ICAD Inc (ICAD) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Q3, 2009 iCAD, Inc.

Earnings Conference Call.

My name is Diana and I will be the operator for today.

At this time, all participants are in a listen-only mode.

But, later, we will conduct a question and answer session.

(Operator Instructions).

I would now like to turn the conference over to your host for today's call, Ms.

Anne Marie Fields, Lippert/Heilshorn.

Please proceed, Ma'am.

Thank you.

Good morning.

This is Anne Marie Fields with Lippert/Heilshorn & Associates.

Thank you all for participating in today's call.

Joining me from iCAD are Ken Ferry, Chief Executive Officer; and Darlene Deptula-Hicks, Executive Vice President and Chief Financial Officer.

After the market closed yesterday, iCAD announced financial results for the third quarter and nine months of 2009.

If you have not received this news release or if you would like to be added to the Company's distribution list, please call Lippert/Heilshorn in New York at 212-838-3777 and speak with Cheryl Palazzo.

Before we begin, I would like to caution that comments made during this conference call by management will contain forward-looking statements that involve risks and uncertainties regarding the operations and future results of iCAD.

I encourage you to review the Company's filings with the Securities and Exchange Commission, including without limitation the Company's Forms 10-K and 10-Q which identify specific factors that may cause actual results or events to differ materially from those described in the forward-looking statements.

Furthermore, the content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, October 29, 2009.

iCAD undertakes no obligation to revise or update any statement to reflect events or circumstances after the date of this conference call.

So, with that said, I would like to turn the call over to Ken Ferry.

Ken?

Thanks, Anne Marie.

Good morning, everyone and thank you for joining us today.

As I reflect back on the last 12 months, iCAD has faced significant challenges, as the declining state of the economy coupled with efforts to reform US healthcare have at a minimum created greater risk and uncertainty for our customers and ultimately our business.

And through this highly volatile period, we've continued to adapt and respond so as to sustain our strategy and longer-term plan for the Company.

So, with this as a backdrop, we're quite pleased to share our third-quarter results with you today.

In spite of an extremely cautious environment for capital spending in healthcare, we delivered our strongest quarterly performance year-to-date.

We were particularly pleased to see that digital tomography system sales in the United States this quarter were the strongest since Q4 of last year, and represented almost 11% growth in system placements over Q2 of this year, according to data published on the FDA web site.

As the fourth quarter is traditionally the strongest of the year, we're gaining confidence that this increasing momentum will continue through to year-end.

In addition to top-line progress versus Q2, we continued to see the results of strong operational discipline.

We posted a profit in the quarter, achieved record gross margin and increased our cash position in what has been a cash flow positive year to date.

So, in taking a closer look at the business, our core digital CAD business showed solid sequential growth of 24% over Q2, but was down compared to Q3 of last year.

This can be attributed to an approximate 30% decline in US digital mammography system placements comparably and the effect of not having the level of pent-up demand from Fuji this quarter that we benefited from in the third quarter of 2008.

As we look at this business going forward, approximately 43% of the US installed base still uses film-based mammography systems, leaving a significant addressable market in what we hope to be a stronger market for several years to come.

In addition, we posted international growth of 20% on a year-to-date basis and believe that the overseas markets will continue to offer growing opportunities for digital CAD as well as for our MRI and CT-based products.

Sales of film-based products declined during the quarter, as these sales are largely driven today by the sale of TotalLook MammoAdvantage, a digitizing comparative reading solution that is typically sold alongside a digital CAD system.

So as our overall demand for digital CAD products has softened this year versus 2008, it has impacted some the sale of TotalLook MammoAdvantage as well.

We also benefited last year from pent-up demand for this product as it was not introduced into the market until late in Q1 of 2008.

Going forward, we see sales in this product category increasing as digital mammography sales rebound.

Additionally, customers that have already shifted to digital mammography technology without the workflow benefits of comparative reading of older exams will likely begin to prioritize the purchase of TotalLook MammoAdvantage in new budgeting cycles to further extend their end-to-end digital workflow.

Service and supply revenue grew nicely in the quarter, as our growing installed base of systems continues to transition from warranty to service agreements and agreement renewals.

Shifting topics, I'd like provide an update on our progress with our MRI CAD business.

We continue to gain traction with the ongoing introduction and launch of SpectraLook and CADvue, our two new breast MRI products and with VividLook, our prostate MRI product.

These products represent a significant growth opportunity for iCAD over the coming years.

We continue to make investments in developing these markets and have made good progress expanding the awareness of MRI and CAD and the growing sales funnel.

As part of these measures, we are increasing our presence with MRI through active participation at specialized medical meetings worldwide as well as through our direct MRI sales efforts.

This is important because sales of MRI CAD are not reliant on sales of new imaging systems but rather are marketed to the installed base of over 10,000 MRI systems worldwide.

At the upcoming Radiological Society of North America Trade Show, the RSNA, we will be showcasing breakthrough enhancements to our MRI solutions for both breast and prostate.

We will be demonstrating as a works in progress, new innovations that will highlight iCAD's unique expertise in CAD and workflow that gives clinicians more information with a simplified user interface.

Regarding RSNA, I want to remind you that we are hosting an Investor Luncheon on December 1 at 12 noon the Hyatt McCormick Center, which is connected to the Convention Center.

We hope that any of you who are planning on attending the RSNA will join us at the luncheon.

Now turning to VividLook, our MRI prostate product.

We remain particularly excited about the opportunity for VividLook, our MRI prostate product.

