Aug 7, 2018
Executives
Matthew Scalo - Head of Investor Relations & Corporate Development James Reinstein - President and CEO Sandy Gardiner - EVP and CFO
Analysts
Anthony Vendetti - Maxim Group
Operator
Greetings, and welcome to the Cutera Second Quarter 2018 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, Matt Scalo. Please go ahead.
Matthew Scalo
Thanks, operator. And welcome to Cutera’s second quarter 2018 Earnings Conference Call.
My name is Matt Scalo, Head of Investor Relations & Corporate Development. And 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 as of current information that is, by its nature, dynamic and subject to change. The forward-looking statements include, among others, statements regarding financial guidance, plans to introduce new products and productivity improvements.
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 and updated in our Form 10-Qs subsequently filed.
Cutera also cautions you not to place undue reliance on forward-looking statements, which speak only as of the date they are 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 alternatives to, the operating performance measured prescribed by GAAP. With that, I will turn the call over to our CEO, James Reinstein.
James Reinstein
Thank you, Matt. Good afternoon, and thanks for joining us today to discuss our second quarter results.
From a revenue perspective, the company performed very well, generating sales of $42.6 million or growth of 17% over second quarter 2017. However, from an operational perspective we have some areas that will require more time than anticipated in order to achieve our gross margin goals.
While our gross margin in the second quarter at 53% did improve sequentially, we did not achieve the results we expected. This was in part as a result of our channel mix shifting more towards international distributors due to our expansion into new markets such as China.
However, the primary impact to gross margin stems from our recent investments made in the service organization as well as other manufacturing process improvements which will take longer to read through on the financials and ultimately result in a planned reduction in our cost of goods. Looking at the second half of 2018, the company’s investment in our global field service team and manufacturing processes will lead to a positive impact on gross margins towards the end of the year and beyond.
Given that our first half gross margin is in the 52% range, we are revising our full year gross margin target range which Sandy will discuss later. Turning back to the topline growth, which continues to be the most compelling part of the Cutera story.
The U.S. sales growth of 16% over Q2 prior year continues to be well above market average which we peg to be at about 9%.
This quarter’s performance reflects continued strong demand in body sculpting with our truSculpt 3D system which grew almost 30% over Q2, 2017. This performance is especially noteworthy considering we launched our next generation system truSculpt iD in July and initiated a limited market release in June.
iD offers hands free functionality and set’s itself apart with excellent clinical results, great patient comfort and a total treatment time in as little as 15 minutes which is approximately seven times faster than the market leader, which is very dramatic in game changing for the market. We believe truSculpt iD will impress customers and their patients with its simple setup, it’s diversity of placement options and the comfortable yet rapid procedure time.
Of course the important factor is the ability of the iD to deliver results that our customers have come to realize with the truSculpt 3D. The combination of all these benefits will result in the patient being able to get in and out of a physician's office in less than 30 minutes, after paying $2000 to $3000 for a highly effective procedure with a high level of patient satisfaction.
We will provide more detail into the truSculpt iD launch at our upcoming investor event on October 9, but I can say truSculpt iD is the biggest launch in the company's history. The sales team is extremely excited to sell this upgraded platform and early user feedback from users in the limited market release has been extremely positive.
We have since launched the iD to the entire North American sales team at a sales meeting in mid-July. It’s a very exciting time, and I look forward to sharing with you the details in October.
To expand upon the revenue story, North American sales in the second quarter were also bolstered by the incremental contribution from the Juliet women's health system, which addresses overall vaginal health and the Secret RF microneedling system which effectively remodels collagen, improves mild wrinkles and diminishes scars. We are pleased with the uptake of both systems and are seeing strong consumable reorder rates for both systems.
We anticipate they will be robust contributors to our growth in 2018 and beyond. Just a brief comment regarding the recent FDA Safety Communication addressing energy based devices and women's health market.
We are not named in the announcement, and we have not received a letter from the agency. Additionally, we are not aware of any adverse events resulting from the use of the Juliet anywhere in the world.
We certainly support any action that helps ensure patient safety. Going forward, Cutera has a robust multifunctional process that reviews our promotional claims and materials to ensure they are truthful, not misleading, fair and balanced and supported by sound scientific evidence.
Taking a look at our consumable product revenue. Revenue from consumable products related to procedures grew 46% year-over-year and accounted for 6% of total sales in the second quarter.
