CYNOSURE INC - FORM 10-Q - November 5, 2010

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EX-32.2 - CERTIFICATION OF THE PRINCIPAL FINANCIAL OFFICER PURSUANT TO SECTION 906 - CYNOSURE INCdex322.htm
EX-31.1 - CERTIFICATION OF THE PRINCIPAL EXECUTIVE OFFICER PURSUANT TO SECTION 302 - CYNOSURE INCdex311.htm
EX-31.2 - CERTIFICATION OF THE PRINCIPAL FINANCIAL OFFICER PURSUANT TO SECTION 302 - CYNOSURE INCdex312.htm
EX-32.1 - CERTIFICATION OF THE PRINCIPAL EXECUTIVE OFFICER PURSUANT TO SECTION 906 - CYNOSURE INCdex321.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 

 

Form 10-Q

 

 

(Mark one)

 

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

For the quarterly period ended September 30, 2010

OR

 

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

For the transition period from              to             

Commission File Number 000-51623

 

 

Cynosure, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   04-3125110

(State or other jurisdiction of

incorporation or organization)

  

(I.R.S. Employer

Identification No.)

5 Carlisle Road

Westford, MA

   01886
(Address of principal executive offices)   (Zip code)

(978) 256-4200

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  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    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions 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 the registrant is a shell company (as defined in Rule 12b-2 of the Act).    ¨  Yes    x  No

The number of shares outstanding of each of the registrant’s classes of common stock, as of November 1, 2010:

 

Class

  

Number of Shares

Class A Common Stock, $0.001 par value   9,661,382
Class B Common Stock, $0.001 par value   2,939,161

 

 

 

Table of Contents

 

Cynosure, Inc.

Table of Contents

 

          Page No.  
PART I    Financial Information   
Item 1.   

Financial Statements (Unaudited)

   
  

Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009

      1   
  

Consolidated Statements of Operations for the Three and Nine Month Periods Ended September 30, 2010 and 2009

     2   
  

Consolidated Statements of Cash Flows for the Nine Month Periods Ended September 30, 2010 and 2009

      3   
  

Notes to Consolidated Financial Statements

      4   
Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

      11   
Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

      19   
Item 4.   

Controls and Procedures

      20   
PART II    Other Information   
Item 1.    Legal Proceedings      20   
Item 1A.    Risk Factors      21   
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      21   
Item 6.    Exhibits      23   
SIGNATURES      24   
EXHIBIT INDEX      25   
EX-31.1 Certification of the Principal Executive Officer   
EX-31.2 Certification of the Principal Financial Officer   
EX-32.1 Certification of the Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002   
EX-32.2 Certification of the Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002   

Table of Contents

 

Cynosure, Inc.

Consolidated Balance Sheets

(in thousands)

 

     (Unaudited)
September 30,
2010		     December 31,
2009		  
Assets     

Current assets:

     

Cash and cash equivalents (Note 4)

    $ 31,883      $ 44,797   

Short-term marketable securities (Notes 4 and 5)

      58,650        23,708   

Short-term investments and related financial instruments (Notes 4 and 5)

      —          18,454   

Accounts receivable, net

      10,899        11,773   

Inventories

      20,294        21,815   

Prepaid expenses and other current assets

      3,867        6,441   

Deferred income taxes

      356        160   
                

Total current assets

      125,949        127,148   
                

Property and equipment, net

      8,903        10,567   

Long-term marketable securities (Notes 4 and 5)

      4,839        5,008   

Other noncurrent assets

      2,205        2,510   
                

Total assets

    $ 141,896      $ 145,233   
                
Liabilities and Stockholders’ Equity     

Current liabilities:

     

Accounts payable

    $ 4,860      $ 4,822   

Amounts due to related party (Note 11)

      2,106        1,350   

Accrued expenses

      10,049        9,535   

Deferred revenue

      2,900        4,269   

Capital lease obligation

      164        264   
                

Total current liabilities

      20,079        20,240   
                

Capital lease obligation, net of current portion

      64        171   

Deferred revenue, net of current portion

      386        620   

Other noncurrent liability

      302        372   

Commitments and contingencies (Note 10)

     

Stockholders’ equity:

     

Preferred stock, $0.001 par value

     

Authorized — 5,000 shares

     

Issued — none

      —          —     

Class A and Class B common stock, $0.001 par value

     

Authorized — 70,000 shares

     

Issued — 9,786 Class A shares and 2,975 Class B shares at September 30, 2010;

Issued — 9,775 Class A shares and 2,975 Class B shares at December 31, 2009, respectively

      13        13   

Additional paid-in capital

      121,165        117,814   

Retained earnings

      3,024        7,773   

Accumulated other comprehensive loss

      (1,672 )      (1,451 ) 

Treasury stock, 125 Class A shares and 36 Class B shares at September 30, 2010 (at cost), and 3 Class A shares and 36 Class B shares at December 31, 2009 (at cost)

      (1,465 )      (319 ) 
                

Total stockholders’ equity

      121,065        123,830   
                

Total liabilities and stockholders’ equity

    $ 141,896      $ 145,233   
                

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

 

1

Table of Contents

 

Cynosure, Inc.

Consolidated Statements of Operations

(Unaudited, in thousands, except per share data)

 

     Three Months Ended
September 30,		     Nine Months Ended
September 30,		  
     2010     2009     2010     2009  

Product revenues

    $ 14,357      $ 13,679      $ 44,963      $ 41,073   

Parts, accessories and service revenues

      4,694        4,258        14,470        12,493   
                                

Total revenues

      19,051        17,937        59,433        53,566   

Cost of revenues

      8,367        7,460        25,529        21,997   
                                

Gross profit

      10,684        10,477        33,904        31,569   

Operating expenses:

         

Sales and marketing

      7,069        8,743        24,116        29,696   

Research and development

      1,899        1,564        5,454        5,001   

General and administrative

      2,688        3,511        8,751        11,440   
                                

Total operating expenses

      11,656        13,818        38,321        46,137   
                                

Loss from operations

      (972 )      (3,341 )      (4,417 )      (14,568 ) 
                                

Interest income, net

      41        83        139        454   

Other income (expense), net

      504        371        (197 )      705   
                                

Loss before provision (benefit) for income taxes

      (427 )      (2,887 )      (4,475 )      (13,409 ) 
                                

Provision (benefit) for income taxes

      33        (972 )      274        (5,149 ) 
                                

Net loss

    $ (460 )    $ (1,915 )    $ (4,749 )    $ (8,260 ) 
                                

Basic net loss per share

    $ (0.04 )    $ (0.15 )    $ (0.37 )    $ (0.65 ) 
                                

Diluted net loss per share

    $ (0.04 )    $ (0.15 )    $ (0.37 )    $ (0.65 ) 
                                

Basic weighted-average common shares outstanding

      12,653        12,712        12,691        12,708   
                                

Diluted weighted-average common shares outstanding

      12,653        12,712        12,691        12,708   
                                

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

 

2

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Cynosure, Inc.

