Varian Medical Systems, Inc. (VAR) CEO Dow Wilson on Q2 2020 Results - Earnings Call Transcript

Varian Medical Systems, Inc. (NYSE:VAR) Q2 2020 Earnings Conference Call May 4, 2020 4:30 PM ET

Company Participants

Anshul Maheshwari - Vice President, Treasury and Investor Relations

Dow Wilson - President and Chief Executive Officer

Michael Bruff - Chief Financial Officer

Chris Toth - President, Oncology Systems

Conference Call Participants

Amit Hazan - Goldman Sachs

Matthew Taylor - UBS Securities LLC

Marie Thibault - BTIG Research

Anthony Petrone - Jefferies

Jason Bednar - Piper Sandler

Jeffrey Johnson - Robert W. Baird & Co.

Vijay Kumar - Evercore ISI

Tycho Peterson – JPMorgan

Operator

Good day, ladies and gentlemen, and welcome to Varian’s Fiscal Second Quarter 2020 Earnings Call. As a reminder, this conference call is being recorded, and a replay can be accessed on the Varian Investor website at www.varian.com/investors.

Now, I will turn it over to Anshul Maheshwari, Vice President of Investor Relations and Treasurer. Thank you. You may begin.

Anshul Maheshwari

Thank you, operator. Good afternoon, everyone, and welcome to Varian’s fiscal second quarter 2020 earnings call. Joining me today on the call are Varian’s President and Chief Executive Officer, Dow Wilson; Chief Financial Officer, Mike Bruff; and President of Oncology Systems, Chris Toth.

Today, we will be – we will cover our second quarter performance and discuss the impact of COVID-19 on our business.

On the Varian Investor Relations website, you can find our fiscal second quarter 2020 press release and earnings presentation, which are intended to provide additional perspective and details. A webcast of this call and any accompanying non-GAAP reconciliations are available on our website at www.varian.com/investorrs.

Unless otherwise stated, all financial results discussed are non-GAAP, all reference to EPS are to net earnings per diluted shares, all growth rates are year-over-year, and any references to orders are gross orders. All reference to organic growth exclude the impact of FX and growth from the acquisition of Cancer Treatment Services International, or CTSI, and Interventional Solutions business. All periods referred to are fiscal periods unless otherwise stated.

During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events, including our comments regarding the impact of COVID-19. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in today’s earnings release, this conference call and our SEC filing. We do not undertake any obligation to update any forward-looking statement.

And with that, I’m pleased to turn the call over to Dow for his comment.

Dow Wilson

Thanks, Anshul, and good day, everyone. Before we get into the details for the quarter, I want to express our gratitude to everyone on the front lines, fighting this global pandemic and hope everyone is staying safe and feeling well from our 10,000-plus employees all over the world, we say thank you.

Furthermore, I want to thank our valuable employees, customers, suppliers and distributors for their hard work, support and partnership during this extraordinary period. Your efforts have ensured that cancer patients globally continue to receive vital treatment.

Our fiscal second quarter performance reflects the escalation of COVID-19 and our global response. On this call, we will share our experience in the quarter, our framework for engaging those who rely on us and our priorities and actions in these challenging times.

The pandemic has created some unique operational challenges around delivery of our products and solutions, as well as open new opportunities. The impact in the quarter, which was driven by timing delays around installation and acceptance of our products, has varied by region based on the stage of containment and government actions.

China and South Korea seem to be ahead of other countries in controlling the pandemic and progressing towards normalcy. Conversely, the rest of APAC, Americas and EMEA geographies continue to take actions to stem the outbreak. While we’re cautiously encouraged by the recovery in China, we remain sensitive to future uncertainties, including continued spread or recurrence of the pandemic, which could slow progress towards recovery.

Our focus now, as it’s always been, is keeping our employees safe, supporting our customers and their patients, ensuring supply chain stability, and maintaining business continuity. Our employees are crucial to our mission. And as we saw this outbreak shift into a pandemic, we took several actions to ensure their safety and well-being.

We instituted work-from-home policies and workplace safety measures and protocols. To support our workforce, we implemented additional employee benefits and March that will continue as needed to fiscal 2020. We also implemented new programs aimed at educating our employees on how to operate in this new virtual physical distancing environment.

We recognize the challenge for healthcare resources to manage COVID-19 and non-COVID-19-related care. Since radiation oncology is not considered an elective procedure, our teams are taking actions on a customer-by-customer basis to ensure they can deliver therapy to patients.

Furthermore, during this pandemic, we have seen in some clinics across the globe, a shift from surgical intervention to radiation oncology further underscoring its importance. We’re actively deploying remote tools across our training, installation and field service teams to ensure continued access to our products and solutions.

We have secured and stabilized our global supply chain, with ongoing efforts in place to continue to monitor and mitigate any new risks that emerge. After being closed for a limited period in the quarter, our essential manufacturing facilities in Beijing and Palo Alto are now fully operational. We continue to ship our products and honor customer commitments during the factory shutdown.

Finally, we’re taking steps to bolster our already strong financial position. In view of the possible continued impact of COVID-19, we’re taking prudent actions to manage costs, while continuing to make planned investments that will allow us to execute our growth plan. Mike will discuss these later.

I believe our long-term fundamentals remain strong, and our business is well-positioned financially and organizationally to weather this environment, as well as extend our global leadership in oncology.

With that, Mike will discuss our financial performance and liquidity in more details.

Michael Bruff

Thanks, Dow, and hello, everyone. Total company revenues were $794 million, up 2% in dollars and 3% in constant currency. Organic revenues declined 1%.

Looking at Oncology Systems, orders were $773 million, up 1% in dollars and 2% in constant currency, and over the trailing 12 months, 5% in dollars and 6% in constant currency. We ended the quarter with a robust backlog of $3 billion, up 3%. To date, we have not seen any COVID-19-related order cancellations.

Revenues were $761 million, up 2% in dollars and 3% in constant currency, driven by strong growth in software and services. On a trailing 12-month basis, revenues grew 10% in dollars and 11% in constant currency. So let me share some insights into the timing of the impact of COVID-19 in the second quarter.

