Accuray's CEO Discusses F2Q 2014 Results - Earnings Call Transcript

| About: Accuray Incorporated (ARAY)

Accuray Incorporated (NASDAQ:ARAY)

F2Q 2014 Earnings Conference Call

January 30, 2014 04:30 PM ET


Lynn Pieper - Investor Relations Counsel, Westwicke Partners

Josh Levine - President and CEO

Greg Lichtwardt - EVP and Chief Financial Officer


Tycho Peterson - JP Morgan

Anthony Petrone - Jefferies Group

Jason Wittes - Brean Capital

Brooks O’Neil - Dougherty & Company

Toby Wann - Obsidian Research Group


Good day, ladies and gentlemen. And welcome to the Q2 2014 Accuray Incorporated Earnings Conference Call. My name is Brianne, and I will be your operator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to Ms. Lynn Pieper, Investor Relations.

Lynn Pieper

Thank you, Brianne. This is Lynn Pieper, Accuray’s Investor Relations Counsel from Westwicke Partners. Thank you for joining us today on our conference call as we review Accuray’s second quarter of fiscal 2014. Joining me today is Josh Levine, Accuray’s President and Chief Executive Officer; and Greg Lichtwardt, Accuray’s Executive Vice President and Chief Financial Officer.

Please note that as of this quarter the company is suspending its practice of providing slide to company's prepared remarks.

Before we begin, I need to remind you that our call today includes forward-looking statements that involve risks and uncertainties. There are a number of factors that could cause actual results to differ materially from our expectations, including risks associated with the effects of the adoption of the new CyberKnife and TomoTherapy Systems; commercial execution; future order growth, future revenue growth, future profitability; and guidance for fiscal 2014.

These and other risks are more fully described in the press release we issued earlier this afternoon, as well as in our filings with the Securities and Exchange Commission. We assume no obligation to update any forward-looking statements.

Now I'd like to turn the call over to Accuray’s President and Chief Executive Officer, Josh Levine. Josh?

Josh Levine

Thank you, Lynn, and thanks for those [Technical Difficulty] [as we review our] results for the second quarter of fiscal 2014. I'll begin today's call with an overview of the quarter, Greg will provide a more detailed financial review and then I'll wrap up with some commentary on our strategy and outlook and we'll open the call up for questions.

The second quarter marks the achievement of several milestones along our path to improve the sustainable financial performance. With respect to orders, we achieved our third consecutive quarter of year-over-year growth in gross order volume. In fact, gross product orders of $80 million in the quarter; get a high order mark since our acquisition of TomoTherapy in June of 2011. This is very gratifying and demonstrates that our enhanced commercial execution coupled with a vastly improved feature set and functionality of our new product platforms is having an impact on customer perception and purchasing decisions.

We are seeing year-over-year growth across all four regions and within both product lines with our international business continuing to lead the way. With respect to revenues, we achieved year-over-year revenue growth of 20% in the second quarter, marking another substantial milestone. In particular, product revenues hit a respectable $45 million and 35% growth. Again this is the first quarter since the acquisition of TomoTherapy of positive year-over-year revenue growth for the company. This result was driven by the strength of our order backlog as well as internal improvements related to our revenue conversion management process which I will highlight in greater detail later in the call.

Lastly we reported adjusted EBITDA profit of $6.8 million in the second quarter also marking the dramatic milestone in our near-term efforts. This result was driven by revenue growth market expansion and operating expense control and come several quarters earlier than anticipated. Both the positive year-over-year revenue growth and adjusted EBITDA profit our metrics we’re working hard to maintain or improve upon. Sustainability of these financial drivers is a key focus for us going forward.

Based on our performance in the first half of fiscal 2014 and our cautious optimism on the continued momentum of converting orders to revenue we are updating our revenue guidance for fiscal 2014 to a range of $340 million to $350 million. This revised guidance reflects revenue growth in the high single-digit low double-digit percent range. I am encouraged by the early progress we’ve made and our results to-date but as we’ve stated before we still have more work ahead of us.

We continue to see strong interest and growing adoption of our CyberKnife and TomoTherapy Systems in all of our regions. In the second quarter we announced that we have expanded our installed-base to over 700 systems worldwide. These systems have been used to treat more than 0.5 million patients, reinforcing market awareness and creditability in Accuray’s positioning as a leader in precise, innovative radiation oncology treatments.

