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Edited Transcript of TOS.TO earnings conference call or presentation 28-Mar-19 12:30pm GMT

Q4 2018 TSO3 Inc Earnings Call

Ste-Foy Apr 8, 2019 (Thomson StreetEvents) -- Edited Transcript of TSO3 Inc earnings conference call or presentation Thursday, March 28, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Glen Kayll

TSO3 Inc. - CFO

* Richard M. Rumble

TSO3 Inc. - President, CEO & Director

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Conference Call Participants

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* Richard Wong

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Presentation

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Operator [1]

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(foreign language) Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the TSO3 Fourth Quarter and Full Year 2018 Earnings Results Call. The English would follow right after the French.

(foreign language) Some of the statements that will be made during this call may be forward-looking in nature. Such statements involve known and unknown risks and uncertainties that may cause the actual results of TSO3 to be materially different from those expressed or implied by such forward-looking statements. The risks, uncertainties and other factors that could influence actual results are described in the TSO3's annual report and part of the SEDAR filing. (foreign language) (Operator Instructions) Mr. Ric Rumble, President and CEO of TSO3; and Mr. Glen Kayll, CFO, will participate in this conference call. I would like to remind everyone that this conference call is being recorded.

And I will now turn the call over to Mr. Ric Rumble. Please go ahead.

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [2]

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Well, thank you, Julie, and welcome everyone to TSO3's Fourth Quarter and Fiscal Year 2018 Conference Call to discuss our financial and operational results for the 3- and 12-month period ended December 31, 2018. Again, my name is Ric Rumble, and I'm President and CEO of TSO3 and joining me on today's call is Glen Kayll, TSO3's Chief Financial Officer. Glen will briefly review the financials for the quarter and the year, after which we'll discuss the activities that occurred during the quarter and subsequent events.

Glen, go ahead.

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Glen Kayll, TSO3 Inc. - CFO [3]

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Thanks, Ric. To begin all dollar figures are stated in U.S. dollars unless I indicate otherwise. First of all, in the third quarter of 2018, TSO3 and our former distributor announced that we mutually decided not to renew the distribution agreement that existed between ourselves.

As a result of this arrangement, TSO3 received unrestricted independent commercialization rights to our STERIZONE VP4 Sterilizers. We repurchased 230 STERIZONE VP4 Sterilizers plus associated accessories for a total cost of $7.9 million and transitioned to TSO3 the service, maintenance, and consumable sales for all existing VP4 Sterilizer customers as well as the sales pipeline in the United States and Canada.

We funded this transfer and the launch of our new commercialization approach with a $20 million debt financing arrangement. This was provided in 2 separate, but concurrent transactions in the form of a $15 million first-lien convertible note and a $5 million first-lien term loan. Both notes compound interest quarterly and allow us to defer payment of interest until the end of their 5-year terms should we so elect. With that in mind, I will turn to our annual and fourth quarter 2018 results.

Our revenue decreased from $19.7 million in 2017 to $2.5 million in 2018. Under our old sales model, in 2017, we sold 170 of our STERIZONE VP4 Sterilizers to our distribution partner, we then worked to sell them into medical facilities around the world. In 2018, we did not sell any sterilizers to them. We did, however, launch our fully independent sales and marketing strategy in August of 2018, and thereafter, shipped 13 sterilizers directly to end customers in the U.S. and Canada between August and year-end.

Total sterilizer revenue in 2018 was a little over $1 million, which represents an average selling price of approximately $80,000 per unit. In addition to this, we recorded $1.5 million of accessories, consumables and service revenues, which is a 44% increase over the prior year. Consumables revenue was $935,000 in 2018 with $0.4 million of that amount coming from the fourth quarter of 2018. This reflects significant growth as a result of installations, inventory stabilization and the ability to sell the consumables at end customer pricing, rather than distributor pricing.

Fourth quarter 2018 revenue grew to $1.1 million, a 37% sequential increase over $0.8 million in revenue recorded in the third quarter of 2018. In the fourth quarter of 2018, we shipped 9 VP4 Sterilizers directly to end customers, 2 of which were 0-dollar purchase orders for units associated with a strategic partnership with an IDN. This customer will work with TSO3 to share key information, will pay full consumables pricing for the consumables it uses, retain ownership of the sterilizers after the project is complete.

