Unassociated Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For fiscal year ended December 31, 2011
 
Commission file number: 000-50644
 
 
Cutera, Inc.
(Exact name of registrant as specified in its charter)
 

Delaware
 
77-0492262
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
 
3240 Bayshore Blvd.
Brisbane, California 94005
(415) 657-5500
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
 

 Securities registered pursuant to Section 12(b) of the Act:
 
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, $0.001 par value per share
 
The NASDAQ Stock Market, LLC
 
Securities Registered Pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ¨  No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ¨  No x
 
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 than 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 ¨
 
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 o   No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
 
Large accelerated
filer  ¨
Accelerated
filer  x  
Non-accelerated filer (Do not check if a smaller reporting company)  ¨
Smaller reporting
company  ¨
 
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Act).   Yes ¨  No x
 
The aggregate market value of the registrant’s common stock, held by non-affiliates of the registrant as of June 30, 2011 (which is the last business day of registrant’s most recently completed second fiscal quarter) based upon the closing price of such stock on the NASDAQ Global Select Market on that date, was approximately $92 million. For purposes of this disclosure, shares of common stock held by entities and individuals who own 5% or more of the outstanding common stock and shares of common stock held by each officer and director have been excluded in that such persons may be deemed to be “affiliates” as that term is defined under the Rules and Regulations of the Securities Exchange Act of 1934. This determination of affiliate status is not necessarily conclusive.
 
The number of shares of Registrant’s common stock issued and outstanding as of February 29, 2012 was 13,954,178.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Part III incorporates by reference certain information from the registrant’s definitive proxy statement for the 2012 Annual Meeting of Stockholders.
 


 
 

 
 
TABLE OF CONTENTS
 
   
Page
PART I
   
     
Item 1.
3
Item 1A.
17
Item 1B.
30
Item 2.
30
Item 3.
30
Item 4.
30
     
PART II
   
     
Item 5.
30
Item 6.
33
Item 7.
34
Item 7A.
47
Item 8.
48
Item 9.
77
Item 9A.
77
Item 9B.
78
     
PART III
   
     
Item 10.
78
Item 11.
78
Item 12.
78
Item 13.
 78
Item 14.
78
     78
PART IV
   
     
Item 15.
79
 
 
PART I
 
ITEM 1.
BUSINESS
 
We are a global medical device company headquartered in Brisbane, California specializing in the design, development, manufacture, marketing and servicing of laser and light-based aesthetics systems for practitioners worldwide. We offer easy-to-use products based on six platforms—CoolGlide®, Xeo®, Solera®, GenesisPlusTM, Excel VTM, and myQTM each of which enable physicians and other qualified practitioners to perform safe and effective aesthetic procedures for their customers.
 
 
CoolGlide- In March 2003, our first product platform, CoolGlide, was launched. This platform offers laser applications for hair removal, treatment of a range of vascular lesions, including leg and facial veins, and Laser Genesis—a skin rejuvenation procedure that reduces fine lines, reduces pore size and improves skin texture.
 
Xeo- In 2003, we introduced the Xeo platform, which can combine pulsed light and laser applications in a single system. The Xeo is a fully upgradeable platform on which a customer can use the following applications that we offer: remove unwanted hair, treat vascular lesions and rejuvenate the skin by treating discoloration, improving texture, reducing pore size and treating fine lines and laxity. This product platform represents the largest contributor to our Product revenue.
 
Solera- In 2004, we introduced the Solera platform, a compact tabletop system designed to support a single technology platform. Solera systems use either infrared (Solera Titan) or pulsed light (Solera Opus) and can be used to remove unwanted hair, treat vascular lesions and rejuvenate the skin. The Solera Opus can support one or more pulsed light applications in a single system.
 
GenesisPlus- In 2010, we introduced the GenesisPlus platform, which is a dedicated laser based system for performing skin rejuvenation procedures and for onychomycosis, or toenail fungus. This system has a hand piece that includes real time temperature monitoring of the treatment area, as well as a non-contact distance gauge using two aiming beams, for improving the clinical result of treatment.  In addition, this system can be used to treat patients with skin concerns such as fine wrinkles, diffuse redness, rosacea, skin texture and pore size.
 
Excel V- In February 2011, we introduced our Excel V platform, a high-performance, vascular platform designed specifically for the core-market of Dermatologists and Plastic Surgeons. This platform provides a combination of the 532 nm green laser with Cutera’s award winning 1064 nm Nd:YAG technology, to provide a single, compact and efficient system that treats the entire range of cosmetic vascular conditions, without the need for costly consumables.
 
myQ- In October 2011, we announced a distribution agreement with Quanta System SpA ─ an Italian Original Equipment Manufacturer (OEM) of laser technologies ─ to market and sell the myQ series of Q-switched lasers in Japan. Q-switched lasers are designed to be used in a wide range of popular aesthetic applications, including superficial and deep pigmented lesions (i.e., melasma), skin rejuvenation, laser skin toning and tattoo removal.
 
Each of our laser and light-based platforms consists of one or more hand pieces and a console that incorporates a universal graphic user interface, a laser or light-based module, control system software and high voltage electronics. However, depending on the application, the laser or light-based module is sometimes instead contained in the hand piece. A description of each of our hand pieces, and the aesthetic conditions they are designed to treat, are contained in the section entitled “Products,” below.
 
We offer our customers the ability to select the systems and applications that best fit their practice and to subsequently upgrade their systems to add new applications. This upgrade path allows our customers to cost-effectively build their aesthetic practices and provides us with a source of recurring revenue.
 
In addition to systems and upgrades, we generate revenue from the sale of post warranty services, Titan hand piece refills, and Dermal filler and cosmeceuticals.
 
The Structure of Skin and Conditions that Affect Appearance
 
The skin is the body’s largest organ and is comprised of layers called the epidermis and dermis. The epidermis is the outer layer, and serves as a protective barrier for the body. It contains cells that determine pigmentation, or skin color. The underlying layer of skin, the dermis, contains hair follicles and large and small blood vessels that are found at various depths below the epidermis. Collagen, also found within the dermis, provides strength and flexibility to the skin.
 
Many factors, such as age, smoking and sun damage, can result in aesthetically unpleasant changes in the appearance of the skin. These changes can include:
 
 
Undesirable hair growth;
 
 
 
Enlargement or swelling of blood vessels due to circulatory changes that become visible at the skin’s surface in the form of unsightly veins;
 
Deterioration of collagen, which weakens the skin, leading to uneven texture, increased pore size, wrinkles and laxity; and
 
Uneven pigmentation or sun spots due to long-term sun exposure.

People with unwanted hair or any of the above-mentioned skin conditions often seek aesthetic treatments to improve their appearance.
 
The Market for Non-Surgical Aesthetic Procedures
 
The market for non-surgical aesthetic procedures has grown significantly over the past several years. The American Society of Plastic Surgeons estimates that in 2011 there were over 12.2 million minimally-invasive aesthetic procedures performed, a 6% increase over 2010 and a 123% increase over 2000. We believe there are several factors contributing to the growth of these aesthetic procedures, including:
 
 
Aging of the U.S. Population- The “baby boomer” demographic segment ─ ages 47 to 65 in 2011 ─ represented approximately 80 million people, or 26%, of the U.S. population in 2011. The size of this aging segment, and its desire to retain a youthful appearance, has contributed to the growth for aesthetic procedures.
 
Broader Range of Safe and Effective Treatments- Technical developments have led to safe, effective, easy-to-use and low-cost treatments with fewer side effects, resulting in broader adoption of aesthetic procedures by practitioners. In addition, technical developments have enabled practitioners to offer a broader range of treatments. These technical developments have reduced the required treatment and recovery times, which in turn have led to greater patient demand.
 
Broader Base of Customers- Managed care and government payer reimbursement restrictions in the United States, and similar payment related constraints outside the United States, may help motivate qualified practitioners from differing specialties to establish or expand their elective aesthetic practices with procedures that are paid for directly by patients. As a result, in addition to the core users such as dermatologists and plastic surgeons, many other non-core practitioners, such as gynecologists, family practitioners, primary care physicians, physicians offering aesthetic treatments in non-medical offices, and other qualified practitioners are offering aesthetic procedures.
 
Non-Surgical Aesthetic Procedures for Improving the Skin’s Appearance and Their Limitations
 
Many alternative therapies are available for improving a person’s appearance by treating specific structures within the skin. These procedures utilize injections or abrasive agents to reach different depths of the dermis and the epidermis. In addition, non-invasive and minimally-invasive treatments have been developed that employ laser and light-based technologies to achieve similar therapeutic results. Some of these more common therapies and their limitations are described below.
 
Hair Removal- Techniques for hair removal include waxing, depilatories, tweezing, shaving, electrolysis and laser and light-based hair removal. The only techniques that provide a long-lasting solution are electrolysis and light-based hair removal. Electrolysis is usually painful, time-consuming and expensive for large areas, but is the most common method for removing light-colored hair. During electrolysis, an electrologist inserts a needle directly into a hair follicle and activates an electric current in the needle. Since electrolysis only treats one hair follicle at a time, the treatment of an area as small as an upper lip may require numerous visits and many hours of treatment. In addition, electrolysis can cause blemishes and infection related to needle use.
 
Leg and Facial Veins- The current aesthetic treatment methods for leg and facial veins include sclerotherapy and laser and light-based treatments. With these treatments, patients seek to eliminate visible veins and improve overall skin appearance. Sclerotherapy requires a skilled practitioner to inject a saline or detergent-based solution into the target vein, which breaks down the vessel causing it to collapse and be absorbed into the body. The need to correctly position the needle on the inside of the vein makes it difficult to treat smaller veins, which limits the treatment of facial vessels and small leg veins. The American Society of Plastic Surgeons estimates that approximately 355,000 sclerotherapy procedures were performed in 2011.
 
Skin Rejuvenation- Skin rejuvenation treatments include a broad range of popular alternatives, including Botox and collagen injections, chemical peels, microdermabrasions, radiofrequency treatments and lasers and light-based treatments. With these treatments, patients hope to improve overall skin tone and texture, reduce pore size, tighten skin and remove other signs of aging, including mottled pigmentation, diffuse redness and wrinkles. All of these procedures are temporary solutions and must be repeated within several weeks or months to sustain their effect, thereby increasing the cost and inconvenience to patients. For example, the body absorbs Botox and collagen and patients require supplemental injections every three to six months to maintain the benefits of these treatments.
 
Some skin rejuvenation treatments, such as chemical peels and microdermabrasions, can have undesirable side effects. Chemical peels use acidic or caustic solutions to peel away the epidermis, and microdermabrasion generally utilizes sand crystals to resurface the skin. These techniques can lead to stinging, redness, irritation and scabbing. In addition, more serious complications, such as changes in skin color, can result from deeper chemical peels. Patients that undergo these deep chemical peels are also advised to avoid exposure to the sun for several months following the procedure. The American Society of Plastic Surgeons estimates that in 2011, approximately 5.7 million injections of Botox and 1.9 million injections of collagen and other soft-tissue fillers were administered; and 1.1 million chemical peels and 900,000 microdermabrasion procedures were performed.
 
 
In radiofrequency tissue tightening, energy is applied to heat the dermis of the skin with the goal of shrinking and tightening the collagen fibers. This approach may result in a more subtle and incremental change to the skin than a surgical facelift. Drawbacks to this approach may include surface irregularities that may however resolve over time, and the risk of burning the treatment area.
 
Laser and light-based non-surgical treatments for hair removal, veins and skin rejuvenation are discussed in the following section and in the section entitled “Our Applications and Procedures,” below.
 
Laser and Light-Based Aesthetic Treatments
 
Laser and light-based aesthetic treatments can achieve therapeutic results by affecting structures within the skin. The development of safe and effective aesthetic treatments has created a well-established market for these procedures.
 
Ablative skin resurfacing is a method of improving the appearance of the skin by removing the outer layers of the skin. Ablative skin resurfacing procedures are considered invasive or minimally invasive, depending on how much of the epidermis is removed during a treatment. Non-ablative skin resurfacing is a method of improving the appearance of the skin by treating the underlying structure of the skin without damaging the outer layers of the skin. Practitioners can use laser and light-based technologies to selectively target hair follicles, veins or collagen in the dermis, as well as cells responsible for pigmentation in the epidermis, without damaging surrounding tissue. They can also use these technologies to safely remove portions of the epidermis and deliver heat to the dermis as a means of generating new collagen growth.
 
Safe and effective laser and light-based treatments require an appropriate combination of the following four parameters:

 
Energy Level- the amount of light emitted to heat a target;
 
Pulse Duration- the time interval over which the energy is delivered;
 
Spot Size- the diameter of the energy beam, which affects treatment depth and area; and
 
Wavelength- the color of light, which impacts the effective depth and absorption of the energy delivered.

For example, in the case of hair removal, by utilizing the correct combination of these parameters, a practitioner can use a laser or other light source to selectively target melanin within the hair follicle to absorb the laser energy and destroy the follicle, without damaging other delicate structures in the surrounding tissue. Wavelength and spot size permit the practitioner to target melanin in the base of the hair follicle, which is found in the dermis. The combination of pulse duration and energy level may vary, depending upon the thickness of the targeted hair follicle. A shorter pulse length with a high energy level is optimal to destroy fine hair, whereas coarse hair is best treated with a longer pulse length with lower energy levels. If treatment parameters are improperly set, non-targeted structures within the skin may absorb the energy thereby eliminating or reducing the therapeutic effect. In addition, improper setting of the treatment parameters or failure to protect the surface of the skin may cause burns, which can result in blistering, scabbing and skin discoloration.
 
Technology and Design of Our Systems
 
Our unique CoolGlide, Xeo, Solera, GenesisPlus, Excel V and myQ platforms provide the long-lasting benefits of laser and light-based aesthetic treatments. Our technology allows for a combination of a wide variety of applications available in a single system. Key features of our solutions include:

 
Multiple Applications Available in a Single System- Our systems comprise of multi-applications that enable practitioners to perform multiple aesthetic procedures using a single device. These procedures include hair removal, vascular treatments and skin rejuvenation ─ including the treatment of discoloration, laxity, fine lines, pore size and uneven texture. Because practitioners can use our systems for multiple indications, the cost of a unit may be spread across a potentially greater number of patients and procedures and therefore may be more rapidly recovered.
 
