Accuray Incorporated (ARAY) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Accuray Incorporated Fiscal Q1 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 follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to hand the call over to your host for today's conference, Mr. Doug Sherk. Sir, you may begin your conference.

Thank you, Chelsea and good afternoon everyone. Thank you for joining us today on our conference call, as we review Accuray's first quarter fiscal 2016 financial results for the quarter that ended September 30, 2015. Participating on today’s call are Josh Levine, President and Chief Executive Officer of Accuray as well as 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 second quarter and full fiscal year 2016. There are a number of factors that could 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. Accuray is out of the gate in fiscal year 2016 in strong fashion. Performance in the first quarter of FY 16 saw continued momentum in order activity for both the CyberKnife and TomoTherapy Systems, driven by our continued focus on commercial execution. For the first quarter we reported gross orders of just under $65 million which represents an 18% increase on a constant currency basis compared with the prior year first quarter. Additionally, on a constant currency basis revenues increased 12% while operating expenses decreased 10% demonstrating our ability to drive significant operating leverage in the business. Those results led to a $10.8 million improvement in EBITDA year-over-year and generated an increase in cash and investments of $9.2 million. To put that in perspective comparatively, in the first quarter of the prior year we had a decrease in cash and investments of approximately $19 million. On the gross order front we continue to see strong traction in CyberKnife System orders with growing unit volumes of our M6 series with the InCise Multileaf Collimator. It is clear that commercial lease of the MLC is transforming the overall functionality and utility of the CyberKnife M6. As more customer sites gain clinical experience they are continuing to see significantly reduced treatment times, increased throughput and a growing volume of patients that can be treated with CyberKnife. On the product registration front, we've obtained regulatory approval for the InCise MLC in the U.S., EU and Japan and we are pursuing approval in additional markets which should drive our opportunity with CyberKnife. Turning to our TomoTherapy System, we are pleased with our continued momentum in the new TomoTherapy orders, both in terms of unit volume as well as the expansion of the types of facilities that TomoTherapy is effectively competing in. We are winning orders from customers with single or dual vaults and in Q1 more than half of the total mix of TomoTherapy orders came from community or regional hospitals. Transitioning to activities related to our China growth strategy we continue to be excited about our commercial growth prospects in China. The five-year overall cancer survival rate is 31% in China which is one of the lowest in the developing world and is indicative of significantly constrained patient access to treatments such as radiation therapy. In our fourth quarter call we stated that of the 34 total Class A licenses awarded to Accuray, all but two have been recorded into our backlog. I can confirm on this call that in the first quarter these two remaining orders went to backlog. With regards to future Class A licenses, we have not received any updates related to the next phase of the Class A radiotherapy procurement process, but the current delay in the release of licenses is consistent with what we've seen over the last two years and regardless of the timing there remains significant growth opportunity. Based on the most conservative projections of cancer incidents and forecasted diagnosis going forward there is a critical lack of radiotherapy treatment capacity to meet the increase in forecasted patient demand. Going forward we believe we are well positioned for the issuance of additional Class A user licenses in this important strategic market. With regards to the macroeconomic factors in China, to date we have not seen any impact on order backlog related to the expected timing of when those systems will go to revenue. Additionally, we have submitted a new product registration application with the CFDA that when approved would enable Accuray to participate in radiotherapy product segments beyond the Class A space in China. Based on our market research, we believe there is an opportunity in the core value segment of the market for a product that has strong utility and customer appear in the smaller mainly private sector provincial hospitals that represent a significant growth opportunity over the next decade. Turning to another of our key initiatives, we continue to advance our selling strategy focused on strategy accounts and group purchasing organizations. In the first quarter we had three system orders that were placed by hospitals affiliated with our GPO partners, which is consistent with activity levels that we reported in our fiscal fourth quarter last year. Additionally, as we reported during our Q4 call, in the current quarter we received a five-unit multisystem order for one CyberKnife and four TomoTherapy Systems in the U.S. which is the first multisystem order of this size since my tenure began at Accuray. The four TomoTherapy Systems will replace conventional linear accelerators in single freestanding centers reinforcing TomoTherapy's value as a mainstream radiation therapy device. We've been communicating over the past several quarters of our focus on overall customer satisfaction rates and I'd like to share some additional insights in this area. The importance of satisfaction and how it impacts future sales applies to both, replacement sales to existing accounts as well as new orders replacing competitive systems. Independent research organizations report that Accuray now consistent scores highest in several customer satisfaction related data points. Additionally a recently published service track radiation oncology report issued by IMV a third-party market research firm including results from more than 500 respondents is another indicator of the impact of our focus on customer satisfaction. In that study Accuray received the highest net promoter score in the industry which is a strong indicator that the users of our products would recommend Accuray systems to a colleague. Our commercial momentum indicates we are making real progress in delivering superior service and reliable product performance on a consistent basis. During the quarter roughly 20% of gross orders were replacement sales to our existing customer base, which shows that our customers value their relationship with Accuray and want to own our latest technology. At the same time, we are experiencing commercial success in winning competitive markers. During the quarter more than a third of gross orders for Accuray systems were to replace conventional linear accelerators. Our entire team is committed to ensuring that our customers can rely on their Accuray equipment to provide their patients with the best possible radiation therapy treatment. These most recent replacement sales and competitive replacement orders reinforced this focus and demonstrate we are making significant progress in driving broad market acceptance with CyberKnife and TomoTherapy Systems. I'd like to finish my remarks with a highlight on our strategic collaboration with RaySearch Laboratories. I am excited about the recently announced expansion of our collaboration and partnership which will lead to the integration of treatment planning support for the TomoTherapy and CyberKnife Systems with the RayStation Treatment Planning System. RayStation is one of the most technically advanced independent treatment planning systems available. The system is well known for its multi-criteria optimization capabilities, which allows users to rapidly assess potential planning alternatives in order to determine optimal plans for every patient. RayStation will provide and ideal complement to the unique Accuray Treatment Delivery Systems enabling customers to choose the delivery technology that will best meet their needs. We expect the initial version of RayStation which will provide planning for our TomoTherapy System will be available in the late summer or fall of calendar 2016. RayStation for CyberKnife will follow that by a quarter or two. Accuray and RaySearch had previously announced a long-term collaboration regarding the RayCare oncology information system. Under that agreement Accuray will have the opportunity to offer RayCare to clinicians who use the TomoTherapy and CyberKnife System product portfolios. We believe the integration of their industry leading treatment planning system along with our innovative delivery systems will enable the clinicians to further optimize their experience and improve market access for Accuray's technologies. Our expanded partnership with RaySearch is also part of our focus on improving our installed base satisfaction, one of our key strategies for growing the business and driving shareholder value. And now I'd like to turn the call over to Kevin to review the key financial highlights. Kevin?