As I previously mentioned, we also recorded $0.4 million of consumables revenue in the fourth quarter of 2018. This includes consumables sold in Canada and the U.S. For our U.S. customers, appear to be tracking as expected within the $20,000 to $30,000 annual revenue consumables run rate and our Canadian customers will, as is customary, run at lower revenue run rate than their U.S. brethren. Revenue in the fourth quarter of 2017 was $5.8 million, which reflects the sale of 50 sterilizers to our former distributor as well as accessories, consumables service and recognized license fee revenue.

Gross profit was $1 million in 2018 or 39% of revenues as compared to $7.7 million or 39% of revenue in 2017. Gross profit in 2018 included onetime adjustments of $1 million for the recovery of warranty expense that we recorded in the third quarter and $0.5 million of raw materials inventory write-down made in the fourth quarter of 2018. This latter write-down related to production materials that are used to build new sterilizers, which we do not expect to do in the coming year, but then we intend to use when we recommence production.

Fourth quarter 2018 gross profit was $0.04 million as compared to $2.3 million and 40% of revenue in the fourth quarter of 2017. Excluding the onetime inventory write-down I just mentioned, non-IFRS gross profit in Q4 of 2018 would have been $0.6 million or 52% of revenue. Generally, our gross profit declined on a year-over-year basis as while we sold sterilizers direct to end users, we did not sell as many sterilizers as we sold to our distributor in 2017.

Our R&D expenses declined to $5.5 million in fiscal 2018 or $5.1 million on a non-IFRS basis after excluding a Q4 2018 nonrecurring write-down of $0.4 million on sterilizers that we developed internally, but we do not expect to commercialize in the upcoming year. This is a meaningful R&D expense reduction relative to the $6.2 million we incurred in 2017 and stems largely from the completion of many of our product development and regulatory clearance efforts during the year as well as a concerted effort to redirect our spending towards sales and marketing. This reduction is also evident when comparing the fourth quarter figures. R&D expenses were $1.1 million in the fourth quarter of 2018 or $0.7 million when excluding the onetime write-down I just mentioned. This compares to $1.3 million in the third quarter of 2018 and $1.8 million in the fourth quarter of 2017.

Our SG&A expenses grew to $10.3 million in 2018 from $8.7 million in 2017. During the year, we grew expenditures in sales, service and marketing capabilities by $2.9 million as we launched a direct sales and services effort. In 2017, our spending in these areas was very limited as we rely predominantly on our distributor for these activities. As a partial offset of these new expenditures, we reduced R&D expenditures as I discussed earlier and produced our general and administrative expenditures by $1.3 million on a year-over-year basis. On a quarterly basis, our SG&A was $2.7 million in fourth quarter of 2018, which was roughly equal to Q3 of this year and $0.7 million higher than the fourth quarter of 2017.

During Q4 of 2018, relative to the same quarter in 2017, we incurred an additional $1.2 million in sales, service and marketing cost to support our direct sales effort, $0.1 million in expense relating to unused intangibles, and this was offset by $0.6 million year-over-year reduction in quarterly general and administrative expenses. Financial income was $1.7 million in 2018 as compared to financial expense of $0.1 million in 2017. We recorded $1.2 million of accrued interest expense in relation to the debt we issued in August and recorded a noncash gain of $2.9 million on the revaluation of the derivative component of the convertible note.

Fourth quarter 2018 financial income was $1.1 million, which is similarly included $0.7 million of accrued interest and $1.8 million gain on the embedded derivative revaluation. Our net loss was $13.2 million or $0.14 a share compared to $7.5 million or $0.08 a share in 2017. Our fourth quarter net loss was $2.7 million or $0.03 a share as compared to a loss of $1.4 million or $0.02 a share in the fourth quarter of 2017.

Regarding cash, we ended the year with $13 million of cash, cash equivalents and investments, this compares to $16.1 million at the end of the third quarter of 2018. In 2018, we consumed $11.8 million in operating cash outflows, excluding the impact of working capital adjustments, which compares to $4.5 million we consumed in 2017. This increase was due to a reduction in the cash contributions associated with revenues and gross profit on a year-over-year basis. In 2018, we consumed $9.7 million from adjustments in working capital, principally from the purchase of $7.9 million of finished sterilizers and associated accessories from our former distributor in August, as opposed to $1.1 million used for working capital in 2017.

