Cutera Inc (CUTR) 2013 Q3 法說會逐字稿

The Cutera, Inc. conference call will begin momentarily. Greetings and welcome to the Cutera, Incorporated third quarter 2013 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, John Mills of ICR. Thank you, Mr. Mills. You may begin.

Good afternoon everyone. Thank you for joining us today to review Cutera's financial results for the third quarter ended September 30, 2013. On the call today is Kevin Connors, Chief Executive Officer; and Ron Santilli, Executive Vice President and Chief Financial Officer. Kevin will start the call with a brief review of the quarter, then Ron will discuss third quarter financial performance. Finally, the Company will open the call for your questions.

Before we start, I want to touch upon any forward-looking statements made during the call, including management's beliefs and expectations about the Company's future results. Please be aware they are based on the best available information to management, and assumptions that management believes are reasonable. 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. Future results may differ materially from management's current expectations, forward-looking statements including statements concerning financial guidance on future revenue growth, expense levels, gross and net margins, the result of cost improvement initiatives, and other financial metrics. Expectations for increasing revenue, the development, commercialization and revenue growth potential of existing and planned new products, while we manage to commercialize new products, and we attempt to launch products according to our plans, there is risk both from regulatory and technical challenges that our actual launch date could be delayed, or the launch of certain products may never occur.

Management plans for the repurchase of Cutera's stock, management and the Board of Directors make no assurances to the magnitude of our planned share repurchases. Although we have established Board approved limits, and the Company has to comply with regulatory and repurchase volume restrictions. Also, management may make additional forward-looking statements in response to your questions. For a complete list of risk factors that could cause Cutera's actual results to differ materially from the forward-looking statements, please refer to the section entitled Risk Factors in the Company's most recent 10-Q filed today with the Securities and Exchange Commission.

With that, I will turn the call over to Kevin Connors, Cutera's President and CEO. Go ahead, Kevin.

Thank you John. Good afternoon everyone, and thanks for joining us today to discuss Cutera's results for the third quarter ended September 30th, 2013. Our revenue for the third quarter of 2013 was $16.8 million. Our current quarter revenue contraction was primarily due to the following key reasons: one, a decline in our podiatry business; two, continued softness in our Canadian operations; three, the Japanese yen devaluation compared to this last time last year; four, lower than expected penetration into the body contouring market with our truSculpt product. I will expand on each of these reasons, provide additional color, and on our initiatives to improve on each of these areas.

Starting with the podiatry business, our podiatry revenue contracted by $1 million relative to last year. Our significant growth in market leadership in this market was built primarily in the United States and Canada, so since beginning of 2013 we have experienced softness in our performance, and we are actively pursuing a number of specific initiatives. We have modified and expanded the North American sales organization, that I will discuss later, that are relevant to our podiatry business future performance. In 2012 we had a dedicated small team in North America calling on podiatrists, we found the challenge of large geographic coverage created inefficiencies. We no longer have a dedicated sales force to this call point, but we have made other sales force modifications in the past quarter. Our GenesisPlus product is the premiere offering in this category, as it was specifically designed for this market, and we have robust clinical experience to share with clinicians.

Additional focus provides opportunities for enhanced commercial performance. However, we are seeing evidence that additional focus is yielding positive early results. Softness in our Canadian business -- our business in Canada declined by over $800,000 relative to the same period last year, some of which was podiatry revenue. The Canadian market has been significant for us for many years, and in the third quarter we had a change in leadership in our Canadian sales team. We are actively re-focusing our resources to achieve significantly improved performance metrics. Our team in Canada has historically been an outperformer, and we are committed to regain our more typical strong performance levels in Canada by augmenting, training, and expanding support. The yen devaluation -- the yen devalued by approximately 25% relative to the US dollar when comparing Q3 of 2013 to Q3 2012. Our Japan source revenue was $3.5 million in Q3 2013. Including the impact of the Japan yen devaluation, we estimate that the foreign exchange impact on our revenue was in the range of $1 million in the third quarter of 2013.

