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Cutera, Inc. (NASDAQ:CUTR)

Q3 2007 Earnings Call

November 5, 2007, 5:00 pm ET

Executives

John Mills - Integrated Corporate Relations

Kevin Connors - President and Chief Executive Officer

Ron Santilli - Chief Financial Officer

Analysts

Phil Nalbone - RBC Capital

Tom Gunderson - Piper Jaffray

Anthony Vendetti - Maxim Group

DaltonChandler - Needham & Company

Jose Haresco - Merriman

Bruce Wilcox - Cumberland Associates

Evan Jones - Bright Leaf Capital

Operator

Good day everyone and welcome to Cutera Inc. third quarter 2007 earnings results conference call. [Operator Instructions] I would now like to turn the call over to Mr. John Mills of Integrated Corporate Relations, please go ahead sir.

John Mills

Thank you. By now everyone should have access to the third quarter 2007 earnings release, which went out today at approximately 4 pm Eastern time. The release is available on the Investor Relations portion of Cutera’s website at Cutera.com and with our Form 8-K filed 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 about future financial performance, the planned expansion of our sales force, distribution networks and customer base, the planned improvements in our distributor and national accounts relationship, and increase in market share, the long term domestic and international growth opportunities and strategies, future spending on various aspects of our operations and the success of our recently launched Pearl product and the development and acquisition of other new products and applications and their anticipated introduction dates.

Also, management may make additional forward looking statements in response to your questions. Factors that could cause Cutera’s actual results to differ materially from these forward looking statements include: its ability to improve sales productivity and increased sales performance worldwide; the length of the sales cycle process; its ability to successfully develop and acquire new products and market them to both its installed base and new customers; unforeseen events and circumstances related to its operations; government regulatory actions; general economic conditions and growth rates of our industry; and as other factors described in the section titled Risk Factors in its most recent 10-Q filed today with the SEC.

These forward looking statements do not guarantee future performance and therefore you should not reply on them in making an investment decision without considering the risk associated with such statements. Cutera also cautions you to not place undue reliance on forward looking statements, especially those related to guidance on future financial performance, which speaks 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.

With that, I will turn the call over to the Company’s President and Chief Executive Officer, Mr. Kevin Connors. Go ahead Kevin.

Kevin Connors

Thank you, John. Good afternoon everyone and thanks for joining us today to discuss Cutera’s results for the third quarter ended September 30th, 2007. On today’s call, I will provide an overview of our results and Ron Santilli, our CFO, will provide additional details on our operating and financial results. Finally, I will provide some closing comments and open the call to your questions.

Our revenue for the third quarter of 2007 was $28.1 million or 12% higher than the $25.1 million reported in the third quarter of 2006. GAAP diluted earnings per share improved to $0.22 in the third quarter of 2007 compared to $0.21 in the third quarter 2006. We are pleased to have achieved revenue growth in all of our major geographic markets. This growth was driven by our continuing implementation of the following strategic initiatives: our Pearl product, which we launched in the second quarter of 2007 continues to receive strong market acceptance and in our second quarter we offered introductory discount pricing on Pearl upgrades in an effort to build a quick reference base, which we anticipate will lead to greater future sales.

During the third quarter of 2007, we achieved record quarterly upgrade revenue of $5 million due primarily to Pearl upgrades. We are very pleased with the positive feedback from both customers and patients. We believe that this product will continue to build sales momentum in the future.

Additionally, our continuing investments in our international sales and marketing efforts have resulted in 35% growth in our international revenue in the third quarter, when compared to third quarter of 2006. We are seeing solid performance and a significant number of our international markets and are continuing to expand our commitments in those markets. We also continue to expand our North American sales force. We’ve reached 64 sales territories at the end of the third quarter 2007, which was our target for the end of the year.

