Accuray Inc (ARAY) 2013 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Q3 2013 Accuray Incorporated earnings conference call. My name is Allison, and l will be your operator for today. At this time all participants are in a listen-only mode. We will conduct a question and answer session towards the end of this conference. (Operator Instructions).

As a reminder, this call is being recorded for replay purposes. And I'd now like to turn the call over to Miss Lynn Piper. Please proceed.

Thanks, Allison. This is Lynn Piper, Accuray's Investor Relations counsel from Western Partners. Thank you for joining us today on our conference call as we review Accuray's third quarter of fiscal 2013. Joining us today is Josh Levine, Accuray's President and Chief Executive Officer, and Derek Bertocci, Accuray's Senior Vice President and Chief Financial Officer. Please note that today we will be referring to information which can be found on a summary slide deck on the Investor Relations page of the Accuray website at accuray.com/Investors.

Before we begin, I need to remind you that our call today includes forward-looking statements that involve risks and uncertainties. There are a number of factors that could cause actual results to differ materially from our expectations, including risks associated to the effects of the introduction of a new CyberKnife and TomoTherapy systems, commercial execution, future order growth, future revenue growth, future profitability, and guidance for fiscal 2013. These and other risks are more fully described in the press release we issued earlier this afternoon, as well as in our filings with the Securities and Exchange Commission. We assume no obligation to update any forward-looking statements.

And now I would like to turn the call over to President and Chief Executive Officer, Josh Levine.

Thank you, Lynn, and thanks to everyone for joining us today as we review our results for the third quarter of fiscal 2013. I will begin with an overview of the third quarter, with Derek providing a more detailed financial review later in the call. I'll then wrap up with some commentary on our strategy and outlook and then we'll open the call up for questions.

In my references to financial results, I'll use non-GAAP numbers as we believe they are a better reflection of the ongoing results of our operations. In our third quarter we started to see early signs of improvement in our commercial momentum as a result of many of the actions we have taken over the past several months. While we still have some heavy lifting to do, I am encouraged by the early progress we have made in improving our commercial execution and unlocking the potential value in the two new products that we announced at ASTRO in October, 2012.

In the third quarter we saw a noticeable improvement in new order volume. Gross new product orders totaled $53.8 million during the third quarter of fiscal 2013, up from $39.8 million during the second quarter of fiscal 2013. Net product orders added to backlog totaled $44.1 million, up from $17.9 million in the second quarter. Importantly, we are seeing enhanced selling focus and improving order pipeline across all four of our regions. We are also seeing higher ASPs on our new models which are positively impacting pricing trends.

Our reported third quarter product revenues were $25.1 million, which were disappointing but not unexpected. These revenue results reflect the impact of a number of factors that we have discussed in previous calls. We expect to see modest improvement in product revenue in Q4.

In the longer term, we expect to see more significant contributions to product revenue from growth in our new order activity. The trends in our Service revenue and gross margin in the third quarter continued to show strong momentum. At $45.5 million, our Service revenue continued to grow, contributing over half of our total revenue for the quarter of $70.6 million. Our Service gross margin improved to 29.5%.

Since our acquisition of TomoTherapy Incorporated, we have consistently improved system uptime which is now approaching 99% globally. We have continued the installation of new design components in the existing installed base and installation of more recently manufactured systems which include the latest generation componentry. All of the latest generation componentry that has been the catalyst for improved reliability has been incorporated into our new Tomo H Series. The result is that we have seen a reduction in service calls and service parts consumption per system. We are clearly turning the corner with improved equipment reliability and growing profitability of the service revenue in our TomoTherapy business.

As anecdotal evidence of what I've just described, I had direct input from the head of a major cancer center in western Europe at the recent ASTRO forum in Geneva that treats approximately 3,300 patients annually. During their evaluation and final decision making process to acquire another LINAC unit, he had heard many stories about reliability challenges affecting early generation TomoTherapy Hi-Art systems. The Cancer Center made the decision to purchase a TomoTherapy system about 18 months ago and the radiation oncologist confirmed that his real world experience has been completely opposite from the poor reliability stories he had heard. He was successfully treating about 20% of his annual patient volume, or roughly 600 patients a year, on his Tomo machine with no significant downtime whatsoever. Many other customers with more recently produced machines also confirmed this doctor's experience.