The CyberKnife and TomoTherapy Systems have been used in 40 countries to treat patients across the full spectrum of radiation oncology cases including, prostate, lung, liver, breast and head and neck cancers. These installation and patient milestones reflect our systems’ continued and growing adoption across the world.

As an example, University of Pittsburgh Medical Center, treated their first patient in October 2013 with their new CyberKnife M6 system with an iris collimator and reported in a press release on Monday at this week and they had experienced the treatment time on that first patient that was half of what it would have been with the previous generation CyberKnife system and that they have treated 80 patients since then.

Dr. Dwight Heron, The Director of Radiation Oncology Services stated in the press release that the CyberKnife is among the most advanced treatment options offered by ensuring the most precise personalized and best treatment available. UPMC of course is one of the largest stereotactic radiosurgery case loads in the country and is performing about 550 cases per year.

Another contributing factor driving the change in market perceptions about our products is the overall reliability improvements we have made for the TomoTherapy product lines specifically. For the past 14 consecutive quarters, we have seen consistent progressive improvement in TomoTherapy service margins that are directly related to proactive redesign up and sourcing of critical parts and componentry and swapping this out for the previous generation componentry in the Tomo installed based.

Today TomoTherapy reliability needs or exceeds industry standards and competitive benchmarking related to system uptime. Our new CyberKnife M6 series system which we introduced in November of 2012 can be ordered in configurations with either a fixed, iris or multileaf collimator or MLC.

Although not currently available for shipment the MLC component remains on track for a limited release in June of 2014 as we indicated last quarter. We continue to bench-test early prototype units and will be starting production of units in a few weeks. Some risk remains in the MLC project particularly after replacing initial units in a commercial setting and begin gathering data on the performance.

While we continue testing and prepare for the initial limited release of the MLC. We are continuing to take orders for all configurations at install and fixes with the fixed and iris collimators and we’ll upgrade customers to the MLC based on availability going forward.

On the marketing front, our focus remains on driving economic and clinical value for both new customers as well as our installed base. As part of this effort we are investing in validated research tools to obtain a deeper level of understanding about the key drivers of customer royalty and satisfaction.

We've been conducting a significant amount of customer market-based research to clarify these important perceptions and attributes and to gain deeper insights into the trigger supporting purchasing decisions. Secondly, we are refining our messaging and product positioning to a variety of multimedia promotional channels.

Lastly, we are improving our salesforce, effectiveness and go-to-market execution with improved downstream marketing capabilities and selling tools and we are growing our sales opportunity [to form a] better regeneration and earlier visibility on deal flow. The net set is that we are changing the customer experience and market perception about our products and the company.

I’ll now turn the call over to Greg to provide more detailed commentary on our financial results and then I’ll wrap-up with some commentary on our strategic outlook and then we’ll open up the call for questions. Greg?

Greg Lichtwardt

Thank you, Josh and good afternoon everyone. I want to start with a reminder that we have reverted to a largely GAAP financial statement presentation affective with the first quarter of this fiscal year. The one exception to that is our adjusted EBITDA metric. As explained last quarter, we find that the accounting impact of the TomoTherapy acquisition that materially obscure the historical results of our core business no longer have the materiality or magnitude of fluctuations to the same degree that they had in the past. We make these changes in order to provide a simpler and clear our presentation that will drive better decision making by management internally and aligns us better with our investors.

Let me now shift to a review of our second quarter financial results. As mentioned by Josh, gross orders of $80.3 million increased 102% compared to the prior year second quarter and 27% compared to the immediately preceding quarter. Of particular strength were orders for the CyberKnife M6 series systems, partially offsetting these strong efforts are the age outs for orders entered 30 months ago for which installation has not occurred.

We do expect that many of these orders which have for now been removed from backlog will eventually install over the next 12 to 15 months once bunker construction is completed. Many of these orders are in the Latin America region for which we have had similar age outs in the past and as such we are being more careful about when we enter orders from this region into backlog.

After age outs net orders for the quarter at $59.4 million is roughly on par with our performance of last quarter. As of December 31, 2013 product backlog at $362 million is 30% higher than the same time in the year ago period.

