Novadaq Technologies' (NVDQ) CEO Arun Menawat on Q4 2015 Results - Earnings Call Transcript

| About: Novadaq Technologies (NVDQ)

Novadaq Technologies Inc. (NASDAQ:NVDQ)

Q4 2015 Earnings Conference Call

February 17, 2016 16:30 PM ET

Executives

Stephen Kilmer - Investor Relations

Arun Menawat - President and Chief Executive Officer

Roger Deck - Chief Financial Officer

Analysts

Margaret Kaczor - William Blair

Jason Mills - Camaccord Genuity

Charles Haff - Craig-Hallum

Matt Blackman - Stifel

Doug Miehm - RBC Capital Markets

Tao Levy - Wedbush Securities

John Gillings - JMP Securities

Ben Haynor - Feltl and Company

Operator

Greetings, and welcome to the Novadaq Fourth Quarter 2015 Financial Results Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Stephen Kilmer. Thank you, you may begin.

Stephen Kilmer

Thanks. Good afternoon, everyone. Thank you for joining us today to review Novadaq Technologies' financial results for the fourth quarter and full year 2015. On the call today representing Novadaq are Arun Menawat, our President and Chief Executive Officer; and Roger Deck, our Chief Financial Officer.

Before we start I want to remind you that certain statements made in this conference call maybe considered forward-looking. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements to be materially different from those implied by such statements and therefore these statements should not be read as guarantees of future performance or results. All forward-looking statements are based on Novadaq's current beliefs, as well as assumptions made by and information currently available to Novadaq, and relates to among other things, results of future clinical tests of the SPY, FIREFLY, PINPOINT and LUNA imaging systems, anticipated financial performance, business prospects, strategies, regulatory developments, market acceptance and future commitments. Listeners are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date of this conference call.

Due to the risks and uncertainties, including the risk and uncertainties identified by Novadaq in its Public Securities filings, actual events may differ materially from current expectations. Novadaq disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events, or otherwise.

With that said, I'll now turn the call over to Dr. Menawat.

Arun Menawat

Thank you, Steve. Good afternoon everyone and welcome. The agenda for today is for Roger to highlight our 2015 fourth quarter financial results. As usual, after that I will discuss the Novadaq’s Q4 achievements and the outlook for our strategic initiatives going forward. Roger, please proceed.

Roger Deck

Thank you, Arun, and good afternoon. I'd like to begin today’s call by summarizing our Q4 results compared to the same quarter last year. Revenues increased by 54% to $20 million in Q4 2015 from $13 million in Q4 2014. Gross profit as a percentage of sales, increased by 2 points from 70% in Q4 2014 to 72% in Q4 2015.

In total, dollar gross profit increased by 57% year-over-year. Overall, we're very excited with the year-over-year results, with the momentum that's developing on the sales side and it's clear to us that our decision to adapt a direct model has paid off.

During our first quarter 2015 conference call, we outlined some new metrics, which we thought would be useful to monitor our progress going forward as a direct sales marketing company. Because of so much of change in our business between 2014 and 2015, there was no way presenting these metrics for 2014.

As a result we presented one data point which was not very useful for trend analysis. The situation has improved through the year and now the metrics table in our press release has all of our 2015 data packed to it, so it’s a good time to review progress in 2015 and what it means for 2016.

At our Q1 call in the spring, we’ll be able to add year-over-year analysis to complement our sequential performance discussion. The current revenue demonstrated consistent growth between Q1 2015 and Q4 2015 in the 10% sequential quarter-over-quarter range, which we think represents a considerable achievement.

We think continued recurring revenue growth in 2016 within a similar range is a reasonable target, with the possible exception of Q1 where growth might be a little slower due to seasonality.

Among our three major revenue categories, the growth rates of recurring revenue is expected to be higher than for the domestic capital sales category and for the international partnered category in 2016.

Throughout the year service revenue will make an increasing contribution to recurring revenue growth as many customers purchased extended service contracts in connection with 2015 capital sales.

The implication of recurring revenue growth exceeding capital sales growth is that we’re likely to make some progress in shifting the revenue mix toward recurring in 2016. As we indicated at our Investor Day in November, we expect recurring revenue to eventually reach 60% of direct sales.

As we discussed a year ago, our major focus in the first half of 2015 was to stabilize the SPY Elite business being transitioned back to Novadaq and to complete the sales extension and the training of the sales team. This negatively impacted capital sales and devising solutions early in the year.

In the second half, with the sales force expansion transitioned behind us, capital sales saw substantial growth as a total of 65 devices were sold in Q4 2015. Just as important, we also saw healthy increase in new device installations with 63 in Q4 2015, both of those numbers are a record for us.

During our Q3 conference call, we disclosed that the installed base which was at about 650 devices at the time, we’ve included approximately 300 devices which had previously been sold and 350 which consummate to be owned by Novadaq. The 350 Novadaq owned devices in some ways represents a capital sales pipeline.

Given that we installed roughly the same number of devices in Q4 as we sold, the number of Novadaq owned installed devices remain substantially unchanged at 350. Early in the year, when we were focused on stabilizing the SPY Elite business, we ran what I would call small installation deficit, but we’ve now brought that substantially to parity in Q4 2015, despite a record quarter for capital sales and the key focus for 2016 is to expand this capital pipeline.

Our gross profit percentage was 72% in the quarter and 71% for 2015. For 2016 there will be two tailwinds affecting gross profit percentage. The suspension of the medical device tax, which should add about 1% to our corporate gross profit and foreign exchange benefits related to our Canadian denominator expenses. These foreign exchange benefits were mostly reflected in our Q4 results, but they’ll have a positive impact on our first half comparisons.

