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Accuray, Inc. (NASDAQ:ARAY)

F2Q08 Earnings Call

January 29, 2009 5:00 pm ET

Executives

Dr. Euan S. Thomson - President and Chief Executive Officer

Derek A. Bertocci - Senior Vice President and Chief Financial Officer

Tom Rathjen - Vice President of Investor Relations

Analysts

Erik Schneider - UBS Securities

Junaid Husain - Soleil Securities

(Samji) - JP Morgan

Mark Arnold - Piper Jaffray

Angela Woodall – Oppenheimer

Peter Bye - Jefferies & Co.

Larry Haimovitch - HMTC

Operator

Welcome to Accuray second quarter fiscal 2009 financial results conference call. (Operator Instructions). At this time, I would like to turn the call over to Mr. Rathjen, Vice President of Investor Relations.

Tom Rathjen

Thank you for joining us this afternoon for Accuray's second quarter of fiscal year 2009 conference call. Joining us today are Dr. Euan Thomson, Accuray's President and Chief Executive Officer, and Derek Bertocci, Accuray’s new Senior Vice President and Chief Financial Officer.

As we did last quarter, we will again be referring to financial data which is found on two slides and a PDF file on the Investor Relations page of the Accuray website at www.accuray.com. Please log on to this site to view this information.

Before we begin, I need to remind you that except for the historical information, the information that follows contains certain forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include the matters described in the Risk Factors section of our reported Form 10-K for 2008 fiscal year as updated from time to time by our quarterly reports on Form 10-Q and other filings with the SEC.

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

Dr. Euan S. Thomson

I’ll start the call with a recap of some of the business highlights for the quarter. Next I will comment on the current state of the market for the CyberKnife. I will then discuss the workforce reduction that we announced today, and then finally I will provide a clinical update. I will then turn the call over to Derek who will provide a detailed review of our financial results and outlook.

To begin with, I would like to provide a review of the financial highlights from the second quarter. Total revenue for the quarter was $57.6 million, a 10.5% increase over the same period last year. Our services revenue was $13.9 million in the quarter, or 24% of total revenue, representing an increase of 56.2% over the same period last year. We continue to see growth in this recurring revenue stream as very positive since it represents steady predictable flow from long-term contracts.

Our net income for the quarter was $1.4 million or $0.02 per diluted share. This includes a mark to market change to other income of approximately $860,000 related to our negotiated agreement for repurchase of our auction rate securities. Derek will give more details of this transaction.

During the second quarter, a total of 10 CyberKnife systems were installed, bringing the worldwide installed base to 155 systems. Six of these systems were installed in the United States, helping us reach and surpass the significant milestone of 100 US CyberKnife systems. Internationally, there were four installations including two in Europe. There were also four additional shipments to distributors that we expect will be installed before the end of fiscal 2009.

Of the 10 systems installed, 8 were accompanied by a commitment to a service agreement, representing continued strong uptake of our high-level service programs and giving us a good indication of further future growth of our recurring revenue streams. We added 9 new system orders to backlog in the second quarter, which together with some renewal of premium service contracts represents a total of $50.5 million. Two of the system orders were from the United States and seven were from international markets. Four of these contracts went directly into non-contingent backlog, representing a value of approximately $20.2 million. In Q2, the total addition of contract value to non-contingent backlog approximately equaled the revenue recognized from backlog, and as a result, non-contingent backlog remained relatively flat at $452 million. Derek will give a further analysis of backlog in a moment.

Now, I’d to transition to a discussion of the market for the CyberKnife. On a worldwide scale, our business has remained relatively strong despite the current economic pressures. Once again, we have no cancellations from non-contingent backlog in the second quarter, and there has been minimal impact on installation schedules. So far, the only significant impact of the current economy has been that during the second quarter, we did see some new customers in the US delaying their decisions to commit to a CyberKnife. This is definitely a United States effect, and it did not apply to all US customers. I should also point that we’re in active discussions with all of these customers, and we strongly believe that they will eventually purchase a CyberKnife. We see the issue more as a matter of timing.

In international territories, although it’s still early days, we are yet to see any significant impact of the economic downturn. Currency exchange rate fluctuations have had some impact on the profit margins of some of our international distributors, but the sales environment remains good, particularly in Europe where we are experiencing a strong growth phase. Last week, I was in Europe meeting with our direct sales force and distributors, and I left those meetings optimistic that our strategy is correct and the demand for CyberKnife is increasing.

