Varian Medical Systems Inc
Q1 2008 Earnings Call Transcript

Published: 24 Jan 2008

[Operator:]

Good day ladies and gentlemen and welcome to the First Quarter 2008 Varian Medical Systems Earnings Conference Call. My name is Eric and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of the conference. [Operator Instructions]. I would now like to turn your presentation over to your host for today's call, Mr. Spencer Sias, Vice President of Investor Relations. Please proceed.

[Spencer R. Sias:]

Thank you. Good afternoon and welcome to Varian Medical Systems conference call for the first quarter of fiscal year 2008. With me are Tim Guertin, President and CEO; Elisha Finney, CFO; and Tai Chen, our Corporate Controller. Tim will start this afternoon by summarizing our financial results and operational highlights for the quarter and Elisha will detail the P&L and balance sheet, and then Tim will finish with the company's outlook for the second quarter and full fiscal year 2008. We will be taking your questions following the presentation. To simplify our discussion, unless otherwise stated, all references to the quarter or year are fiscal quarters and fiscal years, quarterly comparisons are for the first quarter of fiscal year 2008 versus the first quarter of fiscal year 2007. Finally, before beginning, please be advised that this presentation and discussion contains predictions, estimates and other forward-looking statements. Our use of words and phrases such as outlook, expect, believe, can, could, recurring, and similar expressions are intended to identify those statements which represent our current judgment on future performance. While we believe them to be reasonable, these statements are subject to risk and uncertainties that could cause actual results to differ materially. Some of the important risks relating to our business are described in our first quarter earnings release and in our filings with the SEC. We assume no obligation to update or revise the forward-looking statements in this presentation and discussion because of new information, future events or otherwise. And now here's Tim.

[Timothy E. Guertin:]

Thanks Spencer and good afternoon everyone. Well, we are off to a good start for fiscal 2008 with a strong first quarter marked by double-digit growth in net orders, revenues, operating earnings and net earnings, as well as backlog, which hit another record high. Compared to the year ago period, the backlog rose 22% to over $1.7 billion, net orders rose 21% to $493 million, revenues increased 18% to $459 million, operating earnings rose 20% and net earnings per diluted share rose 16% to $0.43. Oncology Systems, X-Ray Products, and our Security and Inspection business all contributed to our growth in net orders, revenues and earnings. Oncology Systems had broad based growth across all major product lines and in all geographic regions. The business achieved healthy gains in gross margins and operating earnings. Compared to the first quarter of last fiscal year, net orders in this business rose 17% to $386 million with 7% growth in North America where we had 19% growth in the year ago quarter and 30% growth in the international markets where orders where down significantly in the year ago quarter. The strong international order growth was driven by a series of major wins in Scandinavia, the UK, Switzerland, Turkey, and India. One of our largest single orders came from Portsmouth hospital in the UK where four Varian accelerators equipped with our OB On-Board Imager were picked to replace competing machines. Orders for image-guided radiotherapy and the radiosurgery products were the prime growth drivers and accelerator unit volume increased nicely. More than 80% of the worldwide orders taken during the quarter for a high-energy Clinac and Trilogy linear accelerators included an OB device for image guidance. As of the end of the quarter, we have completed more than 720 installations of OB equipped IGRT systems, more than double the year ago total and we have many, many more in progress. We had a substantial increase in orders for radiosurgery units including the Trilogy and the Novalis Tx machines. As we reported in our press release today, we booked orders for 14 Novalis Tx configurations, including 10 in the US and four in Europe during the quarter. Orders have come from leading surgical institutions as well as community hospitals for enhancing their radiosurgical capabilities. We believe that the speed, versatility, precision and advanced capability... imaging capability of Novalis Tx enabled us to achieve strong share and substantial growth in the radiosurgical portion of the market. At the end of December, we received regulatory clearance to market our RapidArc capability that improves the precision and dramatically improves the speed of image-guided IMRT and subsequent to the close of the first quarter; we've booked our first RapidArc order. Customer interest in this new capability is tremendous. We believe that together, RapidArc and Novalis Tx represent important new long-term growth drives for our oncology business. Turning to other oncology products, we also achieved double-digit growth in orders for our Eclipse treatment planning software and for our ARIA information and image management system. Our service business also played an important part in the orders growth for Oncology Systems in the quarter. Today it represents better than $350 million in recurring annual revenue for Oncology Systems. This business is expanded with the help of a bigger installed base of OBs and a larger mix of software service agreements. Turning to X-Ray Products, we had another good quarter driven by continued expansion of our business in flat-panel detectors for filmless X-ray imaging. Net orders for X-Ray Products rose 11% to $75 million, driven largely by growth in orders for panels which amounted to nearly 40% of the total orders for the business during the quarter. During the quarter, we continued to build our digital fluoroscopy panel business while gearing up for commercial launch of our new radiographic panels. As we reported at the end of the quarter, we also acquired Pan-Pacific Enterprises, the largest independent distributor of medical X-ray tubes in China for the purpose of marketing, sales and distribution of Varian X-Ray Imaging products there. We expect that this acquisition will enhance the Varian sales channel for both tubes and panels in this important market. Now I'll talk about the category of our other businesses, which is made up of our SIP, Security and Inspection Products, business, our ACCEL proton therapy business, and our Ginzton Technology Center. Compared to the first quarter of last fiscal year, combined first quarter net orders for these businesses tripled to $33 million. This was largely due to our SIP business which grew orders by $19 million. With the help of our acquisition of BIR lat May, we were able to win a very large order for the installation of four freight inspection systems at the US border. Global demand for improved security in ports and border crossing is driving growth in the SIP business and we are expanding our manufacturing capacity in Las Vegas to accommodate this need. We expect to have a cargo screening demonstration unit operating in our new 85,000 square foot plant there before the summer. Now I'll turn it back over to Elisha for a review of the numbers and then come back to you with our outlook for the second quarter and fiscal year 2008.

