ACCURAY INC - Quarter Report: 2014 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, 2014

 

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 31, 2014, there were 77,850,462 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, 2014

 

Table of Contents

 

		Page No.
PART I.	Financial Information	3
Item 1.	Unaudited Condensed Consolidated Financial Statements:	3
	Condensed Consolidated Balance Sheets as of September 30, 2014 and June 30, 2014	3
	Condensed Consolidated Statements of Operations and Comprehensive Loss for the three months ended September 30, 2014 and 2013	4
	Condensed Consolidated Statements of Cash Flows for the three months ended September 30, 2014 and 2013	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	27
Item 3.	Defaults Upon Senior Securities	27
Item 4.	Mine Safety Disclosures	27
Item 5.	Other Information	27
Item 6.	Exhibits	28
Signatures		29

 

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PART I.                 FINANCIAL INFORMATION

 

Item 1.    Condensed Consolidated Financial Statements

 

Accuray Incorporated

Condensed Consolidated Balance Sheets

(in thousands, except share amounts and par value)

(Unaudited)

 

		September 30,			June 30,
		2014			2014 (1)
Assets
Current assets:
Cash and cash equivalents		$	107,295		$	92,346
Short-term investments		45,415			79,553
Restricted cash		1,457			1,492
Accounts receivable, net of allowance for doubtful accounts of $841 and $976 as of September 30, 2014 and June 30, 2014, respectively		52,943			72,152
Inventories		99,994			87,752
Prepaid expenses and other current assets		16,266			17,873
Deferred cost of revenue		12,417			13,302
Total current assets		335,787			364,470
Property and equipment, net		32,733			34,391
Goodwill		58,066			58,091
Intangible assets, net		21,529			23,517
Deferred cost of revenue		2,259			2,899
Other assets		9,263			11,820
Total assets		$	459,637		$	495,188
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	14,695		$	15,639
Accrued compensation		20,358			32,569
Other accrued liabilities		20,438			24,464
Customer advances		20,034			19,804
Deferred revenue		89,340			92,093
Total current liabilities		164,865			184,569
Long-term liabilities:
Long-term other liabilities		7,425			6,593
Deferred revenue		9,483			9,866
Long-term debt		197,371			195,612
Total liabilities		379,144			396,640
Commitment and contingencies (Note 5)
Stockholders’ Equity:
Preferred stock, $0.001 par value; authorized: 5,000,000 shares; no shares issued and outstanding		—			—
Common stock, $0.001 par value; authorized: 200,000,000 shares as of September 30, 2014 and June 30, 2014 respectively; issued and outstanding: 77,422,458 and 77,178,365 shares at September 30, 2014 and June 30, 2014, respectively		77			77
Additional paid-in capital		455,928			451,750
Accumulated other comprehensive income		1,232			1,815
Accumulated deficit		(376,744		)	(355,094		)
Total stockholders’ equity		80,493			98,548
Total liabilities and stockholders’ equity		$	459,637		$	495,188

 

(1) The condensed consolidated balance sheet at June 30, 2014 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,
		2014			2013
Net revenue:
Products		$	33,015		$	29,568
Services		49,366			47,073
Total net revenue		82,381			76,641
Cost of revenue:
Cost of products		20,665			18,601
Cost of services		33,915			31,562
Total cost of revenue		54,580			50,163
Gross profit		27,801			26,478
Operating expenses:
Research and development		14,149			12,950
Selling and marketing		17,974			14,454
General and administrative		10,950			11,360
Total operating expenses		43,073			38,764
Loss from operations		(15,272		)	(12,286		)
Other expense, net		(5,461		)	(2,460		)
Loss before provision for income taxes		(20,733		)	(14,746		)
Provision for income taxes		917			787
Net loss		$	(21,650	)	$	(15,533	)
Net loss per share - basic and diluted		$	(0.28	)	$	(0.21	)
Weighted average common shares used in computing loss per share
Basic and diluted		77,290			74,700
Net loss attributable to stockholders		$	(21,650	)	$	(15,533	)
Foreign currency translation adjustment		(442		)	165
Unrealized gain (loss) on investments		(141		)	290
Comprehensive loss		$	(22,233	)	$	(15,078	)

 

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,
		2014			2013
Cash Flows From Operating Activities
Net loss		$	(21,650	)	$	(15,533	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		4,978			5,448
Share-based compensation		3,273			2,180
Amortization of debt issuance costs		363			343
Amortization and accretion of discount and premium on investments		266			490
Accretion of interest on long-term debt		1,759			1,148
Recovery of bad debt, net		(127		)	(10		)
Provision for write-down of inventories		259			790
Changes in assets and liabilities:
Accounts receivable		17,726			(4,000		)
Inventories		(13,147		)	(6,821		)
Prepaid expenses and other assets		3,233			(2,084		)
Deferred cost of revenue		1,468			(405		)
Accounts payable		9			2,219
Accrued liabilities		(13,237		)	1,623
Customer advances		751			1,932
Deferred revenue		(643		)	1,426
Net cash used in operating activities		(14,719		)	(11,254		)
Cash Flows From Investing Activities
Purchases of property and equipment, net		(2,691		)	(3,206		)
Purchases of investments		(45,739		)	(5,125		)
Sales and maturities of investments		79,470			6,851
Net cash provided by (used in) investing activities		31,040			(1,480		)
Cash Flows From Financing Activities
Proceeds from employee stock plans		1,886			629
Net cash provided by financing activities		1,886			629
Effect of exchange rate changes on cash and cash equivalents		(3,258		)	1,228
Net increase (decrease) in cash and cash equivalents		14,949			(10,877		)
Cash and cash equivalents at beginning of period		92,346			73,313
Cash and cash equivalents at end of period		$	107,295		$	62,436

