Nov 2, 2009
Executives
Kevin Connors - President & Chief Executive Officer Ronald Santilli - Chief Financial Officer, Vice President of Finance & Administration John Mills - Integrated Corporate Relations Inc.
Analysts
Tom Gunderson (Amy in for Tom) - Piper Jaffray Anthony Vendetti - Maxim Group Anewt Medda – Ken Accord Adams Chris Sasooney – Eagle Asset Management
Operator
Welcome to the Cutera incorporated third quarter 2009 earnings conference call. (Operator Instructions).
I would now like to turn the conference over to our host, John Mills, of ICR. Please go ahead, sir.
John Mills
By now everyone should have access to the third quarter 2009 earnings release, which went out today at approximately 4:00 pm Eastern Time. The release is available on the Investor Relations portion of Cutera’s website at cutera.com and with its form 8-K filed today with the SEC and available on its website at sec.gov.
Before we begin, Cutera would like to remind everyone that these prepared remarks contain forward-looking statements, including statements concerning domestic and international growth opportunities and strategies, future spending, expense management and execution on various aspects of our operations and business, expectations for increasing revenue, generating cash and regaining profitability, and the development and commercialization of existing and planned products. Also management may make additional forward-looking statements in response to your questions.
These forward-looking statements do not guarantee future performance and 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. For our 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 our most recent 10-Q, which was filed today November 2, 2009, with the Securities and Exchange Commission.
And With that, I'll turn the call over to the company’s President and Chief Executive Officer, Mr. Kevin Connors.
Kevin Connors
Thank you, John. Good afternoon, everyone, and thanks for joining us today to discuss Cutera’s results for the third quarter ended September 30, 2009.
On today’s call, I'll provide an overview of results and then 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 in the third quarter 2009 grew by 4% $12.2 million compared to second quarter of 2009. This is our first sequential quarterly revenue growth quarter since the market downturn began in 2008, but I think it’s important to point out that we achieved the sequential growth in the third quarter, which is traditionally a seasonally softer period than the second quarter.
As our third quarter results show, customers continue to experience demand for our products from end users; however, many of our customers, our current and prospective customers, remain reluctant to make major capital equipment purchases or are unable to obtain financing during this continuing tight lending environment. In this environment, we believe that the core market of dermatologists, plastic surgeons, and other established medical offices provided us with the best growth opportunities in our industry; therefore, we are actively refocusing our sales marketing and new product development efforts on this market segment.
Last quarter, we announced many key initiatives to drive revenue growth. As a reminder, those initiatives are as follows.
One, enhance luminary development and improve our clinical selling efforts. Two, refocus the message of our product offerings and increase our penetration of the core position market in established medical offices.
We remain focused on these initiatives. International business accounted for 60% of our revenue during the third quarter.
We are pleased with our international infrastructure, which is playing a more significant role in our performance during these challenging times in the United States for this industry. During the third quarter of 2009, we achieved 60% gross margin and decreased our operating expenses by approximately $2.3 million from the second quarter of 2009; however, note that included in our results was a $12.3 million non-cash tax associated with establishing evaluation allowance for our U.S.
deferred tax asset. Ron will explain this in more detail later.
We remain committed to increasing our revenue and profitability though the leverage of our business model. We believe we can achieve break-even profit levels with quarterly levels in the 14 to 15 million dollar range.
Turning to research and development, we are continuing to develop innovative solutions and expand the clinical understanding and applications of our current products. We believe that strategic ongoing investments of product research and development are critical to our future success.
In line with that principle, we are continuing to invest in R&D. We expanded our clinical evaluation of C.
Sculpt in the third quarter and plan to place a significant number of additional units in the fourth quarter. With our technology, we have learned that the procedure requires approximately three months to yield a clinical outcome, which has resulted in a longer clinical evaluation process.
Now, I would like to turn the call over to Ron to discuss our finances in more detail.