[Elisha W. Finney:]

Thanks Tim and hello everyone. As usual, I will walk through the income statement attached to the press release as well as cover a few balance sheet items. As Tim pointed out, the company's first quarter revenues increased 18% to $459 million. Oncology Systems posted an increase of 14%, X-ray Products posted a gain of 12%, and the other category including the ACCEL and SIP businesses mote than tripled revenues to $28 million. Gross margin for the quarter was 42%, up almost 0.5 point from the year ago quarter. Oncology Systems gross margin was 43%, up one point from the year ago quarter, primarily due to higher volume and domestic product mix. This improvement in Oncology's margin was achieved despite a significant shift in the quarter to lower margin international revenues. X-ray Products gross margin was near 40% for the quarter, down one point, mostly because of product mix in our X-ray tube line and some material cost increases. First quarter SG&A expenses were 17% of revenues, up by about 0.5 point from the year ago quarter, due largely to the ACCEL acquisition. R&D expenses were 6% of revenues, lower by 0.5 point from the year ago quarter. Moving down the income statement, first quarter operating earnings increased 20% to $84 million or 18% of revenues, up slightly from the year ago quarter, including the dilutive effects of recent acquisitions. Oncology Systems and X-ray Products together contributed $102 million in operating earnings with our other businesses and corporate consuming a net $18 million. Depreciation and amortization of intangibles totaled $9 million in the quarter. Net interest income totaled $1.6 million, down from the year-a-go period due to lower cash levels in the US and higher borrowing associated with our share repurchase program and working capital requirement. Our effective tax rate was 35%, up four points from the year ago first quarter which benefited from a retroactive reinstatement of the R&D tax credit. The rate was also impacted by our required adoption this quarter of FIN 48 tax accounting. For the year, we now estimate that our tax rate will be between 32% and 33% due largely to geographic shift in profits and the expiration of the R&D tax credit. Average fully diluted shares outstanding were 128 million, down by about 5 million shares from the prior year quarter due largely to the ongoing share repurchase program. We reported fully diluted GAAP earnings per share of $0.43. Turning to the balance sheet, we ended the quarter with $334 million of cash and cash equivalents, $67 million of combined short and long-term debt, and $863 million of stockholders' equity. DSO or days sales outstanding was 87, an improvement of 6 days from the year ago quarter. We achieved record first quarter cash flow from operations of $121 million, about $66 million more than net earnings for the quarter. Other sources of cash included $24 million from stock option proceeds. Primary uses of cash were $41 million for the stock repurchase program, $23 million to pay off short-term borrowings, and $17 million for capital expenditures. During the quarter, we repurchased 920,000 shares of stock under our current share repurchase authorization. Since initiating stock repurchases back in fiscal year 2001, the company has retired almost 32 million shares at an average price of about $38 per share. Now I'll turn it back over to Tim for the outlook.

[Timothy E. Guertin:]

Thanks Elisha. Including the results from the first quarter, we believe that fiscal year 2008 revenues can grow by about 14% and that net earnings per diluted share for the fiscal year could grow to between $2.05 and $2.07. Compared to the results for the second quarter of fiscal 2007, we believe second quarter revenues could increase in the range of 14% to 16% and that net earnings per diluted share could be about $0.51. We will now take your question. Question And Answer

[Operator:]

[Operator Instructions]. Your first question comes from the line of Amit Hazan with Oppenheimer. Please proceed.

[Amit Hazan:]

Hey, good afternoon guys.

[Timothy E. Guertin:]

Hello Amit, how are you?

[Amit Hazan:]

Good. The first question I think I wanted to ask was on guidance. It looks very good and I think I understand, Elisha, what you were saying on the tax rate going up a little bit. But as I plug that into my model, I still can't get to $2.05 to $2.07. I get higher, obviously because of the higher revenue. Can you give us a sense of what else is going on there that we should adjusting to get down to your EPS guidance?

[Elisha W. Finney:]

Yes, I mean, basically, Amit, the guidance remains pretty unchanged at the... above the tax line. With 14% or so revenue growth, we still expect that the pre-tax margin should improve by about half a point, with half of that improvement coming from gross margin, about half from leveraging our operating expenses. Clearly you will have to make some assumptions on the share count, but the tax rate, if you... if we went to the prior guidance of the tax rate, which was between 31% and 32%, we have now taken that up about a full point, what you would see is that the guidance would have increased in line with the $0.03 that we gave in the first quarter, but that's been largely offset by the increase in tax rate. Now, of course if the R&D tax credit is reinstated or if our geographic profits end up being different than what we anticipate now, or if some of the discrete items that we had in the year ago period should recur thus year, then obviously, we could see an improvement in the tax rate, but it's just too early to tell at this point.

[Amit Hazan:]

But again, just to follow up on that, if your revenue guidance increased from 11% to 14% and you had $0.03 upside in the quarter and it doesn't sound like anything else has changed other than the tax rate. We are going to get higher than your EPS guidance. So I guess to ask the question directly, is there anything that changed in cost of operations, SG&A, R&D that's different that would drive it down? Otherwise I would have expected that EPS guidance would have gone up accordingly.

[Elisha W. Finney:]

No, there is nothing different in the operating expense side that we are anticipating. All of the RapidArc introduction as an example has been built into the guidance expectation that we gave.

[Amit Hazan:]

Okay. And then just a question on RapidArc, it sounds like you are starting to get orders, can you give us a sense of how we should be modeling that in terms of penetration into units, what's your expectation as far as units you sell either US or OUS and how... will most people be ordering this under units or will it be like IGRT or what percent of units will be ordered do you predict or can you give us a sense with the RapidArc in the coming... over the coming year, let's say?

