Accuray Inc (ARAY) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Accuray's Third Quarter Fiscal Year 2011 Earnings Conference Call. My name is Erika and I will be your coordinator for today. At this time, all participants are in a listen only mode. We will be facilitating a question and answer session towards the end of this conference. (Operator Instructions).

I would now like to turn the presentation over to your host for today's call Mr. Tom Rathjen, Vice President of Investor Relations. Please proceed.

Thanks Erika. Hello, and thank you for joining us this afternoon for Accuray's conference call as we review the third quarter of fiscal 2011. Joining us today is Dr. Euan Thomson, Accuray's President and Chief Executive Officer, and Derek Bertocci, Accuray's Senior Vice President and Chief Financial Officer.

As we have done in past quarters, we will again be referring to revenue and backlog data which are found in PDF files on the Investor Relations page of the Accuray website at www.accuray.com. Please log onto the 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, but are not limited to, revenue, guidance, installations, gross margins, operating expenses, profitability, clinical acceptance, and regulatory approvals. These and other risks are more fully described in the risk factors section of our annual report on Form 10-K as updated from time to time by our quarterly reports on Form 10-Q and other filings with the SEC.

In addition, nothing in our discussion today should be considered a solicitation of proxies in connection with our pending acquisition of TomoTherapy or an offer to sell or purchase shares of Accuray or TomoTherapy. All such solicitations and offers are to be made pursuant to the proxy statement and registration statement to be filed with the SEC.

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

Thank you, Tom. And thanks for everyone for joining us on today's conference call to review our third quarter of fiscal 2011. I will start with a recap of business highlights of the quarter. I'll comment on the current sales environment for the CyberKnife, provide brief reimbursement and clinical updates, then review the pending acquisition of TomoTherapy Incorporated.

During the third quarter, we added 13 new CyberKnife orders to backlog, increasing total backlog by nearly 18% from the third quarter last year. Four CyberKnife systems were installed and thirteen were shipped during the quarter. During the past four quarters, 55 CyberKnife orders have been added to backlog, 37 units have been shipped and 30 units have been installed for customers around the world.

I'll now provide a brief review of the business highlights of the third quarter of fiscal year 2011, and I'll then turn the call over to Derek for a detailed financial review.

During the quarter, Accuray's total revenue was $54.7 million. Revenue from sources excluding previously deferred Platinum revenue was $54.4 million, representing approximately a 12% increase over the same period last year.

During the third quarter, we recorded a net loss of $1.2 million or a loss of $0.02 per share compared with a net income of $2.3 million or $0.04 per diluted share in Q3 of last year. The loss for the quarter was a result of one-time expenses associated with the pending acquisition of TomoTherapy, which totaled approximately $2.6 million. In addition, we funded a users meeting in Q3 of fiscal 2011 that did not occur last year.

Very little of Accuray's business is replacement equipment. In fact, none of the 13 CyberKnife systems ordered in Q3 were replacement systems. Although this presents Accuray with greater challenges in the sales process, it does mean that each CyberKnife installed can be viewed as an incremental source of future service revenue. Of the $58.5 million added to Q3 backlog, $15.3 million came from new service contracts. As our service contract capture rate remains high, a positive book-to-bill ratio not only indicates future growth in product revenue, but also corresponding growth in future service revenue.

Of the 13 orders, CyberKnife orders, three came from our Americas region, six came from our European region, one was from Japan, and three were from our Asia Pacific region. Eight of the orders were for the latest VSI system. As a reminder, the CyberKnife VSI System is our premium product, providing us with the highest average selling prices and correspondingly higher gross margins.

Derek will provide a more a detailed analysis of backlog in a few minutes. In Q3 as in past quarters, we observed little change in the competitive environment for the CyberKnife. It remains the case that once a healthcare center chooses to create a dedicated full body radiosurgery practice, the CyberKnife is the most likely choice over all other products, including hybrid radiation therapy systems.

Reviewing each region in turn, our US sales force continues to see strong interest in CyberKnife radiosurgery and an improving sales environment. As I will describe shortly, clinical growth for key applications remains strong, and we have a steadily increasing pipeline of potential customers. In all cases, they represent a business expansion for our customers rather than a replacement over an existing device, and we are not yet seeing backlog growth in the US that we are seeing in other parts of the world.

