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Vital Images, Inc. (NASDAQ:VTAL)

Q3 2008 Earnings Call Transcript

November 6, 2008, 11:30 am ET

Executives

Mike Carrel – President & Chief Executive Officer

Peter Goepfrich – Chief Financial Officer

Analysts

Brett Jones – Leerink Swan

Richard Close – Jefferies & Co.

Richard Davis – Needham & Co.

Sean Wieland – Piper Jaffray

Ernest Andberg – Feltl & Co.

Alan Fishman – Thomas Weisel

Chris Sassouni – Eagle Asset Management

Operator

Good day ladies and gentlemen, and welcome to the Vital Images third quarter earnings conference call. At this time, all participants are in a listen only mode. At the conclusion of our remarks, we will conduct a question and answer session. (Operator instructions) As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Mr. Mike Carrel, President and CEO. Please go ahead sir.

Mike Carrel

Thank you, Moira. Good morning everyone and welcome to our third quarter conference call. With me today is Peter Goepfrich, our Chief Financial Officer. Before we begin, I must preface all comments with the Safe Harbor statement. Some of the comments made today will be forward-looking and are made under the Private Securities Litigation Reform Act of 1995. Actual results may differ and factors that may cause results to differ are identified on page ten of the Form 10-K for the year ended December 31st, 2007.

Let me begin today with an overview of our performance and the marketplace as we see it. This morning, we reported third quarter revenue of $17.7 million, which was 3% ahead of the same period last year and 13% higher than the sequential second quarter. Strong international sales through Toshiba largely drove the increase. Top and bottom line figures were ahead of the Street expectations. We are pleased with our performance given the difficult market conditions and we are well positioned to resume stronger growth when the market improves.

Specifically, we're winning deals from competitors and we believe we are gaining market share. We have the largest independent installed base of customers with over 3250 customers, which is a strong barrier to entry and also a platform for long-term growth.

Recently, we just launched a new program to get our installed base on our new enterprise platform and business model, and we're beginning to get some traction.

Further, we hired Vikram Simha as our Chief Technology Officer in August. Vikram will be an incredible asset to our product development efforts and we're thrilled with the progress that he has made so far.

As for recent product developments, we're in the process of launching Vitrea Web. This product as part of our Vital Enterprise will enable seamless access from anywhere at any time to all of our clinical applications on the Web. This is an important step in improving the efficiency for our customers, a key piece to our value proposition. You will hear more about this exciting release in the coming days up to RSNA.

With our strategy to become an enterprise clinical applications company, our sales pipeline is growing in terms of deal size and quality. As we've said in this call before, this is a game changing shift in our strategy and we won't see the result immediately. Enterprise transactions are far larger and involve more high level decision makers on the customer's end. That being said, everywhere our Vital Enterprise solution has been implemented, the customer has recognized and see the value immediately.

As a result of all this, we're generating significant buzz in the marketplace. We were recently recognized by Frost & Sullivan for healthcare innovation, and we also were a part of Intel's keynote address at Oracle OpenWorld conference where we demonstrated our technology to over 10,000 attendees.

We generated $6.3 million in cash flow from operations in the first nine months of 2008. Vital is in an excellent financial position, and as a result, we can and will take advantage of strategic acquisition opportunities, and we anticipate doing so in 2009. We have no detail to share at this point, but we do expect to be active.

Although we are in an enviable financial position, gaining market share and building technology leading products, we believe strong profitability is a necessity for success and greater impact going forward. We are positioned for long term growth and know that we will continue to invest in exceptional customer service, and research and development.

To that end, let me now comment on our cost control initiatives. We've taken a hard look at our expenses across the organization and thoughtfully determined where we can streamline without compromising future growth. As a result of this analysis, we're implementing an 11% reduction to our workforce, affecting approximately 40 employees and many contractors. This step is unfortunate but essential to right-size the company for strong profitability and even better cash flows.

Now, I want to provide a brief update on our markets, the CT Scanner market and the IT or PACS market. As most of you are probably aware, the CT market has been under significant pressure. In fact, the market is down over 20% in the United States in 2008 after a 32% decline in 2007, with expectations even lower for 2009.

Hospital customers are watching capital expenditures even more closely right now, largely due to a less stable financial environment and continued impact of the Deficit Reduction Act. It was recently reported by the GLA [ph] that the DRA was responsible for cutting imaging spending in the US by almost $2 billion in 2007.