In 2018, we invested $0.3 million in property, plant and equipment, and intangible assets, which is a significant reduction to the $1.8 million in 2017. We significantly reduced our investments in equipment, tools, medical devices, and sterilizers used in our laboratories in 2018. In the fourth quarter of 2018, we consumed $3.1 million in cash as opposed to an increase of $11 million in cash in the third quarter. In the fourth quarter of 2018, we used $0.9 million on noncash working capital adjustments and $2.2 million on our other operating activities. This compares to EUR 8.7 million used from noncash working capital adjustments, most of which related to inventory repurchase I mentioned earlier, and $1.7 million used otherwise in operations in the third quarter of 2018.

We invested immaterial amounts on property, plant and equipment and intangible assets in both Q4 and Q3 2018. Finally, we generated $19.9 million from financing activities in 2018, predominantly from the debt we issued in August as compared to $0.5 million in 2017. Cash from financing activities in the fourth quarters of 2018 and 2017 were immaterial.

With that, I would like to turn over the call to Ric.

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [4]

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Well, thank you, Glen. So 2018 was a transition year for TSO3. And during the year, we changed our distribution strategy. We narrowed our geographic focus, moving from a global footprint supporting our distributor to focusing on North America with our own direct sales team. We arrived at this direct-to-market approach working through a committee of independent board members after looking at a variety of alternatives focused on increasing the adoption rate of our product line. I'll review the alteratives available to the company. We decided to allow our exclusive -- co-exclusive distribution agreement with our commercial partner to expire. We concluded a $20 million financing round with Courage Capital. And within a few months of taking the decision and securing the financial resources, we hired experienced sales personnel and designed programs aimed at accelerating the adoption of our technology. We did this maintaining our focus on our primary market that of OR support or the Central Sterilization Department where our product offering demonstrates significant cost reductions by replacing and displacing sterilization technology -- existing sterilization technologies.

We also maintained our support for the GI market, which we consider to be an emerging market opportunity for our technology. Here we see increased evidence of the need and the desire to improve reprocessing of devices historically treated with a less robust high level disinfection process, and we see the move to terminal sterilization, a process, which we are in many ways leading the industry in by documenting the increased number of medical devices, which can be effectively sterilized using our technology.

Now selling capital equipment into the healthcare institutions is a process, and we have said before that we approach our customers in one of 3 ways. We approach them in a traditional clinical sales approach or being ushered into a sales approach influenced by others or meeting directly with executives of systems, buying groups or healthcare networks to describe our product and our offering and what it can do for these customers. The sales cycle itself can take anywhere from less than 90 days, although this is rare to as much as 12 to 18 months. The time needed to close an order is generally influenced by the type of business that is pursued, such as new construction business, which takes the greatest amount of time to close versus planned replacement or emergency replacement business, which is considerably shorter in a process. But we're still young in our direct selling effort. We are closely tracking the amount of time it takes once a PO is issued until the order is delivered. For example, a new construction business can take more than 12 months between receiving the PO and shipping the product while replacement business can take place in less than 1/3 that amount of time. Again, our involvement and therefore, our history in our own sales cycle is fairly new, and we're providing this color to share with you how we are modeling our revenue and run rate at this time.

As a means of jumping into the sales process and establishing a stronger user reference base, the company implemented programs designed to incentivize rapid purchase and installations of our sterilizer. We have refined our sales tools and focused on a benefit of cost saving -- significant cost savings and ease of installation.

We've added sales programs that include pay-as-you-go, pure cost per cycle and straight price programs as a means of driving placements. And I can say that we are seeing early evidence of success. 21 POs in Q4 was a start, but we're still early in the process. First quarter to date leaves us to believe that we will have fewer POs generated than in that fourth quarter. At this time, we see greater than 10, but we will not meet the previous quarters high. Again, sales will be lumpy in the early stages. It's important to note of the POs generated in the last 2 quarters, the majority have come from leads generated directly by TSO3's own sales team.

Having our own dedicated sales and service team covering key North American markets allows us to identify opportunities, anticipate customer requirements and provide the highest level of customer service. Our growing and scrubbed backlog of qualified opportunities now stands at more than 450 units. We add to this list weekly. Business identified by TSO3 sales team is tracked based on anticipated close date and our data suggests that the quarters and the year are back-end loaded. Our sales people are motivated, incentivized and maintain quotas intended to consume the inventory we have purchased back from our distributor.

