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Edited Transcript of ARAY earnings conference call or presentation 23-Apr-19 8:30pm GMT

Q3 2019 Accuray Inc Earnings Call

SUNNYVALE May 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Accuray Inc earnings conference call or presentation Tuesday, April 23, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Joshua H. Levine

Accuray Incorporated - President, CEO & Director

* Michael Polyviou

EVC Group Inc. - Managing Member

* Shigeyuki Hamamatsu

Accuray Incorporated - Senior VP & CFO

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Conference Call Participants

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* Anthony Charles Petrone

Jefferies LLC, Research Division - Equity Analyst

* Brooks Gregory O'Neil

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* Joshua Thomas Jennings

Cowen and Company, LLC, Research Division - MD and Senior Research Analyst

* Marie Yoko Thibault

BTIG, LLC, Research Division - Analyst

* Philip Caldwell Coover

Citigroup Inc, Research Division - Research analyst

* Tycho W. Peterson

JP Morgan Chase & Co, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and welcome to the Accuray's Fiscal Third Quarter Financial Results Conference Call. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Michael Polyviou with EVC Group. Sir, you may begin.

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Michael Polyviou, EVC Group Inc. - Managing Member [2]

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Thank you, Carmen, and good afternoon, everyone. Welcome to Accuray's Conference Call to review financial results for the third quarter and fiscal year 2019, which ended March 31, 2019 as well as recent corporate developments.

Joining us today on the call are Josh Levine, Accuray's President and Chief Executive Officer; and Shig Hamamatsu, Accuray's Senior Vice President and Chief Financial Officer.

Before we begin, I'd like to remind you that our call today includes forward-looking statements that involve risks and uncertainties, including statements regarding our fiscal 2019 guidance, including factors that could affect such guidance, expectations regarding market conditions in China, expectations related to new product releases and future business plans and strategies. There are a number of factors that could cause actual result to differ materially from our expectations, including but not limited to, risks associated with the adoption of the CyberKnife, TomoTherapy and Radixact System's commercial execution; operationalizing the China joint venture and overall strategy in China; timing of China user license issuances and the company's ability to take advantage of the issuance of such licenses; future order growth; future revenue growth; and macroeconomic factors outside of the company's control.

These and other risks are more described -- more fully described in the news release we issued just after the market closed this afternoon as well as in our filings with the SEC. The forward-looking statements on this call are based on information available to us as of today's date, and we assume no obligation to update any forward-looking statements to reflect actual performance or results, changes in assumptions or changes and other factors affecting the forward-looking information except to the extent required by the applicable securities laws.

Two housekeeping items. First, (Operator Instructions). Second, all references we make to the specific quarter in the prepared remarks are to our fiscal year quarters. For example, statements regarding our third quarter refer to our fiscal third quarter ended March 31, 2019.

Now I'd like to turn the call over to Accuray's President and CEO, Josh Levine. Josh, please go ahead.

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [3]

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Thanks, Michael. Good afternoon, everyone, and thank you for joining us on today's call. Accuray's third quarter performance was highlighted by 12% year-over-year gross order growth. The quarter was driven by strength in China and continued momentum for both of our delivery systems and software offerings. We also saw strength in competitive bunker takeouts, which for a fifth straight quarter represented over 20% of our gross orders. On a year-to-date basis, gross orders grew 18%. Also during the quarter, we substantially completed the $15 million cost-savings initiative announced in the second quarter and should realize the full benefit in fiscal year 2020.

Our third quarter highlights also included the execution of our joint venture agreement in China, which we believe will uniquely position us to succeed in that market, which represents the single largest growth opportunity in radiotherapy.

We made progress during the third quarter in operationalizing the joint venture with our partner China Isotope and Radiation Corp, and I'll be providing some more color in detail on this later in my prepared remarks. I'll provide a review of our regional gross orders performance in the quarter, highlight progress with the China joint venture and the China market opportunity as a whole and then conclude with an update on our latest product innovations. I'll then turn the call over to Shig for more detailed review of our financial performance.

Gross orders of $83.6 million in the third quarter increased 12% year-over-year due to strong performance in our APAC region, specifically China where we continue to see demand for our Type A products. As you are aware, end-user customers are still awaiting the issuance of licenses, which we believe will begin by late May or early June. During the third quarter, we took 10 orders from our China distributor and the composition of the orders were primarily for Type A products.

In our Americas region, gross orders were down slightly in Q3 compared to the prior year, but have grown 13% on a year-to-date basis. While the growth in the Americas during the first 9 months is encouraging, it's still a bit early to characterize this trend as a sustained momentum.

In our EMEA and Japan regions, gross orders declined on a year-over-year basis due to tough prior year comparisons. With that said, both EMEA and Japan continued to be strong contributors to our overall gross order number and each contributed over 20% of the total gross orders in the third quarter.

