Cynosure's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Oct.29.13 | About: Cynosure, Inc. (CYNO)

Cynosure, Inc. (NASDAQ:CYNO)

Q3 2013 Earnings Conference Call

October 29, 2013 09:00 AM ET

Executives

Scott Solomon - IR

Michael Davin - Chairman and CEO

Tim Baker - EVP, COO and CFO

Analysts

Matthew Dodds - Citigroup

Richard Newitter - Leerink Swann

Anthony Vendetti - Maxim Group

Jim Sidoti - Sidoti & Company

Operator

Good day and welcome to Cynosure’s Third Quarter 2013 Conference Call. Today’s call is being recorded. There will be an opportunity for questions at the end of the call.

At this time I would like to turn the call over to Mr. Scott Solomon, Vice President for Sharon Merrill Associates. Please go ahead, sir.

Scott Solomon

Thank you, Kevin, and good morning, everyone. Thank you for joining us today. With me on this morning’s call are Michael Davin, Cynosure’s Chairman, CEO and President; and Tim Baker, Executive Vice President, Chief Operating Officer and Chief Financial Officer.

Before we begin, please note that various remarks management makes on this conference call about future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including those discussed in Cynosure’s filings with the Securities and Exchange Commission.

In addition, any forward-looking statements represent the company’s views as of today, October 29, 2013. These statements should not be relied upon as representing the company’s views as of any subsequent date. While Cynosure may elect to update forward-looking statements at some point in the future, the company specifically disclaims any obligation to do so.

To supplement its consolidated financial statements presented in accordance with GAAP, Cynosure uses non-GAAP gross profit, non-GAAP income from operations, non-GAAP net income and non-GAAP diluted earnings per share. These metrics are non-GAAP financial measures which the company believes help investors gain a meaningful understanding of Cynosure’s results exclusive of acquisition related expenses and also to help investors who wish to make comparisons between Cynosure and other companies on both the GAAP and a non-GAAP basis.

The presentation of this financial information is not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with GAAP. For more information on these non-GAAP financial measures, please see the discussion on reconciliation table included in this morning’s earnings release. The table has more details of the GAAP financial measures that are most directly comparable to the non-GAAP financial measures and the related reconciliations between these financial measures.

With that, I’ll turn the call over to Michael Davin.

Michael Davin

Thank you, Scott. Good morning and thank you for joining us in today’s call. I am pleased to report on the significant progress we’ve made in integrating the Palomar Medical Technologies since acquiring the business on June 24th. As you may recall step one was integrated to North American sales teams which we accomplished within a few weeks after the transaction close. We exited the third quarter with a combined field salesforce of 72 reps and managers in North America. And we expect to be north of 80 by year-end.

Outside the North America, we also have streamlined our international direct salesforces consolidating the offices in Europe and the Asia Pacific region. Worldwide headcount was approximately 600 at the end of the third quarter down approximately 8% from the end of the second quarter.

We made good progress in the third quarter and integrating a number of key areas in the organization including research and development, engineering, marketing, compliance, quality assurance, clinical, field and depot service, finance and legal.

The integration of our IT systems is well underway. You may remember that on our July earnings call I discussed our plan to extend our existing lease here in Westfort, add square footage and put Palomar’s former corporate headquarters in nearby Burlington up for sale.

We continue to make good progress on that initiative. We are amending our lease in Westfort and expect to complete the sale of the Palomar building in the fourth quarter, which will further strengthen our balance sheet.

Now let me turn to our third quarter operating results. Total revenues were up 64% for the quarter to $60.7 million, primarily reflecting the addition of Palomar, to put the topline in it contacts total laser revenue for the third quarter was $50.1 million, 14% higher than the combination of Cynosure’s and Palomar’s laser revenue in the third quarter of 2012.

Our focus for the first quarter as combined company was to ensure that our integrated sales team was trained and focused on maintaining broad revenue contribution across all product lines. To this end we were very successful, as the sales team’s rapidly adopted a new technology and products and grew revenues across all product lines. And therefore we will not be breaking out the revenue by company.