While the early generation Tomo systems did have reliability problems, we see very different levels of product performance and reliability with the units manufactured over the past 15 to 18 months and we expect even better performance from our new Tomo H series systems.

While we expect the positive trend in our Service gross margin to continue, we do expect it to experience some quarterly variability. Looking forward, we anticipate continued progress in commercial momentum over the next several quarters driven by improved selling focus and sales funnel management, the economic and clinical validation of the first commercial installations of our new products, and market acceptance driven by the substantial improvement in the reliability of our TomoTherapy product line. During Derek's financial review, he will provide our ending backlog by product line which should provide increased visibility to assist in your financial modeling.

In turning to our new products, while the delay has been frustrating, we are beginning to see the first commercial installations of both of our new generation product platforms. Two weeks ago during the ASTRO forum, we showcased for the first time in Europe our two new systems, the TomoTherapy H series and the CyberKnife M6 series. During the forum, we celebrated the first installation of our Tomo HDA, our first TomoEdge Dynamic Jaws upgrade, our first CyberKnife M6 installation, and the first patients treated with both the new CyberKnife M6 and the TomoEdge. The Tomo H series is a fully integrated radiation therapy system designed to treat the full spectrum of cancer patients. And when equipped with the new TomoEdge dynamic jaws technology, and the VoLO treatment planning capability, it fundamentally changes the product's functionality by offering both faster treatment planning and treatment delivery with better dose distribution. This improved functionality allows the TomoTherapy system to be viewed as a mainstream or workhorse product able to treat a broad spectrum of patient case types in conventional time slots.

On the CyberKnife side of our portfolio, we now have three of our new M6 systems installed, one in January and two in April. The first of these new systems has been used to treat more than 200 patients since February. The customer's product performance experience at this first site has been extremely encouraging in terms of patient throughput and reduced treatment times. And this is just using fixed and iris collimators which validates the improved pro performance characteristics of the new M6 platform when compared to previous generations of the CyberKnife. We expect the performance characteristics to improve still further when we add the multileaf collimator to the M6 platform. The M6 is ideally positioned for the trend toward hyper fractionation and is the product of choice for developing a full body radiosurgery practice.

With the multileaf collimator, or MLC option, it offers greater patient throughput and overall treatment speed and can treat a significantly expanded patient universe which improves the economics for our customers. As far as timing of MLC availability, we are still on schedule to begin to ship starting this summer.

Turning to the status of our commercial organization, we have made significant progress in filling critical roles across the sales and marketing organizations. We now have talented sales and commercial leadership in place in all of our regions. We are starting to see improving momentum as a result of many of the actions we highlighted in January including more focused sales responsibilities by product platform as well as a dedicated sales team responsible for our installed base business. As a result, we are seeing improvements in overall market and opportunity visibility, better sales funnel management, and most importantly, growth in our order pipeline. These elements, when combined with what is clearly a growing level of customer interest in our new products, we expect will drive order growth over time.

Finally, I want to provide an update on our cost restructuring efforts which are integral to driving our business model to a level of sustainable profitability. Early in the calendar year we announced a plan to reduce our operating expenses by $40 million. Our goal is to reduce non-GAAP operating expenses to $38 million per quarter during fiscal year 2014 which begins on July 1st, with some expected quarterly fluctuations. To be clear, we are on track to achieve this goal.

I will now turn the call over to Derek provide you with a more detailed review of our financials and then we'll wrap up with some closing remarks. Derek?

Thank you, Josh. In reviewing the financial results for the quarter, I will focus on our non-GAAP results which we believe are the best indicator of ongoing progress in operations as well as trends that may influence future results. Our press release provides details of the adjustments between GAAP and non-GAAP results. I will specifically make mention if I refer to GAAP results.

