Ladies and gentlemen, thanks for standing by. Welcome to the Cutera Incorporated Second Quarter 2009 Earnings Conference Call. (Operator Instructions).
I would now like to turn the conference over to John Mills. Please go ahead, sir.
Thank you. By now everyone should have access to the second quarter of 2009 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 www.cutera.com and with its Form 8-K filed today with the SEC and available on its website at www.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 regaining profitability, the development and commercialization of existing and planned products, and also management may make additional forward-looking statements in response to your questions.
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.
For our complete list of risk factors that could cause Cutera’s actual results to differ materially from the forward-looking statements please refer to the section entitled Risk Factors in our most recently filed 10-Q, August 3rd, 2009, with the Securities and Exchange Commission.
With that, I'll turn the call over to the company’s President and Chief Executive Officer Mr. Kevin Connors. Go ahead Kevin.
Thank you, John. Good afternoon everyone and thanks for joining us today to discuss Cutera’s results for the second quarter ended June 30, 2009. On today’s call I'll provide an overview of results and then Ron 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 second quarter 2009 was $11.7 million or 53% lower than the $24.8 million reported in the second quarter of 2008. Even though revenue declined, our cash flow from operations was break-even in the second quarter as our net loss was offset primarily by reductions in accounts receivable and inventory balances.
In addition, we ended the quarter with almost $105 million in cash and investments with no debt. We believe our customers continue to experience demand for our products, however, many of our current and prospective customers are reluctant to spend significant amount of money on capital equipment during these unstable economic times.
As we recently announced we are pleased that Chris West will be leading our North American sales organization, in addition to this leadership change, we plan on implementing the following key initiatives, enhance preliminary development and improve our clinical selling efforts.
We focused the messaging of our product offerings and penetrated the core position market, greater emphasis on sales training, which we believe is of particular important now that we are targeting dermatologists and plastic surgery physicians. With these important changes and initiatives, we expect to capture a larger portion of laser and light based aesthetic market, also strategically position us to return to increased growth rates after the market recovers from this economic slump.
We are experiencing some signs of softness in our international business, which are reflected in our recent quarter’s revenue performance. Although the overall international revenue was less than we had expected, we are pleased with the revenue contribution from Australia and from the countries where we are represented by distributors.
During the second quarter of 2009, we had expenses associated with restructuring charges, bad debt expense and higher than normal non-cash based, stock based compensation charges that we do not expect to recur in the second half of 2009.
Ron will explain these in more detail later. Due to our restructuring efforts during the past six months beginning with the third quarter, we expect profitability be achieved in the $15 million per quarter revenue range. We are continuing to evaluate our spending decisions in light of the current environment, but are committed to retaining strong talent to be prepared to take advantage of growth opportunities when the market conditions improve.
I would like to point out that we have not reduced any sales territories since the beginning of the year and not materially changed R&D head count. We will continue to manage our expenses carefully during these uncertain times and make appropriate decisions in an effort to better align our expenses with the current revenue.
The current market environment we believe with the core market of dermatologists, plastic surgeons and other established medical officers provides us with the best opportunities in the industry. Therefore we are actively focusing our sales marketing and new product efforts on this segment of our market. During the second quarter of 2009, almost 50% of our US orders were sourced from these core positions.
Returning 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 of product research and development are critical to our future success. In line with that principle we are continuing to invest in R&D.
We are pleased with the commercialization of our adjustable debt selectivity or ADS technology that was previewed at the American Academy of Dermatology meeting at San Francisco. This latest innovation is a combination of five years of clinical research and collaboration for non-evasive body contouring.
Two key features of this technology, are the ability to selectively target and heat fat cells and to treatment depth within the fat. These combined effects are expected to result in non-evasive body contouring for a wide range of patients. During the second quarter, we expanded our clinical investigation and are continuing to follow the progress of these subjects.
We believe that our extensive portfolio of existing products and continuing investments in R&D will position us well to take advantage of growth opportunities once the market come more stable.
Now, I would like to turn the call over to Ron to discuss our financials in more detail.
Thanks Kevin, and thanks to all of you for joining us today on our second quarter 2009 conference call. Second quarter 2009 revenue was $11.7 million, a 53% decrease when compared to the second quarter of 2008. Net loss for the second quarter of 2009 was $2.4 million or $0.18 per diluted share.
Included in this net loss is approximately $1.5 million or $0.07 per share net of tax relating to unusual operating expenses that are expected to recur in the second half of 2009. The breakdown of those expenses was as follows.