In terms of product mix revenues were distributed across multiple aesthetic applications, with particular demands in areas such as skin resurfacing, wrinkle reduction, tattoo removal, body contouring, hair removal, and benign pigmented lesions.

PicoSure, our new flagship product for the removal of tattoos and benign pigmented lesions, continues to be enthusiastically received by physicians and consumers for the North America and Europe. Given its extremely short pulse duration, the primary technical challenge in developing a commercialized and effective Pico second laser is maintaining optical stability.

I'm delighted to say that the feedback we've received from the customers on the stability of PicoSure and the clinical setting has been excellent as has a response from doctors and consumers about the efficacy of the product.

This month we launched Focus, our new disposable lens array technology from PicoSure. Focus is a high density disposable lens array that redistributes laser energy in a combination of high and low level treatment sounds, stimulating collagen production and remodeling throughout the treatment area. The Focus technology has benefits not only for pigment related indications, but also new potential indications for which we are pursuing regulatory clearances.

We are accurately pursuing additional PicoSure indications in areas such as acne scaring, skin rejuvenation and skin toning as well as continuing to work towards additional international registrations. To that end, we recently received approval from Health Canada to market and sell PicoSure.

Now let me update you on a few other products related items. On our Q2 call, we discussed reliability issues affecting a large dip delivery system Palomar Vectus laser hair removal system. We recently introduced a second generation tip as improved reliability. We are actively shipping the product and have cleared all customer back orders.

This month we launched a new single use sterile disposable fiber for use with our Smartlipo Triplex, Precision TX and Cellulase systems. Our goal is to exceed our customer’s requirements for quality, functionality and patient safety injunction with current regulatory policies. We expect the new packaging will reduce sterilization cost and reduce procedure preparation time and have a positive impact on our disposable revenue stream.

In the R&D area, we're currently working on the development of new flagship products energy delivery systems and technology enhancements scheduled for release through 2015. Ours is a capital intensive business in which returns are driven by focused investments and product innovation and selective acquisitions that go depth and breadth in the product portfolio. We believe we have been executing on these strategies very well.

We also announced this morning that our Board of Directors has authorized to repurchase of up to $25 million of the company’s common stock, at current levels we believe the company stock is attractively valued. This action reflects our ongoing commitment to improving investment value of our stock while at the same time growing our business. Repurchase program will be funded using the company’s working capital.

In closing let me reiterate that we are extremely pleased with the progress of the Palomar integration and our first quarter as a combined company. We expect to complete the integration of the remainder of the organization by the end of this year. The acquisition remains on track to achieve $8 million to $10 million in cost synergies and to be accretive in 2014.

Now let me turn the call over to Tim for his financial review.

Tim Baker

Thanks Mike. Good morning everyone. As we go through the numbers please keep in mind that results for the third quarter of 2013 fully incorporate the Palomar acquisition which closed on June 24. Our results for the comparable period of 2012, unless otherwise noted for Cynosure on a standalone basis.

As Mike mentioned, total revenues for the third quarter of 2013 were $60.7 million, an increase of 64% from $37.1 million in the same period a year ago. Laser product revenue was up 62% to $50.1 million, which represented 83% of revenue in the 2013 period compared with $31 million or 84% of revenue in the third quarter of 2012.

Looking at revenues in more detail and on a combined basis as if we own Palomar in Q3 of 2012, total laser revenue was up 14% year-over-year in the third quarter. By region, North American laser revenue totaled $27 million or 54% of laser revenue in the third quarter of this year, which would have represented a year-over-year increase of 16% had we own the Palomar business in Q3 of 2012. International laser revenue was $23.1 million or 46% of laser revenue in Q3 of this year, up 12% over last year on a combined basis.

Service and parts revenue was $9.4 million was even with last year, while royalty revenue declined 38% to $1.2 million principally because we no longer have to pay royalties to Palomar on the hair removal patents as a result of the acquisition. We continue to see strong average selling prices in the quarter, while the lending environment for aesthetic capital equipment remained favorable.

