Cutera, Inc.
Q1 2017 Earnings Call Transcript

Published: 2 May 2017

[Operator:]

Greetings. And welcome to Cutera Incorporated First Quarter 2017 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. John Mills, Investor Relations Incorporated. Thank you, Mr. Mills. You may begin.

[John Mills:]

Thanks, Operator. Welcome to Cutera's first quarter 2017 earnings conference call. On the call today is Cutera's President and Chief Executive Officer, James Reinstein; and Executive Vice President and Chief Financial Officer, Ron Santilli. After the prepared comments, there will be a question-and-answer session. The discussion today will include forward-looking statements reflecting management's current forecast or expectations of certain aspects of the company's future business, including any financial guidance provided for modeling purposes. Forward-looking statements are based on current information that is by its nature dynamic and subject to changes. Forward-looking statements include, among others, statements regarding financial guidance, plans to introduce new products, expand our sales force, ability to increase revenue, reduce expenses, improve financial results, make productivity improvements, grow market share, realize benefits from additional investment, improve or maintain profitability, penetrate the market, generate cash from operations and plans for stock repurchases. 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-Q as filed with the SEC on May 1, 2017. Cutera also cautions you do not place undue reliance on forward-looking statements which speak only as of the date they were made. Cutera undertakes no obligation to update publicly any forward-looking statements to reflect new information, events or circumstances after the date they were made or to reflect the occurrence of unanticipated events. Future results may differ materially from management's current expectations. With that, I will turn the call over to James.

[James Reinstein:]

