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Cutera (NASDAQ:CUTR)
Q3 2018 Earnings Conference Call
Nov. 6, 2018 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Cutera, Inc. third-quarter 2018 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Matt Scalo, investor relations for Cutera, Inc.

Thank you. Mr. Scalo, you may begin.

Matt Scalo -- Investor Relations

Thanks, operator, and welcome to Cutera's third-quarter 2018 earnings conference call. My name is Matt Scalo, head of Investor Relations and Corporate Development. And on the call today are Cutera's President and CEO James Reinstein and CFO Sandy 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 expectation of certain aspects of the company's future business, including, but not limited to, any financial guidance provided for modeling purposes. The 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 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 section entitled Risk Factors in our Form 10-K as filed with the SEC and updated in our Form 10-Q 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 alternatives to, the operating performance measures prescribed by GAAP. With that, I will turn the call over to our CEO James Reinstein.

James Reinstein -- President and Chief Executive Officer

Thank you, Matt. Good afternoon, and thanks for joining us today to discuss our third-quarter results. We've already issued a release on October 4 and hosted an investor event on October 9. Therefore, my comments today will be abbreviated.

The company reported sales of $40.6 million or growth of 6% over the third quarter of 2017 and represents a year-to-date growth of 13%. The third-quarter performance reflects strong demand in our body sculpting market, with a record launch of our next-generation system, truSculpt iD. At our investor event, one of the leading dermatologists in the United States, Dr. Vic Ross from Scripps, discussed the needs of his practice and how the truSculpt iD provides an ideal solution.

Our next-generation system continues to gather extremely possible user feedback and clear momentum as we continue to penetrate this $1 billion market. North American sales growth in the third quarter was mixed as continued strong demand for our body sculpting systems and the Secret RF microneedling system was offset by the diminished contribution of the Juliet women's health system. We've discussed the impact of the recent FDA communication on the industry, and I want to emphasize that, while we remain firm believers in this market and the longer-term opportunity, we're evaluating best ways for Cutera to position for future success in the women's health market, and we'll keep you updated. It is important to note that our 2018 revenue guidance now incorporates minimal contribution from Juliet in the fourth quarter as we expect the market to remain subdued through the end of the year.

Taking a look at our consumable product revenue. Revenue from consumable products grew 53% year over year and accounted for 6% of total sales in the third quarter. These products include the truSculpt, Juliet and Secret RF platforms, plus the distributed skincare products. Recurring revenue, which includes these products and our service revenue, accounted for 18% of total revenue in the third quarter.

Regarding the sales organizations. Our North American field sales team headcount was essentially flat with the first quarter and down slightly from July. As we've recently mentioned, the North American sales headcount is not at levels that we had expected, but we are in the process of putting in place a new management structure that will better support expansion plans and provide the right environment to scale up. This new structure will be in place on the first of 2019, with the -- but the implementation is occurring now so we can assure our ongoing expansion plans.

Regarding the newly established Practice Development Management team, we expect to have approximately 10 reps by the end of 2018. This team will be working with customers to help build their practices and attract new patients. Turning to international. The third quarter saw a solid growth of 9%, driven broadly across multiple geographies.

Asia, excluding Japan, continues to be a standout as sales grew 25% from the year ago period. We continue to see meaningful growth in China, where we sell the truSculpt 3D via our distribution partner. Overall, third quarter international performance reflected a shift back toward our direct channel versus the second quarter. Overall, gross margin came in at 54%, up 130 basis point sequentially.

Gross margin improvement in the quarter can mainly be attributed to the product mix with truSculpt iD having a positive impact along with early benefits from our ongoing operational improvements. I'd now like to call -- turn the call over to Sandy Gardiner, our CFO.

Sandy Gardiner -- Chief Financial Officer

Thanks, James. Third-quarter revenue was $40.6 million or 6% growth over the third quarter of 2017. U.S. revenue grew 5% over the year-ago period, driven by strong demand for our recently launched truSculpt iD body sculpting system and Secret RF microneedling system.

International revenue grew 9% versus the third quarter of 2017, driven by 16% growth in Europe and 25% growth in Asia, excluding Japan. International sales saw a mix shift back toward our direct channel, which accounted for approximately 44% of the international product sales in the third quarter, up from 35% in the second quarter of 2018. Distributor growth occurred in existing markets and also reflects expansion into new markets such as China. In the third quarter, recurring revenue, defined as service revenue, plus consumable revenue and skincare sales, accounted for approximately 18% of total revenue.

