Doug Sherk - Founder & CEO, EVC Group, Inc. Josh Levine - President, CEO Kevin Waters - SVP, CFO

Tycho Peterson - JPMorgan Lisa Gill - Morgan Stanley Raj Denhoy - Jefferies Suraj Kalia - Northland Securities Jason Wittes - Brean Capital

Good day, ladies and gentlemen and welcome to the Accuray Incorporated Second Quarter Fiscal 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Mr. Doug Sherk, Investor Relations. Please go ahead.

Thank you, operator and good afternoon everyone. Thank you for joining us today, as we review Accuray's second quarter fiscal 2016 financial results for the quarter that ended December 31, 2015. Participating on today's call are Josh Levine, Accuray's President and Chief Executive Officer; and Kevin Waters, Accuray's Senior Vice President and Chief Financial Officer. Before we begin, I would like to remind you that our call today includes forward-looking statements that involve risks and uncertainties including statements regarding our business plans and strategies as well as our outlook for the fiscal third quarter and full fiscal year 2016. There are a number of factors that cause actual results to differ materially from our expectations, including but not limited to risks associated with the adoption of the CyberKnife and TomoTherapy Systems, commercial execution, future order growth, future revenue and macroeconomic factors outside of the company's control. These and other risks are more fully described in the press release we issued after the market closed this afternoon, as well as in our filings with the Securities and Exchange Commission. The forward-looking statements on this call are based on information available to us as of today's date and we assume no obligation to update any forward-looking statements. During the question-and-answer session we request that questioners limit themselves to two questions and then re-queue if you have any additional follow-ups. We thank everyone in advance for their cooperation with this process. And now, I would like to turn the call over to Accuray's President and Chief Executive Officer, Josh Levine.