TruSculpt for the body contouring market. The body contouring market segment continues to grow, and we continue to hear positive comments from our customers regarding our truSculpt product, and our expanding family of truSculpt applicators. However, relative to this high growth market segment, we believe that there is an opportunity to significantly expand our penetration. True to the North American segment, we have made improvements in our overall North American sales force. We have restructured and expanded our number of sales territories, and are targeting approximately 40 sales people in North America, with additional expansion plans for early 2014. This includes a mix of product specialists and sales representatives that sell our entire portfolio.

During the quarter, we established a North American sales specialist function initially for our Excel V, and have been pleased with the early results. We have found the addition of the product specialist sales function has resulted in greater focus for the Excel V business. With our expanded product portfolio, and new launches planned in the near future, it is imperative that we maintain focus in each product category. We are currently expanding the specialist model to other products, where we believe additional focus can provide enhanced performance.

Beyond Japan and Canada our International revenue grew slightly. We experienced growth in many Asian and European markets, including China, the Middle East, and France. We are continuing to invest in our International markets, and are expanding our direct presence in Switzerland and Benelux regions in the fourth quarter 2013.

Turning to Research and Development, we are pleased with the progress the team has made during the quarter which is as follows. During the quarter we launched a new 16-square centimeter truSculpt applicator to treat smaller cosmetic areas. Initial feedback has been very positive, as our key competitors have been unable to provide a solution for treating smaller regions. During the quarter customers included this applicator with most of our truSculpt orders. TruSculpt has the commercial advantage of being a platform that we were able to launch new applicators to better treat different parts of the body, as well as the potential to pursue other aesthetic applications. We are also pleased to be able to offer this new applicator to our existing truSculpt customers, so that they can expand the capabilities of the technology.

At the American Academy of Dermatology meeting in March 2014, we plan to launch three exciting new products, pending regulatory clearances. One, we are encouraged with the progress of our picosecond, dual-wavelength program for the treatment of pigmented lesions, and for tattoo removal. A multiple wavelength solution provides physicians with the ability to successfully treat a broader range of tattooings. Furthermore, we believe our high-performance, flexible platform will allow for clinical research in other dermatologic conditions.

Two, laser hair removal continues to be one of the largest markets in our industry. We plan to launch a premiere offering that incorporates Alexandrite and Nd:YAG laser solutions in a compact, integrated design, similar to our experience on the launch of Excel V, we have found that dermatologists have a preference for high-utility laser solutions, and this product will be in line with our strategy of expanding our portfolio of premium laser-based products. Three, a new applicator on the truSculpt platform that is intended to expand its indications for use, and allow treatment of other parts of the body.

In conclusion, we are pleased with the breadth of programs in our engineering team, and we believe that we have an exciting product pipeline, that combined with improvements we are making with our sales team, will allow us to be positioned for much improved results in the fourth quarter and throughout 2014. Further, we remain pleased with the market acceptance and the revenue growth of our Excel V vascular product. However, our Excel V revenue growth improvements and our cost structure were more than offset by the decline in other areas of our business.

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

Thanks Kevin. Thanks to all of you for joining us today on our third quarter 2013 conference call. Our revenue was $16.8 million, or a decline of $2.6 million from the third quarter of 2012. This decline was primarily due to the following factors. One, our podiatry business declined by approximately $1 million; two, we estimate the Japanese yen devaluation had an impact in the $1 million range; and three, our Canadian business declined by over $800,000, of which the podiatry business decline was roughly half.

Gross margin was 55% for the quarter. Although this was flat compared to a year ago, if we had an increase in revenue we would have experienced a positive impact on our gross margins. This reflects the realization of several cost reductions in recently launched products, which was offset by the impact of the lower than expected volume. Net loss was $1.7 million, or $0.11 per diluted share. Noncash stock-based compensation and depreciation and amortization totalled $1.1 million for the quarter.

