Cutera Inc (CUTR) 2008 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Cutera First Quarter 2008 Conference Call. (Operator Instructions.)

This conference is being recorded today, May 6, 2008. I would now like to turn conference over to Mr. John Mills of ICR. Please go ahead, sir.

By now, everyone should have access to the first quarter 2008 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 web site at cutera.com with our Form 8-K filed with the SEC and available on its web site at sec.gov.

Before we begin, Cutera would like to remind everyone these prepared remarks contain forward-looking statements, including statements concerning the planned improvements from our distribution network, long-term domestic and international growth opportunities and strategies, future spending on various aspects of our operations, the success of our recently launched Pearl product, and the development and acquisition of other new products and applications and their anticipated introduction dates, and our planned increase in market share.

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 the ability to improve sales productivity and increase sales performance worldwide, the length of the sales cycle process, the ability to successfully develop and acquire new products and market them to both its installed base and new customers, unforeseen events and circumstances related to its operations, government regulatory actions, general economic conditions, and those other factors described in the section titled "Risk Factors" in its most recent 10-Q filed May 6, 2008, with the SEC.

These forward-looking statements do not guarantee future performance. Therefore you should not rely on them in making an investment decision without considering the risk associated with such statements.

Cutera also cautions you to not place undue reliance on forward-looking statements, 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.

Go ahead, Kevin.

Thank you, John. Good afternoon, everyone, and thanks for joining us today to discuss Cutera's results for the first quarter ended March 31, 2008. On today's call, I'll provide an overview of our results and Ron Santilli, our CFO, will provide additional details on our operating and financial results. Finally, I'll provide some closing comments and open the call to your questions.

Our revenue for the first quarter 2008 was $21.6 million or 7% lower than the $23.3 million reported in the first quarter 2007. And though we experienced growth in our international business, increased our upgrade service and Titan refill revenue, these improvements were offset by declines in our domestic revenue.

US revenue in the first quarter 2008 was $12.4 million or 22% lower than the amount reported in the first quarter of 2007. These results were caused in part by what we believe is a slowing domestic industry growth rate, but we were also disappointed at the performance levels of our North American business. However, we believe we have a seasoned sales management team, a stable sales workforce, and remain focused on improving our productivity levels.

In an effort to achieve higher performance in North America in the coming quarters, we'll be focusing on several key initiatives, including the following -- implementing sales aligned marketing programs with a greater focus on Pearl and our PSS relationship, increasing sales management efforts, and developing and mentoring our recent hires and preparing for the planned second half product launch of our fractional product, previously - previewed recently at the ASLMS. We are closely monitoring our North American sales performance. We will continue to focus on improving our results. Our international revenue in the first quarter of 2008 grew by 25% when compared to the first quarter of 2007. Growth in our revenue came primarily from Japan, Australia, and many emerging global markets, such as Brazil and European countries. We continue to be pleased with the adoption of Pearl in many of our key international markets and are leveraging the momentum.

During the past few quarters, we have made significant investments [in our national] business that included increased sales, marketing, and customer service efforts through the hiring of personnel and increased marketing in our international subsidiaries, expanding our distributor network in emerging markets and opening a second office in Osaka, Japan. We are encouraged with our international team's progress and believe these investments position us well for future revenue growth.

Turning to research and development, we're continuing to increase our investment in R&D to develop innovative solutions and expand the clinical understanding of our current products. We recently previewed our new fractional ablative technology at last month's ASLMS meeting, with the response being very positive. This new device, designed to improve wrinkles by targeting the deep dermal layer, will enable us to compete in the expanded fractional ablative market and it's expected to contribute to our revenue in the second half of 2008. Historically new clinical applications have been a catalyst for revenue growth in the quarters following their introduction. Also we are pleased with the growing number of positive clinical results and patient reports of our Pearl product and we'll continue our commitment to increase levels of clinical research. Cutera continues to see high demand for our products outside the core specialties of dermatologists and plastic surgeons. In the first quarter of 2008, approximately of our US orders were from the core physicians. This compares to 14% of our US orders in the year-ago quarter. This is in line with Cutera's goal of building and retaining a diverse customer base.