Thank you, John. Good afternoon, everyone and thanks for joining us today to discuss our first quarter 2017 results. We are very pleased to report that we exceeded our revenue guidance and achieved record first quarter revenue and significantly improved profitability. Our first quarter 2017 revenue was $29.3 million, which is a 31% increase from the first quarter of 2016. This result marks our 11th consecutive quarter of double-digit revenue growth and it actually our fifth highest quarterly revenue performance in the history of the company. The organic revenue growth was broad-based throughout our product portfolio and driven primarily by both our newer enlightened and legacy xeo products. We achieved double-digit growth in North America and international markets, with particular strength in the United States. Our North American sales team led by Larry Laber delivered another impressive quarter with product revenue growth of 60% compared to the same period of 2016. We continue to see productivity improvements within our field sales team helping fuel the overall revenue growth. We finished the quarter with 54 salespeople in North America compared to 58 at the end of 2016. This small decline in the number of reps was expected as year-end performance assessment resulted in changes. Larry has aggressively recruited and assembled a first-class team of sales professionals as demonstrated by the year-over-year growth and productivity improvements. We will continue investing in this market and expect to have approximately 70 salespeople in this territory by the end of 2017. Further, we plan to closely monitor the revenue and productivity improvements of our sales teams as we continue to expand. Regarding our customer base, during the first quarter of 2017 core physicians, plastic, surgeons and dermatologists in North America accounted for approximately 46% of our orders, with the balance of those orders received predominantly from primary care physicians. Our sales teams serving international markets led by Miguel Pardos grew product revenue 14% this quarter compared to Q1 2016. We had strong revenue growth in several of our direct countries in Europe, as well as Australia along with solid contributions from our distributor network. We are focused on increasing the growth rate in our international markets with the recent addition of Mosbah Al Khatib to manage our distributor network in the Middle East. Mosbah and I worked together at Cyberonics where he successfully grew that business in a similar role. At our Investor Analyst Day in June we will outline our plans to build markets in additional regions. Our gross margin was 53% in the first quarter of 2017, which is lower than the previous quarter's 56% and our expectations. The decrease is due primarily to the greater than expected demand for our enlighten systems and associated upgrades. Primary reasons for the enlighten III that have lower gross margins include, one, favorable -- offering favorable pricing to our installed base to upgrade to enlighten III. These upgrades will decline throughout the year. Second higher than initial cost both manufacturing and service for our enlighten III system are also expected to decline throughout the year. And finally, normal market seeding with key opinion leaders interested to act as centers of excellence in clinical trial study sites. This is an important marketing tool utilized during the early releases of new products. In spite of our lower-than-expected gross margin, we are pleased to show gap bottomline improvement and positive EBITDA and what has historically been our weakest quarter of the year. We are pleased with our overall financial trajectory and remain focused on growing our topline and improve earnings throughout 2017. Turning to research and development, leading an innovation and offering superior technology are the cornerstones of Cutera's culture and I am proud to be joining the team with so many years of technical innovation incorporated into all our products. Our most recent product accomplishments included the following. First, in 2017 -- I am sorry, first, in December of 2016, we introduce through a limited market release the enlighten III system. The enlighten III combines both pico and nanosecond technology that enables our customers to perform best-in-class tattoo removal, as well as the highly popular skin revitalization procedures. The high-energy system NOW has a third true red 670 wavelength, which we believe provides the most efficacious treatments in the fastest times when compared to other devices on the market. These features are critical for our customers as they look to increase the utility of the enlighten platform with the higher and more rapid return on their investment. Also just last month in April 2017 we introduced our new truSculpt 3D system targeting the body sculpting market. Our truSculpt 3D system includes an optional frequency of 2 megahertz developed to increased procedural efficacy while greatly improving patient comfort. We also introduced the new glide protocol to further enhance the truSculpt efficacy. This new offering will also include a consumable element which we will be -- which will begin recurring revenue to the company once the truSculpt 3D is placed or a current model is upgraded. We're excited about this pending launch and believe this new product iterations will contribute marked improvement to our overall gross margin. Additionally, we’ll continue investments in the truSculpt by providing a hands-free offering in the platform in the second half of 2017. We will, of course, continue gathering additional clinical data and support from key luminaries in the industry. Overall, we expect 2017 to be a productive year for us. On June 14th we will have our Annual Meeting of Shareholders followed by our first-ever Investor Analyst presentation outlining our long-term roadmap. This presentation is open to investors as well as interested research analysts. At the event we will outline our plans to meet the 345 objective. This refers to tripling our revenue that is the three, quadrupling our share price refers to the four and the five is the number of years in which we want to accomplish these goals. 345 is the internal mission that the whole team is behind and striving to make the reality. The global market for aesthetic light and energy based systems is growing at a steady pace and based on our internal estimates using data from public company disclosures and our revenue estimates of private companies, we project the market to be in excess of $2 million this year. Our broad range of products expected market share expansion, commitment to innovation and strong commercial teams should be the catalysts continue fueling our growth in the coming years. I would now like to turn the call over to Ron for his financial review and comments before we open up the call to your questions.

[Ron Santilli:]

