Sensus Healthcare (SRTS)

Mar 13, 2023

Disclaimer
SRTS is a microcap and is best suited for small funds or PAs.

Short pitch
Sensus Healthcare is largely a one-product company that sells a medical device for treating a specific type of skin cancer and presents an interesting investment opportunity with a favorable risk-reward ratio. Company’s market cap is $87 million, it trades at 5.7x normalized LTM earnings, has no debt and $25.5 million in cash. Latest quarterly earnings miss, which was not a real miss and will be addressed further, caused a continuous unjustified selloff which resulted in 40% share price decline to date despite spectacular 65% y/y revenue growth and 270% y/y normalized earnings growth in 2022. A conservative but highly likely 15% revenue growth combined with a re-rate to a more sensible 10x multiple will secure a 100% gain within a one-year time period. 

Brief timeline overview
Sensus Healthcare was founded in 2010 by Joseph (Joe) Sardano and his associates in Boca Raton, Florida. It went public in 2016 at $5.50 per share, raising $11 million . Company boasts a consistent 65% gross margin which creates a case for great operating leverage as SG&A and R&D expenses have stayed largely fixed throughout the history. Sales were not ramping up as rapidly as was initially planned (they rarely do) but the company moved along steadily raising awareness of their best-in-class solution, penetrating the market and expanding geographical presence. Sensus was burning cash for the most part of their existence and had to tap into equity markets in 2018 to raise another $16 million. Well-capitalized and growing, SRTS was set to have a great 2020 after almost breaking even in 2019 but Covid happened and sales tanked from $27 million to $9.6 million. Company sailed the turbulent waters of Covid and managed to make a great comeback with finally making maiden net profit in 2021 followed by a stellar even more profitable 2022.

Joe Sardano, company’s fearless leader, is a recognized professional in the healthcare industry and has a successful history of introducing and commercializing new technologies and services in many areas of medicine. Before co-founding Sensus Healthcare, Sardano held leadership and management roles at CTI Molecular Imaging, GE Medical Systems, Siemens Medical Systems, Elscint Inc and Toshiba America Medical Systems, among others. Today Joe, CEO and chairman, is still the largest shareholder who owns almost 7% of the company. He did reduce his ownership from the 9% mark in the last two years. Seventy years of age, he has never been more enthusiastic about the future of the company.

Skin cancer
Before delving into specifics of the business, let’s have a few words on skin cancer. The sophistication and depth of this particular medical topic cannot be understated so the reader should remember that the following discussion is an oversimplified view of a complex subject through the lens of a generalist who simply tries to identify a potential investment. Keeping that in mind, let’s lay out a few facts which in my opinion are important and relevant to the investment thesis. 

Skin cancer is the most common cancer in the United States: it is estimated that approximately 9,500 people in the U.S. are diagnosed with skin cancer every day. There are three major types of skin cancer: base cell carcinoma (BCC), squamous cell carcinoma (SC) and melanoma. Sensus Healthcare sells equipment for treating non-melanoma skin cancer (NMSC).

Today the gold standard for treating NMSC is Mohs surgery which was introduced in late 1960s and early 1970s. This method requires a surgeon to remove the cancerous tissue. Mohs surgery obviously implies cutting and possible scarring. An alternative method is a superficial radiation therapy (SRT) where, as the name suggests, the low energy X-ray radiation is applied locally on the surface of the malignant skin. The method is non-invasive and its major benefit lies in avoiding the surgery where cutting is involved. Because over 80% of NMSC cases occur in highly sensitive face and head regions, patients like to have a non-invasive method as an option, when possible. 

From company’s prospectus of 2016: Recently, healthcare providers are recognizing the benefits of superficial radiation therapy and there is a resurgence of this technology. Based on a retrospective analysis published in the Journal of the American Academy of Dermatology in 2012, recurrence rates for all tumors at two and five years were 1.9% and 5.0%, respectively, for cases of cutaneous basal cell carcinoma and squamous cell carcinoma treated with superficial radiation therapy, matching the recurrence rates for Mohs surgery. We believe this study illustrates the effectiveness of superficial radiation therapy in the treatment of non-melanoma skin cancer. Superficial radiation therapy is also an effective treatment modality for keloids, which are firm, rubbery lesions or shiny, fibrous nodules, that can vary from pink to the color of the patient’s flesh or red to dark brown in color, in conjunction with surgical removal.

What does a typical treatment look like? A patient would come to the physician’s office 3 to 4 times a week for 4 to 6 weeks. During each visit the doctor applies radiation locally for a couple of minutes. Patients don’t feel anything during the procedure. In fact, they sometimes question whether the equipment works because it does not produce any noise. 

Providing non-invasive pain free skin treatment was a void which Joe Sardano saw as an opportunity to fill and that’s why Sensus Healthcare was created. 