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

Thanks, Kevin, and thanks to you all for joining us today on our first quarter 2008 conference call.

The first quarter 2008 revenue was $21.6 million, a 7% decrease when compared to $23.3 million for the first quarter of 2007. The first quarter of 2008, we had a net loss of $542,000 or $0.04 per diluted share. Product revenue for the first quarter of 2008 decreased 16% when compared to the first quarter of 2007. These results primarily reflect lower levels of product revenue in the US due to lower performance of our North American business.

Upgrade revenue for the first quarter of 2008 was $2.2 million, representing growth of 16% when compared to the first quarter of 2007. This growth continues to be driven by the Pearl application as our existing customers continue to realize the benefits of this new technology.

Service revenue for the first quarter of 2008 increased 41% to $2.7 million when compared to $1.9 million in the first quarter of 2007. We expect this revenue growth to remain strong as our installed base continues to increase and our customers utilize our services to maintain their products after the initial warranty periods expire.

Titan refill revenue for the first quarter of 2008 increased by 23% to $1.4 million compared to $1.1 million in the first quarter of 2007. Titan remains a popular application that is sold on a majority of our Xeo systems.

I will now address our operating performance. Our gross margin in the first quarter of 2008 was 62% compared to gross margin of 67% in the first quarter of 2007. The decrease in gross margin was primarily attributable to higher service revenue as a percentage of total revenue, which has a lower gross margin than our other revenue categories and the reduced leverage of our fixed operating costs due to lower-than-expected product revenue.

We have several internal initiatives with the goal of achieving target gross margin level in the mid 60% range.

Sales and marketing expenses for the first quarter of 2008 were $10.3 million or 48% of revenue compared to $9.1 million or 39% of revenue for the first quarter of 2007. The increase in expenses in the first quarter of 2008 in absolute dollars was due primarily to expenses associated with our international sales and marketing efforts. The increase in expenses as a percentage of revenue was due primarily to lower performance of our North America business.

Research and development expense in the first quarters of 2008 and 2007 were $1.8 million and $1.7 million respectively. Both amounts represented approximately 8% of revenue. We intend to increase our dollar investment in this area and are continuing pursuits to develop innovative products and applications.

General and administrative expenses decreased slightly to $2.9 million in the first quarter of 2008 from $3 million in the first quarter of 2007. G&A expense as a percentage of total revenue increased to 14% in the first quarter of 2008 from 13% in the first quarter of 2007 resulting from the lower revenue base in the quarter.

Our effective income tax rate for the first quarter of 2008 was 30%. For modeling purposes, we suggest using an effective tax rate of approximately 30% for the remainder of 2008.

Turning to the balance sheet, our financial position continues to remain strong. As of March 31, 2008, we had approximately $104.5 million in cash, marketable securities, and long-term investments. This represents approximately $8.20 per outstanding share.

Now I want to address the current issue of auction rate securities. As with many companies, we hold a portion of our investments in auction rate securities. The primary issue with these securities is a lack of liquidity due to failed auctions resulting from the overall credit concerns in the capital markets.

All of our securities are AAA-rated and invested in government-backed student loans. Included in our March 31, 2008 balance sheet is $11.5 million of auction rate securities classified in long-term marketable investments.

During the quarter, we recognized $1.9 million unrealized loss reported in the equity section of our balance sheet. We consider this impairment to be temporary as we have the ability and intent to hold these securities until recovery of the unrealized loss. As a result, there is no impact to our first quarter income statement.

Net accounts receivable at the end of the first quarter of 2008 was $8.3 million and the DSOs were 35 days. Our DSOs continues to remain among the best in the industry and with our - within our target of 35 to 45 days due to a thorough credit approval process and strong collection efforts.

Inventories increased to $9.4 million at March 31, 2008 from $7.5 million at December 31, 2007. The primary reason for this inventory buildup was a higher level of finished goods due to lower-than-expected revenue in the quarter.

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

Thanks Ron.