In the IT or PACS arena, hospitals are looking to improve productivity throughout the entire enterprise, and they are investing in healthcare IT. However, sales cycles are lengthening in this economy for the reasons that I just mentioned above. Currently, we're building enterprise reference sites at marquee facilities throughout the world, and have a significant pipeline that is growing and more to come.

Before I turn over to Peter, I want to reiterate that we are making great progress on several fronts, including product development, the signing of several marquee customers and a transition to a new business model. We also remain committed to exceptional customer service and strong profitability.

Now, Peter going to discuss the third quarter financials in detail. Peter?

Peter Goepfrich

Thank you, Mike. I will not reiterate all the information provided in yesterday's earnings release, but do want to comment on a few key items. Third quarter revenue was $17.7 million compared to $17.1 million in the third quarter last year. Third quarter net loss was $243,000 or a loss of $0.02 per diluted share compared to net income of $927,000, or income of $0.05 per diluted share in the third quarter last year.

The decrease in interest rates over the past year has had a significant impact on the income loss per share year-over-year. Interest income was $1 million in the third quarter of 2008 compared to $2.3 million in the third quarter of 2007. Our return on investments has decreased to 2.6% in the third quarter of 2008, from 5.1% in 2007.

Third quarter adjusted EBITDA, a non-GAAP measure, was $1.4 million compared to $2 million in the third quarter last year. The decrease in adjusted EBITDA was primarily due to increased R&D and international expenses.

Next, let me give you an update on Vital Enterprise which we launched in the second quarter of 2008. Vital Enterprise provides customers with full access to Vital Images' best of class clinical solutions and comprehensive services, including education, professional services and maintenance. It has the flexibility to scale to the size of the customers enterprise by providing access to the complete Vital solution based on unlimited or concurrent users.

During the third quarter, we closed $1.2 million of Vital Enterprise orders which represented $1 million in revenue, compared to $1 million in orders which represented $534,000 in revenue in the second quarter of 2008. As I noted last quarter, as we transitioned to Vital Enterprise, the number of Vitreas, ViTALConnects and options sold is less meaningful and we will begin migrating away from such disclosure. That said, during the third quarter outside of Vital Enterprise, we sold 197 Vitreas and 20 ViTALConnects.

Next, I want to review noteworthy operating expense items. Specifically, third quarter sales and marketing expenses were $7 million compared to $8.1 million in the second quarter of 2008. The decrease was primarily due to reductions in trade show costs and employee compensation. Total employee count was 320 as of September 30th 2008 compared to 322 as of June 30th 2008.

During third quarter, total sales force count, which includes sales management and sales operations decreased from 68 to 62, and direct sales reps decreased from 36 to 32. It is important to note that the fourth quarter is always our highest sales and marketing expense quarter by a significant amount. The fourth quarter is our busiest trade show quarter including RSNA this month, which will cost us over $1 million but yield significant sales leads and visibility in our marketplace.

As Mike discussed, today we announced actions to reduce our costs by over 10% in order to align our operations with current marketing conditions and improve profitability in 2009 and beyond. This initiative is expected to result in a pretax charge of approximately $800,000 in the fourth quarter of 2008.

Now, let's turn to the balance sheet which continues to be strong. As of September 30th 2008, we had cash, cash equivalents and marketable securities of $157.8 million down $10.7 million from $168.4 million as of June 30th 2008. The share repurchase program represented a decrease in cash of $12.1 million during the third quarter. Excluding the share repurchase program, cash, cash equivalents and marketable securities increased $1.4 million during the third quarter.

Regarding the share repurchase program, through October 31st 2008, we've repurchased approximately 1.2 million shares at an average share price of $14.27 and in aggregate, $30 million, which represented approximately 12% of the shares outstanding prior to the implementation of the share repurchase program.

Next, Mike will discuss other noteworthy items from the quarter, as well as provide an update on other priorities.

Mike Carrel

Thank you, Peter. With that background, I will now turn to specific revenue channels starting with Toshiba. Toshiba had an outstanding quarter, up almost 14% over 2007 third quarter. US sales through Toshiba were down year-over-year, but Toshiba sales from Europe and the rest of the world more than offset the domestic shortfall. Discussions are well underway on our next long-term strategic contract which we expect to complete soon.

Next is maintenance and services revenue, which is up 9% over the year-ago quarter. About 83% of our US customers have maintenance and services agreement, up from 52% in 2005, and nearly 50% of our international customers are now on contracts, which is up from 25% a year ago.