In Japan, we have signed 8 purchase agreements since the CyberKnife received regulatory approval for the whole body treatment last June. We’ve now upgraded three sites in Japan to give them body treatment capability, and we expect them to begin treatment of tumors outside of the head and neck region soon. We continue development of our international profile, and since the beginning of the fiscal year 2009 have signed 8 new distributor agreements in seven countries. Whether or not economic trends persist, we view our increasing our international strength as a key element of our financial growth.

While the quality of our backlog continues to increase with 76% of contracts being non-contingent, during the second quarter, we did remove 8 orders out of the contingent category. Our removal of these contingent orders was due to either a reduced confidence or to a customer cancellation. Of the eight contracts removed from contingent backlog, only one was cancelled as a result of the capital freeze. Two were cancelled as a result of failure to obtain certificates of need, and the others were removed from backlog as a result of our reduced confidence that the contracts would lead to a near-term installation. It’s now nearly a year since we had cancellation from non-contingent backlog.

Summarizing our current backlog performance, against only one cancellation, we have added 57 contracts to non-contingent backlog over the past 4 quarters. Since we have seen little to no negative impact on installation schedules and our non-contingent backlog remains strong, we are today reconfirming our fiscal 2009 revenue guidance of $230 to $250 million.

Further, in a proactive effort to contain costs and to accelerate enhanced profitability, Accuray announced today that it has eliminated approximately 60 positions, or approximately 13% of its US workforce. The decision was based upon a comprehensive management review with a focus on improving corporate efficiency and productivity. We expect this workforce reduction to result in approximately $9 million in annual cost savings, and in these times of global economic uncertainty, this focus on efficiency is of particular importance. While this is not an easy decision, we believe that is a prudent course of action and is in the best interest of our shareholders. I’d like to take this opportunity to thank all of our employees for their hard work and assure our customers and investors that this will in no way impact the quality of our products, service, or innovation.

Moving onto our clinical programs, there continues to be tremendous interest from the medical community in CyberKnife radiosurgery treatments. As a reminder, radiosurgery is distinct from radiation therapy in that while radiation therapy tends to be used as a supplement to surgery, CyberKnife radiosurgery is intended to replace surgery. As a result, CyberKnife patients can benefit from a noninvasive tumor destruction process that avoids the need for general anesthesia and an open surgical procedure. This concept was validated at this year’s Society of Thoracic Surgeons or STS meeting this week in San Francisco. The meeting provided tremendous interest and enthusiasm for CyberKnife lung radiosurgery.

Recent publication of several clinical papers describing the benefits of CyberKnife’s accurate delivery of high-dose radiation to treat lung cancer has helped to raise the profile of the CyberKnife to this group of physicians. Discussions led by leading thoracic surgeons, such as Dr. James Luketich, Chief of Thoracic Surgery at the University of Pittsburgh, describing CyberKnife treatment outcomes have highlighted the importance of thoracic surgeons embracing stereotactic radiosurgery. They highlighted the benefits that CyberKnife can bring to a thoracic surgeon’s practice to treat borderline and inoperable lung cancer patients. The STS university session included a teaching lecture delivered by Dr. Richard White of Stanford University for its thoracic surgery residents, in parting his expertise on CyberKnife radiosurgery and the essential role it will play in the future practice of thoracic surgeons.

Dr. Jack Roth, Chief of Thoracic Surgery at MD Anderson and others extended the potential of CyperKnife’s radiosurgery even further through several presentations discussing the recently launched MD Anderson Randomized Study of Surgery versus CyberKnife radiosurgery. This study is poised to provide evidence that may revolutionize the way operable early-stage lung cancer is treated worldwide. In the closing address to one of the general surgical sessions, the session moderator stated that more and more patients are asking for CyberKnife treatment and encouraged participants to get themselves involved.

So, in summary, there are clear indications that physicians and patients are increasingly seeing the impact and value of radiosurgery and specifically the CyberKnife in the treatment of lung cancer.

This growing clinical demand was validated in Q2 by our own treatment statistics. The number of patients treated in the United States during calendar year 2008 increased over 30% when compared to the previous year. In the same period, there was a 43% increase in lung cancer patients treated worldwide with CyberKnife, a 54% increase in prostate patients treated, and 36% increase in liver patients. These statistics indicate a continued strengthening of the demand for CyberKnife radiosurgery to treat soft tissue tumors, a market that has been developed by Accuray’s clinical programs.