The European region remains particularly strong for Accuray. The team reports no signs of the region slowing down, with the momentum continuing in major markets including Eastern Europe. As a sign of this growing momentum, one European CyberKnife site that treated over 600 patients last year ordered a second CyberKnife system. This marks the second customer in the region to order a second CyberKnife unit to address the increasing demand for radiosurgery treatment.

The Asia Pacific region also continues to show strength, particularly in Korea and China.

The Japan region suffered some slowdown in new business immediately following the earthquake and Tsunami in Q3, but the impact is not enough to affect our outlook for this region. One point of note, was that in the area most impacted by the Tsunami, the radiation treatment units from all manufacturers present at the local radiation oncology center were damaged. The only unit working again within a few days was the CyberKnife. As an aid to patients in this region, Accuray donated and upgrade this site to enable the CyberKnife to treat the patients who would otherwise have been treated on the radiation therapy machines. The donation of this upgrade is reflected in our financials, but we wanted to play our part to help cancer patients in this hard hit area.

Significant progress has been made recently in expanding patient access to CyberKnife treatments. In March, Palmetto, the Medicare contractor for eight states including California, Nevada, Hawaii, Ohio, Virginia, West Virginia and the Carolinas, published payment rates for free standing CyberKnife centers at parity with our hospital outpatient departments. This move by Palmetto, adds to similar decision made in other Medicare jurisdictions, including New York, Connecticut and the New England States, and opens up opportunities for CyberKnife sales for free standing centers in these key markets.

In the United States, free standing centers represent approximately 36% of the radiation therapy market. However, as I've said our current projects in the US are 95% hospital based. With the new fee determination by this important Medicare contractor, the free standing market now provides an attractive and viable extension of our market opportunity in the United States.

Also impacting patient access last month, the largest Medicare contractor in the US, Meridian Administrative Services, and one of the only two contractors that did not cover CyberKnife treatment for prostate cancer, retired its policy. This decision removes the previous impediment to claims being paid for CyberKnife prostate treatment in nine Western states, including Arizona, Oregon, Washington and Utah. With this decision, CyberKnife treatment for prostate cancer is now available to Medicare beneficiaries in 46 states plus the District of Columbia. These actions along with continued policy improvements among private insurance providers, expands access to CyberKnife treatment to hundreds of thousands of patients who are battling prostate cancer.

Partially as a result of this progress with patient access, combined with recently published scientific data, we have seen an increase in utilization of the CyberKnife for prostate cancer treatment. In Q3, we observed a 9% increase in prostate cancer treatments with the CyberKnife in North America compared to the previous quarter. Compared to Q3 last year, we have seen a worldwide increase of 20% in prostate cancer treatments, a 14% increase in lung cancer treatments and a 30% increase in liver cancer treatments.

One important event in Q3 was our CyberKnife users meeting. Over 120 CyberKnife clinical and technical abstracts were presented at the meeting. 340 surgeons, radiation oncologists, therapists, medical physicists and other associated professionals from 12 countries were in attendance, sharing their CyberKnife treatment experience. Important updates were presented on all areas of clinical development and the level of enthusiasm and interest for this fast developing field was strong.

In March, we announced our intention to acquire TomoTherapy Incorporated for approximately $277 million in cash and stock. This transformative transaction will create the premier radiation oncology company by combining two best-in-class technologies, treating complementary patient populations with a significantly greater global presence. I'm happy to report that the acquisition process is progressing on schedule with Hart-Scott-Rodino anti-trust clearance occurring last week.

The combination of Accuray and TomoTherapy provides significant increase in scale, a critical element for a capital equipment company. Upon completion of the transaction, Accuray will have significantly increased market presence with the largest sales force creating significant scale and scope. TomoTherapy reported an installed base of 350 units during Accuray's Q3. Adding these units to our own, we'll more than double our market presence and create a larger source of recurring revenue plus enhanced opportunities for the sale of new products, upgrades, cross selling of CyberKnife and TomoTherapy systems, repeat sales and eventually replacement systems through these ongoing business relationships. We anticipate the greater scale should also moderate the inherent lumpiness in our quarterly revenue.

Shortly after we announced our plan to acquire TomoTherapy, we began the process of detailed integration planning. We have hired Deloitte Consulting and one of their experienced M&A integration teams to help us with the process of developing a plan. In order to ensure the plan is comprehensive, we have established a joint integration team made up of members of both companies. They're making excellent progress towards ensuring that we will have a smooth transition, integrating into one company and ultimately delivering value to our shareholders. From a financial standpoint, we expect to achieve significant benefits in both operating efficiencies and from an estimated $25 million in cost synergies related to combining two publicly held companies.

