Accuray Incorporated (ARAY) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 Accuray Incorporated Earnings Conference Call. My name is Regina and I’ll be your conference operator for today. [Operator Instructions] Today's event is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Thomas Rathjen, Vice President of Investor Relations, please go ahead, sir.

Thank you, Regina. Hello and thank you for joining our conference call this afternoon as we review Accuray's second quarter fiscal 2012. Joining us today are Dr. Euan Thomson, Accuray's President and Chief Executive Officer; and Derek Bertocci, Accuray's Senior Vice President and Chief Financial Officer. Please note that today we’ll be referring to financial data which can be found on our 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 presentation includes forward-looking statements that involve risks and uncertainties. There are number of factors that could cause actual results to differ materially from our expectations including risks related to our ability to successfully integrate TomoTherapy, our ability to achieve projected revenue, gross margin and profitability targets and our ability to implement our long term growth strategy. These risks are more fully described in the press release we issued earlier this afternoon, our Form 10-K for fiscal 2011 and our other filings with the Securities and Exchange Commission. We assume no obligation to update any forward-looking statement. And now, I would like to turn the call over to our President and Chief Executive Officer, Dr. Euan Thomson. Euan?

Thank you, Tom and thanks for everyone for joining us today for Accuray’s second quarter fiscal year 2012 conference call. Now, since we’re in this time of rapid transition we’ve also posted some slides on our website to help illustrate the main points we’ll be discussing. During the call we’ll provide both GAAP and non-GAAP numbers, when Derek talks later he’ll refer to both measures. But for the sake of clarity, I’ll refer only to the non-GAAP numbers since they give you a clear picture of Accuray’s ongoing cooperations. Today I’m pleased to report that Accuray delivered a good second quarter marked by solid revenue, continued improvements in gross margins, effective management of operating expenses and positive cash flow. Today’s results give us an even greater confidence in both our path to profitability and our long term growth strategy. This afternoon I’ll update you on our integration of TomoTherapy, I’ll then discuss the global sales environment for our technologies, review growth metrics for the company and comment on a recent development in Medicare CyberKnife coverage. I’ll then turn the call over to Derek Bertocci, who will give a detailed financial review. Our June 2011 acquisition of TomoTherapy dramatically increased Accuray’s global presence, added innovative new technologies to our portfolio and created exciting new revenue opportunities. Shortly after we announced the acquisition of TomoTherapy, we laid out 3 milestones to help you measure our progress through integration and track our return to profitability. The first milestone is to maintain or modestly growth revenue while generating a book-to-bill ratio greater than one, we’re meeting that goal. For the second quarter total revenue was $102.9 million and the book-to-bill ratio was approximately 1.1. Pro forma revenue for the equivalent quarter a year ago was higher, but this reflects a specific pattern in TomoTherapy’s historic fourth quarter revenues. For the 2 years prior to the acquisition TomoTherapy revenues were 50% higher in the December quarter than the average of the other quarters of the year. Therefore, we believe it’s more meaningful to look over the longer time period. Year-to-date revenue for fiscal 2012 was $198.6 million slightly higher than the same period last year on a pro forma basis. That places us in a strong position to achieve our revenue guidance of $400 million to $415 million for the year. During the second quarter Accuray added $70.3 million of net new system orders to backlog, expanding total backlog to $276.8 million. Year-to-date our book-to-bill ratio is approximately 1, which reflects our customary pattern of fewer new orders in Q1 and higher new order flow in Q2 and subsequent quarters. During Q2 we shipped 25 systems while installing 23. Our install base now stands at 616 units worldwide. During calendar year 2011, our install base increased by 15%. That growth came from our equipment being placed in newly constructed rooms and Accuray replacing competitive systems in existing treatment rooms. The majority of our growth in our install base resulted from replacing competitive systems in previously constructive treatment rooms. As our install base continues to grow, service revenue becomes an increasingly significant and stable part of overall revenues and a larger contributor to our overall profitability. Compared to the same period a year ago, the install base grew by 15%, service revenue in Q2 increased by 17%. Clearly, this growing service revenue needs to generate profit and our second integration milestone is that we’ll achieve 10% service growth margin by the end of this fiscal year. As our Q2 results demonstrated we’re on track to outperform on that goal. In Q2 we achieved a positive service growth margin of 12.3% compared with a negative 7.9% last year, which is a testament to the significant progress that we’ve made in reducing the maintenance cost of the TomoTherapy system. In fact, the maintenance cost associated with recently shipped TomoTherapy systems are now approximately the same as those of the CyberKnife which has an extremely positive reputation for a liability. We’re now implementing 3 initiatives to improve service growth