TomoTherapy Incorporated Q3 2008 Earnings Call Transcript

TomoTherapy Incorporated (TOMO)

Q3 2008 Earnings Call

October 28, 2008 5:00 pm ET

Executives

Fred Robertson - CEO

Steve Hathaway - CFO

Analysts

Ben Andrew - William Blair

Mark Arnold - Piper Jaffray

Philip Legendy - Thomas Weisel Partners

Jeff Johnson - Robert W. Baird

Amit Hazan - Oppenheimer & Co.

Brooks West - Craig-Hallum Capital

Paul Choi - Merrill Lynch

Junaid Hussain - Soleil Securities

Presentation

Operator

Good day, ladies and gentlemen, and welcome to quarter three 2008 TomoTherapy Incorporated Earnings Call. (Operator Instructions)

I'd now like to turn the call over to Mr. Steve Hathaway, Chief Financial Officer. Please proceed, sir.

Steve Hathaway

Thanks, Operator. Joining me on today's call is Fred Robertson, TomoTherapy's CEO. Before we begin, I'd like to preface our remarks with a customary Safe Harbor statement.

Today's conference call contains certain forward-looking statements. These statements are based on the current estimates and assumptions of TomoTherapy's management, and are subject to uncertainty and changes in circumstances. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Actual results may vary materially from the expectations contained in today's call.

Important factors that could cause such differences include, among others, those set forth under the headings, "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 10-K filing for the year ended December 31, 2007.

With that, I would now like to turn the call over to Fred for an overview of the quarter and some key highlights. Then, I'll discuss our third quarter financial performance and outlook in more detail. Fred?

Fred Robertson

Thank you, Steve, and good afternoon, everyone. As we indicated in the last earnings call, third quarter financial results were expected to be weak and the performance was consistent with those expectations. We also said that our year will be backend loaded. We currently anticipate that our fourth quarter financial results will be substantially greater than each of the first three quarters. Similar to last year, we expect to finish the year on the strong note.

The current shipments schedule supports this forecast. It's important to note that our improved process for tracking the status of orders in backlog through to delivery and revenue recognition is much more robust than it's been in the past, providing better visibility to our revenue expectations each quarter.

To that end, we are maintaining our guidance for the year, including the expectation of a profitable fourth quarter. We are working diligently to drive revenue and to increase new orders. That's challenging in today's economic environment, but we are encouraged by the enthusiastic early market reaction to our new offering TomoDirect.

TomoDirect was launched at ESTRO at the end of September, and the customer reaction has been very positive. As expected, customers are appreciating the throughput benefit of the fixed-beam delivery that TomoDirect offers. Now they can own a single system that provides the best rotational and fixed-angle delivery treatments.

Even though the product was only launched a couple of weeks before the end of the quarter, it has already been included in a few orders. We have also heard from customers who originally said no to the purchase of Hi-Art system, now coming back and reconsidering their decision, and still others who already ordered other technology saying that if TomoDirect were available when they placed their order, they would have chosen to order a Hi-Art instead.

As mentioned in previous quarters, we will continue to invest in strategic initiatives to deliver profitable growth in the future. These initiatives are focused on driving high value innovation, expanding our global market presence, and enhancing quality and liability. We are being cautious about those investments as we closely monitor the current global economic uncertainty.

Worldwide economic concerns are having an impact on our customers' purchasing decisions. Specifically, with the tightening credit market, some customers have told us that it's becoming more difficult to obtain the necessary financing to purchase or lease treatment systems, and this is lengthening the buying cycle. We have also observed some hospitals cutting staff and other sectors choosing to exit the radiotherapy business altogether. While these may be extreme examples, we cannot ignore what they may portend.

Based on a recent report by the Advisory Board Company, the economic uncertainty appears to be a concern for the entire healthcare system, not unique to TomoTherapy. How the tightened credit markets ultimately play out and affect our space longer-term remains to be seen. However, we believe that the radiation oncology space may be less effected than other segments of the healthcare market due to strong reimbursement, and therefore the fast payback, from purchase of radiation therapy equipment.

Turning to backlog, as of September 30, 2008, TomoTherapy has revenue backlog of $232 million, relatively flat with last quarter. At the end of the second quarter, we refined our backlog definition in order to improve the quality of the reported backlog. Under this new definition, backlog only includes firm orders that have an identified installation site and are likely to be delivered within 24 months. As always, we've had some movements of orders, both into and out of backlog during the third quarter. In addition to the typical movements, we had a single order cancelled, and that cancellation was due to economic factors. We have had no competitive losses.