Product revenue of $25.1 million in the third quarter of fiscal 2013 was down from $33.2 million in the second quarter and down from $61.4 million in the prior year third quarter. This decline was due primarily to the lack of availability of the new CyberKnife and TomoTherapy models that we announced at the ASTRO meeting in late October 2012, combined with delays in expected shipments from backlog. As Josh noted, we anticipate modest improvement in product revenue in Q4 and more significant contributions to product revenue in the longer term from growth in new orders.

The product gross profit margin in the third quarter of fiscal 2013 was unusually low at 34.7%, down from approximately 50% in each of the first two quarters of fiscal 2013. This decline was due mainly to the low level of product revenue and the almost complete lack of revenue from the new CyberKnife M6 series and TomoTherapy H series. Manufacturing overhead per system was significantly higher than normal due to the very low level of production and product revenue.

Revenue and gross profits from our Service business in the third quarter of fiscal 2013 continued to improve following the pattern of steady improvement seen since the acquisition of TomoTherapy, Incorporated. Compared to the third quarter of the prior year, Service revenue increased 13% to $45.5 million from $40.2 million. Service gross profit more than doubled to $13.4 million from $6.5 million and the Service gross profit margin increased to 29.5% from 16.1%.

Service revenue has been growing steadily because most of our systems are purchased by customers for use in newly constructed radiation treatment vaults or to replace competitors' systems in existing vaults. Accuray's systems sold to these customers generate incremental streams of service revenue, increasing our total Service revenue. On average annual service revenue generated by new systems is equal to approximately 10% of the product revenue from the sale of the system. In addition, Service revenue has also grown because many TomoTherapy customers have switched to new market priced service plans that provide higher uptime commitments, some of which also include upgrade protection.

The Service gross profit margin rose principally due to two factors, improvements in the reliability of TomoTherapy systems and the switch of TomoTherapy customers to new market priced service plans. Reliability improved due to the installation of newly designed components in TomoTherapy systems already in the field plus the sale and installation of new systems that were manufactured with the newly designed components. The use of these newly designed components very significantly improves system reliability which reduces the need for service calls and use of replacement parts.

Operating expenses of $44.7 million in the third quarter of fiscal 2013 were down from the second quarter and the prior year third quarter. Excluding restructuring costs, which mainly represent employee severance charges, operating expenses were $39.8 million in the third quarter of fiscal 2013. The restructuring actions we took in the third quarter fundamentally reduced our cost structure. Our goal is to reduce non-GAAP operating expenses to $38 million per quarter during fiscal year 2014 with some expected quarterly fluctuations. This goal is one of the key actions we are taking to position the Company to reach sustainable growth in revenue and profitability.

As Josh noted, we saw a noticeable improvement in new orders for products. Ending backlog was up 7% from the prior quarter and the prior year same quarter and was split approximately 61% for CyberKnife orders and 39% for TomoTherapy orders. We have posted a slide on our website showing backlog activity during the quarter.

We are adjusting our full year revenue guidance down from the prior range of $320 million to $330 million to the range of $310 million to $318 million. This decrease is due to the delays we have experienced in shipping and installing our new models combined with delays in expected shipments from backlog. The first system of each new model has now been installed and used to treat patients. We expect that additional installations and reference sites for these new CyberKnife and TomoTherapy models will contribute to growth in orders and revenue in the future.

While we expect gradual improvement in fiscal 2014, you should expect product revenue to be seasonally light during the coming summer quarter, consistent with the pattern seen in prior years. As product revenue rises in the fourth quarter of fiscal 2013 and beyond, and as we begin to ship more of the new CyberKnife and TomoTherapy models, we expect our product gross margin to return to more traditional levels.

Now I would like to hand the call back to Josh.

Thanks, Derek. I'm encouraged by our more aggressive commercial focus and improving commercial momentum. These are early signs that the actions we have taken are starting to get traction. Our order pipeline and new order momentum are both improving. We are confident that the expanded feature set and functionality of our new products will translate into enhanced economic value for our customers. As a result of all of these factors, we anticipate gradual, continued order growth.

