Earnings Call Transcript - ARAY Q2 2022

Operator, Operator

Good afternoon and welcome to the Accuray Second Quarter Fiscal 2022 Financial Results Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Ken Mobeck, Vice President of Finance. Please go ahead.

Ken Mobeck, Vice President of Finance

Thank you, Gary, and good afternoon, everyone. Welcome to Accuray's conference call to review financial results for the second quarter of fiscal year 2022, which ended December 31, 2021. During our call this afternoon, management will review recent corporate developments. Joining us on today's call are Josh Levine, Accuray's Chief Executive Officer; Suzanne Winter, Accuray's President; and Brandy Green, Accuray's Interim Chief Financial Officer. Before we begin, I would like to remind you that our call today includes forward-looking statements. Actual results may differ materially from those contemplated or implied by these forward-looking statements. Factors that could cause these results to differ materially are set forth in the press release we issued just after the market closed this afternoon as well as in our filings with the Securities and Exchange Commission. 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 as a result of new information or future events, except to the extent required by applicable securities law. Accordingly, you should not put undue reliance on any forward-looking statements. A few housekeeping items for today's call. First, during the Q&A session, we request that participants limit themselves to two questions and then requeue with any follow-ups. Second, all references we make to a specific quarter in the prepared remarks are to our fiscal year quarters. For example, statements regarding our second quarter refer to our fiscal second quarter ended December 31, 2021. Additionally, there will be a supplemental slide deck to accompany this call, which can be accessed by going directly to Accuray's investor page. With that, let me turn the call over to Accuray's Chief Executive Officer, Josh Levine. Josh?

Joshua Levine, CEO

Thanks, Ken, and thanks to everyone joining us on today's call. I'm joined today by Suzanne Winter, our President; and Brandy Green, our interim CFO. Accuray's fiscal 2022 second quarter performance continues to reflect the strong revenue momentum our business is generating but also highlighted the operational headwinds and associated costs created by the COVID environment. Driving our accelerated revenue growth is the continued adoption of our new technology upgrades on the Radixact platform, which are having a positive impact across all regions. Revenue in fiscal Q2 was $116.3 million, which represented a 19.3% year-over-year growth. Gross order volume for the quarter was $85.4 million, which represented a 13.3% year-over-year growth. Suzanne will provide more specifics regarding the regional performance details during her prepared remarks. On the operational end of our business, like many companies across a broad range of industries, in Q2, we saw increasing pressures related to global supply chain headwinds and logistics constraints, and collectively, these challenges had a negative impact on cost inputs to our income statement. Despite these impacts, our sourcing and production teams successfully mitigated many risks in these areas that allowed us to overachieve our production forecasts, which resulted in product revenue growth for the quarter of 45% over prior year. Following our guiding principle of prioritizing patient continuity of care above all else, we also executed successfully in support of our commitments to maintaining availability and delivery of critical service parts for our installed base customers to ensure device uptime and patient treatment continuity. Brandy will be providing greater detail in her prepared remarks about the collective impact of service margins for the quarter, which is where these impacts were most strongly felt. While service margins were impacted, the overall support and cross-functional teamwork that took place in the quarter was extraordinary, and I'm extremely proud of our team and what they accomplished. We believe Q3 and Q4 will remain challenging in terms of the intensity of parts shortages and we will continue to see pressure on our service margins. With that said, our teams are working cross-functionally to preserve production capacity and identify and mitigate risks to stay ahead of supply gaps that could impact production. At present, we are maintaining line of sight to fulfill our latest revenue forecast requirements. We will continue to prioritize and focus on our installed base customer needs to ensure that we have service parts at the necessary stocking levels and in the right locations globally, to maintain existing devices and minimize the risk of treatment disruption for patients. Now I'll turn the call over to Suzanne Winter for more details on commercial highlights during the quarter.

