Cutera Inc (CUTR) 2018 Q2 法說會逐字稿

Greetings, and welcome to Cutera's Second Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Matt Scalo. Please go ahead.

Thanks, operator, and welcome to Cutera's Second Quarter 2018 Earnings Conference Call. My name is Matt Scalo, Head of Investor Relations and Corporate Development. And on the call today is Cutera's President and Chief Executive Officer, James Reinstein; and Chief Financial Officer, Sandra Gardiner. After the prepared comments, there will be question-and-answer session.

The discussion today will include forward-looking statements. These forward-looking statements reflect management's current forecast or expectation of certain aspects of the company's future business, including, but not limited to, any financial guidance provided for modeling purposes. Forward-looking statements are based on current financial information that is, by its nature, dynamic and subject to change. Forward-looking statements include, among others, statements regarding financial guidance, plans to introduce new products and productivity improvements. For words that may identify forward-looking statements, we encourage you to refer to the safe harbor statement in our press release earlier today.

All forward-looking statements are subject to risks and uncertainties, including those risk factors described in section entitled Risk Factors in our Form 10-K, as filed with the SEC and updated in our Form 10-Qs subsequently filed. Cutera also cautions you not to place undue reliance on forward-looking statements, which speak only as of the date they are made. Cutera undertakes no obligation to update publicly any forward-looking statements to reflect new information, events or circumstances or to reflect the occurrence of unanticipated events. Future results may differ materially from management's current expectations.

In addition, we will discuss non-GAAP financial measures, including results on an adjusted basis. We believe these financial measures can facilitate a more complete analysis and greater transparency into Cutera's ongoing results of operations, particularly when comparing underlying results from period-to-period. Please refer to the reconciliation from GAAP to non-GAAP measures in our earnings release. These non-GAAP financial measures should be considered along with, but not as alternatives to, the operating performance measures prescribed by GAAP.

With that, I will turn the call over to our CEO, James Reinstein.

Thank you, Matt. Good afternoon, and thanks for joining us today to discuss our second quarter results.

From a revenue perspective, the company performed very well, generating sales of $42.6 million or growth of 17% over second quarter 2017. However, from an operational perspective, we have some areas that will require more time than anticipated in order to achieve our gross margin goals. While our gross margin in the second quarter at 53% did improve sequentially, we did not achieve the results we expected. This was in part as a result of our channel mix shifting more towards international distributors due to our expansion into new markets, such as China. However, the primary impact to gross margin stems from our recent investments made in the service organization as well as other manufacturing process improvements, which will take longer to read through on the financials and ultimately result in the planned reduction in our cost of goods.

Looking at the second half of 2018, the company's investment in our global field service team and manufacturing processes will lead to a positive impact on gross margins towards the end of the year and beyond. Given that our first half gross margin is in the 52% range, we are revising our full year gross margin target range, which Sandy will discuss later.

Turning back to the top line growth, which continues to be the most compelling part of the Cutera story. The U.S. sales growth of 16% over Q2 prior year continues to be well above market average, which we pegged to be at about 9%. This quarter's performance reflects continued strong demand in body sculpting, with our truSculpt 3D system which grew almost 30% over Q2 2017. This performance is especially noteworthy considering we launched our next-generation system truSculpt iD in July and initiated a limited market release in June. iD offers hands-free functionality and sets itself apart with excellent clinical results, great patient comfort and a total treatment time in as little as 15 minutes, which is approximately 7x faster than the market leader, which is very dramatic and game-changing for the market.

We believe truSculpt iD will impress customers and their patients with its simple setup, it's diversity of placement options and the comfortable yet rapid procedure time. Of course, the important factor is the ability of the iD to deliver results that our customers have come to realize with the truSculpt 3D. The combination of all these benefits will result in a patient being able to get in and out of the physician's office in less than 30 minutes, after paying $2,000 to $3,000 for a highly effective procedure with a high level of patient satisfaction. We will provide more detail into the truSculpt iD launch at our upcoming investor event on October 9, but I can say truSculpt iD is the biggest launch in the company's history. The sales team is extremely excited to sell this upgraded platform, and early user feedback from users in the limited market release has been extremely positive. We have since launched the iD to the entire North American sales team at a sales meeting in mid-July. It is very exciting time, and I look forward to sharing with you the details in October.