As we previously announced, we expect the transaction to generate a loss in fiscal 2012 and to be dilutive to our earnings per share. However, we expect to return to profitability in our fiscal year beginning in July of 2012, with the acquisition to be accretive to our earnings per share. I can report this transaction remains on schedule with an anticipated close in the June, July timeframe.

With that, I'll now turn the call over to Derek for the financial review. Derek?

Thank you, Euan. Revenue for the third quarter of fiscal 2011 was $54.7 million, up 5% from the third quarter of the prior year. Excluding revenue previously deferred for systems sold with legacy Platinum service agreements, revenue was $54.4 million, up 12% from the comparable figure for the third quarter of the prior year.

The gross profit margin for the quarter was 49.9%, up from 48.9% in the third quarter of the prior year. Operating expenses for the third quarter were $27.8 million, an increase of 23% from the same period last year. This increase was driven by $2.6 million of one-time expenses associated with the pending acquisition of TomoTherapy, plus increased expenditures for research and development and marketing. The overall result was a net loss of $1.2 million or a loss of $0.02 per share for the third quarter compared to net income of $2.3 million or $0.04 per diluted share for the third quarter of the prior year.

Excluding the $2.6 million of one-time expenses associated with the pending acquisition of TomoTherapy, results for our third quarter would have been a net profit of approximately $1.4 million or $0.02 per diluted share.

During the third quarter, 13 new orders for CyberKnife systems were added to backlog. There were two cancellations of orders, including an order in Japan that was cancelled and rebooked by a related customer in Q3, The second cancellation was due to a partnership issue.

During the third quarter one order aged beyond 2.5 years in backlog. Customer has not cancelled this order. However, under our policy orders may not remain in backlog for more than 2.5 years. Accordingly, we have removed the value of the order from our reported backlog. On shipment or installation, as appropriate, we will report the value of the order in the related revenue simultaneously. Accordingly, the order will not be part of any backlog in any future period.

In summary, net orders to backlog totaled 10 systems in the third quarter. We shipped 13 units and recognized product revenue on 11 new systems during the third quarter. Net orders to backlog totaled $58 million during the third quarter, $36.5 million for systems and $21.5 million for service.

Comparing the net dollar value of orders received to revenue recognized, our four quarter rolling book-to-bill ratio for systems was 1.2 as of the end of the third quarter. Our backlog of system orders at the end of the third quarter was up 19% from one year ago.

Over the last 12 to 18 months we have broadened our range of customers from which we have received orders. Our systems backlog now includes more orders from major academic institutions and customers in emerging markets. We anticipate that these customers will require more time to move from order to shipment and installation than our average for customers in the past. As a result, we expect that orders for CyberKnife systems currently in our backlog will require more than 12 months on average to convert to revenue. Charts reflecting our backlog have been placed on the investor relations page of the Accuray website.

CyberKnife product revenue totaled $35.2 million and service and other revenue totaled $19.5 million, both up from the third quarter of the prior year. Excluding revenue previously deferred for system sold to Platinum service agreements, product revenue totaled $35 million, up 11% from the third quarter of the prior year.

The increase in product revenue was due to higher average selling prices that we have been able to secure and maintain with the release of the CyberKnife VSI.

Excluding revenue previously deferred for systems sold with Platinum service agreements, services revenue totaled $18.2 million, up 10% from the third quarter of the prior year. The increase in services revenue was due to an increase in the installed base under service contracts. Average service revenue per system remained stable during the third quarter. We had no significant net movement of customers to the less expensive service plans.

We sold systems with Platinum service agreements through fiscal 2006. In such systems all product and service revenue and related cost of sales were deferred until the last promised upgrade was installed. Once this was completed for each system, we began to recognize the deferred revenue and cost of sales over the remainder of the service contract.

We recognized $60 million of Platinum revenue in fiscal 2009, $29 million in fiscal 2010 and expect most of the remaining $5 million in Platinum revenue be recognized in our current fiscal 2011. For systems still covered by Platinum service agreements in fiscal 2011, we recognized $0.6 million of revenue in the third quarter and $4.8 million year-to-date. This virtually completes the recognition of legacy deferred revenue.

