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Executives

John Mills - Integrated Corporate Relation

Kevin Connors - President and Chief Executive Officer

Ronald Santilli - Chief Financial Officer, Vice President of Finance and Administration

Analysts

Thomas Gunderson - Piper Jaffray

Dalton Chandler - Needham & Company

Chris Sassouni - Eagle Asset Management

Mike Neary - Neary Asset Management

Hesham Shaabam - Maxim Group

Cutera, Inc. (CUTR) Q4 2008 Earnings Call Transcript February 9, 2009 5:00 PM ET

Operator

Good afternoon ladies and gentlemen and thank you for standing by. Welcome to the Cutera Incorporated fourth quarter 2008 earnings conference call. During today’s presentation all parties will be in a listen only mode. Following the presentation, the conference will be open for questions. (Operator Instructions) As a reminder, this conference is being recorded today, Monday, February 9th, 2009.

I would now like to turn the conference over to John Mills. Please go ahead sir.

John Mills

Good afternoon. By now everyone should have access to the fourth quarter 2008 earnings release, which went out today at approximately 4:00 pm eastern time. The release is available on the Investor Relations portion of Cutera’s website, at cutera.com and with its Form 8-K filed today with the SEC and available on its website at sec.gov.

Before we begin, Cutera would like to remind everyone that these prepared remarks contain forward-looking statements, including statements concerning domestic and international growth opportunities and strategies, future spending, expense management, and execution on various aspects of our operations and business, expectations for increasing revenue, generating additional cash and maintaining profitability and the development and commercialization of existing and planned products.

Also, management may make additional forward-looking statements in response to your questions. Factors that could cause Cutera’s actual results to differ materially from these forward-looking statements include the global economic crisis which may reduce consumer demand for its products, cause potential customers to delay their purchase decisions, and make it more difficult for some potential customers to obtain credit financing.

Cutera’s ability to increase revenue and manage expenses worldwide, the length of the sales cycle process, our ability to successfully develop and acquire new products and market them to both installed base and new customers, unforeseen events and circumstances related to operations, government regulatory actions, and those other factors described in the section entitled “Risk Factors” in its most recent 10-Q filed November 3rd, 2008 with the SEC.

These forward-looking statements do not guarantee future performance and therefore you should not rely on them in making an investment decision without considering the risk associated with such statements. Cutera also cautions you to not place undue reliance on forward-looking statements, which speak only as of the date they were made.

Cutera undertakes no obligation to update publicly any forward-looking statements to reflect new information, events or circumstances after the date they were made or to reflect the occurrence of unanticipated events.

With that I will turn the call over to the Company’s President and Chief Executive Officer, Mr. Kevin Connors.

Kevin Connors

Thank you, John. Good afternoon everyone and thanks for joining us today to discuss Cutera’s results for the fourth quarter and year ended December 31, 2008. On today’s call I will provide an overview of our results and then Ronald Santilli, our CFO will provide additional details on our operating and financial results. Finally, I will provide some closing comments and open the call to your questions.

Our revenue for the fourth quarter of 2008 was $17.9 million or 32% lower and $26.5 million reported at the fourth quarter 2007. Revenue for the full year of 2008 was $83.4 million or 18% lower than our 2007 revenue of $101.7 million. Year 2008 was a challenging year for our industry as the global recession continues to affect customer purchasing decisions; even our revenue volume was impacted by this economic downturn. The actions we took to manage our expenses and bring them in line with current revenue trends enable us to generate cash and profits to the full year after non-cash impairment charges, net of tax associated with our investments and auction rate securities.

Gross margin for the fourth quarter was 61%, up from 59% in the third quarter of 2008. This improvement was primarily attributed to the improvements and product liability. It was also attributed to cost cutting measures that we recently implemented partially offset by some pricing compression.

