Cutera, Inc.'s CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.11.14 | About: Cutera, Inc. (CUTR)

Cutera, Inc. (NASDAQ:CUTR)

Q4 2013 Cutera, Inc. Earnings Conference Call.

February 11, 2014 / 5:00 P.M. E.T.

Executives

John Mills – IR

Kevin Connors – President, CEO

Ron Santilli – CFO

Analysts

Thom Gunderson – Piper Jaffray & Co.

Anthony Vendetti – Maxim Group

Zack Ajzenman – Griffin Securities

Jack Wallace – Sidoti & Company

Operator

Greetings and welcome to the Cutera Fourth-Quarter and Fiscal Year 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. John Mills of ICR. Thank you, Mr. Mills. You may begin.

John Mills

Good afternoon, everyone. Thank you for joining us today to review Cutera's financial results for the fourth quarter ended December 31, 2013. On the call today is Kevin Connors, Chief Executive Officer, and Ron Santilli, Executive Vice President and Chief Financial Officer. Kevin will start the call with a brief review of the quarter. Then Ron will discuss fourth-quarter financial performance. Finally, the Company will open the call for your questions.

Before we start, I want to touch upon any forward-looking statements made during the call, including management's beliefs and expectations about the Company's future results. Please be aware they are based on the best available information to management and assumptions that management believes are reasonable. 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. Future results may differ materially from management's current expectations, forward-looking statements, including statements concerning financial guidance on future revenue growth, expense levels, gross and net margins, the results of cost improvement initiatives, and other financial metrics, expectations for increasing revenue, the development, commercialization and revenue growth potential of existing and planned new products. While we manage to commercialize new products, and we attempt to launch products according to our plans, there is risk both from regulatory and technical challenges that our actual launch date could be delayed, or the launch of certain products may never occur. Management plans for the repurchase of Cutera's stock, management and the Board of Directors make no assurances to the magnitude of our planned share repurchases, although we have established Board-approved limits and the Company has to comply with regulatory and repurchase volume restrictions. Also, management may make additional forward-looking statements in response to your questions.

For a 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 the Company's most recent 10-Q filed November 4, 2013, with the Securities and Exchange Commission.

With that, I'll turn the call over to Kevin Connors, Cutera's President and CEO.

Kevin Connors

Thank you, John. Good afternoon and thanks for joining us today to discuss Cutera's results for the fourth quarter ended December 31, 2013.

We are encouraged with business trends in our US business, many of our Asia-Pacific distributors and our European operations. Relative to the same period a year ago, we experienced continued Japan currency headwinds and contraction of the podiatry segment of our business. However, revenue from our premier vascular product, ExcelV, expanded dramatically in the quarter. Demand for ExcelV surpassed our flagship Xeo product for the first time. The recent commercial success of ExcelV reflects our customer satisfaction with the impressive clinical capabilities, broad treatment options and overall system innovation. We believe our recently-implemented product sales specialist structure provides a beneficial focus on specific products and has been instrumental to drive ExcelV volume.

Our domestic revenue grew approximately 23% year over year, excluding the podiatry business. We have existing and planned premium product launches that target core physicians consisting of consisting of dermatologists and plastic surgeons.

At the present time, we'll principally focus our commercial efforts on the core segment of the market. Our business in Japan was exposed to a 25% devaluation of the Japanese yen when compared to the fourth quarter 2012, which resulted in a significant decline in revenue. The yen devalued against the US dollar sharply since the first quarter 2013.

During the quarter, we commissioned a leading consulting firm to independently assess our commercial position in our industry. The project's tilt was primarily focused on market research, internal assessment and customer research. The results of this project provided valuable information, including validation regarding the strength of our portfolio products and positive customer perception. There were a number of specific recommendations regarding our sales and marketing efforts to improve our performance that we are actively implementing to achieve our performance targets.

Turning to research and development, we are pleased with the progress that the team has made during the quarter. We will be debuting two new products in March at the American Academy of Dermatology. We will launch a premier laser hair removal workstation and received a 510(k) clearance in the fourth quarter 2013. Laser hair removal continues to be – represent one of the largest categories in the energy-based aesthetic industry. Similar to our experience with the launch of ExcelV, we have found that dermatologists have a preference for high-utility solutions, and this product is in line with our strategy of extending our portfolio of premium laser-based products targeting core physicians. We expect revenue shipments of this product to commence in the second quarter 2014 with the material financial impact occurring in the second half of the year.

