Varian Medical Systems Inc
Q2 2008 Earnings Call Transcript

Published: 24 Apr 2008

[Operator:]

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

[Spencer R. Sias:]

Thank you. Good afternoon and welcome to Varian Medical Systems conference call for the second quarter of fiscal year 2008. With me are Tim Guertin, President and CEO; Elisha Finney, CFO; and Tai-Yun Chen, our Corporate Controller. Tim will start this afternoon by summarizing our financial results and operational highlights for the quarter, Elisha will detail the P&L and balance sheet, and Tim will finish with the company's outlook for the third quarter and full fiscal year 2008. We will take 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 second quarter of fiscal year 2008 versus the second quarter of fiscal year 2007. 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, belief, can, could, promises, 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 risks and uncertainties that could cause actual results to differ materially. Some of the risks relating to our business are described in our quarterly earnings release and in our filings with the SEC. We assume no obligation to update or revise the forward-looking statements because of new information, future events or otherwise. And now, here is Tim.

[Timothy E. Guertin:]

Good afternoon and welcome. Today, we are reporting strong results for the second quarter of fiscal 2008 with tremendous demand for our RapidArc technology for fast, precise image-guided IMRT, double-digit order and revenue growth in our Oncology Systems and X-ray Products businesses, and solid progress in our Security business. These results have given us a more bullish outlook for revenue and earnings for the year. To summarize the financial results for the quarter compared to the year-ago quarter, net earnings per diluted share rose 22% to $0.56, operating earnings rose 19% to $103 million and revenues rose 19% to $528 million. Net orders for the quarter were $519 million, down 2% from the year-ago quarter when the company acquired ACCEL, which at that time had $68 million of orders including $47 million of backlog. Excluding the impact of ACCEL in both quarters, net orders rose 12% to $515 million. Our quarter-ending backlog including ACCEL rose 15% to $1.7 billion. Oncology Systems second quarter net orders rose 11% to $413 million with 15% growth in North America and 6% growth in the international regions. Year-to-date net order growth for Oncology Systems was 14% and for the trailing 12 months, net order growth was 12%. We generated order growth across most product lines but we enjoyed a tremendous response to our RapidArc product for faster delivery of image-guided IMRT, recording more than 60 orders for this capability since we began marketing it in January. This represents the strongest demand for any new Oncology product in our history and it reflects the need for faster, more user friendly and cost-efficient systems that enable clinics to offer advanced radiotherapy to more of their patients. From what we have seen so far, RapidArc promises to be another formidable weapon in the fight against cancer. A broad variety of customers are showing interest in RapidArc. We saw customers adding into their existing orders, ordering it on new machines and ordering upgrades for existing machines that are already equipped with our On-Board Imager. As might be expected, most of the RapidArc orders came from the US where early adopters are concentrated but we also received many orders from leading centers in Europe and Asia. Clinicians everywhere are fairly excited about the potential of this new technology. The faster treatment speed is simply amazing and the potential benefits are many. To clinicians, it means that they should be able to treat many more patients in a day while also potentially reducing the cost for treatment at a time when most healthcare costs are continuously rising. For public healthcare systems, it means they should be able to help more patients and reduce the critical waiting time for treatments. Shorter treatment times also mean that doctors should be able to improve patient comfort and reduce the chance of unwanted motion during dose delivery. This could make it possible to deliver higher doses to the tumor, which studies have shown can be more effective in eradicating cancer. Let me take a moment to address questions that we have received about the safety and treatment quality of this new technology. Preclinical validation worked by clinicians on our RapidArc counts [ph] and others shows that RapidArc treatments are generally... treatment plans are generally equivalent or superior to plans using slower conventional IMRT methods, including helical TomoTherapy. Furthermore, they have shown that treatments can be planned, checked, and delivered safely and routinely. We expect to begin our first RapidArc treatments... shipments by the end of the month. After a brief period of installation and commissioning, treatment programs will be ramping up very quickly. As a reminder, RapidArc is not a standalone specialty product that is limited to one type of treatment. It is a powerful complement to the many treatment capabilities that already exist on Varian's Clinac and Trilogy accelerators. While RapidArc will be great for sites such as prostate and head and neck, other techniques are necessary for many types of cancer and the ability to offer all of these techniques on a single machine is very important. For example, the gold standard for breast cancer treatment is using the stationery beams rather than arcs to avoid hitting the patient's hearts and lungs. This is not an option on some devices, which are limited exclusively to delivering arc therapy. This is just one of many examples where specialty machines limit the treatment options for the clinic and the patient. Clinicians want versatile systems that allow them to choose the method or technique they believe is the optimal treatment for each and every one of their patients. Versatility, like speed, is critical for enhancing the quality and affordability of care. In that vein, we are seeing solid growth in our other oncology products. Unit order volumes for our high-energy accelerators and our OB On-Board Imager were up versus the year-ago period, better than 75% of the high-energy accelerator orders included in OB, and orders for OB upgrades on existing machines also increased over the year-ago quarter’s total, excuse me. The rate of OB installations has increased. As of the end of the quarter, we had completed more than 830 installations of OB units, putting us far ahead of the competition in the deployment of image-guided IMRT. At this rate, I expect we will have more than 1,000 machines equipped with image guidance capability before the end of this fiscal year. We continued to achieve wins in the radio surgery portion of the market during the quarter with year-over-year orders growth for the Varian BrainLAB Novalis Tx product suite and our Trilogy units. We also generated 40% order growth in our brachytherapy business, which has now had two consecutive quarters with solid growth in net orders. Our service and software businesses also contributed to the order growth for Oncology Systems. Given recent reports from other medical device companies, you undoubtedly want to hear me talk about the economic conditions we are experiencing in our oncology market. We've been repeatedly asked whether hospital capital spending budgets are drying up and whether we will be affected by it. We are not seeing signs of tightened spending in hospitals or freestanding clinics. In fact we believe that the Economic Recovery Act in the US may be helping to stimulate some business. Radiotherapy continues to be a profit center and it's a high priority in capital spending budgets. Credit for new purchases appears to be readily available. Also, we are selling treatment machines. No one receives radiotherapy who does not need it. Cancer must be treated and radiotherapy products, particularly new products that enhance the quality and cost effectiveness of care, will always be needed. These factors and our experience during the second quarter give us reason for optimism. Focusing now on X-ray Products, we had another good quarter in revenue driven by... excuse me, a good order and revenue quarter driven by continuing expansion in our business in flat-panel detectors for filmless X-ray imaging. Net orders for X-ray Products rose a remarkable 23% to $83 million including a 10% increase in X-ray tube orders and a more than 50% increase in flat-panel orders. The quarter included a multi-million dollar order for panels from an X-ray equipment manufacturer in China. We are now shipping samples of our new radiographic panel to customers and we hope to initiate volume shipments in this product toward the end of the fiscal year. We expect this to become an important growth driver for the X-ray Product business next fiscal year. The second quarter growth in orders and revenues from both tubes and flat panels as well as the ongoing customer interest in the development of filmless X-ray imaging equipment give us a very positive outlook for this market. In our other category, the second quarter was impacted by our acquisition of ACCEL in the year-ago quarter. Compared to the second quarter of last fiscal year, combined second quarter net orders for ACCEL and our Security and Inspection Products businesses were down by $66 million or 75%. We are continuing to work on development of our ACCEL proton product line and customer interest remains high. We are optimistic that the long-term prospects for this business are solid. Net orders for our Security business were down slightly principally due to order timing. Meanwhile orders totals for the first half were up by more than 60% versus the year-ago period. Our Security business has now moved into its new manufacturing plant in Las Vegas and we are ramping up production there. Customer interest in our broader Security products remains high as nations including the US move to enhance our security. Now I'll turn this over to Elisha for a review of the numbers and then come back to you with our outlook for the third quarter and fiscal year 2008.

