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Cutera, Inc. (NASDAQ:CUTR)

Q1 2014 Earnings Conference Call

May 08, 2014, 05:00 PM ET

Executives

John Mills - Investor Relations and Partner, Integrated Corporate Relations, Inc.

Kevin Connors - President and Chief Executive Officer

Ronald Santilli - Executive Vice President and Chief Financial Officer

Analysts

Tom Gunderson - Piper Jaffray

Anthony Vendetti - Maxim Group

Zack Ajzenman - Griffin Securities

Jack Wallace - Sidoti & Company

Morris Ajzenman - Griffin Securities

Operator

Greetings and welcome to the Cutera Inc. first quarter 2014 earnings conference call. (Operator Instructions) I would now like to turn the conference over to your host John Mills of ICR. Please go ahead, sir.

John Mills

Thank you, operator. Welcome to Cutera's first quarter 2014 earnings conference call. On the call today is Cutera's President and Chief Executive Officer, Kevin Connors; and Ron Santilli, Executive Vice President and Chief Financial Officer. After management's prepared comments, there will be a question-and-answer session.

The discussion today will include forward-looking statements, reflecting management's current forecast or expectations of certain aspects of the company's future business, including any financial guidance provided for modeling purposes, forward-looking statements are based on current information that is by its nature dynamic and subject to rapid and even abrupt changes. All forward-looking statements are subject to risks and uncertainties, which may cause actual results to differ materially from those projected or implied in our statements.

Such risks and uncertainties are discussed in a summary form in today's press release and a detailed discussion of them can be found under the caption Risk Factors in the company's filing in the 10-Q filed today with the Securities and Exchange Commission. 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.

And with that, I'll turn the call over to Kevin Connors.

Kevin Connors

Thank you, John. Good afternoon, everyone, and thanks for joining us today to discuss Cutera's results for the first quarter ended March 31, 2014.

Revenue in the first quarter of 2014 was $16.2 million, which represents a solid increase compared to the same period last year. Our international revenue increased by 7%, led primarily by the growth in revenues from our global distributor network in Japan, despite the continued unfavorable foreign exchange pressure from the devaluation of the Japanese yen.

We are pleased that the investments that we have been making in our international distributor network continue to yield revenue growth for us, especially in Asia-Pacific and European regions. In contrast, our U.S. revenue declined by 7% compared to the same period last year.

The first quarter was a very active quarter, as we showcased two products, expanded our North American sales force and hired a record number field sales people in North America. With the consolidation that has occurred in our industry recently, we believe that it's an opportune time to grow our sales force to capture greater market share.

We plan on expanding the North American region to 40 sales territories and seven specialists. At the end of Q1 2014, we had 36 sales territories filled and had all the sales specialists in place.

We expect to achieve full staffing by the end of the current quarter, which is well ahead of our previous plan to obtain full staffing by December 31, 2014. We continue to believe that our recently implemented sales force specialist structure in North America provides a focus on specific products and has been instrumental in driving our ExcelV business.

While we are pleased with the composition of expanded sales force as well as our high-quality talent recently hired, as is normal with any sales reorganization expansion, we expect productivity improvements to have a significant impact in the second half of 2014.

During the first quarter 2014, we showcased our Excel HR and Enlighten products, which were both well-received by respected physicians at the AAD and ASLMS meetings.

Excel HR is the world's first premier hair removal laser to feature dual wavelengths, 725 nanometer and 1064 nanometer, combined with best-in-class sapphire contact cooling for enhanced patient safety, efficacy and comfort. Excel HR has received 510(k) clearance by the FDA and is expected to commence commercial shipments in the second quarter of 2014, with significant revenue contributions occurring in the second half of 2014.

Enlighten is the first and only laser platform featuring dual wavelength capabilities with both picosecond and nanosecond pulse durations to clear a wide range of tattoo colors, ink compositions and pigment concerns. Enlighten has received the CE Mark approval with 510(k) clearance by the FDA currently pending. We expect to commence commercial shipments in the second half of 2014 with U.S. shipments subject to an FDA clearance.