Technology and Design Leadership- We offer innovative laser and light-based solutions for the aesthetic market. Our laser technology combines long wavelength, adjustable energy levels, variable spot sizes and a wide range of pulse durations, allowing practitioners to customize treatments for each patient and condition. Our proprietary pulsed light hand pieces for the treatment of discoloration, hair removal and vascular treatments optimize the wavelength used for treatments and incorporate a monitoring system to increase safety. Our Titan hand pieces utilize a novel light source that had not been previously used for aesthetic treatments. Our Pearl and Pearl Fractional hand pieces, with proprietary YSGG technology, represent the first application of the 2790 nm wavelength for minimally-invasive cosmetic dermatology. Further, our GenesisPlus platform for performing skin rejuvenation procedures and toenail fungus has a hand piece that includes real time temperature monitoring of the treatment area, as well as a non-contact distance gauge using two aiming beams, for improving the clinical result of the treatment. Excel V is a stand-alone, laser based product that combines a new high power green laser with Cutera's award winning Nd:YAG technology, to provide a system that treats the entire range of cosmetic vascular conditions, without the need for costly consumables.
 
 
 
Upgradeable Platform- We have designed some of our products to allow our customers to cost-effectively upgrade to our multi-application systems (Solera and Xeo), which provide our customers with the option to add additional applications to their existing systems and provides us with a source of recurring revenue. We believe that product upgradeability allows our customers to take advantage of our latest product offerings and provide additional treatment options to their patients, thereby expanding the opportunities for their aesthetic practices.
 
Treatments for Broad Range of Skin Types and Conditions- Our products remove hair safely and effectively on patients of all skin types, including harder-to-treat patients with dark or tanned skin. In addition, the wide parameter range of our systems allows practitioners to effectively treat patients with both fine and coarse hair. Practitioners may use our products to treat spider and reticular veins (unsightly small veins in the leg) and small facial veins; perform skin rejuvenation procedures for discoloration, texture, pore size, fine lines, and laxity on any type of skin; and treat toenail fungus. The ability to customize treatment parameters enables practitioners to offer safe and effective therapies to a broad base of their patients.
 
Ease of Use- We design our products to be easy to use. Our proprietary hand pieces are lightweight and ergonomic, minimizing user fatigue, and allow for clear views of the treatment area, reducing the possibility of unintended damage and increasing the speed of application. Our control console contains a universal graphic user interface with three simple, independently adjustable controls from which to select a wide range of treatment parameters to suit each patient’s profile. The clinical navigation user interface on the Xeo platform provides recommended clinical treatment parameter ranges based on patient criteria entered. And our Pearl and Pearl Fractional hand pieces include a scanner with multiple scan patterns to allow simple and fast treatments of the face. Risks involved in the use of our products include risks common to other laser and light-based aesthetic procedures, including the risk of burns, blistering and skin discoloration.
 
Strategy
 
Our goal is to maintain and expand our position as a leading, worldwide, provider of energy-based aesthetic devices and complementary aesthetic products by executing the following strategies:
 
 
Continue to Expand our Product Offering- Though we believe that our current portfolio of products is comprehensive, our research and development group has a pipeline of potential products under development that we expect to commercialize in the future. In 2010 we launched GenesisPlus and in 2011, we launched Excel V. In addition to products in the laser and light-based aesthetic market, we are expanding our product offering into other complementary aesthetic applications, such as dermal fillers and cosmeceuticals. Such products will allow us to leverage our existing customer call points, and provide us with new customer call points, to generate additional revenue, which will enhance the productivity of our distribution channels.
 
Increasing Revenue and Improving Productivity- We believe that the market for aesthetic systems will continue to offer growth opportunities in the future. We continue to build brand-recognition, add additional products to our international distribution channel and remain focused on enhancing our global distribution network, all of which we expect will increase our revenue. In addition, we plan to grow our U.S. revenue by leveraging our relationship with PSS World Medical Shared Services, Inc., or PSS─ a wholly-owned subsidiary of PSS World Medical ─ that operates medical supply distribution service centers with over 700 sales consultants serving physician offices throughout the United States.
 
Increasing Focus on Practitioners with Established Medical Offices- We believe there is growth opportunity in targeting our products to a broad customer base. However, in response to the 2009 to 2010 global recession, we shifted our focus to the core practitioners and physicians with established medical offices. We believe that our customer success is largely dependent upon having an existing medical practice, in which our systems provide incremental revenue sources to augment their practice revenue.  As such, in 2011 we increased our focus on marketing our GenesisPlus product to podiatrists and our Excel V to dermatologists and plastic surgeons.
 
Leveraging our Installed Base with Sales of Upgrades- In February 2011, we introduced the Excel V and in 2010, we introduced GenesisPlus ─ both stand alone platforms. However in the past, we have introduced new products that allowed existing customers to upgrade their previously purchased systems to offer additional capabilities. We believe that providing upgrades to our existing installed base of customers continues to represent a potentially significant opportunity for recurring revenue. We also believe that our upgrade program aligns our interest in generating revenue with our customers’ interest in improving the return on their investment by expanding the range of applications that can be performed with their existing systems.
 
·
Generating Revenue from Services and Refillable Hand Pieces- Our Titan hand pieces and pulsed-light hand pieces are refillable products, which provide us with a source of recurring revenue from our existing customers. We offer post-warranty services to our customers either through extended service contracts to cover preventive maintenance or through direct billing for parts and labor. These post-warranty services serve as additional sources of recurring revenue.
 
 
Products
 
Our CoolGlide, Xeo, Solera, GenesisPlus, Excel V and myQ platforms allow for the delivery of multiple laser and light-based aesthetic applications from a single system. With our Xeo and Solera platforms, practitioners can purchase customized systems with a variety of our multi-technology applications.
 
 
The following table lists our products and each checked box represents the applications that were included in the product in the years noted.
 
Applications:
             
Hair
Removal:
 
Vascular
 Lesions:
 
Skin Rejuvenation
 
System
Platforms:
 
Products:
 
Year:
 
Energy
 Source:
         
 Dyschromia:
 
Texture,
 Lines and
 Wrinkles:
 
 
Skin
 Laxity:
 
 

 
Melasma & Tattoo Removal:
 
CoolGlide
 
CV
 
2000
 
a
 
x
                     
   
Excel
 
2001
 
a
 
x
 
x
                 
   
Vantage
 
2002
 
a
 
x
 
x
     
x
         
Xeo:
 
Nd:YAG
 
2003
 
a
 
x
 
x
     
x
         
   
OPS600
 
2003
 
b
         
x
             
   
LP560
 
2004
 
b
         
x
             
   
Titan S
 
2004
 
c
                 
x
     
   
ProWave 770
 
2005
 
b
 
x
                     
   
AcuTip 500
 
2005
 
b
     
x
                 
   
Titan V/XL
 
2006
 
c
                 
x
     
   
LimeLight
 
2006
 
b
         
x
             
   
Pearl
 
2007
 
d
         
x
 
x
         
   
Pearl Fractional
 
2008
 
d
             
x
         
Solera
 
Titan S
 
2004
 
c
                 
x
     
   
ProWave 770
 
2005
 
b
 
x
                     
   
OPS 600
 
2005
 
b
         
x
             
   
LP560
 
2005
 
b
         
x
             
   
AcuTip 500
 
2005
 
b
     
x
                 
   
Titan V/XL
 
2006
 
c
                 
x
     
   
LimeLight
 
2006
 
b
         
x
             
GenesisPlus
     
2010
 
a
             
x
         
Excel V
     
2011
 
e
     
x
 
x
 
x
         
myQ
     
2011
 
e
                     
x
 
 
Energy Source: a. 1064nm Nd:YAG laser; b. flashlamp; c. Infrared laser; d. 2790 nm YSGG laser; e. combined frequency 532 nm and 1064 nm Nd:YAG laser
 
Each of our products consists of a control console and one or more hand pieces, depending on the model.
 
Control Console
 
Our control console includes a universal graphic user interface, control system software and high voltage electronics. All CoolGlide systems, GenesisPlus, Excel V and some models of the Xeo platform, include our laser module which consists of electronics, a visible aiming beam, a focusing lens, and an Nd:YAG and/or flashlamp laser that functions at wavelengths that permit penetration over a wide range of depths and is effective across all skin types. The interface allows the practitioner to set the appropriate laser or flashlamp parameters for each procedure through a user-friendly format. The control system software ensures that the operator’s instructions are properly communicated from the graphic user interface to the other components within the system. Our high voltage electronics produce over 10,000 watts of peak laser energy, which permits therapeutic effects at short pulse durations. Our Solera console platform comes in two configurations—Opus and Titan—both of which include a universal graphic user interface, control system software and high voltage electronics. The Solera Opus console is designed specifically to drive our flashlamp hand pieces while the Solera Titan console is designed specifically to drive the Titan hand pieces. The control system software is designed to ensure that the operator’s instructions are properly communicated from the graphical user interface to the other components within the system and includes real-time calibration to control the output energy as the pulse is delivered during the treatment.
 
Hand Pieces
 
1064 nm Nd:YAG Hand Piece- Our 1064nm Nd:YAG hand piece delivers laser energy to the treatment area for hair removal, leg and facial vein treatment, and skin rejuvenation procedures to treat skin texture and fine lines, and reduce pore size. The 1064nm Nd:YAG hand piece consists of an energy-delivery component, consisting of an optical fiber and lens, and a copper cooling plate with imbedded temperature monitoring. The hand piece weighs approximately 14 ounces, which is light enough to be held with one hand. The lightweight nature and ergonomic design of the hand piece allows the operation of the device without user fatigue. Its design allows the practitioner an unobstructed view of the treatment area, which reduces the possibility of unintended damage to the skin and can increase the speed of treatment. The 1064nm Nd:YAG hand piece also incorporates our cooling system, providing integrated pre- and post cooling of the treatment area through a temperature-controlled copper plate to protect the outer layer of the skin. The hand piece is available in either a fixed 10 millimeter spot size for our CoolGlide CV system, or a user-controlled variable 3, 5, 7 or 10 millimeter spot size for our CoolGlide Excel and CoolGlide Vantage systems.
 

Excel V Hand Piece- The Excel V system introduced in February 2011 delivers 1064 nm and 532 nm laser energy to the treatment area for vascular treatments. The Excel V system includes two hand pieces, both consisting of an energy-delivery component, consisting of an optical fiber and lens. One hand piece includes a sapphire window cooling plate with temperature monitoring. The second hand piece does not have a cooling plate and includes a non-contact temperature sensor to monitor the treatment area temperature. In addition, this second hand piece includes two aiming beams that facilitate consistent treatments by maintaining the correct distance of the hand piece to the skin. Both hand pieces offer a spot size range from 1.5 to 12 mm in 0.1 mm increments. Each hand piece is capable of delivering either the 1064 nm or 532 nm laser energy.

GenesisPlus Hand Piece- Our GenesisPlus system launched in 2010 delivers 1064 nm laser energy to the treatment area for toenail fungus and for skin rejuvenation procedures to treat skin texture and fine lines, and reduce pore size. This 1064nm Nd:YAG hand piece consists of an energy-delivery component, consisting of an optical fiber and lens but is lighter since it does not include a copper cooling plate. The hand piece does include a non-contact temperature sensor to monitor the treatment area temperature. In addition, the hand piece includes two aiming beams that facilitate consistent treatments by maintaining the correct distance of the hand piece to the skin. This hand piece offers a single 5 mm spot size.

Pulsed Light Hand Piece- The LP560, ProWave 770, AcuTip 500 and LimeLight hand pieces are designed to produce a pulse of light over a wavelength spectrum to treat discoloration, including pigmented lesions, such as age and sun spots, hair removal and superficial facial vessels. The hand pieces each consist of a custom flashlamp, proprietary wavelength filter, closed-loop power control and embedded temperature monitor, and weigh approximately 13 ounces. The filter in the AcuTip 500 eliminates long and short wavelengths, transmitting only the therapeutic range required for safe and effective treatment. The filter in the LP560, ProWave 770 and LimeLight eliminates short wavelengths, allowing longer wavelengths to be transmitted to the treatment area. In addition, the wavelength spectrum of the ProWave 770 and the LimeLight can be shifted based on the setting of the control console. Our power control includes a monitoring system to ensure that the desired energy level is delivered. The hand pieces protect the epidermis by regulating the temperature of the hand piece window through the embedded temperature monitor. These hand pieces are available on the Xeo and Solera platforms.
 
Titan Hand Piece- The Titan hand pieces are designed to produce a sustained pulse of light over a wavelength spectrum tailored to provide heating in the dermis to treat skin laxity (although it is cleared in the United States by the U.S. Food and Drug Administration, or FDA, only for deep dermal heating). The hand piece consists of a custom light source, proprietary wavelength filter, closed-loop power control, sapphire cooling window and embedded temperature monitor, and weighs approximately three pounds. The temperature of the epidermis is controlled by using a sapphire window to provide cooling before, during and after the delivery of energy to the treatment site. We offer two different Titan hand pieces—Titan V and Titan XL.
 
 
·
Titan V- Titan V has a treatment tip that extends beyond the hand piece housing to provide enhanced visibility of the skin’s surface to effectively treat delicate areas such as the skin around the eyes and nose.
 
·
Titan XL- Titan XL, like the Titan V, has a treatment tip that extends beyond the housing for improved visibility. It also has a larger treatment spot size to treat larger body areas faster, such as the arms, abdomen and legs.
 
The Titan hand pieces can be used on the Xeo and Solera platforms. The Titan hand piece requires a periodic “refilling” process, which includes the replacement of the optical source, after a set number of pulses have been used. This provides us with a source of recurring revenue.
 
Pearl Hand Piece- The Pearl hand piece, introduced in 2007, is designed to treat fine lines, uneven texture and dyschromia through the application of proprietary YSGG laser technology. This hand piece can safely remove a small portion of the epidermis, while coagulating the remaining epidermis, leading to new collagen growth. The Pearl hand piece consists of a custom monolithic laser source, scanner and power monitoring electronics. The scanner includes multiple scan patterns to allow simple and fast treatments of the face. The hand piece includes an attachment for a smoke evacuator, allowing the practitioner to use one hand during treatment.
 
Pearl Fractional Hand Piece- The Pearl Fractional hand piece, introduced in 2008, also uses proprietary YSGG technology and is designed to treat wrinkles and deep dermal imperfections (although it is cleared in the United States by the FDA only for skin resurfacing and coagulation). This hand piece penetrates the deep dermis producing a series of microcolumns across the skin, which can result in the removal of damaged tissue and the production of new collagen. The Pearl Fractional hand piece consists of a custom monolithic laser source, scanner and power monitoring electronics. The scanner includes multiple scan patterns to allow simple and fast treatments of the face. The hand piece includes an attachment for a smoke evacuator, allowing the practitioner to use one hand during treatment.
 
