Powering towards positive adjusted EBITDA
Creo Medical has issued a trading update showing increased licensing and core Creo revenues with steady Consumable sales. Creo, by steadily training more doctors to use its products, expects to see rapidly increasing sales of its dual-energy endoscopy tool: Speedboat. There are now 150 trained doctors of whom 80 are confirmed users of Creo tools. Another 450 doctors are moving along the training pathway.
Creo develops and sells surgical devices like Speedboat for minimally invasive endoscopic surgery mostly used in bowel procedures and increasingly in upper GI surgery. Creo's technology offers both bipolar cutting (electrical localised heating) and microwave coagulation (to stop bleeding). Creo's devices and advanced technologies are now licensed to robotic surgery companies. The new SpydrBlade multi-purpose tool is likely to enter regulatory review in early 2023 and could be marketed by H2 2023. Consumable sales in the US linked to these devices should bring a rising, strong revenue stream. Finally, sales of the Croma dual energy generator, powered by Kamaptive, and partnerships with two robotic surgery companies added FY22 revenues of about £1.2mln in F22 and should grow.
Core sales will drive moves to positive EBITDA
Creo aims to achieve a positive adjusted EBITDA by the end of FY25. To realise this, management expects higher margin core product sales to rise from about £1mln in FY22 to about £15mln in FY25, a Compound Annual Growth Rate (CAGR) of over 90%. Consumable sales could rise in the US to about £12mln; these should add to the steady growth expected in European Consumable sales from about £24.8mln in FY22 to about £30mln in FY25. Future partnering revenues to 2025 could be in the £3-4mln range. After 2025, we expect robotic company partner sales to rise strongly; clinical validation might start in 2023. The better product mix could take the FY25 gross margin to nearly 60% (about 48% in H1FY22) implying about £35mln gross profit on our forecast revenues of over £60mln.
The sales rise expected is accompanied by a reducing R&D budget and careful cost control. Nonetheless, continuing R&D will allow cash tax credits to be claimed, so in FY25 adjusted EBITDA is positive after an expected £3mln tax credit. Administration and sales costs are expected to grow as the main sales effort in the USA and Asia is based on training surgeons.
Creo's trading update disclosed an overall approximate 7% revenue growth over FY21 to about £27mln on our estimate, down from our former forecast of £28mln. FY22 year-end cash was reported at £13.1mln. Due to investment in doctor training, Creo is expected by us to need £15-20mln in further funding during 2023 as it moves towards positive 2025 cash flows. The indicative valuation has been revised. We assume a possible after-tax profit in the £45-50mln range in 2027 on sales of about £140mln, as indicated by management. We then apply a long-term growth rate of 5% and a discount rate of 25%. On this conservative basis, Creo could be worth about £100mln as of 1 January 2023. We note that if the projected growth rates are achieved and inflation falls, the potential value could be expected to be at least double this, possibly about £250mln.
Positive growth prospect
Year end Dec 31 · 2020 · 2021 · 2022 · 2023
Revenue (GBP-mln) · 9.0 · 25.2 · 27.1 · 36.5
Gross Profit (£mln) · 4.0 · 11.6 · 13.1 · 19.1
EBITDA (£M) · (18.7) · (19.0) · (22.8) · (10.5)
Creo management expects a positive adjusted-EBITDA by FY25. The main sales growth is in the Creo core products of Speedboat and, after expected 2023 approvals, SpydrBlade from 2024. The US is the main growth market. Consumable sales linked to Speedboat and SpydrBlade procedures are expected to grow in line.
Growth projections
The scenario envisages relatively flat distributor consumable sales through Creo's European operation of up to £30mln after £24.8mln estimated in FY22. Further US consumable sales add to these. Future licensing income is expected to be between £3mln and £4mln whilst the robotics partner companies integrate aspects of the Creo Kamaptive technology.
Chart 1 - Sales to 2025
Source: ProActive Investors, Creo Reports
Although Creo management still guides to a small pre-tax loss in 2025, this is offset by tax credits so an overall adjusted positive EBITDA is expected. This is despite UK R&D tax credits becoming much less favourable to SMEs.
Margins, costs, tax and profits
The forecast FY25 adjusted EBITDA is projected by us to be about £1.0mln after a tax credit of £3mln. Although we do not make a formal forecast we expect Creo to become profitable after 2025, possibly in the range of £45-50mln by FY27.
Creo, as of FY21, had unused losses of £46.4mln so it is not likely to pay tax before 2027.
Chart 2 - Margins, costs and net profits to 2025
Source: ProActive Investors, Creo reports
A key part of the transition to a positive adjusted EBITDA by 2025 is the curtailment of R&D, down to £6mln from £12.9mln in FY21, and control over admin and sales costs. A rapid 90%+ sales CAGR driven by higher margin Creo core products is also essential and depends on growing the user base by up to 170 surgeons per year.
