Good day ladies and gentlemen, and thank you for your patience. You’ve joined the Accuray Q1 Fiscal 2018 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, this conference maybe recorded. I would now like to turn the call over to your host Mr. Doug Sherk. Sir, you may begin.

Thank you, Latif, and good afternoon, everyone. Welcome to Accuray's conference call to review financial results for the first quarter of fiscal 2018, which ended on September 30, 2017, as well as recent corporate developments. Joining us today 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 during our call today, we include forward-looking statements that involve risks and uncertainties, including statements regarding our future 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 and Radixact Systems' commercial execution; future order growth; future revenue growth; and macro economic 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. Two housekeeping items. First, during the question-and-answer session we request that questioners limit themselves to two questions and then re-queue with additional follow-ups. Second, all references we make to a specific quarter in the prepared remarks are to our fiscal year quarters. For example, statements regarding our first quarter refer to our first fiscal quarter ended September 30, 2017. 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. Accuray's business performed well in the first quarter of fiscal 2018. Orders and revenue both showed healthy growth and with the result of a strong combination from both our Radixact and CyberKnife systems and software products. Our results continue to reinforce that our newest generation of products has strengthened our competitive position and are moving us beyond our traditional presence in academic medical centers and successfully expanding our customer base with more community and regional facilities. Gross orders were $55.66 million for the first quarter, representing year-over-year growth of 11%. Order growth was primarily driven by contributions from our Radixact System, which when combined with TomoTherapy orders, represented approximately 75% of unit order mix during the first quarter. CyberKnife gross orders performed within our expectations and did show growth from prior year. Customer feedback indicates that significant improvements in case mix versatility, speed and overall efficiency are driving customer decisions to select Accuray. On a regional breakdown, our EIMEA region and Japan were strong order contributors for the quarter. While the Americas and APAC regions performed to expectation, China within the APAC region was down year-over-year due to continued delays in the Class A license announcement. Order type in the quarter was weighted toward more new refill bunker opportunities along with competitive wins replacing conventional linear accelerators. Our net orders were $51 million after net age-outs of $4.6 million. Net age-outs were better than our guidance of $6 million to $8 million due to $9 million of previously aged-out orders, primarily from European distributors recognized as revenue in the first quarter. This highlights the fact that orders that age out of backlog still have the potential to go to revenue. Our earning backlog increased 14%…

Thank you, Josh, and good afternoon, everyone. Total revenue for the first quarter was $91 million, representing an increase of 5% over the prior year. Growth in the first quarter was primarily due to year-over-year improvement and distributor order to revenue conversion, which was seen in our European and Japan regions. While still early, it is good to see some traction from our focus on revenue conversion. Product revenue for the quarter was $38.9 million, an increase of 9% over the prior year period. Product revenue was fairly evenly mixed between our CyberKnife and TomoTherapy systems with a very meaningful contribution from Radixact. Service revenue for the quarter was $52 million, an increase of 2% over the prior year. Our overall gross margin for the fourth quarter was 41.9% compared with the prior year period gross margin of 36.2%. The increase was driven by significant improvements in both product and service gross margins. Product gross margins increased to 43.2% in the quarter compared to 34.4% in the first quarter of prior year. Product gross margins were favorably impacted by a larger percentage of our overall sales attributable to CyberKnife systems in the first quarter of 2018 as compared to prior year. Further, prior financial periods recorded a quarterly $2 million intangible amortization charge from the TomoTherapy acquisition. This was fully amortized in Q4 of the prior year and will not reoccur in fiscal 2018. Service gross margins in the first quarter were 40.9% compared to 37.5% in the year ago period. 40.9% service margins represent an all-time high for us and are due to a variety of factors, including improved part reliability, leading to less power consumption, certain high margin service revenues recognized in the quarter and overall cost control. First quarter service margin performance exceeded our plan. However, the…

Thanks, Kevin. Before we open up the call to your questions, I'd like to thank the entire Accuray team for their increased focus, commitment and improving execution in the important work we're involved with. And now we're ready to open the line for questions.

Thank you, sir. [Operator Instructions] Our first question comes from the line of Anthony Petrone of Jefferies. Your line is open.

Thanks, guys. And good afternoon. Congrats on a good quarter here, good start to the year. Maybe one on the longer term outlook for Radixact as it relates to the installed base and then one on guidance. Just as it relates to the installed base, I'm just wondering of the situation during where it seems Radixact is gaining traction, it looks like their competitive takeaways. I mean, how often are you seeing - or what percentage of the orders this quarter were replacements of the existing Tomo base? And how much of a driver do you see turnover of the existing TomoTherapy base for Radixact this year and perhaps into next year? And then I'll have one follow-up on guidance.