I'd like to review a few highlights from last month's ASTRO, our industry’s major trade show. Overall, we had a very strong showing at ASTRO, both from a new product introduction and the sales lead standpoint. At the event, we showcased a number of significant new developments. We introduced TomoDirect, our discrete-angle delivery mode for the Hi-Art treatment system. This innovative new technology allows Hi-Art users to quickly plan and deliver advanced radiation treatments from fixed-beam angles.

TomoDirect greatly increases the overall flexibility and efficiency of the Hi-Art system because it allows customers to deliver more efficient treatments for simple cases. As a result, it enhances customers' revenue generating opportunities, and strengthens their ability to deliver the highest quality radiation therapy to the broadest patient population.

TomoDirect makes the Hi-Art treatment delivery even more efficient. As an example, simple tangential breast cases can be planned from start to finish in less than 10 minutes and delivered in two to three minutes, dramatically faster than current planning and delivery times. Overall response to TomoDirect has been very positive, especially in the single linac centers that we have not yet widely penetrated.

We also featured Tomo Quality Assurance at ASTRO. TQA is the first integrated machine specific quality assurance solution to be offered by a radiation therapy vendor. The TQA application streamlines the collection, and simplifies the review, of data that is used to monitor radiation therapy equipment and procedures.

In addition, TomoTherapy and Vision RT jointly introduced AlignRT 3D Imaging Technology, compatible with both TomoHelical and our new TomoDirect delivery modes. AlignRT does for the Hi-Art what TomoDirect does for Hi-Art treatment delivery. Both provide a new option for our users that can significantly improve patient throughput across a broad range of cancer cases.

Finally, we announced that we're developing the first truly mobile radiation therapy solution. Hi-Art systems placed in trailers for use by customers during new construction to alleviate temporary backlogs, or as a permanent placement for centers that are unable to expand their facility.

We believe that this could be especially beneficial for single linac centers that are upgrading old systems. Today, these facilities are facing large loss of revenue during the multiple months of downtime. Post-ASTRO, we also announced several exciting developments. First, we signed a preliminary agreement with Hitachi Medical Corporation to distribute the higher system in Japan.

Last quarter, we were in a transition with our Japanese distributor. Japan is the second largest medical device market in the world. Hitachi should prove to be an ideal partner, both for TomoTherapy and for our valued Japanese customers and prospects. We anticipate the benefit of this arrangement will begin to be realized in 2009.

We recently announced plans to enhance the remote service and diagnostic capabilities of our system by adding a remote support solution from Questra Corporation. The initial phase of this integration will provide TomoTherapy with the ability to remotely update higher system software, and receive product performance information over secure Internet connection.

In subsequent phases, Questra is expected to offer users remote planning, plan review and quality assurance capabilities. Finally, we recently signed a supply agreement with Novation, the leading healthcare contracting services company of VHA, the University HealthSystem Consortium and Provista. This gives TomoTherapy better access to more than 1,400 not-for-profit community hospitals and 13,000 healthcare education customers.

Compact Particle Acceleration Corporation, a proton therapy development affiliate, also made substantial strides in the quarter. CPAC's development team is on track and by year end is expected to demonstrate the dielectric-wall accelerator; the technology that really forms the heart of the system can accelerate protons. CPAC presentations were made both that ASTRO and the ESTRO generating considerable excitement. It's clear that there is a great demand for affordable, high quality, proton therapy systems.

All of these new products enhancements and developments tied directly into our strategic goals of driving innovation, globalizing our market presence, delivering best-in-class customer service, and enhancing quality, reliability, and efficiencies. Now more than ever it's important for us to continuously improve the Hi-Art system and develop new products that broaden the range of cancer cases we treat.

Despite near-term economic challenges that affect all of us, we remain enthusiastic about TomoTherapy's future. We firmly believe that we have the most advanced and effective system for high quality cancer care. Continued innovation and expansion of our clinical capabilities will extend our technology leadership position, and increase our prospects for greater market share and continued growth.

Finally, a short update on our searches for both the new Chief Financial Officer and Vice President of Sales. We have begun interviewing for both positions, and are encouraged by the high caliber of candidates that we have been seeing. We continued to expect to complete these searches by the end of the year.

I would like to turn the call over to Steve for discussion of our financials, further insight into new order and backlog, and our outlook for the remainder of 2008. Steve?

Steve Hathaway

Thanks, Fred. For the third quarter, the company reported revenue of $27.4 million, a decrease of 54% from $59.2 million in the third quarter of 2007. This was in line with our internal expectations going into the quarter. The revenue decrease was due to fewer systems being installed and accepted this year compared to 2007.

