Accuray Inc (ARAY) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2014 Accuray Incorporated earnings conference call. (Operator Instructions). I would now like to turn the conference over to your host for today Ms. Lynn Pieper, Investor Relations. Please proceed.

Thanks, Chris. This is Lynn Pieper, Accuray's Investor Relations Counsel from Westwicke Partners. Thank you for joining us today on our conference call as we review Accuray's third quarter of fiscal 2014. Joining us is Josh Levine, Accuray's President and Chief Executive Officer; and Greg Lichtwardt, Accuray's Executive Vice President and Chief Financial Officer

Before we begin, I need to remind you that our call today includes forward-looking statements that involve risks and uncertainties. There are a number of factors that could cause actual results to differ materially from our expectations, including risks associated with the effects of the adoption of the new CyberKnife and TomoTherapy Systems, commercial execution, future order growth, future revenue growth, future profitability and guidance for fiscal 2014.

These and other risks are more fully described in the press release we issued earlier this afternoon, as well as in our filings with the Securities and Exchange Commission. We assume no obligation to update any forward-looking statements.

With that, I would like to turn the call over to Accuray’'s President and Chief Executive Officer Josh Levine.

Thank you, Lynn, and thanks everyone for joining us today as we review our results for the third quarter of fiscal 2014. I'll begin today's call with an overview of the quarter and highlight some of our achievements. Greg will provide a more detail financial review and then I will wrap up with some commentary on our strategy and we will open the call up for questions.

Third quarter financial statement results were strong highlighted by impressive growth in revenue, profitable and positive cash flow. We reported revenue of $97.1 million in the third quarter representing a 38% year-over-year growth. Last quarter marked the first quarter of positive year-over-year revenue growth since the acquisition of TomoTherapy, and we are pleased to follow that with another quarter of strong growth. Our CyberKnife and TomoTherapy systems are generating a great deal of interest, and we continue to receive positive feedback from our customers regarding product reliability and performance as measured in third party reports such as [MV by line].

Product performance, reliability and customer service are important aspects of our business where we are driving significant improvements and we are committed to sustaining these levels going forward. Further we reported adjusted EBITDA profit of $7.8 million in the third quarter up 139% year-over-year and 15% over last quarter. This result was driven by revenue growth, margin expansion and operating expense control. We are extremely focused on maintaining or improving on the positive year-over-year revenue growth and adjusted EBITDA profit metrics going forward. Lastly we generated significant positive cash flow this quarter of $14.4 million as a result of the positive adjusted EBITDA and working capital reduction.

With respect to orders as we indicated in terms of directional expectations in our last earnings call both gross and net order volumes were lower year-over-year this quarter. A big contributor to this result is the lack of new order momentum in our U.S. business, which is continuing to lag our International regions in the Company's overall turn around. As we have communicated over the past several quarters the impact of weaker performance in the U.S. has caused us to beoverly reliant on our other regions to produce compensating results in the last 12 months. While there are several factors underlying our current situation in the U.S. certainly one of the biggest factors is the status of our U.S. sales funnel. In general while the quality of the opportunities in the funnel are improving many of the leads we are tracking in the U.S. funnel are in earlier stages in the selling process, which. ultimately impacts the timing to close.

Another contributing factor was the strength of net records orders in the first half of this fiscal year and specifically in the immediately preceding quarter which put additional pressure on our opportunities pipeline and was one of the reasons we highlighted this topic in our last earnings call. Our immediate focus is on those activities that accelerate lead qualification and fill in the sales funnel while continuing to advance the stage-gates for those opportunities that we are already working on.

Additionally we are taking the following steps to drive improved commercial momentum in the U.S. going forward. We have made personnel changes in key sales management leadership in the Americas operating region. We have initiated executive reporting changes to align the U.S. sales and service groups in a fashion that mirrors the organizational design in all of our other regions. This structural alignment has been a key part of our commercial success model outside the U.S. based on on better service responsiveness, improved customer satisfaction and ultimately increased sales. We are making tangible progress in advancing our strategy to develop a GPO strategic accounts contract portfolio to improve our market visibility.