International revenue nearly doubled over the year-ago period. It's important to note that direct international bookings continue to trend upward all year, primarily as a result of the increasing traction that we are seeing in Europe. Currently, we have more than 1000 installations in Europe. In addition, at the beginning of the fourth quarter, we were selected as the vendor of choice with Sectra for all of Northern Ireland.

As part of building our business over the long term is establishing marquee enterprise customers. Continuing a trend from recent earnings calls, let me share with you a couple of examples; UCLA & Sharp Healthcare in San Diego.

First UCLA, it is a terrific example of our solutions in action and they aired on October 30th on lifechanger segment of ExtraTV, a national television news magazine. Dr. Neil Martin, Chief of Neurosurgery, UCLA Medical Center, was interviewed about his work. The spectacular images of the brain produced by our software that he relies upon routinely were shown throughout the entire peek.

UCLA is a marquee customer and one of our top sites. We are currently working with them to develop our future products and our implementation at UCLA demonstrates the enterprise wide nature of our solutions as we provide value to radiology, surgery and other stakeholders.

Next, Sharp Healthcare in San Diego. Sharp is a leading provider in San Diego in Southern CA. With 2600 physicians on staff and more than 1000 additional physicians in affiliated medical groups, we just signed a five-year agreement to employ the Vital Enterprise Solution across their entire enterprise, integrated with the Fuji PACS solution. We won this deal in a highly competitive environment.

Sharp Healthcare selected Vital Enterprise solutions for its high performance applications, flexible and intuitive workflow, and scalability. These are just two examples of the types of wins that we are having in a marketplace and that we see going forward as well. Some of our prominent marquee customers with whom we're actively working with in product development include University of Pittsburgh Medical Center, Brigham & Women's, Johns Hopkins, Detroit Medical Center & Atlanta Medical Center plus many, many more.

Needless to say, we are thrilled about this opportunity to expand our solutions with both UCLA & Sharp, as well as other enterprise opportunities that we're seeing in our pipeline on the RSNA, our largest trade show of the year, which takes place at the end of this month. Throughout the conference, we will demonstrate our full suite of our products including our new Vitrea Web solution.

Let me reiterate how excited I am about having all of our products Web accessible. This is a true innovation that has not been available previously through any provider. Having all of our clinical tools available via the Web will help to further our expansion into the enterprise. If you are planning to attend RSNA, we are holding a meeting and product demonstration for the investment community starting at 7:30 AM on Monday, December 1st at Chicago's McCormick Place. At the meeting, I'll provide a brief update on the company and Vikram will discuss our technology leading products and developments.

Now, let me transition to our outlook. I cannot overstate how confident I am in our new enterprise approach and how much our entire management team and I truly believe in the long-term market opportunities in front of us. While we cannot control the sluggish economy or the speed with which the CT market will rebound, we are controlling what we can and thus maximizing our operating efficiency and cash flows.

At the same time, we are committed for long-term growth, building the best products and solutions, and providing exceptional service to our customers. We believe that we are the best positioned player in the market, from both a technology and financial standpoint, and we intend to build upon this strength.

Our guidance for the remainder of 2008 is unchanged, but given the prospect of a down economy and the pressure on healthcare spending, we anticipate performance in the lower half of the ranges. In summary, we made important progress in the third quarter and are now implementing a cost reduction program to move the company towards stronger profitability and cash flows in 2009.

There is no question that we are the best position player in the market and I believe we are in the threshold of great long-term prospects. And we remain committed to; one, developing the best advanced imaging solutions; two, taking exceptional care of our customers; and three, long-term growth and profitability.

With that, let's turn it over to questions.

Question-and-Answer Session

Operator

(Operator instructions) We'll take our first question from Brett Jones with Leerink Swann.

Brett Jones – Leerink Swan

Thank you and good morning. Mike, the first question I guess is can you go into a little bit more on the Vitrea Web that's launching now? How does this differ from ViTALConnect in terms of the Web access, the functionality that it's successful over the Web, and also VitreaACCESS. Is that – one of the areas that I've a big concern about is having all that functionality accessible over the Web, and I thought before in the past you tried to – you've said that ViTALConnect you could access most. I'm just trying to get a sense for what's going to be different in Vitrea Web?

