Cynosure's (CYNO) CEO Michael Davin on Q1 2014 Results - Earnings Call Transcript

May. 6.14 | About: Cynosure, Inc. (CYNO)

Cynosure, Inc. (NASDAQ:CYNO)

Q1 2014 Earnings Conference Call

May 6, 2014 9:00 AM ET

Executives

Scott Solomon – Vice President-Sharon Merrill Associates

Michael R. Davin – Chairman, Chief Executive Officer and President

Timothy W. Baker – Executive Vice President, Chief Operating Officer and Chief Financial Officer

Analysts

Richard S. Newitter – Leerink Partners LLC

Matthew J. Dodds – Citigroup Global Markets Inc.

Anthony V. Vendetti – Maxim Group LLC

James P. Sidoti – Sidoti & Company, LLC

Zachary R. Ajzenman – Griffin Securities, Inc.

Paul Nouri – Noble Equity Funds

Operator

Good day and welcome to Cynosure’s First Quarter 2014 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 of Sharon Merrill Associates. Please go ahead sir.

Scott Solomon

Thank you Danny and good morning everyone. Thank you for joining us this morning. With me on the 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 forward 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 SEC.

In addition, any forward-looking statements represent the Company’s views as of today, May 6, 2014. 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 profits, 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 helps 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 a 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 financial information prepared and presented in accordance with GAAP. For more information on these non-GAAP financial measures, please see the discussion and reconciliation table included in this morning’s earnings release. The table has more details on 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 R. Davin

Thank you, Scott. Good morning, everyone and thank you for joining us. Revenue in the first quarter of 2014 was $62 million, up more than $20 million compared to the same period of 2013. This 52% increase primarily reflected our June acquisition of Palomar and the continued success of our new PicoSure workstation. On apples-to-apples basis, if we had owned Palomar in Q1 of 2013, total revenue declined about 2% year-over-year.

While our direct subsidiaries in Europe and Asia generated solid first quarter results, their performance was offset by lower revenue from North America, and our international distributors.

In North America, the quarter started slowly and picked up in March. A factor that we believe affected our revenue performance is that we exited 2013 short of the targeted number of sales reps, we believe our needed to cover our greatly expanded product line. Our goal is to end the year with a sales force of more than 80.

We concluded 2013 with 76 reps and managers. We’ve since accelerated our plant hiring bringing our total number of reps and managers at the end of Q1 to 85. Experience tells us it takes about six months for new reps to begin to hit their sales line. This continues to be our expectation particularly now given the breadth of our standard product portfolio. Therefore, we would expect contributions of these new hires beginning in late Q2. We look forward to a positive impact from the 12% increase in our sales force, and we expect to continue to increase the size of our distribution until we’ve achieved aggregate coverage.

With respect to our third-party distributors, we continue to evaluate and integrate a third-party distribution network acquired as part of the Palomar transaction. As expected, strategic changes were made to the international distribution organization at the beginning of 2014 resulted in what we believe will be a temporary disruption as from some third-party distribution markets this past quarter.

We believe we’ll begin to see incremental improvements this quarter and achieve the end goal of increased revenue and enhance operational efficiency by the end of the year. International growth remains a key objective. Towards that end, over the past six months we’ve obtained a number of significant international regulatory clearances allowing us to sell products in a large number of countries and we expect additional approvals soon.

Turning to the Palomar integration, we remain on the schedule. By the end of June, we expect that fully transitioned Palomar’s product line to our contract manufacturing model. Within the same timeframe we also plan to complete the expansion of our Westford facility brining all of us under one roof.

These initiatives should further contribute to the improved operating leverage we’re experiencing as a result of the acquisition. Excluding deal costs, we expect the acquisition to be accretive in calendar 2014 with the implementation of $8 million to $10 million in projected synergies.

As I mentioned at the outset of my remarks, one of the highlights of the quarter was PicoSure, which continues to win over physicians and consumers in the U.S. and internationally. Technology innovation is an important reason for the high levels of satisfaction with this product.

We’ve recently launched a new technology upgraded PicoSure called Boost which magnifies the energy, and shortens the pulse widths for enhance treatment options. The key element of this strategy for PicoSure includes pursuing new market clearances and new marketing approvals for additional indications including acne scaring, skin rejuvenation and skin toning. We’re making strong progress towards this goal.

