May 2, 2016
Executives
John Mills - IR, Integrated Corporate Relations, Inc. Kevin Connors - CEO Ronald Santilli - EVP and CFO
Analysts
Zack Ajzenman - Griffin Securities Anthony Vendetti - Maxim Group Brian Freckmann - Lyon Street Capital Daniel Mendoza - Prospect Capital Advisors
Operator
Greetings and welcome to the Cutera, Inc. First Quarter 2016 Earnings Conference Call.
At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation.
[Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr.
John Mills. Thank you, Mr.
Mills. You may begin.
John Mills
Thanks operator. Welcome to Cutera's first quarter 2016 earnings conference call.
On the call today are Cutera's President and Chief Executive Officer, Kevin Connors, and Executive Vice President and Chief Financial Officer, Ron Santilli. After Management's prepared comments, there will be a question-and-answer session.
Please note that during today's call, we will discuss non-GAAP measures for the statement of operations and net loss per diluted share, which exclude non-cash expenses for stock-based compensation, depreciation and amortization of intangibles. Management believes that the adjusted financial results are more reflective of the measures of how management evaluates Cutera's results of operations and is consistent with financial metrics used by other companies to measure performance.
We have included with our earnings release, a reconciliation from the GAAP results to the non-GAAP measures. The discussion today will include forward-looking statements reflecting management's current forecast or expectations of certain aspects of the Company's future business, including any financial guidance provided for modeling purposes.
Forward-looking statements are based on current information that is by its nature dynamic and subject to rapid and even abrupt changes. Forward-looking statements include, among others, statements regarding financial guidance, plans to introduce new products, expand sales force, ability to increase revenue, reduce expenses, improve financial results, make productivity improvements, grow market share, realize benefits from additional investment, improve or maintain profitability, penetrate the market, generate cash from operations and plans for stock repurchases.
All forward-looking statements are subject to risks and uncertainties including those risk factors described in the section entitled Risk Factors in our Form 10-Q as filed with the SEC today, May 2, 2016. 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.
With that, I'd like to turn the call over to Kevin.
Kevin Connors
Thank you, John. Good afternoon, everyone, and thanks for joining us today to discuss Cutera's results for the first quarter 2016.
We are pleased to report our seventh consecutive quarter of double-digit revenue growth and essentially on par with the highest first quarter revenue in our history. Our strong financial performance and our seasonally softest quarter of the year has us positioned to return to sustainable annual profitability this year.
Our organic revenue growth has broad based throughout our product portfolio and we achieved meaningful productivity improvements in many of our global markets. The ongoing results of our mission to revitalize our commercial team, particularly North America, continue to gain momentum and we're excited about opportunities for continued growth going forward.
Our North American sales team led by Larry Laber delivered another impressive performance by growing product revenue 59% when compared to first quarter 2015. Larry has aggressively recruited and assembled a first-class team of sales professionals and the year-over-year headcount growth and productivity improvements reflect his efforts and achievement.
We finished the quarter with 46 field sales people in North America and we will continue to expand our team and also continue to drive productivity improvements. During the first quarter 2016, core physicians in North America accounted for approximately 61% of our orders with the balance of the orders primarily driven from family practice physicians.
Our sales team in the rest of the world region led by Miguel Pardos realized essentially flat revenue growth year-over-year. However, we experienced very nice recovery with our team in Japan.
We continue to build out our international teams and distributed network, and while performance will vary from quarter to quarter, we are well positioned for solid performance going forward. Foreign currency fluctuations did not affect our revenue performance significantly when compared to the first quarter 2015.
From a product perspective, we experienced strong revenue contributions from all major product lines, including the recently released enlighten and excel HR systems, with strengthened average selling prices as well. Our flagship vascular platform, excel V, in particular showed significant growth in both volume and average selling prices.
Gross margin improved from a year ago as a result of decreased manufacturing cost associated with new product launches and higher volume when compared to first quarter of 2015. We expect to achieve gross margin in the 58% to 60% range in the second quarter and 60% for the full year 2016.
Turning to research and development, innovation in technical leadership is the cornerstone of Cutera's culture and we are proud of the technical innovation incorporated in the enlighten product line. Cutera engineers have developed the first solid-state visible red laser for use in dermatology since the ruby laser in 1962.