Third quarter 2013 adjusted net income which exclude $8 million in cost associated with the acquisition was $5.3 million or $0.23 per diluted share using the effective tax rate of 28%. On a GAAP basis including acquisition-related cost and net loss for the third quarter was $1.3 million or $0.06 per share compared with net income of $3.4 million or $0.25 per diluted share for the same period one year earlier. Please see this morning’s news release for a reconciliation of third quarter 2013 non-GAAP results to the most directly comparable GAAP results.

Gross margin on an adjusted basis which excludes non-cash charges related to purchase accounting effect of the Palomar acquisition was 57.7% compared with 58.2% for the same period of 2012. Gross margin on a GAAP basis for the quarter is 56.2% which is 620 basis points higher than we had anticipated on our July earnings call. We continue to expect to return to our GAAP historical gross margin rate of approximately 58% in Q4.

On an adjusted basis excluding the acquisition-related cost to the Palomar acquisition, total operating expenses for the third quarter of 2013 were $28.5 million or 47% of revenues. On a GAAP basis including acquisition-related cost, total operating expenses for the third quarter were $35.6 million or 59% of revenue compared with $18.2 million or 49% of revenues for the third quarter of 2012.

The dollar increase in operating expenses exclusive of acquisition cost is primarily due to the integration of the Palomar organization. Adjusted operating expenses of $28.5 million as a percentage of revenues of the combined organization for the third quarter of 2013, decreased 230 basis points as we begin to generate operating leverage.

Looking at expenses in more detail on an adjusted basis, selling and marketing expenses increased by approximately $5.7 million in third quarter to $17.2 million from $11.4 million in the third quarter of 2012. The increase in dollars primarily reflects higher sales and marketing expenses to support the Palomar products, as well as the roll out of PicoSure. As a percentage of revenue, adjusted selling and marketing expenses decreased to 28% of revenues on 31% of revenues in the third quarter of 2012. On a GAAP basis including acquisition cost, selling and marketing expenses were $17.4 million.

As Mike mentioned, our North America sales force currently consist of 72 reps and managers and we expect to be north of 80 by year-end.

Research and development expenses on a GAAP basis totaled $5 million in Q3, up approximately $2 million for the same period last year reflecting increased cost attributable to the Palomar acquisition. Research and development expenses were 8% of revenues in both the third quarter of 2013 and 2012.

Excluding acquisition cost, adjusted general and administrative expenses were $5.9 million or 10% of revenues for the third quarter of 2013, an increase of $2.5 million over the prior year period. On a GAAP basis including acquisition-related cost, G&A expenses were $12.7 million or 21% of revenues compared with $3.4 million or 9% of revenues for the same period of 2012.

Cynosure concluded the quarter with approximately $102 million in cash, short-term investments and marketable securities and we continue to have no long-term debt. Day sales outstanding were 62 days at the end of the third quarter, up from 50 days at the end of Q2 primarily reflecting the timing of orders.

Updating a comment I made on our July earnings call, we continue to expect to incur acquisition-related charges of approximately $1.6 million in the fourth quarter related to employment agreement and changes of [control] cost. We expect to incur $750,000 in both Q1 and Q2 of 2014 completing the cost related to the employment agreements and changes of control cost.

We also expect to incur approximately $1 million in non-cash charges associated with the Palomar acquisition for Q4 of 2013 related to the amortization of intangibles. For 2014, we would expect approximately $4 million in non-cash charges related to the amortization of intangibles associated with the Palomar acquisition. In addition, we expect to incur approximately $350,000 in charges for the fourth quarter of 2013 completing legal and accounting services associated with the acquisition.

Before going to the Q&A, let me note that we have several investor events scheduled for November including presentations at the Canaccord Medical Technology & Diagnostics Forum and the Barclays Select Growth Conference. We look forward to seeing you there.

With that we are ready to take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Our first question today is coming from Matthew Dodds from Citigroup. Please proceed with your question.

