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Cutera (NASDAQ:CUTR)

Q3 2011 Earnings Call

November 07, 2011 5:00 pm ET

Executives

Ronald J. Santilli - Chief Financial Officer and Executive Vice President of Finance & Administration

John Mills - Senior Managing Director

Kevin P. Connors - Chief Executive Officer, President and Director

Analysts

Morris Ajzenman - Griffin Securities, Inc., Research Division

Larry Haimovitch - Haimovitch Medical Technology Consultants

Anthony V. Vendetti - Maxim Group LLC, Research Division

Operator

Greetings, and welcome to the Cutera Incorporated Third Quarter 2011 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, John Mills of ICR. Thank you. Mr. Mills, you may begin.

John Mills

Thank you. By now, everyone should have access to the third quarter 2011 earnings release, which went out today at approximately 4:00 p.m. Eastern Time. The release is available on the Investor Relations portion of Cutera's website at cutera.com, and with its Form 8-K filed today with the SEC and available on its website at sec.gov.

Before we begin, Cutera would like to remind everyone that these prepared remarks contain forward-looking statements, including statements concerning domestic and international growth opportunities and strategies; future spending, expense management and execution on various aspects of our operations and business; expectations for increasing revenue, generating cash and improving profitability; the development and commercialization of existing and planned new products; and potential revenue growth from strategic alliances and planned new products. Also, management may make additional forward-looking statements in response to your questions. These forward-looking statements do not guarantee future performance and therefore, you should not rely on them in making an investment decision without considering the risks associated with such statements.

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. For a complete list of risk factors that could cause Cutera's actual results to differ materially from the forward-looking statements, please refer to the section entitled Risk Factors in our most recent 10-Q filed on November 7, 2011, with the Securities and Exchange Commission.

With that, I'll turn the call over to the company's President and Chief Executive Officer, Mr. Kevin Connors. 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 third quarter ended September 30, 2011. On today's call, I'll provide an overview of our company performance, and then Ron Santilli, our CFO, will provide an overview of our financial results. Finally, I'll provide some closing comments and open the call to your questions.

We are pleased with the third quarter 2011 revenue growth of 26%, with the U.S. growing at 43% and international growing at 17%, all compared to the third quarter 2010. This revenue improvement was a direct result of the following key initiatives: First, our GenesisPlus for toenail fungus targeted to podiatrists continues to perform well. In addition to toenail fungus, this product is also used for warts and other aesthetic procedures. During the quarter, we achieved record revenue contribution from this product, sourced primarily from the United States. Going forward, we plan to continue to increase our marketing efforts internationally. Second, our premier vascular system, Excel V, which provides practitioners the ability to treat all vascular conditions, both on the face and body, continue to gain traction on the marketplace. We are -- we remain in a continued launch and are building an installed base of reference sites. The third key contributor for revenue growth last quarter was the sales management changes we implemented earlier this year. Our recently assembled North American sales management team, under the leadership of Michael Poole, has been executing effectively. And their strategies are paying off, as proven by the 43% revenue growth in the United States and Canada contributing significantly as well. In addition, with Chris West returning to Japan to focus on the Pacific Rim countries, we're experiencing strong revenue growth from Japan, Australia and several of our Asian distributors this quarter. Lastly, during the third quarter, we continued to have success in combining Cutera products and upgrades with filler and cosmeceutical products from Merz and Obagi. Filler and cosmeceutical products complement our laser and light-based products and revenue from these product categories grew by 19% in the third quarter of 2011 compared to the third quarter of 2010. The strong performance was partially offset by a decline in our third quarter 2011 revenue from Europe, due to restructuring of the European sales team. With the improvements being implemented there, we anticipate our European business to return to a growth trajectory in the near future. We believe that our strength in sales management teams and new product offerings, we are well positioned to -- for continued top line growth. We currently have 27 sales territories in the United States and Canada, and are anticipating territory expansion within the next 12 months.