[Timothy E. Guertin:]

Yes, Amit, this is Tim. We think that this is going to play out sort of the way IMRT and IGRT has played out; that is in the first year. Because of budgets, people don't necessarily include this right away. You got to remember this is a retrofittable option, so people can buy these things. What they may want to do is just have some assurance to us... from us as to what the price is likely to be when they do order it. And then... so I expect that what we will see is orders will start to pick up over the course of the year, but I expect most of the order impact will be in quarter three and quarter four, and most of the sales impact will be next year. Now, that's not to say that we know sales impact this year and we build some level of sales impact this year, and we are hoping to be positively surprised. But at this juncture, we've built in some... a reasonable number of upgrades and a reasonable number of new situations based upon our experience with IGRT and IMRT. And as I indicated before, if somebody buys the full option here, we are talking in the vicinity of $400,000, if they buy it with the treatment planning and other things, it could be more or if they need an onboard imager to add to their machine as an upgrade, of course that would add to it, but I think... so what will happen is in future quarters, as we talk about this, and as we see how it plays out in the marketplace, we will be able to give you a better insight into this. But right now, we have some... just our assumptions are based upon patterns of adoption that we have seen in previous generations of new technology.

[Amit Hazan:]

Okay. And then just a last question I have I think maybe just as kind of a long-term thought, I don't think we have actually in a while about biologically guided radiation therapy or BGRT and I am wondering if you can give us an update on where you are there in terms of... I am sure it's early work, but where you are there in terms of the work that you are doing, how far away we might be from seeing that come to market and maybe what new technologies would actually be needed for that to work, whether it's some integration of pet et cetera?

[Timothy E. Guertin:]

Yes, there is talk about biologically guided radiation therapy and when we have it... it will be important and we do have it to a limited degree now. And the first manifestation of this is when we do imaging for treatment planning, the idea is to get more information about the cancer that we are looking at. So, for example, whereas we might just see that there is tumor now, we might be able to see more... the full extent of the tumor, we might know whether some of it is hypoxic or might get a sense of what the cell density is of the tumor and the specific percentage of cells that have been... have turned malignant. The malignant potential of the disease, whether it is spread outside of the original tumor, all these kinds of things are information that will be extremely valuable in the planning process. We are a little dependent upon the imaging companies to help us there, which is why we consider our imaging partnerships to be so important because we want to work with those folks to do that. Now I will add that if you take a look at hypoxic imaging, hypoxic means that the cells have low... a low amount of oxygen compared to the normal healthy cells, hypoxic cells are radio-resistant. So, we are working with several universities. They have developed... there is an agent that look like it would be very good for imaging hypoxia, works well with pet and we are starting up Phase I clinical trials that we are helping to fund and I am hoping that if hypoxic imaging works out well, this... if these trials work out well, and we have exclusive rights to this particular agent for radiotherapy planning. If this works out well then this could be the example of the kind of thing that helps us in future years. But I think BGRT is kind of a long-term bet for us. It's not anything that's going to give us money in 2008 and 2009. I am making a long-term bet there. And if other agents come along and we have people who do this for a living, who look at these kinds of things and these kind of opportunities for a living then, of course, we'll do it. And it could change the nature of image guidance in the future, but I expect the biggest impact will be on planning.

[Amit Hazan:]

Okay. Thanks very much.

[Timothy E. Guertin:]

Thank you.

[Operator:]

Next question comes from the line of Tycho Peterson with JP Morgan. Please proceed.

[Tycho Peterson:]

Hi, good afternoon.

[Timothy E. Guertin:]

Hello Tycho.

[Tycho Peterson:]

Hi, wondering if I could dive a little bit more into some of the comments you made around international orders. I know the comp there was a little bit easier, but it sounds like things have picked up in Scandinavia, and I am just wondering in general within Europe, whether this is a reflection of any change in your selling strategy, whether there is any underlying competitive dynamics. And then also, Tim, I think you may have mentioned India, I am just wondering whether you're seeing an up-tick in demand out of the Asia in general?

[Timothy E. Guertin:]

Well, we're trying to be tougher allover the planet in terms of our competitiveness. I would say if there is a difference, it is that we are seeing these countries adopt more and more high-end technology than they might have adopted in the past. So whereas they might have bought less expensive machines with fewer options, they are now buying more expensive machines with more options. And I think we are doing a better job in places like India. I think we are being more aggressive there, and so I think this is manifested. I think it's manifesting in all our territories. Australia is up, Latin America is up, Europe is up, Asia is up. I think all of our territories are seeing the benefit of this, and the whole team is galvanized around these new products because they realize that they have enormous potential to improve cancer care and to improve their impact. Now, we also... there is an FX effects that I want to draw your attention to, which is that although we grew 30%, I think it would have been 20% if it hadn't been for... I think 10% of that was FX. Not that 20% is bad. I think 20% is still a very good number, but you will have to keep that in mind when you take it into account. But I think the teams are just performing quite well.

[Tycho Peterson:]

Okay. And has your level of visibility changed dramatically over the past year? I think it was a year ago we were dealing with some of the tenders out of Europe, and are you more comfortable with where you are in terms of visibility?

[Timothy E. Guertin:]

Well, we have our forecast meetings every year in the first quarter. We take a look at the territories, and we look at deals. We look at deals that we think we have some confidence that are likely to choose Varian, and we look at deals where we are not so confident, and then we work with our sales teams to try to go out and get those. And so, the big mystery... and it's not a mystery, but the big factor that we have to work on over the course of the year, the execution factor is to try to get deals where customers are may be far from certain from choosing us, and we just have to work on those. And I will say that we see a lot of tenders. And these tenders, as we have seen in previous years, have timeframes that we predicted, but those timeframes can move. So altogether, I am feeling better, I am feeling pretty good about international. Certainly, we've had a couple of quarters here that show strength and that fills me with enthusiasm.