In addition to the use of this product as an adjunct screening tool for cancer, we believe it has significant potential as a tool to assist in image-guided biopsies for prostate cancer diagnosis and treatment.

The use of this technology is in its early stage of adoption where awareness and education are critical to drive a widespread use.

Toward that end, we have embarked upon important initiatives that we believe will position iCAD at the forefront of these advancements in prostate imaging.

We've developed a series of educational events designed for the full gamut of professionals who diagnose and treat patients with prostate cancer.

Last week, we launched Innovations in Imaging, our series of educational initiatives focused on how MRI combined with VividLook supports improved prostate cancer management.

We believe these seminars will provide clinicians with a better understanding of how this imaging capability supports better patient care, as well as how it incorporates into their own practices.

Our first series, entitled Prostate MRI - A Paradigm Shift in Prostate Cancer Diagnosis and Management, took place on October 15.

We received an overwhelming positive response from this oversubscribed webinar, which was attended by a number of worldwide specialists representing some of the world's most prestigious medical facilities.

We are hosting another educational webinar on Tuesday, November 10 with Dr.

Russell Low, Medical Director at Sharp and Children's MRI Center, and Assistant Clinical Professor at the University of California, San Diego School of Medicine.

The course will include clinical case reviews that will demonstrate prostate cancer detection in patients with previously negative prostate biopsy and rising PSA, as well as the use of dynamic contrast-enhanced MRI and CAD to monitor prostate cancer response to radiation therapy.

We look forward to continuing this program and expect that these seminars and symposiums will support our efforts to build momentum for VividLook in prostate cancer management.

The combination of awareness, education in our external MRI sales force will help us to capitalize on this growing market opportunity.

Turning to our progress on CT, on May 22, we filed our 510(k) application with the FDA for clearance to market VeraLook for the use in CT colonography or virtual colonoscopy.

Ordinarily, the FDA responds to a 510(k) submission within 90 days.

We're now beyond 150 days and are still waiting word from the agencies.

At the moment, they've acknowledged their delay, attributing it to a backup of submissions and assured us that they will respond to our submission soon.

As a review, CTC employs cutting-edge technology to produce three-dimensional images that permit a thorough, yet minimally invasive evaluation of the entire colorectal structure.

CTC requires no sedation, so patients receiving a CTC exam are able to return to their normal activities immediately following the exam.

By incorporating CAD with virtual colonoscopy, radiologists have the option of using an image analysis tool that will aid them in detecting early-stage polyps as they are providing a list of CAD marks, the potential polyp locations clearly marked for their inspection.

VeraLook has the potential to reduce oversight errors that can occur during a virtual colonoscopy study review due to large number of images generated by the CT system, often exceeding 1,000 images for a single patient.

Once FDA cleared, we will continue to work with our OEM partners to integrate VeraLook into their advanced visualization software programs, which we intend to market for use with the over 30,000 multi-slice CT systems installed worldwide today.

Among efforts to increase awareness was our petition in the International Symposium for Virtual Colonoscopy, which was held in Western Virginia this week in conjunction with the American College of Radiology.

This event is the most significant CTC event of the year.

We had a very strong presence at the meeting and it represented the first public disclosure of some of our product performance data, which resulted in strong interest from this group of CTC thought leaders as well as additional interest from our partners in expanding relationships in this area.

We're pleased to report some unexpected good news on the reimbursement front for virtual colonoscopy.

New payment codes have been established for CTC and all these will not affect CMS's earlier decision on reimbursement it will make getting paid for CTC much easier for the insurers and third parties that are paying for it today.

As you know, we've previously reported that many of the major private payers are already covering CTC for colorectal cancer screening, including UnitedHealthcare, CIGNA, numerous Blue Cross Blue Shield affiliates and many others.

In addition, the American Cancer Society, The American College of Radiology and Multi-Society Task Force for colorectal cancer, all have added guidelines for CTC versus optical colonoscopy and are strong supporters of its reimbursement.

So with the update of our key product programs completed, I'd like to turn things over to Darlene, who'll give you more detailed review of our financials for the quarter.

Thank you, Ken and good morning, everyone.

We were very pleased with our overall financial performance in Q3 and year-to-date, particularly in light of the very challenging business environment.

We're also pleased to see that after three consecutive quarters of softening demand for digital mammography systems, we saw an up-tick in system placements in the third quarter and believe these improvements will hold, if not improve over the coming quarters.

Importantly, despite negative top-line growth this quarter when compared to a record quarter last year, we continue to demonstrate operational excellence that has allowed us to achieve record gross margin, a return to profitability, and to generate cash.

Additionally, we accomplished all this while maintaining a healthy balance sheet.

We believe we're entering the fourth quarter in an even stronger position to capitalize on what we expect will be an improving market in the coming quarters.

Now turning to our third quarter financial results, the 37% comparative decline in total revenues to $7.1 million from $11.2 million in the third quarter of 2008, primarily reflects the challenging economic environment that we're in today and the comparison to a record quarter last year.

This is due largely to the impact of purchase delays for digital mammography systems and CAD.

Important to note, though on a sequential basis, revenues in the third quarter this year improved over the second quarter by 24%.

Digital CAD and MRI revenues declined by 41% to $4.8 million, from $8.2 million comparatively.

As Ken mentioned earlier, last year's record third quarter benefited from the pent-up demand for SecondLook Digital CAD for use with Fuji CR System, which as you may recall received FDA clearance and was launched into the market in the second quarter of 2008.

