Despite making more money this quarter, aesthetic laser maker Cutera (NASDAQ:CUTR) recently reported that profits dropped 27% because of stock-based compensation expenses (once again underscoring the notion that stock options are a cost to business). The company reported $1.1 million in net income this quarter versus the $1.5 million it made last year. Revenues, though, grew 37% to $20.8 million.
But Cutera's got bigger problems than profits. It's the target of a lawsuit by competitor Palomar Medical Technologies (NASDAQ:PMTI) that could very well put it out of business. Indeed, an analyst just initiated coverage of the company with a "sell" rating, because he thinks the company will lose the patent infringement case.
I've written previously that patents by themselves are not a sufficient competitive moat to induce me to invest in a company. Technology can change; competitors can come up with a better mousetrap; a host of things can make the patent obsolete. Yet when they are enforced and upheld, they can be a powerful motivator, at least temporarily. When you fall on the wrong side of that divide, however, a patent can be crippling.
Lumenis, which now trades on the Pink Sheets as a shell of its former self, found out what can happen when you run afoul of patents. Palomar sued it for infringement and settled, allowing the company to license its products. Palomar has said it will not offer Cutera similar terms. Other laser makers like Candela (NASDAQ:CLZR) and Syneron (NASDAQ:ELOS) have not been accused of infringing on Palomar's technology, nor do they expect to be.
Considering the ramifications of a court loss, I decided to read not only the court decision (in pdf format) where Cutera unsuccessfully attempted to have the lawsuit thrown out, but also the patent that it's alleged to be infringing. Admittedly, I'm no patent attorney, and a lot of what is discussed flew right over my head, but it seems to me that on perhaps two of the three issues, Cutera's got some problems.
Palomar contends that its patent allows for a laser device to press against the skin, cool it, and allow a light beam to remove two or more hairs at a time. Cutera counters that its CoolGlide laser is not required to have pressure applied, that the cooling and "lasering" of the hair are separate operations, and that in fact its laser light diverges as it leaves the device, whereas Palomar's patent calls for the light to converge. Wow, talk about hair splitting.
The court, it should be noted, essentially dismisses Cutera's arguments out of hand, and has consistently done so. Undoubtedly that is behind the reason that at least one analyst believes Cutera's going to lose. When the courts don't cotton to your ideas even minimally, you have problems.
I'd have to agree that it doesn't look good for Cutera. Yet it seems specious to me, as a layman, that Palomar can claim protection for the application of pressure to the skin. When you read the court's dissection of the segment, you see that it does not appear to be any novel application here, but rather it's simply the depression of the skin to create a deformity. Placing my finger on my forearm does the same thing and I find it difficult to see how that can be patentable. The court is also dismissive of Cutera's argument that Palomar's patent calls for a simultaneous cooling and lasering of the skin, whereas its device does each operation separately. The court said it doesn't matter what order the operations occur, just so that they are being performed. To me this is open to interpretation and perhaps a different court will see it differently.
The last issue seems problematic. It appears that the Cutera device uses a convex lens, which would cause light to converge, which Palomar's patent protects. However, Cutera has said that its CoolGlide actually has light diverge as it exits the device. The court has said it will let a jury decide the discrepancy in definitions. While there are a few other matters at stake -- such as whether Cutera's device prevents damage to the skin (interestingly, Cutera argues that its device doesn't prevent damage) -- the courts believe there is enough difference of opinion to reject Cutera's plea to summarily dismiss the lawsuit, but it seems there is enough difference in fact to make it difficult for Cutera to prevail.
Should that happen, the one-time high-flying darling of the aesthetic laser industry could be severely crippled. Subject to punitive damages and without access to the technology that allows it to grow, Cutera may end up just singeing itself.
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Fool contributor Rich Duprey owns shares of Candela, but he does not own any of the other stocks mentioned in this article. You can see his holdings here . The Motley Fool has a disclosure policy .