Suzanne Winter, President

Thank you, Josh. Despite the macroeconomic challenges, we have seen very strong demand within the quarter and are very pleased with our topline performance for the quarter and the first half. It represents our fifth consecutive quarter of delivering above expectations in both orders and revenue. These results demonstrate the strength of customer demand for both CyberKnife S7 and Radixact TomoTherapy platforms and the growing recognition by customers that our new product innovations provide a new standard of accuracy and precision needed for the growing trend of SBRT treatments. The growing use of ultra hypofractionated treatments deliver a higher dose of radiotherapy over only one to five treatment sessions, representing a paradigm change offering significant benefits for patients, providers, and healthcare costs. Delivering SBRT treatments can vary substantially across all commercially available linac platforms. Any error in the precision or accuracy of the treatment plan or delivery can have a significant impact on long-term patient outcomes and quality of life especially given the higher dose over fewer fraction treatment paradigm. Our customers are telling us that ClearRT and Synchrony on Radixact and our latest product introduction VOLO Ultra treatment planning are becoming the standard of care and a critical requirement to deliver the highest quality assurance standards required for SRS and SBRT treatment planning and delivery. These new product introductions are driving our win rates, strengthening our average selling price, and accelerating installations. In our developed markets, where it is largely a replacement market, we have been successful in unseating the incumbent linac manufacturers' installed base with approximately 25% of our global system orders replacing a competitive system. We’ve also been strategically focused on ensuring that we secure our own installed base and upgrade them to our latest performance platforms. In Q2, 56% of orders in developed markets represented a trade in and trade up to our latest CyberKnife S7 or Radixact performance platform. In the emerging markets where radiation therapy is under-penetrated, the majority of system orders were sold to new customers, allowing us to further our vision of expanding patient access to advanced radiotherapy care where it was previously unavailable. Looking at our regional performance, we had balanced execution across our four regions with standout performance in the Americas region, which delivered the highest quarterly revenue for that region in our company's history. The Americas region finishes the first half with 27% year-over-year order growth. Orders in the Americas region were split evenly between CyberKnife S7 and Radixact TomoTherapy platforms. Additionally, 100% of Radixact orders included ClearRT and Synchrony capabilities in the configuration. In Japan, we continued strong order performance with 23% year-over-year growth in Q2. Japan's installed base grew by 5.6% in Q2 and has achieved the number two market share position. 40% of Q2 orders in Japan were a replacement of a competitive linac system, demonstrating that ClearRT, Synchrony, and VOLO Ultra are creating a compelling value proposition for providers to switch manufacturers. The EIMEA region is our largest order region and in Q2 delivered 3% growth with strong emphasis on backlog revenue conversion growing revenue 47% for the quarter. Finally, our APAC region posted solid results with China driving 83% Q2 year-over-year growth in orders and finishing the first half with 107% year-over-year growth in orders and 71% year-over-year revenue growth. At the ASTRO Meeting, we successfully introduced VOLO Ultra treatment planning for the Radixact system. Since its introduction, we've received 510(k) and CE Mark clearance and 115 new orders for VOLO Ultra in Q2 and completed the first two global installations. Reception of ClearRT at ASTRO was excellent and during the quarter, we added 21 new orders for ClearRT, bringing our total orders to 68 from only one year ago and we received 510(k) clearance. Additionally, we showcased our online adaptive capability as it works in progress on the Radixact in conjunction with RaySearch, as well as the integration of RayStation with CyberKnife. Our innovation strategy is strengthened by our commitment to best-in-class solutions through strategic partnerships. In summary, we are very pleased with the strong first half topline performance; we are executing our vision of expanding the curative power of radiation therapy to improve patient outcomes and quality of life through investment in R&D and continued cadence of meaningful innovation and new product introductions that will allow us to play offense, gain share, and strengthen the value of our solutions. Now, I'd like to turn the call over to Brandy for her review of the financial details.

