IMRIS: An Undervalued And Misunderstood Bet On Minimally Invasive Surgery Robotics

By Terry Trover :

The investment thesis is simple. IMRIS' ( IMRS ) served market, large tertiary hospitals, has begun to renew spending on state-of-the-art minimally invasive surgery operating rooms. If IMRIS can use cash flow from their existing operations to fund themselves for the next two years, their new technology in development will significantly alter their valuation. First, IMRIS must attain a cash flow neutral status through increased bookings, conversion of their backlog, and lowering operating expenses. Bookings in their core business increased last quarter and are at a rate that could enable profitability in 12-18 months. Management claims to have neutral cash flow in sight in 2015. However, recent conversion of the backlog at gross margin in accordance with their guidance has been a problem. Management has taken steps to increase GM% by encouraging customers to self-source low value-added components. Tapering off in R&D and relocation costs will assist them in controlling cash flow. Ultimately, if they survive independently, their foray into proprietary products (surgical robots, instruments, and disposables) has the potential to drive a much higher multiple. As an acquisition target, IMRIS may have strategic attractiveness to many medical device manufacturers or private equity firms.

Introduction

It must have taken a lot of guts on the part of senior management and the board of directors to relocate IMRIS from Winnipeg to Minneapolis during the worst of the uncertainty associated with the adoption of the Affordable Care Act. Uncertainty surrounding healthcare reimbursements caused hospitals to strictly curtail spending. I work in the healthcare capital equipment industry and know firsthand how tough it was to meet a sales budget during the past 2 years. Their chutzpah in the midst of a difficult market and a declining stock price created a question in my mind, "Why didn't they stay in Canada where they could avoid the cost and hassle of reestablishing themselves in the USA?" What did IMRIS management see as upside? Are they making progress? Is the precipitous decline in the stock price a warning sign or buying opportunity?

Unfortunately for shareholders, the last half year has brought a sequence of troubling news: Q1- missed GM target; Q2 - downward revision to 2014 sales forecast, a CFO that has chosen to leave the company rather than move to the USA, possible delisting from NASDAQ, and finally, uncertainty around the amounts of accounts receivable that will be collected by September 30th, threatening a Facility Agreement from Deerfield Management Company and the ultimate success of the enterprise.

Background and Product Portfolio

Core Business: IMRIS is a medical construction company with FDA approvals that installs expensive magnetic resonance imaging or MR, Computed Tomography or "cat scans" (CT), and X-Ray Angiography imaging equipment. They are listed on the TSX and NASDAQ. Their unique approach to making normally fixed-location diagnostic imaging equipment transportable enables it to be used for therapy inside state-of-the art minimally invasive surgery hybrid operating rooms, usually for neurosurgery, but increasingly used for cardiac and other specialties. Hybrid ORs are large operating rooms where IMRIS' medical imaging modalities such as X-Ray, MRI, CT, and other imaging modalities have converged - providing surgeons with intra-operative access to technology that helps improve patient outcomes. IMRIS does not make diagnostic imaging equipment; they integrate Siemens, their OEM partner's imaging equipment, into the intra-operative environment by suspending it from an IMRIS-designed multi-room gantry system. IMRIS has developed their system to enable the customer to leverage the imaging system across 3 adjacent rooms, which helps amortize the cost of the system and creates opportunities for other surgical specialties to create revenue when utilizing the equipment ( There are several excellent videos here ). IMRIS also installs an audio-visual control system that displays medical images and patient information during minimally invasive surgery. Most IMRIS' customers are large hospitals where cranial neurosurgery and other complicated surgical specialties are conducted. However, because imaging is also used in many types of minimally invasive surgeries, including cardiovascular surgery, the use of IMRIS' product isn't limited to one surgical specialty. This article describes cardiovascular hybrid ORs, where IMRIS' Angio offering would be commonly found.

IMRIS' product name for their integrated gantry and visualization system for hybrid ORs is called the VISIUS Surgical Theatre. In the previous 9 years, they have sold their systems to 61 customers (87 surgical suites and 52 diagnostic rooms). The VISIUS system has a price range of $1.5-$3.5M (CT) and $4-$7M (( MR )). In spite of the high ASP, clinical evidence demonstrates the efficacy and financial advantages of using intra-operative imaging to reduce the need to duplicate a tumor resection surgery because of a missed cancer target. MR, in particular, assists surgeons in the definition of the boundaries between healthy soft tissue and a tumor. Since the Affordable Care Act penalizes hospitals that repeat an ineffective surgery, there is a financial incentive for surgery to be "done right the first time". Their existing VISIUS backlog, including service contracts, as of August 7, 2014, has reached a record level of $128M. According to their most recent MD&A, IMRIS hopes to normalize on a gross margin of 45% on the backlog.