In the first two months, revenues were up approximately 8% year-over-year. As COVID-19 spread globally, our March revenues declined 4% year-over-year, driven by the Americas and EMEA geographies, which combined, declined 7%, partially offset by improved performance in China and South Korea.

Moving into hardware, software and services. Hardware revenues were down 7%. Our worldwide net installed base of 8,634 units grew 342 units, or 4%. This continued growth in our installed base drives future recurring revenues from upgrades, software and services.

Software revenues grew 6%, driven by continued adoption of our software solutions. We remain focused on investing in innovation around efficient clinical workflow, systems integration and treatment planning. Services revenue grew 11% and net of acquisition services revenue grew 4%.

Let me provide some insights by geography. In the Americas, revenues grew 4% and was up 4% in our North America region. Orders were $355 million, down 3%. On a trailing 12-month basis, orders grew 4%.

In EMEA, revenues declined 2%. Orders were $259 million, up 11%. On a trailing 12-month basis, orders grew 9%. In APAC, revenues grew 4%. Orders were $159 million, down 5%, and on a trailing 12-month basis, orders declined 2%.

The Proton Solutions business posted revenues of $22 million, a decline of 32%, primarily driven by a slower order run rate in prior years, partially offset by continued growth in services revenues, which was up 61%. In the quarter, we were awarded two Proton orders in our APAC geography.

Total company gross margins were $339 million, up 6% and 42.7% of revenues, an increase of 150 basis points, driven by our portfolio mix and the benefits from tariff exclusions and acquisition, partially offset by factory costs. Investing in R&D to drive innovation remains core to our growth strategy. In the quarter, we invested $71 million in R&D, up 19%, which is 8.9% of revenues.

SG&A expenses were $166 million, up 16%, which is 20.8% of revenues. Excluding the acquisitions of CTSI, Endocare, Alicon and the Boston Scientific bead portfolio, SG&A was up 5%.

In March, we began to take cost mitigation actions in response to the impact of COVID-19. While we did realize some benefit in the second quarter from slower hiring and travel, we expect the benefit will be more significant in the back-half of the year.

Company operating earnings were $103 million, down 14%, which is 12.9% of revenues, down 230 basis points. The lower operating earnings were a direct result of COVID-19 impact on revenues.

GAAP EPS was $0.47 and non-GAAP EPS was $0.85. This quarter, our GAAP operating earnings and GAAP EPS included a $41 million impairment of our loan receivables from California Proton Therapy Center, due to their operational and market challenges. It also includes a benefit of $9 million from the reversal of acquisition-related earnouts.

Our tax rate was 23% and diluted share count was 91.4 million shares. Cash flows from operations were $22 million, up $35 million, driven by working capital usage and timing of certain tax payments in both years.

Oncology DSO was 110 days flat from last year. As part of our regular review of counterparty credit, to date, we have not seen any material decline in customer credit quality or payment terms due to COVID-19.

Let’s turn to the balance sheet and liquidity. We ended the quarter in a strong position with $1.3 billion in available liquidity, including $668 million in cash and equivalents and $661 million available under our $1.2 billion revolving credit facility that matures in 2024.

Our debt balance at the end of the quarter was $521 million and our net leverage ratio, as defined under our credit agreement, was 0.2 times trailing 12 months earnings before interest, tax, depreciation and amortization, or EBITDA.

Our capital allocation priorities remain unchanged. While we plan to continue investing in our growth initiatives, we are taking proactive precautionary actions to enhance our financial flexibility. For example, we have paused share buybacks to preserve liquidity.

Additionally, in the back-half of the fiscal year, we will be focused on reducing costs. But with the discipline necessary to ensure we continue to prioritize key R&D and productivity programs to support our long-term growth goals. We believe our current liquidity position, combined with the precautionary actions being taken, leave us well positioned to navigate through this economic environment and continue to advance our long-term strategy.

I will now turn it back over to Dow.

Dow Wilson

Thanks, Mike. I’d like to quickly touch on our progress across our strategic enablers this quarter. First, let’s review our progress on innovating in radiation therapy. We continue to expand our market leadership and expand our addressable market with our innovation, comprehensive portfolio and services offerings.

In our Oncology business, we’ve gained market share over the trailing 12 months on both in orders and revenues basis. In February, during the peak of the pandemic in China, we received approval for Halcyon 2.0. The approval reaffirms the government’s commitment to provide patients access to high-quality radiation therapy technology.

The system incorporates imaging technologies such as kilovoltage cone-beam CT and iterative reconstructive cone-beam CT for better soft tissue definition. As order activity in China resumed in March, we received three new system orders and five system upgrade orders for Halcyon 2.0 and we have a strong second-half funnel.

We signed an agreement with National Health Service Trust for 15 TrueBeam machines and five Halcyon systems to equip centers across England. We closed the ProBeam 360 system purchase contract in the APAC geography. This was our second award in the quarter in APAC, as highlighted in our first quarter earnings call in January, we were selected by China Medical University Hospital in Taiwan to install a ProBeam 360 system in a single-room configuration with the ability to add a second gantry later.

University of Alabama at Birmingham Proton Therapy Center treated its first patient on our ProBeam compact system. We currently have 78 Proton rooms under contract, including 39 rooms that are operational across 26 sites globally.

Second, let’s turn to our progress in leveraging artificial intelligence, machine learning and cloud solutions. In February, we received FDA 510 clearance for our Ethos Therapy Solution in the U.S. Customer engagement remains strong and there continues to be excitement around the technology.

In the quarter, we received 15 Ethos orders, including 11 in the Americas, three in EMEA, and one in APAC. We now have five centers treating clinically with Ethos. Treatments at our first clinical site in Herlev Hospital, Denmark, continue to progress Well. The center has already delivered 100 adaptive fractions for bladder cancer patients and they’re seeing impressive treatment margin reduction of up to 50%.

In March, Medisch Spectrum 20 Hospital in the Netherlands, treated their first two patients for prostate cancer. And in Australia, both Icon Group Center and Royal North Shore Hospital, treated their first patients for prostate cancer and head and neck cancer.

