Good day, ladies and gentlemen and welcome to the Accuray Incorporated Third Quarter 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 follow at that time. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to Mr. Doug Sherk of the EVC Group. You may begin.

Thank you, Amanda. Good afternoon, everyone. Welcome to Accuray’s conference call to review financial results for the third quarter of fiscal 2018, which ended March 31, 2018 and 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 would 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 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 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. Two housekeeping items. First, during the question-and-answer-session, we request the questioners limit themselves to two questions and then re-queue 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 third quarter refer to our fiscal third quarter ended March 31, 2018. With that out of the way, I would like to turn the call over to Accruray’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 third quarter results reflect the market momentum we have been building throughout the fiscal year. We generated $99.8 million in revenue during the quarter with Radixact and CyberKnife system sales as well as software upgrades, the main sources of year-over-year revenue growth. Year-to-date, total revenue was up 7%, while product revenue was up 9% compared to prior year. As a result of this performance and our outlook for the fourth quarter, today we are raising the bottom end of our full year revenue guidance to reflect the progress we are making and more timely revenue conversion of our backlog. Kevin will provide more detail on both backlog growth and our revised revenue outlook in his prepared remarks. Gross orders for the quarter were $74.9 million, which puts us slightly behind our internal targets through the first 9 months of the year. However, due to the number of high potential multisystem order opportunities we are currently pursuing, we are still targeting approximately 5% order growth for the full fiscal year. In addition, we ended the quarter with backlog of $468 million, which is 4% higher than the year ago level. Our third quarter gross orders were primarily driven by our TomoTherapy family of products, which represented 75% of the unit volume during the quarter. Radixact systems represented over 80% of all TomoTherapy order volumes, which is up from 70% during the second quarter. To help illustrate the growing market interest in our Radixact system, third quarter orders for this product were the highest they have been for any quarterly period since our full commercial launch a year ago. CyberKnife system orders in the third quarter were a bit behind the prior year due to a…

Thank you, Josh and good afternoon everyone. As Josh highlighted, we have $74.9 million of gross orders in the quarter, with a substantial contribution from our Radixact system. On a net order basis, we generated $40.9 million in our fiscal third quarter which included adjustments of $26 million for age-outs and $8 million for cancellations and other adjustments. Age-outs were slightly higher than expected due to the timing of certain orders converting to revenue. While cancellations can fluctuate quarter-to-quarter, on a year-to-date basis, we have had $10 million of cancellations, which is consistent with prior year and a smaller percentage of our revenue as compared with last year. On a year-to-date basis orders represent a positive book-to-bill ratio of 1.12 and increases our ending backlog which drive future revenues. We anticipate Q4 net age-outs to be at a comparable level to our prior year Q4, which is approximately $20 million. We continued to work on converting these orders to revenue in age-in as we have seen happened in previous quarters. Turning now to our income statement, total revenue for the third quarter was $99.8 million representing a 3% increase over prior year. Revenue growth in the third quarter was driven by more than 30% growth in Europe and high single-digit growth in both Americas and Asia-Pacific. This was offset by a decline in revenues in Japan due to a very tough comparable in the third quarter of prior year. Product revenue for the quarter was $43.2 million, a decrease of 10% over the prior year period. Although total product revenue declined, we recorded growth in every region in the world outside of Japan. Japan product revenues decreased approximately $10 million over prior year. However, Japan is performing very, very near our internal plan on a full year basis. Product revenue…

Thanks, Kevin. Before we open up the call for your questions, I would like to thank the entire Accuray team for their continued focus, commitment and improving execution supporting our important work that’s making a difference in patients’ lives. Operator, we are now ready to open the line for questions.

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

Hi, good afternoon. Thanks gentlemen. I was hoping to start off and ask about new orders in fiscal third quarter and also what guidance implies for fiscal fourth quarter. And I guess I was just needing help just thinking about the fiscal third quarter performance, I mean, you guys did have a very challenging comp from fiscal Q3 last year and typically at least the prior 2 years in fiscal ‘15 and ‘16 in the fiscal third quarter you saw on a dollar basis new orders drop sequentially. Can you just help us remind us about fiscal third quarter last year why that was so strong and how you are thinking about setup for fiscal fourth quarter, was it just Josh in your prepared remarks, I apologize for the lengthy question here, but you talked about multisystem orders and it sounds like multisystem maybe falling out of fiscal third quarter and into fiscal fourth quarter. So, I would love to just hear your thoughts on fiscal third quarter the comp and then also how we should be thinking about the strong growth implied in fiscal fourth quarter new order guidance. And I just have one follow-up?

