Cutera's (CUTR) CEO Kevin Connors on Q2 2014 Results - Earnings Call Transcript

Aug. 4.14 | About: Cutera, Inc. (CUTR)

Cutera, Inc. (NASDAQ:CUTR)

Q2 2014 Earnings Conference Call

August 4, 2014 5:00 pm ET

Executives

John Mills - IR, Integrated Corporate Relations, Inc.

Kevin P. Connors - President and CEO

Ronald J. Santilli - EVP and CFO

Analysts

Thomas Gunderson - Piper Jaffray

Anthony Vendetti - Maxim Group

Jack Wallace - Sidoti & Company

Daniel Mendoza - Prospect Capital Advisors

Zack Ajzenman - Griffin Securities

Operator

Greetings and welcome to Cutera Inc. Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your presenter today, Mr. John Mills of ICR. Thank you, sir, you may begin.

John Mills

Thanks operator. Welcome to Cutera's second quarter 2014 earnings conference call. On the call today are Cutera's President and Chief Executive Officer, Kevin Connors; and Executive Vice President and Chief Financial Officer, Ron Santilli. 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.

With that, I'd like to turn the call over to Kevin. Go ahead, Kevin.

Kevin P. Connors

Thank you, John. Good afternoon, everyone, and thanks for joining us today to discuss Cutera's results for the second quarter ended June 30, 2014. Revenue in the second quarter of 2014 was $17.7 million, representing a slight contraction compared to the same period last year. The U.S. returned to revenue growth, experiencing a 6% increase from the second quarter 2013. We are pleased to have returned to a growth position in the United States as the significant effort we made to expand our sales force has been able to produce a positive trajectory.

However, the growth in U.S. was offset by a decline in revenue from our international business. During the quarter we launched a new product. At quarter end we commenced commercial shipments of Excel HR, our dual wave length premium hair removal system featuring Alexandrite and Nd:YAG technology. This expands our broad portfolio of products into the core physician market of dermatologists and plastic surgeons to provide a premier hair removal solution.

In North America, we have 40 sales territories and product specialists to enhance our sales efforts. Our team continues to ramp up our North American commercial activities associated with the significant expansion we achieved over the past six months. We anticipate continued improvements in our North American revenue in the second half of 2014.

The decline in our international business was primarily due to softness in Japan and other Asia-Pacific distributor countries. We continue to believe that greater focus coupled with strategic investments in our international business represent an important component of our global expansion plan.

To better capture improved performance in these markets, I'm pleased with the recent addition of Miguel Pardos to lead our international business operations. Miguel is an industry veteran with a proven track record in developing and expanding international sales. He has a strong technical and clinical knowledge of aesthetic products and is well-connected in our industry. I am thrilled Miguel has joined our team and believe that he along with other strategic investments and our distribution infrastructure will be instrumental in increasing our international business going forward.

The near-term focus for Miguel will include defining our international commercial priorities to expand our international business. We see many large markets where we presently do not have a significant presence, we anticipate the expansion initiatives will come in both a broader direct strategy as well as cultivating more significant distributor relationships.

At the end of the second quarter, we commenced shipments of Excel HR, our dual wave length premium hair removal product which is targeted to core physicians. We have focused our initial commercial launch of this product in the United States where we performed many physician demonstrations and have received an unusually high close rate. We are pleased with the early customer response to this innovative technology and are actively expanding our production efforts to meet customer demand.

We have successfully established Excel V as the premier vascular solution and we look at Excel HR as an extension of this strategy. These two products have well differentiated features and benefits that justify the premium in the market. As we look forward to our picosecond product, Enlighten, we foresee a similar high-value product profile once we are able to launch.

This is the first year since inception of the Company that we will introduce two new and what we anticipate being high-impact product platforms in the same year. At this point, we are on track to launch our Enlighten product in the fourth quarter of 2014.

As a reminder, Enlighten is our dual wavelength product featuring both a both picosecond and nanosecond technology for removal of tattoos and benign pigmented lesions. This product will be targeting a variety of common tattoo colors and is expected to require fewer treatments.

In addition to tattoo removal, we expect Enlighten to be available to target various pigmented conditions, which is particularly a large market in Asia. Enlighten has received the CE Mark and has pending 510(k) submissions with the FDA. We have submitted two 510(k) applications to the FDA and both included data from clinical studies.

As we look to the future, we see significant opportunities in our business in North America through sales force expansion and international with new leadership that we expect will result in expansion and further penetration. Obviously, we are excited with the introduction of new and exciting products.