Before we turn to Q&A, let me describe the financial elements and the critical areas of focus that will help you track our return to profitability. To achieve breakeven operating profit, we are focused on the following three financial elements. First, order momentum, when converted to product revenue, is clearly the key to our future success. We would need the contribution of approximately $23 million to $25 million in gross profit from product revenue. Assuming historic levels of gross profitability on product sales, this equals $46 million to $50 million in product revenue. Net orders of $44 million this quarter brings us close to this level of product revenue.

Second, service gross profit. Given the steady growth in service revenue and profitability, we expect to be able to achieve approximately $13 million to $15 million of gross profit per quarter in fiscal 2014. This represents a continuation of the improvement we have achieved steadily since the acquisition of TomoTherapy, Incorporated.

And lastly, operating expenses. Our goal is to reduce non-GAAP operating expenses to $38 million per quarter during fiscal year 2014 with some expected quarterly fluctuations. As we continue to strengthen our commercial capabilities and improve sales execution, we expect to drive sustainable revenue growth and operating profitability over the longer term. And we are now ready to take your questions.

(Operator Instructions). Steve Beuchaw, Morgan Stanley.

Hi, good afternoon, and thanks for taking the questions, everyone. Josh, I wonder if you could speak to what you're seeing out in the field as you're launching the new systems on the competitive front. One of the questions that people ask is, are these new systems going to do well in head to head bidding? Clearly nice pickup in the quarter. Can you speak to how much of this has been competitive activity and how you see that dynamic playing out as you're able to get the message out into the field?

Steve, we are very focused on competitive sockets. One of the reasons we earlier in the year talked about the separation and the selling focus split between not just individual product platforms but the new equipment focus on the one hand versus the installed base on the other, was exactly to get better focus, better traction, if you want to describe it that way, and better energy applied to the way we compete for competitive sockets. And also the way we compete in and drive activity in the installed base.

So it's a big piece of our focus right now. Again, everywhere, when you think about where we're positioned as far as our current market share position, everywhere really is a growth opportunity for us. We have -- nowhere in the world, nowhere certainly domestically here in the States in any of our regions, where we don't have a growth opportunity ahead of us. And it really doesn't require us to win every head to head battle to drive a reasonably big impact to our business and our business model. So the competitive activity and the competitive socket focus is a pretty significant part of our thought process right now.

Thanks, that's helpful. I want to revisit a conversation that we've had in the Q&A on the last couple of calls and that's how you think about the ramp over the course of the year. In the past we've talked about the prior level of net orders as being a logical bogey for the end, let's call it the rate at which you exit calendar '13. Is that still the way that you're thinking about things? Or given the strength in the quarter on the order book here, could you be a little bit more optimistic?

Well again, we are -- I don't want to take away from what we've done and I think we're all encouraged about what we saw this quarter as far as improvement in order activity. It's way too early in my mind or anyone else's mind to declare victory here and we're not going to do that. We've got our heads down and we're going to work, keeping our nose on the grindstone, if you want to describe it that way. We -- I think again, as we've described it, we expect to see continued, gradual order activity improvement and growth in order activity over the next several quarters. And we -- the vast majority of the energy internally, at least commercially, that we've talked about over previous calls is focused on insuring that our people have the right tools to compete in the marketplace, that they're getting the support, they're getting the frontend lead generation and the downstream go to market support that they need to be effective competitors in the marketplace. So if you were to ask me confidence factor-wise, do I expect that we'll continue to see improvement over the next several quarters, I would guess the answer is yes.

Great. Thanks so much, everyone.

Deepak Chaulagai, Dougherty & Company.

Good afternoon, gentlemen. Thank you for taking my questions.

Hi, Deepak. By the way, it's kind of hard to hear you, Deepak.

Oh, sorry, I'll just speak louder. Is that good?

Yeah, it's better.

Okay. The net orders were obviously really strong sequentially. Was there one product line that was stronger than the other? I recall last quarter you had new TomoTherapy orders that were stronger than CyberKnife. I wonder if that similar dynamic is in place here, too.

