By Brian Marckx, CFA
CAS Medical (CASM) reported financial results for Q4 2017, which saw revenue well ahead of our pre-preliminary announcement numbers (CASM pre-announced Q4 in early January). Strength in the U.S. market, which has been attributed to a combination of catalysts, more than offset a double-digit decline in international sales and pushed total FORE-SIGHT revenue to an all-time high. Indications, which includes 2018 guidance of low-teens percentage increase in U.S. FORE-SIGHT revenue, are that this momentum will continue, and potentially accelerate. Meanwhile, gross margin slipped a bit in Q4 but (relative to our estimates) was offset by relatively low OpEx – the result was operating loss (from continuing operations) at the lowest (i.e. best) level since at least late-2015. Importantly, management expects a combination of revenue growth, significant widening of gross margin (new, higher-margin sensor just launched) and flattish OpEx to result in reaching EBITDA-positive by Q4 2018 and cash flow-positive by mid-2019.
The domestic market had an extraordinarily strong showing in the quarter with new records set in the U.S. for monitor placements, sensor sales and FORE-SIGHT revenue. The recent pick-up in U.S. sales is highly encouraging given that domestic revenue had flattened at around the $3.7M mark over the previous four quarters (i.e. Q2 2016 – Q2 2017). Since then, U.S. FORE-SIGHT sales set new consecutive all-time highs and averaged $4.1M in Q3 and Q4 2017. Much of the reason for the prior lack of domestic sales traction was due to disruptions caused by restructuring of the sales force as well as new competitor pricing pressures.
CASM addressed these issues through rebuilding the sales team with highly-experienced personnel and implementing additional sales strategies including the use of IDN/GPO sales channels and targeted campaigns focused on large hospital networks. These seem to already be making a positive impact with productivity gains and initial sales to two new large hospital customers both cited as main catalysts to the recent U.S. sales growth.
Also, quite encouraging was that FORE-SIGHT sensors revenue showed meaningful growth in Q4, increasing by approximately 8% on both a yoy and sequential basis. The lack of prior U.S. sales traction was mostly tied to no upward movement in sensor sales. Through the first nine months of 2017 domestic sensor sales increased just 2%, despite 15% growth in the U.S. installed monitor base. This also indicated deteriorating utilization (per installed monitor). Given that sensors account for about 92% of FORE-SIGHT related revenue and U.S. sales contribute ~86%, the meager domestic consumables growth was the main reason for prior lack of meaningful top-line growth. But the Q4 strength may be a harbinger of even stronger sensors growth (and potentially higher utilization) to come as management is guiding for U.S. sensors sales to grow in the mid-teen percentages in 2018.
And, we remain encouraged by certain recent activities and trends – strategic and market-related, which we think bode well for even more traction in sensors sales and overall improvement of financial results. This includes a fairly regular flow of clinical data supporting the use of cerebral oximetry in cardiac surgery as well as other indications, CASM’s high win-rate when prospective customers evaluate their technology (oftentimes against competitors’), early indications that CASM’s focus on hospital systems and larger accounts is bearing fruit, further market share gains against competitors, recapture of some previously-lost accounts and the ageing (average) tenure of the sales force. And, the fact that management reaffirmed 2018 full-year FORE-SIGHT guidance (which was initially issued with the January Q4 preannouncement) is also positive, in our opinion.
As it relates to the sales force, turnover meant that average tenure (and related productivity) had previously fallen and took U.S. sales growth with it. However, despite the lack of overall growth, there were indications that the correlation between tenure and revenue growth also held true as the sales force aged. Management had noted that overall productivity was improving and sensor-related revenue growth among the more tenured reps was relatively very strong. That trend appears to continue – as management, again on the Q4 call, pointed to productivity gains, particularly among the less seasoned reps, as directly benefitting U.S. sensors and monitor revenue. With “full productivity” estimated to take approximately 9 – 12 months to reach and 12 of the 16 current reps having at least one-full year of experience with CASM, we expect to see a continuance of these productivity gains throughout 2018. Importantly, comments on the call also suggest that there is not any expectation of additional turnover.
