iCAD, Inc.
Q4 2016 Earnings Call Transcript

Published: 9 Mar 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the iCAD, Inc. Fourth Quarter and Full-Year 2016 Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder this call may be recorded. I would now like to introduce your host for today’s conference Mr. Zack Kubow of The Ruth Group. Please go ahead, Sir.

[Zack Kubow:]

Thank you, operator, and good afternoon. Thanks for participating in today’s call. Joining me from iCAD are Ken Ferry, Chief Executive Officer; and Rich Christopher, Chief Financial Officer. Earlier this afternoon, iCAD announced financial results for the three and 12 months period ended December 31, 2016. Before we begin, I would like to caution that comments made during this conference call by management that contain forward-looking statements 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 identifies specific risk 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, March 8, 2017. iCAD undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call. With that said, I’d like to turn the call over to Ken.

[Ken Ferry:]

Thanks Zack. Good afternoon, everyone and thank you for joining us today. I’ll begin with a few comments on the fourth 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 to review our key initiatives for 2017 and then we will open the call for questions. Revenue in the fourth quarter increased 15% sequentially, reflecting increased Xoft System and balloon applicator sales and stable results across the rest of our business. This included what was a transitional here for the company during which we faced reimbursement and regulatory headwinds. Despite these challenges, we believe we are well positioned with significant growth potential in the future. One major area of growth opportunity is the large and growing U.S. market where physicians are treating certain non-melanoma skin cancers with our Electronic Brachytherapy system. A second area of considerable growth opportunities with our innovative software that enhances the workflow and cancer detection in 3D tomosynthesis breast exams. We’re currently at the early stage of market adoption in both of these large market segments with significant opportunity for increased penetration and growth for years to come. During the quarter we remain focused on strategic initiatives for these key growth drivers. First, in cancer detection, continuing to develop international opportunities for our new 3D tomosynthesis software, while being highly responsive to the U.S. regulatory process for clearance of our software. Second, in cancer therapy, increasing the number of dermatology practices that are offering skin eBx for the treatment of non-melanoma skin cancer and advancing our skin eBx clinical study in support of our strategy to secure a CPT 1 code. Third, also in cancer therapy, expanding adoption in clinical validation of IORT and GYN in the U.S. and international markets. I’ll provide more detail on these and other items in a moment, but now I’m going to turn the call over to Rich for a more detailed review of our fourth quarter and our full year results. Rich?

[Rich Christopher:]

Thank you, Ken, and good afternoon everyone. It is my pleasure to be joining the call today and I look forward to meeting with many of you in person in the coming months. I am truly excited to have the opportunity to join the iCAD team. This organization has leading technologies in both cancer detection and cancer therapy. I’ve spent almost 20 years in medical dermatology with a focus on both the detection and treatment of cancerous and precancerous conditions. I look forward to my continued service with dermatology community, through our skin eBx business, as well as leveraging my medical imaging background, as we continue to expand our cancer detection platform. And my time with the company, I’ve been extremely impressed by both the caliber of the management team and the employee base. I look forward to working together with my new colleagues to execute on the company’s growth plans in 2017 and beyond. I will now provide an overview of our fourth quarter and full year 2016 financial results. For the fourth quarter of 2016 total revenue was $6.9 million, reflecting a $700,000 or 9% decrease from the prior year quarter. For the full year 2016, total revenue was $26.3 million, representing a $15.2 million or 37% decrease year-over-year. The decline in our revenue was primarily driven by the shortfall in our therapy business. Fourth quarter revenue for our therapy business totaled $2.8 million reflecting a $600,000 or 17% decline from the prior year quarter. For the full year 2016, total therapy revenue was $9.2 million representing a $13.1 million or 59% decrease year-over-year. The decline in our therapy revenue was mainly attributable to reimbursement related changes for the treatment of non-melanoma skin cancer. The reimbursement changes occurring over the last two years, resulted in the need for us to restart our skin eBx business. Formal sales and marketing plans were rolled out in May of 2016. These plans followed a transition period to determine the payment values under the new reimbursement code that went into effect on January 1. I’m pleased to report that we are now making good progress rebuilding the skin eBx business. We ended 2016, with approximately 70 customers under agreement, with a substantial number of them slated for first patient treatment in the first quarter of 2017. To demonstrate our momentum with our skin subscription business consider the following; approximately 150 patient treatments were delivered in the second quarter of 2016 with volume growing to over 1,000 treatments in the fourth quarter of 2016. In addition, IORT balloon sales grew from approximately 1,300 balloons in 2015 to 1,600 balloons in 2016. We experienced positive growth contribution from both the U.S. and international markets reflecting continued growth in procedure volumes at our existing sites. Moving on to the detection business, which includes our digital mammography, breast density, MRI and CT CAD platforms, as well as the associated service revenue, total revenue in the fourth quarter was relatively stable at $4.2 million. For the full year 2016, total detection revenue was $17.1 million, reflecting a $2.1 million or 11% decrease year-over-year. The change in our detection revenues was driven primarily by a $2.1 million year-over-year decline in our MRI revenue. The decline is as a result of the company’s distribution partner in Invivo, exercising its right in August of 2015, to purchase a fully paid up license for the software. This provided the company with a cash payment of $2 million which was being recognized ratably over the life of the contract. We have since sold MRI assets often in Invivo for additional $3.2 million and exited this business in January of 2017. Looking forward, we anticipate accelerated growth in our detention business from our 3D tomosynthesis product, once that product is cleared by the FDA and subsequently launched in the U.S. Moving on to the rest of the P&L. Gross margin in the fourth quarter of 2016 was 65% down from 70% in the fourth quarter of 2015. The decrease in gross margin percent is primarily the result of lower revenue in the quarter coupled with increased mix of system sales from the therapy business in the international markets which carry lower margins. Operating expenses in the fourth quarter of 2016 were $7.8 million, up from $7.6 million in the fourth quarter of 2015. Fourth quarter operating expenses were driven by continued investment in our key grew initiatives. Clinical studies in the therapy business for both skin and breast, increased sales and marketing resources focused on our key growth areas, additional resources to accelerate the on-boarding process in our skin eBx business, and adding to our presence at the major fourth quarter medical meeting such as ASTRO and RSNA. As previously discussed, we believe these investments will accelerate revenue growth for new product sales and increase recurring revenue from our subscription and service businesses. Looking at our profit metrics, non-GAAP adjusted EBITDA for the fourth quarter was a $2 million loss as compared to a non-GAAP adjusted EBITDA loss of $1.1 million in the same period last year. For the full year 2016, non-GAAP adjusted EBITDA was a $5.3 million loss as compared to a $3.9 million profit in fiscal year 2015. The year-over-year reduction in our bottom line was mainly attributable to the decrease in our top line therapy revenue. Turning our attention to the balance sheet, we ended 2016 with $8.6 million in cash on hand. During the fourth quarter of 2016 we used approximately $1.6 million in cash from operations and $1.9 million overall. In summary, we finish 2016 with a relatively strong revenue quarter demonstrating stability in our core business as we position the company for improved growth in 2017. On the expense side, we continue to closely manage our spending against our top line results, while also making strategic investments to support longer term growth, particularly in our skin eBx business. We finish the year with a solid balance sheet and that we had no debt. In addition, we bolstered our cash position in early 2017 by completing the sale of our MRI business for $3.2 million. Lastly, due to the uncertainties primarily associated with the timing of the FDA clearance of our 3D tomosynthesis solution within our detection business, we feel it is not appropriate to provide forward-looking guidance at this time. We will update you on this position on our next quarterly results call. I would now like to turn the call back over to Ken.

