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Positron Corp - Initiating Coverage at Hold

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Brian Marckx, CFA

We are initiating coverage of Positron Corp. ) with a Neutral (Hold) recommendation and $0.04 price target.  See below for free access to our full 18 page report on the company which includes our financial model and provides further detail on the company's businesses, industry, markets, products and competition.  


BUSINESS

Positron Corporation (Positron) began designing, producing and marketing molecular imaging devices for cardiology using Positron Emission Tomography (PET) technology in the early-1980s.  Despite PET providing more accurate scans than single-photon emission computed tomography (SPECT), which has been considered the industry-standard nuclear imaging modality, the company struggled to generate much in the way of revenue or gross profit due to SPECT's deeply entrenched share of the market and slow acceptance by healthcare providers which was exacerbated by unfavorable PET reimbursement policies.  

Positron may be in the midst of a major transition, however.  A favorable shift in industry dynamics coupled with new developments at the company including significant product introductions, a co-development agreement with medical device heavyweight Covidien, the acquisition of a radiopharmaceutical manufacturing facility and a partnership to build a high energy cyclotron may help turn the company's fortunes.

A molecular imaging company, Positron offers the only dedicated PET scanner optimized for cardiac imaging.  Attrius® , which launched in early 2010, is the company's flagship PET scanner which was awarded the Frost & Sullivan "2010 North American Cardiac Molecular Imaging New Product Innovation Award".  With the only standalone cardiac PET scanner on the market, Positron is looking to carve a niche position in between lower cost yet poorer accuracy SPECT imaging and pricey PET/CT combination scanners, the high accuracy of which is unnecessary in cardiac applications.  

While Attrius is expected to provide the bulk of revenue in the near-term, radiopharmaceuticals development and sales to the Attrius customer base is being positioned as the company's fuel for long-term revenue growth.  According to an independent research firm, U.S. sales of radiopharmaceuticals should grow at an annual compounded rate of 22% from 2010 to 2018.  Once functional, Positron's recently announced cyclotron project could be the final link in the company's quest to fulfill most major functions within the nuclear imaging value chain including isotope production, radiopharmaceutical manufacturing, radiopharmaceutical preparation and delivery (PosiRx / Covidien partnership), and imaging (Attrius).  And while Positron's main focus is PET imaging, their recently launched PosiRx™ radiopharmaceutical preparation and dispensing system caters to the significantly larger SPECT system installed base, which is expected to provide customer and revenue diversification.

Positron is currently headquartered in Fishers, Indiana where it also maintains manufacturing capabilities.  All of the company's PET scanners are manufactured through a joint venture called Neusoft Positron Medical Systems in China.  Production of radiopharmaceuticals and development and manufacturing of radiopharmaceutical products and devices are currently handled at a facility in Crown Point, Indiana.  As of May 2011 Positron had 30 employees.       

In an economically-incentivized deal with the city of Noblesville, Indiana, Positron recently announced their intention to relocate their headquarters, R&D and manufacturing facility to that city which is just 8 miles north of Fishers.  Positron will also build a high-energy cyclotron in Noblesville.  The city, which is expected to benefit from job creation and tax revenue, has agreed to provide certain economic incentives in return.  Contingent on Positron securing total financing commitments of $42MM, Noblesville will provide up to $6.7MM of economic development bonds to acquire property for the project.  The city and Positron will also pursue the issuance of up to $40MM in Midwestern Disaster Area Bonds.  Positron will look to raise outside debt financing as well as raise capital through the sale of up to a 49% minority interest in the cyclotron project.   


FINANCIALS

Cash Position
Positron's cash position is precarious.  As of their most recent reporting period (6/30/2011) Positron had $496k in cash and equivalents.  The company's most recent capital raise came from the April 2011 sale of $1.3MM in 8% convertible bonds (due December 2012).  Management's May 2011 shareholder letter mentioned that they began borrowing against their accounts receivable.  Also outstanding are four series of convertible preferred stock - none of which require cash pay dividends, however.  Positron also lists $2.0MM in customer deposits (liability) on its balance sheet related to Attrius system orders that are in process of being fulfilled.  