Matthew Dodds - Citigroup

Hey, good morning. Couple of questions, Michael for you first I guess. I know you're not breaking out the differences in the revenue. Can you at least say which of the two grew faster the 12% or 16% just directionally, I assume based on last quarter Palomar had a much higher skew at the end of the quarter. I'm also assuming you are probably rectifying that. So can you align all that up and just give us some color on the direction?

Michael Davin

Yeah. Matt, I would tell you that as you said we are reporting as one complete company now. It may have been a de minimis increase on the Palomar, but overall, we're combined as one company very pleased how quickly we are able to integrate the sales forces and that was part of our strategy. As I mentioned, we announced the transaction in the March in terms of, during the process of due diligence and moving towards closure. We were able to put an excellent model together in bringing the global distribution together rapidly. And we executed on that literally on June 25th, we were able to begin, bring this recent together. So therefore the integration of the product line and the distribution is in place early on and the acquisition and we’ll be reporting as one company.

Matthew Dodds - Citigroup

Just one other question, you said in the R&D, Michael upfront major new products in 2015 I think in terms of gearing up the R&D. Does that mean ‘14 the gap year or should we see something as well in ‘14?

Michael Davin

No. Actually my comment was that we have several projects that are ongoing especially now with the acquisition of Palomar and acquiring a very strong research and development team. We have strengthened or increased the number of projects post the acquisition. And therefore we have a number of projects that we're working on that will roll out between now and ‘15. So we do expect some technology announcements in 2014.

Matthew Dodds - Citigroup

Okay. Thanks Michael.

Michael Davin

You’re welcome, Matt.

Operator

Thank you. Our next question today is coming from Richard Newitter from Leerink Swann. Please proceed with your question.

Richard Newitter - Leerink Swann

Hi. Thanks for taking the questions. Maybe just to start, Michael, you had mentioned that I think the micro [lens] array technology was launched and it has been commercialized. Can you talk a little bit about when that occurred and how we should think about that technology with respect to PicoSure and what it can do either in margin or sales acceleration for that product line?

Michael Davin

Sure. Rich. We are very excited about launching the CAP technology, which we’ve had in other products, so they are firm of micro rejuvenation technology, also harbored the CAP technology’s unique delivery system. So this is something we anticipated, we’re able to move, launch up a little bit till October to launch it this month. Now it gives the position, the opportunity to deliver this very unique pulse and microlens array approach, so that they can utilize it for variety of indications. Keep in mind, right now our regulatory clearances are taking (inaudible) deletions as well as statute. But as I think mentioned, we are moving towards additional regulatory clearances in this unique delivery system will allow us to achieve that and also allow a physician to broaden the scope and procedures or the indications they can treat with the platform.

Richard Newitter - Leerink Swann

Okay, that’s helpful. And just with respect to some other technology development program that you have for 2014 and into '15. Can you give us a sense of what areas those are focused on?

Michael Davin

Yeah, we certainly are looking to further enhance our short pulse technology. We are also as we mentioned when we did the follow on November into three categories that we’re looking at, fractional technology and ITL which we’re able to acquire in the Palomar transaction. And we also mentioned that looking at the whole noninvasive fat category, so obviously we have an effort going on in treating that indication as well and there are a number of other R&D projects that are early stage.

Richard Newitter - Leerink Swann

Got it. And would it be possible for you to maybe characterize, you’ve got a couple of new product cycles going on right now across Palomar and the Cynosure businesses. Can you just characterize where we are for the key ones like Vectus or Palomar? What are we in for PicoSure and then also for cellulite your flagship ones?

Michael Davin

Sure. I would PicoSure, we are in the first or second inning. We are very pleased as I mentioned with the stability of the platform which is one of our strong interest and we are developing this technology to make sure this is stable platform when it get come out to the customer. And once again we are very pleased to report the stability is excellent, but we are very early in the stage, especially as we get additional regulatory clearances for indications but also additional registrations worldwide and we begin to ship this technology over to Asia and other exciting markets for us.