These products include truSculpt systems, the Juliet and the Secret RF platforms, plus the distributed skincare products. Recurring revenue, which includes these products and our service revenue accounted for 17% of total revenue in the second quarter.
Looking at the sales organization, our North American field sales force consists of 74 reps as of July, up from 68 in the first quarter and we remain on track to expand this group to 80 reps by the end of the year. In addition, we are ahead of schedule in building our consumable sales force, with seven onboard now and expect to have approximately 10 reps in total by the end of 2018.
This team will be working with our customers to help build their practices and attract new patients. Turning to International, the second quarter saw robust system growth of 26%, driven across multiple geographies.
EMEA and Asia grew sales 41% and 26% from a year ago period respectively and reflects a shift towards our global distribution network. As I mentioned earlier, we are starting to see meaningful revenue coming from China, where we launched the truSculpt 3D via [ph] our partner there.
Lastly, I'm pleased to announce our new Chief Operating Officer Jason Richey, who joined the company in early July. I have worked with Jason before and have been impressed with his ability to quickly ramp up business performance, particularly in international markets.
Going forward, the international sales organization will be Jason's highest priority. Jason's arrival now completes the new leadership team here at Cutera which is one of my first priorities upon joining the company.
Cutera has attracted excellent talent at all levels, which will surely enable us to take the company to the next level. I would now like to turn the call over to Sandy Gardiner, our CFO.
Sandy Gardiner
Thanks, James. Second quarter revenue was $42.6 million or 17% growth over the second quarter of 2017.
U.S. revenue grew 16% over the year ago period driven by continued strong demand for our truSculpt 3D body sculpting system, the Juliet laser and Secret RF.
International revenue grew 19% versus the second quarter 2017, driven by 26% growth in system sales. Most international regions grew strong double digits with Japan returning to positive momentum in the second quarter.
International sales saw a mix shift towards our distributor network versus our direct channel. Distributors accounted for approximately 65% in international product sales in the second quarter, up from 50% in the year ago period, impacting gross margins.
Distributor growth occurred in existing margins and also reflects expansion into new markets such as China. In the second quarter, recurring revenue, defined as service revenue, plus consumable revenue and skincare sales accounted for approximately 17% of total revenue.
We continue to see consumable revenue growing strong, supported by our expanding dedicated commercial team. The second quarter marked the annual anniversary of the launch of truSculpt 3D, the company's first system with the procedural revenue stream.
In the year ago period since launch, consumable revenue grew 63% in the second quarter of 2018 as compared to the second quarter of 2017. Revenue from consumables will become more meaningful over time as a going percent of our system sold have a consumable revenue stream.
As for the revenue breakdown by customer segment, our core customers comprised of dermatologists and plastic surgeons accounted for approximately 40% consistent with the last few quarters and the launch of truSculpt 3D. We believe this indicates continued strength in our core customer markets along with expansion of our channel reach into non-core physicians.
Moving on to gross margin and operating expenses. Gross margin was 53% in the second quarter or 180 basis points higher than the first quarter, but down approximately 500 basis points from a year ago period.
Gross margins this quarter reflect a sales mix weighted towards our international distributor network as well as lower average system pricing across many of our legacy products. Our infrastructure investments and the timing of realizing operational improvements also affected gross margin.
We do expect to see continued improvement in gross margin in each successive quarter throughout the year. Sales and marketing expense as a percent of revenue was 37% in the second quarter compared to 35% of revenue in the second quarter of 2017.
The increase reflects our expanding global sales channel, including the build out of our commercial consumable team, an investment that will enable us to grow the procedural related revenue over the long term. Non-GAAP sales and marketing expense as a percent of revenue was 33% in the second quarter compared to 34% of revenue in the second quarter 2017.
Non-GAAP adjustments include non-cash stock-based compensation, depreciation and amortization expense. Research and development expense increased 37% to $4.1 million or 10% of revenue in the second quarter of 2018, as compared to 9% of revenue in the second quarter of 2017.
Non-GAAP research and development expense as a percent of revenue was 9% in the second quarter, compared to 7.5% of revenue in the second quarter of 2017. We remain committed to investing in engineering and clinical research that drives new product innovation.
General and administrative expenses were $4.9 million in the second quarter of 2018, or 12% of revenue compared to $3.5 million, or 10% of revenue in the second quarter of 2017. The increase in general administrative expenses in the quarter is primarily a result of additional headcount, non-cash stock-based compensation and the continued investment in the scalability of operations as compared to a year ago.