We have just completed the roll out of an advance CRM tool or customer relationship management tool, to accelerate sales lead qualification, provide better funnel management visibility and improve the overall sales pipeline. We are expanding downstream marketing support for the U.S. sales team to improve sales lead generation and accelerate the lead qualification process. While we are extremely focused on improving our commercial momentum in the U.S., I should point out that year-to-date global net orders are up 39% compared to prior year, and globally we expected to see an improved level of gross and net order volumes in the fourth quarter. Additionally we are confident in the health and stage-gate status of the sales opportunity funnels in our other operating regions.

Moving on I would like to share with you some of our achievements in the quarter. We are pleased to announce that we have recently won a large contract with Novation, the group purchasing organization that supports over 40% of the hospitals in the U.S. The contract will cover both the CyberKnife and TomoTherapy systems and allows us to leverage our solutions across Novation's sizable network. This three year contract will allow us to offer our systems at excellent values consistent with Novation's commitment to value creation for their hospitals and at the same time will vastly improve our early visibility to upcoming deals within their system. The Novation agreement is effective now and we are optimistic over time it will drive order growth.

We previously had executed a contract with Health Trust for the TomoTherapy product only. Health Trust gives us access to approximately 1,450 additional hospitals. We expect that there will be more contracts signed with large group purchasing organization in the near future.

Next during the quarter we received Shonin approval from the Japanese Ministry of Health, Labor and Welfare to market the CyberKnife M6 system. This marks a key milestone in our strategic growth plan for Japan, which is our largest O.U.S market. We are now able to provide the Japanese market the latest CyberKnife technology which offers the advantages of providing patients the most precise tumor treatments available with increased clinical flexibility, greatly reduce treatment times and ease of use for clinicians. We will be installing a M6 in our training center in Tokyo very soon to support our customer training activities. Customer installation should follow early next calendar year.

And finally the Multileaf Collimator or MLC for the CyberKnife M6 series is set for a limited release in late June in line with our previously communicated plan. Bench testing related to product durability continues to our satisfaction but the real test and feedback will come when we have the first few units installed at customer sites. Our goal is to gather data on the performance of the MLC from these initial sites and find a more comprehensive roll out plan that ensures that we can continue to de-risk the potential of any customer disruption as we expand the roll out.

I will now turn the call over to Greg to provide a more detailed commentary on our financial results. Greg.

Thank you, Josh, and good afternoon, everyone. Josh covered orders for the quarter, so let me just say as of March 31, 2014, product back log of $354 million is 19% higher than the same time in the year ago period.

Moving on to financial statements. Total revenue for the third quarter at $97.1 million is composed of $47 million in product revenue and $50.1 million in service revenue. Product revenue growth of 88%, compares to our low point in the prior fiscal year and demonstrates the remarkable nature of the turn around we are in the midst of. This result is attributable to both increased commercial effort and improvements in the Company's order to revenue conversion process. Service revenue represents year-over-year growth of 10%, driven by the increase in our install base and conversion of customers to higher value service contracts.

Total gross profit of $39.7 million increased 98% over the prior year third quarter. Indicating a further expansion of product margins. Product gross margins which had been in the 30% range in the prior fiscal year quarters due to excess and obsolete inventory reserves, unabsorbed product production overhead and other fixed cost continue to rebound reaching 46.3% this quarter on higher volume and stronger average product revenue. Service gross margin is also significantly higher than the prior year at 35.8%, and represents continued improvement in TomoTherapy systems reliability which is driving lower parts consumption as well as sales of higher margin service contracts.

Operating expenses of $40.2 million in the third quarter represents a decrease of approximately $5 million or 11% compared with spend in the preceding fiscal year third quarter. While total operating expenses increase somewhat from the immediately preceding quarter they are in line with our guidance of approximately $40 million per quarter. Increased spending mostly came from new hires, consulting fees and other elements of employee compensation. As a result of the strength in revenues, improved gross profit and controlled operating expenses adjusted EBITDA improved to a profit of $7.8 million compared to a loss of $19.9 million in the preceding year ago third quarter. Even compared to the immediately preceding quarter we improved adjusted EBITDA by $1 million.