Our performance for the first quarter of 2008 did not meet our internal targets. As mentioned earlier, we'll be focusing our efforts in the coming quarters on a number of strategic programs designed to improve company performance. Some of those initiatives are as follows -- one, increasing performance of the North American business by implementing sales aligned marketing programs, including a greater focus on Pearl and our PSS relationship, increasing sales management efforts and developing and mentoring our recent hires, and preparing for the planned second half launch of our fractional product previously previewed at the ASLMS; two, we will also be continuing our investments in our international markets; three, evaluating and implementing measures to manage expenses and improve gross margins; four, continuing our commitment to R&D spending and new applications; last, while we'll remain focused on driving revenue growth, we will closely monitor sales and marketing expenses to ensure that they remain within targeted levels.

We have a strong portfolio of products and upgrades, including our Pearl. We believe that Pearl has tremendous upside and that as we continue developing clinical support and educating the market about the benefits of Pearl over the competing solutions, we're going to improve our performance in the skin rejuvenation market.

We are also excited about our Pearl fractionated product, which we expect will receive FDA approval and start shipping in the second half of 2008. We are committed to making Cutera a leading global provider of lasers and light-based aesthetic equipment. We remain confident in the opportunities in our industry and our business. We believe the worldwide market for laser and light-based aesthetic equipment will continue to grow in 2008 and beyond.

Now I would like to open the call to your questions.

Thank you,. (Operator Instructions.) Our first question comes from the line of Thom Gunderson, Piper Jaffray. Please go ahead.

Hi, good afternoon. The - I guess I'll jump in just kind of in the middle on service revenue. It's been a long time since we've seen a sequential decline in service revenue. Is there something going on there that doesn't meet the eye right away?

Hey, Thom, this is Ron.

With regard to Q4 service revenue, we actually had a nonrecurring charge there or revenue I should say of about $150,000 related to our Japanese operations. So if you were to back that out, then you would see a slight sequential increase.

And that's the way it should go into the visible future, right?

We would expect that, yes.

All right. And speaking of Japan, higher international spending on your sales and marketing line, which still surprised us a little bit as to the size of that given the revenue base, but spending on international makes sense if that's what's growing. Were there things that accountants wouldn't call one-time, but Wall Street investors might? Opening offices or signing bonuses, something like that?

I can't say that there's anything that jumps out, Thom, other than we have been spending quite a bit in terms of the hiring plan for our sales, marketing, and customer support personnel. And a lot of that happened leading up to the end of the year. So it is affecting the income statement in the quarter. But as you mentioned, we see the opportunities there. We've been investing in our international business for several years now and we're seeing some nice traction in certain [pockets], but we see tremendous opportunities where we've made significant investments as well.

And so would that $10 million-plus be $1 run rate that would be apace going forward in the year?

The $10 million, you're referring to sales and marketing?

Correct.

Yes. Well, obviously...

It doesn't go down.

It won't go down right now. We've made commitments to that. But if you look at our business, Thom, the first quarter is seasonally the softest for us. And so the sales and marketing spend looks out of whack. And then historically, Ron, could you go over where we've been at in other first quarter levels?

Sure. In Q1 '06, we were about 41% in sales and marketing and in Q1 '07, our sales and marketing expenses as a percentage of revenue was about 39%. So we typically run high in Q1. Then it comes down as the year progresses.

But with that said, Thom, it's still at a higher level as a percent than we typically have.

And part of that's the denominator. And then lastly, sort of a subjective question, but I'm curious about your answer, Kevin. And that is you have a lot of competition out there. And you've established your technology, you've established your new product sequence, et cetera. But you've got brand names that arguably consumers know better, whether we're talking Fraxel or SmartLipo or Thermage, does the hiring of a marketing VP with Kraft Foods and [Kodachrome] on her resume make us - does that lead us to believe that maybe there'll be some more marketing and some more branding of the Cutera product line?

Well, I think you're right in describing the market as being very competitive. And we have seen from time to time competitors come out with well branded offerings that have resonated with consumers. So we do recognize the importance of - moving forward of really distilling our marketing image messages and really positioning both our products and our company in the best light in a very dynamic marketplace. So we're very pleased to have hired Sharon recently and we think that she's going to be able to provide a lot of leadership for the things you discussed.

Okay, thanks. I'll get back in line.

Our next question comes from the line of Dalton Chandler, Needham & Company. Please go ahead.