Thank you, Doug, and good afternoon everyone. Thank you for joining us on today's call. Today we reported another quarter of strong financial performance, which included the highest level of quarterly revenue performance in our company's history and perhaps most importantly revenue growth rates had significantly exceed overall market growth. We continue to execute on each of our commercial strategic initiatives and are driving momentum across both our CyberKnife and TomoTherapy product platforms. Our revenue of nearly $109 million for the quarter represented 15% growth in constant currency and our gross orders of $67.1 million came in right where we expected. When looking at our continuing commercial momentum over the previous three quarters as well as guidance for the balance of 2016, Accuray is demonstrating the ability to successfully compete in accounts traditionally dominated by other radiotherapy systems. In the current quarter, a full 30% of our gross orders came from wins in competitive bunkers along with our established reputation for precision and accuracy, customers are increasingly associating Accuray products with reliability and functionality. The competitive take outs are primarily driven by our ability to penetrate single and dual vaults centers with our TomoTherapy System. This is the third quarter in a row that 50% or more of the overall TomoTherapy order mix is in single or dual vault locations. We believe our strategic collaboration with RaySearch Labs will have a positive impact on this trend longer term. Customers have told us they are excited about the future introduction of RayStation for Tomo and believe it will increase the systems utility as a mainstream product. At an increasing rate, we are expanding beyond our traditional strength in academic medical center settings and moving into smaller and medium sized accounts where TomoTherapy as a [stock] [ph], we have been underrepresented. We are also seeing good momentum with our CyberKnife platform primarily because of the availability of the InCise MLC. In the quarter, greater than 80% of the CyberKnife M6 orders included in MLC. We expect this trend to continue over the coming quarters as more radiation oncologists and medical physicists become aware of the benefits of the MLC, which are the result of significantly improved treatment times and expanded clinical versatility, which can positively impact the ROI for perspective accounts. Another growth opportunity for Accuray is our installed base replacement sales cycle going forward. Over the next three years, we will the first true replacement cycle in the company's history. We estimate that a third of our installed base systems most heavily concentrated geographically in the United States and Western Europe will be entering their 10-year replacement cycle. The cycle cuts across both our CyberKnife and TomoTherapy platforms and represents our most significant opportunity to grow sales in the U.S. even in the face of a general lack of new bunker construction in this market. We are pleased with our momentum in this area, as we've been winning 75% to 80% of these replacement opportunities year-to-date with replacement orders representing approximately 15% of all orders in the current quarter. Very few if any of the remaining 20% to 25% of the potential opportunities over the previous three quarters resulted from competitive losses. These bunkers were either consolidated with other centers or shut down entirely. A key element in our bunker retention strategy is our improved reputation for liability and functionality. We are committed to ensuring that every day we earn the right to retain these vaults based on product performance, reliability and service support all of which ultimately translates into improved customer satisfaction and loyalty. On this front, we are receiving strong feedback, the customer like what they see from Accuray. In the latest IMV report published at the end of calendar 2015, Accuray rated number one overall in linear accelerated system performance and garnered the highest net promoter scores of all systems included in this survey which included 450 accounts across the U.S. The net promoter score is a widely accepted loyalty metric and essentially focuses on how likely the clinician would be to recommend our device to another clinical colleague. This independently conducted research is a strong indicator that we're truly changing how the market perceives our products and our company. China continues to represent a significant growth opportunity to drive new orders. While the recent news coming out of China has been strongly negative relative to the slowdown of economic growth, what we are seeing on the ground differs from the macroeconomic narrative. In the second quarter, we moved four orders from the backlog to revenue and we are not seeing order cancellations or construction project slowdowns with customers in China who have orders in the backlog and are in the process of bunker construction. As we previously disclosed of the 39 total National Health and Family Planning Commission Class A radiotherapy licenses issued, we have been issued 34 and all of have been reported to our backlog. Of these 34 total licenses, we have shipped to 23 units and expect to ship the remaining units over the next 12 to 24 months. We have not had a single cancellation in China and we are working closely with our distributors to make sure that end user construction projects remain on track. The Chinese National Health and Family Planning Commission has not yet given any updates related to the next phase of the Class A radiotherapy procurement process. As a result, it's difficult to predict when the Chinese government will issue additional new Class A licenses. However, the current delay in the release of licenses is consistent with what we have seen over the last two years. What we do know in China is that there continues to be a significant gap between the clinical demand for radiotherapy treatments and existing capacity in the market. On the demand side, the projected 65-plus year-old population in China is expected to balloon to quarter of a billion people over the next 15 years. And the projected incidences of cancer diagnosis is expected to grow by over 30% in that same period. On the capacity side of the equation, it's estimated that China has about a quarter of the installed linear accelerators in the market that we see in the U.S. and that the number of patients treated is only 25% to 30% of the total population treated here. The magnitude of the demand capacity gap is significant and represents a great opportunity for us. Historically, our strength in the China market has been in the PLA military hospital segment and large state run public facilities which generally are located in larger metropolitan areas like Shanghai and Beijing. Going forward, we believe the most significant areas for growth in radiotherapy will come from the private hospital sector and it will be smaller or medium sized facilities in the outlying provinces. These smaller facilities will require a different product configuration and feature set than our traditional premium and specialty product portfolio and we are in active development on a product that can be marketed at a competitive price point in the non-Class A radiotherapy segment. We have already begun the regulatory approval process to bring this product to market and expect to receive approval within the next 9 to 12 months. With the aging population and clinical need, we continue to see a significant market opportunity for our systems in China. Lastly, before I hand the call up to Kevin, I would like to touch on the completion of our recent debt financing with Cerberus announced on January 12. We were able to secure $70 million at very competitive terms and will use the proceeds along with cash on our balance sheet to retire our August 2016 convertible bonds without any dilution to shareholders. And with that, I will turn the call over to Kevin, who will provide some additional details on our financial results for the quarter? Kevin?