Total revenue for the second quarter at $93.6 million is composed of $45.1 million in product revenue and $48.5 million in service revenue, even though the prior year represents an easy comparable, product revenue of this order of magnitude is a respectable result and is attributable to both increased commercial effort and improvements in the company’s order to revenue conversion processes.

Service revenue represents year-over-year growth of 9% driven by the increase in our installed base and conversion of customers to emerald and diamond service contracts. Total gross profit of $38.2 million increased 43% over the prior year’s second quarter indicating a further expansion of margins on both product and service.

Product gross margins which had dipped into the 30% in recent quarters, due to excess and obsolete inventory reserves, unobserved production overhead and other fixed cost rebounded this quarter to 44.7% on higher volume and stronger average selling prices. Service gross margin also continued improving due to the TomoTherapy Systems reliability improvement which drove lower parts consumption as well as sales of higher margin service contracts.

As compared to the immediately preceding quarter, a $17 million increase in total revenues has resulted in an $11.7 million increase gross profit and a 610 basis point improvement in margin. This represents the first quarter since the TomoTherapy acquisition that we have achieved total gross margins over 40%.

Operating expenses of $38.9 million in the second quarter represents continued expense control by the company relative to our guidance of approximately $40 million per quarter. This result which is in line with our spend in the preceding first quarter is 20% below the prior year spend or savings of $10 million against our run rate prior to the January 2013 reorganization. While total operating expenses are approximately the same as last quarter, real spend did increase slightly as we did not have expenses for ASTRO and executive severance this quarter as we did in the first fiscal quarter.

As a result of the strength in revenues, improved gross profit and controlled operating expenses, adjusted EBITDA improved to a profit of $6.8 million compared to a loss of $18.1 million in the year ago second quarter. Even compared to the immediately preceding quarter, we improved adjusted EBITDA by over $10 million.

From a balance sheet perspective compared to the prior quarter, net working capital increased $6.7 million excluding the change in cash and investments. This came mostly from an increase in accounts receivable, which is in line with increases in sales. From a cash flow standpoint, we did not achieve cash flow positive this quarter due to the increase in working capital but came much closer to breakeven with the cash in investment usage of only $1.8 million. Compared to the immediately preceding quarter, cash in investment usage decreased by about $10.9 million due to the improvement in adjusted EBITDA.

And lastly with regards to our financial guidance for fiscal year 2014, we are updating and increasing the revenue range by $15 million on the low-end of $340 million and $5 million on the high-end to $350 million. This is essentially acknowledging that we have exceeded expectations in the second quarter total revenue and feel confident in our ability to deliver the rest of the year.

One final comment before I turn the call back over to Josh, a word of caution is appropriate here as it relates to product orders for fiscal 2014. First, 100% and 200% growth for gross and net orders respectively as we achieved in the second quarter is not our expectation for the future. This is an artifact of what was happening with the business in the second quarter of last year, creating an easy comparable.

Our expectation is that net orders in the next two quarters will be somewhat lower than net orders in the first two quarters of this fiscal year in absolute and in year-over-year growth such that we expect to finish fiscal year 2014 with net product orders for the year in the range of $215 million to $225 million. This results in a 25% to 31% growth over the prior fiscal year net orders. It is not our intention to provide ongoing guidance on net orders but we felt it was prudent to provide this update at this time in order to keep expectations in check.

Now I’d like to hand the call back over to Josh for a wrap up.

Josh Levine

Thanks, Greg. I am encouraged that improved commercial and operational execution has resulted in new order momentum over the last four quarters. In addition, we are hearing feedback of the expanded feature set and functionality of our new products is driving improved clinical benefits for patients and economic value for our customers. And importantly, we are seeing positive trends in our overall financial results including conversion of orders supporting strong revenue growth, gross profit improvements and solid expense control which drove profitable adjusted EBITDA in the second quarter.

Our game plan for fiscal year 2014 remains unchanged and continues to be focused on five key areas including growing market share in the U.S., maximizing growth outside the U.S., optimizing the product portfolio to enable growth, maximizing the value of our installed base of business, and improving business processes to enable growth.

Last quarter I reviewed in a general sense our plans in all of these areas and today I wanted to provide you with the specific update on a few of this key initiatives. First, growing our U.S. market share continues to be a strategic deliverable, both in the near and long term.