I should also remind you that the CyberKnife remains the only dedicated whole-body radiosurgery system on the market. It still remains the case that when a hospital has made a decision to embark on a dedicated radiosurgery program, they rarely if ever, select a technology other than the CyberKnife.

Also on the subject of clinical growth, our eighth annual CyberKnife Users Meeting is taking place next week in Florida, and we have more than 500 surgeons, radiation oncologists, physicists, radiation therapists, and administrators registered to attend and learn how to further improve their full-body radiosurgery programs. This level of attendance is extremely positive and reflects the medical community’s continued interest in building successful CyberKnife radiosurgery programs.

Finally, before I turn the call over to Derek, I want to give you an update on the treatment planning service we introduced in January of last year. As a reminder, this service provides our customers and potential customers with access to a dedicated team of remote scientists specializing in CyberKnife radiosurgery treatment planning. The benefit of this service is starting flexibility and enhanced patient capacity of participating treatment centers. This can be especially attractive in an uncertain economy. I am pleased to report that the pilot phase of this program which was conducted with Georgetown University Hospital was completed during the quarter and that we have begun to more actively promote the program to our entire customer base.

Our customers have been pleased with the high quality treatment planning that we can provide, and our initial sales efforts have been promising. We have signed agreements with eight customer sites, and in addition, we have entered into a multi-site agreement with another customer. While we do not expect significant revenue from this service during the remainder of 2009, we do expect this service to begin to further enhance our recurring revenue stream in the mid to long term, and believe that we can finalize several more agreements by the end of the fiscal year.

With that, I will now turn the call over to Derek for the financial review.

Derek A. Bertocci

This afternoon, I will review our financial operating results for the second quarter of our fiscal 2009. As Euan mentioned, total revenue for our second quarter was $57.6 million, a 10.6% increase over the second quarter last year and a 3.2% increase sequentially. During the second quarter, we entered into a settlement agreement with the distributor of our auction rate securities that guarantees repayment of the securities at par value, beginning June 30, 2010. As a result, we recorded a charge of $860,000 or $0.02 per share in Q2 to reflect the current fair market value of these securities and repurchase agreement. Including these charges, Accuray generated net income of $1.4 million for the quarter or $0.02 per diluted share compared to a net income of $2.3 million or $0.04 per diluted share during the same period last year. Our strong performance this quarter was due to an increase in shipments and installations of new CyberKnife systems.

Taking a closer look at second quarter revenue; CyberKnife’s product sales generated $41.3 million. During the second quarter, ten systems were installed which represents an increase over our average quarterly activity in the past. We anticipate that installations will continue to be above average through the end of fiscal 2009.

Services revenue was $13.9 million or 24% of total revenue for the quarter. Our services revenue is generally derived from long-term maintenance agreements of 4- or 5-year terms whose revenue is ratably recognized over the service term providing stability and predictability to our revenue stream as our installed base grows.

Fiscal second quarter 2009 services revenue represented an increase of 56% year over year re-enforcing the growing importance of this recurring revenue stream. Shared ownership arrangements produced $900,000 of revenue during the second quarter, an anticipated decline from the same period last year.

Exiting the second quarter, Accuray had a total of three shared ownership units. The year-over-year and sequential decline in shared ownership revenue was expected following the buy-out and recognition of sales revenue on 12 shared ownership units in fiscal 2008. Other revenue for our second quarter was $1.5 million which includes upgrades for units installed in Japan.

Prior to fiscal 2006, we have sold 30 CyberKnife systems in the US under our Platinum Program. All of these systems were installed by the end of fiscal 2007. As of the end of the second quarter of fiscal 2009, all required upgrades had been installed on 25 of the 30 systems sold under our Legacy Platinum Program. We estimate that most of the remaining deferred Platinum revenue will be recognized as revenue by the end of fiscal 2010.

Looking at installations, ten CyberKnife systems were installed during the quarter, six in the US and four internationally. Of the four international installations, two were in the Europe, one in Japan, and one in Asia outside of Japan. This brought the worldwide CyberKnife installation base to 155 at the end of the second quarter. The geographical breakdown of our worldwide installed base at the end of the quarter was 101 in the Americas, 14 in Europe, 21 in Japan, and 19 in the rest of Asia.

