26 October 2018
By Maynard Paton
Update on Tristel (TSTL).
Summary: I was broadly satisfied with these full-year figures, which set new records for revenue, profit and the dividend. However, the statement and City presentation provided numerous little niggles — not least a bizarre management decision that has delayed product approval within the United States for a further six months. Still, TSTL’s collection of medical disinfectants continue to produce attractive accounts and perhaps their biocidal qualities have been underlined by recent deals with the NHS and Parker Laboratories. I continue to hold.
Shares in issue: 43,700,048
Market capitalisation: £96m
Click here to read all my TSTL posts.
* Record results highlight questionable slides from July’s open day
TSTL’s open-day trading statement from July had already heralded these results:
“Tristel will report record turnover of £22.2m (2017: £20.3m) and pre-tax profit (before share-based payments) of at least £4.4m (2017: £4.1m). Revenue from overseas markets contributed 51.3% of the Group total – a record level (2017: 47%).”
Revenue was indeed a record at £22.2m (up 10%), while pre-tax profit (before some hefty share-based payments) was actually better-than-projected at £4.7m (up 14%). Revenue from overseas markets contributed 51.2% of the group’s top line.
The performance showed revenue, pre-tax profit and the dividend all setting new peaks for the fourth consecutive year:
|Year to 30 June||2014||2015||2016||2017||2018|
|Operating profit (£k)||1,819||2,541||2,568||3,902||3,980|
|Finance income (£k)||(4)||3||12||4||2|
|Other items (£k)||-||-||-||41||-|
|Pre-tax profit (£k)||1,823||2,552||2,593||3,966||4,006|
|Earnings per share (p)||3.25||5.44||5.01||8.06||7.62|
|Dividend per share (p)||1.62||2.72||3.33||4.03||4.58|
|Special dividend per share (p)||-||3.00||3.00||-||-|
Indeed, turnover of £22.2m was just shy of the £22.8m minimum TSTL had projected for 2019 back in October 2016. Meanwhile, pre-tax profit after share-based payments inched only 1% higher. More on share-based payments later.
I should add that these results highlighted a couple of questionable slides from July’s presentation.
In particular, TSTL had said in July that 80% of 2018 revenue “by application” related to products that disinfected medical instruments:
I could not reconcile that 80%. The presentation accompanying these results indicated 75% of all revenue — and 83% of all human healthcare revenue — came from the ‘core’ patent-protected foams, wipes and solutions that disinfect medical devices:
I had assumed the 80% referred to all revenue, which led me to believe in July that sales of the group’s ‘core’ disinfectants had gained a very impressive 19% during the second half.
In actual fact, ‘core’ second-half sales gained only 4%:
|Revenue||H1 2017||H2 2017||FY 2017||H1 2018||H2 2018||FY 2018|
|Medical device disinfection (£k)||7,279||7,822||15,101||8,180||8,410||16,590|
Suffice to say, I will now treat TSTL’s open-day charts with a little more caution.
* Impressive new agreement with NHS sees prices rise by at least 10%
My sums from July suggested UK revenue had grown 6% during the second half. As such, I formed the impression that domestic sales of the ‘core’ medical-instrument disinfectants may have performed particularly well.
Alas, I was a little optimistic. UK progress during the second half was dictated mostly by extra sales of surface disinfectants (for cleaning hospital floors) and a variety of legacy products:
|UK revenue||H1 2017||H2 2017||FY 2017||H1 2018||H2 2018||FY 2018|
|Medical device disinfection (£k)||3,478||3,181||6,659||3,604||3,113||6,717|
|Critical surface (£k)||683||499||1,182||601||644||1,245|
UK sales of the ‘core’ medical-instrument disinfectants fell 2% during the second half. I must confess, that progress does not look great.
At least management provided some background to the UK performance during the City presentation.
First, NHS ordering patterns are somewhat unpredictable.
Apparently, a month with, say, four Thursdays could see lower sales than a month with five Thursdays. Such order timings could then create a sales swing of a few £000k — and the difference between a positive and negative revenue change.
Of more significance was management owning up to “competitive churn” within NHS ultrasound departments. The trophon machines produced by Nanasonics (ASX: NAN) (see below) appear to have persuaded some hospitals to use fewer TSTL wipes.
I was told Nanosonics supplies the machines to UK hospitals for free, and that the firm charges only for the disinfectants. This Nanasonics presentation says:
“A broadening number of selling models each with different revenue profiles, including Managed Equipment Service (MES) in the UK, where a growing number of trophon units were placed with no upfront capital revenue.”