Consolidated Statements of Cash Flows

(Unaudited, in thousands)

 

     Nine Months Ended
September 30,		  
     2010     2009  

Operating activities:

     

Net loss

    $ (4,749 )    $ (8,260 ) 

Reconciliation of net loss to net cash provided by (used in) operating activities:

     

Depreciation and amortization

      4,254        3,948   

Stock-based compensation expense

      3,289        5,110   

Gain on investments

      (21 )      (6 ) 

Loss on disposal of fixed assets

      1        25   

Deferred income taxes

      1        —     

Accretion of discounts on marketable securities

      633        244   

Changes in operating assets and liabilities:

     

Accounts receivable

      728        10,484   

Inventories

      (1,829 )      (529 ) 

Net book value of demonstration inventory sold

      909        520   

Prepaid expenses and other current assets

      2,580        (3,769 ) 

Accounts payable

      68        (1,018 ) 

Due to related party

      768        (4,141 ) 

Tax benefit from stock option exercises

      (2 )      (3 ) 

Accrued expenses

      550        (5,676 ) 

Deferred revenue

      (1,641 )      (238 ) 

Other noncurrent liability

      (1 )      (5 ) 
                

Net cash provided by (used in) operating activities

      5,538        (3,314 ) 

Investing activities:

     

Purchases of property and equipment

      (391 )      (604 ) 

Proceeds from the sales and maturities of marketable securities

      58,366        29,985   

Purchases of marketable securities

      (75,248 )      (27,176 ) 

Increase in other noncurrent assets

      (23 )      (193 ) 
                

Net cash (used in) provided by investing activities

      (17,296 )      2,012   

Financing activities:

     

Excess tax benefit on options exercised

      2        3   

Repurchases of common stock

      (1,146 )      —     

Proceeds from stock option exercises

      84        47   

Payments on capital lease obligation

      (185 )      (303 ) 
                

Net cash used in financing activities

      (1,245 )      (253 ) 

Effect of exchange rate changes on cash and cash equivalents

      89        (210 ) 
                

Net decrease in cash and cash equivalents

      (12,914 )      (1,765 ) 

Cash and cash equivalents, beginning of the period

      44,797        49,257   
                

Cash and cash equivalents, end of the period

    $ 31,883      $ 47,492   
                

Supplemental cash flow information

     

Cash paid for interest

    $ 40      $ 64   
                

Cash paid for income taxes

    $ 549      $ 631   
                

Supplemental noncash investing and financing activities

     

Transfer of demonstration equipment from inventory to fixed assets

    $ 3,181      $ 5,355   

Net unrealized gain on marketable securities, net of $18 and $13 deferred income tax provision

    $ 33      $ 23   
                

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

 

3

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Cynosure, Inc.

Notes to Consolidated Financial Statements

Note 1 — Interim Consolidated Financial Statements

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) for reporting on Form 10-Q. Accordingly, certain information and footnote disclosures required for complete financial statements are not included herein. It is recommended that these financial statements be read in conjunction with the consolidated financial statements and related notes that appear in the Annual Report on Form 10-K of Cynosure, Inc. (Cynosure) for the year ended December 31, 2009. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the financial position, results of operations, and cash flows as of the dates and for the periods presented have been included. The results of operations for the nine months ended September 30, 2010 may not be indicative of the results that may be expected for the year ending December 31, 2010, or any other period.

Note 2 — Stock-Based Compensation

Cynosure recorded stock-based compensation expense of $0.9 million and $1.5 million for the three months ended September 30, 2010 and 2009, respectively. Cynosure recorded stock-based compensation expense of $3.3 million and $5.1 million for the nine months ended September 30, 2010 and 2009, respectively. Cynosure capitalized $32,000 and $53,000 of stock-based compensation expense as part of inventory during the nine months ended September 30, 2010 and 2009, respectively.

Total stock-based compensation expense was recorded to cost of revenues and operating expenses based upon the functional responsibilities of the individual holding the respective options, as follows:

 

     Three Months Ended
September 30,		      Nine Months Ended
September 30,		  
     2010      2009      2010      2009  
     (In thousands)  

Cost of revenues

    $ 66       $ 120       $ 255       $ 383   

Sales and marketing

      339         666         1,509         2,250   

Research and development

      121         209         459         738   

General and administrative

      326         469         1,066         1,739   
                                   

Total stock-based compensation expense

    $ 852       $ 1,464       $ 3,289       $ 5,110   
                                   

Cash received from option exercises was $84,000 and $47,000 during the nine months ended September 30, 2010 and 2009, respectively.

Cynosure granted 438,211 and 506,225 stock options during the nine months ended September 30, 2010 and 2009, respectively. Cynosure has elected to use the Black-Scholes model to determine the weighted average fair value of options. The weighted average fair value of the options granted during the nine months ended September 30, 2010 and 2009 was $5.79 and $4.38, respectively, using the following assumptions:

 

     Nine Months  Ended
September 30,		  
     2010     2009  

Risk-free interest rate

      1.73% - 2.50 %      1.87% - 2.66 % 

Expected dividend yield

      —          —     

Expected term

      5.8 years        5.8 years   

Expected volatility

      58% - 59 %      63% - 64 % 

Estimated forfeiture rate

      5 %      5 % 

Option-pricing models require the input of various subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. Cynosure’s estimated expected stock price volatility is based on its own historical volatility for the 2010 period and based on a weighted average of its own historical volatility and of the average volatilities of other guideline companies in the same industry for the 2009 period. Cynosure’s expected term of options granted in the nine months ended September 30, 2010 and 2009 was derived from the short-cut method. The risk-free rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The dividend yield of zero is based on the fact that Cynosure has never paid cash dividends and has no present intention to pay cash dividends.

 

4

Table of Contents

Cynosure, Inc.

Notes to Consolidated Financial Statements—(Continued)

 

 

Note 3 — Inventories

Cynosure states all inventories at the lower of cost or market, determined on a first-in, first-out method. Inventory includes material, labor and overhead and consists of the following:

 

     September 30,
2010		      December 31,
2009		  
     (in thousands)  

Raw materials

    $ 4,284       $ 3,700   

Work in process

      1,079         1,302   

Finished goods

      14,931         16,813   
                 
   $ 20,294       $ 21,815   
                 

Note 4 — Fair Value

U.S. GAAP establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes the following fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:

 

  •  

Level 1 – Quoted prices in active markets for identical assets or liabilities.

 

  •  

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable markets data for substantially the full term of the assets or liabilities.

 

  •  

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table represents Cynosure’s fair value hierarchy for its financial assets (cash equivalents and marketable securities) measured at fair value as of September 30, 2010 (in thousands):

 

     Level 1      Level 2      Level 3      Total  

Money market funds (1)

    $ 9,639       $ —         $ —         $ 9,639   

State and municipal bonds

      —           12,946         —           12,946   

Treasuries and government agencies (2)

      —           58,527         —           58,527   

Equity securities

      15         —           —           15   
                                   

Total

    $ 9,654       $ 71,473       $ —         $ 81,127   
                                   

 

(1) Included in cash and cash equivalents at September 30, 2010.
(2) $8.0 million included in cash and cash equivalents at September 30, 2010.

At December 31, 2009, Cynosure’s short-term investments consisted of $18.5 million, at par value, of auction rate securities (ARS) investments. The ARS were managed by UBS Financial Services, Inc. (UBS). On November 3, 2008, Cynosure agreed to accept Auction Rate Securities Rights (the Rights) from UBS. On June 30, 2010, Cynosure exercised the Rights and Put its ARS to UBS at full par value. At September 30, 2010, Cynosure held no short-term investments.

During the nine months ended September 30, 2010, there were no significant transfers in and out of Level 1 and Level 2. ARS were transferred from Level 3 to Level 2, as the Rights were exercised at June 30, 2010, providing Cynosure with full par value of the ARS.

 

5

Table of Contents

Cynosure, Inc.

