Good day, ladies and gentlemen, and welcome to the Accuray Incorporated Fourth Quarter and Fiscal Year 2019 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference Michael Polyviou. Sir, you may begin.

Thank you, Daniel, and good afternoon everyone. Welcome to Accuray's conference call to review financial results for the fourth quarter and full fiscal year 2019, which ended June 30, 2019. In addition, during our call this afternoon, management will review recent corporate developments. Joining us today are Josh Levine, Accuray's President and Chief Executive Officer and Shig Hamamatsu, 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 fiscal 2020 guidance, including factors that could affect such guidance, expectations regarding market conditions in China, expectations related to new product releases, 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; operationalizing the China joint venture and overall strategy in China; timing of China user license issuances and the company's ability to take advantage of the issuance of such licenses; 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 news release we issued just 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 to reflect actual performance or results, changes in assumptions or changes and other factors affecting forward-looking information except to the extent required by applicable securities laws. Two housekeeping items: First, during the Q&A session, we request the participant to limit themselves 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, statements regarding our fourth quarter refer to our fiscal fourth quarter ended June 30, 2019. Now I'd like to turn the call over to Accuray's President and Chief Executive Officer, Josh Levine. Josh please go ahead.

Thank you, Michael. Good afternoon everyone and thank you for joining us on today's call. Since we last talked with you in April, our team has continued to execute and build on our recent commercial momentum, advance our opportunities in China, reduce our overall operating costs and achieve full year operating profitability. This afternoon, we have reported results for our fourth quarter and full fiscal year 2019 highlighting this progress. We generated $97 million in system orders during the fourth quarter and $342 million in system orders for the full fiscal year. Year-on-year, orders grew 12% over fiscal 2018. For the fourth quarter, orders increased 1% as compared to last year's period, but that was against the tough prior comparison as we recorded the largest U.S. multi-system order in the company's history in last year's fiscal Q4. Regionally, Japan had the highest order growth rate during the fourth quarter at approximately 20%, while the Asia-Pacific region increased approximately 15% driven by the continued strength in China. In EMEA, orders grew in the mid-single digits during the fourth quarter. This growth was highlighted by the receipt of the first multi-system multi-clinic order that bundled both Accuray and RaySearch Lab's system and software offerings placed by the Swiss Medical Network. Turning to our Americas region. Orders were down in the fourth quarter based on the previously mentioned comparison to the prior year fourth quarter. Nevertheless, fourth quarter orders in our Americas region achieved their highest level for any quarterly period during fiscal 2019 driven by contributions from the U.S. and Latin America. For the full fiscal year 2019, the 12% total order growth was driven by our Asia-Pacific region where pent-up license demand in China resulted in orders nearly doubling on a year-over-year basis. EMEA continued to be the largest contributing region…

Thank you, Josh and good afternoon everyone. As Josh highlighted, for the full year, gross orders were $342.3 million, an increase of 12% over the prior year. We had $97.2 million of gross orders in the fourth quarter, representing a 1% increase over the prior year. Last year's Q4 included the largest U.S. multisystem order in the company's history and therefore presented a tough year-over-year comparison. Starting in fiscal year 2019, gross orders include upgrades purchased through our service contracts. These upgrade orders totaled $1.9 million for the fourth quarter and $5.5 million on a full year basis. Excluding these upgrades, gross orders grew 10% on a full year basis. From a product mix perspective, the TomoTherapy platform led by Radixact accounted for approximately 60% of gross orders for both Q4 and the full year. CyberKnife represented approximately 40% of the total gross orders in both Q4 and the full year. CyberKnife orders grew double digits on a full year basis. Net age-outs for the quarter were $24.1 million, up from $17.1 million in the prior year. Net age-outs consisted of $28.2 million of age-outs offset by $4.1 million of age-ins. Approximately one-third of the net age-outs for the quarter relates to the orders with our long-time distributor in Turkey, where strengthening of the U.S. dollar against the local currency over the past few years has caused a delay in revenue conversion. We also recorded $8.7 million of cancellations and other adjustments. As a result, on a net basis we generated $64.4 million of orders in the fourth quarter. As discussed in prior calls, the volume of order cancellations can fluctuate from quarter-to-quarter. On a full year basis, order cancellations totaled $25 million or approximately 5% of our total backlog which is consistent with prior year. We ended the fourth…