By order type, approximately 25% of overall orders in the third quarter were competitive takeouts, 60% were for new vaults and 15% were replacements on our own installed base. All 3 of these metrics are consistent with our historical ranges.

Turning now to China. When we look at the overall level of linac market penetration compared to mature markets around the world, it is clear that China is currently operating at a significant deficit in terms of clinical treatment capacity. To put this in comparative perspective, in the U.S., we have roughly 12.4 linacs installed per 1 million people. Western Europe has roughly 6 to 7 linacs per 1 million and China is estimated currently to be at 1.4 linacs per 1 million. When China's disease incidents forecasts are taken into account, the current level of radiotherapy treatment capacity represents both a significant concern as well as an opportunity. While the near-term addressable market today is defined by the roughly 1,400 radiotherapy license quota outlined by China's Ministry of Health last October, to keep pace with future patient treatment needs, China will likely need a total of 5,000-plus linacs over the next decade. Given Accuray's current installed base of 900 devices, you can see why we are so excited about China as an overall growth catalyst for our business.

We continue to make operational progress on executing our joint venture strategy. Last week, the JV obtained the business license certification. Having this license certification means we can now begin to apply for the medical device radiation safety license as well as higher employees to staff the JV from a basic infrastructure perspective, which in commercial terms moves us closer to order generation. We expect the JV to have the radiation safety license to sell and take orders sometime during this summer.

During the early stages of ramping the JV, we will continue to work with our current distributor TomoKnife to take and convert orders to revenue to ensure there will be no disruption to our near-term opportunities. Once licenses begin to issue, this initial transition phase will allow us to maximize orders in revenue, while we operationalize the JV to support our longer-term strategy for the China market.

In the first phase of this transition, we anticipate the JV will begin selling Type A and our current Type B Accuray therapy -- Accuray radiotherapy devices, much like a distributor. In the second phase of the strategy, the JV will manufacture and sell a locally branded made in China Type B radiotherapy device. This locally produced product would replace our current Type B TomoH offering. We believe this 2-phase strategy in parallel with our current distributor TomoKnife continuing their sales responsibility over the next year will allow Accuray to best maximize both near- and longer-term opportunities. To enable longer-term market penetration, our manufacturing partner China Isotope has active selling relationships in almost 10,000 China hospitals across more than 30 provinces.

China Isotope's customer relationships are also diverse by hospital type, including many institutions beyond the Tier 1 academic and research-based hospitals, which have been Accuray's strength historically. As a result, we believe that the customer base that China Isotope currently serves will provide Accuray with improved strategic market access that should help diversify and expand our overall market opportunity.

In the near-term, Accuray's order and revenue activity in China will be -- will continue to be partially governed by 2 processes; the license application and issuance process and the tender process. Based on the latest information, the China Ministry of Health is nearing completion of its implementation of license application infrastructure and it is expected that the initial batch of Type A licenses should start to flow soon, most likely in late May or early June.

We then anticipate it will take approximately 6 to 8 additional weeks for the tenders to be awarded and the first units to go to revenue. We, therefore, continue to expect our order activity in China will benefit fiscal 2019 with the bulk of the revenue benefit occurring in fiscal 2020.

As we communicated on our last call, we do anticipate some quarter-on-quarter variability in order flow as this licensing and tender process becomes fully activated, which Shig will cover in more detail shortly.

Turning to our product development road map, our current upgrade strategy is focused on further increasing the speed and utility of our devices and continuing to extend Accuray's historical strength and the overall precision of our treatments. The VOLO Optimizer software upgrade for CyberKnife, which was introduced at ASTRO last fall, is now on approximately 30% of compatible CyberKnife Systems in our installed base.

The VOLO Optimizer reduces treatment times by up to 50%, allowing CyberKnife treatments to be performed in 15 to 30 minutes depending on the disease site. The reduction in treatment planning times is even greater at approximately 90%. We believe the availability of the VOLO upgrade on CyberKnife will be both a catalyst to our installed base replacement cycle and allow us to attract new customers to the CyberKnife platform.

Currently, approximately 100 systems in our CyberKnife installed base are the latest generation M6 platform that is MLC compatible and capable of realizing the full benefits of enhanced treatment times of the VOLO Optimizer. This means a reasonable number of the roughly 250 CyberKnife systems in our installed base are high-value trade and trade up targets for our latest generation CyberKnife platform.

For Radixact, Accuray is bringing the motion synchronization capability currently found on CyberKnife to our extremely versatile Radixact IGRT System. We expect to have our first shipment of this important feature, which we call Synchrony for Radixact by the end of our current fiscal year.