To expand upon the revenue story. North American sales in the second quarter were also bolstered by the incremental contribution from the Juliet women's health system, which addresses overall vaginal health; and the Secret RF microneedling system, which effectively remodels collagen, improves mild wrinkles and diminishes scars. We are pleased with the uptake of both systems and are seeing strong consumable reorder rates for both systems. We anticipate they will be robust contributors to our growth in 2018 and beyond.

Just a brief comment regarding the recent FDA safety communication addressing energy-based devices in women's health market. We are not named in the announcement, and we have not received a letter from the agency. Additionally, we are not aware of any adverse events resulting from the use of the Juliet anywhere in the world. We certainly support any action that helps ensure patient safety going forward. Cutera has a robust multifunctional process that reviews our promotional claims and materials to ensure they are truthful, not misleading, fair and balanced and supported by sound scientific evidence.

Taking a look at our consumable product revenue. Revenue from consumable products related to procedures grew 46% year-over-year and accounted for 6% of total sales in the second quarter. These products include our truSculpt systems, the Juliet and the Secret RF platforms, plus the distributed skincare products. Recurring revenue, which includes these products and our service revenue accounted for 17% of total revenue in the second quarter.

Looking at the sales organization. Our North American field sales force consists of 74 reps as of July, up from 68 in the first quarter, and we remain on track to expand this group to 80 reps by the end of the year. In addition, we are ahead of schedule in building our consumable sales force with 7 on board now and expect to have approximately 10 reps in total by the end of 2018. This team will be working with our customers to help build their practices and attract new patients.

Turning to international. The second quarter saw robust system growth of 26% driven across multiple geographies. EMEA and Asia grew sales 41% and 26% from a year ago period, respectively, and reflects a shift towards our global distribution network. As I mentioned earlier, we are starting to see meaningful revenue coming from China, where we launched the truSculpt 3D via our partner there.

Lastly, I'm pleased to announce our new Chief Operating Officer, Jason Richey, who joined the company in early July. I have worked with Jason before and have been impressed with his ability to quickly ramp up business performance, particularly in international markets. Going forward, the international sales organization will be Jason's highest priority. Jason's arrival now completes the new leadership team here at Cutera, which was one of my first priorities upon joining the company. Cutera has attracted excellent talent at all levels, which will assuredly enable us to take the company to the next level.

I would now like to turn the call over to Sandy Gardiner, our CFO.

Thanks, James. Second quarter revenue was $42.6 million or 17% growth over the second quarter of 2017. U.S. revenue grew 16% over the year ago period, driven by continued strong demand for our truSculpt 3D body sculpting system, the Juliet laser and Secret RF. International revenue grew 19% versus the second quarter 2017, driven by 26% growth in system sales. Most international regions grew strong double digits, with Japan returning to positive momentum in the second quarter. International sales saw a mix shift towards our distributor network versus our direct channel. Distributors accounted for approximately 65% of international product sale in the second quarter, up from 50% in the year ago period, impacting gross margins. Distributor growth occurred in existing markets and also reflects expansion into new markets, such as China.

In the second quarter, recurring revenue, defined as service revenue plus consumable revenue and skincare sales, accounted for approximately 17% of total revenue. We continue to see consumable revenue growing strong, supported by our expanding dedicated commercial team.

The second quarter marked the annual anniversary of the launch of truSculpt 3D, the company's first system with a procedural revenue stream. In the year ago period since launch, consumable revenue grew 63% in the second quarter of 2018 as compared to the second quarter of 2017. Revenue from consumables will become more meaningful over time as the growing percent of our systems sold have a consumable revenue stream.

As for the revenue breakdown by customer segment. Our core customers comprised of dermatologists and plastic surgeons accounted for approximately 40%, consistent with the last few quarters and the launch of truSculpt 3D. We believe this indicates continued strength in our core customer market along with expansion of our channel reach into noncore physicians.

Moving on to gross margin and operating expenses. Gross margin was 53% in the second quarter or 180 basis points higher than the first quarter, but down approximately 500 basis points from a year ago period. Gross margins this quarter reflect a sales mix weighted towards our international distributor network as well as lower average system pricing across many of our legacy products. Our infrastructure investments and the timing of realizing operational improvements also affected gross margin. We do expect to see continued improvement in gross margin in each successive quarter throughout the year.