 

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” or “Accuray”) is incorporated in Delaware. The Company designs, develops and sells advanced radiosurgery and radiation therapy systems for the treatment of tumors throughout the body. The Company conducts its business worldwide. The Company has its headquarters in Sunnyvale, California, with additional locations worldwide.

 

Basis of Presentation and Principles of Consolidation

 

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. 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, 2014 are not necessarily indicative of the results to be expected for the year ending June 30, 2015, for any other interim period or for any future year.

 

These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and accompanying notes for the year ended June 30, 2014 included in the Company’s Annual Report on Form 10-K filed with the SEC. The Company’s significant accounting policies are described in Note 2 to those audited consolidated financial statements.

 

Recent Accounting Standard Update Not Yet Effective

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers: Topic 606 (ASU 2014-09), to supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under existing U.S. GAAP including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 is effective for the Company in its first quarter of fiscal 2018 using either of two methods: (i) retrospective to each prior reporting period presented with the option to elect certain practical expedients as defined within ASU 2014-09; or (ii) retrospective with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined per ASU 2014-09. The Company is currently evaluating the impact of pending adoption of ASU 2014-09 on its consolidated financial statements.

 

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, assessment of recoverability of goodwill and intangible assets, valuation of inventories, share-based compensation expense, income taxes, allowance for doubtful accounts, loss contingencies and corporate bonus expenses. Actual results could differ materially from those estimates.

 

Concentration of Credit and Other Risks

 

The Company’s cash, cash equivalents and investments are 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.

 

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For the three months ended September 30, 2014 and 2013, there were no customers that represented 10% or more of total net revenue. At September 30, 2014, no customers accounted for 10% or more of the Company’s total accounts receivable. At June 30, 2014, one customer accounted for 13% of 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.

 

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 and related 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, Third-Party Evidence (“TPE”), or Best Estimate of Selling Price (“BESP”), using the relative selling price method.

 

Product and Service Revenue

 

The majority of product revenue is generated from sales of CyberKnife and TomoTherapy systems. If the Company is responsible for installation, the Company recognizes revenue after installation and acceptance of the system. Otherwise, revenue is recognized upon delivery, assuming all other revenue recognition criteria are met.

 

The Company offers its systems with post-contract customer support (“PCS”) contracts, installation services, training, and professional services. PCS contracts provide planned and corrective maintenance services, software updates, bug fixes, as well as call-center support. Service revenue is generated primarily from PCS (warranty period services and post warranty services), installation services, training, parts and upgrades that are sold under service contracts, 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 parts or system upgrades where revenue recognition has been deferred. In those cases, the costs are deferred and are recognized over the period of revenue recognition.

 

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.

 

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,
		2014			2013
Numerator:
Net loss used in computing net loss per share		$	(21,650	)	$	(15,533	)
Denominator:
Weighted average shares used in computing basic and diluted net loss per share		77,290			74,700

 

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The potentially dilutive shares of the Company’s common stock resulting from the assumed exercise of outstanding stock options, the vesting of Restricted Stock Units (RSU), Market Stock Units (MSU) and Performance Stock Units (PSU), and the purchase of shares under the Employee Stock Purchase Program (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. Additionally, the 3.75% Convertible Senior Notes due August 1, 2016 (the “3.75% Convertible Notes”), the 3.50% Convertible Senior Notes due February 1, 2018 (the “3.50% Convertible Notes”) and the 3.50% Series A Convertible Notes (the “3.50% Series A Convertible Notes”) due February 1, 2018 (together, the “Convertible Notes”) are included in the calculation of diluted net income per share only if their inclusion is dilutive. For the three months ended September 30, 2014 and 2013, the potentially dilutive shares under the Convertible Notes were excluded from the calculation of diluted net loss per share as their inclusion would have been anti-dilutive. 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 of September 30,
		2014		2013
Stock options		3,032		4,436
RSUs, PSUs and MSUs		4,024		3,011
3.75% Convertible Notes		—		—
3.50% Convertible Notes		8,378		21,576
3.50% Series A Convertible Notes		3,352		—
		18,786		29,023

 

Outstanding Convertibles Notes—Diluted Share Impact

 

The 3.75% Convertible Notes and 3.50% Series A Convertible Notes have an optional physical (share), cash or combination settlement feature and contain certain conditional conversion features. Due to the optional cash settlement feature and management’s intent to settle the principal amount thereof in cash, the conversion shares underlying the outstanding principal amount of the 3.75% Convertible Notes and 3.50% Series A Convertible Notes, totaling approximately 10.6 million shares and 13.2 million shares, respectively, were not included in the potentially diluted share count table above. The Company’s average stock price did not exceed the conversion price of the 3.75% Convertible Notes as of September 30, 2014 and 2013. The 3.4 million potentially dilutive shares of the 3.50% Series A Convertible Notes included in the table above represent the premium over the principal amount due to the higher average share price. The number of premium shares included in the Company’s diluted share count will vary with fluctuations in the Company’s share price. Higher actual share prices result in a greater number of premium shares.