Broader commercial launch will be towards the end of the calendar year. Synchrony corrects for target motion during treatment delivery in real time without the need for gated treatments or uncomfortable patient positioning devices designed to restrict patient movement. The result is efficient treatment deliveries that enable tighter dosing margins, improved sparing of healthy tissues and greater patient comfort. As the original innovator of motion tracking and synchronization with our CyberKnife System, Accuray fully intends to extend our leadership in this important area by transitioning this capability to our Radixact platform.

In addition to Synchrony, we are in active development on enhanced imaging upgrades for both our Radixact and CyberKnife Systems that will improve soft tissue resolution and contrast. We believe these upgrades will expand the market opportunity for both of our treatment delivery platforms.

We anticipate an enthusiastic customer reception for both our Synchrony motion tracking and synchronization upgrade for Radixact and the VOLO Optimizer for CyberKnife at the upcoming ASTRO conference in Milan later this week.

And now I'd like to turn the call over to Shig for a deeper dive into our financial performance in the third quarter and our outlook.

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Shigeyuki Hamamatsu, Accuray Incorporated - Senior VP & CFO [4]

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Thank you, Josh, and good afternoon, everyone. As Josh highlighted, we had $83.6 million of gross orders in the third quarter, representing an increase of 12% over prior year. On a year-to-date basis, gross orders have increased 18% over fiscal 2018.

Starting in fiscal year 2019, we included upgrades purchased through our service contracts in our gross orders and these types of orders totaled $900,000 for our third quarter and $3.6 million on a year-to-date basis.

Excluding these upgrades on service contracts, gross orders increased 10% in the third quarter and 16% on a year-to-date basis.

From a product mix perspective, CyberKnife contributed approximately 45% of total gross orders compared with 35% a year ago, primarily driven by a strong demand in China. The increased contribution from CyberKnife should possibly impact product gross margin as these orders convert to revenue in the future.

Our Radixact and TomoTherapy platform continued to perform well and accounted for approximately 55% of the Q3 total gross orders.

Net age-outs for the quarter was $15.2 million, down from $25.9 million in the prior year. Net age-outs consisted of $20.8 million of age-outs, offset by $5.6 million of age-ins. We also recorded $7.3 million of cancellations and $1.3 million of currency-related adjustments. As a result, on a net basis, we generated $59.8 million of orders in the third quarter.

As discussed in prior calls, the volume of order cancellations can fluctuate from quarter to quarter. On a year-to-date basis, order cancellations totaled $16 million or approximately 3% of our total backlog, which is consistent with our historical trends.

China Type A systems represented about 30% of the total age-outs for the quarter. We continue to believe we will start converting these age-out China orders to revenue, most likely starting in fiscal year 2020 as Type A licenses start to be issued.

We ended our third quarter with backlog of $493.9 million, representing an increase of 5% over prior year.

Turning now to our income statement. Total revenue for the third quarter was $103.2 million, representing a 3% increase over prior year. EMEA, APAC and Japan drove the revenue growth in the quarter. On a year-to-date basis, total revenue grew 4% over prior year.

Product revenue for the quarter was $46.5 million, an increase of 7% over prior year. The product revenue increase was driven by strong demand for the Radixact System, which approximately doubled in unit volume from the prior year. Since its introduction 2.5 years ago, we have recognized revenue for approximately 90 Radixact Systems.

Service revenue for the quarter was $56.8 million, which was relatively flat year-over-year. I would like to remind you that the prior year service revenue included a higher-than-normal level of Accuray's purchaser service contracts, which was driven by new software releases related to our precision treatment planning and iDMS connectivity. As we mentioned in prior calls, timing of upgrades can vary from quarter to quarter. Sequentially, service revenue was up 5% from the previous quarter, driven by continued installed base growth, training and spare parts revenue. On a year-to-date basis, service revenue grew 2%.

Turning now to gross margin. Our overall gross margin for the third quarter was 39.2% compared to 36.3% in the prior year. Year-to-date, our overall gross margin was 38.7% or approximately flat year-over-year. Product gross margin was 41.5% in the third quarter compared to 41.4% in the prior year. On a year-to-date basis, product gross margin was 40.6%, down from 42.5% in the prior year, due to the lower mix of CyberKnife System revenue.

Service gross margin in the third quarter was 37.3% compared to 32.4% in the prior year. The lower gross margin in the prior year included the impact of higher-than-normal service parts consumption in that quarter, which was an isolated incident. On a year-to-date basis, service gross margin was 37.2% compared to 36.3% in the prior year, as we continue to expand our overall service gross margins. We believe our continued investment in service efficiency and parts reliability will continue to improve our service gross margin over time.

Moving down to the income statement. Operating expenses for the quarter were $37.6 million, a decrease of 6% from the prior year. Contributing to the decrease was an $800,000 noncash onetime credit related to a lease termination for one of our office buildings. Excluding this onetime credit, our third quarter operating expenses were $38.4 million, a decrease of 4% from the prior year.