Thank you, Josh and good afternoon everyone. I will start off my portion of our prepared remarks with further detail on product orders and then provide additional color on our P&L and balance sheet. As Josh noted in his comments gross orders were $64.9 million which represented a 10% increase from the prior year first quarter. On a cost and currency basis gross orders increased 18%. With regards to the reconciliation between gross and net orders, age outs, which are orders that have not gone to revenue in 30 months since being recorded offset by orders going to revenue that were previously aged out were $18 million in the first quarter. Our age outs for the first quarter were lower than our forecast of $20 million to $23 million. Cancellations, which occur when a customer definitively cancels their backlog order were $3 million representing one order during the first quarter. With regard to the impact of foreign currency on backlog, the U.S. dollar was fairly stable in the quarter, which resulted in $1.3 million increase to backlog. Net orders totaled $44.8 million in the quarter an increase of 39% over the prior year first quarter. To provide additional color around gross order performance we are pleased with the momentum around CyberKnife orders with strong year-over-year unit volume improvement at our EIMEA and U.S. regions. Additionally, TomoTherapy gross orders were also strong with the EIMEA region experiencing the largest percent growth in regards to TomoTherapy unit volume. As mentioned on our previous call, we are looking for the EIMEA region to generate growth that is significantly in excess of overall market growth in fiscal 2016 and thereafter get started. Moving on to our income statement. Total revenues for the first quarter of $89.6 million represents 9% increase from the prior fiscal year first quarter. On a constant currency basis revenue increased 12%. Product revenues at $40 million increased 21% year-over-year and 22% on a constant currency basis. CyberKnife unit volumes accounted for a majority of the percentage increase in product revenue during the first quarter which we attribute to the commercial availability of the MLC. Service revenues at $49.6 million were up slightly but increased 5% on a constant currency basis, which is consistent with the fourth quarter growth rate. We continue to focus and improve our service contract vacancy rate over time; however, currency is largely still offsetting our increases in the installed base. Total gross profit of $33.9 million increased $6.1 million over the prior year first quarter for 22%. The improvement is attributable to the 280 basis point improvement in our service gross profit margin and 500 basis point improvement in our product gross profit margins. Our overall gross profit margin for the quarter was 37.8% an increase of 410 basis points. On a constant currency basis overall gross profit margin for the quarter is 38.6% or 490 basis points above prior year. Product gross margins were 43% on a constant currency basis compared to prior fiscal year first quarter of 37.4%. Margin improvements were related to the higher priced systems, particularly on the CyberKnife side and lower overall product costs as the prior year first quarter had certain expenses related to our now completed transfer of production from Sunnyvale to the Madison facility. Service gross margins were 35.3% on a constant currency basis compared to prior year first quarter service margins of 31.3%. The improvement in our service gross margins is a direct reflection of our focus on managing service costs, improving the reliability of our systems and the lower percentage of installed systems without service contracts. Now turning to our operating expenses. Operating expenses were lower than the prior year first quarter by 12% demonstrating continued disciplined expense control. The $5.3 million decrease was primarily the result of timing of [indiscernible] related expenses in sales and marketing as also occurred in the first quarter of prior year and fell in the second quarter of this year. Additionally we reduced compensation related expenses in G&A and sales and marketing functions. Stock based compensation expenses were also $800,000 lower in the first quarter of 2016. These decreases were offset by slight increase in research and development to support ongoing product development efforts. Our topline execution and operating expense control resulted in adjusted EBITDA of $2.3 million for the first quarter, a significant improvement over the last year's EBITDA loss of $8.5 million. This performance was driven by all lines of the income statement, revenue, performance, margin expansion and operating expense control. From a balance sheet perspective we had $9.2 million of cash on the balance sheet and ending the