Cutera, Inc.
Q1 2018 Earnings Call Transcript

Published: 9 May 2018

[Operator:]

Greetings, and welcome to the Cutera Incorporated First Quarter 2018 Earnings Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Matthew Scalo, Head of Investor Relations & Corporate Development. Thank you, you may begin.

[Matthew Scalo:]

Thanks, operator. Welcome to Cutera’s first quarter 2018 Earnings Conference Call. My name is Matt Scalo and I recently joined Cutera as Head of Investor Relations & Corporate Development. On the call today are Cutera's President and Chief Executive Officer, James Reinstein; and Chief Financial Officer, Sandra Gardiner. After the prepared comments, there will be a question-and-answer session. The discussion today will include forward-looking statements, these forward-looking statements reflect management's current forecast or expectations of certain aspects of the company's future business, including but not limited to any financial guidance provided for modeling purposes. Forward-looking statements are based as of current information that is, by its nature, dynamic and subject to change. The forward-looking statements include, among others, statements regarding financial guidance, plans to introduce new products and productivity improvements. For words that may identify forward-looking statements, we encourage you to refer to the Safe Harbor statement in our press release earlier today. All forward-looking statements are subject to risks and uncertainties, including those risk factors described in the section entitled “Risk Factors” in our Form 10-K as filed with the SEC on March 26, 2018 and updated in our Form 10-Qs subsequently filed. Cutera also cautions you not to place undue reliance on forward-looking statements, which speak only as of the date they are made. Cutera undertakes no obligation to update publicly any forward-looking statements to reflect new information, events or circumstances or to reflect the occurrence of unanticipated events. Future results may differ materially from management's current expectations. In addition, we will discuss non-GAAP financial measures, including results on an adjusted basis. We believe these financial measures can facilitate a more complete analysis and greater transparency into Cutera's ongoing results of operations, particularly when comparing underlying results from period to period. Please refer to the reconciliation from GAAP to non-GAAP measures in our earnings release. These non-GAAP financial measures should be considered along with, but not as an alternative to, operating performance measured prescribed by GAAP. With that, I will turn the call over to our CEO, James Reinstein.

[James Reinstein:]

