Cutera Inc (CUTR) 2007 Q1 法說會逐字稿

Good day and welcome, everyone, to today's Cutera, Inc. first quarter 2007 earnings results conference call.

(OPERATOR INSTRUCTIONS)

I would now like to turn the program over to John Mills of ICR. Please go ahead sir.

Thank you. By now everyone should have access to the first quarter 2007 earnings release which went out today at approximately 4 p.m. Eastern Time.

The release is available on the investor relations portion of Cutera's website at cutera.com and with our Form 8-K filed with the SEC and available on its website at sec.gov.

Before we begin, Cutera would like to remind everyone that these prepared remarks contain forward-looking statements, including statements concerning future financial performance and guidance including revenue projections, the planned expansion of our sales force, distribution networks, and customer base; improving in our distributor and national account relationships and increase in market share; long-term domestic and international growth opportunities and strategies; future spending on various aspects of our operations; and the development of new products and applications and their anticipated introduction dates.

Also, management may make additional forward-looking statements in response to your questions.

Factors that could cause Cutera's actual results to differ materially from these forward-looking statements include its ability to improve sales productivity and increase sales performance worldwide; its ability to successfully develop and market new products; unforeseen events and circumstances relating to its operations; government regulatory actions; general economic conditions; and those other factors described in the section entitled "Risk Factors" in its most recent 10-Q filed with the SEC on May 7, 2007.

These forward-looking statements do not guarantee future performance and therefore you should not rely on them in making investment decisions without considering the risks associated with such statements.

Cutera also cautions you to not place undue reliance on forward-looking statements, especially those related to guidance on our future financial performance, 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.

With that, I'll turn the call over to the company's President and Chief Executive Officer, Mr. Kevin Connors.

Thank you, John. Good afternoon, everyone, and thanks for joining us today to discuss Cutera's results for the first quarter ended March 31, 2007.

On today's call I'll provide an overview of results, then Ron Santilli, our CFO, will provide additional details on our operating and financial results and comment on 2007 guidance. Finally, I will provide some closing comments and then open the call to your questions.

On April 4th, we announced the preliminary results of our first quarter 2007 revenue and estimated earnings per share and informed the investment community that we had not met our guidance.

We have now had the opportunity to analyze and better understand the issues that caused the shortfall and will be outlining the strategic initiatives that we are implementing to address them.

Now to turn to our results. Revenue in Q1 2007 was $23.3 million, which represents a 12% increase from $20.8 million reported in Q1 2006. This compares to $26 million which had -- that we had guided in January as our first quarter 2007 revenue.

As a consequence of this lower than expected revenue, our diluted EPS was $0.12 compared to $0.21 we had guided in January.

Our international revenue grew 27% when comparing Q1 2007 to Q1 2006. We are pleased with this growth, especially with our performance in Canada, Australia, and some European countries. As a reminder, we have a direct sales organization in Japan, Australia, Switzerland, Canada, France, Spain, and the UK.

Additionally, we have approximately 30 distributors in countries where we don't have a direct presence. We are continuing to see impressive growth opportunities in our international markets.

Our U.S. business increased 6% when comparing Q1 2007 to Q1 2006, which was below our expectations. The primary reasons for the low performance of our North American sales team was the unsuccessful implementation of our junior sales program, higher than normal sales turnover and disappointing results for PSS and other national accounts.

At the end of 2005 we embarked upon an aggressive sales force expansion plan where we hired junior salespeople as a part of a new distribution model focusing primarily on our lower price Solera platform products. The goal was to have a targeted effort directed at a more price sensitive market segment.

This was a deviation from our previously successful sales force expansion practice of hiring senior salespeople and placing them into strategic territories across the country.

By the end of March 2006 we had hired 16 junior salespeople. We believe that we hired many dedicated and enthusiastic people but the model did not prove successful for us and instead resulted in low productivity and consumed a considerable amount of sales management attention. By the end of March 2007, only two junior salespeople remain in those roles.

Another factor leading to lower than expected productivity was unusually high sales turnover. During Q1 2007 11 salespeople transitioned out from the company. Also during that quarter we hired 10 new senior salespeople and reassigned eight of our strongest junior salespeople to senior sales positions.

Lastly, we believe that our U.S. business was also affected in the first quarter 2007 because of disappointing revenue from PSS and other national accounts. This shortfall also contributed to lower performance in our US revenue.