When Accuray is responsible for installation of a CyberKnife system, we recognize revenue only after the installation is complete. In general, when our distributors are responsible for installation, Accuray recognizes revenue upon shipment to the end customer. It is therefore important to note that a period of time often lapses between shipment and installation of the CyberKnife unit in these arrangements.

During the second quarter, we recognized revenue on 13 units, including eight in the US, three in Europe, and two in Asia. Of the US revenue units, six were new system installations and two were associated with the Legacy Platinum accounts. We added nine new system orders to backlog in the second quarter which together with renewal of some service contracts, represented a total addition to backlog of $50.4 million. Two of the system orders were from the United States and seven were from international markets.

At the end of the second quarter, Accuray’s total backlog was $598 million compared to $644 million at the end of the first quarter of fiscal 2009. Non-contingent backlog of $452 million was up $1 million from $451 million at the end of the prior quarter and represents 76% of our total backlog. We added ten orders to non-contingent backlog, four newly signed this quarter and six from prior periods that cleared contingencies during this quarter. Non-contingent backlog represents orders that have no contingencies.

Historically, we have experienced minimal cancellations of non-contingent orders, only one system in the past year. All other customer orders have one or more contingencies that may prevent the shipment of product. We assess these contingencies to gauge the likelihood they will be cleared. Orders that we believe will probably be shipped and installed are included in contingent backlog. Orders with less certainty are not reported as part of backlog. The lack of precision inherent in evaluating these contingencies can, and sometimes, does result in orders initially being judged sufficiently likely to be included in contingent backlog, but later being removed. Given this imprecision, we believe that reporting contingent backlog does not contribute to an accurate reflection of our order of backlog. Some investors have also made this point.

Accordingly, beginning with the first quarter of fiscal 2010, we intend to report only non-contingent backlog, which historically, has been a reliable indicator of our future system shipments and service activity. We will report contingent backlog only through the end of fiscal 2009. Contingent backlog of $146 million was down $47 million from $193 million at the end of the prior quarter. Of the eight contracts removed from contingent backlog, only one was cancelled as a result of a capital freeze. Two were cancelled as a result of a failure to obtain certificates of need and the others were removed from backlog as a result of our reduced confidence that the contracts would lead to a near-term installation.

Of our total backlog, including non-contingent and contingent orders, $311 million is associated with contracts for CyberKnife systems, $249 million associated with long-term service agreements, and $38 million for shared ownership program contracts. Two charts reflecting our backlog have been placed on the Investor Relations page of the Accuray website.

Our gross margins for the fiscal second quarter was 51% compared to 50.9% in the prior quarter. We anticipate that our gross margin for the balance of our fiscal year will be similar to our second quarter. Total operating expenses for the second quarter were $28.8 million or 50% of revenue. Our expenses are up from the second quarter of the prior year due principally to additional costs related to the inventory investigation and higher R&D spending.

Our investment in Research and Development was $8.8 million or 15.2% of total revenue, reflecting Accuray’s ongoing commitment to this important area. Expenses in Q2 were down from Q1 of fiscal 2009 due mainly to costs related to the ESTRO show and $1.7 million of employee severance incurred in Q1.

During the second quarter of fiscal 2009, Accuray recorded a non-cash stock-based compensation charge of $3.6 million. As a reminder, these non-cash charges represent a fair value at the date of grant of stock options calculated using the Black-Scholes Option Price Model and restricted stock, both amortized to expense over their vesting periods.

During the second quarter, we reached a settlement which commits the financial institution holding our auction rate securities to repurchase these securities at full par value beginning June 30, 2010. However, as a result of this agreement, we must now account for these securities as trading securities and recognize the current fair value which resulted in a charge to other income laws in Q2 of approximately $860,000 or $0.02 per share. The financial institution agreed to re-purchase these securities at the full amount that we paid for them. Therefore, ultimately we anticipate incurring no cumulative gain or loss. Between now and the date of repurchase, we will continue to earn interest income in these securities, and we anticipate that the market value will gradually rise towards the par value of the securities.

Accuray is taking steps to enhance its ability to weather potential impact of the current global economic downturn and to position itself for success in the long term. The company has eliminated approximately 60 positions in the US, representing approximately 13% of its US workforce. In addition, we will focus on improving processes and cross-company collaboration to improve the efficiency of our activities. It is estimated that the future annualized savings in employment-related expenses will be $8.7 million per year as a result of these reductions. Due to severance pay and the timing of terminations, this action will not reduce expenses in our third fiscal quarter, and savings in our fourth fiscal quarter of 2009 will be limited. The full benefit of these savings will start in the first quarter of fiscal 2010. Most of the affected jobs are located at Accuray’s Sunnyvale, California headquarters.

