COVID-19 Opportunity Knocks, T2 Answers (NASDAQ:TTOO)


T2 (TTOO), one of the stocks that I have followed for my speculative biotech portfolio, has been on the emergency floor for a while. I consider it as being in the danger zone because it is struggling to commercialize its suite of FDA approved testing devices as I describe below.

T2’s new CEO Sperzel has set a much needed goal of instilling some discipline into T2’s operations. Prior CEO McDonough’s egregious failure to meet overly optimistic projections has done serious damage. During T2’s Q4 2019 earnings call, Sperzel took notice of how poorly T2’s extravagant expenses tracked against its meager revenues.

This article focuses on T2’s prospective performance revealed by its recently released Q2 2020 earnings report. It checks in on how Sperzel is managing to reverse T2’s perilous excesses. Here is my report. First, I will give a brief review of T2’s product offerings.

T2 has a suite of interesting products for quickly and accurately testing for sepsis-causing pathogens

T2’s products consist of a test processing instrument and a variety of panels for use in the instrument. Originally developed by scientists from MIT, T2’s first FDA approvals came in 2014 for:

…the T2Candida® Panel and the T2Dx® Instrument for the direct detection of Candida species in human whole blood specimens from patients with symptoms of, or medical conditions predisposing the patient to, invasive fungal infections.

The slide below from a 5/2020 T2 presentation presents its product offering at that time:

This article also discusses the impact of T2’s new COVID-19 panel. This latter panel qualified for validation on 6/30/20 following an Emergency Use Authorization (EUA) request to the FDA. CEO Sperzel promptly announced its launch as follows:

“We are proud to announce the U.S. launch of our molecular diagnostic test, the T2SARS-CoV-2 Panel, which has demonstrated excellent clinical performance. Adding this test to our existing sepsis-related portfolio illustrates our commitment to transformative diagnostics that improve the lives of patients,… Given the susceptibility of critically-ill COVID-19 patients to develop bacterial or fungal co-infections and secondary infections that can lead to sepsis, we believe our platform can be used to identify acute COVID-19 infections, and optimize outcomes for patients under intensive care.”

While it has authority to market its COVID-19 test it is still seeking its actual EUA. As stated during its Q2 2020 earnings call:

We submit our EUA request to the FDA on July 1, 2020. Given the significant number of EUA submissions, we’re pleased to have recently been assigned an FDA reviewer. We are actively engaged with the FDA in interactive review of the submission. We look forward to completing the process. As a reminder, consistent with FDA guidelines, we are actively selling, marketing and shipping the T2SARS-CoV-2 Panel for clinical use by our customers.

I have long considered T2’s rapid testing technology as offering a significant advantage. I hoped that it would be a resounding commercial success after a few years of trial following FDA 7/2018 approval of its sepsis panel. In fact I have been severely disappointed in this regard. To date T2’s efforts to commercialize its testing platform have been an abysmal failure.

My original diagnosis of the situation excerpted below from “T2: Navigating The Danger Zone” seems to be playing out:

T2’s financial struggles as described below prove that its marketing has so far failed to overcome such predictable hurdles impeding wide adoption of its technology. During T2’s Q2 2020 earnings call CEO Sperzel advised that T2’s new COVID-19 panel is poised to correct this dynamic and put T2 on a path towards commercial viability.

T2’s technological advances have failed to pave the way for financial success

T2’s innovative FDA approved products for rapid detection of disease causing pathogens from whole blood samples have abysmally failed the one test of importance to T2 investors. They have generated nominal revenues against an outsized cost structure.

After ~7 years post FDA approval for its device and >2 years for its sepsis panel, T2 was able to generate a grand total of product revenues of $1 million during Q2 2020 against Q2 2020 costs and expenses of $11.4 million for the quarter.

Consider T2’s Q2 2020 results against its resolution to rightsize its expense structure as CEO Sperzel resolved during its Q4 2019 earnings CC as follows:

So how did T2 do? First let’s consider the size and scope of its current business. Product revenues for Q2 2020 were $1 million, unchanged from product revenues of $1 million for Q1 2020 (p. 2) and on a path to undercut its $5.3 million in product revenues for 2019 (p. 61).

T2’s Q1, 2020 10-Q defines (p. 11) cost of product revenue as including:

This $1 million of product revenues for Q1 2020 was an expensive haul (p. 2). Cost of product revenues for Q1 2020 was ~$4.7 million. In addition, T2 incurred Q1 2020 operational (SG&A) costs of ~$6.5 million. It’s hard not to conclude that T2 has been on a path leading to financial ruin.

Consider that a key part of T2’s plans for resuscitation involved enhancing its sales effectiveness to US hospitals. Further consider that during the height of COVID-19 overwrought hospitals were banning sales meetings. Slam, it looks like there is no room to make up for past failures.