Building on our leadership position in hypofractionation and radiosurgery. Demand for HyperArc, our high-definition radiotherapy solution for stereotactic radiosurgery, has continued to grow. 33% of our TrueBeam installed base now has HyperArc capability and we’re receiving exceptional feedback from the clinical community.

Third, let’s discuss emerging businesses, geographies and technologies. We received an order for 12 TrueBeam machines, 22 Halcyon systems and one VitalBeam from Pharmstandard in Russia. Pharmstandard currently operates Diagnostic Imaging Centers across the country and it extends – and is expanding into cancer care. We’re excited for this first phase of what is a multiple-year plan for expansion into cancer treatment.

CTSI was recently awarded a $15 million five-year contract with Memorial Hermann Health System to provide on-site and remote physics and dosimetry services. Memorial Hermann is the largest not-for-profit health system in Southeast Texas and consists of 17 hospitals, eight cancer centers and three Heart and Vascular Institute.

Since the acquisition of CTSI in May of 2019, the annual run rate for treatment plans has doubled to greater than 16,000 per year. Our pipeline in the United States and globally is strong and continues to expand.

While we had some challenges in the quarter, given the current operating environment and logistical barriers created by the pandemic, I’m very pleased with the team’s execution during the quarter.

Now, moving to guidance. Since our March 9 press release, the severity of the pandemic has expanded globally and has resulted in a dramatic shift in the macroeconomic environment. While our long-term fundamentals remain strong, the uncertainty around the severity and duration of COVID-19 has impacted our ability to reliably quantify the impact of the pandemic for the balance of our fiscal year. As a result, we will be withdrawing guidance for our fiscal 2020.

In lieu of that, I would like Chris Toth, President of our Oncology Systems business, to share with you the trends that we are seeing in the market. Chris?

Chris Toth

Thank you, Dow, and hello, everyone. These are indeed unprecedented times, and the uncertainty from COVID-19 will have an impact for sometime on the healthcare market in capital equipment purchases.

As Mike mentioned, our second quarter performance was ahead of last year until March when we started to see the impact of COVID-19 in the Americas and EMEA. Based on our current visibility, we believe orders and revenues will be stressed in the second-half of our fiscal year due to lockdowns restricting access to sites and delaying bulk construction.

We believe this will have higher impact in our fiscal third quarter, followed by a sequential improvement in our fiscal fourth quarter, assuming no second wave of infections or lockdowns. Let me share the overarching trends we see and how we are positioned as the market leader in radiation oncology and across oncology with an expanding Cancer Care Portfolio.

Let’s start with the market. While delays in elective procedures, such as mammograms, prostate cancer screenings, and radiological exams have slowed new cancer patient treatment starts, treatment itself is not considered an elective procedure. As such, it can only be delayed for a short period of time without significant negative consequences to the patient.

To this end, the criticality of radiation therapy for cancer treatment in the United States has increased since the pandemic again, and this was illustrated in the April 2020 field report published by the Advisory Group. Of the respondents in the study, 60% saw a marginal increase or no change in radiation oncology patient volumes, compared to surgery, where only 10% saw a marginal increase or no change in patient volumes.

As the pandemic stabilizes and cancer screening procedures resume in the U.S. and other markets, we expect to see a catch-up period during which new average daily volumes of radiation therapy treatments will increase significantly in the short-term.

Moving to customers. Based on our interactions with customers, access to the latest radiation oncology solutions remains a priority, and Varian continues to have the best portfolio of solutions in the market.

Orders trends from late March have continued through April, and we expect budget limitations, foreign currency headwinds, lockdowns and uncertainty around the pandemic to drive delays in orders. I will walk you through some of what we are seeing in each geography.

In the Americas during late March, we saw a delay in new orders of approximately $40 million due to COVID-19. North America had the largest portion of these order delays. While order activity resumed in April, it is too early to estimate when it will return to pre-pandemic levels.

We are currently monitoring closely the removal of lockdown restrictions as a critical first step, along with capital budget allocations of hospitals. We believe the recovery in Latin America will follow that of North America.

In EMEA, where we’ve had strong orders growth over the last 12 quarters, customer behavior has varied by country and by the severity of the pandemic. For example, in Germany, activity remains strong. However, in Spain and Italy, we believe that the impact from COVID-19 will affect tenders and new equipment orders.

In India, while demand for our equipment and expansion of cancer care remains strong, the extension of the lockdown has momentarily impacted activity substantially over the past 30 days.

Within Asia Pacific, China’s new tender issuances have resumed close to pre-pandemic levels, indicating stabilization. Further in China, where average daily treatment volumes were most affected globally due to radiation oncology being an inpatient procedure, we are seeing on remotely monitored systems, average treatment volumes return to pre-pandemic levels.

China recovery is being tracked closely and we are cautiously optimistic that it is sustainable. In Japan, post the state of emergency, we have seen some new tender slow, while many active tenders and customer conversations continue towards order placement.

Turning to backlog conversion. With some geographic variation, customer site readiness and access remains challenging. These logistical challenges will be a moderate headwind and will impact timing of certain installations in the second-half of fiscal 2020.

Our teams around the globe have navigated exceedingly well to continue installations and trainings where possible, including leveraging remote technologies. For example, in China, of the 12 accelerator installs delayed in our second fiscal quarter, six were completed in April. This experience leads us to believe that as the pandemic is contained, these challenges will dissipate.

We believe services are reasonably insulated from COVID-19, driven by our large installed base and long-term service contracts, as well as the criticality of radiation oncology treatments. Our service engineers globally continue to access sites to provide critical service to our customers.

Our team’s great customer focus is evidenced by an increase in our Net Promoter Score in all major markets. CTSI technology-enabled services have also positioned us well during this time, through our ability to support treatment planning, quality assurance and other services remotely.

In Proton Solutions, due to the high upfront capital outlay, purchase decision delays will likely be more pronounced. We will continue to execute on projects in our backlog and expect services to be stable and grow over time.

Finally, in Interventional Solutions, decreased access to hospitals has impacted treatment volumes. In many cases, ablation procedures for early-stage cancer patients have been deferred, while advanced stage cancer patients have continued with their local regional treatments, including embolization. We believe these trends will drive near-term pressure across our interventional portfolio. We are encouraged by the resumption of procedure in the Americas and EMEA geographies.

