ACCURAY INC - Quarter Report: 2012 September (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2012

 

or

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from               to              

 

Commission File Number: 001-33301

 

ACCURAY INCORPORATED

(Exact Name of Registrant as Specified in Its Charter)

 

 

1310 Chesapeake Terrace

Sunnyvale, California 94089

(Address of Principal Executive Offices Including Zip Code)

 

(408) 716-4600

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days.  x Yes  o No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o Yes  x No

 

As of October 26, 2012, there were 72,273,072 shares of the Registrant’s Common Stock, par value $0.001 per share, outstanding.

 

 

Table of Contents

 

Accuray Incorporated

 

Form 10-Q for the Quarter Ended September 30, 2012

 

Table of Contents

 

		Page No.
PART I.	Financial Information	3
Item 1.	Condensed Consolidated Financial Statements (Unaudited):	3
	Condensed Consolidated Balance Sheets as of September 30, 2012 and June 30, 2012	3
	Condensed Consolidated Statements of Operations and Comprehensive Loss for the three months ended September 30, 2012 and 2011	4
	Condensed Consolidated Statements of Cash Flows for the three months ended September 30, 2012 and 2011	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
Item 4.	Controls and Procedures	24
PART II.	Other Information	25
Item 1.	Legal Proceedings	25
Item 1A.	Risk Factors	25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 3.	Defaults Upon Senior Securities	30
Item 4.	Mine Safety Disclosure	31
Item 5.	Other Information	31
Item 6.	Exhibits	31
Signatures		32

 

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PART I.                 FINANCIAL INFORMATION

 

Item 1.    Condensed Consolidated Financial Statements

 

Accuray Incorporated

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)

(Unaudited)

 

		September 30,			June 30,
		2012			2012 (1)
Assets
Current assets:
Cash and cash equivalents		$	121,861		$	143,504
Restricted cash		2,611			1,560
Accounts receivable, net of allowance for doubtful accounts of $1,773 and $1,700, respectively		57,620			67,890
Inventories		81,739			81,693
Prepaid expenses and other current assets		17,619			16,715
Deferred cost of revenue - current		4,078			4,896
Total current assets		285,528			316,258
Property and equipment, net		39,536			37,458
Goodwill		59,344			59,215
Intangible assets, net		39,122			49,819
Deferred cost of revenue - noncurrent		3,575			2,433
Other assets		10,912			7,987
Total assets		$	438,017		$	473,170
Liabilities and equity
Current liabilities:
Accounts payable		$	28,025		$	18,209
Accrued compensation		16,226			23,071
Other accrued liabilities		27,025			31,646
Customer advances - current		21,173			18,177
Deferred revenue - current		77,797			83,071
Total current liabilities		170,246			174,174
Long-term liabilities:
Long-term other liabilities		5,592			5,988
Deferred revenue - noncurrent		12,582			9,675
Long-term debt		80,507			79,466
Total liabilities		268,927			269,303
Commitment and contingencies (Note 5)
Equity:
Preferred stock, $0.001 par value; authorized: 5,000,000 shares; no shares issued and outstanding		—			—
Common stock, $0.001 par value; authorized: 100,000,000 shares; issued and outstanding: 72,143,926 and 71,864,268 shares at September 30 and June 30, 2012, respectively		72			72
Additional paid-in capital		411,136			409,143
Accumulated other comprehensive income		2,302			2,837
Accumulated deficit		(240,557		)	(216,427		)
Total stockholders’ equity		172,953			195,625
Non-controlling interest		(3,863		)	8,242
Total equity		169,090			203,867
Total liabilities and equity		$	438,017		$	473,170

 

(1) The condensed consolidated balance sheet at June 30, 2012 has been derived from audited consolidated financial statements.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Accuray Incorporated

Condensed Consolidated Statements of Operations and Comprehensive Loss

(in thousands, except per share amounts)

(Unaudited)

 

		Three Months Ended September 30,
		2012			2011
Net revenue:
Products		$	40,628		$	56,174
Services		42,120			43,401
Other		—			876
Total net revenue		82,748			100,451
Cost of revenue:
Cost of products		24,009			38,373
Cost of services		35,063			37,349
Cost of other		—			301
Total cost of revenue		59,072			76,023
Gross profit		23,676			24,428
Operating expenses:
Selling and marketing		12,889			13,581
Research and development		20,209			20,565
General and administrative		13,269			14,969
Impairment of indefinite lived intangible asset		12,200			—
Total operating expenses		58,567			49,115
Loss from operations		(34,891		)	(24,687		)
Other income (expense), net		(747		)	(2,858		)
Loss before provision for income taxes		(35,638		)	(27,545		)
Provision for income taxes		597			538
Net loss		(36,235		)	(28,083		)
Net loss attributable to non-controlling interest		(12,105		)	(1,573		)
Net loss attributable to stockholders		$	(24,130	)	$	(26,510	)
Net loss per share attributable to stockholders
Basic and diluted		$	(0.34	)	$	(0.38	)
Weighted average common shares used in computing net loss per share
Basic and diluted		71,995			70,263
Net loss attributable to stockholders		$	(24,130	)	$	(26,510	)
Foreign currency translation adjustment		(535		)	835
Comprehensive loss		$	(24,665	)	$	(25,675	)

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Accuray Incorporated

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

 

		Three Months Ended September 30,
		2012			2011
Cash Flows From Operating Activities
Net loss		$	(36,235	)	$	(28,083	)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization		7,827			8,319
Impairment of indefinite lived intangible asset		12,200			—
Share-based compensation		1,755			2,609
Accretion of interest on long-term debt		1,041			639
Provision for (recovery of) bad debt		73			(454		)
Provision for write-down of inventories		375			1,578
Gain on previously held equity interest in Morphormics		(662		)	—
Changes in assets and liabilities:
Restricted cash		(1,050		)	(112		)
Accounts receivable		10,769			(16,659		)
Inventories		(320		)	11,545
Prepaid expenses and other current assets		(3,673		)	2,579
Deferred cost of revenue		(322		)	(3,726		)
Accounts payable		9,805			(14,010		)
Accrued liabilities		(14,872		)	(19,657		)
Customer advances		2,834			(1,647		)
Deferred revenue		(2,707		)	7,763
Net cash used in operating activities		(13,162		)	(49,316		)
Cash Flows From Investing Activities
Purchases of property and equipment, net		(5,319		)	(995		)
Purchase of intangible asset		(232		)	—
Acquisition of business, net of cash acquired		(3,861		)	(1,384		)
Net cash used in investing activities		(9,412		)	(2,379		)
Cash Flows From Financing Activities
Proceeds from issuance of common stock		251			911
Proceeds from debt, net of costs		—			96,100
Net cash provided by financing activities		251			97,011
Effect of exchange rate changes on cash and cash equivalents		680			(1,072		)
Net increase (decrease) in cash and cash equivalent		(21,643		)	44,244
Cash and cash equivalents at beginning of period		143,504			95,906
Cash and cash equivalents at end of period		$	121,861		$	140,150

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Accuray Incorporated

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1. Summary of Significant Accounting Policies

 

Description of Business

 

Accuray Incorporated (together with its subsidiaries, the “Company”) is incorporated in Delaware. The Company designs, develops and sells advanced radiosurgery and radiation therapy systems for the treatment of tumors throughout the body.