Thank you, Matt. Good afternoon, everyone, and thanks for joining us today to discuss our 2018 first quarter results. From a revenue perspective, the company performed well in what is normally a seasonally slow quarter, generating sales of $34.1 million or growth of 16% over first quarter 2017. North American sales, system sales continue to be vibrant, growing 31% over Q1, 2017. The drivers of this growth are a combination of elevated ASPs across most of our platforms as well as the contribution of newly launched systems which bring with them a recurring revenue component related to their usage. I’m referring to our truSculpt 3D body sculpting system, the Juliet Women’s Health System and the Secret RF microneedling system, in fact these three franchisees contributed over 35 % of global revenue in the first quarter. Larry Laber, our VP of North American Sales along with Keith Adams, our Director of North American Sales continues to have the North American team executing at very high levels. Consistent with the prior quarter, our core customer segment comprising of dermatologist and plastic surgeons accounted for 42% of our North American orders in the first quarter. We believe this indicates continuous strength in our core customer market along with expansion of our channel reach into non-core physicians. In short, we continue to demonstrate on our ability to sell to physicians looking to broaden their practices with a patient pay procedural model. Our North American sales force remained constant at 68 reps which is not unusual considering the first quarter tends to experience higher turnover. We expect to expand this group by 10 to 12 reps in 2018. In addition, we’ve commenced building our consumable sales force and expect a higher approximately 10 reps by the end of this year. As for International results, which were flat year-over-year solid double-digit growth in Europe, Middle East and Australia were offset by an administrative regulatory issue in Japan that impacted the registration of our products in that country. This issue created a distraction for the Japanese team that has been completely resolved and we are confident the team will deliver our full year expectation. The growth in other regions benefitted from an expansion of our marketing programs, including the first ever Middle East Cutera University which was held in Dubai in just prior to the Dubai Derma Congress in March. Marina Kamenakis, Global VP of Marketing & Clinical orchestrated an event that featured well known key opinion leaders from the U.S. and the region. Marina and her team will continue to provide these valuable educational programs in other regions including an event in Asia later this quarter. We continue to grow our international sales team with the addition of a net nine reps in the first quarter. This includes the expansion of direct operations in Spain where we expect the team to begin generating revenue this quarter. Our new facility in Madrid will be a training center for our Cutera team mates and of course provide a show room and clinical training center for our customers. Our gross margin was 51% in the quarter and remains in line with our full year goal of 57% to 58%. We’ve talked about the company’s need to make structured investments in order to sustain our short-term and long-term growth rates. We began this effort in late 2017 with a focus on our field service team and manufacturing efficiency. Our VP of service, Mike Palumbo continues to make considerable progress with the service organization. He is effectively adding talent, ensuring the team is equipped with the right level of parts to provide our customers with rapid response times and improve their productivity. This we expect will put us in a better position to grow the long-term recurring service revenue. Further investments are being made in our manufacturing operations. Dan Mindlin, our new VP of Operations, he joined the company earlier this year and immediately identified process improvements that should enhance output, improve our inventory management and reduce our cost of goods. We expect these initiatives, in service and manufacturing to have a positive impact on gross margins in the future, but of course require the investments being made. Turning to the products, in January we commenced the launch of the Juliet laser, a best-in-class product for improving female sexual function and overall vaginal health. We also announced the launch of Secret RF, which is a new fractional radio frequency microneedling device that effectively remodels collagen, improves mild wrinkles and diminishes scars. I couldn’t be more pleased with the strong demand we are seeing for both systems and we anticipate these platforms will contribute strongly to our growth in 2018 and beyond. We also expect the Juliet launch in additional geographies this quarter and we’ll provide an update on our progress on our next call. Our enlighten franchise for tattoo removal and skin revitalization continues to expand as we introduce the latest version enlighten SR in April. The SR focuses on skin revitalization with our signature procedures PICO Genesis and PICO Genesis FX. At the recent American society of laser medicine and surgery conference in April, customer enthusiasm for expanding product line was at record levels and was a fresh reminder to me of the enormous market opportunity for Cutera. Lastly, the company plans to provide more detail on our product pipeline as well as a general corporate update at an analyst day later in the year. I would now like to turn the call over to Sandy Gardiner, our CFO.

[Sandy Gardiner:]

