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ICAD: U.S. Tomo 2.0, Organic Therapy Growth and Leaner Ops Mean Profitability is Realistic

By Brian Marckx, CFA



Q2 2018 Results: U.S. Tomo 2.0, Organic Therapy Growth and Leaner Ops Mean Profitability is Realistic…

iCAD (ICAD) reported financial results for their second quarter ending June 30th. Total revenue missed our number pretty handily, Detection revenue was well-below what we were looking for and tomo adoption does not appear to be as robust as hoped – and despite all that, Q2 2018 was one ICAD’s best quarters in a long time.

Apples-to-apples total revenue was up 8% yoy, gross margins widened 730 bps and operating loss improved by $1.7M to just $939k – the lowest (i.e. best) since Q3 ’15. While much of the improvement in operating loss relates to lower stock comp in the current year period, expenses have already been shed, cash burn is falling and both are expected to continue to improve. As we hoped, shedding of the cash and resource-intensive therapy subscription business has resulted in a rapid improvement in margins and profitability. It is becoming increasingly clear that ICAD’s only misstep in dumping that business was that they didn’t do so sooner (but, of course, hindsight is always 20/20).

So, with that big fat anchor now cut loose, we think near-term operating profitability and positive cash flow generation is foreseeably realistic within the next 18 months (based on our model), and possibly sooner - with timing likely hinging on rate of U.S. adoption of tomo 2.0 and the related revenue curve. That, in turn, hinges on timing of FDA clearance – ICAD filed the PMA in late-May and in ~mid-August received follow-up questions from the agency. Relative to the scope of the questions, management noted on the Q2 call (Aug 14th) that they do not cause serious concerns, that they anticipated responding to them in approximately two weeks (~end of Aug) and “feel confident” that they will have U.S. marketing approval later this year. While we think management’s timelines are realistic, we continue to (more conservatively) model U.S. launch in early 2019.

Total Revenue: $6.2M (vs. $6.8M estimate) down 4% yoy, down 2% sequentially

While yoy total revenue fell 4% in Q2 and fell 5% in 1H’18, excluding contribution from MRI and subscription-Therapy from the prior year period, total revenue (on a current-operations basis) actually increased 8% for the quarter and was up 3% through the first six months of 2018.

As a reminder, the MRI assets were sold in January ’17 and contributed ~$0.3M in Q1’17 and (for some reason still generated revenue of) ~$0.1M in Q2 ’17. Per the Q1 and Q2 ‘18 10-Qs, Therapy revenue from subscription NMSC contributed ~$0.3M and $40k in Q1 and Q2 of this year, compared to ~$0.4M and $0.6M in the prior year periods.

Cancer Detection: $4.0M (vs $4.5M E) down 6% yoy, down 1% sequentially

As Q2 ’17 included ~$100k of MRI-related revenue, cancer Detection performed slightly better on an adjusted (current ops) basis, falling 5% yoy. Through the first six months, Detection revenue fell 8% as-reported and 4% as-adjusted.

Given that we had expected to see more obvious accelerating adoption of tomo by now, Detection has been fairly disappointing so far in 2018. Q2 Detection revenue was nearly identical to that of Q1 of this year - with product revenue of $2.5M and service/supplies revenue of $1.5M in both periods. And, it appears the similarities between the first and second quarter don’t end there, as GE’s lack of sufficient sales effort was cited as a major reason for the lackluster Detection performance in both periods.

We estimate that GE accounts for ~70% - 75% of ICADs OEM Detection revenue. OEM partners (which also includes Fuji and Siemens and, will include others following FDA clearance of tomo 2.0) account for ~50% of total Detection revenue. OEM revenue fell 18% yoy to $1.7M in Q2 and fell 10% yoy (which included a 3% decline in Q1’18) to $3.9M through 1H’18. Meanwhile, Detection revenue from ICAD’s direct sales force, which also accounts for ~50% of total Detection revenue, increased 7% yoy to $2.1M in Q2 and fell 7% yoy (which included a 19% decline in Q1’18) to $3.8M through 1H’18. So, while it’s clear that most of the weakness through the first six months of 2018 does indeed point to the OEM channel, direct sales were also quite weak in Q1 before turning back to meaningful growth in the most recent quarter.

