Accuray Inc (ARAY) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Q2 2010 Accuray Incorporated Earnings Conference Call. (Operator Instructions) Thank you. I would now like to turn the call over to Mr. Tom Rathjen, Vice President of Investor Relations. You may proceed.

Thank you. Hello and thank you for joining us this afternoon for Accuray's conference call for the second quarter of fiscal 2010. Joining us today is Dr. Euan Thomson, Accuray's President and Chief Executive Officer, and Derek Bertocci, Accuray's Senior Vice President and Chief Financial Officer.

As we have done in past quarters, we will be referring to backlog and revenue data, which is found on a PDF file on the Investor Relations page of the Accuray website, at accuray.com. Please log on to the site to view this information.

Before we begin, I need to remind you that except for the historical information, the information that follows contains certain forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include the matters described in the Risk Factors section of our annual report on Form 10-K, as updated from time to time by our quarterly reports on Form 10-Q and other filings with the Securities and Exchange Commission.

And now I'd like to turn the call over to our President and Chief Executive Officer, Dr. Euan Thomson. Euan?

Thank you, Tom, and thanks to everyone for joining us on our second quarter of fiscal 2010 conference call.

Today we're reporting a solid second quarter, with 18 new orders, a 12% increase in backlog during the quarter, solid revenue and 11 CyberKnife installations. For the first half of fiscal 2010 Accuray added 27 CyberKnife systems into backlog and shipped 18 units. As a result, we are raising the lower end of our forecast revenue range. Our guidance is now $220 million to $230 million of revenue for fiscal year 2010.

So, to begin, I'd like to provide a brief review of the business highlights of the second quarter of our fiscal 2010 and I'll then turn the call over to Derek for a detailed financial review.

During the quarter, Accuray's total revenue was $57.3 million. Revenue from sources excluding platinum contracts was $48.2 million. Looking at the past six quarters, core revenue has grown by 30%, which is a strong reflection of the strength of Accuray's ongoing business. The forecasted core growth for the fiscal year is implied in our guidance and Derek will give detail to that shortly.

During the second quarter, we recorded a loss of $1.2 million, or $0.02 per share, which was driven largely by the impact of product mix on gross margin.

Services revenue was $20.7 million in the second quarter, representing 36% of total revenue. We continued to see growth in this recurring revenue stream as very positive, since it represents a steady, predictable revenue flow from long-term contracts.

Service revenue was boosted by our high-level service programs that offer customers access to upgrades on a when-and-if-available basis. These remain very popular with our customers, as they represent a cost-effective way of capitalizing on Accuray's rapid R&D program. Since uptake of these high-level programs remained strong among our new customers, we'd expect service revenue to continue to grow.

Service gross margins are also expected to improve over coming quarters, as Accuray scales it's service business and the upgrade product mix associated with service moves away from recent costly hardware upgrades.

As I mentioned, 18 orders of CyberKnife systems routed into backlog in the second quarter, which, along with service renewal contracts and other ancillary product purchases, contributed a total of $92.1 million. Of the 18 new orders, eight were from the U.S., ten were from international customers, including two from Japan.

On a worldwide scale, it's clear that our sales environment remained strong in Q2. There are early signs of the U.S. market recovery. Our U.S. sales team reports that access to capital is improving. Although we're encouraged by the improving overall environment, we do understand that economic challenges may still persist.

As we've previously described, many international markets are driven by the expanding base of clinical data. It's important to remember that throughout the economic slowdown the number of patients treated with the CyberKnife continued to increase. Every treatment expands the base of clinical knowledge. So, as we emerge from challenging economic times, the case for full body radiosurgery is stronger than ever.

In addition, the creation of a worldwide, regionalized management strategy, which we announced last quarter, is expected to enhance Accuray's ability to respond quickly and more effectively as each region emerges from the recession at different rates.

During the second quarter, 11 CyberKnife systems were installed. The worldwide installed base, as of December 31, 2009, was to 190 systems. Of the 11 CyberKnife systems installed in the second quarter eight were in the U.S. and three at international sites. One of the U.S. installations was a replacement of an older CyberKnife system.