quarter with $153.1 million cash and investments. Accounts receivable decreased by $21 million in the quarter as several revenue transactions that had shipped by way of letter of credit in the fourth quarter of 2015 were converted to cash. The decrease in accounts receivable was offset by $9.6 million net loss and $7.6 million increase in inventories. Our inventories in the first quarter increased primarily to support forecast and revenue transactions and also slight plain growth and service inventories. I would expect going forward that inventory increases in future quarters will be smaller and would expect inventories at the end of 2016 to be approximately the same as at the end of 2015. In regards to our cash flow, we do not expect to repeat the same level of cash flow generation during the second quarter given the largest contributor to the first-quarter performance with the decrease in accounts receivable. However, on a full-year basis we continue to expect our company will be significantly cash flow positive with cash flow increasing in the back half of the year. Lastly, before I move on to guidance, I would like to touch base on our long-term debt outstanding in the form of convertible notes due in August 2016 in February 2018. We continue to diligently explore all available options with our most immediate focus directed to the $100 million convertible notes due in August 2016. You will now notice that these notes are classified as short-term liabilities on our balance sheet. We are focusing on the following strategies for our converts, including refinancing the existing notes with longer-term notes that are purely debt or issuing a new purely debt instrument and using those proceeds to redeem the notes of maturity. However, we haven't ruled out other available options and the board and management are focused on strategies that limit shareholder dilution. We will continue to provide updates as we have additional execution milestones to report. Our shareholders should know that the August 2016 notes are the top of our priority list in terms of action items to improve the capital structure of the company and more importantly putting aside uncertainty over how these will be redeemed. Now moving onto our financial guidance for fiscal 2016. We are reiterating our revenue guidance in the range of $395 million to $410 million representing growth of 4% to 8% over fiscal 2015. Additionally we are not providing quarterly guidance on revenues. However it appears that the current consensus estimates are properly modeled to 2016 quarterly revenue contributions off of 2015 quarterly actual. We are also reaffirming our outlook for adjusted EBITDA guidance in the range of $25 million to $35 million representing growth of $112 to $197% over 2015. We continue to anticipate operating expenses in fiscal 2016 will remain relatively flat compared to 2015. As mentioned previously, the first quarter had reduced tradeshow and headcount related expenses and should not be used as a proxy for operating expenses for the remainder of the year. Additionally we anticipate positive cash flow for the year and if we achieve the upper end of our EBITDA guidance we would be reporting GAAP operating income. Both of these represent important milestones for Accuray and the team is focused on achieving these goals. Continuing on with our guidance we are anticipating gross orders for the full year to be in the range of the current analyst consensus of approximately $295 million which would represent approximately 10% year-over-year growth. Furthermore, given that we are four months into the fiscal year and have greater clarity on the cadence of gross orders we do not expect a precipitous drop in gross orders in the third fiscal quarter of 2016 as experienced in 2015 as we look to produce more consistent results. We expect a similar total gross order number in both our second and third quarter. This will mean year-over-year growth rates on gross orders will be relatively flat to slightly down in the second quarter to a very tough comparable. With respect to future age outs and cancellations in fiscal 2016, second quarter age outs should be in the range of $15 million to $19 million and will continue to decline throughout the year. We believe the quality of our backlog has improved, though there will still be variability between quarters. We continue to expect to see a year-over-year improvement in age outs as a percentage of average backlog driven by the process changes implemented over the previous three fiscal years. Additionally, we are beginning to see orders that have previously aged out come back to revenue which supports the notion that an order greater than 30 months old is not always the lost revenue opportunity for the company. Now I'd like to hand the call back to Josh. Josh?

