Accuray Incorporated (ARAY) Earnings Call Transcript

Hello, good morning. I'm Neil Chatterji, Senior Analyst. Covering med tech and digital health at B. Riley Securities, and I'd like to welcome and thank Suzanne Winter, President and CEO; and Ali Pervaiz, CFO from Accuray for joining us today for our fireside chat. Maybe just to kick it off, if you could just maybe give us kind of your view just on the current state of, first, the hospital capital spending environment. And then secondly, the supply chain environment.

Yes, absolutely. Thanks for inviting us, Neil. It's great to be part of this important conference. Just let me just step back a little bit about Accuray for those that don't know. Accuray is a global leader in precision radiation therapy. And of the patients that are diagnosed with cancer every year, a very high percentage, especially in the U.S., about 60% of patients received radiation therapy. So Accuray plays in this space, and we are really driving technology to improve the lives of patients diagnosed with cancer. Our business is a capital equipment business. And so your question, I think, is very relevant, Neil. I would say right now, what we are seeing, and it varies somewhat by region, but people are being very careful. Hospitals are being very careful with their capital equipment spend. But that being said, cancer care and especially radiation therapy continues to be a very profitable department within the hospital. And so it's a strategic service line for many providers. And as a result, it does get priority in terms of capital equipment spend. And that's what we are seeing from our customers. Again, depending on the region, the sites that have older technology or need to replace are getting a priority in terms of getting new performance equipment so that they can provide advanced care. So that's what we're seeing. We watch it very closely. We work very closely with our customers to help them to get through their own administrative process. In terms of supply chain, I would say that generally, I think things have improved from a year ago when we really started to see this come on. I think logistics has gotten better than it was a year ago. And just from our perspective at Accuray, I think although we are battling supply chain on a daily basis, the breadth of areas of concern have reduced significantly. So maybe we were watching 2 dozen critical parts and supplies a year ago, and now we're really just managing a handful. That being said, we have improved our processes significantly during this period of time. So I think that we are in a better position also to manage any sort of supply chain headwinds. For example, we work very closely with all of our suppliers, and in some cases, helping them to source raw materials for critical subsystems. We have also worked with -- manufacturing has worked very closely with R&D. If we need to design around certain parts in order to have better access. We are doing that as well. And we're also, of course, looking at new and alternate suppliers that are in a better position to be able to supply. So overall, we feel better about it. We're certainly not out of the woods from a supply chain standpoint, but I think we're in a much better position to navigate.

Great. Great. Maybe if we move on, maybe if we can just get an update where you believe we are kind of in the replacement cycles, both in the U.S. and Western Europe and then how your newer products like, say, ClearRT and Synchrony are helping you kind of retain that installed base you have or gain competitive wins.

Yes. Yes. And just again, if we step back and take a look at the radiation therapy market. We compete in about a $3.3 billion market and about 65% of that is in the mature markets, and that is largely a replacement market. And the market catalyst is there is a significant number of older systems that are due to be replaced. And so there's about 2,200 systems worldwide that are 10 years or older. And that is about the average life, 10 to 12 years is about the average life for systems. And so as clinical trends move toward advanced care regimens like SPRT, which is providing a treatment dose in 5 or fewer sessions. That's a major clinical trend. What that requires is also advanced technology. And so those 2 trends are really driving the replacement market in the mature market. It's like the U.S. and like Western Europe. So our growth initiative is really driven much by an emphasis on reinvesting R&D -- reinvesting our revenue back or our profits back into R&D to drive differentiated technology. And most recently, we have introduced ClearRT on our Radixact platform, which is really able to provide CT, diagnostic CT like imaging to guide radiation therapy. It is a differentiator, and we're seeing tremendous traction in our Radixact sales because of the Clear RT. That, in addition to our Synchrony technology, which is a technology that allows us to correct for any sort of tumor motion or patient motion while the patient is on the table, we can automatically, in real time, adjust the delivery of the radiation beam. That is something that is unique to Accuray. And what it means for the patient is less side effects because you'll be getting much more accurate in terms of where the treatment beam is going. And so there's less healthy tissue that is at risk. So those 2 really have driven a tremendous replacement cycle for us. And in the U.S., we are very focused on bringing our aged IB up to the latest level.

Got it. I believe exiting kind of fiscal 2022, you had introduced kind of your key strategic pillars. I was wondering if you could kind of give us an update on how you're progressing against those pillars. First, if you could just maybe talk about your strategy to expand margins over time and get back to pre-COVID levels.