Mike Carrel

Well, ViTALConnect did not have all of the applications on the Web. The Vitrea Web actually works in conjunction with ViTALConnect, and it is a solution that you can access all of the great applications on our Vitrea product accessible via the Web. So, I mean, it's just that simple. Every one of our applications are accessible through the Vitrea platform.

Brett Jones – Leerink Swan

Okay great. And getting to market share, when you talk about capturing market share, and we've kind of gone through this before in the past, can you talk about your win rate and how you're measuring the market share, what you're using to determine market share gains? Because I've spoken with competitors and they claim they're gaining market share, but obviously their finances aren't being published every quarter either.

Mike Carrel

Well, there's a couple of things. One is that we're winning about 60% to 70% of the direct competition that we're involved with so that we know that we're actually winning most of those transactions both here in the United States and globally, outside in Europe et cetera. So, we market by that. We look at the spend and talk to a lot of the industry analysts, a lot of the OEM vendors to understand how large the market is and what they're seeing in this particular space, and again understand that we are from that perspective gaining share. And third, we gather other competitive intelligence that we are very well aware of and tells us that we absolutely are gaining market share.

Brett Jones – Leerink Swan

Sure Mike, that's helpful. One last question and I'll jump back in the queue. Could we talk about some of the workforce reductions, where do you see some of that 11% headcount coming down and I guess I have a question here, I noticed you were hiring opposed to the – you had supposedly hired software developers out in California, are you having trouble attracting software developers in Minnesota and do you have an office out there in California I'm not aware of?

Mike Carrel

A couple of comments on that. First is, the workforce reduction was pretty much across the board, so it actually affected all different areas of the business, G&A, sales and marketing, and R&D. So, it affected all of those different areas. It did not really affect services as much, as we've talked about before, commitment in that particular area. We're still committed in the other areas as well. But, service was not impacted as much. The gross margins continue to be exceptionally strong in that particular area and that revenue base grows nicely as well. But that's kind of the way that it's been impacted. In terms of the hiring, we're looking for – we're trying to find the best talent in the world no matter where it is, and so we're looking to find talent whether it's here in Minnesota, we've got an office in China, and we've looked at hiring people on the West Coast and on the East Coast as well if that's where we can find the best talent.

Brett Jones – Leerink Swan

Thank you.

Operator

We move next to Richard Close with Jefferies & Company.

Richard Close – Jefferies & Co.

Just to follow up I guess on that, so you do have an office in the San Francisco Bay Area?

Mike Carrel

We currently do not have an office in the San Francisco Bay Area, but we do have employees that work in product development throughout the country. So, we have people that work in North Carolina, Seattle, throughout the country. So, we're just looking for the absolute best talent in this space regardless of location.

Richard Close – Jefferies & Co.

Okay, and then Peter had mentioned --

Mike Carrel

I'm sorry, it happens that there's a lot of strong software developers in the San Francisco and Boston area.

Richard Close – Jefferies & Co.

Okay, I guess turning to Vital Enterprise, Peter – and I apologize I didn't get all this information, but I think you said that there is $1.2 million in orders with $1 million hitting the P&L, is that correct?

Peter Goepfrich

I apologize, I misspoke, it's $2.1 million (inaudible) of $1 million to revenue.

Richard Close – Jefferies & Co.

Okay. And that was versus -- you gave some versus, comparison numbers?

Peter Goepfrich

$1 million in revenue – I mean $1 million in bookings last quarter.

Richard Close – Jefferies & Co.

In 2Q?

Peter Goepfrich

In Q2, and then $534,000 in revenue.

Richard Close – Jefferies & Co.

Okay.

Mike Carrel

And just to clarify that, that is on just the Vital Enterprise solution because people still add in our pipeline. We honored all the quotes we had out there from before that we're on just the workstation basis and things like that. So, it was about 45% of our direct license revenue.

Richard Close – Jefferies & Co.

What was the percentage again?

Mike Carrel

45% of license revenue compared to last quarter, it was about 20%.

Richard Close – Jefferies & Co.

Okay, alright. And then, with respect to maybe – I guess McKesson and – are you guys selling the enterprise along with Toshiba and McKesson or is it all indirect ultimately?

Peter Goepfrich

Today it is all – it is all indirect, but we are working our partners, both Toshiba and McKesson who you know are very strategic towards the long-term on ways that they can also position and sell that product as well. Any product that they have, we would transition to our Vital Enterprise.

Richard Close – Jefferies & Co.

