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Accuray Incorporated (NASDAQ:ARAY)

F1Q13 (Qtr End 09/30/2012) Earnings Call

November 7, 2012 5:00 PM ET

Executives

Tom Rathjen - Vice President, Investor Relations

Joshua Levine - President and Chief Executive Officer

Derek Bertocci - Senior Vice President, Chief Financial Officer

Analysts

Steve Beuchaw - Morgan Stanley

Anthony Petrone - Jefferies

Charles Croson - Sidoti & Company

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2013 Accuray Incorporated earnings conference call. (Operator Instructions) I would now like to turn the call over to your host for today, Mr. Tom Rathjen, Vice President of Investor Relations.

Tom Rathjen

Hello, and thank you for joining us for our conference call this afternoon as we review Accuray's first quarter of fiscal 2013. Joining us today is Josh Levine, Accuray's President and Chief Executive Officer; and Derek Bertocci, Accuray's Senior Vice President and Chief Financial Officer.

Please note that today we will be referring to information which can be found in a summary slide deck on the Investor Relations page of the Accuray website at accuray.com/investors.

Before we begin, I need to remind you that our call and associated presentation includes forward-looking statements that involve risks and uncertainties. There are a number of factors that could cause actual risks and uncertainties to differ materially from our expectations, including risks related to our ability to achieve future growth in orders, revenue, and sustain profitability, anticipated trends in gross margins, and operating expenses as well as the impact of the release of new technologies.

These and other risks are more fully described in the press release we issued earlier this afternoon, our Form 10-K for fiscal 2012, our Form 10-Q that will be filed soon, and as updated in our other filings with the Securities and Exchange Commission. We assume no obligation to update any forward looking statements.

And now, I'd like to turn the call over to our President and Chief Executive Officer, Josh Levine.

Joshua Levine

Thank you, Tom. And thanks to everyone for joining us today, as we review our fiscal first quarter. As most of you know, I recently joined Accuray, having arrived after the close of the first quarter. So today, I will provide an overview of some of the highlights of the quarter, and have Derek provide details of the financial results.

I will discuss our successful launch of two new exciting products at the recent American Society for Radiation Oncology or ASTRO Trade Show, what we believe these products mean for Accuray's growth and some comments around my plans, as we move the company forward.

ASTRO is the largest and most important annual event for the radiation oncology industry, attracting clinicians and hospital administrators from around the world. It is the most significant sales event of the year and generates the largest number of sales leads. This year's ASTRO was held in Boston at the end of October. In spite of Hurricane Sandy, the Accuray both attracted a large audience, with about 700 people gathered around for the unveiling of our two new technology platforms.

Our sales and marketing teams conducted non-stop product demonstrations, adding to the growing number of perspective customers. As evidence of customer enthusiasm, a 33% increase in sales leads was generated compared to last year. This year Accuray's products were well represented with 90 clinical and technical abstracts, describing the clinical benefits and outcomes of patients treated with either CyberKnife or TomoTherapy Systems.

TomoTherapy customers demonstrated the ability to create high-quality treatment plans that maximally spare nearby healthy tissues for simple to complex targets throughout the body, enabling the treatment of the full spectrum of patients. Of note, this year's program featured 10 presentations on CyberKnife prostate SBRT that included an 1,100 patient multi-center study, with outcomes reported at five years that were comparable to outcomes reported for longer courses of radiation therapy and surgical treatments for prostate cancer.

This expanding foundation of clinical evidence further supports the advantages to patients, clinicians and payers of the four to five day non-invasive outpatient treatment course of CyberKnife SBRT in the treatment of prostate cancer.

The headline at ASTRO was Accuray's introduction of two new technology platforms, the CyberKnife M6 Series and the TomoTherapy H Series. Both products offer significantly faster throughput, increased precision and the capability of treating larger patient populations, all of which improve the patient experience, provide greater economic benefits to our customers and position the systems to be more competitive as mainstream treatment options.

