Vital Images, Inc. Q1 2008 Earnings Call Transcript

May. 8.08 | About: Vital Images, (VTAL)

Vital Images, Inc. (NASDAQ:VTAL)

Q1 2008 Earnings Call Transcript

May 8, 2008 11:30 am ET

Executives

Mike Carrel – President and CEO

Peter Goepfrich – CFO

Analysts

Ross Muken – Deutsche Bank

Sean Wieland – Piper Jaffray

Ernie Andberg – Feltl & Co.

Topher Orr – Thomas Weisel

Bret Jones – Leerink Swann

Operator

Good morning ladies and gentlemen. Thank you for standing by. Welcome to the Vital Images first quarter conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator instructions) As a reminder, this conference is being recorded today, Thursday, May 8, 2008.

I would now like to turn the conference over to Mr. Mike Carrel, President and CEO. Please go ahead sir.

Mike Carrel

Thanks, Larry, and good morning and welcome to our first quarter conference call. With me today is Peter Goepfrich, our Chief Financial Officer.

Before we begin, I must preface all comments with the Safe Harbor statement. Some of the comments made today will be forward-looking and are made under the Private Securities Litigation Reform Act of 1995. Actual results may differ and factors may cause such results to differ are identified on page 10 of the Form 10-K for the year ended December 31, 2007.

Let me start with an overview of our performance in the marketplace as we see it today. This morning, we reported first quarter revenue that were sequentially ahead of 2007 fourth quarter. That said we are operating in a complex and challenging marketplace. Since becoming CEO in January, I visited with many customers, partners and luminary sites in the U.S. and internationally. They are strong advocates for our technology and our service and these are long-term strengths that will help us weather the tough selling environment that we are in today.

As many of you may already realize, we are operating in two distinct markets, the CT scanner or capital equipment market and the healthcare IT or PACS market. We need to segment our strategies in order to be successful in both of these areas. Within the CT scanner market, GE, Siemens, Philips and (inaudible) have all announced disappointing quarters and outlooks for 2008 in their imaging modality businesses.

We believe decision makers are prioritizing their capital expenditures due to reimbursement pressures and uncertainties and the introduction of the next generation technologies. The CT market is tied to capital equipment spending. Many of our customers are also concerned about economic recession, access to capital and the effects of an election.

On the other hand, our PACS partners particularly McKesson and Cerner had good quarters and it’s no coincidence that they both operate in the healthcare IT arena. In other words, they are selling to the enterprise and are not tied to CT scanner sales. Hospitals understand the need to improve productivity throughout their enterprise and they are investing in healthcare IT, thus our focus in this area.

In a move to help accelerate Vital Images move to the enterprise, leverage our already industry leading Web-based clinical solutions and meet customer expectations, this morning we announced a new business model specifically geared towards enterprise sales. This is not a reactionary move but one that we have been talking about for years and analyzing in a great amount of detail since I became CEO as to how we would get it done. The timing coincided with our sales meeting which is part of our 108 day reignite growth plans. It is something that I strongly believe is necessary and will provide great benefits to both our customers and our financials in the long term.

In a few moments, I will tell you more about our plans to focus on the enterprise market. Regardless of the pricing, it is clear to me that while we have a lot of work to do, we continue to have the best advanced visualization technology and team and we are here to win in the long-term. That drives our priorities and our planning.

This morning, we also announced a $25 million stock buyback. A number of you have asked about a buyback for quite some time. Given our confidence in Vital’s long-term prospects and today’s interest rate environment, we believe our stock is attractive at current levels and that this is a prudent use of our resources. In addition, we are retaining ample cash for acquisitions, particularly transactions that complement and broaden our current suite of applications. We are fortunate to have a strong balance sheet and we want to maintain a healthy cash per share ratio.

At this point, I would like to turn it over to Peter to provide a summary of the financial results for the first quarter and guidance.

Peter Goepfrich

Thanks Mike. As we previously discussed, since the second quarter of 2007, our revenue and operating results have been significantly affected by the industry-wide slowdown in the CT market and the broad impact of the Deficit Reduction Act.

Here's a rundown of the numbers comparing first quarter 2008 with fourth quarter 2007 as this comparison is more relevant to our results and the comparison of year-over-year quarters due to the significant drop-off in revenue after the first quarter of 2007. Comparison of year-over-year quarters is available in our earnings release this morning.

First quarter revenue was $17.3 million compared to $16.7 million in the fourth quarter of 2007. The first quarter net loss was $594,000 or $0.03 per diluted share compared to the net loss of $1.6 million or $0.09 per diluted share in the fourth quarter. First quarter adjusted EBITDA, a non-GAAP measure, was $147,000 compared to a loss of $1.2 million in the fourth quarter of 2007.

