Cutera Q3 2007 Earnings Call Transcript

Nov. 5.07 | About: Cutera, Inc. (CUTR)

Cutera, Inc. (NASDAQ:CUTR)

Q3 2007 Earnings Call

November 5, 2007, 5:00 pm ET

Executives

John Mills - Integrated CorporateRelations

Kevin Connors - President and ChiefExecutive Officer

Ron Santilli - Chief FinancialOfficer

Analysts

Phil Nalbone - RBC Capital

Tom Gunderson - Piper Jaffray

Anthony Vendetti - Maxim Group

DaltonChandler - Needham& Company

Jose Haresco - Merriman

Bruce Wilcox - CumberlandAssociates

Evan Jones - Bright Leaf Capital

Operator

Good day everyone and welcome toCutera 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 thethird quarter 2007 earnings release, which went out today at approximately 4 pm Eastern time. The release is available onthe Investor Relations portion of Cutera’s website at Cutera.com and with ourForm 8-K filed with the SEC and available on its website at SEC.gov.

Before we begin, Cutera would liketo remind everyone that these prepared remarks contain forward lookingstatements, including statements about future financial performance, theplanned 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 growthopportunities and strategies, future spending on various aspects of ouroperations and the success of our recently launched Pearl product and thedevelopment and acquisition of other new products and applications and theiranticipated introduction dates.

Also, management may makeadditional forward looking statements in response to your questions. Factorsthat could cause Cutera’s actual results to differ materially from theseforward looking statements include: its ability to improve sales productivityand increased sales performance worldwide; the length of the sales cycleprocess; its ability to successfully develop and acquire new products andmarket them to both its installed base and new customers; unforeseen events andcircumstances related to its operations; government regulatory actions; generaleconomic conditions and growth rates of our industry; and as other factors describedin the section titled Risk Factors in its most recent 10-Q filed today with theSEC.

These forward looking statements donot guarantee future performance and therefore you should not reply on them inmaking an investment decision without considering the risk associated with suchstatements. Cutera also cautions you to not place undue reliance on forward lookingstatements, especially those related to guidance on future financialperformance, which speaks only as of the date they were made. Cutera undertakesno obligation to update publicly any forward looking statements to reflect newinformation, events or circumstances after the date they were made or toreflect the occurrence of unanticipated events.

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

Kevin Connors

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

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

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

Additionally, our continuinginvestments in our international sales and marketing efforts have resulted in35% growth in our international revenue in the third quarter, when compared tothird quarter of 2006. We are seeingsolid performance and a significant number of our international markets and arecontinuing to expand our commitments in those markets. We also continue to expand our North Americansales force. We’ve reached 64 sales territories at the end of the third quarter2007, which was our target for the end of the year.

Our new Pearlproduct, as with our earlier introduction of Titan, allows us to compete in anemerging segment of the skin rejuvenation market. It provides us with excellentopportunities to sell more systems to new customers and to sell upgrades to ourlarge and expanding install base. Ourinstall base has been quick to embrace this technology as is evidenced by thesignificant increase in our pro upgrade sales. In contrast, the adoption ratefor Pearl, by new customers, wasslower than we expected during the third quarter 2007. We expect new customersales of Pearl to increase as wecontinue developing our clinical support in educating the market about thesignificant benefits of Pearl.

Our customers report a high levelof 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 ofinitiatives, which should position Pearlfor even a more important part of our product offering in the future.

We are pleased with our 35% growthin international revenue, compared to the third quarter 2006. We achievedimprovements in both our Asian and European markets, from both of our directsales organizations particularly in Canadaand Australiaand our distributor network. We received regulatory approval during the thirdquarter to market and sell Pearl inEurope and in Canadaand I believe that this will help increase our international revenue. We also just announced that opening of secondsales office in Japanto better address the needs of new customers. We will continue investing ininternational markets, as we believe they provide excellent long term growthopportunities.

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

I’d like to address our decision todiscontinue giving financial guidance. A number of factors made it moredifficult to accurately predict our future financial performance. As such, wehave elected to discontinue giving financial guidance at this time and arewithdrawing our previously provided guidance. The most significant factors for this change are as follows; asignificant number of our publicly traded companies, competitors, have reportedtheir results for the September 30th quarter, many of whom are showing reducedgrowth rates, particularly in the USmarket, which represents approximately two thirds of our business. This couldindicate signs of a slowing market growth rate, which should make it moredifficult to predict financial performance.