margin even further. The first is to improve the reliability of new TomoTherapy systems beyond their current level and our engineering and manufacturing teams remain focused on this objective. Second, is to roll-out the reliability improvements that we’ve made in new systems into the active installed base. As I indicated last quarter, this will require continued investment on our part. During Q2 for example, we made great progress in installing improved radio frequency components to existing customer’s systems. This particular improvement which we talked about last quarter is now installed on more than 75% of TomoTherapy units. The 12.3% positive growth margin for service was achieved despite this investment. There are other similar improvements which we will be making in the future. The third task to improve service growth margin is to continue introducing industry standard service contracts to TomoTherapy systems. We’ve sold a number of industry standard emerald contracts for the first time to the existing TomoTherapy customers and of particular significance in January we sold our first TomoTherapy diamond contract which gives customers access to certain TomoTherapy upgrades. Importantly the increase in service revenue that will result from the roll-out of these standard and premium level service contracts is not yet reflected in our reported service revenue or gross margins. So, as I've indicated we now believe that we’ll exceed our target of 10% service growth margin by the fourth quarter of this fiscal year and will achieve our target of at least 20% service growth margin by the end of next fiscal year. We commit to keeping you fully informed of our progress. Our third and final milestone is a return to profitability during the latter part of fiscal 2013. In addition to improving service in overall gross margins, we aim to managing operating expenses to approximately 45% or less of revenues by the end of fiscal 2013, with a longer term goal of managing operating expenses to approximately 40% of revenue. In the second quarter we held operating expenses to a level of 44.4% of revenues despite our accelerated investment in R&D. Year-to-date R&D expenditure has increased by approximately 15% compared with the pro forma expenditure in the same period last year. We expect to further accelerate our investment in R&D over the next few quarters as we work on features that continue to improve liability and consolidate the position of our CyberKnife and TomoTherapy treatment systems with the premiere radiation oncology products. As a result of our sequential revenue growth, improved gross margins and moderate operating expenses, we reported a net loss attributable to stockholders for the quarter of $7.1 million or $0.10 per share, this compares with the net loss of a $11 million or $0.16 per share in Q1, which is a clear indicator of our progress toward a return to profitability. The course of the quarter was cash flow positive, a further indicator of our progress. This was first cash flow positive quarter since the acquisition and Derek will give a full explanation of our cash flows in a few minute. Turning now to the global sales environment. In the U.S., we’re still not seeing the growth that we’ve seen in other parts of the world. Economic uncertainty continues to make U.S. customers more cautious and sales of both products necessitate lengthy discussion periods and detailed business plans. Neither of our products has been sold extensively into the U.S. freestanding market in the past and this is the environment which we perceive to be most impacted by access to capital. However, although hospitals do have access to capital as I said, spending patterns remain cautious. As you know, over the past few years, the generally good Medicare coverage for both our systems has one important exception. Coverage for CyberKnife treatment of prostate cancer. With the announcement in January the Trailblazer, Medicare’s regional administrator for Texas, Oklahoma, Colorado and New Mexico will cover CyberKnife treatment for prostate cancer all but one Medicare region now covers the treatment. This opens the door for thousands of men to receive the benefits of effective, non-invasive cancer care with low incidence of side effects and enhance the sales prospects for CyberKnife. In Europe, we’ve seen only limited impact in major European markets from the current economic and fiscal uncertainty, which we believe is a sign that the market for technology treating cancer patients is more robust than other capital equipment markets in the region. In addition, we’re starting to benefit from the impact of Siemens announced exit from the radiation oncology market. During Q2 we entered into a new contract with Siemens that allows the sale of both TomoTherapy systems and CyberKnife systems with Siemens bundled multisystem sales. Separately, we’ve already sold 2 systems that will replace Siemens systems. We remain committed to a long term growth strategy that we’re confident will create significant value to our shareholders. This strategic includes creating innovative next generation technologies backed by IP protection, expanding clinical acceptance as we done for CyberKnife treatment of prostate cancer and increasing our market penetration through cross selling opportunities and geographic expansion into some of the world’s fastest growing market. Let me summarize the 4 key points from our second quarter. First, integration is proceeding on or ahead of schedule. Second, we are maintaining our revenue guidance and our positive book-to-bill ratio guidance. Third, we’re making significant progress on improving service gross margins. And fourth, we’re on track to return to profitability on schedule. And with that I’ll turn the call over to Derek.