Thanks, James. First quarter revenue was $34.1 million or 16% growth over the first quarter of 2017. North America system revenue grew 31% driven by continued strong demand for our truSculpt 3D system and the successful launches of the Juliet and Secret RF systems. When we look outside these three products, it is important to note that average selling prices for our core Xeo and excel systems increased over the first quarter of 2017. We believe this reflects two key points, first the market in both core and non-core segments continue to experience robust demand and second, great execution by our sales force as we continue to price our laser systems at a premium. International revenue was basically flat versus the first quarter of 2017. Europe saw a healthy mid-teens growth but this was offset by a decline in Japan. As James mentioned an administrative issue impacted our ability to sell our full portfolio of products for a portion of the first quarter in Japan. This was resolved by the end of the first quarter and we remain confident the team would deliver in 2018. In addition to the healthy demand for our systems, Cutera is focused on expanding the recurring revenue portion of our total revenue. In the first quarter, recurring revenue defined as service revenue plus consumable revenue in skin care sales accounted for approximately 20% of total revenue in the first quarter. We continue to see consumable revenue growing strong, supported by our expanding dedicated commercial team. This will become more meaningful over time as over 40% of our systems sold in the first quarter will generate consumable revenue going forward. Moving on to gross margin and operating expenses. Gross margin was 51% in the first quarter, over 200 basis points lower than the first quarter of 2017. In the past couple of quarters we have talked about our plan to invest more heavily in our service organization and manufacturing processes towards the end of 2017 and 2018. We continue to move forward with these projects and were appropriate accelerate other activities ahead of schedule. These incremental activities include outfitting the expanding global service team to support strong growth, especially in the U.S. markets going forward. In addition, in order to provide the highest level of service in select markets, we continue to focus on expanding longer-term service contract to coverage. We estimate these two activities along with projects to improve manufacturing efficiencies contributed to the incremental increase in our first quarter cost of goods. We expect these investments to reach up to an improvement in gross margin in the longer terms and also expect gross margins for the full fiscal year to be in the range of 57% to 58%. Sales and marketing expense as a percent of revenue was 38% in the first quarter, compared to 37% of revenue in the first quarter of 2017. The increase reflects continued investments in our global sales channels, including the build out of our commercial consumable team which will enable us to gain market share over the longer term. Research and development expense increased 21% to $3.6 million or 10% of revenue in the first quarter of 2018, flat as a percentage of first quarter 2017 revenue. We remain committed to investing in engineering and clinical research that drives new product innovation. General and administrative expenses were $5.4 million in the first quarter of 2018 or 16% of revenue, compared to $3.2 million or 11% of revenue in the first quarter of 2017. The increase in general and administrative expenses in the quarter was a result of higher audit and tax fees related to the adoption of ASC 606 and the release of a significant portion of our evaluation allowance against certain U.S. deferred tax assets as well as the ongoing infrastructure build out cost compared to a year ago. Operating loss was $4.7 million in the quarter, compared to $1.4 million loss in the same period in 2017. Our GAAP net loss for the first quarter of 2018 was $2 million or $0.15 per diluted share. Non-GAAP adjusted net loss for the same period was $0.3 million or $0.02 per fully diluted share. Non-GAAP adjustments include non-cash stock based compensation, depreciation and amortization expense. Weighted average shares outstanding was $13.6 million versus $13.8 million in the year ago period. Turning to the balance sheet and cash flow, net accounts receivable at the end of the first quarter of 2018 were $19.9 million and our DSOs improved by 3 days from a year ago quarter to 52 days. Inventories were $31 million at March 31, 2018, representing a $2 million increase from December 31, 2017 or an inventory turn ratio of 2.3 times which is below our historical four time figure during the first quarter of 2017. The higher inventory level was driven by an increase in finished goods inventory in anticipation of future sales. Cash used in operations was $10 million for the first quarter compared to $3.8 million in the first quarter of 2017. This change from a year ago was driven by our increased infrastructure cost, the increase in finished goods inventory and the payment of bonuses, commissions and sales achievement awards on a very successful 2017. Our cash position remained strong, and as of the end of March 31, 2018, we held cash and investments of $24 million with no debt, while working capital was $40.2. Turning to guidance for 2018, we reiterate our 2018 financial guidance with a target revenue range of $178 million to $181 million, representing an 18% to 20% increase over 2017. We expect 2018 gross margin to be in the range of 57% to 58%. We forecast operating expenses as a percent of revenue to remain unchanged in the range of 52% to 54% as we continue to invest in product development and the scalability of our operations. Non-GAAP net earnings per fully diluted share is expected to be in the range of $1.03 to $1.11. I would like to now turn the call over to James for his closing comments.

[James Reinstein:]

Thanks, Sandy. In summary, Cutera is constantly striving to provide our physician customers with a portfolio of the most innovative and highest quality products with a premier level of service that enables them to best serve their patients needs. With the operational investments made to date, Cutera is better positioned to execute on this mission and take advantage of the tremendous growth opportunities ahead. Management is also focused on making research allocation decisions that are strategically relevant and offer attractive returns to our shareholders. As the company continues to execute and drive strong double digit revenue growth in 2018, I expect our gross margins to improve from the levels along with increased profitability and cash from operations. I would now like to open up the call for questions. Operator?

[Operator:]

Thank you. [Operator Instructions] Our first question is from Chris Cooley with Stephens. Please state your question.

[Chris Cooley:]

Hey, good afternoon, everyone. Could you hear me, okay?

[James Reinstein:]

Very well, Chris. Good afternoon.