In summary, there are near-term headwinds that will impact this. However, as the market in innovation leader in a market, which will see total new cancer patients increase from an estimated 18 million in 2020 to 25 million in 2030, we believe we are well-positioned for long-term growth in patient care impact.

With that, let’s go to Q&A. Operator?

Question-and-Answer Session

Operator

Thank you. At this time, we’ll conduct our question-and-answer session. [Operator Instructions] Our first question comes from Matt Taylor with UBS. Please state your question. I’m sorry, the first question comes from Amit Hazan with Goldman Sachs. Please state your question.

Amit Hazan

Oh, thanks. Hey, good afternoon.

Dow Wilson

Hi, Amit.

Amit Hazan

Let me start – hey, how are you? Let me start with the comments that you made about the impact in the second-half of March and into April, just to maybe get some clarification there. We’ll start with the $30 million impact. If you can give some qualitative comments on what type of customer was actually canceling and why they were canceling? And then, conversely, what you were seeing from customers that kept installed plans that differentiated them from those that canceled?

Dow Wilson

Yes. Just to be clear, we’re not talking about cancellations. These are $30 million of push-outs in the quarter. So they were sites in Americas and EMEA, where we were not able to get into the site because of COVID-19 restrictions to complete the installation. So that’s what we’re talking about. We had about $30 million of that in the quarter.

When we gave you the main update for guidance, we had seen that already in China. So that was in our revenue guidance at that point in time. And incremental to that guide, what we saw, as we made very clear at that time, it didn’t include the impact of Americas and EMEA pandemic spread. And that’s what we saw over the course of March. Mike, you want to say anything about margin impact to that?

Michael Bruff

Yes. I think it’s important to know, as we saw the impact in March to our Americas and EMEA geographies, those two are the highest gross margin geographies we have, especially in the Americas they’re significantly higher than the rest of our geographies. So that had an impact to our gross margin rate in the quarter.

I think, the other thing to offset that is, there was some unexpected good news in the Asia-Pac geography. It did recover faster than we anticipated when we gave the March 9 update. So that provided us some upside to offset a portion of that $30 million.

Dow Wilson

And maybe just a little more color on the revenue side. In January and February, revenue growth was pretty good. We saw 8% quarter-to-date through February. So, very much on kind of the track of the last several years. And then oncology, March revenues were down 4% year-over-year.

Maybe just as a reminder, that service business continues to be very strong. As we said in the call, services were up 11%, big – nice increase from our CTSI acquisition. What we’re seeing growth on those numbers are very encouraging. And the overall Varian service growth was 5%, and that recurring stream is about half – a little more than half the company now.

Amit Hazan

Good color. And then just my second question is on the U.S. market and investors are understandably focused on that. And, Dow, I’d love your thoughts on just thinking back to 2009, 2010 around that period. And I know it’s not a perfect analogy. But still, if we thought about the hospital side, leave aside the freestanding clinics, but just the hospital side, what is it that you learned during that time period that you think might be applicable to how hospitals might respond in terms of CapEx allocations for the next year or so?

Dow Wilson

Yes. I mean, it’s a great question and we are looking at it. So let me wander for a second and I’ll get right to your question. I think one of the really important things to keep in mind is how much the business has changed over the last decade.

So at that point in time, services were about 30% of revenues. Today, they’re 50% of revenues. At that point in time, the Americas was a much bigger piece of the portfolio. America’s product today, I’m spitballing this, Mike, but 20% to 25%. So – and that’s probably down 10 to 15 points from where it was in 2009 or 2010.

So, that the company is much more resilient, much more diverse. Our backlog coming into this is 30% higher than that point in time. We did look at the comparison 2009. Maybe Chris, do you want to kind of take the team through a comparison here?

Michael Bruff

Yes. If we go back to 2009, we outpaced the rest of the market in terms of orders growth during that time. So the rest of the market saw some decline. I think that there is a similarity there. In that, if you look at our trailing 12-month market share on both orders and revenue, we’re up.

Additionally, as we look at the market, we still see the trends such as adaptive therapy being very important as we think about personalizing care for patients and the market reception on Ethos with the 11 orders in the quarter in North America. And the overall market reaction that we’ve got something that really leapfrogs utilizing artificial intelligence has been strong.

So our portfolio is much broader now than back then. As well as when we look at our position in the market, we really feel that we’ve never been in a stronger position competitively.

Amit Hazan

Thanks very much. I’ll get back in queue.

Operator

Our next question comes from Matt Taylor with UBS. Please state your question.

Dow Wilson

Hi, Matt.

Matthew Taylor

Hello. Thank you for taking the question. All right. So first thing I want to ask about, you mentioned early in the prepare comments there had been a shift in some centers, at least, from surgical intervention to radiation therapy. And I guess, I was wondering if you could expand on that. Is that a material trend? Do you think it’s temporary? How big is that shift then?

Dow Wilson

Chris?

Chris Toth

Yes. Hey, Matt. So we have seen it in a multitude of different cancer service lines, lung, head and neck, as another example. As it initially occurred, it had to do with hospitals focusing on COVID-19 for patient management needing as many inpatient beds available as possible.

Some indicators we’re seeing is that this is not just a U.S. phenomenon in discussions with the NHS in the UK, I’m specifically looking at centers in England. The feedback came that they saw the same shift and we got that input from a surgical oncologist at the NHS who is in the leadership position.

From a long-term perspective, I think this continues to move towards the increase in hypofractionation, of which we’re best positioned in terms of portfolio in the market and total number of patients with well over a million patients treated in a hypofractionated environment. So I do see elements of it sustainable. Time will tell, but more than anything, it just underscores hypofractionation.

Matthew Taylor

Gotcha, gotcha. Okay. I was trying to piece together, when you think about the different moving parts in the first quarter, really kind of two small questions here. One is, if you think about how you’re trending before COVID, and if you didn’t have a disruption that you did at the end of the quarter in the U.S. or in China, could you speak to how you think you would have grown on an underlying basis?

