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Accuray Incorporated (NASDAQ:ARAY)

Lazard Capital Markets Healthcare Conference Call

November 13, 2012 3:30 pm ET

Executives

Thomas Rathjen – Vice President, Investor Relations

Analysts

Sean Lavin – Lazard Capital Markets

Sean Lavin – Lazard Capital Markets

I think we’re going to go ahead and get started. I’m Sean Lavin, the Medical Technology Analyst here at Lazard Capital Markets. I’m very pleased to have Accuray here. Tom Rathjen, the Vice President of Investor Relations is going to give a brief presentation and do mostly QA. Thank you.

Thomas Rathjen

Thank you, Sean. And then we very much appreciate the invitation to your conference again this year. What I’m going to do today is based on Sean’s suggestion, I’m going to make a few general comments and we’re going to Q&A. So we’re proud to have most of our comment during Q&A.

To draw your attention to the forward-looking statements, to Accuray, we’ve had a few interesting elements that have made the story a little more interesting these days, and I’ll talk about both of them. One is a very successful launch of two new products that ASTRO bought two weeks ago in Boston that we think is going to have a significant impact on our sales and our revenue moving forward. And then also we have a new CEO and we’ll talk a little bit about Joshua Levine, and I’ll tell you what I can at this point.

So at ASTRO, we introduced the two new platforms, one for the CyberKnife and one for TomoTherapy. And we are pleased with the level of enthusiasm. With the CyberKnife platform, we introduced the M6 Series that the series of new platforms based on the CyberKnife architecture with all the elements that people have come to know and appreciate with CyberKnife, namely the robotic arm, the ability to track tumors throughout the entire treatment and then very importantly and some of the success apart is the ability to automatically compensate for tumor movement.

And I’ll talk a little bit more about just what these new platforms are, but suffice to say that this allows the promise on radiosurgery to bring in more and more patients. It looks also TomoTherapy. We introduced the new H Series for TomoTherapy. Again three new platforms that that allow the benefits of the helical delivery, the daily imaging of that TomoTherapy has become known for it, but a big element that we are very excited about with this new H Series is the throughout and we see the treatment has been greatly increased. So we now can offer a much faster treatment for TomoTherapy customers.

So what we are seeing is that, we now have two products that can be the best treatment options for both CyberKnife and TomoTherapy customers or patients without compromise and with confidence. So there is no compromise in the treatment plan that goes off.

So let’s take a quick look at the new CyberKnife M6 Series. What we have is the main feature that people are excited about what the new CyberKnife is the addition of the MLC even Multileaf Collimator on the end of or expand the linear accelerator.

So what this does? It now becomes the only system out there that has a Multileaf Collimator that is able to deliver dose in three dimensions. So we are very excited about this and it does several things for us, one beam, that it opens up the market for radio surgical patients, so there were patients that physicians wanted to treat with the CyberKnife, but due to the size of the tumor or perhaps the regular shape of the tumor typically our traditional CyberKnife treatment simply would have taken too long.

Again, keep in mind that the traditional CyberKnife provided pencil beam radiation beams now with MLC, the physicians can actually sculpt the dose or I am sorry sculpt the shape of the beam to coincide with the size of the tumor and it greatly improves the speed. So we are able to incorporate more patients into the radio surgical community and then also because of the MLC and the speed associated with the delivery, we can now, CyberKnife can now provide IMRT treatment as well.

So what this means is, that the hospital customer now has a better ROI. They can treat more patients, and the throughput will be better, so we think this is going to have a big impact on our ability to sell more systems. The Tomo H Series is again delivers on the promise of your original Tomo design, again the helical delivery of radiation with daily imaging, which differentiates it from other systems out there.

And the big news I guess for TomoTherapy is that, the speed of treatment has been dramatically increased. So the throughput is far superior now. The treatment times have been reduced 50% to 70%, so the hospitals now can see many more patients and increase that throughput making the economics much more attractive.

What we’ve added to Tomo, the Tomo H Series is something called TomoEDGE, which is basically dynamic jaws, which helps in the formations of the beam allowing much more rapid delivery of treatment. And then also VoLO software, which is treatment planning software that greatly enhances the speed at which treatment planning can be put together.