[Ken Ferry:]

Thanks, Rich. I’ll now provide a more detailed update on the progress and status of our key growth areas for the fourth quarter and full year 2016. Starting with our skin cancer treatment business we had a strong fourth quarter adding new subscription customers and now have 71 customers in various stages of treating our on-boarding. Of this total about 50% are under the subscription model and the balance own their own machines and purchase X-ray, source and service contracts from us annually. This compares to only 13 active sites in the first quarter of 2016 with only one customer under the subscription model. We believe we’re making good progress in rebuilding this business as an example approximately 50% of our active sites that use our proprietary software into which we contract to utilization. Data shows around a seven-fold increase in delivery treatments from the second quarter to the fourth quarter of 2016. While this progress is considerable, it will take a few more quarters to subscription revenues to begin to make a meaningful impact on overall company revenues. Our longer term goal is to have each practice treating a minimum of 10 patients per month, which is in line with historical utilization levels under the subscription model and at this patient volume, we should be able to generate approximately $150,000 in recurring revenue per site per year. As we make considerable effort in targeted investments to improve our on-boarding process for new customers, we’ve added marketing resources as well in support of helping our customers to attract new patients when eBx would be a good treatment option as an alternative to most surgery. In addition, we have added sales people in the fourth quarter to the dermatology market where we’ve established a track record of success. Lastly, we continue 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 regions that we treated with both surgery. While the costs of this study contributed substantially to our operating expenses in the quarter it is essential to our overall plan to provide national access to the treatment and adequate reimbursement for the physicians offering the service. Moving on to IORT, we added customers both domestically and internationally in the fourth quarter. We now have over 60 sites treating with approximately 50% of them OUS. Our procedure volumes continue to grow nicely as measured by balloon applicator sales in 2016 as Rich mentioned, we sold approximately 1,600 applicators a 19% increase over 2015. Our strategy longer term is to expand our applicator offering, so we can treat more body locations in cancers on a global basis. In the U.S. we are continuing to make progress with our expert clinical study with approximately a 1000 patients now enrolled. We plan to begin publishing early data on recurrence rate soon and hope to use these results of this large study to further adoption from a clinical perspective. In addition, our commercial efforts are focusing on national accounts ACO efforts, surgery centers and teaching hospitals. Internationally, we are focused on increasing regulatory approvals in key markets such as China, India, Saudi Arabia and Egypt as well as increasing penetration of existing markets where we already have a growing presence. Last, we’re looking for additional strategic partners who could help us to expand our presence and penetration in key markets internationally. So in summary, we’re making good progress with the therapy business and we expect it will be more evident on our top line results as we execute on these priorities over the balance of 2017. Turning to our cancer detection business, during the year we’ve made considerable progress with the development of software tools that support the workflow and interpretation of the 3D mammography exams. However, we ran into some significant headwinds with the U.S. FDA regulatory process in the second half of the year. This resulted in a need to do additional data analysis which was completed in January of 2017 and submitted in the form of an amendment to our original PMA application. On March 6, we received positive feedback from the FDA technical review team that they had completed their review of our amendment and that they were satisfied with our response and had no further issues or questions with our application. As a result, we anticipate a favorable recommendation from the technical review team to FDA management to clear our device. We expect to hear something final on our application in the very near future. In Europe, we’re seeing increased momentum with our tomo-detection software. We’ve established a number of reference sites that are helping to educate the market and have increased our presence at major radiology meetings. Speaking of which we just included our participation at the European Congress of Radiology in Vienna where the interest level in tomo-detection software has grown significantly as compared to last year. This interest level should add to our continued progress over the coming quarters. At the end of the Congress, we met with GE our strategic partner for our European business update. They communicated to us that customer interest in 3D tomo-detection software has increased and they are substantially increasing quote activity for new systems bundled with our software. This has resulted in iCAD receiving six to seven orders, the tomo-detection software from European customers so far in Q1 of 2017. Also we continue to have good success marketing breast density software, and we’ll add 3D capability to our 2D density product sometime later in the first half of 2017. Last we are making good progress with the development of multi-vendor tomo-detection product that will be available on other major 3D tomo systems sometime later this year OUS and in early to mid 2018 in the United States. This product has the potential to substantially expand our addressable market. So in summary, we’re making good progress with innovation in our cancer detection business with the hope of demonstrating significant progress on our top line the not too distant future. Before we open the call for questions, I want to reiterate our top priorities for 2017. First in cancer detection, secure FDA clearance for our 3D tomosynthesis software and launch into the market, while continuing to drive adoption of PowerLook upgrades and the adoption of our breast density software. Second in therapy continue increase in the number of dermatology practices that offer our skin eBx solution, the treatment of non-melanoma skin cancer willing existing customers to increase patient volumes. Third also in therapy continue to drive global momentum for breast IORT and GYN applications. Fourth, we continue to invest in clinical studies to build the long term data required to support the use of the Xoft system for the treatment of breast and skin cancer. And lastly to continue to carefully manage all of our costs and investments. So overall we continue to believe we are well positioned to accelerate growth in our cancer detection and cancer therapy businesses hopefully in the second half of this year. We have innovated technologies, strong and expanding clinical evidence, we are addressing large market opportunities. We look forward to updating you on our progress of these goals at coming conferences and meetings and on our first quarter conference call. Now with all that said, operator, let’s open up the call for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question is from the line of Bill Bonello of Craig-Hallum. Your line is open.

