Varian Medical Systems Inc
Q3 2019 Earnings Call Transcript

Published: 25 Jul 2019

[Operator:]

Good day, ladies and gentlemen, and welcome to Varian's Fiscal Third Quarter 2019 Earnings Call. As a reminder, this conference call is being recorded and a replay can be accessed on the Varian Investor website at www.varian.com/investors.Now, I'll turn it over to J. Michael Bruff, Senior Vice President of Investor Relations.

[Michael Bruff:]

Thank you, Dana. Good afternoon, everyone and welcome to Varian’s third quarter conference call. Joining me today on the call are Varian's President and Chief Executive Officer, Dow Wilson; and Chief Financial Officer, Gary Bischoping. Dow will share his thoughts on our results and long-term strategy, and Gary will cover our operating and financial results in more detail. After our prepared remarks, we will be happy to take your questions.On the Varian Investor Relations website, you can find our fiscal third quarter press release and earnings presentation, which are intended to provide additional perspective and details. A webcast of this call and any accompanying non-GAAP reconciliations are available on our website at www.varian.com/investorrs. Unless otherwise stated, all financial results discussed are non-GAAP. All references to EPS are to net earnings per diluted share. All growth rates are year-over-year, and any references to orders are gross orders. All periods referred to are fiscal periods unless otherwise stated, and all references to the trailing 12 months refer to the trailing 12 months ending on the last day of our most recently completed fiscal quarter.The results announced today include the preliminary impact of our recent acquisition of CyberHeart, which closed early in the quarter and Endocare, Alicon and Cancer Treatment Services International or CTSI, which all closed in June.During this call, we will be making forward-looking statements, which are predictions, projections and other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Our results could differ materially because of factors discussed in today's earnings release, this conference call and our SEC filings. We do not undertake any obligation to update any forward-looking statement.And with that, I'm pleased to turn it over to Dow for his comments.

[Dow Wilson:]

