Accuray Inc (ARAY) 2008 Q3 法說會逐字稿

Ladies and gentlemen, thank for standing by, and welcome to the Accuray Incorporated Earnings Conference Call for the Third Quarter Fiscal Year 2008 ended March 29, 2008.

At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. (OPERATOR INSTRUCTIONS.) As a reminder, today's call is being recorded.

At this time, I would like to turn the conference over to Tom Rathjen, Vice President of Investor Relations. Please go ahead.

Thank you very much, and good afternoon. Thank you for joining us today for Accuray's Third Quarter Fiscal 2008 Conference Call. Joining us this afternoon is Dr. Euan Thompson, Accuray's President and Chief Executive Officer, and Bob McNamara, Senior Vice President and Chief Financial Officer.

This quarter, we will be referring to financial data which is found in a PDF file on the Investor Relations page of the Accuray website at www.accuray.com. Please log on to this site to view this information.

Before we begin, I need to remind you that except for the historical information, the information that follows contains certain forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include the matters described in the Risk Factors section of our report on Form 10-K for the 2007 fiscal year, as updated from time to time by our quarterly reports on Form 10-Q and other filings with the SEC.

And now, I would like to turn the call over to our President and Chief Executive Officer, Dr. Euan Thompson. Euan?

Thank you, Tom. I'd also like to thank everyone for joining our call this afternoon.

Today, I'd like to provide highlights of the third quarter of our 2008 fiscal year. I'd also like to discuss our sales environment and the changing market conditions and how we're addressing these changes. And finally, I'll outline our continued clinical growth. Following my remarks, our CFO, Bob McNamara, will discuss our third quarter financial results in detail.

First, let me share the highlights of the quarter. This is our fifth consecutive quarter of record revenue, and our fourth consecutive profitable quarter.

Total revenue for the quarter was $58.8 million, a 57% increase over the same period last year. Net income was $584,000 compared to a net loss of $785,000 in the third quarter of last year. Our services revenue grew 141% to $11 million compared to the third quarter of fiscal '07. We generated 16 new orders during the quarter with a total value of $76.6 million.

Now, I'll give an overview of the Accuray sales environment. Last quarter, we discussed our changing conditions in the marketplace were impacting a segment of our U.S. market. Specifically, the impacted segment represents free-standing providers of CyberKnife radiosurgery, those customers operating outside of a hospital environment. I want to run through that explanation again to make sure it's clearly understood, and then I'll try to quantify some of the impact on how we're addressing it.

To start, despite constant comparisons between ourselves and other manufacturers of radiation equipment, I want to reinforce that Accuray is not in the business of providing traditional radiation therapy technology. I can understand why these comparisons arise, particularly in light of confusing marketing claims by some of our peers.

But, the important thing to remember is that we provide a dedicated radiosurgery system that predominately treats a new group of patients who may well not have been referred for radiation treatment if the CyberKnife were not available. This makes our sales process significantly different from that of the other radiation equipment providers.

For example, the radiation therapy companies rely heavily for much of their business on replacement of existing radiation therapy equipment that has reached the end of its useful life. This replacement equipment is generally purchased by existing providers of radiation therapy services who have a predefined budget and a room ready to house it.

Sales to these customers are usually technical in nature. The customer will want to review a list of the current features of the equipment on offer and make a decision about which manufacturer's system they prefer.

Once their decision is made, installation would tend to follow at a predictable time because the new unit has been purchased to replace an existing one, so the facility to house a system is complete and available.

What I've just described is radically different than the Accuray sales environment and purchase process. Unlike traditional radiation therapy equipment, which is typically used to deliver a course of treatment of six to eight weeks, the CyberKnife system is used to perform radiosurgery, typically in any one to five treatments in as many days.

Whereas conventional radiation therapy will generally follow surgical removal of a tumor by a surgeon, CyberKnife's radiosurgery generally replaces the surgery by destroying the tumor in a non-invasive manner.

As I'll describe later, the radiosurgery market is growing a very fast pace which is very positive for Accuray. But, the key thing to remember is that full-body radiosurgery is a relatively new clinical concept and, as a result, there's generally no budget or space allocation at our customer sites at the time we approach them.

It's more normal that once a customer has recognized the need for a CyberKnife radiosurgery system, as well as the benefits a system can provide, they will need to find a budget and a location. In short, CyberKnife, for very positive clinical reasons, is a new business development proposition for most of our customers.

So, in order to complete a sale of a CyberKnife in an accelerated timeframe, our sales force has to find customers who have access to financing and a location. In past years, particularly in the United States, we found that entrepreneurial physicians and free-standing centers have sometimes been more amenable to taking on that challenge than hospitals.

We certainly do have many hospitals as customers, but it has often proved faster and less challenging to complete a sale in the U.S. to independent entrepreneurial service providers or free-standing centers.

The owners of these centers will often later form joint ventures with a hospital to provide CyberKnife treatments, thereby solving the hospital's problem of budget and space.

During this fiscal year, proposed regulatory changes in the general economy and credit environment have placed more pressure on the business plans at these free-standing centers. As a consequence, we have experienced some slow-down in planned revenue from this market segment.

Last quarter, we reported that some orders had been canceled and that we had removed others from backlog simply because we now have less confidence that certain customers would take delivery of a CyberKnife system in a timely manner.