From a revenue perspective, the overall average selling prices in the third quarter were relatively low, due primarily to the sale of a couple of refurbished systems at lower selling prices. On the other hand, ASPs for new system orders were in line with recent history. Obviously, there are price variances in different areas of the world, and we always see some price fluctuations, but our overall price has remained relatively steady this year.

75% of third quarter revenue was product revenue. The remaining 25% was service revenue. This represents a higher percentage of service revenue than recent quarters due to the relatively low amount of product sales.

From a geographic standpoint, domestic sales accounted for a larger portion of third quarter revenue, versus the same period last year. The international sales mix was only 20% in the third quarter, compared to 50% in 2007. Year-to-date, international sales represented 28% of revenue, which is slightly lower than our recent historical trends.

The third quarter gross margin was negative 3.3%, compared to 37.3% in the prior year period. The negative margin stemmed from lower revenue, higher service and support costs associated with the growing install base, and several reserve adjustments. Included in cost of sales, were a total of $1.5 million of adjustments to the warranty, service contract and inventory reserves. Without these adjustments, the gross margin would have been slightly positive.

Before I discuss expenses, I'd like to remind you that we are required to consolidate the results of Compact Particle Acceleration Corporation into TomoTherapy. The net result is that we are using outside funding for this long-term opportunity to minimize the short-term impact on the company's financials. Based on external funds received to-date, our ownership has been reduced to 18.8% of CPAC. We expect this ownership percentage to continue to decline in the future as we close in more funding.

From an accounting standpoint, 100% of CPAC's expenses have included in TomoTherapy's consolidated financial statements, aligned on the Statements of Operations entitled, "Non-Controlling Interest," adds back credit for the losses attributable to the majority interest in CPAC not owned by TomoTherapy. Because of the complexities of this accounting, we again attached a consolidating income statement to our earnings release.

On to the income statement details. Operating expenses increased to $22.5 million in the third quarter, including $3.3 million of expenses associated with CPAC. Excluding CPAC, operating expenses decreased 8% from the third quarter of 2007. While the company continues to make investments to support future growth, we have slowed operational spending to better match current revenue levels.

One example of our expense controls relates to staffing. We had 721 employees at the end of the third quarter, compared to 724 at the close of the second quarter. We have dramatically slowed hiring. As conditions warrant, we are still selectively adding staff in areas that directly contribute to our growth.

In the third quarter, we had an operating loss of $23.4 million, compared to operating income of $1.3 million last year. The income tax benefit was $6.3 million in the third quarter, versus an expense of $1.5 million in the prior year. The effective tax rate was 29%. The rate is low because of the impact of CPAC. We cannot record an income tax benefit for their losses.

On the bottom line, we reported a third quarter net loss of $13 million, or $0.26 per share, compared to net income of $2.6 million, or $0.05 per share, for the third quarter of 2007.

A few comments on orders and backlog. The value of new sales orders received during the third quarter was $37 million. In our opinion, the new order flow was soft due to several reasons including a heightened competitive environment, increased economic concerns, and challenges in order forecasting and execution.

We received several additional orders during the quarter that did not meet our definition of backlog because they did not have a verifiable site or timeline. These orders were not reported in the new order total. In future quarters, once these orders meet our backlog definition, they will then be reported both in the new orders total and backlog.

Our revenue backlog as of September 30, 2008, was $232 million, relatively flat with the backlog as of both September 30, 2007, and June 30, 2008. For the first time, we saw a large exchange rate impact, resulting in a $4 million reduction in backlog during the quarter, primarily due to a drop in euro rate.

As a reminder, backlog only includes firm orders that the company believes are likely to ship within the next two years. The majority of this backlog is expected to be converted into revenue within 12 months. As always, backlog does not include any revenue from service contracts, which are a small but growing portion of the company's business.

From a backlog management standpoint, we removed a net $14 million orders of backlog during the quarter. Only one order was cancelled and that was for economic reasons. The other orders remained open and were removed due to concerns about the customer site or shipment timetable. These orders could reenter reported backlog once we are more confident in the progress of the customer site preparations.

Approximately 20% of total backlog represents multi-unit orders from for-profit entities in US, compared to a high of one-third of our backlog as of March 3, 2008. As we have indicated in our last two earnings calls, predicting the timing of some of these multi-unit orders is difficult. As this category represents the highest risk component of our backlog, we have removed several units of reported backing over the last two quarter.

We have a relatively short history with some of these accounts, and in several cases, they had not yet installed any TomoTherapy systems. That said, customers are starting to work on several these orders, so we expect to be able to report additional deliveries over the next few quarters.

The good news is that the dollar value of the rest of the backlog, the more predictable individual orders from hospitals or cancer centers, is at an all-time high. And the quality of our overall backlog has improved under the new definition established last quarter.