Our new Pearl product, as with our earlier introduction of Titan, allows us to compete in an emerging segment of the skin rejuvenation market. It provides us with excellent opportunities to sell more systems to new customers and to sell upgrades to our large and expanding install base. Our install base has been quick to embrace this technology as is evidenced by the significant increase in our pro upgrade sales. In contrast, the adoption rate for Pearl, by new customers, was slower than we expected during the third quarter 2007. We expect new customer sales of Pearl to increase as we continue developing our clinical support in educating the market about the significant benefits of Pearl.

Our customers report a high level of patient satisfaction with Pearl, including significantly less discomfort, fewer treatments and less downtime, compared to more invasive competing solutions. We are focusing on a number of initiatives, which should position Pearl for even a more important part of our product offering in the future.

We are pleased with our 35% growth in international revenue, compared to the third quarter 2006. We achieved improvements in both our Asian and European markets, from both of our direct sales organizations particularly in Canada and Australia and our distributor network. We received regulatory approval during the third quarter to market and sell Pearl in Europe and in Canada and I believe that this will help increase our international revenue. We also just announced that opening of second sales office in Japan to better address the needs of new customers. We will continue investing in international markets, as we believe they provide excellent long term growth opportunities.

Regarding North American sales force expansion; we have achieved our 2007 year end target of 64 sales territories ahead of schedule. During the first nine months of this year, we added 33 direct sales people to this team representing the most extensive expansion in our history. We are pleased with the level of talent and we will maintain management’s focus on developing that team.

I’d like to address our decision to discontinue giving financial guidance. A number of factors made it more difficult to accurately predict our future financial performance. As such, we have elected to discontinue giving financial guidance at this time and are withdrawing our previously provided guidance. The most significant factors for this change are as follows; a significant number of our publicly traded companies, competitors, have reported their results for the September 30th quarter, many of whom are showing reduced growth rates, particularly in the US market, which represents approximately two thirds of our business. This could indicate signs of a slowing market growth rate, which should make it more difficult to predict financial performance.

Also, as I mentioned, the adoption rate of Pearl by new customers in the third quarter of 2007 did not meet our expectations. While we remain excited about the Pearl offering and are focused on expanding its market penetration, we believe that we will have better visibility of new sales once we improve our clinical story and better educate the market.

Also, as I mentioned, over 50% of our current North American sales force was hired during the past nine months. While we are pleased with the level of talent and expect to maintain management’s focus on developing them, it will be difficult to accurately predict their performance in the short term. We will closely monitor these factors.

We are continuing to generate cash from operations demonstrating strong leverage in our business model. We ended the quarter with approximately $100 million in cash and marketable securities with no debt. During the third quarter we successfully concluded our stock repurchase plan that we announced in the second quarter of 2007. Under this plan, we acquired 1.1 million shares of our common stock for $25 million.

We are continuing to see high demand for our products outside the core specialties. During the third quarter of 2007 we have booked approximately 20% of our system orders from traditional dermatologists and plastic surgeon specialties. In contrast, 32% of our third quarter 2007 orders came from family practitioners, 5% from OB-GYNs, 13% from other physicians and approximately 30% from med spa businesses.

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

Ron Santilli

Thanks Kevin, and thanks to you all for joining us today on our third quarter earnings release conference call. Before I begin, please note that all of our historical financial performance comments are expressed in GAAP numbers. In addition, to supplement the GAAP numbers, we have provided non-GAAP net income and non-GAAP diluted income per share information that excludes the after tax impact of all stock based compensation expense. We believe that this non-GAAP information provides you with insight to conduct a more meaningful and consistent comparison of our ongoing operating results and trends, compared with the historical results. A table reconciling the GAAP financial information to the non-GAAP information is included in our earnings release.

Beginning with our first quarter 2008 earnings release, we plan to provide only GAAP information, since stock based compensation will be included in the historical 2007 numbers, thus providing you with a meaningful and consistent comparison.

Third quarter 2007 revenue was $28.1 million, a 12% increase when compared to the third quarter of 2006. Net income for the third quarter of 2007 was $3.1 million, or $0.22 per diluted share.