We've adopted several initiatives to improve our North American sales performance. One, we are continuing to restructure our sales force with senior experienced salespeople and have discontinued the junior sales program.

Two, we have dedicated additional sales personnel to our PSS partnership to facilitate increased selling efforts. And three, we plan to expand our North American team and expect to have 64 senior experienced salespeople by the end of 2007.

We realize it will take time to improve our sales performance. As of March 31, 2007, 18 of our salespeople have been in their current positions for less than six months. Our experience is that it takes approximately nine months for a new salesperson to achieve target productivity levels.

As a result of these factors, we are projecting sequentially flat revenue for Q2 2007 but believe our model will support increased growth in the second half of the ear.

During the quarter our average selling prices, particularly on our multi-application Xeo systems, remain firm and in some instances increased.

All the indicators suggest that our market remains strong and continues to attract a broad customer base. We're continuing to see high demand for our products outside the core specialties.

During the first quarter 2007 we booked approximately 14% of our system orders from traditional dermatologists and plastic surgeon specialties.

In contrast, 32% of our first quarter orders came from family practitioners, 15% from OBGYN's, and 12% from other physicians and approximately 17% from non-physician medispa environments.

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

Thanks, Kevin, and thanks to all of you for joining us today on our first quarter earnings release conference call.

Before I begin, please note that all of our historical financial performance and guidance comments are expressed in GAAP numbers, which include the impact of stock-based compensation expenses.

In addition, to supplement the GAAP numbers we have provided non-GAAP net income and non-GAAP diluted income per share information that excludes the impact of all stock-based compensation expenses net of the related income tax effect.

We believe that these non-GAAP numbers provide you with insight to conduct a more meaningful and consistent comparison of our ongoing operating results and trends compared with historical results. A table reconciling the GAAP financial information to the non-GAAP information is included in our earnings release.

First quarter 2007 revenue was $23.3 million, a 12% increase compared to the first quarter of 2006. Net income for the first quarter of 2007 was $1.8 million, or $0.12 per diluted share.

Non-GAAP net income for the first quarter of 2007 was $2.7 million, or $0.18 per diluted share.

Product revenue in the first quarter of 2007 increased by 4% compared to the first quarter of 2006. This weaker than expected growth was primarily due to the reduced performance of our U.S. sales force.

Upgrade revenue in the first quarter of 2007 increased by 69% compared to the first quarter of 2006.

This growth was primarily attributable to additional sales of CoolGlide to Xeo upgrades and increased sales of ProWave and LimeLight hand-piece application upgrades.

Service revenue in the first quarter of 2007 increased by 71% when compared with the first quarter of 2006. We expect this revenue growth to remain strong as the size of our installed base continues to increase and customers use our services to maintain their products after the initial warranty periods expire.

Titan resale revenue in the first quarter of 2007 increased by 17% when compared to the first quarter of 2006. Our customers, particularly high volume Titan users, appear to be using fewer shots than expected, which is resulting in a lower revenue growth rate for this business than we had planned.

But despite this lower growth rate, we are continuing to sell Titan applications on a significant number of our Xeo and Solera platform products. We will continue to monitor this performance and we'll keep you updated on our progress.

I will now address our operating performance. Our gross margin in the first quarter of 2007 was 67% compared to 72% in the first quarter of 2006. This decrease was primarily attributable to $944,000, or 4% of revenue, of royalty expenses associated with our patent license that was not in effect in Q1 '06.

Our gross margin rate was lower than previously guided due primarily to lower sales volume.

We expect our gross margin to be in the range of 66% to 68% in the second quarter of 2007 due to the sequentially flat revenue and to be in the range of 68% to 70% in the second half of 2007 as our revenue increases.

Sales and marketing expenses for the first quarter of 2007 were $9.1 million, or 39% of revenue, compared to $8.5 million, or 41% of revenue, for the first quarter of 2006.

The growth in absolute dollars was due primarily to increased international selling and marketing efforts.

In 2007 we are expecting to continue expanding our market presence, which should result in sales and marketing expenses in the range of 31% to 40% of revenue.

We expect our sales and marketing expenses as a percentage of revenue to decline during the remainder of 2007 as we expect favorable leverage from increased revenue.

Research and development expenses in the first quarter of 2007 were $1.7 million or 8% of revenue, compared to $1.3 million or 6% of revenue, in the first quarter of 2006.