Product margins improved to 60% from 57.3% in the third quarter of the prior year, largely due to the shipment of VSI systems in the third quarter of fiscal 2011. Additional features and capabilities enable VSI systems to garner a higher average price than earlier models. Service margins were 33.4% compared to 39.6% in the prior quarter and 32.7% in the third quarter of the prior year. Service margins vary somewhat by quarter due to variations in service calls and parts usage, but have demonstrated a long-term upward trend due mainly to greater efficiency derived from increases in the number of systems covered by service contracts and lower expense for repair parts.

We expect this long-term trend, upward trend, in service gross profit margin to continue in the fourth quarter of fiscal 2011. We expect our overall gross profit margin will be in the range of 50% to 52% in fiscal 2011, up from 46.9% in fiscal 2010.

During the third quarter, operating expenses totaled approximately $27.8 million, an increase of $5.2 million from the third quarter of the prior year. The increase in operating expenses was driven by $2.6 million of costs associated with the pending acquisition of TomoTherapy and a $1.6 million increase in spending on R&D, which we had previously forecast as part of the development of new CyberKnife technologies. We expect R&D expenses to be still higher in the fourth quarter. Also as we previously forecast, sales and marketing expenses increased during the third quarter due mainly to CyberKnife users meeting occurring in the third quarter this year, but not in prior year.

Accuray's balance sheet remains strong with cash and investments ending the third quarter at $143 million. We expect total revenue for our fiscal 2011 to be towards the lower end of our guidance range of $210 million to $225 million. Excluding $5 million of revenue related to Platinum contracts, leaves a range of $205 million to $220 million in fiscal 2011, up from $193 million in fiscal 2010, excluding revenue from Platinum contract.

As a reminder Accuray's business is inherently lumpy and often challenging to predict because product revenues dependent upon our customers' construction schedules as they build or renovate facilities to house their new CyberKnife system. Delay in a construction project impacts installation and subsequently our ability to recognize revenue in a timely manner. We work closely with our customers to help expedite where possible construction of their CyberKnife facility. Nonetheless, this is a challenge that creates quarter-to-quarter lumpiness.

We believe that we have opportunities to further enhance the role of the CyberKnife in radiosurgery through continued investment in R&D. We also believe we have opportunities to increase global awareness of the benefits of treating cancer patients with CyberKnife radiosurgery. We believe that progress towards these goals will be critical to maximizing the long-term growth in revenue and profitability of Accuray for our shareholders. Accordingly we plan to maintain higher levels of spending in these areas as previously discussed.

On March 7, we announced our agreement to acquire TomoTherapy Incorporated. We have identified three elements that we believe are the keys to making this a successful acquisition from a financial standpoint for our Accuray shareholders. First, TomoTherapy products are the best-in-class for intensity-modulated radiation therapy. We believe this is driving the up trend in orders and revenue that TomoTherapy has experienced over the last year and will support future order growth.

Second, we believe that significant improvements in product reliability can and will be made steadily in the future. We expect that this will enable service to transition from inactivity that was a substantial drain on TomoTherapy's financial results to a profitable business in our fiscal year beginning July 2012 with further improvements in future years.

Third, we anticipate there will be significant cost savings from synergies due to the elimination of redundant activities principally in G&A and marketing. By combining profitable new system revenue with newly profitable service activity plus cost savings from organizational synergies, we expect the TomoTherapy product line will begin to contribute profits and be accretive to Accuray earnings per share in our fiscal year beginning July 2012 with increased profitability in the following years.

Over the past two and a half years, we believe that Accuray has made positive steps in improving its financial reporting including providing greater transparency to the investment community. As we move closer to completing the acquisition of TomoTherapy, considerable attention is being given to integrating the two companies. There are differences in the way that companies have reported financial information and we are evaluating the most effective manner by which to communicate this data. We believe our investors value the type of information that we provide and it is our intention to maintain the philosophy of clarity and transparency after the acquisition is closed.

Now I would like to turn the call back to Euan.

Thank you Derek. With that, we will now be happy to take your questions.

(Operator Instructions). And our first question comes from the line of Josh Jennings with Jefferies. Please proceed.

Hi good afternoon gentlemen. Thanks for taking the questions. How are you? Just first of all I was wondering if could make some comments on the market that you are seeing out there in the US and O-US in terms of any changes in your outlook for strength in 2011 versus coming off of the December quarter?

