Earnings Transcript for CUTR - Q3 Fiscal Year 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

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.

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.

Taylor Harris: Sure. So on the capital price, the list price, Jon, is going to be over $100,000. We're not ready to predict what the ASP is going to be. I will say that it's going to be lower in this initial phase where we're going out to existing customers that will be when we go new. And the reason for that is pretty simple. You had customers already buy into their device through lease payments as well as the higher cost treatment sessions. So that's the current thought on the ASP on capital. And then it's a good question on utilization and would there be different incentives. But really, what we know and our team knows that for anyone to be -- any customer to be viable long term, whichever model they're on, they're going to need support, and they're going to need to see utilization of the device. So I think that there -- for the sake of growth, there is going to be the incentive to -- for us to help customers succeed no matter what business model they're under.

Jonathan Block: Good enough. And the second part we're trying to be one of my typical squeeze 2 in the world. But to the first one, I'm pretty sure I heard you on 2024 revenues down versus the revised '23. Maybe just a clarity question. Is that inclusive of skincare or sort of taking skincare out of the equation? I guess I was asking that an all way. And then Taylor, you did a great job laying out the challenges, and I thought you were very transparent about that on what needs to get done. But I mean, it was a lot. And at the same time, you're trying to take down the employee count by 25%. And seemingly, we have a lot of the sales force intact. So your conviction that you can do those 2 things simultaneously, get that longtime of critical things done within the organization, and do it with just a much smaller employee [indiscernible]

Taylor Harris: Absolutely. I'll start on the 2024 revenue. So the revenue does include a stub period of skincare. So just as you think about 2024 relative to '23, skin care will be lower than in '23 and it goes away because it's a partial year, and it goes away after mid-June. With the core business, we're assuming that the business trends from the second half of this year are reflective of the operating environment for next year, which just means you're going to have a difficult comp year-over-year in the first half of next year. So that business would also be down year-over-year. But then we've got AviClear, which we're excited about with our new offering, driving growth. So that's just directionally the way we thought about the different parts of the business. And then John, I got -- I'll tell you on your question regarding the challenges and what at the same time, having a reduced workforce, I feel really good about where the organization is. The -- and this doesn't show up right now in the numbers that we're reporting. But if you could be here, I think you could feel the energy. So the operations team, for example, are -- they're totally committed to getting Cutera back to great operational performance. And that includes the people who have been here for a while as well as some of the new people. So this is a mountain they're ready to go climb. And the same would be true in all other parts of the company. And a lot of what we did in the restructuring was to address some complexities that didn't need to be in our business that created confusion or lack of accountability. So we've consolidated functions, creating a single point of accountability. And I think that there really is a renewed energy because there's clarity of priority and clarity of ownership, and everybody knows that what they do can and will have an impact on the success of the company and we're also really rallying around the success of the customer. So -- yes, it is something that we are keeping our eye on absolutely, but I feel really good about right now.

Operator: The next question is from Margaret Kaczor with William Blair.

Margaret Kaczor: I maybe wanted to start a little bit on the macroeconomic factors that you referenced at the beginning of the call and kind of throughout. I am curious is the slowdown demand that surprised you still coming from the Med-Spa channel? Or is it starting to expand beyond that into [indiscernible]? And then I don't know if I missed this, but was there a U.S. or U.S. split on capital? Sorry if I did miss it.

Taylor Harris: Okay. I'll answer the first part, and then I'll see if Stuart or Greg can chime in if we have that detail yet on your second question. So Margaret, in the third quarter, we saw reduced capital purchasing activity across all segments of the customer base. And I'm hearing from customers that -- of all stripes that they were seeing a procedural or a patient slowdown as well. However, what I would say is that we have shifted our business over time to be about 75% what you might call noncore. In other words, outside of dermatology and plastics. That is largely the Med-Spa channel, but does include other elements. And so we do think that, that is a more economically sensitive portion of the market, and we're more heavily exposed here. Margaret, I think the second question was the capital sales, the split of international in North America. We were down in both North America and internationally. And Greg, just looking to see if we have any numbers for you.

Margaret Kaczor: Sequential... And part of that follow-up on that one.

Greg Barker: Yes, we were done in both -- so we can talk about that in both...