As we intend to continue increasing our investment in this area, we believe our spending will be in the range of 6% to 8% of revenue for the reminder of 2007.

General and administrative expenses for the first quarter of 2007 were $3 million or 13% of revenue, compared with $4.4 million or 21% of revenue, in the first quarter of 2006.

This decrease in administrative expenses was primarily related to a $1.5 million decrease in legal expenses associated with our patent litigation in Q1 '06 that was settled in June of 2006.

We expect general and administrative expenses to be in the range of approximately $3 million to $3.5 million per quarter for the remainder of 2007.

Our effective income tax rate for the first quarter of 2007 was 34% of revenue -- was 34%. We expect our effective income tax rate to be approximately 33% for the remainder of 2007.

Turning to EPS, please now refer to the non-GAAP reconciliation of our net income and EPS provided in our earnings release. On a GAAP basis, net income per diluted share for the first quarter 2007 was $0.12.

For the same period, non-GAAP net income per diluted share was $0.18. This $0.06 difference represented the after-tax impact of the $1.3 million of non-cash stock-based compensation expenses recorded in accordance with FAS 123R.

Turning to the balance sheet, our financial position continues to remain very strong. As of March 31, 2007 we had over $111 million of cash and marketable securities. This represents over $8 per outstanding share.

For the first quarter of 2007 cash generated by operations was $1.1 million.

Accounts receivable net at the end of the first quarter of 2007 was $8.6 million and the DSOs were 33 days.

Our DSOs continue to remain among the best in the industry and below our target of 35 to 45 days due to a thorough customer approval and credit check process and strong collection efforts within the quarter.

Inventories increased slightly from December 31, 2006 as a result of higher finished goods inventory at March 31, 2007 due to the lower than expected first quarter revenue. In addition, there was a planned wrap-up of raw materials for our Pearl product, which is expected to ship in the third quarter of 2007.

Moving to guidance, in the second quarter of 2007 we are projecting sequentially flat revenue of approximately $23 million, with GAAP and non-GAAP net income per diluted share of approximately $0.08 and $0.14 respectively.

Although strategic initiatives are already in place, it will take some time before we see the expected improvements in U.S. sales force productivity. We expect to see improved productivity later this year and believe that we will see higher growth rates in the second half of 2007.

For full year 2007 we expect revenue of approximately $110 million, with GAAP and non-GAAP net income per diluted share of approximately $0.81 and $1.07 respectively.

Revenue levels for Q3 and Q4 of 2007 are expected to be approximately $28 million and $36 million respectively.

Non-GAAP net income per diluted share excludes the after-tax impact of non-cash stock-based compensation expenses recorded in accordance with FAS 123R. Please refer to our detailed reconciliation of GAAP to non-GAAP financial information attached to the earnings release.

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

Thanks, Ron.

While we're pleased with our international revenue, which grew 27% when comparing Q1 2007 to Q1 2006, the revenue growth in our U.S. business this past quarter did not meet our expectations. However, we remain optimistic about our opportunities for the second half of this year.

We believe that the causes behind our shortfall have been identified and that we have been and will continue implementing strategic initiatives to achieve higher growth rates to capture a larger share in this growing market.

We're excited about our new Pearl application and expect Pearl sales will contribute significantly to our second half 2007 revenue. Pearl, as with the introduction of Titan, will allow us to compete in a new market segment and will provide us with excellent upgrade opportunities from our installed base.

We are also -- we also have additional projects under development. We'll be telling you more about these later in the year.

The fundamentals of our business remain strong. We have one of the most diverse product lines in the industry, enjoy high operating margins, manage a strong balance sheet with over $11 million in cash, and marketable securities with no debt. We have experienced increased traction in our international sales and our product selling prices remain strong.

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

Thank you. (OPERATOR INSTRUCTIONS)

Our first question will come from Phil Nalbone, RBC Capital Markets.

Thank you very much. Good afternoon. Kevin and Ron, what accounts for the heavy turnover of the sales force during the first quarter? Where are these people going? Are they going to competitors or leaving the aesthetic laser segment altogether?

Well, Phil, a variety of reasons. But I think it's important to recognize that we're not having retention problems with our top salespeople. But there's a whole list of reasons that we had the aberrantly high turnover in the first quarter.

Okay. And in the past, PSS has been a significant contributor to your U.S. operations. Why has this channel softened all of a sudden?