Notes to Consolidated Financial Statements—(Continued)

 

 

The following table provides a summary of changes in fair value of Cynosure’s Level 3 financial assets for the nine months ended September 30, 2010 (in thousands):

 

     Level 3 Assets  

Balance at December 31, 2009

    $ 18,454   

Recovery on ARS included in gain on investments

      1,212   

Loss related to value of ARS Rights included in (loss) on investments

      (1,191 ) 

Net settlements

      (18,475 ) 
        

Balance at September 30, 2010

    $ —     
        

Note 5 — Short and Long-Term Marketable Securities

Cynosure’s available-for-sale securities at September 30, 2010 consist of approximately $71.5 million of investments in debt securities consisting of state and municipal bonds, treasuries and government agencies and approximately $15,000 in equity securities. All investments in available-for-sale securities are recorded at fair market value, with any unrealized gains and losses reported as a separate component of accumulated other comprehensive loss. As of September 30, 2010, Cynosure’s available-for-sale securities consist of the following (in thousands):

 

     Market Value      Amortized
Cost		      Unrealized
Gains		      Unrealized
Losses		  

Available-for-Sale Securities:

            

Cash Equivalents:

            

Treasuries and government agencies

    $ 7,999         7,999         —           —     
                                   

Total cash equivalents

    $ 7,999       $ 7,999         —           —     
                                   

Short-term marketable securities:

            

State and municipal bonds

    $ 12,628       $ 12,638       $ 1       $ (11 ) 

Treasuries and government agencies

      46,007         45,951         57         (1 ) 

Equity securities

      15         11         4         —     
                                   

Total short-term marketable securities

    $ 58,650       $ 58,600       $ 62         (12 ) 
                                   

Long-term marketable securities:

            

State and municipal bonds

    $ 318       $ 318         —           —     

Treasuries and government agencies

    $ 4,521       $ 4,516         5         —     
                                   

Total long-term marketable securities

      4,839         4,834       $ 5         —     
                                   

Total available-for-sale securities

    $ 71,488       $ 71,433       $ 67       $ (12 ) 
                                   

Total marketable securities

    $ 63,489            
                 

As of September 30, 2010, Cynosure’s available-for-sale debt securities mature as follows (in thousands):

 

     Total      Maturities  
      Less Than One Year      One to Five Years      More than five years  

State and municipal bonds

    $ 12,946       $ 12,628       $ 318      $ —     

Treasuries and government agencies

      58,527         54,006         4,521         —     
                                   

Total available-for-sale debt securities

    $ 71,473       $ 66,634       $ 4,839       $ —     
                                   

 

6

Table of Contents

Cynosure, Inc.

Notes to Consolidated Financial Statements—(Continued)

 

 

Note 6 — Warranty Costs

Cynosure typically provides a one-year parts and labor warranty on end-user sales of laser systems. Distributor sales generally include a warranty on parts only. Estimated future costs for initial product warranties are provided at the time of revenue recognition.

The following table provides the detail of the change in Cynosure’s product warranty accrual during the nine months ended September 30, 2010, which is a component of accrued expenses in the consolidated balance sheets:

 

     September 30,
2010		  
     (in thousands)  

Warranty accrual, beginning of period

    $ 2,440   

Warranty provision related to new sales

      2,451   

Costs incurred

      (2,862 ) 
        

Warranty accrual, end of period

    $ 2,029   
        

Note 7 — Segment Information

Cynosure identifies operating segments as components of an enterprise about which separate discrete financial information is available for evaluation by the chief operating decision maker, or decision-making group, in making decisions how to allocate resources and assess performance. Cynosure’s chief decision-maker is a combination of the Chief Executive Officer and the Chief Financial Officer. Cynosure views its operations and manages its business as one segment, aesthetic treatment products and services.

The following table represents total revenue by geographic destination:

 

     Three Months Ended
September 30,		      Nine Months Ended
September 30,		  
     2010      2009      2010      2009  
     (in thousands)  

United States

    $ 6,889       $ 8,269       $ 21,564       $ 23,599   

Europe

      4,939         3,380         17,180         12,980   

Asia / Pacific

      5,112         4,225         14,226         11,418   

Other

      2,111         2,063         6,463         5,569   
                                   

Total

    $ 19,051       $ 17,937       $ 59,433       $ 53,566   
                                   

Total assets by geographic area are as follows:

 

     September 30,
2010		     December 31,
2009		  
     (in thousands)  

United States

    $ 125,036      $ 127,752   

Europe

      11,831        13,123   

Asia / Pacific

      6,895        6,346   

Eliminations

      (1,866 )      (1,988 ) 
                

Total

    $ 141,896      $ 145,233   
                

Long-lived assets by geographic area are as follows:

 

     September 30,
2010		      December 31,
2009		  
     (in thousands)  

United States

    $ 7,701       $ 8,398   

Europe

      1,691         2,867   

Asia / Pacific

      1,716         1,812   
                 

Total

    $ 11,108       $ 13,077   
                 

 

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Cynosure, Inc.

Notes to Consolidated Financial Statements—(Continued)

 

 

No individual country within Europe or Asia/Pacific represented greater than 10% of total revenue or total assets for any period presented.

Cynosure Korea has long-lived assets of $1.4 million, or 13% of the Company’s total long-lived assets, as of September 30, 2010. These long-lived assets consist primarily of goodwill and intangibles associated with Cynosure’s acquisition of the aesthetic division of Orient MG in December 2008. Cynosure Spain has long-lived assets of $1.3 million, or 11% of the Company’s total long-lived assets, as of September 30, 2010. These long-lived assets consist primarily of demonstration equipment.

Note 8 — Net Loss Per Common Share

Basic net loss per share was determined by dividing net loss by the weighted average common shares outstanding during the period. Diluted net loss per share was determined by dividing net loss by diluted weighted average shares outstanding. Diluted weighted average shares reflect the dilutive effect, if any, of common stock options based on the treasury stock method. Common shares outstanding includes both Class A and Class B common stock as each participates equally in earnings. Class B shares are convertible at any time into shares of Class A on a one-for-one basis at the option of the holder.

A reconciliation of basic and diluted shares is as follows:

 

     Three Months Ended
September 30,		     Nine Months Ended
September 30,		  
     2010     2009     2010     2009  

Net loss

    $ (460 )    $ (1,915 )    $ (4,749 )    $ (8,260 ) 
                                

Basic weighted average common shares outstanding

      12,653        12,712        12,691        12,708   

Weighted average common equivalent shares

      —          —          —          —     
                                

Diluted weighted average common shares outstanding

      12,653        12,712        12,691        12,708   
                                

Basic net loss per share

    $ (0.04 )    $ (0.15 )    $ (0.37 )    $ (0.65 ) 
                                

Diluted net loss per share

    $ (0.04 )    $ (0.15 )    $ (0.37 )    $ (0.65 ) 
                                

For the three and nine months ended September 30, 2010 and 2009, the number of basic and diluted weighted average shares outstanding was the same because any increase in the number of shares of common stock equivalents for those periods would be antidilutive based on the net loss for the period. During the three months ended September 30, 2010 and 2009, respectively, outstanding options to purchase 1,552,000 and 1,169,000 were excluded from the computation of diluted earnings per share because their inclusion would have been antidilutive. During the nine months ended September 30, 2010 and 2009, respectively, outstanding options to purchase 1,181,000 and 1,150,000 were excluded from the computation of diluted earnings per share because their inclusion would have been antidilutive.

Note 9 — Comprehensive Gain (Loss)

Comprehensive loss is the change in equity of a company during a period from transactions and other events and circumstances, excluding transactions resulting from investments by owners and distributions to owners.

The components of accumulated other comprehensive loss as of September 30, 2010 and December 31, 2009 are as follows:

 

     September 30,
2010		     December 31,
2009		  
     (in thousands)  

Unrealized gain on marketable securities, net of taxes

    $ 39      $ 6   

Cumulative translation adjustment

      (1,711 )      (1,457 ) 
                

Total accumulated other comprehensive loss

    $ (1,672 )    $ (1,451 ) 
                

 

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Cynosure, Inc.