So what use to take an overnight calculation and now be done in a matter of minute? So it really very much increases the viability and the economics behind a Tomo System. What I would give you here very quickly is just take a look at positioning of the new product. So this shaded area shows the traditional use of linear accelerators to deliver radiation therapy. As time passed, some of the liner accelerators developed a greater capability do IMRT, IGRT and even some stereotactic body radiosurgery. Tomo came along and this if niche really was IMRT, so it was really relegated in many cases to been a niche product for complex IMRT cases.

What we’ve done now with Tomo H Series is improved and why the amount of patients that could be treated with the new Tomo platform. So now it can be and so that niche product for complex radiotherapy patients, it can now be that work course, so what this means is those hospitals that have a one valve operation can now use TomoTherapy as that single valve solution. So they should again greatly enhance the ability to sell the TomoTherapy Systems.

The original CyberKnife was again focused strictly on radiosurgery especially SBRT’s stereotactic body or radiation therapy and now with the advanced of the M6 Series and the Multileaf Collimator, we now can incorporate more patients into the treatment regimen, I guess the treatment planning for CyberKnife and we are also able to do some IMRT as well.

So what this means again from the customer standpoint, faster throughput so the economics flip better and also they can treat more patients. So again the economics are enhanced again, we think what would be instrumental and our growth moving forward. So right now we’ve got two products that can essentially be the Radiation Oncology Departments for most hospitals, so we are delighted with this. And again we’re able to treat basically any radiation oncology patients without compromise and with great confident.

We and I’ll open up to questions in a minute. Last week we issued our fiscal Q1, it typically is our weakest quarter, but we did have a ramp in orders, I think orders, do orders is the primary, a metric that most people are looking at these days granted, it was coming off a with a modest comp, but we did have an appreciable increase in new orders and a 9% increases in backlog, so certainly an important funnel here.

So we have a new let’s say to move this forward. We have a new CEO, Josh Levine has been in place for now, he was a month yesterday. So he has been talking a lot about doing his deep dive strategic review of the company. He is going to be very proactive when it comes to meeting with you. He is looking forward to interaction with Wall Street. He enjoyed that when he was with mentor. He is looking forward to it now. What he is doing is, while the strategic review is, he is going to take the next couple of months, but what he does finish this very in-depth review, he will make this very clear as to how the company is evolving.

He will talk about the various metrics of people who are interested in. But one of the elements that Josh is very locked in on, he has been able to replace the technological benefits of our systems to customers need. So he is going to be working very hard to increase that capability in our sales desk.

Josh is a sales strategic marketing individual. He has a strong track record in commercialization. So from a life cycle, from a corporate life cycle standpoint, we think that the timing here is really quite good. We have now really tremendous technology, and now we have the CEO, who is very much focused on been able to sell product effectively and reaching out to increase not only the new orders but ramping revenue and ultimately sustain profitability which all very much important. So that is fit in terms of the comments has instructed, I have tried to be short and sweet, so again I have plenty of time for Q&A. So Sean, far away.

Question-and-Answer Session

Sean Lavin – Lazard Capital Markets

Perfect, thank you. I guess, I’ll start by asking about you launched your M6 CyberKnife and the upgraded TomoTherapy on system at ASTRO. What have you heard from physicians and when do you think we’ll start seeing orders on this?

Thomas Rathjen

Well, we had a nice ramp in sales leads at ASTRO even with the hurricane impeding many people from attending. So we had tremendous interest from the physicians and the various administrators, hospital administrators who are looking for new products. We should be taking orders, I mean we are in the process of taking orders and we should see that hopefully beginning to ramp as the processes. We will begin to ship the new systems after the first year, which will be our fiscal third quarter.

Sean Lavin – Lazard Capital Markets

And what are your CE mark plans for these systems?

Thomas Rathjen

Well, we have 510(k) approval for both systems. We are waiting CE approval for the CyberKnife M6 Series. We have CE for Tomo, yes, with that.

Sean Lavin – Lazard Capital Markets

I’ll go back to the side when you talked about the different products and use of the new products and there is a bigger curve, where they could serve? Are you telling us that you basically have expanding markets now, or is it that with your products that you have, it just becomes more compelling of an opportunity and at the share gain thing versus other vendors or for any markets?

