TomoTherapy Inc. Q1 2008 Earnings Call Transcript

TomoTherapy Inc. (TOMO)

Q1 2008 Earnings Call

April 28, 2008 at 5:00 pm ET

Executives

Steve Hathaway - Chief Financial Officer

Fred Robertson - CEO

Shawn Guse - Vice President, Secretary and General Counsel

Analysts

Thomas Gunderson - Piper Jaffray

Ben Andrew - William Blair

Jeff Johnson - Robert Baird

Paul Choi - Merrill Lynch

Amit Hazan - Oppenheimer

Philip Legendy - Thomas Weisel and Partners

Brooks West - Craig-Hallum Capital

Peter Bye - Jefferies & Company

Junaid Husain - Soleil Securities

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2008 TomoTherapy Incorporated Earnings Conference Call. My name is Karen and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator instructions). As a reminder, this conference is being recorded for replay purposes.

I will now like to turn the presentation over to your host for today’s call, Mr. Steve Hathaway, Chief Financial Officer. Please proceed.

Steve Hathaway - Chief Financial Officer

Thanks operator. Joining me on today’s call is Fred Robertson, TomoTherapy’s CEO. Also joining us for the Q&A session will be Shawn Guse, Vice President, Secretary and General Counsel of TomoTherapy and CEO of our new venture Compact Particle Acceleration Corporation that we just announced this afternoon.

Before we begin, I would like to preface our remarks with a customary Safe Harbor statement. Today’s conference call contains certain forward-looking statements. These statements are based on the current estimates and assumptions of TomoTherapy’s management and are subject to uncertainty and changes in circumstances. Given these uncertainties you should not place undue reliance on these forward-looking statements. Actual results may vary materially from these expectations contained in today’s call. Important factors that could cause actual results to differ materially from those indicated include among others those set forth under the headings, risk factors and management’s discussion and analysis of financial condition and results of operations in our 10-K filing for the year ended December 31, 2007.

With that, I would now like to turn the call over to Fred for a review of TomoTherapy’s first quarter.

Fred Robertson - CEO

Thanks, Steve, and thank you everyone for joining us. As you have seen from today’s release, our first quarter results are inline with the preliminary results we announced on April 17.

Given our strong 2007, this is a somewhat challenging quarter due to the backend loaded nature of our current backlog. While we are obviously disappointed in our performance, the fundamentals of our business remain very strong. We are pleased that the value of new orders increased year-over-year at a rate more than double the growth rate of the overall radiation oncology market. US orders were especially strong, increasing 118% year-over-year, the result which record revenue backlog.

This further affirms our belief in the superiority of the Hi-Art system to provide the best quality treatments to cancer patients. As a public company, it’s easy to become almost only in the performance of our business from a short-term financial perspective. We agree that predictable financial performance is extremely important, but we also need to remind ourselves of our primary goal: to provide the best absolute best possible care for patients with cancer.

We believe that the Hi-Art treatment system is the most advanced radiation therapy platform, improving the effectiveness of treatment for a full range of cancer. Over the long-term we fully anticipate executing on our business plan, which means that we will accomplish our goal of maximizing the penetration of our system throughout the world while delivering growing revenues and profits.

Steve will provide additional details on our financials later in the call. What I would like to focus on today are highlights from the quarter as they relate to our growth strategies of driving innovation, globalizing our market presence, delivering best-in-class customer service and enhancing quality, reliability and efficiencies. This four-pronged approach will allow us to continue to grow TomoTherapy and help more patients worldwide.

First, innovation. From an innovation perspective, we have unwavering commitment to research and development. R&D is the key to maintaining TomoTherapy’s innovation and leadership position.

As we discussed in our February call, during the first quarter, we launched our latest software release, Version 3.1, which improves treatment planning and delivery efficiencies. And combined with our new high performance couch, test sites are dramatically increasing patient throughput without sacrificing quality.

Two other efficiency projects were completed during the quarter, the extended network and the new blade server. The extended network gives customers more flexibility in the placements of the Hi-Art’s computer cluster, while the new blade server provides much faster computer power for planning and optimization processes. This helps both TomoTherapy and our customers. Customers get faster planning and we reduce our costs. Customers also have the option to purchase additional blades to provide even faster planning.

As you may have seen today, we announced the formation of a new entity, Compact Particle Acceleration Corporation or CPAC. TomoTherapy is bringing in outside investors to help fund the development of a state-of-the-art Compact Proton Therapy System featuring a dielectric wall accelerator. This is the same project that we’ve been working on with Lawrence Livermore National Labs. Today’s announcement allows TomoTherapy to reduce its development risk by bringing in outside investors to help fund the development and thereby increase the project speed and likelihood of success.

TomoTherapy retains the core option to acquire the medical applications back from CPAC at a later date. We are excited about the prospects for this work as are others based on the investor interest that we received including many potential future customers. During the quarter, we will also branched [inaudible] treatment front, Veterinary Medicine. We announced at the University of Wisconsin-Madison School of Veterinary Medicine will install a Hi-Art treatment system. Upon installation, this will be the first TomoTherapy system to be used for Veterinary Medicine.

The second growth strategy is globalizing TomoTherapy. I would like to turn to our sales activities. Despite first quarter order weakness in Europe, TomoTherapy’s opportunities abroad continue to be tremendous. The international markets remain underserved. Long-term, we feel that Europe and the Middle East will nearly rival our domestic market opportunity. But from a market penetration standpoint, Asia remains relatively untapped.

As previously announced in early April, we hired an experienced business executive as the Managing Director for Europe and the Middle East. Joseph [Vandem] came to us from GE Healthcare, but he was the Commercial Director of one of the European Divisions to provide experience leadership for our European operations and management of the growing market opportunity in the Middle East.

