Vital Images, Inc. Q2 2010 Earnings Call Transcript

Aug. 6.10 | About: Vital Images, (VTAL)

Vital Images, Inc. (NASDAQ:VTAL)

Q2 2010 Earnings Call

August 05, 2010 11:30 am ET

Executives

Mike Carrell - President & CEO

Peter Goepfrich - CFO

Analysts

Steven Crowley - Craig-Hallum Capital Group

Ernie Andberg - Feltl & Co.

David Larson - Leerink Swann

Richard Close - Jefferies & Company

James Cho - Oppenheimer & Co.

Mohan Naidu - Piper Jaffray

Steven Crowley - Craig-Hallum Capital

Ernie Andberg - Feltl and Company

Operator

Good day everyone and welcome to the Vital Images second quarter earnings conference call. Today's call is being recorded. At this time I would like to turn the call over to Mr. Mike Carrell, President and CEO. Please go ahead, sir.

Mike Carrell

Thank you Marvin and good morning everyone. Welcome to our 2010 second quarter conference call. With me today is Peter Goepfrich, our Chief Financial Officer.

Our most [purposeful] comments are 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 such results to differ are identified on page seven of the Form 10-K for the year ended December 31, 2009.

We are pleased to announce that in a tough market we grew 2010 second quarter revenue 4% to $14 million from $13.4 million in the second quarter of 2009. Additionally, our distribution partner Toshiba continues to face a challenging CT scanner market and therefore our revenues in that channel were below last year's levels. The encouraging news is that we offset the Toshiba shortfall with growth in our other channels, including one, significant increase in direct and other distributed revenue; two, our first sonar deal with the contract we signed during the quarter; three, continued enterprise growth in Europe; and fourth, market acceptance of Vitrea Enterprise Suite 1.3 which was rolled out in May.

We remain confident that our enterprise solutions are the right directions for the company and for our customers. The US News & World Report, hospital "Honor Roll" just released in July derives that point home. All of the 14 hospitals on the list use Vital Images software and solutions and 71% currently have or are in transition to have our enterprise solutions.

We are honored to contribute to this club of the distinguished hospitals. In addition to the sluggishness in CT sales the other down size in the quarter was gross margins, which were impacted by product mix including lower margin hardware sales than usual. Peter will go into some more details when he goes through the financials.

While we continue to control our operating expenses at the seven quarters of positive adjusted EBITDA, second quarter adjusted EBITDA was negative 213. That's not where we wanted to be or where it should be and not where we anticipate our numbers to be in the back half of the year. I want to emphasize that we continue to watch expenses very carefully.

At the end of the second quarter we had 241 employees, down from 246 for 2009 year end. Importantly, we continue to generate cash from operating activities and our balance sheet remains solid with over $143 million in cash, the same as the end of last quarter. As our news release noted our Board auto authorized to buy back stock of an additional $20 million of our common stock. This decision reflects Vital Images' financial strength and are confident in our business going forward.

For more financial details in the quarter, I'll now turn the call over to peter.

Peter Goepfrich

Thank you, Mike. I will begin with a few comments regarding revenue. License revenue increased $597,000 or 13% compared to the second quarter last year. The change consisted of an increase in direct and other distributor license revenue of $1.2 million or 356%, offset by a decrease in Toshiba license revenue of $631,000 or 15%.

License revenue decreased $359,000 or 6% compared to the first quarter of 2010. The change consisted of a decrease in Toshiba license revenue of $932,000 or 21% as second quarter is typically Toshiba's softest quarter. This was offset by an increase in direct and other distributor license revenue of $574,000 or 57%, primarily due to an increase in license revenue from our Hit Distribution Partners.

Maintenance and service revenue decreased $206,000 from the second quarter last year, primarily due to a decrease in educational revenue of $231,000 as a result of a decrease in US license sales across all distribution channels for the proceeding four quarters compared to the proceeding four quarters a year ago. Maintenance and service revenue decreased $639,000 from the first quarter of 2010, primarily due to a decrease of $438,000 for Toshiba billing adjustments relating to stark period in the first quarter 2010 as well as an uptick in bad maintenances in the first quarter compared to second quarter.

For the first time since 2006, McKesson represented more than 10% of total revenue at 12%. This consisted of license revenue of $395,000, maintenance and service revenue of $1.1 million and hardware revenue of $166,000.

Next, I would like to discuss gross margin by revenue category. License fee gross margin was 79.6%, down from the second quarter last year and from the first quarter of 2010, primarily due to a change in product mix, including one, a higher percentage of total license sales relating to installed base customer conversions to which we Vitrea Enterprise Suite which results in lower upfront revenue and therefore lower gross profit than net new sales; two, a lower number of net new Vitrea sales which more often carry higher upfront revenue margin and customer convergence to Vitrea Enterprise Suite, but its important to note that Vitrea Enterprise Suite results in higher long term maintenance and service revenue in Vitrea standalone sales; and three, an increase in third-party software sales which carry lower margins.

