October 15 - SpectraScience (OTCBB: SCIE)

October 15 - SpectraScience (OTCBB: SCIE) has made several announcements over the past month which signal key milestones in its plan to accelerate out of R&D for its cancer screening platforms and into wide-scale sales.

• September 16 - delivered WavSTAT® Optical Biopsy System to the Mayo Clinic and University of California at San Diego/VA to complete studies demonstrating the clinical value of the system as a means of improving screening for esophageal cancer;
• October 1 - delivered WavSTAT Optical Biopsy System to the University of Southern California for similar tests; and
• October 2 - awarded patent in Canada for its WavSTAT Optical Biopsy System. SpectraScience holds about 60 patents globally for its WavSTAT and LUMA® Cervical Imaging Systems.

We have previously written about the real need for a better screening device to detect esophageal cancer, and that the incidence of adenocarcinoma of the esophagus has increased steadily in white Americans over the past 30 years, at a 335% increase in incidence rates amongst women and 463% amongst men.

In order to bring its technology to the market, SpectraScience first has to complete these studies, which are also being performed at Minnesota Gasroenterology and at the Boston University VA Hospital. The speed through which it moves through clinical studies will be contingent on how quickly each of the facilities test the WavSTAT on an appropriate number of subjects. Management has indicated that this can occur as quickly as the first quarter of next year.

In addition to the esophageal application, SpectraScience is already cleared, and is in the process of ramping its sales efforts to address other significant growth markets:

·         Colon - Health experts recommend that men and women of average risk should begin colorectal screenings at age 50.   The number of Americans aged 65 and older are expected to double to 70 million by 2030 increasing the need.

·         Cervix - Recommendations for cervical cancer screening are about three years after first sexual intercourse or by age 21, whichever comes first. Research indicates that women are engaging in sexual activity at earlier ages. The Census Bureau shows that the total population in the U.S. has increased by more than 20 million in the past seven years, and women represent slightly more than 50% of this growth.

The increasing population and the aging population are key trends driving the growth of cancer screening in the U.S. A consequence of this trend is that physicians are under increasing stress to screen greater numbers of patients in the same period of time. 

These trends support our thesis that there is increasing demand for screening methodologies that are more accurate and more efficient. This bodes well for SpectraScience.

The stock is currently trading at about $0.40, representing a market cap of about $30 million, which we think more than factors in discounts against execution risk moving into commercialization mode, and likely doesn't factor in anywhere close to the amount of IP that is wrapped up in the business.

Consider the fact that SpectraScience's all stock acquisition for Luma Imaging Corporation ("LUMA") brought a market-ready product into its portfolio that had approximately $100 million invested in its development by the previous company.  We have previously written that the LUMA System can contribute as much as $17 million to SpectraScience's revenue mix in 2011.

Below is our previously published valuation analysis of SpectraScience's overall business:

SpectraScience is currently trading at a forward 2009 price-to-sales multiple of 6-7x our forecasted revenue of $7.3 million. We recognize the stock is trading at a relative premium to other more established diagnostic companies such as Quest and Laboratory Corp, and even against earlier-stage firms such as SenoRX, but we believe this valuation is sustainable if the company begins hitting milestones that validate our expectations of a CAGR through 2012 of 238%.

Our forecasted growth is based on what we believe are modest assumptions of the Company's penetration into its target segments. If, on the other hand, the Company is not able to gain market acceptance for its products, even on the scale that we have forecasted, then the stock will look expensive. As always is the case, it is up to management to prove out its model and demonstrate the kind of sales ramp that we believe is attainable to justify the current stock price and appreciation from this point. 

Our revenue estimates for SpectraScience are based on key assumptions about market size, expected growth rates for the colon, cervical and Barrett's screening in North America and the EU, and the Company's penetration into each of these segments. We believe our estimates to be conservative. For example, we estimate SpectraScience's penetration into these segments by the year 2012 will be 20%, 8% and 5%, respectively. We also substantially discounted the addressable size for the colon screening market (about 30% of the total end sites) due to the fact that the current gold standard for screenings is so entrenched.

