Feb 14, 2018
Executives
John Mills - ICR-Partner James Reinstein - President and CEO Sandy Gardiner - EVP and CFO
Analysts
Jim Sidoti - Sidoti & Company Anthony Vendetti - Maxim Group
Operator
Greetings, and welcome to the Cutera Fourth Quarter 2017 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, Investor Relations.
Thank you, please go ahead.
John Mills
Thanks, operator. Welcome to Cutera’s fourth quarter 2017 Earnings Conference Call.
On the call today is Cutera's President and Chief Executive Officer, James Reinstein; and Chief Financial Officer, Sandra Gardiner. After the prepared comments, there will be a question-and-answer session.
The discussion today will include forward-looking statements, these forward-looking statements reflect management's current forecast or expectations of certain aspects of the company's future business, including but not limited to any financial guidance provided for modeling purposes. Forward-looking statements are based on current 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 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 or to reflect the occurrence of unanticipated events. Future results may differ materially from management's current expectations.
In addition, we will discuss non-GAAP financial measures, including results on an adjusted basis. We believe these financial measures can facilitate a more complete analysis and greater transparency into Cutera's ongoing results of operations, particularly when comparing underlying results from period to period.
Please refer to the reconciliation from GAAP to non-GAAP measures in our earnings release. These non-GAAP financial measures should be considered along with, but not as an alternative to, the operating performance measured as prescribed by GAAP.
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 2017 fourth quarter and full year results.
We are pleased to report that we achieved record revenue sales again this quarter. We recognized $47.6 million of revenue, a 26% increase compared to the fourth quarter of 2016.
This revenue level is the highest quarterly revenue in the company’s history and represents the 14th consecutive quarter of double-digit revenue growth. During Q4, revenue growth was primarily driven by the truSculpt 3D body sculpting system, which we launched in the U.S.
during the second quarter and in select European countries in the fourth quarter. Additionally, our enlighten platform performed very well in the quarter as did our legacy products, which continue to be meaningful contributors to our diversified portfolio.
Geographically, we grew in both North America and our international markets. Our North American sales led by Larry Laber and Keith Adams, delivered another impressive quarter with system revenue growth of 35% compared to the same period in 2016.
We continue to see productivity improvements within our field sales team, helping fuel the overall revenue growth. In the fourth quarter, the productivity per salesperson was approximately $1.8 million compared to $1.5 million in the fourth quarter of 2016.
We finished the quarter with 68 field salespeople in North America as compared to 59 in the end of the third quarter 2017. Regarding our customer base, core physicians, plastic surgeons and dermatologists in North America accounted for approximately 38% of our orders, consistent with the prior quarter.
We believe this indicates expansion of our channel reach to non-core physicians, as well as continued strength with our core physicians. In short, we continue to demonstrate an ability to sell to physicians, looking to broaden their practices with a patient pay procedural model.
The body sculpting procedure is certainly of primary interest to these practices and the new truSculpt 3D offers an ideal solution for them. Our sales team serving international markets continues to make measurable improvements.
Systems revenue grew by 19% from the prior year fourth quarter reaching a record $11.5 million. This is the international team's second straight quarter of achieving record quarterly revenue.
We saw the strong revenue growth across many of our international markets from both our direct operations in Japan, Australia and Western Europe, as well as strong traction from our distribution partners. The international teams are demonstrating an alleviative level of success, which we expect to continue throughout 2018 and beyond.
One of the principal reasons I joined Cutera over a year ago with my contention based on my extensive international experience that Cutera had multiple opportunities to close the gap between the international and domestic performance. Over the past 12 months we've substantially reinforced our regional leadership in Asia, Europe and Latin America with the recruitment of a number of experienced and talented leaders.
While expected to see most of the progress from these changes in 2018, it is evident with the impressive growth posted over the last two quarters that this is just the beginning of what we believe is possible. Regarding the overall leadership of the international team, we have come to a mutual agreement with Miguel Pardos, who will resign his role as Executive Vice President of International sales effective February 28th of this year.
We appreciate Miguel's contributions and thank him for his professionalism throughout this process. As mentioned the international leadership team consisted of regional leaders must of whom were put in place during the past year.