The new CyberKnife M6 Series is available with a Multileaf Collimator, which provides new efficiencies in the delivery of full body radiosurgery and expands treatments to patients with larger tumors. With the new MLC, the CyberKnife can also deliver IMRT treatments quickly and easily with a wide range of beam angles, all within a standard treatment window.

These new capabilities build upon the unique value of the CyberKnife provides the customers as the only system in the market that automatically corrects for any tumor movement throughout treatment. In other words, the well respected radiosurgery capabilities of CyberKnife are now available to a wider customer base and can be offered to a larger patient population.

The new TomoTherapy H Series builds upon the distinct architecture of the TomoTherapy System, resulting in a clinically efficient treatment system that provide superior performance, enabling treatment of a broad range of patients from routine and simple radiation therapy applications to more complex IMRT and SBRT cases. The new series offers advanced dynamic jaws hardware and VoLO treatment planning software that improves patient throughput through treatment time reductions of 50% to 70%.

VoLO streamlines the treatment planning process, giving the user feedback in minutes rather than waiting overnight. With enhanced throughput and more efficient treatment planning the Tomo H Series improves the quality of treatment for the patient, while improving economic value for the customer.

The new TomoTherapy H Series can now become the work force solution in a single vault setting. The two new technology platforms launched at ASTRO will be integral to our strategic growth agenda, and we expect it will result in both order and revenue growth, which should help us achieve our goal and sustain profitability.

And now, I'll turn the call over to Derek, for a more detailed look at our financials for the quarter.

Derek Bertocci

Thank you, Josh. In reviewing the quarter I will discuss our non-GAAP results. We believe they are the best indicator of progress on our ongoing operations and trends that may influence future results. Our press release provide details of the adjustments between GAAP and non-GAAP results. I will specifically mention, if I refer to GAAP results.

From an overview standpoint, our first quarter reflected good progress on a number of fronts. We also saw the effect of our normal seasonal slowdown in certain areas and some one-time events.

New orders for products of $51.6 million were up 31% from the prior-year quarter. This was driven by an increase in the flow of orders for TomoTherapy Systems, particularly in Asia-Pacific markets and Japan. As Josh mentioned, the new TomoTherapy and CyberKnife Systems we introduced at ASTRO were well received, and we work to capitalize on them to grow new orders in the future.

Accuray and TomoTherapy apply different standards in determining bookings and backlog, prior to the acquisition in June 2011. During the first year after the acquisition, we believed that our book-to-bill ratio was the best way to assess the potential impact of new order flow and business growth prospects.

We now have new order data, covering more than one year that were determined using consistent standards. As such and in response to input from the investment community, we were henceforth focused on the direct comparison of new orders and backlog on a year-over-year basis as the best reflection of the change in Accuray's prospects for business growth.

As we had indicated on our Q4 conference call, total first quarter revenue of $82.7 million was down substantially, 13% below the level achieved in the prior-year quarter. This was driven by a 28% decline in product revenue. An unusually high number of TomoTherapy Systems were shipped in the first quarter last year immediately after the close of the acquisition.

During the first quarter of this year, shipments of TomoTherapy Systems were at more normal levels. Service revenue continued to grow, up 10% from the prior year quarter, reflecting the continued sale of systems to new customers.

These sales are particularly important since to increase the base of installed systems which drives service revenue growth. Our installed base increased by 25 units to 657 systems during the first quarter. Our total gross margin declined to 33.2% from 36.4% in the first quarter of the prior year mainly due to a change in revenue mix.

Service revenue represented 51% of total revenue in the first quarter, up from 40% in the first quarter of the prior year. Given the lower gross margin on service revenue, the change in revenue mix, resulted in a drop in the total gross profit margin. Service gross margin of 16.7% was up from 12.1% in the prior year, due to the continued improvement in reliability of TomoTherapy Systems.