Our focus on new treatment areas as supported by a growing value of clinical research demonstrated breadth of our technology. Indeed Cynosure is well represented at the American Society for Laser Medicine and Surgery Annual Conference. The conference included a combined 35 old abstracts and poster presentations discussing clinical results with our products in areas such as skin rejuvenation and minimally invasive treatments for laser body contouring and lower face and neck revitalization.

A number of these presentations centered on the new indication for PicoSure as well as positive clinical experience with a FOCUS Lens Array, our new disposable energy delivery system which began shipping in Q4. With this unique pulse format, we believe that the FOCUS technology presents the opportunity for physicians to offer highly customizable treatments or mutations.

Now let me update you on an exciting development on the home use front. Unilever, through its Iluminage Beauty, joint venture, recently launched the Skin Smoothing Laser, the first at-home laser FDA-cleared to reduce fine lines and wrinkles around the eyes and mouth at the recent American Academy of Dermatology.

As a reminder we developed that device in partnership with Unilever over the past couple of years and expect to begin receiving royalty payments in the second half of this year. We ended Q1 with nearly $131 million in cash, short-term investments and marketable securities.

As we announced in this morning’s earnings release, the Board of Directors recently increased our share repurchase plan by an additional $10 million for a total of $35 million. Following this increase, we have approximately $19.6 million remaining available to repurchase shares under the program. This actually reflects our ongoing commitments to improve the investment value of our stock while at the same time growing our business.

Looking forward, we believe that we are well positioned to achieve our strategic growth objectives in the year ahead. As I mentioned in our Q4 call, we are working on the development of new flagship products, energy delivery systems and technology enhancements. We expect some technology enhancements in 2014 with the next flagship products slated for introduction in 2015.

We continue to focus on driving returns to focus investments and product innovation as well as accretive acquisitions by expanded debt and brand of our product portfolio. With that I will turn the call over to Tim.

Timothy W. Baker

Thank Mike. Good morning everyone. As I go through the numbers, please keep in mind that the first quarter of 2014 fully incorporates the Palomar acquisition which closed on June 24th of last year.

Total revenues for the first quarter of 2014 were $63 million, an increase of 52% from $40.7 million in the same period of 2013. Product revenue was up 46% to $49.7 million which represented 80% of revenue in the 2014 period compared with $34.1 million or 84% o revenue in the first quarter of 2013.

Looking at revenues on a combined basis, as if we own Palomar in Q1 of last year, product revenue was down 3% in Q1 of 2014.

By region, North American product revenue totaled $21.6 million or 43% of product revenue in the first quarter of this year which would have represented a year-over-year decrease of 12% had we owned Palomar in Q1 of 2013. International product revenue was $28.1 million or 57% of product revenue in Q1 of this year, up 4% over the same period last year on a combined basis.

Service and parts revenue was $10.4 million compared with $9.7 million in the first quarter of 2013. Our royalty revenue of $1.9 million was essentially flat with the same period a year earlier on a combined basis. First quarter 2014 GAAP net income was $689,000 or $0.03 per diluted share using effective tax rate of 35%. On an adjusted basis, excluding acquisition related cost and amortization expenses, net income for the first quarter was $4.2 million or $0.19 per diluted share compared with adjusted net income of $2.7 million or $0.16 per diluted share for the same period one year earlier.

Please see this morning’s release for a reconciliation of first quarter 2014 non-GAAP results to the most directly comparable GAAP results. Gross margin on a GAAP basis for the quarter is 57.1%. Gross margin on an adjusted basis excluding non-cash charges related to the amortization of intangibles was 59.3% compared with 58.5% for the same period of 2013. Excluding acquisition-related cost and amortization expenses, operating expenses as a percentage of revenue was 51.4% compared with 50% in the first quarter of 2013 due to lower than expected revenue in the quarter.

Adjusted operating margin for the first quarter of 2014 was 7.9% compared with 8.5% in the first quarter of 2013. We expect to achieve operating leverage to the combined organization once we complete the expansion of our Westford facility and fully transition the Palomar product lines to our contract manufacturing model, which we expect will be at the end of Q2.

Acquisition related expenses totaled $1.5 million or $0.07 per diluted share in the first quarter of 2014. We expect to incur an additional $1.5 million of expenses to complete the Palomar acquisition and the relocation of the Burlington facility in the second quarter of 2014.

For Q1 2014, we incurred approximately $2.1 million or $0.09 per diluted share in non-cash charges associated with the amortization of intangibles compared with $300,000 or $0.02 per diluted share for the first quarter of 2013. We expect to incur approximately $2 million per quarter for the remainder of 2014 for the amortization of intangibles of which $1.4 million will be charged to cost of good sold.

