TRISTEL: Pandemic-Disrupted FY 2022 Reiterates Reassuring 10-15%/Year Sales-Growth Ambition As US Regulatory Approval Now Relies Upon FDA ‘Negotiation’ Over Product Batches

12 January 2023
By Maynard Paton

Results summary for Tristel (TSTL):

• Another pandemic-disrupted performance, although 10-15% per annum sales-growth guidance suggests hospital customers will soon resume normal purchasing activity.

• Progress was complicated by an accounting U-turn, with Brexit stock-piling, share options, US costs and write-offs creating a wide range of profit outcomes.

• Management webinar comments suggested a positive US regulatory verdict is dependent on a “negotiation” with the FDA concerning data tests using different product batches. 

• A useful 17% operating margin, net cash of £10m, worthwhile cash conversion and low capital requirements imply the group’s disinfectants still enjoy favourable economics. 

• An estimated 24x P/E for FY 2025 is not an obvious bargain, but a premium rating may be justified by a US product approval and hefty royalties appearing soon thereafter. I continue to hold.

Contents

• News links, share data and disclosure
• Why I own TSTL
• Results summary
• Revenue, profit and dividend
• Discontinued operations and accounting U-turn
• Presentation disclosure
• Product categories
• UK versus overseas
• United States: FDA submission
• United States: FDA Predicate and De Novo guidance
• United States: costs and potential
• Patents and chemistry
• Share options
• Financials
• Valuation

News links, share data and disclosure

News: Annual report, presentation and webinar for the twelve months to 30 June 2022 published/hosted 25 October 2022 and AGM statement published 12 December 2022

Share price: 350p
Share count: 47,233,493
Market capitalisation: £165m

Disclosure: Maynard owns shares in Tristel. This blog post contains SharePad affiliate links.

Why I own TSTL

• Develops medical-device disinfectants that face limited direct competition due to proprietary chemistry, instrument-manufacturer approvals, scientific testimonies and regulatory hurdles.

• Enjoys a sizeable and resilient UK market position alongside worthwhile expansion opportunities abroad — most notably within the United States.

• Boasts financials that, pandemic-disruption aside, showcase high margins, low capital requirements, decent cash conversion and no debt.

Further reading: My TSTL Buy report | All my TSTL posts | TSTL website

Results summary

Revenue, profit and dividend

• July’s trading update had already signalled the headline performance for FY 2022:

“Revenue and adjusted profit before tax* for the year from the continuing operations will be in line with consensus forecasts of £28.4m and £4.5m respectively.

*adjusted for share-based payments“

• Revenue from ‘continuing’ operations was £1.2m higher than predicted at £29.6m, while adjusted ‘continuing’ profit before tax seemed to match the predicted £4.5m.

• Correlating July’s update to these FY figures was unfortunately complicated by TSTL reversing the accounting re-jig applied during the preceding H1.

• The preceding H1 witnessed TSTL announce a culling of ‘non-core’ products that led to revenue and profit being classified as either ‘continuing’ or ‘discontinued’.

• But management admitted during the FY webinar that the auditor had disagreed with the H1 ‘continuing’ and ‘discontinued’ interpretation, and had instructed TSTL to revert back to its previous accounting policy.

• The auditor’s instruction meant these FY 2022 results were compiled on the same basis as the FY 2021 results, but on a different basis to the preceding H1 statement (see Discontinued operations and accounting U-turn).

• Interpreting this FY 2022 statement was complicated further by Brexit stock-piling, which generated extra revenue of £0.9m during the prior-year H1 2021 that would have otherwise been earned during H1 2022.

• Total FY revenue including all discontinued products and not adjusted for Brexit stock-piling inched 0.4% higher to £31.1m:

• But FY revenue excluding ‘discontinued’ products and adjusted for the Brexit stock-piling gained 10% to £30.5m, with H2 revenue on the same basis climbing 15% to £16.0m:

• H2 revenue of £16m exceeded the £14-15m six-month revenue reported before the pandemic ‘panic buying’ of H2 2020 and the Brexit stock-piling of H1 2021:

• TSTL’s FY profit progress was also difficult to analyse.

• As well as the Brexit stock-piling and an exceptional £2.4m H1 discontinued-product write-off, reported profit was complicated by TSTL’s usual:
  • Share-based payments (see Share options), and;
  • Costs associated with the US regulatory programme (see United States: costs and potential).

• Other operating income of £167k (relating to chemical-data fees and formulation transfers) also influenced reported profit.

• Including every operating charge, FY operating profit fell 65% from £4.8m to £1.7m.

