Nov 7, 2017
Executives
John Mills – ICR-Partner James Reinstein – Chief Executive Officer Sandy Gardiner – Consultant Chief Financial Officer
Analysts
Jim Sidoti – Sidoti & Company Anthony Vendetti – Maxim Group Larry Haimovitch – HMTC
Operator
Greetings, and welcome to the Cutera Third Quarter 2017 Earnings Conference Call [Operator Instructions] I would now like to turn the conference over to your host, John Mills, Partner ICR.
John Mills
Thank you, operator. Welcome to Cutera’s third quarter 2017 Earnings Conference Call.
On the call today is Cutera's President and Chief Executive Officer, James Reinstein; Consultant Chief Financial Officer, Sandra Gardiner; and outgoing CFO, Ron Santilli. After the 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 change.
Forward-looking statements include, among others, statements regarding financial guidance, plans to introduce new products, productivity improvements and plans for stock purchases. 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 the section entitled Risk Factors in our Form 10-K as filed with the SEC on March 15, 2017 and updated in our Form 10-Qs subsequently filed. 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.
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 the 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 measured as prescribed by GAAP.
And now with that, I'd like to turn the call over to our CEO Mr. James Reinstein.
James Reinstein
Thank you, John. Good afternoon, everyone, and thanks for joining us today to discuss our third quarter 2017 results.
We are pleased to report that we achieved record sales this quarter. We recognized $38.2 million of revenue, a 26% increase from the third quarter of 2016.
This revenue level is a record for any quarter in the company's history and represents the 13th consecutive quarter of double-digit revenue growth. During Q3, revenue growth was broad-based throughout our existing product portfolio, but the primary driver and the largest contributor came from the truSculpt 3D body sculpting system, which we launched in the U.S.
in the middle of the last quarter and in select European countries late in the third quarter. Additionally, enlighten and our legacy xeo products were also key contributors to our overall growth.
Geographically, we grew in both North America and our international markets. Our North American sales team led by Larry Laber, delivered another impressive quarter with product revenue growth of 57% compared to the same period in 2016, despite having to cancel two marketing events in Miami and Houston.
We continued to see productivity improvements with our field sales team, helping fuel the overall revenue growth. In the third quarter, the productivity per salesperson shows a run rate of approximately $1.6 million compared to just $1 million in the third quarter of last year.
We finished the quarter with 59 field salespeople in North America as compared to 56 at the end of the second quarter of this year. Larry continues to aggressively recruit, onboard and maintain a first-class team of sales professionals.
Additionally, we recently hired two in-house recruiters to assist the management team in the sourcing and screening of talent, which we expect to be critically important for us to meet our goal of having around 70 salespeople by the end of 2017. Regarding our customer base, during the third quarter of 2017, core physicians, plastic surgeons and dermatologists in North America accounted for approximately 38% of our orders.
This represents the lowest number in some time, which we believe indicates that we are expanding our channel reach to non-core physicians. We primarily attribute this expansion to our entry into the body sculpting market with a meaningful system, the truSculpt 3D.
The highest increases within our non-core segments were OB/GYN and medical spas. We are encouraged by this shift, as we believe these channels will also help us leverage our other platforms and future offerings.
Our sales teams serving international markets grew product revenue to $10 million, also a company record for international. We saw strong revenue growth in Japan and momentum in Europe with the truSculpt 3D launch, which was executed in some markets towards the end of the quarter.
We believe we're seeing the results of our organizational changes made earlier in the year, as those teams build and execute their plans. We expect this momentum to continue into the fourth quarter to demonstrate even more traction during 2018.
Our gross margin was 58% in the third quarter of 2017. This marks the second consecutive quarter of 58% gross margin.
We continue to focus on our initiatives to improve margins through manufacturing efficiencies, a 60% gross margin in the fourth quarter of 2017 remains the target. We are also pleased with the GAAP net profit of $6.2 million or $0.42 per diluted share.
Non-GAAP adjusted net income of $3.5 million or $0.24 per share excludes the $4 million benefit from the previously announced lease termination payment from the Fremont, California facility, depreciation and non-cash stock-based compensation expense. As with all non-GAAP financial measures, we encourage you to refer to the GAAP to non-GAAP reconciliation provided with our press release.
