Varian Medical Systems Inc
Q1 2010 Earnings Call Transcript

Published: 28 Jan 2010

[Operator:]

Good day, ladies and gentlemen, and welcome to the first quarter 2010 Varian Medical Systems earnings conference call. I will be your coordinator for today. (Operator's 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 and Corporate Communication.

[Spencer Sias:]

Thank you. Good afternoon and welcome to Varian Medical Systems conference call for the first quarter of fiscal year 2010. With me are Tim Guertin President and CEO, Elisha Finney CFO, and Tai Chen our Corporate Controller. Tim and Elisha will summarize our results and we'll take your questions following the presentation. To simplify our discussion, unless otherwise stated, all references to the quarter or the year are fiscal quarters. Quarterly comparisons are for the first quarter of 2010 versus the first quarter of fiscal 2009. All results are for continuing operations which include the sale of the research instruments portion at XL. Please be advised that this presentation and discussion contains forward looking statements. Our use of words of phrases such as outlook, could, should, believe, opportunity, can, estimate, optimistic, hope, expect, and confident, and similar expressions, are intended to identify those statements which represent our current judgment on future performance or other future matters. While we believe them to be reasonable based on information currently available to us, these statements are subject to risks 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. As a reminder our annual stockholders' meeting which will also be webcast is scheduled for February 11th in Palo Alta. We encourage you to vote your proxy. And now here's Tim.

[Timothy E. Guertin:]

Good afternoon and welcome, thanks for joining me in our first quarter fiscal 2010 conference call. Today we are reporting 6% growth in revenues, solid gains in our gross and operating margins, and a 13% increase in earnings per diluted share from continuing operations. Net orders for the company would've grown 1% excluding the reversal of a $62 million proton therapy order, including this reversal net orders fell 10%. Net orders increased in both our oncology systems and x-ray product businesses on the strength of their international markets. Despite the proton reversal our total company backlog grew 4%. Given these results we have elected to raise our guidance for the fiscal year, but before getting to guidance I'll focus on market and operational activity during the quarter and let Elisha give you some color on the numbers. Oncology systems first quarter net orders grew by 2% to $437 million which was nice to see after a decline in the fourth quarter. Net orders rose 19% in international markets with double-digit gains in Asia and Europe while orders fell 13% in North America with declines in both hospitals and freestanding clinics. We start by focusing on the international markets which accounted for more than 55% of the oncology orders during the period. Both Asia and Europe had strong growth helped somewhat by a weaker dollar. Asia's growth was led by the trio of Japan, China, and India. In Japan we benefited from a government stimulus package to enhance cancer treatment capabilities. In China and India demand was strong for high-performance machines and we saw greater interest in our units for more affordable care as well. The star in Europe was Germany where orders more than tripled with activities in private as well as public centers. In all of these markets we're seeing health care systems expanding their radiotherapy and radiosurgery infrastructure to better serve their growing cancer patient populations. In North America we are seeing early signs of renewed interest among freestanding clinics, however hospitals are still constrained by tightened annual spending budgets established last year in response to the recession and concerns about heath care reform. As hospital balance sheets improve we hope to see higher capital spending budgets and a resumption of more normal purchasing patterns. In all of the markets the interest in our products and technology remains very high. Continued demand for our RapidArc product also contributed to oncology's growth and as of the end of the quarter we had installed more than 340 systems. RapidArc is far and away the clear market for fast image guided IMRT. In the quarter we saw a richer order for higher energy Trilogy and Novalis TX machines capable of delivering stereotactic radiosurgery and traditional radiotherapy centers. We expect that radiosurgery is on its way to becoming a standard offering in radiation oncology facilities. We also received our second order, this one from India, for our new cost competitive unique accelerator for image guided RapidArc treatments and we are obtaining clearances to sell this machine in more international markets. Customer interest is strong and we expect this to be a very successful product. Bracket therapy product orders increased with the help of new much faster treatment planning software which uses an algorithm that we are now incorporating into our Eclipse software for planning radiotherapy and radiosurgery treatments. Despite very tough counts from the year ago quarter, our service business expanded nicely and it now represents $0.5 billion business annually. We are focused on achieving a higher contract capture rate among our installed base of accelerators, and as a new data point for UR, install base now stands at 5,800 units with another 500 non-Varian units within our service arena. These installations are split evenly between the North American and international markets. Let me take a moment to address our position relative to competitors. Looking backward over the fiscal year we believe that both Elekta and Varian gained share at the expense of other competitors. At the end of the day though this isn't about beating competitors, it's about beating cancer with better and better products that deliver fast affordable lifesaving treatments. That's our focus. Turning to our x-ray products businesses we passed a major milestone during the quarter as orders for our digital imaging detectors exceeded tube orders and helped to grow x-rays total net orders for the quarter by 9% to $99 million. This product mix shift was a prime contributor to improved margins for this business during the quarter. Our move into digital image detectors has resulted in the continued expansion of the x-ray business and has helped to insulate us from a harsh market environment that is hurting imaging equipment manufacturers, particularly in North America. We talked in the past about being uniquely equipped to offer customers special packages, pairing tubes, and detectors that are optimized for digital x-ray imaging. We landed another significant deal like this in the quarter, a $7 million order from an equipment manufacturer in China. It was among more than $15 million in detector orders from several new customers in Asia and Europe that contributed to the gains made by this business during the quarter. From a geographic perspective the x-ray products order growth stemmed exclusively from international markets, especially Asia. As I indicated a moment ago, North America has been tough for everybody including us. Orders in this region were down particularly for our mammography tubes and detectors for dental and veterinary imaging systems. Our focus now is on segments and customers that are doing well in this market and we believe we can continue to benefit from equipment manufacturers ongoing rollout of filmless x-ray imaging systems which feed the imaging process and lower the cost per procedure. In our other business category including our SIP security and inspection products business, our particle therapy business and our Ginzton Technology Center — combined net orders for the quarter declined $73 million to -$40 million primarily because of the reversal of a $62 million proton order from Skandion Kliniken in Sweden. We also had a $10 million decline in orders for our SIP business which had an unusually strong first quarter in the last year. As most of you know from our earlier 8-K filings during the quarter, Skandion Kliniken cancelled its proton order following its successful court challenge to its public tender process. We are prepared to respond to a new public tender with hopes of being selected again for this project. We have great confidence in the suitability of our particle therapy and pencil-beam scanning technology for this and other proton center projects around the world. As an example we reached a major milestone with this technology in December when we successfully commissioned a second treatment gantry at the RPTC Proton Center in Munich. More than 80 patients have been treated at the clinic to date and more patients are currently undergoing treatment. The clinical implantation of a second gantry is enabling RPTC to double its shipment capacity. We are excited about the growth prospects for this business and we are in active discussions with several groups who are planning to open proton therapy centers in various sites around the world. We're continuing to gain two or more proton orders per year. Despite a slow first quarter our SIP business continues to have a healthy pipeline and good opportunities for growth. Our biggest challenge in this business is dealing with its lumpiness as governments around the world move to deploy this technology in fits and starts. It is clear however that there is a conservative and ongoing effort to improve security at ports and borders and we're confident that our technology will play a key role in this endeavor. We are concentrating on providing security customers with superior value in terms of smaller lighter components and systems that deliver higher image quality as well as faster imaging and analysis for automatic threat detection. For example, the materials discrimination technology that we developed is now included in about 80% of the products we sell for cargo and border security. We expect that this development work will enable Varian to deploy security products in a broader array of fixed and mobile systems as well as applications including screening air cargo. Now I'll turn it over to Elisha for a review of the numbers and then I'll come back to you with our outlook for the second quarter and for the full fiscal 2010.

