Nanosonics (ASX NAN) has a clear and reliable strategy for future development and a revolutionary monopolistic product (Trophon 2). The company also just achieved regulatory approvals in key markets and is selected by the guidelines in both Germany and France. The company also plans to rapidly expand into worldwide markets during FY19.
The company has developed a unique disinfection technology which is the first major innovation in High-Level Disinfection (HLD) for ultrasound probes. The products include Trophon machine, including Trophon EPR (first generation), Trophon2, consumables & accessories, and are sold in 3 different types of selling models.
The main product “Trophon” is an automated system that delivers HLD of ultrasound probes which is highly effective in killing bacteria, fungi, and viruses including the highly resistant HPV virus. North America is their most substantial market making up 89.62% of total revenue in FY18.
They also operate in some European and Asian countries, while still exploring chances to introduce their technology to other new countries. In addition, their successful business model, customer experience, product innovation, operational excellence, people engagement, and value creation, lay the foundation for success.
Flexible selling models
Several selling models are now in operation which can be leveraged for specific customer needs. Each model has different implications for the timing of revenue recognition associated with the capital equipment. However, Nanosonics are assuming that all of them are profitable models in the long term with annuity revenue growth as the installed base grows. These models include Capital equipment sales (Direct), Capital equipment rentals (Direct), Managed Equipment Service model (Direct), Ultrasound Capital Reseller model and Distribution model.
Capital Sale Service (Direct Channel)
- Capital equipment sold upfront with a 12-month warranty.
- Customer purchases consumables as required.
- Customer elects to purchase service contracts from Nanosonics or pays for service and parts as required.
- Continued to represent the main selling model for direct business, particularly in North America.
Managed Equipment Service (Direct Channel)
- Nanosonics provides capital equipment to customer.
- Equipment fully maintained by Nanosonics over its life with the option to roll into a new machine thus retaining the customer in the Trophon ecosystem.
- Customer purchases consumables as required at an ‘all-inclusive’ price.
- Nanosonics owns capital equipment, depreciated over five years.
- No upfront capital revenue recognised by Nanosonics.
Rental (Direct Channel)
- Customer rents capital equipment.
- Equipment fully maintained by Nanosonics.
- Customer purchases consumables as required.
- Managed equipment service and rental sale model, in appropriate markets, provides increased profitability and lower the barriers for market adoption.
Full-Service Distribution (Distribution Channel)
- Distributor purchase capital equipment, consumables and spare parts from Nanosonics.
- The distributor sells capital equipment, consumables and service to the customer on a similar basis to the Direct Channel Capital Sale Model.
Capital Reseller Market (Distribution Channel)
- Distributor purchases capital equipment only from Nanosonics and sells to end customer.
- Customer purchases consumables and service from Nanosonics.
Product innovation and investment
Nanosonics continues to be innovative and invest in product expansion with significant research and engineering capability. The new version of product Trophon2 receives regulatory approvals in the USA, Canada, and Europe.
Strong operational ability
As a medical device company, Quality Management System (QMS) is paramount to Nanosonics. During the year, they passed a number of audits from regulatory authorities and successfully upgraded its QMS to meet the new requirements of ISO 13485: 2016 as well as new requirements from The Medical Device Single Audit Program (MDSAP).
The company has also invested in the IT and ERP system to support expanding operations & future growth. The upgraded systems will benefit to support the ongoing scalability and integration of the company global operations moving forward.
New product pipeline
Another central growth strategy of Nanosonics shares is the expanded portfolio of new infection prevention products. Throughout FY18 Nanosonics continued to make strategic investments in several new product developments. Nanosonics is targeting one or more new infection prevention solutions to be brought to market by the end of FY20, subject to regulatory approvals.
Nanosonic is aiming for the successful introduction of the new product, like Trophon, becoming the new standards of care in the future. The investment in research and development continuous increase over the years reached $9.9 million in FY18 and expected to be $13 million in FY19.
Global annual growth of +25%
Throughout FY18, the Trophon installed base continued to grow 25% globally through FY18. Nanosonics continues to expand and entered into a new capital reseller agreement with GE Healthcare which will commence on 1 July, to provide GE Healthcare customers in France and Sweden with ongoing access to Trophon. This is expected to deliver a material increase in sales and margin.
The upgrade market is expected to commence, especially for existing units that are five years or older. Over time this upgrade market is expected to grow as the existing installed base of Trophon EPRs ages as shown in the figure below.
Trophon supported by international guidelines and studies
Throughout FY18, several important new international guidelines and supporting studies were published. The studies stipulate High-Level Disinfection (HLD) for critical and semi-critical procedures, with a preference for automated, validated systems which Trophon delivers.
These new guidelines and studies further underpin the ongoing adoption of Trophon, at the same time address those needs as the new global standard of care in the field of infection prevention.
