Cutera(CUTR) - 2019 Q4 - Annual Report

Business Overview Cutera, Inc. is a global provider of laser and energy-based aesthetic systems, focusing on product development, market expansion, and recurring revenue generation through direct sales and intellectual property protection, while navigating extensive government regulations Company Background and Products Cutera, Inc. provides global laser and energy-based aesthetic systems, offering diverse platforms and new products like truSculpt flex and excel V+, with many generating recurring revenue from consumables - Cutera is a global provider of laser and energy-based aesthetic systems, offering platforms like enlighten, excel HR, truSculpt, excel V, xeo, Juliet, and Secret RF for a wide range of aesthetic treatments[18] - The company launched several new products recently, including excel V+ in February 2019 and truSculpt flex in June 2019, expanding its offerings in the muscle-sculpting and vascular treatment markets[18][21][27] - Several key products are designed to generate recurring revenue through consumables. truSculpt flex and truSculpt iD use consumable cycles/hand pieces, while Juliet and Secret RF require disposable tips for each procedure[21][22][23][24] - In addition to its own manufactured products, Cutera distributes third-party products, including the Juliet laser for women's health and the Secret RF microneedling device, as well as ZO skincare products in Japan[23][24][29] Market Overview and Trends The global medical aesthetic market, including body contouring and tattoo removal, is projected for significant growth driven by demographic shifts, technological advancements, and increased social acceptance - The global medical aesthetic market is expected to grow at an 11.5% CAGR from 2019 to reach $22.2 billion by 2025. The body contouring market is projected to reach $1.1 billion by 2022[31] - Key market growth drivers include the aging 'baby boomer' demographic, increased safety and efficacy of treatments, expansion of practitioners into non-core specialties, and wider social acceptance of aesthetic procedures[33] - The tattoo removal market was valued at $11.6 billion in 2017 and is projected to grow at 12.7% to reach $27.3 billion by 2023, driven by social and career-related motivations[37] Business Strategy Cutera's strategy emphasizes expanding product offerings, increasing global revenue, leveraging its installed base through upgrades, and generating recurring revenue from consumables and services - Continuously expand product offerings through internal development (e.g., truSculpt flex, excel V+) and distribution of third-party products (e.g., Juliet, Secret RF)[57] - Increase revenue by building brand recognition, adding products to international channels, and enhancing the global distribution network[57] - Leverage the existing installed base by offering upgrades to new platforms and capabilities[59] - Generate recurring revenue from post-warranty services and refillable/consumable products such as Titan, truSculpt iD/flex, Juliet, and Secret RF tips[60][61] Sales, Marketing, and Competition Cutera employs a hybrid sales model and faces intense competition from larger, consolidated rivals in the aesthetic device industry, necessitating product differentiation - The company employs a direct sales and service model in North America, Australia, Japan, and key European markets, complemented by a distributor network in over 40 other countries[97] - The aesthetic device industry is intensely competitive, with rivals including Hologic (Cynosure), Allergan (Zeltiq), Bausch Health, InMode, Syneron Candela, and Sciton[101] - Recent industry consolidation, such as the acquisition of Lumenis by BPEA and Cynosure by Clayton, Dubilier & Rice, has increased competitive pressure[101] - To compete effectively, Cutera must differentiate its products based on performance, brand, service, and price, as competitors may have greater resources or established relationships[102] Manufacturing and Intellectual Property Cutera manufactures products in-house and via third parties, protecting its intellectual property through 32 issued U.S. patents and registered trademarks - Products are assembled and tested at the Brisbane, CA facility and at third-party contract manufacturers, using components and subassemblies from various vendors[108][109] - As of February 28, 2019, the company held 32 issued U.S. patents and had 5 pending U.S. patent applications[111] - The company protects its brand through registered trademarks, including Cutera, CoolGlide, enlighten, truSculpt, and xeo[112] Government Regulation Cutera's medical devices are extensively regulated by the FDA (Class II, 510(k)) and international bodies (CE mark, ISO 13485, MDSAP), also adhering to anti-corruption and data privacy laws - In the U.S., Cutera's products are regulated as Class II medical devices by the FDA and require 510(k) pre-market clearance. The company has obtained numerous 510(k) clearances for its products and various indications[115][119][120] - The company's manufacturing facility is ISO 13485 certified and participates in the Medical Device Single Audit Program (MDSAP), which helps establish compliance in the U.S., Canada, Australia, Japan, and Brazil[125][136] - For sales in the European Economic Area (EEA), the company complies with directives to bear the CE mark, indicating conformity for