Our film-based product revenue was off by 41% in the third quarter to $1.3 million from $2.2 million in the same period last year.

This correlates pretty closely to the decrease in digital CAD sales, which is not surprising as our TotalLook MammoAdvantage comparative reading product is typically sold as sites are preparing to go digital.

We expect demand for this product to pick up again as the market improves and the ongoing transition to digital mammography continues.

Third quarter service and supply revenue increased 17% to $1 million from $871,000 the prior-year quarter.

This is primarily the result of increased service contract agreements, which continue to grow as our growing installed base of customers migrate from warrantee to service contract.

Service contract revenue was up nicely, increasing 25% over the same period last year and representing 91% of our total service and supply revenue for the third quarter.

This large and growing installed customer base offers significant opportunities for growth, not only from new service contracts, but also from potential sales of future new product upgrades.

International sales for the third quarter declined 56% to $371,000 from $836,000 in the prior-year third quarter.

While we saw a decline this quarter, on a year-to-date basis, international sales of $2.8 million showed annual growth of 22%.

We remain confident that overseas markets will continue to provide a growing opportunity for us.

For the quarter, we achieved a record gross margin of 84.8%, up from 84.1% a year ago, primarily the results of optimized pricing and cost management.

Third quarter operating expenses decreased by $1.2 million to $6 million from $7.2 million in the prior-year quarter.

This decrease is due primarily to a reduction in sales commissions and compensation expense, a reduction in clinical trial expense, consulting expenses, travel cost and stock-based compensation expense.

For the third quarter of 2009, we reported net income of $113,000 or $0.00 per share, including stock-based compensation expense of $492,000.

This compares with net income of $2.1 million or $0.04 per diluted share, including stock-based compensation expense of $538,000 for the third quarter of 2008.

Now turning to the nine-month results, for the nine months ended September 30, 2009, total revenues were $20 million, off about 29% as compared with $28.2 million last year.

Again this is largely due to the decline in our digital mammo CAD sales, which have been impacted by capital budget delays brought on by the current state of the economy.

Year-to-date sales of our digital and MRI CAD solutions decreased 38% over the prior-year period to $12.7 million from $20.4 million.

For the first nine months of 2009, film-based product sales of $4.6 million decreased by 13%, and service and supply revenue increased by 9% to $2.8 million.

The gross margin for the first nine months of 2009 was 83%, down slightly from 83.5% in the comparable prior-year nine-month period.

Operating expenses for the first nine months of 2009 of $19 million were essentially flat with the prior-year nine-month period at $19.1 million.

Net loss for the nine-months ended September 30, 2009, including stock-based compensation expense of $1.5 million was $2.3 million or $0.05 per share.

This compares with net earnings including stock-based compensation expense of $1.4 million or $0.09 per diluted share for the nine-months ended September 30, '08.

We exited the third quarter of 2009 with product backlog excluding service and supplies of $653,000, compared with $1.1 million at December 31, '08.

I remind you that a significant amount of our products are booked and shipped within the same quarter.

The backlogs should not be translated into future revenue for any future period.

Now looking at our balance sheet, we continue to maintain a healthy balance sheet through disciplined cash management, tight expense control, and strong inventory planning system.

In addition to generating $308,000 in cash this quarter, we reduced our accounts payable by $1.2 million and reduced our inventory by about $156,000, all versus year-end.

We remain debt-free and ended the quarter with $13.5 million in cash and cash equivalent, compared with $13.1 million at December 31, '08.

As a result, we continue to believe that iCAD is well positioned to benefit from improving market conditions.

As a final topic, let me address 2009 financial guidance.

Although we are increasingly confident about iCAD's performance during the balance of 2009, due to the economic environment and associated uncertainty in the healthcare markets we serve, we've made a decision to defer providing financial guidance at this time.

This decision will be reviewed at year-end and we will provide a further update at that time.

With that operator, let me open up the call to questions.

(Operator Instructions).

We have a question from the line of Jonathan Block, SunTrust Robinson Humphrey.

Please proceed.

Hi.

Thanks and good morning, guys.

Good morning.

Yes.

First question, Ken, maybe you can help us out with the international market, it was a little weak this quarter.

I realized certainly year-to-date, there is still some strength there, up 20%, but is it just the typical lumpiness that occurs OUS or did you see anything internationally that was weaker from the numbers that we saw at MQSA here in the United States?

What I would say, Jon, is the summer quarter in Europe is probably the slowest quarter of the year with the extended vacations that people are entitled to in Europe.

So I think that that probably had, from a timing standpoint, more than anything to do with overall performance.

I think that we've seen in kind of a year-to-date fashion less impact of this negative economic environment in Europe than we have in United States.

It seems like the US has been hit the hardest in terms of demand shift.

Overall, with a 20% growth over last year year-to-date, we've seen stronger demand, but a lot of that has to do with the fact that the governments are the ones that pay for these systems in a lot of the European countries for the most part and they have budgets and have allocated funds and don't have the ability to pull them back real-time, as you might find in the US hospital system.

So, we think the business there is still stronger relative to the US and we do expect to see a much stronger fourth quarter.

Also keep in mind that the 20% growth is after having a very strong growth year in 2008.

So we're growing 20% year-to-date off of a challenging compare.

So we feel very good about the market and we think we just had a pause in the third quarter relative to the summer quarter, and would anticipate a much stronger fourth quarter internationally.

Okay, perfect.

