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Varian Medical Systems, Inc. (NYSE:VAR)

Mid-Year Review Conference

May 14, 2013 12:00 pm ET

Executives

Elisha W. Finney - Chief Financial Officer and Corporate Executive Vice President of Finance

Dow R. Wilson - Chief Executive Officer, President and Director

Kolleen T. Kennedy - Corporate Senior Vice President and President of Oncology Systems

Analysts

David H. Roman - Goldman Sachs Group Inc., Research Division

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Amit Hazan - SunTrust Robinson Humphrey, Inc., Research Division

Amit Bhalla - Citigroup Inc, Research Division

Steve Beuchaw - Morgan Stanley, Research Division

Anthony Petrone - Jefferies & Company, Inc., Research Division

Jeremy Feffer - Cantor Fitzgerald & Co., Research Division

Jason Wittes - Brean Capital LLC, Research Division

Elisha W. Finney

Our midyear review, we're going to talk about the first 2 quarters of fiscal year '13. I'm Elisha Finney, the Chief Financial Officer. And with me today from Varian, we have Dow Wilson, the CEO. We have Kolleen Kennedy, who is the Senior Vice President and President of Oncology Systems. And we have Spencer Sias, who is Vice President of Investor Relations and Corporate Communications.

Before I get started, we will be making some forward-looking statements. So today, I'm going to quickly review the financials, mostly focusing on the second quarter, just a word on the first half. Dow is going to come up and give the strategic overview. He's also going to talk about the Varian imaging components businesses, which were recently restructured. They're now both reporting in to Bob Kluge, and that includes our X-ray Products businesses, as well as our Security and Inspection Products business. Dow will also talk about proton therapy. And then Kolleen will come up and talk about Oncology Systems and the market outlook. And then, we would love to turn it over for Q&A.

So to jump right into the numbers. I would characterize our second quarter as the revenue and the profits being absolutely in line with our expectations. The orders for Oncology Systems, somewhat disappointing, particularly in the U.S, And we're going to spend a lot of time today talking about what's going on in our markets around the globe. X-ray Products had a very strong quarter in both orders, revenues and profits. And our Proton Therapy segment, we start -- as the Scripps project is starting to come down, as that project is completed in terms of revenue recognition, we did start revenue on both the Saudi projects and the Russia project, which was exciting. And then I would say the yen negatively impacted our earnings per share by about $0.02 cents in the quarter.

So in terms of how to read this slide, Varian Medical Systems is the column to your far left, that is the total company results. And then you can see we have it by our 3 segments, Oncology Systems, X-ray Products and then the Other category. And for this purpose, SIP, the Ginzton Technology Center and Corporate is lumped into the other numbers.

You can see total company net orders of $736 million. And while that is down on a reported basis year-over-year, it really is a bit of apples and oranges. And that's because in the year-ago period, we recorded $124 million of Proton Therapy orders. Those are obviously very large deals, very, very lumpy. If you exclude the proton business year-over-year, orders for the total company were flat.

Revenues up 7% for the quarter and gross margin up 41 basis points to 41.6%.

Moving to Oncology Systems. Again, you can see on a constant currency basis, orders were flat and down 2% in dollars. North America was down 9% in orders. EMEA was up 5% in constant currency. The Far East was up 7% in constant currency, and then our other Rest of World was up 16%.

Revenues of $582 million were absolutely in line with expectations, up 3%, with 56% of those revenues from international locations. So that was a 4-point shift to international markets. And even despite that shift and the fact that we started recording excise tax, which impacted us by about $2 million in the second quarter, Oncology was still able to increase the gross margins by 61 basis points to 42.8%. So what we're seeing is that TrueBeam now represents a very high proportion of our high energy unit, and that, that product mix, along with software, was more than enough to offset the shift to outside of North America and to cover the excise tax.

X-ray Products, again, a very strong quarter with double-digit growth in orders and sales. The margin was down about 0.5 point, still at 42%, which is up significantly from where they were just, say, 5 years ago. As the flat-panel products become more mainstream, we did see some pricing pleasure. The margins were down a few points in flat panel. But that said, it's still a much higher margin product line than the X-ray tubes. But you blend it all together, X-ray tubes margin was up and turned in 42%. And I think that should be about where X-ray is able to land going forward in the low 40%.

And then, the only thing I'll mention on the Other category is, again, the proton therapy year-ago quarter just makes these results look a little bit skewed as we did not book an order in this Q2.

R&D and SG&A were even with the year-ago period as a percent of sales, 7% for R&D, 15% for SG&A. So our operating earnings were up 30 basis points to 20.3% of sales. And again, that includes the excise tax at $2 million, as well as a $2.5 million restructuring charge that we took for an accelerated or enhanced retirement program that we offered.

Earnings per share of $1.02 were -- with the lower shares due to our buyback, were up 9% in the quarter.

Just a note on year-to-date, again, if you exclude proton therapy year-to-date, the net orders for the total company would be flat and revenues up 8% and gross margin up about 20 basis points. Oncology Systems would also on orders flat in constant currency, 5% in revenue, and the gross margin down very slightly, about 18 basis points year-to-date. And that's due almost entirely to the excise tax impact.

X-ray Products, very strong, mid-teens growth in orders and sales; and for the year-to-date gross margin, up about 30 basis points. You can see that ROS, return on sales, operating earnings as a percentage of revenue, 20%. That is even with the year-ago first half, even after the excise tax and $6.5 million with total restructuring charge, with some of that taken in our Q1 and the balance in Q2. And earnings per share up 9% to $1.88.

A look at backlog, and this just shows you by year, quarter-over-quarter growth in backlog ended Q2 with just under $2.8 billion, which was up 4% year-over-year. And again, gives us good visibility and predictability, as we look out over the forward 12 months, because the average time in backlog is 12 to 15 months, depending on where the machine is going. If you exclude proton therapy, the backlog for the balance of the company is actually up about 6% from the year-ago period.

Very conservative balance sheet. We ended the quarter with $740 million of cash. Virtually all of that is offshore. We have $56 million that was drawn down under a revolving line of credit that we put in place for the Scripps Proton Therapy Center. That entire facility is $115 million, and $56 million has been drawn at this point.

The total debt of $238 million, and that is really revolver debt that we take on in order to execute on -- under our ongoing share repurchase program.

Day sales outstanding ticked up 4 days to 87 days versus the year-ago period. But if I look at just the rolling 12 months average DSO, as of the end of the second quarter, if I look back a year, we've averaged 85 days, which is actually only up 2 days versus the same metric in the year-ago period.

Collections continue to be good. What we're seeing is that the proton business negatively impacts our DSO because we are recording revenue, we are creating an AR, but we've given extended terms as we're trying to really jump start this Proton Therapy business. So it negatively impacted DSO in the quarter by about 5 days.