On a year-to-date basis, operating expenses were $119 million or down 1% year-over-year. Excluding the onetime charges related to the accounts receivable impairment, severance and lease termination credit, year-to-date operating expenses decreased $5 million or 4% from the prior year.

Adjusted EBITDA for the third quarter was $6.7 million compared to $1.4 million in the prior year. The third quarter adjusted EBITDA excludes the impact of onetime noncash credit related to the lease termination I mentioned earlier.

Adjusted EBITDA on a year-to-date basis was $14.8 million compared to $9.3 million in the prior year. We ended our third quarter with $65 million of cash and short-term restricted cash, which remained flat from quarter to -- from prior quarter as we continue to invest in our working capital to prepare for converting China orders to revenue in fiscal 2020.

Before I move on to discuss our fiscal 2019 guidance, I would like to update the status of the cost reduction initiatives we discussed in our previous calls. With the execution of the initiatives substantially completed, we continue to expect the total savings from this action to be approximately $15 million on an annualized basis and start realizing the full benefit of this action in the fourth quarter of this fiscal year.

Of the expected savings, approximately 30% will benefit gross margin, while the remainder will reduce operating expenses across all functions.

A large benefit of the cost reduction initiatives was realized in our third quarter resulting in $6.7 million of adjusted EBITDA or $23 million on a trailing 12 months basis. This number compares to $17 million of EBITDA we generated in fiscal year 2018. We believe we now have the right operating cost structure in place to expand our EBITDA generation capability as we grow orders and revenue.

Turning now to our guidance for fiscal 2019. Today, we are updating guidance, calling for annual revenue in the range of $415 million to $425 million, which will represent growth of approximately 3% to 5% over fiscal year 2018.

The revenue range provided is reflective of the timing of China license issuances, which, as Josh explained earlier, will not likely benefit us in the fourth quarter. Most specifically, if our end customers have not completed their tender process in the next 30 to 45 days, we don't believe we will be recognizing any China order revenue in the fourth quarter, which will likely result in achieving the lower end of the revenue guidance I just provided.

Regardless of the amount of China revenue we realize in the fourth quarter, we continue to believe that China revenue conversion will accelerate during the first half of fiscal 2020.

We expect adjusted EBITDA range to be $23 million to $29 million. As EBITDA most closely follows revenue, if there is a delay in China licenses and revenue conversion, we would finish the year in the lower end of this EBITDA range.

In terms of gross orders, during fiscal 2019, we have refrained from providing specific guidance on this metric. However, in light of our exceptional 18% year-over-year growth for the first 9 months of fiscal year, driven primarily by pent-up demand from China and the recording of the largest U.S. multisystem order in the company's history during the fourth quarter of fiscal 2018, we felt we should share with you our expectations for full year gross orders.

Currently, the fourth quarter gross orders are expected to be flat to slightly less than last year's figure of $96.4 million, which as I previously mentioned included the largest U.S. order in the company's history.

Therefore, our gross order growth rate for fiscal 2019 would be in the low teens.

Turning to our net age-out forecast. We anticipate fourth quarter net age-outs to be in the mid-$20 million range, although as we experienced in the third quarter, we are and will actively work on converting those orders to revenue.

In terms of our gross margin outlook, we continue to expect overall gross margin to be flat to slightly down to our fiscal 2018 levels. This is a result of the TomoTherapy, Radixact platform contributing to a higher percentage of the total revenue.

We now expect operating expenses for the full fiscal year to be down approximately 2% year-over-year. Excluding the impact of onetime items of impairment, severance and the lease termination credit, operating expenses are forecasted to be down 5% year-over-year.

And with that, I'd like to hand the call back to Josh.

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [5]

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Thanks, Shig. Before we open the call for your questions, I'd like to thank the entire Accuray team for their increased focus, commitment and improving execution, supporting the important work that's making a difference for our customers and patients.

Additionally, we would like our shareholders and analysts to note that on Monday, September 16, from 3:30 p.m. to 5:30 p.m., Central Time, Accuray will host an analyst and investor information session at the ASTRO Conference in Chicago. I wanted to make note of this event today, because it's the first time in many years our company has hosted an investor event at ASTRO and we wanted to give investors and analysts as much advance notice on this date as possible.

And operator, we are now ready to open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is from Josh Jennings with Cowen.

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Joshua Thomas Jennings, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [2]

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Congratulations on the strong order growth and the progress in the China JV. I'm going to start with just the China market. I know that there is a lot of I guess, administrative things that need to happen with the China Ministry of Health still completing the license application and infrastructure as you mentioned in your prepared remarks. It sounds like the last 2 quarters, most of the China orders have been Type A and I was just hoping to understand better the dynamic about why we haven't seen more Type B orders coming out of China? And when you think that, that could be opening up? And when that could turn into a tailwind? Because of the 1,400, I guess, Class A and B licenses in the quarter there, I think the vast majority of 90% or so are type B.