Thanks, Mike and thank you everyone for joining us. Today, I'll share the key milestones we achieved this past quarter, and how they have contributed to our long term strategy. Our core remains strong and we're pleased to see continued momentum in the second half of 2019. We're investing in innovation and future growth opportunities, both organically and through acquisitions, and that together are designed to accelerate our execution to be a broad based cancer solutions company.First, let me touch on our third quarter performance. Total company revenues increased 16% to $826 million. Oncology revenues grew 19% to $793 million, driven by double digit growth in all geographies and strength across our portfolio. Proton revenues were $31 million, down 26%. Operating earnings increased 22% to $144 million or 17.5% of revenues, including a $15 million gross impact from tariffs. GAAP earnings per share was $0.32, which includes a $51 million impairment charge to proton goodwill. Gary will discuss the details of this charge in his section. Non-GAAP EPS of $1.32 was up 26%. Cash flows from operations were $130 million, up $28 million due to increased operating profit and strong collection momentum in our oncology business. This quarter, we closed the acquisitions of CyberHeart, CTSI, Endocare and Alicon.Now, let me provide some additional color on the quarter. In terms of our long term growth and value creation strategy, we made progress across our three growth priorities. First, strengthening our leadership in radiation therapy. Based on public findings, the radiation therapy market grew 11% on an orders basis over the trailing 12 months ending in March 2019 and we grew our worldwide market share by a percentage point during that period.In our oncology business, orders grew 2% in the quarter and 11% in the trailing 12 months. Our worldwide net installed base of 8,412 units grew 366 units or 5%. This robust growth in our installed base drives future recurring software and services revenues. [indiscernible] revenues grew 31%, driven by our TrueBeam and Halcyon platforms. Halcyon orders grew over 150% to 46 in the quarter, of which 60% were taken in emerging markets. We have taken 284 orders of Halcyon since its May 2017 launch. The success of Halcyon has been driven by its unique treatment capabilities, smaller size and lower power consumption requirements. These capabilities have driven greenfield orders, access to smaller vaults, competitive takeouts and general market demand. Ofuna Chuo Hospital and Herlev University Hospital delivered the first Halcyon system treatments in Japan and Denmark respectively. The global installed base for Halcyon is now 90 systems.The development of our artificial intelligence driven multi-modality adaptive radiotherapy suite is progressing well. In anticipation of market introduction, we recently announced the formation of our Adaptive Intelligence Consortium. This consortium will lead clinical trials to develop evidence based clinical protocols for Varian’s planned adaptive radiotherapy solution. The solution will incorporate MR, Tad, CT image information via the form of image registration and artificial intelligence algorithms. This should be the most cost effective, versatile and workflow efficient solution for on-couch adaptive therapy and will be ideal for an alternative payment model or APM value based care environment.On the software front, revenues grew 23%, driven by continued adoption of our recently launched software solutions. Orders for HyperArc, our high definition radiotherapy solution for stereotactic radiosurgery or SRS grew ho double digits in the quarter. We have taken 263 orders since launch in over 40 countries. Orders for Eclipse MCO, our multi criteria optimization planning software, grew over 50% and we have now received nearly 1100 MCO orders in 46 countries.Our services revenues grew 4% to $277 million, driven by our growing installed base. In our approach on solutions business, we took three orders totaling $188 million in the quarter. We were selected by Radiumhospitalet, part of Oslo University Hospital and Haukeland University Hospital Bergen to equip each center in Norway with a ProBeam multi-room system. Additionally, we were selected by Shandong Cancer Hospital in China to equip its new multi-room proton clinical research center with the ProBeam Proton Therapy system. The Shandong order includes our ARIA oncology information management system and Eclipse treatment planning software. We now have a total of 79 proton rooms under contract across 26 sites globally. 35 rooms are currently operational, including 5 rooms which were handed over to clinical operations this quarter. The pipeline for our proton business is healthy and we continue to make progress on installations. We installed cyclotrons at Biopolis in Singapore and King Chulalongkorn Memorial Hospital in Bangkok, Thailand.In October last year, we announced the formation of the FlashForward Consortium to study potentially groundbreaking ultra-high dose rate cancer treatments with protons. This quarter, we signed a strategic cooperation framework agreement with Shandong Cancer Hospital for proton therapy clinical application and research, the first center in China to join the consortium. We also had a successful show at the Particle Therapy Cooperative Group Conference in Manchester with record breaking attendance at our FlashForward Consortium Users Meeting and Symposium.Our second growth priority is to extend our global footprint. In EMEA, this was the eighth consecutive quarter of double digit orders growth on a constant currency basis, driven by outstanding performance in India, the Middle East and Africa. In India, we booked initial orders for two linear accelerators and two brachytherapy systems as part of the Tata Trust Framework agreement. And our Middle East and Africa region continued strong close collaboration with Aga Khan Charity in Pakistan, led to four TrueBeam orders, two each at sites in Karachi, Pakistan and RSLM, Tanzania.In China, our second largest market, key wins at Guangzhou Concord Cancer and Shandong Tumor Hospital fueled strong double digit growth. We took five Halcyon orders during the quarter, bringing the total to 8 in China since receiving regulatory approval last November.Finally, our third growth priority is to expand into other addressable markets. With the acquisition of CyberHeart, we entered the ventricular tachycardia or VTAC market, which is expected to be a $1.4 billion market by 2028. The acquisition of intellectual property enables Varian to innovate in the space of cardiac radioablation. Varian is building a team and portfolio solution to address the VTAC market opportunity. We anticipate conducting clinical trials to demonstrate safety and efficacy for necessary regulatory clearances.In June, we announced the closing of our CTSI acquisition, which is an important step in addressing the growing global cancer burden and the human capital gap through innovation of new multidisciplinary solutions and provision of services as well as enhanced access to patient data for artificial intelligence and deep learning algorithm creation. CTSI operates the American Oncology Institute comprised of 11 cancer centers in India, and CTSI Oncology Solutions are technology enabled services business, supplying over 7000 treatment plans globally each year.Data published in Lancet Oncology suggests that the world will need an additional 3000 radiation oncology centers, 22,000 linear accelerators and 150,000 skilled clinicians by 2035 for radiation oncology alone. CTSI will unlock global access to high quality patient care. Our company entered the interventional oncology market with the acquisitions of Austin, Texas based Endocare and Hangzhou China based Alicon to add cryoablation and microwave ablation therapies to our portfolio.Subsequently, we signed an asset purchase agreement to acquire Boston Scientific’s portfolio of drug loadable microsphere and bland embolic bead products. The interventional oncology market is expected to grow from $860 million this year to $1.1 billion in 2022. These acquisitions serve as the first step in creating a comprehensive interventional oncology platform that includes a consumables business and leverages Varian’s unique software expertise.We're also pleased that Tennessee Oncology selected Varian to implement Noona, a software application for managing patient symptoms and capturing patient reported outcomes in cancer care. As part of this collaboration, Noona will be deployed at more than 30 centers across Tennessee with the goal of reaching approximately 25,000 patients this year. In the past two months alone, 10,000 patients have been enrolled into the use of Noona. Noona was also chosen by the State of Michigan as the vendor for their statewide symptom management and patient reported outcome initiative. Once deployed across 19 centers, Noona will reach close to 60,000 new cancer cases per year. Last week, the first patient was enrolled at Henry Ford Health System.Overall, we're pleased with the progress we made in the third quarter. We remain dedicated to providing patients and clinicians around the world with intelligent cancer care solutions.With that, I'll turn it over to Gary, who will provide more context on the third quarter financial results.