Cash flow from operations was $31 million in the quarter and $103 million for the first half. And we did spend $90 million in the quarter to repurchase 1.4 million shares. If you look at the first half, we have spent $194 million to repurchase 2.9 million shares.

Just another look at operating cash flow, and what this is, is it's taking every quarter and looking at the trailing 12 months. And you'll see that if you average that over the last 2 years, we average about $460 million in any 12-month period of time in cash flow from operations. And while the first half was a little lower than what we have typically expected, you can see, if you look at Q2 '13 for the first -- the trailing 12 months and compare that to Q2 '12 for the trailing 12 months, were actually up. So again, that gives us good confidence as we go forward that, again, we should be around $500 million in cash flow from operations for the year.

And let me just end with the outlook, which I'm simply reiterating the guidance that we gave at the end of the last quarter, revenues growth of about 8% for the fiscal year, EPS $4.09 to $4.14. And I have to stress, and I know we made a big point of this in the conference call that we have a significant amount of proton revenue built into this, and a lot of that coming in Q4, when our expectation is that the Maryland project will be completely financed, we will be able to book the order and a significant amount of revenue for that proton business in the fourth quarter. So for the year, this assumes roughly $80 million of total proton revenue at about a 10% margin for the total year. If, for some reason, Maryland doesn't get financed, obviously, that is a big difference. But as we sit here today, I have no reason to believe that it won't. The building is ahead of schedule. Dow was there. It's a beautiful facility. And so hopefully, this will all come together in our third or fourth quarter.

With that, I'm going to turn it over to Dow for the strategic review.

Dow R. Wilson

Thanks, Elisha, and welcome, everybody. This morning, I'm going to do 2 things. First thing, I'm going to give you a brief little update of our strategic initiatives. And then, we will kind of chunk through each of the businesses and give you some exposure and detail on each of our businesses.

As you know, our overall goal is to help save millions of lives every year around the world. In each one of our businesses, we do this. Incrementally, in the oncology business, we're trying to save 100,000 new lives every year. And then, of course, in our X-ray Products business, we help our partners see new things. We'll talk about some of the exciting new technologies that we have in both the X-ray tube and flat-panel business. And then, as well, to protect lives in our Security and Inspection business, and develop new opportunities for save lives in our proton business.

The 5 initiatives that we've really been pushing for a long time, many of them are not new, it starts with innovation. In the oncology business, it's about differentiation with new products, and it's also by growing the pie with new applications. We continue to be very excited about what's happening in lung cancer and liver cancer, and Kolleen will give you a brief update on that.

In our X-ray business, it's about new products and new market segments, and we believe that with a pipeline that we see and new products in that business that we can continue to achieve very positive double-digit growth in our imaging components business.

Software and services, clearly, it's a great opportunity for us. We're -- we have almost a TrueBeam a day coming out of warranty over the next 12, 15 months. That's a nice boost to our service business. And service and software also helps offset some of the margin dilution we see, as we move internationally. Both these businesses are growing at double-digit rates. And we're also seeing the uptake of both software and services in our international businesses grow as well, and that's very positive.

Protons, we'd love to have it breakeven today or even next year. It is, as you know, dilutive to us. We're pretty philosophical about this. We view this as a long-term investment for the company. We think protons will be very, very important in the long term. And we need to work hard to demonstrate both the clinical evidence as well as the economic evidence of the efficacy of these centers and have some important milestones that we'll update you on later.

And then, of course, as we specially look at some of the slowing of the markets in the U.S., we want to make sure that a better part of our financial performance is coming from the cost side of our P&L. And we'll give you a brief update on that. And we'll kind of do these in the context of each of our businesses. I'll talk about our imaging components business, made up of our X-ray Products business and our Security business, as well as protons. And I'll turn it over to Kolleen to update you about oncology.

As Elisha mentioned, we have combined our 2 components businesses, made up of our X-ray Products group, that's the group that does X-ray, X-ray tubes and flat-panel detectors, as well as our workstation software with our Security and Inspection Products business. This is a business that supplies people like Rapiscan and Smiths in many others in the cargo screening and border protection business.

We combined these businesses, by the way, from a financial reporting point of view. We'll continue to report them separately so that we don't confuse you. But from an operational point of view, they -- we have merged them together and we've been very, very pleased with the results. Clearly, there's been some cost synergy to that. But we're more excited about the market opportunity, both businesses had small growth in the nondestructive test area. And we also have products in both businesses for the security market. It's also meant with a strategy change for us. In our Security and Inspection business, we did have some systems level products. We have decided to exit those, so that we're not competing with our customers and the reception by that from our customers has been very positive, and you'll see that as I show you some results here in a minute. And then clearly, we're leveraging our management, sales, marketing and product engineering groups in these 2 businesses. And we are very, very pleased with the way that has gone so far.

This is a product business -- both of these businesses are very product driven. So product roadmap matters a lot. There's also cost businesses. We drive very aggressively both our product costs and our infrastructure in these businesses. Quality is a huge deal. And as we kind of look long term, that business today is $550 million-ish. And we really want to help this business grow and get to $1 billion platform over the next 3 or 4 years, and believe we can do it.

Last year, as you know, we have a little bit of a pause. We've had very good double-digit growth in this business since 2008, had a little bit of a pause with the recession last year with 5% growth. But we've -- first half last year to first half this year, we've had 16% growth in this business. And we see that kind of growth long term in our X-ray Products business.

As I mentioned, we have refocused our Security and Inspection business to be purely a components operation. So we're -- we have very small systems level business here. It wasn't that big of a deal, but it was causing concern with our customers as we are competing with them. So we exited the systems business. And here, we had a pretty good rebound last year, and then first half this year over first half last year. We also see very good growth in our Security and Inspection business. So we're pleased with that.

On the X-ray side, it's really about taking new products to new segments, where we haven't had products before. So we've introduced this last year a new wireless panel that's getting very good uptake among many of our very large customers. It's being designed into product for either 43 -- by 43-centimeter formats for both digital radiography. And we also bundle it with our InfiMed workstation, and that is giving some very nice uptake. And then we also introduced a very large field-of-view dynamic detector for angiography. Again, our customers here are not GE, Philips, Siemens but everybody else. And everybody else really kind of looks to us in these markets for their products -- for these products. And these are niches where we didn't have product before. And of course, those are being designed in and being launched now by our customers, and will provide volume for us through the next several years.

On the tube side, we continue to leverage our anode-grounded tube technology in both CT and high-end X-ray. The clinical benefit here is really trying to be able to freeze hard motion. And Bob and his team has done a really nice job in this market, and our tube business continues to grow. It's also very, very much an Asia play. Our customers, I think last time, we were in Salt Lake, Bob said he had 50 different X-ray companies asking for quotations from him in China alone. And he and his team had done a really nice job developing that market from Japan, Korea, as well as to new emerging markets and in China.