Turning to research and development. We believe that strategic ongoing investments in product research and development are critical to our future success. In line with that principle, we are continuing to invest in R&D for the next generation of technology and have increased our engineering and clinical research expenditures to develop innovative solutions and expand the clinical understanding and applications of our current products. Earlier this year, we created the Cutera clinic, located in our headquarters in Brisbane, California, and we are pleased with how quickly we are able to perform controlled clinical studies for our new product and existing products. We're excited about the pipeline of new product opportunities in R&D and have augmented our team with top talent, and we believe will enable us to develop differentiated, exciting products for the years to come.

Lastly, we are in the process of launching our recently announced myQ Q-switched laser Japan. By addressing deep dermal pigmentation and melasma, the myQ system complements Cutera's current array of lasers for the anti-aging market. We will initially launch myQ in Japan, where we see a particularly strong demand for this technology and we will evaluate other geographies in the future.

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

Ronald J. Santilli

Thanks, Kevin, and thanks to all of you for joining us today on our third quarter 2011 conference call. The third quarter 2011 revenue was $15.2 million or 26% higher than the third quarter of 2010. Net loss for the third quarter of 2011 was $2.9 million or $0.21 per diluted share. Kevin already discussed the geographical performance, I will now discuss revenue by product category.

Product revenue increased in the third quarter by 56% when compared to the third quarter of 2010. This increase was primarily driven by sales of our GenesisPlus product into podiatrist specialty, followed by sales of Excel V into core specialties. Upgrade revenue declined 51% in the third quarter of 2011, when compared to the third quarter of 2010. Historically, a new product launch has resulted in an increase in upgrade revenue. However, our recently launched GenesisPlus and Excel V are new stand-alone systems versus a handpiece that is upgradable on our existing platforms.

Service revenue remains flat at $3.2 million compared to the third quarter of 2010. The primary component of service revenue is extended service contract amortization. Service revenue has remained flat over the past several quarters due primarily to lower service contract amortization as a result of fewer U.S. customers purchasing extended service contracts, offset by a higher revenue from consumable handpiece purchases and time and material fees charged to customers who are out of warranty.

Titan annuity revenue improved by $384,000 or 59% to $1 million in the third quarter of 2011 compared to the same quarter in the prior year. This increase was primarily due to our voluntary recall of certain Titan XL handpieces. As a reminder, the voluntary recall occurred in the second quarter of 2010 and concluded in the third quarter of 2010. However, as part of the voluntary recall program, we provided our eligible customers with a fully refilled Titan XL handpiece, which resulted in a lower-than-normal Titan annuity revenue.

Fillers and cosmeceuticals revenue was $1.3 million in the third quarter of 2011, an increase of 19% from $1.1 million in the third quarter of 2010. The growth of this revenue category was derived primarily from sales of our Obagi and Merz distributed products in Japan. A significant percentage of our revenue is sourced from existing customers. During the third quarter of 2011, 41% of our revenue was derived from sales of upgrades, service, Titan annuity and filler and cosmeceutical products. We remain committed to strong customer satisfaction and believe we will continue to realize revenue from these annuity revenue categories.

During the third quarter of 2011, approximately 60% of our North America product orders came from the podiatrist specialty. This is a growing market, which represents an opportunity to now actively market and sell our GenesisPlus and other products. Outside the U.S. and Canada, we primarily sell to core physicians. During the third quarter, 15% of our North America orders were derived from core physicians. We are continuing to target the core market segments, as well as other established medical offices. We believe the recently launched Excel V expands, the product offering for this market segment, which offers us the greatest long-term growth opportunity.

I will now address our operating performance. Our gross margin was 56% in third quarter of 2011 compared to 53% in the third quarter of 2010. The increase in gross margin was due to the higher revenue of volume and associate leverage of our fixed cost, and the voluntary recall of Titan XL handpieces that adversely affected our gross margin in the third quarter of 2010. The 56% gross margin rate is lower than we targeted resulting from an unfavorable product mix, as well as an increase in distributor volume related to the lower margin products during the quarter. Sales and marketing expenses were $6.4 million or 42% of revenue in the third quarter of 2011 compared to $5.8 million or 48% of revenue in the third quarter 2010. The increase in expenses is primarily due to higher commission expense, on the higher revenue volume of the U.S. field sales-related expenses associated with the higher level of activity. The decreased cost as a percent of revenue was due to the higher volume.