Thanks, Anthony. This is Kevin. So we had given historically that roughly 15% to 20% of all of our orders on a full year basis have been replacements. On a quarterly basis, it really doesn't make much sense to give specific percents around replacements. What I will say is that the majority of our orders for both Radixact and TomoTherapy actually came more from greenfield opportunities and competitive replacements in our fiscal first quarter. However, on a full year basis, we would still expect replacements to roughly represent the 15% to 20% of our order mix.

It's helpful. And then just on the guidance for improvement sequentially throughout the year and just kind of reflecting, I guess, the $9 million of previously aged-out orders that I think went back into gross bookings. So just to confirm, did $9 million of the $56 million was that from previously aged-out orders? And how should we be thinking about that in the content - in the context of the sequential improvement in gross bookings throughout the year? Or what amount of orders are out there that eventually could come back into the fold? Thanks, again.

Yes. So just a point of clarification, the $9 million that we have stated as aged-in, those are not included in gross orders. So the gross order number that we reported of $55.6 million, those are all new gross orders. When we have a order age-in, we actually run that through a - the net order calculation. So…

Got it…

That's the first point of clarification. The second point in regards to sequential improvement, I would continue to look at it on a trailing kind of 12-month basis. And if you look at kind of Q2 and what a 5% growth would imply, that would probably put the Q2 number more in the $65 million to $75 million range in regards to the trailing 12 months growth rate and then improving sequentially from there.

Thank you

Thank you. Our next question comes from Tycho Peterson of JPMorgan. Your line is open.

Hi. Thanks, guys. This is Julia on for Tycho. Thanks for taking my question and congrats again on a strong quarter. Just a question on Japan, you noted that Japan has seen some very strong growth this quarter. Could you maybe elaborate a little bit what drove the strength in Japan? And then you also mentioned that there is a higher mix of CyberKnife into this quarter, so what drove that? And how sustainable is that down the road? Thank you.

So, Julia, I’ll take the Japan question. I mean, we've seen an improving degree of momentum in Japan over the course of the last several quarters. If you remember that basically a year ago, maybe between 12 to 15 months ago, we were seeing slower revenue conversion time lines in Japan due to a variety of factors that we highlighted back then. That logjam, if you will, has really kind of broken through at this point. And I'd say in general the momentum in revenue conversion from a timing perspective in Japan is at a much healthier cadence, if you will, than we'd seen before. The other contributor to Japan would clearly have to be shown an approval for Radixact, which we received in - earlier in this calendar year basically in the first quarter of the calendar year. So Radixact is becoming a bigger portion of the discussion in terms of funnel -- sales funnel and order activity in Japan. Your second question, can you please repeat the second question?

You mentioned that there - this quarter, the product gross margin was higher because of a higher mix of CyberKnife. So what drove that? And how sustainable is that? Thank you.

Yes. So CyberKnife this quarter represented approximately 50% of our total revenue dollars. And if you compare that to prior year, that prior year first quarter number was probably in the 25% to 30% of total unit volume for CyberKnife. And I wouldn't expect going forward that CyberKnife would represent 50% of revenue deals. It's probably more of a 60-40 split between TomoTherapy and CyberKnife as the deals in our backlog rollout to revenue at least in the near term.

Thank you. Very helpful. And if I can just squeeze in one. You mentioned that there is a projected increase in R&D this year. So just considering that you are already out in the market with Radixact and Onrad, what is driving the increase in R&D? Thanks.

So Julia, we've got product - continued product development activity in several key areas. The first one would be enhanced imaging capability across both platforms, both on the Radixact side and on our large volumetric and large field of view cone beam CT on CyberKnife. So those would be probably a proportionately the biggest part of the spend. Maybe to a little bit lesser degree, software upgrades continuing, especially around CyberKnife optimization. We talked a little bit in our prepared remarks about the next generation of our Precision Treatment Planning System for CyberKnife, focused on overall treatment speed improvement and throughput through the device. So those would be the primary areas of resource allocation in the R&D area.

And just to put some perspective to the numbers, our R&D forecast for the year is to grow to approximately 14% of sales, maybe 15% at the upper end and that will be compared to 13% of sales number over the last few years. So the growth in absolute dollars, we think can support the initiatives that Josh highlighted in his prepared remarks.