[Gary Bischoping:]

Thanks, Dow. As always, I will frame my comments in the context of our long term growth and value creation strategy, which includes balancing growth, profitability and liquidity. So let me start with growth. Companywide revenues were 826 million in the third quarter, up 16% in dollars and 19% in constant currency. One small correction to a prior comment Dow made, our software growth rate was 24% year-on-year.Recent acquisitions of CTSI, Endocare and Alicon contributed revenues of 4.8 million in the quarter. For segment reporting, CTSI will be consolidated in Oncology Systems and Endocare and Alicon will be reported under our other segment.In oncology, revenues were 793 million, up 19% in dollars and 22% in constant currency, driven by double digit growth in all geographies and strength across our portfolio. Tariffs had a 150 basis point negative impact on the growth rate. On a trailing 12 month basis, revenues grew 12% in dollars and 14% in constant currency. CTSI contributed 2.8 million in revenues in the quarter.Orders were 778 million, up 2% in dollars and 4% in constant currency. On a trailing 12 month basis, orders grew 11% in dollars and 13% in constant currency. We ended the quarter with 2.9 billion in backlog, up 7%. In the Americas, revenues grew 19%, was 22% in North America. Orders were 357 million, down 1%. On a trailing 12 month basis, orders grew 6%, including 19 million in orders for six TrueBeam systems and associated software from the Veterans Affairs Medical Centers.In our Europe, Middle East, India and Africa geography, revenues grew 23%. Orders were 281 million, up 8% and 13% in constant currency. On a trailing 12 month basis, orders grew 13%. Asia Pacific revenues grew 11% in dollars. Tariffs had a negative impact on the growth rate of 80 [ph] percentage points. Orders were 140 million, down 1% and grew 1% in constant currency, driven by weakness in Japan, Australia and Southeast Asia, offset by strong double digit growth in China.On a trailing 12 month basis, orders grew 22% with double digit growth in all sub regions. Our proton solutions business posted revenues of 31 million in the quarter, down 26%. Services revenues of 5 million grew 44%. Three orders were taken in the quarter, totaling 108 million.Turning to profitability. Total company gross margin of 42.9% of revenues decreased 160 basis points. This included a negative impact from tariffs of 130 basis points, with the remainder driven by product and geographical mix. Our trailing 12 month gross margin rate was 42.4%, down 150 basis points. This included a negative impact from tariffs of 100 basis points.Oncology gross margin rate was 43.9%, down 210 basis points. This included negative impact from tariffs of 130 basis points, with the remaining difference driven by product and geographical mix. System pricing at the region level remains relatively stable. Looking at proton solutions, gross margin dollars were 5 million. As Dow mentioned, we took a 51 million goodwill impairment for our proton business. Our aspirational goal to achieve near term breakeven earnings for the proton business is impacted by slower than expected order volumes, notwithstanding three orders in the third quarter. We revise our growth expectation based on the current market, resulting in lower evaluation which triggered a non-cash charge to fully impair the proton goodwill.Even with the market recalibration, we intend to grow our market share for the proton business. We remain committed to proton therapy as an important treatment modality in cancer care, complementary to our oncology portfolio, and we continue to invest in Flash technology. Investments will continue to be a key driver of our long term growth and value creation strategy. We invested 62 million in R&D, which is up 4% at 7.5% of revenues. SG&A expenses were 148 million, up 7% at 17.9% of revenues, down 150 basis points.Company operating earnings were 144 million, up 22% at 17.5% of revenues, up 80 basis points. This included a negative impact from tariffs of 160 basis points, more than offset by tariff mitigation execution and operating expense leverage. On a trailing 12 month basis, operating earnings increased 6%, at 16.6% of revenues, down 80 basis points. This included a negative impact from tariffs of 120 basis points.Turning to taxes, our GAAP effective tax rate for the third quarter was 50.9% and our non-GAAP effective tax rate was 18.5%. The lower tax rate in the third quarter is driven by a lapse in statutes in various jurisdictions. GAAP EPS was $0.32, our non-GAAP EPS was $1.32 with diluted share count of 91.8 million shares in the quarter.Turning to the balance sheet and liquidity, we ended the quarter with cash and cash equivalents of 523 million and 401 million in debt. Cash flows from operations were 130 million, up 28 million due to increased operating profit and strong collection momentum in our oncology business. Oncology DSO decreased to 105 days from 106 days in the quarter. In addition to R&D, other investments in the quarter included $19 million in CapEx and 49 million to repurchase shares of our stock. As of the end of the quarter, we had 2.5 million shares remaining under our existing share repurchase authorization.I'll now turn it back over to Dow.