Ronald Santilli
Thanks Kevin, and thanks to all of you for joining us today on our third quarter 2009 conference call. Due to significant changes in the recent business environment, we are providing more of our financial comparisons to the preceding quarter instead of the same quarter a year ago.
We believe this will assist you with better understanding of the changes in our business trends. Third quarter 2009 revenue grew by 4% to $12.2 million compared to the second quarter of 2009.
This is particularly important for us as it reflects the first sequential quarterly revenue growth since the market downturn and it is traditionally a softer period than the second quarter. Net loss for the third quarter of 2009 was $13.4 million or $1.01 per diluted share.
Included in our net loss is approximately $12.3 million non-cash tax charge or $0.92 per diluted share to establish evaluation allowance against our U.S. deferred tax assets that may not be realized.
We determined evaluation allowance was required under general accepted accounting principles due primarily to cumulative losses in recent quarters. Product revenue in the third quarter of 2009 increased 12% when compared to second quarter of 2009.
Growth in this revenue category is important given this typically represents purchases by new customers which provides growth to our other revenue categories. Upgrade revenue for the third quarter 2009 increased 13% when compared to the second quarter of 2009.
Our customers continue to express interest in our Pearl and Pearl Fractional products, and as such they represent an increasing percentage of our upgrade revenue. The clinical results of our Pearl Fractional products are exceeding our expectations and we will continue our focus on selling to the core specialties and building relationships with the market’s segments opinion leaders.
Service revenue for the third quarter of 2009 was $3.2 million compared to $3.4 million for the second quarter of 2009. to the third quarter of 2008.
Our third quarter . Service revenue growth relates primarily to service contract amortization.
This revenue category has remained relatively flat over the past few quarters, due primarily to fewer customers purchasing extended service contracts in response to improved product reliability and the tougher economic times. Titan refill revenue for the third quarter of 2009 was $1.3 million compared to $1.4 million in the second quarter of 2009.
Revenue generated from Titan refills have remained fairly flat during the past few quarters. A significant percentage of our revenue is sourced from existing customers.
During the third quarter of 2009, almost 50% of our revenue was derived from sales of service, upgrades and Titan refills. We remain committed to strong customer satisfaction and believe we will continue to realize revenue growth from our annuity revenue categories once the economy becomes more stable.
I will now address our operating performance. Our gross margin improved to 60% compared to 56% in the second quarter of 2009.
The higher growth percentage was due to a number of factors, including the reduced manufacturing expenses from our first half restructuring efforts and lower service expenses, resulting from improved product reliability. To help you with modeling of our current business, we expect gross margins to be in the range of 60% when quarterly revenue is approximately $13-14 million.
Sales and marketing expenses decreased by $5.1 million or 42% of revenue for the third quarter of 2009. This expense level represents a decrease of approximately $1 million compared to the second quarter of 2009 and was primarily due to our downsized sales and marketing organization in North America and reduced commission expenses.
As we increase our revenue, we expect our sales and marketing expenses as a percentage of revenue to decline. Research and development expenses increased by approximately $200,000 from $1.5 million in the second quarter of 2009 to $1.7 million in the third quarter of 2009.
This expense reduction is due primarily to reduced material spending associated with our product development efforts and clinical trials. We expect to continue investing in our R&D efforts in the future, keeping with our continuing commitment to develop and commercialize innovative products and applications.
General and administrative expenses decreased by $1.5 million from $3.6 million in the second quarter of 2009 to $2.1 million in the third quarter of 2009. The reasons for this spending include $500,000 of non-recurring bad debt expense recorded in the second quarter of 2009, $550,000 of lower non-cash stock based compensation expense, due primarily to shares granted to our independent board members in Q209, and $250,000 of expenses reductions resulting from our first half restructuring efforts, and $200,000 of lower legal spending.
Interest and other income net was $288,000 in the third quarter of 2009 compared to $511,000 in the second quarter of 2009. The lower income is due primarily to lower interest yields on our cash and marketable investments.