So the hospitals have entered into some sort of service/leasing agreement, which appears to be proving increasingly popular. The same Nanasonics presentation also says:
“MES program in the UK to continue gaining momentum — expect FY19 new unit growth of 75% to 100% over FY18, of which 90% will be under MES”.
Mind you, Nanosonics’s entire revenue from Europe, the Middle East and Africa was AUD$3m, or £1.6m, last year. So right now at least, TSTL’s lost sales could be relatively small.
Furthermore, TSTL’s management told me the trophon machines do break down… and that hospitals have to ensure TSTL’s wipes are stocked ready for such occasions.
In addition, the trophon machine disinfects only ultrasound probes.
As far as I know, there is no trophon-equivalent for instruments used within cardiology and ear/nose/throat departments. Some 70%-plus of such departments within UK hospitals currently use TSTL’s wipes and foams.
Probably the most encouraging UK snippet from the City presentation was news that the NHS supply chain had agreed to pay higher prices for TSTL’s products. Amazingly enough, TSTL has pushed through a one-off increase of between 10% and 15% for a new multi-year agreement.
When the price hike was mooted at July’s open day, I doubted whether TSTL could extract such higher payments from the NHS.
So perhaps this new agreement underlines the biocidal attractions of the group’s disinfectants to the health service. I understand the products covered by the price rise earned sales of £6m from the NHS last year.
* International distributors continue to blow hot and cold
Back in July I calculated second-half overseas revenue had grown by 11%, which I thought was “a little weak” given the 28% overseas advance witnessed during H1.
These results confirmed the 11% H2 increase:
|Overseas revenue||H1 2017||H2 2017||FY 2017||H1 2018||H2 2018||FY 2018|
|Medical device disinfection (£k)||3,801||4,641||8,442||4,867||5,006||9,873|
International sales of the ‘core’ medical-instrument disinfectants did not seem impressive during the second half — my sums indicate an 8% H2 advance.
Questions during the City presentation about the second-half overseas performance did not elicit a clear-cut management explanation. However, my calculations point to sluggish sales from TSTL’s third-party overseas distributors:
|Overseas revenue||H1 2017||H2 2017||FY 2017||H1 2018||H2 2018||FY 2018|
|China & Hong Kong (£k)||649||463||1,112||519||552||1,071|
|Total in-house (£k)||3,250||3,717||6,967||4,001||4,322||8,323|
I reckon TSTL’s German subsidiary — which also supplies other central and eastern European countries — lifted sales by 28% during H1 and 24% during H2.
Revenue from Australia and New Zealand (now reported as a single operation) gained 42% during H1, but only 1% during H2.
The first-half Australasian surge was due to the acquisition of the Australian distributor during the previous year. I would like to think this particular division continues to enjoy greater selling opportunities.
Anyway, total in-house international sales gained 14% during H2, compared with 4% for third-party distributor sales.
Management has previously mentioned its distributors blow hot and cold with their sales of TSTL products — often these third parties can be distracted by selling products for other companies.
For example, during 2017, overseas distributor sales dropped 16% during H1 and gained 5% during H2.
The City presentation also revealed a useful snippet on China.
Management said the Chinese operation is to refocus on selling TSTL’s flagship wipes and foams, and will lose other product sales of some £400k during the current year.
(Apparently the lady managing the Hong Kong subsidiary — which was taken in-house by TSTL during the year and is now “performing well” — has started to oversee China, too.)
* Expected Brexit “turbulence” is not management code for a future profit warning
TSTL’s results RNS declared:
“Brexit looms. Our response to the uncertainty surrounding this event is to build inventory of all component parts and finished products. We have advised our continental customers to increase their stockholdings over the coming months in preparation for possible disruption to the supply chain.
Based upon available advice, we believe that we will be able to CE mark our disinfectants and sell them within Europe irrespective of the outcome of the Brexit negotiation.
The only certainty is that we will experience turbulence this year and our normally predictable pattern of trade will be disrupted to some extent. Notwithstanding this near-term uncertainty, the outlook for the Company remains very positive.”
Certainly the phrase “we will experience turbulence this year” read to me as if the company was preparing the ground for a future profit warning. Management told me at the City presentation that my interpretation was definitely not the case.
Instead, management claimed it would be remiss not to mention the likelihood of Brexit causing some disruption — although the scale of any disruption is unknown at present.
