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<h3 class="head">Cutera, Inc.</h3>
<p><em>Nov 24, 2023</em></p>
<p dir="ltr">Share price $2.1<br />SOI 20m<br />Equity $42m</p>
<p dir="ltr">Cash $180m<br />Notes due 2026 $69m<br />Notes due 2028 $233m<br />Notes due 2029 $116m<br />Leases $12m<br />Net debt $250m</p>
<p dir="ltr">EV $292m </p>
<p dir="ltr"><strong>Writeups</strong></p>
<ol>
<li dir="ltr">
<a href="https://www.valueinvestorsclub.com/idea/CUTERA_INC/6467466826">VIC short writeup 2017</a>
</li>
<li dir="ltr">
<a href="https://www.valueinvestorsclub.com/idea/CUTERA_INC/1453420945#description">VIC long writeup 2023</a>
</li>
<li dir="ltr">
<a href="https://twitter.com/harshvyas04">HV</a>’s long <a href="https://img1.wsimg.com/blobby/go/2ec158c1-dd22-49fe-9f7c-70d930f4fbab/downloads/Cutera%20Inc%2015.10.23.pdf?ver=1699659938752">writeup</a> 2023
</li>
</ol>
<p dir="ltr"><strong>Preface</strong></p>
<p dir="ltr">Howard Marks likes “good company, bad balance sheet” type. I believe Cutera is a “good product, bad everything else” type. It is not a high quality company, quite the opposite. I spent some time thinking about it because the setup is quite interesting at current prices. At the very least, it will be entertaining and educational to watch how the story unfolds within a year or two.</p>
<p dir="ltr">Cutera is a cash burning nanocap with a lot of internal problems and huge amount of debt so there is a good chance of massive dilution or even bankruptcy in the future. However, if the new team manages to turn the ship around, the stock is double or triple within the next two years. This opportunity should be considered a call option on new management execution and thus sized accordingly. </p>
<p dir="ltr"><strong>Picture</strong></p>
<p dir="ltr">Here is the story how I see it. Imagine a character from a movie who is running away from a bad guy on the roof of some building. At some point there is an edge and to survive our hero needs to jump between buildings. After he clears the jump and lands on the roof of building number two there is an even more dangerous guy waiting for him. The chase begins again and there is another edge coming soon which means there needs to be another jump. To add to the heat, the gap between buildings number two and number three is even wider than the first one. Chances to succeed are slim but if our hero clears both jumps he will be safe afterwards.</p>
<p dir="ltr">The first bad guy is self-inflicted mismanagement of the company which resulted in massive cash burn. The first jump is to fix internal problems, reduce the cash burn to manageable levels and eventually turn cashflow positive. The second bad guy, who is more dangerous, is $418m worth of convertible notes of which the first part is due in 2026. The second jump is to increase revenues and cashflow to be able to refinance the debt and support higher interest expenses. The second gap is wider because it is easier to fix things within yourself than it is to change the world around you.</p>
<p dir="ltr"><u>First jump</u></p>
<p dir="ltr">Company had $317m at the beginning of FY2023. If they finish FY2023 with $135m (guided) this will imply a $182m burn. Q32023 cash burn was roughly $45m. According to the CEO, the burn rate in Q42023 and Q12024 will be similar and will improve after that. Also, according to management, the core business losses are around $20m per quarter and the rest come from working capital issues, namely AviClear inventory fulfillment and accounts payable honoring. If guidance turns out to be correct we are left with $90m after Q12024 and an improved cash burn rate of, say, $25m per quarter. With that we exit FY2024 with $15m cash and annualized cash burn rate of $100m. Cutera needs to get revenue of $222m and 45% GM in FY2025 to cover this, which is not impossible - they guided $200m for FY2024. </p>
<p dir="ltr">So, here is your first jump. It will take a lot of work. Cutera already announced $20m annualized savings to be expected next year as a result of new cost cutting initiatives. However, LTM SG&A and R&D were $162m and $24m respectively. Last time R&D with SG&A summed up to $100m was during 2020. Will the fixes in working capital bring home $50m of cash? One would doubt it without running the risk of being called too conservative. This doubt translates very well into price action. A billion dollar plus company (yes, billion) just one and a half year ago brags a market cap of $42m today. </p>
<p dir="ltr"><u>Second jump</u></p>
<p dir="ltr">If the first jump is successful, and it is a big “if”, Cutera will have to face another even bigger problem - the debt. Today, interest expense is approximately $12m per year. Luckily, the first note due in 2026 is the smallest one - $69m. Let’s say the current rate of 2.25% goes up 4 times and we end up with a 9% rate. This will result in a yearly interest expense increase of roughly $5m and totalling $17m. Second note due in 2028 carries a value of $233m. This guy will introduce a much higher burden after refinancing. This means Cutera has 2025, 2026 and 2027 to drastically improve its position, namely increase sales, margins and cash flow. Said improvement will mostly rely on the success of AviClear. Even if core business grows by 10-15% it will simply not be enough to generate enough cash to cover core expenses and serve the debt. </p>
