ASX:NAN (Nanosonics):Betting on Innovation and FDA Approval to Shift Market Sentiments

Future of Infection Control

Apr 14, 2024

Disclaimer: The information contained within this website and article is not financial advice and reflects my opinion in a strictly personal capacity. I am an engineer by training and profession; I do not possess formal qualifications in finance or investment. I may hold positions in stocks mentioned and hence probably biased. This website and article isn’t writtent to give you advise. I am just using as my online journal to share knowledge and insights and to get feedback - I can’t guarantee the complete accuracy of all content so don’t relie on it. Please conduct your own research or consult a prefessinal financial advisor - I am not the one.

Introduction

Nanosonics is enhancing infection control in healthcare settings through advanced technological solutions. They have developed and commercialized one product (Trophon2 with AuditPro) and one developed and waiting to be approved by FDA and commercialization (Coris) that are setting new standards in the disinfection of medical devices, ensuring patient safety and healthcare efficiency.

Trophon2 is Nanosonics' flagship product, representing an ultrasound probe disinfection “Microwave-like device”.It is an upgrade from the earlier model, the Trophon EPR. It offers an automated, high-level disinfection solution that's swiftly becoming the global standard of care. Trophon2's ability to deliver a sonically-activated hydrogen peroxide mist provides effective disinfection, reaching areas that traditional methods may miss. It's designed to meet stringent infection control standards and can integrate seamlessly into clinical workflows.

In addition to the Trophon2, the company has introduced the AuditPro system, which enhances the value of their disinfection technology by offering an end-to-end digital compliance and traceability solution. While Trophon2 provides the physical disinfection capability, AuditPro complements it by helping healthcare facilities to monitor, record, and manage the disinfection process, ensuring compliance with regulatory standards.

CORIS, the forthcoming product platform, aims to transform the cleaning of flexible endoscopes. This is a critical area as endoscopes are sophisticated devices that require thorough and meticulous cleaning due to their intricate designs and usage in sensitive procedures. Manual cleaning is not only complex but also poses a risk of infection if not done correctly. CORIS technology aims to set a new gold standard in endoscope cleaning by automating the process and ensuring thorough disinfection, potentially overcoming the limitations and challenges of manual cleaning and reprocessing.

These products reflect Nanosonics' commitment to infection prevention and control, with an emphasis on technological innovation, safety, and compliance, positioning the company as a leader in medical device disinfection

How does it make money?

Nanosonics generates revenue primarily through a couple of key streams related to its infection prevention technology:

Capital Equipment Sales: The company sells its medical devices, most notably the Trophon2, which are automated systems for high-level disinfection of ultrasound probes. These capital sales are usually a one-time revenue for each unit sold. ( It could be upgrade from earlier model Trophon EPR and could be along with AuditPro)
Consumables and Accessories: Alongside the capital equipment, Nanosonics sells proprietary consumables that are used with the Trophon devices. These consumables include chemical indicators, disinfectant cartridges, and other items that are necessary for each disinfection cycle. Since these consumables are used regularly and need to be replaced after a certain number of uses, they provide a recurring revenue stream.
Service (Maintenance and Training) : Nanosonics offers service contracts and maintenance for its devices. This can include regular servicing to ensure the equipment is functioning correctly, as well as any necessary repairs or updates.
The company may also generate income from training healthcare professionals on how to use their devices effectively and safely.

The upcoming launch of the CORIS product for automated cleaning of flexible endoscopes is expected to contribute to the company's revenue streams, potentially adding new capital sales, consumables, and service contracts.

This combination of initial equipment sales and ongoing consumable and service revenue provides a balanced revenue model that includes both one-time and recurring income streams, positioning the company for sustainable growth.

Market Opportunity

Trophon2

Nanosonics has a significant market opportunity for their Trophon units globally, with a total potential market of 140,000 units. As of 1H24, Nanosonics has installed 33,550 units, which is about 24% of this total potential market.