Turning to research and development. One of the cornerstones of Cutera's culture is our commitment to offering superior technology.
Overall, R&D spending in the quarter was up 19% to $3.5 million, demonstrating this commitment of continuous improvement. The hiring of Michael Karavitis as our Chief Technology Officer in August of this year was a significant win for the Company.
Michael is a seasoned R&D executive who understands our technology very well. He also shares our commitment to continuous improvement and the need to having a consistent cadence of new product launches.
In this vein, he comes to us with a number of exciting new ideas that we believe will solidify Cutera's role as the innovation leader within the aesthetics market. Mike and I recently spent time with our newly formed Medical Advisory Board, where we presented our new product road map.
We received excellent feedback, along with the assurance that our direction is sound. This is very motivating for the product development team and myself.
Let me speak to a couple of our recent product launches, starting with the enlighten platform. Our enlighten PICO system for tattoo removal and skin revitalization continues to garner interest and represents one of the highest revenue generators and is fueling much of our growth.
We are committed to this product platform and have plans to expand its functionality and indications for use, enabling our customers to realize a greater on their investment. We plan to introduce a low-cost version in 2018 to be offered in select international markets and focused on skin revitalization procedures.
Now turning to a product launch that we are very proud of, the truSculpt 3D body contouring system. During the latter portion of the third quarter 2017, we expanded the launch of the truSculpt 3D to include select European countries and the response has been very positive.
Overall, truSculpt 3D, which launched in North America earlier this year, is exceeding our expectations and is already our single largest revenue-generating platform, in spite of only being on the market for 4.5 months, basically half of this year thus far. The rollout of this system will continue into the fourth quarter and well into 2018.
I would now like to say a few words about an area of our Company that we really haven't provided appropriate attention to in the past, our global field sales organization, now being led by Michael Palumbo, Vice President of Global Services. With Mike on board, we believe this group can contribute to revenue growth in a meaningful way.
After his initial assessment, Mike presented his plans to invigorate this organization and the contributions they expect to make to our top line growth for several years to come. I had the opportunity to be with the Global Services management team during their first-ever team meeting, where these exciting plans and expectations were discussed.
We have an extensive installed base of over 13,000 systems, representing an opportunity for selling parts, services and service agreements not previously a priority for the company. We are confident that Mike's team can provide superior service to those machines, which will improve our customer satisfaction, increase their productivity and improve our service revenues overall.
You should expect me to provide more detail about the contributions of this team as the results start coming in. Next, regarding our share repurchase program.
I am also pleased to report that we repurchased approximately $6.7 million in stock in the third quarter, bringing the total value of shares repurchased since February of 2015 to $59 million. If you will recall, the board increased the pool by $30 million since the first of the year, of which about $20 million remains available and allows us to maximize our allowable purchases in the fourth quarter.
We believe this is a strong endorsement by the Board of Directors that this team will continue to build value for shareholders. The global aesthetics, light and energy-based systems continues to grow at a steady pace.
Based on our internal estimates, we project the market will be in excess of $2.5 billion this year. We expect our broad range of products, expected market share growth and commitment to innovation and strong commercial teams will be the catalyst fueling our growth in the coming years.
I would now like to turn the call over to Sandy Gardiner, our Consulting and Interim CFO.
Sandy Gardiner
Thanks, James. As James stated earlier, we had a record third quarter with revenue of $38.2 million, representing 26% growth from the third quarter of 2016.
This performance extends our double-digit year-over-year revenue growth to 13 consecutive quarters and is the highest level in company history. The growth was fueled primarily by North America, where our product revenue grew 57%.
We experienced revenue growth over the same period in the prior year in most of our product lines, with particular strength coming from our recently launched truSculpt 3D body sculpting system. We had growth in many product lines, including revenue from our enlighten and xeo platforms, which also grew compared to the same period in prior year.
We are pleased with our continued revenue performance and expect to achieve the higher end of our full year 2017 revenue guidance range of $144 million to $147 million. Gross margin was 58% in the third quarter.
We continue to focus on several initiatives to increase gross margin and are targeting full year 2017 gross margin to be in the range of 58% to 59%. I will now address our operating expense results, where we experienced continued improvement this quarter with total operating expenses as a percent of revenue declining from 54% in the third quarter of 2016 to 42% in the third quarter of 2017, even as we increased our R&D investments.