International sales comprised 23% of our 2008 first quarter revenue. This percentage was down from prior periods, but we expect it to rebound as we continue to expand our international operations. On the domestic front, as of March 31, we had 23 direct sales professionals in the US compared to 15 a year ago. As previously discussed, a fully staffed sales team allows us to focus on our target customers for profit institutions, large national accounts, the aging installed base of competitive system and expanding into more of the marquee accounts with the top 50 cancer centers and the top 100 academic institutions.

The third growth strategy is best-in-class customer service. Delivering best-in-class customer service is a key priority for TomoTherapy. It’s critical to our growth and an area where we have been making significant forward investments. The net result of our initiatives is continued improvement in uptime at our customer site.

As of the end of March, the worldwide average system uptime now stands at 97.4% compared to 97.1% as of 2007 year-end. This represents a significant improvement in uptime from just a few years ago. How do we accomplish this? With investments in the call centers, training, parts warehouses, predictive tools, and more reliable components. We remain focused on continued improvement in uptime going forward. MD Byline, an independent analysis firm just issued their quarterly user satisfaction survey for the first quarter of 2008.

We are pleased to see improved satisfaction from Hi-Art users in system performance, system reliability and service repair quality. This is a positive sign that our customer service investments are being noticed by the user group.

And finally, enhancing quality, reliability and efficiencies. TomoTherapy’s technology offers a distinct competitive advantage that meets the radiotherapy needs of clinicians and their patients. To maintain that advantage, we are making system investments on an ongoing basis to further enhance reliability and quality, allowing us to help more cancer patients’ worldwide.

One of our primary initiatives is to improve the durability of key system components. We identified and are actively working on projects that are all aimed at driving further reliability improvements in the field. During the first quarter, we completed and launched five of our top 20 reliability projects. These changes have been implemented in production and are just beginning to be implemented in the installed base.

As disclosed two weeks ago, we entered into an agreement to acquire privately held linear accelerator manufacturer, Chengdu Twin Peak Accelerator Technology Incorporated based in Chengdu, China. A linear accelerator is a key component in radiation therapy systems. It's used to create high energy X-rays for cancer treatments. The linear accelerator is designed, developed, and manufactured by Twin Peak with the use to supplement our existing supply source.

This deal represents a substantial advance for TomoTherapy that eliminates a sole supplier risk, and as a piece of our longer-term strategy to reduce the cost of the Hi-Art system, thereby increasing our margins.

I would like to close out my portion of the call by sharing a comment from a clinical expert in the field of radiation oncology, Dr. Patrick Kupelian. In beginning of March, we had an Investor Meeting at our headquarters in Madison. Dr. Kupelian, Director of Clinical Research for Radiation Oncology at MD Anderson Cancer Center in Orlando spoke about his early adoption of the Hi-Art treatment system and the center’s recent decision to purchase a second unit. This is what he said. " Early on, we saw TomoTherapy as an innovative tool in the fight against cancer. We recognized the benefit of integrating treatment capabilities onto an imaging device, rather than simply adding imaging to a treatment platform that wasn't originally designed for image guidance. Now, it's difficult to see how we ever performed radiotherapy without effective image guidance. During my ongoing visits with customers in the field are repeatedly are testimonials like these. And its like customers are increasingly seeking out the Hi-Art treatment system.

Now, I’ll turn the call back to Steve to cover our financials in more detail.

Steve Hathaway - Chief Financial Officer

Thanks, Fred. As Fred indicated, the results we reported today are inline with our announcement on April 17. Revenue for the first quarter of 2008 was $38.9 million versus $51.2 million in the first quarter of 2007. The revenue decrease was due to fewer systems installed this year compared to last year. This was expected due to the timing of customer readiness. In addition, the average selling prices in the first quarter were approximately 11% lower than last year. If you remember the first quarter of 2007, our sales included a high number of European sales denominated in euros. This caused our ASPs to be unusually high. We do not see similar pricing over the rest of 2007.

The pricing of orders taken into revenue during the first quarter of 2008 was essentially consistent with that experienced during the last half of 2007. 84% of the first quarter revenue was product revenue. Service revenue is continuing to grow as more systems are covered under service contracts and as we sell parts to our international distributors. As Fred mentioned, international sales comprised 23% of revenue in the first quarter compared to 50% in 2007.

First quarter gross margins were 21.1% versus 42.6% in the first quarter of 2007. The primary reason for the decrease between years is the lower revenue. As you may recall, all service costs are reported above the gross margin line. Because we have a high level of fixed cost in our service infrastructure, the lower revenue has a significant impact on margins. We are seeing two extremes in margins. Low revenue this year resulted in lower margins and very high average selling prices last year resulted in very high margins, much higher than the rest of the year.

Total operating expenses increased as planned during the first quarter as we continued to build the organization and invest in research and development. Operating expenses totaled $20.2 million in the first quarter, up from $15.8 million in the first quarter of 2007 but down sequentially from the $23.2 million in the fourth quarter.

The 2008 expenses included $867,000 of expense related to stock-based compensation and $1.5 million of expense for the proton therapy research collaboration. This compares to $679,000 and $1.1 million respectively in the first quarter of 2007.

As we said in our pre-release call, we’re taking appropriate steps from an expense standpoint to limit the impact of lower revenues. To that end, we are reviewing all discretionary spending. We intend to continue to invest in the business to maximize our growth opportunities but will do so prudently and deferred expenses that don’t directly drive growth.

In the first quarter, we had an operating loss of $12 million compared to operating income of $6 million last year. The income tax benefit was $4.1 million in the first quarter versus an expense of $2.2 million in the prior year. This represented an effective tax rate of 40%.