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 on our growth plan, we believe the investments we're making in R&D and commercial activities are critical and we'll continue with these investments.

In conclusion, our North American sales force expansion is largely complete and we will continue to stay close to the sales training and other commercial activities with a larger, more specialized sales team. And with a broad portfolio of products, we are well-positioned to generate improved performance in the second half of 2014.

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

Ronald Santilli

Thanks, Kevin, and thanks to you all for joining us today on our first quarter 2014 conference call. Our revenue was $16.2 million, up slightly when compared to the first quarter of 2013.

As Kevin mentioned earlier, we are pleased with the growth in our Asia-Pacific region and global distributor network. However, we experienced contraction in our U.S. revenue this quarter, as we have restructured and expanded our sales force and invested in other commercial initiatives.

Net loss for the quarter was $3.6 million or $0.26 per diluted share. The loss included $1 million for non-cash stock-based compensation and depreciation and amortization.

Increased investments in our commercial operations, including the expansion of our direct sales force, hiring of sales specialists, the global sales meeting and the Annual AAD conference, higher than normal material spending in research and development due to the two products under development and $200,000 of non-recurring consulting expenses included in our general and administrative expenses.

As Kevin mentioned, the Japanese yen devalued by approximately 12%, when comparing the average for the first quarter of 2014 to the first quarter of 2013. Our Japanese revenue for the quarter was 24% 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 $300,000, 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 over $500,000 this quarter due to the devaluation.

Fillers and cosmeceutical revenue in Japan increased by $91,000 or 8%, after taking into account the negative impact of the Japanese yen devaluation. Recently we terminated our distributor arrangement with Merz to sell the Radiesse filler product in Japan.

This will have a future adverse affect in our filler and cosmeceutical revenue by approximately $400,000 per quarter. We will continue to distribute the Xeo topical line in Japan and expect quarterly revenue to be in the range of $800,000.

Now, I will address our operating performance. Our gross margin was 55%, up from the 54% in the first quarter of 2013. Our targeted gross margin was higher.

However, we are pleased with our first quarter rate, given the lower than expected total volume and higher than normal percentage of our revenue coming from distributors, which has a lower margin than our direct business. We expect our gross margin range rates to vary with revenue and to be approximately 60% with quarterly revenue at or above the $20 million range.

Sales and marketing expenses were $7.3 million or 45% of revenue compared to $6.5 million or 40% of revenue in the first quarter of 2013. The increase in spending is primarily related to higher personnel cost, due in part to the increased direct sales headcount and our global sales meeting occurring in Q1 2014.

We plan to continue with investments in our commercial channels, but expect this rate to decline as a percent of revenue beginning in the second quarter and continue throughout the year with a target of approximately 38% for the full year.

Research and development expenses increased to $2.6 million in the first quarter of 2014 from $2.1 million in the first quarter of 2013, due primarily to increased spending in materials, 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 in the future.

General and administrative expenses increased by $300,000 to $2.6 million. This increase was primarily due to the final $200,000 payment to a consulting firm to assist us with market research and some other commercial efforts. We expect G&A expenses to be approximately $2.5 million per quarter in the future.

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

Our income tax expense in the first quarter was $37,000. 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 first quarter of 2014 were $6.6 million, and our DSOs were 37 days. We expect our DSOs to remain in the range of 30 to 40 going forward.

Inventories increased by $600,000 to $9.6 million at March 31, 2014, compared to December 31, 2013. The increase in inventory was primarily in anticipation of the new product launches.

Deferred revenue increased by $500,000 during the first quarter of 2014 compared to December 31, 2013. We had an increased number of customers who had purchased multi-year extended service contracts at the time they purchased new systems.

This deferred revenue will be amortized into revenue during the period in which the customer obtains service coverage. This is primarily during the years two and three from the date of purchase.

Regarding our share repurchase, we continue to have an active 10b5-1 program that is for purchases for up to an additional $10 million. However, no stock was repurchased under this program in the first quarter of 2014.