The balance sheet remains strong with $82.3 million in cash and investments following the stock repurchases. As Kevin mentioned, the Japanese yen devalued approximately 25% when comparing the average rates to the third quarter of 2013 to the third quarter of 2012. Our Japanese revenue for the quarter was $3.5 million, of which approximately two-thirds is sourced in Japanese yen. The impact of the Japanese yen devaluation on our revenue this quarter was approximately $600,000 with additional negative impact due to the effective price increase, which is difficult to quantify.

In the aggregate we estimate that our revenue was negatively impacted by approximately $1 million in the quarter. Fillers and Cosmeceuticals revenue in Japan declined by $255,000, or 19% due primarily to the yen devaluation. Although we had a strong filler performance, we are in the process of phasing out distribution of the Obagi products in Japan, and instead have elected to begin distributing the Xeo product portfolio, Dr. Obagi's new company.

One of the factors in our choice to make this change was related to customers' dissatisfaction with competing Internet sales channels available to Obagi customers, our customers' patients. Our physician customers desired to provide these products to their patients directly, thereby capturing recurring product revenue while maintaining a regular patient contact, which can yield additional procedures at the physician's office. In the long-term we believe that this new portfolio which doesn't have a competing Internet sales channel will allow our customers and Cutera to capture all product revenue in Japan, which should result in greater sales levels, as the account volume expands.

Now I will address our operating performance. Our gross margin was 55% in the third quarter of 2013, compared to gross margin of 55% in the third quarter of 2012. We realized the same gross margin percentage of the lower revenue volume. It is our belief our gross margin percentage would have been 58% or greater, if our revenue would have been at the third quarter 2012 level, which would have reflected improved performance. This improved performance is the result of realization of many cost initiatives driven during the past year, and increased reliability of our products resulting in lower service expenses.

Sales and marketing expenses were $6.6 million or 39% of revenue, compared to the $7 million with 36% of revenue in the third quarter of 2012. The decline is largely explained by reduced commissions from the lower volume. We expect our sales and marketing expenses to increase in absolute dollars in the future quarters due to continued expansion of our global sales force, particularly in North America, and increased commissions for higher projected revenue.

Research and Development expenses increased to $2.4 million in the third quarter of 2013 from $2.2 million in the third quarter of 2012. The growth in the current quarter was due primarily to increased material spending which is project timing dependent, related to new product development activity. We remain committed to investing in R&D and launching new products in the future, and expect quarterly spending to be in the range of $2 million to $2.5 million per quarter.

General and Administrative expenses decreased by $300,000 to $2.2 million. The large reduction was due primarily to reduced variable personnel costs and legal-related costs offset by higher costs associated with the commencement of the US medical excise tax on January 1st, 2013. We expect general and administrative expenses to be approximately $2.6 million per quarter in the future, which includes the US medical device excise tax.

Income tax provision -- our tax provision is primarily attributable to International taxes related to our foreign subsidiaries and small amounts of minimum and capital-based taxes in the US. As a reminder we continue to maintain a 100% valuation allowance for our deferred US tax assets. We recorded a one-time tax credit of $169,000 in the current quarter. This includes a one-time credit associated with the releasing of some reserves for uncertain tax position. Going forward for modeling purposes, we suggest using an effective income tax expense of approximately $100,000 per quarter.

Turning to the balance sheet, net Accounts Receivable at the end of the third quarter 2013 were $7.5 million, and our DSOs were 41 days. Our DSOs increased this quarter primarily related to higher revenue contributions from some key International distributor customers who had payment terms. We expect our DSOs to return to the mid-30 days in the fourth quarter as our revenue increases.

Inventories declined by $100,000 to $10.4 million at September 30th, 2013 compared to the second quarter of 2013. This reflects turns of approximately 3 per year. We believe there continues to be room to reduce our inventory further where appropriate and increase our turns to 4 per year. Deferred revenue increased over $750,000 during the third quarter of 2013. We have had an increased volume of customers who purchased multi-year extended service contracts at the time of purchase of their new systems. This deferred revenue will be amortized into revenue during the period in which the customer obtains service coverage. This is primarily years two and three from date of purchase.