Here's a simple breakdown by region:

North America: There's potential for 60,000 Trophon units. Nanosonics has already installed 29,360 units, nearly half (about 49%) of this opportunity.
Europe and the Middle East: The market potential is for 40,000 units. Nanosonics has made a small dent here with 2,090 installed units, representing just over 5% of the market. They've been actively investing in the UK and Germany to grow their presence.
Asia Pacific: The opportunity is also for 40,000 units. Currently, Nanosonics has 2,100 units installed, mostly in Australia and New Zealand (ANZ), which is about 5% of the total Asia Pacific market but covers over 85% of the ANZ market specifically. Investments have been made in expanding into China and Japan.

Now, looking specifically at North America, where Nanosonics has nearly half the market, the question is how much more they can capture. As markets mature and a company captures a large share, growth often slows. Is it what is happening with Nanosonics in North America ? The graph clearly shows a slowing trend in new installations.

However, this slowdown could be influenced by external factors like COVID-19, which affected access to hospitals, and recent hospital capital budgetary pressures, as mentioned by the company's management. These factors may have distorted the growth trend temporarily.

Nanosonics has a strong position in North America, the slowing growth of new installations suggests they may be approaching a saturation point in this region.

Management has been doing all the right things strategically,

Changed the sales channel in North America from Distributor to Direct to increase the gross margin as well to increase penetration to existing hospital ( USA has ~5700 hospital which uses ultrasound extensively and Trophon exists in 70% of these hospitals in at least one department - Direct sale model will increase adoption into other departments of existing trophon using hospital
Recently signed agreement with channel partner agreements to serve Private physician market in OB/GYN and Private Radiology.
Also contemplating about offering rental model ( CAPex to OpEx model) to navigate budgetary pressure

In conclusion, while Nanosonics has a strong position in North America, the slowing growth of new installations suggests they may be approaching a saturation point in this region. Continued growth may depend on their ability to innovate, penetrate less-served markets, and overcome the current budgetary related hurdles

CORIS

What is the issue?

Flexible endoscopes are notoriously difficult to clean due to their intricate designs and frequent use in a variety of procedures, and failure to do so effectively can lead to serious patient safety risks. CORIS is being developed as a response to this pressing healthcare challenge.

It's designed to enhance the automation of the cleaning process, aiming to significantly improve the standard of care for cleaning outcomes. By automating what has traditionally been a manual stage, CORIS seeks to deliver a more consistent, reliable, and verifiable standard of cleaning and There is no alternative available in the market currently.

Is the issue big enough?

Flexible endoscopes is used in various procedures globally. It is an established and growing market based on Nanosonic’s research - 60m procedure annually and growing at around 6% rate. All these procedures are currently being manually cleaned and it cost around US$11 to $37 to clean a single endoscope.
Assuming an average cost of approximately $20 for manually cleaning a single endoscope, the total annual expenditure on manual cleaning alone amounts to a staggering $1.2 billion (USD 1200 million) each year.
The image below shows where these procedures volume coming from and Nanosonic can address majority of these demand based on location.

With such a high cost associated with manual cleaning, the financial and operational incentive for hospitals to switch to an automated solution like CORIS is quite compelling. This does not even take into account the potential reduction in adverse events and improvements in patient safety, which would further strengthen the value proposition of Nanosonics' solution

Management

Nanosonics is now in the hands of professional managers after the retirement of Maurie Stang as Chairman in 2022. they have brought their experience from well-known healthcare firms like Cochlear, GE Healthcare etc. Most of the time I like seeing a founder with enough skin in the game at the helm of things. some investors including myself might be wary because these professional managers don't have as much personal investment in the company as a founder typically would. Although Maurie Stang still hold significant portion of the business roughly around 6% on personal name as well there are some relatives on the register.

Michael Kavanagh, the CEO and President, has been steering the company since October 2013, leveraging his extensive international commercial experience in healthcare and medical devices. His background includes a substantial tenure at Cochlear Ltd, where he played a key role in global marketing for over a decade. He holds roughly 1.2m shares. ( None of these shares are purchased, its all have been collected as part of STI and LTI plans - He does offload some of his holdings time to time - Not necessarily a bad thing but just to keep in mind.)

Nanosonics' financial leadership is in the hands of Jason Burriss, who stepped into the role of Chief Financial Officer in October 2023. His tenure at General Electric (GE) is particularly notable, where he held senior finance roles for 15 years, including a significant position as CFO for GE Healthcare Australia & New Zealand

Steven Sargent, the Non-executive Director and Chairman, who has been with the board since 2016 and took on the role of Chairman in 2022 after the retirement of Maurie Stang . Sargent brings a wealth of knowledge from a distinguished 22-year career at General Electric.