Non-GAAP net income for the third quarter of 2007 and 2006 was $4.2 million, or $0.30 per diluted share. Product revenue in the third quarter of 2007 decreased by 6%, compared to the third quarter of 2006, these results reflected lower levels of product revenue in the US.

Upgrade revenue in the third quarter of 2007 was $5 million, a new Cutera quarterly record for upgrade revenue. This growth was driven by a strong acceptance of our Pearl product by our existing customers. As we have with previous product introductions, we have provided an affordable upgrade path for our customers to acquire this new technology and application, and are encouraged by our customer interest.

Service revenue in the third quarter of 2007 increased by 46%, compared to the third quarter of 2006. We expect this revenue source to continue growing, as the size of our install base continues to increase and customers continue using our services to maintain their products after their initial warranty periods expire. Titan resale revenue in the third quarter of 2007 increased by 14%, compared to the third quarter of 2006. Titan remains a popular application that is sold on a majority of our Xeo systems.

I will now address our operating performance. Our gross margin in the third quarter of 2007 was 66%, compared to 68% in the third quarter of 2006. This rate is slightly lower than we expected due primarily to the lower introductory margins on our Pearl product.

Sales and marketing expenses for the third quarter of 2007 were $10.6 million, or 38% of revenue compared to $8.2 million, or 33% of revenue, for the third quarter of 2006. The increased expenses were primarily due to our North American and international sales force expansion efforts.

Research and development expenses in the third quarter of 2007 were $1.8 million, or 6% of revenue, compared to $1.7 million, or 7% of revenue, in the third quarter of 2006. We intend to continue increasing our investment in this area in our pursuit to develop new and innovative products and applications.

General and administrative expenses for the third quarter of 2007 were $3.1 million, or 11% of revenue, compared with $3 million or 12% of revenue in the third quarter of 2006. Our effective income tax rate for the third quarter of 2007 was 26% of revenue with 26% for the year to date September 30, 2007, our effective tax rate was 31%.

Turning to EPS, please now refer to the non-GAAP reconciliation of our net income and EPS provided in our earnings release. On a GAAP basis, net income per diluted share for the third quarter of 2007 improved to $0.22 from, compared to $0.21 in the same period of 2006. Non-GAAP net income per diluted share remained flat at $0.30 in the third quarter of 2007, compared with 2006. The $0.08 difference between GAAP and non-GAAP EPS represent the after tax impact of the $1.5 million non cash stock based compensation expenses as recorded in accordance with files 123R.

Turning to the balance sheet, our financial position and cash flows from operations continue to remain very strong. As of September 30, 2007, we had approximately $100 million of cash in marketable securities. This represents approximately $7.85 per outstanding share. For the third quarter of 2007, cash generated by operations was $5.1 million. During the third quarter, we successfully concluded our stock repurchase plan that we had announced in the second quarter of 2007. Under this plan we acquired 1.1 million shares of our common stock for $25 million.

Net accounts receivable at the end of the third quarter of 2007 was $11.5 million and the DSOs were 38 days. Our DSOs continue to remain among the best in the industry and within our target of 35 to 45 days due to a thorough credit approval process and strong collection efforts.

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

Kevin Connors

Thanks Ron. We have made significant strides towards improving our performance levels. We have expanded our North American sales territories ahead of plan, and increased our sales management to help leverage future sales. During the quarter, our international revenue grew 35% compared to third quarter 2006 and we've achieved some improvements in both our Asian and European markets. We are pleased with the progress, and we'll continue investing in the international markets; we believe they provide excellent long term growth opportunities.

We are excited about Pearl’s significant potential as evidenced by our record upgrade revenue for the third quarter 2007. We believe that as we continue developing clinical support and educating the market about the benefits of Pearl over the competing solutions, system sales to new customers will increase. We have one of the most diverse product lines in the industry. We enjoy healthy operating margins and strong cash flow. I believe we manage a strong balance sheet with over $100 million in cash and marketable securities with no debt.

Now I’d like to open up the call for your questions.

