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Q4 2013 Earnings Conference Call

February 20, 2014, 8:00 AM ET


Anne Marie Fields - Vice President, LHA

Ken Ferry - Chief Executive Officer

Kevin Burns - Executive Vice President, Finance and Chief Financial Officer


Bill Bonello - Craig-Hallum

Harry Kopelman - HAK Consulting

Jeb Terry - Aberdeen Investment Management

Brian Marckx - Zacks Investment Research

Shawn Boyd - Next Mark Capital


Good day, ladies and gentlemen, and welcome to the Q4 2013 iCAD Inc. Earnings Conference Call. My name is Mark, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. We will conduct question-and-answer session towards the end of the conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

And now, I'd like to hand the call over to Anne Marie Fields, Vice President at LHA. Go proceed.

Anne Marie Fields

Thank you, Mark. Good morning. This is Anne Marie Fields with LHA. Thank you all for participating in today's call. Joining me from iCAD are Ken Ferry, Chief Executive Officer; and Kevin Burns, Executive Vice President, Finance and Chief Financial Officer.

Following the market close yesterday, iCAD announced financial results for the 2013 fourth quarter and full year ended December 31, 2013. If you've not received this news release or if you'd like to be added to the company's distribution list, please call LHA in New York at 212-838-3777 and speak with Carolyn Curran.

Before we begin, I would like to caution that comments made during this conference call by management will contain forward-looking statements that involve risks and uncertainties regarding the operations and future results of iCAD. I encourage you to review the company's filings with the Securities and Exchange Commission, including, without limitation, the company's Forms 10-K and 10-Q, which identify specific factors that may cause actual results or events to differ materially from those described in the forward-looking statements.

Furthermore, the content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, February 20, 2014. iCAD undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call.

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

Ken Ferry

Thanks, Anne Marie. Good morning, everyone, and thank you for joining us. We're very pleased to update you today on the significant progress that we've made throughout 2013, while executing on our oncology plan. The fourth quarter marked our sixth consecutive quarter of revenue growth and adjusted EBITDA profitability. We continue to balance targeted investments in the business with financial discipline and achieved adjusted EBITDA profitability of nearly $2 million for the year 2013.

The most contributor to this favorable momentum is our Therapy business. Following a breakthrough year in 2012, the business grew 47% in 2013. This growth was driven by increases in system sales and an increased recurring revenue from increased utilization. In 2013, we saw 44 systems, nearly 50% more than we sold in 2012. The dramatic growth in our Therapy business is led by the growing demand for the use of the Axxent Electronic Brachytherapy System in the treatment of non-melanoma skin cancer.

Our Cancer Detection business made positive strides during 2013 as we made progress increasing business in our large install base through the balance of new product and service revenue. In particular, we were pleased with the growing demand for the PowerLook Advanced Mammography CAD Platform and service where we added nearly 200 customer contracts, increased revenue by over 13% year-over-year.

But before I look at the specifics of the business, I'm going to turn the call over to Kevin Burns for a detailed analysis of our fourth quarter and full year financial performance. After Kevin's review, I'll provide you with a more detailed business update before opening the call to your questions. Kevin?

Kevin Burns

Thank you, Ken, and good morning, everyone. We delivered a strong financial performance throughout 2013 with strong fourth quarter revenue growth and, as Ken mentioned, six consecutive quarters of adjusted EBITDA profitability. We continue to balance investment in key areas of the business with a view to long-term growth and market penetration, while maintaining adjusted EBITDA profitability. We expect ongoing strength in the results with both our Therapy and Detection businesses throughout 2014.

Let me begin by reiterating how we report revenue, which is by the two main oncology areas in which we operate, specifically Cancer Detection and Therapy. Our Cancer Detection revenue includes all of our image analyses and workflow products, including mammography, MRI and CT CAD platforms, as well as service revenue from these product lines. Our Therapy revenue includes the Xoft, Axxent Brachytherapy System, related accessories, and service and source agreements.

Turning now to a review of our revenue, total revenue for the fourth quarter increased 17% to $9.1 million from $7.8 million in the fourth quarter of 2012, driven by a 60% increase in our Therapy revenue, offset by 12% decline in Cancer Detection revenue. For the total year, revenue increased 17% to $33.1 million. This includes a 47% increase in Therapy revenue and a 2% decline in Cancer Detection revenue.

In the fourth quarter, our Therapy business increased 60% to $5 million in revenue with product revenue up 50% to $3.3 million and service and supply revenue increasing 87% to $1.7 million. In the fourth quarter, we sold 14 controllers, 187 balloon applicators, and we treated well over 1,000 skin lesions. In comparison, we sold eight controllers, 233 balloon applicators and treated approximately 400 skin lesions in the fourth quarter of 2012.

In addition, we ended the year with a recurring revenue run rate in the Therapy business north of $8 million per year. We defined recurring revenue to include the service line as well as balloon applicators, which are recorded as product precedence.

