ONMD: Maintaining Outlook / Outperform Rating

Brian Marckx, CFA

We have updated our report on OnPoint Medical (ONMD.PK) for recent news and events. We are maintaining our Outlook, Outperform recommendation and $3.50/share price target.

Abbott Northwestern Adopts OnPoint’s Software
OnPoint Medical announced in a press release this morning (2/23/12) that Abbott Northwestern, a major Minneapolis, MN-based hospital adopted the company’s MRI QA software for their MRI quality assurance needs. We view this as a meaningful milestone – from both the perspective that the software is now generating commercial revenue and that Abbott Northwestern is a major, highly-respected institution – which lends support for and credibility to the robustness and utility of OnPoint’s software.

Incremental New Financing
As we’ve indicated since initiating coverage of OnPoint in September of last year, with only limited overhead and operating costs, coupled with the fact that development of OnPoint’s software is largely completed (there will be ongoing improvements and added functionality, however), the company’s cash needs are somewhat modest. As cash balance was very slim at the most recent reporting period ($126k at Q3 quarter end), the company will need to raise additional capital, however, and may look to raise more substantial financing in the near future. In the meantime, management has been tapping piecemeal financing as a bridge until raising additional capital – which we think could potentially come with a small (~ $5MM) equity issuance (which is already incorporated into our model assumptions).

  • In a December 1, 2011 8-K filing OnPoint announced that they issued a promissory note to one of their Board members allowing OnPoint to borrow up to $200k. The 12% loan matures November 2013.
  • In a January 6, 2012 8-K filing OnPoint announced that they issued $165k in 15% promissory notes due December 2013. Investors also received ten year warrants to purchase in aggregate (247,500 shares of common stock at $1.00/share.

OUTLOOK
As OnPoint just began commercialization, there remains a significant amount of unknowns which makes predicting its future challenging. And although OnPoint’s software appears to be a major improvement over manual QC with the potential for significant added-value (including streamlined processes and less scanner downtime), novel technologies often suffer from slow acceptance. This may especially prove to the case with smaller imaging facilities which may have only one scanner and have less of an opportunity to reap the benefits of OnPoint’s software. Our “Outlook” considers these challenges and risks (such as assuming the early-adopter market are facilities with more than one scanner) and reflects our “best guess” of how OnPoint’s future will develop based on our due diligence of the company, industry, market and competition.

Management has proven to be fairly frugal and cash-conscious and we expect the initial roll-out will be reflective of this cautious approach. The selling function will at first be handled by a skeleton crew of industry veterans including OnPoint’s CEO who will be calling on high-potential business contacts. The initial launch will likely be somewhat anti-climactic from a revenue standpoint but is expected to be as much about making sales as it is about generating publicity and interest in the software as well as receiving customer feedback. With virtually no direct competition, OnPoint has a rare first-mover advantage and we expect the company will exploit this opportunity by offering attractive front-end pricing in an attempt to grab early market share. Assuming feedback is positive and customer retention high (both of which we expect will be the case), there will hopefully be opportunity to significantly raise prices over the longer-term.

OnPoint expects to continue to further develop the software (handled by outside consultants) so as to include additional functionality. Management will also be gauging demand and collecting feedback throughout the remainder of the current year which will help determine staffing requirements (sales and support staff will be added in increments) and assist in directing marketing initiatives. While OnPoint will need to raise additional capital to fund these initiatives, as noted above, we feel comfortable that there will be sufficient investor interest to continue to finance operations for the foreseeable future. Our model incorporates an assumption that OnPoint raises additional capital through secondary stock issuance in sometime in 2012.

Assuming the MRI launch is successful, OnPoint will begin a greater focus on follow-on imaging modalities, including CT which we think could come to market in 2012. We note, however, that while our model incorporates revenue contribution from CT, that we assume that this added functionality is more of an up-sell opportunity offered at a significant discount to existing MRI customers – meaning margins on the CT product will be a fraction of that for MRI (and with little in the way of fixed costs, OnPoint has flexibility in trimming expenses based on the level revenue). Based on our current model, we believe OnPoint can reach profitability and generate positive cash flow on their MRI product alone. There may also be an opportunity to begin selling overseas, although we do not currently incorporate any international sales into our model. We believe longer-term success will be largely determined by the rate of penetration of the domestic MRI (and to a lesser extent the CT) market.

Revenue
Our revenue model is based on certain assumptions including the rate of growth of OnPoint’s share of the domestic MRI and CT imaging markets, overall growth in each of these markets, and OnPoint’s initial pricing (for both MRI and CT) and future pricing power (which will largely be driven by demand/market share).

While we model only inconsequential revenue in Q4, management’s focus will be to get their foot in the door and generate a buzz about their software. Initial contracts will be relatively low-dollar and possibly shorter-term but there may be potential to score some easy shots on goal through business generated from management’s industry contacts.

For the first half of 2012 we model more of the same – a slow ramp in sales with little in the way of price increases as OnPoint focuses on building the installed base and completes development for CT. By the back half of 2012 OnPoint may begin to see a bigger return on their scaled-up sales and marketing efforts and have the opportunity to start ratcheting up pricing. We model OnPoint’s software to claim roughly 3% of the total MRI QC market (or about 6% of the early-adopter market – as defined earlier) by year-end 2012. We also assume their CT quality assurance software is released towards the middle of 2012 which expands the company’s total target market opportunity by approximately 50% (in $ terms). As noted previously, while there are roughly the same number of CT scanners in use in the U.S. as there are MRI systems, the additional CT functionality to the software will not double OnPoint’s target market as many imaging facilities offer both CT and MRI – as such, we view CT functionality mostly as an up-sell opportunity (i.e. – volume price discounts) to existing MRI customers. We model total revenue of $1.8 million in revenue in 2012 which includes $1.6 million from MRI QA (representing ~ 195 customer contracts) and $60k (representing ~ 30 customer contracts) from CT QA (with the remainder from installation and training revenue).

From 2013 and beyond we model the overall domestic MRI and CT markets to grow at about 3% and 5%, respectively. We look for OnPoint to capture about 7% and 2% (15% and 5% of early-adopters) of these markets in 2013, growing to 20% and 11% by 2015. We also assume OnPoint has ample pricing power and is able to increase average pricing by about 300% in 2013 (compared to 2011 pricing – when we assume OnPoint’s pricing barely covers variable costs) and 550% in 2015 (compared to 2011 pricing). We do not believe our 2015 assumed pricing, at about $1,500 per month per MRI scanner and $650 per month per CT scanner, is aggressive especially when comparing this to the cost of annual scanner service contracts (~ $100k per year) or the cost of unplanned scanner downtime ($1,000 per hour). We model MRI and CT related revenue of $9.2 million and $1.3 million in 2013, respectively, growing to $47 million and $12.9 million in 2015.

EPS
Despite a highly scalable and low-cost business model, we do not expect OnPoint to generate positive net income in 2011 or 2012 as meager revenue from incentivized front-end pricing and a relatively negligible number of customer contracts is insufficient to offset the scale-up in R&D (related to follow-on modalities and software enhancements) and SG&A ( related to increased marketing and additional sales and support personnel). We model EPS of ($0.22) and ($0.13) in 2011 and 2012, respectively.

We expect revenue to begin to significantly ramp in 2013 as a result of firmer pricing, a full-year’s worth of CT sales and realization of the benefits of ramped up sales and marketing efforts. Revenue growth should outstrip that of operating expenses and, combined with significantly wider gross margins as a result of price increases, should result in 2013 being OnPoint’s first full year with positive net income. We model EPS of $0.02 in 2013 and $0.19 in 2014.

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