Thanks James. As James stated earlier, we had record first quarter revenue of $29.3 million, representing 31% growth in the first quarter 2016. This performance extends our double-digit year-over-year revenue growth to 11 consecutive quarters. The growth was fueled primarily by North America where our product revenue grew 60%. International product revenue also grew at a healthy 40% on a year-over-year basis. We experienced revenue growth over the same period in the prior year and most of our product lines particular strength coming from enlighten, our recently launched picosecond technology for tattoo removal and skin revitalization. Although, we had growth in many product lines, it is worth noting that revenue from our xeo platform, our flagship multi-application and multi-technology products also significantly compared to the same period in the prior year. We expect revenue in the second quarter of 2017 to be approximately $32 million and for the full year in 2017 we are increasing our guidance to $140 million compared to the previous range of $135 million to $140 million that we have provided in February 2017. Gross margin was 53% in the first quarter and was lower than we had originally expected to the various reasons that James stated earlier. As a result of our various gross margin initiatives, we expect gross margin to increase sequentially to approximately 56% in the second quarter 2017 and increasing thereafter in the range of 57% to 60% in the second half of the year, with the third quarter at the lower end of the range. Key initiatives that we are focusing on to improve gross margins include, reduced enlighten -- reduce discounted enlighten III upgrades. These upgrades were lower gross margins in Q1 2017 and we are temporarily provided to support our loyal customers. Two to increase enlighten ASPs as we reduce the need to seed key opinion leader and reference sites. Three, reduce enlighten III cost of goods as this product matures in the manufacturing process and its field liability improves. Four, leverage our fixed costs on our projected higher revenue in the remaining quarters of the year. And finally, implement cost reduction initiatives for product cost of goods sold with the target of reaching overall 59% to 60% gross margin rate in the fourth quarter of 2017. I will now address our operating expense results where we experienced significant leverage in our performance. Sales and marketing expenses as a percent of sales decreased to 37% in the first quarter of 2017, compared to 39% of revenue in the first quarter of 2016. We will continue to aggressively invest in our commercial channels to build out our distribution network enabling us to gain market share with above market revenue growth rates. We expect sales and marketing expenses to be approximately 37% of revenue in the second quarter of 2017 and it should decrease steadily throughout the year as our revenue growth resulting in approximately 35% of revenue for the full year of 2017. Research and development expenses were $2.9 million or 10% of revenue in the first quarter 2017, compared to $2.7 million or 12% of revenue in the first quarter of 2016. We continue to invest in R&D while leveraging this expense as a percent of revenue. We remain committed to investing in engineering and clinical research that drives new product innovation and support our clinical superiority. We are planning to moderately increase our investments in R&D activities as the most recent investments are providing targeted revenue growth and commensurate the churns. As such, we plan R&D spend in the range of $3 million to $3.3 million in each of the remaining quarters in 2017. General and administrative expenses were [ph] $3.2 (13

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Anthony Vendetti with Maxim Group. Please proceed with your question.

[Anthony Vendetti:]

Thanks. I wanted to talk a little bit about the enlighten III. A, I know there were some -- lot of upgrades, guess, that impacted the margin. I was wondering if you could talk about was the March gross margin impacted more by upgrades to enlighten III or more from bundling and then just a little more color on whether or not you have another indication for enlighten III?

[Ron Santilli:]

Sure. I will take that. Hi, Anthony. Certainly the upgrades had an impact on it, because those are lower gross margin and we are just temporarily by providing just to support our loyal customers. We also saw enlighten III we’ll continuing to see that market and so the key opinion leaders are discounting there, which is also temporary also impacted the margins and the cost of goods associated to enlighten III being a new product with higher initially but we expect that to come down as a year goes on. When we look at the bundling that that has an impact and I would say it’s a mixture of all those that impacted the lower gross margin than expected originally.

[Anthony Vendetti:]

Okay. And then, is there a new clearance for enlighten III that you can discuss or what is currently out there, what are you currently marketing?

[Ron Santilli:]

Yeah. We recently just received an expanded clearance that basically provides increased energy to get greater efficacious results, as well as faster seen with the product with their largest spot size, so it’s beneficial to our customers.

[Anthony Vendetti:]

And there was some news regarding truSculpt at ASLMS. I was wondering is there any update on truSculpt and whether or not other than we’ve provided on the call, is there any indication that truSculpt growth has picked up since the new clearance for the reduction -- circumferential reduction in the abdomen?

[Ron Santilli:]

We are continuing to increase the truSculpt line, so yes, the clearance and many other things come into play but the recent announcement at ASLMS is brand new, so that product just hitting the market right now maybe more of a Q2 and forward products in terms it’s performance in the product line.

[James Reinstein:]

Yeah. Anthony this is James. The 3D that I mentioned during the call or the prepared statements, that product we are just now getting the field sales force trained on it, as well as the glide protocol and so that will be a second half Q2 launch and the Q3 second half launch for U.S. and international markets.

[Anthony Vendetti:]

Okay. And then the major upgrade with consumable and hands-free that’s by the end of 2017 still?

[James Reinstein:]

Actually, the 3D does include a consumable element, the details of which we will present at our Investor Analyst Day in mid-June.

[Anthony Vendetti:]

Okay. And the hands-free one, is that a 4Q or is that later than that?

[James Reinstein:]

Yeah. That’s second half.

[Anthony Vendetti:]

Okay. Okay. That’s it for now. I will hop back in the queue. Thanks.