Regarding our share repurchase, during the quarter we repurchased $7.6 million of common stock pursuant to the $20 million share buyback program approved by our Board. Our program has two plans. One in the open market during the open window at the discretion of management. The other plan is a 10b5-1 plan which can trigger based on predetermined criteria. We acquired 796,919 shares or almost 800,000 shares at an average price of $9.54, and have up to $12.4 million available for additional purchases. We remain opportunistic with repurchasing our shares. The repurchase program may be suspended or discontinued at any time.

In conclusion, our financial position remains strong as we held cash and investments of $82.3 million with no debt. This represents approximately $5.83 per outstanding share. Our operations have generated approximately $1.1 million of cash in the nine months of this year, and we expect to be accretive in the future.

Now I would like to open up the call for your questions. Operator.

Thank you. (Operator Instructions). One moment please, while we poll for questions. Thank you.

Our first question comes from the line of Thom Gunderson with Piper Jaffray. Please proceed with your question.

Hi, guys.

Hi Thom.

So you must be disappointed with those results, and you delineated the contraction or the decline into several parts. Let me focus on just one of them, and that would be truSculpt North America. We don't have any OpEx to worry about. You are not going to impact the dollar yen trade any time soon.

But on truSculpt you had a competitor report last week that did surprisingly well in the quarter with their non-invasive fat reduction, and I am just wondering how you compare, Kevin, your performance, not just in the quarter but maybe in the last nine months, 12 months to what Zeltiq has been doing, and is it simply a matter of expanding sales territories by four or five, or adding an applicator, or is there something else that needs to be done to change the momentum?

Sure, Thom. Obviously, we track our key competitors, and Zeltiq is one in the body contouring space that has done very well, and as we mentioned in the script, we see this market as an attractive market. We don't have the track record of being in the market as long as that company, and the Liposonix product as well, and there has been a fair amount of a clinical story that has emerged over the years with both of those companies. And this has been the one year anniversary is halfway through Q3 of last year is when we launched this product. So relative to those companies we still think we are early in the game.

Maybe it didn't come across as a strategy in the script, but this notion of bringing specialization to the sales force is something that we are encouraged by the first experience with truSculpt, because it did result in a higher level focus on that product, which translates with the Excel V. We were able to just raise the bar in terms of the focus on that product, and in the script we mentioned that we are looking at that model to serve as a model for other products. Obviously, truSculpt would be one where we think we have a tremendous opportunity with the product that we have today, and then we have been expanding the applicators over the years, so it just seems like we really need to be measuring our performance in this market, relative to the other key competitors and so it is a major opportunity for us, particularly in North America.

Thanks for that, Kevin. On the specialization, you move out of specialization for podiatry, and put it more in the general group, and I get that; there are more territories and so more opportunities to make calls. How many -- and you are talking about success with Excel V -- I know it is early, but how many sales guys are working, are specializing in Excel V?

Right now we have four, and we have each one of the specialists teamed with a territory. So a territory is typically eight reps or so, and then the specialist works with those other eight reps to really cultivate the business in the particular specialty. So this is a different specialization relative to what we had with the podiatry split sales force. We are finding there are much greater efficiencies with this model than what we had with the large geographies in podiatry.

Got it. And then one last area and I will let some others ask questions, and that is new products. New products saved you the last time you had a downturn in the market in the overall recession and you brought yourself back up with a series of new products, Excel and truSculpt being two of them, and now we have got some new products coming up at derm, the real new, new product for me at least is the new tattoo laser. Now in the past you have shown these at the derm meetings and then launched them later. Is that the way we should look at the new tattoo laser, or is it going to be closer to being ready to commercialize?

Well, we are always mindful of the timing of talking about new product launches, and we have talked about three different products that we are excited about. With the laser hair removal platform obviously it would be a risk of cannibalizing our core hair removal business if we would have a delay in the launch of that, so we feel like that is pretty far along, and there are regulatory assumptions with all of these, but we think that having the ability go to market soon after the debut of these products is a key goal for us, and so the R&D team really is working extremely well together, and we have really augmented the team and we are seeing results in terms of prolific activity in the new product department.

Got it. Thanks.