To reiterate, this change in the environment predominately impacted one segment of our U.S. market. There has been no significant impact on our hospital-based customers in the U.S. or in our international business.

Our job over recent quarters has been to continuously evaluate progress of customers with this profile and, where necessary, to remove their orders from our stated backlog.

I do also want to stress that not every customer in this category is at risk. We have successful free-standing centers including those in Miami and San Diego that have extensive clinical programs, and we have many robust orders in our pipeline that we feel confident will complete the installation process.

However, our U.S. sales force is now focused predominately on hospital-based customers and on customers who are less impacted by the regulatory and economic challenges. We are already seeing the positive impact of that effort in the sales pipeline as I'll describe in a moment.

Looking outside of the U.S., I'm pleased to report that six of the 16 orders received during Q3 were from international customers. This represents continued growth in our international business. We're very positive about this trend because, in general, international business is heavily dependent on the strength of clinical data, and we feel this growth to be added confirmation of the increasing strength of our clinical programs.

Again, the issues I've just described regarding free-standing centers do not apply internationally since a vast majority of CyberKnife sales made outside of the U.S. are to hospitals.

In peril to new order generation, we did continue to reevaluate our backlog in the ways I've just described. As a result, we once again removed certain contracts and backlog to ensure that we continue to give investors an accurate picture of business trends. Bob McNamara will be giving a full overview of backlog in a moment.

However, in summary, we generated substantial new backlog, but also removed certain pre-list included contracts from backlog as a result of some cancellations and some unfavorable changes in our perspective of the likelihood of revenue resulting from the contracts.

I've finished with my report on the sales environment. I want to briefly talk about competition. As I mentioned just now, our sales process is different from that of the other radiation equipment providers because clinical utilization of the CyberKnife is different.

CyberKnife radiosurgery is generally delivered to a different group of patients from those who would normally be treated in a radiation therapy department. Importantly, it's still the case that once a facility decides to establish a dedicated full-body radiosurgery program, CyberKnife is the clear choice.

The CyberKnife radiosurgery system is the most accurate full-body radiation delivery system in the world. The gantry-based systems that were originally designed for radiation therapy do not have the CyberKnife's ability to track, detect and correct the tumor in patient movement in real time, and this sets the CyberKnife apart from other devices on the market.

Despite our competitors' claims so-called part-time devices can deliver radiation therapy and perform radiosurgery, it is still the case that the CyberKnife dominates the field of full-body radiosurgery.

To reinforce this, a recent survey of more than 1,400 radiation oncology sites in the United States showed that these so-called part-time devices are having virtually no measurable impact on the rapidly expanding extracranial radiosurgery market.

The independent survey conducted by marketing group, Dominick & Irvine Research, was described in a March 2008 press release. It concluded that an average part-time unit was used to perform radiosurgery on only five patients a year for extracranial tumors. In contrast, each CyberKnife system was used to treat approximately 91 extracranial patients each year.

Survey data also showed that 74% of CyberKnife systems are now being used more than half the time to perform radiosurgery on extracranial tumors, while part-time units were being used at this level less than 1% of the time. Virtually all CyberKnife systems in use today treat some type of extracranial tumor with prostate, lung and spine treatment increasing the most dramatically in 2007. The survey included systems from all the major manufacturers.

The reality is that the CyberKnife is changing the cancer treatment paradigm by offering a treatment that, in many cases, can replace surgery, treat high-risk surgical patients or patients that have no other medical or surgical option. Accuray is, therefore, enabling its customers to expand their radiation oncology treatment business with a new group of patients and an entirely new and unique cancer treatment service.

So, the end result is that once a customer decides to buy a dedicated full-body radiosurgery device, they invariably select the CyberKnife system. The only competition we face from the part-time systems is the budget and space within the hospital. And should we lose that competition and a customer elects to buy a part-time system, they definitely stay on our radar as a potential CyberKnife site in the future because we know they will not be satisfied with the part-time radiosurgery capability in the long-term.

As confirmation of this, several of our most important sites own two CyberKnife systems and radiation therapy systems that are marketed as part-time radiosurgery devices.

So, our strategy is to continue to build the radiosurgery market and to ensure that the CyberKnife remains the brand name technology for that market. In Q3, we continued to make excellent progress with this strategy. CyberKnife systems worldwide treated more than 5,000 patients which represents a 30% increase in treatments from the same period in fiscal '07.

On a particular note, there was an approximately 80% increase in prostate cancer treatments in the U.S. compared with the same period last year, while the number of lung cancer treatments increased by about 50% in the same time period. We hope and expect there to be important publications to further validate this utilization trend and the unique benefits of the CyberKnife system over the coming months and years.

Earlier this month, the results of one study comparing CyberKnife treatment with high dose rate, or HDR brachytherapy, was published in the International Journal of Radiation, Biology, Oncology, Physics, also known as the Red Journal, of the CyberKnife team in San Diego. The study concluded that the CyberKnife's clinical flexibility enabled it to noninvasively deliver complex HDR-like radiation doses to the prostate and also eliminated the need for hospitalization and anesthesia.

HDR brachytherapy is a proven and well-accepted method for treating prostate cancer, but it's also, by its nature, invasive and unpleasant for patients. Its invasive nature also enhances the risk of side effects. Demonstrating that the CyberKnife could replicate the dose characteristics of HDR brachytherapy with a noninvasive treatment is a big step toward validating the efficacy of CyberKnife radiosurgery treatment for prostate cancer.