Excluding the onetime $4 million benefit from the Fremont, California lease termination, operating expenses were 52% of revenue. Sales and marketing expenses as a percent of sales declined 50 basis points to 34.4% in the third quarter of 2017 compared to 34.9% of revenue in the third quarter of 2016.
We will continue to aggressively invest in our commercial channels, enabling us to gain market share with above market revenue growth rate. Research and development expenses increased 19% to $3.5 million or 9% of revenue in the third quarter of 2017 compared to $2.9 million or 10% of revenue in the third quarter of 2016.
We continue to invest in R&D, while leveraging this expense as a percent of revenue. We remain committed to investing in engineering and clinical research that drives new product innovation and support our clinical superiority.
We are planning to moderately increase our investments in R&D activities as the most recent investments are providing targeted revenue growth and commensurate returns. General and administrative expenses were $3.4 million in the third quarter of 2017 or 9% of revenue compared to $2.7 million and the same 9% of revenue in the third quarter of 2016.
We plan to continue investing in our administrated infrastructure to better support our planned revenue growth. Operating income was $6.2 million, due to improved leveraging in our operating infrastructure as well as the onetime $4 million benefit from the real estate lease cancellation.
Excluding the onetime $4 million benefit, our operating income was $2.2 million, an increase of $677,000 or 44% over the same period in 2016. Interest and other income was $197,000 in the third quarter of 2017.
This included approximately $145,000 of interest income, $86,000 of early payment vendor discounts and $32,000 of net foreign exchange losses resulting from revaluing our foreign net assets. Income tax expense was $225,000 in the third quarter of 2017.
This included income tax expense for our foreign entities, AMT taxes for the U.S. operations, capital-based taxes as well as a tax provision for the onetime $1 million benefit received.
For 2017, we expect an estimated tax rate of approximately 3%. We currently have approximately $37 million of U.S.
net operating loss and significant tax credit carryforwards for the federal income tax purposes. At September 30, 2017, we had a full valuation allowance against our U.S.
deferred tax assets. As a result of our recent history of cumulative profits in the U.S.
as well as our expected future profits, we may determine in the coming months that all or a portion of our valuation allowance is no longer necessary. At that time, we will reverse the valuation allowance and recognize an income tax benefit in respect of financial statement period.
Once the valuation allowance is eliminated or reduced, its reversal will no longer be available to offset our current financial statement tax provision in future periods. Our GAAP net income for the quarter was $6.2 million or $0.42 per diluted share.
This includes an approximate $0.27 per share gain related to the onetime payment following the cancellation of our Fremont facility lease as adjusted for taxes. Non-GAAP adjusted income was $3.5 million or $0.24 per diluted share, which excludes noncash stock-based compensation, depreciation and the Fremont facility lease cancellation benefit.
In future quarters, we expect to provide you with our adjusted non-GAAP income in order for you to have a better idea of how we are performing on a cash basis. We are maintaining our previous operating earnings guidance as adjusted for the $0.27 per share gain related to the onetime payment following the cancellation of our Fremont facility lease.
Therefore, GAAP earnings per share is expected to be in the range of $0.77 to $0.81 for the full year 2017. Now turning to the balance sheet and cash flow.
Net accounts receivable at the end of the third quarter of 2017 were $19.6 million and our DSOs were approximately 45 days. For the remainder of 2017, we expect our DSOs to remain close to 45 days, given the continued international launch of truSculpt 3D.
Inventories were $23.7 million at September 30, 2017, representing a $6.8 million increase from the $16.9 million level at June 30, 2017. The higher inventory level is needed to meet our projected revenue growth plans.
Inventory typically turns approximately 4x per year. Cash from operations was $3.7 million for the quarter ended September 30, 2017, and includes the onetime $4 million received for the Fremont facility lease cancellation.
Excluding the onetime $4 million benefit, cash used by operations was approximately $300,000, due primarily to increased working capital investment to support higher revenue levels. Our cash position remains strong, and as of September 30, 2017, we had held cash and investments of $50.5 million with no debt, representing approximately $3.63 per outstanding share.