Upgrades
 
Our Solera and Xeo platforms are multi-application products that are designed to allow our customers to cost-effectively upgrade to our newest technologies, which provides our customers the option to add applications to their system and provides us with a source of recurring revenue. When we introduce a new product, we notify our customers of the upgrade opportunity through a sales call or mailing. In most cases, a field service representative can install the upgrade at the customer site in a matter of hours, which results in very little downtime for practitioners. In some cases, where substantial upgrades are necessary, customers will receive fully-refurbished systems before sending their prior systems back to our headquarters. When customers wish to upgrade from the CoolGlide platform to either a Xeo or a Solera, we provide them with a trade-in value for their CoolGlide and upgrade them to the multi-application platform with the desired applications.
 
 
Service
 
We offer post-warranty services to our customers either through extended service contracts ─ that cover preventive maintenance and/or replacement parts and labor ─  as well as direct billing for detachable hand piece replacements, parts and labor. These post-warranty services serve as additional sources of recurring revenue from our installed base.
 
Titan Hand Piece Refills
 
Each Titan hand piece is a refillable product, which provides us with a source of recurring revenue from our existing customers.
 
Fillers and Cosmeceuticals
 
We distribute Merz’s Radiesse® dermal filler product and Obagi Medical Product, Inc.’s (or Obagi) prescription-based, topical skin health systems (or Cosmeceuticals) to physicians in the Japanese market.

Our Applications and Procedures
 
Our products are designed to allow the practitioner to select an appropriate combination of energy level, spot size and pulse duration for each treatment. The ability to manipulate the combinations of these parameters allows our customers to treat the broadest range of conditions available with a single energy-based system.
 
Hair Removal- Our laser technology allows our customers to treat all skin types and hair thicknesses. Our 1064 nm Nd:YAG laser permits energy to safely penetrate through the epidermis of any skin type and into the dermis where the hair follicle is located. Using the universal graphic user interface on our control console, the practitioner sets parameters to deliver therapeutic energy with a large spot size and variable pulse durations, allowing the practitioner to treat fine or coarse hair. Our 1064nm Nd:YAG hand piece allows our customers to treat all skin types, while our ProWave 770 hand piece, with its pulsed light technology, treats the majority of skin types quickly and effectively.
 
To remove hair using a 1064nm Nd:YAG hand piece, the treatment site on the skin is first cleaned and shaved. The practitioner then applies a thin layer of gel to glide across the skin, and next applies the hand piece directly to the skin to cool the area to be treated and then delivers a laser pulse to the pre-cooled area. To remove hair using the ProWave 770 hand piece, mineral oil is used instead of gel, and cooling is provided by a sapphire window placed directly on the skin, allowing the pulse of light to be applied while the treatment area is being cooled. In the case of both hand pieces, delivery of the energy destroys the hair follicles and prevents hair re-growth. This procedure is then repeated at the next treatment site on the body, and can be done in a gliding motion to increase treatment speed. Patients receive on average three to six treatments. Each treatment can take between five minutes and one hour depending on the size of the area and the condition being treated. On average, there are six to eight weeks between treatments.
 
Vascular Lesions-    Our laser technology allows our customers to treat the widest range of aesthetic vein conditions, including spider and reticular veins and small facial veins. Our CoolGlide and Xeo 1064nm Nd:YAG hand piece’s adjustable spot size of 3, 5, 7 or 10 millimeters, or the Excel V 1064 nm and 532 nm hand piece with adjustable spot sizes from 1.5 to 12 mm, allows the practitioner to control treatment depth to target different sized veins. Selection of the appropriate energy level and pulse duration ensures effective treatment of the intended target. Our AcuTip 500 hand piece, with its 6 millimeter spot size, uses pulsed-light technology and is designed for the treatment of facial vessels.

The vein treatment procedure when using the 1064nm Nd:YAG hand piece is performed in a substantially similar manner to the laser hair removal procedure. The laser hand piece is used to cool the treatment area both before and after the laser pulse has been applied. With the Excel V hand piece the cooling can be performed pre, during and post delivery of the laser pulse. With the AcuTip 500 hand piece, the pulse of light is delivered while the treatment area is being cooled with the sapphire tip. The delivered energy damages the vein and, over time, it is absorbed by the body. Patients receive on average between one and six treatments, with six weeks or longer between treatments.
 
Skin Rejuvenation- Our Nd:YAG laser and light-based technologies allow our customers to perform non-invasive and minimally-invasive treatments that reduce redness, pore size, fine lines and laxity, improve skin texture, and treat other aesthetic conditions. Our myQ Q-switched laser can be used for the treatment of superficial and deep pigmented lesions (i.e., melasma), skin rejuvenations, laser skin toning and tattoo removal.
 
 
Texture; Lines and Wrinkles- When using a 1064nm Nd: YAG laser to improve skin texture, reduce pore size and treat fine lines, cooling is not applied and the hand piece is held directly above the skin. A large number of pulses are directed at the treatment site, repeatedly covering an area, such as the cheek. By delivering many pulses of laser light to a treatment area, a gentle heating of the dermis occurs and collagen growth is stimulated to rejuvenate the skin and reduce wrinkles. Patients typically receive four to six treatments for this procedure. The treatment typically takes less than a half hour and there are typically two to four weeks between treatments.

When treating texture and fine lines with a Pearl hand piece, the hand piece is held at a controlled distance from the skin and the scanner delivers a preset pattern of spots to the treatment area. Cooling is not applied to the epidermis during the treatment. The energy delivered by the hand piece ablates a portion of the epidermis while leaving a coagulated portion that will gently peel off over the course of a few days. Heat is also delivered into the dermis which can result in the production of new collagen. Treatment of the full face can usually be performed in 15 to 30 minutes. Patients receive on average between one and three treatments at monthly intervals.
 
When treating wrinkles and deep dermal imperfections with a Pearl Fractional hand piece, the hand piece is held at a controlled distance from the skin and the scanner delivers a preset pattern of spots to the treatment area. Cooling is not applied to the epidermis during the treatment. The energy delivered by the hand piece penetrates the deep dermis producing a series of microcolumns across the skin, which can result in the removal of damaged tissue and the production of new collagen. Treatment of the full face can usually be performed in less than an hour. Patients receive on average between one and three treatments at monthly intervals.
 
Our CE Mark allows us to market Pearl Fractional in the European Union, Australia and certain other countries outside the United States for the treatment of wrinkles and deep dermal imperfections. However, in the United States we have a 510(k) clearance for only skin resurfacing and coagulation.
 
Toenail Fungus- In addition to performing skin rejuvenation, we have FDA, Health Canada and CE Mark approvals for GenesisPlus that allows us to market it for onychomycosis (or toenail fungus). Tiny pulses of light from an Nd: YAG laser pass through the toenail to the fungus underneath, which is irradiated without any damage to the surrounding nail or skin. The GenesisPlus has two aiming beams that facilitate consistent treatments by maintaining the correct distance of the hand piece to the skin. In addition, during the treatment an integrated sensor is used to actively monitor the temperature of the treatment area.
 
Dyschromia- Our pulsed-light technologies allow our customers to safely and effectively treat red and brown dyschromia, which is skin discoloration, pigmented lesions and rosacea. The practitioner delivers a narrow spectrum of light to the surface of the skin through our LP560 or LimeLight hand pieces. These hand pieces include one of our proprietary wavelength filters, which reduce the energy level required for therapeutic effect and minimize the risk of skin injury.
 
In treating pigmented lesions with a pulsed-light technology, the hand piece is placed directly on the skin and then the light pulse is triggered. The cells forming the pigmented lesion absorb the light energy, darken and then flake off over the course of two to three weeks. Several treatments may be required to completely remove the lesion. The treatment takes a few minutes per area treated and there are typically three to four weeks between treatments.

The 532 nm wavelength green laser option on the Excel V can also be used to treat pigmented lesions in substantially the same way as described above with the pulsed light devices.

Practitioners can also treat dyschromia and other skin conditions with our Pearl hand piece. During these treatments, the heat delivered by the Pearl hand piece will remove the outer layer of the epidermis while coagulating a portion of the epidermis. That coagulated portion will gently peel off over the course of a few days, revealing a new layer of skin underneath. Treatment of the full face can usually be performed in 15 to 30 minutes. Patients receive on average between one and three treatments at monthly intervals.
 
Skin Laxity- Our Titan technology allows our customers to use deep dermal heating to tighten lax skin. The practitioner delivers a spectrum of light to the skin through our Titan hand piece. This hand piece includes our proprietary light source and wavelength filter which tailors the delivered spectrum of light to provide heating at the desired depth in the skin.
 
In treating skin laxity, the hand piece is placed directly on the skin and then the light pulse is triggered. A sustained pulse causes significant heating in the dermis. This heating can cause immediate collagen contraction while also stimulating long-term collagen re-growth. Several treatments may be required to obtain the desired degree of tightening of the skin. The treatment of a full face can take over an hour and there are typically four weeks between treatments.
 
Our CE Mark allows us to market the Titan in the European Union, Australia and certain other countries outside the United States for the treatment of wrinkles through skin tightening. However, in the United States we have a 510(k) clearance for only deep dermal heating.
 
 
Sales and Marketing
 
In the United States we market and sell our products primarily through a direct sales organization. Generally, each direct sales employee is assigned a specific territory. As of December 31, 2011, we had a U.S. direct sales force of 22 employees. We internally manage our U.S. and Canadian sales organization as one North American sales region with 32 territories as of December 31, 2011. In addition to direct sales employees, we have a distribution relationship with PSS World Medical that operates medical supply distribution service centers with over 700 sales representatives serving physician offices throughout the United States. Revenue from PSS was $1.6 million in 2011, $2.6 million in 2010, and $3.8 million in 2009.

International sales are generally made through a direct international sales force of 26 employees, as well as a worldwide distributor network in over 35 countries as of December 31, 2011. As of December 31, 2011, we had direct sales offices in Australia, Canada, France, Japan, Spain and the United Kingdom. Our international revenue as a percentage of total revenue represented 61% in 2011, 64% in 2010 and 61% in 2009.
  
We also sell certain items like Titan hand piece refills and marketing brochures via the internet.
 
Although specific customer requirements can vary depending on applications, customers generally demand quality, performance, ease of use, and high productivity in relation to the cost of ownership. We have responded to these customer demands by introducing new products focused on these requirements in the markets we serve. Specifically, we believe that we introduce new products and applications that are innovative, address the specific aesthetic procedures in demand, and are upgradeable on our customers’ existing systems. In addition, we provide attractive upgrade pricing to new product families and are responsive to our customers’ financing preferences. To increase market penetration, in addition to marketing to the core specialties of plastic surgeons and dermatologists, we also market to the non-core aesthetic practices consisting of gynecologists, primary care physicians, family practitioners, physicians offering aesthetic treatments in non-medical offices, podiatrists and other qualified practitioners.
 
We seek to establish strong ongoing relationships with our customers through the upgradeability of our products, sales of extended service contracts, the refilling of Titan hand pieces, ongoing training and support, and distributing (in Japan only) cosmeceutical and dermal filler products. We primarily target our marketing efforts to practitioners through office visits, workshops, trade shows, webinars and trade journals. We also market to potential patients through brochures, workshops and our website. In addition, we offer clinical forums with recognized expert panelists to promote advanced treatment techniques using our products to further enhance customer loyalty and uncover new sales opportunities.
 
Competition
 
Our industry is subject to intense competition. Our products compete against conventional non-energy-based treatments, such as electrolysis, Botox and collagen injections, chemical peels, microdermabrasion and sclerotherapy. Our products also compete against laser and light-based products offered by public companies, such as Cynosure, Elen (in Italy), Iridex (we acquired their aesthetic laser business in February 2012), Palomar, Solta and Syneron, as well as private companies, including, Alma, Lumenis, Sciton and several other companies.
 
Competition among providers of laser and other energy-based devices for the aesthetic market is characterized by extensive research efforts and innovative technology. While we attempt to protect our products through patents and other intellectual property rights, there are few barriers to entry that would prevent new entrants or existing competitors from developing products that would compete directly with ours. There are many companies, both public and private, that are developing innovative devices that use both energy-based and alternative technologies. Some of these competitors have greater resources than we do or product applications for certain sub-markets in which we do not participate. Additional competitors may enter the market, and we are likely to compete with new companies in the future. To compete effectively, we have to demonstrate that our products are attractive alternatives to other devices and treatments by differentiating our products on the basis of performance, brand name, service and price. We have encountered, and expect to continue to encounter, potential customers who, due to existing relationships with our competitors, are committed to, or prefer the products offered by these competitors. Competitive pressures may result in price reductions and reduced margins for our products.
 
Research and Development
 
Our research and development group develops new products and applications and builds clinical support to address unmet or underserved market needs. As of December 31, 2011, our research and development activities were conducted by a staff of 28 employees with a broad base of experience in lasers, optoelectronics, software and other fields. We have developed relationships with outside contract engineering and design consultants, giving our team additional technical and creative breadth. We work closely with thought leaders and customers, to understand unmet needs and emerging applications in aesthetic medicine. Research and development expenses were approximately $9.1 million in 2011, $7.0 million in 2010 and $6.8 million in 2009.
 
 
Service and Support
 
Our products are engineered to enable quick and efficient service and support. There are several separate components of our products, each of which can easily be removed and replaced. We believe that quick and effective delivery of service is important to our customers. As of December 31, 2011, we had a 30-person global service department. Internationally, we provide direct service support through our Australia, Canada, France, Japan and Spain offices, and also through the network of distributors in over 35 countries and third-party service providers. We historically have provided a standard one-year or two-year warranty coverage on our systems. We have a standard one-year warranty on all systems. We provide initial warranties on our products to cover parts and service and offer extended service plans that vary by the type of product and the level of service desired. Our standard warranty on system consoles covers parts and service for a standard period of one year. From time to time, we also have promotions whereby we include a post-warranty service contract with the sale of our products. Customers are notified before their initial warranty expires and are able to choose from two different extended service plans covering preventative maintenance or replacement parts and labor. In the event a customer does not purchase an extended service plan, we will offer to service the customer’s system and charge the customer for time and materials. Our Titan hand pieces generally include a warranty for a set number of shots instead of for a period of time. We have invested substantial financial and management resources to develop a worldwide infrastructure to meet the service needs of our customers worldwide.
 
Manufacturing
 
We manufacture our products with components and subassemblies supplied by vendors. We assemble and test each of our products at our Brisbane, California facility. Quality control, cost reduction and inventory management are top priorities of our manufacturing operations.
 