To briefly consider some of our other clinical applications, last month we also announced that about 90% of all CyberKnife centers worldwide are now treating lung cancer. In fact, between November 2007 and March 2008, more than 1,000 patients were treated for lung cancer with the CyberKnife system, bringing the total treated to date to more than 5,000 patients.

The CyberKnife system is particularly promising for lung cancer because it's noninvasive, making it one of the only viable options available to patients that may have complicated medical conditions and are considered inoperable.

And as we mentioned in our last call, M.D. Anderson Cancer Center is serving as the lead investigator in an international randomized trial that will evaluate whether noninvasive CyberKnife radiosurgery could be considered a true alternative to surgery for medically-operable early stage lung cancer patients.

I can report today that this clinical trial is moving along as planned. M.D. Anderson has successfully completed its internal review of the protocol, and they expect to begin enrollment of participating CyberKnife centers within the next few months.

To educate future customers on the rapidly developing clinical market, once or twice a year we host what's known as our Robotic Radiosurgery Course. We invite existing CyberKnife customers to this event to present their experiences to qualified sales prospects who are serious about considering a purchase of a CyberKnife system. The most recent Robotic Radiosurgery Course was held in Boston earlier this month.

I'm pleased to report that more than 170 health professionals representing approximately 100 healthcare institutions from 13 different countries attended to hear presentations of the latest scientific and clinical experiences from CyberKnife users around the world. F&Ds included physicians, physicists, nurses, therapists and hospital administrators, all interested in learning the clinical applications of robotic radiosurgery and the specifics of establishing a successful CyberKnife center.

This level of attendance is a record. It represents more than double the number of attendees at any previous course, which is a clear indication of the growing strength of our sales pipeline. At the course, there were oral presentations focused on both intracranial and extracranial treatment experiences, with additional sessions covering coding and reimbursement, pair relations, and a tour of the CyberKnife facility at Beth Israel Deaconess Medical Center in Boston.

Presentation highlights included Winthrop University Hospital's experience treating 230 prostate cancer patients with CyberKnife radiosurgery, demonstrating excellent prostate-specific antigen, or PSA, response and few reports of acute toxicity. They've seen only biochemical failure to date, and that was in a patient with high-risk disease.

Additionally, experiences from Sinai Hospital in Baltimore highlighted the outcomes of 45 patients with pancreatic cancer whose prior surgery or prior radiation was unsuccessful or who were inoperable and who subsequently were treated with CyberKnife radiosurgery. The median overall time from diagnosis was 18.4 months with a local control rate of 91% for these patients. These constitute very promising results given the general poor prognosis for patients with pancreatic cancer.

In summary, the increasing utilization trends and the strength in the growing body of clinical evidence is impressive. It overwhelmingly reinforces both our leadership in the extracranial radiosurgery market and continued strong new customer interest.

In conclusion, there are three points I'd like you to take away from our call today. Firstly, general short-term regulatory development and economic conditions have negatively impacted one segment of our U.S. market and the ability of some of our more entrepreneurial customers to purchase a CyberKnife system.

But, Accuray has taken the appropriate steps to refocus its sales strategy and sales activity. Our sales pipeline is strong, and sales performance in Q3 was solid. Of particular note is the continued growth of our international business.

Secondly, the CyberKnife remains the only dedicated full-body radiosurgery device available. Claims by other radiation technology manufacturers that part-time systems can have an impact on the fast-growing radiosurgery market are not supported by independent marketing data or by our own experiences in a sales environment.

Accuray continues to define the market for full-body radiosurgery, and the CyberKnife system is the obvious choice for hospitals that decide to expand their cancer treatment services by initiating a radiosurgery program.

And finally, clinical data continues to be acquired and published, supporting the use and efficacy of the CyberKnife in treating tumors anywhere in the body. We expect to see sustained increases in the number of patients treated and expansion of use of the CyberKnife to treat new conditions as clinical studies progress and experience continues to grow.

Now, I'd like to turn it over to Bob who will discuss our financial results in the third quarter.

Thank you, Euan, and again, thank you all for joining us on today's call.

This afternoon, I will review our financial and operating results for the third quarter of fiscal 2008.

As Euan mentioned, in the third quarter, Accuray achieved its fifth consecutive quarter of record revenue. Total revenue was $58.8 million, a 57% year-over-year increase from $37.3 million in the third quarter of fiscal year 2007, and a 13% sequential increase over last quarter. For the nine months ended March 29th, total revenue was $159.4 million, an increase of 65% over the first nine months of last fiscal year.

Net income was $585,000, or $0.01 per diluted share, compared to a loss of $785,000, or $0.02 loss per share, during the third quarter of last fiscal year. This marks Accuray's fourth consecutive profitable quarter since becoming a public company 14 months ago. Net income was $5.2 million, or $0.09 per diluted share, for the nine months ended March 29th, compared to a loss of $6.1 million, or $0.26 per share, during the first nine months of last fiscal year.

Taking a closer look at revenue for the third quarter, $40.7 million was generated from product revenue, an increase of $11.2 million over the same period last fiscal year, and up 4% sequentially from last quarter.

Services revenue contributed $11 million during the third quarter, an increase of 141% over the third quarter of last fiscal year. Services revenue primarily is associated with maintenance agreements that our customers enter into with us, generally for four-year terms, and the associated revenue is recognized ratably over the respective service period.

