ICAD Inc (ICAD) 2017 Q1 法說會逐字稿

Good day, and welcome to the iCAD First Quarter 2017 Earnings Conference Call.

Today's conference is being recorded.

At this time, I would like to turn the conference over to Bob Yedid.

Please go ahead, sir.

Thank you, Cody, and good afternoon, everyone.

Thank you for participating in today's call.

Joining me from iCAD are Ken Ferry, Chief Executive Officer; Richard Christopher, Chief Financial Officer.

After the market closed today, iCAD announced financial results for the first quarter, ending March 31, 2017.

Before we begin, I would like to caution that comments made during this conference call by management that contains 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 Form 10-Q and 10-K, 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, May 2, 2017.

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

With that said, I'd like to call -- turn the call over to Ken Ferry, Chief Executive Officer.

Ken?

Thanks Bob.

Good afternoon, everyone, and thank for joining us today.

I'll begin with a few comments on our first quarter financial results and progress with the key growth drivers for our business.

I'll then turn the call over to Rich Christopher, our Chief Financial Officer, for a review of our financial results.

Following Rich's remarks, I'll be back with a more detailed business update and to review our key initiatives for 2017, and then we'll open up the call for questions.

Revenue growth in the first quarter of 2017 was strong versus the first quarter of 2016, reflecting a significant increase in sales of our breast cancer detection and therapy products.

These higher product sales were modestly offset by lower service revenues.

We will provide more detail on these segments of our business later in the call.

Based on a solid start to 2017, we continue to believe iCAD is well positioned for sustained growth over the coming years.

First, we have a considerable growth opportunity particularly in the U.S. and international markets with our innovative software that enhances the workflow and cancer detection in 3D tomosynthesis breast exams.

We were excited to receive PMA approval from the FDA for our PowerLook tomo detection product on March 24, achieving an important milestone for the company.

This is the first product of its kind in the breast health market and one of the first implementations of artificial intelligence in health care.

And second, we continue to make good progress in our skin brachytherapy business, which represents a billion-dollar-plus market opportunity.

We are currently at the early stage of market adoption in both of these large market segments with significant opportunity for increased penetration in growth for years to come.

I'll provide more detail on these and other areas of our business in a few minutes, but now I'm going to turn the call over to Rich Christopher for a more detailed review of our first quarter financial results.

Rich?

Thank you, Ken, and good afternoon, everyone.

I am truly excited to be on the call today to discuss our continued progress.

I would like to review the company's first quarter 2017 financial highlights, which were disclosed in the afternoon's earnings release.

For the first quarter of 2017, total revenue was $6.8 million, reflecting a $750,000 or 12.5% increase over the prior year quarter.

The year-over-year revenue increase reflects growth from both our detection and therapy businesses.

Total revenue in our detection business for the first quarter of 2017 increased by 14% to $4.5 million.

The incremental revenue reflects the growth of our mammography products, including the sales of our 3D tomosynthesis product both in the U.S. and internationally.

We are thrilled to announce the initial sales of our tomo product domestically, which occurred within days after the FDA approval, just prior to the close of the first quarter.

I'd also like to point out that true revenue growth in our detection business was somewhat masked by the presence of our MRI revenue in both the first quarter of 2016 and 2017.

As mentioned on our previous call, our MRI assets were sold off to Invivo for $3.2 million during the first quarter of 2017.

If one were to back out the MRI revenues from both quarters, total detection revenues from ongoing product for the first quarter would be up $840,000 or a strong 25% year-over-year.

Shifting over to our therapy business.

First quarter revenue totaled $2.3 million, reflecting a $200,000 or 9% increase over the prior year quarter.

This increase was entirely driven by incremental product revenue.

We are encouraged by the signs of stabilization that we are seeing in our Skin eBx business.

With the reimbursement that went into effect on January 1 of last year, we believe that dermatologists are in a better position to make a decision to incorporate our Skin eBx system into their practices.

The number of new subscription sites as well as the volume of patient treatments administered continues to grow.

Moving onto the rest of the P&L.

Gross margin in the first quarter of 2017 was 69%, consistent with the prior-year period.

Operating expenses in the first quarter of 2017 were $5.1 million, down from $6.7 million in the first quarter of 2016.

It should be noted that operating expenses in the first quarter of 2017 were positively impacted by a onetime gain of $2.5 million related to the sale of our MRI assets.

This gain was partially offset by a $300,000 increase in stock compensation expense.

This noncash item fluctuates as new equity is granted, legacy grants vest and as our stock price changes, impacting performance-based rewards.

The remaining increase in operating expense was driven by continued investment in our key growth initiatives, which include increased sales and marketing resources focused on our key growth areas and additional resources to accelerate the on boarding process in our Skin eBx business.

We believe these investments will accelerate revenue growth from new product sales and over time will result in increased recurring revenues from our subscription and service businesses.

On our last call, we mentioned that our fourth quarter 2016 operating expenses had increased to $7.8 million and that we expected expenses to come down in the first quarter of 2017.

I'm pleased to report that our first quarter expenses were in line with those expectations.