Thank you, Euan. Today, I will be reviewing our non-GAAP results which we believe are most representative of our ongoing core business. If I refer to GAAP results, I will specifically state so. In our press release announcing our results for this quarter, we provided details of the adjustments between GAAP and non-GAAP results. We also provided pro forma results for the 3 and 6 months period ended December 31, 2010. Unless stated otherwise, all results for prior year periods represent the combined total of the results reported separately by Accuray in TomoTherapy as standalone companies, excluding expenses related to the acquisition that were incurred during those periods. Results of operations for Q2 were on track or ahead of our expectations as we continued to make steady progress with the integration of TomoTherapy. These results demonstrate the progress we’re making towards the goals we identified when we first announced our agreement to acquire TomoTherapy. For the second quarter of fiscal 2012, total revenue and product revenue were lower than in the same quarter of the prior year mainly due to the large seasonal increase in TomoTherapy product revenue in the December 2010 quarter as previously noted by Euan. As our product portfolio and geographic presence become more diversified, we expect this seasonality to smooth out and for revenue to be more evenly distributed throughout the year. Service revenue in the second quarter grew 17% from the prior year due to continued growth in the installed base of both CyberKnife and TomoTherapy systems. Service revenue recognized as a result of payments received from cash basis customers had been unusually high in the first quarter of this fiscal year, but was relatively normal in the second quarter. This sequential decrease matched the ongoing growth in service revenue achieved in the second quarter which we expect to continue as we install new systems in future quarters. The overall gross profit margin in the second quarter of fiscal 2012 rose to 39.6% from 38.1% in the same quarter of the prior year. Our strong products gross profit margin of 55.8% in the second quarter of this year was virtually unchanged from 56.3% in the comparable quarter of last year indicating that our overall product revenue and costs remained in good balance. The service gross profit margin of 12.3% in the second quarter represents an impressive 20.2 percentage point improvement in gross profit margin from the negative 7.9% service gross margin in the second quarter of the prior year. This was the second consecutive quarter of improving service gross profit margins reflecting the significant improvements we have made to the reliability of TomoTherapy systems already installed at customer sites. Our upgrades of systems already in the field will continue throughout this fiscal year and we’re completing these upgrades more efficiently and at lower cost than we originally anticipated. We forecast our service gross profit margin will continue our trend of ongoing improvement over the next year and a half exceeding our 10% target during the fourth quarter of fiscal 2012 and 20% or better during the fourth quarter of fiscal 2013. We continue to manage operating expenses prudently generating $2.9 million of savings in expenses in the second quarter compared to the same period of the prior year. We reduced sales, marketing and G&A expenses by $4.1 million which reflects the progress we are making in realizing operating expense synergies from the combination of the 2 companies. This enabled us to expand our investment in R&D by $1.2 million from the prior year quarter to support our continued development of new technologies for both the CyberKnife and TomoTherapy products. We believe these new technologies will be instrumental in helping us keep our technological edge and grow revenue and profits from the sale of systems and service contracts in the future. The improvements that we have made enabled Accuray to lower the sequential net loss attributable to shareholders to $7.1 million or $0.10 per share from the first quarter loss of $11.1 million or $0.16 per share. These results demonstrate the progress we are making towards the goals we identified when we first announced our agreement to acquire TomoTherapy. During our second quarter, cash increased by approximately $8.5 million. This was due principally to the reduction in our operating loss, solid collections of receivables, reductions in prepaid expenses and increases in deferred revenue due to shipments not yet recognizable as revenue. We will see quarterly fluctuations in receivables but these will balance out over time. Cash at the end of the quarter including restricted cash totaled approximately $152 million. We expect that non-cash expenses such as depreciation and amortization will offset to varying degrees cash required for capital expenditures in manufacturing and R&D as well as for working capital to support revenue growth. Our transition to profitability therefore is the key to sustained positive cash flow for Accuray in the future. We continue to forecast that revenue will be in the range of $400 million to $415 million for fiscal 2012 and expect this will be driven by higher revenue in the fourth quarter. For GAAP reporting purposes, we expect that $9 million of revenue related to purchase accounting adjustments will be recognized in fiscal 2012 bringing GAAP revenue to the range of $409 million to $424 million for fiscal 2012. During the second half of fiscal 2012, we anticipate that R&D expenses will be approximately $4 million higher per quarter than in the first half of fiscal 2012. We also anticipate somewhat higher spending in sales and marketing during this period as we pursue increased bookings of new orders. We continue to believe that Accuray will return to profitability on a non-GAAP basis during the latter part of fiscal 2013. Now, I’ll turn the call back to Euan.