Turning now to the balance sheet. We ended the quarter with cash and short-term investments of $142 million, down sequentially by $17.5 million from June 30th, primarily due to the loss and high level of finished goods inventory.

We currently expect that the fourth quarter will be cash flow positive. In addition to the cash balance, we also have a $50 million line of credit with the bank, which has not been utilized. We feel good about our current balance sheet, and our access to additional capital, if needed.

Receivables decreased by $19.3 million since June 30th due to increased collection. Days sales outstanding was 59 days, compared to 67 days at June 30th. Inventory was $86.6 million at September 30th, up from $75.1 million at June 30th and $53.2 million at the end of 2007.

Much of this increase was due to additional finished systems on-hand, due to the lower sales volume in the third quarter, and preparing for the higher sales expected in the fourth quarter. We anticipate that inventory levels will decline sharply by year end.

Regarding our guidance: based on a thorough review of our backlog, and the estimated timing of customer acceptances, management currently anticipates revenue of $70 million to $90 million, and earnings per share in the range of $0.07 to $0.15 for the fourth quarter of fiscal 2008. We also expect to be cash flow positive for the quarter, as our inventory of finished systems is reduced.

We are maintaining our 2008 revenue guidance of $190 million to $210 million. The loss is expected to be in the range of $0.36 to $0.43 per share. We are intently focused on the company's strategic priorities, and we are taking the necessary steps that we believe will secure a very bright future for TomoTherapy.

Now, I would like to turn the call back to the operator and open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Ben Andrew of William Blair. Please proceed.

Ben Andrew - William Blair

Good morning. I have a couple of quick questions that come to mind, particularly the guidance for the fourth quarter. There is a very wide range of about 7 or so units, it looks like maybe 8.

Can you talk about what is going to push it to one end to the other? Is this just the ability to finish the installed validation, or is there some uncertainty about whether some of these orders are going to get even shift in the period?

Fred Robertson

This is really about the actual timing of the installed validation. These are all firm. As we approach the end of any fiscal year, we look at the potential for something to slide in to next week of the flowing quarter, but we feel pretty good of this.

Ben Andrew - William Blair

Okay. To the extent that you can comment on it, is this pulling anything forward from Q1 or should we expect a relatively strong installation schedule for Q1, Q2 as well as you worked down that backlog?

Fred Robertson

No, we are going to be giving our guidance for 2009 at the time we release our '08 results. We are really trying to manage our backlog relative to customer demand.

Ben Andrew - William Blair

Okay. As you think about Q4 order targets, I mean obviously we have got revenue numbers, but you did not guide to a backlog target. How do you see initial demand other than the anecdotal comments you made for the TomoDirect driving order flow as we go through the fourth quarter and not yet looking at '09?

Fred Robertson

Again we felt we had a strong ASTRO in terms of interest in TomoDirect and in the sales leads that we picked up both at ASTRO and at ESTRO in Sweden, the prior week. While on one hand the market seems weak, but we are concerned about the economy and the impact that that could have on slowing purchase decisions from customers.

We think that with TomoDirect, we have now a much more competitive offering and giving us access to a single linac market segment that previously really were not competing effectively.

Ben Andrew - William Blair

Do you see pricing stable on the contracts you are negotiating now, I mean you made anecdotal comments that things are relatively stable, but is that worsening. Can you drive pricing at TomoDirect or what are you seeing as that competitive pressure increases in a tough economic environment?

Fred Robertson

We have TomoDirect list price at about $300,000. We would certainly hope to gain a value from that. Steve I will let you address the pricing that we have seen in terms of new orders coming in.

Steve Hathaway

Well, as I said in the script that we have seen price relatively stable, although what it has been over this whole year. So that is our expectation going in. We have not needed to heavily discount our orders and we will continue trying to hold that price and hopefully increase the price of TomoDirect.

Ben Andrew - William Blair

The Novation relationship I assume is largely a hunting license with companies that you set up a price discounted contract for a period of time where members of that organization can remember hospitals, can order a system.

Fred Robertson

I would look at this as more of a hunting license.

Ben Andrew - William Blair

Okay. I will jump back in queue. Thanks.

Operator

Your next question comes from the line of Mark Arnold with Piper Jaffray. Please proceed.

Mark Arnold - Piper Jaffray

Good afternoon. To follow up on the TomoDirect comment. You mentioned a few new orders. Are those included in the backlog or would those have been so far here in Q4?

Fred Robertson

There were orders in the backlog, so included in what we brought in the third quarter. Remember, the TomoDirect was launched right at the end of quarter, so there was not that much selling time in quarter, but we were pleased to get orders with that included.