Good afternoon. I wonder if you could comment -- you mentioned you were disappointed with the quarterly results and that you fell short of your internal goals. Was that entirely unit-based or are you seeing ASP pressure as well?

Dalton, the average selling prices have not moved appreciably. But we were hoping for more product sales. And so I think that's the source of the comment with the caveat that it's our toughest quarter in terms of revenue achievement. But we think that we're certainly staffed for much higher business levels than what we had achieved in the first quarter.

Okay. And then just to - sorry, but to come back to the sales and marketing question again, I mean, was there a significant step up in the quarter? You mentioned you had been spending on it all along, but was there a - just a big increment in this quarter?

Well, my comment was really about our international sales and marketing expense. Those has been ramping up. And, Ron, the US expense levels haven't changed not appreciably. So it's really to the international commitments that we've made that've - that have been creeping up over the last several quarters.

Okay. But there was no unusual increase for - in the international either?

I - well, they were planned increases. We see opportunities there and we're making investments and we will continue. But we like what we're seeing in the fundamentals of those markets.

Okay. And then on the domestic side, I mean, what are you seeing with regard to your current sales force and its ability and potential turnover?

Well, the turnover issue, I think we've been relatively stable. We didn't have any aberrant turnover issues in the quarter and we've been pretty stable in terms of our hiring as well. We did a lot of hiring last year and we think that that work is behind us. So we think we're well staffed.

Okay. Can you just remind us how many US territories you have?

We have - North America we had - at the end of March, we had 58 territories with about 56 on hand at that time, so there was about two openings at that time.

Okay. And then what else can you tell us at this point about the new Pearl fractional -- anticipated pricing and if there's a disposable component?

Well, we don't have our FDA clearance, so we can't quote pricing at this point. But we think that the market for having a more significant solution for the treatment of wrinkles is real. And this is another submarket of the fractionated technology market that is really quite new. So we think we will be in the market at the early stages. And at the last [AAD], it seemed that the products that are targeting this market have gotten a lot of attention by physicians. And we think that the wavelength that we've established with Pearl has given us excellent results. And we think we'll be able to leverage that for this new submarket within the fractionated space.

We also believe that this really does play to the strength of the Xeo platform because most of the major players in this space are offering a one-technology answer and commanding a pretty attractive selling price, well north of $100,000. And we think that Xeo having the flexibility to have a broad range of the most popular laser and light-based applications will really allow us to position it very nicely against the other two major competitors in this space.

Okay. Who do you view as the two major competitors?

We think the most recent offering by Reliant and the Luminus product in this space as well.

Okay. And you didn't mention if there is a disposable.

There is not a disposable.

Okay. And then just finally the upgrade path?

Again, Dalton, we're the same. We'll offer this to our customers as an upgrade once we get the upgrade clearance.

Okay. Great. Thanks a lot.

Our next question comes from the line of Phil Nalbone, RBC Capital Markets. Please go ahead.

Thank you. Hi guys. I'm just looking for a little more color on the challenges in your North American business. Can you talk a little bit about how this is kind of manifesting itself at the product end? Is it kind of the inability to sell upgrades to the existing customer base? Is it a more challenging environment to sell new systems? Kind of how do the non-core physicians play into this? Is that suddenly a real issue here because of the economy?

Well, I think there are a number of things happening here, Phil. And we do have the benefit of having a number of our publicly-traded competitors report their results for the first quarter. And it seems that across the board with the exception of one of our competitors, they've seen softening in their US business. And we think that it's a more challenging environment than it was a year ago. And to a large extent, each quarter we are learning new things about the - where the macro issues that certainly we weren't able to anticipate a year ago. But we're trying to manage our way through it as best we can and we think that new, exciting applications has historically been a - the way that we've been able to grow our business during some tough times. And we're focused on bringing new applications to the market as quickly as we can and we're pleased with what we have going on in the lab here.

In terms of the non-core physicians, I think that credit is certainly a consideration. But I think the feedback that we get from our partners that offer leases to our customers is that people with good credit are able to still get good leasing alternatives in the market today. But I think the bar has been raised for customers that might've been on the edge say a year ago. They are having a very difficult time getting leasing alternatives in the market.