[Bill Bonello:]

Hey, good afternoon guys. So a number of questions. But I want to start with the comments around the FDA; it felt like maybe you buried the lead here. It sounded like really incredibly positive commentary, but I just want to make sure we understand. So you’ve got this technical group, that came back to you, they said they have no further – they’re fine with the data you’ve submitted, they have no further questions. Did you say they are giving a positive recommendation to FDA management and what does that actually mean? Tell us kind of what this group is and what their recommendation means?

[Ken Ferry:]

Well, when you submit a PMA application it gets assigned to a technical review group and actually, Bill that’s where we work with. From the time we started which is literally going back to the first module in November 15 to today. That is the group we’ve been interfacing and working with exclusively. And it’s a mixture of technical people with various backgrounds that really assess your application from all different angles. And so we’ve been working with this team for quite some time. And we all know that we read into a roadblock as it related to some cases that were not initially used in the process of identifying the cases that would go into the ultimate reader study. And when we worked through that issue and so forth it was with the same group that we came to a conclusion on what the additional testing would be, and it was very, very rigorous. And when we finalized the testing ultimately, we’re extremely pleased and confident, because the results really did not change the outcome of the reader study. We’re talking about the testing methodology that took the time savings from 29.2% to 28.6% and then another methodology we use that took it from 29.2% to 29.9% savings. So essentially offsetting getting us right back to where our study was. And I think the power of that data analysis drove the team to determine that we basically have answered any and all questions that they have. So once they reach the end of a technical review, it’s the responsibility of that team to determine whether they want to move that application on to FDA management with a recommendation. And obviously they can recommend it’d be approved, they could recommend it’d be declined. It is our understanding that that group has moved this on to the management level with a recommendation for approval. So with that said, obviously management reviews their recommendation, they review summary documents, it’s certainly not a guarantee. But it’s a strong endorsement and what we need to see through over the next month or so is how this would play out. But I think that, while we can never be certain, when you look at the testing we did additional testing, it was overwhelmingly impressive in terms of solidifying the position we had taken all along that the 50 cases of the pool of 575 that were candidates for the study did not get in had absolutely no impact on the actual performance of the study. And so with all that said, we’re very optimistic at this point, but we’re also at the same time a bit cautious, because you can never predict until you have a letter in your hands exactly what you have accomplished and whether you have met your goal in the timeframe that you choose to.

[Bill Bonello:]

Sure. Does any other group weigh into the FDA management or is this technical group they were the ones assigned to review it, they did all of the review, they give everything to management, management reviews, their review so to speak, or is anybody else weighing in that they could influence the final outcome?

[Ken Ferry:]

They have what I call a defined chain of command and the chain of command is reviewing this. And what I would just say in a historical sense, I can’t say it’s specific to our application that in a PMA environment when a review team has done their job thoroughly, really what a management team reject a recommendation and it would also typically take about 30 days from when the recommendation goes in, when all the signatures are gathered and the letter is put together. And I’m again, I want to stress that I’m not inferring that’s exactly what will happen here, I’m only inferring that from history that would be what happens the majority of the time and we’re just hopeful that we would fall into that same cycle.

[Bill Bonello:]

Okay, that is excellent. You answered my next question. That is just absolutely great news, really pleased to hear that from you guys. On the therapy side, so I’m trying to understand because it sounds like you had great progress in terms of the skin, customer additions you continue to make progress on the IORT side, but the therapy service revenue itself was essentially flat sequentially. And so I’m just trying to understand, were there more customers generating – on the skin side, if we start there – were there more customers generating revenue in Q4 than they were in Q3 or where the actual customers that were paying you sort of flat, but you added a whole bunch that are going to turn on in this quarter and afterwards. And if there were more customers generating revenue, why didn’t we – what explains the sort of sequential flat now?

[Ken Ferry:]

