Earnings Labs

Accuray Incorporated (ARAY)

Q3 2012 Earnings Call· Tue, May 8, 2012

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Transcript

Operator

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2012 Accuray Incorporated Earnings Conference Call. My name is Sonya and I will be your coordinator for today. [Operator Instructions] I will now turn the presentation over to your host for today’s conference, Tom Rathjen, Vice President of Investor Relations. Please proceed.

Thomas Rathjen

Analyst

Thank you, Sonya. Hello and thank you for joining our conference call this afternoon as we review Accuray’s third quarter of fiscal year 2012. Joining us today are Dr. Euan Thomson, Accuray’s President and Chief Executive Officer; and Derek Bertocci, Accuray’s Senior Vice President and Chief Financial Officer. Please note that today we will be referring to financial data which can be found in the summary slide deck on the Investor Relations page of the Accuray website at accuray.com/investors. Before we begin, I need to remind you that our presentation includes forward-looking statements that involve risks and uncertainties. There are certain number of factors that could cause actual events, results to differ materially from our expectations including risks related to our ability to achieve projected revenue, gross margin and profitability targets, achieve our TomoTherapy integration goals and improved performance in the U.S. through a realignment of our sales organization. These and other risks are more fully described in the press release we issued earlier this afternoon, our Form-10-K for fiscal 2012 and our other filings with the Security and Exchange Commission. We assume no obligation to update any forward-looking statements. And now, I would like to turn the call over to our President and Chief Executive Officer, Dr. Euan Thomson. Euan?

Euan Thomson

Analyst · Steve Beuchaw with Morgan Stanley

Thank you, Tom, and thanks to everyone for joining us today for Accuray’s third quarter of fiscal year 2012 conference call. To help illustrate the main points discussed this afternoon, we have posted slides on the Investor Relations page of the Accuray website. This afternoon I will update you on our integration metrics for TomoTherapy, discuss the global sales environment for our technologies and comment on the initiation of a landmark clinical study. I will then turn the call over to Derek Bertocci, who will provide a detailed financial review. During the call we will provide both GAAP and non-GAAP numbers. When Derek talks later, he will refer to both measures. But for the sake of clarity, I will refer only to the non-GAAP numbers since they give you a clear picture of Accuray’s ongoing core operations. We are pleased that both our financial and non-financial metrics meet or exceed what we have previously outlined for the investment community. Perhaps most importantly, our key forward indicators including our installed base growth, our shipments, our service margin and our book-to-bill ratio are all positive. While the integration of TomoTherapy is a complex undertaking, we have a clear strategy in place to drive future growth and deliver value to our shareholders. Unlike other companies in our industry, the majority of our installed base is less than 10 years old. As a result, only a fraction of our revenue is generated from replacing our own systems. Our strategy relies on successfully competing to win space in new or existing vaults and to do this we have to have the best technologies. Our Q3 performance demonstrates the success of this strategy. Year-on-year our installed base has increased by approximately 14%, which along with other initiatives, has increased our service revenue by 19%. Importantly, we…

Derek Bertocci

Analyst · JP Morgan

Thank you, Euan. Today, I will be reviewing our non-GAAP results which we believe are most representative of our ongoing core business operations. If I refer to GAAP results, I will specifically say so. In our press release announcing our results for this quarter, we provide details of the adjustments between GAAP and non-GAAP results. We also provided pro forma results for the 3 and 9 month periods ended March 31, 2012. Unless stated otherwise, all results for prior year periods represent the combined total of the results reported separately by Accuray and TomoTherapy as stand lone companies, excluding expenses related to the acquisition that were incurred during these periods. Results for Q3 indicate that we remained on track. We’re ahead our expectations to achieve the integration milestones we identified when we agree to acquire TomoTherapy. For the third quarter and first 9 months of fiscal 2012 total revenue was approximately unchanged from the prior year despite an increase in service revenue. This was caused by a number of factors. Prior to the acquisition Accuray and TomoTherapy accounted for warranty, training and installation services differently. We defer revenue for warranty, training and installation services included in the sale of a system whereas prior to the acquisition TomoTherapy recognized the full product contract price as product revenue, when the system was shipped or installed and accrued the cost of warranty training and installation services to be provided after the shipment or installation. As a result, during the first 3 and 9 month period ended March 31, 2011, TomoTherapy recorded approximately $3 million and $11 million more product revenue for TomoTherapy systems sold then we would have recorded in the same period respectively. We’ve recognized deferred service revenue as warranty services are provided over the term of the warranty. These changes in…