Adding another application for the VISIUS system: IMRIS' announced partnership with Varian ( VAR ) creates an opportunity for another customer set for the VISIUS system. Magnetic Resonance Imaging guided Radiotherapy (MRgRT), promises for increased targeting precision that enables lower dosages of radiation to be used for ablating tumors. Increased accuracy and lower radiation dosages also reduces the likelihood of damage to healthy tissues adjacent to a tumor, thus improving patient outcomes. Since radiotherapy is a commonly used therapy for brain, as well as urology, gynecology, and spinal oncology, the MRgRT concept creates sales synergy with the existing VISIUS platform.IMRIS has not disclosed an average selling price for their part of the MRgRT system, but I guess it to be at least in the range of $4-7M, since it is a variant of their existing MR system. If patient outcomes are improved through the use of Varian's system with VISIUS iMRI, hospitals should be able to begin justifying the purchase of a VISIUS enabled MRgRT system in 2016, when the 510(k) should be obtained. This makes this partnership revenue accretive in 2017 or 2018. See page 19 of this PDF for conceptual images of a MRgRT room.

SYMBIS Surgical Robot - the transformational product leap: In 2010, IMRIS, already listed on the TSX, issued stock on NASDAQ to help fund a surgical robotic program. As IMRIS was dealing with the downturn caused by the Affordable Care Act, they committed significant resources towards the development of the surgical robot, named SYMBIS. IMRIS' robotic technology stems from IP generated by Canada's MDA Corporation that created the remote manipulator arm used in the Space Shuttle's cargo bay. Early cranial neurosurgery began in 2008-2009. Their now refined robot is differentiated from other FDA 510(k) devices because it is constructed with materials that make it impervious to the magnetic attraction caused by the large magnets used in MRI systems. IMRIS has patent protection that expires in 2030 that addresses use of robotics in conjunction with MR. IMRIS anticipates that the average selling price of a SYMBIS system, once commercialized, will range from $1.5M-2.5M. Management projects that each procedure shall generate $1.2K in recurring revenue, per procedure, from consumables and instruments. Since a significant portion of their installed base utilizes the VISIUS for brain surgery, where MR is widely used, IMRIS should have a built-in customer base. In fact, at IMRIS' last user meeting, they had ~ 60 neurosurgeons in attendance that witnessed a product demonstration. Management anticipates a 2015 submission for a FDA 510(k) on this product. This probably makes the SYMBIS a 2016-2017 revenue producer, including system sales, recurring revenue supplies and instruments, and service contracts.

SYMBIS may enable IMRIS to widen their distribution beyond their VISIUS partner Siemens. For instance, MR acquisition equipment is also manufactured by Philips, Toshiba and GE, and hospitals that use those brands of imaging devices may want to purchase a SYMBIS system as well. Also, other surgical applications may arise - besides cranial neurosurgery. Other manual surgery types may possibly be made less invasive when enhanced by MR guidance. In particular, one could envision oncologic robotic brachytherapy, where "radioactive seed implantation therapy" could possibly be done with more accuracy and efficiency than through existing manual methods. If IMRIS obtains 510(k) approvals for urology/gynecology therapy, a whole new service line could be offered by hospitals that possess this technology, making the total ROI story much better for the hospital or clinic. I believe IMRIS must already be thinking about urology due to the Advisory Board seat they offered to Dr. Vipul Patel, M.D.

If prostate brachytherapy is a target market, this makes the SYMBIS system a potentially alternative therapy to radical prostatectomy, a key application for Intuitive Surgical's ( ISRG ) DaVinci system. What if every hospital that had a DaVinci system associated with men's or women's reproductive health also bought a SYMBIS enabled VISIUS Surgical Theatre? Or more likely, what if every hospital leveraged the utility of their VISIUS and SYMBIS investments beyond brain surgery to encompass other types of soft tissue cancer surgeries during open periods on the scheduling calendar? The answer is IMRIS could make that hospital a premium destination for robotic-assisted surgery, create a lot more revenue, have better outcomes, and meet the vision of the ACA by lowering costs of healthcare. That's exciting.