• Excluding share-based payments, US costs and the discontinued-product write-off, FY operating profit declined 8% from £6.0m to £5.5m:

• Adjust for the Brexit stock-piling as well, and the FY operating profit perhaps climbed 17% from £5.3m to £6.2m. 

• Excluding share-based payments and US costs, H2 operating profit climbed 14% from £2.3m to £2.7m:

• Although all the adjustments and guesswork with these FY 2022 figures suggest an ‘underlying’ profit improvement versus FY 2021, ‘underlying’ profit looks to have only matched that of (pre-pandemic) FY 2019 and fallen £1m short of (pandemic-boosted) FY 2020.

• The subdued profit progress reflects the impact of the pandemic. 

• TSTL develops wipes and foams that decontaminate diagnostic medical instruments such as nasendoscopes, cardio echo probes and tonometers, and the number of procedures involving such instruments reduced as hospitals became overwhelmed by Covid-19 matters.

• July’s update had provided earlier encouragement as the pandemic receded…

“Hospitals worldwide are gradually returning to normal levels of service, which for Tristel means an increasing number of diagnostic procedures, each requiring a disinfection event“

• …while this FY statement claimed the recovery was “far from complete“…

“We are confident that there is still a significant improvement in demand ahead of us as the global recovery in the provision of diagnostic services is far from complete.“

• …and reassuringly confirmed FY 2023 had started positively:

“The new financial year has started strongly with first quarter sales up 20% on the prior year — a sales run rate of £34m.“

• A sales run-rate of £34m compares to revenue of £31m reported for this FY.

• TSTL held its H1 dividend and this FY 2022 statement announced an unchanged final dividend — the first occasion the full-year payout has not been lifted since FY 2013: 

• Dividend cover was 1.3x based on adjusted earnings of 8.4p per share and management said during the webinar the payout would be held until dividend cover reached 2x (equivalent to adjusted earnings reaching 13.1p per share). 

• The year’s dividend highlight was revealed within July’s update — a 3p per share special payout. 

• The special was TSTL’s third since FY 2015 and — alongside some confident three-year guidance (see Valuation) — suggests the worst of the pandemic disruption has now passed.

Discontinued operations and accounting U-turn

• The preceding H1 2022 statement announced a welcome culling of legacy products that suffered unfavourable economics:

“During the period the Company refocused the business to accelerate top-line growth and increase profitability as it exits the pandemic. This focus is on Tristel’s proprietary chlorine dioxide technology and the hospital market. These represent “Continuing operations”. 

The Company has discontinued the manufacture and sale of most products in its Anistel and Crystel product ranges and these represent “Discontinued operations”. The Discontinued operations command substantially lower margins, and the Board considers that they will not contribute to future revenue growth without significant investment.“

• The H1 rationalisation was accompanied by an accounting change that divided the group’s revenue and profit into ‘Continuing’ and ‘Discontinued’:

• The H1 re-jig restated certain FY 2021 disclosures and created some confusion.

• For instance, the FY 2021 results had originally declared Other revenue of £3.0m, while the H1 2022 results showed Discontinued revenue for FY 2021 at £3.8m:

• In other words, some products shareholders previously believed generated ‘core’ revenue did in fact generate ‘non-core’ revenue. 

• More worrying was the FY 2021 results originally showed a gross profit of £2.7m from surface disinfectants… but the H1 2022 results restated that £2.7m to £2.1m:

• In other words, the surface-disinfectant division was less lucrative than shareholders had previously thought.

• Management explained the accounting U-turn during the FY webinar:

“We believed in February that we were reporting a discontinued operation and the accounting policy around it we thought we satisfied, which was that… there was a whole division… that we were ceasing. But our auditors have told us they viewed it differently, so it’s not appropriate. It’s a pure accounting decision by KPMG… which I’m actually really disappointed about, because I thought it was really simple and straightforward to restate… It was a huge blow. We were very disappointed not to be able to demonstrate it in that way.“

• Management explained after the webinar that the auditors determined the ceased products were not a discontinued operation because the products did not form a “stand alone” unit (the ceased products in fact shared premises and other services with the rest of the group). 

• TSTL confirmed the discontinued products “made a neutral profit contribution” for FY 2022:

“The rationalisation was committed to at the end of FY21, largely completed by 31 December 2021, and wrapped up in the second half of FY22. The discontinued products generated revenue in FY22 of £1.5m and after all associated overheads, write-off of redundant inventory and internal reorganisation costs, they made a neutral profit contribution to the year. An impairment charge of £2.4m was recorded as all license rights, IP, and intangibles associated with the products were written down in their entirety.“

• The discontinued products generated a £263k operating profit during H1, and the “neutral profit contribution” for FY 2022 implies H2 closure costs were a matching £263k. 