Brandy Green, Interim Chief Financial Officer

Thank you, Suzanne, and good afternoon everyone. Accuray has delivered another strong quarter while navigating notable supply chain and logistics challenges. We are pleased with our ability to scale the company in this demanding environment. First, orders for the second quarter were $85.4 million, an increase of $10 million or 13% over the prior year period from strong innovation-driven order momentum. Looking ahead to the second half of this fiscal year, we anticipate smaller year-over-year gross orders expansion. From a product mix perspective, the total TomoTherapy platform accounted for approximately 66% of gross orders for the quarter, and CyberKnife accounted for the remaining 34%. During the second quarter, we had approximately $4 million of net cancellations and we ended our second quarter with a backlog of $581.3 million, a decrease of 3% from December 31, 2020, driven by increased order to revenue conversions. Now, turning to the income statement. The total revenue for the second quarter was $116.3 million, representing a 19% increase over the prior year. The Americas and EMEA were the primary drivers of our revenue growth. For the first half of fiscal 2022, revenue was $223.7 million, up 22% over the prior year, representing strong customer demand. Product revenue for the quarter was $60.7 million, an increase of 45% compared to the prior year. From a product mix perspective, CyberKnife accounted for approximately 21% of the revenue unit volume in the quarter, while the TomoTherapy platform accounted for the remaining 79%. As a reminder, the mix between CyberKnife and TomoTherapy varies from quarter to quarter. Historically, on an annual basis, our product revenue mix has remained at approximately 30% CyberKnife and 70% TomoTherapy for the past several fiscal years. Service revenue for the quarter was $55.6 million, flat compared to the prior year. Now, turning to gross margin. Overall gross margin for the second quarter was 36.7% compared to 41.9% in the prior year. Product gross margin for the quarter was 41.5% compared to 44.7% in the prior year. During the quarter, for our JV accounting requirements, we recognized deferred product gross margin on one system sold from a prior quarter to our China joint venture that has now been transacted through to the end customer. We have two remaining systems deferred from prior quarters that we expect will transact through the end customers in quarter three. Including the timing difference on these two deferred systems, our product gross margin for the quarter would have been 44.2%. Service gross margin for the quarter was 31.4% compared to 39.8% in the prior year. Supply chain constraints discussed earlier have resulted in parts shortages and elevated costs within freight, logistics, and service parts of $3.7 million compared to the prior year and continues to be a big headwind. Additionally, parts consumption and operational costs were higher than planned, primarily related to increased system installations and related travel associated with topline product growth. Excluding the impact of these supply chain additional costs, we estimate that our service gross margin for the second quarter would have been approximately 38%. Moving down the income statement, operating expenses for the quarter were $38.6 million, an increase of $6 million or 18% from the prior year. The year-over-year increase in operating expenses was primarily related to travel, marketing events, and compensation costs from certain cash preservation actions taken in response to the pandemic. In addition, topline revenue resulted in increased commission costs for the period. Operating income for the quarter was $4 million compared to $8.2 million in the prior year. The operating impact of the China JV for the quarter was a loss of $0.8 million reported in our income statement as a single line item called gain loss on equity investments, right below our operating income line. As our China joint venture continues to ramp its operational commercial activities, we expect that our share of the China JV's quarterly income or loss will continue to fluctuate in the near-term. Adjusted EBITDA for the quarter was $6.8 million, up $1.4 million sequentially and compares to $13.5 million in the prior year period. The reconciliation between GAAP net income and adjusted EBITDA is described in our earnings release issued today. Turning to the balance sheet, total cash, cash equivalents, and short-term restricted cash amounted to $123 million, up $80 million from strong collections compared to $105 million at the end of last quarter. Net accounts receivable was $82 million, down $8 million sequentially and up $70 million from the same period last year, due to 19% revenue growth. Our net inventory balance was $124 million, down $3 million sequentially and $50 million from Q2 of last year, due to an increase in inventory turns and product demand. With strong cash generation from improved balance sheet metrics, we paid $16 million on our term loan and made revolver during the quarter. With that, I'd like to hand the call back to Josh for an update on our fiscal 2022 financial outlook.

Joshua Levine, CEO

Thank you, Brandy. While we continue to see strong customer demand for our products and we believe we will continue to grow in excess of our addressable market rates for the global radiotherapy equipment and treatment planning market, given the imperfect visibility in terms of the current supply chain and logistics environment, we will be revising our full year of financial guidance. Total revenue is being increased to an expected range of $420 million to $430 million compared to the prior range of $420 million to $427 million, which represents year-over-year growth at the midpoint of the range of 7% and reflects strong customer demand for our products. Adjusted EBITDA is now expected to range between $15 million to $20 million compared to the prior range of $33 million to $35 million. Near-term supply chain outcomes could impact the revenue and/or EBITDA range estimates to the upside or downside. And with that, operator, we're ready to open the line for questions.