We expect them to continue the Cutera mission and are confident that they will continue to grow our fragrances globally through market share gains and geographical expansion. We are very confident in their ability to deliver high rates of growth as evident by their last two quarters of record breaking revenue levels.
I will be announcing a new reporting structure for this group in the near future, but in the interim they will report directly to me. Sandy will provide more detail on our fourth quarter results in a few moments, but I'm pleased with our record top line and a strong non-GAAP adjusted net income of $6.1 million or $0.42 per diluted share for the fourth quarter.
And cash generated by operations of $6.7 million, an increase of 41% as compared to the fourth quarter of 2016. 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 20% from the same period and 2016 demonstrating our commitment to continuous improvement.
During the year, we enhanced our product development processors to allow for multiple projects to be run simultaneously, while ensuring that all functions of the company are integrated into the process from project inception. The first product to be launched under this new process was the truSculpt 3D, which I will provide an update about shortly.
We're now operating under this new product development process with a nice line up of projects rolling out in 2018. We also made the strategic decision to get into selected new markets faster via external technologies.
In January, we announced the North American launch the Juliet laser that represents Cutera's first entry into the women's health segment of the esthetics market and offers patients with the best-in-class alternatives to improving sexual function and overall vaginal health. We also announced the launch of Secret RF, which is a new fractional radio frequency microneedling device that effectively remodels collagen, improves mild wrinkles and diminishes scars.
These products were sourced from external manufacturers from whom we license the rights for distribution in North America. We launch to the sales team in early January and are now actively selling these systems.
Our enlighten PICO and nano technology for tattoo removal and skin revitalization continues to represent one of the highest revenue generating platforms and fuels much of our growth. We're expanding our product offering by introducing a lower cost version of our enlighten platform in 2018, focused on skin revitalization with our signature procedures PICO Genesis and PICO Genesis FX, while continuing to expand indications for use in the North American market.
Now turning to a recent product launch that we are expanding geographically, the truSculpt 3D. During the fourth quarter of 2017, we expanded the launch of truSculpt 3D into select European markets and the response has been very positive.
truSculpt 3D was launched in North America in May 2017 and continues to meet our very high expectations. In the fourth quarter truSculpt 3D accounted for the highest level of revenue for any of our platforms and we will continue the international rollout of this system in 2018.
I'd now like to say a few words about our enhanced efforts to support our expanding consumable product offering. We've recently announced the creation of the new dedicated commercial team allowing us to participate in the procedure based recurring revenue along with our physician customers.
The Secrete RF and Juliet Systems require a disposal tip for every procedure similar to our existing truSculpt 3D hand piece. Accompanying the development of this commercial organization, we announced the launch of a new customer support portal called CAMPsite, which provides material to physicians and staff to develop their practices and train personnel.
CAMPsite will also provide internal and external marketing programs to support our physicians' ability to generate patient awareness of new Cutera offerings. 2018 represents Cutera's 20th anniversary, we will be marking this milestone at various events, conferences and symposium starting this weekend at the American Academy of Dermatology.
After two decades of innovation and growth, we feel that we are just now entering the new era of Cutera. The global market for light and energy based esthetic systems continues to grow at a steady pace.
According to global medical esthetics markets analysis, industry revenue is expected to reach $26.5 billion by 2024. Cutera expects to broaden our range of products, 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 CFO.
Sandy Gardiner
Thanks, James. As James stated earlier, we had a record fourth quarter with revenue of $47.6 million, representing 26% growth from the fourth quarter of 2016.
This performance extends our double-digit year-over-year revenue growth to 14 consecutive quarters and is the highest levels in company history. The growth was fueled by North America where our systems revenue grew 35% and international which saw 19% growth.
We experienced revenue growth on both existing and new product lines with enlighten driving existing product growth and truSculpt 3D driving new product growth. Fourth quarter revenues also marked a 25% sequential quarter increase compared to the third quarter of 2017.
Gross margin was 57% in the fourth quarter, 48 basis points lower than the fourth quarter of 2016. Gross margin was impacted primarily by increased warranty costs and investments in our service organization to support our expanding customer base.
