Cutera (CUTR) Q3 2019 Earnings Call Transcript

Cutera (CUTR -0.51%)
Q3 2019 Earnings Call
Nov 07, 2019, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good afternoon, and welcome to the Cutera third-quarter 2019 earnings conference call. [Operator instructions] Please note, this event is being recorded. I would now like to turn the conference over to Matthew Scalo, vice president of investor relations and corporate development. Mr.

Scalo, please go ahead.

Matthew Scalo -- Vice President of Investor Relations and Corporate Development

Thanks, operator. Welcome to Cutera's third-quarter 2019 earnings conference call. My name is Matt Scalo, Cutera's vice president of investor relations and corporate development. And on the call today we have Dave Mowry, Cutera's chief executive officer; and Jason Richey, Cutera's president.

After the prepared remarks, there will be a question-and-answer session. The discussion today includes 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. Forward-looking statements are based on current information that is, by its nature, dynamic and subject to change.

Forward-looking statements including, among others, statements regarding financial guidance, plans to introduce new products, regulatory approvals 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-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 reconciliations 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 would like to turn the call over to our CEO Dave Mowry.

Dave Mowry -- Chief Executive Officer

Thank you, Matt. Good afternoon, and thank you for joining us today. As Matt mentioned, I'm joined by Jason, who will provide additional details on the company's operational performance during the third quarter before I review our financial performance. I would like to begin the call by congratulating the entire Cutera team for delivering another quarter of strong results, reflecting ongoing execution against our key initiatives.

Since joining the company four months ago, I spent a considerable amount of time listening to and learning from various internal and external stakeholders, including our customers, our employees and our investors. This exercise has improve my understanding of the unmet needs within the energy-based aesthetics space, and provided me with significant insight into the many opportunities to grow and differentiate Cutera in this dynamic market. I would like to share some initial observations. First, as I have previously shared, I'm impressed by the depth of talent, the team's commitment to the energy-based aesthetics market and the collective passion to serve our customers here at Cutera.

Second, we had an amazing cadre of respected and influential clinicians across multiple specialties, who are available and excited to provide insight and guidance to our business. Third, there remains a great opportunity to differentiate ourselves within the industry by providing targeted, innovative and evidence-based technologies as well as superior support and service. We plan to lean on these strengths to establish Cutera as a leader within the energy-based aesthetics market. While I'm confident in our ability to deliver long-term shareholder value, I also recognize the immediate tasks that lie ahead of our company.

We must remain focused on executing our current objectives, which will fuel our commercial growth and improve the overall operational efficiency of the business. These vital few initiatives include, driving continued performance across our body sculpting portfolio through the introduction of innovative products like truSculpt flex, that increase our market share as well as expand the existing customer base. Leveraging previous commercial team investments in key regions to deliver sustained, above-market international growth and then applying these learnings to other geographies. Increasing Cutera's recurring revenue through the expansion of our installed base of platforms that generate per procedure revenue, while also directly engaging and supporting our customers' drive increased patient flow on previously installed systems.

And reducing our material cost and supply chain expenses to enable gross margin expansion and improved profitability over the longer term. While none of these objectives will deliver immediate step-function change to our performance, our execution against these vital few initiatives will continue to deliver incremental, albeit lumpy at times, improvement over the next 18 to 24 months to both our top and bottom line performance. In light of these ongoing efforts, my increased confidence and sustainability of our current performance and the cumulative impact of previous execution, I'm pleased to announce that Cutera is raising its 2019 financial guidance. We expect to deliver revenues in the range of $177 million to $179 million for full year 2019 compared to our previous guidance of $165 million to $175 million.

I will provide greater detail later in the call, but I believe our new guidance accurately reflects the organization's momentum and sets the proper tone as we begin planning for 2020 and beyond. With that, I'd like to turn the call over to our President Jason Richey.

Jason Richey -- President

Thanks, Dave. I'd like to start off by expressing how proud I am of our entire team for delivering another quarter of above-market growth. Third-quarter revenue grew 14% over prior year and was driven by the following factors. First, we continue to gain share in the growing $1 billion body sculpting market.