For fiscal year 2013, the Therapy business increased 47% to $16.2 million with product revenue increasing 36% to $11.1 million and service and supply growing 77% to $5.1 million. Service and source growth reflects the increase in the size of our customer base. For the year, we sold 44 controllers, 751 balloon applicators and had a significant increase in skin patients treated. This compares to a 30 controllers, 664 balloon applicators and we treated approximately 800 skin lesions for the full year in 2012.

In the early stages of the Xoft business, we felt that providing detailed metrics of the components of our Therapy revenue, as I just noted, provided investors with a greater understanding of our growth and business dynamics. As we mature and the business has begun to scale as well as for competitive reasons, we'll limit the comments on the detailed revenue components of our Therapy business, while balancing the needs of investors.

Turning now to the Cancer Detection business, total revenue for the fourth quarter was $4.2 million, down 12% compared with last year's fourth quarter. Product sales in the fourth quarter of $1.9 million were down 24%, while subscription-based product and service revenue grew 2% to $2.2 million. Excluding the impact of non-recurring service revenue related to product development, the year-over-year growth of the service business for Q4 was 15% and 14% for the full year.

During 2013, we continued to make great strides with executing our strategy shift for the Detection business. Our plan to leverage our install base with new products and upgrades is delivering results. In 2013, we increased the number of customers under a service agreement by 23% to approximately 1,200 systems and expect the service business to continue to grow throughout 2014 as we continue our focus on recurring revenue. In addition, PowerLook AM, our upgraded CAD platform continues to see growing demand from our install base.

Now turning to the rest of the P&L. Gross profit for the fourth quarter of 2013 increased to $6.3 million or 68.8% of revenue from $5.6 million or 71% of revenue for the fourth quarter of 2012. The lower gross margin was primarily due to product mix and the impact of the medical device excise tax, which went into in 2013. Gross profit for 2013 was $23.1 million or 69.8% of revenue compared with gross profit for 2012 of $20 million or 70.8% of revenue. Please note that in 2013, we recorded the medical device tax as a cost of goods and this impacted our gross margin by approximately 140 basis points for the year. For 2014, we expect our margins to remain steady at approximately 70% with quarterly fluctuations due primarily to revenue mix.

Total operating expenses for the fourth quarter of 2013 increased to $6.9 million from $6.3 million for the same period in 2012. Sequentially, our operating expenses increased by approximately $600,000 as we continued to invest in focused IORT and skin seminars, clinical trials, medical trade shows and instrumental product development. Also, due to higher key full revenues and related performance plans, we had approximately $300,000 of variable expense that we do not anticipate rolling over into the first quarter of 2014.

Turning now to our profit metrics, adjusted EBITDA was $285,000 for the fourth quarter of 2013 compared to $102,000 in the fourth quarter of last year. Adjusted EBITDA for 2013 was $1.9 million or 5.6% of revenue compared with a non-GAAP adjusted EBITDA loss of $1.5 million or a loss of 5.5% of revenue for 2012. As mentioned earlier, this is our sixth consecutive quarter of adjusted EBITDA profitability and an improvement of approximately $3.4 million over 2012 mainly as a result of revenue growth as we had fairly leveled operating expenses on a year-over-year basis.

Looking at other income and expense items in the fourth quarter, we reported a $2.9 million loss due to the change in the fair value of warrants that we issued as part of our financing arrangement. This was driven primarily by the increase in our share price during the fourth quarter. In addition, interest expense in the fourth quarter was $810,000, of which $490,000 is cash payable related to financing and capital lease obligations. The balance of $320,000 represents non-cash amortization of financing cost and settlement obligations.

On a per share basis, our non-GAAP adjusted net loss for the fourth quarter was $0.14 per share compared to a loss of $0.15 per share last year. For the full year, our non-GAAP adjusted net loss was $0.47 per share compared with a non-GAAP adjusted net loss of $0.81 per share for 2012, an improvement of $0.34 per share.

Moving on to the balance sheet, we ended the year with $11.9 million in cash and equivalents compared with $13.9 million as of December 31, 2012. During the year, we used $1.4 million in cash to fund operations and approximately $700,000 for capital investments. Sequentially, we saw a decrease in our DSO to approximately 76 days from 95 days in the third quarter.

In summary, 2013 was a great year, as reflected by our solid financial and operating performance. We're pleased with our progress and expect to build on this foundation in order to continue to drive topline growth and to generate increasing cash flow and earnings in 2014.

With that financial overview, let me now turn the call back to Ken. Ken?

Ken Ferry

Thanks, Kevin. 2013 was indeed a very strong year for iCAD. We believe the considerable progress made in our plan positions us very well for continued growth in 2014. Let me start with a discussion of our Therapy products and then I'll move over to Cancer Detection products.

Our Therapy business had an outstanding year in 2013, driven by the substantial increase in demand for the Axxent Electronic Brachytherapy System for the treatment of non-melanoma skin cancer. Revenue for the non-melanoma skin cancer indication was especially strong, supported by positive clinical data, growing reimbursement and most importantly excellent patient outcomes.