Actually from a new order standpoint in the quarter, the activity was reasonably evenly split. I think when we think about opportunity going forward, we have opportunities, Deepak, in both platforms given the new products. And our energy, again, because of enhanced selling focus with a dedicated group focused on each product platform, we think that's the best way to drive enhanced presence in the marketplace for us and better selling focus and better, more aggressive competitive capabilities in the field. So I think there are opportunities on both sides of the portfolio going forward.

I think that the CyberKnife, the encouraging thing about the product performance characteristics about the CyberKnife M6 that we've seen in some of the newest installations, are that the patient throughput, the efficiency and overall capabilities functionality-wise of that system, even without the MLC, are showing dramatic improvement over the previous generation device. So we think we've got great growth opportunities in both parts of the portfolio and it's nice to have the beginnings of these reference site installations taking place.

Certainly. So you still think the commercial launch for both products somewhere in the summer of Q1 fiscal '14? Or -- I believe Tomo will be launched earlier than CyberKnife, but just refresh us what those tentative dates are.

Yes, just to be clear, Deepak, we have installations that have already taken place. First installations of both devices. Actually the first of the CyberKnife installations took place back in probably early February. The first of the TomoTherapy installations took place much more recently. But again, they are the first of -- again, the reference site activity that we've eluded to in previous calls, and that becomes kind of the starting point for us to be able to get real time product feedback and product capability inputs from customers that are using the devices to treat patients in conversations with other customers who are considering those devices in their equipment purchase decisions.

Right, understood. But the multileaf collimator hasn't been installed yet, right?

No. We basically are saying that the timing of the MLC is still on schedule as we've communicated earlier with regards to beginning shipments this summer. So that hasn't changed. Again, I think the important note there is that we are actually seeing improved functionality in terms of product throughput, patient treatment capability, and terms of treatment times off of the M6 with just fixed and iris collimators. That certainly has been the experience, the product experience in the first site that's been installed in Europe. And that actually is a great new story for us because it was already a terrific product and this just says to us that even without the MLC, it's a better device than the previous generation product.

Right. And last, in terms of sales force realignment, restructuring, it's good to hear that that's almost complete. In terms of the maturity of the sales force or the ramp up, how should we expect each of your four regions to perform? I'm assuming one region, the US region, will be certainly better than the rest because it's more mature and your sales force is more, has had more time with the products than the other regions.

Yes, so I guess just a couple of points to level set the thought process around this. Again, we've seen good traction and improving commercial momentum in execution, but this is still a work in progress. That's I think point number one that I would make. Point number two, Deepak, is that from the time that we started to talk about the sales force realignment, if you want to describe it that way, we were adding people, certainly in the commercial leadership roles, at different points in time over the last 3 or 4 months. So we have basically, most recently finished that process of putting commercial leaders in place in the Asia Pacific region, probably sometime over the last 45 days. We had before that finished out that work and the addition of those people in the EMEA region. So we've added those and filled those slots over the course of the last 3 or 4 months. And we're starting to see -- obviously the longer those people are in place, the better energy and the better impact they're having on the business. So -- but I would say it's a developing situation in terms of the full impact of the new commercial leaders and the sales force realignment. I think that while we're encouraged with what we've seen so far, it's still a work in progress and we would expect it to get better over time.

Sure. Thank you.

Jason Wittes, Brean Capital.

Hi, thank you very much for taking my questions. First, Josh, you mentioned that you're very competitive versus the other players out there. I was wondering, I know that you're trying to focus more heavily on the smaller centers. Were any of these orders to smaller centers or are you still sort of focused on the larger centers right now?

Jason, I'm not sure --

Well you talked about focusing a little bit more on the three LINAC or less centers versus the three or more centers. I think traditionally Accuray, both CyberKnife and TomoTherapy, have gone into the larger three plus centers.

