What Caused Intuitive Surgical (ISRG) to be a 9x Bagger in Less Than 2 Years?

Intuitive Surgical (NASDAQ: ISRG) shares started 2004 at $5 per share and ended 2006 at $45, a 9x return in 2 years.

What caused the explosion in the stock price?

The best I can tell looking back at the data: (1) an enviable market position with a very large total addressable market for its da vinci product and (2) accelerating revenue growth, an earnings inflection point, and EPS acceleration both year-over-year and sequentially.

If we look back at the results, starting in Q1 2004, Intuitive Surgical started posting incredible numbers.

Q1 2004 revenue was up 41% YoY, and earnings inflected to a 2c profit from a loss of 12c in Q1 2003, then the company followed up with 45% revenue growth and 14c EPS in Q2 2004.

If we look back just one quarter to Q4 2003, ISRG posted 30% revenue growth but lost 16c per share.

In my eyes, the Q1 2004 report delivered in late April 2004 caught the imagination of many investors because of the revenue acceleration and an EPS inflection point. The stock was finally ready to go: an enviable market position plus great execution leading to rapidly improving fundamentals put a significant tailwind behind the share price.

Following Q2, ISRG then reported 52% revenue growth and 17c EPS in Q3 2004. Meanwhile, ISRG also reported expanding gross margins from the low 50% range at lower revenue levels, increasing to 64% by Q3 2004 as ISRG enjoyed the benefits of higher margin consumables in its product mix and efficiencies of scale at higher levels of revenue.

It seems like revenue growth coupled with gross margin expansion and operating expenses that grow at a slower pace lead to a rapid expansion of pre-tax operating margins and, consequently, earnings growth which ultimately drives stock prices.

ISRG growth continued to accelerate when it reported Q4 2004 numbers in February 2005, with revenue up 64% and 32c EPS, up from that 16c loss in Q4 2003.

Q1 2005 ISRG revenue growth was 54% and 25c EPS (vs 3c Q1 2004. Gross margins expanded to 65.5%.

Q2 2005 ISRG revenue growth was 70% and 40c EPS (vs 14c Q2 2004). Gross margins expanded to 68%.

It appears like this Q2 2005 earnings report on July 26, 2005 was the catalyst for the next crescendo in ISRG stock price, driving it from $17 per share on July 26 to $24 just two days later on July 28, on its way to finish the year at $45 (nearly a triple in half a year).

More tailwinds to the share price ascent came in October 2005 due to the following Q3 2005 results: ISRG revenue growth was 72% and 55c EPS (vs 17c Q3 2004). Gross margins expanded to 69.5%.

In February 2006, ISRG reported 60% revenue growth and $1.31 EPS (of which there was a $24.1 million tax benefit) so those earnings weren’t totally comparable YoY to the 31c ISRG put up the year before. The stock cooled off from $45 to $30 per share in March 2006 (the CFO disclosed a plan to sell 18,000 ISRG shares), and stayed in that range until January 2007 when ISRG shares started its next ascent to $110 per share by year-end 2007, a 22x bagger in 4 years from the $5 stock price in January 2004.

Why is all this important?

I believe I’ve identified a stock that could start to accelerate revenue and EPS starting in Q4 2018, and this company is a tiny $80M market cap medical device manufacturer called Sensus Healthcare (NASDAQ: SRTS), currently trading at about $5.50 per share.

Not only is the company growing its core superficial radiation therapy (“SRT”) equipment (for use in non-melanoma skin cancer and keloid indications) revenue at 30% YoY, the company appears to be on the verge of inflecting to GAAP profits and a revenue acceleration on the back of a key corporate customer who is finding success in providing turnkey solutions to dermatology clinics across the country, and a product portfolio, geographic reach and sales organization that continues to expand.

Non-melanoma skin cancer and keloids are very large markets. In particular, NMSC affects over 4 million Americans a year alone and is expected to rise to 6 million occurrences per year over the next couple of years. The “gold standard” for removing skin cancers is Mohs surgery, but it is expensive and can cause significant aesthetic damage. Superficial radiation therapy, on the other hand, is less invasive, costs less and at one time, half of all the dermatology clinics in the United States had SRT equipment before it fell out of favor because there weren’t any material advancements to the technology.