Reviewing Accuray’s balance sheet, total cash in investments at the end of December 2008 was $154.7 million. This consists of cash and cash equivalents of $29.4 million, short-term investments of $80.2 million, long-term investments of $44.5 million, and restricted cash of $0.6 million. Deferred revenue was $98 million with $69.5 million in current deferred revenues.

At the end of the quarter, Accuray’s total assets were $285.6 million, and the company continues to have no debt. The strength of our balance sheet provides us with the ability to pursue our business goals without the need to raise capital, an important distinction in a time of economic downturn.

On a personal note, I would like to say how pleased I am to be part of the Accuray management team. Although I have been on board for less than a month, I am encouraged by the significant potential of Accuray and the tremendous opportunity that we have to change the way cancer is treated.

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

Dr. Euan S. Thomson

The second quarter was highlighted by continued revenue growth, steady conversion of contingent and non-contingent backlog, and progress in accelerating installations. Our recurring services revenue is becoming an increasingly significant portion of our overall revenue and will be bolstered by our treatment planning service as more customers take advantage of this productivity-enhancing service.

Despite the current uncertainty in the economy, we believe that there remains robust clinical demand for the CyberKnife, and we are confident that we have crafted a prudent strategy to efficiently capitalize on this demand.

We will now be happy to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is from the line of Erik Schneider with UBS Securities.

Erik Schneider - UBS Securities

I heard the number of Legacy units, I think I heard two, but could you tell us how much revenue was associated with the product and service revenue of those two units?

Derek A. Bertocci

The service revenue that came through that was over and above the service revenue for all Legacy units, it is not just necessarily those two, was about $1.8 million during the quarter.

Erik Schneider - UBS Securities

There was $1.8 million incremental?

Derek A. Bertocci

Yes, for service on Legacy units, that $1.8 million represents the amount of revenue that is in excess of the service revenue over the full 4-year service period for those agreements. In other words, it is the acceleration of revenue due to the accounting for these units.

Erik Schneider - UBS Securities

Okay, and the product revenue?

Derek A. Bertocci

$5.8 million again for all legacy units in the quarter.

Erik Schneider - UBS Securities

And you noted the 60 positions were mostly from headquarters, does that mean it is mostly SG&A or is that also R&D, and could it affect gross margins?

Derek A. Bertocci

It does include all functions in the company, so it will impact all areas, operations, as well as a gross margin.

Operator

Our next question is from the line of Junaid Husain with Soleil Securities.

Junaid Husain - Soleil Securities

Just an obligatory CapEx question for you, more focused internationally, could you give us a sense for what is going on with your international customers? What’s been the dynamics for securing financing for CyberKnife, is it easy, is it hard, and then how would you characterize international hospitals versus US hospitals in terms of enthusiasm for CyberKnife, and then the ability to finance this box just given this capital spending environment we are in?

Dr. Euan S. Thomson

I think we have spoken about this before fairly regularly, what tends to drive our international business is more the perceived clinical value of the product rather than the pure economics, and I think for that reason we’re seeing very strong growth internationally, and I think that’s why it seems to have been so robust in these economic conditions. So, overall I think we’re very very positive about our international businesses. It seems to be very strong, particularly as I indicated previously in Europe where clinical value is the biggest driver if anywhere in the world. I think the nature of the customer there, generically, tends to be larger hospitals and large institutions; that’s just the market is structured, and fewer free-standing centers and smaller centers, and that may also be what makes it a very robust environment.

Junaid Husain - Soleil Securities

Last question for Derek, just a housekeeping question; could you remind me what portion of your marketable securities is levered to auction rate securities, and would you expect similar charges moving forward?

Derek A. Bertocci

Yes. The total value of those from a cost basis is approximately $22 million. As far as those assets, we would expect that they won’t be a charge like this in future quarters. We would expect as the time closes to the date when we will be able to sell them back to the financial institution, that this charge that we recorded this quarter will gradually actually be reversed, and once we get them repurchased by the bank, there will be no loss, and so we will have recouped this accounting entry right now.

Operator

Our next question is from the line of (Samji) with JP Morgan.

