SANUWAVE Health (OTCQB:SNWV) announced financial results for the third quarter, ending September 30, 2011, on November 14. Similar to the prior two quarters, results were again very much in-line with our estimates, and there were no surprises in the press release or 10-Q (filed the same day).
Revenue came in at $162,000 compared to our $240,000 estimate. This miss on revenue is immaterial, both from a current financial perspective as well as a fundamental investment perspective, as 100% of current revenue comes from sales of SANUWAVE's orthoPACE device in Europe, while dermaPACE is expected to the catalyst driving SANUWAVE's revenue for the long-term (we model dermaPACE to launch in the U.S. in the Q2/Q3 2012 time frame). While sales of orthoPACE represent approximately 50% of our $2.5 million 2012 revenue estimate, orthoPACE accounts for less than 3% of our revenue estimate ($55.9 million) in 2014.
Operating expenses in Q3 were $2.19 million, about 11% lower than our estimated $2.48 million due to lower than modeled R&D expenses ($623,000 A vs. $955,000 E).
Q3 EPS was ($0.10), a penny ahead of our ($0.11) estimate, mostly a result of the lower operating expenses.
Cash used in operations was $1.99 million during the three months ending September 30, 2011. Excluding changes in working capital, cash used in operations was $1.74 million, down from $2.04 million in Q2 and almost identical to the $1.74 million used in Q1 of this year.
SANUWAVE exited Q3 with $5.78 million in cash and equivalents.
Outlook: Our Key Assumptions
- Final PMA Filing: Filed July 2011 - in-line with our expectations
- FDA approval: FDA approval comes in the first half of 2012
- dermaPACE Launch: dermaPACE launch commences in Q2/Q3 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
Outlook: Ahead Of 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.
For 2011 we model revenue and EPS of $782,000 and ($0.54), compared to the $728,000 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.
Outlook: After 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, however, until widespread reimbursement comes on-line (around 2014?). 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. around Q2/Q3 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, Dermagraft's sales (entirely U.S.-based) grew from just $9 million in 2007 to $147 million in 2010. KCI's V.A.C product generated $1 billion in U.S. revenue in 2010, for a variety of wound types, including DFU.
Valuation and Recommendation
As Smith & Nephew (SNN) and Kinetic Concepts (prior to it being acquired in November 2011) represented the only two publicly traded companies with a dominant position 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), SNN is currently valued at approximately 9x its 2015 EPS estimates. Kinetic Concepts was acquired for $6.1 billion, or roughly 13x its estimated 2015 earnings.
While SNWV's rate of growth should be more normal come 2015, we believe it will still outpace that of both Kinetic Concepts 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 (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 per share. We are maintaining our Outperform rating.