In 2018, the company saw enhancements in our claims with additional labeling in Europe specifically for the inactivation of prions and in the U.S. where additional testing was completed and added to our regulatory file, which included the data for the industry's largest and leading duodenoscope. In November, we announced that The American Journal of Infection Control published a TSO3 original study on terminal sterilization of duodenoscopes, documenting the ability of our sterilizer to terminally sterilize these most challenging locations of most complex devices.

Now why is that important? In December, the FDA issued a safety communication reporting higher-than-expected contamination rates from reprocessed duodenoscopes even though the existing reprocessing protocols were being followed. This is indicative to us that both regulators and end users are increasingly aware of the public safety issue of under-processed scopes. We recently released that testing was being started on the Fujifilm duodenoscopes supplied by Fujifilm to support end-user request for information.

In addition to this, we are very pleased we're working with an OEM in the design phase of their new family of scopes. This is a first for TSO3. We believe in the potential of our technology and the willingness of the customer and regulators and even the original equipment manufacturers to move towards our mission of a sterile device for every patient.

So we've reduced our OpEx to shift the resources to sales and marketing. We have cash on hand and continue to pay special attention to preserve it. We're demonstrating and providing value to our customers. We are growing our installed base and recurring revenue at a faster pace than in the past 12 months. And our sales teams are gaining traction as demonstrated by our growing pipeline and high-quality opportunities.

And Julie, with that, I would like to open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Richard Wong from Altema Asset Management.

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Richard Wong, [2]

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I guess, couple of clarification questions for me to start things off. Revenue was $1.1 million this quarter, 400k comes from consumables. Is it fair to assume that servicing clients and warranty and the parts are very small part of the remainder of the revenue stream?

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [3]

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Yes, that's correct.

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Richard Wong, [4]

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And I guess, the second part is, with regard to the comment on 9 VP4 shipped in Q4, I'm trying to reconcile that with the past press releases as I recall, at the end of Q3, we have 50 plus installed and then year-end '18 we have 66 installed, and then 12 shipped, but not yet installed, but yet we only shipped 9 in Q4. Is it getting shipped to all of those users in the summer ahead of time? Is that right?

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [5]

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Yes, I mean, we have a running -- we have a couple of running totals, one is backlog, one is shipped, but not yet installed. So when an item gets shipped, it's not necessarily installed right away, and then we will have the items that are sitting in that balance that get installed over time. So that does flow. But we record revenue when we ship.

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Richard Wong, [6]

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So exactly -- so we already shipped 12 in Q4 -- sorry, 12 shipped and then something installed that increased by more than 10. So a lot of those were shipped by getting in the summer then?

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [7]

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Some of them were, and some of them were shipped by us in Q3. So that's [billable].

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Richard Wong, [8]

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Okay, fair enough. Last clarification question, if I guess, you're using the 450 qualified leads now. How does that reconcile with the qualified quotes that we used in the past?

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [9]

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There's a lot of crossover, Richard. When we talk about a qualified (inaudible) lead -- it's one where our people have gone in, met with the accounts, know where the business is. We want to be -- when we're looking at our leads and the process that we're using, we want to put it through a very rigorous process of lead identification and then move it through a qualified process that says we're getting closer to closing. So we put a lot more effort into it to put it into this 450 bucket. We know the people that we're talking to. We know that they've got budgets planned. We anticipate the delivery date, it's a little bit more concrete. So it's a conversion from what we received. We've added a lot to it. Again, more than double the size it was before, and it's got more -- I am going to use the word integrity, that's probably not the right word, but it has got more substance to it.

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Richard Wong, [10]

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Is it fair to say that the qualified lead is a stronger indicator than a qualified quote in terms of low single?

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [11]

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Yes, and again, I'll use the definition that our people are talking directly with our qualified leads, if you will, rather than a quote that may have been submitted for RFQ process, rather than having somebody directly engaged with the end-user customer.

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Richard Wong, [12]

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Okay. That's good. I guess, along that line, any comments on the 200 qualified quotes that we got from our previous distributor.

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [13]

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Again, some of them after we went through them in detail, and met with the end users, did not have the same amount of -- we didn't have the same expectation that the quoting process was originally a line to provide. So I guess, that's my way of saying. We've gone in with a very detailed process. We have talked about our sales process, and it is a value-based system where we identify the lead as it moves through our sales process to close. We -- quoting is just one of the aspects that we would measure, but meeting with the purchasing team and moving all the way through to site visits, installation, pre-check, reviewing of the instrumentation at the hospital to provide documentation that we can in fact sterilize the loads that they would like to do. That is a much more rigorous process that we're involved that's what we're putting into that 450.