Pricing pressure in the market and increased royalty expense also contributes to the decrease. While these factors will continue to impact license fee gross margin in the near term, we don't anticipate lower license fee gross margin the second quarter of 2010. Additionally, the opportunity for net new sales of and add-on sales to Vitrea Enterprise Suite will drive improved license fee gross margin and total gross margin in long term,

Maintenance and service gross margin was 68.8%, down from the second quarter last year and the first quarter of 2010, due to an increase in headcount, contractor and travel-related cost for customer upgrades, as well as the impact of the $231,000 in education revenue decreased from the second quarter last year and a decrease of $438,000 for Toshiba billing adjustments related to stark periods previously noted.

While typically low, the negative gross margin on hardware in the first and second quarter of 2010 was a result of several strategic deals where the revenue allocated to hardware was lower than the cost of the hardware. To reduce factors gross margins decreased 60% to 69.4% compared to 75.7% in the second quarter last year and 74.9% in the first quarter of 2010.

Moving on to operating expenses. Sales and marketing, R&D and G&A expense decreased to $479,000 compared to the second quarter last year, primarily due to a decrease in headcount-related cost. Sales and marketing, R&D, G&A expense decreased $772,000 compared to the first quarter of 2010, primarily due to the $692,000 equity-based compensation charge in the first quarter of 2010 relating to the stock option tender for a play stock options. As noted in our earning's release our board of directors has approved an additional stock buy backup, up to $20 million on top of 566 shares remaining to be purchased under previously approved plan. As of the end of the second quarter, we repurchased 3.3 million shares for $44.0 million since 2008. During the month of July we repurchased 92,000 shares for $1.2 million.

Next, Mike will provide an update on our corporate priorities.

Mike Carrel

Thank you, Peter. In 2010 we are focused on growing our enterprise customer base after laying the groundwork to become an enterprise provider in the previous two years. We extending our technology leadership beyond radiology and cardiology and placing productivity enhancing tools into the hands of more physicians and surgeons, closer to point of care. In other words, we are redefining how imagining is used throughout the entire healthcare enterprise.

This year we are concentrating on four key strategies. They are continuing to diversify revenue from new channels and corporate development, growing our direct sales channel, expanding our product platform for enterprise growth with platform and clinical applications, and aligning with customer success to installed base programs and a commitment to service excellence.

Let's take each of these one by one. First diversifying our revenue channels. Over the last several months we have announced partnerships for expanded agreements with several leading healthcare IT companies. These partnerships are beginning to gain traction with sound growth prospects for the coming years. Our distribution agreement with McKesson which we enhanced and extended last year is starting to generate results.

Second quarter license revenue through McKesson was $395,000 a fourfold sequential increase over the first quarter license revenue and records five deals during the quarter.

McKesson recognizes all images as its preferred provider of advanced visualization products and our new enterprise product release has been well received by their customers. Examples of recent McKesson customers includes St. Joseph's hospital in South Bend, Indiana; Gwinnett Medical Center and Phoebe Putney in Georgia; St. Joseph's Mercy in Ann Arbor, Michigan and Virginia Commonwealth University in Richmond, Virginia. At memorial of Tampa, we have integrated our Victory Enterprise suite with McKesson's cardiology packs for the first time as well.

We have several McKesson reference sites up and running on our enterprise platform, after discussions with our installed base that produce a strong pipeline in the United States. As capital budgets free up and hospitals allocate resources to projects like ours. We are well positioned to expand our Victory Enterprise suite deployment through the McKesson channel.

In the second quarter we continue to book revenue through an agreement with Medtronic launched in late 2009. Under this partnership Vital Images is providing our endovascular stent planning application to specialists using Medtronic stents to treat aortic aneurisms.

Our US role is progressing as planned and we've begun introducing our application in other parts of the world, through Medtronic's regional offices. We are also looking to expand in other areas in the coming years and have build a good relationship throughout the entire Medtronic organization.

In last quarter's call I discussed an agreement with Cerner to seamlessly our Vitrea Enterprise Suite, VES into the Cerner Millennium Platform. Since then, we signed our first Cerner customer in Europe and have developed a strong pipeline of prospects in that region and the United States. Cerner is a global EMR provider and its millennium platform is installed in more that 8,500 healthcare facilities around the world including 2,300 hospitals and 3,400 physician practices. Our agreement with Cerner is the industry's first deployment of advanced visualization through EMR and positions us as one of the US market leaders, as well as gives access to the growing Cerner global business.

We also landed two new customers in Europe through our distribution agreement with Sectra based in Sweden and one of the world's leading healthcare IT companies with more than 1,000 hospital customers. We converted this partnership in the third quarter of 2009 and Cetra now Sectra now offers its customer our Vitrea Enterprise Suite.

