ARAY - Accuray Achieves Record Product Revenue But There's Much Work Still To Be Done

Summary

• Accuray's revenue did fall year-over-year as reported, but the company beat expectations and product revenue reached a new all-time high with 8% year-over-year constant-currency growth.
• Orders grew sequentially at a double-digit rate and net orders doubled; Accuray still has work to do to reach $100M in gross quarterly orders.
• The approval of the Tomo C in China in the second half of fiscal 2024 should be a major turning point for the company, but management has to maintain momentum.
• Accuray shares continue to price in low odds of long-term success and management has to prove that they can build upon this potential turning point in product revenue/orders.

When I last wrote about Accuray (ARAY), I said that , "my pessimism and negativity here may well turn out to mark the bottom," and since then the shares are up 20% (still down 30%-plus year over year) and the company has logged a new record for quarterly product revenue. It's premature to simply extrapolate from this quarter's results, but management didn't change their guidance and hitting the low end of the revenue range requires two more quarters with around 2%-3% better revenue performance than this.

If you look in my archive , you'll see that I've been following Accuray for a very long time, and along the way I've sold some shares at the higher end of the range and re-bought at the lower end, and so it has been possible to make money here. Moreover, the company has done a good job of leveraging its technology in the Japanese and Chinese markets, and the eventual rollout of the company's Tomo C product in China could be transformative.

And yet, there's always been an element to this story where, just as everything seems to be teed up for success, Lucy yanks away the football and investors find themselves on their backs, looking at the sky and wondering what happened. I like this recent progress in the business, and the shares price in low odds of meaningful success, but investors considering this name for the first time should realize that this is a company that has had a great deal of difficulty finding and sustaining a growth trajectory.

Year-Over-Year Comps Don't Tell The True Story

It's tempting to take a quick look at Accuray's fiscal second quarter, see the 1% year-over-year revenue decline, the lack of guidance upgrade, and decline in orders and move along. I think that misses what's going on.

Revenue did indeed fall 1% yoy (it was up 4% in constant currency), but it also improved 19% sequentially and beat expectations by about 7%. More significant to me, product revenue rose about 8% yoy in constant currency and 43% qoq in reported terms, reaching a new all-time high (the previous high was $61M, set a year ago and about two and a half years ago). Service revenue was softer by comparison, flat with the year-ago period.

Cost inflation and supply chain issues are still a factor, but Accuray managed to improve gross margin by 70bp yoy and 150bp qoq to 37.4%, with product gross margin down 320bp yoy and up 300bp qoq to 38.3%. Gross margin can jump around a lot, as it's impacted by the mix of products (CyberKnife vs. Radixact) and the geography in which they sell them. Service gross margin improved more meaningfully, rising 540bp yoy and 50bp qoq to 36.8%.

While operating income was down 32% (with margin down a point to 2.4%), adjusted EBITDA improved 24%, with a 7.4% margin this quarter.

Orders Still Not Where They Need To Be

Looking at orders, gross orders declined about 7% as reported and 3% in constant currency, but did rebound 13% sequentially, and the company posted a 1.25x book-to-bill for the quarter. Net orders were up 2% yoy and more than doubled sequentially; while $41M of orders aged out of the books (installation delays due to COVID-19 have not helped), there were no cancellations.

Still, I need to see more here. The sequential momentum is encouraging, as is a resumption of Type A licensing in China, where Accuray has long enjoyed leading share (above Varian , owned by Siemens Healthineers (SMMNY), the hands-down leader in the radiation oncology equipment market). Likewise, management's report of ascending to the #2 position in Japan validates at least part of my bullish thesis on the company (namely that Accuray's systems are well-suited to the peculiarities of the Japanese healthcare/reimbursement system).

But I have long maintained, and still maintain, that Accuray needs orders to reach $100M on a sustained basis for the business model and the stock to really work. The use of hypofractination (administering radiation therapy in fewer, longer, sessions) is picking up, awareness of the strengths of Accuray's approaches has spread, and Accuray has upped its game significantly in terms of imaging, planning, and treatment execution. Add in the eventual approval of the company's China-made Tomo C product (in a JV with China Isotope & Radiation ), and I can see a path to $100M or more in orders.

Seeing the path and walking the path are two different things, and management cannot afford operational or strategic missteps. My cynicism aside, management has been making better decisions for some time, and I think COVID-19 really knocked things off stride and I'm looking for this to all come together over the next year or so.

The Outlook

I do believe that Accuray has legitimate and material opportunities to do better. Elekta (EKTAY) has had some challenges of its own, and while displacing Varian in markets like the U.S. is just not a credible goal, there are areas (like China) where Accuray can be competitive. It's possible that the new partnership with GE HealthCare ( GEHC ) could expand into something more meaningful over time, and I'd note that when Accuray announced the appointment of a new board member, they didn't exactly bury the fact that he recently sold the company he ran for a significant sum.

At this point I'm not changing my model in any meaningful way. I do feel as though management's targets for this fiscal year are more secure now, but I want to see sustained progress in product revenue and orders before making meaningful modelling changes. As is, then, I'm looking for around 5% to 6% growth over the next five years (with the China Tomo C product being an important part of that) and longer-term growth closer to 5%. I do also believe that the company can generate sustained free cash flow on $500M or more in revenue and double-digit FCF margins on around $750M in revenue.

Between discounted cash flow and growth/margin-driven EV/revenue, I continue to believe that Accuray shares are undervalued. Low-growth small-cap med-tech is a tough place, though, and I think $6 to $7 remains a reasonable upside target for the near term.

The Bottom Line

I've said before that by the time it's obvious that things are working for Accuray again, the share price will already be higher. I do think that the company has potentially turned a corner here, though, and while this is definitely not a name for risk-averse or impatient investors, if management can get its ducks all in a row, and keep them there, there may finally be some rewards for long-frustrated shareholders.

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