Approximately $650,000 for restructuring charges associated with our April headcount reduction, approximately $500,000 for bad debt expense primarily related to a leasing source that has significant financial problems and is unable to pay us, and approximately $300,000 of stock based compensation associated with fully vested shares recently granted to our outside Board of Directors.
Product revenue in the second quarter of 2009 decreased 69% when compared to product revenue in the second quarter of 2008. We believe the global recession continues to affect our industry and customer purchasing decisions thereby having a adverse effect on sales of new system.
Upgrade revenue for the second quarter 2009 decreased 44% when compared to upgrade revenue in the second quarter of 2008 due to the global recession. However, our customers continue to express interest in our Pearl, and Pearl Fractional products, and as such they represent an increasing percentage of our upgrade revenue.
The clinical results of our Pearl Fractional products are exceeding our expectations, and we will continue our focus on selling to the core specialties and building relationships with that market’s segments opinion leaders.
Service revenue for the second quarter of 2009 increased by 26% to $3.4 million compared to the second quarter of 2008. Our second quarter 2009 service revenue growth was attributable to increased service contract amortization resulting from an increased install based of customers. Although our service revenue growth varies from quarter to quarter, over the long term, this revenue category has shown consistent growth.
Titan refill revenue for the second quarter of 2009 decreased 10% to $1.4 million compared to the second quarter of 2008. Revenue generated from Titan refills have remained fairly flat during the past six quarters. We believe this represent solid patient demand.
A significant percentage of our revenue is sourced from existing customers. During the second quarter of 2009, over 50% of our revenue was derived from sales of service, upgrades and Titan refill. We remain committed to strong customer satisfaction and believe we will continue to realize revenue growth from our annuity revenue categories once the economy becomes more stable.
I will now address our operating performance. Our gross margin in the second quarter of 2009 was 56%. This rate is lower than the 59% rate in the first quarter of 2009 due primarily to lower revenue which results in a reduced leverage of our fixed manufacturing and service expenses, higher service and Titan refill revenue as a percentage of total revenue which has a lower gross margin, and higher international distributor revenue which has lower gross margins.
To help you with modeling of our current business, we expect gross margins to be in the 60% range when quarterly revenue is approximately $15 million due to the leverage in our business model. Sales and marketing expenses decreased by $4.3 million or 41% from $10.4 million in the second quarter of 2008 to $6.1 million in the second quarter of 2009.
As a percentage of revenue, the expenses were 52% in the second quarter of 2009 and 42% in the second quarter of 2008. The decrease in expenses in the second quarter of 2009 in absolute dollars was due primarily to our downsized sales and marketing organizations in North America, and reduced commission expense. As we increase our revenue, we expect our sales and marketing expenses as a percentage of revenue to decline in the second half of 2009.
Research and development expenses declined $0.5 million or 25% from $2 million in the second quarter of 2008 to $1.5 million in the second quarter of 2009. This expense reduction was primarily due to reduced material spending resulting from our current project timing whereby our current efforts are mostly labor rather than material expense intensive. We expect to increase our spending in the future keeping with our continuing commitment to develop and commercialize innovative products and applications.
General, administrative expenses increased by over $600,000 from $3 million in the second quarter of 2008 to $3.6 million in the second quarter of 2009. The increase in this spending is primarily attributable to approximately $500,000 of bad debt reserve mostly related to leasing source that have significant financial problems and is unable to pay us.
Approximately $300,000 of higher non-cash stock based compensation expenses for fully vested shares granted to our outside Board of Directors, and approximately $135,000 of general administrative restructuring charges were attributable to our April head count reduction.
As a reminder, for the total company, our restructuring charges were approximately $650,000. Offsetting these increases were primarily lower legal, audit, and tax consulting fees. Interest and other income net was $511,000 in the second quarter of 2009 compared to $857,000 in the second quarter of 2008. The lower income is due primarily to lower interest yields on our cash and marketable investments.
Also, in the second quarter of 2009, we recorded net foreign exchange gain of approximately $130,000, which primarily resulted from a devalued US dollar relative to our foreign subsidiary assets. Our effective income tax rate for the second quarter of 2009 was 43%. For modeling purposes, we suggest using an effective income tax rate of approximately 43% for the remainder of the quarters in 2009.
Turning to the balance sheet, our financial position remains strong. As of June 30, 2009, we had $104.9 million in cash, marketable securities, and long-term investments with no debt. This represents almost $8 per outstanding share.