As we have reported to you in the past, the near term growth opportunities and greater momentum have come from our international business where we have seen the benefits of strong executive leadership driving better process and focused commercial execution. With that said, we need better results in commercial momentum from the U.S. to maintain our growth long term.

As we contrast the differences in commercial momentum in our international business versus what we are seeing in the U.S., we are seeing the impact of earlier commercial leadership changes and selling process improvements in Europe. Additionally, the strategic account selling resources that we've added in the U.S. at the beginning of the current fiscal year are probably a quarter behind where we thought they’d be in terms of order traction. This is not surprising given the nature and overall length of our product sales cycle.

We see our current U.S. commercial momentum and its influence on orders in the second half of fiscal 2014 as really more of a timing issue than a question about whether the orders will actually be there. We are focused on driving adoption of our new products by demonstrating their unique capabilities and advantages through reference sites, supported by a more customer centric marketing program and more effective commercial execution.

Another example of our expanded selling efforts is our focus on strategic channels like GPOs, IDNs and the government channel where historically we have not had much of a presence. We reported to you early this fiscal year that we were adding resources to this critically important selling effort. And while we are confident of the investments we've made in building out our strategic account selling capability, given nature of the sales cycle, it takes several quarters before visible order impact can be seen.

Ultimately, driving our growth agenda in the U.S., depends on our ability to convert competitive accounts and to effectively upgrade our installed base customers. We are confident we have the right resources focused on the right strategies in the U.S. market and that we will begin to see the tangible impact of these efforts over the next several quarters.

The second area to highlight is our focus on maximizing the value and opportunity of our installed base. Year-to-date service revenue growth of 10% reflects one aspect of this focus by selling service contracts and associated upgrades. Having periodic upgrades available to existing customers is vitally important to selling high value service contracts and combines this strategic focus of maximizing the value of our installed base with the optimization of our product portfolio initiative.

A good example of this is our VoLO treatment planning system and TomoEDGE which is the fastest selling TomoTherapy System upgrade ever achieving 30% penetration of the installed base in seven quarters.

We must continue to innovate to maintain a clinical edge for our customers to value optimize their equipment investments. The fact is for the past year we’ve had to be overly reliant on our service revenue stream and we are attempting to build the product revenue stream to open twice the more substantial portion of our total revenues going forward as it should. This in turn will provide the opportunities for ongoing service contract sales, as well as trade-ins and other end of service opportunities.

Finally, our plan for 2014 continues to focus on improving business processes that will allow growth and drive profitability. This quarter we demonstrated improvement in our revenue conversion process that allowed greater visibility earlier in the quarter over the multiple steps required to be able to recognize revenue. As a result, more opportunities were converted and we achieved 36% product revenue growth compared to the year ago second quarter.

During the quarter we went live on a new product lifecycle management system which will help us manage the product innovation and introduction processes from an engineering and operation standpoint. And later this fiscal year, we will be implementing an upgraded customer relationship management system that will improve our sales tracking, planning and forecasting capabilities.

These efforts will have long-term impacts on our business that will drive efficiencies, coordination and improve overall effectiveness that will be necessary for us to achieve our growth objectives.

Our strategic vision is unchanged to leading clinical excellence to innovation and to grow our installed base to make our technologies accessible to more patients and the physicians who treat them. We strive to maximize our customers’ experience with our systems by providing high value and innovative solutions and superior service. We are laying the ground work to ensure continued successful execution of this vision.

Thank you for participating in today’s call. And we are now ready to take your questions.

Question-and-Answer Session


(Operator Instructions). And your first question comes from the line of Tycho Peterson with JP Morgan.

Tycho Peterson - JP Morgan

Maybe just keep me off with me new system traction obviously order growth has been great here. Can you maybe just give us a sense of mix, how many of these are competitive wins. Are you starting to get some traction in discussing [cyclical] site? And then you mentioned working with GPOs, I'm wondering about any kind of implications there around pricing and bundling. So, if you could just touch on that would be helpful.

Josh Levine

Sure Tycho. So, in a general sense, I'd say that we're continuing takeaway more bunkers than we're giving up. And we really haven't gotten very specific about that, but I think just in the context of maybe some of the things that you referred from prior releases or competitors’ discussions, TomoTherapy just as reinforcement to some of the things we've said earlier in the year.