Next, I want to provide an update on Toshiba, our long-time partner and a technology leader in CT scanners. The CT market is facing difficulties due limited hospital CapEX spending and Toshiba is also facing competitive pressures in the US and Europe. The second quarter is often slow for Toshiba, however Vital Images second quarter revenue through Toshiba are $3.6 million compared to $5.8 million in the year-ago period was a little bit lower than we had expected. We are working close with Toshiba and expect growth for the second half of 2010 compared to the first half.

Our second priority is our growing direct enterprise sales channel. Second quarter direct and other distributor revenue grew over 300 % from the year ago period and was also up 60% sequentially from the 2010 first quarter. Most direct sales are now enterprise transactions that build the number of position users while leading to substantive recurring revenue from long-term maintenance and services agreements.

Further, we are winning key deals against the competition. Since the beginning of 2009 we have landed or converted more than 125 direct Vitrea Enterprise Suite customers. Our European team is also starting to perform well, completing 10 enterprise transactions in Europe in the second quarter.

Earlier this year, we established a strategic account team focused on large hospital systems and we are seeing progress in these high level relationships. Recent wins include the medical college of Virginia in Richmond, Trinity Health hospital in Michigan; Banner North Colorado, Medical Center in (inaudible); University Medical Center in Tucson, Arizona; and the Christ Hospital in Cincinnati, Ohio.

Our third priority is expanding our product offerings for enterprise growth with platform and clinical applications. We launched Vitrea Enterprise Suite 1.3 in May as planned. VES 1.3 offers new clinical applications with a rich set of workflow tools in a truth in client solution. Cardiac applications include multi-chamber analysis and adult and pediatric options to automate the analysis or atrial and ventricular chambers.

Additionally, VES 1.3 enables web access to MeVis CT Lung, the first and only clinically validated lung CAD system for chest CT. Outside the US Medicsight's Colon CAD and a new myocardial perfusion application are also available. Our robust, scalable thin client architecture is the foundation for these exciting product developments. We are expanding our leadership in clinical applications by tailoring functionality for radiologists, neurosurgeons, orthopedists, oncologists and other specialists.

At the SIIM, Society of Imaging Informatics and Medicine conference in June, we hosted a tech talk session that brought together 40 medical imaging directors, CIO and tax administrators with Vital Images' leadership team and top engineers, discussions centered on the direction of the industry and shaping future technologies. This kind of feedback and collaboration with a leader in the industry is essential as we develop the next generation of advanced visualization solutions.

Our fourth priority is aligning with our customer success to install base programs and a commitment to service excellence. We do this quarter end and quarter out. Service excellence is a well established priority at Vital Images and essential factor in attracting and retaining customers.

Earlier this year, we became the only advanced visualization provider to receive the JD Power and Associates certification for service excellence following a rigorous audit of our service practices in expensive customer survey. We were recertified by the Technology Services Industry Association for providing superior technical support in services to our customers in North America. All of this is Vital Images are devoted to serving our customers with exceptional clinical and productivity tools, quality training, and responsive support to help to maximize their investments in our solutions.

I also want to note another factor affecting the healthcare IT spending environment. In mid July, CMS announced stage one of the final medical use school, requirements for electronic health records for hospitals participating in Medicare and Medicaid programs. Incentive plans for hospitals under the American Recovery and Reinvestment Act are contingent on meeting these stringent requirements. Understandably, IT administers are focused on the implications of these requirements.

Stage 2 is scheduled for release in 2013 and will address images and imaging reports among other factors. All of these requirements affect IT pursuing decisions. Vital Images is actively involved with various industry trade group associations in discussions regarding stage 2 requirements and advocating for workable imaging requirements.

In short, we believe that imaging plays a critical role in physician to physician and physician to patient communication and having imaging incorporated into the EMR is a valuable efficiency and communications tool that will facilitate better healthcare worldwide.

In summary, we are pleased with the momentum in revenue from our partnerships as well as our direct sales channel in the US and Europe. Although Toshiba faces a difficult selling environment, we remain committed to and continue to anticipate both top and bottom line growth in 2010 over 2009. Now we would like to open the call up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we'll take our first question from Steven Crowley with Craig-Hallum Capital Group.

Steven Crowley - Craig-Hallum Capital Group

I want to make sure I understand Peter what you are communicating about license gross margin in terms of the implications over the relative near term and may be as we look out to next year?

Peter Goepfrich

Yes, I can elaborate on that. If you look to the old workstation market in Vitrea sales, they typically drive overall higher license margins but lower long-term service margins and it is a confined market in each market to radiology space. Making a transition to the enterprise, we're seeing margins because of the mix between conversions of Vitrea, so our effort to get our IV ViTAL Enterprise Suite. We're sacrificing some margins there so single blended margin around 65% for the estimates, primarily driven by the conversion effort. I anticipate that would increase as we get through conversions and have more net new transactions as well as drive longer term maintenance.

