Good day ladies and gentlemen, and welcome to the Second Quarter Fiscal Year 2018 Accuray Incorporated 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’d now like to introduce your host for today’s program Doug Sherk. Please go ahead, sir.

Thank you, Jonathan, and good afternoon, everyone. Welcome to Accuray’s conference call to review financial results for the second quarter of fiscal 2018, which ended on December 31, 2017. 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 our call today includes 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 statement. Two housekeeping items. First, during the question-and-answer-session we request the questioners to limit themselves to two questions and then requeue with any follow ups. Second, all references we make to a specific quarter in the prepared remarks are to our fiscal year quarters. For example, statement regarding our second quarter referred our fiscal second quarter which ended December 31, 2017. With that out of the way, I turn the call over to Accruray's President and Chief Executive Officer, Josh Levine.

Thanks, Doug. Good afternoon everyone and thank you for joining us on today's call. Accuray's fiscal second quarter performance continued to positive momentum which seen over the last several quarters. Contributing to these results were the continuing impact of our latest generation of devices across both our Radixact and CyberKnife product platforms as well as our most recent software upgrades. Our financial performance during the quarter was highlighted by total revenue of $100.3 million, up 15% from prior year. Product revenue increased 33% year-over-year suggesting that we are seeing the early effects of a heightened focus on improving the revenue conversion process related to international distributor orders. Gross order performance for the second quarter of fiscal 2018 was $77.9 million. Order growth was primarily driven by our TomoTherapy family of products which represented 80% of the unit volume during the quarter. More specifically Radixact system orders represented 70% of all TomoTherapy orders. CyberKnife system orders in the second quarter were in line with our expectations but were a bit behind the prior year due to a very strong CyberKnife system order mix in the second quarter of fiscal 2017. Orders from replacement sales to our existing customers during the second quarter of fiscal 2018 were in line with our recent historical order contribution percentage of 15% to 20% of total global order mix. On a regional basis, our EMEA and Japan regions continue to perform well and were strong contributors to our order performance. While our APAC region performed to expectations, China remains a headwind due to uncertain timing related to the Class A radiotherapy license announcement. In our Americas region, with specific reference to our U.S. commercial organization, I can report that we are making progress in the build out and restructuring of the U.S. commercial team that we…

Thank you, Josh. And good afternoon, everyone. Total revenue for the second quarter was $100.3 million representing a 15% increase over prior year. Growth in the second quarter was primarily due to our European and APAC regions. In APAC we generated these increased revenues primarily from sales outside of China. Product revenue for the quarter was $47.1 million, an increase of 33% over the prior year period. Product revenue was fairly evenly mixed between our CyberKnife and TomoTherapy systems with a very meaningful contribution from Radixact. The primary drivers of our product revenue growth has been twofold. First, we are converting the initial orders of Radixact to revenue. We have recognized more than 25 Radixact units since product launch. Second, we increased distributor revenues due to year-over-year improvements in distributor order to revenue conversion. Service revenue for the quarter was $53.2 million, an increase of 2% over the prior year at the sequential increase of $1.1 million due to increased upgrade purchase on service contract. Over 90% of our customers purchase service contracts providing a predictable revenue stream. For the first half of fiscal 2018, revenue grew 10% compared to the prior year. Our CyberKnife system was a major contributor to this growth, which in turn translate into higher product gross margins, which I will discuss later. For the second quarter, overall gross margin was 39.2%, 340 basis point expansion compared with the prior year period gross margin of 35.9%. Product gross margins increased 43% in the quarter, compared to 35.1% in the second quarter of prior year. Product gross margins were favorably impacted by a larger percentage of our overall revenue attributable to CyberKnife Systems and increased Radixact Systems as compared to prior year. Our go-to-market strategy for the Radixact Systems is generating favorable pricing and margins as compared…

Thanks, Kevin. Before we open up the call for your questions, I'd like to thank the entire Accuray team for their increased focus, commitment and improving execution supporting our important work that's make me difference in patient's lives. And operator with that, we're now ready to open the line for questions.