While the replacement market is in it's very early days, it's expected to develop over the coming years as the first commercial systems begin to age, providing our Company another revenue stream. It's important to remember that unlike other radiation system providers, we have not yet had an established business from replacement units. Each CyberKnife sale represents a new business development for our customers.

Since our last quarterly call, we attended the Annual Conference of American Society for Radiation Oncology, or ASTRO, where CyberKnife VSI was introduced. VSI includes some important technological advances, including a 25% increase in radiation dose rate, a 20% increase in robot speed, as well as improved clinical features and planning and workflow efficiencies.

Although CyberKnife VSI was designed to further enhance the delivery of full body radiosurgery, its new optimization tools and increased treatment delivery speed have also enabled expansion of its capabilities to deliver Robotic Intensity Modulated Radiation Therapy, or IMRT.

Full body radiosurgery is a new technique and generally involves a new group of patients. Radiosurgery treatments take place with between one and five patient visits. Robotic IMRT leverages the accuracy benefits and robotic mobility of the CyberKnife to allow clinicians to deliver highly conformal, conventionally fractionated radiation treatments in a more accurate manner than previously possible.

With CyberKnife VSI, treatment times for radiosurgery have been reduced and robotic IMRT can be delivered in 20 minutes or less, which is comparable to conventional radiation therapy equipment.

It's important to note that full body radiosurgery remains the primary focus of Accuray, but expanding CyberKnife's capabilities to include some high-precision IMRT does strengthen the business case for some new customers. Inclusion of some conventionally fractionated treatments in the business case can increase customers' confidence and the potential revenue flow after CyberKnife installation.

We were already able to see the effectiveness of this strategy in Q2. Typically the sales cycle for a CyberKnife is between six and eighteen months. However, following our release of VSI in November, three VSI orders were among the 18 new orders that entered backlog in the second quarter. Accuray will continue to sell the standard CyberKnife in parallel with a new VSI model. We anticipate that VSI will continue to command a premium price as a result of its additional capabilities.

Clinical acceptance of CyberKnife radiosurgery continues to grow. Year-over-year, the number of prostate cancer patients treated on the CyberKnife grew by more than 25% in calendar year 2009 and the total number of prostate cancer patients treated is now close to 4,500.

At the recent ASTRO meeting, more mature data on CyberKnife prostate radiosurgery was presented, highlighting toxicity results comparable to longer, more protracted courses of external beam radiation therapy and erectile function preservation results that rival that of any alternative treatment.

Similarly, lung cancer treatments with the CyberKnife also showed a greater than 25% year-over-year increase in calendar year 2009. More than 12,000 lung cancer treatments have now been delivered with the CyberKnife. In total more than 80,000 patient treatments have now been delivered. More than 25% of these treatments took place during calendar year 2009.

Looking to the future, Accuray believes that every radiation/oncology department will want the ability to perform radiosurgery and that they will buy the best technology. CyberKnife is the clear answer for those customers who want to build a dedicated full body radiosurgery practice. Customers using so-called hybrid systems for occasional radiosurgical treatments are strong future sales candidates of CyberKnife. As these part-time radiosurgical practices become larger and see more complex cases, the demand is expected to increase to the superior capability of the CyberKnife.

With that, I'll now turn the call over to Derek for the financial review. Derek?

Thank you, Euan. I'd like to start with a brief overview of the second quarter's results and then provide details for perspective.

The strong flow of new orders to backlog in the second quarter demonstrates significant customer demand for CyberKnife. Total revenue of $57.3 million was approximately even, compared with $57.6 million for the second quarter of the prior year. Gross margin of 45.3% was improved from the first quarter, but still below the prior year, due mainly to product mix.

We continued to control operating expenses, holding them to $28.3 million, which is below the prior year's level. The overall result was a loss of $1.2 million or $0.02 per share for the second quarter, compared to a profit of $1.4 million or $0.02 per share for the second quarter of the prior year.

New orders to backlog totaled $92.1 million in the second quarter and $150.9 million for the first half of fiscal 2010, representing book-to-bill ratios of 1.6 and 1.4, respectively. The increases in backlog generated by these orders will help support our continued growth in the future.

