Varian Medical Systems Inc. - Shareholder/Analyst Call

| About: Varian Medical (VAR)

Varian Medical Systems, Inc. (NYSE:VAR)

November 03, 2011 11:30 am ET


Lester D. Boeh - Vice President of Emerging Businesses and Vice President of Oncology Systems Security & Inspection Business

Dow R. Wilson - Chief Operating Officer

Robert H. Kluge - Corporate Senior Vice President and President of X-Ray Products

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

Timothy E. Guertin - Chief Executive Officer, President and Executive Director


Steve Beuchaw - Morgan Stanley, Research Division

Amit Bhalla - Citigroup Inc, Research Division

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

Jeremy Feffer - Cantor Fitzgerald & Co., Research Division

Unknown Analyst -

Timothy E. Guertin

Okay. Hello, everybody. We're going to begin the webcast now. I'm going to begin by just telling you we do have handouts for you but they're not quite here yet, so we'll get them to you probably the next half-hour, something like that.

I'm Tim Guertin. I'm the CEO for Varian Medical Systems, and, of course, I know most of you. But just to remind you, for the last 5 years, I've put up a chart showing you what we've accomplished for the last 5 years. And as you can see, from 2006 to 2011 we've had this fairly monotonic increase in orders, revenues and operating earnings. And the question is that I think is in a lot of your minds is, what can we do over the next 5 years? And so we're going to talk a little bit about what we're doing right now and about what we think can be accomplished.

But to just give you my view, if you look at the businesses, the oncology systems business, the X-ray business, the Proton business and the security business, it's sort of outlined here. As you can see, they -- what I'm aiming for is in 2014, I'm trying to get to that $4 billion mark. And as we get into 2016, I'm trying to push us towards the -- a little over $4.5 billion.

And this is organic. This chart is just organic -- I should say it's organics combined with whatever acquisitions you saw us do during the last year. It's not -- there's nothing on here that is M&A related.

So M&A constitutes a possible uplift to this and our M&A goal is -- whatever M&A we're going to do, we want to it to at least fit in as naturally as it can with these 4 businesses so that we can exploit our channel opportunities that exist.

Our 2012 outlook that I gave over the phone, just to remind you, our revenue growth is estimated at 9% to 11%, our EPS is estimated at $3.92 to $4.02. So we're starting the year with a little broader range and then as the year goes on, we'll narrow that range. Elisha wanted it to be a just like a single number, didn't you, Elisha? But we decided that wouldn't work.

First quarter revenues growth estimated at 8% to 9%. EPS estimated at $0.74 to $0.75. And as I indicated, there's a number of single one-time factors that related to tax rate and a variety of other things that happened in the first quarter, the shutdown of the dpiX facility -- all these kinds of things. So first quarter is a little odd but the year itself, I think, is more reflective of our general feeling.

So with that, the agenda today is I'm going to have Elisha talk about the financial picture. Bob Kluge is going to talk about x-rays. Lester is going to talk about emerging businesses. And Dow is going to talk about oncology systems.

Now this is Dow's last appearance as the President of -- where is Dow? there he is -- as President of Oncology Systems. We have promoted him to be the Chief Operating Officer of the company. And sitting next to him is Kolleen Kennedy, who is the President of Oncology Systems going forward. Some of you I think have met Kolleen in the past. But if you haven't, feel free to introduce yourself so she'll be making those oncology presentations. And then in the future we'll do -- I mean, in the end of the meeting, we'll be doing Q&A.

So with that, Elisha.

Elisha W. Finney

Thanks, Tim, and hello, everyone. That sounds a little familiar, doesn't it, for those who have listened to our conference calls. But in all seriousness, thank you so much for coming this afternoon.

I am -- if I can figure out how to get this to advance, here we go. First of all, I'm just going to summarize at a very high level and then we'll come back and talk about the quarter in a little more detail.

This is just a snapshot of the total company. This is on a reported GAAP basis for continuing operations, where orders were up 15%. Of course, that includes the Scripps Proton order. Our sales were up 10% on a reported basis. Earnings per share at $344 million, up 16% year-over-year. 23% operating earnings and just under 6,000 employees.

Again, just as a reminder of our business segments, obviously, Oncology system being the lion's share, as has always been the case, but there is a little bit of shifting going on with Proton therapy and with flat panel growing faster than the core businesses. Oncology is coming down slightly, as a percentage of the overall company. So whereas we were 81% in fiscal year '10, it's 77% in fiscal year '11.

You can see X-ray products due to strong growth at 16% and then the other, which is primarily due to the Proton Therapy order that I'll get to, is now 7% of the total company.

I'm going to depart little bit from how I typically report on the numbers. I'm first going to talk about our core businesses. So I want to give you a lot of detail on oncology systems, on X-ray products, then I want to talk about the other category, which includes the Proton business, and talk about the impact that, that business had on the total company in the fourth quarter and for the fiscal year.

Suffice it to say that we feel like we had a very solid fourth quarter. The core businesses are absolutely intact. That said, it was a complicated quarter on a number of fronts. The revenue and profit came from some different sources than we had expected when we previously had given guidance with more Proton revenue, less security and inspection product revenue and tube revenue.

We did get the Proton order, which had a percentage of completion, which turned into some revenue in the quarter as well, and I'll come back to talk you through the accounting of that.

The gross margin in oncology I think was a highlight in the quarter. It was up quite strongly. And then throughout the quarter, we had extremely volatile foreign exchange rates, both within the quarter and then if you look at quarter-over-quarter, there was a 13% change in just the dollar-euro alone. So it was very complex time to manage the hedging exposure throughout the quarter.

So see oncology turned in 9% orders growth. This was 5% in constant currency. North America was down 2% over a very, very strong year-ago quarter, where they were up 24%. And the International orders were up 22% in the quarter. Again, you'll see the gross margin was a highlight of 2 points to 45%. That was driven largely by Truebeam and also lower installation and warranty costs. And we've been making significant improvements from the beginning of the year to the end of the year and getting these Truebeams installed in great time. And you can see the ROS was up 1 point to 25%.

For the year, oncology orders at 8%, sales at 9% again, driven largely by Truebeam and also by our service organization, which grew 16% in sales in the fiscal year.

The gross margin was flat at 45% for the year. We had very good TrueBeam performance that was offset somewhat by higher installation and warranty costs, particularly earlier in the fiscal year. We continued to make improvements as the year went on. And also as we talked about in our third quarter, some higher than expected retrofit costs which really impacted mostly in our third quarter. And again, we've maintained the ROS at 25%.

Looking at X-ray products, X-ray products had both a very strong fourth quarter and a strong year, and both flat panels and tubes have just exhibited very strong growth all year long. That said, the fourth quarter was still a little weaker than what we had expected as our major customer experienced some rolling shutdowns in Japan. And so even though you see the 11% revenue growth in the X-ray products segment, we were expecting anywhere from $2 million to $3 million higher had we not run into some more of these blackouts that we did.

The gross margin in the quarter was flat. It's still 41%. This is a business that's taken its margin from the mid-30s to the low 40s over the last several years. But we are starting to see as we've moved more into the radiographic panels, some pricing pressure. And that was offset by volume and by quality cost improvements. We did see a little bit of pricing pressure in the RAD panels, which resulted in a flat gross margin. And you'll see again, an ROS of about 25% in this business segment.

For the year, very good growth in both tubes and panels growing in the mid-teens. On the sales line, panels grew faster than tubes, which did allow us to take that margin up by 1 point to 41% for the year. And while on a rounded basis, ROS was flat at 25%, they were actually up about 30 basis points year-over-year.