Well, I think that as I said in the script we are seeing very strong growth in generally internationally particularly in Europe, I think the US for us we're seeing growth in pipeline and a lot of activity, our impression is that the market still isn't at a point where this is translating into sort of rapidly increasing orders compared to say -- say last year. But I think the strength of it is really in the growing activity in the pipeline build that we are seeing.

I think one of the things to note is that the product seems to be still in high interest by customers who view it as really the only choice if they are pursuing a radiosurgery business.

We are not seeing a change in the competitive environment.

Great. And in terms of the AHRQ's technology assessment that was published earlier this week on SBRT or SRS, obviously they came out stating that they really couldn't make much comment because of lack of comparative data. You guys are already doing a comparative study versus surgical candidates for non small cell lung cancer. Any inkling in terms of investing or funding a study looking at prostate SRS for low-class prostate cancer versus prostatectomy?

Well, nothing we want to talk about at this point. Other than to say that it's definitely an interest to us that the data, Josh, the data that we have seen so far indicates that CyberKnife should have very strong role to play and is comparable with other treatment modalities including surgery in many respects. So we would definitely like to see that type of comparative data. But there is nothing that we want to discuss at this particular time.

And just on the reimbursement front. You mentioned some big wins with Palmetto and some of the other decisions that have been made throughout the US for SRS. There have been some rumblings about potential pressure with the proposed rule in July for outpatient centers. Are you hearing any rumors about SRS in terms of positive or negative about potential reimbursement decisions in July? For [proposals that you see]?

Well we obviously don't pay much attention to rumors I think what we focus on are the things that we can really influence, and what we have tried to do over recent years is to really strengthen the clinical case for CyberKnife, and luckily we have also been looking at sort of quality issues and quality of life issues and sort of value issues and I think wherever we look, we see significant strength for CyberKnife as an outpatient treatment compared to surgery.

And I think that it benefits patients, it benefits providers and it benefits payers. So as much as we can be, we are confident whatever comes our way, we can actually have good answers to.

And then, lastly not to push you to comment on competitor, but Varian hosted their mid-year review earlier this week and yesterday in fact, and just a lot of their oncology presentation was on SRS or SBRT, making comments about customers wanting to have a system that can do it all.

Derek your comments in one of my answers refuted that and can you just talk about what you are seeing from your customer base in terms of the obviously there is a -- there is a growth opportunity in SRS. There is demand for it out there, about a dedicated system versus a hybrid system and what you are hearing from your customers, one, and then two, if you are hearing anything positive or negative from your customers now that the merger proposal is made public, thanks -- with TomoTherapy? Thanks a lot.

Thanks Josh. Well, I think that it's fair to say our customers are obviously the ones who are interested in dedicated radiosurgery systems. And I am sure that Varian's customers are the ones who are interested in more of a hybrid approach. What we experience when we go into a sales environment is many centers have a base of IMRTs that they want to satisfy or base of radiation therapy I should say they want to satisfy, and they are interested in exploring radiosurgery, and for those customers the hybrid is a reasonable approach.

Where we focus, are areas where we feel confident, that the center -- the treatment unit would be justified by a full work load of radiosurgery patients. And our job tends to be one of convincing people that they have enough patients, they have enough clinical workflow to support a business [can] for a dedicated solution. Once we are successful in doing that then really they -- in our experience they don't tend to look elsewhere. So that's really the way the dynamic is I think in the market.

Great. And any commentary from customers or -- about the possible merger?

I think I don't want to say too much about it other than to say that generally all stakeholders we have spoken have been extremely positive, and people are excited by the idea of having two best-in-class technologies under one roof. They recognized the TomoTherapy product line's strength in IMRT, and IGRT; the fact it's fully integrated and that can provide a really top class clinical treatment, and they recognize our strength in radiosurgery and the CyberKnife's strength in radiosurgery. So generally I would say a feeling of excitement to see these two product lines come together under one roof.

Thanks a lot, Euan.

Thanks, Josh.

Our next question comes from the line of Larry Solow, CJS Securities. Please proceed.

That's CJS. Good afternoon.

Hi Larry.

Hi Larry.

