Bio-Imaging Technologies Inc. BITI W
September 03, 2002 - 2:22pm EST by
2002 2003
Price: 1.70 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 18 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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By rights I should be submitting this idea to “”, if it exists, because BITI is a classic micro-cap long term growth story. But it is also substantially undervalued, for an artificial reason that value investors might appreciate: it went public prematurely, had poor results, and got delisted from NASDAQ three years ago, just as the industry it pioneered and dominates finally started to take off. So its recent revenue growth in the 90% range, with even more new business pouring into backlog, has barely been noticed, since so few serious investors will look at low priced stocks on the OTC BB, given that venue’s well deserved reputation as a graveyard and garbage pit.

Had BITI stayed on NASDAQ, and retained some visibility, I think its record and prospects are such that it would be selling for $4 or so now. There would be a good case that BITI would be worth buying even there, since it could well become a double digit stock a few years down the line. But that case would have to be made to long term growth investors. Value investors can do well, I believe, by taking advantage of the severe discount based simply on where the stock is trading, a handicap that won’t be permanent.

BITI is the leading independent core lab (“ICL”) in medical image management for clinical trials. Its customers include more than seventy drug, biotech, and medical device companies, and the contract research organizations (“CRO”, e.g., Covance and Quintiles) that work for them. BITI handles the imaging aspects of Phase II and III applications so that they are done in a scientifically valid manner to satisfy the FDA’s increasingly stringent requirements.

BITI works with X-rays, MRI, CT, DEXA, ultrasound, nuclear medicine and angiography, helping its clients design the protocols, providing image data collection, processing, digitizing, and expert reading. BITI’s software analyzes the images and calculates exact measurements for tumors or other items whose size and changes previously had to be judged subjectively. BITI also offers the use of proprietary systems that allow outside radiology experts to do blind readings of images in their own offices or homes, which strengthens a drug company’s FDA application by letting it use recognized specialists worldwide who would not be available to travel to a controlled reading site. BITI’s customers can’t do most of this stuff by themselves, and even if they could, the FDA doesn’t want them to, preferring the integrity of data from an independent lab.

The FDA issued a series of guidelines starting in 1996 that encouraged the use of “surrogate measures” to determine the efficacy of a drug. For example, if a proposed cancer drug caused a tumor to shrink, then that would be considered a success, without requiring a five or ten year wait to see whether that shrinkage affected patients’ longevity. It thus became essential to the FDA that images be evaluated honestly and objectively, and be delivered in a format that allows the FDA to examine the material, image by image, to insure that the claims for the proposed drug are valid.

The FDA also now insists on data security and an imaging audit trail, which further pushes the work from the drug companies themselves to BITI. The Imclone drug rejection last December, in the news because of the insider trading allegations, was a strong message from the FDA. The cause of the rejection was serious flaws in the design and management of the imaging aspect of the application. The explosion of new business that BITI has experienced since that decision is evidence of how much easier this has made its sales task.

Founded in 1990, BITI went public in 1992, and showed minimal sales for many years. There was little reason for drug companies to use its services until they had reason to think that the FDA wanted them to do so. So BITI had to sell its case to the FDA first, and it took many years before the FDA caught on and started insisting that the imaging portion of a drug application be handled with as much rigor and scientific validity as the other aspects of a new drug application, effectively requiring the services of an imaging ICL.

To give a sense of the kind of growth that BITI is now experiencing, here is its Y/Y percentage growth in revenue for the last eight quarters, starting in June 2000: 52%, 43%, 65%, 46%, 44%, 56%, 86%, 82%, 95%. The last three quarters were boosted by the acquisition of a smaller competitor, which came with a modest backlog of business. The real benefit of the acquisition to BITI was the addition of 50 people to help with new contracts that BITI itself was generating.