Okay. And then, when we think about the Sectra relationship, you mentioned in – where was it, Ireland or wherever you're selling with Sectra, is that a workstation agreement or is it testing client agreement?

Mike Carrel

It's the entire Vital Enterprise solution. So, it's the entire solution that we sell is with that one, and that's how we work with Sectra as well. And Sectra is more than just Northern Ireland, there's one deal that we happen to have been awarded in Northern Ireland, but we're working with them in all of Northern Europe quite frankly, and they've been a great partner of ours in Northern Europe.

Richard Close – Jefferies & Co.

Okay. And then, with respect to your market share gains, I guess 60% to 70% direct wins US and globally, and are we – is it safe to assume that all those wins are with respect to the enterprise and it's not workstation related, or are there any workstations in there?

Mike Carrel

It's a mix. As we mentioned before, some of our business is still some workstation business from the quotes we had had from before. But the Vital Enterprise is all encompassing, so as Peter described, the Vital Enterprise either has unlimited users, or concurring users, and you get access to it, you can deploy it on a workstation if you want. And so, that's the beauty of the Vital Enterprise. It doesn't matter in terms – that's the deployment method in terms of whether it goes on to a workstation, goes integrated with the PACS, that is really more of a deployment method than in terms of the business model by which they're buying from us.

Richard Close – Jefferies & Co.

Okay, thank you.

Operator

(Operator instructions) We go next to Richard Davis with Needham & Co.

Richard Davis – Needham & Co.

Thanks. Just a quick question, with regards of the Web product, remind me again, is it coming out at RSNA, and then if I'm a potential customer that – do I have the – is the full featured product – in another words, is it truly generally available or will it be available a few weeks later, a few months or in other words, will I be a – to place an order with you, and then get it installed as quickly as we can get everything up and running?

Mike Carrel

It will be available at RSNA.

Richard Davis – Needham & Co.

Got it, okay. That was the simple question I had, thanks a lot.

Operator

Our next question is from Sean Wieland with Piper Jaffray.

Sean Wieland – Piper Jaffray

Hi, thanks. Just a question about the Sharp deal. You mentioned it was a competitive deal, what was the competitive landscape there? In particular, was Cerner fighting for that business, or were they working with you, and what's the deployment method?

Mike Carrel

We were not – Cerner was not involved in that transition. It was pretty much all of the advance visualization players that you would have out there were involved in it at some point throughout that deal. So there were many different phases throughout that. So, we basically beat all of the major advance visualization companies from the OEM players to the independent players as well. In terms of Cerner, they were not necessarily involved in that. And maybe, when you say deployment in that, what are you describing?

Sean Wieland – Piper Jaffray

Was it one of these, it was an enterprise deal?

Mike Carrel

Yes, it's an enterprise deal, absolutely.

Sean Wieland – Piper Jaffray

Okay, and it's for Vitrea?

Mike Carrel

It's an enterprise deal . They get access to all of our applications to the enterprise.

Sean Wieland – Piper Jaffray

Okay, and that was – was that all in the Q3 bookings number you gave us?

Mike Carrel

Actually, it's in Q4.

Sean Wieland – Piper Jaffray

So, that deal was actually signed since the quarter?

Mike Carrel

It was signed in Q3 and we have installed it in Q4.

Sean Wieland – Piper Jaffray

Okay, so that will show up in the Q4 bookings number and presumably in Q4 revenue?

Mike Carrel

Correct.

Sean Wieland – Piper Jaffray

Okay, good. Thanks a lot.

Operator

Our next question will come from Ernest Andberg with Feltl & Co.

Ernest Andberg – Feltl & Co.

Good Morning.

Mike Carrel

Good Morning.

Peter Goepfrich

Good Morning.

Ernest Andberg – Feltl & Co.

I missed part of the beginning of your comments, Mike. How do you describe the backlog of luminary sites and how it might unfold into revenue over the coming quarters, given $1 million booked in Q1, $2.1 million booked in – pardon me Q2 and Q3? Will that be going up sideways? How should we think about that development?

Mike Carrel

Well, I want to make sure that I segment that question. Those aren't necessarily luminary sites, those are enterprise transactions. They could be at any general customer site. The luminary ones are ones that I'm trying to highlight so that you have a general feel for the types of deployments that we're winning and the types of institutions that we're associating ourselves with long term, whether it's UCLA, Sharp, UPMC, Johns Hopkins, Brigham & Women's, that's just to kind of give you a sense of the type of institutions that we're working with on these enterprise transactions. And quite frankly, enterprise product development, and they're giving us a lot of feedback into the future of the product. So, that's one aspect.

