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Article by DailyStocks_admin    (03-03-08 03:53 AM)

Oliver Press Partners said that it's nominating three candidates for election to the board at the 2008 annual meeting. Oliver Press said there are a number of strategic initiatives that will enhance the company's value, and it has engaged in discussions with the board and management to review these initiatives. Oliver Press currently holds about 3.03 million shares (14.2%).

BUSINESS OVERVIEW

Overview
We provide enterprise-level information technology solutions for the clinical analysis and management of digital medical images within health care provider organizations. Our solutions consist of advanced visualization and image management software for multiple medical specialties, comprehensive reporting and knowledge tools for cardiology, support services and third-party components. Our web-enabled advanced visualization software provides physicians across the enterprise — in multiple medical specialties and at any network access point —with tools to manipulate and analyze images in two dimensions (“2D”) and three dimensions (“3D”). We enable physicians to better understand internal anatomic structure and pathology, which can improve clinical diagnoses, disease screening and therapy planning. We believe our solutions improve physician productivity and patient care; enhance customer revenue opportunities; automate complex, mission-critical medical imaging workflow; and maximize our customers’ return on investment in capital equipment and clinical information systems.
We sell to multi-hospital networks, individual hospitals, physician clinics and diagnostic imaging centers. Health care providers produce growing volumes of medical imaging data that must be analyzed, managed and stored efficiently and cost-effectively. We focus on developing corporate-level relationships with large multi-facility organizations that provide substantial cross-selling opportunities and represent an important competitive advantage for us. Since our first commercial implementation in December 2000, we have implemented our solutions at facilities affiliated with some of the largest multi-facility health care providers in the United States.
As of December 31, 2006, we had $158.4 million in contracted backlog, consisting primarily of fees for contracted future installations and for the support of existing installations, compared with a contracted backlog of $158.0 million at December 31, 2005. From our current contracted backlog, we expect to recognize revenue of approximately $68.2 million during fiscal year 2007, $31.8 million during fiscal year 2008, and substantially all of the remaining $58.4 million by 2011.

We were founded in December 1998 as an Alabama corporation and reincorporated in Delaware in January 2000. On February 14, 2005, we completed our initial public offering. We acquired Camtronics Medical Systems, Ltd., or Camtronics, on November 1, 2005.
Our Opportunity
Demand for advanced visualization and image management solutions is growing as the number and size of imaging exams increase due to accelerating physician adoption of advanced imaging, the growing health care needs of an aging U.S. population and the increasing sophistication of imaging devices such as computed tomography, or CT, magnetic resonance imaging, or MRI, positron emission tomography, or PET, and cardiac catheterization. Existing film-based workflow or department-level picture archiving and communications systems, or PACS, are not sufficient to meet this growing demand. Health care providers need digital infrastructure, storage and image management capabilities to alleviate the operating strain created by medical image records.
The American College of Radiology indicates that overall spending on imaging in the United States is growing 16% annually, from approximately $100 billion in 2003 to $250 billion in 2010. This increase makes imaging one of the fastest growing segments of overall healthcare spending, which, according to the Center for Medicare and Medicaid Services, is growing at a compounded annual growth rate of 7.2%, and is projected to be 20% of United States gross domestic product by 2015.
In addition, in 2005 Frost & Sullivan, a leading health care consulting and research firm, forecasted a 16.8% compound annual growth rate in enterprise cardiology PACS from 2004 through 2011. In 2006, Frost & Sullivan forecasted an 11.3% compound annual growth rate in enterprise radiology PACS from 2005 to 2012.
We believe the rapid expansion in the number and complexity of medical images and the need to automate complex, manual workflow processes are driving health care providers to invest in systems that maximize their return on capital investments in expensive imaging devices and clinical information technology. We facilitate the convergence of imaging technology and clinical automation at the enterprise level by enhancing analysis, integration and automation of medical imaging data. Effective image management can shorten report turnaround times, lower the potential for manual error in data entry and filing, increase staff efficiency, eliminate costs associated with traditional radiological workflow and improve overall diagnostic and clinical quality. We believe the following factors have collectively increased the demand for our solutions:
Increasing Number, Size and Complexity of Imaging Exams. The number of imaging exams performed each year is increasing as a result of a number of factors, including increased physician use of advanced imaging as a non-invasive diagnostic and clinical tool, lowered costs of imaging devices and increased health care needs of an aging U.S. population. At the same time, technological advancements are increasing the size and complexity of individual imaging exams. For example, new CT scanners produce 20 times as much data as prior models, with exams consisting of thousands of individual images yielding 500 to 1,000 megabytes of data per exam, versus only 25 to 50 megabytes just three years ago. One modality manufacturer has announced that they plan to have a 256-slice CT scanner on the market by 2008 which will produce images that are at least ten times the size of the images produced by today’s most advanced scanners. The increasing prevalence of fusion techniques used to combine images from multiple imaging devices increases the complexity of many exams. The rapid growth in the data size of medical images means that medical images also consume a greater share of hospital resources.
Need for Advanced Visualization Tools. The increase in image data is significantly impacting visualization workflow. According to Rick Morin, Ph.D., Professor of Radiology, Mayo Clinic, Jacksonville, Florida, and Eliot Siegal, M.D., Professor of Radiology, University of Maryland, radiologists in 2006 could review approximately 80,000 CT images per day, up from 16,000 in 2002 and 1,500 in 1994. Because the output of a cross-sectional imaging device, such as a CT scanner, may consist of thousands of “sliced” 2D images, physicians need sophisticated software tools to model those images in 3D and allow the viewing of a “virtual” patient at all angles. Treating physicians can benefit from computer-created 3D images and eliminate the need to mentally reconstruct 2D images into a single useful 3D image. This 3D reconstruction improves diagnostic capabilities, treatment and non-invasive surgical planning. Sophisticated new tools, such as 3D volumetric imaging and volume rendering, maximum intensity projection, or MIP, multi-planar reformat, or MPR, and surface shading, are increasingly essential to present medical images in a manner that is valuable to the physician for diagnosis and treatment planning. Moreover, some surgical specialists will not perform a complex surgery without first performing pre-operative 3D planning. Hospitals and hospital networks that provide these advanced visualization tools to physicians have the advantage of attracting patient referrals from those physicians that heavily utilize visualization technology in their practices.
Need for Complete Electronic Health Records. The need to improve clinical care and eliminate inefficiencies in existing paper-based methods, including film-based image management, continues to drive investment in clinical information technology. In 2004, the federal government began several initiatives to accelerate information technology adoption rates within the health care system, including the Presidential appointment of a national health care information technology office and a recommitment to the President’s Information Technology Advisory Committee. Health care providers are implementing clinical information systems to automate clinical documentation and integrate patient information into electronic health records. However, these clinical information systems typically lack the sophistication or capability to incorporate digital medical images from radiology modalities, echocardiology, or the cardiac catheterization lab into patient health records. Incomplete electronic health records can result in delayed diagnosis, billing errors and inefficient workflow. According to the Global Technology Centre in its 2005 publication Reactive to Adaptive : Transforming Hospitals With Digital Technology , one-fifth of medical errors are due to inadequate availability of patient information. A complete electronic health record, which includes all medical images and complete data from cardiac catheterization and echocardiology procedures, enhances the benefits of investment in clinical information technology.
Shortcomings of Film-Based Image Management. Many health care providers still use film to capture medical images from devices such as X-ray machines, which may produce three to four images per typical exam, and CT scanners, which can produce 8,000 images per exam. A film-based system has numerous inefficiencies, including complex exam scheduling, redundant patient data entry, the possibility of misplaced or misfiled notations and case histories, physical films and files that must be copied often or physically moved among the technologist, the specialist physician and the treating physician, degradation in quality, and substantial storage space requirements. Each of these inefficiencies has the potential to increase the total cost per exam.
Limitations of Current Methodologies for Managing Digital Medical Images. Current digital medical image management systems, which correct some of the inefficiencies of film-based imaging, have traditionally consisted of specialized services and technologies tied to specific department-level requirements. For example, a typical PACS installation is a department-level installation with dedicated hardware components primarily designed to address the image storage and distribution needs of a small number of physicians in a single department at a single location (e.g., radiology or cardiology, but not both). While PACS installations may offer substantial automation benefits within a single department over traditional film-based imaging workflow, they do not offer the full potential of an integrated, enterprise-level digital image management solution. In addition, these systems typically do not integrate with clinical and administrative systems without expensive custom programming. Many hospitals that have embraced image automation have had to purchase multiple PACS and software tools for various departments and imaging devices, which presents integration challenges and requires significant investment. Many PACS were developed prior to the recent growth in the use of 3D imaging techniques and do not easily scale to handle the data volume of current imaging devices. PACS visualization tools are typically limited and are not distributable across the network except in a very rudimentary manner.
Our Solutions
We provide enterprise-level information technology solutions for the clinical analysis and management of digital medical images within health care provider organizations.
With our solutions, our customers and their constituents, including physicians, technologists and nurses, can improve overall clinical and diagnostic quality and eliminate much of the labor and other costs of dealing with film, disparate department-level information systems, exam scheduling and redundant data entry. We also help to alleviate heavy burdens on a health care provider’s staff by automating medical image workflow for physicians and technologists. We believe our enterprise visual medical system, or EVMS, solution provides the benefits of current department-level PACS, including increased automation and better efficiency over traditional film-based methods, with added enterprise-level and cross-enterprise-level / community-level connectivity and advanced visualization tools that are not available with a typical PACS installation.