Operator, Operator

We will now begin the question-and-answer session. Our first question comes from Michael Cox with Lake Street Capital Markets. Please go ahead.

Michael Cox, Analyst

Good evening. This is Michael Cox filling in for Brooks O'Neil. Congrats on the quarter. Can you provide some details regarding the go-to-market strategy of the China Type B product with its market introduction scheduled for summer 2022? Are you still on track with that deadline?

Suzanne Winter, President

Thanks for the question. Yes, we continue to be on track with a market introduction starting in August at the China show and going through the fall. While we have seen COVID lockdowns in China, and we continue to do our testing prior to submission for regulatory, we are on track for our introduction to the market. We remain very optimistic about our ability to win market share in the Type B segment, which is growing, and of course, the largest part of the China market when we introduce that jointly developed product.

Michael Cox, Analyst

Okay, that's very helpful. Can you touch upon more with the supply chain? What have you been able to do to resolve it? How long do you think that this issue will persist? And are you also impacted by the tight labor market, in any way, or are the hospitals or outpatient centers being impacted in any way by this worker shortage?

Joshua Levine, CEO

I'll take the second part of that question first. The COVID environment right now continues to be variable site-by-site or region-to-region. The Omicron variant has created some labor tightening and labor shortages in hospitals, but we have not seen any significant headwind here related to access to institutions or our ability to get equipment installed on customer timing requirements. We're monitoring the situation closely, but I'd say on balance, we're still feeling pretty good about access to facilities and maintaining reasonably tight time schedules for equipment installations. Regarding your first question around supply chain, every company in our space is dealing with the same macroeconomic impacts. Our sourcing and manufacturing teams are proactively managing supply gaps. We overachieved the build plan for the quarter and our revenue plan. For Q3 and Q4, we believe that the intensity of parts shortages will continue to be a factor, but we are looking to preserve production capacity and we are identifying and mitigating risks to stay ahead of shortages. We're tightening interactions with suppliers and looking for hard purchase order coverage on all critical parts, stretching those out to 12 months whenever we can. Lastly, we’re early identifying parts and critical components where we anticipate shortages and escalating those early in order to mitigate risks. Those are the primary levers we are operating to. We've got a heavy bias towards fulfilling and taking care of installed base customers, ensuring service parts are available and being delivered while managing costs tightly without impacting customers.

Michael Cox, Analyst

Got it. Thank you very much. Congrats on the quarter.

Operator, Operator

The next question is from Marie Thibault with BTIG. Please go ahead.

Marie Thibault, Analyst

Hi, thank you for taking the questions and congrats on a really strong revenue and order books this quarter. I wanted to ask a follow-up on the supply chain and the macro headwinds, which have certainly been a concern for a while. It sounded like the team was working very hard, but everything remained on track. Just curious what sort of change occurred in the last couple of months? Did it contribute to the record revenue and very strong order book? Are there things outside of these supply chain costs that you can do to offset some of the headwinds? Thanks.

Joshua Levine, CEO

Yes, Marie. To your point, we had a strong quarter from a revenue standpoint. Shipments typically aren't linear throughout the quarter; we typically see more heavily weighted shipments towards the latter part of the quarter. We saw an increase in supply chain shortages as we got deeper into Q2. In December, the level and rate of shortages accelerated. We're doing a lot to get ahead of these challenges and have line visibility to close gaps. We expect to see strain on the supply chain side probably through the end of this fiscal year, Q3, and Q4. Nevertheless, we aim to maintain the ability to fulfill our latest revenue forecast requirements.

Marie Thibault, Analyst

That’s all understood, Josh. I certainly respect the challenges your team's working through. My follow-up is about the revenue guidance increase. It’s nice to see it go upward, but you beat expectations by more than $10 million this quarter. Curious how you're thinking about revenue cadence and if there’s any conservatism built in for COVID or other headwinds?