[Elisha W. Finney:]

Thanks, Tim, and hello, everyone. As usual, I will walk you through the income statement as well as cover a few balance sheet items. And as a reminder, we will only be comparing quarter-over-quarter results on a GAAP basis. These comparisons include the impact of option expensing and the acquisition of ACCEL Instruments in the year-ago quarter. Second quarter revenues are $528 million, increased 19% in US dollars. Oncology Systems posted an increase of 17%, X-ray Products posted a gain of 14% and revenues from businesses under the Other category increased by $13 million or 69%. In local currency, total company revenues increased 15% from the year-ago quarter. The second quarter gross margin for the company decreased by almost two points to 40%. Oncology Systems gross margin fell by 136 basis points to 41.7% due primarily to a significant shift in revenues to lower-margin international regions and losses from currency hedging contracts. X-ray Products gross margin declined by about five points to 36.3%. This was due principally to a decline in flat-panel margins from an unsustainable record level achieved in the year-ago quarter. Rising material cost for our X-ray tubes and panels also contributed to this decline. Second quarter SG&A expenses were $76 million or 14% of revenues, an improvement of 1.5 points from the year-ago quarter and R&D expenses were $32 million or 6% of revenues even with the year-ago period as a percentage of revenues. Moving down the income statement, second quarter operating earnings were $103 million or 19.5% of revenues, even with the year-ago quarter as a percentage of revenues. Our Oncology Systems and X-ray Products businesses together contributed $118 million in operating earnings, while our Other category and corporate consumed a net $15 million. Depreciation and amortization totaled $9 million for the second quarter. Net interest income was $1.5 million for the quarter. The effective tax rate was up by almost one point to 32% and we believe for the full year that the tax rate will be between 32% and 32.5% with a lower rate in Q3 and a higher rate in Q4. Compared to the year-ago quarter, diluted shares outstanding dropped by 4 million shares to 128 million due primarily to the share repurchase program. Diluted EPS was $0.56, an increase of 22% above the year-ago quarter. Now turning to the balance sheet, we ended the quarter with cash and cash equivalents of $360 million, $122 million of combined long and short-term debt and stockholders equity of $908 million. DSO for the quarter was 90, up five days from the year-ago quarter. Second quarter cash flow from operations was $55 million. The primary source of cash was from net earnings. Primary uses of cash were $73 million for the stock repurchase program and $22 million of capital expenditures, which included the expansion of our SIP facility in Las Vegas. During the quarter, we spent $73 million to repurchase 1.5 million shares under a $12 million share repurchase authorization that extends through the end of this calendar year. Now I'll turn it back over to Tim for the outlook.