[Tycho Peterson:]

Okay. And then maybe just touching briefly on the new products, I mean, it sounds like Novalis has done well. Can you characterize may be whether these are existing Varian customers or existing even Trilogy customer or whether you're kind of looking at new customers? And then same thing around RapidArc, obviously, you're just taking the first orders now, but if you can kind of characterize where you see the demand that would helpful.

[Timothy E. Guertin:]

Yes, for Novalis, we are working with BrainLAB, and BrainLAB is approaching neurosurgeons. So some of those are new customers to us. Some of the sites are... we probably almost always know the radiotherapy side of these deals. We will know the radiation therapists, but we may not know the neurosurgeon as well. So, between the Varian team and the BrainLAB team, I think it's expanded the circle of people we are getting to talk to and I think that's probably what's helping us there. In terms of RapidArc, we are talking to people who are radiation therapy customer and so they know us and we know them and very often we have good relationship. So what they want to hear from us is they want to learn more about RapidArc, they want to understand what cases RapidArc is appropriate for, and what cases it's not appropriate for. So they can start to make decisions about acquiring it. And so we...I will also say that we are talking to some customer that we might have lost in the last transaction. And now they are back talking to us because they think that Varian is showing a lot of technological aggressiveness and a lot of imagination and that they maybe would have liked to have seen a few years ago, and they are seeing it from us now, and so we are talking to some new folks who like the direction we are going and think we are showing new leadership.

[Tycho Peterson:]

And with regard to RapidArc in particular, are you getting a lot more questions around dosages at...I mean, I know it's a competitive advantage for you, but is that being brought to the table more from your customers?

[Timothy E. Guertin:]

I am sorry, dosages?

[Tycho Peterson:]

Yes, dosage levels relative to some of the competitive platforms.

[Timothy E. Guertin:]

Well, we are using a lot less dose to deliver the plan. However, the dose of the tumor is the same as it was before. So, we are not changing the way we are treating the patients, we are just... it's a very, very efficient way to deliver dose and exact thing conformal... that's why it's so fast. It's a very efficient method and so that's what they are looking at. They are not assuming that they are going to deliver dramatically more dose to the target, for example. They just want to deliver the same dose to the target and get maybe even better confirmality [ph] than they have had in the past with a lot less work on their part.

[Tycho Peterson:]

Okay. And then just finally on BrachyTherapy, you didn't really talk about that in your comment. Any kind of change in the underlying dynamic there versus Nucletron or just a competitive landscape?

[Timothy E. Guertin:]

Well, it was a good quarter, orders were up more than 30% compared to a year ago. Sales were up in the single-digits, but that's kind of what you would expect after the tough year that they had here last year. We do manufacture this product in Germany, so margins aren't yet what I would hope because of currency effects. But I think BrachyTherapy is on the road to recovery.

[Tycho Peterson:]

Okay. Thank you very much.

[Timothy E. Guertin:]

Thank you.

[Operator:]

Your next question comes from the line of Amit Bhalla with Citi. Please proceed.

[Amit Bhalla:]

Hi. Thanks for taking the question. A couple for Elisha to start off with, Elisha, can you give us your assumptions for currency for the full year and then the currency impact in the quarter, both on the top and bottom line?

[Elisha W. Finney:]

Let me give it to you for the quarter. I am not going to go out on a lam and make any predictions for the year, particularly after the day we had in the market today, in general. Oncology versus 17% total growth would have been 13% total orders growth in local currency. As Tim mentioned, the international as opposed to being up 30% would have been up 20% in local currency. And the total company instead of being at 21% on orders would have been 18%. So we did have 3 or 4 point impact on Q1 in the orders. On the sales line, we just do total company, and instead of 18% sales growth would have been 14%. So, if currencies remain stable, which we know they won't, it should benefit based on where we are in the backlog, but of course that's just a pure guess.

[Timothy E. Guertin:]

We're not predicting any major changes in currencies over the course of the year. So --

[Amit Bhalla:]

And then Elisha, tell us what your underlying assumption is for operating expense leverage that's implied in the guidance?

[Elisha W. Finney:]

Again, for the pre-tax margin for the year to be up about 50 basis points with roughly half of that coming from leveraging our operating expenses.

[Amit Bhalla:]

Okay. Thank you. Couple of other questions, on Novalis Tx 14 new orders in the quarter. How did that breakout between the sales reps from BrainLAB versus Varian? Who is the majority contributor here?

[Timothy E. Guertin:]

There is no way to separate those two numbers from each other. I mean, they are involved in every deal, we are involved in every deal. Sometimes we take the lead, sometimes they take the lead. I am not sure how I would ever give you a number that would properly break those two contributions apart.

[Amit Bhalla:]

Okay. And then on RapidArc, just a question on how are you managing centers if they come to you and are asking to potentially defer orders until they see the product on the market, how are you ensuring that they still have that potential to upgrade?

[Timothy E. Guertin:]

We invite them to California. We run a demonstration for them, and they say thanks very much, and that problem goes away.

[Amit Bhalla:]

I guess let me ask you it a different way. What kind of pushback are you getting since the product is not readily in?