Also, as I mentioned, the adoptionrate of Pearl by new customers inthe third quarter of 2007 did not meet our expectations. While we remainexcited about the Pearl offering and are focused onexpanding its market penetration, we believe that we will have bettervisibility of new sales once we improve our clinical story and better educatethe market.

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

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

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

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

Ron Santilli

Thanks Kevin, and thanks to you allfor joining us today on our third quarter earnings release conference call.Before I begin, please note that all of our historical financial performancecomments are expressed in GAAP numbers. In addition, to supplement the GAAPnumbers, we have provided non-GAAP net income and non-GAAP diluted income pershare information that excludes the after tax impact of all stock basedcompensation expense. We believe thatthis non-GAAP information provides you with insight to conduct a moremeaningful and consistent comparison of our ongoing operating results andtrends, compared with the historical results. A table reconciling the GAAPfinancial information to the non-GAAP information is included in our earningsrelease.

Beginning with our first quarter2008 earnings release, we plan to provide only GAAP information, since stock basedcompensation will be included in the historical 2007 numbers, thus providingyou 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. Netincome for the third quarter of 2007 was $3.1 million, or $0.22 per dilutedshare.

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

Upgrade revenue in the thirdquarter of 2007 was $5 million, a new Cutera quarterly record for upgraderevenue. This growth was driven by a strong acceptance of our Pearlproduct by our existing customers. As we have with previous productintroductions, we have provided an affordable upgrade path for our customers toacquire this new technology and application, and are encouraged by our customerinterest.

Service revenue in the thirdquarter of 2007 increased by 46%, compared to the third quarter of 2006. Weexpect this revenue source to continue growing, as the size of our install basecontinues to increase and customers continue using our services to maintaintheir products after their initial warranty periods expire. Titan resale revenue in the third quarter of2007 increased by 14%, compared to the third quarter of 2006. Titan remains apopular application that is sold on a majority of our Xeo systems.

I will now address our operatingperformance. Our gross margin in the third quarter of 2007 was 66%, compared to68% in the third quarter of 2006. This rate is slightly lower than we expecteddue primarily to the lower introductory margins on our Pearlproduct.

Sales and marketing expenses forthe 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 increasedexpenses were primarily due to our North American and international sales forceexpansion efforts.

Research and development expensesin 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 tocontinue increasing our investment in this area in our pursuit to develop newand innovative products and applications.

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

Turning to EPS, please now refer tothe non-GAAP reconciliation of our net income and EPS provided in our earningsrelease. On a GAAP basis, net income per diluted share for the third quarter of2007 improved to $0.22 from, compared to $0.21 in the same period of 2006. Non-GAAP net income per diluted shareremained 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 ofthe $1.5 million non cash stock based compensation expenses as recorded inaccordance with files 123R.

Turning to the balance sheet, ourfinancial position and cash flows from operations continue to remain verystrong. As of September 30, 2007,we had approximately $100 million of cash in marketable securities. Thisrepresents approximately $7.85 per outstanding share. For the third quarter of 2007, cash generatedby operations was $5.1 million. During the third quarter, we successfullyconcluded our stock repurchase plan that we had announced in the second quarterof 2007. Under this plan we acquired 1.1 million shares of our common stock for$25 million.

Net accounts receivable at the endof the third quarter of 2007 was $11.5 million and the DSOs were 38 days. OurDSOs continue to remain among the best in the industry and within our target of35 to 45 days due to a thorough credit approval process and strong collectionefforts.

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

Kevin Connors

Thanks Ron. We have madesignificant strides towards improving our performance levels. We have expandedour North American sales territories ahead of plan, and increased our salesmanagement to help leverage future sales. During the quarter, our internationalrevenue grew 35% compared to third quarter 2006 and we've achieved someimprovements in both our Asian and European markets. We are pleased with theprogress, and we'll continue investing in the international markets; we believethey provide excellent long term growth opportunities.

We are excited about Pearl’ssignificant potential as evidenced by our record upgrade revenue for the thirdquarter 2007. We believe that as we continue developing clinical support andeducating the market about the benefits of Pearlover the competing solutions, system sales to new customers will increase. Wehave one of the most diverse product lines in the industry. We enjoy healthyoperating margins and strong cash flow. I believe we manage a strong balancesheet with over $100 million in cash and marketable securities with no debt.