[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. First quarter revenues of $541 million increased 6%. Oncology systems posted an increase of 8%, x-ray products posted a gain of 6%, and revenues from businesses under the other category decreased by $5 million or 20%. In constant currency total company revenues increased 3% from the year ago quarter as the result of a weaker dollar. The first quarter gross margin for the company rose 1.5 points to 44.6%. Strong gains in oncology systems and x-ray products gross margins were partially offset by sharp declines among businesses in the other category. Oncology systems gross margin increased nearly three points to 46.5% due primarily to cost control initiatives that improved margins across our product lines and a higher mix of software and service revenue. X-ray products gross margin rose one point to 41.2% due to the higher mix of digital detectors. First quarter SG&A expenses were $84 million or 15% of revenues, a one point improvement from the year ago quarter as a result of tight cost controls. First quarter R&D expenses were $38 million or 7% of revenues, nearly even with the year ago quarter as a percentage of revenue. Moving down the income statement, first quarter operating earnings rose 21% to $119 million or 22% of revenues, up about 2.5 points. Depreciation and amortization totaled $12 million for the quarter. Net interest expense for the quarter was $300,000. The effective tax rate was 33.7% for the quarter, up more than three points from the year ago quarter when we benefited from discrete items including a reinstatement of the R&D tax credit. For fiscal year 2010 we continue to estimate the tax rate will be 31%-32%. Fully diluted shares outstanding were approximately $125 million at the end of the quarter. Diluted earnings per share from continuing operations rose 13% to $0.63. Turning now to the balance sheet, we ended the quarter with cash and cash equivalents of $625 million, debt of $37 million, and stockholders' equity of $1.4 billion. DSO or days sales outstanding for the quarter was 84 days, up one day from the year ago quarter and up three days from the prior fourth quarter. First quarter cash flows from operations was $131 million with most of it coming from net earnings and strong AR collections. Primary uses of cash were $55 million to repurchase 1.3 million shares of stock under our repurchase program and $8 million for capital expenditures. Now I'll turn it back over to Tim for the outlook.

[Timothy E. Guertin:]

Thanks, Elisha. Given our revenue growth, improved margins, and the strength of our earnings in the first quarter, we now believe that revenues for fiscal year 2010 can grow by about 6% over the fiscal 2009 total and that annual net earnings per diluted share could be in the range of $2.76-$2.83. We believe that for the second quarter of fiscal year 2010 total company revenues could increase by about 4% over the prior year period and that net earnings per diluted share could be in the range of $0.66-$0.68. To summarize our thoughts on the quarter and the rest of the year we're cautiously optimistic. We're seeing strength in international markets and we hope to see renewed purchasing activity in North America as new budgets are put in place. Our strategic plans are sound and we're executing well. We remain confident that we can achieve long-term growth in all of our businesses. Thank you and we're now ready for your questions.