And then can you talk about that upside surprise in terms of the comeback that you saw in Asia-Pac? Why do you think it came back more quickly? And what are you seeing in the current trends there in April?

Dow Wilson

You know, Matt, it’s hard to say. I’ve forgotten everything that happened before March 9. So it’s a little bit hard to say. I think, if you were just to look at the last two years, that’s the trend line we’ve been on. Now that’s probably a safe assumption for where we would have been. Chris, do you want to talk a little bit about the China recovery and what we’re seeing?

Chris Toth

I think what we saw there, Matt, was that the cancer care is continuing to be at the top of the list of need in terms of resumption. And so, as there was some loosening or returning to normalcy, there was a desire to resume installations as quickly as possible, saw that in both China and South Korea. This really does continue to reinforce as you think about globally, the reference to in 2020, an estimated 18 million new cancer diagnoses moving in 2030 to 25 million, the reality is there is still major gaps in access to care.

So we foresee with our backlog, which is greater than 3 billion of product, that as we get to a place for lockdowns release, we will be able to resume installations, pending vault construction, completion and other preparatory requirements.

Dow Wilson

Maybe just a little broader context as well, Matt. China is our fastest-growing market. We are cautiously optimistic about what we see where the market leader, Chris talked about Net Promoter Score, the highest Net Promoter Score for the company is in China, it is off the chart.

So our team there is doing a fabulous job. We’ve invested significantly to become really viewed as a local brand. Its treatment volumes are recovering. And in March, we saw pretty much a rebound to their historical level in, that geography. There are almost 5 million cancer patients a year there. it’s not so much a reimbursement-driven market. So it’s a centrally controlled, provincially executed funding model. So, it’s not up to some of the vagaries that we have in some of our other markets.

Matthew Taylor

Great. Thanks, Dow. Thanks for the color.

Operator

Our next question comes from Marie Thibault with BTIG. Please state your question.

Marie Thibault

Hi, thank you for taking the question. It’s really appreciated. Just a quick one here. It’s definitely encourage to hear the signs of resumption to normal in China and South Korea, particularly on the order side. Could you frame up for us some of the differences? Obviously, I know there’s a greater demand for cancer care in those emerging markets. But as we think about U.S. and as things start to – as lockdowns – some return to normal, how should we think about the U.S. trajectory? Any color on how you might be thinking about that at this early stage?

Dow Wilson

It’s a good question. We’re having the debate. I don’t know that we know the full answer to your question, Marie, inside. It’s a – we are seeing recovery to China. It is more centrally mandated. It’s not so much susceptible to kind of the free market, so to speak.

It’s – one of the big differences, though, is that radiation therapy in China is an inpatient treatment. As such, it really – the short-term impact was much deeper in China. So we didn’t see the U.S., in a sample of the thousand dish customers that we looked at, we didn’t see a – we didn’t see much of – that speak of a falloff in U.S. compared to China, because in China, the patients were having to go into a hospital, into a more of a COVID environment, it’s more outpatient, whether hospital or non-hospital based here in the U.S. and a little more COVID-friendly, so to speak.

So we didn’t see the treatment volumes in the U.S. move down. As we kind of model it, it’s a really good question. I’d say, our base case is that, it’s an environment that’s described as recession with economic slowdown and geopolitical stability, that North America would open by the end of May, that EMEA countries open variably in the next few months, China continues to recover. I think, we’ll still see some ongoing Southeast Asia, Korea, Japan, locked down and Australia locked down into the summer.

So that’s kind of our base case. But the reason not to give the guidance is, there is a reasonable probability of a high impact case. which is – does it switch from recession to more severe economic outlook? Are there geopolitical instabilities? Is recovery delayed into 2021? And do we see a second surge of the disease? So that’d be kind of the high-level macro environment from a scenario planning that we’re looking at.

Chris, you want to talk a little bit about some of the U.S. market stuff?

Chris Toth

I mean, one of the other pieces I’d add as we think about the U.S. is the position of our services business. If you look at external benchmarking, such as IMV, we were rated three times higher in Net Promoter Score than other service providers. And as I shared in the call, we’ve watched the criticality of radiation oncology really increase as part of the pandemic. And so with greater than 50% of our business in the North America market coming from services, we feel very strong with that as a baseline as we continue forward.

Dow Wilson

So I think the conclusion is, it is a little uncertain in the short-term. As we said in the script, we do expect a little more pressure in Q3 with sequential recovery in Q4.

Marie Thibault

That’s really helpful. Thank you. You mentioned geopolitical stability. I know there has been increased rhetoric in recent days from officials. With some flared tensions with China, are there any early thoughts or early preparations you’re taking now in case there’s a resumption of trade war, tariffs, that sort of thing?

Dow Wilson

Well, we’ve been very aggressive over the last year-and-a-half at repositioning our supply chain and capability, so that we have a lot more flexibility in our supply chain. I’d say, those plans are 80% to 90% done, so we feel very good about the position that we’re in. So that we don’t have the kind of impact that we had in the last year.

Marie Thibault

Thank you so much.

Operator

Our next question comes from Anthony Petrone with Jefferies. Please state your question.

Dow Wilson

Hey, Anthony.

Anthony Petrone

Thanks, and I hope everyone is staying healthy and doing well and thanks for all the detail. Maybe two on Oncology, one on proton, the two questions on the core oncology business. I guess, specific to the U.S. would be, one, just your conversations with hospitals around how they’re looking at capital budgets at this point? Obviously, there’s still a lot to be determined, but just any data points there?

The second question would be, we’re hearing increasing chatter on even a further potential delay to the radiation oncology bundle. So is that still a Jan 1, 2020 go live, or is there a potential for that to be pushed out? And then I’ll have a follow-up on Proton therapy?

Dow Wilson

Chris, do you want to take that?

Chris Toth

Hi, Anthony. So first on the conversations with customers. As we’ve been going through with customers the activity and their planned or proposed purchases, what we’ve seen is the larger health systems with more spread out networks are continuing their plans. Some community hospitals who’ve been more impacted with COVID-19 in their local or regional area have looked at assessments around timing to proceed forward.