And the next phase of this market is kind of packaging our solutions. It turns out that the best image quality comes from matching a tube and a detector together, and then as well, matching some of the image processing algorithms with the InfiMed workstation technology. So we're seeing opportunities with many of our customers to bring them more of a packaged solution and provide components for all 3 technologies to really help them reduce their cycle time and product development and get the product to market faster and leverage their supply chain with just one vendor. So we're very pleased with where that activity is going.

Transitioning just for a second to proton therapy. Working very hard to commercialize this business. As you know, this year is a big year for us. We will be doing our first patient this summer in San Diego. We do have the -- the building is done. The system is done. We are -- we've got the last few weeks of software development to do. And then we'll turn it over to commissioning here in about a month. And then over the course of the summer, that products will be commissioned. We sent big files and documents to the FDA for our 510(k). We do not have filed 510(k) yet, but are encouraged about the development progress that we're making and look to turn that system over this summer to the Scripps Proton Center and advanced particle therapy company, who is running the center.

We have also begun new installations in Saudi Arabia and St. Petersburg. And Elisha -- as Elisha had mentioned, we have been selected as vendor of choice in both Maryland and Emory and they're encouraged about how those are going.

Now clearly, our view on this is, is it can be a very important technology long term. At the price point it's at today, it's going to be a pretty limited market. But you see here a 2-room center from us. We think we can get cost of that down, pretty substantially from where we are today. And long term, we got to keep working this, but we think in the future, it's going to be a very important technology in the field of radiation and technology. And we want to make sure that we're there with a leadership position.

Let me, with that, turn it over to Kolleen now to talk to you about protons -- or to talk about Oncology Systems.

Kolleen T. Kennedy

Thank you, Dow. Good afternoon, everyone. I thought I'd follow on the frameworks that Dow set up in terms of topics today, starting off a little bit with market conditions and then talking a little bit some of our innovation at Oncology Systems, globalization and what we're putting in place to support that growth internationally. I've separated out software and services from a leadership and growth perspective, and then finally honing in a little bit on operational excellence.

So just as a reminder, the vision in Oncology Systems is a world without fear of cancer. I think by partnering closely with our clinical collaborators around the world, if we can eliminate the fear of the diagnosis of cancer and really turn cancer to a chronically managed disease, we would have been a tremendous step forward for cancer patients around the world. And that's certainly, I think, the goal that we have in place with those clinical health care providers. Our missions to support that vision is to innovate, support and simplify cancer fighting solutions worldwide. And as we see the business growing so much in emerging markets, that simplification and the support is really the critical aspect moving forward.

Why does this matter? If you look at cancer incidents here in the United States alone, women have the incidence rate of 38%, men about 44%, here in the United States. And this is why clearly our vision and mission are so important. In the U.S. alone, one slide ahead here, in the U.S. alone, there will be the probability of being treated 1 person in 7 on Varian equipment.

And if you take a step back and look at why this matters on a global level, there will be 27 million people diagnosed with cancer by 2050. And this is from the American Cancer Society Global Cancer facts and figures. We think this number is huge. It really is driving everything that we do at Varian with respect to innovation, tremendous need for our systems and for our software and support services on a global basis, as well as the customer research that we fund significantly both in the U.S., as well as outside the U.S. We are all working diligently with our clinical partners to really improve that number of 17.5 million deaths. We think that number is far too high. We think there's huge opportunity to do better for cancer patients around the world.

Cancer in men. Looking at disease type prevalence, you can see in that developed markets, #1 for men is prostate. You can see that in the Americas, as well as Western Europe and Australia. Looking into China and the Middle East, #1 is lung, stomach in Japan and then liver -- high-level liver prevalence in Africa.

If you look at women, breast cancer on a global basis, clearly by far the #1 disease site. You have some uterine, gynecological cancers in subcontinent Africa as well as in India, and then of course, you have lung and liver again over in Asia Pac. What these numbers have done is to really help us, in an informed way, put together our treatment programs, meaning we want to put together complete clinical capability across our entire systems to address those particular disease sites. Of course, we want to look at head neck also because there's a very high prevalence over in Asia Pac, but really focusing on lung, breast, prostate and gynecological cancers and really looking at other opportunities through research, to expand the UTR utilization for liver and for a long even more than it currently is through SRS and SBRT.

We believe we have solutions at all price points for market segments around the world. Clearly, there are different clinical capabilities that are both in the developed markets and the emerging markets. We want to make sure that our systems provide treatment planning, information management, analytics, as well as the delivery aspect across all of those disease types for 3D conformal, IMRT, image-guided radiation therapy, SRS, stereotactic body radiation therapy, as people are looking at applying radiosurgery techniques outside of the brain, and making sure that we also can handle our proton and brachytherapy treatment mode as well.

General comments on market conditions. We see continued softness in mature markets, North America, Western Europe, in particular, I think Southern Europe continues to see some austerity in their government programs, lots of economic instability as a result. U.S. driving an awful lot of -- we're seeing an awful lot of uncertainty due to the Affordable Care Act. It is, in fact, we believe slowing down some CapEx purchasing decisions, particularly as we see consolidation throughout the entire health care environment here. Not necessarily some of the stronger freestanding cancer center groups like 21st Century and Vantage, for example, but some of the smaller individual players, some of the smaller community cancer hospitals are becoming part of larger health care networks. And those consolidations are making people take a step back, look at their strategies and which service lines they want to fully support. Generally, cancer is right at the top of that, oncology care. But it really is slowing down some of those CapEx decisions.

And as we look at reimbursement, there's always some uncertainty there. We did see a decline last year. I think Dow is going to comment on that a little bit more looking forward at the end of the program, but it's always something that we look at in terms of the U.S. every year from a reimbursement perspective.

We are in fact continuing to see expansion in emerging markets. There are focused government investment program. You've all heard about Brazil. That tender auction is now scheduled for later in June. We have every intention of being aggressive in that auction. We would like to be successful there. And you can see here on the left-hand side of the screen, what you're looking at is a graph that shows you, in a color representation, the number of radiotherapy machines per million people 64 years and older. Why are we looking at it this way? We're looking at it this way because these are the people that are most likely to be diagnosed with cancer. And the number of machines includes, both linear accelerators and cobalt. Of course, we're seeing less and less cobalt units installed base around the world, being replaced by Linacs, but they are still out there. And what you can see is that in the U.S., there are over 75 treatment machines per million people over 64 years of age. So a very densely populated market.

