Accuray Incorporated (ARAY) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Accuray Incorporated First Quarter, 2017 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 call is being recorded. I would now like to introduce your host for today's conference Mr. Doug Sherk. Mr. Sherk you may begin.

Thank you, Andrea and good afternoon, everyone. Thank you for joining us today as we review Accuray's financial results for the quarter ending September 30, 2016, which is the first quarter of fiscal 2017. 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'd like to remind you that our call today includes forward-looking statements that involve risk and uncertainties, including statements regarding our business plans and strategies as well as our outlook for fiscal 2017. 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 CyberKnife, TomoTherapy, Onrad and Radixact Systems, commercial execution, future order growth, future revenue growth 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 today, we request that questioners limit themselves to two questions and then re-queue with any follow-up question. We thank everyone in advance for their cooperation with this process. And now I'd like to turn the call over to Accuray's President and Chief Executive Officer, Josh Levine.

Thank you, Doug. Good afternoon, everyone and thank you for joining us on today's call. following the market close we announced first quarter financial results that are enabling us to reiterate full fiscal year 2017 guidance calling for improving profitability, greater cash flows and both order and revenue growth for the full year. I'd like to cover a few of the commercial highlights and strategic initiatives from the first quarter before turning the call over to Kevin for a more detailed summary of our financial performance and full year outlook. Accuray's key commercial highlights since we last talked with you in late August took place during the annual ASTRO Conference in Boston last month. First, data showcasing the clinical efficacy of prostate SPRT treatments with CyberKnife in low and intermediate risk patients was presented by Dr. Robert Myer. The 21 center 309 patient study is the first large multi-center clinical trial with long-term follow up and good quality assurance to evaluate the use of SPRT in prostate cancer delivered by the CyberKnife System. These data can help our business in three ways. First by providing compelling evidence of the safety and efficacy of SPRT as a non-evasive treatment options for patients with low and intermediate risk prostate cancer. Second, by supporting the replacement opportunity within our own CyberKnife installed base. And third by demonstrating the clinical benefits that CyberKnife System uniquely provides through its integrated motion management and sub-millimeter precision. The study presented compelling research demonstrating that just five treatments with Accuray's CyberKnife System provides excellent disease control with 97% of low and intermediate risk prostate cancer patients experiencing cancer control five years after receiving treatment with toxicity rates comparing favorably to other radio therapies. Overall, less than 2% of patients had serious side effects after more than five years of follow-up and incidence rate, which can be characterized as rare. This study demonstrates the overall clinical efficacy of the CyberKnife System in addressing prostate cancer, which impacts nearly 1.1 million men worldwide according to the most recent data from Global Can and more specifically is estimated to be over 180,000 new cases in the U.S. alone during 2016. We anticipate the study will lead to an even great appreciation of the efficacy and very favorable tolerability of treatment with the CyberKnife System. There is growing evidence as supported by this study that the cost of multi-disciplinary cancer care can be lowered through expanded utilization of SPRT. And as the role patients as decision markers continues to evolve, CyberKnife is better positioned than ever as a non-invasive clinically effective treatment option. We also unveiled our new Radixact System, which is the next evolution of our low course chemotherapy platform during the ASTRO Conference. The Radixact System along with our new treatment planning and data management systems enables faster more efficient delivery of extremely precise treatment to a wider range of cancer patients. We received positive customer feedback about the automated workflows more powerful linear accelerator and new database features that make the system even easier to operate and integrate within a radiation oncology department. As evidence of this customer enthusiasm we booked several orders in the first quarter of fiscal 2017 for Radixact Systems ahead of our full commercial launch, which we anticipate in the third quarter of this fiscal year. We are executing a multistage rollout throughout is that, focused on insuring launch excellence and high levels of customer satisfaction that involves installation and acceptance testing of several ramp and monitor reference sites prior to full commercialization. Three of the ramp and monitor sites have been installed and are moving forward with the acceptance testing procedures and we expect to have all ramp and monitoring sites in place by the end of our fiscal second quarter, putting us firmly on track to meet our schedule for the full commercial launch. Looking forward, our commercial organization remains focused on executing our product launched and sales strategy to fully maximize the impact of the following catalyst in the back half of our fiscal year. Including the full commercial launch of our new Radixact System, the commercialization of our value position to Onrad System following Chinese FDA approval and the meaningful replacement cycle for Accuray Systems that have been in server for 8 to 10 years. With that I would like to hand the call over to Kevin.