Our solutions offer the following:
Enterprise-Level Image Content Management. Our solutions provide a single data repository for medical images created by digital imaging devices and related patient data across a single or multi-facility enterprise, whether from radiology, cardiology, pathology, orthopedics, obstetrics, gynecology or other departments. This single repository serves as a central point of workflow and content management for those images. Our solutions catalog, archive and route these images through our software, combining centralized control over sensitive patient imaging records with increased availability to physicians and other authorized users in multiple medical specialties and at any network access point. Our solutions integrate with our customers’ existing clinical information and administrative systems, serving as the patient’s visual medical record repository, reducing the risk of billing errors, and lowering the average cost per exam through automation of complex and manual film-based imaging workflow.
Advanced Visualization Technology. Our solutions quickly deliver web-enabled software toolsets and images to physicians throughout the enterprise for diagnostic analysis and treatment planning. Our advanced visualization software allows physicians to see 2D and 3D views of human anatomy and to manipulate, navigate within, and compare imaging exams in order to better visualize internal anatomic structure and pathology. This visualization of medical images can lead to improved clinical diagnosis, disease screening and treatment planning by physicians. Physicians can access our advanced visualization software from any network access point, including home, office or throughout the health care facility. Our intelligent user interface automatically adjusts for the specialty and preferences of each user, the type of imaging device used to create the image, and the particular body part and tissue type being examined.
Specialty-Specific Clinical Applications. With our acquisition of Camtronics in November 2005, we added a full suite of products to enhance capabilities of specialists in the cardiology department. These solutions manage images and clinical data relating to cardiac catheterization, echocardiography, nuclear cardiography, vascular ultrasound, and hemodynamics. We are focused on the development of enhancements and additional functionality to our existing advanced visualization software to further meet the needs of other clinical specialties, including orthopedics, oncology, pathology, obstetrics, gynecology, and neurology.
Open Standards-Based Software. We believe that our use of open standards has enabled us to design software that stores and manages information faster and with fewer hardware resources than competitive systems, a benefit we believe is becoming increasingly important as the data size of many imaging exams grows. We have designed our software to make full use of the DICOM standard for medical image data. Our commitment to open standards such as DICOM and the standard protocol for the storage of text-based patient information, Health Level 7, or HL7, makes our software compatible with new imaging device technologies and other clinical information systems that conform to these standards. We lower our customers’ total costs by eliminating the need for translation to and from non-standard or proprietary communication methods which often require the purchase of additional hardware and software.
Effective Implementation, User Adoption and Support Services. We focus on delivering effective implementation, user adoption and support services as an integral part of our solution. During the implementation phase of our solution, we use proven project management principles to facilitate rapid and complete adoption by our customer. After implementation, we monitor system use and, when appropriate, intervene to make the adjustments we consider necessary to prevent anticipated problems from occurring. We believe our focus on implementation and support services ensures that our customers’ investments in our solutions achieve their financial and operational objectives.
Our Strategy
Our goal is to become the industry leader in enterprise-level information technology solutions for the content management, workflow, and visualization of digital medical images.

Expand Our Market Share by Attracting New Customers. We believe a full range of health care organizations, from stand-alone imaging centers to multi-site hospital systems, represent a largely underserved market for our solution. Our current base of installed facilities represents a small portion of the prospective customers for our solution. We are expanding our sales and marketing efforts so that we may pursue new customers. As we pursue new customers, we intend to continue focusing our efforts on the large, multi-site health care providers that typically recognize the greatest benefits and fastest return on an investment in our solution and represent the largest individual sales opportunities. However, we believe there is additional opportunity in the smaller hospital market, and we are developing a strategy for expansion into the smaller hospital market to address this growing segment of the U.S. medical image management market. We believe our position as a sole source provider of an advanced visualization and image management solution, together with our implementation expertise and our installed base of nationally recognized reference customers will help us attract new customers.
Increase Penetration With Existing Customers. We believe that using our successful relationships with existing multi-facility health care customers to expand our penetration within those organizations and selling additional functionality to our existing installed base are effective ways to increase our operating margins by reducing the average cost of sales and increasing the total revenue from existing customers.
• Increase Installations with Existing Multi-Facility Customers. As of December 31, 2006, we had customer relationships with 19 multi-facility health care providers that control 263 hospitals. Our initial contracts with these customers often provide for implementation of the content management functions and sometimes the advanced visualization functions of our EVMS solution at only a portion of the facilities managed by the parent company. We believe there are opportunities to expand our installed base at facilities that are part of multi-facility systems in which we have a customer relationship with the parent company.