Factors that tend their gross profit percentage included shift in mix towards PINPOINT and DermACELL, which are currently towards the lower end of our gross profit range. Overall, given these factors, we think 70% is a reasonable target for 2016.

In terms of our operating expenses, we anticipate growth in selling and distribution expenses with a little growth in R&D and G&A expense during 2016. Sales growth that we experienced in 2015 was in large part due to the substantial sales expansion undertaken between December 2014 and February 2015.

It further takes three to six months for new sales professionals to come productive. The significant investment we made in selling and distribution expenses at the beginning of the year did not show meaningful results until the second half of the year.

As a result, we experienced significant operating losses in the first half of the year, but we reduced those losses in the second half of the year as gross profits increased significantly in the second half.

The largest factor affecting our cash flow is best described as sales force productivity. In previous calls, we’ve discussed productivity improvements in terms of the roughly 80 sales professionals on our North American sales team during the year.


In Q12015, we indicated the average annualized revenue for sales professional was approximately $400,000. At the time we suggested our plan was to get productivity into the range between 1 million and 2 million per year, in the next two to three years.

In Q4 the productivity range was over 800,000, so we’ve already made quite a bit of progress. Stratification of this sales team provides additional color. The top half of the sales team that is the top 40 sales professionals, generated revenue at over 1.25 million in the second half of 2015 and the top quartile or the top 20 sales professionals generated revenue at a rate of 1.6 million. Those two figures that I just gave you are both annualized rates and they both are referred to the performance in the second half of the year.

Performance on the bottom half of the team and in particular the bottom quartile lacked the top performers by a meaningful amount, meaning there’s still quite a bit of work to do, but it also means there’s still a significant opportunity to improve average performance.

As we conducted our planning for 2016 in the late summer, broadly speaking, our options were to either remain static in terms of the size of the sales team and to generate growth by taking advantage of the productivity opportunities I just described, or to also expand the team further. In the end we concluded that the breadth of opportunities across the product in critical spectrum would be underserved by the size of team we had in 2015.

In particular it’s clear that the wound business was given enough sales attention to fully exploit that opportunity. So the sales expansion for 2016 includes the establishment of the dedicated wound team as Arun will describe later.

As a result of the 2016 expansion, which will be largely complete on March 31, 2016, we expect to see our selling and distribution expenses increase in Q1and there will only be limited growth and expenses throughout the year and that’s the pattern we exhibited in 2015. So we stepped up in the first quarter and then we remained reasonably flat through the year. I think we’re going to see that again.

In terms of operating losses, the pattern in 2016 will be similar to ‘15 as well, although the amplitude will be much less as the relative size of the sales expansion is smaller. So the operating loss will increase somewhat in Q1 2016, but it will be reduced throughout the year.

That concludes my remarks. Thank you for financial performance.

I’d now like to turn the call back to Arun.

Arun Menawat

Thank you, Roger. To summarize the financial results that Roger just presented, Novadaq delivered a strong fourth quarter, characterized by robust revenue growth, increased gross profit and continued expansion of our installed base and higher device utilization. Simply put, it was our best quarter yet.

We’ve also clearly moved beyond the market creation phase with our SPY technology towards the adoption phase, which positions us well for continued growth in 2016 and beyond. And that is where I would like to focus my comments today. Some key activities in the coming years that are important considerations, as we work to maintain the momentum we established in 2015.

I would like to begin by talking about what Novadaq is all about as an organization and what I believe makes our company and our technology so distinct in the eyes of the medical community. Afterwards I’ll spend some time discussing a few specific growth drivers in 2016 and 2017, before I open the calls up for your questions.

Novadaq is a fully functional medical technology company now, with an effective sales team and all the necessary infrastructure needed to operate a direct growth business or positioning the company to continue to grow over the foreseeable future, but you understand that. First, let me tell you how I see the current state of our technology.

As I said before, we’re not a rigid [ph] company nor are we displacing an older device with a new incrementally better device. Novadaq was established based on a unique new idea, that providing new anatomical and physiological information to the physician at the point care will lead to significantly better decisions.

In certain situations, a better decision means better clinical outcome, while in others it can mean doing one surgery instead of two. In other scenarios it may result in less intervention or it can lead to a better diagnosis and quicker intervention to save a patient.

So one thing that is common to all of these situations that the patient has a significantly higher probability of better outcome and the payer gets better value for the dollar. That is why I call it, our technology transformative.

Our imaging technology has created a whole new way of thinking both in the surgical suite and in the fee suite and by the way, I only call it transformative because the healthcare industry is slow by design. In any other industry a game changing technology like ours would be called a revolution and the adoption curve would be much faster.

Overtime, I do expect Fluorescence Imaging will be used in a large number of procedures from diagnosis to surgery to post-operative care. Fluorescence Imaging is not one technology, it is a class of its own and there will be different versions of the technology working in a complimentary manner to uniquely address specific needs in healthcare.

We’re proud to have started the transformation and we remain committed to continuing to provide leadership in the future. Let’s also consider that we’re only in the early generation of the technology to provide imaging for point of care decision making. To bore the analogy from another industry, we’re at the apple two stage of our technology and that there’s a lot more to come in the future.

This is why a solid sales team, seeing to sell and market our innovative technology needed to be homegrown. It’s also why Novadaq continues to invest in research and development, because it allows us to maintain our leadership position. With that context in mind, let me talk about some of our key growth initiatives for 2016 and 2017.

First, our installed base growth and the adoption of our new technology increases in multiple procedures and as Roger mentioned earlier, we have focused and segregated our sales team into two, one for surgery and the other for wound application. These tend to be different call points and relatively different in terms of business case justification.