Notes to Consolidated Financial Statements—(Continued)

 

 

The components of total comprehensive loss for the three and nine month periods ended September 30, 2010 and 2009 are as follows:

 

     Three Months Ended
September 30,		     Nine Months Ended
September 30,		  
     2010     2009     2010     2009  
     (in thousands)  

Cumulative translation adjustment

    $ 966      $ 332      $ (254 )    $ 624   

Unrealized gain (loss) on marketable securities

      15        (12 )      33        (63 ) 
                                

Total other comprehensive gain (loss)

      981        320        (221 )      561   

Reported net loss

      (460 )      (1,915 )      (4,749 )      (8,260 ) 
                                

Total comprehensive gain (loss)

    $ 521      $ (1,595 )    $ (4,970 )    $ (7,699 ) 
                                

Note 10 — Litigation

In 2005, Dr. Ari Weitzner, individually and as putative representative of a purported class, filed a complaint against Cynosure under the federal Telephone Consumer Protection Act (TCPA) in Massachusetts Superior Court in Middlesex County seeking monetary damages, injunctive relief, costs and attorneys fees. The complaint alleges that Cynosure violated the TCPA by sending unsolicited advertisements by facsimile to the plaintiff and other recipients without the prior express invitation or permission of the recipients. Under the TCPA, recipients of unsolicited facsimile advertisements are entitled to damages of up to $500 per facsimile for inadvertent violations and up to $1,500 per facsimile for knowing or willful violations. Based on discovery in this matter, the plaintiff alleges that approximately three million facsimiles were sent on Cynosure’s behalf by a third party to approximately 100,000 individuals. On February 6, 2008, several months after the close of discovery, the plaintiff served a motion for class certification, which Cynosure opposed on numerous factual and legal grounds, including that a nationwide class action may not be maintained in a Massachusetts state court by Dr. Weitzner, a New York resident; individual issues predominate over common issues; a class action is not superior to other methods of resolving TCPA claims; and Dr. Weitzner is an inadequate class representative. Cynosure also believes it has many merits defenses, including that the faxes in question do not constitute “advertising” within the meaning of the TCPA and many recipients had an established business relationship with Cynosure and are thereby deemed to have consented to the receipt of facsimile communications. The Court held a hearing on the plaintiff’s class certification motion on June 17, 2008, but no decision on the motion was rendered. On July 14, 2010, the Court issued an order dismissing this matter without prejudice for Dr. Weitzner’s failure to prosecute the case. On August 12, 2010, Dr. Weitzner filed a motion for relief from the dismissal order, which the Court allowed on August 17, 2010. The Court has not ruled upon the class certification motion. The Court has scheduled a status conference for November 9, 2010. Cynosure is not currently able to estimate the amount or range of loss that could result from an unfavorable outcome of this lawsuit.

On July 16, 2008, Cynosure commenced a declaratory judgment action in the U.S. District Court for the District of Massachusetts requesting a declaration that Dr. Weitzner’s and the putative class claims are covered under the Company’s general liability insurance policies. On August 11, 2008, Cynosure’s insurance company filed an Answer and Counterclaim against Cynosure seeking a declaration that the Company’s policy does not provide coverage for Dr. Weitzner’s claims. On August 19, 2008, Cynosure filed a reply to the Counterclaim. The insurance company filed a Motion for Summary Judgment on December 15, 2008, and Cynosure cross moved for Summary Judgment on January 15, 2009. The court held a hearing on the motions on February 26, 2009, and on April 8, 2009 rendered a decision that Cynosure’s liability insurer is obligated to provide Cynosure with a defense to the Weitzner action and, if necessary, indemnify Cynosure for the putative class claims. Thereafter, Cynosure’s liability insurer filed a motion for reconsideration, which Cynosure opposed. The court denied the insurer’s motion on May 13, 2009. On January 7, 2010, the court entered an Order for Judgment consistent with its April 8, 2009 decision that the insurer is obligated to defend Cynosure against the putative class claims and to indemnify Cynosure for any single damages, attorneys’ fees or costs. Per agreement of the parties, Cynosure was awarded $0.4 million in fees and costs for the period through July 1, 2009. The insurer filed a Notice of Appeal of the judgment on January 27, 2010. The insurer’s appeal of Cynosure’s fee application is currently pending before the U.S. First Circuit Court of Appeals. The matter has been fully briefed and the parties are awaiting an oral argument date.

 

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Cynosure, Inc.

Notes to Consolidated Financial Statements—(Continued)

 

 

In addition to the matters discussed above, from time to time, Cynosure is subject to various claims, lawsuits, disputes with third parties, investigations and pending actions involving various allegations against Cynosure incident to the operation of its business, principally product liability. Each of these other matters is subject to various uncertainties, and it is possible that some of these other matters may be resolved unfavorably to Cynosure. Cynosure establishes accruals for losses that management deems to be probable and subject to reasonable estimate. Cynosure believes that the ultimate outcome of these matters will not have a material adverse impact on its consolidated financial position, results of operations or cash flows.

Note 11 — Related Party Transactions

As of September 30, 2010, El. En. S.p.A. (El.En.) owned 23% of Cynosure’s outstanding common stock. Purchases of inventory from El.En. during the three months ended September 30, 2010 and 2009 were approximately $1.0 million and $1.1 million. Purchases of inventory from El.En. during the nine months ended September 30, 2010 and 2009 were approximately $4.0 million and $3.4 million, respectively. As of September 30, 2010 and December 31, 2009, amounts due to related party for these purchases were approximately $2.1 million and $1.4 million, respectively. There were no amounts due from El.En. as of September 30, 2010 or December 31, 2009.

Note 12 — Income Taxes

At September 30, 2010, there are no material gross unrecognized tax benefits. Cynosure files income tax returns in the U.S. federal jurisdiction, and in various state and foreign jurisdictions. Cynosure is no longer subject to U.S. federal tax examinations for years before 2007. With few exceptions, Cynosure is no longer subject to U.S. state and local or non-U.S. income tax examinations by tax authorities for years before 2006.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties. All statements, other than statements of historical facts, included in this Quarterly Report regarding our strategy, future operations, future financial position, future revenues, projected costs, prospects, plans, objectives of management and expected market growth are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. These forward-looking statements include, among other things, statements about:

 

  •  

our ability to identify and penetrate new markets for our products and technology;

 

  •  

our ability to innovate, develop and commercialize new products;

 

  •  

our ability to obtain and maintain regulatory clearances;

 

  •  

our sales and marketing capabilities and strategy in the United States and internationally;

 

  •  

our intellectual property portfolio; and

 

  •  

our estimates regarding expenses, future revenues, capital requirements and needs for additional financing.

We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements included in our Annual Report on Form 10-K for the year ended December 31, 2009, particularly in Part I — Item 1A and in our other public filings with the Securities and Exchange Commission that could cause actual results or events to differ materially from the forward-looking statements that we make.

You should read this Quarterly Report and the documents that we have filed as exhibits to the Quarterly Report completely and with the understanding that our actual future results may be materially different from what we expect. It is routine for internal projections and expectations to change as the year or each quarter in the year progresses, and therefore it should be clearly understood that the internal projections and beliefs upon which we base our expectations are made as of the date of this Quarterly Report on Form 10-Q and may change prior to the end of each quarter or the year. While we may elect to update forward-looking statements at some point in the future, we do not undertake any obligation to update any forward-looking statements whether as a result of new information, future events or otherwise.

The following discussion should be read in conjunction with, and is qualified in its entirety by, the condensed consolidated financial statements and notes thereto included in Item 1 of this Quarterly Report and the condensed consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K filed with the SEC on March 12, 2010. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.

 

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Company Overview

We develop and market aesthetic treatment systems that are used by physicians and other practitioners to perform non-invasive procedures to remove hair, treat vascular lesions, rejuvenate skin through the treatment of shallow vascular lesions and pigmented lesions, as well as multi-colored tattoos, temporarily reduce the appearance of cellulite, treat wrinkles, skin texture, skin discoloration and skin tightening, and to perform minimally invasive procedures for LaserBodySculpting for the removal of unwanted fat. Our systems incorporate a broad range of laser and other light-based energy sources, including Alexandrite, pulse dye, Nd:Yag and diode lasers, as well as intense pulsed light. We believe that we are one of only a few companies that currently offer aesthetic treatment systems utilizing Alexandrite and pulse dye lasers, which are particularly well suited for some applications and skin types. We offer single energy source systems as well as workstations that incorporate two or more different types of lasers or pulsed light technologies. We offer multiple technologies and system alternatives at a variety of price points depending primarily on the number and type of energy sources included in the system. Our newer products are designed to be easily upgradeable to add additional energy sources and handpieces, which provide our customers with technological flexibility as they expand their practices. As the aesthetic treatment market evolves to include new customers, such as aesthetic spas and additional physician specialties, we believe that our broad technology base and tailored solutions will provide us with a competitive advantage.