Thank you, Josh and good afternoon, everyone. We ended the first quarter with backlog of $407.5 million, up 7% over prior year, which included gross orders of $50.3 million. Net orders were $37.2 million and reflected expected age outs of $11 million and $3.5 million in cancelations. Net orders were also positively impacted by a foreign currency adjustment of $1 million. As we communicated during our last call, the first quarter of this year represented a difficult year-over-year comparison for gross orders. The year ago quarter was highlighted by a bolus of MLC-equipped CyberKnife orders and the first of its kind 5-unit multi-system order in the United States. Both of these factors contributed heavily to the year-over-year growth comparisons in Q1. Let me touch on several other order highlights for the first quarter of fiscal 2017. First, we had several orders for the Radixact System, however as communicated during our fourth quarter call the vast majority of our fiscal 2017 Radixact orders are anticipated during our third and fourth fiscal quarter. Second, single and dual vault sites continue to represent more than 50% of current TomoTherapy orders demonstrating the expanded versatility and workhorse capabilities of the TomoTherapy product line. Third, the majority of CyberKnife M6 orders included a Multileaf Collimator continuing the trend of the majority of CyberKnife orders including our latest technology. Additionally in the first quarter we secured commitments for several replacement system orders that will be finalized in the second quarter due to customer timing and internal customer approval processors. And finally on a geographic basis, we perform above our internal expectations in Japan and Asia Pacific, offset by a shortfall in Americas and EIMEA, which we believe is due to timing of customer orders as oppose to competitive losses. Turning now to our income statements. Total revenues for the quarter were $86.5 million, a decrease of 3% from the prior year period. To reiterate the first quarter should represent the lowest level of revenues for the year as we anticipate a linear progression of revenue as we move to the remaining three quarters. Product revenues for the quarter were $35.6 million. Our Asia Pacific region performed above expectations and we also experienced improved year-over-year product revenues in Japan. This was offset by less than expected performing in the EIMEA, primarily due to some shipments pushed out to later day, although not impacting full year guidance at this time. Service revenues for the first quarter of $50.9 million were up 3% in line with our expectations. Moving down the income statement to gross margins, our overall gross margin for the quarter was 36% down 160 basis points compared with the prior year period. Product gross margins in the quarter decreased 800 basis points over the prior year period of 34% primarily driven by the lower overall sales unit volume this quarter, as well as product and channel mix. Product and channel mix continue to be the most significant factor in regards to quarterly fluctuations in product margins. I would like to be a bit more specific here on margins and product and channel mix. In the fourth quarter of 2016 we had the highest product margins in over four years as a result of the concentration of CyberKnife Systems to revenue. In fact in prior year we averaged in an approximate one-to-one ratio as CyberKnife to TomoTherapy revenues. In our first quarter 2017 this mix was approximately two to one in favor of TomoTherapy. Additionally, I noted strong revenue performance in Japan which is a distributer market and less than expected performance in Europe, which is primarily a direct market. All of these factors volume, channel mix and product mix led to what I would consider our benchmark product gross margins in the first quarter. We do expect quarterly product margins will increase throughout the year. However we will not see substantial improvement until the back half of the year on higher revenue volumes and more favorable product mix. Service gross margins increased 340 basis points from the prior year quarter to 37.5%, primarily due to the cost efficiencies obtained from a larger installed base and our focus on improved power consumption and cost management. As with product margins, service margins can and will fluctuate from quarter-to-quarter and we expect fiscal 2017 service margins to be at or above fiscal 2016, which were 36%. Operating expenses in the first quarter were $37.9 million, a decrease of 8% from the prior year period resulting mainly from decreased legal and R&D expenses of $3 million and $2 million respectively. This decrease was offset by increased trade show and marketing expenses of $3 million. First quarter operating loss was $6.5 million and the GAAP net loss was $9.9 million, or $0.12 per share. GAAP net loss improved from a loss of $13 million in the prior year first quarter. Adjusted EBITDA improved to $1.2 million from an adjusted EBITDA loss of $1.1 million in the year ago period. We have a particularly high level of confidence in our ability to effectively manage costs and achieve our full year adjusted EBITDA guidance in the range of $32 million to $38 million. Let’s turn now to the balance sheet. We had a $124.4 million of cash and investments at September 30, 2016. This balance declined $42.6 million sequentially, reflecting $36.6 million used for the full retirement of the August 2016 convertible notes. Cash used in operations totaled $6.4 million and was within our expectations for the quarter. We still expect to generate full year cash flow in levels at or above fiscal 2016 net of any debt retirement payments. Turning now to our annual guidance for fiscal 2017. We are affirming the guidance provided back in August, which is year-over-year growth of approximately 5% for gross orders, a revenue range of $410 million to $420 million, which is approximately 3% to 5% year-over-year revenue growth. Adjusted EBITDA of $32 million to $38 million, which would represent year-over-year growth of between 30% and 55%. And finally we expect flat operating expenses with $164 million level of spending in fiscal 2016. In regards to order and revenue timing for the full fiscal year we continue to expect approximately 60% of gross orders to occur in the second half of the year. Also the anticipated revenue range is still expected to show a linear quarterly revenue progression improving throughout the year. On our previous call we had estimated approximately 45% of revenues will occur in the first half of the year. With essentially four months of the year behind us and much more visibility into the funnel and installations this first half revenue number is forecasted now to be in the 43% to 44% range. This revised first half percent range represents approximately two to three systems moving from the front half to their back half of the year. Last we anticipate age outs of approximately $21 million in our fiscal second quarter. As in prior year we expect age outs to decrease throughout the year and should again end the year with age outs improving in 2017 as a percentage of ending backlog. And with that I would now like to hand the call back to Josh.