We purchase certain components and subassemblies from a limited number of suppliers. We have flexibility with our suppliers to adjust the number of components and subassemblies as well as the delivery schedules. The forecasts we use are based on historical demands and sales projections. Lead times for components and subassemblies may vary significantly depending on the size of the order, time required to fabricate and test the components or subassemblies, specific supplier requirements and current market demand for the components and subassemblies. We reduce the potential for disruption of supply by maintaining sufficient inventories and identifying additional suppliers. The time required to qualify new suppliers for some components, or to redesign them, could cause delays in our manufacturing. To date, we have not experienced significant delays in obtaining any of our components or subassemblies.
 
We use small quantities of common cleaning products in our manufacturing operations, which are lawfully disposed of through a normal waste management program. We do not forecast any material costs due to compliance with environmental laws or regulations.
 
We are required to manufacture our products in compliance with the FDA’s Quality System Regulation, or QSR. The QSR covers the methods and documentation of the design, testing, control, manufacturing, labeling, quality assurance, packaging, storage and shipping of our products. The FDA enforces the QSR through periodic unannounced inspections. We had 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. There were no significant findings as a result of these audits and our responses have been accepted by the FDA. Our failure to maintain compliance with the QSR requirements could result in the shut down of our manufacturing operations and the recall of our products, which would have a material adverse effect on business. In the event that one of our suppliers fails to maintain compliance with our quality requirements, we may have to qualify a new supplier and could experience manufacturing delays as a result. We have opted to maintain quality assurance and quality management certifications to enable us to market our products in the United States, the member states of the European Union, the European Free Trade Association and countries which have entered into Mutual Recognition Agreements with the European Union. Our manufacturing facility is ISO 13485 certified.
 
Patents and Proprietary Technology
 
We rely on a combination of patent, copyright, trademark and trade secret laws, and non-disclosure, confidentiality and invention assignment agreements to protect our intellectual property rights. As of December 31, 2011, we had 19 issued U.S. patents and 22 pending U.S. patent applications. Acutip 500, Cutera, CoolGlide, CoolGlide Excel, Limelight, Pearl, Pearl Fractional, ProWave 770, Solera, Solera Titan, Titan and Xeo are only some of the trademarks and/or service marks of Cutera in the U.S. and other countries. We have trademark rights to these names and others in the United States and certain other countries. We intend to file for additional patents and trademarks to continue to strengthen our intellectual property rights.
 
We license certain patents from Palomar and pay ongoing royalties based on sales of applicable hair-removal products. The royalty rate on these products ranges from 3.75% to 7.50% of revenue. The patents are set to expire in February 2013 and February 2015. Our revenue from systems that do not include hair-removal capabilities (such as our Solera Titan, Xeo SA, GenesisPlus and Excel V); and other revenue from service contracts, Titan refills, Fillers and cosmeceuticals, are not subject to these royalties. In addition, in 2006 we capitalized $1.2 million as an intangible asset representing the ongoing license for these patents, which is being amortized on a straight-line basis over their expected useful life of 9-10 years. We also have a technology sublicense purchased in 2002, which is being amortized on a straight-line basis over its expected useful life of 10 years.
 
 
Our employees and technical consultants are required to execute confidentiality agreements in connection with their employment and consulting relationships with us. We also require them to agree to disclose and assign to us all inventions conceived in connection with the relationship. We cannot provide any assurance that employees and consultants will abide by the confidentiality or assignability terms of their agreements. Despite measures taken to protect our intellectual property, unauthorized parties may copy aspects of our products or obtain and use information that we regard as proprietary.
 
Government Regulation
 
Our products are medical devices subject to extensive and rigorous regulation by the U.S. Food and Drug Administration, as well as other regulatory bodies. FDA regulations govern the following activities that we perform and will continue to perform to ensure that medical products distributed domestically or exported internationally are safe and effective for their intended uses:

 
·
Product design and development;
 
·
Product testing;
 
·
Product manufacturing;
 
·
Product safety;
 
·
Product labeling;
 
·
Product storage;
 
·
Recordkeeping;
 
·
Pre-market clearance or approval;
 
·
Advertising and promotion;
 
·
Production; and
 
·
Product sales and distribution.
 
·
Complaint Handling

FDA’s Pre-market Clearance and Approval Requirements
 
Unless an exemption applies, each medical device we wish to commercially distribute in the United States will require either prior 510(k) clearance or pre-market approval from the FDA. The FDA classifies medical devices into one of three classes. Devices deemed to pose lower risks are placed in either class I or II, which requires the manufacturer to submit to the FDA a pre-market notification requesting permission to commercially distribute the device. This process is generally known as 510(k) clearance. Some low risk devices are exempted from this requirement. Devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or devices deemed not substantially equivalent to a previously cleared 510(k) device, are placed in class III, requiring pre-market approval. All of our current products are class II devices.
 
510(k) Clearance Pathway
 
When a 510(k) clearance is required, we must submit a pre-market notification demonstrating that our proposed device is substantially equivalent to a previously cleared 510(k) device or a device that was in commercial distribution before May 28, 1976 for which the FDA has not yet called for the submission of Pre-Market Approval, or PMA, applications. By regulation, the FDA is required to clear or deny a 510(k), pre-market notification within 90 days of submission of the application. As a practical matter, clearance often takes significantly longer. The FDA may require further information, including clinical data, to make a determination regarding substantial equivalence. Laser devices used for aesthetic procedures, such as hair removal, have generally qualified for clearance under 510(k) procedures.
 
 
The following table details the indications for which we received a 510(k) clearance for our products and when these clearances were received.
 
     
FDA Marketing Clearances:
 
Date Received:
Laser-based products:
   
- treatment of vascular lesions
 
June 1999
- hair removal
 
March 2000
- permanent hair reduction
 
January 2001
- treatment of benign pigmented lesions and pseudofolliculitis barbae, commonly referred to as razor bumps, and for the reduction of red pigmentation in scars
 
June 2002
- treatment of wrinkles
 
October 2002
- treatment of Onychomycosis for the clearance of nails
April 2011
     
Pulsed-light technologies:
   
- treatment of pigmented lesions
 
March 2003
- hair removal and vascular treatments
 
March 2005
   
Infrared Titan technology for deep dermal heating for the temporary relief of minor muscle and joint pain and for the temporary increase in local circulation where applied
 
February 2004
   
Solera tabletop console:
   
- for use with the Titan hand piece
 
October 2004
- for use with our pulsed-light hand pieces
 
January 2005
   
Pearl product for the treatment of wrinkles
 
March 2007
   
Pearl Fractional product for skin resurfacing and coagulation
 
August 2008
 
Pre-Market Approval (PMA) Pathway
 
A PMA must be submitted to the FDA if the device cannot be cleared through the 510(k) process. A PMA must be supported by extensive data, including but not limited to, technical, preclinical, clinical trials, manufacturing and labeling to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device. No device that we have developed to date has required pre-market approval, although development of future devices or indications may require pre-market approval.
 
Product Modifications
 
We have modified aspects of our products since receiving regulatory clearance, but we believe that new 510(k) clearances are not required for these modifications. After a device receives 510(k) clearance or a PMA, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, will require a new clearance or approval. The FDA requires each manufacturer to make this determination initially, but the FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees with our determination not to seek a new 510(k) clearance or PMA, the FDA may retroactively require us to seek 510(k) clearance or pre-market approval. The FDA could also require us to cease marketing and distribution and/or recall the modified device until 510(k) clearance or pre-market approval is obtained. Also, in these circumstances, we may be subject to significant regulatory fines or penalties.
 
Clinical Trials
 
When FDA approval of a class I, class II or class III device requires human clinical trials, and if the device presents a “significant risk,” as defined by the FDA, to human health, the device sponsor is required to file an Investigational Device Exemption, or IDE, application with the FDA and obtain IDE approval prior to commencing the human clinical trial. If the device is considered a “non-significant” risk, IDE submission to the FDA is not required. Instead, only approval from the Institutional Review Board, or IRB, overseeing the clinical trial is required. Human clinical studies are generally required in connection with approval of class III devices and may be required for class I and II devices. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The IDE must be approved in advance by the FDA for a specified number of patients. Clinical trials for a significant risk device may begin once the application is reviewed and cleared by the FDA and the appropriate institutional review boards at the clinical trial sites. Future clinical trials of our products may require that we submit and obtain clearance of an IDE from the FDA prior to commencing clinical trials. The FDA, and the IRB at each institution at which a clinical trial is being performed, may suspend a clinical trial at any time for various reasons, including a belief that the subjects are being exposed to an unacceptable health risk.
 
 
Pervasive and Continuing Regulation
 
After a device is placed on the market, numerous regulatory requirements apply. These include:
 
 
·
Quality system egulations, which require manufacturers, including third-party manufacturers, to follow stringent design, testing, control, documentation and other quality assurance procedures during all aspects of the manufacturing process;
 
·
Labeling regulations and FDA prohibitions against the promotion of products for un-cleared, unapproved or “off-label” uses;
 
·
Medical device reporting regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction were to recur; and
 
·
Post-market surveillance regulations, which apply when necessary to protect the public health or to provide additional safety and effectiveness data for the device. 

The FDA has broad post-market and regulatory enforcement powers. We are subject to unannounced inspections by the FDA and the Food and Drug Branch of the California Department of Health Services, or CDHS, to determine our compliance with the QSR and other regulations, and these inspections may include the manufacturing facilities of our subcontractors. In the past, our prior facility has been inspected, and observations were noted. There were no findings that involved a material violation of regulatory requirements. Our responses to these observations have been accepted by the FDA and CDHS, and we believe that we are in substantial compliance with the QSR. Our current manufacturing facility has been inspected by the FDA and the CDHS. The FDA and the CDHS noted observations, but there were no findings that involved a material violation of regulatory requirements. Our responses to those observations have been accepted by the FDA and CDHS.
 
We are also regulated under the Radiation Control for Health and Safety Act, which requires laser products to comply with performance standards, including design and operation requirements, and manufacturers to certify in product labeling and in reports to the FDA that their products comply with all such standards. The law also requires laser manufacturers to file new product and annual reports, maintain manufacturing, testing and sales records, and report product defects. Various warning labels must be affixed and certain protective devices installed, depending on the class of the product.
 
Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include any of the following sanctions:
 
 
·
Warning letters, fines, injunctions, consent decrees and civil penalties;
 
·
Repair, replacement, recall or seizure of our products;
 
·
Operating restrictions or partial suspension or total shutdown of production;
 
·
Refusing our requests for 510(k) clearance or pre-market approval of new products, new intended uses, or modifications to existing products;
 
·
Withdrawing 510(k) clearance or pre-market approvals that have already been granted; and
 
·
Criminal prosecution.
 
The FDA also has the authority to require us to repair, replace or refund the cost of any medical device that we have manufactured or distributed. If any of these events were to occur, they could have a material adverse effect on our business.
 
We are also subject to a wide range of federal, state and local laws and regulations, including those related to the environment, health and safety, land use and quality assurance. We believe that compliance with these laws and regulations as currently in effect will not have a material adverse effect on our capital expenditures, earnings and competitive and financial position.
 
International
 
International sales of medical devices are subject to foreign governmental regulations, which vary substantially from country to country. The time required to obtain clearance or approval by a foreign country may be longer or shorter than that required for FDA clearance or approval, and the requirements may be different.
 
The primary regulatory environment in Europe is that of the European Union, which consists of a number of countries encompassing most of the major countries in Europe. The member states of the European Free Trade Association have voluntarily adopted laws and regulations that mirror those of the European Union with respect to medical devices. Other countries, such as Switzerland, have entered into Mutual Recognition Agreements and allow the marketing of medical devices that meet European Union requirements. The European Union has adopted numerous directives and European Standardization Committees have promulgated voluntary standards regulating the design, manufacture, clinical trials, labeling and adverse event reporting for medical devices. Devices that comply with the requirements of a relevant directive will be entitled to bear CE conformity marking, indicating that the device conforms with the essential requirements of the applicable directives and, accordingly, can be commercially distributed throughout the member states of the European Union, the member states of the European Free Trade Association and countries which have entered into a Mutual Recognition Agreement. The method of assessing conformity varies depending on the type and class of the product, but normally involves a combination of self-assessment by the manufacturer and a third-party assessment by a Notified Body, an independent and neutral institution appointed by a country to conduct the conformity assessment. This third-party assessment may consist of an audit of the manufacturer’s quality system and specific testing of the manufacturer’s device. An assessment by a Notified Body in one member state of the European Union, the European Free Trade Association or one country which has entered into a Mutual Recognition Agreement is required in order for a manufacturer to commercially distribute the product throughout these countries. ISO 9001 and ISO 13845 certification are voluntary harmonized standards. Compliance establishes the presumption of conformity with the essential requirements for a CE Marking. In February 2000, our facility was awarded the ISO 9001 and EN 46001 certification. In March 2003, we received our ISO 9001 updated certification (ISO 9001:2000) as well as our certification for ISO 13485:1996 which replaced our EN 46001 certification. In March 2004, we received our ISO 13485:2003 certification, which is the most current ISO certification for medical device companies, and in March 2006, March 2010, February 2011 and January 2012 we passed our ISO 13485 recertification audits.

 
Employees

As of December 31, 2011, we had 200 employees, compared to 187 employees as of December 31, 2010. Of the 200 employees at December 31, 2011, 78 were in sales and marketing, 43 in manufacturing operations, 30 in technical service, 28 in research and development and 21 in general and administrative. We believe that our future success will depend in part on our continued ability to attract, hire and retain qualified personnel. None of our employees are represented by a labor union, and we believe our employee relations are good.
 
Available Information
 
We are subject to the reporting requirements under the Securities Exchange Act of 1934. Consequently, we are required to file reports and information with the Securities and Exchange Commission, or SEC, including reports on the following forms: annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. These reports and other information concerning the company may be accessed through the SEC’s website at www.sec.gov. Such filings, as well as our charters for our Audit and Compensation Committees and our Code of Ethics are available on our website at www.cutera.com. In the event that we grant a waiver under our Code of Ethics to any of our officers and directors, we will publish it on our website.
 
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 2011, our U.S. revenue increased by approximately 21%, compared to the same period in 2010. However, in fiscal year 2010 our U.S. revenue decreased by approximately 8% compared to the same period in 2009. Even though our U.S. revenue has increased in 2011, it continues to be significantly below the pre-2009 levels. If our U.S. revenue does not continue to improve, it could have a material adverse effect on our total revenue, profitability, employee retention and stock price.
 
In 2011, our U.S. revenue increased by approximately 21%, compared to the same period in 2010. Even though our U.S. revenue has increased in 2011, it continues to be significantly below the pre-2009 levels due to several factors, some of which are:
 
·
Our Product and Upgrade ASPs were lower than the pre-2009 levels as a result of customers purchasing fewer applications for systems, lower pricing resulting from competitive discounting pressures and the impact of a shift in our product mix towards lower priced systems.
 