commercial distribution[135] - The company is subject to global anti-corruption laws like the U.S. FCPA and the UK Bribery Act, as well as data privacy laws such as HIPAA in the U.S. and GDPR in the EU[138][139][140][141] Employees Cutera's employee headcount increased to 447 by December 31, 2019, with no union representation and good employee relations - Employee headcount increased from 387 at the end of 2018 to 447 as of December 31, 2019[144] Risk Factors Cutera faces significant risks including operational fluctuations, product defects, sales force turnover, management changes, intense market competition, financial instability, and extensive regulatory and legal challenges Business and Operational Risks Cutera faces operational risks from fluctuating results, product defects, sales force turnover, executive changes, cybersecurity threats, ERP system implementation, and pandemic disruptions - Annual and quarterly operating results may fluctuate significantly due to factors like sales force effectiveness, new product success, and competition[147] - The company experienced significant turnover in its sales professionals in Q1 2020, with many joining a competitor, which may negatively impact sales performance[159][182] - Recent management changes, including the hiring of a new CEO and the resignation of the CFO, may cause business disruption and uncertainty[173][174][175] - The company is implementing a new ERP system, which carries inherent risks of data conversion errors and system failures that could impact timely and accurate financial reporting[196][197] - The coronavirus pandemic poses a risk of business interruption and operational delays due to travel bans and other containment measures[153][203] Market and Competition Risks Cutera faces intense market competition from larger, consolidated rivals in a rapidly innovating industry, with demand sensitive to consumer spending on elective procedures - The aesthetic equipment market is characterized by rapid innovation, requiring continuous development of new products to avoid obsolescence[163][164][170] - The company competes with companies that have greater resources, larger installed bases, and broader product offerings. Recent industry consolidation (e.g., Allergan/Zeltiq, Hologic/Cynosure) has increased competition[234][238] - Demand for products is tied to consumer demand for elective procedures, which are not typically reimbursed by insurance and are sensitive to consumer disposable income[240][241] Financial and Economic Risks Cutera faces financial risks from credit access limitations, international operations (currency, trade barriers, geopolitical instability), stock price volatility, and customer credit defaults - The company amended its revolving line of credit with Wells Fargo after violating financial covenants in 2018. The current agreement requires maintaining a $15 million cash balance at Wells Fargo and removes other covenants as long as no money is drawn[190][193] - International revenue was 42% of total revenue in 2019, exposing the company to risks such as currency fluctuations, trade barriers, and political instability (e.g., Brexit)[212][216][218] - The company's common stock price has been volatile, and failure to meet financial guidance could cause the price to decline further[205][209][210] Regulatory and Legal Risks Cutera faces significant regulatory and legal risks from FDA non-compliance, product liability lawsuits, intellectual property disputes, and adherence to anti-bribery and data privacy laws - Failure to comply with extensive FDA and international regulations can lead to sanctions, recalls, or production shutdowns[243][244] - A July 2018 FDA communication concerning "vaginal rejuvenation" procedures has led to a significant slowdown in sales of the company's Juliet device[248][249] - The company faces risks of product liability suits, which could be expensive and time-consuming, and may arise from product misuse, particularly by non-physicians[264][265][269] - The company is involved in litigation, including a lawsuit filed in January 2020 against a competitor (Lutronic) and former employees for misappropriation of trade secrets[207][735] Properties Cutera's primary corporate office is a 66,000 sq. ft. leased facility in Brisbane, California, supplemented by international leased offices in Japan, France, Spain, and Belgium Properties Cutera's main corporate office is a 66,000 sq. ft. leased facility in Brisbane, CA, complemented by international leased offices in Japan, France, Spain, and Belgium - The main corporate office is a 66,000 sq. ft. leased facility in Brisbane, CA, with the lease term extending to January 31, 2023[309] - The company also leases office space internationally in Japan, France, Spain, and Belgium[310][312] Selected Financial Data Cutera's net revenue grew to $181.7 million in 2019, but the company reported net losses in 2018 and 2019, with comparability limited by new accounting standard adoptions Selected Financial Data Cutera's net revenue reached $181.7 million in 2019, but it incurred net losses in 2018 and 2019, with financial comparability affected by new accounting standards Selected Financial Data (2015-2019) | (in thousands, except per share data) | 2019 | 2018 | 2017 | 2016 | 2015 | | :--- | :--- | :--- | :--- | :--- | :--- | | Statements of Operations Data | | | | | | | Net revenue | $181,712 | $162,720 | $151,493 | $118,056 | $94,761 | | Gross profit | $98,163 | $80,382 | $86,110 | $68,135 | $54,283 | | Income (loss) from operations | $(12,064) | $(13,392) | $11,076 | $(2,397) | $(4,521) | | Net income (loss) | $(12,348) | $(30,770) | $29,993 | $(2,557) | $(4,440) | | Diluted net income (loss) per share | $(0.88) | $(2.23) | $2.04 | $(0.19) | $(0.32) | | Balance Sheet Data (End of Period) | | | | | | | Total assets | $113,738 | $97,637 | $111,238 | $91,854 | $77,518 | | Total stockholders' equity | $45,942 | $46,386 | $64,893 | $61,010 | $50,034 | - Financial results for 2018 and 2019 reflect the adoption of ASC 606 (Revenue), and 2019 results also reflect the adoption of ASC 842 (Leases), which limits comparability with prior years[333][334] Management's Discussion and Analysis (MD&A) This section details Cutera's financial performance, liquidity, and critical accounting policies, highlighting revenue growth, improved gross margin, increased operating expenses, and a net loss, alongside cash flow and debt facility information Results of Operations In 2019, Cutera's net revenue grew 12% to $181.7 million, with improved gross margin but increased operating expenses, resulting in a $12.3 million net loss Revenue by Geography and Product (2019 vs 2018) | (in thousands) | 2019 | 2018 | % Change | | :--- | :--- | :--- | :--- | | Revenue by Geography | | | | | United States | $106,243 | $101,862 | 4% | | International | $75,469 | $60,858 | 24% | | Total Revenue | $181,712 | $162,720 | 12% | | Revenue by Product | | | | | Systems | $140,478 | $132,595 | 6% | | Consumables | $9,648 | $4,162 | 132% | | Skincare | $8,512 | $5,778 | 47% | | Service | $23,074 | $20,185 | 14% | - Gross profit as a percentage of revenue increased to 54% in 2019 from 49% in 2018. The 2018 figure was negatively impacted by a $5.0 million product remediation charge[420][423][424] - Sales and marketing expenses increased by $12.7 million (22%) in 2019, primarily due to a $6.4 million increase in labor costs from increased headcount and higher promotional expenses[426][428] - General and administrative expenses increased by $3.0 million (14%) in 2019, driven by higher personnel costs, professional fees for the ERP system implementation, and executive severance costs[431] - The company reported a net loss of $12.3 million in 2019, compared to a net loss of $30.8 million in 2018. The 2018 loss was significantly impacted by a $17.3 million income tax provision, largely due to a valuation allowance on deferred tax assets[497][435] Liquidity and Capital Resources As of December 31, 2019, Cutera held $33.9 million in cash, with $2.2 million net cash used in operations, and an amended Wells Fargo credit line requiring a $15 million minimum cash balance - Cash, cash equivalents, and marketable investments totaled $33.9 million at December 31, 2019, down from $35.6 million at the end of 2018[437][440] Consolidated Cash Flow Data (in thousands) | Cash flows provided by (used in): | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Operating activities | $(2,217) | $307 | $14,287 | | Investing activities | $1,067 | $10,773 | $17,694 | | Financing activities | $1,414 | $788 | $(31,572) | - The company has a revolving line of credit with Wells Fargo, amended in March 2019. It requires a minimum cash balance of $15 million at Wells Fargo but removes other covenants so long as no money is drawn. No funds were drawn as of Dec 31, 2019[459][461][728] Contractual Obligations as of Dec 31, 2019 (in thousands) | Contractual Obligations | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | | :--- | :--- | :--- | :--- | :--- | :--- | | Operating leases | $8,654 | $2,868 | $5,760 | $26 | $ - | | Finance leases | $1,212 | $543 | $669 | $ - | $ - | | Total leases | $9,866 | $3,411 | $6,429 | $26 | $ - | Critical Accounting Policies and Estimates Cutera's critical accounting policies involve significant judgment in revenue recognition (ASC 606), inventory and goodwill valuation, lease accounting (ASC 842), stock-based compensation, and income tax provisions - Revenue Recognition: Requires judgment in identifying distinct performance obligations, estimating variable consideration, and determining standalone selling prices (SSPs) for bundled products and services[351][353][355] - Valuation of Inventories: Stated at the lower of cost or net realizable value. The company provides for excess and obsolete inventories based on assumptions about future demand and market conditions[369][370] - Stock-based Compensation: Uses the Black-Scholes model for options, which requires subjective inputs like expected volatility and term. The fair value of PSUs is based on achieving performance goals[374][375][382] - Income Taxes: Involves assessing the need for a valuation allowance against deferred tax assets and establishing reserves for uncertain tax positions[388][389][390] Financial Statements and Supplementary Data This section presents Cutera's consolidated financial statements, including balance sheets, income statements, and detailed notes on accounting policies, equity, income taxes, commitments, and subsequent events Consolidated Financial Statements As of December 31, 2019, Cutera reported $113.7 million in total assets, $181.7 million in net revenue, and a $12.3 million net loss, reducing accumulated deficit to ($36.4) million Consolidated Balance Sheet Highlights (as of Dec 31, 2019) | (in thousands) | 2019 | 2018 | | :--- | :--- | :--- | | Cash and cash equivalents | $26,316 | $26,052 | | Total current assets | $95,046 | $87,198 | | Total assets | $113,738 | $97,637 | | Total current liabilities | $58,622 | $47,620 | | Total liabilities | $67,796 | $51,251 | | Total stockholders' equity | $45,942 | $46,386 | Consolidated Statement of Operations Highlights (Year ended Dec 31) | (in thousands, except per share data) | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Total net revenue | $181,712 | $162,720 | $151,493 | | Gross profit | $98,163 | $80,382 | $86,110 | | Income (loss) from operations | $(12,064) | $(13,392) | $11,076 | | Net income (loss) | $(12,348) | $(30,770) | $29,993 | | Diluted net income (loss) per share | $(0.88) | $(2.23) | $2.04 | Notes to Consolidated Financial Statements These notes detail Cutera's accounting policies, including ASC 606 and ASC 842 adoption, stock-based compensation, income taxes, lease commitments, and a subsequent lawsuit Note 1: Summary of Significant Accounting Policies This note outlines Cutera's significant accounting policies, including the adoption of ASC 606 (revenue) and ASC 842 (leases), and details on revenue recognition, inventory, goodwill, and stock compensation - Adopted ASC Topic 606 (Revenue) on Jan 1, 2018, using the modified retrospective method, resulting in a cumulative catch-up adjustment increasing retained earnings by $3.8 million[518][519] - Adopted ASC Topic 842 (Leases) on Jan 1, 2019, resulting in the recognition of operating lease ROU assets of $10.2 million and lease liabilities of $10.1 million on the balance sheet[528][529][530] - Incremental costs of obtaining a contract (sales commissions) are capitalized and amortized over an estimated benefit period of 2.5 years. Capitalized costs were $4.6 million in 2019[521][575][576] Note 6: Stockholders’ Equity, Stock Plans and Stock-Based Compensation Expense Stockholders approved the 2019 Equity Incentive Plan, leading to $9.8 million in stock-based compensation expense in 2019, with $12.2 million unrecognized compensation cost remaining - Stockholders approved the 2019 Equity Incentive Plan, increasing shares available for grant by 700,000[656] Stock-Based Compensation Expense (in thousands) | Expense Category | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Cost of revenue | $1,572 | $743 | $660 | | Sales and marketing | $4,510 | $2,105 | $1,642 | | Research and development | $1,536 | $824 | $936 | | General and administrative | $2,214 | $3,485 | $1,872 | | Total | $9,832 | $7,157 | $5,110 | - A modification to outstanding PSU grants in September 2019 resulted in an additional $1.0 million of stock-based compensation expense recognized during the year[663] - As of Dec 31, 2019, $12.2 million of unrecognized compensation cost related to stock awards is expected to be recognized over a weighted-average period of 2.64 years[674] Note 7: Income Taxes Cutera recorded a minimal income tax provision in 2019, with a $32.4 million valuation allowance against deferred tax assets and significant federal and state NOL carryforwards - As of December 31, 2019, the company has a valuation allowance of $32.4 million against its deferred tax assets, an increase of $4.5 million from 2018[687] - The company possesses federal net operating loss (NOL) carryforwards of $60.1 million and state NOLs of $31.3 million[688] - Gross unrecognized tax benefits were $1.4 million as of December 31, 2019[694] Note 11: Commitments and Contingencies Cutera has $9.9 million in lease commitments and is involved in legal proceedings, including an arbitration demand from its former CFO, not expected to be material Maturities of Lease Liabilities as of Dec 31, 2019 (in thousands) | Year | Operating Leases | Finance Leases | | :--- | :--- | :--- | | 2020 | $2,868 | $543 | | 2021 | $2,613 | $412 | | 2022 | $2,821 | $253 | | 2023 | $326 | $4 | | 2024 | $26 | - | | Total Payments | $8,654 | $1,212 | - In November 2019, former CFO Sandra A. Gardiner filed an arbitration demand against the company regarding her employment and resignation. The company intends to defend the matter vigorously and does not expect the outcome to be material[721] Note 14: Subsequent Events On January 31, 2020, Cutera filed a lawsuit against Lutronic Aesthetics, Inc. and former employees for misappropriation of trade secrets and other violations - On January 31, 2020, the company filed a lawsuit against competitor Lutronic Aesthetics, Inc. and former employees alleging misappropriation of trade secrets and other violations[735] Controls and Procedures Management and independent auditors concluded that Cutera's disclosure controls and internal control over financial reporting were effective as of December 31, 2019 Controls and Procedures Management and independent auditors confirmed the effectiveness of Cutera's disclosure controls and internal control over financial reporting as of December 31, 2019 - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2019[744] - Management's assessment concluded that the company's internal control over financial reporting was effective as of December 31, 2019, based on the COSO framework[748] - The independent auditor, BDO USA, LLP, provided an unqualified opinion on the effectiveness of the company's internal control over financial reporting as of December 31, 2019[486][749]