Very helpful. Thank you so much guys.

Thank you.

Thank you. Our next question comes from Josh Jennings of Cowen. Your question please.

Hi, good afternoon. This is actually Harris Iqbal on behalf of Josh. I appreciate the questions. So within the new leadership for the U.S. business, can you talk about some of the new strategic initiatives being enacted, things such as account targeting or anything else you would like to highlight as things that could kind of support the U.S. franchise?

So as we had talked about in earlier quarters, we've gone through a very significant focus on account targeting, basically focused on -- with emphasis on places that we think we've got a better right to win based on product capability and product positioning. We've also been underpowered, I would say, historically in the U.S. market, where -- we're talking about feet on the street. And so with the new structure, we basically have increased resourcing in the U.S. market to include or to go to three regions from two, increase the number of direct territory sales personnel as well as sales support personnel in the Americas and U.S. geography, specifically. So I think we've got a variety of things taking place there. The first one is really more focused effort by targeting perspective on the places where we think we've got the best right to win, and we got more firepower, if you will, in terms of sales and marketing infrastructure behind it, powering it. So while these things won't yield immediate results, I think directionally we're moving in the right direction in the U.S. market.

Great. That's helpful. And then one additional question on Radixact. Can you talk about the patient throughput you're seeing with some of the earlier doctors, kind of in the early innings here? And then you mentioned a lot of additional features that you will be rolling out or have done recently. How do you plan to market some of those kind of future potential product down the road?

So in terms of throughput and efficiency, Radixact really has been a sea change kind of impact on our treatment speed and overall throughput for the device. The best examples of this are in some of the early ramp and monitor sites, which were the reference sites that we have the device in before it went to full commercial launch. I won't get specific in the institution name, but there is a cancer treatment center in South Florida in Miami that was one of the original ramp and monitor sites that's now treating routinely 35 to high-30s, 35, 38 kind of range of patients in a normal treatment schedule over the course of the day. So I mean, this is pretty significant uplift from what we had seen from previous generation Tomo in terms of H Series treatment speed and throughput. That's being -- it's not an end of one, quite frankly, we're seeing it across the regions at the early adopter sites. The product is performing very well in terms of speed, in terms of the functionality. They're treating cases on these devices now that are, I'd say, broader in mix than we had seen initially or -- from earlier generations of TomoTherapy product. So we're feeling really good about where we're at with Radixact on positioning and overall functionality and efficiency improvements in the platform. Some of the going forward technology and innovation developments we talked about are essentially bringing the same kind of motion management capability that we've enjoyed on CyberKnife over the years with our Synchrony software in terms of the ability to adjust the beam, to changes in target position on an automatic basis. And the things that are in the pipeline or the road map from a development project standpoint on Radixact are really focused on that motion management, improve imaging resolution and imaging capability, and the integrated capability regarding adaptive radiotherapy.

Great. Thank you.

Thank you. Our next question comes from Brandon Henry of RBC Capital Markets. Your question please.

Yeah. Thanks for taking my question. Can you talk about how the sales funnel is progressing for Onrad, given the uncertainties that are in the Chinese Class A quota? And then how should we be thinking about the Onrad ramp for the remainder of fiscal year '18? And then finally, do you have any -- have you seen any movement on the China Class A quota?

So Brandon, this is Josh. The answer is, we don't have any additional information -- incremental information since we reported Q4 with regards to Class A licenses or announcement. I still think we -- our view is very firmly that this is not a question of when, but - not a question of if, but when. It's still something that we think is absolutely going to happen. But what that said, it's really impossible for us to predict the timing of approval, announcement. And it should be obvious to the outside world that we've very little influence over that part of the equation. The parts that we can focus on, and we are focused on, are on Onrad to your earlier question - or your other question. And the Onrad situation is interesting in that while we believe this product will fall based on product specifications and price point, very clearly outside of the Class A characterizations, so it would be on non-Class A product, there's been clearly some overhang, I'd say, created by the delay in Class A announcement and where and how that's being - how that affects the market view there of Onrad, again, given the uncertainty of where Onrad may be in the minds of people would land. I think the longer the time line to a final decision, and it's been a long time line admittedly, the more that uncertainty, if you will, has kind of entered into the market thinking around Onrad. And I think it's created a kind of a slowdown, if you will, of the institution's willingness to move forward aggressively with it. Our distributor in China has added people and resources to increase the energy in terms of building a sales funnel and a pipeline of opportunities for it. But again, I mean I think it probably will be to some degree, linked in timing in terms of Onrad's uplift or uptick, really linked in timing to a Class A announcement. The other part of the strategy that we've been very clear about in the last several quarters is, we're not hanging our hats solely on the Onrad product line. We believe that in order for improved market access and expanded market access and to position the company from an opportunity perspective in China. Having the ability to position ourselves with an on the ground, kind of made in China strategy, which would imply something along the lines of a JV or a collaboration with a Chinese partner is an important part of the thought process for us. So that's another part of this that we're actively pursuing. I don't have an update on timing of that, but I can tell you that a lot of energy is being applied to it right now, and I'd say stay tuned.