Sensus reintroduced the technology in 2011, and has driven its install base to around 400 units. There are 14,000 dermatology clinics in the US, so if we use the 50% penetration rate achieved decades ago, there is a path to 7,000 SRT machines at dermatology clinics in the US alone. And that doesn’t include hospitals, radiation oncology clinics, plastic surgeons or any international opportunity which also dramatically expands the total addressable market for SRT equipment.

Moreover, Sensus recently published the results of one of its key opinion leaders which indicated that keloid recurrence was only 3% when coupled with SRT, which is a statistically significant variance versus the 71% recurrence rate using other methods. Given insurance plans only cover keloid removal when coupled with SRT treatments, I believe this could be a large growth driver for Sensus in the years ahead.

Sensus raised $15.9 million in growth capital in September 2018 to support inventory builds, and to expand its R&D and sales organization for the potential commercial launch of its disruptive Intraoperative Radiation Therapy product (IORT) called Sculptura which is pending FDA 510k clearance.

Analyst estimates call for $7.5M in Q4 2018 revenue, but based on some of my own scuttle research, I believe SRTS could put up a $9M+ revenue quarter which would drive 2-5c EPS (up from a 3c EPS loss in Q4 2017) and result in revenue growth nearing 40%. I think the magic number is 40%+ growth, then acceleration higher than that (as evidenced by the 2004-2005 IRSG results and share price appreciation), but a $9M quarter would provide another period of accelerating revenue growth YoY, Q2 2018 was 22% growth and Q3 2018 was 32%.

None of this $9M projection includes any sales of Sensus’ new IORT product which has a $1.45M list price. CEO Joe Sardano said the company is building 4 beta units, and is in discussions with key teaching institutions who have Investigational Review Board (“IRB”) status, and who can acquire the product before an FDA 510(k) clearance. To that end, Mr. Sardano did suggest that there is a potential to place up to 4 IORT units in Q4, but the company is guiding investors to expect IORT revenue starting in 2019. That said, this company has a history of under promising and over delivering, so I believe there is a decent probability Sensus reports at least one IORT sale before year-end which could provide a meaningful catalyst for the stock.

If we assume SRTS can record about $26 or $27M in 2018 revenue, and the core SRT business can grow 30% in 2019, that leads us to $35M in 2019 SRT revenue. Add in a few million revenue contribution from recently a introduced cosmetic laser portfolio, and we are at $37-$38M for 2019. Then if we add in 4 IORT sales at $1M to the teaching institutions and 4 commercial IORT sales at $1.45M, and it appears like there is a path to $45 to $50M in 2019 revenue. Assuming 62% gross margins and $22M in operating expenses for the year and 16M shares outstanding, it appears like SRTS has a path to earning $5+ million in 2019, or about 30c EPS.

The profitability is nice, but I think the stock will trade more on a revenue multiple if investors become enamored with Sensus’ market position and addressable market, both which seem solid and vast.

Disclosure: Long SRTS shares

Sensus Healthcare (SRTS)

I’ll admit it. I own entirely too many shares of Sensus Healthcare (NASDAQ: SRTS).

Even while markets experience volatility and face many factors that are creating a formidable wall of worry, I think it is best to continue to focus on fundamental research. This ultimately helps investors not get scared out of promising investment opportunities.

As it relates to Sensus, my scuttlebutt research and channel checking indicates that revenue growth is accelerating within Sensus’ core superficial radiation therapy (“SRT”) equipment which is used by dermatologists and radiation oncologists to treat non-melanoma skin cancers and keloids.

What kind of growth are we talking about? Over the last couple of years, Sensus recorded around 30% growth rates. The install base of its SRT machines should expand to greater than 400 by year-end 2018, and most sales are trending towards its feature-rich SRT-Vision system with an $375,000 list price. Sensus’ base line is called the SRT-100 ($200k list price), and provides basic SRT treatment, but omits features such as image-guided therapy.

Meanwhile, the company introduced the SRT-100+ ($250k list price) which adds incremental features to the SRT-100, including cloud-based electronic medical record access and remote treatment monitoring, and made its first commercial sale in early November 2018.

