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iCAD, Inc: Initiating Coverage at Neutral

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Brian Marckx, CFA

We have initiated coverage of iCAD ) with a Neutral rating and $1.30 price target.  See below for free access to our full 20 page report on the company which includes an analysis of iCAD's target markets and competition as well as our detailed financial model and valuation methodology.  While we are positive on iCAD's fundamentals, we believe caution is warranted until there is more clarity on the potential and likely liability related to a recently filed product liability lawsuit.     


Already established as a leading provider of advanced image analysis for mammography, MRI and CT, iCAD, Inc's. (iCAD) December 2010 purchase of Xoft, Inc. (Xoft) expanded their capabilities beyond just cancer detection/diagnosis and into cancer therapy.  Management expects the acquisition to be a catalyst in transforming iCAD from "a leader in image analysis" to a company with "a broader portfolio of oncology solutions that provide targeted analysis, therapy and monitoring throughout the cancer cycle."  Management looks for 2011 to be the front-end of this transformation and believes the company is now well positioned for long-term growth.    

iCAD is the world's largest independent Computer-Aided Detection (CAD) company.  The company's CAD imaging systems are used as an adjunct to mammography (digital radiography, computed radiography and film-based) screening to provide earlier detection of cancer and improve patient outcomes.  iCAD has placed approximately 4,100 systems since receiving FDA clearance of its first breast cancer detection product in January 2002.  The company continues to look to broaden its image analysis capabilities and in August 2010 its CAD technology became the first of its kind to receive FDA clearance for use with virtual colonoscopy in the detection of colonic polyps.  In July 2008 iCAD acquired CAD technology for use with Magnetic Resonance Imaging (MRI) which extended its reach into budding areas of interest in cancer detection including breast and prostate MRI.  

Xoft develops and sells the Axxent System, an electronic brachytherapy (eBxTM) device used primarily for the treatment of breast cancer.  iCAD closed on its $12.9 million acquisition of Xoft on December 30, 2010, marking iCAD's initial foray into cancer therapy. The acquisition will bolt on roughly $7MM in additional annual revenue in the near-term but this is expected to ramp after intraoperative radiation therapy (IORT), Axxent's sweet-spot, gains widespread insurance reimbursement (reimbursement  could be available by January 2012).  eBx directs high dose radiation to the cancerous site while sparing healthy surrounding tissue.  An isotope-free technology delivered in minutes during (and/or after) breast cancer surgery, eBx affords a safe, low cost and mobile alternative to traditional radiation therapy with no compromise in efficacy with the added benefit of significantly shorter treatment times.  Along with breast cancer, the Axxent System is FDA cleared for the treatment of other cancers including endometrial (gynecological) and skin cancers.    


Cash Position
Final payment for the Xoft acquisition (including ~ $1MM in transaction costs) was made in January 2011.  As of their most recent reporting period (3/31/2011) iCAD had $11.3MM in cash and equivalents.  The company has no preferred stock or debt outstanding.  While iCAD recorded a $5MM liability related to the Xoft acquisition, this represents an estimate of potential earn-outs and is contingent on iCAD hitting minimum pre-determined sales of Xoft products (Axxent and related consumables).

iCAD's cash flow from operating activities was ($3.7) million in Q1 2011, the first full period with Xoft included.  The relatively high cash-burn can be attributed to the inclusion of Xoft.  This ($3.7) million compares to $103k in Q1 2010 and $207k for the full-year 2010, both of which had no contribution from Xoft.  iCAD filed an 8-K/A on 3/17/11 which included financial statements of Xoft (prepared by Xoft) for the full-years of 2008 and 2009 as well as nine months ending 9/30 for 2009 and 2010.  On a stand-alone basis Xoft's operating cash flow had been consistently negative, although improving due to a consistent improvement in net loss.  In the nine months ending 9/30/10 Xoft used $7.3 million in cash from operations.  

While iCAD expects to eventually find some synergies with Xoft and reduce combined expenses and related cash burn, they indicated on recent earnings calls that there may not be much opportunity for this during the current year.  At the most recent quarter's cash burn rate iCAD has about 9 months worth of cash on hand.  The level of cash burn should come down, however, especially as Xoft-related sales begin to accelerate - which should happen following the establishment of a CPT I code for reimbursement of IORT breast brachytherapy - which could happen during Q3 of this year.  

iCAD's Q1 (3/31/11) 10-Q notes that they expect cash on hand and cash from operations to be sufficient to sustain operations for at least the next 12 months.  We expect that iCAD will be looking to raise cash by the early part of 2012.  While we have no insight into the likely source of additional financing, for simplicity our model incorporates an assumption that it comes from common stock issuance.        

iCAD breaks out revenue into two categories; products and service/supplies.  Product revenue is further broken out into Digital & MRI CAD and Film-based CAD (beginning Q1 2011 Xoft revenue is also itemized by product and services revenue).        

...Saturation of Digital Mammography Hurts Product Revenue Growth
iCAD saw its product revenue grow from $10.3MM in 2006 to $26.7MM in 2009, largely as a result of an influx of new digital CAD mammography sales from the industry shifting from film-based to digital imagers.  iCAD's product sales growth stalled in early 2009 and has fallen every quarter since Q2 2009 as digital imaging became more saturated and fewer digital imagers were being sold.  Digital / MRI CAD revenue peaked at $26.7MM in 2009 and fell to $15.4MM in 2010.    

iCAD's film-based business, which is driven by customers converting their film images to digital, experienced a similar slide in sales as digital imagers became more commonplace than film.  iCAD's film-based revenue peaked at $7.4MM in 2008.  It fell to $5.8MM in 2009 and $3.3MM in 2010.  