(Samji) - JP Morgan

Could you comment on the average selling cycle for the CyberKnife in the current economic environment, if there has been any significant change there?

Dr. Euan S. Thomson

Internationally, I would say that we haven’t noticed any change in the selling cycle, and topically, it’s a pretty small data of samples that we have right now. We did see some customers that we expected to sign purchase agreements during Q2 that just delayed their final decision. It wasn’t that they decided not to buy a CyberKnife. It’s just that they really wanted to one more round on their business case and their business plan before they signed up. So, as I indicated, we’re still talking to those customers, and we expect them to sign in the end. I think overall, when you translate to the other side of the business which is just as important, or more important, is the transition from a signed agreement into installation. We haven’t seen any significant delays there at all anywhere in the world. So, the installation schedule that we’ve put together, I would say, we haven’t really had impacted by the change in economic environment. So, I think, once people have made the decision and they’ve got everything in a row, then it doesn’t seem that we’re experiencing any delays.

Operator

Our next question is from the line of Mark Arnold with Piper Jaffray.

Mark Arnold - Piper Jaffray

The non-contingent backlog was flat, but the distribution between systems and services changed a little bit, and maybe you mentioned this in the prepared remarks, I just missed it, but can you comment on what’s driving that; did you shift a couple of systems into shared ownership and do you see that trend continuing?

Derek A. Bertocci

There was a slight increase in the amount of service backlog and a slight decrease in the amount of system backlog in the non-contingent. That was the main reason for the shift that you’re talking about, and it was a slight increase in the amount of shared ownership backlog.

Mark Arnold - Piper Jaffray

What would have caused that shift; is it just selling more upgrades and services and taking a couple more out of the CyberKnife product, a couple orders out of there or did those orders actually shift to the shared ownership, and how do we think about that distribution?

Derek A. Bertocci

The shared ownership is a relatively minor thing. As far as the CyberKnife, it was reflecting shipments of orders plus new orders coming in, and we had more service contracts to be also signed in terms of followon agreements for existing customers.

Dr. Euan S. Thomson

We didn’t have any shift to shared ownership as far as I am aware. No customers who were planning to buy shifted to shared ownership. I don’t think that was a feature.

Operator

Our next question is from the line of Angela Woodall with Oppenheimer.

Angela Woodall - Oppenheimer

I am going to go back to the guidance; you’ve mentioned that you’ve done some checks-in and you haven’t seen any delays in your install schedule, and I am just wondering if you could help us gain a little bit of confidence and tell us how frequently do you do these checks; how many customers have you talked to? Just to make us a little bit more secure in your guidance for the year.

Dr. Euan S. Thomson

Since the beginning of this year we’ve definitely accelerated and invested in our point of contact with prospective customers to give ourselves that sense of security too. So, we now have a team of people who have multiple points of contact inside each hospital. So, we’ll be talking to the original physicians, we’ll be talking to the CEO of the hospital, we’ll be talking to the facilities group who may be organizing and coordinating the installation itself, the physical installation. So, we have multiple points of contact now with each of the hospitals. Each one of them inside are on planned installation schedule, it’s had that level of contact. So, we feel fairly secure as much as we can. The unknowns of course are slippage in installation schedule which can occur for a number of reasons and the uncertainty always comes from the fact that each one of these units carries a high dollar value in itself. So, it can change with one or two units being moved around as a result of unforeseen circumstances, but in terms of our own points of contact and our due diligence, I think, we’ve certainly accelerated that and invested in that during this year.

Angela Woodall - Oppenheimer

On gross margin, you’ve had some fluctuation obviously in the gross margin, particularly for your product sales and your services, and I am just wondering, you said that your gross margin, 51%, is a little bit lower than it has been in the past couple of quarters, and you expect it to remain around the same level for the rest of ’09. Can you just talk a little bit about what’s going on within the gross margin line and how we should think about that going forward?

Derek A. Bertocci

The factors that are affecting the gross margin are the mix of products between direct and indirect. In other words, if we’re going to sell the product we’re selling through distribution. The other factor that affects our margin is service and service is gradually growing as a component of revenue. The service business has a lower margin than the sale of product. The combination of those factors yields our outlook on the gross margin.

Operator

Our next question is from the line of Peter Bye with Jefferies & Co.

Peter Bye - Jefferies & Co.