Research and development expenses were $2.4 million for the third quarter of 2011, a 26% increase when compared to $1.9 million for the third quarter 2010. This increase was due primarily to higher personnel expenses, resulting from higher headcount to ramp up the research, development and clinical support of our new products and the expenses associated with the Cutera clinic to perform on-site clinical studies. We remain committed to investing in R&D and launching new products in the future.

General and administrative expenses remained flat at $2.3 million in the third quarter of 2011 compared to the third quarter of 2010. These expenses declined as a percentage of revenue from 19% in the third quarter of 2010 to 15% in the third quarter of 2011 due to the higher revenue volume. Interest and other income net decreased to $91,000 in the third quarter of 2011 compared to $131,000 in the third quarter of 2010, which was due primarily to higher foreign exchange losses resulting from a revalued U.S. dollar. Income tax provision in the third quarter of 2011 was $326,000 due primarily to a $262,000 non-recurring charge related to net unrealized gains on marketable and long-term investments that were included in our accumulated other comprehensive loss. As a reminder, we continue to maintain 100% valuation allowance on our U.S. deferred tax assets and our income tax provision is primarily related to our non-U.S. operations, as well as small amounts of minimum and capital-based tax in the U.S. Therefore, going forward for modeling purposes, we suggest using an effective income tax expense of approximately $50,000 for the future quarters through 2012.

Turning to the balance sheet. Our financial position remains strong. As of September 30, 2011, we had approximately $91.4 million in cash, marketable securities and long-term investments with no debt. This represents over $6.56 per outstanding share. During the third quarter, our operations consumed $3.5 million of cash. However, note that our inventories increased by $1.4 million due to the ramp-up of production for our new products, GenesisPlus and Excel V. And our accounts receivable increased by $830,000 due to the increased revenue during the quarter. Due to the leverage in our business model as our revenue improves, this result in improved profitability in cash flows from operation. Net accounts receivable at the end of the third quarter of 2011 were $4.1 million, and our DSOs were 24 days. Inventories at the end of the third quarter of 2011 were $9.7 million and our inventories are turning approximately 3x per year, which is in line with our previous inventory turns.

Now that I concluded my overview of Cutera's operating and financial performance, I'll turn the call back to Kevin.

Kevin P. Connors

Thank you, Ron. During the fourth quarter of 2011, we remain focused on the following key initiatives: One, expand our global sales and marketing activities for our GenesisPlus product into the podiatry specialty and other physician categories; two, increased revenue from our core market through sales of our existing and Excel V product offerings, this will include developing market reference sites with key opinion leaders and expanding the clinical research of Excel V capabilities; three, launch our myQ Q-switched laser in Japan; four, continued improvement of productivity of our North American sales team; five, restructuring our European sales management team that includes many initiatives to drive revenue growth; six, continue focus on research and development efforts to enable new product launches in the future, as well as build on the clinical support of our existing products; seven, focus on many internal initiatives to drive our gross margins higher and leverage our operating expenses.

With appropriate swift execution of these important initiatives, we remain focused on expanding our global business, which should translate into improved leverage of our operating expenses, resulting in an improved operating performance.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Anthony Vendetti from Maxim Group.

Anthony V. Vendetti - Maxim Group LLC, Research Division

Ron, did you mention what percent of sales was podiatry? I thought I heard the number there.

Ronald J. Santilli

We said 60% of our North American orders came from the podiatry specialty. Outside North America, we sell primarily to the core physician.

Anthony V. Vendetti - Maxim Group LLC, Research Division

Right, right, right. When you -- can you distinguish what you mean by orders are not -- so those were not actual sales for the quarter, correct?

Ronald J. Santilli

The order rate that came in, but not necessarily reflected as revenue. The same figures we've been reporting all along, orders by specialty.

Kevin P. Connors

That's a unit analysis, Anthony. Not sales volume.

Anthony V. Vendetti - Maxim Group LLC, Research Division

Yes. That's what I thought. Okay. So, Kevin, you said in the prepared remarks, the GenesisPlus and the Excel V drove a significant portion of revenue. So if we look at the orders, would it be reasonable to say that over 50% of sales were from GenesisPlus and Excel V? Would that be a reasonable assumption?