[Operator:]

Thank you. (Operator's Instructions) Your first question comes from the line of Amit Bhalla of Citi.

[Amit Bhalla:]

Hi, good afternoon. Tim, I wanted to start with North America oncology and have you talk a little bit more about freestanding clinics as well as the hospitals. Last quarter you said that freestanding was down about 50% and hospitals were down 10%-15%, so maybe you could give a little bit more granularity on how the two performed this quarter? And secondly, reimbursement rates came in better than expected back on November 1, so how much of a positive impact did that have on orders in the quarter?

[Timothy E. Guertin:]

Hi, Amit. Well both hospitals and freestanding of course were not where they were a year ago. A year ago this process was just beginning, people were operating off of budgets that were established in the previous year so we expected that we would have some difficulty there. We are seeing renewed signs of interest in freestanding clinics and we're hopeful that that will turn into more and more business for us as the year goes on. In hospitals they're still operating off of budgets they set last year. We need to see those budgets graduate into new budgets. They're going to do that as they look at their balance sheets. Their balance sheets are looking a lot better now than they were looking when they made these budgets a year ago so I'm hoping that as they look at those balance sheets and as they get pressure from clinicians and their operations to upgrade their equipment and to adopt more modern equipment to replace ageing equipment that they will start to budget more. We didn't see that in the first quarter, we didn't expect to see it in the first quarter, but we're hoping that we will see it more and more as the year goes on. And to remind you, we still have an ageing base. That ageing got a lot worse during the year because there wasn't as much buying and so I think that the pressure to replace that ageing equipment maybe as a high now as it will ever be. And I'll also add that there was concern during the year about what health care reform would be and I think that those concerns are probably not as great now as they might have been for hospitals. And although that situation is probably not over and certainly could come up again I think that hospitals are paired in 2009 for whatever might be coming in 2010 and that that preparation is now built into their budgets and I think that, as I say, their balance sheets are stronger and I think their behavior will be more normal this year than what we saw in 2009.

[Amit Bhalla:]

Tim, I know you don't give order guidance in oncology or for the rest of the business, but is it safe to assume that you expect that within oncology the trajectory to be improving in subsequent quarters of the year?

[Timothy E. Guertin:]

Expect might be too strong a word. Certainly I have good reasons for optimism, but my customers need to change their behavior and people don't change their behavior overnight. So I would say I have good reasons to expect it, I have good reasons to expect it, but I'm going to wait to see them actually change their behavior before I use that word.

[Amit Bhalla:]

And just last for Elisha, Elisha, could you just give us the constant currency quarter growth rates by region for oncology? Thanks.

[Elisha W. Finney:]

Yeah. So total oncology was up 2% in dollars down 3% in constant currency. North America was down 13% and down 14% constant currency due to the Canadian, and then international was up 19% in dollars up 9% in constant currency.

[Amit Bhalla:]

Thanks.

[Operator:]

Your next question comes from the line of Sean Lavin of Lazard Partners.

[Sean Lavin:]

Hello. Congratulations on the strong quarter. My first question has to do with gross margins where you came up in well above our estimate. I wanted to see if you could talk a little bit about the sustainability of these levels?

[Elisha W. Finney:]

Sure. Well without giving a lot of detail by segment, Sean, for fiscal year '10 once you run through the changed guidance through your models you will see that what we're expecting is around 22% ROS of which I'm about 30 to 40 basis points of that I'm suspecting will come from gross margin and the rest will come from leveraging on SG&A. So about a one point in improvement in ROS and roughly half and half if you will between those two elements. Remember in the quarter we had a very good product mix as well as FX helped us. It helped the oncology margin by somewhere around 50 basis points or so in the quarter. The currency has since retreated somewhat so again we're not sure if that's going to repeat from now until the end of the year.

[Sean Lavin:]

Okay. And then my second question is now that you've had a quarter to kind of look at this, can you talk a little bit about the effect the reimbursement change may have had on your freestanding customers?

[Timothy E. Guertin:]

We had a lot of conversations with our freestanding customers during the first quarter that we weren't having within the fourth quarter and they don't react overnight. They do have to go out and get money, they do have to have to put their budgets together, they do have to worry about cash flow which obviously their forward look on cash flow is more positive now that it might have otherwise been. So we saw some behavior change in the first quarter, but there wasn't enough time in the first quarter for them to react, but as I say, the conversations that we had were a lot warmer and fuzzier. And also I would say I guess both big and small customers in the freestanding segment both showed stronger signs of activity and that's good to see.

[Sean Lavin:]

Great, thank you very much.

[Operator:]

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

[Amit Hazan:]

Hey. Good afternoon, guys. First question I think just top level you touched on it specifically, but if we think about your business model and we think about your orders and where they've been in the last 12 months and I think your trailing 12 month orders are now down about 2% or so and your revenue guidance for the next 12 months is up 6%. I know there's a fluctuation when units get placed, but can you help us out in terms of what kind of currency benefit you're expecting and what kind of order rebound you're expecting to get to that 6% growth or if there's really that kind of relationship that's important between the orders and the sales?

[Timothy E. Guertin:]

The first thing I would remind you of is that our backlog did grow and so the reason we're able to forecast revenue growth is because we've had growth in backlog from that.