Certainly. [Operator Instructions]. Our first question comes from the line of Josh Jennings from Cowen. Your question please?

Hi, thanks gentlemen. And congratulations on another strong quarter. I wanted to ask first about the initiatives you put in place to rectify the revenue conversion delays you're experienced in the EMEA and APAC regions. And Josh what do you have experienced to generate a base line level of confidence in the sustainability of the new revenue conversion dynamic. Do you need to see the number of quarters in a row or is it -- just curious in terms of what you are tracking in order to have that confidence level in the new dynamic that you are seeing in the last two quarters?

So, Josh, it’s a couple of things. You know that just by way of background, we've add resources in the form of a dedicated revenue management VP level position that reports to Kevin. We have added additional project management support in the regions to help assist with streamlining processes, assisting distributors with the range of activities that ultimately results in installation and revenue recognition. I think a higher level of accountability quite frankly has started to become visible across all of those activities as a result of some of the resources we’ve added. Again, we are encouraged and pleased with what we’ve seen, its tangible impact obviously in the last two quarters -- this last quarter Q2 specifically in obviously very visible way. I think that there’s more work to do here but the work that we’re doing, the resources and what they’re focused on are definitely having an impact. And I would expect that generally from a directional standpoint we’ll continue to see that going forward. All of this translates ultimately into a more predictable revenue forecast accuracy as we go forward.

Thanks for that. And you talked historically that a search for a domestic JV partner in China. Any update on progress there and can you help us understand how big a deal there could be in terms of unlocking access to the China radiation oncology market opportunity?

So, the discussions and the dialogue from a JV standpoint are still active. We are advancing those discussions as we have kind of shortlisted partners that we are going to be re-meeting with over the matter of -- course of the next week to 10 days in China on the ground there. The focus here is to find a partner that would be both a manufacturing entity or an assembly provider if you will or partner as well as someone who has competency in the regulatory approval process for us to enable an essentially a local ethnic Chinese branded product solution. The opportunity here really has been focused on the portion or the segment of the market that’s going to fall outside of Class A radiotherapy. This is by absolute opportunity, the biggest segment of product opportunity in the market. If you go back to Class A in our earlier estimates, we estimate that even at its peak the Class A radiotherapy segment which is the premium and highest-level specification products and price point products, probably only represented about 15% of the market opportunity in China. So, the big opportunity is still out there waiting to be captured from a value segment and a core segment perspective. And we would hope at this point to have no later than the end of the calendar 2018 year something to announce. But quite frankly I think we are probably on a track to have something to talk about may be by the end of our fiscal cycle at the end of June. So that’s about the timing.

Sounds good. Just one last one, sneak one last one in. Kevin, you reaffirmed guidance including an order growth of 5%, fiscal third quarter has been seasonally weak quarter-to-quarter for a rate [ph] until last year. Can you just remind us what drove these toward seasonality? And then the setup here is for back half, second half weighted order performance. And can you just talk about your confidence there in terms of, I think you said low 80 million for fiscal 3Q and then I would suggest a 100 plus in Q4? But just a guidance on your confidence level. Thanks.

So, our operating plan always assumed a large Q4. So that’s a first point. Right now, we’re currently marketing to our own internal operating plan in the first two quarters and again in Q3 with the low $80 million number I gave. We really expect the largest contribution from the U.S. in our fiscal fourth quarter. Josh had walk through a lot of the initiatives that we commence at the beginning of this year. And we’re really starting to see some attraction in the U.S., I expect a lot of those initial opportunities to come to revenue in our fiscal third and fourth quarter. So, it’s primarily U.S. driven in the back half tempered by a very moderate, conservative view around China and Class A license issuances.

Our next question comes from the line of Anthony Petrone from Jefferies. Your question please.