Kevin P. Connors

Yes. For competitive reasons, we only give that much granularity. I think, we've broken out the podiatry unit analysis to give you a sense of how important that is in our domestic business. But beyond that, we don't want to discuss much more.

Anthony V. Vendetti - Maxim Group LLC, Research Division

Okay. And if you can -- you said you're putting more dollars into R&D and expecting some new technology to come out of that. Is there a timeline for 2012 in terms of new product introductions or a number or anything like that?

Kevin P. Connors

Well, I assume, you'll be at the AAD down in San Diego in the first quarter, we'll have something in the booth to show you.

Anthony V. Vendetti - Maxim Group LLC, Research Division

Okay. So there will be one new one there. Okay, excellent. Can you talk about the -- a little bit more about the competitive landscape. I mean, there's a number of products out there, I mean, Titan was one of the first ones to come out to target non-invasive fat or to target circumferential reduction. There's obviously some other products that have come out, a notable IPO. Can you talk about just clinically, how you feel the Titan product and technology stacks up against these other technologies?

Kevin P. Connors

Well, I think in the case of Titan, it's used primarily on the face, it's used on the body as well. But most of our customers do use it on the face. And so the products you're alluding to are used on the abdomen, love handles and other parts of the body. So they are addressing different parts of the market. But that said, we also have a great interest in continuing to expand our portfolio of products, and we think that there's other non-invasive body contouring categories that are of interest to us.

Anthony V. Vendetti - Maxim Group LLC, Research Division

Okay. Are there any other -- so you see other, either line extensions or application extensions have tightened or various other products that could address body contouring that you may have in development?

Kevin P. Connors

Well, I think both categories are exciting. So I think our Titan business, even during the economic pullback, has shown great robustness, barring the onetime recall that we had. So I think there's a continued demand in the marketplace for it, and where we found the most successes is where we really focused on the procedure itself. And our business in Japan is one where our sales organization tends to stay very close with their customers and help them with the treatment protocol updates, and the Titan revenue there is at record levels per capita. So I think there's some lessons there as we to continue to educate our customers about our products, they tend to use them more.

Anthony V. Vendetti - Maxim Group LLC, Research Division

Okay. And then on the gross margin, Ron, you mentioned there was some unfavorable product mix. And then obviously, the third-party distributors. Did you say, you expect that to improve? And is there a number we should be targeting going forward? Or is that a fluid situation at this point?

Ronald J. Santilli

Anthony, I don't know for sure the answer because product mix shifts from quarter-to-quarter. But this particular one, there was a bit of a shift in it and it was an unfavorable product mix shift. And then of course, there was the -- within the distributor model. But I suspect, we have many initiatives to drive our gross margins up in the future.

Anthony V. Vendetti - Maxim Group LLC, Research Division

Okay. And then just lastly, on the European sales restructuring, is that largely complete? Or is that something that should be complete by the end of the year?

Kevin P. Connors

We've made some strides in that direction, we've -- the basic premise there is, that we see a large opportunity in Europe that we have under-penetrated, so we're looking to make some substantial strides to change that. We think our products bode very well there, particularly products like Excel V, where this wavelength is very well embraced in Europe and we want to get our fair share. So it's important that we have the right sales infrastructure on the ground there in Europe. And we think it's going to have a material positive impact as we look at the next year in particular.

Anthony V. Vendetti - Maxim Group LLC, Research Division

Okay. And then lastly on Asia and the Pac Rim. Other companies have indicated a little bit of softness there. It seem like your numbers there were okay to positive. Anything that you think you're doing there, doing different, before the launch of the myQ Q-switched laser?

Kevin P. Connors

Well, we're actually delighted with our business in that region. Our business in Japan continues to be robust. And as we've talked about on these calls, our ability to offer our customers not just energy sources, the capital equipment products, but injectables and topicals, we really think that's made a nice difference. And then we're very pleased with our distributor business in the region, as well as our business in Australia. So I think the new products are only going to augment our performance, if we're able to execute properly.

Operator

[Operator Instructions] Our next question comes from the line of Morris Ajzenman from Griffin Securities.