 

Basis of Presentation and Principles of Consolidation

 

The condensed consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and a variable interest entity, Compact Particle Acceleration Corporation (“CPAC”) (for further information, see “Note 9, Investment in CPAC”). All significant inter-company transactions and balances have been eliminated in consolidation.

 

The accompanying condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles, (“GAAP”), pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and note disclosures have been condensed or omitted pursuant to such rules and regulations. The unaudited condensed consolidated financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for a fair presentation of the periods presented. The results for the three months ended September 30, 2012 are not necessarily indicative of the results to be expected for the year ending June 30, 2013, for any other interim period or for any future year.

 

Use of Estimates

 

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures at the date of the financial statements. Key estimates and assumptions made by the Company relate to revenue recognition, business combination and intangible asset impairment, inventories, share-based compensation expense, income taxes, loss contingencies and corporate bonus expenses and accruals. Actual results could differ materially from those estimates.

 

Concentration of Credit and Other Risks

 

The Company’s cash and cash equivalents are mainly deposited with several major financial institutions. At times, deposits in these institutions exceed the amount of insurance provided on such deposits. The Company has not experienced any losses in such accounts and believes that it is not exposed to any significant risk on these balances.

 

For the three months ended September 30, 2012 and 2011, there were no customers that represented 10% or more of total net revenue. At September 30, 2012 and June 30, 2012, there were no customers and two customers, respectively, whose accounts receivable balance was 10% or more of the Company’s total accounts receivable.

 

Accounts receivable are typically not collateralized. The Company performs ongoing credit evaluations of its customers and maintains reserves for potential credit losses. Accounts receivable are deemed past due in accordance with the contractual terms of the agreement. Accounts are charged against the allowance for doubtful accounts once collection efforts are unsuccessful. Historically, such losses have been within management’s expectations.

 

Single source suppliers presently provide the Company with several components. In most cases, if a supplier was unable to deliver these components, the Company believes that it would be able to find other sources for these components subject to any regulatory qualifications, if required.

 

Revenue Recognition

 

The Company earns revenue from the sale of products, the operation of its shared ownership program, and the provision of related services, which include installation services, post-contract customer support (“PCS”), training and other professional services. The Company records its revenues net of any value added or sales tax. For arrangements with multiple elements, the Company allocates arrangement fees to product and services based upon Vendor Specific Objective Evidence (“VSOE”) of fair value of the respective elements, or Third-Party Evidence (“TPE”), or Best Estimate of Selling Price (“BESP”), using the relative selling price method.

 

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Product Revenue

 

The majority of product revenue is generated from sales of CyberKnife and TomoTherapy systems. The Company sells its systems with PCS contracts, training, and at times, professional services. PCS contracts provide planned and corrective maintenance services, software updates, bug fixes, as well as call-center support. If the Company is responsible for installation, the Company recognizes revenue after installation and acceptance of the system. Otherwise, revenue is recognized upon delivery.

 

Service Revenue

 

Service revenue is generated primarily from PCS (warranty period services and post warranty services), installation services, training, and professional services. PCS revenue is deferred and recognized over the service period. Installation service revenue is recognized concurrent with system revenue. Training and professional service revenues that are not deemed essential to the functionality of the systems are recognized as such services are performed.

 

Costs associated with service revenue are expensed when incurred, except when those costs are related to system upgrades where revenue recognition has been deferred. In those cases, the costs are deferred and are recognized over the period of revenue recognition.

 

Shared ownership program

 

The Company also enters into arrangements under its shared ownership program with certain customers. These arrangements typically have a term of five years and provide the customer an option to purchase the system during the contractual term at pre-determined prices. Under the terms of this program, the Company retains title to its system, while the customer has use of the system. The Company generally receives a minimum monthly payment and earns additional revenues from the customer based upon its use of the system which are included in product revenue in the condensed consolidated statements of operations and comprehensive loss.

 

Other revenue

 

Other revenue primarily consists of research and development and construction contract revenues.

 

Long-term construction and manufacturing contracts

 

The Company recognizes revenue and cost of revenue related to long-term construction and manufacturing contracts using contract accounting on the percentage-of-completion or the completed contract method. The Company records such revenue under other revenue and cost of such revenue under cost of other revenue in the condensed consolidated statements of operations and comprehensive loss. Any loss provision identified from the total contract in the period is recorded as an increase to cost of revenue.

 

Net Loss Per Common Share

 

Basic and diluted net loss per share is computed by dividing net loss attributable to stockholders by the weighted average number of common shares outstanding during the period. The potential dilutive shares of the Company’s common stock resulting from the assumed exercise of outstanding stock options, the vesting of Restricted Stock Units (RSUs) and Performance-based Stock Units (PSUs), and the purchase of shares under the Employee Stock Purchase Plan (ESPP), as determined under the treasury stock method, are excluded from the computation of diluted net loss per share because their effect would have been anti-dilutive.

 

A reconciliation of the numerator and denominator used in the calculation of basic and diluted net loss per share attributable to stockholders follows (in thousands):

 

		Three Months Ended
		September 30,
		2012			2011
Numerator:
Net loss used in computing basic and diluted net loss per share		$	(24,130	)	$	(26,510	)
Denominator:
Weighted average shares used in computing basic net loss per share		71,995			70,263
Add: Dilutive stock options and awards outstanding		—			—
Weighted average shares used in computing diluted net loss per share		71,995			70,263

 

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The following table sets forth all potentially dilutive securities excluded from the computation in the table above because their effect would have been anti-dilutive (in thousands):

 

		As at
		September 30,
		2012		2011
Stock options		7,703		8,191
RSUs and PSUs		2,007		1,591
		9,710		9,782

 

The 3.75% Convertible Senior Notes due August 1, 2016 (the “Convertible Notes”) are included in the calculation of diluted net income per share if their inclusion is dilutive under the if-converted method. For the three months ended September 30, 2012, the potential dilutive shares under the Convertible Notes were excluded from the calculation of diluted net loss per share as their inclusion would be anti-dilutive.

 

Segment Information

 

The Company has determined that it operates in only one segment, as it only reports profit and loss information on an aggregate basis to its chief operating decision maker. The Company’s long-lived assets maintained outside the United States are not material. Revenue by geographic region is based on the shipping addresses of the Company’s customers. The following summarizes revenue by geographic region (in thousands):

 

		Three Months Ended
		September 30,
		2012			2011
Americas		$	35,811		$	48,849
Europe, Middle East, India and Africa		25,118			28,615
Asia (excluding Japan)		15,121			16,157
Japan		6,698			6,830
Total		$	82,748		$	100,451

 

2. Balance Sheet Components

 

Accounts receivable, net

 

Accounts receivable, net consisted of the following (in thousands):

 

		September 30,			June 30,
		2012			2012
Accounts receivable		$	59,167		$	69,285
Unbilled fees and services		226			305
		59,393			69,590
Less: Allowance for doubtful accounts		(1,773		)	(1,700		)
Accounts receivable, net		$	57,620		$	67,890

 

Financing receivables

 

A financing receivable is a contractual right to receive money, on demand or on fixed or determinable dates, that is recognized as an asset in the creditor’s balance sheet. The Company’s financing receivables, consisting of its accounts receivable with contractual maturities of more than one year, was $5.6 million and $2.5 million at September 30, 2012 and June 30, 2012, respectively and are included in Other Assets in the condensed consolidated balance sheets. There was no balance in the allowance for doubtful financing receivable accounts as of September 30 and June 30, 2012.