If you look at Canada, maybe the Scandinavian countries and Australia, between 41 and 75 units. Western Europe, between 31 and 40. And then in, say, Brazil and South Africa, between 21 and 30. And then in other parts of the world, in China, for example, about 1 machine per million people over 64 year of age, very, very slow number. So if you do the simple math that says if we get the rest of the world not to U.S. standards, not even to Canadian and Australian standards, but to Western European standards, 10,000 more linear accelerators are needed around the world. In addition to the need for linear accelerators, that goes along with software, it goes along with support services. So we think that we are very well positioned to help our clinical partners fulfill this need for additional care around the globe.

So we're going to continue to invest in these different parts of the world with robust product localization. We're going to continue to grow our software sales, marketing, services infrastructure. And again, we've had in our first half our best ever brick orders performance. And I'll talk about that a little bit more in a minute.

If we take a look at some of the trends that we're seeing, I mentioned earlier, an increase in the move from conventional radiotherapy treatment and hypofractionation regimens to radiosurgery and stereotactic body radiation therapy. This data is provided by SG-2 [ph], the third-party group based out of Illinois. And clearly, what they're looking for is a significant increase in intracranial radiosurgery, as well as extracranial radiosurgery applications. So stereotactic body radiation therapy. So were looking at making sure that our systems are capable of providing the tools so that health care providers can use them effectively with these new treatment regimes.

For a moment, let's talk about innovation. As you all know, we've launched the EDGE platform in ASTRO last year. We've been very pleased with how quickly we got 510(k) clearance for that, just a couple of -- well, 3 months ago now. We have our first 2 orders in-house from Henry Ford Hospital in Detroit and Innovation Cancer Center down in Miami, Florida. And we have a very robust pipeline, a lot of interest in this. It is a complete Varian end-to-end radiosurgery suite. And there's been such tremendous interest in it that we've been doing some very good roadshows, some webinars with our customers, who are looking at ways that they can leverage this for their treatment patients.

The one thing I will say iswe don't have CE Mark yet. We hope to have that by the end of this year, so that we can begin to sell the EDGE outside of the U.S. as well.

A quick update on TrueBeam. We just shipped our 500th unit over to Hawaii. It's in the process of being installed now. Surprisingly enough, we had all kinds of people volunteering to get help with that particular installation. But we've been very pleased that we now have over 500 TrueBeam systems installed around the globe. It's been the fast adoption of any accelerator in market history. We've also had tremendous interest in our 6-degree-of-freedom PerfectPitch treatment couch. It really helps quite a bit in that localization and patient positioning piece especially for radiosurgery techniques.

Again, we've implemented intuitive streamline user interface. And I think it's one of the reasons that the TrueBeam has so -- been so greatly accepted. Of course, there is the high-intensity mode, which is flattening filter free with the high-those rates, so it's a very efficient for patient treatment, but especially, that intuitive user interface, our customers really look at us and said, "Okay, you listen. You got it. We are now helping us step through some very sophisticated treatment program very, very well.

And finally, the TrueBeam and TrueBeam STx are available with industry-leading 2.5-millimeter leaves and 5-millimeter leaves MLC technology.

Innovation. ARIA version 11. We've had our version 11 products out, both Eclipse and ARIA for the last 6 months. For ARIA specifically, we now have over 400 sites upgraded around the world. And we've gotten some very positive feedback from our customers about the capabilities that version 11 has brought them, specifically around the workflow capabilities, helping them optimize the utilization of their systems and ensuring that, that workflow works well in their clinical environment. We embedded some quality checklist that were safety focused, again, looking at everything that we can do to help our customers provide safe and effective patient treatments. The iPad application is something that we've gotten very positive feedback on, because it allows the clinician to have access to ARIA, not only at point of where their workstation is, but also they can take that iPad up with them and take them anywhere in the department or even outside of their health care network while supporting hit the requirements for patient information, privacy. They have access to the system in a very noble way.

And I will say the final thing that I would point out there is the patient engagement and survivorship modules are very important, again, as we move cancer to being a chronically-managed disease, all of our customers around the globe are very focused on ensuring that they have appropriate survivorship access and modules for their patients.

Turning to globalization. Just a couple of comments about BRIC growth. So of course, Brazil, Russia, India, and China. And you can see that we've had some really great success over the last 5 years in BRIC with system sales, CAGR of 35%. Service, CAGR of 28%. Then an overall combined systems and service sales, 34% CAGR in those markets. We have continuing and growing market share in those parts of the world, simply due to expanding RT utilization and the fact that we provide simple and effective treatment paradigms with excellent support services.

And we continue to see those governments investments in very large programs such as Brazil. But we also see growth in private opportunities. And that's something that we are going to, as I mentioned earlier, continue to invest in our direct sales in those regions so that we can help develop some of those private opportunities. And Elisha and her team have been very supportive in putting together creative and flexible financing programs in these parts of the world.

Some of the investments we're doing, we're going to continue in our footprint expansion, manufacturing plants. As you may know, we have commented down in Brazil to putting a complexo [ph], which will have manufacturing as well as education, training programs and we'll have embedded R&D and logistics plants, parts depot. We're going to continue to expand our education centers on a global basis. We want to do direct sales and service more as we look at where these emerging markets continue to expand their RT utilization. Our parts depots continue to grow. We're going to be establishing market development teams that will be embedded in the emerging territories around the world, and we'll continue to invest in local government affairs and regulatory expertise, which is so critical in these parts of the world.

A couple of comments about our Siemens strategic alliance. That continues to roll along in a very, very positive way. We've had some great cobranding events, most recently at ASTRO over in Geneva, where we had a joint users meeting. We had 700 people show up, very excited about the opportunity to see what Siemens is doing on oncologic imaging and what Varian is doing on the treatment delivery side. We had our first patient treatment. We've been focusing very much on the engineering side, including ARIA and connecting it to Siemens linear accelerators. This was one of the first goals that we had in our strategic alliance. The engineering team's, as I said, have just been doing a great job. So we had our first patient treatment at Ohio State University last month, and now we have an interface that connects with 80% of the Siemens installed base around the world. So we feel that this has opened up an opportunity for us, a new dialog with that Siemens installed base, and we're excited about that. And we continue to explore some joint development opportunities, as well as on the software side.

In terms of software, very proud of the fact that we have over 3000 ARIA and over 3000 Eclipse sites out there. This number continues to grow. I know when we talk about software leadership, we have a tendency to forget treatment planning, and we are by far the leader in oncology system treatment planning in the marketplace, and it's something that's near and dear to my heart, so I'll never forget it, but I think, sometimes, we forget to talk about it enough.

I already talked about version 11 with ARIA. We are though very much focused on expanding this business for us. It's over $500 million part of our portfolio when you include the services piece and the RapidArc software, and we want to make sure that we continue to support radiation oncology, medical oncology, proton therapy and brachytherapy with our entire software suite.