• The £2.4m discontinued-product write-off recorded during H1 was not changed for this FY. 

• The accounting U-turn unfortunately makes a fully accurate comparison between H1 2022 and H2 2022 impossible.

• But next month’s H1 2023 announcement should include revised H1 2022 figures that will be directly comparable to all other TSTL results. 

• The auditor’s statement within TSTL’s 2022 annual report did not mention the accounting U-turn. Total audit fees for FY 2022 advanced 19% to £331k.

Presentation disclosure

• TSTL’s presentation for this FY 2022 was thankfully more informative than the preceding H1 2022 presentation.

• The H1 powerpoint disclosed revenue only by region:

• But the FY powerpoint disclosed revenue by region in more detail…

• …as well as disclose revenue by product type:

• As such, determining the sales progress of TSTL’s most profitable products (the medical-device wipes and foams) within its largest market (the UK) has once again become possible.

• I trust UK revenue will continue to be disclosed separately from other regions. The UK is by far TSTL’s most mature market and therefore serves as a guide for the sales potential of other countries.

• The original H1 presentation did not include a Pandemic Impact slide.

• But this FY presentation commendably did: 

• The Pandemic Impact slide reveals the quarterly revenue ups and downs as Covid-19 disrupted TSTL’s hospital customers.

• Between Q1 2020 and Q1 2023, revenue from medical-device wipes and foams looks to have advanced by approximately 20%, while revenue from surface disinfectants seems to have increased by approximately 80%.

Product categories

• TSTL’s wipes and foams that decontaminate medical devices remain by far the group’s largest division:

• TSTL divulged an interesting statistic within its July update:

“During the year 15.7 million disinfection events took place with a Tristel medical device disinfectant, which is 31% higher than in the year ended 30 June 2019, before the pandemic struck.“

• Revenue from the medical-device wipes and foams was £20.3m during FY 2019 and £25.4m during FY 2022.

• As such, revenue per medical-device “disinfection event” has declined only a fraction during the last three years, from £1.69 for FY 2019 to £1.62 for FY 2022.

• Cleaning ultrasound probes appears to be TSTL’s primary money-spinner. A statement during June said: 

“Ultrasound probe disinfection is one of Tristel’s most important areas of focus within the hospital infection prevention market and accounts for approximately 40% of the Company’s global revenue which analysts forecast at £28 million for the current financial year.

Duo ULT is widely used throughout Europe, the Middle East, Asia, and Australasia and during the Company’s current financial year the product will have been used in over 8 million disinfection procedures of ultrasound probes worldwide.“

• Representing more than 50% of disinfection procedures during FY 2022 (8-plus million out of 15.7 million) but supporting (at most) 40% of revenue implies the Duo ultrasound foam has a lower price point than the typical group wipe or foam. 

• The medical-device wipes and foams retained an impressive 84% gross margin and represented 87% of group gross profit:

• TSTL’s surface disinfectants — used for cleaning hospital surfaces such as floors, mattresses and bedside tables — displayed lower revenue, lower gross profit and a lower gross margin:

• The weaker surface-disinfectant performance seemed due to the aforementioned discontinued products; the preceding H1 acknowledged some discontinued products had previously contributed to the surface-disinfectant division.

• TSTL was optimistic about the prospects for Cache, its surface-disinfectant brand: 

“Our objective is to create a clearly identifiable segment within surface disinfection for sporicidal products and to be the global market leader in this segment. 

…

The cleaning and disinfection of environmental surfaces in hospitals is ubiquitous and the global expenditure by hospitals on surface disinfection is far greater than the expenditure on decontaminating medical devices. The capability of a disinfectant to kill bacterial spores is the defining hallmark of the best-performing biocides, and chlorine dioxide is one of the elite chemistries that can kill spores.

We expect a legacy of COVID-19 will be that hospitals will be more rigorous in their selection of the best performing and most scientifically validated disinfectant products, which will benefit Cache.” 

• Conversations with TSTL’s staff during July’s open day revealed the surface disinfectants “cannot compete on efficacy alone“, and a product revamp now made “routine” surface disinfection as cheap (if not cheaper) than the ubiquitous (but less effective) pre-wetted plastic wipes. 

• However, management revealed during the FY webinar the surface-product revamp had not yet been launched…

“[Cache] does have a big future. The year was an anomaly, sales have fallen in the UK and that is due to the mix of products within there, the new products we are launching, the capsules, the Tank, they are not launched yet, they are not available and legal to sell, because we have been advised by our hospital market that they need to have the UK CA mark applied to them… So that’s another hurdle for us to jump to obtain regulatory approval for those products as medical devices, even though they are surface disinfectants.”