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

Ronald J. Santilli

Thanks, Kevin, and thanks to all of you for joining us today on our second quarter 2014 conference call. Our revenue was $17.7 million, down 9% when compared to the second quarter of 2013. As Kevin mentioned earlier, we are pleased to see a return to growth in the U.S. as a result of our sales force expansion, but saw a decline in our international business which occurred primarily from Japan and various Asia Pacific distributor countries.

Net loss for the quarter was $2.7 million or $0.19 per diluted share. This loss included $1 million for non-cash stock-based compensation and depreciation, continued investments associated with our North America sales force expansion and other investments in our commercial operations, as well as higher material spending in R&D due to the two products under development.

As Kevin mentioned, we experienced a sharp decline in our Japan business due primarily to a change in leadership. We expect to be back on track with year-over-year growth in our international revenue beginning in the third quarter of 2014 and will be augmented with the leadership of recently appointed EVP of International Sales, Miguel Pardos.

We also experienced a decline with many other Asia-Pacific distributor countries which we consider aberrant and expect it to be back on track to a growth mode in the third quarter of 2014.

Now, I will address our operating performance. The gross margin was 56%, down from the 57% in the second quarter of 2013. The rate decrease was due primarily to our lower volume. We expect our gross margin rates to vary with revenue and be approximately 60%, with quarterly revenue at or above the $20 million range.

Sales and marketing expenses were $7.8 million or 44% of revenues, compared to $7.2 million or 37% of revenues in the second quarter of 2013. The increase in spending is primarily related to higher personnel costs due in part to the increased direct sales headcount associated with our North America sales force expansion.

We plan to continue with investments in our North America channel and now expect to make investments in our international channels. We expect that our sales and marketing spending will be relatively high as a percentage of revenue in 2014 but expect it to decline in 2015 as we derive revenue growth from these investments.

Research and development expenses increased to $2.6 million in the second quarter of 2014 from $2.2 million in the second quarter of 2013, due primarily to increased spending on materials, which is project timing dependent, related to the Excel HR and Enlighten product launches. We expect quarterly spending to decline gradually in the second half of 2014 as the new products commercialize and transfer to manufacturing. In 2015, we expect R&D spending to be in the range of $2 million to $2.5 million per quarter.

General and administrative expenses remained relatively flat compared to a year ago at $2.3 million. Income tax provision or 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 100% valuation allowance for our U.S. deferred tax assets. Our income tax expense in the second quarter was $44,000. Going forward for modelling purposes, we suggest using an effective income tax expense of approximately $75,000 per quarter.

Turning to the balance sheet, net accounts receivable for the end of the second quarter of 2014 was $7.6 million and our DSOs were 39 days. We expect our DSOs to remain in the 30 to 40 day range going forward.

Inventories increased by approximately $400,000 to $10 million at June 30, 2014. The increase in inventories was primarily due to the advanced procurement of inventory associated with our new product launches.

Deferred revenue increased by $750,000 during the second quarter of 2014 compared to the second quarter of 2013. We had increased the number of customers who purchased multi-year extended service contracts at the time they purchased new systems. This deferred revenue will be amortized in the revenue during the period in which the customer obtains service coverage, which is primarily during years two and three from the date of purchase.

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 purchased under this program in the second quarter of 2014.

In conclusion, our financial position remains strong as we hold cash and investments of $81.6 million with no debt. This represents approximately $6 per outstanding share at June 30, 2014. We expect year-over-year revenue growth commencing in the third quarter of 2014 and to improve our profitability due to the leverage in our business model.

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 with Piper Jaffray. Please proceed with your question.

Thomas Gunderson - Piper Jaffray

So first question would be, is the mix of products and upgrades that you reported in the U.S. for Q2 pertain similar to the mix in Q2 '13?

Ronald J. Santilli

Tom, the mix is similar in terms of products and upgrades. In terms of the products, our Excel V product is clearly one that's leading the growth.

Thomas Gunderson - Piper Jaffray

And it was leading the growth a year ago as well?

Ronald J. Santilli

Yes, a year ago it would have been still growing – it was growing a year ago and it's growing even more now from a year ago, if that makes sense.

Thomas Gunderson - Piper Jaffray

Yes, it's accelerated. So the other would be, if the mix is similar, how are you seeing the beginnings of the new larger sales force impacting the various products, are there some that are easier to sell than others?

Kevin P. Connors

Tom, as we said in the script, the Excel HR, our new premium hair removal platform, began commercial activities in the quarter really largely at the end of the quarter. So we didn't have a full quarter of exposure with that product and our ability to demonstrate the product was also limited by production. So it is really early experience with that, but that was also a component of our growth in North America or in the U.S. last quarter. We didn't ship that product – we actually shipped one to Australia.