[Dow Wilson:]

Thanks, Gary. And just a brief clarification on proton orders before we continue, I read $188 million of third quarter proton orders, dyslexic moment, it was $108 million. It is stated correctly in the financial information and as Gary said in his section.Before I discuss guidance, I want to comment on a couple of recent announcements. On July 8, the US Trade Representative announced a retroactive tariff exclusion on multi-leaf collimators sourced from China. We expect the fiscal year 2019 gross tariff impact to reduce by approximately $5 million. Also on July 10, the Center for Medicare and Medicaid Services or CMS announced a proposed radiation oncology payment bundle intended to test an episodic payment structure across a cohort of US hospitals and freestanding cancer centers.At Varian, we've long anticipated the transition to a value based care environment, our innovations over the past decade such as TrueBeam, Halcyon, Bravos, HyperArc, RapidPlan and numerous other innovations combined with our recent acquisition of CTSI provide solutions designed to be the most efficient and effective delivery systems, driving outstanding quality and return on investment as the clear leader in the market and with over 1.5 million patients treated with SRS now SBRT, we are poised to help guide customers in implementing a value based care environment.As the proposed rule enters the comment period and additional data regarding the actual rates and coverage areas are released, we will assess policy implications and work strategically with key stakeholders to advocate for changes that ensure that our customers are best positioned to successfully provide quality care to their patients. And now looking forward, our guidance continues to consider the projected market growth and continued momentum of our products and solutions in the market.Additionally, the $5 million positive impact due to the retroactive tariff exclusion is being reinvested to drive future innovation and support our long term growth, including investments in Flash technology, software capability, key programs such as adaptive radiotherapy and infrastructure. Incrementally, we're also investing in sales and distribution capability to support the global build out of our recent acquisitions.And after carefully considering these factors, we expect the following for the fiscal full year. Revenues of $3.18 billion to $3.21 billion, representing growth of 9% to 10%. Non-GAAP operating earnings as a percentage of revenues of 16.5%. Non-GAAP earnings per share of $4.58 to $4.63 cents. Cash flows from operations of $430 million to $470 million. The guidance continues to assume a non-GAAP effective tax rate of 21% to 22%, a weighted average diluted share count of 92 million, currency rates as of the beginning of the fiscal fourth quarter of 2019 includes the expected net impact of all tariffs currently in effect, and includes acquisitions announced to date.Thank you. And now, let's go to Q&A.

[Operator:]

[Operator Instructions] Our first question comes from the line of Matt Taylor with UBS.

[Matt Taylor:]

So the first topic I wanted to ask about was just some of the changes in the ordering patterns here. Would you say there's any change in the environment in the Americas or in APAC, you called out some weakness in the number of geographies or would you chalk this up to some variability? What are you seeing in terms of trends that would explain some of the difference here?

[Dow Wilson:]

Looking at the biggest picture, first of all, trailing 12 months growth remains robust across all geographies. Our orders are lumpy, as you know, it's also tough to grow off a very large comp. We had a very, very good third quarter last year. And, but now just kind of making around the horn on the geographies, the trailing 12 months in the Americas is 6%. We're very pleased with long term performance. The -- we had strong wins at the Veterans Hospital. I'd say, certainly here in the short term, there's no indication that CMS proposal is impacting US demand, wouldn't make that linkage at all.The US product portfolio remains in a very good position to drive growth. We're seeing software, competitive takeouts, installed base growth, and a lot of folks transitioning to higher technology with SBRT capability. Asia, as I said in the script, we continue to see strong double digit growth in China, despite the fact that we’re not seeing [ph] any traction yet from the licensed quota, but China remains very, very strong, rest of Asia and Japan did not grow in the quarter. These are smaller markets with lumpier businesses, but all are growing double digit on a trailing 12 month basis and it's certainly been strong for us for the last year.As I said about EMEA, this is the eighth consecutive double digit constant currency growth quarter we've had, so we're continuing to see a strong environment there. I mentioned on the call, we did see the first activity in the Tata agreement. We booked two orders in the quarter. Now, we hope that will continue to grow. I think that's probably a pretty good around the horn.Gary, anything to add there, am I missing anything.

[Gary Bischoping:]

No. The software growth continues to perform well from an orders perspective as well as we continue to sell those solutions around the globe. That's the only thing I would add, Dow.

[Dow Wilson:]

Yeah. And maybe, since I messed up the number, we did get three proton orders in the quarter. And I'd also say the funnel looks pretty good there so far after a couple of quarters with no proton activity. It's nice to see that come back.

[Matt Taylor:]

Okay, thanks for that. And then just as a follow up, you did mention the bundled proposal that came out and some initial thoughts on that. And there has not been a linkage to decrease demand, it would be great to hear what you're hearing from customers, what are some of the things that you think might need to change or be commented on during the comments period?

