Cutera, Inc. (NASDAQ:CUTR) Q3 2023 Earnings Call Transcript

Cutera, Inc. (NASDAQ:CUTR) Q3 2023 Earnings Call Transcript November 8, 2023

Operator: Welcome to the Cutera Inc. Third Quarter 2023 Business Update Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. [Operator Instructions] I’d now like to turn the call over to Greg Barker, Vice President of Finance and Investor Relations. Please go ahead.

Greg Barker: Great. Thank you, Gailene, and thank you, everyone, for joining us. With me today is Taylor Harris, Cutera’s Chief Executive Officer; and Stuart Drummond, Interim CFO. Following our prepared remarks, we’ll take your questions. 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 information available to us at the time those statements are made, which by its nature is dynamic and subject to change or management good faith belief as of that time with respect to future events.

Forward-looking statements include, among others, statements regarding financial guidance, regulatory approvals, productivity improvements, and plans to introduce new products and expand into additional geographies. 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 Securities and Exchange Commission 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. With that, it is my pleasure to turn the call over to our CEO, Taylor Harris.

Taylor Harris: Thank you, Greg. Good afternoon, and welcome to Cutera’s third quarter 2023 business update call. I’ll begin with an overview of our third quarter financial results and then take you through the actions that can return Cutera to stronger operational and financial performance. Revenue for the third quarter of 2023 was $46.5 million, a decrease of 26% compared to the third quarter of 2022. Revenue related to capital equipment systems declined 36%, while recurring sources of revenue declined 7%. This revenue performance was below what we had projected internally and assumed as part of our previous guidance. Most of the shortfall came from the core capital business where we faced heavier macroeconomic pressures and impact from our company-specific operational challenges than we had anticipated.

As such, we are adjusting our revenue guidance for the full year 2023 to approximately $205 million, down 19% from 2022. We’re planning for tighter financing conditions and the procedural slowdown to persist. We saw these dynamics build over the summer and gain steam through the third quarter. We’re also planning to be disciplined with pricing and distributor inventory levels, leading to less of a year-end bolus than normal. The entire industry is facing the same macro pressures. For Cutera, our business has migrated into more economically sensitive practices over the past few years, which creates more exposure to discretionary spending. The challenges we’ve experienced some service and reliability has dampened our ability to grow and will likely continue to do so during 2024.

I’ll speak later to how we’re addressing these issues. But a reasonable expectation is that it will take some period of time after that improvement for us to win back trust. We are being patient, putting the customer first and adjusting our cost structure as we wait for the macro and company-specific headwinds to pass. Additionally, AviClear, and our entire skin suite portfolio, including excel V+ and Secret, provide us an opportunity to migrate our business mix back to core dermatology practices over time. We finished Q3 with approximately $180 million of cash on the balance sheet, with Q3 cash burn modestly below Q1 and Q2 levels. We burned a little more cash in the quarter than we had planned due to the reduced top line as well as the necessary catch-up of late payments, particularly to critical materials vendors that we depend on as part of our supply chain.

These same dynamics will also affect our Q4 cash burn outlook. Due to an issue identified with inventory control and accounting, we are unable to provide full financial statements today, and we will be late filing our 10-Q. We believe that these issues will lead to the need to restate Q1 and Q2 results, which we will do prior to filing the third quarter 10-Q. Although the near-term challenges that we outlined on the second quarter call have proven to be stronger than we anticipated, there is significant momentum here at Cutera in a positive direction, and our team is excited about our future. We remain focused on 3 critical priorities: returning to operational excellence, building an AviClear franchise and achieving long-term profitability, and we have made strides in each of these areas.

With the combination of improved operational performance, including service and reliability, growth from AviClear and aggressive cost management, which we have already begun, we believe we can bring the business to cash flow breakeven using the cash we currently have on our balance sheet. Our Cutera University Clinical Forum or CUCF, held last weekend in Las Vegas captures what we are capable of. We had over 700 [indiscernible] and I can tidily heard stories of how much these customers love their Cutera devices. These are some of the top practices. They do their homework, and they view Cutera technology as the best hand sound. We used this event to roll out our new branding for the next era of Cutera, which we have named a new energy and aesthetics.

