Deltex Medical Group plc Better positioned for second half of the year and 2019

Deltex Medical Group plc (LON:DEMG), the global leader in oesophageal doppler monitoring has today announced its results for the six-month period ended 30 June 2018.

Operational highlights

* Andy Mears appointed as CEO in mid-June

* Revised strategy of building a stable business by focussing on driving revenues from existing customers

* Programme of cost reduction and business stabilisation launched in the first half
– significantly accelerated and expanded since June with a significant reduction in sales and marketing costs

* Focus on developing relationships with existing customers also expected to help the generation of incremental revenues from new TrueVue System product launches

* Publication of the large multicentre FEDORA study showing a 76% reduction in total post-operative complications for low and moderate-risk patients using Deltex Medical’s oesophageal doppler haemodynamic monitoring technology

Financial highlights

* A strong prior year comparator for Monitor sales and a number of one-off events associated with Probe revenues (including currency affects, changes in ordering by two large US accounts and a temporary inventory adjustment by a French distributor) resulted in revenues being held back to £2,325,000 (2017 H1: £2,877,000)

* Substantial reductions in overheads: estimated annualised cost savings of c.£2,000,000 to be achieved from actions taken:

· c.£750,000 from actions prior to June

· c.£1,250,000 from actions since appointment of new CEO

* 33% reduction in employee numbers to 56 at 31 August (31 December 2017: 84)

* 30% reduction in sales and distribution costs to £1,373,000 (2017 H1: £1,949,000)

* 14% reduction in total costs to £2,796,000 (2017 H1: £3,265,000)

* Operating loss (before exceptional costs) of £999,000 (2017 H1: £1,082,000)

* Cash on balance sheet at 30 June 2018 of £1,065,000 (31 December 2017: £219,000)

Nigel Keen, Chairman of Deltex Medical, commented:

“The successful £2,050,000 fund raising in February 2018 has put the Group in a stronger financial position – allowing us to improve our business structure.

“We made a number of changes to the Group in the first half – the appointment of a new CEO in June and a revised business strategy – which mean that Deltex Medical is much better positioned for the second half of the year and 2019.

“The lower cost base that the business now operates has given the Group a stronger platform from which to develop.

“Strategically we are now prioritising profitability over securing new customers – and believe that by working more closely with our existing customers we will start to generate incremental revenues more quickly from new product launches on the TrueVue System.”

Chairman’s statement

Introduction
Deltex Medical has developed the ‘international gold standard’ for haemodynamic monitoring with its oesophageal doppler technology. This technology has been shown to improve patient outcomes by enhancing patient safety and lowering attributable healthcare costs. Among other benefits, the use of Deltex Medical’s technology has been shown to result in patients incurring statistically-significant lower rates of surgical site infections (“SSIs”) and acute kidney injuries (“AKIs”). The use of the Deltex Medical oesophageal doppler technology is supported by a substantial body of scientific evidence. Clinicians and health-care systems throughout the world are increasingly recognising the benefits of monitoring and optimising their patient’s haemodynamic status.

Deltex Medical’s recently launched multi-modal TrueVue System – which includes two other complementary haemodynamic monitoring technologies as well as oesophageal doppler – will give clinicians a single platform to choose the most appropriate monitoring modality for the patient’s condition.

Change in strategy
The Group has been investing significantly, particularly in the USA, over several years to grow the base of clinicians who are familiar with and trained to use the TrueVue System and hospitals where it is used. This has called for substantial funding ‘ahead of the curve’ to build a population of potential users who can use the Deltex Medical products effectively and consistently, thereby generating revenues for the business to allow it to grow its user base, develop its product offering and provide a return to shareholders. The strategy has been to continue to invest to grow this base of knowledgeable users and to encourage those users to deploy the system in their clinical practices. This had been expected to result in a significant increase in revenues which would have enabled the Company to generate sufficient cash to fund further growth without needing further calls of capital from its shareholders.