Positron has yet to generate positive cash flow.  Cash used in operations was $4.7MM in fiscal 2010 and $2.5MM through the first six months of 2011 ($1.2MM in Q1 and $1.3MM in Q2).  The company has consistently funded operations through the regular issuance of common stock and preferred shares (outright sale as well as payment for certain services) which we model to continue for at least the next two to three years - this may change, however, as our model does not yet incorporate the effects of financing the cyclotron project.  We will update our assumptions when terms and likelihood of the deal getting done are more certain.

Positron's fragile cash and liquidity position presents a substantial amount of risk for investors - if the company can not raise additional cash in the very near-term, they may not be able to sustain operations.    


Revenue
Positron breaks out revenue into two categories; systems and services.  Attrius systems revenue is recognized only after installation at the customers' facility has been completed, which can lag the actual contract sale date by 4 - 6 months.  At the time of sale customers place deposits with Positron for a portion of the total sales price  - the amount of the deposit varies but we estimate it (based on information in regulatory filings) at approximately 50% of the total price of the system on average.    

Services revenue represents sales of service/maintenance contracts as well as sales of PosiStar.    


…Attrius Jumpstarts Revenue But Margins Remain Anemic
Attrius made its market introduction in early 2010 and through the end of that year Positron had contracts for 15 systems, 5 of which had been installed and which revenue had been recognized from.  This helped push total revenue up to $4.6MM (including $3.7MM from systems) in 2010, from just $1.5MM in 2009.  The remaining 10 system sales not yet recognized in 2010 should hit the income statement during the current year (8 of which were recognized in 1H 2011).  Despite the jump in revenue in 2010, gross income remained barely better than break even at $59k (1.3% gross margin) in 2010 vs. $127k (8.8% gross margin) in 2009.  Gross margin has barely budged during 2011, coming in at 15% in Q1, but only 6% in 1H 2011 (-2.3% in Q2 2011).   



OUTLOOK
     
Our Outlook for Positron is highly subjective and is based largely on anecdotal information gained through discussions with management (management did not provide specific guidance other than what is available in the public domain) and relatively high-level research on the industry.  Our financial projections for Positron are also largely driven by sales of Attrius (especially through 2013).  As such, if reality proves different from our various assumptions (especially relative to growth in sales and margins of Attrius), there is significant risk that Positron's actual financial performance will fall short of our projections.  While at least a portion of this risk should begin to mitigate if Positron can demonstrate an ability to generate sustained and consistent period-over-period (y-o-y as well as q-o-q) growth in Attrius system placements and related gross margins, until there is more clarity relative to a number of other significant lingering unknowns (i.e. - ability to raise additional capital, remaining current on payables, ability to control operating expenses, etc.), an investment in Positron will continue to be inherently highly risky.          

Attrius
Management had been shooting for approximately 30 system sales in 2011 but noted that a recent shortage in PET isotopes have softened PET scanner sales.  The Q2 10-Q implies only one system was sold during the first half of the year.  A July FDA communication alerted PET imaging facilities to halt use of CardioGen-82, a generator which supplies a significant portion of PET tracers due to concern over patient radiation exposure.  While the tracer supply could come back on-line after further review of the generator manufacturer by the FDA, this supply disruption will likely hinder demand (at least in the near-term) for Attrius.

We model only 9 Attrius system sales in 2011 and revenue recognized on 14 systems (which includes installations from the systems sold during 2010).  Assuming isotope shortages reverse and no other significant hindrances arise, we assume Positron is able to increase the rate of unit sales in 2012 to 30.  We model Attrius unit sales of 30 in 2012, 40 in 2013 and 60 in 2014.  Revenue recognition will continue to lag that of sales contracts but the difference should be much more blurred as the overall sales and placement rate accelerates.  We currently model $10.0MM in Attrius sales (recognized) in 2011, growing to $37.5MM in 2014.    

We currently do not see any substantial catalyst that will widen product gross margins, which will continue to hamper profitability and cash flow, especially in the near-term.  While higher production volumes may provide some longer-term product margin relief, we do not believe it will be enough to cover operating expenses.  Instead, we view Positron's hardware business as more of the razor in a razor-razor blade business model and a way for Positron to grow a dedicated customer base to which they can then sell high margin radiopharmaceuticals.     

Service Revenue
Service revenue accounted for about 24% of total revenue in 2010.  We expect service revenue to continue to track at about 10% - 25% of Attrius sales for the foreseeable future.  We look for service revenue of $844k in 2011, growing to $9.4MM in 2014.   