Now to get to some of the more complex issues in the quarter surrounding the Proton Therapy business and Lester's has got lots of pictures and it's a very exciting milestone that we passed in the quarter, when we have our first quarter in the U.S. of $88 million. Because we are going to be accounting as a percentage of completion, we also immediately had $33 million of revenue in the fourth quarter as well.

But because this is our first installation and under this project accounting, we are booking cost equal to revenue i.e. 0 gross margin on any Proton Therapy revenue, until we have built some experience with this and we really know how to determine our cost estimate. But on the first 1 or 2, my expectation is that this is the accounting that we will employ. So any profits on the Scripps deal will be taken towards the end when we are closer to product acceptance.

And in this other category, boy, life would be good if every business could turn in 1,500% orders growth and 53% sales growth. But again, it's just a very strange comparison because of the Proton order. But our SIP, Security and Inspection products business, also had very strong orders in the first quarter. We did miss on the sales line in that business by $10 million to $12 million, particularly due to a large Saudi sale that moved out.

If you look at the full year -- and I have to be very careful because we don't want to get into non-GAAP accounting. So what I'm going to do is just tell you the impact that the Proton business had on the year. So net orders reported basis were up 25% in the quarter. If you exclude the Proton Therapy business, it's up 14% in the quarter.

Revenues were up 10%, including that Proton revenue. And if you were to exclude it, it's up 5%. And you'll see that it appears that the gross margin at 42% was down quarter-over-quarter by a point. But again, if you exclude that $33 million of revenue at a 0 margin, we actually had very strong margin performance of 43.8%, which was up 140 basis points quarter-over-quarter. So very strong margin performance in our core businesses.

And then operating earnings of 22%. Without the Scripps deal, it would've been 23.3% margin, which would've been up 50 basis points quarter-over-quarter.

If you look at the year, obviously, the impact of the Proton deal had less impact over the total year than in the fourth quarter. But still, if you strip out the effects of the Scripps deal, orders would have been 14% instead of 15% for the year, sales would have been 9% versus the 10% reported and the gross margin would've been 44.3%, which was up 80 basis points year-over-year. So again, very good margin performance for the year. And the ROS was at 23%, would've been up about 30 basis points, excluding the Proton deal.

Any questions on the Proton before I move on? I know it's a little complicated but we'll come back to it.

Backlog. Ended the year with $2.5 billion in backlog, which was up 15% year-over-year. If you, again, exclude Proton Therapy, the backlog is still up 13%. So it gives us a lot of visibility and predictability as we move into fiscal year '12. As you know, it takes roughly 12 to 15 months for something to convert from an order to revenue so the average time in backlog is 12 to 15 months, again, giving us pretty good visibility, as we are looking out over next fiscal year.

Finally, just a note on the balance sheet and the cash flow, I would still -- it's a conservative balance sheet. We ended with $564 million of cash, virtually all of that is offshore. We have $19 million in short-term investments. This is a new category on our balance sheet, and this basically reflects the initial funding of the $19 million for the Scripps financing that Varian, along with Orrick Capital Management, have a $165 million debt facility for the Scripps Center. Varian is participating ultimately to $115 million. The beauty of this is we get to use our international cash. It earns 8.25% versus 0 that we are earning today. And there are some revenue share that goes along with this to even enhance the deal above what we are earning on the interest.

Total debt of $198 million. A little higher than what you typically see and that's because we brought down under our letter of credit to do the accelerated share repurchase program. That should complete in about the January-February time frame. We did buy 3.8 million shares under the accelerated program in addition to 1 million shares in the open market following the third quarter.

And then DSO, I would say we ended down 2 days from the prior year. 80 days is very average. If you take the last flowing 4 quarters, we have averaged 80 days. And so our receivables are holding up quite well.

Thank you. And with that, I'm going to turn it over to Bob Kluge.

Robert H. Kluge

Good afternoon. We had a good year last year. We grew 16%. I was happy with that. It's kind of a continuation really of what we've done the last 5 years or so. I'm trying to catch Kolleen but she runs so hard, she's really hard to catch.

We probably had a little weaker fourth quarter than we normally have, as Elisha mentioned, because of the Japan situation. It's kind of funny. I was fooled myself through most of the year because it seemed like even though this tsunami was giving my customers fits and I knew that, that was occurring, they kept ordering product. I think they felt that they were going to get on top of things and catch up production and the like. And toward the end of our fiscal year, it became kind of clear that they all had excess inventory and they couldn't. And so our quarter ended a little bit weaker than it normally would've. But I think if the ground just doesn't shake in Japan with quite the regularity that it has been, we'll all get back on track and, in fact, the customers are getting back on track and inventory levels are trending downwards. So I think that's definitely a transient kind of an effect.

And the long-term effect is really the result of the strategy that we've employed. I mean we try to have the very highest quality, highest technology components, make ourselves very easy to deal with, with big customers like Toshiba, Siemens, whoever, to give our customers an edge and give them both a cost advantage and a performance advantage. And I think the money we put in R&D over the last 10 years or more, particularly in the panel business is really giving us that result.

If you look at the drivers, the industry is really converting from film-based and analog image intensifiers to solid-state, and we've seen this coming, we've invested heavily. Now we've got a great portfolio of products, some real leading-edge products both in X-ray tube and in panel. And we have a lot of new products that are coming out in the coming year that I'm going to talk about little bit later.

But I think this will just continue on. And our customer base is growing. We are at the point, I think, where if you want to buy a high-tech component, you simply have to talk to Varian. If you look at our competitors, we don't have too many standalone competitors. I've got Thales in imaging panels, which is probably the strongest. Samsung is -- I'm not going to make light of them but they haven't done too well, so far. In X-ray tubes, if you want a really high-tier X-ray tube for either CT scanners, cardiac angiographic, it's like we're almost the only place to come. The integrated companies will sell the components to each other, but if Toshiba decides to buy a panel from, say, Canon, they've got to go back on the market and compete with that Canon product. And if they buy the imaging panel from me, I'll custom make it for them, they can put their label on it if they want to, but they will never see me competing in the market against them. We don't sell to hospitals. We only sell to the OEMs. And so that's something that all of our customers are very much aware of. And sometimes it's hard for me to understand people like Canon, Fuji, even Toshiba. They will sell against us competitively, but the customers we sell to don't like the fact that they do that. And even the Toshiba Electron group selling to Toshiba Medical, they buy more from us than they buy it from their own sister division, simply because we'll custom engineer for them, we'll work with them, we'll give them the result that they want. And this strategy has certainly paid off for us.

So if you look at some of the highlights of the year we just completed, the high-tier CT tubes, CT itself might be a relatively flat market. But our customers -- our biggest customer, Toshiba, continues to grow. And we have multiple new customers that have put investment into the CT line like Hitachi. We have Chinese customers, Eastern European customers that are getting into CT, getting into higher-tier CT. And like I said earlier, we are really the only place that you can go to get those products.

And so we're working with a few different people and while none of those volumes are high, you never know who is going to win in the long run. And also they'll add up. I'm more than happy to sell somebody a couple of hundred tubes instead of a couple of thousand. So that's been a growth area for us.