Sensus also introduced a line of lasers for various cosmetic treatments, and CEO Joe Sardano said three units were in the backlog and ready to be delivered in Q4 2018. The key to Sensus’ success is expanding its sales force, product line and geographic reach. I’m expecting lasers to contribute $100k to Q4 sales.

Based on my research, I believe Sensus can deliver 20+ SRT-Vision units in Q4 which equates to $7.5M in Q4 revenue. While I don’t have a good view into SRT-100(+) sales, it appears like Sensus was selling at least 6-12 units per quarter since Q1 2017, while Q3 2018 came in at only 3 SRT-100 units. Based on comments from management, it appears as if former SRT-100 customers are trading up to the feature-rich SRT-Vision line, and the SRT-100 sales are generally trade-ins and sold used.

In addition, only the SRT-100 is approved in various international markets such as China, Mexico and others, so its a bit opaque around what the SRT-100 sales activity will be in any given quarter. That said, it is becoming a de minimus part of the business, but I’m expecting that Sensus and its channel partners can place 5 SRT-100(+) in Q4 which is a seasonally strong quarter. If we use an $150k ASP (to account for trade-in’s and used sales), that adds another $750k to Q4 sales.

Finally, Sensus has a very disruptive product – an intraoperative modulated radiation therapy device called Sculptura — hanging in the balance for FDA 510(k) clearance with the FDA. Sensus’ CEO Joe Sardano indicated the list price will start at $1.45 million, and the company is currently manufacturing 4 beta models to be placed at luminary institutions with IRB status at “very special” pricing.

I think IORT represents a compelling upside option for SRTS shares given the large addressable market for the equipment. Mr. Sardano suggested the reception for IORT at the ASTRO conference was overwhelmingly strong, and radiation oncologists were eager to use the device.

Given SRTS trades at $5.75 as I write this narrative, equating to a $92M market cap, or $75M enterprise value after backing out $17M in net cash, I don’t think the IORT is priced into SRTS shares at current levels. To that end, if Sensus can deliver $8.5M in Q4 revenue ($7.5M SRT-Vision sales, $750k SRT-100(+) sales, $100k laser sales, and $150k in services sales), it would equate to 31% growth YoY and drive about $27M in full year 2018 revenue. At $8.5M revenue at 65% gross margin, that yields $5.5M in gross profit dollars, and I’m assuming about $5M in total operating costs, driving a $500k pre-tax operating margin, or 3 pennies EPS per share (versus a loss of 3 pennies in Q4 2017).

I believe investing in microcap stocks before a GAAP profitability inflection point and/or growth acceleration is one method to drive “alpha” in any market environment. That is the set up we could see for Sensus as it drives patient and dermatologist awareness about its products, and enters the radiation oncology market for IORT.

I’m not sure if or when Sensus will receive FDA clearance to market IORT commercially in the United States, but the company has been actively hiring qualified sales personnel from companies such as Elekta and IBA. If Sensus can sell all 4 “beta” IORT’s to the luminary institutions, and layer in 4+ commercial sales of Sculptura in 2019, coupled with continued 30% growth in SRT sales, Sensus has a path to $45M in 2019 revenue which would drive 67% growth over 2018 revenue ($27M, my estimate), and generate GAAP profits.

How much is the stock worth? I think there is a path to 5-7x 2019 revenue, which would imply a $270 million market cap at the midpoint. There are about 16M shares outstanding, and 2.3M warrants with an exercise price of $6.75 which expire on June 2 2019. If we include the 2.3M warrants in the share count, I’m estimating that there is a path to $15 per SRTS share (not including current cash or cash from warrant exercises in the valuation) if the market warms up to SRTS growth opportunity in SRT and IORT.

One note: there is an overhang from a recent sell-side analyst report who questioned the relationship with Sensus’ largest customer, a turnkey provider of SRT treatments. After considerable due diligence on this relationship, I believe it is a normal and customary relationship, and that the SRT-Vision machines that are being put in the field are highly utilized, and when coupled with additional reimbursements by the CMS, it appears as if the SRT machines throw off enough cash flow to scale the relationship considerably in 2019.

Disclosure: Long SRTS

Entrenched Interests

One of the biggest hurdles to overcome before change can happen is breaking down entrenched interests.

Ever wonder why our current health care system is designed the way it is, dominated by fee-for-service and insurance that is largely tied to employment and the private sector?