Ron, you want to comment on that?

Well, particularly in the Medispa market or the non-physician, those two different submarkets are probably the ones that are becoming more difficult for us to get credit approved. But when it comes to physicians that have been in practice for quite some time that typically are well - that have a good financial background, which many of them do, those still are processed fairly routinely.

Okay. I realize this calls for a lot of subjective judgments and commentary, but I'm going to ask it. Relative to your internal targets for the quarter, how much would you say the shortfall was the product of the sales force disruption or lack of productivity? How much of it was the economy?

You're right, Phil, that is a very subjective question. And we spent a tremendous amount of time trying to take those two things out of that equation. But it's almost impossible to do.

Well, I think the - I guess there are a number of things I would look at. One is that we do see that in our international business, we think we've got a very strong portfolio. It's done well with our direct and sales organization, as well as our distributor model. And so I - we do have a solid product offering. However, we also see the benefit of launching into new applications. And we're committed to doing that. And so I think companies in our space that have tapped into the high growth opportunities have performed better. So I think that's clear that we need to be focused on offering new applications in the future and that would help improve the performance of our North American business. And we've done that time and time again.

We're also staying very close to the expanded sales force. We hired a lot of people last year. We - as we commented earlier, we think that has stabilized. But we are dealing with a number of new managers that have been promoted into those roles from a sales rep role. And so we're training new managers, as well as new salespeople in our North American sales team. But we think they're doing all of the right things to move those people along.

Great. One last thing, Ron. Maybe you can help me reconcile two sets of numbers here. I was under the impression that Cutera ended the December quarter with 64 North American sales territories. Is that correct?

Yes, there were 64 territories at the end of December. Actually, let me - I just want to look at one more - at the end of December, we actually had 60 territories. We had 64 at the end of September.

Okay. So does that represent sort of continual turnover? Or does it represent a paring back of the number of territories?

Well, there's some level of turnover that happens with the sales team and particularly when the numbers get as large as we have today. Obviously in a more challenging environment, we're scrutinizing the decisions to replace or not. We started the expansion at the beginning of last year. We thought the market in North America was growing in the 20%-plus range and we think that number has changed. So we're still committed to a large direct sales force here in North America, but we're looking at the - those decisions on a one-off basis.

Great. Thank you very much.

Our next question comes from the line of Anthony Vendetti, Maxim Group. Please go ahead.

Thanks. I just have a couple of questions.

In terms of the new product launch that you mentioned, Kevin, at - on the bottom of the first page, looking forward to planned new product launch later this year, are you talking about a new product platform? Or is that the fractional Pearl?

It's the latter, Anthony.

The fractional Pearl, okay. Is there any other new products that you're expecting this year?

We have not announced anything new for this year.

Okay. And in terms of the sales force, now that you're down to 58 territories, and I think, Ron, you mentioned 56 were staffed at the end of March 31, 2008. Have you filled those other two positions at this point? Or are you still evaluating whether or not you need to?

I don't know if we have or not. But we certainly are evaluating those each time they come up.

Okay. And in terms of gross margin, I know based on the fact that obviously lower product revenues and higher service revenues, it was a little bit lower. You mentioned I think a goal of mid 60s or so. How do you see that kind of playing out this year? And is that a goal for 2009? Or is that a goal to try to get to by the end of this year?

Yes, Anthony, we looked at the gross margin number slipping over the last couple quarters. And in the fourth quarter call, we mentioned that we had a manufacturing absorption issue and [I think you] recognize that fourth quarter revenue levels are usually significantly higher than we have throughout the year. So we were staffed for it and we felt the negative impact of that in the fourth quarter.

But as we dug into it, we recognized that the good news is that our material cost as a percentage of revenue has stayed relatively stable. And so we see some other controllable costs in our business that are an opportunity for us to set a target that we think is reasonable in the mid 60s range with the caveat that this is with what we think is relatively normal revenue levels.

As the revenue level moves in the positive direction, we think that number can be leveraged to the positive. And you've seen historically that we've had gross margins in the low 70s. So think we think we can return to those levels if we are able to get the significant revenue volume back where we've seen it historically.