Non-GAAP general administrative expense as a percent of revenue was 9% in the second quarter compared to the same 9% of revenues in the second quarter of 2017. Operating loss was $2.2 million in the quarter, compared to $1.7 million income in the same period 2017.
Our GAAP net loss for the second quarter of 2018 was $1.6 million, or $0.11 per diluted share. Non-GAAP net income for the same period was $1.8 million or $0.12 per fully diluted share.
Fully diluted weighted shares outstanding used to compute non-GAAP EPS was 14.3 million versus 14.6 million in the year ago period. Turning to the balance sheet and cash flow, net accounts receivable at the end of the second quarter of 2018 was $22.1 million and our DSO improved by five days to 47 days from the first quarter.
Inventories were $30.1 million at June 30, 2018, representing a decrease of approximately $1 million from March 31, 2018 or an inventory turns ratio of 2.7 times versus 2.2 times in the first quarter of 2018. The reduction in inventories was driven by a decrease in raw materials.
As we continue to realize our investments in operational improvements, we also expect continuous improvement in inventory turns. Cash provided by operations was $3.5 million for the second quarter, compared to $7.7 million in the second quarter of 2017.
This change from a year ago was primarily driven by our increased investments in infrastructure and operational efficiencies for long-term scalability resulting in a net loss of $1.2 million as adjusted for non-cash related items as compared to $3.4 million in the second quarter of 2017. Decreased inventory turns, and an increase in accounts receivables also contributed to the reduction year-over-year and cash provided by operations.
The increase in accounts receivable reflects increased sales from our international distribution network. Our cash position remains strong and as of the end of June 30, 2018, we held cash and investments of $29 million with no debt, while working capital was $41.9 million.
Turning to our 2018 guidance. We reiterate our 2018 target revenue range of $178 million to $181 million, representing an 18% to 20% increase over 2017.
With a first half gross margins encountering headwinds from our investments in service and manufacturing for the future, as well as our international sales mix in the second quarter, we are revising our full year 2018 gross margin target to 53% to 54%. We are confident our investments will ultimately improve gross margins, although in a longer timeframe than we had originally anticipated.
We expect continuous improvement in gross margin with each successive quarter throughout the year. We are also expecting operating expenses as a percent of revenue to be in the range of 56% to 57%, an increase from the previous expected range of 52% to 54%.
This increase is largely attributed to additional non-cash stock-based compensation expense, as well as a continue investment in the scalability for the Company for future topline growth. We will also continue to invest in our product pipeline.
We now expect non-cash stock-based compensation of approximately $10 million versus the previous $8 million to $9 million. With the adjustment to gross margin and operating expenses, our new non-GAAP earnings per share is expected to be in the range of $0.50 TO $0.60.
Lastly, adjusted EBITDA is now expected to be in the range of $7.5 million to $9 million. For computing non-GAAP earnings per share and adjusted EBITDA we have assumed approximately $10 million of non-cash stock-based compensation as previously mentioned and annual effective tax rate of 10% to 12% and approximately 14.5 million weighted average shares outstanding for the full year 2018.
I would now like to turn the call over to James for his closing comments.
James Reinstein
Thanks, Sandy. From an operations perspective we have made substantial progress from expanding our global service team to executing on improvement initiatives in areas like manufacturing which we are confident will bring operating efficiencies, resulting in improved gross margin.
Of course there is a lag in when we will see them translate into improved financial metrics and our new gross margin guidance reflects this shift in timeline. We remain focused on improving gross margins and should see continued sequential improvement in the second half and beyond.
Cutera is constantly striving to provide our customers with the most innovative and highest quality products with the premier level of service that enables them to best serve their patients needs. The launch of our NexGen body sculpting system, truSculpt iD is another example of our commitment.
We are very excited about what this system can do for both our customers and their patients, and how it helps position Cutera to more fully penetrate this large and fast-growing body sculpting market. I look forward to sharing more details of our truSculpt iD experience at our Investor Event on October 9.
As the company continues to execute and drive strong double-digit revenue growth in 2018, I expect our gross margins to improve from current levels along with increase profitability and shareholder value. I would now like to open up the call for questions, operator?
Operator
Thank you. We will now be conducting a question and answer session.