Mammography tubes, that's certainly been a growth area and digital mammography has changed the requirements on X-ray tubes a lot. The throughput is much, much faster on digital. And so it puts a lot of strain on the X-ray tube. And so we've engineered a new series of tubes, and there's a new type of system that I think you're going to see more of, which is a photon counting device, which basically throws most of the beam away and produces a very good image, but it really requires a significantly bigger x-ray tube with specific characteristics. So we've engineered a tube for this market. That's something that's going to hit the market in the coming fiscal year.

Radiographic panels. We sold none a few years ago and $100 million in just radiographic panels this current year. And we're on the cusp of introducing the second generation, which we'll be showing at the RSNA show in November. So I anticipate additional growth there.

When you look at these products as a group again, if you want the real high-performing products, you want to buy a component instead of engineer your own, if you're one of the OEMs, we are getting to be the place to come.

Probably the most significant thing in FY '11 that occurred in our business was just the tremendous effort that we had going on in product development. I had good sales numbers. My profit number was kind of flat from a percentage basis. I really blew the R&D budget. Tim will normally let me it away with that as long as I've got the products coming and I have the products coming.

And so, at the RSNA this year, we're going to have -- the several new CT tubes will be on the floor, some in our booths, some not, some in customers' booths.

The panel business. We've had a number of panels in the works. I've got some slides on this a little bit later on but we've -- in a way been waiting for the new fab. We are partnered in a semiconductor fab with Siemens, Phillips and Thales. And we have to do this because an imaging panel requires a multilayer process that people who do flat TVs, flatscreen TVs and the like aren't really anxious to do.

So anyway, we have been jointly building this brand-new fab in Colorado Springs, which is now available to us this year. We just closed the old fab down last month, and we're just about 100% reliant on the new one. And this gives us some capability to get a better cost picture and get performance like we haven't gotten in the past. There's -- we created the design some time back for a high performance mammography plate and we hadn't been able to build it, We've been waiting for this new fab and so, it's finally here. And so we'll be introducing that product, along with the next generation of radiographic panels, a new high-end cone beam, a state-of-the-art dynamic panel. So -- here's some shots of these products. This top one is a new mammography panel, or tube, that I mentioned earlier. It's not much bigger than the standard product and about 4x more powerful. A very clean beam. We have a couple of customers that are integrating this product into systems at the present time.

The next 2 products down are tubes that are almost a little bit ahead of the generator systems. We have customers that are working. The integration will be a little bit slower but these are angiographic tubes, Mobile C-arm products. We've got a number of people that are working on integration but the generator is a little difficult and going to probably slow that effort down. But over the next few years, these products will grow significantly and become a major factor in our product mix. We went through this with CT tubes. We introduced anode grounded CT tubes 10 years ago and it took 5 years for it to become really a standard of the industry, but it did become that. And I think the same thing is going to happen with these products.

In the panel area, we have really the most full product portfolio in the industry. We cover everything from dental, radiographic, cardiac, angio. And what we're going to introduce is going to make that all the stronger. First off, a mammography detector, you know, selenium panels right now, it's a different type of panel from what we build. Our amorphous silicon with cesium-iodide is more robust, but, in the past, has lacked the image quality to do the mammography job. And we engineered a panel that we felt would be competitive with selenium. If you look at the 4 big imaging companies, Siemens, Phillips, General Electric and Toshiba, GE is already using this approach. They have their own fab, they build their own plate. The other 3 companies are interested. We've supplied samples for the other 3 companies. 2 out of the other 3 are already integrating this in. They haven't figured out exactly where they're going to position it but this is going to be a big seller. We've got the big OEMs interested in this and we've got, somewhere in the ballpark of a dozen medium and smaller players in China, in Europe, all over the place, interested in introducing this product. So I think that as time goes on, this is going to be a very significant product for us.

The wireless panel, wireless radiographic, we were the first company to build a wireless radiographic panel. We put somebody else's name on it and gave them an exclusive. So it's been a successful product for us, but our name hasn't really been out there in the marketplace. This product is really the next generation. We learned a lot on the first pass. This one has got very good transmission capabilities. It's a little more sleek, a little lighter weight, more capable, better electronics and lower-cost electronics. With panels, the price has come down pretty dramatically, but the cost has also come down pretty dramatically. And so we've been able to hold margins fairly well. I think, as Elisha mentioned, last year was the first year that we dropped margin a little bit in a product category and that was about 5 points on the lowest tier. And I think this will position us to get that back. But this is going to be a big product for us. This is going to be at the RSNA in customers' booths. We're probably going to let our customers show it in the first year, and the next year we'll show it. But this product, I think, is probably going to be paced by our ability to build it. Customers want it right now. We're not quite ready. It looks like sometime in the mid second quarter.

And the new high-end dynamic panel. This is where we started out with the highest-tier cone beam dynamic panel. And we had significant advantage on this. The strategy was, if you can build the real high tier 1, you ought to be able to build the basic one or anything down from that.

And so this is probably a third or fourth generation, but it's a very significant upgrade. It's a bigger size. The previous one we had was 40 x 30. This one is 43 x 43, so it will handle a lot of applications where the 40 x 30 was a little too small. Better resolution, better performance. A little bit lighter weight. It's state-of-the-art and we'll have a little bit better cost picture on this as well.

So this is really a year -- the year that we're in right now, fiscal year '12, of product introductions for us. We worked hard over the last couple of years. These are typically multiyear projects and we've got a lot coming out. So this is our introductory year. It's going to be a lot of fun. I think the second half of the year is going to be stronger than the first half. But on balance, I'm looking for a real good year. And these products that I've showed you, we have customers lined up in various stages of integration. So it's not a real big risk. This is going to happen.

And with that, Lester?

Lester D. Boeh

Thanks, Bob. Well, hello, everybody. For those who don't know me. I'm Lester Boeh. I manage emerging businesses for Varian. And right now, we've got 2 businesses in the portfolio that I'm going to talk about today. One is the Security and Inspection products that I'll start with and the other one is the Particle Therapy.

So just a quick reminder of what the Security and Inspection business is. We actually are very similar to Bob's X-ray business in that we supply high energy X-ray sources, as well as detectors and software into the security and inspection market, and that includes, primarily, border security but also, port and airport security and a variety of nondestructive, testing and industrial applications.

And our customers are all the major systems integrators that, for those of you who track the security industry are familiar with, Rapiscan, Smith's, ASME, as well as number a of regional players. And we've seen more and more of these regional players start to emerge in markets that are growing in the Middle East, especially in Eastern Europe.

We also sell to customs agencies, especially in the U.S. as well as the Department of Defense. It's about a $100 million business and the primary market drivers are terrorism, global instability and tax revenue. Most countries are using this to verify the contents of the container or the air cargo container, match-to-manifest and then levering -- charging the appropriate duties should they not be correct. And it turns out there roughly 85% of manifests are wrong. So there's usually a tax collection opportunity for customs agencies for inspecting these containers.

Our strengths. We have a very quick and automated material discrimination and material identification process. That's been expanded over this past year. We now cover 4 major classes of materials in organics, inorganics, metals and high-density materials, and I've also got updated image to show you what that really looks like.

And then the other segment that we are seeing growth in is having a lower-priced, more compact X-ray source that can go into a smaller package, a smaller vehicle or a smaller portal. And so you can reduce the cost and therefore have more of these systems protecting the borders.

We do continue to invest in R&D. We got more than 50 active imaging and security patents just in the Security and Inspection business. And we do shamelessly leverage our oncology footprint, in terms of our distribution, as well as our spare parts distribution and service network.

Some major highlights from this past fiscal year is that we got a $21 million award from U.S. Customs for the -- for our system, the IntellX 3. We've also just completed the vendor testing for the next generate system of IntellX and that's in our Las Vegas facility right now. And we'll be coming soon to a U.S. border crossing near you.