In addition, we will unveil our picosecond technology, pending regulatory indications, for the treatment of pigmented lesions and tattoo removal. In the fourth quarter, we submitted a 510(k) for this product. With a multi-wavelength platform and incorporating other significant technical advancements, we will provide a solution to successfully treat pigmented lesions, as well as a superior technology to treat a broad range of tattooings. Furthermore, we believe our high-performance, flexible platform will allow for clinical research in other dermatologic conditions.

As we look forward, we see significant opportunities in our business. The aesthetic energy-based market continues to expand, and we have opportunities to expand our market share if we properly execute our growth plan. In addition to the recently-mentioned new product introduction plans, we believe investments in our commercial activities are critical. We have recently added a number of key executives to our sales and marketing team to augment our commercial leadership. One of our growth initiatives is to expand our sales organization. We are actively expanding our sales organization to better represent our strong portfolio products and in anticipation of our planned new product launches. In North America, we are in the process of expanding the sales force and are targeting 40 sales territories and additional sales product specialists.

In conclusion, our market is healthy and growing, and we are focused on a number of initiatives to increase our market share.

Now I would like to turn the call over to Ron to discuss our financials in more detail.

Ron Santilli

Thanks, Kevin, and thanks to all of you for joining us today on our fourth-quarter 2013 conference call.

Our revenue in the quarter was $22.2 million, or a decline of 1% million from the fourth quarter of 2012. As Kevin mentioned earlier, we are pleased to see our US business return to revenue growth, driven largely by the growth of our ExcelV product which, however, was offset by the decline in our podiatry business and then the devaluation of the Japanese yen when comparing the fourth quarter of 2013 to the fourth quarter of 2012.

Net loss for the quarter was $278,000, or $0.02 per diluted share. This loss includes $800,000 of non-recurring consulting expenses and $1.1 million for non-cash stock-based compensation and depreciation and amortization. Excluding these expenses, we generated approximately $1.6 million net profit, or $0.11 per fully-diluted share. Cash generated by operations in the fourth quarter was $2.9 million.

As of December 31, 2013, our balance sheet remains strong with $83.1 million in cash and investments following the $10 million of cash used for stock repurchases in 2013. As Kevin mentioned, the Japanese yen devalued by approximately 25% when comparing the average rate for the fourth quarter of 2013 to the fourth quarter of 2012. Our Japanese revenue for the quarter was $3.5 million, or 16% of our total revenue, of which approximately two-thirds is sourced in Japanese yen. The impact of the Japanese yen devaluation on our revenue this quarter was approximately $600,000, with additional negative revenue impact due to the effective price increase, which is difficult to quantify. In the aggregate, we estimate that our revenue was negatively impacted by approximately $1 million in the quarter.

Filler and cosmeceuticals revenue in Japan declined by $256,000, or 19%. Even though we experienced a strong performance from our filler products in the quarter, the yen devaluation offset this strength.

Commencing in the first quarter of 2014, we phased out the distribution of the Obagi products in Japan and instead have begun distribution Xeo skin health product portfolio. Xeo is Dr. Zein Obagi's new company. One of the factors in our choice to make this change was related to customers' dissatisfaction with competing internet sales channels available to Obagi customers, who are customers – who are our customers' patients. Our physician customers desired to provide these products to their patients directly, thereby capturing recurring product revenue while maintaining regular patient contact, which can yield additional procedures at the physician's practice. In the long-term, we believe that this new portfolio, which doesn't have a competing Internet sales channel, will allow our customers and Cutera to capture additional product revenue in Japan, which should result in greater sales levels as the account volume expands.

Now I will address our operating performance. Our gross margin was 59%. We are pleased with this – that this rate has increased from last year due to the realization of many cost initiatives. However, this rate is a little lower than we would expect with revenue in the $22-million range due to a higher level of distributor business and a change in product mix. We continue to target gross margin rates of 60% or higher.

Sales and marketing expenses were $7.8 million, or 35% of revenue, compared to $7.1 million, or 32% of revenue, in the fourth quarter of 2012. The increase in spending is primarily related to a higher commission rate associated with the start-up expenses of our product specialist sales force. Our sales and marketing expenses, as a percent of sales, were 37% in 2012 and 38% in 2013. We expect this rate to slightly increase to 39% in 2014 as we invest in our product specialist sales force and other commercial initiatives.

