Earnings Call Transcript - ARAY Q1 2023

Operator, Operator

Good afternoon, and welcome to the Accuray First Quarter 2023 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, Accuray, Vice President, Finance. Please go ahead.

Ken Mobeck, Vice President, Finance

Thank you, operator, and good afternoon, everyone. Welcome to Accuray’s conference call to review financial results for the first quarter of fiscal year 2023, which ended September 30, 2022. During our call this afternoon, management will review recent corporate developments. Joining us on today’s call are Suzanne Winter, Accuray’s President and Chief Executive Officer; and Ali Pervaiz, Accuray’s 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 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 re-queue 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 first quarter refer to our fiscal first quarter ended September 30, 2022. Additionally, there will be a supplemental slide deck to accompany this call, which can be accessed by going directly to Accuray’s Investor page at investors.accuray.com. With that, let me turn the call over to Accuray’s Chief Executive Officer, Suzanne Winter. Suzanne.

Suzanne Winter, CEO

Thank you, Ken. Good afternoon, and thank you for joining the call. I’m proud of how the Accuray team delivered a solid first quarter of the fiscal year despite the challenging macroeconomic operating environment, and as such, we are reiterating fiscal year guidance on revenue and EBITDA. I will start this afternoon with a reminder of the long-term plan we laid out at the end of fiscal 2022, focused on growing our business faster than the market by delivering differentiated solutions to improve care and outcomes for all stakeholders, growing and improving our service business offering, and finally enhancing margins and cash flow. In fiscal Q1, we have made significant progress in advancing that growth strategy. In the quarter, we introduced new innovative solutions from our investments in R&D, and we continue to execute on our commitment to delivering a robust product pipeline of differentiated solutions, which will deliver revenue, share growth, and shareholder value over the next several years. While we are early in the execution of our plan, we are already starting to see the impact. We recently attended the ASTRO Show in San Antonio, Texas, where it was wonderful to see the radiation oncology community getting nearly back to pre-COVID level attendance and evaluating new technology. At the show, we launched VitalHold, an integrated, automated surface guided radiotherapy solution for breast cancer patients on the Radixact system. This development is part of our partnership with C-RAD. VitalHold, in addition to Synchrony adaptive delivery and ClearRT helical and Ultra High Quality Imaging, provides Radixact customers with the most comprehensive tools to treat breast cancer. This is important because one in eight women will be diagnosed with breast cancer in their lifetime, and as a result, breast cancer represents one of the highest procedure volumes in a typical radiation therapy department. Additionally, at ASTRO, we demonstrated our newest innovation, ARTemis, the online adaptive capability in partnership with RaySearch, a leader in treatment planning and OIS systems. ARTemis uses Radixact ClearRT helical CT images with RaySearch’s AI-powered algorithms to adapt the treatment plan to changes in the patient’s condition that can occur between treatment appointments. ARTemis, in combination with Accuray’s proprietary Synchrony Technology that corrects for changes during treatment delivery, represents a powerful competitive advantage for Accuray and will be a critical tool for the delivery of shorter regimen treatments to deliver a treatment dose over five or fewer fractions. As we execute our growth strategy, we have placed a high priority on key industry partnerships, such as C-RAD, RaySearch, Brain Lab, Limbus AI, all of which have substantially broadened our markets and enabled us to provide best-in-class solutions to key medical centers globally. Earlier this month, we announced a new global commercial partnership with GE Healthcare. GE Healthcare, a global innovation leader with a strategic focus on personalized oncology solutions, chose Accuray because of its strong brand and leadership in Precision Radiotherapy. The