We added 18 orders for CyberKnife systems to backlog, with a value of $84.9 million, plus $7.2 million on renewal of service contracts and other product revenues. Eight of the orders for CyberKnife systems were from U.S. customers and 10 were from outside the U.S., including two orders from Japan. Four of the CyberKnife orders booked to backlog this quarter were shipped and converted to revenue in the quarter.

Backlog was $325 million at the end of the second quarter, up 12% from last quarter's ending backlog of $291 million. Ending backlog was comprised of $116 million of contracts for the sale of CyberKnife systems, $18 million for CyberKnife shared ownership orders and $191 million associated with long-term service agreements. Charts reflecting our backlog have been placed on the "Investor Relations" page of the Accuray website.

Total revenue for the second quarter of $57.3 million is approximately unchanged from the same period of the prior year. System revenue of $35.7 million was $5.6 million lower than the second quarter of the prior year, while service and other revenue of $21.2 million was up $5.7 million from the prior year.

We installed 11 CyberKnife systems in the second quarter of the current year, the same number as in the second quarter of the prior year. However, system revenue was lower in the second quarter of fiscal 2010 because one system was sold under a shared ownership program, which caused revenue to be deferred to future periods.

Of the 11 systems installed, eight were in the U.S. and three in international markets. Two of the international installations were from our European sales region and one from Asia. This brings the worldwide CyberKnife installed base to 190 units at the end of the second quarter, with 124 systems in North America, 23 in Asia, 22 in Europe and 21 in Japan.

Service and other revenue increased due to the continued growth in our installed base and represents 37% of total revenue. Prior to fiscal 2006, we sold CyberKnife systems in the U.S. with the Platinum Service agreements, which entitled customers to specified upgrades over the term of their Platinum Service arrangements. All revenue and cost of sales were deferred when such systems were sold.

After all required upgrades were installed, we began to recognize revenue and cost of sales evenly over the period of service coverage that remained under the original Platinum Service agreement. Final upgrades under Platinum agreements were usually requested by customers and installed several years after the installation of the system. As a result, revenue and cost of sales for systems and service have usually been recognized over the last one-to-two years of a normal five-year Platinum Service term.

All upgrades have been installed by the end of the first quarter of fiscal 2010 on each of the 30 systems sold with Platinum Service agreements. We have fully recognized revenue on 22 of these arrangements and have recognized revenue over the remaining service terms on the eight remaining systems.

We anticipate recognizing approximately $27 million of Platinum revenue in the current fiscal year, with the remainder of approximately $4.0 million to be recognized in fiscal 2011. In fiscal 2009, we recognized $60 million of revenue for systems sold with Platinum Service agreements.

During the second quarter we recognized approximately $9.1 million of revenue for systems still covered by Platinum Service agreements, of which $3.3 million was systems revenue. Platinum Service revenue recognized during the second quarter totaled $5.8 million and was comprised of $1.8 million for service work provided during the second quarter and $4.0 million for service work provided in prior quarters.

Gross margin was 45.3% in the second quarter, up 260 basis points from the first quarter, but below the 51% gross margin in the second quarter of the prior year. The improvement from the first quarter was due mainly to a reduction in service parts' cost of sales from the unusually high level experienced in the first quarter.

The decline in margin from the second quarter of the prior year was due mainly to product mix, since system revenue included more systems with expensive options and accessory products than in prior periods. In addition, upgrades selected by customers under our Diamond Service program were more costly than in the prior year, a pattern that we anticipate will have a moderate impact on upgrade margins for the next two years.

In the second half of fiscal 2010 we anticipate that margins on system revenue will be higher than in the first half and that service margins will be approximately level with the second quarter, yielding an overall gross profit margin in the mid-to-upper 40% range.

Operating expenses totaled $28.3 million, down $0.5 million from $28.8 million in the second quarter of the prior year. The ASTRO meeting, our biggest tradeshow of the year, occurred in the second quarter in fiscal 2010, whereas in fiscal 2009 it took place during the first quarter. Despite the additional expense of the ASTRO show, operating expenses in this year's second quarter were down from the same period of the prior year, reflecting the benefits of ongoing efforts to manage operating expenses prudently.