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

Question & Answer Session

Operator

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

Phil Nalbone - RBC Capital

Okay, I’ll take it. Thank you verymuch and good afternoon. Kevin, let’sstart with kind of a view of the macro environment. Can you give us some sensefor what your seasoned sales reps in the field are communicating back to youright now about the general tone of the market; customer sentiment and whatseems to be happening to the sales cycle and really to the point here, are yousensing that your customers, the physicians and day spas are seeing anynoticeable change in their patient flows or demand or procedure volumes?

Kevin Connors

Yes, Phil. In terms of what we hearfrom our customers, that there is nothing clear in that there is any change totheir fundamental business. Our current owners are reporting some more patientinterest than they have in the past, so I don’t think we’re seeing any impactat the patient level. In terms of the sales cycle, I can’t say we’ve seen thesales cycle really stretch out either. Asyou know, the summer quarter is one where much of the business happens inSeptember, and we certainly experienced that, but as far as we are hearing fromour customers through our user surveys, we are not hearing any erosion in theircore business with our products.

Phil Nalbone - RBC Capital

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

Kevin Connors

Well for us, Phil, we monitorwhat’s going on in the entire industry and keep a very close eye on all thepublicly traded competitors in our space, and historically, the growth rate hasbeen North at 20% a year and as high as 35 plus percent. The second quarter, the publicly tradedcompanies look like they grew about 20%, which is the exact same growth ratefrom the previous year. The informationwe have for the September quarter, which suggested that growth rates really holdback 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 whetherit’s the sign of a trend or potentially just a softer summer quarter. Now forCutera our summer quarter happened to be our second highest in history, but wecertainly take a lot of cues from what we see in the results from ourcompetitors, as well, and that’s one of the reasons that we’ve opted todiscontinue guidance until we can get better clarity of what’s going on in thebroader market trends.

Phil Nalbone - RBC Capital

Okay, Kevin. How was it that youwere able to add so many people to the USdirect sales force during the September quarter, where did these people comefrom, are they coming from competitors, are they experienced in the aestheticlaser market, can they achieve full productivity sooner than we have generallyexpected? I think our generalexpectation for that learning curve is about 9 months.

Kevin Connors

That’s true, Phil, and we plan for9 months ramp up for new hires. We were pleased with our sales managementteam's ability to expand aggressively as they did in the third quarter, and Ithink we were able to achieve that, because we made some significantinvestments in the sales management infrastructure, and promoted a number ofour top producers into sales management roles or they’ll transition into thatin the fourth quarter, and go into a full time sales management role comeJanuary 1. So, we built the sales management infrastructure and the training inanticipation of this pretty heroic initiative, but we spent a lot more time inthe hiring process, we had some outside resources provide us a higher levelcandidate than we've seen in recent quarters, and we think the caliber of thepeople that we have generally is quite high.

So, we have a fair amount ofpositive indications that we've been successful in hiring people. Most of themhave not been from within our industry, and statistically, we haven't been ableto demonstrate that hiring industry people has a direct correlation intoperformance. It's been kind of a mixed experience, and with the sales peoplehere at Cutera.

Phil Nalbone - RBC Capital

Okay. Kevin, can you talk a littlebit about how you're managing this process, you're adding a lot of people veryquickly, you're really restructuring the sales force, you're going to make abunch of top producers, managers. How doyou 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 thefocus of your existing experienced reps as their territories get segmented?

Kevin Connors

It is a delicate process, Phil, andit is a large undertaking, there's no question about that. But as much as wecan, we try to anticipate where the needs would be and try to identifysolutions in advance of the expansion. I alluded to the fact that we identifiedour next wave of sales managers from within, and we're happy that we have thetalent from within to promote people to these roles, but we are transitioningfrom a sales role into a full management role during the second half of thisyear with the plan for them to be in a full time management role for all ofnext year.

Phil Nalbone - RBC Capital

Okay. Thank you very much.

Operator

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

Tom Gunderson - Piper Jaffray

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

Ron Santilli

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

Tom Gunderson - Piper Jaffray

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

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 estimatedtax rate. So 31% would probably be a good number in going forward.