We generated $4 million of operating cash during 2008 and ended the year with $106.8 million in cash marketable securities and long term investments and no debt. In 2009, we plan to continue taking appropriate actions to manage our business during these challenging economic times. In January, in an effort to improve profitability and cash generation, we reduced our workforce by approximately 10% company wide. The flexibility of our business model allows us to quickly respond to changes in our business. We will continue to manage our expenses during these uncertain economic times to keep them in line with revenue ops.

US revenue in the fourth quarter 2008 was $7.4 million or 52% lower than the amount reported for the fourth quarter of 2007 and decreased 35% in 2008, compared to 2007. We believe the revenue decline was primarily driven by continuing recession that is significantly extending our sales cycle.

Cutera’s broad product offering, allows us to compete in many of the industry’s market segments. However, we feel that the continuing recession maybe causing our customer prospects to delay their purchasing decisions. We also believe that those prospects do not have established medical practices and are finding at more difficult to obtain credit financing. In response to current market conditions, we have been increasing our focus on the core market of dermatologists and plastic surgeons and other established medical offices through marketing efforts and product introductions. We are continuing to implement exciting initiatives that target our pearl and recently released Pearl Fractional products specifically to a core market.

International revenue decreased 5% of the fourth 2008 compared to the fourth quarter 2007, but increased 11% of 2008 compared to 2007. International revenue accounted for 59% of the fourth 2008 revenue and 50% of 2008 total revenue. During the year, we saw strength in many of our overseas markets with particular strength in Australia and Japan. We believe that our established international infrastructure has positioned as well for international growth in 2009 and beyond.

Turning to research and development, we are continuing to develop innovative solutions and expand the clinical understanding and applications of our current products. We believe that strategic ongoing investments in product research and development are critical to our future success. In line with that principle we are continuing to invest in R&D rates in the range of 8% to 10% of revenue. We are committed to introducing new products and applications to the various segments of the aesthetic market and we are looking forward to our planned introduction of a non-invasive body contouring product.

During the past five years we will be conducting research in this area, including research commission with the University of California. We believe we have developed a technology with a unique approach that is tailored specifically for this exciting application. We are expanding our clinical research programs and plan to exhibit our technology next month at the upcoming annual meeting of the American Academy of Dermatology in San Francisco.

We are planning to commence commercial shipments in the second half of the year. This body contouring application is the latest addition to one of the most comprehensive product offerings in our industry. Our portfolio is comprised of a broad range of solutions that offer our customers all the popular aesthetic applications for improving a person’s appearance from removing unwanted hair, to treating vascular lesions and rejuvenating skin. Our products in the latter category include laser and other light based systems for treating dyschromia, texture, and lines. Our popular infrared tightening for wrinkles and most recently our Pearl Fractional YSGG lasers for minimally invasive skin rejuvenation.

We believe that this extensive portfolio and our continuing investments in the R&D will position as well for future growth once the market becomes more stable. Now I would like to turn the call over to Ron to discuss our financials in more details.

Ronald Santilli

Thanks Kevin and thanks to all of you for joining us today on our fourth quarter and full year 2008 conference call.

Fourth quarter 2008 revenue was $17.9 million, a 32% decrease when compared to the fourth quarter of 2007. Net loss for the fourth quarter of 2008 was $235,000 or $0.02 per diluted share. Included in this result is the $1.2 million or $0.09 per diluted share non-cash impairment charge net of tax related to the write down of our investment in auction rate securities. Excluding that impairment charge, and after adjusting for the impact of dilutive options, we achieved the fourth quarter profit of $0.07 per share.

Revenue for 2008 was $83.4 million, an 18% decreased when compared to 2007 revenue. Net loss for 2008 was $2.9 million or 22% per share. Included in this result is a $3.6 million or $0.28 per diluted share non-cash impairment charge net of tax related to the write down of our investment in auction rate securities. Excluding the impairment charge and after adjusting for the impact of dilutive options, we achieved a 2008 profit of $0.05 per diluted share.