Thank you, Josh, and good afternoon everyone. I will begin my prepared remarks with additional detail on product orders and then provide additional color on our P&L and balance sheet before concluding with our financial outlook. As Josh noted in his comments, gross orders were $67.1 million and they are very much inline with our internal expectations. We remain firmly on track to achieve our gross order targets for the fiscal year and as I will review later, if we achieve these targets we will generate healthy growth for the third quarter, the fourth quarter and the full fiscal year. Compared to the prior year second quarter, CyberKnife orders continue to show strong growth. TomoTherapy orders decreased year-over-year in the second quarter, which was within our expectations due to the tough comparable in the second quarter of 2015, where we received 12 TomoTherapy orders in the EIMEA region alone, which was a record quarter for that region. We are on track to generate year-over-year growth for TomoTherapy during the second half of the year. Geographically, the Americas, APAC and Japan regions all experienced taller order growth. This was offset by the expected decrease in Europe due to the tough comparable I just noted. On a year-to-date basis all four of our regions are performing as expected. Net orders which are calculated by subtracting age out cancellations and adjusting for foreign currency totaled $42.7 million in the quarter an increase of 3% over the prior year second quarter. This includes age outs of $19 million, cancellation of $3 million which represented one order during the quarter and a foreign currency adjustment of $2.3 million. Please recall that age outs are orders that have not gone to revenue in 30 months since being recorded. Yes, we could and we have experienced age outs converting the revenue after this 30-month period. [Ending] [ph] product backlog was $356.7 million which is 2.5% higher than backlog at the end of the prior fiscal year second quarter. Moving on to our income statement. Total revenues for the second quarter of $108.9 million represents 11% increase from the prior year period. On a constant currency basis, revenue increased 15%, a revenue for the second quarter also set a corporate quarterly revenue record. Product revenues at $55.8 million increased 17% year-over-year or 22% on a constant currency basis both CyberKnife and TomoTherapy product revenues increased over prior year with particularly strong CyberKnife performance in both the U.S. and EIMEA regions, which we attribute to the commercial availability of the MLC. Additionally, TomoTherapy revenue revenues in EMIEA and APAC showed a robust improvement over prior year. Turning to service revenues, service revenues were $53.1 million an increase of 5% or 8% on a constant currency basis. The growth was primarily due to an increase of $1.4 million, which we would consider non-recurring representing a large [indiscernible] of training revenues that were utilized or expired in the current quarter. Our overall gross profit margin for the quarter was 39.1% essentially flat with the 39.2% in the year ago quarter. On a constant currency basis overall gross profit margin for the quarter was 40.7% which is 150 basis points above the prior year period. Product gross margins were 41.3% or 43.6% on a constant currency basis compared to the prior year period of 43%. Margin improvements were primarily related to volume increases offset by a larger percentage of refurbished system sales in the current quarter as compared to prior year. Service gross margins were 36.7% or 37.5% on a constant currency basis which were favorable compared to the prior year period of 35.7%. The improvement in our service gross margin is primarily related to the increase in revenues. Turning to operating expenses, operating expenses were up only slightly for the quarter at 1%, the increase is primarily due to higher legal expenses related to the amended award of an additional $2.1 million for damages to the company's former China distributor as well as increased research and development expenses to support ongoing product development efforts. These increases were to a large degree offset by reduced compensation related expenses, in sales and marketing and general and administrative functions. In regards to profit, we are near operating income breakeven for the quarter compared to a loss of $3.6 million in the second quarter of 2015. Our top-line execution and operating expense control resulted in adjusted EBITDA of $6.8 million for the second quarter compared with last year's EBITDA of $3.7 million. On a full year basis, we have improved EBITDA by $10.5 million compared to the first six months of 2015. Turning now to our balance sheet, we increased cash $2.7 million during the second quarter ending the quarter with $155.8 million of cash in investments. For the first six months of 2016, we increased cash and investment balances by $11.9 million. This is a $33 million improvement in cash flow from the first six month of 2015. On a full year basis, we continue to expect, we will be significantly cash flow positive. Accounts receivable increased by $9.4 million in the quarter primarily due to the increase in revenues. Our inventories in the second quarter decreased by $2.3 million which is consistent with our comments about inventories last year quarter when we noted that we expect modest increases or decreases in quarterly inventory balances as compared to prior year. Additionally, current liabilities increased due to timing of payments and deferred revenues. As Josh touched on subsequent to the end of the fiscal second quarter, we secured $70 million of non-convertible straight debt financing which we will use to conjunction with $30 million of cash from our balance sheet to retire all $100 million as of August 2016 convertible notes. Additionally, as we announced in January, we have officially now retired $63.4 million of the $100 million notes outstanding as of today. We also have a $115 million of February 2018 convertible notes outstanding. We believe it is too early to comment specifically on our plans for these notes, however, we continue to believe that our improving cash flows and expanding EBITDA will enable us to explore additional alternatives that would minimize potential shareholder dilution from these notes two years from now. Turning now to our financial guidance for fiscal 2016, today, we reaffirmed our previous guidance of revenue in the range of $395 million to $410 million and adjusted EBITDA in the range of $25 million to $35 million. At the upper end of our EBITDA guidance, we would be reporting GAAP operating income on a full year basis. We also continued to anticipate operating expenses in fiscal 2016 or remain relatively flat at the high end of revenues to slightly down at the low end of revenues compared to fiscal 2015. In regards to gross orders, we continue to believe our gross orders will be approximately $295 million which would represent 10% year-over-year growth. We also continued to expect the third quarter gross orders will approximate the level of gross orders we achieved in our most recently completed second quarter. If we achieve this level of third quarter gross orders, it will represent 29% growth in gross orders as compared to the year ago period. With respect to future age outs and cancellations in 2016, third quarter net age outs should be in the range of $5 million to $8 million which is consistent with our expectations that age outs would decline throughout the fiscal year. We continue to expect to see a year-over-year improvement in age outs as a percentage of average backlog. Additionally, we continue to expect to see orders that have previously aged out come back to revenue which supports the notion that an order greater than 30 month old is not always the lost opportunity for the company. Finally, I would like to announce that on Friday, May 20, Accuray will be hosting an Analyst Day in New York City from 8:30 am to 12 noon. We will be providing more details on the topic and presenters over the next few months. However, we can tell you that our objective with this event is to demonstrate how the company is positioned to maintain our radiation therapy, precision leadership, while at the same time continuing our momentum in the market that has been established over the past several quarters. Now, I would like to hand the call back to Josh.