Euan Thomson

Analyst · Steve Beuchaw with Morgan Stanley

Thank you, Derek. As we discussed during the third quarter, Accuray remained on target to achieve the 3 milestones established for you to measure our success. We are on track to achieve our revenue guidance and maintain a book-to-bill ratio, greater than one. Our 16.1% service gross margin is ahead of this year’s projection and helping to create a profitable service business. We are on track to return the company to profitability by the latter part of fiscal 2013, ending June 30 2013. And with that we’ll now be happy to take your questions.

Operator

Operator

[Operator Instructions] Your first question comes from the line of Tycho Peterson with JP Morgan.

Evan Lodes

Analyst · JP Morgan

It’s Evan Lodes in for Tyco. Can you talk first about, if you expect book-to-bill to be over one for the year as a whole or does that only account for the fiscal fourth quarter?

Derek Bertocci

Analyst · JP Morgan

Yes, we are expecting the book-to-bill ratio to be over one for the full year.

Evan Lodes

Analyst · JP Morgan

Okay. And then in terms of the product gross margin, there has been a lot of focus on the service gross margin, but can you give us some color on the product gross margin, how we should expect that going forward. And then within product any mix color between Accuray and legacy Accuray, CyberKnife and Tomo approach would be great.

Derek Bertocci

Analyst · JP Morgan

So the product margin has been fairly steady through these quarters and, as I said, we did have some of these mobile units, which essentially similar to the vault construction include a mobile vault, if you will. We don’t make any money on that to speak of, but other than that, the margins have been fairly steady and we would expect them to be reasonably steady in the future. There is always some variability quarter-to-quarter, but not anything that I would think of as significant. And in terms of the profitability of the 2 products, historically there has been slightly higher margins on the CK product line than the TomoTherapy product line, and that might continue for a while.

Operator

Operator

Your next question comes from the line of Steve Beuchaw with Morgan Stanley.

William Carlile

Analyst · Steve Beuchaw with Morgan Stanley

This is Bill Carlile in for Steve. And so on the Siemens dynamic, could you go into maybe a little more detail on how the software dynamics are working there, particularly with regard to the variance Siemens agreements that’s now in place? Are you guys any more or less able to take replacement vaults now that they have a little bit more joined together business?

Euan Thomson

Analyst · Steve Beuchaw with Morgan Stanley

I would say no change. The software issue is obviously -- is their approach to gaining Siemens customers, it doesn’t impact our approach. Our approach is to really get in front of the customer themselves and explain that our products offer significant advantages over what are fairly old architecture systems -- [indiscernible] based systems, and we continue to do that. So the corporate relationship we have with Siemens remains intact as I indicated. The focus for us is certainly to work that to some extent but also to focus primarily on our contacts with customers. They in the end make the decisions.

William Carlile

Analyst · Steve Beuchaw with Morgan Stanley

All right. And on pricing you guys have mentioned broadly pricing ASPs were flat, I think across geographies. One of your competitors had highlighted an increasingly price aggressive dynamic in the United States. And I was wondering if there is more pressure in certain geographies than others with maybe a little offset?