From a balance sheet perspective compared to the prior quarter networking capital excluding cash and investments decrease $9.3 million. This reduction came from unusually large cash collections on current quarter product revenues in the EIMEA region which does reflect an not ongoing expectation. Compared to the immediately preceding quarter cash and investments increased by $14.4 million on positive cash flow from operations resulting from adjusted EBITDA profit and lower working capital. This marks the first cash flow positive quarter in the turn around of the Company and in the last two years. With regards to our financial guidance for the fiscal year 2014 we are updating and increasing the revenue range by $15 million to $355 million to $365 million. This is essentially acknowledging we have exceeded expectations again in the third quarter total revenue and feel confident in our ability to deliver a strong fourth quarter.

Lastly I would like to mention that earlier this month the Company refinanced approximately $70.3 million of aggregate principal amount of its 3.5% convertible notes due in 2018 with new senior convertible notes. The new notes have the same interest rate, maturity and other terms as the old 3.5% convertible notes. The only expectations being that the new notes are convertible in to cash, shares of the Company's common stock or a combination of cash and shares of common stock at the Company's option. We undertook these transaction to reduce the amount of dilution that would have otherwise have occurred from settlement of the Company's outstanding convertible notes. Following the refinancing $170 million of the $215 million in total convertible debt can now be cash or stock settled at the Company's discretion. We expect this means that we will issue between 10 million and 15 million fewer shares as a result of these transaction along with our accounting assertion which now assumes net share settlement. This refinance was down with only a small cash inducement paid to debt holders by the Company, no accounting charges and no increase in the overall level of debt, so these were very shareholder friendly transactions.

Now I would like to hand the call back to Josh.

Thank you, Greg. While I am encouraged by our significantly improved financial results, it is clear we have some continuing head winds in the area of U.S. commercial execution. By observation as I think about the past several years at Accuray I am not surprised that our commercial recovery is taking longer in the U.S. given many of the specific challenges and risks that were more magnified in the U.S. market following the acquisition of the TomoTherapy business in June 2011. As we continue to execute our strategies for a broad based sustainable turn around it is important to remember at the Company's current scale some elements of our performance trajectory while clearly improving directionally may remain lumpy.

With that said, there is value in reminding ourselves how far we have come in the past 18 months. When I joined the Company, we had a business with $240 million in cumulative net operating losses that was continuing to generate net operating losses and cash burn at a rate of $75 million a year. Through a combination of financial and operational actions we have stabilized the business and positioned it for sustainable profitable growth going forward. We are confident going forward that we are on the right path to drive value for all of our stakeholders. Thank you for participating in today's call, and we are now ready to turn the call open for questions.

All right. (Operator Instructions). It looks like your first question comes from the line of Steve Beuchaw from Morgan Stanley. Please proceed.

Good afternoon. Thanks for taking the questions everyone. First just a clarification on the last call you were kind enough to put out a figure a target for net orders for the year that was 215 million to 225 million. Sorry if I missed it. But is that still your thinking for net orders for fiscal 2014?

Steve, the answer is yes. Again as we said last quarter we do not want to be in the business of giving quarterly order guidance, but we believe the full year net product order range that we communicated last quarter of 215 million to 225 million is still a good estimate. Again globally we expect to drive a sequential increase in order volume in Q4 versus Q3 in order to meet that range.

Thanks, that is helpful. I wonder if, Josh, you could put a bit more meat on the bones of the story in terms of the traction you are seeing out there. Could you help us specifically to get to the underlying trend on orders even qualitatively from customers who engage with Accuray since the new systems were rolled out back at ASTRO 2012? It is hard for us to understand on the outside because clearly some of the orders of the last year were catch up from orders that might have been on the books or in the funnel from prior to the launch of the new system and clearly some catch up from orders that might have aged out, and we never really knew frankly how much of the order flow was from that group. So if you isolated new orders from customers who bought into the story since ASTRO 2012 how has that been trending, and it would really help if you could isolate North American in your response. Thanks so much.

So let me start with the level of engagement and the level of interest we are seeing in the products. This is an overall answer in terms of geography, Steve. We are still seeing very, very strong interest. And I think across the board we are very pleased with the level of engagement and interest and positive feedback about the functionality in the new devices, the level of improvement in operating speed and throughput in every aspect you can really measure feedback across the board about the products continues to be strong. And I think we have the right level of momentum there vis-a-vis the products that meet clinical needs and meet customer needs across the board.