Question & Answer Session

Operator

[Operator Instructions] Our first question will go to Phil Nalbone of RBC Capital.

Phil Nalbone - RBC Capital

Okay, I’ll take it. Thank you very much and good afternoon. Kevin, let’s start with kind of a view of the macro environment. Can you give us some sense for what your seasoned sales reps in the field are communicating back to you right now about the general tone of the market; customer sentiment and what seems to be happening to the sales cycle and really to the point here, are you sensing that your customers, the physicians and day spas are seeing any noticeable change in their patient flows or demand or procedure volumes?

Kevin Connors

Yes, Phil. In terms of what we hear from our customers, that there is nothing clear in that there is any change to their fundamental business. Our current owners are reporting some more patient interest than they have in the past, so I don’t think we’re seeing any impact at the patient level. In terms of the sales cycle, I can’t say we’ve seen the sales cycle really stretch out either. As you know, the summer quarter is one where much of the business happens in September, and we certainly experienced that, but as far as we are hearing from our customers through our user surveys, we are not hearing any erosion in their core business with our products.

Phil Nalbone - RBC Capital

Okay. So, given that reality about end user demand, what do you think has been happening to change the tone of the market? To change the ability to predict what purchase decisions are going to look like?

Kevin Connors

Well for us, Phil, we monitor what’s going on in the entire industry and keep a very close eye on all the publicly traded competitors in our space, and historically, the growth rate has been North at 20% a year and as high as 35 plus percent. The second quarter, the publicly traded companies look like they grew about 20%, which is the exact same growth rate from the previous year. The information we have for the September quarter, which suggested that growth rates really hold back significantly to half that level.

Granted, it’s the summer quarter, which is typically a slow quarter in our space, and it’s unclear to us whether it’s the sign of a trend or potentially just a softer summer quarter. Now for Cutera our summer quarter happened to be our second highest in history, but we certainly take a lot of cues from what we see in the results from our competitors, as well, and that’s one of the reasons that we’ve opted to discontinue guidance until we can get better clarity of what’s going on in the broader market trends.

Phil Nalbone - RBC Capital

Okay, Kevin. How was it that you were able to add so many people to the US direct sales force during the September quarter, where did these people come from, are they coming from competitors, are they experienced in the aesthetic laser market, can they achieve full productivity sooner than we have generally expected? I think our general expectation for that learning curve is about 9 months.

Kevin Connors

That’s true, Phil, and we plan for 9 months ramp up for new hires. We were pleased with our sales management team's ability to expand aggressively as they did in the third quarter, and I think we were able to achieve that, because we made some significant investments in the sales management infrastructure, and promoted a number of our top producers into sales management roles or they’ll transition into that in the fourth quarter, and go into a full time sales management role come January 1. So, we built the sales management infrastructure and the training in anticipation of this pretty heroic initiative, but we spent a lot more time in the hiring process, we had some outside resources provide us a higher level candidate than we've seen in recent quarters, and we think the caliber of the people that we have generally is quite high.

So, we have a fair amount of positive indications that we've been successful in hiring people. Most of them have not been from within our industry, and statistically, we haven't been able to demonstrate that hiring industry people has a direct correlation into performance. It's been kind of a mixed experience, and with the sales people here at Cutera.

Phil Nalbone - RBC Capital

Okay. Kevin, can you talk a little bit about how you're managing this process, you're adding a lot of people very quickly, you're really restructuring the sales force, you're going to make a bunch of top producers, managers. How do you do all that without being disruptive to the selling effort going forward, and how do you do all this while insuring that you maintain the loyalty and the focus of your existing experienced reps as their territories get segmented?

Kevin Connors

It is a delicate process, Phil, and it is a large undertaking, there's no question about that. But as much as we can, we try to anticipate where the needs would be and try to identify solutions in advance of the expansion. I alluded to the fact that we identified our next wave of sales managers from within, and we're happy that we have the talent from within to promote people to these roles, but we are transitioning from a sales role into a full management role during the second half of this year with the plan for them to be in a full time management role for all of next year.