Thanks Kevin. I'm encouraged by our performance in Q1 as we show continued momentum in commercial execution across all of our strategic initiatives and we outperformed the markets. We believe that as we continue to execute our fiscal 2016 operating plan, Accuray will finish this fiscal cycle in a vastly different position from a financial perspective relative to growth in orders and revenue, operating profit and positive cash flow generation. And we are now ready to open the call for questions.

[Operator Instructions] And our first question today comes from Steve Beuchaw with Morgan Stanley. Your line is now open.

Hi guys, thanks for taking the questions. I think I'll start actually on the service revenue piece of the story. The one thing that was a little surprising relative to our expectations with service revenue, I wonder if you could just refresh us a little bit on how you're thinking about driving revenue when you could just refresh little bit on how you think about driving service revenue faster, I know part of that is attach rates and then part of it might be service contract structures. Can you give us a sense for how that can evolve over the next year or two? Thanks.

Yes David, it is Kevin. So as I have mentioned in my prepared remarks our constant currency service revenue growth rate in Q1 was 5% which are comparable to the most recently completed fourth quarter. So the growth rate year-over-year is consistent. Also I pointed out that Q1 is typically our lowest quarter in regards to service revenue. There are two factors that contribute to our lower Q1 that would make me believe that moving out the quarters should be higher than the Q1 rate. Those two things are installation and training revenue. So Q1 is when we install typically the least amount of systems. But with every one of those systems we also record installation and training revenue which causes the slight decrease in Q1. In terms of driving future service revenues, we continue to work on our contract vacancy rate. We’ve seen improvement over the last kind of five sequential quarters in terms of driving that number that is basically right around 10% at this time and we’re continuing to look to improve on that.

Got it. And then Josh for you, I would love to just get a bit of reflection. I think about the commentary around orders this year and the 295 figure, I mean the 295 figure is organically actually a little bit bigger number than it was two or three months ago just given that currencies have actually been volatile and negative in some important areas. So number one, am I interpreting this right thinking that your optimism on orders is maybe very slightly incrementally higher than it was when we heard from you on the prior call? And I guess secondarily, are there any things you might spike out as being particularly interesting in terms of how the fiscal year has evolved thus far? Thank you.

So, to answer the first part of it, Steve, I mean I would say we have a robust view of and a positive view of the momentum that the business is now showing over the last several quarters. When you look at the things that we’ve introduced from product portfolio standpoint in terms of the commercial availability of MLC a continued market penetration that TomoTherapy is enjoying some of the things we've talked about with regards to GPO and strategic account, portfolio management have started to kick in and I'd say we have a, from an outlook standpoint we've got pretty strong view of continued momentum. With that said, I think we are working hard to try not to get ahead of ourselves and we want to encourage you and the people listening in on this call to not do that either. We are across all of the commercial execution drivers of the business, we feel strongly about how we’re performing and our ability to execute - to continue to execute going forward. On your question from mix and geography standpoint, I mean I think if you go back to the fourth quarter call in terms of absolute growth percentage relative to orders – gross orders we expected and we are seeing the Americas and the EMEA region will be the largest growth contributors in this fiscal cycle in the year. And we think that that is due to the opportunity for both installed base replacement sale impact as well as taking advantage of the MLC availability and its impact on M6 going forward. When you think about EMEA though, prior year 2015 EMEA was down about 14% in unit impact. So we would on a comparable basis expect that to grow comparably with prior year well in excess of overall market growth rates. We share the same thing obviously with the Americas region relative to expected growth in 2016 and I would say that in general we would expect it to be comparable with what we saw in 2015 which was north of 20%. So with just a final look at China and the Asia-Pacific regions, obviously these are strategic, very significant strategic areas of focus for the business and, but we forecasted probably more modest numbers for the region overall based on really primarily the tough comparables to prior year.

That is as always very helpful. Thanks so much, guys.

Thanks Steve.

And our next question comes from the line of Tycho Peterson with JP Morgan. Your line is now open.

Thanks. Maybe Josh just dovetailing off the last question, can you comment specifically on Japan given the opportunity there of $400 million or so target bunker, how are you thinking about the set up there for this year?

So, we expect Japan will be a good contributor Tycho. I think the opportunity that you’re referring to in those 450 bunkers is with a product that is something other than what we currently have in the portfolio and I would say that this is probably an opportunity that we don’t start to see activated until probably the back half of this year or maybe in late Q3, early Q4. So I would say, I would caution on being too aggressive in factoring that impacting in but we expect that we would be in the market with that product sometime towards the latter part of the year.

And then on the U.S. market in the commentary on competitive wins is encouraging, can you add a little bit more color, I mean presumably these are almost all Tomo systems, but are any of them CyberKnife and maybe also just talk about the pricing dynamics as you are going to swap out competitive systems?

I mean, for us the opportunity in the U.S. market is two-fold. The first one is the replacement sale opportunity. That one is primarily TomoTherapy, although it is not exclusively Tomo, but I would say primarily TomoTherapy in the U.S. replacement opportunity. As you have seen the numbers, the customer sat rates, the third party data, we are I would say well beyond questions about the product performance, product reliability issues. That is certainly helping us in terms of driving wins competitively, both in competitive sockets and obviously becoming a more important option in terms of the existing customer base in terms of trade in, trade up opportunities. CyberKnife is really being driven by the MLC discussion and MLC availability. I think you’ve seen probably some of the information that we’ve put out. We had more information at ESTRO around the product performance improvement side, significant reductions in treatment time, overall throughput. The things that had been the biggest obstacles to adoption around CyberKnife are really quickly being pulled off the table at this point in terms of customer perception. So we feel pretty bullish on where CyberKnife will be overall this year relative to market – for the market impact – for the market penetration based on MLC availability.