Maybe just a few housekeeping that’s starting and revisiting on distributor orders. So maybe just an update on the total install base and specifically the Tomo install base and what percentage of those really are up for renewal and would you view that segment really as sort of low hanging fruit improve for Radixact? And then I have a follow-up.

So, our install base now is North of 800, probably more than 850 range and 800 to 900 install EBITDA range. And those units roughly one-third of those Anthony are older than 8 years, so it would be ripe for replacement.

And then what also is the mix of Tomo within there as well?

It’s Joshua, I’d say of that third of the units that Kevin just talked about probably a 60-40, 60% Tomo family related, 40% CyberKnife mix. And that’s really from a geographic concentration standpoint, primarily in the U.S. and Western Europe.

And again, would you view -- are those discussions sort of on those particular units moving in such a way where you do see that is low-hanging fruit for Radixact?

Yes. I’d say most definitely. I mean, we are really, really focused on the replacement opportunity. It’s a key initiative and key deliverable for our commercial teams in both the U.S. and the EMEA region. And if you think about just over the course for the last two fiscal cycles, two years. We finished fiscal 2016 roughly in the 15% of total order mix ratio in terms of those replacement sales contributions. At the end of fiscal ’17, we were about 20% of total order mix. So, we’re continuing to see that number grow. Radixact sets up nicely quite frankly as a catalyst to be able to trade in trade up, our existing install based Tomo customers to the next generation platform in order for them to be able to put themselves into Q4, the upgrade pathway for motion compensation, improved imaging capability that are going to need to be operating loss of a Radixact based platform in order to upgrade to those product functional capabilities. So, it really serves as a catalyst quite frankly to move the trade and trade up discussion forward.

And then on just distributor conversion in Europe. Can you remind us, I think it was this time last year may have been in fiscal 1Q of '17 where their measures were put in place? But importantly I think from a comp standpoint, what percentage of the U.S. distributor orders were sort of stuck and are now sort of in a position where they can float a revenue, thanks again.

Yeah. I don't know that I can, we have a percentage of orders that were let's say bought down. Just to be clear we put this added emphasis the addition positions I talked about adding before Anthony, we added those in literally in the first fiscal quarter of 2018. We're talking about the VP revenue management position in Q4 of last year, but the additional project management resources in the region working with the distributors, those were all headcount adds in coming into this fiscal cycle in Q1. If you think about just order of magnitude about how the order backlog has shifted overtime, I think we've been public with metrics that say that in the past three years, better than 15% of the distributor generated orders, basically we've had 15% growth in the last three years in distributor generated orders. So, channel mix is having an impact on again the length of time that these orders are sitting in the backlog. We've talked about the range of activities and the processes that when you introduce a distributor organization into site planning, permitting, construction oversight with an end user institution. We don't have direct line of sight anymore in those situations. So, these were the kind of catalyst for us moving in the direction we did with regards to streamlining those processes, putting more direct line of sight from an oversight and reporting structure and accountability perspective in place in order to help move these things along. And I think that we're pretty pleased with what we're seeing to date in that related activity.

And in terms of real tangible dollars and how that translates, if you look at our European region in total, in the first half of 2018 Anthony, Europe represents 35% of our total revenues. And that's compared to only 25% of total revenues in the first half of fiscal '17. And the primary driver of that are the increased activities, Josh just described around distributor conversion.

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

Yeah thanks for taking my question. So, first question on the revenue guidance. By my math it looks like revenue guidance implies kind of fiscal second half '18 revenue growth that is flat to down versus fiscal second half '17. That compares to kind of first half of this year, where you guys grew 10% on the revenue side. So, is this being conservative, or is there something that you need to think about in terms of fiscal second half '18 versus fiscal first half '18 revenue guidance?

Yeah. So, Brandon our back half of the year still does on a year-over-year basis, for second half to first half cause a lot of foreign increase over the first half of the year. And therefore, even though we are trending ahead of kind of where we wanted to be at this time of the year, we feel it’s appropriate to stay focused kind of on our range. We are seeing good progress as Josh mentioned around distributor revenue conversion activities. But right now, we are focused on achieving our guidance and the calendarization is planning out as we expected.