• Cross Sell to Existing Customers. We are also in a strong position to sell additional functionality to our existing customers, including advanced visualization tools for image-intensive medical specialties that may not have been part of the initial sale. As follow-on sales opportunities, we offer our advanced visualization software and other products and additional functionality to radiologists and other specialty groups within the organization. Our offering of our HeartSuite cardiology products gives us broader cross-selling opportunities than we had prior to the acquisition of Camtronics.
Enhance Our Product Offerings. We believe developing or acquiring additional functionality for our existing software, including improved advanced visualization suites of products for multiple specialties will further strengthen our position in the market. Further enhancements to our RadSuite advanced visualization software and our HeartSuite cardiology products should assist us in selling our solution to multi-hospital systems and expanding our existing customer relationships. We also plan to invest further in workflow and integration software to speed integration with existing clinical information systems, including electronic health record systems.
Continue to Deliver Superior Implementation, User Adoption and Customer Support Services. As a single-source provider of advanced visualization and image management solutions, we believe the quality of our implementation, user adoption and support services helps to differentiate us from our competition. We expect to continue to invest in, refine and develop new services to provide our customers with the highest level of services available and to provide us with a base of recurring revenue. We believe delivering superior services will enable us to capture increased market share and enhance our existing customer relationships, thereby increasing our competitiveness.
Maintain Our Open-Standards Focus. We believe our commitment to open standards, such as DICOM and HL7, lowers our development costs, lowers our customers’ total cost of ownership, improves speed and quality of our solution’s integration and differentiates us from our competition. By designing our solution around open standards, we believe we maximize our solution’s integration with our customers’ clinical information technology systems and imaging devices, which reduces our customers’ total cost of ownership. We also believe our open-standards model lowers the hardware costs associated with implementing our solution because it enables our customers to use relatively inexpensive, off-the-shelf hardware to visualize, analyze and manipulate images. We believe that our commitment to open standards enables our customers to maximize their return on investment in imaging devices, computer hardware and clinical information technology systems.
Our Product and Service Offerings
We provide an enterprise-level information technology solution for the clinical analysis and management of digital medical images within health care provider organizations. Our solution consists of image management and advanced visualization software, comprehensive support services and third-party components.


CEO BACKGROUND

Mylle H. Mangum has served as a member of the Board since June 2004. Ms. Mangum has served as Chief Executive Officer of International Banking Technologies, a retail bank design and consulting firm, since October 2003. She was Chief Executive Officer of True Marketing Services LLC, a marketing services company, from June 2002 through October 2003. She was Chief Executive Officer of MMS Incentives, LLC, a private equity company concentrating on high-tech marketing solutions, from 1999 to 2002. She previously served as Senior Vice President of Carlson Wagonlit Travel Holdings, Inc. and Executive Vice President of Holiday Inn Worldwide. Ms. Mangum is a director of Barnes Group Inc., Haverty Furniture Companies, Inc., Payless ShoeSource, Inc., and Respironics, Inc.

Hugh H. Williamson, III has served as a member of the Board since January 2000. Mr. Williamson has served as Chairman of the Board and Chief Executive Officer of XeDAR Corporation since January 2007 and as Chief Executive Officer of Cherry Creek Capital Partners, LLC, a private equity firm, since 1999. He has also served as a principal of Humanade, LLC, a technology private equity firm, since 1995. Since 1992, he has also served as Chief Executive Officer of Schutte & Koerting, Inc. (formerly Ketema, Inc.), a privately held industrial manufacturer of advanced materials, components, and equipment, and is currently its sole shareholder and director. Mr. Williamson is a director of several private companies. Mr. Williamson was elected as Lead Independent Director of Emageon on April 24, 2007, effective as of the close of the Annual Meeting.

Arthur P. Beattie has served as a member of the Board since August 2004. Mr. Beattie has served as Executive Vice President, Chief Financial Officer and Treasurer of Alabama Power Company, a subsidiary of Southern Company, since February 2005. Mr. Beattie previously served as Vice President and Comptroller of Alabama Power Company since 1997. Mr. Beattie is a director of several non-profit entities.

Fred C. Goad, Jr. has served as a member of the Board since June 2004. Mr. Goad is a partner in Voyent Partners LLC, a private equity firm that he co-founded in August 2001. Mr. Goad served as Co-Chief Executive Officer of the Transaction Services Division of Healtheon/WebMD Corporation (now Emdeon Corporation) from 1999 to 2001. He previously served as Co-Chief Executive Officer and Chairman of ENVOY Corporation, a provider of electronic transaction processing services for the health care industry, which was acquired by WebMD in 1999. Mr. Goad is a director of Performance Food Group Company, Luminex Corp., and several private companies.

Charles A. Jett, Jr. has served as Chairman of the Board and Chief Executive Officer since January 2000, and was appointed President in March 2006. From 1997 through 1999, Mr. Jett was Vice President and General Manager of Walker Interactive Systems, Inc. (now Elevon, Inc.), a provider of enterprise financial and management software. He joined Walker Interactive upon its acquisition of Revere, Inc., a software company, where Mr. Jett’s position prior to the acquisition was Chairman, President, and Chief Executive Officer. Mr. Jett joined Revere, Inc. in 1988 as Vice President of Sales, was promoted to President in 1991, and assumed the Chairman and CEO positions in 1994. Prior to his tenure at Revere, Mr. Jett was national sales manager of Shoptrac Data Collection Systems, Inc. Mr. Jett is a director of several non-profit entities and one private company.

Roddy J.H. Clark has served as a member of the Board since June 2000. Mr. Clark has been a managing partner of Redmont Venture Partners, Inc., a private equity firm concentrating in technology markets, since 1998. Mr. Clark is a director of several private companies.

Douglas D. French has served as a member of the Board since October 2006. Since May 2004, Mr. French has been a Principal of JD Resources, LLC, a private equity firm that provides strategic advisory and venture capital services for early stage healthcare companies. From January 2000 through May 2004, Mr. French served as President and Chief Executive Officer of Ascension Health, the nation’s largest non-for-profit healthcare system and an Emageon customer. Mr. French previously served as Executive Vice President and Chief Operating Officer of Ascension Health from 1999 to 2000. Prior to joining Ascension Health, Mr. French served, from 1998 to 1999, as Executive Vice President and Chief Operating Officer of Daughters of Charity National Health System, and from 1994 to 1998, as President and Chief Executive Officer of The Central Indiana Health System St. Vincent Hospitals and Health Systems. Mr. French has over twenty-five years of professional experience in hospital administration.

John W. Thompson has served as a member of the Board since May 2003. Mr. Thompson has served as President of Thompson Investment Management, LLC, a mutual fund investment advisor, since January 2004. Previously, he served as President of Thompson Plumb & Associates, LLC, a mutual fund investment advisor, from 1984 to January 2004 and as its Treasurer from 1993 to January 2004.

SHARE OWNERSHIP

The percentage of shares beneficially owned is based on 21,333,391 shares of common stock outstanding as of March 31, 2007. Shares of common stock subject to options that are currently exercisable or exercisable within 60 days after March 31, 2007 are deemed to be outstanding and beneficially owned by the person holding the options for the purpose of computing the number of shares beneficially owned and the percentage of ownership of such person, but are not deemed outstanding for the purpose of computing the percentage ownership of any other person.

The address of all the directors, nominees and named executive officers is 1200 Corporate Drive, Suite 200, Birmingham, Alabama 35242.

Includes the shares held by the Marianna Thompson Trust for the benefit of Mr. Thompson’s spouse. Does not include 212,622 shares held by two grantor retained annuity trusts, all the beneficiaries of which are Mr. Thompson’s adult children. Mr. Thompson does not have voting or dispositive power with respect to the shares held by these trusts.