[Elisha W. Finney:]

Yeah. So Amit, that's exactly what I was going to say. I mean if you were to strip out the proton order in Q4, backlog is up 7% quarter over quarter which is very much in line with the revenue guidance for the year. Orders that we currently are getting have less impact on fiscal year '10 and more impact on fiscal year '11 so as it starts to accelerate throughout fiscal year '10 as Tim talked about that would be reflective in next year's guidance more than this year just given the fact that the average tenant backlog is 12-18 months. Again we had significant currency help in the first quarter. We averaged about 1.48 on the euro in the first quarter, today we're sitting at about 1.40. So obviously we've tempered our expectations on the dollar a little bit and reflected it in the guidance as well.

[Amit Hazan:]

Okay. And then just secondly following up on the US oncology side if we think about the companies that have reported so far in 4Q that nothing has been great, but that it has shown some improvement and if I think about your numbers from the September quarter it looks just about the same to me if I normalize the comps for September and December and so I'm wondering what you might be seeing that's different. Is there anything that you're seeing that you could parcel out that would be different then what an MRI or a CT manufacturer might be seeing?

[Elisha W. Finney:]

So I would just say that remember we tended to lag into this and lag out and if you look at our year ago quarter we had 11% growth in oncology orders. So a pretty tough cost —

[Timothy E. Guertin:]

For North America.

[Elisha W. Finney:]

Now for total oncology in the year ago quarter so a fairly tough comp compared to where we'll be as we move into Q2 through Q4 when things started to moderate for oncology.

[Timothy E. Guertin:]

It is true. When you compare us to diagnostic radiology when bad things happen they tend to be affected first. They have short cycle orders and their business is impacted before ours. On the other hand, they tend to come out of recessions more quickly than ours. So we're reading their news reports, it's a little difficult to know everything that's going on, but we're reading the reports like you are. But frankly, considering the situation I was thrilled to see what did happen.

[Amit Hazan:]

All right and then just lastly maybe thinking about in terms of ASP and oncology worldwide really, but separated between the US and the rest of the world, just wondering if they're up or down sequentially. In the US I'm just thinking about Novalis and RapidArc driving them up and then wondering if hospital spending pressures are driving them down to any extent and so where is that directionally? And then on the US side I'm thinking of just kind of currency or some mix there and whether that's driving ASPs up or down.

[Timothy E. Guertin:]

Well, ASPs are being — clearly some customers are obviously negotiating aggressively during this period of time. You would expect that. Overall I think we're pretty stable and I think this is a case where in a market like this you want to have certain technological advances where you can get good pricing that holds you up so that all those certain portions of your product line might be under pricing pressure, other portions of your product line are not. And so by introducing new products and new technologies and having a number of superior offerings, overall I think we've been able to do okay and that's why you see the gross margins be as strong as they are. I think that our strategy for prevailing in these kinds of situations has been working out for us and so I think we need to continue to invest. We need to put a lot of money into R&D during this period because R&D is going to yield new products and those new products can give us a wave of stronger results in the future. I would also say that we're winning a fair amount of software business, more software business than we've seen in the past and the gross margins on that business is very good. So between advanced hardware products and advanced software products I think we've been able to hold our pricing in aggregate pretty well.

[Amit Hazan:]

And you're not seeing any increased or incremental pressure from the US hospitals as it relates to that?

[Timothy E. Guertin:]

Well, certain hospitals obviously are trying to use this as an opportunity to negotiate more aggressively with us and we have to negotiate with those people as best we can under these circumstances. Some hospitals are feeling the economic pressure, but I'm just telling you in aggregate I think that having strong offerings is helping us defend our pricing.

[Amit Hazan:]

Great, thanks very much guys.

[Operator:]

Your next question comes from the line of Dalton Chandler of Needham & Company.

[Dalton Chandler:]

Good afternoon. You mentioned your ageing installed base and you're now up to 5,800 units, can you just remind us how many of those are upgradeable to state of the art versus how many just have to be replaced?

[Timothy E. Guertin:]

Probably anything that was made in the last few years is upgradeable. People tend not to upgrade anything that's older than about four or five years so if you take five years it's probably about 2,500 units that are probably in the upgradeable category, and obviously things that were made in the last two years, 1,000 of those are much more likely to be upgraded than things that are older. After they're older than five years people are probably going to think about replacing them.

[Dalton Chandler:]

Okay. And just talk about the process you expect now as you go back through the bidding process for the proton deal, when do you expect to start and how long you might take?

[Timothy E. Guertin:]

We expect that there will be a retender in February-March. The customer has to put that together and we'll expect a decision 90-120 days later so you probably won't hear anything from us until the third quarter and we'll update you on that obviously at the end of the second quarter. And whatever Skandion Kliniken does it will be public so there will be alternate ways to know about it.

[Dalton Chandler:]

Okay. So (inaudible) 90 days after the tender is issued?

[Timothy E. Guertin:]

We're expecting that they'll make their decision between 90-120 days. Now, I think they're eager to make their decision because they don't like to put everything on hold. They have the money, the money is sitting, and I think they're going to want to move quickly. On the other hand, clearly they're going to want to be scrupulous and who can blame them? So we're going to do everything we can to respond to them as quickly as we can and we have every reason to hope that we'll prevail.