During the third quarter of 2017, we repurchased 185,000 shares for a total of $6.7 million at an average price of $36.47 per share. We plan to continue repurchasing shares and, as James mentioned earlier, we will maximize our allowable repurchases in the fourth quarter.
Fully diluted shares outstanding were 14.77 million for the three months ended September 30, 2017, and 14.73 million for the nine months ended September 30, 2017. Our target has been 14 million fully diluted shares outstanding for the full year of 2017.
However, the share price depreciation has been very strong in the share, so even though we will maximize our allowable repurchases in the fourth quarter, it is unlikely we'll reach our goal of a weighted average share count of 14 million for the full year. To the extent that we do not fully utilize the remaining $21 million available under the repurchase plan, we expect to continue repurchasing stock into 2018.
I would like to now turn the call over to James for his closing comments.
James Reinstein
Thanks, Sandy. Overall, we are very encouraged by the progress the entire Cutera team continues to make.
We are particularly pleased with our 13th consecutive quarter of double-digit revenue growth and significant improvement in profitability and cash generation. We expect to continue the year-over-year revenue expansion and market share gains in the fourth quarter of 2017 and beyond.
We further expect annual GAAP profitability and generating cash from operations. I'd like to now open up the call for questions.
Operator?
Operator
[Operator Instructions] Our first question is from Jim Sidoti with Sidoti & Company. Please state your question.
Jim Sidoti
Hi, good afternoon. Can you hear me?
James Reinstein
We can hear you well, Jim. Thanks.
Jim Sidoti
Okay, great. You mentioned there were two selling events canceled during the quarter due to the hurricanes, one in Texas, one in Florida.
Any attempt to quantify what the impact they had on the third quarter revenue? And do you think you will make that up in the fourth quarter?
James Reinstein
It's difficult. I mean, these are marketing events.
We do actually sell at these events, and we – they range in anywhere from $400,000 to $800,000. I think we've done over $1.1 million or $1.2 million.
But we will – we've rescheduled these. One is definitely going to occur in Q4, the other will probably be in Q1 of 2018.
Jim Sidoti
Okay, all right. And then can you give us an update on the hands-free system.
I know you got FDA approval for that in the previous quarter, but where you are with the launch of that? And how you see that ramping out in 2018?
James Reinstein
Yes, so we continue to make progress. There is a few features that we would like to build into to that product, that – with Michael Karavitis coming in as our new CTO.
So we're basically looking at assessing the timing of when we will be doing the limited market release. But we fully expect to launch that in 2108 as we've originally planned.
Jim Sidoti
Okay. And then you mentioned an increase in R&D spending.
Can you give us some kind of clue what that's going forward? Is that the [tattoo] removal market or is that a new market for Cutera?
James Reinstein
Well, certainly, one of our biggest project is the next gen of the truSculpting. But we are definitely looking at other verticals.
As I've mentioned in the past, we are – we've kind of taken a different approach as to how we're doing product development with multiple core teams and a portfolio investment board, which consists of myself, CFO and the other – Sandy and the other functional leaders. And basically, that portfolio investment board with a governance in the purse strings on the projects, and the core teams come to us for approval of projects as well as continuation of the projects from each stage of product development.
And we now have 10 projects under contract with the different – with the four different core teams. And so as a result, we're seeing that we've got a lot of shots on goal.
We're going to create a nice cadence of launches going forward but as well as look at additional verticals where we can compete, where we're not currently competing.
Jim Sidoti
Okay. Last question for Sandy.
You mentioned that you're going to recognize the tax valuation, it sounds like, at some point in 2018. Just want to be clear, does that affect your cash taxes paid or is that just something that will affect the way you report the taxes on the income statement?
Sandy Gardiner
It's the latter. It affects how we report it on the income statement.
So we will not be able to use that as an offset on the income statement in the future period. So we will be looking, do the full analysis at the year-end to determine what evidence exists to be able to reverse basically the tax allowances – the deferred tax allowances.
Jim Sidoti
Okay. But if that does happen, I assume you will let us know what the cash taxes paid are?
Sandy Gardiner
Correct, correct. We would disclose – at the time that we actually do the reversal, we would disclose to you that reversal, and then, we would differentiate the two the reversal as well as any cash taxes paid.