Turning to the balance sheet, we ended the first quarter of 2014 with cash, cash equivalents and marketable securities and short-term investments of approximately $130.7 million. We did not utilize our stock buyback program during the quarter.

As Mike mentioned, we have increased the share repurchase program to $35 million and have approximately $19.6 million remaining available to repurchase shares under the program.

Days sales outstanding were 58 days at the end of the first quarter compared with 48days at the end of the fourth quarter. The increase reflects the increase of international revenue as well as the timing of orders received in the quarter.

With that, Mike and I will be happy to take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now be conducing a question-and-answer session. (Operator Instructions) Our first question is from Richard Newitter of Leerink Partners. Please go ahead.

Richard S. Newitter – Leerink Partners LLC

Hi, guys. Thanks for taking the question.

Michael R. Davin

Hi, Rich.

Richard S. Newitter – Leerink Partners LLC

So, Mike maybe you can just help me understand a little bit more about what kind of dynamics are playing out in the business as we think about the rest of the year, and we think about the first quarter? First, I just want to know, is this more of – there are factors in the first quarter that maybe a bit more transient that it potentially shift some revenue into the back half of the year. And then, also it does exceed like some of these issues that might have been a little bit more specific to the first quarter, that you about them in fourth quarter just question of why you didn’t felt like your sales force hiring? Why wouldn’t you call that out last quarter?

Michael R. Davin

Okay. Rich, first as you know, the first quarter in our industry is always the most challenging quarter historically that has been the case. And it’s for a number of reasons, yes, one coming off at Q4 versus our strongest quarter, moving of the sales force is head down running for a lot of reasons then the company Q1. I think we saw in North America Q1 and I do not want to point to this being a major issue, but certainly in January and February, there are unusually slow, compared to the past Januaries and Februaries, especially I would say east of the Mississippi where we do believe the cold weather certainly affected doctors practices in terms of procedural volumes, cancellations to weather et cetera.

Although March was strong, so that was a real positive and we as go on in the Q2 that momentum has carried into April, which pretty decent April which as you know Q2 historically is our second strongest quarter in our industry in Q4.

As I mentioned, let’s remind ourselves we acquired Palomar, nine months. The integration was completed in terms of braying the distribution together. Then we’ve to rationalize the distribution, because we did make some moves as it relates to consolidation and then expand it.

As we said several times our goal is to get the North American distribution at the end of Q4 north of 80 meeting sales people and we exit around 76 with management. So as far as sales people who revolve the off by about 10. But we were hiring constantly and hopefully into early on the front end of Q1 to get that number up was we were able to execute one, as I mentioned that 85. Although we still believe we want to be north of 90 in North America and hopefully we achieve that goal, sometime at the beginning of the second half or hopeful, sometime by the hopefully we give second half already in middle of Q3.

So certainly we need to expand the distribution of product portfolio is broader than it has ever been, which we are excited about. As you know we also bifurcated sales force, so as we are hiring, hiring across all disciplines of the distribution.

Internationally, where we really saw kind of an interruption we would call it. This with the third-party distributors and primarily the Palomar third-party distributors. Once again that’s not unusual when there is an acquisition the company that acquires has like we do to distribution already present in a number of countries where the acquired company has distribution.

So there is some anxiety or nervousness from the third-party distribution of the acquired company and what is also continue to carry the product line as we go into the first full year, which would have been 2014 this year. So managing that is somewhat tenuous, we are doing the best we can with it. But certainly that is another area that we did see some interruption in Q1, although we are confident in both of these distribution categories they were making all the right strategic moves to get them at the levels and that the synergies that we want of O-U.S. as well as domestic.

Richard S. Newitter – Leerink Partners LLC

Okay, that is helpful. Mike, thank you for that. And then just maybe as we look to the rest of the remainder of the year. is there any thing that you can talk to with respect to your outlook, maybe three months ago. Has anything changed? Is the underlying business and environment as strong as it was? You sounded very optimistic about three months ago on your last call. Can you just characterize kind of what you see out there and how much confidence you’ve in potentially being able to achieve pro forma kind of 10% or higher top line growth rate?