 

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Inventories

 

Inventories consisted of the following (in thousands):

 

		September 30,			June 30,
		2012			2012
Raw materials		$	34,719		$	34,579
Work-in-process		16,541			16,547
Finished goods		30,479			30,567
Inventories		$	81,739		$	81,693

 

Property and equipment, net

 

Property and equipment, net consisted of the following (in thousands):

 

		September 30,			June 30,
		2012			2012
Furniture and fixtures		$	5,966		$	5,921
Computer and office equipment		9,452			9,126
Software		9,409			9,429
Leasehold improvements		16,340			16,065
Machinery and equipment		33,536			33,493
Shared ownership systems		4,979			4,979
Construction in progress		8,794			3,787
		88,476			82,800
Less: Accumulated depreciation and amortization		(48,940		)	(45,342		)
Property and equipment, net		$	39,536		$	37,458

 

Depreciation expense related to property and equipment for the three months ended September 30, 2012 and 2011 was $4.1 million and $4.2 million, respectively.

 

3. Goodwill and Intangible Assets

 

Goodwill

 

Activity related to goodwill consisted of the following (in thousands):

 

		Three Months
		Ended			Year Ended
		September 30,			June 30,
		2012			2012
Balance at the beginning of the period		$	59,215		$	54,474
Addition related to acquisition		77			—
Currency translation and other adjustments		52			—
Adjustments related to prior year acquisition (1)		—			4,741
Balance at the end of the period		$	59,344		$	59,215

 

(1)  Primarily represents liabilities related to the TomoTherapy acquisition.

 

Intangible Assets

 

The Company’s intangible assets associated with completed acquisitions at September 30, 2012 and June 30, 2012 are as follows (in thousands):

 

				September 30, 2012												June 30, 2012
				Gross												Gross
				Carrying			Impairment			Accumulated			Net			Carrying			Accumulated			Net
		Useful Lives		Amount			Charges			Amortization			Amount			Amount			Amortization			Amount
		(in years)
Developed technology		5 - 6		$	48,556		$	—		$	(11,136	)	$	37,420		$	43,455		$	(9,161	)	$	34,294
Backlog		1.25		10,500			—			(10,500		)	—			10,500			(8,867		)	1,633
Distributor license		1.5 - 2.5		2,091			—			(989		)	1,102			1,860			(768		)	1,092
In-process research and development (CPAC)		Indefinite		12,800			(12,200		)	—			600			12,800			—			12,800
				$	73,947		$	(12,200	)	$	(22,625	)	$	39,122		$	68,615		$	(18,796	)	$	49,819

 

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At September 30, 2012, the Company noted certain impairment triggers based on results of research and development work carried out by CPAC. As a result, based on projected future usage of the in-process research and development (“IPR&D”) technology by CPAC, an impairment charge of $12.2 million was recorded during the three months ended September 30, 2012. The Company did not identify any impairment triggers on goodwill or any of its definite intangible and long-lived assets.

 

Amortization expense related to intangible assets was $3.8 million and $4.1 million for the three months ended September 30, 2012 and 2011, respectively.

 

The estimated future amortization expense of purchased intangible assets, excluding in-process research and development, as of September 30, 2012 is as follows (in thousands):

 

Year Ending June 30,		Amount
2013 (remaining 9 months)		$	6,610
2014		8,395
2015		7,953
2016		7,953
2017		7,568
Thereafter		43
		$	38,522

 

4. Financial Instruments

 

The following tables summarize the fair value of assets measured on a recurring basis as of September 30, 2012 and June 30, 2012 (in thousands):

 

		Fair value measurement using
Type of instrument and line item in condensed consolidated balance sheets		Quoted Prices in Active Markets for Identical Instruments (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total balance
Assets at September 30, 2012
Money market funds - included in cash and cash equivalents		$	20,080		$	—		$	—		$	20,080
Certificate of deposits - included in cash and cash equivalents		$	9,775		$	—		$	—		$	9,775
Assets at June 30, 2012
Money market funds - included in cash and cash equivalents		$	40,068		$	—		$	—		$	40,068
Certificate of deposits - included in cash and cash equivalents		$	6,742		$	—		$	—		$	6,742

 

The following tables summarize the fair value of financial instruments that are not measured on a recurring basis as of September 30, 2012 and June 30, 2012 (in thousands):

 

		Fair value measurement using
Type of instrument and line item in condensed consolidated balance sheets		Quoted Prices in Active Markets for Identical Instruments (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total balance
At September 30, 2012
Long-term debt		$	—		$	103,900		$	—		$	103,900
At June 30, 2012
Long-term debt		$	—		$	101,400		$	—		$	101,400

 

The long-term debt is measured on a non-recurring basis using Level 2 inputs based upon observable inputs of the Company’s underlying stock price and the time value of the conversion option, since an observable quoted price of the Convertible Notes is not readily available.

 

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5. Contingencies

 

Litigation

 

From time to time, the Company is involved in legal proceedings arising in the ordinary course of its business. Currently, management believes the Company does not have any probable and estimable loss related to any current legal proceedings and claims that would individually or in the aggregate materially adversely affect its financial condition or operating results. Litigation is inherently unpredictable and is subject to significant uncertainties, some of which are beyond the Company’s control. Should any of these estimates and assumptions change or prove to have been incorrect, the Company could incur significant charges related to legal matters which could have a material impact on its results of operations, financial position and cash flows.

 

Best Medical Trade Secret Litigation

 

On September 3, 2009, Best Medical International, Inc. (“Best Medical”) filed a lawsuit against the Company in the U.S. District Court for the Western District of Pennsylvania, claiming that the Company induced certain individuals to leave the employment of Best Medical and join the Company in order to gain access to Best Medical’s confidential information and trade secrets. Best Medical is seeking monetary damages and other relief. The Company filed a motion for summary judgment on May 20, 2011, Best Medical filed its response on June 21, 2011, and the Company filed a response to their response on July 8, 2011. On October 25, 2011, the court granted summary judgment in favor of the Company on all counts. On November 21, 2011 Best Medical filed a notice of appeal, and the parties await a ruling by the appellate court. At this time, the Company does not have enough information to estimate what, if any, financial impact this claim will have.

 

Best Medical Patent Litigation

 

On August 6, 2010, Best Medical filed an additional lawsuit against the Company in the U.S. District Court for the Western District of Pennsylvania, claiming that the Company has infringed U.S. Patent No. 5,596,619, a patent that Best Medical alleges protects a method and apparatus for conformal radiation therapy. On December 2, 2010, the Court granted the Company’s motion to dismiss, with leave to amend. On December 16, 2010, Best Medical filed an amended complaint, claiming that the Company also infringed U.S. Patent Nos. 6,038,283 and 7,266,175, both of which Best Medical alleges cover methods and apparatus for conformal radiation therapy. On March 9, 2011, the Court dismissed with prejudice all counts against the Company, except for two counts of alleged willful infringement of two of the patents. The Court issued a Scheduling Order on May 12, 2011 appointing a special master for claim construction, and setting a claim construction hearing on January 10, 2012. Best Medical moved to voluntarily dismiss one of the two remaining patent claims on June 28, 2011, which the court granted on June 30, 2011, leaving only one patent (U.S. Patent No. 6,038,283) at issue in the case. The Court held a claim construction hearing on May 16, 2012, and the Company believes the court will issue a claim construction order sometime in December 2012 or January 2013. Best Medical is seeking declaratory and injunctive relief, as well as unspecified compensatory and treble damages and other relief. At this time, the Company does not have enough information to estimate what, if any, financial impact this claim will have.