Phil Nalbone - RBC Capital

Okay. Thank you very much.

Operator

Our next question will go to Tom Gunderson at Piper Jaffray. Please go ahead, sir.

Tom Gunderson - Piper Jaffray

Good afternoon. Let’s do an easy one first, tax rate, 31%; I assume that's what we use going forward for the rest of the year. Where did the improvement come from?

Ron Santilli

For the current quarter, is that what you're referring to Tom?

Tom Gunderson - Piper Jaffray

Well, yes. You went 26% for the quarter, but I’m assuming some of that is back tracking for Q1 and Q2, is that right?

Ron Santilli

Yes, that's what that would be. Otherwise, the rest is just a function of where the income is sourced, internationally, domestic, and estimates that we use in coming up with our estimated tax rate. So 31% would probably be a good number in going forward.

Tom Gunderson - Piper Jaffray

Okay, and then, Kevin, speaking of going forward, I mean I think this is going to be the focus for a while here on Cutera, not giving guidance and then if I've got this right, the other companies reporting in reduced growth rates in the US, the Pearl, sales to new customers didn't meet expectations and, I apologize I didn't hear, did you hit your rate with upgrades that you expected in Q3?

Kevin Connors

Well, we're pleased with the upgrade business. We didn't set specific targets for our upgrade revenue, but philosophically, anytime we launch a new application we do it with the hope of opening new doors to new customers, and so, we did have certain expectations that we'd sell more new systems to generate new customers for Cutera. The upgrade business is an important component for our customers and they appreciate having the ability to have a platform that upgrades to new applications as we’ve done for all these years.

Tom Gunderson - Piper Jaffray

So you were satisfied in the September quarter with the upgrades on Pearl?

Kevin Connors

Yes absolutely.

Tom Gunderson - Piper Jaffray

Okay, and then the last one was 50% of your sales force has been hired in the last nine months. You focus on the public companies but unusually in this particular laser business there’s more private companies than public companies and I’m wondering if you have any visibility on, I am hearing more about AOMA, I’m hearing more about CYTON and I don’t know if that’s just that I’m hearing about it or whether they’re starting to dig in and get some traction, but I’m wondering if that has any impact on your view of the market?

Kevin Connors

No, Tom, it really doesn’t. As much as possible we try to get as much information as we can about what’s going on in terms of real numbers with our competition and we do come up with guesstimates for the privates out there. There are significant numbers of them out there but we still think the lions share of the revenues are coming from the publicly traded companies in the space.

Tom Gunderson - Piper Jaffray

Okay and then ever since the sales shake up that we had earlier in the year and it looks like things have calm down now but you’ve been focused on having 20% growth for next year. That was your mantra, should we assume that that 20% is still intact given that you’re early on the sales force, your customers are still seeing the demand and you still have the launch of the Pearl, most of the launch of the Pearl in front of you?

Kevin Connors

Yes Tom, I think you know that historically we give guidance for the following year on the fourth quarter call. We plan to discuss what’s going on in the marketplace at that point. But right now we’ve got so many different moving parts in terms of the industry, we’re holding off on guidance until we have a sense of, more confidence that we understand what’s going on there.

Tom Gunderson - Piper Jaffray

Okay. Just a simple one again and last one for now, the Pearl upgrade cost to the customers is what?

Kevin Connors

We touched on it in the script but in the second quarter we ran a promotion for our install base and the goal being to build the Pearl story by getting a significant install base and also assisting with the training and things of that nature. So, we started with an upgrade promotion of $40,000 in the second quarter, the third quarter that price increased to $50,000 and then as we have entered the fourth quarter we’ve raised it again to $60,000 list price a Pearl upgrade.

Tom Gunderson - Piper Jaffray

Okay and you’re not seeing any push back on the $60,000 so far?