[Ron Santilli:]

Thanks, Anthony.

[James Reinstein:]

Thank you.

[Operator:]

Our next question comes from Jim Sidoti with Sidoti & Company. Please proceed with your question.

[Jim Sidoti:]

Good afternoon. Can you hear me?

[Ron Santilli:]

Yeah.

[James Reinstein:]

Yes.

[Ron Santilli:]

Hi, Jim.

[Jim Sidoti:]

Great. Can you give us a target on where you think you'll end the year in terms of the number of sales people?

[James Reinstein:]

In North America we will have 70, so up from the -- we close out last year at 58. We have some performance assessment and normal church which is much higher in the first quarter of the year. But I will say 2017 demonstrated the lowest turnover rate that we’ve seen in our sales organization. However, it is not a common that you have movement and so we did go to 54 sales people in U.S. however in North America, by the end of the year we do expect to be at 70.

[Jim Sidoti:]

And there has been an incredible amount of consolidation on the past several weeks. Are you able to get some good sales people from some of those consolidating firms?

[James Reinstein:]

We absolutely have a great deal of interest from those that are [Technical Difficulty] (24

[Jim Sidoti:]

Okay. And then, it seems like you have -- you have played full in the U.S. between the enlighten III and the truSculpt. You have plenty of catalysts to motivate these sales people here in the U.S. What's the big thing that you think will drive growth outside the United States in 2017.

[James Reinstein:]

Yeah. We are just now in the process of releasing the enlighten III in international markets and then the same truSculpt 3D with glide protocol will be launched internationally in the second half of the year, actually starting in Q2, we will launching that in international markets. And then just like in the U.S., the second half of the year we will be launching hands-free or what we are calling internally the truSculpt 2.0. That covers your question.

[Ron Santilli:]

Okay, Jim.

[Operator:]

Our next question is a re-quetion from Anthony Vendetti. Please proceed with the question.

[Anthony Vendetti:]

Yeah. Just to go back to enlighten. Are you able to break out the new sales versus upgrades for the quarter?

[Ron Santilli:]

We don’t break out those specifics, but we did have a good deal of both -- it exceeded our demand not only for new system sales but also our installed base coming back to us to upgrade to that third wavelength. So we got a lot of enlighten business during the quarter.

[Anthony Vendetti:]

Okay. And then on bundling, what percent of your revenues was from bundling or what percentage of your product from bundling?

[Ron Santilli:]

That number just continues to go up, let me see, I am sorry, just grabbing just a second here, yes, for the quarter, when you look at a year ago the bundling business was up about 48% from a year ago. So that shows you the 2016 progress. We continue to increase the volume coming through bundling and that continuing in the 2017. For the quarter it represented about 17% of our North American product sales came from our bundle transactions.

[Anthony Vendetti:]

Okay. And would you say that that had -- so that had a little bit impact on gross margin but not a lot of that, correct?

[Ron Santilli:]

That’s correct. It certainly have some impact on gross margin, because as we are bundling transactions that is bringing typically a lower selling price and so it does have an impact on gross margin.

[Anthony Vendetti:]

But gross margin expectation or guidance for you by the end of year that exit the end of the year like in fourth quarter you still expecting gross margin to be in the 58% to 60% range?

[Ron Santilli:]

Yes. That’s correct. I think we are going to be able to get there by the time we exit the year based on the initiatives that we described which we are aggressively pursuing.

[Anthony Vendetti:]

Okay. Well, I just wanted to say, Ron, it’s been a pleasure to work with you and disappointed that you will be moving on, but wanted to wish you the best of luck with your future.

[Ron Santilli:]

Thanks. I appreciate. I appreciate that Anthony.

[Anthony Vendetti:]

Okay. Great.

[James Reinstein:]

He is not leaving tomorrow though, just to keeping things, he will, yeah, just to comment on that. We do have a search ongoing and Ron, he and I worked extremely well together and he has agreed to stay on until we find his successor and then he will remain as needed until the transition is complete.

[Ron Santilli:]

Absolute.

