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…

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…

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.