Yes. Okay, Josh. So, let me take the third quarter just as a starting point. We highlighted in the prepared remarks that we see a growing number in terms of funnel opportunities in multisystem multi-facility orders. That’s the good news. The challenge is because the complexity of those transactions i.e. the number of devices spread across the number of facilities, spread across the number of participating clinical personnel and administrative personnel, but have input into the decision-making process, it creates longer timelines and quite frankly some variability in order timing to be predictive about close time. I think that the deal that the reference we made to the announcement that we will have this week about Mercy reflects that. That was an order that we have had expected in Q3 that slipped to 4, but quite frankly it’s a significant opportunity for us. As we indicated it’s the largest order that we have had in the U.S. market in 5 years and we feel good about that win, but again so the opportunity set that we are facing relative to more multisystem orders is a positive. It’s just a little bit more difficult to predict when they will happen. And so if you have one of those big ones that slips from Q3 to Q4, it can create some disruption relative to the expectations that exist out in the market. As far as prior year comps, I am going to let Kevin give you his response on that one.

Yes. So, Josh, first off good afternoon. If you are looking at the year-over-year comp, I think it’s important to point out that we had double-digit order growth in this most recently completed third quarter in all of our regions, except Asia-Pacific led primarily by our European region. So year-over-year basis, you are really looking at the decline in APAC which was expected and in our plan due to our tempered deal on the Class A quota in fiscal 2018.

Okay, thanks. And just on fiscal fourth quarter, the guidance implies north of 20% new order growth, you do have a very easy, but is there a multisystem baked into that guidance just with the commentary, Josh, you just provided again just in terms of the complexity, the timing of those orders. Just wanted to get a sense of how that fiscal fourth quarter is shaping up and whether we have – you are relying on another multisystem order with that kind of complexity of timing issue surrounding it?

I think we feel pretty good Josh about where we sit in Q4. It is a big step up, but given kind of what’s already in the hopper I think we are feeling good about where we should land there. So again, the multisystem order – the funnel opportunities that we are chasing and that we have in front of us are spread across all regions and we have those opportunities kind of presenting themselves through Q4 and into the beginning of fiscal ‘19 So, it gives us some confidence that we should be able to make that step up in Q4.

Okay, great. And just one last one on just looking out into 2019, I know you are not going to give out your guidance, but just considering order growth you are expecting to experience for the full year ‘18 where the backlog stands, can you help us just to think through your confidence level in terms of the ability to grow the revenue base off of the fiscal ‘18 level, how are you going to accelerating revenue growth I think your guidance implies kind of 3% to low-4% range modest acceleration to the higher kind of 4% range, I just wanted to kind of get – test your temperature there on the ability to either maintain this level of growth or accelerate into ‘19? Thanks a lot, gentlemen.

Yes. So without giving guidance maybe I will just go to tackle your question in different way, if you take our implied gross order guidance in the fourth quarter along with the implied revenue range you are looking at backlog growth at the end of the year that should be up 7% to 9% which historically would be a good reflection of what we believe the future product revenue growth of the business should be moving forward on the product side. And then in my prepared remarks I have said that you should expect service revenue to grow more in line with our installed base, which is in that 4% to 5% range. So I definitely think Josh, we should be able to maintain our growth rates moving forward with our increases in backlog.

Thanks again.

Thank you.

Thank you. Our next question is from the line of Brooks O'Neil of Lake Street Capital. Your line is open.

Good afternoon, I know you talked a little bit about where you are at with U.S. commercial execution, but can you just amplify a little bit about how you feel about your U.S. commercial organization and what the outlook is in this country?