The service gross margin declined from 19.9% reaching the immediately preceding fourth quarter, due mainly to high parts usage on TomoTherapy Systems in Japan. Accuray took over service responsibility for these TomoTherapy Systems in Japan as of July 1, and has begun to retrofit systems as required with our newer, more reliable components.

We expect this retrofit process will run through the second quarter ending December 31. When complete, this should significantly improve reliability on these systems and reduce service costs. The gross margin on the product revenue was 50.1%, down from 52.6% in the prior year's first quarter, due mainly to the lower level of production which resulted in a higher overhead cost per system.

Operating expenses of $45.2 million from the first quarter were approximately unchanged from $44.7 million in the prior years for this quarter, but down significantly from $51.6 million, in the immediately preceding fourth quarter. The reductions were across all functions and relate to our efforts to control expenses, as well as the timing of certain activities.

In the second quarter of fiscal 2013, we expect operating expenses to increase substantially due to a peak in R&D program activity, significant marketing activity related to the launch of the two new products introduced in October as ASTRO, and costs related to the departure of Accuray's former CEO. Once these activities are completed, we expect operating expenses to trend back towards the level incurred in the first quarter of fiscal 2013.

Our net loss was $16.9 million or $0.23 per share during the first quarter on a non-GAAP basis, compared to $11.1 million or $0.16 during the first quarter of the prior year. In determining our financial results under GAAP, during the first quarter we recorded a $12.2 million charge to write-down the value of intangible assets recorded upon the acquisition of TomoTherapy in June 2011.

These intangibles assets related to in-process research and development technology created by CPAC, a company invested in by TomoTherapy and accounted for as a variable interest entity. The impact of this write-down is excluded from our non-GAAP results.

And now I would like to turn the call back over to Josh.

Joshua Levine

Thanks Derek. I want to take a few minutes and discuss the progress that I'm making on my strategic and operational review of the business. I've been spending considerable time looking at the business from an outside-in approach, gaining important inputs from customer interaction, plus ongoing exposure to a broad range of internal and external information sources.

In addition to spending time with our customers, I'm having valuable conversations with thought leaders, provider organizations and our employees. The scope of my review is on both strategic and operational elements and is generating significant insights about all aspects of our business and our industry.

Some early observations are that Accuray enjoys a strong and positive reputation for outstanding technology innovation. A primary element of our strategy will be to translate our differentiated technology features into customer benefits, both clinically and economically.

Going forward, you can expect us to more customer-driven and focused organization. We will prioritize creating value for our customers, which will be driven our ability to link our outstanding technology more effectively to customer unmet needs.

Simply put, we will place greater value on strategic market with emphasis on driving customer value and become a more aggressive and formidable competitor. During this period, I realized that the investment community has many questions regarding our forecast and financial guidance with an understandable desire for greater insight into how I see the business evolving, rather than rush into quick judgments about the business. I believe I owe it to our shareholders, employees and customers to be thoughtful in my assessments.

At the end of this revenue period, I look forward to providing guidance on our strategic agenda and associated financial metrics, until then I'll ask for your continued patience. And we'll now be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question will come from the line of Steve Beuchaw, Morgan Stanley.

Steve Beuchaw - Morgan Stanley

I wonder if you guys could clarify just on the orders in the quarter, if there was any contribution, perhaps outside the United States, of the new products, and if so, could you dimension that contribution so far?

Derek Bertocci

We obviously, did not receive approval for the new CyberKnife model. So there were no orders taken from that. There were some discussions with customers, but those will be mainly impacting orders we think going forward.

Steve Beuchaw - Morgan Stanley

And then on the trajectory of growth over the course of the year, Josh, I understand you don't want to go into a tremendous amount of debt around what the outlook is for the business. But I think you guys were pretty clear on the prior quarter that, what we would see in the first quarter in terms of orders it would reflect some sort of drag associated with the uncertainty ahead of ASTRO, as customers are wrestling with lack of detail around what these new systems might look like. So all that said, is it still the right way to think of this year as a year of accelerating order trends, and as the growth that we saw in the order trend here in the first quarter, a logical proxy for the balance of the year.