Michael R. Davin

Yes, so you are asking me how we see the industry, and I will say we can look at certain macro type of indicators to in particular that were events that we recently held and concluded at the end of Q1 and the beginning of Q2, and that was the American Academy of Dermatology which was in Denver. Normally it’s in late February, early March unfortunately it was in late March, last week of March. And there is a number of disruptions as it relates to that. We get a number of lead session for North America, all that meeting that we can start to utilize as we used to drive some business in Q1. But because of the lateness of the meeting this year, we didn’t have that advantage. I’d also tell you though the American Academy of Dermatology which I believe we might have attended, I think I know a number of our analysts did attend, it was poorly attended.

I don’t know if that is because it was in Denver. And this is the first time I can recall in my 25 years of the industry they were being in Denver. The venue was – it’s not a venue that we would believe we had greater attendance. But the attendance are more significant than we would have anticipated. So that meeting was poorly attended and therefore lead generation and boost activity in sales were all I would say considerably over prior years.

Also the American Society for Laser Medicine and Surgery was held in the first week of April. So the two meetings were timed very closely together that meeting was held in Arizona. I can tell you it was a great meeting for us as it relates to scientific presentation as I mentioned 35 abstracts and poster presentations more than anyone else in the industry. For then we went into the exhibit hall it was pretty very quiet actually, it was very quiet. Booth activity as well as lead generation in sales.

So those are two very important meetings, industry meetings for us. We did speak to other companies AAD for example. They weren’t even light based technology companies, and also complained about the lack of the attendance as well as activity. And then ASLMS which is specific to our industry. I spoke to a number of our industry players that were very disappointed in the poor attendance.

Now it’s a few things you can take away there, maybe the timing of them being so close to each other. Doctors are not willing to take that much time out of their practice, two weeks in a row, those interrupts procedure time and revenue generated in their practice. I think Denver was a poor selected location especially off such a cold winter. I don’t think it’s a very desirable so it’s for people in the East Coast who want to attend the meeting. And then the ASLMS piggybacking right behind that as I mentioned a minute ago, I think also interrupted doctors want to attend the meetings, because they were taken revenue days out of their practice.

So as I look at – I think this quarter is going to be very important for the industry, Rich, as I mentioned it is the second strongest quarter historically in our industry. We are hopeful that we will see the kind of traction in Q2 that we normally see and then hopefully that will continue its momentum for the remainder of the year. But I think it’s too early for us to get an industry read. I guess the only other comment I would make if you look at 2013, compared to 2012 and the publicly traded group as I know you cover several of them.

If you pull Cynosure out, we grew 16% organically year-over-year, but the rest of the industry was down 3% year-over-year. So I think we have to see how things play out over the next couple of quarters.

Richard S. Newitter – Leerink Partners LLC

Okay, but the messaging is generally that things have come back – coming out of the first quarter a bit stronger that you saw in the beginning of the quarter trends in the second quarter remained healthy as far as you can tell. And then is that the correct characterization?

Michael R. Davin

All I can tell you is we were glad that March was much stronger than January and February, but as I mentioned January and February were unusually poor, compared to past Januaries and Februaries. And April once again was just concluded good momentum carried over from March into April. But we still are looking to see how the rest of the quarter plays out.

Richard S. Newitter – Leerink Partners LLC

Okay thanks. I will jump back in queue.

Michael R. Davin

Thanks.

Operator

Thank you. The next question is from Matthew Dodds of Citigroup. Please go ahead.

Matthew J. Dodds – Citigroup Global Markets Inc.

Hi good morning. Two different questions, I’ll focus on Q1, so Michael for the bad weather I mean you are not really procedure driven, your systems out, why would bad weather impacts your system sales so much. Is this really a few extra sales people that cause such as decline?

Michael R. Davin

Yes, Matt, like I said, I’m not pointing to weather what I’m saying is I can’t tell you that our January and February, which is historically hard are not strong months. For a variety of reasons, we’re unusually we compared to our past Januarys and Februarys and I do not at all want to allude to this was a weather impact. I think we look at the distribution not being the size that we wanted to be going into the quarter.

We look at there was some interruption from physicians we hear that they saw a cancellation and therefore, procedural volumes were up in January and February because folks didn’t want – remember these are cash bearing procedures people are willing to put off their laser hair removal, if they minus 10 degree so if it’s snowing in Atlanta.

So and I’m not saying that was a primary reason or any reason, saying that we did hear some of that and then the good news is March was much stronger but I think we found ourselves in a situation after January and February which report to cover the full quarter in the month was not going to be possible.

Matthew J. Dodds – Citigroup Global Markets Inc.

Okay, and if you look at the product line broadly and you recall that PicoSure is doing well. Was there anything that did particularly bad or do you think Smartlipo MPX now has kind of hit the later inning but, is there anything we can tell you that on the different types of systems?