In terms of on the enterprise side, we should anticipate that we're going to continue to see more and more of our transactions come through the enterprise platform, and that number should trend up. Obviously, we're not giving guidance for the future – I should say that. I mean, obviously we said that we're not giving guidance for 2009 right now. It is an uncertain environment in terms of the overall economics, that's why we made some of the cost changes that we've made today.

We do feel like we're the best positioned in the marketplace, and would you feel like our pipeline is building with some great transactions, but the timing right now is one that is uncertain primarily due to the economic conditions that we've got out there. Things just push off, people are trying to get financing, endowments are affecting it in terms of the amount of money that they're earning on interests or other aspects or their endowments are impacting it, because they have a lot of their money in stocks and they use that for capital expenditures et cetera. So, all that is having an impact on the timing of those deals.

Sean Wieland – Piper Jaffray

Alright. Peter, I presume the $800,000 of expenses for the reduction are in your guidance for the year?

Peter Goepfrich

Yes.

Sean Wieland – Piper Jaffray

Where primarily will that fall, G&A or across the board and expense?

Peter Goepfrich

We'll line item it out as a separate line.

Sean Wieland – Piper Jaffray

Separate line item, okay. Thank you.

Peter Goepfrich

You're welcome.

Operator

Our next caller is Steven Halper from Thomas Weisel.

Alan Fishman – Thomas Weisel

Hi, this is Alan Fishman for Steve. I wanted to ask about the sales rep decline and were those people that you intended to let go, and how is the restructuring going to affect direct sales in the US and then in Europe as well?

Mike Carrel

In terms of the direct sales force, we went through a cost reduction effort that was across the board. And so, it was not only in sales, it was sales, marketing, G&A and R&D as I mentioned earlier. And it was an effort to try to get us to become stronger and more profitable on the bottom line as I talked about. And in terms of that, we anticipate that we're going to get more efficient on our sales force in the coming years, and so it was definitely an effort to go down that path as well.

Alan Fishman – Thomas Weisel

Okay. And then turning to Toshiba and I guess strong performance in Europe and the rest of the world, what is the – can you give any comments around Japan that grew fairly quickly in the quarter and kind of how you're seeing your sales efforts, now that you're selling indirectly through Toshiba in that market?

Mike Carrel

In Japan, it's still I would say a very immaterial dollar amount in our revenue today. We anticipate long-term, that will not be the case, but today it is. We're working very closely with Toshiba on the technology development, on the 320 which we anticipate long-term will be their core high-end market in Japan. But right now, that is a new market and new development at this point in time. So, we anticipate more revenue out of that in 2009 and 2010 and beyond, but in 2008, there's not just much revenue coming out of Japan.

Alan Fishman – Thomas Weisel

I see. So lastly, have you seen any impact from the 320 yet in those international sales or not?

Mike Carrel

Yes. We've seen an impact of it, it's definitely in those numbers. It's not the majority of it by any means at this point in time.

Alan Fishman – Thomas Weisel

Okay.

Mike Carrel

We anticipate though that there's a lot of interest in that product and it's a fantastic product, by far the best product that's on the market today. So, from that standpoint, we feel that it is going to get traction.

Alan Fishman – Thomas Weisel

Okay, thank you.

Operator

Our next question will come from Chris Sassouni with Eagle Asset Management.

Chris Sassouni – Eagle Asset Management

Hi, good Afternoon. Could you talk a little bit about the upcoming November 19th, I guess it's the CMS panel on virtual colonoscopy? It appeared that six months ago, there didn't seem to be as much of a groundswell of support for it, and now things have suddenly or seemingly changed. I was just wondering if you could comment on what you're hearing or seeing as that date approaches, which I think is November 19th?

Mike Carrel

Yes, I'll make a couple of comments on it. We were just at the Virtual Colon Show recently where we demonstrated our software, and I think it was clear from the workstation face-off that we had there, because they called the workstation face-off there that we've got the best application in the market. Many comments to that from the various different physicians that were utilizing the products, and I was there for about a day and a half or so from that standpoint. They talked a lot about the reimbursement, asked about risks, and very specifically about the date coming up.

I think there's uncertainty in terms of what's going to happen. I don't think anybody knows for sure. I think everybody believes there is going to be a reimbursement, and that it is going to happen, it is inevitable from that standpoint probably in the February timeframe, and that there will be some ruling in November, but it will actually be kind of official sometime in the first quarter of next year.