Okay. And then one question on the Americas region, that’s a region that’s obviously underperformed in past quarters. Can you discuss what is giving you confidence in a fiscal second half improvement in the Americas region? Is there something you are seeing in terms of the sales funnel post the recent hires?

Yes, Brandon, so this is Josh. The -- just comparatively if you think historically we have been underpowered from just about any metric you would use in terms of feet on the street comparatively from a commercial infrastructure standpoint with competitors. It was the catalyst quite frankly that really kind of drove us to taking a hard look at the market opportunity, the consultant project that we talked about commissioning at the end of last year and really focusing the energies of that work in several areas. One was customer segmentation and essentially competitive account targeting. Those places quite frankly where we based on our latest generation of products, our physician in the market where we’ve been strong historically, basically defining a competitive targeting analysis that was kind of where do we have our best right to win. The other really important element that was added to that was a sales resource deployment analysis which essentially was a territory level market coverage model from a territory standpoint. And I think one of the things that’s really pretty evident at this point is as we’ve gotten to the end of the restructuring and the hiring related to the US market is that we’ve added a significant amount of talent to the organization. It’s resourced quite frankly in the form of additional territory sales directors, strategic account sales managers, some general development people but high-level people, people that have come to us with market and domain experience in our space. So, there is a domain expertise factor here that we’re believing and hoping that there’s going to be a kind of a shortening of the traditional ramp that would be normally be associated with new people. And so, while we do have I would say a healthy percentage of people on board now that are relatively new to Accuray over the last 90 or 120 days, they are not new to the space. They are people that are proven performers in our domain over earlier years and many years. So, I think that’s the thought process that when we look at the ramp and the activity in the funnel that we are taking some confidence in as we look towards the back half of the year and with specifically kind of a focus on Q4.

Thank you. Our next question comes from the line of Tycho Peterson from JPMorgan. Your question please.

Hey, thanks. Josh on Radixact you talked about kind of the replacement cycle and the opportunity there. Just curious on greenfield opportunity and competitive, what the funnel looks like there?

I mean our activity for Radixact, Tycho, really kind of stands the gamut, that covers the waterfront if you will of opportunities. I mean, as you know, we continue to be successful in smaller footprint situations, community and regional hospitals, single and dual settings. We’ve had some install based obviously replacement sale opportunities that have been more in our traditional academic medical center situations. But in all of the markets, where we’ve got Radixact approved, which is basically now U.S., Japan and Europe, we’re leading with that product as opposed to the Tomo H series. And right now, we’re seeing a growing sales funnel in terms of a healthy mix of replacement opportunities, new bunkers, competitive target opportunities. And we feel good about the market uptake for that product and where the funnel is right now. I mean again, if you go back to some of the remarks or metrics, we shared in the prepared remarks. 50 systems over the course of the last year with almost half of those going to revenue in the last two quarters or three quarters is we think a pretty strong indicator of market adoption and market uptake for this device.

And then I guess thinking I had a little bit on pipeline here you talk about enabling motion management on Radixact and then improved imaging on both CyberKnife and Radixact. Can you maybe just talk on timeline and precession to rollout? I know that’s in development to when you think you roll that out?

I mean, I think the early stage is a visibility for some of those projects. We’re thinking maybe 18 to 24 months.

And then on CyberKnife. Can you give us a sense of what percentage of the install basis is at this point upgraded to M6 and I guess is there additional room here for further upgrades?

The answer is there is. I don’t know, if we have, I don’t have the upgraded to M6 data in front of me. But the reality is there are still, a reasonable degree of devices out there without an MLC, the Multileaf Collimator. And so that really is where the opportunity is for us. That probably represents -- I’m going to guess it probably represents at least 60% plus, 65% plus of the install based that still is not operating with the M6 platform. So, our level of penetration with MLC on M6 has probably been 30%, 35%, which leaves obviously a lot of runway for us.