[Chris Cooley:]

Good afternoon. Couple from me here at the start. Could you maybe quantify for us what you think the impact to the first quarter was associated with the Japanese regulatory issue? And then I'd be curious as well, you talk about holding up and actually increasing your ASPs during the quarter with strong demand for not only Secret. Juliet and truSculpt, but also the core business. We do actually heard that there's actually some pressure on the PICO space here recently. So I would love to get your thoughts on just the overall demand, when we think about it by category and how you see the competitive position for Cutera within those respective segments? Thanks so much.

[James Reinstein:]

Okay. Sure, Chris. Let me take the pricing question first. What we realized basically in all of the categories there's an increase in our average selling price with the exception of that PICO category that you mentioned. We do still maintain a premium price within that category compared to competition. However there is quite a bit of pricing pressure in the category, where we did a decline in our own ASPs. However xeo, excel, V and HR are all appreciated either a slight or more reasonably slightly larger increase in our average selling price which is a great testament to the North American sales team as well as some of the direct markets teams in international markets by being able to command that premium price. Your first question was with regards to Japan. Don't really want to quantify a specific number. I will say that without this destruction and the need to exchange products, which the team was really focused on doing as well as getting the manufacturing -- for manufacturing license reinstated, which they actually did in record time and allowed us to start shipping the products again. I would say that international probably really would have seen double-digit growth without that issue.

[Chris Cooley:]

Okay. And if I could maybe just squeeze one more and then I will get in queue. Are you able to provide any color in terms of the lift to total growth in a quarter from the step up in ASP, so basically just kind of trying tease at a volume versus pricing type equation?

[Sandy Gardiner:]

Well, most of the increase actually did come from volume as a percentage, but there certainly was a nice contribution on the pricing indication as well.

[Chris Cooley:]

Okay. Thank you very much.

[James Reinstein:]

Yes. I think the pricing is just – I think the pricing just shows that we are able to maintain a slightly increase our ASPs which more importantly shows that we didn't decline.

[Chris Cooley:]

Got it. Thanks so much.

[Operator:]

Our next question comes from Jon Block with Stifel. Please state your question.

[Jon Block:]

Great. Thanks. Good afternoon. Couple of question from me. James, maybe just high-level, the overall environment for North America equipment. We love to hear your thoughts there. You got at least one competitor talking about hiring a lot of reps recently and integrating them and maybe getting more aggressive in terms of how they're approaching the market. So just taking a step back, well, up to hearing your thoughts on sort of the embedded environment right out there now in North America?

[James Reinstein:]

Well, I think certainly as has been the last few years, several quarters, the North American sales organization is just performing at a very high level growing over 30% this quarter. When you look at competition lot of which are private, so it's hard to get a real handle, but I can assure you that we were outpacing the market at a north of 30% growth rate. Given the demand for sales people and within our sales organization we certainly were net-net remained at the 68 number which is not surprising and fully with what we expected, but we certainly did hire quite a few but we also let some go as well. Hopefully that I covered your question.

[Jon Block:]

Yes. Certainly did. And then just for gross margins for the year. Sandy or James, I don't if you want to give it, but any color should on the cadence of the improvement was lower than what we were expecting in 1Q, but you held your expectations for the years. So maybe the step 2Q versus 3Q versus 4Q. How should we see unfolding throughout 2018 and then I just got one more quick one? Thanks.

[Sandy Gardiner:]

So, I think for 2Q we've talked about we're making these investments both in service and manufacturing. So in Q2 we expect to still make some of these investments because we have accelerated the investment for the long-term growth but suffices to say we expect over the course of the year both with completing or largely completing the investments but also the mix of the products as we've always talked about 3-D drives the higher gross margin but then the launch of Juliet and Secret were very successful in the first quarter and we continue to see that that will improve and lift gross margin over the rest of the year as well.

[James Reinstein:]

And I think add to that, these investments are really focused on improving either cost of goods or our ability to more efficiently manufacture as well as service. That the products and while probably not as a significant contributor as we'll see in outer years but we'll start to see the consumable products selling on these products – on the system that we're selling now, the Julliet, the Secret and the truSculpt 3D.