 

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. 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,
		2014			2013
Americas		$	38,478		$	39,253
Europe, Middle East, India and Africa		30,937			18,766
Asia (excluding Japan and India)		4,882			7,299
Japan		8,084			11,323
Total		$	82,381		$	76,641

 

Information regarding geographic areas in which the Company has long lived tangible assets is as follows (in thousands):

 

		September 30,			June 30,
		2014			2014
Americas		$	29,099		$	30,542
Europe, Middle East, India and Africa		1,417			1,665
Asia (excluding Japan and India)		423			444
Japan		1,794			1,740
Total		$	32,733		$	34,391

 

2. Balance Sheet Components

 

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 Company’s balance sheet. The Company’s financing receivables, consisting of its accounts receivable with contractual maturities of more than one year, totaled $0.7 million and $2.8 million at September 30, 2014 and June 30, 2014, respectively and are included in Other Assets in the consolidated balance sheets. There was no balance in the allowance for doubtful accounts related to such financing receivables as of September 30, 2014 and June 30, 2014, respectively, as revenue is recognized on a cash basis for these receivables.

 

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Inventories

 

Inventories consisted of the following (in thousands):

 

		September 30,			June 30,
		2014			2014
Raw materials		$	42,564		$	37,003
Work-in-process		23,755			17,692
Finished goods		33,675			33,057
Inventories		$	99,994		$	87,752

 

Property and equipment, net

 

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

 

		September 30,			June 30,
		2014			2014
Furniture and fixtures		$	5,327		$	5,351
Computer and office equipment		11,307			10,540
Software		10,817			10,736
Leasehold improvements		19,313			18,991
Machinery and equipment		46,548			45,730
Construction in progress		5,010			5,877
		98,322			97,225
Less: Accumulated depreciation		(65,589		)	(62,834		)
Property and equipment, net		$	32,733		$	34,391

 

Depreciation expense related to property and equipment for the three months ended September 30, 2014 and 2013 was $3.0 million and $3.2 million, respectively.

 

3. Goodwill and Intangible Assets

 

Goodwill

 

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

 

		Three Months			Year
		Ended			Ended
		September 30,			June 30,
		2014			2014
Balance at the beginning of the period		$	58,091		$	59,368
Currency translation and other adjustments		(25		)	(1,277		)
Balance at the end of the period		$	58,066		$	58,091

 

In the second quarter of fiscal 2014, the Company performed its annual goodwill impairment test. Based on this analysis, the Company determined that there was no impairment to goodwill. The Company will continue to monitor its recorded goodwill for indicators of impairment. In the three months ended September 30, 2014, there were no indications of impairment.

 

In connection with the acquisition of TomoTherapy in fiscal year 2011, the Company recognized liabilities related to unrecognized tax benefits as part of purchase accounting. During its first quarter of fiscal year 2014, the Company determined that certain of these liabilities related to unrecognized tax benefits were recorded in error. The Company evaluated the effects of this error on the financial statements and concluded that the error was not material to any prior annual or interim periods or the current period. In September of 2013, the Company reduced goodwill and accrued liabilities by $1.3 million to remove the liability recorded in error.

 

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Intangible Assets

 

The Company’s unamortized intangible assets associated with completed acquisitions at September 30, 2014 and June 30, 2014 are as follows (in thousands):

 

				September 30, 2014									June 30, 2014
				Gross									Gross
				Carrying			Accumulated			Net			Carrying			Accumulated			Net
		Useful Lives		Amount			Amortization			Amount			Amount			Amortization			Amount
		(in years)
Developed technology		5 - 6		$	46,747		$	(25,218	)	$	21,529		$	46,747		$	(23,230	)	$	23,517

 

The Company did not identify any triggering events that would indicate potential impairment of its definite-lived intangible and long-lived assets as of September 30, 2014 and June 30, 2014.

 

Amortization expense related to intangible assets for the three months ended September, 2014 and 2013 was $2.0 million and $2.2 million, respectively.

 

The estimated future amortization expense of purchased intangible assets as of September 30, 2014 is as follows (in thousands):

 

Year Ending June 30,		Amount
2015 (remaining 9 months)		$	5,965
2016		7,953
2017		7,568
2018		43
Thereafter		—
		$	21,529

 

4. Financial Instruments

 

The Company considers all highly liquid investments held at major banks, certificates of deposit and other securities with original maturities of three months or less to be cash equivalents.