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [3]

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Yes, you're absolutely right, Josh, on that. The mix is much heavier overall to the Type B side. The simple answer is that the -- we have been building -- kind of building out the additional dealer network on -- or sales agent network on the Type B side. As we talked about in prepared remarks, the JV will end up -- well, first of all, the transition between TomoKnife and the JV that our distributor TomoKnife kind of the historical distributor has a 12-month payout to continue to sell, and we want that activity continue for reasons related to continued momentum and -- but the Type B products are really probably going to be more of a joint venture focus. And the work that's taking place right now on that front is to lineup sales agents across the bulk of the provinces to assist in that effort. And I don't think quite frankly it's going to be too much longer before we start to see some Type B activity start to flow. I mean, again, as you pointed out, the first 2 quarters of -- or the last 2 quarters of activity have really been Type A-centric and more focused on that side that's because TomoKnife has continued to be the -- essentially the kind of the sales force of record, a historical record, if you will, but the JV is going to be starting to ramp and start to contribute to the Type B side of this I would predict in the next quarter or 2, and it should flow pretty good from there. So really more just startup infrastructure and startup related ramp than anything else.

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Joshua Thomas Jennings, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [4]

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Understood. Which is the -- my second question -- follow-up question is just on the Americas business. You guys anniversary the U.S. sales restructuring effort this quarter and that brought a lot of fruit over the last 4 quarters. But can you just talk about, I guess, how we should think about the Americas franchise and the comps over the next couple of quarters and whether that region can return to growth in the coming quarters?

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [5]

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Sure. The simple answer is, yes. I have an expectation that the Americas and the U.S. geography predominantly are going to contribute to a greater extent than they have. The numbers right now -- the percentage growth in order of volume looks pretty frothy, but that's against obviously, I'd say, fairly modest baselines from prior year. They've been moving in the right direction though for the last 2 or 3 quarters. So I'd say there is some consistency there in what we're seeing. I think the funnel in general is improving. There are -- as we've talked about in the last quarter too, there are some multisystem orders in the U.S. funnel -- in the Americas funnel that I think, again, are making progress. And I think that we'll finish this year at a reasonably strong percentage growth from the U.S. over prior. But again, I think we're just being realistic and transparent about the prior year numbers. I mean we're just -- those really aren't necessarily the kind of benchmark that I would like to hold the U.S. team accountable to. But based on the funnel that I see developing and I think the quality of the people that we've added and the leadership that's in place, Josh, I feel good about where the U.S. should end up over the course of certainly the next, I'd say, 4 to 6 quarters. So more to come there. We need to execute, but I feel good about where we're headed.

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Operator [6]

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And our next question is from Anthony Petrone with Jefferies.

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Anthony Charles Petrone, Jefferies LLC, Research Division - Equity Analyst [7]

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Congratulations also on a strong quarter and obviously the development in China. I'm going to start with a couple of questions on China and then I'll just shift over to Radixact and some of the clearances and new solutions on that system. But on China, maybe you understood Josh, just on how the rest of the fiscal year is going to play out and maybe just to piggyback on Josh's question, as we look into really over through 2021, what is the company's expectation on the number of licenses that ultimately will convert to orders in revenue out of that estimated 1,400 total between Class A and Class B through the soft deadline of 2021? And then I have a follow-up on the JV.

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [8]

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I mean, Anthony, at any level of analysis that's obviously, it's a lot of devices. The number -- the aggregate number of licenses in the quota is a big number. With that said, the market has gone at least 2 years with essentially being in park, at least the public facilities market. Obviously, the private facilities have had a little bit more leeway, but the vast majority of the market in terms of existing -- served market institutions have really not been able to acquire the equipment that they need based on lack of clarity, at least in our situation lack of clarity around Type A versus Type B. It's impossible to predict in absolute terms what the Ministry of Health will issue, but as an internal metric, we're making assumptions around 75%, 80% of that 1,400 license universe across both A and B. That's kind of an internal set of assumptions we're making relative to a number of aspects of our business planning processes. You might imagine we've got a ramp production from a revenue support standpoint to meet that kind of accelerated or expanded forecast going forward in the next 24 months, a number of other internal systems and requirements to support the business. So we've had to make certain assumptions about what it looks like. And the internal take or benchmark, if you will, is probably somewhere in that 75% to 80% kind of range. It could be higher than that. I mean, again, there is a lot of work to do to get -- once the licenses start to flow, there's still a lot of work required to get equipment in the ground from an installation and a training standpoint, but I think that our aspects or our estimates, if you will, of what's actionable or what will be actionable in the next 2 years is probably somewhere in that 75% range.

