products or enhancements in international markets effectively, or at all, which could have a material adverse effect on our business and growth strategy.

 

Any defects in the design, material or workmanship of our products may not be discovered prior to shipment to customers, which could materially increase our expenses, adversely impact profitability and harm our business.

 

The design of our products is complex. To manufacture them successfully, we must procure quality components and employ individuals with a significant degree of technical expertise. If our designs are defective, or the material components used in our products are subject to wearing out, or if suppliers fail to deliver components to specification, or if our employees fail to properly assemble, test and package our products, the reliability and performance of our products will be adversely impacted. As an example, in 2010, we incurred significant expenses for the voluntary recall of our Titan XL hand pieces.

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If our products contain defects that cannot be repaired easily, inexpensively, or on a timely basis, we may experience:

 

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Damage to our brand reputation;

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Loss of customer orders and delay in order fulfillment;

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Increased costs due to product repair or replacement;

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Inability to attract new customers;

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Diversion of resources from our manufacturing and research and development departments into our service department; and

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Legal action.

The occurrence of any one or more of the foregoing could materially increase expenses, adversely impact profitability and harm our business.

 

We depend on skilled and experienced personnel to operate our business effectively. If we are unable to recruit, hire, train and retain these employees, our ability to manage and expand our business will be harmed, which would impair our future revenue and profitability.

 

Our success largely depends on the skills, experience and efforts of our officers and other key employees. Except for Change of Control and Severance Agreements for our executive officers and one key employee, we do not have employment contracts with any of our officers or other key employees. Any of our officers and other key employees may terminate their employment at any time. We do not have a succession plan in place for each of our officers and key employees. In addition, we do not maintain “key person” life insurance policies covering any of our employees. The loss of any of our senior management team members could weaken our management expertise and harm our business.

 

Our ability to retain our skilled labor force and our success in attracting and hiring new skilled employees are critical factors in determining whether we will be successful in the future. We may not be able to meet our future hiring needs or retain existing personnel. The staff we hire to perform administrative functions may be become stretched due to our increased growth and they may not be able to perform their jobs effectively or efficiently as a result.

 

We may face particularly significant challenges and risks in hiring, training, managing and retaining engineering and sales and marketing employees. Failure to attract, train and retain personnel, particularly technical and sales and marketing personnel, would materially harm our ability to compete effectively and grow our business.

 

Product liability suits could be brought against us due to a defective design, material or workmanship or misuse of our products and could result in expensive and time-consuming litigation, payment of substantial damages and an increase in our insurance rates.

 

If our products are defectively designed, manufactured or labeled, contain defective components or are misused, we may become subject to substantial and costly litigation by our customers or their patients. Misusing our products or failing to adhere to operating guidelines could cause significant eye and skin damage, and underlying tissue damage. In addition, if our operating guidelines are found to be inadequate, we may be subject to liability. We have been involved, and may in the future be involved, in litigation related to the use of our products. Product liability claims could divert management’s attention from our core business, be expensive to defend and result in sizable damage awards against us. We may not have sufficient insurance coverage for all future claims. We may not be able to obtain insurance in amounts or scope sufficient to provide us with adequate coverage against all potential liabilities. Any product liability claims brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing continuing coverage, could harm our reputation in the industry and could reduce product sales. In addition, we historically experienced steep increases in our product liability insurance premiums as a percentage of revenue. If our premiums continue to rise, we may no longer be able to afford adequate insurance coverage.

 

If customers are not trained and / or our products are used by non-physicians, it could result in product misuse and adverse treatment outcomes, which could harm our reputation, result in product liability litigation, distract management, result in additional costs, all of which could harm our business.

 

Because we do not require training for users of our products, and sell our products at times to non-physicians, there exists an increased potential for misuse of our products, which could harm our reputation and our business. U.S. federal regulations allow us to sell our products to or on the order of “licensed practitioners.” The definition of “licensed practitioners” varies from state to state. As a result, our products may be purchased or operated by physicians with varying levels of training, and in many states, by non-physicians, including nurse practitioners, chiropractors and technicians. Outside the United States, many jurisdictions do not require specific qualifications or training for purchasers or operators of our products. We do not supervise the procedures performed with our products, nor do we require that direct medical supervision occur. We and our distributors generally offer but do not require product training to the purchasers or operators of our products. In addition, we sometimes sell our systems to companies that rent our systems to third parties and that provide a technician to perform the procedures. The lack of training and the purchase and use of our products by non-physicians may result in product misuse and adverse treatment outcomes, which could harm our reputation and our business, and, in the event these result in product liability litigation, distract management and subject us to liability, including legal expenses.