 

The Company classifies all of its investments as available-for-sale at the time of purchase because it is management’s intent that these investments are available for current operations and includes these investments on its balance sheets as short-term investments. Investments with original maturities longer than three months include commercial papers, U.S. agency securities, non-U.S. government securities and investment-grade corporate debt securities. Investments classified as available-for-sale are recorded at fair market value with the related unrealized gains and losses included in accumulated other comprehensive income (loss), a component of stockholders’ equity. Realized gains and losses are recorded based on specific identification of each security’s cost basis.

 

The Company defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy contains three levels of inputs that may be used to measure fair value, as follows:

 

Level 1— Unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.

 

Level 2— Other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including:

 

·                  Quoted prices for similar assets or liabilities in active markets;

·                  Quoted prices for identical or similar assets in non-active markets;

·                  Inputs other than quoted prices that are observable for the asset or liability; and

·                  Inputs that are derived principally from or corroborated by other observable market data.

 

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Level 3— Unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.

 

The following tables summarize the amortized cost, gross unrealized gains, gross unrealized losses and fair value by significant investment category for cash, cash equivalents and short-term investments (in thousands):

 

		September 30, 2014
											Estimated Market Value
		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Cash and Cash Equivalents			Short-term Investments
Cash		$	93,041		$	—		$	—		$	93,041		$	—
Level 1
Money market funds		10,255			—			—			10,255			—
		10,255			—			—			10,255			—
Level 2
Commercial paper		21,320			—			(3		)	3,999			17,318
U.S. Agency securities		1,997			—			(5		)	—			1,992
Non-U.S. government securities		3,098			—			(7		)	—			3,091
Corporate notes		23,120			—			(106		)	—			23,014
		49,535			—			(121		)	3,999			45,415
Total		$	152,831		$	—		$	(121	)	$	107,295		$	45,415

 

		June 30, 2014
											Estimated Market Value
		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Cash and Cash Equivalents			Short-term Investments
Cash		$	91,797		$	—		$	—		$	91,797		$	—
Level 1
Money market funds		549			—			—			549			—
Level 2
Corporate notes		79,535			72			(54		)	—			79,553
Total		$	171,881		$	72		$	(54	)	$	92,346		$	79,553

 

The Company’s Level 2 investments in the table above are classified as Level 2 items because quoted prices in an active market are not readily accessible for those specific financial assets, or the Company may have relied on alternative pricing methods that do not rely exclusively on quoted prices to determine the fair value of the investments.

 

The Company had investments that were in an unrealized loss position as of September 30, 2014. The Company determined that (i) it does not have the intent to sell any of these investments and (ii) it is not likely that it will be required to sell any of these investments before recovery of the entire amortized cost basis. The Company reviews its investments to identify and evaluate investments that have an indication of possible impairment. As of September 30, 2014, the Company anticipates that it will recover the entire carrying value of such investments and has determined that no other-than-temporary impairments associated with credit losses were required to be recognized during the three months ended September 30, 2014.

 

Contractual maturities of available-for-sale securities at September 30, 2014 were as follows (in thousands):

 

		September 30, 2014
		Amortized Cost			Fair Value
Due in 1 year or less		$	29,062		$	29,033
Due in 1-2 years		10,307			10,259
Due in 2-3 years		6,167			6,123
		$	45,536		$	45,415

 

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The following table summarizes the carrying values and estimated fair values of our long-term debt (in thousands):

 

		September 30, 2014						June 30, 2014
		Carrying Value			Fair Value			Carrying Value			Fair Value
3.75% Convertible Notes		$	89,776		$	106,830		$	88,511		$	115,415
3.50% Convertible Notes		44,654			67,769			44,654			79,388
3.50% Series A Convertible Notes		62,941			106,761			62,447			125,065
Total		$	197,371		$	281,360		$	195,612		$	319,868

 

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.

 

5. Commitments and Contingencies

 

The Company’s contractual obligations were presented in the Annual Report on Form 10-K for the previous annual reporting period ended June 30, 2014. There have been no material changes outside of the ordinary course of business in those obligations during the three months ended September 30, 2014.

 

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 losses related to any current legal proceedings and claims. Although occasional adverse decisions or settlements may occur, except as described below, management does not believe that an adverse determination with respect to any of these claims would individually or in the aggregate materially adversely affect its financial condition or operating results. For certain legal proceedings, management believes that there is a reasonable possibility that losses may be incurred. Management currently estimates a range of loss (in excess of amounts accrued) between zero and $0.5 million in the aggregate for such legal proceedings, where it is possible to make such estimates. 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 that could have a material impact on its results of operations, financial position and cash flows.

 

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, 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 to review Rotary Systems’ amended complaint and set a calendar for discovery. The court ruled on the amended complaint, and the parties have started discovery, which was originally expected to be completed by October 2013. The parties jointly asked the court to extend discovery until February 2014. The Company filed a motion for summary judgment and, on September 11, 2013, the court held a hearing on the Company’s motion for summary judgment and to stay discovery pending the ruling on the summary judgment motion. On December 5, 2013, the court ruled in favor of the Company. Rotary Systems filed its notice of appeal on January 29, 2014. On April 14, 2014, Rotary Systems filed its appellant brief with the court. On June 2, 2014, the Company filed its response brief, and on June 27, 2014, Rotary Systems filed its reply brief with the court. The court heard oral argument on September 24, 2014. The Company anticipates that the court will issue its decision by the end of calendar year 2014.