The adoption of the Deltex Medical technology by those qualified users into their clinical practices has been slower than anticipated and this has led to the Group using rather than generating cash, resulting in a series of capital raisings from shareholders. Whilst this strategy has continued to expand the population of trained potential users of the Group’s products, it has become increasingly clear that the subsequent revenues are arising more slowly than originally expected. Accordingly, the Board decided to re-evaluate the strategy of committing substantial resources to market development in advance of revenue generation.

The successful fund raising in February 2018 gave the opportunity to re-visit the Company’s strategy with a view to focussing on generating revenues by developing and servicing the existing customer base. It is expected that this will generate cash that can then be deployed ‘behind the curve’ without needing repeatedly to access capital from shareholders. Cash surpluses will be used to develop further users and to progress the roll out of the new modalities within the TrueVue System – which will further enhance the capabilities of the system itself.

Adoption of this revised strategy may develop new customers at a slower rate than has been experienced to date but uptake by the existing user base is expected to be enhanced.

This change in strategy has resulted in a number of changes – including the appointment of Andy Mears as CEO in June as well as the implementation of a restructuring programme – which have provided a much stronger and robust platform from which to build the business. Andy Mears is well suited to drive increased use by clinicians as he successfully led the Deltex Medical sales and marketing effort in different parts of the world for several years; furthermore, with his engineering background he is the acknowledged ‘product champion’ for the TrueVue System.

Key events in the first six months
The first six months of 2018 represented a period of significant activity – and substantial change – for the Group, including:

* in February 2018, the Group successfully raised £2,050,000 (net of expenses) to strengthen its balance sheet and for general working capital purposes;

* in March, the large FEDORA study was published which demonstrated that, among other things, use of Deltex Medical’s oesophageal doppler monitoring technology resulted in a 75% reduction in total post-operative complications as well as reduced length of stay for both moderate-risk and low-risk patients;

* in April, the Group’s French distributor won a contract for haemodynamic monitoring for Paris’s government-funded hospitals. The contract is worth a minimum of €4 million over the eight-year life of the tender; and

* in June, the senior management of the Group was changed with the appointment of Andy Mears as Chief Executive Officer.

Market dynamics – and how to optimise the Group’s market position
Since the promotion of Andy Mears to CEO on 13 June, the Board has been considering carefully how to maximise value for Deltex Medical shareholders as well as monetise the value inherent in the Group’s technology.

The Group’s doppler-based haemodynamic monitoring technology provides accurate, real-time, multi-factorial data for anaesthetists and intensivists which can be used to improve outcomes for anaesthetised patients undergoing surgery or sedated patients in the intensive care unit. Deltex Medical is generally acknowledged to have developed the international ‘gold standard’ for high quality haemodynamic monitoring data; however, there is a trade-off between the inherent quality and fidelity of the data and the ease-of-use of the technology. Whereas Deltex Medical’s technology measures blood flow and other critical physiological characteristics in real-time, most of the Group’s competitors use algorithm-derived information which provides clinicians with an approximation of the haemodynamic status of the patient. This algorithm-derived information does not enjoy the same depth of support in the scientific literature; however, such devices are typically easier and cheaper-to-use than Deltex Medical’s high accuracy technology and this can create marketing and adoption issues for Deltex Medical, particularly when selling into price-sensitive markets. The Group believes that the scientific evidence base strongly supports the use of its technology over the selection of easier-to-use and cheaper alternatives and this difference lies at the heart of the commercialisation and market-education dynamic the Group is working to optimise.

The Board has now decided to modify the Group’s approach to the market. Clearly the Group has a substantial number of customers around the world, including in the USA, who have already accepted the advantages inherent in the oesophageal doppler technology and it makes good commercial sense to focus on developing the business around that existing customer base. Moreover, the Board believes that focussing on building closer relationships with these established customers will provide the Group with a significantly more effective platform for launching new, complementary technologies on its multi-modal TrueVue System.

The combination of a lower cost-base – due to substantial reductions in sales and marketing expenditure – and an improved platform for future product launches is attractive. In addition, this lower cost strategy de-risks the Group financially as it reduces substantially the business’s cash breakeven point.