Well, I don't view it as something that will continue on this trajectory. It's -- I just think we didn't manage the relationship as closely as we have in the past and that's why we think having increased focus with dedicated sales resources to the PSS relationship, should really turn things around for us.

Okay. Ron, perhaps you can say a few things that would help us get comfortable with the revised guidance for the full year. In particular, perhaps you could walk us through kind of how you have built the internal revenue forecasts that underlie today's guidance.

What are the metrics that you're using, what sort of overseas sales growth is embedded in the model and when we look at the U.S. business for the balance of the year, what are your assumptions about the sales force productivity levels per rep?

Okay, Phil, we typically go through a process whereby we look at the number of people that are out there in the field and the productivity that we expect from each one.

We've done that in the past and we continue to do that in the future. I think the difference is we've kind of outlined these areas that we were weaker in with the sales turnover, the junior program and the PSS.

We expect to be able to turn those around and improve the productivity as well as we're planning to expand to the U.S. sales force into the second half of the year. And so all of that together was part of the buildup in getting us to the $110 million guidance for revenue top line.

Okay. Can you tell us what your expectation is for overseas market growth for the remainder of the year?

Well, in the past for competitive reasons we haven't disclosed our guidance growth for domestic versus international and we don't intend to do that here either.

Okay. Guys, assuming that it takes about nine months for each rep to get up the learning curve to be fully productive, how many of your direct U.S. reps should be kind of at the fully functional level by the end of the calendar year and can you kind of give us some sense for what the expected level of productivity per rep is? What are you measuring them by?

It's Kevin. As we mentioned in the script, we're -- we have a significant number of people that have been with the company for six months or less and so obviously going into the latter part of this year we would expect them to be contributing at full productivity levels.

But we also are going to be expanding so we will be hiring -- we'll make that 64 territories by the end of the year, so those are people that will not be contributing at the same level that the people have been with us for nine months.

Okay. Just one final thing and I'll go into the queue. Kevin, can you talk about anything that seems to have changed in the broader environment for aesthetic laser products? Have you seen any noticeable difference in end user demand or utilization patterns or kind of the competitive landscape?

Phil, we're not seeing it. In fact, we tracked the companies that have reported in our space and the numbers don't support continued growth in the 20% range. So we're not observing anything in terms of a market change.

Obviously, new applications in this space tend to get a lot of attention. That's why we think it's important for us to successfully launch the Pearl, which we think will have an impact.

But new products have always been one of the key catalysts for our growth and we'll continue to develop new applications in order to see the growth rates that we're satisfied with.

Thank you.

And our next question comes from Anthony Vendetti with Maxim Group.

Maybe, Kevin, you can expand a little bit on the new products. You said shipping the Pearl by third quarter. I guess, a, is it possible that that will ship a little bit sooner, maybe by the end of this quarter, and could that provide some upside to the guidance for this quarter?

And then can you talk a little bit about the applications that you're working on now in terms of in what particular areas just generally?

Sure, Anthony. Well, last quarter we did get FDA clearance for Pearl and at that point we were able to accept orders for that and we have been able to build a backlog for that. So we think the early interest in Pearl is very positive.

And we feel comfortable that we should be able to achieve the target revenue levels in the third and fourth quarter. There is a possibility there could be some revenue in the second quarter, but we're not expecting a significant amount, if there is any at all.

In terms of new applications, we haven't in the past talked about what we have going on in the R&D group until we're close to launching the product.

But these are new aesthetic applications that we're currently not participating in and looking at a number of exciting technologies that we think will make a huge impact in our business.

And can you talk about then maybe just -- it sounds like they're new platforms altogether, but can you talk about just maybe the timing? Are these scheduled more for AAD 2008 or is it possible one of these products gets out before the end of this year?

Well, as you know, Pearl is what we're focused on for this year, so in the second half we'll experience that launch. And we don't anticipate another new product launch during the calendar year and typically the AAD is where we do display our new technology.

Okay. And just a little more color on the sales force turnover. Obviously there's -- going to a number of these conferences, obviously there's a lot of moving around among salespeople. Certainly you're not the only company to experience turnover. But can you talk a little bit about the significance of the turnover?

Where is -- I mean part of it sounds like it was related to the junior sales program, maybe that may have caused some of the senior salespeople to leave, I'm not sure.

But how many salespeople do you have right now because according to the press release it looks like the turnover was greater than 20 over the last six months. You said 11 left in the first quarter.