We reported a first quarter net loss of $6.2 million or $0.12 per share compared to pro forma net income of $3.9 million or $0.09 per diluted share for the first quarter of 2007. The 2007 pro forma results do not include the accretion of redeemable, convertible preferred stock of $134.9 million. Including this accretion, the 2007 first quarter net loss attributable to common shareholders was $131.1 million or $12.13 per share.

Looking at the company from a staffing perspective, our workforce has grown from 491 at the beginning of 2007 to 707 at the close of the 2008 first quarter. 42 employees were added during the first quarter. Two-thirds of the new hires were in our customer support organization. We intend to continue to judiciously add staff both here and abroad to drive our expected future growth.

Now, a short comment on orders and backlog. The value of new orders received during the first quarter totaled $55 million, a 23% increase over the first quarter of 2007. US orders were especially strong, more than doubling year-over-year. As noted in our pre-release this was impacted by new order sluggishness in Europe. As of March 31, 2008, revenue backlog was a record $260 million, a 60% increase from our backlog at March 31, 2007.

As we discussed during the pre-release call, for the first time, we had to reverse four units totaling approximately $11 million out of backlog. 3D systems were from an organization that exited the radiation therapy business. The other unit was lost due to a merger of two hospitals, as each had an Hi-Art system on order. To reiterate our policy, we calculate backlog as firm customer purchase orders for systems and other options. It also does not include any service revenue.

Turning to the new entity that we set up for proton therapy work. Because of several factors, including our ownership level, the call option and our overall control of the organization, we are required to consolidate CPAC’s results into TomoTherapy. Thus, the total expenses incurred by CPAC will be included in TomoTherapy’s R&D expenses. However, there will be a credit below the line to adjust our minority interest in that entity.

The net result is that we are able to use outside funding for a higher risk, higher reward opportunity and minimize the impact on our financials, while providing complete transparency to our investors.

Turning to the balance sheet. We ended the quarter with cash and marketable securities of $165.8 million, down $26 million since year-end, primarily due to the net loss and a higher level of finished goods inventory.

Receivables decreased by $7 million since December 31, 2007. Day sales outstanding was 74 days, up from 50 days at year-end. The DSO was unusually high at March 31, but several large receivables were collected right after quarter-end.

Inventory was $68.6 million at March 31, 2008, up from $53.2 million at year-end. Much of this increase was due to additional finished systems on hand.

Regarding our guidance for 2008, let me once again emphasize what we have stated many times before. Our financial results are heavily influenced by the readiness of customers to receive their Hi-Art system. The majority of the company’s revenue is recognized based on the customers’ acceptance of the Hi-Art system. Thus, quarter-to-quarter fluctuations in revenue are normal and should be expected. We continue to believe that the strength of the business should be measured by annual revenues and growth in backlog.

At present, we anticipate 2008 revenue of $255 million to $290 million and net income in the range of $0.14 to $0.33 per diluted share. As we explained in our pre-release conference call, the reduction from our original 2008 guidance was due to a slight delivery shift in the timing of customer installations. We now have more multi-unit owners in backlog and they are remaining there longer than our single unit orders have historically.

Consistent with our prior guidance, we currently expect 30 to 40% of our revenue to be generated in the first half of 2008. Based on analysis of our growing backlog and the anticipated timing of customers construction projects that must be completed prior to system delivery, we expect 60 to 70% of our revenue to be generated in the second half of the year, building somewhat incrementally each quarter. We are intently focused on the customers’ strategic priorities and we are taking the steps we believe to secure a very bright future for TomoTherapy.

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

Question-and-Answer Session

Operator

(Operator instructions). And your first question comes from the line of Thomas Gunderson with Piper Jaffray. Please proceed.

Thomas Gunderson

Hi, good afternoon.

Fred Robertson

Good afternoon.

Thomas Gunderson

Fred, maybe we can start with Europe, others that have reported in your area have also shown some weakness there. Do you have any color that you can add to what might be going on in Europe, do you think it’s a Q1 phenomenon or is there something else going on in Europe and if you can pull that into rest of world? I know you talked about un-penetrated markets, but as far as where you see your sales coming for rest of year, is Europe still a strong place to go or is Asia going to have to make up for it?

Fred Robertson

Yeah Tom, we have every reason to believe that we will be successful in Europe. We have a strong pipeline and I don’t want to break the statistics out by pull. However, we did have a very weak quarter in the Europe in Q1. Our new Managing Director just started a few weeks ago, so he is getting up to speed as well as the issues we think that again, we try to look at this business from an annual basis and we believe that Europe has significant opportunity, and we are going to continue to drive the execution of the organization to maximize our performance there. In December, we announced an additional six distributors as we continued to expand our global footprint, but I am not sure how much of this was market relative to own execution, but we are addressing our piece of it now.

Thomas Gunderson

And rest of world?

Fred Robertson

Again we’re -- each market is different and we think that ultimately our orders and ultimately revenues will mirror the global market opportunity, which today is somewhere in the 50 to 60% US, 40 to 50 rest of world.

Thomas Gunderson

Okay, thanks. And then Steve on the Linear Accelerator OEM that you've got in China now you told us on the pre-call that you would be able to talk a little more about maybe the timing of when that could be accretive to margins. Are you able to have some visibility on that now?

Steve Hathaway

A little bit more visibility from the standpoint, you know, we expect this product to start impacting the production towards the end of this year, and we believe based on the current cost for that system that it will have a positive impact on margins next year.

Thomas Gunderson

Okay, thanks. And then last question or two questions on CPAC. Did you say Shawn is there? Can Shawn talk?

Fred Robertson

Yes, Shawn will head the CPAC question, Tom.