Information regarding Deerfield Capital, L.P., Deerfield Management Company, L.P. and James E. Flynn is based solely upon a Schedule 13G filed by Deerfield Capital, L.P., Deerfield Management Company, L.P. and Mr. Flynn with the SEC on January 23, 2007. Deerfield Capital, L.P. beneficially owns 610,274 shares, and Deerfield Management Company, L.P. beneficially owns 992,826 shares. Shares listed as beneficially owned by Deerfield Capital, L.P. are owned by the following entities: Deerfield Partners, L.P. and Deerfield Special Situations Fund, L.P. Shares listed as beneficially owned by Deerfield Management Company, L.P. are owned by the following entities: Deerfield International Limited and Deerfield Special Situations Fund International Limited. James E. Flynn is the managing member of J.E. Flynn Capital LLC, the general partner of Deerfield Capital, L.P., and is the managing member of Flynn Management LLC, the managing member of Deerfield Management Company, L.P. The address for Deerfield Capital, L.P., Deerfield Management Company, L.P. and Mr. Flynn is 780 Third Avenue, 37th Floor, New York, NY 10017.

Information regarding Wells Fargo & Company is based solely upon a Schedule 13G filed by Wells Fargo & Company with the SEC on January 24, 2007. The Schedule 13G was filed by Wells Fargo & Company on its own behalf and on behalf of the following subsidiaries on a consolidated basis: Wells Capital Management Incorporated, a registered investment advisor; Wells Fargo Funds Management, LLC, a registered investment advisor; Peregrine Capital Management, Inc., a registered investment advisor; and Wells Fargo Bank, National Association, a bank. The address for Wells Fargo & Company is 420 Montgomery Street, San Francisco, CA 94104.

Information regarding Brown Advisory Holdings Incorporated is based solely upon a Schedule 13G filed by Brown Advisory Holdings Incorporated with the SEC on February 14, 2007. The address for Brown Advisory Holdings Incorporated is 901 South Bond Street, Suite 400, Baltimore, MD 21231.

Information regarding HealthCor Management, L.P. and Messrs. Healey and Cohen is based solely upon a Schedule 13G filed by Healthcor Management, L.P. and Messrs. Healey and Cohen with the SEC on February 14, 2007. Messrs. Healey and Cohen are Managers of HealthCor Associates, LLC, the general partner of HealthCor Management, L.P. The address for HealthCor Management and Mr. Healey is 152 West 57th Street, 47th Floor, New York, New York 10019. The address for Mr. Cohen is 12 South Main Street, #203 Norwalk, CT 06854.

MANAGEMENT DISCUSSION FROM LATEST 10K

Company Overview
We provide an enterprise-level information technology solution for the clinical analysis and management of digital medical images within multi-hospital networks, community hospitals and diagnostic imaging centers. Our solutions consist of advanced visualization and image management software for multiple medical specialties such as cardiology, radiology and orthopedics, comprehensive support services and third-party components. Our web-enabled advanced visualization software, which is hosted by the customer, provides physicians across the enterprise — in multiple medical specialties and at any network access point — with dynamic tools to manipulate and analyze images in both a 2D perspective and a 3D perspective. With these tools, physicians have the ability to better understand internal anatomic structure and pathology, which can improve clinical diagnoses, disease screening and therapy planning. Our open standards-based solutions are designed to help customers improve staff productivity, enhance revenue opportunities, automate complex medical imaging workflow, lower total cost of ownership and provide better service to physicians and patients.
Our fiscal year ends on December 31. References below to annual periods or years refer to the fiscal years ended December 31.
Results Overview
Total revenue for 2006 was $123.5 million, representing a 64.5% increase over 2005. The increase was comprised of a 50.6% increase in system sales revenue and a 92.5% increase in support services revenue. Our overall gross margin percentage increased from 41.1% for 2005 to 45.2% for 2006. We achieved gross margin percentages of 42.5% and 49.5% for system sales and support services revenue, respectively, during 2006, compared to 43.4% and 36.4%, respectively, for 2005. Our net loss was $6.0 million in 2006 compared to a net loss of $5.0 million in 2005, including $5.4 million and $0.2 million, respectively, in acquisition related integration costs in those years.
As of December 31, 2006, we had $158.4 million in contracted backlog, consisting of fees for contracted future installations and for the support of existing installations, compared with a contracted backlog of $158.0 million at December 31, 2005. We expect to recognize revenue from our current backlog of approximately $68.0 million in 2007 and $32.0 million in 2008. Substantially all of the remaining $58.0 million, which primarily consists of recurring revenue from support services, is expected to be recognized by 2011. Our backlog will generally decrease as we recognize revenue under existing contracts, and it will increase as we enter into new contracts. However, our order and revenue patterns increasingly consist of relatively shorter periods between initial order and completion of installation, particularly for add-on orders from existing customers and, as a result, annually reported contracted backlog figures may not accurately portray historical or prospective sales activity levels.
Initial Public Offering And Camtronics Integration
On February 14, 2005, we completed our initial public offering of common stock. We sold 5.0 million shares of our common stock at a price of $13.00 per share. On February 18, 2005, our underwriters exercised the over-allotment option to purchase 750,000 additional shares at a price of $13.00 per share. Total proceeds from the initial public offering, net of underwriting discount and offering expenses, were $67.2 million. At December 31, 2006, we had 21,433,574 shares of common stock issued, 21,257,817 shares of common stock outstanding, and 36,424 warrants to purchase shares of our common stock outstanding at an exercise price of $5.52 per share.
On November 1, 2005, we acquired all the stock of Camtronics Medical Systems, Ltd., based in Hartland, Wisconsin, for $40.4 million in cash. As of December 31, 2006, we have completed the integration of Camtronics into the Company.

Our Market
We believe the health information technology market is exhibiting the following trends:
• Increasing procedure volumes

• Increasing procedure size

• Modality “blending”, a layering of studies from two separate modalities for diagnostic and treatment purposes

• Expanding adoption and use of standards

• Increasing emphasis by payors, healthcare providers, and government agencies on electronic health record integration

• Body transparency, a new paradigm for navigating through large volumes of information
The amount of imaging data being generated by health care providers is growing extremely rapidly. This data must be stored and made available for easy retrieval. Increasingly, health care information users want access to the stored data at any time, and in any location. In addition, modalities that provide non-invasive alternatives continue to expand into other clinical domains. Examples include:
• MR and CT angiography

• Multi-Detector CT for heart and chest imaging

• CT/PET Fusion

• Cardiac catheterization
One area that has received significant attention is advanced visualization, which uses 3D and other advanced analytic tools as key elements in an enterprise visual medical system. Earlier generation PACS have focused primarily on single departments and have utilized generic 2D tools. A complete enterprise visualization system must not only support full 2D capabilities, but also include 3D tools, integrate easily into other information systems, and adhere to standards. To understand these images, referring physicians need tools that adapt to their specialty.
Our solutions can be extended to multiple stakeholders throughout the health care enterprise. Our solutions go beyond moving images from point A to point B to effectively distributing multi-specialty tools and clinical content using a web-enabled platform. Our solutions not only manage very complex datasets, but also perform advanced visualization such as 3D reconstruction and analysis within the viewing application, and distribute essential clinical tools through the network.
Significant Events in 2006
During the year ended December 31, 2006, we continued to focus on our core set of strategic goals. We believe the following 2006 events were significant with respect to our goals:
• We successfully completed the integration of Camtronics into our business, including integration of the management structure and sales force, commencement of cross-selling efforts, consolidation of the engineering staff, and consolidation of the administrative function including financial systems.

• In November, we entered into strategic relationships with Vital Images, Inc. and AllScripts Healthcare Solutions allowing us to offer the complementary products of those companies with our products across our installed base of customers.

• We expanded our customer relationships to now encompass 588 medical facilities, 460 of which have installed our products.