Hi. Just curious I mean you guys talked sort of talked about this. But considering all the recent data over the last 12 months. Are you seeing sort of an acceleration at least in interest among new clients and maybe just hasn't translated into -- maybe it hasn't expedited the actual order, and the sales cycle still takes a while, but are you actually seeing a lot of new interest because of this new data out there?

Yes, I think that's the way I would characterize it. I mean if you look at the clinical expansions for these new applications, I mean clearly there is a lot of rapid growing acceptance, the things which will continue to drive our growth going forward. And these things, I would say are pretty unique to the CyberKnife as well. I mean prostate radiosurgery in particular. CyberKnife is still -- is the only treatment modality that has significant experience with hyper fractionated radiation treatments for prostate cancer.

So I think from a clinical standpoint onwards there is a lot of interest, starts with our existing sites. Also in terms of new projects, we are seeing a lot of new projects start up, we are seeing people and I would say with more positive motivation towards purchasing in the United States.

Outside the US, it hasn't really changed, I mean we have been maintaining pretty strong growth for some time now. Inside the US I think our sense is that our projects take somewhat longer than perhaps other radiation treatment technologies to come through, primarily because of the dynamic we just discussed. We are not selling right now to free standing centers, although we would like to move towards that market. And each project is a major new clinical development. So I think it has be evaluated and considered from the whole range of different angles and that naturally takes longer than a simple replacement of a unit that's pretty much similar to the unit that's been removed.

Right, this is much more of a missionary sale. Are you seeing any just interest in general from these free standing centers?

Well, we really haven't focused on that area for some time, because it's just not been something that's easily done for us. And so we see this development with Palmetto in particular as a very significant move for us. Now, of course we now need to go out and kind of build the relationships in those areas and it's not something that will turnaround overnight. But I think the fact that we really have only been able to address a smaller say two-thirds of the market in the United States up until now, and now we can get to an area where it's historically fairly entrepreneurial and relatively fast moving I think is definitely exciting for us.

One other point for you to keep in mind, Larry, I think is the increase in procedure volume.

Right.

Is the underlying representation of increase in demand from doctors and patients.

Right. And obviously that takes a little time to flow through to more orders I imagine. You talked about the revenue per service contract, which appears to have stabilized over the last few quarters, and I gather the adoption of Diamond Plus is helping that out?

Yes. It has been well received by our customers, it gives them a little bit more flexibility and we've had good uptake on it.

And I think you gave this number, the amount of the installed base that's currently on a service plan?

I don't have the number handy, but it's probably in excess of 90%, and more of them were on Diamond than Emerald.

Okay. And then, just housekeeping, I guess I assume all the due diligence or the stuff, expenses related to Tomo acquisition that's all in the -- that's the G&A number, and that's why that's inflated?

Yes, yes. And by the way the service numbers I gave you represent our -- the markets where we are direct. Obviously distributors cover of service in the markets where they are handling it.

Right, absolutely. And, any update on Siemens, I imagine the distribution is still continuing and I gather the R&D part of that is really kind of in -- on a hold, is that fair to say?

Yes. It's hard for us to give a detailed update at this time. I think we are in discussion and we will update everybody as soon as we can. I mean, various things have impacted the relationship partly things that have happened inside Siemens in terms of their own internal reorganization and for the shifting priorities there. And from outside now with this pending acquisition, we have to evaluate whether or not it really changes the dynamic. But we will update everybody as soon we can on that one.

Okay. And then, just last question -- just on the gross margin, you had actually on your product side had a pretty nice uptake and sort of been looks like it's at least sustainable for the last three quarters around 60%, and I imagine that's likely mostly due to the VSI, is that something that you think that 60% number give or take -- not an exact, do you think that's a sustainable type of a number on the product side?

I think we would expect that's our goal to stay in that range. I think we obviously -- you can always balance additional margin versus additional sales, and we have to always sort of keep that balance in mind so that we're maximizing our actual dollars of profit, not just the maximum profit on any individual sale. But I think that that ballpark is what our goal is.

Okay, great. Thanks a lot guys and we we'll see you in a couple of weeks in our Chicago conference. Thanks.

Okay.

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

Hey, good afternoon. Maybe just first question on the stepped up R&D investment, I know you talked about this before, but can you just talk about when we will start to maybe see some benefits and just directionally where you are going with the incremental R&D spend?