Management reckoned the advice for continental customers to “increase their stockholdings” would not bolster the group’s forthcoming interim results through one-off ‘forward orders’.
Attendees at the City presentation were told that new revenue-recognition rules (IFRS 15) would “smooth out” any distortion. For example, if a customer buys some wipes during the first half for use during the second half, revenue and profit would be recognised during the second.
I can only presume TSTL will be told by the customer about such ‘forward orders’. IFRS 15 will not re-jig cash movements, and any pre-Brexit bulk purchases will naturally bolster TSTL’s bank balance.
For what it is worth, the CE mark mentioned within the results RNS should be obtained through a straightforward “paper exercise”.
* Choosing the FDA’s predicate option seems completely bizarre to me
The following text was the most disappointing part of the results RNS (my bold):
“We are preparing a submission to the FDA for Duo as a high-level disinfectant. The intended use patterns will be for intra-cavity ultrasound probes, nasendoscopes, and lastly certain ophthalmic devices. If successful, this will position us in three of the clinical areas in which we are most successful in other geographical markets. We expect to submit the application for 510(K) approval during the financial year ending 30 June 2019.”
Oh dear. Back in July, the directors had reiterated an FDA submission would be made by the end of December 2018.
A delay of six months may not seem long, but TSTL’s North American project has now become very protracted. My notes from 2015 recall management initially hoping FDA approval would be received by June 2017!
Anyway, the results RNS said:
“Our submission to the Food and Drug Administration for Duo is progressing well and we recently received very constructive feedback from the agency which will help guide us to its completion.”
Management admitted at the City presentation that the “constructive feedback” concerned the approval procedure TSTL had taken. Essentially TSTL had chosen the wrong option.
You see, the FDA has two application processes:
ii) de novo, for products that are essentially new to the FDA.
TSTL and its consultants had believed a (quicker and easier) predicate application was going to be sufficient. However, the FDA’s “constructive feedback” suggested a de novo application would be more suitable.
I have to say, the decision to even consider a predicate application seems completely bizarre to me.
That’s because past TSTL presentations have witnessed management bemoan how the FDA has never:
i) approved a chlorine dioxide disinfectant before (TSTL’s disinfectants are based on chlorine dioxide), and;
ii) approved a disinfectant foam before (TSTL’s initial products for approval are foams).
Even to me — a layman shareholder with no FDA knowledge whatsoever — attempting the “substantial equivalence” route was always going to be rather optimistic.
This predicate/de novo bungling underlines the seemingly botched leadership of this entire FDA application process.
A striking example of why the FDA project has taken so long lays within my notes from a February 2017 presentation.
I wrote then:
“I thought it a tad ominous that management used the adjective “tortuous” to describe the FDA’s demands for ensuring the disinfectants continued to work properly right until the end of their shelf lives.”
Well, 18 months later, and the 12-month shelf-life tests for the FDA will only finish in November! I am not sure why the shelf-life tests were so late in starting.
Anyway, the time between now and June 2019 will be spent converting the predicate application to a de novo application, and collecting yet more data.
Extra details required include an “ergonomic study”, which will prove how hospital staff can apply TSTL’s disinfectants correctly on medical instruments.
* Parker Laboratories and a mooted 17.5% royalty
An encouraging snippet from the City presentation was the revelation that TSTL would earn at least a 17.5% royalty from its US sales.
Parker Laboratories — TSTL’s sales, manufacturing and marketing partner in the States — is set to earn the same profit following a “balanced negotiation”.
TSTL’s directors reckoned a 17.5% royalty was the minimum level acceptable — as the rate reflected the margin enjoyed within the rest of the group.
I must confess, a 17.5% royalty agreement does seem very generous. Bioventix (BVXP) for example earns a 2% royalty from its antibodies. Let’s hope Parker has calculated its projections properly.
I should add that TSTL’s tie-up with Parker is perhaps the saving grace of this protracted US project.
To recap, Parker is the world’s leading supplier of ultrasound gel and offers TSTL a ready-made nationwide salesforce alongside FDA-approved manufacturing facilities. Parker also boasts a 60-year history of private, family ownership — suggesting the business takes a cautious, long-term outlook.
In fact, I would like to think the likes of Parker would only become involved with a small UK firm such as TSTL because the disinfectants concerned are actually quite good and are likely to sell quite well.
The following picture shows some early exhibition co-operation:
At least Parker appears confident TSTL’s disinfectant foams will eventually receive FDA approval.