Thomas Rathjen

Yeah, I think the takeaway message is that in the past, both of these products were viewed as niche products were CyberKnife is viewed and it’s still be the leader in radiosurgery and Tomo would be the specialty product for difficult IMRT cases. Now with the enhanced capability, the amount of patients that can be treated will be expanded, so that become more work course products as opposed to those that will be more of the niche product, yes.

Sean Lavin – Lazard Capital Markets

As you think about your installed based on both the CyberKnife system and the TomoTherapy system? What percent do you think will decide to upgrade these new systems over to say the next five or next 10 years?

Thomas Rathjen

Yeah, that’s a good question. Both Tomo and CyberKnife being marketing their products in 2002, so if you thinking about a 10 year of life cycle, we’re just coming up on the early stages of replacing these older systems with new and again there are not a lot of the amount there, but we’re going to start seeing more and more replacement business.

As we move along, I think Sean, most of the customers who want to replace an older system will do so with the newer technologies and as we move forward, I think we’ll find that I think in the past we’ve talked about 15% of our revenue in the next, while by 2015, we should have about 15% to 17% of our revenue being generated from the replacement market today as well less than 10%, so that will become a larger market for us as we move forward.

Sean Lavin – Lazard Capital Markets

How many units are sold overall in the industry and then given here, would be more applicably the new products what market share do you expect you can gain back?

Thomas Rathjen

Sure, that number varies, but I think we are looking at something like, 7,000 to 8,000 linear accelerators worldwide. And our market share has been probably around 7% or it’s less than 10%. I think now that these products will have a wider appeal, but wider application we should be able to make the case much easier with our client, so we would anticipate been able to gain some share.

Another point I would like to make, some that differentiates Accuray from our larger competitors is that, over 90% of the installations we do are in whilst that use to have either a competitive product or it’s a newly constructive bond as opposed to our larger competitors who spend 75% of their revenue coming from replacing their own systems.

So what that means is if 90% of our installations are new installations, this means an increasing amount of new revenue from service. So we are seeing an increasing revenue from service which is the life blood of a product or consumer product, but products like ours, I mean, we need that is the life blood, it’s the razor blade to the razor.

Sean Lavin – Lazard Capital Markets

How are your sales reps position the M6 versus Varian to H product?

Thomas Rathjen

I think it’s pretty early to say, I think what we are trying to point out is that, the new product that Varian is coming out with is still based on the original C-arm gantry architecture that would makes up all their products as opposed to the design differential of Tomo, which again is based on a CT architecture that allows imaging to take place everyday helical delivery and now what the dynamic jaws on the VoLO software, we are able to get that, those treatment times down to standard treatment slots.

Sean Lavin – Lazard Capital Markets

Then a couple of questions on question, with the margin profile the new versus your products versus the outlines and what’s the actual ticker price of each product?

Thomas Rathjen

Yeah, good question. We haven’t talked about margins on new products on low ASPs. We typically do that for competitive reasons. So I don’t have answer for you other than to say that we anticipate in selling the systems at a slight premium on the low-end, again there are three versions of both the CyberKnife and the TomoTherapy products. The thought is that we should see a slight increase on the lower wrong version and there will be more of a premium on the higher end product, but more than that we haven’t sell.

Sean Lavin – Lazard Capital Markets

Two questions on reimbursement, one on I guess the revision of the freestanding center codes whether they are looking at kind of down 30% now more down 15% obviously does involve older systems that involve some of them, do you think that is (inaudible) change it opens that market back up? And then second on the new CPT code for thoracic surgeons what are you doing to educate those doctors and how important the dose?

Thomas Rathjen

Well, I think anytime you can remove hurdles that have been an impediment for thoracic surgeons or pulmonologist to incorporate radiosurgery into their practices is a great thing. So we’ve been delighted to see this new CPT code for professional reimbursement for thoracic surgeons and pulmonologist. We hope and we would anticipate that we would see more of these physicians incorporating full body radiosurgery (inaudible) and hopefully employ this tactic and technique for more of their patient. So we don’t see any downsize certainly. And your other question Sean was?

Sean Lavin – Lazard Capital Markets

On the change in the freestanding centers of the 30% or going to 15%, is that enough to open those centers back up to?