In my opening address at CUCF, I highlighted our vision to provide not only the best technology, but also the best partnership-oriented support for our customers and to help them transfer the energy of our team and technology to create transformative outcomes for their patients. We acknowledge that we have fallen short in the ways we have supported customers in recent years, but we highlighted the strides we are making and we’re committed to more. As one customer remarked to me, you’ve always had great products. If you can get the post-sales support model, right, this company won’t be stoppable. And that is the plan. As we turn to Cutera around, I will continue to update you on the 3 priorities that I outlined on last quarter’s call. I am happy to say that those are still the same priorities and that we are making progress.

First, operational excellence. Before we can return to growth, we must address our operational challenges. Shortly after I started, we brought in Jeff Jones as our Chief Operating Officer, and we consolidated several functions underneath them, including production, supply chain, quality and field service. Jeff has made some critical new hires and he and his team are making strong early progress. The team has identified the key root causes for challenges that we have in 5 areas: product reliability, field service delays, lack of inventory control, supply/demand mismatches and excessive cost of operations. They’ve also put an action plan together that remediates the most critical elements of these issues by the middle of 2024 with ongoing improvement opportunities beyond that point, particularly in the area of cost control.

A few examples. In the area of field service, our backlog of open cases had reached an all-time high as of mid-2023. Over the last few months, though, that backlog has already been reduced by 80% with most of the remaining cases depending on spare parts availability to resolve. The team believes that it can substantially clear this backlog by year-end while also returning to industry-standard response times for new service calls and then to exceed industry standards by the second quarter of 2024. In inventory management, we have assembled a materials control team and a retraining operations personnel on utilization of our ERP system. As Stuart will describe later, we identified a significant issue with how the company has been managing inventory during 2023.

We will conduct another physical inventory count at year-end and plan to fully remediate our challenges by mid-2024. On the cost front, Cutera has been overspending in operations in recent periods due to a lack of process and discipline exacerbated by the stress that the AviClear launch placed on the organization and the supply chain. The company has not had effective processes for either repairing and reusing components to get a return from field service calls or for checking the quality of purchased materials and rejecting those that aren’t usable. We are implementing these processes in the fourth quarter. The company has not done a good job of selecting vendors for certain components, resulting in the purchase of lower quality materials that then need to be scrapped or replaced.

We had moved to outsource production of AviClear and excel V+ but it caused positions that were higher than what we could achieve in-house. We are correcting those decisions and have brought in experienced talent in managing supply chains in the medical device and laser-based aesthetics industry. The operations team also sees significant opportunity to manage better our freight and warehousing expense. In the near term, through Q1 of 2024, these positive operational improvements will actually have an adverse effect on cost of goods and cash burn. By resolving the backlog of service challenges, we are spending more on spare parts and service than we did during the time when service calls were not being addressed. In addition, we still have purchase commitments to vendors for the initial ramp-up of AviClear that will persist into early next year.

However, after we resolve the service backlog and fulfill these AviClear commitments, we should begin to see improvement in cost of goods as well as working capital. Our second key priority is growing the AviClear franchise. As a reminder, we halted new placements of AviClear 3 months ago in order to catch up with demand and to rethink our go-to-market approach. We have done that. And at CUCF, this past weekend, we introduced an enhanced AviClear offering that provides greater flexibility and simplicity when utilizing this innovative first-to-market technology. This new business model offers the option to purchase the device upfront with a corresponding reduction in ongoing treatment costs to the practitioner. Along with greater business model flexibility, we will be offering a hardware and software upgrade that simplifies the user experience, significantly improves product reliability and move filling from a per patient model to paying for individual treatment cycles.

As part of this transition, the AviClear software will no longer require patient-specific QR codes, which have been a source of operational and billing complexity. Instead, customers will be able to purchase packages of treatment cycles, which mirrors the model for Cutera’s truBody platform. This has traditionally worked well both for customers and the company. On the utilization front, we are planning enhanced programmatic support through cooperative marketing and education, including a multi-day university-style training program supported by the company’s clinical training team. The company is beginning a North American limited commercial release in Q4 2023 focused on existing customers, followed by a broader launch in Q1 2024. Additionally, the company will begin an international limited commercial release in select countries starting in Q1 of 2024.