[Operator Instructions] Our first question comes from Jonathan Block with Stifel. Please go ahead.
Unidentified Analyst
Hey, guys, it's Dennis on for Jon. Thanks for taking the question.
I guess the first question would be recognizing its kind of still early days at a high-level, could you comment on utilization across truSculpt than maybe utilization for Juliet and Secret RF?
James Reinstein
Sure. Appreciate you joining, Dennis.
I mean the early days from truSculpt, we did do a limited market release on the iD and what's actually pretty amazing is we've already some reorders which as you know or may not know can actually be done right off of the machine using IoT or cellular connection. So even that we placed those in the latter part of June we already have had some reorder of procedures.
And then of course the 3D grew nearly 30% over prior year quarter which was actually the quarter of the launch. So even though we're on the precipice of launching the iD we were still selling a significant amount of the 3D, and that really just speaks to the size growth and overall interest in those body sculpting market.
And the iD really is a step forward for us even beyond what the 3D was doing.
Unidentified Analyst
Great. Thanks for that color.
I guess the other question would be recognizing this year's looks to more of investment year. How do view leverage return in your model either next year or in out years?
Thanks for taking the questions.
Sandy Gardiner
Sure. So this is Sandy.
I think you really hit the nail on the head. That is exactly how we view the share as an investment year.
Now really setting ourselves up for scalability but also well beyond the revenue that we're going to put up this year, so we have mentioned and fully expect to get operating leverage in 2019 and beyond.
Operator
Thank you. Our next question comes from Chris Cooley with Stephens.
Please go ahead.
Chris Cooley
Good afternoon. Thanks for taking the questions.
I apologize in terms of the couple of calls, if you touched on this in your prepared remarks or already in the Q&A, but fairly sizeable reduction the company's CY 2018 earnings here versus your prior expectations? Could you just walk us through, I understand the incremental non-cash stock expense, but just a little more on the gross margin side there?
How much of that is just a function of the mix? And then what is the incremental growth that you assume that you're going to get I guess out of the distributor network going forward did offsets, I'm assuming some softness in the core because but as you've maintained your top line guidance, so just trying to put the various pieces together here when I think about 2018?
Thank you.
James Reinstein
Okay. Yes.
Thanks for the question Chris, and sort of covered a lot of ground there. Let me speak first on the gross margin and some of the specific activities we're doing to address.
We've talked before that we really do need to improve our operational processes if you will and part of that is really looking at the manufacturing floor and the footprint that we got there and quite frankly overall layout as well as that relates to the inventory. We're also initiating and optimizing a contract manufacturing.
We will be implementing regional distribution center so that we can be more efficient as we do tend to close the quarter with significant amount of shipments going out the door. At the end of the quarter it makes sense to have those products already deployed near where we're going to be delivering to the customers for revenue.
And then, as we've talked about before we're still in manual world of processing orders and managing inventory and until we get an ERP system which we kicked off just recently to initiate that process until that ERP system is up and running. That will be next year sometime.
And then, do we do have new leadership and operations, who start at the beginning of Q2 and has brought a significant amount of great ideas and processes -- process ideas that we're going to be implementing over the period of time. So, the reality of it is, this is a matter of when not if with regards to how we achieve this.
And quite frankly the good news is all of this is within our control. This isn't some external forces or government mandate that we cannot control.
These are all activities that are within our bounds. And then with regards to the international we'd always plan to expand into other markets.
Certainly China has come on here recently with solely just with the truSculpt 3D being launched. We also had some good tailwinds from parts of the European distributor network as well.
And so we generally saw good growth across all of the international markets. And that was well within line with what we expected.
Chris Cooley
Okay. Super.
And maybe just two quickies for me and I'll get back in queue. Did you break out the contribution from Paragon in the quarter as I believe or I should say, is that was a new distributor agreement?
So I'm assuming that had to be incremental relative to what you were anticipating for the quarter. And then just for my last question here, can you help us a little bit with the timing of these investments when we think about the flow-through on the OpEx side, do the remainder, is it ratable through the back half of the year or is it skewed more towards one period?
Thank you.
James Reinstein
Okay. Thanks Chris.
I'll take the front end of that question. Paragon, just others on the call are aware that is our partner in China.
They are third-party distributor. We signed up with them in Q4 of last year and this last quarter Q2 was when we really had meaningful revenue coming out of that relationship as expected.