 

Rotary Systems

 

On April 28, 2011, a former supplier to TomoTherapy, Rotary Systems Incorporated, filed suit in Minnesota state court, Tenth Judicial District, Anoka County, against TomoTherapy alleging misappropriation of trade secrets, as well as several other counts alleging various theories of injury. Rotary Systems alleges TomoTherapy misappropriated Rotary Systems’ trade secrets pertaining to a component previously purchased from Rotary Systems, which component TomoTherapy now purchases from a different supplier. The suit alleges TomoTherapy improperly supplied the alleged trade secrets to its present supplier, Dynamic Sealing Technologies Inc. (also a named defendant in the suit). Rotary Systems has made an unspecified claim for damages of greater than $50,000. TomoTherapy moved to dismiss the case on May 19, 2011,

 

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and on August 29, 2011, the court granted the motion to dismiss with respect to all counts other than the count alleging misappropriation of trade secrets. On May 21, 2012, the court granted the Company’s motion for sanctions, in part, and gave Rotary Systems sixty days to identify the alleged trade secrets with specificity or face dismissal of its claim with prejudice. The court held a hearing on September 20, 2012, and the Company awaits the court’s ruling. At this time, the Company does not have enough information to estimate what, if any, financial impact this claim will have.

 

Radiation Stabilization Solutions Patent Litigation

 

On September 15, 2011, Radiation Stabilization Solutions LLC (“RSS”) filed a patent infringement complaint in the United States District Court for the Northern District of Illinois, Eastern Division. The complaint, alleged the Company’s sale of the TomoHD product induces infringement of or contributorily infringes U.S. Patent No. 6,118,848, or the ‘848 Patent, and sought unspecified monetary damages for the alleged infringement. The complaint also named Varian Medical Systems, Inc., BrainLab AG, BrainLab, Inc., Elekta AB and Elekta, Inc. as defendants, alleging that certain of their products also infringe the ‘848 patent. On October 27, 2011, the Court dismissed the complaint without prejudice because non-resident defendants had been improperly named in the complaint.

 

On October 28, 2011, RSS filed a new complaint against the Company and a customer of the Company in the United States District Court for the Northern District of Illinois, Eastern Division. The new complaint repeats the original complaint’s allegations against the Company and seeks unspecified monetary damages for the alleged infringement. The complaint further alleges that the customer directly and indirectly infringes the ‘848 patent, and seeks unspecified monetary damages for the alleged infringement. RSS also filed individual suits against each of Varian and Elekta and several of their respective customers. RSS served the complaint on Accuray and its customer on December 7, 2011. On January 30, 2012 the Company filed a motion to dismiss the complaint, and the Court heard oral argument for the motion on June 29, 2012. On August 21, 2012, the court granted the Company’s motion in part and gave RSS leave to amend the complaint. On September 21, 2012, RSS filed an amended complaint. On November 2, 2012, the Company and RSS entered into a settlement agreement, under which the Company will pay $150,000 to resolve all outstanding claims.

 

Accuray Securities Complaint

 

On November 1, 2012, a complaint was filed in Santa Clara County Superior Court purportedly on behalf of a class of shareholders seeking to enjoin the shareholder vote to be held at our annual meeting scheduled for November 30, 2012. The complaint names as defendants the Company and the members of the board of directors and alleges that the disclosures in the proxy statement for the annual meeting concerning the advisory vote on executive compensation and the proposal to amend the certificate of incorporation to increase the number of authorized shares are inadequate and constitute a breach of fiduciary duty. In addition to an injunction, the complaint seeks unspecified monetary damages and other relief. At this time, the Company does not have enough information to estimate what, if any, financial impact this complaint will have.

 

Software License Indemnity

 

Under the terms of the Company’s software license agreements with its customers, the Company agrees that in the event the software sold infringes upon any patent, copyright, trademark, or any other proprietary right of a third party, it will indemnify its customer licensees against any loss, expense, or liability from any damages that may be awarded against its customer. The Company includes this infringement indemnification in all of its software license agreements and selected managed services arrangements. In the event the customer cannot use the software or service due to infringement and the Company cannot obtain the right to use, replace or modify the license or service in a commercially feasible manner so that it no longer infringes, then the Company may terminate the license and provide the customer a refund of the fees paid by the customer for the infringing license or service. The Company has not recorded any liability associated with this indemnification, as it is not aware of any pending or threatened actions that represent probable losses as of September 30, 2012.

 

6. Acquisition

 

On July 16, 2012, the Company acquired the remaining 90% of the outstanding shares of Morphormics, Inc. (“Morphormics”), a privately-held developer of medical imaging software based in North Carolina. The purpose of this acquisition was to enable the Company to extend auto-contouring capabilities for both the CyberKnife and TomoTherapy systems to improve disease specific workflows. The Company previously held 10% of the outstanding shares of Morphormics which was carried at zero value prior to the acquisition and re-measured to its acquisition-date fair value of $0.7 million based on the fair value of the consideration transferred. As a result, the Company recognized a gain of $0.7 million in other income (expense), net, during the three months ended September 30, 2012. The acquisition has been accounted for as a business combination using purchase accounting and Morphormics’ results of operations are included in the condensed consolidated financial statements from July 16, 2012. The acquisition was not considered a material business combination and was funded through cash on-hand. As per the acquisition agreement, $0.9 million of the purchase consideration is to be paid on April 16, 2013 and is included in other accrued liabilities in the condensed consolidated balance sheet at September 30, 2012. The Company has not incurred material severance or acquisition-related costs.

 

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The fair value of total purchase consideration paid and payable for 100% of Morphormics’ equity interest as of the acquisition date was as follows (in thousands):

 

Cash paid and payable		$	5,385
Fair value of pre-existing investment in Morphormics		662
Total		$	6,047

 

The total purchase price was allocated to the net tangible and intangible assets acquired and liabilities assumed based on their fair values as of the acquisition date as follows (in thousands):

 

Cash and cash equivalents		$	668
Accounts receivable		283
Other current assets		7
Amortizable intangible assets - developed technology		5,100
Goodwill		77
Accrued compensation		(88		)
Total purchase price		$	6,047

 

Developed technology represents the fair value of Morphormics’ imaging software product which is being amortized on a straight-line basis over an estimated life of 5 years.

 

Pro forma results of operations for the acquisition have not been presented because it is not material to the Company’s condensed consolidated statements of operations and comprehensive loss, balance sheets, or cash flows.

 

7. Share-Based Compensation

 

The following table summarizes the share-based compensation charges included in the Company’s condensed consolidated statements of operations and comprehensive loss (in thousands):

 

		Three Months Ended September 30,
		2012			2011
Cost of revenue		$	247		$	558
Selling and marketing		220			229
Research and development		516			602
General and administrative		772			1,220
		$	1,755		$	2,609

 

At September 30, 2012 and June 30, 2012, capitalized share-based compensation expenses of $0.4 million were included as a component of inventories.