Thank you, Derek. As we discussed during the second quarter, Accuray remained on target to achieve the 3 milestones established for you to measure our success. We delivered solid revenue on the book-to-bill ratio greater than 1, our 12.3% gross margin is helping create a profitable service business and is ahead of this year’s projection. Through effective management of operating expenses, we’re on track to return the company to profitability by the end of fiscal 2013. Finally, you’ll see that the slides we posted today on the Investor Relations page of our website include an indicative picture of what the financials of the company could look like once we reach an installed base of 1,000 systems. And with that we’ll now be happy to take your questions.

[Operator Instructions] And your first question today gentlemen come from the line of Steve Beuchaw with Morgan Stanley.

One follow up on the Trailblazer coverage and in past instances have you seen an expansion of coverage in a region drive new orders over the next 6 months, 12 months, 18 months? What's a logical expectation for any impact there?

I don’t know that we’ve got that level of granularity in our data to be honest. I think that overall we see the sales environment generally sort of loosening up and the business case for CyberKnife is very dependent on the level of coverage that can be achieved. So, I think we would definitely expect to be a positive move, exactly how we transition into new orders is a little bit tougher to say, but it certainly a positive.

Following up on your comments Derek -- I’m sorry Euan -- on the freestanding center market could you go into a bit more detail there? I appreciate that it is less than 10% of your business, but could you spend a little bit more time on the balance of the issues that you’re seeing and their impact?

Well, I think we’re responding to what others have quoted as sort of a decline in the market and trying to analyze why that might be. I think that one of the factors that we’ve come up with is that, we feel that the majority of financial pressure in sort of tough economy climate and tough times for obtaining capital is fought within those smaller freestanding centers that are more dependent on sort of independent financing. Our business is primarily with hospitals as I indicated and we’re hearing from our customers is that yes, they have access to capital. So, that the impact that we’re seeing on our sales environment is that we find they're very, very detailed in terms of that business plan. They’re looking at returns in investment and with fewer deals there's certainly kind of increased competition. But overall, we’re not forecasting a change in the forecast that we entered the year with in terms of either product line in the United States at this point.

Your next question is from the line of Tycho Peterson with JPMorgan.

It's Evan Lotus in for Tycho. I had a couple of questions, I guess, first could you maybe talk about some of the data that you expecting to come out, specifically on prostate, this year and where and when we might see sort of larger studies that are now maturing to five years.

Sure. I think the key thing is data will actually be there, I think. We know that the 3 key sort of independent studies, the one from Stanford, the one from Naples and the one from Winthrop, have all reached the point where the follow up will mature through the 5 year point. And of course, that’s seen as a natural milestone in cancer treatment. As for the timing of the release of the data or even the details of the data itself, it’s a little bit harder for me to be specific. Other than to say that from what we know, we haven’t seen any changes in the trends which are very positive from a clinical standpoint, I mean. An effective treatment and one which reduces very low side effects, even compared to more established treatment with allergies [ph] .

Okay, and then, could you talk a little bit more about, give some more color on orders, either by product or by geography, I guess mostly where you’re seeing strength with Tomo versus where you’re seeing strength with CyberKnife?

We are not at the thinking of breaking things down by individual product line. I think what I can say is that we’re anticipating that we for both product lines that we will reach the end of the year achieving our initial sales forecast and in fact, overall, I would say we’re seeing some very encouraging signs particularly around the TomoTherapy products since the acquisition was completed. I don’t think it would be going too far to say that we’re feeling actually pretty positive about the way things are panning out for the TomoTherapy products since the acquisition.