Product revenue for the fourth quarter of 2008 decreased 40% when compared to the fourth quarter of 2007. We believe these results were primarily driven by customer prospects deferring their purchase decisions during these uncertain economic times.

Upgrade revenue for the fourth quarter of 2008 decreased 42% when compared to the fourth quarter of 2007. Upgrade sales of our new Pearl Fractional product were lower than expected which we believe is primarily attributable to the global recession. The clinical results of our Pearl Fractional products are continuing to exceed our expectations and we will continue our focus on selling to the core specialties and building relationships with the market segments opinion leaders.

Service revenue for the fourth quarter of 2008 increased 8% to $3 million, compared to the fourth quarter of 2007. Although we are pleased with our fourth quarter growth rate, our sequential service revenue growth rates are declining as a result of fewer customers electing to purchase post-warranty service contracts.

We believe this reduced customer demand for service contract is due to a challenging economic environment and a strong reliability of our products. Customers are apparently more willing to accept the financial risk of paying on time material basis rather than purchase a term service contract.

Titan refill revenue for the fourth quarter of 2008 increased 13% to $1.4 million compared to the fourth quarter of 2007. This growth rate in Titan refills indicates that procedure volume is strong even during this tougher economic condition.

We are continuing to experience growth in our business from existing customers. During the fourth quarter of 2008, 36% of our revenue was derived from sales of service, upgrades, and Titan refill. We are committed to strong customer satisfaction and believe we will continue to realize greater growth in our annuity revenue categories once the economy becomes more stable.

I will now address our operating performance. Our gross margin in the fourth quarter of 2008 was 61%. This rate is lower than a 63% rate in the fourth quarter of 2007 but it is an improvement from a 59% rate in the third quarter of 2008. We are pleased with our sequential growth in gross margin percentage rate which is primarily attributable to increased product reliability and expense management partially offset by pricing compression in the market. The improvements in product reliability have positively impacted all of our products and are a result of continuing efforts on quality and customer care.

Sales and marketing expenses for the fourth quarter of 2008 were $6.6 million or 37% of revenue, compared to $9.4 million or 36% of revenue for the fourth quarter of 2007. The decrease in expenses in the fourth quarter of 2008 in absolute dollars was due primarily to our down sized sales and marketing organizations in North America. In addition our effective commission rates for that quarter was below the rate used for the fourth quarter of 2007 due to lower than expected revenue. This resulted in a significant one time reduction in commission expense in the fourth quarter of 2008.

For modeling purposes, if we are to assume revenue level in the first quarter of 2009 as we had in the fourth quarter of 2998, we estimate sales marketing expenses in the first quarter will be approximately $1 million higher. This increase would be primarily due to the reduced commission expense in the fourth quarter that will not recur in the first quarter and expenses associated with our participation in the upcoming American Academy of Dermatologists’ Annual Meeting.

Research and development expenses increased from $1.7 million in the fourth quarter of 2007 to $1.9 million in the fourth quarter of 2008. We intend to increase our dollar investment in this area in line with our continuing commitment to develop and commercialize innovated products and application. We expect to spend in the range of 8% to 10% of revenue on R&D in the near future. General administrative expenses were $2.7 million in each of the fourth quarters of 2007 and 2008. Although total spending was flat as a percentage of revenue, it increased from 10% to 15% due to lower levels of revenue in the fourth quarter of 2008.

Interest and other income net was $ 555,000 in the fourth quarter of 2008. Included in this number was $686,000 of interest income reduced by a $153,000 in foreign exchange losses. The foreign exchange losses resulted primarily from translation losses due to the strengthening U.S. dollar and its impact on revaluing our international assets. Our effective income tax rate for 2008 was only 22%, well below of previous expectations due primarily to lower than anticipated profits. For the fourth quarter of 2008 our effective tax rate was 76% of free tax loss.