Total truSculpt revenue, which includes our fat reduction systems, truSculpt 3D and iD as well as our new muscle sculpting system, truSculpt flex, grew 43% over third quarter of 2018. The formal launch of the truSculpt flex in North America in the third quarter was a great start for what we believe to be a truly differentiated platform. Overall customer feedback has been extremely positive. And in many cases, users are now treating patients with a combination treatment using truSculpt iD first followed by truSculpt flex, with very encouraging early results.

These two systems, in combination, provide the clinician with an unmatched suite of body sculpting capabilities. Second, truSculpt procedure-related revenue grew triple digits over prior-year third quarter. As Dave mentioned earlier, we are focused on increasing our recurring revenue streams. One of our objectives is to launch systems that provide access to procedure-related revenues, like our truSculpt family of products and Secret RF, which will advance us toward this goal.

We estimate that approximately 18% of our current active installed base generates consumable revenues, up from 13% at the end of 2018. Our commercial efforts in the third quarter further accelerate this installed base objective with over 50% of systems sold in the quarter providing access to longer-term recurring revenue in the form of consumables. The third factor is our North American sales and leadership team. We continue to see significant progress and improved continuity as this team matures.

We now have the right leaders and the scale-able structure in place, and our financial performance this quarter reflects these improvements. As mentioned on our second-quarter earnings call, we continue to see pricing stability across legacy products from this new leadership team, helping to deliver improved gross margins. In addition to our investment in the sales leadership team, we made investments in building out a practice development team, whose task is to partner with customers to ensure their early success and to assist with sustained improvement of patient flow. These field-based practice development managers are an essential component to our strategy of driving recurring, procedure-related revenues.

And while it's still early, we are pleased with the returns on this investment thus far. The final factor I'd like to outline is our international commercial team, which has demonstrated the value of effective restructuring efforts within the specific reasons we had targeted. Third-quarter results were especially strong in Japan, where our bifurcated sales force continues to drive skin care revenues without distracting our capital equipment and energy-based aesthetic business. We've taken steps to apply some of our learnings from Japan and Australia and New Zealand to our European and Middle East regions, shifting our direct and distributor management structures and strategies.

We remain bullish on our international opportunities as we continue to improve our global commercial team and layer in new products such as truSculpt flex, which we expect to launch during the first half of 2020. We're also pleased with the expansion of our gross margins during the quarter, which improved to 57%. This result reflects a combination of product mix within the systems revenue as well as an increasing percentage of revenue coming from our consumable revenue streams. Additionally, we benefited by favorable geographic mix as our North American team continues to gain momentum and our direct international sales contributed at a higher percentage over prior periods.

In addition to the benefit from product and geographic mix, we had some minor contributions in cost improvement from our supply chain team in the period, making some progress on our key operational improvement initiatives. While we are pleased with our efforts to date, we have a few more quarters before we'll see the full impact of our cost reduction efforts. And now to provide additional details on the company's financials and to outline our increase guidance, I'd like to turn the call back over to Dave.

Dave Mowry -- Chief Executive Officer

Thanks, Jason. As stated earlier, our third-quarter revenue was $46.1 million, up 14% from the same period a year ago. U.S. revenue in the third quarter grew 9% year over year, driven by continued share gains of our truSculpt body sculpting portfolio.

This portfolio now includes the truSculpt flex, which moved into full commercial launch for North America in the third quarter. In addition, we saw solid performance from the Secret RF microneedling system as well as our upgraded vascular laser system, the excel V+, launched earlier this year. The truSculpt portfolio remains strong and generated 43% worldwide revenue growth in the third quarter of 2019. In the third quarter, recurring revenue defined as consumable, service and skin care revenue grew 51% over third-quarter 2018 and accounted for approximately 24% of total third-quarter revenue, up from 18% in the year-ago period.