We continue to see consumable revenue growing strong, supported by our expanding dedicated commercial team. Consumable revenue grew 53% in the third quarter of 2018 as compared to the third quarter of 2017. Revenue from consumables will be more meaningful over time as the growing percent of our systems 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 each quarter since the launch of truSculpt 3D in mid-2017. We believe this indicates continued strength in our core customer market along with expansion of our channel reach into noncore physicians. Moving on to gross margin and operating expenses. Gross margin was 54% in the third quarter or 130 basis points higher than the second quarter, but down approximately 430 basis points from the year-ago period.

This sequential improvement mostly reflects product and channel mix with modest, but visible savings generated from our infrastructure investments and early operational improvement activities. Sales and marketing expense as a percent of revenue was 36% in the third quarter compared to 37% of revenue in the second quarter of 2018 and 34% of revenue in the third quarter of 2017. The increase reflects our expanding global sales channel, including the buildout of our commercial consumable team, an investment that will enable us to grow the procedural-related revenue over the longer term. Non-GAAP sales and marketing expense as a percent of revenue was 33% in the third quarter compared to the same 33% of revenue in the third quarter of 2017.

Non-GAAP adjustments include noncash stock-based compensation, depreciation and amortization expense. Research and development expenses declined slightly to $3.2 million from $3.5 million in the third quarter of 2017. Research and development expense on both a GAAP and non-GAAP basis was 8% of revenue in the third quarter compared to 9% of revenue in the third quarter of 2017. We remain committed to investing in engineering and clinical research that drives new product innovation.

General and administrative expenses were $5.2 million in the third quarter of 2018 or 13% of revenue compared to $3.4 million or 9% of revenue in the third quarter of 2017. The increase in general and administrative expense in the quarter is primarily a result of additional headcount earlier in the year, noncash stock-based compensation and the continuing investment in the scalability of our operations as compared to a year ago. Non-GAAP general and administrative expenses as a percent of revenue was 11% in the third quarter compared to 8% of revenue in the third quarter of 2017. Operating loss was $1 million in the quarter compared to $6.2 million income in the same period of 2017.

The third quarter of 2017 included a onetime $4 million benefit related to the termination of the facility lease in Fremont, California. Our GAAP net loss for the third quarter of 2018 was $873,000 or $0.06 per fully diluted share. Non-GAAP net income for the same period was approximately $1.6 million or $0.11 per fully diluted share. Fully diluted weighted average shares outstanding used to compute non-GAAP EPS was 14.3 million versus 14.8 million in the year ago period.

Turning to the balance sheet and cash flow. Net accounts receivable at the end of the third quarter of 2018 was $25.4 million and our DSOs expanded by 9 days to 56 days from the prior quarter. Inventories were $31.3 million at September 30, 2018, representing a slight increase of approximately $1 million from June 30, 2018, or an inventory turns ratio of 2.4 times versus 2.7 times in the second quarter of 2018. This sequential increase in inventory partially reflects preparation activities in front of our seasonally stronger fourth quarter.

Cash used in operations was $1.6 million for the third quarter compared to cash provided by operations of $3.7 million in the third quarter of 2017. The third quarter of 2017 included the onetime $4 million benefit related to the termination of the facility lease in Fremont, California. Excluding the onetime $4 million benefit, cash used by operations in the third quarter of 2017 was approximately $300,000. Increased working capital investments contributed to the year-over-year increase in cash used by operations.

Our cash position remains strong, and as of September 30, 2018, we held cash and investments of $26.9 million with no debt, while working capital remains over $42 million. Turning to our 2018 guidance. We reiterate our 2018 target revenue range of $165 million to $170 million as preannounced on October 4, representing a 9% to 12% increase over 2017. We also reiterate our full-year 2018 gross margin target of 53% to 54%.

We are beginning to see the benefits of our recent investments and should continue to support gross margins in 2019 and beyond. With the revised annual revenue guidance of October 4, we now expect operating expenses as a percent of revenue to be in the range of 57% to 58%. It's important to note the total nominal dollar operating expenses in the third quarter actually decreased due to certain variable costs. For example, we now expect 2018 noncash stock-based compensation of approximately $8 million, down from $10 million due to falling short of our internal 2018 financial targets.

Non-GAAP earnings per diluted share is expected to be in the range of $0.40 to $0.50 and adjusted EBITDA is expected to be in the range of $2 million to $4 million. I would now like to turn the call over to James for his closing comments.