• We achieved record bookings and revenue, improved our gross margins, reduced our operating expenses as a percentage of revenue, and generated positive operating cash flow while avoiding the incurrence of debt.
Sources of Revenue
A typical sale of our solution is comprised of system sales and support services. Revenue from system sales is derived from the licensing of our Advanced Visualization, Clinical Content Management, and Clinical Workflow for RadSuite and HeartSuite (collectively referred to as our Enterprise Visual Medical System, or EVMS), as well as from sales and integration of third-party components that are required to implement our solution. Support services revenue is derived from fees related to the implementation, training and on-going customer support of our solution.
Our software is comprised of four main components: RadSuite Advanced Visualization, our suite of software tools for the advanced visualization and analysis of digital medical images; Clinical Content Management, our image archival and distribution management software; Clinical Workflow, our standards-based software used to manage integration and data migration between our solution and other health information systems throughout the enterprise; and HeartSuite, our suite of software tools focused on the cardiology department. Although Clinical Content Management and HeartSuite software products are available collectively as stand-alone applications, we offer our software primarily as an integrated enterprise-level image management solution. License pricing for RadSuite Advanced Visualization is primarily determined by either the number of licenses based on the number of concurrent users or on the average annual study volume. License pricing for Clinical Content Management and Clinical Workflow is determined based on projected volume and size of image studies to be stored or migrated by the particular customer. License pricing for HeartSuite software products is determined based on the number of workstations purchased. We offer customers our software as perpetual or term licenses, in either case with maintenance and support relating to the software. Term licenses for our software are typically from two to ten years with annual renewals after the initial term. The sale and integration of third-party components typically include servers, data storage, backup and recovery systems, workstations and monitors, database software and computed radiography devices as well as orthopedic templates and dictation systems.
We also derive revenue from the provision of support services, including implementation, project planning, management, design and training services. Our customers typically contract for these support services pursuant to their initial agreements with us. The initial term of these support services under these agreements range from one to ten years, with a typical duration of five years. Upon expiration of the initial term, these agreements typically renew automatically from year-to-year thereafter until terminated.
Ascension Health, the largest not-for-profit hospital system in the United States, is our largest customer. Revenue associated with facilities controlled by Ascension Health accounted for approximately 27% of both our total revenue during 2006 and our total contracted backlog at December 31, 2006. We anticipate that Ascension Health will continue to be a significant customer as we continue to support our existing installations as well as sign add-on orders and new order addenda with additional Ascension Health facilities.
Cost of Revenue
The cost of system sales consists of the cost of third-party components and the cost of software licenses. The cost of our third-party components consists primarily of direct and indirect expenses related to the purchase, manufacturing, shipment, installation and configuration of our solutions. The cost of our software licenses consists

primarily of the amortization of acquired software and the amortization of capitalized software costs for internally developed software.
The cost of our support services consists primarily of labor costs and overhead relating to the implementation, installation, training, application support and maintenance of our solution as well as costs related to maintenance of third-party components. The cost of support services revenue varies based upon the productivity of our support services organization as well as costs associated with the use of outside contractors to support internal resources.
Gross Profit
Our overall gross profit has improved due to an increase in the software content of our system sales and in recurring support services revenue derived from our growing installed base of customers. Gross profit from system sales varies based on several factors, including:
• actual sales prices negotiated in the contracting process;

• costs associated with purchasing and manufacturing third-party components;

• fluctuations in prices received from third-party component manufacturers and distributors relative to the mark-up percentages provided for in customer contracts; and

• the relative mix of the hardware and software components comprising system sales in a given period.
Gross profit from support services varies based on several factors, including:
• actual services fees negotiated during the contracting process;

• productivity of our professional service team;

• costs of service agreements related to third-party components included in our solution; and

• costs associated with the use of outside contractors.
Operating Expenses
Research and Development . Research and development expenses consist primarily of employee-related expenses, allocated overhead, and the costs of outside contractors. We have historically focused our research and development efforts on improving the functionality, performance, and integration of our software products. We expect that research and development expenses will increase as we strive to introduce additional products and services.
Sales and Marketing . Sales and marketing expenses consist primarily of employee-related expenses, including travel, marketing programs, allocated overhead and sales commissions. We expect that sales and marketing expenses will increase as we expand our selling and marketing activities associated with existing and new product and service offerings to existing and new customers, and build brand awareness.
General and Administrative . General and administrative expenses consist primarily of employee-related expenses, professional fees, other corporate expenses and allocated overhead. We expect that general and administrative expenses will increase as we add personnel and incur additional professional fees and administrative costs related to the growth of our business and operations, including additional compliance costs in connection with public company corporate governance and financial reporting requirements.

Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates.
We believe that, of our significant accounting policies, which are described in Note 2 of the notes to our consolidated financial statements, the following accounting policies involve the greatest degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.
Revenue Recognition and Deferred Revenue . While the basis for software license revenue recognition is substantially governed by the provisions of AICPA Statement of Position 97-2, (SOP 97-2), Software Revenue Recognition , as amended, in the application of this standard, we exercise judgment and use estimates to determine the amount of system sales and support services revenue to be recognized in each accounting period.
We sell software under three types of licenses:
• Perpetual licenses : software licensed on a perpetual basis to a customer based on a fixed number of users and/or estimates of annual study volumes with no right to return the licensed software.

• Enterprise licenses : software licensed on a perpetual basis to a customer (typically a multi-facility health care provider), as opposed to licensing based on a fixed number of users or on estimates of annual study volumes, with no right to return the licensed software.

• Term licenses : software licensed on a term basis according to a fixed number of users and/or estimates of annual study volumes.
Generally, our software license arrangements do not include significant modification or customization of the underlying software and, as a result, we recognize license revenue when: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) customer payment is deemed fixed or determinable; and (4) collection is probable. We assess each of the four criteria as follows:
• Persuasive evidence of an arrangement exists : It is our customary practice to have a written contract, which is signed by both the customer and us, or a purchase order from those customers that have previously negotiated a standard end-user license arrangement, prior to recognizing revenue on an arrangement.

• Delivery has occurred : It is our customary practice to obtain acceptance for our software, which is evidenced by written customer acknowledgement. In the event that we grant a customer the right to specified upgrades, we defer recognition of the entire arrangement fee until we deliver the specified upgrades as we have not established vendor-specific objective evidence (VSOE) of fair value for specified upgrades. Specified upgrades include, but are not limited to, future software deliverables that are stated in the customer contract.

• The customer’s payment is deemed fixed or determinable : We assess whether fees are fixed or determinable and free of contingencies or significant uncertainties at the time of sale and recognize revenue when all other revenue recognition requirements are met. If the fee is determined not to be fixed or determinable, we recognize revenue as the amounts become due and payable.