In the second quarter, our cash and investments balance increased by $1.9 million due to the redemption of $3.9 million of our higher risk auction rate securities, which were deemed at their par value of $3.9 million. As of June 30, 2009, we had $7.6 million of auction rate securities per quarter on our balance sheet had a par value of $9.3 million.
We are pleased that our cash flow from operation was break-even in the second quarter, as our net loss was offset primarily by reductions in our accounts receivable and inventory balances.
Net accounts receivable at the end of the first quarter of 2009 were $2.8 million and the DSOs were 22 days. Our DSOs continue to remain strong and we are better than our targeted 35 to 45 days due to a thorough credit approval process and strong collection efforts. Inventories decreased $1.1 million from March 31, 2009, to June 30, 2009. We are comfortable with this quarterly inventory position and remain diligent in our efforts to continue further reductions during the second half of 2009.
Now that I’ve concluded my overview of Cutera’s financial performance, I’ll turn the call back to Kevin.
Thanks Ron. Our focus during the next few quarter will include, one, the continuation of our marketing and clinical work on our Pearl and Pearl Fractional products with a hightened 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 these applications presents to practitioners and their patients.
Two, efficient launch of our planned body contouring product, three, increased emphasis on our North American luminary development, clinical selling and fields training. Near term prospects for our industry are difficult predict due to economic uncertainty, we believe that our worldwide distributor network, strong balance sheet, with almost a $105 million in cash and investments with no debt, a broad portfolio products and various research and development projects under way, offer continuing long term growth opportunities for our company.
Now, I would like to open the call for your questions. Operator?
(Operator Information) Your first question comes from Tom Gunderson - Piper Jaffray.
Tom Gunderson - Piper Jaffray
The economy is obviously not in our control and has been the major cloud here. Have you seen, Kevin, any correlation with sales in particularly hard to hit parts of the country?
Hard to read TV set accurately, Tom, typically it tends to track our sales reps and the length of time that they have been in their territory and the strengths of their personal skills. But, I can’t say that we could see anything in terms of one part looking worse than the next.
Tom Gunderson - Piper Jaffray
International was a little lower than I had expected, and I’m wondering was there any, you mentioned Australia and other distributor countries been being strong are there any areas that we are surprisingly weak?
Well, we had a international review meeting early in July, and from that I think, there is a sentence that some there is a timing issue, so I’m not sure we are ready to declare that our international business is on a negative trajectory here. But clearly we are looking for higher production out of our direct operations and we have been fortunate to have pretty strong distributor business in the past and we think that will come back.
Tom Gunderson - Piper Jaffray
Last question, I’ll get back in queue. But the tone and maybe I was hearing too much between the lines. But the tone was that second half will be better than Q2 is showing and the restructuring and maybe we have gotten a bottoming here, correct me if I am getting the tone wrong but if I am getting it right, what gives you, Kevin, confidence that there is light at the end of the tunnel here and in 2009?
Tom, I think we are focused on the overall market opportunity and certainly the aesthetic market has contracted pretty significantly but we still see somewhere around a $700 million global opportunity and for us to achieve, say 10% share of that is something that we think is reasonable, and therefore able to execute a crisp plan with the right people in place I think we can achieve that.
From the expense side, we have set the threshold down to $15 million a quarter to break-even, and, so we are looking to put together the right plan to go after that $700 million opportunity, and hopefully in the future that $700 million opportunity gets to be a bigger opportunity but we think we should be able to achieve that.
Your next question comes from Anthony Vendetti - Maxim Group.
Anthony Vendetti - Maxim Group
I just wanted to follow-up first on that plus Kevin on the market share and so forth. You are targeting $15 million to break-even, is it safe to say that that is the revenue target for the third and fourth quarter.
Anthony, we are not giving any guidance about that. There have been a lot of moving parts in our market and the contraction rate has moved around quite a bit from quarter-to-quarter, quarter so, we are not providing any guidance moving forward, but as of the roll out that we did when the Q1 results came and from the public companies, we could build up about a $700,000 million market as of that time. So, no, please don’t read to be a revenue guidance estimate on our behalf.
Anthony Vendetti - Maxim Group
Okay, and on the body-contouring product, you’ve been mentioning, and a lot of R&D efforts going into it. Can you get a little more specific regarding potential launch date and specifically, what the product will encompass in terms of the applications.