Thanks Shig. Before moving into Q&A, I'd like to spend a few moments on some of the details related to recent developments with U.S. reimbursement. In July, CMS unveiled a radiation oncology alternative payment model that will be tested over a five-year period and is currently anticipated to be implemented sometime in the first half of calendar 2020. As proposed, 40% of all radiation oncology providers will be required to participate in the model, which will apply to both hospitals and freestanding-cancer treatment centers. We believe that the proposed national payment rates and subsequent adjustments will likely result in increased utilization of hypofractionation and SBRT treatments. As an original pioneer in the areas of hypofractionation and SBRT, we believe Accuray is well positioned to benefit from the likely changes in clinical practice that will result from implementation of the APM. At our upcoming analyst event to be held on September 16 at ASTRO, we'll be providing an expanded overview of Accuray's latest technology upgrades and how we see these advancements potentially benefiting from reimbursement trends. Before we open the call up for questions, I'd like to thank the entire Accuray team for their commitment, increased focus, improved execution in supporting the important work that's making a difference in patients' lives. And now operator, we're ready to open the line for questions.

[Operator Instructions] Our first question comes from Anthony Petrone with Jefferies. Your line is now open.

Thanks, Josh. Thanks, Shig. Maybe I'm going to begin with guidance fiscal 2020 and just kind of moving through the moving parts here. Shig you mentioned 150 basis point impact from tariffs to 25% tariffs. So if I'm doing the math correctly, if we back that out, the implied underlying guidance is something around down 60 basis points to up 1.8% and you're coming off fiscal 2019 where you did 3.4%. And so I'm just wondering the spread between where we're exiting 2019 and the underlying outlook excluding tariffs for 2020, how much of that is purely the delay in Class A licenses. And is anything baked in there for the U.S. as perhaps maybe hospitals hesitate a little bit as the APM is sort of finalized and implemented? And then I have a follow-up. Thanks.

Yeah. Anthony thanks for question. You're right about the math. If you do the 1.5% tariff impact on let's say roughly $400 million that's about $6 million so that is the dollar impact on the tariff. And so if you remove that, you can say that top end of our range is $420 million plus $6 million, $426 million over what we had there for 2018-2019 and FY 2019. So the -- as Josh and I said in prepared remarks, a lot of the muted growth unfortunately in the FY 2020 is impacted by the China Type A revenue. We now expect to be the second half of fiscal year and all of that is due to the license timing, which is outside our control. Good news is that we're getting a lot more clarity on the license issuance timing as the day goes by, so that's a good news, it’s just the timing slipped. And I think you heard I speak about the other regions Japan and EMEA in particular, we're expecting flat slightly down for them -- these regions due to what we think is a one-year hiccup in terms of managing the end-user installation timing. But as I said, they grew double digits in the fiscal 2019. So clearly the management of the revenue conversion pipeline has been very effective the last couple of years. But again these two regions, we think we -- by the time we finish FY 2020 going into FY 2021, they might be in a growth mode going into 2021 as we resolve these temporary issues on installation schedule. And we got the modest growth in revenue expected for AMS revenue. Josh you want to add something?