The situation in the U.S. is not necessarily product related it is really more I will call it systemic funnel issues or systemic issues that have gotten in the way or created longer timelines to advance funnel opportunities or the sales leads we are able to manage to or track. We have had virtually no visibility at all in the U.S. market that would come from normally the kind of natural contracting opportunity that you would see in a typical device med tech company with regards to GPO and strategic accounts. So while I can not qualify it specifically or quantify it specifically we know that Varian and Electra enjoy reasonably significant piece of their activity in the U.S. market through the fact that they have contracts with GPO and strategic accounts they have early visibility into the deal opportunity flow in those systems, and we quite frankly have been operating at a major, major deficit in that regard. So when you start to talk about how much of the market we see in the U.S. we have been quite frankly operating with one hand tied behind our back because of the lack of GPO capability and the contract portfolio there.

Secondarily, another one of the systemic challenges I point to is coming out of the TomoTherapy acquisition the only region in the world where we didn't have a full end point to end point executive responsibility for sales and service and all of the functional aspects that touch the market touch customers which give you the ability quite frankly to meet customer needs with regards to service responsiveness and overall support for customers. The U.S. market was not aligned the way the O.U.S. regions were, so EIMEA, Japan, Asia-Pac they were all a year and a half quite frankly or more ahead, maybe even more ahead of the U.S. in terms of this functional structure and functional alignment. And quite frankly by learnings over time we have seen that become a major, major difference in how we have supported customer satisfaction and ultimately how we have driven sales in the other regions of the world. And again we were operating at a pretty significant deficit in that regard in the U.S. market.

Last but not least I would say while customer perceptions about product reliability across the board have been an issue for the Company since the Tomo acquisition there is no question that the over hang created in customer perception about the reliability was clearly more magnified if you will or amplified in the U.S. market. We also weren't as responsive quite frankly to some of it as rapidly as we probably should have been or could have been. We were more focused on cost than we were on customer satisfaction. I think understandably so given what we inherited in the Tomo acquisition, but again that is one of the other major elements in the U.S. market that I think haveimpeded our ability to really build an advanced sales opportunity funnel.

Thanks, that is real helpful. One clarification, do you have a sense, Josh, for what percentage of (Inaudible) orders in North America go through GPOs?

We have tried to triangulate on that number. I think it would be hard to predict with a great degree of accuracy. Basically it would be a significant portion of the opportunities. In other words if an individual hospital that is part of a group purchasing system is about to purchase a $2 million, $3 million, $4 million device to replace something in a bunker they have right now or to build out or outfit a new bunker one of the first things we are going to do is look to see if the system they are a member of from a GPO perspective has something on contract. Estimates 75% of the market probably in terms of transaction is from an initial point of visibility it is coming through a GPO or strategic account purchasing contract.

Thank you so much, very helpful.

All right. It looks like you have another question coming from the line of Tycho with JPMorgan. Please proceed.

This is Jordan McKinnie on for Tycho. Thanks for taking the questions. I was wondering could you give us some color on where you saw the cancellation versus age outs in the quarter and what drove them?

So there were only two age outs in the quarter which is significantly less than what we saw obviously in the second quarter but more in line with an average over a one year period. Age outs typically occur O.U.S quite frequently they are in the Latin America and China region specifically. And that is in line with the commentary we gave last quarter.

Okay. And then could you give some color on your regional growth and what your EIMEA strategy and where you are seeing market share gains?

We have been consistently communicating and there is no change in that communication in terms of the trends, Jordan. About the health of our sales funnel and commercial execution that is driving growth in the EIMEA region in Japan and in the Asia-Pacific region as well. If you were to skin ask on a more granular level within those regions where we are really seeing improved market penetration I would say in Western Europe, Germany and France from an anchor stand point that would be two of the markets that I point out. Japan has continued to be a consistent performer for us. And I believe we are still in a growth in terms of market share mode there both on the TomoTherapy side and on the CyberKnife side, and again we are seeing good growth and healthy momentum in the Asia-Pacific region as well. So those three areas of the world continue to be I will call the compensation if you will in terms of commercial execution and commercial momentum in offsetting the lag in what we know is going to happen in the U.S. market.