 

Performance-Based Awards

 

During fiscal 2012, the Compensation Committee of the Board of Directors of the Company approved the granting of PSUs to employees of the Company which vest only upon meeting certain financial performance criteria during the performance period commencing on the first day of the Company’s 2012 fiscal year and ending on the last day of the Company’s 2013 fiscal year. If the PSUs do not become vested as a result of the Company’s performance during the performance period, all PSUs are automatically forfeited by the participants effective as of the last day of the performance period. During fiscal 2012, approximately 1.0 million PSUs were granted to employees valued at approximately $3.9 million which was based on the fair value of the Company’s common stock on the grant date and will be recognized over the requisite performance period based on management’s assessment of the probability of achieving the performance criteria. Approximately 0.9 million PSUs are outstanding as of September 30, 2012.

 

As of September 30, 2012, management assessed that it was not probable that the performance criteria would be met during the performance period and accordingly, no compensation cost has been recognized for the PSUs to date or during the three months ended September 30, 2012. If in a future period management revises its assessment and concludes that it is probable that the performance criteria will be met, the Company will record a cumulative catch up compensation charge for the PSUs in that period. Remaining compensation charges would be recognized ratably over the remaining performance period.

 

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8. Debt

 

On August 1, 2011, the Company issued the Convertible Notes to certain qualified institutional buyers or QIBs. The Convertible Notes were offered and sold to the QIBs pursuant to Rule 144A under the Securities Act of 1933, as amended. The net proceeds from the $100 million offering, after deducting the initial purchaser’s discount and commission and the related offering costs, were approximately $96.1 million.  The offering costs and the initial purchaser’s discount and commission (which are recorded in Other Assets) are both being amortized to interest expense using the effective interest method over five years. The Convertible Notes bear interest at a rate of 3.75% per year, payable semi-annually in arrears in cash on February 1 and August 1 of each year, beginning on February 1, 2012. The Convertible Notes will mature on August 1, 2016, unless earlier repurchased, redeemed or converted.

 

The Convertible Notes were issued under an Indenture between the Company and The Bank of New York Mellon Trust Company, N.A., as trustee. Holders of the Convertible Notes may convert their Convertible Notes at any time on or after May 1, 2016 until the close of business on the business day immediately preceding the maturity date.  Prior to May 1, 2016, holders of the Convertible Notes may convert their Convertible Notes only under the following circumstances: (1) during any calendar quarter after the calendar quarter ending September 30, 2011, and only during such calendar quarter, if the closing sale price of the Company’s common stock for each of 20 or more trading days in the 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 130% of the conversion price in effect on the last trading day of the immediately preceding calendar quarter; (2) during the five consecutive business days immediately after any five consecutive trading-day period (such five consecutive trading-day period, the “Note Measurement Period”) in which the trading price per $1,000 principal amount of Convertible Notes for each trading day of that Note Measurement Period was equal to or less than 98% of the product of the closing sale price of shares of the Company’s common stock and the applicable conversion rate for such trading day; (3) if the Company calls any or all of the Convertible Notes for redemption, at any time prior to the close of business on the business day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate transactions as described in the Indenture. Upon conversion by holders of the Convertible Notes, the Company will have the right to pay or deliver, as the case may be, cash, shares of common stock of the Company or a combination thereof, at the Company’s election. At any time on or prior to the 33rd business day immediately preceding the maturity date, the Company may irrevocably elect to (a) deliver solely shares of common stock of the Company in respect of the Company’s conversion obligation or (b) pay cash up to the aggregate principal amount of the Convertible Notes to be converted and pay or deliver, as the case may be, cash, shares of common stock of the Company or a combination thereof in respect of the remainder, if any, of the Company’s conversion obligation in excess of the aggregate principal amount of the Convertible Notes being converted. The initial conversion rate is 105.5548 shares of the Company’s common stock per $1,000 principal amount of Convertible Notes (which represents an initial conversion price of approximately $9.47 per share of the Company’s common stock). The conversion rate, and thus the conversion price, are subject to adjustment as further described below.

 

Holders of the Convertible Notes who convert their Convertible Notes in connection with a “make-whole fundamental change”, as defined in the Indenture, may be entitled to a make-whole premium in the form of an increase in the conversion rate.  Additionally, in the event of a fundamental change, as defined in the Indenture, holders of the Convertible Notes may require the Company to purchase all or a portion of their Convertible Notes at a fundamental change repurchase price equal to 100% of the principal amount of Convertible Notes, plus accrued and unpaid interest, if any, to, but not including, the fundamental change repurchase date.

 

On or after August 1, 2014 and prior to the maturity date, the Company may redeem for cash all or a portion of the Convertible Notes if the closing sale price of its common stock exceeds 130% of the applicable conversion price (the initial conversion price is approximately $9.47 per share of common stock) of such Convertible Notes for at least 20 trading days during any consecutive 30 trading-day period (including the last trading day of such period).

 

In accordance with Accounting Standards Codification (“ASC”) 470-20 Debt with Conversion and Other Options, the Company separately accounts for the liability and equity conversion components of the Convertible Notes. The principal amount of the liability component of the Convertible Notes was $75.9 million as of the date of issuance based on the present value of its cash flows using a discount rate of 10%, our approximate borrowing rate at the date of the issuance for a similar debt instrument without the conversion feature. The carrying value of the equity conversion component was $24.1 million. A portion of the initial purchaser’s discount and commission and the offering costs totaling $0.9 million was allocated to the equity conversion component. The liability component will be accreted to the principal amount of the Convertible Notes using the effective interest method over five years.

 

The following table presents the carrying value of the Convertible Notes as of September 30, 2012 (in thousands):

 

Carrying amount of the equity conversion component		$	23,189
Principal amount of the Convertible Notes		$	100,000
Unamortized debt discount (1)		(19,493		)
Net carrying amount		$	80,507

 

(1)As of September 30, 2012, the remaining period over which the unamortized debt discount will be amortized is 46 months.

 

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A summary of interest expense and effective interest rate on the liability component related to the Convertible Notes for the three months ended September 30, 2012 and 2011 was as follows (in thousands):

 

		Three months ended			Three months ended
		September 30, 2012			September 30, 2011
Effective interest rate		10.0		%	10.0		%
Interest expense related to contractual interest coupon		$	938		$	625
Interest expense related to amortization of debt discount		1,041			639
Total interest expense recognized		$	1,979		$	1,264

 

9. Investment in CPAC

 

In April 2008, TomoTherapy established a new affiliate, CPAC, to develop a compact proton therapy system for the treatment of cancer. As its initial investment in CPAC, TomoTherapy contributed intellectual property with a fair market value of approximately $1.9 million. Since then, CPAC has raised additional funds from TomoTherapy, the Company and other investors through the sale of stock and issuance of promissory notes. As of September 30, 2012, the Company and its wholly owned subsidiary, TomoTherapy, together own approximately 15.4% of the outstanding stock of CPAC and approximately 16.3% on a fully diluted basis. Although TomoTherapy’s and the Company’s combined ownership in CPAC is less than 50%, the Company includes CPAC in its condensed consolidated financial statements because the Company and TomoTherapy are the primary beneficiaries of CPAC (a variable interest entity, or VIE). The Company and TomoTherapy were involved in the design of CPAC, from which CPAC cannot depart due to restrictions that are part of its financing arrangements. The Company also provided intellectual property, which is the basis of CPAC and also holds influence over the VIE through representation on CPAC’s board of directors. Further, the Company has an option to either acquire CPAC or enter into a distribution arrangement for the technology developed by CPAC as further described below. CPAC’s outside stockholders’ interests are shown in the Company’s condensed consolidated financial statements as “Non-controlling interest.” The liabilities of the VIE do not represent additional claims on the Company’s general assets; rather they represent claims against the specific assets of the VIE. Likewise, the assets of the VIE consolidated by the Company do not represent additional assets available to satisfy claims against the Company’s general assets. The creditors of the VIE do not have recourse to the Company. Total assets and liabilities of CPAC were $2.4 million and $2.2 million, respectively, as of September 30, 2012 and $15.0 million and $0.6 million, respectively, as of June 30, 2012, which are included within the Company’s condensed consolidated balance sheets. See Note 3, Goodwill and Intangible Assets for details of the impairment charge recorded for CPAC’s in-process research and development intangible asset in the three months ended September 30, 2012.