Our net loss and adjusted EBITDA improved in the first quarter of 2008 primarily because the fourth quarter of 2007 included $1.1 million in costs related to our biggest tradeshow RSNA and a charge of $885,000 related to Jay Miller’s resignation.

License revenue was $9.4 million versus $9.1 million in the fourth quarter of 2007. Maintenance and services revenues were $7.5 million versus $7.3 million in the fourth quarter of 2007. Direct revenue that is revenue generated outside our partners Toshiba and McKesson was $6.9 million versus $7.6 million in the fourth quarter of 2007. International revenue totaled $4.1 million or 24% of revenue in the first quarter versus $4.2 million or 25% of total revenue in the fourth quarter of 2007.

Gross margin was consistent at 77% over the first quarter and fourth quarter. Interest income was $1.7 million in the first quarter versus $2.2 million in the fourth quarter of 2007. Our return on investments decreased to 3.8% in the first quarter from 5.1% in 2007 and 4.9% in the fourth quarter of 2007. We anticipate further decreases in interest income due to interest rate cuts and a reduction in cash and investments as a result of the share buyback program.

Next, I want to review first quarter operating expenses. After the second quarter of 2007, we initiated certain cost control measures as a result of the downturn in the market. Specifically, we froze headcount and only hired key persons in research, development and customer support that support our top priorities in 2008 and long-term. Total headcount was 328 as of June 30, 2007, 323 as of March 31, 2008 and 320 as of April 30, 2008. Additionally, we significantly curbed discretionary spending in capital expenditures.

As we discussed last quarter, we are carefully managing our cost structure and will not cut cost or initiatives that support our long-term strategies. First quarter sales and marketing were $8.1 million or 46% of revenue compared to $9.1 million or 54% of revenue in the fourth quarter of 2007. The decrease was primarily due to significantly lower tradeshow expenses as previously discussed.

R&D expenses were $4.3 million or 25% of revenue compared to $3.9 million or 23% of revenue in the fourth quarter 2007. This level is consistent with our commitments to developing industry leading software solutions. G&A expenses were $3.7 million or 21% of revenue compared to $4.4 million or 27% of revenue in the fourth quarter of 2007. This decrease was largely result of the $885,000 charge in the fourth quarter related to Jay Miller’s resignation.

Now, let’s turn to the balance sheet. We continue to maintain a strong balance sheet. As of March 31, 2008, we have cash, cash equivalents and marketable securities of $178.9 million up slightly from $178.4 million as of December 31, 2007. In the first quarter, we generated $1.1 million in cash from operations.

Next, Mike will discuss other noteworthy items from the quarter as well as provide an update on our 2008 priorities.

Mike Carrel

Thank you, Peter. With that background, I will now comment on specific revenue channels starting with Toshiba. First quarter was our largest Toshiba quarter in the year. Our relationship with Toshiba is stronger than ever and this partnership is an important contributor in both U.S. and international markets. We get asked regularly about our partnership with Toshiba and if it holds us back. In our opinion, it is quite the opposite. While we need to make bold moves in positioning and pricing to go after the enterprise, Toshiba provides us many avenues for future growth in alignment with an industry leader. It is a great partnership from this prospective and we are focused on growing this relationship in many directions.

To that end, here are some recent developments with Toshiba that will benefit both of us in the future. First, to better serve Toshiba and to have clear delineation between our enterprise and Toshiba business, we announced in March that Steve Anderson will lead our global relationship with Toshiba. This means that Steve will be working with Susan Wood, our EVP of Marketing and Technology, and will be responsible for sales and marketing support as well as working cross functionally with product development and service to make sure we are best serving Toshiba and maximizing our revenue and customer satisfaction.

Steve has over six years of experience working with Toshiba throughout the world in varying roles, customer support, engineering, international, and sales operation. This perspective puts him in a unique position to help serve our largest partner and to help drive exceptional growth through this channel for the long term.

Second, Toshiba introduced the first dynamic 320 channel CT scanner, the AquilionONE which was prominently exhibited at the March 2008 ACC meeting and the November 2007 RSNA. At both events, demonstrations of the AquilionONE used our software. This enhanced CT scanner has the potential to revolutionalize patient care by reducing diagnostic time for life-threatening condition such as stroke and heart disease from days and hours to minutes. We did our Vitrea fX in partnership with Toshiba specifically for AquilionONE and we now have both FDA marketing clearance and CE Mark approval.