We have steadily been investing in the service organization since mid-Q3 2017. This investment includes additional headcount as well as providing the field engineers a greater number of on hand parts to more efficiently support our customers.
The additional headcount under Michael Palumbo’s direction is also focused on the growth of service revenue, largely driven by service contract for systems coming up warranty. We expect higher service revenue in the future quarters, as the service contract sold now will result in future revenue due to the amortization of revenue over the period the services are provided.
In addition, we believe we will begin to leverage these investment in 2018, which will lead to improvements in gross margin in the future. I will now address our operating expense results.
Total operating expenses as a percent of revenue were 48% in the fourth quarter of 2017, this compares to 46% in the fourth quarter of 2016, with an increase mainly driven by higher sales and marketing costs, attributed to new product launches and expansion of our commercial team. In addition, we continue to increase our investments in R&D.
Sales and marketing as a percent of revenue was 32% in the fourth quarter, compared to 31% of revenue in the fourth quarter of 2016. The increase from the prior year quarter represents continued investments in our global commercial channels, including the build out of our new commercial team that is expanding the consumable side of our business, enabling us to gain market share with continued above market revenue growth rate.
Research and development expense increased 20% to $3.5 million or 7% of revenue in the fourth quarter of 2017, compared to $2.9 million or 8% of revenue in the fourth quarter of 2016.As you can see from the recent introductions of Juliet and Secret RF, we continue to expand our portfolio of products to address new and existing markets. We remain committed to investing in engineering and clinical research that drives new product innovation and supports 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 3.9 million in the fourth quarter of 2017 or 8% of revenue, compared to $3 million and the same 8% of revenue in the fourth quarter of 2016.
Operating income was $4.5 million in the quarter, compared to $4.4 million in the same period of 2016. Interest and other income was a $138,000 in the fourth quarter of 2017.
Income tax benefit was $18.2 million in the fourth quarter of 2017. We mentioned to you on our third quarter call that as of September 30, 2017, we had a full valuation allowance against our U.S.
deferred tax assets, due to our recent history of cumulative profits in the U.S., as well as expected future profits we determined that as of December 31, 2017, it is more likely than not that a portion of our U.S. deferred tax assets would be realized for federal and U.S.
states, except California. Therefore, we’ve recorded a new valuation allowance release of $26.3 million, representing significant portion of our valuation allowance against certain U.S.
deferred tax assets. We continue to maintain a full valuation allowance against the net deferred tax assets, primarily relating to the State of California.
The release of the valuation allowance resulted in an income tax benefit in the fourth quarter, partially offset by recording the current tax provision for our U.S. and foreign based operations.
As we enter into 2018, we no longer have a full valuation allowance to offset our tax provision in future periods. As a result in 2018 we expect a combined effective tax rate for our worldwide operations of approximately 10% to 12%, which includes the effect of the decreased corporate federal tax rates resulting from the 2017 tax reform.
Now turning to the tax reform, as you're all well aware the Tax Cuts and Jobs Act was signed into law in late December and became effective on January 1st. We are required to recognize the effect of the tax law changes in the period of enactment, such as remeasuring our U.S.
deferred tax assets and liabilities in accordance with U.S. GAAP.
In the fourth quarter we have recorded a $7.3 million adjustment to our U.S. deferred tax assets, which consist primarily of net operating losses and tax credit carryforwards.
While there are many moving pieces, the key impact to our business is that meaningfully lowers our expected future tax rate. We do not expect the tax reform to significantly impact the cash flow in the near-term.
At December 31, 2017, we had approximately $35 million of federal net operating loss carryforwards, and $21 million of state net operating loss carryforward available to offset future taxable income. We expect to be able to utilize these net operating loss carryforwards in advance of their expiration dates beginning in 2029.
Please note that because of the significant changes into the law, the overall impact of the U.S. tax reform is subject to further analysis as this legislation is interpreted and clarified.
Our GAAP net income for the fourth quarter of 2017 was $22.9 million or $1.57 per diluted share. Non-GAAP adjusted income for the same period was $6.1 million or $0.42 per fully diluted share.
Non-GAAP adjustments include non-cash stock-based compensation, depreciation expense and the release of a significant portion of our valuation allowance against certain U.S. deferred tax assets, partially offset by the revised measurement of the U.S.
deferred tax assets, resulting from the U.S. tax reform.