There are approximately 3 million cases of non-melanoma skin cancer that are treated each year in the United States. We estimate the addressable market for our therapy to be approximately 1 million of those cases. The current standard of care is most surgery, a procedure where the tissue is examined while the patient waits for the pathologist to examine the tissue specimen for cancer cells in order to determine where to remove tissue next. This procedure is time-consuming and often leads to scarring.

By contrast, the Xoft system protocol typically provides a five-minute non-invasive, non-radioactive treatment to the skin cancer lesion twice a week for four weeks. The interest in our skin cancer application is expanding rapidly as awareness is increasing for the positive clinical and cosmetic outcome associated with the procedure. Dr. Ajay Bhatnagar who will be presenting his study data using the Xoft system at the upcoming American Academy of Dermatology Annual Meeting in March, he will be presenting clinical outcomes data on 172 patients with 247 non-melanoma skin cancer lesions treated with the Xoft system showing excellent cosmesis and acceptable toxicity with no recurrences after three years post-treatment. Study by Dr. Bhatnagar continued to be an important component for driving adoption and for supporting favorable and more widespread reimbursement.

Currently, there are 16 stage with positive payment policies. We are working expanding this a multi-faceted plan on both the regional and national payer level. In addition, we're working to enhance education and awareness of the positive clinical outcomes of our Electronic Brachytherapy approach to treating non-melanoma skin cancer as we build preference for the Xoft system with dermatologists and radiation oncologists.

We will continue to pursue strategic dermatology alliances such as the ones we have with DermEbx and Advanced Rad Solutions that expand access to the Xoft system at dermatology centers. These alliances are proving to be very beneficial as these partners offer a range of turnkey services to enable the dermatology practice to be treating patients shortly after the system is installed in their facility.

Our regional marketing efforts are focused on medical education, educational seminars on the skin application and are led radiation oncologists in collaboration with dermatologists to educate other physicians on how to incorporate Xoft into their practices. The participation and interest level in these seminars is very high. We anticipate that a high percentage of the attendees will turn into sales leads.

In addition to the live educational symposium, we are planning to offer educational webinars, expand our trade show presence at dermatology meetings, initiate our user group meetings and continue to invest in additional clinical studies to demonstrate the effectiveness of the technology.

To summarize our view of the skin market, we believe the opportunity to treat non-melanoma skin cancer patients will be a considerable growth opportunity for the company for years to come. We also believe that we've established a leadership in this early-stage market based on the effectiveness of our technology and published clinical data. This has created a differentiated value proposition for both patients and physicians.

Shifting to our breast IORT application, we continue to see steady progress. Balloon applicator sales, which is an indication of procedure volume, increased 15% in 2013. The target audience for this procedure is primarily breast surgeons and radiation oncologists. We are investing in regional educational seminars in breast IORT as well. We recently hosted a highly successful symposium in New York City with approximately 60 physicians attending.

Last evening, we hosted another successful breast IORT symposium at Philadelphia. And in the coming weeks, we will host an educational symposium at the Miami Breast Cancer Conference, which is one the premier medical meeting for breast cancer surgeons.

Our multi-center clinical trial evaluating safety, efficacy and cosmetic outcomes using IORT to treat the early-stage breast cancer with the Xoft system continues to gain momentum. To date, 19 medical centers across the US have enrolled nearly 250 patients. We plan to add several high-volume sets in the coming months which are going to have 500 patients enrolled in the study by year-end. We expect to report interim data from this prospective study sometime in 2015. Positive data from the studies such as this should enhance the clinical awareness of breast IORT and support continued reimbursement improvements.

As with the skin cancer application, we're also focused on reimbursement and have invested in issue with national and regional payers to further improve reimbursement for hospitals and physicians. As we continue to drive the adoption of these clinical products in the US, we also have significant untapped opportunities abroad. We believe that the international opportunity for breast IORT in particular in emerging markets has tremendous potential to have a meaningful impact on our business longer term.

Our international plan is to accelerate adoption in Europe, Canada, Mexico, Taiwan and Hong Kong, while entering the Russian, South Korean and Australia and New Zealand markets during 2014. We also expect to launch in China in 2015.

We've just begun to penetrate this very large market opportunity in skin and breast cancer. Therapy growth should continue to be positively impacted by our regional medical education programs, ongoing positive clinical data and improve reimbursement as we expand the number of systems placed and achieve meaningful recurring revenue from increasing utilization.

So let me turn to the Cancer Detection business. Our 2013 results demonstrated the business has stabilized and we are positioned to return to a growth trajectory by 2015. In 2014, we expect to see demand for the PowerLook CAD from new customers and as an upgrade to our considerable install base. In addition, we saw growing interest and demand for automated tools for the measurement of breast density in 2013. Our second half sales of the Volpara breast density product were very strong and anticipate this continuing in 2014.

We also significantly increased our service agreement business in 2013, growing it by nearly 200 customers. This was accomplished through our OEM partners and through direct sales to our customer base. We expect this momentum to also continue in 2014.