The fourth quarter tax rate and benefit are unusually high due to the following: One, the benefit recorded to the fourth quarter of 2008 resulting from actual pre-tax loss in contrast to the previously expected profit level. Two, tax exempt interest income becoming a larger percentage of the pre-tax loss and three, the benefit associated with the extension of the R&D tax credit that was approved by Congress in October of 2008 and was recorded in our fourth quarter of 2008.

For 2009 modeling purposes we suggest using an effective income tax rate of approximately 30%. Turning to the balance sheet our financial position remained strong. As of December 31st 2008 we had $106.8 million in cash, marketable securities and long-term investment with no debt. This represents approximately $8.34 per outstanding share. We consumed $1.9 million of cash during the fourth quarter of 2008 but are pleased with having generated $4 million during 2008. For 2008 we recorded non-cash impairment charges of $3.6 million net of tax or $0.28 per diluted share associated with our investment in auction rate securities.

The $2.4 million of that amount was recorded in the third quarter of 2008. The remaining $1.2 million charge was taken in the fourth quarter of 2008. These non-cash unrealized losses have no tax consequences on our income statement. As a reminder as of December 31, 2008 we had $13.4 million par value invested in various auction rate securities, investing primarily in student loans that were valued at $9.8 million as of December 31, 2008.

The majority of these securities are guaranteed at maturity by the Federal Government. The securities are scheduled to mature 20 to 35 years from now. Liquidity for these securities was previously provided by an auction process which typically occurred every 30 days. However, due to the U.S. financial crisis these auctions have been failing since February of 2008 thus temporarily eliminating the short term opportunity for liquidity.

Though we took this non-cash impairment charges in the third and fourth quarters of 2008 we have not felt any of these impaired securities. Subsequent to December 31, 2008 we were able to liquidate $250,000 of our auction rate security investment at par value. If this market re-establishes itself we will be able to recover some or all of the charge, however, as devaluation of these securities further deteriorates we may record additional impairment charges in future quarters.

Net account receivable at the end of the fourth quarter of 2008 was $5.8 million and the DSO was 30 days. Our DSOs continue to remain strong and were better than our targeted 35 to 45 day due to a thorough credit approval process and strong collection effort. We have not changed our credit standards during these tougher economic times and are pleased with our results. Inventories increased slightly from $8.8 milliom at September 30 of 2008 to $9.9 million at December 31, 2008. These increases are primarily due to a higher level of finished goods resulting from lower than expected revenue in the fourth quarter of 2008. We expect our inventory level to decrease in 2009.Now that I have concluded my overview of Cutera’s financial performance; I will turn the call back to Kevin.

Kevin Connors

Thanks Ron. At 2009 we will be focusing our efforts on – one, continuing our marketing work on our Pearl and Pearl Fractional products with a heightened focus on dermatology and plastic surgeon offices. Our clinical results for these products are continuing to exceed our expectations and we remain excited about the opportunities and applications present to practitioners and their patients.

Two, we will be focusing in 2009 to timely and efficiently launch of our planned non-invasive body contouring product. Three, we are focused on increasing sales productivity through such measures as increased record selling and targeted marketing initiatives to core positions and established medical offices.

Four, we will also be continuing our efforts in 2009 to managing expenses in line with our revenue levels, maintaining profitability and improved cash generation. While the near term prospects for our industry are difficult to predict due to the economic uncertainty, we believe that our world wide distribution network, solid cash position, significant customer base, diverse portfolio products and various research and development projects under way will offer continuing long-term growth opportunities for our Company.

Now, I would like to open the call for your questions. Operator?

Question-and Answer Session

Operator

(Operator instruction)

Your first question comes from the line of Thomas Gunderson - Piper Jaffray

Thomas Gunderson - Piper Jaffray

I guess I would like start with the headcount reduction that you did in January, the last 10K you had 273 people and that was roughly half in sales and marketing and half in everything else. Was there a proportional cut across the board?

Ronald Santilli

When you compare to the 10K you mean for the period ended 12/31/2007, correct?

Thomas Gunderson - Piper Jaffray

Correct.