After adjusting for the onetime gain on the sale of our MRI assets and excluding the changes in stock compensation expense, first quarter 2017 operating expenses were $500,000 lower than the fourth quarter of 2016.

Looking at our profit metrics.

GAAP net loss for the quarter was $500,000 or $0.03 per share, representing a $2 million improvement over the loss of $2.5 million or $0.16 per share in the comparable prior year quarter.

The year-over-year favorability in our bottom line also reflects the $2.5 million gain on the sale of our MRI assets.

On a non-GAAP adjusted EBITDA basis, the net loss for the first quarter of 2017 was $1.5 million, which was consistent with the prior-year quarter.

Turning our attention now to the balance sheet.

We ended the first quarter of 2017 with $9.5 million in cash on hand as compared to the $8.6 million we had on hand as of December 31, 2016.

During the first quarter of 2017, we used approximately $1.6 million in cash from operations, which was more than offset by the $2.85 million cash flow -- cash inflow related to the sale of the MRI assets.

Overall, we started 2017 with a strong first quarter, building on the solid progress that we made in the fourth quarter of 2016.

On the expense side, we continued to make selective strategic investments to support long-term growth, particularly in both tomo detection and Skin eBx.

Our balance sheet is solid, and we have no debt.

Lastly, while we are pleased to have received FDA approval for our 3D tomo software, we will not be providing forward-looking guidance until such time as we have better visibility on the revenue ramp for both our tomo and Skin eBx products.

I would now like to turn the call back over to Ken.

Thanks, Rich.

I'll now provide a more detailed update on the progress with our key growth areas in the first quarter and for the balance of the year.

In our Cancer Detection business, as I mentioned earlier, we were very excited to receive PMA approval from the FDA late in the first quarter for our PowerLook detection product.

We're pleased to have several sales of our new product within days of the PMA approval, reflecting the urgent need for interpretive tools that can assist radiologists to read these data-intensive exams in an accurate and productive manner.

To illustrate this point further, a radiologist typically reads 4 views of the breast in a 2D exam.

In a 3D exam, a radiologist typically reads 75 to 80 views per breast.

In our U.S. clinical reader study using PowerLook tomo detection, 20 radiologists read 240 tomo exams with an average reduction in reading time of greater than 29%, without compromise in detection accuracy.

We received additional feedback from the radiologists that participated in the study that there were many additional workflow benefits when using our tool.

In the U.S., we're working closely with GE's breast imaging field team to launch the product to their growing tomo system customer base as well as to new potential customers.

We've also recently increased our presence at key imaging meetings such as the European Congress of Radiology, which took place in March in Vienna, and the Society of Breast Imaging ACR symposium, which took place in April in Los Angeles.

We will continue to raise our visibility at these meetings with abstracts and presentation on our 2 clinical reader studies conducted in conjunction with the development of the product.

We were pleased to achieve extensive media coverage from our press release on the approval of PowerLook tomo detection.

A total of 244 news outlets published the release, reaching a total potential audience of approximately 90 million viewers.

In addition, we've launched an aggressive multifaceted marketing campaign that includes articles in key journals, targeted advertising, web optimization and educational initiative designed to build strong awareness in the market for the availability of this powerful new tool.

Lastly, we are making significant progress with the development of a next-generation, multivendor, tomo detection software product that should be available on other major 3 3D tomo systems in late 2017 for the OUS market and early to mid-2018 in the U.S. market.

The performance of our 3D PowerLook tomo detection product is an excellent example of iCAD's latest innovation built on artificial intelligence.

This product utilizes a sophisticated branch of AI, call deep learning, which enables our solution to achieve extremely high cancer detection rates, while providing significant improvements to workflow.

We intend to leverage our core artificial intelligence technology platform to other imaging modalities over time.

Turning to our Therapy business in the skin cancer treatment segment.

We are pleased with the progress we're making adding new sites and onboarding our existing subscriptions customers.

We made targeted investments to improve our onboarding process for new customers late last year, and these efforts on now paying off.

Moreover, we have added marketing resources in support of helping our customers in their efforts to attract new patients to their practices in those cases where eBx would be a good treatment option as an alternative to Mohs surgery.

We had a strong presence at the American Academy of Dermatology in Orlando, where we hosted in-booth education sessions in early March which were well attended.

Additionally, we've ramped up our marketing value-added services offering, providing customers numerous ways to market the availability of Skin eBx treatments in their community and educate patients on the value of the treatment.

We are pleased with the success that we are experiencing in signing up new customers and with the increasing volume of procedures at our existing customer sites.

Among our customer base, the treatment rate has grown 45% in Q1 when compared to Q4 of 2016.

While we're definitely making progress, we're finding that it still takes a fair amount of time to get practices on board.

And once the onboarding process is completed, getting them to the point where they are treating approximately 10 patients a month will take some time.

Under the subscription model, however, at this patient volume we should be able to generate approximately $150,000 in recurring revenue per site per year.

Overall, while this progress is considerable, it'll take a few more quarters for these subscription revenues to begin to make a more meaningful impact on overall company revenue.