Yeah. Anthony just to tag on Shig's piece, you got a part of your question, which you ended with was really around how much if anything we've baked into some of the assumptions on guidance related to slowdown perhaps in purchasing decisions based on CMS' direction. The answer on that last piece is virtually nothing. I don't think anybody right now can predict what the implementation timing we've got, obviously, understanding about implementation timing from CMS probably sometime in the first half of the next fiscal cycle, the next calendar year. But the reality is it's a complex proposed model. There are a lot of moving pieces to it. I happen to believe very, very strongly that when you look at what will result in terms of clinical practice, direction and impact, we are probably going to benefit more than any of our competitors from what is happening with the reimbursement. It's moving people in a direction that we have more continuous experience with related to hypofractionation and SBRT treatments than arguably the bulk of the people we compete against. So I think over time there's no question that we'll benefit from it and I think that our portfolio was well-positioned to capitalize on what CMS would like to see happen there, which is patients treated more rapidly with higher doses. But I think it's too early to call whether or not there's going to be a definitive impact or slow down or freeze if you will on purchasing decisions. And, therefore, we didn't really have anything baked into the guidance related to that component.

Great. And then I'll just add the follow-up, going back to China. I mean, do you think as trade war continues back and forth, I mean is there any risk to the target now of the second half for Class A license contribution? And I'll get back in queue. Thanks.

Yeah. So again I think you heard me say in last quarter's call, it would be terrific to wake up in the morning and not have a tweet or another headline related to trade war or tariffs and the back and forth it's been taking place. With that said, we still have a high degree of confidence that these licenses are going to issue. One of the reasons that we put the prepared remarks in place that we did in today's discussion related to China Isotope and Radiation Corp. is that if you think about what's going on between China-U.S. relations and then you look at what we've experienced with the practical flow of regulatory decisions or licensing and permitting that the JV structure has been receiving approvals on over the last 120 days, we've had three wins in terms of the permitting and licenses that business structure needed to start operation. And I'm thoroughly convinced that the reason it went so rapidly and was so effective was because we're dealing quite frankly with the Chinese government directly. It's not Washington, it's not President Trump, it's us dealing with our partner and they are a very, very large state owned entity. And they have an inside the tent view I think and capability of helping advance some of these things and I think that what we've seen is indicative of that. So again if nothing else it just reaffirms in our minds that we've got the right partner and we're seeing them help and interject themselves in ways that I think over time will continue to be helpful. Right now, again, based on what you heard us say in prepared remarks, the early indications are that we have a reasonably substantial number of Tier 1 hospitals with applications in the system for Type A license review and approval that are related to either a Radixact product or CyberKnife product. And I think that we feel well positioned based on that. Again, we're not going to win -- probably not going to win all of those, or not going to get approval on all of those, but I think that we feel good about what we see at this point directionally in terms of momentum or the representation of our products in the total pool of applications that are related to Type A.

Okay. Thanks again.

Thank you. And our next question comes from Josh Jennings with Cowen. Your line is now open.

Hi. Good evening. Thanks for taking the questions. I just wanted to follow up on China. Just with the Class A license timing, I know, it's a wildcard and out of your control and unpredictable, but just so I think we're all clear when you do get the licenses in terms of recognizing revenue in the back half, you guys will recognize revenue upon the license granting and you -- you'll ship to TomoKnife and you'll be able to recognize revenue there. I'm just trying to think about the risk of if licenses are granted later in the first half of this fiscal year versus -- or the benefit of them being recognized earlier, relative to your guidance here.

Yes. Josh, this is Shig. I'll take that question. In general, you're correct. When we ship to TomoKnife, that's the timing of revenue recognition for us. And just to add a little more clarity there the -- once the license is granted to end-user hospital, there's additional step to go through the tender process. So I just want to make it clear that, beyond the licenses grant there's additional step of the tender process for public hospitals in China to go through the bidding. And after bidding is complete, that's when and how a shipment occurs to TomoKnife and take revenue.

Josh, just to be clear on what Shig just said, I want to make sure we're precise on this, that the tendering process is essentially a process that will define and lock down the contractual terms between the distributor and the end-user facility that's receiving the license. It does not open -- it's not an open-bidding situation relative to something that would result in a different product being awarded a license in that customer -- that end-user customer situation, just for purposes of clarification. But what Shig has identified is right on in terms of we'll recognize revenue when we ship to TomoKnife. And inventory availability for us is not going to be a problem in us being able to respond rapidly to -- once hospitals are ready to install and once TomoKnife is ready to take product.