Yes. Yes. So our strategic growth agenda, I'm going to let Ali talk a little bit about our margin expansion pillar. But we are exiting our fiscal year '22 with 8.5% overall growth and 22% growth on the product side. So we are going to continue to grow our revenue faster than the market and that is gaining share through this disruptive innovation that we've talked about. Another pillar is growing our service business. Our service business has been flat and the ability to offer new service offerings will be a critical part of our growth initiative. At the same time, we are laser-focused on margin expansion and profitability initiatives so that we grow our EBITDA. And finally, strategic partnerships is our final pillar in the use of strategic partnerships really to help us to get better access to the market and really transform the business. But let me hand it over to Ali to talk a little bit about our margin expansion because I think that's an exciting area for us.

Yes. Thanks, Suzanne. And Neil, thanks for having us. Just like Suzanne mentioned, in terms of margin expansion, it's been a major focus for us going into our fiscal year '23. And the way that we really think about it is probably in 4 different ways. Number one, it's around pricing and really being focused on ensuring that the deals that we engage in are profitable deals and are going to get us to the target profitability levels that we would like for the company for the years to come. And so the way that we've really activated that is number one, really armed our commercial teams with the right tools so that they actually understand the profitability associated with the deals that they're engaging in and gives them the flexibility to be able to position our products in the right way with the different segments that we plan. And then also, we've aligned a lot of their incentive compensation to this profitability. And so really, it's about holding price and starting to get price accretion over the course of the next couple of years. So price is 1 of them. I think number 2 is really being focused on product cogs. So really just reducing the cost associated with our overall products. And really, our supply chain team is leading this effort. But we're taking a two-pronged approach over here. Number 1 is really working with our suppliers to determine how do we actually go about reducing the costs that we have associated with these particular parts, but then also working with our engineering teams to take a look at some of our high-value products and parts and determining a way to take cost out. And so we think that over time, that's actually going to help our overall product margins and it's also going to help our service margins because a lot of these different parts are actually used in our service businesses field replaceable units. So that's really the focus on taking cost out from our product -- from our overall products. The third component is Suzanne mentioned, it is really a focus on our service business. And the way that we're tackling that is, number one, really just taking a look at all of the different service offerings that we have and being able to come out with new offerings that are more customer-centric that we think are actually going to add to our profitability for our service business. And then the biggest cost within our service business is really around parts consumption and labor costs for our field engineers. And so we're just taking a look at -- we're just taking a common sensible approach and just taking a look at all the different parts that we consume and really determining a way to extend the life of those different parts so that we're not replacing them as frequently, which is going to reduce our spend in parts consumption. And then when it comes to our field service engineers, it's all about efficiency and just driving efficiency over there. So we're really focused on ensuring that our service business, again, from an offering standpoint and reducing costs as part of our margin expansion initiative. And then lastly, taking a look at all of our OpEx, right, really taking a look at any dollar that we spend and making sure that we're getting the right return on investment. And so that's -- all of this is really all about a cultural mindset shift, which is something that Suzanne and myself, along with our leadership is really driving. And so we're really excited about it, right? I mean I think margin expansion is going to be a focus for the years to come. And we think that we have a good start to it. It's going to take us probably 12 to 24 months to get to pre-COVID levels. And then from there, we think that we probably have even more to do. So again, very excited about our margin expansion initiatives.

Great. And then I know you guys kind of both touched on the service side and the margin piece of that. Maybe just -- is there anything you could -- any other color you can add in terms of the transformation of the service business from a top line perspective?

Yes. I mean I think the only thing I would add is I think we have a history of really a service business that it was primarily break/fix. And so I think that there's such an opportunity for us with the life cycle of the products that we deliver, where we have a relationship with the customer for 10 to 12 years. And so I think as Ali talked about sort of unbundling our service contracts and being able to offer advanced service offerings to help our customers throughout that life, and it's not just break/fix, but it's advanced training. We know that there's turnover within departments, and they need ongoing training. There's advanced clinical training as the clinical trends and new protocols and new clinical evidence comes to market. So we want to help our customers to be able to learn how to provide advanced care using our devices. And so all of those, I think, are valuable to customers, and what we have heard from our customers is they're willing to pay for that as well. So I think we are taking a full look at how other companies in capital equipment are offering additional service and putting that into our strategy as well.