Thank you. Our next question comes from the line of Anthony Vendetti with Maxim Group. Please proceed with your question.

Thanks. So Kevin, I just want to understand these new products at AAD just to follow up, I guess. Is the new high-performance laser system that was scheduled to be launched at the end of the year, is now going to be one of the three launched at AAD, or is that separate?

No. That is correct. You have got it right.

Okay. Okay. And is that the picosecond one, or is that the, which one was that of the three?

Okay. So we talked about three. So one is the hair removal platform with the Alexandrite technology, as well as Nd:YAG. We talked about the dual-wavelength picosecond product, which is for the treatment of pigmented lesions, and tattoo removal for a broader range of tattooings, and then another extension to the truSculpt family of applicators.

But I am just trying to understand the one that was supposed to be launched by the end of the year, is that the picosecond one or is that the laser hair--?

No. We were looking at the hair removal platform by the end of the year.

Got you. Okay.

The Alexandrite moved to AAD to make sure our resources are there to get both the Alexandrite and the pico products ready for AAD.

Okay. Got it. Got it. And just can you give us an update on where you are with the FDA process for the picosecond?

On past calls we have talked about having a constructive discussion with the FDA. We were able to have our team meet with the reviewer and the division, or the branch chief I believe was there, and talked about the path to getting an ultimate indication for both pigmented lesions and the removal of tattoos. So it was a very good meeting, and so we have plans for both of those 510(k)s being submitted, and whether we get the clearance in time for the meeting or not, clearly we are working towards that, but that is out of our control to some extent.

Sure. Sure. No. I understand that. And then lastly on the sales force, in terms of the reorganization there, and so forth, do you feel, because the softness now in Canada has been sort of an ongoing story for this year, do you feel with the change made specifically there, the management there, that A, you are on the right path to turn that around, and then when specifically was that management change made?

The specific date -- I couldn't tell you the exact date, but it was the first month of the third quarter, I believe. Yes. So the team in Canada, as we have talked on the various calls in the past, we have had a really successful track record, and the team of great achievers were still intact largely, and we have expanded there and so we have some new people onboard, but we are really digging into the details of getting that business level to where it needs to be, and we don't think that the market has changed. There are always bumps that happen, but we believe we have the right people on the ground, and we just think that staying closer to the execution on these opportunities should get the business where it needs to be.

Okay. Great. Thanks guys.

Thanks.

Thank you. Our next question comes from the line of Morris Ajzenman with Griffin Securities. Please proceed with your question.

Hi, guys.

Hey, Morris.

First question. You went through some of the shortfalls, podiatry, $1 million year-over-year, Canada $800,000 year-over-year, and then the yen impacting approximately $1 million. So those three outside of truSculpt which you didn't put a number on equates to about $2.8 million. So if you are looking at $2.8 million, and you add that to the top line just for argument's sake, you would have been flat versus a year-ago, and even sequentially. And the industry has shown growth. What else beyond, even making those adjustments, you are still kind of flat. Can you maybe put some color on truSculpt just to help us understand, even with those adjustments you look like your top line is still lagging with the industry in the numbers that were exhibiting recently?

Yes. Sure. I think you have it right in general, Morris. And we didn't put a number on truSculpt, but clearly as we talked earlier in the call, we see what is happening with one of our competitors in particular, and we see that has a huge market, which represents a tremendous opportunity for us, that we are clearly focused on getting our fair share, but in terms of the industry, clearly the Zeltiq performance is notably fantastic, but we are still waiting for some of our other competitors to report, and we will gauge our performance relative to the whole peer group, but the short answer is we have got to get more of the truSculpt opportunity in our business.

Let's just switch over to podiatry. Pinpoint there was a small competitor has been acquired by a larger well-known competitor of yours, and they seem to be having better traction. Is that part of the reason with revenues being down year-over-year? You talked about the sales force, but are there competitive pressures that are impacting you there?

What acquisition are you referring to, Morris?

Well, Pinpoint is now part of Cynosure now?