We have not heard feedback from them at this point that they have stopped their plans around specific projects, more of a timing conversation. And then within the freestanding segment, a little bit of a mix, depending upon geographic position of the institution.

As we do look at the mix, I know I’ve said it a few times, but in North America greater than 50% of our base is services, which is a really important part of the business and it keeps strong continuity with each of those sites. So it’s still too early to really make a call with respect to North America and we’re continuing to stay close to our customers.

On the second point regarding APM, really, as we’ve seen APM since the inception and discussion around it, value-based care is where the market has been heading towards. We have the best portfolio for value-based care environment. We have not seen any impact on purchase decisions from APM. In fact, if you go back to Q1, you saw solid North America orders growth. You also heard our commentary around some of the push-outs in March and related to COVID-19 and really tying to North America.

So if anything, we’ve just seen the consistent focus as folks have been preparing for APM, and thus, we don’t really see it as a big net impact one way or another with respect to a slightly longer delay.

Dow Wilson

And the question about Proton, Anthony?

Anthony Petrone

Yes. Just a follow-up would be, again, do you think the actual date could be pushed out by CMS. We’re hearing it could be pushed out even further than January 1, 2021, so the first one. And then on Proton, you have a loan impairment this quarter. Just as you think about the Proton portfolio, are there any other impairment risks across that portfolio? Thanks.

Dow Wilson

Mike?

Michael Bruff

Yes. Anthony, good question. We did have an impairment with CPTC this quarter, the California Proton Therapy Center, or Treatment Center. And it was – in the COVID environment, the operations were impacted predominantly through slower patient volumes and an affiliation with a significant clinical partner that stalled. And quite frankly, their ability to refinance their debt in this market is at risk.

So those were the factors that were unique to see PTC. And so we believe it’s an isolated situation, and that’s why we took the impairment. Based on the patient information that’s available to us at the end of the quarter, we don’t see a similar risk at other centers at this point, but we review these things regularly.

Anthony Petrone

Okay. Thank you.

Operator

Thank you. Our next question comes from Jason Bednar with Piper Sandler. Please state your question.

Jason Bednar

Yes, thanks. Good afternoon, everyone. Thanks for taking the questions and all the details in the prepared remarks there, Dow and Chris. A couple of questions from us. Maybe starting on your European franchise, where growth was really strong again in the quarter.

I believe you recently had a leadership transition over in Europe, a planned transition, but a transition nonetheless. That’s been a region where Varian has done a phenomenal job, growing above market, wining over some key accounts. So just hoping you could offer some views today on the stability of that franchise going forward now in light of that leadership change and the pandemic?

Dow Wilson

Yes. I mean, from a market point of view, that market has obviously been on a tear the last couple of years. So we had a very significant quarter, again, this quarter, with two large wins that I mentioned in the script, the National Health Service in the UK and Pharmstandard in Russia.

So those were two very big wins. We do worry a little bit about that market in the second-half. So as we look to Italy, Spain, in particular, what the impact is in those markets? Clearly, there’s going to be a slowdown to recovery in those markets.

Michael Bruff

Yes. I think my adds there would be, as we look at the region, first, EMEA is really a composite of the developed Europe, as well as some growth platform. So India as an example, we consolidate in our EMEA geography. In addition to that, as you think about Africa, with a population of over 1 billion and very restricted access to care across the continent.

So when we think long-term about the region, we have the replacement cycle in the developed market, or we have a very robust installed base, and then a lot of growth opportunities throughout the emerging areas.

The CTSI acquisition that we made positions us well in those growth opportunities. Those are geographies where you see a smaller or reduced number of clinical personnel to perform treatment planning or other services. And so CTSI can augment nicely and makes for another addition to our portfolio of solutions.

So, in net, we will see some areas, which were harder hit by the pandemic that do slowdown, but it’s a very diverse geographic platform. And we remain positive from a longer-term perspective.

Jason Bednar

All right. Very helpful. And then just two more quick follow-ups for me. First, I don’t think you made any comments – sorry, if I missed it, if you made any comments on your long-range plan you provided back in November. I just didn’t know if that was something you’re recommitting to today or not? And then a quick one on Ethos. Just to – any timelines that you’re giving on when to expect approval out of China?

Dow Wilson

You want to get the approval one first, Chris, and then I’ll talk about the long-range stuff.

Chris Toth

Sure. On China approval for Ethos, that’s in the 12 to 14-month range in terms of clearance. I do want to make one other comment on Ethos, though, it was in prepared remarks and this emphasis around as we look at 100 patients treated at our first center, Herlev Hospital in Denmark, the results of 50% reductions in dose to critical structures and more focused on the target, I think this is the type of data you’re going to see come that’s going to really drive Ethos across all of the markets.

Dow Wilson

And then relative to the first part of your question, Jason, I can assure you that we did not have COVID-19 in our long-range plan when we generated it. Clearly, our long-range guidance is based on our business momentum and long-term outlook, combined with our strategic initiatives and the kind of execution track record that we’ve had.

Here, we still feel very good about the strategy. We think it’s – overall, strategic direction that company is right on. We’re going to continue to invest in our R&D initiatives. It’s a heavy organic growth. With some M&A, we’ll continue to look at our Interventional Solutions business, how we can enhance it. But the portfolio is very well positioned to grow and take market share over time and expand the market through our technology-enabled services and other software offerings.

We mentioned on the call this win at – in Texas Memorial Hermann, $15 million over five years, that’s something we would not have had one year ago. And the CTSI acquisition is continuing to really have a great impact on the company and feel very good about – we talked about how, in the last 10 years, we’ve gone from 30%, 35% of the company being in services to over half a company today being in services, I think, we got round two of that coming. And with our CTSI build-out, so we like it.

So is the short-term, a short V or a long V or a long L or whatever your economics friends like to call it, the short answer is, I don’t know. I would say our long – once we get through that trough, we think this thing is right back to its long-range targets.

Jason Bednar

Great. Very helpful. Thanks so much.

Operator

Thank you. Our next question comes from Jeff Johnson with Baird. Please state your question.

Jeffrey Johnson

Yes, thanks. Good evening, guys. I got maybe one higher-level…

Dow Wilson

Hi, Jeff.