As it relates to wholesale networks, while CASM continues to have great success in winning new business when head-to-head evaluations of FORE-SIGHT vs. competitors’ technology is done at the clinician level (i.e. when functionality, utility and clinical outcomes are the decision-making criteria), competitors have had success in thwarting CASM’s market share gains by use of IDNs and GPOs, where the purchasing decision is often based mostly on price. CASM is fighting back, however, and recently implemented initiatives aimed at the IDN and GPO channels which management has since indicated are seeing some success.
It seems clear that when CASM can shift the conversation and decision-making to clinical outcomes and functionality, their chance of winning new business goes way up. The clinical superiority of their product is supported by the ~70 new customer close rate when prospective clinicians perform a clinical evaluation of FORE-SIGHT. Management noted that during 20017, 45% of monitor placements reflect market share gains (i.e. account wins from competitors) with the other 55% related to expansion of the tissue oximetry market.
Large accounts are particularly attractive given their greater relative utilization (i.e. sensors demand) and one of CASM’s tactics that they mentioned which has shown early success is to detail directly to larger providers within an existing IDN and then use that leverage to expand out to the other IDN members. Encouraging is that management noted that they recently recouped a portion of a major account that they had previously lost, that they won a contract with a larger IDN on the west coast and scored other new accounts during Q3 2017. These new accounts, which more recently included a “major university system in the Midwest” (which CASM won in Q4 2017) already appear to making a meaningful impact – in fact, CASM attributed some of the strong U.S. sales in Q4 to fulfillment of initial orders related to two new large hospital-network customers.
Maturation of Reps, Leading Technology, New OEM Option Expected to Benefit Sales Growth…
While still relatively young in tenure, aging of the sales force appears to have resulted in the hoped-for gains in productivity. As of November 2017, only 8 of 15 reps had been with the company prior to the start of 2017. Today, 12 of the 16 are fully-tenured (i.e. with the company for at least 12 months). As is commonplace with medical device sales, reps’ experience gains over time will translate into gains in sales productivity. This certainly appears to be consistent with CASM’s experience. With an average 3 to 4 months until a rep may reach full productivity, CASM is heading into 2018 with a sales force that could be placing 100 monitors or more per quarter in the U.S. by the end of the year (for reference 198 monitors were shipped in the U.S. in 2017).
Clinical superiority of FORE-SIGHT as well as continued expansion of the overall tissue oximetry market represent the long-term revenue catalysts, in our opinion. With additional evidence of the utility in various procedures and associated improved patient outcomes when cerebral oximetry is employed, the size of the market will undoubtedly continue to expand and remains relatively under-penetrated. So, while CASM's recent headwinds have been disruptive, we think their 70+% win-rate when prospective customers perform a clinical evaluation of FORE-SIGHT speaks to the robustness of the clinical competitive advantage of their technology which we believe will translate into continued market share gains.
The company’s recent strategy of targeting hospital networks and other large accounts appears to also be already paying dividends. Recent wins in just the last few months already contributed – and were associated with the strong domestic performance in monitor and sensors sales in Q4. That momentum, as it relates to the recent account wins as well as with already engaged-but-not-yet-closed (closing a potential sale can be a months or quarters’ long process) prospects, is expected to flow into 2018. Success on this strategy could be key to further steepening the rate of revenue growth – highly encouraging is the apparent early success in that regard.
2018 may also benefit from a supplemental revenue stream as CASM hopes to roll-out their FORE-SIGHT technology into a format compatible with third-party monitors. This ‘FORE-SIGHT OEM Module’, a 510(k) application for which was filed with FDA in January, will provide all of the same FORE-SIGHT functionality but without the need for CASM’s monitor (instead, a cable will interface between third-party monitors and the FORE-SIGHT sensors). CASM expects to partner with third-party monitor manufacturers – which potentially presents not only an efficient distribution channel but also immediate expansion of their Rolodex and sales reach. CASM hopes to have FDA clearance and launch the product sometime in 2018.
Our price target has moved from $3.00 to $3.50/share on valuation. See below for free access to our updated report on CASM.
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