Also from a commercial standpoint, we added sales people in the fourth quarter for the dermatology market in geographies where we have seen an established track record of reimbursement success.

Lastly, we've continued to make considerable investments in support of our longer-term strategy to secure a CPT 1 reimbursement code for skin cancer treatment.

In the fourth quarter, we completed one of the key studies needed for our application, which compares patients that were treated with electronic brachytherapy to those with similar lesions treated with Mohs surgery.

The study is essential to our overall long-term plan to provide national access to the treatment and adequate reimbursement for the physicians offering the service.

Moving onto IORT for breast and gynecological indications.

We added customers domestically and internationally in the quarter and are pleased with the procedure volume growth we're continuing to see at our established sites.

Our strategy longer term is to leverage the value of our platform technology and expand our applicator offering so that we can treat more types of cancers.

This will be particularly important to expanding our international business.

We are continuing to make progress with our ExBRT clinical study, the largest U.S. IORT study to date with approximately 1,000 patients now enrolled.

We plan to begin publishing early data later this year on the results of this study and expect the results to further drive adoption from a clinical perspective.

In addition, our commercial efforts are focusing on our national accounts, ACO efforts and surgery centers in addition to teaching hospitals.

Internationally, we now have 45 centers treating, with growing procedure volume, while we continue focus on increasing regulatory approvals in key markets such as China, India, Egypt and Saudi Arabia.

Lastly, we're looking for additional strategic partners that could help us to expand our presence and penetration in key markets internationally over time.

So in summary, we're making good progress with our Cancer Detection and Cancer Therapy businesses.

And we expect that this will become more evident on our top line results as we execute on these priorities over the course of 2017.

Also, our goal over time is to reestablish growth with our service revenues, as we believe we're on track to do this, particularly with the launch of our PowerLook tomo detection software and the service strategy that we have developed for this product.

So before we open up the call for question, I'd like to reiterate our top priorities for 2017.

First, in Cancer Detection, aggressively launch our 3D tomosynthesis software into the U.S. market, taking advantage of the recent PMA approval, while also continuing to drive adoption of PowerLook tomo detection for international markets; second, in therapy, continue increasing the number of dermatology practices that offer our Skin eBx solution for the treatment of non-melanoma skin cancer, while assisting existing customers to increase patient volumes; third, continue to drive global momentum for breast and IORT and GYN applications; fourth, continue invest in clinical studies to build the long-term data required in support of our increased adoption of Xoft eBx for the treatment of breast and skin cancer; and lastly, continue to carefully manage our expenses and cash flow.

So overall, we have a strong conviction that we are well positioned to accelerate growth in our Cancer Detection and Cancer Therapy businesses, especially in the second half of this year.

We have innovative technologies, growing positive clinical evidence.

We are addressing large markets at the early stage of penetration.

We're especially interest in expanding our artificial intelligence deep learning expertise, as evidenced in our PowerLook software, in breast and other imaging areas.

We look forward to updating you on our progress of these goals at the coming investor conferences, medical meetings and on our second quarter conference call.

I think now we're ready, operator, to open up the call to questions.

(Operator Instructions) We'll take our first question from Kevin Ellich with Craig-Hallum.

I have a couple here.

Starting with cancer -- your Cancer Detection business.

The newly improved tomo CAD is already generating sales.

Can you tell us how much outreach are you guys doing versus GE system users coming to you proactively?

Well, the way we've established the channel strategy is on an international basis, which is largely Europe at the moment.

The sales are going exclusively through GE.

And we actually saw a nice pickup in sales in the first quarter internationally.

I believe we sold 7 or 8 systems after a slower start in 2016.

And then the feedback we got from the GE team at the European Congress of Radiology in Vienna back in March is that the interest and the demand from a quoting and activity is picking up very nicely.

There also were a lot of presentations and discussions at that meeting around tomosynthesis and the need for detection tools.

So we're kind of optimistic that the international market, which was strongest to date in Q1, all through GE sales teams in the various countries will continue.

In the United States, we have more of a divide-and-conquer strategy, I guess is best I can describe it, where we are targeting the GE installed base of existing systems, while the GE salespeople primarily work on new customers.

And it's really a collaborative effort where we're involved with the GE sales team on all of the transactions, but we're taking the lead in working with their customer base.

That customer base, as we've talked about, is approximately about 300 systems today.

And at the same time, they're spending a significant amount of time with new customers in that they just introduced in the same time frame we've got our approval their second generation tomo system, which is called Pristina, much more competitive system than their first generation.

So I think we've got kind of a perfect storm here, where they have a new second-generation tomo system hitting the market at the same time that our interpretive software is hitting the market.

They have about 34, 35 or so salespeople out there directly selling the product, with a primary focus on new customers.

We have 6 dedicated outside reps and 3 inside salespeople spending quite a bit of time working the installed base and then working collaboratively with GE to bring those transactions to fruition.

So it's really a collaborative sales effort.

Obviously, it's a co-exclusive agreement, where GE can sell the product anywhere and we can sell the product anywhere.

So we're working in good coordinated fashion.

And I think, obviously, we're really at the early stages.