Thomas Gunderson

Shawn, can you give us a little bit of a sense of the timeline here? You probably don’t want to give exact, but if you do go ahead, but otherwise give us a range of when we might be able to see the first one or two placed commercially?

Shawn Guse

Sure Tom, as best we can. Obviously, this is a long range product development project and we are still completing some very substantial pieces of R&D to carry it out. We are hopeful to have our first prototypes in our customers’ hand sometime in 2011 and to have the first commercial units out the following year. Obviously, we have a lot of work between now and then but those are targets at the moment.

Thomas Gunderson

Okay. And then Steve just to follow up, your guidance for earnings in ’08 includes the R&D on all of this for CPAC, right?

Steve Hathaway

Correct.

Thomas Gunderson

Okay. Thanks gentlemen.

Steve Hathaway

Sure.

Operator

Your next question comes from the line of Ben Andrew with William Blair. Please proceed.

Ben Andrew

Good afternoon. Just following up on Tom’s question on the CPAC side, can you be a little more precise relative to what you think the dollar spending will be in terms of total R&D, total SG&A and then what the minority interest stake will be and the add-back will be below the line?

Shawn Guse

What period of time are you looking at, Ben?

Ben Andrew

Start with ’08 because you have not guidance ’09, but just to understand that, I think would be very helpful and then if you can directionally talk about ’09?

Shawn Guse

We are looking at total expenditures both before and after the formation of the entity and its taking up investment of somewhere between 8 and $12 millions in 2008. TomoTherapy’s specific percentage of that is still being worked out because as the press release stated TomoTherapy’s contribution will be equal to the value of the intellectual property that we are contributing and that valuation is just being completed at the moment. So, it’s a just bit premature for us to say what that it is, but it will be a relatively small percentage of the total enterprise.

Ben Andrew

So it actually could be less than 20% but because of the control issue you have to consolidate, is that right?

Shawn Guse

That’s correct, around both accounts.

Ben Andrew

Okay, alright. And so then if we think about 8 to $12 million, was there absolutely nothing in there for Q1 other than 1.5 million direct, so would we see this expense likely starting in Q2 and is that the difference between the 8 and $12 as the exact timing?

Shawn Guse

That’s correct and also because we are now in the process of closing these phases of funding, we can also begin to do some true re-planning of the project schedule and determine whether or not we can accelerate some of the R&D by making such acquisitions of additional materials or talent to accelerate the project, but those are the decisions that will be made in the coming three to six months.

Ben Andrew

Okay.

Steve Hathaway

And Ben, I just want to make sure we are clear on that 8 to $12 million that Shawn referenced because that’s the total R&D expense that will appear in the R&D line and then with this back off of the minority interest below the line, we will come up with a lesser number after we get them with this valuation process.

Ben Andrew

Right. I mean, for now we just have to pick a number and just back out most of it, if you will?

Steve Hathaway

Yeah, I mean…

Fred Robertson

Without the valuation, it’s really hard to give you anything principal, Ben.

Ben Andrew

I understand. You don’t want to negotiate that on a open call, I assume.

Shawn Guse

Good point.

Ben Andrew

I guess turning to the core business then Steve and Fred, you mentioned pricing dynamics relative to Europe and that Q4 -- second half of ’07 to this quarter pricing in the US and rest of world was flattish, how does US compare year-on-year?

Steve Hathaway

As far as the pricing in revenue that we bring through on the revenue side, it’s pretty flat than where we were last year. It’s a different answer if you are looking at the incoming orders from the order perspective, it is down slightly maybe 2% or 3%.

Ben Andrew

Okay. So year-on-year realized pricing on new orders is down 2 or 3% in the US?

Steve Hathaway

Right.

Ben Andrew

Okay. And then, with the build in inventory that you experienced this quarter with the slower deliveries, have you changed kind of throughput or productivity within the plant today?

Steve Hathaway

Yes, actually that started occurring towards the end of the quarter that we scaled back a little bit on our production expectations for the year to make it more inline with what our current guidance is.

Ben Andrew

Was there any cuts in staffing or just kind of having people…?

Fred Robertson

Remember we, we’ll be delivering these units that are in backlog, the only question is timing. I think what Steve said we hired 40 some people in the first quarter, the bulk of these are oriented in the customer support, in revenue generating activities but we have not had any staffing cut backs.

Ben Andrew

Okay. I just wanted to make sure I understand the productivity there of that group. And then you gave some guidance still sticking with the 30 to 40% of revenues coming in the first half of the year. Can you say directionally if it’s heading towards the lower end or the higher end of that range at this point because for a month I know it's difficult and for longer term business, but I think a little bit more guidance in the short-term basis even if not explicit might be helpful for the group?

Fred Robertson

Unfortunately, we are not going to provide anymore guidance other than to say it’s going to be the 30 to 40%.

Ben Andrew

Okay, thank you.

Operator

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

Jeff Johnson

Thank you. Thanks for taking the question guys.

Fred Robertson

Sure.

Jeff Johnson

Couple of things here. Steve just clarifying question on the consolidation here of the Lawrence Livermore deal, the 8 to $12 million that you are talking about and then back out the consolidated part, that's not your part if you will. The 8 to $12 million back out, I think Shawn threw out a number there maybe 80% of that in the minority interest or whatever the number ends up being. That would suggest a run rate on an annual basis on a net basis for you, 2 to $3 million versus 1.5 million this quarter. So, is it conceivable on a net basis your investment here is going to go down as far as the impact on the bottom line?

Fred Robertson

Well again that is based on what is the valuation and that pulling on the valuation of the IT, so we have to wait for that to come in. As far as I just want to be clear though on the other statement; we did not make any comments about the 80% coming off. I think that was Ben talking about even if it could be under the 20% for consolidation purposes. But we really have to wait for that but, we expect it to be less than the 8 or the 8 to $12 million significantly. We just don’t know the level at this point in time.