Given the rather lackluster Detection numbers through the first half of 2018, we have again lowered our growth estimates. We had previously modeled a much steeper ramp going into Q3 with the expectation that the European tomo 2.0 roll-out would begin to accelerate, although have since tempered that optimism. But while the initial roll-out in Europe may be somewhat flatter than what we had envisioned, we do expect it to gain momentum through the end of this year and continue to like the long-term adoption and growth fundamentals. We are also encouraging that ICAD appears committed to penetrating the European market and growing their distribution footprint in key markets, including Germany and France. ICAD noted that initial interest of 2.0 in Europe, including from KOL’s, has been very positive.

But, the U.S. market is where the majority of the opportunity lies. And, we still like the big-picture view. Rates of adoption of new 3D capable machines has been somewhat slow-going – perhaps related to budget resets and/or lack of widespread insurance coverage for tomo (both of which can be an impediments to hospitals committing to the technology). But, with new budgets and building awareness of the benefits of 3D vs. 2D (such as lower recall rates), adoption should increase. Reading 3D images is more time consuming, however, which will drive demand for ICAD’s software. Insurers who do not already reimburse for tomo will likely soon have little choice but to do so, which should help alleviate any ROI-related concerns at the provider level. And, finally, providers will leverage tomo as competitive differentiation, prompting other hospitals to follow suit and also adopt the technology. While much of the volume is still for the 2D product (even for new machines that are capable of both 2D and 3D), we expect current headwinds to adoption of 3D tomo to dissipate over time. With approximately two-thirds of the U.S. market still yet to adopt tomosynthesis, significant upside remains.

And while we expect to see sequential growth of ICAD’s GE-only tomo product, their next-generation software (Version 2.0) offers a much greater opportunity for the company. This product is not only expected to reduce reading time but also further improve on accuracy to the point where radiologists will only need to read abnormal exams. This combination could prove of significant value in reducing reading time and, potentially, reduce staffing needs thereby helping to lower related costs. It also can be used on all manufacturers machines, which significantly increases the size of ICAD’s target market.

Eventual release and potential publishing of the U.S. reader study (which was used to support the 2.0 PMA filing) could also help facilitate adoption. Results were compelling – showing an 8% increase in accurately detecting cancer (ie 8% increase in sensitivity), 7% reduction in the number of false positives (ie 7% increase in specificity) and 53% reduction in reading time (as compared to reading without 2.0). The fact that the study showed a simultaneous increase in both sensitivity and specificity, combined with the magnitude of improvement (for context, a 5% increase in detection is considered clinically meaningful) and massive reduction in reading time, is rather extraordinary and should be a very persuasive marketing message as to why radiologists should adopt the tool. The study results will be presented at the RSNA Annual Meeting in November.

ICAD filed their 2.0 PMA submission to FDA in late-May and in ~mid-August received follow-up questions from the agency. Relative to the scope of the questions, management noted on the Q2 call (Aug 14th) that they do not cause serious concerns, that they anticipated responding to them in approximately two weeks (~end of Aug) and “feel confident” that they will have U.S. marketing approval later this year. While we think management’s timelines are realistic, we continue to model U.S. launch in early 2019. ICAD noted that they expect to add to their direct sales force to support the U.S. launch of tomo 2.0.

Given the industry shift from 2D to 3D and wider breadth of machines that this second-gen product has availability for (~75% of tomo systems are non-GE machines) and its enhanced features, U.S. introduction of this should result in an accelerated growth curve of the Detection segment.

ICAD’s digital breast density software (version 3.4) for tomosynthesis, which received FDA clearance in August, provides another growth opportunity and, perhaps just as importantly, adds what is increasingly becoming must-have functionality. Growth has been spurred by increasing awareness of the false negative risk on mammography of dense breasts. That has resulted in more and more states (currently 36 states and increasing) mandating that patients must be notified of their breast density.

Cancer Therapy: $2.2M (vs. $2.3M estimate): 0% yoy, -6% sequentially

Therapy product sales were $708k, slightly ahead of our $650k estimate. Therapy services/supplies was $1.5M, about 11% shy of our $1.7M number. Total Therapy revenue was flat through 1H’18 ($4.5M). While slightly below our estimate, Therapy revenue actually held up very well. Q2 numbers further highlight how much of a drag the skin subscription business was on the segment and ICAD as a whole.

Subscription NMSC contributed ~$0.3M and $40k in Q1 and Q2 of this year, compared to ~$0.4M and $0.6M in the prior year periods. So, excluding skin-subscription, Therapy revenue grew 46% yoy in Q2 and 24% through 1H’18. OUS IORT revenue has been a major catalyst in the past and continues to be. More surprising is that U.S. IORT has recently showed glimpses of growth. Through 1H’18 balloon volumes are up 22% worldwide – that includes 20% growth in the U.S. (and 25% OUS).