[Timothy E. Guertin:]

No, I mean, our customers are used to new things coming out from us. They just want to talk to us. They want to see the slides. They want to know what we are doing. They want to get an intuitive understanding of what it is we are doing, and after we do that, they are fine, they get it. We have people here who are... have strong degrees and physics background. And so our physicists can sit with the physics people from our customers and they can go through the technology, and when people see what we did, and get their heads around, they realize that this is actually a very reasonable step for us to take. It is... when people first hear about it, it is a little shocking that this could be done. But the more they understand it, the more they realize that this is actually a reasonable technological step forward and that we haven't... there were no laws of nature we invented.

[Amit Bhalla:]

Well, I'd just ask... of course just a last question here on the physicists, kind of learning curve that they need to get up to be fully... do well on RapidArc.

[Timothy E. Guertin:]

Well, the biggest issue will be quality assurance and treatment planning. Delivery is I think pretty relatively straight forward for them because that will be conducted by the techs. But they need to know how to run a treatment plan using the new modules and... in Eclipse and they need to know how to verify on their machine that their machine is behaving the way it ordinarily would. This is am IMRT procedure, but it has some differences from the old IMRT procedures. So, there will be some learning that goes on there, and we are going to have to work with... in our profession there are people who specialize in working with customers on this kind of thing, and so we will be working with them. We will also produce documents and white papers that sort of show how this can be done, and we are going to have to work with our... we have our own trainers and our own trainers are going to have to be taught how to go out and show people how to do this. So far I don't... I anticipate that it's work, but nothing that we haven't seen before and we are starting to gear up for it of course now.

[Amit Bhalla:]

Okay, thanks a lot.

[Operator:]

Next question comes from the line of Mark Richter with Jefferies & Co. Please proceed.

[Mark Richter:]

Good evening guys.

[Elisha W. Finney:]

Hi Mark.

[Mark Richter:]

International oncology orders look reasonably strong, while US missed our estimates on a fairly easy year-over-year comp. I mean, can you talk about specifically what you are seeing in the competitive front in the US and then OUS, has the launch of Elekta's VMAT product in the current quarter affected new orders yet or the competitive market yet or do you think it's still too early to tell?

[Timothy E. Guertin:]

Mark, let me begin. I think the year ago comp for North America was up 19%. So it wasn't an easy comp.

[Elisha W. Finney:]

And the international was --

[Timothy E. Guertin:]

International that had the easy comp, not North America.

[Mark Richter:]

That's what I was referring to, sorry.

[Timothy E. Guertin:]

Okay, fine. In terms of competition, you are talking about Elekta --

[Elisha W. Finney:]

With their new VMAT.

[Timothy E. Guertin:]

with their new VMAT. I'd tell you, I have read the Elekta press releases, I've read what TomoTherapy has said, and I have to say one of my competitors is spending a lot of time saying it's not possible for Varian to do this without hurting treatment's quality and the other competitor is saying, hey, this works great and we've got it too. So, we are kind of in that amusing phase. However, we have a 510(k), we are running extensive tests, the things that people are announcing... our competitors are announcing now which is that they have partners who are going to help them run stuff we've doing for months, and in fact in some cases over a year. And so I think we are well down the road, we know a lot of things that they may not know here. And I am going to add we have some intellectual property here that I think is very valuable. So I think we are in a good position.

[Mark Richter:]

The US market, can you just comment on what sort of trends you are seeing maybe versus international on the competitive side?

[Timothy E. Guertin:]

Let me see how can I answer this. I can only give you some anecdotal evidence because one quarter isn't enough to know, especially since we didn't get RapidArc approval until the very end of the quarter, but I would say I have spoken to a lot of customers, they come here, they sit with us, and they ask a lot of questions and I see incredible enthusiasm on the part of those customers for what we have done. Exactly when that will manifest in an order is always hard to perfectly predict, but I would say people... I have seen a lot of excitement on the part of customers who have come to visit us and that's nice to see. That isn't same old, same old. They are seeing new stuff and they feel... they feel that this is once again radiation therapy is changing and they are glad to see that Varian is doing this kind of thing. So it's hard, I can't give you orders guidance for North America. We don't do that, but I will just anecdotally say certainly the conversations that I've had with customers have been quite warm and delightful.

[Mark Richter:]

Right. And based on our conversation with clinicians, it seems like RapidArc is a nice... is a nice advancement to Trilogy. I guess the question is why would any one order Trilogy without RapidArc and are you taking orders for Trilogy without RapidArc?

[Timothy E. Guertin:]

Yes, RapidArc of course works on both the IX and on the Trilogy. But that's your point, you are saying on the most advanced machine, why wouldn't they order RapidArc. I think you raised a good point, it's certainly a point that we going to make to them, when we talk to them, but they come into this process with budgets and we have to take those into account. So for some of these people, they will add it to the budget, they want it before they deliver for. For all of these people, they will amend their order before delivery, and for other people, they will order, there is an upgrade later on.

[Mark Richter:]

I'm sorry, the last question just is what is the timeline associated with RapidArc international... internationally for launch?

[Timothy E. Guertin:]

Well, our release data is the same for North America and for international. So we are going to release that in the spring, and we will release it all over the world at the same time.

[Elisha W. Finney:]

And we could apply for a CE mark as soon as we go into production.

[Timothy E. Guertin:]

Right.

[Mark Richter:]

Okay, perfect. Thanks guys.

[Operator:]

Your next question comes form the line of Dalton Chandler with Needham & Company. Please proceed.

[Dalton Chandler:]

Hi. First just a quick follow-up on the Novalis comments you made about. Now getting into some neuro accounts with the help of BrainLAB, of those 14 orders you took, how many were to neuro versus radiation oncology?