Okay. And would you mind giving us your total install base?

The total install base as of March 31 is 730 systems.

Okay. Thanks.

All right. It looks like you have another question coming from the line of Jason Wittes with Brean Capital. Please proceed.

Thanks for taking the question. I just wanted to go back and focus a little bit on the U.S. Josh, you mentioned the U.S. being behind you gave some parameters around that. Is that based on the funnel you have right now? It seems like you are saying we are six months to a year behind before we see some substantial orders from the U.S. and it also sounds like the big driver there is going to have to be these national contracts and GPO of which you just signed one or at least announced signing one this afternoon.

Jason, the answer is we certainly are in certain systemic discussion or elements I highlighted earlier one being the structural alignment between sales and service some of those type of situations we probably are a year or more behind the O.U.S regions, but quite frankly we have been working hard to accelerate funnel management, funnel visibility in the U.S. market. The better visibility that results from the enhanced CRM tool we put in place hopefully accelerate lead generation and stage-gate movement in the funnel. I don't think we are year off quite frankly in terms of being able to see tangible results and improvement in the U.S. funnel and U.S. momentum. I think we are probably a quarter or two away. But it is something we are exceedingly focused on and it is something that is getting all of the right kind of attention going forward.

You have in the past given this I don't know if it is possible to the get percentage O.U.S., U.S. break down for revenues and for orders this quarter.

I don't think we have been quite frankly all that granular about it. It would be remidst of me not to take that opportunity though to thank the people who are running our International business because quite frankly their backs are hurting. They have been carry the offset quite frankly for the U.S. lag, and the commercial leadership in that team in Europe, in Japan, in Asia they have done a hell of a job for us. And I think again if you think about what I just describe in terms of another quarter or two before we start to see real funnel improvement and real stage-gate advancement in terms of the U.S. sales funnel I think we are going to continue to count on our teams in EIMEA, Japan and Asia-Pac to continue do the things they have been doing all along. The good news is I have a high degree of confidence in the strength of the funnel and the opportunities they are working with. And commercial momentum is an interesting thing. Once you can start to generate traction if you keep doing the things that got you there it can continue. I am appreciative number one of the work the guys outside of the U.S. have done, and I am highly confident they are going to continue to carry the banner for us until our brethern in the U.S. come online, which quite frankly we have the gas chips turned up on high for that group.

Understood. One other clarification or detail and that is last quarter you had a very big (Inaudible) of CyberKnife that kicked in. That was somewhat unusual. Have the CyberKnife orders continued into Q3 if I look at the break down of the orders for this quarter?

If you look at gross and net for Q3 both product platforms obviously were down on a sequential quarter-to-quarter basis. We are still very pleased quite frankly with the way CyberKnife is moving in terms of the M6 and the adoption and the market reception for it. Obviously the MLC we believe should and will help that discussion. We have product as we said in the last couple of quarters that functionality wise is performing at treatment speed through put user interface in terms of treatment planning applications in a much different way than the previous generation devices. So we continue to be pleased with the M6 momentum if you will overall.

Great, thanks guys. I will jump back in queue.

All right. So it looks like you have another question. The next question comes from the line of Toby Wann with Obsidian Research Group. Please proceed.

Good afternoon guys. Quickly could you give us a break down of revenue of U.S. versus O.U.S just in terms of a percentage? Is it still 70/30 I think is what it used to trend.

Jason just asked that and we are going to ask you to wait until the 10-Q is filed.

Okay. No problem. With regards to the structural realignment in the U.S. were there any charges associate and expenses incurred in this quarter that are not going to be present on a go forward basis? I know you did manage to the $40 million on the expense side it is up a little bit sequentially but how should we think about that on a go forward basis? Still that $40 million is the target and below that?

Just to be clear I will take the first part of that question. The answer is no there were no one time nonrecurring charges in the quarter related to any of the organizational alignment discussions that I talked about. It was really more of executive reporting changes.

Okay.

We now have for the first time in the U.S. market maybe ever quite frankly at least that I'm aware of, we have a unified executive responsibility for all of the actions and activities that are market facing under one unified executive chain of command. It may not sound like a like but it is a big deal. If you want to see proof of that, I would point to what is happening in the other regions of the world right now for us as proof positive of that.