Right, the larger academic centers. So I would say just to be clear, we really are probably most focused at this point -- I mean I don't want to say that we're excluding three plus vault academic teaching facilities, but we think that we've got a great opportunity probably in dual vault opportunities or dual vault customer locations. And that's certainly gotten a lot of our focus and a lot of our energy in the thought process around commercial rollout.

But we have reference sites that are either already installed or will be installed across, that represent a cross section, if you will, of customers out in the world. So they're not all of one flavor or shape if you will, all single vault, all dual vault, but it's a mix. The other think I guess I would point out is the other area that has really gotten a reasonable degree of focus and attention from us, because we think it's an opportunity, is the GPO and the strategic account opportunity. I think we eluded to, in our January comments, that our presence in that channel or that segment of the market is reasonably under represented and under penetrated and we think that there's an opportunity there for us. So we have, since January, we've added resources that are focused on just building relationships with group purchasing organizations, integrated delivery networks, as well as freestanding, proprietary networks. So we're getting, I'd say we're getting much better presence and improving market visibility in those channels as well.

Okay, that's fair, very fair. Also, I wanted to ask, if you compare this quarter to last, last quarter the order rate was obviously disappointing. But I think there was a lot of moving pieces. If you were to sort of go back and be the Monday night quarterback, what exactly would you attribute sort of the shortfall last quarter to looking back? It sounds like from I can gather the sales force had a lot of moving parts and that definitely hurt you. Is that kind of the way to think about it at this point?

Yeah, I think it's -- it really hasn't changed message-wise since the beginning. We -- lack of product availability, the gap between our announcing new product systems and the launch of those systems at ASTRO last fall created a lag or a freeze effect on customers that were either considering purchases or had orders in the backlog that they'd postponed or pushed out delivery of equipment on in an effort to learn more about new products. Some of those were requiring renegotiation of agreements in order to upgrade an order within the backlog. But that real world effect of that lag that was created was not insignificant. That coupled with the sales force restructurings that we had eluded to earlier in the year that were, quite frankly, had occurred prior to my arrival here, we had several restructurings that were I'd say more than just realignments. They were wholesale restructurings of the field organization in the US market. That was highly disruptive, quite frankly, to our selling momentum. So it was -- you could describe it as kind of the perfect storm of the confluence of all those pieces coming together, but independently none of them were insignificant. When you put them all together, they took a toll on the quarter.

Right. Obviously. Then just a last question on just the US market. ASTRO has proposed potentially bundling radiation oncology payments. There's a few other proposals out there. How is that impacting order rates? And how might that impact the usage of your equipment?

We are close and are continuing to stay close to not just ASTRO, but Radiation Therapy Alliance and the other groups that are active in Washington with regards to proposed legislation, proposed changes and thought processes around reimbursement and the like. I think it's difficult -- I don't think anyone can completely predict with precision where this is going to land. But I think that when you start to think about the kinds of things from a fee and a structure standpoint that might kind of enter into people's thought processes in Washington, it seems like case rate reimbursement. Those types of things, we actually think it helps when you think about our equipment and the clinical capability that we have, the trends towards hyper fractionation, trends toward collapsing the treatment timeline or the paradigm into much shorter time spans, we think actually plays to our strengths.

You may not have seen it or you may have seen it, but the ASTRO Group put out word about a revised policy that endorsed SBRT as a first line option for prostate cancer. Which, again, we think is a terrific opportunity for us. And again, that hasn't necessarily yet translated into changes at the reimbursement level, but it certainly -- it certainly is encouraging, at least in its thought process, to encourage the payer side of the world to consider things like CyberKnife for treatment of prostate cancer. So I mean the jury is still out on where this will all land, but I think that we are as well positioned as anybody in this discussion. Our high precision, our capability in radiosurgery, we think is certainly, it puts us in a reasonably competitive position given kind of where this thing might head from a future payer strategy standpoint.

Okay, thank you. Just one clarification and I'll jump back in queue. I mean one of your larger competitors did mention that the market for purchasing in the US was clogged due to some uncertainty related to reimbursement. I just wanted to know if you saw the same thing this quarter.