Our third and final priority involves our management of the core business. For this priority, we are solely focused on improving the profitability profile of the business. Given the macro and company-specific headwinds we are facing on the top line, we think that is the right approach for the near term. Specifically, we are focused on ASP management, product mix and cost structure. In October, we initiated a global restructuring program, which will impact all functions and geographies across the company. The goals of this program are to align and structure the external-facing portions of the company’s business to better serve customers, improve communication and coordination and gain operational efficiencies in support of long-term financial health.

The changes made in the organizational restructuring have been carefully planned to ensure that customers will not experience disruptions in the service that they receive. During the end of the fourth quarter, the restructuring program is expected to reduce headcount by close to 25%, resulting in personnel-related savings of over $20 million on an annualized basis. We’re going through a bottoms-up zero-based 2024 budget process for cost of goods and nonpersonnel operating expenses during the month of November. And we are planning on additional belt-tightening activities coming out of that process. We are also focused on pricing and mix. In the third quarter, our ASPs improved relative to the first half of the year. This may have cost us some revenue, but we need to preserve brand integrity and gross margin to allow for profitable growth over time.

We are also putting incentive structures and promotional activities behind our higher-margin product opportunities. And as part of our restructuring, we’re creating more of an emphasis on driving utilization and growth of consumables, both for AviClear and [indiscernible]. I’ll now turn it over to Stuart to provide more detail.

Stuart Drummond: Thanks, Taylor. As Taylor mentioned, revenue for the third quarter of 2023 was $46.5 million, a decrease of 26% compared to the third quarter of 2022. Revenue related to capital equipment systems declined 36%, while recurring sources of revenue declined 7%. Within our skincare and AviClear businesses, we had assumed that revenue would be similar in Q3 compared to Q2. However, our skincare business in Japan declined $3.3 million sequentially, while AviClear revenue was relatively stable. Most revenue shortfall came from the core capital business where we face heavier macroeconomic pressures and impact from a company-specific operational challenges than we had anticipated. We are unable to provide full financial results for the third quarter at this time due to an issue we identified with inventory accounting.

We performed the full physical count at September 30 to assess the effectiveness of our efforts to remediate the inventory-related material weakness disclosed in our 2022 10-K. Unfortunately, this count indicated the value of our inventory on hand was around $8 million to $9 million lower than our recorded value. We’re seeing the process of analyzing these inventory differences line by line. But at this stage, we believe a significant portion of $8 million to $9 million difference released the prior 2023 quarters. We’re still in the process of assessing the impact on prior quarters. After that analysis, assuming the impact is material, we would need to restate our first and second quarter 10-Qs and in file our 10-Q for the third quarter. We believe this process could take up to a few weeks.

As Taylor mentioned, our revised 2023 revenue guidance is approximately $205 million. In terms of our cash outlook, we’re now planning to end the year with approximately $135 million of cash. This is a result of a combination of the reduced revenue and therefore, collections outlook, the corrective actions we are taking with respect to link payments to vendors, and activating the supply chain to meet our spare part needs in order to meet the service needs of our installed base. We anticipate having high levels of spend on materials purchasing through the first quarter of 2024 related to these remediation actions and committed purchase orders with the AviClear supply chain that cannot be canceled. There’s good news here, though, as we get through these cash out fees, we will have an inventory and successful balance that could be leveraged and turned into cash over time.

AviClear is the most notable. By the end of the first quarter of 2024, we will have significant AviClear-related inventory and successive balances on our balance sheet, which should be sufficient for multiple years of supply. What that means is that as we shift to an upfront purchase model, we should have minimal incremental cash costs associated with the capital purchase price of [indiscernible] as we convert both inventory FX asset balances and to cash. Our inventory position for the core capital business will also be in an elevated position, although not at the same degree of AviClear. We should be able to realize working capital improvements as we move through 2024 as we do a better job going forward on matching our supply and demand at the component level and as we do a better job with the materials management processes that we referenced earlier.

AviClear gives us confidence in the adequacy of our cash resources, even assuming continued softness demand. For 2024, we plan for revenue to be below $200 million, and we are building a cost structure and working capital assumptions accordingly. Our key assumptions are that revenue trends for our core capital and consumables business from the second half of 2023 stay intact next year. In other words, we’re not planning for an improvement in the macroeconomic environment. We are also assuming that our skincare business in Japan will go away after the second quarter of 2024 as a manufacturer takes over the distribution business. Offsetting these reductions in revenue should be growth in the AviClear franchise with strong cash conversion dynamics, as Taylor referenced before.