[Timothy E. Guertin:]

Thanks, Elisha. Given the strong results from the second quarter and positive outlook in all of the major markets that we serve, we now believe that revenues for fiscal year 2008 could grow by 15% to 16% over fiscal year 2007 and that net earnings per diluted share for the fiscal year could be $2.09 to $2.11. For the third quarter of this fiscal year, we believe that revenues could grow in the mid-teens versus the year-ago quarter and that net earnings per diluted share could be $0.45 to $0.47. All in all, Varian customers around the globe are moving forward with their plans to protect and save lives using our technology and products. We will now take your questions. Question and Answer

[Operator:]

[Operator Instructions]. Your first question comes from line of Jason Wittes of Leerink Swann. Please proceed.

[Jason Wittes:]

Hi, thank you very much. First, I want to start with the obvious, that is capital equipment expenditures, maybe save the trouble of getting more questions on this, that is... I mean, one of your competitors did say they also did not see any impact from cap expenditure financing but they did not dismiss the fact that maybe later on in the year, they might. What is your outlook on that in terms of the customers you have been talking to and your feeling in terms of whether or not that may just trouble as the year progresses?

[Timothy E. Guertin:]

We have talked to people and we're just not picking up any evidence that that's happening for us.

[Jason Wittes:]

Okay. Fair enough.

[Timothy E. Guertin:]

And maybe in other products... other business lines, it is but we are not picking it up.

[Jason Wittes:]

Okay. And would the same go for X-ray and for Security because the Security business, I guess your order rates were down a little bit this quarter, any thoughts there?

[Timothy E. Guertin:]

Yes... no, we are not picking up any problem in those areas either I will say in the Security business, this is a business where orders come in large lumps and we had a large lump in just [inaudible].

[Elisha W. Finney:]

Yes, for the half, Jason, the Security Products is up over 60% in orders. So, it looks good.

[Jason Wittes:]

Okay. Now looking at the order overseas, you had a tough comp but the order rates came in a little lighter than we expected. Could you give us a little more color in terms of how Asia looked and how Europe looked and if there was any things that we should be looking for there?

[Timothy E. Guertin:]

Yes, the orders for Europe were up about 4% for Oncology, I assume is what you mean, Jason.

[Jason Wittes:]

Yes, I do. Thank you.

[Timothy E. Guertin:]

Oncology orders were up about 4% in quarter two versus 13% in the year-ago quarter. Asia… excuse me, The Far East was up like 97%, it was a huge increase over the year-ago quarter. The Rest of the World was down quite a bit. And that's just because we include Australia in the Rest of the World for us, and Australia had an extremely strong year last year and the year before and we didn't expect that to repeat. We knew sooner or later that it would have an impact and this was the quarter in which it had that impact. So Europe, I think, Europe tends to be a major factor in this and it was up 4% but we don't see any issues in Europe going forward. And so we are not --.

[Elisha W. Finney:]

Jason, I would also just call your attention to the trailing 12 months, which I think is more reflective of what's really going on in any particular region because, like Tim said, you are going to get extreme lumpiness from quarter-to-quarter. But if you look at the trailing 12 months, US is up 9%; international, up 16%. So we got back into double-digit order growth on the trailing basis.

[Jason Wittes:]

Okay. Fair enough. Just quickly on RapidArc, 60 orders is pretty impressive and it sounds to me like you think that we're still somewhat in the early innings here. Do you… should we expect sequentially every quarter you see an increase in this number in terms of going from 60 to say 100, 200, etcetera or how should we think about the pickup of RapidArc at this point?

[Timothy E. Guertin:]

Usually, I mean there was always the opportunity for some kind of a pent-up event in the beginning. We've been talking about this to some extent and not taking orders for six months before we were... before we had 510(k). So I'm not going to... I can’t… and I can't predict what we're going to see in quarter three and quarter four. Over time I expect this number to rise considerably, but –

[Jason Wittes:]

There was a bolus effect, I guess, you're saying in this quarter?

[Timothy E. Guertin:]

Yes, there could be a bolus effect. I'm not saying that there is but when the market knows that you're going to do something and they build up interest for it, and you can get an initial bolus and then you get your standard market, but over time, I expect that RapidArc is... people get a look at the results that other people are getting… looking at RapidArc, they are going to get excited and they are going to want it for themselves. So I expect it will build but I'm not predicting what it will do in quarter three.

[Jason Wittes:]

Okay. And just quickly on that as well, are most of these upgrades or are some of these also de novo orders?

[Elisha W. Finney:]

It's kind of across the board, Jason. So it's on machines already in backlog, it's on new machine orders as well as upgrades. If I had to take a swag, I would say upgrades were about 20%... 15% to 20% of the total.

[Timothy E. Guertin:]

Actually I have the number.

[Jason Wittes:]

Okay.

[Timothy E. Guertin:]

It’s… upgrades was 10% of the impact, so --.

[Jason Wittes:]

And the rest was de novo?

[Timothy E. Guertin:]

And the rest was either orders that were backlog or new machines.

