Brian Marckx, CFA
Q1 2011 Financial Results
SANUWAVE Health (SNWV) announced financial results for the first quarter ending March 31, 2011 on May 16, 2011. Aside from operating expenses coming in about 16% lower than our estimate, results were very much in-line with our expectations. The 10-Q did not include any other surprises. Noteworthy is that SANUWAVE continues to expect to make the final PMA module filing for dermaPACE during the current (Q2) quarter.
Q1 2011 revenue of $252k was slightly ahead of our $210k estimate and represented growth of 76% from Q1 2010. European sales of orthoPACE, which launched overseas in July 2010, were the major reason for the increase in revenue.
Operating expenses were $2.21 million compared to our $2.63 million estimate. R&D and SG&A expense both came in about 16% lower than our estimates. Operating expenses fell 25% from the same period in 2010 mostly as a result of lower R&D expenses related to clinical trials of dermaPACE. We expect operating expenses to edge up throughout 2011 from the Q1 levels.
EPS came in at ($0.14) in Q1 2011, $0.02 ahead of our ($0.16) estimate. EPS improved from ($0.24) posted in Q1 2010.
Cash
Cash used in operating activities was $2.0 million during the three months ending 3/31/2011. Excluding changes in working capital, cash used in operations was $1.7 million.
SANUWAVE exited Q1 with $2.3 million in cash and equivalents but pro forma for $8.5 million net proceeds of the April 2011 private placement of 2.8 million shares of stock, cash balance was approximately $10.8 million.
OUTLOOK
OUR KEY ASSUMPTIONS
• Final PMA Filing: 3rd and final PMA module is filed in Q2 2011
• FDA approval: FDA approval comes in the first half of 2012
• dermaPACE Launch: dermaPACE launch commences in the first half of 2012
• Reimbursement in the Early Years: some regional private insurers provide reimbursement following dermaPACE launch
• Widespread reimbursement: CPT I (relative value) code is established by the end of fiscal 2014, triggering widespread public and private insurance coverage of dermaPACE
• Pipeline: development of the pipeline (for orthoPACE as well as for additional wound indications for dermaPACE) is slow-going until dermaPACE sales begin to ramp
• No Pipeline Contribution: our model (which goes out to 2015) does not incorporate any contribution from any pipeline indications or products
OUR OUTLOOK: Pre dermaPACE Launch
We model relatively little revenue growth prior to the dermaPACE launch. While both dermaPACE and orthoPACE are CE Marked for sale in Europe, we do not expect either to generate much in the way of revenue until well after they enter the U.S. market. Cash operating expenses during 2011 should also remain relatively in-line with the prior year.
For 2011 we model revenue and EPS of $982k and ($0.53), compared to the $728k and ($1.15) posted in 2010. We caution not to read much into our modeled improvement in EPS for 2011 as this is driven mostly by our estimated decrease in non-cash compensation expense, lower (non-cash) loss on extinguishment of debt and a higher share count.
OUR OUTLOOK: Post dermaPACE Launch
We expect the dermaPACE launch to represent the first of two inflection points for SANUWAVE. Prior to gaining Medicare reimbursement, success of dermaPACE will largely be predicated on the degree of interest from private insurers. As the private insurance “majors” typically follow Medicare's lead, SANUWAVE will initially be calling on more regional payers. While we have no specific insight into the degree of formulary coverage that dermaPACE may enjoy in the early years, based on efficacy seen in the top-line results, cost advantages over competing therapies and the potential to leverage relationships built during the Ossatron years, we think it is reasonable dermaPACE can gain some level of reimbursement prior assignment of CPT relative value codes.
We expect revenue growth will likely be somewhat moderate until widespread reimbursement comes on-line (~ 2014?), however. Nonetheless, SANUWAVE's small size and the high margins expected from the procedure kits (eventually approaching 90%), combined with the large size of the DFU market, means positive cash flow and EPS could potentially be attained in short order – and possibly prior to gaining Medicare reimbursement.
We currently model dermaPACE to launch in the U.S. towards the back half of Q2 2012 and for the bulk of our $2.5 million revenue estimate for 2012 to come during the second half of the year. We also model roughly one-half of this $2.5 million in revenue total to come from continued international sales of orthoPACE.
We assume SANUWAVE places just under 70 dermaPACE units through the end of 2012 and utilization (i.e. – patients treated per device) is initially relatively low but increases over time. SANUWAVE could be detailing dermaPACE with a sales force of up to 25 by the end of that year, which is expected to grow to approximately 50 by year-end 2013. As the instrument will be loaned free of charge (with related depreciation running through COGS), revenue (from sale of procedure kits) and profitability will lag growth in the installed base, especially initially. As utilization increases, this lag will narrow and margins should widen. For 2013 we model revenue of $16.6 million which reflects an estimated installed base of approximately 240 units and average utilization per device at about 5 patients per month.
Medicare reimbursement is the second major expected inflection point for SANUWAVE. We currently model this to come sometime during 2014, at which time growth in the installed base and utilization should substantially steepen. Leveraging a greater installed base and the high margins afforded by the procedure kits should result in rapid improvement in cash flow and profitability. We think the installed base grows to about 490 units by year-end 2014 and model revenue and EPS of $56 million and $0.09 in that year. Our 2015 revenue estimate of $117 million represents an installed base of just under 800 units and equals less than 5% of the total expected direct expenditures for DFU treatment by that time – based on what appears to be significant advantages of dermaPACE over other therapies for DFU, our revenue (and EPS) estimates could prove conservative.
To put our revenue estimates into context, (as noted earlier in this report) Dermagraft's sales (entirely U.S.-based) grew from just $9 million in 2007 to $147 million in 2010. Kintetic Concepts' V.A.C product generated $1 billion in U.S. revenue in 2010 (for a variety of wound types, including DFU).
VALUATION / RECOMMENDATION
As Kinetic Concepts (NYSE:KCI) and Smith & Nephew (NYSE:SNN) represent the two publicly traded companies with dominant positions in SANUWAVE's target markets, we use these for comp valuation purposes. We model SNWV to post EPS of $0.42 in 2015 (the second full year of estimated positive EPS and when growth should be more normalized). Based on analyst's five-year growth estimates (2010 to 2015), KCI and SNN are currently valued at approximately 12x and 10x their respective 2015 EPS estimates.
While SNWV's rate of growth should be more normal come 2015, we believe it will still outpace that of both KCI and SNN. We acknowledge the significantly greater inherent risks of an investment in early-stage company such as SANUWAVE with a yet-to-be proven technology for their target application (i.e. – DFU). As such we assign only a slight valuation premium based on the expected higher rate of growth. We value SNWV at $6.00 per share, reflecting approximately 14x our 2015 EPS estimate of $0.42.
As some of these risks (probability of FDA approval, interest from physicians, Medicare reimbursement, etc.) abate, we think SNWV will deserve to trade at an even higher premium. Valuation could also benefit as the viability of SANUWAVE's pipeline becomes more clear. As it is now, our target price is $6.00 / share. Based on the current market price we feel the shares are near fair value and are maintaining our Neutral (HOLD) recommendation on SANUWAVE.
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