I cannot say I am not disappointed about T2 Biosystems’ (TTOO) Q2’19 results. The main issue that drove the stock down was full-year guidance that went from $20 million to between $8.7 million and $9.6 million. Both product revenue and research revenue were lowered for different reasons.

As for product revenue, the company said:

1) New contracts were slightly lower than they expected

2) The validation and evaluation period is taking longer than expected

3) As a result, slower ramp-up periods will impact revenue for the second half of the year.

As for research revenue, the company said:

In addition, due to a delay in the closing of an anticipated contract, we now anticipate that a portion of the research revenue expected this year will shift from 2019 into 2020. The good news is that our confidence is this agreement being signed is unchanged, only the timing has changed, having been pushed back three to four months.

If we deliver on our contracted activities, we will still receive the full agreed-upon revenue, but it will roll over to next year. In addition, we continue to work on other partnership opportunities that could further grow research revenue and expand the applications of our technology to potentially open new market opportunity.

So ballpark, my models for what I thought was going to happen have been pushed out by 3-6 months.

Pertaining to the change in guidance

Now, let me say something about the change in guidance. When a company provides guidance, which, in the past, we were spot on, I have to believe management. While guidance can change, as in this case, I cannot disregard guidance. And as such, I have to take management at its word.

In my previous article on the company, I hinted that if guidance was met, the company would not need additional funds. I stand by this statement; however, the problem is that guidance has changed.

And while I am very disappointed that it did, I cannot make investment decisions disregarding company guidance (for any company).

So, while I will give a hat-tip to the bears for being correct in the short term, the longer-term outlook for the company has not changed, outside of the fact that now it will likely need additional capital.

Why I said that additional dilution might not matter

In a previous article on the company back in July 2018, I said the following:

Even with a very bad balance sheet, even with minuscule revenue, the market will push up shares, because the valuation of the company was a fraction of what the market valued other companies in the vitro diagnostics space.

Indeed, the stock since then moved from about $5 per share to about $9 today. This despite the fact the company raised $52.6M in June. So my original theory that shares will push higher, despite the need for capital, played out.

In other words, I and every analyst on the street were aware of the future possible cash needs of the company. Nevertheless, the price target for TTOO shares for a very long time been around $10 a share or higher. This is because the market puts a very high premium on diagnostic companies.

So, when a stock is worth a fraction of its future potential, the possibility of dilution usually does not matter much (as it didn’t in the case of TTOO for a long time).

To prove this point, the company raised $53M in June of 2018 and also raised $17.5M in September of 2017, yet, at no point, did that deter its share price. In fact, everyone knew additional capital would be needed, yet, shares still rallied from the $5 handle to over $8 a share. This is why in previous articles, I didn’t expect the fear of dilution to deter the share price much.

So, what happened this time? I am not sure. On the one hand, guidance was probably the main reason for the steep decline in shares after Q2 and also the bear raid that has been ongoing for some time now.

Now, I am not blaming short sellers; however, when several million shares are sold short, most stocks will bend. And while longer term I think the stock price will bounce back and reach new highs, in the short term, short sellers have been vindicated.

I want to remind readers on the high value put by the market on diagnostic companies of all sorts.

Last year, Zoetis (ZTS) bought Abaxis, a veterinary diagnostics company for $2B, yet the company at the time was only doing about $200M in revenue and barley growing revenue over the past 3 years.

I have also mentioned Accelerate Diagnostics (AXDX), which is doing even less revenue than T2, with twice the cash burn, yet, the company is still valued about $1B.

I can find many more examples; however, my point is that the patents and the technology many times is worth more than short-term revenue or cash flows. And, in the case of T2, the market is totally underestimating the future possibilities of the technology and the company.

The good and the bad of the conference call

In the conference call, the company said if its current installed base of customers were able to ramp-up to full utilization, the company estimates it could generate $30-35 million in product revenue as is. Of course, as more customers sign up, that will be increasing over time.

The question is how long will this take. The company expects to average about $300,000 in annual revenue from each T2DX instrument, translating into about 1,500 tests per instrument when customers have ramped-up. However, it takes an average 6-9 months for evaluation and validation, and then a total of an additional 18 months for an account to become ramped-up.