Michael R. Davin

We have one area, where we had a strong performance last year, although we anticipated to see some weakness this year was onychomycosis. Although, I think as you know, we decided to go into a distribution agreement with the number one player from a technology perspective for that indication. I know another competitor of our significant follow-up on their onycho contributions, revenue contributions almost a year ago.

We saw greater than what we expected pull back in onychomycosis in Q1 but going forward, we think that will continue to be the case. We think lower cost technology is coming to address the indication and devices that our industry has brought to market are seeing a significant pull back in terms of the acquisition. So that was one area in particular we saw a big pull back, but we anticipate that to be the case for the remaining quarters going forward.

Matthew J. Dodds – Citigroup Global Markets Inc.

Particularly, how big was that product, like that can you even say on an annual basis or anything was that big?

Michael R. Davin

In the quarter itself, it was just over a $1 million last year in Q1.

Matthew J. Dodds – Citigroup Global Markets Inc.

Yes.

Michael R. Davin

But down about $1 million compared to Q1 last year.

Matthew J. Dodds – Citigroup Global Markets Inc.

And then the other area, it was on the distributors and the issues. Can you say sort of where they are located? Is it mostly Europe or is this also some other areas outside the U.S. and is a realistic thing you kind of fix them in a quarter to how long does it take to make this change?

Michael R. Davin

Matt, it’s a great question. I should tell you, we had six distributors or six countries that we would say misfired, of the six, four of them were Palomar distributors and as I mentioned on earlier for Richard’s question, we do believe some of that was giving those distributors comfort that they were going to be able to continue to carry the product line after the first of the year, we acquired at late June.

So the second half of the year, I think they continue to have a line and they were curious towards that, we continue to have it going forward. Also to remind everyone, 8% of our revenue comes from our direct offices, high 70%, so we are much more direct focused than most of our competitors. And so it’s a natural assumption with distributors and you can’t really control distributors’ anxiety. We may choose to go direct in countries were they really where we had – recover our third-party distribution.

There also two countries where we saw interruption we believe more from macro events. Turkey in particular we saw a currency affect there. Turkey has always been a very strong distributor for us and this is a Cynosure distributor. And then in Russia, we saw some pullback as well and if you believe there was a lot for mill from a macro kind of political unrest that was going with the Olympics going on at that time, but we also had a situation going out of (indiscernible). So we do know that there was some disruption as it related activity to the uncertainty and the macroenvironment. Those are two countries where we did see an underperformance again so projected revenues for the quarter.

Matthew J. Dodds – Citigroup Global Markets Inc.

So I see all six distributors then did it’s kind of business as usual…

Michael R. Davin

Well, I can tell you Matt is, we know exactly where the holes are and the gaps are and rest assured we are in direct concept communication with those distributors in giving them comfort and giving them guidance but also looking to get guidance from them, how they. How they feel? They will recover in Q2 in the balance of the year against Q1.

Matthew J. Dodds – Citigroup Global Markets Inc.

Okay, thanks Michael.

Michael R. Davin

Thanks Matt.

Operator

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

Anthony V. Vendetti – Maxim Group LLC

Thanks. Just wanted to talk a little bit about Smartlipo and Cellulaze. You talked about the onychomycosis but is – are the sales for both of those products and I know sometimes they are sold in conjunction, where the sales for those products still a big contributor to the growth or is most of the growth coming from PicoSure at this point.

Michael R. Davin

As you know, a minimally invasive business is pretty unique to design as sort of laser or light based technology. And it is a strong revenue contributor to our overall revenues. Although remember now, we don’t really combine Cellulaze (indiscernible) as we launched about 18 months of figures go, we launched Smartlipo Triplex and that platform is really the number one platform that sells in the portfolio because their offers positioned all three categories in the minimally invasive Arena that being lipolysis, Cellulaze as well as Precision TX which we launched about a year ago.

So that platform offers all the way provides a doc can meet all the delivery systems and it’s not unusual for the doctor to – to represent the doctor up to that platform so they can treat all three indications. Whenever these products have now been out about two years and as we’ve said, you get to a certain level of revenue and that sustains I’d say we are about sustaining level as it relates to the minimally invasive products contribution to our overall revenue.

Anthony V. Vendetti – Maxim Group LLC

Okay and then, I noticed in the GAAP presentation that wasn’t or anything that you’ll see what the stock-based comp was that just rose into the number because it was not significant or for the quarter.