Services growth, just a tremendous performance from Patrick and the team there. They are on a 1 billion trajectory. I think we're going to have a challenge between Bob's team and Patrick of who can get to $1 billion first. Good performance, 16% CAGR over the last few years. We're about 10% so far in the first half of the year here in FY '13. We've got some great flexibility and customization on the services contract. We're, in fact, doing a good job of pulling back some third-party service contracts here in the United States, and working more effectively outside the U.S. with large institutions that have their own biomedical engineering teams, getting some very, very positive feedback there.

As I mentioned earlier, we'll continue to invest in our global parts depot network, especially in some of the BRIC territories such as Russia, and we're continuing to invest in our software imaging expertise. One of the value adds that I think we don't talk about enough is our training and education teams, our help desk teams around the world. We've invested in over 250 clinical resources that are positioned around the world. They have adopted and followed us on this strategy. So in fact, we have folks in French Canada, supporting France, depending on what time of the day it is, which has been very successful. We have folks in Australia, folks here in the United States, and we provide training and support in more than 15 languages around the world. We've adopted a blending learning strategy, which again has -- or resulted in very satisfied customers. They can go online and access peer-to-peer training courses or webinars at their convenience. We've gotten some great feedback about that, and our help desk supports customers around the world with more than 70,000 touches every year.

Turning quickly to operational excellence here. One of the key areas of focus for us, I'll talk about IEW productivity very briefly. Our installation team has done an amazing job over the last few years, taking what used to be a 12-week installation process for linear accelerator down to 3 weeks. It's more reproducible. It's done with a higher level of quality and at a pace that our customers can now rely on. And we've done a really great job there in terms of taking per overall revenue achievement and our percentage of installation cost, down to about 3.1% from what was 4.8%, and we're on track to exceed that level of productivity this year.

And then in terms of remote servicing and support, this is something that Dow has been very strong in supporting through our company, and certainly something that we're focusing on with SmartConnect, where we can do remote diagnostics and service, get the customer back up and running without ever having to go on-site, if at all possible. And if we do have to go on-site, we know what piece of equipment to take with us to get them back up and running as quickly as possible.

And the last slide is just a comment on the fact that we are continuing to focus on gross margin. I think Elisha pointed that out earlier in terms of the achievements that we had in the last 18, 24 months. We are customizing some of our packages based on market segment. We're trying to increase our software components in these package deals. We're growing services contract capture at the point of sale of the linear accelerator, and we're offering more creative and flexible finance programs. And we're really focusing after supply chain productivity on a global supply basis and leveraging the strength that we bring to that particular aspect of our business. I think that was my last slide. Back to Dow.

Dow R. Wilson

Let me just wrap up by talking a little bit about our outlook, starting with U.S. reimbursement. We don't see any major cuts in 2014. There still is some risk, perhaps, in the freestanding segment. But we do think the hospital segment should remain positive, firm in 2014. There's lots of conversation about ACOs and bundling and et cetera. And certainly, going to see some pilots maybe even in 2014, but broad co-bundling, not likely until 2015. And then, I guess, maybe just let me emphasize that our approach really plays well into this marketplace. So we continue to be the leaders in throughput, in return on investment for our customers and flexibility and versatility with very high quality and cost effective treatments across our product line. And then as the world goes to more hypofractionated radiotherapy schemes, our new product with the EDGE radiosurgery product is also very, very well-positioned for that market.

Overall, across the business in oncology, our outlook, we see still continued growth, as Kolleen mentioned, outside of the U.S. with some struggle in the U.S. market, leading to an overall global scenario in the mid-single-digit percent growth year-over-year. Software and service, radiosurgery and emerging markets will be the upsides in those markets. Our imaging components, we continue to see double-digit growth there, driven by digital imaging, and as I mentioned, selling up some of these niches, where we don't have product, and bringing new product to an expanded product portfolio.

The Proton business, we believe we can get it to a $200 million, $300 million business, and as I mentioned, is solely driven by the clinical need there with the better toxicity and the uniqueness of the Bragg peak in protons and really a long-term play for our company.

Investment summary. We're the market and technology leader. We've got terrific global growth platforms in our radiotherapy product line, in our radiosurgery product line, with film-less X-ray imaging and our 2 business, proton therapy and important border protection. Our annual service revenue is $750 million, and couple that with our 2 business, we have a growing recurring revenue stream in the company, not quite 40%, and we want to keep feeding that. And as Elisha mentioned, we have a very strong balance sheet and significant cash flow, and look to continue our capital structure through efficient stock buybacks to our investors. And with that, I'll invite Elisha and Kolleen up, and we'll open it up for some questions.

Yes. So the folks on the webcast can hear. Why don't we start with Jason now?

Question-and-Answer Session

Unknown Shareholder

Just a question on the outlook. You mentioned bundling's probably 2 to 3 years out, does that mean the U.S. market remains somewhat suppressed and cloudy until that [indiscernible]

Dow R. Wilson

I think the -- we've seen a lot of our customers this last quarter. I think our hospital customers are kind of a wildcard. They're being cautious right now, but I think that the economic scenario for them in the short term is positive. Where it ends up long-term and what happens to their -- it's interesting, you talk to CEOs, what you hear is my capital budgeting and my capital CapEx is coming down. Then you ask them, what are they doing next year, well, it's up 5% next year. And that's a little bit the kind of scenario that our customers are painting. So it will be interesting to watch the hospital market. I think it's a freestanding market. There's still a little uncertainty as to what happens. I do believe we will see some bundling pilots, but in large measure that the market should continue pretty much the way it is. David, what's next, yes?

David H. Roman - Goldman Sachs Group Inc., Research Division

David Roman from Goldman Sachs. I had one strategic question and one financial question for Elisha. Maybe on the strategic side, Dow, on the conference call, you made a passing reference to just sort of being a mid-single-digit growth company. As I look at the numbers that you put out here, it actually looks to be a little bit higher than that. But if you look across the geographies that you serve and your competitors, how should we think about the long-term growth of the business? Is 4% to 6% a good baseline number? And why would it be materially higher than that?

Dow R. Wilson

We think the oncology business is probably in that range, and then protons and our imaging components business will be on top of that. So the company growth rate is probably 2 or 3 points better than 4% to 6%. Elisha, do you want to fix that?

Elisha W. Finney

No. That's perfect.

David H. Roman - Goldman Sachs Group Inc., Research Division

And then maybe on the financial side, you've...

Dow R. Wilson

And that's revenue growth. We can get some earnings and EPS leverage on top of that.

David H. Roman - Goldman Sachs Group Inc., Research Division

And sort of on that topic, you've been pretty judicious at buying back stock. You made the comment about all your cash being outside the U.S. We talked about this on the fall conference earnings a little bit. A lot of your peers are sort of borrowing pretty aggressively to buyback stock. Can you maybe just talk about how you think about the use of debt to repurchase shares and then what options are they going to with that cash oversea to create value if you're not going to repatriate it?

