Tim Boreham is one of Australia's best-known small-cap share analysts and business journalists.
Experts
Reflecting on his 10 years as CEO of the medical device play – a milestone achieved last month – Michael Kavanagh says the numbers tell the story.
A decade ago, Nanosonics (ASX:NAN) turned over $14.8 million, two years after its Trophon probe sterilisation device was approved in the US. The company also lost $5.8 million.
Fast forward to 2022-’23 and the company posted $166 million of revenue and made a net profit of just under $20 million.
Kavanagh adds the numbers tell only part of the story.
“The part I’m most proud of is the amazing capabilities we have built into the business,” he says.
“We are one of a handful of labs in the world today (with expertise) in biofilm on medical devices, especially in very small lumens of less than one millimetre in diameter.
“We have had to build capabilities in biosciences, microbiology and chemistry.”
Having Trophon-ized hospitals around the world – especially in the US – Nanosonics is poised to commercialise its second instrument, called Coris (see below).
Based in Sydney, Nanosonics was founded in 2001 by microbiologist Dr Ron Weinberger and engineer Stuart Hodgetts, who were inspired by the need for hospitals to reduce infections caused by poorly-cleaned medical devices.
The first device iteration was the Trophon EPR – as in Enhanced Protection and Reprocessing – which uses hydrogen peroxide vapor to disinfect ultrasound probes much more thoroughly than the old manual methods.
Nanosonics claims the Trophons protect 98,000 patients daily from ultrasound probe cross contamination – or 25 million a year.
Hey! That’s almost the size of Australia’s population.
Nanosonics listed in May 2007, raising $27 million at 50 cents apiece.
The company launched the Trophon EPRs in 2009 and the pimped-up Trophon 2s in 2018.
The US Food and Drug Administration (FDA) approved the Trophons in 2011.
Previous to his decade-long Nanosonics gig, Kavanagh was marketing head honcho at Cochlear.
Another key contributor is Maurie Stang, who chaired the company from 2007 until July last year.
On October 3 this year, long-time chief financial officer McGregor Grant stepped down, in favor of former local GE Healthcare CEO Jason Burriss. Grant has since won a board seat on, and is chair of, device play Impedimed.
A notable recent Nanosonics board addition is Dr Larry Marshall, the sometimes-controversial scientist and entrepreneur who headed CSIRO for more than eight years.
About the size of a microwave, Trophons sanitise probes to certified high level disinfectant (HLD) standards.
The units protect against nasty bugs including drug-resistant bacteria, fungi, blood-borne viruses, venereal diseases and – if anyone still cares – Sars-Cov-2.
The Trophon process takes seven minutes and produces harmless water and oxygen as a byproduct of the disinfectant hydrogen peroxide.
Pre-Trophon, sterilisation standards have ranged from a quick ‘once-over’ with a cloth to a procedure involving an isolating room with dangerous chemicals.
As well as selling (or leasing) the units, Nanosonics also makes money from servicing and consumables. The latter consists mainly of the hydrogen peroxide canisters that are used in the procedure (rather like a dishwasher powder tablet).
In the US, the Trophons were distributed exclusively by GE Healthcare. But this arrangement was revised and the company now mainly sells directly.
Nanosonics continues to grow its base of Trophons – albeit at a slower run rate than pre-pandemic.
“Our customers [hospitals] are experiencing one of the most difficult operating environments for a very long time,” Sargent told last week’s AGM.
“Costs are rising at a faster rate than revenue and governments have increasing budgetary pressures.”
As of June 2023, Nanosonics had an installed base of 32,450 Trophons, up nine per cent for the year and 55 per cent higher than five years ago.
Of these, 28,390 are in the US (up nine per cent). Europe and the Middle East account for a further 2,100 (up 10 per cent) and Asia Pacific (mainly Australia) another 2,050 (up eight per cent).
The full-year accounts show 2,600 newly installed Trophons, down 16 per cent year-on-year.
But there were 1,800 upgrades from Trophon to the bells-and-whistles Trophon 2. These units include enhanced audit features to enable hospitals to keep up with ever-stricter compliance requirements.
A new product, Coris, is intended for flexible probes commonly used in procedures such as colonoscopies, gastroscopies, enteroscopies, endoscopic ultrasounds and bronchoscopies.
They have more fiddly bits than rigid endoscopes and are harder to clean, a process requiring scrubbing and long hours of standing.
As a guide, up to 200 manual actions are required (such as brushing and flushing) to clean the instruments. Because the channels can be one millimetre in diameter, “extensive biofilms” – that is, gunk – remain after cleaning.
Cleaning the probes costs $US11 to $US37 each – more than mere lunch money.
Coris delivers a “novel sonicated mist” that penetrates probe surfaces including the body handle and all crevices, thus reducing the risk of pathogens.
As with the Trophons, the Corises emit harmless oxygen and water.