Ronald Santilli

So there were quite a few changes throughout the year. Our headcount in early January, after we have this cut was down to around 220. A lot of this in sales and marketing but it did go into other functions within our Company as well.

Thomas Gunderson - Piper Jaffray

And you will be taking a charge then in Q1 for that round?

Ronald Santilli

There will be some charge, yes, that is correct for the some of the actions that we are taken in January but some of those were also taken throughout 2008.

Thomas Gunderson - Piper Jaffray

Okay and then along those same line, the lower headcount presumably more productivity watching your expenses on any of the lines, are you prepared to say that your goal is to be cash positive in 2009 or that you will be cash positive in 2009, how we should look at them?

Ronald Santilli

Our goal is to be cash positive in 2009. Yes.

Thomas Gunderson - Piper Jaffray

Okay and then Kevin, do you have any sense that you can give us on the international side of things. It did well relatively less poorly in Q4 but starting to maybe catch up with the U.S, is the international market so under penetrated that we are not going to see the impact of the economic downturn or is the rest of the world catching up to the dismal U.S.?

Kevin Connors

Well, we are keeping our ear close to the ground Tom. We are seeing pockets of actually pretty good performance abroad. Our business in Japan and Australia, some of our distributors have really done pretty well so we cannot predict what the future looks like in international business but we are being opportunistic where we see pockets of strong performance.

Thomas Gunderson - Piper Jaffray

Okay and the last question and I will get back in queue is, you mentioned some pricing pressure in your prepared remarks, is that across the U.S. or is it pockets or various territories or regions?

Kevin Connors

It is not a drastic shift we are seeing here, Tom but as we mentioned that we see some signs of compression in pricing and it tends to be in pockets.

Operator

Your next question comes from the line of Dalton Chandler - Needham & Company. Go ahead please.

Dalton Chandler - Needham & Company

I wonder if you could share any additional details about the body shaping product with us. You mentioned that it is a unique technology, maybe you can describe that and also if there is a disposable associated with that?

Kevin Connors

As we mentioned earlier we have been working on it for quite a long time and what we like about it is that we do not have to break the skin. So it is a non-invasive solution and we are able to rely on the unique properties of fat and dermal tissue that allow us to use an electrical energy source that selectively targets the fat cells. So it is a thermal approach but we are able to successfully cool the tissue that we do not want to target and heat the fat cells.

Dalton Chandler - Needham & Company

Okay. Is there a disposable associated with it?

Kevin Connors

Yes.

Dalton Chandler - Needham & Company

Okay and do you have approval for the product yet?

Kevin Connors

We have FDA approval for our product and we will look to provide broader indications for use local. We will continue to work with the FDA to extend our indications for use.

Dalton Chandler - Needham & Company

Okay. What is the label that you have right now? Is it cellulite or is it actual…?

Kevin Connors

It is a cellulite indication.

Dalton Chandler - Needham & Company

Okay. Do you think it would be able to get an indication for certain reduction at some point?

Kevin Connors

We are looking at that.

Operator

Your next question comes from the line of Chris Sassouni - Eagle Asset Management. Go ahead please.

Chris Sassouni - Eagle Asset Management

I was wondering…, you guys did a great job of controlling your expenses given the reduction and revenues. What I cannot figure out is why the cash flow from operation was negative given that you are adding back all the non-cash charges and it looks to me it is like either because of the build in inventories or one of the other working capital accounts and perhaps also this change in income tax asset liability. You just talked us through because the presumption is that on a normalized basis as we go forward year you are going to be, theoretically, will be producing cash I mean there should have been something so different about this quarter that as we march through first, second, third, and fourth quarter rather than some launch expenses and or conference expenses that we should not have positive cash flow from operations?

Kevin Connors

Certainly it is our goal to be cash positive from operations and in this last particular quarter we did have our eyes in inventories. So that worked against us and we also had a tax payment that we needed to make. Those two things was a majority piece of the $1.9 million that absorbed cash during the quarter.