[Jason Wittes:]

And just one last thing on this and I'll jump back in queue. How long… if you just did an upgrade, how long would it take you to actually get that delivered? Is that a relatively quick turnaround or is that still a 9 to 12-month waiting period?

[Timothy E. Guertin:]

No. How long would it take us to get delivered?

[Jason Wittes:]

For an upgrade.

[Timothy E. Guertin:]

We probably know almost everybody, we are going to be upgrading for the next three, four months because they probably already ordered, that doesn't mean that we will be flexible. I think when we get through the next couple of months and we get our learning curve down, then the time period will be like three months.

[Elisha W. Finney:]

Yeah. But understand there are some prerequisites that the customer has to have in terms of what imaging device, collimator device, etcetera. So depending on if they already have all of that and if they don’t can really change the amount of time.

[Jason Wittes:]

Great, thank you.

[Timothy E. Guertin:]

Thanks, Jason.

[Operator:]

Your next question comes from the line of Amit Hazan of Oppenheimer. Please proceed.

[Amit Hazan:]

Thanks. Hi, good afternoon, guys.

[Timothy E. Guertin:]

Hi, Amit, how are you?

[Amit Hazan:]

Good. Maybe just starting with your guidance, I’m hoping to get a little bit of clarity. It looks like with the beat that you had this quarter, you raised by… you raised your earlier EPS guidance by a little bit less than what you beat by and if I'm not mistaken, at least you remind us that it looks like the tax rate that you're guiding to is maybe just slightly less than what it was guided to last quarter. Maybe help us out in understanding if we're losing any margin along the way here or what's going on between the guidance in this quarter?

[Elisha W. Finney:]

Yes, Amit, you are right that the tax rate is slightly lower than what we had thought it was going to be for the year but understand, some of that was already reflected in the second quarter. So of that call it $0.05, some of that is already reflected in the tax rate. If you look at the full year, you are still going to see a slight increase in the operating margin percentage. What we're seeing is some toggling between gross margin and between the leveraging of the SG&A as the FX impacts are helping us on the top line, but as you know, we have hedged those contracts at the year-ago period, we lost in the gross profit dollars, so the gross margin percentage is coming down. So versus what we had first thought, you're going to see a little bit of variability between how much of this comes from margin versus leverage, I suspect most of it now is going to come from leveraging our operating expenses that you are still going to see a pre-tax margin in the 19% to 19.5% range which is kind of in line with what we had previously talked about.

[Amit Hazan:]

Okay, that's helpful. And then just a couple sets of questions on RapidArc, following up. First of all, I'm just wondering, first of all, how long it's taking these customers to evaluate the product right now and what do you think if that's the right thing to think about going forward? And then I am most interested in your new orders, your new unit, your new system orders and how many RapidArcs were ordered on those and I'm wondering if you can give us some color on how it is for you from a competitive standpoint now an ability to offer that. I mean, you're feeling like you're gaining share with those. Are you able… are you winning deals that you may otherwise not have or focusing on the new orders side of it, maybe give us some color on that?

[Timothy E. Guertin:]

Okay. So, there is a lot of questions in there. If I miss some of them, you will have to remind me. But on deals for new machines, about 60% of the orders we got for RapidArc were on new machine orders. So some people went back and upgraded their backlog, etcetera. In terms of how long it takes people to evaluate it, because we don't... we're just now shipping clinically… well, we will be shipping clinically by the end of the month, the Clinical Systems, what people have been doing to evaluate is they've either been visiting a member of the RapidArc Council who had seen it and some of whom had actual working prototypes and were able to run it, or they come to Palo Alto and we would run it on our machines here, we demonstrate the system. That was about a one-hour discussion. They see it, they look at the plan. Sometimes they bring their own plans and run the cases and then we take one out and run it on the machine so they could see it run and get a feeling for it. So it's not a long and complicated argument, it's about... it's not an argument at all. It's about a one-hour demonstration of the capabilities and then people are… people get it, it’s not hard for them to get. What was the third part of your question again?

[Amit Hazan:]

Well, I don't even remember. I think...

[Timothy E. Guertin:]

Okay. You're making me feel better.

[Amit Hazan:]

I think it's just in terms of the new unit that you had ordered this quarter, and if you can give us some color, if you feel those are deals you would have won anyway, or if this has changed the competitive dynamics on the ground for your at all?

[Timothy E. Guertin:]

Well, you kind of have to ask our competitors if it’s affected the dynamic and of course, I'm pretty sure, I know what their answer will be. But, if we take more than 60 orders, it certainly has had an affect. Clearly our competitors are concerned about RapidArc, they are all reacting to it, but I have to say, our mission is to fight cancer and we consider this an important advance in that battle, and so the only people we're... the people who are really interested in their opinion are the investigators and the customers who are going to use this clinically and are going to do the research for us and they're going to be the final judges. But, so far based upon what we've been told, what comments people have made, they regard what we have done here is important, they regard it superior to other choices that they have seen, they think it's a very compelling technology and they think it's going to be formidable.