 

Sarif Biomedical Patent Litigation

 

On January 28, 2013, Sarif Biomedical filed a patent infringement complaint against the Company in the U.S. District Court for the District of Delaware. The complaint alleges the Company’s CyberKnife System directly infringes U.S. Patent No. 5,755,725 and seeks unspecified monetary damages for the alleged infringement. Accuray filed an answer to the complaint in March 2013. The parties have exchanged initial discovery requests and responses. The court issued a scheduling order on April 29, 2014. Accuray made its first document production on May 30, 2014. Discovery closes on May 5, 2015, and trial is set for April 11, 2016.

 

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Cowealth Medical

 

On February 27, 2014, Cowealth Medical Holding Co., Ltd. (“Cowealth”), Accuray’s former distributor in China, submitted a request for arbitration with the International Chamber of Commerce International Court of Arbitration (“ICC”) alleging, among other matters, that Accuray breached its distributor agreement with Cowealth by wrongfully terminating Cowealth as its distributor and misappropriated certain of Cowealth’s confidential information. Cowealth is seeking damages and injunctive relief. Accuray’s answer and counterclaim were submitted to the ICC on May 12, 2014, and Cowealth served its reply on June 27, 2014. A hearing has been set for January 27, 2015.

 

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, 2014.

 

6. 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,
		2014			2013
Cost of revenue		$	395		$	454
Research and development		894			478
Selling and marketing		651			371
General and administrative		1,333			877
		$	3,273		$	2,180

 

7. Debt

 

 3.75% Convertible Senior Notes due August 2016

 

On August 1, 2011, the Company issued the 3.75% Convertible Notes to certain qualified institutional buyers, or QIBs. The 3.75% Convertible Notes were offered and sold to the QIBs pursuant to Rule 144A under the Securities Act of 1933, as amended, or Rule 144A. 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 3.75% 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 3.75% Convertible Notes will mature on August 1, 2016, unless earlier repurchased, redeemed or converted.

 

The 3.75% 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 3.75% Convertible Notes may convert their 3.75% 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 3.75% Convertible Notes may convert their 3.75% 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 3.75% 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 3.75% 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 3.75% Convertible Notes, the Company will have the right to pay

 

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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 3.75% 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 3.75% Convertible Notes being converted. The initial conversion rate is 105.5548 shares of the Company’s common stock per $1,000 principal amount of 3.75% 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 3.75% Convertible Notes who convert their 3.75% 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 3.75% Convertible Notes may require the Company to purchase all or a portion of their 3.75% Convertible Notes at a fundamental change repurchase price equal to 100% of the principal amount of 3.75% Convertible Notes, plus accrued and unpaid interest, if any, to, but not including, the fundamental change repurchase date.

 

Prior to the maturity date, the Company may redeem for cash all or a portion of the 3.75% 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 3.75% 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, or ASC 470-20, Debt with Conversion and Other Options, the Company separately accounts for the liability and equity conversion components of the 3.75% Convertible Notes. The principal amount of the liability component of the 3.75% 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 is being accreted to the principal amount of the 3.75% Convertible Notes using the effective interest method over five years.

 

3.50% Convertible Senior Notes due February 2018

 

In February 2013, the Company issued $115.0 million aggregate principal amount of its 3.50% Convertible Notes to certain QIBs. The 3.50% Convertible Notes were offered and sold to the QIBs pursuant to Rule 144A. The net proceeds from the offering, after deducting the initial purchaser’s discount and commission and the related offering costs, were approximately $110.5 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 3.50% Convertible Notes bear interest at a rate of 3.50% per year, payable semi-annually in arrears in cash on February 1 and August 1 of each year, which began on August 1, 2013. The 3.50% Convertible Notes will mature on February 1, 2018, unless earlier repurchased, redeemed or converted.

 

In April 2014, through a series of transactions, the Company refinanced approximately $70.3 million aggregate principal amount of the 3.50% Convertible Notes with approximately $70.3 million aggregate principal amount of the Company’s new 3.50% Series A Convertible Senior Notes due 2018 (the “3.50% Series A Convertible Notes”). The remaining balance of the 3.50% Convertible Notes was $44.7 million as of September 30, 2014.

 

The 3.50% 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 3.50% Convertible Notes may convert their 3.50% Convertible Notes at any time until the close of business on the business day immediately preceding the maturity date. The 3.50% Convertible Notes are convertible, as described below into common stock of the Company at an initial conversion rate equal to 187.6877 shares of common stock per $1,000 principal amount of the 3.50% Convertible Notes, which is equivalent to a conversion price of approximately $5.33 per share of common stock, subject to adjustment.

 

Holders of the 3.50% Convertible Notes who convert their 3.50% 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 3.50% Convertible Notes may require the Company to purchase all or a portion of their 3.50% Convertible Notes at a fundamental change repurchase price equal to 100% of the principal amount of 3.50% Convertible Notes, plus accrued and unpaid interest, if any, to, but not including, the fundamental change repurchase date.