We're also seeing good traction with MRI CAD through our strategic partner Invivo and Philips healthcare business. We have a strong product roadmap primarily focused on prostate care today and we have plans to expand to new application areas over time. We anticipate continued growth in our refunding in software license royalties over 2014.

And finally, we're very enthusiastic about the opportunity to provide software workflow tools for the interpretation of mammography 3D images for tomosynthesis. As the 2D digital systems market transitions to 3D systems over the coming years, we believe the opportunity to be considerable similar to when (inaudible) market moved to first-generation digital technology, today we're simultaneously developing our first set of software tools, while continuing to collect tomo studies from a number of leading international sites to provide sufficient studies for our robust product roadmap.

We hop we'll release our first of these products internationally late in 2014 and in US in early 2015. So in closing my opening comments, we're very enthusiastic about our prospects for the next 12 months in both businesses. The work we've done and the investments we've made in 2013 put us in a strong position to deliver continued strong growth throughout 2014. Our goal remains to drive topline growth, while balancing investments for future growth in order to build a profitable company to enhance shareholder value over time.

And now, operator, please open up the call for questions.

Question-and-Answer Session


(Operator Instructions) First question comes from the line of Bill Bonello of Craig-Hallum.

Bill Bonello - Craig-Hallum

Just curious if you can give us any more color about the Xoft placements in the quarter and/or the pipeline? Are you seeing more multi-unit placements? Do you expect to see that going forward, or is it one practice one system at a time?

Ken Ferry

Well, Bill, I think obviously we had a bang-up year selling 44 systems and 14 in the fourth quarter. So obviously a record year, but also a record quarter. The sales in the system were dominated by skin. We had a solid year with IORT system placements, but really were dominated by skin. The other thing I would point out which I think is important is if you go back to 2012 when we sold 30 systems, I think it went to veterinary market, so when you really make an apples-to-apples comparisons, we've not sold any systems in '13 to the vet market. We sold 44 systems compared to 24 the year prior into the human market, which is about an 83% increase.

So we're very, very pleased with the overall progress year-over-year. We've placed 74 systems in the last two years compared to 2011 when we placed only 13. So the momentum over two years has been very considerable in both skin as well as IORT.

Now as it relates to skin placements, it is kind of a mixed shift. We do get some multi-system sales. What you're finding is large dermatology practices, which have number of offices, are placing these into multiple offices. In the beginning it was one that might be shared amongst several offices within close proximity. What we're finding today is once the procedure volumes get to a certain level, they're buying additional machines. It's really about a rollout and a responsible implementation.

So we're seeing multiple system orders. We're also seeing single orders based on the pace at which they want to implement these in the various sites. So the skin market still is where we're laser-focused. It's a very, very big opportunity. We seem to see a perfect storm from studies reimbursement and interest. It's new opportunity for both the dermatologists and radiation oncologists from a treatment protocol. And that tends to bode well for removing any obstacles to adoption.

So I think we're pretty good about things and we're optimistic as we go forward as well.

Bill Bonello - Craig-Hallum

And when we think about sort of skin placements going forward, I mean looking forward, as you mentioned, was really strong. Should we think of that as a bit of an anomaly and maybe think more of sort of eight to 10 systems per quarter with obviously variation on a quarter-to-quarter basis going forward as opposed to sort of looking at this as the new way at which you're placing systems?

Ken Ferry

I would answer that two ways, Bill. One is that historically, your fourth quarter, particularly on a calendar basis, tends to be the biggest quarter of the year. And for whatever reasons, whether we've trained our customers to wait for the year-end to get their best deal or whether your salespeople have the opportunity to get into the highest commission plan and all the different dynamics that go on, typically the fourth quarter is your strongest. And conversely, your first quarter tends to be weaker. So I don't think that phenomenon is really going to change significantly from a seasonality of the business.

I would also say that just in a general sense, we're very bullish on the year in our ability to continue to grow. I mean we wish we could train customers in this early a stage in the market to buy on timely quarterly basis. And so I do expect we're going to see some spikes and some troughs and things over the course of the year just because of the nature of being in the market and being in an early stage. So we can't necessarily take Q4 and say that's a baseline or a floor. What I would say is we're very, very confident that 2014 will be a strong growth year for the company as well as a strong growth year in skin market.

Bill Bonello - Craig-Hallum

And just as a final question on that, I know you don't have visibility necessarily into timing. But aside from sort of the macro things that you said, what gives you that confidence? Is it speed on the street, feedback from salespeople and where you've identified real customers where you know you're going to be placing systems at some point? I mean what kind of visibility do you have into the pipeline?

Ken Ferry

Well, we have a direct sales force in the United States and a number of them are focused on the skin market. We obviously have a database where they log in all of their prospects and funnel and so forth. We also have dedicated partners in the skin market, as I mentioned, DermEbx there as an example. So they're a great benchmark in our monthly and quarterly conversations as to what they see for activity. So we get a pretty good vision, if you will, of what's out there. And the overall level of activity is higher. We're doing the skin symposiums where we're bringing dermatologists, radiation oncologists together on a regional basis. The attendance at those meetings has been brisk, very, very positive. So there's a number of ways that we can assess activity in the marketplace.