While competitors may claim that they can process the DICOM data from the AquilionONE, Vitrea fX was exclusively developed in partnership with Toshiba and it is the only software that can process the dynamic volume datasets from the AquilionONE. In combination, our technologies enable the imaging and analysis of dynamic flow and perfusion in the brain, producing a complete stroke workup in just a few minutes. Nobody else can provide this with the AquilionONE. Toshiba has already sold many systems worldwide with our software and plans to begin full production of the AquilionONE in late 2008.

Third, as you are all well aware, we added Japan to our worldwide distribution and licensing agreement. I have mentioned it before that Toshiba, the industry leader in CT technology, had previously worked with other advanced visualization companies and they selected Vital because of our superior technology, work flow, and customer service. We are both honored and excited and we expect significant revenue from Japan beginning in 2009.

Fourth, to support our efforts to sell more enterprise transactions, last week Toshiba America started selling our Web solutions. We have plans to roll this out worldwide and believe it will provide long-term upside in this channel and give us an enterprise foothold for customer upgrades, so a number of positives on Toshiba front.

Next, I will comment on Vital Images' maintenance and services revenue which was comparable to the year ago period. We recently announced that our installed base now totals 3,200 customer sites and nearly 5,000 installations. Taking exceptional care of our customers is our top priority. We are investing heavily in this area and have strong customer service ethic. The customer is at the center of everything that we are doing. In fact, we are in a process of conducting a JD Power audit and expect to be certified for service excellence within the next 12 months.

About 80% of our U.S. customers have maintenance and services agreements, which is up from 52% in 2005 and our percentage of international customers under maintenance has grown from less than 30% at the end of 2007 to over 40% today.

Internationally, we now have an installed base of more than 1000 installations including 650 installations in Europe alone. Toshiba continues to be a strong contributor in the European market. Although our direct sales have been slow, the pipeline is growing and is ten times larger than it was this time last year.

The last year’s expansion of our sales office in Den Haag, the Netherlands, we now have direct sales coverage in all major European nations. I believe the investment made to date in building our sales, service, and show site capabilities in Europe is critical to our long-term growth and success.

In China, we now have regulatory approval to sell our products on a direct basis there and we are in the process of expanding our distribution relationships beyond Toshiba. For several years, we have had an R&D office in Beijing and that is increasingly productive and allows for 24/7 development and testing. We have over 30 people in China today. We believe China is a large long-term opportunity and we are already beginning to win deals and expand our pipeline.

We are also looking at new distributor relationships in other countries to expand our international footprint. License fee revenue from McKesson our primary U.S. partner was up approximately 100% or $400,000 from Q4 of 2007. Specifically, we are working closer with the McKesson team to identify and cultivate tax prospects. One opportunity is the patch replacement market in large academic centers where Vital enjoys an impressive installed base.

Similar to Toshiba, in an effort to reignite growth in this channel we have just rolled out our Web-based products to our McKesson installed base through their installed base sales force. There are over 250 McKesson and Vital joint customers today and we plan to provide them all with Web access to our clinical tools. This is a very exciting opportunity for both companies and we should see some results in late 2008.

To build the business over the long term, we are executing on the three priorities I mentioned on the Q4 2007 conference call. Let me update you on each. First is to reignite growth by focusing on larger enterprise-wide sales within the healthcare IT market and this morning we announced Vital Enterprise specifically for this market. This business model offers customers anywhere, anytime enterprise-wide access to all our powerful advanced visualization solutions as well the ability to expand the solution as their requirements change.

Our aim is to make the customer experience an incredibly positive one. From the initial purchasing process to the easy to use clinical applications, education and ongoing support in resources that we provide, we are second to none in this area. The new pricing model scale is based on the size of the enterprise by providing the customer the option to license our complete solution based on unlimited users or concurrent users depending on their needs.

Additionally, we will offer our customers the ability to buy through capital or subscription pricing. This flexibility will comment in the software industry is unique to the advanced visualization imaging space. We believe that this model will aid [ph] in driving larger enterprise transactions by providing simplified scalable pricing.

Some of you may be asking, will the subscription model impact short term revenue? While we are bringing down guidance, this is due to market uncertainty and so we believe the answer to this question is no. The reason based on our analysis is only a small percentage of the existing customer base will actually purchase this way but it demonstrates a willingness to be flexible and easy to work with.

Additionally, most of the organizations that buy this way will purchase – were pushing out decisions and we believe we may be able to use this to bring transactions that will otherwise not be possible. As for the long-term when successful this model will provide a much stronger recurring revenue stream for us.