Although we expect next year’s revenue to be below our 2023 level, we anticipate cash flow to be significantly reduced next year due to a combination of the cost reduction activities, reduced one-time expenses and working capital improvements. A meaningful portion of our expected cash burn in 2024 will still be related to one-time outlays, including the AviClear and [indiscernible] for committed purchase orders in the early part of the year as well as nonrecurring expenses such as the retention payments. On a run rate basis, that means we would be entering 2025 to a much more manageable burn rate, which we should be able to further mitigate through growth in AviClear and there’s a continued work down of inventory, allowing for favorable working capital benefits.

With that, I’ll turn the call over to Taylor for closing comments.

Taylor Harris: Thanks, Stuart. I just want to say thank you to the team at Cutera. We’re going through a number of challenges as a company, but we have a great team, which we’ve supplemented recently with some high-caliber new hires, including our COO, Jeff Jones; and Brent Hauser, our President of International, both of whom have significant laser aesthetics industry experience. The team has a lot of energy, and we’re committed to the success of our companies and of our customers and our company. Operator, we’re now ready for the question-and-answer session.

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Q&A Session

Operator: [Operator Instructions] Our first question is from George Sellers with Stephens Inc.

George Sellers: Start on the AviClear commercial strategy and the changes there. Could you give some additional details on maybe what you’re expecting in terms of your existing physician customers? How many are hoping to purchase AviClear, maybe what the breakdown could look like between owned AviClear devices versus the licensed AviClear devices strategy that you have currently? And any details on pricing would be helpful.

Taylor Harris: Sure. So let me start just with the business model and pricing, and then we’ll move into some thoughts around our existing customer base. So on the business model, just to be clear, we’re going to be going to our existing customers and telling them that they have an option. The option is they can stay on the current model, which is a lease model with approximately $500 list price per cycle, so $1,500 for a session of 3 cycles for a patient or they could purchase the device. And on the purchase, if they take that option, then the price per cycle per treatment would go down to a list price of $250. So that starts to get the procedural economics more in line with other products, other procedures in the aesthetics industry.

And with the opportunities that we’re looking at for cooperative marketing additional support, we think that, that will be an attractive option. So that’s the different business model options. Now let’s talk about the existing customer base. So a little too early to give specific numbers on leased versus owned. But if you look at our overall base, we still have about 1,250 devices, AviClear devices in the field. That’s about the same level as at the end of the second quarter. So there were some additional installations, but there were some returns. We already have 200 scheduled returns. And I think it’s possible that up to 50% would end up coming back due to just lack of engagement. And so then you’re left with, call it half of that $250 million — and we’ll see.

I think there will be a mix. It’s not going to be uniform in terms of lease versus purchase. But we think that both options can work for customers. When we did the market research, it would indicate that more customers over time would want to own versus lease. But we’ll let the data speak for itself as we go out to customers.

George Sellers: Okay. That’s really helpful. Thank you for walking through some of those details. And maybe one simple clarifying question for the AviClear devices that are turned I know you have an inventory. When you go out to new customers with those, is there still the option to either purchase or license those devices, or going forward for new customers? Is it primarily just a purchase commercial strategy?

Taylor Harris: Good question. Right now, for new customers, we’re not planning on offering the lease model, but we’re first going to focus on the existing customer base. And so we do have a little bit more time to assess response here. And so open — we’re open-minded about that. But right now, the plan would be just to go forward with the capital purchase model with new sales.

George Sellers: Okay. Great. Thanks for that. And I’ll leave it at those 2 questions back in the queue. Thank you all for the time.

Operator: The next question is from Jon Block with Stifel.

Jonathan Block: Maybe the first one, just to continue with the AviClear [indiscernible]. To the 250 option for the treatment, I don’t know if I missed it, but arguing what would be the company ASP on the capital if the process were to choose that option? And then maybe just to demat a little bit. How do you handle it from a sales rep perspective or driving customers into practices? Because what you might be left with a situation where you drive a customer into a certain practice and the dollars back to Cutera are different to one door versus another door and how you’re able to manage that depending on how the docs select lease versus buy. And then I’ll ask my follow-up.