Now turning to the balance sheet and cash flow, net accounts receivable at the end of the fourth quarter of 2017 were $20.8 million and our DSOs improved 5 days sequentially to 40 days. Inventories were $28.8 million at December 31, 2017, representing a $5.1 million increase from $23.7 million level at September 30, 2017.
The higher inventory level is needed to meet our projected revenue growth plans. Inventories typically turn approximately 4 times per year.
Cash from operations was $6.7 million in the fourth quarter, operating cash flow for the full year 2017 was $14.3 million, up $12.3 million from 2016. Our cash position remained strong, and as of December 31, 2017, we held cash and investments of $35.9 million with no debt, representing approximately $2.66 per outstanding share.
During the fourth quarter of 2017, we repurchased approximately 504,000 shares for a total of $21.4 million at an average price of $42.43 per share. With these repurchases in the quarter, we fully utilized our share repurchase authorization.
Fully diluted shares outstanding were $14.57 million for the three months ended December 31, 2017 and $14.73 million for the year ended December 31, 2017. Turning to guidance for 2018, we expect revenue in the range of $178 million to $181 million, representing an 18% to 20% increase over 2017.
We expect gross margin percentages in the range of 57% to 58% and operating expenses to remain consistent with the 2017 levels in the range of 52% to 54% of revenue as we continue to invest in product development and the scalability of our operation. Lastly, as previously stated, we expect an effective tax rate of approximately 10% to 12%.
This result in an adjusted EBITDA in the range of $15 million to $17 million as compared to $13.2 million in 2017. Non-GAAP net earnings per fully diluted share is expected to be in the range of $1.03 to a $1.11 for the full year 2018, as compared to $0.93 for the full year of 2017.
We have assumed non-cash stock-based compensation between $8 million and $9 million and approximately 50 million weighted average shares outstanding for the full year 2018. I would like to now turn the call back over to James for his closing comments.
James Reinstein
Thanks, Sandy. We are very excited about 2018 and the growth opportunities we have in front of us.
We entered the year with the strongest portfolio of product offerings in the company's history. We have a commercial sales team focused solely on recurring revenue opportunities and the recently expansion of our global service offering.
As our guidance indicates we expect continued year-over-year revenue expansion and market share gains in 2018, as well as increased annual profitability and cash from operations. I would like to thank all of the Cutera team for a strong year in 2017, and the great position we have for us as we enter 2018.
I would now like to turn the call over for questions. Operator?
Operator
Thank you. [Operator Instructions] Our first question is from Jim Sidoti with Sidoti & Company.
Please state your question.
Jim Sidoti
Good afternoon, can you hear me?
James Reinstein
Yes, Jim.
Jim Sidoti
Great. Just going through some of the details in the guidance for 2018.
If I look at 2017, the revenue was weighted toward the back half about 56%, 57% of the revenue came in the back half for the year in 2017, do you expect that to be the same in 2018?
James Reinstein
For the most part, yes, Jim that's generally how grow -- we've been growing quarter-over-quarter consecutively from Q3 to Q4, even though Q3 was our largest quarter on record, we did grow 25% over that quarter in Q4. So it tends to hate to say hockey stick element to it, but it certainly is a second half of the year weighting towards how we’ll rollout the revenue in 2018.
Jim Sidoti
And then can you update us on the status of the hands-free fat removal product and if that is included in the guidance for 2018?
James Reinstein
So we continue to make headway with that, as you know we actually delay the launch of it because of the success we’re having with the truSculpt 3D. So we're basically holding on the launch as well as taking that time to add some features that we think could be game changing.
And we expect to rollout of our product in 2018, probably in second half.
Jim Sidoti
Okay. And is there the significant contribution from that included in the revenue guidance you gave today?
James Reinstein
The contribute -- I mean, we'll be up against the comps of the truSculpt 3D. So, overall we do expect growth, but we are going to be up against the comps of the truSculpt 3D.
However, that assumption of revenue and a pickup of revenue is built into the 2018 guidance for sure.