[Timothy E. Guertin:]

These are shades of gray, where to some extent the neurosurgeon is involved, and to some extent the radiation therapist is involved. And very often the budget actually exists in the radiation therapy department, although the neurosurgeon maybe the key driver for the decision. And frankly, we don't... so long as we get the order, we are not... we talk to both of them as tough they are equal partners in making this decision, and I... we don't have a measurement that sort of breaks it down between who is who. That being said, anecdotally, I have talked to some neurosurgeons lately, and we were just at sales meeting in Southern California where we met with neurosurgeons who made this decision, and they were very, very enthusiastic. They compared us with other technologies. One of the speakers talked about Trilogy and talked about how we could treat people faster than he has ever been able to do it before, that he had treated some particularly difficult cases that he had never been able to treat before, or he has been able to only treat with older technology. And now he is a year or two out from treating those patients because he says most... if there had been errors or imprecisions in the treatment, they would have manifested their side effects within the first year. And he said the same quality of treatment they had before and so more and more of their patients are being shifted over to the Trilogy, more and more of their neurosurgery patients. So anecdotally, I can tell you that neurosurgeons are getting more excited and that we have more reference sites now than we had even six months ago where neurosurgeons are willing to stand up and say this is really the state-of-the-art for doing this.

[Dalton Chandler:]

So then is it fair to say in the orders you have seen so far, it's anticipated that at those facilities the system would be shared between neurology and radiation oncology?

[Timothy E. Guertin:]

There is a range. Some of them... the Trilogy is almost exclusively used by the neurosurgeon. But the nice thing about Trilogy is that it can be used by a combination of the two, can be scheduled between the two. And so that's why a Trilogy is a great machine for hospitals because they get maximum revenue and they get maximum versatility out of the machine. But if you have a high patient load, there is no reason the Trilogy is less expensive than our competitors for doing radiosurgery. So, if you buy it to do specifically radiosurgery, in terms of capital cost, you are less than our competitors; in terms of quality of treatment you are equal or better than our competitors, in terms of speed you are faster than our competitors. So there is no disadvantage to buying it exclusively for radiosurgery. But if your radiosurgery volume isn't enough to sustain a machine by itself, you have the advantage that you can share it.

[Dalton Chandler:]

Okay. And then earlier there was a fair amount of discussion about your updated guidance on the bottom line, but you did have a nice increase in the top line. Could you give us a little more granularity on whether that's coming from oncology or it's coming more from X-ray and is it North America versus international?

[Elisha W. Finney:]

Well, a big piece of that is coming from our SIP business, which would be... it's goings to be approaching $100 million this year in the sales line. So based on the very strong first quarter that we had for orders in that business, that impacted the total year as well as pretty significant growth coming out of the X-ray Products segment and then I would say growth that we had that we've talked about for Oncology Systems. So that is not changing, but more of the growth now coming out of cargo screening and flat panel.

[Dalton Chandler:]

Okay. All right, thanks very much.

[Operator:]

Next question comes from line of Jason Wittes with Leerink Swann. Please proceed.

[Jason Wittes:]

Hi, thank you. Can you hear me?

[Timothy E. Guertin:]

Yes, Hey Jason. We are can hear you fine.

[Jason Wittes:]

Great, hey how are you. I guess first question, a lot of questions about RapidArc and I just wanted to clarify, I've heard the price of RapidArc is somewhere around $200,000, is that is that a fair ballpark in terms of what you are charging physicians for?

[Timothy E. Guertin:]

Our number is $400,000.

[Jason Wittes:]

400,000.

[Timothy E. Guertin:]

Yes.

[Jason Wittes:]

Okay. And I guess at least the way I have looked at it is the real advantage to RapiArc is that physicians use better competitively as opposed to increase in ASP [ph], although I might have to revise that if you are charging $400,000, not $200,000 for it. But nonetheless have you seen changes in how... in your competitive positioning against say TomoTherapy which RapidArc definitely seems to address their technology?

[Timothy E. Guertin:]

Well, I've definitely had people come to me who were considering our competitors who are now decided to go with us and talked to several people like that because they wanted to see this kind of technology on Varian machines. We had a form of volumetric modulated arc on our machines before. So when people talk about VMAT, that's something we have been offering since the mid-1990s on our machines and a certain level of capability and so they have... but they wanted a really advanced form of that in which you do a lot more careful modulation as you rotate the machine. So they are seeing that with RapidArc plus, RapidArc is a major speed breakthrough in terms of delivering that kind of treatment. And part of that is because of the clever way that this was planned. I sat down with one of our engineers the other day and had him take me through the whole secret of why so much it's so much more efficient and so much more speedy than what we have seen before and you kind of gave me a better intuitive understanding of that. So, I think it helps us against all of our competitors. I think we are ahead of our competitors in terms of doing this. I think that... and we've proven that it can be done with one arc, which is something that not everybody has been able to demonstrate at all and we have proved that it can work on fairly complicated locations, not just simple ones like prostrate, but other sites as well. So, it's anecdotally... all I can tell you is I think it's definitely helping us and I have got individual stories that show me that it helped and I have talked to radiation therapists who just can't wait.

[Jason Wittes:]

Okay, that's fair. I guess just moving on to the guidance you gave for this year. Should we assume that as this year progresses that international release sort of lead the charge or is that going to vary from quarter-to-quarter?

[Elisha W. Finney:]

It's going to vary tremendously from quarter-to-quarter. Obviously you saw the orders pattern in the first quarter, most of those international orders will not deliver for at least 12 if not 15 months out, but that bodes well for FY09 in the international market. If I look at backlog today, it's roughly 60% North America, 40% international, but you are going to have huge variations in any given quarter.

[Timothy E. Guertin:]

I described in order when I was talking earlier that was I think four machines, and you got to remember if you take four machines and multiply it by the average price of machines, these individual orders can be huge. And so, if an individual order happens in North America and one of these large orders happens in North America and doesn't happen internationally or moves two weeks out of a quarter, well then it can have a big effect. So we are... this mix between international and North America is not something you can predict on a quarterly basis, it's a much more long-term factor.