Liquidity, Accounting Practices & Future Profitability

IMRIS' MD&A (Aug 7, 2014) claims they do not foresee the need for an additional cash infusion, yet confusingly, they anticipate cash operating expenses of $27M and only have $16.8M in cash + restricted cash + A/R. How can they avoid dilution or additional debt?

IMRIS, as I have stated, is presently an integrator of imaging equipment manufactured by Siemens. As an integrator, they utilize an accounting practice that is widely used in the construction industry. Accounting 101 for the construction industry is to recognize project revenue and profit on a percentage of completion basis. It is common for construction companies to require a cash deposit at various milestones during the project.IMRIS defines those milestones as time of purchase order, arrival of equipment, installation of equipment, and final acceptance.IMRIS states they receive approximately 25-30% down payment at the beginning of a project. However, since the largest costs in an operating room construction project typically occur in the equipment phase or later,IMRIS cannot recognize all of the cash down payment as revenue. (Obviously later project milestones also trigger cash payments from the customer as well.) IMRIS therefore records customer funds they've received in advance of their criteria for revenue recognition as Deferred Revenue, which is a liability on their balance sheet.IMRIS' Deferred Revenue liability, which really should be titled "customer advanced cash deposits", has increased since Q4 2013, from $9.5M to $13.5M. Cash + Restricted Cash + Deferred Revenue has actually increased modestly since their December 2013 filing, which indicates slightly improving liquidity, not decreasing liquidity.

Cash+Restricted Cash+Deferred Revenue TTM

Balancing the so-called "liability" of possessing customer cash deposits is the asset called Unbilled Receivables, which management describes as "revenue recognized in advance of criteria for invoicing customers". Importantly, this has declined in the past 4 quarters. The reason why knowledge of their Unbilled Receivables is important, I believe, is because it provides a level of transparency that helps prevent one of the oldest tricks in the book, which is revenue acceleration without services being rendered.

Unbilled Receivables TTM

Here's a hypothetical scenario -IMRIS receives a $4M purchase order for a VISIUS system. Attached to the p/o is a $1M down payment that triggersIMRIS to undertake planning of the project. Since there are less direct costs associated with the project in the first phase compared to later phases,IMRIS cannot recognize the entire $1M down payment as Sales at the time the order is booked. If IMRIS has a 45% GM expectation on the $4M project, they anticipate $1.8M in gross profit and $2.2M in costs. Let's say that only $200K in project costs are realized in the first quarter after receipt of their p/o, since it is largely just an exercise in engineering and architectural services at this phase.IMRIS can only recognize sales revenue that is proportional to their $200K in direct project costs and the estimated 45% GM, which enables them to report only $360K in revenue during that quarter. The remaining $640K in customer cash shows up on the Balance Sheet as a liability! This is important - IMRIS' fortunate receipt of a $4M purchase order and a $1M down payment does not appear on the balance sheet as Cash or on the Income Statement as a Sale. In just the last quarter,IMRIS received purchase orders from 4 customers that may represent $10-20M in future Sales. Theoretically, those purchase orders have included at least $3.3M in cash down payments, as evidenced by the increase in Q2 Deferred Revenue. This is why management states that the best barometer for measuring the future performance of the company is increases in the backlog - not a snapshot of Sales in the previous quarter.

Management has claimed that their goal is to restore the firm to cash flow neutral this year. Management predicts $27M in cash expenses opex and $33M including non-cash expenses in 2014. As explained above, conversion of the backlog into recognized Sales revenue is key. Hopefully, they will not have additional significant project delays or legal matters that might impact the profitability of any of their on-going projects. Assuming management is legitimately reporting unforeseen circumstances, I believe through sound execution, management can use the project business to help subsidize further development of the SYMBIS and associated instruments/disposables. IMRIS projects 2015 revenues of $60-65M, which if they realize a 45% GM, equals 2014's cash expenses. That is good news.

Finally, I estimate thatIMRIS needs about $75-80M in consistent annual sales (assuming GM and overhead percentages stay the same as 2014) to be profitable.IMRIS has already booked, but not recognized, $40.5M in the first 6 months of 2014, so this is a positive indicator. It takesIMRIS 12-18 months to convert backlog into revenues. Fortunately, with an estimated growth rate of 15% for hybrid ORs,IMRIS may finally have a tailwind.