First is just a followup on the time horizon there; for the ten systems that were installed, what was the average length of the contract from where it was signed? Do you have that?

Dr. Euan S. Thomson

We don’t have details of that, but I can tell you that there is a big spread, as there always is, and it becomes as we work on our process of minimizing the time between contract signing and installation. What we’re seeing as success stories are very often that we’re bringing in installations based on contracts that were signed some time ago. So, we ourselves are really assessing what’s the best metric to use for that success. Sometimes it can be that the contracts have been there for sometime and we’ve been successful in shaking them out of that phase and getting them installed. Other times our success just comes from a very short installation time. I would say, my perception of it right now, is that there hasn’t been a particular shift, and there is still a fairly wide spread, but we’ll certainly try and keep track of that, we’re trying to keep track of that for our own benefit, and as we gain more insight into exactly how to value that, we’ll pass it onto you.

Peter Bye - Jefferies & Co.

Okay, great. I am not sure if I heard you correctly, but I think you said you haven’t lost any orders in the non-contingent backlog?

Dr. Euan S. Thomson

There’s one in the past 12 months, about last February or so. So, it seems to be a very robust measure. The measure we’re using for non-contingent contracts appears to be very robust which is why we’re feeling that much confidence in it.

Operator

Our last question is from the line of Larry Haimovitch with HMTC.

Larry Haimovitch - HMTC

Euan, during your prepared remarks you touched a little bit on some of the areas which were showing strong procedure growth. Could you give us a little more color on a couple of the areas you are particularly excited about, where you see some real uptake in the market and where you see this particular procedure might become a very significant, very important procedure to drive future unit installations?

Dr. Euan S. Thomson

We’re still seeing strong and steady growth in the intracranial and generally in the CNS procedures, and spinal, but lesser than intracranial, and as we always have done are seeing that as the base mark, the one we started with, the one with longest experience, clinical validation, and one where people understand it most from a referral pattern point of view. I think the ones we’re most excited about going forward are the ones that I called out in the scripted portion. I think lung is increasingly becoming known; lung radiosurgery, almost exclusively with the CyberKnife is becoming known in the thoracic surgery world, and it was a great conference for us this last week with a lot of specific calling out of the CyberKnife itself and an almost a call to action from some of the participants or thoracic surgeons to pay attention to the CyberKnife because it would definitely have an impact on that practice, which we think is a very good sign, and that coupled with a strong growth in our own treatment numbers gives us a very good feeling about that one. I think prostate still remains not a critical part probably at the sales process, but it’s still the fastest growing application. I think inside the CyberKnife world amongst people who have experience with the CyberKnife, I think, when they see its application in other areas, it gives them the confidence to move ahead, possibly faster than people who don’t have an experience of the CyberKnife. So, it’s a little bit of a mixed bag as far as prostate is concerned right now, but we’re seeing very very strong growth as I indicated, and I think, that for the future of course that has to be one of the biggest, if not the biggest potential application.

Larry Haimovitch - HMTC

Okay, and a quick followup question; do you see correlation between the growth of procedures and installations? You’ve got several that are growing very very nicely. I would assume that over time that that does drive new installations or even second installations at some hospitals. Is that a fair proxy that as procedures grow we should see that driving placements as well, Euan?

Dr. Euan S. Thomson

Yes, I think particularly where you see growth which is faster than growth in the installation base, because that indicates changing of the markets and a growth in the overall procedure demand. So, we’re seeing, for example, CNS brain treatments in particular tend to track pretty much with the installed base, and that doesn’t indicate the change in the dynamic of the market, and necessarily a future change in the essential demand for the CyberKnife, but I think where you see such strong growth particularly lung, liver, and prostate, those are already growing faster than the rate of installation, which indicates a growing clinical demand, and of course we believe and expect that would translate into increased CyberKnife demand.

Operator

There are no further questions at this time. Presenters, do you have any closing remarks?

Dr. Euan S. Thomson

The second quarter was highlighted by continued revenue growth, steady conversion of contingent and non-contingent backlog, and progress in accelerating installations. Our recurring services revenue is becoming an increasingly significant portion of our overall revenue. Despite the current uncertainty in the economy, we believe that there remains robust clinical demand for the CyberKnife, and we’re confident that we’ve crafted a prudent strategy to efficiently capitalize on this demand. Thank you for your time today. We look forward to talking to you on our next call.

Operator

This concludes today’s conference call. You may now disconnect.

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