[Dalton Chandler:]

Okay. And just a final question on the unique, I know you mentioned you had another order in the quarter, but is that helping you at all in any of the discussions you're having where you're competing with some of the players out there who have been trying to compete on price?

[Timothy E. Guertin:]

Yes. In price competitive situations this machine is exactly designed to work in those because it offers a superior set of capabilities in a very inexpensive machine.

[Dalton Chandler:]

So you're pleased with the way it's performing and the conversations you're having?

[Timothy E. Guertin:]

Yeah. I mean we're just getting started, but having RapidArc alone on that machine gives it a real edge. It's a very sophisticated machine and yet it hits a price point that's very appropriate for certain markets that are highly price sensitive.

[Dalton Chandler:]

Okay. Thanks a lot.

[Operator:]

Your next question comes from the line Tycho Peterson of JP Morgan.

[Tycho Peterson:]

Hey, good afternoon. Tim, maybe just taking up on your comments about radiosurgery and more of a movement towards standard of care, can you talk a little bit about how you size that market opportunity and maybe also if you can just kind of touch on whether these are new customers or they're existing customers that are adding capabilities and maybe clinically where you're seeing the fastest growth in radiosurgery?

[Timothy E. Guertin:]

Yeah. This market is split into parts and we compete. There is a hybrid part and then there is a special machine part where people want to have a machine that can only do radiosurgery and that's a much smaller portion of the market. The hybrid piece is much, much larger and that's the piece where we compete and I think we're doing very well there. I think we had, as I recall, a very large number of Trilogy and Novalis business this quarter so we're doing well. We ultimately believe that every radiation therapy department is going to want to have the ability to do radiosurgery and they're going to want to buy the technology that it takes to do that and it may not be more than one machine, but we think that everybody's going to want to be able to ultimately do this as a part of what they do. That being said, there is a market for people who make machines that are specific only to radiosurgery. Our machines obviously can do radiosurgery very fast and very successfully for people who want to have that and so our machine can be used as a special machine, but by its very nature it's a machine that can do both special and general radiation therapy which gives it an advantage in a lot of those situation. In terms of the overall market size I'm not sure that I've sized it recently, but obviously I think if you add all the players together it's probably a $500 million piece of the market, but the difficulty is that when you just look at the hybrid market since those machines are being bought for general radiation therapy as well as specific, I'm not sure how you would separate those two markets from each other and it's probably inappropriate to do so. But it's a substantial area of interest for our customers.

[Tycho Peterson:]

And can you give us a sense as to when you might think about a replacement cycle for some of those early Trilogy systems that were placed or is more about kind of growing the market at this point?

[Timothy E. Guertin:]

It's probably about growing the market more. It's probably about replacing machines that are a lot older than Trilogy and getting those machine removed. I think Trilogy is still a young enough machine that it's probably premature of me to think about that, but some of those machines yeah, they could be candidates for a RapidArc upgrade where we shipped them Trilogy before the creation of RapidArc because we now offer software capability where RapidArc could be used for stereotactic radiosurgery and radiotherapy. So there may be upgrade opportunities there, but I don't think there's a replacement opportunity yet.

[Tycho Peterson:]

Okay, that's helpful. There have been a couple of articles in the Times this week about clinical treatment errors, can you just talk about whether there are any potential sort of changes coming in terms of regulating medical physicists and how you think about some of the blowback from some of the press that's been out there?

[Timothy E. Guertin:]

Yeah. It's hard to know where things are going to ultimately go. I have to say if the goal of the New York Times is to remind us that outcomes depend upon safety and that we should all be scrupulous about safety and that's a message we clearly support. Our fear is that if patients don't get treatments that they need because they have been frightened, these are already scared people so to scare them further so that they don't go get their treatment obviously is not something we would like to see. I will tell you that we put safety first. You can't get good outcomes without having good safety. We put safety first and we always have and we offer extensive training in our Varian facility. In Las Vegas we go out and do seminars in the world and how to use our products right and we bring in world class expects to do that and so we're going to always continue to put safety patient first. In terms of what added regulation we might see it's hard to say. I think that all of us are interested — the societies, Astro, the ACR, the Acro, the ASRT, and the AEPM, are all very interested in seeing safety be a high priority for them and I expect that the first thing we're going to see is that those organizations work with their membership and work with manufacturers to ask what can be done. I think that we're already heavily regulated. Anybody who thinks that the FDA isn't incredibly scrupulous has never been visited by the FDA because they are tough and they are very scrupulous in terms of their behavior. So hopefully the lesson learned in all of this will be that all of us will work together and the societies and industry to create a better climate for patient safety.

[Tycho Peterson:]

Great. That's very helpful. Thank you.

[Operator:]

Your next question comes from the line of Vincent Ritchie (ph) of Wells Fargo Securities.

[Vincent Ritchie:]

Hi, guys. First question I guess is just a simple housekeeping question. Right now what is the split of where your cash is located?

[Elisha W. Finney:]

As of the end of the calendar year we had about $65 million or so in the US. The balance is mostly in Europe.

[Vincent Ritchie:]

Okay, great. And Tim, just based on you what you just gave us some nice detail on the install base, what's your sense of what the average age of the install base is?

[Timothy E. Guertin:]

Oh I don't have a current number, but it's got to be — with 5,800 machines in services and the average age has got to be out there at 9-10 years, but I don't know for sure.