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In the past we entered into strategic alliances to distribute third party products internationally. To successfully market and sell these products, we must address many issues that are unique to these businesses and could reduce our available cash reserves and negatively impact our profitability.

 

In the past we entered into distribution arrangements pursuant to which we utilize our sales force and distributors to sell products manufactured by other companies. In Japan we distribute a Q-switched laser product manufactured by a third party OEM. We also have an agreement with Obagi to distribute certain of their proprietary cosmeceuticals, or skin care products in Japan. We have entered into a contract with ZO and with effect from the fourth quarter of 2013, plan to discontinue sales of some of the Obagi cosmeceutical products in favor of comparable ZO products. Each of these agreements requires us to purchase annual minimum dollar amounts of their product. If we do not make these minimum purchases, we could lose exclusivity for distributing these products to physicians in Japan. Finally, we also have an agreement with Merz Aesthetics to distribute its Radiesse® dermal filler product in Japan.

 

Each of these distribution agreements presents its own unique risks and challenges. For example, to sell products in partnership with Obagi we need to invest in creating a sales structure that is experienced in the sale of cosmeceuticals and not in capital equipment. We need to commit resources to training this sales force, obtaining regulatory licenses in Japan and developing new marketing materials to promote the sale of Obagi products. For each of these distribution arrangements, until we can develop our own experienced sales force, we may need to pay third party distributors to sell the products which will result in higher fees and lower margins than if we sell direct to customers. In addition, the minimum commitments and other costs of distributing products manufactured by these companies may exceed the incremental revenue that we derive from the sale of their products thereby reducing our available cash reserves and negatively impacting our profitability.

 

We cannot provide any assurances that we will realize the anticipated benefits from the Iridex aesthetic acquisition or that we will not have to record an impairment charge with respect to the intangible assets related to this acquisition.

 

On February 2, 2012, we completed the acquisition of certain assets of IRIDEX Corporation’s global aesthetic business. This acquisition was considered a business combination for accounting purposes, and as such, in addition to valuing all the assets, we recorded goodwill associated with the expected synergies from leveraging the customer relationships and integrating new product offerings into our business in the future. At September 30, 2013, we have net intangible assets of $2.0 million and $1.3 million of goodwill. While the integration of the operations, service business and the VariLite product has been completed, we cannot provide any assurances that we will ultimately realize the anticipated benefits from this acquisition.

 

Identifiable intangible assets and goodwill are subject to impairment testing and are reviewed for impairment when events or circumstances indicate that such assets may not be recoverable at their carrying value. We evaluate the recoverability of the carrying value of the identifiable intangibles based on future estimated undiscounted cash flows. If the future estimated undiscounted cash flows or the significant operating assumptions upon which they are based, change in the future, we may be required to recognize an impairment charge in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets.

 

Should conditions and estimates used for recording the identifiable intangibles and goodwill be different from management’s original estimates, material write-downs of long-lived assets and / or goodwill may be required, which would adversely affect our operating results and could negatively impact our stock price.

 

Adverse conditions in the global banking industry and credit markets may adversely impact the value of our marketable investments or impair our liquidity.

 

We invest our excess cash primarily in money market funds and in highly liquid debt instruments of the U.S. government and its agencies and U.S. municipalities, in commercial paper and high grade corporate debt. As of September 30, 2013, our balance in marketable investments was $67 million. The longer the duration of a security, the more susceptible it is to changes in market interest rates and bond yields. As yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. For example, assuming a hypothetical increase in interest rates of one percentage point, the fair value of our total investment portfolio as of September 30, 2013 would have potentially decreased by approximately $848,000, resulting in an unrealized loss that would subsequently adversely impact our earnings. As a result, changes in the market interest rates will affect our future net income (loss).

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The price of our common stock may fluctuate substantially due to several factors, some of which are discussed below. Further, we have a limited number of shares of common stock outstanding, a large portion of which is held by a small number of investors, which could result in the increase in volatility of our stock price.