agreement will allow both companies to advance personalized cancer care and offer solutions throughout the care pathway from precision diagnostics, precision treatment delivery, and planning to precision monitoring post-treatment. Our joint goal is to leverage the expertise, commercial footprint, and best-in-class technologies of both companies to advance care, expand global reach, and reduce the time between cancer detection and treatment. At ASTRO, we held a clinical session for analysts and investors where key U.S. opinion leaders discussed innovation and the future of radiotherapy. At the session, we announced support for clinical evidence generation that will help in three significant ways: One, driving the adoption of SBRT and SRS into clinical practice. Two, demonstrating the impact of Accuray technology, and finally generating clinical data to assist with reimbursement. Key opinion leaders discussed plans for a clinical registry using Accuray technology in prostate cancer, breast cancer, and in neuro-functional care. For the quarter, we delivered $96.5 million in revenue, driven by strong demand in Japan and EIMEA. Revenue for the quarter reflected a 10.5% increase in units year-over-year. We were unable to recognize three planned shipments due to delivery delays of critical sub-components from a few suppliers. While supply chain conditions have generally improved, we continue to navigate and actively support a few key suppliers. However, our teams understand the issues and are proactively addressing short, mid, and long-term solutions until conditions improve. Additionally, as expected, China revenue was a headwind, down 55% year-over-year, primarily due to the impact of their zero COVID policy. Despite the macro headwinds, underlying customer demand is strong. This is evidenced by improving demand trends we see in orders. We booked 32 new system orders for Radixact and the CyberKnife S7 driven by the Americas and APAC regions. Reported orders growth overall was flat but grew approximately 6.5% once adjusted for FX compared to the extraordinary quarter last year, which grew approximately 38% due to pent-up demand following COVID. We continue to be encouraged by the commercial traction of new innovations like ClearRT, Synchrony, and VOLO Ultra, which are driving our trade-in, trade-up win rates and capturing competitive bunkers. Approximately 22% of our system orders came from displacing competitive systems. Despite the impact on revenue in China due to their COVID lockdown, we are encouraged to see signs of improved performance within the China market. The China region orders grew 33% year-over-year, lifted by wins with our current product in the Type B segment. In the Type A segment, we were pleased to see the reactivation of the Type A bidding after a long delay. Customers that were holding Type A licenses in the second round of bidding have successfully initiated their bidding processes, allowing them to begin installation planning for 18 Accuray Systems, which we expect to see delivered over the first three quarters of calendar year 2023. Finally, I’m pleased with the significant progress our regulatory and operations teams have made to advance our JV Type B product for market clearance. I’m pleased to announce that all product testing has been completed and our NMPA regulatory submission has been received by the agency one month ahead of expectations and is formally in process for review. Our JV partners are initiating targeted market introductions with a full launch beginning in the spring of calendar year 2023. We continue to make progress on our service growth agenda. This will be a transformational journey for our service business over the next several years and we are already beginning to see improvements in service margins and expect to announce new service and support solutions in the second half of 2023. Finally, our margin and profitability expansion plan have been activated. We have identified three pillars for our focus. First, pricing discipline to capture higher value for our innovation. Second, reducing our product and service costs, and lastly, optimizing our operating expenses. Ali will speak more about our margin of profitability execution plan. Overall, I’m pleased with the performance of our teams this quarter, and I will now turn it over to Ali to discuss the financial.