Timothy W. Baker

And – I’m just give you the stock comp numbers that really happy for Q1 it was $442,000 in sales and marketing, $227,000 R&D, $729,000 G&A and $55,000 in COGS. So the total is $1.465 million.

Anthony V. Vendetti – Maxim Group LLC

What was the last quarters COGS, how much?

Timothy W. Baker

$55,000.

Anthony V. Vendetti – Maxim Group LLC

Okay and then, just in terms of the breakup for the revenue guideline I know you gave the percentages in general, but did you have that breakout or give that later?

Timothy W. Baker

In terms of year-over-year growth, is it?

Anthony V. Vendetti – Maxim Group LLC

Not in terms of year-over-year growth, just in terms of North American product revenue, international revenue.

Timothy W. Baker

So, North America product revenue was $21.6 million, which is 43% of the total product revenue and international was $28.1 million or 57% of the total.

Anthony V. Vendetti – Maxim Group LLC

Okay. And then, just I thought Mike you mentioned, the organic growth rate I know which indicates the quarterly revenue, if you had owned Palomar, what about the opposite, what if you didn’t own Palomar, what was Cynosure’s organic growth or is there a decline in the first quarter for Cynosure as well?

Michael R. Davin

No, we thought in the past, so we don’t breakout Palomar versus Cynosure revenue, so we look as a combined basis and the combined company year-over-year we would have been down 2%, if you look at from Cynosure reported number that were up 52%, if you look at what we actually reported last quarter, last year for Q1 what we reported for this year Q1.

Anthony V. Vendetti – Maxim Group LLC

Okay great. All right. Okay. Just, Mike. I know you’ve talked a little bit about sort of the outlook that as we go forward. There were some abstracts talking about laser treatment for fat destruction. Can you talk a little bit about the product roadmap or what we should be expecting over the next 12 to 18 months? Or next year’s AAD, which I think is in San Francisco?

Michael R. Davin

Yes. That’s correct. So, as we mentioned even in our Q4 call, we have number of research and development projects are engaged right now. At the ASLMS, I think your question centers around will be that (indiscernible) indications that were given by Dr. Decorato on our non-invasive fat approach and we’ve also disclosed that Cynosure is organically working on a non-invasive body contouring platform, a flagship platform that we planned to launch in 2015.

I give you a little more color on that, we have two initiatives right now, that we are aggressively funding and driving as it relates to that platform. It runs on the development and innovation side, where we’re developing, like I said organic platform that we believe will be unique, and there will also be a flagship platform to address non-invasive body contouring similar to some of the other products as you know that are out there, it’s been a very exciting market for us.

We’ve been doing work on at the research levels for 2.5, three years now. We have excellent clinical validation some of that information was presented in the two papers today at LMS by Dr. Decorato.

The other initiative is our regulatory initiative. So we are pursuing the non-invasive fat clearance. A number of our competitors are not taking that direction with the regulatory side of this opportunity, let me going more forward temporary cellulite or circumferential reduction. We are pursuing the non-invasive fat clearance, we’ve already met with the FDA. We have already established our protocol. We’ve already selected our sites and we will be began to in the clinical treatment as it relates to that submission this summer.

So we believe in a parallel path. We will get the clearance, which I will tell you is expensive, but will be well worth the investment within nine to 12 months and we believe we will also be launching our platform at a similar time frame sometime in 2015.

Anthony V. Vendetti – Maxim Group LLC

Okay, great. That’s great update. Thanks. Appreciate it.

Michael R. Davin

You’re welcome.

Operator

Thank you. The next question is from Jim Sidoti of Sidoti & Company. Please go ahead.

James P. Sidoti – Sidoti & Company, LLC

Good morning. Can you hear me?

Michael R. Davin

Yes, Jim.

James P. Sidoti – Sidoti & Company, LLC

Great. You mentioned that you should expect royalty revenue from Unilever in the back half of this year. Can you give us some sense on the magnitude and how that will be booked? Will there be any cost of goods sold related to that?

Timothy W. Baker

Sure. This is Tim. So as we announced, they have launched the product at AG and credit a substantial display there. They expect to bring it to the market by the end of Q2. We don’t know exactly the date. And just to remind you, we’re seeing quarterly (indiscernible) and we have said probably in the past that our royalty rate in the mid-single digit. It does fluctuate based on volume and revenue goals, but you should – safe to assume it’s in the mid-single digit.