Mark Arnold - Piper Jaffray

Understand. Then obviously you have some a greater sense of confidence in the Q4 shipments. Given the numbers you have laid out in your press release on the call here and given that continued inventory build in Q3. Is it safe to assume that a decent percentage of these have already shipped so far this month?

Fred Robertson

We really do not go into details of when things are shipping, some have shipped but we are not talking about the specific timing within the quarter.

Mark Arnold - Piper Jaffray

Okay. As we look at the CPAC going forward, how should we look at that number, is this quarter here a good run rate? Should we see that continue to ramp up a little bit? How should we look at that here over the next few quarters?

Fred Robertson

We anticipate the TomoTherapy's CPAC investment remain relatively flat. The reason behind seeking external funding was to take advantage of exciting technology opportunity that we otherwise would not have been able to afford. So by bringing in outside funding, we are able to accelerate that development while moderating the risk to TomoTherapy.

Mark Arnold - Piper Jaffray

Okay. I will leave it at that. Just couple other follow-ups. The Hitachi relationships in Japan, you put out the press release here few weeks ago. Is there a timeline there? I mean you mentioned that we expect to see benefit of that in 2009. I know you took some order out of backlog in last quarter related to Japan.

Can you give us just a sense as to when you think you are going to have assigned final agreement there? What might be the implications are related to those orders up took out of backlog last quarter? Finally, concerning that same relationship, is the Hitachi relationship one that you think you can build on maybe even outside of Japan going forward?

Fred Robertson

We hope that we will have the contractual relationship solidified by the end of the calendar year. The initial focus is on Japan. In terms of the timing of orders that were in process, I am optimistic that we will be able to recapture that to the backlog in terms of the exact time frame, I can not give you the detail. The Schonen or the regulatory permit for Japan is in the process of being transferred over to Hitachi and that is one of the gating factors.

Mark Arnold - Piper Jaffray

Okay. Just one last question. You mentioned the mobile service partnership with Alliance Imaging. Do you have any timelines around the availability there? I realize there is some development work around shielding in particular. Can you give us any sense as to how you are approaching that and when do you think that might be a viable business or a viable service that you or Alliance can provide?

Fred Robertson

We are looking at having the first unit available in 2009 and we will be able to assess market demand better at that point and determine how quickly we will ramp this up.

Mark Arnold - Piper Jaffray

All right. Thank you.

Operator

Your next question comes from the line of Philip Legendy with Thomas Weisel Partners. Please proceed.

Philip Legendy - Thomas Weisel Partners

Hi, good afternoon, gentlemen.

Fred Robertson

Hi, Phil.

Philip Legendy - Thomas Weisel Partners

I was wondering, I would like to drill down on the economic impact that you have seen. Specifically, when the broader economy becomes an issue, maybe fill in some of the details for us, who was hurt most and how did the problems manifest themselves?

In other words, are you seeing people just hesitant to do anything? Because I was surprised to hear about half eventually exiting radiation oncology just given how profitable it is. How do you tie that all together?

Fred Robertson

We are seeing some signs especially in the United States if the economy has started to impact our business, and frankly healthcare in general on the capital equipment side. Most of the issues that we have seen appear to be related to new orders, not orders that are in our backlog. Although we did mention we had one cancellation of an order resulting from financial problems that were experienced by our customer.

From a new order perspective, we heard a couple of examples at the end of the quarter during the height of the bank lending issues where customers could not be quoted a lease rate from the bank, even though the lease had been approved. We know of some hospitals that have initiated capital spending freezes or laid off people.

Most our customers are not reporting problems, but we are beginning to hear more and more concerns that are certainly large fear factor at work here which is difficult to quantify, but we are concerned about it.

Philip Legendy - Thomas Weisel Partners

I know that you work with the leasing partner. I wonder have you had conversations, I am sure you have with those individuals and what is the feedback from them? Are they still willing to lend and do you still have that option for customers that are unable to find financing elsewhere?

Fred Robertson

Yes. We have a third-party firm that we work with. Generally, it is a relatively small percentage of customers that ask us for financing assistance maybe 10% or 15% of our orders. We said, do you know of anyone and then we turned them over to primarily one leasing partner, but we have a few that we do work with.

Based on our conversations, generally they are still lending and still providing financing. So it depends on who you are talking to and who are working with and it sounds like that some firms are and then other banks are frozen up. So I think it really depends on the customer and their financial wherewithal.

Philip Legendy - Thomas Weisel Partners

How about in the international markets what are you seeing, how is this all playing through in Europe for example?

Fred Robertson

The economic concerns are global I think. We certainly have seen specific slowdowns in markets like India and Turkey. It will be interesting to see as oil prices plummet what that goes to the traditional oil rich economics in terms of their investments in healthcare.