We have applied an inflation-adjusted 25% discount rate and assumed a 5% long-term growth rate. Using the Gordon Growth Model, this indicates a possible £250mln value in 2027 (assuming no tax and profits of over £45mln). Discounted to January 2023, this indicates a £100mln current value. However, if inflation falls reducing the discount rate to, for example, 15%, the NPV could be about £250mln if sales and margins are as forecast.
Valuation
Training is the critical sales parameter
The Creo business plan assumes that a steady and increasing number of specialist surgeons will be trained each year to use the technology. The product range is shown in Exhibit 1.
Initially, surgeons will be trained on Speedboat and will do endoscopic gastrointestinal removal of precancerous and early-stage cancerous lesions that have not penetrated the outer layers of the lower GT tract. Speedboat can also be used for operations on the upper GI tract in the oesophagus. Creo has other products, like SpydrBlade, a scissor-like cutting and sealing device, and as these are approved (SpydrBlade approvals are expected over H1 2023) training will also be done on these. SpydrBlade is expected by management to be a highly versatile and useful surgical tool that will broaden the base of potential indications.
Exhibit 1 - Creo product range
Source: Creo Medical
Over 2022, Creo trained 150 surgeons on Speedboat use worldwide but mainly in the USA. The numbers were 60 in H1 and 90 in H2. Of these, about 80 are currently using Speedboat, but more of these can be expected to use the products. The rate of training will be increased with more Europe and Asian surgeons being added. At the end of 2022, there were about 450 surgeons on the five-stage “Pioneer” training programme. The projected move to a positive adjusted EBITDA by FY25 is predicated on up to 170 surgeons a year being trained and becoming users from 2023. Accordingly, we see the training numbers, and use rates, being a critical parameter for investors to track.
To forecast sales, Creo divides trained surgeons into one of three active categories, below and Chart 3. Note that as surgeons are trained on courses that are spread over each year, the average number active in each year is lower — that is, surgeons trained in January can operate for 11 months but those trained in November may only operate for a few weeks.
User catagories
Creo models its expected sale development based on use rate per trained surgeon with three categories assumed.
Early: Still adapting to the technology. These are expected to run one procedure per month on average so each generate about $11k per year. However, most are expected to gain confidence and could progress to normal users.
Normal: The surgeon has the equipment but not using it to its full capacity perhaps because of the patient mix or limitations on reimbursement. These use on average one device per week or 52 each year generating about $45k a year in sales.
High: These do on average about two procedures a week, so each generates around $90k a year in sales. A proportion of specialists with dedicated clinics will run many more.
Chart 3 - Cumulative, active users
Source: Creo report and estimates
Not all early users are converted to normal or high users. We expect the annual conversion rate of early users to normal users to be around 40%-60%. The conversion rate from normal to high users was around 7% in 2021 according to Creo, and we expect this to be about 5% in subsequent years.
These conversion rates mean it is important to maximise the throughput of early users to drive sales to normal and high users. As early users are converted to more frequent use, and the company trains more early users every year, revenues from normal and high users will scale at an increasing rate. This drives Creo's expected high sales volumes and values from 2026 onwards. A key aspect is securing appropriate payor reimbursement. Hospitals also need to build the technology into their procedures, procurement and systems. The gradual adaptation of medical bureaucratic systems is a key factor.
Revised financial forecasts FY22 and FY23
Given the more detailed forecast models from Creo and January trading update, we have revised our financial forecasts for 2022 and 2023. P&L Table1, Cash Flow Table 2 and Balance Sheet Table 3. These will be updated later with the FY22 results.
We formerly expected revenues of £28mln with an adjusted EBITDA loss of £21mln and year-end cash of £16mln. We now expect revenues of just over £27mln with an adjusted EBITDA loss of about £23mln; year-end cash was reported as £13.1mln.
In FY23 we now think revenues could improve significantly after training surgeons in the US and the opening of the Singapore support hub in 2022. We formerly expected revenues of £32mln with an adjusted EBITDA loss of £17.5mln. We now expect FY23 revenues of about £36mln and an adjusted EBITDA loss of £11.7mln.
Capital needs in 2023
We note that investment into training will be continued, but R&D expenditure will reduce. This will still require Creo to seek more funding during 2023 whilst sales and margins build. Given that we estimate net cash use in 2023 will be about £15mln, which is more than the £13.1mln year-end FY22 cash, we expect Creo to need £15-20mln of further cash in 2023. This should also cover expenses and the working capital needs over 2024 and into H1 2025. Beyond that, if sales and expenses track as estimated, the company could be cash positive. However, with major market opportunities opening based on its patented dual energy technology, Creo may wish to expand and to develop further innovative products.
Table 1 - Creo FY22 Profit and Loss
Source: ProActive estimates, Creo reports
Table 2 - Creo FY22 Cash Flow
Source: ProActive estimates, Creo reports
Table 3 - Creo FY22 Balance Sheet
Source: ProActive estimates, Creo reports