Steven Crowley - Craig-Hallum Capital Group

And the crossover point to more new installations, when do you think that becomes possible, is it late this year, is it next year? What's the best guess on that?

Mike Carrell

Steve, when you say the crossover point, what exactly are you referring to?

Steven Crowley - Craig-Hallum Capital Group

Obviously, we are in a period where there is a greater mix of conversions. At the same time you've been filling up the funnel of perspective new accounts for enterprise deployments. And I guess the crossover point is when does your installation mix gets more bias towards new accounts and therefore when do we see a license gross margin that gets back up into the historical range?

Mike Carrell

I think you are going to see a mix for the next six to 18 months in terms of between the two. Our pipeline is very rich as you mentioned on some of the net new ones and you went to couple of those and they can change the margin profile very quickly on the license revenue side of things. But in terms of the time and work continuing to convert, we're trying to convert our entire installed base over the VES and as we convert them some of those are going to be lower margin upfront but longer term, a lot healthier on the maintenance and services margins for us. It really depends on how quickly we ramp up some of the new sales and those new budgets that open up on some of the bigger deals that we are working on.

Steven Crowley - Craig-Hallum Capital Group

And specifically in terms of the margin number being down below where its run for a long time on the license margin side, what were you trying to tell us Peter over the near term that its going to stay down here in the upper 70s for license margin or that it can move back towards the low to mid 80s over the next several quarters?

Peter Goepfrich

We don't anticipate it getting lower than it is today. We think this is kind of a low water mark. We don't anticipate it getting up to the mid 80s near term but in the short term certainly below 80s.

Steven Crowley - Craig-Hallum Capital Group

Then in terms of some of the dual pipeline that's developed for the second half of the year and beyond. The mention of some competitive wins; it sounds like maybe you had a bit of a delta there in terms of your competitive successes, is that the accurate read on my part and what kind of color can you give us?

Mike Carrell

When you see delta meaning?

Steven Crowley - Craig-Hallum Capital Group

You're having more success or is it just the same amount of success?

Mike Carrell

No, that's not having much more success within our competitive installed base. So, we are winning not only both within our, many deals that have not come to revenue yet where we've been chosen as the vendor of choice. Our people are looking at our products as we are the only truly scalable solution that's out there today. We've now got many reference sites on our new platforms that people can refer to. We've had very successful deployments. And so, I know, we're seeing a higher win ratio from that standpoint.

Steven Crowley - Craig-Hallum Capital Group

Final question from me and then I will hop back in the queue. In terms of service, you referenced that you had your first deal signed in the quarter. Does that mean it wasn't revenues in the quarter and what are the prospects for revenue and deals in the second half of the year?

Mike Carrell

The deal was revenue, you should not have talked about that there was actually the first deal that was more fine-end revenue in the quarter. So we actually we got both of that and we are working the pipeline. We got a really nice pipeline with Cerner, but the relationship is young in terms of kind of how we bring some of those through. And as you might know, a lot of them are attached from the large transaction that they are working and so we are actually learning kind of how to work through the center process.

I don't want to give any kind of guarantee by any means in terms of what the revenue is going to be in Q3 or Q4 from Cerner but it is a long term relationship and every indication so far has been very positive in terms of the roll-out to the reference sites, the interactions in the field with our team. We've trained about I think 15 or so people in the Cerner organization on our products, so they are actually out. They have come to our facility here in Minneapolis. They have been training on our parts for several days. We've been interacting with them at the field levels at both IDNs and major accounts. And so it's actually been a great relationship and the pipeline again is building. But, the relationship is new at this point in time and it's only going to expand.

Operator

Thank you. Our next question comes from Ernie Andberg with Feltl and Company.

Ernie Andberg - Feltl & Co.

Good morning, Mike and Pete. Just take a little bit further on the trail, just gone down. Your argument is that as you do more enterprise systems your maintenance and service margins should start to get better. What kind of time horizon to expect there, Pete?

Peter Goepfrich

The time horizon would be partially dictated by the market. Right now the indication Mike gave was six to 18 months for seeing this conversion of broader effort but you really have to look to us generating more license revenue and seeing a broader turn in the market first to continue to drive that improves maintenance and service margin.

Ernie Andberg - Feltl & Co.

Okay so tied to the same factors as driving the license line margin.

Peter Goepfrich

Through less of the extent, but yes.

Ernie Andberg - Feltl & Co.

Mike, you indicated disappointment in the EBITDA contribution in the quarter and suggested that it should get better in the second half yet Peter is telling us to pamper our expectations on gross margins. How do I think about those two issues?

Mike Carrell

Well, we're not going into flip in the sense that we anticipate growth year-over-year in 2010 and 2009 which enables us to drive some of the EBITDA growth.

Ernie Andberg - Feltl & Co.