The change took place as of January 1 and I’m pleased to say that it had done extremely well. Both sales teams report to the same VP of Sales to allow conversions at a point where we can leverage both sides appropriately at the fee suite level.

We finished 2015 with approximately 80 sales professionals and as of today we are at 95. We do expect that our new hires will not impact the first half of 2016, but we do expect them to begin to produce by the second half of the year. This expansion and creation of two sales channel is an important part of our growth strategy in 2016 and beyond.

Second, we’re spending in international markets. In 2016, we expect that revenues in international markets will grow at the same pace, 30% plus, matching the expectations of the domestic market. The primary growth in international markets is likely to come from Asia, as we’re now selling in China, Japan, Korea and India and the feedback has been very positive.

SPY technology has also been received well in Europe. Recently a clinical study that made our PILLAR II study in colorectal surgery was published and not surprisingly produced results that were similar to that of PILLAR II. Now, a government sponsored grant has been approved in Europe to conduct a study similar to PILLAR III study. We are impressed with that attention that the European’s are paying to our technology.

Third, let us talk about products. We’re pleased with the growth of the tissue revenue in Q4, as our market development efforts earlier in the 2015 began to show up in the numbers. DermACELL is definitely a better product than the industry leading product. We’re also pleased that leading surgeons and hospitals are switching to DermACELL. Both of these factors continued to give us optimism for continued growth of DermACELL, both in breast and in wound applications.

The LUNA product also received significant accolades from the early adaptors. Opinion leaders have also given us positive feedback about the introduction of the variability in that which we affectionately call the LUNA Score, which acts as an aid to the decision making process. We believe that this upgrade along with a focused sales team will drive revenues of LUNA in 2016.

Our first and core product SPY Elite remains our main seller today. We’ve seen a return to momentum for the adoption of SPY Elite, particularly in breast reconstruction cases and we expect that adoption of SPY Elite will continue in 2016.

PINPOINT, being upgraded with three accessories, the software color coated to us into CSF for short, has been proven to be viable in most [indiscernible] procedures. We continue to see very positive feedback for the use of CSF, will drive the use of our technology in more procedures.

The SPY handheld that will run off from the PINPOINT platform will provide versatility to many surgeons, specialties including general surgery, colorectal and gynecological surgery, particularly as they look for anatomy in difficult to reach areas of the body.

All in all while our products are in different stages of adoption, we believe that all of them will deliver growing revenues in 2016.

Now, let me turn my attention to growth for 2017 and the investments that we are making for that this year. As you know, we’re currently funding two multicenter Level 1 clinical studies both using PINPOINT. The studies [indiscernible] about lymph node visualization, this is a non-superiority study, will compare visualization of 300 lymph nodes with the current standards in figuring [ph] versus five imaging technology. The study is recruiting now and we expect to have results in Q4. Using this study, we will submit our application for a FDA label for lymph node visualization for SPY technology.

The second multicenter Level 1 study titled PILLAR III will evaluate improvements in clinical outcome in low anterior colon resection surgery, particularly as the outcome relates to post operation leakages. This study has already recruited over 125 patients and we look to have interim results in Q1 2017. We believe that both studies will reach their end point and the results will be key growth drivers of our technology.

Finally, I do want to brief you on the fact that we are working on a number of new additional molecules that are targeted towards the visualization of certain specific anatomy. These new technologies will not replace what we do today, but add on to our capability. The investment in this research today will likely add to growth in future years.

The final thing that I would like to discuss today before I turn the call over for questions is a very brief review of our 2016 guidance. In case you missed the press release that we issued ahead of the J.P. Morgan conference. I noted at the beginning of this call that 2015 was our best year yet and we expect that this growth trajectory to continue throughout 2016.

Based on our planning and budgeting works, we anticipate that our full revenue for 2016 to land in at approximately in the range of 84 million to 86 million, which would represent total year-over-year revenue growth of between 32% and 35%. That would also put up an approximate 100 million annualized revenue run rate by the end of the year and is an important milestone for Novadaq.

This concludes my prepared remarks. With that I’ll turn the phone over to the operator and request that the lines be opened for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question is from the line of Margaret Kaczor from William Blair. Please go ahead.

Margaret Kaczor

Hi, good afternoon guys.

Arun Menawat

Good afternoon, Margaret.

Margaret Kaczor

First of all thanks for the additional clarity and communication, very helpful. But just to be clear, in your guidance, are you guys assuming no revenues from any of the new sales reps that you added either in Q4 or Q1and what should we assume preoperatively for some of the more tenure reps, given that of the sales force into surgical and wound care, specifically in the first or second segment, I guess again because you’re moving away from LUNA initially?

Arun Menawat

Margaret in general what we’re saying is that just as it happened in 2015, generally speaking our quarter-over-quarter revenue numbers increased and that is because we added people earlier in the year and they became productive as the year went by. And I think that we’re starting at a much higher plateau this year because we have about 80 people who have experience, but then the new people I think will start to become productive in the second half. So I think you’re right, it’s kind of fair to assume that the trajectory would be at a high level, but kind of similar to the way it was last year. And so we’re not assuming much productivity from that group in the first half of this year.

Margaret Kaczor

And did you guys see activity on the first half of last year and after that you ended up hiring or not much?

Arun Menawat

In the second half certainly, I’m not sure if I understood the question completely, but certainly they made an impact in the second half of the year, but not the first. And also we expect both in terms of the surgical sales expansion that we’ve done as well as the wound team care. Although, to be honest, we started the wound care team with a handful of pretty good performers, so it’s not starting at zero.