And then, just maybe moving over to colon, like you said, you are in the holding pattern with the FDA, maybe if you can just help us out, ideally you could get that at the end of this year or maybe early 2010.

Maybe you could help identify what you think is really the low-hanging fruit from the colon opportunity in 2010?

Right.

The timing on colon is very hard, and if you've noticed and I'm sure you have, the FDA has had a lot of internal discussion going regarding the testing of CAD products across all categories and that's been going on for several years, and it has culminated in a guidance document that is in a preliminary form that was just published in the last week or so.

That document will circulate for approximately 90 days, and in the midst of that circulation, they're actually holding a second panel meeting in November in Washington on CAD.

And so really what we are dealing with is the FDA trying to get alignment on what the proper testing paradigm should be for CAD under certain circumstances, whether it's a supplement and an added capability to an existing product or a brand-new application for something that's new or breakthrough in the industry.

So we think that unfortunately, we're caught up in this as many other companies that are in the space.

So our ability to project when we will come out the other end of this process is very hard and then what the opportunity or low-hanging fruit as you mentioned would be.

What I would say is as we read through the guidance document, we probably followed as best as you could these new guidance views that the FDA had relative to our submission on colon.

We did the reader study, we followed it in a manner that was consistent with all of the meetings that we had with the group at the FDA that has published this guidance document.

So we're very, very confident of our submission, both from a process standpoint and from a performance standpoint.

The big challenge, of course, is when will we get the approval.

I think once we have the approval, there certainly are a number of areas within the United States and internationally where CTC procedures are growing.

And so the low-hanging fruit for us is obviously going to be in those sites where CTC has had significant traction.

There is a fair amount of procedure volume going and ultimately, CAD has enormous benefit when you are trying to read a high volume of procedures.

So those are the obvious targets.

We will work those targets with our OEM advance visualization partners and expect to have sales sometime next year relative to the US as well as the OUS market.

Now the exact timing and the magnitude is a bit challenging.

One other point I would make on CTC is that the insurance payment environment has improved significantly.

And as I mentioned in my opening remarks that there has now been CPT codes for CT colonography established.

There are actually three codes, one for screening CTC without contrast, one for diagnostic CTC without contrast, and one for diagnostic CTC with contrast.

And that is going to be a big, big plus so that when the privates payers, the big guys like CIGNA, UnitedHealthcare, the Blue Cross Blue Shield affiliates that pay for this now need to go to the reimbursement phase, it would be much more straightforward and much more easy for them to get reimbursed.

We are also hearing that reimbursement on the private side is running around $700 for the CTC procedure which is also encouraging.

So to kind of sum it up, we are very enthused about this market opportunity.

This move relative to the CPT codes will help significantly with the major payers that are paying for it today and really what we've got to do is get a reading from the FDA which we expect at any time relative to our submission and understand where we stand and what we would need to get clearance and then ultimately enter this market.

So we are very bullish about the opportunity; unfortunately, the timing is probably the biggest challenge right now.

Okay, I surely understand that.

I think, and I don't want to back you in the corner to get one number, but I'm just trying to figure out, we see some stabilization here on digital mammo; we can extrapolate that into the model in 2010.

Just for simplicity, if you assume a Jan.

1 approval for colon, and I realize that's probably aggressive, but in the first 12 months do you view this as a $1 million opportunity, $5 million opportunity or somewhere in-between?

I think it's a good question but it's a hard question for me to answer right now.

I think the dynamics of timing is a major component of this.

The procedure volumes in the payer side is a major impact on volumes.

So I guess what I would say is that we think in the second half of next year, we'd have much more of a chance for this to have a significant impact on revenue.

We're not now, with this FDA environment being what it is and all the processes between guidance papers and panel meetings, really bullish on something happening early in the year.

We have some very, very I think encouraging internal projections but with respect to disclosing them, I think it would be premature.

Okay, great.

And one last one and then I'll just get back in the queue.

And on the MRI side of things, I believe it was one of the competitors, I think confirming that was purchased, and maybe if you can just give us some details on what you see from a competitive standpoint, has anything changed?

I would love your thoughts there.

I would say that in the MRI space, for breast, not much has changed.

I think there is still steady increasing procedure volume and demand, and that's been going on since really 2003 right through when in 2007, American Cancer Society established guidelines for breast MRI screening and in diagnostic care.

So we see steady demand there.

The area of MRI that we do get excited about the most though is the prostrate opportunity.

We really think that that could be a significant market and that's why we have put such an emphasis on education and we are in these different seminars and symposium that we are hosting, whether they are webinars or at the RSNA itself, really trying to get the word out and the education out to all of the thought leaders and leading radiologists, in particular, we really think would really enjoy using this technology in lieu of some of the more, I guess, data technologies today.

So we are really excited about prostrate MRI as an opportunity.

We all know what the flaws in accuracy are relative to the PSA blood test.

We all know what some of the benefits are to using a contrast-enhanced MRI study of the prostrate for diagnosis and treatment, and treatment assessment.

So, I think what I would say is that we are getting more and more excited about the prostrate MRI opportunity, recognizing that it's early in the market adoption phase.

Education is a big, big important component but the demographics, if you will, of the number of men in their life, the number of new prostrate cancer cases and contrasting that to this archaic kind of PSA blood test screening capability that is used as the standard today.

This could easily become over time a market as big as the mammography market.

So we are very, very bullish on that, and we are taking a leadership position in the education side of this such that when this market gets that broader education and the demand for procedures grows, we'll become a clear leader in providing CAD to the radiologists that are reading these prostate MRI exams.