Okay. And then last one, you made an interesting comment about some of the older systems age-outs are kind of coming back to revenue. I’m wondering if you can maybe just elaborate a little bit on that are you changing your selling effort or is there some other dynamic and then how big is that opportunity for some of those older age-outs actually turning to revenue?

Yes Tycho, this is Kevin. It represents an opportunity for us and in the last two quarters we have had two units in each quarter, two in this first quarter and two last quarter that would have aged-out and now gone to revenue. I think we feel cautiously optimistic, at this point I would say with orders that have aged-out where we see that it’s really an end user side issue. It could be we saw a lot of issues around currency in countries where the dollar has strengthened and the distributor would pay us in dollars and the end user contract is in local currency. So I’m not prepared to give kind of a percent as to what we think can come back in the future, but the fact over the last two quarters, we have added $10 million in product revenue that is previously aged-out and gone back into revenue.

That is interesting, thanks guys.

Yep.

And our next question comes from Brooks O’Neil with Dougherty & Company. Your line is now open.

Brooks are you there? Brooks O’Neil: I’m sorry, congratulations on the strong results in Q1. I’m looking forward to the rest of the year.

Thank you. Brooks O’Neil: So, you mentioned that some of the CyberKnife momentum was related to the recent release of the MLC. I just want to be sure that you feel there is sustainability to the momentum in that product line that goes beyond just taking advantage of backlog or systems that have been waiting for the availability of the MLC?

Yes I mean just to be crystal clear about this, the order mix is heavily represented by new orders. I think we said last quarter that 80% of the orders that we took for CyberKnife M6 included an MLC. So I think that strongly speaks to that piece. As you know, there were orders in the backlog that had been orders that were placed with the MLC and that were waiting for release in commercial availability. So those are also part, obviously part of the impact and overall contribution. But, I guess the other thing I would note Brooks is that we had probably a maybe five or six month hedge spot in the U.S. in commercial lease just given the difference in timing between when we were getting all the work done at our evaluation sites that we had talked about early on. You will remember that we add some U.S. locations, you will remember that we also add some international locations primarily focused in Western Europe, the Eurozone countries and we were – we had the lease essentially for sale MLC in the U.S. market probably back maybe April, May timeframe of this year, but we didn’t release for sale in Europe which is the other big contributing element to this until probably about two months ago. So we think that there is absolutely no, number one we have not done ramping in the U.S. that is one observation, number two we barely started ramping in Europe at this point and Japan and some of those other markets. So I’m highly encouraged about the trends, the impact that we’re seeing, the momentum relative to order activity and order volume and I’m going to suggest that that will continue. Brooks O’Neil: That is great. And then secondly, you talked about the value priced or sort of let’s call it midstream system you’re planning for China, do you see any opportunity for a system like that in other markets around the world?

Yes, so the answer is yes, the focus, the near term focus is obviously the China opportunity just given the magnitude of what is – what is in front of us there, but we do think that there are opportunities for that kind of core value product in other markets, either emerging markets or even perhaps in some mature markets. It is probably less likely that you would see that in the U.S. and basically in terms of product segmentation and market segmentation, these are products that from a functionality standpoint well having reasonably strong clinical utility. They probably would not be considered premium products in terms of product positioning. So less likely you would see us in the U.S. market or the Americas region with that kind of an offering. Brooks O’Neil: Okay, good and then just last question. Kevin talked a lot about the focus on the converts in addressing those. I’m just curious if you would be willing to put any parameters around timing, are you thinking you might be able to achieve something sooner rather than later or do you think it will go right down to the August deadline?

Sooner rather than later would be the strong, strong response to that message. And this has a lot of energy attached to it has a lot of focus attached and we have no intention of waiting until those notes come to maturity next August. Brooks O’Neil: Great, congratulations again.

Thank you.

And our next question comes from Jason Wittes with Brean Capital. Your line is now open.

Hi thanks for taking my questions. Just wanted to make sure I understand the timelines for the lower cost system. Is sounds like you just submitted in China and is there when should we anticipate approval and it sounds like also Japan has been submitted as well from your earlier discussions, is that the right way to think about it and kind of what timeframe do you have to think about it.

Yes, Jason. So look we are excited about this opportunity. For competitive reasons I am going to prefer not to get too detailed on this topic, but in a general sense I say from a China standpoint, we have submitted the product registration applications CFDA and we believe that there are other markets as well that offer an opportunity for this product. The estimate right now is that timing of approval in China specifically is likely to be probably sometime in early calendar year 2017.

Okay, that is helpful and also on China for the Premium segment, you mentioned there is a pause in terms of approvals for new systems, when should we expect that to resume or what is the general thinking in terms of timing on that?