Our effective income tax expense for the third quarter of 2009 includes a $12.3 million non-cash charge to establish evaluation allowance for our U.S. deferred tax assets.
Our deferred tax asset consists primarily of deductible temporary timing differences between book and tax returns; however, due to recurring operating losses in our U.S. business over the past several quarters, U.S.
GAAP requires that to record evaluation allowance to reduce our deferred tax asset. It is important to note that this is a non-cash book charge and that to the extent we generate U.S.
taxable income in the future periods, we will still be able to utilize our deferred tax assets. This will have an effect of reducing our future effective tax rate until we have fully utilized our written down deferred tax assets.
For modeling purposes, we suggest using an effective income tax rate of approximately 25% for the fourth quarter of 2009 and 2010. Turning to the balance sheet, our financial position remains strong.
As of September 30, 2009, we had $104.2 million in cash, marketable securities, and long-term investments with no debt. This represents almost $8.00 per outstanding share.
Our auction rate security balance continues to climb primarily due to redemptions made at full par value. As of September 30, 2009, we had $7.3 million of auction rate securities with a par value of $8.9 million.
We are pleased that our cash flow from operations was nearly break-even in the third quarter. Our third quarter net loss was offset primarily offset by non-cash deferred tax asset and evaluation allowance, stock base compensation charges, and further reduction in our inventory levels.
Net accounts receivable at the end of the third quarter of 2009 were $2.6 million and the DSOs were 20 days. Our DSOs continue to remain strong and we are better than our targeted 35 to 45 days, due to a thorough credit approval process and strong collection efforts.
Inventories decreased by approximately $800,000 from June 30, 2009 to September 30, 2009. We are pleased with this reductions made here to date and remain diligent in our efforts to continue further reductions in the fourth quarter of 2009.
Now that I’ve concluded my overview of Cutera’s financial performance, I’ll turn the call back to Kevin.
Kevin Connors
Thanks Ron. Our focus during the next few quarter will include enhanced luminary development and improving our clinical selling efforts, continue to focus the messaging of our product offerings to increase penetration of the core position market, and establish medical offices.
While the near term prospects for our industry continue to be difficult to predict, due to the economic uncertainty, we believe with our worldwide distribution network, strong balance sheet with almost $104.1 million in cash and investments, no debt, a broad portfolio of products, and various R&D products underway, we can provide continuing long term growth opportunities for our company. Now, I would like to open up the call for your questions.
Operator?
Operator
Thank you, sir. (Operator Information) Our first question comes from Tom Gunderson - Piper Jaffray.
Amy in for Tom Gunderson - Piper Jaffray
It’s actually Amy in for Tom. With regards to your refocus efforts on the core market and wondering if you could characterize for us your results on that subject, there are certain things that are going well and on the other side things that you think may need some more work.
Kevin Connors
I think a lot of the focus is regarding the nuances of successful successfully selling products to the dermatologists and plastic surgeons. They tend to be more technical in nature and they tend to have tremendous expertise as it relates to lasers and dermatology.
When we’re selling to the non-core physicians, typically our sales rep is the laser expert and we have to educate them on both the technology as well as the business opportunity that our products represent. So it really is a pretty significant change in the way we approach the derms and plastics relative to the non-core, which at one point accounted for 80% of our business.
So it’s ongoing training, something that we’re committed to with our sales team and so we think we’ve got a start here, but we don’t think we’re done with the mission.
Amy in for Tom Gunderson - Piper Jaffray
On that note, Ron, do you have the split of revenues for this quarter?
Ronald Santilli
Yes, for the bookings in N.A. for the third quarter, about 25% of them were core and 75% non-core.
Amy in for Tom Gunderson - Piper Jaffray
Hoping you could give us an update on where you’re at as far as the sales force.
Ronald Santilli
I think we’re at around 30 territories at this point in N.A.
Amy in for Tom Gunderson - Piper Jaffray
And those are all filled?
Ronald Santilli
There may be one or two open. There’s always some level of openings, but right now we’re set to about 30.