Ali Pervaiz, CFO

Thank you, Suzanne, and good afternoon, everyone. I would like to start by thanking our global cross-functional team who executed with dedication to deliver a solid first quarter of fiscal 2023 despite ongoing challenges including supply chain shortages, the COVID-19 lockdown in China, the war in Ukraine, global inflationary pressure, and FX headwinds in our non-U.S. markets. Total revenue for the first quarter was $96.5 million, which was down 10% compared to the prior fiscal year, mainly driven by supply chain constraints and a $5.8 million foreign exchange headwind on a constant currency basis. Product revenue for the first quarter was $44.6 million, which was down 15.4% from the prior year and down 11.4% once adjusted for the impact of FX compared to tough comparisons in Q1 last year when product revenue grew 69% due to pent-up demand after COVID delays. We were unable to ship three planned units in the quarter representing approximately $6 million due to last-minute shortages for critical components, but we were able to fulfill our customers' demand in early October. Service revenue for the quarter was $51.9 million, which was down 5% from the prior year but up 1.7% once adjusted for the impact of FX, which had a $3.7 million impact. Growth orders for the first quarter were $69.8 million, which was flat from the prior year and up 6.5% or $4.7 million once adjusted for the impact of FX. As discussed in our prior earnings call, our book-to-bill ratio, which is defined as gross orders divided by product revenue, was 1.6 in the first quarter, which is at a healthy level compared to the industry standard of 1.2 to 1.3. We are making excellent progress and our teams continue to focus on booking orders that are expected to convert to revenue in a more time-efficient manner prior to 30 months. Moving to backlog. As a reminder, we report product order backlog, which is 30 months or younger. We ended the first quarter with backlog of approximately $538 million, which is 10.7% lower than the prior year due to $51 million of order backlogs that are aged beyond 30 months within this quarter, mainly driven by customer installation delays. We had minimal cancellations with only one unit canceled at $1.5 million and $3.5 million of FX and other adjustments. Our global commercial teams are focused on converting all orders, regardless of time in the backlog, to revenue. In Q1, this resulted in $5.9 million of orders converting to revenue within the quarter that had aged out previously. Our overall growth margin for the quarter was 35.9% compared to 36.8% in the prior year, which is a decrease of 90 basis points driven by unfavorable product mix, continued product cost inflation, and service FX impact, which was partially offset by improved service margins with signals that our pricing and cost discipline actions are taking shape in the service business. Operating expenses for the quarter were $36.8 million compared to $37.1 million in the prior year, showing good cost control as we continue to push our team to drive cost discipline and focus on return on investment. Operating income for the quarter was minus $2.2 million compared to $2.4 million from the prior year. Adjusted EBITDA for the quarter was $1.9 million compared to $5.4 million in the prior year, primarily due to lower revenue, which had an impact of $5.8 million on the top line and higher than expected FX impact, particularly in Japan and EMEA. 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 $81 million compared to $88.7 million at the end of last quarter. Net accounts receivable were $77 million, down $17 million from last quarter as we had strong collections performance. Our net inventory balance was $153 million, up $26 million from the prior year, as we have built up our inventory to navigate through the ongoing supply chain challenges to fulfill our customer demand while ensuring healthy service stock levels. As Suzanne mentioned earlier, we have activated our margin expansion plans that are focused on three critical areas. The first area is pricing discipline to capture the right value for our innovations. We have aligned our commercial teams’ incentive plans to focus on capturing value and margin on incoming orders and provided them with the tools to ensure the right profitability levels. In the service organization, we are adjusting pricing and service contracts that are up for renewal and working on enhanced offerings to accommodate the needs of our customers, specifically in the areas of training and installation. The second area is to focus on reducing our overall product costs. Our sourcing organization is working with key suppliers to drive productivity on high-cost parts, and our engineering teams are engaged in cost-down projects alongside our joint venture partner. Additionally, the teams are focused on lowering our overall inbound and outbound logistics costs. We believe the reduced costs from these focus projects will also improve service margins in the coming quarters. Lastly, we are optimizing our operating expenses by ensuring we are getting the right return on the investments made in the business and revisiting all our direct and indirect spending to identify key areas of opportunity. We are confident that taking these actions will get us back on track to pre-COVID market levels. It is important to note that we recently amended our credit facility for Q2 and the remainder of FY 2023 to provide more flexibility as we position ourselves for accelerated growth and investment while considering the headwinds of the current supply chain and foreign exchange environment. As both Suzanne and I highlighted earlier, supply chain constraints and the headwinds associated with foreign exchange were the two biggest factors that impacted our business performance in Q1. While we are doing everything we can to manage through these challenges, the FX impact alone represented a $5.8 million negative hit to our top-line compared to last year’s exchange rates in our non-U.S. markets. We are reiterating our full-year guidance and will closely monitor the impact of macroeconomic trends, particularly FX. Those are our key financial highlights, and with that, I would like to hand the call back to Suzanne.

Suzanne Winter, CEO

Thank you, Ali. In summary, I would like to thank our teams for their unwavering support of our customers, enabling them to provide the highest level of care to patients. We expect to continue navigating the uncertainty of the macroeconomic and geopolitical conditions and reiterate guidance with expected revenue in the range of $447 million to $455 million and adjusted EBITDA in the range of $26 million to $30 million. We remain encouraged by the growing customer demand for Accuray technology and our robust product pipeline and remain optimistic about market trends that favor Accuray technology and where we are positioned to win and take market share. As an organization, we are strengthening our fundamentals, advancing key growth catalysts in China, and creating new strategic partnerships like our partnership with GE Healthcare, all of which we believe will create long-term and meaningful value for patients, healthcare providers, employees, and our shareholders. I will now turn it back over to the operator for Q&A.

Operator, Operator

The first question comes from Brooks O’Neil with Lake Street Capital. Please go ahead.

Charlie Montang, Analyst

Hi. This is Charlie Montang on for Brooks O’Neil. Just a couple of quick questions from me. My first one is when do you think the GE partnership can contribute to revenue, and do you think GE can help with hospital accounts, or do you need to integrate more products to generate meaningful revenue?