Can you talk about where the sales force is now, exactly how many have left over the last six months, and then what's your ramp-up to the 64 approximately going to look like?

Yes, let me see if we can answer all those, Anthony. We lost 11 and hired 10 over the first quarter. And there's a variety of reasons. We have been hiring quite a few salespeople over the years and we try our best to do a thorough job in terms of the interviewing process and training.

But inevitably some of those hirings don't work out the way we hope. But we're expecting to have a couple more territories added this quarter and then be fully staffed in the fourth quarter with the 64.

Where are you at now? What's the number right now, senior sales?

The number of territories is about 50.

We have about 56 total senior territories at this point.

56 now, okay. Great. Okay, thanks. I'll get back in the queue.

Thanks, Anthony.

(OPERATOR INSTRUCTIONS) Well take our next question from Dalton Chandler with Needham & Co.

Hi, guys.

Hey, Dalton.

Hey, first of all, just a little housekeeping. You went through the breakout of sales to traditional and primary care, et cetera, pretty quickly and I didn't quite get it all down. Could you --

Sure.

-- one more time?

Let's see here. It's 14% -- where are we?

14% derms and plastics, 32% from family practitioners, 15% from OBGYN, 12% from other MDs, and 17% from non-physicians/medispa environments.

Okay, I think I did get that right and I think that adds up to 90%, doesn't it? Yes, that adds up to 90%.

I'm sorry -- the family practice is 42%.

Okay. And then just on your guidance for the second half of the year, you're expecting revenue growth to return, but still not -- looks like it's still not quite back to the 20% industry levels you're talking about. When do you think you could get back to industry level growth?

Well, obviously the first quarter was a surprise for all of us. We felt that the momentum we had in the fourth quarter gave us confidence that we'd be able to grow at rates that we've seen in the past. So it's the process of building this up, I think we really want to have a pretty conservative approach to this.

But we are returning to the model that's worked for us for all these years, which is continued expansion of our senior sales model coupled with new product introductions.

So we think we should be on a trajectory as we end 2007 to be on the growth rates that we've seen in the past.

Okay. And you're looking for a pretty big jump between the second and third quarters. Historically that's been flattish because the third quarter is seasonally weak. So are you really counting on a lot of these new sales reps to -- or newer sales reps to really be up to speed by the third quarter?

Well, it's the sales force expansion but it's also the launch of Pearl.

Okay. So -- all right. Okay, that's all I have for now. Thanks.

Thanks, Dalton.

We'll go next to Sean McMahon with Kennedy Capital Management.

Thanks for taking my question. Kevin, any thoughts on a buyback here?

Yes, we've had those discussions with our Board. Just had a Board meeting within the month and we have agreement in principle. We have to get the board to approve the specifics of such a plan.

Can you share how big?

We're not in a position to talk about that right now, but as soon as we get their buy-in on it we'll be sure to put out an announcement.

Great. Thank you.

We go now to Jose Haresco with Merriman Curhan Ford.

Hi, guys. Good afternoon.

Hi, Jose.

Quick question here. You had mentioned earlier that the junior sales program was specifically focused in the more price sensitive areas of the market. Could you give us a little bit more clarity on what exactly might not have gone right with that approach?

And a second follow-up question is where do we intend to source these senior salespeople from? Most companies in this space have done a lot of hiring in the last, call it 12 to 15 months, and senior sales reps are pretty notoriously hard to get.

So are you guys thinking of raiding other companies or are we looking at other device (inaudible) companies at this point?

Well, Jose, I think the basic concept was to focus on a more price sensitive segment of the market. We've been able to grow our business mainly by selling the higher priced Xeo platform. And our average selling prices are very high with that product line.

So we're looking to focus on the Solera platform and we thought that having a group that's just focused on a lower price point in the market would make a lot of sense. Now, in hindsight, we didn't give that sales force a lot of the tools that our senior sales force has.

Lead generation was really reserved primarily for the senior sales force and so the junior rep was responsible for cold calling and really generating their own leads. So I think it was in hindsight a very difficult role to be successful with.

In terms of our hiring profile, I think that we hire people that come from outside the industry routinely. And in fact, our greatest success with hiring has been with reps that come from organizations that have excellent sales training programs in place and I think we'll continue to have a blend where we have industry people as well as people that have had capital equipment and sales experience.