I think that's kind of a general feeling within the industry. The question is how much, and then what impact is that going to have on both the radiologists and the gastroenterologists. And that's really what and who's going to basically take it over and what the impact at – a lot of the discussion was around that. I don't know that anybody is conclusive on that at this point in time from the discussions that I was a part of at the meeting.

Chris Sassouni – Eagle Asset Management

And then, just in terms – maybe I missed it earlier, but – I know the charges that you're taking for the headcount reduction, but what will the annualized savings be from that headcount reduction?

Peter Goepfrich

Approximately $4 million to $5 million.

Chris Sassouni – Eagle Asset Management

And then, is there any – certainly your competitor is – it's been alleged that you use pricing in the marketplace, where you're having competitive bid situation, RFPs. What are you seeing in terms of pricing in the marketplace with your competitors and is pricing really – in this economic environment, there's got to be a balancing act between the functionality of the products that these hospitals are evaluating and pricing? So, a little bit about what's happening in the environment right now with pricing?

Mike Carrel

A couple of comments on that. In terms of the numbers that Peter talked about, were the headcount components of the cost reduction, we anticipate there will be some other savings as well that we'll quantify in more detail on the earnings call and when we give guidance for 2009 as well. So, there's other cost measures that we're doing. Getting to your specific question, in terms of pricing, what we're seeing in the marketplace today is that, quite frankly it's our pricing. The way that we're going to market is changing the way people have to think about it, and that's a positive.

We are creating a market in terms of around what the pricing should be and how to leverage the advanced visualization to the enterprise. And that's why when I talked about this being a game-changing look at it, I think that we're actually changing the way people are thinking about it to be more aligned with the way healthcare IT is, and it's been very receptive from all of our customers from that standpoint. So, what you're seeing is larger deals, larger sized transactions long-term that are basically coming into fruition here. I'm not sure about the specific question.

In terms of the economics in terms of the pressure on pricing, there's always pressure on pricing, and I don't know that it's that much different. It's really more people just saying, “Am I going to buy this today or am I going to push it off and where am I going to find the budget in 2009-2010 for this, because I believe that advanced utilization needs to be throughout an entire enterprise." Those are the comments customers are making to us. We're getting into their budgets, we're winning deals now that we're going to see in 2009 and 2010, and they're trying to find budgets for these larger transactions.

Chris Sassouni – Eagle Asset Management

And I'm just curious, in the last couple of weeks, whether you've seen a sudden shift, so we were coming down through the third quarter and however the sales cycles were aligning themselves as your sales reps were going out and calling on clients, let's take that as a snapshot and compare it against any changes that you've observed just in the month of October? Because something is – a lot of the companies I spoke to, something seems to have shifted pretty dramatically in October, and I'm just curious whether you saw the same thing.

Sometimes, I heard that things have frozen up for the first couple of weeks of October and then they sort of let go. Other times, people have said, right now a lot of hospitals are in their capital budgeting cycles. Some of them are saying we're going to freeze up or dramatically slow down capital expenditures for Q4 specifically and/or decrease the amount of capital expenditures for next year. So, I'm just wanting to understand, you talk to a lot of hospitals, I would imagine you have heard many similar things or not?

Mike Carrel

I don't know that it's just for October. I mean, I think if you listened to the Philips [ph] conference call, they saw the last two weeks of September when you started to really see some of those types of discussions coming up. So, I think it was a little bit earlier than the beginning part of October. I think you're right – that's right, some of the uncertainty that's out there that I mentioned in my scripts, very specifically. I think people are uncertain in terms of how much budget they're going to get, where they're going to get the budget from. They love the projects. They've chosen us as vendor of choice, but they're trying to find out when the budget's going to come in, can they squeeze it into this year. And yes, they're going through the capital budgeting but they are getting a lot of pressure. So, I think you're correct from that standpoint.

Chris Sassouni – Eagle Asset Management

Okay. The average size of one of your systems right now that you're – one of the contracts that you've sold is roughly how much?

Peter Goepfrich

It's approximately $175,000 for the Vital Enterprise.

Chris Sassouni – Eagle Asset Management

And is there any – the other thing I guess, if you already have an implementation, let's say that someone has signed a contract and begun the implementation, is anybody stopping implementation or saying, we're going to halt what we've just started or the implementation is all going through because it doesn't take that long to implement?