...Service / Supplies Revenue Holding Up
Service and supplies revenue mostly represents extended service warranties on iCAD's products.  As iCAD's products largely consist of sophisticated software, most customers will opt for these extended warranties.  Service / Supplies revenue has held up relatively well, growing from $3.3MM in 2008 to $4.0MM in 2009 to $5.8MM in 2010.    


Digital & MRI CAD
Digital & MRI CAD accounted for 82% of product revenue and 63% of total revenue in 2010.  While iCAD does not disclose the percentage of Digital & MRI CAD revenue that comes from digital CAD (i.e. - mammography CAD), management has indicated that it represents the vast majority.  Therefore, especially in the near-term, sales of iCAD's mammography CAD products will have the greatest influence on growth in Digital & MRI CAD revenue.  Sales in international markets, which can be somewhat choppy, accounted for approximately 16% of total revenue in 2010.    

Despite film-based systems still accounting ~ 22% of all mammography instruments in the U.S., we expect Digital & MRI CAD revenue to continue to struggle in the near-term as a result of the continued slowing pace of film-to-digital conversions.  Mammography CAD sales in iCAD's international markets was also soft in Q1 2011 despite the roll-out of SecondLook Premier in Canada and Europe during the period.  Economic softness hampered international mammography CAD sales which may be a recurring theme throughout the year.  Management recently indicated that sales of MRI CAD has been very strong as a result of new product launches in late 2010.  While MRI CAD should continue to show strength through the remainder of 2011 from the roll-out of new OEM agreements and the continued benefit of recent product enhancements, due to the relatively small contribution to overall revenue, growth in this segment will likely not be enough to offset declining mammography CAD sales.

We model a rebound in Digital & MRI CAD sales growth beginning in 2012 due to a combination of factors.  The declassification of digital mammography from PMA to 510(k) that happened in late 2010 has sparked a resurgence in activity from several OEM's, a number of which are in various stages of bringing new digital mammography systems to market.  The major catalyst to Digital / MRI growth in 2012 should be the launch of SecondLook in the U.S. - if all goes well a 510(k) filing will happen later this year and the product will hit the U.S. market by mid-2012.  And finally, CAD for CTC, breast MRI and prostate MRI could all see an uptick in demand.  CTC (VeraLook) should benefit from the recent agreement with Vital Images and new potential deals with GE and Philips materializing in 2012.  Revaluation of the ACRIN study should be completed and published and potentially lead to eventual Medicare reimbursement - if that happens iCAD's CTC CAD sales could ramp quickly.  Prostate MRI (VividLook), while still struggling to gain acceptance despite proven benefits against PSA, may experience slow but steady growth.  iCAD has seen some success in terms of sales of VividLook through education about the benefits of prostate MRI CAD which should continue to be the case in 2012.  Breast MRI (SpectraLook), which remains a significant growth category in Europe, could reverse the recent slide in international sales, especially with strengthening in world economies.      

Film-based CAD
Film-based accounted for 18% of product revenue and 14% of total revenue in 2010.  We model film-based sales to continue to decline going forward as a direct result of the slowing conversion rate of film to digital mammography.  

Xoft revenue was approximately $5.5MM in 2010 (prior to iCAD's acquisition).  Xoft product revenue, which includes sales of the Axxent controller, in Q1 2011, the first full quarter under iCAD, was $960k.  Xoft service and supplies revenue, which includes sales of the x-ray source, disposables and extended warranties, was $360k.  iCAD/Xoft announced the recall of the FlexiShield in early February 2011.  Management indicated that the recall has stunted Axxent sales as customers have been hesitant to buy the system until a replacement shield is available.  The new shield has since been submitted for FDA clearance and could be available in the market in Q3 of this year.

We model total (Axxent controller and supplies/services) Xoft sales of $7.0MM in 2011, with the majority of revenue weighted towards the back half of the year.  Going into 2012 we think Xoft sales could begin to show a significantly greater rate of growth predicated on the assumption that a CPT I code (with a favorable relative value) for IORT brachytherapy is assigned and active by the early part of that year.  This also assumes that there are so significant lingering hangovers from the shield recall.  Our Xoft-related revenue forecasts assume Axxent's penetration of the brachytherapy-appropriate breast cancer market (currently ~ 110k annual procedures) is approximately 4% by year-end 2012, 10% in 2013 and 15% in 2014, the market grows at 2% per year and 3 procedures per unit per week.  Our model also includes only marginal revenue contribution from Xoft for indications other than breast cancer (i.e. - skin, endometrial, etc.) as we currently view these as more ancillary applications.           

Revenue and EPS Estimates
Management's revenue guidance as of 5/3/2011 for 2011 is $32MM - $35MM.  This was revised lower from $34MM - $38MM following the recall of FlexiShield.  We more conservatively model revenue of $28.7MM in 2011.  With management's focus on the integration of Xoft and growing the top-line, we do not expect much in the way of cost-cutting redundant expenses in 2011.  We model of  EPS of ($0.31) in 2011.  

We look for revenue to grow to $38.2MM in 2012 and $83.2MM in 2014 and also expect iCAD to begin to realize some much more substantial operating leverage going into 2012.  We model EPS of ($0.22) in 2012 and approximately break-even EPS in 2014.    

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