[Amit Hazan:]

Okay. And just one follow-up on RapidArc would be just as it starts to the P&L next quarter, I'm wondering if you can give us a sense of what the ASP we should be thinking of is for these upgrades that are going to hit the revenue line first? And then, at least if there is… I mean, we are imagining that this is going to be mostly gross margin improvement, but give us a sense of how this might flow through or it’s exceedingly going to be really an impact in the early quarters?

[Timothy E. Guertin:]

I think we have indicated that the list price is around 400 which you have to remember includes a lot of elements to enable customers to implement it. We are obviously for competitive reasons love [ph] to reveal what our actual achieved pricing will be, but I will say that we did okay.

[Elisha W. Finney:]

And Amit, in terms of how it's going to flow through the P&L, it is software, so we recognized on acceptance. And understand most of this is an FY09 revenue of that. So as we talked about, about 90% of these orders came through on either machines already in backlog or on new systems, which implies that many of these will be delivered in fiscal year '09. So we have built in some estimates of what we believe RapidArc will do in terms of sales for this fiscal year, but it’s primarily an '09 revenue story.

[Amit Hazan:]

Okay. And then just one final one from me, just pushing you a little bit on the OUS orders, we saw Elekta, I guess your biggest competitor, their orders were pretty soft in Europe as well, really soft in their last reported quarter, in fact… actually in the last six months, I'm just wondering in Europe if you're seeing anything particular, any kind of a lull before people start ordering RapidArc or if there is anything you can point to that might be kind of a broader slowdown that at some point may either pickup or anything you can help us to give an idea what's going on there?

[Timothy E. Guertin:]

Well, first, I would remind you that in Europe, year-to-date we’re up 15%. So, we are not year-to-date seeing a softness. Yes, in quarter two, it was 4% but as you know, international territories are lumpy. So I wouldn't draw conclusions based upon quarter two, I would look at the more of the year-to-date numbers. Obviously international territories go up and down and this is why we tend to talk about the US as one territory and we tend to give you the entire international market although we do give you a color on it. The fact is that individual companies move all over the countries, move all over the place from quarter-to-quarter and year-to-year and so it's a little hard to predict. But I'm not… we are not unsatisfied with our prospects in Europe and will... we hope that as we… as the leaders there adopt RapidArc and other things that it will be a stimulus to additional business.

[Amit Hazan:]

Okay, fair enough guys, thanks very much.

[Timothy E. Guertin:]

Thank you.

[Operator:]

The next question comes from... your next question comes from the line of Amit Bhalla of Citi. Please proceed.

[Amit Bhalla:]

Hi, thanks for taking the question. I just wanted to start first with Elisha. Can you give us what the constant currency growth rate was in orders in Oncology and give us a color, or give us some split, US, OUS of those 60 RapidArc orders?

[Elisha W. Finney:]

Okay, I'll give you the first part, we are not going to break out the second part. So it came from, as we talked about in the script, mostly... RapidArc came mostly from the US where you have the concentration of early adaptors but we did see significant orders coming out of Europe and Asia as well, but it was concentrated in the US. In terms of the constant currency, if you look at Q2 orders for just Oncology, instead of 6% international growth in US dollars, it was zero in local currency and then again 15% in North America and if you look at it for the first half, instead of 17% growth in dollars, Oncology achieved 9% in constant currency.

[Amit Bhalla:]

Okay, thanks. And just on RapidArc, is there anything that kind of precludes you from performing second arcs to treat cancer patients, anything maybe on the patent side or on the software side that would keep the technology from doing treatments with two arcs? And I have one other follow-up.

[Timothy E. Guertin:]

I guess in terms of second arc, I know some people have claimed rights there. We don't think we are prohibited from... the way we are doing it we think we are fine and… but frankly, we have been able to do what we wanted to do with a single arc and so we are not sure why we want to do that.

[Amit Bhalla:]

Okay and just... I did one other additional question on just capital spending, I guess, if we were to back out the RapidArc orders in the fiscal second quarter for Oncology, where would we be in order growth or if you wanted to answer in different way, could you also talk to us about what’s order growth for just the linear accelerator business?

[Timothy E. Guertin:]

Yes, we don't... Amit, we don't break them apart that way. As far as we're concerned, advances in technology count and they need to be included, it’s just... if we had a new feature... I mean we're talking about RapidArc because we think it's important but we had new features all the time and we think it's proper to include them in orders and so we don't break it out and once again if I start giving you numbers, you're going to divide by units and you're going to get price and I just don't want to give away pricing information to competitors. So I can't help you.

[Amit Bhalla:]

Okay. Just normally finish off with Novalis and Novalis, 14 orders last quarter, was it directionally up or down this quarter? Thanks for taking the questions.

[Timothy E. Guertin:]

Novalis plus Trilogy, it’s hard for us to know sometimes because customers order… some customers order Trilogy and some of them order Novalis, but the sum of the two is up.

[Amit Bhalla:]

What was the sum of the two then last quarter in units?

[Timothy E. Guertin:]

In the year-ago number?

[Amit Bhalla:]

And quarter ago.

[Timothy E. Guertin:]

Last quarter. Oh, well, I'm talking about year-over-year. I mean quarter one was unusually strong because we just introduced the product. So I don't know that comparison off the top of my head.

[Amit Bhalla:]

And I'll follow up offline. Thanks.