Right. So essentially, Bill, if you go back to our peak, we had about 135 sites treating all of them under some sort of a contractual agreement with us, variety agreements, depending on whether it was a subscription customer or a capital costumer on their gear or one of the service provider companies we’re doing business with. And in that sense, what happened over the course of 2016 which probably did not get a lot of communication in the middle of the year as we were trying to project what we could do, is a number of those customers contracts came to an end and they did not renew. So at a point in time we had actually said we thought we might be able to sign up as many as 100 customers this year. And we actually probably did exactly that or down close to it. But what has happened to us is, we’ve had significant attrition of number of customers the contract expired, they didn’t renew, and there’s a variety of reasons for that. In some cases they were low volume sites and when they looked at the reimbursement level, they said, this doesn’t work for us any longer. Other cases they said that, we want to watch this for six or 12 months because we felt kind of burned when things changed radically in 2015, so we really want to watch the reimbursement and see if it’s stable and consistent and so on and so forth. And so for a variety of reasons, we lost a number of customers which would have clearly shown up in our service line. And so we had a lot of attrition over the course of the year, as we were adding customers. So there were some takeaways at the same time we were adding customers into our base. So then when you look at these 71 customers, about 50% of these 35 or so are capital customers that owner machines. And in that case those dollars don’t fall into the subscription line. So what ends up happening is, as we were treating a lot of source and service contracts from those that to decided to not renew or to wait on whether they wanted to renew, right. We were putting in business and essentially source and service contracts for about 50% of these new turn offs if you will sites. So that would leave you with about 35 or 36 solution customers. And then when you look at the solution line, obviously we had some contractual tailing of business over the first part of 2016 and then in essence due to contract we were still getting some pretty solid revenue from a number of sites, but they weren’t treating very many patients. I mean just they were treating next to nothing, but they were contractually obligated to pay us. So it’s a little bit misleading. So now what we have is 35 or 36 solution customers of which probably, I would say 10 or 12 are very actively now back up and treating and the other say two-thirds of them are still in the process of beginning to treat or actively planning to be on board over the next few months. So it’s an evolving process and it will come to some sort of logical fruition from a revenue growth standpoint, but there’s just a lot of moving parts right now. And it’s a more complicated topic I guess than I can give it accurate justice to. But the way I would just take a look at the business is to say this, we have about 35 sites that are capital customers, between source and service they would probably give us an average $50,000 to $75,000 a year in recurring revenue, we have another 35 or 36 sites that are on the subscription model. When those customers reached the point of treating 10 patients per month, they will probably give us approximately $150,000 a year in recurring revenue. So when you blend those two areas together, those 71 customers, and you look at the contractual side with capital and with a normal value of 10 patients a month with a 35 or 36 solution, that’s probably worth about $8 million or $9 million a year annually. So that gets you at a run rate up past $2 million a quarter. And that’s the way, I would think about that as we make progress with those accounts over the course of 2017. Now the other angle on this is adding customers, right. So then you move forward and say how many can you add in 2017 and just for using, let’s just say, modeling hypothetical, maybe we can add 10 or 12 a quarter. So we can add maybe 40 or 50 more customers throughout the course of 2017. Now those customers will allow the subscription, they will not be a blend like we’ve had in this restart time. So those sites should be worth at their volumes of 10 patients a month at least run $150,000, which could be another $6 million to $8 million of annualized revenue. So, when you kind of frame up 2016 and 2017, you’ve got a $15 million, $16 million, $17 million business that between now and the end of 2017 it should be under some sort of an active contract driving towards that sort of volume. And that’s probably the best way I can describe kind of where we are today and where I think we’re headed between now and roughly 12 months from now.

[Bill Bonello:]

That actually is an incredibly detailed and helpful overview. If I can just follow-up on a couple of things to make sure I understand. Would you say that the customers that were switching off, going off contract completing their contract. Have you essentially lost all of that revenue or is there any offsetting revenue decline that we should still be expecting in Q1 or subsequent to that.

[Ken Ferry:]

I think we’ve pretty much bottomed. And I think – as you look at our service revenue I think it was in $4 million-ish, $5 million-ish range in that ballpark that’s probably a good solid floor for us in terms of that business. And obviously going forward, what we’ll ultimately see is – as we grow the IORT business the service line from a contractual standpoint will grow as the skin capital customers renew annually that should grow as source contracts get renewed obviously that should grow. And the biggest growth though should come on the subscription line. Because really when you think about the service aspect as you get this to 70 to 100, 150 subscription customers that subscription line is the one that will grow at a much higher rate probably than our traditional service line. That’s the one that really indicates that we’re getting good penetration in the skin market. So I would think of it as more the growth engine. You go back in time to say the first quarter of 2015 subscription line was in the $4 million to $5 million a quarter range. And obviously at lower reimbursement rates we’re going to need to be treating a lot more patients in light of it being a pure subscription business these days. But the market opportunities out there, I’ve said it many times, there’s about a million patients – a 3 million patient base that’s getting treated to some sort of skin cancer that we’re a perfect fit to treat. There’s also over 7,000 dermatology practices with three dermatologists or more in the country. And when you look at the number of sites we’re treating today, my quick math would tell me we’re in 1% market penetration, and again with growing strong clinical data. So, we’re optimistic, we may have been a little more optimistic than we should have been about the pace of the restart of this business. But I do feel we have our arms around it, we’ve also added some resources too on the on boarding process and we’ve changed some of our processes. So that our goal today is to take what has been roughly about a 90 day window on average to get a customer from contract to treat down to 45 days. And so that isn’t at 45 but it’s going down based on some additional resources we’ve added. So it’s a collection of things we’re doing but we think over the course of 2017 probably more towards the second half you’ll start to see more of a meaningful impact in terms of top line revenue from skin.

[Bill Bonello:]

Okay. That’s extremely helpful. And then just two other questions if I can, on the detection – back to the detection side any update on the – you probably gave some but on the next-gen product sort of what’s your latest thinking on timing there.

[Ken Ferry:]

Sure. Our hope is to have that product in the OUS market by the end of the calendar year. And I think it’s likely to be towards the middle of 2018. So you could say we’re roughly 15 months plus or minus timeframe. We’re excited about that product because with the learnings we’ve gathered using machine and deep learning on the product we’ve built a very confident R&D team. We have I think an impressive talented group of Ph.D.’s that have now got through a first generation product based on deep learning. And that’s not to be minimized because in today’s healthcare environment and obviously other applications deep learnings being applied and it’s very sophisticated and it’s extremely powerful if you have the right expertise in the right data. So we’re taking some very good learnings from this first product that we used deep learning applying it to the next one. And we really believe we can develop a product for the balance of the tomo market, which obviously those outside of GE. We can develop a very powerful next generation product and it could dramatically increase our addressable market. When you talk to the radiologist and you ask them what they’re reading experiences with tomo exams they will continue to tell you that their biggest issue is reading time. I’ve had one radiologist who is a extensive tomo user say to me that, when it’s my data read the tomo exams I add two hours to my work day. It used to be an eight hour day it’s now a 10 hour day to read the same number of exams that used to read in 2D. So to have a product on the market today that has been vetted in two reader studies to save you about 29% on average. And these are readers that we’re using the tool for the first time training and potentially using it simultaneously. We think our value proposition is very, very compelling; it’s right on with what the customers need and the next-gen product is going to be better and it’s going to address more of the partners that we have out there outside of GE in the market. So that could be a real big opportunity for us. So it’s a kind of long story short we’re on plan. I think it is late this year OUS and it will probably be Q2 to late Q2 timeframe provided of course that our readers will do a reader study for that product as well and if we get through all the regulatory hurdles in a predictable manner. And the last thing I would add, as we learned a lot good and bad from our most recent ongoing regulatory process for our current products. So hopefully those learnings will help us with the next one.