(Operator Instructions).

We do have a question from the line of Matthew Scalo, Canaccord Adams.

Please proceed.

Hi guys, very good quarter.

Good morning, Matt.

I wanted to check in on the -- so the sequential growth on the digital side, can you walk me through how much of that was possibly inventory restocking from your partners versus potentially some of that installed base from Fuji out there that they planned on loading up CAD, they never did in that third quarter or fourth quarter of 2008 and now they are coming back and having CAD installed on those systems?

I think Matt, the way I would look at it is that Q2, when we look at the MQSA data, it was the weakest quarter of the year from a demand standpoint and so obviously our partners at the end of Q1, as we talked about after the Q2 call, had put in more of their traditional stocking inventories only to see the weakest quarter of the year occur versus what you typically would see in Q2 was maybe your second strongest quarter of the year next to Q4.

So basically they went through this digestion of the inventory and became cautious, obviously with the direction of the market.

Well, as we entered into Q3, their inventory levels were extremely low.

They hadn't taken any stock to get into the third quarter and then what happened?

We saw 11% increase in demand per the MQSA data in the United States, relative to Q2.

So hence you've got partners that are essentially out of stock, demand is up 11% and so they are obviously buying more.

And so really what it came down to was simply demand was greater and all of our partners bought more product in Q3 than obviously in Q2.

And I would say it was across the board, it was not really one company and a unique situation.

What I will tell you is that GE had an extremely strong quarter and as we talked to GE about the market, while they don't see dramatic growth being achieved in the market, they believe particularly in the United States that they are taking market share.

They believe they are taking significant market share over the last several quarters and the performance that they had with us in the third quarter was very significantly up from Q1 and Q2.

So I suppose that would bear out their sentiment.

So that probably had some impact overall.

But otherwise, what we saw from Fuji or Siemens or our broader partners is pretty consistent business in the quarter, slightly better than their run rates in the first two quarters.

So I don't think there was any real, unique one-time scenario, if you will.

And as it came to the end of Q3, these companies did not necessarily place the type of stocking orders that they had in the first quarter for Q4, which is why we are still encouraged that our business in the fourth quarter should be stronger than it was in the third quarter and allowing us to finish the year in a very strong note compared to the first half of the year.

So that would really be the best way I could describe for you the dynamics around demand contrasting it to prior quarters.

It's extremely helpful, Ken.

But it seems like you're extremely confident about fourth quarter trends here and yet not enough to offer guidance, is there --?

Well, I think that given the volatility we saw in the first half, our confidence in our ability to perform at a higher level is high.

With that said, every time you turn around, there is something new news wise in the economy that contradicts this recession is over and we are on a recovery with real growth.

And so when I look at the contradicting data that comes out every day related to the economy, I'm just not comfortable at this point in time with guidance.

I do think though that as we performed very, very accurately and consistent with our internal projections for the third quarter, we've put together fourth quarter projections that we're also very confident of and believe we will show again further progress on top-line growth and bottom-line profit compared to, say, Q3.

But with that said, we've decided to reserve guidance because we still believe the environment has too much contradicting economic data on a daily basis for us to really be able to establish what we think is a solid trend and then ultimately give guidance that we can't deliver on.

Okay, that's a great answer.

Thanks.

Do you think GE is taking share over at least the last couple of quarters due to that US-based facility that they now are no longer supply constrained or is it just preference for their product per se?

Yes, I think what we hear is preference and I think they have come to the realization that this is a much more competitive market on pricing and I think they have become more aggressive as it relates to pricing and I think that's great because obviously in our case, we have established contracts with these companies, such that our pricing is firm and as I had probably mentioned in past calls, our new pricing kicked in with these companies around the first of the year to the end of the first quarter.

And one of the reasons that our gross margin was substantially better in the third quarter was that our contract pricing is now higher with all of our OEM partners.

So as their demand now is getting better, what's really nice about that is our average selling prices are going up and our gross margin is going up because of the high-margin content in our digital product.

So I would say that GE believes that product performance and probably more sharper pricing has helped them to take share from all of their competitors and I can only comment that in the third quarter, given the up-tick in business that we had with them versus Q1 and Q2, it certainly would seem to support that and we're hopeful that it's sustainable into the fourth quarter, because obviously, they are on a calendar year-end, and we would really like to see the strong momentum that they had in Q3 continue, whether it's demand in the market or some combination of demand and market share.

Okay.

And then just I guess switching to MRI CAD, your comments on prostate sounds very exciting.

I am just curious about the cost associated, the education programs going on, is that incremental, is that additive or was that already kind of in prior estimates for expenses going forward?

That's a good question.

We've had to modify our expenses so many times over the course of the year with the volatility, if you will, in demand, and we've taken our expenses down pretty significantly.

So what I would say is that we had planned all along to invest in this education as part of our year.

We've done a good job cutting expenses in just about every other category to be able to afford to continue this investment.

I think that if you look at our balance sheet, three quarters into the year, we've done a very good job preserving our product plans and our growth opportunities, and as we look at the growth opportunities right now, even though it's probably not as immediate, the biggest one we see is prostate MRI on the horizon.

So we are not going to cut back in any of our investments in education and market adoption.

What we will do is certainly cut back in all other areas that we feel that we're not going to see the short-term or the long-term benefits of those investments and we've done a lot of that to ensure that those programs we think that have the highest potential would be maintained.