[Timothy E. Guertin:]

Okay.

[Operator:]

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

[Junaid Husain:]

Good afternoon, guys.

[Elisha W. Finney:]

Hi.

[Timothy E. Guertin:]

Good afternoon.

[Junaid Husain:]

Just given a lot of noise in the radiation oncology space relative to one of your competitors with regards to multi-unit orders and the timing of these orders from a revenue recognition perspective, I suspect that you guys over the years have always had to deal with multi-unit orders. Could you tell us what percentage of your backlog represents these multi-unit orders? And then as you look out to 2008, if you have noticed any pushback from hospitals on the receiving end of these multiple systems?

[Elisha W. Finney:]

Oh, boy! I don't have an exact figure for you, Junaid. I would say that it's more likely to come from either international deals, which tend to be large, bulk government buys and international represents on average about 50% of our total and then probably the freestanding centers in the US would be more likely to come in and order bulk units as they’re filling up multiple sites that they are addressing. In terms of on the revenue side, I mean, yes, we tend to get orders that come in bulk but clearly we know that they are not all going to install at the same time. You have to move these things through elevator shaft and you're only going to do that serially, not at the same time. So it's just a matter of keeping up with the customer’s construction schedules and where they are at on room readiness and planning accordingly.

[Timothy E. Guertin:]

What is your… maybe rephrase your question a little bit, specifically, what is it you’re worried about?

[Junaid Husain:]

Well, I'm just wondering if you're seeing any pushback from the hospitals. And so they use the... will take the first system and then will take the next system a couple of months later as kind of their rationale for spacing out just in the event that they are having any credit issues.

[Timothy E. Guertin:]

I see [ph] what you're saying. No. No, we haven't seen that.

[Junaid Husain:]

Okay. That's helpful. And then with regards to the RapidArc orders that you have booked to date, could you give us a sense for the hospitals that are placing the orders? Is it coming from the large academic medical institutions or is it the for-profit freestanding centers, whatever metrics you can provide to help us understand the caliber of institution that's placing RapidArc would be helpful?

[Timothy E. Guertin:]

I guess, I'm going to have to say that it's coming from the whole universe of institutions. We are seeing all types of institutions. Certainly, we are seeing academic interest but we're also seeing interest by people who do therapy everyday. There are obviously... there is a certain group of customers who are... who like new technology, who want to be first and who want to do it first. But what you have to remember is that a lot of the people who work at these... and you would think that would be academic institutions. But the fact is that a lot of people who work at these other institutions got their training at academic institutions and they are often academically very talented and skilled people. So even though they operate in a local clinic, they may see this early adoption as something they want to do. So you've seen MIMA come in, I don't know if you've heard presentations by them in Florida, they are an example of an institution that has a lot of capability to take on new technologies and so they are an example of what we are talking about. So we see the mix across the way. I will say that among the non-academic institutions, people who had a heavy patient load were especially interested.

[Junaid Husain:]

Okay, that's helpful. And then, Tim, relative to how you see RapidArc growing out over the next few months, are you still of the opinion that the easy money, the low-hanging fruit, if you will, represents instruments that are currently in backlog versus upgrades of the installed base?

[Timothy E. Guertin:]

Yes, it would be tempting to think that but in fact we've... certainly in the first quarter, most of the interest was new people who were placing orders for new machines. I think in the early stages, that's the way it’s going to be. Upgrades to both backlog and upgrades to installed machines historically happens second because they have to go back and get the budget to do that and that they have to go back to administration and they have to have the conversation, administration once evidenced. So if you are an early adopter type, then you're used to providing that evidence, you have that kind of relationship with your administration. So we tend to see that, but for everybody else, it's... if they are looking at buying 2 million and now they want to buy 2.4 million, that's an easier argument to have with administration, something new has happened and so we want to add this capability and that’s an easier discussion to have with your administration than for people who want to get upgrades.

[Junaid Husain:]

Okay. Fair enough. And then Elisha, just a couple of quick numbers if I could. Are you giving out an updated Trilogy number of the installed base and then the number of Trilogies that were ordered in the quarter?

[Elisha W. Finney:]

No, we do not.

[Timothy E. Guertin:]

No, we've... we talked about… I guess, we've done that in the past, but we have decided that we are... that's a number we want to... for our… once again for competitive reasons keep to ourselves.

[Junaid Husain:]

Could you give us the… an updated installed base number, total installed base, total [inaudible]?

[Elisha W. Finney:]

I don't have an exact number, it's around 5,000.

[Junaid Husain:]

Okay. That's fine.

[Timothy E. Guertin:]

For the total?

[Elisha W. Finney:]

For the total.

[Junaid Husain:]

And then lastly relative to your competition, the folks that TomoTherapy put out an interesting press release about a month ago, the TomoTherapy Treatment Quality Challenge. I was wondering what your thoughts on this... what are your thoughts on this relative to your confidence level in RapidArc head-to-head with the pilot system?