Okay. And second question. I think you guys slightly raised operating expense growth guidance, but you kept EBITDA guidance the same. So can just talk about where that additional spend is going? And then what is the offset to keep EBITDA guidance the same? Is it just higher confidence and gross margins for the year?

Yes, it's a great observation, Brandon. So on our previous call, we had guided to 3% OpEx, and we increased that higher into 5% in my prepared remarks. And I think you hit the nail in the head where we did see some stronger gross margins in the first quarter that we think are going to allow us to may be power up a little more in R&D. I also had said in my prepared remarks that service gross margins are now going to be 100 to 200 basis points over prior year and in our fourth quarter we are more looking at a 100 basis-point improvement on the high end. So we're taking some of that overage and applying it back into the business. And I think as you've seen with us over the last few years, we do have the ability to kind of power up or power down on the OpEx lines, depending on where the land within the revenue range and still be comfortable with the $30 million EBITDA on the high side.

Okay, thanks.

Thank you. Our next question comes from Amit Hazan of Citi. Your line is open.

Hey, guys. This is Phil on for Amit. Can you hear me?

Yes.

Yes.

All right. Great. Thanks for taking the question. I think a couple on sort of go-to-market strategy, noting that community and regional facilities increased focus. Can you sort of talk to the challenges in transitioning the commercial strategy in that direction? And maybe give some anecdotal evidence of how those discussions, the - how wins in that setting, those discussions differ a bit from where we've been in academic?

Well, I think the primary driver here is just the significant shift in product performance, product functionality and reliability and improvement in all of those areas. I mean, we - these were facilities, both regionally and community-wise that we really didn't have a very large presence in historically, because of shortcomings quite frankly and product reliability, lack of throughput and treatment speed and efficiency. And our latest generation of products has really closed the gap fully quite frankly from where we had been as a company if you go back 5 or 6 years ago. So in smaller regional or community based hospitals, where you'd be thinking in terms of a single bunker or dual bunker kind of footprint, we really weren't getting an audience at all in those types of accounts, if you go back 5 or 6 years ago. And today, we're positioned from a competitive and a strategic positioning standpoint based on mix shifts and product capability. We're positioned much more strongly. So I mean that's really what's driving and fueling the - our presence in those types of customer segments now and the momentum. And I - if you look back over the last several quarters, we pretty consistently been seeing overall mix - the mix of overall Tomo orders in those smaller setting types of accounts, approaching 40%, maybe even 50% in some quarters. So I'd say that's a pretty good endorsement or proxy for market recognition that our products are performing in a way that they hadn't been historically and making a difference in how customers are perceiving our viability as a clinical treatment choice.

That's great. And then sort of, I guess, along those lines in settings where you're transitioning the competitive account or potentially taking and share in a multi-vault site. What is the discussion like in terms of integrating new software that you guys have been highlighting at ASTRO? And in settings where you're transitioning just one vault, what is sort of the integration with the current treatment planning software system? And what goes into that? Thanks.

So our connectivity discussion is improving pretty significantly over time. We - our - the latest wave of treatment planning capabilities and software upgrades are really - across both platforms are really making a difference in how customers are perceiving the viability of - again, of our products in terms of integrating into their current collection of other equipment, if you talk by vault setting. The area that we don't have today a product of our own is on the OIS side, not the treatment planning side, but the oncology information system platform. And -- but we connect quite frankly with ARIA and MOSAIQ, which are the big products being used exclusively in the market at this point. And the connectivity situation in terms of our ability to integrate a - with a single bunker into a multi-vendor setting is pretty straightforward at this point. We get support from the software side, again for both ARIA and MOSAIQ. So we haven't been kept out, if you will, of those opportunities based on lack of connectivity. The other thing I would highlight is, as we've mentioned in the past, through the collaboration we have with RaySearch Labs, they are reasonably soon going to be coming to market with their first-generation OIS system, which is known as RayCare, and we will be integrated with that platform once that comes to market. So again, I think both across our own software suite of products as well as the relationship with RayCare, we're pretty well positioned going forward in terms of connectivity overall.