[Jason Wittes:]

Well, I guess, I just used... you implied there was fundamental changed overseas, there are more countries that you are getting more traction with, that's what I was picking up on.

[Timothy E. Guertin:]

We certainly saw that in the first quarter, absolutely in the first quarter we did, yes.

[Jason Wittes:]

Could any of that be related to RapidArc by the way?

[Timothy E. Guertin:]

We don't think so. I mean, in the sense that yes, they know we have RapidArc that created enthusiasm, but we weren't selling it anywhere. I would have to say it's actually image guidance starting to pick up internationally. I mentioned that we got to 80%... I think more than 80% on image guidance worldwide. So that's a good number because as you know, we were nearly 100% in North America. So we are starting to pick up internationally. So I would say the effect is probably more image guidance in this quarter than it is RapidArc.

[Jason Wittes:]

Okay. That's good.

[Timothy E. Guertin:]

So, RapidArc is yet to come.

[Jason Wittes:]

Another RapidArc question here and that is how long does it take to retrofit RapidArc on to a machine at this point?

[Timothy E. Guertin:]

The machine itself is pretty fast. I think we are talking about what a day... if they have to change... the biggest impacts are not going to be on the machine. The biggest impacts are on information system and treatment planning because we have to... and probably not even treatment planning that's probably pretty fast. I think it's going to be that if they, if they have to... if they haven't upgraded their information system for a long time, then they could have a major upgrade to support the information system. If they decide to switch from a competitor to us in terms of the information system because they want to implement RapidArc and may be they feel like our support for RapidArc is better, so they decide to switch, well, then... then you have the data migration problem of taking the patient data from the old system and moving it to the new system. So... and that can add time, but if you're just talking about the machine itself, this is a very rapid upgrade.

[Jason Wittes:]

But the software will take more time... more downtime to actually get installed et cetera you are saying?

[Timothy E. Guertin:]

Well, it means that it more hours and maybe it will add a day, may be it will add...

[Jason Wittes:]

So we are talking two or three days you have... you can get this installed and then from a retrofit basis... okay.

[Timothy E. Guertin:]

Yes, that's probably right. And that's heck of a lot faster than IGRT. But for example, if they didn't have IGRT and had to buy IGRT, then you would have to add the IGRT time, but we will do them in parallel so that we won't had actual time to the IGRT upgrade, we will get them both done at the same time. But so it's upgraded to go with it that will cause the thing. RapidArc per se is not the problem.

[Jason Wittes:]

Okay. Just curious for Novalis, does that benefit from any robotic codes or there is really, is that -- ?

[Timothy E. Guertin:]

We use all the same codes that other people use.

[Jason Wittes:]

Okay. Very good, thank you very much.

[Timothy E. Guertin:]

Thank you Jason.

[Operator:]

The next question comes from the line of Julie Hoggatt with Noble Financial. Please proceed.

[Julie Hoggatt:]

Hi guys, and congratulation on a good quarter.

[Timothy E. Guertin:]

Thanks Julie.

[Julie Hoggatt:]

Elisha... you're welcome. Elisha, I was wondering can you tell me why other long-term liabilities on the balance sheet increased so much from last quarter? I think they about tripled. And can you explain how that's going to affect the income statement going forward?

[Elisha W. Finney:]

If not the income statement, Julie, this is just basically a reclassification of tax reserves under FIN 48 accounting, some short-term to long-term.

[Julie Hoggatt:]

Okay. And can you quantify possibly the percentage of upgrades you're expecting from your RapidArc revenue or what you're seeing maybe in the orders that you are receiving?

[Timothy E. Guertin:]

We don't have... you are trying to... say your question again.

[Julie Hoggatt:]

I am sorry. I am trying to figure out if this is going to be... most of your revenue for RapidArc is going to be for upgrades or if it's just going to be for new machines?

[Timothy E. Guertin:]

Oh, for this year, I... we think it's going to be 90% for new machines, and about 10% for upgrades. Upgrades budgeting requires a long time to get. Now, the 10% we will get will be customers who have a lot of flexibility in their budget cycle.

[Julie Hoggatt:]

Okay. And is the $400,000 that you mentioned for the addition to a new machine, or is that the cost for the upgrade?

[Timothy E. Guertin:]

They are nearly the same number.

[Julie Hoggatt:]

Okay, okay. That's all my questions. Thank you.

[Timothy E. Guertin:]

Thank you Julie.

[Elisha W. Finney:]

Thanks, Julie.

[Operator:]

Your next question comes from the line of Junaid Husain with Soleil Securities. Please proceed.

[Junaid Husain:]

Hi guys. Good afternoon.

[Timothy E. Guertin:]

Good afternoon.

[Junaid Husain:]

Tim, regarding the Novalis Tx machine, I think you guys introduced the Tx with BrainLAB back in October after you got the 510(k) for the new collimator. So in two months time, you got 14 orders, which I guess would be a pretty quick selling cycle in my mind, is that fair to say?

[Timothy E. Guertin:]

Well, these are probably people that BrainLAB and Varian have been talking to for a while. So, it's not... it wasn't like we introduced the machine and turned on the fax machine and got the orders. These are people we've been courting for a while, but for a lot of them this was very good news. This is what they were waiting for, for us to do.

[Junaid Husain:]

Right.

[Timothy E. Guertin:]

And so it probably singed the deal for them in their minds.

[Junaid Husain:]

So, say, 15 to 20 instruments per quarter run rate, that's kind of on the high end then for 2008. Would it be less than that?

[Timothy E. Guertin:]

I am probably reluctant to give guidance on that number.