Jim Sidoti
Okay, thank you.
James Reinstein
Thanks, Jim.
Operator
Our next question is from Anthony Vendetti with Maxim Group. Please state your question.
Anthony Vendetti
Thanks. So I was just wondering a little more detail on the rollout of the hands-free.
How that is expected to go? I know you mentioned end of this year moving and more in the first quarter of next year.
But specifically, what countries, and when do you expect full rollout?
James Reinstein
Yes, so I think, certainly, first half of next year we'll have the complete launch global, wherever we do have approvals. Currently, we already have approval in the U.S.
So that's no longer the barrier for now – for us right now. The hurdles we're trying to get over have to do with technology.
And then sort of as a backdrop to that, because of the success we're realizing with the 3D, we want to continue with that launch and not defocus the organization from that because we really are seeing just tremendous uptake of that product and the offering that it's providing in the body sculpting space.
Anthony Vendetti
So it kind of sounds like there's no real rush. I mean, obviously, you want to get it out, but there's no rush because 3D is doing well.
So you're going to make sure that everything is checked off and working well, the way you expect it to, before officially launching it here in the U.S. and then on a country-by-country basis next year?
James Reinstein
Absolutely.
Anthony Vendetti
And any discussion on pricing in terms of the base system and then the recurring piece?
James Reinstein
We haven't – actually, we're not discussing that publicly. But obviously, we're not first to market, and we will have to be competitive.
However, if we can bring some game-changing features to it, then obviously we would expect to get premium from that.
Anthony Vendetti
Okay, great. I’ll hop back in the queue.
Thanks.
James Reinstein
Okay, thanks.
Operator
[Operator Instructions] Our next question is from Larry Haimovitch with HMTC. Please state your question.
Larry Haimovitch
Good afternoon. Hey, congratulations on another tremendous quarter, James.
James Reinstein
Thank you, Larry.
Larry Haimovitch
Can you update us on the competitive landscape at all? There's been lot changes as you're well aware over the last several months with acquisitions.
Any thoughts? I know you were – at one point had been able to hire a few of the sales reps from another company.
Can you update us, please?
James Reinstein
Well, we've been very selective, quite frankly, with very few exceptions, where we tend to hire sales people from outside the industry. We did pick up a few sales reps from competition, given the disruption that's occurred in the market.
It was some opportunistic hires, I guess, you would say, where we were able to bring in a team to cover a whole metropolitan area. But for the most part, Larry is of the opinion that he builds laser reps.
He doesn't hire them. So he has got his process.
And I – also, as I mentioned, we did bring in two, call it, in-house recruiters that are really going to support the sales management team because recruiting – screening, recruiting, onboarding is a pretty significant time drain for a sales management team and not a lot gets done at the end of the quarter. So having these two recruiters onboard really does create some bandwidth for the team as well as gets the best candidates possible in a most efficient way.
So we're very excited to have those two individuals join the team.
Larry Haimovitch
Great. And my second question, James, aside from worrying about the Houston Rockets, what are the things you worry about in the business day-to-day?
James Reinstein
It's almost solely on the Rockets, after that victory against the Warriors.
Larry Haimovitch
I know, I know. Don't rub it in.
James Reinstein
Yes. I mean, this is – basically, Larry, I think you know me well enough.
I worry about everything. And try to get to sleep each night.
Larry Haimovitch
Okay. Is anything particular?
I mean, is it hiring that's concerning you or is it getting the new products out? Anything in particular?
James Reinstein
Nothing specific. Pretty much everything.
We've got our objectives we want to hit. We've got the guidance that we put out there.
While we're confident, until it's done, it's never done.
Larry Haimovitch
Of course. Great.
Thanks, again.
James Reinstein
Yes, thank you.
Operator
Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back over to management for closing remarks.
James Reinstein
So I'd like to thank, everyone, for joining us today. We will be presenting at two upcoming conferences.
This week, Canaccord and next week Stifel Healthcare Conference. So hopefully, some of you can join.
There will be webcast presentations. And, obviously, I look forward to giving you updates as we close out Q4 and the full year 2017.
We'll be doing that in – obviously in early 2018. Look forward to speaking to you then.
Thank you.
Operator
This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.