Suzanne Winter, CEO

Great. Thank you for the question. We are very excited about our GE partnership. While it is early in the partnership, we believe in the short term we will be able to deliver differentiated solutions from precision diagnostics to precision treatment delivery. Together, I think we will have better visibility within the marketplace for our solutions. They obviously have a very strong commercial muscle. So we will have the ability to reach more of the market and greater customer access by leveraging the relationships that they have on the IDM level and the government level. In the short term, key performance indicators that we are going to be looking for are an increase in our order funnel growth, the development of some key strategic reference sites, as well as just ongoing operational mechanisms. Long term, we expect to see financial contributions, and we should look for more opportunities for synergy and joint solution development.

Charlie Montang, Analyst

Okay, great. Thank you. And then my last question is, you guys recently issued a press release about the submission of Tomo in China. When is the expected approval, and can you say when you expect initial orders to contribute to revenue?

Suzanne Winter, CEO

Yes, thank you for the question. We are very enthusiastic about the fact that things are starting to move in China. This was an area where we were waiting to complete the submission for our JV-developed Type B product, so the fact that it is in the regulatory process is very exciting. Now, the typical process there is quite long, and of course we can never predict the regulatory process, but it historically takes about 12 months. So what we would be expecting is that 12 months from now we would have regulatory clearance to be able to take orders and be in a shipping position.

Charlie Montang, Analyst

Okay. Thank you. That is it for me and congrats on a great quarter.

Suzanne Winter, CEO

Thank you.

Operator, Operator

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

Josh Jennings, Analyst

Hi. Good evening. Thanks for taking the questions. I wanted to follow-up with a multilayer question regarding the GE partnership. I wanted to better understand the process for both Accuray and GE. Were you both looking for partners on the other side of the radiation oncology imaging side? The reason I ask is it just seems like a big validating signal that GE has decided to partner with Accuray. Secondarily, one of the competitive risks of the Siemens varying combination has been the potential for that entity to leapfrog competition with the integration of advanced imaging platforms into radiation oncology systems. So I wanted to just better understand what is on the table. I know we talked a little bit about this at ASTRO, but I mean, is it everything from MRI integration to improving the current ClearRT imaging to full diagnostic grade to functional imaging and incorporating that into Accuray’s platforms, is this what we should be thinking about in terms of R&D collaborations?

Suzanne Winter, CEO

Thanks for the question, Josh. To address the two parts of your question: From GE Healthcare's standpoint, one of the strategies they are looking at is to have a strategic focus on peer pathways, with oncology being one of those areas. They chose to partner with Accuray because we have a strong brand in the premium high-performance markets in terms of sub-millimeter precision. They see the clinical trend favoring shorter duration treatments, and they also recognize an opportunity to shorten the time between diagnostics and treatments. Together, we present a united solution to customers looking to build comprehensive cancer centers that incorporate both diagnostic imaging and treatment delivery. In the longer term, there is an opportunity for synergy as GE is a global leader in imaging, which is becoming increasingly important in radiation therapy.

Josh Jennings, Analyst

Thanks again.

Operator, Operator

Your next question comes from Neil Chatterji with B. Riley. Please go ahead.

Neil Chatterji, Analyst

Hi guys, thanks for taking the question. I guess congrats on getting the China JV registration submitted. Just curious about your view on any kind of geopolitical risk with China and any potential for that to slow down the regulatory process or does having the domestic partner help shield you from that? And then I have one follow-up.

Suzanne Winter, CEO

Thanks for the question, Neil. We are obviously watching that very closely. The good news is that we do have a JV partner based in China, which is a state-owned entity. This offers us an advantage in the midst of geopolitical conditions. Whether that will help us in the regulatory submission process remains unclear, but it allows us to hedge a little against what is currently happening.

Neil Chatterji, Analyst

Got it, that is helpful. And then, just in terms of the partnership strategy and how it aids customer relationships, just curious if we could get an update on the status of the Limbus AI partnership for automated contouring. Is that integrated offering still on track for an early 2023 launch?

Suzanne Winter, CEO

Yes, thank you for the question. The importance of being able to correct for changes that happen with the patient is becoming critical, particularly for shorter treatment durations. So we do have a partnership with RaySearch, which is a leader in treatment planning. They also possess a very strong AI-backed algorithm for treatment planning. We are collaborating to bring this to market as quickly as possible. We did demonstrate this at ASTRO, and we expect, although regulatory approval timelines are challenging, that we should be in a position for full market launch in summer 2023.

Neil Chatterji, Analyst

And sorry, I was asking specifically about Limbus AI.