Recurring revenue growth has shown positive momentum year to date with the continued expansion of installed systems with a per procedure revenue stream and the utilization of those systems as well as our past investments in our Practice Development Management and global service teams. International revenue grew 21% compared to the third-quarter 2018. As mentioned earlier, Japan and Australia drove significant growth in the quarter regarding channel mix, direct sales efforts accounted for 55% of third-quarter international product revenue, compared to 45% in the second quarter and 44% in the year-ago period. As I move into the discussion on our gross margin and operating expense, I'll focus my comments on our adjusted or non-GAAP results to provide insights into the underlying trends in our business.

Please refer to today's press release for a detailed description of the year-on-year changes third quarter GAAP and non-GAAP results. Non-GAAP gross margin was 58% in the third quarter or approximately 350 basis points higher than the year-ago period. The expansion in gross margin mainly reflects the combination of solid total revenue growth, product and channel mix, incremental cost improvements within supply chain and the increased stability in select system selling prices. Moving on to operating expenses, 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 2018.

On a nominal dollars basis, third quarter sales and marketing spend increased approximately $2 million over the year-ago period, reflecting some of the investments in the leadership structure and practice development managers executed in the first quarter of 2019 as well as the increased variable spend associated with the 14% year-over-year revenue growth. Non-GAAP research and development expenses were $3.2 million in the third quarter of 2019. R&D expenses in this business can be a bit lumpy due to the timing of certain development activities, clinical studies and new product introductions. The company remains committed to investing in engineering and clinical research at the current rate.

Non-GAAP general and administrative expense increased to $5.9 million in the third quarter of 2019, compared to $4.4 million in the same period of 2018. Contributors to this sequential change in G&A expense in the third quarter include increased personnel-related expenses, including recruitment costs, legal fees, credit card fees and allowances for doubtful accounts due to higher revenue lever -- levels from a year ago. In addition to customary stock-based compensation, depreciation and amortization expenses, non-GAAP expense also excludes our CRM and ERP implementation costs. Non-GAAP operating income was $2.4 million in the quarter, compared to $1.4 million in the same period of 2018.

Non-GAAP net income for the third quarter of 2019 was approximately $2.2 million or $0.15 per fully diluted share. Fully diluted weighted average shares outstanding used to compute non-GAAP EPS was 14.8 million shares. As mentioned on previous calls, we have a full valuation allowance to offset our tax provisions in future periods. Turning to the balance sheet and cash flow, net accounts receivable at the end of third quarter 2019 were $23.2 million, and our DSOs decreased by one day to 46 days from second-quarter 2019.

Inventories were $34 million at September 30, 2019, representing an increase of approximately $2.7 million from the prior-year period. The key driver of our inventory change is related to the increased levels of finished good. This reflects our efforts to get out in front of demand for the recently launched new products, to level load our production plants in advance of our historical strongest demand period, and the activation of the additional retail distribution center, enabling sustained lower freight expense. Cash used in our operating activities was $2.3 million in the third quarter of 2019, compared to $1.6 million in the third quarter of 2018, reflecting increased inventory levels, partially offset by streamlined supply chain processes and enhanced credit and collections policies.

Our cash position remains strong, and as of September 30, 2019, we held cash and investments of approximately $29.3 million with no debt, and with working capital of $35.9 million. Now turning to our 2019 guidance. We remain focused on continuing to execute our commercial and operational initiatives, which are reflected in our third quarter performance. Considering our overall performance year to date, we are raising our 2019 financial guidance to reflect our continued progress against these initiatives.

Total revenue will be in the range of $177 million to $179 million or growth of approximately 9% to 10% over 2018. We anticipate full year non-GAAP 2019 gross margins to improve over full year non-GAAP level in 2018 as we stabilize our legacy business and begin to see the early benefits of the infrastructure investments. Lastly, 2019 adjusted EBITDA will now be estimated in the range of $3.5 million to $4.5 million, up from prior guidance of $2 million to $4 million. I would be remiss not reiterating my many thanks to the entire Cutera team for their efforts and commitments to delivering results that were reflected in these third quarter performance numbers.