 

From December 2010 through March 2012, the Company, TomoTherapy and certain other CPAC investors purchased convertible promissory notes from CPAC. Total consideration for the notes that the Company and TomoTherapy purchased was $1.2 million. Under the terms of the December 2010 notes, TomoTherapy received warrants for 1,386,981 common shares of CPAC. Other participating investors also purchased $3.3 million of the convertible notes which were included in “other accrued liabilities” in the Company’s condensed consolidated balance sheets prior to their conversion to equity in April 2012. The other investors also received warrants under the terms of the December 2010 notes for an aggregate of 1,386,983 shares of CPAC, which were equity classified. The notes bore interest at 12% and were convertible based on a per share conversion price as defined in the notes. The CPAC warrants described above are exercisable through November 2020 at an exercise price of $0.57 per CPAC common share. At September 30, 2012, none of these warrants had been exercised.

 

On March 9, 2011, TomoTherapy entered into a revolving promissory note with CPAC. On May 10, 2011, the revolving note was amended to increase the maximum amount available to borrow to $1.9 million. As of September 30, 2012, $2.3 million of principal and accrued interest was outstanding under the revolving note. The revolving note bears interest at 12% per annum compounded quarterly. This note and related interest is eliminated in consolidation.

 

On April 20, 2012, the Company entered into various transactions with CPAC and its other stockholders pursuant to which the Company invested $1.1 million and also converted the outstanding principal and accrued interest on its convertible promissory notes, amounting to $1.3 million, into preferred stock. The other note holders also converted their outstanding principal and accrued interest, amounting to $3.6 million into preferred stock. Certain other investors also participated in the financing. In connection with such transactions, the Company received warrants for 338,839 common shares of CPAC. These warrants are exercisable through April 2017 at an exercise price of $0.8725 per CPAC common share. At September 30, 2012, none of these warrants had been exercised. The $1.9 million principal amount revolving promissory note remains outstanding but its maturity date was extended from December 31, 2011 to December 31, 2012 as part of the April 2012 transaction.

 

In connection with the April 2012 transactions, the Company modified the option it previously held to purchase a portion of the CPAC stock held by other CPAC investors. The Company now has the option, upon the occurrence of certain events, to elect to either acquire CPAC at the then-determined fair value or enter into a non-exclusive supply and distribution agreement for CPAC’s compact proton therapy products. The triggers for the option becoming exercisable include CPAC achieving certain technical milestones or the CPAC board approving a proposal for the acquisition of CPAC.

 

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The Company and CPAC also amended certain licensing relationships for the DWA technology by and between the Company, CPAC and Lawrence Livermore National Security, LLC (“LLNS”) and terminated a previous arrangement pursuant to which the Company had provided CPAC with certain accounting and back office support and management services.

 

In July 2012, some of the participating investors of CPAC purchased convertible notes from CPAC for $1.3 million. The notes bear interest at 12% per annum and mature on May 31, 2013. The outstanding notes at September 30, 2012 are included in “other accrued liabilities” in the Company’s condensed consolidated balance sheets.

 

At September 30, 2012, the Company’s equity investment in CPAC was $4.3 million and the outstanding receivables from CPAC were $2.6 million, which includes $1.9 million of the principal portion of the revolving promissory note issued by CPAC. The equity investment and the outstanding receivables are eliminated in consolidation. If CPAC is not successful in raising additional funds to continue its development efforts, or if it is not successful in development of the compact proton accelerator technology, or if it is not successful in commercialization of the technology, or if the Company is not in a position to finance its option to purchase CPAC or to become a supplier or distributor of its technology, the Company may need to write down or write off the equity investment and outstanding receivables.

 

10. Subsequent Events

 

Change in Chief Executive Officer

 

On October 11, 2012, Dr. Euan S. Thomson, Ph.D. resigned from his positions as President and Chief Executive Officer of the Company. In addition, on October 11, 2012, Dr. Thomson also resigned as a member of the Board of Directors of the Company. In connection with his resignation and separation from the Company in October 2012, the Company and Dr. Thomson entered into a General Release and Separation Agreement (the “Separation Agreement”) on October 27, 2012, in accordance with the terms of his employment letter agreement. Dr. Thomson received approximately $1.2 million of severance related compensation and accelerated vesting of equity awards of approximately $0.5 million under the Separation Agreement. In addition, the Company and Dr. Thomson entered into a Consulting Services Agreement on October 27, 2012, whereby Dr. Thomson would provide the Company with consulting services in exchange for a monthly consulting fee of $20,500 for a period of six months.

 

Effective October 12, 2012, Joshua H. Levine was appointed President and Chief Executive Officer of the Company. Mr. Levine was also appointed as a director of the Company by the Company’s Board of Directors effective October 12, 2012 to fill the vacancy created by Dr. Thomson’s resignation.

 

Market Stock Unit (“MSU”) program

 

In October 2012, the Compensation Committee approved a new performance equity program, referred to as the market stock unit program (“MSU Program”). The program uses the Russell 2000 index as a performance benchmark and requires that the Company’s total stockholder return exceed that of the Russell 2000. Based on a sliding scale of how much the Russell 2000 benchmark is exceeded, participating executives can earn up to a maximum of 150% of the target number of shares over two measurement periods, one at the end of fiscal 2014 and another at the end of fiscal 2015.

 

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Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition as of September 30, 2012 and results of operations for the three months ended September 30, 2012 and 2011 should be read together with our condensed consolidated financial statements and related notes included elsewhere in this report. Statements made in this Form 10-Q report that are not statements of historical fact are forward-looking statements and are subject to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements in this report relate, but are not limited, to: expectations related to profitability and cash flows in fiscal 2013; sufficiency of cash resources and expected cash flows to fund future operations; expected uses of cash during fiscal 2013; the anticipated drivers of our future capital requirements; the impact of our recent sales reorganization on sales performance, particularly in the United States; anticipated increases in service revenue; the ongoing impact of purchase accounting adjustments; our expectations regarding the factors that will impact sales, competitive positioning and long-term success for our CyberKnife and TomoTherapy Systems; our expectations regarding the impact on our revenues and business of the introduction of our new CyberKnife and TomoTherapy Systems; and the anticipated risks associated with our foreign operations and fluctuations in the U.S. dollar. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from expectations, including risks detailed from time to time under the heading “Risk Factors” in Part II, Item 1A of this report and in Part I, Item 1A of the Company’s report on Form 10-K for fiscal year 2012. Forward-looking statements speak only as of the date the statements are made and are based on information available to the Company at the time those statements are made and/or management’s good faith belief as of that time with respect to future events. The Company assumes no obligation to update forward-looking statements to reflect actual performance or results, changes in assumptions or changes in other factors affecting forward-looking information, except to the extent required by applicable securities laws. Accordingly, investors should not place undue reliance on any forward-looking statements.