Entrenched interests.

Clinicians are incentivized to over prescribe services because the economics are such that they can get paid more for just performing more procedures, not necessarily based on the patient health outcome. We need to move more towards a value based approach for health care reimbursements.

Private health insurers obviously don’t want a single payer health care system because it puts them out of business. Better to pay up for lobbyists and political contributions than ceasing to exist. Call it a cost of doing business.

As part my investment research, I sometimes look at medical device manufacturers as an area of potential opportunity, particularly for companies that appear to provide cost effective, positive outcomes relative to the current status quo.

One such example is Sensus Healthcare (NASDAQ: SRTS), and their approach to treating non-melanoma skin cancers and keloids with a treatment known as “superficial radiation therapy” as opposed to Moh’s surgery (for skin cancer).

The Center For Medicare/Medicaid Services (CMS) is the entity that sets government reimbursement levels for healthcare procedures. Moreover, I understand the American Dermatology Association (ADA) is an industry group that provides comments/opinions on the dermatology market. The ADA only officially recommends Moh’s surgery or excision for skin cancers, but does offer that other types of treatments such as radiation therapy can be an effective option for certain patients.

I understand Moh’s surgery reimbursement can approach $25,000, all-in (including cosmetic surgery), relative to SRT which is reimbursed at a $2,000 for a full treatment (and also includes reimbursement for other physician check up work) which requires about 13 treatments to eradicate the skin cancer using the technology. This, of course, is the main drawback to SRT: it requires patients to visit the dermatology clinic 2-3x per week for 6 weeks to administer the full treatment, although the SRT treatment takes only a few minutes to perform. The benefit is SRT does not require any cutting and resultant cosmetic damage, leaving some patients to prefer the SRT option over Moh’s.

Moving to Sensus’ new product — an Intraoperative Modulated Radiation Therapy device called Sculptura — and we see another CMS reimbursement issue arise. IORT is administered once during a tumor removal surgery with radiation directed at the tumor bed to avoid further spread of cancerous cells. Alternatively, the current standard for radiation is for high dose rate products, delivered on a fractionated basis, which exposes patients to much higher levels of radiation. And you guessed it: external beam radiation therapy costs the CMS much more because it is based on the number of times the procedure is performed (fractionated) versus the patient outcome.

Because many governments are moving more toward a value based approach towards health care reimbursements, I’m hopeful that a product like Sculpura will gain market acceptance and that radiation oncologists/clinics/hospitals can realize a fair return on their investment. Sculptura will be offered at a $1.45 million list price, and is sold with an annual service contract but the device does not have recurring consumable sales. This aligns with value-based health care business models.

The trick will be to overcome entrenched interests that exist in the market today.

My hope and expectation — as idealistic as it sounds — is that patient outcomes and value matter. Healthcare should be like any other competitive industry — the provider of the safest, most cost effective treatments with the best patient outcomes should win in the marketplace.

If you are interested, you can check out Sensus Healthcare’s investor deck here.



How Do You Know?

There is comfort in certainty. But how do we know what we think we know is certain?

The truth is we don’t know anything for certain. We can’t. When life throws us the proverbial curveball, the inherent uncertainty in which we operate on a daily basis is a kind of stomach tossing awareness becomes painfully apparent.

We live in an incredibly complex, ever evolving landscape. Have you been watching the news lately? One problem, however, is the news itself. Attention grabbing headlines can change sentiment in a hurry. And because humans are herd-seeking followers, the collective sentiment can have a profound influence on one’s individual outlook. If enough people start believing a new narrative, a self-fulfilling prophesy can sometimes result. Things overshoot both on optimism and pessimism spectrum.

Humans are incapable of processing or knowing all the relevant information pertinent to making a decision, that in itself creates uncertainty. We want certainty that we are making optimal choices, but we need to recognize and respect our blind spots.

So if our decisions are inherently uncertain, how does one make a decision at all given the risk of being wrong?

A decision maker needs to assess all the available data, and come up with a number of potential responses. It is OK to make a bad decision or be wrong, but the ability to course correct is much more important. After all, one can be right for all the wrong reasons, or get something wrong when the decision was based on a sound process.

Luck is an important variable.