It was truly a team effort. Before I open the call to your questions, I'd like to take a minute to thank Sandy Gardiner, our CFO, for her leadership and support over my first quarter with Cutera. As many of you know, Sandy has decided to move on for personal reasons, and we respect your decision. During her tenure at Cutera, Sandy helped deliver improvements across many internal processes.

Appointed CFO in December of 2017, Sandy's focus has been on strengthening the organization and enhancing our processes. I am thankful for the period of overlap that we did share and wish to thank her for her contributions and wish her great success in future endeavors. And now let's open the call for questions. Operator?

Questions & Answers:

Operator

[Operator instructions] The first question today comes from Chris Cooley with Stephens. Please go ahead.

Chris Cooley -- Stephens Inc. -- Analyst

Good afternoon, and thank you for taking my questions. Congratulations on the continued progress, sir.

Dave Mowry -- Chief Executive Officer

Great. Thanks. Hey, we're -- I'm just going to say we're looking forward to seeing you guys next week at your conference and appreciate your question.

Chris Cooley -- Stephens Inc. -- Analyst

Look forward to seeing you as well. Just two for me, and I'll get back in queue. I guess first, from just a top line perspective, really encouraged by what you were realizing so far to date in the body sculpting segment as a whole. Could you just talk about plans for the continued rollout of flex here in the United States? And maybe help us try and parse the related growth a little bit more there.

How much of this is expansion of the total installed base versus maybe leveraging the existing installed base with now -- with flex as well? And then I have a quick follow-up.

Dave Mowry -- Chief Executive Officer

Yes. It's a great question. Jason, maybe you want to just talk a little bit about the truSculpt flex and your plans.

Jason Richey -- President

Sure. As I -- right now -- Chris, good to hear your question. Right now we are in full market release within North America. We are really encouraged by what we've seen thus far.

Muscle sculpting is pretty hot right now. But it's still early for us in terms of what that looks like long term. The plan is to roll out flex to rest of world, in particular, Europe, Australia, New Zealand and the Middle East in the first half of 2020. We're still waiting to go through the regulatory process there.

But right now we're in full go in North America. So it's early, but so far the response from clinicians has been incredibly encouraging. And one of the things that we didn't totally expect was the fact that many of the physicians that have purchased a truSculpt iD are also utilizing truSculpt flex with the iD. And the preliminary results are quite strong.

So we don't have a clinical protocol on that or anything, but it's just anecdotal information, but really encouraging. And we'll just keep pressing forward and see where we land. But so far, so good. I think we have a nice product.

I think it's differentiated from other products in the market. And there seems to be quite a bit of buzz around that at this point in time.

Chris Cooley -- Stephens Inc. -- Analyst

Agreed. Agreed. There was definitely a buzz at the plastic surgery meeting earlier this year by [Inaudible]. I guess my -- just my other quick follow-up here, I was also pleased to see the progress on recurring revenue, as defined, continuing to increase as a percentage of total sales.

I know you don't have guidance yet for 2020, but I can obviously always ask anyway. So talk to us a little bit about what you think we can see there in terms of continued progress as a percentage of sales, I would assume that would continue to build momentum, as I think you said greater than 50% of the systems sold during the quarter had a consumable component associated with it. But just help me think about, one, how that mix looks over time? And then two, what you think that does to the overall operating profile of the company, maybe from a bigger picture perspective?

Dave Mowry -- Chief Executive Officer

That's a great question. Thanks for that, Chris. I'd like to answer it. First of all, by stating, listen, I think everyone recognizes that body sculpting, in particular, is a big lever for this company, and something that we continue to invest in and drive.

And I think it isn't by mistake or by accident that we find ourselves in the situation we're in. This has been a thoughtful and very focused execution plan that we think has many legs or much legs left in it. That said, we think that the recurring revenue streams, specifically those of consumable, are the things that help boyee this company and inoculate it against some of the economic cycles that typically have been presented. So as a result, it's been a focus for us to continue to move forward and be aggressive in presenting, if you will, promoting those products that have the consumables.