Vital Enterprise is a game changing move which differentiates us. It is the result of a great deal of analysis, benchmarking and many conversations with our customers. We have also tested this in the marketplace and we unveiled the Vital Enterprise at our national and international sales meetings the past two weeks. I can say unequivocally our team is excited about the prospects of selling the Vital Enterprise.

In addition to the new pricing, we have developed a detailed plan of action to reignite growth in this tough selling environment. Some examples include improved communication and interaction with our customers, accelerated investment in clinical and technical sales support, the rollout of the ability to provide customized HL7 integrations, the expansion of our reference sites for our full Web based solution and much, much more. The new pricing model and other plans are not short term fixes. It will take 12 to 18 months to fully gain traction and we view 2008 as a transition year.

The second corporate priority is to take exceptional care of our customers by listening to their feedback and providing service beyond expectations. This is what we now refer to as service excellence. For two weeks in March, I had the pleasure of visiting nearly 20 customer sites across the United States including Stanford, UPMC, Birmingham Women, Beth Israel Deaconess, Palo Alto Medical Foundation, UCLA, just to name a few of our outstanding customers. I met with doctors, CIOs, CEOs and technical personnel. My purpose was to listen to how our customers use our products and better understand their needs. It was an exhilarating two weeks.

In addition to their commentary that we have the best advanced visualization solution on the market today, their suggested focus areas are consistent with our development initiative, namely seamless integration of advanced visualization with PACS systems, making all our applications accessible on the Web, and ongoing education throughout the life cycle of our products.

Third priority is to continue to develop and launch the best advanced visualization analysis solutions. We have made important investments in R&D and we will continue to do so. With less than ideal market dynamics, the benefits may not be apparent now but we are confident that these investments will pay dividends going forward and we are already seeing progress.

As you can tell from the new pricing model, our strategy is to offer unlimited access to our core solutions at as many institutions as possible and then continue to differentiate by innovating in various clinical specialties, building easy to use productivity enhancing and clinically relevant applications in areas where we have always excelled and always been number one.

Developing our products to support this strategy is key to our long term growth and differentiation. That said, our products as they exist today are competing successfully and we are winning many more deals than we are losing and I have an exciting example of an enterprise deal to share with you, UPMC.

UPMC is the University of Pittsburgh Medical Center. Over the past several weeks, I have had the opportunity to see what I call the foundation of our future at UPMC. I spent more than two days with Dr. Shrestha, Medical Director of Informatics at UPMC and meeting and kicking off what we call a revitalization effort with many people throughout the entire UPMC Enterprise, the CIO, Chairman of Radiology, doctors, technicians, PACS administrators, et cetera.

I truly believe Dr. Shrestha is taking the right approach to rolling out our software, the full solution suite to the entire UPMC Enterprise. It is well planned, getting buy-in, has a lot of education and exceptional communication throughout. This is a model for all our other enterprise customers.

To give you an idea of the scope, here is a snapshot of UPMC. They have over 180 radiologists and at least that many residents and fellows. They do over 2 million exams per year and are growing rapidly. They have over 20 hospitals and 15 imaging centers in the western PA and expanding both in Pennsylvania and internationally. They have over 7,000 referring physicians who all want access to our tools.

Dr. Shrestha has built a great deal of enthusiasm for this launch at UPMC. And while many at UPMC have been doing GEAWs for many years, we are beginning to convert them one by one. One formerly skeptical doctor on the staff kicked off the revitalization meeting by demonstrating live cases via the Web in front of the UPMC administration and doctors. It was a huge success. There is nothing like customers bragging about what they can do with our software to improve patient care. As a result of the successes to date, Dr. Shrestha has agreed to speak at our annual meeting. He is a true evangelist for our solutions.

As you can probably see or hear, I am excited not only about the future but about how our products are being deployed today in the enterprise which will absolutely improve patient care at UPMC and other facilities.

Now, let me transition to our guidance discussion. Although the revised guidance we provided indicates a weak 2008, I cannot emphasize enough how confident I am in our new enterprise approach and how much I truly believe in the long term market opportunities in front of us. While we cannot control the timing of the CT market rebound, we are committed to re-igniting growth, building the best products and solutions and providing exceptional service.

For the full year, we expect the following; revenue of approximately $66 million to $72 million dollars, pre-equity based EBITDA or adjusted EBITDA of breakeven to $5 million, GAAP net loss of $0.30 to $0.10 per share.

I want to assure you that we are focused on measures we can take to regain our sales momentum and we are keeping close tabs on external factors affecting our markets. At the same time, we are closely watching our expenses and continuing to analyze how we allocate all of our resources.

Now, I will turn it to Peter to discuss the guidance in a little bit more detail.