Okay, Ken, you kind of re-branded those products at the last RSNA, anything new that we should be expecting at this RSNA as far as the MRI CAD product itself?

And frankly, looking back over the year, have sales, has the progress there met or exceeded your internal expectation?

Well, the RSNA plan is to show works in progress, as I mentioned in my opening comments, both across the breast and the prostate product.

We think that there are some opportunities to really enhance the products, to really make them that much more competitive and part of it is traditional things around improving user interface and so forth, but also this is a market that will move more from an IT standpoint to more of a thin client approach.

So we are looking at more of an approach from a user interface, thin client standpoint to enhance the products and then also what we bring to the table that we think is a big differentiator for us is the fact that we're essentially a morphology or patent recognition CAD company that now has a powerful footprint in workflow as well and when you look at the other players in MRI, they are basically really heavily weighted towards workflow only, and what we bring is this mammography morphology-based CAD capabilities along with the workflow capabilities and while we are not going to be releasing something to the market in the near term in that regard, we think that can give us a unique sustainable advantage over time as we bring out further generations of the MRI product.

So we'll be showing some -- I think some good innovation there, as it relates to both breast and prostate at the meeting.

As it relates to sales, what I would say is no different than what's been challenging in the economy.

Demand has not been as strong as we had hoped this year for MRI products.

I think that you could say our timing was not ideal where we introduced these products in the fourth quarter of 2008.

The funnel is very, very large and part of the benefit of that is that we have a large direct sales force contrasted to our competitors and I think that as things get better in the economy, more and more opportunities will fall through that funnel and create more business.

So, we've seen sequentially more business each quarter in the category.

We've seen more business coming on the prostate side, which is encouraging and we believe we have a shot in the fourth quarter at having a very, very strong quarter.

We've already landed two very large orders and that combined with a very strong funnel gives us the confidence that our MRI sales in the fourth quarter will be very, very strong, although we aren't at this point disclosing exactly what those numbers are publicly.

Okay.

Thank you.

(Operator Instructions).

We do have a follow-up question from the line of Jonathan Block.

Please proceed.

Hi, just maybe two quick ones.

Number one, just Darlene, this is for you on the R&D.

The R&D popped in -- or increased a bit late '08 and early '09, I believe when you readied the submission for colon CAD in a $2.2 million, $2.3 million and now it has sort of declined back to that $1.7 million run rate.

Again, just from a modeling perspective, do you think that's sort of the steady rate to use going forward as we roll into 2010?

Yes, Jonathan.

I think you have that picture down pat pretty well as we, in the second half of last year and early into the first, say, five months of this year that colon clinical trial over that time period cost us about almost $1.2 million to do that trial.

So what you're seeing now is those costs being eliminated.

We're still working on our budget for next year and so we will update you as we go along, but I don't think we're going to have anything of that magnitude, at least over the next couple of quarters.

So you should see the R&D run rate [hold] pretty steady going forward.

Okay.

And maybe just another modeling question.

On the gross margin, digital allows you get to sort of the mid-80s.

In terms of the other products that you're out there with the MRI or even the Colon CAD, would anything change substantially from a margin perspective that we should be aware of, even if it's not 2010, 2011 and beyond?

What's the margin structure of some of these newer products in the pipeline?

I would say the margin structure more closely models the digital product structure.

Part of it is it will always be a blend, how much is the second license versus a full-blown system of that server, but I think you can model it pretty closely along the SecondLook Digital line, which is the majority of the business and why we are getting this gross margin up a little bit all the time.

So I think if you kind of keep it in the high-80s type [trend], it'll work out well for you there.

Okay, last one.

Ken, I think you've probably done a much better job than even some of the companies involved in tomo, predicting when it's going to get approved by the FDA, et cetera.

So maybe if you can just help us out, that's another growth opportunity for you in terms of when tomo is out there, your ability to provide tomo -- CAD for tomo, which from what we hear is essential from a workflow perspective, so how do you view that?

Is that a 2011, is that a 2013?

And then I know Siemens actually has tomo available OUS.

Are you -- have you been providing them with CAD, or are they doing their internal CAD OUS and you'll be the provider here in the US?

Thanks, guys.

Sure.

In terms of our view on tomo, it's very unclear in the United States and the only information that we're aware of is what's public relative to Hologic's efforts in different back and forths that they've had with the FDA, where they now I believe have de-emphasized the submission for a period of time.

I'm not sure if that's the data collection or the different things they need to respond to, but clearly the timing seems to have moved out, for sure.

So what we would say is that we're really not counting on a material progress in 2010.

From our standpoint, our ability to sell CAD in the tomo world is probably a 2011 phenomenon.

So we're not really seeing any progress within the FDA with companies that are either in or about to get into a cycle.

So knowing that this is still a PMA world, it could easily take a year from an initial submission for our partners to have a product and we don't know that any of our partners are in the FDA actively at this point.

So with that said, the earliest we would think there'd be tomo revenues would be probably sometime in 2011, as it relates to CAD; exactly when again will be a lot dependent upon when our partners get in the queue, when they get approval, and then when we submit and then get approval sequentially since we can't do this simultaneously with our submission.

So 2011 is probably the time frame.

We are aware that Siemens has placed some early units in Europe.

We have at the RSNA for several years been showing tomo CAD on Siemens images.