Got it. Got it. I guess just coming back to one of the other pillars, just in terms of the kind of the differentiation and innovation side. If you can just talk about the progress you've made on the R&D pipeline with your various partnerships, both in breast and neuro, and the expectations for further developments in '23?

Yes, yes. And we have 2 very unique, very powerful platforms. One is our CyberKnife platform, which is a robotic system that just had sub-millimeter precision and is really positioned for radiosurgery and also SBRT. We've done very well in prostate cancer with the CyberKnife and you may see commercials if you're in the New York area, just on the marketability of the product because it is so unique. We also have our Radixact platform, which basically it's a CT linear accelerator. So a full diagnostic like CT that delivers radiation therapy. Those 2 base technologies really have allowed us to take the radiation therapy technology further than conventional linear accelerators that are in the market today. So we have really focused our R&D on those type of differentiators using our base technology to really advance care. Most recently, in addition to ClearRT on the Radixact platform, and the Synchrony that is on both of our platforms, we introduced a comprehensive breast package. And partnerships are a critical part of our strategy. We can't do it all. And so we are really looking for best-in-class technologies that are in the marketplace today that we can partner so that together, 1 plus 1 equals 3. And our breast package, we have partnered with C-RAD that has a surface-guided radiation therapy and really allows us now to offer on the Radixact, the most comprehensive breast package in the industry. And breast is a large part of the patient population that comes into a radiation therapy department. It's probably 25% on average. So it's a significant patient population. We also, on the CyberKnife, we do very well in the neuro space. Because of that sub-millimeter precision, the CyberKnife is uniquely positioned for any sort of Neuroradiosurgery. So we have partnered with Brainlab. Brainlab is a leader in surgical navigation, especially on the neuro side. And so together with their treatment planning and contouring algorithms, we now have a package that is fantastic, not only for radiation therapy department but those shared departments with the neurosurgeon that uses radiation therapy for both functional disease as like essential tremor or pain or in addition to neuro tumors. RaySearch is another important partner for us. They make a treatment planning system and an OIS system RayCare. We have partnered with them on both of our platforms, again, for those customers that want to have an agnostic department where they have a treatment planning system that can work on multiple systems and they are an important partner. And then finally, we have our partnership with GE Healthcare. We've had a lot of enthusiasm around the GE Healthcare partnership, but that's a very important partnership for us. We think that their goal of providing precision diagnostics combined with our precision therapy and then again, their precision monitoring and survivorship afterwards is just an incredibly valuable partnership that we think will create a lot of value for patients, for providers, but also for shareholders as well.

Great. Great. Maybe just turning to China. Could you maybe just update us on where things stand there both on kind of the Type A fronts after the bidding process there was reactivated and then also on the Type B front for which you had submitted the JV registration?

Yes. Yes. China is a very important part of our growth strategy. We talked about a replacement market in the mature markets. Well, in the emerging markets, where there is a lack of access to radiation therapy. China is at least half of that market potential. And that's about a $1.3 billion new system opportunity each year, and China is about half of that. We have partnered and we have a unique joint venture with China Isotope & Radiation Corporation in China, with the goal of getting domestic presence there, as well as developing together a product that is considered made in China for the Type B space as well as using their manufacturing scale to help us to reduce cogs and provide additional capacity. But basically, the China market, again, is the Type A, and that's what we answered first. And the Type A is more of the premium market, and we have done very well in that space. We have greater than 75% market share in the Type A segment. What that's allowed us to do is really build the Accuray brand in one of the largest emerging markets. And then while we are jointly developing the Type B product and waiting for that to come to market, we believe we'll do very well in the Type B market as a result of that halo effect from our branding in Type A. So our Type B product is completed. It has been submitted for NMPA approval in November, and we expect a normal time frame of about a year for clearance. But we think in the back half of fiscal year '24, we'll really start to see the impact of the Type B product. Type A, also, despite the COVID lockdown, we were really pleased at the end of this calendar year to see the Type A bidding resume. And we successfully brought 18 of our customers through the bidding process, and we expect those Type A 18 systems to go to revenue over the next 3 to 4 quarters. And then we anticipate being able to play in the Type B market. And the Type B market is the bigger market and is growing at about 12% CAGR. So we're excited about our partnership with our China JV partner, and we think it will be an important part of our business moving forward.