Joshua Levine

Steve, obviously before I joined the company, I listened to the guidance and the specific dialogue in the discussions in the yearend earnings release. And I think Derek at the time as well as my predecessors talked about what were tough year-on-year comps when you looked at first quarter this year versus first quarter prior year. And obviously, I think that that was accurate and it was reflective of the reality that we had experienced coming out of the TomoTherapy acquisition, given their backlog and their pipeline.

As Derek alluded to, we did not receive U.S. FDA 510(k) approval prior to ASTRO and we didn't actually even have it at the show. We missed it just by a couple of days actually. So were unable to be very expansive or aggressive, if you want to describe it that way, in our efforts on a pure selling basis or direct selling basis at the show. I think, we certainly from a product highlight and feature standpoint, we gave people a pretty good sense about the significant leap in capabilities on the CyberKnife side, on the new system that it represented.

And I mean, we're pleased with what we saw in terms of order growth this quarter. The plan that was communicated as it related to fiscal '13 guidance, I won't be commenting on either reaffirming or suggesting changes it in anyway for reasons I've already gone into with regards to my business assessment, strategically and operationally.

But I think the way just from a flow standpoint, the way that it's been described, and I would say again, based on what was communicated in the prior quarter, it looks like the revenue growth and the order growth is certainly more heavily skewed to the back half of the year. I think that's still a reasonable assumption in terms of flow.

And again, I think looking at what we generated in order growth this quarter, I think we feel pretty good about that is it a proxy perspective for going forward, probably right now too early for me to answer the question, outside a week after ASTRO in terms of linking the pieces.

Operator

Next question comes from the line of (inaudible).

Unidentified Analyst

You mentioned, I think you said 33% more interest out of ASTRO than last year. I assume that's new products. Can I get a sense of how long that would take to translate into true orders? And secondly, I believe that you had mentioned last quarter that the new systems will be available for upgrades, so if you were in the backlog, you could go ahead and upgrade the systems. Is that still the case and what kind of interest did you get from ASTRO to make you related to that?

Joshua Levine

Derek and I have kind of split this. Let me just answer the latter part of your question first, which is the upgradeability. As far as the CyberKnife M6 that really should be thought of as a completely new platform. And as such, upgradeability of that for existing CyberKnife customers, there really is in an upgradeability a capability there.

Unidentified Analyst

But what about those in backlog, sorry to interrupt, I just wanted to clarify?

Joshua Levine

We will be allowing customers and engaging customers in conversation about those in the backlog, about upgrading to the M6 going forward. So the answer to that is yes.

Derek Bertocci

Please note, in terms the time for a new order, the normal cycle if you will. And normal is really a tough word, depends on where the customer is and what their status is, if it's a large governmental institution, you maybe looking at a multiyear budgeting cycle, if it's a private institution, they maybe able to react quicker.

You would normally see at least a year cycle from a customer expressing a first interest to placing an order. That being said, there is a pipeline of customers, who have been in the process of learning about the TomoTherapy System or the CyberKnife System. And the new technologies would only make it more attractive for themselves to the extent that those customers are already in the pipeline, if there is a strong sense that they would be looking at the new systems.

Unidentified Analyst

And just one quick follow-up and that is, in terms of pricing. I guess my understanding from ASTRO was, there is three levels of the new Tomo's platform and the new CyberKnife platform, and they start at about $0.5 million-plus from the old system, is that the right way to think about it?

Derek Bertocci

The three platforms in each of the two product lines are designed to provide different price entry points and different feature sets, and there is expected to be some significant range in that price. I think that you can think of the top-end system being significantly more than the prior systems that existed, but at the lower-end we would try and have systems that would be price competitive as maybe with customers or in markets where they don't want all the features.

Operator

Next question comes from the line of Anthony Petrone, Jefferies.