Amy in for Tom Gunderson - Piper Jaffray
As far as the body contouring product, can you give us when we might be looking for an actual launch?
Kevin Connors
Sure. We’ve been working with five physicians as well as UCSF with the clinical research we’ve been doing and we’re now looking to expand our clinical understanding by placing an additional 10-15 units out in the field this quarter.
So this is something that will be happening in the coming weeks we’re hopeful. In the process of the clinical investigation, we’ve uncovered some design iterations that were required in order to improve the patient experience, mainly addressing some discomfort that we uncovered as a part of it as well, some ergonomic changes.
So this has resulted in the clinical evaluation taking longer than we expected, but we’re hopeful by getting 10-15 more out, it could really accelerate our ability to close the loop on the changes we’ve made.
Amy in for Tom Gunderson - Piper Jaffray
Are we still a couple quarters out?
Kevin Connors
Can’t say right now, but we’re hopeful we can pull it toward the beginning of the year, but we’re going to learn a lot more shortly.
Operator
Your next question comes from Anewt Medda – Ken Accord Adams.
Anewt Medda – Ken Accord Adams
Can you give a little more granularity in terms of the sales outside of that product line, which is excellent in the quarter. Are you seeing repeat business from service and upgrades and refills, is that coming more from the core or the non-core?
Ronald Santilli
We don’t track that by core versus non-core, but historically two thirds to three quarters of our business has been with non-core. I would assume that’s how the service and Titan refill will track.
Anewt Medda – Ken Accord Adams
Can you talk a little bit more about given the credit difficulties, how are reps going out and facilitating the sale? Are you working with any lenders?
Ronald Santilli
Clearly the credit markets have tightened up during this past year. We’ve always remained fairly diligent to work with our leasing partners and we have multiple to help us through these transactions.
Physicians that are purchasing our equipment and placing it in their established medical office are typically credit worthy, but the process obviously takes a lot longer now than it used to. But physicians who are purchasing and placing it outside of an established medical office or non-physicians are having a much harder time during these economic times.
We continue to work with the leasing companies and do what we can to help support them, but it still is obviously very tight out there.
Anewt Medda – Ken Accord Adams
Body contouring product, what would the strategy be in terms of a rollout? Are you going to try and put the product in certain opinion leaders hands so that you can see good results over the first couple of quarters while it’s launched or do you have a strategy in place and what type of price win are we thinking about for the product?
Kevin Connors
It’s not dissimilar to what we’ve done in the past. We like to get our new technology in the hands of thought leaders and clearly the five docs that we’ve worked with so far in that camp and looking to expand that.
So we’re trying to get a better understanding of the clinical parameters that are required to get a successful outcome. In terms of pricing, we haven’t announced anything just yet, but it’ll be something in the $100,000 range.
Anewt Medda – Ken Accord Adams
Any anecdotal in terms of results or comfort or excitement about the product that you’d like to share?
Kevin Connors
Well I think the category, body contouring, is an exciting one in the industry reports that I’ve read that look at exciting areas to be in clearly flag this is one the key ones and opens up a whole new category of patients. So a lot of excitement about it.
Operator
Your next question comes from Anthony Vendetti - Maxim Group.
Anthony Vendetti - Maxim Group
I want to first focus on the credit issue, because that seems to be a gaiting factor here. We’re hearing that the demand is starting to pick up, but the credit markets remain tight.
Have you worked out any new agreements with larger banks or other leasing companies that you haven’t worked with in the past?
Ronald Santilli
We have a variety of banks that we work with and have relationships with to ensure we are able to get the best credit terms possible for our customers. So in that case, nothing’s changed, but clearly during the past year, the environment has changed and with that we’ve just continued to work with them to figure out what we need to do to get more of these approved.
Kevin Connors
Anthony, I think clearly the credit market has been more challenging now and we find ourselves much closer to the funding sources than we once did. A year and a half or so ago, it used to be a broker would be able to get documents approved while the rep is often at the doctor’s office.