Elisha W. Finney

Sure. Well, we would love to have a repatriation holiday, but we're not counting on that. So if we can find some acquisition opportunities offshore, that's something that we would definitely consider, but we're not going to go acquire just to say we're putting that money to work. You have seen us take on debt in the U.S. so that we can continued with a fairly aggressive share repurchase program and that's been in place. I've been at this job for 14 years. I think about 12 years, we've been in the market quarter income, quarter out, repurchasing shares. We are not adverse to taking on debt necessarily. We're going to our whole strategy sessions and our strategic planning, looking out over our 5-year growth to rise and from what our initiatives are and what our cash needs are going to be, and debt may very well be a piece of that as we're looking at what capital structure that we need to support those growth plans. When you can borrow at 2%, it's probably a pretty smart thing to do. I prefer not to be using the revolver like we're using today. So that's the discussion that's going on. Yes?

Dow R. Wilson

Jeff, go ahead.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Jeff Johnson, Robert W. Baird. So question, I guess, for Kolleen and then maybe for Dow, a different one. Kolleen, you talked about some of the slowdown in the U.S. being consolidation driven, things like that. As I think about -- is that a cyclical risk or is that a longer-term risk or said another way, is that kind of a 6 to 9 months risk? Is it maybe a 12 or 24 months risk? One of the things that I'd love to hear from you is if you put a hospital that has, let's say, a busy linear accelerator, together with a -- consolidate somebody who has a busy linear accelerator, there's still going to be that need to add capacity over time. So is it hospitals are consolidating centers that are less busy and now all of a sudden, they plaque in the system? And is there any data out there on capacity utilization? Or it's just -- do we just need a clearing event of feeling a little better on the economy or feeling a little better visibility on things and then you can start to see some repurchases going on of these linear accelerator?

Kolleen T. Kennedy

Well, it's great question. There's an awful lot going on out there right now in the market. There's the consolidation, as we talked about, and people looking at their service lines. You've got some capacity limitation. You've got some sites that are evolving their treatments regime to become more radiosurgery-like. So they're reducing the number of fractions. So some are going all the way to radiosurgery, 5 fractions and less. Some are going from the historical 35, 40 fractions, down to around 20. And clearly, a lot of patient engagements is driving that aspect of it, and this is a very U.S.-focused answer. So there is that uncertainty, what's going to happen with reimbursement that is causing a little bit of a slowdown, but there's also the changing demographics in the United States. One of the things that we've seen in BRIC alone, the number of generation, there are people over 60 years of age is going to be increased by 87% in the next 20 years. In the United States, it's a little bit less, maybe around the 70s percentages points. But clearly, the aging demographics, are going to help drive the need, if you want to call it that, for cancer treatment. So whether it's 6 months or 9 months, I think it's going to take a little bit of time for all of us to play out. These are very comprehensive consolidation structures that are being put in place. But there's also an aging fleet of linear accelerators out there, 10 to 15 years. One of the great things about Varian accelerators are they last 10, 15, 20 years, and you can upgrade them throughout pretty much the entire portfolio. But there is going to come a time when they want to do the new treatment techniques, the need to replace some of those older systems that are 10 to 15 years old. So I think it's going to be a little bit longer than 6 to 9 months til all of these kind of plays out, but I think this overall message is uncertainty. It's going to slow down some of the CapEx decision points, while trying to balance that with aging boomers and then also the nature of replacing aging fleet.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Fair enough. And then the follow-up for Dow, just I know I've asked you this question before, but I'm going to ask it again is, on Brazil, does there come a point where it just make sense to walk away? I mean, my biggest concern is...

Kolleen T. Kennedy

Yes.

Jeffrey D. Johnson - Robert W. Baird & Co. Incorporated, Research Division

Let me just, I guess, finish the question, then you can say yes, again, maybe. It seems to me the biggest risk here is that you set a presence. And some other emerging markets can say, "Hey, if Brazil can get these egregiously low terms, then so can we." And so how do you conceptually think about that, given your comments, just recently here that you're going to [indiscernible]

Dow R. Wilson

We're thinking very hard about it. We definitely have walkaway points in this negotiation. I'll say that in 8 years, my 8 and 9 years in doing this, we've seen 2 deals of this size. Well, and the other one was maybe more close to this size. So you have to have that with the U.K., which was actually structured to the PFI and the public-private partnership. The -- so we might see some from some geographies. We certainly see lots of deals in the 10 to 20 Linacs. That's not unusual, but to see transactions over 20 Linacs is actually very, very rare, and I'm looking at some other emerging countries who've been through that exercise. We know of one right now that's at about the 20-Linac level, and that will be aggressive scenario as well as from pricing point of view, I'm sure, for everybody who wants to play. But we're very careful about it, and it's -- as Elisha likes to say, it's kind of damned if you do, damned if you don't, and happy one day, sad the next, whether you win or lose. But we're trying to be very prudent about what our pricing strategy is on Brazil. Now I think who's next?

Unknown Shareholder

Sal Krono [ph] Source Capital Group. TIME magazine, several weeks ago, had a major one page article on hospitals and their opaque pricing policies and it was quite damaging, I thought, and very informative. And I'm just wondering what's your take on that and how does that impact your business if hospitals come under greasy scrutiny by customers and the government sector, particularly with care and medical?

Dow R. Wilson

Yes, I think it's clear in the long-term that our models are going to flip from the fee-per-service generated model, where a lot of these incentives are a little bit backwards to some kind of capitated cannibal care model. And when that happens, the incentive is flipped for cost efficiency. I think the very encouraging thing for us is that's how most of the markets are for us outside of the U.S. And of course, the competition for us in that scenario is not other radiation therapy companies, it's surgery and chemotherapy. And the cost and effectiveness of radiation in that environment is very, very good. And then you overlay on top of what's already kind a good -- kind of a good news scenario are the trends that Kolleen talked about for hypofractionation. I think it positions us very, very well to have -- to be a positive player in delivering cost effective cancer care in the long term.

Unknown Shareholder

So as hospitals undergo that change, is there going to be pause in spending patterns?

Dow R. Wilson

Absolutely, yes. And we saw this in both -- as I mentioned on the call a couple weeks ago, we saw this both in 1982 when DRGs came as well as in the early '90s. There wasn't much actual reform that happened with Hillary Clinton initiatives, but it was enough that caused the markets to pause. So we may see that. So that will be interesting to watch. I think -- who is next here, Tyco?

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Tycho Peterson from JPMorgan. Just a question on the U.S. market, you emphasized -- heavy emphasis on prostate in one of the slides. As we think about the emergence of watchful waiting, why doesn't that ultimately impact the installed base of Linacs? I mean, why doesn't it shrink in the U.S. overtime with more watchful waiting?