Margaret Kaczor

Okay and then in terms of the underlying capital equipment environment, a lot of people have been questioning the strength of that as you go into this year, so I’m not sure if you guys can give us any clarity in terms of what you’re saying has to expand and if you’re saying some of the hospitals really double down on SPY and buy a second system.

Arun Menawat

So if I understand the question correctly, I think if you’re referring to macro market conditions, to be honest, we have not seen any impact on that. Our pipeline going into Q1 is pretty strong and I think with respect to hospitals and orders we are definitely seeing a trend where the larger hospitals are ordering their second and third devices and those are starting to be straight purchase orders. So, I would say we are pretty comfortable with what we are seeing at the moment.

Roger Deck

Just one other thing that I would add Margaret is. We gave our guidance that our ranges reminded us of - and I think the consensus is broadly consistent with that. We have also looked at the consensus on a quarter-by-quarter basis and it does show a pullback in Q1 form Q4 which we think is normal business for us, so it make sense to us. I think on the recurring revenue side, we will see certainly positive growth from Q4 to Q1 and it is not quite at that 10% sequential level, but then on the capital side, we think this is seasonality that will pull us back a little bit and start building that up again on the second quarter.

Arun Menawat

Yeah, but I think Margaret, since the half of the first quarter is over already I think we are pretty comfortable with the consensus estimate of Q1.

Margaret Kaczor

Okay and I am going to take one more and then get back in queue, but for DermACELL I think you guys ended the year around 50 accounts of 405 lead accounts. So how is that paved for the new DermACELL account coming along and what is the difference in terms of revenue for new account versus an older account, thank you.

Arun Menawat

Sure, we did add several new accounts in Q4 for DermACELL, I think we said 50 were probably well above 75 at the moment. So it was a very good quarter for DermACELL. I think that if I look at the data, it is not just the fact that we are growing the number of accounts, it is the caliber of the accounts, it is the leading hospitals with the opinion of leading surgeons who are actually making the switch and that is actually the source of the confidence in that product line for the future for us.

Operator

Our next question comes from Jason Mills from Canaccord Genuity. Please go ahead.

Jason Mills

Thank you, Arun, Roger. Good afternoon, thanks for taking the question. Can you hear me okay?

Arun Menawat

Yes, Jason, please.

Jason Mills

Perfect, so I wanted to start off just falling on the previous line of thinking about your sort of the guiding of your guidance through the year. So just help me out Arun with a few things, so the first half of the year, certainly the first quarter on a year over basis it is relatively easy comp, it’s just because that was the build of your sales force on the wound care side which as you mentioned, will contribute more in the back half of the year. So could you help me sort of understand on a year-over-year basis - I can certainly I understand from a capital perspective sequential growth of 10% is not something that you would expect Q4 to Q1. On a year-over-year basis given the comps and then the sales force, when that will become productive it seems like the growth guidance you’ve given for the year maybe somewhat consistent as year-over-year the quarter is going. Could you just help me with the different countervailing transact.

Arun Menawat

Okay, Jason let me make sure I understood the overall. I think the overall guidance we feel pretty good about based on six weeks into the year that we would be in that 84 to 86. I think that we typically don’t give guidance on the quarter-over-quarter basis. But as I already mentioned I think again given the half of the Q1 is done, it feel pretty good about the consensus estimate of Q1, which if you really look at it then from the perspective I think quarter-over-quarter obviously we will have to increase to make the yearly consensus of guidance. And I think in general I think we feel pretty good about the granularity that is there at the moment and I think changes obviously will come into that. And I think as I said, that basically necessitates that we would finish the year with a run rate of about a 100 million, which we feel pretty good about. So I think overall, we’re kind of - at the moment we are sort of narrow, we think that we are in the guidance, we’re delivering, we are executing and generally at least at the hospital level we have not seen anything that gives us any pause or concern at the moment at least.

Jason Mills

Right and that gives segue into the second question, I was struck by positive tone as you went through each of your core franchises, whether be SPY Elite or PINPOINT or in tissue. I’m wondering if you could just take a step back and help us think through the momentum in each of those businesses and which ones sort of enter the year sort of at a run rate or momentum that is perhaps running even higher than what your guidance is. I guess in a nutshell, if we see upside of your guidance this year, where would you expect we would see it?

Arun Menawat

So, generally you know I think we have talked about this last year, that SPY Elite, really breast surgery and some of the other reconstruction procedures were SPY Elite continues to become critical. I think we continue to believe it is driving towards standard of care and so given that I think you’ll continue to see rapid news coming SPY Elite. And I think they will dominate 2016 as well.

With respect to DermACELL I think with one year under the belt and with some more clinical data under the belt and as I mentioned the surgeons who are opinion leading surgeons having switched now. I think our confidence level is better on DermACELL also and there is a recent study that came out which is on our website which is a randomized controlled study, multi-centre randomized control study using DermACELL in wound which shows phenomenal results and so we think that study will also drive DermACELL in wound care this year as well. So I feel pretty good about that.

With PINPOINT, I think that the adoption primarily is in colorectal surgery and gyno [ph] and again I continue to receive significant both publication and adoption from big-name hospitals, but it is newer product, it is a little bit early-stage, but I think with the new software, the 5 millimeter scope which is pretty good product and the handheld that we will be introducing earlier this year. I think will also begin to drive PINPOINT in the second half quite a bit.

And really I think LUNA probably will take second half of the year, but it should really be a growth driver more for later this year and then maybe in 2017. So I think that the products will grow, we do have the brand of being a company with the best products and we will maintain that and then we will see how it goes.