Our product development obviously is something that we don't give details on in terms of what it is that we are developing. And we have indicated that we expect the expense to go up in the fourth quarter. As far as when we're going to release something, I don't want to give a specific timeframe. It depends on, of course, getting the R&D work done and getting to the point of releasing it, but it is something that it will take some time. It's not five years, but it's not next week.

Okay. And then, on Tomo, I know Josh asked earlier about kind of customer reception, how do we get comfortable with kind of the risk around maybe competitive swap outs in the bunkers as you are going through this merger and integration process?

Competitive swap outs meaning other people taking the bunker slots?

Correct.

I guess I can't give any absolute guarantees of that. We haven't seen any pressure in that direction from our side. On their side we have quite limited visibility, but we are reassured by continuation of their sales momentum. I think that would probably be the first phase it would appear as extra pressure as opposed to maybe people removing slots that -- there maybe things we don't know about, but we haven't seen any of those signs.

And, Euan, can you just talk about what the internal reception do the deal has been just among the sales force?

Yes. I think very positive. I mean I think one another thing that's important to remember is that we are not -- we're seeing this as a scaling operation. The synergies that we have talked about have really been around kind of G&A areas and things associated with running two public companies. And a lot of those are the ones which are fairly obvious related to two sets of public filings, and two sets of order fees, and so on. And things which are fairly easy to see.

Although there will fairly be other cost synergies they -- we're not anticipating they are focused in any of the areas that are key to future growth. And I would say that the commercial areas are clearly one of those. We've got some anticipated synergies from the fact that we will only need to attend a tradeshow once as opposed to twice as two companies.

Beyond that, I think we all excited by the idea of greater sales presence both I would say our sales team and the R&D team are excited to have access to other technologies and to start looking at ways in which we can help to accelerate each product line using experience gained from the other. The general mood is very positive.

Okay. And then I want to make sure we understand the backlog dynamic here. You went from 19 new orders last quarter and you are down to 13. I understand you had a couple of cancellations, but to be clear are you seeing kind of an extended selling cycle in this environment, and your comments earlier that there's kind of delayed uptake as people get comfortable with some of the new treatment areas?

No, those comments are particularly related to the US, but I think that you shouldn't forget, you followed us for some time, Tycho, you've watched several Q3s and -- you know that our Q3 tends to be somewhat similar to our Q1. It tends to be a down quarter in terms of new order inflow. If you look at rolling full quarter performance it's actually very strong and there is plenty of lines of growth there.

Okay. And then just last one can you talk about traction with Lung optimized and partial breast?

Yes. Those are being well received. So partial breast is obviously not a product, it's just a clinical capability that people are exploring. And we know of somewhere between 5 and 10 sites that are treating partial breast through radiation, and we run a training course held on it during last quarter. And it was extremely well attended. I mean there seems to be a huge amount of interest around that. So we'll watch that first roll out amongst our existing installed base. We'll start tracking numbers of patients treated and we'll learn more as we go along.

For LOT, a lot of interest, lot of interest. I think people are excited by the idea of CyberKnife now being used to treat lung cancer without fiducials at a greater level of accuracy. And I think that it's -- all the customers I've spoken to about it have been truly appreciative of what it can bring to them, and we're seeing lot of interest in terms of uptake through [retirement] programs and uptake through upgrades. A little early to give sort of numerical updates on those, but we definitely will do that as we go forward.

Thank you.

Our next question comes from the line of Drew Jones with Stephens Inc. Please proceed.

Hey guys, thanks for taking the question, was going to start out on capacity, I know obviously there is some limiting factors on the end of the customer, but when we think about what you guys can control, what is your capacity in terms of quarterly production and installs?

So our production is a combination of items we manufacture ourselves in-house and parts that we source from outside. We feel at this point that we have significant capacity to increase our production, and if necessary, especially given the long lead times that we have in terms of customer installations that we would be able to scale our capacity upward if necessary.

I guess the most important message is that capacity is not a limiting factor. We can, we are not operating at capacity now. We could set up capacity if we need to do.

Okay, great. As we think about VSI and the feedback that you guys are getting from customers out there. Do you guys have a feel the mix in terms of procedures? What -- is it still just spillover for radiation therapy or is there any sort of significant portion of the procedure mix that's on the VSI system?

That's an interesting question. So as you know, as you remember, the capability of VSI is that it delivers very fast, radiosurgery treatment. It's so fast when you look at it compared to a standard treatment unit, and if were to use it in IMRT mode, then it would actually be competitive in IMRT mode.