Philip Legendy - Thomas Weisel Partners

Okay. Are you willing to give the number of TomoDirect orders that were in the backlog this quarter?

Fred Robertson

That is relatively small number. We will not be releasing specific unit information.

Operator

Your next question comes from the line of Jeff Johnson with Robert W. Baird. Please proceed.

Jeff Johnson - Robert W. Baird

Thank you. Good afternoon.

Steve Hathaway

Hi, Jeff.

Jeff Johnson - Robert W. Baird

A couple of things here, Steve. Starting with you just to clarify; was there any foreign currency impact on orders or revenue in the quarter, if that was on backlog? Just to be clear, from a pricing standpoint, I know the revenue you booked this quarter, pricing on those systems was generally stable, but even orders coming in the door, you feel like pricing has remained relatively stable?

Steve Hathaway

Yes, in first part of your question no foreign currencies really no foreign currency impact on orders coming in the door or on P&L. As far as the new orders, as I said, the new orders, the pricing is very consistent with what has been earlier.

Jeff Johnson - Robert W. Baird

All right. Great. Then turning to Europe, specifically, new management team in place there. Could you talk maybe qualitatively about how that new management team is executing?

Fred Robertson

When you think about the cycle time of orders in this business, any changes going to take time. We remain pleased with the leadership we have in place and the progress we are making in the European markets.

Jeff Johnson - Robert W. Baird

All right. I think conversations going back a quarter or two, maybe suggested that there were some orders that were essentially on the table, just hadn't been closed as you are await to put the new management team in place there. Has that been executed on or maybe has that been drawn out at this point as well?

Fred Robertson

I think that is in process, but again the cycle time here while people are nervous about the economy, I think has potential to be prolonged worldwide.

Jeff Johnson - Robert W. Baird

All right. Thanks, Fred. Order trend or orders this quarter at 37 million, we are on new trend. Would we consider this a new trend line? It is about 50% below where you are trailing 12 months by annualized this quarter. Again maybe qualitatively if you do not want to quantitatively guys, but where should we be thinking about order trends on a go forward basis here?

Fred Robertson

The reported number again is as we are trying to shift the backlog as extremely high quality, we had actually a few orders that probably previously might have been put into backlog that they were hold after the site. The market does seem to still be a growth market, therapy is not optional. It looks like for 2008 we will probably still see low double-digit growth in the markets and we believe that our new product offering, we are going to continue with TomoDirect, we are going to more competitive globally.

So in terms of what can we do to drive orders growth, we will still need to selectively add sales people to get better coverage in the US, especially, selectively adding distribution ex-US. We will continue to invest in training for the sales teams, remembering that probably a close to a third of our US teams have only been with the company for a year or less. We are recruiting for new sales leadership for our global sales lead, and I think that, again, with time, will have an impact.

So we are reentering the Japanese market. I think that points to a handful of things that we are doing to improve the orders flow with the backdrop of the economy that we are really still trying to assess the impact.

Jeff Johnson - Robert W. Baird

Okay. Fair enough. Then, the last question, just what the economy points there Fred? Some of your competitors have reported that they are really not seeing an impact, it sounds like you are. Is there something structurally different about your end markets or the customers you serve, where you think you may be seeing the impact more so than others in the industry?

Fred Robertson

I have a difficult time, plenty of difference in end customers. I can only reflect on our experience for what we are seeing and what we are hearing in the marketplace.

Jeff Johnson - Robert W. Baird

Fair enough. Thanks.

Operator

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

Amit Hazan - Oppenheimer & Co.

Thanks. Hi, good afternoon.

Steve Hathaway

Hi, Amit.

Amit Hazan - Oppenheimer & Co.

Steve, can I ask you just a follow-up? Did you say that about 10% to 15% of your units are financed?

Steve Hathaway

Yes. When people come to us requesting financial assistance, it is a relatively small percentage of our orders that they come to us and say, can you help direct to someone that can provide financing. Most people come with cash or some financing already in place.

Amit Hazan - Oppenheimer & Co.

Okay. So do you have any sense of what percent of units end up getting finance as opposed to being paid for in cash in total?

Steve Hathaway

No, we really do not have a good handle on that because like I said they ultimately, we get cash on the back end and we do not really track how they get their money.

Amit Hazan - Oppenheimer & Co.

Okay. Would you say that the economic issues have weakened in recent weeks in terms of you talking to your customers?

Steve Hathaway

It is too short of time probably to really state that just based on our experience at the end of the quarter which was right in the midst of pretty severe market turmoil. It is something that is a concern.

Amit Hazan - Oppenheimer & Co.

