ASX:NAN — Company Profile
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Nanosonics manufactures and sells a high level disinfection unit for ultrasound probes, the Trophon EPR, which is increasingly becoming the gold standard for disinfection procedures.
Sales have tripled in recent years as increasing regulatory standards have accelerated the adoption of more rigorous disinfection models. Importantly, there remains a huge global market opportunity, with the company estimating a potential installed base of 120,000 units.
At the end of FY2018, nanosonics had an installed base of 17,740 units, predominantly in the USA (where the market opportunity is estimated to be for around 40,000 units).
The business has a ‘razor and blade’ model, providing it with very ‘sticky’, high margin, recurring revenue thanks to the sale of consumables. As the installed base grows, and as usage increases, the potential here is significant.
The business is has no net debt, plenty of cash, strong sales momentum, a good industry tailwind, market leading positioning and capable & aligned management.
Growth is expected to remain strong as the company consolidates its lead in major markets, moves into new geographies, and expands its technology to service a wider array of disinfection needs.
My market survey of two (2) suggests very good penetration of the market here
Aussie technology at its finest
Being in the healthcare field ive asked around and although our institution owns a nanosonic, it is barely used - meaning minimal purchase of the high margin consumables. This is particularly the case when simple plastic disposable covers or antibacterial wipes will do (unless doing an invasive ultrasound- which is not overly frequent).
Further risk is the new version 2 - which doesnt seem to be much of a benefit for a radiology practice owner. Yes it may mean tracking or auditing cleaning of ultrasound probes is easier, but it doesn’t sound overly cost effective for radiology practices to upgrade? If services don’t upgrade their product and the patent runs out, surely competition will occur and margins will be pressured.
If nanosonics are able to adjust their technology to provide disinfecting for other medical products than that would be a game changer... although this doesnt seem to be the case (yet?)
A new agreement with GE was announced August 2017 (see link). Comes into effect on July 1, 2019 Prior to this, GE was the main sales channel, accounting for a strong majority of sales (over 65% in FY2017) Nanosonics will gain a material increase in sales and margin on consumables in North America
Sales Channels In 2017 they established ‘capital reseller agreements’ with the majority of ultrasound OEMs. After the sale, Nanosonics is responsible for training, maintenance and supply of consumables Established a direct sales operation for Canada in 2017 Has its own direct sales operation in North America Sales partnership with Japanese distributor: http://www.asx.com.au/asxpdf/20170616/pdf/43jzb0qhsp0w8s.pdf
Nanosonics focuses on a MES model in the UK.
Clients pay an “all-inclusive” fee for consumables and get the machine and maintenance included as part of that for a fixed contract period. Nanosonics retains ownership of the Trophon unit.
The advantage is that it helps some clients overcome a capital constraint, which is a major consideration in the UK market.
130 unit placed in UK during FY17
Nanosonics expect the majority of hospitals in the UK to adopt this model
The MES model reduces revenues in the short term even though the long term implication for revenues is that the company is no worse off. Basically, sales are just spread over a longer period.
As of June 2017, had 14,100 Trophon units in operation.
In North America, there is an installed base of 12,400 units across 3,500 facilities (giving an average of 3.5 units per facility).
Ultrasound probes are sterilised by a Trophon unit 40,000 times per day in North America (so each machine is, on average, used 3.2 times per day).
Nanosonics estimates that there is a potential for an installed base of 40,000 units in North America. That is, market could expand by over 3 times
There are 36 NHS trusts in the UK using Trophon
Nanosonicshas a market penetration of 70% in Australia (2017 Results presentation has details -- see link)
As of FY2017 they had a 75% gross margin. That was the same as FY2016, and is a big improvement on previous years (2013 was 57%, 2014 was 65%, 2015 was 69%) -- presumably due to increase consumable sales as a proportion of the total.
Nanosonics just broke even in 2016, with 2017 the first meaningful profit.
Has generated FCF in 2016 & 2017
STI are up to 50% of fixed salary and are paid in cash and shares STI’s measured against sales and PBT (60%) as well as individual performance goals (40%)
LTI are up to 60% of fixed salary and paid in shares LTI’s Revenue and/or EPS as well as TSR against comparator group
His fixed remuneration is $540k
He holds 1.3 million shares, As well as 240k performance rights and 211k options subject to vesting conditions
For the FY ending June 30, 2018, Nanosonice saw an 11% drop in revenue. This was largely due to reseller destocking and customers deferrals ahead of Trophon2 rollout (slated for Q1 FY2019).
Operating costs were up >40% from Q1 to Q4, mainly due to expanded headcount. Combined with the decline in sales, net profit was down 60%. Management said costs will continue to increase, expected to grow to $53m in the current year.
That's prety ugly headline numbers, but the reason for the drop in sales is transitory, and indeed the sales pace should pick up markedly as the new Trophon2 unit is rolled out, new sales resources bear fruit and the replacement cycle starts to kick in (~1/3 of installed base is > 4 years or more old).
Importantly, the installed base continued to grow strongly, albeit at a slower pace than the previous year. Units in operation grew 25% to 17,740 units, with North America up 26% and EMEA up 49% (off a small base, and on a mainly MES model which sees no upfront sales, but far higher consumables revenue).
As such, revenue from consumables was up 25%.
Nanosonics still reckons it has only 15% of the available global market opportunity, and 39% of US. It is also looking to launch "one or more" new products by FY2020.
Going forward, Nanosonics expect strong growth in installed based in UK, 75-100% in current year, with US installed based expected to grow by another 20-25%
Also, the new agreement with GE, which kicks off in July 2019, will see Nanosonics supply consumables direct to customers, and will see a significant uptick in sales and margins at that time.
Finally, the balance sheet remains super strong, with no debt and $69m in cash.
Overall, i still really like this company and do not think the latest results are concerning when looked at in the longer-term context. Nanosonics are fast growing a very high margin recurring revenue stream, and there is a lot of poetntial for expansion. Importantly, it is cash flow positive with oodles of cash. The added costs certainly push back the cash flow profile I had been assuming previously, and I have lowered my valuation to account for this. But these investments should underpin future growth (although i'd revisit my bullishness if this doesnt prove true).
Although shares are above my valuation (at time of posting), i'd need a pretty big premium before i was tempted to sell
Trophon 2 has been granted regulatory approval sooner that expected.
Product will be released during Q1 of FY19. May have some sales and inventory impact short term.
This is certainly good news. Keeps the product set at the forefront of the industry, will continue the expansion of the installed base, makes the offering more compelling from a regulatory compiance standpoint, and shows the company's R&D efforts are yielding (at least some) tangible results.