• Management added during the webinar that surface disinfectants were being given away to help create awareness:

“The gross margin has fallen as a consequence of sampling and giveaways, in order to get the product moving.” 

• Management told webinar attendees to take the long-term view with the surface division:

“You’ve got to take a long-term view, we have a big ambition [with surface disinfectants], it’s not going to happen in anything other than many years.” 

• I have been a TSTL shareholder for nine years, during which time revenue from the medical-device wipes and foams has quintupled to £25m and revenue from surface disinfects has quadrupled to £3m.

• In theory at least, a much more effective surface cleaner that is cheaper than the ubiquitous pre-wetted plastic wipe — as well as being much more environmentally friendly — ought to have a big future.

• The downside with surface disinfectants may not be their future growth rate, but their significantly lower price point compared to the wipes and foams.

• Management presentation comments from FY 2018 suggested the NHS was purchasing low-grade surface wipes at 2p a pop. 

• Assuming TSTL effectively price matches that 2p, enormous volumes will therefore be needed if surface disinfectants are ever to represent a notable proportion of TSTL’s profit. 

• TSTL promoting the environmental benefits of its surface disinfectants against pre-wetted wipes does raise the question about the environmental impact of its own Trio wipes product.

• Do note that Other revenue of £2.5m included ‘discontinued’ revenue of £1.5m, which still leaves revenue of £1m earned beyond hospital wipes, foams and surface disinfectants.

UK versus overseas 

• UK revenue represented 35% of total revenue, the lowest full-year proportion in TSTL’s history:

• UK revenue has stagnated somewhat since (pre-pandemic) FY 2019…

• …while overseas revenue has advanced higher:

• Reasons for the diverging performances may include:
  • Tighter pandemic restrictions within the NHS than overseas;
  • Greater ‘discontinued’ products sold within the UK;
  • TSTL acquiring distributors within markets such as Benelux, France, Italy and Malaysia, and;
  • Favourable currency fluctuations.

• But perhaps the fundamental reason for the diverging performances is TSTL’s much greater UK market share. The group started to experience slower domestic progress way back in H1 2016:

“Slowing growth in the United Kingdom is due to the very high levels of market penetration that we have achieved in the clinical areas of the hospital that we target.“

• TSTL’s largest overseas region, central Europe (Germany, Poland and Switzerland), has in contrast witnessed its revenue more than double since FY 2016:

• Furthermore, the subsequent performances of overseas distributors acquired by TSTL have been particularly impressive.

• TSTL acquired its Australian distributor for £1.1m during FY 2017.

• Australasian sales (i.e. Australia and New Zealand) have since climbed 87% from approximately AU$3.9m to approximately AU$7.3m (six-year CAGR: 11%).

• TSTL acquired its Benelux/French distributor for £6.4m during FY 2018.

• Western Europe sales (i.e. Benelux and France) have since climbed approximately 86% from €3.1m to approximately €5.7m (four-year CAGR: 17%).

• TSTL acquired the outstanding 80% of its Italian distributor for £0.6m during FY 2020.

• Italian sales have since climbed 70% from €700k to approximately €1.2m (three-year CAGR: 19%).

• TSTL’s UK progress can be influenced by revenue fluctuations created by the NHS Supply Chain (the group’s largest customer):

“Hospital medical device decontamination revenues were derived from a large number of customers but include £4.572m from a single customer which makes up 18% of this segment’s revenue (2021: £5.727m, being 24%). Hospital environmental surface disinfection revenues were derived from a number of customers but include £1.636m from a single customer which makes up 51% of this segment’s revenue (£0.930, being 23%).”

• Revenue earned from the NHS Supply Chain was £6.2m for FY 2022, but adjusted for Brexit stock-piling would have been £7.1m — and in excess of the record £6.6m earned from the Supply Chain during FY 2019.

• TSTL’s UK revenue remains dominated by the Supply Chain:

• Prior to the recent Brexit stock-piling, TSTL previously cited the Supply Chain’s unpredictable buying patterns and bulk purchases for some inconsistent UK performances. 

• TSTL did not appear concerned about any NHS budget pressures, with the presentation slides confirming “an actual price increase of 6-8% being implemented during the course of H1 [2023] in all geographical markets.”

• The proportion of total revenue derived from the NHS Supply Chain has reduced from 26% during FY 2017 to 20% during FY 2022.