<p dir="ltr">$300m revenue at 50% gross margin results in $150m of gross profit which will likely be the minimum amount in 2028 to cover expenses including higher debt payment and to have some free cash flow. If we assume core business grows 15% from 2024 to 2028 (not a heroic assumption) we’ll need some $80m to come from AviClear. Today, AviClear annual revenue is $16m so a $80m figure is not so distant. </p>
<p dir="ltr">It will be a much easier life if both jumps are cleared. </p>
<p dir="ltr"><strong>AviClear</strong></p>
<p dir="ltr">AviClear is a laser solution for treating acne. The only peer competitor is Accure. AviClear entered the market slightly earlier (6 months or so) so there are more reviews online on AviClear. For example, there is no Accure on Realself yet. On Reddit when people ask about Accure results there are a lot of responses like “I haven’t tried Accure but did try AviClear”. Both solutions are slightly more than a year old so it is too early to draw any deterministic conclusions. For the most part, both solutions do seem to work. </p>
<p dir="ltr">So far there are 1250 AviClear units in the field with 250 of them in the process of being returned due to lack of engagement. At first, the idea was to lease out the AviClear equipment to customers (dermatologists, medspas) for a flat fee and further share revenue for usage. One course of three treatments costs the end user $3k of which Cutera takes half. This business model makes sense but failed to perform. </p>
<p dir="ltr">With a new model, which was announced during the Q32023 call, Cutera wants to sell the equipment instead of leasing it. ASP is $100k but will be offered at a discount to the customers which have the units already in place. By following this model the company will get upfront cash injection for every sale which is good considering the balance sheet situation. However, I honestly doubt this approach will do wonders in the current economic environment. For dermatology owners paying $5k a year and then sharing revenue is almost a risk free option to generate more cash. I don’t see a good argument for purchasing the equipment outright. Cutera generates roughly $2.5m per quarter from per treatment revenue which translates to 3400 users a year or fewer than 3 users per AviClear unit per year. With these numbers no medspa owner is concerned about giving away too much money to Cutera by not buying the equipment outright. </p>
<p dir="ltr">I am very curious to see how this plays out and hope I am wrong about this. </p>
<p dir="ltr"><strong>CEO</strong></p>
<p dir="ltr">Taylor Harris, one might argue, is the only thing that gives hope to investors today. He participated in three successful exits in his previous jobs as CFO. He is still young and has a lot to prove - this is his first role as a CEO. One would think it must feel personal for Taylor to make this situation work because it could be a career making moment. Imagine turning around the company from such a disastrous plight it finds itself in today - what a line to have on your resume! </p>
<p dir="ltr">Taylor bought $300k worth of stock at $10 per share and is deep in red. People, yours truly included, are eagerly waiting to see more of Form 4 filings. </p>
<p dir="ltr"><strong>Valuation</strong></p>
<p dir="ltr">How to value this? No earnings, no EBITDA, no EBIT, no FCF, no BV, no nothing. We can only say it is trading at one fifth of projected 2024 revenue. If by the end of FY2024 Cutera has $15m cash this gets us EV of $445m (42-15+418). We can say that EV is 5x gross profit. If we take our second jump assumptions and get to $300m of revenue and 50% gross margin by 2028 we’ll have around $10m of free cash flow after covering operations and interest expense. That puts you at 4.2x of 2028 FCF. </p>
<p dir="ltr">Ultimately, CUTR is a call option on management execution and company’s survival. If they manage to start generating any FCF in the future a modest 10x multiple will cause the stock to re-rate. But the chances are very slim and the market doesn’t believe in a positive outcome.</p>
<p dir="ltr"><strong>Bad</strong></p>
<p dir="ltr">This is a paragraph to remind us that Cutera is a total disaster today. It has barely managed to make any profit as a public company since 2004. It had a boardroom fight which resulted in lawsuits and no credible management for prolonged time. This absence of leadership further worsened the situation - working capital problems, field service ticket backlog was the highest in company’s history, $8-9m inventory shortfall, being late in 10-Q filing and the product that was supposed to take the company to the next level is being returned due to lack of engagement. Add $418m of debt on top of that. This is not even a full list. No wonder share price plummeted from the highest of $72 to the lowest of $1.5.</p>
<p dir="ltr">All that said, investing is not buying good things, it is buying things well. I think Cutera is a nice call option at this price. </p>
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