As it relates to Vectus and Icon, they are both we would say also maybe the second and third inning, very exciting new products for our distribution. Once again the Icon is an outstanding platform for fractional capabilities as well as an IPL platform. And cellulite is really in its second year, once got it’s unique, more niche market for the minimally invasive indication it that market more so the derm surgeon and the plastic surgeon. So all four of those products we would say are early in the game.

Richard Newitter - Leerink Swann

Okay. And then just what if I could one last one, was there anything this quarter across either Cynosure or Palomar or geographically that either took you by surprise, anything that was just a little bit didn’t perform as well as expected, that you would call out or any kind of one-time areas of weakness?

Tim Baker

No.

Richard Newitter - Leerink Swann

Anything that exceeded your expectations?

Tim Baker

Yeah, well, the management team executed on the integration, very, very pleased with the focus on bringing together a very large transaction and also staying very focused on the day-to-day business. So couldn't be more pleased with where we are with the integration process.

Richard Newitter - Leerink Swann

Thanks a lot.

Operator

Our next question today is coming from Anthony Vendetti from Maxim Group. Please proceed with your question.

Anthony Vendetti - Maxim Group

Thanks. Just a couple of questions on PicoSure and then just some financial questions. So on PicoSure, I know we’ve talked about some of the new indications that you are working on for them. Can you give us an idea Mike if where that is in terms of submission to the FDA, has it been submitted yet and sort of what the timeline is for some of these new indications?

Michael Davin

As I mentioned, skin rejuvenation Anthony, acne scaring, obviously skin toning, we see all three of those indications has been very large global indications. And when we look at skin toning and pigmented lesions, obviously the Asian Pacific market is very large demand for the treatment. Benign pigmented lesions and the skin toning indication as you know where the product is not available as of yet in the Asia Pacific market, but we are driving the regulatory process to make the product available over there in 2014.

So we have a number of ongoing activities as it relates to registrations to U.S. as well as indications. We are driving the clinical process needed for submission to treat additional indications with Pico. I'm not clearly comment on where we are with the FDA for obvious reasons, but you can bet that we’re very, very active both on the regulatory side and on the registration side for this very unique and exciting technology.

Anthony Vendetti - Maxim Group

It is one of the indications you’re still looking for is striae for stretch marks as well as that?

Michael Davin

Yeah. We also -- as you know we’ve done some early stage clinical for striae, but we want to be careful there as a number of companies have claimed to be able to treat striae. In our expectation there are real good clinical result on striae. It’s not been met yet, but we’re very early in the game as it relates to treating that indication with Pico. We are seeing some nice early stage clinical results and we think now with the CAP lens array being available that we can further broaden the results as it relates to treating striae in these other indications we mentioned.

Anthony Vendetti - Maxim Group

And that new tip, the focused tip, is that available immediately for shipping or when is that going to be available?

Michael Davin

Shipping now. And so we’ve obviously reached out to our install base, so let them know it’s available. So it’s an upgrade to the install base and then as it relates to new product shipment, it’s available today.

Anthony Vendetti - Maxim Group

And could you just go over the general pricing for that and ASP for PicoSure, is that still over 200?

Michael Davin

As far as the last part of your question, yes. The ASP is still over 200 on PicoSure and the CAP lens array comes in the package of three for $500, for lens array $1500 a package.

Anthony Vendetti - Maxim Group

And then Mike on this new product, I know you said about you’re working on a lot of different things, noninvasive fat being one of them and plans to roll out across by 2015. Is there anything specifically that we should expect at either AAD or [ASYLUM] early next year, is that too early as you are trying to combine these two companies and it’s more of in terms of new platform situation more of a 2015?

Michael Davin

Yeah, I don’t really want to comment on when the products will be to market, but I can tell you that we will have a very exciting as ASYLUMs. AAD, we are looking forward to as well, but ASYLUMs. We’re now going to be exciting because the potential product launches but because we believe we have a very strong podium presence as it relates to a number of publications that will probably presented not only PicoSure but other technologies that we are working on.

Anthony Vendetti - Maxim Group

Okay. Lastly, Tim, the breakout for stock-based comp please?

Tim Baker

So sales and marketing is $260,000 for the quarter, R&D is 132, G&A is 430 and there is $40,000 comp, so total 866 for the quarter.