In conclusion, our financial position remained strong as we hold cash and investments of $83.8 million with no debt. This represents approximately $6 per outstanding share at March 31, 2014. With the leverage in our business model, the recently expanded North America sales team and the planned new product launches, we expect to improve our profitability in the future.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Tom Gunderson from Piper Jaffray.

Tom Gunderson - Piper Jaffray

So, Kevin, on the sales force expansion, can you give us a sense of where they came from and how much experience they have in the category and what do you think it might take for them as far as time to get up to speed? If you hired somebody that was selling other aesthetic products in the same territory for the competitor, it might take a couple of months. If you hired somebody out of school it might take a year. Where were you on that?

Kevin Connors

Tom, it's a blend of backgrounds. However, we have benefited from recent consolidation in this industry. So there are number of qualified candidates that we're able to bring onboard. And so we've got a bucket of people that look like that. So we're very happy that we're able to get those folks. The timing of that hadn't coincided with our expansion, and we probably wouldn't have the success rate with the qualified people.

And then, at we have other people that came from other backgrounds, but generally capital equipment medical folks. And you're right, it does take longer for people that haven't been in this specific industry. And then the other thing that was a factor that we had to create new territory alignments. So in some cases that meant to, even though they're experienced people, there is a ramp-up associated with connecting with a slightly modified group of customers in that the new territory.

Tom Gunderson - Piper Jaffray

So I'll try and put words in your mouth. I was going to say I'm not going to, but I'm going to try to, and that would be we might start to see an effect of a more productive sales force in Q3 and full force in Q4?

Kevin Connors

Yes, absolutely, Tom. We're expecting year-over-year growth beginning in Q3 at a minimum. And we're really very happy that we were able to accelerate this expansion plan and largely have it taking care of in the first quarter as we're preparing for these two exciting new product launches.

And quite frankly, we're now competing against companies that have more feet on the street and it's important that we recognize that and have the scale that we need in order to go toe-to-toe with the key competitors there. But we're happy that this is behind us, because it did create, as you can imagine with so much hiring, it did create some distraction from -- and lack of focus with the management team.

But just to give some rough numbers. We've got sales reps as well as the specialists as we talked about. Last quarter, the combined it was about 28 reps and then we have sales management on top of that. And then the target that we're going for with this expansion is 47. And sitting here today, we're largely there now. So it's been a very busy and exciting first quarter to get this on line faster we expected.

Tom Gunderson - Piper Jaffray

And then as long as we're talking sales force, you had a SWAT team sales force for ExcelV of four or five people, and I'm assuming that they're the same as they were last quarter. How did that go in Q1?

Kevin Connors

Well, we expanded the number of ExcelV specialist by one in the quarter. And as we talked about we're very pleased with the level of people that we're able to recruit, when we did that last year, and to the point that two of those individuals have been promoted into full management roles. So we're happy to reassess, to promote from within, so we had a higher number of replacements, but we got other high-caliber people that are now new to the company.

Operator

Our next question comes from Anthony Vendetti from Maxim Group.

Anthony Vendetti - Maxim Group

On the CE Mark approval for Enlighten, your picosecond laser, can you talk about how you could -- because you said you had planned to commence launch of the product in the third quarter, you have CE Mark approval, so how are you planning to roll that out internationally? And then can you just update us, Kevin, on where we are with the FDA, if you've submitted all the questions, you're just in a wait-phase here. Just a little color on that would be great.

Kevin Connors

I'll start with the FDA question. We submitted our first 510(k) application with clinical data in the fourth quarter. And we've gotten some feedback questions from the FDA and I think the nature of the questions has been constructive and we're responding to that.

And then in Q1, we submitted a second 510(k) submission for specifically for tattoo removal. So that's two 510(k)'s that are pending. And the timing is likely that the pigmented lesion submission that we put in will get clearance first, depending if the FDA agrees with the data that we have.