But I would say in a general sense, all of those different elements, if you will, or feedback are positive. So we are very enthused. We have actual relationships in our field. We are now essentially going to have a team of dedicated skin specialists versus having a team of dedicated IORT people, so that we're going to put 100% focus in the different markets with specialists, which we think that additional focus will help us since the sale of an IORT system versus skin are very different. So we're doing a lot to just get even more laser-focused. And from all the different indicators that drove us to achieving 34 systems sold in 2013, all seem to be stronger relative to going into 2014.


The next question comes from the line of Dr. Harry Kopelman of HAK Consulting.

Harry Kopelman - HAK Consulting

I just have a couple of questions relative to new development and growth in other areas. Any idea what the impact the robotic surgery might have on treatment arm, for example, in prostate, I'm wondering if that and perhaps even breast? And then I was really interested if you analyze your users from a perspective of profitability per, say, dermatology site versus breast site, when you consider them to be fully loaded?

Ken Ferry

We're looking at IORT from a minimally-invasive standpoint relative to moving into what I call other organs or body areas. What we really do think in most cases is we need to be looking at very focal tumor in a very concentrated size. So in breast, it's very, very specific in terms of the tumor size that we would treat. So I'm not sure as it relates to prostate, given the size of prostate and the number of lesions that you could need to treat. So we're not necessarily focused there.

But there are a number of examples where minimally-invasive IORT could be very, very high potential going forward. But again, I think we're trying to provide a highly concentrated, highly focal treatment. When cancer is more spread, more pervasive, more invasive, there're more traditional types of radiation that could be used. So we're definitely looking outside of our current applications. But today, it's breast, today it's skin. We do have a number of applications approved for endometrial, cervical and we're certainly look to expand upon that. But again, in the type of cancers that are extremely focal, given the nature of how we deliver the therapy.

Kevin Burns

So from a profitability standpoint, in the skin market, as you may know, the reimbursement is between $1,000 and $3,000 per fraction in those areas that are paying, which translates into a reimbursement of anywhere from $8,000 to $15,000 per patient per lesion. And the cost of our system, if you amortize that out over five years, is a couple of thousand dollars. And then there's obviously associated cost for radiation oncology, support and radiation therapy support. So you add all that together, the margin in the skin market from a dermatology standpoint are very high percentages.

And then IORT market, as you know, most of our business is done in the hospitals. Those margins are not as healthy, primarily because the reimbursement is a little bit low. And we've been working on some of those programs. With all that said, in the IORT area, when we hospitals launch, we do see them increase their overall patient volume. So we did a case study at a major hospital center, and I think their patient volume increased 20% over their existing run rate, because they offered IORT. It doesn't mean all those patients came in and ultimately received IORT. They may have gone onto different treatment. But just because they offered the program, they show additional patients through the hospital system, which obviously adds to the financial benefit of the system.

Harry Kopelman - HAK Consulting

And then on the financial side, I was wondering when you guys think you're going to hit profitability based upon your earnings per share estimate.

Kevin Burns

So the way we think about the business from a profitability standpoint is $8.5 million to $9 million gives us adjusted EBITDA margins of 3% to 5%. And from a cash standpoint, it's [ph] 3,500.

Harry Kopelman - HAK Consulting

I was wondering relative to the first question, my real question had to do with the compatibility between the Xoft technology robotic surgery. I mean there are a lot of places that surgeons can get these days in a lot easier manner with robotics. And I just wasn't aware or nor familiar enough with the actual applicators in the way that surgeons do their procedures to know whether or not the two would be compatible or to be made to be compatible at some point? I guess I mean the robotic surgeries are very focal as well, as you pointed out.

Ken Ferry

I don't know that we've done extensive research, but I do think it's a very interesting topic to you point of focal surgery and focal therapy. It is something that I think some of our Ph.D. guys have looked at peripherally. And so I honestly can't give you any kind of adept today. I think it's a very good suggestion and something we should take another look at maybe in a little bit more depth. But certainly, focal surgery and focal therapy make a lot of sense. It isn't something today we've done a very active program on, but it's certainly something I think we should another look at.

Harry Kopelman - HAK Consulting

And should that be compatible, then of course there're other potential channel partners that you'd have, I mean, of a significant nature, because they're already in just to suggest.

Ken Ferry

No, I think it's a good idea. What we've found, though, with this opportunity is perfecting the technology quite frankly and getting the 510(k) is the easy part. The efficacy and the risk of recurring cancer is the part that is so important to the use of the technology and it takes time to build studies and to follow patients and so forth. So I think we're very interested in the concept. The amount of time it takes to get to market is a different discussion and it's a big investment. And so at this point, what we've tried to do as a company is to really look at the indications we have, looking at the markets being so early on in terms of adoption and we've put a lot of resources into the education and studies that support the use across the indications we have. But we do have a longer-term roadmap. And I think looking at robotics and looking at targeted surgery and targeted focal therapy absolutely makes sense.