Nanosonics has a policy that requires Non-executive Directors and Executive KMP to have a minimum equity holding equivalent to the previous year’s annual Director fee (including superannuation and excluding committee fees) or base salary.

Balance Sheet

Nanosonics has a very strong and clean balance sheet with close to 120m cash and no debt as well as 28m of investories.

As of 31 December 2023, the total cash and cash equivalents amount to $118,315,000. This total is broken down into three categories:

Cash at bank and on hand: $19,696,000
Deposit on call: $2,644,000
Short term deposits: $95,975,000

Financial Performance

The graph below shows that Nanosonics demonstrating a strong financial performance characterized by year-on-year growth in both revenue and gross profit. This sustained growth indicates the effectiveness of the company’s business model, which encompasses both capital equipment sales and recurring revenue streams from consumables and services.

The consumables segment is particularly lucrative, contributing high-margin revenue, leading to higher incremental profits as sales volume increases. Overall Nanosonics operates in high 70s gross margin.

However, Nanosonics’ reliance on a single product, Trophon, makes R&D investment crucial for diversification and long-term sustainability. The revenues and profits from Trophon are being reinvested to fund these efforts, with the goal of broadening the product portfolio. Coris represents a considerable R&D endeavor that has experienced delays. However, these delays are not uncommon in the device development lifecycle, particularly when targeting FDA approval, which is rigorous and time-consuming.

While revenue and gross profit have seen impressive growth, net profit does not necessarily keep pace due to the high R&D expenditure as can be seen from the graph below. This scenario is typical for companies in growth phases that prioritize market expansion and product development over short-term profitability.

Nanosonics’ strategy underscores a commitment to innovation and long-term value creation, which may not immediately reflect in net profit margins but positions the company for potentially greater success upon the successful launch and adoption of new products like Coris. The following graph shows the management commitment. I am more forgiving because company is funding these expenses from positive cashflow as opposed to keep raising capital.

Outlook for FY24 and Market Sentiment

Management have to downgrade their expectation of FY24 during announcement of 1st half result. The full-year revenue is forecasted to be between $164m and $171m with gross margin range of 76-78% ( essentially, for FY24 there won’t be any growth year on year because of uncertainties related to ongoing budgetary pressures and broader economic conditions. Adapting to these challenges Nanosonics has moderated its expectation for operating expenses growth to 9-11% ( a reduction from the previously expected growth of 17-22%)

The lack of growth forecasted for FY24, coupled with delays in the development and commercialization of CORIS, has dampened investor sentiments lately toward the company and that can be seen in the following graph even though Revenue has increased substantially from 2016 to 2024, but Share price has gone from high of $7-8 to $2.80, questions are raised on Trophon market saturation as well as CORIS commercialization delay.

Valuation

Nanosonics has roughly 303m shares on issue at share price of $2.90 it gives roughly 880m market cap and an enterprise value of $760m.

For $880 million, you get a business that is projected to generate approximately $170 million in revenue in FY24 from its Trophon operations, and it is on the verge of having another product potentially approved by the FDA, which could significantly enhance its value

If we set aside the Coris development for the moment and rely on the management's unaudited profit and loss figures for the Trophon business, we see that it generated a net profit after tax (NPAT) of $32.5 million in FY23 and $18.2 million before tax in FY24. Therefore, the company is currently trading at 27 times the profitability of its Trophon business. Essentially, if you're comfortable with this earnings multiple, then you're effectively getting $118 million in cash and the potential of Coris at no additional cost

But it raises a couple of intriguing questions for anyone interested in the company's future.

Firstly, can the Trophon business continue its growth trajectory, or is it tapping out its market potential? And secondly, how will Coris, assuming it gets FDA approval, shake up the earnings landscape for Nanosonics in the coming years? While FY24 hasn't been all sunshine for Nanosonics, leading to a sizable market cap reduction, some see a glimmer of future potential that could turn the tides. It's a scenario that surely stirs up debate: is Nanosonics poised for a surprise comeback, or is the market's caution justified? The next few chapters in the company's story will be critical in answering these questions. What do you think?