• Collection is probable : Likelihood of collection is assessed on a customer-by-customer basis. If it is determined from the outset of an arrangement or at the time of add-on sales to existing customers that collection is not probable based upon our credit review process, revenue is recognized on a cash-collected basis if all other criteria are met.
We account for software license and non-recurring support services revenue included in multiple element arrangements using the residual method. Under the residual method, the fair value of the undelivered elements (i.e., software maintenance and ongoing support services) based on VSOE of fair value is deferred and the remaining portion of the arrangement fee is allocated to the delivered elements (i.e., software license and non-recurring support services). If evidence of the fair value of one or more of the undelivered services does not exist, revenue is deferred and recognized when delivery of those services occurs or fair value can be established. We determine VSOE of fair value for ongoing support services revenue based upon the renewal rates for the maintenance and ongoing support, which coincide with our pricing model. Significant incremental discounts offered in multiple element arrangements that would be characterized as separate elements are infrequent and are applied to the initial arrangement.
For term license arrangements, we recognize revenue for the multiple element arrangement over the term of the arrangement beginning in the month after we receive customer acceptance, provided that the other revenue recognition criteria have been met.
Software maintenance services generally include rights to upgrades (when and if available), telephone support, updates and bug fixes. Software maintenance revenue is recognized ratably over the term of the maintenance contract on a straight-line basis when all the revenue recognition requirements are met. We include the first year of software maintenance in the software license fee. We defer this software maintenance fee based on its fair value and recognize it ratably over the first year of the arrangement.
Ongoing support services generally include telephone support related to third-party components. Ongoing support service revenue is recognized ratably over the term of the ongoing support services contract on a straight-line basis when all the revenue recognition requirements are met. As it relates to services, we may also provide services that vary depending on the scope and complexity requested by the customer. Examples of such services include additional database consulting, system configuration, existing systems interface, and network consulting. These services generally are not deemed to be essential to the functionality of the software. If we have VSOE of fair value for the services, the timing of the software license revenue is not impacted, and service revenue is recognized as the services are performed. We commonly perform services for which we do not have VSOE of fair value and, accordingly, the software license revenue is deferred until the services are completed.
Revenue related to product sales is recognized upon shipment provided that title and risk of loss have passed to the customer, there is persuasive evidence of an arrangement, the sales price is fixed and determinable, collection of the related receivable is reasonably assured and customer acceptance criteria, if any, have been successfully demonstrated. We classify shipping and handling cost in cost of system sales.
Third-party component revenue, including hardware sales and hardware maintenance, is recognized in accordance with contractual terms. When we are responsible for installing third-party components, revenue is recognized when the third-party components are delivered, installed and accepted by the customer. When we are not responsible for installing the third-party components, revenue is recognized when the third-party components are delivered to the customer. When third-party components and related maintenance are not separately priced in our contracts, we recognize revenue related to the arrangement when all revenue recognition criteria have been met.
The following is a summary of our product warranty and guarantee and our related accounting policies for these agreements:
(1) Our sales agreements with customers generally contain infringement indemnity provisions. Under these agreements, we agree to indemnify, defend and hold harmless the customer in connection with patent, copyright or trade secret infringement claims made by third parties with respect to the customer’s authorized use of our products and services. Our sales agreements with customers sometimes also contain indemnity provisions for death, personal injury or property damage caused by our personnel or contractors in the course of performing services to customers. Under these agreements, we agree to indemnify, defend and hold harmless the customer in connection with death, personal injury and property damage claims made by third parties with respect to actions of our personnel or contractors. The indemnity obligations contained in sales agreements generally have no specified expiration date but typically limit the amount of award covered to a portion of the fees paid by the customer over a portion of the contract term. We have not previously incurred costs to settle claims or pay awards under these indemnification provisions. Accordingly, we have no liabilities recorded for these provisions as of December 31, 2006.
(2) We warrant that our software products will perform in all material respects in accordance with our standard published specifications in effect at the time of delivery of the licensed products to the customer as long as the contract remains in effect. Additionally, we warrant that our services will be performed by qualified personnel in a manner consistent with normally accepted industry standards. We provide for the estimated cost of product and service warranties based on specific warranty claims and claim history. As of December 31, 2006 we have $0.8 million of liabilities recorded for these agreements.
Billings may not coincide with the recognition of revenue. Unbilled revenue, which is included in accounts receivable in the consolidated balance sheet, occurs when revenue recognition precedes billing to the customer, and arises primarily from sales with predetermined billing schedules. Billings in excess of sales (deferred revenue) occur when billing to the customer precedes revenue recognition, and arise primarily from sales with partial prepayments upon contract execution and from maintenance revenue billed in advance of performance of the maintenance activity. We recognize deferred revenue, as applicable, upon delivery and acceptance of products, as ongoing services are rendered or as other requirements requiring deferral under SOP 97-2 are satisfied. Costs related to deferred revenue are included as an asset in our consolidated balance sheet and charged to expense when the related deferred revenue is recognized.
The timing of customer acceptances could significantly affect our results of operations during a given period. As noted above, we require written acknowledgement from the customer to evidence that delivery of the products or services has occurred. Delays in the implementation process could negatively affect operations in a given period by increasing volatility in revenue recognition.
Research and Development Costs . Research and development costs are charged to expense as incurred. However, costs incurred for the development of software that will be sold, leased or otherwise marketed are capitalized as incurred after technological feasibility has been established and capitalization ceases when the software is generally available for release. Judgment is involved in determining when technological feasibility is reached. We believe that technological feasibility is reached when we have completed a working model that is ready to be beta-tested at a customer site. These capitalized costs are subject to an ongoing assessment of recoverability based on anticipated future revenue and changes in technologies. Costs deemed not recoverable are charged to expense. Costs that are capitalized primarily consist of direct labor.
Amortization of capitalized software development costs begins when the product is available for general release. Amortization is provided on a product-by-product basis using the straight-line method over periods not exceeding three years.
Intangible and Other Long-Lived Assets . U.S. generally accepted accounting principles require the purchase method of accounting for all business combinations after June 30, 2001, and that certain acquired intangible assets in a business combination be recognized as assets separate from goodwill. Accordingly, we identify and allocate values to intangible assets based on discounted cash flow analyses and market research, as well as our judgment. Intangibles determined to have an indefinite life are not amortized but are tested for impairment at least annually. We evaluate intangible assets for impairment on an annual basis and also if and when impairment indicators are identified. In assessing the recoverability of intangibles, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. These estimates include forecasted revenue, which is inherently difficult to predict. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets. Property, equipment and intangible assets are amortized over their useful lives. Useful lives of the intangible assets are based on management’s estimates of the periods over which such assets will generate revenue.

Results of Operations
Revenue
Individual radiology system sales typically are larger in terms of both sales dollars and implementation time than individual cardiology system sales. In any given period, the mix of total system sales revenue to total support services revenue, the mix of hardware to software comprising system sales revenue, and the mix of radiology revenue to cardiology revenue can produce significant variability in the levels of revenue and gross margin reported.