So the results are all kind of expected. We also know that there's a lag between our installed unit. And when we start to see consumables. And that range is depending upon the customers' usage and speed and how fast they ramp.

But we recognize that the installed base that we put in place this year probably hasn't really generated a lot of consumables in this year. And so we're very excited and hopeful that, that will continue to pay dividends in the future, specifically around those consumable products of truSculpt flex, truSculpt iD and Secret RF, which are really some of the leading platforms that we've seen this year.

Operator

The next question comes from Jon Block with Stifel. Please go ahead.

Jon Block -- Stifel Financial Corp. -- Analyst

Thank you, and good afternoon, guys. The first one, you mentioned good pricing trends. It's helping with gross margins recurring as a percent of sales also increasing, aiding gross margins, which are really a solid number in the quarter. So just at a high level, how do we think about gross margins longer term.

At the Analyst Day a year or so ago, there really were a lot of compelling initiatives that you guys talked about and laid out around GM's, I think, procurement, etc. So are those opportunities, they -- are they still there, when we think about gross margin increasing going forward?

Dave Mowry -- Chief Executive Officer

Yes, great question, Jon. So first of all, I think the long-term gross margin is to get into the low to mid-60s. I think this is not an immediate thing. We're not going to get there in the next 12, 18 months.

But we think that -- and we don't believe it to be aspirational. We believe it to be an execution story of what we can work through. Historically, I'd say that the supply chain -- the investments in supply chain, specifically, supplier management and component cost controls haven't really delivered a lot of value here. So you've had a lot of hustling and shuffling of things in order to offset the pricing pressures on the legacy products.

We think we can get out in front of that. We've made some recent investments in some staff. We brought in some folks that I think can help move the needle quickly and aggressively in how we position the products and how we manage our vendors. I think that there's a lot of legs in that improvement.

That being said, there is a constant pricing pressure that we're going to have to outpace. And you do that not only by cost controls, etc., but you also do it by launching new products and shifting mix. And we are benefited by the mix we saw specifically in the quarter, being more heavily driven by some of the newer technologies that we can command price, number one, but have also been designed with a little bit more thoughtfulness around cost.

Jon Block -- Stifel Financial Corp. -- Analyst

Got it. Very helpful. And Jason, this one might be for you. I'm just -- I know it's early, but curious what you're seeing in the field for iD and flex.

And what I mean by that is from a consumer standpoint, is it the same consumer for fat reduction in muscle toning or a different consumer. And maybe more important, from a practice standpoint, are there some practices moving forward with flex that previously just weren't interested in fat reduction because maybe they thought they were late to the game. I would love your thoughts there.

Jason Richey -- President

Yes. We're seeing a little bit of everything, Jon. I would say that most of the customers that are adopting flex earlier customers that also got into the game, either with some form of cryolipolysis device or with truSculpt iD. Both have been very open to the flex technology just because it's a nice complement to the vertical, if you will.

They have something that can treat fat now. They have something that stimulates muscle. And it gives them a more comprehensive approach to drive a patient's desired outcome. In terms of where we go with this? We've been going, obviously, to our installed base, which has been very open to this technology.

But we've also been going into brand-new customers that we haven't been in before. And I think going in there with the technology that's, I would say, dramatically differentiated from the competition in terms of what we can provide with flex, it's really opened the door to quite a few customers that we didn't have access to before. And I would say that the majority -- well, at least 60% of the transactions that we've done are flex or with customers that we've not sold to before.

Dave Mowry -- Chief Executive Officer

Yes. The one thing I would add, by the way, that's a great answer, Jason. I think it's very clear that this is a differentiated technology that people are clamoring for. We just got back from the Cutera University Clinical Forum, which is a meeting that we conduct for customers.

We had about 400 or so, a little bit more than 400 customers together. And we put on a forum where our -- some of our faculty members or key opinion leaders present their cases. And was really telling to me, Jon, was the fact that one of the plastic surgeons that's a panelist, somebody that we don't talk too often, but it was a panelist, was basically promoting the benefit of this paired treatment mentality of using iD with flex in the same procedure setting. So in other words, you'd come in, you get iD and then you'd get flex before you went home.