Research and development expenses increased to $2.4 million in the Q4 2013 from $2.1 million in Q4 2012, due primarily to increased material spending, which is project timing-dependent, related to two planned product launches. We expect quarterly spending to be in the range of $2 million to $2.5 million per quarter going forward.

General and administrative expenses increased by $700,000 to $3.1 million. This increase was primarily due to the $800,000 payment to a consulting firm to assist us with market research and some other commercial efforts. We expect G&A expenses to be approximately $2.6 million per quarter in the future. However, we expect the first quarter of 2014 to be approximately $200,000 higher due to the final portion of the previously-announced $1-million payable for the non-recurring consulting expenses.

Income tax provision. Our tax provision is primarily attributable to international taxes related to our foreign subsidiaries and small amounts of minimum and capital taxes based in the US. As a reminder, we continue to maintain a 100% valuation allowance for our US deferred tax assets.

Our income tax expense in the fourth quarter was $43,000. Going forward, for modeling purposes, we suggest using an effective income tax expense of approximately $50,000 per quarter.

Turning to the balance sheet, net accounts receivables at the end of the fourth quarter of 2013 were $9.7 million, and our DSOs were 40 days. We expect our DSOs to remain in the 30-40 range going forward.

Inventories declined by $1.4 million to $9 million at December 31, 2013, when compared to September 30, 2013. For the year, inventory was reduced by $2.1 million. While we are pleased with the quarterly achievement of 4 inventory turns, we expect our inventories to increase in the future as we ramp up production for our new products.

Deferred revenue increased over $1.2 million during the fourth quarter and by $3.1 million for the full year of 2013. We had an increased volume of customers who purchased multi-year extended service contracts at the time of purchase of their new systems. This deferred revenue will be amortized into revenue during the period in which the customer obtains service coverage. This is primarily years two and three from the date of purchase.

On our share repurchase, during the fourth quarter we repurchased $2.4 million of common stock. During 2013, we acquired 1.1 million shares of common stock at an average price of $9.43 for $10 million. We remain opportunistic with repurchasing our shares and have an active 10b5-1 program that is active for purchases for up to an additional $10 million.

In conclusion, our financial position remains strong as we hold cash and investments of $83.1 million with no debt. This represents approximately $6 per outstanding share. Our operations generated cash of $2.9 million and $4 million for the fourth quarter and full-year of 2013, respectively. We expect to be accretive in 2014 as well.

Now I'd like to open up the call for your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is from Thom Gunderson of Piper Jaffray. Please go ahead.

Thom Gunderson – Piper Jaffray & Co.

Hi, guys. So the new products at AAD, Kevin – the picosecond, I get. Laser hair – maybe you could give us a little bit more on what makes that different and better, and then where the utility actually comes from that you talked about. And then I missed what the third product was.

Kevin Connors

Yes, Thom. We just touched on the two in the press release and script. Starting with the hair removal product, as we discussed in the script, this is still one of the largest aesthetic energy-based categories that we have in our industry. And we – similar to what we did with ExcelV, we really wanted to engineer a superior technology that would allow significant benefits to the physician and patient, and so it's kind of the yolk of what we did successfully within the vascular space. We want to offer the same high-performance system in the hair removal space as well.

Thom Gunderson – Piper Jaffray & Co.

Got it. So it's – is it – I looked at ExcelV when it came out as being more designed for what the core market – the plastic surgeons and the dermatologists – were looking for. Is that a fair assessment and is that what you're saying for the new laser hair removal?

Kevin Connors

That's correct. That's exactly it. We really are focusing on products designed for the core segment of the market, and these are premium high-performance products. And there are some specific things – and if you're going to be at the big derm meeting coming up in Denver, I'd be happy to walk you through that. But with regard to the picosecond product, again, we've submitted a 510(k) for the treatment of benign pigmented lesions, and we're hopeful to get that clearance. We also have a CE regulatory strategy in place for that. So depending on what indications we get, we'll have that messaging appropriately at the American Academy of Derm meeting. But we think it's a really exciting platform. I think in Asia, in particular, the pigmented lesions market is massive and there are other areas in dermatology that we're really excited to also better study with this technology.

Thom Gunderson – Piper Jaffray & Co.

And then on the sales force expansion, could you talk – just remind me where we are at the beginning of '14 and how you expect – I imagine you're not adding everybody in the first quarter, but maybe you are – just how you expect the cadence of that throughout the year.