So there's a tremendous amount of activity that's growing, lots of quoting.

But we're still early, and it's going to take us I think, as I've said earlier, this quarter to work through that activity before we start to see any real measurable impact in terms of revenue.

Got it.

Ken, did I hear you correctly, did you say the U.S. installed base was 300 systems?

Approximately.

That's our estimate.

Okay.

Understood.

And then, is development of the next-generation product still expected to be done in the next month or so?

Do you have any (inaudible)?

Yes, it's on schedule.

It will have to go through additional testing internally.

And then I think the most important step, as we've learned in the prior submission, is we have to do a reader study to prove the performance of the product.

And so as we all know, reader studies can take time.

But we still believe that this product could be available OUS in probably the fourth quarter of this year.

And it could be available in the first or second quarter, with any luck, in the United States.

We obviously have the benefit of having been through this whole process once.

Our colleagues at the FDA now have experience, obviously, working end-to-end in the approval of the first tomo detection software in the market.

And we're excited about this product.

The early testing results are just tremendously promising.

This product we think could have some breakthrough performance results that have not been achieved, even with radiologist using the current detection tool.

So we're extremely optimistic about it.

Our PhDs are very capable, talented people that have now moved to a second-generation product and brought all that learning with them.

And it will be available for all of the rest of the market.

And so my hope would be in the Q1, Q2 time frame of 2018 this product will be out there in United States market and depending on the relationship we've built with the different tomo system providers could substantially increase the size of our addressable market.

Understood.

And then switching over to the skin business.

I think at the end of 2016 you guys had said you had 70 customers.

Wondering where that stands now?

Well we've done 2 things.

One is we continued to increase the number of new customers under contract.

But I think the best way to think about this business is that long term this is a subscription-based business.

And in a subscription-based business the way we have modeled it, it's all about patient volume.

At the end of the day, certainly the number of sites matter.

But what matters most is patient volume, and the more sites that are treating and the more patients that are being treated has a direct impact on our revenues.

And so I can maybe provide you with just a little bit history so we can get a sense of where the trend is in that business.

If you go back to the third quarter of 2016, we believe that we treated just over 5,000 treatments.

So 5,000 fractions were treated in the quarter.

In the fourth quarter of 2016, we treated just about 7,000 treatments in the quarter.

And in Q1 of this year, the quarter we're now reporting on, treatments exceeded 10,000.

So when you think about that, it's a pretty dramatic increase in the number of treatments that we're providing for patients.

Do you have another question?

Yes, I do actually.

So you know that's very helpful information.

What's the average revenue per customer?

And are those customers treating patients at anywhere near that level that you're expecting or what your internal expectations are?

Well, the way I would look at is each patient gets typically 8 treatments.

So in terms of translating that, that's about 660 patients treated in the third quarter, 875 patients in the fourth quarter and about 1,265 in the first quarter.

And the way that the model would ultimately work, just to maybe take it up a level, is if a site treats 10 patients per month, we would on average receive about $150,000 of annual recurring revenue from that site.

And our challenge at the moment is we do not have a lot of these sites at that level of volume yet.

And so ultimately, we're not seeing the revenue growth in a dramatic fashion yet, although we are seeing very encouraging signs the number of patients, the number of total treatments growing very fast.

The other dimension to this which adds a little complexity is today about 80% of these treatments are being done on sites that own their own machine, which have a very different business model than subscription.

However, the entire business is rapidly shifting to subscription.

And in a nonsubscription site where they own their machine, the level of services we offer are much less.

And that average annual revenue is more in the $50,000 range.

So we are obviously now kind of migrating from more of a capital model with a lower service entity to one that is much higher subscription with a much higher recurring revenue.

So the mix shift is occurring, where the growth, quite frankly, is happening much faster, as I referenced in those numbers, on the subscription side.

However, we're still going through a transition from a more traditional capital model where the recurring revenue from those customers is much lower.

So we're kind of in this transitionary period where treatment volume is growing significantly.

Revenue is growing for certain but not in proportionate a manner.

But I really think by the end of this calendar year, it will start to kind of more even out relative to the increase in subscription customers and revenues from those particular sites.

Got it.

I've 2 last quick questions.

First, on gross margin, it was better than we expected, largely driven by services and supplies, I guess.

What were the main drivers behind the improved gross margin we saw in that segment?

And then second, anything on the regulatory front that we should be thinking about for the year?

And then in concert with that, could you give us an update on what you're doing or you plan to do from a clinical data standpoint to get a CPT 1 code for Skin eBx?

Margin improvements.

Rich?

So on the margin improvement, I think you're talking about on a consecutive quarter basis.

We were flat at 69% year-over-year for the first quarter but up a bit as compared to the fourth quarter of 2016.

And it really comes down to product mix.

We're making higher margins on both our software and our services than we are on our hardware.

So depending on the product mix in any one given quarter, those numbers can be moved around.

On top of that, as well as the mix internationally and domestically, obviously, we have a higher margin here in the U.S., particularly on the software side, than we do internationally.

So depending on the mix of both geography as well as product mix, you can see swings from quarter-to-quarter related to that.