This innovative solution will incorporate a third wavelength, 670 nanometers, resulting in greater clinical capabilities for our customers. We believe our continued commitment for advancing our technology will provide physicians expanded treatment options for treating benign pigmented lesions, utility and other aesthetic procedures and will enable customers to provide best-of-class therapy and better efficacy than any device in the market today.
Our current line of enlighten products has FDA clearance for benign pigmented lesions and multi-colored tattoo removal. The newly developed enlighten 670 nanometer technology has the CE Mark approval for the treatment of benign pigmented lesions and removal of multi-colored tattoos and is currently pending a 510(k) clearance for the removal of benign pigmented lesions with the FDA.
The global market for aesthetic light and energy based systems is growing at a steady pace and we estimate it approaching approximately $2 billion per year. Our broad range of products, expected market share expansion, commitment to innovation as well as our strengthened commercial leadership team should all serve as catalyst to fuel our growth as we look forward.
Now, I'll turn the call over to Ron to discuss our financials.
Ronald Santilli
Thanks, Kevin, and thanks to all of you for joining us today on our first quarter 2016 conference call. First quarter revenue was $22.4 million, up 18% when compared to the first quarter of 2015.
Our year-over-year double-digit revenue growth rate during the past seven quarters validates our choices to drive growth organically, through investing internally in our commercial teams and introducing new and innovative products. The first quarter of 2016 revenue volume rivals an all-time first quarter record, which places us on track to achieve GAAP profitability in 2016.
We expect our revenue growth to be in excess of the overall market rate of growth for the industry and we are guiding the second quarter of 2016 revenue growth to be in the 15% range when compared to the second quarter of 2015. Gross margin improved 310 basis points to 56% in the first quarter of 2016 from 53% in the first quarter of 2015 due to improved leverage, reduced cost related to our recently introduced products and improved average selling prices.
As Kevin mentioned earlier, gross margin rate growth is a key goal for our Company to drive increased financial performance. We expect gross margin in the 58% to 60% range in the second quarter 2016 and approximately 60% on an annual basis in 2016.
I will now address our operating expense results. Sales and marketing expenses as a percent of sales decreased to 39% in the first quarter of 2016 compared to 43% of revenue in the first quarter of 2015.
We continue to expect our sales and marketing expenses to grow moderately in absolute dollars in 2016, but continue to decline as a percent of revenue as we leverage our expenses based on our anticipated revenue growth. As such, we expect our second quarter 2016 sales and marketing expenses to be in the range of 35% to 37% of revenue.
Research and development expenses were $2.7 million in the first quarter of 2016, up from the $2.4 million in the first quarter of 2015. We remain committed to continued investments in engineering and clinical research that drive new product innovation.
We are planning to increase our investments in research and development activities as the most recent investments are providing targeted revenue growth and commensurate returns. As such, our quarterly R&D spend is anticipated to be in the range of $2.7 million to $3 million per quarter.
General and administrative expenses decreased as a percent of revenue and increased slightly on an absolute dollar basis from $3 million in the first quarter of 2015 to $3.2 million in the first quarter of 2016. We expect our quarterly G&A expenses to range from $3 million to $3.2 million per quarter in 2016.
Our GAAP net loss for the quarter was $2.1 million or $0.16 per diluted share. On a non-GAAP basis, after adjusting for the $1.6 million of non-cash expenses related to stock-based compensation, depreciation and tangible amortization, our net loss would have been under $500,000.
Turning to the balance sheet and cash flow, net accounts receivable at the end of the first quarter 2016 were $11.2 million and our DSOs were 45 days. Our DSO rate was unusually high due to back-ended revenue in the first quarter of 2016 to international distributors who have longer payment terms than direct customers.
We expect our DSOs to return to the 35 to 40 day range in the future. Inventories were $13.5 million at March 31, 2016.
Our inventories increased from December 31 due to inventory ramp-up for expected revenue growth and our enlighten product advancements. Cash from operations consumed $4 million during the quarter due primarily to pay-down of our accrued liabilities for year-end commission, bonus and tax payments as well as for inventory purchases for expected revenue growth primarily related to our next generation enlighten product launch.
We expect to be cash accretive in future quarters as we continue to leverage our revenue growth and we don't expect any signification changes in other working capital assets other than normal quarter to quarter fluctuations. Our cash position remained strong.