Thanks, Kevin. Before we open the call up for your questions, I'd like to thank the entire Accuray team for their focus and commitment to the important work our company is doing in improving the lives of cancer patients by providing leading edge treatment solutions. And with that operator we’re now ready to open up for questions.

Thank you. [Operator Instructions] our first question comes from the line of Tycho Peterson with JP Morgan. Your line is open.

Hey, thanks. Josh appreciate the comments on Radixact can you maybe talk a little bit about the funnel in terms of kind of mix of customers and your confidence that that can drive an upgrade cycle for the Tomo install base?

So again the reception and the feedback that we got at ASTRO Tycho was very, very positive. The feedback we're getting from ramp and monitor sites with regards to people's views about product efficiency and time saving features and efficiencies are already being reported by those ramp and monitor sites, which were the primary reference accounts. And so again those things are really I think good indicators for us. I think in my prepared remarks we identified that we’ve taken several orders to the backlog already in Q1, which is probably a quarter and half ahead of when our full commercial launch is actually scheduled. So I think we're feeling pretty good right now with regards to forward-looking expectations and interest in the product, the platform. And again the timing lines up well given where we're at in our replacement cycle.

And then maybe shifting gears, can you talk on Onrad as we think about rolling that our in China next year, what is kind of the early demand there look like?

Yeah, so as I indicated in some of the prior discussions, this is the first foray for us into product segment outside of Class A radiotherapy. And by that nature of those customers, these are tender processes at the prudential MOH level that are going to take some time. But interest in the product looks good. I think the prudential the administrative process in terms of the prudential tender activity, it does introduce a couple of new steps into impact the current sales timelines with the review process for submitted bids are expected we’ll probably see a little bit longer timeline in terms of overall selling cycle. But overall we're pleased with where initial thought process is and account targeting activity would put us in terms of having the funnel to be successful with this when we get moving.

Okay. And then just lastly on the data that you highlighted at ASTRO, just trying to think about how much you're going to be investing in going out and kind of educating people around the studies. How do we think about this kind of ultimately translating into demand?

So it's interesting. This really represents in our view the first long-term data supporting efficacy and importantly safety radiation therapy SPRT in particular. When you think about it in the context of prostate patients a non-invasive option. And so we are hoping to get as much visibility for the state and what it means as possible. We've already seen some benefits in terms of general media pickup that have served to increase awareness of CyberKnife as a safe option. But we're developing marketing tools to enable customers to communicate the benefits of this data and CyberKnife treatment of prostate specifically. We're also partnering with external groups like RSS, Radio Surgical Society and others to increase clinician and awareness of the data. So, I mean we've got several levers that we're operating and pushing on with regards to creating greater awareness for this information. And so we've got high hopes for the kind of impact that this would have in terms of spurring CyberKnife sales going forward.

Okay, thank you.

Thank you. Our next question comes from the line of Anthony Petrone with Jefferies. Your line is open.