Kevin Connors

Well, we’re early in the quarter Tom, so we’ll have more to discuss with you when we talk about the fourth quarter. We continue to be very positive about Pearl just based on the fact that we’ve got really happy customers and patients that love the procedure. We are confronted with a market that knows a lot about the competing technologies out there, namely Fraxel and a whole variety of different technologies to try to address the Fraxel product, and we’ve been focusing on the benefits of what Pearl can provide relative to the Fraxel alternatives today.

Tom Gunderson - Piper Jaffray

Just a quick follow up Kevin, those 40 goes to 50 goes to 60, the customers knew those were coming at a pre defined date?

Kevin Connors

We have announced them to the sales force in advance, so we gave our customers the opportunity to close business at each quarter at those locked in prices.

Tom Gunderson - Piper Jaffray

Got it. Thank you.

Operator

We’ll next go to Anthony Vendetti at Maxim Group. Please go ahead.

Anthony Vendetti - Maxim Group

Thanks, good afternoon. Just to focus a little bit more on ASPs, obviously newer products like the Pearl you’re able to charge a premium for and ratchet prices up. Can you talk about, because some of your competitors have mentioned that some of the Legacy products have seen some ASP pressure and your gross margin did drop again a little bit this quarter, could you talk a little bit about the pricing on some of the older Legacy products, some of the hair removal products, and so forth?

Kevin Connors

We did the analysis on our gross margin downward pick. It wasn’t a significant one, but after looking at the data it was determined that we could attribute that to the promotional pricing on Pearl. The market as has been reported by the competitors you mention it, some of them are reporting pricing pressure and we didn’t see a significant change outside of the Pearl promotion, but we are certainly monitoring it very closely and that’s another thing that makes it more difficult for us to predict our financial future.

Anthony Vendetti - Maxim Group

Okay, I guess in terms of the financial guidance going forward there are, and I think you mentioned this too, you haven’t seen really an elongation of the sales cycle, and are physicians actually delaying purchasing. Because I’m just trying to figure out if that has something to do with it, or is it just the overall slowdown in the market that you’re seeing from competitors, that’s causing you to kind of step back?

Kevin Connors

Well, the main reason we’re stepping back, it’s just looking at the data we’re seeing from our publicly traded competitors, that’s certainly the one that got our attention, more than anything else. The reasons for customers holding off, we’re not convinced we fully understand them. We have a number of ideas about why they’re holding off, and it could be that there’s just a general cautious environment for the meantime, but we don’t know if this is the sign of a trend, or just a slightly slower summer quarter for the industry.

Anthony Vendetti - Maxim Group

So in terms of the Legacy products, even though you’re not seeing any pricing pressure, are you seeing a drop off in actual interest in purchasing those products at this point?

Kevin Connors

No. I can’t say we are. We look at our lead activity, and that looks very strong. So again, Anthony, its kind of mixed signals here we just want to make sure that we’re communicating responsibly about what we see on the horizon.

Anthony Vendetti - Maxim Group

Is it safe to assume that these are relatively new developments, since it looks like you’ve purchased all of the buyback between; it looks like an average price of between $24 and $25, right?

Ron Santilli

In that range, yes. It’s at 1.1 million shares for $25 million. I think we concluded it in August.

Anthony Vendetti - Maxim Group

Okay. Concluded in August. Lastly, on the Titan, the refills picked up a little bit. Can you talk about, just in general, how the sales are going or upgrade sales are going for the Titan?

Kevin Connors

Ron, our Titan business, it still continues to be a [Inaudible] of our Xeo sales?

Ron Santilli

Yes, and the Titan refilled business grew 14%, quarter over quarter, but I would say, on average, more than 50% of our Xeo owners include a Titan on their device.

Anthony Vendetti - Maxim Group

Okay. Thanks. I’ll hop back in the queue.

Operator

Our next question goes to Dalton Chandler at Needham & Company.

DaltonChandler - Needham & Company

First of all, I just wanted to clarify, on the 14% Titan refill that was quarter over quarter or year over year?

Ron Santilli

That’s Q3 06’ to Q3 07.