Products 
I said SRTS is a “largely” one-product company because there are, in fact, three main products which are just different variations of one device within the same product line. The base model is SRT-100 - an R2D2-looking piece of equipment on casters with a motorized arm attached to the top (my sincerest apologies to the company for such an insulting description of their flagship product). The machine is very mobile thanks to casters and very compact with a footprint of only 30"x30". SRT-100 Plus is a base model with a number of additional features which include newer X-ray tube with extended functionalities. The latest and greatest model is SRT-100 Vision which includes an ultrasound imaging module that enables tracking of treatment progress. SRT-100, SRT-100 Plus and SRT-100 Vision models sell at approximately $200k, $250k, and $375k list prices, respectively.

The equipment is produced in Tennessee by a third-party manufacturer which Sensus has worked with since day one. Contract between the parties is renewed annually. SRTS has a single preferred supplier for X-ray tubes and some other major device components. Although other suppliers exist in the market, the company believes that the preferred supplier’s products are of a superior quality. Overall, Sensus Healthcare weathered the recent storm of supply chain issues very well without any material impact on the business. You can’t mention supply chain issues without adding interest rate hikes nowadays, especially if any kind of manufacturing is involved. We’ll discuss the interest rates impact later but I’ll say here that the price increase, albeit small, is passed on to the customer.

Business
The company’s revenues come from selling the aforementioned devices, and services related to maintaining and repairing those devices. Annual unit sales since 2017 look like this: 64, 61, 76, 20, 73, 131. You can clearly see a Covid drop and then a phoenix-like rebound.  More than 95% of the units are shipped within the US. Second largest geography is China which just recently reopened and where 14 units were shipped in the latest quarter alone. With China reopening and continuous strong local demand I expect that at least 150 units will be shipped in 2023. 

Service revenues have been creeping up consistently and noticeably from $1.8 million in 2017 to close to $5 million in 2022. Company offers a 1-year free warranty with every unit sale and extended warranty for an additional price. I expect service revenue figure to keep accelerating because there are more units in the field every year and more units that are coming off of the warranty. 

On one conference call Joe pointed out it took the company ten years to ship 500 systems and that he thinks it would take less than half that to ship another 500. I think he was being conservative. By the end of 2022 SRTS had an installed base of 695 units in at least 18 countries. Is that a lot? In the US there are 14,000 dermatologists and 1,000 Mohs surgeons, representing more than 8,500 offices, with further 6,500 plastic surgeons and 5,500 radiation oncologists. From a conference call, “skin cancer is a large and growing condition with estimates that 1 in 5 Americans will develop skin cancer during their lifetime. This tells us that nearly 70 million people will contract non-melanoma skin cancer in this country. So clearly, this is a need for our SRT systems both now and even more so in the future”.

I am not a big fan of “TAM is X and if we could get a Y portion of it we’d be happy” pitch but the SRTS situation is different because they are the only player in town. Yes, there are no other companies in the US that do what Sensus does. Of course, competition will eventually flock in but it will take some time before any meaningful challengers arise. After all, this is medical equipment that treats cancer we are talking about. Moreover, I would argue that competition will help to increase awareness of SRT solution and serve as an overall positive development because Mohs surgery is still a primary go-to solution worldwide. 

I have not done extensive research on global players but the ones Internet investigation led to are in Europe - Xsoft, Xstrahl and Oncobeta. None of them can sell in the US or China yet. None of them operate at a scale similar to Sensus. Revenue growth in the US alone will cause a significant SRTS value appreciation so the potential future issue of having to fight European companies for the rest of the global market will just be a good problem to have. 

Sensus Healthcare sells its products through direct sales teams and global distribution partners to dermatology practices, cancer centers, hospitals and plastic surgery clinics. Latest 10-K states that one particular customer accounted for 57% of total sales in 2021. The customer is SkinCure Oncology (SCO). This is a peculiar situation because SCO, who has an exclusive partnership with SRTS, should not be treated (in my mind) as a typical customer who poses high concentration risk. SCO’s entire business is built around SRT-100 Vision to provide a turnkey solution for the end customers. They basically enable hassle free implementation of SRT solution for dermatology practices. The services include initial room buildout, state registration, machine installation and calibration, training, administrative support and radiation therapist hiring - all of this for a share of future revenue that physician’s office will generate. SkinCure started in 2016 and is growing very rapidly having implemented Sensus’ solution in 230 practices. So, I consider SCO as a value-added reseller that is killing it rather than a high concentration risk. “I wish we had more people like them”, Joe said once. 

Sensus has been aggressively pursuing digital marketing and SEO strategy. The CEO claims that within the last 6 to 8 months patient queries went from 2 per week to astonishing 30 to 35 per day. Company has dedicated staff who answer questions and educate people on SRT solution. SRTS then sends potential patients to dermatology practices which already have the equipment installed. The company can now also target practices in specific areas that get a lot of inquiries because they have the numbers at hand. Sales pitch becomes easy and convincing: “look at all the business you are missing out on”. With this development I expect direct sales revenue percentage to increase and SkinCure portion to decrease but both should grow in absolute numbers.