[Jon Block:]

Okay. And last one from me, just little bit any for you reiterate in the guidance that 103 to 111 a non-GAAP EPS, remember previously that was I believe of the 50 million share count. Is that the same and I just ask because the 1Q 2018 share count was little bit lower than what we were thinking about? Thanks guys.

[Sandy Gardiner:]

Yes. So it is still also the 15, because we do see average weighted shares as we go through the year both with divesting the PSUs, RSUs we expect that to tick up a little but. So close to the 50 million and does still also include the 8 million to 9 million of stock-based compensation as well.

[Jon Block:]

Thanks.

[James Reinstein:]

Thanks Jon.

[Operator:]

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

[Anthony Vendetti:]

Thanks. Yes. Just wondering if you could talk a little bit more about enlighten SR, you launch globally I guess in April. What expanded indications, because obviously picsecond laser, are there new FDA cleared indications or what expended indications will this be useful and with picosecond in general under some pricing pressure what you expect the ASP to be?

[James Reinstein:]

So probably won't discuss specific ASPs, for it. However, the launch of this product was really to answer what's going on PICO where other competitors are out there with less power devices with fewer wavelengths and still trying to price within this category. So the SR is focused just on skin revitalization versus being the premier tattoo removal devices that the enlighten 3 is and that's really what its geared for. There is not any expansion or indication, it just an offering within the enlighten family.

[Anthony Vendetti:]

So, it is more – James, then is it more of a scale down where it just going to do skin revitalization whereas the other one will do more or?

[James Reinstein:]

Yes. Absolutely, Anthony, that's exactly what it's for. And probably geared more towards the international market?

[Anthony Vendetti:]

Okay. More towards international. And then on truSculpt 3D, are you going to wait for the Analyst Day to do an update on the hands-free status?

[James Reinstein:]

I can give you an update there which is that is still inline with original timing for launch which would be in Q3 of this year. And so that hasn't changed and we look forward to having that launch during the third quarter.

[Anthony Vendetti:]

Okay. And then – okay, that's good for now. I'll jump back. Thanks. Appreciate it.

[James Reinstein:]

Okay. Thanks Anthony. Our next question comes from Jim Sidoti with Sidoti and Company. Please state your question.

[Jim Sidoti:]

Good afternoon, can you hear me?

[James Reinstein:]

Yes, we can Jim.

[Jim Sidoti:]

Great. On the G&A line you said you have some expenses due to the auditors and some consultant because you are changing your tax status. Should we consider that kind of a one time item and what's a good level for G&A spending for the rest of the year?

[Sandy Gardiner:]

Yes. So it is a one-time event in the first quarter that was related to the closing of the year when all of that was going on. So that is considered as the one time event. And I would say, thinking about it for the year as we have discussed in our guidance we expect to maintain the same level as last year. So roughly 9% to 10% as a percentage revenue.

[Jim Sidoti:]

Okay. Then on the balance sheet other assets went up about 5 million in a quarter, can you tell what that was?

[Sandy Gardiner:]

Yes. So in relation to the implementation of ASC 606 we are actually – you have to capitalized your cost and go back and flow it through retained earnings and put it in the appropriate places. So that lot of that has to do with the capitalization of the commissions that we needed to take back to the balance sheet.

[Jim Sidoti:]

Okay. And then, you noted that consumables were about 20% of revenue in the quarter. How does that compared with the year ago?

[Sandy Gardiner:]

Year ago it was 14%.

[Jim Sidoti:]

Okay. And…

[James Reinstein:]

Yes. So --and that does include the service agreements parts and labor.

[Jim Sidoti:]

In both this year and last year?

[James Reinstein:]

Correct. Yes. So the addition this year, call it, the upside to the growth is, one is that we did have an uptick in the percentage of system that did purchase service agreement that did go up. However we'll start to see that revenue kind of basically clocking every month or reported every quarter. As well as for the first time we've got real consumable revenue meaning participating in the procedures of revenue. So we're either selling a needle cartridge or tip for the Juliet or and hand piece for the truSculpt.

[Jim Sidoti:]

Okay. And you said you were going to add 10 reps for consumables, that's in addition to the 12 that you have – you have plans to add for systems. Is that correct?