We focus our development and marketing efforts on offering leading, or flagship, products for the following high volume applications:

 

  •  

the Elite product line for hair removal, treatment of facial and leg veins and pigmentations;

 

  •  

the Smartlipo product line for LaserBodySculptingSM for the removal of unwanted fat;

 

  •  

the Affirm/SmartSkin product line for anti-aging applications, including treatments for wrinkles, skin texture, skin discoloration and skin tightening;

 

  •  

the Cynergy product line for the treatment of vascular lesions;

 

  •  

the Accolade product line for the removal of benign pigmented lesions, including pigmented lesions as well as multi-colored tattoos; and

 

  •  

the TriActive product line for the temporary reduction of the appearance of cellulite.

We sell our products through a direct sales force in North America, France, Spain, the United Kingdom, Germany, Korea, China and Japan and through international distributors in 72 other countries. We may experience a seasonal effect on our business during the summer months due to a decrease in patient procedures in certain markets which results in a decreased demand for our products.

We generate revenues primarily from sales of our products, parts and accessories and from services, including product warranty revenues. During the nine months ended September 30, 2010, we derived approximately 76% of our revenues from sales of our products and 24% of our revenues from parts, accessories and service revenues. During the nine months ended September 30, 2009, we derived approximately 77% of our revenues from sales of products and 23% of our revenues from parts, accessories and service revenues. Generally, we recognize revenues from the sales of our products upon delivery to our customers and revenues from service contracts and extended product warranties ratably over the coverage period and revenues from service in the period in which the service occurs.

We sell our products directly in North America, France, Spain, the United Kingdom, Germany, Korea, China and Japan and use distributors to sell our products in other countries where we do not have a direct presence. During the nine months ended September 30, 2010, and 2009 we derived 59% and 52% of our revenues, respectively, from sales outside North America. As of September 30, 2010, we had 32 sales employees covering North America, 29 sales employees in France, Spain, the United Kingdom, Germany, Korea, China and Japan and 29 distributors covering 72 countries.

 

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The following table provides revenue data by geographical region for the nine months ended September 30, 2010 and 2009:

 

     Percentage of Revenues  
     Nine-Months
Ended September 30,		  

Region

    2010     2009  

North America

      41 %      48 % 

Europe

      29        24   

Asia/Pacific

      24        21   

Other

      6        7   
                

Total

      100 %      100 % 
                

See Note 7 to our consolidated financial statements included in this Quarterly Report for revenues and asset data by geographic region.

Results of Operations

The following table contains selected income statement information, which serves as the basis of the discussion of our results of operations for the three months ended September 30, 2010 and 2009, respectively (in thousands, except for percentages):

 

     Three Months Ended
September 30,		     $
Change		     %
Change		  
   2010     2009      
   Amount     As a % of
Total
Revenues		     Amount     As a % of
Total
Revenues		      

Product revenues

    $ 14,357        75 %    $ 13,679        76 %    $ 678        5 % 

Parts, accessories and service revenues

      4,694        25        4,258        24        436        10   
                                                

Total revenues

      19,051        100        17,937        100        1,114        6   

Cost of revenues

      8,367        44        7,460        42        907        12   
                                                

Gross profit

      10,684        56        10,477        58        207        2   

Operating expenses

             

Sales and marketing

      7,069        37        8,743        49        (1,674 )      (19 ) 

Research and development

      1,899        10        1,564        9        335        21   

General and administrative

      2,688        14        3,511        20        (823 )      (23 ) 
                                                

Total operating expenses

      11,656        61        13,818        77        (2,162 )      (16 ) 
                                                

Loss from operations

      (972 )      (5 )      (3,341 )      (19 )      2,369        71   

Interest income, net

      41        —          83        1        (42 )      (51 ) 

Other income, net

      504        3        371        2        133        36   
                                                

Loss before provision (benefit) for income taxes

      (427 )      (2 )      (2,887 )      (16 )      2,460        85   

Provision (benefit) for income taxes

      33        —          (972 )      (5 )      1,005        103   
                                                

Net loss

    $ (460 )      (2 )%    $ (1,915 )      (11 )%    $ 1,455        76 % 
                                                

 

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Revenues

Revenues in the three months ended September 30, 2010 increased from the three months ended September 30, 2009 by $1.1 million or 6%. The increase was attributable to a number of factors (in thousands, except for percentages):

 

     Three Months Ended
September 30,		      $
Change		     %
Change		  
     2010      2009       

Product sales in North America

    $ 6,485       $ 7,470       $ (985 )      (13 )% 

Product sales outside North America

      7,872         6,209         1,663        27   

Parts, accessories and service sales

      4,694         4,258         436        10   
                                  

Total Revenues

    $ 19,051       $ 17,937       $ 1,114        6 % 
                                  

 

  •  

Revenues from the sale of products in North America decreased 13% from the third quarter of 2009 primarily due to a decrease in the number of units sold. We believe that the availability of credit remains limited and demand for discretionary aesthetic laser treatments remains uncertain and as a result, our revenues may continue to be adversely affected. We develop and market aesthetic treatment systems (capital equipment) that are used by physicians and other practitioners to perform non-invasive and minimally invasive procedures in the aesthetic marketplace. These procedures are discretionary and not reimbursed by third-party insurers. The significant majority of our business each quarter is derived from new customers. A portion of our customers finance the purchase of these lasers through third party finance companies or banks. During the third quarter of 2010, credit continued to be difficult to obtain and, as a result, our potential customers were not as able to expand their practices or commit to purchasing equipment from us.

 

  •  

Revenues from sales of products outside of North America increased by approximately $1.7 million, or 27%, from the 2009 period primarily due to stronger revenues from our European and Far East distributors.

 

  •  

Revenues from the sale of parts, accessories and services increased by approximately $0.4 million, or 10%, from the 2009 period, primarily due to an increase in revenues generated from the sale of our service contracts as well as an increase in sales of certain parts and accessories.

Cost of Revenues

 

     Three Months Ended
September 30,		     $
Change		      %
Change		  
     2010     2009       

Cost of revenues (in thousands)

    $ 8,367      $ 7,460      $ 907         12 % 

Cost of revenues (as a percentage of total revenues)

      44 %      42 %      

Total cost of revenues increased $0.9 million, or 12%, to $8.4 million for three months ended September 30, 2010, as compared to $7.5 million for the three months ended September 30, 2009, partially related to our 6% increase in total revenues as well as a higher percentage of product revenue from international distribution, where our products tend to have lower average selling prices than in North America. Our total cost of revenues as a percentage of total revenues was 44% for the three months ended September 30, 2010, from 42% for the three months ended September 30, 2009 resulting in a decrease in our gross margin.

Sales and Marketing

 

     Three Months Ended
September 30,		     $
Change		     %
Change		  
     2010     2009      

Sales and marketing (in thousands)

    $ 7,069      $ 8,743      $ (1,674 )      (19 )% 

Sales and marketing (as a percentage of total revenues)

      37 %      49 %     

Sales and marketing expenses decreased $1.7 million, or 19%. The decrease is primarily attributed to a decrease of $0.9 million in personnel, administrative costs and travel expenses associated with the overall reduction of our worldwide direct sales organization and a decrease in promotional costs of $0.5 million, primarily due to a decreased number of clinical workshops, trade shows and other promotional efforts. Stock compensation expense also decreased $0.3 million as compared to the 2009 period. Our sales and marketing expenses for the three months ended September 30, 2010 decreased as a percentage of revenue to 37% primarily due to the reduction of these expenses as compared to the three months ended September 30, 2009.

 

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Research and Development

 

     Three Months Ended
September 30,		     $
Change		      %
Change		  
     2010     2009       

Research and development (in thousands)

    $ 1,899      $ 1,564      $ 335         21 % 

Research and development (as a percentage of total revenues)

      10 %      9 %      

Research and development expenses increased $0.3 million, or 21% for the three months ended September 30, 2010 when compared with the three months ended September 30, 2009. The increase is primarily due to increased professional fees and consulting associated with clinical studies.

