Nov 8, 2016
Executives
John Mills - IR, Integrated Corporate Relations, Inc. Ronald Santilli - EVP and CFO
Analysts
Anthony Vendetti - Maxim Group Zack Ajzenman - Griffin Securities Brian Freckmann - LS Capital
Operator
Greetings and welcome to the Cutera Inc. Third 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 of ICR. Thank you.
Mr. Mills, you may begin.
John Mills
Thanks, operator. Welcome to Cutera's third quarter 2016 earnings conference call.
On the call today are Cutera's Interim Chief Executive Officer and Chief Financial Officer, Ron Santilli. After Ron's prepared comments, there will be a question-and-answer session.
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 our sales force, ability to increase revenue, reduce expenses, improve financial results, make productivity improvements, grow our 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 Securities and Exchange Commission today.
But you are also caution you do 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 Ron.
Ronald Santilli
Thank you, John. Good afternoon, everyone and thank you for joining today to discuss our third quarter 2016 results.
I am pleased to report that we exceeded the preannounce preliminary results reported on October 11. We achieved revenue in the third quarter of 2016 of $30.3 million, which is a 31% increase from the third quarter of 2015.
This revenue represents a record third quarter and the second highest quarterly revenue in our history. This result also marks our ninth consecutive quarter of double-digit revenue growth.
We are happy to report that our gross margin improved sequentially, as well as year-over-year and I am particularly excited about our return to GAAP profitability, which illustrates the leverage in our business model. Our financial performance in third quarter and overall financial trajectory has us on track with our previously stated goals of strong revenue growth and GAAP profitability for the full year of 2016.
Our organic revenue growth was broad-based throughout our product portfolio and we achieved significant productivity improvements in both of our regional markets in North America and the rest of the world. The management changes we implemented in hiring industry experienced veterans to lead our commercial teams have paid off as it is reflected in our revenue improvements over the past two years.
We remain optimistic about our opportunities for continued long-term growth. Our sales team in the rest of world region led by Miguel Pardos delivered an impressive 52% increase in product revenue year-over-year, driven by a well-balanced growth in the Asia-Pacific region, as well as with our European distributors.
In particular, we achieved strong growth in our Japanese and at Australia direct operations. Foreign currency changes with the Japanese yen moved favorably when compared to the third quarter of 2015, resulting in a favorable revenue impact of approximately $600,000 when measured in constant currency.
We had no other meaningful changes in other foreign currency. Our North American sales team led by Larry Laber also delivered yet another impressive revenue achievement by growing product revenue 28% when compared to the same period last year.
For the first nine months of this year North American product grew by 44% compared to the same period last year. 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 was 56 field sales people in North America, as compared to 42 from a year ago. In seeing the market opportunities in North America and, as well the productivity improvements experienced over the past year under the leadership of Larry, we plan to continue investing in this market and project that we will have approximately 60 field sales people in this territory by December 31, 2016.
Further, we plan to closely monitor the revenue and productivity improvements of our sales teams and will continue to expand on our team to drive revenue growth in 2017. During the third quarter 2016, core physicians in North America accounted for approximately 55% of our orders with the balance of the orders received primarily from family practice docs.
From us specific product perspective, we are pleased with the performance of our entire product portfolio, as we continue to grow our revenue across all our categories. In the current quarter, we experienced strong revenue growth from not only our recently released enlighten and excel HR products, but also from our legacy xeo, excel V, and truSculpt platforms.
Turning to research and development. Innovation and technological leadership of the cornerstones of Cutera's culture and we are proud of the many years of technical innovation incorporated in all of our products, including enlighten.
We are planning to continue investing in the enlighten platform and our current product extensions, include the following. We recently launched our PicoGenesis application and enabling our customers to perform skin revitalization procedures, utilizing our high-energy system, providing an effective treatment in the fastest time.
And we just recently received a 510 K clearance from the FDA for a third wavelength, a true red six 670 nanometer for benign pigmented lesions that will allow for greater clinical capabilities for our customers. We plan to launch our three wavelength enlighten 3 platform at the end of this quarter.
We are in the process of finalizing this launch plan, but do not expect it to have a meaningful impact on the fourth quarter shipments. We believe this new product will be the best in class, 3 wavelength laser in the market that will allow our customers the ability to remove all tattoo ink colors and provide PicoGenesis skin revitalization with improved efficacy and faster treatment than any other system in the market.