 

In this report, “Accuray,” the “Company,” “we,” “us,” and “our” refer to Accuray Incorporated and its subsidiaries.

 

Overview

 

Products and Markets

 

We believe we are the premier radiation oncology company based on our history of rapid innovation and our leading edge technologies designed specifically to deliver radiosurgery, stereotactic body radiation therapy, intensity modulated radiation therapy, image guided radiation therapy and adaptive radiation therapy that is tailored to the specific needs of each patient. Our suite of products includes the CyberKnife® Systems and the TomoTherapy® Systems. The systems are highly complementary offerings, serving distinct patient populations treated by the same medical specialty.

 

The CyberKnife Systems are robotic systems designed to deliver radiosurgery treatments to cancer tumors anywhere in the body. They are the only dedicated, full body radiosurgery systems on the market. Radiosurgery is an alternative to traditional surgery for tumors and is performed on an outpatient basis in one to five treatment sessions. It allows for the treatment of patients who otherwise would not be treated with radiation, who may not be good candidates for surgery, or who desire non-surgical treatments. The use of radiosurgery with CyberKnife Systems to treat tumors throughout the body has grown significantly in recent years, but currently represents only a small portion of the patients who develop tumors treatable with CyberKnife Systems. A determination of when it may or may not be appropriate to use a CyberKnife System for treatment is at the discretion of the treating physician and depends on the specific patient. However, given the CyberKnife Systems’ design to treat focal tumors, the CyberKnife Systems are generally not used to treat (1) very large tumors, which are considerably wider than the radiation beam that can be delivered by CyberKnife Systems, (2) diffuse, wide-spread disease, as is often the case for late stage cancers, because they are not localized (though CyberKnife Systems might be used to treat a focal area of the disease) and (3) systemic disease, like leukemias and lymphomas, which are not localized to an organ, but rather involve cells throughout the body.

 

We believe that the long term success of the CyberKnife System is dependent on a number of factors including the following:

 

·                  Adoption of our recently launched new CyberKnife platform and receipt of regulatory clearances associated with such new platform;

 

·                  Change in medical practice to utilize radiosurgery more regularly as an alternative to surgery or other treatments;

 

·                  Greater awareness among doctors and patients of the benefits of radiosurgery with the CyberKnife Systems;

 

·                  Continued evolution in clinical studies demonstrating the safety, efficacy and other benefits of using the CyberKnife Systems to treat tumors in various parts of the body;

 

·                  Continued advances in technology that improve the quality of treatments and ease of use of the CyberKnife Systems;

 

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·                  Improved access to radiosurgery with the CyberKnife Systems in various countries through regulatory approvals;

 

·                  Medical insurance reimbursement policies that cover CyberKnife System treatments; and

 

·                  Expansion of sales of CyberKnife Systems in countries throughout the world.

 

The TomoTherapy Systems are advanced, fully integrated and versatile radiation therapy systems for the treatment of a wide range of cancer types. We began selling TomoTherapy Systems after our acquisition of TomoTherapy Incorporated on June 10, 2011. Radiation therapy is used in a variety of ways, often to treat tissue surrounding a tumor area after surgical removal of the tumor and also as the primary treatment for tumors. Radiation therapy treatments impact both cancer cells as well as healthy tissue; therefore the total prescribed radiation dose is divided into many fractions and delivered in an average of 25 to 35 treatment sessions over several weeks. Radiation therapy has been widely available and used in developed countries for decades, though many developing countries do not currently have a sufficient number of radiation therapy systems to adequately treat their domestic cancer patient populations. The number of radiation therapy systems in use and sold each year is currently many times larger than the number of radiosurgery systems. Large companies, including Varian Medical Systems, Inc. and Elekta AB, generate most sales in this market. We believe the TomoTherapy Systems offer clinicians and patients significant benefits over other radiation therapy systems in the market. We believe our ability to capture more sales in this established market will be influenced by a number of factors including the following:

 

·                  Adoption of our recently launched new TomoTherapy platform and receipt of regulatory clearances associated with such new platform;

 

·                  Greater awareness among doctors and patients of the benefits of radiation therapy using TomoTherapy Systems;

 

·                  Advances in technology which improve the quality of treatments and ease of use of TomoTherapy Systems;

 

·                  Greater awareness among doctors of the improvement in reliability of TomoTherapy Systems; and

 

·                  Expansion of TomoTherapy System sales in countries throughout the world.

 

Sale of Our Products

 

Generating revenue from the sale of our systems is a lengthy process. Selling our systems, from first contact with a potential customer to a signed sales contract that meets backlog criteria, generally spans six months to two years. The time from receipt of a signed contract to revenue recognition is governed generally by the time required by the customer to build, renovate or prepare the treatment room for installation of the system. This time varies significantly, generally from six to twenty-four months.

 

In the United States, we market to customers, including hospitals and stand-alone treatment facilities, directly through our sales organization. Outside the United States, we market to customers in over 80 countries directly and through distributors. We have sales and service offices in Japan and many countries in Europe and Asia.

 

The following table shows the number of systems installed by geographic region as of September 30, 2012:

 

Americas		376
Europe, Middle East, India and Africa		150
Asia (excluding Japan)		86
Japan		55
Total		667

 

International sales of our products account for a significant and growing portion of our total net revenue. Revenue derived from sales outside of the United States was $46.9 million and $51.6 million for the three months ended September 30, 2012 and 2011, respectively, and represented 57% and 51% of our net sales during these periods, respectively.

 

Backlog

 

We report backlog in the following manner:

 

·                  Products: Orders for systems, upgrades, and our shared ownership program are reported in backlog, excluding amounts attributable to PCS (warranty period services and post warranty services), installation, training and professional services.

 

·                  Service: Orders for PCS, installation services, training and professional services are not reported in backlog.

 

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For orders that cover both products and services, only the portion of the order that is recognized as product revenue is reported as backlog. The portion of the order that is recognized as service revenue (for example, PCS) is not included in reported backlog. Additionally, orders for TomoTherapy Systems made on or before June 30, 2011, that met the historical TomoTherapy backlog criteria have been grandfathered into, and are included in, our backlog, with the exception of orders that would have “aged out” as of June 30, 2011. TomoTherapy previously did not have an “age out” criteria, so we have adjusted the TomoTherapy backlog to age out orders where 2.5 years have passed from the time the order entered TomoTherapy’s backlog. As of September 30, 2012, product only backlog was $294.3 million as compared to $270.8 million as of September 30, 2011.

 

In order for the product portion of a sales agreement to be counted as backlog, it must meet the following criteria:

 

·                  The contract is signed and properly executed by both the customer and us. A customer purchase order that is signed and incorporates the terms of our contract quote will be considered equivalent to a signed and executed contract;

 

·                  The contract is non-contingent—it either has cleared all its contingencies or contains no contingencies when signed;

 

·                  We have received a minimum deposit or a letter of credit; the sale is a direct channel sale to a government entity, or the product has shipped to a customer with credit sufficient to cover the minimum deposit;

 

·                  The specific end customer site has been identified by the customer in the written contract or written amendment; and

 

·                  Less than 2.5 years have passed since the contract met all the criteria above.

