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Accuray Incorporated (ARAY)

Q4 2017 Earnings Call· Tue, Aug 22, 2017

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Transcript

Operator

Operator

Good day ladies and gentlemen. Welcome to the Accuray Fourth and Full Year 2017 Earnings Conference Call. [Operator Instructions]. As a reminder, today's conference is being recorded. I'd now like to turn the conference over to Doug Sherk. Sir, you may begin.

Douglas Sherk

Analyst

Thank you, operator. Good afternoon, everyone. Welcome to Accuray's conference call to review financial results for the fourth quarter and fiscal year 2017 which ended June 30, 2017, as well as recent corporate developments. Joining us today are Josh Levine, Accuray's President and Chief Executive Officer; as well as 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 risks and uncertainties, including statements regarding our business plans and strategies. 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, TomoTherapy, Radixact and Onrad 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. [Operator Instructions]. And now, I'd like to turn the call over to Accuray's President and Chief Executive Officer, Josh Levine.

Joshua Levine

Analyst

Thank you, Doug. Good afternoon, everyone and thank you for joining us on today's call. I’ll begin with a brief overview of our fourth quarter and full year financial results which were consistent with the preliminary results we issued last month. Then I’d like to highlight some of the specifics regarding the improvements we’re making to strengthen our market position in terms of our product capabilities and commercial processes. Gross orders were $85.7 million for the fourth quarter and $298.3 million for the full fiscal year. On an annual basis, our gross orders grew 5% year-over-year and our backlog grew 12% to a record $453 million at June 30, 2017. Our fiscal fourth quarter order results were primarily driven by momentum of our new Radixact System that was launched commercially in the fiscal third quarter. Radixact represented two-thirds of our TomoTherapy order mix in the fourth quarter up significantly on a sequential basis from 25% during the third quarter. We also had strong orders for our CyberKnife System particularly in Europe. These results speak to the improving functionality and the growing body of data regarding the clinical effectiveness of our latest generation products. While revenue for the quarter was $112 million and represented year-over-year growth of 18%. Our full year revenue of $383 million represented a disappointed year-over-year decline of 4%. As we highlighted in our third quarter earnings release, we are taking significant steps to improve the revenue conversion process related to the growing backlog of distributor associated orders. While we are still relatively early in the implementation of these new processes, I think it's important to share some of the steps we are taking to drive improvement in this area. The organizational changes we announced on our last earnings call to drive order and revenue growth, began with…

Kevin Waters

Analyst

Thank you, Josh and good afternoon everyone. For the fourth quarter, gross orders were $85.7 million and $298 million for the full year representing 5% growth year-over-year. This is consistent with the guidance provided at the beginning of the year. For the full year our Europe, APAC and Japan regions all experienced between 10% to 15% order growth in 2017 which was offset by subpar order performance in the Americas region. Regarding the Americas region, today we highlighted the additional focus we are applying to capitalize on a replacement opportunity. Which included a recently completed realignment of commercial resources in the US. While our gross order volume in the US was less than anticipated, I do want to point out that we did not have a significant number of competitor takeaway. In fact, that number was two systems in the US for the full year. Additionally, the majority of our orders in the US for fiscal 2017 represented sales to our own installed base which is encouraging for future growth given Radixact full commercial launch did not occur until the back half of fiscal 2017. As previously noted, Europe, APAC and Japan all experienced double-digit order growth. European orders were led by CyberKnife system sales which were broad-based in nature across both direct and distributor markets. APAC and Japan had both strong Radixact and TomoTherapy orders. Radixact orders in Japan have been extremely positive since receiving showing an approval in January. Our APAC strength was driven by several Radixact orders in Korea and Hong Kong in the second half of 2017. Regarding full year order mix, global replacement orders represented approximately 20% of total full year orders which is an improvement from the prior year where replacement orders represented 15% of our total orders. Orders for our TomoTherapy systems at…

Joshua Levine

Analyst

Thanks Kevin. Before we open the call for questions, I'd like to thank the entire Accuray team for their increased focus and commitment to the important work we're doing to achieve our mission of improving the lives of cancer patients by providing leading edge treatment solutions. And operator we are now ready to open the line for questions.