Our next question comes from the line of Jeb Terry of Aberdeen Investment Management.

Jeb Terry - Aberdeen Investment Management

A question on the number of cases, wasn't quite sure. The number of skin cases, I think, you said it was like 1,000 for the quarter. Is that correct?

Ken Ferry

It was well over 1,000. And unfortunately, we're not getting all of our sites reporting. So this is one of those metrics that we had data available and so we don't have all the sites. It's not something we're going to be talking about going forward. Needless to say, obviously the volume has been raising nicely with all of our systems out there being utilized and each of the systems increasing their utilization, I think, is a fair statement as well.

Jeb Terry - Aberdeen Investment Management

Okay. Well, that was the nature of my question, since you had kind of a heavy back half of the year and kind of full placements and it does take some time to get those up to some normalized rate of utilization. So moving to this year and the second quarter of this year, sort of those units placed in Q3, Q4 will be coming onstream, I suppose?

Kevin Burns

That's right. We're doing a lot of business through our partners. And they're on average putting these systems to work in the production in the clinical study between 30 and 60 days out. So we're going to start to see the impact of our Q4 controller sales in February, March, April timeframe. From a revenue standpoint, we're going to start to increasing our source revenue even more.

Jeb Terry - Aberdeen Investment Management

Given all the bad weather, I guess was there any weather impact that has slowed down the rate of utilization, say, in the last number of months, three months or so?

Ken Ferry

Yeah, I think it's possible, but it's not anything we can track. And I would think it would be de minimis given that the majority of the systems there, West of the Mississippi. But one of the obvious indications for us relative to skin procedure is the amount of sources that we're selling relative to the contracts. So even though we can't get all the sites to give us accurate amount of data, to Kevin's point, as we said, the source revenue is the largest component of our recurring revenue in the business. It's more than 50%. That actual component of recurring revenue doubled in 2013 versus 2012.

And given that we used more source time in the skin market and we're slanted obviously towards a lot of sales in that market, we do expect that component of our recurring revenue to continue to grow at a very health clip and really drive that portion of the business, if you will, at a pretty significant growth rate, given the number of skin sites we now have as well as again how much utilization they do from a patient standpoint. In the IORT world, one procedures, 10 or 12 minutes. In this case, you're basically providing a patient with roughly 40 minutes of treatment over the course of, say, four weeks.

So more patients, more source time and hence more source revenue.

Jeb Terry - Aberdeen Investment Management

I guess your thoughts on the utilization as a percentage of what the ultimate utilization would be, it seems to be quite low at this point.

Ken Ferry

Yeah, absolutely. I mean the systems there capacity-wise, when you think about five-minute treatment per patient, you could crank through a substantial number of patients. But you know what, what we love about the skin market is that the absolute size, the number of patients is very significant. As we've talked about the clinical outcomes, the cosmetic outcomes supported by Dr. Bhatnagar's study particularly is very, very positive. The reimbursement is strong. And again, the source component is something our customers use a lot of source minutes. And it is the biggest contributor to the recurring revenue portion of the business.

And one of the things we're really attracted to when we looked at the Xoft technology was that as you get critical mass, so to speak, on placements, Jeb, the recurring revenue really, really grows. And just to give you an example, our recurring revenue in the first quarter of 2013 was just $1 million. In the fourth quarter, it was just under $2 million. So we almost doubled recurring revenue from the first quarter of the year to the fourth quarter. So that gives us some indication. When you really get a number of systems placed and procedure volumes start to really ramp, what a dramatic impact that can have on the recurring revenue portion of your business.

Jeb Terry - Aberdeen Investment Management

And on the conference that's coming up next month, in the world of dermatology, I'm just kind of curious how large that might be and then what that might be able to put some context on what kind of exposure you would have to the dermatology customer base through that conference?

Ken Ferry

I don't have exact numbers on attendees. This is in March in Denver, but it's the biggest dermatology meeting in the United States. And so we're very, very enthused about being there. And Dr. Bhatnagar is going to present his data there too, which I think is very, very powerful. So we think that's just another example of focused touch point with this market. And we're still investing and ramping, because calling on dermatologists is really something we've only really put tremendous focus on the last year or so. So we're excited about being at this academy meeting. It's a big one. And I think the buzz around treating non-melanoma skin cancer with radiation of radioisotope-free technology is really gaining traction.

15,000 I think is the number we're hearing of attendees. So that's a big, big conference, lots of exhibit space. And for us, it's going to be an extremely timely opportunity.


The next question comes from the line of Brian Marckx of Zacks Investment Research.

Brian Marckx - Zacks Investment Research

Kevin, you had guided to $6 to $6.5 million for quarterly operating expenses in the past. Do you think that that's going to continue to be the case in 2014?

Kevin Burns

In Q4, we expensed about $6.9 million, as I mentioned in the remarks. A couple of hundred thousand dollars of that I think is more in kind performance related. So I think going forward, our operating expenses are going to be closer to $6.5 million range. And as the business starts to scale, we may start to invest additional money going forward to accelerate growth as well. So I think we're more in the $6.5 million range and perhaps growing throughout the year a little bit.