Oh, it is a distribution agreement. It is not an acquisition. At least I haven't seen any news break on that, so that has been in place for I don't know, a year and a half or so, that is not new. I think in the case of our experience in podiatry is that we had that dedicated team, and some of those sales reps did very, very well, but as I alluded in the prepared comments, the overall approach created some inefficiencies, because the reps were carrying or covering such a large geography. So with our early positive experience with the specialist model, we think that other products should make sense to evaluate that as well.

Okay. One last question, and I will get back in queue. On the Titan and truSculpt hand piece refills, they are both down sequentially and year-over-year in double-digits, mid-teens to lower-20% range, and truSculpt again will be rather new, it's my presumption that Titan is even a bigger percentage decline. Can we read into this in any manner?

Well, there are two primary reasons there. One, the Titan hand piece refill is largely being impacted in Japan with the yen, because we have a big installed base there, so that pulled part of it down, and truSculpt we have gone to a non-refillable process. So we are not getting the refill business there either.

If the customer is willing to pay for a service contract with it, so it is just a different bundling approach.

Correct.

Oh, I understand. Okay. Okay. Thank you.

All right, Morris.

Thanks, Morris.

Thank you. (Operator Instructions). Our next question comes from the line of Jack Wallace at Sidoti & Company. Please proceed with your question.

Good afternoon guys. Thanks for taking my call.

Hi Jack.

Hi there.

In a previous quarter's calls, you had been nice enough to break out truSculpt and Excel V as a combo as a percentage of sales. What was that figure for this quarter?

Just as a combination, we may have had made a comment, but we don't have any regular disclosure regarding those two items.

Yes. I remember making a comment of the product sales. It was like 50% at that one quarter. We don't have that calculation in front of us, Jack.

Okay.

But anecdote, well, Excel V had nice growth year-over-year, and truSculpt we have been seeing opportunities for improved performance.

Okay. Thank you. And then I guess just looking out a couple of years now, part of the last couple of quarters here have relative underperformance, and part of it you are pointing at the sales staff, part it has been now a little bit of the truSculpt not maybe getting adapted as quickly as anticipated with the new products to be commercialized in the upcoming year, and I guess two years out, do you see these products becoming a significant, say in the 30% to 50% range of revenue contribution, or do you still see your legacy products going ahead and being much larger contributors, like they had, say, last year?

Well, we think that a couple of things are going on. Number one is with the prolific R&D activities that are underway, we think that the product portfolio is going to be very fresh. We are making major strides in doing that, so I think continuing to step on the accelerator on the development programs, and I think that we have other things in mind for beyond what he we have talked about on today's call, but it is also clear to us that we have to get our commercial house in order, in terms to maintain the proper focus on all of these different products. It is great to have an ever-broadening portfolio of products, but it does make it incumbent upon us to structurally identify how we are going to maintain focus on the legacy products, rather than this year's model getting a lot of focus, and that other product categories get a lack of attention.

Thank you. And then you mentioned in the prepared remarks and again in the question and answer session here, that the podiatry segment was disappointing. It was down year-over-year and likely sequentially. How much of that was an impact from the de-specialization of that segment?

It is hard to get a number on that, but clearly in this script and press release we tried to provide more granularity to the various components of the business, so that you can gets a better sense of the magnitude of these various things. All I will say is that we haven't concluded that the market disappeared on us. We wrapped up the fourth quarter last year with a very strong podiatry, and we are certainly are doing what we think is appropriate to get our fair share back.

Thanks. And lastly here, can you maybe break out the mix of the repurchase in the quarter, how much of that was from the discretionary repurchase, and how much of that was on the repurchase that had the specific triggers within it?

All it of was from the discretionary. The 10b5-1 has not reached its threshold yet.

Thank you. That will be all for me.

Okay.

Thank you. There are no further questions at this time. I would like to turn the floor back over for closing comments.

Thank you for participating on our call today. We will be attending a number of Investor Events in the coming months, and we will update you on business progress on the fourth quarter of 2013 on the conference call on February 2014. Good afternoon, and thanks for your continued interest in Cutera.

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