Yes.

Sorry.

I was actually talking about relative to our expectations margin came in better.

So that's great.

And then on the regulatory front, anything we should be thinking about?

The only thing we have going on in regulatory is we're developing breast density for 3D exams.

And we had been working through a process to go to the FDA with a submission, and we found that the performance of the product really wasn't reaching the level of accuracy that we felt we needed.

So we decided to kind of go back and do some additional development work.

And so our expectation is probably that in the third quarter of this year we're going to be submitting a -- it'll be a 510(k).

And today, we have a product available that measures density in 2D exams.

And our hope would be that by the third quarter we will have a 510(k) in front of the FDA with the type of performance we feel is appropriate to get something approved, hopefully by sometime in the fourth quarter.

So that would probably be the only regulatory activity this year.

The other one though, of course, would be the next-generation tomo product.

That one will probably began in early Q4.

But obviously, we are not expecting to get the outcome of that until 2018.

So I think we do have a second major regulatory process, but our expectation, of course, is that that's a 2018 clearance if we're on a typical schedule.

So the only thing that might come out of regulatory would be density in a 3D fashion.

And there was 1 last question I missed after the regulatory.

I'm sorry.

Oh, yes, it was about what you're doing from a clinical data standpoint to get a CPT 1 code for Skin eBx?

Sure.

So what we just completed was a matched-pair study at the end of Q4, where there were 300 patients that received eBx and 300 patients with very similar lesions that had been treated with Mohs surgery.

And those patients were followed for approximately 3 years.

And what we found in the study was that the recurrence rates were almost identical both in -- in both cases less than 1%.

So as it relates to a CPT 1 code, that is one of the important studies, but it's not the only study.

So we have other studies that we are pulling together that we've already -- authors have conducted and published on.

We're contemplating the possibility of doing some additional study or studies.

And obviously, that will impact whether we apply this year or next year for a CPT 1. So we're working through it.

What I would say though is the most compelling progress is the study we conducted and finished in the fourth quarter.

It's the first time we've done a study that was head-to-head with Mohs surgery with similar type patients.

And the outcome was extremely favorable.

So we'll continue to work it.

And at the same time, our reimbursement experts are helping to get that data in front of the medical directors of each of the MACs that do not provide coverage and payment today because that kind of new information could help us to fill out more coverage from a CPT 3 standpoint across the country.

It's very compelling data.

So we can still make reimbursement progress short of having a CPT 1 code.

And I'll take our next question from Brian Marckx with Zacks Investment Research.

Just on detection revenue, to start with, was there any MRI amortization in the quarter?

I think you guys sold the business in January, if I'm correct.

But if you can just -- was there any of that amortization that hit the detection revenue in Q1?

Sure Brian, it was approximately $300,000 worth of MRI revenues in the first quarter of 2017.

And there was approximately $600,000 in the first quarter of '16.

So there was a $300,000 swing from year to year based on that sale.

And that's all done right now, it's going forward?

That's correct.

And Rich, on sales and marketing expense, you talked about the change in Q1 of last year and Q4 last year.

Some of that was stock comp I believe.

Can you tell me what the difference in stock comp was versus Q4 of last year, I might have missed it?

I'm sorry, are you isolating sales and marketing?

Or are you talking about total operating expense?

I'm sorry.

Yes, in sales and marketing?

Okay.

The sales and marketing swing from the first quarter of '17 versus the fourth quarter of '16, correct?

Correct.

There's an $80,000 increase quarter-over-quarter in sales and marketing related to stock compensation expense.

So how -- can you kind of flesh out the difference?

Brian, I'm sorry.

It's a $23,000 increase for the quarter.

I'm sorry.

Okay, great.

Yes, appreciate that.

I know you guys have talked about adding some sales personnel.

And Ken, I think you alluded to that in the prepared remarks.

Is that kind of what makes up the difference in the sequential difference in the sales and marketing then, aside from the $80,000 increase in stock comp?

Yes.

Well, just going back to the numbers.

And I want to make sure you have it right, Brian, because I actually answered your second question first, which is why it's confusing matters here.

So just to backtrack.

Sales and marketing expense quarter-over-quarter is up $100,000.

$20,000 of that is stock compensation expense.

$80,000 of that is headcount-related expense associated with the incremental heads that we added in the fourth quarter.

Got it.

I got you.

I guess I missed that.

I apologize.

Okay.

Okay, that's great.

Appreciate that, Rich.

And so going forward are -- can you guys help us a little bit with what we should expect in terms of operating expense, at least in terms of the SG&A line in 2017?

Particularly, now that you've got tomo 3D in the U.S., how does that potentially affect OpEx, I guess in 2017?

Well, Brian, we haven't necessarily broken down those items in the past on a projection business.

I think on our last call we said we were comfortable with $30 million worth of total operating expense for the year, and we're still on track with that.

Okay.

All right.

In terms of the skin business, Ken, it sounds like things are moving in the right direction.

Particularly, it sounds like that utilization, based on the numbers that you cited, it's up about 40% from Q3 to Q4 of '16 and then another 30% or so from Q4 '16 to Q1 '17.

