ICAD: Strong Detection Revenue, Skin Utilization

Zacks Small Cap Research

By Brian Marckx, CFA

Q3 2013 RESULTS

iCAD (ICAD) announced financial results for the third quarter ending September 30th.  Revenue came in only slightly softer than our number and while only eking out just better than 1% yoy growth (note that Q3 2012 was a fairly strong quarter and a tough comp), the details behind the itemized revenue lines continue to paint the picture that the recent shift towards a greater focus on recurring and services oriented revenue streams, primarily in the Detection segment, are paying off.  Detection revenue posted 14% growth in Q3 with management noting that they continue to grow the number of customers covered by service agreements, on both a yoy as well as qoq basis.  And while revenue in the Therapy business fell almost 10% in Q3, utilization, particularly in skin procedures, continues to trend upwards with the number of skin lesions treated quadrupling from Q3 2012.   Therapy revenue can fluctuate somewhat widely from q-to-q given the variability in controller placements - important is that we continue to be encouraged by what we're seeing in terms of utilization -  which is the long-term driver of revenue and margins in this segment.  Through the first nine months of 2013, Therapy revenue is up 41%.

Much of the recent growth in Therapy is coming from skin which we think will continue given catalysts such as positive clinical trial data supporting the use of eBx in non-melanoma skin cancer, fairly rapid geographic growth in reimbursement and overall increased awareness (by both dermatologists as well as consumers) of its benefits over traditional surgical excision.  ICAD remains very active in promoting at all these levels.  We think it is reasonable to expect that an increase in reimbursement, from both an uptake on the payer side as well as level of reimbursement, will be facilitated with additional positive clinical data.  This will be supported by published manuscripts and presentations such as the recent presentation at ASTRO detailing positive three-year follow up data on non-melanoma skin cancer patients (n=187) treated with Xoft.

Recent and upcoming product launches and an increase in service and recurring revenue streams remain the catalysts to growing the Detection segment.  Management has indicated that the recently introduced PowerLook platform is seeing significant interest.  Demand is coming from both OEM partners as well as upgrades to ICAD's installed base.  Management also pointed towards increased service contract sales to GE's installed base as benefitting the recent Detection revenue growth.  Tomosynthesis remains one of the major expected growth catalysts over the mid to long term.

Growth in procedural volumes and the shift towards greater services based revenue also looks to be benefitting margins with the gross margin holding up impressively despite the bite from the recently implemented medical device tax.  Management continues to be diligent on watching operating expenses which has had a dramatically positive impact on improving the bottom line results and on the cash flow statement.  Operating expenses have fallen almost 6% through the first nine months of 2013 compared to the same period in 2012 while revenue has grown almost 17% over the same period.  Importantly, the cuts in operating expenses have not compromised clinical research or marketing and promotional activities, which include attendance at industry events and conferences and activities related to promoting reimbursement of IORT.  We continue to expect to see additional operating leverage with further revenue growth, the combination of which, along with an even wider gross margin, we think will result in positive earnings for the full year 2014.  Management also noted on the Q3 call that they expect to generate positive cash flow in Q4.

Revenue
Revenue of $8.3MM was up 1% y-o-y and about 3% lower than our $8.6MM estimate - the difference due to 18% lower than modeled Therapy revenue which was partially offset by a 16% beat in Detection revenue.

> Cancer Detection: 
$4.3MM actual (+14% yoy) vs. $3.7MM estimate

Total product revenue in cancer detection was about $2.3 million, up from about $2.0 million in Q3 2012 and better than our $2.0 million estimate.  It's been well detailed that Detection-related revenue growth had been hampered in the past given ICAD's previous focus on squeezing the last vestiges of the benefits from the conversion by imaging facilities from film-based to digital mammography.  While ICAD does not break out the specific film-to-digital conversion related revenue, we think it's now relatively minimal.  We point this out as it provides even greater insight into the success that ICAD has had in growing of revenue from the Detection segment's new product lines as well as their services and subscription-based offerings.  Q3 saw Detection product revenue growth of 11% despite a likely precipitous drop in film-to-digital conversion related revenue.

In 2012 iCAD implemented a shift in strategy to one with a greater focus on services and subscriptions with the goal of leveraging more recurring revenue and higher margins.  We think it's now obvious that this is bearing fruit with Detection services revenue growing 22% in Q4 2012 and almost 19% through the first nine months of 2013.  Management noted that the number of customers under service agreements has increased by 14% since the end of 2012.  And despite the newly implemented 2.3% medical device tax, iCAD has been able to maintain beefy margins, which we think is a direct benefit of the recent shift towards services/subscriptions.

We continue to expect the Detection segment to remain on track for sustained growth.  This being fueled by new product launches (PowerLook AMP, CAD for tomosynthesis, etc.), more annual licensing agreements,  increased service contracts (to iCAD's installed base as well as OEM partners'), partnership deals with OEM's with new products, development projects and service contracts, and the recently penned MRI software development deal with Invivo.  iCAD launched the first two products through this new Invivo relationship in March which should provide a more substantial revenue contribution in the second half of 2013.