TSTL’s executives told the presentation that the relationship with Parker was “very, very productive and harmonious”, and that Parker has even asked TSTL to manufacture some of its own low-level disinfectants.
I should add that TSTL’s executives continue to avoid giving any projections concerning the potential of the US market. Instead, management pointed investors to Nanosonics and its trophon machine to judge the Stateside sales potential.
Last year, Nanosonics earned revenue of AUD$54m — approximately £30m — from disinfecting ultrasound probes within North America:
For what it is worth, back in 2016, TSTL’s management said the US market could be worth £18m annually based on just the two disinfectants being submitted for FDA approval.
These days, not even the February 2018 guidance of commencing US sales during the year to June 2019 is mentioned.
* The ‘one-off’ write-off could have been deemed ‘exceptional’ — but wasn’t
These results contradicted another slide from July’s open-day presentation.
Attendees sitting in the summer marquee were shown this chart:
The US regulatory project apparently represented 3% of revenue — or £660k. However, these results said the cost was £500k — and management said all the costs were expensed during the first half (although the work was undertaken during both halves). This time last year, management was predicting US project costs of £800k for 2018.
I am not sure what to make of all of this — although I think the lower-than-expected US costs are due to conservative accounting rather than management massaging the books.
Whatever, operating profit before share-based payments and US regulatory costs were flat during the second half:
|H1 2017||H2 2017||FY 2017||H1 2018||H2 2018||FY 2018|
|Operating profit before SBP and US costs (£k)||1,898||2,625||4,523||2,504||2,641||5,145|
|Share-based payments (£k)||(5)||(116)||(121)||(164)||(501)||(665)|
|US costs (£k)||(200)||(300)||(500)||(500)||-||(500)|
|Operating profit (£k)||1,693||2,209||3,902||1,840||2,140||3,980|
In my view, the notion of TSTL’s conservative bookkeeping is underlined by the accounting treatment of the firm’s Hong Kong purchase. A footnote in the annual report reveals:
TSTL did not deem such a ‘one-off’ write-off to be exceptional — although it easily could have been declared as such. Second-half operating profit gained 8% adjusted for this write-off, share-based payments and US costs.
* Attempting to disrupt the 2p-per-wipe hospital-cleaning market
Management spent a lot of time extolling Hot Shot during the City presentation. Hot Shot is a new product for cleaning mattresses, bedside tables and other items that hospital patients come into contact with.
The presentation slideshow showcased the product’s environment-friendly credentials.
The aim is to “disrupt” the suppliers of ordinary cleaning wipes. “Good data” from the NHS supply chain apparently indicates 17 wipes are used per patient per day by the health service.
TSTL’s management claimed the cleaning wipes are only as effective as Flash or Dettol domestic cleaners and are sold to the NHS for as little as 2p each.
In contrast, Hot Shot would be much more effective as a hospital disinfectant — but would be sold to the NHS at 5p per dosage.
TSTL’s executives argued a premium product should be priced accordingly. The execs added that Hot Shot’s greater cost would be counterbalanced by the savings following fewer hospital infections — although the details of such savings were not revealed.
I can’t say I was convinced. In fact, TSTL’s management admitted a pilot project within four Sheffield hospitals had required an “immense” effort to change the working habits of staff from using the 2p wipes to TSTL’s Hot Shot.
Management did say at the presentation that if Hot Shot was priced at between 2.5p and 3p per dosage, a good margin would still be generated.
The executives also mentioned the group’s product for cleaning hospital floors earned revenue of £1.25m last year from 80 (20%) UK hospitals. The market size for disinfecting UK hospital floors is £20m.
* Substantial share-based payments may only be relevant if the share price reaches 350p
The headline figures within these results were blighted by a significant £665k share-based payment charge.
TSTL has some form with share options. I will not recount the whole sorry saga (you can read full details here) but during 2016, the executives and senior managers collected a £1m options windfall following — in my view — the dubious disclosure of trading information and of the option plan itself.
I must add that the directors have since told me they “strongly rebut” the allegations of a lack of disclosure and of them “dipping their fingers into the till”.
Anyway, the directors decided to award themselves more options during 2017.
This time the terms of the award were announced very clearly and the new scheme was actually put to a vote at last year’s AGM.
This latest option batch will come good only if:
i) the share price trades at 350p or more for at least three months before 30 June 2021, or;
ii) the company is acquired (which is standard for option schemes).