Kevin Connors

Sure. Well, we'll give you a little history first. We had a podiatry sales force layered on top of our aesthetic team, and that was largely disbanded about a year ago. We haven't expanded the aesthetic sales organization with the exception of the ExcelV specialty sales force that we introduced in Q3, and we had that team fully assembled going into the fourth quarter. So it's still early days with the ExcelV team, and we're very pleased with the early experience with that, largely contributing to a significant increase in our North American sales force towards the end of 2013. So we're going from somewhere in the mid-20s from an area sales manager headcount, as we ended 2013 with a plan to get to 40 sales reps with the specialty sales force layered on top of that.

Thom Gunderson – Piper Jaffray & Co.

Great. Thanks. That's it for me, guys. Thank you.

Kevin Connors

Thanks, Thom.

Operator

Thank you. The next question is from Anthony Vendetti of Maxim Group. Please go ahead.

Anthony Vendetti – Maxim Group

Thanks. Just to follow up on the sales, so you ended 2013 with mid-20s, and by end of 2014 you expect to be at 40. And then you have a separate ExcelV team. How many people are on that team?

Kevin Connors

We have an ExcelV sales specialty team targeting 5, and we have a smaller specialty team for the truSculpt specialists. So in terms of what that will look like at the end of the year, we think the 5 is probably a good number for the ExcelV specialists, and we're evaluating the truSculpt specialists. But again, on top of that, we'll have the 40 generalist area sales managers.

Anthony Vendetti – Maxim Group

Okay. And this quarter, the core versus non-core breakout?

Kevin Connors

About 62% core, Anthony, with – leaving 38% to non-core. So you can see the growth in the core transactions for us, driven by ExcelV.

Anthony Vendetti – Maxim Group

Right. Right. And so in the non-core, that includes your podiatry sales, correct?

Kevin Connors

Yes.

Anthony Vendetti – Maxim Group

Okay. Okay. And is the podiatry market getting more competitive or is it just – what do you think is the main reason for the sales dropoff there?

Ron Santilli

Well, we think we've got a great product in podiatry and we still sell the product. For us, quite frankly, it's a question of focus. We've got so many opportunities in front of us and I think the progress we've made with the ExcelV selling into the core segment of the market is strategically of interest to us as we plan for these new – other core high-performance products that are being launched.

Anthony Vendetti – Maxim Group

Okay. And then Kevin, just on the high-performance laser, which already has FDA approval – the high-performance laser hair removal system – you said it was mostly – look at second half in terms of sales there. Is that because starting at AAD you're going to be just rolling it out to the key opinion leaders and luminaries before you start to roll it out nationwide?

Kevin Connors

Well, it's typical of any product launch. We will have it at the AAD and we will be taking orders for the product, but – and we do plan to have some revenue in the second quarter as well. But just from a modeling perspective, I think the material impact of that product launch will be felt the second half.

Anthony Vendetti – Maxim Group

Okay. And then I know that the – based on what you said – that the picosecond is in the process of a 510(k) FDA approval. At best you could tell today, based on the comments back from the FDA, what's – where do you see that process rolling out in terms of FDA approval – if you could provide at least a range or a window – assuming everything continues to go well?

Kevin Connors

Well, we're pleased with the development activities internally. We're pleased with the clinical work that's been done with the product. However, in terms of predicting the FDA timeline, I really would rather not do that. We've worked with the agency to lay out protocol for these (inaudible) submissions, and we're encouraged by the scope of what's been asked of us, but we will work very closely with the agency to be sure that we're answering any of their questions and do everything we can to facilitate the process. But on top of that, we have a CE strategy that's moving along very nicely as well, and that's more predictable in terms of being able to get regulatory clearances in the EU.

Anthony Vendetti – Maxim Group

So is it possible or likely that CE mark approval happens first?

Kevin Connors

Well, I think we expect the CE mark to be done by the time we have it at the AAD. We're not – we haven't done that yet, but that's our plan.

Anthony Vendetti – Maxim Group

Okay.

Kevin Connors

In terms of how quickly the agency can turn around our first submission, we – we'll just be as responsive as possible to any questions they have.

Anthony Vendetti – Maxim Group

And then just lastly on R&D, is the R&D team – the (inaudible) laser people – is that R&D team still in place and is that what gives you confidence in more – or future new products from that team?