 

In accordance with guidance in ASC 470-20, Debt with Conversion and Other Options and ASC 815-15, Embedded Derivatives, the Company determined that the embedded conversion components of the 3.50% Convertible Note do not require bifurcation and separate accounting. The remaining $44.7 million principal amount of the 3.50% Convertible Note has been recorded in Long-term Debt on the consolidated balance sheet as of September 30, 2014.

 

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3.50% Series A Convertible Senior Notes due February 2018

 

On April 17, 2014, the Company entered into note exchange agreements with certain holders (the “Participating Holders”) of the 3.50% Convertible Notes to refinance approximately $70.3 million aggregate principal amount of the 3.50% Convertible Notes with approximately $70.3 million aggregate principal amount of the 3.50% Series A Convertible Notes. Pursuant to the note exchange agreements, the Company also paid the Participating Holders an aggregate of approximately $0.4 million in cash in connection with such transactions. The principal amount of 3.50% Convertible Notes refinanced for each $1,000 principal amount of the 3.50% Series A Convertible Notes was $1,000 and the amount in cash paid per $1,000 principal amount of such 3.50% Convertible Notes delivered was determined in individual negotiations between the Company and each Participating Holder. The Series A Convertible Notes have the same interest rate, maturity and other terms as the 3.50% Convertible Notes, except that the 3.50% Series A Convertible Notes are convertible into cash, shares of the Company’s common stock or a combination of cash and shares of common stock, at the Company’s option.

 

The 3.50% Series A 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 3.50% Series A Convertible Notes may convert their Securities at any time on or after November 1, 2017 until the close of business on the business day immediately preceding the maturity date. Prior to November 1, 2017, holders of the 3.50% Series A Convertible Notes may convert their Securities only under the following circumstances: (1) during any calendar quarter after the calendar quarter ending September 30, 2014, 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 3.50% Series A Convertible Notes for each trading day of that Securities 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; or (3) upon the occurrence of specified corporate transactions as described in the Indenture. Upon conversion by holders of the 3.50% Series A 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 17th 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 3.50% Series A 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 3.50% Series A Convertible Notes being converted. The initial conversion rate is 187.6877 shares of the Company’s common stock per $1,000 principal amount of 3.50% Series A Convertible Notes (which represents an initial conversion price of approximately $5.33 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 3.50% Series A Convertible Notes who convert their 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 3.50% Series A Convertible Notes may require the Company to purchase all or a portion of their 3.50% Convertible Notes at a fundamental change repurchase price equal to 100% of the principal amount of the 3.50% Series A Convertible Notes, plus accrued and unpaid interest, if any, to, but not including, the fundamental change repurchase date.

 

In accordance with Accounting Standards Codification, or ASC 470-20, Debt with Conversion and Other Options, the Company separately accounts for the liability and equity conversion components of the 3.50% Series A Convertible Notes. The principal amount of the liability component of the 3.50% Series A Convertible Notes was $62.5 million as of the date of issuance based on the present value of its cash flows using a discount rate of 7%, 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 $7.9 million. In addition, the portion of the cash amount paid to the Participating Holders totaling $370 thousand was allocated to the debt discount with the remaining $47 thousand to equity component. The liability component is being accreted to the principal amount of the 3.50% Series A Convertible Notes using the effective interest method through the maturity in February 2018.

 

The following table presents the carrying values of all Convertible Notes as of September 30, 2014 (in thousands):

 

		3.75% Notes			3.50% Notes			3.50% Series A Notes			TOTAL
Carrying amount of the equity conversion component		$	23,189		$	—		$	7,844		$	31,033
Principal amount of the Convertible Notes		$	100,000		$	44,654		$	70,346		$	215,000
Unamortized debt discount		(10,224		)	—			(7,405		)	(17,629		)
Net carrying amount		$	89,776		$	44,654		$	62,941		$	197,371

 

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A summary of interest expense on all Convertible Notes is as follows (in thousands):

 

		Three months ended September 30,
		2014			2013
Interest expense related to contractual interest coupon		$	1,943		$	1,944
Interest expense related to amortization of debt discount		1,759			1,148
Interest expense related to amortization of debt issuance costs		363			343
		$	4,065		$	3,435

 

8. Accumulated Other Comprehensive Income

 

The components of comprehensive gain (loss) consist of net loss, unrealized gains and losses on available-for-sale investments, changes in foreign currency exchange rate translation and net changes related to defined benefit pension plan. The unrealized gains and losses on available-for-sale investments, changes in foreign currency exchange rate translation and net changes related to defined benefit pension plan are excluded from earnings and reported as a component of stockholders’ equity. The foreign currency translation adjustment results from those subsidiaries not using the United States dollar as their functional currency since the majority of their economic activities are primarily denominated in their applicable local currency. Accordingly, all assets and liabilities related to these operations are translated at the current exchange rates at the end of each period. The resulting cumulative translation adjustments are recorded directly to the accumulated other comprehensive loss account in stockholders’ equity. Revenues and expenses are translated at average exchange rates in effect during the period.