Jason Mills

That’s terrific, however, I will sneak one more and I will get back in queue. Specific to DermACELL Arun, just looking at breast reconstruction and knowing that you are into 25,000 procedures and breast with SPY right now, $30000 or $4000 in tissue each procedures, we can do the math on that market opportunity. So it strikes me as a year in which DermACELL’s, the revenue from DermACELL could be quite a broad range right because - anywhere from maybe 10 million to 30 million to 40 million. I am wondering how do we - as the outsider is looking at moment, how do we best access what DermACELL revenue contribution for you this year?

Arun Menawat

And Jason I think on paper and the earlier doctors, if we look at those two factors I think it does look good. Obviously execution is the key for us, it has been last year and it will be this year, so I want to wait and see, but I definitely think that DermACELL should begin to continue to show adoption in 2016.

Jason Mills

Thanks, Arun.

Arun Menawat

Yeah, thank you Jason.

Operator

Our next question comes from Charles Haff of Craig-Hallum. Please go ahead.

Charles Haff

Hi, thanks for taking my question. I had a question for you on the sales force, so you mentioned that you have 95 reps now and you ended the fourth quarter with 80. Was the difference, 15 reps were those wound team reps or was that a mixture?

Arun Menawat

It is a little bit of a mix, I think we are probably about 10 on the wound side at the moment and the rest were on the surgery side. So on the wound side the leadership is the team that has already been there, so it is not like an entirely new team and I feel very good about the leadership team on the wound side. I mean I feel very good about the leadership team on sales and marketing in general, but I think on the wound side is making progress at a very good pace.

Charles Haff

Okay and then when you think about your goals for sales force productivity with 1 million to 2 million, is that confined to the surgical side or would you expect the wound care reps to also be able to eventually achieve the same goals?

Roger Deck

Sure, I guess when we established that as a target it was one team and so that as meant to address. I don’t think any concerns about applying that to both sides of the business and I also wouldn’t say that is necessarily the top end of the range either. We benchmark ourselves against other companies and frankly LifeCell is one of them. They are company that has previously sold a mix of florescence imaging and tissue and they actually have productivity that’s quite a bit higher than that. So these create some balance for you.

Arun Menawat

So Charles, we are looking at this more as a value of business model overall because we think that if we can get in that range particularly in the $1.5 million to $2 million range per sales person and 70% margin range, we think this business can produce in pretty good cash over time as we grow. So I think it is more of a statement from our perspective of the value of the business model at the moment.

Charles Haff

Okay and then my last question on wound is, in terms of capital equipments with wound care centers do you think that they would typically have different purchasing behavior than the hospitals, any differences that that you can kind of highlight to help us for modeling purposes?

Arun Menawat

Yes, most definitely and that was in fact one of the reasons we felt that focusing the teams into two would make sense. So when we go into the surgery suite the value proposition is improving outcomes and reducing cost and doing new types of surgeries that will bring new values to the hospital. On the wound side it is actually quite different because of the wound side the business model and the value proposition is about you know their reimbursed, there is an APC code and so there is revenue coming into the hospital. We’ve also demonstrated to our early adopters that there is higher compliance which means more revenue through higher compliance, so it is - it’s actually a - it can be a very quick pay back or if they’re renting or placing this could pretty much be a cash flow positive business model. So those are two very different business model and I think we have to execute and not that I’m worried about it I think we did execute well second half of last year, so I think we will. But I think that if we can execute, I think certainly LUNA will definitely start to produce pretty good results in the second half of this year.

Roger Deck

I would just say also, our assumption, our working assumption is that we need to show these outpatient centers a cash flow breakeven fairly readily and so that’s more structuring our business, so that there is a minimum barrier to enter into that perspective. But it is interesting to note that quite a few of our sales last year and we expect this again this year, where the wound care centre actually realizes, this is a powerful tool for bringing patients into the hospital system and they buy into a whole story beyond sort of breaking even on patient by patient basis and that is the basis on which we actually saw, we have beautiful [ph] principals that these things really have value [indiscernible].

Charles Haff

Great, thanks for taking my question.

Arun Menawat

Thank you, Charles.

Operator

Our next question is from Rick Wise with Stifel. Please go ahead.

Matt Blackman

Hi, everyone. It's actually Matt Blackman in for Rick.

Roger Deck

I would answer a couple.

Matt Blackman

Hi everyone, how’re you doing? A couple of questions and the first one is a multipart question, so let me just get it all out of the way and then move onto the second one. I wanted to start with recurring revenues per direct systems, part one of the question may be - that is for you Roger, just want to confirm that as I look through the spacing of recurring revenues per direct system growth through 1Q to 4Q that - so the modest growth you are seeing is mostly a function of the fact that you keep diluting the denominator by adding your systems and there is nothing going on outside of that, is that the right way to think about it? And then the second part of the question is may be both you and Arun could answer this is, are you sort of laid out as we look at that metric over the next however many of years taking that annualized rate of recurring revenue per direct system it is roughly sort of high 30s now and somewhere in the 50,000 per year range. Can you just help us understand how you drive that higher is simply increase utilization across the installed base and increased utilization of things like DermACELL or as we think about that number and our expectation is - the application that you have to add incremental products like DermACELL like things to drive that type of revenue for recurrence and then I have one follow-up as well.