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Anthony Charles Petrone, Jefferies LLC, Research Division - Equity Analyst [9]

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That's helpful. And just on the JV structure and as it relates specifically to Type B out of the gate here you have Onrad and TomoH. You had mentioned on the last call that the second phase of the JV will really be centered around the locally manufactured product that will be focused in Type B regions. Just how is that going to work out between 2 transitions? In other words, do you think the market within Type B freezes a bit as it waits for the local product or do you expect that you will see some early traction with TomoH and Onrad?

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [10]

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I think we'll see some early traction with TomoH and Onrad. I think -- I mean the degree of pent-up demand is pretty significant. And that obviously, the bigger upside here, the bigger volume requirements are coming from smaller- and medium-sized facilities, which are facilities that are -- hospitals that are kind of outside of the major population centers in the provinces, and that's where China Isotope and Radiation Corps market presence is. They have a presence -- a sales presence in something like 30 different provinces that represent the bulk of the geography. And their active resources of their's in place, active customer relationships and we hope to leverage a lot of that, or at least -- more than our fair share, call it, in the ramp with just the products it will add in the near term. Going forward, the manufacturing facility that's going to produce our Type B product that China made Type B product that facility is already in -- they are building that facility out as we speak. So this is not something that we're -- that they're sitting on or we're sitting on waiting for licenses to issue. There is a ramp here that's required and we needed to start, quite frankly, as soon as we could following the execution of the JV agreement and we've done that. So they're moving as expeditiously as they can and we are in full support of that. We want to have a product registration package that we can get in front of CFDA as soon as possible for review and all of that should help to -- as soon as they are ready to start producing and as soon as we've got a regulatory approval process obtained, we should be in business on the Type B side with the locally manufactured product.

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Operator [11]

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Our next question comes from Brooks O'Neil with Lake Street Capital Markets.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [12]

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I hope I can sneak in a couple of quickies here. First, Josh you mentioned competitive wins. I didn't hear you say a lot about replacement cycle progress in the U.S., could you just give us a quick update on that?

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [13]

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Yes, replacement cycle in the U.S., again, it's not just a U.S. discussion, it's a U.S. and Western Europe opportunity. But again, it's been relatively stable at roughly 15% to 20% of the total gross order volume. So it's consistent with where it's been, Brooks. And again, I think that our view is that with the things that we're launching or have launched in the last quarter and the going forward quarter on the upgrade side with VOLO and soon to be Synchrony and Radixact, we think these are catalysts for replacement sale opportunity for trade and trade up of all the generation devices in both geographies, both U.S. and Western Europe.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [14]

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Perfect. That's great. Secondly, you mentioned soft tissue visualization with Synchrony. Can you just give us a feel or your perspective on how that will match up with the offerings of competitors we are hearing so much about?

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [15]

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I would characterize what we're doing on imaging from a relative capability standpoint. I would encourage you or characterize you to think of it in terms of diagnostic quality CT capability, which we think is going to provide with really terrific contrast. We think that's going to be, quite frankly, very, very competitive with any of the cone beam capability that's out there right now from competitors. Again, it will not have the contrast that MRI capability will, but Radixact will run circles around from a workflow standpoint and a throughput and efficiency standpoint. It will be able to do things from a workflow perspective and a throughput perspective that you can't do with an MRI linac. So again, I don't think a head-to-head comparison there can be made nor would I say that again we're not -- you've heard us say this in the past, we're not seeing devices of ours decommissioned to make room for MRI linacs, either the MRIdian device or the Unity device. So I don't believe that in the primary customer base that our history has where we've been the strongest historically in terms of academic or research-based medical centers. We are not in a zero-sum gain from a bunker competition standpoint without the MRI linac devices. I think when we get our imaging solutions to market, they will be very, very competitive, if not even more capable than cone beam -- KB cone beam, which is kind of -- that's kind of been the industry standard, if you will, prior to at least for the more workhorse product offerings, if you will.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [16]

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Sure. And if I could sneak in 1 last one, could you just comment on your balance sheet and any strategy you're currently contemplating with regards to, I think, remaining converts?

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Shigeyuki Hamamatsu, Accuray Incorporated - Senior VP & CFO [17]

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Yes. Brooks, thanks for the question. I think we've got 3 more years to go. I think for time being we're focusing on generating cash and trying to pay down the non-converted debt in the near term. I think we need to talk about the convert sometime soon, but that will probably also depend on stock price as well in a couple of years to see what the stock price is and how to approach the -- either -- what do we convert and in terms of refinancing that piece of it. So I would just leave that one out.

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Operator [18]

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And our next question is from Sean Lavin with BTIG.