Valuation Methodologies

I do not feel that there are comparable competitors (intraoperative construction companies); therefore the first two comparison methods below apply to cyclical, often money losing technology companies. I feel that the cyclical nature ofIMRIS' business, which appears to be rebounding; and the historic trend to recognize more revenue in later quarters, justifies this approach. I have also provided estimates of the organic value of their IP and the cash generation from their service business. I welcome your review and constructive criticism.

1. Price/Sales (Today's Share Price/Revenue per Share TTM)= $0.60/.78= .77
2. EV/Revenue (EV Today/Revenue TTM)= $40/$40=1.00
3. Replacement Cost (Sum of Parts)

IP for VISIUS system for MR, CT, Angiography and MRgRT

• I estimate $20-30M to reproduce the engineering and operations capabilities

SYMBIS IP and product prototypes

• I estimate $40M to replicate all the engineering up to this stage

SYMBIS P/S

A 10x P/S of 2017 SYMBIS sales is widely variable and could range from $200M (10 units x $2M ASP) to $600M (30 units x $2M ASP) + recurring revenue.

1. Recurring Service and Consumables Revenue

• Even ifIMRIS stopped producing VISIUS systems today, the service business should have a high EBITA. Each installed system should have a 7-12 year product life with 5-10% of the original average sale price as the basis for an annual service contract. There are 139 VISIUS systems (87 ORs and 52 diagnostic rooms).IMRIS reports they have received $2.7M in each of the last 2 quarters, so lets assume $10.8M in annual service contract renewals. With an average of 10 years of installed utility, for simplicities sake, and with no growth of the installed base factored in, total revenue received is ~ $108M. Total GP at 45% is $48M. NPV 10 is $20M. However, since IMRIS is growing their installed base of VISIUS on an annual basis of 10-20 installations let's assume a 10% annual growth in the installed base and therefore, service contracts. With 10% growth in annual service contracts, the total revenue over 10 years is $169M. Total GP at 45% is $76M. NPV10 is $32M.
• Management predicts SYMBIS service agreements should be 10% of the estimated ASP of a system. $1.5-2.5 is the announced price range of the SYMBIS. I think it is reasonable and conservative to assume that 10 SYMBIS systems should be sold annually between 2016-2020. Therefore we should estimate the annual service revenue to be in approximately $20M/year or $9M in GP. Total GP by 2020 is thus an additional $36M. Add a NPV calculation to meet your estimates.
• SYMBIS recurring instrument sales and consumables. Unfortunately, I cannot accurately estimate the procedure volume since FDA 510(k)'s have not been submitted. All revenue generated in this product category is upside.

2. Possible upgrades of installed, obsolescent imaging equipment that have been previously installed

• Revenue of ~$10M a year beginning in 2015. Just a guess on my part. This will increase annually as the installed base of equipment ages. GP is indeterminate.

Surgical Robotic Comparables

I do not believe thatIMRIS is a robotic company at present, nor will their revenue be primarily robotic derived in the next 3-5 years. However, the addition of the SYMBIS (as well as introductions of disposables and instruments that create recurring revenue) does add diversity to their income stream and will change the P/S multiple significantly. For instance, MAKO Surgical (MAKO), which was never profitable, was acquired by Stryker for nearly 13x Sales.

Hansen ( HNSN ) is not presently profitable and presently trades at 5x Sales. (Hansen does not have the funding flexibility that IMRIS' integration business provides them.) Finally, Intuitive Surgical, the business model template for profitable surgical robotic companies, trades at 8.5x Sales.IMRIS at .77 P/S seems like a bargain especially compared to MAKO and HNSN.

Strategic Value and the Possible Suitors

Medtronic (MDT) -IMRIS could be purchased by their in-town neighbor, Medtronic. Medtronic would benefit because the implantation of deep brain implantables for pain management is an increasingly important part of Medtronic's product portfolio.

Siemens - Siemens is a strategic partner ofIMRIS. Siemens could benefit by acquiringIMRIS so to provide a proven, turn key integration system to their customers.

Varian - Varian could acquireIMRIS to complement their radiotherapy product portfolio. Directed radiation therapy equipment is always associated with imaging equipment, so VAR might want to diversify and be an integrator for multiple imaging brands. Additionally, since Varian also manufactures brachytherapy catheters or "seeds", which could potentially be more accurately be placed by MR and a robotic system like the SYMBIS.

Siemens, Toshiba, Samsung - Any of these manufacturers (or others) of diagnostic medical imaging equipment might purchaseIMRIS and create a captive customer for their brand. This could help them increase market share vs. Siemens.

