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SNWV: Disappointing Q3 Revenue But SNWV Expects Record Sales in 2018

11/29/2017
By Brian Marckx, CFA

OTC:SNWV

Q3 Results, Operational Update: Another Top-Line Dud But We Still Expect OUS Adoption To Improve….

SANUWAVE (OTC:SNWV) reported Q3 financial results and provided a business update.  Similar to the first two quarters of the year, revenue was disappointing.  But, given that management had mentioned on the Q2 call (in August) that July was a record in terms of device shipments and that they were expecting Q3 sales to be up dramatically from the prior quarter, the most recent number was particularly disheartening.  The relative dud of a topline number in Q3, coupled with longer than anticipated runway in generating initial sales from new territories and lack of any obvious meaningful revival in sales from S. Korea (i.e. SNWV’s leading market), means revenue will almost certainly be nowhere close to a record in 2017.  But, while management’s 2017 revenue prediction will not be met, based on their comments on the Q3 call relating to anticipated demand (which includes recent feedback from distributors), they do expect to see record revenue in 2018 (regardless of FDA’s decision). 

The good news as it relates to recent financials is that operating expenses trended much lower from Q2 and, despite the miss to management’s sales guidance, cash burn remained on the low end of SNWV’s range of expectations.

Relative to the operational update – in terms of the OUS business, management noted on the call that they have recently been and will continue to be busy attending industry events and, even holding their own symposium, with the goal of generating additional awareness of their device with the hope that it translates into a greater ramp in international sales.  Clinical data and KOL attention may be key to sparking additional demand and both of these are main topics of SNWV’s refreshed strategy.  The recently penned MundiMed agreement will not result in significant income in 2017 (although initial upfront payment to SNWV and a handful of device sales to MundiMed should be incremental to Q4) but, assuming consummation of the definitive agreement, approval of dermaPACE by Brazilian regulators and launch shortly thereafter, it is possible that material contribution from the JV could happen in 2018.  

As it relates to the U.S. strategy, while SNWV indicated that they have been in regular contact with FDA, their last official interaction was during the summer when they submitted formal responses to additional questions from the agency.  Indications are that this is now a wait-and-see period with the hope that FDA returns a positive decision to the De Novo application (which was filed 494 days ago) soon.  

Financials
Q3 revenue was $162k, representing yoy decline of 37%.  While revenue grew 46% sequential, the qoq comparable was relatively extremely easy given that Q2’s sales of just $111k were the lowest since at least Q2 2008 (which is the furthest back that we looked).  Revenue was $422k through the first nine months of 2017 – which is down 42% from the comparable prior-year period and represents the lowest revenue among any consecutive three-quarter period since the $382k generated from Q4 ’09 to Q2 ’10.  

Q3 revenue missed our $371k estimate by 56%, which follows a 55% miss in Q2 ($111k A vs. $244k E) and a 19% miss in Q1 ($150k A vs. $185k E).  Based on SNWV’s comments on recent earnings calls, we had opined that revenue weakness may have been related to mostly non-fundamental reasons such as adverse timing or, in the case of S. Korea, political turmoil.  But, given continued trends of estimates (ours and management’s) overshooting actuals by large margins with seemingly little relationship between the misses and the presumed causes, we now believe demand-related traction via expansion of the distribution footprint may not materialize as quickly as we had previously anticipated.

S. Korea, which SNWV has indicated remains the company’s leading market, was expected to represent much of the anticipated revenue growth during 2017 as a result of availability of reimbursement.  That appears to not have materialized – whether that is due to the political upheaval earlier this year or something else, is not completely clear.  But, the fact that SNWV’s distributor accounts for 78% of the company’s A/R balance and 48% of their bad debt balance, may suggest that their S. Korean partner is having difficulty finding buyers.  

While we have tempered our forecasted sales from S. Korea, for several reasons we do think that it is more likely than not that revenue growth will materialize from this territory.  Management provided some specifics on the Q3 call relative to utilization in S. Korea – noting the number of reimbursement cycles that clinicians have gone through – and while the figures (i.e. 300 to 400 reimbursement cycles) are not particularly meaningful to us (i.e. we don’t have the decoder ring), the fact that SNWV can track activity and indicated that it is increasing is a positive development, in our opinion.  Management also noted on the Q3 call that the order book for 2018 is “dramatically larger than we’ve ever seen out of any one country”.  Additionally, SNWV mentioned that new clinical and published data should be forthcoming from S. Korea in both DFU as well as scar tissue (following C-section) – our experience is that positive and compelling published data is typically the single-most influential aspect of any sales/marketing strategy.

Another issue that management pointed towards that has hampered demand growth is longer-than-anticipated regulatory approval in many of the territories where SNWV recently signed distribution contracts.  While SANUWAVE brought on distribution in six new territories during 2017, regulatory approval is still outstanding in many of these.  We think another factor may be slower than anticipated adoption of SNWV’s device in countries where it has recently gained regulatory clearance.  KOL-support and leading with clinical data is now at the forefront of marketing strategies, which may improve uptake.   

Q3 OpEx was $742k, which is well below our $909k estimate and a significant decrease from both Q2 2017 ($1.39M) and Q3 2016 ($912k).  The majority of the sequential decline reflects lower non-cash stock compensation in Q3.  