Revenue for 2006 was $123.5 million, a 64.5% increase over 2005 revenue of $75.1 million and a 166% increase over revenue for the year ended December 31, 2004. These increases reflect both the organic growth of our products and the results of our acquisition of Camtronics and its cardiology line of products on November 1, 2005. Excluding cardiology products acquired with the Camtronics acquisition, our revenue grew by 25% in 2006.
System sales revenue for 2006 was $75.3 million, a 50.6% increase over 2005 systems sales revenue of $50.0 million. As described above, the acquisition of Camtronics on November 1, 2005 was a contributing factor in our 2006 system sales revenue growth, but our system sales excluding cardiology products grew as well, by approximately 19% in 2006. This growth was the result of greater numbers of systems installations for both existing and new customers, and of greater acceptance of our products in the marketplace, particularly with multi-facility health care providers. Growth in our radiology line of products was driven in equal parts by increased sales of software and third-party components, with our sales of software licenses particularly strong with existing customers.
The increase in system sales revenue from 2004 to 2005 was attributable to an increase in the number of new and existing customer installations offset by a decrease in the size of these installations, as well as the recognition of $4.5 million of revenue deferred in 2004 and recognized in 2005. During 2005, we had more acceptances of our software and third party components than in 2004. The average revenue recognized per acceptance decreased slightly in 2005 as compared to 2004, the result primarily of an increase in add-on sales to our existing customer base, which tend to be smaller than initial sales to new customers. Also during 2005, we recognized system sales revenue of $4.5 million related to two contracts for which we deferred revenue in 2004 as a result of the existence of certain undelivered upgrades. We delivered the additional software features during 2005 and recognized the system sales revenue associated with these contracts.
Support services revenue grew by 92.5% to $48.2 million in 2006 from its 2005 level of $25.0 million. As described above, our acquisition of Camtronics on November 1, 2005 was a contributing factor in our support services revenue growth, but our legacy service offerings grew as well, by 38% in 2006 to over $32.0 million. Both the professional services and system maintenance components of support services revenue grew substantially in 2006. Support services revenue is ancillary to system sales revenue and therefore tends to grow as system sales revenue grows, as new or add-on system installations are completed and as more customers subscribe to our maintenance services.
The increase in support services revenue from 2004 to 2005 was attributable to an increase in customer installations. Approximately $5.7 million of the increase in support services revenue for 2005 was attributable to an increased number of customers that implemented our solution and pay us ongoing support and maintenance fees. Also included in this $5.7 million increase is the recognition of $1.6 million of revenue related to the contracts mentioned above for which we deferred revenue in 2004 as a result of the existence of undelivered upgrades. We delivered the additional software features during 2005 and recognized the support services revenue attributable to the previously provided services for which we had deferred support services revenue. The remaining $6.3 million increase was related to an increase in non-recurring revenue related to services such as implementation and training for new customers as well as add-on services for existing customers.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

COMPANY OVERVIEW
Emageon provides an enterprise-level information technology solution for the clinical analysis and management of digital medical images within multi-hospital networks, community hospitals, and diagnostic imaging centers. The Company’s solution consists of advanced visualization and image management software, third-party components, and comprehensive support services. The Company’s web-enabled advanced visualization software, which is hosted by the customer, provides physicians across the enterprise, in multiple medical specialties and at any network access point, with dynamic tools to manipulate and analyze images in both a two dimensional and three dimensional perspective. With these tools, physicians have the ability to better understand internal anatomic structure and pathology, which can improve clinical diagnoses, disease screening, and therapy planning. The Company’s open standard solution is designed to help customers improve staff productivity, enhance revenue opportunities, automate complex medical imaging workflow, lower total cost of ownership, and provide better service to physicians and patients.
RESULTS SUMMARY
The medical imaging industry and the Company’s 2007 revenues have been adversely affected by slower market demand for medical imaging software, hardware, and support services relative to prior periods. In addition, the Company’s primary radiology market has become largely a replacement market with longer sales cycles. Revenue for the three months ended September 30, 2007 (the Company’s third fiscal quarter of 2007) was $22.7 million, a 31.2% decrease from the third quarter of 2006. For the nine months ended September 30, 2007, total revenue was $75.7 million, a 16.0% decrease from the comparable prior year period. The net loss for the third quarter of 2007 was $4.3 million, or $0.20 per share, compared to a net loss of $0.3 million, or $0.01 per share, in the third quarter of 2006. For the nine months ended September 30, 2007, the Company’s net loss was $6.4 million, or $0.30 per share, compared to a net loss of $8.1 million, or $0.39 per share, in the first nine months of 2006.
The Company’s third quarter operating loss increased from $0.4 million in 2006 to $4.5 million in 2007, the result primarily of the negative effects of a $10.3 million decline in revenue and an 8.8 percentage point decline in gross margin, offset by a decline in sales and marketing and general and administrative expenses and by the elimination of expenses incurred in the integration of Camtronics into the operations of the Company. Excluding the nonrecurring expenses of that integration included in third quarter 2006 operations, the Company’s operating loss increased by $6.2 million in third quarter 2007 compared to third quarter 2006.
The Company’s operating loss for the nine months ended September 30, 2007 improved from $8.3 million in 2006 to $7.0 million in 2007, the result primarily of a gross margin improvement of 2.3 percentage points and the elimination of expenses incurred in the integration of Camtronics into the operations of the Company, offset by a decline in revenue in the period of $14.4 million. Excluding the effects of nonrecurring expenses of that integration included in 2006 results of operations, and excluding the Company’s second quarter 2007 restructuring charge for employee terminations, the Company’s operating loss increased by $2.5 million in the nine months ended September 30, 2007 compared to the nine months ended September 30, 2006.
Net cash used in operations in the third quarter of 2007 was $1.5 million, and for the nine months ended September 30, 2007 was $1.8 million. At September 30, 2007 the Company had approximately $17.8 million in unrestricted cash and cash equivalents, a decline of $5.2 million from the December 31, 2006 level.
Revenue and Gross Margin
Revenue consists of system sales and support services revenue. System sales revenue is comprised of revenue from sales of the Company’s software and third-party components, primarily computer hardware. Costs of system sales revenue consist of purchases of hardware and software from third party vendors for use by customers and the internal costs of the Company’s software licenses. Software development expenses are generally included in research and development expense in the Company’s statement of operations.
Support services revenue is comprised of revenue from professional services such as implementation and training, as well as ongoing maintenance services. Costs of support services revenue consist of labor, overhead, and associated costs of implementation, installation, and training on behalf of customers, and the costs of providing continuous support of hardware and software sold to customers.
The characteristics of individual system sales can vary significantly as to length of implementation time, total value of the sale, and gross margin earned. In addition, in any given period, the mix of system sales revenue to support services revenue and the mix of hardware and software comprising system sales revenue can produce significant variability in the levels of revenue and total gross margin reported.

Summary
Total revenue in third quarter 2007 was $22.7 million, a 31.2% decrease from third quarter 2006. For the nine months ended September 30, 2007, total revenue was $75.7 million, a 16.0% decrease from the comparable prior year period. These declines in revenue reflect soft system sales bookings experienced by the Company and in the industry in general, beginning in late fourth quarter 2006 and extending through 2007. Third quarter 2007 gross margin on total revenue declined compared to the prior year period by 8.8 percentage points, and improved by 2.3 percentage points in the nine months ended September 30, 2007 compared to the prior year period. The two components of the Company’s revenue and gross margin are discussed individually below in comparison to the prior year periods.
Sequentially, third quarter 2007 total revenues decreased by $2.8 million from the second quarter of 2007.