But it's not -- I mean, I was kind of surprised that we didn't see a little bit I guess better or bigger increase sequentially in the therapy services and supply revenues.

Can you kind of talk about why if utilization is going up why we wouldn't see more of an increase given that, that line item is essentially kind of flat for about the last 5 quarters when utilization has been increasing?

Sure.

And there's probably, Brian, 2 factors impacting that.

One is we're still attritting capital customers that own their machines that their contracts have expired and they've not renewed.

So when you look at the total peak, when we had 135 sites treating, we probably had about 80 or 85 treating owning their own machines and maybe 50 that were treating on a subscription-type model.

So what's happened is a lot of these capital customers, quite frankly, didn't renew agreements.

So we've had revenue dropping off from I guess you could say source and service agreements that were being driven by a capital customer.

And they're still attritting.

So that's reducing contract revenue in the skin business.

The second factor is that as of today of all those treatments, using the 10,000 treatments in Q4, 80% of them were delivered by sites that own their own machine.

So -- and hence, that's a site that is only going to give us $50,000 to $60,000 a year.

So the 2,000 treatments that we delivered from the subscription business is literally up 100% quarter-over-quarter.

We delivered a 1,000 treatments on subscription in Q4.

We delivered 2,000 in Q1.

So that's where the growth will come from.

But in the meantime, we're still attritting capital customers that chose not to renew.

And I'll give you an example of that.

We have several third-party service providers.

In one case, one of those service providers owned over 25 of our machines.

They had gone from 25 machines in play treating patients at our peak down to 0. They're now back with 8 or 10 machines back in the field as the market is rebuilding, but as the contract for those other 15 that are essentially mothballed come up, they're not renewing them.

They will initiate a new contract when the demand supports it.

So it's a bit of a complicated story.

The good news is, as I said earlier, you really want to measure this business by the number of treatments delivered.

That directionally is the most important variable, not the number of sites and so on and so forth related to capital versus subscription.

It's really the number of patients treated.

But there's an additional time element before that will turn into really meaningful revenue.

And that's how we're looking at the business, and we're very encouraged by the pace of treatment growth.

With that said, it needs to shift over to subscription more so than from capital, which is definitely, as I pointed out, it's grown 100%, where quarter-on-quarter total treatments grew 45%.

So clearly, it's moving in the direction we want it.

And it will over the next several quarters continue at a pretty rapid pace.

And then, you'll start to see a pretty significant revenue growth.

And at the same time, we should bottom out on these contracts with capital customers that own a skin machine that chose not to renew their contracts.

So one thing is taking revenue away, and the other one should start to push it back into the revenue line.

And again, I think we're only a few quarters away from starting to see a more measurable impact on total therapy revenues as it relates to skin.

Okay.

That's helpful.

Do you have an idea on how many of the capital customers or percent of the capital customers, I guess, prior to the reimbursement issue that didn't end up renewing through today, kind of rough guess, I guess?

I guess it would be 50%.

And we'll take our next question from Jeb Terry with Aberdeen Investment Management.

Hey, Ken, can you all hear me fine?

Yes, Jeb go ahead.

Couple of question.

A lot was answered before.

But relative to the existing customers, the installed base of GE that where you have the ability to directly market, am I correct in recalling that those customers effectively already have an outdated PowerLook version, and hence there may be a relatively short sales cycle, getting those patients to upgrade?

In other words, it's an upgrade as opposed to new -- net new experience for that customers?

Is that correct?

Well, basically, what we had chosen to do is to move to a new higher-performing hardware, with the tomo product, Jeb.

And the reason for that is the run time on the old product was longer than we felt made sense for customers.

So while technically it could be a relatively easy upgrade being software only, the actual processing time for the exams increased to a point where it would've only made sense for customers that would do batch processing, meaning that they run all the processing overnight and then they read them in the morning.

And that's not to say there's not a number of customers that do that.

But to be able to really get 2 minute processing per exam is what we wanted to get done, and simultaneous exams at the same time, we had to go to a new hardware set.

So it's going to be a more substantial upgrade for those customers.

With that said, we've got special pricing for PowerLook a customer that's now going to what we call PowerLook Pro versus a customer buying something brand new.

So they will get a more favorable price as a PowerLook customer.

So that will help.

The other issues which has caused some timing in the installed base is the reading today is being done on the GE mammo workstation, which is called Seno Iris.

And a number of the customers have that product, and a number of them have the earlier version.

So if they're on the earlier version, they have to buy an upgrade to the workstation as well as to buy our tomo upgrade.

So it is a little bit more complex than we'd probably like it to be, and hence it will take a little bit more time.

But what I can tell you is from our sales team data that they have given us, there's probably right now about 80 to 100 customers out there with serious interest in doing an upgrade, adding our capability in their install base; and that's probably over the next, say, 12 months.

And that number is building.

So that's very encouraging to have that many customers that have already got into serious conversations with us.

Really, that's only approximately 1/3 of their installed base.

But we haven't been out there that long.

And to have that many showing strong interests and have expectation in 12 months or so to upgrade, my sense is that, that number will grow.