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Marie Yoko Thibault, BTIG, LLC, Research Division - Analyst [19]

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It's Marie Thibault on for Sean Lavin tonight. I appreciate all the level of detail you've given us kind of on the China JV and the tender process. I wanted to ask just one follow-up on that. And when you said, usually it takes about 30 to 45 days for the tender process to start up, is that sort of an average? Is that -- do we see kind of a bulk of tenders be issued around that? Or do we -- could we see some kind of jump out in front and come in quicker? I'm just trying to get my hands around the likelihood of seeing anything in the -- in this current fiscal year?

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [20]

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Yes. I mean, I guess, it is possible, Marie, that there could be stuff things that come sooner, but I think as far as our view and we've kind been -- I think we've been growing in our view on this that -- we're strengthening our view on this from an internal perspective that it's just been so difficult to with any degree of precision, imagine or predict forward-looking how these processes get fully activated that it becomes -- if the tenders are -- that process isn't completed by really legitimately by the end of this month or the first week or 2 of the month of May, the window of time or the -- if the licenses aren't issued by -- in that time frame. The tender processes, we think probably less likely to occur on a time frame that would give us the chance to take revenue in this fourth quarter -- in the current quarter. So we've been -- I mean maybe we've been conservative in that. But just given what we believe -- what we've seen historically, what we believe is happening, we think that's probably the right approach, the conservative approach. I think it's interesting that the application process, we had heard a lot about the application process and the Ministry of Health has developed -- what's been happening behind the scenes is they've been developing an online application process to assist the thousands of institutions that have an active application that they want to submit and have in the active queue for the tender process that's forthcoming. And that online -- the build-out of that online infrastructure, the validation of it, our understanding from our people on the ground there is that's what's taken the added time here. So again, we just think it probably makes the most sense to be more reserved in our outlook with regards to the timing of that and how that translates into the timing of revenue recognition for us. I think what it says to me is that the first quarter of fiscal '20 and the first half of fiscal '20 are going to be big ramps in terms of revenue.

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Marie Yoko Thibault, BTIG, LLC, Research Division - Analyst [21]

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Okay. I appreciate that info, Josh. And I guess, my second question I'd like to turn back kind of the domestic market. I know that a few quarters back there was a lot of focus on the potential for multisystem orders. Were there any multisystem orders in the quarter? Or what sort of that funnel look like to you at this point?

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [22]

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There was nothing of note in the quarter that we're reporting today, but I will tell you that there are in the funnel going forward a number of multisystem orders that we've been progressing or advancing over the course of the last few quarters. And I think some of them could hit this quarter, some of them are likely, if they're not this quarter, then there are in probably the first half of fiscal '20. And so, again, I think that they've made -- that the U.S. team has made pretty good progress in teeing those up and advancing them, but again nothing to report or to forecast definitively in the current quarter that we're reporting.

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Operator [23]

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And our last question is from Tycho Peterson with JPMorgan.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [24]

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Josh, I'm going to start with reimbursement. CMS, obviously, lead kind of the bundling, they didn't put the rates out but we know it's coming. Just curious what you're hearing in the field from customers? Obviously, it didn't seem like it impacted the order book, but as we think about bundling going forward, how do you think the response will be from the customer base?

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [25]

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Yes. It's good to hear from you, Tycho. So if CMS sticks to historical timing, we would expect to hear something in probably in the month of July. I mean they've been -- if you go back to last 5 or 6 years, they've been as early as July fourth weekend, sometime -- a couple of years they've been later. But July would probably be a good expectation if they stay to historical precedent. The general, I'd say set of assumptions from everybody close to this is that it will be -- the final rule will capture some kind of alternative payment model, something around value-based care, something that would be really encouraging more at least in specific radiotherapy terms, things that would move customers and hospitals essentially more to a hypofractionated or SBRT kind of a treatment model and away from the -- what I'll call the fraction preservationist kind of approach, which has been the IMR team model or the 3 conformer model of kind of long-standing history. So you're talking about for the patient, you're talking about faster -- shorter treatment regimens for sure and for payers you're talking about a more accelerated time line and one that is probably more cost efficient in construct than what's been in place over a long period of time. We think we're positioned and you've heard us say this in the past, we think we're positioned pretty strongly with our portfolio. We think on both platforms, we really have solutions technically and treatment-wise that fit that model going forward. So -- but again, nothing definitive as of now. If a final rule comes out on typical time lines from CMS, it will probably be some time this summer.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [26]

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Okay. And then on the software side, I think you guys announced during the quarter you had your first treatment partnering up with RayStation with RaySearch. I'm just curious if you can you talk about how that relationship has evolved? And should we see kind of more joint sales with RayStation going forward on the Anderson deal?