Well, as we said in the script, we vastly expanded our clinical research and development efforts during the quarter, we are pleased with that. We have treated a number of patients and we are following them to measure their progress. We have an FDA clearance for the product for the treatment of cellulite, and we are looking at continuing to expand our clinical understanding of the technology and we’ll have more report after the end of third quarter.
Anthony Vendetti - Maxim Group
Okay, and then Ron, couple of questions on the financial side. International revenues, can you just give me what it was for the quarter and the year-over-year change and then the FX gains, what did that contribute to the floor in terms of dollars and EPS?
Sure, I think international was $7.1 million of revenue this quarter compared to a year ago in the same quarter was $12.4 million or down 42%. Also 7.1 million over the $11.7 million revenue number for the quarter represent 61% of our total revenue for the quarter.
With regard to foreign exchange, we had about a $130,000 of foreign exchange, translational foreign exchange income in our income statement primarily related to the devaluation of the U.S. dollar against Euro and the Japanese yen.
Anthony Vendetti - Maxim Group
Okay and lastly, on the long-term investments, you obviously have a very large cash on the balance sheet, cash and investments, how much of that of the $105 million or $104.9 million is long-term investments?
The $7.6 million is long-term investments and that’s all auction rate security.
Anthony Vendetti - Maxim Group
Okay, and you have taken a ride-off for that. So the $7.6 million that’s left in auction rate securities, do you feel this is an amount that you are comfortable with or an amount that won’t require a future write-off?
Yes, that amount at par is worth $9.3 million, so it’s about a $1.7 million write down thus far. As you have seen over time, actually we have been able to redeem some of our auction rate securities including the higher risk ones at par. So, we are very comfortable with that valuation and hope at some point to actually receive even a higher value than what’s on the balance at this point.
(Operator Instructions) Your next question comes from Dalton Chandler - Needham & Co.
Dalton Chandler - Needham & Co.
Let me try to ask this question a little different way. Historically, the third quarter has been the seasonally weakest, and it is usually down sequentially from the second quarter, is there a reason you see that maybe that wouldn’t happen this year?
Well, I think the trends have been aberrant for the last three quarters. So it’s hard to predict what the industry trends will look like, but you are correct that historically when the market is cooperating the summer quarter tends to be a light one.
We have basically looked at the business in that target that we discussed earlier, $15 million, we think that on a normalized basis that’s probably a good level for us to set our expense levels, while we have continued to monitor our expenses we did not initiate any material changes in head count after the second quarter.
Dalton Chandler - Needham & Co.
Okay, and you talked about interest in your products, but reluctance to purchase, but I know financing has also been an issue, so can you talk about what’s in the pipeline for new business that actually would like to purchase but just can’t get financed.
Yes, so there is finance issue, there is the appetite for making the major capital equipment purchase, and in the case of our business for many years we are extremely successful and targeting the non-core physician segment of market, and in our case that accounted for about 80% of our business and that’s our belief that the non-core physicians don’t have the appetite for making a major purchase like this, more so that what we are experiencing with the derms and plastic.
So, in our calls we talk about the importance of aligning with the healthier segment of the business. So, that’s where our exposure was. The leasing side, it is tougher, but we still find that people that have decent credit scores were able to get financing but the threshold certainly have gone in the wrong direction.
It’s just taking a lot longer to get financed than it did in the past, so that’s causing customers to have more time to think during that purchasing process.
Dalton Chandler - Needham & Co.
Okay, I know you don’t like to I guess preview new products, but could you talk about at least the quantity of new products that might in the pipeline in over six months or so, away from AAD at this point.
Kevin P. Connors
Well, we have multiple major endeavors under way, Dalton, and we do for competitive purposes referring from discussing those sales organization isn’t even informed of those things, so obviously we want to keep silent to investors as well.
Dalton Chandler - Needham & Company
Okay, the last question. Can you just remind us how many sales territories do you have in North America right now?
Kevin P. Connors
At the end of June, we still had the 34 territories but with the few openings at that time.
Thank you. At this time I’m not showing any further questions. I would now like to turn the call back over to Kevin Connors. Please go ahead.
Thank you for participating on our call today. We look forward to seeing you at various investor events during the quarter, and updating on our third quarter conference call in November. Good afternoon, and thanks for your continuing interest in Cutera.
Thank you. Ladies and gentlemen that does conclude our conference for today. If you would like to listen to a replay of today’s conference call please dial 303-590-3030 or 1800-406-7325 using the access code 4110289.
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