[Vincent Ritchie:]

Okay. Great, thanks. And I guess a couple of other med tech companies have noted that in the current environment they'd have to increase their R&D spend just due to pressures that they're seeing in changes in the way regulations have been done and the current environment. What are your guys' thoughts on that because you guys have been a pretty steady 6%-7% of sales spend since your spin and Tim made some comments about R&D being important for future growth so just curious of your perspective on that.

[Elisha W. Finney:]

Yes. I expect we're going to be closer to the 7% versus 6%-6.5% for this year so we have made a concerted effort to increase R&D. We think in this environment when it's been tough that this is a way to play offense and so the plan is that it will be somewhere close to 7% of revenues.

[Vincent Ritchie:]

Okay, great. And just going forward, what are your thoughts just in terms of what's going on with the FDA?

[Timothy E. Guertin:]

What's going on with the FDA? How do you mean?

[Vincent Ritchie:]

Well it just seem to me that for certain companies they seem to have taken the perspective that it's getting harder to get products approved and whether something besides (inaudible) or PMA and I'm just curious if you guys are seeing anything along those lines?

[Timothy E. Guertin:]

Well so far so good. I mean I will tell you that the amount of stuff that we have to submit to the FDA when we go to them for approval is enormous. I mean, we ship an incredible amount of documentation and they are incredibly rigorous and they come back and ask good questions. So I know it's very unpopular to be proud of federal agencies, but I think you should be proud of the FDA in terms of the way they behaved in the medical device business, certainly in the area of radiation therapy. So from my perspective I think they treated us fairly.

[Elisha W. Finney:]

I would just say that it's an area that we have really beefed up resources over the last several years so I don't anticipate anything significantly different going forward. It's been an area that we have beefed up over the last two or three years.

[Timothy E. Guertin:]

Yeah. And we don't count that in our R&D, but there's other segments of the company where we've added a lot of people and we're still adding people so we're putting a lot of emphasis on compliance and good manufacturing practices.

[Vincent Ritchie:]

Okay, great. And then lastly, with the x-ray business you mentioned that the order for the panels were ahead of the tubes at this point in time. What kind of gross margin effect can we see, if any, on that?

[Elisha W. Finney:]

Well, the panel margins are significantly higher than tube margins, somewhere around 45%-50%. So what happened is by virtue of the mix changing towards more panels in the quarter, it allowed the x-ray margin to go up by about a point to 41%. To put it in context, if you were to go back five or six years ago the x-ray margins were in the mid-30s so panel has had a significant impact on taking their margins up.

[Vincent Ritchie:]

Great. Thanks for taking my questions.

[Operator:]

Your next question comes from the line of Jeffrey D. Johnson of Robert W. Baird & Co.

[Jeffrey D. Johnson:]

Thank you. Good afternoon, guys. Tim, I'm wondering, obviously a very good quarter here, congratulations on that — looking at the guidance for the rest of the year it seems to imply maybe 2%-5% EPS growth or low to mid-single digits EPS growth throughout the rest of the year. Is that just tracking kind of your order trend last year that fell off starting kind of in fiscal Q2 last year? Is it conservatism on your part? Just how should we think, any color around the rest of your year's EPS guidance?

[Timothy E. Guertin:]

Yeah. I'm going to let Elisha take the first stab at that and then I'll think about it while she's answering.

[Elisha W. Finney:]

Yes (laughter). Thank you, Tim. I mean, around 6% on revenue, and again that's mostly just reflecting what is in the backlog and pretty modest expectations for this year in the orders that will be delivered in this year so really it is a reflection of what happened last year on the orders front. I would draw your attention to the EBIT increase because that's really how we manage the company internally and that's going up 10% or so once you model this out to get a 22% ROS. So there is going to be some leverage with a 6% revenue. Of course currency can move that and it is early in the year, I will say that. We don't come out and say yes we're being conservative, but it is early and there's a long time between now and fiscal year end.

[Jeffrey D. Johnson:]

All right, well that's helpful. And Elisha I didn't hear an answer earlier when the question was asked on revenue guidance for the year at 6%. Have your currency assumptions changed within that going from 4%-5% revenue growth to 6%? Is that kind of a constant currency increase in that revenue guidance or have your assumptions changed?

[Elisha W. Finney:]

Well, they have changed somewhat from the last quarter guidance that we gave you. I mean if you look back at the Q1, the euro was at about 1.48, today we're at about 1.40. So when we get to the point when we give guidance for the quarter or the year we put a range around where the euro is currently sitting so clearly with the dollar strengthening somewhat that did impact the guidance for the year. So the increase in guidance is really more of a reflection of what we saw in the first quarter where we had a significant help from FX as well as strong orders and sales in service and software.

[Jeffrey D. Johnson:]

And just to clarify, I can be slow on the uptake here sometimes so forgive me, but essentially what you're saying is your currency assumption is for less of a benefit for the year than maybe last quarter when you first put guidance out you were expecting currency could benefit?

[Elisha W. Finney:]

That is a fair way to put it.

[Jeffrey D. Johnson:]

Okay. And then Tim, I guess another question for you just on RapidArc. We've done some survey work just here over the last week or two and seeing maybe some signs of some increased interest in uptake on that. Obviously it's been a great product for two years, but on the upgrade side especially maybe some increased interest going into calendar '10 here. Any color you can provide there? Have you seen anything change out in the field?