It is important to note that services revenue was 19% of total revenue this quarter, up from 12% during the same period last year. This expanding stream of revenue provides Accuray with an increasingly significant source of recurring revenue as we move forward.

Shared ownership programs contributed $2.7 million during the quarter, up from $2.4 million for the third quarter of last year, and down from the $3.0 million last quarter. This decrease is due to shared ownership buyouts in previous quarters.

Other revenue contributed $4.3 million, compared to $809,000 in the third quarter of last fiscal year. This quarter's other revenue was primarily related to specialized upgrade services for units previously sold in Japan. Of the $58.8 million of total third quarter revenue, 18% came from our international business.

Now, I would like to remind everyone how we recognize product revenue which is generally in one of three ways. First, product revenue is recognized upon CyberKnife installation and acceptance where Accuray carries the responsibility, such as our direct territories in North America, Hong Kong and several European countries.

Second, when selling through certain distributors to international customers, we recognize product revenue upon shipment to the end customer. In these cases, the distributor assumes responsibility for installation and our contractual obligations are met upon shipment.

And third, product revenue is recognized from Legacy Platinum accounts. As you recall, once the final upgrade has been installed on these contracts, we then ratably recognize the value of that agreement over the remaining life of the contract.

Exiting the third quarter of fiscal 2008, all of these 30 Legacy Platinum systems are installed, and we are recognizing revenue on 18 of them. Of the 12 systems that remain, most have only one or two upgrades left before we can begin to recognize that revenue.

During the quarter, we sold the rights to six of our shared ownership units to Alliance Imaging. Alliance is a leading national provider of shared service and fixed site diagnostic imaging services with 88 imaging centers and 12 radiation therapy centers.

This transaction provides the opportunity to develop a strategic relationship with Alliance and encourages Alliance to partner with the growing number of hospitals interested in establishing a full-body radiosurgery program. Alliance has established a dedicated business unit, known as Alliance Radiosurgery, to operate these sites and pursue the radiosurgery market.

Two additional sites bought out their shared ownership agreement, one of which included a free-standing physician group that was already using the system. The other was sold to 21st Century Oncology in connection with their acquisition of the Radiation Oncology Services business at the hospital where the CyberKnife is located.

We don't disclose the specific selling prices for any deals because of competitive reasons, but it should be noted that multi-year service agreements providing recurring revenue have been signed as part of these deals.

These transactions reduce the number of shared ownership sites to four. We installed one new shared ownership unit during the third quarter.

We will continue to offer our shared ownership programs as we see advantages in maintaining this program. It provides customers an effective lease-to-buy structure, therefore making it easier for qualified institutions with capital constraints to obtain our technology, build a customer base and revenue stream which will ultimately fund the outright purchase of the system. It will be a smaller part of our business, but nonetheless important.

Our goal in connection with shared ownership transactions will be for customers to ultimately purchase the system either early at their election or in accordance with the provisions of the shared ownership agreement.

Gross margin for the fiscal third quarter was 44.7%, resulting primarily from the lower-than-average margins from the sale of the shared ownership systems. In addition, as previously noted, we delivered multiple specialized upgrades for units in Japan which also yield a lower overall margin.

While gross margin was pressured in the third quarter, we expect margins to return to levels approximating recent historical averages in the fourth quarter as we do not anticipate activity of the same magnitude that resulted in the margin pressures.

Total operating expenses for the third quarter of fiscal 2008 were $27.4 million, or 47% of revenues, an improvement from 61% of revenues in the third quarter of 2007 and 52% sequentially. Our investment in research and development was $8.6 million for the quarter and shows improvement as a percentage of revenue.

In Q3, R&D was 15% of revenues. Q2 of this fiscal year, it was 16%. And a year ago, it was 19%. So, the total of research and development expenditures as a percentage of total revenue has been decreasing sequentially, but our absolute dollar investment in R&D continues to increase as we are committed to continuing to develop and improve our technology.

During the third quarter of fiscal 2008, we recorded non-cash stock-based compensation of $4.2 million, or $0.07 per diluted share. There were eight new system installations completed in the third quarter -- five in the United States, two in Japan, and one in Asia -- bringing the worldwide installed base to 134. As of the end of the fiscal third quarter, the geographic installed breakdown is as follows: Americas 87, Japan 19, Rest of Asia 16, and Europe 12.

Now, I would like to spend some time discussing backlog with an effort to provide greater transparency. Let me start by saying that our definition of backlog has remained the same and that backlog includes signed contracts that the company believes have a high probability of being recognized as revenue in the future.

We would like to provide more color and insight into our current backlog. As such, we have posted a chart on the Investor Relations section of our corporate website at www.accuray.com. The chart shows a segmented snapshot of backlog. We have also shown Q2's balance, so that you can draw sequential quarter-on-quarter comparisons.

Backlog at the end of the third quarter of fiscal 2008 was $602 million, up from the same period last year, but down sequentially from the previous quarter's balance of $660 million.

Aside from revenue coming out of backlog, the sequential decrease of $58 million is a net result of cancellations of existing contracts of approximately $54 million, combined with unfavorable contract movements out of backlog based on our specific assessment. All of these cancellations were associated with contingent contracts and 90% were non-hospital deals.