[Bill Bonello:]

Okay. Thank you. And then just one final question, the gross margin I get the year-over-year decline but there was a pretty steep decline sequentially as well. Is that in part related to that you did have these subscription customers or you still were getting payment from them but not necessarily incurring much cost from them and as they kind of fell off you sort of lost that that incremental profit. And if not what is sort of the sequential explanation for the sequential decline? And where should we look for the gross margin to go near-term and maybe mid-term?

[Rich Christopher:]

Yes. I think really if you think about it Bill we didn’t sell any Xoft systems in Q3. And those are the lower margin areas contrasted the software, right. So in essence that’s a big part of it, as you go from not selling any capital systems to selling four, as I believe we did in the fourth quarter. And then on top of that half of them or two of them were in international, where we go through distributor. And so you’re selling these at about 50% of what had been a normal sell through price in the United States. So I think that’s probably more than anything that mix if you will have to do with a margin change. But when you look at our business when we’re performing well, our revenues are typically – let’s say, $7 million-ish range and there’s a good solid mix of U.S. therapy units combined with strong software sales. I think that 70% to 72% gross margin range is something we can achieve. The forward-looking aspect of that will really depend on the tomo-CAD product. And if we are able to get that product into the market soon and we get the sort of market reception over the next several quarters the software product will be driving top line revenue more so than anything else we’re doing, and we all know the margins in our software business are up around 80%. So that has the opportunity to gain another point or two of gross margin maybe between the introduction of the product in the United States and maybe at the end of the year. But I think, a range of let’s say 72% best case, 74%, 75% is within our sites and it really will depend on the growth of the top line in the mix. And the mix has to be more influenced by a software product because that’s really where the richest margins are.

[Bill Bonello:]

Excellent. Thanks for bearing with all those questions.

[Ken Ferry:]

Sure. Thanks, Bill.

[Operator:]

Thank you. [Operator Instructions] Our next is from the line of Jeb Terry of Aberdeen. Your line is open.

[Ken Ferry:]

Hi, Jeb.

[Jeb Terry:]

Hi, gentlemen. Well, congrats, the FDA finally coming through. My question relates to tomo adoption rate and in the past you talked about how GE has an installed base if you will of tomo units both in the United States and OUS that have been I guess, awaiting availability that they don’t have CAD features at this point. How big is that number of GE sites that might be installed and ready to accept your CAD product?

[Ken Ferry:]

Yes. It’s an estimate, since they don’t disclose that kind of information publicly. But I would say in a ballpark sense you’re probably talking about 300 to 350 systems in OUS and another 300 to 350 in the United States has an installed base. So obviously with that installed base as CAD is available depending on the availability of capital dollars, it is hard to predict the timing Jeb of how fast those customers will decide to buy this upgrade. At the moment as well, the customer will be required to buy an upgrade from GE to the workstation as well as to buy the CAD products. So they will need to buy two upgrade, unless they’re on the latest version of GE market’s workstation and some aren’t some are not. So it’s really kind of a mixed bag, but the opportunity is substantial. If you look at the OUS opportunity combined with the U.S. opportunity in the installed base, I mean, if I would just make a ballpark guess, it could be a $50 million worth of our product going to GE, a transfer price if they were to capture all those sites over some period of time and have the customer upgrade. But I’ll tell you what’s got us kind of excited about this relationship, is last week GE got approval for their second generation tomo system called Pristina. And this product as we understand it has a very strong differentiated functionality contrasted to their prior generation product and is very, very competitive in the market. And so we’re pretty excited that they are bringing a second generation tomo product to the market, which will have a lot of – as we understand it, workflow benefits in terms of the way you interact with the system, giving them a much more competitive system. And so for us the benefit of going out together now, with our software with GE having at even more competitive system in their first gen, gets us excited because not only would that be motivation for their customer base to upgrade or to buy it outright if they haven’t gone to tomo yet, which the majority have not, but it’s also a market share play, where they can start really going after Hologic who is the leader and with a more competitive product and with our software as a differentiator relative to the workflow. It could be a real game changer in terms of taking share from the competition. So that’s what we’re most excited about as we get out in the market. And we’ve shown our CAD product to a lot of Hologic users, and they want it, they think it’s a great, great tool. So if we don’t end up with the opportunity to work with Hologic users, which we hope to, we’re certainly planning that with our next-gen product at a minimum our product today could be a real differentiator for GE and taking some market share points, in a market that is only about 25% gone from 2D to 3D. So there’s a lot of real estate out there to be upgraded from 2D machines to 3D. So we’re excited about the installed base, don’t get me wrong. But we think there’s going to be a lot of action on new sockets as well as adding to the installed base of 2D machines with 3D machines. So exciting times as we get to the market jointly with very competitive offerings and differentiated for sure.

[Jeb Terry:]

To that point, I guess then. So they’ve got several hundred of installed tomo devices, first gen devices. They will have more of the second gen of marketing hitting. Will they be making – having installs later this year, would they be ready to do that given the FDA approval last week?

[Ken Ferry:]

My understanding is that they were planning to make a small number of shipments actually in March. And that they would be close to full capacity shipment while starting in Q2. And so if that is the case this product by the way has been shipping over U.S. for I believe about six months. So they definitely have already got traction with OUS. But the plan at least as I understood it was to have shipments in – some number of shipments, limited number in the month of March, but then being capable of full shipment capacity starting in the second quarter. So hopefully our timing with the FDA and their ability to ship the new product would come together in early Q2. And if that would be the case, we could be in the market working together in plus or minus 30 days or so.

[Jeb Terry:]

Okay. That was my question and so assuming FDA of 30 days after March 6, which in early April, you’ve got trial of green light from them, and obviously – and I know you all have been preparing for that date, so you get your ducks in a row for deliveries, board or shipments. I guess and so you’re saying you could see some revenue in 2Q from tomo and then if that would start to escalate Q3and Q4.