[Dow Wilson:]

Yeah, clearly, I'd say the number one item is people are still looking for more clarity. They didn't give everything, just to remind everybody kind of from the top, this is a proposed rule. And, we will be working with stakeholders to address issues. But, we've long anticipated transition to value based care environment. Our innovations, especially our big ones with Halcyon, TrueBeam, HyperArc, RapidPlan, all of these have had, in the back of our minds, as we've developed them or transition to this kind of payment model.We're also very encouraged, we haven't known CTSI very long, but we're very encouraged about the kind of play it gives us, it gives us an opportunity to consult and sell with people, as they go through this transition. So we think, so the short version is, from a product line portfolio perspective, I think we're really in very good shape to help our customers. In terms of the proposed rule itself, it remains in the comment period. The actual rates and the geographic areas are not yet released. So, that’s a very key piece of information, we're going to need to kind of complete the final assessment on the policy implications, we do have some concerns as to other stakeholders in the field. There's lots of data and complexity to sort through, but we're working with ASTRO and others to advocate for changes to ensure our customers are in a very good position.Just kind of coming back to the portfolio position, I think we're in a really good shape and niche players are going to have difficulty, justifying slower treatments and higher costs. That's kind of what this comes down to. So from a share perspective, I think we're in very good shape, maybe even at better shape than ever. And, as to what it happens in the market, I think we really kind of have to kind of look at the final rates before we can make that assessment.

[Operator:]

Our next question comes from the line of Amit Hazan with Citi. Amit, your line is now live.

[Amit Hazan:]

I want to start with guidance. I apologize if I missed it. But, can you give us a kind of better understanding of the higher revenues, but tighter EPS guide, just thinking through some of the positives that you're experiencing with the Halcyon installs now coming through, the tariff mitigation that you've been mentioning for the second half of the year, the big software growth, seems to be some pretty good visibility, but the -- obviously the operating margin coming down to 16.5%, and a tighter EPS range, just help us out with what the offsets are there.

[Gary Bischoping:]

Amit, great question. And, first of all, I’d say, yeah, as you referenced, the revenue is definitely growing and we felt good about that and Dow referenced some of the tailwinds we're seeing in the marketplace, and trailing 12 months orders are in good shape. And, we're certainly getting a little help from acquisitions there. And that will translate into some of that revenue guide increase that you just saw.From an operating perspective, I just got to kind of help you think maybe a little sequentially from Q3 and Q4 a couple of things. So first of all, as we alluded to in the CTSI announcement, there's $0.03 of dilution here that you're going to see that we talked about in the quarter, next quarter. I would say the tax rate from an EPS perspective is seasonally low in the third quarter. Under FIN 48, we set up reserves for uncertain tax positions. And typically in Q3, we have lapses in the statutes of limitations in various jurisdictions. And that causes a seasonally low tax rate in Q3 that bounces back up into Q4.We have a little more interest from the IOS acquisitions, interest expansion in the IOS acquisitions that we just talked about. And then, I think one of the things that we want to make sure that’s fully understood here is, the ongoing nature of the investments we've been making, not only in R&D, but also in sales and marketing and G&A to support that long term growth. For the Boston Scientific beads portfolio that's pending close, we're going to build into a sales force for that. And so we'll make ongoing investments there in that SG&A line to make sure we support that growth rate over time.The last thing I would point to here is, the current range that we gave from an EPS perspective, which is narrowed, the prior midpoint of our guidance is still within that range. So, we like how this is positioned relative to wrapping up the year and facing into this tariff, tariff challenge that we had, I feel like we're operating very, very well in that environment and delivering strong growth on top of it.

[Dow Wilson:]

Maybe if I could just maybe make a few comments too about the reinvestment side. We've been making some ongoing investments in our software upgrades in emerging markets, field teams, so that's kind of ongoing, little bit infrastructure support to go with that. But then when you look at the acquisitions, CyberHeart is very exciting. It's an intellectual property acquisition. We think it can be a very substantial piece of business, it's going to require some clinical trial work and some investment to get going. So, we've got that ticked off.We haven't owned them very long as I mentioned, but we're very encouraged by what we see with the interventional oncology play, three acquisitions there, Endocare and Alicon and then the asset purchase from Boston Scientific, that's $1 billion plus -- will be $1 billion plus market with very generously accretive gross margin rate. So our challenge there is to kind of bring that to global scale. So we've got some investment going on there. And then as I mentioned, the CTSI play, literally with every day, we like it more and more, opportunity to pivot that business into a technology enabled services business and really help grow the business also with accretive gross margin rates. So, that's a little bit where the investments are going, in the kind of the $0.04 ish impact that we've got here in Q4.

[Amit Hazan:]

Okay, and just to make sure we're clear on that. So the prior guidance of 16.5% to 17.5% going to 16.5% now, it sounds like that's all related to acquisition. There's nothing else that's impacting that reduction.

[Gary Bischoping:]

Predominately investments to support acquisitions, and that's diluted to get to scale and get to those higher gross margin rates in growth over time.

[Dow Wilson:]

And then the tax and tariff piece that you talked about.

[Gary Bischoping:]

Well, the tax and tariffs will be below that line. Yeah. From an operating earnings perspective, that is correct.