Tom Gunderson - Piper Jaffray

Okay, and then, Kevin, speaking ofgoing forward, I mean I think this is going to be the focus for a while here onCutera, not giving guidance and then if I've got this right, the othercompanies reporting in reduced growth rates in the US, the Pearl, sales to newcustomers didn't meet expectations and, I apologize I didn't hear, did you hityour rate with upgrades that you expected in Q3?

Kevin Connors

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

Tom Gunderson - Piper Jaffray

So you were satisfied in theSeptember 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 butunusually in this particular laser business there’s more private companies thanpublic companies and I’m wondering if you have any visibility on, I am hearingmore about AOMA, I’m hearing more about CYTON and I don’t know if that’s justthat I’m hearing about it or whether they’re starting to dig in and get sometraction, but I’m wondering if that has any impact on your view of the market?

Kevin Connors

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

Tom Gunderson - Piper Jaffray

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

Kevin Connors

Yes Tom, I think you know thathistorically we give guidance for the following year on the fourth quartercall. We plan to discuss what’s going on in the marketplace at that point. Butright now we’ve got so many different moving parts in terms of the industry, we’reholding off on guidance until we have a sense of, more confidence that weunderstand what’s going on there.

Tom Gunderson - Piper Jaffray

Okay. Just a simple one again andlast one for now, the Pearl upgradecost to the customers is what?

Kevin Connors

We touched on it in the script butin the second quarter we ran a promotion for our install base and the goalbeing to build the Pearl story by getting a significantinstall 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, thethird quarter that price increased to $50,000 and then as we have entered thefourth 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 pushback on the $60,000 so far?

Kevin Connors

Well, we’re early in the quarterTom, so we’ll have more to discuss with you when we talk about the fourth quarter.We continue to be very positive about Pearljust based on the fact that we’ve got really happy customers and patients thatlove the procedure. We are confronted with a market that knows a lot about thecompeting technologies out there, namely Fraxel and a whole variety ofdifferent technologies to try to address the Fraxel product, and we’ve beenfocusing on the benefits of what Pearlcan provide relative to the Fraxel alternatives today.

Tom Gunderson - Piper Jaffray

Just a quick follow up Kevin, those40 goes to 50 goes to 60, the customers knew those were coming at a pre defineddate?

Kevin Connors

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

Tom Gunderson - Piper Jaffray

Got it. Thank you.

Operator

We’ll next go to Anthony Vendettiat 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 Pearlyou’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 Legacyproducts have seen some ASP pressure and your gross margin did drop again alittle bit this quarter, could you talk a little bit about the pricing on someof the older Legacy products, some of the hair removal products, and so forth?

Kevin Connors

We did the analysis on our grossmargin downward pick. It wasn’t a significant one, but after looking at thedata it was determined that we could attribute that to the promotional pricingon Pearl. The market as has beenreported by the competitors you mention it, some of them are reporting pricingpressure and we didn’t see a significant change outside of the Pearlpromotion, but we are certainly monitoring it very closely and that’s anotherthing that makes it more difficult for us to predict our financial future.

Anthony Vendetti - Maxim Group

Okay, I guess in terms of thefinancial 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 physiciansactually delaying purchasing. BecauseI’m just trying to figure out if that has something to do with it, or is it justthe overall slowdown in the market that you’re seeing from competitors, that’scausing you to kind of step back?

Kevin Connors

Well, the main reason we’restepping back, it’s just looking at the data we’re seeing from our publiclytraded competitors, that’s certainly the one that got our attention, more thananything else. The reasons for customers holding off, we’re not convinced wefully understand them. We have a numberof ideas about why they’re holding off, and it could be that there’s just ageneral cautious environment for the meantime, but we don’t know if this is thesign 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 offin actual interest in purchasing those products at this point?

Kevin Connors

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

Anthony Vendetti - Maxim Group

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

Ron Santilli

In that range, yes. It’s at 1.1million 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 stillcontinues to be a [Inaudible] of our Xeo sales?

Ron Santilli

Yes, and the Titan refilledbusiness grew 14%, quarter over quarter, but I would say, on average, more than50% of our Xeo owners include a Titan on their device.

Anthony Vendetti - Maxim Group

Okay. Thanks. I’ll hop back in thequeue.

Operator

Our next question goes to DaltonChandler at Needham & Company.

DaltonChandler - Needham& Company

First of all, I just wanted toclarify, 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 Pearlsales to new customers being a bit below expectations, can you talk about whatyou think has happened there. Is it just a lack of understanding about theindication or is it something specific to the product?