Anthony Petrone - Jefferies

I had a couple on CyberKnife and a couple on Tomo. Derek, if you could clarify the 12% decline in CyberKnife orders in the quarter, in the last quarter we spoke about that, and there was a potential that at least some of that could be related to the anticipation of the new launch at ASTRO, and then obviously, we had some reimbursement uncertainty. So I don't know to what extent you could sort of look at that number and credit some of that decline to the anticipation at ASTRO and perhaps some hesitation due to the reimbursement proposal that was out in June, ahead of the final announcement that we had a few weeks ago?

Derek Bertocci

I don't think we actually talked about the breakout of the orders between the two product lines, Anthony. In terms of the orders, I did indicate that the order growth was driven by TomoTherapy. So to the extent that implies that the CyberKnife order growth wasn't driving that, that's an accurate statement.

As far as the CyberKnife growth and why, I think that there was probably an anticipation of a new CyberKnife technology perhaps being more of an advance than perhaps they were anticipating with the TomoTherapy technology. So I guess that would be my only comment.

Anthony Petrone - Jefferies

And I was just referring to the commentary in the press release, the 12% decline in CyberKnife orders. The next question will be just overall on strategy, the pricing strategies to follow-up there. Accuray has typically been at the higher end of the market in terms of pricing. It sounds like that will be the case for the new systems. I'm just wondering. Josh, with you coming onboard, how you view pricing as a strategy? In other words will you continue to want to be at the very high end of the market or there will be some flexibility in pricing going forward?

Joshua Levine

So, Anthony, I think if I just refer back to one of the previous questions that Derek answered. And when you think about the information we presented at the Investor Conference, at the show, there is a range, call it base model, and then add on features from there in both the TomoTherapy H Series and CyberKnife. And it really is at the, I'll call it the fully loaded version or the upper end of the range vis-à-vis capabilities and feature set that we're talking about a price point premium type of positioning.

So I think the view that we have is, what we have, it offer us a lot of flexibility. We can flex up in terms of feature set and price, we can flex down or towards the base model, and if you want to describe that of either range. Getting capturing full price for premium features and capabilities and premium feature set in my mind is important, but we recognized right now that we have to grow. And we've got a balance of finding the right balance, Anthony, between driving the top line, driving volume and improving the businesses profitability.

I think as I should, in the previous comments in Boston, we recognized that we're not getting a hall pass in terms of being able to do one or the other. We're going to do a little bit of both. So I would say that we are flexible in our thought processes. I think the product lines ups and the way we're structuring them, in terms of features sets and price points across the range offers a lot of flexibility and we want to take advantage of that.

Derek Bertocci

One thing, Anthony, just as a follow-up point to expand on what Josh said, in terms of pricing we are clearly trying to recognize the value of the new technologies that we're bringing to the market. We're also conscious of the balance between price and volume and so the goal was really to maximize our gross profit margin.

So I think that you should look at this as an opportunity for us with the new technologies, potentially increase our volume and thereby get more profit dollars, but not necessarily improve the gross profit margin.

Anthony Petrone - Jefferies

Derek, can you just provide an update on how many of the Tomo users have converted to a Diamond Plus service contract?

Derek Bertocci

The conversion is in the 35% to 40% range at this point.

Operator

Your next question comes from the line of Charles Croson, Sidoti & Company.

Charles Croson - Sidoti & Company

First one I got here real quick, to Derek, just kind of teasing a little bit more about the growth in orders you guys might expect over the next few quarters. You said that, typically even though that these are new technologies or the new systems, I should say, somewhat probably wouldn't be as difficult for newer customers to understand the upgrades as opposed to just coming on to getting involved in this system.

If we take anywhere from a year for them to commit to giving a purchase order, would that suggest then that maybe we would expect the growth in purchase orders to take place more towards the back half of the year. Just trying to tease that out a little bit more, if you can comment on that?

Derek Bertocci

So we do have significant pipeline of customers who are working on all of the time. And I think those customers who are at various stages in their evaluation process, there maybe some slight interruption as they evaluate the new technologies, so that could cause some delay.