Thanks and good afternoon. Maybe just to start higher level market question Varian [ph] last night seem to just put out their just an updated view on market growth rates specifically in the U.S. just wondering if sort of your in line with that 4% to 6% view? And sort of how do you see the transition to stereotactic machines taking place over the next two to three years? And then I have a couple of follow ups.

So Anthony our view of overall market growth hasn't really deviated and we're probably still in overall [indiscernible] market in low to mid-single-digits. But if you look overall at the trends towards SPRT stereotactic radio surgery, the environment that we're going to be operating in from a reimbursement perspective. We think that the growth overall can actually look more exciting longer term when you think about the adoption of SPRT in hyperfractionated treatments for a larger universe of patients. So when we -- we talked about our fiscal '17 guidance back in the last quarter we said we expect overall revenue growth of 3% to 5%, with product revenue growth specifically somewhere in the mid to high-single-digits. And we still feel good about that outlook. Again that's a full year that would translate from a full year standpoint into product revenue growth in mid to high-single digit. So we still haven't changed our view about that outlook.

I guess on that an extension to that would be, I think there was a multi-system order Josh that you had called out last quarter. And I'm just wondering what percentage of that order has now hit bookings? And then maybe just an update on base retention I guess the statistics were that 15% to 20% of orders were coming from the base and sort of the win rate on competitive situations in the own base was 80% I am wondering if you just have an update on that. Thanks.

Yeah I would say from an installed base standpoint those trends or those parameters or those metrics are still good. I think we've got obviously as you'd imagine just given the new product cycle we have a lot of attention and a lot of focus on protecting our installed base sockets. And that isn't going to change quite frankly I just would expect that intensity to grow going forward over the full year this year. And I think people are genuinely excited about Radixact and the integrated treatment planning and IDMS systems that are going to be coming out with it. So I feel good about where we're at with regards to maintaining the win rate in our own bunkers. So I would say that's kind of the really no change in our view with that longer term.

And I will take the second part of your question in regards to the multi-system order. So that order you referenced with NHS was actually fully booked in our prior fiscal fourth quarter. So there is no impact on bookings in the first quarter of 2017.

Got you. And the last from me, just maybe an update on pricing. Now that you have two systems coming into the portfolio Radixact and Onrad, how significant is the price delta from the existing portfolio? Thanks again.

So we are as we've said in several of the most recent past quarters, in places where we are competing for competitive sockets single and dual vault are mainly the ones that come to mind in this discussion. We're experiencing competitive price pressure, but I would not characterize it as significant. And in fact we basically said that we estimated that that probably was a -- in absolute dollar impact to top-line of gross order activity in the prior year probably about $5 million over the course of the full year last year. So replacement sales opportunities Anthony are in our own sockets from a competitive standpoint are also probably being sold at a slight discount. We've got trade in trade up promotions taking place. But again nothing that I would characterize as really significant pricing pressure. But all of what I've just talked vis-à-vis kind of discounts to kind of average sell prices are factored into our 2017 order guidance for the full year.

Thank you.

Thank you. Our next question comes from the line of Brandon Henry with RBC Capital. Your line is open.

Yeah, thanks for taking my question. I think on the call you pointed out softer Americas and European performance. And I think ovarian also saw some weaker performance in the European region as well. So maybe you can just spend a minute discussing kind of the reason for the weakness and what you're seeing in the European market. And are there certain parts of Europe that are more or less weak versus other parts? And then I have couple of follow ups.

Yeah so I had referenced -- I'll take the question initially that we did -- we're slightly below plans on some softness in Europe and Americas. However I also say that some of that softness was due to mix as oppose to any type of macroeconomic issue where we did have a larger percentage of TomoTherapy system orders in this quarter as compared to CyberKnife orders. We also have in Europe in particular very tough comparable in Q1 in regards to Q1 of fiscal '16 had of bolus of MCL-equipped orders of CyberKnife in Europe. So it makes for a tough comparable. And then third we did have in both the U.S. and Europe and I'm not talking of large absolute number of systems one or two in each region on the replacement side where we have actually secured the customer commitment however we’re still working through the paper work so to speak to get that order book, which we expect to be in the second quarter. So I think in line with some of the comments made yesterday that the European weakness is I’d say more looking backwards and looking forward we’re pretty positive on the sales funnel we have in Europe for fiscal 2017.