Euan touched on the uncertain regulatory and financial environment that affected these deals. It did not affect the non-contingent deals. In fact, over the last 18 months, we have only had three non-contingent contracts cancelled and two of those were from the same group.

Of the $602 million in total backlog, $332 million, or 55%, is associated with CyberKnife systems, and $270 million is associated with recurring revenue.

At this point, I would like to walk through the chart and give you some basis to stratify the risk profile of the backlog.

The chart segments ending backlog into non-contingent and contingent backlog, and then further breaks down these categories into CyberKnife, services, and shared ownership.

Of the ending total backlog of $602 million, approximately 64%, or $386 million, is non-contingent backlog, in that the contingencies to which the contracts are subject have been satisfied. This reflects an increase of $14 million over the last quarter and represents a movement of $86 million from contingent to non-contingent during the quarter.

The remaining 36%, or $216 million, of backlog is contingent backlog which may include standard contingencies such as board approval or certificates of need. Of this contingent segment, about two-thirds represents hospitals and roughly one-third consists of contracts that are associated with entrepreneurial free-standing sites which includes physicians or physician groups that are embarking on their first equity venture without an existing hospital relationship.

It is also important to note that not all contracts signed this quarter are included in backlog. Every order that is received is reviewed to assess the magnitude of the contingencies and, if they are deemed significant, then the order is excluded from the ending backlog for the respective period until the probability of installation associated with the contract is deemed reasonable to be included.

In addition, on a quarterly basis, we review each contingent contract included in backlog, specifically whether customer engagement and progress towards satisfaction of contingencies warrant continued inclusion of the contract within backlog.

Moving to our balance sheet, cash and investments as of March 29, 2008, was $165.5 million. This consists of cash, short-term investments and approximately $21 million in long-term investments.

Deferred revenue was $118.4 million with $86 million in current deferred revenues. Total assets at the end of the quarter were $293.9 million, and the company continues to have zero debt.

Last August, Accuray's board of directors approved a stock purchase plan providing the company with the ability to acquire up to $25 million worth of its common shares in the open market for a period of one year. Within this third fiscal quarter, we repurchased $18 million worth of stock and, through March 29th, we have repurchased approximately 1.9 million shares, or $21.6 million worth of our equity.

Turning to guidance, last quarter we gave a revenue range of $210 million to $230 million for the fiscal year 2008. We are reaffirming this range.

In summary, Accuray has had its fifth consecutive quarter of record revenues and its fourth consecutive quarter of profitability, and its balance sheet remains strong and without debt.

And with that, I would like to turn the call back to Euan.

Thanks, Bob.

So, in summary, despite challenges to one segment of our U.S. market, over overall sales performance continues to be solid, and our revenue once again reached a record level this quarter.

CyberKnife has once again been validated as the clear leader in the fast-growing field of body radiosurgery, and our clinical programs continue to expand. This is an excellent indicator of future growth to come.

And now, I'll be happy to answer your questions.

Thank you. The question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS.) Thom Gunderson, Piper Jaffray.

It's actually Amy calling in for Thom this afternoon.

One quick question--.

--Hey, Amy.

As far as international and domestic type order growth, you mentioned that you're seeing some strength international whereas, on the other hand, some of the other players in the radiation and oncology field have noted weakness in Europe. I'm wondering if you can give us any more color from your perspective on what you're seeing as far as pockets of strength or weakness in different international geographies.

Yes. It's difficult to comment on other people's perspective of the market. I mean, I can comment on our own which is that Europe is actually, right now, one of our high growth areas, very definitively.

I think we had somewhat of a slow start which is not unusual for Europe because the European market is very sensitive to clinical data, and new technologies tend to be slower to take off.

I think some of our competitors, or some of our peers I should say, came into the replacement market and that market was already well-established, so the whole dynamic was slightly different. Now, how that market is affected, I really couldn't say.

But, from our perspective, I think people are really seeing the clinical value, and CyberKnife is the technology that essentially, we believe, reduces the overall cost of treatment of cancer by avoiding the need for surgical procedure. And in a price-sensitive market like Europe, once you have good clinical data, which we're really starting to get now, I think we could definitely expect to see this particular market grow for us, and the signs are definitely there right now that it is.

Okay.

And then, kind of a follow-up. Over the last couple of quarters, there have been, as Bob mentioned, with the distributors that have the ability to do the install, you can recognize revenue up-front. What is the typical lag time for those units to actually be installed?

Well, it really depends on the distributor, but a couple of months is certainly reasonable. It depends on how it's shipped, if it's shipped by boat, if it's shipped by airplane.

But, when we ship, they know where it's going. They know the end customer because, obviously, these are very expensive units, and they want to make sure that they've got their money in hand or, at least, the money is safe, that they know they're going to get the money before we even ship. Similarly, we want to protect ourselves, so that we want to make sure that we're not shipping any units without certainty of receiving the cash for that.

So, it's usually just the next quarter that you'll see that come through as far as the install?

Generally, yes.

Okay.

And then, one just quick numbers question. The interest and other line, is there anything nonrecurring type or unusual included in that line this quarter?

Well, the upgrades of the Japan units in the -- are you talking about down below?

Right, as far--.

--You talking about other revenue or the -- yes. No, it's just interest--.

--Okay--.

--If you're talking about other income and expenses, that line?

Right.

Yes, it's just interest.

Okay. Thank you.

Peter Bye, Jeffries & Company.

Hi, Peter.

Hi, Peter.