Thank you, Kevin. I'm encouraged by our performance in Q2 as we show continued consistency in our operating results and momentum in commercial execution across all of our key strategic initiatives. Our improved execution has lead to significant year-over-year growth in revenues, EBITDA and cash flow generation. We are now ready to open the call up for your questions.

[Operator Instructions] Our first question comes from the line of Tycho Peterson from JPMorgan. Your question please.

Thanks. And congrats on beating your own pre-announcement on the top-line there. Good quarter. I guess, you guys are bucking the trend a bit and then some of the emerging markets, we heard some pretty negative commentary from Varian earlier in the week. Can you maybe just talk on, I guess specifically on China and Japan visibility into those markets for the next couple of quarters from your perspective?

Yes. I mean, I think it's fair with the macro comment. I will remind you that we forecasted at the beginning of the year in our gross order guidance. Our most significant contributing regions to achieve our gross orders was growth in the U.S. region and the European region. So our China and APACs strategy forecasted modest growth heading into this region such that the macro factors going on there, while a risk don't give us concern at the moment regards to our gross order numbers we put out for the full year.

Tycho, I think, wanted to just amplify in that, I think the question I think that's kind of hanging in the air in people's mind is around China and around Class A licenses and where -- what's next with regards to Class A radiotherapy procurement process in general. To Kevin's point, we don't need huge heroics in terms of near term impact in order activity in China to be able to deliver the order guidance that we have. So we also think quite frankly that we are going to be entering into at some point maybe a 9 to 12 months from now, a new products like go in China relative to the value product we talked about. So from a visibility and a runway standpoint, we like where we are headed there.

And then I guess, do we think about the U.S. market on TomoTherapy, when you've got anywhere from 4% to 8% share in single and dual vaults as you've talked about. Do you need to place additional resources to try to convert more of that market. And maybe just touch on the pricing dynamic as well as you got to try to convert some of those customers?

Yes. So in general, I think you probably have heard us talk a lot about especially in U.S. market the replacement cycle. Replacement cycle is a really kind of a unique inflection for us because it's the first time in our life cycle as a business that we enter into this kind of a replacement sales opportunity. If you look at the last several quarters, we are operating at about 50% or 50% plus mix of overall Tomo gross orders in these smaller footprint settings. Again, when you compare that to where we've been traditionally that's a very unique change for us. And we think that when you look at both -- where Tomo was now with regards to how it's performing the replacement cycle opportunity, the improving commercial execution side of it. I think we feel like there is a good runway in front of us with regards to Tomo continued placement in these -- in a broader context in terms of customer types and locations. Again, it will vary a little bit quarter-to-quarter but I think that we feel good about the likelihood of that continuing. U.S. market pricing conditions in general, we don't see anything that is really creating or a cause of concern for us, in the near to intermediate term with regards to pricing. I mean I will tell you that there is -- outside the U.S. there are probably some pockets where we have seen selectively both Varian and Elekta more aggressive on pricing. But we are trying hard quite frankly to stay out of that fray with the two lager companies. And again, I think the given our positioning right now. We are pretty confident that we can avoid getting dragged into that.

Okay. And then, just lastly on software, we don't hear as much about it from you as maybe some of the other companies in the space but you are spending $60 million a year on R&D. Can you maybe just talk a little bit on how much of an internal focus and emphasis you are placing on software and are you hearing from customers that you couldn't should be don't go over there?