But if gross margins are going to remain under pressure in the second-half and you've done a good job on maintaining your operating expense levels, how do we think about going to positive EBIT in the second half? Is it just volume related?

Mike Carrell

It's definitely its volume related, yes. It's that simple. If you look at the numbers in the top lines in Q3 and Q4 of last year, we're saying we're going to grow on the top line there. We'll get some leverage on that standpoint and as Peter noted, we believe that the gross margins in particular in the second quarter were at the low point and before clashes about the back half of the year for sure and we should be but at the same time, we know that we anticipate the top line will grow a bit in the back half.

Peter Goepfrich

And then on to that Ernie we have reduced and continue with operating expenses as a run rate compared to last year. They are down from last year, so that's adding to the improved profitability of that.

Operator

Thank you. Our next question comes from David Larson with Leerink Swann.

David Larson - Leerink Swann

Just a couple of quick questions for the Cerner deal, that was in more than 10% of revenue. Was it?

Mike Carrell

That was not.

David Larson - Leerink Swann

Okay. Can you give any more color on how much this deal can contribute to your top line, any more clarity on sort of what the potential is there?

Mike Carrell

Well, I think the way we've given the clarity on the potential there is that we've kind of shown you the size of Cerner. And Cerner is a multi billion dollar organization. It's the number one player in EMR market. They clearly see that imaging is a strategic portion of their business going forward. They have got the same vision for how imaging can play within that room and that's really what the market opportunity is. They have got over 23 hospitals worldwide that we're going to now get access to and they have got a sales force that's outselling.

In terms of the dollar numbers, we're not going to get in the specifics, but I think you can begin to look at the size of that market, the touch dollars are spent in that market and begin to kind of really look at our long-term vision how that's coming together.

David Larson - Leerink Swann

And can you give us any sense on the economics like the pharma sales person for Cerner, what's my motivation to sell your product? How much am I going to get earned and obviously I don't need or expect to get specifics, but can you give a sense on the sort of like what the motivation is on their part like how much they receive?

Mike Carrell

They are motivated just like they are motivated to sell their products relative to their commission plans and things like that. And number, number two it's a differentiator. The products that we have with them as I mentioned in my release, they are going to try to win deals and use this as a tool to help them win deals which is the only truly integrated product into their platform and I think that that's what they're looking to aim to do. Then also, if you listen to their conference calls a lot their sales don't come from net new deals, but come from install they sell, and kind of continuing to enhance their customer service and customer satisfaction and bringing tools together. And what a great tool that the customers know about and are aware and wanted the enterprise wise and it's a great way to do it through them, so there's huge value added that they are bringing to their customers that they are advisors to for lack of a better word.

David Larson - Leerink Swann

Okay great and then in terms of reimbursement, I think the final Medicare rule came out a couple of months ago, what did you guys think of that was? Did you guys dig through that and as far as reimbursement rates go for imaging code, was there anything in there that sort of stood out?

Mike Carrell

Yes, I don't think there was anything that was surprising, we have looked at it, obviously reimbursement in general came down and they are going to continue to be pressure on that. I don't that hasn't changed in the last two, three, four years on that particular port. Obviously that's the reduction I got a big hit back in 2006 and a big impact on us. These were changes that we expected and anticipated and so I don't know if that helps answer the question.

David Larson - Leerink Swann

All right and then just one last question, when you guys buy back stock, do you buy back in the open market?

Peter Goepfrich

Yeah through under 25 on plan, though it is open market

.

Operator

Thank you. Our next question will be from Richard Close with Jefferies & Company.

Richard Close - Jefferies & Company

Yes thank you. With respect to the cheaper revenue, just want to go over that again what it was in quarter, can you give those numbers again?

Mike Carrell

Yes, license revenue $3.6 million, maintenance and service $2.9, hardware $100,000,

Richard Close - Jefferies & Company

Okay so there is three points, just want to be sure that that compares to the $4.2 million a year ago?

Peter Goepfrich

Yes

Richard Close - Jefferies & Company

And then what are your thoughts on Toshiba? I guess the trends that are going on with respect to that channel?

Mike Carrell

I mean several things first and foremost they continue to be a great partner for us. Last week I just spend a lot of time with the President and CEO Tsunakawa-san. I'll be actually heading out to Japan after this call. The relationship there on both the technical and global market stance is very strong especially in CT part of the business. We are working with them to better understand their needs in other aspects of they business and to kind of expand from that standpoint. They are growing share in MR and in ultrasound and some of the other areas.

They continue to be focused being a top player in the CT space. They've got a great scanner in the market and so our partnership is very strong. So then, they are seeing growth in the Asia market as or if you look at the results from GE, Siemens in particular, you see that their growth is actually in those areas and then also in the Americas but not north America where they have all seen declines in both Europe and the North American Toshiba is not different, in terms of our numbers with them.