We also demonstrated expanded material discrimination capability and we've got greater sensitivity especially in thin materials. And we've started deploying our dual-view imaging systems. I've spoken about this in the past, but we now have some of these sites up and operational. And these are high-volume locations. So where you have very busy, active border crossings, where you want to process more vehicles, this can process roughly 100 vehicles per hour. So that's getting to a level to where it starts to make sense to process every vehicle that's crossing a border.

So how are we going to leverage growth in the coming year? Well, we've been focusing a great deal -- most of our market is in high energy. This is about a $400 million market every year, and we're about 20% of that total segment.

But right next door, in the low-energy, is a market that's about 3x the size, and that's in the lower energy, nonintrusive energy market, or NII. And so we are developing products and solutions that allow us access to that market so we can access a growing market as well as a greater variety of platforms that we can make available to our customers.

So what does this mean? Well, if you look on the left, you'll see the accelerator is called an Mi6. That's our highest volume unit right now. We sell that into border crossings especially but also ports of entry in airports. And that sells for about $675,000.

Right next to it is the next-generation compact system called the CX1. And that reduces the price to about $250,000. So as you can imagine, when you look at the package, you see the large cabinet on the left, that's called a modulator cabinet. We've redesigned that so that it now fits in the box and we've also made the box smaller.

So this means that our customer or end-user can put this X-ray source into a much smaller package, for a lower cost vehicle or lower cost gantry and come out with a system in the sub $1 million range, whereas a typical mobile system today sells for $1.6 million to $1.8 million.

We've also been productizing the generation that comes after that, because it turns out next-generation is never good enough. Tim always wants to know what comes after that. So what comes after that is an even more compact system that's actually man-portable. And the whole thing fits into those 3 cases that you see there. And that can be taken out into a field for a variety of field imaging solutions.

So smaller is what's big in our market. This is the CX1 you see there on the left. And then you see on the right, this is a typical, lower cost border inspection solution. You can see that the X-ray head mounts on the back of the vehicle. This vehicle also has an onboard generator so it's all completely self-contained. And so it's just -- it's towed to a border crossing, say, with a Humvee, or some other small vehicle, deploys in about 15 minutes and you're up and operational. And so -- whereas a previous generation of this type of inspection system, would be in the $1.6 million to $1.8 million range, this is something that can be sold for about $900,000.

So we've seen that -- we've shipped about 20 of these X-ray sources to go into these types of units. And they've been deployed in places where we're probably not going to take a lot of customers on site visits, mostly in Afghanistan. And so far, they've been performing very well in that environment.

I mentioned before the materials discrimination. And this is really what the next generation of material discrimination looks like. What you're looking at in this upper image is actually a forklift. And there's a test piece on there and you see 3 different objects behind that test piece. One is a heavy metal, lead. The other one is steel, and the other one is an inorganic, probably plastic.

But what about these images? If you're actually looking at these objects through more than a foot of solid steel, so that gray area you see around there is actually a block of solid steel with those objects placed behind it. And so we can give a great deal of information about the objects that are hidden behind -- inside of containers as well as behind other heavy objects.

So I'll move on now to the Particle Therapy business. And as we've seen the market continue to grow in this area, we see the possibility for about 3 to 4 new centers being launched each year. Our goal is to get at least half of those. So if we can do 2 a year, that's actually a pretty good business to start with. That's about $160 million to $170 million a year.

The first of which for us, in the U.S., is the Scripps Proton Therapy Center. We just had the Cyclotron delivered there last week. We finally were able to book the equipment order right at the end of September and, as Elisha mentioned, that was $88 million in orders and a little over $30 million in sales.

We also signed a 10-year operations and maintenance agreement for about $60 million and the installation is now underway. And we should see our first patient there in the summer of 2013.

We also signed a purchase agreement for the University of Maryland Proton Therapy Center. It's a very similar configuration to what you see in San Diego. And then we also signed a concession agreement for the Mestre Proton Therapy facility, which will be housed near Venice, Italy. And what this is a contract now that we're a member of a consortium that has a guaranteed revenue stream from the healthcare system for a period of 15 years for delivering Proton Therapy treatment.

Some other highlights. We did finish the first Cyclotron. We got it through the manufacturing process, the testing process and we did manage to ship it. We all would've preferred that it was a little bit closer to the factory in Germany but we were able to prove out that we can deliver these Cyclotrons just about anywhere in the world. It was shipped across the ocean, through the Panama Canal and up the West Coast and delivered to the site in San Diego just this past week. We did receive 510(k) during fiscal year '11.

We also's constructed an open-to-gantry test facility here in the U.S. And so this allows us to do not only R&D on gantries but it also allows us the location for doing customer visits and customer training without disrupting the activities in the clinic. And this is in northern Illinois, about an hour west of Chicago.

We made great progress on implementing the RT, radiation therapy, workflow capabilities into Proton Therapy, especially for in-room imaging and patient motion management. And really in order for us to be successful in this business, we have to take out the cost of treatment per patient. That includes both reducing the cost of the equipment, as well as dramatic improvements in clinical workflow. So we're concentrating our R&D efforts in both of those areas, and I'll talk about that in a little bit more detail.

We've also come out with a new industrial design that is probably hard to see from this picture. But it's much more consistent with what you see in the TrueBeam family. We've also created a common user interface. So anybody that uses a TrueBeam can walk into the TrueBeam -- I mean, walk into our Proton system, with ProBeam environment and immediately feel comfortable and understand the logic and the workflow of how the system operates.

So this was the Cyclotron installation. For those of you wondering how this is done, we transport the Cyclotron to the site and there's a large bridge crane that we use for lifting the Cyclotron up and into the building and dropping it down into the bunker, where it will be permanently housed. And then you can see above in that upper right-hand picture, what happens is the rest of the roof is put in place with these pre-cast concrete sections that once the Cyclotron is in place, we simply use that same crane to stack those precast sections into the roof and close it off. And then the system is ready to be turned on.

So this is the Cyclotron's permanent home now. It'll sit in this room for at least the next 30 years, maybe even longer. And we've already started delivering and installing the beam line sections as well. So installation has been underway of other components for about a month, but the Cyclotron is -- was a major milestone for us.

So we need to address market needs as I mentioned before. And we have done a number of surveys and conducted focus groups. And what customers are telling us is they do want an integrated solution from a single provider. We went through this learning curve in radiation therapy, where you had somebody supplying an accelerator, somebody supplying treatment planning, somebody is supplying an information system. And getting those to work together in harmony long-term is -- has been a difficult problem. And so that's one of the reasons why we've been so successful in radiation therapy is because we have turnkey solutions. We need to do the same thing in Proton therapy. It's a path we've been down before so we feel comfortable that we can be successful at that.

We also want to have more advanced treatment delivery, be available for protons in order to do Proton radiosurgery, Proton, RapidArc and those types of procedures.

So going beyond -- but the new, new thing in Proton therapy is intensity modulator Proton therapy, which we already have. So obviously, we're pushing the boundaries to go on to what comes after that.

But customers know that the useful life of this system is going to be very long, so they want to be able to adopt and integrate new capabilities as they get released. So we've redesigned the control system to be able to adapt to that.