Lastly, as mentioned in our second quarter conference call, we are planning to increase our investment in our truSculpt platform to enable us to more aggressively compete in the body sculpting market. We currently have a pending FDA submission for a circumferential reduction clearance and plan to make some exciting product line enhancements in 2017, subject to FDA approval that will include adding a consumable revenue stream.
We believe that our enhanced version of truSculpt f for circumferential reduction will offer compelling advantages in terms of efficacy and return on investment for the practitioner when compared to existing offerings for body contouring in the marketplace today. Recall that truSculpt is based on our proprietary RF technology which we believe is best suited for body contouring as it selectively targets fat cells and will ford as a meaningful cost advantage.
Overall, we expect 2017 to be a busy year for us and we look forward to updating you on future calls, as our exciting pipeline of product innovations rolls out in the commercial launch. The global market for aesthetic light and energy based systems is growing at a steady pace and we estimated approximately $2 billion per year.
Our broad range of products, expected market share expansion, the commitment to innovation, as well as our strengthened commercial leadership team should all service as catalyst to fuel our growth as we look forward. As mentioned in August of this year, our board has commenced a search for a permanent CEO.
The naming of a permanent CEO is expected to be completed by the end of calendar year. Turning to our financial performance.
As I said earlier, we had an impressive third quarter revenue of $30.3 million. We expect our revenue growth rate to continue to be in excess of the overall market rate of growth for the end industry and are guiding the fourth quarter 2016 revenue to be approximately $36 million or 20% growth compared to a very strong fourth-quarter 2015.
We further expect to grow our revenue in 2017 to be within the range of our recent growth rates and expect to be GAAP profitable and cash accretive for the full year of 2017. We will provide more specific guidance in 2017 during our fourth quarter earnings call in February of 2017.
Gross margin increased slightly from 58% in the third quarter 2015 to 59% in the third quarter of 2016. This was due primarily to our ASP's remaining firm, as well as improved leverage in our revenue growth.
Gross margin improvement is a key goal for our company to drive increased financial performance. We expect gross margin to further improve in the fourth quarter to approximately 60%.
For 2017 due to the seasonality of our revenue during the quarters, we expect to be able to continue improving our gross margin modestly on a year-over-year basis. I'll now address our operating expense results where we experienced significant leverage in our performance.
Sales and marketing expenses as a percent of sales decreased to 35% in the third quarter of 2016 compared to 38% of revenue in the third quarter of 2015. We continue to aggressively invest in our commercial channels to build out our distribution network, enabling us to gain market share with above market revenue growth rates.
We expect our sales and marketing expenses to grow moderately in absolute dollars quarter-over-quarter, 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 fourth quarter 2016 sales and marketing expenses to be in the range of 34% to 35% of revenue.
Research and development expenses were $2.9 million in the third quarter of 2016. We remain committed to continued investments in engineering and clinical research that drive new product innovation.
We are planning to slightly increase our investments in research and development activities as the most recent investments are providing targeted revenue growth and commensurate returns. As such, R&D spend is anticipated to be in the range of $2.8 million and $3.2 million in the fourth quarter and in 2017.
General and administrative expenses decreased from $2.9 million in the third of 2015 to $2.7 million in the third quarter of 2016. We expect our quarterly general and administrative expenses to range from $3 million to $3.2 million in future quarters.
And now the best part, our GAAP net income for the first quarter - for the quarter was $1.6 million or $0.12 per share. We are pleased to have executed our plans to achieve profitability for the quarter and expect to achieve GAAP profitability for the full year of 2016 as well.
We also expect to be profitable in 2017, given our revenue growth projections and continued leverage in our model. Turning to the balance and cash flow, net accounts receivable the end of the second quarter 2016 were $11.7 million and our DSOs were 35 days.
In the future we expect our DSOs to be in the 35 to 40 day range. Inventories were $16.5 million at September 30.
Our inventories increased from June 30 due to the ramp up for expected revenue growth and the plan launch of our enlighten 3. Cash from operations generated over $1.6 million for the quarter.