Jim Sidoti
Okay. And Sandy the $8 million to $9 million of stock-based expense that you have in the non -- you excluded from the non-GAAP guidance.
Is that after tax or before tax?
Sandy Gardiner
That actually is before tax.
Jim Sidoti
Okay. So if I tax effect that it’s about 12% and I assume 15 million shares, so that's about $0.50 of EPS?
Sandy Gardiner
Yes, so that's why we have felt that guiding to a non-GAAP EPS is more appropriate because of the significant moving parts not to mention the tax reform and how that is going to affect us, but also the increase in the stock-based compensation. So, going forward we'd like to provide you with a non-GAAP EPS so it’s better comparable for year-over-year.
Jim Sidoti
Okay. So the metrics you gave for sales and marketing and G&A for 2018, I assume that excluded the stock based expense?
Sandy Gardiner
No, those were actually GAAP, the only two guidance measures that are non-GAAP is the earnings per share and the adjusted EBITDA. The gross margin, as well as operating expense range of 52% to 54% are GAAP measures.
Jim Sidoti
Okay, all right, great. Thank you for clearing that up.
All right, that's it for me. Thank you.
James Reinstein
Thanks, Jim.
Operator
[Operator Instructions] Our next question comes from Anthony Vendetti with Maxim Group. Please proceed with your questions.
Anthony Vendetti
Thanks. Yes, thank you.
I just wanted to talk about the some of the two new products, can you talk about the royalty arrangement or how that's going to work in terms of how you're going to account for it?
James Reinstein
So the arrangements we have with the OEM manufacturers is that we basically import the product to North America at a transfer price. And then we have a gross margin build off of that transfer price.
And essentially it's accounted for as the costs-of-goods.
Anthony Vendetti
Costs-to-goods. And you have exclusive distribution in the U.S., correct?
James Reinstein
In for both products in North America, so U.S., Canada.
Anthony Vendetti
Across North America. Okay, great.
And then just on the picosecond technology or enlighten product. There is a lot of competition in that space.
And we've been hearing over the last several quarters that there has been some price competition. And I was just wondering are you seeing any pricing pressure.
And if not, why do you believe you're not seeing pricing pressure with the enlighten?
James Reinstein
No, we're absolutely seeing far more competitive deals when it comes to the PICO, nanosecond technology. While the overall prices eroded a bit, I can tell you that because of our technology because of our execution out in the field, we have been able to maintain a nice premium versus the -- even on head-to-head competitive deals we've been able to still win the revenue with a higher price sometimes as high as 20%.
Anthony Vendetti
Okay. And then I missed the beginning of the call, I didn’t know if you talked about any sales or what the percentage of your sales this in the fourth quarter were bundled sales, where you sold more than one product into a client.
James Reinstein
We didn't comment on that. And we're -- basically we're estimating it or the number we're looking at is about 20% of our revenue were bundled sales in North America.
Anthony Vendetti
20% bundled. And I thought I caught the end of this, but I know you would hire people internally to build the sales force to help accelerate the build out of the North American sales force.
I was just wondering has that expedited the number of hires in the fourth quarter. How many did you hire in the fourth quarter and what's the year-end goal for 2018?
James Reinstein
So we definitely did hire two what we call internal recruiters. Two individuals that joined the company in the beginning of Q4.
And we were able to add about net nine sales individuals in North America. They're also helping on R&D with the recruiting there as well for our facility here -- our R&D facility here in the headquarters in Brisbane.
And then for the goals for 2018, we're looking to add about a net 12 call it in North America. So growing from 68 to about 80 by the end of 2018.
Anthony Vendetti
Okay, great. I'll hop back in the queue.
Thank you.
James Reinstein
Thanks, Anthony.
Operator
[Operator Instructions] If there are no further questions, I'd like to turn the call back to Mr. James Reinstein for closing comments.
James Reinstein
Thank you very much. And thanks everyone for participating in our call today.
We will be attending a number of investor events in the next few months. And we'll be featuring our new products this weekend in San Diego at the American Academy of Dermatology.
We hope to see you there. Good afternoon and thank you for your continued interest in Cutera.
Operator
This concludes today's conference. You may disconnect your lines at this time.
Thank you for participation and have a wonderful day.