Okay. Just on a -- you'd also mentioned that fewer -- that you're finding that customers were using fewer shots on the Titan. Am I recalling that correctly?

Yes.

Is it still something that has to do with the transition from the first generation to the second generation Titan or is there something more endemic in the market such that there are less procedures being done over a given period such as are we moving away from skin tightening and moving over to other forms of photo-facial or something that doesn't have a -- something that doesn't have a razor/razorblade attached to it?

Right. Well, we -- as Ron mentioned in his comments, we're monitoring it very closely and we do see it as an opportunity to better understand why that revenue ramp-up has dropped off. As Ron mentioned, our customers are continuing to buy Titan as part of the Xeo solution. We just need to understand why the utilization isn't where we thought it would be.

Okay. And last question and I'll get back in the queue. When you guys think of the Pearl, who is your perfect customer for that? Who's the first person your reps are calling? Is it the installed base, is it the new account out there who's likely to buy a fully loaded Xeo Titan and a Pearl? How do you prioritize those groups?

Well, it's all of the above, Jose. Obviously, our installed base is a prime candidate for an upgrade, but we're also finding a lot of interest in the market for procedures that offer a more pronounced outcome and so we're able to have a more aggressive solution for treating wrinkles and fine lines.

Okay. Thanks.

Our next question comes from Alex Arrow with Lazard Capital Markets.

Hi. Thanks. Good afternoon. Kevin, the 14 junior salespeople that left over the course of the last year, can you say how many of those had sort of nontraditional backgrounds that you've been known to have success recruiting from versus people that came from the laser industry?

I think without exception these did not -- these individuals were not from the laser industry.

And is that -- are you going to depart from that strategy now that you've had this sales force set of challenges that you're going to be taking more traditional type salespeople and do you think that was one of the reasons the problem happened?

Well, I think there's a couple of things. One is that we really didn't give them in hindsight all the support that we give our senior people.

We do funnel leads to our senior people, we have the PSS relationship and so there are a number of things that have contributed to the success of our senior sales model.

And so we're going to return to that model, the only exception being we now have dedicated resources -- salespeople to the PSS relationship. And PSS is quite excited about that modification to the relationship.

Okay, but I mean it's occurred to me that maybe this was a uniquely Cutera strategy versus other laser manufacturers to hire people that didn't come from the laser industry as sales reps.

That could be viewed as an isolated reason for the -- for the revenue shortfall and that going forward, if you're not going to be doing that anymore, then that's reason to expect a better revenue result. Is that a fair amount of reasoning?

I think so, Alex. And again, in hindsight, we should have done this on a smaller level than we did. We hired 16 people in this unproven model and so it was a painful event for us.

But we think the model that has been successful in the past is one where we continue to add more senior salespeople that have sold capital equipment preferably and that's what we're resuming to.

Okay. So given that, then, why is the guidance now -- the new guidance that you gave this afternoon suggests a continued loss of share as opposed to the recovery that it sounds like you're predicting qualitatively?

With more experienced salespeople, why is the guidance suggesting that you're going to keep losing share?

Well, obviously we're trying to get back on the growth trajectory that we've had in the past and we have a plan that I think will get us there. But there's risk associated with the plan as well.

We have a new product launch with Pearl that we're very hopeful that will go successfully, as we plan, and then continued expansion of the sales organization is also something that requires crisp execution. And we have to have additional sales management roles created in order to do that.

So it's more of an execution concern than anything else, but we do believe the market is continuing to grow in that 20% range and we need to get on the other side of that 20%.

Okay. And if you could help me understand the territory number. You said there's 56 territories going to 64 by the end of 2007. Of the 56 you have now, are 14 of those the ones the ones that had sales force turnover, so are you actually going to be hiring a net of 22 salespeople or is this 56 without -- after the 14 have left?

I'm not quite sure. As I said on the call, we had 10 people leave in the quarter -- or we had 11 people leave and we hired 10 and we've been at that 56 number for quite some time, Alex, over the year. So we're pretty close to that number now. And so we're going from the 56 number to the 64.

And that's the number of territories out there in the country.

Okay, so the people that left, they were territory carrying reps; they weren't sort of assistants to other reps?

Well, the junior rep is the cold calling profile that we talked about earlier. But we lost some of the junior people as well in the quarter.

Okay. And my last question, if I could, just on the timing of the shipment of the Pearl, why -- what's holding up the shipment until the third quarter?