United States: FDA submission

• The preceding H1 statement had reiterated TSTL would submit its application for FDA product approval by 30 June 2022:

“In the USA we have re-commenced state-by-state registration of Duo Ultrasound under our EPA approval and are confident we will complete the FDA De Novo submission for Duo by June this year“

• An update on 30 June 2022 confirmed the submission had occurred…

“Tristel… the manufacturer of infection prevention products, reports that it has submitted its De Novo request for approval to the FDA, the United States regulatory body responsible for medical device disinfectants. Tristel Duo ULT is used for the disinfection of ultrasound probes.“

• …and expressed confidence about the impact an FDA approval would have on the group:

“The United States is the largest ultrasound market in the world.. .Duo ULT is recognised as a leading high-level disinfectant throughout the rest of the world, and our entry into the United States market will be a significant inflection point for the Company.“

• June’s update also noted additional data requests from the FDA were “commonplace“…

“The FDA’s De Novo review and approval process stipulates a 150-day decision timeframe. Additional data requests are commonplace, and the FDA website states that the average duration for review and approval is approximately 11 months.“

• …and sure enough, an update during September revealed the FDA had requested additional data:

“In June Tristel achieved a major milestone event by making its De Novo submission to the USA Food and Drug Administration (FDA) for its Tristel DUO ULT product which is used as a high-level disinfectant for ultrasound intra-cavity probes. Following the FDA’s complete review of the submission, it has provided the Company with an Additional Information request.

As previously outlined to shareholders, Additional Information requests are commonplace within the De Novo submission process, and therefore the previous guidance on the average duration for review and approval of approximately 11 months remains accurate for this submission. The Company and its advisors are confident that the 180-day timeline set by the FDA to return the information will be met. The overall expected timescale for the process is unchanged.“

• These FY 2022 results confirmed the FDA’s decision should be published by June 2023:

“After more than five years of data generation, we lodged our De Novo submission for the high-level disinfectant Duo ULT with the FDA in June 2022. Our best intelligence is that De Novo submissions are typically decided upon by the Agency within twelve months.“

• The results RNS did not shed any light as to what additional information the FDA required.

• But management did reveal during the webinar the request for additional information was “pretty extensive“:

“The submission was extensive, it ran to many hundreds of pages, it underwent a successful completeness check by the agency, and then they completed their review… and as a consequence of completing that review provided us with a detailed and pretty extensive request for supplemental additional information and clarification on many points, a lot of the data they want clarification, some challenges as to the methods we had used to generate that data and we are now in the process of discussing and negotiating with the FDA, so we really do understand with our advisors what they want, and the detail and the protocols and the methodologies they want us to employ and then we will go off and get that additional data generated.” 

• Management also said during the webinar the additional request involved applying the same batch of product for all three categories of testing: 

“So they [the FDA] ideally want [us] to use the same batch of product across all three categories of testing. We couldn’t, because what was used in the potency testing in 2015, 2016, was out of date, and so you can’t work with it. So you can see some of the practical difficulties that we have encountered. 

But they have rules and guidelines and so the guideline says that we should use the same batch that’s used across all three tiers [of categories], so a bit of negotiation and… we will go back as far as we can with the batches that we still have in storage, and use that on at least two of those categories.”

• The saving grace is the usage of “ideally“, “guideline” and “negotiation“, which implies TSTL may persuade the FDA the whole testing process does not have to be repeated with the same batch of product.

• TSTL has already taken five years to undertake the tests to support this FDA submission.

• Management said during the webinar it was confident of a “successful outcome”:

“Nothing that they [the FDA] have presented us with causes us any great concern. It’s well within our gift to generate the responses that they are looking for. It’s important there is no ambiguity about what we do because we have to get it all done within the 180-day period, but we are confident we will. And we have to remain confident that we will get a successful outcome from the FDA.”

• And that confidence was repeated within December’s AGM statement:

“…[W]e are preparing the additional data requested by the FDA in September. We expect to submit it in March next year, meeting the FDA’s deadline and facilitating a decision from the agency around our year-end in June.  We remain confident of a successful outcome.”

• The risk of course is the FDA ‘negotiations’ do not go well, TSTL can’t generate the necessary additional information by March and the FDA approval timetable slips further… 

• …or even worse, the FDA demands a fresh submission with completely new data based on a single product batch.

United States: FDA Predicate and De Novo guidance

• TSTL has been consistently optimistic about FDA submissions and timetables.

• My notes from 2015 recall management initially hoping FDA regulatory approval would be received by June 2017.

• By October 2016, the directors were forecasting US revenue being earned during the year to June 2019.

• By October 2018, the directors were expecting the FDA submission would be completed by June 2019.