So we are working with Siemens; we are not in a position to be offering something eminently in Europe with Siemens on tomo, but we're certainly collaborating with them as we have on a tomo product, probably with more of a US focus given the adoption rate of CAD in the United States versus international, but we're talking to them about a CAD product for their tomo platform and would expect to have one obviously sooner in Europe than in the United States, since they have not submitted in the US to our knowledge, but we certainly are in collaboration with them and we'll have something for all of the various markets over a reasonable period of time.

Great.

Thanks, guys.

Okay.

The next question will come from the line of Richard Deutsch, Ladenburg Thalmann.

Please proceed.

Yes.

Thank you.

Can you speak to your expectations for outside US plans for 2010?

Well, in 2010, Richard, I think that obviously, it starts with digital mammography and with the nice growth that we've had this year, majority of that has been digital mammography.

So I think on a positive note, we don't believe that the international market for digital mammography is as penetrated as the US market.

So, with 57% of the US market having gone digital and 43% still using film, we think that the international opportunity is much greater because far less than 50% of the international market has gone digital.

So I think that initially, we're excited about the notion of increased growth in digital mammography OUS and then obviously increased CAD sales, and that has been evident this year relative to where the US market is.

Beyond that, we really believe MRI is also a significant opportunity internationally, as we have been to recent meetings, as an example, the French Radiology Meeting was held just in the last week or so.

We're seeing a very high interest in Europe in MRI CAD and so we clearly see that as a significant opportunity.

And I also think that we're seeing both breast and prostrate interest in MRI, particularly in Europe.

Beyond that, our product for Colon, CTC will be available for a full year in the international markets in 2010.

So we certainly see some interest there, but probably not quite as great an interest as we've seen in MRI.

So we're clearly looking at mammography, higher growth in the international markets; we're looking at MRI as a significant opportunity in international markets and to a certain extent, CTC as we would not have the regulatory restrictions there that we have in the United States and essentially will have a full year of selling.

So we're expecting that our international business will again grow at a faster rate in 2010 than our US business based on all of the dynamics that I just mentioned.

So we're kind of excited and see that as real opportunity for the company over the next coming years.

Ken, how are you represented over there?

Is it an OEM model or is it direct sales or a combination of both?

It's a blended model.

We basically have for the mammography business, it's pure OEM, and all of our OEM partners are using the same bundling technique they use in the United States.

So when they sell a digital mammography machine, they buy the CAD from us, they would sell a bundled sale.

We have a direct person who sits in Paris that manages our international business there.

And basically, we do have a group of distributors that we use for our MRI products there in Europe, and we are also working on the CTC side with our advanced digitalization partners and would be looking to sell through them.

So as an example, Viatronix is one of our advanced digitalization partners that has an excellent advanced digitalization application for the colon.

And the product will be available through Viatronix for the full year of 2010, and they would take the product from us in an OEM transaction similar to mammography and then resell their application combined with our CAD.

So it's really a blending of OEM sales using our established partners as well as our distributors as it relates to MRI products.

We are in active conversations on the MRI side with the big imaging companies, and we are hoping at some point next year to land some sort of an agreement with our MRI products, with the bigger imaging companies, which would also add more of an OEM opportunity.

That one is our preference at this point versus putting more feet on the ground, which is a more expensive proposition.

And one final question, since they're socialized more over there, do you see any resistance from the establishment on a cost basis or any other objections to CAD in Europe?

I think you do because of the point of it being a government-funded healthcare and mammography is really the great example unfortunately.

The adoption rate for CAD and mammography, let's say, in Europe is probably 25% to 30%, whereas nearly 100% on the systems that go out in the United States.

And what you're dealing with a lot is that the radiologists are government employees and that even in the Western European countries, the established reading protocol is that two radiologists read every mammogram, even the normal exams, and when you think about that, it's just totally impractical in the United States that actually two radiologists for the level of reimbursement have the time to read two exams and because of that protocol in the Western European country, even though their screening programs have improved the volume of mammograms, the adoption of CAD with a single radiologist has not been as fast or prevalent as it should be, even though there has been several studies that have been published that show that CAD plus single radiologist find more cancers than two radiologists reading independently without CAD.

You would think that, that would be a logical catalyst for the market to shift to a single radiologist with CAD, but as I say, since it is more single-payer government-funded healthcare, they just don't have the -- let's say, the cost dynamics, they don't have the litigation dynamics, they don't have the reimbursement dynamics that have driven CAD adoption wise.

So I think that that's what you do face in the international markets, probably a lesser extent for MRI and CT.

So I think that we will probably find less barriers for MRI and CT sales internationally versus mammography since they don't have these established reading paradigms.

All right.

Thank you.

Welcome.

The next question will come from the line of Jeb Terry, Aberdeen Investment Management.

Please proceed.

Good morning, Ken, Darlene.

Good morning, Jeb.

Good morning, Jeb.

Darlene, a couple of very easy questions.

Headcount, CapEx and depreciation?

Yes, the current head -- I am sorry, go ahead.

I would say -- and then also if you could discuss what contributed to the growth in your deferred revenue?

So from a headcount perspective, as you recall last quarter, in the July time frame, we reduced our headcount by about ten people.

So our headcount today is around 110 and holding, and I think we will stay that way through the remainder of the year.

And of those people who were -- I would say those ten headcount reduction were sort of across the board, so not one area more than another to speak of.

So, it's pretty across the board.

So headcount is down to around 105.

From a capital -- a CapEx perspective, this is -- just continues not to be a very capital-intensive business at all.

So you keep seeing the sort of net capital equipment number go down because the depreciation continues to tick through.