I remember reports have come out exactly what the new date is for the quarter so I don't have that to talk about on this call today but they are clearly in that area. They are not losing share. They are wining a lot of deals and they've got great scanners. And their belief is that market is going to come back. The question is when and when is the recovery going to happen and they believe they've got the scanner. It's best in the marketplace, the 320 scanner, and it is a great machine.

Their focus on pediatrics which as I mentioned we built out a pediatric application very specifically for that. Its really the only one in the marketplace today differentiated from every other vendor that's out there. Also very focused on [stroke] centers as well which again we believe we've got the best applications in that area. So they are focused on specific areas where we are targeting it and the partnership remains strong

Richard Close - Jefferies & Company

And what was Toshiba license revenue in first quarter of this year? I don't have that right in front of me.

Peter Goepfrich

4.5.

Richard Close - Jefferies & Company

Okay, so 4.5 to down where it is here in the second quarter. So when we think about these gross margins, how do you see a pretty big step down, first quarter to second quarter? I guess some of us here are just trying to get comfortable with if we look a year-to-year as out, what is the margin profile as you completely switch over to your enterprise often?

Mike Carrell

It's a great question. Obviously its one that we knew would be probably the focus of the call today. We are going through the conversions and what you saw this quarter was a lot of deals that we want to do the conversion which are at lower margins because we are converting a workstation to the Vitrea Enterprise Suite with the larger maintenance contract on the back end of it.

And so it depends on how long it takes us to do the conversion but we can go back now into that installed base because once they are on our VES solution, there's a lot of levels to go in and sell new applications or new users as they expanded out the enterprise. And so, that's why when we talked that we believe that the second quarter's kind of that lower mark but we are going to have enough conversions going on throughout this year and next year and we are hoping to basically expand within those accounts and then grow on new accounts. And so the margin profile can get better for sure. We are giving specifics.

Richard Close - Jefferies & Company

Why don't you give us an example of one of these conversions then where you are going from an installed workstation to a converted enterprise offering? What has been the step up in actual revenue based on the conversion?

Mike Carrell

When you say the step up in revenue, we'll get a step up. Lets just say it was at a $50,000 maintenance contract before they may convert actual number of the Vitrea license to VES licenses. We will get a modest amount of software upfront. We'll probably give some hardware included in that net. Obviously a very from that standpoint and we will step up the maintenance contract quite a bit on top of that, depending on the account and how many they have. Let's say it could go from, and again, these examples not specifics, some 50,000 to say 75,000 for us in customer would be idea that now that they've got an enterprise, why we cannot sell additional users going forward. All when we come up with new applications, we can sell those new applications to them from that standpoint

Richard Close - Jefferies & Company

So what I am trying to get a handle on have you actually seen situations or can you quantify situation where you've gone from a workstation, you converted and then you guys have been successful, and in adding additional license in terms of can you give us an example to some extent?

Mike Carrell

I can give you some examples but there aren't than many yet because many of them are conversions as opposed to, most of them today are the conversions and not the net new ones that we are getting, we are adding on top of those. And so there is several way we've gotten a new user, one or two user on top of that but as the demand is increased at the site, they want one or two more concurrent users and that credit some. But it hasn't been meaningful enough revenue to bring the margins up at this point. We are getting more on the maintenance one. Almost every one of those has every one of those has increased maintenance on top of what you have got today which obviously is going to be in a four to five year contract that we basically sign at the time of that sale.

Richard Close - Jefferies & Company

What's in it for the customer to convert, why would they decide to do that?

Mike Carrell

Because they probably had a Vitrea product that had when they brought it from us, it was Vitrea and it's our work station with four options on it. So they get upgraded options, they get all the options that we've got in existence at that time. They get something that they can actually have enterprise wide and distribute to all the different physicians or patients and actually get access to it. They get wins our backend database associated, they get better integration capabilities within their EMR and their pack system and I can go through a list of probably other 20 benefits that they are going to get because there is obviously clinical benefits for the different applications that they are getting into well. So there is a lot of benefit that they are getting to do that. They get a lot for that conversion and that modest increase on the maintenance side and what we get is we believe that as they distribute it across the enterprise demand is going to increase as part of that demand and when that demand increases, more physicians are going to want to get access to it.

Richard Close - Jefferies & Company

So when we look at in terms quarter what percentage of that overall and maybe you gave this and I apologize if I missed it. But what percentage of your maintenance revenue would be associated with the enterprise product? What percentage would we be at currently?

Mike Carrell

A recently small number primarily just because we've done 125 conversions of an install base of 4,000 and depending on how you add enterprise because, if you're talking about just those 125 that would be one number. If you are talking about adding that to all the revenue that we have gotten through our McKesson channel or through the sector channels, there are others that have sold from before. So, obviously they are going to number (inaudible). Its small today, but clearly obviously a growing number for us.

Richard Close - Jefferies & Company

So this process is going to be a definitely what, call it a three plus year process as evolution?