Peter Goepfrich

First, I want to explain why after announcing an inline revenue quarter we reduced our 2008 outlook. As we’ve discussed, the CT market continues to be weak and it will take time for our new pricing model to fully gain traction in the IT market. Furthermore, we closed less direct business in the first quarter than we initially forecasted. Historically, we close a high percentage of forecasted business and this was not the case in the first quarter.

Deals continue to push in the future quarters as many of our customers are delaying equipment related purchases to which Vital sales are often tied. Our pipeline is stronger than ever, but the timing of deals has become less predictable. As a result, we’ve produced our guidance and anticipate that the second quarter revenue will be down relative to the first quarter as revenue through Toshiba is typically lower in the second quarter.

Additional factors we consider, gross margins of 76% to 77% for expenses – sales and marketing expenses of approximately 45% to 48% of total revenue, research and development expenses of approximately 24% to 26% of revenue, and G&A expenses of approximately 18% to 20% of total revenue. We anticipate equity based compensation of $5.3 million to $5.6 million, and expect depreciation expense of approximately $5.3 million to $5.6 million, and CapEx of approximately $4.8 million to $5.1 million, as well as amortization of acquired intangibles of $1 million.

We estimate interest income of $4 million to $5 million compared to $8.9 million in 2007. It is important to note that we anticipate significantly lower interest rates in 2008 compared to 2007 due to general market conditions as well as the stock buyback program. Further changes in interest rates could have a significant impact on our results. And finally, an effective income tax rate of 32% to 36%.

Now, back to Mike.

Mike Carrel

Thank you, Peter. In summary, we are optimistic about our long term prospects and remain committed to developing the best advanced visualization and analysis solutions, taking exceptional care of our customers and re-igniting long-term growth.

Now, we would like to open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question comes from the line of Ross Muken with Deutsche Bank. Please go ahead.

Ross Muken – Deutsche Bank

Good morning gentlemen.

Mike Carrel

Good morning, Ross.

Ross Muken – Deutsche Bank

So, as we look at sort of the end market, you clearly laid out that the weakness continues to persist in I guess the imaging landscape. Could you characterize sort of what – when you talk to your customers in the field, what the response is today versus three to six months ago? Because I understand the conservatism around not having the deal flow come as you thought in the quarter. But, just can you give us a better characterization what truly it is like when you get out there and you’re trying to win new business in this kind of a market environment?

Mike Carrel

Sure. The big issue that we are seeing right now is we just didn't close as much as we typically have closed in the past. And most of that is just that the environment that it’s pushing. Historically, we have closed a lot of business in the last two weeks of a quarter and this quarter was no different. But on a direct basis, the percentage of deals that closed from what we would have anticipated and seen in the past was very different and we thought we were being conservative when we’re looking at the forecasting.

So, that is what gives us some pause about the uncertainty looking forward and we want to make sure that we are setting the appropriate type of guidance on it. I think that at the end of March it took a lot of people by surprise like the GEs and the Siemens of the world and you can see that in some of their announcements as well. And so, from my prospective what you're seeing is people are just – there's just an uncertainty out there, what's going to happen and when do they want to push that capital budget and when are they going to pull the trigger on it. I do think that they are eventually going to spend. The question is the timing of that.

Ross Muken – Deutsche Bank

And what do you think we need to see to get a bit more confidence or what do you think the hospitals need to see in order to believe that we're going to see a turn in the cycle? Obviously we have some new product momentum coming, but what do you think is sort of the key inflection point so we could say, okay, the hospital market is far less impaired in the imaging space. Clearly they are going to be more willing to take on new technology such as yours.

Mike Carrel

You mentioned one of them. I think obviously the newer technology that is coming out, but I think that in addition to that as some of the uncertainty around the economy and around some of the reimbursement pressures, I think some of that has already happened with CMS and the rulings that came out there that were positive, and I think you'll begin to see some of those effects come out. But, I don't think it is all of a sudden one month the world changes. I think it's going to be an evolutionary change as opposed to something happens one quarter over another. You'll begin to kind of see it in a sequential quarter over time.

Ross Muken – Deutsche Bank

And in terms of the new Enterprise solution, does that change the typical sales cycle or how does that impact you guys from a deal perspective in terms of deal flow? And what different approach does a salesman have to go in and how do you train them to sell that type of a deal versus the typical way you were selling?

Mike Carrel

You have got a lot of questions in there so I will try to answer one by one. The first part of that question was what is different in terms of the deal flow and the timing of it. Quite frankly, it actually depends on the customer. In some cases, what we're hearing and we rolled this out to our sales team over the last two weeks is that they are more excited and this is actually going to push deals and allow them to come into this quarter as opposed to not – deals that may otherwise have been pushed out for a variety of different reasons, they are now thinking about it differently. That is kind of one type of deal.