And as we've noted in the past, while CT colon CAD revenue has yet to gain much traction in the U.S. as a result of a dearth of reimbursement, management recently indicated they are seeing some growth internationally and this remains a viable domestic growth opportunity with sufficient reimbursement.  The additional data from the ACRIN study that were recently published could be a catalyst to eventually gaining Medicare reimbursement for CT colon CAD. 

> Cancer Therapy: 
$4.0MM (-10% yoy) actual vs. $4.8MM estimate

Cancer therapy fell 10% yoy but was up 2% sequentially.  Controller sales can be somewhat variable q-to-q and fell from 12 sold in Q3 2012 to 10 sold in Q3 2013 so despite nice growth in utilization and consumables sales, the drop in controllers sales resulted in a decrease in total Therapy revenue.  Importantly utilization is increasing.  ICAD sold 194 balloon applicators with over 1,000 skin lesions treated in the most recent quarter compared to 150 applicators (+29%) and 250 lesions treated in the year earlier period.  As the installed controller base grows, growth in consumables revenue should accelerate.

Growth appears to be coming from several fronts, including more favorable reimbursement, greater awareness of the benefits of IORT compared to traditional whole breast radiation therapy, and substantial interest and procedural volume (skin cancer treatment typically requires more than one visit) coming for use in non-melanoma skin cancer.

iCAD, who was instrumental in the pursuit of getting higher reimbursement for IORT treatment, notes that they expect to continue to be active in driving more demand for their Axxent system which will include awareness building efforts, post-marketing studies and continued lobbying for even greater reimbursement for breast IORT and initial reimbursement for skin.  Management again noted on the earnings call that they continue to make progress with both regional and national payers on reimbursement - most recently noting that as of Nov 1st 19 states will have a "positive policy" related to non-melanoma skin cancer whereas this stood at just 10 states in July of this year.  Clearly the reimbursement picture is improving which has almost certainly aided uptake and utilization of Xoft for skin cancer.

Much of the recent growth in Therapy is coming from skin which we think will continue given catalysts such as positive clinical trial data supporting the use of eBx in non-melanoma skin cancer, fairly rapid geographic growth in reimbursement and overall increased awareness (by both dermatologists as well as consumers) of its benefits over traditional surgical excision.  ICAD remains very active in promoting at all these levels.

We think it is reasonable to expect that an increase in reimbursement, from both an uptake on the payer side as well as level of reimbursement, will be facilitated with additional positive clinical data.  This will be supported by published manuscripts and presentations such as the recent presentation at ASTRO detailing positive three-year follow up data on non-melanoma skin cancer patients (n=187) treated with Xoft.

The company is also now tapping international markets with a handful of sites in Europe and one in Asia currently using Axxent.  In April they announced distribution agreements for parts of China and Russia - launch in which is expected to happen following requisite regulatory approvals - potentially culminated in the next 12 months.  More recently they penned a distribution agreement in Canada.

We continue to see tremendous upside in the breast cancer indication.  We think utilization remains relatively low and penetration of Axxent in the U.S. breast IORT market is likely only in the low single digits.  Greater awareness and improved reimbursement could provide catalysts to ramp penetration, utilization and revenue.  Relative to skin cancer, procedural volumes continue to be on the rise which has been a meaningful contributor to the success of iCAD's Therapy business.  The Therapy business should further benefit as additional indications come online, including for cervical cancer which is now still in the early launch phase.

EPS
Q3 EPS (excluding non-cash revaluation of warrant liability) of approximately ($0.11) was slightly below our ($0.08) estimate as a result of the miss on the top-line and slightly higher operating expenses (although very much in-line with mgmt's guidance), which was partially offset by a wider gross margin (71.5% A vs. 69.5% E).  EPS was better than the ($0.12), excluding warrant liability revaluation, in Q3 2012.  ICAD continues to keep a lid on operating expenses.  Management reiterated their previous guidance on operating expenses which is to maintain them at the mid-to-low $6MM range (which, with anticipated revenue growth should result in nice operating leverage).

Cash
iCAD exited Q3 with $10.2 million in cash and equivalents, down from $12.9 million at the end of Q2.  Cash used in operating activities was an outflow of $2.5 million, which included a $2.3 million increase in A/R.  Management addressed the A/R on the call, noting that they adjusted terms based on the type of customer but indicated the credit is quality and expected the balance to come down.  Adjusted EBITDA was approximately $545k in Q3 and $1.6 million in the first nine months of 2013.  This compares favorably to EBITDA of $240k and ($1.6) million in the comparable year earlier periods.  Q3 2013 marks the fifth consecutive quarter of positive adjusted EBITDA.  Given our expectations of significant revenue growth, gross margins maintained at 70%+, and incrementally increasing operating leverage, we continue to believe that the current cash balance along with cash from operations will be more than sufficient to fund the company for the foreseeable future.

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