Mike Carrell

The full revolution of our 4,000 customers install base piece could be that long, but at the same time I also believe that people are going to begin to not move a little bit faster especially as they are looking at the integration as the EMR in the other area and we're also seeing a lot of activity at those sites to upgrade faster and bigger upfront.

Richard Close - Jefferies & Company

So when you sell through McKesson and that 10% of revenue and you are only selling this new offering, are you selling workstations?

Mike Carrell

We sell as new offerings.

Richard Close - Jefferies & Company

And then really only on the workstations that you would be selling would be through Toshiba, correct?

Mike Carrell

Primarily, yes. Somebody came to us and wanted one current user, that's really just the deployment mechanism more than anything else, but.

Operator

Our next question will come from James Cho with Oppenheimer & Co.

James Cho - Oppenheimer & Co.

I just wanted to revisit the conversion timeframe of six to 18 month. It seems like there's quite a wide range for me, can you maybe perhaps give us some more color on that and plus any factors that may tighten that down to a lower end of six to let's say 12 month?

Mike Carrell

Well, the reason for six to 18 months is that I am giving you an essence based on the conversion as Richard and I just spoke about, the conversion of our entire install base is going to take longer than 18 months. If everybody converted tomorrow, we've got a whole different profile that everybody would be incredibly happy with from that standpoint, but that's not going to happen that we are going to convert all 4,000 that quickly. Some don't want to convert in that timeframe.

In terms of the six to 18 months what I was referring to was very specifically saying we got a pipeline that's building up net new customers or those that are converting that already get it and don't necessarily want to just convert. They actually want to convert and begin to expand at the same time and it was around kind of where you're starting to see some of that margin improvement relative to these larger transactions that begin to come down to the budget cycle and the timing of kind of healthcare spending and the reason it's a, I am giving you a longer timeframe is really timing is of the issue relative to healthcare spending and when some of that kind of comes through. And so, I don't think I want to narrow that timeframe necessarily for you at this time.

Operator

Our next question comes from Mohan Naidu with Piper Jaffray.

Mohan Naidu - Piper Jaffray

Just a quick question on stage II requirements. You talked about having imaging and imaging reporting requirements. What are your expectations there? Are you expecting to have advanced imaging or anything that's not in the requirements?

Mike Carrel

Obviously there is no guarantee but we're very hopeful that that's going to be the case, yes. Seeing it about 30% of exams that get reviewed at the portion that gets reviewed on a patient record, today is imaging its just not attached to imaging record and so that's the critical piece to us. Some of us sees it well, we do that's why we got the vision and we share that vision with them. They are trying to get a jump start on it which is why they are working with us today, because they see us as the best player in the industry to be able to help and convert that when the time comes.

Mohan Naidu - Piper Jaffray

On the Cerner, you guys did one deal in the quarter. Do you guys have any internal targets between you and Cerner, any number of deals to be down in the contract or anything, in the partnership?

Mike Carrell

We definitely have internal targets but there's nothing that we are going to share externally at this point in time until we start to see some traction and then we can talk more specifically about it. But we are confident that there is a lot of good going on in that relationship and we've got our reference sites up and running and are working today, and they are investing tremendous amount of time, energy and money to make sure that this partnership works and we are seeing it by the amount of training that they are doing with their sales team, with their marketing team, with their product team and so there is a lot of good collaboration that is going on there and a lot of it reminds me of the strength of relationship that we had with Toshiba before. It's a true partnership from that standpoint and we feel like we are working very close with them. And obviously they are a large company with a huge distribution and they are one of the best players in the EMR space today.

Mohan Naidu - Piper Jaffray

Okay. Any specific customer segment that you guys are targeting?

Mike Carrell

In terms of with Cerner or in general?

Mohan Naidu - Piper Jaffray

With Cerner.

Mike Carrell

Well so, they are going to establish 2,300 customers so its really looking at their entire installed base. They are really kind of mid to high end market, not necessarily much in the long market so that the target is really what their installed based targets are.

Mohan Naidu - Piper Jaffray

Okay. Any deals from Medtronic in the quarter? Not sure if you guys gave that details?

Mike Carrell

We sell to Medtronic directly. They are the customer, they don't resell our product. We did sell through Medtronic and we've got a maintenance stream that comes through from Medtronic as well for the support of the applications that we've got up there in the field with their sales force today. It was a smaller number in this quarter. As I mentioned in my words, talked about how that relationship continues to expand and we're having conversations throughout the entire Medtronic organization.

Operator

Thank you. Our next question will come from Steven Crowley with Craig-Hallum Capital.

Steven Crowley - Craig-Hallum Capital

In terms of looking at maintenance, we've come through a couple of periods here where there have been some distortions. I am trying to get a feel for the normalized growth rate of the maintenance stream. You're certainly enhancing the maintenance revenues you can generate from customers. So I would think there is a growth rate that we should be able to plan on. Is that a low to mid single digits growth rate ex the distortions of Toshiba's catch up in maintenance revenues, is that the right way to think about it?