On the larger transactions at the Enterprise, they are going to the bigger deals. They are going to take more time because you are attacking a space much like UPMC where you are talking about a 20 hospital system and how do you get access to that. You've got deals that might be in the pipeline that were a lot smaller and you are trying to convince them and show them a totally different solution, and that may extend some of the deals out a little bit. So, it really depends on where you are in the sales cycle today. You may get – the way that we have done it is that you actually get credit for the purchases that you make, so they may make a decision on a small decision today and then a bigger decision over time. And it's something that's unique within our installed base.

In terms of training, that's where we have been spending the last several weeks with our sales force. We have been getting them ready for understanding how to attack the enterprise, talk to the CIOs, the CFOs, the financial impact and ROI analysis that this has on their institution long-term. And we have been going through a lot of that training over the last several weeks and we are going to continue to do it, be out in the field with them over the next several months as well.

In addition to that, we've got executives that are going to be on calls working very aggressively with our sales team and pitching and helping sell at that CIO and C level executive.

Ross Muken – Deutsche Bank

Okay. Great, Mike.

Mike Carrel

I think that’s all of the points there, Ross.

Ross Muken – Deutsche Bank

Yes. I think you did. Thank you very much.

Operator

Thank you, sir. Our next question comes from the line of Sean Wieland with Piper Jaffray. Please go ahead.

Sean Wieland – Piper Jaffray

Alright thanks. Just a follow-up on Ross' question, is there going to be a new structure in the sales team? Do you need to hire people that have that Enterprise sales experience? And I guess what kind of expectations do you have for these Enterprise deals in terms of sales cycles and things of that nature?

Mike Carrel

In terms of the sales force, we've got a sales force and a great team out there today. We're confident that most of them, in fact all of them, can make the transition to the enterprise sales. We have been training a lot of them, getting them up to speed on it and quite frankly a lot of the hires that we've been hiring recently do come from this kind of Enterprise-type environment. So we've been very, very focused on that and putting some very specific training in place. We've made some structural changes in our sales force that we think are very positive to enable us to do this. We promoted one of our zone directors as we call them to help on the U.S. operation so that Steve Canakes can actually focus on a lot of these large transactions and help drive it, and also help sell them internationally as well. And that will kind of free him up from some of the day-to-day stuff at the level and really focus on some of these big transactions which he is exceptional at training the team on. And so, we've done some structural things from that perspective as well.

In terms of the length, it depends on the deal. We've been working on this as I mentioned earlier in – for the last three months from the moment that I became CEO trying to focus on what were those top 100 deals that we could attack segment and go after the marketplace with this type of solution.

Sean Wieland – Piper Jaffray

Have the comp plans changed for the reps to handle this kind of re-focus on the Enterprise?

Mike Carrel

Our comp plans do reflect this, but I'm not going to go into detail about the specific comp plan, but they do reflect the change in the Enterprise.

Sean Wieland – Piper Jaffray

Okay. And then do you see that most of the Enterprise sales, are they going to – are you going to be going after them from a direct perspective or through your channel partners?

Mike Carrel

Well, it’s a little bit of both. So our direct team is absolutely going after them, but we also announced today that both Toshiba and McKesson have the capabilities of selling ViTAL Connect. That is a new rollout that we just did in the last two weeks and we believe that provides a great foothold into selling the full breadth of the entire solution. What they do is they have got the capability to sell a certain number of concurrent licenses and that provides a nice foothold for us to get in there long-term to sell a broader Enterprise strategy.

Sean Wieland – Piper Jaffray

Okay. And is Cerner on board with the new Enterprise plan?

Mike Carrel

When you say on board …

Sean Wieland – Piper Jaffray

Well, meaning, I mean you referenced UPMC and so are you working closely with Cerner in some of their Enterprise opportunities?

Mike Carrel

We are not specifically working closely with Cerner. We have a lot of deals where they happen to be, but we are not necessarily working that closer with them. With Cerner, they typically give us leads as opposed to working and selling to them directly which we have got with McKesson.

Sean Wieland – Piper Jaffray

Okay. Thank you very much.

Operator

Thank you, sir. Our next question comes from the line of Ernie Andberg with Feltl & Co. Please go ahead.

Ernie Andberg – Feltl & Co.

Good morning.

Mike Carrel

Good morning, Ernie.

Ernie Andberg – Feltl & Co.

How does the new pricing model potentially affect the revenue flow, Mike, if you sell a subscription versus an outright sale?