But in the meantime, we think that reasonable revenue levels, setting a target for the mid 60s is something that we should set as a goal. And in terms of how long it takes to get there, well, we're working on it now. We're not going to commit that we'll have it next quarter, but we're - we certainly are working with the team to get there as quickly as we can.

And just on ASPs, they haven't decreased materially? I think Candela mentioned they were down 4% or 5%. Do you want to quantify materially? Are you using the materiality rules 3% or...

Well, let me just - I didn't think of that rule when I commented on it. But in general, Anthony, we've been able to add more value to the Xeo platform with new applications. And as you've seen, our average selling price has actually moved north over the years pretty significantly.

And so with the launch of Pearl, we saw some positive impact of selling price there. That's not to say that we aren't in situations where the prices are in question and we have to respond to those. But we have a number of different models that we can offer the market. And so we're able to deal with it that way.

Okay. And lastly on PSS, you mentioned that's one of the things you want to improve upon. And I know that that relationship's been intermittently great and then in some quarters not as good as you would expect. Where is that now and what would you do or what would you like to do to try to make that more consistent going forward?

Well, I think the consistency is the biggest challenge we have with it. I never - I don't think we've ever characterized the relationship as not being good. We work very well with the team. And PSS has somewhere around 200 vendors that they work with. And so the challenge for all of us that are partners at PSS is to get their mind share.

And actually, Anthony, we've been pleased with the outputs from PSS. I mean, in '07, they helped contribute to something north of $14 million in our revenues in the US. So we do believe it's an opportunity for us and we're going to continue working that relationship and that partnership.

Okay, great. Thanks guys.

(Operator Instructions.) Our final question is from the line of Jose Haresco, Merriman. Please go ahead.

Hello? Jose?

Hi, good afternoon, gentlemen.

Hi.

Hi.

A couple of questions here. You have mentioned several times now that obviously the quarter was disappointing. Can you give us just a little bit of flavor as to where in the quarter the disappointment lay? Is it in the beginning of the quarter in terms of building that initial sales pipeline? Or more towards the end as you're trying to close the deal? Could you - could we start with that one?

Well, Jose, it's...

Both.

So I don't really have an answer for that. I mean, we - the way the business unfolds and I think pretty much for the entire industry is that the order rate is backend-loaded. And so I think every company in the space, if not every capital equipment manufacturer would like to have smooth orders throughout the quarter. We'd get one-thirteenth of the business every week. But it just doesn't work that way. So we'd love to have that problem fixed, but I don't think we're alone with that.

So by definition, we expect a lot of business to come at the very end. And we just didn't see the uptick in our North American business. But as I mentioned, it typically is the softest quarter for us. And - but we still saw nice growth in our international business.

Well, let me ask it another way. As you headed into the quarter in January, were you - were your initial sales pipeline or your leads going coming out of the AAD and things like that giving you a sense that you -- we get an understanding that Q1 is always tough, that your funnel would be big enough to carry you through the quarter.

Well, first of all, the AAD is not till mid quarter. And so January's a pretty quiet month for the space. We think we're doing the right things in terms of getting lead generation. And - but we think that doctors are just taking longer to make those buying decisions and we've heard that from other competitors in this space. So we don't think we're the only ones feeling that.

So we think we are doing the right things in terms of getting the pipeline where we need it to be. But at the end of the day, we weren't able to get as many of those deals across the finish line.

Okay. Ron, I have a question for you. On the SG&A expense, I think you mentioned that a good chunk of the jump was because you were continuing to build infrastructure overseas. Is it possible for you to quantify the impact of currency in the first quarter in establishing those OUS channels?

I haven't quantified that. I don't think it's significant because we do incur a fair amount of our expenses in US dollars, as well as the foreign currencies. So I did not do a calculation and I don't think it's a material number.

Okay, great. Thank you.

Ladies and gentlemen, that does conclude our question and answer session. I will turn the conference back to management for closing remarks. Please go ahead.

Thank you for participating in our call today. We look forward to updating you on progress on our second quarter conference call in August. Good afternoon and thanks for interest in Cutera.

Ladies and gentlemen, that does conclude the Cutera first quarter 2008 earnings conference call. Thank you for your participation and have a pleasant day. You may now disconnect.