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Richard Wong, [14]

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That's very good color. I guess, in terms of the color between Q4 and Q1. Obviously, Q4 has the long Christmas season on it, but yes, we do more kind of -- mores sales activity there. Maybe some color in Q1, what are we seeing? And what's the difference between this quarter and the last quarter?

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [15]

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At this point, I think it's more just timing than anything else. Our people are actively engaged. We have 10 people in the field right now that are working their sales leads and their opportunities to close. Whether they close this quarter or next, it's not really what we're focusing. I know that's a 90-day period that we're measured on, but the issue that we're focusing on right now is making sure everyone that we can close is getting closed. There is a lengthy process to getting documentation signed at the hospital level. They don't necessarily work to our time lines. Sometimes we are able to use price to incentivize an early let's get into the quarter and that's pretty much industry-wide, but what we're focusing on is getting the customer. Now having said that, of that 450 lead opportunities that we have, we track that based on -- we anticipate close dates, and we can see based on all of our data that at the end of every quarter, we have a spike, in other words, hospitals have learned how to buy at the end of the quarter because of these price incentives and hospitals tend to seasonality where you see it grow over the life of the year and so the back end of the year is always more heavily weighted than the first.

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Richard Wong, [16]

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That makes sense. And so was 10, kind of 10 plus is a little bit ambiguous, is it like a 10, is it 11, is it like 18, any workflow if you can put out?

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [17]

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Thank you, Richard for that. The reality is that here we are where we just said the quarter is a back-end, and so if I answer that question, it is 10 plus, but it will probably change by the end of the day, and might even change by tomorrow, I would expect, but at the end of the day, what we're doing, we have a large number of opportunities that we are trying to close now. Whether they close for the end of business tomorrow or we get them in the next couple of weeks. It is not as important as we get them. In 2 weeks from now, we're running into the AORN, the big Perioperative Nurses Association meeting in Tennessee. And we go immediately from there into the SGNA, which is the meeting associated with the endoscopes and as such. So we've got a lot of customer visits planned at these 2 events and obviously, we go right from there to the IAHCSMM Meeting, the CS Meeting, and right from there to the APEC meeting. It is the heavy time and our people have multiple meetings with customer-to-customer activity. People, who have purchased our equipment, people who are happy using our equipment, who have used our service, are sitting down with other potential customers, who are in the process of looking at our equipment. So we're putting customers to customers together, and I wanted to be careful that we don't look at the lumpiness of Q1 as an indication of what we think is going to happen. We think this year is going to develop into something very significant. The team is still very engaged and very optimistic, and we're working our tail off to make sure we get every single piece of business we can.

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Richard Wong, [18]

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That's great to hear. So I guess with the 10 plus in the Q1, that does not reach our goal to place 200 plus for the year?

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [19]

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I have been asked -- is this a linear regression analysis, and the answer to that is absolutely, no. It will be lumpy, it will be -- we expect it to be big and spotty, and the team is heavily incentivized to get to that level.

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Operator [20]

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(foreign language) Mr. Rumble, there are no further questions at this time. So I'll let you to conclude.

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Richard M. Rumble, TSO3 Inc. - President, CEO & Director [21]

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Thank you, Julie. In summary, why do we remain confident in our technology and our ability to make meaningful share in this market? One, we're delivering value and our customers are happy. We're delivering our promised cost effectiveness and throughput enhancements. We are meeting customer expectations and providing highly-valued service as evidenced by customers signing long-term service contracts with TSO3.

Our sales team is engaged, motivated and incentivized, and there is a buzz, the market is increasingly aware of the value proposition that we bring. This is reflected in our growing pipeline of opportunities. People are talking about us. We're increasingly becoming relevant. In order to accelerate our installed base, we need to keep the pressure on. We need to continue to disrupt the sales process with a variety of incentives and initiatives, which we're doing. Yes, our sales process is still young, and it's lumpy, but I remain confident that we will improve in our pace of deployment and our leading technology as more and more customers realize its value, we will continue to grow. We're fighting for every piece of business, we're executing on our plan. Thank you for your time today.

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Operator [22]

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(foreign language) Ladies and gentlemen, this concludes your conference call for today. Thank you for your participation, you may now disconnect your lines.