Cash used in operating activities was $372k and $945k ($819k and $2.42M, ex-changes in working capital) in the three and nine months ending 9/30/2017.  Cash balance was just $40k at Q3 quarter-end.  Per the 10-Q, SNWV issued $1.12M in 10% convertible notes in early November.  Management continues to expect monthly cash burn to average $125k - $225k through the remainder of 2017.  While the upfront (received in Q4) and subsequent (over the first 18 months) fee payments from MundiMed should provide incremental capital, it will not be enough to fully fund operations.  SNWV indicated that they have been evaluating similar agreements with potential partners in India, China and the Middle East which, if closed, could also possibly bring in additional funds to the company.  But, we continue to expect the company to look to raise additional cash via the sale of equity or debt or potentially through one or more partnering arrangements. 

International Strategy…
As a reminder, earlier this year management outlined several goals that they expected to accomplish by year-end including the onboarding of an additional 7 - 10 new distributors/territories.  Including the MundiMed JV, they are now at number six and based on comments on the Q3 call, management believes that they will further expand their international footprint by the end of 2017.  While many of the recent additions are in the orthopedics space, MundiMed adds a high-potential wound care channel and other DFU opportunities could follow - which could be facilitated if and when dermaPACE is approved in the U.S. (as OUS uptake is likely to benefit from implied validation that comes from FDA approval).  SNWV is also currently evaluating several wound care related distributors in parts of Europe.        

Recent "wins" on this front included the signing of major distributors in Taiwan and Indonesia as well as engaging an organization in Columbia to source qualified distributors in that country.  Romania is another country where they also recently added distribution.  SNWV is also active in looking to expand to other parts of Asia (including China, India and Thailand) as well as to the Middle East and S. Africa – all of which represent relatively large populations and could be particularly well-suited for a MundiMed-type arrangement (i.e. JV with large, local and experienced distributor).  SNWV attended both MEDICA and Wounds Canada and mentioned that feedback from distributors suggests device sales should significantly pick up next year and result in record international sales.  However, given the optimistic-yet-not-fulfilled assumptions during 2017 related to revenue, our model implies somewhat more conservative OUS (ex-MundiMed) sales (although we do expect significant growth compared to 2017, we are modeling 2018 int’l sales slightly below that of 2016).  

SNWV recently updated their strategy in selecting distribution partners with additional emphasis placed on expertise in wound care versus orthopedics given the differences and difficulties in detailing to two distinct end-markets.  Management also noted that some of their distributors - notably Alat Medika (a prominent Indonesian med-tech company) - also have the capabilities to help facilitate clinical trial activities in their respective territories. 

As we have noted in the past, given the dearth of non-invasive and relatively inexpensive DFU-treatment options, we think dermaPACE has a place in chronic wound care and believe a reasonable scenario exists where SNWV can reach a point of operating profitability from OUS business alone.  Clearly, much of the ultimate success of the international strategy may rely on partnering with organizations with sufficient and appropriate expertise, contacts and channel depth (at both private and national healthcare levels) to execute their strategy.  We have yet to see much substance (in the form of revenue) from this international expansion - although given the lag between fundamental operational progress and related revenue, the next few quarters should be a much better judge in that regard.  

This international strategy involves targeting key opinion leaders to help drive adoption.  Management noted that it typically takes about 3 – 9 months after a new distributor/territory comes online to be able to assess the potential of the launch and before any significant related revenue may be generated.  As such, assuming SNWV continues to expand their distribution footprint through the remainder of the current year, much of the revenue benefit may not be realized until 2018.  Nonetheless, we had expected to see a more meaningful contribution from new territories by now, particularly as new distributors are required to purchase at least two systems initially ($40k - $60k revenue).  

As noted, management mentioned on the Q2 call (mid-August) that they had record shipments in the month of July and that they continued to expect 2017 would be a record year in terms of revenue.  While our model was much more conservative (and did not imply record sales for 2017), clearly even our assumptions were too optimistic.  The speed with which dermaPACE gains regulatory approval in new territories appears to have been overestimated, as does the rate of adoption in those countries where the device is already cleared for sale.  

While it is not completely clear what the issues have been, we have found that it is not uncommon to overestimate initial adoption.  We have seen adoption of novel therapies (particularly therapeutic devices) hampered by a variety of headwinds including lack of appropriate reimbursement, “insufficient” clinical evidence, healthcare system structural impediments, less-than-competent distribution, less-than-compelling competitive differentiation, unworkable economics, cost and lack of access to healthcare, among a whole host of others. 

But, as noted, the recent feedback from SNWV’s distribution partners appears to be favorable as it relates to anticipated demand.  As these local distributors should have the best insight into what challenges they may face in their respective markets, presumably their optimism suggests that any hurdles are manageable and demand will be relatively robust in 2018.  Publication of additional clinical trial manuscripts as well as a determined focus at the KOL level, will be strategies that SNWV will employ to improve adoption.  Supplemental awareness-building efforts, including attendance and participation at industry events and conferences, such as MEDICA, as well as hosting their (first in a long time) own symposium (which management mentioned is expected to be well-attended) will also be a part of the adoption-sparking strategy game plan.        

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