Anthony Vendetti - Maxim Group

$40,000 comp. Okay, great. Thanks guys.

Operator

Our next question today is coming from Jim Sidoti from Sidoti & Company. Please proceed with your question.

Jim Sidoti - Sidoti & Company

Can you just give us a little color on the one-times, were they mostly severance payments or whether it’s step-up charges for the inventory or can you just describe what that was and why do think those will all begin next year?

Tim Baker

Sure Jim. Yeah, they’re combination of one-time cost associated with change in control and severance agreement, that’s the bulk of it. There was some inventory step up which was completed in Q3, so we're done with that. We’ll see none of that come through Q4 and then there are some one-time costs associated with accounting and legal costs. So as we mentioned and kind of scheduled out going to the rest of this year, we think we’re really pretty much completing the bulk of it by the end of the year which is some small trailing severance agreements into Q1 and Q2 and that will be done.

Jim Sidoti - Sidoti & Company

Okay. And then I think you said the amortization from the deal was stepped up to about $1 million in the fourth quarter, but it wasn’t even half of that in the third quarter so.

Tim Baker

It was a push and that goes to cost to goods sold Jim. So Q3 was also about a $1 million of non-cash charge, majority goes through COGS.

Jim Sidoti - Sidoti & Company

Okay. So that line on the P&L won’t look much different in the fourth quarter than it did in the third quarter?

Tim Baker

That’s correct. Yeah.

Jim Sidoti - Sidoti & Company

And then you mentioned you’re adding eight sales people, how long does it take them to get online? Do you think that all take a little bit step back in the operating margins because of that next quarter or do you think that you will be able to absorb that?

Michael Davin

Okay. So in terms of sales people now Tim addressed the absorbing question. But it will be north of 80 by the end of the year, Jim and we stood at 72 at the managers right now. We are fully engaged in the hiring process. And we estimate about six months for a rep to come up to speed, there may be a little bit longer now with the breadth of the product portfolio being so extensive. We are modifying our training programs and looking at ways to accelerate absorption by the sales rep, but we would expect a contribution somewhere around six months after being hired.

Jim Sidoti - Sidoti & Company

Okay. All right. Thank you.

Operator

Thank you. Our next question is coming from Andy Schopick a private investor. Please proceed with your question.

Unidentified Analyst

Thank you and good morning. Tim, couple of quick ones for you. What was cash flow from operations in the third quarter?

Tim Baker

Yeah. Cash flows from operations for the quarter end was negative 4$.4 million which really related to cash payments from Q2 in terms of cost associated with acquisition like investor bankruptcies and severance agreements.

Unidentified Analyst

Okay. With respect to of the cost associated with the acquisition of Palomar, apparently you are giving us guidance now that will be above $4 million for the year, about $1.6 million in Q4?

Tim Baker

Correct.

Unidentified Analyst

And that's basically those particular costs as their line item will go away basically in 2014, you’ve identified some other additional of reoccurring items with respect of employment agreements, but the acquisition related charges basically will be completed this year?

Tim Baker

Except for there is a little bit of hangover, the $750,000 per quarter for Q1 and Q2 of next year is the tail-end of the change of control agreement. So next year 2014, we $1.5 million and then we will go away.

Unidentified Analyst

Okay. One other thing I noticed I just wanted to call to your attention; on the income statement below the loss from operations, you have the interest income line there and then other expense line net which actually is positive. It seems to me that would have been better represented as other income/expense net because it is a positive number and I am wondering what comprise that $721,000?

Tim Baker

Yeah. That was only that it relates to FX gain and loss.

Unidentified Analyst

Okay, all right. Thank you very much.

Tim Baker

Thank you.

Operator

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mr. Davin for closing comments.

Michael Davin

Thank you operator and thank you for joining us this morning. We look forward to keeping you up to date on our progress. Have a great day.

Operator

Thank you. That does conclude today’s teleconference. You may disconnect your lines at this time. And have a wonderful day. We thank you for your participation today.

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