Mike Carrel

The implementations are going through.

Chris Sassouni – Eagle Asset Management

Okay, alright, thank you.

Operator

(Operator instructions) We'll take a follow up from Richard Close with Jefferies & Company.

Richard Close – Jefferies & Co.

Yes, Peter, really quick, just so I have these numbers right, with respect to the Vital Enterprise and $1 million in revenue that you recognized in the third quarter, you're saying that's 45% of --

Peter Goepfrich

Of direct license revenue.

Richard Close – Jefferies & Co.

Direct license revenue, just domestically or just in total?

Peter Goepfrich

Globally, total.

Richard Close – Jefferies & Co.

Okay. And then with respect to just I guess this last comment, Mike, you said that you've been chosen as vendor of choice in a bunch of deals and can you quantify that? How many deals you guys have already been chosen, and so, it's just pretty much a done deal, they're waiting to get the budgets filled, any type of like quantity of – or range of size of deals there that you've been already chosen?

Mike Carrel

No, Richard. We're not going to disclose or talk about the quantity or size of those types of -- so, I mean, because we're in the process of working through with their budget and that's not something that we can disclose. We'll disclose obviously at the time of the quarter that what the revenues look like. But disclosing that, when we don't know what the timing is in the uncertain environment that we're in today, that's not something that we're comfortable at disclosing or talking about.

Richard Close – Jefferies & Co.

Okay, well let me just try it from a different angle then. You have deals that you've gone through essentially an RFP process and almost everything is done except for signing on the dotted line it sounds like, is that the case?

Mike Carrel

No. We've gone through a process where we talk to our customers. They want us as their vendor of choice for the Vital Enterprise, and we're working with them on their budgets for 2009, 2010, 2011, and working actively with them to find out where they're going to get their budgets from the various different departments et cetera. We don't necessarily have all the Ts and Cs pulled together. It's actually working with them on their budgets. But we're actively working with them as partners with their solutions. So, a lot of this is installed based work, where we're upgrading our installed base to the Vital Enterprise and they continue to love using our products.

Richard Close – Jefferies & Co.

Okay. So, would the majority of it already be existing customers or is it 50/50 of these deals that are sort of out there waiting to get the budgets assigned? Is it 50/50 between new clients and existing clients, or is it skewed towards existing?

Mike Carrel

It's skewed towards existing, but we do have some new ones as well. But it's skewed towards existing because we've had partnerships and relationships with them for a long time. So, most of those are customers are that we've worked with. But they've also worked with other vendors as well. It's not a non-competitive environment. It's still competitive because then they have worked with other vendors and had multiple workstations at their facilities. But they've decided that we're the right choice for the enterprise type solution.

Richard Close – Jefferies & Co.

Okay, thank you.

Operator

And we have another follow up from Brett Jones with Leerink Swan.

Brett Jones – Leerink Swan

Thank you. Just a quick clarification. Mike, from your comments, it sounded as if you're honoring standalone workstation orders that were in the pipeline previously. Have you guys switched to only selling enterprise deals? I was under the impression that you were pushing enterprise deals, but you will continue to sell on a standalone basis also, is that correct or no?

Mike Carrel

It is correct, although the way you buy on a standalone basis is you buy a concurrent user from us, which effectively includes access to all the applications on the Web, but it can be deployed as a workstation, so we'll deploy it as a workstation. If you want to buy one concurrent user, you get that workstation plus you get more. So, you actually get more than just the single workstation. So we will absolutely deploy it that way.

Brett Jones – Leerink Swan

Okay. But they're all classified now as enterprise deals going forward?

Mike Carrel

Correct.

Brett Jones – Leerink Swan

Okay, thank you.

Operator

(Operator instructions) And Mr. Carrel, there are no questions in the queue at the moment sir.

Mike Carrel

Okay, thank you Moira. Thank you everyone for joining today, really appreciate it. These have been great questions. We're eagerly getting ready for RSNA and hope to meet many of you there at the meeting that I described earlier. You'll be pleased to see the in-depth capability that we're providing to our customers on Vitrea Web as we've talked about in this call today. Deploying a true enterprise wide solution is key to our long-term growth and that is exactly what the team is focused on and is doing. Again, thank you for joining us today.

Operator

Ladies and gentleman, that does conclude today's conference. Once again, we do thank you for your participation. We wish you a pleasant day and you may now disconnect.

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