To its credit, T2 was able to drive its cost of product revenue down to $2.3 million for Q2, 2020 (p. 2) with its SG&A expenses down to $5.1 million. Still it’s tough to do a happy dance when costs of ~$7.4 million measured up against revenues of $1 million. In a way it’s a measure of how far T2 had strayed from financial orthodoxy when you consider that its expense performance for Q2 2020 was indeed a significant improvement.

Ironically, the same COVID-19 emergency that shut off T2’s access to hospitals is morphing into free access to high level communication for T2’s COVID-19 test

T2’s legacy business plan put it in an untenable situation of selling a discrete solution for patient care to established institutions that was out of sync with their practices. As noted above T2’s testing solutions are only suitable for high volume use. T2 was working at selling its systems to large US hospitals.

The proof that T2 was fighting an uphill battle lies in its results as stated above. The best capitalized business in the world will struggle with a business that spends five dollars in product revenue for every revenue dollar it brings in.

During T2’s Q1 2020 conference call it withdrew its Q4 2019 guidance which had called for the following:

During T2’s Q2 2020 conference call, it initiated a brand new guidance as follows:

If we unpack the situation, we find that T2 has a total of $2 million of actual product sales for the first half of 2020. It is now guiding for $11-12 million of additional product sales for the second half of 2020. Alarm bells may be sounding for some old T2 hands; are we reentering an era of overpromise and underperform such as occurred under the prior administration?

Certainly the analysts participating in the call were alert to this possibility. Of the five analysts asking questions, three drilled down on this new guidance. The first such question came from Max Masucci of Canaccord Genuity. This Q&A went as follows:

Machiavelli coined the phrase that was famously used by Churchill to the effect that one should never let a good crisis go to waste. So it is that T2’s current strategy is to use the urgency around COVID-19 testing to achieve placement of its instrument in hospitals over the near term; in doing so it expects to access its share of the $41 billion in US sepsis related healthcare costs.

T2’s future is brighter than it has been and yet there are still questions

It’s never fair to complete an article about a danger zone company without taking a look at its liquidity. CFO Sprague ended his T2 Q2 2020 earnings call presentation with the following report:

Net loss for the second quarter of 2020 was $10.7 million, $0.09 per share compared to a net loss of $15.6 million, $0.35 per share in the prior year period. We completed the ATM offering in July 2020, and there is no remaining availability. Cash, cash equivalents and marketable securities as of July 31, 2020, were $69.1 million. We remain compliant with the terms of our CRG debt facility.

Certainly $69.1 million serves as a solid chunk of liquidity for T2. Its net cash used in operating activities for the first half of 2020 was ~$28 million. If it maintains operations at its current level, it appears well fixed for a year.

Nonetheless, it dare not backslide. Its grandiose ambition as stated by CEO Sperzel at the outset of its Q2 2020 earnings call is of the sort which might easily give rise to uneconomical decisions:

I want to take a moment to emphasize T2 Biosystems’ mission. To fundamentally change the way medicine is practiced through transformative diagnostics that improve the lives of patients around the world.

T2 definitely needs to walk, as in achieving earnings in excess of expenses, before it imagines that it can fundamentally change anything. Also, note CFO Sprague’s precise wording when discussing T2’s loan with CRG. When you access T2’s Q2 2020 10-Q and search for the string “CRG” it returns 33 entries.

T2 may be in compliance with this loan, however it has not been easy. At page 17 the 10-Q recounts the various deals it has made with CRG following this ill-advised 2016 borrowing of $40 million. The loan is secured by substantially all of T2’s assets including its intellectual property.

A proper analysis of the loan is beyond the scope of this article. However, its existence presents an ongoing threat to T2 and its shareholders. I will again mention one aspect of the loan I regard as particularly troubling described in the 10-Q as follows:

The Term Loan Agreement includes a subjective acceleration clause whereby an event of default, including a material adverse change in the business, operations, or conditions (financial or otherwise), could result in the acceleration of the obligations under the Term Loan Agreement. Under certain circumstances, a default interest rate of an additional 4.0% per annum will apply at the election of CRG on all outstanding obligations during the occurrence and continuance of an event of default.

Conclusion

My outlook for T2 has always been cautious. However I have moved from bullish, to neutral to bearish as its prospects have diminished. Following its announcement of its new COVID-19 strategy I am moving from bearish to neutral. I am an occasional and current investor in T2 and a long time fan of its rapid pathogen testing devices.

I am very much rooting for T2 to succeed in its new strategy of using the lure of rapid COVID-19 tests as a path to placement of a critical mass of devices in hospitals. If all goes well, I will be able to write a subsequent T2 article as a confirmed bull.

For the time being its prospects are far too tenuous for such a carefree approach. T2 has yet to prove that it can operate its business as an effective commercial enterprise. Even if it is able to convince hospitals to pony up for COVID-19 testing capacity, it still needs to prove that its device fits in a hospital’s normal workflow at an acceptable cost that earns a solid growing return for T2.

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.

Additional disclosure: I may buy or sell TTOO over the next 72 hours.

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