So I mentioned before our R&D activities. There's 2 major areas of focus. One is in quality of care, so reducing the amount of dose that gets treated to healthy tissues surrounding the tumor but also more advanced motion management capabilities. If any of you have gone into a Proton Therapy Clinic, the workflow is actually quite antiquated. It's like radiation therapy was 20 years ago. So we have the ability to improve the clinical workflow because every additional patient that the site can treat on a daily basis means pretty significant improvement in revenue and also improving the user environment. So instead of a hodgepodge of systems and subsystems from multiple vendors, everything comes from the same company. Everything looks and works and feels the same.

And then making it more economically viable. So what we're targeting is if we can improve clinical workflow enough that you can treat the same number of patients with a 2-room system that you can with a 3 room system, that has a huge economic impact for the customer. If we can get that equipment priced down into the $50 million range, now you've got a price range that a large hospital can do on their own. They don't have to form a consortium with a number of other hospitals. And so we can speed up the process of this technology being purchased and deployed and put into clinical use.

And then also the material and process development improvements that we've done so successfully in radiation therapy related to manufacturing but also installation and commissioning, we think we can months out of the installation and commissioning process just by applying the tools and knowledge that we've gained in 50 years in radiation therapy.

So with that, I'll turn it over to Dow to talk about oncology.

Dow R. Wilson

Hi, everybody. When we think about the oncology strategy, we really think about 3 fundamental things. First of all, our business is all about innovation. And clearly, when you look back at the last couple of years, RapidArc, TrueBeam and other important innovations that we've brought to market have been a huge growth driver for us. Our market is still very, very much innovation driven. The day we forget that is the day we're in trouble. But we're going to talk about each of these points kind of a little bit rear-view mirror and then how we think about them as we look forward. So innovation, globalization and services are kind of the big 3 that we think about as we think about growth going forward.

Some of the highlights from 2011. Our orders were up 8%. We think that's 3 points faster than market growth. In North America, we grew 5% with some pretty tough comps as you know here in the second half. And we believe we took share in North America and grew faster than the market in North America.

Internationally, we grew 11%, which we had a very significant headwind in Japan and some softness in southwestern Europe but had a terrific year this year in international market and again believe that we significantly grew faster than market growth in those markets and won some share.

Our software sites over the last 3 years have doubled. Average annual growth rate per Eclipse and ARIA have been good double-digit growth rates.

Our service business has been growing in the mid-teens and we continue to leverage our install base.

Clearly one of the highlights of 2011 has to be TrueBeam. We now have 380 orders, have done 145 installations. We're ahead of where we thought we would be and really pleased with the success of this product in the market. 70% of our USA orders are now TrueBeam. 40% of our worldwide orders are TrueBeam. And we're well on to the next releases of what TrueBeam is going to be and very excited about both the clinical opportunities that those give us as well as the financial opportunities in terms of upgrade and refreshing our install base.

RapidArc continues to go very, very strong. We have more than 2,000 orders. That number is larger than most of the install base of our competitors. We have 2,000 orders now for RapidArc. We've booked over $300 million of software for RapidArc. We're on, again, well into the kind of the next generation of RapidArc, being able to gate the RapidArc as we rotate to correspond to patients and a need to motion manage the tumor and we estimate that we've treated at least 20,000 patients so far in just the last couple of years with this new technology.

As I mentioned, our Software business is rising very, very well. Our treatment planning is recognized now as the best product on the market. We get a lot of benefits from integrating our product line, ARIA, Eclipse and then the treatment delivery whether it's Arc, Trilogy, Clinac iX or TrueBeam platform. Frankly, we're a little bit surprised that we've been able to kind of put this much distance between ourselves and our competitors in some of these advanced application areas and this is the reason why. We're able to integrate across the product line because new features require something in information systems, treatment planning and treatment delivery. And we can do all those with a very strategic focus and make sure we can deliver the innovation across the product line for our customers. And I think we're bringing and managing innovation to market much faster than our competitors.

And we're seeing that by some outside bodies. We won the Class award this last year ranked #1 for our ARIA radiation oncology information system. Class in healthcare IT is kind of the Gartner of our industry. It's a big deal to win their award and we're very pleased with the continued success, not just financially but of how our users are responding to our product.

On Eclipse, it's really been a story across our product line of productivity and outcome. And we're seeing that in Eclipse as well. We're trying to bring more and more knowledge -- historical knowledge of what the -- of what our users have been doing to the product. So as they segment and contour tumors, how do we leverage that information for the next patient and how do we make it simpler and faster. And that's really the message here is the same kind of things that we've done on the treatment delivery side in going from half hour treatment delivery to 2 or 3 minutes. That's what we're now doing with Eclipse and really trying to drive the productivity of our customers on the treatment planning side of the business.

So here's a case for both prostate cancer and head and neck cancer, where we can automatically segment the anatomy, for example, in the case of the bottom right, miss the femoral head and deliver the dose to the prostate and make sure that, that contouring happens in the highest quality, no variation kind of way.

As we do these things, our install base is growing. You see most of the growth is international, but our worldwide Linac install base the last 4 years has been growing about 5% a year. The North American market is up a little bit. And then of course, most of the growth is out of the International market. With that kind of unit growth, we've been getting priced growth. We get more upgrade opportunity, more service opportunity. So we really kind of get a nice boomerang effect out of pretty solid unit growth in our install base.

And then a part of that growth as well has come from a much broader and differentiated product line. You see just a half a dozen years ago. We had the low energy Clinac at the bottom end of the family. We priced that product probably about $750,000. And we had Trilogy in the 2.5 to 3 range. But you can see over the last half a dozen years, what went to our product line. We can really recover any price point from $4.5 million to $750,000. Some products are pretty much exclusively oriented at the International market. Almost every product in this basket is radiosurgery capable, RapidArc capable. We've got some advantages there that our competitors do not have. We can manage the motion, provide image guidance at a lower price point than historically and really give our customers both the capability and the clinical workflow that they are looking for.

As we kind of look out over the next 5 years, it's a disease management discussion. And as we think about how we're going to evolve our product line over the next 5 years it's really looking at lung, liver, prostate, breast and the other cancers and reflecting that back to our technologies and taking again a system view of what is required to make sure that we can deliver in treatment planning, treatment delivery, record and verify, practice management, data management, healthcare informatics just all the way across the board what our customers want.

And so each of these areas has a specific strategy as to how we're going to evolve our product line. I'll talk briefly a little bit about some of those. In the case of lung cancer, I think you know the statistics. Lung cancer is now the biggest cancer killer. There are about 1 million people, 1 million men and half a million women diagnosed each year, and the, of course, the mortality rate is about equal to the diagnosis rate. So it is far and away the biggest killer of cancer patients today.

Now there's been 2 very promising studies. One in non-small-cell lung cancer, these are small tend to be peripheral lesions and one, kind of surprising, people thought that radiation would never be able to do large, central, non-operable central lung cancer lesions. And we're showing very good success in studies of each of these cancers with outcome that's equal or better than surgery and at least in the case of the second study with the inoperable cancers. Very good toxicity results as well. So we're very, very encouraged by these studies and think we've got a very promising future for lung cancer.

What's it going to take? Gated RapidArc is a big deal here. You want to be able to get the dose in as quickly as you can and get the patient off the table. Real-time triggered imaging is a big deal, that's what you're seeing here in the image. These happen to be fiducial markers. We can watch those fiducial markers as the lung moves and turn off and on the beam so that we're missing other critical tissue or if the cancer or the tumor moves outside of the treatment plan in some way to make sure that we're not radiating healthy tissue.

Dose rate is a big deal. We still have far and away the fastest machine, the ability to get dose in quickly and the hypofractionated treatment is very, very important.