Great. And then just a follow-up question again on China, it's a hot topic. Just in terms of your gross order guidance in the mid-single-digit range. I mean, how should we be thinking about Class A licenses being granted and the impact to potential that pent-up demand and maybe even stronger order flow out of China? And also, can you just remind us how once the JV is fully in play and sales responsibility shift over from TomoKnife to the JV, those Type A or Class A orders will still flow through Accuray's order number? And I just want to make sure that there's not going to be any overhang there in terms of Type A orders falling off of your backlog or into your gross order number. Thanks for taking the questions.

Yes. Sure. So just -- well, Shig and I will tag-team this. Just to answer your the last part of your question directly, one of the reasons we put the structure in place and negotiated the agreement details, the way we did between ourselves, our JV partner CIRC and TomoKnife is, we wanted to make sure that exactly what you were asking about was not going to happen, that we weren't going to have any disruption from a revenue conversion cycle standpoint in the transition between TomoKnife and China Isotope. And so, TomoKnife has a protective window, if you will, for a defined number of accounts that they are going to be able to take revenue on and will do so, quite frankly, for the next -- for a defined period of time. And at the end of that period, all revenue will be flowing through the JV structure. The selling activity for Type B products, I mean, we have TomoH today that's available for sale. And we've got a window of time, obviously, before a local product is going to be available and manufacture it for us. But we have a network of distributors or dealers, if you will, that are covering the vast majority of the provinces at this point. They're in place, they are people that -- our CEO there, who's our former GM for the Accuray APAC region that he worked with in prior lives at Siemens and other companies, so he's got a strong commercial experience with them. They are on board, they're already trained and they are actively out trying to sell TomoH under the Type B discussion or at least positioning that product. So, we think that we have the right mechanisms and protections in place to ensure, no disruption or no overhang to use your terminology in that transition.

Yes. And Josh to kind of hit some of the points you are raising. In transitioning, Type A activities from TomoKnife to JV on order front, there will be no loss to backlog in that process. In other words, we have, you heard the number $100-plus million of backlog in Type A we have with TomoKnife. TomoKnife has opportunity to convert those backlogs to revenue over the next couple of years and they'll focus on that. And there's no orders lost or backlog lost in that transition I want to make that clear. And as we said, right now, JV and TomoKnife are also sourcing additional orders on top of what we already have on Type A. And the one the press release we had about a month ago on our JV progress, one or two orders they received was -- JV received was Type A. So, they are already generating both Type A and Type B orders. So hope that answers your question. And I think the other one was our mid-single digit order growth guidance in how to think about China, the -- we are expecting additional China orders to flow in fiscal 2020. And obviously the assumption is embedded in the mid-single digit guidance. However, I do expect top comp year-over-year on China because as you pointed out, we had a bolus of orders in Q2, Q3. So, we want to see some top comp on the order side in China particular in fiscal year 2020.

Great and just a follow-up just, so we're clear on just on the gross order flow through the year. When you have that transition from TomoKnife to the JV for selling Type A and Type B, will the Type A and Type B orders be recognized through the JV or will you guys recognize those orders as gross orders for Accuray? And could there be any disruption to order growth or is that been accounted for in that mid-single digit gross order guidance you've provided?

Yes. So logistically, the way it works Josh is that, obviously the end users will place an order with joint venture because obviously the joint venture is the local distributor of our product. And the joint venture will turn around and place the order with Accuray at which point it becomes our backlog. So, hopefully that makes it clear for you the logistics of the order receipt.

Perfect. And that's for Type A and Type B Shig?

Correct.

Great. Thank you.

Yep.

Thank you. And our next question comes from Brooks O'Neil with Lake Street Capital Markets. Your line is now open.

Well, good afternoon. I have a couple of questions. On August 2, you guys filed an 8-K indicating that you had terminated the employment of your Chief Commercial Officer. Could you just give us any color that you're able to offer as it relates to what was going on there? What is going on there?