As of March 31, 2016, we held cash and investments of $44.4 million with no debt, which represented approximately $3.40 per outstanding share. In the first quarter of 2016, we repurchased 28,000 shares for $305,000 per our share repurchase program.
We plan to continue to utilize our $10 million authorized stock buyback program to be opportunistic with repurchasing our stock. In conclusion, we are pleased with the achievement of our continued revenue growth, gross margin improvements, leveraging of our operating expenses, our strong cash position, during what has historically been a seasonally weakest quarter of the year.
For the second quarter of 2016 and beyond, while there are certain unpredictable factors that may impact our global business, including unfavorable currency movements and international political headwinds, we believe we will continue to realize improvements in our financial performance. We expect healthy revenue expansion and continued market share gains in our remainder of the year.
We further expect to leverage our operating expenses resulting to GAAP profitability and cash generation from operations for the year. I'd like to now open up the call for questions.
Operator?
Operator
[Operator Instructions] Our first question comes from Zack Ajzenman with Griffin Securities. Please state your question.
Zack Ajzenman
Nice strength there on the top line, but if I can start on gross margins, the improvement this quarter of about 310 basis points looks pretty good, but the question I had, given the broad-based improvements across the portfolio and ASPs this quarter and compared to Q1 last year were, I think the gross margin was hampered by a higher mix of distribution business, I was kind of thinking gross margins would be even stronger this quarter. So as we think about 2016 as a whole, I know you guys mentioned a 60% gross margin, that would imply final nine months of this year to have a gross margin of greater than 61% or so, which compares to, at least by our calculation, the final nine months of 2015 having gross margin of about 58.5%.
So can you just kind of maybe help us with the specific areas that give you guys the confidence for gross margin improving about 300 basis points or so for the rest of 2016?
Ronald Santilli
Sure. Good question, Zack.
I really appreciate you looking into all the details and your historical information is accurate. Then again, we do feel good about where we are at.
We're on track, perfectly on plan, but if you look at the continued growth that we expect on the revenue side with the market rate of growth, of course that we're planning to exceed, we feel good that there's very good leverage in the model, and as our revenues continue to grow, we see pretty good expansion in the gross margin line. So from that perspective, and as we mentioned earlier, not only the leverage but the cost reductions we have continued to get and we will continue to get in our products, we feel good that over the course of the year we'll see it in the 60% overall gross margin rate.
Zack Ajzenman
Okay, thank you. And on the additional wavelength for enlighten 670, can you – when did the wavelength receive CE Mark, and maybe just a little more color around the launch schedule for Europe, is that underway or are you guys still waiting FDA clearance?
Kevin Connors
We are waiting FDA clearance and we really think the offering will be available in the second half.
Zack Ajzenman
Okay, thanks. And then maybe one more, Kevin, you mentioned Japan, nice recovery this quarter.
2015, I think it was mostly a function of currency but Japan was down about 14% year-over-year. Maybe just a little more color on the prognosis for 2016 given the country is relatively significant in terms of the overall Company?
That would be great. Thank you.
Kevin Connors
Sure. You look back to several years, Japan accounted for about 25% of our total revenue.
So it's always been a material part of our business and we spend a lot of time out there just to make sure we're staying close to what's happening with our organization. We have great leadership there.
The sales team in particular has really been significantly upgraded in my view. And as Ron mentioned in his prepared comments, foreign exchange will remain a wildcard.
However, we think that Japan is a critical long-term part of our overall strategy. And we announced earlier in the quarter that we got a big regulatory inflation in Japan and that product, enlighten, is in its early days in that market and which we anticipate continuing to be a strong part of our future there.
Operator
Our next question comes from Anthony Vendetti with Maxim Group. Please state your question.
Anthony Vendetti
Before going on to the question, I just wanted to follow up on the enlighten clearance. I believe in Japan, did you receive that literally the last day in the quarter, in the first quarter, March 31?
Kevin Connors
It was in the final month, and so it really just began a lot of our marketing activities with that clearance. So again, it's early days with enlighten in Japan.