[Junaid Husain:]

Okay, sure. Fair enough. And then guys as we get close to getting RapidArc place to Centers, help me understand what else needs to get done with this product before it's ready to go live with your customers. At the ASTRO meeting you didn't have some of the bells and vessels on the software, things like automated quality assurance. So, as you... as we look to the spring launch, can you give us a feel for the remaining things on your list of things for your ready to go to market?

[Timothy E. Guertin:]

Yes. What we are doing internally is what we call V&V or verification and validation. So, the software runs, the coding is done. What our guys are doing is running tests on the machine to verify things and calculations and then verifying that there is nothing unexpected going to happen that we can't... that we have to take care of in the next two to three months. So, this is a long process for us. Usually from the time that we finish software until the time we are ready to ship a product it is going to be about three months, longer for some products, but for this product it's probably about three months. Another factor is on the treatment planning, the same thing we have... we are going through the testing process there and what we are doing is we are running through case after case after case. So we are taking cases that we would have treated with IMRT and putting them into our planning system and seeing what happens and then we will run verification tests and we will run them in the factory and so, it's just a great deal of testing, looking for issues that we might want to correct before we are ready to ship. But I think we are on track for spring.

[Junaid Husain:]

Okay that sounds fair. And then just given the data driven nature of the medical physics community, I was wondering what your strategy was to get some clinical data and scientific publications on RapidArc out there with the medical community, do your academic collaborators plan on an active publishing schedule for 2008? Could we expect to see stuff at say the AAPM or at ASTRO?

[Timothy E. Guertin:]

We are not going to have any difficulty getting people to write on this. We are... we have an advisory council now in Europe that is helping us, will be adding more people in the United States who will be working with us on this and they will try to make the paper deadlines for ASTRO and AAPM which are coming up fast, and so we have to give people early additions. The difficulty here is that we... until we release it clinically, we can't put it on somebody's machine, even if they plan to just run test because that effectively replaces the old machine with the new software and we don't want the new software even to be physically present on the machine until we have tested every permutation of its use. So it's going to be difficult for everybody to make... I think to make clinical data papers available by AAPM, but I think you will see physics papers by AAPM.

[Junaid Husain:]

Okay fair enough. And then last question maybe for Elisha, or maybe for you Tim. With regards to your X-ray Products business, you had pretty good growth in this business for the last couple of years. Help us understand how you view this business in 2008, especially if some of your CT customers for X-ray tubes are feeling their own businesses pressured and what kind of impact do you think that could have on the S-ray franchise?

[Elisha W. Finney:]

Well, in terms of the tube business, I mean... our expectation is still going to be in the mid single-digits in terms of orders and sales growth. Where we are really differentiating ourselves I think is in the flat panel business. We saw 25% growth in orders and sales in flat panels in Q1. We are gearing up with the new radiographic panels. We are getting very close to signing several contracts with very large customers for those panels. So I feel pretty confident that we can turn in and say mid teen growth for the total X-ray segment in sales for this year. So it will be just about a $300 million business for this year.

[Junaid Husain:]

Thanks, that's all I have got for you guys, thanks so much.

[Timothy E. Guertin:]

Thanks.

[Operator:]

Your final question comes from the line of Tycho Peterson with JP Morgan, please proceed.

[Tycho Peterson:]

Thanks for taking a follow-up.

[Timothy E. Guertin:]

Welcome back.

[Tycho Peterson:]

Yes, thank you. One question I had was just about the installed Linec [ph] base and the idea that RapidArc may drive an acceleration of the conversion. Can you give us a sense as to what percentage of your installed base is not Clinac iX or upgradable at this stage and do you anticipate driving an upgrade cycle with some of these old [indiscernible] that are out there with RapidArc?

[Elisha W. Finney:]

Well, I think, maybe the best way to think about it, Tycho, is there are 720 installs of IGRT out of our 5800-5900 installed base. So that would be the most sophisticated machines which is just a fraction of the total having IGR capability today.

[Timothy E. Guertin:]

We have 5,000 machines totally in our background, our installed base and you take those 700 machines, but we're putting in a lot of course every quarter and we're upgrading some old machines. But still it's... since we want IGRT to be on these machines in order to do RapidArc, I would anticipate that by the end of the year, we are probably talking about 1000 machines that are eligible for this. For machines that are more than 10 years old, I think I haven't calculated that number recently, but I recall it to be north of 1500 machines that are over 10 years old. So what we really would like to do is get those 1500 machines to start coming out and then of course several hundred machines become 10 years old every year, and so we would like to see those machines come out and if those things happen, it would get enormous boost to the replacement market for us. That's mostly in North America. Internationally as I've indicated in the past, we still don't see the replacement market being that strong. These are mostly new machines because there just aren't enough machines internationally. And so, almost every machine is a new machine rather than an old machine, replacing an old machine.

[Tycho Peterson:]

Okay, great, yes that's really helpful. Thank you.

[Timothy E. Guertin:]

Okay, thank you.

[Operator:]

We have no more audio questions at this time. I'd like to turn the call over to Mr. Spencer Sias. Please proceed.

[Spencer R. Sias:]

Thank you, thank you for participating. For those of you who may have come in late, this call has been taped and it will be available for replay on the Investor Relations page of our new website at www.varian.com/investor beginning at 4 PM Pacific Time today. You can also access a replay via telephone by calling 1-888-286-8010 from inside the US or 1-617-801-6888 from outside the US and entering confirmation code number 11826350. The telephone replay will be available beginning at 4 PM Pacific Time through 5 PM, this Friday January 25th. The replay will be archived and is available on the company website for one year. Thank you.

[Operator:]

Thank you for your participation in today's conference. This concludes our presentation. You may now disconnect and have a good day.