James Reinstein -- President and Chief Executive Officer

Thanks, Sandy. The company continues to make important progress with our operational and proven initiatives. As we demonstrated at our investor event, each of our prioritized activities can move the needle when it comes to our company's longer-term margin structure. Our progress is just beginning to show in our financials.

We remain focused on driving growth, while improving overall margins and expect to see continued improvement as we exit 2018 and beyond. Cutera is constantly striving to provide our customers with the most innovative and highest-quality products with a premier level of service that enables them to best serve their patients. The launch of the next-generation body sculpting system, truSculpt iD, is another example of our commitment. We're 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.

With that, I would like to ask the operator to open up the call for questions. 

Questions and Answers:

Operator

Thank you. [Operator instructions] Our first question comes from the line of Jonathan Block with Stifel. Please proceed with your question.

Denis Edward Kelleher -- Stifel Financial Corp. -- Analyst

Yes, yes. This is Denis on for Jon. Thanks for taking the question. I understand it's early days, but can you speak to any other recent utilization trends you've seen with truSculpt iD? And I've just got another follow-up question.

James Reinstein -- President and Chief Executive Officer

Yes, it's really early. We did have very good shipments in Q3. Certainly, a record over what we've done in the prior-launch quarter for the truSculpt 3D. And some of these units haven't even been installed yet, so it's really very early or too early to, in fact, to be able to report anything on consumption at this point.

I will say the feedback has been very positive, given the fact that this technology really wins on all marks. It's anatomically agnostic. I mean you can put the hand pieces where you want on the pad. You have a very comfortable and fast procedure, 15-minute procedure, and the breakdown time is very, very short as well without any staff work -- post-procedure work required.

And so essentially, the patient can get in and out of the practice in less than 30 minutes. So it's very, very good throughput for the practice and very comfortable and appealing to the patients. So longer term, we do expect that consumables will be very robust.

Denis Edward Kelleher -- Stifel Financial Corp. -- Analyst

Great, thanks. That's helpful color. And stepping back to body sculpting market at large. In the first half of the year, we tracked CoolSculpting grew over 30% in the U.S., then growth took a step back in the third quarter, a pretty step back.

Do you expect this step back is due to iD interaction? Or do you -- or would you think it's more attributable to other technologies getting mind share? Thanks for taking the questions.

James Reinstein -- President and Chief Executive Officer

Sure, no problem. It will be hard for me to comment on what happened with CoolSculpting and their growth. A lot of it has to do with what comparable they were up against, timing of their M&A transaction and the acquisition of ZELTIQ. So it's really hard to -- for me to make comment on that.

I will say that we were up some -- up against some pretty tough comparables as we launched truSculpt 3D in mid-2017, and we're still able to see some growth. So we're very confident, very comfortable with our growth rates and pleased with the outcome, and what a great job the sales organization is doing. Thanks for the question.

Operator

Our next question comes from the line of Jim Sidoti from Sidoti & Company. Please proceed with your question.

Jim Sidoti -- Sidoti & Company -- Analyst

Good morning. Can you hear me?

James Reinstein -- President and Chief Executive Officer

Yes. Hi, Jim.

Jim Sidoti -- Sidoti & Company -- Analyst

Sorry. Good afternoon. It's been a long day. Can you give us any sense on how body sculpting sales did relative to a year ago? And even though I know a year ago was the launch of the truSculpt 3D system, which is a pretty strong quarter.

James Reinstein -- President and Chief Executive Officer

Yes. So again, we were up against the comparable of a big launch. Now the second biggest launch in company's history was the truSculpt 3D and now the biggest is the iD. And still we grew over 20%.

So we're, as I was saying earlier, very, very pleased with the performance of the sales organization. And with this product, customers are responding extremely well to what this product offers them and their patients.

Jim Sidoti -- Sidoti & Company -- Analyst

All right. Based on your guidance, you're looking for a reasonable step up in the fourth quarter. Is there any concerns with capacity at this point? Or do you think you're all set for the pickup in demand?

James Reinstein -- President and Chief Executive Officer

No, we've made a number of improvements within our operations, manufacturing, floor layout, going to assembly line, particularly for truSculpt iD. So -- and we did have a slight build up as you saw in our uptick on finished goods in preparation for Q4. So we're confident that we're going to have everything that the team is ready to get -- bring in orders for and us to get out the door.