Operator

Operator

Thank you. And our first question will come from the line of Joshua Jennings of Cowen. Your line is now open.

Joshua Jennings

Analyst

Good evening gentlemen, thanks a lot. I wanted to ask just a couple of questions on guidance. Gross order and backlog grew is 5% that’s similar to the order growth you guided to for fiscal 17 and you hit that level and a similar comp last year. Can you help us with any detail on how that order funnel is shaping up here as you sit in the first quarter of fiscal 18 versus last year entering fiscal 17?

Kevin Waters

Analyst

Yes, Josh thanks for your call this is Kevin. The first think I’d point out with regards to kind of order growth is our APAC region, we are forecasting in our 2018 a year-over-year decrease in orders due to kind of our tempered view on Class A. So that will be the first kind of point to make there. I’d also say that from a region standpoint, we are expecting our Americas region to represent the highest rate of growth in our 2018 order guidance. That is primarily due to the replacement opportunity that we've discussed and also due to the fact that 2018 will have full Radixact launch in the US where we didn’t complete those four ramp in monitor sites until the end of the first quarter.

Joshua Jennings

Analyst

Great. And then just on the revenue guidance. Can you just help us, I know you had some comments about some of the processes you put in place to improve order revenue conversion? But can you just talk about some of the assumptions that are in play for that 5% to 10% system revenue guide just in terms of levels of improvement you expect in fiscal 18 versus fiscal 17?

Kevin Waters

Analyst

Yes. So, the first this I’d point out Josh is that, while the revenue growth overall is in the low single-digits. It does represent product revenue growth of 5% to 10% and that’s our backlog growth that’s up 12% percent year-over-year. So, we're already starting off the year with a backlog number that should support product revenue growth in that range. The bottom and a part of our overall revenue range, I would say allows for the continued delay in China revenue installation as well as no real significant improvement in the conversion timeline. So, we believe in this guidance, we kind of allowed for no improvement in the revenue conversion matter that you brought up. I would also suggest to help on a regional basis, we are expecting at the higher end of the range that the largest growth and product revenue would come from the European region which we've discussed if we had a fairly weak 2017 due to the distributor conversion issue. So lower end, not much improvement in conversion. Higher end we start to get some traction with the initiatives that Josh went through in his prepared remarks.

Joshua Levine

Analyst

Hi Josh, this is Josh Levine. Let me just add or amplify on some of Kevin’s thoughts. To the point that he highlighted just a moment ago, I’d say we are being cautious on the APAC and the China contribution in the 18 guidance and we're also recognizing that we with some of the work that we've been doing and some of the investments we’re going to be making in the US market this year, we are going to -- we need to give some time in the were going to. We need to US market for the new commercialization efforts in Radixact and some of the things we're looking at from a commercial performance improvement standpoint and an investments and infrastructure perspective. Some of that to take whole, but I'm going to predict that we will be a much more effective selling organization in the US market in fiscal 18 than we have in the last several years. I think the product line up and the market acceptance of both Radixact and CyberKnife in their current form latest generational form is going to translate into more momentum in that regard. So, we feel good about, again region to region it looks a little bit different but we feel good in general about the strength of the portfolio and where it can take us.

Joshua Jennings

Analyst

Great. Thanks for those details. And just lastly, your gross margin guidance 40% and your historic path to profitability is some of the year goals of moving north of 40% and improved operating income and EBITDA margins. Well, can you just from a high level just talk about where you guys are on that path to profitability? Thanks a lot.

Kevin Waters

Analyst

Yes. So, I’ll take a margin question and then I’ll address kind of the profitability comment. So, the total margins in our guidance are overall at 40% to help that does represent product gross margins in the 43% to 44% range. That would be a significant improvement off the 37% we just completed. I remind you Josh that we do have $8 million or approximately 400 basis points in product margins related to intangible amortization that goes away essentially at the end of fiscal 17. So that benefits product margins by 400 basis points right there. So, you are looking at 200 basis points improvement and product margins do primarily to volume and cost initiatives. On service, we’re forecasting essentially flat service margins to up slightly 100 basis points Now our goal in the intermediate term is to still drive that number to 40% but that is 2018 on service up roughly 100 basis points. With regards to profitability, I point out that both the low end and the high end of our fiscal 18 guidance does assume operating income. So that would be operating income he got in does assume are operating income so that that would be operating income really for the first time in the post combined company’s history and we will achieve that about the low and high end of our 18 guidance.