TomoTherapy from an adoption standpoint continues to be a really, really strong situation. We took away three bunkers with the TomoTherapy products in the quarter. And we had two CK competitive knockouts in the quarter. So again, I feel good about adoption of the new products. I think we are -- again we were hoping to selling time upfront given some of the delays, but we really are starting to I think get some traction and hit our strike here.

On the GPO and strategic accounts front, we had said early on that these were channels that were strategically important to us. But when you look at the company's history, we really hadn't participated in a big way from a present standpoint in those channels. And we added resources at the beginning of this year, this fiscal cycle. And those resources are at this point really ramping up given the nature of the sales cycle and the length of the sales cycle and the kind of the contracting protocols that many of the groups that we’re interacting with have already in place.

It takes a little while, several quarters to kind of start to build some momentum there, but I think we’re comfortable with what we’re seeing at this point. We’re probably a quarter or so may be behind from a timing perspective. Where we would have projected, we would have been, but again, I am not referred by that and I don’t have any question from a strategy and a resource commitment standpoint that we’ve got the right people and the right strategies in place. I think we’re going to have a lot more to talk about more comprehensive and specific detail standpoint over the next several quarters.

Tycho Peterson - JP Morgan

And then on the reimbursement changes, I think you’re pretty effective in getting the message out there, it was effectively washed, but now that your customers have had some time to digest the changes, any change in dialog from them?

Josh Levine

No, nothing that represents a change in anything we’ve already formally communicated.

Tycho Peterson - JP Morgan

Okay. And then for Greg, can you maybe just touch on the convert and how we should be thinking about that?

Greg Lichtwardt

So we have these two converts outstanding, one of them matures in August of 2016, the other one in February of 2018. Both are currently expected to be settled in stock, although the 2016 notes can be settled in cash or equity. As we disclosed in the 10-Q filing, we have both of those settled today. It would cause us the issue about 33 million shares which is significant dilution relative to our 75 million shares outstanding. So I think I am very encouraged by the recovery of the business, here I think that means that we can begin to consider a lot of different options for settling or refinancing this notes.

And without getting into too much color here, at the appropriate time we’ll execute on the strategy that meets with the approval of our board and that strategy will be based on the best interest of our shareholders.

Tycho Peterson - JP Morgan

Okay. That’s helpful. Thank you very much.


Your next question comes from the line of Anthony Petrone with Jefferies Group.

Anthony Petrone - Jefferies Group

Thank you and good afternoon. And maybe Greg, if we could just touch on the discrepancy in gross to net bookings in the quarter and maybe just get a broader sense of that number, so not only I am assuming that this happens on a quarterly basis. So is there a number that in totality that has moved out of backlog because it’s aged beyond 30 months? And how large is that number just to get a sense of what portion of that could potentially come back into bookings in future quarters?

Greg Lichtwardt

Yeah, so age outs by definition are inherently lumpy. In the first fiscal quarter, we saw one system age out in the second quarter now we saw six systems age out. And this is really an artifact of orders that were entered into backlog 30 months ago. So there is really nothing that we can do about that currently.

The industry faces age outs, our competitors have them, but with the much larger gross order number it just isn’t noticed as much for them as it is for us. As I explained in my prepared remarks, most of these age outs for the quarter and even historically have come from the Latin America South America region. And as a result, what Josh and I are doing as a team here is to be much more careful about when we enter orders to be certain that in the future the rates of age outs will decrease.

Anthony Petrone - Jefferies Group

Okay. And what are the triggers for actually bringing an age out back in to bookings and backlog?

Greg Lichtwardt

Yeah. So if these systems go to [installation] and we have met all of their requirements to recognize revenue then they came back into an order and they go directly to revenue. In the meantime, they will stay out of backlog and we do believe that many of these systems will come back to revenue in the next as I said, 12 to 15 months.

Anthony Petrone - Jefferies Group

Very helpful and then a couple for Josh, and I’ll get back in queue. Maybe you mentioned sort of the uptick in CKM6 orders here, but also that the MLC is going to be on sort of an early preview to come this summer. I’m just wondering what kind of obstacles those represent if you’re getting early adopters of M6 with the fixed or Iris collimator and if they choose to take on the MLC, does that present any challenges and what would the downtime beyond that system for those early adopters.