I'm not in a position, Jason, to comment on what one of our bigger competitors said or didn't say. Again, we -- we're focused on our opportunities and we think we're well positioned.

Great. Thank you very much.

Anthony Petrone, Jefferies & Company.

Thanks, gentlemen. Good afternoon. Just to stay on, Josh, to stay on the reimbursement topic for a moment, do you care to throw your line in the sand for potentially where do you think CMS might propose rates come this June? Obviously last year the experience was a pretty [triconium] proposal and then that was mitigated toward the end of the year. In addition to that, the stereotactic rates I believe were inched up a bit on the hospital side and obviously the proposal on IMRT was negative but mitigated, again. So that was positive for Accuray in the sense of CyberKnife. But here we have the M6 coming out, so just curious to get your thoughts on sort of the dynamic of where you think things could shake out and how you think that plays out both for IMRT and SRS rates. Thanks.

Yeah, Anthony, listen, this is the great pastime right now, trying to predict what CMS will or won't do. And I'm going to take a pass on this because quite frankly I've learned the hard way in a lot of other areas of med tech/med device that trying to predict what the people in Washington are going to do around these discussions are, in most historical examples, next to impossible. I think the thing I would say just generally is this. It doesn't matter from an environmental standpoint whether we were going to be operating under Obama Care or some other form of healthcare reform. The practical reality is that you better have some kind of clinical and economic justification for your technology and the support, the validation of your technology, from both clinical and economic standpoints in data in order to have I think a viable seat at the table longer term. I think without a health cost management capability or strategy, I think you end up running the risk that you end up marginalized. And I think we feel good about where we're at with both of those discussions, both clinically and economically. We're continuing to fund the studies and the work that support the use of our products and why they're the right choice. And whatever the folks in Washington are going to do, it's impossible to predict where this will land. But I think that we feel reasonably optimistic that regardless we're going to land in a pretty good place.

That's helpful. Just turning it over to the P&L, a couple of questions there, then I'll get back in queue. Obviously the bookings number was up substantially sequentially but yet the full year guidance comes in a little bit here. So it would just be helpful to get an update on the length of the sales cycle. I mean is that still in the process of elongating or has that stabilized? And just where does that stand? And then one follow up on margins. Thanks.

Yeah, I think, Anthony, just to clarify your question, or to kind of put it in perspective, I think what you were just referring to was really the lag time or the product revenue that we recognized this quarter. And you kind of asked the question in length of sales cycle terms. The real crux or the underlying driver there is the timeline it takes to get from the backlog to the P&L. And as we talked about just a moment ago, and I think Derek referred to it in his prepared remarks, the bigger impactor to that is really the lack of availability of the new products in the quarter, the delay in the availability of those products. And some of the customer effect that I described before around this lag that was created or the freeze that was created on customers in the backlog taking timely delivery of the equipment that they had on order with us. So really, none of that is directly related to sales cycle time.

That's helpful. I guess that relates also to the last question just on system margin. So is that purely just an overhead issue or are there other areas where you could potentially attract system margin expansion? Or is it just a function of getting that volume flow? Thanks again.

So, Anthony, this is Derek. The answer to that is that there are really -- the challenge falls into two areas. One, the product mix included almost none of our new models. And the new models, as Josh pointed out earlier, are selling with new features and new capabilities and so we're getting a higher price on those. The older models sell at a lower price so we did have a mix issue in the quarter. Secondly, because the volume, the overall volume of sales as well as production was far below normal. The amount of overhead per unit was substantially above, well above normal. So when you put those two factors together, you end up with the abnormally low margin in the third quarter.

I indicated we expect to see improvement in future quarters. In the fourth quarter and in the first quarter we would expect to see some improvement in shipments and we would expect to begin to ship the new models, so we'd see some improvement in average selling price and margin on that regard. But we expect to still see the factoring in the fourth quarter working through the production overhang that arose in the second quarter because of the delay in getting the new models into production. And in the summer quarter, while we expect it will again be better than it was in the third quarter, we'd still see that the summer quarter is traditionally the quarter, as I mentioned, where product shipments are relatively seasonally light. So our overall margins in the summer will still be somewhat impacted by the seasonally light shipments and production.