Jeff Johnson

Okay. So, somewhere, yeah, that’s there. And then two other questions here for you. The six distributors in Europe that were put in place near the end of the year, I think the answer to this is no, but, were there any initial sales to those distributors that made a pull-forward some business into Q4 out of Q1 and we could normalize out of that as we get into Q2 or were there no [inaudible] sell-in to those distributors in the Q4?

Fred Robertson

I believe as we mentioned in the fourth quarter conference call, we did have some orders coming out of those distributors in the fourth quarter. I do not believe any of those having shipped at this point in time.

Jeff Johnson

Okay. But, again, no stocking sales or anything like that?

Fred Robertson

No, nothing like that, no.

Jeff Johnson

Material orders in hand?

Fred Robertson

Correct.

Jeff Johnson

Yeah, fair enough. And then last question just on the China base. When I -- just conceptually, as you read through the agreements that you guys filed a couple of weeks or week ago on that, sounds like a relatively early startup company I think the purchase price was somewhere in the 3 to $4 million range if you do that math on the conversion. How does that play into the uptime argument and what have you with your system, any concerns there putting that an upstart Lin Ac, maybe as we get into the end of this year or into 2009 from a quality standpoint?

Fred Robertson

We have had on this like we have had in our recent quality and reliability initiatives where we have done exhaustive, accelerated life testing, and this is a design that we haven’t done life testing and in fact the component life span is considerably longer than our current systems. So, we believe we are looking at improvement in uptime and reliability that will move the needle on our gross margins and also have an impact on customer uptime.

Jeff Johnson

Great, thanks guys.

Operator

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

Paul Choi

Great, thanks. Can you guys hear me?

Fred Hathaway

Yes, we can.

Paul Choi

Okay, great, thanks. Just, now that you guys had a couple more weeks here into the quarter, if you could maybe just provide some color and what you are seeing in terms of timings for orders potentially converting from initial engagement with the customer into something that you can book on to paper there. Are you guys seeing anything potentially being pushed out a quarter or two longer perhaps than you had previously expected given the fact that some hospitals and standalone tenders maybe experiencing a little bit of tighter financing?

Fred Robertson

Paul, we’ve said at our previous call that the multi-system orders we believe tend to remain in backlog longer than the single system orders just because they are installed sequentially and so that our view there hasn’t changed. As far as the credit markets and we haven’t seen any impact from tight credit markets on either current customers or on prospective customers. We don’t believe that our cycle time in terms of in order to cash process really is any different than we described a couple of weeks ago.

Paul Choi

Okay. I was actually just referring to new potential customers, not customers in the backlog at the moment, but thank you for that clarification. I guess next at this point now that we’ve seen Varian report approximately, I can say 60 Rapid Arc orders in the quarter. Can you perhaps give us your prospects on what do you think the biggest difference is between your order growth and the orders they booked in the quarter? Do you think the primary difference that accounted for that delta is it being able to show clinical difference generating data? Is it communicating your value proposition or is it sales reach do you think at this point?

Fred Robertson

That’s a whole bunch of questions. We’ve been competing against Rapid Arc in the marketplace for over a year. It sounds like the orders that the Varian took probably represent some accumulation of demand that without -- they didn’t divulge a lot of a detail as to the exact nature of that. I think when we look at objective evidences, our biggest growth in the first quarter was 23% in a market that was growing around 11%, so that’s again we grew out of proportion to market growth and our biggest growth was in the US market which is the most competitive market, so of US, we have continued to take market share and we feel pretty good about that.

Paul Choi

Okay. And then may be one shop-keeping question. Steve, I think the share count dropped about 4 million sequentially. Can you walk us through that in terms of what you did in the quarter?

Steve Hathaway

That’s just really a difference between basic share and fully diluted shares because of the loss, you can’t go to fully diluted shares, so the basic shares outstanding are about 50 million and prior quarters we had fully diluted shares at cost of 54 million.

Paul Choi

So should we think about in terms of the full year averaging around some perhaps somewhere around 52 million, is that a reasonable number?

Steve Hathaway

Yeah, it’s -- depending on the position for the year and our guidance is towards profitability, so we expect to use the fully diluted share number, which is closer to 54 million.

Paul Choi

Okay, thanks a lot. I will jump back in queue.

Operator

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

Amit Hazan

Thanks very much. Hi, good afternoon guys.

Fred Robertson

Hi Amit.

Amit Hazan

I thought I would start and push you a little bit on the US order number, I recognize what you are talking about with regard to the year-over-year strength but as we look at the last four quarters, I am actually not seeing much growth at all, and you can please correct if I am wrong. I am looking at about 16 units that you have ordered this quarter and when I look at the last four quarters since really the June quarter of '07 that’s the lowest order number in the US that I have got in my model and may be I am completely off and tell me if I am, but are you seeing any growth in actual unit orders in the US over the last four quarters?

Steve Hathaway

I think there must be an issue with your model or your numbers because we are seeing year over year growth. Now if you are looking at…

Amit Hazan

That's year over year, but I am referring to just the last four quarter so since September, December, March.

Steve Hathaway

Right. If you’re looking at sequential growth, you have to remember that we are talking about the first quarter versus the fourth quarter and we just like everyone else in this market selling a piece of capital equipment that the first quarter ends up being weakest quarter of your year, and that’s historically being the case for us, that’s historically the case with our competitors as well. Our customers realize that when the fourth quarter of the year occurs and they really pushes for fourth quarter, always thinking they can get better deal. So everyone has a very high order rate in the fourth quarter and then it tends to fall down in the first quarter and we are no different than everyone else in that perspective. But, if you are going year over year, we are showing growth from the first quarter of last year to the first quarter this year.