What we are seeing from the systems that are been installed so far is some IMRT treatments being delivered, but I would say the CyberKnife is still recognized predominantly as a focused and dedicated radiosurgery product. And where it comes in useful, and I think this is very we've seen sort of an uptick in our sales generally since we launched VSI, it's useful for people to have confidence that they will have enough patients.

I mentioned the sales dynamic earlier on, and these are new customers with the new-- that haven't necessarily run a dedicated radiosurgery system before. And they need to know there will be enough patient flow. Showing that VSI has the capability of treating outside of radiosurgery, amongst the patient base that they currently have, gives them extra confidence and reassurance and it's useful for kind of accelerating projects and moving sales along. We don't expect to ever become VSI -- to be used like a hybrid system where its basis is IMRT. It really is a specialized radiosurgery unit in line with all other CyberKnife systems.

Okay. And last one, after you guys close Tomo, can you remind me, the timeline to cross training the -- your service techs and then also the Tomo service techs?

Well, we haven't spoken about specific timelines, and in fact you know as we go through the details of integration, we'll identify where we have people that can help. We don't need to do that on day one because obviously, service engineers are highly trained individuals. We are not looking to make sweeping changes in the service that's provided to either unit.

What we are seeing is that as we train people over the first year or so on the other technologies, then we will have capacity for expanding without necessarily increasing the number of service engineers that we have. So I think we see that as more of a medium to long-term priority, and it may be territory by territory as we start installing systems that overlap with somewhere where we already have service engineer servicing the other product, and there may not be an immediate need to do that.

Thanks guys.

Thanks.

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

Hi Junaid.

Hey guys good afternoon. I apologize, I've been going back and forth between conference calls so some of these questions might have already been asked. Euan, as you -- as you talk to the sales teams on either side, what do you get the sense is that the pervading mood from your customers? From an ordering perspective, do you view this transition period as business as usual, or do you get the sense that customers are holding off on purchasing a CyberKnife or a Hi-Art until the transaction has consummated?

Obviously, it's a good question, obviously for antitrust reasons we have limited contact with their sales force, much more contact with ours and it's important that both companies maintain sort of independent momentum and focus on their own businesses until the deal is actually closed, and that's the way we've been operating.

I can answer it peripherally by some of my discussions with customers, and I alluded to this is one of the early questions. I would say the mood amongst customers is positive, very positive about this transaction. I think people are excited by the idea of having both these best-in-class technologies under one roof. I think that customers are looking for choice is my sense, and having a single company that can give them the best products for what we consider to be the best products for IMRT and for radiosurgery both in one place, makes that company a real consideration, and possibly I think I believe personally believe going forward that will be one of the added intangible values of this transaction.

And then just as a follow up to that, I think the natural tendency for companies after a transaction like this is announced just -- to some extent, analysis paralysis amongst employees. I've certainly gone through that companies in the past, productivity can potentially abate -- obviously this has business ramifications -- are you sensing some efficiencies being lost during the transition period?

No, I think we -- both teams are sophisticated teams. We have highly dedicated and focused employees, and TomoTherapy is the same way. I am clearly mature enough and intelligent enough to realize that business priorities rule the day. We've seen people taking extra time to involve themselves in integration activities, putting in extra hours, extra work and we are extremely grateful to them all for doing that.

And I think overall, we are feeling that things are coming together, considering the scale of the transaction that really the -- now for both companies is transformative, and I think that considering that we are really encouraged by what we are seeing with the interaction so far.

Got you. And then Euan, last question for you, the hospital out-patient reimbursement rates are coming out in either June or July, have you -- have you been hearing anything on the kind of reimbursement front for 2012?

No. I think we -- well see, we wouldn't hear anything in advance. I think pretty significant though in terms of what I talked about in the scripted section about Palmetto, having access to -- starting to have access to some key states now with confirmed reimbursement for free standing centers, I think is a big business positive for us. It's been an area that we really haven't had access to before. And we are all excited by that.

Great. That's all I have got guys. Thanks so much.

Thank you.

We have no further audio questions at this time.

Okay. So thank you everybody. Accuray remains dedicated to improving the life of cancer patients worldwide. As always, I want to take a moment to acknowledge Accuray employees and the tremendous contribution they make every day. Thank you for joining us today and we look forward to speaking with you on our next call.

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