So we would expect to see some revenue probably in Q4 based on Q3, Q2 sales. But at this point in time, we can’t really quantify that until we see the success of their sales launch. As far as the revenue, it will be all revenue with no costs associated against that. So it will be a few drops in the bottom line.

James P. Sidoti – Sidoti & Company, LLC

All right. And as far as the adjustments in the current quarter and roughly speaking there’s about $5 million adjustments to the amortization and integration costs, I think you said before the amortization, probably was a little over $2 million.

Timothy W. Baker

Yes, it was about $2.1 million of amortization cost and $1.5 million of, what we call, acquisition-related expenses. So about $3.6 million in total.

James P. Sidoti – Sidoti & Company, LLC

Okay. That’s after-tax number?

Timothy W. Baker

No, that’s the pre-tax number and does not include stock comp. So if we add stock comp to that then you’re about your $5 million number, correct.

James P. Sidoti – Sidoti & Company, LLC

Okay. And so that $1.5 million should go away by 2015, but the $2.1 million will stick around it sounds like?

Timothy W. Baker

That’s right. Actually that $1.5 million should go away by Q2. One more quarter of acquisition cost and then that will be behind us and then we will try the amortization going forward.

James P. Sidoti – Sidoti & Company, LLC

Okay, all right. Thank you.

Timothy W. Baker

Yes.

Operator

Thank you. The next question is from Zack Ajzenman of Griffin Securities. Please go ahead.

Zachary R. Ajzenman – Griffin Securities, Inc.

Thanks. Good morning. First question, what would you estimate is the transition rate for the minimally invasive systems here in North America in the core customer base?

Michael R. Davin

It’s a tough question, Zach. We’ve been in minimally invasive life based market now since 2006 where we see that gross FDA clearance for our Smartlipo platform. So that’s now been eight years. And knowing the addressable market where the core market is plastic surgeon, is derm surgeon, is an aesthetic surgeon. So my guess at least maybe 25%, 30% for people that are interested in breaking life based technology into their profit to address these indications. It’s important to note that there are conventional approaches out there where traditional liposuction or also laser ultrasound opportunity.

So the doctors have a variety of approaches that can be less expensive compared to bring light-based technology in, albeit light-based technology has significant advantages in terms of how they can treat and what they can do with a light-based device versus a conventional device and also advantages to the patient. But I would estimate somewhere around there, but we don’t have an actual number.

Zachary R. Ajzenman – Griffin Securities, Inc.

Okay. And sticking with the North American market, can you shed any light on the direction with ASPs for some of your core products this past quarter on a [12 micron SSI] (ph)?

Michael R. Davin

Sure. So we basically do not see any kind of significant decrease in ASPs for the quarter. Again, we continue to set the value on return on investment for these doctors and we’ve been successful with that. So we haven’t seen any significant decrease really in ASP.

Zachary R. Ajzenman – Griffin Securities, Inc.

Okay. And last question on the strategic shift that went out with some of the international distributors. How might that affect the initiative that’s laid out for 2014 to introduce the PicoSure product to third-party and national distributors?

Michael R. Davin

Yes, it’s a good question. So we have launched now the PicoSure technology to almost all of our direct offices wherever we receive regulatory clearances. For example, just recently we received clearance in Korea. So now we’d launch in Korea. We’re very excited about that. We still do not have clearance yet in China and we’re moving the needle as it relates to that submission and hopefully we’ll see that by year-end or early 2015.

But we are direct in Europe or – countries as well as Asia and also not initially because Australia with adding that as a direct office for Palomar acquisition, that product is rolled out. As it relates to third-party distributors, we have an initiative already in place. We’ve selected third-party distributors that want to carry the product and that can carry it based on regulatory clearances. For example, we do have regulatory clearance in Taiwan. There we’re getting to get trained on servicing the technology and selling the technology.

We also are largest distributor in the Middle East, just placed their first order for PicoSure. They’ve also been trained. So the initiative for third-party distributors, which we said all along, we launched this technology beginning of last year. We will not move without the distributors until late Q4 or Q1 of 2014. That initiative has begun and those distributors that are interested are now being trained or have been trained and are selling the product.

Zachary R. Ajzenman – Griffin Securities, Inc.

Great. Thank you.

Operator

Thank you. The next question is from Paul Nouri of Noble Equity Funds. Please go ahead.

Paul Nouri – Noble Equity Funds

Hey, good morning. Do you have the recurring revenue number as a percent of sales?