Chris Sassouni - Eagle Asset Management

Okay. Alright and then just back to the body contouring, I take it that the FDA is okay with something like cellulite because the amount of fat license or lipo-license that you will be doing would not be in such a volume that they would be concerned about the things that they are concerned about with something like Liposonic or [ultra machine].

Kevin Connors

Yes Chris. We are not looking to provide a solution for significant volumetric change in the fat content. So, it is a sculpting application. So, it is a noninvasive liposuction procedure that can remove liters of fat. We are looking at more confined regions that we are looking to target with a noninvasive solution.

Chris Sassouni - Eagle Asset Management

Okay. And then if you just compare this to some of the other Bello shape or some of the other technologies that are out there, what do you like about this particular technology versus the others that have been currently indicated for cellulite?

Kevin Connors

I think some of those noninvasive solutions on the market have not been able to deliver the kinds of clinical outcomes that we are looking to achieve with our technology. So, again, we are relying on the formal properties of fat and how it is different than the dermis and underlying muscle as well as the electrical properties that allow us to have a truly selective application.

Chris Sassouni - Eagle Asset Management

Okay. But in the limited clinical that you operated on from everything that you can tell both in your pre-clinical work and your clinical work it lies not just in heating fat away, perhaps some other technologies where there is some evidence of lipolysis?

Kevin Connors

Yes. We have been able to observe a form of necrosis in the fat region.

Chris Sassouni - Eagle Asset Management

Okay. And it is pretty selective specifically for fat?

Kevin Connors

That is correct.

Operator

Your next question comes from the line of Mike Neary - Neary Asset Management.

Mike Neary - Neary Asset Management

Do you believe your business has a positive value? I mean the market value of your Company right now is $77 million. You have $107 million in cash so the market thinks your business is worth negative 30 million and you and the board, you know the business better than anybody, are not buying back stock at these prices. Can you just talk about that a little bit?

Kevin Connors

We are actively having those discussions with the board, so we have historically purchased shares. I think we bought shares about a year and a half ago. So, it is an active discussion with the board. The entire sector has been battered in terms of valuation of the space. We generated cash from operations during the year and our commitment is to continue to focus on managing the business such as we are generating cash. We are disappointed with the value that the stock is, but we think we need to focus on the fundamentals and ultimately that will work its way through.

Mike Neary - Neary Asset Management

I agree. It seems you cannot control what the stock price does but I mean you could still have a very strong balance sheet, even if you bought back 20% or 30% of your shares and you dramatically increase the long term value of the business per share if your business has a long term value.

Kevin Connors

That is right. As I mentioned, we are having these discussions with the board and the board has shown a willingness to support purchasing stock in the past and I think this will be something that we will continue to discuss.

Operator

Your last question comes from the line of Hesham Shaaban - Maxim Group.

Hesham Shaabam - Maxim Group

I just have one quick question. Do you have the breakout for stock based comp by line item?

Ronald Santilli

I do approximately. For the quarter stock based compensation expense was approximately $1.2 million. Are you looking for more details than that?

Hesham Shaabam - Maxim Group

Yes. I am looking by expense line, like how much was attributed to sales and marketing, research and development and such.

Kevin Connors

I think in the cost of sales component was approximately $199,000. Sales and marketing was about $365,000. R&D was about $185,000 and G&A was about $487,000.

Operator

Thank you. Ladies and gentlemen that does conclude our question-and-answer session for this conference. I would now like to turn the conference back over to Kevin Connors for any closing statements.

Kevin Connors

Thank you for participating on our call today. We look forward to seeing you at various investor events during the quarter, and updating our first quarter conference call on May. Good afternoon and thanks for your continuing interest in Cutera.

Operator

Ladies and gentlemen this concludes the Cutera Incorporated fourth quarter 2008 earnings conference call. You may access the replay system for this conference by dialing 800-406-7325 or 303-590-3030, entering the access code of 3966078. Thank you for you participation and you may now disconnect.

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