So we're counting on their install base for some meaningful business.

Again, I think it's really a Q3, Q4 time frame based on timing issues for them to find the cash and to coordinate an upgrade between us and GE.

But I believe that those sites will all upgrade over time.

And the question is really -- just really about the pace.

Okay.

And so that upgrade still in effect is a bundle notwithstanding the fact you don't have a breast density suitable products for tomo?

And so...

We're having a little trouble hearing you, Jeb.

So can you refresh our memory as what the ASP is for these upgrades?

The upgrade's going to vary in price.

I think thinking about in the $40,000 to $50,000 range is probably a good ballpark number, depending on the configuration.

And that would be for one connection to a machine.

That wouldn't include additional licenses.

Somewhere in that range.

Okay.

Great.

And I'm really intrigued by your comments about your next generation tomo detection, which would be multivendor available and with the inclusion of [FDI].

Can you clarify what size of market increase or addressable market comes with that?

Your -- you mentioned I think twice that it would be applicable to other cancers other than breast cancer -- other detection modalities?

Well, the way I would look at it, Jeb, is if you look at the MQSA data, what's being projected in the MQSA data is a total install base of about 17,000 tomo machines when the market is saturated.

And so that's at least what the number is out there.

So when you think about 17,000 systems in the United States, that's an $800 million or $900 million addressable market.

Now obviously, it takes time, and there'll be others in the market, and I don't want to be naïve to assume we would get all the business.

But that's the size of the business of the market.

It's 17,000 systems, and this product will be compatible and available for all of the vendors.

And so today about 25% of that projected market is -- has a system from one of the different companies.

So in essence, since no one has tomo CAD other than us, our view of the entire market, which now includes GE of course, is it's an $850 million opportunity if you just say each socket is worth $50,000 times the 17,000 tomo systems that are projected by MQSA in their database.

So that's a big opportunity.

Obviously, we all know Hologic has the majority of them.

So I think the challenge for us is whether we are able to be successful in adopting our systems on Hologic platforms, something we're planning to make available.

What level of interest, what level of cooperation with them, what level of customer demand driving that opportunity, all that is to be determined.

But we have done quite a bit of testing with the new product.

And all I can say in the preliminary phase is that we've been extremely pleased that this product has really overachieved in the early stage performance-wise based on our original metrics.

So that may help us to move through the reader study and the regulatory process more quickly than we originally anticipated, provided the continued testing -- results from the testing ultimately are as strong as the preliminary testing.

Is it still fair to say that Hologic has not developed a tomo reader?

I think you mentioned in the past that you've been in discussions that they don't have the necessary -- a competitive offering at this point as they had in the 2D world?

Yes, that's true.

They don't.

Now I would expect that they'll have something.

Right?

They're not sitting still.

They're the market leader.

So I think the question is really when will they have something and how well will it perform.

And obviously, my selfish interest would be that we're on a second-generation product, while they're possibly on a first-generation product.

And if our performance is an order of magnitude better and their customers see that, there should be significant opportunity for us.

But all of that is probably a 2018 to be determined.

I think right now though what I would simple say is that we've done some pretty significant preliminary testing on this new product, and the performance is significantly higher than we originally expected.

And that could bode well for our other partners like Siemens and Fuji, who each have now approved systems and a reasonable market share in the United States.

I mean between the 2 of them, they probably own 20% of the 2D market.

So if you extrapolate that out to a 17,000 system and now you'd have another 3,500 sockets if they were able to hold onto their 2D sockets, right?

So 3,500 is -- let me just do the math quickly just for the heck of it.

That's $175 million of addressable market, not considering whether we're able to business with Hologic customers.

So we think we've got a very powerful 2-step process between the product that has been approved and the pace and the success we've had thus far with the next-gen product.

And we've got a very talented group of PhDs that are very, very competent in AI and machine learning.

They have adapted those skills very, very nicely to this next-gen product given what they learned with the first one.

And I'm really hopeful that by this time next year that product could be available in the United States.

We'll have to see.

We had our challenges on predicting the first product, but we learned an awful lot from that, and my hope is that we and the FDA will go in to this next cycle in a position where we can move it along more quickly.

(Operator Instructions) We'll move on to Shawn Boyd with Next Mark Capital.

Ken, quick question on therapy.

Of the service revenues at $1.8 million, how much of that was for breast IORT?

Shawn, we don't really break that out, but what I would say is probably 50% to 60% and the balance for skin.

Does that sound, Rich, like it's directionally pretty close?

I thought so.

Yes.

Somewhere in that range would be IORT because every -- Shawn, every IORT site buys a service contract and buys and x-ray source contract from us.

So today, that's a pretty constant business, and it's growing each year in terms of the number of sites.

And obviously in our service line, it's a little bit more volatile, I guess is a term I would use, is the skin impact on service revenue.

As I mentioned earlier, we have still have attrition of these capital customers in the skin space.

And at the same time, we're rapidly moving over to a subscription model.

And so all of that sort of a transition has the skin portion of our service business kind of moving in positive and negative directions.

The IORT portion is very stable and is growing each quarter, and again, it represents maybe 50% or 60% of the total.