General and Administrative

 

     Three Months Ended
September 30,		     $
Change		     %
Change		  
     2010     2009      

General and administrative (in thousands)

    $ 2,688      $ 3,511      $ (823 )      (23 )% 

General and administrative (as a percentage of total revenues)

      14 %      20 %     

General and administrative expenses decreased $0.8 million, or 23%, due primarily to a $0.3 million decrease in legal and professional costs incurred in connection with our patent infringement case against CoolTouch, which was settled in January 2010 and a decrease in stock compensation expense of $0.4 million for the three months ended September 30, 2010 as compared to the three months ended September 30, 2009.

Interest Income, net

 

     Three Months Ended
September 30,		      $
Change		     %
Change		  
     2010      2009       

Interest income, net (in thousands)

    $ 41       $ 83       $ (42 )      (51 )% 

The decrease in interest income, net is primarily due to our investing in securities that bear less risk and lower interest rates than the comparable period in 2009.

Other Income, net

 

     Three Months Ended
September 30,		      $
Change		      %
Change		  
     2010      2009        

Other income, net (in thousands)

    $ 504       $ 371       $ 133         36 % 

The increase in other income, net is primarily a result of larger net foreign currency remeasurement gains in the third quarter of 2010 primarily associated with the strengthening of the euro, compared to the third quarter of 2009.

Provision (Benefit) for Income Taxes

 

     Three Months Ended
September 30,		     $
Change		      %
Change		  
     2010     2009       

Provision (benefit) for income taxes (in thousands)

    $ 33      $ (972 )    $ 1,005         103 % 

Provision (benefit) as a % of loss before provision (benefit) for income taxes

      8 %      (34 )%      

The provision for income taxes results from a combination of the activities of our domestic and foreign subsidiaries. During the three months ended September 30, 2010, we recorded an income tax provision of $33,000, representing an effective tax rate of 8%. Given the uncertainty of future income in the U.S. we continue to maintain a valuation allowance against our net domestic deferred tax assets, and therefore we did not record a benefit for our current losses in the U.S. for the third quarter of 2010, with the exception of the portion that can be carried back to recover income taxes paid in prior years. During the three months ended September 30, 2009, we recorded an income tax benefit of $1.0 million, representing an effective tax rate of 34%. The effective tax rate from the 2009 period to the 2010 period changed primarily due to the valuation allowance maintained against the net domestic deferred tax assets, including the deferred tax asset on the portion of the current quarter net operating loss which cannot be carried back at September 30, 2010.

 

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NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009

The following table contains selected statement of operations information, which serves as the basis of the discussion of our results of operations for the nine months ended September 30, 2010 and 2009, respectively (in thousands, except for percentages):

 

     Nine Months Ended
September 30,		              
     2010     2009              
     Amount     As a % of
Total
Revenues		     Amount     As a % of
Total
Revenues		     $
Change		     %
Change		  

Product revenues

    $ 44,963        76 %    $ 41,073        77 %    $ 3,890        9 % 

Parts, accessories and service revenues

      14,470        24        12,493        23        1,977        16   
                                                

Total revenues

    $ 59,433        100 %    $ 53,566        100 %    $ 5,867        11 % 

Cost of revenues

      25,529        43        21,997        41        3,532        16   
                                                

Gross profit

      33,904        57        31,569        59        2,335        7   

Operating expenses

             

Sales and marketing

      24,116        41        29,696        55        (5,580 )      (19 ) 

Research and development

      5,454        9        5,001        9        453        9   

General and administrative

      8,751        15        11,440        21        (2,689 )      (24 ) 
                                                

Total operating expenses

      38,321        64        46,137        86        (7,816 )      (17 ) 
                                                

Loss from operations

      (4,417 )      (7 )      (14,568 )      (27 )      10,151        70   

Interest income, net

      139        —          454        1        (315 )      (69 ) 

Other (expense) income, net

      (197 )      —          705        1        (902 )      (128 ) 
                                                

Loss before provision (benefit) for income taxes

      (4,475 )      (8 )      (13,409 )      (25 )      8,934        67   

Provision (benefit) for income taxes

      274        —          (5,149 )      (10 )      5,423        105   
                                                

Net loss

    $ (4,749 )      (8 )%    $ (8,260 )      (15 )%    $ 3,511        43 % 
                                                

Revenues

Revenues in the nine months ended September 30, 2010 increased from revenues in the nine months ended September 30, 2009 by $5.9 million, or 11%. The increase in revenues was attributable to a number of factors (in thousands, except for percentages):

 

     Nine Months Ended
September 30,		      $
Change		     %
Change		  
     2010      2009       

Product sales in North America

    $ 20,680       $ 21,520       $ (840 )      (4 )% 

Product sales outside North America

      24,283         19,553         4,730        24   

Parts, accessories and service sales

      14,470         12,493         1,977        16   
                                  

Total Revenues

    $ 59,433       $ 53,566       $ 5,867        11 % 
                                  

 

  •  

Revenues from the sale of products in North America decreased $0.8 million for the nine months ended September 30, 2010 when compared with the nine months ended September 30, 2009 primarily due to a decrease in the number of units sold. We believe that the availability of credit remains limited and demand for discretionary aesthetic laser treatments remains uncertain and as a result, our revenues may continue to be adversely affected. We develop and market aesthetic treatment systems (capital equipment) that are used by physicians and other practitioners to perform non-invasive and minimally invasive procedures in the aesthetic marketplace. These procedures are discretionary and not reimbursed by third-party insurers. The significant majority of our business each quarter is derived from new customers. A portion of our customers finance the purchase of these lasers through third party finance companies or banks. During the first three quarters of 2010, credit continued to be difficult to obtain and, as a result, our potential customers were not as able to expand their practices or commit to purchasing equipment from us.

 

  •  

Revenues from sales of products outside of North America increased by approximately $4.7 million, or 24%, over the 2009 period, due to an increase in the number of units sold by our Asian and European subsidiaries as well as our international distributors in Europe and the Far East regions as a result of improved global economic business conditions compared with the first nine months of 2009.

 

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  •  

Revenues from the sale of parts, accessories and services increased by approximately $2.0 million, or 16%, over the 2009 period, primarily due to an increase in revenues generated from the sale of our service contracts as well as an increase in sales of certain parts and accessories.

Cost of Revenues

 

     Nine Months Ended
September 30,		     $
Change		      %
Change		  
     2010     2009       

Cost of revenues (in thousands)

    $ 25,529      $ 21,997      $ 3,532         16 % 

Cost of revenues (as a percentage of total revenues)

      43 %      41 %      

The increase in the cost of revenues was primarily attributable to an 11% increase in revenues for the nine months ended September 30, 2010 as compared with the nine months ended September 30, 2009. Our cost of revenues increased as a percentage of total revenues to 43% for the nine months ended September 30, 2010, from 41% for the nine months ended September 30, 2009, resulting in a decrease in our gross margin. The decline in gross margin in the 2010 period as compared to the 2009 period primarily was the result of the higher percentage of laser revenue from international distribution where the company’s products tend to have lower average selling prices than in North America.

Sales and Marketing

 

     Nine Months Ended
September 30,		     $
Change		     %
Change		  
     2010     2009      

Sales and marketing (in thousands)

    $ 24,116      $ 29,696      $ (5,580 )      (19 )% 

Sales and marketing (as a percentage of total revenues)

      41 %      55 %     

Sales and marketing expenses decreased by $5.6 million, or 19%. The decrease is due to a $2.2 million reduction in promotional costs associated with workshops, tradeshows and other promotional efforts; a reduction of $2.7 million of personnel costs, travel expenses and other administrative costs associated with the overall reduction of our worldwide direct sales organization, and reduced stock compensation expense of $0.7 million. Our sales and marketing expenses for the nine months ended September 30, 2010 decreased as a percentage of revenue to 41% due to the reduction of these expenses as well as an 11% increase in revenues for the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009.