The role of Calypso here is exciting for us. We're not sure exactly how it's going to pan out. We do not have 510(k) approval yet for that product in the lung. But we're working hard on that and we think there's going to be an important role for the Beacon to play in a lung cancer. Calypso is the kind of gold standard for precision and knowing exactly where you are. That's why we're excited about it.

It also has a role in prostate cancer. Some of their early work done in prostate cancer shows -- gives us sort of the ability to dose escalate and reduce toxicity by reducing margins because of the confidence that people have in the placement of the Beacon. So that looks very good. And we have been FDA approved for a multi-standard trial for an IDE for lung cancer. That's going to take us a while to complete, but at least the process is underway for our second application of Calypso in treatment of cancer.

As I mentioned, there has been a study done with very good toxicity results, very good margin reduction in some low-risk prostate cancer -- 80 low-risk prostate cancer patients that looks very, very encouraging and the results of the Phase II study that the Calypso team has done.

We kind of like to think about some of the things in the context of again what they're going to do together. So imagine a Beacon telling us exactly where the prostate cancer is and now being able to insert some hydrogel from our -- we have them already positioned in Augmenix. We can see here in this image on the bottom left you see the prostate and the dose area in red, and you see the rectum with a yellow circle there on the right. You're looking at the SpaceOAR hydrogel it is inserted between the prostate and the rectum. And just by generating that space, we can get much better toxicity reduction and virtually eliminate rectal toxicity as one of the toxicities in prostate cancer, at least this is where we're headed. So again, kind of taking a systems view of prostate cancer, the world clearly is going to a higher dose rate in this disease and then being able to spare those critical tissues is a big, big deal and we're excited about where that can go.

Looking at breast cancer, again, we think -- we do a lot of breast cancer today probably 80% at least in the developed world, probably 80% of breast cancer patients get radiation. But we think we can again improve the capability of our product here by improving heart and lung sparing. So this is using a prone position, you can see the patient laying down on the table here, and by getting more separation of the breast tissue, what you're seeing here on the left is the standard supine position. There in the red is the tumor, and then on the right you can see the separation between the tumor and the rest of the critical anatomy behind the patient wall. So kind of a simple innovation, it's a product that we can take to our entire install base and market and we're excited both about the improvement and the business opportunity that we have in breast cancer.

Breast cancer continues to be in the news. There was a Lancet study just published during the last couple of weeks, that with radiotherapy and lumpectomy really is the standard of care with recurrence risk cut from 35% to 19% during the first 10 years and the risk of death cut from 25% to 21% in the first 15 years. You've heard us talk about breast-cancer before, it's always been 5-year survival rate. And now we're talking about 10 and 15 year survival rates. Just to show you the kind of progress that we're making in this disease is very, very exciting.

So we kind of add that all up and say what's the opportunity? What you're looking at here is a map of the world and color-coded by the number of radiotherapy machines per million population over age 65. So that blue country there, there happens to be 75 machines per million in the U.S., far and away, the most machines per million population. You can see Scandinavia, Switzerland, Turkey, for whatever odd reason, Australia are between 41 and 75 machines per million. And then the rest of the world is much lower than that. China and India, I believe they're both around 10 machines per million below age 65.

So if we just kind of conservatively say what if we got the world to kind of the low end of the Western European standard, what that would mean for us is 10,000 new accelerators. That's roughly a doubling of our install base. So we're going to try and do that all next week. But obviously it's going to take us some time to do that. Our biggest challenge is education and training, but we really believe that the need is out there and people are asking for the technology. There's a growing need in the market of the role of radiation therapy. Interestingly enough, in the U.S. it's a very reimbursement-driven scenario. Outside of the U.S., it's a clinical-need driven scenario and people are seeing the benefit and the cost productivity of radiation therapy versus other therapeutic approaches and are adopting radiation therapy at an increasing clip which is exciting for us. And we've certainly seen this in our own business as we've gone from low mid-40s kind of percent per year in international to just last year, over 54% of our orders were international. And we've now given them the place on the bottom of the chart, I guess, historically that was always the North America.

So building our global footprint. Just in Q4 alone, we had orders from 50 countries. Amazing performance, our service is in 100 countries around the world. We have major training facilities, I think you've heard this from us before, in U.S., Switzerland and we have new facilities in China, India and Japan. And we continue to grow that capability. In the educations facilities, our customers are looking for more peer-to-peer kind of training from us, and we're busy trying to provide those capabilities so our customers can really learn what they need to practice radiation therapy in these geographies.

And of course all these has led to just terrific growth in our Service business. $100 million of growth year-over-year, $550 million in 2010 to $655 million this past year. The install base is driving that, a richer product mix, we're getting more price with the higher price point products. A lot of extended warranty options. We now have a dedicated sales force, not in all markets but in especially in our developed markets, a dedicated sales force that's out selling these products, getting professional services to help our customers think through workflow changes, as they are implementing new technology and increasing products that they're asking from us.

And at the same time, we're driving productivity through technology in this business. It's not just a wrench-turning business. It's a -- there's a lot of technology, a lot of proactive diagnosis that we do, a lot of remote capability and can we fix the machine and get the customer up before we have to send somebody to the slight [ph] and you really see that in our offerings as well as our installation and warranty numbers. Our installation and warranty numbers have come nicely down.

So we think we can continue to grow this business. In the U.S., our customers -- radiation therapy is a profit center and uptime is very critical for our customers, and to be able to offer products that meet that uptime is a big deal. We've got a new offering, our PremierAssurance offering, that our customers can tailor to their needs there. More and more customers are 2-shift, they're looking for after hours coverage from us. They're looking for more help as their profitability grows with their volume. We talked a little bit about SmartConnect. We've got a huge install base. This is a big reason that customers buy from Varian is that we've got the best service capability in our industry. And of course, on top of that our product has a reputation as the highest reliable product out there.

So our goal is to get to $1 billion by 2015 in this business. And I think we're well on our way there. And with that, I think we'll wrap up with the business discussions and invite the Varian team back up and we'll take whatever questions you have.

Timothy E. Guertin

Okay. So now you know we can see a Coke can through 12 inches of steel.

Dow R. Wilson

I hope that's impressive.

Timothy E. Guertin


Question-and-Answer Session

Unknown Analyst -


Timothy E. Guertin

Excellent point there, I especially liked that last point.

Dow R. Wilson

Please repeat that question.

Timothy E. Guertin


Dow R. Wilson

So the question was what are the advantages that Varian has by being in the Proton business and the conventional radiation therapy business? How does that help us in both businesses?

Timothy E. Guertin

I think that the #1 thing it does is it puts us in a consultative selling position with our customers. There's a lot of questions about Proton. One of the most expensive things about developing our Proton business is the investment in your sales force. Well, guess what -- we already have that. We've got well over 100 people worldwide selling. And so we just train those people and they can go out and at least do the bird dogging for us. We don't have to invest in sending out PhD physicists and protons out to some customer who is going to buy in 2018, which is there's a lot of those in the Proton business, there's a lot of tire ticking going on so we can develop that market, and educate through our full line sales force. And then when the time really comes where they're a little further down the funnel in terms of their purchasing, we can get the right people involved. So I think that helps us a lot in the go-to-market strategy. On the clinical side, there's a -- we can take a look, we are working with RTOG and other groups to make sure that the studies get done in the places where they need to be done. So I'm not sure that prostate cancer is the #1 target for us in Proton, a lot of people are going to do it. We were down in the center in Philadelphia yesterday and they've negotiated with their payers so that their payers are agnostic, whether it's protons or photons, but they're not getting any incremental reimbursement for a prostate patient in Philadelphia.