That was exactly why we initiated the collaboration with RaySearch Labs. That one is an external collaboration, we think its aligned us with quite frankly the strongest player in the space both from a product capability standpoint than a customer and market perception standpoint. So we like that relationship and we think when we have basically RayStation which is their treatment planning platform in place for TomoTherapy and CyberKnife, it actually improves our product positioning competitive strategic positioning for our products. And we talked of a larger academic centers, the more sophisticated medical physicist staffs their product -- their treatment planning product RayStation is really kind of consider the gold standard. So that was a way for us to be able to improve the functionality and the utility of treatment planning software without a large spend internally from -- organic R&D spend rate. So there is -- we have other work taking place in terms of delivery -- the delivery software and other software, but I think the strategic view is that we will always probably from this point forward have a combination of both internal and external activity taking place here. It's probably not realistic Tycho for us given where we are at financial bandwidth voice to do all of the software work that we need to internally.

Okay. Understood. Thanks.

Thank you. Our next question comes from the line of Steve Beuchaw from Morgan Stanley. Your question please.

Afternoon guys, this is Lisa on for Steve. I was just hoping to hopefully get a little bit more color if you guys could dig into on the ramping [plug] [ph] in the fourth quarter guide for gross order?

So you want to -- you are looking for walk on gross orders to get to the 295. So when I said in my prepared remarks was the third quarter gross orders are going to essentially approximate our Q2 gross orders. So and I said that I would represent 29% year-over-year growth. So the plug you are looking for Q4 would be $96 million which on the surface sounds like a large leap sequentially. However, if you go back and look at gross order cadence in 2015 that Q4 number of $96 million to get to $295 would be 13% year-over-year growth, which is the number I think we feel comfortable with at this time.

Great. Thanks. And actually another question for your Kevin. I was hoping you can maybe help us think through currency for the balance of the year maybe touching on FX and orders and top-line in P&L?

I mean, our guidance right now assumes, it allows for some room for a continued strengthening of the dollar. I think as of yesterday, we held pretty steady here over the last few weeks. Our guidance anticipates a continued strengthening of the dollar, so I'd characterize that.

Great. Thanks. And just one last one, if you could just touch on, how we should be thinking about the GPO contribution going forward for the balance of the year?

Yes. So we've actually seen the impact of some of the work that we have done with GPOs and strategic accounts. In the previous quarter, our first fiscal quarter we didn't specifically call out any GPO related activity in the second quarter or anything specific to strategic account impact. But, and I think it's -- it's realistic to say that it isn't likely that we will see things on an every quarter basis, but we have obviously started to see the impact of that work it's really kind of generated -- allowed us to generate in the previous quarter. The first of multisystem -- real multisystem orders in the company's history. So and there are I would say more, more opportunities like that represented in our pipeline. So again, it's not a -- not something that from an expectation standpoint, I would expect to see an impact on every quarter. But we are showing the impact already of the work that we have done and I think some of that will continue.

Great. Thank so much.

Thank you. Our next question comes from the line of Raj Denhoy from Jefferies. Your question please.

Yes. Hi, good afternoon.

Hi, Raj.

I wonder if I could ask a bit about the replacement cycle which were headed into -- it's proven a bit elusive to the other companies that have talked about replacement cycle and upgrade cycle that they were expecting, some of your lager competitors. I'm curious, if there is anything you can -- you can point too or anything you are doing to perhaps accelerate that replacement cycle at least maybe [indiscernible] capture more of it.

Yes. It's a good question. I mean, again, it represents especially in markets like the U.S. where we got essentially no new bunker construction and it really represents an opportunity. The simple answer is, we are really, really focused on this. We track as we do with all the other opportunities and deals in our sales funnel and our pipeline, we're the installed base opportunities as very separate distinct deal -- potential deals. There is a significant focus on the part of our sales organization and our sales management team on that opportunity as well. And it cuts across both CyberKnife and the TomoTherapy platforms probably a little bit more heavily weighted to Tomo than CyberKnife, but it certainly, if you looked it across the entire U.S. market, both platforms are reasonably strongly represented. So and we are -- I think the reason that we are excited about this, number one is, we are coming into this replacement cycle at a time when quite frankly we had -- we have the strongest -- the strongest product line up and the best functioning products that the company has had in it's history. All the work that we have done over the last three plus years with regards to product improvement, functionality improvement, reliability, upgrading of our service and support. All other things that we started to report on a regular basis the customer perception, metrics on, customers sat, customer loyalty, we are really lining up in a perfect timeframe kind of a horizon here because it's -- all of this is building and it's kind of come to fruition at the moment in time and we are coming into this, this next 36 months when we got a real inflexion point and a [indiscernible] of opportunities in our own bunkers. And we are laser locked on that -- essentially that strategy, bunker retention.