·
Historically, we have introduced a new product every year since 2000, which typically resulted in increased revenue. However, in 2009 and until August 2010, we did not have a new product. In August 2010, we launched GenesisPlus and in February 2011, we launched Excel V. Even though we have introduced these new products and experienced sales increases as a result, there can be no assurance that they will translate into increased revenue in the long term in the U.S.
 
·
Although our U.S. Titan hand piece refill revenue increased by 19% for the year ended December 31, 2011, compared to the same period in 2010, our U.S. Titan hand piece refill revenue was still lower than the levels prior to the second quarter of 2010. That was due to a voluntary recall of certain Titan XL hand pieces in the second quarter of 2010, whereby all customers that had a Titan XL hand piece subject to the recall were provided with a fully refilled Titan XL hand piece. This delayed their purchase of a refill and resulted in a decline of our Titan refill revenue.
 
 
If our U.S. revenue does not continue to improve, it could have a material adverse effect on our total revenue, profitability, employee retention and stock price.
 
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.
 
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. In addition, we have lost some of our sales professionals in response to the decline in their earnings resulting from the decreases in their commissions.
 
We have selectively hired new sales professionals and managers in key territories to fill vacant positions.  For example, in December 2010, Michael Poole joined us as Vice President of North American Sales, which allowed our previous Vice President of North American Sales to return to Japan in an expanded role to lead our Pacific Rim operations. Although Mr. Poole has over 17 years of broad sales experience and was employed by us from 2004 to 2008, Mr. Poole has limited prior experience in managing a large sales force. We have been training our existing and recently recruited sales professionals to better understand our product technology and how it can be positioned against our competitors’ products.  These initiatives are intended to improve the productivity of our sales professionals, our revenue and profitability.
 
In the third quarter of 2011, our European-sourced direct and distributor revenue declined significantly, compared to the same period in 2010. We have restructured our European sales team as well as our direct hub operation in Switzerland and in December 2011, we engaged a distributor that was set up by some of our former sales employees. In addition, we continue to hire additional sales personnel to manage our European business. These initiatives are intended to improve our European-sourced revenue.
 
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 from the 2011 level, 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 in 2011 was 57%, compared to 57% in 2010 and 59% in 2009. Our gross margin is impacted by the revenue that we generate and the costs incurred to generate the revenue. 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, or a shift in our product mix towards products with lower average selling prices. 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 activities and using cash in the process. We plan to continue making such investments in order to bring new products to market.
 
If our revenue does not continue to improve from the 2011 level, 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.
 
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:
 
General economic and business conditions;
 
 
The overall demand for our products by the core market specialties of dermatologists and plastic surgeons;
 
Governmental budgetary constraints or shifts in government spending priorities;
 
General political developments;
 
Natural disasters, such as the March 2011 earthquake and tsunami in Japan; and
 
Currency exchange rate fluctuations.
          
Macroeconomic developments like the 2009 - 2010 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
 
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. This legislation, however, does include several aspects that will apply to us, including a tax on our U.S. revenue which is applicable to us beginning in 2013. While we are presently evaluating the full scope of how this legislation will impact our operations, including how to administer this tax, we believe this will adversely affect our future profitability and financial condition.
 
Demand for our products in any of our markets could be weakened by several factors, including:
 
Our ability to develop and market our products to the core market specialties of dermatologists and plastic surgeons;
 
Poor financial performance of market segments that try introducing aesthetic procedures to their businesses;
 
The inability to differentiate our products from those of our competitors;
 
Reduced patient demand for elective aesthetic procedures;
 
Failure to build and maintain relationships with opinion leaders within the various market segments;
 
An increase in malpractice lawsuits that result in higher insurance costs; and
 
The lack of credit financing for some of our potential customers.
 
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.
 
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 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. In 2011, we launched our vascular laser product – Excel V – 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 light-based aesthetic procedures. Since the first quarter of 2010, we have been distributing cosmeceutical products and dermal fillers in the Japanese market. To grow in the future, we must continue to develop and 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:
 
Develop and acquire new products that either add to or significantly improve our current product offerings;
 
Convince our existing and prospective customers that our product offerings would be an attractive revenue-generating addition to their practice;
 
Sell our product offerings to a broad customer base;
 
Identify new markets and alternative applications for our technology;
 
Protect our existing and future products with defensible intellectual property; and
 
Satisfy and maintain all regulatory requirements for commercialization.
 
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.
 
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:
 
Speed of new and innovative product development;
 
Effective strategy and execution of new product launches;
 
Identify and develop clinical support for new indications of our existing products;
 
Product performance;
 
Product pricing;
 
Quality of customer support;
 
Development of successful distribution channels, both domestically and internationally; and
 
Intellectual property protection.
          
 
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.
 
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), Palomar, Solta, and Syneron and 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, we acquired the aesthetic business unit of Iridex in February 2012, Solta (previously Thermage) acquired Aesthera in February 2010 and Reliant in December 2008; Syneron acquired Ultrashape in March 2012 and Candela in September 2009; and Cynosure acquired the aesthetic laser business of HOYA ConBio in June 2011. 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.
 
We may face problems with the integration of our acquisition of IRIDEX Corporation’s global aesthetic business.
 
On February 2, 2012, we completed our acquisition of certain assets of IRIDEX Corporation’s (IRIDEX) global aesthetic business.
 
We cannot be certain that this integration will be successful or that we will realize the anticipated benefits of the acquisition.  In particular, we may not be able to realize the strategic and operational benefits and objectives we had anticipated, including, greater revenue and marketing opportunities.  In addition, the demand for our combined product offerings may fluctuate and we will face competition from new competitors in the market for our products.  Our ability to realize the strategic and operational benefits and objectives of this acquisition may be impacted by several factors including:
 
The potential disruption of the company’s ongoing business and diversion of management resources;
 
The difficulty of incorporating acquired products, technology and rights into the company’s products and services;
 
Unanticipated expenses related to integration of operations;
 
Potential periodic impairment of goodwill and intangible assets acquired, if any; and
 
Potential inability to retain, integrate and motivate key personnel.
 
Any of the above mentioned factors, as well as the inability to realize the long-term anticipated synergies of the acquisition of these assets, may have a material adverse effect on our business, operating results and financial condition.
 
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 light-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:
 
 
Consumer disposable income and access to consumer credit, which as a result of the unstable economy, may have been significantly impacted;
 
The cost of procedures performed using our products;
 
The cost, safety and effectiveness of alternative treatments, including treatments which are not based upon laser or light-based technologies and treatments which use pharmaceutical products;
 
The success of our sales and marketing efforts; and
 
The education of our customers and patients on the benefits and uses of our products, compared to competitors’ products and technologies.
 
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.
 
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.
 
If our products contain defects that cannot be repaired easily, inexpensively, or on a timely basis, we may experience:
 
Damage to our brand reputation;
 
Loss of customer orders and delay in order fulfillment;
 
Increased costs due to product repair or replacement;
 
Inability to attract new customers;
 
Diversion of resources from our manufacturing and research and development departments into our service department; and
 
Legal action.
           
The occurrence of any one or more of the foregoing could materially increase expenses, adversely impact profitability and harm our business.
 
To successfully market and sell our products internationally, we must address many issues that are unique to our international business.
 
International revenue represented 61% of our total revenue for the year ended December 31, 2011 compared to 64% for 2010. 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.  For example, in 2011 our European revenue declined 38%, compared to 2010, due in part to employee turnover. Further, in the fourth quarter of 2011, some of our direct sales personnel in Switzerland set up an independent distributor company.
 
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.
 
 
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:
 
Difficulties in staffing and managing our foreign operations;
 
Export restrictions, trade regulations and foreign tax laws;
 
Fluctuating foreign currency exchange rates;
 
Foreign certification and regulatory requirements;
 
Lengthy payment cycles and difficulty in collecting accounts receivable;
 
Customs clearance and shipping delays;
 
Political and economic instability;
 
Lack of awareness of our brand in international markets;
 
Preference for locally-produced products; and
 
Reduced protection for intellectual property rights in some countries.
 
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.
 
Federal regulatory reforms and changes occurring at the U.S. Food and Drug Administration, or 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.
 
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 treatment of 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.
 
The FDA and state authorities have broad enforcement powers. If we fail to comply with applicable regulatory requirements, it could result in enforcement action by the FDA or state agencies, which may include any of the following sanctions:
 
Warning letters, fines, injunctions, consent decrees and civil penalties;
 
Repair, replacement, recall or seizure of our products;
 
Operating restrictions or partial suspension or total shutdown of production;
 
Refusing our requests for 510(k) clearance or pre-market approval of new products, new intended uses, or modifications to existing products;
 
Withdrawing 510(k) clearance or pre-market approvals that have already been granted; and
 
Criminal prosecution.
          
 If any of these events were to occur, it could harm our business.
 
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, or 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. 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. 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.
 
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.
 
 
In 2010 and 2011 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 2010 and 2011, we entered into distribution arrangements pursuant to which we utilize our sales force and distributors to sell products manufactured by other companies. Commencing in the fourth quarter of 2011, we began to distribute in Japan a Q-switched laser product manufactured by a third party OEM. In the first quarter of 2010, we entered into an agreement with Obagi to distribute certain of their proprietary cosmeceuticals, or skin care products, in Japan. This agreement requires us to purchase an annual minimum dollar amount of their product. The minimum purchase requirement for 2012 is $2.0 million. If we do not make these minimum purchases, we could lose exclusivity for distributing Obagi products to physicians in Japan. Finally, we also have an agreement with Merz Aesthetics to distribute their 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.
 
If PSS World Medical fails to perform to our expectations, we may fail to achieve anticipated operating results.
 
We have a distribution agreement with PSS World Medical. PSS sales professionals work in coordination with our sales force to locate new customers for our products throughout the United States. Revenue from PSS has significantly declined since 2008. Our revenue from PSS, as a percentage of worldwide revenue, was 3% for the year ended December 31, 2011, 5% in 2010 and 7% in 2009. Although we continue to work closely with, and focus our attention on, our PSS relationship, there is no assurance that this will translate into increased revenue for us. Further, if revenue from PSS does not improve, or if they terminate our relationship, it may have an adverse effect on our revenue results of operations and 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 December 31, 2011, our balance in marketable investments was $74.7 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 December 31, 2011 would have potentially decreased by approximately $608,000, 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).
 
We may be required to record impairment charges in future quarters as a result of the decline in value of our long-term investments in auction rate securities (ARS).
 
Included under the caption of “Long-term investments” in the Consolidated Balance Sheet as of December 31, 2011 are $3.9 million (par value) of ARS. These ARS were designed to provide liquidity through an auction process that resets the applicable interest rate at predetermined calendar intervals, generally every 35 days. Though approximately $9.5 million (par value) of our original holdings of $13.4 million (par value) of ARS have been redeemed at full par value since 2008, auctions for the remaining ARS in our portfolio at December 31, 2011 continue to fail and they remain as illiquid. Upon an auction failure, the interest rates do not reset at a market rate but instead reset based on a formula contained in the prospectus of the individual security, which rate is generally higher than the prevailing market rate. The failure of the auctions impacts our ability to readily liquidate our ARS into cash until a future auction of these investments is successful, a buyer is found outside of the auction process, or the ARS is refinanced by the issuer into another type of debt instrument. If there is a decline in fair value in our ARS that is considered other-than-temporary then we would have to record an impairment charge in our Consolidated Statement of Operations for the loss in value associated with the worsening of the credit worthiness (credit losses) of the issuer, which would reduce future earnings, harm our business and may cause our stock price to decline.
 
 
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, 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. 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.
 
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 December 31, 2011, approximately 45% 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:
 
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;
 
The general market conditions unrelated to our operating performance;
 
Sales of large blocks of our common stock, including sales by our executive officers, directors and our large institutional investors;
 
Quarterly variations in our, or our competitors’, results of operations;
 
Changes in analysts’ estimates, investors’ perceptions, recommendations by securities analysts or our failure to achieve analysts’ estimates;
 
The announcement of new products or service enhancements by us or our competitors;
 
The announcement of the departure of a key employee or executive officer by us or our competitor;
 
Regulatory developments or delays concerning our, or our competitors’ products; and
 
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 do not have any experience as a team with acquiring companies or products. If we decide to expand our product offerings beyond laser and light-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.
 
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:
 
Interruption of supply resulting from modifications to or discontinuation of a supplier’s operations;
 
Delays in product shipments resulting from uncorrected defects, reliability issues or a supplier’s variation in a component;
 
A lack of long-term supply arrangements for key components with our suppliers;
 
Inability to obtain adequate supply in a timely manner, or on reasonable terms;
 
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;
 
Difficulty locating and qualifying alternative suppliers for our components in a timely manner;
 
Production delays related to the evaluation and testing of products from alternative suppliers and corresponding regulatory qualifications; and
 
Delay in supplier deliveries.
           
 
Any interruption in the supply of components or materials, or our inability to obtain substitute components or materials from alternate sources at acceptable prices in a timely manner, could impair our ability to meet the demand of our customers, which would have an adverse effect on our business.
 
Intellectual property rights may not provide adequate protection for some or all of our products, which may permit third parties to compete against us more effectively.
 
We rely on patent, copyright, trade secret and trademark laws and confidentiality agreements to protect our technology and products. At December 31, 2011, we had 19 issued U.S. patents. Some of our components, such as our laser module, electronic control system and high-voltage electronics, are not, and in the future may not be, protected by patents. Additionally, our patent applications may not issue as patents or, if issued, may not issue in a form that will be advantageous to us. Any patents we obtain may be challenged, invalidated or legally circumvented by third parties. Consequently, competitors could market products and use manufacturing processes that are substantially similar to, or superior to, ours. We may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by consultants, vendors, former employees or current employees, despite the existence generally of confidentiality agreements and other contractual restrictions. Monitoring unauthorized uses and disclosures of our intellectual property is difficult, and we do not know whether the steps we have taken to protect our intellectual property will be effective. Moreover, the laws of many foreign countries will not protect our intellectual property rights to the same extent as the laws of the United States.
 
The absence of complete intellectual property protection exposes us to a greater risk of direct competition. Competitors could purchase one of our products and attempt to replicate some or all of the competitive advantages we derive from our development efforts, design around our protected technology, or develop their own competitive technologies that fall outside of our intellectual property rights. If our intellectual property is not adequately protected against competitors’ products and methods, our competitive position and our business could be adversely affected.
 
We offer credit terms to some qualified customers and also to leasing companies to finance the purchase of our products. In the event that any of these customers default on the amounts payable to us, our earnings may be adversely affected.
 