Really it's software manufacturing that we outsource, so most of our capital expenditures tend to be around new laptops for employees and turning that over or servers for -- to store our algorithms and so forth or to update the booth for RSNA and things like that.

So we're just not a very capital-intensive business, which works out very, very nicely for us.

And I am sorry, I missed, what was the other question?

Well, the -- just depreciation and what was the CapEx for the [fourth quarter]?

Deferred revenue was the other one.

Deferred revenue.

So the deferred revenue goes up -- you're seeing our service contract revenue continue to tick up here, it's up 25% or so over last year and we'll -- as we get those orders, we'll put those service contracts that continue to build our deferred revenue and we take that down every month out of deferred revenue into actual revenue.

So the more we -- service contracts we close, they sit up in that deferred revenue number.

Okay, certainly helps visibility.

And should -- perhaps Ken, can you comment on where Carestream must stand right now?

And is that still something that might be -- well, who knows what the impact might be, if you could help us understand where that is?

Sure.

Carestream obviously is a CR mammo competitor with Fuji, and probably along with Fuji has the biggest footprint in CR systems on a global basis.

Unfortunately, Carestream is still waiting on FDA approval for their CR mammo product and that's been in the FDA for several years and while they are growing optimistic about their ability to get approval, it's still not in hand.

We've made some great progress with them in terms of collaboration and really believe within probably 60 days of their approval, we will have something into the FDA.

So we've really been getting ahead on the testing, we had worked through a lot of our contractual issues.

They still believe they have a very large and loyal installed base waiting for them and believe that they have some unique features and a very attractive price point from an upgrade standpoint to enter that market.

So the unfortunate side is we really can't get to the final phase of our testing until they have FDA approval.

They claim it's coming at any time but with that said, we've been feeling that sort of response for probably close to a year.

So we think it's going to be a real opportunity.

Whether they will get approval this quarter and whether we could in, let's say, one cycle get through the FDA, that would probably put us out toward the middle of 2010 before we would have the ability to ship systems and that would assume that everything goes well.

As I mentioned earlier, a lot of different moving parts with the FDA these days.

So if they do get approval this quarter, we're hopeful they will, we would certainly hope if we're into the FDA by the early part of 2010 that in the second half of the year, we would have an approval and I just think that our overall work with them and also some of their work with the FDA when they were looking to submit their own CAD product at one point which they've decided not to do would increase our chances of getting a more swifter approval than the current state of affairs there.

And are you having any success with them outside US or with any of the other CR providers outside of US?

We have done some business with Fuji outside of the US and actually done some business with Agfa outside of the US, and we have done a trickle of business with Philips outside of the US.

But so far, the CR international market has been for mammography with CAD very slow in developing.

So what I would say is we had a handful of orders across those companies but not any real traction.

Our significant growth internationally has really been a combination of full-field digital mammography systems principally from GE and adding CAD to a number of those systems as they have done well in expanding their international footprint.

And then secondly, TotalLook MammoAdvantage has actually became a more popular product internationally where for quite some time internationally, there was a lot of resistance to digitizing and in certain countries, digitizing has now become more popular in that people have recognized the real benefits to digital workflow.

When I say that though Canada probably has been our most exciting opportunity for growth with TotalLook MammoAdvantage outside of the US.

We have done very well in Canada, which does obviously fit in to our international numbers but we are selling more of those products in different countries around the world so that that has been a growth catalyst for us internationally.

Regarding TotalLook, it looks like you had a quarter-to-quarter decline there.

Is that -- is there is difference in the attachment rate or is there just something just seasonal or --?

Yes, that's a good question, Jeff.

We've really scrubbed that data well because obviously, in Q2 with softer digital revenues, we did have stronger performance with TotalLook MammoAdvantage and what we found basically is obviously the attachment rate has been probably consistent, actually increasing to a certain extent.

So the good news is that for every ten digital mammography machines that go out, there is a higher percentage of TotalLook MammoAdvantages going out but that overall number has obviously come down significantly.

We are also selling this product to the installed base that went digital, but resisted the digitizing thinking that when they did need to look at prior exams, they would just bring out the film and put [it] on a light box.

And I think in the first several quarters of the year, we actually saw a lot of business from those customers that initially didn't believe they needed to digitize their film library and decided to do so.

And in the third quarter, we saw a sharp decline in business from those customers that had already gone digital with mammography which as we look at the fourth quarter, we think it was more of a -- I don't know, episodic or timing scenario.

We expect that product to be much stronger in sales in the fourth quarter.

Quite a few orders that came in early in the fourth quarter, as an example, were targeted to Q3.

So some of it was timing.

So I would say it was a collection of issues for why the quarter was softer, but we anticipate a much stronger fourth quarter for the product based on our current sales forecasts.

Okay.

Well, thanks very much and congratulations.

A spectacular performance actually, all things considered.

Great, thank you.

Thank you.

And this concludes the question-and-answer portion of today's conference.

I'd like to turn the call back to Mr.

Ken Ferry for closing remarks.

Well, thank you, all, very much for joining us this morning and for your continued interest in iCAD.

We look forward to updating you on our progress when we report our fourth quarter in early 2010.

In addition, for those of you that will be attending the upcoming RSNA Meeting at Chicago, we hope you'll be able to join us at our Investor Luncheon Meeting on December 1 at noon in the Hyatt McCormick Place Center.

So again, thanks for joining us and have a good day.

Ladies and gentlemen, this concludes today's conference.

Thank you for your participation.

You may now disconnect and have a good day.