DaltonChandler - Needham & Company

Okay. Then, on the Pearl sales to new customers being a bit below expectations, can you talk about what you think has happened there. Is it just a lack of understanding about the indication or is it something specific to the product?

Kevin Connors

Yes, Dalton, we basically have come out with a completely different approach to treat that patient that was interested in having a Fraxel procedure, and the things that we try to address with Pearl is to reduce treatment discomfort instead of requiring six to eight procedures, we believe that we’re able to show excellent results with two procedures, and then the operative time, instead of it being an hour per procedure or so, we can offer a 15 minute procedure. So we have many really excited customers and very excited patients about it but it’s a question of educating the market about this new alternative being out there where the market really has heard a lot about the other competing technologies.

DaltonChandler

Okay, and you specifically mentioned positioning it versus the Fraxel, how do you approach that when you go to market with the product?

Kevin Connors

Well, as I said, there is a significant amount of brand recognition with those other Fraxel products in the market, and those procedures have been available for several years now. So, our goal is to demonstrate that this is the next generation in this treatment.

DaltonChandler - Needham & Company

So, but specifically, you’re positioning this as fewer, shorter treatments or similar results?

Kevin Connors

It’s the factors I mentioned just a second ago, it’s far less procedure discomfort, fewer procedures, so we can offer two procedures versus the six to eight, and a very short operative time.

DaltonChandler - Needham & Company

Okay, then, just a final question on the, as you upped the introductory pricing and you’re now at $60,000 for the upgrade, is that the final price point or would you expect that to continue to increase?

Kevin Connors

We’re constantly evaluating our pricing Dalton, but we feel that we’ve got a great technology and relative to the other alternatives in the marketplace we think that this is very aggressively priced.

DaltonChandler - Needham & Company

Okay, and actually I did just have one other question. Given that 3Q is seasonally weak, and it’s usually especially seasonally week internationally, but you had very strong international growth, was that just the new markets that you added going direct or was there something else driving that?

Kevin Connors

Well we touched on some of the bright spots, we’ve seen some pockets of nice growth and we’ve been talking about Canada for quite some time now and we’re continuing to see strong performance there. We’re direct in Australia and that’s turned out to be a nice market for us. We’re continuing to make significant investments in Japan where we’re direct and we see great potential there. We also have a number of new regions where we have a distributor network now and we’ve been able to partner with some excellent distributors out there. So, it’s really kind of a combination of all those things.

DaltonChandler - Needham & Company

Okay, thanks.

Operator

Our next question goes to Jose Haresco at Merriman. Please go ahead.

Jose Haresco - Merriman

Hi good afternoon gentlemen. Just wanted to follow up on the international growth. Could you give us a sense of how much of that growth was driven by direct sales versus distributor sales and then within that distributor category how much of it was existing distributors versus new distributors?

Ron Santilli

Jose, this is Ron. We don’t break out the direct versus indirect for international but I will say the growth was by both, the direct channels as well as the distributor channels. In terms of the distributors, as Kevin had mentioned just a second ago, a lot of that was driven by new distributors that we’ve been working on for the past year in signing up in other various countries.

Jose Haresco - Merriman

Okay. On the upgrade revenue that is obviously up significantly this quarter, is it fair to say that, I guess could you give us a better sense of how much of your install base you’ve kind of worked through this quarter, even qualitatively in terms of upgrading the Pearl, and then are you sensing that that type of enthusiasm for the Pearl across the entire install base or is it pockets or is there some geographic segmentation that is going on?

Ron Santilli

Well, in terms of penetration for the install base, the end of the quarter we have approximately 3,800 units in the field. So that would, from a penetration perspective, would be very small in terms of the numbers of existing customers who have upgraded.

Jose Haresco – Merriman

Okay. Ron, can you give us a better breakdown on the margins for each of these revenue categories here within the domestic market, both on the core products, on services, on Titans and how those margins break out individually?