While we qualify customers to whom we offer credit terms (generally net 30 to 90 days), we cannot provide any assurance that the financial position of these customers will not change adversely before we receive payment. Our general and administrative expenses and earnings are negatively impacted by customer defaults and cause an increase in the allowance for doubtful accounts. In the event that there is a default by any customers to whom we have provided credit terms in the future, we may recognize a bad debt charge in our general and administrative expenses and this could negatively affect our earnings and results of operations.
 
We are subject to fluctuations in the exchange rate of the U.S. dollar and foreign currencies.
 
As a result of recent fluctuations in currency markets and the strong dollar relative to many other major currencies, our products priced in U.S. dollars may be cheaper or more expensive relative to products of our foreign competitors, which could result in volatility in 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, Canadian Dollar and British Pound Sterling. As a result, changes in the exchange rates of these currencies to the U.S. Dollar will affect our results from operations.
 
The expense and potential unavailability of insurance coverage for our customers could adversely affect our ability to sell our products, and therefore our financial condition.
 
Some of our customers and prospective customers have had difficulty in procuring or maintaining liability insurance to cover their operation and use of our products. Medical malpractice carriers are withdrawing coverage in certain states or substantially increasing premiums. If this trend continues or worsens, our customers may discontinue using our products and potential customers may opt against purchasing laser and light based products due to the cost or inability to procure insurance coverage. The unavailability of insurance coverage for our customers and prospects could adversely affect our ability to sell our products, and that could harm our financial condition.
 
 
Anti-takeover provisions in our Amended and Restated Certificate of Incorporation and Bylaws, and Delaware law, contain provisions that could discourage a takeover.
 
Our Amended and Restated Certificate of Incorporation and Bylaws, and Delaware law, contain provisions that might enable our management to resist a takeover, and might make it more difficult for an investor to acquire a substantial block of our common stock. These provisions include:
 
A classified board of directors;
 
Advance notice requirements to stockholders for matters to be brought at stockholder meetings;
 
Limitations on stockholder actions by written consent; and
 
The right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer.
           
These provisions, as well as Change of Control and Severance Agreements entered into with each of our executive officers, might discourage, delay or prevent a change in control of our company or a change in our management. The existence of these provisions could adversely affect the voting power of holders of common stock and limit the price that investors might be willing to pay in the future for shares of our common stock.
 
ITEM 1B.
UNRESOLVED STAFF COMMENTS
 
Not applicable.

ITEM 2.
 
Our corporate headquarters and U.S. operations are located in an approximately 66,000 square foot facility in Brisbane, California. We lease these premises under a non-cancelable operating lease which expires on December 31, 2017. In addition, we have leased office facilities in certain international countries as follows:
 
Country
 
Square Footage
 
Lease termination or Expiration
Japan
 
Approximately 5,878
 
Two leases, one of which expires in December 2013 and one which expires in March 2015.
Switzerland
 
Approximately 3,174
 
One lease which expires in March 2013.
France
 
Approximately 450
 
One lease which expires in November 2014.
Spain
 
Approximately 269
 
Lease automatically renews at the end of each six-month period.
 
We believe that these facilities are adequate for our current and future needs for at least the next twelve months.
 
ITEM 3.
LEGAL PROCEEDINGS

We are not a party to any pending litigation that we believe will have a material impact to our results of operations.
 
ITEM 4.
MINE SAFETY DISCLOSURES
 
Not applicable.
 
PART II
 
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Stock Exchange Listing
 
Our common stock trades on The NASDAQ Global Select Market under the symbol “CUTR.” As of February 29, 2012, the closing sale price of our common stock was $9.35 per share.

Common Stockholders
 
We had 10 stockholders of record as of February 29, 2012. Since many stockholders choose to hold their shares under the name of their brokerage firm, we believe, the actual number of stockholders was in approximately 2,000.
 
 
Stock Prices
 
The following table sets forth quarterly high and low closing sales prices of our common stock for the indicated fiscal periods:
 
 
Common Stock
 
 
2011
 
2010
 
 
High
 
Low
 
High
 
Low
 
4th Quarter
 
$
7.93
   
$
6.96
   
$
8.39
   
$
7.01
 
3rd Quarter
   
8.74
     
7.03
     
9.00
     
6.99
 
2nd Quarter
   
9.46
     
7.59
     
12.04
     
8.62
 
1st Quarter
   
9.94
     
8.08
     
11.03
     
8.25
 
 
 Performance Graph
 
Below is a graph showing the cumulative total return to our stockholders during the period from December 31, 2006 through December 31, 2011 in comparison to the cumulative return on the NASDAQ Composite Index (U.S.) and the NASDAQ Medical Equipment Index during that same period.
 
 
The information under “Performance Graph” is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference in any filing of Cutera under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this 10-K and irrespective of any general incorporation language in those filings.
 

Dividend Policy
 
We have never paid a cash dividend and have no present intention to pay cash dividends in the foreseeable future. We intend to retain any future earnings for use in our business.
 
We did not sell any unregistered securities during the period covered by this Annual Report on Form 10-K.
 
The information required by this Item regarding equity compensation plans is incorporated by reference to the information set forth in Part III Item 12 of this Annual Report on Form 10-K.
 
Securities Authorized for Issuance under Equity Compensation Plans
 
See Part III, Item 12 for information regarding securities authorized for issuance under equity compensation plans.
 
 
ITEM 6.
SELECTED FINANCIAL DATA
 
The table set forth below contains certain consolidated financial data for each of our last five fiscal years. This data should be read in conjunction with the detailed information, financial statements and related notes, as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.
 
     
Year Ended December 31,
 
Consolidated Statements of Operations Data (in thousands, except per share data):    
2011
     
2010
     
2009
     
2008
     
2007
 
Net revenue
  
$
60,290
   
$
53,274
   
$
53,682
   
$
83,379
   
$
101,726
 
Cost of revenue
  
 
25,978
     
23,058
     
21,759
     
32,358
     
35,002
 
Gross profit
  
 
34,312
     
30,216
     
31,923
     
51,021
     
66,724
 
Operating expenses:
  
                                     
Sales and marketing
  
 
25,499
     
24,735
     
24,286
     
35,354
     
38,277
 
Research and development
  
 
9,141
     
7,004
     
6,810
     
7,550
     
7,169
 
General and administrative
  
 
10,104
     
9,576
     
10,320
     
11,270
     
11,721
 
Litigation settlement
  
 
     
     
850
     
     
 
Total operating expenses
  
 
44,744
     
41,315
     
42,266
     
54,174
     
57,167
 
Income (loss) from operations
  
 
(10,432
)
   
(11,099
)
   
(10,343
)
   
(3,153
)
   
9,557
 
Interest and other income, net
  
 
614
     
583
     
1,572
     
3,046
     
4,207
 
Other-than-temporary impairments of long-term investments
  
 
     
     
     
(3,554
   
 
Income (loss) before income taxes
  
 
(9,818
)
   
(10,516
)
   
(8,771
)
   
(3,661
   
13,764
 
Provision (benefit) for income taxes
  
 
243
     
2
     
8,908
     
(792
)
   
3,260
 
Net income (loss)
  
$
(10,061
)
 
$
(10,518
)
 
$
(17,679
)
 
$
(2,869
 
$
10,504
 
Net income (loss) available to common stockholders used in basic net income per share
  
$
(10,061
)
 
$
(10,518
)
 
$
(17,679
)
 
$
(2,869
 
$
10,504
 
Net income (loss) per share:
  
                                     
Basic
  
$
(0.73
)
 
$
(0.78
)
 
$
(1.33
)
 
$
(0.22
 
$
0.80
 
Diluted
  
$
(0.73
)
 
$
(0.78
)
 
$
(1.33
)
 
$
(0.22
 
$
0.74
 
Weighted-average number of shares used in per share calculations:
  
                                     
Basic
  
 
13,807
     
13,540
     
13,279
     
12,770
     
13,153
 
Diluted
  
 
13,807
     
13,540
     
13,279
     
12,770
     
14,228
 
 
   
As of December 31,
 
Consolidated Balance Sheet Data (in thousands):
 
2011
   
2010
   
2009
   
2008
   
2007
 
Cash and cash equivalents
  $ 14,020     $ 12,519     $ 22,829     $ 36,540     $ 11,054  
Marketable investments
    74,666       77,484       76,780       60,653       88,510  
Long-term investments
    3,027       6,784       7,275       9,627       7,429  
Working capital (current assets less current liabilities)
    89,075       90,339       96,015       101,644       106,894  
Total assets
    111,353       111,805       121,352       137,476       138,653  
Retained earnings (accumulated deficit)
    (3,325     6,736       17,254       31,410       34,279  
Total stockholders’ equity
    91,567       95,417       100,853       112,108       109,353  
 
 
 ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion should be read in conjunction with our audited financial statements and notes thereto for the fiscal year ended December 31, 2011. This Annual Report on Form 10-K, 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 7, the forward-looking statements are based upon our current expectations, estimates and projections and that 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. The 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, improve the performance of our worldwide sales and distribution network, and to the outlook regarding long term prospects. We caution you not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Form 10-K.
 
Some of the important factors that could cause our results to differ materially from those in our forward-looking statements, and a discussion of other risks and uncertainties, are discussed in Item 1A—Risk Factors commencing on page [17]. We encourage you to read that section carefully as well as other risks detailed from time to time in our filings with the SEC.

Introduction
 
The Management’s Discussion and Analysis, or MD&A, is organized as follows:
 
 
Executive Summary. This section provides a general description and history of 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.
 
Critical Accounting Policies and Estimates. This section describes the key accounting policies that are affected by critical accounting estimates.
 
Recent Accounting Guidance. This section describes the issuance and effect of new accounting pronouncements that are and may be applicable to us.
 
Results of Operations. This section provides our analysis and outlook for the significant line items on our Consolidated Statements of Operations.
 
Liquidity and Capital Resources. This section provides an analysis of our liquidity and cash flows, as well as a discussion of our commitments that existed as of December 31, 2011.

Executive Summary
 
Company Description. We are a global medical device company specializing in the design, development, manufacture, marketing and servicing of laser and light-based aesthetics systems for practitioners worldwide. We offer easy-to-use products based on six platforms — CoolGlide®, Xeo®, Solera®, GenesisPlusTM, Excel VTM, and myQTM — each of which enables physicians and other qualified practitioners to perform safe and effective aesthetic procedures for their customers. Commencing in the fourth quarter of 2011, we launched a new Q-switched laser product called myQ in Japan, that Cutera sources from a third party original equipment manufacturer (OEM). The Xeo and Solera platforms offer multiple hand pieces and applications, which allow customers to upgrade their systems, which we treat as Upgrade revenue. 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, Titan hand piece refills, and 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. In the United States, we market, sell and service our products through direct sales and service employees, and a distribution relationship with PSS World Medical Shared Services, Inc. (“PSS”), a wholly owned subsidiary of PSS World Medical which has over 700 sales representatives serving physician offices throughout the United States. We also sell certain items such as our Titan hand piece refills and marketing brochures online.
 
 
International sales are generally made through direct sales employees and a worldwide distributor network in over 35 countries. Outside of the United States, we have a direct sales presence in Australia, Canada, France, Japan, Spain, Switzerland (however, beginning October 1, 2011 we engaged a distributor in Switzerland instead of selling directly) and the United Kingdom.
 
Products.  Our revenue is derived from the sale of Products, Upgrades, Service, Titan hand piece refills, and Dermal fillers and cosmeceutical products. Product revenue represents the sale of a system. A system consists of a console that incorporates a universal graphic user interface, a laser and/or light-based module, control system software and high voltage electronics; as well as one or more hand pieces. However, depending on the application, the laser or light-based module is sometimes contained in the hand piece such as with our Pearl and Pearl Fractional applications instead of within the console. In the fourth quarter of 2011, we launched a new Q-switched laser system called myQ.
 
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. This provides customers the flexibility to upgrade their systems whenever they want and provides us with a source of recurring revenue which we classify as Upgrade revenue. Service revenue relates to amortization of prepaid service contracts, direct billings for detachable hand piece replacements and revenue for parts and labor on out-of-warranty products. Titan hand piece refill revenue is associated with our Titan hand piece which requires replacement of the optical source after a set number of pulses have been used. In Japan, we distribute Merz Pharma GmbH’s (Merz) Radiesse® dermal filler product; and Obagi Medical Products, Inc.’s (Obagi) cosmeceutical products.
 
Significant Business Trends.  We believe that our ability to grow revenue will be primarily dependent on the following:
 
 
Continuing to expand our product offerings ─ both through internal development and sourcing from other vendors.
 
 
Ongoing investment in our global sales and marketing infrastructure.
 
 
Use of clinical results to support new aesthetic products and applications.
 
 
Enhanced luminary development and reference selling efforts (to develop a location where our products can be displayed and used to assist in selling efforts).
 
 
Customer demand for our products.
 
 
Consumer demand for the application of our products.
 
 
Marketing to physicians in the core dermatology and plastic surgeon specialties, as well as outside those specialties.
 
 
Generating ongoing revenue from our growing installed base of customers through the sale of Service, Upgrade, Titan hand piece refills, and Dermal fillers and cosmeceutical products.
 
Our U.S. revenue increased by 21% and our international revenue increased by 9% in 2011, compared to 2010. We believe the increase in U.S. revenues was attributable to several factors, including:

 
FDA clearance of our GenesisPlus system for onychomycosis, or toenail fungus, in April 2011.
 
Commencement of Excel V shipments in the second quarter of 2011
 
Effective U.S. sales management changes implemented in early 2011.

Our total international revenue increased by 9% in 2011, compared to 2010, and represented 61% of our total revenue.  The international revenue growth was sourced primarily from Australia, Canada, Japan, and several of our international distributor countries, partially offset by declines in Europe.  In Australia and Canada, our revenue increased by 123% and 34% respectively in 2011, compared to 2010, primarily as a result of increased product sales.  With respect to Japan, our revenue increased by 10%, primarily as a result of continued growth from our Dermal fillers and cosmecuticals business.
 
Our gross margin remained flat at 57% in 2011, compared to 2010, which was attributable to several factors, including:

 
An improvement of our 2011 margins for Titan refill revenue, given 2011 did not have costs associated with the recall of certain Titan XL hand pieces in 2010;
 
·
An increase of $823,000 of Titan refill revenue, for which we traditionally earn a higher gross margin than our blended total gross margin percentage;
 
 
 
Improved gross margin on our Dermal fillers and cosmeceutical products sold in Japan, due to higher average selling prices resulting from favorable foreign exchange rates; which was offset by
 
Lower gross margins for our Product revenue, resulting from an unfavorable product mix towards lower margin products.