Josh Levine

Yeah. I mean, Anthony I think we actually think this is -- we’re in a pretty positive situation. And again, from an MLC availability standpoint, the fact that we've been delayed is unfortunate; we've spoken about this in the past. But I think in order to be clear to the market at this point it certainly become included the people who have installed M6, they have practical experience with the systems functionality they are, they are seeing a remarkably faster more user friendly system in terms of product functionality.

In terms of people that had orders in the backlog and that have installed within Iris or fixed collimator and are still waiting for MLC. The MLC upgrade is a relatively straight forward discussion. It doesn’t involve a lot of downtime. And this is not a -- something more than probably just a couple of days, there will be calibration, business calibration required once the MCL is installed. But you are not talking about something that would be disruptive from a patient treatment schedule standpoint or create significant downtime for the account.

So right now, we’ve got a product that has improved functionality over the previous generation. And when we can shift and install MLCs, we will do so. In the meantime, we are continuing to take orders for the M6. And all of what we’ve communicated over time around M6 and MCL from a timing perspective is all kind of covered under our current guidance.

Anthony Petrone - Jefferies Group

Very helpful. And then last one for me Josh, maybe we haven’t heard around Siemens share gains in a while, so maybe just a quick update on the amount of orders that you are entertaining from Siemens and how successful Accuray is in those competitive situations? Thanks.

Josh Levine

Yeah. It’s a question that has come up over time. I don’t think we have been very granular or specific with it. I mean at the end of the day, competitive bunker conversion is a big focus for us regardless of who owns the bunker. And I understand, recognize that kind of the void in the marketplace that Siemens’ exit created, you know in the markets where that Varian has a relationship with them at this point. We are in the competitive mix in those discussions when those bunkers come up. But from a -- and we’ve got -- we understand where the bunkers are, we understand what the replacement cycle is for where those systems reside, but we are not going to start reporting by competitor on competitive bunker takeouts.


And your next question comes from the line of Jason Wittes with Brean Capital.

Jason Wittes - Brean Capital

Hi, thanks for taking the question. So couple of things, first off, in terms of -- I appreciate that you provided some net order guidance. This is obviously a very strong quarter. I think you should describe the age out this quarter. If I look at the number that you're kind of projecting for the rest of the year, it sounds like it's going to stand at $55 million to $60 million range. Are there further age outs likely of such substance as record next two quarters that work into that thinking?

Josh Levine

Well, so Jason this is Josh. I mean, I think we've been very, very consistent over time with this discussion and age outs are something that everyone experiences. The unfortunate reality for us is given our size and scale, they affect us in a much more visible way than they do our competitors. When you think about a typical unit volume situation for us in a given quarter, you're talking about maybe 22 systems, 23 systems. So at that level of volume, a unit here or there makes an impact.

And so, we said that there will be some quarter-to-quarter variability in this discussion. And I think that's really kind of part of our thinking. I think the other part of what you heard Greg talk about before is that we are working diligently on the making sure that what goes into the backlog going forward is -- our systems that we'll operate roof to installation and commissioning inside of the 30 month window that part of that order, that that the backlog criteria.

The Latin America and South America situation, I think we've been pretty expensive on over time [more if] not when we got age out challenges, it’s been in that region of the world. These are things more if not associated with delay in bunker construction and long, very well construction cycle to modification cycle. So, but again, these are things, processes that we’re actively managing at this point proactively.

Jason Wittes - Brean Capital

Okay. I understood, understood. And then I wanted to ask, you talked about region, I wonder if you give a little more color on regions in terms of where the growth was this year. I understand this quarter was still more OUS than U.S. Can you give us a sense if I look at Asia, Europe, U.S. and Latin America kind of where the hot points were?

Josh Levine

Yeah. I mean Europe, I would say Europe in the following order, Europe, Japan, other parts of the Asia Pacific, RIM that would be your key drivers.

Jason Wittes - Brean Capital

Okay. And also do you breakout the number of units you actually shipped at versus install this quarter?

Greg Lichtwardt

We have decided to span that metric in our press releases. I’ll give you the total installed base is now 711.