Operator

Operator

Thank you. And our next question will come from the line of Tycho Peterson of JP Morgan. Your line is now open.

Tejas Savant

Analyst

Hi guys, this is Tejas thanks for taking the questions. Just one quick follow-up on the revenue conversion issue. Are you at the point now where you see a clear path where the backlog growth and revenue growth should move and lock step in Europe over the course of this year or are we still not there yet? Obviously, your competitors also pointed to a three to six months lag because of distributor issue.

Kevin Waters

Analyst

Yes, this is Kevin. I think we put the right processes in place already and really communicating our expectations to the regional teams moving forward. We’ve had a full review of all of the deals and backlog that are in our revenue forecast for 18. We've added more resources to the regional teams. And another thing we've done is we've also changed the sales teams’ variable compensation to be more weighted towards revenue in 18 as compared to 17. So, I think we've made some good initial steps and we saw some good traction in Q4. With that said, I think a linear progression of revenues next year has a lot to do with that conversion process improving more in the latter half than at the beginning half. So, it’s nice to see some early traction but I still think we’re not all the way there yet. And ultimately the goal as you pointed out is that you should be very similar product revenue growth in line with our backlog growth.

Tejas Savant

Analyst

Got it. That’s helpful. Just moving on to China, I know you spoke about the radiotherapy licenses issue being a little bit of a damper on your growth and explaining the Rangers of your guidance. As far as I’m aware I mean Onrad sort of like moderation and growth you spoke about is independent off the Class A radiotherapy licenses, is that correct and then if so what exactly are the factors that play there? Are there any sort of shift in competitive dynamics going on now in China that’s resulting in more I guess modest growth expectations for Onrad in '18?

Joshua Levine

Analyst

So, there's no question that our belief is that based on product specifications and price point Onrad should fall outside of the Class A licensure discussion. But until there's a definitive announcement from the Ministry of Health that clearly characterizes or defines what will and won't fall into Class A, I think one of the things that's occurred over time is there are the longer the time line the more uncertainty that the market has about some of the product -- where product will fit and I think that has absolutely caught Onrad to some degree which is why our order uptake for this product has been more moderated then we would have expected. At the end of the day, we believed again that Onrad isn’t going to be a Class A device. But until there is perfect clarity on final decision on all of the Class A characterizations and what fits in Class A, I think we’ll continue to have some - again more moderated uptake of Onrad. I think we have seen -- we're focusing on more local selling activity again the non-Class A products should -- are really more going to be controlled by a provincial or local level selling and tender process. We've seen our distribution partners actually expand some of their presence in terms of sales and sales support personnel on a local level in the provinces to help push those opportunities along, and we’ve got a growing funnel with our distribution partners with Onrad in some of those province opportunities but it's -- I don't think there's any question that the market will benefit from a clarity in signal value standpoint by a definitive Class A announcement and that's kind of where we are at this point. I think that given our success almost, we became somewhat of a prisoner of that success with our focus on Class A a year, maybe beyond a year ago and we're kind of still caught in that conundrum at this point given the delay in the regulatory clarity. With that said arm I think that Kevin highlighted in guidance, we are I think appropriately baking what I just described into our order our order and revenue outlook and guidance for FY18 and progress that we make in Onrad and the China situation in general I think would be really upside opportunity given our current outlook and forecast in the 18 guidance. So, I think we've kind of appropriately calibrated how big a contributor China could be or will be in the FY18 year.

Tejas Savant

Analyst

Got it. Thanks for the color guys.

Operator

Operator

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

Anthony Petrone

Analyst

Thanks, and good afternoon. Maybe Josh, I’ll start with a couple of questions on 2018 and then couple on distributor conversion as well. Maybe just your thoughts on specifically the general competitive dynamics heading into 2018, maybe in the US North American markets just given Helical launch and some of the recent disruption we've seen over and like that. And then maybe more specifically what percentage of I guess the global installed base of Accuray is up for renewal in fiscal 18? And then I have a couple of follow-ups.