Morris Ajzenman - Griffin Securities, Inc., Research Division

Just a little further clarity. In the press release, you talked about, I guess, looking into the fourth quarter, you just gave a comment, we expect will result in improved margins and cash flow in the fourth quarter 2011 compared to 2010. Are we referring to gross margins? Operating margins? What are we referencing, when we say improve the margins in the fourth quarter year-over-year?

Ronald J. Santilli

I think, Morris, in general, all margins. We're always expecting to increase. We have many initiatives internally to improve our gross margins. We want to improve our profitability and we wanted to get back to a cash generation perspective.

Morris Ajzenman - Griffin Securities, Inc., Research Division

Okay. So last year in the fourth quarter, if I'm correct, gross margin was 59%. Based on what you just said there, we should expect to see increase from the fourth quarter gross margin of last year, is that fair?

Ronald J. Santilli

It's certainly possible.

Morris Ajzenman - Griffin Securities, Inc., Research Division

Okay. And any comment on revenues. I know, Kevin, you've said you want to increase revenues. Is it fair to look at -- it doesn't matter if you look at it sequentially year-over-year, coincidently doable at $15.2 million last year and the most recent quarter. Can we expect, again, assuming no major catastrophe happens worldwide, that revenues should grow?

Kevin P. Connors

Well, we don't give that. But the fact that we're looking to expand our sales force should give you some indications on how we're looking at the future.

Operator

Our next question comes from the line of Larry Haimovitch from HMTC.

Larry Haimovitch - Haimovitch Medical Technology Consultants

Kevin, I have a question and I also have a comment. My question is, when I look at the aesthetic space today, some of the most rapid growth is coming in areas where the companies have developed consumer-attractive products that are going straight to the consumer channel and actually bypassing the physician completely. I'm thinking of things like TRIA. I'm wondering in the long-term strategic plan that you're working on all the time, I'm sure, Kevin. Where does this sit in Cutera's future?

Kevin P. Connors

Well, in the case of the company you mentioned, they're privately-held company and so as such, we don't get access to their financial performance. But it's my understanding that it's been quite a cash-rich investment reaching out to the consumer with products that are developed to the consumer and having the right distribution strategy in place. So that's really not in our sweet spot. Not to say that we don't keep our finger on the pulse of what's happening in that space, we do. But right now, we're standing on the sidelines until we see a real opportunity emerge. But so far, there have been companies that have been in there and generate some revenue, but it's not clear that this is a profitable endeavor. And we would rather direct our efforts towards the professional market, and our strategy has been to focus on core physician, launch of the Excel V. We're getting a very warm reception from dermatologists and plastic surgeons. So that's kind of a different strategy from some of our competitors.

Larry Haimovitch - Haimovitch Medical Technology Consultants

Great. And then perhaps a request or a comment. Conference calls are meant to be for all of us and it should not become one-way interviews by analysts. And I would request that both of you, think in the future, of letting people ask 1, 2 or 3 questions and not 10 questions. We have limited time and I don't think it's fair to allow someone to dominate with question-after-question-after-question. Ultimately, Kevin, it's your responsibility as the CEO and Ron, as the CFO, to police that. So I would just like to make that request.

Kevin P. Connors

Yes, I hear you, Larry. It's -- we kind of make this the most efficient use of everybody's time and Ron and I are accessible to all of our investors. So it's important that we be accessible and I spend time in the road to meet the investors face-to-face. So investor relations are important part of our business.

Larry Haimovitch - Haimovitch Medical Technology Consultants

No, I understand. But I mean, when someone comes on a conference call and asks 10 questions and monopolizes the time, that's my complaint.

Kevin P. Connors

All right. Understood.

Operator

Gentlemen, there are no further questions left in the queue. I'd like to hand the call back over to management for closing comments.

John Mills

Thank you for participating on our call today. We look forward to seeing you at the Piper Jaffrey Healthcare Conference in New York on November 29, and the Cannaccord Genuity Conference in San Francisco on December 6. We will update you on our business progress on the fourth quarter conference call in February 2012. Good afternoon, and thanks for your continued interest in Cutera.

Operator

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

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