Just to be specific, I think as I said in my prepared remarks that what we are seeing timing wise right now is actually not inconsistent with what we’ve seen over the course of the last two years. It has been a kind of a rolling experience in starts and stops right. We have had reasonably long time gaps and delays over the course of the last two years, two and a half years in Class A licensed issuance, cadence if you will. So what we’re seeing right now is not inconsistent with what we’ve experienced in the past and we are obviously very focused on this. It’s been a source terrific success for us over the course of last couple of years, but we don’t have any direct influence over the Ministry of Health there relative to timing. So it’s – we are certainly feeling like we’re still well positioned and as those licenses get issued, I’m going to guess it we are going to continue to compete very successfully for them.

Okay. That's very helpful. One last question, in terms of CyberKnife with the InCise MLC, how are customers using that system now versus how they were using CyberKnife without the MLC, are you seeing a noted changed in procedures are doing, maybe you could elaborate, that would be very helpful?

Yes, so the answer is what the most immediate impact is probably directly related to deal size. So you’ve got the benefits of a greater deal size with the MLC. You also have an efficiency obviously relative to treatment speed and throughput that is really vastly different. I mean it is a significant step change in terms of what customers had experienced Jason, prior to MLC availability. The biggest areas of our clinical case mix or application through the evaluation size continue to be things like SRS or intra-cranial is still a heavy piece of the mix, but basically liver, prostate SBRT, prostate cases and so I would say a reasonably broad mix of clinical application and case mix focused since we've launched it.

And so it sounds like I definitely understand the efficiency help as to your SBRT procedures, but I’m just curious if even some centers are starting to venture off and do some more standard relation type procedures like IMRT and things like now that they can do it?

I know that there are accounts that are experienced CyberKnife users that have MLCs being installed at literally at present, kind of as we speak, that are talking about things like breasts. That's another interesting one I think that probably would not have been kind of keyed up in the old days before MLC availability. If you think about the advances that have been made in SBRT prostate over the course of the last several years, I think there are a lot of folks out there that are starting to believe that breasts could be that same kind of ramp potentially.

Okay. Very helpful, thank you Josh.

And our next question comes from Anthony Petrone with Jefferies. Your line is now open.

Thanks and good afternoon. Maybe to start on gross order growth in the quarter and even guidance for the year, I’m just wondering if you could maybe breakout the extent how much of the growth is actually coming from competitive wins and how much Josh, you alluded to replacement orders as well, how much is coming from replacement orders from renewal of the base?

So, I’m going to, we could be in a race here to see if Kevin finds it first or I find it first.

Let me address your replacement question going forward because we’re not going to provide specific numbers around how much of the gross order forecast is specific to replacements. However, what we can remind you is that we do have approximately five times the number of units coming up on the replacement cycle as compared to the previous three years. So this does represent a tremendous opportunity for us that is factored into our guidance. We think given the increased TomoTherapy reliability, customer satisfaction, those are really critical elements achieving those replacement wins and we have been able to win our replacement bunkers at a fairly high rate.

And maybe just to quantify that a bit, I mean can you give us an update on the total installed base today and maybe a percentage of that that is coming up for renewal? I mean by our estimates I think the total installed base between CyberKnife and Tomo is around 700 systems, but maybe just to clarify and get fresh numbers on that would be helpful?

Yes, I mean so we have stopped giving exact installed base estimates. I think to do a replacement model you could assume between 775 and 800 or so installed. We presented at the Morgan Stanley Conference I'd encourage you to look at the breakout between the gross units that are coming up on replacement cycle, but it represents roughly 200 units that are coming on their tenure life over the next three years.

I mean you say in round numbers Anthony you'd say somewhere between 25% and a third of the installed base over the course of the next 36 months which is really a very unique situation for us. It is heavily concentrated in the U.S. and Western Europe. It represents both product platforms, probably just given the mix between the installed base of Tomo versus CK, certainly heavier Tomo, but both are represented and it’s coming, quite frankly it’s coming at a good time given the work we have done quite frankly to drive the improvement in customer satisfaction and overall market perception about the utility, the functionality improvements in the product. I mean treatment speed, treatment planning capability. We've got the best products this company has ever had in the market place today and customers are recognizing that and that’s an important lever for us in our install base for placement sales strategy.

It is interesting feedback and may be just to kind of segway into a theme at ESTRO which was stereotactic radiosurgery and sort of kind of factor that back into the renewal. Do you think that a larger amount of the base could actually switch over to CyberKnife just considering that the estimates out there for us are quite higher in terms of growth, so you think is that a theme that can potentially happen?