Roger Deck

Sure, let me take the first one, I mean, if you are to say that our options are broadly to go deep in accounts or to go and get lot of accounts. And we’re not really faced with such a stark decision, we really devolved. So if we had to prioritize one today, we really want to get our technology into a lot of centers and we are really focused with grabbing real estate so to speak. So we have been probably putting more effort into installing new accounts and we are very positive in our ability to drive that recurring revenue over time, but it is not like step one, step two you get the thing out there, you get - buy in some customers and really that’s what we are look at sort of [indiscernible] for driving revenue over the long-term. In terms of driving it, I think over the next 1 to 3 years, I think certainly DermACELL is an important part of it and Jason kind of highlighted some of the message suggests that could be pretty powerful. Some of the other elements are, we have been selling some systems in 2015, we’ll continue doing that in ‘16. We find it when hospitals are literally invested in the technology, usage comes up and then eventually the service revenue really takes hold as well. So we’re starting to see that bit by bit, but that sort of gives you short-term focus and the long-term vision in terms of how we get substantial recurring revenue growth.

Matt Blackman

Okay, that is very helpful and then my follow-up question is on Arthrex and I know it is still early, but was hoping any sort of anecdotal or qualitative or even quantitative feedback on how that premarketing agreement is going and I know it’s actually getting me numbers on systems, but is it starting to be productive, is it something that can take a couple of quarters back half of ‘16, any sense of how that’s ramping early on.

Roger Deck

Sure, Matt I think you are right. Our thesis when we did the agreement was that it would really have an impact on the second half of the ‘16 and I think that is still where we see it. We are in the process of bidding with them, we have closed deals here and there, but they are definitely not material overall at the moment. We kind of think that it is part of dual prong strategy that we will sell directly on the clinical basis and as far as the multicentre - multi-device deal where they were bidding on a large contract then they would bid our devices along with theirs. I think that thesis is pretty much intact overall.

Matt Blackman

That’s all I had, thank you so much.

Roger Deck

Wonderful, thank you.

Operator

Our next question is from Doug Miehm from RBC Capital Markets. Please go ahead

Doug Miehm

Thank you and good afternoon guys.

Arun Menawat

Good afternoon Doug.

Doug Miehm

First question just has to do with the competitive environment, I know this year key competitor right now, they’ve reported little earlier and indicated that you’d won several, I think the number was five head-to- head battles against them in terms of putting in your equipment versus there’s. I’m just curious, could you give us few more details on what seems to be winning these head-to-head battles and if you’re seeing a - are they changing the way they’re approaching the model or you guys as a competitor or anything like that.

Arun Menawat

Sure Doug, I think that what you said is pretty much what we have seen, typically in the head-to-heads that we have done, we are winning. I think that it is a big company and I’m sure there will be some accounts where they have leverage because of their relationships and so on but so far we have not seen much of that type of impact. And I just don’t have a whole lot to say at the moment about it. I would say I think the other part of it - I think that certainly I do want to provide the other context is that, when you look at our company SPY, we have successfully - we have been very successful against a competitive [indiscernible] to the point really it isn’t there and I think on the LUNA side, it is a really unique product and the software that we introduced is really, really unique and highly patented, so that I really don’t anticipate substantial competitor strategies in the near future there. So I think it is really 30% of our opportunity and so far what we have seen we are pretty comfortable.

Doug Miehm

Okay, just a couple of housekeeping questions, what is the balance right now between surgical sales people and wound care sales people and then for Roger you were gracious enough to give us your top 40 salespeople who are doing about 1.25 million each right now, but I’m just wondering is there a big difference between what the wound care sales force is generating versus the surgery sales force on that account.

Roger Deck

Sure but the top half was doing about one and a quarter. The top quarter is actually doing by $1.6 million. But again we kind of look at that as a peripheral principle, but we can’t get people to a pretty productive level. Certainly the wound team is a mixed answer, they’re certainly behind us. It is a new focus for them, but they were the people who on our team who had the most success in LUNA last year and just had a bent towards that part of the business. Some of them are in leadership position and the so they are not necessarily starting from a standing start, but it is a new team and the messaging it is really gelling as we speak and they are just really getting ready to attack that market with a tremendous amount of enthusiasm I think it is going to take little bit of time to see that actually show up in our overall corporate results, but it is very exciting time for them right now.

Doug Miehm

Okay and sorry what was the split between the two groups in terms of salespeople.

Roger Deck

It is 85 in surgery and 10 in wound.

Doug Miehm

Oh, okay so I missed that. Okay and then just with to SG&A growth I know that you are only adding a few extra sales people relative to what you have right now, but in terms of overall growth in that line item this year could you give us range of what that might look like? I know that you said R&D would be basically the same may be a little bit higher, but SG&A would help and then finally if I got this right the 3.7 million warrant revaluation was worth about $0.06 this quarter relative to what you reported?

Roger Deck

I’m going to answer the last question first which is yes, that’s what is is. I think the sales expansion is probably more than having a few people, it is little bit more than that, it’s probably 25% on the surgical side and then over a little bit spread more through the year will eventually get to 20 people on the wound side growth. It is not insignificant it is relative to the size of our team and our operational at start of the year it is relatively less than what we had to undertake last year. I think maybe I would encourage you to operating expenses in Q4 forward [ph] by $20.5 million. I think that if you look at the total I think you could see that increased by sort of 10% to 15% in Q1 and then stay relatively constant. Not entirely constant but not much growth after that step up in the first quarter

Doug Miehm

Okay, great thanks very much.

Roger Deck

Thank you, Doug.

Operator

Our next question comes from Tao Levy from Wedbush Securities. Please go ahead.

Tao Levy

Hi, good afternoon.

Arun Menawat

Good afternoon, Tao.

Tao Levy

One of the changes you guys that made in the selling strategy when you went direct, you started selling the systems instead of just placing them and the offset there is supposed to be your higher volumes to offset the potentially lower price under disposable. So I was wondering have you started the see that play out where hospitals that are bought the system whether it is outright or from a previously leased or placed system whether have you seen much higher growth rates and procedures.