So, as I see it, currently, it takes about 2 years from the time a customer is signed on till the time he is fully ramped. While this might change in the future, it is a bit disappointing because I was modeling a much shorter time period.

However, the above figures only include the T2Bacteria and T2Candida panels. When the company gets approval for its other panels in the pipeline, I think ramp-up revenue will be much higher.

While I have not been able to find any recent data, there were about 3.4M Lyme disease tests done in 2014 on 2.4M specimens, at an estimated cost of $500M. This in the U.S. alone. So, if T2 can capture even 10% of that revenue, it could mean break-even for the company on its Lyme panel alone.

As per the conference call, Tom Lowery repeated what we already know about the Lyme pane. That is, clinical data demonstrates the sensitivity of T2Lyme to far exceed that of current PCR tests. Also, specificity is 100%. Meaning if the panel says you don’t have it, you don’t have it. And as I said before, knowing for sure you do not have Lyme is just as important in knowing that you do.

However, he also said, the FDA asked the company to expand the scope of the company’s pivotal study, to include patients without an EM rash and early-stage infected patients. The company said it has 300 frozen samples from patients with and without a rash and is working with the FDA in the preferred approach for analyzing the data from clinical samples.

While the company did not say how much longer it will take to conclude the study, I am modeling one more quarter plus another quarter before the company receives FDA clearance. So, I am currently modeling FDA approval in mid-2020.

However, it’s not just the Lyme panel that will provide additional revenue, the company’s pipeline includes the T2Candida Auris RUO panel and the T2Resistance panel.

As for the T2Resistance panel, the company said it will make it available for RUO by the end of Q3, which was a pleasant surprise because I thought it would be available by the end of the year. As for Europe, the company is on track for a CE mark version that will enable the company to sell in Europe by the end of the current year.

So, while a fully ramped T2DX instrument can probably do about $300,000 in revenue with the T2Bacteria and T2Candida panels, that figure will probably be higher when the other panels in the pipeline become available. The problem is that the company is running against the clock and its balance sheet.

About the financing agreements

The company said that it entered into two agreements that enable the company to raise as much as $60M subject to limitations.

Lincoln Park Capital is obligated to purchase shares of the company’s common stock when the company chooses, with the restriction being it cannot offer more than 20% of its outstanding stock at less than $1.52 a share. Also, at the company’s choosing, Canaccord will sell on a best efforts basis as much as $30M in common shares.

The company estimates that it might need up to $40M in additional capital to reach revenue to $65-75M. So, not only will the above financial agreements help towards that goal, but the company will also reduce its cash-burn to about $8 per quarter towards that end.

So, as far as the dilution factor, it’s probably a non-event anymore because it’s as if it has already happened.

Bottom line

Yes, I am disappointed that guidance changed, and I am also disappointed that it will take longer for customers to ramp-up than previously thought. However, longer term, these issues do not change the potential of the company and the technology.

It is still my belief that at some point in the future, the T2 platform will not only make most blood cultures obsolete, but it will also render most ID/AST platforms obsolete.

This will probably happen when the company introduces its new T2Bacteria panel that will be able detect 30-40 species. Even with 30-40 species as opposed to 250, it will still identify 99% of the most common blood infections in many hospitals (depending on geographic location), and at least 95% in just about every hospital. When that happens, T2Bacteria will basically sell itself.

Investors need to understand that the company is currently selling to a very small number of hospitals, and none of them have ramped-up yet. There are 6,200 hospitals in the US alone, with many times that number in the rest of the world. Please note that as of June 30, the company has 107 instruments placed or contracted to be placed. This is a very tiny percentage of its addressable market.

If one does the numbers, even if the company can get 1,000 hospitals all over the world to use its platform, it will mean billions in revenue at some point in the future.

I still believe investors who buy at current levels will make out like bandits over the next decade, making as much as 100x their money, even with further dilution.

In my opinion, the risk reward possibilities are such, that it might be prudent for investors to buy just 1% of their portfolio in TTOO shares and pretend they lost this money. On a daily basis, we lose or make 1%, and it won’t make a difference.

Disclosure: I am/we are long TTOO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-08-05