• And by February 2019, TSTL had withdrawn all FDA guidance after receiving feedback from the agency during the preceding September:

“We received the FDA’s feedback on 25 September 2018 to the pre-submission written review which we lodged in July 2018. Their feedback was to follow a De Novo pathway rather than the Predicate pathway.“

• Back in February 2019, TSTL noted the FDA had already accepted the group using (the less demanding) 510(K) Predicate route for regulatory approval:

• The FDA’s change of mind to a (more demanding) De Novo application meant TSTL required far more testing and data for its regulatory submission. 

• But TSTL remained optimistic despite the FDA’s change of mind.

• Full-year results published on 17 October 2018 — three weeks after the FDA’s revised application guidance was received on 25 September 2018 — revealed TSTL still hoping to submit an application based on the original (and less demanding) 510(K) Predicate process:

“We are preparing a submission to the FDA for Duo as a high-level disinfectant… We expect to submit the application for 510(K) approval during the financial year ending 30 June 2019.“

• An AGM update on 11 December 2018 — more than two months after the FDA’s revised application guidance was received — then stated the FDA project was “progressing as planned“:

“The Company is performing in line with management’s expectations and our United States regulatory approvals project is progressing as planned.”

• With the benefit of hindsight, TSTL ought to have formally disclosed the FDA’s revised application guidance earlier than it did. 

• The FDA application process started during 2015, and the subsequent setbacks and confusion allow layman shareholders the right to doubt whether a positive FDA verdict will be received within TSTL’s current expectations.

• For what it is worth, I am quite sure TSTL’s Duo foam boasts all the scientific qualities to meet the FDA’s requirements. The same foam is after all currently used without problem in many other countries.

• But whether TSTL’s extra test data will meet the FDA’s additional-information requirements remains to be seen.

• The application setbacks of the past will be quickly forgotten if, as TSTL expects, the FDA announces an approval by June this year.

United States: costs and potential

• As the FDA decision is awaited, sales of Duo foam have begun in the States under EPA approval (for disinfecting ultrasound consoles). December’s AGM statement confirmed:

“With respect to North America, we have made our first sales in the United States and Canada…“

• Management did not suggest during the webinar the EPA approval would lead to an immediate sales bonanza: 

“You can regard this as a soft market introduction with a view to gaining brand awareness, getting the product into our distribution network in the States, which has been established with our partner Parker Laboratories, all in preparation for the FDA launch, later next year, or indeed we may well find that this product approved by the EPA, as an intermediate level disinfectant… will in its own right be very successful. And that would be our hope.“

• Hints of potential long-term sales in the States were dropped during July’s open-day presentation.

• Management more than once referred to the North American ‘consumable’ revenue of £30m enjoyed by Nanosonics (NAN), the Australian manufacturer of the Trophon machine that disinfects ultrasound probes.

• NAN’s consumable revenue is generated from the sale of disinfectants used within its Trophon machines. 

• Conversations with staff at July’s open day indicated TSTL plans to price its disinfectants in the States at the same level as NAN’s Trophon disinfectants.  

• NAN’s FY 2022 results showed North American revenue of AU$107m (c$79m), comprising AU$34m (c$25m) from the sale of machines and AU$73m (c$53m) from consumables and servicing: 

• NAN has installed 26,130 Trophons in North America and still reckons the market could sustain 60,000 Trophons.

• Wishful thinking I know, but assuming TSTL can one day achieve NAN’s £30m consumable revenue in the States, the mooted 17.5% royalty from sales handled by Parker Laboratories would lead to US royalty income exceeding £5m.

• £5m of US royalties would be very significant versus FY 2022’s operating profit (before share-based payments, US costs and discontinued-product write-downs) of approximately £6m.

• NAN’s revenue is limited to disinfecting ultrasound probes, while TSTL’s wipes and foams can disinfect ultrasound probes as well as numerous other medical devices. 

• US costs were £0.6m during H1 and £0.2m during H2, taking the aggregate US expense to £3m:

• Adjusting TSTL’s reported profit for US costs allows shareholders to better judge the group’s underlying profitability. US costs up to FY 2022 have of course been accompanied by no US revenue.

Patents and chemistry

• TSTL has regularly cited patents as part of its competitive advantage: 

“In its broadest sense, our intellectual property relates to:

1. Patents, trademarks and registered designs;
2. The scientific validation of our chemistry and our products that have entered the public domain, via a number of peer‐reviewed and published papers, and;
3. The certification by medical device manufacturers that our chemistry is compatible with their products. We enjoy official compatibility with the instrumentation of 56 medical device manufacturer, with respect to 1,449 of their individual models.”