Brian Marckx - Zacks Investment Research

Relative to the Therapy business in Q4, was there any kind of unusual lumpiness relative to source revenue based on bulk orders or whatever it might be?

Kevin Burns

No, our source revenue, almost all of it is recognized ratably over the term of the agreement and though they're typically one year. So we usually don't get spikes in the source revenue. That is just recognized ratably over the term of the agreements with our customers.

Brian Marckx - Zacks Investment Research

And in Detection, the business has shown nice improvement, but yet to be consistently growing. Is the current iron in the fire enough to grow the business in 2014, do you believe?

Ken Ferry

So if you look back on 2013 and you do a little deeper analysis, Brian, we actually had some elements to grow. To give you an example is that the business was down 2% roughly or so versus the year prior. However, international was down considerably. And if you look at the US business, it actually grew a couple of percent. So we had a couple of percent growth. The other thing that's dragging on our growth is the analog products, which are declining rapidly, as you would expect.

So just as an example, in '13, the analog product sales were down almost $1 million compared to the year prior. So if you kind of carve out what I would call the negative growth drivers, which would be the decline of the film-based business and weaker international sales mainly because our biggest part of the GE launch their tomo product in June of 2013 and they focused almost exclusively on tomo, we actually had growth in the US business. We had real strong growth in service. We had actually scope in MRI and we were just ahead slightly a couple of points as well in digital CAD, even though the market was declining. And that's a reflection of how well we're getting traction on our upgrade business.

So there's lots of moving parts. I think that's a good point. But there were some core portions of that business that grew. And again, the US business did have modest growth. So as you kind of look into '14, we think we're going to get continued strong traction on our upgrade with PowerLook. We have an aging install base. We have hardware in that install base that is obsolete. Customers know that. They're not under some sort of a support agreement. And if systems go down, they essentially have to buy new systems. So we've been able to get a number of customers to upgrade to the new platform, new features, particularly the breast density. So we think the Volpara breast density could contribute to growth in 2014.

Our relationship with Invivo is gaining traction. We had a strong fourth quarter on license revenue for MRI for prostate. We are off to a very strong start in 2014 with them as well. So we think that is an initiative that can grow. We are actually seeing pretty strong interest internationally on colon CAD. And Vital Images as our partner internationally has shown some pretty good traction. So there is a, I guess a baseball term, lot of singles and doubles being hit in the business. We think that the business is stable and it could show modest growth in '14 versus '13 for those particular factors.

The other thing I would say is we're making good progress on tomo in creating a set of workflow tools to help with the interpretation of tomo images for mammography. We're hopeful that maybe in late Q4, we could have a product ready internationally, and then in the first quarter or two of 2015, depending on the regulatory cycle have something in the United States. So we think we could have a very solid year in '14. There are some growth drivers that are not going to turn us into the growth mode we have in Therapy, but they could certainly give us modest growth over '13 and put us in a very, very good position to grow in a much more substantial way in 2015.

Brian Marckx - Zacks Investment Research

Can you give me the film-based revenue for the year for 2013 and the year for 2012?

Kevin Burns

Film-based in 2013 was about $550,000 and it was about $1.46 million in 2012. So down almost $1 million year-over-year.


The next question comes from the line of Shawn Boyd of Next Mark Capital.

Shawn Boyd - Next Mark Capital

You mentioned the pipeline earlier. I think you talked in the past about sort of the size of that pipeline and maybe a number of the deals or dollar size. Anything you can give us there would be real helpful.

Ken Ferry

Yeah, I don't recall putting a firm number, if you will, on the size of the pipeline. And I assume we're talking specifically about skin. What I would say, though, is that from the data we have in the and from the correspondences and dialog with our dedicated skin partners, the overall activity is clearly continuing to increase. And so I can't really spell out a very specific number in terms of the funnel size. But what I would say is that we feel confident that the growth will continue throughout '14 in this market based on several things.

One is the increasing interest in the geographies where we have existing strong reimbursement with both customers looking to expand that have already purchased into other sites as well as new customers. We see emerging reimbursement moving towards the Midwest. St. Louis is one example. So we definitely think that the opportunity to move East, if you will, and into more addressable markets that reimbursement has been established clearly is going to increase demand.

And I think also as we get more awareness out there, whether it's the national meetings like the Academy of Dermatology coming up in March or the regional symposiums, all this bodes very, very well for dermatologists and radiation oncologists to want to get into this therapy. So I can't give you a hard number. What I can say is that the overall activity level is substantially higher today than it was a year ago. And we think that bodes well for a strong 2014 in the skin market.

Kevin Burns

95% of our customer, Shawn, are in three states, primarily in the Southwest. And two of those states are file and pay. So if you do the math, as you know, we have 16 states that are positive pay. We had one with a high percentage of customers in there at this point. So we have 15 states with positive pay that we're working on entering. We've added two new salespeople since the end of the year that are focused on skin and actually help grow our pipeline and sales as well going forward.