[James Reinstein:]

Yes. That's correct. And we've got three of them already on board and they are downstairs training as we speak.

[Jim Sidoti:]

Okay. So if we look out four, five years where would you like to see consumables as a percentage of revenue?

[James Reinstein:]

Yes. I think we're taking out to 2021. we should be call it north of 10% maybe closer to 15% to 20% would be that number.

[Jim Sidoti:]

Okay. Thank you.

[James Reinstein:]

All right. Thanks Jim.

[Operator:]

[Operator Instructions] Our next question comes from Anthony Vendetti with Maxim Group. Please state your question.

[Anthony Vendetti:]

Yes. Just a couple of follow-up, bundled sales this quarter, did you give that percentage or did you have that percentage?

[Sandy Gardiner:]

Yes. We didn't actually give it, but it remains in line with the prior quarters roughly about 20% of our sales are in bundled transactions.

[Anthony Vendetti:]

Okay. And then, I know you mentioned you hired some direct reps internationally, how many direct reps do you have internationally right now?

[James Reinstein:]

Sorry, just going to look at that one up there. There are 48 direct reps in 10 countries.

[Anthony Vendetti:]

Okay. So Miguel Pardos is no longer actuary [ph] I guess as in February. Do you have some – is there someone that has replaced him or is it someone in a different role that's doing what Miguel is doing for international sales?

[James Reinstein:]

This point we haven't replaced him, but search is ongoing and we are certainly narrowing the list. And in the interim the five regional leaders are reporting directly to me.

[Anthony Vendetti:]

Okay. All right. And then I know you have hired two internal people to help with the recruitment of direct sales reps here in the U.S. Has that target for the end of 2018 – has that target changed? As that increase? Is it still around 80s? Is that the direct sales reps on number for 2018?

[James Reinstein:]

Yes. We remain – we want to add 10% to 12% for year going forward and so we should land this year probably around 80, if it 75 [ph], its 82 even better.

[Anthony Vendetti:]

Okay. Great. All right. That was it from me. Thanks.

[James Reinstein:]

Okay. Sure. Thanks.

[Operator:]

Thank you. and our next question comes from Larry Haimovitch with HMTC. Please state your question.

[Larry Haimovitch:]

Good afternoon. Sandy, this is a follow-up to the question that Jon Block asked. For the first quarter gross margin was 51%. I thought you said the gross for the year was going to 57. Did I hear that correct?

[Sandy Gardiner:]

That is correct. 57% to 58% for the full year.

[Larry Haimovitch:]

Full year. So that would imply by the fourth quarter probably gross margins in excess of 60%. Now I haven't penciled up the math exactly, but it would certainly imply a very nice step-up in gross margins through the year to where you'd exit at over 60%. Is that math sound approximately correct?

[Sandy Gardiner:]

Our target has always been internally to the 60% and that's what we are continue to strive for with both these investments but also the product mix and the efficiencies that we're actually putting in with in manufacturing that should lower our cost of goods.

[Larry Haimovitch:]

Okay. So 60% never means realistic.

[James Reinstein:]

Yes. We're just reiterating the 57% to 58% which has implication which you stated.

[Larry Haimovitch:]

Okay, great. Thanks. Hey, James get ready for the big [Indiscernible].

[James Reinstein:]

You know, what I know Houston going to there. I'm not sure about warriors.

[Larry Haimovitch:]

Yes. Wait till tonight.

[James Reinstein:]

Okay. We look forward to it, Larry.

[Larry Haimovitch:]

Me too. Congrats on the quarter.

[James Reinstein:]

Okay. Thanks very much.

[Operator:]

Ladies and gentlemen, it appears that there are no further questions at this time. I'll turn it back to management for closing remarks. Thank you.

[James Reinstein:]

So thank you very much. We appreciate everyone joining the call today and look forward to seeing you at upcoming healthcare conference as well as the Investor Analyst Day at will have later in the year. Thanks and good day.

[Operator:]

This concludes today's conference. All participants can disconnect. Have a great day. Thank you.