Sales and marketing expense as a percent of revenue was 37% in the second quarter compared to 35% of revenue in the second quarter of 2017. The increase reflects our expanding global sales channel, including the build-out of our commercial consumable team, an investment that will enable us to grow the procedural-related revenue over the long term.

Non-GAAP sales and marketing expense as a percent of revenue was 33% in the second quarter compared to 34% of revenue in the second quarter of 2017. Non-GAAP adjustments include noncash stock-based compensation, depreciation and amortization expense.

Research and development expense increased 37% to $4.1 million or 10% of revenue in the second quarter of 2018 as compared to 9% of revenue in the second quarter of 2017. Non-GAAP research and development expense as a percent of revenue was 9% in the second quarter compared to 7.5% of revenue in the second quarter of 2017. We remain committed to investing in engineering and clinical research that drives new product innovation.

General and administrative expenses were $4.9 million in the second quarter of 2018 or 12% of revenue compared to $3.5 million or 10% of revenue in the second quarter of 2017. The increase in general administrative expenses in the quarter is primarily a result of additional headcount, noncash stock-based compensation and the continued investment in the scalability of operations as compared to a year ago. Non-GAAP general administrative expense as a percent of revenue was 9% in the second quarter compared to the same 9% of revenue in the second quarter of 2017.

Operating loss was $2.2 million in the quarter compared to $1.7 million income in the same period 2017. Our GAAP net loss for the second quarter of 2018 was $1.6 million or $0.11 per diluted share. Non-GAAP net income for the same period was $1.8 million or $0.12 per fully diluted share. Fully diluted weighted shares outstanding used to compute non-GAAP EPS was 14.3 million versus 14.6 million in the year ago period.

Turning to the balance sheet and cash flow. Net accounts receivable at the end of the second quarter of 2018 was $22.1 million, and our DSO improved by 5 days to 47 days from the first quarter. Inventories were $30.1 million at June 30, 2018, representing a decrease of approximately $1 million from March 31, 2018, or an inventory turns ratio of 2.7x versus 2.2x in the first quarter of 2018. The reduction in inventories was driven by a decrease in raw materials. As we continue to realize our investments in operational improvements, we also expect continuous improvement in inventory turns.

Cash provided by operations was $3.5 million for the second quarter compared to $7.7 million in the second quarter of 2017. This change from a year ago was primarily driven by our increased investments in infrastructure and operational efficiencies for long-term scalability, resulting in a net loss of $1.2 million as adjusted for noncash-related items as compared to $3.4 million in the second quarter of 2017. Decreased inventory turns and an increase in accounts receivables also contributed to the reduction year-over-year in cash provided by operations. The increase in accounts receivable reflects increased sales from our international distribution network. Our cash position remained strong. And as of the end of June 30, 2018, we held cash and investments of $29 million with no debt, while working capital was $41.9 million.

Turning to our 2018 guidance. We reiterate our 2018 target revenue range of $178 million to $181 million, representing an 18% to 20% increase over 2017. With a first half gross margins encountering headwinds for from our investments in servicing and manufacturing for the future as well as our international sales mix in the second quarter, we are revising our full year 2018 gross margin target to 53% to 54%. We are confident our investments will ultimately improve gross margins, although in a longer time frame than we had originally anticipated.

We expect continuous improvement in gross margin with each successive quarter throughout the year. We are also expecting operating expenses as a percent of revenue to be in the range of 56% to 57%, an increase from the previous expected range of 52% to 54%. This increase is largely attributed to additional noncash stock-based compensation expense as well as the continued investment in the scalability of the company for future top line growth.

We will also continue to invest in our product pipeline. We now expect noncash stock-based compensation of approximately $10 million versus the previous $8 million to $9 million. With the adjustment to gross margin and operating expenses, our new non-GAAP earnings per share is expected to be in the range of $0.50 to $0.60.

Lastly, adjusted EBITDA is now expected to be in the range of $7.5 million to $9 million. For computing non-GAAP earnings per share and adjusted EBITDA, we have assumed approximately $10 million of noncash stock-based compensation as previously mentioned, an annual effective tax rate of 10% to 12% and approximately $14.5 million weighted average shares outstanding for the full year 2018.

I would now like to turn the call over to James for his closing comments.

Thanks, Sandy. From an operations perspective, we have made substantial progress from expanding our global service team to executing on improvement initiatives in areas like manufacturing, which we are confident will bring operating efficiencies, resulting in improved gross margin. Of course, there is a lag in when we will see them translate into improved financial metrics and our new gross margin guidance reflects this shift in timeline. We remain focused on improving gross margins and should see continued sequential improvement in the second half and beyond.