[Ken Ferry:]

Yes, we should. It’s hard to predict exactly how much and how fast, because customers – because this is a PMA product, they haven’t had the ability to have it quoted. So they may have budgeted for the tomo machine, but I think that in some cases I’m sure customers have said, well, gee, what’s up with 3D CAD, because we use it in 2D and should we budget roughly the same amount of money when we purchased the 2D. So I’m sure a lot of that discussion is going on. But with that said, it’s hard to determine how quickly a lot of institutions or big practices can go back and get extra funding beyond what they already budgeted for their machine, tomo machine. So it’s a little hard to say, but I definitely expect more revenue in Q2 if we have the approval. The other thing I’m optimistic about is in Europe. I mentioned in my script that we’ve actually got six or seven orders this quarter for European customers. And when we were at the European Congress of Radiology in Vienna this week and last week, we’re seeing a very, very strong interest. What’s interesting going on in Europe is actually even more strong interest 2D CAD than we’ve seen in quite some time. And so what we’re seeing there which is a little bit surprising is there’s still a lot of analog systems. And so as the systems are moving from analog to digital in Europe still, we’re now starting to see a renewed interest in 2D CAD and at the same time we had a business call with GE yesterday with their European team, they’re seeing a lot of interest in tomo and CAD and at the Congress the lead count that we got was significantly higher than we got last year. So I think the opportunity in Q2 for tomo revenue for CAD is both a European opportunity as well as a domestic. It won’t just be counting on the U.S., we’re starting to finally see after 40 and number of months of effort. We’re starting to see the European market perk up. With that said though, I would just caution that tomo for screening is becoming more and more problem in United States which makes CAD so much more important. It really is not being used for screening other than a handful of private centers in Europe. So it’s a different market, which will develop at a different pace, but I definitely believe that it’s coming and it’s getting momentum and we were quite honestly pleasantly surprised by the activity at our at our booth at the meeting in Europe. And then specifically more specifically in the GE booth, a lot of activity and tomo-CAD was front and center and we definitely see momentum finally after a lot of months of hard work to get this product positioned in the market in major European countries where GE has a strong presence.

[Jeb Terry:]

Now in the past, we assumed that when someone with the tomo, that would force them to upgrade to PowerLook and at that point of time they’d be bringing on the breast density module. Is that still the way to look at so it be kind of three discrete products that would go into the install?

[Ken Ferry:]

Yes. What we’re trying to do, particularly with our direct sales, is to sell a bundle which would – in the 2D world sell PowerLook as an upgrade to a customer include breast density. And so they would be buying essentially a new platform with two distinct applications. As we go forward into the tomo, we’re going to be trying to obviously sell individual applications on that platform or bundle and GE as well. We don’t have the approval yet for the 3D density. So that will be more of a timing issue, that’s probably going to be more in the – for the middle of this year. We had to go back and do some work on that product based on some dialogue with the FDA. So we’re probably at least a quarter out from having density in 3D. However, it doesn’t stop us obviously from selling to 2D and then upgrading that at a later time. So, yes, we’re definitely trying to sell this as a bundle as a broader solution, the relationship we with GE allows us to sell direct. So we do have our team focused on their installed base of tomo machines, obviously trying to sell both of our density today, but obviously as we hopefully at some point soon get approval also the tomo-CAD upgrade to get more leverage for both of those applications.

[Jeb Terry:]

Very good. Any change in the pricing range per bundle or for those parts, should we think differently about that.

[Ken Ferry:]

Well. I would say that, we probably have taken the price of the density modules down a little to incent the customer to buy along with the PowerLook product. So a license in density might be selling for I don’t know 30% or 40% less than we were selling it when it was a standalone. But if you’ve already engaged with that customer you sell him a PowerLook adding that license let’s say, $15,000 versus $20,000 or $25,000 is still good business for us. So we have – I would try to motivate the customer to add density licenses and it has been successful with a lot of customers.

[Jeb Terry:]

Very good. Well, thanks so much. Appreciate it.

[Ken Ferry:]

Sure. Thanks, Jeb.

[Operator:]

Thank you. Our next question is from Brian Marckx of Zacks Investment. Your line is open.

[Brian Marckx:]

Good afternoon, guys. Ken, I think you mentioned that relative to the tomo FDA application that it was your understanding that the technical group would recommend approval just wondering if there’s any more that you’re willing to share in terms of I guess specifics relative to why it is that it’s your expectation that they will recommend approval.

[Ken Ferry:]

Well it’s based on two things Brian. First and foremost is the outcome of the additional testing we did. I don’t want to bore you with a lot of details but what we basically did was we had 575 regulatory cases of which stratification tool narrated down to 240 cases for the study. And there were 50 cases that we took out because there was disagreement on the findings relative to the diagnosis and were not included in consideration for the original study, and that’s what was the issue with the FDA. And what they wanted us to do was to take a sampling of those 50 cases they would never used and do some stimulated testing to show that the benefit of 29.2% savings in reading time would still apply with this additional data. So what we ended up with was a two tier testing paradigm where in one case they literally took the entire dataset of 575 cases now including these 50 that were in question and they did 10 different samples to get to 240. And when they did that somewhere between 16 to 26 of these 50 questionable cases were drawn into the mix. In one testing methodology keep in mind this is 10 samples, these cases that we have not been tested were submitted and cases of identical findings or close to identical findings were taken out. So that was deemed to be the harder testing methodology. So when you take 10 draws and you put in 16 to 26 of these 50 cases that were originally not used into a base of 240, which is like changing the mix by say 6% to 9% depending how many. And the actual reading time reduction goes from 29.2% to 28.6% that’s very, very minimal. The second methodology did the same exact thing were it drew cases 10 times of the 575 and again, 16 to 26 of these 50 non-tested cases were chosen but then randomly cases were taken out of the 240 and then these cases submitted in. In that case the productivity went up, were 29.2% to 29.9%. So my point being that’s extensive testing and it’s very, very hard to dispute that there was absolutely no impact from these cases that were originally not utilized. So that’s really Brian to be honest, that’s really where our confidence comes. That we were able to prove from a statistical analysis beyond any reasonable doubt that these cases in question’s had absolutely no bearing from the outcome of our study. So that is the basis for when the technical team says we’re satisfied with your responses and we have no more questions one can only logically think that as they move this on to the next phase, which is management review that they would be in support of it being approved. And that’s just my opinion, I’m not saying that they said that, I’m just simply saying that’s our logic based on all the data analysis that I just try to describe at a high level.