So it’s an interesting question. I think when you think about mainstream product configuration and mainstream products, market acceptance, market adoption, I think the Tomo will still be more of a mainstream product based on a couple of factors, not the least of which is just the overall footprint. You are talking about product replacement in a way [indiscernible] situation. If you talk about a competitive situation, you are talking about a bunker that would be probably need more modification based on the power, the system and the footprint. Tomo is certainly much more of a replacement sale in that kind of a situation. But there is no question that the trend towards SBRT and SRS from both a clinical adoption standpoint and a reimbursement methodology standpoint are driving probably greater usage of those modalities over time for the foreseeable future. I mean it trends towards hyperfractionation. I am going to predict they are not going away. I mean I think that the market has clearly both clinically and from a patient experienced patient quality of life standpoint come to recognize hyperfractionation and SBRT and SRS are the if not the preferred approach, certainly an approach that more and more people are trying to adopt and give themselves capability around. So I do think that also says that it should be a reasonably strong level of contribution in terms of continuing CyberKnife momentum.

That's helpful. And may be just turning to the P&L last one from me is just the service margin. If we could just get an update there, sequentially it came in a bit, but [indiscernible] certainly. I am just wondering if what happened sequentially in the quarter with service margins and maybe as we look forward do you still expect that sort of kind of increase to a blended rate that you know can be anything upward 30s? Thanks.

Yes, so what we said in our guidance is that we have a blended lower end margins to be flat and up 200 basis points on the high end and I think that will be a good proxy for full year service margins as well. So Q1 has always historically had lower service margins frankly due to the lower revenue in the first quarter. So I would expect service margin improved throughout the year and you know I guess more in line with our historical 2015 margin rate, which is kind of more into the 35% that 37% range for the rest of the year.

Thanks again. A - Joshua Levine No problem.

And our next question comes from Suraj Kalia with Northland Securities. Your line is now open.

Good afternoon gentlemen.

Hi Suraj.

Hey Suraj.

Josh and Kevin, congrats again on a nice quarter. It’s good to see you guys sharpening the company pretty well. Josh three questions if I may, you know let me start out with the first again on China and I'll piggyback on Jason’s question. My apologies that this is a little unfair. So you guys are coming out with a new system that potentially we don’t know all of the details, but is at a lower price point just given my experience interacting with you guys, the customer feedback in the field, and I doubt you guys would trade-off reliability, throughput, efficacy of the machine to save cost. Having said that Josh, why can’t this platform, however in the final form it is, why can't it be you know translated to let the U.S. or O-U.S. other geographies, I guess I am just trying to understand, there is some price elasticity of demand. We have [indiscernible] fighting with each other on price, would such as system help you all in such bidding situations or you are saying no, we are just going to stick with China in the certain target market.

So this is matter of really, you know kind of its basic level of thought process, Suraj. This is a matter of priorities and magnitude. When you think about China or when we think about China, conservatively probably over the course of the next decade there is probably going to be 4000 or 5000 linear accelerators that ends up in the ground over the course of the next decade. The vast majority of those, probably 80% to 85% of them are not in class A, so we have been very successful in the last two years in the Class A radiotherapy space, but that really is not kind of where the big growth drivers are going forward. It’s in the non-Class A products. And just to be clear we are not talking about trading off product functionality, product reliability for to be able to play for bigger piece of the market. We think we have got a product configuration and a solution that will make sense for not – maybe not everybody in that, that universe of opportunity in China. but certainly a large piece of the growth there is going to come from the provinces, it’s going to come from most likely the private sector. There are going to be smaller footprint facilities and having a product that's got regional clinical utility and is used to operate is going to be based on out market research going to have high utility and high-value and a customer appeal. So that’s just primary focus. Could it over time, could it become a fighting brand kind of product at some point down the road if we needed it to be? I guess the answer is yes, but that really isn’t part of the thought process today I think there will be other markets still outside of China that also represents an opportunity for it relative to product configuration and market positioning. So emerging markets are markets that are certainly more price sensitive and maybe a bit more basic in product configuration, but there is a long way between the very, very low end and low, low end of the market and we are replaying at the very upper end into the market. And to be clear we are not talking about a device, like configuration or price point that we are intending to be competing at a low, low end of the market. I mean it’s, I think if you are talking about million dollars, sub million product that isn’t where we're going to be. With that said, there is a lot of room and there is a lot of opportunity we believe between $1 million, $2 million $3 million at the low end and maybe $1 and three quarters of a million, $2 million dollars at the high end and so that core value segment there is really kind of where we envisioned this strategy to play.

Fair enough, Josh one question for you and then one for Kevin and I will hop back in queue. The alignment with the research with treatment planning strategy software, Josh can you give us some additional clarity, what is the gap you all realized and how does research help fill that gap?