Physicians
A few words on how physicians are paid. Just like with skin cancer comments, the following is an oversimplified description of an otherwise cumbersome process. Typical patient treatment course involves certain services and procedures provided by the physician office. Each service rendered has a specific code which defines the price of the service. After treatment is finished, the physician puts a list of codes together and files a claim for reimbursement to CMS (Centers for Medicare and Medicaid Services). It is important to understand that CMS, as a government entity, determines which services get reimbursed and sets the prices for those services every year. There is one particular code - CPT 77401: Under radiation treatment delivery - which is used whenever patients undergo SRT-100 treatment. CMS increased reimbursement amount for this code by 66% in 2021. The code has not seen a meaningful revaluation since 2002 which means CMS finally started to wake up to the fact that SRT solution is being used widely and effectively. According to their report “CPT code was identified through a screen of high-volume growth, for services with 2017 Medicare utilization of 10,000 or more that has increased by at least 100 percent from 2012 through 2017”. CMS will benefit from wider adoption of SRT technology because overall reimbursement for Mohs surgery is higher. For example, in 2017, inflation-adjusted Medicare payments for Mohs surgeries totaled $537 million. I don’t have the numbers for SRT treatment reimbursements but I suspect they are orders of magnitude lower. 

All involved parties will benefit from the success of Sensus Healthcare: patients get a non-invasive and less stressful treatment, physicians don’t lose customers to a different department (surgery) and get paid, and CMS saves money by reimbursing a smaller amount. At a first glance, the only “loser” here is Mohs surgeon who doesn’t get the business. The fact that there are only thousand Mohs surgeons in the US and there are three million Americans affected by NMSC annually tells me that nobody will lose business any time soon. 

According to the management the majority of physicians buy the equipment with cash. But for those who can’t or don’t want to spend the entire amount upfront Sensus offers a fair market value lease program. “Two patients a month to breakeven” was the company's pitch for a while now, long before interest rates increased. As explained on the conference call, it was actually 1.25 patients a month so for obvious reasons that number was rounded up to two. After interest rates went up significantly in recent times it is “really” two patients a month now to breakeven. The price hike was passed on to the customer but the sales pitch did not change, which is great. 

Numbers
Revenues soared from $27 million in 2021 to $44 million in 2022, operating income increased from $4.1 million to $14.8 million showcasing fantastic operating leverage (margin expansion from 15% to 33%). SRTS did some hiring and internal promotions in 2022 so SG&A rose by an amount of just shy of $2 million. Going forward I don’t expect SG&A and R&D figures to increase much which sets a fixed operating cost and creates a precedent for potential earnings boom should revenue grow at a decent pace. This is a beautiful setup. 

Why is the company trading at 5.7x normalized LTM earnings? The situation we have today is a result of investors’ mood swings, not deterioration of the company’s fundamentals. Two latest quarterly reports are associated with “missed” revenues and earnings. Q3 is a historically slow quarter for the company because a lot of potential customers - doctors - are out for vacation. And this fact was spelled out on the prior conference calls. Furthermore, hurricane Ian caused even further slowdown and the company reported $9 million in sales as opposed to expected $9.5 million. This miss caused a huge selloff cutting share price in half despite the fact that the result was fantastic given how disastrous the hurricane actually was! SRTS took advantage of the situation and bought back $3 million worth of shares. In early January quarterly pre-announcement stated that revenue for Q4 will exceed $13 million, which was a market “beat”. The expectations rose immediately after the release and when the company later actually reported revenue of $13.1 million they ended up “missing” by $100k. This was perceived as a “second miss in a row” and another selloff followed. During the last two quarters share price experienced extreme volatility with a pronounced downtrend which is unwarranted given the company’s underlying business has never been in a better shape. I hope they are buying back shares now. 

What’s a fair value of Sensus?  The investment thesis is very simple and hinges on a question of whether the company sells more equipment or not. Given where the industry is at, I argue that it will. A 15% growth gives us $50 million revenue and $17 million profit which at a non-demanding PE ratio of 10 results in almost a double from here. Downside is well protected at current valuation. Looking at the numbers, the company breaks even at around 60 units per year. This would imply more than 50% drop in sales which I would consider as a highly unlikely event. Plus, cash represents 30% of market cap at today’s prices.

Other product lines
SRTS has started commercializing two more product lines in the aesthetic field: small lasers and transdermal infusion equipment. The sales of these medical devices do not contribute meaningfully to the top line yet and I consider the success of these endeavors as a call option. I’d rather see SRTS be laser-focused (couldn’t help myself) on their core business. Company had previously developed a medical device for breast cancer treatment but sold it in February of last year for $15 million. I believe slow market adoption, a strong need to cut expenses during Covid and increased demand for the main product line which requires attention were the main reasons behind the sale. R&D expenses fell substantially from $6.5 million pre-Covid to $3.5 million last year. 

Conclusion
Sensus Healthcare is a founder-led profitable growing medical device company with an excellent product that market values and needs, which translates into high gross margins and superior operating leverage. Due to the recent indiscriminate selloff that is more related to investors’ sentiment and expectations rather than the company’s fundamentals, SRTS trades at a very attractive valuation and presents a great investment opportunity. We are looking at a 100% gain potential in a moderately conservative scenario within a one-year timeframe. An optimistic scenario for the next few years could easily result in 200-300% gain. And, fortunately, we get to make a bet with a solid downside protection.

Update [Mar 20, 2023]: Competition section is incorrect. Please see corrected version here.