Ronald J. Santilli

Yes, that's right.

Kevin P. Connors

But we're seeing the new sales force embrace that new product as well as Excel V and other products that have been legacy products with us.

Thomas Gunderson - Piper Jaffray

I realized that HR wasn't contributing that much, I just wondered by smaller territories and new faces whether there were some products that the new territories were doing better at and others that might kick in later in the year.

Kevin P. Connors

The way we look at the expansion, Tom, is that it's typically six months from the time that we begin that process, and as you know we started that during the first quarter. So we really anticipate seeing more visible signs of that getting traction in the second half.

Thomas Gunderson - Piper Jaffray

And that last question, I'll get back in queue, on Enlighten and shipments, I think last quarter you said second half and this quarter you're saying fourth quarter, and I understand the semantics are similar but in Wall Street speak we think second half is midnight on July 1st and Q4 is more into October. Was there any change in your view, any change in the timeline for shipping Enlighten?

Kevin P. Connors

We're not seeing any material change in that, and when we talked about timing on that, as you get closer to it, it becomes more obvious where that is likely to land, whether it's in the third quarter or the fourth quarter. Obviously we're still awaiting the FDA to get back to us on our two submissions, but we're pleased to get the Excel HR successfully launched in the third quarter and it's important because it allows us to – in the second quarter, it allows us to focus our engineering efforts on completing Enlighten.

Thomas Gunderson - Piper Jaffray

Got it. Thanks guys.

Operator

Our next question comes from Anthony Vendetti with Maxim Group. Please proceed with your question.

Anthony Vendetti - Maxim Group

I just wanted to ask a question a little bit more on Enlighten. So Enlighten received CE Mark approval in the first quarter, right, towards the end of first quarter?

Kevin P. Connors

It was in the first or the end of the fourth. I can get back to you just to clarify that.

Anthony Vendetti - Maxim Group

So when you say it's going to be commence shipments in the fourth quarter, are you talking about U.S. shipments or are you talking about all shipments even though you already have CE Mark approval?

Kevin P. Connors

We often are able to get our international clearances before we get FDA clearance, and so we prefer to launch close to home if we can, and in the case of that product we preferred to start our shipments here in the States. But if for whatever reason, and we're not anticipating any reason to change our thinking on this, but if there is some sort of a delay in the domestic clearance, we have the option and plan to ship to Europe with the clearance that we have.

Anthony Vendetti - Maxim Group

Okay, so basically by this statement, you will be shipping Enlighten in the fourth quarter, whether that'd be in the U.S. or in Europe, but you'll commence shipments by then, and my only question is, if the answer to that is yes, is even with a preference of shipping in the U.S. first and now with Miguel onboard, is there any reason not to plan to at least slowly rollout Enlighten at some point in the third quarter internationally?

Kevin P. Connors

There are some international meetings that I think we think would be appropriate for us to focus on Enlighten outside the United States, in Europe specifically. And as I said, we hold that strategy to go to Europe before we start shipping in the United States if we don't get the FDA indication in the near-term.

Anthony Vendetti - Maxim Group

Okay. And then, Ron mentioned that the decline in other Asia Pac countries was an anomaly. Can you talk about what happened in those particular countries, was it distributor relationships that ran awry or what happened in those countries and is it all pretty much fixed? And then Japan continues to be soft, is that you think that's at a trough now and just an understanding of where things are there?

Kevin P. Connors

Just to back up a little bit with international, it certainly is pullback in the second quarter but in first quarter that business grew 7%. So we're not really at a point where we're going to call that there is a trend in the market or products in the market. There are a number of relatively small things that added up. And so I think there's a timing issue, Anthony, our filler and injectable product line, that was off about 200,000 to the negative. And we've got some really strong distributors and sometimes the business can get a little bumpy, so our Asia-Pacific distributor relative to last year was off about 800,000, in that range. So, we're not dissatisfied with the commitment we have from our key distributors in the region, but we do think that from time to time it does get lumpy.

Anthony Vendetti - Maxim Group

Okay. And then in the U.S., you said you had 40 sales territories. Is that your full complement for the rest of this year, or as you get ready for the fourth quarter launch of Enlighten, you may look to add some more territories?

Kevin P. Connors

We certainly are staying very close to the aggressive expansion that we began at the beginning of the year, and again the numbers were somewhere around 25-ish.

Ronald J. Santilli

28.