Jeffrey Johnson

…hey, good evening. Maybe one higher-level question for you and Chris, and then maybe one modeling question for Mike. But from a higher-level, Dow, just what do you – where do you think conversations are going to go over the next six to 12 months with various hospitals and other service providers on the hierarchy of radiation oncology versus other hospital CapEx that could happen?

I think back in the 2009, 2010 period, radiation oncology, given its return, it did have a high priority in where hospitals would spend. I think, Chris has mentioned in the past, there’s some 5,500 C Series, probably down to 5,000. C Series…

Dow Wilson

Yes.

Jeffrey Johnson

… Linac’s out there now, that could really get a nice throughput advantage. So just how to think about the hierarchy of spend next year at the hospital level?

Dow Wilson

I think other than the kind of COVID preparedness and what do we see for ICU capacity in vents, I don’t think it changes. Chris, do you want to add anything?

Chris Toth

Yes, that corresponds to some of the independent research we’ve seen that it’s still very highly prioritized. And Jeff, as you articulated, the ROI is very strong. That ROI being strong does not only manifest itself in the U.S. I mean if you think about other markets where maybe it’s a socialized healthcare environment, but it’s not a specific dollar return.

If you look at one linear accelerator can accomplish in terms of number of patients throughput per day versus an OR, there are some real advantages there. So I think it’s too early to tell. As we shared, we’ve been looking at a multitude of different scenarios. But we still see radiation oncology having a strong position, both economically and clinically.

Jeffrey Johnson

All right. That’s helpful. Thank you. And, Mike, just from a modeling perspective, that 50% of your revenues that services, historically, we kind of think of that growing on whatever your TTM installed base has grow and maybe some competitive wins in there as well. Is that the right way to think about it still over the next few quarters or hospitals asking for any kind of relief in the near-term on what they’re paying maybe for some of the services? Anything at all, on that part of the business? Can that 50% really continue to grow here in the next few quarters and really protect the hardware downside that we’ll see maybe in the near-term?

Michael Bruff

Jeff, as Chris stated in his prepared comments, we believe that our services business is relatively insulated. And that business has been built up over many years as we’ve grown our installed base and invested in software. And software investments also give us the opportunity to obtain software service agreements over time. So those growth elements have delivered very strong services growth over the last couple of years.

Now, the services growth this quarter is 11%. Now organically from a – from an oncology perspective, that’s around 4% growth. So that’s a little bit more in line with our installed base. We did have some revenue that we took last year, which depresses the growth rate year-on-year.

But for all intents and purposes, we’re in that mid single-digit services growth rate year-on-year and that tracks very well with the installed base, plus the innovations that we’ve driven in our – on our software.

Jeffrey Johnson

Thank you.

Michael Bruff

…as well – and Jeff as well, the other thing and I know that you took a look at this about 12, 18 months ago. But it’s not to be overlooked at the Proton Services is growing 61%. We continue to handover rooms operationally. And as we do and they move through the warranty period, we’re able to generate services revenue there. So that’s a really good story from an economic perspective in that business.

Jeffrey Johnson

Understood. Thank you.

Operator

Our next question comes from Vijay Kumar with Evercore ISI. Please state your question.

Vijay Kumar

Hey, guys, thanks for taking my question. I had a few. So hopefully, I can rattle off as much as I can. One, may be on the comments around March business friends heading into April. Was the last week of March directionally for you guys the worst? Are we past the worst? Or is April the worst for you guys? Any color on how we should be thinking about the upcoming quarter, I think, would be helpful?

Dow Wilson

I’d say, the third and fourth week of March, first week, April, kind of the same.

Vijay Kumar

Gotcha. And then on, I guess, the service revenues up double digits really strongly. Is – was CTSI flowing through that piece as well? And just how we should be thinking about near-term, just given the lockdowns on that piece?

Dow Wilson

Yes. CTSI does flow through in our services business. It’s very interesting to see how it happens in the – in this environment. A lot of this work is done remote and a lot of it is supported by electronic digital technology.

So it’s actually – as – I can remember it, me or Chris, who said in our comments, the number of treatment plans we’re doing on an annualized rate has doubled. We’ve gone from 8,000 – run rate of 8,000 treatment plans a year to 16,000 treatment plans a year. So you can see the kind of confidence that our customers are putting in us. And yes, there was – we saw a bigger falloff in China. We don’t have much CTSI in China.

We did see a fall drop off, as Chris said, here in the U.S., but we’ve also that rebound pretty quickly to historical levels. So the CTSI is, at least, in the U.S. piece of CTSI is not that big impacted. The piece of CTSI that is impacted is the care businesses that we’re in, in India. And we have seen the lockdown there and it has impacted the CTSI revenues there. But we’re also seeing that rebound and believe that should come back pretty quickly.

Dow Wilson

That’s helpful, Dow. And if I could sneak in one last one, on the cost actions, I think, I don’t think I heard what the – maybe a dollar figure or perhaps how to think about incremental decremental margins here heading the back-half? Thank you.

Dow Wilson

Well, let me make a few comments here and Mike can fix it, too, when I’m done. By the way, I was pretty close in my spitballing before I said 20% to 25%, it was 22%. So 22% U.S. hardware on that number. Anyway, for costs, let me just say, I wanted to reiterate from a liquidity perspective, the financial flexibility that we’ve built. Mike emphasized that.

And having said that, we’re considering a broad range of options as a precautionary measure just to make sure we can maintain our flexibility in all scenarios, in both those scenarios I talked about. So our focus will be on reducing costs without impacting key R&D and productivity programs. We started some of those in March, slowing down hiring, replacement, hiring and travel. But we’ll have some incremental stuff that we do here soon as well.

Just as a reminder, as we think about that, new cancer patients are going from 18 million this year to 25 million in 2030. So we’re going to prioritize investments and focus on our long-term growth strategy. We’ll take some costs out of second-half. We’ll be thoughtful and disciplined about how we do that with the recovery in place.

We will say that our cost mitigation options range on both the OpEx side, operating expense side as well as our product cost side, as we work through the volumes that the market is going to demand for both workplace and workforce considerations. So that’s as much as at least at this point that we’re going to talk publicly about.