So it’s two-fold. The first is on oncology information system platform. We do not, we are the only one of the three major companies that doesn’t have our own oncology information platform, OIS system and that has in certain situations that's proven to be limiting for us relative to market access. If we are a device that is being chosen in a third bunker or a forth bunker and already almost there for running in that facility to support the other devices and the other bunkers, we have a connection requirement to get connected into an interface with that OIS platform, we can make that happen but it’s quite frankly it is not as user friendly as it needs to be. And ultimately that is the focal point here is it needs to be more user friendly and we need to reduce our dependency on our friends at Varian and Elekta to get us connected. That is one, that is on the OIS side. On the treatment planning side, over the course of the last two plus years, we continue to hear from customers that have RayStation which is the number one, market leading, independent treatment planning capability and quite sophisticated quite frankly relative to what is out there from the other players. We continue to hear from people that have that product installed and that also are either using our products on the delivery side or considering using our products on the delivery side and there has been a significant amount of market input around encouragement that we need to figure out how to get ourselves connected with RayStation because more and more people want to use that system to drive all of the equipment in those customer locations. So again it is as workflow efficiency and a customer driven kind of an input that has led us down this path.

Got it. Kevin, last question and my apologies if you already highlighted this on the call. For your gross orders can you give us some additional color on geographies and growth rates and the split between Tomo and CK? Thank you for taking my question?

So what we gave at the end of last quarter in regards to regional full year performance, sometimes we give on a full year basis. However, we are not going to give specific growth rates by region on a quarterly basis. In fact the numbers on growth, they are not terribly meaningful in looking at it on a quarter-to-quarter basis. What I can say though is that our EIMEA region and our Americas region what I said in my prepared remarks are kind of leading the charge in regards to gross order performance which is in line with our plan. I also said in regards to the product specific the CK product represented a higher percent of growth than the TomoTherapy product on a year-over-year basis.

Thank you. And our next question comes from Toby Wann with Obsidian Research. Your line is now open.

Hi guys. Thanks for taking the questions. Could you just kind of talk about the sales funnel with regards to the GPOs? Here in the U.S. you guys have had some pretty decent traction going forwards seems to be accelerating just kind of maybe a little more color on all of that?

Yes, I mean, it took a while to get things moving, but it’s moving. I think that we’ve done a good job of working with those organizations to be able to identify joint opportunities and mutual opportunities. Again it probably took longer to start to see traction with it than would have been ideal, but it’s I believe an activity and a support that we are planning with them that is having some – it is having impact. We've got orders in the last two quarters that are really identifiable as opportunities that were not tracked prior to getting GPO agreements signed. So there is kind of a direct linkage there. We actually have been very involved beyond the GPO discussion with strategic accounts, so for some of the proprietary network partners with regards to freestanding centers and that was the order that we highlighted that took place in the quarter, the five system order with four Tomo’s and one CK. So we are starting to get some momentum. We are starting to see some traction. I would – I still think that this is going to be Toby it is going to be on a quarter-to-quarter basis; there is going to be variability.

Right.

So it is the wrong assumption to just kind of take where we are at in the last couple of quarters and start to streamline into the upper right hand corner of the graph. It is going to be – it is going to vary from quarter-to-quarter. But the funnel, the funnel that is related to that I think is improving and we’re starting to show that we can execute against it.

That’s helpful color and then with regards to kind of trade in, trade up kind of what traction you guys see in there or are you seeing orders come from that program so far?

Yes, I mean, I think in my prepared remarks I said during the quarter roughly 20% of the gross orders were replacement sales at our existing customer base. So that is directly linked to that the phenomenon that of Kevin highlighted earlier which is roughly 25%, 30% of our installed base comes in for tenure replacement cycle over the course of the next three years. That is a big opportunity for us. Bunker retention is absolutely a priority and we are bidding at a very high rate or we are retaining those bunkers at a very high rate.

That's helpful. That's it from me. Thanks so much for the questions.

Thank you and our next question comes from Jeff Bernstein with Cowen Prime Services. Your line is now open.

Hi guys, it is a nice quarter. I love the cash generation.

Thank you.

So just, most of my questions were answered, but I think you talked last quarter that a lot of the line Accuray placements were kind of coming out of old Siemens installed base. Is that still the case or any color there?

I mean prior quarter I think the opportunity that we talked about or the win we talked related to Siemens bunkers replacement was probably the order that multi-system order that was in kind of a large proprietary strategic account customer that is in the freestanding incentive business. I think that one was really more movement against old Siemens lamps [ph]. I mean we continue to see those bunkers come up for replacement opportunity based on the aging cycle and again Tomo and it's improvement in reliability, functionality or all of it really has made given us an opportunity where we can at least be a viable kind of option to compete with those bunkers. If you go back two or three years, that was not the case. We really did not have a strategy to play. So, based on some of the legacy challenges with the device, it is encouraging to see that movement in those situations because it speaks to the 180 degree turnaround that we've made in product reliability and product performance.

Terrific, keep up the good work guys thanks.

Thank you.

Thanks.

Thank you and I am not showing any further questions at this time. I would now like to hand the call back to management for closing remarks.

Thank you, operator. I just want to take this opportunity to thank the 1000 plus Accuray worldwide employees for their contributions in the first quarter of this year and recognize their passion and commitment to what we're doing together to bring benefits to the customers and their patients. For those of you listening in, thanks for joining on this afternoon's call and we look forward to speaking with you on the Q2 call. Thanks very much.