[Anthony Vendetti:]

James, can you say where you are in the search, is it beginning stage, do you have candidates already identified?

[James Reinstein:]

We have some candidates identified and they are going through the process now.

[Anthony Vendetti:]

Okay. Great. Thank you.

[Ron Santilli:]

Thanks, Anthony.

[Operator:]

Our next question comes from Brian Freckmann with LS Capital. Please proceed with your question.

[Brian Freckmann:]

Hey, guys. How are you? Do you hear me?

[Ron Santilli:]

Hi, Brian. Yeah. We can hear you.

[James Reinstein:]

Hi, Brian.

[Brian Freckmann:]

Okay. Great quarter, great North American numbers, I am surprise on 54 sales people, that's a big number, so to the salesforce you are doing a job. And I know this is going to -- I don't know how best this question comes out, but and I appreciate the guidance as always, that’s extremely helpful. Would you care to help us out with the back half of the year and I only ask that, because after beating the first quarter revenue numbers and giving guidance, obviously, one of the headlines is that, you missed the EPS number? And I think, I'm -- it seems like after having a really good revenue number, it would be better if people sort of figure out what the back half would look like, so they can have some sense of putting together their models and I was hoping you could help us out a little bit, because it's a big ramp, what you're kind of estimates are and how that should flow through each quarter?

[Ron Santilli:]

Well, I think, Brian, if you go back and look historically, which I am sure you looked. The back half is the largest part of our profitability, that’s where we get the greatest leverage from model, that’s where the bulk of the revenue, certainly over 50% of it comes in the second-half. And so we expect, when we talk about that EPS guidance of $0.45 to $0.50, obviously a great piece of that -- the greater share is going to come in the second-half. I don't have any specific numbers other than those that I have laid out there for you, but we expect to have a big half as we did in -- in the second half as we did last year and the year before and as the history kind of dictate.

[Brian Freckmann:]

Right. And may to ask in a different way, I mean, obviously, given the first quarter number and the second quarter guidance, all your earnings will come from the back half. I think it's more of a question if rather than having people put in the third quarter estimate that might be too high, not understanding sort of the impacts of one together, I mean, I am just trying to figure out, how one should think about, what the good sense just going back to last -- using last year third quarter and fourth quarter as comps, I guess, I am just getting at the fact that you guys have had some -good revenue numbers, it looks like business is getting better for you and just try to make sure that that is conveyed in the correct manner?

[Ron Santilli:]

Yeah. That’s the good point and certainly we expect to be profitable for the remaining quarters of the year Q3 and Q4, with Q4 being the obviously the largest contributor, we are talking about $0.03 for Q2 and that’s going to leave the remainder of the $0.45 to $0.50 being in the back half. And but we expect to finish strong, we have got lot of initiatives driving that and again the history will dictate that you are going to have a lot of profit development in the second half.

[Brian Freckmann:]

Okay. Okay. And -- sorry, if I took last year instead of the breakdown of the profits in that same format would that be a good place to start?

[Ron Santilli:]

Yeah. I think so.

[Brian Freckmann:]

Okay. Would -- like fourth quarter maybe being double, what third quarter is, if my memory serves me -- I mean, maybe not exactly but almost?

[Ron Santilli:]

Yeah. I mean, you are going to get great leverage, if your margins are going to -- your gross margins are going to be in that 58% to 60% and you're going to really get leverage from the OpEx as we have done in the past, we are going to see that same thing in Q4 with higher revenue than we had certainly in Q4 ’16.

[Brian Freckmann:]

Okay. Thanks a lot. I will take the rest offline.

[Ron Santilli:]

Thanks, Brian.

[Operator:]

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

[James Reinstein:]

Thank you. And thank you all for participating in our call today. We will be presenting at various investor conferences and we have our first ever Investor Analyst Day following our Annual General Meeting to be held on June 14, 2017 at our corporate headquarters in San Francisco. We intend to showcase our products and facility with on-site treatments. We look forward to updating you on our business progress in the second quarter of 2017 conference call in August 2017. Good afternoon and thank you for your continued interest in Cutera.

[Operator:]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.