Mike Carrel

Yes. I will focus on that and there's two, there's short-term and long-term. You've got, depending on how many people sign up for the subscription that we are now offering on every one of our deals, it would depend on how many people sign up for that. But, as I mentioned, we don't think that it is going be that material upfront, but a lot of the budgets still do come from the capital cycle because there's really two components to the Enterprise piece here. One is the unlimited nature for the access piece and the other one is the way that they can buy it with a capital or through a subscription model. And so, from a revenue standpoint, we anticipate – Peter talked about that in Q2, I don't think it has much to do with a pricing model as much as the softness in the market. We anticipate a little bit of downturn in the second quarter with a pickup little bit in the back half. Some of that has to do with what we anticipate from Toshiba.

When you look at the flow of this, if we get more and more people on subscription models, I believe those are people that would not have purchased on the capital model otherwise and it's actually a net new sale for us, mostly. And in addition to that, it will add to our long-term revenue, because it will be a nice recurring revenue stream on top of the maintenance stream that we already have.

Ernie Andberg – Feltl & Co.

Fair enough. On just the operating expense side, obviously RSNA and some other shows distort your sales and marketing spend up in the fourth quarter. You've given annual guidance on ranges for your operating expense categories. Is that the only quarter that is sort of distorted relative to where we were in the first quarter, Peter?

Peter Goepfrich

I can take that, Ernie. The fourth quarter is typically the starter quarter. First quarter gets a little high too because we have some bigger trade shows internationally as well, but typically it's the fourth quarter that has a big spike.

Ernie Andberg – Feltl & Co.

Fair enough. Thank you.

Operator

Thank you, sir. Our next question comes from the line of Steven Halper with Thomas Weisel. Please go ahead.

Topher Orr – Thomas Weisel

Yes. Hi, guys. This is actually Topher Orr in for Steve.

Mike Carrel

Hi Topher.

Topher Orr – Thomas Weisel

How are you doing? I just had two questions here. First, how many new Vitrea/ViTAL Connecters were sold in the quarter, and second, what's the total licenses now for your installed base?

Peter Goepfrich

I will cover that first part. I missed the second part of your question, but 215 was the Vitrea and 16 ViTAL Connect, the combined solution would have been 16 ViTAL Connect with 16 of those Vitreas, so 215 and 16. One thing to note that as we transition our model over to the broader enterprise, that the meaningful – the value we ascribed to individual licenses becomes less. So, as far as guiding you and you guys building models based on licenses, it is probably going to dissipate. It's become less meaningful because we are covering the broader enterprise and providing unlimited access so it becomes less of a gauge going forward.

Mike Carrel

And that is an incredibly important point. I am going to play off that. So, we've got over 5,000, I use the word installations on the call today on purpose because those are 5,000 installations where we have got a server or we've got a workstation today. In the future and as we are selling the new enterprise model, you get both as part of your solution. So they are not going to be decoupled. You basically get Web access with every buy that you get with us as opposed to what Peter talked about where it was broken up by ViTAL Connect and Vitrea previously.

Topher Orr – Thomas Weisel

Okay, great. Thanks.

Operator

Thank you, sir. Our next question comes from the line of Bret Jones with Leerink Swann. Please go ahead.

Bret Jones – Leerink Swann

Hi good morning, Mike and Peter. I wanted to focus in on how you see the market evolving, Mike. I know we talked in the past and you've said that essentially the functionality between Web based offering and ViTAL Connect will merge with what you are able to accomplish through Vitrea. I wanted to know, does that still hold true, and really how does the enterprise wide approach really affect that? I would think that if everything is going to migrate over to the Web-based approach that you are just essentially selling ViTAL Connect and there really isn't much to the idea of selling into the entire enterprise, or am I missing something there?

Mike Carrel

You are missing a nuance that is pretty important which is today when somebody buys a Vital Enterprise and a Vital solution from us, they are getting access to all the best applications via the Web. And there are technical ways that we go about doing that, but they are basically getting full breadth and access to the solution. So that is the way that we are going to market with it.

Bret Jones – Leerink Swann

Are you able to offer total functionality on the (inaudible)?

Mike Carrel

We’re able to have access through the Web to all the functionality.

Bret Jones – Leerink Swann

All right, so it is a viewer at this point for some of the applications as opposed to be being able to do the processing through the Web or am I – is that correct?

Mike Carrel

No, we've got a server that processes and does all the basic functionality, does all the cardiac functionality, and then you've got access to what was formally known in working on Vitrea where you can basically get access to it as well. We used to sell something called the Vital Access where you could basically get access to it by dialing in. And today, you can get access to that with the full solution.