 

As of June 2013, approximately 44% of our outstanding shares of common stock were held by 10 institutional investors. As a result of our relatively small public float, our common stock may be less liquid than the stock of companies with broader public ownership. Among other things, trading of a relatively small volume of our common stock may have a greater impact on the trading price for our shares than would be the case if our public float were larger. The public market price of our common stock has in the past fluctuated substantially and, due to the current concentration of stockholders, it may continue to do so in the future. The market price for our common stock could also be affected by a number of other factors, including:

 

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Litigation surrounding executive compensation has increased with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act. If we are involved in a lawsuit related to compensation matters or any other matters not covered by our D&O insurance, there could be material expenses involved, fines, or remedial actions which could negatively affect our stock price;

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The general market conditions unrelated to our operating performance;

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Sales of large blocks of our common stock, including sales by our executive officers, directors and our large institutional investors;

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Quarterly variations in our, or our competitors’, results of operations;

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Changes in analysts’ estimates, investors’ perceptions, recommendations by securities analysts or our failure to achieve analysts’ estimates;

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The announcement of new products or service enhancements by us or our competitors;

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The announcement of the departure of a key employee or executive officer by us or our competitor;

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Regulatory developments or delays concerning our, or our competitors’ products; and

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The initiation of litigation by us or against us.

Actual or perceived instability in our stock price could reduce demand from potential buyers of our stock, thereby causing our stock price to either remain depressed or to decline further.

 

We may be involved in future costly intellectual property litigation, which could impact our future business and financial performance.

 

Our competitors or other patent holders may assert that our present or future products and the methods we employ are covered by their patents. In addition, we do not know whether our competitors own or will obtain patents that they may claim prevent, limit or interfere with our ability to make, use, sell or import our products. Although we may seek to resolve any potential future claims or actions, we may not be able to do so on reasonable terms, or at all. If, following a successful third-party action for infringement, we cannot obtain a license or redesign our products, we may have to stop manufacturing and selling the applicable products and our business would suffer as a result. In addition, a court could require us to pay substantial damages, and prohibit us from using technologies essential to our products, any of which would have a material adverse effect on our business, results of operations and financial condition.

 

We may become involved in litigation not only as a result of alleged infringement of a third party’s intellectual property rights but also to protect our own intellectual property. For example, we have been, and may hereafter become, involved in litigation to protect the trademark rights associated with our company name or the names of our products. Infringement and other intellectual property claims, with or without merit, can be expensive and time-consuming to litigate, and could divert management’s attention from our core business.

 

Any acquisitions that we make could disrupt our business and harm our financial condition.

 

From time to time we evaluate potential strategic acquisitions of complementary businesses, products or technologies. We may also consider joint ventures and other collaborative projects. We may not be able to identify appropriate acquisition candidates or strategic partners, or successfully negotiate, finance or integrate any businesses, products or technologies that we acquire. Furthermore, the integration of any acquisition and management of any collaborative project may divert management’s time and resources from our core business and disrupt our operations and we may incur significant legal, accounting and banking fees in connection with such a transaction. In addition, if we purchase a company that is not profitable, our cash balances may be reduced or depleted. We have limited experience as a team with acquiring companies and products. If we decide to expand our product offerings beyond laser and other energy-based products, we may spend time and money on projects that do not increase our revenue. Any cash acquisition we pursue would diminish our available cash balances to us for other uses, and any stock acquisition could be dilutive to our stockholders.

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While we from time to time evaluate potential acquisitions of businesses, products and technologies, and anticipate continuing to make these evaluations, we have no present understandings, commitments or agreements with respect to any material acquisitions or collaborative projects.

 

Our manufacturing operations are dependent upon third-party suppliers, making us vulnerable to supply shortages and price fluctuations, which could harm our business.

 

Many of the components and materials that comprise our products are currently manufactured by a limited number of suppliers. A supply interruption or an increase in demand beyond our current suppliers’ capabilities could harm our ability to manufacture our products until a new source of supply is identified and qualified. Our reliance on these suppliers subjects us to a number of risks that could harm our business, including:

 

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Interruption of supply resulting from modifications to or discontinuation of a supplier’s operations;

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Delays in product shipments resulting from uncorrected defects, reliability issues or a supplier’s variation in a component;

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A lack of long-term supply arrangements for key components with our suppliers;

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Inability to obtain adequate supply in a timely manner, or on reasonable terms;

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Inability to redesign one or more components in our systems in the event that a supplier discontinues manufacturing such components and we are unable to source it from other suppliers on reasonable terms;

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Difficulty locating and qualifying alternative suppliers for our components in a timely manner;