[Operator Instructions] Your next question comes from the line of Anthony Petrone with Jefferies.

I’m going be in the backlog for a moment. Can you elaborate how many Tomo systems were dropped out of the backlog this quarter and how many reentered that were dropped out last quarter? I just want to get a handle on that new system backlog number of $70.3 million.

There aren’t any that were dropped out in last quarter that came in this quarter. There were a couple of orders that we did not have full deposits and so forth on, that shipped this quarter, but they will be recorded as orders this quarter.

We didn’t actually have any cancellations in Q2?

So, no cancellations and no reentry, just to be sure that new system number has...

As Derek says, these are all new orders.

Okay. And then, just in terms of revenue I guess to go back to that for a moment. I know you’re not breaking things down to that level, but it seems it was a little bit light relative to the individual companies reported results last year and I am just wondering if there was either a moderation in CyberKnife in the queue and/or not a similar acceleration in Tomo systems that we saw last quarter. I don’t know if you can give a little bit more color on system revenues in the queue?

The factors that led us to have a stronger quarter last quarter relative to the prior year and this quarter looking little less strong are related. So, the biggest thing going is that TomoTherapy, prior to the acquisition, had a very unusual seasonal pattern in shipment of systems. Their December quarter in the last two years was approximately 50% higher on average than other quarters in the year. They just happened to have a lot of shipments that went out in the December quarter. What you saw in the pattern of shipments that has occurred since Accuray has acquired TomoTherapy, is a more balanced shipment of those units across both the first and second quarters. As far as, also if we look into our shipments, our backlog is still very solid. We did notice and we had mentioned this in prior calls that on our CyberKnife product line as we have been evolving and growing our business from a more U.S. focused business to a worldwide focused business that orders from customers as we expand around the world on average are taking a little bit longer to go from order to install. So that also somewhat tempered the results this quarter. As far as our sales pipeline, we continue to see it as a very strong pipeline in terms of new customer prospects, so we look at this more as a timing issue than anything else.

That's very helpful and just 2 quick follow ups if I may. Just to stay on products for the moment in relation to Siemens, in light of the extended distribution agreement with the Siemens, what is the approach now to go after that new business? Should we assume now that the Accuray sales force kind of does not go after that business and just leaves it up to Siemens or is it going to be a dual effort by the Siemens sales force as well as Accuray's?

I think, we're far from leaving it to Siemens. I think that we are going to be very focused on talking to the people who really make the decisions and those with the customers. The Siemens arrangement will really help us in, in environments where they’re having -- where they're doing kind of a bundled sale. In the past they might have done CT scans, MRI scanners, the link bundled in with radiation oncology product. Not that it always be the case, but at least they have it as an option now to bundle in our products under those circumstances with some pre-agreed business conditions that may well help us in the future. But our main efforts are around capitalizing on the increased opportunity from Siemens exit are really focused on individual customer discussions.

The last one for me is on the service margins. So you had the increase this quarter. If you care to break that out, did you, how close are you to profitability, specifically on the Tomo side? And then a follow up there would be, what are the short and medium term targets for diamond and emerald penetration into the 350 plus or so Tomo accounts?

As far as the TomoTherapy service product line and its margins, as we had indicated we expected to have that product line transition from a very significant loss of 47% in 2010 calendar year to a breakeven or slight profit in the latter part of our fiscal ’13 year. As you can see from the reported results we are ahead of our target and we expect that we will be slightly ahead of our target of that 20% target next year overall, which would imply that it would become profitable, breakeven or profitable in the latter part of fiscal ’13. As far as the emerald and diamond contracts, it is the first quarter that we have those contracts. We are seeing the initial uptake from customers. It's still little bit early after only a couple of months of selling to draw a lot of conclusions as to the effect on the P&L, but it will be a positive impact.

There are no further questions at this time I'll go ahead and turn the call back over to management for some closing remarks.

Thank you for joining us for this afternoon's call. I want to take a moment to acknowledge Accuray employees for their continued hard work and dedication to success as we improve the life of cancer patients globally. We look forward to speaking with you on our next call.

Ladies and gentlemen thank you for your participation in today's conference. This does conclude the presentation and you may now disconnect. Have a great day.