Suzanne Winter, President

You're right; the demand has been very strong in the first half. It was likely front-loaded in terms of the momentum we are seeing. We are being cautious given the uncertainty of supply chain challenges in the back half of the year. Demand is strong, though, and we have a sizable backlog with installation readiness. That’s why we raised guidance on the high end, but we have a wider range due to the uncertainty around supply chain. Assuming we can navigate as we have in the first two quarters, we'll be at the higher end of that range.

Marie Thibault, Analyst

Thank you, Suzanne.

Operator, Operator

The next question is from Josh Jennings with Cowen. Please go ahead.

Josh Jennings, Analyst

Hi, good afternoon. Thanks for taking my questions. The new order growth pace in the first half of fiscal 2022 significantly outpaced the market rate and seemingly gained share. Can you speak on the sustainability of the share gain trajectory? Also, are new technology launches like ClearRT, Synchrony, and VOLO helping the order growth results and witnessing any average selling price lift as well? Finally, are you seeing any benefits from the Varian and Siemens merger disruption?

Suzanne Winter, President

Yes. The new product innovation is driving our win rates and order momentum. We are also seeing a price lift on those products that include the latest innovations like ClearRT, Synchrony, and VOLO Ultra. We expect that as we continue to innovate across both platforms, we will see price gains on configurations. It reinforces our strategy of increasing our spend in R&D and meaningful product innovation to differentiate our technology from competitors. Regarding the Siemens-Varian merger, we haven't seen a big change since previous earnings calls. We believe the merger benefits the Siemens DI business more than pulling business towards Varian. However, their platform primarily relies on conventional linear accelerator technology; as the trend shifts towards SBRT and the need for enhanced imaging, better motion tracking, and adaptive delivery, we believe they will face challenges. This presents an opportunity for Accuray technology, positioning us well to gain share.

Operator, Operator

The next question is from Frank Pinal with Jefferies. Please go ahead.

Frank Pinal, Analyst

Hello, can you hear me?

Operator, Operator

Yes, Frank, you're on.

Frank Pinal, Analyst

Great. Sorry about that, guys. First, congrats on a really nice quarter. Strong beat on the top line. I'm just wondering, on the CMS RO bundle, I know it’s early in implementation, but I'm wondering what you're seeing at this point. Are reimbursements in line with expectations? Or do you expect any ASP pressures based on that?

Suzanne Winter, President

Thanks for the question, Frank. We're disappointed at the further delays in implementation, which got wrapped into some infrastructure initiatives in December. However, this delay may provide additional breathing room for providers to prepare for the changes. The key trends remain the same; there’s an emphasis on value and outcomes over volume, regardless of the CMS decision timing. Other drivers in the marketplace, such as commercial private payers, have already shifted toward reimbursement favoring hypofractionation. Additionally, the aged equipment of the installed base in the U.S. and the need to upgrade to newer technology for ultra hypofractionated treatments is a growth catalyst. We’re well-positioned to capitalize on these trends and are working closely with ASTRO to ensure the reimbursement rollout optimally supports SBRT.

Frank Pinal, Analyst

Great. Thank you. Just one last question here on essential tremor and epilepsy. You touched on that during Analyst Day. That's a potentially expansive market. I'm wondering if you've put any brackets around the potential market size entry and milestones at this point?

Suzanne Winter, President

We have not established that yet, but we will formally introduce our partnership with Brainlab at the Radiosurgery Society Meeting in March. That will be the first time that we present our combined treatment planning capabilities more familiar to neurosurgeons. As we progress, we will have more information about the market potential in those areas.

Frank Pinal, Analyst

Great. Thank you very much.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Josh Levine for any closing remarks.

Joshua Levine, CEO

Thank you, operator. I'd like to thank the entire Accuray team for their continued focus and commitment to great commercial and operational execution in the face of the challenging environment we find ourselves in. Despite the headwinds we highlighted this afternoon, the clinical impact related to our most recent product innovations have resulted in vastly improved strategic positioning for our technology, and customer demand, as you heard from Suzanne, remains very high. While we're not pleased with the impacts on margins and profitability currently, we believe we are taking the right actions to strengthen our internal processes, making Accuray a stronger company through these supply chain challenges, which will drive positive cost productivity improvements over time. We look forward to speaking with you all again in April for our fiscal third quarter earnings release. Thank you very much.

Operator, Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.