Timothy W. Baker

Yes. If you look at our recurring revenue, we consider they’re part of service on an installed base as well as our disposal piece. It’s about 16% of our total revenue in this quarter.

Paul Nouri – Noble Equity Funds

And can you talk about the sales force strategy again? So you combine Cynosure and Palomar, kind of pick the best of both sales teams, maybe (indiscernible) people now you’re rebuilding again?

Michael R. Davin

Yes, that’s correct. I mean when we acquired Palomar at the end of Q2 last year, looking at North America if we kept it hold, it would have about 84 to 85 reps. To your point, we did use some cleansing of the distribution. The claim went down to about 70 and now we’re back to the 85 number.

We hope to be north of 80 at the end of Q4, but once again the hiring process or the profile people would look for, this wasn’t the level or caliber of people who are into that process and we just do lot of hire for the sake of hiring. Now that we’re at the 85 number with managers actually in Q1, our goal now and it has been our goal is to get north of 90. So we are fully engaged right now in new process and hire new process to get North America north of 90. We love to see it by the end of this quarter. I think realistically it will be sometime in the second half.

I know what we’ll do is look at that more closely to see if they continues the expansion about that north of 90 number, but right now we want to get that level. And then, OUS, in our direct offices we’re also hiring and then we also have the third-party distributors.

Paul Nouri – Noble Equity Funds

Okay. Can you talk about the R&D? And if you fully combined the Cynosure and Palomar R&D departments or if there’s still some of that to come?

Michael R. Davin

No. So actually really that just happened. And I think if you might be aware we were in two separate buildings up until recently the end of Q1 as we begin to the move out the Burlington facility, which we sold. We had two arms of R&D, one over in Burlington and one in Westford. Now that has been combined as of about four weeks ago. So we’re all under one roof and we also have consolidated all of the different disciplines as it relates to the research and development department.

Paul Nouri – Noble Equity Funds

And you must kind of stay focused on growing the sales force and working around the products you have now and bringing out or are you looking to maybe add some bolt-on acquisitions to what you have?

Michael R. Davin

Yes, we are. Since 2011 we began acquiring, 2012. Yes, our initiative is still to in, a parallel path drive an addition organically to little over $20 million a year, investing in research and development and then also utilizing our $131 million in cash, given the balance sheet that continued with the strategic acquisitions. And to your point probably now we’re a little more focused on bolt-on type acquisitions and we are active as it relates to our M&A subcommittee, which we have two Board members in considered and also members of the executive team and we are currently active and looking at opportunities from a non-organic event.

Paul Nouri – Noble Equity Funds

And on the gross margin side, is there any room for improvement there with the two companies combined or is this kind of what we should be looking at towards closing?

Michael R. Davin

Yes, we do expect to see some improvement. As we mentioned earlier, we are working towards the increasing of migrating the Palomar manufacturing products out to our contract manufacturing where we’ve been very successful and kind of driving utilization and cost down. So that should be complete by the end of Q2 and we will expect to see some gross margin improvement as we go into the back half of the year.

Paul Nouri – Noble Equity Funds

All right. Thank you.

Operator

Thank you. The next question is from Richard Newitter of Leerink Partners. Please go ahead.

Rich Newitter – Leerink Partners LLC

Hi. Thanks for the follow-up. Tim, I was just wondering given that it sounds like some of the benefits for the payoff from the sales force was high in the first quarter, probably won’t begin until maybe the end of 2Q and to 3Q. I know you don’t give guidance, but could you help us maybe or is there anything you want to call out as we do update our models with respect to the cadence on EPS and/or margins moving to the year, is 2Q kind of going to look a little bit more like 1Q or is the pickup in sales going to provide for leverage there and it should be pretty consistent with what we’ve seen in historical years?

Timothy W. Baker

I think as Mike said, April was moving directionally the way that March ended and we were expecting to move forward that way. I think as Mike has alluded to, it’s probably too early to tell what that’s going to mean. I will from an operating model I think we will continue to adjust the model accordingly based on what we anticipated revenue to be, so I think we’ll continue to be flexible and as we’ve demonstrated in the past that we will run the business according to what is the business is. So I expect the model and principle to stay intact but the numbers within they change.

Rich Newitter – Leerink Partners LLC

Okay, thank you.

Michael R. Davin

You are welcome.

Operator

Thank you. We have no further questions in queue at this time. I’d like to turn the floor back over to Mr. Davin for any closing remarks.

Michael R. Davin

Thank you operator. Thank you for joining us this morning, we look forward to keeping you updated on our progress. Have a great day.

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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