Euan Thomson

Analyst · Steve Beuchaw with Morgan Stanley

There has really been no change, as I think Derek indicated and I think when I look globally at price pressure, I think the biggest price pressure tends to be in the emerging markets and we don’t really have products for large scale sales into emerging markets. That is a battle that is fought for the lower end of the technology spectrum and our products tend to be the premium products that are focused on more developed markets. So overall, I would say no macroscopic changes in pricing, no competitive elements forcing pricing changes. We really sell our systems based on their technological advantages, when people recognize those, I won’t say there is no price negotiation, but it’s not really as much of a competitive price dynamic.

Operator

Operator

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

Anthony Petrone

Analyst · Anthony Petrone with Jefferies

Just a couple on the PACE study that you initiated and I wondered if you could share with us specifically when enrollment begins on that study and what are the major time hurdles where you’ll accrue and publish data over the 10 year horizon?

Euan Thomson

Analyst · Anthony Petrone with Jefferies

Sure. So the study has begun enrollment at the Leeds Center in the U.K., the Royal Marsden Hospital and we’ll expand to other centers. We have some centers going through their review board and they will be the first to bring -- to start enrolling patients in addition to the Royal Marsden. We also have a actually a fairly large number of centers both in Europe and actually in the United States as well. And who are going through the early stages but as given us the verbal commitment they will enroll patients. In terms of milestones and timelines the overall the study needs to accrue still over a 1,000 patients we don’t really want to the too detailed of timeline on that you could think of it in terms of 2 to 3 years probably for total accruals to be completed, but that doesn’t mean 2 to 3 years prior and before any data comes out. First group of patients -- cohort of patients that's some reasonable number you would expect the early census to think about publishing sort of early information about say, side-effects and acute impacts of treatment. So that could happen within a couple of years.

Anthony Petrone

Analyst · Anthony Petrone with Jefferies

Okay. And then the R&D ramp sequentially, was any related to the commencement of PACE and from this level that you recognized in the quarter, what do we expect for R&D expenses?

Euan Thomson

Analyst · Anthony Petrone with Jefferies

There was nothing in the quarter related to PACE. I think as Derek indicated, you can think about this level carrying on. We don’t have any anticipated dramatic increases in R&D expenditure, but we are, we recognize significantly up over prior quarters and we want people to be prepared for, for that level to increase. The key is that we’re, I think that we are extremely excited about the rate at which we’re developing new technologies and we’re very bullish about the impact of those technologies once they are released.

Derek Bertocci

Analyst · Anthony Petrone with Jefferies

Just to clarify Anthony, we expect that level of R&D spending to be -- remain at that level for the next several quarters.

Anthony Petrone

Analyst · Anthony Petrone with Jefferies

Great and then last one from me is, you mentioned in the release and your prepared comments, Euan, about the sales force realignment and in last quarter you had sort of a Tomo shifting pattern seem to impact product sales to an extent. So I am wondering what was the impetus behind having to realign the sales force and where specifically were you are seeing weakness and of all the changes you have made, how do you see that sort of benefiting the overall business going forward?

Euan Thomson

Analyst · Anthony Petrone with Jefferies

I am not sure about the comment you made about TomoTherapy System, but I’ll address the -- sort of the global sales environment and perhaps our -- and how our sales force is aligned with it. I think the environment to selling 2 products versus one product, when we went through the acquisition was different in different parts of the world. In distributed territories preferred mode of operating was to maintain both distribution channels, and that’s proving to be very effective. So, as we indicated Japan, is actually doing extremely well, APAC and EMEA maintaining the momentum. In the U.S., we had a merged, combined direct sales force selling 2 different products. I think you can take this realignment as an indication that we’ve -- we’re really learning what works and what doesn’t work. We've seen territories where we are having success in selling. We got certain other territories in the United States where we’re seeing less success. And the purpose of the realignment is really to replicate success across the entire U.S. market. And of course, the boundaries on expansion of sales in the United States are sort of the macroeconomic environment, however, even with those constraints in place we were seeing differences which we felt gave us opportunity to improve in certain of the underperforming territories. So we’ve got in place now. We’ll have approximately the same number of people, it’s not a reduction. We are aligning teams which replicate the successful territories, and there are teams of people with different skill sets who are brought in at different times in the sales process, and I think it reflects how much we’ve learned over the past 3 quarters.