The revenue numbers actually understate BITI’s growth, because backlog has also been rising rapidly. When BITI gets a new contract, the dollar amount goes into backlog, and turns into earned revenue typically from six months to several years, as patients are recruited for the study and images get generated. So the best measure of BITI’s net new business generation in any quarter is its revenues plus any change in backlog. For the six months ending June, for example, service revenues (ignoring pass through costs) were up 88% to $8.3M from $4.4M, and in addition backlog rose from last December’s $28.7M to $34.6M. Adding the $5.9M increase in backlog to the $8.3M reported revenues shows that $14.2M of net new business was generated in the first half. (Note: this is my calculation; the company doesn’t report this number as such. It occasionally reports a dollar amount of new contracts, but that is a gross figure, not net, and is not calculable historically from any figures in SEC filings.)

The numbers are impressive. Three factors make me think that big increases are likely for many years:

1. BITI is the largest ICL, and the one who pioneered the field. Its competition consists primarily of a few smaller commercial ICLs, one of which BITI acquired last November. Increasingly, just as in olden days when “no one ever got fired for buying IBM”, the drug companies use BITI because it is the leader, and a safe choice with which the FDA is likely to be happy. At present, for example, there are three major CROs competing to manage one large study for a major drug company; all three have proposed using BITI as ICL for the imaging aspects of the study. With increasingly stringent FDA requirements, it is now nearly impossible for a new entrant to the field to gain any traction. The fee that an ICL charges is such a small percent of the total cost of a clinical trial that a drug company would be foolish to risk everything with an inexperienced ICL to try to save a few bucks.
2. The number of studies that use imaging is rising rapidly. Active medical research fields that use imaging of various kinds include cancer, arthritis, osteoporosis, Alzheimer’s, MS, stroke, cardiovascular, diagnostic agents, and wound healing. More sophisticated medical imaging equipment is allowing the observation of previously undetectable bodily changes, leading to more image based drug studies.
3. BITI gets nearly all its revenues from Phase II and III studies. (Phase I just makes sure that the proposed drug is safe, and isn’t concerned with looking at images to determine if it is effective.) The vast majority of the new molecular entities developed by biotech and genomics research are still in preclinical work, or at most Phase I, setting the stage for an explosion of Phase II and III work later in this decade.

BITI has been modestly profitable for eight consecutive quarters. With its strong top line growth, and a growth in personnel from 64 in September 2000 to 160 now, BITI’s focus has been more on delivering high quality service to clients than maximizing profitability. The company is well aware of its inefficiencies, and expects to deliver much higher returns in the next few years.

Some improvements are already observable. For example, as BITI no longer needs to do extensive missionary work to get business (“the sales cycle is getting shorter” it states), marketing expense so far this year was flat, even as revenues doubled. The company still needs to add a CFO and a few other fixed costs, but other than that, costs should soon start rising slower than sales. The end of a costly lease that came with the acquisition last year will bring decent savings starting in January.

Pretax earnings are presently running at about 8% of sales, but the company’s goal is about twice that. It hopes to achieve that within two years if the top line growth falls to 40%, or longer than that if the recent 90% growth rate continues, causing the company to focus more on maintaining quality during breakneck growth than on increasing efficiency.

One avenue of profitability improvement will be better allocation of resources. The services that BITI provides on a given project include numerous tasks, requiring a wide range of skill levels. Too many mundane aspects of a project are still being done by higher ranking staff; having lower paid people do those things would free up the more skilled people for higher value added tasks.

BITI’s backlog gives one a good start in making estimates. Although there is no reason why this should necessarily be the case, since the mix of shorter and longer projects can vary, as a general rule it appears that about 60% of BITI’s backlog at any given time will turn into earned revenues in the subsequent four quarters. For 2002 year ending December service revenues should reach about $17M, versus $8.8M for the previous FY ending 9/01 (there was a stub quarter in December 2001 as the company switched to a calendar year.) Fully diluted EPS should reach about $0.13 lightly taxed, or about $0.09 as if fully taxed. Next year BITI appears heading toward sales of $22-25M and eps of about $0.15 fully diluted fully taxed. Sales of $28-$32M and eps in the $0.25 area seems plausible for 2004. There is no reason to think the growth would stop there.