That's helpful. And just if I can, into the fourth quarter, is there anything in there from the product recall or is that de minimis into the fourth quarter?

The costs related to the product recall are very minor.

Charles Croson, Sidoti & Company.

Hi, guys, thanks for taking the questions. Can you hear me okay?

Yep, great.

Great. Thank you. I might have missed this, I've been bouncing around calls here. So the breakup in order systems for, id orders for the quarter, which others I think have said, definitely a nice improvement sequentially. What was at hospital versus center and then new customer versus old?

Just in general, Charles, I'd say that the mix, the product mix in the new order activity was reasonably balanced between the two parts of the platform. And I would say that for now, at least for this quarter, the activity was probably really more of what you would expect traditionally from us which was more hospital based as opposed to freestanding center. I would expect over time we will start to manage and impact that with the efforts we're making around the national account and some of the strategic account focus on GPOs and freestanding centers, proprietary networks there. But for now, for the quarter that we reported, it would have looked customer mix-wise similar to the way it had historically which was more hospital based

Okay, that's helpful. And Derek, one thing I noticed here on the presentation slides is the goal to get to around $13 million to $15 million per quarter in service gross profit. Since you're already there right now and then you'll be shipping more systems, particularly on the Tomo side, that will get better service margins and then you might be able to squeeze out some market service contracts. Is that a fair range there? Or is that kind of -- is there room for upside on that side or has the low hanging fruit pretty much been squeezed out in terms of the service gross margin? Thanks.

So I would say that in terms of whether there's upside, I'd say that in the long run of course the service area we would see that there's potentially further growth beyond that. We were trying to give a reasonable outlook for the next say year or so and we think that that's a reasonable outlook. As far as whether we've captured the easiest, low hanging fruit, I would say that we've made substantial progress on that. We still have systems that are, older systems that have not by any stretch have most of their parts or the newly designed parts installed. So we still have improvement that we can make on that.

The new systems going out in the field today are considerably more reliable and therefore our costs are getting better and much more in line with the revenue that we're bringing in.

Okay, that's helpful. And then just one last one if I may. The MLC, when you guys start shipping that in the summer, is that going to be starting with limited shipments initially? And then once you ship it, is there a potential revenue recognition tied to that? That would just be helpful. Thanks.

Yeah, just to be clear, Charles, the systems that are out in the field right now, the M6s that would be getting an MLC on it going forward, we have recognized no revenue related to the MLC. So in other words, if you looked at the existing customer locations that have an M6, those orders came in either with fixed or fixed and iris collimators and the MLC would be an addition or an upgrade to that base platform. So the cost or the revenue related to the MLC upgrade would be recognized at the time that they get installed and they go to ATP and get certified or commissioned.

The first part of your question, the answer is we've said we're on track to begin shipping MLCs this summer. That's still an accurate assessment. I would expect that we will -- I guess it would probably be appropriate to say we'll be shipping in a limited form, but again, probably improving over time. I think at this point we have customers that don't want their -- they don't want to disrupt their treatment schedules, they don't want to have to bring a system down for an extended period of time and potentially deal with the addition of the MLC if the MLC is not something that would be applicable to a big portion of their patient mix at present. I mean again, we've got people that have treated 200 patients in the first several months of this year, the calendar year, and so patient flow and volume is significant. And we would time MLC installations around what works for customer site by site kind of considerations.

Okay, Derek and Josh, thank you so much. That's very helpful. Appreciate it.

Thank you, I'd now like to turn the call over to Josh Levine for closing remarks.

Thank you. Well we're encouraged about the early signs of progress we've made in improving the operational performance of the business. We recognize that we have more work ahead of us. We are aggressively focused on those activities that will unlock the value in our new products and allow us to become a profitable, growth oriented business. Thank you for joining us on this afternoon's call and we look forward to speaking with you on our fiscal yearend call.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and good day.