Research and Development

 

     Nine Months Ended
September 30,		     $
Change		      %
Change		  
     2010     2009       

Research and development (in thousands)

    $ 5,454      $ 5,001      $ 453         9 % 

Research and development (as a percentage of total revenues)

      9 %      9 %      

Research and development expenses increased by $0.5 million for the nine months ended September 30, 2010, when compared with the nine months ended September 30, 2009. This increase is primarily due to increased professional fees and consulting associated with clinical studies.

General and Administrative

 

     Nine Months Ended
September 30,		     $
Change		     %
Change		  
     2010     2009      

General and administrative (in thousands)

    $ 8,751      $ 11,440      $ (2,689 )      (24 )% 

General and administrative (as a percentage of total revenues)

      15 %      21 %     

General and administrative expenses decreased $2.7 million, or 24%, due to a decrease of $1.3 million in legal and professional services costs associated with the patent infringement case against CoolTouch, which was settled in January 2010, a $1.2 million decrease in bad debt expense and $0.2 million decrease in other administrative costs.

 

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Interest Income, net

 

     Nine Months Ended
September 30,		      $
Change		     %
Change		  
     2010      2009       

Interest income, net (in thousands)

    $ 139       $ 454       $ (315 )      (69 )% 

The decrease in interest income, net is primarily due to our investing in securities that bear less risk and lower interest rates than in the comparable period in 2009.

Other (Expense) Income, net

 

     Nine Months Ended
September 30,		      $
Change		     %
Change		  
     2010     2009       

Other (expense) income, net (in thousands)

    $ (197 )    $ 705       $ (902 )      (128 )% 

The decrease in other (expense) income is primarily a result of net foreign currency remeasurement losses in the first three quarters of 2010 compared to net foreign currency remeasurement gains in the first three quarters of 2009 due to the weakening of the U.S. dollar, primarily against the euro.

Provision (Benefit) for Income Taxes

 

     Nine Months Ended
September 30,		     $
Change		      %
Change		  
     2010     2009       

Provision (benefit) for income taxes (in thousands)

    $ 274      $ (5,149 )    $ 5,423         105 % 

Provision (benefit) as a % of loss before provision (benefit) for income taxes

      6 %      (38 )%      

The provision for income taxes results from a combination of the activities of our domestic and foreign subsidiaries. During the nine months ended September 30, 2010, we recorded an income tax provision of $0.3 million, representing an effective tax rate of 6%. Given the uncertainty of future income in the U.S. we continue to maintain a valuation allowance against our net domestic deferred tax assets, and therefore we did not record a benefit for our current year losses in the U.S. for the first three quarters of 2010 with the exception of the portion that can be carried back to recover income taxes paid in prior years. During the nine months ended September 30, 2009, we recorded an income tax benefit of $5.1 million, representing an effective tax rate of 38%. The effective tax rate from the 2009 period to the 2010 period changed primarily due to the valuation allowance maintained against the net domestic deferred tax assets, including the deferred tax asset on the portion of the current year net operating loss which cannot be carried back at September 30, 2010.

Liquidity and Capital Resources

We require cash to pay our operating expenses, make capital expenditures and pay our long-term liabilities. Since our inception, we have funded our operations through private and public placements of equity securities, short-term borrowings and funds generated from our operations. At September 30, 2010, our cash, cash equivalents and short and long-term marketable securities were $95.4 million. Our cash and cash equivalents of $31.9 million are highly liquid investments with maturities of 90 days or less at date of purchase and consist of cash in operating accounts and investments in money market funds. Our short-term marketable securities of $58.7 million consist of investments in various state and municipal governments, U.S. government agencies and treasuries, all of which mature by September 22, 2011. Our long-term marketable securities of $4.8 million consist of investments in state and municipal governments and U.S. government agencies and treasuries all of which mature by September 17, 2012.

Our future capital requirements depend on a number of factors, including the rate of market acceptance of our current and future products, the resources we devote to developing and supporting our products and continued progress of our research and development of new products. We incurred less capital expenditures for the nine months ended September 30, 2010 than the same period in 2009 and expect capital expenditures for 2010 to be less than 2009. During the nine months ended September 30, 2010 and 2009, respectively, we transferred $3.2 million and $5.4 million, respectively of demonstration equipment to fixed assets.

On July 28, 2009, our Board of Directors authorized the repurchase of up to $10 million of our Class A common stock, from time to time, on the open market or in privately negotiated transactions under a stock repurchase program. The program will terminate upon the purchase of $10 million in common stock unless our Board of Directors discontinues it sooner. During the nine months ended September 30, 2010, we repurchased 121,152 shares of our common stock at an aggregate cost of approximately $1.1 million and at a weighted average price of $9.46 per share under this program. As of September 30, 2010 we have repurchased an aggregate of 124,466 shares under the program.

 

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We believe that our current cash, cash equivalents, marketable securities and investments, as well as cash generated from operations, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for the foreseeable future.

Cash Flows

Net cash provided by operating activities was $5.5 million for the nine months ended September 30, 2010, and resulted primarily from the net loss for the period of $4.7 million, increased by approximately $7.5 million in depreciation and amortization and stock-based compensation expense and by approximately $0.6 million in accretion of discounts on marketable securities. Net changes in working capital items increased cash from operating activities by approximately $2.1 million primarily related to a decrease in prepaid expenses and other assets of $2.6 million associated with our income tax refund, a decrease in accounts receivable of $0.7 million due to increased collection efforts and an increase in amounts due to related parties and accrued expenses of $1.3 million. These changes were partially offset by a decrease in deferred revenue of $1.6 million. Net cash used in investing activities was $17.3 million for the nine months ended September 30, 2010, which consisted primarily of net purchases of marketable securities of $16.9 million and $0.4 million used for fixed asset purchases. Net cash used in financing activities during the nine months ended September 30, 2010 was $1.2 million, principally relating to $1.1 million in the repurchase of our common stock and $0.2 million for payments on capital lease obligations partially offset by $0.1 million of proceeds from stock option exercises during the nine months ended September 31, 2010.

Net cash used in operating activities was $3.3 million for the nine months ended September 30, 2009. This resulted primarily from the net loss for the period of $8.3 million, increased by approximately $9.1 million in depreciation and amortization and stock-based compensation expense and by approximately $0.2 million in accretion of discounts on marketable securities. Net changes in working capital items decreased cash from operating activities by approximately $4.4 million principally related to a decrease in accounts receivable of $10.5 million due to increased collection efforts and reduced sales. This was offset by an increase in prepaid expenses and other assets related to our tax benefit position, and a decrease in amounts due to related party, accrued expenses and accounts payable. Net cash provided by investing activities was $2.0 million for the nine months ended September 30, 2009, which consisted primarily of the net proceeds of $2.8 million from the sale and maturities of marketable securities, partially offset by $0.6 million used for fixed asset purchases. Net cash used in financing activities during the nine months ended September 30, 2009 was $0.3 million, principally relating to payments on capital lease obligations.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations set forth above are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate our estimates and judgments, including those that relate to revenue recognition, allowances for doubtful accounts, inventories, warranty obligations, stock-based compensation and income taxes. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances. These estimates and assumptions form the basis for making judgments about the carrying values of assets and liabilities, and the reported amounts of revenues and expenses, that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. A discussion of our critical accounting policies and the related judgments and estimates affecting the preparation of our consolidated financial statements is included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009. There have been no material changes to our critical accounting policies as of September 30, 2010.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The following discussion about our market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative financial instruments.

Interest Rate Sensitivity. We maintain an investment portfolio consisting mainly of money market funds, state and municipal bonds, and U.S. government agencies and treasuries. The securities, other than money market funds, are classified as available-for-sale and consequently are recorded on the balance sheet at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive (loss) income. All investments mature by September 17, 2012. These available-for-sale securities are subject to interest rate risk and will fall in value if market interest rates increase, which could result in a realized loss if we are forced to sell an investment before its scheduled maturity. We currently have the ability and intent to hold our fixed income investments until maturity. We do not utilize derivative financial instruments to manage our interest rate risks.

 

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The following table provides information about our investment portfolio in available-for-sale debt securities. For investment securities, the table presents principal cash flows (in thousands) and weighted average interest rates by expected maturity dates.