[Amit Hazan:]

So, I’ll just stick with this topic for my last question, and just thinking about this obviously just past this next quarter, I think people will understand dilution from deals, but as I think about the year and you guys having started out at 17% to 18% operating earnings, talking about getting to north of 20 and here we are, looking to end the year at 16.5, inevitably, the question is going to come and go. So, how do we think about this for next year? So, can you, I know, you're not going to give guidance, but can you talk just directionally to, whether in aggregate the acquisitions are going to be accretive next year and whether some of the items that I mentioned that seem to be positives for you are going to start to pay off and how we should start to think about that 16.5% as we go into next year, is that now the new base and we just work off of that for another 100 basis points, or is there more room because of some of the one times and other impacts this year?

[Dow Wilson:]

I think a couple of things there, I mean, great question. So, first of all, there's roughly 160 basis point impact from tariffs in that number. Okay, and so, let's add that to the top, and then that starts to get you, heading in the right direction relative to the 20%. The 20% that we gave, certainly wasn't inclusive of what's going on with the tariff environment we're in today. So that's kind of point one.Two is, yes, we are seeing some nice tailwinds from hardware accretion from Halcyon. We've now got 90 of those installed in the world and good healthy backlog to pull from. So, we're seeing that nice accretion. I would say that, we are seeing dilution on the other side of that from the acquisitions, investments in Flash and other investments that we've alluded to along the way. And, I would say that software is going to continue to be a good tailwind for us. We saw it here in the third quarter, we anticipate seeing it for the rest of the year and continue to be a nice mix up from a margin rate perspective. Proton profitability has improved the last two years on a year-over-year basis and with Kolleen at the helm and the work she has underway, we hope to continue that down the path. So -- and then we'll get some operating leverage out of this portfolio, as we stabilize those investments to support the growth in the near term. So, we feel good about where we're exiting the year from an operating earnings perspective. And to remind you that even with the tariffs, we're still going to grow operating earnings dollars on a year-over-year basis.

[Operator:]

Our next question comes from the line of Jason Bednar with Robert W. Baird.

[Jason Bednar:]

Dow, I just want to come back to the China quota. I mean, how would you suggest that quota is going to contribute to your business here going forward. I mean, and how should we think about it for fiscal ‘20, assuming that we start to see it here coming in a bigger way in the coming quarters? And is it fair to think it's a gradual ramp up, is that the right way to think about it? And is that market, the China market running really into any bottlenecks that's holding up that quota from being executed?

[Dow Wilson:]

I think the short version is, to where we are today, it's kind of within our expectations. I do think we've got to watch it going forward. You've got the data on the 1200 to 1400 systems that they had licenses that they were going to do, we've kind of thought from the beginning that that would be a gradual ramp that they had a lot of work to do to get that done. We are seeing some of that work come together, now kind of how the whole China economy plays into this and what's going on, will they spend the money, I think that's a question that we're just really not going to see till next year, next fiscal year for us.So, short version is, nothing we've seen so far surprises us, it's kind of on track for what we thought would happen. The licenses are moving through the provinces. And as soon as we see that, we’ll certainly let you know. I would say that absent all that, we're still seeing a very strong market, it's been strong double digit in the quarter and in the trailing 12 months. And our share is very, very good, 55% public win rate. So we're, I think, very well positioned and kind of like what we're seeing, even despite the quota not hitting maybe as fast as some people had hoped.

[Jason Bednar:]

And then I did want to come back to Matt’s question earlier and just maybe dig in on APAC a bit more. I mean, do you think you just ran into an air pocket with some of those markets, like whether it was Japan or Southeast Asia or Australia? Or has CapEx spending softened in some of those markets? I mean, just trying to understand what's really going on in there in those markets, just especially in light of what had been some pretty darn good growth rates you've been putting up here the last few quarters?

[Dow Wilson:]

Yeah. I mean, clearly, China was very strong, as I mentioned, strong double digit growth, both in the quarter and the trailing 12. In the quarter, both Japan and rest of Asia were down and down not insignificantly. These markets are just lumpy. So, we look very much the trailing 12 on these markets. It's been strong double digit, both in Japan and in the trailing 12. But they are markets, for example, Australia, the market is very tender driven. And you could get five or six LINACs [ph] one quarter and zero the next. So, we got some of that lumpiness kind of going on in those markets. So, at this point, I wouldn't over read anything into Asia. We continue to see a strong Asia and believe it's going to be a good geography for us. We've recently retooled kind of our rest of Asia team. We got very strong leadership in China, Japan and Australia and we've retooled our Southeast Asia leadership team, really like the team that's in place and, pushing that market and seeing some market development and growth there.One of the things that maybe just to come back to the Halcyon comment that Gary mentioned, we did 46 Halcyon orders in the quarter, 60% of them are in emerging markets. The really amazing statistic is nearly every one of the emerging market orders was a new vault, so this is growing our installed base, growing the beach front of the business, long term growth of our service and software business, it's doing exactly what we wanted to do and kind of really responding to that Lance's study that we famously quoted now for three or four years and it's just fun to see the fulfillment of that, fulfilling that access to care in these markets where cancer patients have not had radiation therapy as part of their arsenal.