Okay. Fair enough.

The answer to the rest of your question is our outlook for the fourth quarter is also for $40 million in operating expenses and we will provide 2015 guidance in the fourth quarter earnings call likely in August of this year.

Okay. One last one and I will jump back in queue. With regard to pricing general commentary is everybody still behaving rationally out there from a pricing stand point?

Yes. We have nothing that I would say at least in the quarter occurred that was outlier activity or things that are different than what we had seen over the course of the last several quarters.

Okay. Thank as lot.

(Inaudible). Yes.

Thanks a lot. Congratulations.

All right. So it looks like you have another question coming from the line of Steve Beuchaw with Morgan Stanley. Please proceed.

Thanks for taking a second round. I wonder if there is any early feedback on the MLC now that you have a product you can probably start showing to key customers? Are you at the point yet where you have been able to show a functioning MLC to a potential customer to someone along the lines of a maybe UPMC and do you have any early feedback on that product whether it is perspective what it might do for throughput or just general level of interest in the market to the extent that you have seen any feedback up to this point?

Just specifically to answer that question the answer, Steve, is we don't have a device component that we have actually launched or released into a customers hands that basically resides on a device at this point, that is still probably about 60 days away we are targeting and believe we are in a time frame of late June limited release As you would expect customers coming through our site, visit site tours especially people we have worked with for a long time have seen devices on the bench top but nothing that would provide them with the ability to give us feedback in a true commercial setting. So we are still a little bit ahead of the moment in time quite frankly where we would be able to answer your question directly around customer feedback specific to having a device in their own setting.

Got it. Makes sense. Josh, I know your mantra is that your market share is low and given where you market share is the end market conditions you are facing don't matter so much. I wonder if in this quarter given that there is a little bit of capital pressure in the U.S. there is some evolving parts in terms of how equipment is purchase in China and Japan and we of course have a disruption in Russia. Were there any cases where you saw an end market hiccup that might have had any impact on the business in the quarter. Thanks so much.

No. There isn't anything here that I would attribute to market conditions or changes in market conditions or shift in philosophical views regarding CapEx spending in any way. I am not going to and no one in this organization, Steve, is going to make an excuse for something that didn't happen that was really related to quite frankly what I consider and what we consider off benchmark performance. We have to do a better job of managing the funnel and filling the funnel and advancing the funnel in the U.S. market and we have to do a better job of supporting customer needs. And we have ever touch point in our organization that touches those activities I think aligned and lined up today in a way we are going to be much better at it going forward. And I wish there were a way that I could push a button and accelerate the health of the U.S. funnel overnight, I can't. But I am highly confident what we are seeing in the other regions of the world is going to be the pattern that emerges in the U.S. and we are going to stay after it until that is case quite frankly.

Great. Thanks again.

All right. It looks like you have another question coming in from the line of Brooks O’'Neil with Dougherty & Company. Please proceed.

I got on a little late. But I am just curious, I am wondering if you can comment on how you feel you stack up relative to competition on the software dimension and if software is a bit of an issue competitively are there anything you think you can do to bridge the gap or close the gap (Inaudible). Thank as lot.

Brooks, I'm not going to get into specifics about strategic product pipeline detail. I have commented publicly and I have been asked in public settings before about the strategic implications of connectivity and the like and quite frankly it is a topic that I answered it then I will answer it the same way today. It is important. We are very, very focused on understanding how we can close some of those gaps. I don't think quite frankly it is an overly big gating item for us, it is a gating item. But I think we are proving we can sell through it in many cases and we are working hard to try to address some of the connectivity issues and call it gaps if you will that we think exist to improve our overall product capabilities which is what we would continue to do under any circumstances. Again I don't want to use that as an excuse quite frankly for what happened in Q3.

I applaud what you are doing, and I appreciate your insight. Thanks a lot.

No problem.

All right. So it looks like there are no further questions at this time, so I will go ahead and hand it back over to Josh Levine for closing.

We want to thank all of you for participating in today's call, and we look forward to speaking with you at the yearend and Q4 earnings release. Thank you very much.