Kevin Connors

Well, the core team that you're referring to, yes, is in place and we're augmenting the team. We're really delighted with the progress we're making on these simultaneous new product launches. So it's a daunting task to do two at once, but I'm really impressed with what I'm seeing from the team.

Anthony Vendetti – Maxim Group

Okay. Great. I'll hop back in the queue. Thanks, guys.

Kevin Connors

Thanks.

Operator

Thank you. (Operator Instructions). The next question is from Morris Ajzenman of Griffin Securities. Please go ahead.

Zack Ajzenman – Griffin Securities

Hi. Thanks. This is Zack calling in for Morris. A few questions. Just to go a little further on Anthony's previous question, obviously the timing on the FDA can be uncertain – CE mark approval, a little better (inaudible). How about some of the Asian markets and especially China?

Kevin Connors

We don't have a submission in with China right now. I think once we get the other indications nailed down – we have a list of other countries, including Japan, where we have a large direct presence there and local regulatory people to assist us in achieving that. But right now, the two major markets are US and the EU, and Health Canada will also be something that is in the hopper.

Zack Ajzenman – Griffin Securities

Okay. And for the hair removal product, how should we think about some of the pricing metrics, the ASP and how it may affect corporate margins once the product is launched?

Kevin Connors

Yes. We're not discussing the pricing of it. But our internal targets have margins that are accretive to our current portfolio, and that's true with both of these products.

Zack Ajzenman – Griffin Securities

Thank you.

Operator

Thank you. The next question is from Jack Wallace of Sidoti and Company. Please go ahead.

Jack Wallace – Sidoti & Company

Good afternoon, Kevin and Ron. Thanks for taking my questions.

Kevin Connors

Hi, Jack.

Ron Santilli

Hi, Jack.

Jack Wallace – Sidoti & Company

Can you give just a little update on the truSculpt – I believe the third product that I may have mentioned would have been an additional applicator for truSculpt, and on previous calls you've been nice enough to at least combine, I guess, performance comments of the truSculpt and the ExcelV together. Can you give us just a little update on how that's been going?

Kevin Connors

Yes. There are plans for another extension of applicators for truSculpt. The scope of that program, relative to the two that we focused on in the call, is not nearly as extensive. And then in terms of the performance, we really – I think Q4 – it was largely an ExcelV story. That's why we wanted to kind of give some color on that – that for the first time in 10 years, I'd imagine, that our flagship CO product was eclipsed by ExcelV. But we continue to see great opportunities for the truSculpt and moving the specialty model to the truSculpt model is – that really shine a brighter light on that. And that's just beginning now.

Jack Wallace – Sidoti & Company

And I'm sorry – I may have missed it. How many specialist reps are in the truSculpt specialty team?

Kevin Connors

It's a modest number right now in terms of what we have planned. We want to spend more time understanding the market to a greater detail before we expand that.

Jack Wallace – Sidoti & Company

Okay. Thank you. And then could you also go into a little more detail on some of the points of emphasis and focus on the commercial side of the business that were discussed with the consultant?

Kevin Connors

Well, I think there are a number of things that we learned from that. Again, the primary focus was on the commercial side of our business with North America being at the center of the discussion, as well as our marketing initiatives. But with that said, we did commission them to look at how the company looks from the outside in and how our portfolio is perceived in the marketplace and how the company's perceived in the marketplace, and we got confirmation that those were both very positive. And then a lot of the things that we learned on the sales side had to do with how our prospecting level compares to other competitors in the space, just an analysis of how our feet on the street compared to the competition, and quite frankly, we have – our global base is a single-digit market share. So it really spoke to major investments and getting more feet on the street in North America, but we're looking at the entire globe to do that because we think we've got a – the right portfolio and more things coming.

Jack Wallace – Sidoti & Company

Great. Thank you. And then can you just confirm a number for me? We're looking for 40 sales managers by the end of the year, and what are we starting with?

Kevin Connors

Mid-20s.

Jack Wallace – Sidoti & Company

Mid-20s. Okay. Thank you.

Operator

Thank you. Ladies and gentlemen, that is all the time we have for questions today. I would like to turn the floor back over to management for any additional remarks.

Kevin Connors

Thank you for participating in our call today. We'll be attending a number of investor events in the coming months and we'll update you on our business progress in the first quarter 2014 conference call in May 2014. Good afternoon and thanks for your continued interest in Cutera.

Operator

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.

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