[Operator:]

Our next question comes from the line of Anthony Petrone with Jefferies.

[Anthony Petrone:]

And maybe I'll stay on APAC orders for a sec and move into just reimbursement. Just as we look ahead and when we start to see orders from say Tata and then also the outstanding tenders that are in China, that 1400 or so systems, I mean, how are you expecting eventually that to roll through? I mean, it seems that it possibly will cause even more lumpiness, as time goes on or you're expecting perhaps maybe a more measured processes as both Tata and the tenders in China begin.

[Dow Wilson:]

Let me talk India first. We’re very pleased with the Tata relationship, a big piece of our EMEA growth this last year has been India. And that continues, even, it's kind of same story in both India and China, right. I mean, the core business is doing very, very well. If you look at it on a revenue basis, our five year CAGR in India is 20%. So that's kind of the India story. Our radiation therapy utilization in India is less than 20%. So there's still a huge access issue. That's what the Tata foundation really wants to get at. We booked the first two orders. It's underway, two LINACs and two brachytherapy orders, so those are kind of their pilots to get it going.I think there's been a lot of focus on the election and the campaign and now, the government is rolling out budgets, I think we will see, over the next few years, more engagement from the government buyers in India. So, you have kind of our core market, the Tata Foundation, and the India government getting into it. So, I mean, it's going to be a little bit lumpy and we don't guide to orders, but that's kind of the market that we're seeing in India. On China, we're seeing the historical market, as I mentioned a minute ago, is very strong and continues to be strong.I would maybe add one thing to it. And that is we're starting to see a private market emerge in China. And, that's good. The Ministry of Health thing as I mentioned, it's on our expectations. We had hoped to see some here in the second half of the year. I think, that's what we said earlier in the year. We do see provinces starting to kind of get their ducks in a row and line up, now what economy emerges in China and is there some fiscal restraint and how does that impact us, I couldn't look in the eye and tell you how that's going to impact us one way or the other at this point. But, maybe there would be some of that. But frankly, the core business continues to rock in China and we feel very comfortable about its growth and about our market position there, I mean, literally, that our market share has been trending up there the last eight, nine quarters and continues to be very strong position as a leader, so grateful for that.

[Anthony Petrone:]

And just to follow-up there in the US on reimbursement, understanding, it's early here, but as you look at sort of what's out there in the proposal, is there any early view on perhaps what impact this could have on one hand, when there's changes, maybe it leads to a little bit of hesitation on hospitals, but on the other hand, it seems like going to value based could trigger an upgrade cycle if your systems are really not prepared to do, really hyper fractionation really, so maybe just some early thoughts there.

[Dow Wilson:]

I think it's really a good question. We're watching it very, very closely. My view of this is there's one negative and one positive. The negative is, it's uncertain and at uncertain times, people hesitate a little bit. The positive is, with this transition to more value based, we're going to see a shift to more hyper fractionation. And, there's no product portfolio better positioned in the world than ours to take advantage of that. And that could cause people to really look at their fleet of LINACs and say, boy, are we well positioned for that transition, and, I need a better SRS/SBRT capability, and I need to be able to do it in my standard treatment slot.So, it's, I think it's a nice opportunity for both new systems and for upgrades. We could sell imaging upgrades, more rapid plan upgrades. I'm very encouraged. I mentioned briefly our Adaptive Therapy Consortium, to do that in a existing treatment window without impacting the productivity of our customers is a big deal. So, they can maintain and grow their return on investment with equipment. So we think we're in, so I think that's the positive. I think the positive is there is some encouragement to swap out old stuff. And then there will be a little uncertainty, while people kind of transition into the new alternative payment model.

[Operator:]

Our next question comes from the line of Tycho Peterson with JPMorgan.

[Tycho Peterson:]

Hey, I'll start with where you left off. You made a comment earlier about working with customers to address some of the issues around bundling. Can you maybe elaborate on that and what's kind of a range of acceptable outcomes in your view when we do get the physician fee schedule, in terms of cuts?

[Gary Bischoping:]

I think the only outcome I could really predict is, we’ll know in November and December. So, I mean, they've been very regular in terms of their timing. We see the trial balloon in July. And then the final proposal comes out in November, December. We have not seen actual rates in geographic areas yet as part of this. So that's one item, the mandatory nature of it is another item. Anyway, we're working with a number of customers, freestanding hospital, academic, across the board, working with our trade association [indiscernible] and of course through ASTRO to raise some of the issues we have and make sure the voices are heard, so that cancer patients continue to receive the best quality care.

[Tycho Peterson:]

And on Halcyon, I appreciate the commentary, can you just comment on the KV launch, how much is that driving demand at this point, what's the mix like KV versus non-KV enabled systems?