Cutera is constantly striving to provide our customers with the most innovative and highest-quality products with a premier level of service that enables them to best serve their patients' needs. The launch of our next-gen body sculpting system, truSculpt iD, is another example of our commitment. We are very excited about what this system can do for both our customers and their patients and how it helps position Cutera to more fully penetrate this large and fast-growing body sculpting market. I look forward to sharing more details of our truSculpt iD experience at our investor event on October 9.

As the company continues to execute and drive strong double-digit revenue growth in 2018, I expect our gross margins to improve from current levels, along with increased profitability and shareholder value.

I would now like to open up the call for questions. Operator?

(Operator Instructions) Our first question comes from Jonathan Block with Stifel.

It's Denis on for John. I guess, the first question would be, recognizing it's kind of still early days, at a high level, could you comment on utilization across truSculpt and maybe utilization for Juliet and Secret RF?

Sure. Appreciate you joining, Denis. I mean, the early days from truSculpt, we did do a limited market release on the iD. And what's actually pretty amazing is, we've already had some reorders, which, as you know or may not know, can actually be done right off of the machine using IoT or cellular connection. So even though we placed those in the latter part of June, we already have had some reorder of procedures. And then, of course, the 3D grew nearly 30% over prior year quarter, which was actually the quarter of the launch. So even though we are on the precipice of launching the iD, we were still selling a significant amount of the 3D. And that really just speaks to the size, growth and overall interest in this body sculpting market. And the iD really is a step forward for us, even beyond what the 3D was doing.

Great. I guess the other question would be, recognizing this year looks to be more of an investment year, how do you view leverage returning to your model either next year or in out years?

Sure. So this is Sandy. I think you really hit the nail on the head. That is exactly how we view the share as an investment year, really setting ourselves up for scalability but also well beyond the revenue that we are going to put up this year. So we have mentioned and fully expect to get operating leverage in 2019 and beyond.

Our next question comes from Chris Cooley with Stephens.

I apologize, I was juggling a couple of calls here if you touched on this in your prepared remarks or already in the Q&A. But fairly sizable reduction to the company's CY '18 earnings guidance versus your prior expectations. Could you just walk us through -- I understand the incremental noncash stock expense, but just a little bit more on the gross margin side there, how much of that is just a function of the mix? And then what is the incremental growth that you assume that you're going to get, I guess, out of the distributor network going forward, although -- or did it offset I'm assuming some softness in the core because you've maintained your top line guidance. So just trying to put the various pieces together here, when I think about 2018.

Okay. Yes, thanks for the question, Chris. And sort of covered a lot of ground there. Let me speak first on the gross margin and some of the specific activities we're doing to address. We've talked before that we really do need to improve our operational processes if you will. And part of that is really looking at the manufacturing floor and the footprint that we've got there and, quite frankly, overall layout, as well as that relates to the inventory. We're also initiating and optimizing contract manufacturing. We will be implementing regional distribution centers so that we can be more efficient as we do tend to close the quarter with significant amount of shipments going out the door at the end of the quarter. It makes sense to have those products already deployed near where we're going to be delivering to the customers for revenue. And then as we've talked about before, we're still in the manual world of processing orders and managing inventory. And until we've got an ERP system, which we've kicked off just recently to initiate that process, until that ERP system is up and running that will be next year sometime. And then we do have new leadership in operations, who start at the beginning of Q2 and has brought a significant amount of great ideas and processes -- process ideas that we're going to be implementing over the period of time. So the reality of it is, this is a matter of when not if with regards to how we achieve this. And quite frankly, the good news is, all of this is within our control. This isn't some external forces or government mandate that we cannot control. These are all activities that are within our bounce. And then with regards to the international, we had always planned to expand into other markets. Certainly, China has come on here recently with -- solely just with the truSculpt 3D being launched. We also had some good tailwinds from parts of the European distributor network as well. And so we generally saw good growth across all of the international markets, and that was well within line with what we expected.

Okay, super. And then maybe just 2 quickies from me and I'll get back in queue. Did you break out the contribution from Paragon in the quarter, as I believe, or I should say is that was a new distributor agreement, so I'm assuming that had to be incremental relative to what you were anticipating for the quarter? And then just for my last question here, can you help us a little bit with the timing of these investments when we think about the flow-through on the OpEx side to the remainder, is it ratable through the back half of the year? Or is it skewed more towards one period?