As the market fundamentals for adoption strengthen internationally, Nanosonics shares set geographical expansion as their core element of growth strategy. A business development manager was appointed in FY18 to access market opportunities for the European, EMEA region. Market preparation activities currently underway with a number of new distributors appointed in Scandinavia, the Kingdom of Saudi Arabia, Kuwait and Israel. This provides the opportunity to continue growing and expanding geographically.
|Direct operation||North America, UK, Germany|
|Distributor partnership||Australia & New Zealand, France (GE Healthcare), Sweden (GE Healthcare)|
|Distributor partnership in place & Marketing activities underway||Kuwait, Israel, Qatar, Singapore, Hong Kong|
|Distribution partnership in place||Russia, Ireland|
|Regulatory approval in place & Exploring distributor for market entry||south Korea, Saudi Arabia|
|Regulatory approval in place & market development activities underway||Japan|
Slight fall in capital revenue due to the adoption of Trophon 2
Total sales of Nanosonics shares reflect a 10% reduction in capital revenue on the prior year, Nanosonics points out that this is associated with the earlier than anticipated regulatory approval of trophon2 with North America and European, and subsequent run down of Trophon EPR (the first generation) inventory by distributors. Also, some customers deferring purchase pending launch of trophon2 in Q1 of FY19. However, the increase of sales of consumables and service were up 25% reflecting the increasing installed base, demonstrating strong growth in the annuity revenue profile.
There are a few material business risks Nanosonics needs to be aware of including significant distribution customer, Research & development and commercialisation, competition, intellectual property, supply chain, regulation, financial product liability, and cybersecurity. Although most of the threats the company has the strategy to manage the risk, there are still some other problems, for example, the regulations applied in different countries and single market reliance.
Significant distribution customer
Nanosonics shares (ASX NAN) relies heavily on the US market, and this is where 89.62% of the revenue is generated from. In addition, the key distribution US customer accounts for around 49.3% of the group’s revenue, however, the second largest is only 4.6%.
To mitigate the risk, the Group has further strengthened its direct operations in North America and now has significant direct sales operations in place which continue to grow and can be scaled further. In addition, it is also growing its operations in other key markets.
Research & Development and commercialisation
So far, the company only has one core product which is Trophon and recognises the need to diversify its product portfolio by creating a new product. Although the new product will take time to get a range of regulatory approvals, the company needs to increase their investment in research and development.
To manage this risk, the company has clearly defined a framework to support the processes covering product ideation, development, and subsequent commercialisation and has made the progress of additional technologies a key strategic priority and investment. In addition, the company also engages with a range of experts in relevant fields to determine the focus of its R&D effort.
Obsoletion of Trophon
The potential for increased competition exposes Nanosonics shares to the risk of losing market share. A company is also exposed to the risk of medical and technological advancement by competitors where alternative products or methods are developed and commercialized that will render Trophon obsolete.
To address this risk, the company has invested in R&D for the second generation of Trophon, trophon2 which was released to the market in August 2018, and continues to invest heavily in product diversification.
Intellectual property infringement
The company relies heavily on its ability to maintain and protect its intellectual property (IP) including registered and unregistered IP. Infringements brought by a third party can include the expiry of its IP, the risk of being unable to register the underlying subject matter or processes in any new products and the risk that third parties may claim that the company infringes the rights.
The company seeks appropriate patent and trademark protection and manages any specifically identified IP risks. Along with internal personnel to manage IP opportunity and risk, Nanosonics works closely with specialists and advisors to continually manage its IP opportunities and threats. The company tries to ensure that its projects, products, and related activities include an appropriate assessment of any third-party IP profile against its IP profile.
Supply chain risks
The company has the high managing risks in the supply chain particularly its dependence on critical suppliers for the supply of key materials which carries the risk of delay and disruption. Additionally, certain materials are only available from some sole suppliers, and regulatory requirements could make substation costly and time-consuming.
To mitigate this risk, Nanosonics regularly monitors its suppliers and their performance and seeks to enter into agreements where appropriate to mitigate any supply risk. Inventories are managed in sufficient quantities for continued product supply in the short term.
The company operates in a highly regulated industry, and medical devices are subject to the strict regulations of various regulatory bodies in different countries where the products are sold. Regulatory bodies perform regular audits of Nanosonics’ manufacturing sites as well as its third-party suppliers, and failure to satisfy regulatory requirements presents significant risks.
Highlights of the company for the FY19 will be the introduction of new products, Trophon EPR and Trophon 2, both of them will be soon available in the first season. In addition, the company also has a great expectation in the different sales area, including Europe, North America, and Japan.
Europe The company will focus on the United Kingdom, Germany, and France. With the introduction of EPR and Trophon2 next year, there will be a strong adoption in the UK, particularly MSE, which will drive 90% of the revenue in the British market. In addition, the Trophon 2 product will be soon released in the German market and both of the products will be in the French and German guidelines, significantly improving the sale.
Asia The company believes Japan is a tremendous potential market because of the positive preliminary study on probe contamination. Therefore, the company will continue with further studies as part of a strategy to strengthen fundamentals for adoption in Japan. Pre-marketing activities to continue throughout FY19. Regulatory approval of Trophon2 in Japan expected by end FY19.
North America Expected to continue to grow with FY19 adoption similar to FY18.
Active investment in growth with total FY19 OPEX expected to be approximately $53 million, including $13 million in R&D, with the majority of that R&D expense directed towards new product development.
Nanosonics shares (ASX NAN) have strong potential upside
Nanosonics shares (ASX NAN) have done well over the past year, and in our opinion, could have a very bright future ahead. The existing market is only scratching at the surface of a global market opportunity and Nanosonics is aiming for a large geographical expansion globally. Additionally, its strong product innovation could position Nanosonics as a world leader in infection prevention.
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