[Timothy E. Guertin:]

I think we did see some increased interest in the upgrade business. I don't think it was so substantial that I would draw particular attention to it, but certainly the majority of that is still on new orders that we get and I would expect upgrades — but I have to tell you that when a market is troubled like it is in North America, surprisingly the upgrade business doesn't get as much emphasis as you would think. People tend to preserve their capital for new equipment so upgrades tend to be stronger when markets are stronger. So if I'm going to expect upgrades I'm going to expect them mostly outside the US and that's probably where we'll continue to put attention for the time being. And then as the market comes back in the US I think that will create more opportunities for us. My indications are that yes there's some strength there, but not enough to be that I would want to particularly draw your attention to it.

[Jeffrey D. Johnson:]

All right, great. That's helpful. And then last question just for me, you called out the $7 million and the $15 million in x-ray orders and I guess the $7 million made up part of that $15 million in the new customers orders.

[Timothy E. Guertin:]

For the customer, yes.

[Jeffrey D. Johnson:]

And I'm trying to kind of reconcile that, or not reconcile, but look at that and look at the fact that your sequential comps here go from 21% x-ray order comp last year from positive 21 to a -17% in Q2. So my gut is that we're going to get a real big uptick here in x-ray orders, but you also called out those one offs that I'm wondering if I should kind of take out of the fiscal Q1 as I think about the sequential trend or how should I think about that?

[Timothy E. Guertin:]

Well that particular deal we drew attention to because it was both a tube and a flat panel order so you have to actually split it up. It's not just tubes and it's not just flat panels, but definitely tubes in the US are not where we want to see them and neither is it for flat panels. Our strength is outside of North America and so we draw attention to these because I think that more and more of our business in the future is going to be these combination orders, but I mean that was — when you get panel orders they're distributed over time of course in terms of how they're delivering, it's just that that one was particular nice to have.

[Jeffrey D. Johnson:]

Okay. And as we go up a negative 30% order comp in North America from last year in the second quarter and understanding you don't give order guidance, but would it surprise you to see negative growth on top of negative comps that sizable?

[Timothy E. Guertin:]

Bob Kluge isn't here with me so I'm going to speak on his behalf. Yes, that would surprise me if it was negative on top of negative and that was such a shockingly negative inventory correction last quarter, but I don't want to be too optimistic, but that would surprise me, yeah.

[Jeffrey D. Johnson:]

That's as close as I've heard you give order guidance so I appreciate that. That's all I've got. Thanks, guys.

[Timothy E. Guertin:]

Elisha's going to kick me under the table (laughter).

[Jeffrey D. Johnson:]

Have a good evening, thanks.

[Operator:]

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

[Junaid Husain:]

Good afternoon, guys. Tim, relative to China, broad strokes, can you give us a sense for how your oncology business is fairing here? Just relative to Chinese health care reform, are you seeing any government tenders go your way for linacs?

[Timothy E. Guertin:]

We're getting very good business. We had very good growth in China. I think we have a lot of opportunities in China. I think China is going to invest more in radiation oncology over the next few years. We see all kinds of positive signs that the Ministry of Health plans to invest more here and I think we have share opportunities in China as well. I think we can gain share especially at the higher end of the market. We're going to have our work cut out for us. It is a difficult market. The customers are very demanding and there's a large price sensitive portion to the market. We have to provide good service. It's a very large geographic area. It won't be simple to do and we're going to have to invest, but I think the opportunities in China over the next few years are quite strong.

[Junaid Husain:]

And then relative to your manufacturing facility in, I believe it's Beijing, just given the certification received to manufacture the tubes, any thoughts on shifting some of your US-based manufacturing operations from say Salt Lake to Beijing?

[Timothy E. Guertin:]

No, that operation there is just for the purpose of supplying the China market. We have ample need for our facility in Salt Lake City so no, I wouldn't imagine that will shift. It's just the China market is a very difficult market to serve from Salt Lake City and so we want to have more and more capability to manufacture those tubes in China and we want to be able to reload tubes and we have a reload facility where we can get old tube housing back and put new tubes in them and that has to be close tow here you need the tubes. So I think China's very important to us, but it's primarily important to us for the China market.

[Junaid Husain:]

Fair enough. And then just relative to the tubes business in general can you give us a sense for how this business is recovering, especially as it relates to one of your largest OEM customers? Do you get the sense that we're feeling the bottom here and that ordering trends are either leveling or potentially picking up?

[Timothy E. Guertin:]

Internationally I'm very comfortable. In North America the problem is reimbursement for diagnostic radiology is still not where it needs to be and in fact there were proposals to cut it further and those proposals were going to be countermanded by Congress when it acted on health care reform and now they have — that doesn't seem to be happening and so there needs to be other bills raised in Congress and they have not yet happened. So I don't think I can speak to the US market until I see more action in defense of the industry by Congressional leaders, but I think the international opportunities are great and I know that Bob is putting a lot of attention on those international markets and we are putting attention on the North American market too. We have some great replacement tubes. We're a high quality low-priced vendor in North America. Our sales team is focused on using this opportunity to get us additional business in the North American market, but it's still a definite nasty headwind in that market.