 

Although our backlog includes only contractual agreements from our customers to purchase CyberKnife Systems or TomoTherapy Systems, we cannot provide assurance that we will convert backlog into recognized revenue due to factors outside our control, which includes, without limitation, changes in customers’ needs or financial condition, changes in government or health insurance reimbursement policies, changes to regulatory requirements, or other reasons for cancellation of orders.

 

We also use book-to-bill ratios to assess the quality and growth of our backlog. The ratio is calculated for a period as new orders booked and included in backlog upon meeting criteria described above less any orders cancelled from backlog, and the resultant net orders being divided by total product revenue recognized during that period.

 

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Results of Operations

 

Three months ended September 30, 2012 compared to three months ended September 30, 2011

 

Net Revenue

 

		Three Months Ended
		September 30,									Variance in
(Dollars in thousands)		2012			2011			Variance			Percent
Products		$	40,628		$	56,174		$	(15,546	)	-28	%
Services		42,120			43,401			(1,281		)	-3	%
Other		—			876			(876		)	-100	%
Net Revenue		$	82,748		$	100,451		$	(17,703	)	-18	%

 

Total product revenues during the three months ended September 30, 2012 decreased by 28% from the three months ended September 30, 2011 primarily due to a lower number of unit sales, which was partially offset by higher revenue per unit and decreases in revenue deferrals for units sold with extended payment terms. We recognized revenues on 15 units during the three months ended September 30, 2012 as compared to 24 units during the three months ended September 30, 2011.

 

Services revenues during the three months ended September 30, 2012 decreased by $1.3 million from the three months ended September 30, 2011. Service revenues were higher in the three months ended September 30, 2011 due to inclusion of $5.1 million of service revenues arising from purchase accounting adjustments related to the TomoTherapy acquisition which was completed in June 2011. Such purchase accounting adjustments were not material during the three months ended September 30, 2012. Excluding such adjustments, service revenues increased by $3.8 million during the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 due to increases in our installed base. We expect our service revenue to increase as our installed base continues to grow.

 

Gross Profit

 

		Three Months Ended September 30,
		2012					2011
		(Dollars in			(% of net		(Dollars in			(% of net
		thousands)			revenue)		thousands)			revenue)
Gross profit		$	23,676		28.6	%	$	24,428		24.3	%
Products		16,619			40.9	%	17,801			31.7	%
Services		7,057			16.8	%	6,052			13.9	%
Other		—			0.0	%	575			65.6	%

 

Gross margins during the three months ended September 30, 2012 improved by 4.3 percentage points as compared to the three months ended September 30, 2011. Product margins were higher during the three months ended September 30, 2012 primarily due to the favorable impact of a net reduction in purchase accounting adjustments resulting from the acquisition of TomoTherapy on June 10, 2011. Service margins were higher during the three months ended September 30, 2012 primarily due to improvements in the reliability of the TomoTherapy Systems, partially offset by the unfavorable impact of a net reduction in purchase accounting adjustments resulting from the acquisition of TomoTherapy on June 10, 2011.

 

In accordance with purchase accounting standards, a number of adjustments were recorded to the value of assets and liabilities of TomoTherapy as of the closing of the acquisition on June 10, 2011. These included the write-up of inventory based on selling price rather than cost of manufacturing, the write-down of deferred product revenue, the write-up of deferred service revenue, and the recording of intangible assets related to developed technology and to backlog existing at the time of the acquisition. On the acquisition date, deferred service and product revenues were valued at cost plus a reasonable margin. Purchase accounting adjustments reduced gross profit for the three months ended September 30, 2011 by $9.2 million as follows: Product revenues were reduced by $0.5 million while product cost of revenues was increased by $11.4 million; Services revenues were increased by $5.1 million while services cost of revenues was increased by $2.4 million. Purchase accounting adjustments reduced gross profit for the three months ended September 30, 2012 by $3.6 million resulting primarily from the reduction of product revenue by $0.3 million and increases in product cost of revenues by $3.4 million. The impact of purchase accounting adjustments, other than the amortization of intangible assets assigned to developed technology, are expected to be significantly smaller during the rest of fiscal 2013 and subsequent years.

 

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Selling and Marketing

 

		Three Months Ended
		September 30,									Variance in
(Dollars in thousands)		2012			2011			Variance			Percent
Selling and marketing		$	12,889		$	13,581		$	(692	)	-5	%
Percentage of net revenue		15.6		%	13.5		%

 

Selling and marketing expenses decreased by $0.7 million during the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 primarily due to decreases in travel, tradeshow and other operational related expenses of $1.0 million due to cost control initiatives, which was partially offset by increases in compensation and facilities related expenses of $0.4 million due to increases in headcount.

 

Research and Development

 

		Three Months Ended
		September 30,									Variance in
(Dollars in thousands)		2012			2011			Variance			Percent
Research and development		$	20,209		$	20,565		$	(356	)	-2	%
Percentage of net revenue		24.4		%	20.5		%

 

Research and development expenses decreased by $0.4 million during the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 primarily due to decreases in project related consulting and travel costs of $1.2 million due to cost control initiatives, which was partially offset by increases in compensation, employee related costs and facilities related expenses of $0.7 million due to increases in headcount.

 

General and Administrative

 

		Three Months Ended
		September 30,									Variance in
(Dollars in thousands)		2012			2011			Variance			Percent
General and administrative		$	13,269		$	14,969		$	(1,700	)	-11	%
Percentage of net revenue		16.0		%	14.9		%

 

General and administrative expenses decreased by $1.7 million during the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 primarily due to lower consulting, legal and accounting related expenses of $1.5 million.

 

Impairment of indefinite lived intangible assets

 

We incurred $12.2 million of impairment charges related to the write-down of our in-process research and development (IPR&D) asset during the three months ended September 30, 2012 based on results of research and development work carried out by CPAC, a variable interest entity consolidated by us. See Note 3, “Goodwill and Intangible Assets” for details.

 

Other Income (Expense), Net

 

		Three Months Ended
		September 30,									Variance in
(Dollars in thousands)		2012			2011			Variance			Percent
Other income (expense), net		$	(747	)	$	(2,858	)	$	2,111		-74	%

 

Other income (expense), net, was $0.7 million of net other expense for the three months ended September 30, 2012, compared to net other expense of $2.9 million for the three months ended September 30, 2011. During the three months ended September 30, 2012, we incurred interest expense of $2.1 million related to our 3.75% Convertible Senior Notes due August 1, 2016 (the “Convertible Notes”). This was partially offset by gains of $0.9 million from foreign currency transactions primarily due to the appreciation of the Japanese Yen against the U.S. Dollar and recognition of a $0.7 million gain on our previously held equity interest in Morphormics, Inc., resulting from our acquisition of Morphormics on July 16, 2012. See Note 6, “Acquisition” for further details.

 

During the three months ended September 30, 2011, we incurred interest expense of $1.3 million related to our Convertible Notes which were issued on August 1, 2011, and foreign currency transaction losses of $1.5 million.

 

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