[Dow Wilson:]

Let’s see. I don't have it here for you. If I get it before the end of the call, oh, here we go. We got -- 55% is KV. Let me start over. 60% of this is in emerging markets. So, you could say that the 40% that's in developed markets, almost all of that is -- virtually 100% of that is KV. I'd say in emerging markets, maybe 10% to 15% of it is -- has a kilovoltage imager in it. I think the one thing that we're excited about is the kilovoltage imager is not yet launched in China. We don't have regulatory approval for that yet in China. And I think our Chinese customers are in part waiting for that. And, that's going to be another elbow of growth for us when we bring that into the market.

[Tycho Peterson:]

All right, and one or two quick ones for Gary. I have to ask on cash flow, because you did cut it again, can you maybe highlight what's behind that?

[Gary Bischoping:]

It’s really related to growth, as we're growing faster, as outlined by the upgrade in the growth rate, we're going to put some more receivables on the board and carry a little more inventory. So, that's kind of the bulk of it -- of the small change we made there. And, let's say on the flip side of that, our oncology business saw a record collections quarter, so really good collections by the team. And our DSL and oncology was down from 106 days last year to 105 days this year, and is down from 110 in the prior quarter. So, the teams are executing very well. It's just, we're growing fast, so we're going to use a little more working capital.

[Tycho Peterson:]

And then on tariff, you offset the impact on EBIT this quarter, are tariffs then a net tailwind to earnings growth next year as you lap the softer first half or do you plan to kind of reinvest that.

[Gary Bischoping:]

We'll talk a lot more about that as we talk to you guys next quarter, but we've seen some good momentum as you outline as we've gone through the year here.

[Operator:]

Our next question comes from the line of Vijay Kumar with Evercore ISI.

[Vijay Kumar:]

Hey, guys, thanks for taking my question. I have a few here. Maybe just starting on the fourth quarter guidance here, Gary, if I understand correctly, the 10% revenue growth for the year, that's implying low single digit top line for Q4. Were revenues pulled forward into 3Q, I'm just trying to understand, you did 16 reported, 19 constant currency. Why is that decelerating to 3% reported in Q4?

[Dow Wilson:]

Yeah, big compare from last year Vijay. When you look at what we did in the fourth quarter of fiscal ’18, that's the majority of the reason and going off that big compare is always a challenge. We're up to the challenge. And as you outlined, given the guidance, we’ll seek growth here. So, that's really the long and short of it here from a revenue growth perspective.

[Vijay Kumar:]

The EPS guidance, that's implying $1.21 at the high end, that's 15% below street models for Q4. I'm just wondering if there was any timing element from 3Q to 4Q, obviously, you had a really strong 3Q, that EPS number basically implies a sequential deceleration in op margins, am I looking at this the right way in terms of the implied fourth quarter guidance on EPS and margins?

[Gary Bischoping:]

So, it implies a sequential decline in earnings per share. Right. So the first thing that I think you have to look at from a quarter-on-quarter perspective is, the tax rate, like I outlined. That's certainly the sequential tax rate decline that I talked about earlier. Under FIN 48, we set up reserves for uncertain tax provisions and positions and in the third quarter, we had some of the statute limitations and various jurisdictions lapse there. So you see, seasonally, as you’ve seen in the last couple of years, a drop in the growth, a drop in the tax rate in the third quarter and that'll pop back up in the fourth quarter. That's a big part of that earnings per share sequential change.CTSI, the $0.03 dilution, we'd already talked about, that you'll see in the fourth quarter. We'll have some more interest expense, as we go from Q3 to Q4, given the acquisitions that are outstanding, and then as Dow outlined, we continue to make investments across the SG&A line to support that growth rate, building out a sales, distribution, marketing with the acquisitions we're very excited to have in the portfolio.

[Vijay Kumar:]

And if I could just squeeze in one on the bundling side, when I was reading the document, it looked like freestanding centers are getting paid double digits, about 11% higher than hospital rates. Is that -- am I reading that correctly? And what percentage of your backlog is from freestanding centers, is comprised of freestanding centers right now?

[Dow Wilson:]

I'm not sure about your math on the first part, Vijay. I know in a lot of areas, the reimbursement rates have been equalized. So, that might be something we can tackle in another call somewhere.In terms of the second part of your question, percent of backlog, I mean, there was a day a decade ago when the freestanding market was a quarter of our business. Today, it's less than 5% of our business.

[Operator:]

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Dow Wilson for closing remarks.

[Dow Wilson:]

Thank you. In closing, we're excited about the strong momentum in the business and look forward to continuing to execute on our growth priorities. We remain committed to investing in innovation and future growth opportunities, both organically and through acquisitions. These activities accelerate our strategy to be a broad based cancer solutions company to drive toward the ultimate victory, a world without the fear of cancer. Thanks for joining us today.

[Operator:]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.