Operator

Operator

Your next question comes from the line of Charles Croson with Sidoti & Company.

Charles Croson

Analyst · Charles Croson with Sidoti & Company

Okay. The first one on the -- if we can just kind of talk about where were some of the purchase orders are coming from, where these key wins coming from a day, they largely newer customers and I know direction, I know you don’t break this out some numerically, but if you can give us directionally, which had stronger orders, was it the CyberKnife or TomoTherapy device?

Euan Thomson

Analyst · Charles Croson with Sidoti & Company

So, we don’t break out the orders between products, but I can say that and I think as we’ve indicated before where we’re particularly pleased with the way in which the TomoTherapy system orders are tracking. In terms of geographic mix I think we’ve sort of covered that. Overall, I would say the EMEA tends to be a very strong performer for us. We are very pleased with the progress we’ve made in Japan and APAC is certainly there as sort of a stalwart as well. So those are the real strengths. The type of customer I would say hasn’t changed very much. Concerning [ph] The U.S., we are focused still on the hospitals rather than the free standing centers. Internationally, we are very successful at the larger centers, but also at the smaller centers as well. Centers generally internationally tend to be larger than the U.S. You then tend to get the small independent standalone free standing vault so much in the U.S. So none of those dynamics I would say have really changed during the last quarter or 2.

Charles Croson

Analyst · Charles Croson with Sidoti & Company

I see, okay. And then just the cross selling opportunities, have you really seen -- got the sales force trained on cross selling both of these and have you seen a pretty good improvement with that and what you think that might do going forward?

Euan Thomson

Analyst · Charles Croson with Sidoti & Company

Yes, they are definitely there. Now those types of sales that resulted from cross selling are not necessarily quick wins. They still -- people still have to get budget together and get to know the product. So we are definitely seeing an increase in activity. We have had some wins from cross selling and we’ve had some very good indicators that our customers there that will in fact buy the other product. So there is definitely a lot of activity there, I would say that will probably be something that feeds us into next year.

Operator

Operator

Your next question comes from the line of Sean Lavin with Lazard Capital Markets.

Marie Thibault

Analyst · Sean Lavin with Lazard Capital Markets

It’s Marie Thibault for Sean Lavin. Congrats on the improvement in the service gross margin. I recall last quarter you said that as a result of the field upgrade to the Tomo Systems, there could be lumpiness in that metric from quarter-to-quarter. I just want to confirm. Should we still expect some lumpiness there or in the near term or will it be more steady improvements as we’ve seen over the last few quarters.

Euan Thomson

Analyst · Sean Lavin with Lazard Capital Markets

I think there will be some lumpiness in the amount of the improvement but overall I think you can expect this trend to continue. I think it’s been a real success story for us so far and all the indicators are that, that should carry on. We are very pleased and I think for those of you that have had feedback from customers I think you’ll find increasingly that customers are recognizing that and we would attribute some of that recognition of the improving reliability of TomoTherapy systems to sort of on-going sales success of that product line.

Marie Thibault

Analyst · Sean Lavin with Lazard Capital Markets

Okay. Great and I am just curious to hear a few more details on the strong growth you mentioned at Japan. Was it a recent ramp in order growth and do you think this increased payment that came on April 1 is going to have a near-term impact on order growth in the country?