Our gross margin in 2010 was 57%, compared with 59% in 2009. This decline was due to several factors, including:

 
The 2010 voluntary recall of certain Titan XL hand pieces whereby eligible customers were provided with fully refilled hand pieces;
 
A $1.7 million, or 31%, temporary decrease in our Titan refill revenue in 2010, compared to 2009, for which we traditionally earn a higher gross margin than our blended total gross margin percentage;
 
Our ASPs declined in 2010 due primarily to customers purchasing fewer applications on their platforms and due to competitive discounting pressures; and
 
A higher proportion of distributor revenue, that carries a lower gross margin; partially offset by
 
Lower manufacturing expenses resulting from headcount reductions; and
 
Reduced warranty and service expenses as a result of improved product reliability (for products other than Titan XL hand pieces).

Our sales and marketing expenses increased to $25.5 million in 2011, compared with $24.7 million in 2010.   This increase was associated with higher personnel expenses and an increase in travel and entertainment expenses associated with the increase in revenue, which was partially offset by reduced promotional and marketing related spending. As a percentage of net revenue, our 2011 sales and marketing expenses declined to 42%, compared to 47% in 2010, due to the higher revenue in 2011.

Our research and development, or R&D, expenses increased to $9.1 million in 2011, compared with $7.0 million in 2010. This increase was associated with higher personnel expenses resulting primarily from higher headcount and consulting services in engineering relating to new product development programs. As a percentage of net revenue, R&D expenses increased to 15% in 2011, compared to 13% in 2010.

Our general and administrative, or G&A, expenses increased to $10.1 million in 2011, compared with $9.6 million in 2010. This increase was due primarily to increased facility costs — associated with the relocation of our Japan offices and the closure of our Switzerland office — higher legal fees due in part to business development activities, and a reduced benefit associated with doubtful debt recoveries in 2010 that did not recur in 2011. As a percentage of net revenue, G&A expenses decreased slightly to 17% in 2011, compared to 18% in 2010, due to the higher revenue in 2011.
 
Factors that May Impact Future Performance
 
Our industry is impacted by numerous competitive, regulatory 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 with 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 I, Item 1A “Risk Factors.”
 
Critical Accounting Policies and Estimates

The preparation of our Consolidated Financial Statements and related disclosures in conformity with generally accepted accounting principles in the United States (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 Securities and Exchange Commission (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. Our critical accounting estimates are as follows:
 
 
Revenue Recognition
 
We recognize revenue from the sale of Products, Upgrades, Titan hand piece refills, and Dermal fillers and cosmeceuticals when title and risk of ownership has been transferred, provided that:
 
 
Persuasive evidence of an arrangement exists;
 
Delivery has occurred or services have been rendered;
 
The fee is fixed or determinable; and
 
Collectability is reasonably assured.

Determination of whether persuasive evidence of an arrangement exists and whether delivery has occurred or services have been rendered, are based on management’s judgments regarding the fixed nature of the fee charged for services rendered and products delivered, and the collectability of those fees. In instances where final acceptance of the product is specified by the customer or collectability has not been reasonably assured, revenue is deferred until all acceptance criteria have been met. Revenue under service contracts is recognized on a straight-line basis over the period of the applicable service contract. Service revenue, not under a service contract, is recognized as the services are provided. Should changes in conditions cause management to determine these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected.
 
Fair Value Measurement of our Long Term Auction Rate Securities Investments
 
We hold a variety of interest bearing auction rate securities (ARS) that represent investments in pools of student loan assets. At the time of acquisition, these ARS investments were intended to provide liquidity through an auction process that resets the applicable interest rate at predetermined calendar intervals, allowing investors to either roll over their holdings or gain immediate liquidity by selling such interests at par. Since February 2008, uncertainties in the credit markets affected our ARS investments and auctions for some of our ARS have continued to fail to settle on their respective settlement dates while some have been redeemed in full at their respective par values. The current portfolio of investments shown as “Long term investments” in our Consolidated Financial Statements represents those investments that are not currently liquid and we will not be able to access these funds until a future auction of these investments is successful, a buyer is found outside of the auction process or the issuer refinances their debt. Maturity dates for these ARS investments range from to 2032 to 2041.
 
At December 31, 2011, total financial assets measured and recognized at fair value were $89.6 million and of these assets, $3.0 million, or 3%, were ARS that were measured and recognized using significant unobservable inputs (Level 3). During 2011, $4.4 million of ARS were redeemed at their full par value, as a result we transferred from Level 3 assets $3.7 million to cash and this resulted in a gain of $668,000 being recorded to accumulated other comprehensive loss in 2011.
 
As of December 31, 2011, we had $3.9 million par value ($3.0 million fair value) of long-term ARS investments. The aggregate loss in value is included as an unrealized loss in accumulated other comprehensive income (loss). Given observable market information was not available to determine the fair values of our ARS portfolio, we valued these investments based on a discounted cash flow model. While our ARS valuation model was based on both Level 2 (credit quality and interest rates) and Level 3 inputs (pricing models), we determined that the Level 3 inputs were the most significant to the overall fair value measurement, particularly the estimates of risk adjusted discount rates. The expected future cash flows of the ARS were discounted using a risk adjusted discount rate that compensated for the illiquidity. Projected future cash flows over the economic life of the ARS (of approximately 10.0 – 12.5 years) were modeled based on the contractual penalty rates for the security added to a tax adjusted LIBOR interest rate curve. The discount rates that were applied to the cash flows were based on a premium over the projected yield curve and included an adjustment for credit, illiquidity, and other risk factors. See Note 1 “Summary of Significant Accounting Policies - Fair Value Measurements” in Notes to Consolidated Financial Statement in Part II, Item 8 of this Form 10-K for more information.
 
The valuation of our investment portfolio is subject to uncertainties that are difficult to predict. Factors that may impact the valuation include duration of time that the ARS remain illiquid, changes to credit ratings of the securities, rates of default of the underlying assets, changes in the underlying collateral value, market discount rates for similar illiquid investments, and ongoing strength and quality of credit markets. If the auctions for our ARS investments continue to fail, and there is a further decline in their valuation, then we would have to: (i) record additional reductions to the fair value of our ARS investments; and (ii) record unrealized losses in our accumulated other comprehensive income (loss) for the losses in value that are associated with market risk. If the decline in fair value is considered other-than-temporary then we would have to record an impairment charge in our Consolidated Statement of Operations for the loss in value associated with the worsening of the credit worthiness (credit losses) of the issuer, which would reduce future earnings and harm our business.
 
Recognition and Presentation of Other-Than-Temporary-Impairments

We review for impairments on a quarterly basis in order to determine the classification of such as “temporary” or “other-than-temporary.” Factors that we consider to make such determination include the duration and severity of the impairment; the reason for the decline in value and the potential recovery period; and our intent to sell, or whether it is more likely than not that we will be required to sell, the investment before recovery. Beginning April 1, 2009, if an entity intends to sell, or if it is more likely than not that we will be required to sell, an impaired debt security prior to recovery of its cost basis, the security is other-than-temporarily impaired and the full amount of the impairment is required to be recognized as a loss through earnings. Otherwise, losses on securities which are other-than-temporarily impaired are separated into:
 

 
(i)
the portion of loss which represents the credit loss; or
 
(ii)
the portion which is due to other factors.

The credit loss portion is recognized as a loss through earnings while the loss due to other factors is recognized in other comprehensive income (loss), net of taxes and related amortization. At December 31, 2011, we had $3.9 million of par value ARS investments. We intend to, and have the ability to, hold these investments until the anticipated date of maturity. As such, we treat the decline in value as temporary and have recognized approximately $873,000 in unrealized  losses. Given we believed that such losses were not credit related, we have included them in accumulated other comprehensive loss.

Prior to April 1, 2009, all declines in fair value deemed to be other-than-temporary were reflected in earnings as realized losses. With respect to the ARS that we held as of April 1, 2009, we determined that the cumulative effect adjustment required to reclassify the non-credit portion of previously recognized other-than-temporarily impaired adjustments was $3.5 million. Therefore, we increased our accumulated earnings and decreased our accumulated other comprehensive income (loss) by the $3.5 million cumulative effect adjustment. 

Stock-based Compensation Expense
 
Employee stock-based compensation is estimated at the date of grant based on the employee stock award’s fair value using the Black-Scholes option-pricing model and is recognized as expense ratably over the requisite service period in a manner similar to other forms of compensation paid to employees. The Black-Scholes option-pricing model requires the use of certain subjective assumptions. The most significant of these assumptions are our estimates of the expected volatility of the market price of our stock and the expected term of the award. The expected volatility is a 50%/50% blend of implied and historical volatility. We have determined that this is a more reflective measure of market conditions and a better indicator of expected volatility, than its limited historical volatility since the initial public offering of our common stock. When establishing an estimate of the expected term of an award, we consider historical experience of similar awards, giving consideration to the contractual terms of the awards, vesting requirements, and expectation of future employee behavior, including post-vesting terminations. As required under GAAP, we review our valuation assumptions at each grant date, and, as a result, our valuation assumptions used to value employee stock-based awards granted in future periods may change.
 
As of December 31, 2011, the unrecognized compensation cost, net of expected forfeitures, was $4.6 million for stock options and stock awards and $31,000 for the employee stock purchase plan which will be recognized using the straight-line attribution method over an estimated weighted-average remaining amortization period of 2.49 years and 0.33 years, respectively. See Note 5 “Stockholders’ Equity, Stock Plans and Stock-Based Compensation Expense,” in the Notes to Consolidated Financial Statement in Part II, Item 8 of this Form 10-K for more information.
 
Valuation of Inventories
 
We state our inventories at the lower of cost or market, computed on a standard cost basis, which approximates actual cost on a first-in, first-out basis and market being determined as the lower of replacement cost or net realizable value. Standard costs are monitored and updated quarterly or as necessary, to reflect changes in raw material costs, labor to manufacture the product and overhead rates. We provide for excess and obsolete inventories when conditions indicate that the selling price could be less than cost due to physical deterioration, usage, obsolescence, reductions in estimated future demand and reductions in selling prices. Inventory provisions are measured as the difference between the cost of inventory and estimated market value and charged to cost of revenue to establish a lower cost basis for the inventories. We balance the need to maintain strategic inventory levels with the risk of obsolescence due to changing technology and customer demand levels. Unfavorable changes in market conditions may result in a need for additional inventory provisions that could adversely impact our gross margins. Conversely, favorable changes in demand could result in higher gross margins when product that had previously been written off is sold.
 
Warranty Obligations
 
We provide a one-year standard warranty on all systems. Warranty coverage provided is for labor and parts necessary to repair the systems during the warranty period. We provide for the estimated future costs of warranty obligations in cost of revenue when the related revenue is recognized. The accrued warranty costs represent our best estimate at the time of sale, and as reviewed and updated quarterly, of the total costs that we expect to incur in repairing or replacing product parts that fail while still under warranty. Accrued warranty costs include costs of material, technical support labor and associated overhead. The amount of accrued estimated warranty costs obligation for established products is primarily based on historical experience as to product failures adjusted for current information on repair costs. Actual warranty costs could differ from the estimated amounts. On a quarterly basis, we review the accrued balances of our warranty obligations and update based on historical warranty cost trends. If we were required to accrue additional warranty cost in the future due to actual product failure rates, material usage, service delivery costs or overhead costs differing from our estimates, revisions to the estimated warranty liability would be required, which would negatively impact our operating results.
 
 
Provision for Income Taxes
 
We are subject to taxes on earnings in both the United States and various foreign jurisdictions. As a global taxpayer, significant judgments and estimates are required in evaluating our uncertain tax positions and determining our provision for income taxes on earnings. We perform a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest.
 
Our effective tax rates have differed from the statutory rate primarily due to the tax impact of tax-exempt interest income, foreign operations, research and development tax credits, state taxes, certain benefits realized related to stock option activity, and changes in valuation allowance. Our current effective tax rate does not assume U.S. taxes on undistributed profits of foreign subsidiaries. These earnings could become subject to incremental foreign withholding or U.S. federal and state taxes, should they either be deemed or actually remitted to the United States. The effective tax rate was approximately (2)% in 2011, 0% in 2010, and (102)% in 2009. Our future effective tax rates could be affected by earnings being lower than anticipated in countries where we have lower statutory rates and being higher than anticipated in countries where we have higher statutory rates, or by changes in tax laws, accounting principles, interpretations thereof, net operating loss carryback, research and development tax credits, and due to changes in the valuation allowance of our U.S. deferred tax assets. In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.
 
At December 31, 2011, we had an aggregate of approximately $2.7 million of unremitted earnings of foreign subsidiaries that have been, or are intended to be, indefinitely reinvested for continued use in foreign operations. If the total undistributed earnings of foreign subsidiaries were remitted, a significant amount of the additional tax would be offset by the allowable foreign tax credits. It is not practical for us to determine the additional tax of remitting these earnings.
 
Our deferred tax assets are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carryforwards. A valuation allowance reduces deferred tax assets to estimated realizable value, which assumes that it is more likely than not that we will be able to generate sufficient future taxable income in certain tax jurisdictions to realize the net carrying value. The four sources of taxable income to be considered in determining whether a valuation allowance is required include:
 
 
Future reversals of existing taxable temporary differences (i.e., offset gross deferred tax assets against gross deferred tax liabilities);
 
Future taxable income exclusive of reversing temporary differences and carryforwards;
 
Taxable income in prior carryback years; and
 
Tax planning strategies. 

Determining whether a valuation allowance for deferred tax assets is necessary requires an analysis of both positive and negative evidence regarding realization of the deferred tax assets. In general, positive evidence may include:
 
 
A strong earnings history exclusive of the loss that created the deductible temporary differences, coupled with evidence indicating that the loss is the result of an aberration rather than a continuing condition; and
 
An excess of appreciated asset value over the tax basis of our net assets in an amount sufficient to realize the deferred tax asset.
 
In general, negative evidence may include:
 
 
A history of operating loss or tax credit carryforwards expiring unused;
 
An expectation of being in a cumulative loss position in a future reporting period;
 
 
 
The existence of cumulative losses in recent years; and
 
A carryback or carryforward period that is so brief that it would limit the realization of tax benefits. 

The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified and judgment must be used in considering the relative impact of positive and negative evidence.

In evaluating the ability to recover deferred tax assets, we considered available positive and negative evidence, giving greater weight to our recent cumulative losses and our 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. We also considered, commensurate with its objective verifiability, the forecast of future taxable income including the reversal of temporary differences. At the end of the quarter ended September 30, 2009, changes in previously anticipated expectations and continued operating losses resulted in a valuation allowance against our tax benefits since we no longer considered them “more-likely-than-not” realizable. We also performed this evaluation as of the year ended December 31, 2011 and determined the full valuation allowance was still required.