Yeah. Brooks, this is Josh. I can confirm that the – our Former Chief Commercial Officer has left the organization on an interim basis. The regional GMs are reporting to me directly which I'm – and they are very comfortable with. It's given me direct line of sight to the business and the trends in each region. And in my mind ensures that we'll minimize any business disruption as a result of our Chief Commercial Officer's departure. It's very much a business-as-usual environment. We've got an active search underway for a new commercial leader. And as we have additional updates or news to report on this topic we'll do so.

That sounds great, I appreciate that. Second question, I had was you guys talked quite a bit in your prepared remarks about your excitement about the motion management capabilities you're introducing to the marketplace. Can you just in layman's terms give us a little bit of a sense for how you feel those position you competitively in the environment you see out there in the marketplace right now as it relates specifically to motion management capabilities you bring as well as what you're seeing from your competition?

So the world that we will be living in all of us will be living in Brooks going forward will see a shift in case mix from IMRT cases and 3D conformal cases to much more much higher dosing fractions and fewer fractions. So think in terms of those – historical mix moving more to SBRT cases and SBRT cases driven by hypofractionated treatment regimens as opposed to more conventional fractionation approach. And so the – that movement is going to – and CMS is taking this into account when they start – when you look at their proposed APM, because they are talking about patient, about quality measures, they're talking about patient safety measures. So there is likely going to and certainly will be, I'm guessing some transition here from a clinical practice standpoint that people that and the providers that are not as familiar with or haven't historically been doing as much SBRT work or hypofractionated work are actually going to need to come through some kind of a learning curve. And the learning curve is really about confidence, clinical confidence in being able to increase the dose and deliver it over fewer fractions from where they've been. And ensuring -- and what drives that confidence clinically is knowing that, you are going to have the beam focused on the target as you want it as precisely as it can possibly be. And our view is that we have -- we pioneered the use of hypofractionation. If you go back 15 years ago, 18 years ago, we were the only voice in the marketplace talking about this and SBRT. And it was because, CyberKnife was a unique technology that allowed you to do this safely. Increase the dose and ensure that motion management through Synchrony was able to accommodate for either positional changes by the patient, motion of -- respiratory motion from a patient breathing or any other changes that needed to be taken into account that would require synchronization compensating for the motion and synchronizing the beam. And we do that in real-time. We do that on an automated basis in real-time. That's a very, very different mechanism than our competitors are using. Gating patient restraints, you can go down the list, but none of them provide the peace of mind and the confidence clinically to be operating at dosing levels those higher-fraction dosing levels that SBRT cases are going to require. And that's why I think we're feeling the way we are about what benefit -- what the value proposition looks like in our product portfolio, when you think about this kind of new backdrop or future backdrop related to what CMS wants to have happen with the APM.

Sounds like a very positive environment for you and I am excited. Thank you very much.

Thanks, Brooks.

Thank you. And our next question comes from Tycho Peterson with JPMorgan. Your line is now open.

Hey, thanks. Josh, I wanted to go back to some of the comments you made before on the bundle and you highlighted it's a complex model a lot of moving pieces. I'm just curious if you could talk qualitatively about what you are hearing from customers, because the idea that we might not see CapEx freeze is a little bit odd. I mean, I would think, customers may pause until there's better kind of visibility here.