Amit Hazan

Let me try to rephrase. In March quarter whatever units you have and I recognized you don’t -- probably don’t want to divulge the exact number. Were the unit orders in the March quarter higher than they were in either the December, the September or the June quarter of 2007?

Steve Hathaway

I don’t have the unit numbers in front of me and like I said it’s you need to look at quarter-over-quarter and we are no different than everyone else in spite as the first quarter being our weakest quarter from all other perspective. Yet, we grew 23% and yet we doubled our orders in the US, so we are feeling pretty great about that.

Amit Hazan

Okay, and maybe I’ll get with you offline on that one. And then just another question on the guidance, I want to first of all get a little bit of clarity in terms of the multiple unit that you have in backlog whether you had realized, how long did those take from order to installation?

Fred Robertson

As we said those units tend to install sequentially and depend on how many there are. I would say each of that customers is somewhat different, but on average, we believe that they will stay in backlog longer than our traditional base of single unit orders.

Amit Hazan

Okay. And that’s something that you learned because of what you saw this quarter? I am just trying to understand because you have ’08 guidance that goes all the way to the end of December. So, we’ve got some time here which means that these are units that would have maybe placed in the December quarter or this year that you are thinking now going to ’09, is that the right way to think about it?

Fred Robertson

We had a strong quarter in Q4 of ’07. As you look at Q1 of ’08, certainly some of the units that we booked will come into the front part of 2009. I think in the past we have stated that we -- our average time in backlog was somewhere in the 9 to 12 months with bulk of our revenue being realized within a year of difference probably, and so given that now close to a third of our backlog is in multi system orders, probably the average time in backlog has slightly extended. It's hard for me to give you a concrete answer as to because it does vary by customer.

Steve Hathaway

And just to follow up on what Fred said, it’s not the single unit orders that are extending, its these multi unit orders that are extending. And one year ago we had essentially none of these orders in our backlog and it’s just been over the last year that we’ve started to having progress with these multi unit centers and now with a greater portion of our backlog. And as we are seeing that, they tend to be sequential. And if they order four units, they don’t want four units in six to nine months, they want four units over a period of time which is beyond what a single unit order person would want.

Amit Hazan

Okay. And I guess that lead us into the backlog. I actually have a question on that too. One of your competitors talked about backlog and they do it differently than you, but they talk about thinking that 10% of backlog might drop off. I’m sorry if you mentioned it on the last call, maybe I missed it. But, how do we think about your backlog, how much confidence do you have in that 260 million becoming revenues in the future and how much should shareholders believe will become revenues? Is it a 100% that we should or are you thinking that some will be subject to revision, how do we think about that number?

Steve Hathaway

We are feeling very confident about our current backlog, but you never know. If you look at all of our competitors, there is some level of order cancellations by everyone in this capital equivalent market and I have heard people talk about a 3 to 4% cancellation rate. This is the first quarter that we never had to reverse anything out of backlog, reversals for units. So, it’s first time we had to do it. Will we have to do it again in the future? Maybe, but right we are just looking at the current status and where we are based on our analysis of our backlog. We expect at this point in time that all the units in our current backlog will turn into revenue.

Amit Hazan

Okay. And just one final on for me. You talked about controls over discretionary spending, I am wondering if you can give us some specifics there as to what’s your planning on doing and the extent of the savings there?

Fred Robertson

I mean, we are doing I guess all the normal things that a company would do when they are looking at expenses and that means we are looking at hiring very closely over the last few years. We’ve added a lot of people, so we are looking at what do we do from a hiring standpoint, let’s make sure we are just hiring the key positions we need. We are looking at travel and going through and trying to analyze travel more. I mean, we are going through all the major expense categories and from a discretionary standpoint asking ourselves do we really need to incur those expenses and can we eliminate or defer some of those expenses with an eye towards what are those expenses that will help us most as we think about continuing to grow this business.

Amit Hazan

Okay, fair enough. Thanks very much

Operator

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

Philip Legendy

Hi, guys.

Fred Robertson

Hi, Phil.

Philip Legendy

I wanted to see now that the dust has settled, would you talk a little bit about how and I'd like to focus just on the first quarter. How did the first quarter's results compared to what you had been projecting internally?

Fred Robertson

Internally?

Philip Legendy

Right. Because the street had seems, I know that you've said on the last call you felt the street had gone a bit ahead of your expectations, so just help us understand what were your expectations?

Steve Hathaway

Your statement is absolutely correct that the street was ahead of our internal expectations, we put the 30 to 40% of revenue to come in the first half and our internal expectations were for a lower amount of revenue in the first quarter than what the street had.

Philip Legendy

Okay. And then again I wanted to push you a bit on to see if I could on the multi Lin Ac customers. Did the multi Lin Ac purchasing issue have a significant impact on the first quarter or just on the full year guidance?

Steve Hathaway

It had no impact on the first quarter.

Philip Legendy

Okay. And then how have you -- is there something different about those customers about the way that you monitor those customers from the normal customers or from single unit purchasing customers because I know you monitor construction very closely, so maybe you just help us understand how did they slip under the radar?

Fred Robertson

I think they are different and our project managers and site people will have better visibility into the earlier units in the sequence than the latter units in the sequence. So as we try to understand what production installation and ultimately revenue slot that’s going to be, we have a little less clarity on the tail-end of those larger orders and that’s for us given it’s a pretty significant shift in our backlog, we are developing new processes to manage that. I expect that we will continue to get better at that but again in the last 12 months it’s been a pretty significant shift in the backlog. In many respects that's a positive. We are now competing in a rapidly growing market segment. Our technology has been embraced; this is not only of the highest quality but a very versatile technology that is capable of treating the broad spectrum of patients. So, it’s a great segment to compete in and we just have to tune our internal processes to ensure that we don’t -- that we meet our own expectations and that we can deliver on other guidance.