And then with the CE Mark, what's important about that is that it really does allow us to begin regulatory submissions in other countries outside of Europe. We believe that the market for this product is extremely exciting in Asia. And so we're now working towards getting those submissions underway.

So if we get a clearance from the FDA on either of the two applications that are underway, we'll be able to begin commercial promotion of the product at that time, subject to the limitations of the indications for use. But it will allow us to start quoting the product here in the states and we're diligently working on getting the international submissions expanded as well.

Anthony Vendetti - Maxim Group

And then, when you do launch it outside of the U.S., have you decided if you're going to roll it out slowly to luminaries outside of the U.S. or is it going to be commercially available immediately?

Kevin Connors

We don't really have a staged approach in terms of how we plan to do it outside of the United States. And if we're working with our distributor partners, they typically will start by getting the device in the hands of key opinion leaders. And so we'll do the same thing for our business in Europe at the appropriate time. But we're not looking to generally approach the rollout of this product as a Phase 1 or Phase 2. It's all going to be at one-time.

Anthony Vendetti - Maxim Group

And lastly, on the margin for this product, is it safe to assume that the margin for this product, even though you haven't set final pricing yet, should be above your current corporate gross margin?

Kevin Connors

Right, we can't quote the product. So in that sense we can't share what our thinking is. But with our current planned pricing for this product, we think it's going to be accretive for our gross margins.

Operator

Our next question comes from Zack Ajzenman from Griffin Securities.

Zack Ajzenman - Griffin Securities

Just to be clear on Enlighten, in Europe this second half, do you guys plan on commercializing that product irregardless whether or not you hear back from the FDA?

Kevin Connors

Well, of course, with the submission of that, getting the CE Mark clearance, it's the strategy of distributing this product globally. So yes, we will.

Zack Ajzenman - Griffin Securities

And then turning here to the domestic market, can you speak broadly about anything that may -- any underlying dynamics within the core customer base, the plastic surgeons, derms and others, customers, prospective customers in the first quarter? Any just broad trends, if you could provide some color there, please.

Kevin Connors

Unfortunately, with all the moving parts we had internally, it's hard for us to glean what's happening on a macro level in terms of the domestic market, but there are number of other things that could be happening, but we unfortunately aren't in a position to assess that due to the extensive expansion we did here.

Zack Ajzenman - Griffin Securities

How about sales trend domestically throughout the quarter or month-to-month, any variances?

Kevin Connors

Well, the business in general is backend loaded. So the third month throughout the industry is the strongest month. And in our case, we've got a lot of things internally that happened in the first part of the quarter. Ron alluded to our global sales training or our global sales meeting, lot's of tradeshow activity, it's great connecting with customers, but the flip side is a lot of your resources were out of the field.

Zack Ajzenman - Griffin Securities

Again, looking at domestic business, the last quarter you guys broke out revenues excluding the podiatry business. Do you care to comment on that number again?

Ronald Santilli

It was fairly flat year-over-year now. So we've kind of achieved our flat performance there.

Zack Ajzenman - Griffin Securities

And what's, sort of the latest updates or color around Genesis Plus, truSculpt?

Kevin Connors

There is the no material change in our Genesis Plus strategy, but we've reported on these calls for the last year's, it is consistent. And then truSculpt, the one development there is that we have put more focus on the product. We've hired two specialists for truSculpt recently. And we have a lot of happy customers, and so we're really trying to take a deeper dive such that we can extract a larger opportunity with that product.

Operator

Our next question comes from Jack Wallace from Sidoti & Company.

Jack Wallace - Sidoti & Company

And Ron, when you were going through your remarks you had mentioned that overall volume, sales volume was a bit below expectations in the quarter. How much of that was structural with the reorg and how much of that was still the sales force, I guess, getting their mojo back?

Ronald Santilli

I don't know if I would say, characterize it has been below expectations, but clearly as Kevin had commented earlier, though there is a lot going on with the hiring process within the North American team and in the U.S. that had an impact on the volume. But we expect all of that to be increasing as we move throughout the year.