Operating expenses increased $3.0 million from the first quarter, due to a number of factors, including ASTRO show expenses, restructuring expenses associated with our initiative to regionalize sales and marketing activities and increased legal and accounting expenses, including for shareholder litigation in the buyout of product registration rights from our distributor in Japan.

The income tax benefit in the second quarter reflects a federal law change enacted in November 2009 that allows an elective increased carry-back period for net operating losses, or NOLs, incurred in tax years ending after December 31, 2007 and beginning before January 1, 2010, including the ability to fully offset alternative minimum taxable income from those losses.

The impact of the anticipated carry-back resulted in a tax benefit of $0.9 million being recorded during the three months ended December 31, 2009. Offsetting this tax benefit were approximately $0.2 million of expense for foreign and state taxes.

Accuray's balance sheet remains strong, with cash and investments ending the quarter at $151.1 million.

Turning to guidance for fiscal 2010, we forecast that total revenue will be in the range of $220 million to $230 million, an increase to the lower end of our prior revenue guidance, which was $215 million to $230 million.

Legacy Platinum revenue is expected to total $27 million in fiscal 2010, down from $60 million in fiscal 2009. Total revenue, excluding the amounts related to legacy Platinum contracts, is expected to be in the range of $193 million to $203 million in fiscal 2010, up from $174 million in fiscal 2009. This represents an increase in revenue related to current product sales in the range of 11% to 17% in fiscal 2010.

Now I would like to turn the call back to Euan.

Thank you, Derek. We had a strong second quarter in fiscal 2010 in terms of new orders added to backlog, total revenue, installations and clinical growth. As a result, we are raising the lower end of our revenue guidance for fiscal 2010.

In addition, I'm delighted to announce that during the second quarter a milestone was reached. There are now over 80,000 patients worldwide who have received CyberKnife treatment, a validation to the continued expansion and adoption of full body radiosurgery.

With that, we'll now be happy to take your questions.

Operator, are you there?

(Operator Instructions) Mark Arnold, Piper Jaffray & Co.

Good afternoon, guys. Can you just give us an update on when, or if there is an update, on when you'll begin the CyberKnife with VSI and then also were there any orders to freestanding centers in the quarter?

So we're anticipating shipping some VSI, the first of the VSI units during Q3, so this quarter that we're in now. Freestanding centers, I'm not remembering any freestanding centers. I can't say definitively without the list in front of me.

Okay and then can you talk at all about how customers and potential customers are talking about using VSI? I think you guys talked at ASTRO about it providing, I guess, in a sense, an insurance policy against, well to make sure you get reimbursed before you knew whether you could get reimbursed from payors on SBRT, or stereotactic procedures.

But are your customers talking about using VSI to do straight IMRT? Are they looking at it using it do IMRT with a boost treatment, maybe in the case of prostate? I'm just curious if you're getting any feedback from customers on how they intend to use it.

Some of all of those applications. I think people are talking about using it for prostate and in the boost circumstances, as you indicated, potentially. People are also talking about using it for breast treatment, breast cancer treatments, partial breast radiotherapy, some rear radiation of head and neck tumors. But I would say that you actually characterized it reasonably well just now.

I think that the way most people, most of the conversations I've had with customers over VSI, the impact has been when they're considering their business case. It's very nice for them to be able to put down additional treatments that they are firm and solid on, because they represent patients they're already treating.

As you know, for most radiation/oncologists the flow of patients with the CyberKnife tends to be from a different patient pool. They're not generally patients they've seen before. So, under those circumstances, there's always some -- an element of uncertainty associated with it. Clearly the validate that with surgeons and referring physicians, but there is some uncertainty.

So it's nice for them to be able to draw from their own patient pool when they put the business case together and that's definitely been impactive in a couple of discussions I've been involved with firsthand.

Josh Jennings, Jefferies and Co.

Thanks a lot, gentlemen. Just to go to the first question just quickly, just newer generation was impressive. I believe it's the highest level you've had in six quarters. And just wanted to get your thoughts on how sustainable you think this level of customer demand is and how much of an interest boost did you get from ASTRO?