And then last one, you talked about current order and backlog recognition being conservative. In light of ASC 606 and what your competitor had to go through. Are you expecting any impact on order of revenue, volatility and visibility?

No. I have talked in my prepared remarks that we currently already defer training revenue in our current financial statements and only recognize that when it’s delivered, which I know some of the competitive comments have said they are changing how they account for that. So that won’t be a change in timing for us. And then as I had also noted that while ASC 606 doesn’t directly address backlog, we also have never included any type of service offering or un-built service contracts in our backlog. But 606 could give us an opportunity, because valuate other criteria in our backlog for example the 30 months age-out criteria is something we're continuing to evaluate if that's the right benchmark.

Thank you. Our next question comes from the line of Brooks O'Neil from Lake Street Capital. Your question please?

Good evening guys, congratulations on terrific results here. I was curious when I talk with investors, one of the big sort of macro pushbacks I get is people feeling like the hospital environment both here and in other parts of the world is not sufficiently strong to allow you to see an acceleration in your revenue and order growth. And I was hoping you might just give us some sense of sort of what you see as the overall environment out there, number one. Number two, the strategic importance of radiation equipment for particularly the state-of-the-art equipment for these potential customers. And then three, just a quick overview of how you assess your competitive posture today, that'd be very helpful. Thank you very much.

So, let me start with the first part of the question, which was kind of the macro CapEx environment. I think we're in a more stable place today than we've been in quite some time. I mean if you go back over the course of the last several years, we've been in the affordable care act of Obamacare, we've been out of the affordable care act of Obamacare. I would say certainly probably more people hospital sea level capital commitment standpoint, several years ago looking more cautiously perhaps about the CapEx environment. Those conversations from where I sit right now and from what we've seen are really behind us. The reality is that radiotherapy when it's done right is an absolute profit center for most hospitals. And comparatively an important part of their clinical strategic positioning discussion as it relates to multidisciplinary cancer care model. So again, I think we're in a relatively good place again compared to the last several years in terms of where we're at now. I would say generally, we are seeing a much more stable recently stable reimbursement environment. Last July, CMS announced kind of where we'll be in radiation reimbursement, and again the net effect for us and the space overall, I believe has been relatively neutral to slightly positive. I think longer term, on the reimbursement front, there is no question that just directionally people are moving and I think the system is moving too more of an episodic payment type of model. But we think as we've talked about in the past, we're well positioned to deal with that. When you start talking about more treatment volume around stereotactic body radiotherapy and image guided IMRT, our portfolio lines up well with those directional reimbursement trends and kind of strategic trends. So, I…

That’s extraordinarily positive thought. A couple of weeks ago I wouldn’t have asked this question because the stock was quite a bit lower than it is right now. But right now, I would think you might actually be in the range of the convert, and as Kevin mentioned just the 13 million that might be susceptible to that. But would you be willing to just say what you think some of the more palatable actions might be for addressing that Kevin?

Yes, correct. So, the 13 million remaining on the convert will be calculated at the closing price at the end of January and there could be a possibility of that price which the company has set aside 2.5 million shares to settle that. However, as I mentioned in my prepared remarks we’re working over the next few weeks on various strategies to minimize that dilution and there’s some very obvious kind of scenarios that could come to mind. One would be going to the convert holders directly to negotiate a payment in cash rather than shares which is one of the reasons we raised our cash in December 2017. And the other could be to mitigate the shares issued in the open market, some type of stock repurchase equal to the stock that’s issued. But at this point we are considering all alternative. Our goal still remains the same, which is to minimize the amount of dilution that’s going to out in the market after February 1st.

Thank you. And this does conclude the question-and-answer session of today’s program. I would like to hand the program back to Josh Levine President and CEO for any further remarks.

Thanks, Jonathan. And thank you everyone for your participation this afternoon. We look forward speaking with your and we’ll report our Q3 results at the end of April. Thank you and have a good evening.

Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.