I like option plans that are based on share prices. You see, everyone knows exactly when the options have vested and shareholders can always take advantage of the higher price and sell.
True, a share price may not reflect the long-term value of a business. But then again, alternative measures such as earnings per share, return on equity, and so on, can all be fudged to trigger option payouts — and subside thereafter, too.
The drawback to TSTL’s new options is the 1p exercise price. So if the company is taken over for peanuts, the options will vest and management will receive some extra money — yet shareholders will be mugged.
TSTL’s management told me at the City presentation that the £665k option cost was represented by a £200k charge for general staff options and £465k for the new management scheme.
Note that accounting rules require a share-based payment charge to be applied even if these management (and any other) options turn out to be worthless (i.e. the share price never trades at 350p or more for at least three months before 30 June 2021).
As such, I would argue that considering only the cost of the general staff options might be more practical — at least until the share price approaches 350p and the management options stand any chance of vesting.
* Cash flow, net cash, operating margin and return on equity
Despite the questionable open-day charts, hefty share-based payments and inconsistent reporting of US costs, TSTL’s financials generally look in good shape.
Cash generation appears fine:
|Year to 30 June||2014||2015||2016||2017||2018|
|Operating profit (£k)||1,819||2,541||2,568||3,902||3,980|
|Depreciation and amortisation (£k)||885||844||966||1,243||1,498|
|Net capital expenditure (£k)||(1,084)||(1,045)||(889)||(959)||(1,450)|
|Working-capital movement (£k)||524||(606)||467||(530)||(520)|
|Net cash (£k)||2,614||4,045||5,715||5,088||6,661|
During the last five years, total expenditure on tangible and intangible assets has been matched by the combined depreciation and amortisation charged against earnings.
Meanwhile, the aggregate working-capital movement shows a £665k outflow of cash — which looks modest to me given operating profit has more than doubled to £4m-plus since 2014.
Following £1.8m spent on dividends, the year-end cash position improved by £1.6m to £6.7m. At the City presentation, management revealed the latest cash position to be £7.3m (equivalent to 16.7p per share). The balance sheet continues to carry no debt and no pension obligations.
Elsewhere, TSTL’s operating margin remains at a level that underlines the competitive strength of the group’s patents, secret ingredients, proprietary know-how and independent scientific testimonies:
|Year to 30 June||2014||2015||2016||2017||2018|
|Operating margin* (%)||13.5||17.0||15.8||21.7||20.2|
|Return on average equity** (%)||13.1||22.6||21.7||33.8||28.8|
(*before US regulatory costs **adjusted for net cash)
Returns on equity remain at very acceptable levels, too.
My previous TSTL write-ups have often mentioned the share price expecting great things from North America.
But with the share price now down to 220p, perhaps investors have cooled on the FDA application and subsequent US progress. I can’t blame them — I mean, the FDA application process has dragged on for three years now, while early US sales are still a few years away, too.
Anyway, taking TSTL’s 2018 pre-tax profit before share-based payments of £4,645k and:
* Adding £500k to adjust for US regulatory costs;
* Adding £196k to adjust for the early termination charge paid to the Hong Kong distributor, and;
* Subtracting £300k as a guess for share-based payments relating only to the general staff scheme (which is £100k more than management’s estimate to give some room for error)
…I arrive at an ‘underlying’ pre-tax profit of £5.0m. Applying the standard 19% UK tax rate gives earnings of £4.1m or 9.3p per share.
After subtracting the year-end 15p per share cash position from the 220p share price, my underlying P/E comes to 205p/9.3p = 22.
In the past I have ‘fairly valued’ TSTL excluding the US at 20 times earnings, which seems about right given the business enjoys a decent competitive position, repeat revenue, satisfactory financials and respectable growth opportunities elsewhere in the world.
On that 20x multiple, TSTL excluding the US could be worth 187p per share, or £82m. As such, the US project could be valued currently at 33p per share, or £15m.
Look forward long term, and that £15m might one day seem quite cheap.
As I mentioned earlier, Nanosonics generates revenue of £30m a year within North America for disinfecting ultrasound probes. FDA approval for Nanosonics’s trophon machine was granted during 2011.
Could TSTL’s disinfectants also generate North American sales of £30m seven years after FDA approval? To be honest, I do not know.
But I am sure my £15m North American valuation would become a lot larger if such sales were actually achieved.
In the meantime, the 4.58p per share dividend provides patient shareholders with a 2.1% income.
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Disclosure: Maynard owns shares in Bioventix and Tristel.