Euan Thomson

Analyst · Sean Lavin with Lazard Capital Markets

As you probably know, nothing in Japan happens at lightning speed. So we don’t expect it to impact things overnight, but I think we’ve generally found that we’re just steadily building momentum in Japan. We released the G4 CyberKnife product. We’ve had a focus now on an increasing number of clinical applications. We are seeing increased use of the Stereotactic Body Radiotherapy throughout the body, which is slow and steadily increasing demand. We have formed now a very good relationship from a sales standpoint with Hitachi, our TomoTherapy distributor in Japan. They seem really engaged and hardworking. And so overall, I think we’re just seeing a very solid foundation, and it’s already starting to impact sort of new orders. So when we compare it year-on-year, and I think we feel, we feel pretty positive about the way the Japanese market is going for us right now.

Operator

Operator

Your next question comes from the line of Junaid Husain with Dougherty.

Junaid Husain

Analyst · Junaid Husain with Dougherty

Yes, Derek on the gross margin line, is there any way that you can help us things grew just the -- just the TomoTherapy service margins in the quarter relative to the prior year period?

Derek Bertocci

Analyst · Junaid Husain with Dougherty

In turn, well, we’re not breaking out the product lines, but are you looking at the TomoTherapy service improvement?

Junaid Husain

Analyst · Junaid Husain with Dougherty

Correct.

Derek Bertocci

Analyst · Junaid Husain with Dougherty

So the TomoTherapy service improvement has been following along the path that we had laid out, which was basically to take it from where we inherited it at the end of calendar 2010 minus 47%, our goal was to get it to 0, or slightly above 0, to hit our 20% target by the fourth quarter of fiscal ‘13. We still feel that we’re on track for that to at least achieve that or beat it. So we certainly think that we’re on track for hitting those numbers for the TomoTherapy service business.

Euan Thomson

Analyst · Junaid Husain with Dougherty

It becomes slightly harder to break out one particular product line, as we bring the 2 service teams together, because they are shared overall resources and costs and so on, and we do now have a certain number of service engineers even servicing both product lines. So it becomes a little harder to break it out. I think the data that we’ve given, which should help you is the data we showed last quarter, which is up our slide set again today, which shows the cost of servicing a new TomoTherapy system compared to the cost of servicing the overall installed base. And that compares with the cost of the CyberKnife, so you’ve got there to the 3 pools of machine that you can use for a relative comparison.

Junaid Husain

Analyst · Junaid Husain with Dougherty

Got it, that’s helpful. And then with regards to the higher installed base, I know your engineers have been looking at ways to improve the reliability of the machine and freestanding centers. Internationally, we are very successful. At what point, do you retrofit the higher installed base within the new Linac and have you already started

Euan Thomson

Analyst · Junaid Husain with Dougherty

Yes, so we will slowly put those new Linacs into the installed base. Obviously our priority is to make sure we have enough of those new Linac accelerators to go into all the new systems we ship. With the surplus in capacity that’s starting to arise, we will actually start to feed those into the base. On the radio frequency, the radio frequency upgrades that we talked about a couple of quarters ago is now completed that was a cost that we incurred to actively upgrade the installed base with a related improvement.

Junaid Husain

Analyst · Junaid Husain with Dougherty

Okay. And then Derek could you tell me what’s the - the [indiscernible] accelerator -- what’s your cost utilization currently are you basically selling everything you make there? Or taking the old Linacs and putting on every [indiscernible]?

Derek Bertocci

Analyst · Junaid Husain with Dougherty

So the new Linac from our Twin Peaks facility has been on every new system we produced since the beginning of calendar 2011. We are also then now getting productions to the point where as Euan mentioned we have some capacity to handle service replacements. So all new systems from 1 year and a quarter ago forward, has the new Twin Peaks Linac.

Operator

Operator

At this time, I show no questions in the queue.

Euan Thomson

Analyst · Steve Beuchaw with Morgan Stanley

Okay. Thank you for joining us on this afternoon's call. I want to take a moment to acknowledge Accuray employees for their continued dedication to success and to a continued focus on improving the life of cancer patients globally. We look forward to speaking with you on our next call.

Operator

Operator

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation. Have a wonderful day.