I got it.

That helpful.

And yes, I understand the volatility between the 2, so that's kind of why I'm asking.

And on the products revenues, I'm guessing, we sold maybe 2 systems -- 2 Xoft systems in the quarter.

And those are probably both IORT, is that -- and I -- forgive me if I missed that earlier.

I don't think I heard if it was [placements]?

Yes, I think we sold 4. And 2 are domestic, and 2 were international, if I recall.

And 1 of the international systems may have had some acceptance language, so I'm not sure we actually recognized revenue on one of the systems we shipped.

But they obviously are all these days IORT.

We haven't sold a dermatology capital system in quite a while.

The whole market is moving more towards the subscription based.

Right.

Okay.

So just jumping over to detection.

So the business grew -- when we back out the MRI comparison there, the business grew 25% year-over-year.

We're in still early days.

We've had a couple of month now to sell under the U.S. market with tomo CAD.

But at this point, is it safe to assume that from those levels we'll probably growing sequentially through the rest of the year?

And sort of certainly more Q3, Q4, but we've got a base level here?

Or do we pull anything into the March quarter?

Yes, I think the way I would look at it is we had an extraordinarily strong international CAD quarter.

We -- and then -- and when I say that I'm talking about 2D.

We literally had several very large tenders in -- 1 was in Ukraine, another 1 was in -- I don't recall exactly where in Europe, but we received several very large orders for 2D CAD in Europe in the quarter.

We did, as I mentioned, sell 7 or 8 tomo CAD licenses in the quarter as well.

But we had an very unusually strong international quarter.

What's hard to predict is whether there's a trend there.

What we're hearing in Europe is, number one, if customers are still on analog platforms, and there still are a fair number, that when they move to digital technology they're now buying CAD.

We're also seeing existing customers in the 2D world upgrading to buying CAD.

And so what's interesting, in the first quarter we had probably our strongest international quarters in years.

And what you would normally expect, "Well, it must be the tomo product is really kicking in." On one hand, yes, we had a strong quarter with tomo.

And I would say of that 7 or 8 licenses, sure I would expect at least that many licenses in Q2.

But I don't know we would see these large orders that we saw in these various countries.

So I think it's hard to say today that there would be growth overall.

And I think -- in addition, we had a particularly strong product quarter in the United States.

And so for us to build on that sequentially, what it would really require for us to have a substantial tomo contribution, both in Europe and in United States.

And to be perfectly honest, it's just too early in the process to predict that to happen.

I still believe that tomo business in the U.S. will drive the top line the most.

But I think it's still a late Q2, kind of Q3 phenomenon.

So at this point in time, it's really hard to give you a real definitive answer to your question.

And that does conclude today's question-and-answer session.

I would now like to turn the conference back over to Mr. Ken Ferry for any additional closing remarks.

Thanks, operator.

I'd like to thank everyone for participating in our first quarter conference call today.

We spent quite a bit of time discussing our 2 most important growth initiatives.

Obviously, the skin market and the treatment of nonmelanoma skin cancer is our largest opportunity.

It's a $1 billion-plus market.

We spent a lot of time in 2016 preparing and rebuilding that business, and just based on sheer treatment volume progress, we feel we're making good solid progress, and we'll sustain that for the foreseeable future.

So we're getting encouraged that our skin business is starting to grow nicely.

Again, we believe over time, as we've mentioned earlier, it will be reflected in our financial results, particularly on the top line, in a more favorable fashion.

As it relates to our tomo detection business, we're just really excited and really looking forward to that opportunity.

Customer engagement and feedback has been just outstanding.

Just anecdotally, we were just at the Society for Breast Imaging in Los Angeles in April.

That is a meeting of the top radiologists that typically only read breast exams.

And the reaction of customers coming into our booth was just incredible.

And anecdotally, one customer literally said to us, a radiologist, that this capability was a jaw-dropping, competitive advantage for GE in the marketplace.

Another radiologist said to us that in her radiology suite they had something like 10 machines, 9 of which were Hologic tomo, and only 1 was GE.

And after seeing our software, she intended to only image her patients on the GE machine so that she would have the benefit of our software.

So we are seeing some terrific feedback from our customers related to the contribution the software makes.

We're making significant investments in helping to market that software.

And we're very hopeful over the next 3 or 5 years that it will be a sustainable growth area for us and our business, as our large installed base and new customers move from 2D to 3D technology.

And then lastly, on the artificial intelligence front.

We are growing very strong in our confidence around machine learning.

And we're looking at a number of different application areas in the imaging space where our competence can be extended beyond breast health.

Those opportunities would, again, further the size of our addressable market over the longer term and certainly be areas where we can make major contributions, particularly to the radiologist and their productivity as they read more and more exams across the spectrum of imaging modalities.

So with that, thank you all very much for participating again in the call.

And we look forward to speaking with you again at the investor meetings, medical meetings and certainly when we provide our second quarter financial results, sometime towards the later part of the summer.

Good day.

Thank you.

And that does conclude today's conference.

Thank you for your participation.

You may now disconnect.