Hi, this is Peter and Josh Jennings.

Hi, Josh.

Hey, Josh.

I think I may have missed it. The order number in the quarter, was it $76 million?

Yes, total, yes.

Total new orders.

Total new orders, correct.

And then, how does that compare on a year-over-year basis from the fiscal third quarter of last year?

Well, year-to-date orders are about 20% higher than year-to-date last year.

And you were just about to comment on the other income line. Was there any reason why it was such a big number this quarter? Was it just timing, and it just happened to work out that way?

Yes. Are you referring to other income or other revenue?

I'm sorry, other revenue, excuse me.

Yes. That's just a matter of timing.

Great.

And just back to your new orders, can you breakout sort of the breakdown between international and domestic orders for the quarter?

So, we said in the call six out of the 16 were international orders.

Okay, thank you.

So, could you maybe comment on the bump-up on the accounts receivables and anything in particular there, international, with Japan, with--?

--Sure. Yes, there's actually two parts to that. But, that's really just a timing issue because if the installs occurred towards the end of the quarter, then the receivables tend to come in after the quarter.

So, would you expect that to come back down on the June quarter?

Correct.

Okay, thanks.

I mean, it would depend on the number of installs at the end of June but, yes, in terms of those dollars coming into the company, yes.

Great.

And just one more, you commented that trends have been positive with sort of refocusing the sales force on the hospital-based customers. Can you give us any more color on that in terms of what those trends have led to? Were those positive in this quarter?

I would say it's still kind of a work in progress to some extent. They were generally positive trends. I think the biggest indicator we had during this quarter was the attendance at the Robotic Radiosurgery Course. As we said, almost 100 different institutes represented there.

And what we're seeing in the pipeline is a definitive trend towards the hospital versus non-hospital deals.

Okay.

And I would add that those deals tend to be ones which are harder to kind of incentivize to a quick sale. It tends to be more of a process inside the hospital.

You can offer a sales promotion, for example, and when you're dealing with sort of an entrepreneurial site, then it's more likely to be effective in closing a deal in short-term than going through a hospital which has just got a natural buying cycle and there's nothing you can really do to push it through the system.

So, we're very, very positive about the overall trend and what we're seeing in the pipeline. I think that to maintain the level of sales activity that we have, despite the pressures that we've been pretty open about, I think is actually a sign of overall strength of the market.

And I do want to stress that what we're talking about is just one segment of the U.S. market and all other aspects of the market really remain strong for us.

And then, just one last question on that front. On the competitive side, are you seeing that your sales force is coming head-to-head on accounts they're looking to develop a stereotypic radiosurgery program? Any competitors out there that you're seeing more frequently in the quarter?

No. We're seeing a lot of noise and marketing activity, but the reality is I don't think the market has really changed for us. I think that the -- sort of Novalis, for example, has always been there. We made this point last quarter.

And I do want to be very strong about this, that the level of competition we tend to see with these part-time systems, which are all that is really out there, is for budget and for space inside the hospital. And it's very typical that we'll come into the hospital and we'll be talking to them about a full-time radiosurgery program, whereas somebody else is there saying, "You can really make do by upgrading your existing [Linact]," and offering some part-time radiosurgery. And that's the big decision that the hospital faces.

Whenever they choose to go for a full-body radiosurgery program, I can't think of a single site where we've seen them choose anything other than the CyberKnife, and that's really born out by the strength of the market.

We tend to answer a lot more inquiries -- and I've said this many times to individuals -- a lot more inquiries about this competitive overlap in the sort of investor relations world than we do in the marketplace.

And the reason for that is really demonstrated by the Dominick & Irvine data. We have there solid evidence that very few extracranial radiosurgery cases are ever treated on these part-time units. And I think the market tends to understand that. The customer market tends to understand that, so the choice is relatively clear for them.

So, in terms of an overall trend, I would say no significant difference other than a fair amount of activity, noise.

All right, great. Thanks a lot.

Junaid Husain, Soleil Securities.

Hi, Junaid.

Hi, Junaid.

Good afternoon, gentlemen.

Relative to the $54 million of contracts that you removed from backlog, when you guys described your backlog assumptions back in the fiscal second quarter, I guess the question becomes why didn't you remove this $54 million of contracts back then, or was there something different back then than what we saw in the fiscal third quarter?

Sure, yes.

Well, first of all, let me just say the cancellations occurred for several reasons, mostly due to the concerns around the uncertainty relating to regulatory changes, underwriting arrangements with hospitals.

So, this ambiguity affected customers and, most importantly, affected their business models, right? And so, this is why they cancelled their orders. Now, they've cancelled them at least until there's more clarity around that uncertainty.

And what happened originally was there was supposed to be -- and this is what our regulatory advisors tell us -- there was supposed to be a decision, or at least an announcement made about November timeframe. And so, some people, when that decision wasn't made in November, they cancelled. Other people waited to see, okay, well, that means they're going to make this announcement soon.

Well, now, what we've heard is that the conclusion or the announcement won't be made until July. And so, the remaining customers who were sort of sitting on the sidelines waiting for that clarity didn't get it, and so now they have pulled back on their contracts.

And this announcement is relative to--?

--So, Junaid, it's the CMS ruling. When the CMS proposed changes to -- or updating Medicare reimbursement, when they made their announcement last summer about the proposed changes, they mentioned in that that they would be evaluating these under-arrangements, which is where essentially a free-standing center contracts with a hospital. The hospital bills Medicare patients who are treated, and they pay the free-standing center under contract.

