By Brian Marckx, CFA

Q3 Financial Results, Business Update…

Zecotek (ZMS.V) (ZMSPF) filed fiscal Q3 financials (ending April 30, 2015). Revenue remains tepid and continues to mostly reflect small orders of the LFS crystals from PET OEM's and CERN which are testing them for various instruments and projects. While these evaluation periods have been drawn out longer than anticipated, the fact that orders continue to flow (albeit small orders) is a positive sign and an indication that customers remain interested in potentially incorporating the crystals in their workflow and products. And larger orders should be on the horizon. In fact ZMS notes in the Q3 MD&A that, "The Company has firm commitments for future delivery of crystals and the positive growth in revenue will accelerate in the fourth quarter as the Company continues to fulfill these and new obligations as customers demand."

While Zecotek did not specify the customers that they expect additional order flow from in Q4, there are several committed tickets yet to be filled. This includes the $2 million Hamamatsu purchase order and a December 2014 order for $500k worth of crystals from (unnamed) organizations investigating use of the LFS crystals in small and next-gen Time-of-Flight PET scanners. In addition, validation of the LFS scintillation crystals for use in small PET scanners in applications such as pre-clinical pharmaceutical research for drug development is ongoing by certain international PET OEM’s.

And the crystals are also still being used in various experiments by CERN and remain a viable candidate for use in the Large Hadron Collider. While a supply agreement with CERN, which ZMS had expected would be consummated in early 2015 has yet to be announced, we still think that this is still in the cards as CERN completes its validation process. And perhaps the results of CERN's recent experiment which showed the LFS crystals produced a superior coincident time resolution as compared to competing (LYSO crystals from St. Gobain and CPI) crystals could benefit order flow and finalization of a supply agreement from CERN. This seems to be supported by comments from CERN's senior research scientist who noted following results of the testing that, "Our team is impressed with the test results and with the competitive pricing of the LFS crystals. We are therefore proceeding to use Zecotek's LFS crystals for our PET-CERN projects."

Results of CERN's comparison of LYSO and LFS crystals were presented in a poster session at the 2015 Institute of Electrical and Electronics Engineers (IEEE) Conference held in Seattle. Below is part of the poster that was presented which graphically illustrates the more precise coincident time resolution of the LFS crystals versus the LYSO crystals from St. Gobain and Crystal Photonics, Inc. We view this as a meaningful "win" for ZMS as LYSO crystals are used in many of the OEM Time-of-Flight scanners (i.e. - high-end, high resolution scanners) and had been considered the highest performing crystals available. Higher performing crystals can be a tremendous competitive advantage as performance of crystals is a key factor in demand of PET scanners. In fact, this was at the heart of a court decision in a 2007 lawsuit where Siemens claimed St. Gobain infringed their LYSO crystals patent and that Philips (which purchased St. Gobain's crystals) would not have been able to compete in the high-end PET scanner market had they not illegally infringed Siemens' LYSO IP. And as a reminder, it was St. Gobain's LYSO crystals that Zecotek claimed infringed their patent that was the subject of the recently settled lawsuit. This validation by CERN could have very positive effects in terms of demand for the LFS crystals.

And finally in terms of potential additional near-term demand, with ZMS's lawsuit against Philips and St. Gobain settled, this opens up the very real possibility that Philips and Zecotek enter into a supply agreement. Last year Philips suspended CT/PET scanner production at its Cleveland, OH facility after FDA raised concerns about manufacturing processes and controls. Philips did not provide specifics surrounding the issues cited by FDA although has publicly noted that production at Cleveland remains at a very low level and may not be back to cull capacity until the current year-end due in part because “it took longer than anticipated to complete the necessary remediation at some of our suppliers….” While speculation, this could relate to suppliers for crystals.

And conclusion of the lawsuit also removes any possible hesitance by any of ZMS’ other potential customers, including other PET OEM’s, CERN and Hamamatsu-related customers to place orders until the patent issue was resolved.

We are maintaining our Buy recommendation.

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