Okay. In the past if we think about just the past three months, six months, have you seen both delays on the order side in terms of actually getting an actual firm order? On the installation side, is that a fair way to think about it that you are seeing delays on both sides?

Steve Hathaway

No, I would say that the majority of the delays we see from the economy or at least where people use the economy are on the order side that we are seeing people not committing to orders. As far as the installation side, we are not seeing the same level of concerns. People tend to have their financing in place before they start constructing or bring in a unit. So we are not seeing it on the installation side.

Amit Hazan - Oppenheimer & Co.

So in the past quarters, this year when you have come in a little bit below expectation, it has not been because of that.

Steve Hathaway

On the revenue side?

Amit Hazan - Oppenheimer & Co.

Yes.

Steve Hathaway

Correct.

Amit Hazan - Oppenheimer & Co.

Okay. What I am try to get around to is, I am still when I look at what your revenue number implies in the fourth quarter in terms of unit installations. I am getting to somewhere around 25 units or so, which would be as good of a quarter as you have ever had, and its conditions are indeed worsening.

I am wondering and I am looking at the midpoint of your guidance. I am wondering how aggressive it is and I am wondering about your discussing the unknown factor of just how bad things might get. How realistic is your guidance? Anything you can add in terms of color about your confidence on the fourth quarter unit number?

Fred Robertson

Well, like I said, I think the number one, our fourth quarter shipments are based on our detailed review shipments, customer-by-customer and looking at the site preparations of those customers. So it is based on this revised shipment tracking process that we implemented in Q2 and most, if, not all of those sites have already have started those site preparations and by the time you start that site construction, generally financing is already in place. So we really have not seen any impact of the economic concerns once someone gets to that point that they have started construction.

Amit Hazan - Oppenheimer & Co.

Okay. Then the last question for me is more on the expense side. Going forward you talked a little bit I think about what you have done so far, what specifically can you target to make sure you get back to and perhaps maintain profitability going forward. Are there any plans already in place that you can discuss?

Steve Hathaway

Yes. If you think about operating expenses, we are certainly taking a very hard look at expenses, but we also operating the company with a long-term vision, we do not want to sacrifice growth opportunities by making short-term unfocused expense cost.

We have sold down out hiring, but we do continue to selectively invest in the big opportunities that we see. We are watching our travel expenses carefully, telecom and the usual things.

Amit Hazan - Oppenheimer & Co.

Okay, thanks very much.

Operator

Your next question comes from the line of Brooks West with Craig-Hallum Capital. Please proceed.

Brooks West - Craig-Hallum Capital

Good afternoon. Thanks for taking the question. Just Steve referred on the couple of units that you mentioned were refurbished. I am wondering what was the background. Are those customers that are buying a new unit maybe that were early customers? If so, are they buying another TomoTherapy unit? Is there a trend they are going forward where we might see more of those types of transactions?

Steve Hathaway

I would not say there is any trend going forward. We do periodically have the opportunity to offer a refurbish system out onto the marketplace and we are able to do that at a reduced price. Generally these are units that we have use internally for R&D purposes and these things, we refurbish and resale and we can do that at a lower price.

Brooks West - Craig-Hallum Capital

Okay. So they are not coming on customer sites, the other Tomo test units?

Steve Hathaway

Correct.

Brooks West - Craig-Hallum Capital

Okay. That is it. Thank you.

Operator

Your next question comes from the line of Paul Choi with Merrill Lynch. Please proceed.

Paul Choi - Merrill Lynch

Great. Thanks for taking the question. Steve, in terms of the gross margin adjustments that you said, I think it was about $1.5 million. Can you walk us through that one more time in terms of what was exactly adjusted for please?

Steve Hathaway

Yes, there was about $1.5 million adjustment and I should first start off by saying what it was not. These are not adjustments related to increases in the cost of servicing out in the field. On average, our cost of servicing unit has been going down this year, especially from a parts usage standpoint. We did have this about a $1.5 million adjustment related to several things, and included in that were an extra provision for a couple of warranty extensions; we had a timing issue related to service parts that are returned from the field; and what we do with those parts is, we fully reserve those parts at the point in time they come back from the field, and until we see final disposition of those parts. So we find out that some are under warranty from suppliers, and other parts would be repaired, so we can recover part of that reserve.

We had an adjustment for some new contracts that had to be covered under the service loss provision. Those were the main components of that adjustment.

Paul Choi - Merrill Lynch

Okay, so in terms of the counter account, some of that $1.5 million could possibly be a put back in, and if so, perhaps at what point?

Steve Hathaway

As I said, it is timing. So it is constantly rolling through.