Kevin Connors

Yes, Dalton, we basically have comeout with a completely different approach to treat that patient that wasinterested in having a Fraxel procedure, and the things that we try to addresswith Pearl is to reduce treatment discomfort instead of requiring six to eightprocedures, we believe that we’re able to show excellent results with twoprocedures, and then the operative time, instead of it being an hour per procedureor so, we can offer a 15 minute procedure. So we have many really excitedcustomers and very excited patients about it but it’s a question of educatingthe market about this new alternative being out there where the market reallyhas heard a lot about the other competing technologies.

DaltonChandler

Okay, and you specificallymentioned positioning it versus the Fraxel, how do you approach that when yougo to market with the product?

Kevin Connors

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

DaltonChandler - Needham& Company

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

Kevin Connors

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

DaltonChandler - Needham& Company

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

Kevin Connors

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

DaltonChandler - Needham& Company

Okay, and actually I did just haveone other question. Given that 3Q is seasonally weak, and it’s usuallyespecially seasonally week internationally, but you had very stronginternational growth, was that just the new markets that you added going director was there something else driving that?

Kevin Connors

Well we touched on some of thebright spots, we’ve seen some pockets of nice growth and we’ve been talkingabout Canadafor quite some time now and we’re continuing to see strong performance there.We’re direct in Australiaand that’s turned out to be a nice market for us. We’re continuing to make significantinvestments in Japanwhere we’re direct and we see great potential there. We also have a number ofnew regions where we have a distributor network now and we’ve been able topartner with some excellent distributors out there. So, it’s really kind of acombination of all those things.

DaltonChandler - Needham& Company

Okay, thanks.

Operator

Our next question goes to JoseHaresco at Merriman. Please go ahead.

Jose Haresco - Merriman

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

Ron Santilli

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

Jose Haresco - Merriman

Okay. On the upgrade revenue thatis obviously up significantly this quarter, is it fair to say that, I guesscould you give us a better sense of how much of your install base you’ve kindof 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 theentire install base or is it pockets or is there some geographic segmentationthat is going on?

Ron Santilli

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

Jose Haresco – Merriman

Okay. Ron, can you give us a betterbreakdown on the margins for each of these revenue categories here within thedomestic market, both on the core products, on services, on Titans and howthose margins break out individually?

Ron Santilli

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

Jose Haresco - Merriman

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

Ron Santilli

Yes, when you look at the overseascontributions, you also have to look at direct versus indirect, but they run inthe same direction.

Jose Haresco - Merriman

Okay, all right, thank you verymuch.

Operator

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

Bruce Wilcox - CumberlandAssociates

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

Ron Santilli

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

Bruce Wilcox - CumberlandAssociates

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

Kevin Connors

Yes Bruce, this is a subject ofdiscussion frequently at our board meetings and so we certainly have almostevery board meeting have had this discussion. I think the board is alsointerested in finding ways that we can grow the business by strategicpartnerships and things of that nature but we visit this topic frequently.

Bruce Wilcox - CumberlandAssociates

Okay.

Operator

Anything else Mr. Wilcox?

Bruce Wilcox - CumberlandConsulting Group

No, thank you, that’s fine for now.

Operator

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

Evan Jones - Bright Leaf Capital

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

Kevin Connors

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

Evan Jones - Bright Leaf Capital

Okay, but is there a category ofhair 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 notkind of keeping up?

Kevin Connors

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

Evan Jones - Bright Leaf Capital

Okay. Do you give any give anycredence that here in the US Market last year you had a bunch of entrepreneursout there building med spas and that’s where a lot of sales come from that kindof slowed down. The physicians are still buying but the med spa business is notwhere it was and that’s why of some units are being pulled back across the boardwith you and your competitors?

Kevin Connors

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

Ron Santilli

Thirty percent of the orders takenin Q3.

Kevin Connors

Thirty percent of our orders in thethird 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 turnthe call back to Mr. Connors for any closing comments. Sir.

Kevin Connors

Thank you for participating on ourcall today. We’ll be presenting at the Piper Jaffray and RBC HealthcareConferences in the fourth quarter of the year and the Needham Conference in thefirst quarter of 2008. We look forward to updating you on our progress on ourfourth quarter conference call in February. Good afternoon and thanks for yourinterest in Cutera.

Operator

Thank you that does conclude thecall. We do appreciate your participation.

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