Mike Carrell

We are not going to give specifics on the growth rate this time but I mean obviously we're protecting that base that we've got today and as we had more enterprise customers, we anticipated there's going to be some growth coming after that from the maintenance stream, but are also managing very tightly and making sure people don't come off of maintenance and signing on for long term contracts as well. The other impact obviously is on the services side where we saw lows last year that Peter mentioned specifically on education reflecting the really I mean the lows in this quarter and we anticipate that as we sell more systems now that we're actually going to get that education and the installation numbers should grow in the back half of this year and into next year.

Steven Crowley - Craig-Hallum Capital

Okay. So in terms of your ability to keep people on maintenance, are you happy with the metrics you're seeing that would reflect that?

Mike Carrell

We are happy with the metrics that we are seeing in particular in the US marketplace given that there has been a lot of pressure for people to cut operating expenses across all the areas. So we are actually pretty happy with the ability to pretty much maintain. We saw a little bit of the dip at the end of last year, in 2009, in terms of the number of people on maintenance but this year we are actually seeing some of that strength come back and so we feel good about it. 2009 was obviously tougher year. I see we are just rushing down completely. So we are kind of playing a little bit catch up on some of those, and so we are very happy from that standpoint. If you look outside of the US we don't have great coverage in terms of the ability kind of get more maintenance streams going forward and we're working on plans and ways to do that in countries outside the US.

Steven Crowley - Craig-Hallum Capital

And then in terms of McKesson, you obviously had a nice dollar quarter in terms of license revenue from McKesson this quarter, a big jump from last quarter. But I think this is the second quarter in a row where you've had multiple, several deals for new license. And is that a steadily building opportunity set or was there something that was fluky good about it this quarter?

Mike Carrel

No, I think that our relationship of McKesson continues to improve. We've got the best product integrated in to their systems today. We've now got reference sites up and running. I think I mentioned on the last call, I do not talk about in specifics in this call but in April of this year I went and visited about 10 of those customers that are now actually deploying and putting VES out there on the market and we're starting to get a really good buzz for the type of solutions that's being delivered and so there's a lot of conversions going on in the McKesson install base and there is a lot of what's going on and McKesson is really convergence from their old systems to the new system and upgrades from that standpoint and so we will anticipate there is a big install base that we're jointly working with McKesson. We're taking care of those customers in the right way and we feel that that momentum will continue throughout not only this year but in to next year.

Steven Crowley - Craig-Hallum Capital

Okay. And then you referenced that there was additional opportunity within Medtronic, other divisions that could utilize your product. Is that a riper opportunity set than other major medical devices where you could do something similar to what you're doing with Medtronic?

Mike Carrel

I'd say yes and no and what I mean by that is the yes part of that is, we're really focused on making sure we take care of Medtronic and make them successful in the marketplace where our partner and customer that we've gone to market with on that front and so as a result of that, that's really our prime focus and they are introducing us within other divisions, within their organization.

We're on a small division today, but we want to make sure that we're servicing them properly first and foremost and taking care of them. So the yes is that, its natural for them to begin to introduce us, it's a longer self, it's a long self like they're kind of get into other different areas. In terms of other device manufactures it's clearly an area that we're looking at, at net new opportunities, things that Medtronic doesn't necessary provide and into other areas that we're very open to conversations with other parts that serve other avenues.

Operator

Thank you. Our next question will come from the Ernie Andberg with Feltl and Company

Ernie Andberg - Feltl and Company

You gave us some numbers on the pieces of the McKesson business in the second quarter. The maintenance and service was $1.1 million. Was that an ongoing kind of level of maintenance and service? Or was it an allocation from the new sales that you made?

Peter Goepfrich

Back from last year and we talked about I think it coming out of Q4 call, we generated $3.4 million in maintenance revenues through McKesson last year. That is an ongoing stream of over 200 customers that they pay in maintenance on. The increases you're beginning to see are a reflection of these net new deals we're doing with them as well as the conversion of their own share ID to the 300 price suite.

Operator

Thank you. And with that, we have no further questions in queue. I would like to turn the conference back over to Mike Carrel for any additional or closing remarks.

Mike Carrel

Okay thank you Marvin and thank you everyone for your questions today. I think we had a nice rich discussion. We entered the second half of 2010 with a strong sales pipeline in the United States and Europe. Revenue for distribution partnerships is beginning to ramp up and our recently released VES 1.3 solution is gaining market acceptance. Vital Images is well positioned for growth in 2010 and beyond and we're optimistic about our long-term future. Again, thank you for joining us today. We'll see you on the next call.

Operator

And that does conclude today's conference. Ladies and gentlemen again we appreciate everyone's participation today.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!