Vijay Kumar

Okay. Thanks, guys.

Operator

Our next question comes from Tycho Peterson with JPMorgan. Please state your question.

Tycho Peterson

Hey, thanks, Dow, your commentary on hospitals and CapEx implies a fairly steep recovery once we kind of get back to a more normalized environment. Can you maybe just talk to why you think that’s the case, given the state of hospital finances we’ve seen one bankruptcy at this point? And what gives you the confidence that we will see a fairly quick recovery?

Dow Wilson

Well, I mean, first of all, I didn’t mean if I signaled the really quick recovery, I didn’t say that. I said, we don’t know if it’s going to be a short shallow V, a quick over V or a long V just in terms recovery. So I didn’t want to give anybody that impression. I did say that the Americas represents 22% of our – the American product represents 22% of our portfolio now, service is now half.

So it’s not that barometer, it was 10 years ago, when it was probably 40% of our number. I’d say in the U.S., we – with the services portfolio we have, we’re much more resilient than we used to be, growing CTSI business, growing services business. I think that we’ve seen a general trend in the last five years of consolidation and the strong remains strong. And those are the – frankly, those are the ones that we’ve seen investing in radiation oncology.

Our Americas growth rate, the last 2.5 years has been very strong, strong, mid single-digit 5%, 6%. And that’s been the market that we’ve seen in the last three, four years. The – we have gone out and touched our backlog to make sure that they’re secure. We haven’t seen any cancellations in our backlog. As I said, we have seen some pushes, but that’s ability to get a vault constructed because of construction shutdowns in the lockdown or access to vaults.

So we’ve touched hundreds of customers in the process of doing that, maybe even thousands of customers. And I don’t know, Chris, you want to add any color there?

Chris Toth

I think the one other add would be that, we’re not just dependent on CapEx as we look at our products and giving them into institutions. We’ve also looked at OpEx type of solutions and had some success there with software over time, and we’re taking those learnings and just adapting to the environment to make sure that we can get the right solutions in our customers’ hands to help patients.

Dow Wilson

Now there’s no question that there’s going to be some short-term perturbation that comes out of this. But as we get a quarter down the road, we think it roars back.

Tycho Peterson

And then maybe on that point, you highlighted the $1.3 billion in liquidity and the balance sheet. I mean, would you ever explore alternate financing models? You don’t have an operating lease model for your systems, but would you ever explore using your own balance sheet to place capital? And then for Mike, any recent cash conversion step down again, can you touch on that?

Dow Wilson

I’d say the short version is probably not. We do have some pilots running where we combine some capital with a CTSI broader play. That looks really interesting, where we go in and kind of do an operating cost and capital cost play. So we are piloting that.

I’d say most of our customers, the thing to remember is our cost of equity is much more – much higher than the cost of capital for a U.S. 501(c)(3) not-for-profit customer. They’re looking at cost of capital of 2%, whereas ours is 8-ish. And so I don’t think we can get down there at that level. And people who are doing this on capital can do it, because they have a large amount of consumables or something else that they’re flowing through.

So I think our business model doesn’t – we will continue to kind of push these pilots and see where they go. We like what we’re seeing so far. By the way, the Memorial Hermann is not that, that’s a pure services play, $3 million a year for five years. We can do, hurry up, Chris, let’s do a whole bunch more of those. And that’s what we want to do.

Michael Bruff

Can I take the cash conversion question, Dow?

Dow Wilson

Yes, yes.

Michael Bruff

Yes. Tycho, look, from a Q2 perspective and what we’ve seen to date, our collections have remained fairly strong and our DSOs flat from last year. We haven’t seen any COVID-related impact to terms or the quality of our AR. The inventory that we have, we had expected actually at the beginning of the year for our first-half inventory to be a little elevated, and it’s fairly on our expectations.

I think the makeup of the inventory is a little different. We have a little increased finished goods and lower raw materials, but that’s simply due to some of the factory shutdown and timing of revenues. But the inventory is roughly in line with where we thought. And our accounts payable are in line as well. I think we’ll continue to see how this plays out.

But as you mentioned, kind of in the beginning of your question, we do have $1.3 billion in liquidity. It is a very strong position from our perspective to whether the different types of scenarios that we’ve been modeling out. And in those scenarios, we model out different impacts on cash conversion.

And again, we can weather these types of scenarios fairly well. But the cost mitigation actions that we are driving today will just continue to give us the flexibility that we want the cushion that we want in that flexibility that we’ve built up over time.

Tycho Peterson

Thanks. And then one last one for Dow on Ethos. It’s early days, but can you just talk on whether any of the 15 orders were competitive wins? And how are you thinking about competitive positioning there? Thanks.

Dow Wilson

Yes. Chris, this is close enough to it. Chris, go for it.

Chris Toth

Yes. Thanks. Thanks, Tyco. Yes, they were. We had multiple that were competitive wins. One specifically comes to mind that was in the freestanding segment, it was against an MR-Linac. And the choice was to go with Ethos for being able to have multimodality imaging, AI and have the flexibility to treat both adaptive cases on a daily basis, as well as conventional cases. We think this is going to be something that actually accelerates in terms of importance based on the current environment.

Tycho Peterson

Thank you.

Operator

Thank you. That concludes our question-and-answer session. I’ll turn it back to management for closing remarks. Thank you.

Dow Wilson

Thank you, operator. Thanks for the great questions. We are in an unprecedented environment, as COVID-19 continues to challenge every company, institution and person around the world. This pandemic is a reminder of the importance of health and the relevance of our mission to help patients fight an insidious disease, cancer.

Our solid orders growth over the last several years has resulted in a strong product backlog. And currently, our growing installed base has allowed us to build a stable and predictable services revenue stream. And finally, our conservative fiscal philosophy has enabled us to have a very strong balance sheet, all of which position us well as we navigate this unique environment.

Looking forward, we will continue to invest in our strategic enablers and remain committed to innovating and investing in new technologies to drive towards the ultimate victory, a world without fear of cancer. Thanks for joining us today.

Operator

Thank you. This concludes today’s conference. All parties may disconnect. Have a great evening.