Joshua Levine

Analyst

So that's a pretty broad multi-part question Anthony. Let me try to take it from chronologically from where you started. Competitive dynamics, you know there's been a lot of noise quite frankly about Halcyon and I think one of the interesting kind of the below the surface maybe not as visible to people is how strong continued interest and customer feedback is for our Radixact product. And I think that again because we launched full commercial launch at the end of Q3, I would say we're still in a reasonably early stage with regards to Radixact roll out. But when you look at the places where we’re winning with Radixact, we are continuing to be successful in new order generation in smaller to medium sized accounts again those single, dual vault accounts which I think is really the truest test of Radixact and how it positions competitively against Halcyon. It’s absolutely being viewed as a well-placed product very broad case mix capability and very simple to use. So, a lot of the same thought processes that you hear or by products you hear from variance messaging. You could say the same thing about Radixact, maybe even more so from a case mix standpoint I think we've got a product that's got the broadest capability from a clinical standpoint of any product in the marketplace. Again, footprint product is going to fit in, very competitive small bunker sizes are very short quality assurance processes and installation processes. You have the benefit of Helical IMRT delivery in the context of very very effective and efficient dose delivery and dose customization. I think that our competitors have gotten a lot of air time for a product that is a Radixact or TomoTherapy lookalike quite frankly but when you pull it down under - tear it down under the covers. You don't have time for pound you don’t have the same capabilities. So, I think we're going to continue to win in competitive evaluation’s in places that we haven't had, again haven’t typically had success in the past in some of those small to medium size accounts.

Anthony Petrone

Analyst

That’s helpful. And then maybe just an update on the number of the percentage of the installed base of next year in fiscal 18? And then lastly just on distributor conversions you mentioned sort of in guidance that actually we should see Onrad in China and Radixact in Japan. I'm just wondering in the distributor relationships in those two markets, do you think you'll face some of the similar issues that you've seen in Europe or do you expect sort of a more normalized revenue conversion outcome from China and Japan?

Joshua Levine

Analyst

I think to the point, the primary question Anthony again the resources that we’re adding right now are just to be clear they are in EMEA and in APAC and I think that we are getting ahead although admittedly it’s early. We are getting ahead process wise and resource wise have improved cloudy and visibility on what’s in the FY18 revenue forecast and higher levels of confidence quite frankly relative to predictability of that forecast. That really is the by product or that takeaway from the work we're doing with regards to the PP revenue management position that reports to Kevin, the added project management resources that are being added at the regional level in both APAC and EMEA and so again, I think that probably the biggest impact of all of what I just described will come in the second half of fiscal 18. I think our visibility and confidence factor about what we're already seeing even though it's early. It's very very high. Just another point I guess about kind of the distributor, the nature of the distributor orientation of this challenge. The good news is we have the ability to participate in markets where there is significant growth through good distribution partners and that's really what's been driving the overall shift in mix, order mix to more distributor generated orders. It’s actually grown probably in excess of 15% in terms of overall end-to-end movement over the course of last two and a half to three years. So that you could look at it and you could say our revenue conversion has linked and the answer is it has. We know what we have to do at this point and we've got the resources lined up to go fix that but just to be clear we're participating in those markets where those orders are coming through distribution partner where quite frankly we wouldn't have the bandwidth financially to be able to be a direct player. So, there's a trade-off here, I think we've got our arms around in a really good way and a strong way. The work that we've been talking about now over the course of the last quarter or so with regards to revenue conversion specifically related to distributor order generation. So, I think it's going to be an approving situation.

Anthony Petrone

Analyst

Thank you again.

Operator

Operator

Thank you. I'm showing no further questions at this time. I would like to turn the conference back over to Josh Levine, President and CEO for closing remarks.

Joshua Levine

Analyst

Thank you, operator and thank you everyone for your participation this afternoon. We look forward to speaking with many of you at ASTRO next month and our first fiscal quarter earnings call in October. Thank you again and have a good evening.

Operator

Operator

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