Paul Choi - Merrill Lynch

Okay, fair enough. Okay, then in terms of the service business guys, can you think any renewals in terms of service contracts or upgrades? Can you tell us how many people are continuing to extend their contracts or re-up them?

Steve Hathaway

I think virtually all of our customers who are off of warranty have service contracts, and they continue to renew.

Paul Choi - Merrill Lynch

Are they moving towards more of your higher-end service contracts? Or are they sticking more with your middle offering or do they tend to go for a higher service package on average?

Steve Hathaway

Yes, on average it tends to be that they are higher end service contracts, the top of the line…

Paul Choi - Merrill Lynch

Okay, great. That is encouraging to hear. In terms of the $4 million adjustments, Steve that you mentioned for currency in the backlog, would there be any potential future adjustments as a result of a currency based on the movements we have seen thus far in the quarter in the exchange rates based on what you can tell at current exchange rates that we should think about.

Steve Hathaway

Well, we consistently readjust backlog every quarter for the current exchange rates and generally that involves while most of our contracts are dollar denominated, we do have some of the contracts in Europe are Euro denominated and that is where most of our adjustments come in. As you know, we have seen some pretty dramatic change in the euro rates here over the last month or so.

Paul Choi - Merrill Lynch

Right. Can you then give us a sense of how much of your backlog as of now is U.S versus International?

Steve Hathaway

On average it is consistent with our long-term trends. So I think it is about 60% domestic, 40% international, but even that international is broken out between Europe and Asia and all the Asia is dollar denominated and a portion of the Europe is dollar denominated.

Paul Choi - Merrill Lynch

Okay, that is useful. Okay, I will jump back in line. Thank you.

Operator

Your next question comes from the line of Junaid Hussain with Soleil Securities. Please proceed.

Junaid Hussain - Soleil Securities

Good afternoon.

Steve Hathaway

Hi, Junaid.

Junaid Hussain - Soleil Securities

Steve, sorry to keep counting away on this. I am trying to understand your guidance for the fourth quarter on the top, $70 million to $90 million feels like an awfully big number especially given the tight credit markets, especially given what is going on with hospital spending, especially what is going on with the relatively robust rapid does your guidance reflect these three realities? Or do you feel that these realities are more of an issue for say, net order growth on a go-forward basis versus revenue growth for the fourth quarter.

Steve Hathaway

I think as we have been saying all along that this quarter included. We have not had losses of orders for competitive purposes. So that when you look at what is going on and as we track the orders in our backlog and the expectations of shipments from our backlog, we have been consistently saying all year that we were going to be very back end loaded because we saw big bowlers of shipments occurring in the fourth quarter, and that is what we are seeing on our shipments tracking.

As I have talked about before, a lot of these sites have started their preparations and they have the financing in place and they are moving forward. So we feel very good about fourth quarter guidance that we provided for the revenue.

Junaid Hussain - Soleil Securities

Okay, fair enough. Then Fred, relative to your recently signed agreement with Novation, can you help us understand the importance of having a GPO for a radiation oncology purchase. I was under the impression that given the relatively sophisticated sale of our radiation oncology machine, not a lot of instruments are typically purchased through a GPO, what is it about this arrangement with Novation in your mind makes a higher system compelling for Novation hospital?

Fred Robertson

I think having bigger contract with the GPO just removes one obstacle in the sales process. There are varying levels of compliance that individual customers in terms of how they manage their relationship with the GPO. So obviously it is not mandatory given and to begin with radiation oncology systems are unlike compliance with, say, a disposable contract.

Junaid Hussain - Soleil Securities

Okay. Just switching gears a little bit going to Hitachi in Japan; how is this agreement structured from a sales and marketing perspective, I am assuming that you are going to leverage the Hitachi radiology sakes team in order to facilitate the sale?

Fred Robertson

Hitachi will function as a full distributor, with responsible for sale, marketing and service with our support.

Junaid Hussain - Soleil Securities

Can you give us a sense for the selling cycle in Japan? Is it similar to the US or is it shorter or is it longer?

Fred Robertson

In our experience it is been similar. Let say relatively developed market, second largest market in the world and we are very excited to be reengaging.

Junaid Hussain - Soleil Securities

Okay, good enough. That is all I got.

Operator

(Operator Instructions). At this time, there are no additional questions in the queue. I would now like to turn the call back over to Dr. Fred Robertson for any closing remarks. Please proceed.

Fred Robertson

In closing, I would like to say that with our recent new product introductions and key partnership agreements, which firmly believe that TomoTherapy technology offers a distinct competitive advantage that meets the wide ranging needs of cancer treatment marketplace and most importantly patients.

I would like to thank you for joining us today, and we look forward to updating you again next quarter.

Operator

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

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