[Brian Marckx:]

Right. Yes, appreciate it. Ken is there a guide line in terms of a time clock when you would expect to hear – does the clock reset at this point. And if so what is the clock.

[Ken Ferry:]

There is no real clock in a PMA world right it’s technically 180 days when the amendment went in, which was January 23 or 24. However, I think a positive sign is that within six weeks we had the notification last week that the reviewers were going to have a formal team meeting on Monday, the 6th. So obviously in the statute of 180 days didn’t apply. And then to our pleasant surprise Brian, they had the meeting on Monday, the 6th, so they actually called us, after the meeting to tell us the outcome of the meeting which is again another very positive sign. So what I’ve said earlier was without it neisserially being specific to this application is the management review process can take up to 30 days. And either it comes back signed and you get an approval letter or it comes back rejected with whatever the reason it would be rejected. So I believe we’re in that sort of a cycle, and we’ll have to just wait and see what the ultimate outcome is.

[Brian Marckx:]

Okay. In terms of the next-gen tomo product, can you remind me – you mentioned there’s you’re going to run a reader study. If you can just talk a little bit more about that in terms of size and timing I guess. And then if you could remind me what the pathway is. Is that a 510(k) and you can use your prior tomo product as the predicate.

[Ken Ferry:]

Yes. This will also be a PMA application. And in essence if I were to contrast what we’ve done in this study we will have cases from multiple companies. So as an example we’re going to have Hologic data we’re going to have Siemens data, we’re probably going to have Fuji and possibly other companies’ data. And in an essence what we will be doing is will be doing a study on what we describe as a multi-vendor product, which would be – and GE data, shouldn’t forget that. So that when this product hopefully gets approved the testing would have been done across all of the major companies as opposed to our original study which was exclusively GE data. And so we believe the study process will be the same where we will have to establish a protocol that the number of cases to be included, the mix and characteristics of the cases and a number of radiologists that would read without our tool and then come back after a washout and read with our tool. To try to answer your question we really don’t know yet to be honest how much our current experience will leverage into a smaller or larger study. My hope would be obviously we could do a smaller study because they’re expensive and they take time. But we haven’t got to that point yet, where we’ve discussed this with the FDA. So I’d like to think worst case study would be similar to what we did 240 cases read by 20 radiologist. But we really haven’t got to that point where we’ve discussed the characteristics of the study.

[Brian Marckx:]

Okay, great. One on the therapy side I got – I fell off the call for a minute. So I might have missed it. Did you talk about the number of systems tails in Q4 and how many were to skin and how many were to breast?

[Ken Ferry:]

Yes. What we’ve said is we place four systems, they were IORT and two of them were the United States and two of them were international.

[Brian Marckx:]

Okay. All right thank you.

[Ken Ferry:]

Thanks, Brian.

[Operator:]

Thank you. Our next question is from Jeff Link of Invemed. Your line is open.

[Jeff Link:]

Yes, hi. I want to just clarify again I know you gave a good detailed hence or at the beginning regarding the product revenue under the therapy side of the business. Just trying to understand are the – the doctors who have who own the machine are the consumables and products that they are buying to operate those machines do they fall into that product revenue category or is it under the service revenue.

[Rich Christopher:]

It would fall under the service revenue because what they would do is they would buy a X-ray source contract which entitles them to X number of therapy minutes based on what they pay. And there’s different categories of number of minutes you can buy as well as unlimited. And then there’s also traditional service contract. So when we think about our capital customers, we call that owns their machine. The recurring revenue, we would see from those in skin would be almost exclusively X-ray source and service that goes in the service line that does not win the product line. The only thing that could win the product line would be if they were to buy new applicators, the stainless steel applicators that are used for the delivery of our therapy for skin patients. That technically falls into the product line. But product line is typically hard where the product itself the console.

[Jeff Link:]

Okay. You also had mentioned that – started to do the CPT 1 code was expensive. And I’m just wondering given the fact that you were – you kind of your bottom line expenses were $7.9 million. What would you expect the run rate in 2017 to be and I guess are there any of the CPT 1 studies that need to be done this year that also may keep that number higher than maybe what a more normalized run rate would be?

[Ken Ferry:]

Sure. As we roll forward obviously we’re trying to manage our expenses as best we can as it relates to the top line revenue. And we talk about expenses for the quarter, I would say in the fourth quarter, we did have incremental expenses related to that CPT 1 study that sort of drove that number little bit higher. But as we roll forward here, we are probably looking expenses in the $30 million to $35 million range depending on top line revenues.

[Jeff Link:]

And what again would you say is going to be the revenue break-even and I understand there’s always a difference in the gross margin depending on the product mix. But what would you say, we have discussed this before but I just wanted to just get if there’s an update on what you would say the break-even on cash flow what kind of revenue numbers you need to be doing on a quarterly basis to kind of get to a break-even cash flow?

[Ken Ferry:]

Right. So with the existing expenses and as the operating expense estimate that I just outlined, break-even is probably in the 8.5% range top line revenue.

[Jeff Link:]

Okay. Very good, that’s all I had. Thanks very much. Good job.

[Ken Ferry:]

Yes, thank you.

[Operator:]

Thank you. Our next question is from Shawn Boyd of Next Mark Capital. Your line is open.

[Shawn Boyd:]

Good afternoon, and thanks for taking the question. Just you can – if I can jump in on cancer detection for a second, you mentioned the six to seven orders already received from European customers so far in Q1. If we just sort of put U.S. approval off to the side for a second. With that kind of order activity and just the traction you are saying after a few months, I read the point where we start to see sequential growth in cancer detection without any U.S. approval?