And the intent was that was not only do you get the benefit of the iD and the benefit that, that creates from a fat reduction, but you get the metabolic rise from flex that would help accelerate further fat reduction and accelerate the results. And now there's no clinical evidence that's been produced or presented at this point. But I can tell you that the photos that he was sharing were pretty compelling and very exciting to us. So it's something we're going to want to continue to explore and then potentially further promote.

Operator

[Operator instructions] The next question comes from Jim Sidoti with Sidoti & Company. Please go ahead.

Jim Sidoti -- Sidoti and Company -- Analyst

Good afternoon. A quick question on the year – fourth-quarter guidance. Just looking at the past few years, revenue between Q3 and Q4 has been up at least $5 million or even a little bit more. If you take the high end of the guidance you provided today, you're looking for about a $3 million rate increase from Q3.

Can you give us a little color on as to why that is?

Dave Mowry -- Chief Executive Officer

Yes. Well, look, Jim, first of all, thanks for the question. I think you know by now that we're being very thoughtful around not getting too far out in front of ourselves. Remember, we just had the launch of flex, and we knew that was going to be a big launch, and we knew that, that was going to hit in the third quarter.

So as we think about that launch, and we think about the timing and the lumpiness of capital sales. We wanted to be very thoughtful and prudent about what may or may not take place in the fourth quarter, knowing that we went so aggressively with that product in the third quarter. That being said, Jason and I think are both very excited about what this product means on a longer-term basis. But listen, in capital business, it's a lot more to do with the timing of launches and availability of product than it is period-over-period.

So we wanted to be thoughtful around that, Jim, and not get too far out in front of ourselves. But we're bullish on the portfolio. We're bullish on the things that Jason mentioned in terms of the North American sales team and the international launches that will be coming as well. So just trying to be thoughtful.

Jim Sidoti -- Sidoti and Company -- Analyst

OK. Yes. No, looking at the inventory increase, it definitely seems you are expecting a pickup in Q4. So I was just a little bit confused about the guidance.

The other question I had -- I'm sorry.

Dave Mowry -- Chief Executive Officer

I just wanted -- if I could, Jim. I just want to make sure I address that comment because part of that inventory is about getting it out into the regional distribution centers that we've established to lower long-term freight costs. And when you forward-stock inventory, you have to build it in advance and place it, which we have taken the advantage of doing in the third quarter to allow us to better level-load our production facilities and not stress them in the fourth-quarter demand or surge.

Jim Sidoti -- Sidoti and Company -- Analyst

OK. All right. And then just the last question for me. Juliet, was that significant at all in the year-ago period.

And I assume it wasn't real material in 2019?

Jason Richey -- President

Yes. I think you're thinking about that the right way. We had -- we definitely had much better sales same quarter previous year. This last quarter, it was not material.

Jim Sidoti -- Sidoti and Company -- Analyst

Can you give us some sense on what the headwind was? Is it over a couple of million or not that much?

Dave Mowry -- Chief Executive Officer

I think you're probably a little bit off on the magnitude there.

Jason Richey -- President

Yes. A little bit less than that.

Operator

This concludes our question-and-answer session. I will now like to turn the conference back over to Dave Mowry for any closing remarks.

Dave Mowry -- Chief Executive Officer

Well, thank you, operator. I just wanted to thank everyone that was on the call today for their continued interest in Cutera. We certainly appreciate your attention and we look forward to providing you with an update on our fourth quarter and full- year results in early 2020. Thank you for your participation.

Have a lovely day.

Operator

[Operator signoff]

Duration: 35 minutes

Call participants:

Matthew Scalo -- Vice President of Investor Relations and Corporate Development

Dave Mowry -- Chief Executive Officer

Jason Richey -- President

Chris Cooley -- Stephens Inc. -- Analyst

Jon Block -- Stifel Financial Corp. -- Analyst

Jim Sidoti -- Sidoti and Company -- Analyst

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