Unknown Analyst -


hospitals on Proton Therapy centers and you're in competition with other companies and that you are -- you're a real company, there are assets there, there's diversification, there is history. It's not just a new company that has a lot of debt and no real assets?

Timothy E. Guertin

Right. Yes. I mean the...

Unknown Analyst -

And how much of an advantage do you think that is?

Timothy E. Guertin

It's been a tremendous advantage. We're essentially almost guaranteed, when we can easily get the meetings, we're almost guaranteed a spot in the final round of the decision-making process. But the fact that we can leverage all that history and all that experience, because in order for Protons to be this successful, we have got to get better at clinical workflow and reducing that cost per patient. And this is a well-worn path for us. We've been down this curve, we know how to do image guidance, we know how to do motion management, we know how to do information integration, we know how to do advanced planning in a very quick way. And we know how to keep all that integration working together. And as customers get to the learning curve, they get beyond just the initial a Proton is a Proton is a Proton. Then when they really understand what the challenges are going to be, when they want to put a center in and when they want to get it operational, we become a pretty attractive alternative. So then it becomes a matter of making sure you've got the right configuration and the right solution for the market but also understanding how to find the local payers, how to negotiate the contracts with those payers to make sure you've got an adequate revenue stream when you start to serve the patient in catchment area. This is still a new enough area that I don't want to use the phrase if you build it they will come. But I mean it's -- there's -- it's not that big of a challenge to fill up a patient schedule when you put a proton system in place just because of the lack of the number of facilities that are in the U.S. That will change over time and catchment areas will start to shrink. But right now, catchment areas are still pretty large and so there's still quite a bit of focus on these larger facilities, the 4 and 5 treatment room facilities like San Diego. But we think once you see that the larger regions get those larger centers, you'll start to see kind of the mid-tier population areas that also want to have proton therapy that have a smaller catchment area that need a 2-room system and that has to work -- that has to work very, very efficiently over a long period of time and that's where we -- we're an attractive alternative

Unknown Analyst -


and as they've been out they want a robotic device and here at the academic centers they're all going to have proton therapy and they're going to go out to large community hospitals that maybe one day will be able to afford a $25 million or $50 million two-room proton therapy.

Timothy E. Guertin

Yes. We're also seeing demand though from the patient population because patients are doing a lot more research when they're diagnosed with the disease and they stumble across the proton options and alternatives. So they just start to call around and look for places where they can get that service. So you see a much higher percentage of self-referral in proton than you do in any other modality.

Steve Beuchaw - Morgan Stanley, Research Division

It's Steve Beuchaw of Morgan Stanley. I wonder if you could spend a little bit more time on Augmenix. I wonder particularly if you could give us more of a sense for how and when you can take the Augmenix product and get patients to a higher energy, more hypofractionated treatment. When does that happen and what does that mean for you competitively?

Elisha W. Finney

I'll answer the when and then we can come back to the how. We -- when we invested in Augmenix we've had an option to acquire the remainder of their company at a predetermined but undisclosed price so that is all just based on milestones on getting Varian's approval.

Timothy E. Guertin

So we do have the CE Mark. Customers in Europe are very excited about it. They are using it in both standard fractionation and in hypofractionated environments. I think with the hypofractionation there's a real player and for them this is just cost and it kind of comes back to what we were talking about before, they're really driving efficiency with hypofractionation. For us, I think what the exciting part of it is, is why can't we get every prostate. That's our goal.

Steve Beuchaw - Morgan Stanley, Research Division

And then a somewhat similar question thinking about 2 things. One, the IMR rollout at ASTRO and then extended OBI functionality on Clinac. On these new products, could you tell us more how you're thinking about these as either market growers or share gainers and what your targets are? .

Timothy E. Guertin

I think it's a couple of things. First of all it's an install base play because all of these will go on our install base products so that's a big deal for us. We do see them as market growers, because it's bringing more demanding applications into radiation therapy especially lung cancer. And we think we're ahead competitively so it's helping us certainly at the margin from a share point of view. It's tough to grow share when you've got our kind of share. But we have grown share this last year, and I think our motion management tool is a part of it. That's not the only thing because again it's kind of the ability to deliver the whole application. So IMR is a big deal because now we can gate the beam. When the tumor goes outside the beam, we go to a safe mode. But to be able to -- from a clinical point of view, one of the most important things is to be able to deliver maximally and as fast as you can the dose into the tumor. And in a tough motion environment, we're far and away with that.

Dow R. Wilson

Let me add a little bit of mathematics to the Augmenix question for you. There's -- There are about 200,000 prostate cancer patients in the United States per year about 100,000 of them are treated with radiation. If you double that for the world, 200,000 is more than that. Because you have to do more than double, it's 200,000 or 300,000 for the world at $1,000 per injection, you can see the kind of money that's possible here. Now, between here and there is a lot of research, papers, regulatory approvals, building sales forces, all those kinds of things. But I think this is a high potential business.

Jeremy Feffer - Cantor Fitzgerald & Co., Research Division

Jeremy Feffer, Cantor Fitzgerald. Third quarter gross margin obviously had a little flip from the retrofitting. You talked about that being a one-time issue. Obviously, gross margin is sort of back up to normal levels in the fourth quarter. To what extent is that -- may that pop up again, going forward? Obviously, there's a lot in the press on product safety. And I know you guys have usually nipped those issues in the bud with a lot of recall things like that. What sort of expectations are there heading into fiscal '12? .

Timothy E. Guertin

I'd say number one, there's always a little bit of risk because we're always learning. So every service call that we get, we evaluate from a safety lens. It can be the most mundane part failure, the most mundane user error. We evaluate it from a safety point of view. And if there's a safety risk, we're going to go back and fix our install base. That's our philosophy as a company number one. Number two, as the world has gone to hypofractionation, the risk is way up. So if you're delivering more dose in a treatment session, your safety risk is much higher than delivering 1/40th today, 1/20th or 1/40th of that dose in over many fractions. So really what drove a lot of this retrofit cost is we went back and we went through all of our historical complaints and evaluated them for safety risk in a hypofractionated case. And we found some that were okay in a fractionated environment that weren't okay in a hypofractionated environment. And we've gone back and fixed our install base and that's who we are and that's the commitment we're going to make.

Elisha W. Finney

And we have retrofitted custody for every single quarter, always have, always will. It's just part of being a medical device manufacturer. But in the third quarter year-over-year which is a large delta that won the growth margin. Oncology ended up at 45% for the fourth quarter, 45% for the year. I think it's 45% for FY '12 should be sustainable, maybe a little bit of improvement. That's all been driven by TrueBeam and by increasing services.

Timothy E. Guertin

And I think the real harbinger of our product quality is installation and warranty process and those are coming down nicely.

Jeremy Feffer - Cantor Fitzgerald & Co., Research Division

And just very quickly this is for Tim, you talked a little bit about reimbursement expectations on the call. Obviously in the interim we had a final rule come out, I'm wondering if you had any updated thoughts there.

Timothy E. Guertin

Well, some of the things were a little worse than expected. Some were a little better than expected. But it was about as expected. And our customers are not reacting at all. So I think that's good.

I think we have one over one over here and then we'll get to you.