 

The components of accumulated other comprehensive income in the equity section of the balance sheets are as follows (in thousands):

 

		September 30,			June 30,
		2014			2014
Net unrealized gain (loss) on short-term investments		$	(123	)	$	18
Cumulative foreign currency translation gain		1,922			2,364
Defined benefit pension obligation		(567		)	(567		)
Accumulated other comprehensive income		$	1,232		$	1,815

 

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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, 2014 and results of operations for the three months ended September 30, 2014 and 2013 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: our future results of operations and financial position, including the sufficiency of cash resources and expected cash flows to fund future operations, including the next 12 months; our backlog and expectations regarding age-outs of contracts, the effects of our process improvements on age-outs, backlog and revenue; expected uses of cash during fiscal 2015; the anticipated drivers of our future capital requirements; the anticipated successful introduction of the MLC for the CyberKnife Systems, the timing of its release and its impact on our business; our expectations regarding the factors that will impact sales, competitive positioning and long-term success for our CyberKnife and TomoTherapy Systems; our belief that TomoTherapy Systems offer clinicians and patents significant benefits over other radiation therapy systems in the market; the anticipated risks associated with our foreign operations and fluctuations in the U.S. dollar and foreign currencies as well as our ability to mitigate such risks; and our business strategy, plans and objectives. Forward-looking statements generally can be identified by words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “may,” “will be,” “will continue,” “will likely result,” and similar expressions. 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 annual report on Form 10-K for fiscal year 2014. 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

 

Accuray Incorporated is a radiation oncology company that develops, manufactures, sells and supports precise, innovative treatment solutions. Our leading edge technologies are designed to deliver advanced radiation therapy including radiosurgery, stereotactic body radiation therapy, intensity modulated radiation therapy, image guided radiation therapy and adaptive radiation therapy tailored to the specific needs of each patient. Our suite of products includes the CyberKnife® Systems and the TomoTherapy® Systems. The systems are complementary offerings, optimized to serve separate patient populations treated by the same medical specialty, with advanced capabilities that offer increased treatment flexibility.

 

The CyberKnife Systems are robotic systems designed to deliver radiosurgery treatments to cancer tumors anywhere in the body. The CyberKnife Systems are the only dedicated, full body robotic 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

 

In October 2012, we introduced our CyberKnife M6 Series Systems that have the option of: fixed collimator, iris collimator, and/or multi-leaf collimator, or MLC. The initial supplier producing the MLC for our CyberKnife M6 Series Systems experienced low manufacturing yields and initially delivered only a small number of units. In addition, our initial life-cycle testing revealed that the MLC did not have the durability that we, and our customers, expect in our products. Subsequently, our internal testing of the MLC has been concluded to our satisfaction and we have begun our evaluation of the MLC in the field, with the goal of ensuring that we introduce a clinically effective and reliable collimator. While we are confident in our path forward, due to the complexity of the MLC, there is still some risk in this project that could cause further delays. In the meantime, and despite the delay in the launch of the MLC upgrade, we are continuing to book orders and install the CyberKnife M6 Series Systems with fixed and iris collimators.

 

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

 

·                  Adoption of the CyberKnife M6 Series Systems;

 

·                  Production and shipment of MLC that meets the standards that we, and our customers, expect in our products;

 

·                  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 CyberKnife Systems;

 

·                  Continued evolution in clinical studies demonstrating the safety, efficacy and other benefits of using 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 CyberKnife Systems;

 

·                  Improved access to radiosurgery with 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. In October 2012, we introduced TomoTherapy H Series Systems that come in configurations of TomoHTM, TomoHDTM and TomoHDATM. 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. 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 will be influenced by a number of factors including the following:

 

·                  Adoption of the TomoTherapy H Series Systems;

 

·                  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 varies significantly and could generally span 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.

 

In the United States, while we primarily market to customers, including hospitals and stand-alone treatment facilities, directly through our sales organization, and we also market to customers through a sales agent and group purchasing organizations. Outside the United States, we market to customers directly and through distributors. We have sales and service offices in many countries in Europe, Japan and other countries in Asia, South America, and throughout the world.

 

Backlog

 

We report backlog in the following manner:

 

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

 

·                  Service: Orders for PCS, upgrades acquired through the upgrade rights included in our service contracts, 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 will be recognized as product revenue is reported as backlog. The portion of the order that will be recognized as service revenue (for example, PCS) is not included in reported backlog. Product backlog totaled $364.0 million as of September 30, 2014. This included $37.6 million of orders for either CyberKnife M6 Systems configured with an MLC or orders for MLC units to upgrade existing installed CyberKnife M6 Systems. Additionally, for $29.2 million of CyberKnife orders, the customer has the option to upgrade to the new platform (M6) if the CyberKnife M6 Series is approved by regulatory authorities in its country prior to shipment. Product backlog totaled $364.7 million as of June 30, 2014.

 

In order for the product portion of a CyberKnife or TomoTherapy System 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;

 

·                  For orders in our Latin America region, we request supporting evidence that the end customer has commenced construction to place our products if the site does not already exist; and

 

·                  Less than 2.5 years have passed since the contract met all the criteria above. If more than 2.5 years have passed since the contract has met all of the requirements above, it is considered “aged-out” and the revenue associated with the contract is removed from our backlog calculation.