Cost reduction programme
The Group had already started to reduce its costs substantially and benefitted during the first half from actions taken around the end of the prior year and the start of the current year resulting in estimated annualised cost-savings of approximately £750,000. Since the appointment of the new CEO in June, initiatives designed to increase sales effectiveness and re-focus the business around the existing customer-base have been significantly accelerated and expanded. This has resulted in a restructuring of the business with the removal of a layer of senior management, which with other initiatives will give rise to further estimated annualised cost-savings of approximately £1,250,000. The magnitude of the cost reduction programme can also be seen in the Group’s employee number data. The number of employees at the end of August was 56, representing a 33% reduction from the 84 people employed on 31 December 2017.

In the short-term, the Board believes that cost cutting is absolutely critical as it allows Deltex Medical to move more quickly to a cash breakeven point and thereby start to “take control of its destiny” in terms of paying its way from cash generated from its trading activities. However, this only represents the first part of the strategy for the Group going forward; other parts include a more focussed selling effort to existing customers, using the cash generated to expand the user base and to finance further development of the TrueVue System.

New product development and the TrueVue System
The Group’s initial – and principal – technology is doppler-based oesophageal haemodynamic monitoring. This technology generates highly accurate, real time data; however, it can only be easily used on anesthetised or sedated patients. Accordingly, it does not provide the hospital with the complete solution for the haemodynamic monitoring of all of its patients.

Deltex Medical recently launched its TrueVue System monitoring platform which comprises three haemodynamic monitoring technologies: (i) its existing oesophageal doppler ultrasound (TrueVue Doppler); (ii) high-definition impedance cardiography (TrueVue Impedance); and (iii) pulse pressure waveform analysis (TrueVue PressureWave). The TrueVue System enables the Group to sell its haemodynamic monitoring technologies into a larger addressable market within a given hospital.

The TrueVue System is currently available in the UK, continental Europe and a number of other international markets. 510(k) regulatory clearance has now been obtained from the US Food & Drug Administration (FDA) to market the TrueVue System in the USA, with product launches planned for 2019.

In general terms there is a trade-off between the ease-of-use and the precision of the data generated from each monitoring technology. The TrueVue platform enables clinicians to match the appropriate technology to the risk profile of the patients as they move through the hospital. For example, high-risk, anaesthetised patients undergoing surgery can be treated under the guidance of the extremely precise TrueVue Doppler, whereas lower-risk, awake patients in a high dependency unit can be monitored using non-invasive TrueVue Impedance.

The TrueVue System is implemented by upgrades to the existing Deltex Medical machines which are already installed with the users. However, the Group is also developing a new monitor which will provide clinicians with a more modern and user-friendly interface with the TrueVue System’s capabilities.

Notwithstanding the importance of updating and extending the Group’s technology-based products, the Board has decided to reduce the rate of new product development. This reduction in monthly cash expenditure on research and development will help to reduce the Group’s cash breakeven point – and will also help ensure that in the short term the primary focus of the senior management of the Group will be on increasing probe usage by existing customers.

The UK market
The UK market – and in particular sales into NHS hospitals – remains challenging. In the last couple of years the Group had anticipated supressed UK revenues and accordingly had taken the decision to reduce its investment in sales and marketing into the UK market. However, Deltex Medical does believe that there are opportunities to build revenues from its existing UK customer base.

The US market
The US market remains critically important for the future prospects of the Group. The US healthcare system tends to support higher price points than other markets. Further, the US reimbursement system – involving both public payers such as Medicare, Medicaid and private sector insurance companies – has been shown to help drive the adoption of new technology as well as usage rates of disposables used within medical devices. In addition, the US market tends to influence other international territories – particularly in the Middle East and Asia – where a number of US hospital Groups own or manage prestigious overseas hospitals.