Okay. Thanks, Chris. I'll take the front end of the question. Paragon, just so others on the call are aware, that is our partner in China. They're our third-party distributor. We signed up with them in Q4 of last year. And this last quarter Q2 was when we really had meaningful revenue coming out of that relationship as expected.

And then Chris, in regards to your question on the operating expenses, so one of the things I think to note here, we do provide the GAAP to non-GAAP reconciliation because we do think it's important for you to be able to compare period-to-period, removing all these noncash items. And so making that statement for Q2 in totality operating expenses were 51% this year versus 50% last year. So only a 100 basis points year-over-year. And with our new operating expense guidance that we are giving and stock-based compensation going up to $10 million from the previous $8 million to $9 million, if you look at non-GAAP for the full year last year, it was 49%, and we are expecting about 50% to 51% total on a non-GAAP basis. So we're talking about 100 to 200 basis points over last year because much of this is noncash related. And we'll always see the fourth quarter having a bit larger increase than the third quarter.

(Operator Instructions) Our next question comes from Anthony Vendetti with Maxim Group.

I was just wondering, James, if you can talk a little bit about the truSculpt iD, and I know it was launched July 16, just a little more color on when it started shipping? And then how you achieve the significantly shorter procedure time, just a little bit of the engineering behind that?

Okay, sure. Good question. Thanks, Anthony. So the base technology is the same, it's radio frequency. However, we have added a second RF card so that we're able -- and it's still 2 megahertz as it is with the 3D. But that additional RF card allows us to have 2 handpieces functioning at the same time. There is a total of 6 handpieces, which again are, what I would characterize as being anatomically agnostic. You can essentially put it where you want on the apex of the fat. So you're not bound by the patient's anatomy. And those 6 handpieces are placed, and then 2 are on at one given time and then it rotates to the next pair and then the next pair and then it goes back to the original pair. And that basically replicates that glide technique, which was so effective in obtaining the lipolysis in the truSculpt 3D, and we're able to replicate that with the truSculpt iD. Hope that answered your question.

Yes, and then just on the shipping, do you have enough production that you're able to start shipping? And what does the early demand look like at this point ?

So we did do a limited market release in June, and we basically shipped everything we built. And then we've been ramping production since then. And we feel very confident that we will be able to meet the demand that the sales team is going to go out and generate following the sales meeting, which, as I mentioned, was mid-July. And the early indications from the limited market release, where we've got some very key physicians, one in particular is Dr. Anne Chapas there in New York City, is quoted on our website, is extremely impressed with the speed of setup, the time, obviously the time of procedure, but then the breakdown and then getting the patient in and out of the practice is going to make her facility, her practice that much more productive. And of course, that will be true for any type of practice that's using the iD.

Okay. Then just lastly on the enlighten, the excel V, some of the legacy products, you mentioned in the press release a little bit lower than average selling price. Were you experiencing that on those products or any one specific product?

Yes, as I've said in the prior quarter call, the enlighten III, the PICO second laser has really experienced a pretty significant drop in average selling price. And therefore, it does impact the gross margin. That has become a very crowded space since the launch of 3D and certainly has impacted the overall ASPs of our legacy products. But if you look to the products that are really dominating and getting the most attention of the sales organization and therefore the market, it is the truSculpt, now the iD, the Juliet and the Secret, all of which have a recurring revenue stream once they're placed. So it becomes a nice annuity. And the other point I'd like to make with regards to iD, that per procedure revenue we're going to achieve is going to be increasing significantly, more than doubling what we're getting today from the truSculpt 3D and with minimal amount of cost because they are going to be purchasing the procedures right off the screen versus doing a handpiece swap.

Okay. So the second RF card, so what is the total disposable per procedure for truSculpt iD?

We're not disclosing that for competitive reasons. But what I can say is that the 3D, we were getting about $100 per procedure, and we are more than doubling that with the ID.

I would like to turn the floor to James for closing comments.

Okay. Thank you, operator. Thanks, everyone, for participating in our call today. In addition to the Investor Day, which I mentioned on October 9 in our California facility in Brisbane, California, we will be attending a number of investor events in the next few months, and I hope to see you there. Good afternoon, and thank you for your continued interest in Cutera.

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