Yes. Brooks, you know that we basically made what for us has been really probably the most substantial commercial infrastructure investment we have made in the time that I have been here in the U.S. market in the first part of this fiscal year. In absolute headcount, it was probably something in the low to mid-teens in terms of total personnel that’s not all salespeople, but it’s a combination of salespeople, folks across clinical applications, marketing, etcetera, so pretty significant incremental investment for us from a commercial standpoint. We feel good about the people we brought onboard. The vast majority of them are competitors of – folks from competitors and people with proven track records. And but again just given the nature of the length of the sales cycle in this business model, you are going to see some ramp, time to ramp as you might expect. And I think we are starting to see as I mentioned in my prepared remarks and starting to see some light at the end of the tunnel with regards to indicators both in terms of funnel activity and funnel strength and kind of some of the activity that we are starting to see that would lead us to believe that incremental spend is going to start to kick in here. I think we saw a little bit of it in this order that we highlighted in our prepared remarks. And I feel good about the opportunities that exist in the U.S. market for us going forward. There is more – there are more multi-system orders. There are more opportunities for us in single and dual vaults that we really haven’t had a chance to plan in historically. So I think we feel pretty good about where we should be. But I mean on a comparative basis, we still have work to do in the U.S. market. The U.S. is not operating at the level of consistent performance that we see in our EMEA region or the Japan region by comparison. So getting better, funnel looks good, feel good about kind of the ramp we are starting to see, but more work to do, it’s too early to declare victory.

Okay, all that’s very helpful, I really appreciate it. Would you say that in the U.S. you are seeing a real manifestation of the replacement cycle we have been expecting or are you seeing more competitive takeaways are opening new bunker opportunities, how would you characterize it?

I wouldn’t characterize it from a contribution standpoint. New bunker opportunities are not part of that mix. I would say it’s a combination of replacement sale opportunities, so bunk of retention of our legacy bunkers and competitive takeaways in the context of us moving into single and dual vaults that we haven’t been able to compete in really effectively if you look back over the last several years.

Great. Just one more for me, I am pretty excited about the success you are having with Radixact that’s tremendous. Are you seeing – would you see – you are seeing any cannibalization of your CyberKnife opportunities because of that or is it pretty much incremental in your mind?

No, there is no – the success and the ramp we are seeing with Radixact really doesn’t impact the CyberKnife discussion. As you heard us talk about in prepared remarks, we had a little bit softer quarter in CyberKnife than we would have liked, but at the end of the day, it came against a prior year comp that was very strong in prior year third quarter. And if you look historically CyberKnife sales for us have been somewhat cyclical you know it will run kind of in a – it will oscillate if you will between quarters. We will have a strong one. We will have a softer one just the kind of the nature I think of the sales process for that device. Because it is more of a specialty device, it’s less of a replacement, a pure replacement opportunity although we have a fair number of replacement opportunities for CyberKnife in the U.S. and Western Europe as well.

Great. Thank you very much.

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

Yes, thanks for taking my question. With more clarity in China now, can you spend some time discussing the opportunity for Onrad in China and how quickly you think this product could ramp? And couple of follow-ups.

So Brandon, we have our distributors there and our team there have really been working hard to position Onrad in the value segment over the course of probably the last 15 to 18 months as we have talked about in the past prior to real clarity around where those products were going to land in terms of their classification, I think that we have characterized it as a little bit of a headwind in that. People are kind of taking a wait-and-see approach rather than being more aggressive in jumping in with Onrad decisions. With the decision now behind us and clarity around where it falls, I think we feel like we should be able to see some impact – order impact within the next quarter or so. And I would say you will start to see some – we will start to see some in Q4 and it should improve from there. So, I think we have said several months, but I think that means the beginning of which would be next quarter and moving forward from there into early fiscal ‘19.

Okay. And then any clarity you can provide on the slides the Mercy order, would you guys haven’t hit your gross order guidance with this order in fiscal 3Q?

Yes.

Okay. And can you also provide some thoughts in terms of your confidence and reaffirming the guidance, the growth order guidance for the year and how much flexibility do you have in that fiscal 4Q guidance, should several of these multi-order system orders slip into fiscal year ‘19?

So we – again, the funnel opportunity that we have improving in the U.S. still strong in Western Europe that the one big area quite frankly from a regional contribution standpoint that really now should be also kicking in is the Asia-Pacific discussion because of China which we just discussed. So, I think when you look at these things in the aggregate, it leaves us feeling pretty good – feeling pretty good about where we are and our ability to deliver what we recognized as a pretty good size step up or step change in Q4 order activity.

Okay. And then just last question for me obviously fiscal year ‘18 EBITDA guidance was lowered, I think you talked about strategic investments you are making in gross margins, can you just provide some additional insight to both of those issues? And on the investment side, where are you making the investments and what types of technologies do you think you can accelerate? Thanks.