Thomas Rathjen

Yes, it could. Our focus has really been on the hospital market. So unlike other companies in the space, our exposure to the freestanding centers has been something less than 10%. We do have some TomoTherapy systems in freestanding centers, but that is not a market that we are really focused on. So the impact for us really has been minimal, I think what CMS has been trying to do obviously is gain some parity in IMRT reimbursement rates between the hospital and the freestanding center. So the hospital rates are actually going up a little bit and there is that 15% cut as you mentioned freestanding. Yes.

Unidentified Analyst

On the hospital side purchase linear machine, is it a profitable venture for them or is it more of a traffic generating purchase where they kind of market effect they have these high machines to drive other customers to their hospital.

Thomas Rathjen

Sure both, I think typically the most hospitals the Radiation Oncology Department is frequently the most profitable department in the hospital and the return on investment on the systems is really quite good.

The other part of your question is also true. Many hospitals will utilize these new technologies as a way to differentiate themselves from the other hospitals in the region and that hopefully drive business their way. So I know here in New York area, there are a few of centers that advertise, I guess on the radio quite handling about the CyberKnife at various centers.

So it does offer the hospital the opportunity to be able to differentiate them self. And also keep in mind with radiosurgery, in most cases this is the patient population to hospital normally would not see. And as a result, if they can attract patients to the hospital, this is a new patient population, new revenue stream for the hospital and again it can be extremely profitable.

Sean Lavin – Lazard Capital Markets

Just given that you now launched two new platforms, I imagine you worked on for a while, what is R&D focusing on now with all of those two things?

Thomas Rathjen

Well, we don’t talk about what the projects are, but we’ve had a long history have been innovated and that that’s part of the DNA of the company. So that will not end. But Sean, we just don’t talk about specifics. But again, if you look at history, what we have done is had a strong upgrade capability of coming out with products and services that will allow the systems to more effectively treat patient. So you can count on us continuing to come up with upgrades to the system.

Sean Lavin – Lazard Capital Markets

And then on service margin, I think obviously you’ve made a lot of headway on the Tomo service margin, I think I came in both of your expectations and most investor expectations. What is left to be done on those systems as ready further improvement we should expect on those systems or kind of where we’re going to be?

Thomas Rathjen

Well, I think if you look at the new systems that are coming out, all of those from a reliability standpoint or far more reliables in any of the older systems. We have basically solved the reliability challenges that Tomo has had. And so all the new systems that have been installed over the last year or so since we taken over the company have been profitable from a service standpoint.

Now I think the challenge remains to role these upgrades out into the installed base and get those existing systems to be more profitable. But if you look at just the level of success that we’ve had, the installed base, the cost of service of that installed base have been decreasing rapidly as well. So we may good in those. We certainly not finished with the workdays we done, but I think we’ve made very good strive.

Sean Lavin – Lazard Capital Markets

As you look at your sales force in your sales organization, obviously a lot of changes in the last year of the acquisition. Did you feel like where you need to be that nearly figure or nearly small or the right size?

Thomas Rathjen

Well, I think talking to our salespeople I think we’re at the right size at this point from a sales organization. We had that reorganization as many of you know over the summer and that is taken effect. Now we should see some benefits to that reorg and we should see more production coming out of the U.S. sales force. But I think we’re above where we need to be for now. But we will continue to evaluate and move forward.

Sean Lavin – Lazard Capital Markets

I guess that the last question I have in, any update on when we might see the long data out of M.D. Anderson?

Thomas Rathjen

I would love to see that. That is really a great study. We should see some preliminary data, and this is just me, I would think over the next 12 to 18 months we could see some preliminary data and what Sean is referring to is the operable lung study out of M.D. Anderson in Texas. This is comparing the CyberKnife and radiosurgery to lung surgery for patients who are able to have better operable. These are patients that have the ability to receive surgery. So what we’re doing is comparing two different arms, one being the surgical arm versus CyberKnife.

And I think once that data comes out, it will be very interesting to see just what happens to the market, when the outcomes are at least as good with CyberKnife. And then non-invasive painless way as opposed to having once just cracked in the hospital for a weekend to be out of work in the period, so anyway I think…

Sean Lavin – Lazard Capital Markets

I’d like to thank you very much. We’re out of time.

Thomas Rathjen

Okay. Thank you.

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