Q3 preview
TSO3 will report Q3 financial results on Tuesday, November 7. Despite a regulatory landscape shifting in favour of TSO3’s technology and a clear need to find better ways to sterilize certain medical devices, we nonetheless believe that the VP4 sales ramp in the third quarter will again be incremental. For the third quarter, we forecast revenue
of $5.7 million (based on an expected 45 units shipped, a sequential increase of 5 units compared to Q2) and adjusted EBITDA loss of ($0.9 million), compared to Street estimates of $5.3 million and ($1.4 million), respectively. During the conference call, we expect management will provide an update on its strategy to ramp production of VP4 in the US.
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
• Catalyst likely pushed out to mid-2018. TSO3 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 now expect an FDA decision by mid-2018 but continue to believe an approval 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 needs 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 several quarters. However, we believe that the upside potential from this market opportunity is immense.
Estimate revisions
With little indication of additional purchase orders from Getinge, and no visibility on installations likely forthcoming, we are lowering our 2017 and 2018 VP4 shipment forecasts ahead of the print. We now forecast a total of 176 units shipped in 2017 (down from 194) and 390 units next year (from 420). As a result, our 2017 revenue and adj. EBITDA forecasts decline from $23.8 million to $21.8 million and ($2.6 million) to ($3.3 million), respectively, in 2017, and from $61.2 million to $57.0 million and $13.8 million to $12.0 million, respectively, in 2018.
Valuation
We value TSO3 based on a DCF model, using an unchanged 13.5% discount rate and 3.0% terminal growth. The impact of our estimate revisions to our valuation is modest. Based on this analysis, our target remains C$5.25, which represents an annualized return of 94.4% and continues to support our BUY recommendation.