Yes. So, I mean, I haven't had any overt inputs that are -- I'm -- give me pause or trepidation or concern about long delays, Tycho. I think the reality is that, again, what CMS is hoping to do is to try and get this implemented as rapidly as they can. You know that we're in a public comment period right now. As you might imagine, in typical fashion, all the constituents that have a stake in the outcome here, being led by ASTRO are assembling information and putting their information together to be able to present to CMS. I think, when you think about what they've communicated so far, what CMS has communicated so far, there are -- the big topics, at least from what ASTRO was saying and what I'm gathering is that, the national payment rate, the view generally is that -- the census is, that it's low. There are also a whole series of withholds and adjustments that will be a part of the payment model that are going to need to be worked through. And so, I think, that there's going to be some negotiation and some movement on those before the music stops playing and something gets definitively rolled out. But I know that CMS wants to get moving on this rapidly. So, I think, that that in general should try and create an environment where it moves this along. I mean, I think that there will be some people that will probably take a wait-and-see approach to, if they are in the midst right now of purchasing decisions definitively. But I think directionally, people that are understanding what CMS wants to have happen here with regards to the movement to SBRT case mix and hypofractionated treatment delivery, I think that, if you use that directional context for what the world is going to look like and how you're going to have to be operating it clinically, I think, it takes a lot of the confusion out of, or the potential confusion out of where this should land. And, again, it supports a more rapid -- people being able to make decisions about what they need to do from an equipment standpoint.

Okay. That's helpful. And then on VOLO on -- and kind of the replacement cycle here, I think, you talked in the past about a-third of the compatible CyberKnife customer base has already adopted. Can you just talk a little bit about how you think about the adoption curve and the replacement cycle around VOLO going forward?

Yeah. We have again in round numbers about 350 CyberKnifes in the installed base. And roughly as you pointed out about a third of those are in the latest-generation device M6. And that's the part of the installed base that's device compatible or backward integratable from an installed base compatibility standpoint, which essentially leads another 65% or 70% of the installed base that are pre-M6 devices. And that is a primary target for our VOLO software upgrade introduction. And that's a -- I'd say the heaviest concentration geographically is the U.S. and EMEA with the concentration in EMEA really in Western Europe. And that's the selling focus right now related to VOLO.

And then on guidance, a question on margin. You're guiding to flat gross margins. You had a good double-digit CyberKnife orders which is higher margin for you guys. Can you maybe just talk about give-and-take on gross margins? And then any profitability comments as we think about 2020 for you guys with respect to net income that is? Yeah.

Yeah. So gross margin, Tycho, you heard I say that we're guiding to flat 39% year-over-year. And that includes the 1.5% impact from tariffs. So if you remove that tariff impact, we would have been something like 40%, 40.5% showing improvement year-over-year. We certainly think that we can improve on coming into this year. The mix of CyberKnife as you pointed out has a higher margin. We also see the benefit of the cost actions we took last year, some of that went to a COGS line, but the tariff impact is really kind of pressing it down unfortunately for our fiscal 2020. And then the profitability metric again we are very happy about $600,000 small fee amount, but it is operating profit that we turned first time since the TomoTherapy acquisition in 2011. And the cost cutting obviously is paying off. And even though that we're guiding to relatively flat revenue here, we can expand on the operating line going into fiscal 2020 here.

Okay. And if I could just ask one last one. In Japan you had a great order number, but you're talking about some kind of delays there. Can you just clarify what's exactly going on in the Japanese market?

Yes. It's basically -- I mean as you've heard us kind of in different moments in time talk about in the past we've got -- we've added resources as Shig indicated in the site planning area in support of distributors. But quite frankly in Japan specifically there is a -- especially around technically complex construction-related type projects there are competing resources now in play with regards to the Olympic construction infrastructure buildup. And I think that that's probably the single biggest contributor to end-user delays or slow down if you will on revenue conversion cycle. I don't see this as a continuing trend. We actually saw -- have seen since the -- probably the end of 2016 we've seen in the last several years much improved revenue conversion cycle activity based on some of the steps we took and implemented back then. And I think that these are more transitional or transitory. Japan and EMEA in the context of Shig's remarks, I don't see this being a long-term situation Tycho, but it's definitely going to slow things down with regards to revenue generation capability in those two regions for fiscal 2020.

Okay. Thank you.

Thank you. Ladies and gentlemen, this concludes our question-and-answer session. I would now like to turn the call back over to Josh Levine for any closing remarks.

I want to thank everyone for joining the call this afternoon. And we look forward to speaking with you again in October when we report our fiscal 2020 first quarter. Thanks very much for participating.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone, have a wonderful day.