Margaret Kaczor: I wanted to hit the cash burn, it was helpful color both on the call and the front-end comments in the PR. But I think I'm doing the quick math right, where maybe you're assuming a $45 million burn in the fourth quarter. I know there's some onetime restructuring cost in that, but let's call it something like $170-ish million annualized, right? So then you've got the restructuring savings of $20 million annualized. So maybe we're down to $150 million please correct my math, I'm not perfect on that. Now Avis going to be better from a cash flow perspective, but maybe you can bridge back debt by how much? And is there a possibility where that burn can go down to $100 million or less for 2024?

Taylor Harris: Sure. Yes. So to jump to the end of your question, the answer is yes. And just maybe let me give you some color from the third quarter that would be helpful here. So in the third quarter, we burned $43 million of cash. And of that, it was about $20 million that related to the core losses of the business with the remainder being primarily working capital changes, and that's both the buildup of inventory with AviClear primarily, but also with the core as well as this issue that we referenced of being late with our payables and needing to pay that down so that we're being a good partner to our vendors. And that's actually critical as we try to address our inventory and our service parts challenge. We need to be on good terms with our vendors so that we're getting in the parts that we need. So hopefully, what that shows you just from the Q3 analysis is that a substantial part of our burn in 2023 was related to either working capital or nonrecurring items. So just one more comment on this front. Q4 as well as Q1 of next year, we'll have the similar dynamics. But after that, we do believe that we're going to be able to shift into a different load with respect to working capital, where we're able to start working down, AviClear as well as the core inventory positions and will be caught up on our payables. So that's going to be -- that plus the new business model that we have for AviClear should result in more favorable cash dynamics Q2 onward of next year.

Operator: Our next question is from Matthew O'Brien with Piper Sandler.

Matthew O'Brien: This is Samantha on for Matt. Thanks for taking the question. The first one for you, Taylor. Now that you've been there for a few months, I was just wondering are seeing -- could you characterize, I guess, how you are versus your expectations? Are they significantly worse than when you walk through the door?

Taylor Harris: Well, I would say that there is a mix of good and bad relative to -- or favorable-unfavorable relative to expectations, but it skews favorable. And let me just start with that. I think I would go back to the same comments I made earlier, that what really will matter here in the medium and longer term is do we have the right technology and then the right team. And on the technology front, that's always been clear with Cutera. We've got great products. And what I'm even more encouraged about and when I started is the quality and the commitment level of the team, and that who's going to go make this happen. So that is absolutely the overriding since that I have. However, it is -- there are more headwinds facing the business than we realized 3 months ago and certainly than we realized 9 months ago. And those are both in, I'd say, largely in the macroeconomic category, but we have continued to under some fragility in the foundation, processes that were -- that have not been working, miscommunication, and those did get to a breaking point. For example, we identified this inventory management issue that we're going to have to address, but we're taking these in stride. I think we've got the right team to take care of them. So we're going to get through those and then move on with returning the business to growth.

Matthew O'Brien: Great. Thank you for that. I just one more on that inventory issue. Could you just provide a little bit more detail and maybe timing on when you expect that to kind of be solved?

Stuart Drummond: Hi, it's Stuart speaking. Thanks for the question. Yes, so we did account September 30. There are 3 locations covering about 89% of our total inventory. And so the amount we counted was around $8 million to $9 million lower than what would have been recorded in our ERP system. So now we're going through the process of assigning the $8 million to $9 million to prior quarters. So sector there's a material misstatement in previously filed quarterly numbers in 2023. We think about half of that difference we've identified. It relates to a process happening in our ERP system, whereby returns, we're ending up in double docking value. And then the residual balances, there's really a laundry list of individual items that we're still assessing. So we think, to your second question around timing, we indicated it could take up to 3 weeks. That's an estimate. As I say, we need to continue this assessment, and then we need to get our auditors through our assessment as well.

Operator: The next question is from Anthony Vendetti with Maxim Group. [Technical Difficulty]. This concludes the question-and-answer session. I'd like to turn the meeting back over to Taylor Harris for any closing remarks.

Taylor Harris: Great. Thank you. In closing, I would like to thank 2 members of our Board who have recently announced their resignations, Janet Widmann and Juliane Park. Thanks so much to Janet and Juliane for their years of service, Cutera. I think we -- you're leaving us in a good spot. And then to the rest of the team, thanks for all the hard work and dedication. Thanks to everyone for joining us today, and have a good evening.

Operator: This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.