 

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. In addition, after 2.5 years, if we have not been able to recognize revenue on a contract, we remove the revenue associated with the contract from backlog and the order is considered aged out.  Contracts may age out for many reasons, including inability of the customer to pay, inability of the customer to adapt their facilities to accommodate our products in a timely manner, inability to timely obtain licenses necessary for customer facilities or operation of our equipment among other reasons for delays.

 

It is our expectation that we will experience a comparable level of age-outs during the second fiscal quarter of 2015 as we experienced in the first fiscal quarter of 2015. To the extent product revenues are greater than net orders during this period we will experience a decrease in backlog. We expect that age-outs beginning in the fourth fiscal quarter will return to levels comparable to the quarterly average for fiscal year 2014. As the improvements to the order process initiated by the Company 12 to 24 months ago are implemented, we anticipate that age-outs will decrease over time. However, our improvements to our order process may not have the intended effect of reducing age outs, which would have an adverse effect on our ability to recognize revenues from contracts that are included as backlog.

 

The below table is provided for comparison purposes only. Gross orders are defined as the sum of new orders recorded during the period adjusted for any revisions to existing orders during the period. Net product orders are defined as gross product orders less cancellations, age-outs and foreign exchange adjustments.

 

		Three Months Ended September 30,
		2014			2013
Gross Orders		$	58,763		$	63,398
Net Orders		32,282			60,063
Order Backlog at the end of the period		364,007			347,825

 

Gross orders decreased by $4.6 million for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013 primarily due to a decrease in orders of upgrades.

 

Net orders decreased by $27.8 million for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. Age-outs and cancellations were $20.4 million in the first quarter of fiscal 2015 in comparison to $3.3 million in the first quarter of fiscal 2014. In addition, gross orders were reduced by $6.1 million in the first quarter of fiscal 2015 due to negative foreign currency impacts. Our backlog includes amounts not denominated in U.S. Dollars and therefore fluctuations in the U.S. Dollar compared to other currencies will impact backlog. Generally, strengthening in the U.S. Dollar will negatively impact backlog. Foreign currency impact on product backlog in the three months ended September 30, 2013 was not material.

 

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Results of Operations — Three Months Ended September 30, 2014 and 2013

 

		Three months ended September 30,
		2014					2013					2014-2013
(Dollars in thousands)		Amount			% (a)		Amount			% (a)		% change
Products		$	33,015		40	%	$	29,568		39	%	12	%
Services		49,366			60		47,073			61		5
Net revenue		$	82,381		100	%	$	76,641		100	%	7	%
Gross profit		$	27,801		34	%	$	26,478		35	%	5	%
Products gross profit		12,350			37		10,967			37		13
Services gross profit		15,451			31		15,511			33		(0	)
Research and development expenses		14,149			17		12,950			17		9
Selling and marketing expenses		17,974			22		14,454			19		24
General and administrative expenses		10,950			13		11,360			15		(4	)
Other expense, net		5,461			7		2,460			3		122
Provision for income taxes		917			1		787			1		17
Net loss attributable to stockholders		$	(21,650	)	26	%	$	(15,533	)	20	%	39	%

 

(a)         Expressed as a percentage of total net revenue, except for product and services gross profits which are expressed as a percentage of related product and sevices revenue.

 

Net Revenue

 

Sales of our products outside of the Americas region account for a significant portion of our total net revenue. Revenue derived from sales outside of the Americas region was $43.9 million and $37.4 million for the three months ended September 30, 2014 and 2013, respectively, and represented 53% and 49% of our net sales during these periods.

 

Product Net Revenue. Product net revenue increased by $3.4 million for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. Product net revenue increased $2.7 million primarily due to a higher number of units sold and also a higher average selling price due to product configuration mix. The number of units recognized in revenue during the three months ended September 30, 2014 increased by 8 percent as compared to the same period in fiscal 2013. In addition, product revenue upgrades increased by $0.7 million in the three months ended September 30, 2014.

 

Services Net Revenue. Services net revenue increased by $2.3 million for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. The increase in services net revenue was primarily attributable to an increase in our installed base and customer conversion to higher priced maintenance contracts (particularly the TomoTherapy Systems).

 

Gross Profit

 

The overall gross profit and product margins for the three months ended September 30, 2014 was relatively unchanged as compared to the three months ended September 30, 2013. Services gross margin for the three months ended September 30, 2014 decreased by 2 margin points primarily due to the impact of changes in foreign exchange rates and field service personnel costs because of a 4 percent increase in headcount to further focus on service excellence and customer satisfaction.

 

Research and Development

 

Research and development expenses were $14.1 million in the three months ended September 30, 2014 as compared to $13.0 million in the three months ended September 30, 2013, which represents an increase of $1.1 million, or 9%. The increase was primarily due to an increase in stock-based compensation expense of $0.4 million from increased grants of equity awards and higher values per grant, a $0.2 million increase in vacation expense due to less vacation taken during the period, a $0.2 million increase in consulting fees primarily due to the MLC related research and development activities, and a $0.4 million increase in allocation expense due to increase in facilities related expense allocated for research and development.

 

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