Like most value investors, I treat projections out more than a few quarters very skeptically, especially when I am the one doing the projecting. But other than execution risk, BITI is in a position with an awful lot of visibility. The backlog is there. The economy doesn’t matter. The number of phase II and III trials with heavy imaging content will continue to grow. Regulatory hurdles create a wide moat around BITI’s business, making new competition or price wars highly unlikely—if anything, some pricing power on the part of BITI and the other ICLs could develop. Even the recent disappointing trend in drug and biotech profitability isn’t going to significantly change R&D spending by those companies, because coming up with powerful new drugs is the only way out of their troubles, and they know it.

Facing an ideal situation in terms of demand, BITI’s biggest challenge will be managing its growth, adding enough of the right people, and making sure that no mistakes happen to damage its reputation with clients and the FDA. So far management, led since 1998 by CEO Mark Weinstein, has passed that test, although the company is still some distance from earning the kind of margins that should accrue to the market leader in a hard to enter, fast growing field.

Another risk to consider is that in every quarter a big chunk of revenues comes from relatively few projects. Sometimes something adverse will be discovered that causes the an immediate cessation of a clinical trial, and could make for a disappointing quarter. Similarly, the pace of project execution is out of BITI’s hands. If the drug company or CRO is behind schedule in recruiting patients for a study, then images (and therefore revenue to BITI) won’t be generated at the pace expected, resulting in inefficiencies from misallocated staff.

As to finances, a positive is that BITI should not need to raise capital again. Although it does have to invest in computers and communications equipment (cap ex this year about $1.1M versus $0.8M depreciation), it requires its clients to put up substantial front money early in a contract. That, plus its increasing profitability, should eliminate external financing needs, assuming nothing major goes wrong.

Outstanding shares plus options comes to around 10.2M shares. In addition, there is a three year convertible promissory note of about $1M outstanding payable to Quintiles, the seller of the competitor BITI bought last November. The conversion rate depends on the stock price at the time of conversion, with a 25% discount to the market price and a $0.906 floor. If the stock drops and holder chooses to convert, that could add a maximum of about 1M extra shares. At the current price, the potential is 700K additional shares. The scheduled pay down of the note reduces the potential shares over time, as would any increase in the stock price. A performance bonus connected with the acquisition, to be determined after this year’s results are in, could add as many as 200K additional shares, although probably much less than that. Quintiles has indicated a desire to collect in cash rather than convert to shares, but since that opinion could change, one must allow for the additional dilution.

Of the 8.4M shares presently outstanding, Covance, an early investor, owns 2.35M. Insider holdings are only several hundred thousand shares, although if you add in their options, almost all of which are in the money, they total over 2M. As is usually the case with obscure OTC BB stocks, trading is very thin, and one must never place market orders.

While by any standard BITI is still a tiny company, it dominates a fast growing niche business, with strong prospects for many years of very high growth ahead, regardless of the economy, and with competition limited by regulatory hurdles. Were it going public now, even in the recent depressed IPO market, or if had never been demoted from NASDAQ, a stock price of $4, creating a fully diluted market cap of about $42M, wouldn’t look at all out of line. That would be a bit more than two times this year’s revenues, or 1.3 times this year’s pace of net new business, counting the growth in backlog, and 16 times a plausible guess of fully taxed, fully diluted EPS in 2004.

With its actual price of less than half that, I think BITI is a real bargain, caused, I believe, by its being an OTC BB stock and thus overlooked by growth investors, who would pay a lot more if they knew the company and its story. That is why it is a value play too, at least at this price.


Very strong, consistent growth for several years now, with rising backlog assuring continuation, too good to be ignored forever.
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