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [27]

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Yes. I think we will. We have -- our view is that they are becoming -- when you look at where their installation is taking place, the growth in their installed base, they continue to be the fastest-growing stand-alone treatment system provider in the market. They have become -- at the academic level or research-based medical center level, they've become in many locations kind of the system of choice across a wide variety of equipment. So they plan for multiple devices, multiple types of products and they've made it easier for customers to say anything that falls outside of our ability to plan on RayStation really is kind of an outlier situation for us that we'd rather not deal with. So we think strategically it still makes a lot of sense for us to be working with them. They help expand and leverage our reach and they help position us in a way that is we can avoid being the outlier quite frankly, i.e., the one product line on the system side that has to have its own workstation for treatment planning purposes outside of RayStation, which they have that's planning for everything else they own. So it just makes a lot of sense strategically. We've got, I think, the right mindset and incentives in place between the organizations at the field level to encourage joint selling activity and joint account targeting. And so I still think what we're doing there from the outset strategically it still makes sense, and I would predict that it will have a bigger impact going forward.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [28]

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Okay. And then last one. I appreciate all the color on China. As we think about China Isotope kind of ramping up on their locally made device, should we assume this as accretive to margins? Or how should we think about the margin impact?

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Shigeyuki Hamamatsu, Accuray Incorporated - Senior VP & CFO [29]

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Yes. Thanks for the question, Tycho. We do think it should help our margin. We certainly have negotiated pretty good the transfer price with the joint venture from our perspective. So we do expect that to be gross margin accretive.

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [30]

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I also think that on that topic we'll get better efficiency over time from them. I think that the supply chain opportunities over time will be a bigger impact than they certainly are at the outset. We will be the supply chain source for them with parts and key componentry out of Madison, out of our manufacturing facility in Madison, at least to begin with. But there is already thoughts and conversations taking place between the 2 organizations, Tycho, around forward-looking thoughts and how we leverage that up in ways that can help both organizations. So I think that it should be -- that should be another impact -- a positive impact for margin over time or reduction in COGS.

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Operator [31]

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And our next question is from Philip Coover with Citi.

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Philip Caldwell Coover, Citigroup Inc, Research Division - Research analyst [32]

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I was hoping on the heels of CT imaging kind of coming to market. Can you provide an update on your thoughts on adaptive therapy, maybe timing or your outlook for the same product on that front?

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [33]

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So again, we're probably in the 18-month time line on imaging, commercialization, Phil, and so that's got to be -- that's clearly the primary gating item on this. From an adaptive therapy standpoint, I mean, I think that our ability to -- and the work we've done to improve treatment planning speed with VOLO improve optimization around plan comparisons, all of these things should assist pretty substantially in making adaptive -- truly adaptive therapy a reality and a more efficient process than it is today. And so I think the view is that the only way adaptive therapy takes place is of an MRI linac. I think those are -- those views are -- I would describe them as constrained.

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Philip Caldwell Coover, Citigroup Inc, Research Division - Research analyst [34]

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Sure. Okay. All right. That was helpful context and [expanding] question, but I appreciate it. A bit more technical second one, if I could. A little bit of the age-in age-out dynamic. Can you talk about how China is sort of impacting that? And any impact to the timing on cancellations at this point, maybe a question for Shig there?

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Shigeyuki Hamamatsu, Accuray Incorporated - Senior VP & CFO [35]

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Yes, Phil. So the age-out, as I said in my prepared remarks, for the quarter was totaled $21 million and 30% of that was China, just to kind of give you a sense. The -- so China continue to have some age-out, but as I said also in my remarks, that we will continue to work on those. Those are still good orders, as you know. It's just more than 30 months old before the policy gets phased out. But again, we are going to continue to work on those to convert them into revenue starting in FY '20. And then none of the cancellation was from China, by the way.

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Philip Caldwell Coover, Citigroup Inc, Research Division - Research analyst [36]

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Okay. None of the cancellations from China. And as we age back in, are we going to see sort of like a book-to-bill conversion where we age back and then convert to revenue in the same corner on the China front? Or is there going to be some [lead time]?

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Shigeyuki Hamamatsu, Accuray Incorporated - Senior VP & CFO [37]

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Yes, exactly. Mechanically speaking, you are right. I mean, when something age backs in just like we did in this quarter we had a couple of deals there. And it goes back to backlog, but it comes out immediately, because it's almost book-and-bill in the quarter mathematically speaking.

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Operator [38]

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And I'm not showing any further questions in the queue. I would like to turn the call to Josh Levine for any final remarks.

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Joshua H. Levine, Accuray Incorporated - President, CEO & Director [39]

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Thanks, operator, and thank you, everyone, for your participation this afternoon. We look forward to talking to you on our Q4 and full year update. Thanks very much.

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Operator [40]

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And with that, ladies and gentlemen, we thank you for participating in today's conference. This concludes the program. You may all disconnect. Have a wonderful day.