Dow R. Wilson

You can fix this, Kolleen. What we're hearing from our customers, I'd say 2/3 of our customers are saying it's anniversaried already. The Mass General study was published 15, 18 months ago, and they had started to see a decline. 21st century mentioned it in their quarterly report in the fourth quarter. I believe it was the fourth quarter. But in the first quarter, they said their number of treatments is coming back up with the continued decline in prostate. Our game is there might be a little bit of risk in prostate. We're clearly fighting a prostate battle, especially with improved conformality and toxicity reduction. We believe that versus surgery, we have better results for erectile dysfunction, especially on the first 5 years after therapy. Interesting this morning, customers told me about a new study that is underway that looks very, very positive for us on that front. We still got to change our referral pattern. But then the other option is -- the other activity going for us is we're bringing more lung and liver patients into the radiation treatment suite, and these are, in fact, cancers that require more time with the patient, more treatment time. So I think it's going to be interesting to watch. There's no question that watchful waiting will have some impact, and what the net impact is, I think, is pretty hard to tell. I'll just underscore what Kolleen said and that is, long-term, we do think this trend towards hypofractionation is probably the bigger thing that's going on. That may, in fact, reduce the number of factions and have some of the same impact that you're talking about, but it will cause an upgrade cycle because people have to have the right kind of equipment to do those treatments.

Kolleen T. Kennedy

Amit?

Dow R. Wilson

Amit?

Amit Hazan - SunTrust Robinson Humphrey, Inc., Research Division

Amit Hazan from SunTrust. Two questions, one just a very quick one. When you mentioned bundling, just for clarification, you are -- I think you were talking specifically just about the freestanding market. And just to clarify, have you heard anything on the hospital side that would indicate there is bundling coming on the hospital side?

Dow R. Wilson

Haven't heard anything on the hospital side, but I think there will be some -- I think we would -- we will see some experimentation even on the hospital side.

Amit Hazan - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And then second question for Elisha on operating margin. I think that you used up about 50 basis point improvement. I think nowadays, you're talking about 30 to 50 basis point improvement. We've obviously seen that great shift geographically. Can you just talk a little bit about your confidence level in the 30 to 50 basis points and what the key variables might be over the next 1 to 3 years? And what do you think, is that 60 [ph]?

Elisha W. Finney

Sure. And it's not going to be perfect year in and year out, it's 25 to 50 basis points, but you're testing me there, Amit. That's looking out over 5 years. I think that is a target that we can average, but there may be years where we have particular investments that we need to make, whether it be in emerging markets, whether it be in trials to prove our technology, whatever form it takes. So I wouldn't look for a perfect linear up on that, but we do think where we're going to get leverage is on the corporate cost structure, and we are committed to growing particularly the G&A slower than we grow the pipeline and we've been very, very consistent at doing that. But again, you're going to get some variability if you look out over 5 years, and I think we should be able to get up from the 20.5% towards the 21.5%, 22%.

Amit Bhalla - Citigroup Inc, Research Division

Amit Bhalla for Citi. Question for Elisha. Just modeling in some respect, the conversion from orders to revenue on your P&L is somewhat formulaic and with the volatility and uncertainty you're talking about, this would imply a much higher percentage of kind of book and ship orders in that current year. I know in the past, when these book and ships were an issue or they create a little bit of volatility, you were modeling something here in the range of 20% of -- given year, book and ship related. Anything you can help us in trying to updating that?

Elisha W. Finney

Well, if you look at the backlog for oncology, it's up 6%. So that's -- so the -- it's not too far off from what we're guiding for the year in terms of revenue. And again, were going to take significant proton revenue if and when Maryland gets booked and financed, and so that's in those numbers as well. We can book -- we will book an order up that has up to a 24 months delivery period, but on average, it's 12 to 15 months, and so I think that's pretty consistent. We do have some, what we call book and ships in any given year. Obviously, orders that come in Q1 and Q2 have a higher degree of confidence that they're going to ship in the same year than orders that are going to come later in the half. But we go through thousands and thousands of line item of backlog, looking at when the estimated delivery dates are, and determining how to give that guidance by quarter.

Amit Bhalla - Citigroup Inc, Research Division

And just a second one on proton, Dow, in one of your slides, you talked about the two-room proton at a more cost-effective solution. Could you just give a little more detail there and timing there?

Dow R. Wilson

Sure. The 6, 7, proton systems that we have in backlog, I think all are 4 beam line, 3 Gantries and 1 beam line, called 4-room systems. So maybe 1 that's 5 -- 1 or 2 that are 5. In the future, we see that dramatically changing. We think people will get -- people will order 1, 2 and 3-room systems so that's going to be part of the change. Some of that's just pure economics. Some of it's patient volume. Clearly, if you can leverage the Cyclotron cost over more beam line, that's good. It gives you a lower cost per treatment, but that also assumes an infinite supply of patients, and that's not going to last forever. So we do see that changing then from a technology point of view. We can also get the cost of the beam line itself down so there's -- the 3 big cost elements of proton center are the Cyclotron, the beam line and the Gantries, and those are the 3 big pieces that we're going to work pretty aggressively really over the next 5, 6 years. Steve?

Steve Beuchaw - Morgan Stanley, Research Division

It's Steve Beuchaw from Morgan Stanley. I wonder, and I'm not sure if this is for Kolleen or Dow, but if you can comment on the competitive environment for linear accelerators in the U.S., you have 2 competitors in the sense that both are understandably optimistic about their latest system launches. So I wonder if you could give us a sense for how you're thinking about the competitive environment, what sort of reaction you might have both in the field as well as in the way you're thinking about it. And then as a corollary to that, I wonder if both of these companies are [indiscernible] higher prices. Could this be a catalyst for better pricing trends and volumes [ph]?

Dow R. Wilson

Kolleen, you want to go?

Kolleen T. Kennedy

Sure. So I think a couple different things. I mean, clearly, the oncology market right now is a duopoly, primarily CeRiN and Elekta. And I think we're both gaining Marcum's [ph] point of share, at least, sense of third-party organizations such as Siemens. So I think with the launch of both of our systems, we're addressing that need that we saw are moving towards more hypofractionation treatments and particularly adopting more and more radio surgery treatment techniques. I think the feedback we've heard from the community in general about the Versa HD System is that it's a solid system, but it's not of TrueBeam capability. They've got 5-millimeter leaves. Of course, with our high-def, we've got the 120-leaf, and then we have our high def with 2.5-millimeter leaves. In terms of conformality, that seems to be still where the neurosurgeon, the thoracic surgeons and those folks who are looking at radiosurgery want to have that level of precision when they're treating their patients, and also organ avoidance. So I think we're seeing some good response on the high end. It would be based on the need and the driving that we saw towards hypofractionated treatments. And then second question, sorry?