Anthony Vendetti
It seems like that would be, just from our channel checks, obviously a large market for enlighten. Can you compare how the initial four to five weeks of enlighten is going or is it too early to compare it to its launch in the U.S., is it a similar trajectory or can you comment a little bit on the opportunity there, and how many salespeople, distributors are focusing on that opportunity?
Kevin Connors
Our entire sales team in Japan is focusing on the product and I'm hesitant to project that after such a short experience there in Japan. With that said, the early indications that you get – clearly, interest from physicians is extremely high and we've had an energized sales team, so I think our outlook is very encouraging in Japan.
Anthony Vendetti
So just if you can give me an idea, how many total sales and between direct and distributor do you have in Japan focused on?
Kevin Connors
We were direct in Japan. We don't have any distributor relationship.
There are sub-dealers in Japan that are common, but it really is a direct model. And I think our sales headcount there is around eight for our capital equipment.
Anthony Vendetti
Okay, eight sales. And then just you commented a couple of times, Kevin, on the ASP in the press release and particularly said it was strengthening for excel V, but talked about ASP improvement.
Excel V, can you talk a little bit about why you're seeing improvements there, is it an enhancement to the product? And then in terms of enlighten, a lot of competition in the picosecond category.
Is the 670 nanometer wavelength giving you pricing power in the picosecond category?
Kevin Connors
On the issue of pricing, I think that there's a number of factors that are probably pretty obvious, but having technology that's well-differentiating is a critical component, also coupled with a highly trained sales team that can tell value story with our products and our utility and having a team that can sell premium products and get rewarded with the appropriate pricing. So it's hitting on all those things and I think that our comment about having growth among all of our major product categories is another indication that we've got a sales team that can effectively tell a pretty complex portfolio story, and I think all those things manifests itself into the selling price of the product.
Anthony Vendetti
Are there any of the older products that are seeing declines or are the older products at a stable price and it's the new products where you're getting the ASP improvement?
Kevin Connors
We're not seeing any trends of overall average selling price pressure. The volume for a given product category will change from quarter to quarter, but I think the 30,000 foot view is that across the board we think we're getting our fair pricing.
Anthony Vendetti
Okay, great. I'll jump back in.
Thanks.
Operator
Our next question comes from Brian Freckmann with LS Capital. Please state your question.
Brian Freckmann
Just a quick question. I think you guys said 46 salespeople in North America sort of at the end of the quarter.
If you could remind me what that was I guess first quarter last year and if you care to guess where that number might be exiting 2016?
Ronald Santilli
Sure. I think looking back about a year, there was a lot of moving balls in the air at that time, but the equivalent headcount there was at least 10 to 12 people down from where we are today.
So 47 would fall into say the 35 to 37 range. Going forward…
Kevin Connors
I think my halftime or as a halfway point this year, we anticipate it being somewhere around 50, and then we plan to continue to add through the end of the year approaching 60 sales reps. And just apples-to-apples, we did have a fair amount of turnover with the sales team a year ago, in Q1 a year ago.
So there are lot of new hires that reflected in Ron's number, so sales force productivity lagged that. So I think we've got a much bigger and stronger sales team in place when we compare it to the same period a year ago.
Brian Freckmann
Okay. I'm sorry, you said 50 by halfway and maybe 60 by the end of the year?
Sorry, just want to make sure I was hearing that correctly.
Kevin Connors
That's correct.
Brian Freckmann
Okay. Obviously it's been – when you sort of dig out some of the parts and you start looking at it, obviously North American product sales were up 59%, and if on apples-to-apples, 46 versus 35-ish, you've got 31% more salespeople generated a 59% North America bump.
Obviously that's why I'm thinking 60 is better than 46, but could you just talk about what's happening there and how you add 30% more salespeople and you're getting as I said on your 60% jump in North American product sales, what's kind of been behind that?
Kevin Connors
I think one of the critical components is our sales management team just does a really good job of training these reps and the management team is extremely hands-on with the reps, and I think that is one of the key reasons that our relatively new sales team that was onboard a year ago was able to ramp up faster than what we've experienced historically. And again, having great products, I mean that all is a great combination.
Brian Freckmann
Okay. And then someone did ask about Japan, and I know you guys don't know what's going to happen there exactly, but maybe a better way to ask that same question would be, when you started the year, was there a dollar/yen number you expected?