But I think in general, we would expect that the customers that are in the evaluation process will be able to see the benefit of the new technologies. There will be potentially some delay if they choose to move to another, higher level offerings that we have now, that it might have to go back to some finance committee to get approval for a higher purchase price. I certainly as time goes on, those steps would all be within the timeframe, once we get to the latter part of this year.

Charles Croson - Sidoti & Company

And then if I can ask on the sales force restructuring that you guys had the previous quarter, can you go back into that a little bit. I know you're trying to model that more of the international distributor model. Can go often to how is it been going and what might need to still be done for the rest of the year?

Derek Bertocci

The sales force restructuring, I think that you're referring to is the U.S. sales force team. Essentially, as you remember, we restructured the team into four-man team from two-man teams, and went from 10 to five regions in an attempt to make sure that each region have the companion of both selling skills, technical demonstrations skills, new client or new customer pursuit skills as well as the deal closing skills. So that's the four different players.

And that organization became fully staffed some time during the summer. And so now, probably a month into having it fully staffed, I think that the evaluation of that and the progress they are making will take some time. We're focusing on that team and making sure that that team gets the appropriate attention to try and make sure that that team brings the capabilities that they need to the marketplace.

As far as that team, it was similar, if you will to some of the structures we had in some of the foreign countries where, because of the nature of the members we had, implicitly we ended up with the right mixtures, more regularly in some of the international markets that we did in the U.S.

Joshua Levine

Let me expand a little bit on what Derek just said. A couple of points I think are worthy of note. One is that, when you look at the structure of the U.S. sales organization and the mix of skills that Derek highlighted in each one of those four-man or called them pods, if you want to think of them in that way. The bulk of that quite frankly, the thought process was motivated by the two new systems and technology platforms that we been launched at ASTRO.

We thought quite frankly that skill set and that range of skill sets lined up best with what the new products were going to require in terms of, for quite frankly, just driving growth. So that's one point, I think I'd highlighted.

The other is this is, as you might imagine, given what we've said now over the course of last three weeks or three and half weeks that I've been here, we are going to transition and I would suggest, I've already transitioning to being a substantially more customer-focused, market-driven company, culturally, internally here at Accuray and in our field sales origination.

From a marketing standpoint, from a field, commercial organization standpoint, these are areas that I'm not an expert today on Accuray's business and on the technical aspects of our products. These are areas that from a carrier and experience standpoint, I am highly comfortable and comfortable with and they're going to get a lot, quite frankly, a lot of my personnel attention going forward.

We've got a terrific Chief Commercial Officer, Kelly Londy. I think she has built a great team, and they are trained. They're going to continue to get trained. And I think we're going to be fine with the organization that we have.

Again, it's probably, as Derek described before, too early today to draw definitive assessments about specific people or specific areas of the country and how they're doing. But in general, I've lot of interaction with this group at ASTRO. Spent a lot of time with them in the booth, spend quite frankly a lot of time with them outside of the booth.

And I think that I was quite frankly, I was very impressed. And I know that's a short study window, if you want to describe it that way. But I am pretty confident that we've got the team that can carry us forward and drive the kind of growth we're looking for.

Derek Bertocci

I just wanted to add one other comment with an answer I made, and I wanted to clarify it to Anthony earlier, the portion of TomoTherapy customers that have moved to the new contracts, covers both the Emerald and Diamond contracts, when I said the 35% to 40%. I think there may have been some miss clarification that it was just Diamond, it's both Diamond and Emerald.

Operator

And there are no more questions at this time. This concludes the question-and-answer portion for today. I'd now like to turn the call back to Joshua Levine for closing remarks.

Joshua Levine

We want to thank you for joining us on this afternoon's call. I would like to acknowledge Accuray's employees globally for their continued dedication to improving the lives of cancer patients worldwide. And we look forward speaking with you on our next call. Thank you very much.

Operator

And thank you again, ladies and gentlemen for you participation. This concludes today's conference. You may now disconnect. And have great day.

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