Suzanne Winter, CEO

Yes, so Limbus AI is another partnership that we have. We are looking for an online adaptive capability within our own precision treatment planning systems. That offering will follow what we introduce with RaySearch. Our goal is to provide customers numerous options; if they prefer to go with RaySearch, they can, or they can utilize Accuray’s Precision Treatment Planning. I would expect that offering to lag by approximately three to six months from the RaySearch introduction.

Neil Chatterji, Analyst

Great. Thank you.

Operator, Operator

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

Sam Eiber, Analyst

Hey, good afternoon Suzanne and Ali. This is Sam Eiber for Marie. Thanks for taking the questions. Maybe just following up on some of these partnerships here, multiple ones ongoing at the moment. How significant of a differentiator could some of these be in driving competitive wins or faster trade-ins and trade-ups? Is it something that could have the same impact that Synchrony and ClearRT had when those initially rolled out?

Suzanne Winter, CEO

Thank you for the question. Yes, I believe that the partnership we have with C-RAD, which we introduced at ASTRO, is now providing us with VitalHold, which is a breast cancer package. I would say this is very important to driving trade-ins and trade-ups and new systems. It has been something our customers have been requesting, especially for the Radixact. This solution significantly enhances the versatility of the Radixact System because breast cancer patients constitute about 25% to 30% of a typical radiation therapy department. Thus, having this solution, in addition to ClearRT and Synchrony, is now establishing a comprehensive solution for patients with both simple and complex cases. We are optimistic about each partnership's potential to enhance our ability to access customers, increase system versatility, and deliver a differentiated value proposition.

Sam Eiber, Analyst

Got it. Really helpful there, Suzanne. Maybe I can just ask one more about the order environment. Another strong quarter here from a gross order standpoint. Can you share how that works on a geographical basis—any areas of relative strength or weakness in the quarter?

Suzanne Winter, CEO

Yes, in this quarter, we observed strength in orders primarily from the U.S. and the APAC region, with specific positivity from China, which was encouraging to see. We are monitoring regional performances to understand market dynamics better. However, we did notice some delays in installations among U.S. customers due to their own supply chain challenges and increased construction costs. It’s important to note that demand remains robust. The slowdown appears temporary rather than a halt in demand. Additionally, there have been recent developments regarding RO-APM, the new reimbursement model from CMS, signaling strong potential for the U.S. market. We are excited to see how that unfolds.

Sam Eiber, Analyst

Great. Thanks for taking the questions.

Operator, Operator

Your next question comes from Jason Wittes with Loop Capital. Please go ahead.

Jason Wittes, Analyst

Hi, thanks for taking the questions. First off, it is encouraging to hear the order rates picked up in China. Can you provide a sense of how much China is in the backlog and what your outlook is in terms of when those might be placed and recognized as revenue?

Suzanne Winter, CEO

Yes, we mentioned in the script that while we cannot give specific numbers, it is public information that several customers have successfully passed through the bidding process for Type A licenses. We know there are 18 systems that should start recognizing revenue over the next several quarters. However, specific timing is still pending as this is freshly confirmed.

Jason Wittes, Analyst

Okay. That is helpful. And you also mentioned some commentary about your OpEx strategy. It sounds like you are implementing stricter protocols for sales, which I imagine may tighten some variance. Am I reading that correctly? Additionally, could you elaborate on your focus on service margins? Is that efficiency-focused internally or also linked to pricing?

Suzanne Winter, CEO

Yes, that is a bit of both, Jason. I'll let Ali provide additional details.

Ali Pervaiz, CFO

Thank you for the question. We had a solid finish on OpEx because we continue to drive cost discipline internally. Given the volatile macroeconomic environment we are in, we are scrutinizing both direct and indirect costs to ensure that any expenses have the right return on investment. Regarding service margins, we are active on both fronts—getting the right pricing for offerings and introducing new products that should improve margins as well as ensuring that we control service costs effectively, particularly related to parts consumption and technician utilization.

Jason Wittes, Analyst

Great. That is helpful as well. A quick follow-up on the GE relationship. Has it been disclosed that this partnership includes R&D collaboration or is it strictly distribution-focused?

Suzanne Winter, CEO

At this point, it is primarily a commercial agreement focused on distribution.

Operator, Operator

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

Suzanne Winter, CEO

I want to thank everyone for your attendance on the call. This concludes our earnings call, and we look forward to speaking with you all again on the January 1st fiscal 2023 second quarter earnings release.

Operator, Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.