Radiopharmaceuticals / Consumables
Our Radiopharmaceuticals / Consumables line item includes contribution from the Covidien co-promotion of SPECT consumables and sales of indium oxine and PET radiopharmaceuticals.  Assuming the cyclotron build-out progresses as the initial plan suggests, we will also eventually include forecasted revenue generated from sales of isotopes - which should also directly facilitate radiopharmaceuticals sales growth and related margins.  When it becomes more clear as to construction timelines and there is more certainty relative to when the project could be completed and functional, we will update our model accordingly.  

In the meantime Positron will look to generate revenue from the Covidien co-pro through placement of PosiRx systems and launch of their indium oxine product - eventually followed by sales of PET radiopharmaceuticals.  We model SPECT consumables revenue to be driven mostly by PosiRx system placements.  While we model PosiRx system placements to be negligible in 2011, we think this could begin to accelerate going into 2012 and begin to generate more meaningful revenue in 2013.  

Our model assumes only a very modest contribution from indium oxine during the current year, which we believe will remain relatively insignificant in the following years.  Indium oxine represents a foot-in-the-door for Positron, however and hopefully an opportunity to become relevant in the large, rapidly growing and high margin market for radiopharmaceuticals.  While offering a potentially very lucrative opportunity (and much more than any of their other products) for Positron, the manufacture, production, FDA approval and commercialization of PET radiopharmaceuticals is likely at least two years away.  As a result, we model radiopharmaceutical revenue to remain modest (<10% of total revenue) until around 2014, at which time Positron's revenue, profitability and cash flow could all show meaningful improvement.    

We model radiopharmaceutical / consumables revenue of less than $1MM in 2012, growing to $13.4MM in 2014.  


Revenue and Net Income Estimates
We look for revenue of $10.9MM in 2011, growing to $60.3MM in 2014.  Lackluster gross margins coupled with little leverage in operating expenses as a result of R&D related to radiopharmaceutical development and additional sales and marketing expenses related to accelerating system placements means Positron will likely continue to run an operating loss through at least 2013.  Our assumption that Positron is able to reach profitability in 2014 is based largely on high-margin radiopharmaceuticals showing a significant sales ramp beginning in the early part of that year.  If Positron is unsuccessful in their quest to manufacture radiopharmaceuticals, we fear that the company may have a very low chance of reaching profitability solely with their Attrius business.     

We model net loss of $6.0MM in 2011, turning to net income of $1.7MM in 2014.  With almost 800MM common shares currently outstanding (and just over 3 billion on a dilutive basis) which will grow if Positron continues to finance operations through the sale of common and convertible securities, we model $0.00 in EPS through at least 2014.  As noted earlier, however, Positron's capital structure could potentially change significantly, contingent on financing of the cyclotron project.  We will update our share count estimates if and when appropriate.    



VALUATION / RECOMMENDATION

As we model POSC to post negative income and EPS through 2013, along with the enormous outstanding share count, valuation using a P/E multiple is not appropriate.  Instead we value Positron using competitor enterprise value/sales multiples (EV/S).  There are no similarly sized (i.e. - microcap) competitors with available analyst revenue estimates.  As a result we use revenue estimates of much larger companies in the medical imaging and cardiac care spaces as comparables (ZOLL, THOR, COV, HOLX).  Average comparable EV/S (using estimated 2012 sales) currently stands at 2.7x.  Applying this to our estimated 2012 revenue of $14.6MM for Positron results in an enterprise value of $33MM, or $0.04/share.  POSC currently trades at approximately $0.02/share.  We are initiating coverage of Positron with a Neutral rating.

Our Neutral recommendation reflects substantial risks of an investment in Positron.  If the company can demonstrate a sustained ability to increase the Attrius unit placement rate, increase gross margins and reduce cash burn, we feel a significant portion of these risks will be mitigated which could prompt us to upgrade to Outperform.  If, on the other hand, the company's financial position / liquidity deteriorates further and/or they fail to remain current on near-term obligations (i.e. - accounts payable), this could trigger a downgrade in our recommendation to Sell.   As it stands now, our price target is $0.04 with a Neutral (Hold) recommendation.  
        

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