Bret Jones – Leerink Swann

Okay. So you don’t really …

Mike Carrel

It's really just toggling. I mean if you are sitting at the desk and you're the radiologist, the cardiologist, somebody else, you can basically get access to it. You used to have to buy them individually. So each individual place and location would have to buy that Vitrea access. Today, you are getting it as part of the solution.

Bret Jones – Leerink Swann

Okay. So, you don't envision a situation where your workstations actually disappear and is replaced by the functionality of the Web, where everything is accessed through the Web and processed over the Web?

Mike Carrel

I'm not necessarily saying that, no. I mean, I think that there is always going to be a place for some aspects of the workstation, yes. But you will be able to get and you can today get just about all of that accessible on the Web today.

Bret Jones – Leerink Swann

Okay, all right. Well, I had another question just on – I was curious if we strip out, and this is a financial question, if we go to – if we look at the G&A in the quarter, if I am stripping out the one-time charge for Jay Miller in Q4 and also stripping out (inaudible), it looks like there was a material bump up in the G&A if I am doing that correctly, and I was wondering is that tied to severance costs, because you talked about streamlining the headcount a little bit?

Mike Carrel

No, that's actually tied to our audit and public company cost related to doing our annual report and everything else that goes with it. So most of our audit costs are in that quarter as well as all the things we do for the annual meeting.

Bret Jones – Leerink Swann

Okay, so that should trend back down then?

Mike Carrel

And there’s a little bit from a restructuring standpoint as well.

Bret Jones – Leerink Swann

Okay, and then one last question …

Mike Carrel

It’s a small immaterial number.

Bret Jones – Leerink Swann

Okay, got you. And one last question, I did want to go back to the Enterprise just for a second. When we think about the OEM relationships in Toshiba, does this affect their mandatory minimums or does this just enable them to go back and sell ViTAL Connect back into the base?

Mike Carrel

It enables them to go back and sell them to the base.

Bret Jones – Leerink Swann

Okay. And do you get – from your standpoint, are they actively pushing your products or is it more than just an attachment rate when they sell a new CT scanner?

Mike Carrel

I’m not sure that I understand the question.

Bret Jones – Leerink Swann

Well, I guess, I guess historically have they really been doing much sales where they go back into the base? I note that was talked about with Japan and how aggressively Toshiba would go back in and sell it to the base. Historically, does Toshiba do that? Do you anticipate that they will aggressively go back into their base and try and sell ViTAL Connect?

Mike Carrel

Do you mean separate, just so that I understand, separately from when they are having a CT sale?

Bret Jones – Leerink Swann

Exactly.

Mike Carrel

No, they typically sell at the time of the CT sell. That is when they are selling it and what this is allowing them to do is to go sell the Web based product while they are selling that to create a differentiator for them out in the marketplace.

Bret Jones – Leerink Swann

All right, great. Thank you very much.

Operator

Thank you, sir. And our next question is a follow-up question from the line of Ernie Andberg. Please go ahead, sir.

Ernie Andberg – Feltl & Co.

Mike, how does the new Web based solution compare with competitive kinds of product out there?

Mike Carrel

We believe that we’ve got the best technology in Web based solution on the market today.

Ernie Andberg – Feltl & Co.

Short answer, thank you.

Operator

Thank you, sir. And ladies and gentlemen, that does conclude our question and answer session for today. I'd like to turn it back to Mr. Carrel for any closing remarks.

Mike Carrel

Thank you, and thank you everyone for coming on the call today. The slowdown in the CT market has created a difficult sales environment, but does not change the value of our technology to the healthcare enterprise. As Dr. Shrestha from UPMC told me last month, "One of the main clinical benefits of 3D advance visualization is the fact that the technology can ingest, digest and assimilate the tsunami of datasets that are being thrown at us by the-ever proliferating multi-slice CTs. It makes sense of every pixel of data that is captured. Otherwise there is no logical way to actually be able to fully comprehend the added volumes. Additionally, the ability to bring volumetric examinations to the point where I can make a definitive yes/no decision in just a few clicks like with the Vital software is huge. Thank you for all you are doing in advanced visualization."

As we look forward, we are confident in our technology and products and we are optimistic about our growth opportunities. Physicians and other healthcare providers increasingly recognize the value of our products in improving their own productivity and patient care. As one customer told me recently, stay focused on building and maintaining the best products in the market and you will win, and we are committed to doing that.

Again thank you for joining us today.

Operator

Ladies and gentlemen, this concludes the Vital Images first quarter conference call. You may not disconnect. Thank you for using AT&T teleconferencing and have a pleasant day.

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