 

     As of
September 30, 2010		     Maturing in
2010		     Maturing in
2011		     Maturing in
2012		  

Investments (at fair value)

    $ 71,473      $ 20,393      $ 48,261      $ 2,819   

Weighted average interest rate

      0.35 %      0.19 %      0.41 %      0.59 % 

Foreign Currency Exchange. A significant portion of our operations is conducted through operations in countries other than the United States. Revenues from our international operations that were recorded in U.S. dollars represented approximately 38% of our total international revenues during the nine months ended September 30, 2010. Substantially all of the remaining 62% were sales in euros, British pounds, Japanese yen, Chinese yuan and South Korean won. Since we conduct our business in U.S. dollars, our main exposure, if any, results from changes in the exchange rate between these currencies and the U.S. dollar. Our functional currency is the U.S. dollar. Our policy is to reduce exposure to exchange rate fluctuations by having most of our assets and liabilities, as well as most of our revenues and expenditures, in U.S. dollars, or U.S. dollar linked. We have not historically engaged in hedging activities relating to our non-U.S. dollar operations. We sell inventory to our subsidiaries in U.S. dollars. These amounts are recorded at our local subsidiaries in local currency rates in effect on the transaction date. Therefore, we may be exposed to exchange rate fluctuations that occur while the debt is outstanding which we recognize as unrealized gains and losses in our statements of operations. Upon settlement of these debts, we may record realized foreign exchange gains and losses in our statements of operations. We may incur negative foreign currency translation charges as a result of changes in currency exchange rates.

 

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2010. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2010, our principal executive officer and principal financial officer have concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — Other Information

 

Item 1. Legal Proceedings

In 2005, Dr. Ari Weitzner, individually and as putative representative of a purported class, filed a complaint against us under the federal Telephone Consumer Protection Act, or the TCPA in Massachusetts Superior Court in Middlesex County seeking monetary damages, injunctive relief, costs and attorneys fees. The complaint alleges that we violated the TCPA by sending unsolicited advertisements by facsimile to the plaintiff and other recipients without the prior express invitation or permission of the recipients. Under the TCPA, recipients of unsolicited facsimile advertisements are entitled to damages of up to $500 per facsimile for inadvertent violations and up to $1,500 per facsimile for knowing or willful violations. Based on discovery in this matter, the plaintiff alleges that approximately three million facsimiles were sent on our behalf by a third party to approximately 100,000 individuals. On February 6, 2008, several months after the close of discovery, the plaintiff served a motion for class certification, which we opposed on numerous factual and legal grounds, including that a nationwide class action may not be maintained in a Massachusetts state court by Dr. Weitzner, a New York resident; individual issues predominate over common issues; a class action is not superior to other methods of resolving TCPA claims; and Dr. Weitzner is an inadequate class representative. We also believe we have many merits defenses, including that the faxes in question do not constitute “advertising” within the meaning of the TCPA and many recipients had an established business relationship with us and are thereby deemed to have consented to the receipt of facsimile communications. The Court held a hearing on the plaintiff’s class certification motion on June 17, 2008, but no decision on the motion has been rendered.

 

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On July 14, 2010, the Court issued an order dismissing this matter without prejudice for Dr. Weitzner’s failure to prosecute the case On August 12, 2010, Dr. Weitzner filed a motion for relief from the dismissal order, which the Court allowed on August 17, 2010. The Court has not ruled upon the class certification motion. The Court has scheduled a status conference for November 9. We are not currently able to estimate the amount or range of loss that could result from an unfavorable outcome of this lawsuit.

On July 16, 2008, we commenced a declaratory judgment action in the U.S. District Court for the District of Massachusetts requesting a declaration that Dr. Weitzner’s and the putative class claims are covered under our general liability insurance policies. On August 11, 2008, our insurance company filed an Answer and Counterclaim against us seeking a declaration that our policy does not provide coverage for Dr. Weitzner’s claims. On August 19, 2008, we filed a reply to the Counterclaim. The insurance company filed a Motion for Summary Judgment on December 15, 2008, and we cross moved for Summary Judgment on January 15, 2009. The court held a hearing on the motions on February 26, 2009, and on April 8, 2009 rendered a decision that our liability insurer is obligated to provide us with a defense to the Weitzner action and, if necessary, indemnify us for the putative class claims. Thereafter, our liability insurer filed a motion for reconsideration, which we opposed. The court denied the insurer’s motion on May 13, 2009. On January 7, 2010, the court entered an Order for Judgment consistent with its April 8, 2009 decision that the insurer is obligated to defend us against the putative class claims and to indemnify us for any single damages, attorneys’ fees or costs. Per agreement of the parties, we were awarded $0.4 million in fees and costs for the period through July 1, 2009. The insurer filed a Notice of Appeal of the judgment on January 27, 2010. The insurer’s appeal of our fee application is currently pending before the U.S. First Circuit Court of Appeals. The matter has been fully briefed and the parties are awaiting an oral argument date.

In addition to the matters discussed above, from time to time, we are subject to various claims, lawsuits, disputes with third parties, investigations and pending actions involving various allegations against us incident to the operation of its business, principally product liability. Each of these other matters is subject to various uncertainties, and it is possible that some of these other matters may be resolved unfavorably to us. We establish accruals for losses that management deems to be probable and subject to reasonable estimate. We believe that the ultimate outcome of these matters will not have a material adverse impact on our consolidated financial position, results of operations or cash flows.

 

Item 1A. Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described in our Annual Report on Form 10-K for the year ended December 31, 2009 in addition to the other information included in this quarterly report. If any of the risks actually occurs, our business, financial condition or results of operations would likely suffer. In that case, the trading price of our common stock could fall.

As of September 30, 2010, there have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009, although we may disclose changes to such risk factors or disclose additional risk factors from time to time in our future filings with the SEC.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On July 28, 2009, our Board of Directors authorized the repurchase of up to $10 million of our Class A common stock from time to time on the open market or in privately negotiated transactions under a stock repurchase program. The program will terminate upon the purchase of $10 million in common stock unless our Board of Directors discontinues it sooner. During the three months ended September 30, 2010, we repurchased 113,452 shares of our Class A common stock under this program at an aggregate cost of approximately $1.1 million and at a weighted average price of $9.44 per share. As of September 30, 2010, we had repurchased an aggregate of 124,466 shares under the program.

 

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The following table provides information about purchases by the Company of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act during the quarter ended September 30, 2010:

 

Period

    Total number
of shares (or
units)
purchased		      Average price
paid per share
(or unit)		      Total number of
shares (or units)
purchased as
part of publicly
announced plans
or programs		      Maximum
number (or
appropriate
dollar value) of
shares (or units)
that may yet be
purchased under
the plans or
programs		  

July 1, 2010 — July 31, 2010

      29,823       $ 9.57         29,823       $ 9,606,753   

August 1, 2010 — August 31, 2010

      65,820         9.37         65,820         8,990,157   

September 1, 2010 — September 30, 2010

      17,809         9.45         17,809         8,821,795   
                                   

Total

      113,452       $ 9.44         113,452       $ 8,821,795   
                                   

 

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Item 6. Exhibits

(a) Exhibits

 

Exhibit

No.

   

Description

31.1    Certification of the Principal Executive Officer
31.2    Certification of the Principal Financial Officer
32.1    Certification of the Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification of the Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant certifies that it has caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

   

Cynosure, Inc.

(Registrant)

Date: November 5, 2010     By:   /S/    MICHAEL R. DAVIN        
      Michael R. Davin
      Chairman, President, Chief Executive Officer
Date: November 5, 2010     By:   /S/    TIMOTHY W. BAKER        
      Timothy W. Baker
      Executive Vice President, Chief Financial Officer and Treasurer

 

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EXHIBIT INDEX

 

Exhibit

No.

   

Description

31.1    Certification of the Principal Executive Officer
31.2    Certification of the Principal Financial Officer
32.1    Certification of the Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification of the Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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CYNOSURE INC Reports