Prices soften for PET and PET/CT as competition for sales heats up

CTI quarterly results show shrinking margins

Increasing price competition by major competitors is shrinking margins for PET and PET/CT scanners at CTI Molecular Imaging, which sells the scanners directly and through Siemens and Hitachi. In a conference call Aug. 5 to discuss third quarter results, CTI executives said they would continue their price war with competitors, namely Philips and GE, and predicted continued pressure on scanner margins through the first quarter of next year as the company implements an aggressive plan to win sales.

"We are convinced we are pursuing the right strategy, as we are building a large recurring revenue business and service, FDG tracer sales, and network and marketing solutions sales," said Terry D. Douglass, Ph.D., company chairman and CEO.

The reassurance was not enough for investors, however. News of shrinking margins in the wake of eroding scanner prices caused the stock to drop from $16 to $13.

But CTI executives assert they are looking at the long-term picture and setting the foundation to reap recurring revenues through the sale of Total Solutions packages. These packages include a PET or PET/CT along with maintenance contracts, upgrades, tracer sales, and networking services designed to build patient volume at customer sites. Hawked by the company's direct sales force, each brings in between $3 and $4 million over the five years following an order.

"It is critically important for CTI to build a strong direct presence in the market now to cement customer relationships so that over time we are well positioned to sell additional products and services and future upgrades," he said.

The company expects its position to improve next year for several reasons. Foremost is technology. Douglass believes prospective buyers will favor CTI's systems, which are based on the fast scintillator LSO (lutetium oxyorthosilicate). LSO acquires more counts and promises faster throughput than other scintillators. CTI plans to introduce a next-generation PET scanner next year that will take advantage of LSO technology and require fewer parts, thereby reducing manufacturing costs and improving margins.

The company also expects to improve margins by integrating workstations from Mirada Solution, a British firm that specializes in medical software. The Mirada workstation will replace CTI's current offering, which has little or no margin, according to Douglass.

CPS, the joint venture between CTI and Siemens that makes PET equipment, is working with its partners to reduce costs by streamlining distribution. CTI is involving its partners, particularly Siemens, in efforts to cut the cost of CT components built into its hybrid scanners. Douglass is bullish on his company's Total Solutions package, which provides a continuing stream of revenue, and he expects improvements in the firm's service business and PETnet, which sells positron tracers.

"Our service and PETnet businesses have become a larger part of our total business, with a growing installed base of scanners, and their margins will grow as the installed base grows," he said.

Third quarter numbers were encouraging. For the period ending June 30, the company reported net revenue growth of 44% to $99 million over the year-earlier quarter, a 64% jump in bookings to $126 million, and a 66% jump in backlog to $202 million. Net income was $7.5 million, or 16¢ per share on a fully diluted basis, compared with a net loss attributable to common shareholders of $2.3 million, or (7¢) per share on a fully diluted basis, in the prior fiscal year's third quarter.

During the quarter, CTI shipped 49 scanners and booked orders for an additional 65. CTI Services shipped 19 of these scanners, compared with 12 in the second quarter of fiscal 2003, and booked 24 new orders. Of these bookings, 80% were from the nonhospital segment of the market and 85% were orders for the company's comprehensive set of products and services. At the end of three quarters, CTI had booked 74 orders for scanners through its direct sales force, compared with 13 for the same period in the previous year. Douglass predicted the firm would exceed 100 orders in the fiscal year.

In the third quarter, PETnet's revenues grew 28% on a 13% sequential increase in FDG doses over the second quarter. On a year-over-year basis, deliveries of FDG doses grew 52% compared with the prior year period. PETnet expanded its distribution network during the quarter to 39, adding a PET molecular probe manufacturing and pharmacy center in Little Rock, AR, and another in Phoenix.

"Volumes and profitability improved noticeably in the third quarter," Douglass said, "as PETnet returned to profitability after three quarters of losses."

Cash and marketable securities at the end of the quarter were $74.2 million. Cash flow from operations was $9.1 million. Capital expenditures were $7.3 million.

With relatively little debt and positive cash flow, company strategists sense an opportunity to gain market share by meeting softening prices from competitors. Based on the backlog of orders and projected sales by the end of the fiscal year, Douglass believes CTI will soon achieve a 25% to 30% market share through its direct sales efforts. If all sales of distributors are figured in, the company's market share will exceed 50%, he said.