So, they said they would evaluate this. And this wasn't specifically to do with CyberKnife. I think they were looking at the broader picture. A lot of imaging centers and imaging services are provided in this way.

And then, everybody was really waiting for clarity. So, we had some people that kind of reacted to that immediately and it sort of changed their business model. They either pulled back or delayed, and that was really the first impact that we saw. And that materialized really over the summer.

And then, people were expecting, when they published the final rule change, to have some more clarity, and that was the one that happened in November. The reality was that CMS didn't really clarify the situation. They said that they had a lot of data, a lot of input from a lot of different people, and that they're evaluating that over the course of time.

And I think when people didn't get the clarity that they were hoping for, then we did have another batch of people that reevaluated their business plans.

Okay, that's helpful.

Let's switch gears just a bit and talk about Alliance Imaging. And I can appreciate that you don't want to give us what the ASP was on those boxes that you sold to Alliance. But, can you tell me where those revs show up on the P&L? Are they showing up in the -- I'm assuming they're showing up in the product line, then.

That's correct.

Okay.

And the purchase price, does the purchase price represent the fair value of the instruments, or did you--?

--Well, the purchase price technically represents the total value of the unit and the relationship. So, an important component of that is, in fact, the recurring revenue stream -- for us, is the recurring revenue stream that we will be receiving.

And so, this is not as if they're buying brand new CyberKnifes from us and their sort of ownership is slightly different. What they're really doing is they're buying the revenue stream associated with those products because the products are already installed at hospital sites, and there's a revenue share in place at that site.

So, a lot of the value for us, as Bob said, was in the recurring revenues going forward. And in fact, just to sort of give you an example of value of that, the net change in backlog for us was only about $4 million or so because they signed up for very valuable long-term service arrangements at the same time.

Okay.

And then, Bob, on the gross margin front, so, the instrument margins are lower than I was modeling and down sequentially. And when I look over the last year or so, the instrument gross margins seem to have been steadily coming down since their highs, let's call it, like the low 60's in early 2007, which of course begs the question what's happening to pricing?

Um-hmm. Well, I'll just speak to the variables that can affect that. Certainly, pricing is one of those, although we have kept our pricing up in the U.S. Internationally, when we're working through distributors and if the product mix is growing towards distributors, they obviously have to have their cut, so that does affect the gross margin.

Got you.

And then, the shared ownership revs, I guess half or more of it's going away, and the shared ownership actually had pretty decent gross margins. So, I guess how should we be thinking about gross margins now, I guess just given the fact that the shared ownership revs are lower with a lower gross margin contribution?

Yes. Well, I think the total gross margin, the way to think about it is we clearly are going to be trying to improve that based on what this quarter would show. And because of the two items that we spoke about, the shared ownership purchase as well as the upgrade units in Japan, that did dampen the gross margins. So, going forward, we would expect it to get more to the historical levels and in the 50's.

So, don't forget that with the shared ownership program, we do have some kind of committed costs associated with that. We have to provide service. We also have to provide a level of upgrade depending on the commitment we make when we sign the original agreements. So, there are definitely costs associated with the revenue we generate from those.

I think what we're looking to do, at least from these particular contracts, is just sort of tidy that up and put it into a more conventional service line.

All right. Good enough, guys. Thanks so much.

Thank you.

We ask that you please limit your questions to one. Eric Schneider, UBS.

Good afternoon, or good evening.

Hi, Eric.

Hi, Eric.

I can probably get it into one question, but it's going to have a lot of "ands" in it. So, on the backlog, first, thank you very much for providing more information because I think that's going to be helpful for us and for investors.

Are you going to restate or provide the details going back farther given how long the window is from order to install? That's, I think, necessary for people to figure out what they should be expecting in terms of revenues in the next year.

Yes. I think what you're asking really -- we're not going to go back historically and restate all of this, but we have shown Q2, so you have the breakdown there. And if you go way back, I think you've got some non-contingent numbers as well that have been public.

But, the way to think about this -- because I think what you're really asking what's the risk profile of this backlog? And the way to think about it is the non-contingent, very, very low, low risk. In fact, just under half of this is actually already installed, so we're going to be getting the services revenue on that.

If you focus on the contingent piece, you know that we've actually pulled out a lot of the contracts out of here based on this quarter's assessment. And when we do that, we look at each contract and we say, "Okay. What is the demonstrated progress towards contingency resolution, and what milestones have they achieved?" So, we've really scraped this.

Now, what's left are contracts where the highest risk profile of the customer is probably this entrepreneurial free-standing center which is about a third of this total contingent. And so, if you wanted to handicap this backlog, that would be a good way to look at it.

But, we won't go back and break this out on a quarterly basis.

And I think one of the reasons, again, for not doing that, as Bob indicated, is when we're giving you non-contingent backlog, we have such a low fall-out rate from our non-contingent backlog that it really should reinforce your ability to build the model.

Okay.

And on the new orders, do those almost all go into the contingent bucket of that backlog? When we calculate the changes second to third quarter and look at the new orders, it looks like about $69 million of those $77 million of new orders is now in the contingent bucket of backlog. Is that right, or did I mess up the math?

