Investment Recommendation
TSO3 reported Q1 results that were slightly below our estimates. Revenue for the quarter was $4.2 million, compared to our forecast of $4.6 million. Although the company did not provide a breakdown of consumables revenue, we do note that gross margin ticked up slightly to 37%, which we believe reflects the increase in higher-margin consumables for the quarter. TSO3 reported adjusted EBITDA of ($1.2 million) in Q1, moderately below our estimate of ($1.0 million). Importantly, total deliveries of VP4 sterilizers to partner Getinge were 36 units during the quarter, in line with our estimate of 35 units. Although the company does not provide updates on installations, management did report record installations in Q1. Moreover, with the European launch gaining momentum, we expect both deliveries and installations to accelerate into the end of the year.
We believe that VP4 has the potential to dominate the low-temperature sterilizer market. For those with a two to three-year time horizon, we believe that fundamentals remain intact and we would recommend investors accumulate the stock at these levels.
Investment Highlights
* Potential for additional expanded claims in 2017. The company believes it is prudent to seek additional expanded claims for individual duodenoscopes, and is working with a leading OEM to gain FDA approval for a specific device. We continue to expect this claim will be granted before the end of the year, which could provide a significant potential catalyst for the stock.
* The potential to be the dominant low-temperature sterilizer on the market. As a larger proportion of medical devices need to be processed using low-temperature sterilization, we believe TSO3 is best positioned to ultimately replace legacy technologies like steam sterilization. This advantage is due to VP4’s larger capacity and ability to process mixed loads relative to competitors, in our view.
* VP4 launch should be steady, but extended claims drive upside to our peak forecasts. Given the long-sales cycle for low-temperature sterilizers, we do not expect the impact of broad extended claims to be felt for a few quarters. However, we believe that the upside potential from this market opportunity is significant.
Estimate Revisions
We have updated our model for the quarter and modestly tweaked our gross margin estimates lower, resulting in a lower adjusted EBITDA loss of ($1.3 million) from ($1.0 million), previously.
Valuation
We value TSO3 based on a DCF model, using an unchanged 13.5% discount rate and 3.0% terminal growth. Based on this analysis, our target remains C$5.25, which represents an annualized forecast return of 71.0% and continues to support our BUY recommendation.
(Estimates Revised - 8 pages)