Ron Santilli

Sure, we don’t specifically break that out but just kind of in general the products appear and upgrades are in similar percentages as what you see on our corporate gross margin. Titan refill business tends to be higher than that and the service business tends to be a little bit lower. The reason the service margins are lower, there’s less cost associated to it, and so it tends to bring a similar bottom line contribution.

Jose Haresco - Merriman

Okay, and is that true for the overseas contributions in each of those revenue lines?

Ron Santilli

Yes, when you look at the overseas contributions, you also have to look at direct versus indirect, but they run in the same direction.

Jose Haresco - Merriman

Okay, all right, thank you very much.

Operator

And our next question goes to Bruce Wilcox at Cumberland Associates. Please go ahead.

Bruce Wilcox - Cumberland Associates

Hi, good evening. Could you just update, what was your share count at the end of the quarter? We have the average in the release but where did you wind up at?

Ron Santilli

I don’t have the exact number but I think the outstanding share count is about 13.5 million.

Bruce Wilcox - Cumberland Associates

So you completed your repurchase authorization, you still have a $100 million of cash. What is the company’s thinking and intent with regards to potentially renewing that?

Kevin Connors

Yes Bruce, this is a subject of discussion frequently at our board meetings and so we certainly have almost every board meeting have had this discussion. I think the board is also interested in finding ways that we can grow the business by strategic partnerships and things of that nature but we visit this topic frequently.

Bruce Wilcox - Cumberland Associates

Okay.

Operator

Anything else Mr. Wilcox?

Bruce Wilcox - Cumberland Consulting Group

No, thank you, that’s fine for now.

Operator

We’ll go next to Evan Jones with Bright Leaf Capital, please go ahead.

Evan Jones - Bright Leaf Capital

Hi, thanks, just trying to get back into the US market a little bit. If we assume that the majority of the product upgrades are Pearl and you deduct that out of the US market, what are the product categories that are turning negative for you in the US?

Kevin Connors

Well, first of all in the second quarter we had very strong upgrade business as well and a negligible amount of that was Pearl, so I think with a larger sales force here North America, I think a lot of the new hires are spending time with our existing customer base and that’s reflected in our increase upgrade business in general. So, I think the overall upgrade opportunity continues to remain very attractive.

Evan Jones - Bright Leaf Capital

Okay, but is there a category of hair removal or skin tightening or one of the other categories that is slower, because I’m just trying to get feel for which of the Legacy business is not kind of keeping up?

Kevin Connors

Well, hair removal continues to be a very popular procedure for us and, probably, a third or so of our procedures are hair removal, so that’s continuing to grow with us. The new category we’re in now with Pearl, we think is growing at a faster rate. We had it pegged at $150 million market growing at about 30% last year, so we believe that one is growing faster.

Evan Jones - Bright Leaf Capital

Okay. Do you give any give any credence that here in the US Market last year you had a bunch of entrepreneurs out there building med spas and that’s where a lot of sales come from that kind of slowed down. The physicians are still buying but the med spa business is not where it was and that’s why of some units are being pulled back across the board with you and your competitors?

Kevin Connors

Its funny you should as that question, because if you look at our historical performance this quarter is actually is one of strongest med spa quarters in history, I’m sure it’s about the strongest. What 30% our business?

Ron Santilli

Thirty percent of the orders taken in Q3.

Kevin Connors

Thirty percent of our orders in the third quarter. So that is a shift for us.

Evan Jones - Bright Leaf Capital

Okay. Thanks a lot.

Operator

At this time I would like to turn the call back to Mr. Connors for any closing comments. Sir.

Kevin Connors

Thank you for participating on our call today. We’ll be presenting at the Piper Jaffray and RBC Healthcare Conferences in the fourth quarter of the year and the Needham Conference in the first quarter of 2008. We look forward to updating you on our progress on our fourth quarter conference call in February. Good afternoon and thanks for your interest in Cutera.

Operator

Thank you that does conclude the call. We do appreciate your participation.

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Source: Cutera Q3 2007 Earnings Call Transcript
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