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

Anthony from Jefferies. I'll stay on oncology for a moment, then I'll call you, Tim. Can you go over the North American Linac market and maybe explain what do you think the gating factor is in the replacement cycle? And when do you think technological obsolescence will actually begin to pull everyone through and I then have a quick one for Bob and Lester on emerging markets on proton?

Dow R. Wilson

There are a lot of factors in the U.S. market. Clearly, reimbursement is one of those factors. I think people are waiting a little bit here. We'll see how they react to this news. I agree with Tim, early returns are kind of what we expected. We're not seeing it drive a lot of behavior. We are seeing the hospital market be more aggressive about getting out into the community, so the kind of the big inner city, academic and community hospitals are -- urban hospitals are getting out into the communities we're seeing that. I think TrueBeam is driving a lot of interest in the U.S. It's still is our biggest market. We are seeing people replace faster. I'd say in the U.S., we are seeing a lot more customers replace in the kind of 7 to 10-year timeframe as opposed to the 10 to 15-year timeframe. That's anecdotally I don't know if we've quantified that to the gnat's eyebrow. But I'd say in general terms that's what we're seeing in the U.S. What did I miss there? Was there another piece of that question?

Elisha W. Finney

The only thing I would add is history repeats itself. What we tend to see with a new technology is you can see the early adopters and then they -- so we've had a lot of people purchase our TrueBeam and they're now screening patients on it. They'll go back and upgrade their second and third machines so that they create redundancy in the department. So you start to see hospitals start to standardize on the latest technology after they've gotten fully up-to-speed on it.

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

Then a 2 quick follow-ups on the digital mammography tube. Can you explain where ASPs and COGs are on that relative to existing tubes and then on the proton business, where do you expect the throughput on Scripps is once it's up and running. Where's throughput, do you expect it to be when it's completed where can it go. And is throughput still a barrier in terms of getting more customers to sign on. Just...

Timothy E. Guertin

I would be reluctant to speak to the COGs on a particular tube.

Elisha W. Finney

Me, too.

Timothy E. Guertin

A, because I don't know and, b, because I probably shouldn't do that. So -- but the information I have in the meetings as I look at the gross margin of tubes is that they should be -- they should not be hurting our gross margin or our business in adding substantially to our volumes. So I think we're okay but I we can't give you any more specific number than that. As for proton, your question was Scripps throughput?

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

Scripps throughput. Where do you expect?

Dow R. Wilson

In terms of their anticipated patient load? Yes. Well, the modeling obviously, has a whole variety of scenarios, depending on how many of the -- how much the local referral base they get plus how much of the external direct catchment area they're able to draw in. But the numbers range anywhere from about 1,500 patients a year up to a little over 2,000 patients a year.

Elisha W. Finney

And the reimbursement rates just went up for Proton so that helps those numbers.

Dow R. Wilson

Right. Yes. We just had and increase. So that helped obviously.

Amit Bhalla - Citigroup Inc, Research Division

Amit Bhalla from Citi. A question on just competition, I think, generally one of the questions come up about competition is directed around the Elekta and Accuray. I was actually more curious about the Far East given that region of the world is a market that is a big opportunity for you, can you talk a little bit about some of these multinational conglomerates like Mitsubishi, Hitachi and Toshiba and what you see as their potential to get into this market and be competitors?

Timothy E. Guertin

Sure. I think in the case of Japan, we have not seen a lot of momentum yet out of the Toshiba Elekta line. So our share in Japan still is about the same share as we have in the U.S. We had very good share year in Japan this year. The Viro products, Mitsubishi products were not seeing much uptake anywhere in the world. I'm not sure what the distribution rates are in Japan. I think Mitsubishi hasn't in Japan, but I maybe wrong about that. But I [Indiscernible] has in the rest of the world but the -- this is a product that requires very significant room and for marginal benefit versus traditional accelerators. So we're not seeing much uptake from that product. In China, it's more about the traditional competitors. It's more an Elekta Siemens scenario. We have -- we don't believe that the -- the China market is interesting, the market wants great technology at a low price. And so low tech at low price actually doesn't work that well. And some of our competitors have some offerings some kind of canal water offerings, but we have not seen a competitive uptake in that market. And in the second half, we grew share very nicely in China. We we're #1 in China in the second half and feel very good. We've retooled our sales force, we've added, maybe not quite 10 salespeople in China and I really like what we see in that market going forward.

Amit Bhalla - Citigroup Inc, Research Division

And then a question for Elisha. Maybe I have missed it on the conference call but you just mentioned that there was a Saudi order pushout in the quarter that impacted revenue. Can you quantify that and just talk a little bit more about that?

Elisha W. Finney

10 million to 12 million or so. We had several pushouts with Saudi with the vast majority of that in the SIP business.

Amit Bhalla - Citigroup Inc, Research Division

Oh, in the SIP business.

Timothy E. Guertin

Yes. It wasn't on oncology.

Elisha W. Finney

Exactly, SIP business. No, no, no. Oncology was within sitting distance of our forecast.

Timothy E. Guertin

Right there. No. There was a hand. Are you just rubbing your head? I have a bid?

Lauren Blum

Lauren here. Lauren Blum, Capital Counsel. I just wanted to hear about the uptake of UNIQUE, I mean, we've talked a lot about the International market and the lack of -- the few machines per million people outside and we talked about revenue and that would impact it.

Dow R. Wilson

We are seeing very good uptake of the UNIQUE product. Eastern Europe, Middle East, Southeast Asia and Brazil. We're not seeing good uptake yet in China because we don't have regulatory approval yet we have to go through a clinical study there. We do have a product in that market, CX, that's one of the products on the chart here and CX has had very good uptake in China. So between the 2 products, we introduced the CX in that market about 3 years ago. And it took it a while to get going. But this last year we had very good growth in that product in China. And again, it's the kind of product the market wants it's RapidArc capable, image guidance capable, if you can get in at a low price point if you don't have the budget and upgrade later or if you got a little more budget, you can go right now. And for a very good $1 million to $1.5 million, depending on the configuration price point, get in with some really good technologies, very tactic capable. So it's a nice product in the market.

Elisha W. Finney

It's incremental typically so it's not cannibalizing higher margin products. So...

Timothy E. Guertin

So I'll kind of summarize for you. In the Oncology business, our growth opportunities relate to giving a lot of people in the U.S. reasons to replace their units and making throughput very high so when people add new site they can quickly come up to a breakeven point at new facilities. Internationally, we have a gigantic opportunity that we're going to have to build over time but especially in developing market. There is possibilities in Europe but in the rest of the world, the radiation therapy market is hugely underserved so we think we have big opportunities. In security and inspection, I think we have growth opportunities related to the inspection market. It's hard to specify what it will be in a given year. But over the long run, I think we have $100 million worth of potential additional business in that business. In Protons, we're going to leverage the technology that we have in the Oncology business to get us up to speed in protons faster. We're leveraging our technology. We're leveraging our sales force. And so I think that this is a very large potential business for us. And in X-ray tubes, we're finding more things for Bob's sales force to sell. He's got a great sales force. He's got a great series of tubes. If we can add mammo tubes, radiographic panels, 43 x 43 panels, anything we can think of for Bob to sell, we want him to sell it because it's just all upside for us in order to do that. So I think Bob has a couple of $100 million worth of upside as you look at that. And the other big gainer for us is the Service business in oncology. It has been growing hugely. As we expand internationally, there are gigantic opportunities for us in service. So I can see a lot of runway for us to grow the company, and that's the underlying message. We have a lot of execution to do too but I think it's a good thing that we're doing that. Thank you all for coming.

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