So it was a great fast process before. Now we don’t have that luxury.
So credit is tough, but I think the thing to keep in mind is that it’s slowing down the sales process and any time that happens, it’s going to have a negative impact on the industry, but we continue to find lending sources out there that are interested in the business.
Ronald Santilli
I think the other thing, Anthony, is that it’s not worsening. I don’t see the credit side worsening.
It hasn’t improved significant, but on the good side it’s not getting much worse.
Anthony Vendetti - Maxim Group
What I’m trying to see also, because I know some of the leasing companies had left the business altogether several months back or as much as 12 months ago when significant credit problems. What I’ve heard is that in addition to some of those companies starting to come back, there are new ones, even though they’re coming in with stringent terms.
New ones actually saying hey, there’s a void here, let’s fill that. I was just trying to sense if you’re seeing that as well.
Ronald Santilli
I’m not seeing a lot of new entrants into the lease financing market. There still are quite a few players out there and we continue to work with them, but if the question is do I see a lot of new entrants, I haven’t seen that.
Anthony Vendetti - Maxim Group
I know, Kevin, you had mentioned in the past that you’re looking at ways to focus more on the core. Can you talk about any specific programs or things you’re doing to focus on that group?
Kevin Connors
Well there’s a long list of things we’re doing to be more successful with the derms and plastics, but it starts with the field with our local sales reps developing local luminaries. That’s one of the most effective ways of being successful.
Quite frankly, derms want to talk to other derms. They don’t want to talk to an OGBYN about their experience, so it’s important that we have that established.
But we also have some marketing events that we share with some of the other companies in the same space that have a larger presence with the derms and plastics and if we’re able to leverage those relationships, that also helps.
Anthony Vendetti - Maxim Group
Is it true that part of the change in the direction of the sales force, the new head of sales, is sort of aligned with that focus more on core physicians?
Kevin Connors
That’s right. Christ West has run our operation in Japan and that’s essentially all derms and plastics.
He’s got a medical sales background and so his orientation is that way.
Anthony Vendetti - Maxim Group
Lastly, Ron, can you break out the stock base comp?
Ronald Santilli
The total for the quarter was about $900,000 of which $160,000 was in cost of goods sold. Sales and marketing was about $250,000.
About $125,000 for R&D, and $365,000 for GNA.
Anthony Vendetti - Maxim Group
I know it’s difficult as we’re moving through these quarters, are you sensing some stabilization in terms of the floor for demand or in terms of what you’re seeing in terms of the sales? Do you think we’re nearing the bottom, close to the bottom, and just waiting for an improvement in the credit markets or a pickup of the economy.
Do we need both to happen to see any type of significant improvement?
Kevin Connors
Well, it’s hard to call a bottom, but it sure feels like it’s more stable than it was. For many quarters, we saw pretty significant contraction for the entire industry and that seems to have changed a bit.
With that said, we have a number of our competitors that reported some sequential contraction, nothing significant, but we tend to associate that with seasonality, but it’s hard to read those tea leafs too closely.
Operator
Your next question comes from Chris Sasooney – Eagle Asset Management.
Chris Sasooney – Eagle Asset Management
In terms of your comments regarding True Sculpt, are you still planning on demoing that product at AAD?
Kevin Connors
Yes.
Chris Sasooney – Eagle Asset Management
So would there be an opportunity for people to use it in some way, shape, or form?
Kevin Connors
It’s not a regulatory issue right now. We’ve got clearance for treatment of cellulite.
We’re just getting a better understanding of what the clinical capabilities of the product is. So we’re going to go from five doctors to somewhere between 15 and 20 doctors that have experience with it, so we’re hopeful that we’ll have some experience the users are able to talk about their experience at AAD.
Chris Sasooney – Eagle Asset Management
If you just reflect on the feedback that you’ve gotten from the five doctors that have used it relative to your expectations of what the device could do separate and apart from how big the market could be for this device as opposed to other body contouring devices, is it generally meeting your expectations?