So when you gave that number of -- 15% of the orders were replacements in the quarter, what's the context for that, so a year ago in this quarter where was the rate of replacements in your orders, the percentage of replacements in your orders?

We are more Raj in the high single digit. The last two quarters we have been between 15% and 20% respectively. I don't want to pin us down to that number on a quarterly basis. I do think it's safe to say going forward on an annual basis, the replacement opportunity is a key factor to give us confidence to say that we could grow it 2x to 3x, market rate of growth.

Okay. That's helpful. And just one last one, you mentioned even despite the heavy age-outs you've seen in the last couple of quarters that you do expect some of those potentially come back and I'm curious if there is anything you can offer in terms of -- how often that has happened, if there is any particular of the $44 million in age out, the last two quarters you would expect to capture -- or still capture back?

Yes. I mean historically, we have disclosed, so we didn't have any orders at age out come to revenue this quarter. However, in the previous two quarters before that we had two in the first quarter and two in the fourth quarter. And I'm not going to give a number each quarter but what I can say is, Josh and I were confident that we have orders that have aged out that we know we are working opportunity, we know construction in process and it's just a matter of time.

Okay. Thank you.

Thanks Raj.

Thank you. Our next question comes from the line of Suraj Kalia from Northland Securities. Your question please.

Good afternoon, gentlemen. Congratulations in the quarter. So Josh, let me start off with at least a question for you. For the Chinese market, Josh, obviously, there are macro level issues that everyone are concerned about. I know you guys don't give granularity to the extent that that I'm about to ask. But could you please give us color for exiting fiscal Q4, you know, what is the contribution from China that is baked into gross order number because sequentially there is a huge step, I understand the year-over-year comparison, I get it. Just trying to understand what -- where are the various buckets that will contribute to the $95 million, $96 million gross order number?

So the -- as I mentioned before Suraj, we don't have to have China with a huge inflection of point or [indiscernible] of opportunity here or near term order activity in order to deliver Q3 and Q4 or the full year $295 million gross order guidance number. As Kevin mentioned earlier, we actually had said several times that the biggest contribution proportionately in this year's new order activity would be coming from the Americas and EMEA. What China has become now obviously is a big future growth story given our success rate with the Class A licenses. And hopefully with our ability to expand beyond Class A radiotherapy into the value segment. So -- but as a percentage just as a -- kind of another benchmark, as a percentage of the overall backlog, right now, China is still a relatively modest number.

Right. I mean Josh had mentioned in his comments that the China is looking -- there is 11 units in backlog now. If you walk back the orders we've taken compared to what's been shipped. I think a fair to think of our growth year-over-year and maybe perhaps to help you understand why we are expecting the back half growth is -- one is, large growth in the CyberKnife product platform is availability now of the MLC. It's the replacement cycle that we've talked about representing the huge opportunity for us. And it's also the TomoTherapy being placed and have been available InCise single and dual vault where historically we -- we didn't show up and now we are. I mean those are the three items that are driving growth.

Okay. And Kevin two questions for you, first, I thought I heard you say something about a large [indiscernible] service orders at least there was commentary and I did not catch that what was that --

So I just want to be completely transparent here. So we had service revenue grow 5% this year -- this quarter, excuse me, 8% on a constant currency basis. And that's not the forward run rate right now for service revenue for the business. We had a benefit of $1.4 million in the quarter for training revenue. I characterize that as a large one-time event where we had training revenue that was utilized or expired. On an absolute dollar basis going forward in 2016, we are expecting early modest growth in service. I said last quarter that a 5% constant currency growth rate in 2016 is more appropriate and I wanted to address the fact that it was 8% this quarter. That's why we brought that up.

Fair enough. And Kevin product gross margins were sequentially down on an as reported basis. What should I -- what should we read from that and how should we look upon product gross margins exiting the fiscal year? Thank you for taking my questions.