Dow R. Wilson

I'll let -- price stability, I think we have seen the last several quarters has been a good pricing for us. So we've, at least, seen that last couple of orders. Clearly, I don't think there's really new news that accurate. They were always kind of a fairly high-priced player. This is a fairly new move for Elekta and to the high-end. And although there's still substantial weaknesses that their system has that mostly have to do with the efficiency and speed of delivering beam. So they've got -- they still got ways to go. Anyway, so we're pretty optimistic about where we are, and as I think I mentioned on the call, from a competitive point of view, Versa's not new to us in new system orders. We've been competing against for some time. Yes?

Anthony Petrone - Jefferies & Company, Inc., Research Division

Anthony from Jefferies. Quick one on gross margin. Dow, you mentioned on the call 300 TrueBeams are moving out of warranty. Can you just give us an update on the difference between TrueBeam service contract in your existing contracts and what that means for gross margin? I have a follow-up on hypofractionation.

Dow R. Wilson

I'd say the price difference is $75,000 higher on TrueBeam than on a C-Series Clinac, and the contract capture rate on new equipment is always higher than old. It's probably 15 to 20 points higher. I'd say, on average, we probably are 70%-ish of contract capture rate, and on TrueBeam, it's -- the early ones, it's not quite 100, but we expect that will probably settle down in the 85-ish range. And then yes, I think we've -- I think we said we've got the 300 coming out of warranty over the next 18 months, 1 work day, not every day of the week, but one every work day of the week.

Anthony Petrone - Jefferies & Company, Inc., Research Division

Is there a way to boil that down, the gross margin impact this year?

Elisha W. Finney

Well, without getting that specific between different service contracts, but if you look at the overall business, obviously, software has the highest growth margin in the 80% or so range as you would expect. We're still investing heavily in R&D and marketing in our software products. So from a contribution margin, it's not that high. Service would be the highest contribution margin product line because it has a gross margin in, call it, the 50% range, and virtually all of that falls to the bottom line. We didn't have excess leaves and then accelerator. So it's a whole blend within that product drive -- product mix, drive, margin and oncology more than anything else, followed by geographic mix, followed by volume. In our X-ray Products segment, it is volume, first and foremost, product mix and then geography.

Anthony Petrone - Jefferies & Company, Inc., Research Division

And the last one is just on hypofractionation. Can you just talk about the drivers for that? Is it more reimbursement driven? Is it clinical data driven? Is it some of the incentives you have in place to upgrade to EDGE?

Dow R. Wilson

Kolleen?

Kolleen T. Kennedy

So the hypofractionation trends has started actually a few years ago from physician's desire to have better outcomes for their patients. And also from our patient's desire to not have to come in for 30 to 40 fractions on a daily basis. So really, there are multiple aspects that are driving that move towards hypofractionation. And the technology is available now that allows you to treat with the level of precision both on the physician side, as well as the image guidance side to make sure that as you're increasing that daily fraction, you are in fact treating what the physician wanted to. And historically, you didn't have the technology to allow you to do that.

Jeremy Feffer - Cantor Fitzgerald & Co., Research Division

Jeremy Feffer from Kantor Fitzgerald. Two more on photon. First, Dow, you were talking in the prepared remarks on the -- your efforts to drive more clinical validation. I'm wondering where that stands. Where do you expect volumes can go and does that drive any sort of reimbursement down the road?

Dow R. Wilson

Yes, the first clinical validation for us is doing a patient. So that will happen this summer. And then we're working with Advanced Particle Therapy, our partner at -- in San Diego, Maryland and Emery, and they will be clearly adding to the clinical research that's happening in protons. We believe that protons will have the significant role in places where clinical structures are very, very close, obviously, in children. Unfortunately, that's not a huge market in eye cancers, could have a very important role in head, neck and lung. It -- there's not a demonstrated benefit to protons yet in prostate. There are studies being done in prostate, but it will be clinicians to see where that plays out. So I guess, as we kind of look at it, it's -- we think protons can really have a clinical advantage in 15% to 20% of cancer treatments. The studies have yet to bear that out though. Your point is right on, and we've got to work on that. We'll be working on that with our partners as we install and get ramping up.

Jeremy Feffer - Cantor Fitzgerald & Co., Research Division

Okay. And then quickly one other. As we get that past this point of dilution, what kind of margins do you think that business can have over the longer term?

Dow R. Wilson

The nice thing is the service margins are as good as the service margins in our service business, and they come in $6 million, $5 million to $7 million per treatment center chunks. So that grows pretty quickly. Now the equipment margins in the short term are -- short term is, at least, 3 years will be diluted to our average. They're very low today, but we think we can -- 25 to 30 is probably the right range. That fairly should...

Kolleen T. Kennedy

That's fair.

Dow R. Wilson

I think we have time for one more. And then we'll hang around and close down the webcast after this question.

Jason Wittes - Brean Capital LLC, Research Division

Jason Wittes from Brean Capital. Just a quick follow-up. Elisha, would you mind quantifying the fourth quarter impact from the proton or growth in the top and bottom line so we know how to think about it?

Elisha W. Finney

Well, you know it isn't year-to-date. So for Q3, I believe what we have built in for proton revenue is somewhere around $6 million to $8 million. Again, they'll have a little bit of Saudi, a little bit of Scripps, a little bit of the Russia deal. With the bulk of that, which leaves you, I think, when you do your math, it will be about $50 million coming in Q4, and the bulk of that will be reliant on this Maryland project.

Jason Wittes - Brean Capital LLC, Research Division

The EPS impact for that business is really a variable margin item [indiscernible]?

Elisha W. Finney

Yes, but, again, we've been running at neutral to negative 1 on the gross margin line. And by the time you get to the end of the year, it will be about a 10% gross margin contribution. So $8 million for the full year. So you can kind of do the math and figure out $2 million, $3 million from there. So obviously, the Maryland financing is a very important trigger.

Jason Wittes - Brean Capital LLC, Research Division

Okay. Then just one quick follow-up on your outlook for the market. You've been asked about the competition. I think Versa's been out there. Accuray, I think, [indiscernible] is still a pretty small player, but is there any anticipation of seeing delayed orders [indiscernible] out there where people are looking at?

Dow R. Wilson

I think if there's any delay, it's due to the kind of macro -- first of all, o U.S., going to investors, 60% of the business, you'll see that keep going. In the U.S., any delay is not going to be competition driven. It's going to be the macro environment.

Dow R. Wilson

Okay. Thanks, all, for joining us. We'll have to see you again at Astro this year, which is in...

Elisha W. Finney

In Atlanta.

Dow R. Wilson

So see you in Atlanta. Thank you.

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