[Ken Ferry:]

That would be technically challenging Shawn, and the reason I say that is we actually in 2016 had $2 million worth of MRI business, right in our base. So you really can say to yourself that when you add it all up it was a combination of product and service. But that added up to do the math right about $500,000 a quarter and that’s gone based on the transaction. So if I were to adjust for that if you were to kind of basically adjust for that factor. I certainly think it’s possible we could start to see some modest growth from a base standpoint. But I really think a comparative growth again minus MRIs apples-to-apples mammography if you will. In a fashion that really is meaningful will require U.S. approval. We’re encouraged by the international market but that could move the needle a $200,000 a quarter and I hope it goes to $400,000, $500,000 a quarter soon. I just don’t want to get ahead of it because it’s finally happening and I don’t want to overstate how quickly it will continue to ramp. So that one’s a little difficult, we worked really hard since we got the CE mark for that product to get the market acceptance. And we knew it’d be much longer in heart of the U.S. for a lot of different reasons. We’re just finally seeing some daylight here. So I don’t want to get ahead of it. But my answer would be we could see some modest growth minus the MRI number. I think it’s really going to take the U.S. approval before you’ll start to see comparative growth in that business that you would be impressed with.

[Shawn Boyd:]

Got it, Okay, Ken, that’s really helpful. And then my second question just moving over to therapy for a second, you mentioned that solutions customers will contribute in the neighborhood of the $150,000 a year once you are up to 10 patients a month. Is there a graduated fee schedule there, when solutions customer would stay in a lower fee if they’re unable to get their business up to that 10 patients a month level?

[Ken Ferry:]

Well, basically there is really a combination of fixed costs and variable costs with that model. And obviously putting in the machine there’s a fixed cost on a monthly basis which goes into the model. And there’s some variable cost based on the amount of labor that is required radiation techs physicists and so forth. So it’s really, it’s a model that has I guess I’m described it has some variables that are fixed and variables that are not. And so it really behooves them to treat more patients. We also have another model on the subscription which is a flat out on a per fraction basis where we essentially get a fixed amount of money per fraction. And so in that case again the more the Street is that is for all of us, that model we are very careful with because we only want to use it with sites that have the potential to really do some significant volumes because in the beginning we’re putting a lot of expense out by putting these resources into the customer environment in the machines. And then our revenue is solely dependent on how many patients they treat. So we have different subscription models. And ultimately, the customer depending on which model they are on, have some sunk cost in the beginnings and obviously over time their expenses would be more favorable in the context of more volume. But really it’s a mixed model with some fixed cost and some variable. Even on the model where we do it on a per fraction basis. They have to give us a pretty substantial deposit. And so it’s not a straightforward answer, I need to say that but it really is a mix of fixed and variable cost that goes into this. And both size us in the practice obviously do much, much better with this business model when they’re up treating that number I talked about earlier which is about 10 patients per month.

[Shawn Boyd:]

I got it. Okay. And just with that breakdown one last time on the 70 – I’m sorry I think we had about 71 sites treating in of those the solutions customers around 35 to 36, it’s just an average. Go head.

[Ken Ferry:]

Yes, let me say it is 50/50 about half of those sites are only machines and about half of them are solutions customers.

[Shawn Boyd:]

Okay. And is it fair to – is it possible to say what that kind of average patients per month is on the solutions customers?

[Ken Ferry:]

Yes, that’s a good question. I’d be honest with you – what is holding us back is that about 50% of those are treating but only about 10% of them are actually hitting the volumes that we talked about. And that’s holding us back to, there’s still in what I call the early ramping phase and that has clearly contributed to why the subscription line is not growing as fast. So if you’ve got 35 of them and about say 40% are treating at this point. And the balance are in process, of that total again it is not a significant number that have hit that 10 patients per month, it’s probably of the 36, it’s probably about maybe five, others are on their way. So it’s really just not a big number yet, and that has contributed clearly to as not seeing a more significant ramp. But just to kind of lift it up a level, what I would share with you is that when you look at our total of the 71 machines, our estimates from our various software sources and source usage. As an example, we believe that 875 patients were treated in the fourth quarter. That’s versus 660 patients that were treated in the third quarter. And if you go back to the first quarter that number was probably around 100 patients. So there are different models obviously once capital with a very different revenue profile versus subscription. But if you netted out what I’m trying to say is that we’re seeing a lot more traction with our capital customers that own that machines at the moment. But we think that’s going to flip over time because the growth in contract is now almost – and truthfully it’s almost exclusively subscription. And so it’s going to shift and since the backlog of on boarding is exclusively subscription, that’s where we’re going to be counting on the traction going forward. So it’s really in the short-term skewed towards those that owns the machines but we believe over the course of this year, you can see a shift with the revenues will grow driven by the subscription business, a combination of getting the customers that are already treating doing higher volumes getting the ones that have not been on boarded, on boarded in the next 30, 60, 90 days and then capturing it adding new customers each month to that backlog.

[Shawn Boyd:]

Got it, okay. Thanks for the additional color. And best of luck guys.

[Ken Ferry:]

Sure. Thanks Shawn.

[Operator:]

Thank you. And that concludes our Q&A session for today. I’d like to turn the call back over to Mr. Ken Ferry for any further remarks.

[Ken Ferry:]

I would like to thank everyone for joining the call today. We have made some progress in our business. We’re pleased with that on one hand. On the other hand, we feel we can make significant progress going forward. We think we have two very strong growth opportunities, we’ve talked about those in the therapy business, we’re starting to see some progress there. We’re very hopeful that in the not too distant future we’ll see some additional progress in our cancer detection business. And that should allow us to strengthen and sustain a stronger top line growth. We’re very mindful of our expenses and we are trying to control expenses and really spend on those things that are very critical to our long-term success as well as growing the top line in the short-term. We’re also very mindful of our cash, we did finish the year with about $8.6 million but we did, to Rich’s earlier point add to that with the sale of our MRI assets and we’re going to try to preserve our cash and spend it very, very wisely until we reach the point of cash flow positive, which hopefully going to happen at some point in the second half of 2017 So with that said, thank you all for your time and your interest and we look forward to speaking with you again when we announce our first quarter 2017 results. Have a good day.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Everyone have a great day.