We expect to be cash flow positive in future quarters as we continue to leverage our revenue growth and we don't expect any significant changes in other working capital assets other than normal quarter-to-quarter fluctuations. Our cash position remained strong and as of September 30, 2016 we held cash and investments of $46.4 million with no debt, which represented approximately $3.50 per outstanding share.
In the third quarter of 2016 we repurchased approximately 176,000 shares for $1.9 million. We have approximately $5.1 million in our authorized $10 million share repurchase program and plan to be opportunistic with repurchasing our stock.
In conclusion, we are pleased with the achievement of our continued revenue growth, gross margin improvements, return to profitability, cash generation from operations and our strong cash position. For the fourth of 2016 and beyond, while there are certain unpredictable factors that may impact our global business, including unfavorable currency movements and domestic and international political headwinds, we believe we will continue to realize year-over-year improvements in our financial performance.
We expect continued healthy year-over-year revenue expansion and market share gains in the fourth quarter of 2016 and into 2017. We further expect to sustain our annual GAAP profitability and continued generating cash from operations.
I'd like to now open up the call for your questions. Operator?
Operator
[Operator Instructions] Our first question comes from Anthony Vendetti of Maxim Group.
Anthony Vendetti
Thank you. I'm wondering if you could get into a little more detail on truSculpt, I know, you mentioned you expect to have a new consumable component to it and you are seeking FDA clearance, 510(k) clearance, for circumferential reduction.
I was wondering if you could tell us whether you are - any change to the product? Is it an upgrade to the product or is it just a trial that you are submitting for the circumferential reduction clearance?
And then if you could give us a little more detail on what the consumable will look like or how much it will cost or any detail around that would be helpful? Thanks.
Ronald Santilli
Sure. Clearly the truSculpt - increasing our presence in the body sculpting market is a priority of ours and the truSculpt product has been and is a good product as RF technology targets the fact, so we've always believed in that, but we haven't had the appropriate commercial indication or clearance to aggressively market it.
So the reason we conducted this study that we've recently done and the application that we submitted is to get us to aggressively participate in that. In addition to the current product we want to enhance it.
We've got some exciting things that we'll add in 2017. We'll talk more than as we get closer, but with that - with the enhancements we will also add a consumable to the product.
So again, we'll talk more in 2017 as we get closer. But those are the general feelings in the direction that we're headed into the body market.
Anthony Vendetti
Okay, then in terms of, with enlighten, there seems to be a lot of competition there. We heard there is price competition in the Picosecond technology space.
I was just wondering whether you are seeing any ASP erosion with enlighten or any of your other products right at this point?
Ronald Santilli
You know, we always had heavy competition out there, but our ASPs are continuing to hold firm as is indicated in our trending upward gross margins. So we're seeing a pretty good situation out there for ASP's.
Anthony Vendetti
Okay, in terms of international it sounds like you had a really nice bounce back quarter there, up 52%, was that A-Pac of international or product revenue total?
Ronald Santilli
That would be all the international or rest of world, we should say everything, but North America and Canada.
Anthony Vendetti
Okay, great. And then lastly on the sales you said you ended the quarter with 56, what was the goal by the end of the year?
Ronald Santilli
60, six zero by the end of the year.
Anthony Vendetti
Okay. And then on product bundling, some of the companies in this space are seeing more of that, did you see more of that this quarter than you did last quarter, less of that is that part of the strategy going forward or not really?
Ronald Santilli
We're just continuing to see more and more multiunit sales and that’s probably due to the multiple platforms that we have focused on the hair removal, the tattoo and skin revitalization, of course our multi-application, multi-technology xeo product and then truSculp. So we got such a wide array of products that with a more aggressive and more sales force, we can just see more bundled system.
So that's certainly is part of our long-term strategy as well.
Anthony Vendetti
Okay. And then just lastly, on new product platforms is there anything planned for 2017 in terms of the new product platform other than stuff that you have mentioned in terms of consumable and new clearances for truSculpt?
Ronald Santilli
We haven't mentioned anything about our new platform yet, other than our focus on enlighten and truSculpts in 2017.
Anthony Vendetti
Okay, great. Thanks.
Ronald Santilli
Thanks, Anthony.
Operator
[Operator Instructions] Our next question comes from Zack Ajzenman of Griffin Securities.
Zack Ajzenman
Hi. Thanks, good afternoon Ron.
Ronald Santilli
Hey, Zack.