Philip Legendy

And are there specific changes that you’ve made now to try it out -- have you made a change in process about how you monitor those customers?

Fred Robertson

Yes, we’ve continued to tune that process, but we are working hard on that.

Philip Legendy

Okay. And then just a quick financial one and that’s my last question. SG&A was down pretty substantially in dollars sequentially. Was that due entirely just to lower selling commissions or was there anything else going on there?

Steve Hathaway

From an SG&A standpoint, it’s probably a few things when you look at the first quarter versus the fourth quarter. You are absolutely right. The commissions' impact from the standpoint of less customer activity in orders and acceptances, which is where our commissions are paid, you had impact of major trade shows in the third and fourth quarter, which also reflects those expenses and then we had additional bonus provision in the fourth quarter because we had such a great year last year that we had to put more money in the bonus expense. So those pieces impacted our expenses when you compare the fourth quarter to the first quarter.

Philip Legendy

So, is the first quarter kind of a more reasonable run rate to expect for the year than the fourth quarter of last year?

Steve Hathaway

I would -- without providing detail guidance, I would expect the SG&A to increase from here as we have more success with sales and expenses and our commissions go up and that sort of thing and as we add a few more people and that sort of things, so there will be growing level of expense over the year.

Philip Legendy

Okay, thanks very much.

Operator

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

Brooks West

Hi, guys. Couple of backlog or R&D pipeline questions. Topotherapy and motion management haven’t talked about recently. Can you give us an update on where those projects are?

Fred Robertson

Yeah, both of those are important projects in TomoTherapy internally as we look at continuing to enhance our throughput especially for simple cases. I think as you come and join us at the major trade show through the year, we will give a glimpse as to the sequence of these things, both from a continuing to repeat through innovation and having the most robust technology as well as including the throughput without sacrificing quality, those are the two major initiatives that you will see coming at in the 2008 customer communication.

Brooks West

Okay. And let me drill down a little bit more. Varian talks in its marketing materials and on its calls about and I will use the prostate case, which seems to be the standard case, delivering comparable clinical results to a Hi-Art procedure, but doing that in two minutes versus their purported 15 to 20 minutes for TomoTherapy. And I am sure you would like to clarify the time on that, but can you talk about the impact you are seeing from, you got the 3.1 software or the [3 meg] couch and then these new projects, the magnitude of throughput improvement that you might be able to see for Hi-Art?

Fred Robertson

Well, back to the beginning part of your question. There doesn’t seem to be any clinical data from our competitors’ product. So I think that's an important distinction. The second is that your estimate of treatment time for TomoTherapy prostate is grossly inaccurate, which is another misconception that’s been perpetuated in the marketing literature.

Brooks West

Well, I’m trying to use their numbers knowing that your numbers are lower than them?

Fred Robertson

We eagerly await objective published clinical data.

Brooks West

Okay. So, I mean, when I’ve heard you guys talk, you are in the range of maybe a 5 minute treatment for a prostate, when I hear you guys at the podium versus a 2 minute and obviously the treatment couch, I guess I’m just trying to draw out how much more improvement is there in the treatments that might away this throughput concern?

Steve Hathaway

I think you are confusing throughput with claims for beam-on time.

Brooks West

Okay.

Steve Hathaway

They are very different things. We are looking at the length of time to do the integrated process. TomoTherapy is capable of treating prostate cancer in a couple of minutes of beam-on time and that’s the users can select the multi modulation they want to use and they can select the quality. And most of our customers choose to give high quality treatments and they are willing to spend an extra minute or so to do that. I think the crux of your questions relates to are the clinicians confused because certainly the financial community is confused. We are not aware of a single customer in our near-term program who has chosen Rapid-Arc or Hi-Art system and we think that we have published data that this will become ultimately more clear overtime.

Brooks West

Great, thank you. And can you comment on -- we are looking at first shipments of Rapid-Arc at the end of the month, what kind of a timeframe could you expect to see some initial head to head studies come out?

Fred Robertson

I think you have to ask Varian about that. It’s dependent on when they ship their product because they haven’t seen any data.

Brooks West

Okay. And then on the four profit centers obviously that’s become a greater portion of your business, can you comment how much of a -- let me ask you in a different way. What percentage of the global market do you think that the four profit centers are and I guess it's more of a US phenomenon than a non-US? And what kind of opportunity do you -- you have a dollar amount in terms of the four profit opportunity that you see?

Fred Robertson

It’s difficult to pin down a dollar amount, this is an entrepreneurial segment that is -- we see more prominently in the United States. I think it’s because there is recognition among the entrepreneurs that radiation oncology has been really largely insulated from the Deficit Reduction Act reimbursement chambers and it's still very attractive space. So, we see this as an attractive growth segment in the US market. The hospital base market is more of a replacement market.

Brooks West

Okay. I think that will be it. Thank you very much.

Operator

And your next question comes from the line of Peter Bye with Jefferies & Company. Please proceed.

Peter Bye

Hi, good evening. This is actually [Josh Harrington] for Peter. My first question is with the sluggishness that you noted in Europe and the hiring of a new Managing Director, can you comment on any some specific strategic initiatives you implement to jump start those two, that region and then anything strategic that you’ll do to execute in the Middle East?

Steve Hathaway

I think one of the keys for us for growing Europe is to have more kind of regional European management. We’ve been recruiting for -- looking for the right level of talents and we’ve been looking for several quarters. We are pleased that Jeff has joined us. I think he brings all the right process and the commercial skills to really take advantage of what we see as a significant opportunity.