Roger Deck

I think we have I mean we have had sequential growth and procedures at about 9% sort of if you take taken numbers of quarters together sequential quarters again. And I think that some of that just comes from the very effect that you’re talking about and then growth in imaging kit recurring revenue is little bit less than that 9%, the recurring revenues driven little bit more by DermACELL, we talked about that little bit at the investor day. So we are seeing imaging kit volumes to go up. We don’t see quite that much growth in recurring revenue from that part of the business because of what you’re talking about. But you know I think that towards the second half of the year and I think we are going to start to see that slowdown because it is going to find a level and at some point you’re going to see that volume increases drive revenue close to direct directly. We are not quite there yet but I expect we would be there towards the end of the year.

Arun Menawat

Generally, the trend is definitely there.

Tao Levy

Okay and you mentioned at the beginning of you’re prepared remarks that you essentially sold systems as you shipped, was there any difference between kind of those two metrics across industry product areas?

Roger Deck

I think there is a small difference I wouldn’t say it is a major thing our SPY business is more material, more SPY things out there. So we sold few more SPY systems in terms of the level of installations actually 10 point is running ahead of SPY. SPY is actually - very getting new, we are doing some placements with SPY because some customers still want to do it on that basis, which we are open to for a limited period of time. But I would say that we are still little more SPY and installing little more PINPOINT in overtime I think it is natural the sales will take equal out. For SPY to restart and get direct feels now [ph], so the second, third system are generally direct sales. So we are not necessarily placing the SPY, we are just selling them at the moment now.

Tao Levy

Okay and then the last question on the clinical side, with the FILM study and hoping to get indication for evaluation of lymph nodes. Is there any clue to what that be for sentinel lymph nodes and I know it is a gynecology study, but is that all the - potentially you have broader portability across different anatomies.

Arun Menawat

Yes, so the indication that we are seeking is a broader indication because more than gyno data will be presented through FDA when we apply and we have the thoracic and colorectal and other procedures will be in the application. With respect to sentinel lymph versus visualization at the first, the first one that we are planning is really to get to lymph node visualization on label and there is already published data from Sloan Kettering where they have used our technology to show that they can actually see the sentinel lymph node and they have actually done outcomes analysis on that data and it is really promising information. So we think that if we can get this on label just as visualization will be able to use that analysis to then market the product both ways, that’s the idea.

Tao Levy

Okay, great, thank you.

Arun Menawat

Sure.

Operator

Our next question comes from Matt O'Brien from Piper Jaffray. Please go ahead.

Unidentified Analyst

Hi, this is actually JP and thanks for taking my questions.

Arun Menawat

Hi JP.

Unidentified Analyst

So, since you kind of bifurcated the sales force between wound and surgical, have you seen the pipeline change it all or two tuned of how, so like 80% of revenue came from SPY this year, does the pipeline looking maybe 70% SPY, maybe 30% PINPOINT and LUNA or is it too early?

Arun Menawat

Yeah, no JP, it is little bit early, but I think Roger kind of addressed to what we can tell you from the earlier indicator, the LUNA side of the team, the wound team is pretty excited right now. They are growing, they have got - they still have some, good things to sell, but it is too early what the qualitative results will be.

Unidentified Analyst

Okay, I just want to clarify something that I think Roger said in the Q & A, if you have 95 reps right now and I think the goal is to grow LUNA by another 10 and then surgical by another 25%, so is it into [ph] your goal to get towards that 125 number of reps?

Roger Deck

I would say a 120, I would say the surgical side is going to go 100 and I think we’re going to take the wound team to about 20. So we are well into take a little bit of time on that wound side so not all happen in Q1, may be not even in Q2.

Unidentified Analyst

Okay and then maybe I’m wrong here, but I thought we are going to get some in interim two or three data this summer and I think you said it is going to come in Q1 ‘17 has something changed there or I have just mistaken?

Arun Menawat

No, I think we have always said that it is Q1 ‘17 is when we would publish. We expect publication.

Unidentified Analyst

Okay and then with some of these newer molecules, are you going to need to do additional trials and I assume those are kind of cancer and immunology or can you gives us any clues on those?

Arun Menawat

Sure, so basically what we’re saying is that we have seen enough progress, we are in clinical already and that we have seen enough progress and we expect to announce at least one molecule this year. And then what the exact pass rate to getting it approved and so on. We expect that we will have enough risk reduction to have a very high level of confidence, that we will have I guess I should say an approvable molecule, announced this year that’s our thesis at the moment. We are very excited about it

Unidentified Analyst

Great, thanks for taking my question.

Arun Menawat

Thank you JP.

Operator

Our next question is from John Gillings form JMP Securities. Please go ahead.

John Gillings

Hey guys, can you hear me okay?

Arun Menawat

Yes.

John Gillings

Okay, great. Thanks. So I want to follow-up on wound, I know bunch of people has hit on it already but you know people are kind of excited about the opportunity there and what is going to hope happen with the direct sales force. So you have got about 10 people, you have got 10 more slated for higher this year and you said you kind of willing to take your time there, what would need to happen in that business substantially to speed up hiring or potentially go higher than 20 in the 2016?