Our rationale in determining the addressable market size for colon cancer screening is based on discounting the approximately 6,300 Centers of Excellence and endoscopy labs to 1,890 and assuming SpectraScience's unit sales model of approximately $59,000 per unit.

Additional upside to our forecasted revenue contribution is the sale of disposable forceps at approximately $125 which, if a center/lab is performing 10 procedures per week, would represent an additional $65,000 per year to SpectraScience for disposable sales, or literally $24.5 million to our estimated contribution of $22.3 million in unit sales for the colon screening application. Our decision to leave this contribution out of our forecasts in this initial report is that we still do not know exactly what to expect in terms of the sales model and elasticity that will ultimately be successful for the company. At present, the Company intends to employ the disposal model, but this could change based on the dynamics in the market. 

Our rationale in determining the addressable market size for cervical cancer screening is based on discounting the number of facilities in the U.S. providing screening (3,000) by about 47% to the number of facilities treating more than 50 patients on a monthly basis, which are about 1,605. Management has indicated that these are the facilities that will be the most likely to purchase the Luma System.  Then, based on an assumed number of 2,000,000 colposcopy procedures performed in the U.S. each year, we assumed a number of about 53% of the total procedures multiplied by the Company's fee-per-use model at $255 to arrive at a current market size of about $214 million. We assume also that this market will grow at a rate smoothed out at about 2% per year through 2012. Based on this analysis, we arrive at a revenue contribution for SpectraScience's cervical cancer application of approximately $24 million by 2012.

Our rationale in determining the addressable market size for Barrett's is based on backing into three groups for which there are recommendations for endoscopic screening: those with chronic heartburn (about 36,000,000 in the U.S.); those with incidence of low grade dysplasia (about 720,000 in the U.S.) that should be screened twice per year; and those with incidence of high grade dysplasia (about 108,000 in the U.S.) that should be screened four times per year. We arrived at a cumulative annual number of screenings in the U.S. of about 3.6 million screenings per year to arrive at an estimated $1 billion market.

Again, in our forecasts, we only included the fee-per-use model and have excluded the disposable forceps component until we see the sales model further validated, bringing our forecasted contribution from the Barrett's application to $30 million by 2012.  If we included this component at $125 per use, then the additional contribution to our revenue forecast by 2012 would be about $25 million.

We continue to believe that SpectraScience's outlook is getting better, as it gets closer to closing on sales opportunities that it has been building in its WavSTAT and LUMA pipelines over the past two quarters. It is important to realize that building these pipelines takes time, but recently hired sales VP Chris Jackson is experienced in building revenues for emerging businesses in the medical devices industry, and based on our conversations with him, we are confident that he is up to the task here as well. Adding to our confidence in the company's outlook, is that the business is supported by a strong cast of characters on the board, including former head of Health & Human Services, Tommy Thompson, and its executive management team has successfully built businesses in this sector before.

Disclaimer: Information has been obtained from sources considered to be reliable, but we do not warrantee that it is accurate or complete. This material is not an offer to sell or a solicitation of an offer to buy any securities. While we believe all sources of information to be factual and reliable, in no way do we represent or warrantee the accuracy thereof, nor the statements made herein. THE READER SHOULD VERIFY ALL CLAIMS AND DO HIS OR HER OWN DUE DILIGENCE BEFORE INVESTING IN ANY SECURITIES MENTIONED. COMMON STOCKS INVOLVE SUBSTANTIAL RISK AND IT IS POSSIBLE TO LOSE YOUR ENTIRE INVESTMENT.   This information is not an endorsement of the Company by SCP. SCP is not responsible for any claims made by the Company. You should independently investigate and fully understand all risks before investing. Statements included in this email or fax may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements involve a number of risks and uncertainties such as competitive factors, technological development, market demand and the Company's ability to obtain new contracts and accurately estimate net revenues due to variability in size, scope and duration of projects, and internal issues in the sponsoring client. Further information on potential factors that could affect the Company's financial results, can be found in the Company's Registration Statement and in its Reports on Forms 10-K and 10Q filed with the Securities and Exchange Commission (SEC).