I know you took three orders for VSI, but any further color there? Are you still experiencing any flow from ASTRO in fiscal Q3 and did the reimbursement rule that came out on November 1st play any part in terms of this acceleration in new orders?

Well, we don't want to -- I'll try and get through all of those, but if I don't -- if I forget one then you'll remind me I'm sure. So generally I think we don't want to give a sales forecast, but what I said in the scripted portion I think we would definitely stand by, that we're getting a good sense of optimism from the salesforce.

We had, in the U.S. we definitely had reports from our sales team of a couple of customers who had put their decisions on hold for a period of time during the economic uncertainty and had come back to them and reinitiated their discussions, which is very positive. And probably, generally, a greater access to capital is playing a part too. So I think there's a definitely a spirit of optimism in the sales team.

ASTRO, I think, for us was impactive. I think VSI helped. As I indicated just now in the previous answer, I think VSI is particularly impactive where a customer is kind of on the cusp. I can't reinforce enough, all of our decisions are based on a new customer flow.

These are new projects, new developments for hospitals and that's strong in terms of the argument for why they should put their capital behind this project, because it's an increased revenue flow as opposed to a replacement system. But nevertheless, that increased revenue does depend on a new group of patients, so to have this element in the mix really does help. And I think that launching VSI at ASTRO as well as the overall, I think, interest level at ASTRO for the CyberKnife generally was impactive and even encouraging for our sales team.

Thanks and then maybe just a follow-up on the previous question, on freestanding centers. My understanding is that the backlog fallout throughout in fiscal 2009 was really predicated on freestanding centers' lack of access to capital. What is the status there? Are they getting back involved in the SRS space in terms of interest and they also having better access to capital?

We had a change in our dynamic of freestanding centers, I think really back in 2007. For us, the freestanding reimbursement environment has always been less certain than the reimbursement environment in hospitals. And when CMS announced that they would be looking at the under-arrangements between freestanding centers and hospitals several years ago now, we had some fallout of freestanding centers at the time.

Since that time, we've really focused our salesforce very much on hospitals. It's created a more certain business case, more certain orders, ones that flow better through to revenue and for that reason, I think, we were pretty much -- we haven't been significantly affected by any changes in freestanding centers lately.

Jeremy Feffer, Oppenheimer & Co.

Hey, good afternoon. This is actually Jeremy Feffer for Amit.

Hi Jeremy.

Hi Jeremy.

How are you? First question. Of the 18 new orders, how many of those were actually new versus how many were previously reported, that had been revised out of backlog in recent quarters?

So we are trying to be clear on the backlog that we have a standard today, which is what we believe is representative of an order and these are the orders that met that. We've tried to make clear that that's the standard we're following, so we're not going to look at dissecting each order as to what it might have been in a prior definition. And I think also our salespeople are working on getting the orders that meet the standard today and that's really what we're focusing on, so that's what we're reporting to the outside.

Okay, so --.

Just to sort of reinforce that a little bit further as well, I mean, if you -- we've now given three quarters of backlog using this consistent -- sorry, two quarters using this consistent definition and I think you've got some data for comparison now.

Okay and if we think about this 18 number, is this -- I know you're not really giving guidance on order numbers going forward, but is this a run rate that we should be thinking about? Is this a number that can be replicated in the next few quarters?

Well, I think I said in the previous question that it's really we are describing, I think, a more optimistic environment in our sales, amongst our sales team. But we do want to hold back from giving any sales forecasts. The environment generally is positive for us and we're having good reports back from the salesforce.

Okay and then just finally just want to have a better understanding of margins going forward. I think you mentioned gross margins you're expecting in I think you said mid-to-high $40 million going forward?

Yes, mid $40 million.

Okay and sorry, just one last bit of clarification just so we don't have any confusion. These new orders were not previously in backlog, correct, the new 18?

Correct.

Okay. Okay. I'll jump back in queue. Thank you.

(Operator Instructions) Erik Schneider, UBS.