• Some of TSTL’s patents are due to expire within the next few years.

• Google Patents shows the expiry dates of TSTL’s wipe patents to be:
  • UK: 7 May 2024 (GB 240 4337)
  • EU: 26 July 2024 (EP 174 2672)
  • US: 7 September 2024 (US 808 0216)

• Google Patents shows the expiry dates of of TSTL’s foam patents to be:
  • UK: 27 January 2026 (GB 242 2545)
  • EU: 27 January 2026 (EP 184 3795)
  • US: 11 September 2030 (US 884 0847)

• Management said during the preceding H1 2022 webinar:

“It is more than the patent that gives us our protection. There is proprietary know-how that is in the formulation“

• I have previously concluded the “proprietary know-how that is in the formulation” — which I believe is not cited in the patent — relates to the speed of the chemical reaction.

• A short discussion with Bruce Green, the chemist who devised TSTL’s disinfectant chemistry, at July’s open day provided further insight into the group’s competitive advantage.

• According to Mr Green, the competitive advantage is not only helped by not divulging the chemistry, but also by not divulging the “manufacturing that goes into the chemistry“.

• Mr Green added that large American companies have tried to ‘reverse engineer’ TSTL’s chemistry, but had no success because they “did not know the right route to go“.

• Mr Green summarised the situation by telling me “don’t be concerned” about the patents expiring.

• Mr Green was notably bullish on the opportunity from new (but not yet approved) patents, which attempt to ensure manual cleaning is as effective as automated cleaning by filming and analysing the process.

• I believe these new patents to be GB 259 7911, GB 259 7912 and GB 259 7913, which all cover the “validation of procedures in a decontamination process” that involve “capturing a video stream of a work area… in which the… procedure is carried out by a user [and] analysing the video stream…” 

• If approved, these new patents could be — at least according to Mr Green — a “game changer on a world basis”.

Share options

• Significant share-based payments have featured regularly within TSTL’s accounts.

• Between FY 2016 and FY 2022, share-based payments reduced the aggregate pre-exceptional operating profit by £4.2m, or 12%:

• FY 2022 witnessed share-based payments reduce pre-exceptional operating profit by £596k, or 13%.

• Note that the share-based payment charge was £884k during H1, meaning H2 incurred a £228k share-based payment credit. 

• Accounting rules say companies should calculate a share-based payment charge even if the options eventually become worthless.

• TSTL’s (somewhat contentious) 2015 senior management options were granted when the shares were 96p and would vest if the price topped 134p. 

• TSTL’s (less contentious) 2018 management options were granted when the shares were 275p and would vest if the price reached 350p, 425p and 500p.

• All the 2015 and 2018 options vested as the share price climbed from 96p to 500p.

• TSTL granted 800k further executive-director options at the start of calendar 2021 when the shares were 500p.

• These 800k options will vest in full if profit before tax (and share-based payments!) surpasses £11.5m and the share price tops c750p during FY 2024:

• For any of the 800k options to pay out, profit before tax and share-based payments has to reach £10m during FY 2024 (versus £4.7m for FY 2022) or the share price has to trade at a c600p average during Q4 2024.

• TSTL’s pandemic-hindered progress during FYs 2021 and 2022 suggests profit before tax reaching £10m — let alone the maximum £11.5m threshold — by FY 2024 to be very remote.

• The present 350p share price is well below the minimum c600p requirement, too.

• This latest 800k batch of options is therefore likely to become worthless — and the year’s £596k share-based payment charge is therefore likely to become very irrelevant. 

• The real cost of options to ordinary shareholders is through dilution and not accounting charges.

• TSTL’s share count has advanced 14% since the start of FY 2016, with 12% due to options and 2% due to the purchase of the Benelux/France distributor. 

• The 2022 annual report showed 2,083k total options outstanding and a 47.2m share count, which indicates a maximum further dilution of 4.4%.

Financials

• TSTL’s accounts appear in adequate shape despite the pandemic hindrance and accounting U-turn.

• Excluding share-based payments, US costs, discontinued-product write-offs and other operating income, operating profit of £5.4m equated to a useful 17% operating margin:

^{(*before share-based payments, US costs, write-offs and various minor items)}

• The lower margin during the pandemic-disrupted years of FYs 2021 and 2022 has been due primarily to greater staff costs. TSTL said:

“Overheads (excluding share-based payments, depreciation, amortisation and impairment) rose by 6% from £16.4m to £17.4m, principally due to the increase in headcount from 189 to 199. The associated increase in wages and salaries of £0.7m (excluding share-based payments) was partially offset by a reduction in travel and the number of medical conferences at which we exhibited.“

• The extra headcount in part relates to greater compliance requirements:

“Compliance can only be achieved by increasing overhead to attract the best Quality Assurance and Regulatory Affairs people in a highly competitive market for such skills. This is one cause of the upwards pressure on our business costs.”