In recent years US hospitals have faced increasingly large financial penalties – in the form of reduced reimbursements by government-funded payers such as Medicare and Medicaid – in the event of patients experiencing avoidable post-operative complications such as AKIs and/or SSIs. Accordingly, Deltex Medical believes that its TrueVue Doppler technology, supported by the evidence base including the recently published FEDORA study, will be able to generate additional revenues from its existing US customers as a result of the increased focus on avoiding AKIs and SSIs. In addition, there are other opportunities to improve the commercial position of Deltex Medical’s technology in the USA by better aligning the usage protocols of its technology more closely with the US reimbursement system.

The Board anticipates that the lower sales and marketing costs associated with the Group’s US operation should result in the US subsidiary contributing meaningfully to the costs of running the UK operations which are in place to support the Group’s users worldwide.

International sales
The Group has developed a large network of some 40 international distributors which sell Deltex Medical’s haemodynamic monitoring technology, including the probes. The gross margin on the probes generated by distributor sales are inevitably lower than sales generated by the Group’s direct sales activities in the USA and the UK; however, such distributed sales do not incur significant sales and marketing costs.

Financial information
Data on probe revenues has already been announced in the pre-close statement on 25 July 2018. The probe revenues in the table below show declines, however sales in the USA were held back by the weaker US dollar compared with H1 2017, together with changes in ordering by two large accounts, masking encouraging growth in use by major hospital systems. In addition, International sales were lower due to temporary inventory adjustment by the Group’s French distributor in preparation for the transition to the previously announced new large Paris hospital contract.

The Board believes that there is scope to drive up probe usage in these three areas on the back of the commercial refocussing activities that have been put in place since the appointment of the new CEO.

The Group generates an attractive gross margin from the sales of probes used within its haemodynamic monitoring technology. The consolidated gross margin on probes was 78% (2017 H1: 83%).

Sales and distribution costs declined by 30% to £1,373,000 (2017 H1: £1,949,000). Other overheads were essentially unchanged resulting in total costs of £2,796,000 (2017 H1: £3,265,000).

In the first half there were net exceptional costs of £142,000 (2017 H1: Nil) relating to costs associated with the cost reduction programmes. An equivalent amount is expected in the second half. Further information on the exceptional items are set out in note 15 of the accompanying financial information.

The operating loss before exceptional costs and other gains was £999,000 (2017 H1: £1,081,000). The loss for the period was £1,194,000 (2017 H1: £1,093,000).

Following the fund raising at the beginning of the year, the Group has much improved financial resources with cash on the balance sheet of £1,065,000 at 30 June 2018 (2017: £219,000) and a lower operating cost-base.

Current trading and prospects
Deltex Medical has world-leading technology which has taken many years to develop and optimise. It has also taken significant time and investment to build – with the support of a number of Key Opinion Leaders around the world – the impressive body of supporting scientific publications which advocate the use of Deltex Medical’s technology to improve patient outcomes.

More recently, there has been an increased focus in a number of healthcare systems in developed markets on patient safety. The introduction of financial penalties associated with avoidable post-operative complications such as AKIs and SSIs gives a platform for the Group’s technology to play an important role in supporting a broad range of patient safety initiatives as well as helping hospitals reduce the financial penalties associated with avoidable complications.

The Board believes that Deltex Medical has good prospects to improve significantly the financial returns that it generates from its long-standing investment in haemodynamic monitoring technologies. As a first step the business has been re-focussed and costs have been significantly reduced, enabling it to build a platform to expand from via the adoption of its broader-applicability TrueVue System.

The Board notes that, as a result of the previously reported poor trading in H1 2018 and the implementation of the new strategy, revenues for the year ending 31 December 2018 will be behind market expectations and lower than those reported in 2017. However, the impact of lower revenues will be offset by the newly implemented cost reductions with the loss for the year expected to be in line with market expectations.

Although the revised strategy has only been in place since mid-June, there are already a number of encouraging signs relating to the performance of the Group based around its smaller, leaner and more focussed structure.

The Board is encouraged by the prospects for the Group going forward with a significantly lower cost base providing a solid platform for a more focussed sales approach and the delivery of the TrueVue System.