Zack Ajzenman
Question on enlighten 3, which sounds like its going to launch towards the end of this year, is that going to be a global launch or just here in North America?
Ronald Santilli
We probably will start close to home to begin with and the ultimately in 2017 we'll be expanding it outside the US.
Zack Ajzenman
Okay. And through the first half of the year the international product segment…
Ronald Santilli
Hey, Zack, not hearing you very well Zack.
Zack Ajzenman
Sorry. Can you hear me now?
Ronald Santilli
Much better.
Zack Ajzenman
Okay. First half of the year, the international product business seemed to drag a bit, it was down call it mid-single digits through the first half of the year.
I believe a part of that declined or a meaningful part of that decline had to do with the distribution business. Can you give us a little more insight into what the distribution business did here in Q3?
Ronald Santilli
Sure. The distribution business can be lumpy or can fluctuate from quarter-to-quarter.
If you look at the rest of the world business on a nine months year-to-date basis and you compare 2016 to 2015, our rest of world business is up about 12%. So we're pleased with that, but we also understand that there can be some fluctuations in quarter-to-quarter.
Keep in mind half of our international business or rest of world business is direct and the half is coming through distributor network.
Zack Ajzenman
Got you. Got you.
And a question on enlighten, I am curious as to what percent of enlighten buyers currently or this past quarter are dermatologists?
Ronald Santilli
Originally when we launch the products we really thought enlighten with its price point a premier capabilities was going to be primarily targeted to derms and plastics, the core markets. But the fact of the matter is there in terms of our current sales volume level, it’s the same group of same breakdown as our general core and non-core roughly 50-50 between core and non-core.
So we see a lot of non-core that is primarily family practitioners that are buying into the enlighten product as well.
Zack Ajzenman
Interesting, okay, great. Thanks a lot.
Ronald Santilli
Thanks, Zack.
Operator
Our next question comes from Brian Freckmann of LS Capital.
Brian Freckmann
Hey, guys, congratulations on the quarter.
Ronald Santilli
Hi, Brian,
Brian Freckmann
Just a quick question on you outlook on the fourth quarter, can you maybe get a little more granule about, obviously, within that $36 million, should we be looking at the ratios that we had last year of percent of products, to other and North America to international and apply those to that same $36 million or is there anything specific that you should call out that might be different?
Ronald Santilli
No I don’t see anything different that’s changing from any of the current trends that we're seeing today Brian.
Brian Freckmann
Okay. Then, that just a question, what is your expectation potentially on the headcount next year?
I know you said about 60 this year, but I'm just trying to get a sense of what that might be in '17?
Ronald Santilli
Yes, we haven’t talked about 17 yet, we will on the next conference call. We do believe it will obviously go up and we are still seeing nice performance in productivity and as well as growth in the marketplace.
But we are selective in how we're adding out there, but we definitely expect to continuing adding salespeople and to continue to go the productivity levels.
Brian Freckmann
Okay. Then finally just as you think about getting -- I think your indication was just right below 60% margins in the fourth quarter.
As you look at that, what is the variation between product lines, is there a range you could think about, as you think about what products have you sold in the quarter. Is there any variability?
Was it 59% to 61% or how do you think about that?
Ronald Santilli
Yes, it’s a good question, there always – there is a range because we have discussed we have not only product variation with different margin, but we had direct versus indirect distribution, which has different margin. And I think I will arrange probably as you just mentioned, kind of in the between 59, 61, I kind of just call it the approximately 60% just kind of make it a little simpler for the analyst and the other people modeling.
But you're right, the range is probably more into the 59 to 61 range depending on how the product mix and distribution mix comes in for the quarter.
Brian Freckmann
Okay. You said you guys would provide some form of a full-year '17 guidance after the fourth quarter call, is that correct?
Ronald Santilli
That’s correct. We will prepared at that point to talk more about 2017.
Brian Freckmann
Okay. All right, guys.
Thank you. Congratulations.
Ronald Santilli
Thank you, Brian. Thanks.
Operator
Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call back to Mr.
Ron Santilli for closing remarks,
Ronald Santilli
Thank you. We will be attending some investor marketing events in the fourth quarter and hope to see you in the coming months and look forward to updating you on our business progress on the fourth quarter 2016 conference call in February of 2017.
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.