Well, just the engineering program is still in its final throes right now so we --- as I said, there may be some revenue in the second quarter but it won't be a substantial amount.

Okay, but you're predicting pretty close to July 1st or do you think it'll start sometime in the middle --?

We believe that our previous comments about scheduling shipments for the summer were on track, so there's nothing that has us concerned about that.

Okay. And when you say the summer, you mean the midpoint of the summer, like July 1st?

We expect to be at full manufacturing ramp-up in the third quarter.

Right, at the beginning of the third quarter?

It probably will be the beginning of the third quarter, Alex.

Okay. Thank you.

We'll go next to (inaudible) with Manhasset Capital. Please go ahead.

Ron, can you give us an idea of the operating cash flows we might expect this year, assuming you hit your revenue and earnings guidance for the full year?

Right. As you know, we did about $35 million or so last year operating and adjusted for the settlement payment and we have $1.1 million in Q1 of this year.

I have not projected that out in the remainder of the year, but certainly would expect us to be able to -- with the guidance that we've given, been able to see at least $10 million, something north of $10 million.

Okay. And in the past Cutera's discussed a few strategic options for the use of the large cash balance of $110 million now. I think the two major strategic discussions were both acquisitions and/or a buyback.

Amongst your public competitors we've seen just one, I think, in the last few months make -- strike a deal or two, both not very large, very small uses of cash.

Can you give us an idea if indeed you're still looking at acquisitions or strategic deals or partnerships and if so what the size of them might be?

We are actively exploring those on a regular basis and obviously we have not done anything like that yet. But it's something that we're continuing to explore.

Okay. Barring a major shift or large strategic transaction, it looks like you've got potentially here greater than a third of your market cap in cash.

And just trying to ask the question that was asked earlier slightly differently here, you're looking at generating $10 million in operating cash flow, roughly, this year. The deals that are out there so far in the space aren't huge.

So what kind of cash balance do you guys need to operate the company, assuming you still generate cash? You've got a lot of cash you're sitting on, so just trying to back into the buyback size here.

Right. Well, as you know, we've been generating cash for many years now and so we haven't been in a negative cash position for probably since 2000. But, so in that sense we really don't need to maintain much of a cash position in order to support the operation.

So should we -- when we assume a buyback, then, I guess the size buyback that you guys might be looking at might be one that's quite substantial?

We're not in a position to comment on that just yet.

Okay. All right, fair enough. Thanks a lot, guys.

Thanks.

And we'll take our next question from Chris Sassouni with Eagle Asset Management. Please go ahead.

Good afternoon. I'm puzzled by something. It appears to me that in one quarter everything that went wrong seems to be attributable to sales management.

And so I'm sort of scratching my head in that there hasn't been any mention about either changes in the sales management position, although you made some mention of perhaps adding to sales managers.

So I'm wondering how so many things could go wrong because you're talking about managing the existing sales force, managing the new reps, hiring new reps and also having challenges with your, I guess your only and largest strategic distribution partner, at least in the U.S.

So could you help us understand from a sales force management perspective what, in your opinion, went wrong and were there -- and are there personnel changes coming?

I think we try to really categorize it in three different areas. One is during the quarter we had aberrantly high turnover, we had a junior sales strategy that did not contribute and we were expecting contributions by the end of last year, and then the national account business relative to a year ago was off. And we've got initiatives in place to address each of those three areas.

So what you're telling me is -- you've basically recited for me what you had already said before were the problems.

I guess what I'm asking you is, are the people that are in charge of sales management, in your opinion, the right people to carry this thing forward?

Well --

Because there were obviously some challenges that happened all in one shot. It just seems amazing to me that all this could happen in a span of 90 days.

Right. Well, as I mentioned, we felt -- it was a very positive ending to 2006 with a very strong fourth quarter and I think in hindsight it did mask some of the problems that we were dealing with.

But we've got a lot of confidence in the team and I think the biggest mistake that we made as a management team was really to explore the junior rep program in the grand scale that we did.

Okay. Well, maybe then let's take it -- so let's assume that your assessment of the market growth rate, at least in the U.S., is at least 20% and maybe it's a hair higher than that.