And is there an exclusive agreement with RayCare that you're just characterizing?

No. I mean, I believe that their belief or their hope is that there'll be other programs in integrate. But when you think about quite frankly how the market is served today, ARIA and MOSAIQ represent close to 100% of the OIS systems that are being used in the biggest facilities, especially in multi-vendor settings. And so RayCare - we will have some, I think some momentum behind us by having -- being aligned with RayCare in a connectivity context.

All right. That’s great. Thanks very much Josh.

Thank you. [Operator Instructions] Our next question comes from the line of Jeff Bernstein of Cowen. Your line is open.

Hey, guys. Just a couple of questions. Wanted to see if you could follow up a little bit deeper on the expanded reimbursement for SBRT for prostate that you've got. And whether that's the first of more and what your thoughts around that?

So Jeff, as I mentioned in my prepared remarks that was Regence BlueCross BlueShield. They cover about 2.5 million lives in the Pacific Northwest. I should point out that, that's lives, that isn't necessarily male lives. So we should be a little bit conservative with regards to what we - how we position that. But I mean this is the latest in a growing trend quite frankly in SBRT prostate coverage. All of the major Medicare carriers, I think 13 of the 15 regions inside of CMS cover SBRT now. So it's become very much the norm or the mainstream, if you will. And I think the - our view from a product perspective is that the data that is becoming available today and has been available over the course of the last, let's say, 12 to 18 months is absolutely fueling some of this. You get great clinical outcomes. This is a - from radiotherapy standpoint, especially hypofractionated treatment, the kind that's delivered by CyberKnife, this is a very cost-effective way for low- to intermediate-risk patients to get treated with very low side effects and very high quality of life outcomes. So we think that this is not a kind of a flash in the pan situation. This is a continuing and a growing trend, one that we think is going to continue.

So do you look at this as being a compelling reason for a customer to choose you guys now? And has that been in place for a while? Or is this evolving?

So I think just to be safe, we're clear in the answer. I think this is something that's good for our industry. When you think about hypofractionated treatment though, we've been at a hypofractionated treatment longer than anybody else. We pioneered the use of hypofractionated treatment with CyberKnife. And there are really kind of anchor institutions around the country that have made CyberKnife a very, very strong part of their overall marketing and business development efforts in terms of their areas of service in their communities. Prostate is one of the fastest growing, if not the fastest-growing procedure application of the CyberKnife platform. About 50% of the installed base case mix today is still intracranial. And then in descending order, lung, liver and prostate are next. The prostate in terms of absolute procedure growth is the fastest growing. So I think this is a good news. It's indicative of a strong trend for us and one that I think is going to continue.

So I know this has been - there's a big deal here in New York. So does that mean that you can kind of take that type of experience and market it now more broadly and say, "Hey, look what Sterling's doing and how successful they are being?

So it will vary from institution to institution, but there is no question that the success models that have been developed, Winthrop being a good example in New York, Georgetown in D.C. is another. I would say that these are good reference points - strong reference points on how to build certainly prostate-centric practices - radiotherapy practices using CyberKnife as kind of the platform of choice. So I think in general, these are good reference points for us in order to try to have them expand their -- the market knowledge about what's possible with the device.

Got you. And then just on the - you reported some better improved deliveries in distribution-driven territories, which has been a problem previously. Can you just talk about the mechanics of that a little bit and kind of what's going right there?

Yes, this is Kevin. As we announced earlier, we had hired a dedicated VP of Revenue Resource to manage that process internally. We've also hired feet on the street with regional project managers. And you're right, the product mix was highly weighted towards our European region and that's highly weighted towards some of the distributors we've talked in the past about. If you look at Europe in total, that region now for Q1 of '18 represented 40% of our total revenue compared to just 25% in the first quarter of last year. So it's nice to see some early traction with changes we've made in regards to revenue conversion.

That’s great. Thanks.

Thanks, Jeff.

Thank you. At this time, I'd like to turn the call back over to President and CEO, Josh Levine, for any closing remarks. Sir?

Thank you, operator. Thank you everyone for participation in the call this afternoon. And we look forward to speaking with you when we report Q2 results at the end of January. Thank you, and have a good evening.

Ladies and gentlemen, that does conclude the program. Thank you for your participation.