Long-Lived Asset Impairment
 
Long-lived assets, such as property and equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not ultimately be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its ultimate disposition. If the sum of the expected future cash flows is less than the carrying amount of those assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. Through December 31, 2011, there have been no such impairments.
 
Litigation
 
We have been, and may in the future become, subject to legal proceedings related to securities litigation, intellectual property and other matters. Based on all available information at the balance sheet dates, we assess the likelihood of any adverse judgments or outcomes for these matters, as well as potential ranges of probable loss. If losses are probable and reasonably estimable, we record an estimated liability. 
 
Recent Accounting Guidance
 
For a full description of recent accounting pronouncements, including the respective expected dates of adoption and effects on results of operations and financial condition see Note 1 “Summary of Significant Accounting Policies — New Accounting Standards” in the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.

Results of Operations
 
The following table sets forth selected consolidated financial data expressed as a percentage of net revenue.
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
                   
Net revenue
   
100
%
   
100
%
   
100
%
Cost of revenue
   
43
%
   
43
%
   
41
%
Gross profit
   
57
%
   
57
%
   
59
%
Operating expenses:
                       
Sales and marketing
   
42
%
   
47
%
   
45
%
Research and development
   
15
%
   
13
%
   
13
%
General and administrative
   
17
%
   
18
%
   
19
%
Litigation settlement
   
%
   
%
   
1
%
Total operating expenses
   
74
%
   
78
%
   
78
%
Loss from operations
   
(17
)%
   
(21
)%
   
(19
)%
Interest and other income, net
   
1
%
   
1
%
   
3
%
Loss before income taxes
   
(16
)%
   
(20
)%
   
(16
)%
Provision for income taxes
   
1
%
   
%
   
17
%
Net loss
   
(17
)%
   
(20
)%
   
(33
)%
 
 
Net Revenue

The following table sets forth selected consolidated revenue by major geographic area and product category with changes thereof.

 
  
Year Ended December 31,
 
(Dollars in thousands)
  
2011
 
% Change
   
2010
 
% Change
   
2009(1)
 
Revenue mix by geography:
  
                             
United States
  
$
23,313
 
21
%
 
$
19,337
 
(8
)%
 
$
21,019
 
Percent of total
   
39
%
       
36
%
       
39
%
                                 
Japan
  
$
15,019
 
10
%
 
$
13,625
 
41
%
 
$
9,636
 
Asia, excluding Japan
  
 
4,984
 
(3
)%
   
5,131
 
9
%
   
4,727
 
Europe
  
 
3,571
 
(38
)%
   
5,801
 
(18
)%
   
7,087
 
Rest of the world
  
 
13,403
 
43
%
   
9,380
 
(16
)%
   
11,213
 
Total international revenue
  
 
36,977
 
9
%
   
33,937
 
4
%
   
32,663
 
Percent of total
   
61
%
       
64
%
       
61
%
                                 
Total consolidated revenue
  
$
60,290
 
13
%
 
$
53,274
 
(1
)%
 
$
53,682
 
                                 
Revenue mix by product category:
  
                             
Products
  
$
33,703
 
21
%
 
$
27,808
 
4
%
 
$
26,842
 
Upgrades
  
 
3,505
 
(27
)%
   
4,824
 
(24
)%
   
6,343
 
Service
  
 
13,411
 
%
   
13,231
 
—  
%
   
13,186
 
Titan hand piece refills
  
 
4,686
 
21
%
   
3,863
 
(31
)%
   
5,599
 
Dermal fillers and cosmeceuticals(1)
  
 
4,985
 
41
%
   
3,548
 
107
%
   
1,712
 
Total consolidated revenue
  
$
60,290
 
13
%
 
$
53,274
 
(1
)%
 
$
53,682
 

(1)Beginning in 2010, we classified revenue from dermal fillers and cosmeceuticals product in the revenue category ‘Dermal fillers and cosmeceuticals.’ Previously, we classified this revenue under the category of ‘Products.’ As such, we reclassified the 2009 revenue from ‘Products’ to ‘Dermal fillers and cosmeceuticals.’

Revenue by Geography:
 
In 2011 our net revenue increased by 13%, compared to 2010, and in 2010 it declined by 1%, compared to 2009.

Our U.S. revenue increased by 21% in 2011, compared to 2010. We believe the increase in U.S. revenues in 2011, compared to 2010, was attributable to several factors, including:

 
FDA clearance of our GenesisPlus system for onychomycosis, or toenail fungus, in April 2011.
 
Commencement of Excel V shipments in the second quarter of 2011.
 
Effective U.S. sales management changes implemented in early 2011.

Our U.S. revenue decreased by 8% in 2010, compared to 2009. We believe the decline in U.S. revenues was attributable to several factors, including:

 
Our Products and Upgrades ASPs declined in 2010 and 2009, compared to their respective prior years. This was attributable primarily to customers purchasing fewer applications for systems and lower pricing resulting from competitive discounting pressures.
 
Our unit sales of Products and Upgrades increased in 2010, compared with 2009.
 
We experienced a temporary decline in our Titan refill revenue in 2010, compared to 2009, due to a voluntary recall of certain Titan XL hand pieces. All customers that had Titan XL hand pieces subject to the recall, were provided with fully “refilled” hand pieces, which delayed their purchase of a refill.

International revenues increased by 9% in 2011, compared to 2010, and increased by 4% in 2010, compared to 2009. The growth in our international revenue in 2011 was derived from higher product revenue in Canada, Australia, several of our international distributor countries and by higher Dermal fillers and cosmecuticals sales in Japan, offset by a decline in product revenue in Europe. Our total international revenue increased by 9%, with growth being sourced primarily from Australia, Canada and Japan, partially offset by declines in Europe.  In Australia and Canada, our revenue increased by 123% and 34% respectively in 2011, compared to 2010, primarily as a result of increased product sales.  With respect to Japan, our revenue increased by 10%, primarily as a result of continued growth from the Dermal fillers and cosmeceuticals business.
 

Revenue by Product Category:

Our product revenue increased by 21% in 2011 and by 4% in 2010, compared to the respective prior year periods. The 2011 increase in product revenue was primarily attributable to the U.S. FDA clearance of the GenesisPlus system for toenail fungus in April 2011 and the commencement of Excel V shipments in the second quarter of 2011. The 2010 increase in product revenue was primarily attributable to revenue from the GenesisPlus product that was launched in the third quarter of 2010. We believe that in 2010 and in 2009 some of our U.S. current and prospective customers that did not have established medical offices, were reluctant to purchase capital equipment due to the general economic uncertainty and tight credit conditions, which contributed to the decline in our revenue in these years.

Upgrade revenue decreased by 27% in 2011 and by 24% in 2010, compared to the respective prior year periods. Prior to 2009, we introduced new products that allowed existing customers to upgrade their previously purchased systems to obtain benefits from the additional capabilities, which drove our upgrade revenue. However, since 2008 we have not introduced any new products that our customers could purchase as an upgrade to their previously purchased system. Instead, we have launched new stand alone products (GenesisPlus in 2010 and Excel V in 2011), which has resulted in a decline of our upgrade revenue since 2008.

Our service revenue increased by 1% in 2011 compared to 2010, and remained relatively flat in 2010, compared to 2009. Service contract amortization is the primary component of our service revenue. The increase in 2011 was the result of higher international service revenue being partially offset by a decline in U.S. service revenue. The increase in international service revenue is due to an increased installed base and a higher number of customer purchased service contracts. The decline in our U.S. service revenue was primarily attributable to lower contract amortizations as a result of fewer customers purchasing extended service contracts, a decline in our service contract pricing, partially offset by higher revenue from the sale of detachable hand pieces (other than Titan refills).  In 2010 service revenue remained flat compared to 2009 as a result of the decline in unit sales in 2009 that included an element of deferred revenue for service contracts beyond our standard one-year warranty term.

Our Titan hand piece refill revenue increased 21% in 2011, compared to 2010, and decreased 31% in 2010, compared to 2009. The increase in 2011 was due primarily to the partial recovery of our Titan refill revenue following the voluntary recall of our Titan XL hand piece commencing in the second quarter of 2010, in which we provided our eligible customers with a fully “refilled” Titan XL hand piece, which delayed their purchase of a refill. The decline in our Titan refill revenue in 2010, compared to 2009, was also primarily attributable to the Titan XL recall.
 
Our Dermal filler and cosmeceutical business increased by 41% in 2011, compared to 2010, and by 107% in 2010 compared to 2009. This increase was due primarily to the higher number of customers purchasing Obagi products, which we began distributing in Japan in the first quarter of 2010, and due to the expansion of cosmeceutical product lines being distributed.

Gross Profit
 
 
 
Year Ended December 31,
 
(Dollars in thousands)
 
2011
 
% Change
 
 
2010
 
% Change
 
2009
 
Gross Profit
 
$
34,312
 
14
%
 
$
30,216
 
(5
)%
$
31,923
 
As a percentage of total revenue
 
 
57
%
 
 
 
 
57
%
 
 
 
59
%
 
Our cost of revenue consists primarily of materials, personnel expenses, royalty expense, warranty and manufacturing overhead expenses. Gross margin as a percentage of net revenue remained flat at 57% in 2011, compared to 2010, which was primarily attributable to the following:
 
 
An improvement of our 2011 margins for Titan refill revenue, given 2011 did not have costs associated with the recall of certain Titan XL hand pieces in 2010;
 
An increase of $823,000 of Titan refill revenue, for which we traditionally earn a higher gross margin than our blended total gross margin percentage;
 
Improved gross margin on our Dermal fillers and cosmeceutical products sold in Japan, due to higher average selling prices resulting from favorable foreign exchange rates; which was offset by
 
Lower gross margins for our Product revenue, resulting from an unfavorable product mix towards lower margin products.

 
Our gross margin in 2010 was 57%, compared with 59% in 2009. This decline was due to several factors, including:
 
 
The 2010 voluntary recall of certain Titan XL hand pieces whereby eligible customers were provided with fully refilled hand pieces;
 
A $1.7 million, or 31%, temporary decrease in our Titan refill revenue in 2010, compared to 2009, for which we traditionally earn a higher gross margin than our blended total gross margin percentage;
 
Our ASPs declined in 2010 due primarily to customers purchasing fewer applications on their platforms and due to competitive discounting pressures; and
 
A higher proportion of distributor revenue, that carries a lower gross margin; partially offset by
 
Lower manufacturing expenses resulting from headcount reductions; and
 
Reduced warranty and service expenses as a result of improved product reliability (for products other than Titan XL hand pieces).
 
Sales and Marketing
 
 
 
Year Ended December 31,
 
(Dollars in thousands)
 
2011
 
% Change
 
 
2010
 
% Change
 
 
2009
 
Sales and marketing
 
$
25,499
 
3
%
 
$
24,735
 
2
%
 
$
24,286
 
As a percentage of total revenue
 
 
42
%
 
 
 
 
47
%
 
 
 
 
45
%

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 increased $764,000 in 2011, compared to 2010, which was primarily attributable to the following:

 
$988,000 increase in personnel expenses attributable primarily to higher commission expenses as a result of the higher revenue;
 
$541,000 increase in travel, entertainment and sales meeting expenses due to increased sales activity; offset by
 
Reduced promotional and marketing related spending of approximately $781,000 attributable to fewer workshops, lower spending on public relation and other marketing activities.

In 2010 sales and marketing expenses increased by $449,000 compared to 2009. This increase was primarily attributable to:

 
$855,000 increase in personnel expenses in marketing due primarily to an increase in headcount resulting from the creation of three new departments: post marketing studies (clinical development), business development and telesales;
 
$242,000 increase in international spending on workshops, advertising and other promotional activities; offset by
 
A decline in U.S. sales personnel expenses by $617,000 due to lower headcount; and due to decreased sales commissions resulting from lower U.S revenue.
 
Sales and marketing expenses as a percentage of net revenue, decreased to 42% in 2011, compared to 47% in 2010 and 45% in 2009. The decrease in 2011 was due primarily to an increase in our total revenue in 2011.
 
Research and Development (R&D)
 
 
 
Year Ended December 31,
 
(Dollars in thousands)
 
2011
 
% Change
 
 
2010
 
% Change
 
 
2009
 
Research and development
 
$
9,141
 
31
%
 
$
7,004
 
3
%
 
$
6,810
 
As a percentage of total revenue
 
 
15
%
 
 
 
 
13
%
 
 
 
 
13
%
 
Research and development (R&D) expenses consist primarily of personnel expenses, clinical, regulatory and material costs. R&D expenses increased $2.1 million in 2011, compared to 2010, which was primarily attributable to:

 
·
$1.8 million increase in personnel expenses due to higher headcount and higher consulting fees of $367,000, both, to ramp up the research, development and clinical support of our new products; offset by
 
·
A decrease in material spending of $165,000.

In 2010 R&D expenses increased by $194,000, compared to 2009, which was due primarily to higher personnel expenses resulting from higher headcount in engineering relating to new product development programs.
 
 
General and Administrative (G&A)
 
 
 
Year Ended December 31,
 
(Dollars in thousands)
 
2011
 
% Change
 
 
2010
 
% Change
 
 
2009
 
General and administrative
 
$
10,104
 
6
%
 
$
9,576
 
(7
)%
 
$
10,320
 
As a percentage of total revenue
  
 
17
%
       
18
%
       
19
%
 
General and administrative expenses consist primarily of: personnel expenses, legal fees, accounting, audit and tax consulting fees, and other general and administrative expenses. G&A expenses increased by $528,000 in 2011, compared to 2010, which was primarily attributable to:

 
$162,000 increase in facility costs due to the relocation of our offices in Tokyo, Japan and the closure of our office in Switzerland;
 
$143,000 increase in legal fees, primarily associated with business development activities, including the acquisition of assets from Iridex; and.
 
$137,000 increase in bad debt expense attributable to a reduced benefit associated with doubtful debt recoveries in 2010, that did not recur in 2011

In 2010 G&A expenses decreased by $744,000, compared to 2009. This decrease was primarily attributable to:

 
a $626,000 reduction in bad debts expense due to a large non recurring expense in 2009; and
 
a $201,000 reduction in legal fees and legal settlement expenses.

Litigation Settlement
 
In 2009, we settled our TCPA class action lawsuit and in that regard recorded a charge of $850,000 for the cost of the settlement, net of administrative expenses and amounts that were recovered from our insurance carrier.

Interest and Other Income, Net
 
The components of “Interest and Other Income, Net” are as follows:

    Year Ended December 31,  
(Dollars in thousands)
  
2011
 
% Change
   
2010
  
% Change
   
2009
 
Interest income