Thanks, good afternoon or evening. On the product margin question, the product margin where it sounds like you're ascribing the degradation there to specific upgrade characteristics, now you think that's going to go for the next two years, but you think its better in the second half of this year. Can you just describe both why you think it should go on for two years and how you're confident that it's less impactful to margin in the second half of this year?

The particular upgrades that we are referring to, they're under our Diamond program and some customers will elect to use Diamond coverage from future years and commit themselves to the Diamond program into the future and the revenue for that Diamond will be recognized in the future. So we match the revenue and the expense by amortizing the costs over that period of time. That's the reason why these lower margin upgrades will impact the margin over the next couple of years.

In terms of why we anticipate this getting better, we don't see as many of these type of orders coming through in the future so that we would expect, perhaps, some of the more normal margin upgrade business coming through.

So do you think it should go back, that product margins should sort of retrace back to the high 50's where they were?

Well, this is -- these upgrades are in the service cost of sales and margins. So it's not part of product margins, it's in the service margin area.

Josh Jennings, Jefferies and Co.;

Great, just had just a quick follow-up. Is there any way you guys could just give us some review of where enrollment stands for some of the studies that are ongoing, one the MD Anderson study and the University of Pittsburgh study, both on lung? And then any data that we should be expecting throughout the course of this calendar year from Stanford or Swedish or Naples on prostate? Thanks.

Yes. So the MD Anderson study has started to accrue patients. We're not going to give details of patient numbers on an ongoing basis, but it's begun. I think that will be -- we anticipate a long accrual process for that. It's not a study that's going to be over and done with fast.

As far as prostate is concerned, there were some interesting papers, abstracts at this year's ASTRO from a number of centers. We're not -- we don't know what's next in terms of publications, but the major centers, I think, gave some pretty good updates at the time. The Stanford data, which is a lung, a small group of patients, 30 patients, the longest study time still looks very good for local control.

The other two larger groups of patients, Winthrop and Naples, they have not been followed as long. But they're also reporting encouraging results and in general, the side effects profile, which is one thing we're very concerned with, to date looks extremely competitive let's say with other treatment methods. So, considering the ease-of-use of the CyberKnife, just from a patient's perspective and how little disruption it causes to patients' lives, then to have that type of toxicity profile is very encouraging and we'll just have to wait and see how the data matures from this point forward.

Kiana?

Junaid Husain, Soleil Securities

Good afternoon, everyone.

Hi, Junaid.

Hi Junaid.

Euan, there's been a bunch of noise of late, articles in the New York Times and such with regards to radiation delivery targeting errors and I believe they were talking about IMRT specifically in these articles versus high energy radiosurgery. But, Euan, two questions. Would you say that this is more headline noise versus the greater trend that's been noted in the scientific literature? And then, secondly, what's been the track record for CyberKnife relative to tracking errors?

So I'll answer the second question first. I think we have an extremely good record. I want to make a general commit about the New York Times articles, which is that it's very unfortunate for the patients concerned. They shouldn't have been affected in this way. It's something that all of us in the radiation industry, whether we're in clinical practice or in the companies providing equipment, feel very badly about. ASTRO characterized it best, I think, saying that one patient is too many and we all feel like that.

None of the patients involved in the article were CyberKnife patients. We wait to see where it goes from here in terms of follow-up. We'll certainly be observing things very, very closely and if there's any lessons that we can learn from this in any aspect at all, then we're certainly going to implement any changes that are prescribed and suggested. But so far, I think the impact on us has not been direct.

I think one thing it does highlight is the importance of making sure that radiation is targeted in the right location and that dosimetry is carried out correctly. Of course CyberKnife, in the first respect, has a significant advantage in that it's an image-guided, robotic treatment and we therefore have very small margins in an automated characteristic -- an alternated targeting process.

With no further questions in the queue, I would like to turn the call back over to Mr. Euan Thomson for closing remarks. You may proceed.

Thank you. So the second quarter of fiscal 2010 was one that was characterized by solid orders and installations. Accuray remains dedicated to expanding the use of CyberKnife radiosurgery as we change the way in which cancer is treated around the world. As always, I want to take a moment to acknowledge Accuray's employees and the tremendous contribution they make every day. Thank you for joining us today and we look forward to speaking with you on our next call.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.