Intuitive Surgical - ISRG could benefit by possessing an alternative robotic therapy for urology/gynecology cancer treatment that does not require resection of a tumor.

Private Equity - They could add liquidity and discipline, and flip IMRIS in 3 years once SYMBIS is a released product and VISIUS has demonstrated additional growth.

Possible Reasons for lack of interest in IMRIS

• Slowing sales and in 2012, 2013, early 2014.
  • The ACA induced slowdown appears to have bottomed and is likely easing. I don't believe this is a factor any longer, considering the new bookings and the record sales backlog.
  • The long installation cycle (12-18 months) inhibits revenue recognition. IMRIS must execute on product installations to be able to recognize revenue and profit. Investors should look at Bookings, not Sales, as a predictor of future profitability.

• Earnings impacted by relocation costs and R&D.
  • Past history. Ignore them.
• Loss of Institutional Investors. Institutional holdings of IMRIS have declined from 75% to 30% in the last year. The very low share price and the exodus of Canadian funds, possibly due to the relocation, may explain the decline in institutional ownership. At this point,IMRIS is priced like a call option, not a stock.
• The previously mentioned parade of bad news in the preceding 6 months. Let's hope the new CEO and yet-to-be named CFO can prevent recurrences.

Potential Future Downside Catalysts

• Failure to book new orders will also limit cash infusion.IMRIS must demonstrate continued growth in bookings and timely execution to convert the backlog.
• Further dilution or debt.
• Must maintain close relationships with partners like Siemens and Varian or their integration activities shut down.
• Delisting on NASDAQ due to sub $1.00 stock price could occur on Feb. 23, 2015.
• Potential non-cash charge associated with restating goodwill or other asset impairments due to the low market cap.

Potential Upside Catalysts

• Hire a replacement CFO.
• Achieve cash flow neutral status by end of 2014.
• Continued growth in backlog and new order bookings in 2014 & 2015 to attain profitability.
• Revenue recognition driving reversion to the mean valuation in late 2014 or early 2015.
• Shipment of first SYMBIS robot by end of 2014.
• SYMBIS obtains FDA 510(k) in late 2015 or 2016. Commercial shipments begin.
• Varian partnership results in FDA 510(k) in 2015 or 2016.
• Upgrade cycle begins a tailwind after 7-12 years of installed usage. 2015-2020.
• IMRIS acquired due to low market cap and high strategic value.

Closing

In spite of the ACA induced slowdown and disappointments in the past 2 quarters, if IMRIS survives their present liquidity issues, which seems to have stabilized, and are able to convert VISIUS backlog into recognizable sales revenue; I think they are a good bet. Their booked revenue should convert in 2015 to ~$27M, which equals cash expenses in the present fiscal year.

IMRIS reported $16.9 in Cash + Restricted Cash + Accounts Receivable on June 30th, 2014. Conceptually, adding the "hidden" $13.5M in customer cash deposits (Deferred Revenue) almost doubles their short term liquidity to $32M. IfIMRIS is able to achieve a cash flow neutral status with just VISIUS system revenue, they should trade close to 3x Sales on $35M (~$2.10).IMRIS will have to execute on sales and project management to enable VISIUS to fund the company organically. However, the diversification/introduction of SYMBIS will enable a new business model and a different multiple- but there will be a relatively slow revenue ramp up through the rest of this decade. The largest near term catalyst for the stock price is their possible acquisition value to an established large medical device OEM that may want to acquire a larger market share of imaging equipment, an installation and warranty services play, or a surgical robotic business.

If IMRIS is acquired in a friendly manner, once they have proven their ability to self-fund for the next 2 years, they launch SYMBIS and MRgRT, and they reach profitability around my estimate of $75-80M in revenue, I think valuation could range between 5-10x sales, considering their blended product revenue compared to MAKO, HNSN, and ISRG. That's $400-800M in market cap. SinceIMRIS only trades at ~$30M market cap today... that potential expansion in their market cap explains to me whyIMRIS management justified relocation and large investments in R&D in spite of the uncertainties caused by the ACA. The payoff is huge.

Disclosure: The author is longIMRIS. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The opinions in this are mine. I could be wrong, qualitatively or quantitatively, so please do your own research. I have not conversed or exchanged any information related to this article with any of the firms or people that I have mentioned. All data in this article was obtained from web sites, social, and print media sources. Conjectures onIMRIS or other cited firms' strategies are simply my opinion.

See also Gilead: Still 40% Upside Ahead on seekingalpha.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.