• Employee productivity has unsurprisingly declined during the pandemic:

• Revenue per employee is not unsatisfactory at approximately £160k, but is back to a level first seen during FY 2015.

• TSTL’s balance sheet implies the business remains an inherently capital-light operation.

• Net assets of £29m less intangibles (£9m) and cash (£9m) leaves £11m, represented mostly by working capital (£7m) and property, plant and equipment (£3m). 

• £11m compares to FY 2022 operating profit (before share-based payments, US costs and discontinued-product write-offs) of approximately £5m, and implies TSTL may not need to reinvest huge amounts to advance profit further. 

• Cash flow remains respectable. 

• The year ended with cash at £8.9m, up £0.8m, after £3.5m was generated by the business, £0.4m was raised through options and £3.1m was paid as dividends.

• For this FY and on aggregate during the last five years, net expenditure on tangible and intangible assets has been commendably matched by the combined depreciation and amortisation expensed against earnings:

^{(*before share-based payments and write-offs)}

• Working capital has absorbed an extra £3.4m during the last five years, which does not seem too horrendous given revenue during the same time has advanced by £11m, or 50%.

• SharePad shows stock and debtor levels versus revenue as being reasonably consistent, while decreasing creditor levels presumably reflect TSTL paying suppliers faster and does not feel too worrying:

• December’s AGM statement said cash had increased after the year-end to “approximately £10m“.

• TSTL carries no bank debt and no final-salary pension obligations:

Valuation

• December’s AGM statement implied revenue may advance at least 9% to at least £34m for FY 2023:

“The Company is returning to its pre-pandemic growth trajectory, with first half revenue expected to exceed £17m, compared to £15m in the first half of last year. Revenue growth is consistent across all our geographical markets. Gross margin is in line with expectations…

The Company is making good progress… [and] we face the prevailing economic environment with confidence“”

• FY 2023 revenue growth excluding the discontinued products should be greater than the implied 9%. 

• Looking further out, this FY statement repeated the three-year guidance unveiled at July’s open day:

i) sales growth in the range of 10% to 15% per annum as an annual average over the three years;

ii)  the achievement in each year of an EBITDA margin (excluding share-based payment charge) of at least 25%.

• The guidance was almost the same as that set during October 2019 for the three years to FY 2022:

“i)  sales growth in the range of 10% to 15% per annum as an annual average over the three years;
ii)  the achievement in each year of an EBITDA margin (excluding share-based payment charge) of at least 25%, and
iii)  to increase profit before tax (excluding share-based payments) year-on-year, independently of the other two targets.

• This time the third ambition — to increase profit before tax year-on-year — has been dropped.

• TSTL commendably compared the 2019 targets to the group’s subsequent performance:

• Management confirmed during the webinar that no US sales were included in the new three-year guidance. 

• Achieving the top-of-the-range 15% revenue-growth target would deliver FY 2025 revenue of £47.3m.

• Then meeting the minimum 25% Ebitda margin (before share-baed payments) would give FY 2025 Ebitda of £11.8m.

• Less FY 2022’s depreciation and amortisation of £2.7m then produces a pre-tax profit of £9.1m.

• Applying the forthcoming 25% standard UK tax rate then leaves earnings of £6.8m or 14.5p per share.

• The valuation sums could be fine-tuned further for lease costs, the cash position, depreciation/amortisation changes and tax intricacies, but the 350p share price at 24 times my 14.5p per share calculation — for FY 2025 — does not indicate an obvious bargain.

• The premium share-price rating may be justified if:
  • TSTL’s secret chemistry, manufacturer agreements and regulatory approvals continue to underpin a worthwhile competitive advantage;
  • The renewed focus on hospital wipes, foams and surface cleaners revives TSTL’s operating margin and employee productivity;
  • TSTL proves resilient against a tricky global economy and enjoys further meaningful growth within its established markets, and;
  • An FDA approval is received as expected, US sales suddenly take off and hefty royalties are quickly collected. 

• June’s update was positive on that final point:

“Within the next five years we have high hopes that America will be a significant revenue and profit contributor to the Group“.

• But the likely share-price downside remains significant should TSTL fail to obtain FDA approval after taking eight years to lodge a submission.

• While shareholders await the FDA’s verdict, the trailing 6.55p per share ordinary dividend supports a modest 1.9% income.

Maynard Paton