So Brandon I will start and I think Kevin can amplify in this, but one of the things that we recognize very clearly is we are at a point in our evolution that we don’t have the luxury of being able to just grow from a top line standpoint and not care about what the bottom line looks like. Our balance sheet, our capital structure the improvements we have made in all of those areas have been directly related to our ability to generate more consistently free cash flow and generate more EBITDA. And so this is a balancing act for us that we take very seriously, our focus right now is to continue to be able to show that we can accelerate and ramp revenue growth, but not give up the impact to the bottom line. Again, we made some conscious decisions coming at the fiscal ‘18 that have been I think both Kevin and I feel very certain that they have been the right decisions for longer term revenue momentum, but given some of that spend and some of the one-time or the margin impacts that we have seen and really been surprised by quite frankly in some aspects of the service business. It’s put this quarter certainly and then on a full year basis given how late in the year it’s been, it’s put our ability to deliver the committed number from the beginning of FY ‘18 it’s put it in jeopardy. And so what our view going forward is we have to do both. We have to continue to accelerate revenue growth and we have to be able to show that we can generate incrementally more free cash flow going forward and get this business to a sustainable level of profitability in terms of GAAP operating income or GAAP net income.

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

Hey, guys. This is Tejas on for Tycho. Just a couple of ones here for me on APAC, so first on China, you said you had announced a JV by your next earnings call, can you just elaborate on what you are looking for in terms of an ideal partner there and what segments of the market you hope to target via the JV? And then on India recently you highlighted the sale of two Radixacts by Apollo Hospital, so what does your installed base look like today in the country and how big could the opportunity potentially be for you down the road?

Yes. So, let me take the China piece first. Basically, the ability for us to be able to ensure that we have good market access longer term in China through the presence of having a local branded product solution with the assistance of a local manufacturing partner I think is an important part of our growth strategy going forward, so that’s kind of the background on that. I think our view is that someone that has from either an existing manufacturing capability or someone that has the experience in the regulatory processes that will allow us to bring product to market whether it’s from a prior experience in the linac business or not is less important probably, but those are the primary drivers in terms of what I would describe as the characteristics of what we were looking for. I would also point out that this is not a – this is not a pure R&D and start from scratch product development activity cycle, this is really more of a product branding and local regulatory and assembly type of presence in that context, so something that would look very different than essentially a start from scratch build it entirely ourselves kind of scenario. On the India opportunity, our installed base I think right now is probably somewhere in the low to mid 20s kind of installed device base size and growing nicely quite frankly and one that we feel good about going forward.

I think, this is Kevin, it’s been I don’t want to say surprising, but I think nice to see is we have actually seen some receptivity to our next generation Radixact platform in India. So, I know lot of folks may view India as more of an emerging market, lower price point type of market, but we have been successful. We have a direct operation there. We have been able to take Radixact orders. And I think what we are hearing from customers in India, the throughput of Radixact and the reliability does make an ideal solution for the hospitals in India that many of those devices can be running 18 to 22 hours a day. So we have seen some nice uptake there.

Got it. That’s helpful. And one quick one here for me on the U.S., so I know last quarter you said your commercial build-out on the reorg in the states was largely complete and how should we think about sort of visibility overall in the market given that you have had some success there in terms of your commercial organization, but on the other hand you have these large lumpy orders. Is there anything you can do in terms of these large multi-facility orders in terms of just getting a better sense of order timing and flow and getting people to sort of place orders before the quarter closes or is it largely driven by factors that are beyond your control? And then secondly what’s the split like in terms of competitive wins of the single and dual vaults unit level versus replacing your own instruments. Is it 50:50?

We are still replacing our own bunkers. We are replacing our own installed base situations at a level of about 15% to 20% of total order volume on a global basis. The biggest geographic representation or areas of concentration for replacement sale opportunities continues to be the U.S. and Western Europe. So I’d say that’s the primary driver of the replacement sale discussion and where those opportunities are.

And then if you look at just replacing conventional linear accelerators and competitive bunkers, those obviously vary from quarter-to-quarter, but we have been running in the 15% to 25% of all of our sales are competitive replacements, which would leave roughly 50% of our remaining sales to more Greenfield type opportunities, which you would see in APAC in Eastern Europe.