[Elisha W. Finney:]

Yeah. So to put it in context too, Junaid, I mean the tube orders were down single digits so it's not like it fell off a cliff, it's just that panel orders were up very significantly in the quarter and that's how we got 9% orders growth in x-ray.

[Junaid Husain:]

Right, gotcha. And then Elisha I've got a couple of quick ones for you, did you have any order cancellations in the quarter on oncology?

[Elisha W. Finney:]

We always have order cancellations in the quarter, but nothing that was unusual other than obviously the proton order that we took out of backlog, but well within our normal guidelines in the quarter for oncology.

[Junaid Husain:]

And then can you remind me how many shares you have outstanding on your share purchase?

[Elisha W. Finney:]

In our share repurchase we have a new authorization that started with this calender year '10 of 5 million shares.

[Junaid Husain:]

All right, good enough. That's all I've got for you guys.

[Operator:]

Your next question comes from the line of Josh Jennings of Jefferies & Company.

[Josh Jennings:]

Hi, good afternoon. I guess just a start on the SRS side or the Novalis TX side. I mean, can you comment on the percentage? I think you put that out there last quarter, the percentage of your orders that Novalis TX took on the total oncology number?

[Timothy E. Guertin:]

I don't have that number and I don't think we release it every quarter, so I don't have that number for you today I'm sorry.

[Josh Jennings:]

Okay. And can you share what your Novalis TX install base is out there at this point?

[Timothy E. Guertin:]

You should have sent me that question in advance so I could prepare it. I don't have that number.

[Josh Jennings:]

No problem.

[Timothy E. Guertin:]

We think it's about 100.

[Josh Jennings:]

About 100, okay great. And if you're looking at your customer base specifically on the freestanding center side, but maybe also thinking about your hospital customers and their ability to access financing and sort of how that's trending, is that improving as you move out into calendar 2010 and where are you at on that in terms of the trend there?

[Elisha W. Finney:]

I am not aware of any significant issues on our customers being able to access money. And as you guys probably know I have a customer finance team where we go out and facilitate financing for our customers and then we sell that to banks and to leasing companies and they are busier than ever and are getting lots of business off the street that way.

[Timothy E. Guertin:]

Yeah. I haven't had any complaints from the sales department that we couldn't get people financing. I will say we had an awards banquet the other night in which we give out awards to people who get leasing business, sales people who get leasing business, and I think there were nearly twice as many people getting awards this year than last year so that activity is way up, but nobody is complaining that they're having any problem doing it.

[Josh Jennings:]

Great. And so would you say trends are improving or are they remaining steady as they have been in your fiscal Q4?

[Timothy E. Guertin:]

Well, the trend is improving clearly.

[Josh Jennings:]

Okay. And then just back to gross margins on the oncology division, a nice three point move, can you break out between service and systems whether one was a driver or not and was there sort of an equivalent improvement there?

[Elisha W. Finney:]

Yeah. Well, we saw gross margin improvement virtually across all of the product lines within oncology driven a lot by cost control measures that were put in place so over time and cost of quality measures, et cetera. I will say the service area which has been growing quite nicely has seen a significant improvement in margins resulting from service software agreements where we're seeing those to our service organization and so service was a big contributor to that improvement, FX, as well as product mix on software.

[Timothy E. Guertin:]

And I think we're watching our Ps and Qs on cost.

[Elisha W. Finney:]

Absolutely.

[Timothy E. Guertin:]

And I think that's making a difference for us. I use the word cautiously optimistic when I gave guidance, we need to be careful during this period of time. So although we are investing more and we have been in hiring mode for the positions we essentially need, we're going to continue to be careful until we see the situation show the kind of turnaround we want to see.

[Josh Jennings:]

Excellent. Last question just on your RapidArc software and just your views on the competition out there in Arc therapy. (Inaudible) VMAT offerings still seem to be having trouble getting out of the gates in the US and you have Philips who just introduced their SmartArc offering into the US and do you expect competition to increase? You guys are the first to market leader and as was mentioned earlier the trends are that there is increasing demand potentially out there, but on the competitive side how are you looking at that?

[Timothy E. Guertin:]

Well, I think we've been in pretty good shape for the last two years in terms of what we introduced. We brought our product to market, it was ready to go. We'd done a lot of work to get ready. Our competitors are starting to come out with their offerings and we'll get a better look at them over time to make the comparison. So far our customers are calling me and telling me they still like our offering and they still think it's a superior offering which is good to hear. I will also say that we're a moving target. We're going to introduce new versions of RapidArc and those new versions of RapidArc offer new features. So we're not sitting still, we're not resting on our laurels, we're going to come out with new stuff that I think moves the bar ever higher. So we have an edge there, that edge has helped us in gross margin. I think that edge has helped us be competitive and we'll continue to move forward and stay as far ahead in the race as we can.

[Josh Jennings:]

All right, thanks a lot.

[Operator:]

This concludes the Q&A portion of today's conference. I would now like to turn the call back over to Mr. Spencer Sias. Please proceed.

[Spencer Sias:]

Thank you for you for participating. For those that have come in late this call has been taped and it will be available for reply beginning at 4

[Operator:]

Thank you for your participation in today's conference. You may now disconnect. Good day.