Peter Bye

Okay, great. And not only been a month in the quarter, but I mean can you comment on whether you’re seeing trends in the sluggishness in Europe reversing it off?

Steve Hathaway

I think it’s premature to make a comment on that.

Peter Bye

Okay. And just a follow-up in terms of your internal estimates for the quarter, the new order number of 55 million, I mean, would that be internal projections or your internal goals?

Steve Hathaway

We are staying away from giving guidance on a quarterly basis.

Peter Bye

No, I mean the 55 million that was done in the first quarter that you reported of new orders?

Fred Robertson

The question was whether that was…

Peter Bye

Whether that met or exceeded your internal goals through the quarter for new orders?

Fred Robertson

Again, we are not releasing that information.

Peter Bye

Okay, alright. Thanks for taking the questions.

Fred Robertson

Sure.

Operator

And your final question comes from the line of Junaid Husain with Soleil Securities. Please proceed.

Junaid Husain

Good afternoon gentlemen.

Fred Robertson

Good afternoon.

Junaid Husain

In terms of key metrics that you’ve talked about in the past, I think you’ve previously said that within the next, call it three years, you are looking for a service revenue mix of about 12%, gross margins of about 40%, and operating margins of about 15%. Just given your current situation, do you think that these are still reasonable expectations over the next three years?

Steve Hathaway

There is three different questions in there and as far as the 12% service revenue, I think that we are right on track with that, actually we were higher than that in the first quarter because that was impacted by the lower system sales. As far as the 40% gross margins, that is still our goal for the end of 2009 and while we’ve had some push off of orders from 2008; those orders are going into 2009. So we feel very good about our early backlog for 2009. And if we can just fill the orders on top of that to continue the backlog growth to achieve a 40% gross margin number in 2009 is still very strong likelihood.

As far as the 15% operating margin that is going to be impacted by the accounting for CPAC. And with CPAC coming into the -- being consolidated in R&D that it's going to have a direct impact on operating margins and we will not show 15% operating margins and we’ll have to make some sort of adjustments for CPAC and try to get a good understanding and good apples and apples comparison for that.

Junaid Husain

Got you. And then regarding your net order growth in the quarter, could you remind me, I think that net order growth was about 23%. Does that include the impact of currency or was that an FX neutral number?

Steve Hathaway

That includes the impact to currency.

Junaid Husain

Okay, that’s helpful. And then relative to the service plans you currently have for the Hi-Art systems, can you remind me what’s the average selling price for say an annual services contract?

Steve Hathaway

On average for a service contract, it’s somewhere around 210,000 to $250,000 range.

Junaid Husain

And does that cover spare parts, service support, software/hardware upgrades?

Steve Hathaway

That is all parts and service, has no software upgrades in it.

Junaid Husain

Okay. And then can you tell me have you reached profitability on your service plan?

Fred Robertson

No, we have not.

Junaid Husain

Okay. And then what portion of your installed base has purchased a service plans, does everyone or…?

Fred Robertson

Everyone.

Junaid Husain

Okay. And then a question on reimbursement relative to the robotic radiosurgery reimbursement codes G0439 and G0440, when you look at the Hi-Art system, conceivably it could be viewed as a robotic device, like a CyberKnife System. Do you get the sense when you talk to your hospital customers that perhaps some hospital administrators are submitting claims for Hi-Art procedures using the robotic radiosurgery codes?

Fred Robertson

We do know that in a customer survey that we did about a year ago something like two-thirds of our installed base were using TomoTherapy as an appropriate tool for stereotactic radiotherapy and stereotactic radiosurgery both intracranial and extracranial.

Junaid Husain

And, when they make the submissions, when they submit the claim, are they submitting the claim under the robotic radiosurgery codes, do you have that in for me?

Steve Hathaway

No, I don’t have a factual answer for you but, there is -- those codes were not vendor specific.

Junaid Husain

Thanks. Have you talked to your customers about using the robotic radiosurgery codes or is that something that they need to discuss internally amongst themselves in terms of whether they are comfortable getting the claims using those codes?

Steve Hathaway

We don’t really provide billing services for our customers.

Junaid Husain

Okay. And then last question with regards to the Hi-Art treatment system Version 3.1, could you tell me what percentage of the installed base has received the software upgrade?

Fred Robertson

That’s being rolled out to our installed base as a field action. Currently I don’t know what -- I don’t know what percentage of installed base is being upgraded yet. It’s been very successful in out pilot sites some months ago that’s where the data came from -- for the treatment enhancements. So, that have to be entire installed base.

Junaid Husain

Do you expect all of your customers to move to the software?

Fred Robertson

Is that a when or is that do we…?

Junaid Husain

No, I’m asking you would expect all of your customers to move to the software, they would all take the upgrade?

Fred Robertson

I would assume they would all be very interested in getting the 3.1 software, it’s a benefit from a throughput perspective. The base software is offered to all customers.

Junaid Husain

But it’s not part of the service contract, so presumably you might have to purchase the upgrade then?

Steve Hathaway

There is additional functionality which a customer can purchase. The base level of the software will go out to our whole install base.

Junaid Husain

Got you. Fair enough. That’s all I have got. Thanks.

Fred Robertson

All right.

Operator

There are no additional questions at this time. I would like to turn the presentation over for closing remarks to Dr. Fred Robertson, CEO. Please proceed.

Fred Robertson

Thanks operator. In closing, I would like to say that we firmly believe that TomoTherapy’s technology offers a distinct competitive advantage that meets the radiotherapy needs of clinicians and their patients. We are expanding our domestic and international sales footprint and making key infrastructure and system investments for sustained growth allowing us to help more cancer patients throughout the world.

Thank you for joining us today, and we look forward to updating you on our second quarter results in July.

Operator

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

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