Got it. And then on the commercial organization in terms of getting better visibility on the larger orders, any thoughts there?

Yes, lots of thoughts, we are working hard at it. The reality is we – I think some of this is it’s a lumpy business to begin with. I think our lack of scale creates actually higher peaks and valleys than our competitors and I am not complaining about that. The onus is on us to figure out how to be forward-looking and dialing in expectations from a forecast accuracy standpoint to the greatest degree we can and greatest degree of accuracy we can and we are working hard at that. I think it’s maybe complicated a little bit in the U.S. market by again how new the resources are that we have got in place. We have got probably 65%, 70% of our territories are people that have been in place for less than a year. And so just again given the length of the sales cycle and the complexity of the deal flow that we are looking at with more multisystem orders, it becomes a little bit more challenging with the folks that have been in place on a shorter timeframe quite frankly then would be ideal, but I would expect this would be improving over time. I don’t know that we will ever – until we grow our way quite frankly to a level of scale that we – and order even a single quarter if it’s a multisystem deal, not having the ability to move order to impact us in terms of we can make the commitment or not make the commitment until we get to that level of scale, I think that will probably be subject to some continuation of this, but I think you should be confident knowing that we are working hard to minimize the quarter-to-quarter variability in order activity.

Got it. Thanks guys. Appreciate the color.

Thank you.

Thank you. Our next question is from the line of Amit Hazan of Citigroup. Your line is open.

Hey, guys. This is Bhalla on for Amit. You hear me okay?

Yes.

Great. So, the first one on the increased R&D spend I think you guys noted future imaging enhancements that are going to be coming. Can you touch briefly on what that pipeline may entail and then any updated thoughts that you have around adaptive therapy offering and what that might look like for Accuray?

Yes. So, we are excited about the things that we have got. Our biggest investments being made in terms of the roadmap, the specific roadmap projects, I would say from the key programs right now, the Big Three would be diagnostic CT quality capability on Radixact, that would be in the form of kVCT imaging capability, the next generation optimization and volumetric imaging capability on the CyberKnife, which is the programs we have talked about in conjunction or collaboration with medPhoton and then true adaptive therapy capability on Radixact. We have also talked about in prepared remarks we just launched an MVCP enhancement on the existing Radixact platform. That’s the CTrue iterative reconstruction, which is really focused on soft tissue resolution enhancement and it’s gotten some very good feedback at least in early stage discussions with early users of the product and the software. So, again, it’s probably very more heavy to the imaging upgrade, imaging enhancement end of the spectrum in terms of the topical areas and we are excited about the things we have got going on. We will get to something approaching diagnostic CT quality capability on the next turn of image upgrades for Radixact and CyberKnife both.

That’s all. Great. Any timing around the next turn of image upgrades?

I think we have talked about something on the Radixact side, maybe something in the next 18 roughly months or so and CyberKnife probably a little bit beyond that.

That’s great. Thanks. Second one, I certainly appreciate the increased revenue range I guess tightening higher range, but you know that expectation for service revenue to return back towards installed base growth. Does that – that essentially means that you have exhausted the opportunity there with the software upgrades? Why isn’t there more of a runway there?

Yes. I actually think there is more of a runway. I was pointing to more our full year service revenue growth given where we started off the year kind of in the low single-digits. So, if you go back to Q1 and Q2 we are only growing at 2%. So, the Q4 guidance would imply that there is runway left in our software upgrade, but I actually do think that’s an area as a company where we are putting some focus into installed base upgrade sales, because not only does that help the top line, those upgrades are typically more margin rich than product revenue sale. So, it also helps the bottom line.

One of the areas we have added resources when we talked about the build or the investment incrementally in U.S. commercial infrastructure, one of the area specifically was installed base, dedicated installed base, personnel people that were focused on mining the installed base specifically for things just like the topic you talked about software upgrades, other upgrades from a hardware standpoint. And so I think we are getting better focus and better – more feet on the street, better focus, better intensity if you will on those types of products, specifically, which I think should continue our trends going forward.

Alright. That’s all very helpful color. Thanks, guys.

Thank you.

Thank you. And at this time, there are no further questions. I would like to turn the conference back over to Josh Levine, Accuray’s President and CEO.

Thank you, operator and thank you everyone for participation this afternoon. We look forward to speaking with you on our fiscal fourth quarter earnings call. Thank you and have a good evening.

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.