Given the size of China and India and their ever-increasing prosperity, these countries may represent significant growth opportunities. The relatively enormous population, combined with the convenience of radiation therapy at the time of surgery with eBx (versus traditional radiation which requires multiple trips back following lumpectomy), are reasons why ICAD believes China could represent another significant market for Xoft. ICAD’s IORT balloon applicators recently received CFDA approval. This follows prior approval of the console in that country. ICAD noted on the Q2 call that they will be installing the first two systems in China later this year. Meanwhile, Xoft received approval from India’s Atomic Energy Board in late-August of this year and the first Xoft system was placed in that country at Omega Hospitals Hyderabad.

ICAD notes that they continue to see growing international demand in several newer applications – including brain, rectal and prostate. This is in addition to breast and gyn, which have already witnessed meaningful demand. ICAD will continue their international expansion strategy and expects to soon enter Saudi Arabia, Egypt, Colombia and Africa.

With more data supporting the benefits of IORT versus traditional radiation therapy, we continue to think adoption in the U.S. market could soon begin to accelerate. Intraoperative Radiation Therapy (IORT): A Series of 1000 Tumors, a study of 984 breast cancer patients which received IORT breast cancer therapy (between June 2010 and August 2017), was published in Annals of Surgical Oncology in July 2018. Results to-date showed local recurrence rates (i.e. primary endpoint) at median follow-up of 36-months which are comparable to that of the landmark prospective TARGIT-A and ELIOT trials.

Publication of ICAD's ExBRT (Safety and Efficacy Study of Intra-Operative Radiation Therapy (IORT) Using the Xoft Axxent eBx System at the Time of Breast Conservation Surgery for Early-Stage Breast Cancer) study could happen later this year and further spur adoption. Enrollment (n=1,200) recently completed with median follow-up of just under two years. The study is being conducted at 20+ sites in the U.S. and Canada and is evaluating safety, efficacy, cosmetic outcomes and quality of life of patients for 10 years post-treatment.

Also adding to the evidence supporting the use of IORT instead of traditional EBRT was a study that was recently published in Cost Effectiveness and Resource Allocation. The study (see Appendix in our updated report – link below) demonstrated that IORT is associated with a longer quality of life, lower overall cost and higher monetary benefit as compared with external beam radiation therapy among patients with early-stage breast cancer.

Relative to NMSC, ICAD noted that they are now detailing to cancer centers, as well as their legacy focus on dermatology practices. We expect they will continue to pick their spots as dictated by areas with favorable reimbursement. Given shedding of the subscription-related cost base, we think any topline growth in the NMSC business should be incremental (relative to 2017) to profitability. And, we still remain optimistic longer term on NMSC given clinical outcomes supporting use of eBx. Clinical data continues to show excellent outcomes including superior cosmetic results and patient satisfaction as compared to surgery, which should help support the quest for favorable insurance reimbursement. At ASTRO 2017 ICAD presented data from their NMSC matched-pairs study (n=369) which showed similar cancer recurrence rates at more than 3 years follow-up between eBx and Mohs surgery (i.e. standard therapy). Additionally, cosmetic outcomes were as good or better among the eBx cohort as compared to Mohs. Another ASTRO presentation, relating to the treatment of peri-ocular NMSC, showed treatment with Xoft was associated with a 99% control rate at 2 years follow-up among patients (n=86) with basal cell carcinoma and squamous cell carcinoma of the eyelid.

Gross margin, OpEx and Cash flow
Gross margin was 77.6% in Q2 and 74.4% in 1H ’18 which compares to 69.0% and 69.6% in the prior year periods. Operating loss was $939k and $4.1M in Q2 and 1H’18, compared to $2.6M and $5.6M in the prior year periods. So, while (as-reported) revenue fell 4% and 5% yoy in Q2 and 1H’18, COGS and OpEx fell significantly more. COGS fell 28% and 20% over those same periods while OpEx fell 20% and 9%.

Cash used in operating activities was $822k and $1.5M ($422k and $3.0M, ex-changes in working capital) in the three and six months ending 6/30/18, compared to $1.6M and $3.3M ($572k and $1.7M, ex-changes in working capital) in the prior year periods.

We cover ICAD with a $6.75/share price target. See below for free access to our updated report which includes our valuation methodology and financial model.

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