Kevin Connors
Sure. I think it’s important to recognize that this is a non-evasive procedure, so it’s not going to have the same clinical outcome as a surgical procedure, but from our clinical experience we did identify that discomfort was an issue that came up and so we have made some design changes as well as some ergonomic areas that we need to improve upon and the way the machine is being used.
So I think it’s been very helpful to get the clinical experience. In terms of getting the final end point, the interesting thing about our business is that we have products that have been on the market for five years that we’re learning new protocols to improve the clinical outcome.
So I think it’ll be that type of long-term benefit to getting these machines out there and get in the hands of people that tend to learn more about it than we know about it.
Chris Sasooney – Eagle Asset Management
If you just take a look at the physician marketplace, primarily the non- core, in line of everything that happened with healthcare reform, Medicare reimbursement cuts, and so forth. If you take the credit markets off to the side, when you’re talking to these non-core physicians, is there as strong an interest in establishing aesthetic practices as a means to augment income as before the recession?
Kevin Connors
I can say anecdotally that we hear from non-core physicians that they are so excited about these procedures. So it’s not as if that’s dried up.
It’s just the appetite for risks that we’re taking on a lease is a difficult thing for doctors to get their minds around. I just think as confidence comes back into the system, I think those doctors will come back.
Chris Sasooney – Eagle Asset Management
Do you expect any fourth quarter increase in demand because of the tax credit?
Kevin Connors
Again, that’s a hard one to quantify, but we do tend to hear from physicians’ accounts in the fourth quarter regarding this. So I do think there is a benefit that tends to happen in fourth quarter, but I can’t quantify how large the benefit is.
Chris Sasooney – Eagle Asset Management
You alluded to sales cycles elongating. If you reflect back on what the sales cycles were a year ago versus today, how much have they elongated?
Kevin Connors
Well that’s a very good question. I would say that the days of getting the one-day turnaround on a credit app are behind us and it’s probably on the order of a couple weeks is the typical experience that we’re up against and I think from a training side, we really are trying to direct our sales people to get that ball rolling as quickly as possible such that we can determine on the frontend whether we’ve got an account that has the credit wherewithal to do the transaction or not.
So we’re really trying to move that forward as much as we can.
Chris Sasooney – Eagle Asset Management
From the point at which one of your reps first encounters a prospective physician customer to the point which they would actually sign on the dotted line for a contract or sale, how long is that taking from start to finish?
Kevin Connors
Again, this is going to be an anecdotal response, Chris, but in good times that cycle from the time we engage until close would be less than 90 days. Now it feels like it’s a couple of quarters.
Operator
(Operator Instructions) Your next question comes as a follow-up from Anewt Medda.
Anewt Medda – Ken Accord Adams
Can you talk about pricing. Was there any hits to ASPs during the quarter?
Ronald Santilli
No major changes on the average selling price.
Anewt Medda – Ken Accord Adams
Any thoughts on the fourth quarter? I know you guys don’t give guidance, but it’s typically the strongest quarter of the year.
Any type of outlook?
Kevin Connors
Well first of all we’re happy that we were able to show some sequential growth in the third quarter knowing that typically is seasonally one of the lighter quarters of the year. We’re trying to extrapolate with very few data points here, but we are hopeful that is the case that the seasonality of the fourth quarter will give us a tail wind.
Operator
Thank you, and we have no further audio questions at this time. I’d like to turn the call back over to management for any closing statements.
Kevin Connors
Thank you for participating in our call today. We look forward to seeing you at various investor events during the quarter and updating on our fourth quarter conference call in February.
Good afternoon, and thanks for your continuing interest in Cutera.
Operator
Ladies and gentlemen, this concludes the Cutera third quarter earnings conference call. This conference will be available for replay after 8:00 pm ET today through November 16, 2009 at midnight ET.
You may access the replay system at any time by dialing 800-406-7325 and entering the access code 4174694. Thank you for your participation and you may now disconnect.