Jack Wallace - Sidoti & Company

So the 7% decline in North American sales, that was in and around internal expectations?

Kevin Connors

So again, we indicated during the last call that the bold initiatives to expand the commercial side of our business, most specifically North American sales, it was going to be something that would, we too have benefited that for second half. So we are not surprised that with all the distraction and massive hiring that could be a slight pullback in the business.

Jack Wallace - Sidoti & Company

So it sounds more structural and reorg related than anything else.

Ronald Santilli

That's what we tried to comment on to say that we're really preparing for that second half and the new products.

Kevin Connors

We could have phased the expansion, but we thought it'd be better to get all the territories identified at the beginning of the year, do the best to hire the quality people and do it as quickly as we can, because if you break it up into a number of different phases, each time it's done, it does cause some distraction.

Jack Wallace - Sidoti & Company

Certainly I understand, and I think you made the right move there, frontloading the hiring process. And then did I hear you correctly, Ron, looking for revenue of roughly $20 million in the second quarter?

Ronald Santilli

I don't recall giving any guidance on the revenue side.

Jack Wallace - Sidoti & Company

I believe there was a $20 million number that was somewhere in the prepared remarks, and I must've misheard that, what it was?

Ronald Santilli

That was probably related to gross margin, that we said, about $20 million is where we see a 60% gross margin.

Jack Wallace - Sidoti & Company

And then lastly, just extrapolating on the previous question about truSculpt, with the hiring of the two specialists, if those specialists are able to go ahead and boost sales, it was the way you've seen them so far, could you see that sales team expanded throughout the course of the year?

Kevin Connors

Well, that is certainly our intent. We think we've got a great technology. And we wouldn't have made additional investments to that product unless we saw the opportunity. So yes, we do expect to get to higher volumes levels of that product and putting additional focus, certainly provided a binary change in the commercial success of our ExcelV. So the specialist program to different product, but the specialist program in that case was a real game changer for us.

Operator

We do have a follow-up coming from Zack Ajzenman from Griffin Securities.

Morris Ajzenman - Griffin Securities

This is Morris. Zack passed this time over to me. What's your take on the macro outlook? It's kind of mixed numbers coming out there from the other competitors in the industry. And any thought of the industry moderating here the growth rate, any concerns, or any uplifting comments of that, things will start improving? What's your take on the macros of the past quarter or two and how it looks go3ing forward?

Kevin Connors

There is the earlier question about how we look at domestic markets from a macro perspective. We just, with all the changes we did in the first quarter, we can't really provide an opinion on that. We had too many internal things. And we've had a couple of publicly traded companies reported, and one showed significant growth, the other one was slightly down.

But I think we make our decisions about market trends not based on one quarter, we look at kind of a trended performance, and last year we saw a very nice growth in this space. And so we're continuing to make big debts on the future, open terms of commercial investments.

We talked about our North American strategy on this call, but we've got other international initiatives that are equally as bold level talking about in future calls. And again, the other investment is obviously in our new products. We had never launched two major platforms at same the time. So this makes sense for Cutera at this point in time.

Morris Ajzenman - Griffin Securities

One last question for, Ron, you reported a GAAP loss of $0.26. You've put out some pro forma, non-cash compensation and other numbers there. What would be a pro forma number and then an adjusted pro forma number for these other one-time events? Do you care to provide any estimates on those sort of numbers or adjustments on those numbers?

Ronald Santilli

I think we were just trying to provide a little bit more color on what those expenses, what the increases were caused by. Some of those are really ongoing, because they're initiatives that we will continue with. So if you really want to get into non-GAAP, you would just subtract out the $1 million of non-cash stock-based comp and amortization and depreciation.

That's typical in getting to the EBITDA kind of approach. But the others were there primarily for color. G&A, I had mentioned the $200,000 of consulting expense. That clearly will not be going forward. We're now done with that. But on the sales and marketing side, I think we're going to continue making investments there.

Operator

Thank you. At this time, we have no further questions. I will turn the call back over to Kevin Connors for closing comments.

Kevin Connors

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

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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