Kevin P. Connors

28, going to 40, and then specialists on top of that, so it's a pretty bold effort we have, so we want to make sure that we stay very close to those new people in particular to ensure that they're getting the traction. We do think that the market would justify continued expansion in terms of our headcount on the sales side but we have to weigh that with how much can we digest, one at a time.

Anthony Vendetti - Maxim Group

Okay. And just remind me how many specialists do you have now?

Kevin P. Connors

Seven.

Anthony Vendetti - Maxim Group

Seven, okay. Okay, and just Ron, the devaluation of the yen, how much has that contributed to the weakness in Japan?

Ronald J. Santilli

It was insignificant for the quarter when compared year-over-year, Anthony.

Anthony Vendetti - Maxim Group

Okay, great. All right, guys, thanks.

Operator

(Operator Instructions) Our next question comes from Jack Wallace with Sidoti & Company. Please proceed with your question.

Jack Wallace - Sidoti & Company

Just want to follow-up a little bit on the international sales front. Kevin, on one hand you're saying there are some smaller things, a little bit of bumpiness, possibly just some lumpiness in the quarter, and then on the other hand you've got a new international sales manager here looking to expand your distributor base and possibly also moving to a direct model to augment that. But it seems like there's maybe a little bit more going on than just there being some basic lumpiness or timing issues. Am I reading too much into that?

Kevin P. Connors

Our direct business in Japan also, as we said in the script, that was soft. So that largely coupled with the things you're talking about in our Asia-Pacific distributors really made up the bulk of it. Our European business was on target, our business in Australia was also on target. So it's not, we're not dismissing a 19% contraction relative to a year ago, but in terms of the appropriate steps we think that continuing to showing a bright light on the region is prudent and we are excited to have new leadership that's been very focused in that part of the world in particular.

Jack Wallace - Sidoti & Company

And how much of I guess the revamped push to your international, particularly the Asian markets, is going to have to do with the new products you're bringing, particularly the Enlighten?

Kevin P. Connors

That part of the world is very strong market for a product like Enlighten. So we've got some regulatory strategies for that region that will allow us to get into that market as quickly as we can. So we see that as a big deal for us. There is a tremendous interest in the treatment of benign pigmented lesions in that part of the globe, and whereas here in the States I think a lot of focus on the tattoo removal aspect of the product. So we're excited to aggressively go after our regulatory submissions as soon as we can get them in.

Jack Wallace - Sidoti & Company

Is there I guess a relative timeline of those submissions to the U.S., before, after, around the same time?

Kevin P. Connors

We've got, for certain countries we're actively working on our submissions as we speak.

Jack Wallace - Sidoti & Company

Okay thanks. And then, Ron, to your I guess relative margin guidance based off of level of revenue, I believe it was $20 million again for a 60% gross margin. Did I hear that correctly?

Ronald J. Santilli

That's correct, in that range.

Jack Wallace - Sidoti & Company

In that range. So just looking back a couple of quarters, you did 58.6% in the fourth quarter of last year on $22 million plus in revenue. At $20 million going forward, you're really looking for a much better contribution from your new products here which I believe have been loosely guided to be higher-margin products. Am I reading that correctly?

Ronald J. Santilli

I mean you're seeing it right. If you look at year ago too, we did $19.5 million in revenue, we did 57% gross margin. So we are looking to move that forward, and the new products do play a key role in that as well as some other initiatives that we have in play. So we certainly see that there's a pull associated with it but we think it's within reach.

Jack Wallace - Sidoti & Company

Okay. And then lastly, with any potential direct model or it's been a direct model, excuse me, in Asia, are we going to see I assume a smaller growth than what you saw here in North America in the first two quarters? I guess what is the additional headcount going to look like?

Kevin P. Connors

We're working with Miguel right now. As we said in the script, it's question of prioritizing where we want to focus our resources abroad, but as we discussed earlier, there are many high-growth markets where we don't have a significant footprint and we want to be as opportunistic and aligned with our product portfolio, where we see the greatest opportunities to grow our business outside of the United States, and we're working actively with Miguel on that as we speak.

Jack Wallace - Sidoti & Company

Okay, thank you. That will be all for me.

Operator

Our next question comes from Dan Mendoza with Prospect Capital Advisors. Please proceed with your question.

Daniel Mendoza - Prospect Capital Advisors

I've got a couple of questions. Can you give a timeframe for when there'll be enough Excel HR demo units to go around?

Kevin P. Connors

We had just a handful last quarter and manufacturing has taken over production of that now, and the production lines…

Ronald J. Santilli

We are ramping up but it would probably going to take the better part of this quarter to really get the demo need that we want fulfilled here in the States, and then we'll in Q4 be able to start getting international sales.