Obviously we've seen quite a strength in the yen. I was kind of curious, when you originally gave your guidance, did you reiterated, that number was probably 120 and now we're at 106, did you originally guided a 120 number?
I'm just trying to understand sort of how to think about the potential for Japan.
Ronald Santilli
Right. When we budgeted, and actually now as we have guided, assumed exchange rates that were very similar to that of the end of the year.
We don't project increases or decreases in foreign exchange rate during the budgeting process and now the forecasting, and at this point we've pretty much kept our rates the same. So, long way of answering your question, no, we haven't, our guidance does include the current exchange rate.
Brian Freckmann
Okay. And then just kind of looking at the other business lines, I mean North American product has been outstanding and you guys have obviously found the right salespeople, pushing the right buttons, hire the right people to grow that.
What initiatives in 2016 would you say in regards to the rest of the world, or is that a 2017 project, how should we think about the actions going to be taken there to potentially get similar outcomes as we have started to see with North America?
Kevin Connors
We touched on Japan already, so I won't focus more time on that, but we think the trends there are looking really good. And once again, I think the sales management in Japan has made big difference.
We're doing some other things with our direct operation in Europe and with anticipation of improved results. And then that coupled with continued sales force expansion where we're direct and locating new distributor partners where we opt to do that.
So we're shining with bright light on the global commercial side, but the North American market is obviously the largest single market, and when you have a management team that's stable and in place, scaling that is a lot easier than say scaling your business in France.
Brian Freckmann
Yes. Keep up the good work.
Thanks so much.
Operator
Your next question comes from Dan Mendoza with Prospect Capital Advisors. Please state your question.
Daniel Mendoza
Most of them have been asked, but just on the enlighten front, can you give us a sense for the success that you might be having there with kind of new accounts, as in folks that haven't done a lot of business with Cutera in the recent past?
Ronald Santilli
I'm sorry.
Kevin Connors
New accounts or I think new customers.
Ronald Santilli
Actually we're seeing a mixture of both, whether they are new or existing customers. I'd say that really our installed base is still very interested.
They are not just sterns and plastics but we're finding that product to be well-suited for some of our non-core physicians as well. But with that said, we're finding half the transactions that are non-existing customers as well.
So, penetrating both sides.
Daniel Mendoza
Sorry, and you said, it was roughly sort of a 50-50 mix between existing…
Ronald Santilli
Yes, in that range.
Daniel Mendoza
Okay, interesting. And then are there any other additional international clearances that are likely in 2016, or do you have most of them come from China?
Kevin Connors
At any given time we've got lots in progress. I can't give you an exact number, but we clearly want to have all of the technological advances that we've done with enlighten and these other products allow us to be marketed in these markets around the globe.
So we do anticipate additional clearances but I can't give you a specific number.
Daniel Mendoza
Okay, that's helpful. And then I guess maybe just lastly, have you seen any impact of the [Luminus] [ph] acquisition from being acquired in Q4 of last year in terms of availability of talent or the focus of the company that has been acquired?
Kevin Connors
I have to say that it's not obvious to us that acquisition had any impact on the Company. But in terms of talent, Larry has opted to build his own salespeople and they are usually not industry people.
Every now and then we'll hire somebody from within the industry, but I think Larry and his team have a unique approach and they like to build people up in terms of [indiscernible] but this is the way that Larry and the team I think is best.
Daniel Mendoza
Okay, that's helpful. And I mean maybe related to that, does that model play in international markets in terms of hiring people from outside the industry and then kind of the other processes that you put into place or is that a little bit of a different market where maybe…?
Kevin Connors
I don't think so really. I think that top talent usually doesn't want to leave their jobs.
So that's why we think that finding people from different backgrounds in the medical field has been helpful to us, but having very hands-on sales management around the globe I think is the critical component there.
Daniel Mendoza
Okay, great. Thanks.
Operator
Mr. Connors, there are no further questions at this time.
Would you like to make any closing remarks?
Kevin Connors
Yes, thank you. Thank you for participating on the call today.
We'll be attending many investor marketing events in the second quarter and hope to see you in the coming months. We look forward to updating you on our business progress in the second quarter 2016 conference call in August 2016.
Good afternoon and thank you for your continued interest in Cutera.
Operator
This concludes today's conference. Thank you for your participation.
You may disconnect your lines at this time.