ARAY - Accuray Results Weren't Bad But There's Still No Growth

Summary

• Accuray's fiscal first quarter results weren't far off of expectations, and the book-to-bill was strong as the company logged more new system orders.
• While gross orders were healthy, net orders and backlog declined on age-outs, and Accuray's history of recapturing aged-out orders is not especially strong.
• Accuray's China JV has filed for approval of its Class B system, and the company has formed a collaboration with GE's GE Healthcare unit.
• Acceleration in product orders, revenue, and profits can still drive a higher share price, but it is long past time for the company to deliver on its potential.

Accuray ( ARAY ) has put another quarter in the books, and nothing has really changed for the better. There are understandable explanations (or excuses) for the ongoing underwhelming performance, including supply issues and COVID disruptions in China, but the reality is that there has always been some “short-term issue” here to explain away weak performance, but the performance has never improved on a sustained basis.

That’s a grim opening, but with the shares down another 30% since my last update , it’s hard to have a rosy outlook here. It’s not so much that I’ve turned bearish, but there’s only so many times you can talk about progress and potential in the underlying business in the absence of real underlying evidence of progress in the financials. I’ve said in the past that Accuray needs quarterly orders around $100M to really make a go of it, and the company hasn’t been there since the summer of 2021 (and has never achieved it two quarters in a row, I believe).

Is there upside here if management can execute on opportunities in China and Japan? Yes. But that upside has to be weighed against the risk/likelihood that this company continues to drift until it runs out of cash and that any future acquisition is at a fire-sale price.

Not Much To Get Excited About In FQ1

Accuray’s fiscal first quarter results weren’t anything to get excited about, though they weren’t a disaster.

Revenue fell 10% as reported and about 5% in constant currency to $96.5M, missing by around 4%. Given that the company would have met expectations absent the forex effect and that sell-side analysts aren’t always great about factoring in forex, I don’t think this is an especially meaningful miss.

Product revenue declined 16% as reported and about 11% in constant currency to $44.6M. With underlying units up almost 11%, it would seem there was a significant mix shift toward the Radixact/Tomo systems versus CyberKnife (management didn’t provide details). Service revenue rose 5% as reported and rose about 2% in constant-currency terms to $51.9M.

Gross margin declined about a point, falling from 36.8% to 35.9%. Product gross margin fell five points (from 40.3% to 35.3%), and while higher input costs and forex would explain some of that, so too would a mix shift toward fewer CyberKnife systems. Service gross margin improved about three points to 36.3%.

Adjusted EBITDA fell 65%, with a margin of 2.0% versus 5% a year ago and 10.6% the year before that.

Orders were flat as reported and up more than 6% in constant currency terms to $70M, with a book-to-bill of 1.6x. Net orders fell 52% yoy to a bit under $20M, and backlog declined 11% yoy and 5% qoq to $538M, with age-outs tied to delays in customer acceptance and installation (driven largely by COVID) driving about $51M of the weakness. While formal order cancellations remain low, I don’t see strong evidence of Accuray gaining back the age-outs of years past, so I would still regard this as a weak outcome.

Will Recent Announcements Drive A Real Inflection?

Accuray continues to roll out improvements for its systems, including the recently-introduced VitalHold breast cancer package for Radixact. Over the last several years the company has introduced numerous improvements to the underlying systems, the imaging capabilities, and the planning software, but it has yet to result in any profound change in market share or order trends.

Management did announce the filing of the Tomo C system, the first Class B system developed with its Chinese partner China Isotope & Radiation Corp (part of China National Nuclear Corporation or CNNC). Management mentioned a typical 12-month process to obtain approval, after which the companies can start taking orders and shipping product. The Class B system market in China should support 1K to 1.5K systems per year, and CIRC has relationships with around 10,000 hospitals in China, so this should be a significant opportunity, but it remains to be seen what the margin/profit contributions from this JV will ultimately be for Accuray.

There was also a recent announcement from Accuray and General Electric ’s ( GE ) GE Healthcare regarding a collaboration in precision radiation therapy. As is often the case with collaborations, the press release was vaguely-worded, and Accuray management’s commentary on the earnings call was likewise vague regarding the immediate benefits to the company. GE Healthcare is a major player in imaging and precision medicine, and it sounds as though the initial focus of this collaboration will be ensuring inoperability of GE imaging and Accuray treatment systems.

That’s fine as far as it goes, but it is definitely short of a marketing partnership where GE would more actively push Accuray’s treatment systems to its imaging customers. Such an arrangement could come in the future, and could be transformative for Accuray, but I would caution investors not to place too many expectations on this relationship at this point.

The Outlook

It’s fair to point out that Accuray’s business in China remains hamstrung by the country’s zero-COVID policy and ongoing lockdowns; revenue declined 55% this quarter, though orders rose 33%. Accuray has done well in China and China remains a major market opportunity for the company, but has yet to drive that hoped-for ramp in the financials. I’d note that Class A system revenue in China amounted to $65M of revenue in FY’22, or about 15% of reported revenue (or about 30% of product revenue), and overall revenue from China made up 20% of FY’22 revenue for Accuray (and likewise 20% in FY’21).

I’m still expecting mid-single-digit revenue growth for FY’23 (management maintained guidance with FQ1’23 earnings), and I’m also still looking for long-term revenue growth in the neighborhood of 5%. That would be modestly ahead of global radiation oncology market growth, and the company’s upside remains driven by getting more U.S. radiation centers onboard (particularly in response to system/software improvements) and delivering on the large potential of the China market.

Management is taking another crack at margin-improvement efforts (as is rival Elekta ( EKTAY )), and while I think the company can generate positive free cash flow on $500M in revenue, I think it will take $750M in revenue to get to double-digit FCF margins. Depending upon how much revenue growth comes from China, though, and how the company can leverage its JV partnership, there could be room for upside there (more operating leverage).

The Bottom Line

Accuray looks undervalued on discounted cash flow and a multiples-driven EV/revenue approach, but the reality is that valuation isn’t a driver here. The market needs to see real evidence of a credible and sustained acceleration in the base business, including orders, and execution on the opportunity in China. The stock could well move before the company reaches and holds $100M/quarter in orders, but I still believe that’s the level the company needs for sustained progress.

My pessimism and negativity here may well turn out to mark the bottom. I still see a path forward for the company (and stock), but I don’t want to ignore or downplay the reality that Accuray has continued to struggle to deliver consistent results, let alone consistent improvement, and investors attracted by the upside potential need to at least understand the risk of “more of the same” muddle-through results.

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