Shawn Boyd - Next Mark Capital

That led right to my next question, which is going to be the concentration of the controller placements over the past couple of years on skin. So 95% of the customers are in the three states. Is that what I just heard?

Ken Ferry

That's correct. It's California, Nevada and Arizona. And two of those states are silent from a reimbursement standpoint, but they've been paying consistently. And Arizona is a positive pay policy state. That is where most of our business is concentrated. We have initiatives underway for the other positive payment states, which is helping both our pipeline and funnel.

Shawn Boyd - Next Mark Capital

In terms of the third-party providers that you work with sometimes here, I would assume that interest is probably continuing to accelerate and you're getting more third-party programs that you can work with on the skin side, is that a fair statement or not?

Kevin Burns

It is. And in the fourth quarter, I think we had one or two just start their operations and business and they're starting. And then we have other ones that are looking to partner with us in other territories as well. So DermEbx and ARS are certainly our partners and they're doing a great job in the market, but we're seeing some other folks starting to enter as well.

Shawn Boyd - Next Mark Capital

And then just on breast IORT, did controller placements in breast IORT grow in 2013 or were they fairly flat?

Kevin Burns

They were actually down. So in 2012, we sold about 15 units. In 2013, we sold 10 units. Our balloon procedure volume was up about 15% on a year-over-year basis. The number of new system placements was down a little bit on a year-over-year basis.

Shawn Boyd - Next Mark Capital

And as we go into 2014, would you expect that to continue to be steady, or would you expect to see some sort of inflection on the breast IORT placements this year?

Ken Ferry

I think we expect to see it grow from last year. We had a particularly strong year in '12. We doubled the number of systems in '12 versus '11. I think we sold seven IORT systems in '11 and then we sold 15 in '12. So we doubled the number in '10 and '13. So we did go down. What we're seeing though, Shawn, is the sites that are up are steadily increasing their volumes and that relates to the number of balloons sold. So what we're very encouraged by is the sites we've sold to have done all the right things in terms of establishing a patient protocol, a marketingness to their patients and they're seeing increased amount of procedure volumes, which as we know brings in a lot more business beyond just the actual procedure.

So we've a number of sites that have been very, very successful. And we think those references will bode well for us in terms of gaining more sites. Our funnel was pretty strong in the second half of the year. A number of deals just did not get across the goal line by year-end and we hopeful that as we get into 2014, we're going to start to see more of those transactions close. Also, we think IORT in international markets is a real attractive value proposition. Often, you go to some of the developing countries where getting the patients to the therapy is not trivial. Being able to bring this therapy to the patients in a mobile fashion could really be positive.

So we're investing more internationally, which we think will also increase IORT since the market for skin right now is more US-centric. So we have a much more ambitious plan. As I talked about in my opening comments internationally this year, we have several dedicated senior resources within the company focused on it. And I think we'll see a lot more IORT sales in international markets in '14 versus what we did in '13. So we add that to a stronger US market, we feel confident we will grow in terms of number of new system placements in '14 versus '13 in that space.

The clinical data continues to be strong and the reimbursement continues to be strong directionally in terms of making progress for increasing reimbursement each year in the hospital setting. So we still think this is a real solid business opportunity.

The other thing related to IORT we're doing is we're very investigating the notion of adding Electronic Brachytherapy IORT as a boost such that post-lumpectomy, they would get a boost and then in addition to the boost, they would get a shorter regiment of whole breast radiation. We very recently brought a panel of experts together to discuss how we could establish a clinical protocol for using IORT as a boost and then obviously modifying the whole breast radiation. If you do that, you almost double the number of patients that would be eligible for IORT as a boost. And so we're looking at a way of possibly opening up a study with those that want to follow those protocol or use this as a boost to do so. There are several sites that are doing that today and we're relying on a lot of their experience and expertise along with expert panel.

So that's something we're also investing in with IORT. And if we can combine boost with monotherapy, our sense is that the addressable market may come close to doubling in the near term. So we're very, very committed to IORT. We think the value proposition for the patients is enormous and the addressable market is still very considerable. And at this point, I would say it's low penetration.

And as we look out to '14, we'd like to think there is the possibility of substantially increasing balloon sales again, because we have the number of sites that are increasing their volume as we bring on new sites.


There are no further questions. So I'd now like to hand the call over to Mr. Ferry for closing remarks.

Ken Ferry

So I'd like to thank everyone for calling into our quarterly and full year results. We're very, very pleased with our progress in 2013 both from a product roadmap standpoint as well as from a financial performance standpoint. We're very, very confident and enthused about our future. We believe we've got solid plans in place, focused resources. And ultimately as we are now in a middle of Q1 2014, are very, very enthused and optimistic about a strong year.

So with that, I thank you all for your interest in the company. We look forward to speaking with you again at the end of our first quarter as we report our first quarter results. So thanks again and have a good day.


Thank you for your participation in today's conference, ladies and gentlemen. This concludes the presentation and you may now disconnect. Have an enjoyable day.

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