Sandy Gardiner
And then Chris, in regards to your question on the operating expenses, so one of the things I think to note here, we do provide the GAAP to non-GAAP reconciliation because we do think its important for you to be able to compare period-to-period removing all these non-cash items. And so making that statement for Q2 in totality operating expenses were 51% this year versus 50% last year, so only 100 basis points year-over-year.
And with our new operating expense guidance that we are giving and stock-based compensation going up to $10 million from the previous $8 million to $9 million, if you look at non-GAAP for the full year last it was 49% and we are expecting about 50% to 51% total on a non-GAAP basis. So we're talking about 100 to 200 basis points over last year because much of this is non-cash related.
And we'll always see the fourth quarter having a bit larger increase than the third quarter.
Chris Cooley
Thank you.
Operator
[Operator Instructions] Our next question comes from Anthony Vendetti with Maxim Group. Please go ahead.
Anthony Vendetti
Thank you. I was just wondering, James, if you can talk a little bit about the truSculpt iD and I know it was launched in July 16, just little more color on when it started shipping?
And then how you achieve the significantly shorter procedure time, just little bit of the engineering behind that?
James Reinstein
Okay, sure, good question. Thanks Anthony.
So the base technology is the same, its radio frequency. However, we have added a second RF card, so that we're able – and it still two megahertz as it is with the 3D.
But that additional RF card allows us to have two handpieces functioning at the same time. There's a total of six handpieces which again what I would characterize as being anatomically agnostic.
You can essentially put it where you want on the apex of the fat, so you're not bound by the patient's anatomy. And those six handpieces are placed and then two are on at one given time and then it rotates to the next pair and then the next pair and then it goes back to the original pair.
And that basically replicate that glide technique which was so effective in obtaining lipolysis in the truSculpt 3D and we're able to replicate that with the truSculpt iD. Hope that answered your question?
Anthony Vendetti
Yes. And then just on the shipping, do you have enough production that you are able to start shipping and what does the early demand look like at this point?
James Reinstein
So, we did do a limited market release in June and we basically shipped everything we built. And then we've been ramping production since then and we feel very confident that we will be able to meet the demand that the sales team is going to go and generate following the sales meeting, which as I mentioned was mid-July.
And the early indications from the limited market release where we've got some very key physicians, one in particular is Dr. Ian Chap is there in New York City.
He's quoted on our website is extremely impressed with the speed of setup, the time – obviously the time of procedure within the breakdown and then getting the patient in and out of the practices is going to make her facility, her practice that much more productive and then of course that will be true for any type of practice that's using the iD.
Anthony Vendetti
Okay. Then just lastly on the enlighten, excel V, some of the legacy products you mentioned in your press release, a little bit lower than average selling price.
Were you experiencing that on those products or any one specific product?
James Reinstein
Yes. As I've said in the prior quarter calls, the enlighten III PICO second laser has really experienced a pretty significant drop in average selling price and therefore it does impact the gross margin, that has become a very crowded space since the launch of 3D and certainly has impacted the overall ASPs of our legacy product, but if you look to the products that are really dominating and getting the most attention of the sales organization and therefore the market, it is the truSculpt now the iD, the Juliet and the Secret, all of which have recurring revenue stream once they're place, so it becomes a nice annuity.
And the other point I'd like to make with regards to iD. That per procedure revenue we're going to achieve is going to be increasing significantly, more than doubling what we're getting today from the truSculpt 3D.
And with minimum amount of cost because they are going to be purchasing the procedures right off their screen versus doing a handpiece swap.
Anthony Vendetti
Okay. So the second RF card, so what is the total disposable per procedure for truSculpt iD?
James Reinstein
We're not disclosing that for competitive reasons, but what I can say is that the 3D we were getting about $100 per procedure and we're more than doubling that with the iD.
Anthony Vendetti
Okay, great. I'll jump back…
James Reinstein
Okay.
Operator
Thank you. I would like to turn the floor over to James for closing comments.
James Reinstein
Okay. Thank you, operator.
Thanks everyone for participating in our call today in addition to the Investor Day which I mentioned on October 9th in our California facility in Brisbane, California. We will be attending a number of investor events in the next few months and hope to see you there.
Good afternoon and thank you for your continued interest in Cutera.
Operator
This concludes today's teleconference. Thank you for your participation.
You may disconnect your line at this time.