[Timothy E. Guertin:]

Well, clearly, they are concerned about RapidArc. They see it as something that is threatening or else they wouldn’t have done this. But we don't... this is just not the kind of thing that we do and we don't... as I indicated, I think on an earlier questionnaire, our goal here is to fight cancer and we've calculated... we have done enough dose plans to know in our testing that this is an important improvement for our users and so we are going to it field it and a lot of our users have indicated that they think RapidArc is well enough, is good enough and fast enough and easy enough for them to use that this will be a preferred solution for them in the future. As to what impact they will have on competitors or what their thoughts might be, that's an issue for them.

[Junaid Husain:]

Great. Thanks so much, guys. That's all we have.

[Timothy E. Guertin:]

Thank you.

[Operator:]

Your next question comes from the line of Jeff Rodi [ph] of Figal Bryan [ph]. Please proceed.

[Unidentified Analyst:]

Hi, guys. Congratulations on a good quarter.

[Elisha W. Finney:]

Hi, Jeff [ph].

[Unidentified Analyst:]

I was curious trying to understand just a little bit more about what the average size of Security order looks like.

[Timothy E. Guertin:]

Oh, boy! Let me think. They range... you got to remember that the order to the end customer includes a facility. So the... so if it's a government that’s buying it, the order is in the millions. But our piece may be relatively small. It may range from a couple hundred thousand dollars up to $1 million depending upon what level of capability. So I would have to say small systems, small machines are in the couple hundred thousand range. And I should add this thought. This is one of the reasons why we were interested in BIR, because we realized that we were just selling linear accelerators and a lot of our customers wanted really good imaging systems. And so by adding those imaging systems, we were able to increase our share of the overall end unit business. And so, that's why we had some strong orders associated with the IntellX. This is a product that came to us with BIR that actually enables us to scan drugs. And so the IntellX adds a substantial amount of volume. So we will see that play out over time, that's still a relatively new thing for us. But I expect that it will be a source of growth. I think, BIR by itself would have had a certain degree of success. But the combination of BIR with Varian will be much more successful than either company would have been on its own.

[Unidentified Analyst:]

Hello.

[Elisha W. Finney:]

Did we lose you, Jeff [ph]?

[Timothy E. Guertin:]

Are we still connected, Operator?

[Operator:]

Yes, he is not.

[Timothy E. Guertin:]

Okay.

[Operator:]

Your next question comes from the line of Tycho Peterson of JPMorgan. Please proceed.

[Tycho Peterson:]

Good afternoon.

[Timothy E. Guertin:]

Hi, Tycho.

[Tycho Peterson:]

I appreciate the color you guys provided on the hospital spending. I am just curious, I know it's an early developing business for you. But does this change your outlook on proton at all given that that's where you are going to need new facility build out to happen? You talked obviously about this being a longer-term contributor. But --?

[Timothy E. Guertin:]

Well, it's reassuring that we're not seeing this effect. But protons are such a gigantic expenditure compared to a linear accelerator. A linear accelerator, if the room is $0.5 million, $0.75 million and the machine is in the $2 million or more range, well, then that total transaction is in the $2.5 million to $3.5 million range. A proton facility for four rooms including construction of the facility is in the $110 million, $120 million range. So it's an entirely different thing. So what they do is if you have to view it not as normal capital equipment for a hospital, they make it as a strategic decision and it's like laying in huge infrastructure for the future as though they were buying a power plant, for example. And so they view it that way and they get their capital in different... it's not like a normal capital budget. It's a special item that they build up to for years. They usually get special people to help them arrange the financing. It's much more complicated and that's why the transactions last for a long time.

[Tycho Peterson:]

I guess that was the heart of my question and given that you're getting specked in earlier in the process there, what are you seeing further down the road then?

[Timothy E. Guertin:]

So far all the people that we're talking to, their projects are still on.

[Tycho Peterson:]

Okay.

[Timothy E. Guertin:]

So nobody has come to us and said we can't get the money. Everybody is still active.

[Tycho Peterson:]

Okay. On the RapidArc, again appreciate the color there, with regards to the retrofits given some of the challenges you had in the past on IGRT, can you give us a sense as to how we should think about downtime? And I appreciate it's kind of the second wave of adoption that will be retrofitting their older systems and then also to what extent you think you can convert some of the older linear accelerators that are out there in the field?

[Timothy E. Guertin:]

If they have an OB, as we have indicated, we're right now, we feel that we want to put this on machines that have the latest image guidance for the simple reason that this is an ultra-conformal technique and these outcomes are being compared to other ways of doing outcome, other ways of doing Arc IMRT. All Arc IMRT systems... or other Arc IMRT systems use image guidance and we think image guidance needs to be done on these systems to make sure conformality is maintained. So assuming they have an On-Board Imager on the machine, if I address the question of how long it takes to put in, right now, we've run some experiment jobs, just tell you a story; we recently put one of these things on a machine that had IGRT, we started Friday night, we put it on the machine and because it was not FDA approved, we had to take it off by Monday morning and we got it on and took it off by Monday morning and ran test site. So that's reassuring that it can be done. However, I will admit that when we do this, there's no shortage of talent available on that side to make sure that that happens. So I don't expect that every time I expect that. But I would expect that within six months, we will certainly get the times down. And I will also indicate that, we can put this on machines that are many years old. So I expect that the upgrade opportunities are significant and providing, they have an OB, I think this will be a relatively short upgrade. Now, following our physical upgrade, the customer does have to commission. And there, what we have done is we have gone out and found a number of institutions who are willing to help customers go rapidly through their commissioning process and they’re… we are... they're not going to do that through us, they’re going to offer it directly to customers. It's not going to be in our price book to do that but we're going to introduce them. If customers want help doing commissioning, we're introducing to people because what we want to do is get the largest number of people able to use this clinically as we can over the course of the next six months, that's the way we get maximum impact on cancer outcomes and for patients.