Jason Wittes - Brean Capital


Greg Lichtwardt

And if you want more detail than that Jason, we can take that offline.

Jason Wittes - Brean Capital

Okay. No, I think I am good. Thank you very much. Nice quarter.


Your next question comes from the line of Brooks O’Neil with Dougherty & Company.

Brooks O’Neil - Dougherty & Company

Yeah. Just following on there, I am curious, obviously we hear a lot about this general turmoil outside the United States, but it doesn’t seem at least on the surface to be affecting you guys at least at this time. Could you just comment about that a little bit?

Josh Levine

Brooks, I think what we’ve seen is that if you go back over the last probably year and half or two years and some of this precedes my involvement with the company. We were already moving to make commercial leadership changes in the parts of the world where you’ve seen, where we just characterize our growth and kind of consistent rolling performance has been some of the strongest from a regional perspective. And I think that stable leadership is one answer, improved selling processes as a result of that and training and [talent] upgrades from a selling resource perspective is another.

So these areas where we have made earlier changes in both leadership and in selling process improvement are the places for us today that are leading the performance momentum. And we would expect that to continue. I think that we also have an understanding based on the timing differences of when we were making changes and changes were made in the U.S. market and the Americas region.

We expect that we’d start to see some traction, similar traction in the next several quarters here. So clearly, from a -- the last three or four quarters on a consecutive rolling basis, it’s been the international market that’s led the business for us.

Brooks O’Neil - Dougherty & Company

That’s good. And then just because I am still fairly new to the process, obviously the product lifecycle that you run is now; I guess a little bit more than a year old. I am curious what your perception is of how long these products will have legs in the marketplace you are seeing out there today?

Josh Levine

Yeah, I’d say in general that the product replacement cycle for these products in general is probably somewhere in the 8 to 10 year range. So we are talking about products, again we will continue to innovate and continue to upgrade these two platforms, we will stand still on that. But there is a lot of runway ahead for the M6 and for the TomoTherapy H Series.

Brooks O’Neil - Dougherty & Company

That's great. Congratulations on a great quarter. And I’m really happy for you guys.

Josh Levine

Thank you.


Your next question comes from the line of Toby Wann with Obsidian Research Group.

Toby Wann - Obsidian Research Group

Hi, good afternoon everybody. Congratulations guys on the quarter and the strong order growth. A couple of quick questions as it relates to service margins and product margin, obviously continued success there in executing that. As we kind of think about kind of where margins have been where they’ve come, what should we be kind of thinking about as where they could possibly go. I know services margin [I think] 37% is probably the highest you guys have posted in many years. And so I know -- I guess kind of where should we be thinking about how about how that thing rolls forward? And then on the product gross margin, I think a couple of years ago it was about 15%; I mean what's kind of the timeline runway. Not to kind of pin you guys down on a number or time period, but kind of where would that -- how are you guys thinking about that?

Greg Lichtwardt

Thank you, Toby for the question. So, product gross margin in the 50% range is still a goal for the company. We are probably one to three years away from that. Mostly what we need is product revenue, revenue volume. I will add that in 2017 we lose the single largest category fixed cost and other cost of goods sold which is the amortization of the developed technology intangibles from the TomoTherapy acquisition and that will make a significant improvement in gross margin as well.

But in terms of color on the current year, I would say for the remainder of 2014 product margins are going to fluctuate first of all. And for the outlook I would say that the average for the full year will be similar to what we averaged in the first half of the year, but it is going to fluctuate in between the third and the fourth quarter.

Service gross margin, 40% is still a goal and that is driven by increasing our installed base, continuing to rollout new [componentry] into the TomoTherapy installed base and continuing the adoption of higher value service contracts whereby no means 100% penetrated those initiatives. And I would say we are probably again one to three years away from realizing that. And for the balance of this year I would say that service margins will remain sort of in the mid 30% range.

Toby Wann - Obsidian Research Group

Okay. That’s helpful. Thank you. I appreciate the color. Congratulations.


There are no further questions. I would now like to turn the call back over to Mr. Josh Levine, President and CEO.

Josh Levine

I’d like to thank everybody for joining us on this afternoon’s call and look forward to speaking with you again when we publish third quarter results. Thank you very much.


Ladies and gentlemen that will conclude today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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