Daniel Mendoza - Prospect Capital Advisors

Okay, that is helpful. And then just a follow-up on the questions about sort of the regulatory pathway for Enlighten in Asia, again kind of a timeframe for when that product might be commercially available in some markets in Asia?

Kevin P. Connors

We certainly anticipate shipping in some markets in the first half of next year. Obviously Europe we can export doing that in the second half of this year. The regulatory timelines are becoming more and more challenging with higher levels of regulatory rigor that we're experiencing abroad. However, we see markets like South Korea as being a huge one for this and Japan as well. So we're actively coordinating our regulatory activities to reflect that.

Daniel Mendoza - Prospect Capital Advisors

Okay, that's helpful. And last question, Ron, was on deferred revenue. I'd say I've been around on multiple calls and on the transcript it looks like you said deferred revenue was up $700,000 year-over-year, but quickly going to the press release, I think is that number quarter to quarter and it's up $3.3 million year-over-year or do I have that reversed?

Ronald J. Santilli

No, you have it right, it's quarter to quarter. If I said that wrong, I apologize, but I meant from March 31 to June 30 it was up $750,000.

Daniel Mendoza - Prospect Capital Advisors

Okay. And is $3.3 million about the right number for year-over-year?

Ronald J. Santilli

Yes. I was saying it was around $3 million but it could very well be in the $3.3 million range.

Daniel Mendoza - Prospect Capital Advisors

Okay, great, thanks.

Operator

Our next question comes from Zack Ajzenman with Griffin Securities. Please proceed with your question.

Zack Ajzenman - Griffin Securities

First question, more of a clarification, Kevin, in your prepared remarks I just think you mentioned that you anticipate there's a continued improvement in North America in the second half of 2014. So is it fair to model then that sales continue to get stronger than the 6% we saw in the second quarter moving into the 3Q and 4Q?

Kevin P. Connors

Yes, in past quarters we've talked about that we really have the sales in the second half for North America and sales force contributions to take hold, and even though we anticipate that it's typically six months for a new sales rep to hit their stride, we're pleased to see early signs that there's evidence that we're seeing that in the second quarter.

Zack Ajzenman - Griffin Securities

Okay. And on United States, can you comment generally on what you see in the core physician landscape and that environment in the market and what sort of growth rate you see the market growing at now?

Kevin P. Connors

Ron has the numbers in terms of the split between core and non-core in the U.S.

Ronald J. Santilli

That was, let me get that, just a second, the core was about 73% in North America in the quarter with the balance coming up primarily from family practice people as well as maybe a little bit of podiatry. So that 73% is very strong growth in the core market which is one of our key initiatives.

Kevin P. Connors

We haven't had that level of core business probably in excess of eight years or so.

Ronald J. Santilli

Yes.

Zack Ajzenman - Griffin Securities

Okay. And again, on the U.S., I'm just trying to get a better handle on gross margin, so if U.S. sales were stronger this quarter relative to the international business, can you provide a little more color on why we didn't see contributions or more contributions to the gross profit line when U.S. sales typically carry higher margins?

Ronald J. Santilli

I understand what you're saying. The distributor mix wasn't significantly different. It did go down a little bit from the upper 20s to 25% say. Remember you're not getting much impact from the new products. There was a little bit of HR that shipped at the very end of the quarter but it's the second half that the new products will have a larger impact. And again, you look a year ago on slightly higher revenue, we had only 1 percentage point higher in gross margin. So it seems like it's tracking well except for the new products which will primarily be second half.

Zack Ajzenman - Griffin Securities

Okay. And I think this was touched on earlier in the call, but Excel HR, has there been clinical data submitted to countries outside of the U.S. at this point?

Kevin P. Connors

We have a CE Mark for the product and we're going to customary sequence of expanding regulatory clearances where we have a larger presence abroad.

Zack Ajzenman - Griffin Securities

Okay. And last question, any color or comments around progress made with the recently installed sales specialist for the truSculpt product?

Kevin P. Connors

Nothing material on truSculpt but the specialists are playing an important role in terms of getting our new people in particular up to speed quicker. So our specialists are more experienced in this business and are able to provide value on a number of levels on the commercial side.

Zack Ajzenman - Griffin Securities

Thanks a lot.

Operator

At this time, I would like to turn the call back over to management for any closing comments.

Kevin P. Connors

Thank you for participating in our call today. We'll be attending a number of investor events in the coming months and will update you on our business progress in the third quarter 2014 conference call in November. 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 and have a great day.

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