[Tycho Peterson:]

Okay. That's helpful. And then finally, Elisha, you had talked about higher material cost for the X-ray business. Are you passing those on to your customers or --?

[Elisha W. Finney:]

We try but as you know our largest customers were actually entering into annual and sometimes multi-year contracts that do have some pricing step-ups in it, but it's hard to match that up exactly. I know that X-ray probably found it a little shocking when we talked about 5 points gross margin in a quarter, but if I bring you back to the year and versus where they were two years ago, X-ray has really brought their margin levels up by virtue of the flat-panel technology. So I looked back for fiscal year '06, they were in the mid-30, they were at about 35%. And for this year, they’re going to be in the 38% to 39% gross margin level. So we really have taken those levels up by virtue of these panel products.

[Timothy E. Guertin:]

Yes. I'll just add that. And clearly, we buy materials all over the world and the euro has affected the cost of certain materials for us, competition from other nations for scarce materials has gone up and has driven up the price of certain rare metals and all of… and we use a lot of rare metals in our X-ray tubes. And so that has impacted our cost. So all the... this factory, if I could say that they have one… they have many core skills. But, one of their core skills is that they systematically work to get to control their cost because they know, they expect that the cost of commodities are going to go up and so they constantly work at improving their processes, improving the way they do things. That’s why we invest in capital equipment for tubes is because we know we have to attack this problem. So some quarters, we get... we'll introduce a change and we get a cost reduction and materials didn't go up that much in that quarter. So we get a big benefit for X-ray tubes. In other quarters, we see the costs go up but the results of our cost reduction efforts in other places didn't hit and so that's why you see this number jump around. But overall, I'm very proud of their ability to keep on top of cost.

[Elisha W. Finney:]

And I would just add in the year-ago quarter, we shipped some, if my memory serves me correct, some beta panels at extremely high pricing and that was just unsustainable. So most of the impact was just given that we are now in production volumes as opposed to those beta volumes.

[Timothy E. Guertin:]

Right.

[Tycho Peterson:]

Okay. Thank you very much.

[Operator:]

Your final question comes from the line of Gill Alexander [ph] of Darfield Associates [ph]. Please proceed.

[Unidentified Analyst:]

Good afternoon. Nice quarter.

[Timothy E. Guertin:]

Hi, Gill [ph].

[Elisha W. Finney:]

Hi, Gill [ph].

[Unidentified Analyst:]

A question, could you maybe update us on using your machine on treating breast cancer now, and what still has to be done?

[Timothy E. Guertin:]

Well, we treat breast cancer regularly with our machines. Breast cancer… since the... if you look at the way breast cancer is done, what you want to try and do is treat the breast itself and you want to try to minimize the amount of dose you give to lung wall and to heart because the lung and the heart are very sensitive to dose. And so generally breast cancer is treated with tangents where you come in tangent to the chest wall and try to minimize dose that way and you also want to minimize dose to the opposite breast because stray dose could cause secondary cancers in 20 to 30 years and we want to avoid that. And the purpose of breast... the ordinary procedure for breast cancer is you remove the lump, you remove the area of tumor and then you treat the breast prophylactically. Now having said that, there is interest in some quarters in taking a certain subset of patients and only treating the area immediately around the [inaudible] wound. There is some thought that certain patients would qualify and that they are going to get the same outcome. Frankly, no one... I mean although there is cosmetic results are known, we need patients that are out 10 to 15 years before we know whether that works. So I regard that as somewhat experimental but there is still this interest. There are some women who for lifestyle reasons don't want to go through the 30 fractions of external beam radiation therapy. They want to have it in a shorter period of time. So they are interested in having a partial, let's call, partial breast irradiation. But as I say, we don't have long-term studies on partial breast. There are reasons when you look at surgical studies that were done at the past, not to be wholly optimistic about that being the right way to go. But for patients who might not have received radiation therapy at all because of lifestyle reasons, that's a better choice than not doing any radiation at all. Have I covered your questions?

[Unidentified Analyst:]

Yes. And do you use brachytherapy much or not too much?

[Timothy E. Guertin:]

Brachytherapy is a common treatment for breast. There was a rise in interest in brachytherapy using the MammoSite device. Once again that's a partial breast irradiation solution and we don't know what the results are going to look like out ten years.

[Unidentified Analyst:]

Thank you very much.

[Timothy E. Guertin:]

In five years, okay.

[Operator:]

That concludes our Q&A session for today. I will now turn the call back over for closing remarks.

[Spencer R. Sias:]

Thank you for participating. For listeners 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 website at www.varian.com/investor beginning at 4

[Operator:]

Thank you for your participation in today's conference. This concludes the presentation, you may now disconnect. Have a great day.