The company says 60 million endoscopies are done each year in the US, Europe, and Australia, with gastroscopies (especially colonoscopies) accounting for 45 million.
Kavanagh expects Coris to have “at least the same” financial impact as Trophon, although the revenue from capital (equipment) sales are likely to be lower.
That’s because the Corises are placed centrally, rather than at the point of care (as with the Trophons). But the units are likely to be used more, resulting in higher consumables income.
“With Coris we clearly understand the problem and have been able to innovate in a very complex area,” Kavanagh says.
Not for the first time, the FDA recently showed “it’s my way or the highway” by demanding that testing of Nanosonics’ key new product, Coris, be carried out on its shores and not here.
An FDA submission under the agency’s de novo (novel device) route is now expected in the March quarter of 2024.
Kavanagh says the FDA wanted to see more work in relation to “human factors” – that is, ensuring the instrument can be easily used and not misused.
He says the FDA’s demands were a blessing in disguise: “It’s lot better to know [the requirements] before you submit for approval, rather than to have to go back and re-do them.”
Nanosonics is part of the FDA’s Safer Technologies Program (Step), a ‘concierge’ style process to improve communication with the agency and streamline the route to approval.
“The review does not bypass statutory requirements or make it faster, but it certainly helps the cause,” Kavanagh says.
Consolidating its post-pandemic recovery, Nanosonics reported revenue of $166 million, 38 per cent higher, in the year to June 2023.
Net profit surged 431 per cent to $19.9 million. Adjusted to exclude expenditure on growth initiatives, earnings from the existing sales grew 175 per cent to $32.5 million.
At August’s full-year profit, management guided to 15 to 20 per cent revenue growth in 2023-’24.
At last week’s AGM, management declined to update the current-year outlook, given only four months of it had elapsed.
The 2022-’23 research and development bill amounted to $29.5 million, up 32 per cent and attributable mainly to the Coris program.
The R&D spend accounted for 18 per cent of revenue, compared with the industry standard of 12 per cent. But Kavanagh says this proportion will decline as the company matures and grows its revenue.
Capital sales (that is, Trophon units) accounted for 67 per cent of total revenue ($54.2 million, up 44 per cent), with consumables (the cartridges) and service income accounting for the rest (112 million, up 35 per cent).
Over the last 12 months, Nanosonics shares have traded between $3.28 (mid-October 2022) and $5.80 (late April this year).
They peaked at a record $8 in December 2020 and have traded as low as 18 cents (November 2018).
Broker Wilsons’ Nano-watcher Dr Shane Storey says the company’s full-year earnings beat expectations, but the Coris delay announcement was “clearly the biggest disappointment”.
He notes the “ongoing dismay of investors who have long awaited Nanosonics’ second product”.
The firm chalks in a modest $12.8 million of inaugural Coris revenue in the 2025-’26 year.
Dr Storey still rates Nanosonics as “overweight” – which is current stockbroker-marketing-speak for “a buy” – but has downgraded his valuation from $6 to $5.46.
RBC Capital Markets concurs the profit was okay, but lower-than-expected new Trophon sales, the Coris delay and weak guidance were all negatives.
For its two bobs’ worth, Citi rates the stock a sell, with a revised valuation from $4.20 a share to $3.90.
“It remains unclear when markets outside the US will become material,” the firm harrumphs.
Is Nanosonics undervalued?
Kavanagh notes the Trophon business generated a pre-tax profit of $44 million, which means the company would be wildly profitable if it simply stopped investing in new products.
The installed Trophon base is still ticking up and with the average unit now seven years old, more users will be angling for an upgrade.
Management cites an “installed base opportunity” of 140,000 units: 60,000 in the US, 40,000 in Europe/Middle East and 40,000 in Asia Pacific.
If Crucible’s slide rule is correct, Nanosonics has a 23 per cent overall market penetration. But this is skewed by a market share approaching 50 per cent in the US and only five per cent in Europe and the Asia Pacific (albeit with 85 per cent saturation of the Australian market).
Not surpassing, the company is ramping up its sales efforts in the UK, Ireland, and Germany, while it’s got more than a weather eye on the germ-obsessed Japanese market.
One broker opines the company is “catalyst-less” until Coris gets to market – a claim with which Kavanagh can’t agree.
“The growth prospects for the business for Trophon alone are still quite robust and the business continues to evolve,” he says.
As one market luminary – possibly Warren Buffett – once said: the share market is the transfer of wealth from the impatient to the patient.
On that note, Nanosonics’ 15 per cent share slide since its financial results might present an opportunity for the true believers.
The views, information, or opinions expressed in the interviews in this article are solely those of the interviewees and do not represent the views of Stockhead. Stockhead does not provide, endorse or otherwise assume responsibility for any financial product advice contained in this article.
Disclosure: Dr Boreham is not a qualified medical practitioner and does not possess a doctorate of any sort. But he likes to think he posits probing questions while keeping clean at the same time.
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