Yes. I mean -- I'm not trying to be sure when I say this, plus you really shouldn’t read too much into it. The biggest driver of our product gross margin is location of sales. And to the extent that we sell more in one quarter, distributor we saw more in certain regions as compared to others or direct. That number is going to fluctuate, but you can pretty much look back over time and even forward-looking 41% to 45% product margin is the range we are going to be in. And the single biggest factor is what I just mentioned, channel mix. So I won't read into it. It's hard to answer your question.

Fair enough, thank you.

No problem.

Thank you. Our next question comes from the line of Jason Wittes from Brean Capital. Your question please.

Hi. Thanks for taking the questions. Just wanted to get a sense of the single and dual level -- dual bunkers that you are competing against. Is it a three-way race generally speaking or is it a two-way race in terms whom you are competing against, obviously Varian being in there but it's also Elekta sort of in there in terms of competing for those bunkers in a general sense?

I would say to some degree, I mean it varies from account to account and region to region, Jason, but when you look at the relative share of market that the three companies have, you said in general that seven of the ten bunkers in the U.S. are Varian bunkers, two of the ten are Elekta bunkers and we've got the tenth or the last one. More often than not what that will imply is, Varian is quite frankly the -- when we show up to compete for that -- that other bunker it's Varian's more often than not it's Varian's product that we are -- we are in competition with. There is some -- there are some pockets of Elekta installed base systems but again, proportionately it would follow what I just described in terms of share of market.

So with that in mind, is it a -- is really a two way race or a three way race in general of these open bunkers?

More often not it's probably a two way race.

Okay. That's helpful. And just to kind of clarify your comments on China, it sounds like basically there is no cancellation that marketing is going fine for you. You mentioned also that they haven't reinstated the whole licensing -- the Class A licensing program. But it sounds to me, do you have any visibility in terms of when that might be reinstated and kind of how should we be thinking about orders for the rest of the year until that program is reinstated?

On the front part of the question, beginning part of the question.

Yes.

We don't have any better visibility then we have last quarter or there anyone else quite frankly at this point about when NHFPC is likely to announce an update on their Class A radiotherapy license program. I did say in my prepared remarks that this delay -- this delay is actually consistent with what we've seen from them over the course of the entire first quarter of roughly 60 some odd licenses. You know, if you remember correctly, we went some period of time -- extended period of time with no licenses being issued and then there was a bonus of licenses released and so it has been choppy if you will from a rollout standpoint over time. And this doesn't, we are not finding this inconsistent with what we have seen in the past. I think that our understanding and belief is that a Class A radiotherapy category product very high end product from a technical and product specification and capability standpoint, is some procurement mechanism is going to remain in tact for those products and whether it's in the form of the Class A license program that they had for the last several years or something new. We think we are well positioned to be able to compete in that product segment going product. The other part of that discussion though that we want to make sure that we reinforce which has been part of our messaging in the last several quarters is, with all of the activity around Class A and our success rate there, it still only represents probably 12% to 15% of the overall Linac procurement situation in the country, 60% of the market opportunity there is in the -- that value segment that we are in the process of trying to develop a product for and get through the regulatory approval process. So we think that Class A or whatever program is ultimately introduced for that Class A segment, we are well-positioned going forward given what we -- what we've already seen and we hopefully are going to be participating in -- with a different product offering in the largest segment of the market opportunity there longer term in the value segment.

Okay. That's helpful. And I believe it's an earlier question, I guess it was Tycho asking about regions, last night, Varian did mention Japan was particularly weak as was Europe, love to get your take in terms of those markets and Europe performance there?

I will start with the last one which is Europe. I mean our EMEA region continues to be in our minds a successful contributor and kind of a disproportionate contributor right now. And I think the health of the funnel there is strong and so I don't have -- I'm not losing a lot of sleep over EMEA. Given our performance in Japan, the last several years and their consistency, I mean I think Japan for us is probably in a -- I will say at reload mode to some degree relative to the order flow over the last couple of years. But I think in that market too we are well-positioned going forward and we like the intermediate term outlook there. It's probably the market where we got a greatest degree of any region in our system, the great history of market share and market penetration. So those are not -- neither one of those are markets or regions that are causing us to lose sleep.

Okay. Great, Josh. Thank you very much.

Thank you. This does conclude the question-and-answer session of today's program. I would like to hand the program back to management for any further remarks.

So I would like to take this opportunity to thank all of the Accuray employees worldwide for their contributions in our second quarter of fiscal 2016. For those of you listening in thanks for joining us this afternoon. And we look forward to speaking with you on the third quarter call. Thanks very much.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.