Arun Menawat

Sure, what we have basically done is, our team is taking a very targeted approach and I feel very comfortable with the approach at the moment because we have done it before. We did it this way with SPY, we did this way with PINPOINT and so we are sort of think that we know that how to get there now with new products. It is a targeted team we are not nationally selling in a hurry. We are [indiscernible] we are using a certain set of criteria that gives us targeted number of wounds clinic that we would want to go to and what we are really looking for is really honing the selling methodology at the moment. And we have - as I said we are very confident about this and I think you’re right that there is lot of excitement but I think that what we need to see is really come how quickly that excitement turns into dollars. And so I think that is really how we are going to describe all it. I can tell you that we’re not going to be too conservative as we have not done [ph] last year either. We will as soon as we start to see the indeed, the paper are starting to look like it is going to work we expect. We will pull the trigger and get extra people. So, I mean I guess what I’m saying is don’t take read too much into that, just think that we have a milestone set that we have announced, that we have given to our team. As they meet with their milestone we will either become more aggressive or adjust the model where we have people. That’s the idea.

Roger Deck

Yeah maybe the way I said that sounded like we are relaxed in terms with phasing [ph] we are trying to push back as quickly as we can, this is the difference that I was alluding to I guess compared on the surgical side. We have 100 territories defined today, we’re not going to change them all year and so we don’t have sales rep in a territory we don’t have courage today and we needed right away that the difference of getting out. We are very excited about pushing wound team as fast as we can.

John Gillings

Okay, that’s helpful guides I appreciate that. And then maybe just a follow-up on the question that Jason asked earlier about potential areas for upsize. So looking at the Arthrex agreement you talked about that kind of potentially starting to contribute more in the back half of the year you started doing some bids and at the reason conference you said that you probably the second half of the year before you really know how well that was going. Is that something where you would have potentially baked a conservative number in to guidance if it goes well you could see some upside or if not how should we think about that piece?

Arun Menawat

John, I think it is a great question and I think for us it’s about execution and I think that in terms of preparation and how things the Arthrex, sales team to get ready and help we are working with the marketing people to get all the literature we feel very pretty good about that. But I just think it is too early for us to sort of comment on exactly how well or what the issue we will face and I think there is nothing negative about this, just said I want to wait and see that’s all again.

John Gillings

That’s fair enough and then just quickly turning to some of the surgeon training you guys are doing. You talked before about these ASPS conferences and the importance of that environment, the surgeon to surgeon contact. Do you have any sort of metrics coming out of those that will help us understand that if a surgeon attend one of those meetings, how likely are they to become a user later on, is there any way to sort of quantify the impact of those events?

Arun Menawat

Yes, we don’t publish that but we actually measure it after every meeting and we can tell you it is our best driver of adoption of our technology. And we do measure it and it is the best investment in marketing that we can make sometimes.

John Gillings

Okay, I appreciate that and then just one last quick finance one, in terms of the operating cash burn you obviously made pretty significant improvement year-over-year from fourth quarter ‘14 given the comments that were made earlier about sort of the cadence of SG&A growth pumping in the first quarter and flattening out a bit. Should we think about operating cash burn as in those same terms that it would increase in the first quarter and then kind of level out given all the people you’re hiring in sales is that there is a way to think about that.

Roger Deck

Yeah, I think the curve looks the same, but the amplitude of the curve is less, right. So we are not going to burn what we did in the first quarter of 2015, but the pattern is going to be similar.

John Gillings

Okay, perfect that’s everything we have thanks guys.

Arun Menawat

Wonderful, John.

Operator

Our next question is from Ben Haynor of Feltl and Company. Please go ahead.

Ben Haynor

Good afternoon gentlemen, just kind of following up on the sales force question in terms of the run rate for the top half and the bottom half, is there any other color you could provide there in terms of differences in tenure, differences in territories anything like that?

Arun Menawat

I’m not sure. I mean I think for surgery where we’re covering mission wide in US. In terms of wound, we’ve identified certain regions and they relate to - I mean I think in general terms they’re sort of grow more diabetic patients or demography favors where there are more wound clinics and so on. I don’t know if I have answered your question Ben.

Roger Deck

Let me take a shot at this, I think when we expanded the team at the beginning of the year, we started the correlation between tenure and performance and we’re still to date. Well, I guess coming to the end of the year, one of the things that we notice is that we started to identify some of the poor performers or some of the people who have actually been around a while and that’s an example of a management decision that gets much easier than it used to be. So I think that variable [indiscernible], still we continue to have a meaningful amount of turnover and I guess I still view that really as an opportunity. So there are some people we’re identifying, who have been around for a while and are on the bottom half and it gets pretty hard for them to [indiscernible].

Arun Menawat

From the other process we have a job to do and we follow a process in terms of the sales team and you’ve heard from our metric, we used some of that metrics to make decisions and we’ve tried to work with everyone with pretty good job training, we’ve got a very good training center and so on.

Ben Haynor

So that’s what I was looking for, that’s helpful. And then how is the feedback on the new LUNA software?

Arun Menawat

Yeah, I mean we need more data, I mean the feedback in terms of the physician saying, hey, I need a number to simplification and I can follow this and if it’s going down I know that my therapy is working and then all of that works great, but we do need more data, so we are running a few registry studies of different kinds to figure out exactly how they can interpret this and so, I think that is definitely part of the program in the first half of this year to get these registries, to get the data to become more meaningful in terms of clinical interpretation of the number. But I think overall the feedback is actually extremely positive.

Ben Haynor

Okay, great. That’s all I have, thank you very much gentlemen.

Arun Menawat

Wonderful Ben.

Operator

It appears no further questions, so I would like to turn it back over to Dr. Menawat for closing remarks.

Arun Menawat

I would thank all of you for participation today and your interest in Novadaq. And I look forward to updating everyone on our financials at our Q1 ‘16 call. Thank you.

Operator

Thank you, this does conclude today's conference. You may disconnect your lines and have a wonderful evening.

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