Okay. And then on Japan I think in the past you did kind of mentioned that construction delays are causing some longer conversion time orders to revenue in that region, but I think you mentioned that the Asia Pacific region actually came in better this quarter. So can you just update us on what you’re seeing in the Japanese or Asian oncology market?

Yeah so just to be clear we actually have two separate regions at Accuray so one is Asia Pacific, which would include China and then we separately report Japan and in my prepared remarks I had put forth that both of those regions have performed above expectations from a revenue standpoint in our fiscal first quarter. So it’s nice to see now in this quarter product moving in Japan from the backlog to revenue, which we communicated on our fourth quarter call we were anticipating would happen in 2017.

Okay. And then just last question from me, product gross margins obviously came in a little bit lower than we were expecting, I think last quarter you suggested that for the full year product gross margins to be kind of flat to up 100 basis points, is it still the right target? And if so can you kind of talk about your expectations for the progression in that product gross margins throughout the year? Thanks.

Yeah I think our expectations overall haven’t changed, but what I wanted to be sensitive to in the prepared remarks is that first off the takeaway not being that the pricing environment had anything to do with Q1 margins because that wouldn’t be a proper takeaway. We do anticipate as with revenue that product margins will steadily increase throughout the year on higher revenue volume. So while the forecast is to end essentially 2017 where we ended 2016 we’re not going to get to 44% until kind of the Q3 to Q4 range. So it will be a linear progression just like revenues. We are highly sensitive again to product mix and product volumes and the 2:1 ratio of TomoTherapy to CyberKnife in the first quarter explains really most of the reasons for probably a shortfall to expectations and product gross margins.

Okay, thank you.

Thank you.

Thank you [Operator Instructions]. Our next question comes from the line of Josh Jennings with Cowen. Your line is open.

Hi, good afternoon gentlemen thanks. I was hoping just to ask two questions on Radixact. The first you described that 2:1 Tomo to CyberKnife order ratio, but was there any impact by the launch of Radixact on either gross orders in terms of delaying an order by a customer or fallouts whether any TomoTherapy orders that’s fell out in anticipation of reordering Radixact?

No Josh I don’t see -- we didn’t see anything that would have been an impact in that regards as we mentioned I guess in our Q4 release we have put some technology protection options together and people that are -- that want to get an order in the system basically today are being able to protect that upgrade option to Radixact if at the time they go to installation Radixact is ready to ship and be installed. So, I think we’ve done a pretty good job at creating a softer transition as possible between H-series and Radixact going forward. I would say with regards to kind of gross order impact we have gone through a pretty exhaustive process of making sure that we’ve selected the right reference sites, ramp and monitor sites. And we may have had some -- in an effort to get those survey, the first three sites in place, putting and incentives in place to encourage that to occur as rapidly as possible, may have created a little bit of impact or discount to dollar volume, but again we don’t see that as a continuing and ongoing approach. The reference -- getting the reference sites the ramp and monitor sides up running and getting us feedback with regards to acceptance testing criteria and information was really kind of the primary focus here in terms of speed and timing.

And just to following that up, the concern about freezing the market so to speak with the announcement of Radixact our Q1 order results while I won’t give specific breakout between products, we did have a larger percentage of TomoTherapy orders in the first quarter compared to CyberKnife System orders, which would suggest to us that that concern isn’t one we should be terribly worried about as we go through the next few quarters.

Great. And then just wanted to follow-up historically you guys were having more and more success in the single and dual vault segment of the market and I was hoping that you might be able to parse that historic success rate between single and dual vault centers because the reason being that our checks at ASTRA suggest that Radixact made the Tomo platform much more competitive in the single vault segment. So, was a lot of the success historically driven by success in dual vaults or was it proportionally distributed between both single and dual vaults? Thanks a lot.

Yes, Josh, I would say absolutely probably in looking in backwards, probably more heavily weighted towards dual vault settings and I think you are right, the feedback we’ve gotten around the Radixact platform is that the product capability and the positioning create maybe some more leverage for us in single vault settings longer term.

Great, thanks again.

Thanks, Josh.

Thank you. I’m not showing any further questions at this time. I’d now like to turn the call back to management for any closing remarks.

Thank you, operator. And thank you everyone for your participation this afternoon. We look forward to talking with many of you on our upcoming conferences and when we report Q2. Thank you.

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program and you may now disconnect. Everyone have a great day.