System Sales Revenue
Third quarter 2007 system sales revenue declined by $8.7 million, or 44.7%, compared to the third quarter of 2006. For the nine months ended September 30, 2007, system sales revenue was $35.6 million, or 34.3% less than in the first nine months of 2006. The most significant factors contributing to both the third quarter and year to date declines in revenue are general weakness in demand across the Company’s primary markets, an increasingly longer sales cycle in the Company’s primary radiology market, which is now largely a replacement market among the Company’s traditional larger-sized existing and potential customers, and delays in the award of several specific sales contracts from customers.
Third quarter 2007 system sales revenue includes approximately $1.2 million of software revenue resulting from an amendment to an existing customer agreement executed in third quarter 2007. This revenue, which had previously been deferred by the Company, related to completed implementations of the Company’s systems at several of that customer’s sites. The original customer agreement included a refund clause that resulted in a requirement for accounting purposes to defer the revenue and recognize it over a five to eight year period. The amendment to the agreement deleted the refund clause and added a liquidated damages cap of $1.0 million that would be activated in the event of discontinuance of the Company’s support of the software purchased by the customer. Pursuant to the terms of the amended contract, the Company has segregated $1.0 million of its cash representing the amount of potential liquidated damages under the amendment, has classified that cash as a non-current asset in the balance sheet, and has deferred $1.0 million in associated revenue pending expiration of the liquidated damages provisions of the amendment.
The percentage of total system sales revenue represented by software sales was lower in third quarter 2007 than in third quarter 2006. On a year to date 2007 basis, the percentage of total systems sales revenue represented by software was higher than in the comparable period in 2006, due in large part to two individually significant software-only sales in 2007 and to individually significant hardware sales in the first half of 2006 that increased that period’s system sales hardware content.
In an effort to broaden its potential markets, the Company acted in third quarter 2007 to introduce its products to the medium-to smaller-sized hospital market, but does not anticipate significant penetration of this market until 2008.
System Sales Gross Margin
The Company’s system sales gross margin was 40.9% for third quarter 2007 compared to 44.7% in third quarter 2006. Third quarter 2007 margin was lower than expected, in large part because of lower sales bookings activity in earlier quarters that resulted in a lower volume of system installations in the third quarter, and because of the lower percentage of software revenue to total system sales revenue for the period as described above.
For the nine months ended September 30, 2007, system sales gross margin was 40.0% compared to 37.4% for the same period in 2006. Current year to date gross margin was lowered by lower volume, offset by a higher mix of software systems revenue to total system sales revenue, as described above. System sales gross margin for the first nine months of 2006 was adversely affected by first half 2006 system sales revenue characterized by a high hardware content in the systems sold.
In general, the costs of third party hardware components tend to lower the Company’s system sales gross margin. The Company’s system sales gross margin may significantly fluctuate from period to period depending on the mix of revenue recognized in a given reporting period, hardware versus software content of sales recognized, and the timing of completion of installation and customer acceptance of larger dollar individual sales.
Support Services Revenue
The Company’s support services revenue declined by $1.6 million, or 11.9%, in third quarter 2007 compared to the prior year period, and increased by $4.3 million, or 11.9%, for the nine months ended September 30, 2007 compared to the same period in 2006. Support services revenue, which consists primarily of system installation services, customer training, professional services, and system maintenance services, is ancillary to the Company’s system sales revenue and therefore fluctuates with both the level of system sales revenue and its timing on a period to period basis. Sequentially, support services revenue was $2.3 million, or 16.2%, lower in third quarter 2007 than in second quarter 2007 as the result of a lower volume of system installations and related fees during the third quarter of 2007.
Support Services Gross Margin
The Company’s support services gross margin was 39.2% in third quarter 2007, a 15.4 percentage point decrease from the third quarter 2006 level, and was 46.6% for the nine months ended September 30, 2007, approximately equal to the comparable prior year period. Support services gross margin in 2006 did not include the costs of support personnel who at that time were performing duties of an administrative nature. In 2007, those personnel no longer perform administrative functions and their cost is therefore included in support services cost of revenue, lowering 2007 gross margin. Support services gross margin has been further lowered by a lower volume of system installations, resulting in lower revenue relative to the generally fixed costs of support personnel. Offsetting these negative factors is the positive impact of the Company’s elimination of support positions and restructuring in May 2007. The Company believes that its support services gross margin will fluctuate from period to period as the fixed costs of support personnel are spread over support revenues that fluctuate with the level of system sales revenue.
Going forward, the Company expects a normalized support services gross margin in the mid- to high forty percent range assuming growth in support services revenue and efficiencies in its management of support staff, but also expects some timing-based variability in support services gross margin from period to period as the result of timing of closure of individual services contracts.
Research & Development, Sales & Marketing, and General & Administrative Expenses
Total research and development, sales and marketing, and general and administrative expenses for the quarter ended September 30, 2007 were $13.2 million compared to $13.5 million in the corresponding prior year period, a decrease of $0.3 million or 2.2%. This net decline was the result primarily of an increase in research and development expenses resulting from increased utilization and costs of outsourced services, offset by a decrease in general and administrative expenses resulting from a decline in the administrative duties of support services personnel. As a percentage of revenue, these expenses were 58.2% in third quarter 2007 compared to 41.0% in third quarter 2006.
For the nine months ended September 30, 2007, total research and development, sales and marketing, and general and administrative expenses were $38.4 million, down $0.1 million from the comparable prior year period, the result primarily of a decline in general and administrative expenses, offset by significantly increased research and development expenses, both for the reasons described above. As a percentage of revenue, these expenses were 50.7% in the nine months ended September 30, 2007 compared to 42.7% in the comparable prior year period.
The Company continues to seek to identify opportunities to reduce or limit the growth of its operating expenses in an effort to better align these expenses with the expected level of revenue growth.
Research and Development Expenses
Research and development expenses increased by $1.0 million, or 21.0 %, in third quarter 2007 compared to third quarter 2006. The increase is the result of higher utilization and higher costs of outsourced research and development and related services and expenses in 2007, offset by reduced engineering salary and related costs resulting from the Company’s lowering of engineering headcount in May 2007. As a percentage of revenue, research and development expenses were 24.5% in third quarter 2007 compared to 13.9% in third quarter 2006.
For the nine months ended September 30, 2007, research and development expenses increased by $2.6 million, or 20.5%, over the prior year period for the same reasons as described for third quarter 2007 above. As a percentage of revenue, research and development expenses were 20.3% in the first nine months of 2007 compared to 14.2% in the first nine months of 2006.

Sales and Marketing Expenses
Sales and marketing expense in the third quarter of 2007 was $4.1 million, down $0.3 million from third quarter 2006. Of the primary items comprising sales and marketing expense, salaries and benefits, including sales commissions, were flat to down compared to the prior year period, as were travel and related expenses. The level of commission expense recognized in a given period is affected by the timing of receipt of sales order bookings and revenue recognition. As a percentage of revenue, sales and marketing expenses were 18.1% in third quarter 2007 compared to 13.4% in third quarter 2006.
Sales and marketing expenses in the nine months ended September 30, 2007 were flat with the comparable prior year period at $13.0 million. Salaries and benefits were flat, while travel was slightly down and overhead expenses slightly up period to period. As a percentage of revenue, sales and marketing expenses were 17.2% in the first nine months of 2007 compared to 14.5% in the first nine months of 2006.
General and Administrative Expenses
General and administrative expenses decreased by $0.9 million, or 21.0%, in third quarter 2007 compared to third quarter 2006. In 2006, a portion of support services personnel were temporarily engaged in activities of an administrative nature, and accordingly their cost was charged to general and administrative expense. These personnel no longer perform administrative duties and therefore these costs are no longer included in general and administrative expenses. In addition, the Company’s incentive bonus expense was less in third quarter 2007 than in third quarter 2006 as a result of the financial performance of the Company through third quarter compared to its financial goals for the year. As a percentage of revenue, general and administrative expenses were 15.6% in the third quarter of 2007 compared to 13.6% in the third quarter of 2006.
For the nine months ended September 30, 2007, general and administrative expenses decreased by $2.7 million, or 21.3%, over the prior year period. The decline in expenses related to the duties of customer support personnel and the decline in incentive bonus expense, both as explained for the third quarter above, are primarily responsible for the year to date decline. As a percentage of revenue, general and administrative expenses were 13.2% in the first nine months of 2007 compared to 14.1% in the first nine months of 2006.

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