So given that you've got the Pearl coming onboard, given that you'll have seasoned salespeople in all of the territories and that your sales force, you'll have the largest productive sales force that you've ever had in your history because we're going to presume that the 14 or so reps that were junior reps were non-productive so now if you come into the end of the year and you have all 64 positions hired and more or less seasoned and productive to where they should be, theoretically you will have the largest and most productive sales force that you've ever had. Is that correct?

That's correct.

Okay. So then I guess -- I guess we can presume that going into '08 that there should be an acceleration of revenues beyond the market growth rate simply by virtue of the size of your sales force and their productivity and the fact that you will still be relatively early in the launch of the Pearl. Is that fair?

Well, clearly we monitor our performance relative to what's happening in the marketplace. We want to grow faster than the market's growing. So it's clear that we (in) 2008 we want to be north of that 20% growth rate that we believe the market's growing.

Okay. So if I just -- if I just do the math off of a base of 110 and you're going to grow faster than the growth of the market, you're going to end up in the $140 million to $150 million range for '08?

And I'm not asking you to give guidance, I'm just asking you to comment as to whether the thinking is correct or not.

Well --

Something would have to go terribly wrong, including overseas and/or again something wrong with the U.S., for that not to happen.

Well, again, our plan is to get us back on the growth rate that we've seen in the past. And so it takes time to do it and that's why we're guiding down for the second quarter. But we want to be on that growth trajectory as we enter 2008.

Right, so as you enter 2008 you've got 64 reps that are all productive, you're six months into the launch of Pearl, which looks to be a pretty significant product that I don't see too many other products that would compete against it, and you're going into AAD with presumably at least one product that you're going to showcase at AAD.

That is our goal.

Okay. Then let me turn my attention then to the international area. One of your competitors reported, while their sales aren't all that great overseas, numbers that were well north of 70% growth.

You're reporting -- you're reporting a number in the OUS market that is slightly higher than what you would have liked to have reported in the U.S. So I guess what I'm trying to figure out, is there something different about your OUS opportunity than your competitors?

Well, we have competitors that have 50% or greater of their business outside of the United States and those companies tend to be companies that have been in the market for an extended period of time.

We're making significant investments OUS because we want half our business to come from outside the United States. So we are closing that gap, but it just takes us a long time to do that.

And our next question will come from Dalton Chandler with Needham & Co.

Oh, I'm sorry. My question was answered. Oh, wait, I'm sorry. I apologize if you gave this, but did you give the percentage of revenue in royalty payments for the quarter?

Ron did, I think, 4%?

I don't think we did. It was related to Q1 '06, the part in the earlier script. But it's still approximately 4% of revenue.

Okay. Thanks.

We'll move on to Jose Haresco with Merriman.

Just a quick follow-up question on the PSS World Medical issue. Could you just give us a refresh on how PSS World Medical works with your sales force and how it's going to be different now going forward?

Well, we've had a relationship with PSS now for about four years, something like that.

Yes.

And the way the relationship works is that any business that PSS brings to us, they're compensated for those deals. And in the past we've had the -- our senior salesperson work side by side with the PSS rep and our salesperson is compensated for any deals that are done through PSS as well.

So the main difference now is that we will have in some parts of the country a dedicated PSS person that works with the PSS reps in that person's territory. And our senior person will no longer be part of those transactions.

Okay, so that rep would essentially be the person responsible for closing that sale?

That's right. And the exciting part of this program is that we've seen a pretty significant amount of our business come through PSS, but it really is spotty. And by having this dedicated sales strategy, we believe we can extract more from the PSS relationship.

And do you think that it's been spotty because some of the sales folks on your side have been not being able to follow through fast enough or the leads aren't -- where's the disconnect between moving it from one salesperson to essentially a PSS dedicated one --

Right.

-- [and now you're just -- it's all] they're doing at this point?

Well, we have certain reps that really seem to embrace the relationship and do quite well with it and other reps that for a long list of reasons hadn't had the same level of excitement. So it really is on our side that I think the relationship either works or it doesn't work.

Okay. Thank you.

And at this time that would conclude our question and answer session. I'd like to turn the conference back to our speakers for additional or closing comments.

Thank you for participating in our call today. We look forward to updating you on our progress next quarter.

We plan on making many investor visits in May and June and we'll be presenting at the Needham & Co. biotechnology and medical technology conference in New York, which will be held on June 13th and 14th.

We look forward to seeing you then. Good afternoon and thanks for your interest in Cutera.

Thank you, everyone, for your participation on today's conference call. You may disconnect at this time.