Jim Sidoti -- Sidoti & Company -- Analyst

OK. And with regard to the size of the sales force, I know you no longer expect to hit that 80 number. Can you give us a new target?

James Reinstein -- President and Chief Executive Officer

We're going to do everything we can to get to that 80 number. So the expectation is, we'll get as close as possible to that. So mid-70s would probably be somewhere we would land with the idea that we're going to bring in as many folks as we can. And then, as I said in my prepared remarks, as we are going to change the structure of the sales management organization, we basically had doubled the sales organization with the same number of managers and these are the -- this is the team that does the recruiting, the onboarding, the accountability management, and so we've -- we will expand the number of managers we have in order to basically have the structure in place to grow the overall sales organization for not only in 2019, but beyond.

Jim Sidoti -- Sidoti & Company -- Analyst

And do you still expect to add 10 salespeople for the consumables? Or has that changed with the recent FDA warning letter on the women's health issues?

James Reinstein -- President and Chief Executive Officer

No. We started the hiring of these practice development managers in early part of the year, early 2018, with the anticipation of the truSculpt iD launch. Obviously, Juliet is one of the products that they're involved in and driving consumables on, but it's also Secret iD or Secret RF as well as the truSculpt iD and even the 3D handpieces prior to that. So we will continue to grow that organization.

We continue to have good expectation as to what our percentage of revenue will be derived from consumables. And so, therefore, that team will continue to grow. We'll get to the 10 about -- or about 10 for this year and continue to grow it into 2019.

Jim Sidoti -- Sidoti & Company -- Analyst

OK. Thank you.

James Reinstein -- President and Chief Executive Officer

Thanks, Jim, for the questions.

Operator

[Operator instructions] Our next question comes from the line of Alexander Scharf with Maxim Group. Please proceed with your question.

Alexander Scharf -- Maxim Group -- Analyst

Hi. This is Alex on for Anthony Vendetti. James, you've talked a little bit about having product launches every year, two -- at least two product launches per year. Can you give any sort of indication of what you're planning for 2019? Would those be upgrades or completely new products or anything -- any sort of color you can give around that?

James Reinstein -- President and Chief Executive Officer

Yes. So what we've said at our investor event on October 9 is that, there's a portfolio of projects that we're managing. Some are going to be iterations on existing legacy products, some are going to be movement into an adjacent space and then some are going to be first movers, so I mean that they hit as currently planned. And so as we look out at our portfolio of projects and what we're going to be launching, it will be two or more every year.

And we're not going more specific than to say that that's what we're going to do. So it will be one of those three categories or two of those three categories that I just mentioned, either iterating on existing technology or systems, moving into adjacent space or like I said, first mover, but like we said, managing it as a portfolio of projects.

Alexander Scharf -- Maxim Group -- Analyst

Got it, got it. And then in terms of your long-term guidance, $350 million of revenue in 2021. Can you just talk a little bit about how you plan to get there? And what you need to execute to hit that, I guess, doubling of revenue over the next three years?

James Reinstein -- President and Chief Executive Officer

Yes. So if you look at where -- when we first laid out this plan, the 3-4-5 Plan, it contemplated growing -- tripling the revenue in five years from where we were in 2016. And our CAGR over the last year is in the mid-20% range -- or the last two years, sorry, from year-to-date basis. And so we're going to have to step it up in the next couple of years in order to achieve that.

Again, we'll do that both from organic, and we'll also look at what we may need to do externally as well.

Alexander Scharf -- Maxim Group -- Analyst

Great. Thanks for taking the questions.

James Reinstein -- President and Chief Executive Officer

Yes. Thank you for your interest.

Operator

There are no other questions in the queue. I'd like to hand the call back to management for closing comments.

James Reinstein -- President and Chief Executive Officer

Well, thanks, everyone, for joining and participating in the call today. Both myself and Sandy will be participating in a number of investor conferences in November, and we hope we have the opportunity to see you and chat with you there. With that, we'll bid you a good afternoon, and thank you for your continued interest in Cutera.

Operator

[Operator signoff]

Duration: 33 minutes

Call Participants:

Matt Scalo -- Investor Relations

James Reinstein -- President and Chief Executive Officer

Sandy Gardiner -- Chief Financial Officer

Denis Edward Kelleher -- Stifel Financial Corp. -- Analyst

Jim Sidoti -- Sidoti & Company -- Analyst

Alexander Scharf -- Maxim Group -- Analyst

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