No, not all of the orders that we take, the order immediately goes into any backlog. There's an element of it that we consider, that we have to observe for a little while to make sure that we even put it into the contingent backlog.

And it's rare, I would say, for the dollar value of orders to go straight into non-contingent backlog. The exception to that, I think, would be international orders where we, I think -- what number was it -- five systems from international customers that went straight into non-contingent this quarter.

Okay.

I'll respect the request and get back in queue.

Thank you, Eric.

And we have six minutes left for today's conference call. Tycho Peterson, JPMorgan.

Hi, thanks for taking my call. It's [Tace] in for Tycho.

Just a question about the treatment planning service that you mentioned that you were starting to launch last quarter, can you give some clarity on how that's progressing?

Yes. We're doing well. We have our first customer lined up, and we're on the verge of initiating the treatment -- oh, sorry, the service.

So, you haven't booked any revenues from that, but it--?

--None of the revenue in this quarter is from that service.

Okay, great. Thank you.

You're welcome.

Amit Hazan, Oppenheimer & Company.

Hi.

Hi, Amit.

First of all -- can you hear me?

Yes.

Yes.

First of all, on your new orders of $76.6 million, I mean, obviously, when we do the math just like you asked us to do in the past, we don't get to that number. So, do you want to give us the breakout of what component of that $76.6 million doesn't even go into your backlog number?

Yes, about 80% went into backlog.

Okay.

So, what is the point of giving us the other 20% at this point?

Really showing you the level of sales activity. So, I think we recognize that this is a very fast-changing environment, and I think the perspective from that is the greater clarity and the greater information we can give you, the better it will be.

Yes. Keep in mind that each time we go through this, we do look at the customer. We look at their ability to follow through. And so, these orders are very important. The customer has spent a lot of time getting this contract, reviewing the contract, having their attorneys review it. And they're signing this very important document, so they take it very seriously.

Now, when it comes into our house, then we do a review of it, and we decide whether or not it should be included in backlog. But, that doesn't mean that just because it's not in backlog now, it won't be in backlog later.

David Fondrie, Heartland Funds.

Yes, good afternoon.

Hey, David.

Hi, David.

I wonder, just thinking about your operating model here and specifically sales were up, and yet we still didn't cover operating expenses which were relatively flat. As you go forward, are you going to grow into your operating expense? I mean, is that the plan, to grow into operating expense as opposed--?

--Yes, yes. Thanks for the question.

I mean, the reason that we weren't more profitable this quarter almost is because of the lower gross margin. That's really where -- with a higher gross margin, that we will be able to leverage that and that will drop to the bottom line. So, profitability is clearly one of our priorities.

Now, that said, we want to make sure we're not shortchanging the future of the company by not investing in things like R&D, in things like marketing and sales, as we build the business.

Keep in mind that we really do have to invest quite a bit ahead of when the revenue is recognized because you build out your sales organization, you sign these contracts, and you're not actually going to see the revenue until 12 to 18 months later.

Larry Haimovitch, HMTC.

Good afternoon.

Hello.

Could you talk a little bit about your share buyback? You bought back I think 1.7 million shares. What have you authorized for further buyback?

Well, yes. So, the existing buyback that is in place was a $25 million repurchase. And so, of that, we've purchased $18 million this quarter. In total, we purchased $21.6 million worth, which is 1.9 million shares.

So, you bought another 200,000 so far this quarter. Is that right?

Well, it's actually prior to the quarter.

And are you continuing to buy the stock now? Because you do have authorization to.

Well, technically, we're in a closed period, and so--.

--Oh, okay--.

--During a closed period, which begins generally two weeks before--.

--Okay, got you--.

--The quarter ends, or if there's even material inside information--.

--Yes, yes--.

--We can't actually buy it on the open market, so we have to wait until--.

--Right--.

--An open period which is, in this case, 48 hours after (inaudible).

Bob, what's the long-term investment in the balance sheet this quarter that appeared for the first time, $21 million?

Oh. So, okay, yes. So, that is a cash investment. It's auction rate securities. So, we've got about $21.4 million in auction rate securities. These are student loans backed. They're all AAA-rated. And so, we have them in the long-term portion. We could hold them to maturity. It doesn't really affect our liquidity.

And we did, however, take a temporary impairment charge of $1.1 million to record the investments at their current value, so we're going to keep them there basically until there's resolution on the entire auction rate securities situation. But, we don't have a short-term need for that cash given our strong financial balance sheet.

That concludes the question and answer session today. At this time, Dr. Euan Thompson, I will turn the conference back over to you for any additional or closing remarks.

Thank you.

So, in conclusion, there are several key points to take note from our call today. Firstly, despite certain short-term regulatory and economic challenges to one segment of our U.S. market, our sales pipeline remains strong and sales performance in Q3 was solid.

Secondly, the CyberKnife remains the only dedicated full-body radiosurgery device available. Claims by other radiation technology manufacturers that part-time systems can have an impact on the fast-growing radiosurgery market are not supported by independent marketing data or by our own experiences in the sales environment.

And finally, clinical data continues to be acquired and published, supporting the use and efficacy of the CyberKnife in treating tumors any where on the body. We expect to see sustained increases in the number of patients treated and expansion of use of the CyberKnife to treat new conditions as clinical studies progress and experience continues to grow.

Thank you to everybody for your time today. We look forward to talking to you next time.

Thank you for your participation. This concludes today's conference. You may now disconnect.